-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, T0iwHxPCT+NoubVcYaG+CjDdP3u3HTq4m2OU6v4mSicdVxK03GbawK4L2G46VZ10 0au/LIGcZuT3A9Mtcgp52w== 0001019056-04-001499.txt : 20041228 0001019056-04-001499.hdr.sgml : 20041228 20041228085218 ACCESSION NUMBER: 0001019056-04-001499 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 7 CONFORMED PERIOD OF REPORT: 20040930 FILED AS OF DATE: 20041228 DATE AS OF CHANGE: 20041228 FILER: COMPANY DATA: COMPANY CONFORMED NAME: VALLEY FORGE SCIENTIFIC CORP CENTRAL INDEX KEY: 0000836429 STANDARD INDUSTRIAL CLASSIFICATION: ELECTROMEDICAL & ELECTROTHERAPEUTIC APPARATUS [3845] IRS NUMBER: 232131580 STATE OF INCORPORATION: PA FISCAL YEAR END: 0930 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 001-10382 FILM NUMBER: 041227438 BUSINESS ADDRESS: STREET 1: 136 GREENTREE RD STE 100 CITY: OAKS STATE: PA ZIP: 19456 BUSINESS PHONE: 6106667500 MAIL ADDRESS: STREET 1: 136 GREEN TREE ROAD STREET 2: STE 100 CITY: OAKS STATE: PA ZIP: 19456 10-K 1 valley_10k.txt FORM 10-K SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K (Mark One) [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934. For the fiscal year ended September 30, 2004 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934. For the transition period from ____________________ to ________________ Commission File Number: 001-10382 VALLEY FORGE SCIENTIFIC CORP. (Exact name of registrant as specified in its charter) PENNSYLVANIA 23-2131580 (State or other jurisdiction of (I.R.S. employer incorporation or organization) identification no.) 136 Green Tree Road, Oaks, Pennsylvania 19456 (Address of principal executive offices and zip code) Telephone: (610) 666-7500 (Registrant's telephone number, including area code) Securities registered pursuant to Section 12(b) of the Act: Name of Each Exchange Title of Each Class on which Registered ------------------- ------------------- Common Stock, no par value Boston Stock Exchange Securities registered pursuant to Section 12(g) of the Act: None Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X] Indicate by check mark whether the Registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). Yes [ ] No [X] The aggregate market value of voting stock held by non-affiliates of the Registrant, computed by reference to the closing bid and ask prices as reported by The Nasdaq Stock Market on December 16, 2004 was $7,509,116. At December 16, 2004 there were 7,913,712 shares of the Registrant's Common Stock outstanding. DOCUMENTS INCORPORATED BY REFERENCE Certain information required by Items 10, 11, 12, 13 and 14 of Form 10-K is incorporated by reference from the Definitive Proxy Statement for the Annual Meeting of Stockholders of the Registrant, or an Amendment to this Annual Report on Form 10-K, to be filed within 120 days after the end of the fiscal year covered by this Annual Report on Form 10-K. VALLEY FORGE SCIENTIFIC CORP. FORM 10-K FOR THE FISCAL YEAR ENDED SEPTEMBER 30, 2004 TABLE OF CONTENTS PART I PAGE ---- Item 1. Business 1 Item 2. Properties 23 Item 3. Legal Proceedings 24 Item 4. Submission of Matters to a Vote of Security Holders 24 PART II Item 5. Market for Registrant's Common Equity and Related Stockholder Matters and Issuer Repurchases of Equity Securities 25 Item 6. Selected Financial Data 26 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operation 27 Item 7A. Quantitative and Qualitative Disclosures About Market Risk 35 Item 8. Financial Statements and Supplementary Data 35 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 35 Item 9A. Controls and Procedures 35 PART III Item 10. Directors and Executive Officers of the Registrant 36 Item 11. Executive Compensation 36 Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters 36 Item 13. Certain Relationships and Related Transactions 36 Item 14. Principal Accountant Fees and Services 36 PART IV Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K 37 (i) VALLEY FORGE SCIENTIFIC CORP. PART I ------ Item 1. BUSINESS - ------ -------- This report on Form 10-K contains certain forward looking statements regarding future events with respect to Valley Forge Scientific Corp. ("Valley Forge", "we", "us" and "our" refer to Valley Forge Scientific Corp., a Pennsylvania corporation, unless the context otherwise requires). Actual events or results could differ materially due to a number of factors, including, those described herein and in the documents incorporated herein by reference and those factors described under "Factors that Might Affect Future Results." Overview Valley Forge is a medical device company that develops, manufactures and sells medical devices for use in surgery and other healthcare applications. Our core business is the sale of bipolar electrosurgical generators and other bipolar generators, based on our proprietary DualWave(TM) technology, and complementary instrumentation and disposable products. Since our formation in 1980, the primary focus of our technology has been directed to the field of neurosurgery. For over 20 years, we have entered into distribution agreements with Codman & Shurtleff, Inc., a Johnson & Johnson affiliate, to market and sell our neurosurgery products. In 1999, we entered the dental market with the development of our Bident(R) Bipolar Tissue Management System. On October 25, 2004, we entered into an agreement with Stryker Corporation for the distribution and sale of a lesion generator for the percutaneous treatment of pain based on our proprietary technology. In fiscal 2005 and beyond, we plan to expand the market for our products with our new multifunctional bipolar electrosurgical generator and new proprietary single-use hand switching bipolar instruments, new products based on our proprietary lesion generator technology, and other products and product refinements. Recent Events Agreement with Codman & Shurtleff, Inc. On October 15, 2004, we entered into a new agreement with Codman & Shurtleff, Inc. ("Codman"), our principal customer, that defines our business relationship from October 1, 2004 to December 31, 2005. Under the agreement, Codman is given distribution rights to our existing products in the fields of neurocranial and neurospinal surgery as well as a limited right of first refusal until March 31, 2005 regarding the marketing of our new multifunctional electrosurgical generator and single use hand-switching bipolar instruments in the fields of neurocranial and neurospinal surgery. Under the agreement, Codman continues to be the exclusive worldwide distributor of our existing products in the fields of neurocranial and neurospinal surgery through March 31, 2005, and the nonexclusive distributor in those fields until December 31, 2005, as those terms may be extended by mutual agreement of the parties. For the period from October 1, 2004 to March 31, 2005, Codman has agreed to make minimum purchases of $1 million per calendar quarter. Supply and Distribution Agreement with Stryker Corporation. On October 25, 2004, we entered into a supply and distribution agreement with Stryker Corporation ("Stryker") for the distribution and sale of a lesion generator for 1 the percutaneous treatment of pain . The supply and distribution agreement is the culmination of over two years of collaborative efforts with Stryker. The term of the agreement is for slightly over five years, commencing on November 11, 2004 and ending on December 31, 2009, and grants Stryker exclusive worldwide marketing rights for distribution and sale of the lesion generator for use in percutaneous treatment of pain. In the first agreement year, Stryker has agreed to make minimum purchases in excess of $900,000 for a combination of sales demonstration units and commercial sales units. In the second and third agreement years, Stryker has agreed to make minimum purchases of approximately $500,000 per year for commercial sales units. Minimum purchase requirements for agreement years four and five are to be determined by the parties based on market conditions and other factors. The agreement also provides Stryker certain rights for other new product concepts developed by Valley Forge in both pain control and expanded market areas. Option Agreement to acquire Malis(R) Trademark. On October 22, 2004, we entered into an option agreement with Dr. Leonard Malis, Professor and Chairman Emeritus of Mount Sinai School of Medicine Department of Neurosurgery and one of Valley Forge's directors. Under the option agreement Valley Forge is granted an option to acquire the Malis(R) trademark, which is owned by Dr. Leonard I. Malis, at any time over a period of five years. The Malis(R) trademark is a name widely recognized and respected in the neurosurgery field. Dr. Malis has in the past licensed, and currently is licensing, the Malis(R) trademark to Codman in connection with products sold by Codman to end users, which includes products that Valley Forge sells to Codman. We paid Dr. Leonard I. Malis $35,000 for the option and are required to pay an annual fee before each anniversary of the option agreement of $20,000 for each of the first two anniversaries and increasing to $60,000 before the fourth anniversary in order to continue the option in effect from year to year. In the event that we decide to exercise the option, Dr. Malis will be paid $4,157,504, which includes interest, in twenty six equal quarterly installments of $159,904, and which will be evidenced by a promissory note secured by a security interest in the trademark and certain of our patents. Strategy Our goal is to become a global leader in the development and marketing of bipolar medical devices and other products for use in specialty surgical and healthcare fields and then expand the use of our bipolar electrosurgical products into general surgery. The key elements of our strategy include the following: Increasing Revenues in the Neurosurgery Field with Our New Multifunctional Bipolar Electrosurgical System. Our new multifunctional bipolar electrosurgical system, which includes a new state-of-the-art bipolar generator and our new proprietary single use hand-switching bipolar instruments, is designed to perform an expanded array of procedures with its enhanced features and functionality. We are completing the development of this product and are in the process of evaluating distribution channels. Expanding the Use of Our New Multifunctional Bipolar Electrosurgical System into Other Surgical Markets. The increased power and functionality of our new multifunctional bipolar electrosurgical system is designed to allow a surgeon to perform functions similar to as traditional monopolar systems, without the inherent safety issues and other limitations of monopolar systems. This new system is reported to have applications in surgical markets such as 2 spine, maxillofacial, ear, nose and throat (ENT), orthopedic and general surgery. Our current plan is to sell this system to end-users through marketing, distribution or other alliances with healthcare companies that specialize in these surgical areas. Expanding Our Product Line. We plan to introduce other products and disposable instruments we have developed or are developing for other specialized procedures. For example, we recently commenced selling to Stryker Corporation a new lesion generator for the percutaneous treatment of pain, based on our proprietary technology. We also continue to review market potential and product refinement opportunities for other applications of our lesion generator technology, including intracranial applications. Valley Forge Technology The foundation of our bipolar electrosurgical systems lies in our proprietary DualWave(TM) technology. Using our DualWave(TM) technology, our bipolar generators are able to deliver two separate waveforms to perform the two separate and distinct functions of cutting and coagulation. We do not believe that it is either safe or effective to use the same waveform for coagulation that is used for cutting. With the virtual elimination of heat and current spread, our technology can be used in direct contact with nerves, bones, blood vessels and metal implants, and can be used in virtually all areas of the human body safely. Our bipolar electrosurgical systems consist of a solid state microprocessor controlled generator, utilizing our DualWave(TM) technology, single-use disposable cords, which attach the hand-held bipolar instrument to the generator, and single-use instruments, which we are selling in the dental field and which we have developed for use in surgical fields. We also develop, manufacture and sell modules and other accessories to handle specific functions required by a particular surgical discipline. For example, in neurosurgery we sell irrigation modules, which allow the neurosurgeon to pump a saline solution into the surgical field while cutting tissue or coagulating blood vessels, and a specially designed single-use plastic tube set, which connects the electrical current from the generator and fluid from the irrigation module to the hand-held instrument. Our cutting waveform uses molecular resonance to cut, rather than heat through an advancing spark. Our generators contains a rigidly stabilized voltage control to provide an extremely gentle cut, using about one fifth the power of other generators. The cutting current, which is delivered only to the tissue between the two electrodes of the instrument, offers safety advantages by the absence of current spread and markedly reduced heating of adjacent tissues. This makes our product safe to use in virtually all areas of the human body. Our coagulation waveform is unique in that it is totally aperiodic and nonrhythmic. The timing of electrical bursts within the waveform are randomly spaced, and the waveform itself is random in timing so that it is truly aperiodic. Regardless of how high the voltage setting of the unit, or how long the surgeon applies the current, the coagulation waveform simply will not cut. Our strictly regulated constant voltage supply allows for precise, gentle and progressive coagulation in either totally dry or fully irrigated fields, including fields totally submerged in saline. These effects are produced in our generators through the lowest practical output impedance. 3 Our bipolar electrosurgical generators deliver both cutting and coagulation through bipolar handheld instruments, providing both the active electrode and the return path through the handheld instrument back to the generator. The performance of bipolar disposable handheld instruments is also enhanced by an irrigated field, further minimizing the risk of heat buildup and tissue damage. Our bipolar electrosurgical systems are designed to replace other surgical tools, such as monopolar electrosurgical systems, lasers and ultrasonic aspirators used in soft tissue surgery. Electrosurgery Surgical procedures are performed using a variety of methods and instruments, including electrosurgical generators. Electrosurgical generators perform two specific functions, tissue cutting and coagulation (sealing) of blood vessels. The application of hot cautery to seal blood vessels has been in existence for more than 5,000 years. Early cauterization techniques employed iron instruments heated in an open flame, then introduced into the wound. The electrosurgical generator was first introduced in 1924, by noted neurosurgeon, Dr. Harvey Cushing, who partnered with a Harvard University physicist, Dr. William Bovie, to design a spark gap electrosurgical generator. The generator worked by advancing a spark to tissue, to generate heat, providing cauterization. Today's electrosurgical generators have become more sophisticated, utilizing high voltage, radiofrequency or RF, currents to cut and coagulate tissue. Modern electrosurgical generator outputs are distinguished as either "monopolar" or "bipolar." Both generate high frequency electrical current in defined wave forms for surgical purposes. A single generator may deliver both monopolar and bipolar outputs from different instrument connecting points. The distinction between monopolar and bipolar refers to the manner in which the current is delivered to and removed from the patient's body. Fundamental electrical circuitry principles apply to the use of high voltage, high frequency currents for surgical applications. The current must be generated within the electrosurgical generator in an appropriate form, delivered to the patient through a delivery system consisting of cables and electrosurgical instruments, pass through some portion of the patient's body the extent of which depends upon whether the output system is monopolar or bipolar, exit the patient's body through a return path consisting of a return electrode and cables, and return to the generator to complete the circuit. Modern electrosurgical generators are "isolated," meaning they are electrically separated from common ground circuits so that the current must return to the generator, not to a random ground point, for the circuit to be completed and the generator to operate. This is a key safety factor. Monopolar Electrosurgery Systems Monopolar electrosurgical systems typically create sine wave periodic outputs for cutting and coagulation purposes. This output is delivered to the surgical site by means of an insulated, hand held electrode with a very small tip designed to concentrate the current at a specific contact point for the purpose of surgical cutting or coagulation. This is known as the "active electrode". The concentration of current at a point is necessary for a surgical effect to occur. This current must then be removed from the body and returned to the generator. This is accomplished by collecting the current at another point 4 on the patient's body distant from the surgical site, usually the thigh or buttock. The current passes through the patient's body to the return point of collection, dispersing over a large area of the body between the surgical site and the return point. The current is collected over a large surface area electrode known as a dispersive, or "return, electrode". In monopolar electrosurgery, the dispersion of current over an electrode with large area, as opposed to a point source, during the collection is used to prevent unintended burn or damage being performed at the return electrode site. Traditional monopolar electrosurgery results in generation of high temperatures at the surgical site due to the requirements of the cutting technology and the high current levels required. This may result in thermal injury to surrounding tissue, including charring, drying, and other effects that may impair healing. There are three significant safety hazards associated with monopolar electrosurgey: o Heat Build-up. Considerable heat buildup may occur in tissue surrounding the surgical site, the hazards of which vary depending upon the surgical site involved. There are no recognized methods of controlling this risk other than the surgeon's choice of power setting and his skill in use of the instrument. o Current Passes Through Human Body. The electrical current must pass through significant areas of the patient's body between the surgical site and the return electrode. It is recognized that this dispersion of electrical current in the body can cause damage to tissue, blood vessels and nerves along the path of current travel. This is controllable only by careful selection of the return electrode site and the power settings chosen by the surgeon. o Unintended Tissue Damage. Tissue damage can occur at the return electrode site, commonly called a "return electrode burn", if the return electrode is improperly placed, or not fully in contact with the body, the conductive gel on the electrode has dried out, and for many other reasons. This occurs when the surface area over which the current is collected shrinks, creating an alternate point for the concentration of current, which results in burns at the point where the current exits the human body. Modern monopolar generators employ monitoring circuitry to attempt to ensure the adequacy of the return electrode surface area. Bipolar Electrosurgical Systems Bipolar electrosurgery also employs an active electrode and a return electrode for delivery of current to the patient's body for surgical purposes and for removal of that current from the patient's body. The distinctive difference is that both the active electrode and the return electrode are contained in the same hand held instrument, eliminating the need for the current to pass through the patient's body between the surgical site and the return electrode. This is accomplished by the design of the hand held instrument to create two electrical poles (hence "bipolar") in the instrument in contact with the patient. The current can only flow between these two contact points, which are typically only millimeters apart. This, coupled with an aperiodic wave form results in a requirement for lower current levels entering the patient's body, 5 limits the heat buildup at the surgical site to eliminate the risk of surrounding tissue damage, eliminates the flow of current through non surgical areas of the patient's body, and eliminates any risk of damage at a secondary site. The Neurosurgery Market There are an estimated 3,600 Board Certified Neurological Surgeons in the United States, and an estimated 15,000 neurosurgeons worldwide. Neurological surgery is a medical specialty dealing with disorders of the brain, skull, spinal cord, cranial and spinal nerves, the autonomic nervous system and the pituitary gland. It is estimated that approximately 500,000 brain and spine surgery procedures are performed each year in the United States. A prominent use of bipolar electrosurgical instrumentation in neurosurgery is tumor removal. There are over 100 different types of brain tumors and more than 180,000 Americans are diagnosed with brain tumors each year. The most common brain tumors in adults are: glioblastoma, meningioma, and oligodendroglioma. Approximately 2,200 children are also diagnosed with a brain tumor each year, with the most common being medulloblastoma and astrocytoma. For each bipolar neurosurgical procedure, the neurosurgeon needs hand-held instruments that will cut, divide, core or remove tissue and tumors and coagulate blood vessels. The neurosurgeon also needs to connect that instrument with a cord/tubing set to the bipolar generator and irrigation unit, which provides fluids to the surgical site. In neurosurgery, a bipolar electrosurgical system is the modality of choice, largely due to the efforts of Dr. Leonard I. Malis, one of our directors. Dr. Malis, who is Professor and Chairman Emeritus of the Mount Sinai School of Medicine Department of Neurosurgery, designed and developed the first commercial bipolar coagulator in 1955, and pioneered the use of bipolar electrosurgery for use in the brain. Dr. Malis is a frequent author and lecturer on neurosurgery and bipolar electrosurgery. Our Neurosurgery Bipolar Systems. - -------------------------------- Our neurosurgery bipolar systems, which were developed in conjunction with Dr. Leonard I. Malis, are used to cut, core and divide tissue and tumors and coagulate blood vessels in the brain and spine. Our neurosurgery bipolar systems, which are currently marketed and sold by Codman & Shurtleff, Inc. to end-users under the Malis(R) tradename, a tradename owned by Dr. Leonard I. Malis, are used by neurosurgeons worldwide. Our neurosurgery bipolar systems are surgical devices intended to perform two separate functions: bipolar cutting of tissue and bipolar coagulation of blood vessels. Our systems are typically comprised of the bipolar electrosurgical generator, an irrigation module, a foot pedal control, connecting cables and tubing sets. In conjunction with our new multifunctional bipolar electrosurgical generator, we are developing an array of single use hand switching bipolar instrumentats in varying sizes and shapes that will connect to the generator via a single-use disposable bipolar cord and tubing sets. 6 Our bipolar generator delivers our DualWave(TM) bipolar cutting and bipolar coagulation through radio frequency waveforms. Our irrigation modules deliver fluids, such as saline, to the surgical field through a hand-held instrument. With the use of bipolar hand-held instruments connected to our bipolar generator, a surgeon can cut tissue and seal blood vessels in an irrigated surgical field. The surgeon can control the mode of operation with the foot pedal control and power setting with keys on the front panel of the controller. Codman markets and sells our current line of neurosurgery products under the following product names: Generators/Irrigators --------------------- - Malis(R) CMC(R)-III Bipolar Generator (High power cutting/ coagulation) - Malis(R) Bipolar Synergy(R) Generator (Low power coagulation) - Malis(R) CMC(R)-III Irrigation Module - Malis(R) 1000 Irrigation Module Disposable Cord Sets -------------------- - Malis(R) Bipolar Cord/Irrigation Tubing Set - Malis(R) Bipolar Cord Other Products -------------- - Malis(R) Titanium Surgical Mesh Our new multifunctional bipolar system, which we expect to commence selling in fiscal 2005, consists of the following components: - Multifunctional bipolar electrosurgical generator - Single use hand-switching instruments of various configurations and shapes - Disposable connecting cables and cord/tubing sets Other Surgical and Medical Markets Bipolar Electrosurgical Generators ---------------------------------- Building upon our DualWave(TM) technology used in bipolar electrosurgical generators in neurosurgery, our strategy is to expand the market for our new multifunctional bipolar electrosurgical generator and single use hand-switching bipolar instruments in other clinical and surgical markets that have a need for bipolar electrosurgery. We also continue to research market potential and product refinement opportunities for additional clinical applications of our bipolar electrosurgical generators using our DualWave(TM) technology. Potential additional fields for our multifunctional bipolar electrosurgical system include: general surgery, minimally invasive applications in various clinical fields, maxillofacial surgery, ENT, plastic surgery and general surgery. 7 Lesion Generators ----------------- On October 25, 2004, we entered into a supply and distribution agreement with Stryker Corporation for the sale to Stryker Corporation of a lesion generator for the percutaneous treatment of pain, which culminated over two years of collaborative efforts with Stryker Corporation. The agreement with Stryker currently covers the manufacture and supply of a lesion generator unit and certain accessories. The lesion generator for the percutaneous treatment of pain is designed to coagulate living human tissue for interventional pain treatment. The system provides an electrical stimulator for nerve localization and various coagulating outputs that are selectable based on the procedure undertaken. The generator is configured for bipolar output, to minimize current leakage, but is also be capable of monopolar operation. An electrode is used to deliver coagulation energy to the targeted tissue. The electrode is connected to the generator by means of a connecting cable. We are in the process of developing bipolar electrodes to be used with the generator unit. We also continue to review market potential and product refinement opportunities for other applications of our lesion generator technology, including intracranial applications. The Dental Market There are an estimated 150,000 professionally active dentists in the United States. As primary oral health care providers, approximately 80% of dentists are generalists, and approximately 20% are specialists. More than 90% of active dentists are in private practice. There are currently more than 20 different procedures with the American Dental Association, ADA, codes eligible for insurance reimbursement, for which bipolar electrosurgery can be used. Examples of commonly performed procedures include: o Gingivectomey / Gingivoplasty (surgical treatment of gingivitis), o Connective tissue graft, o Surgical removal of residual tooth roots, o Crown and bridge preparation, o Biopsy of oral tissue, o Excision of cysts or tumors, benign and malignant, and o Surgical removal of impacted or erupted tooth. Our Bident(R) Bipolar Tissue Management System - ----------------------------------------------- Our Bident(R) Bipolar Tissue Management System uses the same DualWave(TM) technology used in our neurosurgery bipolar systems to allow dentists to work in direct contact with metal implants, nerves, bone and blood vessels, essentially eliminating collateral tissue damage from current spread and heat buildup. Dentists are particularly affected by the limitations of monopolar electrosurgical systems to work safely around metal implants, bone, nerves and blood vessels due to the nature of delicate structures they work within. We believe, the elimination of the grounding pad through bipolar delivery of our 8 current to cut and coagulate in our Bident(R) Bipolar Tissue Management System is also an important factor to dentists concerned with both safety, and patient perception/fear of the equipment used in the general dentistry setting. Our Bident(R) Bipolar Tissue Management System is a surgical device, which performs two separate functions: bipolar tissue cutting and bipolar coagulation of blood vessels. The size, features and overall power output of the generator itself is different than our neurosurgery bipolar system, to meet the need for a cost effective, office style generator for the dentist. The system is comprised of the electrosurgical generator, a foot pedal control, connecting cables and an array of disposable bipolar hand-held instruments, which are attached to the generator via a single use bipolar cord. Dentists can use our disposable bipolar hand-held instruments to cut tissue and to seal blood vessels. The dentist can control the mode of operation with the foot pedal and power setting with knobs on the front panel of the generator. Our disposable bipolar hand-held instruments are available in various tip sizes, shapes and angles to perform the varying procedures performed by the dentist. We currently sell sixteen different models of disposable bipolar hand-held instruments for dental procedures. We believe that the typical use for each dental surgical procedure is one to two disposable instruments and one disposable cord set. Our current bipolar dental products, which we sell directly to dentists and through distributors consist of the following: Generator --------- - Bident(R) Bipolar Surgical Generator Bipolar Instrument and Cord Sets -------------------------------- - Bident(R) Bipolar Flap Access Pen - Bident(R) Bipolar Gingivoplasty Pen - Bident(R) Bipolar Gingivectomy Pen - Bident(R) Bipolar Gingival Troughing Pen 5 mm (.012") - Bident(R) Bipolar Gingivectomy Pen (.020") - Bident(R) Bipolar Coagulating Ball 3mm - Bident(R) Bipolar Coagulating Ball 3mm (30(Degree)) - Bident(R) Bipolar Gingivoplasty Loop 1.5x9mm - Bident(R) Bipolar Gingivoplasty Loop 1.5x9mm (30(Degree)) - Bident(R) Bipolar Gingivoplasty Loop 3x5mm - Bident(R) Bipolar Gingivoplasty Loop 3x5mm (30(Degree)) - Bident(R) Bipolar Gingivoplasty Loop 3x8mm - Bident(R) Bipolar Gingivoplasty Loop 3x8mm (30(Degree)) - Bident(R) Bipolar Gingivoplasty Loop 5x5mm - Bident(R) Bipolar Gingivoplasty Loop 5x5mm (30(Degree)) - Bident(R) Bipolar Cord Set 9 Manufacturing and Supplies We conduct the manufacturing of our bipolar generators and irrigation systems in our facility in Philadelphia, Pennsylvania. Our products are manufactured from raw materials and components supplied to us by third parties. Most of the raw material and components we use in the manufacture of our products are available from more than one supplier. For some components, however, there are relatively few alternate sources of supply and we rely upon single source suppliers or contract manufacturers. For example, we currently subcontract the manufacturing of our disposable instruments with a single contract manufacturer and we subcontract the manufacture of our disposable cord and tube sets with a single manufacturer. Our profit margins and our ability to develop and deliver such products on a timely basis may be adversely affected by the lack of alternative sources of supply in the required timeframe. Our manufacturing process is subject to the regulatory requirements of the Federal Good Manufacturing Practice Regulations as promulgated by the Federal Food and Drug Administration, commonly referred to as the FDA, as well as other regulatory requirements of the FDA, which mandate detailed quality assurance and record-keeping procedures and subjects us to unscheduled periodic regulatory inspections. We conduct quality assurance audits throughout the manufacturing process and believe that we are in compliance with all applicable government regulations. Marketing and Sales To date, with the exception of our dental products, we have sold our products to third party distributors pursuant to agreements or other alliances, who in turn sell our products to end-users. Codman & Shurtleff, Inc. For over twenty years, we have entered into distribution agreements with Codman to sell and distribute our products in the field of neurosurgery. During the 2004 fiscal year, we extended the term of a distribution agreement, which we originally entered into on December 11, 2000, until September 30, 2004. Under that distribution agreement, as extended, Codman was granted the exclusive worldwide right to sell our then existing neurosurgery products in the fields of neurocranial and neurospinal surgery on the condition that Codman & Shurtleff, Inc. make agreed upon minimum purchases. On October 15, 2004, we entered into a new agreement with Codman, that defines our business relationship with Codman from October 1, 2004 through December 31, 2005. Under this new agreement, Codman is given distribution rights to our existing neurosurgery products in the fields of neurocranial and neurospinal surgery as well as a limited right of first refusal until March 31, 2005 regarding the marketing of our new multifunctional electrosurgical generator and single use hand-switching bipolar instruments in the fields of neurocranial and neurospinal surgery. Codman continues to be the exclusive worldwide distributor of our existing products in the fields of neurocranial and neurospinal surgery through March 31, 2005, and the nonexclusive distributor in those fields until December 31, 2005, as those terms may be extended by mutual agreement of the parties. For the period from October 1, 2004 to March 31, 2005, Codman has agreed to make minimum purchases of $1 million per calendar quarter. We perform product development, manufacturing and clinical and regulatory functions for our neurosurgery bipolar systems. 10 For the 2004, 2003 and 2002 fiscal years, we had sales to Codman of approximately $4,099,000, $4,231,000 and $4,515,000, respectively. In fiscal 2004, approximately 86% of our sales were derived from sales to Codman and in fiscal 2003 and 2002 approximately 95% and 90% of our sales, respectively, were derived from sales to Codman. Codman also sells its own passive hand-held instruments under the Malis(R) tradename, which it licenses directly from Dr. Leonard I. Malis, which are used in conjunction with our neurosurgery bipolar systems, and for which we do not receive any revenues. Stryker Corporation. On October 25, 2004, we entered into a supply and distribution agreement with Stryker Corporation for the distribution and sale of a percutaneous pain control generator. The supply and distribution agreement is the culmination of over two years of collaborative effort with Stryker. The term of the agreement is for slightly over five years, commencing November 11, 2004 and ending on December 31, 2009, and grants Stryker exclusive worldwide marketing rights for distribution and sale of a lesion generator for use in percutaneous treatment of pain. In the first agreement year, Stryker has agreed to make minimum purchases in excess of $900,000 for a combination of sales demonstration units and commercial sales units. In the second and third agreement years, Stryker has agreed to make minimum purchases of approximately $500,000 per year for commercial sales units. Minimum purchase requirements for agreement years four and five are to be determined by the parties based on market conditions and other factors. The agreement also provides Stryker certain rights for other new product concepts developed by Valley Forge in both pain control and expanded market areas. Approximately 6% of our sales in fiscal 2004 were derived from sales to Stryker. Boston Scientific Corporation. In February 2002, we entered into an agreement with Boston Scientific Corporation to provide primarily product support for the installed base of Boston Scientific's "Symmetry Endo-Bipolar Generator" and the Mini-SymmetryTM generators, which we had previously manufactured for Boston Scientific Corp. Our neurosurgery bipolar systems are sold in certain foreign markets by Codman. Prior to sales in certain foreign markets, we are required to comply with applicable foreign government regulations. Our business is not affected to any material extent by seasonal factors. Competition We believe that principal competitive factors with our bipolar electrosurgical products are product features, quality, safety, ease of use, cost, acceptance by leading physicians, and other clinical benefits. We believe that our proprietary DualWave(TM) technology, which delivers both bipolar cutting and bipolar coagulation with two separate waveforms, distinguishes our bipolar electrosurgical systems from electrosurgical systems sold by other entities, which do not offer both bipolar cutting and bipolar coagulation. We believe that our unique bipolar electrosurgical products offer enhanced capabilities and safety advantages as compared to monopolar electrosurgical systems. The medical device industry is intensely competitive in almost all segments and tends to be dominated in large more mature markets by a relatively small group of large and well financed companies. We also compete with smaller, 11 entrepreneurial companies. There can be no assurance that these or other companies will not succeed in developing, or have not already developed, technologies or products that are more effective than ours or that would render our technology or products obsolete or uncompetitive. Neurosurgery - ------------ In neurosurgery, we believe that we are the principal manufacturer of bipolar electrosurgical systems. Our neurosurgery bipolar electrosurgical systems which are sold and distributed by Codman compete against manufacturers of electrosurgical systems, including the Valleylab division of Tyco International Ltd., Erbe and the Aesculap division of B. Braun. In addition, our products compete with smaller specialized companies and larger companies that do not otherwise focus on neurosurgery. Our products also compete with other technologies, such as lasers, ultrasonic aspirators, handheld instruments and a variety of tissue removal systems designed for removing brain and cranial-based tumors, such as an ultrasonic tissue aspiration system also manufactured by the Valleylab division of Tyco International Ltd. Dental Market - ------------- We believe that we are the only manufacturer of bipolar electrosurgical systems serving the dental market. Our Bident(R) Bipolar Tissue Management System competes with monopolar electrosurgical systems manufactured by Ellman, and laser and other monopolar electrosurgical systems manufactured by several other companies including Parkell. Other Markets - ------------- In other markets, our bipolar electrosurgical generators and disposable products will compete with large companies, such as the Valleylab division of Tyco International Ltd. and Conmed, which manufacture and sell electrosurgical medical devices. Our bipolar electrosurgical systems will also compete with laser systems, traditional hand-held scalpels, and other technologies. The lesion generator for the percutaneous treatment of pain competes with other pain control devices as well as pain control medications. We cannot assure you that we, or the companies with whom we contract to sell our products, can effectively convince physicians and surgeons to purchase our products in the face of competition. Research and Development Strategy Our research and development primarily focuses on developing new products based on our proprietary Dual Wave(TM) technology and our expertise in bipolar electrosurgery. We are continually working on new products and instrumentation as well as enhancements to existing products to meet the needs of surgeons in various surgical disciplines. In September 2002, we entered into a development agreement with Stryker Corporation for the development of a lesion generator for use in the percutaneous treatment of pain, which resulted in our entering into a supply and distribution agreement with Stryker Corporation for that generator on October 25, 2004. For the 2004, 2003 and 2002 fiscal years, we expended $508,287, $489,930 and $360,111, respectively, for research and development. We anticipate that we will continue to incur research and development costs in connection with 12 development of products. Substantially all of our research and development is conducted internally. In the 2005 fiscal year, we anticipate that we will fund all our research and development with current assets and cash flows from operations. From time-to-time we review our research and development programs to ensure that they remain consistent with and supportive of our growth strategies. Government Regulation The marketing and sale of our products in the United States is governed by the Federal Food, Drug and Cosmetic Act administered by the FDA, as well as varying degrees of regulation by a number of state and foreign governmental agencies. FDA regulations are wide ranging and govern the introduction of new medical devices, the observance of certain standards with respect to the design, manufacture, testing, labeling and promotion of devices, the maintenance of certain records, the ability to track devices in distribution, the reporting of potential product defects and patient incidents, the export of devices and other matters. All medical devices introduced into the market since 1976, which include substantially all of our products, are required by the FDA as a condition of sale and marketing to secure either a 510(k) Premarket Notification clearance or an approved Premarket Approval (PMA) application. A Premarket Notification clearance indicates FDA agreement with an applicant's determination that the product for which clearance has been sought is substantially equivalent to another medical device that was on the market prior to 1976 or that has received 510(k) Premarket Notification clearance. The process of obtaining a Premarket Notification clearance can take several months and commonly involves the submission of limited clinical data and supporting information, while the PMA process can take up to several years and typically requires the submission of significant quantities of clinical data and manufacturing information. Federal, state and foreign regulations regarding the manufacture and sale of medical devices are subject to future changes. We cannot predict the impact, if any, these changes might have. These changes, however, could have material impact on our business. We may not receive the necessary regulatory approvals or clearances, including approval for product improvements and new products, on a timely basis, if at all. Delays in receipt of, or failure to receive regulatory clearances or approvals could have a material adverse effect on our business. In addition, even after clearance is given, if a product is hazardous or defective, the FDA has the power to withdraw the clearance or require us to change the device, its manufacturing process or its labeling, to supply additional proof of its safety and effectiveness or to recall, repair, replace or refund the cost of a medical device. To comply with the FDA regulations, we may incur substantial costs relating to laboratory and clinical testing of new and existing products and the preparation and filing of documents in formats required by the FDA. Under FDA regulations, after a device receives 510(k) clearance, any modification that could significantly affect its safety or effectiveness, or that would constitute a major change in the intended use of the device, technology, materials, packaging, and certain manufacturing process requires a new 510(k) clearance. The FDA requires a manufacturer to make this determination in the first instance, but the FDA can review any such decision, and if it 13 disagrees it can require a manufacturer to obtain a new 510(k) clearance or it can seek enforcement action against the manufacturer. We are also required to register with the FDA as a device manufacturer and are required to maintain compliance with the FDA's Quality System Regulations, or QSRs. The QSRs incorporate the requirements of Good Manufacturing Practice and relate to product design, testing, and manufacturing quality assurance, as well as the maintenance of records and documentation. The FDA enforces the QSRs through inspections. We cannot assure you that we or our key component suppliers will not encounter any manufacturing difficulties, or that we or any of our subcontractors or key component suppliers will be able to maintain compliance with regulatory requirements. We may not promote or advertise our products for uses not within the scope of our clearances or approvals or make unsupported safety and effectiveness claims. Further, we are required to comply with various FDA requirements for labeling and promotion. The Medical Device Reporting regulations require that we provide information to the FDA whenever there is evidence to reasonably suggest that one of our devices may have caused or contributed to a death or serious injury or, if a malfunction were to recur, could cause or contribute to a death or serious injury. In addition, the FDA prohibits us from promoting a medical device before marketing clearance has been received or promoting a cleared device for unapproved indications. Noncompliance with applicable regulatory requirements can result in enforcement action, which may include: o warning letters; o fines, injunctions and civil penalties against us; o recall or seizure of our products; o operating restrictions, partial suspension or total shutdown of our production; o refusing our requests for premarket clearance or approval of new products; o withdrawing product approvals already granted; and o criminal prosecution. We have received Premarket Notification 510(k) clearance for our existing bipolar electrosurgical generators and disposable instrumentation. We have filed and also expect to file new applications during the fiscal 2005 year to cover new products and variations on existing products. We cannot assure you that we will be able to obtain necessary clearances or approvals to market any other products, or existing products for new intended uses, on a timely basis, if at all. Delays in receipt or failure to receive clearances or approvals, the loss of previously received clearances or approvals, or failure to comply with existing or future regulatory requirements could have a material adverse effect on business, financial condition, results of operations and future growth prospects. Medical device regulations also are in effect in many of the countries outside the United States in which our products are sold. These laws range from comprehensive device approval and quality system requirements for some or all of our medical device products to simpler requests for product data or certifications. The number and scope of these requirements are increasing. In June 1998, the European Union Medical Device Directive became effective, and all medical devices sold in the European common market must meet the Medical Device 14 Directive standards. For European common market distribution, we have received ISO 9001 certification for the IEC version of our neurosurgery bipolar system (marketed by Codman under the name CMC(R)-III-IEC) and that unit bears a CE mark. Failure to maintain the CE Mark will preclude our distributor from selling our products in Europe. We cannot assure you that we will be successful in maintaining certification requirements. We believe that we are in material compliance with regulations promulgated by the FDA, and that such compliance has been and is anticipated to be without adverse effect on our business. Patents and Intellectual Property Valley Forge Patents and Intellectual Property ---------------------------------------------- Our ability to compete in an effective manner depends primarily on developing, improving and maintaining proprietary aspects of our bipolar technology. There are two principal United States patents that are directed towards our DualWave(TM) bipolar technology used in our bipolar electrosurgical systems. Our first patent, which was issued on May 27, 1986, expired on May 27, 2003. Our second patent was issued on June 17, 1994. We are also in the process of seeking patent protection for certain aspects of our new multifunctional bipolar electrosurgical system. Our bipolar electrosurgical generators are based on the combination of both of these patents and other know-how and trade secrets. We also own two United States patents, which are used in our disposable hand-held bipolar instruments, and we have applied for United States patents on additional disposable instrumentation and electronic circuitry. We seek patent protection of our key technology, products and product improvements in the United States and may seek patent protection in selected foreign countries. When determined appropriate, we will enforce and defend our patent rights. In general, however, we do not rely exclusively on our patents to provide us with any significant competitive advantages as it relates to our existing product lines. We also rely upon trade secrets, know-how, and continuing technological innovations to develop and maintain our competitive advantage. In an effort to protect our trade secrets, we generally require our employees, consultants and advisors to execute proprietary information and invention assignment agreements upon commencement of employment or consulting relationships with us. These agreements typically provide that all confidential information developed or made known to the individual during the course of their relationship with us must be kept confidential, except in specified circumstances. We cannot assure you that employees or consultants will not breach the agreements, that we would have adequate remedies for any breach or that our trade secrets will not otherwise become known to or be independently developed by competitors. We cannot assure you that the patents we have obtained, or any patents that we may obtain as a result of our patent applications, will provide any competitive advantages for our products or that they will not be successfully challenged, invalidated or circumvented in the future. In addition, we cannot assure you that competitors, many of whom have substantial resources and have made substantial investments in competing technologies, will not seek to apply for and obtain patents that will prevent, limit or interfere with our ability to make, use and sell our products either in the United States or in international markets. 