UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended September 30, 1996
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ___________to _________
Commission file number 2-93826-W
CHEUNG LABORATORIES, INC.
(Exact name of registrant as specified in its charter)
Maryland 52-1256615
State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization
10220-I Old Columbia Road
Columbia, Maryland 21046-1705
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (410) 290-5390
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $.01 per share
--------------------------------------
(Title of Class)
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K (ss. 229.405 of this chapter) is not contained
herein, and will not be contained, to the best of Registrant's knowledge, in
definitive proxy or information statements incorporated by reference in Part III
of this Form 10-K or any amendment to this Form 10-K. [ ]
As of November 22, 1996, 25,206,360 shares of the Registrant's Common
Stock were issued and outstanding. As of November 22, 1996, the aggregate market
value of voting stock held by nonaffiliates of the Registrant was approximately
$7,977,252 based on the average of the closing bid and asked prices for the
Registrant's Common Stock as quoted NASD OTC Bulletin Board.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the following documents are incorporated by reference in this
Report on Form 10-K: None.
PART I
ITEM 1. BUSINESS
The Company
Overview
Cheung Laboratories, Inc. ("CLI" or the "Company") was incorporated in
the State of Maryland in 1982 under the name A.Y. Cheung Associates, Inc. The
Company changed its name to Cheung Laboratories, Inc. on June 31, 1984. CLI is
engaged in developing and marketing minimally invasive medical devices and
systems utilized in the treatment of cancer and in the treatment of
genitourinary diseases associated with benign growth of the prostate in older
males, the most common being benign prostatic hyperplasia ("BPH"). The Company
has recently acquired the right to use technologies which the Company believes
have the potential to significantly enhance the capabilities of both its cancer
and BPH treatment systems.
The Company's current cancer treatment system is the Microfocus 1000,
which is designed to increase the efficacy of existing cancer treatment
modalities, including external beam radiation, interstitial radiation,
brachytherapy and chemotherapy. The Microfocus 1000 utilizes proprietary
microwave technology to preferentially heat the cancerous area to a temperature
sufficient to cause cell death in the cancerous cells. Because healthy cells are
not as susceptible to heat as cancerous cells, they can survive the
thermotherapy. The treatment is currently utilized primarily on surface cancers.
The Microfocus 1000 also utilizes licensed patented technology which the Company
calls Direct Coupling Technology ("DCT"). The DCT allows the Microfocus 1000 to
air cool the body surface while applying the heat. The Microfocus 1000 has Food
and Drug Administration ("FDA") premarket approval ("PMA") and has been
marketed by the Company since 1989.
The Company recently acquired an exclusive license to use three patents
involving a technology known as Adaptive Phased Array ("APA") from the
Massachusetts Institute of Technology ("MIT"). APA technology was originally
developed for use in microwave radar systems for the U.S. Department of Defense
to track targets and to nullify the energy beam from enemy jamming equipment.
The Company is incorporating the APA technology into a device based on the
current Microfocus 1000 which is currently designated as the Microfocus APA (the
"Microfocus APA"). Based upon information currently available, the Company
believes the Microfocus APA will allow focusing microwave heat on target tumors
inside the body and will nullify undesired heat induced in healthy tissue. The
current thermotherapy systems, including the Microfocus 1000, are useful only on
superficial cancers. The Microfocus APA will allow thermotherapy treatment to be
administered to malignant tumors deep within the body such as lung, pancreatic,
breast and prostate cancer. It will be minimally invasive in that one or more
thin catheters will be inserted into the tumor and surrounding area to
facilitate the placement of sensors and a temperature probe. The sensor acts as
a guidance center which generates feedback signals to the system to make
adjustment in order to maintain the focus of heat within the tumor even if a
patient moves his or her position. The temperature probe maintains proper
temperature within the tumor and surrounding areas. The Company is in the
engineering stage to develop the commercial applications of the APA technology.
The Company is required to seek an investigational device exemption ("IDE") from
the FDA to begin patient studies in the United States. Data from such studies
will used to seek PMA which must be received prior to commercial distribution of
the Microfocus APA in the United States.
The Company's BPH systems currently include the Microfocus 800, 500C, 100C
and 100 (collectively "Microfocus System") which are all designed to treat BPH.
The Microfocus 800 is the most current design and is targeted for use by private
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urologists in their offices. The procedure utilizes a non-surgical
catheter-based therapy that incorporates proprietary microwave technology and is
designed to preferentially heat diseased areas of the prostate to a temperature
sufficient to cause cell death in those areas. The Company does not have an IDE
or PMA on the Microfocus System and it is therefore not currently available for
commercial distribution in the United States. The Microfocus System is
manufactured in Canada and is approved for export from Canada.
The Microfocus System is a thermotherapy system which utilizes
transurethral and transrectal applicators to deliver heat directly to diseased
portions of the prostate. CLI has conducted preclinical evaluations on its
Microfocus System and is now waiting for protocol from its principal
investigator to obtain data for the filing of an IDE with the FDA to allow
restricted sales of systems to hospitals in the United States. This procedure is
required to place the Microfocus System in hospitals within the United States
and gather clinical data for safety and efficacy demonstrations. Such
demonstrations are necessary to obtain a PMA from the FDA for commercialization
in the United States. The Microfocus System is currently sold outside of the
United States.
The Company has recently acquired by license patented compression
technology from MMTC, Inc. ("MMTC") which is being incorporated into a device to
be utilized with the catheter used in the Microfocus System. The device consists
of a microwave antenna combined with a balloon mechanism which expands to
compress the walls of the urethra as the prostate is heated. The Company is in
the engineering stage to develop a commercial application of the technology. The
device will require the Company to seek an IDE and PMA from the FDA prior to any
commercial sales of the device in the United States.
The Company's objective is to establish itself as a leader in the
design, development, and marketing of clinically effective minimally-invasive
thermotherapy solutions for the treatment of cancer and for urological
disorders. To date, the Company has focused on marketing current products and,
other than for the Microfocus 1000, has not had the capital to seek governmental
approvals and complete commercialization of its technology. The focus will now
be expanded to integrate new technology recently acquired by the Company to
significantly expand the capabilities and market for its products and increase
efforts for FDA approval of all products. Key elements to achieve the broadened
strategy are to (i) develop products for the oncology market, (ii) focus on the
large and growing urology market, (iii) develop new marketing strategies and
relationships based upon selling services and sharing treatment revenue, (iv)
establish strategic partnerships, (v) maintain technological leadership and
protect technology advantages through patents and (vi) seek early regulatory
approvals in target markets.
Targeted Illnesses
The Company's products and potential products seek to treat cancer and
BPH.
a. Cancer. Historically, cancer has been treated by surgical intervention,
chemotherapy or radiation therapy. The Company's equipment for the treatment of
cancer is based upon a microwave thermotherapy system. Thermotherapy (also known
as hyperthermia), or heat therapy, has been used in medicine since antiquity. In
modern thermotherapy, a controlled heat dose is targeted to treatment sites
using microwave and/or other energy for therapeutic benefits. Thermotherapy is
effective in treating malignant tumors because these tumors cannot effectively
withstand the increased temperatures brought about by the thermotherapy
treatment, while normal tissue can withstand the higher temperatures. Because
cancerous tissue has poor blood circulation, its capacity to dissipate heat is
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less than that of normal tissue. As an adjuvant to surgery, thermotherapy is
used to decrease tumor mass and thereby facilitate its removal surgically. As an
adjuvant to radiation therapy, thermotherapy has been shown to be particularly
effective in killing cells which are resistant to radiation therapy.
Thermotherapy has also been shown to enhance the effectiveness of certain forms
of chemotherapy by killing cells in areas poorly served by the tumor's
circulatory system. In the case of both radiation therapy and chemotherapy,
thermotherapy may, in time, permit lower dosages and, therefore, reduced side
effects.
Thermotherapy can be administered to various anatomical sites through
local, regional or whole body administration. Local thermotherapy treatment may
be invasive (internal) or non-invasive (external). Invasive heating techniques,
in turn, may be interstitial (via implants into body tissue) or intracavitary
(via natural bodily orifice). Regional thermotherapy treatment is primarily
non-invasive, via external beam radiation. Whole body thermotherapy has been
effectively employed as an adjuvant to chemotherapy, but only by practitioners
skilled in the complex techniques which minimize the side affects of the
procedure.
Thermotherapy has been the subject of medical investigation and
commercial interest in the United States, Canada, Europe, and Asia for almost 25
years. Because of a well-documented biological rationale for the use of
thermotherapy as a tumor-shrinking agent, it was originally greeted with great
optimism by oncologists. This optimism was founded on many published reports
that thermotherapy enhanced the effectiveness of radiation by killing cells
exponentially as a function of temperature at temperatures greater than 42
degrees celsius maintained for certain minimal time periods, and selectively
killing S-phase and other radiation-resistant cells. Thermotherapy was also
found to enhance the effectiveness of chemotherapeutic agents through a variety
of mechanisms including increase in drug uptake, inhibition of repair
mechanisms, and temperature-dependent increases in drug activity.
The results of early clinical trials in the United States, however,
have been disappointing due to the lack of effective equipment. Most of the
equipment used in the past to heat the tumors was crudely designed. In many
instances, the equipment was thought to be able to heat large deep-seated tumors
when only small superficial tumors could in fact be heated.
Due to the initial hope associated with the use of thermotherapy to
treat cancer, many companies attempted to develop thermotherapy systems. Early
developers of thermotherapy equipment conducted phase III randomized studies in
the United States. These trials became known as the Radiation Therapy Oncology
Group 81-04 study (the "RTOG Study"). The results of the RTOG Study published in
1989 showed no clear treatment benefits when combining thermotherapy and
radiation therapy as compared to the radiation therapy alone. These study
results had a negative effect on thermotherapy use and research. Until the
recent publication of numerous European clinical trials reporting the
effectiveness of the thermotherapy as an adjuvant therapy to radiation, the RTOG
Study proved to be a difficult barrier to companies attempting to win market
acceptance for their FDA- approved thermotherapy devices. Despite the negative
RTOG Study, thermotherapy is currently used on a limited basis at oncology
centers in the United States, primarily for the treatment of superficial cancer.
In contrast to the use of thermotherapy in the United States, the use
of thermotherapy in Europe and Asia is more widespread both commercially and
clinically. Since 1993, numerous randomized clinical trials have reported that:
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o thermotherapy combined with radiation therapy doubles the
tumor complete response compared to radiation therapy alone;
and
o thermotherapy combined with chemotherapy doubles the tumor
complete response compared with chemotherapy alone.
Unlike radiation therapy or chemotherapy, which are highly toxic treatment
modalities, thermotherapy is relatively innocuous. For this reason,
thermoenhanced combination therapies are associated with little or no additional
patient morbidity or side effects. Nevertheless, the fundamental shortcoming of
existing thermotherapy equipment is the same everywhere: the inability to
achieve focused heating of deep tumors while sparing adjacent and intervening
normal tissue and skin. Despite 25 years of effort by engineers and clinicians,
the problem of targeting the cancerous tumor with the therapeutic agent (heat)
has not advanced far beyond what was possible at the beginning of the
thermotherapy "era." For this reason, the Company believes that the combination
of the thermotherapy treatment and the APA focusing technology for heating of
deep tumors constitutes a significant advance in the use of thermotherapy as a
cancer treatment.
b. Benign Prostatic Hyperplasia. BPH is a non-cancerous urological disease in
which the prostate enlarges and constricts the urethra. Symptoms associated with
BPH affect the quality of life of millions of sufferers worldwide and BPH can
lead to irreversible bladder or kidney damage. The prostate is a walnut-size
gland surrounding the male urethra that produces seminal fluid and plays a key
role in sperm preservation and transportation. As the prostate expands, it
compresses or constricts the urethra, thereby restricting the normal passage of
urine. This restriction of the urethra may require a patient to exert excessive
bladder pressure to urinate. Since the urination process is one of the body's
primary means of cleansing impurities, the inability to urinate adequately
increases the possibility of infection and bladder and kidney damage.
Because BPH is an age-related disorder, its incidence increases as the
population ages. As many as 27 million men between the age of 50 and 80 in the
United States alone suffer from BPH. As the population continues to age, the
number will continue to increase dramatically. Current estimates are that by the
age of 55, fifty percent of all men, and by 80, eighty percent of all men will
have BPH.
Like cancer, BPH historically has been treated by surgical intervention
or by drug therapy. As BPH progresses, the urethra passing through the prostate
constricts making urination difficult. The primary surgical treatment for BPH is
transurethral resection of the prostate ("TURP"), a procedure in which the
prostatic urethra and surrounding diseased tissue in the prostate are trimmed,
thereby widening the urethral channel for urine flow. While the TURP procedure
typically has been considered the most effective treatment available, the
procedure has many shortcomings which undermine its value. A significant number
of patients who undergo TURP encounter significant complications. These
complications can include painful urination, infection, impotence, incontinence
and excessive bleeding. Furthermore, the cost of the TURP procedure is also very
high, ranging from $8,000 to $12,000. Medicare alone spent $1 billion to cover
TURP procedures last year. This high cost also fails to reflect the cost of lost
work time and reduction in quality of life. Finally, the TURP procedure is time
consuming, requiring hospitalization for up to three days.
Other less radical surgical procedures are available in addition to the
TURP procedure. Interstitial RF Therapy and Laser Therapies employ concentrated
radiofrequency waves or laser radiation instead of a surgical knife. There is
minimal bleeding and damage to the urethra associated with these procedures.
However, the side effects and costs associated with surgery still remain.
5
Drug therapy has emerged as an alternative to surgery in the last
several years. There are several drugs available for BPH treatment, the two most
widely prescribed drugs being Hytrin and Proscar. Hytrin works by relaxing
certain involuntary muscles surrounding the urethra, thereby easing urinary flow
and Proscar is intended to actually shrink the enlarged gland. Drugs, however,
offer only modest relief and cost hundreds of dollars per year. In short,
neither the surgical nor the medicinal treatments available for BPH provide
satisfactory, cost-effective solutions to BPH.
With the limited effectiveness of BPH drugs and the cost and potential
side effects associated with surgery, the Company believes thermotherapy
provides a better alternative for the treatment of BPH. The Company further
believes the percentage of men with moderate to severe symptoms of the disease
who seek treatment will increase in the future as a result of increased consumer
knowledge of the disease and the development of treatments with less severe
complications and side effects than traditional treatments.
Cheung Laboratories Approach.
Cancer Treatment. The Company has received PMA from FDA for the use of
the Microfocus 1000 as an adjuvant to radiation therapy for surface and
subsurface cancer. The Company's clinical studies submitted to the FDA indicate
a better than 86% positive response rate which is the best among all competing
systems. However, the Microfocus 1000 still suffers from the limitations of
inability to focus deep and surface hot spots at undesirable locations. The
Company intends to utilize the licensed APA technology to improve the
performance of the Microfocus 1000. With added hardware and software, the
Company is in the development stage of a thermotherapy system capable of
focusing accurately and delivering repeatable microwave energy to induce
hyperthermia without undesirable hot spots within surface and subsurface tumors
such as breast tumors. With additional antenna and geometric configuration
design, and frequency modification, the Company hopes to develop thermotherapy
systems for deep seated tumors such as those located in the lung, prostate,
rectum, liver and pancreas. The Company now possesses the technology which it
believes will lead to the capability to develop and commercialize the next
generation of thermotherapy equipment which is capable of overcoming the
previous limitations of current thermotherapy systems, thus allowing the
realization of minimally invasive, non-toxic and side effect free treatment to
cancer.
