-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, AsB8n1lC6IK++kky8yDqLnArYSAmME/ywWETYnX03n2Zkbeg7sjt6b5AWmUGjtS9 LZEzCQZNlBKdFLV/MY85Fw== 0000891554-99-000001.txt : 19990105 0000891554-99-000001.hdr.sgml : 19990105 ACCESSION NUMBER: 0000891554-99-000001 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 8 CONFORMED PERIOD OF REPORT: 19981003 FILED AS OF DATE: 19990104 FILER: COMPANY DATA: COMPANY CONFORMED NAME: BEI MEDICAL SYSTEMS CO INC /DE/ CENTRAL INDEX KEY: 0000851478 STANDARD INDUSTRIAL CLASSIFICATION: INDUSTRIAL INSTRUMENTS FOR MEASUREMENT, DISPLAY, AND CONTROL [3823] IRS NUMBER: 710455756 STATE OF INCORPORATION: DE FISCAL YEAR END: 0927 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 000-17885 FILM NUMBER: 99500382 BUSINESS ADDRESS: STREET 1: 100 HOLLISTER ROAD STREET 2: STE 2500 CITY: TETERBOR STATE: NJ ZIP: 07608 BUSINESS PHONE: (201) 727-4900 MAIL ADDRESS: STREET 1: 100 HOLLISTER ROAD CITY: TETERBOR STATE: NJ ZIP: 07608 FORMER COMPANY: FORMER CONFORMED NAME: BEI ELECTRONICS INC DATE OF NAME CHANGE: 19920703 10-K 1 ANNUAL REPORT UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K [X] Annual report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the fiscal year ended October 3, 1998 or [ ] Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 Commission file number 0-17885 BEI MEDICAL SYSTEMS COMPANY, INC. (Exact name of Registrant as specified in its charter) Delaware 71-0455756 -------- ---------- (State or other jurisdiction of (I.R.S. Employer Identification No.) incorporation or organization) 100 Hollister Road Teterboro, New Jersey 07608 --------------------------- (Address of principal executive offices) (Zip code) (201) 727-4900 -------------- (Registrant's telephone number, including area code) Securities registered pursuant to Section 12(b) of the Act: None ---- Securities registered pursuant to Section 12(g) of the Act: Common Stock, $.001 par value ----------------------------- Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes __X__ No _____ Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant's knowledge, in proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ] The approximate aggregate market value of the voting stock held by non-affiliates of the Registrant as of December 10, 1998 was $10,981,502 (A). As of December 10, 1998, 7,778,296 shares of Registrant's Common Stock were outstanding. (A) Based upon the closing sale price of the Common Stock on December 10, 1998 as reported on the Nasdaq National Market System. Excludes 1,921,495 shares of Common Stock held by directors, executive officers and stockholders whose ownership exceeds ten percent of Common Stock outstanding on December 10, 1998. Exclusion of shares held by any person should not be construed to indicate that such person possesses the power, direct or indirect, to direct or cause the direction of the management or policies of Registrant, or that such person is controlled by or under common control with Registrant. 1 DOCUMENTS INCORPORATED BY REFERENCE Registrant's Proxy Statement with respect to its 1999 Annual Meeting of Stockholders to be filed with the Securities and Exchange Commission is incorporated by reference into Part III, Items 10, 11, 12 and 13 of this Report. 2 TABLE OF CONTENTS Page ---- PART I Item 1. Business...................................................... 4 Item 2. Properties.................................................... 46 Item 3. Legal Proceedings............................................. 46 Item 4. Submission of Matters to a Vote of Security Holders........... 46 PART II Item 5. Market for Registrant's Common Equity and Related Stockholder Matters................................... 47 Item 6. Selected Financial Data....................................... 49 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations................. 50 Item 7a. Qualitative and Quantitative Disclosures about Market Risks... 57 Item 8. Financial Statements and Supplementary Data................... 58 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure........................ 80 PART III Item 10. Directors and Executive Officers of the Registrant............................................. 81 Item 11. Executive Compensation........................................ 81 Item 12. Security Ownership of Certain Beneficial Owners and Management......................................... 81 Item 13. Certain Relationships and Related Transactions................ 81 PART IV Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K....................................... 82 Signatures .............................................................. 86 3 PART I Except for the historical information contained herein, the following discussion contains forward-looking statements that involve risks and uncertainties. When used herein, the words, "intend", "anticipate", "believe", "estimate" and "expect" and similar expressions as they relate to the Company are intended to identify such forward-looking statements. The Company's actual results, performance or achievements could differ materially from those discussed here. Factors that could cause or contribute to such differences include, but are not limited to, those discussed in Item 1, "Business" as well as Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations." ITEM 1. BUSINESS BEI Medical Systems Company, Inc. ("BEI Medical" or the "Company") develops, manufactures and markets a broad array of advanced systems and devices for minimally invasive diagnostic and therapeutic procedures in the field of gynecology. BEI Medical has an existing base of systems and devices it currently markets to gynecologists in over 5,000 hospitals, clinics and office-based practices in the United States and in 45 other countries worldwide. The Company's systems and devices include both disposable and reusable medical instrumentation used in the diagnosis and treatment of selected high incidence gynecological conditions affecting the cervix, uterus and other aspects of the reproductive system, as well as products used to facilitate oncological procedures and perform pelvic reconstructive surgery. The Company believes its existing product lines serve as a platform from which it can develop and introduce innovative products to provide gynecologists with a comprehensive selection of technologically advanced systems and devices. Currently, BEI Medical is focusing its development and commercialization efforts on three systems, including: i.) the Hydro ThermAblator(R) ("HTA(R)") to treat menorrhagia, or excessive uterine bleeding, ii.) bipolar electrosurgical therapy systems to perform LLETZ procedures and treat uterine fibroids, and iii.) the Corson Office Hysteroscopy System (TM) to provide advanced uterine visualization capabilities. BEI Medical believes these new products complement existing product lines and will allow the Company to leverage its established direct sales force to market to both new and existing customers. Industry Overview Women's healthcare represents a large and rapidly growing segment of healthcare expenditures. Government spending on women's healthcare for Medicare and Medicaid benefits alone is expected to exceed $200 billion in 1998. Women rely on their gynecologists for specific healthcare needs from puberty, through their childbearing years, to menopause and beyond. The National Ambulatory Care Survey, conducted by the National Center for Health Statistics, indicates that women in the United States make over 51 million visits to OB/GYN offices annually. Additionally, as the women's population ages, the number of visits annually and the incidence of gynecological conditions requiring diagnosis and treatment will increase. The Company believes that better informed women, combined with the fact that nearly half of the gynecologists under the age of 45 are women, has resulted in a 4 heightened awareness of women's health issues. As a result, women are driving the demand for and implementation of new and innovative diagnostic and therapeutic procedures. In view of these developments, HMO's have become more responsive to women's healthcare needs by increasingly authorizing patients to go directly to gynecologists, who are more aware of the latest technologies and procedures available for treating gynecological conditions than are the patients' primary care physicians. Functioning as the gatekeeper, the gynecologists are in a position to determine and recommend which technologies and procedures are most appropriate for their patients. Minimally invasive surgical techniques were developed in response to the desire by physicians and patients for lower risk, less traumatic surgical procedures. Minimally invasive procedures reduce anesthesia requirements, do not require extensive post-operative follow-up, reduce the risk of post-operative complications, and shorten the recovery period, allowing patients to return to productive lifestyle activities sooner. Gynecologists have long utilized minimally invasive techniques such as laparoscopy and hysteroscopy, and have recently added endometrial ablation to their outpatient approach to therapy. The acceptance of these procedures by the healthcare industry and the subsequent development of the ability to perform them on an outpatient basis have contributed to cost containment and greater efficiency in the delivery of healthcare services. In response to these pressures, hospitals are focusing on a limited number of specialties and shifting an ever-increasing percentage of surgical procedures to an outpatient basis to avoid the costs associated with the patient remaining in the hospital overnight. Current estimates indicate that outpatient surgery represents 70% of the total surgical market, and includes laparoscopy, hysteroscopy and endometrial ablation. As a result, freestanding outpatient surgery centers are the fastest growing segment of the healthcare market. The Company believes it is well positioned to provide innovative systems and devices used in minimally invasive procedures which may allow certain gynecological procedures to be performed in an outpatient setting in a safe and cost-effective manner. Business Strategy The Company's goal is to become a leading provider of minimally invasive advanced systems and devices to be used in an outpatient setting serving the specific needs of gynecologists and their patients. Its special emphasis is on the diagnosis and treatment of disorders and conditions of the cervix, uterus and other aspects of the reproductive system and particularly to offer alternatives to existing procedures for the treatment of abnormal bleeding and uterine fibroids. The key components of the Company's strategy are as follows: Offer a Broad Gynecological Product Line. BEI Medical intends to continue to offer a broad array of minimally invasive gynecological systems and devices to its existing customer base of gynecologists in over 5,000 hospitals, clinics and office-based practices in the United States and 45 other countries worldwide. The Company plans to develop and expand its market share through 5 internal development, licensing and acquisition of additional complementary product lines. Leverage Existing Base of Customer Relationships. The Company's sales force can leverage its existing customer relationships by introducing newly developed or acquired systems and devices that are complementary to the Company's existing product lines. In addition, the Company intends to expand its base of customers through the introduction of new products, such as the HTA system and bipolar electrosurgical therapy systems for LLETZ treatment of abnormal cervical tissue and for treatment of uterine