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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR FISCAL YEAR ENDED SEPTEMBER 30, 1998
Commission File Number: 0-18933
ROCHESTER MEDICAL CORPORATION
MINNESOTA 41-1613227
State of Incorporation IRS Employer Identification No.
ONE ROCHESTER MEDICAL DRIVE
STEWARTVILLE, MINNESOTA 55976
Address of Principal Executive Offices
Telephone Number: (507) 533-9600
Securities Registered pursuant to Section 12(b) of the Act: None
Securities Registered Pursuant to Section 12(g) of the Act:
COMMON STOCK WITHOUT PAR VALUE
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Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter
period that the Registrant was required to file such reports), and has been
subject to such filing requirements for the past 90 days. Yes __X__ No_____
Check if no disclosure of delinquent filers pursuant to Item 405 of Regulation
S-B is contained in this form, and no disclosure will be contained, to the best
of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. _____
The issuer's revenues for its most recent fiscal year were $9,518,000.
The aggregate market value of voting stock held by non-affiliates based upon the
closing NASDAQ sale price on December 4, 1998 was $56,940,650.
Number of shares outstanding on December 4, 1998 was 5,321,000 Common Shares.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of Registrant's Proxy Statement for its February 4, 1999 Annual Meeting
of Shareholders are incorporated by reference in Part III.
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PART I
ITEM 1. BUSINESS
OVERVIEW
Rochester Medical Corporation (the "Company") was incorporated in Minnesota
in April, 1988. The Company develops, manufactures and markets a broad line of
innovative, technologically enhanced latex-free urinary continence care products
to the home care and acute care (hospital) markets.
The Company's home care products include a line of male external catheters
for the management of male incontinence and line of intermittent catheters for
the management of male and female urinary retention. The Company has developed,
and is conducting clinical trials of its advanced FEMSOFT(R) female continence
insert, a soft, liquid-filled, conformable urethral insert, a new product for
managing female incontinence. The Company's hospital products include a line of
standard Foley catheters and the advanced RELEASE NF (TM) antibacterial Foley
catheter for the prevention of hospital acquired urinary tract bacterial
infection ("UTI"). The Company utilizes its proprietary, patented technology for
the manufacture of its currently marketed devices, and continues to research and
develop new products based on its technology.
The Company markets its standard and advanced products under its own
ROCHESTER MEDICAL(R) brand through a field sales force and international
distributors. The Company markets its standard products through private label
distribution agreements under brands owned by its private label customers. The
Company supplies various of its standard products under such arrangements to the
ConvaTec division of E.R. Squibb & Sons, Inc., a subsidiary of Bristol-Myers
Squibb Company ("ConvaTec"), Hollister, Incorporated ("Hollister") and Mentor
Corporation ("Mentor"), as well as to a number of other private label customers.
During the fiscal year ended September 30, 1998, the Company increased its
marketing and sales activities; revised its marketing arrangement with ConvaTec;
obtained marketing approval for, and began marketing, its RELEASE NF
antibacterial Foley catheter; continued clinical testing of the FEMSOFT insert
in preparation for FDA and CE mark submissions; completed construction and
installation of new manufacturing capacities; and expanded administrative
infrastructure necessary to support its increasing activities.
THE CONTINENCE CARE MARKET
URINARY SYSTEM AND CONTINENCE CARE. In a normally functioning urinary
system, the kidneys filter waste products from the circulatory system, creating
urine to remove the waste. Urine drains from the kidneys into the bladder, which
serves as a reservoir until emptied through urination. Urinary continence, or
the appropriate storage and release of urine, is controlled by the bladder neck
and the urinary sphincter, which surrounds the bladder neck and urethra, acting
together as a valve. As the bladder fills, the bladder is relaxed while the
urinary sphincter contracts to prevent urination. During urination, the urinary
sphincter relaxes as the bladder contracts to evacuate urine through the bladder
neck and urethra. Urinary dysfunction may result from a malfunction of any part
of the system. Urinary continence care involves both the treatment and
management of urinary dysfunction and the temporary management of a normally
functioning urinary system during surgery, post-operative recovery and other
forms of acute care.
URINARY DYSFUNCTION; INCONTINENCE; RETENTION. Urinary dysfunction affects
approximately 11 million women and two million men in the United States. Urinary
dysfunction can be characterized as either incontinence or retention. Urinary
incontinence is the inability to control one's urinary function, leading to
involuntary and frequent urine leakage from the bladder. Urinary incontinence
may result from one or more conditions: weakened pelvic muscles; pelvic organic
prolapse; tumors or other cancers and cancer treatments; prostate surgery;
pelvic trauma; spinal cord damage; and medications. Urinary retention is the
inability to voluntarily, spontaneously and completely empty one's bladder,
preventing urine flow even though the bladder continues to fill.
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Urinary retention is commonly caused by neurogenic bladder, an inability of the
bladder to contract in a normal manner to initiate voiding, and urinary tract
obstruction, a blockage of the bladder neck or urethra which prevents the normal
passage of urine. Neurogenic bladder is often a result of spinal cord injury,
diabetes, Parkinson's Disease, multiple sclerosis and other nervous system
trauma. Urinary retention patients often experience a combination of
incontinence and retention.
The consequences of urinary dysfunction, including depression, discomfort
and embarrassment about appearance and odor, are significant and often result in
a dramatic change in quality of life. Urinary dysfunction often results in loss
of self-esteem, an increased dependence on caregivers, a loss of mobility and
social withdrawal and isolation. In addition, urinary dysfunction has been
associated with a number of physical effects, including a predisposition to
perineal rashes, pressure ulcers, urinary tract infections, urosepsis, falls and
fractures. In the elderly, urinary dysfunction is a major cause of
institutionalization into a nursing home.
CURRENT TREATMENTS FOR AND MANAGEMENT OF URINARY DYSFUNCTION. Approximately
$15 billion is spent annually in the United States for the medical treatment and
management of urinary dysfunction. Of this amount, the Company estimates that $3
billion is spent annually on management products and devices and the remainder
is spent on institutionalization and medical treatments, including surgery,
pharmaceuticals and behavior therapies. To date, available medical treatments
and management products have had limited success in incontinence management.
URINARY CONTINENCE CARE DEVICES
MALE EXTERNAL CATHETERS. Male external catheters are disposable devices for
the management of male incontinence. The male external catheter consists of a
condom-like sheath that tapers into a cone and funnel. The sheath is unrolled
upon the penis and adheres by means of an adhesive, either contained as a part
of the wall of the sheath ("self-adhering") or provided by a separate strip of
adhesive tape ("tape-on"). The male external catheter drains through an attached
tube into a leg bag which is periodically emptied. Typically, the male external
catheter is removed and discarded daily. Male external catheters are designed to
be self-administered. These catheters are used primarily in home care settings
and long-term care facilities. Potential drawbacks of male external catheters
are leakage, skin irritation, inconvenience and reduced mobility. The Company
believes that approximately 75% of male external catheters sold worldwide are
made of latex, which results in many of the disadvantages associated with latex
products described below.
URETHRAL INSERTS AND BLADDER NECK SUPPORT PROSTHESES. The bladder neck and
urethra are delicate structures of mucous membranes and muscle that manage the
flow of fluids from the body. The urethra is a narrow, ribbon shaped canal,
which in females gradually twists and curves slightly from the bladder neck to
the exterior opening. As a result of the urethra's structure and sensitive
tissues, any rigid, nonconformable device that is inserted into the urethra has
the potential to distort the urethra's shape, cause muscle erosion and irritate
or damage the urethral tissues and make them more susceptible to infection.
Recently, bladder neck support prostheses for female stress incontinence have
been introduced to the market. Bladder neck support prostheses manage
incontinence by lifting the bladder neck and urethra through pressure applied
from the device in the vaginal cavity. Urethral inserts occlude the female
urethra to manage incontinence. One urethral insert consisting of a relatively
rigid, nonconformable material was introduced into, and later withdrawn from the
market.
INTERMITTENT CATHETERIZATION. Intermittent catheterization is the preferred
management modality for patients with urinary retention. Intermittent
catheterization involves the use of a straight catheter inserted through the
urethra into the bladder to achieve voiding. Patients using intermittent
catheterization often must perform this procedure every three to six hours. This
procedure can be uncomfortable, is associated with an increased incidence of
urinary tract infection, and in some patients may result in severe urethral
irritation. As an adjunct to medical treatments, primarily behavioral therapies,
intermittent catheterization increasingly is being recommended to manage urinary
incontinence.
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URINE DRAINAGE MANAGEMENT. During surgery, post-operative recovery and
certain other acute care settings, it is often necessary for medical
professionals to monitor the flow of urine, and manage the urinary functions, of
patients with normally functioning urinary systems. Typically, urine drainage
management is accomplished by placing a Foley catheter in these patients. HHS
has reported estimates that as many as one out of four hospital patients in
acute care settings undergoes a short-term Foley catheterization. The Company
believes over 90% of such patients require a Foley catheter for seven days or
less. Foley catheters are also used on a limited basis to manage urinary
dysfunction. The United States Department of Health and Human Services ("HHS")
has reported that more than 100,000 residents in nursing homes in the United
States have long-term Foley catheters in place to manage urinary dysfunction.
The Company estimates that sales of Foley catheters and related accessories in
the United States are currently approximately $240 million per year.
The Foley catheter is an in-dwelling catheter that provides continuous
drainage of the bladder. A Foley catheter consists of a tube (the "catheter
tube") with interior conduits ("lumens") and an inflatable balloon portion near
one end. The balloon end of the Foley catheter is inserted through the urethra
into the bladder. A sterile saline solution is injected into the balloon lumen
to inflate the balloon inside the bladder and prevent the catheter from being
withdrawn. Urine drains through eyelets in the tip of the catheter into the
drain lumen, which is connected by tubing to an external collection device, such
as a leg bag. A Foley catheter is inserted primarily by healthcare professionals
and is not designed for self-administration.
The regular use of Foley catheterization for urinary drainage management is
associated with hospital acquired UTI. Hospital acquired UTI is primarily caused
by bacteria that migrate through the urethra into the bladder along the outside
of the catheter. The Company and other industry sources estimate that 10% to 30%
of patients who receive Foley catheters while in hospital develop UTI as a
direct result of catheterization. Hospitals have reported that cases of hospital
acquired UTI account for 1,000,000 infections each year, and represent 40% of
all hospital-acquired infections. Hospital acquired UTI prolongs patients'
recovery time and increases mortality risk. The cost of treating these
infections is estimated at approximately $1 billion annually in the United
States. The Center for Disease Control (CDC) estimates an average $680 of direct
costs to treat each incident of hospital acquired UTI, a cost which is several
magnitudes greater than the cost of a Foley catheter. Moreover, increases in the
number of multi drug resistant (MDR) strains of bacteria and the incidence of
MDR strains of hospital acquired UTI are growing causes of concern among
physicians and hospital infection control specialists and can result in severe
complications, substantially increased costs and increased patient morbidity and
mortality during recovery from common hospital procedures.
The Company believes that approximately 90% of the Foley catheters sold
worldwide are made of latex. Although latex has certain attractive physical
characteristics and cost advantages, latex contains natural proteins and
allergens that may irritate and damage the surrounding tissue. Latex catheters
may be less comfortable to use than synthetic catheters because crystals of
urine salt can form more easily on the surface of latex catheters. These
crystals can make withdrawal of latex catheters cause painful tissue trauma, and
can also result in the development of permanent strictures (scar tissue) inside
the urethra. Healthcare providers now recognize that latex can also cause
allergic reactions that may be life-threatening for some patients. Concerns
about latex allergies among healthcare workers and the general population have
also increased in recent years, and latex-related law suits have been brought by
health care workers and patients against manufacturers and hospitals. It has
been reported that 10% to 15% of healthcare workers are sensitive to latex
healthcare products. As a result, healthcare institutions are increasingly
attempting to limit their workers' exposure to latex, and some are establishing
entirely latex-free operating rooms.
New FDA rules now require labeling of latex medical devices to warn of
possible allergic reactions. The rules require that all medical devices
containing natural rubber latex be labeled with the warning, "Caution: This
Product Contains Natural Rubber Latex Which May Cause Allergic Reactions." The
new rules also require deletion of labeling claims stating that latex medical
devices are hypoallergenic.
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ROCHESTER MEDICAL SOLUTIONS
The Company develops, manufactures and markets a broad line of innovative,
technologically enhanced latex-free urinary continence care products to the home
care and hospital markets. All of the Company's products are designed to improve
the quality of continence care by providing improved medical outcomes on a cost
effective basis. The Company's technologically advanced products (RELEASE NF
catheter and FEMSOFT insert) are designed to provide clinically and commercially
attractive solutions to the limitations of current continence care products. The
Company believes that its proprietary manufacturing technologies, including its
liquid encapsulation techniques, automated production processes and synthetic
materials know-how, enable the Company to manufacture products with innovative
designs and features that may provide improved medical outcomes, improved
patient satisfaction, elimination of risk of allergic reactions to latex, ease
of use, cost effectiveness and consistent quality.
PRODUCTS AND PRODUCTS IN DEVELOPMENT
The Company has the following disposable, latex-free continence care
devices that are currently marketed or in development for urinary dysfunction
and urine drainage management:
PRODUCT APPLICATIONS CLASS
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CURRENT PRODUCTS
HOME CARE
Male external catheters Management of male incontinence Standard (1)
PERSONAL CATHETER(TM) Intermittent self-catheterization for urine Standard (1)
retention management
HOSPITAL CARE
RELEASE NF catheter Reduction of hospital acquired UTI in surgery Advanced (2)
and post-operative recovery urine drainage
management
Foley catheters Surgery and post-operative recovery urine Standard (1)
drainage management
PRODUCTS IN DEVELOPMENT
HOME CARE
FEMSOFT insert Female incontinence management Advanced (2)
HOME CARE OR HOSPITAL CARE
Other Surgery and post-operative recovery; urine Standard (1)
drainage management; female and male or
incontinence management Advanced (2)
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1. Offers enhanced features over functionally equivalent competitive products.
2. Offers advanced features that the Company believes are not available in
commercially marketed competitive products.
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HOME CARE PRODUCTS
MALE EXTERNAL CATHETERS. The Company manufactures and markets three types
of silicone male external catheters: the ULTRAFLEX(R), "POP-ON"(R) and
WIDE-BAND(R) catheters. The ULTRAFLEX catheter has adhesive positioned midway
down a standard length catheter sheath. The "Pop-On" catheter has a sheath that
is shorter than that of a standard male external catheter and has adhesive
applied to the full length of the sheath. It is designed to accommodate patients
who have retracted penises or other physical impediments to using standard
length male external catheters. In addition, the Company believes the "POP-ON"
catheter may be used as an alternative to standard length catheters.
The Company's WIDE-BAND self-adhering male external catheter, which is of
standard length, has an adhesive band which extends over the full length of the
sheath, providing approximately 70% more adhesive coverage than other male
external catheters currently marketed. The WIDE-BAND catheter is designed to
reduce the adhesive failure and resulting leakage that may occur with male
external catheters due to normal activities, which is a common complaint among
users of male external catheters.
All of the Company's male external catheters are produced in five sizes for
better patient fit. The Company's silicone male external catheters have
advantages compared both to latex catheters and to other non-latex catheters.
Silicone is a non-toxic, biocompatible and hypoallergenic material that
eliminates the risks of latex-related skin irritation. Silicone catheters are
also odor free and have greater gas permeability than catheters made from other
materials, including latex. Gas permeability reduces skin irritation and damage
from catheter use and thereby increases patient comfort. Unlike latex male
external catheters, the Company's silicone catheters are transparent, permitting
visual skin inspection without removal of the catheters and aiding proper
placement of the catheters. The Company's catheters also have a kink-proof
funnel design to ensure uninterrupted urine flow. The self-adhering technology
of the Company's catheters eases application of the catheters and provides a
strong bond to the skin for greater patient confidence and prolonged wear.
Finally, unlike the processes used by manufacturers of competitive catheters,
the Company's proprietary manufacturing processes enable it to manufacture its
"POP-ON" catheter with sufficient adhesive strength in a shorter sheath, and
enable it to manufacture its WIDE-BAND catheter with an adhesive band extending
the length of the sheath, thereby significantly increasing adhesive coverage.
The Company sells silicone male external catheters under the ROCHESTER
MEDICAL brand and to private label customers. The WIDE-BAND male external
catheter is currently sold only under the ROCHESTER MEDICAL brand.
The Company also manufactures and sells male external catheters made from a
proprietary non-latex, non-silicone material to certain private label customers.
Certain of these catheters use the same self-adhesive technology as the
Company's silicone male external catheters. Like the silicone male external
catheters, these non-silicone catheters eliminate the risk of latex reactions
and latex-related skin irritations. The non-silicone catheters also are odor
free.
PERSONAL CATHETER(TM). The Company's PERSONAL CATHETER is a disposable
intermittent catheter manufactured from two different silicones, with a stiff
core catheter tube and a softer outer cover. This construction provides
sufficient stiffness for ease of insertion, while the softer cover is designed
to reduce tissue irritation during insertion. Most competitive intermittent
catheters are made from thermoplastics, which become stiffer when cool and more
flexible when warm, and which also tend to deform if bent for any length of time
as when carried in a purse or pocket. The PERSONAL CATHETER is not sensitive to
normal temperature variations and does not deform if bent for storage. The
Company produces the PERSONAL CATHETER in three lengths and multiple diameters.
The Company markets PERSONAL CATHETER under the ROCHESTER MEDICAL brand.
FEMSOFT INSERT. The FEMSOFT insert is a disposable device currently in
clinical trials for the management of stress incontinence in active women. It
is a soft, conformable urethral insert that assists the female urethra and
bladder neck to control the involuntary loss of urine. The device can
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be simply inserted, worn and removed for voiding by most women. It requires no
inflation, deflation, syringes or valving mechanisms.