BPH Treatment. The Microfocus patented technology further enhances the
therapeutic capabilities of the treatment by providing combined therapy of
compression and heat. Preclinical studies in phantoms and animal tissues
indicate the technology will not only provide long term clinical benefits as in
the case of other BPH systems but also immediate symptomatic relief which is
also necessary for most BPH patients.
Business Strategy
The Company's mission is to develop effective and clinically-practical
means of applying heat for therapeutic purposes. The Company's initial objective
will be the design, development and marketing of microwave-based treatments for
urological disorders, cancer and other diseases. The Company believes its depth
of experience and its relationship with third parties in technological,
manufacturing and marketing matters position the Company to exploit this market.
To meet this objective, the Company has identified the following actions upon
which the Company will focus its efforts:
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Enhancement of Benign Prostatic Treatments.
The technology licensed from MMTC allows the design of a catheter which
combines tissue compression with thermotherapy for BPH treatment. Such a
combination therapy is believed to be synergistically beneficial clinically
since compression may provide immediate urine obstruction relief and
thermotherapy produces long term symptom relief control resulting from shrinkage
of the benign growth. With this new technology, the Company believes that it
will be able to offer a new BPH treatment system superior to other commercially
available BPH thermotherapy devices.
Development of Specific Cancer Treatments.
The Microfocus APA is in the design stage and will be a patented breast
cancer thermotherapy system for the purpose of heating both primary ductal
tumors in compressed breast tissue as well as recurrent breast cancer (chest
wall) tumors. The compressed breast tissue geometry is desirable in a
thermotherapy treatment for four primary reasons:
o compressing the breast tissue to the range of 6 to 8
centimeters requires less penetration for microwaves;
o breast compression to a flat geometry allows a single
applicator design to treat a wide range of breast sizes;
o standard x-ray imaging techniques can be used with the breast
compression to accurately locate the tumor; and
o patient motion effects which could degrade the thermotherapy
treatment are minimized.
The amount of breast compression can be varied to accommodate patient
tolerance. When completed, the Company anticipates that the standard
breast-compression thermotherapy system will feature a phased array system using
dual-opposed applicators. If marketing studies determine that compression is
undesirable, the Company can design a somewhat more costly four-channel phased
array system that will deliver deep thermotherapy using an adaptive breast
cradle to immobilize but not compress the breast.
The Microfocus APA will later be modified to incorporate additional
patented technology licensed from MIT. This additional technology allows
deep-heating thermotherapy. A prototype of this system involving a monopole
annular phased array which would surround the patient is presently planned. The
adaptive phased array will be used to treat deep-seated tumors in organs like
prostate, liver, pancreas, rectum, and cervix. Rings of different sizes will
permit thermotherapy for other cancer sites such as the head, neck and limbs.
In addition, the APA technology will also allow the development of an
externally focused minimally invasive treatment system for prostate cancer.
Develop Technological Partnerships.
In addition to collaboration with MIT and MMTC, the Company is working
with, or anticipates working with various international and domestic
institutions to assist in the development and testing of new Microfocus
products. There is no assurance that such partnerships will develop.
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Marketing.
The Company intends to create a marketing and sales strategy to allow
it to become the market leader in the business of microwave thermotherapy
systems for treatment of cancer, BPH and other diseases. The Company will seek
to establish itself as the technology leader in the thermotherapy business and
form strategic marketing alliances with other partners to implement its
marketing and sales plan worldwide.
The Company believes its licensed proprietary technology will allow the
instrumentation of a new line of thermotherapy systems which will provide
significant benefits over existing products. The Company has retained a product
design firm in Chicago to coordinate the engineering of initial prototypes and
manufacturing of the final products. Working closely with clinicians, scientists
and the Company, the product designers will construct working prototypes for
clinical trials. The Company anticipates that such prototypes will result in
enhanced thermotherapy systems for manufacturing and marketing.
The Company further believes that with its licensed technologies, the
Company can develop clinical thermotherapy treatment systems capable of offering
minimally-invasive, effective non-toxic and side effect free treatment which
targets only the tumors in patients suffering from cancer, BPH and other
diseases. The Company is formulating a sale and distribution strategy based on
placements of systems in hospitals and clinics in order to derive profit from
sharing of patient treatment revenue.
In the cancer treatment market, the Company is developing the concept
of thermoenhanced combination treatment procedures which combine thermotherapy
with radiation therapy and/or chemotherapy. Thermotherapy treatment is used to
improve the efficacy of these existing treatments while decreasing system
toxicity. The Company plans to place Microfocus 1000 systems, and when available
Microfocus APA systems, in treatment centers at nominal costs to the centers
themselves and to share in treatment revenue.
The Company intends to re-engineer its Microfocus System to include the
MMTC technology, to create a second generation, versatile and low cost BPH
treatment system with the added capability of balloon compression and
minimally-invasive temperature sensing. With these new technologies, the Company
believes it can obtain governmental approval which will allow it to compete in
the new BPH treatment market recently created as a result of the FDA's approval
of the first microwave BPH treatment device, as well as the growing market of
prostate cancer treatment. The Company plans to market its lines of prostate
treatment systems by forming individual joint ventures with private
entrepreneurs and urologists to operate prostate treatment clinics. The Company
intends to derive most of its revenue from sharing treatment revenue rather than
from the initial sale of the systems.
Cheung Laboratories Product Description and Technology.
Cancer Treatment.
Microfocus 1000
The Company's Microfocus 1000 is manufactured at the Company's
headquarters from various components provided by suppliers. Some of the
components are modified by the Company or by the manufacturer at the Company's
direction. The Company considers there to be proprietary trade secret knowledge
involved in the manufacture of some of the components of the Microfocus 1000 and
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in the assembly of the components to form the Microfocus 1000. The Company has
taken what it considers appropriate steps to safeguard this proprietary
information. Other than its rights to use patents under license, the Company
does not have patents on any of the components of the Microfocus 1000 or on the
complete Microfocus 1000.
Competitors of the Company, particularly BSD Medical Corporation and
Labthermics Technologies, Inc., have obtained a number of patents on
thermotherapy products. The Company does not believe that the Microfocus 1000
infringes on any valid patents granted to others.
The Company expects to rely upon trade secrets, unpatented proprietary
know-how and technological innovation in maintaining the competitive position of
its Microfocus 1000. The Company intends to apply for patent protection for any
patentable product it may develop. The Company believes it possesses significant
proprietary knowledge relating to its hardware and software that are utilized in
connection with the Microfocus 1000. However, there can be no assurance that
competitors may not independently develop similar technology or that the Company
will be able to maintain the secrecy of its proprietary information. There can
also be no assurance that competitors will not claim that the Microfocus 1000 or
another Company product infringes on a patent held by such competitor. If an
owner of a patent were to assert an infringement of its patent(s) against the
Company, and the Company were ultimately determined to be infringing a valid and
enforceable patent, and if a license could not be obtained on a reasonable basis
from such patent owner or such products could not be re-designed so that they no
longer infringed the other patent(s), there could be a material adverse effect
on the Company's business.
The Microfocus 1000 has FDA premarket approval and has been marketed
since 1989. For the year ended September 30, 1996, the Company sold 0 Microfocus
1000 systems. Since obtaining the PMA, the Company has sold over 35 Microfocus
1000 systems worldwide.
Prostatic Treatment.
BPH Systems
CLI designed the Microfocus System for the treatment of BPH
("Microfocus Systems"). The four versions of the Microfocus System are the
Microfocus Models 800, 500C, 100C and 100. The Microfocus System is presently
being manufactured via a joint venture in Canada and sold in Europe and the Far
East. For the year ended September 30, 1996 the Company sold four (4) Microfocus
Systems, with sales from inception of the Company to date totalling over 75
Microfocus Systems.
CLI is conducting preclinical evaluations on its BPH systems to obtain
data for the filing of an IDE (Investigational Device Exemption) with the FDA to
allow restricted sales of systems to hospitals in the USA. The Company is
recently received the protocol from its principal investigator which will allow
the Company to proceed with its FDA approval efforts. This procedure is required
to place the BPH system in United States hospitals and gather clinical data for
safety and efficacy demonstrations. Such demonstrations are necessary to obtain
a PMA from the FDA for commercialization in the United States.
Patents and Proprietary Rights
The Company owns no patents. The Company has under license one U.S. patent
on the Microfocus 1000, three U.S. patents on the technology underlying the
Microfocus APA and one U.S. patent on the technology underlying the improved BPH
9
treatment system. The United States patents licensed to the Company claim
methods and devices which the Company believes are critical to providing safe
and efficacious treatment for cancer and BPH. One of the MIT patents as well as
the BPH patent also have or will have patent protection in a number of foreign
jurisdictions, including Canada and selected European nations.
The patents and the rights under which they are asserted are as
follows:
1. DCT Technology. The Company received an exclusive license to the use
of the DCT technology from Haim Bither Cancer Institute ("H.B.C.I."). The DCT
technology allows the Company to air cool the area being treated with
microwaves. The Company has no further obligations to maintain or preserve its
rights to use this patent. The Patent expires on May 31, 1999.
2. APA Technology. On June 12, 1996, the Company entered into a Patent
License Agreement with the Massachusetts Institute of Technology ("MIT"). The
terms of the license agreement have since been modified. Pursuant to the
license, the Company has the exclusive right to use the technology in breast,
head and neck and deep seated thermotherapy of other organs. Assuming certain
milestone criteria are met, the license will not expire until 10 years after the
first annual sale or use of the licensed technology or June 1, 2008, unless
further extended. The Company is obligated to pay a royalty to MIT based
principally upon treatment revenue.
3. BPH Balloon Therapy. On August 23, 1996 the Company entered into a
License Agreement with MMTC, Inc. ("MMTC"). Pursuant to the license, the Company
has the exclusive worldwide license to use microwave balloon catheters. The
license is perpetual unless certain events of default occur. The Company has
paid and is obligated to pay royalties and licensing fees. Failure to comply
with the payment obligations will allow MMTC to cancel the license.
There can be no assurance, however, that the patents being licensed
will offer any degree of protection from competitors. There can be no assurance
that any of the licensed patents or applications will not be challenged,
invalidated or circumvented in the future. In addition, there can be no
assurance that competitors, many of which have substantial resources and have
made substantial investments in competing technologies, will not seek to apply
for and obtain patents that will prevent, limit or interfere with the Company's
ability to make, use or sell products utilizing the patented technologies in the
United States or in international markets.
Other companies have developed or are in the process of developing
medical methods and devices to treat BPH and cancer with microwave energy.
Several companies have applied for, and in some cases received, patents related
to such medical methods and devices. The Company has not received any notices of
infringement from any other company.
The Company also relies on trade secrets and proprietary know-how,
which it seeks to protect, in part, through proprietary information agreements
with employees, consultants and other parties. The Company's proprietary
information agreements with its employees and most of its consultants contain
industry standard provisions requiring such individuals to assign to the
Company, without additional consideration, any inventions conceived or reduced
to practice while retained by the Company, subject to customary exceptions. The
Company's officers and other key employees also agree not to compete with the
Company for a period following termination. There can be no assurance that
proprietary information or non-compete agreements with employees, consultants
10
and others will not be breached, that the Company would have adequate remedies
for any breach, or that third parties will not nonetheless gain access to the
Company's technology.
Third Party Reimbursement
The Company believes that third party reimbursement will be essential
to commercial acceptance of the Microfocus 1000, the Microfocus APA and
Microfocus System procedures, and that overall cost effectiveness and physician
advocacy will be keys to obtaining such reimbursement. The Company believes that
the procedure can be performed for substantially lower total cost than surgical
treatments for BPH or cancer or continuous drug therapy. Consequently, the
Company believes that third party payers seeking procedures that provide quality
clinical outcomes at lower cost will help drive acceptance of the Company's
products.
The Company's strategy for obtaining reimbursement in the United States
is to obtain appropriate reimbursement codes and perform studies in conjunction
with clinical studies to establish the efficacy and cost effectiveness of the
its procedures as compared to surgical and drug treatments for BPH and cancer.
The Company plans to use this information when approaching health care payers to
obtain reimbursement authorizations. The Company also plans to work closely with
the medical community to establish an attractive relative value and
reimbursement level for the Microfocus procedure.
With the increasing use of managed care and capitation as a means to
control health care costs in the United States, the Company believes that
physicians may view the Company's products as a tool to efficaciously treat BPH
and cancer patients at a lower total cost, thus providing them with a
competitive advantage when negotiating managed care contracts. This is
especially important in the United States, where a significant portion of the
aging Medicare population is moving into a managed care system.
Following regulatory approval, physicians using the Company's Microfocus
1000 or, when completed, the Microfocus APA to treat cancer and the Microfocus
System to treat BPH will submit insurance claims for reimbursement for the
procedure to third party payers, such as Medicare carriers, Medicaid carriers,
Health Maintenance Organizations ("HMOs") and private insurers. In the United
States and in international markets, third party reimbursement is generally
available for existing therapies used to treat cancer and BPH. The availability
and level of reimbursement from such payors for the use of the Company's
Microfocus 1000 and the Microfocus System will be a significant factor in the
Company's ability to commercialize its cancer and BPH systems. The Company
believes that new regulations regarding third party reimbursement for certain
investigational devices in the United States will allow it to pursue early
reimbursement from Medicare with individual clinical sites prior to receiving
FDA approval. However, the Company believes that FDA approval will be necessary
to obtain a national coverage determination from Medicare. The national coverage
determination for third party reimbursement will depend on the determination of
the United States Health Care Financing Administration ("HCFA"), which
establishes national coverage policies for Medicare carriers, including the
amount to be reimbursed, for coverage of claims submitted for reimbursement
related to specific procedures. Private insurance companies and HMOs make their
own determinations regarding coverage and reimbursement based upon "usual and
customary" fees. Reimbursement experience with a particular third party payor
does not reflect a formal reimbursement determination by the third party payor.
There can be no assurance that the Company will receive favorable coding,
11
coverage and reimbursement determinations for its Microfocus System, Microfocus
1000, and when available, Microfocus APA from Medicare and other payers or that
amounts reimbursed to physicians for performing its procedure will be sufficient
to encourage physicians to use the Company's products.
Internationally, reimbursement approvals for the Microfocus procedure
will be sought on an individual country basis. Some international countries
currently have established reimbursement authorizations for transurethral
microwave therapy. Clinical studies and physician advocacy will be used to
support reimbursement requests in countries where there is currently no
reimbursement for such procedures.
Manufacturing
The Microfocus 1000 and the Microfocus System were designed to be
manufactured under FDA approved Good Manufacturing Procedures ("GMP").
Historically, the Company has manufactured and assembled the Microfocus 1000 in
its Columbia, Maryland facility and its Microfocus System at the site of its
joint venture in Canada. While the Microfocus System will continue to be
manufactured at the current location in Canada, the Microfocus 1000 (and
successor products) will be manufactured by third party contractors. The Company
intends to manufacture the Microfocus APA in the same manner as the Microfocus
1000.
The Company's products are designed and manufactured with proprietary
know how the Company has developed over its history. Proprietary know how is
required to manufacture the subassemblies including, but not limited to, the
solid-state microwave generators, cooling units, microwave applicators and
control algorithms that run the systems. All third party contractors will be
required to sign agreements to protect any disclosed proprietary know how.
Research and Development
The Company continues to refine and upgrade the components of its
Microfocus 1000 and Microfocus System and to pursue the use of thermotherapy in
the treatment of various diseases. The Company also has been successful in
developing relationships with outside parties for research and development.