fibroids. Develop and Commercialize Innovative Technologies. BEI Medical intends to continue to develop cost-effective, minimally invasive technologies that complement its existing product lines and provide new market opportunities. The Company is currently directing product development efforts at international commercialization of its Hydro ThermAblator system and is conducting its United States Food and Drug Administration ("FDA") Phase III clinical trials in the United States. The HTA is intended to provide a minimally invasive alternative treatment to hysterectomy and other procedures currently used to treat menorrhagia, or excessive uterine bleeding. Acquire and License Complementary Technologies. BEI Medical intends to continue to expand its product line through selective business acquisitions and licensing of complementary technologies. In 1997, the Company acquired rights to distribute Gyne-Tech's colposcope and cryosurgery systems to diagnose and treat conditions of the cervix. Also in 1997, the Company acquired exclusive rights from Valley Forge Scientific Corporation to distribute specialized patented bipolar electrosurgical therapy systems for LLETZ treatment of abnormal cervical tissue and for treatment of uterine fibroids. The Company is also focused on commercialization of the Corson Office Hysteroscopy System providing an advanced uterine visualization system for gynecologists. The Company licensed exclusive manufacturing and marketing rights to that product in 1996. Expand Global Sales and Marketing. The Company plans to increase market penetration through the expansion of its direct sales and marketing activities targeting the more than 33,000 gynecologists practicing in the United States. Within the past year the Company has broadened its sales force in the United States by adding 61 independent field sales representatives to complement its 12 person inside sales force. BEI Medical plans to penetrate international markets further through expansion of its network of distributors. In addition, the Company intends to sponsor or participate in clinically based seminars conducted by the Company's clinical investigators to familiarize practitioners with innovative systems and devices, such as the HTA and the bipolar electrosurgical therapy system, and to teach their uses. The Company also plans to continue to support its sales and marketing efforts through participation in trade shows, both nationally and regionally and through periodic distribution of a specialty direct mail catalogue. Expand Key Relationships with Leading Clinicians. BEI Medical has developed working relationships with key clinicians regarding the evaluation and use of innovative products and procedures that address gynecological conditions. The Company has formed a Scientific Advisory Board consisting of leading practitioners, which consults on the refinement of existing lines, on the development of new products, on the evaluation of new technologies and 6 treatment approaches, and on changes in healthcare reimbursement policies and practices. Existing Base of Products The Company currently manufactures and markets a line of minimally invasive systems and devices for the diagnosis and treatment of high incidence gynecological conditions affecting the cervix, uterus and other aspects of the reproductive system, as well as products used to facilitate oncological procedures and perform pelvic reconstructive surgery. The Company currently markets over 500 products to an existing base of gynecologists in over 5,000 hospitals, clinics and office-based practices in the United States and to distributors in 45 other countries worldwide. Management believes the Company has demonstrated core competencies in developing the technologies necessary to manufacture a variety of products used in gynecological procedures, including visualization, energy delivery, gas pressure/flow control, fluid delivery, microprocessor-controlled systems, catheter technology and surgical instrumentation/fabrication. BEI Medical intends to leverage these competencies, as well as its existing base of customers, to continue to develop and market new products in the field of gynecology. The Company believes that by providing a broad array of systems and devices, it will continue to differentiate itself to its customers from single product or narrow product offering suppliers. The Company currently sells a line of specialty instruments, procedure kits, disposables and equipment for gynecologists, as outlined in the following table. - -------------------------------------------------------------------------------- Clinical Target Key Products - -------------------------------------------------------------------------------- Cervix o Bi-Safe I(TM) bipolar electrosurgical generator and bipolar LLETZ electrode system, for removal of abnormal tissue from the cervix* o Colposcopy instruments, including biopsy forceps and specula o Gyne-Tech (TM) colposcopes systems, for tissue destruction o Gyne-Tech cryosurgical systems, for tissue destruction o OS Finder(TM) dilator, for cervical canal access o Plus II(TM) monopolar generator and monopolar LLETZ Plus(TM) electrodes, for removal of abnormal tissue from the cervix - -------------------------------------------------------------------------------- Uterus o Corson Office Hysteroscopy System, with ancillary instruments, for examination and therapy of the inner surface of the uterus o Hydro ThermAblator, for treatment of excessive menstrual bleeding** o Hysteroscopic Insufflator, for precise control of uterine distension* o Z-Sampler(TM) endometrial suction curette, for tissue sampling to detect carcinoma or precancerous conditions* - -------------------------------------------------------------------------------- 7 - -------------------------------------------------------------------------------- Clinical Target Key Products - -------------------------------------------------------------------------------- Infertility o Corson Office Hysteroscopy System, with ancillary Diagnosis instruments, for examination and therapy of the inner surface of the uterus o Hysteroscopic Insufflator, for precise control of uterine distension o Laparoscopic Insufflator, with high flow capability to maintain proper peritoneal cavity distension* o OS Finder dilator, for cervical canal access o SHG catheter, for distension during sonohysterography o Z-Sampler endometrial suction curette, for endometerial dating and to monitor hormonal therapy effects* o ZUI(TM) uterine injector, for hysterosalpingography o ZUMI(TM) uterine manipulator/injector, for manipulation of the uterus and injection of contrast media* - -------------------------------------------------------------------------------- Oncological o Endo-Sock(TM)/Mega Pouch, for laparoscopic tissue Surgery and removal* Pelvic Reconstruction o Laparoscopic Insufflator, with high flow capability to maintain proper peritoneal cavity distension* o MIYA Hook(TM), for pelvic suspension surgery o Nichols-Veronikis Ligature Carrier, for pelvic suspension surgery* o Soderstrom LAVH Manipulator(TM), for laparoscopically assisted hysterectomy o Z-Clamps(TM) & Z-Scissors(TM), specially designed instruments for hysterectomy - -------------------------------------------------------------------------------- * Proprietary technologies for which the Company or the manufacturer owns or licenses patents. See "Risk Factors -- Reliance on Patents and Protection of Proprietary Technology" ** Not available in the United States New Products and Technologies The Company intends to develop, license and acquire new complementary technologies that it plans to phase into future product offerings. The Company has focused its recent efforts on the development and commercialization of the following systems: o The patented Hydro ThermAblator system for treatment of menorrhagia, or excessive uterine bleeding. o Specialized proprietary bipolar electrosurgical therapy systems used for LLETZ treatment of abnormal cervical tissue and for treatment of uterine fibroids. o The Corson Office Hysteroscopy System for improved uterine visualization. 8 o These new products and their potential are more fully discussed below. See "Risk Factors -- Uncertainty of Market Acceptance." The female reproductive system consists of the uterus, ovaries and fallopian tubes. The uterus is a highly vascular, muscular organ which lies below the abdomen in the pelvis. Although the size and shape of a normal uterus can vary significantly, the uterus is typically a pear shaped organ about 7 to 8 cm long and 4 to 5 cm at its widest point. Within the uterus lies the cavity where fetal development takes place during pregnancy. The cavity is lined by the endometrium, which is filled, with tiny blood vessels. The endometrium can vary in depth from 1 mm to over 10 mm. The thick muscular layer surrounding the endometrium is called the myometrium. The bottom of the uterus is known as the cervix. The cervix is richly supplied with nerves, making it the most sensitive portion of the uterus. The cervix leads to the vagina, a muscular tube that leads to the exterior of the body. Extending from each side near the top of the uterus are the fallopian tubes that lead to the two ovaries. The fallopian tubes are very narrow, convoluted in shape, with many folds, and are delicate and difficult to access. As a result, they do not lend themselves to easy study and treatment. The ovaries' primary functions are to secrete hormones, such as estrogen, and store the female reproductive cells or ova. The fallopian tubes transport the ova to the uterus for fertilization as part of the monthly menstrual cycle. The fallopian tubes are the organs in which conception occurs and at least one fallopian tube must be open to permit the passage of sperm. The fallopian tubes serve a critical function in the reproductive process and are often the focus of treatment when the objective is to increase a women's reproductive potential, such as in the treatment of infertility. Normal menstruation is a 28-day cycle that repeats itself throughout a woman's reproductive life. This cycle is controlled by the interaction between pituitary and ovarian hormones and is associated with the release of an egg from its ovary for possible fertilization. The ovaries secrete estrogen and a second hormone, progesterone, which causes the endometrial lining to thicken, preparing it to receive and nourish a fertilized egg. If an egg is fertilized, it implants into the endometrium and is nourished by the rich endometrial blood supply. If the egg is not fertilized, levels of estrogen and progesterone decrease, the coil shaped arteries supplying the endometrium with blood constrict, and the endometrial lining breaks down and is shed during menstruation. Menstruation typically begins between the ages of 11 and 14 years and ends between the ages of 45 and 55 with the onset of menopause, correlating with the diminution of ovarian functional and hormonal production. At that time, the menstrual cycle becomes irregular and eventually ceases completely. The Hydro ThermAblator or HTA Abnormal Uterine Bleeding Approximately 2.5 million women each year in the United States seek medical treatment from their gynecologists for abnormal uterine bleeding. Abnormal uterine bleeding includes disorders of the menstrual cycle, such as irregular bleeding, and menorrhagia, or excessive uterine bleeding (defined as total 9 blood loss exceeding 80 ml per menstrual cycle or prolonged bleeding beyond seven days). Abnormal bleeding is considered a symptom of an anatomic irregularity, hormonal imbalance or a systemic disease. Commonly, however, it is the result of disorders