The FEMSOFT insert consists of a small cylindrical, liquid-filled silicone
membrane, approximately two inches in length. The membrane has a bulb-shaped
portion near the tip and an oval-shaped tab at the end that remains outside the
urethra. The tip of the device is inserted into the urethra by use of a
disposable applicator which resides in a central tube extending the length of
the device. As the device is inserted, the pressure from the urethra compresses
the bulb causing the liquid to move toward the external end of the device. When
the bulb portion enters the bladder, the pressure exerted by the urethra causes
the liquid to refill the bulb portion, which seats the device in the bladder
neck and urethra. The user removes and discards the disposable applicator,
allowing the urethra to resume its natural curve and shape. The silicone tab of
the insert remains outside the urethra after insertion. When a user needs to
void, the tab is pulled to remove the insert; the device is discarded and
another inserted.
The FEMSOFT insert is designed such that incidental pressures on the
bladder caused by normal activity, which are typically the immediate causes of
stress incontinence, improve the seal created by the device in the bladder neck,
thereby helping to prevent leakage. Steady pressure from a contracting bladder,
however, as during voluntary urination, will compress the bulb and expel the
device. These features also provide for ease of use, while at the same time
minimizing the possibility of harm in persons who may be unable to otherwise
remove the device due to injury or loss of consciousness.
The Company believes the FEMSOFT insert will provide significant advantages
in the management of female stress incontinence. The FEMSOFT insert is a
minimally invasive device that provides a patient with effective control of her
urinary function and eliminates the need for collection bags and pads or liners
that can cause embarrassment, restrict mobility and compromise lifestyle. In
addition, the soft, liquid-filled silicone membrane of the FEMSOFT insert has
been designed to conform to the irregular shape of the urethra and follow the
movements of the urethra during normal activities, thereby helping to reduce
chafing, abrasion and leakage. The FEMSOFT insert has also been designed to
provide a variable, supportive pressure to the muscles of the urethra and
bladder neck, while reducing tissue erosion and loss of muscle tone. Although
intended principally for the management of female stress incontinence, the
FEMSOFT insert may also be suitable for the management of some conditions of
urge incontinence or mixed stress and urge incontinence.
The FEMSOFT insert will be a prescription device that will require the
patient to visit her physician. Before a patient begins using the FEMSOFT
insert, the physician will fit the patient with the proper size and instruct the
patient on proper application of the FEMSOFT insert. The Company anticipates
manufacturing the device in combinations of three widths to provide a proper
fit.
The FEMSOFT insert requires PMA approval by the FDA before it may be
marketed commercially. A Company funded clinical trial of the FEMSOFT insert,
which began in February 1997, is being conducted at eight sites in the United
States under an Investigational Device Exemption ("IDE") application approved by
the FDA. The clinical trial protocol contemplates 150 patients, each studied
over a 12 month period. All required patients are enrolled in the trials.
Interim clinical trial results covering 148 patients, were reported at the
November 1998 Annual Meeting of the American Urogynecologic Society in
Washington D.C,. and, according to a principal investigator, indicate that the
device is effective with minimal adverse events. The Company intends to continue
the trials to conclusion, and to conduct the long term follow-up study which is
a typical requirement following the granting of a PMA application for a new
device. Over 80% of the patients who have already completed the 12 month trial
have enrolled in the long term follow-up study.
In November 1998, the Company met with FDA staff members for a PMA
presubmission conference concerning the sufficiency of these interim clinical
data to support a PMA filing. Although the Company believes that the results of
the presubmission meeting were satisfactory and intends in the near future to
submit its PMA application based on the interim clinical data, the process for
obtaining FDA approval is unpredictable and often lengthy, and there can be no
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assurance that the FDA will grant approval in a timely manner, if at all.
Concurrently with its PMA submission, the Company intends to apply for CE mark
certification; as to the eventual receipt of which, no assurance can either be
given. Even if regulatory approval is obtained, there can be no assurance that
the FEMSOFT insert will perform as designed or will be successfully marketed.
HOSPITAL PRODUCTS
RELEASE NF CATHETER The Company's RELEASE NF catheter is a silicone Foley
catheter that incorporates all of the advantages of the Company's silicone Foley
catheters (as described below) and has been designed to reduce the incidence of
hospital acquired UTI. Using patented technology, the RELEASE NF catheter
incorporates nitrofurazone, long recognized as an effective broad-spectrum
antibacterial agent, into the structure of the catheter permitting sustained
release of a controlled dosage directly into the urinary tract to prevent the
onset of infection. The RELEASE NF catheter received marketing approval from the
FDA in January 1998 pursuant to a 510(k) submission.
The RELEASE NF catheter was evaluated in a prospective, randomized,
double-blinded clinical trial at the University of Wisconsin which evaluated 344
patients in acute care, intensive care and surgical settings. The clinical
trial, which was funded by the Company, demonstrated that use of the RELEASE NF
catheter yielded a six-fold reduction in the incidence of hospital acquired UTI
compared to use of a silicone, non-medicated Foley catheter in patients who were
catheterized for one to five days, a period that is typical of approximately 90%
of all hospital Foley catheterizations. The RELEASE NF catheter was
well-tolerated by the patients using it, and no complications or attributable
side-effects or systemic absorption of nitrofurazone were observed. The clinical
study was designed and carried out by Dennis G. Maki, M.D., Professor of
Medicine and Head of the Section of Infectious Diseases in the Department of
Medicine of the University of Wisconsin Medical School, and Hospital
Epidemiologist.
Nitrofurazone, which has been used as a broad spectrum antibacterial agent
for over 40 years, is effective against both gram-positive and gram-negative
bacteria. Laboratory tests of the RELEASE NF catheter, which were funded by the
Company, have shown it to be broadly active against many of the types of multi
drug resistant (MDR) bacteria, that are associated with hospital acquired UTI
caused by Foley catheterization. MDR bacterial infections are a serious medical
complication and pose a serious infection control problem. Hospitalized patients
who become infected with MDR bacteria can face severe, even fatal complications.
Besides their own serious condition, however, they also become reservoirs for
the spread of such infections and a medium for the mutation of new antibiotic
resistant strains. The laboratory tests of the RELEASE NF catheter against MDR
bacteria strains were conducted at the VA Medical Center, Minneapolis,
Minnesota, by Dr. James R. Johnson, Associate Professor, University of Minnesota
Department of Medicine. A total of 80 clinical isolates, derived primarily from
the urine of infected patients, were tested in vitro against RELEASE NF catheter
sections and control catheter sections. The tests included both the antibiotic
susceptible and the MDR strains of the same species. The tests showed the
RELEASE NF catheter sections to be effective against five of six species of MRD
bacteria, and against all six of the their antibiotic susceptible strains.
Nitrofurazone, an active ingredient of the catheter, is a chemosynthetic
substance that kills bacteria by inhibiting a broad range of bacterial enzymes,
particularly those involved in both the aerobic and anaerobic degradation of
glucose and pyruvate. This inhibition process is different from the mechanisms
of the organically derived antibiotics that are typically administered
systemically for the treatment and control of hospital acquired UTI.
FOLEY CATHETERS. The Company offers Foley catheters in a standard two lumen
version and in a three lumen version for irrigation of the urinary tract. These
Foley catheters are available in all standard adult and pediatric sizes as well
as in specialized pediatric sizes. All of the Company's silicone Foley catheters
eliminate the risk of the allergic reactions and tissue irritation and damage
associated with latex Foley catheters. The Company's Foley catheters are
transparent which enables healthcare professionals to observe urine flow. The
Company's standard Foley catheters also feature solid, rounded tips for ease of
insertion and smooth, proportional eyes for ease of insertion and maximum
drainage. Unlike the manufacturing processes used by producers
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of competing silicone Foley catheters, in which the balloon portion is formed by
hand in a separate procedure involving gluing and burnishing, the Company's
automated manufacturing processes allow the Company to integrate the balloon
into the structure of the Foley catheter, resulting in a smoother, more uniform
exterior that may help reduce irritation to urinary tissue.
The Company's standard Foley catheters are packaged in single catheter
strips and sold under the ROCHESTER MEDICAL brand and under private label
arrangements. In addition, the Company sells its standard Foley catheters in
bulk under private label arrangements for packaging in kits with tubing,
collection bags and other associated materials. The Company's standard silicone
Foley catheters are priced competitively compared to a substantial majority of
Foley catheters sold in the United States.
OTHER PRODUCTS IN DEVELOPMENT
The Company has developed, and is continuing to develop, other home care
and hospital care continence products, including its female catheter, its female
valved catheter and its COMFORT SLEEVE(R) Foley catheter, that utilize the
Company's patented technology to provide enhanced standard features or advanced
functional designs. These products are in various stages of development and
commercialization, including certain products for which the Company has already
obtained FDA marketing approval. The Company intends to continue the development
and commercialization of these products consistent with market opportunities and
the Company's financial and personnel resources. There can be no assurance,
however, that the Company will successfully develop, obtain necessary FDA
approvals for, or successfully commercialize any of these or other of its
products in development.
TECHNOLOGY
The Company uses proprietary, automated manufacturing technologies and
processes to manufacture continence care devices cost effectively. The
production of the Company's products also depends on its materials expertise and
know-how in the formulation of silicone and advanced polymer products. The
Company's proprietary liquid encapsulation technology enables it to manufacture
innovative products, such as its FEMSOFT insert, that have soft, conformable,
liquid-filled reservoirs, which cannot be manufactured using conventional
technologies. Using this liquid encapsulation technology, the Company can mold
and form liquid encapsulated devices in a variety of shapes and sizes in an
automated process. The Company's manufacturing technologies and materials
know-how also allow the Company to incorporate a sustained release antibacterial
agent into its products. The Company believes that its manufacturing technology
is particularly well-suited to high unit volume production and that its
automated processes enable cost-effective production. The Company further
believes that its manufacturing and materials expertise, particularly its
proprietary liquid encapsulation technology, may be applicable to a variety of
other devices for medical applications. The Company plans to consider,
commensurate with its financial and personnel resources, future research and
development activities to investigate opportunities provided by the Company's
technology and know-how.
The Company believes that its proprietary manufacturing processes,
materials expertise, custom designed equipment and technical know-how allow it
to simplify and further automate traditional catheter manufacturing techniques
to reduce the Company's manufacturing costs. In order to manufacture high
quality products at competitive costs, the Company concurrently designs and
develops new products and the processes and equipment to manufacture them.
MARKETING AND SALES
To date, the majority of the Company's revenues have been derived from
sales of its products under private label arrangements with medical products
companies, and such arrangements, are likely to account for a significant
portion of the Company's revenues in the foreseeable future. However, the
Company has begun to focus most of its marketing efforts on gaining increased
market recognition and sales of ROCHESTER MEDICAL brand products. In particular,
the Company intends to focus on marketing and selling its RELEASE NF catheter
under the ROCHESTER MEDICAL
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brand, and, assuming the Company receives FDA approval, also selling the FEMSOFT
insert under the Rochester Medical brand.
SALES AND MARKETING OF ROCHESTER MEDICAL BRAND PRODUCTS. The Company
directly sells ROCHESTER MEDICAL brand products in the domestic market,
primarily to key accounts consisting of significant buying groups, dealers,
distributors, institutions and home care providers. The Company believes that
purchasing power in the healthcare market is being centralized in these large
purchasers of healthcare products, and that there is an opportunity to market
effectively to a large portion of the domestic continence care market with a
limited, focused sales organization by marketing to these significant
purchasers. The Company's sales force focuses on differentiating the Company's
products on the basis of quality, the potential for improved medical outcomes
and cost effectiveness.
The Company's sales and marketing organization is managed by the Company's
Vice President of Marketing and Sales, who oversees both domestic and
international sales activities for branded and private label sales. The Company
has an 11 person domestic sales force supported by a small, centralized customer
service and telesales staff. The Company has developed and continues to build a
network of independent distributors to market and sell its ROCHESTER MEDICAL
brand products in foreign countries, and currently has arrangements covering 38
countries.
The RELEASE NF catheter, which received FDA marketing clearance earlier
this year, is the first of the Company's products to be offered directly to
hospitals under the Company's own brand. Most US hospitals are members of group
purchasing organizations ("GPO's) and only purchase under their GPO contracts.
The Company's initial sales activities are directed to securing inclusion under
GPO contracts and securing successful product evaluations at individual
hospitals. To date, the Company has secured inclusion under two large, national
GPO contracts representing a collective membership of 1,600 hospitals
nationwide, and the Company is actively engaged in the product evaluation
process for the RELEASE NF catheter at a number of major medical institutions.
The Company is actively pursing additional GPO contracts and additional product
evaluations for the RELEASE NF catheter. There can be no assurance that these
activities will result in any material amount of sales of RELEASE NF Catheters.
The Company believes that the introduction and marketing of the FEMSOFT
insert, if FDA marketing approval is received, will differ significantly from
that of its other products. The Company currently anticipates that this strategy
will require significant physician and clinician education efforts and
substantial consumer oriented media advertising. The educational efforts
directed to clinicians may include personal visits and demonstrations; the
preparation and presentation of instructions for the prescription, sizing and
use of the FEMSOFT insert and for follow-on procedures for patient care and
monitoring; and the preparation of written, audio and video materials for
clinicians to use for patient education purposes.
PRIVATE LABEL ARRANGEMENTS. The Company sells certain of its current
products, including male external and Foley catheters, under private label
arrangements to established medical products companies that provide the Company
with commercial distribution of its products, a large sales force and broad
access to the hospital, long-term care, home care and physician markets. The
Company supplies male external catheters and Foley catheters to ConvaTec under a
revised agreement. The Company is the exclusive supplier of Hollister's
requirements of self-adhering non-latex male external catheters which Hollister
resells under its own brand. The Company supplies Mentor with silicone male
external catheters, which Mentor resells under its own brand. The company also
supplies certain of its current products to other private lable customers for
resale under their own brands.
MANUFACTURING
The Company designs and builds custom equipment to implement its
manufacturing technologies and processes. The Company's manufacturing facilities
are located in Stewartville, Minnesota. The Company produces its Foley catheters
on one production line and its male external catheters on
10
other lines. The Company has constructed a separate manufacturing facility to
house its liquid encapsulation manufacturing operations, and has installed the
FEMSOFT insert manufacturing line in this facility.
The Company maintains a comprehensive quality assurance and quality control
program, which includes documentation of all material specifications, operating
procedures, equipment maintenance and quality control test methods. To control
the quality of its finished product, the Company uses ongoing statistical
process control systems during the manufacturing process and comprehensive
performance testing of finished goods. Each Foley catheter's balloon function is
tested, and each male external catheter is visually inspected. The Company has
obtained ISO 9001 certification and CE mark quality system certification for its
Foley catheter and male external catheter production lines. The Company is
required to obtain additional ISO 9001 and CE mark certifications for the new
liquid encapsulation manufacturing line through a separate qualification process
for which the Company is presently preparing to apply.
The Company's manufacturing facility has been designed to accommodate the
specialized requirements for the manufacture of medical devices, including the
FDA's requirements for Quality System Regulation ("QSR"). In connection with the
PMA for the FEMSOFT insert, the Company will be required to establish that its
new liquid encapsulation manufacturing facility complies with QSR.
SOURCES OF SUPPLY
The Company obtains certain raw materials and components for a number of
its products from single suppliers. The Company depends on Dow Corning and GE
for raw materials used in the manufacture of its silicone male external Foley
and intermittent catheters. The loss of either of these suppliers, or a material
interruption of deliveries from either one, could have a material adverse effect
on the Company. Although the Company considers its relationship with Dow Corning
to be satisfactory, Dow Corning is currently in bankruptcy proceedings and there
can be no assurance that Dow Corning will continue to manufacture silicone or to
supply silicone to medical device manufacturers, such as the Company. The
Company believes that most, if not all, of the silicone it currently purchases
from Dow Corning or GE could be replaced by silicone from other suppliers, and
the Company has located and evaluated other potential suppliers. In the event
that the Company had to replace Dow Corning or GE, however, the Company would be
required to repeat biocompatibility testing of its products using the silicone
from the new supplier, which may result in disruption of the Company's
production of catheters, and might be required to obtain additional regulatory
clearances.
To date, the Company has fulfilled its requirements for nitrofurazone,
which is used in its RELEASE NF catheter, through a single distributor. Although
the Company is aware of other distributors who are able to supply nitrofurazone,
the Company does not currently have arrangements for alternative supplies. In
the event that the Company had to replace its supplier, the Company would be
required to repeat biocompatibility testing of its products using the materials
from the new supplier, which might disrupt production of the RELEASE NF
catheter, and might also require additional regulatory clearances. To avoid such
disruption, the Company keeps on hand an inventory of nitrofurazone sufficient
to cover the Company's anticipated needs for at least a year. There can be no
assurance that alternative sources for nitrofurazone will be available on
reasonable terms, if at all.
The Company believes there are adequate alternative sources of supply
available for the Company's other raw material requirements. In order to
minimize the possibilities of disruption in the production of its products, the
Company has begun to conduct routine sourcing and testing of raw materials,
including silicone and other polymers, in order to provide alternate sources of
raw materials in the event of supply shortages from its current suppliers.
RESEARCH AND DEVELOPMENT
The Company believes that its ability to add new products to its existing
continence care product lines is important to the Company's future success.
Accordingly, the Company is engaged
11
in ongoing research and development to develop and introduce new products which
provide additional features and functionality.
The Company's principal research and development efforts are currently
directed toward completing clinical trials of the FEMSOFT insert. The Company is
also focused on refining process parameters, and debugging and validating the
manufacturing processes for its automated liquid encapsulation line for
production of the FEMSOFT insert. In the future, consistent with market
opportunities and the Company's financial and personnel resources, the Company
intends to perform clinical studies for other of its products in development,
including those that have already obtained FDA marketing clearance.
Research and development expense for fiscal years 1998, 1997 and 1996, was
$1,384,000, $1,451,000 and $1,182,000, respectively.