The APA technology recently licensed by the Company was originally
developed for phased array radar applications. MIT and the Company have worked
together over the past two years in the development of a comprehensive phased
array thermotherapy system using prototypes of various array applicators
developed for various tumor sites. Preclinical evaluations in test phantoms have
demonstrated that one configuration of this system is suitable for the heating
of tumors in breast tissue. Further developments will lead to other
configurations most suitable for treatment of prostate, brain, liver, lung and
other deep seated tumors.
The Company intends to initiate clinical evaluations of the APA
technology in the United Kingdom at a cancer research center. The Company is
presently negotiating a clinical study research agreement with the institution.
Clinical trials in the United States will begin after the receipt of an IDE from
the FDA.
The MMTC technology recently licensed by the Company is a bimodal
treatment which the Company believes will yield a better and faster response
rate while using lower and safer amounts of power. Based upon initial review of
the technology, the Company believes the technology can easily be incorporated
into the current Microfocus 800 system. Clinical trials are planned for early
1997.
12
In September 1996, the Company retained the engineering firm of Herbst
LaZar Bell Inc. ("HLB") to assist in the adaptation of the APA technology into
the Microfocus APA. Under the agreement with HLB, the APA technology will be
used to develop a prototype Microfocus APA which will be utilized in treating
breast cancer. The engineering will focus on integrating the Microfocus 1000
with the Microfocus APA and updating software. The Company will pay HLB 55% of
its standard fee rate and the balance of any fees will be paid in shares of
Common Stock at a value of $1.25 per share.
Competition
Thermotherapy For Cancer
The Company believes that there are at least six other domestic firms,
as well as a number of foreign firms, producing, or designing and intending to
produce, thermotherapy systems to treat cancer. Of those firms, at least four
have obtained PMA for their machines and several have obtained IDE for their
machines. Some, and possibly all, of those firms have greater resources than
those which the Company now has or may reasonably be expected to have in the
near future. Other firms not presently in competition with the Company may
decide to produce thermotherapy systems which compete with those of the Company.
At least some of those firms may reasonably be expected to have resources
greater than those of the Company. As acceptance of thermotherapy as a cancer
treatment increases, the Company expects that the competition will also
increase. There can be no assurance that the Company will be able to
successfully meet such competition. In addition, the thermotherapy industry is
one of rapid technological change. There can be no assurance that systems or
technologies superior to that of the Company will not be produced.
The two major competitors of the Company for the Microfocus 1000 are
BSD Medical Corporation in Salt Lake City, Utah ("BSD") and Labthermics
Technology, Inc. in Champaign, Illinois ("Labthermics"), each of which
manufactures thermotherapy machines competitive with the Company's Microfocus
1000. The major factors in competition for sales of thermotherapy equipment are
product performance, product service and product cost. The product performance
of the Company's Microfocus 1000 in PMA clinical trials has been superior to the
performance of competing machines. The system manufactured by BSD uses microwave
technology. Labthermics uses ultrasound technology to heat the cancer site. As
previously mentioned, the Company received PMA approval of its Microfocus 1000
on November 17, 1989.
BSD received its FDA approval in 1983 and was allowed to begin
marketing its system at that time. To date, BSD has sold approximately 200
thermotherapy systems worldwide. As of September 30, 1996 with the Company's
limited marketing efforts, 35 of the Microfocus 1000 have been sold worldwide.
Therefore, BSD has a much larger presence in the thermotherapy market than has
the Company.
As thermotherapy manufacturers penetrate the market, there will be an
increase in price competition. There are signs that price competition is
actively taking place in the current market. The Company feels that its business
strategy and low production costs for its Microfocus 1000 will enable it to be
very price competitive.
Service in the thermotherapy business includes maintenance of the
thermotherapy machines to minimize downtime as well as training for personnel
who will utilize the machines to render treatment to patients. The Company has
warranty and service policies which are competitive within the industry.
13
The Company's warranty for the Microfocus 1000 is for a period of 12 months and
the Company offers a service policy following expiration of the warranty. These
terms are substantially similar to the warranties and service policies offered
by competitors. The Company provides three to four days of training for the
personnel who will be operating each machine that the Company sells. The Company
also provides training programs at its facility in Maryland for doctors who
desire to receive training on the Company's Microfocus 1000. Both training
courses are helpful in marketing the Company's Microfocus 1000, because users
who become familiar with one machine have a reluctance to switch to another
machine which would require additional training. For this reason, the Company
will seek to increase the frequency of its training sessions given at its
facility in Maryland. BSD provides a similar training course on a quarterly
basis at its facility in Salt Lake City.
Thermotherapy For Prostatic Diseases
The thermotherapy industry is highly competitive. Along with
technological developments affecting the equipment, increasing usage of
thermotherapy for other medical purposes is also developing. The latest and
potentially largest market is the use of thermotherapy for the treatment of
prostatic diseases, namely the urethral obstruction caused by Benign Prostatic
Hyperplasia (BPH). Due to the increased potential of this marketplace, there
will be a greater number of domestic and international companies entering this
field. The Company believes there are as many as 10 companies in the USA and as
many as 15 companies worldwide which are planning or already active in this
marketplace.
On May 7, 1996, the FDA for the first time approved a microwave based
BPH treatment device manufactured by EDAP Technomed, Inc. ("Technomed"). This
approval should enhance market acceptance of microwave BPH treatment systems
both in the United States and abroad but gives Technomed a competitive advantage
of being first to the market in the United States. Currently, the Company
manufactures and sells its BPH treatment systems outside of the United States
through its Canadian facility. The Company's BPH systems are not approved by the
FDA for sale in the United States. However, the Company intends to apply for FDA
approval in the near future.
With the increased number of companies in the BPH thermotherapy
treatment market, many of those companies have greater resources than the
companies already in the field of thermotherapy treatment for cancer. Large
global companies such as Dornier, Olympus and EDAP Technomed International
("Technomed") will spend large amounts of resources to market and develop the
BPH industry. In addition to the above companies, the following are companies
offering BPH thermotherapy systems in the worldwide marketplace: BSD, Direx
Medical, Technomatix (Primus), Lund Science, Quantum, GENEMED, Bruker, Urologix,
and Meditherm. There are several other companies which have not yet brought
their products to the international marketplace. Presently, Technomed is
considered the market leader with its system called the Prostatron. The
Prostatron unit is a high cost system which sells for approximately U.S.
$500,000. Other companies are marketing their systems in the range of US
$100,000 to $300,000. The Company is manufacturing its line of Microfocus BPH
Systems at its facility in Canada and is presently offering the systems in the
range of U.S. $50,000 to $150,000. To date, it is believed there are over 600
installed BPH Systems worldwide of which Technomed and Direx have the largest
share of approximately 30% combined. There are approximately 75 Microfocus BPH
Systems installed worldwide.
14
Government Regulation
United States Regulation. In the United States, the FDA regulates the
sale and use of medical devices, which include the Company's thermotherapy
systems for both cancer and BPH. A company introducing a medical device in the
United States must go through a two step process. The company must first obtain
an Investigational Device Exemption ("IDE") permit from the FDA. In IDE is
granted upon the manufacturer adequately demonstrating the safety of the device
for patient use. Receipt of the IDE allows the use of the device on patients for
the purpose of obtaining efficacy confirmation. A PMA is granted upon
compilation of sufficient clinical data to establish efficacy for the indicated
use of the device. This process is not only time consuming but is also
expensive. Obtaining PMA is a significant barrier to entry into the
thermotherapy market. Firms which lack PMA face significant impediments to the
successful marketing of their thermotherapy equipment, because under applicable
regulations customers can obtain reimbursement from Medicare, Medicaid and
health insurers only for treatment with products that have PMA.
CLI has an IDE and PMA for the Microfocus 1000. The Company does not
have an IDE on the Microfocus System.
The Federal Communications Commission (the "FCC") regulates the
frequencies of microwave and radio-frequency emissions from medical and other
types of equipment to prevent interference with commercial and governmental
communications networks. The frequency of 915 MHZ has been approved by the FCC
for medical applications and machines utilizing that frequency do not require
shielding to prevent interference with communications. The Microfocus 1000 and
the Microfocus System utilize the 915 MHZ frequency.
In December 1984, the Health Care Financing Administration ("HCFA")
approved reimbursement under Medicare and Medicaid for thermotherapy treatment
when used in conjunction with radiation therapy for the treatment of surface and
subsurface tumors. At this time, most of the large medical insurance carriers in
the United States have approved reimbursement for such thermotherapy treatment
under their health policies. Thermotherapy treatment administered using
equipment which has received PMA is eligible for such reimbursement.
The Company and its facilities are subject to inspection by the FDA at
any time to insure compliance with FDA regulations in the production and sale of
medical products. Failure to comply or maintain compliance with those
regulations could have a material adverse effect upon the Company's operations.
The Company believes that it is substantially in compliance with FDA regulations
governing the manufacturing and marketing of medical devices.
Foreign Regulation. Sales of medical devices outside of the United
States are subject to United States export requirements and foreign regulatory
requirements. Export sales of investigational devices that are subject to PMA
requirements and have not received FDA marketing approval generally may be
subject to FDA export permit requirements under the Federal Food, Drug and
Cosmetic Act ("FDC Act") depending upon, among other things, the purpose of the
export (investigational or commercial) and on whether the device has valid
marketing authorization in a country listed in the FDA Export Reform and
Enhancement Act of 1996. In order to obtain such a permit, when required, the
Company must provide the FDA with documentation from the medical device
regulatory authority of the country in which the purchaser is located, stating
that the device has the approval of the country. In addition, the FDA must find
that exportation of the device is not contrary to the public health and safety
of the country in order for the Company to obtain the permit.
15
The Company currently sells products in selected countries in Asia and
Europe. The registration requirements within these countries is the sole
responsibility of the distributors in each of these countries. Legal
restrictions on the sale of imported medical devices vary from country to
country. The time required to obtain approval by a foreign country may be longer
or shorter than that required for FDA approval, and the requirements may differ.
The Company expects to receive approvals for marketing in a number of countries
outside the United States prior to the time that it will be able to market its
products in the United States. The timing for such approvals is not known.
Product Liability and Insurance
The business of the Company entails the risk of product liability
claims. Although the Company has not experienced any product liability claims to
date, any such claims could have an adverse impact on the Company. In the past
and currently, the Company has not maintained product liability insurance. The
Company is currently in the process of securing product liability insurance in
the amount of $5,000,000. The Company evaluates its insurance requirements on an
ongoing basis. There can be no assurance that product liability claims will be
covered by such insurance, will not exceed such insurance coverage limits or
that such insurance will be available on commercially reasonable terms or at
all.
Terminated Business Opportunities
Due to the slow development of the market for thermotherapy products,
the Company sought to develop other business opportunities to provide a quicker
and greater return to the Company's shareholders. With the recent acquisition of
new technology, the Company believes that its best opportunity for long-term
growth is to focus its activities on its core business--thermotherapy products.
Accordingly, the Company has terminated, or is terminating, the joint ventures
and/or business opportunities which do not focus on or enhance the core
business. The following are assets and projects which have been terminated
during 1996:
Aestar Fine Chemical Company. The Company has previously disclosed the
investment in the Company by Mr. Gao Yu Wen of assets valued at approximately
$10,000,000 in exchange for 20,000,000 shares of Common Stock of the Company. As
part of the investment of Mr. Gao in the Company, Mr. Gao transferred to the
Company a 9.5% interest in the Aestar Fine Chemical Incorporation Limited
Company ("Aestar"). Aestar is a corporation organized under the laws of the
People's Republic of China. The Company originally looked to this interest in
Aestar as a significant source of dividend income and as a vehicle to facilitate
joint ventures for the manufacturing and sale of cosmetics in China.
On June 8, 1996, the parties entered into a Redemption Agreement by
which the Company agreed to repurchase from Mr. Gao 16,000,000 shares of the
Company's Common Stock in consideration for the Company's 9.5% interest in
Aestar and to repurchase an additional 4,000,000 shares of Common Stock at a
price of $.55 per shares for a total of $2.2 million. Under the terms of the
Redemption Agreement, the entire 20,000,000 shares were retained by Mr. Gao to
secure the payment of the $2.2 million. On October 23, 1996, the Company and Mr.
Gao, through his representatives, executed an Amendment by which Mr. Gao agreed
(i) to immediately deliver to the Company the 16,000,000 shares of Common Stock;
(ii) to give the Company an additional one month to purchase the remaining
4,000,000 shares; and (iii) to reduce the purchase price to $2,160,000. Pursuant
to the terms of the Amendment, on October 23, 1996, Mr. Gao's representatives
delivered duly executed stock certificates and stock powers for the 16,000,000
16
shares of Common Stock which stock has been cancelled on the records of the
Company. This represents a repurchase by the Company of nearly forty percent
(40%) of its issued and outstanding stock.
Eastwell Management Services Limited. The Company entered into
negotiations to acquire 100% of the outstanding stock of Asia-Pacific
Communication Corporation Limited, formerly known as Novatel, Asia ("APC"), from
Eastwell Management Services Limited ("Eastwell") in exchange for 24 million
shares of the Company's Common Stock and warrants to acquire another five
percent (5%) interest in the Company. The proposed terms of the agreement were
set forth in an Acquisition Agreement, dated March, 1994 (the "Acquisition
Agreement"). APC (which was formerly known as Novatel, Asia) is in the business
of manufacturing telecommunications equipment and providing telecommunications
services. The consummation of the agreement with Eastwell was contingent upon
satisfaction of certain conditions precedent. Because those conditions were not
satisfied, the Company elected not to proceed with the agreement with Eastwell.
There is no written agreement terminating the contemplated transaction with
Eastwell.
Rainbow Ball Development Limited. On October 11, 1993, the Company
entered into an agreement with Mr. Carlton Poon ("Poon") whereby Poon agreed to
provide approximately $125,000 U.S. to fund a joint venture between the Company
and Poon named Rainbow Ball Development Limited ("Rainbow Ball"). Rainbow Ball
was formed to develop, manufacture and market certain medical imaging technology
and a portable x-ray device. After Mr. Poon funded the $125,000 the parties
decided not to proceed with the joint venture. By means of a Termination
Agreement, dated August 28, 1996, the parties terminated the joint venture.
Under the terms of the Termination Agreement, the Company is to deliver to Mr.
Poon 355,757 fully paid and non-assessable shares of Company Common Stock in
full satisfaction of all obligations of the Company and Rainbow Ball to Mr.
Poon.
Unisol. By Purchase Agreement, dated April 26, 1995, the Company
entered into an agreement to purchase a 50% interest in the United Aerosol and
Home Products Company, Ltd. ("Unisol"), located in Zhongshan, China, from Cosmos
Peace Development Corporation, a Hong Kong corporation ("Cosmos"). The Company
was introduced to Unisol through Mr. Gao as part of the joint ventures to be
implemented in China. Unisol is a specialty chemical and fine chemical aerosol
packaging and bottle/can filling business. The purchase price was to be 20% of
the appraised value of Unisol equipment, payable in the Company's Common Stock
based upon the value of the Common Stock at the close of business on April 26,
1996. The Unisol acquisition was executed as part of the Gao transaction. The
intent of the Unisol acquisition was to manufacture and package personal care
and cosmetic products. The agreement was verbally terminated on October 23,
1996, at the same time that the Company executed the Amendment by which the
Company redeemed its stock from Mr. Gao. There is no written agreement
terminating the relationship between the Company and Unisol.
