ITEM 1. BUSINESS
This Annual Report on Form 10-K contains forward-looking statements, including statements about new product introductions, expectations as to future sales of the Company's products, the availability of supplies, the sufficiency of the Company's capital resources to meet anticipated capital requirements, the Company's intentions to expand its indirect sales force and the Company's expectations as to future expenditures, including research and development expenditures. For this purpose, any statements contained herein that are not statements of historical fact may be deemed to be forward-looking statements. Without limiting the foregoing, the words "believes", "anticipates", "plans", "expects", and similar expressions are intended to identify forward-looking statements. These forward-looking statements involve risks and uncertainties, and the Company's actual results may differ significantly from the results discussed in the forward-looking statements. Factors that might cause such a difference include, but are not limited to the availability of capital resources, the availability of third-party reimbursement, government regulation, commercialization and technological difficulties, general economic conditions and other risks detailed below. See "Certain Factors That May Affect the Company's Future Operating Results."
Vision-Sciences, Inc. (the "Company") develops, manufactures and markets products for endoscopy which have infection control advantages over conventional flexible endoscopes. The Company has developed, and is marketing, proprietary flexible endoscope systems designed to eliminate the risk of cross-contamination to patients and health-care professionals which results from the reuse of conventional flexible endoscopes. The Company's systems consist of two main components--a proprietary sterile disposable sheath, known as an EndoSheath System (EndoSheath) and a reusable flexible endoscope incorporating the Company's proprietary design. The EndoSheath is designed to cover all surfaces of the endoscope that come in contact with the patient and contains the air, water, suction and accessory channels that are a part of conventional flexible endoscopes, thus providing a contamination-free instrument and substantially reducing the burdensome cleaning required of conventional flexible endoscopes. The Company has developed a family of disposable EndoSheath/reusable flexible endoscope systems for gastrointestinal endoscopy and began commercial shipments of its first such system, a fiberoptic sigmoidoscope, in April 1993.
The Company also manufactures and sells disposable EndoSheaths for use with certain conventional flexible endoscopes currently sold by the Company and other manufacturers. In December 1992 the Company began commercial shipments of its first such EndoSheath, for use with one of its nasopharyngo-laryngoscopes ("ENT endoscopes"). In January 1993 the Company received clearance from the U.S. Food and Drug Administration (the "FDA") to market four additional disposable EndoSheaths for use with certain other ENT endoscopes. In February 1994 the Company received clearance from the FDA to market its black and white CCD video sigmoidoscope and EndoSheath system. In February 1995 the Company received clearance from the FDA to market its 130 cm length fiberoptic colonoscope and EndoSheath system and its fiberoptic gastroscope and EndoSheath system. In December 1995 the Company received clearance from the FDA to market its fiberoptic ENT scope. In December 1996 the Company received clearance from the FDA to market its fiberoptic bronchoscope and EndoSheath system. In January 1997 the Company received clearance from the FDA to market its color video sigmoidoscope.
ENDOSCOPY
BACKGROUND
Endoscopy is a minimally invasive technique that is being used with increased frequency in a growing number of medical applications. Endoscopes are used for a variety of screening and diagnostic procedures and are also used therapeutically as an alternative to more traditional surgical procedures. Endoscopic therapeutic procedures, unlike more traditional "open" surgical procedures, can be performed without a
major incision, in most cases without general anesthesia, and are, therefore, safer and less expensive than traditional surgical procedures. In addition, endoscopic procedures are typically performed on an outpatient basis and generally involve less recovery time and patient discomfort than traditional surgery. The patient benefits and cost savings associated with endoscopy have caused many governmental reimbursement programs and private health insurance plans to encourage the use of endoscopic procedures in a number of medical applications.
Flexible endoscopes are tubular instruments that enter the body through a natural orifice and enable physicians to view the interior of a body organ or cavity remotely and perform various screening, diagnostic, and therapeutic procedures. Flexible endoscopes generally utilize fiberoptic bundles or video camera technology for image production. The physician can steer the distal portion of a flexible endoscope with control knobs on the endoscope's operator body. By maneuvering the tip of the endoscope, the physician can access body regions through lengthy and twisted passageways (such as the colon) and perform a variety of procedures. Most flexible endoscopes contain a series of channels running the length of the endoscope for delivery of air, water, suction and accessory devices, such as biopsy forceps and cutting instruments.
Rigid endoscopes generally utilize a stainless steel tube encasing a series of high resolution lenses to transmit the optical image. Most rigid endoscopes do not contain the channels that are characteristic of flexible endoscopes. Rigid endoscopes are currently utilized for diagnostic and surgical procedures such as arthroscopy, laparoscopy, and urological and gynecological procedures. While rigid endoscopes for other medical applications, such as bronchoscopes, sigmoidoscopes, and nasopharyngo-laryngoscopes are still marketed, they have largely been supplanted by flexible endoscopes, which offer improved patient comfort and better handling capabilities. The Company does not currently plan to participate in the rigid endoscope market.
APPLICATIONS
Flexible endoscopes are widely used in hospitals, clinics, and physicians' offices primarily on an outpatient basis. The Company's flexible endoscopes are designed primarily for screening, diagnostic, and therapeutic procedures in fields such as gastroenterology, surgery, primary care, otolaryngology (ear-nose-throat medicine, or "ENT"), and pulmonary medicine. The Company estimates, based on various industry sources, that approximately 20 million flexible endoscopic procedures in these fields were performed in the United States in 1995.
GASTROINTESTINAL ENDOSCOPY. The Company estimates, based on industry sources, that over 12 million flexible endoscopic procedures involving the screening, diagnosis or treatment of the colon, esophagus, stomach and duodenum were performed in the United States in 1995. Continued growth in such procedures is expected to result from an increase in sigmoidoscopies performed for the purpose of detecting cancer of the descending colon, as well as the increased medical needs associated with an aging population. The American Cancer Society has recommended that every adult over the age of 50 (currently approximately 60 million Americans) receive a screening sigmoidoscopy every three to five years.
The most common flexible endoscopes used in gastrointestinal endoscopy are as follows:
- Sigmoidoscopes are used for viewing the sigmoid colon and descending colon for screening and diagnostic purposes, such as screening for colon cancer. An estimated 4.7 million procedures were performed in the United States in 1995 by gastroenterologists, family practitioners, and general and colon-rectal surgeons in hospitals, clinics, and physicians' offices primarily on an outpatient basis.
- Colonoscopes are used for viewing the complete colon for screening, diagnostic and therapeutic purposes, such as removing polyps. Colonoscopy is often performed following sigmoidoscopy. An estimated 3.6 million procedures were performed in the United States in 1995, primarily by gastroenterologists and colon-rectal surgeons in hospitals and clinics.
- Gastroscopes are used for viewing the esophagus and the stomach for diagnostic and therapeutic purposes, such as detecting and cauterizing ulcers. An estimated 4.2 million procedures were performed in the United States in 1995 by gastroenterologists in hospitals and clinics.
- Duodenoscopes are used for viewing and intubating the biliary and pancreatic ducts from the duodenum for diagnostic and therapeutic purposes, such as detecting gallstones. An estimated 400,000 procedures were performed in the United States in 1995 by gastroenterologists in a hospital setting.
- ENT Endoscopes. These endoscopes are used for viewing the ears, nose, throat and larynx for diagnostic purposes, such as testing for throat cancer. The Company estimates, based on industry sources, that approximately 4 million such procedures were performed in the United States in 1995, generally by otolaryngologists and allergists in hospitals, clinics, and physicians' offices.
- Pulmonary Endoscopes. A bronchoscope and an intubation endoscope are flexible endoscopes used for viewing the trachea, bronchi and lungs for diagnostic and therapeutic purposes, generally by pulmonary specialists and anesthesiologists in a clinic or hospital setting. The Company estimates, based on industry sources, that approximately 1 million procedures using flexible bronchoscopes were performed in the United States in 1995. Because pneumonia is common in persons infected with the HIV virus, and because bronchoscopy is often used to make this diagnosis, there has been increased usage of bronchoscopes for this purpose, as well as greater recognition of the need to perform bronchoscopies in a contamination-free manner to protect both the HIV positive patients (who have weakened immune systems) and subsequent patients on whom the bronchoscope is used.
PROBLEMS WITH CONVENTIONAL FLEXIBLE ENDOSCOPES
While endoscopy represents a significant advance in the field of clinical medicine, conventional flexible endoscopes present a number of health risks and problems to both patients and medical personnel. Conventional flexible endoscopes are intended for repeated use in hundreds of procedures and, with each use, come in contact with some combination of the patient's blood, tissue, mucus, saliva and stool. Therefore, a conventional flexible endoscope must be meticulously manually cleaned and disinfected after each procedure. However, the design of conventional flexible endoscopes makes it difficult to attain high- level disinfection after cleaning. As a result, the repeated use of conventional flexible endoscopes and the difficulty in thoroughly cleaning and disinfecting them after each use create the following problems:
- Patients, and to a lesser degree the physician using the flexible endoscope and the nurse assistant cleaning it, are exposed to the risk of infection from contaminated endoscopes that results from their repeated use.
- The nurses or other medical personnel who clean the endoscope face health risks from exposure to toxic disinfecting agents used in the cleaning process.
- The proper cleaning of a flexible endoscope is relatively expensive, time-consuming and arduous.
- The repeated cleaning of a flexible endoscope subjects it to wear and tear, reduces its useful life, and impairs the quality of its optics; in addition, improper cleaning can cause blocked channels, which require expensive endoscope repairs.
- The time needed to clean a flexible endoscope after each use results in a period of "down time" during which the endoscope cannot be used and may require users to buy and maintain multiple endoscopes.
DIFFICULTY OF PROPER CLEANING. The problems associated with cleaning conventional flexible endoscopes can be better understood by examining the cleaning procedures they require. The cleaning of endoscopes is generally the responsibility of the nurse or endoscopic assistant. The Society of Gastroenterology Nurses and Associates, Inc., in 1990 published Recommended Guidelines for Infection Control in
Gastrointestinal Endoscopy Settings (the "SGNA Guidelines"). Although cleaning procedures for endoscopes vary widely, the following is a summary of the principal steps in the cleaning procedures that are called for by the SGNA Guidelines.