15 Other companies and entities have filed patent applications or have been issued patents relating to monopolar and/or bipolar electrosurgical methods and devices. We do not believe that our products currently infringe any valid and enforceable claims of others. We cannot assure you that we will not have to defend ourselves in court against allegations of infringement of third-party patents. DualWave(TM), Bident(R), Bi-Safe(TM), Gentle Gel(R) and the Finest Energy Source Available for Surgery(R) are some of the trademarks of Valley Forge. All other brand names, trademarks and service marks appearing in this report not identified as trademarks of Valley Forge are the property of their respective holders. Option Agreement to acquire Malis(R) Trademark ---------------------------------------------- On October 22, 2004, we entered into an agreement with Dr. Leonard Malis, Professor and Chairman Emeritus of Mount Sinai School of Medicine Department of Neurosurgery and one of Valley Forge's directors, under which we are granted an option to acquire the Malis(R) trademark, which is owned by Dr. Malis, at any time over a period of five years. The Malis(R) trademark is a name widely recognized and respected in the neurosurgery field. Dr. Malis has in the past licensed, and currently is licensing, the Malis(R) trademark to Codman in connection with products sold by Codman to end users, which includes products that we sell to Codman. We paid Dr. Malis $35,000 for the option and are required to pay an annual fee before each anniversary of $20,000 for each of the first two anniversaries of the option agreement and increasing to $60,000 before the fourth anniversary in order to continue the option in effect from year to year. In the event we decide to exercise the option, Dr. Malis will be paid $4,157,504, which includes interest, in twenty six equal quarterly installments of $159,904, and which will be evidenced by a promissory note secured by a security interest in the trademark and certain of our patents. Product Liability Risk and Insurance Coverage The development, manufacture, sale and use of medical products entail significant risk of product liability claims. We maintain product liability coverage at levels we have determined are reasonable. We cannot assure you that such coverage limits are adequate to protect us from any liabilities we might incur in connection with the development, manufacture, sale or use of our products. In addition, we may require increased product liability coverage as our sales increase in their current applications and new applications. Product liability insurance is expensive and in the future may not be available on acceptable terms, if at all. A successful product liability claim or series of claims brought against us in excess of our insurance coverage could have a material adverse affect on our business, prospects, financial condition and results of operations. Employees At September 30, 2004, we and our subsidiaries had 22 full-time employees, including executive officers. From time to time we retain part-time employees, engineering consultants, scientists and other consultants. All full-time employees participate in our health benefit plan. None of our employees are represented by a union or covered by a collective bargaining agreement. We consider our relationship with our employees to be satisfactory. 16 SPECIAL NOTE REGARDING FORWARD LOOKING STATEMENTS The information provided in this Annual Report on Form 10-K, including statements under "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Business" contain in addition to historic information, "forward looking" statements or statements which arguably imply or suggest certain things about our future. Statements which express that we "believe", "anticipate", "expect", or "plan to" as well as other statements which are not historical fact, are forward looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These include, but are not limited to statements about: any competitive advantage we may have as a result of our installed base of electrosurgical generators in the neurosurgery market; our belief that our products exceed industry standards or favorably compete with other companies' new technological advancements; and the future success of our new products and disposable instrumentation in the neurosurgery and other markets; our ability, along with the third parties with whom we contract, to effectively distribute and sell our products and the continued acceptance of our products in the marketplace. These statements are based on assumptions that we believe are reasonable, but a number of factors could cause our actual results to differ materially from those expressed or implied by these statements including: o general economic and business conditions; o our expectations and estimates concerning future financial performance of our products and the impact of competition; o existing and future regulations affecting our business; o other risk factors described in the sections entitled "Factors that Might Affect Future Results" in this report. We do not intend to update or revise these forward looking statements. FACTORS THAT MIGHT AFFECT FUTURE RESULTS The Medical Device Industry Is Highly Competitive, And We May Be Unable to Compete Effectively with Other Companies. In general, the medical technology industry is characterized by intense competition. We compete with established medical technology and pharmaceutical companies. Competition also comes from early stage companies that have alternative solutions for the markets we serve or intend to serve. Many of our competitors have access to greater financial, technical, research and development, marketing, manufacturing, sales, distribution services and other resources than we do. Further, our competitors may be more effective at implementing their technologies to develop commercial products. Our competitive position will depend on our ability to achieve market acceptance for our products, develop new products, implement production and marketing plans, secure regulatory approval for products under development, and protect our intellectual property. We may need to develop new applications for our products to remain competitive. Technological advances by one or more of our current or future competitors could render our present or future products obsolete or uneconomical. Our future success will depend upon our ability to 17 compete effectively against current technology as well as to respond effectively to technological advances. Competitive pressures could adversely affect our profitability. The largest competitor for our neurosurgical generator is the Valleylab division of Tyco International Ltd. In addition, our product lines could compete with smaller specialized companies or larger companies that do not otherwise focus on neurosurgery. Our dental business is small compared to its principal competitors, which sell laser devices. Our new multi-functional bipolar electrosurgical system will compete with monopolar devices manufactured by the Valleylab division of Tyco International Ltd. Finally, in certain cases our products compete primarily against medical practices that treat a condition with medications. Our Business Depends Significantly On Key Relationships With Third Parties, Which We May Be Unable To Establish And Maintain. Our current business model depends on our entering into and maintaining distribution or alliance agreements with third parties concerning product marketing and sales. Our most important agreement is with the Codman & Shurtleff, Inc., an affiliate of Johnson & Johnson, for the sale of our neurosurgery products. Sales to Codman accounted for 86% of our sales in fiscal 2004, and 95% and 90% of our sales in fiscal 2003 and 2004, respectively. On October 15, 2004, we entered into a new agreement with Codman extending an exclusive distributorship relationship until March 31, 2005 and a nonexclusive distribution relationship until December 31, 2005. Termination or nonrenewal of this relationship would require us to develop other means to distribute our neurosurgery products and could adversely affect our sales, operations and growth. Our ability to enter into agreements with third parties depends in part on convincing them that our technology can help them achieve their goals and execute their strategies. This may require substantial time, effort and expense on our part with no guarantee that a relationship will result. We may not be able to establish or maintain these relationships on commercially acceptable terms. Our future agreements may not ultimately be successful. Even if we enter into distribution or alliance agreements, the contracting parties could terminate these agreements, or these agreements could expire before meaningful milestones are reached. The termination or expiration of any of these relationships could have a material adverse effect on our business. Much of the revenue that we may receive under third party distribution or alliance agreements will depend upon our distributors' ability to successfully introduce, market and sell our products. Our success depends in part upon the performance by these distributors of their responsibilities under these agreements. Some distributors may not perform their obligations when and as we expect. Thus, revenues to be derived from distributors may vary significantly over time and be difficult to forecast. Some of the companies we currently have distribution agreements with or are targeting as potential allies offer products competitive with our products or may develop competitive production technologies or competitive products without our participation, which could have a material adverse effect on our competitive position. Our Operating Results May Fluctuate We have experienced operating losses at various times since our inception. Our operating results, including components of operating results, such as gross margin on product sales, may fluctuate from time-to-time which 18 could affect our stock price. Our operating results have fluctuated in the past and can be expected to fluctuate from time-to-time in the future. Some of the factors that may cause these fluctuations include, but are not limited to: o the introduction of new product lines; o the level of market acceptance of our products; o the timing of research and development expeditures; o timing of the receipt of orders from, and product shipments to, distributors and customers; o timing of expenditures; o changes in the distribution arrangements for our products; o manufacturing or supply delays; o the time needed to educate and train a distributor's sales force; o costs associated with product introduction; o product returns; and o receipt of necessary regulation approvals. Our Products May Not Be Accepted In The Market Or May Not Effectively Compete With Other Products Or Technologies. We cannot be certain that our current products or any other products that we may develop or market will achieve or maintain market acceptance. Certain of the medical indications that can be treated by our devices can also be treated by other medical devices or by medical practices that do not include a device. The medical community widely accepts many alternative treatments, and certain of these other treatments have a long history of use. We cannot be certain that our devices and procedures will be able to replace those established treatments or that either physicians or the medical community in general will accept and utilize our devices or any other medical products that we may develop. For example, we cannot be certain that the medical community will accept our new multifunctional electrosurgical generator and proprietary hand-switching bipolar electrosurgical instruments over traditional monopolar electrosurgical generators. In addition, our future success depends, in part, on our ability to develop additional products. Competitors may develop products that are more effective, cost less, or are ready for commercial introduction before our products. If we are unable to develop additional commercially viable products, our future prospects could be adversely affected. Market acceptance of our products depends on many factors, including our ability to convince third party distributors and customers that our technology is an attractive alternative to other technologies, to manufacture products in sufficient quantities and at acceptable costs, and to supply and service sufficient quantities of our products directly or through our distribution alliances. In addition, limited funding available for product and technology acquisitions by end users of our products, as well as internal obstacles to end user approval of purchases of our products, could harm acceptance of our products. The industry is subject to rapid and continuous change arising from, among other things, consolidation and technological improvements. One or more of these factors may vary unpredictably, which could 19 materially adversely affect our competitive position. We may not be able to adjust our plan of development to meet changing market demands. Changes In The Health Care Industry May Require Us To Decrease The Selling Price For Our Products Or Could Result In A Reduction In The Size Of The Market For Our Products, Each Of Which Could Have A Negative Impact On Our Financial Performance. Trends toward managed care, health care cost containment, and other changes in government and private sector initiatives in the United States and other countries in which we do business are placing increased emphasis on the delivery of more cost-effective medical therapies that could adversely affect the sale and/or the prices of our products. For example: o there has been a consolidation among health care facilities and purchasers of medical devices in the United States who prefer to limit the number of suppliers from whom they purchase medical products, and these entities may decide to stop purchasing our products or demand discounts on our prices; o major third-party payors of hospital services, including Medicare, Medicaid and private health care insurers, have substantially revised their payment methodologies, which has resulted in stricter standards for reimbursement of hospital charges for certain medical procedures; o Medicare, Medicaid and private health care insurer cutbacks could create downward price pressure on our products; o numerous legislative proposals have been considered that would result in major reforms in the U.S. health care system that could have an adverse effect on our business; o there is economic pressure to contain health care costs in international markets; and o there have been initiatives by third-party payors to challenge the prices charged for medical products that could affect our ability to sell products on a competitive basis. Both the pressures to reduce prices for our products in response to these trends and the decrease in the size of the market as a result of these trends could adversely affect our levels of revenues and profitability of sales. To Market Our Products under Development We Will First Need To Obtain Regulatory Approval. A Failure To Comply With Extensive Governmental Regulations Could Subject Us To Penalties And Could Preclude Us From Marketing Our Products. Our research and development activities and the manufacturing, labeling, distribution and marketing of our existing and future products are subject to regulation by numerous governmental agencies in the United States and in other countries. The Food and Drug Administration (FDA) and comparable agencies in other countries impose mandatory procedures and standards for the conduct of clinical trials and the production and marketing of products for diagnostic and human therapeutic use. Products we have under development are subject to FDA approval or clearance prior to marketing for commercial use. The process of obtaining necessary FDA approvals or clearances can take years and is expensive and full of uncertainties. Our inability to obtain required regulatory approval or clearance on a timely or acceptable basis could harm our business. Further, 20 approval or clearance may place substantial restrictions on the indications for which the product may be marketed or to whom it may be marketed. Further studies may be required to gain approval or clearance for the use of a product for clinical indications other than those for which the product was initially approved or cleared or for significant changes to the product. Furthermore, another risk of application to the FDA relates to the regulatory classification of new products or proposed new uses for existing products. In the filing of each application, we are required to make a judgment about the appropriate form and content of the application. If the FDA disagrees with our judgment in any particular case and, for example, requires us to file a PMA application rather than allowing us to market for approved uses while we seek broader approvals or requires extensive additional clinical data, the time and expense required to obtain the required approval might be significantly increased or approval might not be granted. Approved and cleared products are subject to continuing FDA requirements relating to quality control and quality assurance, maintenance of records, reporting of adverse events and product recalls, documentation, and labeling and promotion of medical devices. The FDA as well as foreign regulatory authorities require that our products be manufactured according to rigorous standards. These regulatory requirements may significantly increase our production costs and may even prevent us from making our products in amounts sufficient to meet market demand. If we change our approved manufacturing process, the FDA may need to review the process before it may be used. Failure to develop our manufacturing capability may mean that even if we develop promising new products, we may not be able to produce them profitably, as a result of delays and additional capital investment costs. In addition, failure to comply with applicable regulatory requirements could subject us to enforcement action, including product seizures, recalls, withdrawal of clearances or approvals, restrictions on or injunctions against marketing our product or products based on our technology, and civil and criminal penalties. See "Business-Government Regulation". Our Intellectual Property Rights May Not Provide Meaningful Commercial Protection For Our Products And Could Adversely Affect Our Ability To Compete In The Market. Our ability to compete effectively depends in part, on our ability to maintain the proprietary nature of our technologies and manufacturing processes, which includes the ability to obtain, protect and enforce patents on our technology and to protect our trade secrets. We own patents that cover significant aspects of our products. Certain of our patents have expired and others will expire in the future. In addition, challenges may be made to our patents and, as a result, our patents could be narrowed, invalidated or rendered unenforceable. Competitors may develop products similar to ours that our patents do not cover. In addition, our current and future patent applications may not result in the issuance of patents in the United States or foreign countries. Further, there is a substantial backlog of patent applications at the U.S. Patent and Trademark Office, and the approval or rejection of patent applications may take several years. Our Competitive Position Depends, In Part, Upon Unpatented Trade Secrets Which We May Be Unable To Protect. Our competitive position is furthermore dependent upon unpatented trade secrets. Trade secrets are difficult to protect. We cannot assure you that others will not independently develop substantially equivalent proprietary information and techniques or otherwise gain access to our trade secrets, that 21 our trade secrets will not be disclosed, or that we can effectively protect our rights to unpatented trade secrets. In an effort to protect our trade secrets, we generally require our employees, consultants and advisors to execute proprietary information and invention assignment agreements upon commencement of employment or consulting relationships with us. These agreements typically provide that, except in specified circumstances, all confidential information developed or made known to the individual during the course of their relationship with us must be kept confidential. We cannot assure you, however, that these agreements will provide meaningful protection for our trade secrets or other proprietary information in the event of the unauthorized use or disclosure of confidential information. We May Become Subject to a Patent Litigation The medical device industry has been characterized by extensive litigation regarding patents and other intellectual property rights, and companies in the medical device industry have employed intellectual property litigation to gain a competitive advantage. We cannot assure you that we will not become subject to patent infringement claims or litigation or interference proceedings declared by the United States Patent and Trademark Office to determine the priority of invention. It May Be Difficult To Replace Some Of Our Suppliers. Outside vendors, some of whom are sole-source suppliers, provide key components and raw materials used in the manufacture of our products. For example, we currently subcontract the manufacturing of our disposable cord and tubing sets with a single manufacturer. Although we believe that alternative sources for many of these components and raw materials are available, any supply interruption could harm our ability to manufacture our products until a new source of supply is identified and qualified. In addition, an uncorrected defect or supplier's variation in a component or raw material, either unknown to us or incompatible with our manufacturing process, could harm our ability to manufacture products. We may not be able to find a sufficient alternative supplier in a reasonable time period, or on commercially reasonable terms, if at all, and our ability to produce and supply our products could be impaired. If we were suddenly unable to purchase products from one or more of our suppliers, we could need a significant period of time to qualify a replacement, and the production of any affected products could be disrupted. While it is our policy to maintain sufficient inventory of components so that our production will not be significantly disrupted even if a particular component or material is not available for a period of time, we remain at risk that we will not be able to qualify new components or materials quickly enough to prevent a disruption if one or more of our suppliers ceases production of important components or materials. If Our Manufacturing Facility Was Damaged And/Or Our Manufacturing Processes Interrupted, We Could Experience Lost Revenues And Our Business Could Be Adversely Affected. We manufacture our bipolar generators and irrigators at one facility. Damage to this facility due to fire, natural disaster, power loss, communications failure, unauthorized entry or other events could cause us to 22 cease development and manufacturing of some or all of these products. Although we maintain property damage and business interruption insurance coverage on this facility, we may not be able to renew or obtain such insurance in the future on acceptable terms with adequate coverage or at reasonable costs. We May have Product Liability Claims and Our Insurance May Not Cover All Claims Our products involve a risk of product liability claims. We may not be able to obtain insurance for the potential liability on acceptable terms with adequate coverage or at reasonable costs. Any potential product liability claims could exceed the amount of our insurance coverage or may be excluded from coverage under the terms of the policy. Further, our insurance may not be renewed at a cost and level of coverage comparable to that then in effect. The Market Price of Our Stock May be Highly Volatile During the 2003 and 2004 fiscal years, our common stock has traded in a range of $1.05 and $2.40 per share. The market price of our common stock could continue to fluctuate substantially due to a variety of factors, including: o Our ability to successfully commercialize our products; o The execution of new agreements and material changes in our relationships with companies with whom we contract; o Quarterly fluctuations in results of operations; o Announcements regarding technological innovations or new commercial products by us or our competitors or the results of regulatory approval filings; o Market reaction to trends in sales, marketing and research and development and reaction to acquisitions; o Sales of common stock by existing stockholders; and o Economic and political conditions. The Loss Of Key Personnel Could Harm Our Business. We believe our success depends on the contributions of a number of our key personnel, including Jerry L. Malis, our President and Chief Executive Officer. If we lose the services of key personnel, those losses could materially harm our business. We do not maintain any significant key person life insurance on Mr. Malis. Item 2. PROPERTIES. - ------ ---------- We currently lease approximately 4,200 square feet of office and warehouse space at a base monthly rent of $4,643 (with increases based on increases in the producer price index) in an office building in Oaks, Pennsylvania, approximately 12 miles northwest of Philadelphia, Pennsylvania. The current lease term ends on June 30, 2005. Our manufacturing operations are conducted in a building owned by our wholly owned subsidiary, Diversified Electronics Company, Inc., with approximately 15,000 square feet in Philadelphia, Pennsylvania. We are in the process of negotiating a lease for a new facility, which will combine our operations into a single facility. 23 Item 3. LEGAL PROCEEDINGS. - ------ ----------------- From time to time we may be subject to litigation claims. Valley Forge is one of the defendants in a lawsuit entitled Jeffrey Turner and Cathryn Turner, on behalf of Morgan Rose Turner v. Phoenix Children's Hospital, Inc., et al. which was filed in the Superior Court of the State of Arizona, Maricopa County (No. CV2002-010791) on September 19, 2002. This lawsuit is currently in the discovery process. The plaintiffs seek damages against the defendants for permanent brain damage suffered by one of the plaintiffs, a four year old girl, during surgery in June 2000. The claim against Valley Forge is a product liability claim. We deny any wrongdoing and will vigorously defend ourself in this matter. We have a $1 million product liability insurance policy, which has a $10,000 deductible, that applies to damages and attorney fees. The damages being claimed by the plaintiffs against all defendants exceeds our then in effect policy limits and our current net worth. An outcome of the above described litigation matter that adversely impacts Valley Forge's financial condition or results of operation is not considered probable. We record a liability when a loss is known or considered probable and the amount can be reasonably estimated. If a loss is not probable a liability is not recorded. Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. - ------ --------------------------------------------------- No matters were submitted to a vote of the security holders during the fourth quarter of fiscal year 2004. ADDITIONAL INFORMATION The following information is furnished in this Part I pursuant to Item 401(b) of Regulation S-K. Executive Officers Of The Company The executive officers of Valley Forge are elected annually and serve at the discretion of the Board of Directors. The only family relationship between any of the executive officers and our Board of Directors is that Jerry L. Malis is the brother of Dr. Leonard I. Malis, a member of the Board of Directors. The following information indicates the position and age of our executive officers as of the date of this report and their previous business experience. Name Age Position with Valley Forge - ---- --- -------------------------- Jerry L. Malis 72 Chairman of the Board, Chief Executive Officer and President Marguerite Ritchie 66 Vice President-Operations, Secretary Michael Ritchie 41 Vice President-General Manager, Treasurer 24 Jerry L. Malis, has served as our Chief Executive Officer, President or Vice-President and a Director since our inception in March 1980. As of June 30, 1989, Mr. Malis was elected as our Chairman of the Board. He has published over fifty articles in the biological science, electronics and engineering fields, and has been issued twelve United States patents. Mr. Malis coordinates and supervises the development, engineering and manufacturing of our products and is in charge of our daily business operations. He devotes substantially all his business time to the business of the Valley Forge. Marguerite Ritchie, Secretary of Valley Forge, has been employed by us since 1985. In addition to being Secretary, Ms. Ritchie is Vice-President of Operations in charge of our production and regulatory matters. Prior to becoming Vice-President of Operations, she held several other administrative and operations positions with Valley Forge. Michael Ritchie, Treasurer of Valley Forge, has been employed by us since 1994. In addition to being the Treasurer of the Company, Mr. Ritchie is Vice-President-General Manager responsible for financial reporting and contract administration. Mr. Ritchie has also held positions of General Manager and Purchasing Manager. He received a B.S. degree in accounting from LaSalle University and a B.S. degree in engineering from Drexel University. PART II ------- Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY - ------ ------------------------------------- AND RELATED STOCKHOLDER MATTERS. ------------------------------- Our Common Stock, no par value, is quoted on the Boston Stock Exchange under the symbol VLF, and traded in the over-the-counter market, and is included in the Nasdaq - Small Cap Issues under the symbol "VLFG." The table below sets forth the range of high and low closing bid quotations per share of Common Stock as reported on Nasdaq. Quotations represent prices between dealers and do not necessarily represent actual transactions. None of the prices shown reflect retail mark-ups, mark-downs, or commissions. COMMON STOCK High-Bid Low-Bid -------- ------- Fiscal 2003 First Quarter............. $1.88 $1.23 Second Quarter............ 1.54 1.05 Third Quarter............. 1.57 1.10 Fourth Quarter............ 1.75 1.15 Fiscal 2004: First Quarter............. $2.40 $1.31 Second Quarter............ 2.16 1.50 Third Quarter............. 2.20 1.84 Fourth Quarter............ 2.03 1.43 For purposes of calculating the aggregate market value of shares of voting stock of Valley Forge held by non-affiliates, as shown on the cover page of this report, we have assumed that all outstanding shares not held by our directors and executive officers and stockholders owning 5% or more of 25 outstanding shares were held by non-affiliates. However, this should not be deemed to constitute an admission that any such person are, in fact, affiliates of Valley Forge. Further information concerning ownership of Valley Forge's voting stock by executive officers, directors and principal stockholders will be included in our definitive proxy statement to be filed with the Securities and Exchange Commission. The number of stockholders of record as of December 16, 2004 was approximately 105, which includes stockholders whose shares were held in nominee name. The number of beneficial stockholders at that date is estimated to be in excess of 1,100. We have not paid any dividends to date, nor do we expect to do so in the foreseeable future. Item 6. SELECTED FINANCIAL DATA - ------ ----------------------- The selected financial data set forth below should be read in conjunction with the "Management's Discussion and Analysis of Financial Condition and Results of Operations" and our consolidated financial statements and notes thereto appearing elsewhere in this Form 10-K. The statement of operations data for the year ended September 30, 2004, 2003 and 2002 and the balance sheet data as of September 30, 2004 and 2003 have been derived from audited consolidated financial statements included elsewhere in this report. The consolidated statement of operations for the years ended September 30, 2001 and 2000 and the balance sheet data as of September 30, 2002, 2001 and 2000 have been derived from audited consolidated financial statements that are not included in this report. The historical results are not necessarily indicative of the results of operations to be expected in the future.
Statement of Operations Data: For Fiscal Year Ended: 2004 2003 2002 2001 2000 ---------------------- ------------ ------------ ------------ ------------ ------------ Net Sales $ 4,756,439 $ 4,474,308 $ 5,021,931 $ 5,263,485 $ 4,397,939 Income (loss) from Operations 178,054 155,427 632,000 485,746 (110,817) Net Income (loss) $ 111,420 $ 108,925 $ 380,527 $ 330,221 $ (54,312) ============ ============ ============ ============ ============ Basic Earnings (loss) per share $ 0.01 $ 0.01 $ 0.05 $ 0.04 $ (0.01) ============ ============ ============ ============ ============ Diluted Earnings (loss)per $ 0.01 $ 0.01 $ 0.05 $ 0.04 $ (0.01) share ============ ============ ============ ============ ============ Balance Sheet Data: At September 30, 2004 2003 2002 2001 2000 ---------------- ------------ ------------ ------------ ------------ ------------ Current Assets $ 3,976,550 $ 3,777,456 $ 3,981,746 $ 3,516,992 $ 3,093,698 Total Assets 4,523,238 4,374,413 4,570,035 4,171,214 3,852,079 Current Liabilities 258,069 216,457 353,281 283,186 182,185 Long Term Liabilities 15,743 19,950 14,357 19,280 20,661 Retained Earnings (deficit) 720,896 609,476 500,551 120,024 (210,197) Stockholders' Equity 4,249,426 4,138,006 4,202,397 3,868,746 3,649,233
26 Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION - ------ ----------------------------------------------------------- AND RESULTS OF OPERATIONS - ------------------------- The following is a discussion and analysis of Valley Forge Scientific Corp.'s financial condition and results of operations for the fiscal years ended September 30, 2004, 2003 and 2002. This section should be read in conjunction with the financial statements and related notes thereto appearing elsewhere in this Form 10-K. This discussion and analysis contains forward-looking statements that involve risks, uncertainties and assumptions. Our actual results may differ materially from those anticipated in these forward looking statements as a result of many factors including but not limited to those under the headings "Special Note Regarding Forward Looking Statements" and "Factors That Might Affect Future Results" in Item 1 of this Report. Overview Valley Forge is a medical device company that develops, manufactures and sells medical devices for use in surgery and other healthcare applications. Our core business involves the sale of bipolar electrosurgical generators and other bipolar generators, based on our DualWave(TM) technology, and complementary instrumentation and disposable products. Our current line of bipolar electrosurgical products are used in neurosurgery and spine surgery and in dental applications. We also recently commenced selling a lesion generator for the percutaneous treatment of pain. In fiscal 2005 and beyond, we plan to expand the market for our products with our new multifunctional bipolar electrosurgical generator and new proprietary single-use hand-switching bipolar instruments, new products based on our proprietary lesion generator technology, and other products and product refinements. Our new multifunctional bipolar electrosurgical system, which is expected to be introduced in the market in fiscal 2005, is designed to replace other surgical tools, such as monopolar electrosurgical systems, lasers and ultrasonic aspirators. We believe our DualWave(TM) technology distinguishes our products from our competitors. With appropriate technique, our bipolar electrosurgical systems based on our DualWave(TM) technology allow a surgeon or dentist to cut tissue in a manner that minimizes collateral damage to surrounding healthy tissue and to coagulate blood vessels quickly, safely and efficiently. By substantially reducing damage to surrounding healthy tissue, the surgeon or dentist can work safely in close proximity with nerves, blood vessels and bone. Our bipolar electrosurgical systems can also be used in close proximity with metal implants and irrigated fields. For over 20 years, we have had worldwide exclusive distribution agreements with Codman & Shurtleff, Inc., a subsidiary of Johnson & Johnson, Inc., ("Codman") to market our neurosurgery bipolar electrosurgical systems and other products. During 2004 fiscal year, we extended the term of a distribution agreement, which we originally entered into with Codman on December 11, 2000, until September 30, 2004. On October 15, 2004, we entered into a new agreement with Codman defining our business relationship from October 1, 2004 through December 31, 2005. Under the agreement, Codman continues to be the exclusive worldwide distributor of our existing products in the fields of neuorcranial and neurospinal surgery through March 31, 2005 and the nonexclusive distributor in those fields until December 31, 2005, as those terms may be extened by mutual 27 agreement of the parties. Under the agreement, Codman is also given a limited right of first refusal until March 31, 2005 regarding the marketing of our new multifunctional electrosurgical generator and single use hand switching bipolar instruments in the fields of neurospinal and neurocranial surgery. Historically, we have derived a significant portion of our sales from sales to Codman. For the 2004 fiscal year, 86% of our revenue was derived from sales to Codman. Our goal is to be the global leader in the development of bipolar medical devices and other products in specialty surgical and healthcare fields and then expand the use of our bipolar electrosurgical products into general surgery. The key elements of our strategy include: o Expanding the use of our new multifunctional bipolar electrosurgical system into other surgical markets, such as spine maxillofacial, ENT, orthopedic and general surgeries. o Increasing revenues in the neurosurgery field with our new multifunctional bipolar electrosurgical system. o Expanding our product lines with new products, including a new lesion generator for the percutaneous treatment of pain and other applications of our bipolar lesion technology. Results of Operations Summary Sales of $4,756,439, for fiscal 2004 were 6% greater than sales of $4,474,308 for fiscal 2003 and 5% less than sales of $5,021,931 for fiscal 2002. Operating income was $178,054 in fiscal 2004 as compared to $155,427 in fiscal 2003 and $632,000 in fiscal 2002. Net income for fiscal 2004 was $111,420 as compared to $108,925 for fiscal 2003 and $380,527 for fiscal 2002. Sales Total Sales and Gross Margin on Sales:
2004 2003 2002 ---------- ---------- ---------- Total sales: $4,756,439 $4,474,308 $5,021,931 Cost of sales: 2,316,304 2,264,902 2,463,209 Gross profit on sales: 2,440,135 2,209,406 2,558,722 Gross profit as a percentage of sales: 51% 49% 51%
The increase in sales in fiscal 2004 as compared to fiscal 2003 reflects an increase in sales of our Bident(R) Bipolar Tissue Management System for dental applications and new sales to Stryker Corporation of a lesion generator we developed for the percutaneous treatment of pain, which was partially offset by a decrease in sales to Codman & Shurtleff, Inc. The decrease in sales in fiscal 2004 compared to fiscal 2002 reflects a decrease in sales to Codman. Sales of our neurosurgical products to Codman & Shurtleff, Inc. decreased to $4,099,000 in fiscal 2004 as compared to sales of $4,231,000 in fiscal 2003 and sales of $4,515,000 in fiscal 2002. The decreased sales reflect a decrease in sales volume of neurosurgical products. Included in sales to 28 Codman for fiscal 2004 is a one-time payment of $57,920 in the second quarter of fiscal 2004 that Codman made to satisfy its minimum purchase obligation under the first three month extension of the term of the then existing distribution agreement. During fiscal 2004, we extended a distribution agreement with Codman on a quarterly basis until September 30, 2004. On October 15, 2004, we entered into a new agreement with Codman which defines our business relationship from October 1, 2004 to December 31, 2005. Under the new agreement, Codman continues to be the exclusive worldwide distributor of our existing products in the fields of neurocranial and neurospinal surgery through March 31, 2005, and the nonexclusive distributor in those fields until December 31, 2005, as those terms may be extended by mutual agreement of the parties. For the period from October 1, 2004 to March 31, 2005, Codman has agreed to make minimum purchases of $1 million per calendar quarter. For fiscal 2004, sales of the Bident(R) Bipolar Tissue Management System for dental applications were $422,000, or 9% of sales as compared to approximately $185,000, or 4% of sales, for fiscal 2003 and approximately $347,000, or 7% of our sales, for fiscal 2002. Sales of the Bident(R) Tissue Management System of $35,250 in the fourth quarter of 2004 decreased as compared to the sales in the third quarter of fiscal 2004 as we directed more of our resources towards the completion of a new lesion generator for the percutaneous treatment of pain and our distribution arrangement with Stryker Corporation for that product. For fiscal 2005, we are considering product modifications and other strategies for our dental products. During fiscal 2004, we had sales to Stryker of $189,160, which includes sales of demonstration units of a lesion generator for percutaneous treatment of pain. On October 25, 2004, we entered into a supply and distribution agreement with Stryker Corporation for that generator. The supply and distribution agreement is for a term commencing on November 11, 2004 and ending on December 31, 2009, under which Stryker has agreed to make minimum purchases of approximately $900,000 in the first agreement year for a combination of sales demonstration units and commercial sale units and minimum purchases of approximately $500,000 per year for commercial sale units in the each of the second and third agreement years. Minimum purchase requirements for agreement years four and five are to be determined by the parties based on market conditions and other factors. The agreement also provides Stryker certain rights for other new product concepts developed by Valley Forge in both pain control and expanded market areas. Sales by Medical Field: The table below sets forth our sales by medical field of "Generators, Irrigators and Other Products" and "Disposable Products" for fiscal 2004, 2003 and 2002. Sales of "Generators, Irrigators and Other Products" in "Other fields" represent sales to Stryker Corporation and sales of "Disposable Products" in "Other fields" represent sales to Boston Scientific Corporation and direct sales to hospitals. 29
---------------------------------------------------------------------------------------------- 2004 2003 2002 ------------ ------------ ------------ ---------------------------------------------------------------------------------------------- Generators, Irrigators ---------------------- and Other Products ------------------ ---------------------------------------------------------------------------------------------- Neurosurgery field $ 2,115,536 $ 2,092,830 $ 2,627,233 ---------------------------------------------------------------------------------------------- Dental field $ 366,795 $ 168,338 $ 347,000 ---------------------------------------------------------------------------------------------- Other fields $ 187,750 -- -- ------------ ------------ ------------ ---------------------------------------------------------------------------------------------- Total of all fields: $ 2,670,081 $ 2,261,168 $ 2,974,233 ---------------------------------------------------------------------------------------------- Disposable Products ------------------- ---------------------------------------------------------------------------------------------- Neurosurgery field $ 1,754,276 $ 1,894,743 $ 1,584,230 ---------------------------------------------------------------------------------------------- Dental field $ 68,810 $ 16,160 ---------------------------------------------------------------------------------------------- Other fields $ 31,929 $ 23,505 $ 31,850 ------------ ------------ ------------ ---------------------------------------------------------------------------------------------- Total of all fields: $ 1,855,015 $ 1,934,408 $ 1,616,000 ----------------------------------------------------------------------------------------------