Ardex Equipment, LLC. The Company invested $450,000 (of which $50,000 has
been repaid to the Company) to acquire a 17.1111% interest in Ardex Equipment,
LLC ("Ardex"). The Company originally contracted to acquire a controlling
interest in Ardex. Ardex manufactures industrial plumbing equipment. With the
redemption of the Common Stock from Mr. Gao, the Company is also terminating its
relationship with Ardex. Under the terms of a Binding Letter of Intent, dated
August 2, 1996, agreed to convert the Company's equity interest into a 5 year
negotiable promissory note, to bear interest at the rate of eight percent (8%).
The note is payable on an interest-only basis until the principal becomes due.
Principal becomes due upon the first to happen of the following: (i) a public or
private offering successfully completed by Ardex of $1.5 million in the
aggregate or more; (ii) ninety (90) days following a year end of Ardex in which
17
sales for the year have been $3,000,000 or more; (iii) Ardex having a cash
balance of $800,000 or more from operations; or (iv) five years from the date of
the promissory note.
Employees
As of September 30, 1996, the Company had seven (7) full-time
employees, of whom three (3) are managerial, one (1) is engineering, one (1)
administrative, one (1) is in production in the main office in Maryland and one
(1) employee is in the Hong Kong office.
None of the Company's employees is represented by a collective
bargaining organization. The Company considers its relations with its employees
to be good.
ITEM 2. PROPERTIES
The Company's corporate headquarters consist of approximately 5,918
square feet of office, laboratory and production space at 10220-I Old Columbia
Road, Columbia, Maryland 21046-1705. The Company leases the premises from an
unaffiliated party on an oral month-to-month basis.
Monthly rent is $4,172.00.
The Company also leases office space consisting of approximately 500
square feet located at 11/F Flat B, Hanley House 68 Canton Road, T.S.T. Kowloon,
Hong Kong. The property is leased on an oral month-to-month basis from an
unaffiliated party at a monthly lease rate of $1,200 (U.S.).
ITEM 3. LEGAL PROCEEDINGS
The Company presently is not a party to any litigation, and the Company
is not aware of any threat of litigation.
In the normal course of business, the Company may be subject to
warranty and product liability claims on its thermotherapy equipment. The
Company does not have a product liability insurance policy in effect. The
assertion of any product liability claim against the Company, therefore, may
have an adverse affect on its financial condition. As of September 30, 1996, no
liability claims against the Company have been asserted.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of the security holders during the
calendar year ending 1996.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS
The Company's Common Stock is traded on the NASD OTC Bulletin Board.
The quotations set forth below reflect inter-dealer prices, do not include
retail markups, markdowns or commissions, and may not necessarily represent
actual transactions. There were approximately 2,600 holders of record of the
Common Stock as of September 30, 1996. The Company has never paid cash dividends
on its stock and does not expect to pay any cash dividends in the foreseeable
future.
18
Year ended September 30
Period 1995 1996
- ------ ---- ----
High Low High Low
---- --- ---- ---
1st Quarter (Oct. 1 to Dec. 31) 19/32 1/4 17/32 1/2
2nd Quarter (Jan. 1 to March 31) 35/64 1/4 5/8 25/64
3rd Quarter (April 1 to June 30) 1 5/8 1-1/16 17/64
4th Quarter (July 1 to Sept. 30) 1-23/32 31/32 1-9/32 21/32
ITEM 6. SELECTED FINANCIAL DATA
The following table summarizes certain financial data for the Company for the
years ended September 30, 1996, 1995, 1994, 1993, and 1992 and is qualified in
its entirety by, and should be read in conjunction with the Financial
Statements, the related Notes thereto and "Management's Discussion and Analysis
of Financial Condition and Results of Operations" included elsewhere in this
report.
Fiscal Year Ended
September 30,
1992 1993 1994 1995 1996
---- ---- ---- ---- ----
Statement of Operations Data:
Revenues:
Product Sales $2,012,544 $1,811,774 $1,025,651 $157,618 $74,006
Research and development contracts 18,750 40,377 60,742 0 0
------- ------- ------- ------- -------
Total revenues 2,031,114 $1,852,151 $1,086,393 $157,618 $74,006
Cost of product sales 733,111 694,150 494,946 67,350 64,406
------- --------- --------- ------- ------
Gross margin on product sales 1,298,003 1,158,001 591,447 90,268 9,600
Other costs and expenses:
Research and development 152,898 186,916 202,569 18,546 94,012
Selling, general and administrative 574,005 739,595 704,295 1,369,845 1,338,370
Amortization of intangible assets - - - -
Total operating expenses 726,903 926,511 906,864 1,388,391 1,432,382
Profit (Loss) from operations 571,110 231,490 (315,417) (1,298,123) (1,422,782)
Other income (expense) 147,390 (7,244) 170,997 (8,389) (425,183(1))
Interest income (expense) (210,870) (236,847) (184,700) (90,808) (85,506)
Extraordinary Item - Gain or forgiveness
of debt 591,728
Net income (loss) 507,620 (12,601) 390,880 (1,397,317) (1,933,471)
Net loss per share(1) 0.034 ($.001) $.023 ($.060) ($.049)
Weighted average shares outstanding(1) 15,081,378 15,608,490 16,712,978 23,466,070 39,499,650
At September 30,
1992 1993 1994 1995 1996
---- ---- ---- ---- ----
Balance Sheet Data:
Working Capital (2,795,328) (2,434,832) (748,193) (1,101,136) (646,754)
Total Assets 1,111,676 998,403 955,456 9,710,742 9,321,600(2)
Long-term debt, less current maturities 26,000 2,000 1,213,000
Redeemable Convertible Preferred
Stock
Accumulated deficit (9,214,607) (9,271,725) (8,880,845) (10,278,162) (12,211,633)
Total stockholders' equity (deficit) (2,716,230) (2,346,021) (666,542) 8,128,768 6,755,874(2)
(1) Includes $17,009 gain on disposition of investment in Ardex Equipment,
L.L.C.
19
(2) On October 23, 1996, the Company, based on the provisions of an agreement
reached on June 6, 1996, as amended, redeemed 16,000,000 shares of its Common
Stock. The redemption provided for the Company to return its investment in
Aestar Fine Chemical Company (valued at $8,000,000 on the Company's September
30, 1996 balance sheet) and to relinquish its rights to the funds held under an
investment contract ($40,000 at September 30, 1996) in order to affect the
transaction. This transaction has a significant impact on the financial
position, current ratios and stockholder's equity of the Company. If the
foregoing transaction had occurred on or before September 30, 1996, total assets
would have been reduced by $8,040,000 and stockholder's equity would have
reduced by $8,040,000, resulting in a negative stockholder's equity of
($1,284,126).
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Forward-Looking Statements
Statements regarding the Company's expectations as to demand for its
products and certain other information presented in this Form 10-K constitute
forward looking statements within the meaning of the Private Securities
Litigation Reform Act of 1995. Although the Company believes that its
expectations are based on reasonable assumptions within the bounds of its
knowledge of its business and operations, there can be no assurance that actual
results will not differ materially from its expectations. Factors which could
cause actual results to differ from expectations include, but are not limited to
the following:
1. Decreasing Sales, Increasing Losses and Undercapitalization. The Company's
product sales have been substantially decreasing over the past three years.
There is no assurance sales will increase with the application of new
technologies being developed by the Company. The Company has had increasing
losses for the last three years which have resulted in an accumulated deficit of
$12,211,633 for the period ending September 30, 1996. Losses will continue until
current and future sales increase substantially. The Company lacks adequate
capital to finance its research and development and marketing. Lack of adequate
capital and governmental regulatory approvals will effect future sales.
Furthermore, hyperthermia has not been widely accepted by the medical community
as an effective cancer treatment.
2. Limited Products. The Company currently has a limited number of products.
Failure to develop new products utilizing current products and newly acquired
technology will effect the profitability of the Company.
3. Lack of a Current Marketing Plan. The Company does not have an active current
marketing plan. It is developing a plan to share revenue from treatment which is
dependant on market acceptance and adequate capitalization.
General
Since inception, the Company has incurred substantial operating losses,
principally from expenses associated with the Company's research and development
programs, the clinical trials conducted in connection with the Company's
thermotherapy systems and the preparation of the related IDE and PMA application
for submission to the FDA. The Company has experienced significant operating
losses and as of September 30, 1996 had an accumulated deficit of $12,211,633.
The Company expects such operating losses to continue and possibly increase in
the near term and for the foreseeable future as it continues its product
development efforts, expands its marketing and sales activities and scales up
its manufacturing operations. The Company's ability to achieve profitability is
dependent upon its ability to successfully obtain governmental approvals,
manufacture, market and sell its new technology and integrate such technology
20
into its thermotherapy systems. The Company has not been able to successfully
market its current thermotherapy system. There can be no assurance that the
Company will be able to successfully commercialize its newly acquired technology
and apply it to its current thermotherapy systems or that profitability will
ever be achieved. The operating results of the Company have fluctuated
significantly in the past on an annual and a quarterly basis. The Company
expects that its operating results will fluctuate significantly from quarter to
quarter in the future and will depend on a number of factors, many of which are
outside the Company's control.
The major obstacles facing the Company over the last several years have
been inadequate funding, a negative net worth, and the slow development of the
thermotherapy market as a sizeable market due to technical shortcomings of the
thermotherapy equipment available commercially. To overcome these problems,
during the past two years the Company embarked upon a diversification program
whereby the Company sought a strategic partner that could provide both capital
and new opportunities for the Company. The result of this effort was the
agreement with Mr. Gao Yu Wen which infused capital and gave the Company the
opportunity to develop through a strategic alliance was to be a cosmetic and
fine chemical business for the sale of these products in China. As set forth
above in "Terminated Business Opportunities," the relationship with Mr. Gao has
been terminated and the Company has redeemed 16 million of the 20 million shares
purchased by Mr. Gao.
The Company has refocused the Company's efforts on the enhancement of
current products through the development of new technology and sale of the
thermotherapy products as the Company's core business. The Company is currently
focused on the enhancement of its thermotherapy equipment and obtaining
governmental approvals. Towards this end the Company has licensed the APA
technology and the MMTC technology.
The Company anticipates that its results of operations will be affected
for the foreseeable future by a number of factors, including its ability to
develop the new technology to enhance its current systems, regulatory matters,
health care cost reimbursements, clinical studies and market acceptance.
Results of Operations
Comparison of Fiscal Year Ended September 30, 1996 to Fiscal Year Ended
September 30, 1995
Product sales decreased to $74,006 in fiscal 1996 from $157,618 in
fiscal 1995. The decrease was due, primarily, to decreased emphasis on sales of
Microfocus products as the Company sought other business opportunities. With the
renewed focus on the development and sale of the Microfocus products, the
Company anticipates that sales of its thermotherapy systems will account for all
sales in the foreseeable future. The Company will focus on developing its new
products. Increased sales of products are not expected until the new
technologies are developed and approved for sale by governmental regulatory
agencies.
Cost of product sales decreased to $64,406 in fiscal 1996 from $67,350
in fiscal 1995 due to decreased sales volume. The Company expects gross margins
to increase in the future due to improved overhead absorption and manufacturing
efficiencies.
Research and development expense increased to $94,012 in fiscal 1996 from
$18,546 in fiscal 1995 due to increased emphasis on technology enhancements. The
Company expects to significantly increase its expenditures for research and
21
development to fund the development or enhancement of products by incorporating
the APA technology and the MMTC technology.
Selling, general and administrative expenses decreased in amount to
$1,338,370 in fiscal 1996 from $1,369,845 in fiscal 1995. The Company expects
selling and marketing expense to increase substantially as it expands its
advertising and promotional activities and increases its marketing and sales
force, principally for the commercialization of its thermotherapy systems.
Interest expense decreased to $85,506 in fiscal 1996 from $90,805 in
fiscal 1995.
Comparison of Fiscal Year Ended September 30, 1995 to Fiscal Year Ended
September 30, 1994
Product sales decreased to $157,618 in fiscal 1995 from $1,086,393 in
fiscal 1994. The decrease was due, primarily, to continued slowing sales in the
thermotherapy market.
Cost of product sales decreased to $67,350 in fiscal 1995 from $494,946
in fiscal 1994 due to decreased sales volume.
Research and development expense decreased to $18,546 in fiscal 1995
from $202,569 in fiscal 1994. Most of the decrease was due a softening of the
marketplace for thermotherapy products and a shift in focus from development
efforts relating to the Company's core technologies to seeking new business
opportunities and partners.
Selling, general and administrative expenses increased to $1,369,845 in
fiscal 1995 from $704,295 in fiscal 1994.
Interest expense decreased to $90,808 in fiscal 1995 from $184,700 in
fiscal 1994 due to conversion of debt to equity.
Liquidity and Capital Resources
Since inception, the Company's expenses have significantly exceeded its
revenues, resulting in an accumulated deficit of $12,211,633 at September 30,
1996. The Company has funded its operations primarily through the sale of equity
securities. At September 30, 1996, the Company had cash, cash equivalents and
short-term investments aggregating approximately $246,931. Net cash used in the
Company's operating activities was $1,462,588 for the fiscal year ended
September 30, 1996.
The Company does not have any bank financing arrangements. The
Company's indebtedness consists of two notes payable to Dr. Augustine Cheung
with a total face amount of $121,419; a note payable to Yu Shai Lai in the
amount of $36,041; a note payable to Ada Lam in the amount of $28,502; a note
payable to Ruth Kurz in the amount of $93,750; a note payable to Lake Shu Loon
in the amount of $10,000; an oral agreement to pay Charles Shelton an amount
currently estimated between $35,000 and $50,000; and trade debt totaling
$197,190. In addition, commencing on July 10, 1996, the Company sold $1,205,000
in senior secured convertible notes accruing interest at 8 percent per annum
(the "Senior Notes"). The Senior Notes have priority over payment of any other
indebtedness of the Company. The holders of the Senior Notes can elect to either
convert the notes into Common Stock at an option price of $0.41 per share or be
paid principal and interest upon the earlier to occur of (i) the next private
offering; or (ii) December 31, 1997.
22
The Company has incurred negative cash flows from operations since its
inception, and has expended, and expects to continue to expend in the future,
substantial funds to complete its planned product development efforts, including
seeking FDA approval for the domestic sale of the Company's products, expand its
sales and marketing activities and scale up its manufacturing. The Company
expects that its existing capital resources will not be adequate to fund the
Company's operations through the next twelve months. The Company is dependent on
raising additional capital to fund its development of technology and to
implement a marketing plan. Such dependence will continue at least until the
Company begins marketing its new technologies. The Company's future capital
requirements and the adequacy of available funds will depend on numerous
factors, including the successful commercialization of the thermotherapy systems
progress in its product development efforts, the magnitude and scope of such
efforts, progress with preclinical studies and clinical trials, the cost and
timing of manufacturing scale-up, the development of effective sales and
marketing activities, the cost of filing, prosecuting, defending and enforcing
patent claims and other intellectual property rights, competing technological
and market developments, and the development of strategic alliances for the
marketing of its products. To the extent that funds generated from the Company's
operations are insufficient to meet current or planned operating requirements,
the Company will be required to obtain additional funds through equity or debt
financing, strategic alliances with corporate partners and others, or through
other sources. The Company does not have any committed sources of additional
financing, and there can be no assurance that additional funding, if necessary,
will be available on acceptable terms, if at all. If adequate funds are not
available, the Company may be required to delay, scale-back or eliminate certain
aspects of its operations or attempt to obtain funds through arrangements with
collaborative partners or others that may require the Company to relinquish
rights to certain of its technologies, product candidates, products or potential
markets. If adequate funds are not available, the Company's business, financial
condition and results of operations will be materially and adversely effected.