COMPETITION
The continence care market is highly competitive. The Company believes that
the primary competitive factors include price, product quality, technical
capability, breadth of product line and distribution capabilities. The Company's
ability to compete is affected by its product development and innovation
capabilities, its ability to obtain regulatory clearances, its ability to
protect the proprietary technology of its products and manufacturing processes,
its marketing capabilities, its ability to attract and retain skilled employees,
and, for products sold in managed care environments, its ability to maintain
current distribution relationships, to establish new distribution relationships
and to secure participation in GPO purchase contracts. The Company believes that
it will be important for the Company to differentiate its products in order to
attract large customers, such as distributors, dealers, institutions and home
care organizations.
The Company's products compete with a number of alternative products and
treatments for continence care. The Company's ability to compete with these
alternative methods for urinary continence care depends on the relative market
acceptance of alternative products and therapies and the technological advances
in these alternative products and therapies. Any development of a broad-based
and effective cure for a significant form of incontinence could have a material
adverse effect on sales of continence care devices such as the Company's
products.
The Company competes directly for sales of continence care devices under
the Company's own brand with larger, multi-product medical device manufacturers
and distributors such as ConvaTec, C.R. Bard, Inc., Allegiance Euromedical,
Kendall Healthcare Products Company, Sherwood Medical Company, Hollister and
Mentor. In order to compete in the developing managed care environment in the
United States, the Company seeks inclusion of its products in GPO purchase
contracts and also supplies various male external and Foley catheters to certain
of these competitors (ConvaTec, Allegiance, Mentor and Hollister) who market
such devices under their own brands as a part of their broader product lines.
Many of the competitive alternative products or therapies to the Company's
products are distributed by larger competitors including Johnson & Johnson
Personal Products Company, Kimberly-Clark Corporation and Proctor & Gamble
Company (for adult diapers and absorbent pads), and C.R. Bard, Inc. (for
injectable materials). Many of the Company's competitors, potential competitors
and providers of alternative products or therapies have significantly greater
financial, manufacturing, marketing, distribution and technical resources and
experience than the Company. It is possible that other large healthcare and
consumer products companies may enter this market in the future. Furthermore,
academic institutions, governmental agencies and other public and private
research organizations will continue to conduct research, seek patent protection
and establish arrangements for commercializing products in this market. Such
products may compete directly with products which may be offered by the Company.
PATENTS AND PROPRIETARY RIGHTS
The Company's success may depend in part on its ability to obtain patent
protection for its products and manufacturing processes, to preserve its trade
secrets and to operate without infringing the proprietary rights of third
parties. The Company may seek patents on certain features of its products and
technology based on the Company's analysis of various business
12
considerations, such as the cost of obtaining a patent, the likely scope of
patent protection and the benefits of patent protection relative to relying on
trade secret protection. The Company also relies upon trade secrets, know-how
and continuing technological innovations to develop and maintain its competitive
position.
The Company owns 14 United States patents and a number of corresponding
foreign patents that generally relate to certain of the Company's catheters and
devices and certain of the Company's production processes. In addition, the
Company owns a number of pending United States and corresponding foreign patent
applications. The Company may file additional patent applications for certain of
the Company's current and proposed products and processes in the future.
There can be no assurance that the Company's patents will be of sufficient
scope or strength to provide meaningful protection of the Company's products and
technologies. The coverage sought in a patent application can be denied or
significantly reduced before the patent is issued. In addition, there can be no
assurance that the Company's patents will not be challenged, invalidated or
circumvented or that the rights granted thereunder will provide proprietary
protection or commercial advantage to the Company.
Should attempts be made to challenge, invalidate or circumvent the
Company's patents in the United States Patent and Trademark Office and/or courts
of competent jurisdiction, including administrative boards or tribunals, the
Company may have to participate in legal or quasi-legal proceedings therein, to
maintain, defend or enforce its rights in these patents. Any legal proceedings
to maintain, defend or enforce the Company's patent rights can be lengthy and
costly, with no guarantee of success. There also can be no assurance that the
Company will file additional patent applications or that additional patents will
issue from the Company's pending patent applications.
A claim by third parties that the Company's current products or products
under development allegedly infringe their patent rights could have a material
adverse effect on the Company. The Company is aware that others have obtained or
are pursuing patent protection for various aspects of the design, production and
manufacturing of continence care products. The medical device industry is
characterized by frequent and substantial intellectual property litigation,
particularly with respect to newly developed technology. Intellectual property
litigation is complex and expensive, and the outcome of such litigation is
difficult to predict. Any future litigation, regardless of outcome, could result
in substantial expense to the Company and significant diversion of the efforts
of the Company's technical and management personnel. An adverse determination in
any such proceeding could subject the Company to significant liabilities to
third parties, require disputed rights to be licensed from such parties, if
licenses to such rights could be obtained, and/or require the Company to cease
using such technology. There can be no assurance that if such licenses were
obtainable, they would be obtainable at costs reasonable to the Company. If
forced to cease using such technology, there can be no assurance that the
Company would be able to develop or obtain alternate technology. Additionally,
if third party patents containing claims affecting the Company's technology are
issued and such claims are determined to be valid, there can be no assurance
that the Company would be able to obtain licenses to such patents at costs
reasonable to the Company, if at all, or be able to develop or obtain alternate
technology. Accordingly, an adverse determination in a judicial or
administrative proceeding or failure to obtain necessary licenses could prevent
the Company from manufacturing, using or selling certain of its products, which
could have a material adverse effect on the Company's business, financial
condition and results of operations.
There also can be no assurance that any third party does not currently
have, has not applied for, or might not in the future apply for, additional
patents in the United States or abroad which, if ultimately granted, might be
infringed in such country by any of the Company's products as currently
configured or any other product of the Company and provide the basis for an
infringement action in such country against the Company.
The Company also relies on proprietary manufacturing processes and
techniques, materials expertise and trade secrets applicable to the manufacture
of its products. The Company seeks to
13
maintain the confidentiality of this proprietary information. There can be no
assurance, however, that the measures taken by the Company will provide the
Company with adequate protection of its proprietary information or with adequate
remedies in the event of unauthorized use or disclosure. In addition, there can
be no assurance that the Company's competitors will not independently develop or
otherwise gain access to processes, techniques or trade secrets that are similar
or superior to the Company's. Finally, as with patent rights, legal action to
enforce trade secret rights can be lengthy and costly, with no guarantee of
success.
GOVERNMENT REGULATION
The manufacture and sale of the Company's products are subject to
regulation by numerous governmental authorities, principally the FDA and
corresponding foreign agencies. In the United States, the medical devices
manufactured and sold by the Company are subject to laws and regulations
administered by the FDA, including regulations concerning the prerequisites to
commercial marketing, the conduct of clinical investigations, compliance with
QSR and labeling.
A manufacturer may seek from the FDA market authorization to distribute a
new medical device by filing a 510(k) Premarket Notification ("510(k)") to
establish that the device is "substantially equivalent" to medical devices
legally marketed in the United States prior to the Medical Device Amendments of
1976. A manufacturer may also seek market authorization for a new medical device
through the more rigorous Premarket Approval ("PMA") application process, which
requires the FDA to determine that the device is safe and effective for the
purposes intended.
All of the Company's currently marketed home care and hospital care
products have received FDA marketing authorization pursuant to 510(k) filings,
and certain of the Company's products in development have also received such
authorization.
The Company has yet to apply for and receive FDA marketing authorization
for certain of its products in development. The Company has received approval of
an IDE application to conduct multi-site clinical studies of its FEMSOFT insert,
which commenced in early 1997. The Company plans to submit a PMA application for
the FEMSOFT insert in the near future. A PMA application must be supported by
extensive clinical trial and other data. The Company's anticipated PMA filing
will be based on interim clinical study results described elsewhere in this
Report, and there can be no assurance that the FDA will consider that clinical
data to be sufficient to warrant review of the application as filed; or, if the
filing is accepted, that the reported data is sufficient in the FDA's judgment
to grant the application. As a condition of FDA approval of the Company's
anticipated PMA filing based on interim clinical study results, the Company will
be required to complete the current clinical study of the FEMSOFT insert and
submit the additional data to the FDA for its further consideration to determine
whether such approval, if granted, should not be withdrawn. The Company will
also be required to conduct a long term follow-up study of the device and submit
that data to the FDA for its further consideration of the long term effects of
the device and its determination whether the device may continue to be marketed.
There can be no assurance that these additional data will be sufficient in the
FDA's opinion to permit continued marketing of the device even if a PMA filing
for the FEMSOFT insert is initially approved by the FDA.
The PMA application approval process can be expensive, uncertain and
lengthy. A number of devices for which premarket approval has been sought have
never been approved for marketing. The review time is often significantly
extended by the FDA, which may require more information or clarification of
information already provided in the filing. During the review period, an
advisory committee may be convened to review and evaluate the application and
provide recommendations to the FDA as to whether the device should be approved.
In addition, the FDA will inspect the manufacturing facility to ensure
compliance with the FDA's QSR requirements prior to approval of an application.
If granted, the approval of the PMA application may include significant
limitations on the indicated uses for which a product may be marketed, and may
require continued accumulation and submission of clinical data for further
consideration by the FDA.
Consistent with market opportunities and financial and personnel resources,
the Company intends to pursue, as appropriate, the PMA or 510(k) processes for
other products, including
14
certain of the Company's products in development, that the Company may consider
suitable for development and commercialization.
The Company is also required to register with the FDA as a medical device
manufacturer. As such, the Company's manufacturing facilities are inspected on a
routine basis for compliance with QSR. These regulations require that the
Company manufacture its products and maintain its documents in a prescribed
manner with respect to manufacturing, testing and quality control activities.
The Company underwent its latest QSR inspection by the FDA in November 1998, and
no substantial matters of non-compliance were reported to the Company. In
connection with the anticipated PMA application for the FEMSOFT insert, the
Company will be required to establish that its new liquid encapsulation
manufacturing facility complies with QSR. As a medical device manufacturer, the
Company is further required to comply with FDA requirements regarding the
reporting of adverse events associated with the use of its medical devices, as
well as product malfunctions that would likely cause or contribute to death or
serious injury if the malfunction were to recur. FDA regulations also govern
product labeling and can prohibit a manufacturer from marketing an approved
device for unapproved applications. If the FDA believes that a manufacturer is
not in compliance with the law, it can institute enforcement proceedings to
detain or seize products, issue a recall, enjoin future violations and assess
civil and criminal penalties against the manufacturer, its officers and
employees.
The Company may become subject to future legislation and regulations
concerning the manufacture and marketing of medical devices. Such future
legislation and regulations could increase the cost and time necessary to begin
marketing new products and could affect the Company in other respects not
currently foreseeable. The Company cannot predict the effect of possible future
legislation and regulations.
Sales of medical devices outside the United States are subject to foreign
regulatory requirements that vary widely from country to country. These laws and
regulations range from simple product registration requirements in some
countries to complex clearance and production controls in others. As a result,
the processes and time periods required to obtain foreign marketing approval may
be longer or shorter than those necessary to obtain FDA approval. These
differences may affect the efficiency and timeliness of international market
introduction of the Company's products. For countries in the European Union
("EU"), medical devices must display a CE Mark before they may be imported or
sold. In order to obtain and maintain the CE mark, the Company must comply with
the EU Medical Device Directive ("KU Directive") and pass an initial and annual
facilities audit inspections by an EU inspection agency. The EU Directive
requires compliance with ISO 9001 and other specified standards. The Company has
obtained ISO 9001 certification and quality system certification for the CE mark
for its currently marketed standard products. The Company is pursuing CE mark
certification for the RELEASE NF catheter, which may require a more complex,
lengthy and uncertain procedure due to the drug release feature of the catheter.
In order to maintain certification, if granted, the Company will be required to
pass annual facilities audit inspections conducted by EU inspectors. The
certification is site specific, and in connection with the Company's anticipated
CE Mark application for the FEMSOFT insert, the Company will undergo a similar
certification process for its FEMSOFT manufacturing facility. There can be no
assurance, however, that the Company will be able to obtain or maintain all
necessary regulatory approvals or clearances, including CE mark certification,
for its products in foreign countries.
In addition, international sales of medical devices manufactured in the
United States that have not been approved by the FDA for marketing in the United
States are subject to FDA export requirements. These require that the Company
obtain documentation from the medical device regulatory authority of the
destination country stating that sale of the medical device is not in violation
of that country's medical device laws, and, under some circumstances, may
require the Company to apply to the FDA for permission to export a device to
that country.
Under certain of the Company's international distribution agreements, the
other parties have agreed to bear the burdens and costs of obtaining applicable
export and international regulatory approvals. The Company has agreed to
cooperate where necessary in obtaining such approval.
15
THIRD PARTY REIMBURSEMENT
In the United States, healthcare providers that purchase medical devices
generally rely on third party payors, such as Medicare, Medicaid, private health
insurance plans and managed care organizations, to reimburse all or a portion of
the cost of the devices. The Medicare program is funded and administered by the
federal government, while the Medicaid program is jointly funded by the federal
government and the states, which administer the program under general federal
oversight. The Company believes its currently marketed products, including the
RELEASE NF catheter, are generally eligible for coverage under these third party
reimbursement programs. The Company is currently unable to fully assess
eligibility of the FEMSOFT insert for reimbursement at this time. As a result,
the competitive position of certain of the Company's products may be partially
dependent upon the extent of reimbursement for its products.
The federal government and certain state governments are currently
considering a number of proposals to reform the Medicare and Medicaid health
care reimbursement system. The Company is unable to evaluate what legislation
may be drafted and whether or when any such legislation will be enacted and
implemented. Certain of the proposals, if adopted, could have an adverse effect
on the Company's business, financial condition and results of operations.
In foreign countries, the policies and procedures for obtaining third party
payment of reimbursement for medical devices vary widely. Compliance with such
procedures may delay or prevent the eligibility of the Company's branded and/or
private label products for reimbursement, and have an adverse effect on the
Company's ability to sell its branded or private label products in a particular
foreign country.
PRIVATE LABEL DISTRIBUTION AGREEMENTS
CONVATEC. In April 1998, the Company and ConvaTec entered into a Revised
and Restated Distribution Agreement (the "Revised ConvaTec Agreement"), which
grants ConvaTec, subject to obligations and limitations imposed by certain of
the Company's other distribution agreements, certain rights to market the
Company's Foley catheters and male external catheters under the ConvaTec brand.
The Company retains worldwide rights to market its products under the Rochester
Medical brand.
The Revised ConvaTec Agreement provides that ConvaTec will purchase, and
the Company will supply, all of ConvaTec's requirements of standard and "POP ON"
versions of silicone male external catheters for sale in a "Coexclusive
Territory;" that the Company will supply ConvaTec with such silicone male
external catheters as it may order from time to time for sale outside of the
Coexclusive Territory; and that the Company will supply ConvaTec with Foley
catheters as it may order from time to time for sale worldwide. The Coexclusive
Territory is defined to include all countries within the geographic boundaries
of Central America, South America, Australia, Japan, New Zealand, South Africa,
Israel, Iran, Iraq, Lebanon, Oman, Saudi Arabia, Syria, United Arab Emirates and
Yemen. The Revised ConvaTec Agreement also provides, subject to the mentioned
obligations and limitations, that the Company will not appoint any other private
label distributor for silicone male external catheters within the Coexclusive
Territory.
The Revised ConvaTec Agreement does not include any minimum purchase
requirements or require that ConvaTec market any or all of the Company's
products. The Company will provide all manufacturing and packaging of the
Company's products for ConvaTec. The ConvaTec Agreement provides, however, in
the event that the Company is unable to supply ConvaTec's requirements for
products for any reason other than a shortage of raw materials and the Company
is unable to find a suitable replacement in a commercially reasonable time,
ConvaTec will be deemed to have a license to the Company's technologies for
purposes of manufacturing such products for ConvaTec.
The Revised ConvaTec Agreement has an initial term expiring April 30, 2006,
and is automatically renewable for successive annual extensions, subject to
either party giving notice of intent not to renew. Either party may terminate
the Revised ConvaTec Agreement only upon the other party's material breach of
the Revised ConvaTec Agreement, bankruptcy or insolvency, or inability to
perform under the Revised ConvaTec Agreement for a period of more than six
months.
16
The Company has agreed to indemnify ConvaTec against certain liabilities,
including any patent infringement claims by third parties.
Under a separate agreement, the Company supplies ConvaTec with tape-on
non-silicone male external catheters. This agreement has an initial term
expiring September 1999 and is subject to automatic annual renewals cancelable
on six months notice by either party. The agreement may be terminated at any
time, upon six months written notice given by ConvaTec without cause, or by the
Company if ConvaTec fails to make certain agreed minimum purchases.
Sales of products to ConvaTec represented 25% of the Company's revenues in
fiscal 1998 and 24% of revenues in fiscal 1997.
HOLLISTER. The Company is the exclusive supplier of Hollister's
requirements of self-adhering non-latex male external catheters which Hollister
resells under its own brand. As a part of its agreement with Hollister, the
Company has agreed to restrict its ability to sell self-adhering non-silicone
male external catheters on a private label basis to other manufacturers and
distributors for distribution outside of the United States and Canada. The term
of the agreement commenced May 1, 1998 and expires April 30, 2002. During that
period, Hollister is subject to a minimum purchase requirement of four million
non-silicone catheters at the rate of at least one million catheters per year.
Sales of products to Hollister represented 7% of the Company's revenues in
fiscal 1998 and 10% of revenues in fiscal 1997.
MENTOR. The Company sells silicone male external catheters to Mentor
pursuant to a Male External Catheter License, Sales and Distribution Agreement,
as modified in September 1995 (the "MEC Agreement"). Additionally, the Company
granted to Mentor a non-exclusive, paid-up, royalty free license to make, use
and sell silicone male external catheters that the Company currently sells to
Mentor. The Company also granted Mentor a non-exclusive, paid-up, royalty free
license to use for any purpose all technical know-how and/or trade secrets
disclosed by the Company to Mentor pursuant to or in connection with the MEC
Agreement which relate to the manufacture of silicone male external catheters.