- Inspection--Endoscopes should be tested for leaks and inspected for damage. Even small leaks can lead to costly fiberoptic or video component damage or contamination of the endoscope.
- Cleaning--After gross cleaning to remove patient material, endoscopes should be thoroughly rinsed, the detachable parts should be removed and cleaned and exteriors should be sponge-cleaned. All internal channels that are accessible should be scrubbed with brushes, while unreachable air and water channels should be rinsed clear of residual patient organic matter, as the presence of such matter diminishes the effectiveness of the disinfecting agents used. The endoscope should then be washed in a detergent and enzyme solution, with such cleaning agents drawn through internal channels. The endoscope should then be rinsed, with excess water removed, since residual water can dilute disinfectants.
- Disinfection--Endoscopes should be disinfected using recommended chemical agents or an automated cleaner. Disinfectants must also be drawn through internal channels during this process. Although certain sterilization methods are available for flexible endoscopes, conventional heat sterilization will destroy flexible endoscopes.
- Rinsing--To ensure that patients are not exposed to toxic disinfectants, endoscopes should be thoroughly rinsed using either tap water or sterile water, followed by a final rinse in an alcohol solution.
- Drying--Endoscopes and channels should be dried using forced air, then flushed with an alcohol solution, prior to storage.
- Storage--Endoscopes should be hung vertically in well-ventilated cabinets to prevent recontamination or damage between uses.
Proper cleaning of conventional flexible endoscopes, even when done in compliance with the SGNA Guidelines, is difficult to achieve for a number of reasons. Firstly, the design of conventional flexible endoscopes, which includes channels, joints and crevices, makes it difficult to reach and clean all parts of the endoscope. As the SGNA Guidelines state, an endoscope's "complex and fragile structure presents problems in cleaning/disinfecting/sterilizing". Secondly, the Company believes the most important step in the cleaning process is the manual removal of organic material, and therefore, the opportunity for human error is always present, even if optimal cleaning procedures are followed. Finally, there are questions concerning the efficiency of some disinfecting agents used in the endoscope cleaning process. For example, in 1991 the FDA recommended that the medical profession cease the use of Sporicidin, a widely-used endoscope disinfectant, based upon the FDA's conclusion that this disinfectant does not work. The FDA has also required that the manufacturers of chemical glutaraldehyde-based disinfectants change the recommended soak time on their instructions for use from 20 minutes to 45 minutes, and increased the temperature from 20 degrees Celsius to 25 degrees Celsius. This longer soak time means slower turnaround on conventional scopes, and the increased temperature of the glutaraldehyde is hazardous due to increased caustic vapors released during heating.
HEALTH RISKS. Because flexible endoscopes are difficult to clean properly, sterilization (the complete elimination of microbial life) is virtually impossible to achieve. Therefore, "high-level disinfection" (the elimination of all microbial life other than the most highly resistant spores) is the standard for flexible endoscope cleaning currently recommended by the Centers for Disease Control. However, studies indicate that high-level disinfection is often not attained and that cross-contamination remains a risk to patients and medical personnel.
An FDA-sponsored study published in THE AMERICAN JOURNAL OF MEDICINE in March 1992, reported that 23.9% of the gastrointestinal endoscopes tested produced 100,000 or more bacterial colonies after all cleaning and disinfection procedures had been completed, and the endoscopes were deemed ready for use on the next patient. This study concluded that "actual disinfection/sterilization procedures for endoscopes are not always optimal, and high-level disinfection of gastrointestinal endoscopes is not always achieved." Numerous infectious agents, including tuberculosis and salmonella, have been reported in the medical literature as having been transmitted through the use of contaminated endoscopes. Concern about the risk of endoscopic cross-contamination has also been heightened by the increasing prevalence of the HIV and hepatitis viruses.
The cleaning procedures required for endoscopes also subject medical personnel to health risks (such as severe eye, nose and throat irritation, nausea, headaches, asthma and skin rashes) from exposure to toxic disinfecting agents. The Occupational Safety and Health Administration has classified glutaraldehyde, a key ingredient in many endoscope disinfecting agents, as a highly toxic material and requires hospitals, clinics, and physicians' offices to reduce the level of emissions to .2 parts per million wherever glutaraldehyde is used. In addition, toxic disinfectants must be disposed of in compliance with applicable environmental laws.
OTHER PROBLEMS. In addition to the health problems posed by the use and cleaning of conventional flexible endoscopes, the required cleaning of these products is relatively expensive, time-consuming and arduous. The Company estimates, based upon its own experience, that the cleaning and disinfection procedure required following each use of a flexible endoscope, if done in compliance with the FDA recommendations, would take 60 minutes. The repeated cleaning in harsh chemical disinfectants also subjects a flexible endoscope to wear and tear, reducing its useful life and impairing the quality of its optics. Moreover, the failure to clean all organic materials from a flexible endoscope's channels is a common cause of blocked channels, which require expensive endoscope repairs as well as a back-up inventory of endoscopes. In addition, the need to properly clean a flexible endoscope after each use requires that each doctor performing endoscopies must either have access to a number of endoscopes or be forced to wait an estimated 60 minutes between each endoscopic procedure (assuming the endoscope is cleaned in compliance with FDA Guidelines).
COMPANY STRATEGY
The Company's primary business strategy is to develop, manufacture and market products for endoscopy which have infection-control advantages over conventional flexible endoscopes. To implement this strategy, the Company has developed, and is marketing and selling, a proprietary flexible endoscope system which consists of two main components--a proprietary sterile disposable sheath, known as an EndoSheath, and a reusable flexible endoscope incorporating the Company's proprietary design. In particular, the Company has developed, and is marketing and selling, a family of disposable EndoSheath/ reusable flexible endoscope systems for gastrointestinal endoscopy and pulmonary endoscopy. The Company has also developed EndoSheaths for use with certain conventional flexible endoscopes (such as ENT endoscopes) currently sold by the Company and other manufacturers.
The Company believes that its EndoSheath technology offers the following advantages over conventional reusable flexible endoscopes:
- It represents the only known effective technology designed to eliminate the risk of cross-contamination from prior use of a flexible endoscope.
- It is designed to substantially reduce the health risks to nurses and other medical personnel resulting from exposure to toxic disinfecting agents used in the cleaning process.
- It significantly reduces the time and effort involved in the cleaning and disinfection of conventional flexible endoscopes by hospital staff.
- It will reduce endoscope wear and tear resulting from repeated cleaning and reduces endoscope repair costs, as the air, water, suction and accessory channels that are the source of a majority of repairs have been made part of the disposable EndoSheath.
- It reduces endoscope "down time" and thereby allows hospitals and clinics to stock a smaller number of flexible endoscopes, since there is little delay before an endoscope is ready for use in the next procedure.
- It increases the number of patients physicians can examine because of the reduced delay in endoscope processing between procedures.
During the fiscal year ended March 31, 1998, the Company has also pursued a strategy of exploring diversification toward the development of improved endoscopes and related imaging devices. Included in these exploratory areas have been the following: - The use of advanced CMOS sensors in video endoscopes, in order to reduce their cost and size over traditional CCD sensored video endoscopes. - The use of 3-Dimensional visualization enhancements to improve the perception of endoscopic images for both medical and industrial markets. - The development of a new line of fiberoptic ENT endoscopes.
These and other areas of exploration have been undertaken with appropriate third-party assistance, where applicable. The goal of these investigations has been to analyze opportunities to further leverage the Company's core competencies in its current markets, while at the same time analyzing new technologies the Company may develop or acquire to enhance its offerings. As of the date of this filing, there are no firm commitments to pursue any of these strategic directions.
PRODUCTS AND PRODUCT DEVELOPMENT PROGRAMS
The Company's primary products include proprietary flexible endoscopes, EndoSheaths, and related products for a variety of medical applications. In addition, the Company currently manufactures and sells ENT endoscopes, borescopes (endoscope-like devices for industrial applications), and related products.
ENDOSHEATH/ENDOSCOPE SYSTEMS
The Company has developed a family of proprietary flexible endoscope systems consisting of two main components--proprietary sterile disposable sheaths, known as EndoSheaths and reusable flexible endoscopes incorporating the Company's propriety design. The EndoSheaths and endoscopes included in this system are functional only when used together.
Conventional flexible endoscopes generally include fiberoptic bundles or video cameras for image production, a series of channels for delivery of air, water, suction, and accessory devices and an operator body containing user control knobs. The Company's proprietary design separates these features between the disposable EndoSheath and the reusable endoscope. The Company's proprietary flexible endoscopes include the lighting, imaging and operator control features necessary to perform the intended medical procedures. The endoscopes also include microswitches instead of valves, and control knobs that may be removed for sterilization. The EndoSheaths, which are designed to cover all surfaces of the endoscope that come in contact with the patient, contain the air, water, suction, and accessory channels that are a part of conventional flexible endoscopes, thus eliminating the need to clean these channels. The Company believes, based upon its own quality assurance testing of this product and physicians who have purchased and are using the system, that this product functions clinically in essentially the same manner as conventional flexible endoscopes, requiring no retraining of personnel or changes in procedural techniques.
Installation of the EndoSheath onto the reusable endoscope can be performed in a matter of minutes and is accomplished by inflating the sterile EndoSheath with air, allowing the endoscope to be easily inserted into the EndoSheath. After an endoscopic procedure, the disposable EndoSheath is then re-inflated, and the flexible endoscope is removed from the EndoSheath. The EndoSheath and packaging are
then discarded, and the reusable endoscope is ready for use with a new EndoSheath in the next procedure. This process takes 4 to 5 minutes, as compared to the 60 minutes estimated for the proper cleaning of a conventional flexible endoscope.
Due to the fact that the Company believes that sigmoidoscopy is one of the most frequently performed endoscopic procedures, a fiberoptic sigmoidoscope was the Company's first disposable EndoSheath/reusable flexible endoscope system. The Company received FDA clearance of its 510(k) Pre-market Notification for this product in October 1992 and began commercial shipments of this product in April 1993. The Company also received FDA clearance of its 510(k) Pre-market Notification for its black and white CCD video sigmoidoscope and EndoSheath system in February 1994, its 130 cm length fiberoptic colonoscope and EndoSheath system in February 1995, its fiberoptic gastroscope and EndoSheath system in February 1995, and its fiberoptic ENT scope in December 1995. In December 1996 the Company received clearance from the FDA to market its fiberoptic bronchoscope and EndoSheath system. In January 1997 the Company received clearance from the FDA to market its color video sigmoidoscope.