The Company has agreed to pay Gao Yu Wen $2,160,000 on or before March
31, 1997 to redeem 4,000,000 shares of the Company's Common Stock. The Company
has agreed to pay MIT $10,000 in 1997 and also must develop time table which
requires the expenditure of research and development funds. The Company has also
entered into a Settlement Agreement, dated October 28, 1996, whereby the Company
undertook to use its best efforts to pay to William O. Cave, a former director,
the sum of $194,825 on or before February 28, 1997. The Company has a contingent
liability to MMTC in the amount of $50,000 in 1997 if the Company fails to meet
the milestones identified under "Patents and Proprietary Rights," above; and
must develop criteria which require the expenditure of research and development
funds. The Company is also required to pay HLB certain engineering fees, the
amount of which are presently unknown. The Company is also required to do
clinical trials to prepare for submission of products to the FDA. The amount
required to perform such trials and to prosecute the applications in not
currently known. The Company does not currently have funds available to do such
trials and clinical work. The Company has committed to pay advisors and officers
pursuant to contractual arrangements set forth in "Directors and Executive
Officers of the Registrant" and "Certain Relationships and Related
Transactions." The Company will be dependent on additional capital to be raised
to fulfill all of the above agreements and obligations.
During fiscal year 1996, the Company issued a large number of options and
warrants in connection with its funding activities. Options or warrants to
officers, directors, related parties and five percent (5%) shareholders are
addressed in Part III of this Form 10-K. In addition to those options and
warrants, the Company has issued options and warrants in connection with funding
activities to purchase a total of 4,670,715 shares of Common Stock, with
23
exercise prices ranging from $.25 per share to $.41 per share. Some of the
warrants issued have anti-dilution provisions which may affect the total number
of shares available for purchase under the warrants.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements, supplementary data and report of independent
public accountants are filed as part of this report on pages F-1 through F-15.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE
No change of accountants and/or disagreements on any matter of
accounting principles or financial statement disclosures have occurred within
the last two years.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The directors and executive officers of the Company are as follows:
Name Age Positions with the Company
- -------------------- ----- -----------------------------------
Augustine Y. Cheung 49 Chairman of the Board
Verle D. Blaha 66 Chief Executive Officer, President
and Director
Charles C. Shelton 51 Executive Vice President
and Director
Robert F. Schiffmann 61 Director
Joseph M. Colino 57 Director
John Mon 44 Treasurer/General Manager
Dr. Cheung was the founder of the Company, was President from 1982 to
1986, was Chief Executive Officer from 1982 to 1996 and has been Chairman since
1982. From 1982 to 1985, Dr. Cheung was a Research Associate Professor of the
Department of Electrical Engineering and Computer Science at George Washington
University and from 1975 to 1981 was a Research Associate Professor and
Assistant Professor at the Institute for Physical Science and Technology and the
Department of Radiation Therapy at the University of Maryland. Dr. Cheung holds
a Ph.D. and Masters degree from University of Maryland.
Mr. Blaha has been a director, President and Chief Executive Officer of the
Company since September 6, 1996. Prior to joining the Company, Mr. Blaha
provided consulting services to the microwave industry. From 1986 to 1991, Mr.
Blaha was a director, and the President and Chief Operations Officer for the
Company. From 1982 to 1986, Mr. Blaha was Vice President and General Manager of
Holaday Industries, Inc. From 1957 to 1982, Mr. Blaha held a succession of
senior management positions at Litton Industries, Inc. Mr. Blaha was Senior Vice
President of Technology and Development of Litton's Microwave Cooking Products
Division. Mr. Blaha holds a B.S.B and an MBA degree from University of
Minnesota.
24
Mr. Shelton has served as the Company's in-house counsel from 1993 to 1996,
and as Executive Vice President and a director from 1993. Mr. Shelton has
practiced in the areas of corporate and tax law with Charles C. Shelton, PA,
from 1993 to the present. From 1973 to 1993, he practiced law with Semmes, Bowen
& Semmes. Mr. Shelton is a Vice President and director with HRP Technologies,
Inc. (previously known as Ardex Equipment, LLC), a public company traded on the
Bulletin Board.
Mr. Colino has been a director since 1995. From 1991 to the present, Mr.
Colino has served as the President of HRP Technologies, Inc. (previously known
as Ardex Equipment, LLC) and Parec Enterprises, Inc..
Mr. Schiffmann has served as a director of the Company since September
1986. Since 1991, Mr. Schiffmann has served as President of R. F. Schiffmann
Associates, Inc., a microwave consulting laboratory. He is also Chairman of
Quicklave L.L.C., and Microwave Concepts, Inc., which are independent research
companies specializing in microwave technology. Mr. Schiffmann holds a Bachelor
of Science Degree in Pharmaceutical Science from Columbia University and a
Master of Science degree from Purdue University.
Mr. Mon has served as Treasurer/General Manager of the Company since 1989.
From 1984 to 1988, Mr. Mon was an economist with the U.S. Department of Commerce
in charge of forecasting business sales, inventory and prices for all business
sectors in the estimation of Gross National Product. Mr. Mon holds a B.S. degree
from the University of Maryland.
Mr. Shelton and Mr. Colino have notified the Company that they will not
serve on the Board of Directors after the expiration of their current terms and,
accordingly, they are not seeking re- election to the Board of Directors.
Nominee to the Board of Directors
The following individual has been nominated to serve on the Board of
Directors:
Warren C. Stearns. Mr. Stearns was nominated to serve to on the Board of
Directors on August 14, 1996. Mr. Stearns has been and currently is President of
Stearns Management Company, a capital advisory firm, since 1989. Prior to 1989,
Mr. Stearns acted as vice president of Stearns Management Company. Mr. Stearns
holds an M.B.A. degree from Harvard University and a B.A. degree from Amherst
College.
Advisory Board
The Company is presently organizing an Advisory Board to be comprised
of business and industry professionals and experts. The Company presently
anticipates have as many as six members on the Advisory Board. The purpose of
the Advisory Board will be to assist the management of the Company in
identifying technology trends and new business opportunities within the
industry. The Advisory Board will operate in a consulting fashion and will not
act as managers or directors of the Company. The following persons have been
nominated to serve on the Company's Advisory Board:
Stuart Fuchs. Mr. Fuchs has been nominated to serve as Chairman of the Advisory
Board. He is President of Nace Resources, Inc., a firm providing consulting and
marketing services to companies in the biotechnology and medical device fields.
25
Prior to founding Nace in 1995, Mr. Fuchs was an investment banker in the Fixed
Income Division of Goldman Sachs & Co. in New York and Chicago. Until joining
Goldman Sachs in 1976, he was an attorney practicing securities and tax law with
Barrett Smith Shapiro & Simon in New York, New York. Mr. Fuchs is a graduate of
Harvard College and Harvard Law School.
Michael Davidson, M.D. Dr. Davidson has been nominated to serve as a member of
the Advisory Board. Dr. Davidson is a physician specializing in design of
clinical trials. Dr. Davidson currently practices and is President of the
Chicago Center for Clinical Research. Dr. Davidson holds a B.A., M.S. from
Northwestern University and a M.D. from Ohio State University.
The Company may designate additional individuals to serve on the
Advisory Board as the Company identifies individuals with appropriate
qualifications.
Compliance with Section 16(a) of the Exchange Act
Section 16(a) of the Securities Exchange Act of 1934 requires the
Company's officers and directors, and persons who own more than ten percent of a
registered class of the Company's equity securities, to file reports of
ownership and changes in ownership with the Securities and Exchange Commission
and the National Association of Securities Dealers. Officers, directors and
greater than ten-percent shareholders are required by Securities and Exchange
Commission regulations to furnish the Company with copies of all Section 16(a)
forms they file. Based solely on a review of the copies of such forms furnished
to the Company between October 1, 1995 and September 30, 1996, on year-end
reports furnished to the Company after September 30, 1996 and on representations
that no other reports were required, the Company has determined that during the
last fiscal year all applicable 16(a) filing requirements were met except as
follows:
Dr. Augustine Y. Cheung, Chairman of the Board of Directors, acquired 2,000
shares of Common Stock on January 17, 1994; acquired 1,2000,000 shares of Common
Stock on June 30, 1994; acquired 2000 shares of Common Stock on December 31,
1994; acquired 249,058 shares of Common Stock on June 30, 1995; acquired 52,000
shares of Common Stock on September 30, 1996; and disposed of 195,000 shares of
Common Stock on March 7, 1995. Dr. Cheung also received an option to acquire
50,000 shares of Common Stock on December 31, 1996 and an option to acquire
400,000 shares of Common Stock on May 16, 1996. Each of these transactions
should have been reported on Form 3 and Forms 4. The transactions were instead
disclosed on a Form 5 filed on or about November 10, 1996.
John Mon, Treasurer/General Manager, and a former director of the Company,
acquired 2,000 shares of Common Stock on January 17, 1994; acquired 49,800
shares of Common Stock on January 17, 1994; acquired 2,000 shares of Common
Stock on December 31, 1994; and acquired 58,505 shares of Common Stock on June
30, 1995. Mr. Mon also received an option to acquire 400,000 shares of Common
Stock on May 16, 1996. These transactions should have been reported on Form 3
and Form 4. The transactions were instead disclosed on a Form 5 filed on or
about November 10, 1996.
Robert F. Schiffman, a director, acquired 62,000 shares of Common Stock on
September 30, 1996 and received an option to purchase 100,000 shares of Common
Stock on May 16, 1996. These transactions should have been disclosed on Forms 4.
The transactions were instead disclosed on a Form 5 filed on or about November
13, 1996.
26
Charles C. Shelton, a director and Executive Vice President, acquired 103,000
shares of Common Stock on December 20, 1993; acquired 2,000 shares of Common
Stock on January 17, 1994; acquired 150,000 shares of Common Stock on September
9, 1994; acquired 2,000 shares of Common Stock on January 17, 1996; and received
an option to acquire 400,000 shares of Common Stock on May 16, 1996. These
transactions should have been reported on Form 3 and Form 4. The transactions
were instead disclosed on a Form 5 filed on or about November 16, 1996.
Joseph M. Colino, a director, acquired 2800 shares of Common Stock on June 30,
1995. This transaction should have been reported on Form 3. The transaction was
instead disclosed on a Form 5 filed on or about November 15, 1996.
ITEM 11. Executive Compensation
The following table sets forth the aggregate cash compensation paid for
services rendered to the Company in all capacities during the last three fiscal
years to the Company's Chief Executive Officer and to each of the Company's
other executive officers where annual salary and bonus for the most recent
fiscal year exceeded $100,000.
Summary Compensation Table
Annual Compensation Long-Term All Other
Compensation Awards Compensation
($)
Other Annual Restricted Stock
Name and Salary Bonus Compensation Stock Awards Options
Principal Position Year ($) ($) ($) ($) (#)
Augustine Y. Cheung, Chairman 1996 $125,000 2,000(1) 400,000(2)
of the Board of Directors 1995 $125,000 2,000 -
1994 $114,480 2,000 50,000(3)
=============================== ======== ============ ========== ============= ============= =========== ===============
(1) In each of 1994, 1995 and 1996, Dr. Cheung received 2,000 shares of
Common Stock for his services as a director.
(2) In 1996, Dr. Cheung received an option to purchase 400,000 shares at
$0.35 per share, exercisable on or before May 16, 2001
(3) In 1994, Dr. Cheung received and option to purchase 50,000 shares at
$0.125 per share, which he exercised on September 30, 1996.
There are no option, retirement, pension, or profit sharing plans for
the benefit of the Company's officers, directors and employees. The Company does
provide health insurance coverage for its employees. The Board of Directors may
recommend and adopt additional programs in the future for the benefit of
officers, directors and employees.
Option Grants in 1996
Information concerning 1996 grants to named executive officers is reflected
in the table below. The amounts shown for each of the named executive officers
as potential realizable values are based on arbitrarily assumed annualized rates
of stock price appreciation of five percent and ten percent over the full five
(and in one case eight) year term of the options. These potential realizable
values are based solely on arbitrarily assumed rates of price appreciation
required by applicable SEC regulations. Actual gains, if any, on option
exercises and Common Stockholdings are dependent on the future performance of
27
the Company and overall stock market conditions. There can be no assurance that
the potential realizable values shown in this table will be achieved.
Option Grants in 1996
Potential Realizable Value
at Assumed Annual Rates
of Stock Price Appreciation
Individual Grants for Option Term
% of Total
Options
Options Granted to
Granted Employees in Exercise Expiration
Name (#) 1996 Price Date (5%) (10%)
Augustine Y. Cheung 400,000 16.53% $0.35 5/16/2001 $38,679 $ 85,471
Verle D. Blaha 400,000 16.53% $0.41 8/13/2004 $78,302 $187,548
John Mon 400,000 16.53% $0.35 5/16/2001 $38,679 $ 85,471
Charles C. Shelton 400,000 16.53% $0.35 5/16/2001 $38,679 $ 85,471
========================== ============== ================ ============ ============= ================ ================
Aggregated Option Exercises and Year-End Option Values in 1996
The following table summarizes for each of the named executive officers
of the Company the number of stock options, if any, exercised during 1996, the
aggregate dollar value realized upon exercise, the total number of unexercised
options held at September 30, 1996 and the aggregate dollar value of the
in-the-money unexercised options, if any, held at September 30, 1996. Value
realized upon exercise is the difference between the fair market value of the
underlying stock on the exercise date and the exercise price of the option. The
value of unexercised, in-the-money options at September 30, 1996 is the
difference between its exercise price and the fair market value of the
underlying stock on September 30, 1996, which was $1.03 per share based on the
closing bid price of the Common Stock on September 30, 1996. The underlying
options have not been and may never be exercised; and actual gains, if any, on
exercise will depend on the value of the Common Stock on the actual date of
exercise. There can be no assurance that these values will be realized.
28
Aggregated Option Exercises in 1996 and Year-End Option Values
Value of Unexercised
In-the-Money Options
Number of Unexercised Options at 9/30/96 at 9/30/96
Shares
Acquired on Value Realized
Name Exercise ($) Exercisable Unexercisable Exercisable Unexercisable
Augustine Y. Cheung 50,000 $45,310 400,000 0 $272,480 0
Verle D. Blaha 50,000 $45,310 400,000 0 $272,480 0
John Mon 0 0 400,000 0 $272,480 0
Charles C. Shelton 0 0 400,000 0 $272,480 0
Robert F. Schiffman 0 0 100,000 0 $ 68,120 0
=========================== =============== =============== ============== ============== ============== ===============
Long-Term Incentive Plan Awards in 1996
The registrant has no "long-term incentive plan".
Future Benefits or Pension Plan Disclosure in 1996
The Company has no such benefit plans.
Director Compensation
During 1996, the Company paid to each outside board member $500 per
year. Each director receives an automatic grant of 2,000 shares of Common Stock
for each year served.
Employment Contracts and Termination of Employment and Change-In-Control
Arrangements
Verle D. Blaha. On August 15, 1996, the Company entered into a letter
agreement with New Opportunities, Ltd. ("NOL") a company controlled by Mr.
Blaha. Pursuant to the Agreement, Mr. Blaha agreed to become a director,
President and Chief Executive Officer of the Company in exchange for the Company
paying NOL the following:
1. Payment of $25,000.
2. Payment of $175.00 per hour, to a maximum of 8 hours per day,
40 hours per week regardless of actual time spent.