In connection with such licenses, upon Mentor's request, the Company is required
to assist, consult, and cooperate with Mentor in the assembly, design,
engineering, manufacturing, inspection, and servicing of the catheters and
components thereof, as well as assist in the selection of the necessary and
proper plant layout, machinery, tools, equipment, and production flow for the
economical manufacture of the catheters and their components by Mentor. Mentor
must reimburse the Company for any costs incurred in providing such cooperation
and assistance. Mentor has not requested the Company's assistance.
The Company is aware that Mentor has recently built a catheter
manufacturing facility for the production of silicone catheters such as it now
purchases from the Company. Although Mentor continues to order product from the
Company at levels reasonably consistent with past order patterns, there can be
no assurance that Mentor will continue purchasing products from the Company at
such levels, or at all, in the future.
The license to manufacture, use and sell silicone male external catheters
may be assigned only in connection with Mentor's sale or disposition of its
external catheter product line, or in connection with the merger, consolidation,
or similar corporate reorganization of Mentor or the sale of all or
substantially all of its assets. Mentor may sublicense the license to use
technical know-how and/or trade secrets only for purposes other than the
manufacture of the catheter to persons who agree to maintain the confidentiality
of the Company's know-how and trade secrets.
The MEC Agreement does not require Mentor to purchase any minimum amount of
product from the Company. Mentor manufactures and sells products directly
competitive to the male external catheters which it purchases from the Company,
and Mentor continues to develop other directly competitive products. Mentor has
recently introduced a new non-silicone, non-latex male external catheter which
it manufacturers itself. The Company cannot now estimate the impact, if any, of
this new device on Mentor's future purchases of silicone male external catheters
from the Company.
Sales of products to Mentor represented 21% of the Company's revenues in
fiscal 1998 and 30% of revenues in fiscal 1997.
17
EMPLOYEES
As of September 30, 1998, the Company employed 180 full-time employees, of
whom 137 were in manufacturing, and the remainder in marketing and sales,
research and development and administration. The labor market for medical device
manufacturing personnel has tightened in Minnesota, and particularly in the
Rochester area where the Company's manufacturing facilities are located. This
has resulted in upward pressure on wages for production workers but has not, to
date, adversely affected the Company's ability to hire and retain capable
manufacturing personnel. The Company is not a party to any collective bargaining
agreement and believes its employee relations are good.
ITEM 2. PROPERTIES
The Company's administrative offices and liquid encapsulation manufacturing
facilities occupy a 52,000 square foot manufacturing and office facility on a 28
acre site owned by the Company and located in an industrial park in
Stewartville, Minnesota. The Company's male external and Foley catheter
manufacturing facilities consists of a 34,000 square foot manufacturing and
office building located on a nearby 3.5 acre site owned by the Company in the
same industrial park.
A part of the Company's properties is subject to certain financing
arrangements. See Note 8 of Notes to Financial Statements.
ITEM 3. LEGAL PROCEEDINGS
The Company is not involved in any material legal proceedings.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the fourth
quarter ended September 30, 1998.
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PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Common Stock is quoted on the NASDAQ National Market under the symbol
ROCM. The following table sets forth, for the periods indicated, the range of
high and low last sale prices for the Common Stock as reported by the NASDAQ
National Market.
HIGH LOW
------- -------
FISCAL 1997
First Quarter .................................. $19.125 $15.250
Second Quarter ................................. 21.000 16.000
Third Quarter .................................. 16.250 12.250
Fourth Quarter ................................. 18.000 12.750
FISCAL 1998
First Quarter .................................. $17.875 $11.875
Second Quarter ................................. 16.000 13.125
Third Quarter .................................. 15.375 14.000
Fourth Quarter ................................. 15.000 8.000
HOLDERS
As of December 4, 1998, the Company had 111 shareholders of record. Such
number of record holders does not reflect shareholders who beneficially own
Common Stock in nominee or street name.
The Company has paid no cash dividends on its Common Stock, and it does not
intend to pay cash dividends on its Common Stock in the future.
19
ITEM 6. SELECTED FINANCIAL DATA
The following selected financial data of the Company as of September 30,
1998 and 1997 and for the three fiscal years ended September 30, 1998, 1997 and
1996 are derived from, and are qualified by reference to, the financial
statements of the Company audited by Ernst & Young LLP, independent auditors,
included elsewhere in this Form 10-K. The following selected financial data as
of September 30, 1996, 1995 and 1994 and for the fiscal years ended September
30, 1994 and 1995 are derived from audited financial statements not included
herein. The information set forth below should be read in conjunction with
"Management's Discussion and Analysis of Financial Condition and Results of
Operations," the Financial Statements and Notes thereto and other financial
information included elsewhere in this Form 10-K.
FISCAL YEARS ENDED SEPTEMBER 30,
------------------------------------------------------------
1998 1997 1996 1995 1994
-------- -------- -------- -------- --------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Statements of Operations Data:
Net sales ............................ $ 9,518 $ 7,615 $ 5,540 $ 3,131 $ 2,189
Cost of sales ........................ 6,604 4,869 3,788 2,448 1,716
-------- -------- -------- -------- --------
Gross profit ........................ 2,914 2,746 1,752 683 473
Operating expenses:
Marketing and selling ................ 3,191 2,210 1,351 858 574
Research and development ............. 1,384 1,451 1,182 358 210
General and administrative ........... 1,445 1,499 1,112 766 692
-------- -------- -------- -------- --------
Total operating expenses ............ 6,020 5,160 3,645 1,982 1,476
-------- -------- -------- -------- --------
Loss from operations ................. (3,106) (2,414) (1,893) (1,299) (1,003)
Interest income ...................... 848 657 818 56 78
Interest expense ..................... -- (342) (285) (68) (39)
-------- -------- -------- -------- --------
Net loss ............................. $ (2,258) $ (2,099) $ (1,360) $ (1,311) $ (964)
======== ======== ======== ======== ========
Net loss per common share -- basic
and diluted ......................... $ (.44) $ (.51) $ (.35) $ (.49) $ (.36)
Weighted average number of common
shares outstanding .................. 5,141 4,132 3,867 2,682 2,660
AS OF SEPTEMBER 30,
------------------------------------------------------------
1998 1997 1996 1995 1994
-------- -------- -------- -------- --------
Balance Sheet Data:
Cash, cash equivalents and
marketable securities .............. $ 16,410 $ 4,639 $ 17,408 $ 2,905 $ 1,370
Working capital ...................... 19,245 7,081 18,861 4,348 2,822
Total assets ......................... 37,736 18,613 23,888 7,163 5,631
Long-term debt ....................... -- -- 3,321 3,036 395
Accumulated deficit .................. (9,774) (7,516) (5,418) (4,058) (2,747)
-------- -------- -------- -------- --------
Total shareholders' equity ........... $ 30,918 $ 17,181 $ 19,231 $ 3,672 $ 4,815
======== ======== ======== ======== ========
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
GENERAL
The Company designs, develops, manufactures and markets urinary continence
care products for sale to the home care and hospital care markets. Through
fiscal 1992, the Company was a development stage company, engaged primarily in
the development of its products and manufacturing operations and systems. In
fiscal 1992, the Company began commercial sales under a private label
arrangement. In fiscal 1993, the Company also began marketing products under the
ROCHESTER MEDICAL brand.
20
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, certain items
from the statements of operations of the Company expressed as a percentage of
net sales:
FISCAL YEARS ENDED
SEPTEMBER 30,
------------------------------------
1998 1997 1996
---------- ---------- ----------
Net sales:
Private label ..................... 75% 78% 82%
Rochester Medical brand ........... 25 22 18
-- -- --
Total net sales .................... 100% 100% 100%
Cost of sales ...................... 69 64 68
--- --- ---
Gross margin ....................... 31 36 32
Operating expenses:
Marketing and selling ............. 34 29 25
Research and development .......... 15 19 21
General and administrative ......... 15 20 20
--- --- ---
Total operating expenses ........... 64 68 66
--- --- ---
Loss from operations ............... (33) (32) (34)
Interest income, net ............... 9 4 9
--- --- ---
Net loss ........................... (24)% (28)% (25)%
=== === ===
FISCAL YEAR ENDED SEPTEMBER 30, 1998 COMPARED TO FISCAL YEAR ENDED
SEPTEMBER 30, 1997
NET SALES. Net sales increased 25% to $9.5 million in fiscal 1998 from $7.6
million in the prior fiscal year. The increase results from sales growth in both
ROCHESTER MEDICAL brand and private label products. Sales of ROCHESTER MEDICAL
brand products increased 40% to $2.4 million in fiscal 1998 from $1.7 million in
fiscal 1997, reflecting growth of 62% in domestic sales and 16% in international
sales. Virtually all of the domestic growth in branded sales was from sales of
the Company's standard products, for which marketing efforts have been
progressively increased by the recently expanded field sales force. Sales to
private label customers increased 20% to $7.1 million in fiscal 1998 from $6.0
million in fiscal 1997. Sales to Convatec, Mentor and Hollister accounted for
25%, 21% and 7%, respectively, of fiscal 1998 net sales compared to 24%, 30% and
10%, respectively, in fiscal 1997.
GROSS MARGIN. The Company's gross margin was 31% in fiscal 1998 compared to
36% for fiscal 1997. The gross margin rate has been adversely impacted by
expansion of production facilities and support operations, shift in product mix
toward lower margin products and increases in production wage rates. The Company
expects continued downward pressure on gross margins in future periods
associated with additional depreciation and other capacity expansion and
production scale-up costs. The trend of reduced margins is expected to continue
until such time, if ever, the Company is able to increase utilization of the
expanded manufacturing facilities, and increase sales levels of its higher
margin RELEASE NF product line.
MARKETING AND SELLING. Marketing and selling expense increased 44% to $3.2
million in fiscal 1998 from $2.2 million in fiscal 1997. The increased expense
is due primarily to market introduction costs for the RELEASE NF catheter,
expansion of the domestic field sales force and costs associated with the
addition of two new sales and marketing management personnel.
RESEARCH AND DEVELOPMENT. Research and development expense decreased 5% to
$1.4 million in fiscal 1998 compared to $1.5 million in fiscal 1997. The primary
activity affecting research and development expense levels is the ongoing
clinical testing for the FEMSOFT insert.
GENERAL AND ADMINISTRATIVE. General and administrative expense decreased
4% to $1.4 million in fiscal 1998 from $1.5 million in fiscal 1997. The
decrease in administrative expense
21
reflects efforts to contain costs, including deferral of planned business system
development expenditures until fiscal 1999.
INTEREST INCOME AND (EXPENSE), NET. Net interest income increased to
$848,000 in fiscal 1998 compared to $316,000 in fiscal 1997. The increase in net
interest income in fiscal 1998 is a result of investment of net proceeds from
the Company's November 1997 public stock offering and repayment of a convertible
note to ConvaTec (See Liquidity and Capital Resources).
FISCAL YEAR ENDED SEPTEMBER 30, 1997 COMPARED TO FISCAL YEAR ENDED
SEPTEMBER 30, 1996
NET SALES. Net sales increased 37% to $7.6 million in fiscal 1997, from
$5.5 million in the prior fiscal year. The increase was due primarily to growth
in sales of both ROCHESTER MEDICAL brand and private label products. Sales of
ROCHESTER MEDICAL brand products increased 68% to $1.7 million in fiscal 1997
from $1.0 million in fiscal 1996, reflecting 48% growth in domestic branded
sales and 99% growth in international branded sales. Private label sales
increased 33% to $6.0 million in fiscal 1997 from $4.5 million in fiscal 1996.
Sales to ConvaTec, Hollister and Mentor accounted, respectively, for 24%, 10%
and 30% of fiscal 1997 net sales compared, respectively, to 12%, 12% and 29% of
fiscal 1996 net sales.
GROSS MARGIN. The Company's gross margin as a percentage of net sales was
36% in fiscal 1997 compared to 32% for fiscal 1996. Fiscal 1997 gross margin
benefited from manufacturing efficiencies associated with higher production
volumes. The Company expects gross margin to be reduced in future periods by
depreciation and other expenses associated with the expansion and scale-up of
the Company's manufacturing facilities.
MARKETING AND SELLING. Marketing and selling expense increased 64% to $2.2
million in fiscal 1997 from $1.4 million in fiscal 1996. The increased expense
reflects expansion of the Company's domestic direct sales organization and
increased product promotion spending, in particular increased marketing and
selling activities for ROCHESTER MEDICAL brand products.
RESEARCH AND DEVELOPMENT. Research and development expense increased 23% to
$1.5 million in fiscal 1997 from $1.2 million in fiscal 1996, due to incremental
costs associated with clinical studies for new products, in particular the
FEMSOFT insert.
GENERAL AND ADMINISTRATIVE. General and administrative expense increased
35% to $1.5 million in fiscal 1997 from $1.1 million in fiscal 1996, due to
requirements for business and administrative infrastructure development to
support current and anticipated growth.
INTEREST INCOME (EXPENSE), NET. Interest income decreased to $657,000 for
fiscal 1997 from $818,000 for fiscal 1996, as a result of earnings on lower
levels of cash available for investment. Interest expense in fiscal 1997 and
fiscal 1996 related to the convertible note to ConvaTec that the Company repaid
on September 30, 1997.
LIQUIDITY AND CAPITAL RESOURCES
The Company has financed its operations primarily through public offerings
and private placements of its equity securities, and has raised approximately
$40.7 million in net proceeds since its inception. In August 1995, the Company
received proceeds of $3.0 million from issuance of a convertible note to
ConvaTec. The Company repaid the ConvaTec note on September 30, 1997, with
accrued interest, for a total amount of $3.7 million.
As of September 30, 1998, the Company had total cash and marketable
securities of $16.4 million, a net increase of $11.8 million compared to
September 30, 1997. The Company used a net $1.9 million of cash to fund
operating activities during fiscal 1998, primarily reflecting the net loss
before non-cash depreciation charges, and a net increase in working capital
assets of $0.4 million. Capital expenditures of $2.3 million were made during
fiscal 1998, substantially all of which relate to completion of the Company's
production facilities expansion. The Company completed a public stock offering
in November, 1997 that raised net proceeds of $15.9 million.
22
The Company intends to use approximately $1.4 million during the coming
year for expansion of production infrastructure, primarily to increase RELEASE
NF and Foley catheter production capacity and to upgrade business and
manufacturing information systems. The Company also intends to expend
substantial funds for product research and development, expansion of sales and
marketing activities, product education efforts, advertising and other working
capital and general corporate purposes. Although the Company believes that its
existing resources and anticipated cash flows from operations, will be
sufficient to satisfy its capital needs for approximately the next two years,
there can be no assurance that the Company will not require additional financing
before that time. The Company's actual liquidity and capital requirements will
depend upon numerous factors, including the timing of regulatory approvals, if
any, for the FEMSOFT insert; the costs and timing of expansion of sales and
marketing activities; the amount of revenues from sales of the Company's
existing and new products; changes in, termination of, and the success of,
existing and new distribution arrangements; the cost of maintaining, enforcing
and defending patents and other intellectual property rights; competing
technological and market developments; developments related to regulatory and
third party reimbursement matters; the cost and progress of the Company's
research and development efforts; and other factors. In the event that
additional financing is needed, the Company may seek to raise additional funds
through public or private financing, collaborative relationships or other
arrangements. Any additional equity financing may be dilutive to shareholders,
and debt financing, if available, may involve significant restrictive covenants.
Collaborative arrangements, if necessary to raise additional funds, may require
the Company to relinquish its rights to certain of its technologies, products or
marketing territories. Failure to raise capital when needed could have a
material adverse effect on the Company's business, financial condition and
results of operations. There can be no assurance that such financing, if
required, will be available on terms satisfactory to the Company, if at all.
IMPACT OF YEAR 2000
The Year 2000 issue is the result of computer programs which were written
using two digits rather than four to determine the applicable year. The Year
2000 issue may also affect computer chips that process data-sensitive
information which are embedded in computer hardware and machinery. Any computer
programs and hardware or equipment that have date-sensitive software or chips
may recognize a date using "00" as the year 1900 rather than the year 2000. This
could result in a system failure or miscalculations causing disruptions to
operations, including temporary inability to process transactions, send invoices
or engage in similar normal business activities.
The Company utilizes a variety of computer programs for its systems of
manufacturing, distribution and administration. In addition, certain of the
Company's plant and manufacturing equipment contains date-sensitive memory
chips. The Company is presently conducting an assessment of its computer
programs and equipment. The Company has made inquiries of its vendors who
provide the Company with computer programs and equipment, including hardware and
software used in the Company's automated manufacturing processes. The Company
has also recently hired a consultant to assist the Company with its assessment.
Based upon results of that assessment to date and upon certifications and
assurances received from its software vendors, the Company has reviewed a
majority of its computer programs and equipment and has not identified any
programs or equipment that are not Year 2000 compliant. The Company anticipates
that it will be able to complete the assessment and implement any necessary
modifications during calendar 1999. During its assessment to date, the Company
has not identified any material costs related to Year 2000 issues. If for any
reason, however, the ongoing assessment discovers that the computer programs or
equipment have a component that is not Year 2000 compliant and the Company is
unable to implement necessary modifications on a cost-effective or timely basis,
the Company could experience a significant operational issue that could have a
material impact on the operations of the Company. Such impacts could include
disruptions in one or more of the Company's manufacturing processes resulting in
delays in production and the Company's inability to manufacture and deliver
product to fulfill customer orders.
In addition, each company with which the Company conducts business, such as
banks, payroll processors, vendors and customers, must address their own Year
2000 issues. The failure of these
23
companies to be Year 2000 compliant may affect the ability of the Company, among
other things, to obtain critical supplies or receive payment on outstanding
invoices. Depending on the extent of such issues, this could have a material
adverse effect on the Company's results of operations and liquidity.