within the uterus itself, such as fibroids and, more rarely, endometrial cancer. Abnormal uterine bleeding can also be caused by other factors, including medication side effects from post-menopausal hormone replacement therapy, miscarriage and retained tissue after child birth. Today, there are over 31 million post-menopausal women in the United States and over seven million are receiving hormonal replacement therapy. These women may experience a return to undesired menstrual bleeding as a consequence of hormonal replacement therapy. Various drug therapies and surgical approaches are available for treatment of abnormal menstrual bleeding. Treatment of abnormal menstrual bleeding usually begins conservatively with drug therapy and, if necessary, proceeds to more invasive surgical methods. The traditional approach to treatment of menorrhagia, or excessive uterine bleeding has included hormonal therapy, dilation & curettage ("D&C"), and ultimately hysterectomy. Hormonal therapy can be effective in many cases, however, the therapy can be of long-term duration at considerable monthly expense and menorrhagia may persist despite hormonal therapy. D&C is commonly performed, although a significant percentage of the endometrial lining of the uterus may be missed, and there is little evidence that D&C provides any meaningful long-term benefit. Many of the nearly two million women who annually receive hormonal therapy or D&C fail to have satisfactory resolution of their excessive bleeding problem. Hysterectomy, the surgical removal of the uterus with accompanying risks of post surgical complications, has historically been the ultimate solution offered for long-term relief to women who continue to bleed despite hormonal therapy or D&C. Of the approximately 600,000 hysterectomies performed annually in the United States, it has been estimated that more than 150,000 are performed for the relief of heavy bleeding from benign causes. Considerable attention has been focused on the frequency with which hysterectomy is performed, suggesting that many of the procedures were not necessary. Rather than removing the uterus, alternative approaches to the treatment of excessive uterine bleeding have been attempted. The first successful endometrial ablation procedures, utilizing laser photovaporization of the endometrium, were published in 1981 in the Journal of the American Association of Gynecologic Laparoscopists. By 1990, reports appeared regarding the successful use of a urologic resectoscope to deliver electrosurgical current as the means of coagulating the endometrium. Both of these surgical endometrial ablation techniques require significant distention of the uterus to create working space. A risk of excessive absorption of non-conductive (salt free) fluid into the vessels of the uterus also exists due to the high pressures (100-150 mmHg) used to distend the uterine cavity. When significant amounts of this non-physiologic fluid is absorbed, the resulting fluid overload can cause hyponatremia (dilution of body fluids resulting in electrolyte imbalance), pulmonary edema (fluid in the lungs), cerebral edema (swelling of the brain), and even deaths have been reported. Both of these surgical ablation techniques require the tedious "painting" of the entire lining of the uterus to control depth of thermal destruction, as 10 well as attention to safety issues (i.e., perforation or hemorrhage) throughout the typical 30-60 minutes required to complete treatment of the entire lining of the uterus under general anesthesia. While these surgical endometrial ablation techniques offer advantages over traditional hysterectomy, clinical results are extremely dependent on the skill and experience of the surgeon. In general, because of the technical proficiency required to achieve good results, the time required to complete the procedure, and the risks associated with laser and electrosurgical roller-ball ablation, neither of these ablation techniques have become widely popular. Other non-surgical techniques for treatment of excessive uterine bleeding are under development and in various stages of FDA clinical trials, including devices that employ fluid-filled heated balloons, electrodes on the surface of a balloon, microwave energy, radio frequency (RF) currents, and cryosurgery (freezing). Two such devices, the ThermaChoice balloon from Gynecare (a subsidiary of Johnson & Johnson) and the VestaBlate from Valleylab, (a subsidiary of U. S. Surgical/Tyco) have recently received permission from the FDA to market in the United States. The Company believes that these devices are limited in their effectiveness due to their inability to fully conform with the convoluted surface of the entire uterine lining, their inability to reach into narrow cornual areas, and their inability to conform to the shape of a broad range of uterine sizes. Further, these devices do not allow the gynecologist to visualize the uterine cavity prior to treatment, to definitively confirm proper placement inside the uterine cavity to observe treatment, or to immediately evaluate the effect of treatment, because they do not include hysteroscopic capability. Recently the United Kingdom Department of Health, Medical Devices Agency, notified medical administrators, surgeons and nurses of reports of a number of incidences of uterine perforation and injury to adjacent organs involving devices for endometrial ablation by thermal means. The notice advised practitioners to verify the correct placement of such devices within the uterus prior to their use. The Company believes the HTA will reduce the risk of perforation due to its integral hysteroscope, which provides visual confirmation of uterine anatomy and verification of instrument position. The characteristics of various endometrial ablation technologies currently under development or commercialization are outlined below. 11
Comparison of Endometrial Ablation Technologies - ----------------------------------------------------------------------------------------------------------------------- Compatibility With Varying Method of Uterine Size & Pressurization of Device Technology Introduction Location of Energy Source Shape the Uterine Cavity - ----------------------------------------------------------------------------------------------------------------------- Balloon containing heated Blind insertion Heater inside balloon, inside Low High, fluid uterus 150+ mmHg - ----------------------------------------------------------------------------------------------------------------------- Balloon with conductive Blind insertion External electrosurgical Low High, electrodes generator, electrodes inside 150+ mmHg uterus - ----------------------------------------------------------------------------------------------------------------------- Microwave probe Blind insertion External microwave generator, Low Not applicable applicator inside uterus - ----------------------------------------------------------------------------------------------------------------------- Cryogenic probe Blind insertion External unit, probe inside Low Not applicable uterus - ----------------------------------------------------------------------------------------------------------------------- Conductive mesh electrode Blind insertion External electrosurgical Low Vacuum generator, electrode inside uterus - ----------------------------------------------------------------------------------------------------------------------- Free fluid circulation Blind insertion Heater inside probe, inside High Low, probe uterus < 50 mmHg - ----------------------------------------------------------------------------------------------------------------------- Free fluid circulation Insertion with External Heater, circulation to High Low, hysteroscope visual control, uterus < 50 mmHg connected to Hydro ThermAblator video monitor - -----------------------------------------------------------------------------------------------------------------------
The Hydro ThermAblator Solution The Company has developed the patented Hydro ThermAblator (HTA) technology as an alternative to existing treatments for menorrhagia, or excessive uterine bleeding, as well as other proposed ablation treatments currently under development. Management believes that the patented HTA offers distinct advantages compared to existing and emerging ablation technologies for the treatment of excessive uterine bleeding: o Integral hysteroscope provides visual confirmation of uterine anatomy and instrument position, as well as continuous observation of treatment effect. 12 o Variation in uterine size and shape are easily accommodated by freely circulating heated saline. o Freely circulating heated saline allows even and complete treatment of the entire endometrium. o Low pressurization of the uterine cavity reduces risk and patient discomfort. o Does not require extensive training prior to use. o Clinical outcome is not dependent on user experience or variation in technique. o Minimally invasive short duration procedure with limited risk. The Company's initial target market for the HTA is the 150,000 hysterectomies performed in the United States annually for menorrhagia or excessive menstrual bleeding from benign causes. Additionally, the Company has identified a market opportunity among the nearly two million women suffering from abnormal uterine bleeding in the United States for whom the prospect of long-term hormonal therapy or repeated D&C procedures is undesirable, or for whom such treatments are ineffective. The Company also believes that a market opportunity exists among the over seven million post-menopausal women who are currently receiving hormonal replacement therapy that can result in an undesirable resumption of menstrual bleeding. BEI Medical also believes marketing opportunities will develop among women seeking a cessation of menstruation, either electively as a lifestyle choice or in conjunction with tubal sterilization. The HTA System The HTA has been designed to offer the gynecologist a minimally invasive, non-surgical method to treat excessive uterine bleeding in an outpatient or office setting. The HTA consists of a portable treatment unit, incorporating microprocessor control of fluid temperature and fluid circulation. The mobile unit provides a drawer for procedure supplies, and a shelf to house the Company's Integrated Video System ("IVS") for display of the hysteroscopic image on a video monitor. Precisely heated saline is circulated within the patient's uterus, under the direct visual control of the gynecologist, for approximately ten minutes to cause ablation of the entire endometrial lining. By utilizing freely circulating heated saline at low pressure to distend the uterine cavity, thermal energy is evenly transferred to all areas of the uterine cavity including the areas of the cornua (the area where the fallopian tubes enter the uterus) which can be difficult to treat with other devices. The use of physiologic saline eliminates concerns about fluid absorption overload, and low pressure prevents escape of fluid from the fallopian tubes. The incorporation of a hysteroscopic telescope provides visual control during introduction, positive visual confirmation of proper placement within the uterine cavity as well as continuous visualization of the effects of the treatment. The digital displays of the HTA control unit guide the user through the HTA procedure, providing step-by-step visual prompts that facilitate ease of use and consistent results. During the procedure an automated microprocessor system controls the ablating temperature and monitors fluid volume to measure and reduce possibilities of fluid absorption