3. Reimbursement of business expenses and providing residential
accommodations in Maryland and all utilities.
4. Options to acquire 400,000 shares of the Company's Common
Stock for a term ending August 13, 2004 at a price of $.41.
5. Full indemnity by the Company.
6. The Agreement terminates January 27, 1997, but the Company and
Mr. Blaha anticipate that the employment relationship will
continue on similar terms.
Other
29
Stock Option Plans
The Company does not currently have any Stock Option Plans. The Company
anticipates adopting such a plan during fiscal year 1997.
Report of the Compensation Committee on Executive Compensation
The Company does not presently have a Compensation Committee, but the
Company contemplates formation of a Compensation Committee during the fiscal
year 1997.
The Compensation Committee of the Board of Directors will be composed
of two non-employee directors. The Committee will be responsible for
establishing and administering the compensation policies applicable to the
Company's officers and key personnel.
Stockholder Return Performance Graph
Federal regulation requires that inclusion of a line graph comparing
cumulative total shareholder return on Common Stock with the cumulative total
return of (1) NASDAQ Combined Index and (2) a published industry or
line-of-business index. The performance comparison appears below. The Board of
Directors and its Compensation Committee recognize that the market price of
stock is influenced by many factors, only one of which is Company performance.
The stock price performance shown on the graph is not necessarily indicative of
future price performance.
[GRAPHIC OMITTED]
30
ITEM 12. Security Ownership of Certain Beneficial Owners and Management
The following table sets forth information regarding shares of voting
securities of the Company beneficially owned as of September 30, 1996 by: (i)
each person known by the Company to beneficially own 5% or more of the
outstanding voting securities, (ii) by each director or nominee for director,
(iii) by each person named in the summary compensation table and (iv) by all
officers and directors as a group.
Name and Addresses Percentage
of Officers, Directors and Amount of of Voting
Principal Shareholders Common Stock* Securities*(1)
- ----------------------------- --------------- ---------------
Augustine Y. Cheung(2)(3)
10220-I Old Columbia Road
Columbia, MD 21046-1705 6,669,408 26.46
Verle D. Blaha(2)(5)(6)
14 Sunset Lane
North Oaks, MN 55127 1,053,186 4.18
John Mon(2)(7)
10220-I Old Columbia Road
Columbia, MD 21046-1705 566,418 2.25
Robert F. Schiffmann(2)(8)
149 West 88th Street
New York, NY 10024 310,684 1.23
Joseph M. Colino(2)
1952 Cardinal Lake Drive
Cherry Hill, NJ 08003 5,500 **
Charles C. Shelton(2)(3)
9160 Rumsey Road, Suite B-1
Columbia, Maryland 21045-1928 665,250 2.64
Revlon Group, Incorporated
and its wholly-owned subsidiary
PPI Four Corp.
767 Fifth Avenue
New York, New York 10153 1,500,000 5.95
Yue Soon Limited
287-291 Des Vouex Rd. Central,
21st Floor
Hong Kong 1,600,000 6.34
Gao Yu Wen
Zhongshan Economic Committee
Sun Wen Road
E. Shigizhongshan
Guangdong, China 4,030,000(3) 15.99
Executive Officers and
Directors as a group (6 individuals) 9,270,446 36.78
===================================== ================= ================
* Assumes exercise of all exercisable options held by listed security holders
which can be exercised within 60 days from September 30, 1996.
** Less than 1%.
31
(1) Except as noted, the above table does not give effect to an aggregate of
approximately 4,670,715 shares of Common Stock underlying outstanding stock
options and warrants held by persons not reflected in this table. Outstanding
options and warrants entitle the holders thereof to no voting rights.
(2) Director or Executive Officer.
(3) Includes 400,000 shares underlying an option exercisable commencing
May 16, 1995 through May 16, 2001 at $.35 per share.
(4) Since the end of the Fiscal Year, the Company has repurchased from Mr.
Gao 16,000,000 shares in exchange for the Company's 9.5% interest in
Aestar. Accordingly, Mr. Gao presently owns only 4,030,000 shares.
(5) Does not include 42,000 Common Shares owned by Luveral Blaha, Mr.
Blaha's wife. Mr. Blaha disclaims any beneficial ownership with respect
to said Common Shares. The Company believes Luveral Blaha owns 42,000
Common Shares.
(6) Includes 400,000 shares underlying an option to New Opportunities, Ltd,
an affiliate of Mr. Blaha's. The option exercisable commencing August
15, 1996 through August 14, 2004 at $.41 per share.
(7) Includes 400,000 shares underlying an option to Mr. Mon exercisable
commencing May 16, 1996 through May 16, 2001 at $.35 per share.
(8) Includes 100,000 shares underlying an option to Mr. Schiffmann
exercisable commencing May 16, 1996 through May 16, 2001 at $.35 per
share. Also includes 1,500 shares held by Marilyn T. Schiffmann, his
wife; 725 shares held as custodian for Erica M. Payne, UGMA NY; and 725
shares held as custodian for Robert F. Schiffmann Jr. UGMA NY.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
SMC Contract. On May 28, 1996, the Company entered into a consulting
agreement with Stearns Management Company ("SMC"). Warren C. Stearns, a nominee
to the Board of Directors, is President of SMC. Pursuant to the Agreement, SMC
has an exclusive arrangement to render services involving solicitation of
outside capital, restructuring the Company, business plans, marketing, election
of advisory personnel, adding additional directors and sale of stock by
insiders. The agreement is terminable upon 10 days written notice or otherwise
stays in effect for one year or until a registration statement covering a public
offering of the Company's securities is declared effective by the SEC.
In exchange for such services, SMC was paid $57,000 and the Company (i)
granted to SMC a transferable warrant to purchase 168,292 shares of Common Stock
(which have been assigned to Amalgam and (ii) agreed to grant to assignees of
SMC a warrant to purchase, in the aggregate, a five percent (5%) interest in the
equity of the Company as of the next registered public offering of Common Stock
of the Company. The warrants, all of which are exercisable at $0.41 per share,
contain anti-dilution provisions and are exercisable for five years and
renewable for an additional five years. Mr. Stearns is paid a per diem expense
of $1,500 per day or $190 per hour and reimbursement for expenses at cost plus
20%.
Nace Resources Contract. On August 1, 1996, the Company entered into a
Consulting Agreement with Nace Resources, Inc. ("NRI"), an affiliate of Mr.
Fuchs, chairman of the Advisory Board. The agreement requires Mr. Fuchs, as
designated consultant, to consult and advise the Company with respect to the
development and application of the Company's products and proprietary
32
technology. The term of the agreement is for a one year period with an
additional renewal period. The Company paid $75,000 to NRI and commencing August
1, 1996, shall pay $20,000 per month. NRI has agreed to defer $5,000 per month
until the Company receives $5,000,000 of gross proceeds from an offering of the
Company's stock. In addition, the Company will reimburse NRI for expenses.
In addition to the compensation due under the terms of the consulting
agreement, the Company has agreed to grant to NRI warrants to purchase 397,619
shares of Common Stock, subject to adjustment, at an exercise price of $0.41 per
share for consulting services. In addition, the Company has granted to NRI
warrants to purchase approximately 195,122 shares of Common Stock at an exercise
price of $0.41 per share in exchange for providing certain financial advisory
services to the Company in 1996. Finally, Mr. Fuchs will be entitled to
additional warrants to purchase shares of Common Stock after completion of the
next offering. The number of shares granted will depend on the offering price of
the Common Stock.
Promissory Notes. From 1987 through 1995, the Company borrowed money
from related parties. In 1996, the Company formalized such borrowings by
executing promissory notes to the following related parties:
An unsecured term note, dated June 30, 1994, payable to Dr. Augustine
Cheung, accruing interest at the rate of ten percent (10%) per annum, in the
amount of $42,669. The principal and accrued interest shall be due and payable
on its maturity date on June 30, 1998.
An unsecured term note, dated January 26, 1987, payable to Dr.
Augustine Cheung, accruing interest at the rate of twelve percent (12%) per
annum, in the amount of $78,750. The principal and accrued interest shall be due
and payable on its maturity date on January 26, 1998.
A demand note, dated May 16, 1988, payable to Yu Shai Lai, a relative
of Dr. Cheung, accruing interest at the rate of twelve percent (12%) per annum,
in the amount of $36,041.
A demand note, dated October 2, 1990, payable to Ada Lam, a former
employee, accruing interest at the rate of twelve percent (12%) per annum, in
the amount of $28,502.
The Company also may have the obligation to execute a promissory note
payable to Charles C. Shelton in the face amount of $50,000. The Company has
certain offsets available against Mr. Shelton so the final amount to be due
under this promissory note is still under negotiation.
Settlement Agreement. On October 28, 1996, the Company entered into a
Settlement Agreement with William O. Cave, a former director of the Company.
Under the terms of the Settlement Agreement, the Company paid $30,000 to Mr.
Cave and agrees to pay an additional $194,825. The Company is to use its best
efforts to pay this sum on or before February 28, 1997. If the balance owing is
not paid on or before February 28, 1997, then the outstanding balance shall
accrue interest at the rate of 15% per annum. In addition, the Company agreed to
grant to Mr. Cave warrants to purchase 56,340 shares of Common Stock at an
exercise price of $.50 per share.
Rescission Agreement. On February 16, 1995, Gao Yu Wen executed a
subscription agreement with the Company to purchase 20,000,000 shares of Common
Stock at $.50 per share or $10,000,000. The price was paid by paying $2,000,000
cash and property transferring to the Company 9.5% of the outstanding equity of
Aestar Fine Chemical Company ("Aestar"). On June 6, 1996 the Company and Gao
entered a Redemption Agreement wherein the Company renounced any interest in
Aestar and Gao agreed that upon the Company delivery $2,200,000 to Gao he would
return
33
return the 20,000,000 shares of the Company. The promise to pay $2,200,000 by
November 30, 1996 was secured by all 20,000,000 shares. On October 23, 1996, the
Company and Mr. Gao executed a Amendment by which the terms of the Redemption
Agreement were modified. Under the terms of the First Amendment, Mr. Gao agreed
to immediately convey to the Company certificates representing 16 million shares
of Common Stock. The $2,200,000 payment was reduced to $2,160,000 and the timing
was extended until December 31, 1996, with an additional three months period at
a penalty of 3/4% per month. On October 23, 1996, Mr. Gao conveyed the 16
million shares to the Company.
On April 26, 1995, the Company entered into an Investment Agreement
with Gao whereby the Company transferred $700,000 to Gao to invest as agent of
the Company at the rate of no less than 17% per annum. Gao repaid $190,000 by
September 30, 1996. The remaining amount has been forgiven as part of the
Redemption Agreement.
Rescission of Ardex Acquisition. On or about March 31, 1995, the
Company invested $400,000 in Ardex Equipment, LLC ("Ardex") and paid $50,000 to
Charles C. Shelton and Joseph Colino, who were then directors of the Company, in
exchange for a 17.1111% interest in Ardex. In 1996, the Company received $50,000
distribution from Ardex. On August 2, 1996, the Company and Ardex entered into a
binding Letter of Intent rescinding the Company's investment in Ardex (the
"Rescission"). Pursuant to the Rescission, the Company was to receive a 5-year
negotiable promissory note for $350,000 bearing interest at 8% per annum.
Interest only is paid until the principal becomes due. Principal is due upon the
first of the following events to occur: (i) completion of a public or private
offering by Ardex of $1,500,000 or more; (ii) 90 days following the year end in
sales have been or exceed $3,000,000; (iii) Ardex having a cash balance of
$800,000 or more from operations; or (iv) five years from the date of the note.
The note is to be secured by a limited guarantee of Charles C. Shelton, Joseph
Colino and John Kohlman only to the extent of their interest in Ardex and their
options in the Company. In addition, Mr. Shelton is to execute a promissory note
for $15,000; Mr. Colino is to execute a note for $22,500; and Mr. Kohlman is to
execute a note for $12,000. These notes will be secured by the same security as
the Ardex note. Under the terms of the Rescission, all of the previously
mentioned notes and ancillary documents were to have been executed on or before
August 31, 1996, but none have been delivered to the Company as of the date
hereof. The Company is continuing with its efforts to obtain the documents
contemplated by the Rescission.
Legal Fees. Charles C. Shelton, Esq. rendered legal services to the Company
throughout the year ended September 30, 1996. Mr. Shelton billed the Company
fees totalling $118,204, $92,052 of which was billed by Charles C. Shelton,
$10,000 of which was for services as an employee of Company, and $16,152 for
expenses.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES AND REPORTS ON
FORM 8-K
(a)(1) Index to Financial Statements and Supplemental Schedules
Title of Documents Page No.
Independent Auditors' Report F-1
34
Balance Sheet F-2
Statements of Operations F-4
Statements of Changes in Stockholders' Equity F-5
Statements of Cash Flows F-6
Notes to Financial Statements F-8
(a)(2) No schedules are provided because of the absence of conditions under
which they are required.
(b) Reports on Form 8-K.
The following reports on Form 8-K were filed by the Company during the last
quarter of the period covered by this report.
On August 28, 1996, the Company filed a report on Form 8-K announcing
the execution of the an exclusive license agreement with MMTC.
On September 6, 1996, the Company filed a report on Form 8-K announcing
the appointment of Verle D. Blaha as acting President and Chief Executive
Officer of the Company.
On October 23, 1996, the Company filed a report on Form 8-K announcing
the redemption of 16,000,000 shares of the Company's Common Stock from Mr. Gao
Yu Wen.
The Company filed no other reports on Form 8-K during the fourth
quarter of its fiscal year ended December 31, 1996.
(c) Exhibits.