ENT ENDOSHEATHS
The Company has developed EndoSheaths for use with ENT endoscopes. ENT endoscopes do not contain air, water, suction, or accessory channels and, therefore, do not require the Company's proprietary flexible endoscope design in order to be used with an EndoSheath. In addition, because ENT endoscopes do not contain channels, the EndoSheath covers the distal end of the endoscope thus making these EndoSheaths a simpler and less expensive product. The Company received FDA clearance of its 510(k) Pre-market Notification for its first ENT EndoSheath in October 1992 and began commercial shipments of this product in December 1992. In January 1993, the Company received FDA clearance of its 510(k) Pre-market Notification covering four additional disposable EndoSheaths for use with the Company's other ENT endoscope, two ENT endoscopes sold by Pentax Precision Instrument Corporation ("Pentax"), and an ENT endoscope sold by Olympus Optical Co., Ltd. ("Olympus"). The Company began shipping its EndoSheath for use with an endoscope sold by Olympus in March 1993 and began shipments of the three other EndoSheaths during fiscal 1994. In December 1995 the Company received clearance from the FDA to market its own fiberoptic ENT scope, and in December 1996 the Company received clearance from the FDA to market its fiberoptic bronchoscope and EndoSheath barrier. Other Products
Under the Machida name, the Company designs, manufactures and markets flexible borescopes, which are similar in design to endoscopes and are used for inspection and quality-control functions in industrial applications, such as the inspection of aircraft engines and nuclear power plants. Through Machida, the Company was the first to offer a flexible borescope with a grinding attachment that allows users to "blend", or smooth small cracks, in small turbine blades of jet engines without disassembling the engine, which would involve significant expense and delay. The Company also offers a variety of ancillary products for use with flexible endoscopes and borescopes, such as light sources, cameras, adapters, accessories and imaging systems. Sales of these non-medical and ancillary products were approximately $3.6 million, or 45%, of the Company's net sales in fiscal 1998. The Company expects that net sales of these products over the next several years will remain relatively constant and will constitute a continually decreasing percentage of the Company's total business.
SALES AND MARKETING
The Company expects that the customers for its disposable EndoSheaths, flexible endoscopes and related products will be Gastroenterologists, Colon and Rectal Surgeons, Otolaryngologists, Pulmonologists, Primary Care Physicians, and high-volume users in hospitals, medical clinics, and physicians' offices. As of May 31, 1998, the Company had three marketing employees, and utilized independent sales representatives, distributors and/or dealers in both North America and Europe, and intends to expand this indirect sales force over the next year.
Although the Company has no specific plans or commitments in this regard, the Company may also license to one or more third parties rights to manufacture and sell reusable flexible endoscopes incorporating the Company's proprietary design features, while retaining the rights to manufacture and sell the EndoSheaths used with these endoscopes.
The Company sold its ENT endoscopes, disposable ENT EndoSheaths, and related ancillary ENT products through an exclusive five-year distribution agreement, which commenced in March 1994, with the ENT Division of Smith & Nephew, Inc. ("Smith & Nephew"). In March 1998 the Company and Smith & Nephew replaced this agreement with a new agreement expiring in March 1999, and a firm, non-cancelable purchase order for the supply of 200,000 ENT EndoSheaths during fiscal year 1999. The new agreement does not include any provision for the supply of ENT endoscopes to Smith & Nephew by the Company, although the Company expects to supply such endoscopes according to individual orders placed by Smith & Nephew during the fiscal year.
The Company's borescopes are sold both directly by its Machida subsidiary and through independent sales representatives.
In the fiscal year ended March 31, 1998, sales to foreign customers accounted for approximately 8% of the Company's annual net sales. The Company currently sells certain models of its borescopes and endoscopes outside of the United States. Although the Company expects to continue to sell such products outside of the United States, the Company expects that the substantial majority of the sales of its new EndoSheaths and proprietary flexible endoscopes will be made to customers within the United States.
Sales to unaffiliated customers outside of the United States were approximately $675,000, $718,000 and $652,000 for the fiscal years ended March 31, 1996, 1997 and 1998, respectively.
In the fiscal year ended March 31, 1996, Smith & Nephew accounted for 15% of net sales and Kelly Air Force Base accounted for 10% of net sales. For the fiscal year ended March 31, 1997, Smith & Nephew accounted for 36% of net sales. For the fiscal year ended March 31, 1998, Smith & Nephew accounted for 35% of net sales.
MANUFACTURING AND SUPPLIERS
The Company produces its EndoSheaths at its Natick, Massachusetts facility using molded and extruded components purchased from independent vendors, some of which are manufactured to the Company's specifications. Most purchased components are available from multiple sources. With the exception of its supply agreement with Asahi Optical Co., Ltd. ("Asahi") and Applied Fiberoptics, Inc. discussed below, the Company has no agreements with any of its vendors or suppliers and purchases its required components and supplies on a purchase-order basis. The Company contracts with third parties for the sterilization of the EndoSheaths.
The Company assembles its flexible endoscopes designed for use with its EndoSheaths at its Orangeburg, New York facility using purchased components and subassemblies, as well as certain proprietary components produced by the Company. Most purchased components and subassemblies are available from more than one supplier. However, certain critical components, such as image bundles and operator control bodies are currently being purchased solely from Asahi, which is the parent company of a competitor of the Company. These components are being purchased pursuant to a supply agreement, which expires in March 1999, subject to earlier termination by mutual consent or upon breach or bankruptcy and which may be extended with the consent of both parties. The Company believes that while substitute components, which are currently produced by sources other than Asahi, would be available, such substitute components may be more expensive and of a lower quality and may require a redesign of the Company's endoscope and additional regulatory clearances. Moreover, such substitute components may not be immediately available in quantities needed by the Company. The Company's inability to obtain a sufficient quantity of such critical components on favorable terms could materially adversely affect the
Company's business. To date, the Company has encountered no significant difficulties or delays in obtaining a sufficient quantity of such critical components or subassemblies for the Company's proprietary flexible endoscopes designed for use with its EndoSheaths. However, there can be no assurance that no difficulties or delays will be experienced in the future as the Company increases its manufacturing operations.
The Company has entered into a manufacturing agreement, which expires in February 2001, with Applied Fiberoptics of Sturbridge, Massachusetts, to supply a fiberoptic ENT scope. Subsequent to March 31, 1998, the Company entered into negotiations with Applied Fiberoptics to amend the terms of the agreement to allow for each party to design, manufacture and sell its own ENT endoscope.
The Company's borescopes are assembled using components and sub-assemblies purchased from independent vendors. While most components and sub-assemblies are currently available from more than one supplier, certain critical components are currently purchased only from Machida Endoscope Company, Ltd., an unaffiliated Japanese company. The failure of the Company to obtain a sufficient quantity of such components on favorable terms could materially adversely affect the Company's business.
The Company's light sources, camera, adapters, accessories and imaging systems for non-medical applications are generally purchased by the Company from a variety of vendors.
The Company has negotiated the worldwide, royalty-free exclusive right from a third party to use polymer technology for manufacturing optically clear windows to be included in its EndoSheaths for use with ENT endoscopes. The Company has also negotiated a license to include the same technology in its EndoSheaths for use with intubation endoscopes and bronchoscopes.
COMPETITION
The Company believes that the primary competitive factors in the flexible endoscope market are the safety and effectiveness (including optical quality) of the products offered, ease of product use, product reliability, price, physician familiarity with the manufacturer and its products and third-party reimbursement policies. In its non-medical markets, the Company believes that product effectiveness, ease of product use, product reliability and price are the principal competitive factors. The Company's ability to compete in its markets is affected by its product development and innovation capabilities, its ability to obtain required regulatory clearances, its ability to protect the proprietary technology included in its products, its manufacturing and marketing skills and its ability to attract and retain skilled employees.
The flexible endoscopes and related products currently sold and under development by the Company face competition primarily from medical products companies such as Olympus and Pentax, a subsidiary of Asahi. In addition, any company that is able to significantly redesign conventional flexible endoscopes to simplify the cleaning process, or significantly improve the current methods of cleaning flexible endoscopes, would provide competition for the Company's products. The principal competitors for the Company's non-medical products are Olympus and Welch Allyn, Inc.
Many of the Company's competitors and potential competitors have greater financial resources, research and development personnel, and manufacturing and marketing capabilities than the Company. In addition, it is possible that other large health care companies may enter the flexible endoscope market in the future.
PATENTS AND PROPRIETARY RIGHTS
The Company's success depends in part on its ability to maintain patent protection for its products, to preserve its trade secrets and to operate without infringing the proprietary rights of third parties. The Company's strategy regarding the protection of its proprietary rights and innovations is to seek patents on those portions of its technology that it believes are patentable, and to protect as trade secrets other confidential and proprietary information.
The Company and its subsidiaries currently hold 20 U.S. and 18 foreign patents and have 2 U.S. patent applications and 4 foreign patent applications pending, all of which relate to its disposable EndoSheaths and reusable flexible endoscopes. These issued patents will expire on various dates in the years 2005 through 2016. There can be no assurance that the Company's pending patent applications will result in patents being issued or that competitors of the Company will not circumvent, or challenge the validity of, any patents issued to the Company. In addition, in the event that another party infringes the Company's patent rights, the enforcement of such rights is at the option of the Company and can be a lengthy and costly process, with no guarantee of success.
Some of the technology used in, and that may be important to, the Company's products is not covered by any patent or patent application of the Company. The Company seeks to maintain the confidentiality of its proprietary technology by requiring all employees who work with proprietary information to sign confidentiality agreements and by limiting access by parties outside the Company to such confidential information. However, there can be no assurance that these measures will prevent the unauthorized disclosure or use of this information, or that others will not be able to independently develop such information. Moreover, as is the case with the Company's patent rights, the enforcement by the Company of its trade secret rights can be lengthy and costly, with no guarantee of success.