or loss and assure consistent treatment effect without depending on user skill level. At any time, the gynecologist can interrupt the treatment and, if desired, the 13 circulation of room temperature saline will rapidly cool the patient's uterus. As a result of ablation of the endometrial lining of the uterus, the regeneration of the endometrium and resulting periodic menstrual bleeding is either significantly reduced or eliminated. Results of Clinical Trials The Company completed FDA required Phase I clinical trials with 20 patients in April 1996, and was given permission to proceed to a Phase II trial of the HTA. Phase II treatments of 20 patients were completed in December 1997. Follow-up outcome data from the Phase II patients was compiled and submitted to the FDA in June 1998. This outcome data compared favorably with the results of alternative therapies, showing an amenorrhea rate of 57.9%, at six months follow-up examinations. When these patients whose menstrual bleeding was eliminated are grouped with the remainder of the patients whose menstrual bleeding was significantly reduced, the overall success rate was 94.7%. A protocol violation related to pharmaceutical administration required that one patient be removed from consideration in the study, with only one of the remaining 19 patients (5.3%) failing to show an improvement from HTA treatment. There is no assurance the Phase III results will be consistent with the results obtained by the Company in its Phase II trials or that they will support the safety and efficacy of the HTA. The Company received approval to begin Phase III Clinical Trials in August 1998, and the first treatments were conducted in September 1998. BEI Medical has initiated its Phase III clinical trials at 11 sites and will treat 276 patients suffering from menorrhagia, or excessive uterine bleeding. The study will compare the safety and efficacy of the HTA endometrial ablation treatment to electrosurgical rollerball ablation, one of the current treatments for excessive uterine bleeding. The Company anticipates completing the treatment phase of the clinical trials in early 1999. Data from examinations one year following treatment is required for approval of its premarket approval ("PMA") application, but the Company will begin submitting six-month data to the FDA when it becomes available. There can be no assurance that any data obtained from the Phase III trial will support the safety and effectiveness of the HTA. Failure of the data to support the safety and effectiveness of the HTA would have a material adverse effect on the Company's business. Certain international markets will require similar regulatory approvals. The Company has received permission from Lloyd's Registered Quality Assurance Ltd. ("LRQA"), the Company's "notified body", to apply the CE Mark to the HTA and to the sterile disposable HTA Procedure Kit. In February 1997, the Company selectively initiated deliveries of HTA systems in some of those countries where regulatory authorities permit sales. On this basis, deliveries have been made in Belgium, Brazil, France, Hong Kong, Israel, Italy, Germany, New Zealand, Portugal, Spain, Switzerland, and in the United Kingdom. Recently, regulatory authorities in Australia and in Canada have granted permission for the sale of the HTA system. Over 340 treatments using the HTA have been completed worldwide, demonstrating its ease of use. Management is encouraged by the follow-up of patients at selected international sites, which now exceeds 18 months. The Company believes the pattern of patient follow-up condition reflects results that are consistent with traditional laser and electrosurgical ablation methods and superior to other emerging technologies. See "Business - Government Regulation." 14 Rights Granted Johnson & Johnson Development Corporation In connection with a $1.5 million equity investment in the Company in February 1996, Johnson & Johnson Development Corporation ("J&J") received a right of first negotiation to manufacture and/or distribute any product primarily intended for use in endometrial ablation acquired or developed after the date of the agreement ("Ablation Products") and the right to consult in connection with FDA applications with respect to such Ablation Products. The right of first negotiation is effective for a ninety-day period commencing on the earlier of i.) J&J's notice to the Company of its desire to manufacture and/or distribute an Ablation Product and ii.) the date the Company notifies J&J of approval from the FDA to market an Ablation Product. In the event that the parties are unable to agree upon mutually acceptable terms, then the Company may either manufacture and/or distribute the Ablation Product itself or enter into an agreement with a third party on terms that in the aggregate are not materially less favorable to the Company than those offered by J&J. In addition, the Company may enter into agreements with third parties prior to the J&J negotiation period, provided such agreements are terminable by the Company within two years after the Company and J&J enter into a manufacturing and/or distribution agreement. Depending upon the timing and progress of clinical trials, the Company expects that the HTA system may be subject to J&J's right of negotiation and consultation. Bipolar Electrosurgical Therapy System In July 1997 the Company licensed the rights to market proprietary bipolar electrosurgical therapy systems to perform LLETZ procedures to treat abnormal cervical tissue and to treat uterine fibroids. The Company markets and distributes new, proprietary bipolar electrosurgical therapy systems which eliminate the risk of alternate site burns associated with currently available monopolar electrosurgical systems because energy travels only through the tissue joining the two small active electrodes at the treatment site. The bipolar electrosurgical therapy systems were introduced to the United States market at the American College of Obstetricians and Gynecologists (ACOG) annual meeting in May 1998. LLETZ Procedures More than 50 million PAP tests are performed annually in the United States, of which approximately 5-7% are interpreted as abnormal. These patients are candidates for further diagnosis, which often takes the form of magnified examination of the suspicious tissue utilizing a colposcope. When abnormal tissue is recognized during a colposcopic examination, the gynecologist can perform electrosurgical excision of lesions from the cervix, a procedure known as LLETZ (Large Loop Excision of the Transformation Zone). Since 1990, the LLETZ procedure has become a standard approach to care in the clinical office practice of most gynecologists. These LLETZ procedures have been done using monopolar electrosurgical systems. The use of monopolar electrosurgical systems requires the use of an external return electrode and the use of insulated ancillary instruments. Electrosurgical energy in a monopolar system flows along a random pathway from the point of contact of the active electrode, through the patient's body, seeking the external return electrode. Alternative ground pathways in contact with the patient's body present a risk 15 of alternate site burns as the electrosurgical energy exits the patient's body at a point other than the external return electrode. The use of the bipolar LLETZ system removes the requirement for the use of insulated ancillary instruments and can reduce the overall cost of the disposable components required for treatment through the use of a proprietary design bipolar electrode and the elimination of the requirement for a patient return electrode. The following are advantages of BEI Medical's bipolar electrosurgical therapy systems when employed for LLETZ treatment: o Patented electrode design provides precise area of electrosurgical effect. o Reduces overall cost of disposable components through elimination of items required for monopolar treatments. o Eliminates risk of alternate site burns associated with monopolar technology. o Eliminates need for insulated ancillary instruments. Fibroid Treatments During the course of their lives, it is estimated that as many as 50% of all women will develop uterine fibroids (benign tumors, also known as myomas). Uterine fibroids can cause an enlargement of the uterus that puts pressure on the bladder, resulting in frequency of urination or incontinence; if the fibroid grows towards the back, pressure can cause lower back pain, discomfort with activity or intercourse, or constipation. A fibroid may cause sterility if it blocks the fallopian tube. It may also interfere with fetal growth, and may cause difficult childbirth. Fibroid growth is stimulated by estrogen, and hormonal drug therapies exist which can be used to shrink fibroids on a short-term basis only. These drugs, which block the production of estrogen by the ovaries, do not offer a long-term solution since side effects mimic menopause. Although the majority of women with fibroids may never have symptoms that require treatment, it is estimated that 30% of the 600,000 hysterectomies performed annually in the United States are the choice of last resort for symptomatic fibroids. Fibroids can grow either subserosally (near the outer surface of the uterus) or submucousally (inside the uterus). Symptomatic subserosal fibroids are often treated by hysterectomy, but can also be surgically removed through a myomectomy, thus leaving the uterus intact. Myomectomies require a similar surgical approach as an abdominal hysterectomy and can expose the patient to significant risk. When the fibroid is excised during a myomectomy, there is a risk of hemorrhage due to the vascularity of the uterus wall and the uterine wall requires repair with sutures to regain its structural integrity. Recently a laparoscopic technique has been introduced to remove subserosal fibroids which requires the surgeon to puncture the uterine wall and cut the fibroid into small pieces with a mechanized device. This procedure is highly skill dependent and can result in adhesion (scar tissue) formation between the uterine wall and adjacent organs. BEI Medical's BiSafe(R) bipolar electrosurgical therapy system includes specially designed laparoscopic needle electrodes for a treatment of fibroids, 16 known as myolysis. Utilizing laparoscopic visualization, the surgeon introduces the bipolar needle electrode, retracted into its protective sleeve, through a small puncture in the abdominal wall. The electrodes are advanced and introduced into the fibroid tissue, and bipolar electrosurgical energy desiccates the fibroid and destroys its blood supply. This procedure can be repeated if there are multiple fibroids. In the weeks following the treatment, the fibroid(s) shrink in size, relieving the symptoms caused by the original growth of the fibroid(s), avoiding the need for complete surgical removal. The Company plans to introduce the laparoscopic portion of the BiSafe system to the market in calendar year 1999. The gynecologist can treat submucousal fibroids using a hysteroscopic resectoscope, an instrument adapted from urology, to electrosurgically shave away fragments of the fibroid. This technique requires significant distension of the uterus to create working space with the risk of excessive absorption of non-conductive (salt free) fluid into the vessels of the uterus due to the high-pressures (100-150 mmHg). When significant amounts of this non-physiologic fluid is absorbed, fluid overload can cause hyponatremia (dilution of body fluids resulting in electrolyte imbalance), pulmonary edema (fluid in the lungs), cerebral edema (swelling of the brain), and even deaths have been reported. This technique requires precise control of the depth of thermal destruction caused by the monopolar electrosurgical energy used to cut and coagulate. While this surgical technique offers advantages over traditional hysterectomy, clinical results are extremely dependent on the skill and experience of the surgeon. BEI Medical's BiSafe bipolar electrosurgical therapy system to treat submucousal fibroids is being expanded to include: i.) specially designed bipolar needle electrodes to shrink fibroids and ii.) specially designed resectoscope electrodes to allow the gynecologist to shave away fragments of a fibroid without the major risks of traditional systems. Much of the risk of excessive absorption of non-conductive fluid associated with the use of existing monopolar resectoscope systems is eliminated, since the patented bipolar system will allow use of physiologically compatible fluids to distend the uterine cavity. The Company intends to introduce the hysteroscopic portion of the BiSafe system in late calendar year 1999. The following are advantages of BEI Medical's bipolar electrosurgical therapy systems when employed for subserosal and submucousal fibroid treatment: o Minimally invasive techniques to avoid hysterectomy and surgical myomectomy. o Potential to preserve reproductive function by saving the uterus. o Bipolar hysteroscopic electrodes minimize risk of fluid overload through use of saline. o Bipolar electrosurgical technology eliminates damage to adjacent organs caused by random pathway monopolar current. o Eliminate risk of alternate site burns associated with monopolar technology. 