The following documents are included as exhibits to this report:
Exhibit Description
Number
3.1 Articles of Incorporation of the Company as filed May 19,
1982 with the State of Maryland Department of Assignments
and Taxation.(1)
3.1.1 Articles of Amendment and Restatement to the Articles of
Incorporation of the Company as filed June 21, 1984 with
the State of Maryland Department of Assignments and
Taxation.*
3.1.2 Articles of Amendment to the Aritcles of Incorporation of
the Company as filed December 14, 1994 with the State of
Maryland Department of Assignments and Taxation*
3.2.1 Amendment to the By-laws of the Company adopted December 9,
1994*
35
Exhibit Description
Number
9.1 Irrevocable Proxy between Augustine Y. Cheung, as
representative of the Company and Gao Yu Wen regarding
20,000,000 shares of Common Stock dated June 6, 1996
(pursuant to the Redemption Agreement, the number of
shares governed by the proxy has been reduced to
4,000,000)*
10.1 Patent License Agreement between the Company and
Massachusetts Institute of Technology dated June 1, 1996
(Confidential Treatment Requested)*
10.2 License Agreement between the Company and MMTC, Inc. dated
August 23, 1996 (Confidential Treatment Requested)*
10.3 Letter Agreement between the Company and H.B.C.I., Inc.
dated September 17, 1996*
10.4 Letter Agreement between the Company and Herbst, Lazar,
Bell, Inc. dated october 4, 1996*
10.5 Agreement between the Company and Stearns Management
Company dated May 28, 1996*
10.6 Consulting Agreement between the Company and NACE
Resources, Inc. dated August 1, 1996*
10.7 Settlement Agreement between the Company and William O.
Cave, dated October 28, 1996*
10.8 Redemption Agreement between the Company and Mr. Sun Shou
Y. representative of Mr. Gao Yu Wen, dated June 6, 1996 and
Letter of Intent between the parties dated May 27, 1996*
10.9 Amendment among the Company, Sun Shau Yi, Ou Yang An, Gao
Yu Wen, dated October 23, 1996*
10.10 Binding Letter of Intent Concerning Rescission of Cheung
Laboratories, Inc. Investment in Ardex Equipment, LLC
between the Company and Ardex dated August 2, 1996*
10.11 Letter Agreement between the Company and New Opportunities,
Ltd., an affiliate of Verle D. Blaha, dated August 15,
1996*
10.12 Unsecured Promissory Note, dated June 30, 1994, in the
amount of $42,669 and bearing interest at ten percent
per annum, payable to Augustine Cheung*
10.13 Unsecured Promissory Note, dated January 26, 1987, in the
amount of $78,750 and bearing interest at the rate of
twelve percent, payable to Augustine Cheung*
10.14 Demand Promissory Note, dated October 2, 1990, in the
amount of $28,502 and bearing interest at the rate of
twelve percent, payable to Ada Lam*
10.15 8% Senior Secured Convertible Note*
10.16 Registration Rights Agreement*
10.17 Warrant to Purchase Shares of Common Stock of Cheung
Laboratories, Inc.*
10.18 Certificate of Warrant to Purchase Common Stock of Cheung
Laboratories, Inc. dated June 1, 1996*
10.19 Certificate of Warrant to Purchase Common Stock of Cheung
Laboratories, Inc. dated May 28, 1996*
21.1 Subsidiaries of the Registrant
23.1 Consent of Stegman & Company, independent public
accountants of the Company*
27.1 Financial Data Schedule
- ------------------
* Filed herewith
(1) Pursuant to Rule 12b-32, this exhibit is incorporated herein by
reference to the exhibits filed with respect to the Company's
Registration Statement on Form S-1, as amended, originally filed on
October 17, 1984, Registration No. 2-93826-W.
36
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
CHEUNG LABORATORIES, INC.
December __, 1996 By /s/ Verle D. Blaha
---------------------
Verle D. Blaha
Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed by the following persons on behalf of the Registrant and
in the capacities and on the dates indicated:
Signature Title Date
/s/ Verle D. Blaha Chief Executive Officer, December __, 1996
- -------------------- President and Director
Verle D. Blaha
/s/ John Mon General Manager, Treasurer December __, 1996
- ---------------------
John Mon
/s/ Dr. Augustine Y. Cheung Chairman December __, 1996
- ----------------------------
Dr. Augustine Y. Cheung
/s/ Robert F. Schiffmann Director December __, 1996
- -------------------------
Robert F. Schiffmann
/s/ Charles C. Shelton Director December __, 1996
- -------------------------
Charles C. Shelton
/s/ Joseph M. Colino Director December _, 1996
- -------------------------
Joseph M. Colino
37
CHEUNG LABORATORIES, INC.
REPORT ON AUDITS OF
FINANCIAL STATEMENTS
FOR THE YEARS ENDED
SEPTEMBER 30, 1996, 1995 AND 1994
No extracts from this report may be published without our written consent
Stegman & Company
TABLE OF CONTENTS
INDEPENDENT AUDITORS' REPORT
FINANCIAL STATEMENTS Page
Balance Sheets 1 - 2
Statements of Operations 3
Statements of Changes in Stockholders' Equity 4
Statements of Cash Flows 5 - 6
NOTES TO FINANCIAL STATEMENTS 7 - 15
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Stockholders
Cheung Laboratories, Inc.
Columbia, Maryland
We have audited the accompanying balance sheets of Cheung
Laboratories, Inc., as of September 30, 1996 and 1995, and the related
statements of operations, changes in stockholders' equity, and cash flows for
each of the three years in the period ended September 30, 1996. 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 Cheung
Laboratories, Inc., as of September 30, 1996 and 1995, and the results of its
operations and its cash flows for each of the three years in the period ended
September 30, 1996 in conformity with generally accepted accounting principles.
The accompanying financial statements have been prepared
assuming that the Company will continue as a going concern. As discussed in Note
2 of the financial statements, the Company has suffered recurring losses from
operations, which raise substantial doubt about its ability to continue as a
going concern. Management's plans regarding those matters are also described in
Note 2. The financial statements do not include any adjustments that might
result from the outcome of this uncertainty.
Towson, Maryland
November 1, 1996
F-1
CHEUNG LABORATORIES, INC.
BALANCE SHEETS
SEPTEMBER 30, 1996 AND 1995
ASSETS
1996 1995
---------------------------------
CURRENT ASSETS:
Cash $ 246,931 $ 7,238
Accounts receivable (net of an allowance for
doubtful accounts of $20,770 and $56,659 in
1996 and 1995, respectively) 154,335 137,101
Interest receivable - related parties 5,333 -
Inventories 270,952 301,279
Prepaid expenses 1,669 7,669
Other current assets 26,755 25,551
----------- -----------
Total current assets 705,975 478,838
----------- -----------
PROPERTY AND EQUIPMENT - at cost:
Furniture and office equipment 176,541 168,777
Laboratory and shop equipment 62,228 74,733
----------- ------------
238,769 243,510
Less accumulated depreciation 205,766 197,897
----------- -----------
Net value of property and equipment 33,003 45,613
----------- ------------
OTHER ASSETS:
Investment in Aestar Fine Chemical Company - at cost 8,000,000 8,000,000
Investment in Ardex Equipment, L.L.C. - at equity - 482,991
Funds held under investment contract 40,000 650,000
Notes receivable - Ardex Equipment, L.L.C. 400,000 -
Patent licenses (net of accumulated amortization
of $37,328 and $26,650 in 1996 and 1995,
respectively) 142,622 53,300
----------- ------------
Total other assets 8,582,622 9,186,291
----------- -----------
TOTAL ASSETS $9,321,600 $9,710,742
========== ==========
See accompanying notes.
F-2
LIABILITIES AND STOCKHOLDERS' EQUITY
1996 1995
--------------------------------
CURRENT LIABILITIES:
Accounts payable - trade $ 197,190 $ 228,360
Notes payable - related parties, current portion 331,712 463,685
Accrued interest payable - related parties 339,660 343,265
Accrued interest payable - other 8,417 5,264
Accrued compensation 186,459 352,498
Accrued professional fees 76,352 1,500
Other accrued liabilities 100,905 69,871
Deferred revenues 112,031 115,531
------------- ------------
Total current liabilities 1,352,726 1,579,974
------------ ------------
LONG-TERM LIABILITIES:
Note payable - related party, due after one year 8,000 2,000
Notes payable - private placement 1,205,000 -
------------ ----------
Total long-term liabilities 1,213,000 2,000
------------ --------------
Total liabilities 2,565,726 1,581,974
------------ ------------
STOCKHOLDERS' EQUITY:
Capital stock - $.01 par value; 51,000,000 shares
authorized, 41,206,360 and 39,207,664 issued and
outstanding for 1996 and 1995, respectively 412,063 392,076
Additional paid-in capital 18,555,444 18,014,854
Accumulated deficit (12,211,633) (10,278,162)
------------ ------------
Total stockholders' equity 6,755,874 8,128,768
------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS'
EQUITY $ 9,321,600 $ 9,710,742
=========== ===========
F-3
CHEUNG LABORATORIES, INC.
STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED SEPTEMBER 30, 1996, 1995 AND 1994
1996 1995 1994
--------------------------------------------------------------
REVENUES:
Hyperthermia sales and parts $ 134,006 $ 157,618 $1,025,651
Consulting service and repairs - - 60,742
Returns and allowances (60,000) - -
----------- -------------- ----------
Total revenues 74,006 157,618 1,086,393
COST OF SALES 64,406 67,350 494,946
----------- ------------ -----------
GROSS PROFIT 9,600 90,268 591,447
----------- ------------ -----------
OPERATING EXPENSES:
Selling, general and administrative 1,338,370 1,369,845 704,295
Research and development 94,012 18,546 202,569
----------- ------------ -----------
Total operating expenses 1,432,382 1,388,391 906,864
----------- ------------ -----------
(LOSS) INCOME FROM OPERATIONS (1,422,782) (1,298,123) (315,417)
COSTS INCURRED IN DEVELOPING
COSMETICS DIVISION (471,000) - -
EQUITY IN LOSS OF ARDEX EQUIPMENT,
L.L.C. - (17,009) -
GAIN ON DISPOSITION OF INVESTMENT
IN ARDEX EQUIPMENT, L.L.C. 17,009 - -
OTHER INCOME 28,808 8,620 170,997
INTEREST EXPENSE (85,506) (90,805) (184,700)
----------- ------------ -----------
LOSS BEFORE INCOME TAXES AND
EXTRAORDINARY ITEM (1,933,471) (1,397,317) (329,120)
INCOME TAXES - - (128,272)
-------------- -------------- -----------
LOSS BEFORE EXTRAORDINARY ITEM (1,933,471) (1,397,317) (200,848)
EXTRAORDINARY ITEM - Gain due
to forgiveness of debt (net of tax of
$128,272 for 1995) - - 591,728
-------------- ------------- -----------
NET (LOSS) INCOME $(1,933,471) $(1,397,317) $ 390,880
=========== =========== ==========
EARNINGS PER COMMON SHARE:
Loss before extraordinary item $(.049) $(.060) $(.012)
Extraordinary item .000 .000 .035
------- ------- -------
Net (loss) income $(.049) $(.060) $ .023
====== ====== ======
See accompanying notes.
F-4
CHEUNG LABORATORIES, INC.
STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED SEPTEMBER 30, 1996, 1995 AND 1994
Additional
Common Stock Paid-In
Shares Amount Capital Deficit Total
-------------------------------------------------------------------------------
Balances at October 1, 1993 15,900,000 $159,000 $ 6,766,704 $ (9,271,725) $(2,346,021)
Reissuance of retired shares 219,251 2,192 - - 2,192
Issuance of 2,504,400 shares of
common stock as payment of
indebtedness and expenses 2,504,400 25,044 1,261,363 - 1,286,407
Net income - - - 390,880 390,880
--------------- ------------ --------------- ------------- -------------
Balances at September 30, 1994 18,623,651 186,236 8,028,067 (8,880,845) (666,542)
Sale of common stock 20,003,000 200,030 9,801,470 - 10,001,500
Issuance of 581,013 shares of
common stock as payment of
indebtedness and expenses 581,013 5,810 185,317 - 191,127
Net loss - - - (1,397,317) (1,397,317)
-------------- ----------- --------------- -------------- -------------
Balances at September 30, 1995 39,207,664 392,076 18,014,854 (10,278,162) 8,128,768
Sale of common stock 1,299,711 12,997 406,513 - 419,510
Issuance of 698,985 shares of
common stock as payment of
indebtedness and expenses 698,985 6,990 134,077 - 141,067
Net loss - - - (1,933,471) (1,933,471)
-------------- ------------ --------------- ------------- ------------
Balances at September 30, 1996 41,206,360 $412,063 $18,555,444 $(12,211,633) $ 6,755,874
========== ======== =========== ============= ===========
See accompanying notes.
F-5
CHEUNG LABORATORIES, INC.
STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED SEPTEMBER 30, 1996, 1995 AND 1994
1996 1995 1994
----------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net (loss) income $(1,933,471) $(1,397,317) $390,880
Noncash items included in net (loss) income:
Funds held under investment contract used
for cosmetic division expenses 471,000 - -
Depreciation and amortization 18,545 13,922 13,043
Bad debt expense 51,397 180,539 11,114
Gain on disposition of investment in Ardex
Equipment, L.L.C. (17,009) - -
Equity in loss of Ardex Equipment, L.L.C. - 17,009 -
Forgiveness of debt - - (720,000)
Common stock issued for operating expenses 9,000 108,926 21,320
Net changes in:
Accounts receivable (68,631) 208,680 (80,423)
Inventories 45,327 (80,478) 167,783
Accrued interest receivable (5,333) - -
Prepaid expenses 6,000 (5,875) 5,875
Other current assets (1,204) (25,551) -
Accounts payable - trade (31,170) 15,299 30,842
Accrued interest payable - related parties 53,462 84,889 163,609
Accrued interest payable - other 3,153 (41,163) (13,133)
Accrued compensation (166,039) 51,423 174,802
Accrued professional fees 74,852 (174,606) 6,848
Other accrued liabilities 31,033 24,803 (124,497)
Deferred revenues (3,500) 105,531 (2,117)
------------ ------------ ----------
Net cash (used) provided by operating activities (1,462,588) (913,969) 45,946
----------- ------------ ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Rescission of investment in Ardex Equipment, L.L.C. 100,000 - -
Purchases of patent licenses (100,000) - -
Investment in Ardex Equipment, L.L.C. - (500,000) -
Purchase of property and equipment (10,256) (5,183) (3,384)
Funds invested - investment contract - (700,000) -
Funds returned - investment contract 139,000 50,000 -
------------ ------------ ---------
Net cash provided (used) by investing activities 128,744 (1,155,183) (3,384)
------------ ------------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from notes payable 1,205,000 - -
Payment on notes payable - related parties (48,973) - -
Payment on notes payable (2,000) (24,000) -
Proceeds of stock issuances 419,510 2,001,500 -
------------ ------------ -----------
Net cash provided by financing activities 1,573,537 1,977,500 -
------------ ------------ -----------
NET INCREASE (DECREASE) IN CASH 239,693 (91,652) 42,562
CASH AT BEGINNING OF YEAR 7,238 98,890 56,328
------------- ------------ ---------
CASH AT END OF YEAR $ 246,931 $ 7,238 $ 98,890
=========== ============ ========
See accompanying notes
F-6
Cheung Laboratories, Inc.
Statements of Cash Flows (Continued)
For the Years Ended September 30, 1996, 1995 and 1994
1996 1995 1994
--------------------------------------------
Schedule of noncash investing and financing transactions:
Stock issued as debt and accrued interest repayment:
Notes payable $75,000 $50,000 $959,230
======= ======= ========
Accounts payable $ - $ - $ 24,000
========== ========= ========
Accrued interest $57,067 $32,200 $291,666
======= ======= ========
Schedule of noncash investing and financing activities:
Proceeds of notes payable:
Increase in notes payable $ - $25,223 $ 50,000
Offset of accounts payable - (25,223) (50,000)
--------- -------- ---------
Net cash received $ - $ - $ -
========== ========= ===========
Payment on notes payable:
Decrease in notes payable $25,223 $24,000 $ -
Offset of accounts receivable (25,223) - -
--------- ---------- ----------
Net cash paid $ - $24,000 $ -
========== ======= ==========
Acquisition of a 9.5% interest in the Aestar Fine
Chemical Company in exchange for
16,000,000 shares of common stock $ - $8,000,000 $ -
========== ========== =========
Rescission of investment in Ardex Equipment,
L.L.C. in exchange for notes receivable $400,000 $ - $ -
======== ========= =========
Cash paid during the year for:
Interest $45,000 $47,079 $33,991
======= ======= =======
Income taxes $ - $ - $ -
========= ========= =========
See accompanying notes.
F-7
CHEUNG LABORATORIES, INC.
NOTES TO FINANCIAL STATEMENTS
FOR THE YEARS ENDED SEPTEMBER 30, 1996, 1995 AND 1994
1. DESCRIPTION OF BUSINESS
Cheung Laboratories, Inc. (the "Company") is in the business of providing
hyperthermia products for medical applications. The Company markets its products
internationally and was classified as a development stage company until October
1, 1989.