In fiscal 2004, 56% of our sales related to sales of bipolar electrosurgical generators, irrigators and accessories as compared to approximately 51% and 59% of our sales in fiscal 2003 and 2002, respectively. Sales of disposable products accounted for approximately 39% of our sales in fiscal 2004 as compared to approximately 43% of our sales in fiscal 2003 and approximately 32% of our sales in fiscal 2002. Cost of Sales Cost of sales for fiscal 2004 was 49% of sales, compared with 51% of sales, for fiscal 2003. During fiscal 2002, cost of sales was 49% of sales. Gross margin was 51% for fiscal 2004 as compared to 49% for fiscal 2003 and 51% for fiscal 2002. The increase in gross margin as a percentage of sales in fiscal 2004 as compared to fiscal 2003 is primarily attributable to increased sales volume. We cannot be sure that gross margins will remain at current levels or show improvement in the future due to the distribution channels used, product mix, and fluctuation in manufacturing production levels and overhead costs as new products are introduced. In addition, inefficiencies in manufacturing new products and the distribution channels utilized to sell those products may adversely impact gross margin. Operating Expenses Selling, general and administrative expenses increased to $1,713,325, or 36% of sales, in fiscal 2004, from $1,523,751, or 34% of sales, in fiscal 2003, and from $1,503,001, or 30% of sales, in fiscal 2002. Selling, general and administrative expenses reflect increased selling and marketing expenses incurred in connection with implementing the sales and marketing plan, which we commenced in fiscal 2003, for the Bident(R) Bipolar Tissue Management System and increased transactional legal fees incurred during the fourth quarter of fiscal 2004. Research and development expenses were $508,287, or 11% of sales, in fiscal 2004, $489,930, or 11% of sales, in fiscal 2003, and $360,111, or 7% of sales, in fiscal 2002. We will continue to invest in research and development to expand our technological base for use in both existing and additional clinical areas. The increase in research and development expenses in fiscal 2004 was primarily related to the continued development of our new multifunction bipolar electrosurgical generator and instrumentation and the completion of the lesion 30 generator for use in the percutaneous treatment of pain for which we entered into a supply and distribution agreement with Stryker Corporation on October 25, 2004. Other Income and Expense, net Other income and expense, net, increased for fiscal 2004 to $23,030 from $11,451 for fiscal 2003 and decreased from $23,111 for fiscal 2002 due primarily to interest income. At the end of fiscal 2004, we had $2,322,559 in cash and cash equivalents as compared to $2,305,556 at the end of fiscal 2003 and $2,543,898 at the end of fiscal 2002. Income Tax Provision The provision for income taxes was $89,664 for fiscal 2004 as compared to $57,953 for fiscal 2003 and $274,584 for fiscal 2002. Our effective tax rate in fiscal 2004 was approximately 45% as compared to approximately 35% in fiscal 2003 and approximately 42% in fiscal 2002. Net Income Net income increased slightly to $111,420 for fiscal 2004, as compared to net income of $108,925 for fiscal 2003. Net income was $380,527 for fiscal 2002. Basic and diluted income per share was $0.01 for fiscal 2004 as compared to basic and diluted income per share of $0.01 for fiscal 2003 and $0.05 for fiscal 2002. Liquidity and Capital Resources At September 30, 2004, we had $3,718,481 in working capital compared to $3,560,999 at the end of fiscal 2003 and $3,628,465 at the end of fiscal 2002. The primary measures of our liquidity are cash, cash equivalents, accounts receivable and inventory balances, as well as our borrowing ability. The cash equivalents are highly liquid with original maturities of ninety days or less. Cash provided by operating activities was $33,577 for fiscal 2004 as compared to $9,009 used in fiscal 2003. The cash provided by operating activities was mainly attributable to operating profits net of adjustments for non-cash items, a decrease in prepaid items and other current assets of $117,773 and an increase in accounts payable, accrued expenses and income taxes payable of $35,862 offset by increases of $282,918 in accounts receivable, $76,807 in inventory and $28,321 in deferred tax assets. In fiscal 2004, accounts receivable net of allowances increased by $282,918 to a total of $646,224 at the end of fiscal 2004. The increase in accounts receivable was principally due to the timing of shipments and increased sales during fiscal 2004. In fiscal 2004, inventories increased by $76,807 to a total of $781,604 at the end of fiscal 2004 compared to $775,183 at the end of fiscal 2003. The increase was primarily due to increased inventory to meet anticipated sales of the lesion generator for the percutaneous treatment of pain. Inventories were kept at these levels primarily to support anticipated future sales activity. 31 In fiscal 2004, we used $20,887 for the purchase of equipment and building improvements in connection with our manufacturing operations. Net property and equipment decreased to $147,967 at the end of fiscal 2004 as compared to $156,697 for fiscal 2003 and $136,131 for fiscal 2002. In August 2002, our Board of Directors terminated our then existing stock repurchase plan and authorized a new repurchase plan to purchase up to 200,000 shares of our common stock. We did not purchase any of our stock in fiscal 2004 pursuant to this plan. In fiscal 2003, we used $173,216 to repurchase 127,600 shares of our common stock pursuant to the stock repurchase plan. All the shares of common stock repurchased were retired. To date, we have repurchased 154,100 shares of our common stock under the plan, leaving a balance of 45,900 that is available for repurchase under the plan. On October 22, 2004, we entered into an option agreement to purchase the Malis(R) trademark from Leonard I. Malis. Under the option agreement, we are granted an option to acquire the Malis(R) trademark at any time over a period of five years. We paid Dr. Leonard I. Malis $35,000 for the option and are required to pay an annual fee before each anniversary of the option agreement of $20,000 for each of the first two anniversaries and increasing to $60,000 before the fourth anniversary in order to continue the option in effect from year to year. In the event that we decide to exercise the option, we will pay Dr. Leonard I. Malis $4,157,054, which includes interest, in twenty-six equal quarterly installments of $159,104, and which will be evidenced by a promissory note secured with a security interest in the trademark and certain of our patents. At September 30, 2004, we had cash and cash equivalents of $2,322,559. We plan to finance our operating and capital needs principally with cash flows from operations and existing balances of cash and cash equivalents, which we believe will be sufficient to fund our operations in the near future. However, should it be necessary, we believe we could borrow adequate funds at competitive rates and terms. Our future liquidity and capital requirements will depend on numerous factors, including the funds we expend in marketing, selling and distributing our products, the success in commercializing our existing products, development and commercialization of products in other clinical markets, the ability of our suppliers to continue to meet our demands at current prices, the status of regulatory approvals and competition. We have a line of credit of $1,000,000 with Wachovia Bank, N.A. which calls for interest to be charged at the bank's national commercial rate. The credit accommodation is unsecured and requires us to have a tangible net worth of no less than $3,000,000. Our current tangible net worth exceeds $3,000,000 at September 30, 2004. As of September 30, 2004, there was no outstanding balance on this line. 32 USE OF ESTIMATES AND CRITICAL ACCOUNTING POLICIES The preparation of financial statements and related disclosures in conformity with accounting principles generally accepted in the United States requires management to make judgments, assumptions, and estimates that affect the amounts reported in the Consolidated Financial Statements and accompanying notes. Note 1 to the Consolidated Financial Statements describes the significant accounting policies and methods used in the preparation of the Consolidated Financial Statements. Estimates are used for, but not limited to, the accounting for the allowance for doubtful accounts and sales returns, inventory allowances, warranty costs, contingencies and other special charges, and taxes. Actual results could differ materially from these estimates. The following critical accounting policies are impacted significantly by judgments, assumptions, and estimates used in the preparation of the Consolidated Financial Statements. Allowances For Doubtful Accounts, Sales Returns and Warranty Costs We evaluate the collectibility of accounts receivable based on a combination of factors. In circumstances where a specific customer is unable to meet its financial obligations to us, we record an allowance against amounts due to reduce the net recognized receivable to the amount that we reasonably expect to collect. For all other customers, we record allowances for doubtful accounts based on the length of time the receivables are past due, the current business environment and our historical experience. If the financial condition of customers or the length of time that receivables are past due were to change, we may change the recorded amount of allowances for doubtful accounts in the future. We record a provision for estimated sales returns and allowances on product revenues in the same period as the related revenues are recorded. We base these estimates on historical sales returns and other known factors. Actual returns could be different from our estimates and the related provisions for sales returns and allowances, resulting in future changes to the sales returns and allowances provision. Our warranty obligation is affected primarily by product that does not meet specifications within the applicable warranty period and any related costs to repair or replace such products. Should our actual experience of warranty claims differ from our estimates of such obligations, our provision for warranty costs could change. Inventories Inventories, consisting of purchased materials, direct labor and manufacturing overhead, are stated at the lower of cost, determined by the moving average method, or market. At each balance sheet date, we evaluate inventories for excess quantities and identified obsolescence. Our evaluation includes an analysis of historical sales levels by product and projections of future demand, as well as estimates of quantities required to support warranty and other repairs. To the extent that we determine there are excess quantities based on our projected levels of sales and other requirements, or obsolete material in inventory, we record valuation reserves against all or a portion of 33 the value of the related parts or products. If future demand or market conditions are different than our projections, a change in recorded inventory valuation reserves may be required and would be reflected in cost of revenues in the period the revision is made. Amortization Periods We record amortization of intangible assets using the straight-line method over the estimated useful lives of these assets. We base the determination of these useful lives on the period over which we expect the related assets to contribute to our cash flows or in the case of patents, their legal life, whichever is shorter. If our assessment of the useful lives of intangible assets changes, we may change future amortization expense. Deferred Tax Assets and Liabilities Our deferred tax assets and liabilities are determined based on differences between the financial statement and tax bases of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. Deferred tax assets are reduced by a valuation allowance when a determination is made that it is more likely than not that a portion or all of the deferred tax assets will not be realized. Loss Contingencies We are subject to claims and lawsuits in the ordinary course of our business, including claims by employees or former employees, with respect to our products and involving commercial disputes. Our financial statements do not reflect any material amounts related to possible unfavorable outcomes of claims and lawsuits to which we are currently a party because we currently believe that such claims and lawsuits are either adequately covered by insurance or otherwise indemnified, and are not expected, individually or in the aggregate, to result in a material adverse effect on our financial condition. However, it is possible that our results of operations, financial position and cash flows in a particular period could be materially affected by these contingencies if we change our assessment of the likely outcome of these matters Goodwill Impairment We perform goodwill impairment tests on an annual basis and between annual tests to determine if events or circumstances indicate that goodwill may have been impaired. In response to changes in industry and market conditions, we may be required to strategically realign our resources and consider restructuring, disposing, or otherwise exiting businesses, which could result in an impairment of goodwill. Impairment is measured by the difference between the recorded value of goodwill and its implied fair value when the fair value of the reporting unit is less than its net book value. 34 Impairment of Long-Lived Assets Long-lived assets and certain identifiable intangible assets to be held and used are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable. Determination of recoverability is based on an estimate of undiscounted future cash flows resulting from the use of the group of assets and their eventual disposition. Measurement of an impairment loss for long-lived assets and certain identifiable intangible assets that management expects to hold and use is based on the fair value of the asset. Long-lived assets and certain identifiable intangible assets to be disposed of are reported at the lower of carrying amount or fair value less costs to sell. Stock-Based Compensation We account for stock-based employee compensation using the intrinsic value method of accounting. Under this method, employee stock-based compensation expense is based on the difference, if any, on the date of the grant between the fair value of the Company's stock and the exercise price of the award. We account for stock options issued to non-employees using the fair value method of accounting, which requires us to assign a value to the stock options issued based on an option pricing model, and to record that value as compensation expense. We use the Black-Scholes option pricing model. If we were to account for stock options issued to employees using the fair value method of accounting rather than the intrinsic value method, our results of operations would be significantly affected. Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. - ------- ---------------------------------------------------------- Not Applicable. Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. - ------ ------------------------------------------- Financial statements and financial statement schedules specified by this Item, together with the report thereon of Samuel Klein and Company, are presented following Item 15 of this report. Information on quarterly results of operations is set forth in our financial statement under notes to consolidated financial statements, Note 15 Quarterly Results (unaudited). Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING - ------ ----------------------------------------------------------- AND FINANCIAL DISCLOSURE. - ------------------------ Not applicable. Item 9A. CONTROLS AND PROCEDURES - ------- ----------------------- Our management, including our Chief Executive Officer/Principal Financial Officer, conducted an evaluation of the effectiveness of our disclosure controls and procedures as of September 30, 2004. Based on that evaluation, our management, including our Chief Executive Officer/Principal Financial Officer, has concluded that our disclosure controls and procedures are effective. During the period covered by this report, there was no change in our internal control over financial reporting that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. 35 PART III -------- Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT. - ------- -------------------------------------------------- The information concerning directors and executive officers of Valley Forge Scientific Corp. is incorporated by reference to the information set forth either: (i) in our Definitive Proxy Statement for our 2005 Annual Meeting of Stockholders, or (ii) in an amendment to this Annual Report on Form 10-K (collectively the "2004 Proxy Information"), which in either case will be filed within 120 days after the end of the fiscal year covered by this Annual Report on Form 10-K. Item 11. EXECUTIVE COMPENSATION. - ------- ---------------------- The information regarding executive compensation is incorporated by reference to the information set forth in the 2004 Proxy Information. Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT - ------- -------------------------------------------------------------- AND RELATED STOCKHOLDER MATTERS. - ------------------------------- The information concerning the security ownership of certain beneficial owners and management and related stockholder matters is incorporated by reference to the information set forth in the 2004 Proxy Information. Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. - ------- ---------------------------------------------- The information concerning certain relationships and related transactions is incorporated by reference to the information set forth in the 2004 Proxy Information. Item 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES - ------- -------------------------------------- The information required to be disclosed concerning principal accountant fees and services is incorporated by reference to the information set forth in the 2004 Proxy Information. 36 PART IV ------- Item 15 EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM - ------- ----------------------------------------------------------- 8-K. - --- (a) and (d) Financial Statements and Financial Statement Schedules. See Index to Financial Statements and Financial Statement Schedules on Page F-1, herein. (b) Reports on Form 8-K. On August 12, 2004, Valley Forge Scientific Corp. filed a report on Form 8-K regarding a press release for our the third quarter and nine months operating results for fiscal 2004. (c) Exhibits The following is a list of exhibits filed as part of this annual report on Form 10-K. Where so indicated by footnote, exhibits which were previously filed are incorporated by reference. For exhibits incorporated by reference, the location of the exhibit in the previous filing is indicated in parentheses. 2.1 Agreement and Plan of Merger between Valley Forge Scientific Corp. and Diversified Electronic Corporation dated August 31, 1994. (4) (Exhibit 2.1) 3.1 Articles of Incorporation, restated to include amendment to Articles of Incorporation dated August 26, 1999. (8) (Exhibit 3(a)) 3.2 Second Amended and Restated By-Laws of the Company. (13) 4.1 Form of Common Stock Certificate - (2) (Exhibit 4(a)). 10.1 Valley Forge Scientific Corp. 2001 Stock Plan (11) 10.2 Valley Forge Scientific Corp. 2000 Nonemployee Directors Stock Option Plan (11) 10.3 Assignment of Know-How Agreement, dated June 30, 1989 - (2) (Exhibit 10(g)). 10.4 Assignment of Patents - Bipolar Electrosurgical Systems, June 30, 1989 - (2) (Exhibit 10(h)). 10.5 Assignment of Patents - Binocular Magnification System, June 30, 1989 -(2) (Exhibit 10(i)). 37 10.6 Assignment of Malis trade name, dated June 30, 1989 - (2) (Exhibit 10(j)). 10.7 401(k) and Profit-Sharing Plan - (3) (Exhibit 10(x)). 10.8 Promissory Note from Jerry L. Malis to the Company. (5) (Exhibit 10(k)) 10.9 Commercial Lease Agreement between GMM Associates and the Company dated July 1, 1995 (6) (Exhibit 10(p)) 10.10 Promissory Note from Jerry L. Malis to the Company (7) (Exhibit 10(p)). 10.11 Addendum to Commercial Lease Agreement between the Company and GMM Associates dated as of July 1, 2000 (9) (Exhibit 10.2). 10.12 Agreement with Codman & Shurtleff, Inc. dated October 15, 2004 (1). 10.13 Supply and Distribution Agreement with Stryker Corporation dated October 25, 2004 (1). 10.14 Option Agreement for Malis Trademark with Leonard I. Malis dated October 22, 2004 (1). 21 Subsidiary of Registrant (13) (Exhibit 22). 23 Consent of Samuel Klein and Company (1). 31.1 Certification of the Chief Executive Officer and Principal Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (1). 32.1 Certification of the Chief Executive Officer and Principal Financial Officer to Section 906 of the Sarbanes-Oxley Act of 2002 (1). - ----------------- (1) Filed herewith (2) Previously filed with the Registration Statement of the Company on Form S-18, Registration No. 33-31008-NY, and incorporated herein by reference. (3) Previously filed with the Registration Statement of the Company on Form S-18, Registration No. 33-35668-NY, and incorporated herein by reference. (4) Previously filed with the Company's Form 8-K dated August 31, 1994, and incorporated herein by reference. (5) Previously filed with the Company's Form 10-K for the year ended September 30, 1994, and incorporated herein by reference. (6) Previously filed with the Company's Form 10-K for the year ended September 30, 1995, and incorporated herein by reference. (7) Previously filed with the Company's Form 10-K for the year ended September 30, 1998 and incorporated herein by reference. 38 (8) Previously filed with the Company's Form 10-K for the year ended September 30, 1999 and incorporated herein by reference. (9) Previously filed with the Company's Form 10-Q for the quarter ended December 31, 2000, and incorporated herein by reference. (10) Previously filed with the Registration Statement of the Company on Form S-8 Registration No.333-72296, filed on October 26, 2001 and incorporated herein by reference (11) Previously filed with the Registration Statement of the Company on Form S-8 Registration No.333-72134, filed on October 24, 2001 and incorporated herein by reference. (12) Previously filed with the Company's Form 10-K for the year ended December 31, 2001 and incorporated herein by reference. (13) Previously filed with the Company's Form 10-K for the year ended December 31, 2003 and incorporated herein by reference. 39 SIGNATURES Pursuant to the requirements of the Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized on this 22nd day of December, 2004 VALLEY FORGE SCIENTIFIC CORP. By: /s/ JERRY L. MALIS ------------------------------- Jerry L. Malis, President Pursuant to the requirements of the Securities Act of 1934, this report has been signed by the following persons on behalf of the Registrant and in the capacities and on the dates indicated. Signature Title Date --------- ----- ---- /s/ JERRY L. MALIS Chairman of the Board, December 22, 2004 - -------------------------- President (chief executive Jerry L. Malis officer and principal financial and accounting officer) /s/ LOUIS UCHITEL Director December 22, 2004 - -------------------------- Louis Uchitel /s/ LEONARD I. MALIS Director December 22, 2004 - -------------------------- Leonard I. Malis /s/ BRUCE A. MURRAY Director December 22, 2004 - -------------------------- Bruce A. Murray /s/ ROBERT H. DICK Director December 22, 2004 - -------------------------- Robert H. Dick VALLEY FORGE SCIENTIFIC CORP. For Fiscal Year Ended September 30, 2004 FORM 10-K Index to Financial Statements and Financial Statement Schedules Independent Auditor's Report F-2 Balance Sheets - September 30, 2004 and 2003 F-3 Statements of Operations - Years ended September 30, 2004, 2003 and 2002 F-4 Statements of Stockholders' Equity - Years ended September 30, 2004, F-5 2003 and 2002 Statements of Cash Flows - Years ended September 30, 2004, 2003 and 2002 F-6 Notes to Financial Statements F-7 - --------------- All other schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission are not required under the related instructions or are not applicable, and therefore have been omitted. F-1 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM The Board of Directors and Stockholders Valley Forge Scientific Corp. and Subsidiary Oaks, Pennsylvania We have audited the accompanying consolidated balance sheets of Valley Forge Scientific Corp. and Subsidiary as of September 30, 2004 and 2003 and the related consolidated statements of operations, stockholders' equity and cash flows for each of the three years in the period ended September 30, 2004. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Valley Forge Scientific Corp. and Subsidiary as of September 30, 2004 and 2003, and the results of its operations and its cash flows for each of the three years in the period ended September 30, 2004, in conformity with U. S. generally accepted accounting principles. /s/ SAMUEL KLEIN AND COMPANY SAMUEL KLEIN AND COMPANY Newark, New Jersey November 19, 2004 F-2 VALLEY FORGE SCIENTIFIC CORP. AND SUBSIDIARY CONSOLIDATED BALANCE SHEETS September 30, ----------------------- ASSETS 2004 2003 - ------ ---------- ---------- Current Assets: Cash and cash equivalents $2,322,559 $2,305,556 Accounts receivable, net 646,224 376,915 Inventory 781,604 775,183 Prepaid items and other current assets 146,411 268,371 Deferred income taxes 79,752 51,431 ---------- ---------- Total Current Assets 3,976,550 3,777,456 Property, Plant and Equipment, Net 147,967 156,697 Goodwill 153,616 153,616 Intangible Assets, Net 218,398 256,681 Other Assets 26,707 29,963 ---------- ---------- Total Assets $4,523,238 $4,374,413 ========== ========== LIABILITIES AND STOCKHOLDERS' EQUITY - ------------------------------------ Current Liabilities: Accounts payable and accrued expenses $ 245,828 $ 216,457 Deferred revenue 5,750 -- Income taxes payable 6,491 -- ---------- ---------- Total Current Liabilities 258,069 216,457 Deferred Income Taxes 15,743 19,950 ---------- ---------- Total Liabilities 273,812 236,407 ---------- ---------- Commitments and Contingencies Stockholders' Equity: Preferred stock -- -- Common stock (no par, 20,000,000 shares authorized, shares issued and outstanding at September 30, 2004 and 2003 - 7,913,712 3,528,530 3,528,530 Retained earnings 720,896 609,476 ---------- ---------- 4,249,426 4,138,006 ---------- ---------- Total Liabilities and Stockholders' Equity $4,523,238 $4,374,413 ========== ========== - -------------------- The accompanying notes are an integral part of these financial statements. F-3 VALLEY FORGE SCIENTIFIC CORP. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF OPERATIONS For the Years Ended September 30, ------------------------------------ 2004 2003 2002 ---------- ---------- ---------- Net Sales $4,756,439 $4,474,308 $5,021,931 Cost of Sales 2,316,304 2,264,902 2,463,209 ---------- ---------- ---------- Gross Profit 2,440,135 2,209,406 2,558,722 ---------- ---------- ---------- Other Costs: Selling, general and administrative 1,713,325 1,523,751 1,503,001 Research and development 508,287 489,930 360,111 Amortization 40,469 40,298 63,610 ---------- ---------- ---------- Total Other Costs 2,262,081 2,053,979 1,926,722 ---------- ---------- ---------- Income from Operations 178,054 155,427 632,000 Other Income (Expense), Net 23,030 11,451 23,111 ---------- ---------- ---------- Income before Income Taxes 201,084 166,878 655,111 Provision for Income Taxes 89,664 57,953 274,584 ---------- ---------- ---------- Net Income $ 111,420 $ 108,925 $ 380,527 ========== ========== ========== Income per Share: Basic income per common share $ 0.01 $ 0.01 $ 0.05 ========== ========== ========== Diluted income per common share $ 0.01 $ 0.01 $ 0.05 ========== ========== ========== Basic weighted average common shares outstanding 7,913,712 7,960,676 8,067,286 Diluted weighted average common shares outstanding 7,976,833 7,986,448 8,154,570 - -------------------- The accompanying notes are an integral part of these financial statements. F-4 VALLEY FORGE SCIENTIFIC CORP. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY FOR THE YEARS ENDED SEPTEMBER 30, 2004, 2003 AND 2002
Common Stock No Par Value ---------------------------- Number Common Total of Stock Retained Stockholders' Shares Amount Earnings Equity ------------ ------------ ------------ ------------ Balances, October 1, 2001 8,067,812 $ 3,748,724 $ 120,024 $ 3,868,748 Purchases and Retirement of Common Shares (26,500) (46,878) -- (46,878) Net Income for the Year Ended September 30, 2002 -- -- 380,527 380,527 ------------ ------------ ------------ ------------ Balances, September 30, 2002 8,041,312 3,701,846 500,551 4,202,397 Purchases and Retirement of Common Shares (127,600) (173,316) -- (173,316) Net Income for the Year Ended September 30, 2003 -- -- 108,925 108,925 ------------ ------------ ------------ ------------ Balances, September 30, 2003 7,913,712 3,528,530 609,476 4,138,006 Net Income for the Year Ended September 30, 2004 -- -- 111,420 111,420 ------------ ------------ ------------ ------------ Balances, September 30, 2004 7,913,712 $ 3,528,530 $ 720,896 $ 4,249,426 ============ ============ ============ ============
- -------------------- The accompanying notes are an integral part of these financial statements. F-5 VALLEY FORGE SCIENTIFIC CORP. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Years Ended September 30, -------------------------------------------- 2004 2003 2002 ------------ ------------ ------------ Cash Flows from Operating Activities: Net income $ 111,420 $ 108,925 $ 380,527 Adjustments to reconcile net income to net cash provided by (used in) operating activities: Depreciation and amortization 70,087 66,641 84,784 Writedown of property, plant and equipment -- 16,500 5,300 Reduction of allowance for loans and advances to employee -- -- (47,790) Interest accrued on loans and advances to employees and related parties (2,313) (2,382) (2,810) Provision for obsolete and slow moving inventory 70,386 109,635 52,875 Provision for (recovery of) bad debts, returns and allowances 13,609 (43,000) 50,003 Changes in assets and liabilities: (Increase) decrease in accounts receivable, net (282,918) 4,024 217,208 (Increase) decrease in inventory (76,807) (1,986) 263,829 (Increase) decrease in deferred tax assets (28,321) 24,862 28,087 (Increase) decrease in other assets 3,256 (25,792) 1,275 (Increase) decrease in prepaid items and other current assets 117,773 (135,205) (38,705) Increase (decrease) in accounts payable and accrued expenses and income taxes payable 35,862 (136,824) 70,095 Increase in deferred revenue 5,750 -- -- Increase (decrease) in deferred tax liability (4,207) 5,593 (4,923) ------------ ------------ ------------ Net cash provided by (used in) operating activities 33,577 (9,009) 1,059,755 ------------ ------------ ------------ Cash Flows from Investing Activities: Proceeds from repayment of employee loans 6,500 10,000 57,261 Loans and advances to employees -- -- (1,436) Acquisition of intangible assets (2,187) (2,608) (8,621) Purchases of property, plant and equipment (20,887) (63,409) (16,805) ------------ ------------ ------------ Net cash provided by (used in) investing activities (16,574) (56,017) 30,399 ------------ ------------ ------------ Cash Flows from Financing Activities: Repurchase of common stock -- (173,316) (46,878) ------------ ------------ ------------ Net cash used in financing activities -- (173,316) (46,878) ------------ ------------ ------------ Net Increase (Decrease) in Cash and Cash Equivalents 17,003 (238,342) 1,043,276 Cash and Cash Equivalents, beginning of year 2,305,556 2,543,898 1,500,622 ------------ ------------ ------------ Cash and Cash Equivalents, end of year $ 2,322,559 $ 2,305,556 $ 2,543,898 ============ ============ ============
F-6 VALLEY FORGE SCIENTIFIC CORP. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
For the Years Ended September 30, ------------------------------------------ 2004 2003 2002 ------------ ------------ ------------ Supplemental Disclosures of Cash Flow Information: Cash paid during the year for: Interest $ -- $ -- $ -- ============ ============ ============ Income taxes $ 21,400 $ 271,300 $ 186,960 ============ ============ ============
- -------------------- The accompanying notes are an integral part of these financial statements. F-7 VALLEY FORGE SCIENTIFIC CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. THE COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES The Company - ----------- Valley Forge Scientific Corp. ("VFSC") was incorporated on March 27, 1980 in the Commonwealth of Pennsylvania and is engaged in the business of developing, manufacturing and selling medical devices and products. On August 18, 1994, VFSC formed a wholly-owned subsidiary, Diversified Electronics Company, Inc. ("DEC"), a Pennsylvania corporation, in order to continue the operations of Diversified Electronics Corporation, a company which was merged with and into VFSC on August 31, 1994. VFSC and DEC are referred to herein as the "Company". Principles of Consolidation and Basis of Presentation - ----------------------------------------------------- The accompanying financial statements consolidate the accounts of the parent company and its wholly-owned subsidiary. All significant intercompany accounts and transactions have been eliminated in consolidation. Use of Management's Estimates - ----------------------------- The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Cash and Cash Equivalents - ------------------------- The Company considers cash equivalents to be all highly liquid investments with original maturities of three months or less. Substantially all cash and cash equivalents are held in one major financial institution. Segment Information - ------------------- The Company has one operating segment comprised of its bipolar electrosurgical generators and instrumentation products. The Company's business is conducted entirely in the United States. Major customers are discussed in Note 10. Fair Value of Financial Instruments - ----------------------------------- Carrying amounts of certain of the Company's financial instruments, including cash and cash equivalents, receivables, accounts payable and other accrued expenses approximate fair value because of their short maturities. Reclassifications - ----------------- Certain reclassifications have been made to prior year balances to conform to the current presentation. F-8 VALLEY FORGE SCIENTIFIC CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 1. THE COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) Revenue Recognition - ------------------- The Company sells its products to U.S. based national and international distributors and dealers which include Codman and Shurtleff, Inc. ("Codman"), an affiliate of a major medical company. A significant part of the Company's sales are made pursuant to a distribution agreement with Codman, the Company's largest customer, which provides for worldwide exclusive distribution rights of neurosurgery products during the term of this agreement. This distribution agreement includes a minimum purchase obligation which is adjusted annually during the term of the agreement. It also includes a price list for the specified products, which is fixed for a period of time, after which these prices are subject to adjustment by the Company due to changes in manufacturing cost or technological improvements to the products. In November, 2003 this agreement was extended for three months to March 31, 2004, with a minimum purchase obligation during this period of $1,000,000. In March, 2004 the agreement was further extended for three months through June 30, 2004, with a minimum purchase obligation during that period of $1,000,000 and on June 29, 2004 it was extended again through September 30, 2004 with the same $1,000,000 minimum purchase obligation during that period. All other terms of the distribution agreement remained in full force and effect for the year ended September 30, 2004. (See Subsequent Events for explanation of a new agreement with this customer). During the three months ended March 31, 2004, Codman elected to pay the Company $57,920, pursuant to the distribution agreement in lieu of purchasing approximately $116,000 of product which would have been required to meet the minimum purchase obligation under the agreement, as extended, for the period. The Company received the payment on April 16, 2004. The amount received is included in sales for the year ended September 30, 2004. Had this amount not been recorded, sales would have been $4,698,519 for the year ended September 30, 2004 and gross profit would have been $2,382,215 (50.7% of sales). No such payment to the Company was required in the quarters ended June 30, 2004 or September 30, 2004. Product revenue is recognized when the product has been shipped which is when title and risk of loss has been transferred to the customer. Service revenue substantially relates to repairs of products and is recognized when the service has been completed. Revenues from license and royalty fees are recorded when earned. The Company reduces revenue for customer returns and allowances. In addition, the Company accrues for warranty cost and other allowances based on its experience and reflects these accruals in cost of sales or administrative expense as applicable. Inventory - --------- Inventory is stated at the lower of cost, determined by the moving average cost method, or market. The Company provides inventory allowances based on slow-moving and obsolete inventories. Property, Plant and Equipment - ----------------------------- Property, plant and equipment are recorded at cost. Depreciation is computed by the straight-line method over the estimated useful lives of the assets, which vary from three to thirty-nine years. Leasehold improvements are being amortized over the related lease term or estimated useful lives, whichever is shorter. F-9 VALLEY FORGE SCIENTIFIC CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 1. THE COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) Property, Plant and Equipment (Continued) - ----------------------------------------- Upon retirement or other disposition of these assets, the cost and related accumulated depreciation are removed from the accounts and the gains or losses are reflected in the results of operations. Routine maintenance and repairs are charged to expense as incurred. Intangible Assets and Goodwill - ------------------------------ Intangible assets, consisting of patents, licensing agreements, proprietary know-how, logos and cost of acquisition are amortized to operations under the straight-line method over their estimated useful lives or statutory lives, whichever is shorter. Acquisition costs have been capitalized and are being amortized over 5 years. All other intangible assets, except for goodwill, are being amortized over periods ranging from 10 to 17 years. The Company accounts for goodwill in accordance with Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets" (SFAS 142), which addresses the financial accounting and reporting standards for goodwill and other intangible assets subsequent to their acquisition. This accounting standard requires that goodwill no longer be amortized, and instead, be tested for impairment on a periodic basis. Pursuant to adoption of this accounting standard, on October 1, 2001, a transitional impairment test was completed on March 31, 2002, and no impairment was identified. Subsequent impairment tests have been performed annually as of March 31, 2003 and 2004 and no impairment has been identified. In accordance with SFAS 142, the Company discontinued the amortization of goodwill effective October 1, 2001. Therefore, goodwill has not been amortized in any year presented in these financial statements. Impairment of Long-Lived Assets - ------------------------------- The Company has adopted Statement of Financial Accounting Standards No. 144, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of" (SFAS 144). Pursuant to SFAS 144 long-lived assets, or asset groups and certain identifiable intangible assets to be held and used are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable. Determination of recoverability is based on an estimate of undiscounted cash flows resulting from the use of the asset, or asset groups, and its eventual disposition. Measurement of an impairment loss for long-lived assets, or asset groups, and certain identifiable intangible assets that management expects to hold and use is based on the fair value of the asset. Long-lived assets, or asset groups and certain identifiable intangible assets to be disposed of are reported at the lower of carrying amount or fair value less costs to sell. Research and Development - ------------------------ Costs associated with development of new products are charged to operations as incurred. F-10 VALLEY FORGE SCIENTIFIC CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 1. THE COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) Advertising Costs - ----------------- Advertising expenditures relating to the advertising and marketing of the Company's products and services are expensed in the period the advertising costs are incurred. Prior to 2003, substantially all cost of such product marketing and advertising had been borne by the Company's major distributors. During the year ended September 30, 2003, due to the Company's strategy shift to market and sell the Bident dental products utilizing the Company's proprietary resources, the Company incurred marketing and advertising costs of approximately $161,000. For the year ended September 30, 2004, these costs were approximately $130,000. Income Taxes - ------------ Tax provisions and credits are recorded at enacted tax rates for taxable items included in the consolidated statements of operations regardless of the period for which such items are reported for tax purposes. Deferred tax assets and liabilities are determined based on the differences between the financial statement and tax bases of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. Deferred tax assets are reduced by a valuation allowance when the determination can be made that it is more likely than not that some portion or all of the related tax assets will not be realized. Comprehensive Income - -------------------- The Company reports components of comprehensive income under the requirements of Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income" (SFAS 130). This statement establishes rules for the reporting of comprehensive income and its components which require that certain items such as foreign currency translation adjustments, unrealized gains and losses on certain investments in debt and equity securities, minimum pension liability adjustments and unearned compensation expense related to stock issuances to employees be presented as separate components of stockholders' equity. Earnings per Share - ------------------ The Company computes earnings per share in accordance with Statement of Financial Accounting Standards No. 128, "Earnings Per Share" (SFAS 128). Basic earnings per share is computed by dividing income available to common stockholders by the weighted average number of common shares outstanding. Diluted earnings per share reflects the potential dilution that could occur if securities or other agreements to issue common stock were exercised or converted into common stock. Diluted earnings per share is computed based upon the weighted average number of common shares and dilutive common equivalent shares outstanding, which include convertible debentures, stock options and warrants. F-11 VALLEY FORGE SCIENTIFIC CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 1. THE COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) Accounting for Stock-Based Compensation - --------------------------------------- In December, 2002, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure - an amendment of FASB Statement No. 123" (SFAS 148). SFAS 148 amends SFAS 123, "Accounting for Stock-Based Compensation", to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, SFAS 148 amends the disclosure requirements of SFAS 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. SFAS 148 was effective for the Company as of January 1, 2003. The Company has not elected a voluntary change in accounting to the fair value based method, and accordingly, the adoption of SFAS 148 did not have any impact on the Company's results of operations or financial position. Employee stock plans are accounted for using the intrinsic value method prescribed by Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees", (APB 25). The Company utilizes the Black-Scholes option valuation model to value stock options for pro forma presentation of income and per share data as if the fair value based accounting method in SFAS 123 had been used to account for stock-based compensation. For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options' vesting periods. In accordance with SFAS 123, only stock options granted after September 30, 1995 have been included for the Company's pro forma information as follows:
September 30, ------------------------------------------ 2004 2003 2002 ------------ ------------ ------------ Additional compensation expense, net of tax effect $ 56,229 $ 57,180 $ 89,333 Pro forma net income 55,191 51,745 291,194 Pro forma income per share: Basic 0.01 0.01 0.04 Diluted 0.01 0.01 0.04
Recent Accounting Pronouncement - ------------------------------- In November, 2004 the Financial Accounting Standards Board issued Statement of Financial Accounting Standard No. 151, "Inventory Costs, an amendment of ARB No. 43, Chapter 4" (SFAS 151). SFAS 151 amends the guidance in ARB No. 43, Chapter 4, "Inventory Pricing", to clarify the accounting for abnormal amounts of idle facility expense, freight, handling costs, and spoilage. This statement requires that those items be recognized as current period charges regardless of whether they meet the criterion of "so abnormal" which was the criterion specified in ARB No. 43. In addition, this Statement requires that allocation of fixed production overheads to the cost of production be based on normal capacity of the production facilities. This pronouncement is effective for the Company beginning October 1, 2005. The Company does not expect the adoption of this pronouncement to have a material impact on its future financial condition or results of operations. F-12 VALLEY FORGE SCIENTIFIC CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 2. ACCOUNTS RECEIVABLE The Company provides an allowance for doubtful accounts equal to the estimated uncollectible amounts. The Company's estimate is based on historical collection experience and a review of the current status of trade accounts receivable. It is reasonably possible that the Company's estimate of the allowance for doubtful accounts will change. Accounts receivable consists of the following: September 30, ----------------------- 2004 2003 ---------- ---------- Accounts receivable $ 661,704 $ 378,786 Less: Allowances 15,480 1,871 ---------- ---------- $ 646,224 $ 376,915 ========== ========== The Company provided for estimated doubtful accounts through charges to selling, general and administrative expenses for $5,179, $ - 0 - and $50,003 for the years ended September 30, 2004, 2003 and 2002, respectively, and wrote-off $ - 0 - - , $ - 0 - , and $34,375, respectively, against this allowance for these periods. In addition, during the year ended September 30, 2004 the Company increased the allowance by approximately $8,400 based on its experience with sales returns, primarily related to medical products and instruments. During the year ended September 30, 2003, the Company recorded a benefit of $43,000 arising from the collection of an account receivable which had been previously provided for, and further reduced the allowance by approximately $2,700. 3. INVENTORY The Company provides an allowance for slow moving and potentially obsolete inventory. Inventory consists of the following: September 30, ----------------------- 2004 2003 ---------- ---------- Finished goods $ 94,405 $ 88,401 Work-in-process 396,810 316,600 Materials and parts 424,052 433,459 ---------- ---------- 915,267 838,460 Less: Allowance for slow moving and obsolete inventory 133,663 63,277 ---------- ---------- $ 781,604 $ 775,183 ========== ========== The Company provided for obsolete and slow moving inventory through charges to cost of sales for $70,386, $109,635 and $52,875 in the years ended September 30, 2004, 2003 and 2002, respectively, and wrote off $ - 0 - , $134,928 and $41,183, respectively, against this allowance in these periods. F-13 VALLEY FORGE SCIENTIFIC CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 4. PROPERTY, PLANT AND EQUIPMENT
September 30, Useful Life ---------------------------------- (Years) 2004 2003 ------- ------------- ------------- Land - $ 11,953 $ 11,953 Buildings and improvements 15 - 39 103,467 94,832 Furniture and fixtures 5 - 7 17,953 17,953 Laboratory equipment 5 - 10 378,159 370,119 Office equipment 5 185,530 181,318 Leasehold improvements 3 - 5 9,413 9,413 ------------- ------------- 706,475 685,588 Less: Accumulated depreciation and amortization 558,508 528,891 ------------- ------------- $ 147,967 $ 156,697 ============= =============