The Company has used its own personnel to make inquiries to vendors and to
begin the Year 2000 assessment process. Other than such personnel expenses, the
Company estimates that it has spent to date less than $5,000 on Year 2000
compliance issues. The Company cannot now estimate the costs it may be required
to incur in order to resolve any such compliance issues which may be disclosed
as a result of its assessment procedures being undertaken by the Company.
Specific factors that might cause such material expenditures not now anticipated
by the Company include, but are not limited to, the availability and cost of
trained personnel, the validity of certifications and assurances furnished by
software vendors, the effectiveness of software upgrades received by the Company
from its software vendors, the results of the ongoing assessment and similar
uncertainties. The Company currently has no contingency plans in place in the
event issues are encountered with Year 2000 compliance. The Company intends to
further evaluate the status of Year 2000 compliance in March 1999 and determine
at that time whether a contingency plan is necessary.
IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS
In June 1997, the Financial Accounting Standards Board ("FASB") issued FASB
Statement No. 130 "Reporting Comprehensive Income," which establishes standards
for the reporting and display of comprehensive income and its components in the
financial statements. The FASB also issued FASB Statement No. 131, "Disclosures
about Segments of an Enterprise and Related Information," which significantly
changes the way segment information is reported in annual financial statements
and also requires selected segment information in interim financial reports to
shareholders. Both statements are effective for fiscal years beginning after
December 15, 1997 and, based on current circumstances, the Company does not
believe the effect of adoption is material to the financial statements.
BUSINESS OUTLOOK
The following discussion, as well as certain information presented
elsewhere in this Form 10-K, including statements made in the sections captioned
"Business," "Management's Discussion and Analysis of Financial Condition and
Results of Operations" and "Risk Factors," and elsewhere in this Form 10-K
constitute "forward-looking statements" within the meaning of the Private
Securities Litigation Reform Act of 1995. Such forward-looking statements may be
identified by the use of terminology such as "may," "will," "expect,"
"anticipate," "predict," "intend," "designed," "estimate," "should" or
"continue" or the negatives thereof or other variations thereon or comparable
terminology. Such forward-looking statements involve known or unknown risks,
uncertainties and other factors which may cause the actual results, performance
or achievements of the Company, or industry results, to be materially different
from any future results, performance or achievements expressed or implied by
such forward-looking statements. Such factors include, among other things, the
following: the lack and uncertainty of regulatory approval for the Company's
products in development, primarily the FEMSOFT insert; the uncertainty of market
acceptance of the RELEASE NF catheter and FEMSOFT insert; the risks associated
with the Company's expanded reliance on sales of Rochester Medical brand
products and the Company's limited sales and marketing experience with Rochester
Medical brand product sales; the Company's history of losses and uncertainty of
profitability; the Company's dependence on a small number of private label
distributors for the majority of its sales; the Company's dependence on limited
or single sources of supply for critical raw materials; uncertainties associated
with beginning production on the Company's new liquid encapsulation
manufacturing line and expanded Foley catheter and male external catheter
manufacturing lines; the Company's highly competitive industry and risks that
advances in alternative treatments or products could make the Company's products
obsolete; changes in, or failure to comply with, government regulations; the
uncertainty of third party reimbursement for certain of the Company's products;
the Company's dependence on and the uncertainty of patent and proprietary
technology protection; possible product liability litigation;
24
potential fluctuations in the Company's quarterly results; the Company's
dependence on key employees; general economic and business conditions; and other
factors referenced in this Form 10-K.
The Company believes that it has begun to benefit from the recent and
growing market preference for non-latex products, particularly with increased
demand for its silicone Foley catheters. New FDA labeling regulations that
became mandatory in September, 1998 require that latex products contain a
warning label as to the inherent risks associated with latex product use. In
light of these inherent risks, many customers and medical institutions are now
seeking non-latex alternatives such as those the Company offers.
Since receiving FDA marketing approval for the RELEASE NF catheter in
January, 1998, the Company has been engaged in market introduction activities
domestically and in pursuing regulatory approvals, including CE mark, for
introduction into overseas markets. Following initial presentation of the
RELEASE NF catheter at a series of medical trade shows and conventions in May of
this year, the Company has focused its selling efforts on negotiating contracts
with group purchasing organizations (GPOs) and on securing product evaluations
in medical institutions. These activities are generally considered prerequisites
to obtaining order volumes of any significance when introducing a new medical
product into the hospital market. Typically, the selling process includes (i)
making the product available under group contract, (ii) introducing the product
directly at medical institutions to secure an evaluation (iii) gaining
acceptance of the product by institution's product review committee following
successful trial and evaluation, and (iv) securing product orders. The Company
believes the RELEASE NF catheter will be undergoing such product evaluations at
a number of major medical institutions in the coming months, and that the
results of such evaluations will be a principal consideration in decisions by
such institutions whether or not to purchase the product. Such evaluations,
moreover, do not necessarily conform to scientifically designed protocols and
may yield results adversely affecting purchasing decisions. Market acceptance of
the RELEASE NF catheter, and sales thereof, will depend in large part on the
Company's ability to secure participation under GPO contracts, its ability to
secure hospital trials of the product, and the results of such hospital trials,
none of which can be predicted.
The Company has increased Foley catheter production capacity during the
current quarter with the addition of peripheral manufacturing equipment and the
expansion of the production work force. The increase was undertaken in response
to an increase in order volumes for the Company's silicone Foley catheters, as
well as in anticipation of manufacturing capacity requirements for the RELEASE
NF catheter. Aside from the Foley catheter production area, the Company expects
to experience excess capacity costs, including depreciation charges, associated
with its new manufacturing facilities, which will affect margins until such time
as sales volumes provide a level of utilization to absorb these costs.
The Company intends to continue expanding its domestic field force for
branded products and to further develop its international branded product sales
activities. Since revising its agreement with ConvaTec in May 1998, the Company
has begun marketing efforts to expand its base of customers in major
international markets now accessible under private label. Mentor Corporation,
one of the Company's largest private label customers, has recently advised
ROCHESTER MEDICAL of its intention to manufacture its own silicone male external
catheters under a royalty-free license it holds from the Company. In light of
its revised Agreement with ConvaTec and the potential for declines in sales to
Mentor, the Company will seek to enter into private label agreements with new
customers. The Company's expense levels are based in part on the Company's
expectations as to future revenue levels and to a large extent are fixed in the
short-term.
The labor market for medical device manufacturing personnel has tightend in
Minnesota, and paricularly in the Rochester area where the Company's
manufacturing facilities are located. This has resulted in upward pressure on
wages for production workers but has not, to date, adversely affected the
Company's ability to hire and retain capable manufacturing personnel.
The Company is satisfied with the progress of the FEMSOFT insert clinical
trials and with the results of its PMA presubmission conference with the FDA.
The Company believes that the interim
25
clinical trial results derived to date are statistically significant and
predictive of the results to be derived from the continuing study, and therefore
the Company plans to submit a PMA application in the near future. The Company
cannot estimate the time that will be required for FDA review following the
submission, nor can the Company predict the FDA's response to that submission.
RISK FACTORS
UNCERTAINTY OF MARKET ACCEPTANCE OF NEW PRODUCTS
Much of the Company's ability to increase revenues and to achieve
profitability and positive cash flow will depend on the successful introduction
of its products and products in development, including the RELEASE NF catheter
which has recently been commercially introduced or the FEMSOFT insert which has
not yet been commercially introduced. Both of these products represent new
methods for urinary continence care. There can be no assurance that these
products will gain any significant degree of market acceptance among physicians,
healthcare payors and patients, even after all regulatory and reimbursement
approvals have been obtained. The Company believes that recommendations by
physicians and clinicians will be essential for the market acceptance of these
products and there can be no assurance that any such recommendations will be
obtained. Broad market acceptance of the Company's advanced products, including
the RELEASE NF catheter and the FEMSOFT insert, may require lengthy hospital
evaluations and/or the training of numerous physicians and clinicians. The time
required to complete such evaluations and/or such training could result in a
delay or dampening of such market acceptance. Moreover, health care payors'
approval of reimbursement for the Company's products and products in development
will be an important factor in establishing market acceptance. Patient
acceptance of these products will depend on many factors, including physician
recommendations, the degree, rate and severity of potential complications, the
cost and benefits compared to competing products or alternative medical
treatments, lifestyle implications, available reimbursement and other
considerations. In addition, the Company has not yet determined final pricing
for all of these products, and the Company's pricing policies could adversely
impact market acceptance of these products as compared to competing products and
alternative treatments. Any of the foregoing factors, or other factors, could
limit or detract from market acceptance of these products. Insufficient market
acceptance of these products could have a material adverse effect on the
Company's business, financial condition and results of operations.
RISKS ASSOCIATED WITH MARKETING AND SALES OF ROCHESTER MEDICAL BRAND PRODUCTS
To date, the Company has depended to a significant extent on marketing its
continence care products under private label arrangements. A key element of the
Company's business strategy is to pursue sales growth of its ROCHESTER MEDICAL
brand products, and to develop market recognition for the brand to support the
market introduction of the RELEASE NF catheter and the future market
introduction of the FEMSOFT insert, as well as other products in development.
The success of the Company's strategy will depend on its ability to overcome
established market positions of competitors and to establish its own market
presence. The Company is actively pursuing sales of its current Rochester
Medical brand products through a dedicated domestic sales force, and is engaged
in developing market strategies for its planned Rochester Medical brand
products, particularly the FEMSOFT insert. One of the challenges facing the
Company in this respect is the need to obtain inclusion under healthcare group
purchase arrangements. Healthcare purchasing is becoming increasingly
centralized, which may put the Company at a disadvantage compared to companies
with a wider array of products. To date, the Company has obtained inclusion
under two such contracts. In addition, many purchasers of urine drainage
catheters prefer to purchase such catheters packaged in a tray, which is a
single container including a catheter and related accessories, such as
collection bags. The Company currently offers only the RELEASE NF catheter in
trays. Not also offering its other urine drainage products in kits or trays can
be a competitive disadvantage with potential customers who prefer such
packaging. Although the Company may address this disadvantage in the future, the
Company does not currently have a supply arrangement for tray components at
prices which would permit its standard, lower margin products to be
26
offered in trays. There can be no assurance that the Company will succeed in
marketing its products under the ROCHESTER MEDICAL brand, will further develop
its marketing and sales force to expand its sales activities, or obtain
inclusion in additional group purchasing contracts. Moreover, the FEMSOFT
insert, if approved by the FDA and introduced commercially, may require the
Company to undertake extensive educational efforts directed to physicians and
clinicians and significant media advertising directed to consumers. The Company
has no previous experience with such educational efforts or consumer oriented
media advertising, and there can be no assurance that the Company will be
successful in such activities.
The Company has entered into collaborative arrangements with a number of
distributors providing for the marketing and sale of certain of the Company's
products in various international markets. In general, pursuant to these
agreements, the Company is required to provide quantities of its products for
sale by its distributors, and the Company's distributors are required to use
their best efforts to market and sell the Company's products in their respective
markets. Failure by the Company's distributors to effectively market the
Company's products in their respective markets could have a material adverse
effect on the Company.
LACK OF REGULATORY APPROVAL
The Company believes that regulatory approvals for its products in
development, particularly the FEMSOFT insert, are materially important to the
Company. The production and marketing of the Company's products in development,
including FEMSOFT insert, and certain of the Company's ongoing research and
development activities are subject to regulation by numerous government
authorities in the United States and other countries. The FEMSOFT insert has not
been authorized for commercial distribution in the United States or any foreign
country, and will require FDA authorization before the Company may begin
marketing it in the United States as well as similar authorization from
appropriate regulatory bodies in foreign jurisdictions prior to
commercialization in such jurisdictions. The process of obtaining FDA and other
domestic and foreign regulatory authorization is unpredictable and often
lengthy, and there can be no assurance that the FDA or any other regulatory body
will grant authorization any product in a timely manner, if at all. The Company
intends to submit a PMA for the FEMSOFT insert based on data derived from an
ongoing multi-site clinical trial. There can be no assurance that such trials
when completed will yield data that support the safety and efficacy of the
FEMSOFT insert or that such clinical trials, FDA review or continued development
efforts, will not identify technical, manufacturing, design or other obstacles
that could delay submitting a PMA. If the FEMSOFT insert is not determined by
the FDA to be safe and effective, or if the Company otherwise fails to obtain
FDA approval of the FEMSOFT insert, or if the Company experiences a significant
delay or unforeseen expenditure in the course of attempting to obtain such
approval, scaling-up manufacturing, or marketing such product, if approved, the
Company could be materially adversely affected. The Company is pursuing CE mark
certification for the RELEASE NF catheter to permit the Company to market the
catheter in member countries of the EU. Due to the drug release component of the
RELEASE NF catheter, this certification procedure is a more complex, lengthy and
uncertain procedure than the company has undergone to date in connection with CE
certification of its other products. The Company cannot estimate the length of
time that will be required to complete the CE certification procedure for the NF
RELEASE catheter, and the Company cannot predict the outcome of that procedure.
If the Company cannot obtain CE Mark certification for the RELEASE NF catheter,
Company's results of operations will likely be affected.
LIMITED REVENUES; HISTORY OF LOSSES AND ANTICIPATED FUTURE LOSSES
The Company has generated only limited revenues to date and has experienced
net losses since its inception. Net losses for the fiscal years ended September
30, 1996, 1997 and 1998 were $1.4 million, $2.1 million and $2.3 million,
respectively. The Company had an accumulated deficit of approximately $9.8
million at September 30, 1998. The Company's ability to increase revenues and
achieve profitability and positive cash flow will depend in part upon the
Company's ability to complete development of, and/or successfully introduce, new
products, particularly the RELEASE NF catheter and FEMSOFT insert, of which
there can be no assurance. The Company expects to incur
27
substantial expenses for commercialization of the RELEASE NF catheter, and for
clinical testing, development and commercialization of the FEMSOFT insert, as
well as for other new products and products in development. In addition, the
Company anticipates increased operating expenses as it expands its sales and
marketing organization and activities. The Company will also experience
additional manufacturing expenses in connection with the ongoing expansion and
scale-up of capacity at its manufacturing facilities. A substantial portion of
the expenses associated with the expansion and scale-up of the Company's
manufacturing facilities are fixed in nature (i.e. depreciation) and will reduce
the Company's operating margin until such time, if ever, as the Company is able
to increase utilization of such expanded capacity. As a result, the Company
expects to incur substantial operating losses for the foreseeable future and
there can be no assurance that the Company will ever generate substantial
revenues or achieve or sustain profitability.
HIGHLY COMPETITIVE MARKETS; ALTERNATIVE TREATMENTS; TECHNOLOGICAL ADVANCEMENTS
The medical products market in general is, and the markets for urinary
continence care products in particular are, highly competitive. The Company's
ability to compete in the urinary continence care market depends primarily on
price, product quality and features, technical capability, breadth of product
line and distribution capabilities. Many of the Company's competitors have
greater name recognition than the Company and offer well known and established
products, some of which are less expensive than the Company's products. As a
result, even if the Company can demonstrate that its products provide greater
ease of use, lifestyle improvement or beneficial effects on medical outcomes
over the course of treatment, the Company may not be successful in capturing a
significant share of the market. In addition, many of the Company's competitors
offer broader product lines than the Company, which may be a competitive
advantage in obtaining contracts with healthcare purchasing groups, and may
adversely affect the Company's ability to obtain contracts with such purchasing
groups. The Company relies to a large extent on distribution relationships that
include the Company's products, both those sold under private label arrangements
and those marketed under the ROCHESTER MEDICAL brand, as part of broader product
offerings. There can be no assurance, however, that the Company will be able to
maintain such relationships or that they will be successful in inducing
significant purchasers to buy the Company's products. Additionally, many of the
Company's competitors have substantially more marketing and sales experience
than the Company and substantially greater resources to devote to such efforts.
Finally, other factors within and outside the Company's control will also affect
its ability to compete, including its product development and innovation
capabilities, its ability to obtain required regulatory clearances, its ability
to protect the proprietary technology included in its products and manufacturing
processes, its manufacturing and marketing capabilities and its ability to
attract and retain skilled employees. There can be no assurance that the Company
will be able to compete against such competitors or against potential
competitors, or that competition in the Company's markets will not result in
pricing pressures that would adversely affect the Company's unit prices and
sales levels any of which could have a material adverse effect on the Company's
business, financial condition and results of operations.
In addition to the Company's products, urinary continence care can be
managed with a variety of alternative medical treatments and management products
or techniques, including adult diapers and absorbent pads, surgery, behavior
therapy, pelvic muscle exercise, implantable devices, injectable materials and
other medical devices. Moreover, manufacturers of products similar to the
Company's are engaged in research to develop more advanced versions of current
products. Many of the companies that are engaged in such development work have
substantially greater capital resources than the Company and greater expertise
than the Company in research, development and regulatory matters. There can be
no assurance that the Company's products will be able to compete with existing
or future alternative products, techniques or therapies, or that advancements in
existing products, techniques or therapies will not render the Company's
products obsolete. Finally, the Company's urinary dysfunction products are
management options, not a permanent cure. The development of a cure for urinary
dysfunction would have a material adverse effect on the Company's business,
financial condition, and results of operations.