To date, no claims have been brought against the Company alleging that its technology or products infringe intellectual property rights of others. However, there can be no assurance that such claims will not be brought against the Company in the future or that any such claims will not be successful.
GOVERNMENT REGULATION
The medical products currently marketed and under development by the Company are regulated as medical devices by the FDA under the federal Food, Drug and Cosmetic Act (the "FDC Act") and require regulatory clearance prior to commercialization in the United States. Under the FDC Act, the FDA regulates clinical testing, manufacturing, labeling, distribution and promotion of medical devices in the United States. Various states and other countries in which the Company's products may be sold in the future may impose additional regulatory requirements.
Following the enactment of the Medical Device Amendments to the FDC Act in May 1976, the FDA classified medical devices in commercial distribution into one of three classes, Class I, II, or III. This classification is based on the controls necessary to reasonably ensure the safety and effectiveness of the medical device. Class I devices are those devices whose safety and effectiveness can reasonably be ensured through general controls, such as adequate labeling, pre-market notification, and adherence to the FDA's GMP (Good Manufacturing Practices) regulations. Some Class I devices are further exempted from some of the general controls. Class II devices are those devices whose safety and effectiveness can reasonably be ensured through the use of special controls, such as performance standards, post-market surveillance, patient registries and FDA guidelines. Class III devices are devices which must receive pre-market approval by the FDA to ensure their safety and effectiveness. Generally, Class III devices are limited to life-sustaining, life-supporting or implantable devices.
If a manufacturer or distributor of medical devices can establish that a new device is "substantially equivalent" to a legally marketed Class I or Class II medical device or to a Class III medical device for which the FDA has not required pre-market approval, the manufacturer or distributor may seek FDA marketing clearance for the device by filing a 510(k) Pre-market Notification. The 510(k) Pre-market Notification and the claim of substantial equivalence may have to be supported by various types of information indicating that the device is as safe and effective for its intended use as a legally marketed predicate device.
Following submission of the 510(k) Pre-market Notification, the manufacturer or distributor may not place the device into commercial distribution until an order is issued by the FDA. By regulation, the FDA has no specific time limit by which it must respond to a 510(k) Pre-market Notification. At this time, the
FDA typically responds to the submission of a 510(k) Pre-market Notification within approximately 90 days. The FDA may declare that the device is "substantially equivalent" to another legally marketed device and allow the proposed device to be marketed in the United States. The FDA may, however, determine that the proposed device is not substantially equivalent, or may require further information, such as additional test data, before the FDA is able to make a determination regarding substantial equivalence. Such determination or request for additional information could delay the Company's market introduction of its products and could have a material adverse effect on the Company.
If a manufacturer or distributor cannot establish to the FDA's satisfaction that a new device is substantially equivalent, the manufacturer or distributor will have to seek pre-market approval ("PMA") or reclassification of the new device. A PMA application would have to be submitted and be supported by extensive data, including pre-clinical and clinical trial data, to demonstrate the safety and efficacy of the device. Upon receipt, the FDA will conduct a preliminary review of the PMA application to determine whether the submission is sufficiently complete to permit a substantive review. If sufficiently complete, the submission is declared fileable by the FDA. By regulation, the FDA has 180 days to review a PMA application once it is determined to be fileable. While the FDA has responded to PMA applications within the allotted time period, PMA reviews more often occur over a significantly protracted time period and generally take approximately two years or more from the date of filing to complete. A number of devices for which FDA marketing clearance has been sought have never been cleared for marketing.
If human clinical trials of a proposed device are required and the device presents "significant risk", the manufacturer or distributor of the device will have to file an investigational device exemption ("IDE") application with the FDA prior to commencing human clinical trials. The IDE application must be supported by data, typically including the results of animal and mechanical testing. If the IDE application is approved, human clinical trials may begin at the specific number of investigational sites and could include the number of patients approved by the FDA.
Flexible endoscopes, EndoSheaths, and accessory products have been classified by the FDA as Class II devices, and a Section 510(k) Pre-market Notification must be submitted to and cleared by the FDA before such devices can be sold. The Company has received FDA clearance of its 510(k) Pre-market Notifications for the following products as of the dates noted. The Company expects that it will be required
to obtain 510(k) clearance for each additional disposable EndoSheath/reusable flexible endoscope system that it develops in the future.
The Natick, Massachusetts and Orangeburg, New York facilities are registered with the FDA as medical device manufacturers. As a result, these facilities are subject to the FDA's "Good Manufacturing Practices" ("GMP") regulations, which regulate their manufacturing, testing, quality control and documentation procedures. The Company is also required to comply with the FDA's labeling requirements, as well as its information reporting regulations. The export of medical devices is also subject to regulation in certain instances. The Company's compliance with these various regulatory requirements will be monitored through periodic inspections by the FDA.
The process of obtaining required regulatory clearances can be lengthy and expensive, and compliance with the FDA's GMP regulations and regulatory requirements can be burdensome. Moreover, there can be no assurance that the required regulatory clearances will be obtained, and those obtained may include significant limitations on the uses of the product in question. In addition, changes in existing regulations or the adoption of new regulations could make regulatory compliance by the Company more difficult in the future. The failure to obtain the required regulatory clearances or to comply with applicable regulations may result in fines, delays or suspensions of clearances, seizures, or recalls of products, operating restrictions and criminal prosecutions, and could have a material adverse effect on the Company.
THIRD-PARTY REIMBURSEMENT
Hospitals, medical clinics and physicians' offices that purchase medical devices such as the Company's EndoSheaths and flexible endoscopes generally rely on third-party payors, such as Medicare, Medicaid, and private health insurance plans to pay for some or all of the costs of the screening, diagnostic and therapeutic procedures performed with these devices. Whether a particular procedure qualifies for third-party reimbursement depends upon such factors as the safety and effectiveness of the procedure, and reimbursement may be denied if the medical device used is experimental or was used for non-approved indication. The Company believes, based upon its knowledge of third-party reimbursement practices, advice from consultants in this area and four years of selling experience, that third-party reimbursement will be available for most procedures using its disposable EndoSheath/reusable flexible endoscope systems. However, the Company's Sigmoidoscope EndoSheath when used in a physician's office on a Medicare patient has, to date, not received a reimbursement value from the Health Care Financing Administration.
Third-party payors use a variety of mechanisms to determine reimbursement amounts for procedures such as endoscopies. In some cases, reimbursement amounts are based upon the provider's costs associated with the procedure, including materials costs. In such a situation, the cost of the EndoSheath used in the procedure would likely be covered by the reimbursement payment. In other cases, payment is a fixed amount per procedure, per hospital day, or per hospital stay; such a payment would not cover the cost of materials, such as the EndoSheath, used in the procedure. However, in some cases where reimbursement is a fixed amount per procedure, an additional materials reimbursement may be available to cover the cost of certain supplies used. As endoscopies performed with conventional flexible endoscopes do not require any significant supplies, materials reimbursements for the Company's EndoSheaths may become available at some point in the future.
There can be no assurance that third-party reimbursement will be available for procedures performed with the Company's products or that the cost of the Company's EndoSheaths would be covered by such reimbursement in the future. In addition, reimbursement standards and rates may change. The Company believes that the failure of users of the Company's products to obtain adequate reimbursement from third-party payors could have a materially adverse effect on the Company.
PRODUCT LIABILITY AND INSURANCE
The nature of the Company's products exposes the Company to significant product liability risks. The Company maintains product liability insurance with coverage limits of $2,000,000 per year. The Company believes that this level of coverage is adequate, given its past sales levels and its anticipated sales levels for the fiscal year ending March 31, 1999. The Company will reevaluate the adequacy of this coverage when and if its sales levels substantially increase. No product liability claims have been brought against the Company to date. However, there can be no assurance that product liability insurance will continue to be available to the Company on acceptable terms, or that product liability claims in excess of the Company's insurance coverage, if any, will not be successfully asserted against the Company in the future.
RESEARCH AND DEVELOPMENT
The Company believes that its future success depends in part upon its ability to develop new products and enhance its existing products. In the past the Company has devoted significant funds and efforts to research and development. In order to lower expenses in the year ended March 31, 1998, the Company reduced its efforts in the development of new products. The Company expects to incur lower costs for research and development in fiscal 1999, compared to amounts incurred in fiscal 1998.
The Company's research and development efforts in fiscal 1996 focused on the 130 cm length fiberoptic colonoscope and EndoSheath system, the fiberoptic gastroscope and EndoSheath system, the fiberoptic bronchoscope and EndoSheath system, the vacuum ENT EndoSheath, the fiberoptic ENT EndoSheath and the color CCD video sigmoidoscope and EndoSheath system. During fiscal 1997, the
research and development efforts focused on the fiberoptic bronchoscope and EndoSheath system, the vacuum ENT EndoSheath, the color CCD video sigmoidoscope and EndoSheath system as well as refinement and cost reduction of existing products. During fiscal 1998, the research and development efforts focused on image-guided surgical applications using third-party surgical navigation technology combined with EndoSheath technology and refinement and cost reduction of existing products. The Company's research and development expenses in fiscal years 1996, 1997, and 1998 were $2,399,000, $2,289,000 and $763,000, respectively. The Company's research and development efforts in fiscal 1999 are expected to be concentrated primarily on continuing enhancements of, and additions to, the fiberoptic sigmoidoscope and EndoSheath system and, subject to the outcome of negotiations with Applied Fiberoptics, the development of a new ENT scope. During fiscal 1999 the Company also expects to expend efforts in areas related to advanced endoscopic imaging technology, including CMOS sensors and 3-Dimensional imaging systems. These efforts will be undertaken primarily through relationships which are currently being developed.
EMPLOYEES
As of April 30, 1998, the Company had 71 employees. No Company employees are represented by a labor union. The Company believes that its employee relations are good. The Company's success will depend in large part upon its ability to attract and retain highly qualified scientific, management, sales and marketing personnel.
ITEM 2.
ITEM 2. PROPERTIES
The Company's principal executive offices and medical research and development facilities currently occupy approximately 20,000 square feet of space in Natick, Massachusetts under a lease which expires in November 2000. The Company's EndoSheath products are manufactured in a 20,000 square foot facility in the same industrial park in Natick under a lease which expires in November 2003. The operations of the Company's Machida subsidiary are located in Orangeburg, New York under a lease for approximately 25,000 square feet which expires in August 2000. As part of its plans to continue to reduce expenses in fiscal 1999, the Company plans to consolidate its operations in Natick into one facility.