Depreciation is reflected in both cost of sales and selling, general and administrative expenses. Total depreciation for the years ended September 30, 2004, 2003 and 2002 was $29,617, $26,343 and $21,174, respectively. In addition, in accordance with SFAS 144, the Company wrote down certain molding equipment intended to be utilized in the production of certain disposable surgical products, to their estimated fair values. For the years ended September 30, 2004, 2003 and 2002, the Company wrote down $ - 0 - , $16,500 and $5,300, respectively. These write downs are included in the statement of operations under the caption "Other Income (Expense), Net". 5. INTANGIBLE ASSETS Intangible assets consist of the following: September 30, Useful Life ----------------------- (Years) 2004 2003 ---------- ---------- ---------- Patents/trademarks/logos, licensing agreements 17 $ 573,804 $ 571,617 Proprietary know-how 15 452,354 452,354 Acquisition costs 5 55,969 55,969 ---------- ---------- 1,082,127 1,079,940 Less: Accumulated amortization 863,729 823,259 ---------- ---------- $ 218,398 $ 256,681 ========== ========== Total amortization for the years ended September 30, 2004, 2003 and 2002 was $40,470, $40,298 and $63,610, respectively. Amortization for the years ended September 30, 2005, 2006, 2007, 2008 and 2009 is estimated to be $40,778, $40,778, $40,665, $40,131 and $34,902, respectively. F-14 VALLEY FORGE SCIENTIFIC CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 5. INTANGIBLE ASSETS (Continued) During the year ended September 30, 2003, a patent for the technology underlying the "aperiodic" wave form utilized in some of the Company's products expired. The remaining patent, which relates to the Company's current bipolar electrosurgical generators, expires in the fiscal year ending September 30, 2011. 6. RELATED PARTY TRANSACTIONS Loans Receivable - ---------------- On July 6, 1998, Jerry L. Malis, a principal shareholder, director and officer of the Company, borrowed $15,015 from the Company. The note is payable on demand and has a stated rate of interest of 5.42%, the then current "Applicable Federal Rate" as set forth under the Internal Revenue Code. The Company has additional loans due from Jerry L. Malis payable on demand with similar interest terms as stated above ranging from 4.83% to 6.97%. The collective loans, which total $41,792 as of September 30, 2004, are partially secured by 5,833 shares of common stock of the Company. As of September 30, 2004 the pledged stock had a value of approximately $9,333. The balance of these loans is included on the balance sheet under the caption "prepaid items and other current assets" and as of September 30, 2004 and 2003, was $41,792 and $45,979, respectively, which includes accrued interest of $20,461 and $18,148, respectively. Consulting Services - ------------------- During 2004, 2003 and 2002 the Company engaged R.H. Dick and Company, Inc., a corporation owned by Robert H. Dick, a director of the Company, to provide certain investment banking and consulting services. For the years ended September 30, 2004, 2003 and 2002 the Company incurred consulting fees for these services, excluding reimbursement of out-of-pocket expenses in an amount totaling $7,500, $10,000 and $10,000, respectively. As of September 30, 2004 and 2003, the Company owed R.H. Dick and Company $ - 0 - and $5,000, respectively. The liability is reflected on the balance sheet under the caption "accounts payable and accrued expenses". Also, commencing in June 2004 the Company engaged Bruce Murray, a director, to provide certain business consulting services. The fees for these services totaled $30,025, excluding reimbursements of out-of-pocket expenses. The amount owed Bruce Murray at September 30, 2004 was $12,128 and is reflected on the balance sheet under the caption "accounts payable and accrued expenses". 7. LINE OF CREDIT The Company has a line of credit of $1,000,000 with Wachovia Bank, formerly First Union National Bank, which calls for interest to be charged on any loans under this line equal to the bank's national commercial rate. The line is unsecured and any borrowing under the line would be payable on demand, require monthly interest payments on any unpaid principal and a reduction of any loan balance to zero for a minimum of thirty consecutive days during each twelve month period. In addition, the loan covenant calls for a minimum tangible net worth of no less than $3,000,000 during the term of the extended line of credit. At September 30, 2004 and 2003, there were no outstanding balances under this line. F-15 VALLEY FORGE SCIENTIFIC CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 8. COMMITMENTS AND CONTINGENCIES Litigation - ---------- The Company is subject from time to time to litigation arising from the normal course of business. In management's opinion, any such contingencies would be covered under its existing insurance policies or would not materially affect the Company's financial position or results of operations. On July 25, 2001 the Company was named as a defendant in a lawsuit filed in the United States District Court for the Eastern District of Pennsylvania by a former employee alleging gender discrimination and sexual harassment. On March 2, 2002 the Company, without admitting any liability, entered into a settlement agreement and pursuant to this agreement, paid the plaintiff $37,000, an amount which was net of certain amounts due from this party. This payment is reflected in other costs under selling, general and administrative expenses for the year ended September 30, 2002. On September 19, 2002, the Company was served with a complaint that was filed in the Superior Court of the State of Arizona, County of Maricopa, entitled Jeffrey Turner and Cathryn Turner et al v. Phoenix Children's Hospital, Inc., et al, (CV 2002-010791) in which the Company was named as one of the defendants. The plaintiffs seek damages from all defendants for permanent brain damage suffered by a four year old girl during a surgery that took place in June 2000. The alleged damages sought by the plaintiffs against all parties are in excess of the Company's product liability insurance policy limit of $1,000,000, and the Company's net worth. The claim against the Company is a products liability claim. The Company's product liability insurance carrier is providing the Company's defense in this matter. This insurance coverage has a $10,000 deductible that applies to attorney fees and damages which has been provided for in other costs under selling, general and administrative expense for the year ended September 30, 2002. In an answer that was filed on November 26, 2002, the Company denied any wrongdoing. The Company believes the claim is without merit and is vigorously defending itself in this action. This case is currently in the discovery process. Regulatory Compliance - --------------------- The Company is subject to regulatory requirements throughout the world. In the normal course of business, these regulatory agencies may require companies in the medical industry to change their products or operating procedures, which could affect the Company. The Company regularly incurs expenses to comply with these regulations and may be required to incur additional expenses. Management is not able to estimate any additional expenditures outside the normal course of operations which will be incurred by the Company in future periods in order to comply with these regulations. Employment Agreement - -------------------- On October 1, 2002 the Compensation Committee of the Board of Directors approved a base salary of $220,000 for Jerry L. Malis, the Chairman and CEO of the Company. His base salary for the years ended September 30, 2004, 2003 and 2002 were approximately $220,000, $220,000 and $199,000. F-16 VALLEY FORGE SCIENTIFIC CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 9. COMMITMENTS AND CONTINGENCIES (Continued) Employment Agreement (Continued) - -------------------- Subsequent to September 30, 2002, the Compensation Committee of the Board of Directors approved a $25,000 cash bonus to Mr. Malis for services rendered during the year ended September 30, 2002. The bonus was accrued for the year ended September 30, 2002 and is reflected on the statement of operations in "selling, general and administrative expenses". 401(k) Profit Sharing Plans - --------------------------- The Company's 401(k) Plan and Profit Sharing Plan cover full-time employees who have attained the age of 21 and have completed at least one year of service with the Company. Under the 401(k) Plan, an employee may contribute an amount up to 25% of his compensation to the Plan on a pretax basis not to exceed the current Federal limitation per year (as adjusted for cost of living increases). Amounts contributed to the 401(k) Plan are nonforfeitable. Under the Profit Sharing Plan, a member in the plan participates in the Company's contributions to the Plan as of December 31 in any year, with allocations to individual accounts based on annual compensation. An employee does not fully vest in the plan until completion of three years of employment. The Board of Directors determines the Company's contributions to the plan on a discretionary basis. The Company has not made any contributions to date. Stock Option Plans - ------------------ On July 6, 1988, the Company adopted a Nonqualified Employee Stock Option Plan (the "1988 Plan") pursuant to which 500,000 shares of Common Stock were reserved for issuance to employees, officers, directors or consultants of the Company. Options granted pursuant to this plan were nontransferable and expired if not exercised after ten years from the date of grant or for such lesser term as approved by the Board of Directors. Options were granted in such amounts and at such prices as determined by the Board of Directors, but the price per share could not be less than the fair market value of the Company's Common Stock as of the date of grant. On January 16, 2001, pursuant to the adoption of the 2001 Stock Plan (the "2001 Plan"), the 1988 plan was terminated. As of the date the plan was terminated, a total of 404,800 options had been granted and were outstanding. On December 12, 2000, the Company adopted a Non-employee Directors Stock Option Plan ("Directors Plan") pursuant to which 150,000 shares of Common Stock have been reserved for issuance to non-employee directors of the Company. The Directors Plan was approved by the Company's stockholders on March 14, 2001. Shares issued pursuant to options granted under this plan may be issued from shares held in the Company's treasury or from authorized and unissued shares. Under this plan, each Director, on an annual basis, shall be automatically granted 10,000 options upon the first business day after being elected a director. The options are immediately vested on the date of grant. Discretionary options granted pursuant to this plan shall be determined by the Board of Directors or a duly appointed stock option committee (the "Committee"). Options granted pursuant to this plan shall be nonqualified stock options as defined in Section 422 of the Internal Revenue Code, will be nontransferable and expire if not exercised after ten years from the date of grant or for such lesser term as approved by the Committee. All options shall be issued at a price per share equal to the fair market value of the Company's Common Stock as of the date of grant. F-17 VALLEY FORGE SCIENTIFIC CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 9. COMMITMENTS AND CONTINGENCIES (Continued) Stock Option Plans (Continued) - ------------------ On January 16, 2001, the Company adopted the 2001 Stock Plan (the "2001 Plan") pursuant to which 345,000 shares of Common Stock have been reserved for issuance to employees, officers and consultants of the Company. The 2001 plan was approved by the Company's stockholders on March 14, 2001. Shares issued pursuant to this plan may be issued from shares held in the Company's treasury or from authorized and unissued shares. Options granted pursuant to this plan are generally nontransferable, except in the event of a participant's death, in which case the options shall be transferable to the participant's designated beneficiary or as permitted by law. The options shall expire if not exercised after ten years from the date of grant or for such lesser term as approved by the Board of Directors or a duly appointed committee. Options issued to employees who are then later terminated for cause generally are immediately forfeited. Options may be granted in such amounts and at such prices as determined by the Board of Directors or the duly appointed committee, but the price per share shall not be less than the fair market value of the Company's Common Stock as of the date of grant in the case of an incentive stock option and not less than 85% of the fair market value of the Company's Common Stock as of the date of grant in the case of a non-qualified stock option, as defined in section 422 of the Internal Revenue Code. As referred to in Note 1, the Company has adopted the disclosure provisions of SFAS 123, and SFAS 148. As permitted under these statements, the Company retained its current method of accounting for stock compensation in accordance with APB 25. F-18 VALLEY FORGE SCIENTIFIC CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 9. COMMITMENTS AND CONTINGENCIES (Continued) Following is a summary of the Company's various stock option plans:
Weighted Average Range of Weighted Remaining Exercise Average Contractual Prices Exercise Life Shares Per Share Price (Years) ------------ ------------ ------------ ------------ Options outstanding at October 1, 2001 483,075 $1.13 - 4.25 $ 2.29 7.39 Granted 47,500 1.85 - 2.75 2.42 9.64 Exercised -- -- -- Surrendered, forfeited or expired (12,725) 1.13 - 4.25 2.55 5.38 ------------ ------------ ------------ Options outstanding at September 30, 2002 517,850 1.13 - 4.25 2.30 6.31 Granted 50,000 1.06 - 1.70 1.22 9.46 Exercised -- -- -- Surrendered, forfeited or expired (88,000) 1.50 - 3.63 3.11 2.47 ------------ ------------ ------------ Options outstanding at September 30, 2003 479,850 1.06 - 4.25 2.04 6.55 Granted 30,000 1.79 1.79 9.50 Exercised -- -- -- -- Surrendered, forfeited or expired (2,600) 1.85 - 4.25 3.79 1.63 ------------ ------------ ------------ Options outstanding at Setpember 30, 2004 507,250 $1.06 - 3.75 $ 2.01 5.96 ============ ============ ============
As of September 30, 2004, 457,250 of these options outstanding are vested and are exercisable at prices ranging from $1.06 to $3.75 which correspond to a weighted average exercise price of $1.97 and a weighted average remaining contractual life of 5.97 years. F-19 VALLEY FORGE SCIENTIFIC CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 9. COMMITMENTS AND CONTINGENCIES (Continued) Assumptions used in the Black-Scholes option valuation model to estimate the value of the Company's options included in pro forma amounts in Note 1 are as follows:
For the Years Ended September 30, ----------------------------------------------------- 2004 2003 2002 ---- ---- ---- Risk-free interest (based on U.S. Government strip bonds on the date of grant with maturities approximating the expected option term) 4.00% 3.65% - 4.00% 3.84% - 5.13% Dividend yields 0% 0% 0% Volatility factors of the expected market price of the Company's Common Stock (based on historical data) 79.70% 158.4% - 163.9% 165.1% - 169.7% Expected life of options 10 Years 10 Years 10 Years
The weighted average fair value of options granted during the years ended September 30, 2004, 2003 and 2002 were as follows:
2004 2003 2002 -------- -------- -------- Stock Prices Equal to Exercise Price $ 1.49 $ 1.21 $ 2.40 Stock Prices in Excess of Exercise Price $ -- $ -- $ -- Stock Prices Less than Exercise Price $ -- $ -- $ --
The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because the Company's stock options have characteristics significantly different from those of traded options, and because changes in subjective input assumptions can materially affect the fair value estimated, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its stock options. In management's opinion existing stock option valuation models do not provide a reliable single measure of the fair value of employee stock options that have vesting provisions and are not transferable. F-20 VALLEY FORGE SCIENTIFIC CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 9. COMMITMENTS AND CONTINGENCIES (Continued) Operating Leases - ---------------- The Company leases approximately 4,200 square feet of office and warehouse space in an office building in Oaks, Pennsylvania, from GMM Associates, a Pennsylvania general partnership, whose partners are Jerry L. Malis, Leonard I. Malis, (principal shareholders, directors, and/or officers of the Company), and the Francis W. Gilloway Marital Trust, the successor in interest to Thomas Gilloway, an officer of the Company until the time of his death on February 18, 2001. The lease which commenced on July 1, 1995 for a term of five years provided for a monthly base rent of $4,716 (with increases based on increases in the consumer price index) which include costs associated with real estate taxes, maintenance and utilities. During December 2000 the lease was extended for an additional term of five years effective as of July 1, 2000 with a monthly base rent of $4,643 (with increases on June 30th of each year based on increases in the Producer Price Index). All other terms remain the same. The related expense for this lease for the years ended September 30, 2004, 2003 and 2002 was $60,517, $59,608 and $57,740, respectively. As of September 30, 2004, the Company was current on all rental obligations due the related party. The Company has also entered into leases for certain equipment under operating lease agreements with terms ranging between two and four years. A schedule of future minimum payments under all operating leases is as follows: Years ending September 30, -------------------------- Related Other Party Operating ------------ ------------ 2005 $ 46,400 $ 22,244 2006 -- 14,958 2007 -- 9,147 2008 -- 680 ------------ ------------ $ 46,400 $ 47,029 ============ ============ 10. MAJOR CUSTOMERS For the years ended September 30, 2004, 2003 and 2002, a significant part of the Company's revenues were derived from one major customer pursuant to a distribution agreement under which the Company granted the exclusive right to sell its electrosurgical systems and other products developed by the Company in the field of neurosurgery. Revenues derived from this customer are approximately as follows: Percent of Total Revenues Revenues -------- -------- Year ended September 30, 2004 $ 4,099,000 86% Year ended September 30, 2003 $ 4,231,000 95% Year ended September 30, 2002 $ 4,515,000 90% F-21 VALLEY FORGE SCIENTIFIC CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 10. MAJOR CUSTOMERS (Continued) At September 30, 2004 and 2003, this customer accounted for approximately 87% and 93%, respectively, of the Company's accounts receivable. 11. STOCKHOLDERS' EQUITY Common Stock - ------------ On August 26, 1999, the Company filed an amended and restated Certificate of Incorporation increasing the shares of Common Stock the Company is authorized to issue from 10,000,000 to 20,000,000 shares with no stated par value. The holders of Common Stock have no preemptive rights and the Common Stock has no redemption, sinking fund or conversion provisions. Each share of Common Stock is entitled to one vote on any matter submitted to the holders and to equal rights in the assets of the Company upon liquidation. All of the outstanding shares of Common Stock are fully paid and nonassessable. In April 2000, the Board of Directors of the Company approved a stock repurchase program continuing a prior program whereby the Company may, from time to time, repurchase on the open market up to 200,000 shares of the Company's Common Stock. In August 2002, the Board of Directors of the Company voted to terminate the then existing program and approved a new program for the repurchase of up to 200,000 shares of the Company's Common Stock. During the fiscal years ended September 30, 2004, 2003 and 2002, the Company repurchased for retirement - 0 - , 127,600 and 26,500 shares at an aggregate cost of $ - 0 - , $173,316 and $46,878, respectively. Preferred Stock - --------------- The Company is authorized to issue 487 shares of preferred stock, $1,000 par value. The holders of the preferred stock would have no voting rights or preemptive rights. Upon liquidation of the Company, a $1,000 per share liquidating dividend must be paid upon each issued and outstanding share of preferred stock before any liquidating dividend is paid on the Common Stock. For each of the years ended September 30, 2004, 2003 and 2002, there were no issued or outstanding preferred shares, and the Company has no intention to issue any preferred stock in the immediate future. F-22 VALLEY FORGE SCIENTIFIC CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 12. EARNINGS PER SHARE For the Years Ended September 30, ------------------------------------ 2004 2003 2002 ---------- ---------- ---------- Basic Income Per Share: Income available to common shareholders $ 111,420 $ 108,925 $ 380,527 ========== ========== ========== Weighted average shares outstanding 7,913,712 7,960,676 8,067,286 ========== ========== ========== Basic Income Per Share $ 0.01 $ 0.01 $ 0.05 ========== ========== ========== Diluted Income Per Share: Income available to common shareholders $ 111,420 $ 108,925 $ 380,527 ========== ========== ========== Weighted average shares outstanding 7,913,712 7,960,676 8,067,286 Dilutive shares issuable in connection with stock plans 63,121 25,772 87,284 ---------- ---------- ---------- Diluted weighted average common shares outstanding 7,976,833 7,986,448 8,154,570 ========== ========== ========== Diluted Income Per Share $ 0.01 $ 0.01 $ 0.05 ========== ========== ========== Options to purchase 507,250, 479,850 and 517,850 shares of common stock were outstanding at September 30, 2004, 2003 and 2002, respectively, and 302,250, 314,850 and 68,100 of these shares were not included in the computation of diluted earnings per share in accordance with SFAS 128, as the potential shares are considered anti-dilutive. F-23 VALLEY FORGE SCIENTIFIC CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 13. PROVISION FOR INCOME TAXES Provision for income taxes is as follows: For the Years Ended September 30, ------------------------------------- 2004 2003 2002 ---------- ---------- ---------- Current: Federal $ 81,350 $ 19,075 $ 204,500 State 32,550 12,790 40,200 ---------- ---------- ---------- 113,900 31,865 244,700 ---------- ---------- ---------- Deferred: Federal (21,840) 18,392 20,703 State (2,396) 7,696 9,181 ---------- ---------- ---------- (24,236) 26,088 29,884 ---------- ---------- ---------- $ 89,664 $ 57,953 $ 274,584 ========== ========== ========== The Company's effective tax rate was 44.6%, 34.7% and 41.9% for the years ended September 30, 2004, 2003 and 2002, respectively. Reconciliation of income tax at the statutory rate to the Company's effective rate is as follows:
For the Years Ended September 30, ------------------------------------------- 2004 2003 2002 -------- -------- -------- Computed at the statutory rate 30.7 % 28.3 % 34.0 % State taxes net of federal tax benefit 6.9 7.2 6.6 Other 7.0 (0.8) 1.3 -------- -------- -------- 44.6 % 34.7 % 41.9 % ======== ======== ========
F-24 VALLEY FORCE SCIENTIFIC CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 13. PROVISION FOR INCOME TAXES (Continued) Certain items of income and expense are recognized in different years for financial reporting and income tax purposes. Deferred income taxes are provided in recognition of these temporary differences. The items that give rise to deferred income taxes are as follows:
September 30, ----------------------- 2004 2003 ---------- ---------- Deferred Tax Assets: Difference in capitalization of inventory cost $ 73,468 $ 50,670 Difference in reporting bad debts 6,284 761 ---------- ---------- Total Deferred Income Taxes $ 79,752 $ 51,431 ========== ========== Deferred Tax Liability: Difference in reporting depreciation and amortization on long-term assets $ 15,743 $ 19,950 ---------- ---------- Total Deferred Income Taxes $ 15,743 $ 19,950 ========== ==========
14. CONCENTRATIONS OF CREDIT RISK Financial instruments which potentially subject the Company to concentration of credit risk consist principally of short-term cash investments and trade receivables. The Company maintains substantially all of its banking activities with one bank and cash balances throughout the year generally exceeded the federally insured limits of the FDIC and SIPC of $100,000. The Company typically invests cash balances which exceed $100,000 in money market accounts, money market mutual funds or short-term municipal securities. At September 30, 2004 and 2003, the balances the Company held in these securities was approximately $2,234,000 and $2,163,000, respectively. As indicated in Note 10, at September 30, 2004 and 2003, accounts receivable from the Company's largest customer comprised approximately 87% and 93%, respectively, of its net accounts receivable. Because these receivables are due from a subsidiary of a major medical products company, and arose from sales pursuant to an agreement with this company, management believes that its potential credit risk associated with this receivable is minimal. F-25 VALLEY FORGE SCIENTIFIC CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 15. QUARTERLY RESULTS (UNAUDITED) The following table presents selected unaudited quarterly operating results for the Company's eight quarters ended September 30, 2004 for continuing operations. The Company believes that all necessary adjustments have been made to present fairly the related quarterly results.
First Second Third Fourth Fiscal 2004 Quarter Quarter Quarter Quarter Total - ----------- ------------ ------------ ------------ ------------ ------------ Net sales $ 1,199,469 $ 1,132,771 $ 1,274,389 $ 1,149,810 $ 4,756,439 Gross profit 644,165 620,907 652,321 522,742 2,440,135 Income (loss) from operations 121,858 13,612 109,721 (67,137) 178,054 Net income (loss) 72,979 7,579 65,006 (34,144) 111,420 Basic and diluted net income (loss) per common share $ 0.01 $ 0.00 $ 0.01 $ (0.00) $ 0.01 Fiscal 2003 - ----------- Net sales $ 1,019,942 $ 1,289,136 $ 1,081,872 $ 1,083,358 $ 4,474,308 Gross profit 486,355 665,733 583,749 473,569 2,209,406 Income from operations 60,639 45,742 43,230 5,816 155,427 Net income 40,139 29,593 37,353 1,840 108,925 Basic and diluted net income per common share $ 0.01 $ 0.00 $ 0.01 $ 0.00 $ 0.01
16. SUBSEQUENT EVENTS On October 22, 2004 the Company executed an Option Agreement with Dr. Leonard I. Malis, a director and stockholder of the Company, giving the Company the right to purchase from Dr. Malis his "Malis" trademark as registered with the U.S. Patent and Trademark Office. The Company paid Dr. Malis $35,000 for this option which terminates on September 30, 2005. This option is renewable on an annual basis through October 1, 2008, and the agreement provides a schedule of amounts that are required to be paid for each annual renewal period. If all renewal periods are utilized the total that would be paid by the Company to extend the option through September 30, 2009 would be $175,000. The exercise price of the option is $4,157,504 that would be paid with an initial payment of $159,904, and the execution of a note payable to Dr. Malis for $3,997,600 which includes interest. This note would be secured by a security interest in the Company's rights to the "Malis" trademark, and certain of the Company's patents. F-26 VALLEY FORGE SCIENTIFIC CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 16. SUBSEQUENT EVENTS (Continued) On October 25, 2004 the Company executed a Supply and Distribution Agreement ("the Agreement"), with Stryker Corporation (a Michigan corporation), ("Stryker"), which provides for the Company to supply to Stryker and for Stryker to distribute exclusively, on a world-wide basis, a generator for the percutaneous treatment of pain. The Agreement is for a term of five years after the first acceptance of the generator by Stryker, which was on November 11, 2004. There is a minimum purchase obligation that is specified by "Agreement Year". The first Agreement Year commenced on the date of the first acceptance by Stryker of a generator product delivered by the Company as ready for commercial sale, which was November 11, 2004, and ends on the last day of the calendar quarter in which the first anniversary date of such inception date occurs. In the first Agreement Year Stryker is required to make minimum purchases of $937,500 comprised of demonstration and commercial sales units. In the second and third Agreement Years, Stryker is required to make minimum purchases in each year of $487,500 of commercial sales units. On or before the beginning of the last calendar quarter of the third Agreement Year, and each Agreement Year thereafter, the Company and Stryker will conduct good faith negotiations regarding the minimum purchase obligation for the next Agreement Year. Also, during the first two months of the last calendar quarter in any Agreement Year, the Company and Stryker will conduct good faith negotiations regarding changes in prices that will take effect on the first day of the ensuing Agreement Year. Any price increase is limited to 3% over the price in effect for the preceding Agreement Year. The Agreement also provides Stryker certain rights for other new product concepts developed by the Company in both pain control and expanded market areas. The Agreement contains various terms related to the provision of repair services for the product by the Company and maintenance of spare parts, the distributor's obligation to market the product, to provide training to sales personnel, and other provisions. On October 15, 2004, the Company executed a new agreement with Codman & Shurtleff, Inc., its largest customer, ("Codman"), for the period October 1, 2004 through December 31, 2005. The agreement provides for exclusive worldwide distribution rights of the Company's existing neurosurgery products in the fields of neurocranial and neurospinal surgery until March 31, 2005, and non-exclusive rights in these fields from April 1, 2005 through December 31, 2005. The agreement also includes a price list for the specified products, and a minimum purchase obligation of $1,000,000 per calendar quarter through March 31, 2005. There is no minimum purchase obligation for the period April 1, 2005 through December 31, 2005. The agreement also provides that the above-indicated periods of exclusive and nonexclusive distribution rights can each be extended by mutual consent of the parties. F-27 VALLEY FORGE SCIENTIFIC CORP. For Fiscal Year Ended September 30, 2004 FORM 10-K EXHIBIT INDEX Exhibit 10.12 Agreement with Codman & Shurtleff, Inc. dated October 15, 2004. Exhibit 10.13 Supply and Distribution Agreement with Stryker Corporation dated October 25, 2004 Exhibit 10.14 Option Agreement for Malis Trademark with Leonard I. Malis dated October 22, 2004 Exhibit 23 Consent of Samuel Klein and Company Exhibit 31.1 Certification of Chief Executive Officer and Principal Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 Exhibit 32.1 Certification of the Chief Executive Officer and Principal Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 EX-10.12 2 ex10_12.txt EXHIBIT 10.12 Exhibit 10.12 AGREEMENT --------- This AGREEMENT ("Agreement"), dated as of October 1, 2004, by and between VALLEY FORGE SCIENTIFIC CORP. a Pennsylvania corporation with a business address of 136 Green Tree Road, Oaks, PA 19456 ("Valley Forge"), and Codman & Shurtleff, Inc. ("CODMAN") a corporation existing under the laws of Massachusetts with a business address of 325 Paramount Drive, Raynham, MA 02767. WHEREAS, CODMAN develops, manufactures, and markets medical instruments, implants and accessories for the diagnosis and treatment of conditions affecting the central nervous system; WHEREAS, Valley Forge develops, manufactures and supplies medical devices and related instrumentation and accessories used for the bipolar electrical and radio frequency surgical treatment of bodily tissues and titanium mesh products related to surgery; WHEREAS, the parties desire that CODMAN distribute Valley Forge's Existing Products (as defined below) through December 31, 2005 under the Valley Forge Patents (as defined below) pursuant to the terms of this Agreement; WHEREAS, the parties desire to set forth certain other agreements regarding Valley Forge's New Product (as defined below); and WHEREAS, the parties desire to agree upon other matters as set forth herein. NOW, THEREFORE, in consideration of the mutual promises, covenants and agreements hereinafter set forth, the parties hereto agree as follows: ARTICLE ONE DEFINITIONS ----------- As used throughout this Agreement, each of the following terms shall have the respective meaning set forth below: "Affiliate" of a party shall mean any entity or person that directly or indirectly controls, is controlled by or is under common control with such party. For purposes of this definition, "control" shall mean the possession, directly or indirectly, of the power to direct or cause the direction of the management and policies of an entity, whether through the ownership of voting securities, by contract or otherwise. 1 "Calendar Quarter" shall mean the calendar quarter customarily used by CODMAN for internal accounting purposes consisting of approximately three months in which each of the first two months consists of four weeks and the third month consists of five weeks. "Valley Forge Patents" shall mean (i) all of the Patents as defined below, (ii) all other patents and applications for patents that cover the manufacture, use, importation or sale of any Existing Product, in which Valley Forge (or any Affiliate of Valley Forge) has any rights, any foreign counterparts thereof, as well as all continuations, continuations-in-part, divisions and renewals thereof, all patents which may be granted thereon, and all reissues, reexaminations and extensions. "Field" shall mean the practice of neurocranial and neurospinal surgery. "Improvement" shall mean any adaptation, change, redesign, improvement, modification of any Existing Product (as defined below), the Specifications (as defined below) therefor, the Raw Materials (as defined below) or the method or process of manufacture or production of any Existing Product provided, however, any adaptation, change, redesign, improvement, or modification of any Existing Product which results in such Existing Product being indicated for use in applications other than those within the Field shall not be considered an Improvement. Notwithstanding anything in this Agreement to the contrary, an Improvement shall not mean the New Product, or any adaptation, change, redesign, improvement, modification of the New Product. "Know-How" shall mean all know-how relating to the development, manufacture, sale or use of any Existing Product, including, without limitation, processes, techniques, methods, products, apparatuses, biological materials and other materials and compositions which are reasonably related thereto. Notwithstanding anything in this Agreement to the contrary, Know-How shall not mean any know-how relating to the development, manufacture, sale or use of the New Product. "Manufacturing Costs" shall mean the direct labor, direct overhead and Raw Materials costs incurred in the manufacture of Existing Product. 2 "Patents" shall mean the U.S. Patents set forth on Schedule C, along with any foreign counterparts thereof, as well as all continuations, continuations-in-part, divisions and renewals thereof, all patents which may be granted thereon, and all reissues, reexaminations, extensions, patents of addition, and any subsequent improvement patents or applications, such improvement patents and applications being those the practice of which falls within the claims any of said patents. "Existing Products" shall mean the medical devices, disposables and accessory products indicated for use in the Field as described in Schedule A attached hereto. "New Product" shall mean the New Product as described in Schedule B, attached hereto. "Accessory Products" shall have the meaning set forth in Schedule A, attached hereto. "Medical Device Products" shall have the meaning set forth in Schedule A, attached hereto. "Disposable Products" shall have the meaning set forth in Schedule A, attached hereto. "Raw Materials" shall mean the materials, components, and packaging required to manufacture and to package any Existing Product in accordance with the Specifications. "Specifications" shall mean the specifications for the design, composition, product safety assurance, manufacture, packaging, and/or quality control of any Existing Products the same may hereafter be modified by mutual agreement of the parties in writing. Schedule D, attached hereto, references the document that contains the agreed upon Specifications for the Existing Products, which is made a part hereof. "Exclusivity Term" shall have the meaning set forth in Section 10.01, herein. "Extended Term" shall have the meaning set forth in Section 10.02, herein. "Exclusivity End Date" shall mean March 31, 2005, or such later date as may be mutually agreed to in writing by CODMAN and Valley Forge. 3 ARTICLE TWO SUPPLY OF PRODUCT, PRICE, OTHER TERMS ------------------------------------- 2.01 Distribution Rights. Valley Forge hereby appoints CODMAN, and CODMAN hereby accepts appointment, as Valley Forge's exclusive worldwide distributor of the Existing Products in the Field for the Exclusivity Term of this Agreement. Thereafter, Valley Forge hereby appoints CODMAN and CODMAN accepts appointment, as Valley Forge's non-exclusive worldwide distributor of the Existing Products in the Field for the Extended Term of this Agreement. Valley Forge understands and agrees that during the term of this Agreement, CODMAN may utilize its Affiliates to act as distributors hereunder in certain geographic areas, provided that CODMAN shall at all times remain responsible for performance of all of its obligations under this Agreement. (a) The parties acknowledge that Valley Forge develops, manufactures and markets through other distributors medical devices and related instrumentation indicated for use outside the Field, and that it is in the parties' mutual interest to ensure that such other products are not used in the Field during the Exclusivity Term. In the event Valley Forge becomes aware during the Exclusivity Term that any of its other distributors of its medical devices and related instrumentation intended for use outside the Field are promoting the use of such devices and/or instrumentation in the Field, Valley Forge shall take all such reasonable actions as may be permitted by law to prevent or discourage such promotion in the Field. (b) Valley Forge acknowledges that CODMAN and Dr. Leonard I. Malis have entered into a trademark/license agreement ("Trademark Agreement") for the "Malis" trademark ("Trademark"). On this date, Leonard I. Malis and CODMAN have entered into an extension of the Trademark Agreement coterminous with the Exclusivity Term and the Extended Term. Valley Forge consents to CODMAN using the "Malis" trademark in accordance with the terms of the Trademark Agreement as extended, and CODMAN consents to Dr. Leonard I. Malis entering into an option agreement with Valley Forge and transferring to Valley Forge the Trademark on terms substantially similar to the form of option agreement, attached as Exhibit A, hereto. 4 2.02 Supply of Product. During the term of this Agreement, Valley Forge shall supply all product quantities of Existing Products as required by CODMAN (and its Affiliates), subject to the terms and conditions of this Agreement, for distribution for use in the Field pursuant to this Agreement. Each such Existing Product shall be manufactured and packaged by Valley Forge or its suppliers in accordance with the Specifications. 2.03 Prices. (a) The initial price (the "Price") for each Existing Product (other than sample, special or prototype products) during the term of this Agreement is as set forth on Schedule E attached hereto. The Prices set forth in Schedule E include all costs of manufacturing and packaging in accordance with the Specifications and such Prices are F.O.B. Valley Forge's facilities in Philadelphia, PA or Oaks, PA. (b) The Prices set forth on Schedule E shall remain in effect through December 31, 2005. (c) Valley Forge hereby agrees that it shall use its good faith efforts to minimize its Manufacturing Costs of producing the Existing Products to the extent it may do so without compromising the quality of the Existing Products or compliance with terms of this Agreement. 2.04 Forecasts. The parties understand and agree that certain critical Existing Product components have significant procurement lead times, and the parties understand and acknowledge that the prices of Existing Products above the levels set forth in the forecasts will be greater than the prices set forth in Schedule E, attached hereto. Attached as Schedule F are CODMAN's forecasts for Medical Device Products and Accessory Products for the period from October 1, 2004 to December 31, 2005 and forecasts for Disposable Products for the period from October 1, 2004 to June 30, 2005. On or before March 31, 2005, CODMAN shall provide to Valley Forge its forecasts for the Disposable Products for the period from July 1, 2005 to December 31, 2005. If CODMAN does not provide to Valley Forge its projections for the Disposable Products by March 31, 2005, the projections for the period from July 1, 2005 to December 31, 2005 shall be the same as the forecasts for quantities of Disposable Products for the immediately preceding six (6) month period. Valley Forge shall be under no 5 obligation to supply CODMAN Disposable Products for the period from July 1, 2005 to December 31, 2005 in quantities in excess of 125% over the forecasted amounts for the immediately preceding six (6) month period. CODMAN will confirm these projections with the issuance to Valley Forge of its official purchase order. 2.05 Orders. CODMAN shall place any binding orders for Existing Products by written or electronic purchase order (or by any other means agreed to by the parties) to Valley Forge. Such purchase orders shall set forth the desired date of delivery with respect to the Products ordered and shall be placed at least ninety (90) days prior to such desired date of delivery for all Medical Device Products and at least sixty (60) days prior to such desired date of delivery for all Disposable Products and Accessory Products. To the extent there is any conflict or inconsistency between this Agreement and any purchase order, purchase order release, confirmation, acceptance or any similar document, the terms of this Agreement shall govern. Valley Forge shall be obligated to supply up to 110% of the quantity forecasted pursuant to Section 2.04. Orders in excess of such 110% shall be subject to acceptance by Valley Forge; provided that Valley Forge will accept such excess orders to the extent it has, and its suppliers have the manufacturing capacity to supply them. 2.06 Delivery. All charges for final packaging and transport packaging are included in the Price. All shipments must be accompanied by a packing slip that describes the articles, states the purchase order number and shows the shipment's destination. Valley Forge agrees to promptly forward the original bill of lading or other shipping receipt for each shipment in accordance with CODMAN's instructions. Valley Forge further agrees to promptly render correct and complete invoices to CODMAN, and to accept payment by check or, at CODMAN's discretion, cash or electronic transfer of funds. All invoices submitted by Valley Forge shall be payable net within thirty (30) days after the date of such invoices. The date of invoice with respect to any Existing Product shall not be earlier than the date of shipment of such Existing Product. 2.07 Shipment. Valley Forge shall ship Existing Products, at CODMAN's cost to the extent set forth in Section 2.03, to any location chosen by CODMAN utilizing carriers approved by CODMAN. The risk of loss with respect to all Existing Products shall remain with Valley Forge until the products to be shipped are loaded on to the carrier specified by CODMAN. Valley Forge will package all Existing Products in accordance with the packaging requirements included in the Specifications. 6 2.08 Minimum Purchase Requirements: (a) Existing Products. CODMAN shall purchase Existing Products from Valley Forge for the period from October 1, 2004 to March 31, 2005 in the minimum dollar amount of $1 million dollars per calendar quarter ("Minimum Dollar Purchase Obligations"). (b) The Minimum Dollar Purchase Obligations shall be proportionally reduced on a unit-for-unit product basis to the extent (i) Valley Forge is for any reason unable to supply Existing Products in accordance with the terms of this Agreement, (ii) the particular Existing Product is recalled or withdrawn from the market for reasons of product safety, efficacy, reliability or deviation from the Specifications, or (iii) a third party infringes any of the Patents and such infringement is deemed the cause for the Minimum Dollar Purchase Obligations not to be met. The Minimum Dollar Purchase Obligations for the particular Existing Product or Products shall be reduced to zero in any given year in which the Existing Product or Products are the subject of a formal claim filed in a proceeding in the U.S. by a third party asserting that the manufacture, importation, use or sale of the Existing Product or Products infringes the intellectual property rights of a third party and will be adjusted prospectively upon final resolution of such claim. If the claim is filed in a proceeding outside the U.S. for a particular product, then the Minimum Dollar Purchase Obligations for the particular Existing Product shall be reduced on a proportionate basis based on sales of the particular Existing Product in the country where the claim is filed as compared to the total worldwide sales of the same Existing Product. ARTICLE THREE ADDITIONAL OBLIGATIONS OF THE PARTIES ------------------------------------- 3.01 Sales of Existing Products. All business decisions relating to the sale, price, marketing and promotion of any Existing Product supplied under this Agreement shall be within the sole discretion of CODMAN. Valley Forge further agrees that (i) payment by CODMAN to Valley Forge of the Prices set 7 forth in Section 2.03 hereof for purchased Existing Product, and (ii) satisfying the Minimum Dollar Purchase Obligations; shall constitute complete satisfaction of any duty, whether express or implied, which could be imposed upon CODMAN to commercially exploit its rights under this Agreement and are accepted by Valley Forge in lieu of any best efforts obligations on the part of CODMAN, and the remedies for the failure to fulfill any such obligations shall be limited, as applicable, to loss of exclusivity, termination or the payment of the Price for purchased Existing Product as expressly set forth herein. 3.02 Package Labeling. CODMAN shall be responsible for the text and regulatory compliance of all package labels, labeling and Existing Product inserts used in connection with the Existing Products. For purposes of this Agreement the terms "label" and "labeling" shall have the meanings set forth in Sections 201(k) and 201(m) respectively of the U.S. Federal Food, Drug and Cosmetics Act. 3.03 Provision of Information by Valley Forge. Valley Forge shall, at the request of CODMAN, provide CODMAN with the following information relating to the Existing Products and to the extent reasonably available to Valley Forge, at no cost to CODMAN: (i) provide all relevant information on product safety, efficacy, reliability and performance characteristics; (ii) the Device Master Record and Device History Record, as defined in 21 Code of Federal Regulations, Part 820, for the Existing Products and components thereof; (iii) copies of all U.S. and foreign regulatory submissions, including any 510(k) submissions for the Existing Products; (iv) supply the written text of a technical service manual and user manual for each Existing Product in "print ready" form at no cost to CODMAN. CODMAN will supply Valley Forge with a quantity of technical service manuals and user manuals at its cost and Valley Forge will ship the same with each unit of Existing Product purchased. 