28
DEPENDENCE ON DISTRIBUTION ARRANGEMENTS
A significant portion of the Company's net sales to date have depended on
the Company's ability to provide products that meet the requirements of medical
product companies with which the Company has private label or distribution
arrangements, and on the sales and marketing efforts of such entities. These
arrangements are likely to continue to be a significant portion of the Company's
revenues in the future. Private label arrangements with medical products
companies accounted for approximately 82%, 78% and 75% of the Company's net
sales for fiscal years 1996, 1997 and 1998, respectively. The Company will also
continue to establish additional distribution arrangements for private label
sales and distribution arrangements for ROCHESTER MEDICAL brand products. There
can be no assurance that the Company's private label purchasers and other
distributors will be able to successfully market and sell the Company's
products, that they will devote sufficient resources to support the marketing of
any of the Company's products, or that they will market any of the Company's
products at prices which will permit such products to develop, achieve, or
sustain market acceptance. Furthermore, there can be no assurance that the
Company's private label or other distributors will continue to purchase
significant amounts of product from the Company. The Company cannot forecast
with any reasonable degree of assurance the amount of future purchases, if any,
by ConvaTec, which represented 25% of net sales during fiscal 1998, or by
Mentor, which represented 21% of net sales during fiscal 1998. The failure of
the Company's private label purchasers or other distributors to continue to
purchase products from the Company at levels reasonably consistent with their
prior purchases or to effectively market the Company's products could have a
material adverse effect on the Company's business, financial condition and
results of operations. Moreover, in addition to the restrictions and obligations
described below, the private label agreements impose certain obligations upon
the Company relating to, among others, delivery of commercial quantities of its
products, delivery of products in accordance with specifications, the
maintenance of product liability insurance and certain indemnification
obligations. The failure or inability of the Company to comply with the terms of
these agreements could permit the Company's private label purchasers and other
distributors to terminate their respective agreements. In addition, there can be
no assurance that any of these private label purchasers or other distributors
will perform its obligations under its respective agreement with the Company.
Any such termination or abandonment could have a material adverse effect on the
ability of the Company to market and sell its products.
The Company's distribution agreement with ConvaTec generally precludes the
Company from distributing male external catheters through any other private
label purchaser in the territories of Central America, South America, Australia,
Japan, New Zealand, South Africa, Israel, Iran, Iraq, Lebanon, Oman, Saudi
Arabia, Syria, United Arab Emirates and Yemen; although the Company may market
such products under its own brand in such territories.
The Company is also party to a private label agreement with Mentor pursuant
to which the Company granted Mentor a non-exclusive, paid-up, royalty free
license to make, use and sell the silicone external catheters that Mentor now
purchases from the Company. As a result, there can be no assurance that Mentor
will not begin to manufacture the silicone external catheter itself and
discontinue its purchase and marketing of the Company's product. Such
discontinuation could have a material adverse effect on the Company's business,
financial condition and results of operations. Mentor has recently introduced a
new non-silicone, non-latex male external catheter which it manufactures itself.
The Company cannot now estimate the impact, if any, of this new device on
Mentor's future purchase of silicone male external catheters from the Company.
The Company is also aware that Mentor has recently built a catheter
manufacturing facility for the production of silicone catheters such as it now
purchases from the Company. There can be no assurance that Mentor will continue
purchasing products from the Company at such levels, or at all, in the future.
In addition, sales of the Company's products under its private label
arrangements compete with sales of the Company's ROCHESTER MEDICAL brand
products. Such competition might have an adverse effect on the Company's ability
to establish its Rochester Medical brand or on the Company's margins.
POSSIBLE NEED FOR ADDITIONAL CAPITAL
The Company intends to expend substantial funds for expansion of sales and
marketing activities, product education efforts, advertising and other working
capital and general corporate purposes. Although the Company believes its
existing resources and anticipated cash flows from operations will be sufficient
to satisfy its capital needs for approximately the next two years, there
29
can be no assurance that the Company will not require additional financing
before that time. The Company's actual liquidity and capital requirements will
depend on numerous factors, including the timing of regulatory approvals, if
any, for the FEMSOFT insert; the costs and timing of expansion of sales and
marketing activities; the amount of revenues from sales of the Company's
existing and new products, including the RELEASE NF catheter; changes in,
termination of, and the success of, existing and new distribution arrangements;
the cost of maintaining, enforcing and defending patents and other intellectual
property rights; competing technological and market developments; developments
relating to regulatory and third party reimbursement matters; the cost and
progress of the Company's research and development efforts; and other factors.
In the event that additional financing is needed, the Company may seek to raise
additional funds through public or private financing, collaborate relationships
or other arrangements. Any additional equity financing may be dilutive to
shareholders, and debt financing, if available, may involve significant
restrictive covenants. Collaborative arrangements, if necessary to raise
additional funds, may require the Company to relinquish its rights to certain of
its technologies, products or marketing territories. Failure to raise capital
when needed could have a material adverse effect on the Company's business,
financial condition and results of operations. There can be no assurance that
such financing, if required, will be available on terms satisfactory to the
Company, if at all.
DEPENDENCE ON SINGLE OR LIMITED SOURCES OF SUPPLY
The Company is dependent upon Dow Corning Corporation ("Dow Corning") and
General Electric Corporation ("GE") for raw materials used in the manufacture of
certain of its silicone products. Dow Corning is currently in bankruptcy
proceedings and there can be no assurance that Dow Corning will continue to
manufacture silicone or to supply silicone to medical device manufacturers,
including the Company. To date, the Company has fulfilled its requirements for
nitrofurazone and for catheter trays, which are each used for the RELEASE NF
catheter, through a single distributor of each such component, and the Company
has fulfilled its requirements for block co-polymers used in its non-silicone,
non-latex catheters. Although the Company is aware of other distributors who are
able to supply nitrofurazone, catheter trays or block co-polymers, the Company
does not currently have arrangements for alternative supplies. If the Company
were to lose its current suppliers of any of these materials or components, it
would be required to identify a new supplier for that material, repeat
biocompatibility testing of its products using the raw materials from the new
supplier, might be required to seek additional regulatory clearance or might
incur additional costs for such components. The loss of any such supplier or any
significant decrease or interruption in supply could interrupt the manufacture
of the Company's products and have a material adverse effect on the Company's
business, financial condition and results of operations. Moreover, the
significance of product liability litigation to suppliers of raw materials used
in the manufacture of medical devices has caused such suppliers to carefully
evaluate the use of those raw materials in certain medical devices. There can be
no assurance that the Company's suppliers might not in the future change their
policies regarding raw materials usage, or that such a change, if it occurred,
might not adversely affect production of the Company's then-current products or
its product development activities.
UNCERTAINTIES ASSOCIATED WITH MANUFACTURING FACILITIES
The Company has completed installation of equipment and components
necessary to equip its recently-constructed liquid encapsulation manufacturing
facility for initial production requirements, and is presently refining process
parameters and debugging and validating the manufacturing processes for the
FEMSOFT insert in preparation for commercially scaled production. In connection
with its PMA application for the FEMSOFT insert, the FDA will inspect the
Company's new liquid encapsulation manufacturing facilities, processes and
record keeping systems. In addition, those same facilities will be required to
undergo a separate inspection by designated representatives of the European
Union for CE mark certification for the FEMSOFT insert as a condition for
selling that product in the EU. The Company may encounter delays and technical
difficulties, along with associated cost over-runs while seeking to obtain
regulatory approval for, and beginning commercial production on the new
production lines, any of which could have a material adverse effect on the
Company. Additionally, there can be no assurance that the new facilities will
enable the Company
30
to produce the quantities of products required for commercialization in the
United States and abroad. The inability to produce products in such quantities
or to utilize such new capacity fully could have a material adverse effect on
the Company.
EFFECTS OF GOVERNMENT REGULATION
The Company's products, product development activities and manufacturing
processes are subject to extensive regulation by the FDA and by comparable
agencies in foreign countries. In the United States, the FDA regulates the
introduction of medical devices as well as manufacturing, labeling and record
keeping procedures for such products. The process of obtaining marketing
clearance for new medical products from the FDA can be costly and time
consuming, and there can be no assurance that such clearance will be granted
timely, if at all, for the Company's products in development, or that FDA review
will not involve delays that would adversely affect the Company's ability to
commercialize additional products or to expand permitted uses of existing
products. Even if regulatory clearance to market a product is obtained from the
FDA, this clearance may entail limitations on the indicated uses of the product.
Marketing clearance can also be withdrawn by the FDA due to failure to comply
with regulatory standards or the occurrence of unforeseen problems following
initial clearance. The Company may be required to make further filings with the
FDA under certain circumstances, such as the addition of product claims or
product reformulation. The FDA could also limit or prevent the manufacture or
distribution of the Company's products and has the power to require the recall
of such products. FDA regulations depend heavily on administrative
interpretation, and there can be no assurance that future interpretation made by
the FDA or other regulatory bodies, which may have retroactive effect, will not
adversely affect the Company. The FDA and various state agencies inspect the
Company and its facilities from time to time to determine whether the Company is
in compliance with regulations relating to medical device manufacturing
companies, including regulations concerning manufacturing, testing, quality
control and product labeling practices. A determination that the Company is in
material violation of such regulations could lead to the imposition of civil
penalties, including fines, product recalls, product seizures, or, in extreme
cases, criminal sanctions.
A portion of the Company's revenues are dependent upon sales of its
products outside the United States. Foreign regulatory bodies have established
varying regulations governing product standards, packaging requirements,
labeling requirements, import restrictions, tariff regulations, duties and tax
requirements. The Company relies on its third-party foreign distributors to
comply with certain foreign regulatory requirements. The inability or failure of
the Company or such foreign distributors to comply with varying foreign
regulations or the imposition of new regulations could restrict the sale of the
Company's products internationally and thereby adversely affect the Company's
business, financial condition and results of operations.
DEPENDENCE ON THIRD PARTY REIMBURSEMENT
The Company's products are purchased by hospitals and other users, which
bill various third party payors, such as government health programs, private
health insurance plans, managed care organizations and other similar programs,
for the health care products and services provided to their patients. Payors may
deny reimbursement if they determine that a product used in a procedure was not
used in accordance with established payor protocols regarding cost-efficient
treatment methods, was used for an unapproved indication or was not otherwise
covered. Third party payors are increasingly challenging the prices charged for
medical products and services and, in some instances, have pressured medical
suppliers to lower their prices. The Company is unable to predict what changes
will be made in the reimbursement methods used by third party health care
payors. There can be no assurance that treatments utilizing the Company's
products will be considered cost effective by third party payors, that
reimbursement for such treatments will be available or, if available, that payor
reimbursement levels will not adversely affect the Company's ability to sell its
products on a profitable basis. Moreover, Medicare, Medicaid and private third
party payors may limit reimbursement for disposable devices such as those
manufactured by the Company by implementing fee schedules or by allowing
reimbursement for only a fixed number of devices per month. In addition,
healthcare costs have risen significantly
31
over the past decade, and there have been and may continue to be proposals by
legislators, regulators and third party payors to curb these costs. The Company
is currently unable to comprehensively assess the eligibility of the FEMSOFT
insert for reimbursement. Failure by users of the Company's products to obtain
reimbursement from third party payors, changes in third party payors' policies
towards reimbursement for the Company's products or legislative action limiting
reimbursement for certain procedures or products could have a material adverse
effect on the Company's business, financial condition and results of operations.
DEPENDENCE ON PATENTS AND PROPRIETARY RIGHTS
The Company's success may depend in part on its ability to obtain patent
protection for its products and manufacturing processes, to preserve its trade
secrets, and to operate without infringing the proprietary rights of third
parties. The validity and breadth of claims covered in medical technology
patents involve complex legal and factual questions and, therefore, may be
highly uncertain. No assurance can be given that the scope of any patent
protection under the Company's current patents, or under any patent the Company
might obtain in the future, will exclude competitors or provide competitive
advantages to the Company; that any of the Company's patents will be held valid
if subsequently challenged; or that others will not claim rights in or ownership
of the patents and other proprietary rights held by the Company. There can be no
assurance that the Company's technology, current or future products or
activities will not be deemed to infringe upon the rights of others.
Furthermore, there can be no assurance that others have not developed or will
not develop similar products or manufacturing processes, duplicate any of the
Company's products or manufacturing processes, or design around the Company's
patents. The Company also relies upon unpatented trade secrets to protect its
proprietary technology, and no assurance can be given that others will not
independently develop or otherwise acquire substantially equivalent technology
or otherwise gain access to the Company's proprietary technology or disclose
such technology or that the Company can ultimately protect meaningful rights to
such unpatented proprietary technology.
The medical device industry is characterized by frequent and substantial
intellectual property litigation, particularly with respect to newly developed
technology. Litigation may be necessary to enforce patents issued to the
Company, to protect trade secrets or know-how owned by the Company, or to
determine the ownership, scope or validity of the proprietary rights of the
Company and others. Intellectual property litigation is complex and expensive,
and the outcome of such litigation is difficult to predict. Any such litigation,
regardless of outcome, could result in substantial expense to the Company and
significant diversion of the efforts of the Company's technical and management
personnel. As a result, a claim by a third party that the Company's current
products or products in development allegedly infringe its patent rights could
have a material adverse effect on the Company. Moreover, an adverse
determination in any such proceeding could subject the Company to significant
liabilities to third parties, require disputed rights to be licensed from such
parties, if licenses to such rights could be obtained, and/or require the
Company to cease using such technology. If third party patents containing claims
affecting the Company's technology were issued and such claims were determined
to be valid, there can be no assurance that the Company would be able to obtain
licenses to such patents at costs reasonable to the Company, if at all, or be
able to develop or obtain alternate technology. Accordingly, an adverse
determination in a judicial or administrative proceeding or failure to obtain
necessary licenses could prevent the Company from manufacturing, using or
selling certain of its products, which could have a material adverse effect on
the Company's business, financial condition and results of operations.
POSSIBILITY OF PRODUCT LIABILITY LITIGATION; POSSIBLE INADEQUACY OF INSURANCE
The medical products industry is subject to substantial product liability
litigation, and the Company faces an inherent business risk of exposure to
product liability claims in the event that the use of its products is alleged to
have resulted in adverse effects to a patient. Although the Company has not
experienced any product liability claims to date, any such claims could have a
material adverse effect on the Company, including on market acceptance of its
products. The
32
Company maintains general insurance policies that include coverage for product
liability claims. The policies are limited to an aggregate maximum of $6 million
per product liability claim, with an annual aggregate limit of $7 million under
the policies. The Company may require increased product liability coverage as
new products are developed and commercialized. There can be no assurance that
liability claims will not exceed the coverage limits of the Company's policies
or that adequate insurance will continue to be available on commercially
reasonable terms, if at all. A product liability claim or other claim with
respect to uninsured liabilities or in excess of insured liabilities could have
a material adverse effect on the Company's business, financial condition and
results of operations.
DEPENDENCE ON KEY PERSONNEL
The Company is dependent upon Anthony J. Conway, the Company's Chief
Executive Officer and President, and upon Philip J. Conway and Richard D. Fryar,
Vice Presidents of the Company, who together perform the substantial majority of
the Company's research and development efforts as well as perform various
management functions. Additionally, the Company is dependent on the services of
Brian J. Wierzbinski, the Company's Chief Financial Officer, as well as on the
services of Randy C. Dennis, the Company's principal marketing and sales
officer. The Company also depends on its ability to attract and retain
additional highly qualified management and technical personnel. Additionally,
the Company's future success depends on its ability to attract and retain
skilled and unskilled production personnel in accordance with future sales
volumes. The Company faces intense competition for qualified personnel in all of
the aforementioned areas, and there can be no assurance that the Company will be
able to attract and retain such personnel. The loss of the services of one or
more of the current management group or the inability to hire additional
personnel as needed could impair the Company's ability to commercialize and
manufacture its products or to develop new products and could have a material
adverse effect on the Company's business, financial condition and results of
operations.
FLUCTUATIONS IN QUARTERLY FINANCIAL PERFORMANCE
The Company may experience significant fluctuations in revenues and results
of operations on a quarter to quarter basis in the future. Quarterly operating
results may fluctuate due to numerous factors, including the timing of
regulatory approvals, if any, of the FEMSOFT insert, the timing and level of
market acceptance, if any, of the RELEASE NF catheter and FEMSOFT insert, the
timing and level of expenditures associated with new product development
activities, the timing and level of expenditures associated with expansion of
sales and marketing activities and overall operations, the Company's ability to
maintain consistently acceptable yields in the manufacture of continence care
products, the success of the activities conducted under private label
arrangements, changes in demand for the Company's products based on changes in
third party reimbursement, competition, changes in government regulation and
other factors, the timing of significant orders from and shipments to customers,
and general economic conditions. These factors are difficult to forecast, and
these or other factors could have a material adverse effect on the Company's
business, financial condition and results of operations. Fluctuations in
quarterly demand for products and order cancellations may adversely affect the
continuity of the Company's manufacturing operations, increase uncertainty in
operational planning, disrupt cash flow from operations and contribute to the
volatility of the Company's stock price. The Company's expenses are based in
part on the Company's expectations as to future revenue levels and to a large
extent are fixed in the short-term. If actual revenues do not meet expectations,
the Company's business, financial condition and results of operations could be
materially adversely affected.
POTENTIAL VOLATILITY OF STOCK PRICE
In recent years, the stock markets have experienced price and volume
fluctuations that have particularly affected medical technology companies,
resulting in changes in the market prices of the stocks of many companies which
may not have been directly related to the operating performance of those
companies. Factors such as variations in the Company's financial performance,
changes in stock market analysts' recommendations regarding the Company,
announcements of
33
technological innovations by the Company, its competitors or providers of
alternative products, therapies or results of clinical trials or other
regulatory or reimbursement developments relating to the Company could cause the
market price of the Common Stock to fluctuate substantially. Broad market
fluctuations, or other factors affecting the market prices of the stocks of
medical technology companies generally, may adversely affect the market price of
the Common Stock.
34
ITEM 7A. QUANTATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
The Company's operations are not currently subject to market risks for
interest rates, foreign currency exchange rates, commodity prices or other
relevant market price risks.
ITEM 8. FINANCIAL STATEMENTS
ROCHESTER MEDICAL CORPORATION
FINANCIAL STATEMENTS
YEARS ENDED SEPTEMBER 30, 1998, 1997 AND 1996
PAGE
-----
Report of Independent Auditors ..................................... 35
Audited Financial Statements ....................................... 36-46
Balance Sheets .................................................... 36
Statements of Operations .......................................... 37
Statement of Shareholders' Equity ................................. 38
Statements of Cash Flows .......................................... 39
Notes to Financial Statements ..................................... 40
35
REPORT OF INDEPENDENT AUDITORS
Shareholders
Rochester Medical Corporation
We have audited the accompanying balance sheets of Rochester Medical
Corporation as of September 30, 1998 and 1997, and the related statements of
operations, shareholders' equity and cash flows for each of the three years in
the period ended September 30, 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 Rochester Medical
Corporation at September 30, 1998 and 1997, and the results of its operations
and its cash flows for each of the three years in the period ended September 30,
1998, in conformity with generally accepted accounting principles.