In an effort to diversify the Company's operations and investments,
the Company acquired an interest in the Aestar Fine Chemical Company ("Aestar")
in 1995. Aestar is located in the City of Zhongshan, China, and operates in the
cosmetic and fine chemicals business. The Company's previous business plan
relating to this investment was to use the dividend income it anticipated to
receive from Aestar for development of cosmetics and fine chemical joint
ventures. Subsequently, in 1996 the Company has reached an agreement with Aestar
to rescind this agreement.
Additionally, the Company has rescinded its interest in Ardex
Equipment, L.L.C., (Ardex) which operates in the industrial plumbing equipment
business.
2. GOING CONCERN UNCERTAINTY
The accompanying financial statements have been prepared in
conformity with generally accepted accounting principles, which contemplates
continuation of the Company as a going concern. However, the Company has
sustained substantial operating losses in recent years. In addition, the Company
has used substantial amounts of working capital in its operations.
Further, at September 30, 1996, current liabilities exceed current
assets by $646,754. The Company has defaulted on a substantial majority of its
loan agreements because cash flow is insufficient to make principal and interest
payments on a timely basis. In view of these matters, realization of a major
portion of the assets in the accompanying balance sheet is dependent upon
continued operations of the Company, which in turn is dependent upon the
Company's ability to meet its financing requirements and the success of its
future operations.
During 1996, in an attempt to focus its resources on its core
business, the Company rescinded its investment in Ardex and entered into an
agreement to rescind its investment in Aestar. The rescission of Aestar has been
disclosed in the notes to the financial statements as a subsequent event and it
had a significant impact on the Company's financial condition and stockholder's
equity. See note 14 for a further impact of the rescission.
Despite these efforts, working capital deficits continue as the
majority of cash funds raised during 1996 was in the form of the issuance of
capital stock and deft financing through private placement.
F-8
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Accounts Receivable
Accounts receivable consist of the following:
1996 1995
--------------------------
Trade receivables $138,465 $192,444
Related party receivables:
Microfocus 1,910 1,316
Ardex Equipment, L.L.C. 34,730 -
Allowance for doubtful accounts (20,770) (56,659)
--------- ---------
$154,335 $137,101
======== ========
Inventories
Inventories are stated at the lower of cost or market. Cost is
determined using the average cost matters. Inventories are comprised of the
following at September 30:
1996 1995
-----------------------------
Materials $169,752 $220,553
Work-in-process 46,062 52,449
Finished products 55,138 28,277
--------- ---------
$270,952 $301,279
======== ========
Property and Equipment
Depreciation is computed using the straight-line method for
financial reporting and accelerated methods for tax reporting purposes.
Depreciation is computed over the estimated useful lives of the assets as
follows:
Furniture and office equipment 5 years
Laboratory and shop equipment 5 years
Depreciation expense for the years ended September 30, 1996,
1995 and 1994 was $7,868, $7,259 and $6,380 respectively. Major renewals and
betterments are capitalized at cost, and ordinary repairs and maintenance are
charged against operations as incurred. Related costs and accumulated
depreciation are eliminated from the accounts upon disposition of an asset and
the resulting gain or loss is reflected in the statement of operations and
accumulated deficit.
F-9
Investments - at Equity
Investments in which the Company has a 20% to 50% interest or
otherwise exercises significant influence are carried at cost, adjusted for the
Company's proportionate share of their undistributed earnings or losses.
Otherwise, investments are carried at cost and dividend income is recognized as
earned in other income.
Patent Licenses
The Company has purchased several licenses to use the rights
to patented technologies. Patent licenses are amortized straight-line over the
remaining patent life. Amortization expense for the years ended September 30,
1996, 1995 and 1994 was $10,678, $6,663 and $6,663, respectively.
Revenue Recognition
Revenue is recognized when systems, products or components
are shipped and when consulting services are rendered. Deferred revenue includes
customer deposits received on contingent sale agreements.
Research and Development
Research and development costs are expensed as incurred.
Equipment and facilities acquired for research and development activities which
have alternative future uses are capitalized and charged to expense over their
estimated useful lives.
Net Income (Loss) Per Share
Net income (loss) per share is computed based upon common
shares outstanding during the periods after giving retroactive effect to all
stock splits and conversions. Net income (loss) is based on the actual weighted
average number of common shares outstanding during the period of 39,499,650 for
1996, 23,466,070 for 1995, and 16,912,978 for 1994.
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 reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
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4. PROSPECTIVE ACCOUNTING PRONOUNCEMENTS
Accounting for the Impairment of Long-Lived Assets
In March 1995, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 121, Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to Be Disposed Of, (SFAS No. 121).
SFAS No. 121 requires that assets to be held and used be evaluated for
impairment whenever events or circumstances indicate that the carrying value may
not be recoverable. SFAS No. 121 also requires that assets to be disposed of be
reported at the lower of cost or fair value less selling costs. Implementation
of SFAS No. 121 is not expected to have a material impact on the results of
operations or financial position. SFAS No. 121 is effective for the Company as
of October 1, 1996.
Accounting for Stock Based Compensation
In October 1995, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 123, Accounting for Stock Based
Compensation (SFAS No. 123), which is effective for the Company's year ending
September 30, 1997. SFAS No. 123 allows companies either to continue to account
for stock-based employee compensation plans under existing accounting standards
or to adopt a fair-value-based method of accounting as defined in the new
standard. The Company will follow the existing accounting standards for these
plans, but will provide pro forma disclosure of net income and earnings per
share as if the expense provisions of SFAS No. 123 had been adopted.
Implementation of SFAS No. 123 is not expected to have a material impact on
results of operations or financial condition.
5. RELATED PARTY TRANSACTIONS
Notes Receivable - Related Parties
Notes receivable due from related parties consist of the
following:
1996 1995
------------------------
Term note due August 31, 2001 from Ardex
Equipment, L.L.C., accruing interest at
8% per annum. $350,000 $ -
Term note due August 31, 2001 from the
principals of Ardex Equipment, L.L.C.,
accruing interest at 8% per annum. 50,000 -
--------- ------
$400,000 $ -
======== =====
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Notes Payable - Related Parties
Notes payable to related parties as of September 30 are
comprised of the following:
1996 1995
----------------------------
Term note payable to an officer and stockholder of
the Company, accruing interest at 10% per annum. $ 42,669 $42,669
Term notes payable to an officer and stockholder of
the Company, accruing interest at 12% per annum. 78,750 85,000
Demand note payable to relative of an officer and
stockholder of the Company, accruing interest at
12% per annum. 36,041 36,041
Demand note payable to related party of remainder
of funds borrowed for discontinued project, note
bears interest at 12% per annum. 28,502 28,502
Term notes payable to interested parties of the
Company accruing interest at 9 to 12%
per annum. 103,750 223,473
Term note payable to stockholder of the Company
accruing interest at 10% per annum payable in
monthly payments of $2,000 for 25 months. The
note is secured by all accounts receivable and
general intangibles of the Company. 50,000 50,000
--------- ---------
339,712 465,685
Less current portion 331,712 463,685
--------- ---------
Long-term portion - due in 1997 $ 8,000 $ 2,000
======== =========
Interest accrued on these notes amounted to $339,660 and
$343,265 at September 30, 1996 and 1995, respectively.
Notes Payable - Private Placement
During the year ended September 30, 1996, the Company issued
$1,205,000 in senior secured convertible notes accruing interest at 8% per
annum. The notes and accrued interest have priority over payment of any other
indebtedness of the Company. On or after the next private offering, or upon
maturity, whichever shall first occur, the holder may elect to convert the
principal amount and any accrued interest into common stock at an option price
of $.41 per share or can elect to be repaid from the proceeds of the private
offering. The notes mature and become due the earlier of the next private
offering or December 31, 1997. Interest accrued on these notes amounted to
$1,262 at September 30, 1996.
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6. INVESTMENT IN AESTAR FINE CHEMICAL COMPANY - AT COST
During 1995, the Company acquired a 9.5% equity interest in Aestar
Fine Chemical Company (Aestar) in exchange for 16,000,000 shares of its common
stock. The investment is carried at cost, as measured by the $.50 per share fair
market value of the 16,000,000 shares of the Company's common stock. There were
no dividends received during the years ended September 30, 1996 and 1995. The
common stock of Aestar is not actively traded, therefore the market value of
this investment is not readily determinable. The Company has subsequently
entered into an agreement to rescind this investment. See note 14 to the
financial statements.
7. INVESTMENT IN ARDEX EQUIPMENT, L.L.C. - AT EQUITY
The Company purchased a 19.25% equity interest in Ardex Equipment,
L.L.C. (Ardex) in 1995. The investment is carried at cost, adjusted for the
Company's proportionate share of Ardex's loss from the purchase date through
September 30, 1995. Ardex is not actively traded, therefore the market value of
this investment is not readily determinable. During 1996, the Company entered
into an agreement to rescind its investment in Ardex, the effects of which are
reflected in these financial statements.
8. FUNDS HELD UNDER INVESTMENT CONTRACT
During 1995, the issuance of 20,000,000 shares of common stock to
Mr. Gao Yu Wen enabled Mr. Gao to obtain a majority interest in the Company. Mr.
Gao has essentially recapitalized the Company through this investment of
$2,000,000 in cash and an $8,000,000 interest in Aestar. Pursuant to the terms
of an investment agreement between the Company and Mr. Gao, the Company has
invested surplus working capital funds in Hong Kong and China. At September 30,
1995, the Company had drawn $50,000 from the account, reducing the balance to
$650,000. The balance as of September 30, 1996 has been further reduced to
$40,000 to reflect $471,000 in costs incurred by Mr. Gao while developing a
cosmetic division in Hong Kong on behalf of the Company, per an agreement,
subsequently entered into to rescind the investment in Aestar Fine Chemical
Company.
9. INCOME TAXES
Income tax expense on (loss) income before extraordinary item
differs from that computed at the federal income tax rate as follows:
1996 1995 1994
------------------------------------
Income tax (benefit) at statutory rate
(34%) $(657,380) $(475,088) $(128,272)
Tax benefits not recognized 657,380 475,088 -
--------- --------- --------
Income tax (benefit) expense $ - $ - $(128,272)
=========== ========= =========
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The tax benefit of net operating losses has been completely offset
by a valuation allowance until the Company demonstrates earnings that would
utilize the net operating loss carryforwards. The 1994 tax benefit resulted from
utilizing net operating loss carryforwards as a result of a gain from the
forgiveness of debt. At September 30, 1996, the Company has net operating loss
carryforwards exceeding $10,000,000. These carryovers expire in various amounts
through the period 1997 to 2011. Due to the sale of stock to the majority
stockholder, the use of the net operating losses will be subject to an annual
limitation.
10. COMMON STOCK
During the year ended September 30, 1996, the Company issued
1,299,711 shares of common stock for $419,510, 689,985 shares were issued to
extinguish debt, and 9,000 shares were issued as payments for various operating
expenses.
During the year ended September 30, 1995, the Company issued
20,000,000 shares of common stock in exchange for $2,000,000 in cash and
$8,000,000 as a 9.5% interest in the Aestar from an investor. This transaction
enabled the investor to obtain a majority interest in the Company's common
stock. Additionally, the Company issued 3,000 shares of common stock for $1,500,
360,000 shares were issued to extinguish debt, and 221,000 shares were issued as
payments for various operating expenses.
During the year ended September 30, 1994, the Board of Directors and
stockholders authorized the issuance of 35,100,000 additional shares of common
stock. In addition 219,251 of retired shares were reissued, 2,174,800 shares
were issued to extinguish debt and 329,600 shares were issued as employee wages.
11. STOCK OPTIONS AND WARRANTS
The Company has granted stock options to certain employees on a
periodic basis at the discretion of the Board of Directors. Options are granted
at market value at the date of the grant and are immediately exercisable.
Following is a summary of stock options as of and for the year ended September
30, 1996:
For the year ended September 30, 1996:
Share options granted 2,420,000
Price range of share options granted $.35 to $.41
Options exercised 100,000
Price range of shares exercised $.35 to $.41
As of September 30, 1996:
Unexercised options outstanding 2,850,000
Weighted average exercise price $.34
Price range of outstanding options $.25 to $.41
F-14
As of September 30, 1996 there were warrants outstanding to purchase
3,320,715 shares of the Company's stock at a price of $.41 per share. The
Company is also obligated to sell additional shares to certain individuals at a
price based on future stock sales by the Company.
12. COMMITMENTS AND CONTINGENCIES
Potential Liability and Insurance
In the normal course of business, the Company may be subject to
warranty and product liability claims on its hyperthermia equipment. Currently,
the Company does not have a product liability insurance policy in effect
although management does anticipate obtaining such coverage when adequate
financial resources are available. The assertion of any product liability claim
against the Company, therefore, may have an adverse effect on its financial
condition. As of September 30, 1996, no product, warranty claims or other
liabilities against the Company have been asserted.
Warranty Reserve
The Company warrants its hyperthermia units to be free from
defects in material and workmanship under normal use and service for the period
of one year from the date of shipment. Claims have been confined to basic
repairs. Given the one year limitation of the warranty, management has elected
to not set up a warranty reserve but, instead, to expense repairs as costs are
incurred.
13. GAIN ON EXTINGUISHMENT OF DEBT
The 1994 extraordinary gain of $591,728 (net of income taxes)
results from the forgiveness of notes payable and accrued interest.
14. SUBSEQUENT EVENT - STOCK REDEMPTION
On October 23, 1996, the Company, based on the provisions of an
agreement reached on June 6, 1996, redeemed 16,000,000 shares of its common
stock.
The redemption provided for the Company to return its investment in
Aestar Fine Chemical Company (valued at $8,000,000 on the Company's September
30, 1996 balance sheet) and to relinquish its rights to the funds held under
investment contract ($40,000 at September 30, 1996) in order to affect the
transaction. This transaction has a significant impact on the financial
position, current ratios and stockholders' equity of the Company. If the
foregoing transaction had occurred on or before September 30, 1996, total assets
would have been reduced by $8,040,000, and stockholders' equity would have
decreased by $8,040,000, resulting in a total negative stockholders' equity of
$(1,284,126).
As part of this agreement, the Company has the option to redeem an
additional 4,000,000 shares owned by the Gao Group if a payment of $2,160,000 is
made on or before December 31, 1996. This deadline may be extended until March
31, 1997 with the payment of an .75% monthly interest factor.
F-15
15. SUBSEQUENT EVENT - PURCHASE OF PORTABLE X-RAY TECHNOLOGY
On August 28, 1996, the Company entered into a termination agreement
with Carlton Poor, a representative of Rainbow Ball Development Limited
("Rainbow Ball"). This agreement terminated a previous agreement with Rainbow
Ball under which the Company was to share its portable x-ray business line. The
termination agreement returns all rights to the portable x-ray business line to
the Company in exchange for 355,757 shares of the Company's common stock to be
issued in October 1996.
16. SUBSEQUENT EVENT - TERMINATION OF PURCHASE OPTION
On April 26, 1995, the Company entered into an agreement to purchase
a 50% interest in the United Aerosol and Home Products Company, LTD ("Unisol"),
located in Zhongshan, China. Unisol is a specialty chemical and fine chemical
aerosol packaging and bottle/can filling business. The purchase price was to be
20% of the appraised value of Unisol equipment, payable in the Company's common
stock at the close of business on April 26, 1996. The Unisol acquisition was
executed as part of the Gao transaction. This agreement was verbally terminated
on October 23, 1996, at the same time that the Company executed the agreement by
which the Company redeemed its stock from Mr. Gao.
F-16