3.04 Changes. In no event shall any change in form, fit or function, safety, efficacy or reliability, or the appearance of an Existing Product ("Significant Change") be made without the prior written approval of CODMAN. If the parties agree on any such change, they shall modify the Specifications to reflect the same. Valley Forge further agrees that no significant changes to the method or process of manufacture or production of any Existing Product or the Raw Materials shall be made without prior written notification to and approval of CODMAN. As used in this Section 3.04, the term "significant change" shall mean any change that (i) results in a change to the Specifications (ii) affects Existing Product performance, labeling, physical appearance or configuration, 8 software (other than debugging or other error correction which does not otherwise affect on the performance of the software), packaging, or sterilization processes, (iii) affects Product safety, reliability or integrity or (iv) requires a submission to or approval from a governmental body. In the event of any significant change, CODMAN shall have the responsibility to establish an appropriate qualification protocol, if required by CODMAN, and CODMAN and Valley Forge shall determine an appropriate inventory level for the pre-change Existing Product in order to cover on-going requirements during the qualification process. The parties will negotiate in good faith to determine the change in the purchase price, if any, which may be required by the change. 3.05 Insurance. Valley Forge agrees to procure and maintain in full force and effect during the term of this Agreement valid and collectible insurance policies in connection with its activities as contemplated hereby which policies shall provide Comprehensive General Liability coverage including Existing Products and Contractual Liability coverage in an amount not less than $5 million per occurrence. Such policy shall name CODMAN as an insured or an additional insured. Upon CODMAN's request, Valley Forge shall provide to CODMAN certificate of coverage or other written evidence reasonably satisfactory to CODMAN of such insurance coverage. Such insurance policy shall provide that in the event such insurance coverage should be materially adversely changed or terminated for any reason, the insurer thereunder will give Valley Forge and CODMAN ten (10) days' prior notice. The existence of such coverage shall in no way limit Valley Forge's liability or obligations hereunder. 3.06 Training. CODMAN shall develop and implement training programs for its sales representatives and customers with respect to the operation and maintenance of the Existing Products. Valley Forge shall be responsible for the technical accuracy of all training materials and shall assist CODMAN in preparing the technical aspects of such training programs. Valley Forge shall actively participate in training CODMAN trainers, who will in turn train CODMAN sales representatives and customers. 3.07 Governmental Registrations. CODMAN shall apply, in its name and at its cost, for all governmental registrations required for CODMAN to market Existing Products during the Exclusivity Term as a distributor in those 9 countries where CODMAN desires to market Existing Products during the Exclusivity Term, unless the applicable laws of a particular country require that such registrations be obtained by and in the name of the manufacturer of the applicable product, in which event Valley Forge shall apply for such approvals at CODMAN's cost. Valley Forge shall reasonably cooperate with CODMAN in its efforts to obtain such approvals. Valley Forge agrees that CODMAN shall have access to all of Valley Forge regulatory submissions and technical files for the Existing Products to the extent necessary to exercise its rights or fulfill its obligations hereunder. 3.08 CODMAN will: i. advertise the Existing Products in those medical journals and/or Direct Mail which in its judgment are best suited for sale of the Existing Products, a copy of such advertisement will be reviewed by Valley Forge prior to its release. In disagreements as to marketing or sales content, CODMAN shall prevail. On matters of technical description or medical use or practice, Valley Forge shall prevail. ii. show the Existing Products at the AANS and CNS and such other trade shows as mutually agreed upon by CODMAN and Valley Forge. iii. CODMAN will review its marketing plan for the Existing Products with Valley Forge on a semi-annual basis, commencing within forty-five (45) days of the signing of this Agreement. 3.09 Valley Forge shall: (a) during the Exclusivity Term provide CODMAN with field testing units of the New Product for CODMAN's evaluation and testing; provided, however, notwithstanding anything in this Agreement to the contrary, except as set forth in Section 3.11, below, CODMAN shall have no rights regarding New Product (including without limitation distribution or sales rights), except as agreed by Valley Forge in writing in Valley Forge's sole and absolute discretion. (b) use commercially reasonable efforts (i) to enter into a lease for a new facility to consolidate its existing Philadelphia and Oaks facilities into a single facility; and (ii) to occupy that facility by December 31, 2004. During the Exclusivity Term, Valley Forge will review with CODMAN from time-to-time the plans to consolidate its operations into a single facility, including its efforts to sell its existing Philadelphia facility. 10 3.10 During the Exclusivity Term, Valley Forge and CODMAN will cooperate with each other in good faith to develop mutually agreeable project plans and schedules for the review and evaluation of the New Product and will conduct project reviews no less frequently than monthly in order to enable Valley Forge to complete field testing units for the New Product by the November 30, 2004 target date. CODMAN will conduct its field testing and evaluation of New Product within ninety (90) days after the date that the field testing units of the New Product are delivered by Valley Forge to CODMAN, but in no event later than the end of the Exclusivity Period ("Evaluation Period"). 3.11 Limited Right of First Refusal for New Product During the Exclusivity Term (a) During the Exclusivity Term, prior to offering the New Product to a third party distributor to distribute or sell the New Product for use in the Field, Valley Forge shall offer CODMAN the right of first refusal to market the New Product in the Field by giving CODMAN a written notice ("New Product Notice") of the minimum purchase requirements CODMAN's purchase price for the New Product, and other terms, after which CODMAN shall have a period of thirty (30) days or until the end to the Exclusivity Term, whichever is earlier, ("New Product Decision Period") to enter into a distribution agreement for the New Product under the terms set forth in the New Product Notice or other terms mutually agreed upon in writing by Valley Forge and CODMAN ("New Distribution Agreement"). (b) In the event CODMAN (i) gives written notice to Valley Forge of its decision not to exercise its right of first refusal during the First New Product Decision Period, or (ii) if CODMAN fails to enter into a New Distribution Agreement with Valley Forge during the New Product Decision Period, then, notwithstanding anything in this Agreement to the contrary, Valley Forge may pursue other distribution opportunities for the New Product in the Field, on terms that are, in the aggregate, not less favorable to Valley Forge than the terms specified by Valley Forge in the New Product Notice or contained in the last subsequent proposal by Valley Forge to CODMAN, if any, and, in the event that Valley Forge desires to pursue such less favorable distribution opportunities, then Valley Forge shall be required (each time such situation 11 arises during the Exclusivity Term) to give a new notice to CODMAN pursuant to this Section 3.11 and comply with the right of first refusal set forth herein. (c) Notwithstanding anything in this Agreement to the contrary, the right of first refusal set forth in Section 3.11(a) and (b), above shall terminate at the end of the Exclusivity Term. (d) Furthermore, notwithstanding anything in this Agreement to the contrary, the right of first refusal in Section 3.11(a) and (b), above shall not apply to Valley Forge or any wholly-owned subsidiary marketing or selling the New Product through its own sales force or through independent sales representatives. Valley Forge (including any wholly-owned subsidiaries), however, agrees not to market or sell the New Product in the Field through its own sales force or through independent sales representatives until the earlier of the expiration of the Evaluation Period or the end of the Exclusivity Term. ARTICLE FOUR QUALITY/DEFECTIVE PRODUCT/INSPECTIONS/TESTING --------------------------------------------- 4.01 Inspections. CODMAN shall have the right, upon reasonable notice to Valley Forge and during regular business hours, to inspect and audit the facilities being used by Valley Forge (or any third party) for production and storage of Existing Products to assure compliance by Valley Forge (and its suppliers) with (i) all applicable statutes, laws and regulations, including, without limitation, Quality System Regulations ("QSRs") enforced by the United States Food and Drug Administration (the "FDA"), (ii) CODMAN Quality Assurance Policies, (iii) Johnson & Johnson Corporate Quality Assurance Requirements, and (iv) the terms and provisions of this Agreement. Valley Forge shall within fourteen days remedy or cause the remedy of any deficiencies which may be noted in any such audit or, if any such deficiencies can not reasonably be remedied within such fourteen day period, present to CODMAN a written plan to remedy such deficiencies as soon as possible; and the failure by Valley Forge to remedy or cause the remedy of any such deficiencies within such fourteen day period or to present such a plan within such fourteen day period and then use its best efforts to remedy or cause the remedy of such deficiencies in accordance with such written plan, as the case may be, shall be deemed a material breach of this 12 Agreement. Valley Forge acknowledges that the provisions of this Section 4.01 granting CODMAN certain audit rights shall in no way relieve Valley Forge of any of its obligations under this Agreement, nor shall such provisions require CODMAN to conduct any such audits. 4.02 Acceptance; Disposition of Non-Compliant Product. CODMAN shall have no obligation to pay for any Existing Product that is subject to such a claim of non-compliance with the specifications; provided CODMAN shall pay for Product within 30 days of receipt unless such Existing Product has been rejected within such 30-day period. Valley Forge shall replace at its own cost and expense, including reimbursement of freight costs incurred by CODMAN, Existing Product that fails to comply with the Specifications or other warranties made in Article Five, which replacement shall constitute CODMAN's sole and exclusive remedy therefor (but in no way limiting Valley Forge's indemnity obligations under Section 6.01). CODMAN shall notify Valley Forge of the existence and nature of any non-compliance with the specifications that comes to its attention and shall return such non-compliant Existing Product to Valley Forge within fifteen (15) days after it is rejected by CODMAN. Valley Forge shall have a reasonable opportunity, not to exceed ten (10) days from receipt of such Existing Product, to inspect such non-compliant product and provide CODMAN an explanation of the non-compliance and proposed course of action (i.e. repair (including the nature of the repair) or replacement of the Existing Product). The acceptance (or non-rejection) of any Existing Products shall in no way limit CODMAN's rights under Valley Forge product warranty or for indemnification hereunder; provided however that Valley Forge shall replace non-compliant product (i) under this Section 4.02 if found to be non-compliant within 60 days following receipt thereof by CODMAN and (ii) under Section 5.01 if found to be non-compliant after such 60 day period. 4.03 Independent Testing. If, after Valley Forge's inspections of any Existing Product, the parties disagree as to whether such Existing Product conforms to the Specifications, either party may deliver the item to an independent third-party laboratory, mutually and reasonably acceptable to both parties, for analytical testing to confirm such item's conformance to the Specifications. All costs associated with such third-party testing shall be at CODMAN's expense unless the tested item is deemed by such third-party to be not in compliance with the Specifications, in which case all such costs, including reimbursement of freight and disposition costs, shall be promptly paid by Valley Forge. No inspection or testing of or payment for Existing Product by CODMAN or 13 any third-party agent of CODMAN shall constitute acceptance by CODMAN thereof, nor shall any such inspection or testing be in lieu or substitution of any obligation of Valley Forge for testing, inspection and quality control as provided in the Specifications or under applicable local, state, or federal laws, rules, regulations, standards, codes or statutes. 4.04 Corrective Action. In the event any governmental agency having jurisdiction shall request or order, or if CODMAN shall reasonably determine to undertake, any corrective action with respect to any Existing Product, including any recall, corrective action or market action, and the cause or basis of such recall or action is attributable to a breach by Valley Forge of any of its warranties, guarantees, representations, obligations or covenants relating to that Product, then Valley Forge shall actively cooperate with CODMAN in executing such corrective action relating to Existing Product quality and performance, and Valley Forge shall reimburse CODMAN for the reasonable out of pocket costs of such action, including the cost of replacing any Existing Product which is so recalled, whether or not any such specific unit of Existing Product shall be established to be in breach of any warranty by Valley Forge hereunder: provided however, if none of the units of Existing Product returned to Valley Forge are determined to be (in accordance with the terms of Sections 4.02 and 4.03) in breach of any warranty provided by Valley Forge hereunder, then CODMAN shall reimburse Valley Forge for its reasonable out of pocket costs for such action, and CODMAN shall not offset amounts owing to Valley Forge for the cost of any Existing Product returned to Valley Forge. 4.05 Notice of Audit or Inquiry. Each party agrees to promptly notify the other of any FDA audit, or any audit by any other regulatory body, of its facilities used for the manufacture, storage or distribution of Existing Products, or any request for information from the FDA, or other regulatory body, related to the manufacture of Existing Products, as soon as practicable after it received notice of such audit or request. 4.06. Warranty Service. With the exception of disposable and limited-use products, Valley Forge agrees to perform repair, maintenance, modification and other services (including warranty repairs) on a timely basis on Existing Products purchased by CODMAN, its Affiliates, or its customers. All requests for service from customers shall be directed to CODMAN, who will arrange for the customer to ship the applicable Existing Product directly to Valley Forge. Valley Forge will repair and return product in accordance with CODMAN instructions. In the case of out-of-warranty service, Valley Forge will 14 bill CODMAN, who in turn will bill the customer. The rates for out-of-warranty service shall be agreed upon from time-to-time by CODMAN and Valley Forge. Subject to the availability of specific parts from suppliers, Valley Forge agrees to maintain an inventory for spare and replacement parts for each Existing Product sold under this Agreement if and when production ceases for a period of at least three (3) years following the delivery date of the particular Existing Product. 4.07. Medical Device Reports; It will be the duty of CODMAN to notify the FDA of any Medical Device Reports pertaining to the Existing Products. CODMAN shall notify Valley Forge at the same time that it notifies the FDA. 4.08 Recalls and Market Withdrawal: Valley Forge and CODMAN shall actively cooperate in investigating the circumstances underlying in the Medical Device Report and in responding to FDA inquiries. In the event any governmental agency having jurisdiction shall request or order, or if CODMAN shall determine, in its sole discretion, to undertake any corrective action with respect to any Existing Product (or any finished Existing Product containing or contained in any Existing Product), including any recall, corrective action or market action, and the cause or basis of such recall or action is attributable to a breach by Valley Forge of any of its warranties, guarantees, representations, obligations or covenants contained herein, then Valley Forge shall be liable, and shall reimburse CODMAN for the reasonable costs of such action including the cost of any Existing Product (or any finished Existing Product containing or contained in any Existing Product) which is affected thereby whether or not such particular Existing Product shall be established to be in breach of any warranty by Valley Forge. ARTICLE FIVE REPRESENTATIONS AND WARRANTIES ------------------------------ 5.01 (a) Valley Forge warrants to CODMAN that the Existing Products will meet the Specifications and will be free from material defects in material, workmanship and design, PROVIDED THAT: 1. The Existing Product has been installed, stored, used and maintained in strict compliance with the safety procedures, Operating Instructions and storage and handling requirements provided with the Existing Product. 15 2. Valley Forge or an authorized Valley Forge representative is notified. At such time Existing Product shall be taken out of service, as soon as notice of an alleged defect is received by CODMAN or the alleged defect appears. 3. The Existing Product has not been subject to (i) neglect, misuse or operation contrary to the Operating Instructions provided with the Existing Product or (ii) improper storage or handling contrary to the storage and handling instructions provided with the Existing Product. 4. No repairs have been attempted or parts replaced by anyone not authorized by Valley Forge to perform such repair, and that the Existing Product serial number, date stamp or other identification marks have not been removed or defaced. (a) Valley Forge's liability under this warranty is limited to the supply of replacement parts or Existing Product, or labor and parts repair at an authorized Valley Forge facility, to a value not exceeding the original Valley Forge invoice price of the Existing Product. The warranty does not include: i) Packaging, freight and insurance to and from authorized Valley Forge repair facility. ii)Existing Products not provided by Valley Forge or damage to the Existing Product that is caused by any such products. (b) Valley Forge represents and warrants that it complies and shall comply with applicable statutes, laws, ordinances, rules and regulations relating to the manufacture, assembly and supply of the Existing Product, including, without limitation, those enforced by the FDA (including compliance with QSRs and GMPs) and International Standards Organization (ISO) Rules 9,000 et seq. Valley Forge represents and warrants that it has obtained ISO 9001 certification and has where required by the applicable regulations, submitted to the FDA an application for 510K clearance for the Product and that the applications for such certification and clearance contain (or prior to certification or clearance will contain) complete and accurate information and that the information contained therein, obtained in good faith in compliance with all applicable statutes, laws, ordinances, rules and regulations. 16 5.02 Execution and Performance of Agreement. Valley Forge and CODMAN each represents and warrants to the other that it has full right, power and authority to enter into and perform its obligations under this Agreement. Valley Forge and CODMAN each `further represents and warrants to the other that the performance of its obligations under this Agreement will not result in a violation or breach of, and will not conflict with or constitute a default under any agreement, contract, commitment or obligation to which such party or any of its Affiliates is a party or by which it is bound and that it has not granted and will not grant during the term of this Agreement or any renewal thereof, any conflicting rights, license, consent or privilege with respect to the rights granted herein. 5.03 Intellectual Property. Valley Forge represents and warrants to CODMAN that Valley Forge owns all of the rights, title and interest in and to the Valley Forge Patents and Know-How and all other Valley Forge intellectual property that appear on Valley Forge intellectual property or used in connection with the Existing Products; no academic institution, member of an academic institution, corporation or other entity, or any local, state or federal government holds any property rights through it in any Existing Product; Valley Forge is able to consummate this Agreement in the capacity of a free agent; the manufacture, use and sale of the Products in accordance with the terms of this Agreement does not and will not infringe any third party's rights under any patent; the use of the Valley Forge Trademarks by CODMAN hereunder does not and will not infringe the rights of any third party; and Valley Forge is presently aware of no infringement by any third party of any Valley Forge Patent or any Valley Forge Trademark. 5.04 (a) VALLEY FORGE MAKES NO WARRANTY OTHER THAN THOSE EXPRESSLY MADE HEREIN, EXPRESS OR IMPLIED, INCLUDING WITHOUT LIMITATION, ANY WARRANTY OF MERCHANTABILITY OR OF FITNESS FOR ANY PARTICULAR PURPOSE. (b) THE ABOVE WARRANTY SHALL SUPERSEDE THE DISCLAIMER OF WARRANTIES STATEMENT WHICH IS INCLUDED IN THE OPERATING INSTRUCTIONS, OR ANY OTHER DOCUMENTATION PROVIDED WITH THE PRODUCT, TO THE EXTENT THE PROVISIONS OR SUCH DISCLAIMER OF WARRANTIES ARE INCONSISTENT WITH THIS WARRANTY. 17 (c) NOTHING CONTAINED IN THIS ARTICLE 5 SHALL IN ANY WAY LIMIT VALLEY FORGE'S INDEMNITY OBLIGATIONS UNDER SECTION 6.01. ARTICLE SIX INDEMNIFICATION --------------- 6.01 Indemnification by Valley Forge. Valley Forge shall indemnify and hold harmless CODMAN and its Affiliates and their respective officers, directors and employees from and against any and all claims, damages, lawsuits, liabilities, costs, charges, judgments and expenses (including interest, penalties and reasonable attorneys' fees) (collectively "Damages") incurred by such party arising out of or resulting from (i) material breach by Valley Forge of any of its representations, warranties, guarantees, covenants or obligations contained herein; or (ii) manufacturing defects in Existing Products Valley Forge supplied to CODMAN pursuant to this Agreement, except to the extent caused by CODMAN's distribution practices, CODMAN's advertising or promotional material for the Existing Products that has not been approved by Valley Forge, or misrepresentations of the Existing Products by CODMAN, or improper use of the Existing Products. Except for the parties to this Agreement and their affiliates, no other persons shall be a third party beneficiary of this Section 6.01. 6.02 Indemnification by CODMAN. CODMAN shall indemnify and hold harmless Valley Forge and its Affiliates and their respective officers, directors and employees from and against any and all Damages incurred by such party arising out of or resulting from (i) any material breach by CODMAN of any of its representations, warranties, guarantees, covenants or obligations contained herein or (ii) the use of the Existing Products (including personal injury and product liability claims) to the extent caused by CODMAN's distribution practices, CODMAN's advertising or promotional material for the Products that has not been approved by Valley Forge, or misrepresentations of the Existing Products by CODMAN. Except for the parties to this Agreement and their affiliates, no other persons shall be a third party beneficiary of this Section 6.02. 6.03 Claims. Each indemnified party agrees to give the indemnifying party prompt written notice of any matter upon which such indemnified party intends to base a claim for indemnification (an "Indemnity Claim") under this 18 Article Six. The indemnified party shall have the right to participate with the indemnifying party in the indemnifying party's defense, settlement or other disposition of any Indemnity Claim, subject to the ultimate control of the indemnifying party. With respect to any Indemnity Claim relating solely to the payment of money damages and which could not result in the indemnified party's becoming subject to injunctive or other equitable relief or otherwise materially adversely affect the business of the indemnified party in any manner, and as to which the indemnifying party shall have acknowledged in writing the obligation to indemnify the indemnified party hereunder, the indemnifying party shall have the sole right to defend, settle or otherwise dispose of such Indemnity Claim, on such terms as the indemnifying party, in its sole discretion, shall deem appropriate, provided that the indemnifying party shall provide reasonable evidence of its ability to pay any damages claimed and with respect to any such settlement shall have obtained the written release of the indemnified party from the Indemnity Claim. The indemnifying party shall obtain the written consent of the indemnified party prior to ceasing to defend, settling or otherwise disposing of any Indemnity Claim if as a result thereof the indemnified party would become subject to injunctive or other equitable relief or the business of the indemnified party would be adversely affected in any manner. 6.04 Survival. This Article 6 shall survive any termination of this Agreement. ARTICLE SEVEN INABILITY TO MANUFACTURE, FORCE MAJEURE --------------------------------------- 7.01 Failure to Supply. (a) During the Exclusivity Term, should Valley Force be unable to or fail for any reason, other than as set forth in paragraph 7.02 hereof, to manufacture an Existing Product in accordance with the agreed upon Specifications or quantities or to comply with applicable Good Manufacturing Practices as specified in paragraph 5.01 (a) (hereinafter referred to as a "Manufacturing Deficiency"), CODMAN within sixty (60) days of the discovery of the Manufacturing Deficiency, on ninety (90) days prior written notice to Valley Forge, may remove the particular Existing Product from the terms of this Agreement. During the ninety (90) day notice period set forth in the preceding sentence, Valley Forge will have the right to cure such Manufacturing Deficiency in order to keep the particular Existing Product in compliance with the terms of this Agreement, in which event the notice shall be null and void. 19 7.02 Force Majeure. Valley Forge shall not be liable for any failure to supply, deliver or for any delay in the delivery of the Existing Products hereunder, when any such failure or delay is caused, directly or indirectly, by fires, floods, accidents, explosions, strikes or other labor disturbances (regardless of the reasonableness of the demands or labor), wars, shortages of fuel, power, or raw materials, inability to obtain or delays of transportation facilities, acts of God, or any cause, whether similar or dissimilar, to the foregoing beyond the reasonable control of Valley Forge, as the case may be affecting Valley Forge's production and/or delivery of the Existing Products covered by this Agreement or CODMAN's acceptance or resale thereof. Such failure will be excused for three months or as long as such event shall be continuing (whichever period is shorter) provided that Valley Forge gives immediate written notice to CODMAN of the Force Majeure Event. Valley Forge shall exercise all reasonable efforts to eliminate the Force Majeure event and to resume performance. In the event the failure continues beyond three months then CODMAN may at CODMAN's option require Valley Forge to find another source (approved and qualified by CODMAN) within thirty (30) days from the end of the three month period to manufacture and supply the Existing Products in accordance with the Specifications. The provisions of this paragraph shall not serve to modify any rights CODMAN may have under paragraph 7.01 concerning Valley Forge's inability to manufacture. ARTICLE EIGHT CONFIDENTIALITY --------------- 8.01 Confidential Information. As used herein, "Confidential Information" shall mean the Specifications, the Know-How, the Manufacturing Costs, information pertaining to the New Product or any other Valley Forge product (including information obtained from the testing and evaluation of the New Product pursuant to this Agreement and Specifications and Know-How pertaining to the New Product) the Raw Materials, and all other confidential or proprietary information that is reduced to writing, marked as confidential and given to one party by the other party relating to such other party or any of its Affiliates, including information regarding any of the products of such other party or any of its Affiliates, information regarding its advertising, 20 distribution, marketing or strategic plans or information regarding its costs, productivity or technological advances. Neither party shall, during the term of this Agreement and for a period of five years following the termination or expiration of this Agreement for any reason, use, or disclose to third parties any Confidential Information of the other (except to the extent reasonably necessary to exercise its rights or comply with its obligations under this Agreement) and each party shall insure that its employees, officers and agents shall not use, or disclose to third parties any Confidential Information of the other (except to the extent reasonably necessary to exercise its rights or comply with its obligations under this Agreement); provided, however, that CODMAN may disclose Confidential Information of Valley Forge to CODMAN's Affiliates and consultants if such persons are informed of the confidential nature of such information and are under contractual obligation to CODMAN to keep such information confidential and not use or disclose such Confidential Information. Confidential Information shall not include information that (i) was already known to the receiving party at the time of its receipt thereof, as evidenced by its written records (other than information obtained from Valley Forge or from a third party that did not have the right to make a disclosure of information without violating an obligation of confidentiality), (ii) is disclosed to the receiving party after its receipt thereof by a third party who has a right to make such disclosure without violating any obligation of confidentiality, (iii) is or becomes part of the public domain through no fault of the receiving party or (iv) is required to be disclosed to comply with applicable laws or regulations or an order of a court or regulatory body having competent jurisdiction. ARTICLE NINE LICENSE RIGHTS -------------- 9.01 License Upon Bankruptcy. Valley Forge hereby grants to CODMAN an exclusive worldwide license, with the right to grant sub-licenses to its Affiliates, under the Valley Forge Patents and Know How in the Field, to use, sell, make and have made the Existing Products, and to use the Valley Forge Trademarks in connection therewith for the Exclusivity Term (collectively the "Bankruptcy License Rights"); provided, however, that the Bankruptcy License Rights granted hereunder shall be subject to the terms of Section 9.02, and shall be effective only if during the Exclusivity Term (i) a Title 11 proceeding has been voluntarily filed by Valley Forge, or filed by a third party and not dismissed within 90 days thereafter, and (ii) this Agreement has been rejected 21 in the Title 11 proceeding (a "Bankruptcy Event"). Notwithstanding anything in this Article 9 to the contrary, CODMAN shall not have any Bankruptcy License Rights, nor shall it exercise any Bankruptcy License Rights, other than after the occurrence of a Bankruptcy Event. Furthermore, notwithstanding anything in this Article 9 to the contrary, any and all Bankruptcy License Rights shall terminate at the Exclusivity Term of this Agreement. 9.02 Rights Upon Bankruptcy. All rights and licenses to Valley Forge Patents and Know-How granted under this Agreement by Valley Forge to CODMAN are, for all purposes of Section 365(n) of Title 11 of the U.S. Code ("Title 11"), licenses of rights to intellectual property as defined in Title 11. Valley Forge agrees during the term of this Agreement to create and maintain current copies or, if not amenable to copying, detailed descriptions or other appropriate embodiments, of all such Valley Forge Patents and Know-How. If a case is commenced by or against Valley Forge under Title 11, then, unless and until this Agreement is rejected as provided in Title 11, Valley Forge (in any capacity, including debtor-in-possession) and its successors and assigns (including, without limitation, a Title 11 trustee) at its option shall either perform all of the obligations provided in this Agreement to be performed by Valley Forge or provide to CODMAN all such intellectual property reasonably required to make or have made, use and sell Existing Products in the Field (including all embodiments thereof) held by Valley Forge and such permitted successors and assigns, as CODMAN may elect in a written request, immediately upon such request. If a Title 11 case is commenced by or against Valley Forge, this Agreement is rejected as provided in Title 11 and CODMAN elects to retain its rights hereunder as provided in Title 11, then Valley Forge (in any capacity, including debtor-in-possession) and its successors and assigns (including, without limitation, a Title 11 trustee) shall provide to CODMAN all such intellectual property (including all embodiments thereof) held by Valley Forge and such successors and assigns immediately upon CODMAN's written request therefor. All rights, powers and remedies of CODMAN, as a licensee hereunder, provided herein are in addition to and not in substitution for any and all other rights, powers and remedies now or hereafter existing at law or in equity (including, without limitation, Title 11) in the event of the commencement of a Title 11 case by or against Valley Forge. CODMAN, in addition to the rights, powers and remedies expressly provided herein, shall be entitled to exercise all 22 other such rights and powers and resort to all other such remedies as may now or hereafter exist at law or in equity (including Title 11) in such event. 9.03 Prosecution of Patents. Valley Forge agrees to, at its expense, prosecute, or cause to be prosecuted to allowance or rejection, and reasonably maintain, in the United States and such other countries selected by mutual agreement of Valley Forge and CODMAN, the patents and patent applications included in the Valley Forge Patents. Valley Forge shall issue as a patent each such application prosecuted to allowance. Valley Forge shall pay all government fees required to keep in force patents and applications therefor included in the Valley Forge Patents and shall submit evidence to CODMAN, upon request, that said government fees have been timely paid. 9.04 Third-Party Infringement. In the event there is infringement by a third party of any Valley Forge Patent and CODMAN becomes aware of such infringement, CODMAN shall give Valley Forge written notice to that effect, including with such written notice evidence establishing a prima facie case of infringement by such third party. Valley Forge shall bear all expenses of any suit brought by it based upon such infringement and shall retain all damages or other monies awarded or received in settlement of such suit. If, after the expiration of ninety (90) days from the date of such notice, Valley Forge has not obtained a discontinuance of such infringement or brought suit against the third party infringer, then CODMAN shall have the right, but not the obligation, to bring suit against such infringer. Valley Forge will cooperate with CODMAN in any such suit for infringement brought by CODMAN against a third party, and shall have the right to consult with CODMAN and to participate in and be represented by independent counsel in such litigation at its own expense. CODMAN shall bear all expenses of such suit, and shall retain any damages or other monies awarded or received in consequence of such litigation. 9.05 Ownership of Developments. (a) All inventions made, conceived or acquired by Valley Forge, and the intellectual property related to any Existing Product, the New Product ,or any other product including any Improvement of any such product and Know-How related to any such product shall be the exclusive property of Valley Forge. 23 (b) Except as provided in Section 9.05(a), above, all inventions made, conceived or acquired by CODMAN, and the intellectual property related thereto, will be the exclusive property of CODMAN. ARTICLE TEN TERM AND TERMINATION -------------------- 10.01 Exclusivity Term. The "Exclusivity Term" of this Agreement shall commence on October 1, 2004 and continue until March 31, 2005, or such later date that is mutually agreed to in writing by CODMAN and Valley Forge, or such earlier date as provided in this Section 10.. 10.02 Extended Term. The "Extended Term" shall be from the end of the Exclusivity Term to December 31, 2005, or such earlier date as provided in this Section 10. Notwithstanding anything in this Section 10 to the contrary, neither the Exclusivity Term nor the Extended Term shall be subject to early termination as a result of Valley Forge merging or combing with another entity. 10.03 Termination for Breach. If either Valley Forge, on the one hand, or CODMAN, on the other hand, shall materially breach any covenant, agreement or obligation under this Agreement, then the other party may give notice to terminate this Agreement by giving such party notice of such breach. The party receiving such notice shall have ninety (90) days from the date of receipt thereof to cure such breach. If such breach is not cured within such ninety (90) day period, then the non-breaching party shall have the right to terminate this Agreement effective as of the end of such period. In the event such breach is cured during such period, such notice shall be of no force or effect and this Agreement shall not be terminated. 10.04 Termination for Insolvency. Either party may terminate this Agreement upon notice if the other party makes an assignment for the benefit of creditors, is the subject of proceedings in voluntary or involuntary bankruptcy instituted on behalf of or against such party, or has a receiver or trustee appointed for all or substantially all of its property; provided that in the case of an involuntary bankruptcy proceeding, such right to terminate shall only become effective if the other party consents to the involuntary bankruptcy or such proceeding is not dismissed within ninety (90) days after the filing thereof. 24 10.05 Termination for Patent Infringement. CODMAN may terminate this Agreement at the end of a 90-day period following Valley Forge's receipt of written notice from CODMAN if a judgment from a court of competent jurisdiction in the United States holds that the manufacture, use, importation or sale of the Medical Device Products, which have not been discontinued or otherwise removed from Schedule A, infringe the patents rights of a third party. 10.06 Effect of Termination. Notwithstanding the termination of this Agreement for any reason, each party hereto shall be entitled to recover any and all damages (other than consequential damages) that such party shall have sustained by reason of the breach by the other party hereto of any of the terms of this Agreement. Termination of this Agreement for any reason shall be without prejudice to Valley Forge's right to receive all payments accrued and unpaid on the effective date of termination and shall not release either party hereto from any liability which at such time has already accrued or which thereafter accrues from a breach or default prior to such expiration or termination, nor affect in any way the survival of any other right, duty or obligation of either party hereto which is expressly stated elsewhere in this Agreement to survive such termination. In the event of termination for any reason, CODMAN shall have the non-exclusive right to continue to market and distribute the Existing Products until its inventory is fully depleted. 10.07 Survival of Certain Provisions. The provisions of this Agreement set forth in Sections 10.06 and 8.01 and Articles Six and Eleven, and any remedies for the breach thereof, shall survive the termination of this Agreement under the terms hereof. ARTICLE ELEVEN MISCELLANEOUS ------------- 11.01 Arbitration. a) Any dispute, claim or controversy arising from or related in any way to this Agreement or the interpretation, application, breach, termination or validity thereof, including any claim of inducement of this Agreement by fraud or otherwise, will be submitted for resolution to final and binding arbitration pursuant to the commercial arbitration rules then pertaining of the Center for Public Resources ("CPR"), except where those rules conflict with these provisions, in which case these provisions control. The arbitration will be held in Philadelphia, Pennsylvania. 25 b) The panel shall consist of three arbitrators chosen from the CPR Panels of Distinguished Neutrals each of whom is a lawyer specializing in business litigation with at least 15 years experience with a law firm of over 25 lawyers or was a judge of a court of general jurisdiction. In the event the aggregate damages sought by the claimant are stated to be less than $5 million, and the aggregate damages sought by the counterclaimant are stated to be less than $5 million, and neither side seeks equitable relief, then a single arbitrator shall be chosen, having the same qualifications and experience specified above. c) The parties agree to cooperate (1) to obtain selection of the arbitrator(s) within 30 days of initiation of the arbitration, (2) to meet with the arbitrator(s) within 30 days of selection and (3) to agree at that meeting or before upon procedures for discovery and as to the conduct of the hearing which will result in the hearing being concluded within no more than 9 months after selection of the arbitrator(s) and in the award being rendered within 60 days of the conclusion of the hearings, or of any post-hearing briefing, which briefing will be completed by both sides with 20 days after the conclusion of the hearings. In the event no such agreement is reached, the CPR will select arbitrator(s), allowing appropriate strikes for reasons of conflict or other cause and three peremptory challenges for each side. The arbitrator(s) shall set a date for the hearing, commit to the rendering of the award within 60 days of the conclusion of the evidence at the hearing, or of any post-hearing briefing (which briefing will be completed by both sides in no more than 20 days after the conclusion of the hearings), and provide for discovery according to these time limits, giving recognition to the understanding of the parties hereto that they contemplate reasonable discovery, including document demands and depositions, but that such discovery be limited so that the time limits specified herein may be met without undue difficulty. In no event will the arbitrator(s) allow either side to obtain more than a total of 40 hours of deposition testimony from all witnesses, including both fact and expert witnesses. In the event multiple hearing days are required, they will be scheduled consecutively to the greatest extent possible. d) The arbitrator(s) shall render their award following the substantive law of New Jersey. The arbitrator(s) shall render an opinion setting forth findings of fact and conclusions of law with the reasons therefor stated. A transcript of the evidence adduced at the hearing shall be made and shall, upon request, be made available to either party. 26 e) To the extent possible, the arbitration hearings and award will be maintained in confidence. f) The United States District Court for New Jersey may enter judgment upon any award. In the event the panel's award exceeds $5 million in monetary damages or includes or consists of equitable relief, then the court shall vacate, modify or correct any award where the arbitrators' findings of fact are clearly erroneous, and/or where the arbitrators' conclusions of law are erroneous; in other words, it will undertake the same review as if it were a federal appellate court reviewing a district court's findings of fact and conclusions of law rendered after a bench trial. An award for less than $5 million in damages and not including equitable relief may be vacated, modified or corrected only upon the grounds specified in the Federal Arbitration Act. The parties consent to the jurisdiction of the above-specified Court for the enforcement of these provisions, the entry of judgment on any award, and the vacatur, modification and correction of any award as above specified. In the event such Court lacks jurisdiction, then any court having jurisdiction of this matter may enter judgment upon any award and provide the same relief, and undertake the same review, as specified herein. g) Each party has the right before or during the arbitration to seek and obtain from the appropriate court provisional remedies such as attachment, preliminary injunction, replevin, etc. to avoid irreparable harm, maintain the status quo, or preserve the subject matter of the arbitration. h) EACH PARTY HERETO WAIVES ITS RIGHT TO TRIAL OF ANY ISSUE BY JURY. i) EACH PARTY HERETO WAIVES ANY CLAIM TO PUNITIVE OR EXEMPLARY DAMAGES FROM THE OTHER. j) EACH PARTY HERETO WAIVES ANY CLAIM OF CONSEQUENTIAL DAMAGES FROM THE OTHER EXCEPT WITH RESPECT TO ANY BREACH OF SECTION 8.01; IT BEING AGREED THAT A PARTY MUST PROVE THE EXISTANCE OF, AND ITS ENTITLEMENT TO, CONSEQUENTIAL DAMAGES WITH RESPECT TO A BREACH OF SECTION 8.01 IN ACCORDANCE WITH APPLICABLE LAW. 11.02 Publicity. Except as provided in Section 3.02, and excepting public press releases describing material events as required under applicable regulations of the Securities and Exchange Commission, neither party hereto shall originate any publicity, news release, or other announcement, written or 27 oral, whether to the public press, the trade, CODMAN's or Valley Forge's customers or otherwise, relating to this Agreement, or to performance hereunder or the existence of an arrangement between the parties without the prior written approval of the other party hereto. Valley Forge shall not use the name of Johnson & Johnson, CODMAN, or any of its Affiliates for advertising or promotional purposes without the prior written consent of CODMAN. 11.03 Headings. The Article and Section headings contained in this Agreement are for reference purposes only and shall not affect in any way the meaning and interpretation of this Agreement. 11.04 Notices. All notices and other communications hereunder shall be in writing. All notices hereunder of an Indemnity Claim, a Force Majeure Event, default or breach hereunder, or, if applicable, termination of the term hereof, or any other notice of any event or development material to this Agreement taken as a whole, shall be delivered personally, or sent by national overnight delivery service or postage pre-paid registered or certified U.S. mail, and shall be deemed given when delivered, if by personal delivery or overnight delivery service, or three business days after deposit in the mail, if sent by U.S. mail, and shall be addressed as follows: If to Valley Forge: Valley Forge Scientific Corp. 136 Green Tree Road P.O. Box 1179 Oaks, PA 19456 Fax: (610) 666 7565 Attention: President with a copy to: Russell U. Schenkman, Esq. Schenkman Jennings & Howard, LLC 13 Roszel Road Suite C225 Princeton, NJ 08540 If to CODMAN: Codman & Shurtleff, Inc. 325 Paramount Drive Raynham, MA 02767-0350 Attention: President 28 with a copy to: General Counsel Johnson & Johnson One Johnson & Johnson Plaza New Brunswick, NJ 08933 or to such other place as either party may designate by written notice to the other in accordance with the terms hereof. 11.05 Failure to Exercise. The failure of either party to enforce at any time for any period any provision hereof shall not be construed to be a waiver of such provision or of the right of such party thereafter to enforce each such provision. 