/s/ ERNST & YOUNG LLP
ERNST & YOUNG LLP
Minneapolis, Minnesota
October 23, 1998
36
ROCHESTER MEDICAL CORPORATION
BALANCE SHEETS
SEPTEMBER 30,
-----------------------------
1998 1997
------------ ------------
ASSETS
Current assets:
Cash and cash equivalents ................................ $ 2,864,922 $ 1,191,428
Marketable securities .................................... 13,545,271 3,447,461
Accounts receivable, less allowance for doubtful accounts
($50,000--1998; $62,000--1997) .......................... 1,955,048 1,967,194
Inventories .............................................. 2,209,599 1,653,733
Prepaid expenses and other current assets ................ 489,001 253,785
------------ ------------
Total current assets ...................................... 21,063,841 8,513,601
Property, plant and equipment:
Land ..................................................... 169,707 161,001
Buildings ................................................ 5,220,078 2,277,825
Construction in progress ................................. 3,373,888 5,409,591
Equipment and fixtures ................................... 5,167,000 3,776,997
------------ ------------
13,930,673 11,625,414
Less accumulated depreciation ............................ (2,510,975) (1,855,980)
------------ ------------
Total property, plant and equipment ....................... 11,419,697 9,769,434
Patents, less accumulated amortization ($550,441--1998;
$428,736--1997) .......................................... 252,212 330,338
------------ ------------
Total assets .............................................. $ 32,735,750 $ 18,613,373
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable ......................................... $ 766,304 $ 457,565
Accrued compensation ..................................... 523,612 382,744
Accrued clinical costs ................................... 294,495 410,450
Accrued expenses ......................................... 233,610 181,641
------------ ------------
Total current liabilities ................................. 1,818,021 1,432,400
Shareholders' equity:
Common Stock, no par value:
Authorized shares -- 20,000,000
Issued and outstanding shares; 5,269,500--1998;
4,133,500--1997 .......................................... 40,692,202 24,697,199
Accumulated deficit ...................................... (9,774,473) (7,516,226)
------------ ------------
Total shareholders' equity ................................ 30,917,729 17,180,973
------------ ------------
Total liabilities and shareholders' equity ................ $ 32,735,750 $ 18,613,373
============ ============
SEE ACCOMPANYING NOTES.
37
ROCHESTER MEDICAL CORPORATION
STATEMENTS OF OPERATIONS
FISCAL YEARS ENDED SEPTEMBER 30,
-------------------------------------------
1998 1997 1996
----------- ----------- -----------
Net sales ............................................ $ 9,518,311 $ 7,615,439 $ 5,540,408
Cost of sales ........................................ 6,604,201 4,869,646 3,788,584
----------- ----------- -----------
Gross profit ......................................... 2,914,110 2,745,793 1,751,824
Operating expenses:
Marketing and selling ............................... 3,190,642 2,209,747 1,351,443
Research and development ............................ 1,384,210 1,450,883 1,181,569
General and administrative .......................... 1,445,167 1,499,696 1,111,905
----------- ----------- -----------
Total operating expenses ............................. 6,020,019 5,160,326 3,644,917
----------- ----------- -----------
Loss from operations ................................. (3,105,909) (2,414,533) (1,893,093)
Other income (expense):
Interest income ..................................... 847,662 657,622 818,387
Interest expense .................................... -- (341,753) (285,166)
----------- ----------- -----------
Net loss ............................................. $(2,258,247) $(2,098,664) $(1,359,872)
=========== =========== ===========
Net loss per common share -- basic and diluted ....... $ (.44) $ (.51) $ (.35)
=========== =========== ===========
Weighted average number of common shares
outstanding ......................................... 5,140,670 4,131,600 3,866,764
=========== =========== ===========
SEE ACCOMPANYING NOTES.
38
ROCHESTER MEDICAL CORPORATION
STATEMENT OF SHAREHOLDERS' EQUITY
COMMON STOCK
---------------------------- ACCUMULATED
SHARES AMOUNT DEFICIT TOTAL
------------ ------------ ------------ ------------
Balance September 30, 1995 ................ 2,724,000 $ 7,729,518 $ (4,057,690) $ 3,671,828
Common Stock issued in public offering ... 1,323,500 16,199,395 -- 16,199,395
Exercise of common stock warrants ........ 80,000 720,000 -- 720,000
Net loss for the year .................... -- -- (1,359,872) (1,359,872)
------------ ------------ ------------ ------------
Balance at September 30, 1996 ............. 4,127,500 24,648,913 (5,417,562) 19,231,351
Exercise of common stock options ......... 6,000 48,286 -- 48,286
Net loss for the year .................... -- -- (2,098,664) (2,098,664)
------------ ------------ ------------ ------------
Balance at September 30, 1997 ............. 4,133,500 24,697,199 (7,516,226) 17,180,973
Common Stock issued in public offering ... 1,125,000 15,862,253 -- 15,862,253
Exercise of common stock options ......... 11,000 132,750 -- 132,750
Net loss for the year .................... -- -- (2,258,247) (2,258,247)
------------ ------------ ------------ ------------
Balance at September 30, 1998 ............. 5,269,500 $ 40,692,202 $ (9,774,473) $ 30,917,729
============ ============ ============ ============
SEE ACCOMPANYING NOTES.
39
ROCHESTER MEDICAL CORPORATION
STATEMENTS OF CASH FLOWS
FISCAL YEARS ENDED SEPTEMBER 30,
--------------------------------------------------
1998 1997 1996
----------- ----------- -----------
OPERATING ACTIVITIES
Net loss ............................................. $(2,258,247) $(2,098,664) $(1,359,872)
Adjustments to reconcile net loss to net cash used
in operating activities:
Depreciation and amortization ....................... 776,699 538,523 477,682
Changes in operating assets and liabilities:
Accounts receivable ................................ 12,146 (453,617) (761,353)
Inventories ........................................ (555,866) (462,450) (425,139)
Other current assets ............................... (235,216) (169,591) 295,272
Accounts payable ................................... 308,740 (500,386) 753,622
Other current liabilities .......................... 76,882 597,022 126,474
----------- ----------- -----------
Net cash used in operating activities ................ (1,874,862) (2,549,163) (893,314)
INVESTING ACTIVITIES
Capital expenditures ................................. (2,305,258) (6,880,833) (1,725,841)
Patents .............................................. (43,579) (66,905) (82,452)
Purchase of marketable securities .................... (50,871,767) (18,388,824) (17,220,523)
Sales and maturities of marketable securities ........ 40,773,957 23,954,885 9,815,605
----------- ----------- -----------
Net cash used in investing activities ................ (12,446,647) (1,381,677) (9,213,211)
FINANCING ACTIVITIES
Interest expense added to note payable ............... -- 341,826 285,000
Proceeds from sale of Common Stock ................... 15,995,003 48,286 16,919,395
Payments on long-term debt ........................... (3,662,451) --
Net cash provided by (used in) financing
activities .......................................... 15,995,003 (3,272,339) 17,204,395
----------- ----------- -----------
Increase (decrease) in cash and cash equivalents ..... 1,673,494 (7,203,179) 7,097,870
Cash and cash equivalents at beginning of period...... 1,191,428 8,394,607 1,296,737
----------- ----------- -----------
Cash and cash equivalents at end of period ........... $ 2,864,922 $ 1,191,428 $ 8,394,607
=========== =========== ===========
SEE ACCOMPANYING NOTES.
40
ROCHESTER MEDICAL CORPORATION
NOTES TO FINANCIAL STATEMENTS
SEPTEMBER 30, 1998
1. BUSINESS ACTIVITY
Rochester Medical Corporation (the "Company") develops, manufactures and
markets innovative urinary continence care products for urinary dysfunction
management and urine drainage management. The Company currently manufactures and
markets a broad line of functionally and technologically enhanced latex-free
versions of standard continence care products, including male external
catheters, Foley catheters and intermittent catheters. The Company is also
developing innovative and technologically advanced products designed to provide
clinically and commercially attractive solutions to continence care needs.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
CASH EQUIVALENTS
The Company considers all highly liquid investments with a remaining
maturity of three months or less when purchased to be cash equivalents.
MARKETABLE SECURITIES
Marketable securities are classified as available for sale and consist of
U.S. Treasury Bills and certificates of deposit. At September 30, 1998 and 1997,
the market value of marketable securities approximates cost.
MANUFACTURING AND SALES
The Company manufactures and sells its products to a full range of
companies in the medical industry on a worldwide basis. There is a concentration
of sales to larger medical wholesalers and distributors. The Company performs
periodic credit evaluations of its customers' financial condition. The Company
requires irrevocable letters of credit on sales to certain foreign customers.
Receivables generally are due within 30 days. Credit losses relating to
customers consistently have been within management expectations.
INVENTORIES
Inventories, consisting of material, labor and manufacturing overhead, are
stated at the lower of cost or market. Cost is determined by the first-in,
first-out (FIFO) method.
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost less accumulated depreciation.
Depreciation is based on estimated useful lives of 4 - 35 years computed using
the straight-line method.
PATENTS
Capitalized costs include costs incurred in connection with making patent
applications for the Company's products and are amortized on a straight-line
basis over eight years. The Company periodically reviews its patents for
impairment of value. Any adjustment from the analysis is charged to operations.
RESEARCH AND DEVELOPMENT COSTS
Research and development costs are charged to operations as incurred.
Research and development costs include clinical testing costs, certain salary
and related expenses, other labor costs, materials and an allocation of certain
overhead expenses.
INCOME TAXES
Income taxes are accounted for under the liability method.
STOCK-BASED COMPENSATION
The Company follows Accounting Principles Board Opinion No. 25, "Accounting
for Stock Issued to Employees" ("APB 25"), and related interpretations in
accounting for its stock options.
41
ROCHESTER MEDICAL CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Under APB 25, when the exercise price of stock options equals the market price
of the underlying stock on the date of grant, no compensation expense is
recognized.
The Company has adopted the disclosure-only provisions of Statement of
Financial Accounting Standards No 123, "Accounting for Stock-Based
Compensation".
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates.
IMPAIRMENT OF LONG-LIVED ASSETS
The Company will record impairment losses on long-lived assets used in
operations when indicators of impairment are present and the undiscounted cash
flows estimated to be generated by those assets are less than the assets'
carrying amount.
NET LOSS PER SHARE
Net loss per share is computed using the weighted average number of common
shares outstanding during the period. Common equivalent shares from stock
options and convertible debt are excluded from the computation as their effect
is antidilutive. In February 1997, the Financial Accounting Standards Board
(FASB) issued FASB Statement No. 128, "Earnings Per Share." This statement
replaces the presentation of primary earnings per share (EPS) with basic EPS and
also requires dual presentation of basic and diluted EPS for entities with
complex capital structures. This statement was adopted in fiscal 1998. For the
years ended September 30, 1998, 1997 and 1996 there is no difference between the
basic loss per share under Statement No. 128 and net loss per share as reported.
IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS
In June 1997, the Financial Accounting Standards Board ("FASB") issued FASB
Statement No. 130 "Reporting Comprehensive Income," which establishes standards
for the reporting and display of comprehensive income and its components in the
financial statements. The FASB also issued FASB Statement No. 131, "Disclosures
about Segments of an Enterprise and Related Information," which significantly
changes the way segment information is reported in annual financial statements
and also requires selected segment information in interim financial reports to
shareholders. Both statements are effective for fiscal years beginning after
December 15, 1997 and, based on current circumstances, the Company does not
believe the effect of adoption is material to the financial statements.
3. ADVERTISING COSTS
The Company incurred advertising expenses of $414,000, $185,000, and
$151,000 for the years ended September 30, 1998, 1997 and 1996, respectively.
All advertising costs are charged to operations as incurred.
42
ROCHESTER MEDICAL CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
4. INVENTORIES
Inventories are summarized as follows:
SEPTEMBER 30,
--------------------------
1998 1997
---------- ----------
Raw materials ....................................... $1,351,628 $1,019,021
Work-in-process ..................................... 630,945 504,120
Finished goods ...................................... 277,059 222,592
Reserve for inventory obsolescence .................. (50,033) (92,000)
---------- ----------
$2,209,599 $1,653,733
========== ==========
5. SHAREHOLDERS' EQUITY
STOCK OPTIONS
In August 1998, the 1991 Stock Option Plan (the Plan) was amended to
increase by 300,000 shares the number of shares authorized for issuance to
1,000,000 shares, subject to shareholder ratification at the Company's 1999
Annual Meeting. Under terms of the Plan, the Board of Directors may grant
employee incentive stock options equal to fair market value of the Company's
Common Stock or employee non-qualified options at a price which cannot be less
than 85% of the fair market value. Automatic non-employee director options are
also covered under the Plan, under which 1,000 shares are granted at fair market
value to non-employee directors on the date of each of the Company's Annual
Meetings.
The 1995 Non-Statutory Stock Option Plan authorizes the issuance of up to
50,000 shares of Common Stock. In September 1995, Medical Advisory Board members
were granted options to purchase 12,000 shares of the Company's Common Stock at
an exercise price of $15.75 per share.
Option activity is summarized as follows:
SHARES WEIGHTED AVERAGE
RESERVED OPTIONS EXERCISE PRICE
FOR GRANT OUTSTANDING PER SHARE
--------- ----------- ----------------
Balance as of September 30, 1995 ......... 133,500 216,500 $ 8.35
Options granted .......................... (253,000) 253,000 14.32
Increase in authorized shares ............ 400,000 -- --
-------- -------
Balance as of September 30, 1996 ......... 280,500 469,500 11.57
Options granted .......................... (79,000) 79,000 17.26
Options exercised ........................ -- (6,000) 11.42
Options canceled ......................... 7,500 (7,500) 15.70
-------- -------
Balance as of September 30, 1997 ......... 209,000 535,000 12.35
Options granted .......................... (226,000) 226,000 14.90
Options exercised ........................ -- (11,000) 12.07
Options canceled ......................... 27,000 (27,000) 14.13
Increase in authorized shares ............ 300,000 -- --
-------- -------
Balance as of September 30, 1998 ......... 310,000 723,000 $ 13.09
======== =======
The weighted average fair value of options granted in 1998 and 1997 was
$6.87 and $6.62 per share, respectively. The exercise price of options
outstanding at September 30, 1998 ranged from $6.75 to $20.00 per share as
summarized in the following table:
43
ROCHESTER MEDICAL CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
5. SHAREHOLDERS' EQUITY (CONTINUED)
WEIGHTED AVERAGE
NUMBER REMAINING NUMBER WEIGHTED AVERAGE
OUTSTANDING CONTRACTUAL EXERCISABLE EXERCISE PRICE
RANGE OF EXERCISE PRICES AT 9/30/98 LIFE AT 9/30/98 PER SHARE
- -------------------------- ----------- ---------------- ----------- ----------------
$6.75 - $10.75............ 199,000 4.8 years 144,000 $ 7.85
13.00 - 14.75 ............ 323,000 8.2 years 126,500 13.77
15.38 - 20.00 ............ 201,000 8.4 years 34,000 17.17
------- -------
723,000 7.1 years 304,500 $ 11.35
======= =======
The number of stock options exercisable at September 30, 1998, 1997 and
1996 was 192,750, 105,625 and 32,750 at a weighted average exercise price of
$10.60, $9.75 and $8.69 per share, respectively.
The Company has elected to follow Accounting Principles Board Opinion No.
25, Accounting for Stock Issued to Employees ("APB 25") and related
interpretations in accounting for its employee stock options because, as
discussed below, the alternative fair value accounting provided under FASB
Statement No. 123, "Accounting for Stock-Based Compensation" ("Statement 123"),
requires use of option valuation models that were not developed for use in
valuing employee stock options. Under APB 25, when the exercise price of the
Company's employee stock options equals the market price of the underlying stock
on the date of grant, no compensation expense is recognized.
Pro forma information regarding net loss and loss per share is required by
Statement 123, and has been determined as if the Company had accounted for its
employee stock options under the fair value method of Statement 123. The fair
value of these options was estimated at the date of grant using the
Black-Scholes option pricing model with the following weighted average
assumptions: risk-free interest rate of 5.5%; volatility factor of the expected
market price of the Company's common stock of .342 and a weighted average
expected life of the option of seven years.
The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options which have no vesting restrictions
and are fully transferable. In addition, option valuation models require the
input of highly subjective assumptions. Because the Company's employee stock
options have characteristics significantly different from those of traded
options, and because changes in the subjective input assumptions can materially
affect the fair value estimate, in management's opinion, the existing models do
not necessarily provide a reliable single measure of the fair value of its
employee stock options.
For purposes of pro forma disclosures, the estimated fair value of the
options is amortized to expense over the option's vesting period. The Company's
pro forma information is as follows:
YEAR ENDED SEPTEMBER 30,
---------------------------------------------------
1998 1997 1996
------------- ------------- -------------
Pro forma net loss .......................... $ (2,408,949) $ (2,209,749) $ (1,429,168)
Pro forma net loss per common share ......... $ (.47) $ (.53) $ (.37)
These pro forma amounts may not be indicative of future years' amounts
since the statement provides for a phase in of option values beginning with
those granted in fiscal 1996.
WARRANTS
In connection with the November 1995 public offering, the Company sold to
the underwriters for a nominal purchase price five-year warrants to purchase
75,000 shares of Common Stock at $14.85 per share. The warrants can be exercised
any time through November 2000.