17 The Corson Office Hysteroscopy System The need to provide a definitive diagnosis of uterine abnormalities led to the development of hysteroscopy. A gynecologist may look inside the uterus with a hysteroscope, a thin telescope-equipped device that is inserted through the cervix. The hysteroscope is attached to a light source and camera allowing the gynecologist to view the endometrial lining on a video monitor to identify fibroids, make directed biopsies, and perform minimally invasive therapeutic procedures. Direct visualization of the lining of the uterus provides a more precise diagnosis of uterine abnormalities than D&C, HSG or ultrasound imaging. Gynecologists commonly use hysteroscopy; however, in the past most hysteroscopic procedures have been done in the hospital environment, often in the operating room under general anesthesia. This has been due to a number of factors, including the high cost of complete hospital style hysteroscopy systems, large diameter instrumentation that makes comfortable use in the office with local anesthesia impractical, and the lack of third party payor incentives for office based procedures. The transition of hysteroscopic procedures from the hospital environment to the gynecologist's office practice is being driven by the following: i.) patient's desire to avoid hospitalization, ii.) physician's desire for efficient use of time resulting in improved office economics, and iii.) third party payors are providing incentives to relocate procedures to more cost-effective environments. The Company believes that only 20-25% of the approximately 19,000 gynecology practices in the United States are currently equipped to offer office-based hysteroscopic procedures to their patients, providing a significant business opportunity to the Company. The Company has obtained an exclusive license to manufacture and market the Corson Office Hysteroscopy System, developed in conjunction with Stephen Corson, M.D., a recognized authority on and teacher of hysteroscopic techniques, and is currently marketing the product. This system is designed around a specially developed telescope that has a smaller diameter (3mm) and is equipped with an optical system that provides a wider field of view than other hysteroscopic telescopes. This optical system allows panoramic viewing of the uterine cavity without significant maneuvering of the telescope, thus eliminating the principal source of patient discomfort. The system also features a patented hysteroscopic CO2 insufflator that allows precise control of distension of the uterine cavity for diagnostic procedures without the need for fluid management systems. The Company believes that the Corson Office Hysteroscopy System offers a distinct advantage compared to traditional hysteroscopy systems by incorporating the following features: o Reduced outer diameter allows for use with patient comfort. o Panoramic viewing without uncomfortable instrument manipulation. o Option of CO2 gas or continuous flow liquid for distension of the uterus. o Modular design to minimize initial investment, allowing future expansion of capabilities. o Both diagnostic and therapeutic capabilities. 18 o Instrumentation for biopsy, cutting and grasping. o Specifically designed for office use with a favorable cost/benefit ratio. Sales and Marketing The Company's sales and marketing strategy is to increase market penetration through the expansion of its direct sales and marketing activities targeting the more than 33,000 gynecologists practicing in the United States. BEI Medical's domestic distribution network includes approximately 12 inside sales personnel and two field managers in addition to 17 independent manufacturers' representative organizations, employing approximately 61 field representatives to market its products directly to gynecologists in hospitals, surgical centers and office based practices. BEI Medical's independent manufacturer's representative organizations generally consist of experienced sales professionals with industry-specific knowledge. They also represent manufacturers of other medical products that are complementary with the Company's products and work on a straight commission basis. The Company's direct sales force can leverage its existing customer relationships by introducing newly developed, acquired or licensed systems and devices which are complementary to the Company's current product lines. In addition, through the introduction of new products that enhance the gynecologist's practice, such as the HTA, the bipolar electrosurgical therapy systems, and the Corson Office Hysteroscopy System, management intends to expand the Company's base of customers for both existing and new products. The Company plans to further penetrate international markets through expansion of its network of country-specific distributors. Internationally, BEI Medical sells its products through distributors in 45 countries and distributors in 14 countries have begun marketing the HTA. The Company may also rely on these distributors to assist it in obtaining reimbursement approvals from both government and private insurers in certain international markets. The Company does not currently have distributors in a number of significant international markets that it has targeted and will need to establish additional international distribution relationships in order to sell its products in those markets. Additionally, the Company offers electrosurgical devices and disposable electrodes designed specifically for gastrointestinal endoscopy. These products are sold through a separate network of independent manufacturer's representatives. This range of gastrointestinal products is not expected to provide a significant increase in future revenues. Also, a variety of products are manufactured by BEI Medical for sale by third parties under various original equipment manufacture ("OEM") agreements, but the Company expects these OEM arrangements to decline as a percentage of revenues. In fiscal 1998, revenue of gastrointestinal endoscopy products and OEM revenue were 9.7% and 9.9% of BEI Medical's revenue, respectively, compared to 8.9% and 17.1% in fiscal 1997 and 15.5% and 14.5% in fiscal 1996. The Company also markets products that are manufactured by third party vendors, where the regulatory approval and compliance for these products has been obtained and is controlled exclusively by the third party vendor. Any FDA regulatory or compliance actions against these companies could affect the 19 third party vendor's ability to supply the Company, which in turn could have a material adverse impact on the Company. BEI Medical plans to continue to support its gynecology sales and marketing efforts through the participation in regional and national trade shows which the Company believes will reinforce market presence, increase awareness of its products, introduce new products, and develop actionable sales leads for its sales force. Periodic distribution of its specialty office gynecology direct mail catalog will also be continued. Promotional literature and new product announcements will continue to be distributed via insertion with invoices and insertion in merchandise shipments to leverage relationships with existing customers as well as maintaining its on-line catalog (www.beimedical.com). The Company plans to participate in and sponsor postgraduate courses on the diagnosis and treatment of cervical conditions to support the marketing of products such as the Gyne-Tech colposcopes and the Bipolar LLETZ system. Sponsorship will be provided for clinically-based seminars conducted by the Company's clinical investigators to familiarize practitioners with innovative systems and devices developed by the Company, such as the Hydro ThermAblator. Internationally, BEI Medical will continue to support the efforts of its distributors through sponsorship of guest speakers at national conventions and at clinical seminars and through the sponsorship of postgraduate courses. Competition The Company operates in a highly competitive industry. Many of the Company's existing competitors have significantly greater financial resources and manufacturing capabilities, are more established, have larger marketing and sales organizations and have larger technical staffs than the Company. BEI Medical believes that its products compete primarily on the basis of price, design, performance, reliability, delivery service and support. The principal competitors for the Company's core gynecology products include Circon Corporation, CooperSurgical, Inc., a subsidiary of The Cooper Companies, Inc., Karl Storz GmbH, Leisegang Medical, Inc., a subsidiary of Galileo Corporation, Olympus Corp., Utah Medical Products, Inc., Wallach Surgical Devices, Inc., and Richard Wolf Medical Instruments Corp. The principal competitors for the Company's Hydro ThermAblator and the bipolar electrosurgical therapy system include FemRx, Inc., a subsidiary of Ethicon, Inc./Johnson & Johnson, Gynecare, a subsidiary of Ethicon, Inc./Johnson & Johnson (whose ThermaChoice balloon, a device for endometrial ablation, has been cleared to be marketed in the United States by the FDA), Valleylab, Inc., a subsidiary of U.S. Surgical/Tyco (whose VestaBlate balloon, a device for endometrial ablation, has been cleared by the FDA to be marketed in the United States) and Wallsten Medical SA. Other large healthcare companies may enter the market for minimally invasive diagnostic and therapeutic gynecological products in the future. Competing companies may succeed in developing technologies and products that are efficacious or more cost effective than those currently offered or that may be developed by BEI Medical. The Company believes that its ability to compete effectively depends on its ability to continue to develop proprietary products that fulfill unmet gynecological market needs and to anticipate changing marketplace demands, to 20 continue to attract and retain highly qualified personnel, to obtain the required regulatory approvals, and to continue to manufacture and successfully market