11.06 Assignment. This Agreement, or any of the rights and obligations created herein, shall not be assigned or transferred, in whole or in part, by either party hereto without the prior written consent of the other party; provided, however, that either party shall have the right to assign any or all of its rights or obligations under this Agreement to any Affiliate, or a successor to that part of its business to which this Agreement relates. Any attempted assignment or transfer of such rights or obligations without such consent, except as provided herein, shall be void. Subject to the foregoing sentence, this Agreement shall bind and inure to the benefit of the parties hereto and their respective successors and assigns. 11.07 Severability. In the event that any one or more of the provisions (or any part thereof) contained in this Agreement or in any other instrument referred to herein, shall, for any reason, be held to be invalid, illegal or unenforceable in any respect, then to the maximum extent permitted by law, such invalidity, illegality or unenforceability shall not affect any other provision of this Agreement or any other such instrument. Any term or provision of this Agreement which is invalid, illegal or unenforceable in any jurisdiction shall, to the extent the economic benefits conferred by this Agreement to both parties remain substantially unimpaired, not affect the validity, legality or enforceability of any of the terms or provisions of this Agreement in any other jurisdiction. 11.08 Relationship of the Parties. The relationship of CODMAN and Valley Forge established by this Agreement is that of independent contractors, and nothing contained herein shall be construed to (i) give either party any right or authority to create or assume any obligation of any kind on behalf of the other or (ii) constitute the parties as partners, joint venturers, co-owners or otherwise as participants in a joint or common undertaking. 29 11.09 Competing Products. Valley Forge recognizes and acknowledges that CODMAN (and its Affiliates) has been, and will continue to be, actively involved in the design, development and marketing of instruments and accessories for the treatment of neurological and spinal disorders. Except for the Existing Products in Schedule A, CODMAN shall not, during the Exclusivity Term of this Agreement market for specific use in the central nervous system (i.e. the cranial cavity and spinal column), itself or through any third parties, bipolar generators and associated products for use with the bipolar generators, irrigators, integrated cord and tubing sets (except as noted in Schedule A), footswitches, footpedals, footswitch cables, generator remote controls, or disposable hand-held surgical bipolar electrosurgery pens, disposable hand-held surgical bipolar electrosurgery coagulation balls, or disposable hand-held surgical bipolar electrosurgery loops; it being agreed by Valley Forge that nothing contained in this Section 11.09 shall restrict an Affiliate of CODMAN from engaging in any of the above described activities independently of CODMAN, provided such Affiliates do not have access to, or use, Valley Forge's confidential information. Furthermore, it being agreed that nothing contained in this Section 11.09 shall restrict CODMAN during the Exclusivity Term from marketing or selling its own or another bipolar generator solely for the use in the field of the percutaneaous pain treatment, but in no other field. Subject to the confidentiality provisions in this Agreement and other agreements entered into between CODMAN and Valley Forge, after the Exclusivity Term, CODMAN shall be free to market or sell its own or another manufacturer's bipolar generators, associated products for use with such bipolar generators, irrigators, integrated cord and tubing sets, footswitches, footpedals, footswitch cables, generator remote controls, disposable hand-held surgical bipolar electrosurgery pens, disposable hand-held surgical bipolar electrosurgery coagulation balls, or disposable hand-held surgical bipolar electrosurgery loops. 11.10 Entire Agreement. It is the desire and intent of the parties to provide certainty as to their future rights and remedies against each other by defining the extent of their undertakings herein. This Agreement constitutes and sets forth the entire agreement and understanding between the parties with respect to the subject matter hereof and is intended to define the full extent of the legally enforceable undertakings of the parties hereto, and no promise, agreement or representation, written or oral, which is not set forth explicitly in this Agreement is intended by either party to be legally binding. Each party 30 acknowledges that in deciding to enter into this Agreement and to consummate the transactions contemplated hereby it has not relied upon any statements, promises or representations, written or oral, express or implied, other than those explicitly set forth in this Agreement. This Agreement supersedes all previous understandings, agreements and representations between the parties, written or oral, with respect to the subject matter hereof. 11.11 Counterparts. This Agreement may be executed in one or more counterparts, each of which shall be deemed an original, but all of which together shall constitute one and the same instrument. 11.12 Expenses. Each party shall pay all of its own fees and expenses (including all legal, accounting and other advisory fees) incurred in connection with the negotiation and execution of this Agreement and the arrangements contemplated hereby. 11.13 Modifications and Amendments. This Agreement shall not be modified or otherwise amended except pursuant to an instrument in writing executed and delivered by each of the parties hereto. 11.14 Construction. The parties have participated jointly in the negotiation and drafting of this Agreement. In the event an ambiguity or question of intent or interpretation arises, this Agreement shall be construed as if drafted jointly by the parties and no presumption or burden of proof shall arise favoring or disfavoring any party by virtue of the authorship of any of the provisions of this Agreement. 11.15 Governing Law. This Agreement shall be governed by, and construed in accordance with, the laws of the State of New Jersey, without giving effect to the choice of law provisions thereof. 11.16 Incorporation of Exhibits and Schedules. The Exhibits and Schedules identified in this Agreement are incorporated herein by reference and made a part hereof. 31 IN WITNESS WHEREOF, the parties hereto intending legally to be bound hereby, have each caused this Agreement to be duly executed as of the date first above written. VALLEY FORGE SCIENTIFIC CORP. By: /s/ JERRY L. MALIS ------------------------------ Jerry L. Malis CEO and President Date: October 15, 2004 ---------------------------- CODMAN & SHURTLEFF, INC. By: /s/ GLEN A. KASHUBA ------------------------------ Glen A. Kashuba Worldwide President Date: October 15, 2004 ---------------------------- 32 EX-10.13 3 ex10_13.txt EXHIBIT 10.13 Exhibit 10.13 SUPPLY AND DISTRIBUTION AGREEMENT THIS AGREEMENT is made and effective the 25th day of October, 2004 ("Effective Date") between Valley Forge Scientific Corp., a Pennsylvania corporation, ("VFS"), and Stryker Instruments Division of Stryker Corporation, a Michigan corporation ("Distributor"). WITNESSETH WHEREAS, VFS designs, develops, manufactures and sells bipolar electronic systems and stimulators; WHEREAS, Distributor designs, develops, manufactures and markets medical devices, including devices for the treatment of chronic pain; WHEREAS, VFS and Distributor entered into a certain Development Agreement dated as of September 6, 2002 (the "Development Agreement") pursuant to which they collaborated to determine the feasibility of the commercialization of certain products, which Development Agreement has terminated in accordance with its terms; WHEREAS, as a result of the collaboration under the Development Agreement, VFS desires to manufacture and supply to Distributor certain products, which are more fully described in Schedule A, as the same may be amended or supplemented from time to time by an instrument executed on behalf of each of VFS and Distributor (the "Products"), all in accordance with the terms and conditions set forth herein; and WHEREAS, Distributor desires to purchase Products from VFS and distribute the Products throughout the world for use solely in connection with the percutaneous treatment of pain (the "Field"). NOW, THEREFORE, in consideration of the foregoing and the mutual covenants and agreements contained herein and intending to be legally bound, the parties agree as follows: SECTION I SUPPLY AGREEMENT 1. Supply Requirements. 1.1 Distributor agrees to purchase from VFS and VFS agrees to sell to Distributor the Products on the terms set forth in this Agreement solely for use in the Field. 1.2 (a) VFS shall deliver to Distributor, for Distributor's inspection, a reasonable number of preproduction quality samples of each of the Products ("Inspection Samples") as agreed upon by the parties which conform to the specifications, consisting in the case of the Products designated as the Generator Product thereon (the "Generator Product") of the relevant manufacturing specifications and subsidiary detail specifications, as set forth in Schedule A, and drawings agreed upon by Distributor and VFS ("Specifications"), including reports documenting that the Products have been inspected and tested. (b) Distributor shall provide to VFS any objections it has concerning the conformance of the Inspection Samples to the Specifications within thirty (30) days after receipt of the Inspection Samples (the "Inspection Period") and VFS shall make such changes to Products prior to production. If no objections are received by Distributor during the Inspection Period, the Inspection Samples shall be deemed acceptable by Distributor. The Inspection Period for the Inspection Samples of the initial Products covered by this Agreement that are listed in Schedule A on the Effective Date shall be known as the "Initial Inspection Period". 1.3 On or prior to the end of the Initial Inspection Period, Distributor shall deliver to VFS a forecast of Distributor's requirements for Products during the initial six-month period after the Initial Inspection Period. On or before the last day of each month after the Initial Inspection Period and during the Term, Distributor shall deliver to VFS a six-month rolling forecast of Distributor's requirements for Products. Each forecast shall specify the quantities of each Product and the projected shipment dates therefor. The first three months of the initial six-month forecast shall represent Distributor's binding purchase order for the quantities of Products specified therein. For each six-month rolling forecast thereafter, the third month of such rolling forecast shall be Distributor's binding purchase order for the quantities specified therein. VFS shall not be obligated to supply quantities of Products in excess of those quantities subject to binding purchase orders. VFS, however, shall use its commercially reasonable efforts to deliver to Distributor, pursuant to purchase orders, quantities of Products even if Distributor has modified a projection of Product requirements for such quantities. Three (3) months prior to the end of each Agreement Year (as defined below) during the term of this Agreement, Distributor and VFS shall meet to review the projected quantity mix of Products for purchase during the next Agreement Year for manufacturing planning purposes. 1.4 It is understood that the terms of this Agreement shall supersede any conflicting terms of purchase orders for all purchases of Products. 1.5 Distributor and VFS have agreed upon the following minimum purchase requirements (the "Initial Products Minimum") for the first three (3) Agreement Years for the Generator Product: Initial Agreement Year Products Minimum -------------- ---------------- 1 * 2 * 3 * 2 For purposes of this Agreement, the term "Agreement Year" shall mean the period beginning on the date of the first acceptance by Distributor of a Generator Product delivered by VFS to Distributor as ready for commercial sale (Distributor shall diligently and in good faith promptly evaluate the "readiness for commercial sale" of the Generator Product that VFS has delivered to Distributor) and ending on the last day of the calendar quarter in which the first anniversary date of such date occurs, unless such anniversary date is the first day of a calendar quarter, in which case the first Agreement Year shall end on the last day of the preceding calendar quarter, and each successive twelve (12)-month period thereafter. On or before the beginning of the last calendar quarter of the third Agreement Year and each Agreement Year thereafter, VFS and Distributor shall conduct good faith negotiations regarding the Initial Products Minimum for the next Agreement Year. In the event that one or more new products have been added to Schedule A as contemplated by Section I, Paragraph 1.6(a), a separate minimum purchase requirement shall be agreed for each Product that is a New Field Product ("New Product Minimum"). Notwithstanding the foregoing, the minimum purchase requirements shall be reduced for each Agreement Year to the extent that (i) VFS shall fail to deliver Products, subject to binding purchase orders with a projected shipment date during such Agreement Year, within thirty (30) days after the projected shipment date but, in any event, during such Agreement Year, and/or (ii) VFS has been advised by Distributor in writing and in timely manner that Products delivered during such Agreement Year do not conform to the requirements of Section I, Paragraph 4 (which writing shall specify in reasonable detail how the Products do not conform to the requirements of Section I, Paragraph 4) and, if it is determined that such Products do not conform to the requirements of Section I, Paragraph 4, replacements conforming to the requirements of Section I, Paragraph 4 have not been delivered during such Agreement Year. 1.6 (a) If during the term of this Agreement, VFS develops or acquires rights to any new product indicated for use in the Field ("New Field Product") then, prior to offering such New Field Product to a third party for use in the Field, VFS shall offer Distributor the right of first refusal to market the New Field Product in the Field under the terms of this Agreement", by giving Distributor a written notice ("New Field Product Notice") of the product specifications, intended use, projected availability, Distributor's purchase price for the New Field Product, the applicable New Product Minimum, and other terms, after which Distributor shall have thirty (30) days ("First New Field Product Decision Period") to inform VFS in writing of its interest to market such product under the terms proposed, subject to satisfactory review of a "Field Ready Prototype" of such New Field Product; provided, however, that Distributor shall have no rights to any new product for which the idea was initially brought to VFS by a third party unless VFS in writing seeks Distributor's input in connection with the development thereof, in which case the parties shall agree in advance as to Distributor's rights. During the First New Field Product Decision Period, VFS shall provide to Distributor such information reasonably available to VFS, which Distributor reasonably requires regarding the new product, subject to confidentiality and non-disclosure provisions in this Agreement. The term "Field Ready Prototype" shall mean a prototype functionally ready to be used in the indicated clinical testing applications, except for complying with applicable government regulations related to such testing, which shall be the sole responsibility of Distributor. In the event Distributor gives written notice to VFS of its decision not to exercise its right of first refusal during the First New Field Product Decision Period, or fails to give written notice to VFS of its decision to 3 exercise its right of first refusal within said First New Field Product Decision Period, then, notwithstanding anything in this Agreement to the contrary, VFS may pursue other distribution opportunities for the New Field Product in the Field, on terms that are, in the aggregate, not less favorable to VFS than the terms specified by VFS in the New Field Product Notice or contained in the last subsequent proposal by VFS to Distributor, if any, and, in the event that VFS desires to pursue such less favorable distribution opportunities, then VFS shall be required (each time such situation arises) to give a new notice to Distributor pursuant to this Paragraph 1.6(a) and comply with the right of first refusal set forth herein for an additional thirty (30)-day period following the receipt of such new notice by Distributor. In the event Distributor gives written notice to VFS of its decision to exercise its right of first refusal during the First New Field Product Decision Period, VFS shall provide to Distributor a Field Ready Prototype of the New Field Product when such prototype is available, after which Distributor shall have ninety (90) days to determine whether the Field Ready Prototype is acceptable to Distributor ("Second New Field Product Decision Period") and to agree in writing to have the New Field Product be added to Schedule A of this Distribution Agreement under the terms set forth in the New Field Product Notice, whereupon the parties shall agree upon the initial production run purchases and add such New Field Product to Schedule A. Notwithstanding the foregoing, the Second New Field Product Decision Period shall be extended to forty-five (45) days after receipt of the necessary government approvals, if any, for the clinical testing of the Field Ready Prototype of the New Field Product provided that Distributor has in good faith commenced the effort to obtain such approvals promptly after giving written notice of its decision during the First New Field Product Decision Period to exercise its right of first refusal with respect to such New Field Product and using commercially reasonable efforts has diligently pursued the obtaining of such approvals until such approvals are obtained. During the Second New Field Product Decision Period, VFS shall provide to Distributor such information reasonably available to VFS, which Distributor reasonably requires regarding the new product, subject to confidentiality and non-disclosure provisions in this Agreement. In the event Distributor gives written notice to VFS of its decision not to exercise its right of first refusal during the Second New Field Product Decision Period, or fails to give written notice to VFS of its decision to exercise its right of first refusal within said Second New Product Decision Period, then, notwithstanding anything in this Agreement to the contrary, VFS may pursue other distribution opportunities in the Field, for the New Field Product on terms that are, in the aggregate, not less favorable to VFS than the terms specified by VFS in the New Field Product Notice or contained in the last subsequent proposal by VFS to Distributor, if any, and, in the event that VFS desires to pursue such less favorable distribution opportunities, then VFS shall be required (each time such situation arises) to give a new notice to Distributor pursuant to this Paragraph 1.6(a) and comply with the right of first refusal set forth herein for an additional thirty (30)-day period following the receipt of such new notice by Distributor. (b) During the term of this Agreement, prior to offering a new product indicated for use in lesion/ablation applications in conjunction with generator products with the same features and technical specifications as the Generator Product ("New Outside Product") to a third party distributor to distribute or sell the New Outside Product for use in the field of orthopedic surgery, ENT, craniomaxillofacial surgery or head and neck surgery (individually an "Expanded Field" and collectively "Expanded Fields"), VFS shall offer Distributor the right of first refusal to market the New Outside Product by 4 giving Distributor a written notice ("New Outside Product Notice") of the minimum purchase requirements, the particular Expanded Fields where the New Outside Product is indicated for use, Distributor's purchase price for the New Outside Product, product features and benefits, general specifications and other terms, after which Distributor shall have a period of thirty (30) days after delivery of a Field Ready Prototype of such New Outside Product ("New Outside Product Decision Period") to enter into a distribution agreement for the New Outside Product under the terms set forth in the New Product Notice that VFS plans to offer such New Outside Product to a third party distributor ("New Distribution Agreement"). In the event the Distributor (i) gives written notice to VFS of its decision not to exercise its right of first refusal during the New Outside Product Decision Period, or (ii) if Distributor fails to enter into a New Distribution Agreement with VFS during the New Outside Product Decision Period, then, notwithstanding anything in this Agreement to the contrary, VFS may pursue other distribution opportunities for the New Outside Product in the Expanded Field(s) designated in the New Outside Product Notice, on terms that are, in the aggregate, not less favorable to Valley Forge than the terms specified by VFS in the New Outside Product Notice or contained in the last subsequent proposal by VFS to Distributor, if any, and, in the event that VFS desires to pursue such less favorable distribution opportunities, then VFS shall be required (each time such situation arises during the term of this Agreement) to give a new notice to Distributor pursuant to this Paragraph 1.6(b) and comply with the right of first refusal set forth herein for an additional thirty (30)-day period following the receipt of such new notice by Distributor. Notwithstanding anything in this Agreement to the contrary, the right of first refusal in this Paragraph 1.6(b) shall not apply to (i) the marketing or sale by VFS (including a Permitted Assignee as defined in Section III, Paragraph 8.3) or its subsidiaries or other affiliates of any product through its own sales force or through independent sales representatives and (ii) any neurocranial or neurospinal application of any product. (c) Notwithstanding anything in this Agreement to the contrary, the rights of first refusal set forth in this Paragraph 1.6 shall terminate upon the earlier of (i) the termination of this Agreement or (ii) upon the failure of Distributor to satisfy the Initial Products Minimum or a New Product Minimum, as the case may be, for any Product or New Field Product as set forth in Section I, Paragraph 1.5, herein. 1.7 (a) If Distributor does not meet the Initial Products Minimum and/or a New Product Minimum for an Agreement Year, Distributor may, at its option, nevertheless be deemed to have fulfilled such obligation by paying VFS an amount (the "shortfall amount") equal to fifty percent (50%) of the difference between (A) the amount Distributor would have paid to VFS had it fulfilled such minimum purchase requirement for such Agreement Year and (B) the amount Distributor has paid (or will pay) for the applicable Product or Products actually purchased during such Agreement Year. Such payment, if made, shall be due within thirty (30) days following the end of the such Agreement Year in which Distributor did not fulfill its minimum purchase requirement. 5 (b) If Distributor does not meet the Initial Products Minimum and/or a New Product Minimum (or pay the applicable shortfall amount pursuant to Paragraph 1.7 (a)) during an Agreement Year, VFS shall have the right to terminate this Agreement, with respect only to the Products that are listed on Schedule A on the Effective Date if the failure relates to the Initial Products Minimum and/or with respect only to the applicable New Field Product if the failure relates to one or more New Product Minimums, upon ninety (90) days prior written notice to Distributor, such notice to be given not later than fifteen (15) business days after the expiration of the 30-day period referred to in Paragraph 1.7(a). The parties agree that, notwithstanding anything to the contrary in this Agreement, if they mutually agree that material changes in market conditions have occurred, then they will in good faith renegotiate the Initial Product Minimums and/or the applicable New Product Minimums rather than terminate this Agreement. 2. Prices and Payment. 2.1 During the first Agreement Year, pricing of Products shall be according to the terms set forth in Schedule B attached hereto. 2.2 Upon the request of either party, the parties shall negotiate in good faith during the first two months of the fourth quarter of each Agreement Year with respect to changes in the pricing of Products to be effective on the first day of the second Agreement Year and of each Agreement Year thereafter. Such negotiations shall take into account, among other things, the competitive market conditions then existing, the cost of materials and labor, quantities of Products to be purchased by Distributor and economic conditions. The price in effect for any Product for any Agreement Year shall, however, not increase by more than three percent (3%) over the price in effect for the preceding Agreement Year. Price increases resulting from improvements or changes in a particular Product shall be negotiated in good faith by both parties prior to the delivery of the improved or changed Product and shall not be subject to the foregoing limitation on the amount of increase. 2.3 Payment to VFS for Products shall be made forty-five (45) days following the date of the invoice from VFS (which shall be no earlier than the date of shipment) for Products specified in purchase orders and not rejected by Distributor for nonconformance pursuant to Section I, Paragraph 4.1. All payments to VFS under this Agreement shall be made in U.S. dollars. All payments due under this Agreement not made on their due date shall bear interest at the lesser of (i) one and one-half percent (1.5%) per month and (ii) the maximum lawful interest rate permitted under applicable law. 3. Shipment. 3.1 All sales of Products shall be F.O.B. VFS's factory at the prices set forth in Schedule B, which prices shall be exclusive of freight, insurance and taxes. VFS shall, at Distributor's cost, ship the Products to any location chosen by Distributor, utilizing carriers chosen by Distributor. Title and risk of loss or damage to the Products shall pass to Distributor at the time they are loaded on to the carrier specified by Distributor. 6 3.2 Unless otherwise agreed in advance, all Products, inclusive of operating and service manuals and complete standard sets of accessories, shall be packed, labeled, marked and otherwise prepared for shipment by VFS in such a way as to be acceptable to carriers and in accordance with good commercial practice, so as to minimize risk of loss or damage in transit. An itemized packing list and Product inspection report in the form set forth in Schedule C attached hereto shall accompany each shipment. 4. Specifications, Testing, and Warranty. 4.1 VFS agrees to sell the Products to Distributor for use in the Field, for the term of this Agreement and warrants that such Products will meet the Specifications or such modified specifications as may be agreed upon in writing by Distributor and VFS. Distributor shall have a period of thirty (30) days from date of receipt of Products to inspect and accept Products that conform to the Specifications or reject Products that do not conform to the Specifications. Rejection of non-conforming Products by Distributor shall not excuse VFS from its obligations to deliver Products pursuant to this Agreement. 4.2 VFS reserves the right to make engineering changes that do not affect the form, fit, function, performance or appearance of the Products and that do not require regulatory approval without the prior approval of Distributor; provided, however, that VFS shall provide Distributor with notice of such change as promptly as practical after VFS's final internal approval of such change. With regard to all other material changes to the Products, VFS agrees to give Distributor written notice and to simultaneously provide Distributor with Specifications for the changes. No changes relating to the form, fit, function, performance or appearance will be made to any Products supplied to Distributor at any time without the prior written approval or deemed approval as provided below of Distributor. Distributor agrees to inform VFS of its approval or disapproval of changes relating to the form, fit, function, performance or appearance of the Products within thirty (30) days after receiving notice of any such proposed changes. If Distributor does not respond to VFS within said thirty (30)-day period, the change will be deemed to have been approved. 4.3 Distributor may request, in writing, that VFS change the Specifications or otherwise incorporate changes into the Products and/or develop customized Products for Distributor. Such request will include a description of the proposed changes that will reasonably permit VFS to evaluate the cost and feasibility. Within forty-five (45) days after receiving such a request from Distributor, VFS will advise Distributor whether it is reasonably able to make such changes and, if so, the timetable and terms and conditions under which it would make such changes, and any resulting increase or decrease in prices hereunder. VFS's evaluation shall be in writing and, if it is reasonably able to make the change, it shall also state the impact on delivery schedules for Products covered by pending purchase orders hereunder. If, after good faith negotiations, Valley Forge and Distributor agree upon the terms of the changes, then this Agreement, the Specifications, delivery schedules and pricing schedule will be amended accordingly. i. Unless otherwise agreed to in writing by VFS and Distributor, purchases by Distributor of more customized products shall not be credited to Distributor in meeting the dollar amount of the minimum purchase requirement pursuant to Section I, Paragraph 1.5. 7 ii VFS shall not unreasonably refuse to incorporate the changes or develop a more customized product when requested by Distributor . 4.4 Within the times specified in this Paragraph 4.4, Distributor shall have the right to return to VFS, for full credit/refund plus cost of freight, any Product that is defective or fails to comply with the Specifications, provided, however, that such defect or failure is in no way the result of any modification to the Product, improper repair, or of any damage (assuming proper packaging for transportation by VFS) to the Product after loaded on to the carrier specified by Distributor. Notwithstanding failure of Distributor to inspect and/or return any shipment, or its acceptance of any shipment, Distributor shall be entitled to return to VFS, for either repair, free of charge, credit/refund or exchange, at VFS's option, any Product that is defective or fails to comply with the Specifications if returned by Distributor within one (1) year after shipment of Generator Product by Distributor to its end user or ninety (90) days after shipment of any other Product by Distributor to its end user. Notwithstanding anything in this Agreement to the contrary, the use of any instrument other than one approved by VFS for use with the Generator Product shall void all warranties contained in this Agreement with regard to the Generator Product. 4.5 In the event it is discovered by Distributor, and VFS is notified by Distributor within the time periods stated in Section I., Paragraph 4.4 hereof, that a Product is defective or fails to comply with the Specifications, Distributor shall return the Product to VFS and specify in writing the alleged complaint, Product code, serial number, if there is one, and the return address of Distributor or the end user if the Product is to be drop shipped to the end user. VFS will, at its option and at its expense, either repair or replace such defective Product within fifteen (15) business days after its return by Distributor, freight prepaid to VFS at its repair facility, and receipt by VFS at such facility. If VFS determines that the returned Product has been abused by the end user, VFS shall provide Distributor with a quote for repair of the Product and Distributor shall either agree to pay for the repair, parts, labor and calibration or instruct VFS to return the Product to Distributor without repairs. In either case, Distributor shall pay the freight for return of the Product to Distributor. VFS shall charge Distributor for any such repair, parts, labor and calibration as set forth in Section I, Paragraph.4.6 hereof. 4.6 VFS agrees to provide repair, maintenance, modification and other services on a timely basis on units of the Generator Product purchased by Distributor or its end user at $125.00/hour (as increased by the percentage increase (if any)in the Consumer Price Index (CPI), as defined by the U.S. Department of Labor, Bureau of Labor Statistics measured as of the ninth month of the then current Agreement Year as compared to the CPI measured as of December 2002), plus the charges for repair parts. Notwithstanding the foregoing sentence, the hourly rate that VFS charges Distributor for such services shall not exceed the lowest rate that VFS charges any other customer for similar services. Upon request by Distributor, VFS shall provide to Distributor its then current price list for spare or replacement parts for Generator Products. VFS agrees to maintain an inventory of spare and replacement parts for the Generator Product if and when production ceases for a period of at least five (5) years 8 following the last delivery date of a Generator Product to Distributor. VFS agrees to refurbish Generator Products at a cost agreed upon annually by VFS and Distributor. 4.7 VFS MAKES NO WARRANTY OTHER THAN THOSE EXPRESSLY MADE HEREIN, EXPRESS OR IMPLIED, INCLUDING WITHOUT LIMITATION, ANY WARRANTY OF MERCHANTABILITY OR OF FITNESS FOR ANY PARTICULAR PURPOSE. 5. Compliance With Laws and Regulations. 5.1 VFS represents and warrants that it is and, during the term of this Agreement, will continue to be (i) a Domestic Device Establishment, registered with the FDA and (ii) ISO 9001 and EN 46001 certified. VFS further represents and warrants that all Products sold and delivered to Distributor under this Agreement shall be manufactured in accordance with the Specifications, applicable industry standards and current Good Manufacturing Practices ("cGMPs") as set forth in the Quality System Regulation promulgated by the FDA and found in Code of Federal Regulations, Title 21 Part 820 (the "QSR") and in accordance with all United States applicable statutes, laws, standards and regulations (including, but not limited to, the United States Medical Devices Amendments of 1976) and the regulations promulgated thereunder, including the QSR, that are applicable to the Products. VFS agrees to provide Distributor with copies of its FDA registration, ISO 9001 certificate and EN 46001 certificate. 5.2 Distributor, upon reasonable advance notice to VFS during normal business hours, may on an annual basis visit VFS manufacturing facilities to observe VFS quality assurance procedures for testing, packaging and shipping during VFS's initial production runs of the Products and shall have the right to evaluate VFS's manufacturing, documentation control, inspection and calibration systems. Such visits by Distributor personnel will be mutually scheduled by Distributor and VFS. 5.3 VFS shall notify Distributor of any FDA audit, or any audit from any other regulatory body, of its facilities for the manufacture of the Products, or any request for information from the FDA or other regulatory body related to the manufacture of the Products, as soon as practicably possible after receipt of such notice of such audit or such request. VFS shall notify Distributor as soon as practicable after receiving notice of any claim or action by the FDA or other regulatory body stating any non-compliance with this Paragraph 5 or any notice with respect to any violation of applicable statutes, laws, rules or regulations. Both parties shall notify each other of any adverse reaction, malfunction, injury or other similar claims with respect to the Products or the devices in which they are incorporated, of which either party becomes aware. The parties shall discuss and determine the responsibility for the investigation of all such complaints and the responsible party shall forward to the other a summary of its findings with respect thereto. Distributor shall be responsible for managing all customer and end-user communications with respect to such complaints and for filing any medical device report required to be filed with the FDA and vigilance reports required to be filed with regulatory authorities in other jurisdictions in which the Products are marketed. Nothing 9 herein shall preclude either party from taking any action that it is required to take under applicable law or regulation. 5.4 Unless otherwise agreed to in writing by the Parties, VFS shall be responsible for the preparation, submission and obtaining of appropriate documents for regulatory clearance to market the Products in the United States, including but not limited to 510(k)'s and/or PMA's, as may be applicable, and shall provide copies of such documents to Distributor upon request. VFS shall provide Distributor with such information as VFS and Distributor shall reasonably agree upon, for the purpose of registration and/or regulatory clearance to sell the Products in any other country in which Distributor proposes to sell the Products. Distributor shall be solely responsible, at its own cost, to obtain the CE mark on any Products subject to this Agreement. Any additional costs reasonably incurred by VFS in obtaining and/or maintaining international compliance will be billed to Distributor (and paid by Distributor) at VFS's direct engineering costs, as the costs are incurred during the approval process. If compliance is not commercially reasonable in a particular country foreign to the United States, VFS and Distributor will negotiate in good faith in an attempt to determine whether compliance will be obtained. 5.5 If requested by Distributor, VFS, at Distributor's cost, shall take all steps necessary to obtain and maintain determinations that the Products meet the consensus-based standards of safety required by the Occupational Safety and Health Act as determined by one or more Nationally Recognized Testing Laboratories and the equivalent approvals under the applicable standards promulgated by the Canadian Standards Association, the International Electrotechnical Commission, the German Technical Inspection Associations (TUVs) or their equivalents in other jurisdictions. 5.6 This Agreement shall be reviewed by VFS at least annually for compliance to ISO 9001 Section 4.3. 5.7 Unless otherwise agreed to in writing by the parties, VFS shall take all action necessary and bear all engineering costs incurred to insure that the Products and any changes or improvements to the Products conform with applicable regulatory standards required to allow application of the CE mark for the Products, recognizing that Distributor will be responsible for obtaining the CE mark for the Products and all costs for submission and testing in connection associated therewith. 6. Product Recall. If either party believes that because of a defect in manufacturing or design a recall, market withdrawal, safety alert or similar action ("Recall") of any Products is desirable or required by law, it will promptly notify the other party. The parties will then discuss reasonably and in good faith whether such Recall is appropriate or required and the manner in which any mutually agreed Recall shall be handled. This Paragraph 6 shall not limit the obligations of either party under law with respect to Recall of Products required by law or properly mandated by governmental authority. Voluntary Recalls shall be conducted by mutual agreement (agreement not to be unreasonably withheld). VFS shall bear all reasonable costs and expenses of any such Recall which relates to the manufacture of the Products. Distributor shall maintain complete and 10 accurate records for such periods as may be required by applicable law of all the Products sold by it. The parties will cooperate fully with each other in effecting any Recall of the Products pursuant to this Paragraph 6. However, Distributor shall be responsible for the actual conduct of any Recall of the Products, including communications with customers and end-users, and for any required notification to the FDA and other applicable regulatory authorities in respect thereof. 7. Product Name/Private Labeling. Distributor shall have the right to market and advertise Products exclusively in the Field under Distributor's name, trademarks, trade names, labels or other designations (collectively referred to as the "Marks") for the term of this Agreement. All of such Marks shall remain the property of Distributor, and VFS shall have no rights thereto. Distributor agrees to recognize the role of VFS as manufacturer of the Products through identification of VFS on the Products and literature relating thereto with the "Manufactured by Valley Forge Scientific Corp." logo, except as otherwise required for CE marked Products. SECTION II DISTRIBUTION AGREEMENT. 1. Appointment. 1.1 VFS hereby grants Distributor exclusive worldwide marketing rights for distribution and sale of the Products for use in the Field for the term of this Agreement ("Exclusive Rights"). VFS shall not distribute or cause to be distributed products in the Field that are competitive with the Products during the term of this Agreement. Nothing in this Agreement shall restrict VFS or its subsidiaries or other affiliates from selling the Products to others for use outside of the Field. 1.2 (a) Distributor covenants and agrees that it and its distributors shall not directly or indirectly sell the Products for any use outside of the Field. (b) Distributor covenants and agrees that it will not sell any bipolar electrosurgical products for use in the Field other than the Products for the term of this Agreement. Notwithstanding the foregoing, Distributor may sell the N-50 products and accessories currently marketed by it prior to the date of first commercial sale of a Generator Product by Distributor. After such first commercial sale, Distributor shall be prohibited from selling the N-50 generator products other than the sale of its inventory of such generator products existing immediately prior to such first commercial sale. Nothing in this Agreement shall prohibit Distributor from continuing to sell accessories for use with the N-50 generator products and servicing such products sold by Distributor. 1.3 For the term of this Agreement, Distributor shall have the right to distribute and sell the Products and all modifications, improvements, and developments incorporated into the Products and accessories and components thereof manufactured by VFS in the Field and to appoint sub-distributors for national and international sales in the Field. 11 2. Responsibilities of Distributor. 2.1 In marketing the Products, Distributor shall use commercially reasonable efforts in the promotion and sale of the Products and in providing support to end users who own the Products and prospective customers for the Products. Within thirty (30) days prior to the end of the Initial Inspection Period, Distributor shall provide to VFS a marketing plan for the Products. 2.2 Distributor will: i. advertise the Products in medical journals that in its judgment are suited for sale of the Products, and the copy of such advertisement, as well as any and all other brochures, marketing and sales materials, etc. used by Distributor shall be subject to review by VFS for technical accuracy prior to its release. In disagreements as to marketing or sales content, Distributor shall prevail. On matters of technical description or medical use or practice, VFS shall prevail; ii. show the Products at a minimum of four (4) trade shows per year; iii. provide education to the customer/end user on proper use of all Products prior to initial use; and iv. Review its marketing plan for the Products with VFS on a semi-annual basis. 2.3 Distributor shall maintain methods for identifying and tracing Products that it distributes. Distributor and VFS shall agree upon methods for this tracking system. 2.4 (a) Distributor agrees to designate one or more "Distributor Trainer(s)." Distributor shall be responsible for all costs associated with the Distributor Trainer(s), including without limitation, the cost of training the Distributor Trainer(s) so that they are able to provide comprehensive training to Distributor's sales representatives, which training shall include preparing sales representatives to educate the customer/end-user on the uses and operation of the Products. VFS shall assist Distributor in preparing sales training and customer education materials. All materials must be approved by VFS before distribution to sales representatives and customers. Distributor shall bear all costs of production of these educational materials. (b) VFS shall attend up to two (2) Distributor meetings per year in order to assist Distributor in providing training for Distributor Trainers and sales representatives at no cost to Distributor. Additional training will be provided by VFS as agreed upon by VFS and Distributor and with VFS being reimbursed for all travel expenses for its employees. 3. Technical Assistance and Labeling. As promptly as possible after completion of any development work and at such other times as are reasonably requested by Distributor, VFS will furnish Distributor with examples of VFS labeling, user and technical manuals, in 12 electronic file form to the extent available, for the Products and written information regarding the Products required for inclusion in customer user and service manuals. Distributor and VFS agree to cooperate in issuing any changes to the manuals through agreed upon Engineering Change Orders (ECO's). VFS will also assist and cooperate with Distributor in reviewing Distributor developed labeling, manuals and sales information about the Products for technical content. Distributor will be solely responsible for all costs, including the design, production, printing, and distribution costs, of customer user manuals and sales aids or marketing materials for the Products in the Field.. 4. Patent Infringement. 4.1 VFS represents that the waveform and circuitry of the Generator Product is covered by the patents and patent applications set forth on Exhibit 1 attached hereto, which are exclusively owned or licensed by VFS. If a third party claims that the sale, distribution or use of the Products infringes a patent or trademark owned by that third party and such party threatens to commence or commences a suit or action based upon such claim, the parties agree to notify each other promptly of such threat of action or action, and to cooperate with each other in the defense of such a suit or action, subject to the indemnification obligations set forth in Section III., Paragraph 4.1. 4.2 In addition to the requirements of Section II., Paragraph 4.1 hereof, if the sale, distribution or use of a Product (other than the Products designated as Developed Products on Schedule A) infringes on the patent of a third party, and Distributor or its customer is enjoined by final judgment of a court of competent jurisdiction from using the Product, VFS shall (or if any Product or part thereof becomes, or in VFS's opinion is likely to become, the subject of a claim of infringement of any intellectual property right of a third party, VFS may), at VFS's option, either (i) replace or modify the Product so that it becomes non-infringing or (ii) procure for Distributor the right to continue to sell the Product for the term of this Agreement, or, if neither (i) or (ii) is feasible, terminate this Agreement with regard to the infringing Product and repurchase all Distributor's inventory of the infringing Product at the price paid by Distributor, including freight. 5. Manufacturing Rights. 