The Company's currently occupied Natick facilities and the Orangeburg facility are registered with the FDA as medical device manufacturing facilities and are, therefore, subject to the FDA's GMP regulations regarding manufacturing, testing, quality control and documentation procedures. The Company believes that the physical characteristics and layouts of these facilities are adequate to manufacture its products in compliance with applicable FDA regulations.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
As of March 31, 1998, there were no material legal proceedings to which the Company or any of its subsidiaries is a party, or of which any of their properties is subject.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of the Company's security holders during the last quarter of the fiscal year ended March 31, 1998.
EXECUTIVE OFFICERS OF THE COMPANY
Katsumi Oneda, a co-founder of the Company, has been President, Chief Executive Officer, and Chairman of the Board of Directors of the Company since October 1993. He served as Vice-Chairman of the Board of Directors of the Company from May 1992 to October 1993, as Honorary Chairman of the Board of Directors from October 1991 to October 1993, and as Chairman of the Board of Directors from September 1990 to October 1991. From 1979 to December 1990, he was President and Chief Executive
Officer of Pentax Precision Instrument Corporation. Mr. Oneda is a director of several private companies. He has been a director of the Company since 1987.
Lewis C. Pell, a co-founder of the Company, has been Vice-Chairman of the Board of Directors of the Company since May 1992. Mr. Pell has served as a director of Heart Technology, Inc., a publicly-held medical device company. Mr. Pell is a founder or co-founder of a number of other privately-held medical device companies, including Biosense, Inc., Influence, Inc., Flexiclave, Inc., iSight, Inc., Vitality Biotechnologies, Inc. Mr. Pell was co-founder and a director of Versaflex Delivery Systems, Inc. and InStent, Inc., which were sold in 1988 and 1996, respectively, to Medtronic, Inc. In 1983, Mr. Pell co-founded American Endoscopy, Inc. and served as a director until it was sold in 1986 to C.R. Bard, Inc. In September 1979, he co-founded Pentax Precision Instrument Corporation and served as Executive Vice President and director until December 1990, when it was sold to Asahi Optical Company.
Gerald B. Lichtenberger, Ph.D., joined the Company in January 1997 as Executive Vice President, Chief Operating Officer, Acting Chief Financial Officer and Secretary. Prior to joining the Company, Dr. Lichtenberger served since 1990 as President and a Director of iSight, Inc., a developer and manufacturer of digital video cameras and components. Dr. Lichtenberger was Vice President of Strategic Planning and Vice President of Operations of Pentax Precision Instrument Corporation from 1986 until 1990, and was President, Chief Executive Officer and Chairman of the Board of Directors of Systems of the Future, Inc. from 1979 until 1986.
James A. Tracy joined the Company in July 1997 and was elected Vice President Finance in August 1997. From 1994 to 1996, Mr. Tracy was the Vice President Finance at ORS Environmental Systems, a manufacturer of environmental equipment and sensor instrumentation. From 1990 to 1994 he was Vice President Finance at Sigma Designs, Inc., a publisher of CAD software. From 1986 to 1990 he was Vice President Finance for Aegis, Inc., a manufacturer of microcircuit packages. Prior to 1986 he worked for other manufacturing companies. Mr. Tracy received a CPA certificate in 1975.
E. Paul Harhen joined the Company in September 1993 as Manager of Manufacturing Engineering and was elected Vice President of Operations in November 1995. Prior to joining the Company, Mr. Harhen worked from March 1993 until September 1993 as a manufacturing consultant helping companies to find ways to automate production of high volume products. Mr. Harhen held various engineering and operations positions at Johnson & Johnson, a medical products company, from April 1981 until March 1993. Mr. Harhen has resigned from the Company effective May 31, 1998.
Officers are elected on an annual basis and serve at the discretion of the Board of Directors.
PART II
ITEM 5.
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS
From December 15, 1992 to October 29, 1997, the Company's Common Stock was quoted on the Nasdaq National Market, and since October 30, 1997, the Company's Common Stock has been traded on the Nasdaq SmallCap Market under the symbol VSCI. The following table sets forth the high and low sale prices for the Common Stock on the Nasdaq National Market, or the Nasdaq SmallCap Market, as the case may be, as reported by Nasdaq during the periods indicated.
Such over-the-counter market quotations reflect inter-dealer prices without retail mark-up, mark-down, or commission and may not necessarily represent actual transactions.
As of May 29, 1998, there were 16,650,021 outstanding shares of Common Stock held by 256 stockholders of record, in addition to which there were approximately 2,250 beneficial stockholders.
The Company has never paid cash dividends on its Common Stock, and the Company does not expect to pay any cash dividends on its Common Stock in the foreseeable future. In accordance with a demand line-of-credit agreement that the Company has with a bank, the Company is prevented from paying cash dividends on its Common Stock.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The following table summarizes certain selected financial data and should be read in conjunction with the financial statements and related notes on Appendix A to this report.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
BACKGROUND
Vision-Sciences, Inc. develops, manufactures and markets unique flexible endoscope products utilizing disposable sheaths which provide the users quick, efficient product turnover while ensuring the patient a contaminant-free product.
RESULTS OF OPERATIONS
FISCAL YEARS ENDED MARCH 31, 1998 AND 1997
Net sales for the fiscal year ended March 31, 1998 were $7,998,000, a decrease of $332,000, or 4%, compared to the prior fiscal year. The decrease in net sales was primarily attributable to medical sales decreasing $238,000, or 5%, and industrial sales decreasing $94,000, or 3%, compared to the prior fiscal year ended March 31, 1997.
The decrease in medical sales resulted primarily from a decline in the sales of scopes of $605,000, or 29%, offset by an increase in the sales of the Company's proprietary EndoSheath-Registered Trademark- product of $319,000, or 15%. The decrease in sales of scopes was due primarily to lower demand for scopes that use the Company's proprietary EndoSheath technology. In addition, the Company had an increase in the sales of certain medical devices of $138,000. The Company does not expect to continue to sell these devices in fiscal 1999, but will concentrate on penetrating the market for EndoSheaths, especially the ENT market. Sales of the Company's ENT sheath increased by $278,000, or 28%, compared to the sales in fiscal 1997, due primarily to the fact that the ENT sheaths are less expensive, and can be utilized on scopes manufactured by other companies. In March 1998 the Company received a firm order for ENT sheaths which will result in a minimum sales increase of $269,000, or 21%, compared to sales in fiscal 1998. The decrease in industrial sales for the fiscal year ended March 31, 1998, compared to the prior fiscal year, resulted primarily from reduced demand from the defense market.
Gross profit for the fiscal year ended March 31, 1998 increased $683,000, or 93%, to $1,419,000. The increase in gross profit was due primarily to an improved sales mix oriented towards sheaths, which have a higher gross margin than scopes. In addition, the Company incurred significantly lower costs for scrap and manufacturing overhead, and was able to increase its utilization of manufacturing capacity, as compared to the prior fiscal year.
Selling, general, and administrative expenses for the fiscal year ended March 31, 1998 decreased $1,341,000, or 27%, to $3,559,000, compared to the prior fiscal year and represented 44% of net sales versus 59% in the prior fiscal year. The decrease resulted primarily from sales and marketing expenses decreasing $1,296,000, or 46%, versus the prior fiscal year, primarily due to reduced headcount, and general and administrative expenses decreasing $45,000, or 2%, versus the prior fiscal year, primarily due to lower expenses for business insurance and other costs.
Research and development expenses for the fiscal year ended March 31, 1998 decreased $1,527,000, or 67%, versus the prior fiscal year and represented 10% of net sales in the current year versus 27% of net sales in the prior fiscal year. These lower expenses were due primarily to reduced headcount and lower spending for new products. In fiscal 1999 the Company plans to continue to reduce spending for research and development for new products, and concentrate on making improvements to its existing products.
Interest income, net, for the fiscal year ended March 31, 1998 decreased $27,000, or 16%, to $147,000, compared to the prior fiscal year due to lower levels of cash equivalents and marketable securities.
Other income, net for the fiscal year ended March 31, 1998 increased $86,000, or 95% over the prior fiscal year, primarily due to increased royalty income from new and existing agreements, including an initial license fee of $50,000 received in the three months ended June 30, 1997. The agreement which was
the primary source of royalties for fiscal 1997 expired in July 1997. The Company does not expect to derive significant income from royalties in fiscal 1999.
FISCAL YEARS ENDED MARCH 31, 1997 AND 1996
Net sales for the fiscal year ended March 31, 1997 increased $2,108,000, or 34%, compared to the prior fiscal year. The increase in net sales was primarily attributable to medical sales increasing $2,210,000, or 85%, partially offset by a decrease in industrial sales of $102,000, or 3%, compared to the prior fiscal year ended March 31, 1996.
The increase in medical sales primarily resulted from the Company being allowed to market the ENT EndoSheath product, which received FDA 510(k) clearance to market during December 1995, throughout the entire fiscal year, together with growing shipments of the sigmoidoscope EndoSheath system during the year. The decrease in industrial sales for the fiscal year ended March 31, 1997, compared to the prior fiscal year, resulted primarily from the fact that non-recurring revenue of $634,000 was recognized during the third quarter of the prior fiscal year upon completion of a government contract.
Gross profit for the fiscal year ended March 31, 1997 increased $1,714,000 to $736,000. The increase in gross profit was primarily a result of increased sales volume, which allowed better utilization of manufacturing capacity and higher absorption of manufacturing overhead, as compared to the prior fiscal year.
Selling, general, and administrative expenses for the fiscal year ended March 31, 1997 decreased $1,458,000, or 23%, compared to the prior fiscal year and represented 59% of net sales versus 102% in the prior fiscal year. The decrease resulted primarily from general and administrative expenses decreasing $890,000, or 30%, versus the prior fiscal year, primarily due to reduced headcount, and selling and marketing expenses decreasing $568,000, or 17%, versus the prior fiscal year, primarily due to the restructuring of the Company's sales and marketing organization, wherein sales activities are to be performed by independent sales representatives rather than a direct sales force.