high quality products. See "Risk Factors -- Competition; Uncertainty of Technology Change." Manufacturing BEI Medical's manufacturing operations consist primarily of the manufacture and assembly of electromechanical equipment such as the Hydro ThermAblator, electrosurgery generators, endoscope illuminators, endoscopes and electronic insufflators. Some component fabrication and assembly of various non-electrical products, both disposable and reusable, is also performed. Approximately 29.3% of the Company's annual revenue in fiscal 1998 was derived from internally manufactured products. The Company also utilizes contract manufacturers to make a variety of non-electrical medical devices to Company design specifications, including the disposable HTA procedure kit, hysteroscopy systems, disposable catheters and reusable instruments. Approximately 54.1% of the Company's annual revenue in fiscal 1998 was derived from products produced for the Company by contract manufacturers. In addition, the Company purchases a number of products for resale under both exclusive license agreements and non-exclusive agreements including the Company's line of bipolar generators and disposables, smoke evacuators, colposcopes and cryosurgery products. See "Risk Factors --Dependence on Third Party Vendors." BEI Medical also produces a variety of electrosurgical generators, laparoscopic insufflators, endoscopic light sources, and associated disposable products designed for use in various medical/surgical procedures and sold under OEM labeling arrangements. In the third quarter of fiscal 1998, the Company consolidated its manufacturing, distribution and administrative activities located in Hackensack, New Jersey and Chatsworth, California into a single 24,400 square foot facility located in Teterboro, New Jersey. The Company believes the consolidation will reduce operating costs due to the elimination of redundant operations and provide additional space to accommodate future growth. Additionally, engineering efforts are underway to reduce the cost of the disposable HTA procedure kit as volume increases by streamlining production methods and eliminating or replacing higher cost methods and materials. In order to commercialize the HTA successfully, BEI Medical must manufacture or assemble the HTA itself or through third parties in accordance with the FDA requirements, in commercial quantities, at high quality levels and at reasonable costs. The Company has not yet produced the HTA in substantial quantities, but expects that its manufacturing experience with other medical electronic systems and consumable medical products will be transferable to the HTA. Failure of the Company to produce the HTA in commercial quantities at high quality levels and at commercially reasonable prices would have a material adverse effect on the Company's business, financial condition and results of operations. See "Risk Factors -- Scale Up Risk." During fiscal 1996, BEI Medical's manufacturing facilities received ISO 9001 certification from Lloyds Register Quality Assurance, Ltd. ("LRQA"). LRQA will conduct semiannual audits in Teterboro, New Jersey. The most recent audit of the Company's manufacturing facilities in Teterboro, New Jersey was in 21 October 1998. The audit report did not include any negative observations or identify any areas of noncompliance. Additionally, the Company's facilities and documentation procedures for the manufacture of medical devices are required to conform to the FDA's Quality System Regulations ("QSR") through its facilities inspection program. The FDA most recently inspected the Company's manufacturing facilities in Teterboro, New Jersey in September 1998 for compliance with the QSR. Upon completion of the inspection, the FDA did not issue a Notice of Adverse Findings. Withdrawal of QSR compliance status would have a material adverse effect on the Company's business, financial condition and results of operations. Research and Development; Technology BEI Medical intends to develop and expand its market share through internal development, licensing and acquisition of additional product lines. The Company's principal development effort has focused on proprietary devices for minimally invasive procedures in gynecology. The Company's internally funded research and development expenditures were $2,866,000, $1,864,000 and $1,328,000 for the fiscal years 1998, 1997 and 1996, respectively. The Company anticipates that the vast majority of current spending on research and development over the next 12 months will be devoted to completing the HTA clinical trials and gaining FDA approval of the product. Product concepts, internally or externally originated, are developed into commercially viable systems and devices by relying on core competencies. The Company's areas of core competency include visualization, gas pressure/flow control, fluid delivery, energy delivery, microprocessor systems, catheter technology and surgical instrumentation/fabrication. For instance, development of the HTA system from the Goldrath patent required application of visualization technology to allow the gynecologist to monitor the process, precise control of fluid pressure and energy delivery to perform the ablation and microprocessor control of complex heating and safety systems. Additionally, the Company continues development efforts to improve and enhance its disposable and instrument product lines for both outpatient and office applications. Through strategic alliances, the Company also continues to develop new applications related to fibroid resection for its bipolar electrosurgical generators. The Company also works with several OEM customers for the adaptation of its proprietary technology to various private label requirements. BEI Medical has developed working relationships with key clinicians on the evaluation and use of innovative products and procedures that address gynecological conditions. The Company has formed a Scientific Advisory Board consisting of leading practitioners, which consults on the refinement of existing lines, on new product development, on evaluation of new technologies and treatment approaches, and on changes in healthcare reimbursement policies and practices. Licenses, Patents and Proprietary Technology The Company's policy is to protect its proprietary position by, among other methods, filing United States and foreign patent applications to protect technology, inventions and improvements that are important to the development of its business. 22 The Company's success depends in part on its ability to obtain and maintain patent protection for its products and processes, to preserve its trade secrets and to operate without infringing the proprietary rights of third parties. The Company's strategy regarding the protection of its proprietary rights and innovations is to seek patents on those portions of its technology that it believes are patentable and to protect as trade secrets other confidential and proprietary information. As of October 3, 1998, the Company had a portfolio including 16 United States patents and one allowed United States patent, in addition to certain issued foreign patents. Among the 16 patents issued in the United States, four patents are related to the development of the HTA. Corresponding applications have been filed in certain foreign countries relative to the HTA. The Company's policy is generally to file patent applications in foreign countries where rights are available and the Company believes it is commercially advantageous to do so. No assurance can be given that any patents from pending patent applications or from any future patent applications will be issued, that the scope of any patent protection will exclude competitors or provide competitive advantages to the Company, that any of the Company's patents will be held valid if subsequently challenged or that others will not claim rights in or ownership of the patents and other proprietary rights held by the Company. The Company also owns certain registered trademarks, and has applied for other trademarks in certain foreign countries. Inclusive to the patent portfolio, the Company holds the rights and title to the patent for its Uterine Manipulator/Injector ZUMI product line, under an agreement with James H. Harris, M.D. This patent was issued in 1984 and is expected to expire in 2001. This ZUMI product line accounts for a significant percentage of the Company's disposable instrument revenues. In 1997, the Company entered into an agreement with Valley Forge Scientific Corporation giving the Company worldwide marketing rights for distribution of the bipolar electrosurgical therapy systems, in the field of gynecology. This patented bipolar technology is applicable to LLETZ procedures. Patents cover the bipolar generator product and the loop electrode product for LLETZ, each of which are owned by Valley Forge. Nothing in this agreement constitutes a transfer to BEI of any of the patents, intellectual property rights, trade secrets or know-how of Valley Forge relating to the Valley Forge products or a license for BEI to use such patents, intellectual property rights, trade secrets or know-how. The remaining term of the agreement is 57 months subject to negotiating annual minimum requirements after the first fifteen-month period, for subsequent twelve-month periods. The medical device industry has been characterized by extensive litigation regarding patents and other intellectual property rights, and many companies in the industry have employed intellectual property litigation to gain a competitive advantage. There can be no assurance that the Company will not become subject to patent infringement litigation or an interference proceeding declared by the United States Patent and Trademark Office ("USPTO") to determine the priority of inventions. The defense and prosecution of patent suits, USPTO interference proceedings and related legal and administrative proceedings are both costly and time consuming. Litigation may be necessary to enforce patents issued to the Company, to protect the Company's trade secrets or know-how or to determine the enforceability, scope and validity of the proprietary rights of others. Any litigation or interference proceedings involving the Company will result in substantial expense to the Company and significant diversion of effort by the Company's technical and management personnel. 