5.1 (a) Should VFS be unable to or fail for any reason, other than as set forth in Section I, Paragraph 5.2 hereof, to manufacture a Product in quantities at least equal to the Initial Products Minimum or the applicable New Product Minimum, as the case may be, that are in accordance with the agreed upon Specifications, applicable industry standards and current Good Manufacturing Practices ("cGMPs") as set forth in the Quality System Regulation promulgated by the FDA and found in Code of Federal Regulations, Title 21 Part 820 (the "QSR") that are applicable to the Products (hereinafter referred to as a "Manufacturing Deficiency"), Distributor within 30 days of the discovery of the Manufacturing Deficiency, on one hundred and twenty (120) days prior written notice to VFS, may: (i) remove the particular Product from the terms of this Agreement; or (ii) exercise the right to designate a manufacturer, set forth in Paragraph 5.1(b) herein. During the one hundred and twenty (120)-day notice period set forth in the preceding sentence, VFS will have the right to cure such Manufacturing 13 Deficiency in order to keep the particular Product in compliance with the terms of this Agreement and, if it is successful in doing so, the notice shall be null and void. (b) In the event that VFS fails to cure the Manufacturing Deficiency, Distributor may at Distributor's option require VFS to find and contract with another source (reasonably acceptable to Distributor) within thirty (30) days to manufacture the Product in accordance with the Specification set forth in Schedule A. VFS agrees to provide such source with the technology necessary to enable it to manufacture the Product and to render such other assistance as may reasonably be requested to assure an orderly transition of the manufacturing operation. 5.2 VFS shall not be liable for any failure to supply or deliver, or for any delay in the delivery of, the Products hereunder, when any such failure or delay is caused, directly or indirectly, by fires, floods, accidents, explosions, strikes or other labor disturbances (regardless of the reasonableness of the demands or labor), wars, shortages of fuel, power or raw materials, inability to obtain or delays of transportation facilities, acts of God, or any cause, whether similar or dissimilar, to the foregoing beyond the reasonable control of VFS, as the case may be, affecting VFS's production and/or delivery of the Products covered by this Agreement or Distributor's acceptance or resale thereof. Such failure will be excused for three months or as long as such event shall be continuing (whichever period is shorter) provided that VFS gives immediate written notice to Distributor of the Force Majeure Event. VFS shall exercise all reasonable efforts to eliminate the Force Majeure event and to resume performance. In the event the failure continues beyond three months, then Distributor may at Distributor's option require VFS to find and contract with another source (reasonably acceptable to Distributor) within thirty (30) days from the end of the three-month period to manufacture and supply the Products. VFS agrees to provide such source with the technology necessary to enable it to manufacture the Products and to render such other assistance as may reasonably be requested to assure an orderly transition of the manufacturing operation. 5.3 (a) Valley Forge hereby grants to Distributor a royalty-free license to use all techniques, processes, documentation and know-how that have been developed or are owned by VFS or as to which VFS has acquired any rights that are necessary or useful in the manufacture of the Products (the "Manufacturing Technology") in the Field to use, sell, make and have made the Products for use in the Field (collectively the "Bankruptcy License Rights"); provided, however, that the Bankruptcy License Rights granted hereunder shall be subject to the terms of Paragraph 5.3(b) and shall be effective only if (i) a petition under Title 11 of the United States Code ("Title 11") has been voluntarily filed by VFS, or involuntarily filed by a third party or parties and not dismissed within ninety (90) days thereafter, and (ii) this Agreement has been rejected in the Title 11 case (a "Bankruptcy Event"). Notwithstanding anything in this Paragraph 5.3(a) to the contrary, Distributor shall not have any Bankruptcy License Rights, nor shall it exercise any Bankruptcy License Rights, other than after the occurrence of a Bankruptcy Event. Furthermore, notwithstanding anything in this Paragraph 5.3(a) to the contrary, any and all Bankruptcy License Rights shall terminate at the end of the term of this Agreement. (b) All rights and licenses to Manufacturing Technology granted under this Agreement by VFS to Distributor are, for all purposes of Section 365(n) of Title 11, licenses of rights to intellectual property as defined in Title 11. VFS agrees during the term of this Agreement to create and maintain 14 current copies or, if not amenable to copying, detailed descriptions or other appropriate embodiments, of all such Manufacturing Technology. If a case is commenced by or against VFS under Title 11, then, unless and until this Agreement is rejected as provided in Title 11, VFS (in any capacity, including debtor-in-possession) and its successors and assigns (including, without limitation, a Title 11 trustee) at its option shall either perform all of the obligations provided in this Agreement to be performed by VFS or provide to Distributor all such Manufacturing Technology reasonably required to make or have made, use and sell Products (including all embodiments thereof) in the Field +held by VFS, as provided in this Agreement, as Distributor may elect in a written request, immediately upon such request, and VFS shall not interfere with Distributor's rights. If a Bankruptcy Event occurs and Distributor elects to retain its rights hereunder as provided in Title 11, then VFS (in any capacity, including debtor-in-possession) and its successors and assigns (including, without limitation, a Title 11 trustee) shall provide to Distributor all such Manufacturing Technology (including all embodiments thereof) held by VFS immediately upon Distributor's written request therefor and nothing herein is intended to, nor shall, impair or adversely affect Distributor's rights under Title 11, including under Section 365(n) of Title 11. SECTION III GENERAL PROVISIONS 1. Term. 1.1 Unless terminated sooner pursuant to Section III., Paragraph 2 hereof or extended as provided herein, the term of this Agreement shall commence on the Effective Date and shall continue in force until the end of the fifth Agreement Year. If on or before the end of the fourth Agreement Year, the term of this Agreement has not been extended beyond the end of the fifth Agreement Year by written agreement of Distributor and VFS, the parties on written notice from either party shall for a period of ninety (90) days after such written notice (but in no event shall such period extend past the end of the fifth Agreement Year) conduct good faith discussions at mutually convenient times regarding the terms and conditions of an extension to this Agreement. While the parties are obligated to discuss an extension in good faith, there is no obligation on the part of either party to agree to an extension. 2. Termination and Remedies 2.1 Either party may terminate this Agreement upon written notice to the other party in the event of a material breach of this Agreement by the other party which is not cured within ninety (90) days after written notice of such breach is given. Notwithstanding the foregoing, (i) in the event Distributor fails to timely pay for shipped Products within the time period set forth in Section I, Paragraph 2.3 or breaches the covenants and agreements in Section II, Paragraph 1.2 (a), VFS may terminate the Agreement if such breach is not cured within ten (10) days after written notice by VFS; (ii) in the event that Distributor breaches the covenants and agreements in Section II, Paragraph 1.2(b), VFS may terminate this Agreement if Distributor does not cease from selling products in breach of the terms of Section II, Paragraph 1.2(b) ("Prohibited Products") within ten (10) days after written notice and within sixty (60) days after such written notice pay to VFS an amount for each Prohibited Product sold by Distributor equal to fifty percent (50%) of the then current price of the Product that has the same or similar use as the Prohibited 15 Product; (iii) in the event of a breach of Section III, Paragraph 3, and in addition to all other rights and remedies that VFS has under this Agreement or at law or equity, VFS may terminate this Agreement within ten (10) days after written notice to Distributor; and (iv) in the event a business combination transaction occurs that results in a New VFS (as defined in Section III, Paragraph 8.3) that competes with Distributor or its affiliates in the manufacture and/or sale of products for use in the field of pain management, Distributor may terminate this Agreement by giving at least ninety (90) days' written notice to such New VFS at any time during the six (6)-month period following the effective date of such transaction. The notice and cure periods in this Paragraph 2.1 shall not apply to Distributor's failure to satisfy its minimum purchase requirements or payment of the shortfall amount as set forth in Section I, Paragraph 1.7. 2.2 Either party, at its election, may declare the other party to be in default under the Agreement and, without prejudice to any of its rights hereunder, may forthwith terminate the Agreement by written notice to the other party in the event the other party (i) makes a general assignment for the benefit of creditors, (ii) has a receiver of all or substantially all of its assets appointed, (iii) files a voluntary petition for reorganization or other arrangement or in bankruptcy under the U.S. bankruptcy laws, or (iv) is declared insolvent. 2.3 Notwithstanding anything to the contrary in this Agreement, any termination of this Agreement will not affect any rights of either party arising under this Agreement prior to such termination. In addition each party shall have all rights and remedies available to it at law or equity, except as limited by the terms of , Section III, Paragraph 2.4, below. 2.4 NOTWITHSTANDING ANYTHING IN THIS AGREEMENT TO THE CONTRARY, EACH PARTY HERETO WAIVES ANY CLAIM TO PUNITIVE DAMAGE OR EXEMPLARY DAMAGES FROM THE OTHER. NOTWITHSTANDING ANYTHING IN THIS AGREEMENT TO THE CONTRARY, EACH PARTY HERETO WAIVES ANY CLAIM OF CONSEQUENTIAL DAMAGES FROM THE OTHER EXCEPT WITH RESPECT TO ANY BREACH OF SECTION III, PARAGRAPH 3; IT BEING AGREED THAT A PARTY MUST PROVE THE EXISTENCE OF, AND ITS ENTITLEMENT TO, CONSEQUENTIAL DAMAGES WITH RESPECT TO A BREACH OF SECTION III, PARAGRAPH 3 IN ACCORDANCE WITH APPLICABLE LAW. 3. Confidential Information. 3.1. As used herein, "Confidential Information" shall mean the Specifications, all know-how relating to the development, manufacture, sale or use of any Product, including, without limitation, processes, techniques, methods, products, apparatuses, biological materials and other materials and compositions which are reasonably related thereto, the direct labor, direct overhead and raw materials costs incurred in the manufacture of Product, the raw material, and all other confidential or proprietary information that is reduced to writing, marked as confidential and given to one party by the other party relating to such other party or any of its affiliates, including information regarding any of the products of such other party or any of its affiliates, information regarding its advertising, distribution, marketing or strategic plans or information regarding its costs, productivity or technological advances. Neither party shall, during the term of this Agreement and for a period of five (5) years following the termination or expiration of this 16 Agreement for any reason, use or disclose to third parties any Confidential Information of the other (except to the extent reasonably necessary to exercise its rights or comply with its obligations under this Agreement) and each party shall insure that its employees, officers and agents shall not use or disclose to third parties any Confidential Information of the other (except to the extent reasonably necessary to exercise its rights or comply with its obligations under this Agreement); provided, however, that Distributor and VFS may disclose Confidential Information to their employees on a need to know basis provided such persons are informed of the confidential nature of such information and are under contractual obligation to not use the Confidential Information and to keep such information confidential. Confidential Information shall not include information that (i) was already known to the receiving party at the time of its receipt thereof, as evidenced by its written records, (ii) is disclosed to the receiving party after its receipt thereof by a third party who has a right to make such disclosure without violating any obligation of confidentiality, (iii) is or becomes part of the public domain through no fault of the receiving party or (iv) is required to be disclosed to comply with applicable laws or regulations or an order of a court or regulatory body having competent jurisdiction. 3.2 In the event that a party receives a subpoena which requires the disclosure of Confidential Information, such party shall provide the other party at least ten (10) days' written notice of such subpoena prior to the return date, or as much advance notice as possible if the return date is in less than ten (10) days, to allow the other party to move to quash such subpoena. The party shall not disclose the Confidential Information during the notice period and during the pendency of any motion to quash the subpoena. 3.3 Title to all tangible forms of Confidential Information, including any copies thereof, shall be and remain with discloser. The recipient shall not copy or reproduce, in whole or in part, any Confidential Information from the discloser without written authorization except as is necessary to fulfill the purpose of this Agreement. Upon written request or termination of this Agreement, all tangible forms of Confidential Information with exception of an archive copy to be used solely for compliance with the recipient's obligations under this Agreement or applicable law, shall be promptly returned to the discloser or destroyed. 4. Indemnification and Insurance. 4.1 VFS shall indemnify and hold Distributor harmless against any and all claims, suits, proceedings, expenses, attorney's fees, recoveries and damages, including expenses of total or partial Recall of Products, caused by defects in design, materials, or workmanship of the Products or based on a claim that the Products (other than the Products designated as Developed Products on Schedule A) or their use infringes upon the claim of a patent of a third party, except to the extent caused by Distributor's distribution practices, Distributor's advertising or promotional material for the Products that has not been approved by VFS, misrepresentations by Distributor, use of the Product in an application or an environment for which it was not designed or contemplated hereunder, or modifications to, or improper repair of the Product. The indemnification obligation, however, shall not apply if any Product is used in conjunction with a device, instrument or product that is not approved for use with the Product. 17 4.2 VFS shall maintain product liability insurance (containing either a vendor's endorsement or a contractual liability coverage) on Products supplied by VFS with minimum limits of three million dollars ($3,000,000.00)/five million dollars ($5,000,000.00) and shall furnish to Distributor, within thirty (30) days after the Effective Date of this Agreement, a certificate of insurance by the carrier including the foregoing endorsements, coverage and limits providing that such insurance may not be cancelable without at least thirty (30) days prior notice to Distributor. 4.3 Distributor shall indemnify and hold VFS harmless against any and all claims, suits, proceedings, expenses, recoveries and damages, including expenses of total or partial Recall of Products caused by Distributor's distribution practices or Distributor's advertising or promotional material for the Products, which advertising or promotional material has not been approved by VFS, or misrepresentations of the Products by Distributor or damage to the Products caused by unauthorized repair or modification of the Products by Distributor. 5. No Transfer of Patent and Know-How. Nothing in this Agreement constitutes or shall be construed as a transfer to Distributor of any of the patents, intellectual property rights, trade secrets or know-how of VFS relating to the Products or any other products or products-in-development of VFS or a license for Distributor to use such patents, intellectual property rights, trade secrets or know-how. 6. Representations, Warranties and Agreements of VFS 6.1 VFS is a corporation duly organized and validly existing in good standing under the laws of Pennsylvania. VFS has the corporate power to execute, deliver and perform this Agreement. 6.2 The execution and delivery of this Agreement by VFS does not, and the performance of VFS's obligations hereunder will not, violate any provision of the organization documents of VFS or violate any provision of, or result in a breach of any of the terms or provisions of or the acceleration of any of the obligations under, or constitute a default under, any mortgage, lease, agreement, instrument, order, arbitration award, judgment or decree to which VFS is a party or to which VFS or its assets, properties or business are subject to on the date hereof. This Agreement is a valid and binding agreement of VFS enforceable against it in accordance with its terms. 6.3 VFS is not party to any agreement with or obligation to any third-party or any other legally binding commitment of any kind or nature whatsoever that would, in the reasonable opinion of VFS, adversely affect VFS' ability to perform the terms of this Agreement. 6.4 No approval of any person, entity or government authority is necessary with respect to the execution, delivery and performance by VFS of this Agreement. 18 7. Representations, Warranties and Agreements of Stryker. 7.1 Stryker is a corporation duly organized and validly existing in good standing under the laws of Michigan. Stryker has the corporate power to execute, deliver and perform this Agreement. 7.2 The execution and delivery of this Agreement by Stryker does not, and the performance of Stryker's obligations hereunder will not, violate any provision of the organization documents of Stryker or violate any provision of, or result in a breach of any of the terms or provisions of or the acceleration of any of the obligations under, or constitute a default under, any mortgage, lease, agreement, instrument, order, arbitration award, judgment or decree to which Stryker is a party or to which Stryker or its assets, properties or business are subject to on the date hereof. This Agreement is a valid and binding agreement of Stryker enforceable against it in accordance with its terms. 7.3 Stryker is not party to any agreement with or obligation to any third-party or any other legally binding commitment of any kind or nature whatsoever that would, in the reasonable opinion of Stryker, adversely affect Stryker's ability to perform the terms of this Agreement. 7.4 No approval of any person, entity or government authority is necessary with respect to the execution, delivery and performance by Stryker of this Agreement. 8. Miscellaneous. 8.1 This Agreement is not intended to create a partnership, association, joint venture or unincorporated business between VFS and Distributor, or any other type of entity which could be determined to be obligated to file tax or reporting returns pursuant to the Internal Revenue Code (or similar taxing laws of any county or U.S. State). Except as otherwise provided herein, each party hereto shall be responsible for the payment of all expenses or obligations incurred by it, including payments of withholding, social security, or other taxes or charges applicable to its employees, consultants, or contractors. Except as provided herein, neither party shall have the right to make any agreement in the name of the other party, nor obligate the other party to pay any amount, perform any act, or incur any liability or obligation. 8.2 Except as specifically agreed to in writing, each party shall bear all cost and expenses which it incurs in connection with this Agreement. 8.3 Except as provided below, this Agreement may only be assigned with the prior written consent of the other party, which consent shall not be unreasonably withheld. Notwithstanding the foregoing, (i) a business combination transaction that results in another person or entity (a "New VFS") becoming the owner of in excess of 35% of VFS' voting securities, whether through a merger or sale of stock, or acquiring all or substantially all of the assets of VFS, or otherwise obtaining effective operating control of VFS or (ii) any other change in VFS' stockholders shall not constitute an assignment of this Agreement by VFS that requires Distributor's consent provided that VFS obtains the written agreement of any New VFS to be bound by this Agreement as was VFS. In the event of any permitted assignment pursuant to this Paragraph 8.3, the assignee, 19 including without limitation a New VFS (the "Permitted Assignee"), shall automatically be entitled to the benefits and terms of this Agreement as was the assignor from and after the date of such assignment and shall automatically be obligated as was the assignor as to all obligations then accrued or thereafter to accrue under this Agreement. 8.4 No amendment of modification or addition hereto shall be effective or binding on either of the parties hereto unless or until the same is reduced to writing and signed by both parties. 8.5 This Agreement, together with its Schedules and Exhibit, embodies the entire understanding between the parties regarding the subject matter hereof and supersede any and all prior understandings and agreements relating to such subject matter. 8.6 The validity and interpretation of this Agreement shall be governed by the laws of the State of New York. Any disputes or contentions arising in connection with this Agreement between the parties shall, if possible, be settled in an amicable way. If, however, no understanding is reached, such disputes and contentions shall be exclusively and finally settled by binding arbitration before three (3) arbitrators in accordance with the rules of the American Arbitration Association. All arbitrations shall take place in New York, New York. 8.7 If the performance of this Agreement or any obligation hereunder, except the making of payments hereunder, is prevented, restricted or interfered with by reason of fire, flood, earthquake, explosion or other casualty or accident; strikes or labor disputes; inability to procure parts, supplies or power; war or other violence; any law, order, proclamation, regulation, ordinance, demand or requirement of any government agency; or any other act or condition whatsoever beyond the reasonable control of the affected party, the party so affected, upon giving prompt notice to the other party, shall be excused from such performance to the extent of such prevention, restriction or interference; provided, however, such prevention, restriction or interference does not continue for more than one hundred and twenty (120) days and provided that the party so affected shall take all reasonable steps to avoid or remove such causes of nonperformance and shall resume performance hereunder with dispatch whenever such causes are removed prior to such one hundred and twenty (120) days. This Paragraph 8.7 shall not be applicable to the failure of VFS to supply or deliver, or for any delay in the delivery of, the Products, which failure or delay shall be covered by Section II, Paragraph 5.2. 8.8 It is expressly understood that the failure of either party to enforce any rights arising from the failure of the other party to perform, or perform properly, the other party's obligations hereunder shall not constitute a waiver of its rights arising from such failure or improper performance, and that enforcement of any right hereunder shall not preclude exercise of any other remedies available at law. All rights and remedies, whether conferred hereby or by any other instrument or by law shall be cumulative, and may be exercised singularly or concurrently. 8.9 If any provision of the Agreement is held invalid by law, rule, order, or regulation of any government or by the final determination of any court of the United States, such invalidity shall not affect the enforceability of any other provision in this Agreement not held to be invalid. 20 8.10 This Agreement may be signed in counterparts; each counterpart shall constitute an original document, but all of which shall constitute one instrument. This Agreement may be duly executed and delivered by a party by execution and facsimile delivery of signature page of a counterpart to the other party, provided that, in such case, the executing party shall promptly deliver a complete counterpart that it has executed to the other party. 8.11 Any press release or other disclosure to the public regarding this Agreement and the transactions contemplated hereby shall be mutually agreed upon by the parties hereto; provided, however, that either party may make any such public announcement or disclosure that counsel advises in writing is required by applicable securities laws or regulations or rules or agreements with any stock exchange on which its shares are listed, in which case the party making the announcement or disclosure shall inform the other party in advance of the timing and proposed content and shall provide the other party with reasonable opportunity to review and comment on any such required announcement or disclosure. 8.12 All notices and consents hereunder shall be in writing and shall be deemed to have been properly given and to be effective on the date of delivery if delivered in person, by one-day courier service or by facsimile transmission (provided a copy is sent by one-day courier service) to the respective address or facsimile number provided below or to such other address or facsimile number as either party shall designate by written notice to the other in such manner: To VFS: ------- Valley Forge Scientific Corp. 136 Greentree Road, Suite 100 Oaks, Pennsylvania 19456 Attention: Michael Ritchie, Vice President-General Manager Facsimile: (610) 666-7565 with a copy to: Russell U. Schenkman, Esq. Schenkman Jennings & Howard, LLC 13 Roszel Road, Suite C-225 Princeton, New Jersey 08540 Facsimile: (609) 799-1555 To Distributor: --------------- Stryker Corporation Stryker Instruments Division 4100 East Milham Avenue Kalamazoo, Michigan 49001-6197 Attn: Dave Koldyke, Vice President, Finance and Accounting Facsimile: 269-324-5331 21 with a copy to: John H. Denne, Esq. Winston & Strawn LLP 200 Park Avenue New York, New York 10166 Facsimile: (212) 294-4700 IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be executed as of the Effective Date by their duly authorized officers. Stryker Corporation Valley Forge Scientific Corp. By: /s/ CURT HARTMAN By: /s/ JERRY L. MALIS --------------------------- ----------------------------- Title: President Title: President Date: October 25, 2004 Date: October 25, 2004 22 EX-10.14 4 ex10_14.txt EXHIBIT 10.14 Exhibit 10.14 OPTION AGREEMENT ---------------- THIS AGREEMENT is entered into as of October 22, 2004, by and between Leonard I. Malis, an individual, with an address at 219-44 Peck Avenue, Queens, NY 11427 ("LIM") and Valley Forge Scientific Corp., with an address at 136 Green Tree Road, Oaks, Pennsylvania 19456 (hereinafter referred to as "VLF"). RECITALS -------- A. LIM is the sole owner of the "Malis" trademark ("Trademark"), which is further described in Schedule A, attached hereto; and B. LIM desires to grant to VLF and VLF desires to purchase from LIM a call option (hereinafter referred to as the "Option") under which LIM at the written request of VLF shall sell to VLF the Trademark upon the terms set forth in this Agreement. NOW, THEREFORE, for and in consideration of the foregoing, and in consideration of the sum of THIRTY-FIVE THOUSAND ($35,000.00) Dollars paid by VLF to LIM, the receipt of which is hereby acknowledged, and the mutual covenants and conditions hereinafter set forth, the parties do hereby agree as follows: 1. OPTION TO PURCHASE. LIM hereby grants to VLF the Option under which LIM, upon the written request of VLF, shall sell the Trademark to VLF upon the terms and conditions set forth below. (a) Time for Exercise of Option. Commencing on the date of this Agreement and ending at 6:00 p.m. (New York, New York time) on September 30, 2005 (the "Termination Date") VLF may exercise the Option to purchase the Trademark. The Termination Date may be extended by VLF on an annual basis until September 30, 2009 provided that VLF makes the payments to LIM set forth below: 1. Upon VLF paying LIM the sum of $20,000 at any time during the period between October 1, 2004 and September 30, 2005, the Termination Date shall be extended until September 30, 2006. 2. Provided the payment in subparagraph (a)(1), above, has been timely made, upon VLF paying LIM the sum of $20,000 at any time during the period between October 1, 2005 and September 30, 2006, the Termination Date shall be extended until September 30, 2007. 3. Provided the payments in subparagraphs (a)(1) and (2), above, have been timely made, upon VLF paying LIM the sum of $40,000 at any time during the period between October 1, 2006 and September 30 2007, the Termination Date shall be extended until September 30, 2008. 1 4. Provided that payments in subparagraphs (a)(1), (2) and (3), above, have been timely made, upon VLF paying LIM the sum of $60,000 at any time during the period between October 1, 2007 and September 30, 2008, the Termination Date shall be extended until September 30, 2009. (b) Notice of Exercise of Option. The Option may only be exercised on or before the Termination Date upon written notice of exercise by VLF ("Notice of Exercise") given to LIM, specifying a closing date and time ("Closing Date") during business hours (9:00 a.m. to 6:00 p.m., New York, New York time) no less than two (2) business days after Notice of Exercise and no later than thirty (30) business days after the date of the Notice of Exercise. (c) Expiration of Option. The Option shall expire if the Notice of Exercise for is not received by LIM by the Termination Date. (d) Exercise Price of the Option. The exercise price ("Exercise Price") of the Option shall be FOUR MILLION ONE HUNDRED AND FIFTY SEVEN THOUSAND FIVEHUNDRED and FOUR DOLLARS ($4,157,504.00) payable on the Closing Date as follows: (i) By delivering to LIM The sum of ONE HUNDRED FIFTY NINETHOUSAND NINE HUNDRED AND FOUR ($159,904.00) Dollars; and (ii) By delivering to LIM (i) a duly executed note ("Note") in the amount of THREE MILLION NINE HUNDRED AND NINETY SEVEN THOUSAND SIX HUNDRED ($3,997,600) Dollars, a copy of which is attached as Exhibit A, hereto; and (ii) a duly executed security agreement ("Security Agreement"), a copy of which is attached as Exhibit B, hereto, securing the obligations under the Note. (e) Codman Payments. Up to and including the Closing Date, LIM shall continue to receive from Codman & Shurtleff, Inc. ("Codman") all royalty payments pursuant to the Codman Agreement (as hereinafter defined), as amended, ("Codman Royalties"). If VLF exercises the Option, then after the Closing Date the only payments that LIM shall receive in connection with, or relating to, the Codman Agreement, as amended, are Codman Royalties from Codman (i) for VLF products bearing the Trademark sold by VLF to Codman from the end of the last period (prior to the Closing Date) that Codman has paid LIM Codman Royalties until the Closing Date, and (ii) for the sale of non-VLF products by Codman prior to the Closing Date (collectively "Post Closing LIM Payments") and VLF shall receive and shall have the exclusive right to all other Codman Royalties and payments under the Codman Agreement, as amended. The parties hereto acknowledge and agree that Codman Royalties are payable by Codman only when such products are actually sold by Codman to end-users. 2. REPRESENTATIONS BY LIM. LIM represents and warrants to VLF as follows: (a) Powers; Authorization; Enforceable Obligations. LIM has the power and authority and legal right to execute, deliver and perform this Agreement and any other instruments of transfer, assignment and conveyance required to be delivered hereunder and all schedules and exhibits hereto 2 (collectively, the "Agreement"). The execution, delivery and performance of this Agreement and the transactions contemplated hereunder have been duly authorized and no further action is required. This Agreement has been and will be, as the case may be, duly executed and delivered by LIM, and this Agreement constitutes and will constitute, as the case may be, legal, valid and binding obligations of LIM, enforceable against him in accordance with its terms. (b) Validity of Agreement. The execution, delivery and performance of this Agreement by LIM does not and will not contravene or violate (a) any existing law, rule or regulation to which LIM is subject, or (b) any judgment, order, writ, injunction, decree or award of any court, arbitrator or governmental or regulatory official, body or authority which is applicable to LIM or the Trademark, nor will such execution, delivery or performance violate, be in conflict with or result in the breach (with or without the giving of notice or lapse of time, or both) of any term, condition or provision of, or require the consent of any other party to, any agreement, contract, lease, license, permit, or other document or understanding, oral or written, to which LIM is a party or to which LIM or the Trademark may be bound or affected thereby. No authorization, approval or consent, and no registration or filing with, any governmental or regulatory official, body or authority is required in connection with the execution, delivery and performance of this Agreement by LIM. (c) Compliance with Laws. LIM has complied with, and is not in violation of any applicable law, rule, order, ordinance or regulation to which the Trademark is subject, which would materially impair the value of the Trademark or the use of the Trademark by VLF, and to LIM's knowledge has not failed to obtain or to adhere to the requirements of any license, permit or authorization necessary for his ownership of the Trademark, which would materially impair the value of the Trademark or the use of the Trademark by VLF. (d) Title. LIM has good, valid, and exclusive title to the Trademark, free and clear of all liens, charges, security interests, claims and encumbrances of any nature whatsoever, and LIM shall convey, transfer and assign to VLF on the Closing Date such title to the Trademark, free and clear of all liens, charges, security interests, claims and encumbrances of any nature whatsoever. Copies of LIM's registrations for the Trademark in the United States Patent and Trademark office are attached as Schedule C, hereto. (e) Trademark. LIM holds all permits and other authorizations pertaining to the Trademark. (f) Contracts. The only agreement LIM has entered into regarding the Trademark is with Codman. The only agreement currently in effect regarding the Trademark is a certain agreement dated October 15, 2004 between Codman and LIM ("Codman Agreement"). As set forth in the Codman Agreement, the agreement and all extensions set forth in Schedule B, attached hereto, expired in accordance with their terms on December 31, 2003. (g) Litigation. There is no litigation, arbitration, investigation, labor dispute or grievance or other proceeding before any court, arbitrator or governmental or regulatory official, body or authority pending or, to the best of LIM's knowledge, threatened against LIM, any of his assets, properties, the Trademark, or the transactions contemplated by this Agreement and there are no outstanding judgments against LIM or the Trademark. 3 (h) Brokers. All negotiations relative to this Agreement and the transactions contemplated hereby have been carried on by LIM directly with VLF and without the intervention of any other person purporting to act on behalf of or retained by LIM and in such manner as not to give rise to any valid claim against LIM or VLF for a finder's fee, brokerage commission or like payment. The representations of LIM in this Section 2 shall be true and correct on the Closing Date and shall survive for a period of six (6) years after the Closing Date, provided, however, the representations in Section 2(c) and (g), shall only survive for a period of two (2) years after the Closing Date 3. REPRESENTATIONS OF VLF. VLF represents and warrants to LIM as follows: (a) Corporate Existence. VLF is a Pennsylvania corporation duly organized, validly existing and in good standing under the laws of the State of Pennsylvania and has the corporate power and authority to carry on its business as has been and is now being conducted. (b) Corporate Powers; Authorization; Enforceable Obligations. VLF has the corporate power and authority and legal right to execute, deliver and perform this Agreement. The execution, delivery and performance of this Agreement and the transactions contemplated hereunder have been duly authorized by all necessary action of the VLF's Board of Directors, and no further corporate action is required. This Agreement has been and will be, as the case may be, duly executed and delivered by VLF, and this Agreement constitutes and will constitute, as the case may be, legal, valid and binding obligations of VLF, enforceable against it in accordance with its terms. (c) Validity of Agreement. The execution, delivery and performance of this Agreement by VLF does not and will not contravene or violate (a) any existing law, rule or regulation to which VLF is subject, (b) any judgment, order, writ, injunction, decree or award of any court, arbitrator or governmental or regulatory official, body or authority which is applicable to VLF, or (c) the Certificate of Incorporation or Bylaws of VLF, nor will such execution, delivery or performance violate, be in conflict with or result in the breach (with or without the giving of notice or lapse of time, or both) of any term, condition or provision of, or require the consent of any other party to, any agreement, contract, lease, license, permit, or other document or understanding, oral or written, to which VLF is a party or may be bound or affected thereby. No authorization, approval or consent, and no registration or filing with, any governmental or regulatory official, body or authority is required in connection with the execution, delivery and performance of this Agreement by VLF. (d) Brokers. All negotiations relative to this Agreement and the transactions contemplated hereby have been carried on by VLF directly with LIM and without the intervention of any other person purporting to act on behalf of or retained by VLF and in such manner as not to give rise to any valid claim against LIM or VLF for a finder's fee, brokerage commission or like payment. 4 The representations of VLF in this Section 3 shall survive the exercise of this Option. 4. COVENANTS OF LIM. (a) LIM covenants and agrees that from the date of this Agreement until the earlier of the Termination Date or the Closing Date, LIM will: (i) Encumbrances. Not enter into, assume or create any mortgage, pledge, conditional sale, lien, security interest, option, encumbrance or charge of any kind whatsoever on the Trademark or enter into any agreement pertaining to the Trademark (other than pursuant to the Security Agreement). (ii) Notices to VLF. Provide VLF with immediate notice of any of the following occurrences: (a) filing of litigation, enforcement of judgment against LIM or the Trademark or knowledge of written notice of enforcement of a judgment against LIM or the Trademark; (b) written or electronic notice of any threatened litigation against LIM or the Trademark; (c) any communication received by LIM from any governmental entity or body (local, state, federal or foreign) pertaining to the Trademark; and (d) notices received by LIM relating to liens, loans, encumbrances, claims, charges or security interest involving the Trademark. (iii) No Shop Clause. LIM shall not directly or indirectly through any person or entity solicit, initiate or encourage submission of proposals or offers from any person relating, directly or indirectly, to the Trademark or participate in any negotiation regarding, or furnish to any other person any information with respect to, or otherwise cooperate in any way with, or assist or participate in, facilitate or encourage, any effort or attempt by any other person to or seek, directly or indirectly, to acquire any interest in the Trademark. (iv) VLF shall have the right to negotiate the terms of an amendment to the Codman Agreement with Codman or a new agreement for the Trademark with Codman; provided, however, that prior to the Closing Date VLF cannot bind LIM to any amendment to the Codman Agreement or a new agreement with Codman, in each case without LIM's prior written consent, which consent shall not be unreasonably withheld or delayed; (v) LIM will not enter into any agreement for the extension, modification or renewal of the Codman Agreement, except for extensions of the term of the Codman Agreement for periods of no more than three (3) months at a time, without the prior written consent of VLF, which consent shall not be unreasonably withheld or delayed. In all cases, LIM will give VLF no less than fifteen (15) days notice prior to discussing or entering into any extension of the Codman Agreement with Codman. (b) Cooperation. After the exercise of this Option by VLF in accordance with the terms set forth herein, LIM shall take such action and execute such documents as VLF shall reasonably require in order to properly assign and transfer to VLF the Trademark on or after the Closing Date and to effectuate the terms of this Agreement. 5 5. COVENANTS OF VLF. (a) Trademark. After the Closing Date, VLF shall have the unrestricted right to take any action pertaining to the Trademark. (b) Payment Received From Codman. In the event that VLF receives Post Closing LIM Payments from Codman, VLF shall promptly forward such payment(s) to LIM. (c) Tax Treatment of Trademark Acquisition. For federal income tax purposes, VLF will treat its payment of the Exercise Price as amounts chargeable to a capital account under Section 1253(d)(2) of the Internal Revenue Code of 1986, as amended ("Code"), and will not claim any deduction including, but not limited to, a deduction for a license, lease, royalty or other payment with respect to its payment of the Exercise Price, provided that (i) VLF may claim an amortization deduction of the Exercise Price under Section 197 of the Code, as amended, or any successor statute, and (ii) VLF may claim a deduction for imputed interest in connection with the payment of the Exercise Price. 