Research and development expenses for the fiscal year ended March 31, 1997 decreased $110,000, or 5%, versus the prior fiscal year and represented 27% of net sales in the current year versus 39% of net sales in the prior fiscal year. These expenses were primarily due to the Company focusing its research and development efforts on bringing its bronchoscope EndoSheath System to market, as well as ongoing improvements in its other products. The bronchoscope EndoSheath System received FDA 510(k) clearance to market in January 1997, and initial orders for the system were received during the fiscal year ended March 31, 1997.
Interest income, net, for the fiscal year ended March 31, 1997 decreased $135,000, or 44%, over the prior fiscal year due to lower levels of cash equivalents and marketable securities.
Other income (expense) for the fiscal year ended March 31, 1997 increased $72,000, or 389% over the prior fiscal year, primarily due to increased royalty income.
LIQUIDITY AND CAPITAL RESOURCES
In the fiscal years ended March 31, 1996, 1997 and 1998 the amount of cash used in the Company's operation was $6,953,000, $4,964,000 and $1,624,000, respectively. Cash used in operations during fiscal years 1996, 1997 and 1998 was primarily devoted to manufacturing, marketing and research and development.
Accounts receivable declined $410,000 in the year ended March 31, 1998, due primarily to improved collections compared to the prior year. Days sales outstanding improved to 44, compared to 79 at March 31, 1997.
The Company's inventories decreased from $706,000 at March 31, 1997 to $681,000 at March 31, 1998. The decrease was primarily due to reductions of raw materials and finished goods inventories due to increased sales volume of sheaths, appropriate substitutions of raw materials and adjustments to record excess/obsolete inventory.
The Company currently plans to spend no more than $250,000 on capital purchases in fiscal year 1999. These capital expenditures are expected to relate primarily to manufacturing equipment, tooling, molds and, to a lesser extent, computer equipment and software, leasehold improvements, demonstration equipment, and furniture and fixtures. The Company has no material commitments for capital expenditures. The Company anticipates a negative cash flow during at least the first three quarters of fiscal 1999.
On December 23, 1997, the Company completed a $2.0 million private equity placement of the Company's common stock with Mr. Katsumi Oneda, Chairman, CEO and President, and Mr. Lewis C. Pell, Vice Chairman. Mr. Oneda and Mr. Pell each purchased 970,874 shares of common stock at a price of $1.03 per share, which represented 80% of the average closing price of the common stock during the five trading days ended December 22, 1997. After this transaction, Mr. Oneda and Mr. Pell beneficially own approximately 26.5% and 25.8%, respectively, of the outstanding shares of common stock of the Company
At March 31, 1998 the Company's principal sources of liquidity included an aggregation of $2.9 million in cash and cash equivalents and marketable securities. In addition, the company has a demand bank line of credit under which the Company may borrow up to $250,000 in cash, net of any outstanding letters of credit. At March 31, 1998, the Company had acceptances payable totaling $52,000 maturing in April and May 1999. The Company has pledged $250,000 to secure the bank line of credit. The line is subject to renewal in February 2002.
The Company has incurred losses since its inception, and losses are expected to continue through the fiscal year ending March 31, 1999. The Company has funded the losses principally with the proceeds from public and private equity financings. The Company has reduced its operating losses significantly in the year ended March 31, 1998, compared to the year ended March 31, 1997, and expects the loss in fiscal 1999 will be less than in fiscal 1998. In April 1998 the management implemented plans to further reduce the funds required to operate the business, and believes the Company, as restructured, will not require additional outside funding during fiscal 1999. The plans implemented include a reduction in headcount in April 1998 and consolidating the Natick facility into one building during the first quarter of fiscal 1999. The management expects these plans, along with other cost reductions, will result in annualized savings of over $1,000,000 in fiscal 1999. However, there can be no assurances that additional funding will not be necessary, and management may be required to obtain additional financing or an alternative means of support during fiscal year 1999.
CERTAIN FACTORS THAT MAY AFFECT THE COMPANY'S FUTURE OPERATING RESULTS
Factors that may affect the Company's future operating results include, without limitation, the following:
The Company has incurred substantial losses since its inception, and there can be no assurance that the Company will achieve a profitable level of operations in the future. The Company anticipates a negative cash flow during at least the first three quarters of fiscal 1999. The Company may be required to obtain additional financing in order to continue to operate as a going concern. There can be no assurance that such financing will be available on terms acceptable to the Company, if at all. Therefore, there is substantial doubt concerning the Company's ability to continue as a going concern.
There can be no assurance that third-party reimbursement will be available for procedures performed with the Company's products or that the cost of the Company's EndoSheaths would be covered by such reimbursement in the future. In addition, reimbursement standards and rates may change. The Company
believes that the failure of users of the Company's products to obtain adequate reimbursement from third-party payors could have a materially adverse effect on the Company.
The Company's products and its manufacturing practices are subject to regulation by the FDA and by other state and foreign regulatory agencies. The process of obtaining required regulatory clearances can be lengthy and expensive, and compliance with the FDA's GMP regulations and regulatory requirements can be burdensome. Moreover, there can be no assurance that the required regulatory clearances will be obtained, and those obtained may include significant limitations on the uses of the product in question. In addition, changes in existing regulations or the adoption of new regulations could make regulatory compliance by the Company more difficult in the future. The failure to obtain the required regulatory clearances or to comply with applicable regulations may result in fines, delays or suspensions of clearances, seizures, or recalls of products, operating restrictions and criminal prosecutions, and could have a material adverse effect on the Company.
Certain critical components of the Company's products, such as image bundles and operator control bodies are currently being purchased solely from Asahi Optical Co., Ltd., which is the parent company of a competitor of the Company. These components are being purchased pursuant to a supply agreement, which expires in March 1999, subject to earlier termination by mutual consent or upon breach or bankruptcy and which may be extended with the consent of both parties. The Company believes that while substitute components, which are currently produced by sources other than Asahi, would be available, such substitute components may be more expensive and of a lower quality and may require a redesign of the Company's endoscope and additional regulatory clearances. Moreover, such substitute components may not be immediately available in quantities needed by the Company. The Company's inability to obtain a sufficient quantity of such critical components on favorable terms could materially adversely affect the Company's business. In addition, the Company's borescopes are assembled using components and sub-assemblies purchased from independent vendors. While most components and sub-assemblies are currently available from more than one supplier, certain critical components are currently purchased only from Machida Endoscope Company, Ltd. The failure of the Company to obtain a sufficient quantity of such components on favorable terms could materially adversely affect the Company's business.
The Company's ability to compete in its markets is affected by its product development and innovation capabilities, its ability to obtain required regulatory clearances, its ability to protect the proprietary technology included in its products, its manufacturing and marketing skills and its ability to attract and retain skilled employees. The flexible endoscopes and related products currently sold and under development by the Company face competition primarily from medical products companies such as Olympus and Pentax, a subsidiary of Asahi. In addition, any company that is able to significantly redesign conventional flexible endoscopes to simplify the cleaning process, or significantly improve the current methods of cleaning flexible endoscopes, would provide competition for the Company's products. The principal competitors for the Company's non-medical products are Olympus and Welch Allyn, Inc. Many of the Company's competitors and potential competitors have greater financial resources, research and development personnel, and manufacturing and marketing capabilities than the Company. In addition, it is possible that other large health care companies may enter the flexible endoscope market in the future.
The Company's success depends in part on its ability to maintain patent protection for its products, to preserve its trade secrets and to operate without infringing the proprietary rights of third parties. There can be no assurance that the Company's pending patent applications will result in patents being issued or that competitors of the Company will not circumvent, or challenge the validity of, any patents issued to the Company. There can be no assurance that measures taken by the Company to protect its proprietary information will prevent the unauthorized disclosure or use of this information, or that others will not be able to independently develop such information. In addition, in the event that another party infringes the Company's patent rights or other proprietary rights, the enforcement of such rights is at the option of the Company and can be a lengthy and costly process, with no guarantee of success. Moreover, there can be no
assurance that claims alleging infringement by the Company of other's proprietary rights will not be brought against the Company in the future or that any such claims will not be successful.
The nature of the Company's products exposes the Company to significant product liability risks. The Company maintains product liability insurance with coverage limits of $2,000,000 per year. The Company believes that this level of coverage is adequate, given its past sales levels and its anticipated sales levels for the fiscal year ending March 31, 1999. The Company will reevaluate the adequacy of this coverage when and if its sales levels substantially increase. No product liability claims have been brought against the Company to date. However, there can be no assurance that product liability insurance will continue to be available to the Company on acceptable terms, or that product liability claims in excess of the Company's insurance coverage, if any, will not be successfully asserted against the Company in the future.
The Company is currently in the process of evaluating its information technology infrastructure to assess its exposure to the "Year 2000" computer problem. Based upon its work to date, the Company believes that no critical software systems will be impacted by this situation. Systems currently used by the Company are already "Year 2000" compliant. The Company does not currently have information regarding the "Year 2000" compliance status of its customers or suppliers, and there can be no assurance that that the Company's customers and suppliers will not be adversely affected by the "Year 2000" problem. Nonetheless, the Company believes that the "Year 2000" problem will not have a material impact on the Company's business operations or financial condition.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The information required by this Item is attached as Appendix A.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
Not applicable.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this Item is contained in (1) the table appearing under the heading "Election of Directors" in the Company's Proxy Statement for its 1998 Annual Meeting of Stockholders (the "1998 Proxy Statement"), which table is incorporated herein by reference, and (2) Part I hereof under the caption "Executive Officers of the Company."
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this Item appears under the headings "Election of Directors--Director Compensation; Executive Compensation; and Agreements with Senior Executives in the 1998 Proxy Statement, which sections are incorporated herein by reference.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this Item appears under the heading "Stock Ownership of Certain Beneficial Owners and Managers" in the 1998 Proxy Statement, which section is incorporated herein by reference.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this Item appears under the heading "Certain Relationships and Related Transactions" in the 1998 Proxy Statement, which section is incorporated herein by reference.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) Index to Consolidated Financial Statements.
1. FINANCIAL STATEMENTS. The following financial statements and schedule of Vision-Sciences, Inc. are included as Appendix A of this Report:
Consolidated Balance Sheets--March 31, 1997 and 1998.