23 An adverse determination in a judicial or administrative proceeding or failure to obtain necessary license could prevent the Company from manufacturing and selling its products, which would have a material adverse effect on the Company's business, financial condition and results of operations. The Company also relies upon trade secrets and technical know-how and continuing technological innovations to develop and maintain its competitive position. The Company typically requires its employees, consultants and advisors to execute appropriate confidentiality and assignment of invention agreements in connection with their employment, consulting or advisory relationship with the Company. There can be no assurance, however, that these agreements will not be breached or that the Company will have adequate remedies for any such breach. Furthermore, no assurance can be given that competitors will not independently develop substantially equivalent proprietary information and techniques or otherwise gain access to the Company's proprietary technology, or that the Company can meaningfully protect its rights in unpatented proprietary technology. Government Regulation The preclinical and clinical testing, manufacturing, labeling, distribution and promotion of the Company's products are subject to extensive and rigorous government regulation in the United States and other countries. Noncompliance with applicable requirements can result in enforcement action by the United States Food and Drug Administration, including, among other things, warning letters, fines, injunctions, civil penalties, recall or seizure of products, total or partial suspension of production, failure of the government to grant premarket clearance or premarket approval for devices, withdrawal of marketing clearances or approvals, and criminal prosecution. A medical device may be marketed in the United States only with the FDA's prior authorization. Devices classified by the FDA as posing less risk are placed in Class I or Class II and require the manufacturer to seek "510(k) clearance" from the FDA prior to marketing. Such clearance generally is granted when submitted information establishes that a proposed device is "substantially equivalent" in intended use and safety and effectiveness to a "predicate device," which is a legally marketed Class I or Class II device or a "preamendment" (in commercial distribution before May 28, 1976) Class III device for which the FDA has not called for PMA applications (defined below). The Company's HTA system is classified by the FDA as a Class III device, which is considered to pose the greatest risk to patients (e.g., life-sustaining, life-supporting or implantable devices, or devices that are not substantially equivalent to a predicate device). A Class III device generally must undergo the FDA's PMA process, which requires the manufacturer to prove the safety and effectiveness of the device to the FDA's satisfaction. A PMA application must provide extensive preclinical and clinical trial data and information about the device and its components regarding, among other things, manufacturing, labeling and promotion. As part of the PMA review, the FDA will inspect the manufacturer's facilities for compliance with the QSR, which includes elaborate testing, control, documentation and other quality assurance procedures. 24 Upon submission, the FDA determines if the PMA application is sufficiently complete to permit a substantive review and, if so, the application is accepted for filing. The FDA then commences an in-depth review of the PMA application, which the Company believes typically takes one to three years, but may take longer. The review time is often significantly extended as a result of the FDA asking for more information or clarification of information already provided. The FDA also may respond with a "not approvable" determination based on deficiencies in the application and require additional clinical trials that are often expensive and time consuming and can delay approval for months or even years. In recent years, the FDA has heightened its scrutiny of clinical data submitted in support of PMA applications. During the review period, an FDA advisory committee, typically a panel of clinicians, likely will be convened to review the application and recommend to the FDA whether, or upon what conditions, the device should be approved. Although the FDA is not bound by the advisory panel decision, the panel's recommendation is important to the FDA's overall decision making process. If the FDA's evaluation of the PMA application is favorable, the FDA typically issues an "approvable letter" requiring the applicant's agreement to comply with specific conditions (e.g., changes in labeling) or to supply specific additional data (e.g., longer patient follow up) or information (e.g., submission of final labeling) in order to secure final approval of the PMA application. Once the approvable letter is satisfied, the FDA will issue a PMA order for the approved indications, which can be more limited than those originally sought by the manufacturer. The PMA order can include post-approval conditions that the FDA believes are necessary to ensure the safety and effectiveness of the device, including, among other things, restrictions on labeling, promotion, sale and distribution. Failure to comply with the conditions of approval can result in enforcement action, including withdrawal of the approval. The PMA process can be expensive and lengthy, and no assurance can be given that any PMA application will ever be approved for marketing. Even after approval of a PMA, a new PMA or PMA supplement is required in the event of a modification to the device, to its labeling or to its manufacturing process that affects the safety or effectiveness of the device. There can be no assurance that a PMA application will be submitted for any of the Company's Class III devices or that, once submitted, the PMA application will be accepted for filing, found approvable, or, if found approvable, will not take longer than expected to obtain or include unfavorable restrictions. A clinical study in support of a PMA application for a "significant risk" device requires an Investigational Device Exemption ("IDE") application approved in advance by the FDA for a limited number of patients. The IDE application must be supported by appropriate data, such as animal and laboratory testing results. The clinical study may begin if the IDE application is approved by the FDA and the appropriate institutional review board ("IRB") at each clinical study site or through use of a central IRB. If the device presents a "nonsignificant risk" to the patient, a sponsor may begin the clinical study after obtaining IRB approval without the need for FDA approval. In all cases, the clinical study must be conducted under the auspices of an IRB pursuant to FDA's regulatory requirements intended for the protection of subjects and to assure the integrity and validity of the data. During a clinical study, the Company is permitted to sell the products used in the study for an amount that does not exceed recovery of the costs of 25 manufacture, research, development and handling. The Company's failure to adhere to regulatory requirements generally applicable to clinical studies or to any conditions of IDE approval could result in a refusal by the FDA to grant marketing clearance or approval for the Company's products. There can be no assurance that any clinical study proposed by the Company will be approved by the FDA, will be completed or, if completed, will provide data and information that support PMA approval or 510(k) clearance or that support authorization for additional clinical investigations of the type necessary to obtain approval or clearance. Devices manufactured or distributed by the Company pursuant to FDA clearance or approval will be subject to pervasive and continuing regulation by the FDA and certain state agencies. The Company will be subject to inspection by the FDA and such state agencies, and will have to comply with the host of regulatory requirements that usually apply to medical devices marketed in the United States, including the FDA's labeling regulations, the QSR, the Medical Device Reporting ("MDR") regulations (which require that a manufacturer report to the FDA certain types of adverse events involving its products), and the FDA's general prohibitions against promoting products for unapproved or "off-label" uses. In addition, Class II devices can be subject to additional special controls (e.g., performance standards, postmarket surveillance, patient registries, and FDA guidelines) that do not apply to Class I devices. The Company's failure to comply with applicable regulatory requirements could result in enforcement action by the FDA, which could have a material adverse effect on the Company's business, financial condition and results of operations. Unanticipated changes in existing regulatory requirements, failure of the Company to comply with such requirements or adoption of new requirements could have a material adverse effect on the Company's business, financial condition and results of operations. The Company also is subject to numerous federal, state and local laws relating to such matters as safe working conditions, manufacturing practices, environmental protection, fire hazard control and hazardous substance disposal. There can be no assurance the Company will not be required to incur significant costs to comply with such laws and regulations in the future or that such laws or regulations will not have a material adverse effect upon the Company's business, financial condition and results of operations. The Company distributes products manufactured by third party vendors, where the regulatory approval and compliance for these products has been obtained and is controlled by the third party vendor. Any FDA regulatory or compliance actions against these companies could affect the third party vendor's ability to supply the Company or require the Company's participation in product recalls, which in turn could have a material adverse impact on the Company. The Food and Drug Administration Modernization Act of 1997 also makes changes to the device provisions of the Food, Drug and Cosmetic ("FDC") and other provisions in the FDC Act affecting the regulation of devices. Among other things, the changes will affect the IDE, 510(k) and PMA processes, and also will affect device standards and data requirements, procedures relating to humanitarian and breakthrough devices, tracking and postmarket surveillance, accredited third party review, and the dissemination of off label information. The Company cannot predict how or when these changes will 26 be implemented or what effect the changes will have on the regulation of the Company's products. Distribution of the Company's products outside the United States is also subject to regulation, which varies widely from country to country. The time required to obtain needed regulatory clearance by particular foreign governments may be longer or shorter than that required for FDA clearance or approval. In addition, the export by the Company of certain of its products that have not yet been cleared or approved for domestic distribution may be subject to FDA export restrictions. There can be no assurance that the Company will receive on a timely basis, if at all, any foreign government or United States export approvals necessary for the marketing of its products abroad. In January 1995, the Medical Device Directive ("MDD") was fully implemented in the European Union, which is intended to make European Union regulatory requirements more consistent. Under MDD, the Company is subject to "prior notice" of intent to conduct clinical studies in the European Union. This process, similar to the FDA IDE process, requires regulatory documents and test information to be submitted to the governmental agency of each country in which the Company intends to conduct clinical studies. In order to commence commercial marketing of its products in the European Union, the Company is required to file for a CE Mark approval. In January 1998, the Company received CE Mark approval for the HTA System from LRQA, an organization that certifies the safety of medical device products and the quality assurance systems put in place by the manufacturer of the medical device. There can be no assurance, however, that the Company will be successful in obtaining CE Mark approval for any other products in a timely manner, if at all, and any failure to receive or delay in receiving such approval could have a material adverse effect on the Company's business, financial condition and results of operations. See "Risk Factors -- Government Regulation." Employees As of October 3, 1998, BEI Medical had 73 full-time employees, including 11 in research, development and engineering, 24 in marketing and sales, 27 in operations and 11 in administration. There