6. DELIVERIES AND CONDITION OF CLOSING. (a) Deliveries by LIM. At Closing, LIM shall deliver to VLF the following documents, in form and substance satisfactory to VLF: (i) A good and sufficient assignment and bill of sale ("Transfer Documents") with covenants of warranty, assignments and endorsements, and other good and sufficient instruments and documents of conveyance and transfer, in form and substance reasonably satisfactory to VLF and its counsel, as shall be necessary and effective to convey, transfer and assign to, and vest in, VLF as of the Closing Date good, valid and exclusive title to the Trademark, free and clear or any and all liens, encumbrances, security interests, option or charges, whatsoever (other than pursuant to the Security Agreement); (ii) A duly executed certificate of LIM, certifying that all the representations and warranties in Section 2 are true and correct as of the Closing Date and that LIM has performed and complied with all agreements and conditions required by this Agreement to be performed and complied with by LIM prior to or on the Closing Date; (iii) A written notice to Codman in a form acceptable to VLF advising Codman that the Trademark has been transferred to VLF as of the Closing Date; and (iv) Such other documents that VLF or its counsel may reasonably request to complete the transactions contemplated under this Agreement, including any consents from Codman that are required under the Codman Agreement for LIM to transfer the Trademark to VLF. (b) Deliveries by VLF. At Closing, VLF shall deliver to LIM the following: 6 (i) The sum of One Hundred Fifty Nine Thousand Nine Hundred and Four Dollars ($159,904.00) by wire transfer, certified check or bank cashiers check. (ii) a duly executed Note and Security Agreement; (iii) A certificate of VLF duly executed by an authorized officer of VLF, dated as of the Closing Date, certifying that all the representations and warranties in Section 3 are true and correct as of the Closing Date and that VLF has performed and complied with all agreements and conditions required by this Agreement to be performed and complied with by VLF prior to or on the Closing Date; (iv) a written notice to Codman stating that LIM shall receive royalties from Codman on sales of all VLF products to Codman, prior to the Closing Date that bear the Trademark; and (v) A copy of the resolutions adopted by VLF's Board of Directors relating to the transactions contemplated by this Agreement, certified as of the Closing Date to be complete and correct by the Secretary or an Assistant Secretary of VLF. 7. GENERAL PROVISIONS (a) Binding Effect; Assignment. This Agreement will be binding upon and inure to the benefit of the heirs, legal representatives, successors and assigns of the parties. (b) Fees and Expenses. Each party will bear its own expenses and fees incurred in connection with this Agreement and the transactions contemplated hereby. (c) Counterparts. Any number of counterparts of this Agreement may be signed and delivered and each will be considered as an original and together they will constitute one agreement. (d) Entire Agreement. This Agreement constitutes the entire agreement between the parties pertaining to its subject matter and supersedes all prior and contemporaneous negotiations, agreements and understandings, written and oral, of the parties in connection herewith. No representation, covenant or condition not expressed in this Agreement will affect or be effective to interpret, change or restrict this Agreement. No amendment, modification, termination or attempted waiver of any of the provisions of this Agreement will be binding on the parties unless in writing signed by all of the parties hereto, and no waiver of any provision of or default under this Agreement will affect the right of the parties thereafter to enforce any other provision or to exercise any right or remedy in the event of any other default, whether or not similar. (e) Notices. All notices, demands and other communications which are required to be given to or made by either party to the other in connection with this Agreement will be in writing, will be deemed to have been given when the next business day after properly sent by reliable next business day courier (as evidenced by the receipt from such courier) to the following addresses: if to LIM: to the address set forth on the first page of this Agreement with a copy to Richard Kurnit, Esq., Frankfurt, Kurnit, Klein & Selz, P.C., 488 Madison Avenue, New York, NY 10022; or if to Purchaser, VLF to 7 Jerry L. Malis, CEO, Valley Forge Scientific Corp., 136 Green Tree Road, Suite 100, P.O. Box 1179, Oaks, PA 19456 with a copy to Russell U. Schenkman, Esq., Schenkman Jennings & Howard, LLC,13 Roszel Road, Suite C-225, Princeton, New Jersey 08540. (f) Headings. Captions contained in this Agreement are inserted only as a matter of convenience and in no way define, limit or extend the scope of this Agreement or any provision hereof. (g) Severability. If any provision of this Agreement, or the application of such provision to any person or circumstance, is declared by a court of competent jurisdiction to be invalid for any reasons, such invalidity shall not affect the remaining provisions hereof or the application of such provisions to persons or circumstances other than those to which it is held invalid and this Agreement will be construed and enforced as if such invalid provisions had never been inserted. (h) Waiver. Any of the terms and conditions of this Agreement may be waived in writing at any time before the Closing Date by the party entitled to the benefit thereof. (i) Third Parties. Nothing herein expressed or implied is intended or shall be construed to confer upon or give to any person or entity, other than the parties hereto, any rights or remedies under or by reason of this Agreement. (j) Arbitration. (i) All disputes, claims, or controversies arising out of or relating to this Agreement or any other agreement executed and delivered pursuant to this Agreement or the negotiation, validity, execution or performance hereof and thereof or the transactions contemplated hereby and thereby that are not resolved by mutual agreement shall be resolved solely and exclusively by binding arbitration to be conducted in accordance with the rules of the American Arbitration Association ("AAA") then in effect in the State of New York. The arbitration shall be held in New York City, New York before a single arbitrator knowledgeable in business law matters. (ii) The initial fees and cost of the arbitrator shall be borne equally between the disputing parties. The prevailing party in such arbitration, as determined by the arbitrator, and in any enforcement or other court proceedings, shall be entitled as part of the award to the extent permitted by law, to reimbursement from the other party for all of the prevailing party's costs (including, but not limited to the arbitrator's compensation), expenses, and attorneys' fees. (iii) Nothing in this section shall limit any right that any party may otherwise have to seek to obtain (i) preliminary injunctive relief in order to preserve the status quo pending the disposition of any such arbitration proceeding or (ii) temporary or permanent injunctive relief from any breach of any provision of this Agreement. (k) Governing Law. This Agreement will be governed by, construed and enforced in accordance with the laws of the State of New York without application of principles of conflicts of laws. All parties submit to 8 the exclusive jurisdiction of the State and Federal Courts of the State, City and County of New York for any legal matters pertaining to this Agreement. IN WITNESS WHEREOF, the parties have executed this Agreement the date first written above. WITNESS: LEONARD I. MALIS /s/ LEONARD I. MALIS ------------------------------------- Leonard I. Malis VALLEY FORGE SCIENTIFIC CORP. By: /s/ JERRY L. MALIS --------------------------------- Jerry L. Malis, CEO and President 9 Exhibit A SECURED TERM PROMISSORY NOTE Principal Amount: $3,997,600 Date: _________, 200_ Oaks, PA FOR VALUE RECEIVED, Valley Forge Scientific Corp., a Pennsylvania corporation, with a principal business address at 136 Green Tree Road, Suite 100, P.O. Box 1179, Oaks, PA 19456-1179 (the "VLF") promises to pay to Leonard I. Malis, an individual, with an address at 219-44 Peck Avenue, Queens, New York 11427 (hereinafter "LIM"), the principal sum of THREE MILLION NINE HUNDRED AND NINETY SEVEN THOUSAND SIX HUNDRED DOLLARS ($3,997,600.00) No Interest. This Note shall not bear interest. Principal Payments. VLF shall pay principal in twenty-five (25) equal installments of ONE HUNDRED AND FIFTYNINE THOUSAND NINE HUNDRED AND FOUR ($159,904.00) (individually an "Installment Payment" and collectively "Installment Payments") commencing three months after the date hereof ("Commencement Date") and continuing on each three month anniversary of the date of this Note until the principal sum is paid in full. VLF shall make all payments to LIM at LIM's address shown above or at such other place as LIM may designate in writing. Prepayment. This Note may be prepaid in whole or in party without penalty. Late Charges. If an Installment Payment is not paid within fifteen (15) days of its due date, VLF will be charged 5.00% of the unpaid portion of the regularly scheduled payment. VLF shall pay this late charge for the purpose of defraying the expense incident to the handling of the delinquent payment. Furthermore, if VLF is in default of an Installment Payment, then interest ("Default Interest") shall accrue on the entire unpaid balance of this Note from the date of such default until the date of payment of such Installment Payment at an annual rate equal to the lesser of 12% or the maximum rate of interest permitted by applicable law. Default. Each of the following shall constitute an event of default ("Event of Default") under this Note. i. Payment Default. VLF fails to make any payment when due under this Note; provided however, the VLF shall not be considered to be in default if a payment is made within five (5) business days of its due date. ii. Bankruptcy Event. (a) VLF makes a general assignment for the benefit of creditors; or (b) (b) VLF commences (as the debtor) a case in bankruptcy, or commences (as the debtor) any proceeding under any other insolvency law; or 10 (c) A case in bankruptcy or any proceeding under any other insolvency law is commenced against VLF (as the debtor) and a court having jurisdiction enters a decree or order for relief against VLF as the debtor in such case or proceeding, or such case or proceeding is consented to by VLF or remains undismissed for sixty (60) days, or VLF consents or admits the material allegations against it in any such case or proceeding; or . (d) A trustee, receiver or agent (however named) is appointed or authorized by a court of competent jurisdiction to take charge of substantially all of the property of VLF for the purpose of general administration of such property for the benefit of creditors and the order making such appointment or granting such authorization is not vacated within sixty (60) days, during which period such trustee, receiver or agent shall not have taken any action with respect to the property of VLF which might materially adversely prejudice the interest of LIM under the security agreement entered into on this date between LIM and VLF ("Security Agreement") securing the obligation of VLF under this Note. iii. Merger. VLF sells all or substantially all of its assets or merges or is consolidated with or into another corporation in which the VLF stockholders immediately prior to such merger or consolidation own less than 50% of the outstanding voting securities of such combined entity immediately after the Merger; provided, however, this provision shall not apply to a merger, consolidation or sale in which the Option Agreement, of even date by and between VLF and LIM ("Option Agreement") is required to be exercised by VLF as a condition to closing; iv. Change in Control. A "Change in Control" of VLF after the date of this Note. A "Change in Control" shall mean any transaction, or related series of transactions occurring after the date of this Note, pursuant to which one or more persons or entities acting in concert collectively acquire more than fifty percent (50%) of the outstanding voting securities of VLF. v. Cross Default under the Security Agreement. The occurrence and declaration of an Event of Default under the Security Agreement. LIM's Rights. Upon the occurrence of an Event of Default upon written declaration by LIM the remaining unpaid Principal and Default Interest thereon shall become immediately due and payable. No waiver of any default hereunder shall be construed as a waiver of any subsequent default, and the failure to exercise any right or remedy hereunder shall not waive the right to exercise such right or remedy thereafter. Suits for Enforcement and Remedies. If an Event of Default occurs, the holder of this Note may proceed to protect and enforce such holder's rights either by suit in equity or by action at law, or both, whether for the specific performance of any covenant, condition or agreement contained in this Note or under the Security Agreement or in aid of the exercise of any power granted in this Note or under the Security Agreement, or proceed to enforce the payment of this Note or to enforce any other legal or equitable right of the holder of this Note or under the Security Agreement. No right or remedy herein shall be cumulative and shall be in addition to every other right and remedy given hereunder or under the Security Agreement or now or hereafter existing at law or in equity or by statute or otherwise. Without limiting the generality of the foregoing, if an Event of Default has occurred, no holder of this Note shall be 11 required to resort to any particular security, right or remedy or to proceed in any particular order of priority, and the holder of this Note shall have the right at any time and from time to time, in any manner or in any order, to enforce its security interests, liens, rights and remedies, or any of them, as it deems appropriate in the circumstances. Unconditional Obligation; Fees; Waivers; etc. i. if the holder of this Note shall institute any action to enforce the collection of any amount of Principal and/or Default Interest and/or late charges on this Note, there shall be due and payable from VLF on demand, in addition to the then unpaid amounts due, all reasonable costs and expenses incurred by LIM in connection therewith, including, without limitation, reasonable attorneys' fees and disbursements. ii. No forbearance, indulgence, delay or failure to exercise any right or remedy with respect to this Note shall operate as a waiver, nor as an acquiescence in any default, nor shall any single or partial exercise or any right or remedy preclude any other or further exercise thereof or the exercise of any other right or remedy. iii. This Note may not be modified or discharged orally, but only in writing duly executed by the holder hereof. iv. VLF hereby waives presentment, demand, notice of dishonor, protest and notice of protest. Security For Payment. The payment obligations of VLF and the collection rights of LIM under this Note are secured by the pledge to LIM of certain assets of VLF pursuant to the terms of the Security Agreement. Governing Law. This Agreement will be governed by, construed and enforced in accordance with the laws of the State of New York without application of principles of conflicts of laws. All parties submit to the exclusive jurisdiction of the State and Federal Courts of the State, City and County of New York for any legal matters pertaining to this Agreement. Successor Interests. The terms of this Note shall be binding upon VLF, and upon VLF's successors and assigns, and shall inure to the benefit of LIM and his heirs, personal representatives and successors. Notwithstanding anything in this Note to the contrary, this Note may not be transferred by LIM to anyone other than LIM's heirs, legal representatives or beneficiaries under his will, his "immediate family members" (which shall be defined as his wife, children, grandchildren, siblings and their spouses) or to a trust or other entity for the sole benefit of LIM or his immediate family members. Time of Payment. Payment to be made by the VLF to the LIM pursuant to the terms of this Note shall be tendered by VLF to the LIM by company check, during normal banking hours on any banking business day. If the date set for payment is not a banking business day, such payment may be made on the next succeeding banking business day and Default Interest and late charges (if applicable) shall continue to accrue on any amount so effected until the payment thereof on such extended due date. 12 Construction. Headings of the various paragraph of this Note are for convenience of reference only and shall in no way modify any of the terms or provisions of this Note. Notices. All notices, demands and other communications which are required to be given to or made by either party to the other in connection with this Note will be in writing, will be deemed to have been given the next business day after properly sent by reliable next business day courier (as evidenced by the receipt from such courier) to the following addresses: if to LIM: to the address set forth on the first page of this Agreement with a copy to Richard Kurnit, Esq., Frankfurt, Kurnit, Klein & Selz, P.C., 488 Madison Avenue, New York, NY 10022; or if to, VLF: to Jerry L. Malis, CEO, Valley Forge Scientific Corp., 136 Green Tree Road, Suite 100, P.O. Box 1179, Oaks, PA 19456 with a copy to Russell U. Schenkman, Esq., Schenkman Jennings & Howard, LLC,13 Roszel Road, Suite C-225, Princeton, New Jersey 08540. IN WITNESS WHEREOF, the undersigned has caused this Note to be duly executed, attested and delivered by its authorized and empowered officer, as of the day and year first written above. ATTEST VALLEY FORGE SCIENTIFIC CORP. By: - ---------------------------------- --------------------------------- 13 Exhibit B SECURITY AGREEMENT This Security Agreement is made on _____, 2004, BETWEEN the Debtor, Valley Forge Scientific Corp., a Pennsylvania corporation, with a business address of 136 Green Tree Road, Oaks, PA 19456, referred to as "Grantor"; AND the Secured Party, Leonard I. Malis, an individual, whose address is at 219-44 Peck Avenue, Queens, New York 1142712, referred to as the "Lender". Definitions. The following capitalized words and terms shall have the following meanings when used in this Agreement. Unless specifically stated to the contrary, all references to dollar amounts shall mean amounts in lawful money of the United States of America. Words and terms used in the singular shall include the plural, and the plural shall include the singular, as the context may require. Words and terms not otherwise defined in this Agreement shall have the meanings attributed to such terms in the Uniform Commercial Code as in effect from time to time in the State of Pennsylvania: a. Agreement. The word "Agreement" means this Security Agreement, as this Security Agreement may be amended or modified from time to time, together with all exhibits and schedules attached to this Security Agreement from time to time. b. Change of Control. The word "Change of Control" shall mean any transaction, or related series of transactions occurring after the date of this Agreement, pursuant to which one or more persons or entities acting in concert collectively acquire more than fifty percent (50%) of the outstanding voting securities of VLF. c. Collateral. As defined on page 2 of this Agreement. d. Event of Default. As defined on page 4 of this Agreement. e. Indebtedness. The word "Indebtedness" means the indebtedness evidenced by the Note and all interest, fees, costs, expenses, reimbursement obligations, indemnities and other liabilities owed to or incurred by Lender in connection with the Note, the collection thereof, this Security Agreement, and the enforcement of Lender's rights hereunder, including without limitation of reasonable attorneys' fees and expenses and sums advanced by Lender to protect the Collateral or otherwise as permitted under this Agreement. f. Note. The word "Note" means the Installment Note executed by Valley Forge Scientific Corp. to Lender in the principal amount of $4,157,504.00 of even date, together with all renewals of, extensions and modifications. g. Property. The word "Property" means all of Grantor's right, title and interest in and to all the Property as described in the "Collateral Description" section of this Agreement. Grant of Security Interest. To induce Lender to accept the Note and the terms thereof, as payment for Grantor's exercise of a certain option agreement dated October ____, 2004, by and between Grantor and Lender ("Option Agreement") 14 and for other valuable consideration, Grantor grants to Lender a first priority security interest in the Collateral to secure the Indebtedness and agrees that Lender shall have the rights stated in this Agreement with respect to the Collateral, in addition to all other rights which Lender may have at law or in equity. Collateral Description. The word "Collateral" as used in this Agreement means the following described property of Grantor, wherever located, in which Grantor is giving to Lender a security interest for the payment of the Indebtedness and performance of all other obligations under the Note and this Agreement: a. All Grantor's rights in the "Malis" trademark and all variations thereof ("Trademark") and all goodwill associated therewith, now existing or hereafter adopted or acquired, all registration and recordings thereof, and all applications in connection therewith, whether in the United States Patent and Trademark Office or in any similar office or agency of the United States, any State thereof or any other country or any political subdivision thereof, or otherwise, and all common-law rights related thereto, and the right to obtain all renewals, extensions and continuations thereof. b. Grantor's patents as identified in Schedule A, attached hereto, (the "Patents" and, collectively with the Trademark the "Intellectual Property"), and all reissues and extensions thereof and all goodwill associated therewith, all applications for letters patent of the United States or any other country and all divisions, continuations and continuations-in-part thereof, and all rights to obtain any reissues or extensions of the Patents as identified in Schedule A. c. All renewals, of any of the Intellectual Property. d. All proceeds (including insurance proceeds) from the sale, destruction, loss, or other voluntary or involuntary disposition of any of the Intellectual Property described in this Collateral section and all royalties and licensing fees of, to or from any such Collateral. Grantor's Representations and Warranties with Respect to the Collateral. With respect to the Collateral, Grantor represents and warrants and covenants to Lender that: a. Perfection of Security Interest. Grantor agrees to execute, deliver, file and record all such financing statements or other documents and to take whatever other actions are requested by Lender to perfect and continue Lender's security interest in the Collateral. Grantor authorizes Lender to file financing statements where desirable in Lender's judgment to perfect such security interest without the signature of Grantor. b. Information Regarding Names; Notices to Lender. Grantor has disclosed to Lender on Exhibit A hereto complete and correct information regarding Grantor's exact legal name and all prior or current names and trade names used by Grantor. Grantor will promptly notify Lender in writing at Lender's address shown above (or such other addresses as Lender may designate from time to time) at least ten (10) business days prior to any (1) change in Grantor's name; (2) change in Grantor's state of organization; or (3) conversion of Grantor to a new or different type of business entity. 15 c. No Violation Authority. The execution delivery, and performance of this Agreement will not violate any law or agreement governing Grantor or to which Grantor is a party. Grantor has full power and authority to grant security interests in the Collateral and to execute, deliver and perform its obligations in accordance with the terms of this Agreement. d. Transaction involving Collateral. Grantor shall not sell, offer to sell, or otherwise transfer or dispose of any particular Intellectual Property that constitutes the Collateral. Grantor shall not pledge, mortgage, encumber or otherwise permit the Collateral to be subject to any lien, security interest, encumbrance, or charge, other than the security interest provided for in this Agreement, without the prior written consent of Lender. This includes security interests even if junior in right to the security interests granted under this Agreement. Notwithstanding anything to the contrary in this Agreement, the Note or the Option Agreement, prior to the occurrence and declaration of an Event of Default, nothing in this Agreement, the Note or the Option Agreement shall (i) restrict, prevent or limit Grantor from entering into any licensing agreements, royalty agreements, distribution agreement or other agreements, pertaining to the Intellectual Property with third parties in arms length transactions or from receiving royalties or other fees or payments pertaining to the Intellectual Property; (ii) in any manner whatsoever restrict, prevent or limit Grantor's use of the Intellectual Property in the ordinary course of its business; (iii) restrict, prevent of limit Grantor's rights under any license, royalty or other agreement to collect and use any payments, fees or amounts due and payable to Grantor under such agreements, without any accounting whatsoever to Lender. e. Title. Grantor represents and warrants to Lender that Grantor holds the same title to the Trademark that was conveyed to Grantor by the Lender and has title to the other Collateral, free and clear of all liens and encumbrances except for the lien of this Agreement. No financing statement covering any of the Collateral is on file in any public office other than those which reflect the security interest created by this Agreement or to which Lender has specifically consented. Grantor shall defend Lender's rights in the Collateral against the claims and demands of all other persons. f. Repairs and Maintenance. Grantor agrees to keep and maintain, and to cause others to keep and maintain, the Collateral in good order, repair and condition at all times while this Agreement remains in effect. Grantor further agrees to pay when due all claims for work done on, or services rendered or material furnished in connection with the Collateral so that no lien or encumbrance may ever attach to or be filed against the Collateral. g. Records, Inspection of Collateral. Lender and Lender's designated representatives and agents shall have the right at all reasonable times to examine and inspect the Collateral wherever located. Grantor shall keep and cause to be kept accurate and complete records of the Collateral and its proceeds at its principal place of business, which records will be made available for inspection and copying upon such premises by Lender at any reasonable time during normal business hours. h. Taxes, Assessments and Liens. Grantor will pay when due all taxes, assessments and liens upon the Collateral i. Compliance with Governmental Requirements. Grantor shall comply promptly with all laws, ordinances, rules and regulations of all governmental authorities, now or hereafter in effect, applicable to the 16 ownership, production, disposition, or use of the Collateral. Grantor may contest in good faith any such law, ordinance or regulation and withhold compliance during any proceeding, including appropriate appeals, so long as Lender's interest in the Collateral, in Lender's opinion, is not jeopardized. j. Financing Statement. Grantor authorizes Lender to file a UCC-1 financing statement, or alternatively, a copy of this Agreement to perfect Lender's security interest. At Lender's request, Grantor additionally agrees to sign all other documents that are necessary to perfect, protect, and continue Lender's security interest in the Property. This includes making sure Lender is shown as the first and only security interest holder on the title covering the Property. k. Intellectual Property. (i) Schedule A, hereto lists all Patents which are Collateral. (ii) On the date hereof, to Grantor's knowledge all Intellectual Property is valid, subsisting, unexpired and enforceable, has not been abandoned and does not infringe the intellectual property rights of any other person. (iii) To Grantor's knowledge, no holding, decision or judgment has been rendered by any governmental authority which would limit, cancel or question the validity of, or Grantor's rights in, any Intellectual Property in any respect that could reasonably be expected to have a material adverse effect on Grantor. (iv) No action or proceeding is pending, or, to the knowledge of Grantor, threatened, on the date hereof (a) seeking to limit, cancel or question the validity of any Intellectual Property or Grantor's ownership interest therein, or (b) which, if adversely determined, would have a material adverse effect on the value of any Intellectual Property owned by Grantor. (v) Grantor will promptly notify Lender if any application or registration relating to any Intellectual Property becomes forfeited, abandoned or dedicated to the public, or any adverse determination or development in any proceeding in the United States Patent and Trademark Office regarding Grantor's ownership of, or the validity of, any Intellectual Property or Grantor's right to register the same or to own and maintain the same. (vi) In the event that Grantor determines that any Intellectual Property is infringed, misappropriated or diluted by a third party, Grantor shall (a) take such actions as Grantor shall reasonably deem appropriate under the circumstances to protect such Intellectual Property and (b) if such Intellectual Property is of material economic value, promptly notify Lender after it learns thereof. Grantor's Right to Possession. Until the occurrence and declaration of an Event of Default, Grantor shall have sole possession and beneficial use of all the Collateral and may use it in any lawful manner. If Lender at any time has possession of any Collateral after an Event of Default, Lender shall be deemed to have exercised reasonable care in the custody and preservation of the Collateral if Lender takes such action for that purpose as Grantor shall request 17 or as Lender shall reasonably determine appropriate under the circumstances, but failure to honor any request by Grantor shall not of itself be deemed to be a failure to exercise reasonable care. Lender shall not be required to take any steps necessary to preserve any rights in the Collateral against prior parties, nor to protect, preserve or maintain any security interest given to secure the Indebtedness. Lender's Expenditures. If any action or proceeding is commenced that would materially affect Lender's interest in the Collateral or if Grantor fails to comply with any provision of this Agreement, including but not limited to Grantor's failure to discharge or pay when due any amounts Grantor is required to discharge or pay under this Agreement or the Note, Lender on Grantor's behalf may (but shall not be obligated to) take any action that Lender deems appropriate, including but not limited to discharging or paying all taxes, liens, security interest, encumbrances and other claims, at any time levied or placed on the Collateral. All such expenditures incurred or paid by Lender for such purposes will then bear interest at the rate of six percent (6%) per annum from the date incurred or paid by Lender to the date of repayment by Grantor. All such expenses will become a part of the Indebtedness and, at Lender's option, will (A) be payable on demand; or (B) be added to the balance of the Note and be apportioned among and be payable with any installment payments to become due during the remaining term of the Note. This Agreement also will secure payment of these amounts. Such right shall be in addition to all other rights and remedies to which Lender may be entitled upon Default. Default. Each of the following shall constitute an Event of Default under this Agreement: a. Other Indebtedness Default. Grantor fails to make any payment when due under any Indebtedness, other than the Note. b. Other Defaults. Grantor fails to comply with or to perform any other term, obligation, covenant or condition contained in this Agreement. c. Insolvency. (i) The termination of existence or cessation of business by Grantor; (ii) Grantor commences (as the debtor) a case in bankruptcy, or commences (as the debtor) any proceeding under any other insolvency law; (iii) A case in bankruptcy or any proceeding under any other insolvency law is commenced against Grantor (as the debtor) and a court having jurisdiction enters a decree or order for relief against Grantor as the debtor in such case or proceeding, or such case or proceeding is consented to by Grantor or remains undismissed for sixty (60) days, or Grantor consents or admits the material allegations against it in any such case or proceeding; and (iv) A trustee, receiver or agent (however named) is appointed or authorized by a court of competent jurisdiction to take charge of substantially all of the property of Grantor for the purpose of general administration of such property for the benefit of creditors and the order making such appointment or granting such authorization is not vacated within 18 sixty (60) days, during which period such trustee, receiver or agent shall not have taken any action with respect to the property of Grantor which might materially adversely prejudice the interest of Lender under this Agreement. e. Cross Default. An Event of Default under the Note. f. Change of Control. A Change of Control of Grantor. g. The levy of any writ of execution or other judicial process upon any of the Collateral, which is not released within thirty (30) days thereafter. h. Cure Provisions. If any default under subparagraph a or b is curable, it may be cured (and no event of default will have occurred) if Grantor, after receiving written notice from Lender demanding cure of such default: (1) cures the default within thirty (30) days; or (2) if the cure requires more than thirty (30) days, immediately initiates steps reasonably sufficient to cure the default and thereafter diligently continues and completes all reasonable and necessary steps sufficient to produce compliance as soon as reasonably practical. Rights and Remedies on Default. If an Event of Default occurs under this Agreement, at any time thereafter, Lender shall have all the rights of a secured party under the Pennsylvania Uniform Commercial Code. In addition and without limitation, Lender may exercise any one or more of the following rights and remedies: a. Accelerate Indebtedness. Lender may declare the entire Indebtedness immediately due and payable upon notice to Grantor. b. Assemble Collateral. Lender may require Grantor to deliver to Lender all or any portion of the Collateral and any and all certificates of title and other documents relating to the Collateral. Lender may require Grantor to assemble the Collateral and make it available to Lender at a place to be designated by Lender. If the Collateral contains other goods not covered by this Agreement at the time or repossession, Grantor agrees Lender may take such other goods, provided that Lender makes reasonable efforts to return them to Grantor after repossession. c. Sell the Collateral. Lender shall have full power to sell, lease, transfer, or otherwise deal with the Collateral or proceeds thereof in Lender's own name or that of Grantor. Lender may sell the Collateral at public auction or private sale. Lender will give Grantor, and other persons as required by law, reasonable notice of the time and place of any public sale, or the time after which any private sale or any other disposition of the Collateral is to be made. However, no notice need by provided to any person who, after Event of Default occurs, enters into and authenticates an agreement waiving that person's right to notification of sale. The requirements of reasonable notice shall be met if such notice is given at least ten (10) days before the time of the sale or disposition. All expenses relating to the disposition of the Collateral, including without limitation the expenses of retaking, holding, insuring, preparing for sale and selling the Collateral, shall become a part of the Indebtedness secured by this Agreement shall be payable on demand, with interest at six percent (6%) per annum from date of expenditure until repaid. 19 d. Application of Proceeds. Any proceeds received by Lender in respect of any sale or collection from or other realization upon all or any part of the Collateral following the occurrence of an Event of Default may, in the discretion of Lender, be held by Lender as collateral for, and/or then or at any time thereafter applied by Lender as follows: (i) first, to pay all costs, expenses and charged of every kind (including reasonable attorneys' fees and costs) for pursuing, searching, protecting, taking, removing, storing, safekeeping, caring, preparing for sale, advertising, selling and delivering the Collateral and otherwise enforcing this Agreement and the Note; (ii) second, to pay the Indebtedness; and (iii) third, to pay the remaining funds, if any, after payment of the Indebtedness in full, to Grantor or to whomever may be lawfully entitled to receive such surplus. Payments received from any third party on account of disposition of Collateral shall not reduce the Indebtedness until paid in cash to Lender. The application of proceeds by Lender shall be without prejudice to Lender's rights as against Grantor or other persons with respect to any amount of the Indebtedness, which may remain unpaid. Any such deficiency shall be paid forthwith to Lender by Grantor. e. Appoint Receiver. Lender shall have the right to have a receiver appointed to take possession of all or any part of the Collateral, with the power to protect and preserve the Collateral, to operate the Collateral preceding foreclosure or sale, and to collect the leases and rents from the Collateral and apply the proceeds, over and above the cost of the receivership, against the Indebtedness. The receiver may serve without bond if permitted by law. Lender's right to the appointment of a receiver shall exist whether or not the apparent value of the Collateral exceeds the Indebtedness by a substantial amount. f. Collect Revenues, Apply Accounts. Lender, either itself or through a receiver, may collect the payments, rents, income and revenues from the Collateral. Lender may at any time in Lender's discretion transfer any Collateral into Lender's own name or that of Lender's nominee and receive the payments, rents, income, and revenues therefrom and hold the same as security for the Indebtedness or apply it to payment of the Indebtedness in such order of preference as Lender may determine. g. Other Rights and Remedies. Lender shall have all the rights and remedies of a secured creditor under the provisions of the Uniform Commercial Code in the State of New York, as may be amended from time to time. In addition, Lender shall have an may exercise any or all other rights and remedies if may have available at law, in equity, or otherwise. h. Cease using Trademark. Lender shall have the right to require Grantor to immediately cease using the Trademark on any or all of Grantor's property or products it sells to others. i. Election of Remedies. Except as may be prohibited by applicable law, all of Lender's rights and remedies, whether evidenced by this Agreement, the Note, or by any other writing, shall be cumulative and may be exercised singularly or concurrently. Election by Lender to pursue any remedy shall not exclude pursuit of any other remedy, and an election to make expenditures or to take action to perform an obligation of Grantor under this Agreement, after Grantor's failure to perform, shall not affect Lender's right to declare a default and exercise its remedies. 20 Appointment of Lender as Lawful Attorney. During Leonard I. Malis' lifetime and provided that Leonard I. Malis is the Lender, upon and after the occurrence of an Event of Default, and the Grantor's failure to cure such Event of Default within thirty (30) days after notice to Grantor of such Event of Default and of Lender's intent to exercise its rights under this paragraph Grantor hereby irrevocably makes, constitutes and appoints Leonard I. Malis its true and lawful attorney (and agent-in-fact) for the purposes set forth in the following sentences of this paragraph. Upon and after the occurrence of an Event of Default, and the Grantor's failure to cure such Event of Default within thirty (30) days after notice to Grantor of such Event of Default and of Lender's intent to exercise its rights under this paragraph, Leonard I. Malis or his agent may, without any further notice to Grantor and at such time or times thereafter as Leonard I. Malis in his sole discretion may determine, in Grantor's or Lender's name: (i) give notice to account debtors and demand payment of obligations included in the Collateral; (ii) enforce payment and exercise all of Grantor's rights and remedies with respect to the collection of obligations relating to the Collateral by legal proceedings or otherwise; (iii) settle, adjust, compromise, discharge, release, extend or renew obligations relating to the Collateral; (iv) transfer into the name of Lender or the name of Lender's agent or nominee any of the Collateral; (v) make, settle and adjust claims under policies of insurance relating to the Collateral, endorse or sign the name of Grantor on any check or other item of payment for the proceeds of such policies of insurance, and make all determinations and decisions with respect thereto; and (vi) receive and direct the disposition of any proceeds of any Collateral. Indemnification. Grantor hereby agrees to indemnify and hold harmless Lender and agents against and from any and all claims, actions, liabilities, costs and expenses of any kind or nature whatsoever (including reasonable fees and disbursements of counsel) that may be imposed on, incurred by, or asserted against any of them, in any way relating to or arising out of this Agreement, any exercise of remedies hereunder or any other action taken or omitted by them hereunder, except that such claims, actions, liabilities, costs and expenses directly resulted from the gross negligence or willful misconduct of such indemnified persons. Waivers by Grantor. Except as otherwise expressly provided in this Agreement or the Note, the Grantor waives: (i) presentment, demand, and protest and notice of protest, default, compromise, settlement, extension, or renewal of the Note; (ii) notice prior to taking possession or control of Collateral or any bond or security that might be required by any court prior to allowing Lender to exercise any of Lender's remedies; (iii) the benefit of all valuation, appraisement, and exemption laws; (iv) any right to require Lender to proceed against any other person or collateral held from any other person; (v) any right to require Lender to pursue any other remedy in Lender's power whatsoever; and (vi) any defense arising out of any election by Lender to exercise or not exercise any right or remedy it may have against Grantor, any other person or any security held by it, even though such election operates to impair or extinguish any right or reimbursement to subrogation or other right or remedy of Grantor against any other person or any such security. Assignment by Lender. Upon the occurrence of an Event of Default, Grantor agrees that Lender may assign or otherwise transfer this Agreement, or the Note, and may deliver all or any part of the Collateral to the transferee(s), who shall thereupon become vested with all the powers and rights in respect thereto given to the Lender herein or in the Note transferred, and Lender shall thereafter be fully discharged from any liability or responsibility with respect thereto. 21 Miscellaneous Provisions. The following miscellaneous provisions are a part of this Agreement: a. Amendments. This Agreement together with the Note constitutes the entire understanding and agreement of the parties as to the matters set forth in this Agreement. No alteration of or amendment to his Agreement shall be effective unless given in writing and signed by the party or parties sought to be charged or bound by the alteration or amendment. b. Attorneys' Fees; Expenses. Grantor agrees to pay upon demand all of Lender's costs and expenses, including Lender's reasonable attorneys' fees and Lender's legal expenses, incurred in connection with the enforcement of this Agreement after the occurrence of an Event of Default. Lender may hire or pay someone else to help enforce this Agreement, and Grantor shall pay the costs and expenses of such enforcement. Costs and expenses include Lender's reasonable attorneys' fees and legal expenses whether or not there is a lawsuit. Grantor also shall pay all court costs and such additional fees as may be directed by the court. c. Caption Headings. Caption headings in this Agreement are for convenience purposes only and are not to be used to interpret or define the provisions of this Agreement. d. Governing Law. This Agreement will be governed by, construed and enforced in accordance with federal law and laws of the State of New York. This Agreement has been accepted by Lender in the State of New York. The parties hereto (i) agree that any legal suit, action or proceeding arising out of or relating to this Agreement shall be instituted exclusively in the New York State Supreme Court or the United States District Court for the Southern District of New York; (ii) waive any objection which they may have now or hereafter based upon forum non conveniens or to the venue of any such suit, action or proceeding; and (iii) irrevocably consent of the jurisdiction of the New York State Supreme Court or the United Stated District Court for the Southern District of New York in any such suit, action or proceeding. e. No Waiver by Lender. Lender shall not be deemed to have waived any rights under this Agreement unless such waiver is given in writing and signed by Lender. No delay or omission on the part of Lender in exercising any right shall operate as a waiver of such right or any other right. A waiver by Lender of a provision of this Agreement shall not prejudice or constitute a waiver of Lender's right otherwise to demand strict compliance with that provision or any other provision of this Agreement. No prior waiver by Lender, nor any course of dealing between Lender and Grantor, shall constitute a waiver of any of Lender's rights or of any of Grantor's obligations as to any future transactions. Whenever the consent of Lender is required under this Agreement, the granting of such consent by Lender in any instance shall not constitute continuing consent to subsequent instances where such consent is required and in all cases such consent may be granted or withheld in the sole discretion of Lender. f. Notices. Any notice required to be given under this Agreement shall be given in writing, and shall be effective when actually delivered, when actually received by telefacsimile (unless otherwise required by law), or the next business day after deposited with a nationally recognized overnight courier, with receipt acknowledge directed to the addresses shown near the beginning of this Agreement. Any party may change its address for notices 22 under this Agreement by giving formal written notice to the other parties, specifying that the purpose of the notice is to change the party's address. For notice purposes, Grantor agrees to keep Lender informed at all times of Grantor's current address. A copy of all notices to Grantor shall be sent to Russell U. Schenkman, Esq., Schenkman Jennings & Howard, LLC, 13 Roszel Road, Suite C-225, Princeton, NJ 08540. A copy of all notices to Lender shall be sent to Richard Kurnit, Esq., Frankfurt, Kurnit, Klein & Selz, P.C., 488 Madison Avenue, New York, NY 10022. g. Severability. If a court of competent jurisdiction finds any provision of this Agreement to be illegal, invalid, or unenforceable as to any circumstances, that finding shall not make the offending provision illegal, invalid, or unenforceable as to any other circumstance. If feasible, the offending provision shall be considered modified so that it become legal, valid and enforceable. If the offending provision cannot be so modified, it shall be considered deleted from this Agreement. Unless otherwise required by law, the illegality, invalidity, or unenforceability of any provision of this Agreement shall not affect the legality, validity or enforceability of any other provision of this Agreement. h. Successors and Assigns. Subject to any limitation stated in this Agreement on transfer of Grantor's interest, this Agreement shall be binding upon and inure to the benefit of the parties, their successors and assigns. If ownership of the Collateral becomes vested in a person other than Grantor, Lender, without notice to Grantor, may deal with Grantor's successors with reference to this Agreement and Indebtedness by way of forbearance or extension without releasing Grantor from the obligations of this Agreement or liability under the Indebtedness. Notwithstanding anything in this Agreement, the Note or the Option Agreement to the Contrary, this Agreement or the rights granted hereunder may not be transferred by Lender to anyone other than Lender's heirs, legal representatives or beneficiaries under his will, or his "immediate family members" (which shall be defined as his wife, children, grandchildren, siblings and their spouses) or to a trust or other entity for the sole benefit of Lender or his immediate family members. i. Survival of Representations and Warranties. All representations, warranties, and agreements made by Grantor in this Agreement shall survive the execution and delivery of this Agreement, shall be continuing in nature, and shall remain in full force and effect until such time as Grantor's indebtedness shall be paid in full. j. Time is of the Essence. Time is of the essence in the performance of this Agreement. k. Waive Jury. All parties to this Agreement hereby waive the right to any jury trial in any action, proceeding, or counterclaim brought by any party against any other party. Termination of Agreement and Security Interest Notwithstanding anything in this Agreement to the contrary, upon the payment by Grantor of all amounts due and owing under the Note, this Agreement and all security interests created hereunder shall automatically terminate, and Lender shall promptly execute such documents that Grantor reasonably requests to evidence such termination of this Agreement and the security agreements created hereunder. 23 GRANTOR: Valley Forge Scientific Corp. By: -------------------------------- LENDER: Leonard I. Malis -------------------------------- Leonard I. Malis 24 EX-23 5 ex_23.txt EXHIBIT 23 SAMUEL KLEIN AND COMPANY INDEPENDENT ACCOUNTANTS We consent to the incorporation by reference in the registration statements of Valley Forge Scientific Corp. and its subsidiary on Form S-8 (File No. 333-63637; 333-72296 and 333-72134) of our report dated November 19, 2004 on our audits of the financial statements of Valley Forge Scientific Corp. and its subsidiary as of September 30, 2004 and 2003, and for each of the three years in the period ended September 30, 2004, which report is included in this Annual Report on Form 10-K. SAMUEL KLEIN AND COMPANY /s/ SAMUEL KLEIN AND COMPANY Newark, New Jersey December 22, 2004 EX-31.1 6 ex31_1.txt EXHIBIT 31.1 Exhibit 31.1 CERTIFICATION OF CHIEF EXECUTIVE OFFICER AND PRINCIPAL FINANCIAL OFFICER Pursuant to 18 U.S.C. Section 1350 As Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 I, Jerry L. Malis, certify that: 1. I have reviewed this annual report on Form 10-K of Valley Forge Scientific Corp; 2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report; 3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and c) Disclosed in this report any change in the registrant's internal control over financial reporting that occured during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of the annual report) that has materially affected, or is reasonably likely to materially affect the registrant's internal control over financial reporting; and 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): a) All significant deficiencies in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls over financial reporting. /s/ JERRY L. MALIS Dated: December 22, 2004 ---------------------------------------- Jerry L. Malis, Chief Executive Officer and President, Principal Executive Officer, and Principal Financial Officer EX-32.1 7 ex32_1.txt EXHIBIT 32.1 Exhibit 32.1 Certification of Chief Executive Officer and Principal Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 In connection with this annual report on Form 10-K for the year ended September 30, 2004 ("Report") of Valley Forge Scientific Corp., I, Jerry L. Malis, President, Chief Executive Officer and Chairman of the Board of Valley Forge Scientific Corp., hereby certify that, to my knowledge: o The Report fully complies with the requirements of Section 13 (a) or 15 (d), as applicable, of the Securities Exchange Act of 1934; as amended, and o The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of Valley Forge Scientific Corp. Date: December 22, 2004 /s/ JERRY L. MALIS ---------------------------------- Jerry L. Malis President, Chief Executive Officer, and Principal Financial Officer The foregoing certification is furnished solely to accompany the Report pursuant to 18 U.S.C. Section 1350, and is not being filed for purposes of the Securities Act of 1934, as amended, and is not to be incorporated by reference into any filing of the Company, whether made before or after the date hereof, regardless of any general incorporation language in such filing. -----END PRIVACY-ENHANCED MESSAGE-----