Consolidated Statements of Operations--For the years ended March 31, 1996, 1997 and 1998.
Consolidated Statements of Stockholders' Equity--For the years ended March 31, 1996, 1997, 1998.
Consolidated Statements of Cash Flows--For the years ended March 31, 1996, 1997, and 1998.
Notes to Consolidated Financial Statements.
2. FINANCIAL STATEMENT SCHEDULES. The following consolidated financial statement schedule is included on page S-1.
Schedule II--Valuation and Qualifying Accounts
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.
3. EXHIBITS. The exhibits which are filed with this report or which are incorporated herein by reference, are set forth in the Exhibit Index on page E-1.
(b) Reports on Form 8-K.
Not applicable.
SIGNATURES
Pursuant to the requirements of Sections 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.
Date: June 16, 1998
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the date indicated.
APPENDIX A VISION-SCIENCES, INC. AND SUBSIDIARIES
Consolidated Financial Statements as of March 31, 1997 and 1998 Together with Auditors' Report
VISION-SCIENCES, INC. AND SUBSIDIARIES INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Vision-Sciences, Inc.:
We have audited the accompanying consolidated balance sheets of Vision-Sciences, Inc. (a Delaware corporation) and subsidiaries as of March 31, 1997 and 1998, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the three years in the period ended March 31, 1998. 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 generally accepted auditing standards. Those standards require that we plan and perform the audit 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 used 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 Vision-Sciences, Inc. and subsidiaries as of March 31, 1997 and 1998, and the results of their operations and their cash flows for each of the three years in the period ended March 31, 1998, in conformity with generally accepted accounting principles.
The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. The Company has incurred substantial losses for the years ended March 31, 1996, 1997 and 1998, and losses are expected to continue at least through 1999. The Company may be required to obtain additional funding or alternative means of financial support in order to continue to operate as a going concern. Given these factors, there is substantial doubt concerning the Company's ability to continue as a going concern. Management's plans in regard to these matters are discussed in Note 1. The accompanying consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.
Our audits were made for the purpose of forming an opinion on the basic financial statements taken as a whole. The schedule listed in the index to consolidated financial statements is presented for purposes of complying with the Securities and Exchange Commission's rules and is not a part of the basic financial statements. This schedule has been subjected to the auditing procedures applied in the audits of the basic financial statements and, in our opinion, fairly states, in all material respects, the financial data required to be set forth therein in relation to the basic financial statements taken as a whole.
Boston, Massachusetts May 1, 1998 (except for the matter discussed in Note 11, as to which the date is May 9, 1998)
VISION-SCIENCES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS--MARCH 31, 1997 AND 1998
The accompanying notes are an integral part of these consolidated financial statements.
VISION-SCIENCES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE YEARS ENDED MARCH 31, 1996, 1997 AND 1998
The accompanying notes are an integral part of these consolidated financial statements.
VISION-SCIENCES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY FOR THE YEARS ENDED MARCH 31, 1996, 1997 AND 1998
The accompanying notes are an integral part of these consolidated financial statements.
VISION-SCIENCES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED MARCH 31, 1996, 1997 AND 1998
The accompanying notes are an integral part of these consolidated financial statements.
VISION-SCIENCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 1998
(1) OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES
Vision-Sciences, Inc. (the "Company") was organized in 1987 to manufacture and assemble optical products. The Company's products and accessories, which provide minimally invasive access to areas not readily visible to the human eye, are used within one industry segment.
The Company expects to derive a substantial portion of its future revenues from its disposable EndoSheath/reusable endoscope systems. The Company has invested substantial funds in this product's development. The Company has incurred losses for the years ended March 31, 1996, 1997 and 1998, and losses are expected to continue at least through fiscal 1999. In April 1998, management implemented plans to reduce the funds required to manage the business, and believes the Company, as restructured, will not require additional financial support for the fiscal year 1999. However, there can be no assurance that additional funding will not be necessary, and management may be required to obtain additional financing or an alternative means of support during fiscal 1999. The Company is also subject to other risks, including, but not limited to, the successful marketing of its products, United States Food and Drug Administration (FDA) clearance and regulation, and dependence on key personnel.
The accompanying consolidated financial statements reflect the application of certain accounting policies as described below and elsewhere in the notes to consolidated financial statements. The preparation of the accompanying consolidated 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, 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 in the future could differ from those estimates.
(A) PRINCIPLES OF CONSOLIDATION
The accompanying consolidated financial statements reflect the accounts of the Company and its wholly owned subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation.
(B) BASIC AND DILUTED NET LOSS PER COMMON SHARE
During the year ended March 31, 1998, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 128, EARNINGS PER SHARE.Basic net loss per share is based upon the weighted average number of common shares outstanding. For the years ended March 31, 1996, 1997 and 1998 diluted net loss per common share is the same as basic net loss per common share as the inclusion of other shares of stock issuable pursuant to stock options and warrants would be antidilutive.
(C) DEPRECIATION AND AMORTIZATION
The Company provides for depreciation and amortization using the straight-line method in amounts that allocate the cost of the assets over their estimated useful lives, as follows:
VISION-SCIENCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 1998
(1) OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) Leasehold improvements are amortized over the shorter of their estimated useful lives or the lives of the leases.
(D) REVENUE RECOGNITION
The Company recognizes revenue upon product shipment.
(E) INVENTORIES
Inventories are stated at the lower of cost or market using the first-in, first-out (FIFO) method.
The components of inventories are as follows:
Work-in-process and finished goods inventories consist of materials, labor and manufacturing overhead.
(F) OTHER ASSETS
Other assets consist of deposits and patent costs. Patent costs are amortized on a straight-line basis over 17 years. The Company follows the provisions of SFAS No. 121, ACCOUNTING FOR THE IMPAIRMENT OF LONG-LIVED ASSETS AND FOR LONG-LIVED ASSETS TO BE DISPOSED OF. SFAS No. 121 requires that long-lived assets be reviewed for impairment by comparing the fair value of the assets with their carrying amount. Any write-downs are to be treated as permanent reductions in the carrying value of the assets. The Company believes that the carrying values of these assets are realizable as of March 31, 1998.
(G) FOREIGN CURRENCY TRANSACTIONS
The Company charges foreign currency exchange gains or losses in connection with its purchases of products from vendors in Japan to operations in accordance with SFAS No. 52, FOREIGN CURRENCY TRANSLATION. For the three years ended March 31, 1998 these amounts were immaterial and have been charged to operations.
(H) CASH AND CASH EQUIVALENTS
The Company classifies investments with original maturities of three months or less, consisting of U.S. Government issues and commercial paper, as cash equivalents. Cash equivalents are stated at amortized cost, which approximates market value.
VISION-SCIENCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 1998
(1) OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) (I) MARKETABLE SECURITIES
Marketable securities consist of marketable financial instruments with original maturities greater than 90 days. The Company has established guidelines relative to concentration, maturities and credit ratings which maintain safety and liquidity.
The Company has classified its investments in marketable securities as available-for-sale securities, in accordance with SFAS No. 115. Marketable securities as of March 31, 1998 are recorded at market value, which approximates amortized cost.
As of March 31, 1998, the Company held securities of the U.S. Government or political subdivisions thereof with a weighted average maturity of 58 days.
(J) RESEARCH AND DEVELOPMENT EXPENSES
Research and development expenses are charged to operations as incurred.
(K) CONCENTRATION OF CREDIT RISK
SFAS No. 105, DISCLOSURE OF INFORMATION ABOUT FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK AND FINANCIAL INSTRUMENTS WITH CONCENTRATION OF CREDIT RISK, requires disclosure of any significant off-balance-sheet and credit risk concentrations. Financial instruments that potentially subject the Company to concentration of credit risk are principally cash, marketable securities and accounts receivable. The Company places its cash in federally insured institutions and invests in marketable securities in highly rated investment vehicles. Concentration of credit risk with respect to accounts receivable relates to certain domestic and international customers to whom the Company makes substantial sales (see Note 8). To reduce risk, the Company routinely assesses the financial strength of its customers and obtains letters of credit or advance payments for most of its international sales; as a consequence, the Company believes that its accounts receivable credit risk exposure is limited. The Company maintains an allowance for potential credit losses, but historically has not experienced any significant credit losses related to any individual customer or group of customers in any particular industry or geographic area.
(L) DERIVATIVE FINANCIAL INSTRUMENTS AND FAIR VALUE OF FINANCIAL INSTRUMENTS
The Company does not have any derivative or other financial instruments as defined by SFAS No. 119, DISCLOSURE ABOUT DERIVATIVE FINANCIAL INSTRUMENTS AND FAIR VALUE OF FINANCIAL INSTRUMENTS.
SFAS No. 107, DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS requires disclosure of an estimate of the fair value of certain financial instruments. The Company's financial instruments consist of cash equivalents, accounts receivable and acceptances payable. The estimated fair value of these financial instruments approximates their carrying value at March 31, 1997 and 1998. The estimated fair values have been determined through information obtained from market sources and management estimates.
VISION-SCIENCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 1998
(2) DEBT
The Company has a demand line-of-credit agreement with a bank in support of general working capital needs and the issuance of commercial and standby letters of credit. Borrowings under the agreement bear interest at the bank's prime rate (8.5% at March 31, 1998) and are secured by the Company's cash and marketable securities held by the bank. The Company may borrow up to $250,000 (net of any letters of credit) under the line of credit, which is subject to renewal by the bank on February 15, 2002. Under this agreement, the Company is also subject to certain covenants, including the prohibition of paying cash dividends on its common stock. At March 31, 1998, the Company had acceptances payable aggregating $52,383, maturing in April and May 1998.
(3) DEFERRED CREDIT
In connection with the organization of Machida Incorporated, a wholly owned subsidiary, in 1987, the Company acquired substantially all of the assets subject to related liabilities of Machida America, Inc. The purchase price of $849,000 consisted of $305,000 in cash, $432,000 in notes payable and $112,000 in Cooper Life Science, Inc. common stock (the ultimate parent entity of Machida America, Inc.), owned by the founders of Machida Incorporated. In accordance with Accounting Principles Board Opinion No. 16, BUSINESS COMBINATIONS (APB 16), the purchase price was allocated based on the estimated fair values of the net assets acquired and liabilities assumed. The fair value of the current assets, net of the liabilities assumed, exceeded the purchase price by $731,000. In accordance with APB 16, this excess was recorded as a deferred credit, which was amortized to operations over its expected benefit period of 10 years. At March 31, 1998, the deferred credit was fully amortized.