44
ROCHESTER MEDICAL CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
6. INCOME TAXES
Deferred income taxes are due to temporary differences between the carrying
values of certain assets and liabilities for financial reporting and income tax
purposes. Significant components of deferred income taxes are as follows:
SEPTEMBER 30,
------------------------------
1998 1997
------------ ------------
Deferred assets:
Net operating loss ........................... $ 3,496,000 $ 2,710,000
Allowance for uncollectible accounts ......... 17,000 21,000
Inventory reserves ........................... 17,000 31,000
Inventory capitalization ..................... 46,000 --
Accrued expenses ............................. 31,000 17,000
------------ ------------
Subtotal ..................................... 3,607,000 2,779,000
Deferred liability:
Depreciation and amortization ................ 350,000 318,000
------------ ------------
Net deferred income tax assets ............... 3,257,000 2,461,000
Valuation allowance .......................... (3,257,000) (2,461,000)
------------ ------------
Net deferred income taxes .................... $ -- $ --
============ ============
The Company will be subject to federal income taxes when operations become
profitable. The Company's tax operating loss carryforwards of approximately
$10,283,000 can be carried forward to offset future taxable income, may be
limited due to changes in ownership under the net operating loss limitation
rules, and expire in years 2005 through 2013.
7. LONG-TERM DEBT
Long-term debt consisted of a $3,000,000 convertible loan and accrued
interest with ConvaTec (see Note 10). The loan was unsecured and was due August
11, 2000. Interest on the loan was payable at a rate of 9.75% at maturity
together with the principal amount. On September 30, 1997, the Company repaid
the note and accrued interest in its entirety.
8. LEASES
Rent expense from operating leases for the years ended September 30, 1998,
1997, and 1996 was $7,000, $69,000, and $60,000, respectively.
9. RELATED PARTY TRANSACTIONS
The Company's corporate legal counsel is the brother-in-law of the CEO and
President, the Vice President of Operations and of a member of the board of
directors of the Company. During the years ended September 30, 1998, 1997, and
1996, the Company incurred legal fees and expenses of approximately $71,000,
$90,000, and $83,000, respectively, to such counsel for services rendered in
connection with litigation and for general legal services. Management believes
the fees paid for the services rendered to the Company were on terms at least as
favorable to the Company as could have been obtained from an unrelated party.
The chairman and chief executive officer of Mentor Corporation is the
brother of the CEO and President, the Vice President of Operations, and a member
of the board of directors of the Company.
The Company entered into an agreement with Halcon, Inc. to purchase office
furniture valued at $406,000. During the years ended September 30, 1998, 1997
and 1996, payments made under this agreement were $4,000, $316,000 and $86,000,
repectively. The chief executive officer of
45
ROCHESTER MEDICAL CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
9. RELATED PARTY TRANSACTIONS (CONTINUED)
Halcon, Inc. is a director of the Company and the brother of the CEO and
President and the Vice President of Operations of the Company. Management
believes that the terms of the agreement are at least as favorable to the
Company as could have been obtained from an unrelated party.
The Company contracts with Petersen Blacksmith Company for the fabrication
of customized, proprietary manufacturing equipment used in the Company's
automated production lines. During 1998, 1997 and 1996, the Company paid
Peterson Blacksmith Company the sum of $230,997, $252,161 and $12,199,
respectively. Michael Petersen, the proprietor of Petersen Blacksmith Company,
is the brother-in-law of a Director and Vice President, Research and Development
of the Company. Management believes that the terms of the agreement are at least
as favorable to the Company as could have been obtained from an unrelated party.
10. CONVATEC AGREEMENT
On August 11, 1995, the Company entered into a Distribution and
Co-Development Agreement (the "Distribution Agreement") with ConvaTec, a
division of E.R. Squibb & Sons, Inc., a wholly-owned subsidiary of Bristol-Myers
Squibb Company ("ConvaTec"), for the purpose of marketing and distributing the
Company's incontinence and urological devices. Under the Distribution Agreement,
the Company has granted ConvaTec, subject to obligations and limitations imposed
by the Company's other distribution agreements, worldwide rights to market the
Company's current products and products in development. The Company is obligated
to offer ConvaTec rights of first and last refusal to market all products
developed after the date of the Distribution Agreement. Under the Distribution
Agreement, the Company retains worldwide marketing rights to its products under
the Rochester Medical brand.
In April 1998, the Company and ConvaTec entered into a Revised and Restated
Distribution Agreement (the "Revised Agreement") which grants ConvaTec limited
territorial rights to market certain of the Company's standard male external
catheter and Foley catheter products under the Convatec name. In addition to
retaining worldwide marketing rights for Rochester Medical brand products, the
Revised Agreement provides the Company exclusive marketing rights for its
advanced products and products in development.
11. SIGNIFICANT CUSTOMERS
Significant customers, measured as a percentage of sales, are summarized as
follows:
SEPTEMBER 30,
-------------------------
1998 1997 1996
------ ------ ------
Significant customers:
ConvaTec ....................... 25% 24% 12%
Hollister ...................... 7 10 12
Mentor ......................... 21 30 29
-- -- --
Total ............................ 53% 64% 53%
== == ==
In May 1998, Mentor advised the Company of its intention to manufacture its
own silicone male external catheters under the royalty-free license it holds
from the Company, but has not specified an effective date for terminating
purchases from the Company.
46
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS
Incorporated herein by reference to portions of the Proxy Statement for
Annual Meeting of Shareholders to be filed with the Securities and Exchange
Commission within 120 days of the close of the fiscal year ended September 30,
1998.
ITEM 10A. EXECUTIVE OFFICERS OF THE COMPANY
The executive officers and directors of the Company are as follows:
NAME AGE POSITION
- ------------------------- --- -----------------------------------------------
Anthony J. Conway 54 Chairman of the Board, Chief Executive Officer,
President and Secretary
Philip J. Conway 42 Vice President, Operations and Director
Richard D. Fryar 51 Vice President, Research and Development and
Director
Brian J. Wierzbinski 40 Chief Financial Officer, Treasurer and Director
Randy C. Dennis 45 Vice President, Marketing and Sales
Darnell L. Boehm(1)(2) 50 Director
Peter R. Conway 44 Director
Roger W. Schnobrich(1)(2) 68 Director
- ------------------
(1) Member of the Compensation Committee of the Board of Directors.
(2) Member of the Audit Committee of the Board of Directors.
ANTHONY J. CONWAY, a founder of the Company, has served as Chairman of the
Board, Chief Executive Officer, President and Secretary of the Company since May
1988. In addition to his duties as Chief Executive Officer, Mr. Anthony Conway
actively contributes to the Company's research and development and design
activities. From 1979 to March 1988, he was President, Secretary and Treasurer
of Arcon Corporation ("Arcon"), a company that he co-founded in 1979 to develop,
manufacture and sell latex-based male external catheters and related medical
devices. Prior to founding Arcon, Mr. Anthony Conway worked for twelve years for
International Business Machines Corporation ("IBM") in various research and
development capacities. Mr. Anthony Conway is one of the named inventors on
numerous patent applications that have been assigned to the Company, of which to
date 14 have resulted in issued United States patents.
PHILIP J. CONWAY, a founder of the Company, has served as Vice President,
Operations and as a director of the Company since May 1988. Mr. Philip Conway is
responsible for overseeing plant design and operation, and is also active in the
Company's research and development and design activities. From 1979 to March
1988, Mr. Philip Conway served as Plant and Production Manager of Arcon, a
company that he co-founded. Prior to joining Arcon, Mr. Philip Conway was
employed in a production supervisory capacity by AFC Corp., a manufacturer and
fabricator of fiberglass plastics and other composite materials. He is one of
the named inventors on numerous patent applications that have been assigned to
the Company, of which to date 14 have resulted in issued United States patents.
RICHARD D. FRYAR, a founder of the Company, has served as Vice President,
Research and Development and as a director of the Company since May 1988. Mr.
Fryar is responsible for overseeing the Company's research and development and
regulatory affairs activities. From 1984 to March 1988, Mr. Fryar was employed
by Arcon, a company that he co-founded, in research and development capacities.
From 1969 to 1984, he was employed by IBM in various research and
47
development capacities. He is one of the named inventors on numerous patent
applications that have been assigned to the Company, of which to date 14 have
resulted in issued United States patents.
BRIAN J. WIERZBINSKI has served as the Company's Chief Financial Officer
since February 1996, with principal responsibility for management of the
Company's financial and administrative affairs. From 1986 until joining the
Company in 1996, Mr. Wierzbinski was employed in various financial management
capacities by Ecolab Inc., most recently as Asia Pacific Vice President,
planning and control. Prior to joining Ecolab Inc., Mr. Wierzbinski was employed
for six years in various audit and audit management capacities by KPMG Peat
Marwick. Mr. Wierzbinski is a certified public accountant.
RANDY C. DENNIS has served as the Company's Vice President of Marketing and
Sales since July 1998, with principal responsibility for management of the
Company's marketing and sales activities. From 1989 until joining the Company in
1998, Mr. Dennis was employed by Lake Region Manufacturing, Inc., a medical
device manufacturer, most recently as Vice President of Marketing and Sales.
From 1979 to 1989, he was employed in various marketing and sales capacities
with, respectively, Medtronic Inc., Mallinkrodt, Inc., and Penwalt Corporation.
DARNELL L. BOEHM has served as a director of the Company since October
1995. Since 1986, Mr. Boehm has served as a Director and the Chief Financial
Officer and Secretary of Aetrium, Inc., a manufacturer of electromechanical
equipment for handling and testing semiconductor devices. From October 1988 to
March 1993, Mr. Boehm served as the Acting President of Genesis Labs, Inc., a
manufacturer of medical diagnostic products. He is also the principal of Darnell
L. Boehm & Associates, a management consulting firm.
PETER R. CONWAY has served as a director of the Company since May 1988. He
has been a director and the Chairman and Chief Executive officer of Halcon
Corporation, a manufacturer of quality office furniture, of which he was a
co-founder, since 1978. From 1979 to 1985, Mr. Peter Conway served as a director
of Arcon.
ROGER W. SCHNOBRICH has served as a director of the Company since October
1995. Mr. Schnobrich has been a partner with the law firm of Hinshaw &
Culbertson since 1997. Prior to joining Hinshaw & Culbertson, Mr. Schnobrich
was a partner in the law firm of Popham, Haik, Schnobrich and Kaufman Ltd. for
more than five years. Mr. Schnobrich serves as a director of Developed
Technology Resource Inc., a company that invests in business, technology and
infrastructure in the former Soviet Union.
Messrs. Anthony J. Conway, Philip J. Conway and Peter R. Conway are
brothers.
The Compensation Committee of the Board of Directors has power and
authority to recommend compensation for the Company's executive officers. The
Audit Committee has oversight over the process of auditing the Company's
internally prepared financial statements, and is charged with reviewing any
potential conflicts of interest. Mr. Anthony J. Conway serves ex officio as a
member of each committee.
ITEM 10B. COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT
Incorporated herein by reference to portions of the Proxy Statement for
Annual Meeting of Shareholders to be filed with the Securities and Exchange
Commission within 120 days of the close of the fiscal year ended September 30,
1998.
ITEM 11. EXECUTIVE COMPENSATION
Incorporated herein by reference to portions of the Proxy Statement for
Annual Meeting of Shareholders to be filed with the Securities and Exchange
Commission within 120 days of the close of the fiscal year ended September 30,
1998.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Incorporated herein by reference to portions of the Proxy Statement for
Annual Meeting of Shareholders to be filed with the Securities and Exchange
Commission within 120 days of the close of the fiscal year ended September 30,
1998.
48
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Incorporated herein by reference to portions of the Proxy Statement for
Annual Meeting of Shareholders to be filed with the Securities and Exchange
Commission within 120 days of the close of the fiscal year ended September 30,
1998.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a)(1) The following financial statements are filed herewith in Item 8.
(i) Balance Sheets as of September 30, 1998 and 1997.
(ii) Statements of Operations for the years ended September 30, 1998,
1997 and 1996.
(iii) Statement of Shareholders' Equity for the years ended September
30, 1996 and 1995.
(iv) Statements of Cash Flows for the years ended September 30, 1998,
1997 and 1996.
(v) Notes to financial statements at September 30, 1998.
(a)(2) Financial Statement Schedule. None
(b) Exhibits
The following exhibits are submitted herewith:
3.1 Articles of Incorporation of the Company, as amended.
(Incorporated by reference to Exhibit 4.1 of Registrant's
Registration Statement on Form S-2, Registration Number
33-97788).
3.2 Restated Bylaws of the Company. (Incorporated by reference to
Exhibit 3.2 of Registrant's Registration Statement on Form S-18,
Registration Number 33-36362-C).
3.3 Amendment to Restated Bylaws of the Company. (Incorporated by
reference to Exhibit 4.3 of Registrant's Registration Statement
on Form S-2, Registration Number 33-97788).
4.1 Specimen of Common Stock Certificate. (Incorporated by reference
to Exhibit 4.4 of Registrant's Annual Report on Form 10-KSB for
fiscal year ended September 30, 1995.
4.2 The Company's 1991 Stock Option Plan as amended (Incorporated by
reference to Exhibit 4.5 of Registrant's Registration Statement
on Form S-8, Registration Number 333-10261.
4.3 Amendment to the Company's 1991 Stock Option Plan as amended.*
10.1 Employment Agreement, dated August 31, 1990 between the Company
and Anthony J. Conway. (Incorporated by reference to Exhibit
10.13 of Registrant's Registration Statement on Form S-18,
Registration Number 33-36362-C).
10.2 Employment Agreement, dated August 31, 1990 between the Company
and Philip J. Conway. (Incorporated by reference to Exhibit
10.14 of Registrant's Registration Statement on Form S-18,
Registration Number 33-36362-C).
10.3 Change of Control Agreement dated December 4, 1998, between the
Company and Philip J. Conway.*
10.4 Employment Agreement, dated August 31, 1990 between the Company
and Richard D. Fryar. (Incorporated by reference to Exhibit
10.15 of Registrant's Registration Statement on Form S-18,
Registration Number 33-36362-C).
10.5 Change of Control Agreement dated December 4, 1998, between the
Company and Richard D. Fryar.*
49
10.6 Employment Agreement dated February 1, 1996 between the Company
and Brian J. Wierzbinski. (Incorporated by reference to Exhibit
10.10 to Registrant's Annual Report on Form 10-KSB for the
fiscal year ended September 30, 1996).
10.7 Change of Control Agreement dated December 4, 1998, between the
Company and Brian J. Wierzbinski.*
10.8 Employment Agreement dated July 6, 1998 between the Company and
Randy C. Dennis.*
10.9 Change of Control Agreement dated December 4, 1998, between the
Company and Randy C. Dennis.*
10.10 Male External Catheter License, Sales and Distribution Agreement
dated April 24, 1991, between the Company and Mentor
Corporation. (Incorporated by reference to Exhibit 10.7 of
Registrants Registration Statement on Form S-1, Registration
Number 33-40934).
10.11 Amended UF Catheter Exclusive OEM/Private Label Agreement dated
March 18, 1994, between the Company and Hollister Incorporated.
(Incorporated by reference to Exhibit (a)(i) of Registrant's
Quarterly Report on Form 10-QSB for the quarter ended March 31,
1994).
10.12 First Amendment to Amended UF Catheter Exclusive OEM/Private
Label Agreement dated May 7, 1997, between the Company and
Hollister Incorporated. (Incorporated by reference to Exhibit
10.13 of Registrant's Quarterly Report on Form 10-Q for the
quarter ended June 30, 1997).
10.13 Revised and Restated Distribution Agreement, dated as of May 6,
1998, between the Company and E. R. Squibb & Sons, Inc. (through
its ConvaTec division). (Incorporated by reference to Exhibit
10.17 of Registrant's Quarterly Report on Form 10-Q for the
quarter ended March 31, 1998).
23 Consent of Ernst & Young LLP.*
27 Financial Data Schedule.*
- ------------------
* Filed herewith.
(c) Registrant filed no Report on Form 8-K during its fourth fiscal
quarter.
50
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Exchange Act,
the registrant has caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized on this 17th day of December, 1998.
ROCHESTER MEDICAL CORPORATION
By: /s/ ANTHONY J. CONWAY
------------------------------------
Anthony J. Conway
PRESIDENT
Pursuant to the requirements of the Exchange Act, this Report has been
signed below by the following persons in the capacities and on the dates
indicated.
/s/ ANTHONY J. CONWAY Dated December 17, 1998
--------------------------------
Anthony J. Conway
Chairman of the Board, President and Director
(Principal Executive Officer)
/s/ BRIAN J. WIERZBINSKI Dated December 17, 1998
--------------------------------
Brian J. Wierzbinski
Chief Financial Officer, Treasurer and Director
(Principal Financial Officer)
/s/ DARNELL L. BOEHM Dated December 17, 1998
--------------------------------
Darnell L. Boehm, a Director
/s/ PETER R. CONWAY Dated December 17, 1998
--------------------------------
Peter R. Conway, a Director
/s/ PHILIP J. CONWAY Dated December 17, 1998
--------------------------------
Philip J. Conway, a Director
/s/ RICHARD D. FRYAR Dated December 17, 1998
--------------------------------
Richard D. Fryar, a Director
/s/ ROGER W. SCHNOBRICH Dated December 17, 1998
--------------------------------
Roger W. Schnobrich, a Director
51
INDEX TO EXHIBITS
EXHIBIT PAGE
- ------- ----
4.3 Amendment to Stock Option Plan .......................................
10.3 Change of Control Agreement dated December 4, 1998 between the Company
and Philip J. Conway ................................................
10.5 Change of Control Agreement dated December 4, 1998 between the Company
and Richard D. Fryar. ...............................................
10.7 Change of Control Agreement dated December 4, 1998 between the Company
and Brian J. Wierzbinski. ...........................................
10.8 Employment Agreement dated July 6, 1998, between the Company and Randy
C. Dennis ...........................................................
10.9 Change of Control Agreement dated December 4, 1998 between the Company
and Randy C. Dennis .................................................
23 Consent of Ernst & Young LLP .........................................
27 Financial Data Schedule ..............................................