(4) INCOME TAXES
The Company accounts for income taxes under the liability method in accordance with SFAS No. 109, ACCOUNTING FOR INCOME TAXES. Under SFAS No. 109, deferred tax assets or liabilities are computed based on the differences between the financial statement and income tax bases of assets and liabilities as measured by the enacted tax rates.
The components of the net deferred tax asset recognized in the accompanying consolidated balance sheets with the approximate income tax effect of each type of temporary difference are as follows:
VISION-SCIENCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 1998
(4) INCOME TAXES (CONTINUED) The Company has recorded a valuation allowance equal to its net deferred tax asset due to the uncertainty of realizing the benefit of this asset.
At March 31, 1998, the Company has operating loss carryforwards available to offset future federal taxable income of approximately $40,500,000. These operating loss carryforwards expire at various dates through 2012 and are subject to review and possible adjustment by the Internal Revenue Service.
The Internal Revenue Code limits the amount of net operating loss carryforwards that companies may use in any one year in the event of cumulative changes in ownership over a three-year period in excess of 50%.
(5) STOCKHOLDERS' EQUITY
(A) SALE OF COMMON STOCK
During fiscal 1997, two of the Company's stockholders/executives invested $2,000,000 in the Company's common stock at a price per share equal to the closing price of the stock on the Nasdaq National Market on December 17, 1996. During fiscal 1998, two of the Company's stockholders/executives invested $2,000,000 in the Company's common stock at a price per share equal to 80% of the average closing price of the stock on the Nasdaq SmallCap Market during the five-day trading period ending on December 22, 1997. The proceeds of the common stock sales were received directly by the Company in exchange for newly issued shares of common stock.
(B) STOCK OPTION PLANS
The Company has a stock option plan (the "1990 Plan") under which it may grant key employees and consultants incentive and nonstatutory stock options at the fair value of the stock on the date of grant. Options become exercisable at varying dates ranging up to five years from the date of grant. The Board of Directors has authorized the issuance of options for the purchase of up to 2,375,000 shares of common stock under the 1990 Plan, of which 442,766 shares remain available for future grant.
VISION-SCIENCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 1998
(5) STOCKHOLDERS' EQUITY (CONTINUED) A summary of the 1990 Plan activity is as follows:
The following table summarizes information about stock options outstanding and exercisable at March 31, 1998:
In October 1995, the Financial Accounting Standards Board (FASB) issued SFAS No. 123, ACCOUNTING FOR STOCK-BASED COMPENSATION, which requires the measurement of the fair value of stock-based compensation to be included in the statement of operations or disclosed in the notes to the financial statements. The Company has determined that it will continue to account for stock-based compensation for employees under APB Opinion No. 25 and elects the disclosure-only alternative under SFAS No. 123 for stock-based compensation awarded in the years ended March 31, 1996, 1997 and 1998 using the Black-Scholes option pricing model prescribed by SFAS No. 123. The underlying assumptions used are as follows:
VISION-SCIENCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 1998
(5) STOCKHOLDERS' EQUITY (CONTINUED) (b) Stock Option Plans (Continued)
Had compensation cost for the Company's stock option plans been determined consistent with SFAS No. 123, pro forma net loss and net loss per share would have been:
Because the method prescribed by SFAS No. 123 has not been applied to options granted prior to March 31, 1995, the resulting pro forma compensation cost may not be representative of that to be expected in future years.
Under the 1990 Plan, there remain 2,051,638 shares of common stock reserved for the exercise of stock options.
On August 16, 1993, the Company adopted another stock option plan (the "1993 Plan") under which it may grant up to 200,000 nonstatutory stock options to nonemployee directors of the Company at the fair value of the stock on the date of grant. In the year ended March 31, 1995, options to purchase 20,000 shares at an exercise price of $5.50 per share were granted, and options to purchase 20,000 shares of common stock at an exercise price of $11.625 were canceled. In the year ended March 31, 1998, options to purchase 40,000 and 20,000 shares of common stock at exercise prices of $11.625 and $5.50, respectively, were canceled. Options become exercisable over a four-year period from the date of grant. As of March 31, 1998, options to purchase 20,000 shares of common stock were exercisable under the 1993 Plan. The Company has reserved 200,000 shares of common stock for the exercise of stock options under the 1993 Plan. As of March 31, 1998, 180,000 shares are available for future grant under the 1993 Plan.
(6) COMMITMENTS AND RELATED PARTY TRANSACTIONS
The Company conducts a portion of its operations in certain facilities leased from a partnership owned in part by certain stockholders. Rental expense charged to operations for these facilities was
VISION-SCIENCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 1998
(6) COMMITMENTS AND RELATED PARTY TRANSACTIONS (CONTINUED) approximately $299,000, $204,000 and $186,000 for the years ended March 31, 1996, 1997 and 1998, respectively. In addition, the Company leased a vehicle and other facilities from nonrelated parties under various agreements that expire through November 2003. Rental expense charged to operations under leases from nonrelated parties was approximately $281,000, $283,000 and $283,000 for the years ended March 31, 1996, 1997 and 1998, respectively. Future minimum lease commitments under all operating leases are approximately as follows:
(7) 401(K) PLAN
The Company has a 401(k) plan (the Plan) whereby employees may contribute a certain percentage of their annual compensation, up to a defined maximum. The Company may, but is not obligated to, contribute up to a certain percentage of each employee's contribution. During the years ended March 31, 1996, 1997 and 1998, the Company recorded expense of approximately $32,000, $31,000 and $31,000, respectively, relating to the Plan.
(8) EXPORT SALES AND SIGNIFICANT CUSTOMERS
Sales to unaffiliated customers outside of the United States were approximately $675,000, $718,000 and $652,000 for the fiscal years ended March 31, 1996, 1997 and 1998, respectively.
For the fiscal year ended March 31, 1996, one customer accounted for 15% of net sales, and another customer accounted for 10% of net sales. For the fiscal years ended March 31, 1997 and 1998, one customer accounted for 36% and 35% of net sales, respectively.
(9) ACCRUED EXPENSES
Accrued expenses consist of the following:
VISION-SCIENCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 1998
(10) NEW ACCOUNTING STANDARDS
In June 1997, the FASB issued SFAS No. 130, REPORTING COMPREHENSIVE INCOME. This statement requires companies to classify items of other comprehensive income by their nature in a financial statement and display the accumulated balance of other comprehensive income separately from retained earnings and additional paid-in capital in the equity section of the balance sheet, and is effective for the Company's year ended March 31, 1998. The Company's only item of other comprehensive income relates to foreign currency translation adjustments, which were immaterial and charged to operations for the years ended March 31, 1996, 1997, and 1998.
In July 1997, the FASB issued SFAS No. 131, DISCLOSURES ABOUT SEGMENTS OF AN ENTERPRISE AND RELATED INFORMATION. SFAS No. 131 requires certain financial and supplementary information to be disclosed on an annual and an interim basis for each reportable segment of an enterprise. SFAS No. 131 is effective for fiscal years beginning after December 31, 1997. Unless impractical, companies would be required to restate prior period information upon adoption. The Company does not expect this accounting pronouncement to materially effect its financial statements.
(11) SUBSEQUENT EVENT
In May 1998 the Company signed a non-binding letter of intent (the "Letter") to acquire 25% of the fully diluted share capital of 3DV Systems Ltd. ("3DV"), an Israeli company that is a wholly-owned subsidiary of RDC Rafael Development Corporation Ltd. ("RDC"), an Israeli company, for $3 million in cash. The Company made a non-refundable advance of $500,000 to 3DV in May 1998. If the Company enters into a binding agreement with 3DV, this advance will be credited against the $3 million purchase price; otherwise it will be forfeited.
If the Company enters into a binding agreement and acquires the 25% interest in 3DV, the Company will also obtain exclusive worldwide rights to commercially exploit products that incorporate, or use, component parts embodying technology developed by 3DV. In addition, the Company would obtain the right to acquire the remaining 75% of the share capital of 3DV in the future, at the then fair market value, under certain conditions, and 3DV would obtain the right to require the Company to purchase the remaining 75%, under certain conditions. The Company will issue 500,000 shares of Vision-Sciences common stock to RDC upon the execution of a definitive agreement in exchange for the right to purchase the remaining 75% of 3DV and certain other rights.
In addition, Asahi Optical Co. Ltd. ("Asahi"), a Japanese company, has expressed its intent to invest $5 million in a private placement of the Company's common stock. This investment is contingent upon the Company executing sublicenses with Asahi for certain applications of the 3DV technology and other technology to be developed by an individual with whom the Company would enter into a consulting agreement.
The proposed transactions discussed above are subject to the execution of definitive agreements, and there can be no assurance that any of such transactions will be consummated on the terms described above, or at all.
SCHEDULE II
VISION-SCIENCES, INC. AND SUBSIDIARIES
VALUATION AND QUALIFYING ACCOUNTS FOR THE YEARS ENDED MARCH 31, 1996, 1997 AND 1998
S-1
EXHIBIT INDEX
E-1
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* Management contract or compensatory plan or arrangement filed as an exhibit to this Form pursuant to Items 14(a) and 14(c) of Form 10-K.
(1) Incorporated by reference from the Annual Report on Form 10-K from the fiscal year ended March 31, 1993.
(2) Incorporated by reference from the Registration Statement on Form S-1 (File No. 33-53490).
(3) Incorporated by reference to the Quarterly Report on Form 10-Q for the quarter ended June 30, 1993.
(4) Incorporated by reference from the Annual Report on Form 10-K from the fiscal year ended March 31, 1994.
(5) Incorporated by reference from the Quarterly Report on Form 10-Q/A for the quarter ended June 30, 1994.
(6) Incorporated by reference from the Annual Report on Form 10-K from the fiscal year ended March 31, 1995.
(7) Incorporated by reference from the Annual Report on Form 10-K from the fiscal year ended March 31, 1996.
E-2