are no unions representing the Company's employees. The Company believes that its relations with its employees are good. Risk Factors Limited Operating History; History of Losses and Possible Future Losses; Fluctuations in Operating Results The Company has a limited medical device operating history upon which an evaluation of its prospects can be made. Such prospects must be considered in light of the risks, expenses and difficulties frequently encountered by entrants into the medical device industry, which is characterized by an increasing number of participants, intense competition and a high failure rate. Historically, BEI Medical has incurred significant losses in its medical device business and expects losses to continue for at least the next several years. In addition, the Company expects that it will continue to expend substantial resources in funding clinical trials in support of regulatory and reimbursement approvals, expansion of marketing and sales activities and 27 research and development. BEI Medical's future revenues will depend upon, among other factors, its ability to cost-effectively commercialize the Hydro ThermAblator (HTA) and any other of the Company's new products, such as its hysteroscopy system and its bipolar electrosurgical therapy system. There can be no assurance that the HTA or such other new products will be successfully commercialized or that the Company will achieve significant revenues from either international or domestic sales of such products. In addition, there can be no assurance that the Company will achieve or sustain profitability in the future. In the event the Company is unable to achieve profitability or secure additional sources of capital, its ability to continue as a going concern may be severely impaired. See "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Business -- New Products and Technologies." 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. These factors include actions relating to regulatory and reimbursement matters, the extent to which the Company's products gain market acceptance, the timing and size of international distributor purchases and the timing of product approvals. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." Future Capital Needs The Company's capital requirements depend on numerous factors, including the progress of the Company's clinical research and product development programs, the timing and receipt of regulatory clearances and approvals, and the resources the Company devotes to developing, manufacturing and marketing its products. The Company's capital requirements also depend on the resources required to expand and develop a direct sales force in the United States and to expand the Company's manufacturing capacity, and the extent to which the Company's products gain market acceptance and sales. The timing and amount of such capital requirements cannot be predicted accurately. The Company is currently seeking additional financing. Consequently, although the Company believes its existing cash balances together with operating revenues, tax refunds and anticipated working capital financing will provide adequate funding to meet the Company's liquidity requirements for the next twelve months, there can be no assurance that additional financing will be available on terms favorable to the Company, or at all. In the event the Company is unable to generate sufficient cash flows from revenues or secure additional sources of capital, its ability to continue as a going concern may be severely impaired. Any additional equity financing may be dilutive to stockholders and debt financing, if available, may involve restrictive covenants and/or also be dilutive to stockholders. See "Management's Discussion and Analysis of Financial Condition and Results of Operations--Liquidity and Capital Resources." Government Regulation The medical devices to be marketed and manufactured by the Company are subject to extensive regulation by the FDA and, in some instances, by foreign and state governments. Pursuant to the Federal Food, Drug, and Cosmetic Act, as amended (the "FDC Act"), and the regulations promulgated thereunder, the FDA regulates the preclinical testing, manufacture, labeling, sale, 28 distribution, and promotion of medical devices. Before a new device can be introduced into the market, the manufacturer must obtain market clearance through either the 510(k) premarket notification process or the lengthier PMA application process. Noncompliance with applicable requirements, including FDA's QSR can result in, among other things, warning letters, fines, injunctions, civil penalties, public notifications, recall or seizure of products, total or partial suspension of product revenues, failure of the government to grant premarket clearance or premarket approval for devices, withdrawal of marketing approvals, and criminal prosecution. The FDA has the authority to require repair, replacement or refund of the cost of any device manufactured or distributed by the Company. The process of complying with FDA regulations with respect to new and existing products can be costly and time-consuming. FDA requirements for the Company's HTA require obtaining FDA premarket approval. The first stage of the PMA process is submission of an application for an IDE. The IDE permits clinical evaluations of products on human subjects under controlled experimental conditions by designated qualified medical institutions. The Company is conducting clinical trials of the HTA pursuant to a phased IDE that has been approved by the FDA. The Company completed a Phase I safety feasibility study of the HTA in April 1996 and in June 1998 completed a Phase II feasibility study limited to twenty patients. The Company has also obtained FDA conditional approval for Phase III trials and is currently enrolling and treating patients. The Company is required to conduct a full-scale Phase III safety and efficacy study to obtain data necessary to support the submission of a PMA application. There can be no assurance that any data obtained from the Phase III study will support the safety and effectiveness of the HTA. The second stage of the PMA process is the PMA application, which is a comprehensive report of all data and information obtained by the applicant throughout the product's development and testing. The PMA includes reports of prior inventions, QSR information, the results of bench testing of the device and other data and information including the results of the IDE clinical studies. The FDA will issue a PMA if it finds that the safety and effectiveness of the product have been sufficiently demonstrated and that the product complies with all applicable regulations and standards. After reviewing the PMA application, the FDA may require further clinical evaluation of the product, terminate the clinical studies, issue a PMA, or require additional patient follow-up for an indefinite period of time. Approval of the Company's PMA application for its HTA will depend on a wide variety of factors, many of which are outside the Company's control. There can be no assurance that the Company will reach a stage of development at which filing a PMA application will be appropriate, nor that it will be successful in obtaining a PMA for the HTA in a timely manner, or at all, which is necessary to market the Company's HTA commercially in the United States. Delays in obtaining marketing approvals and clearances in the United States, or recalls related to the Company's other products, could have material adverse effects on the Company and its operations. Although the Company has been successfully inspected with respect to its former facilities for compliance of its operations with the QSR, final approval of the HTA will require an inspection by the FDA to determine whether the Company's operations at its new facilities conform with the FDA's current QSR. Even after approval of a PMA, a new PMA or PMA supplement is required in the event of a modification to the device, to 29 its labeling or to its manufacturing process that affects the safety or effectiveness of the device. Until the Company receives a PMA for the HTA, the Company will be subject to FDA-imposed limitations on the number of HTA procedures that may be performed in the United States, as well as the number and location of clinical sites at which procedures may be performed. As the Company approaches these limitations, it will be required to apply to the FDA for approval of additional procedures, but there can be no assurance that such approval will be received on a timely basis, if at all. Should it reach the limits authorized by the FDA, the Company would be unable to conduct additional HTA procedures in the United States until such time as a PMA is approved, if at all, or until such time as approval for additional clinical procedures is obtained. The timing of the PMA review process is unpredictable, and the failure to obtain the necessary approval on a timely basis would have a material adverse effect on the Company's business, financial condition and results of operations. The Company manufactures and markets a number of general gynecological and surgical devices for which 510(k) clearances have been obtained. Any modifications to the Company's currently marketed devices that could significantly affect their safety or efficacy or that would constitute a major change to the intended use will require new 510(k) submissions. There can be no assurance that Company can obtain such 510(k) clearances in a timely fashion, or at all. Delays in modifications resulting from the 510(k)-clearance process could materially adversely effect the Company. In addition, the Company has made modifications to its 510(k) cleared devices that the Company believes do not require new 510(k) notices based upon an FDA guidance document intended to assist the companies in performing the analysis of whether a new 510(k) submission is required. There can be no assurance, however, that the FDA would agree with any of the Company's determinations not to submit a new 510(k) notice for any of the changes made to the device. If the FDA requires the Company to submit a new 510(k) notice for any device modification, the Company may be prohibited from marketing the modified device until the 510(k) notice is cleared by the FDA. In addition, the Company manufactures and markets products, including ZSI gynecological products and Meditron medical devices, the rights to which it obtained through the acquisition of other medical device companies. There can be no assurance that the acquired companies were in compliance with applicable FDA regulations at the time they were acquired and that any noncompliance on the part of the acquired companies would not have regulatory consequences for the Company. Noncompliance on the part of the acquired companies could have a material adverse effect on the Company's business, financial condition and results of operations. The Company is subject to certain FDA regulations governing defective products and complaints about its products. The Company's products are subject to recall at any time by the FDA or the Company if it appears that use of the products could result in, among other things, unwarranted health risks. The FDA has authority to inspect the Company's facilities to ensure compliance with the FDC Act and regulations thereunder. Failure to comply with these regulations could have a material adverse effect on the Company's business, financial condition and results of operations. 30 The Company distributes products manufactured by third party vendors, such as the bipolar electrosurgical systems provided by Valley Forge and the colposcope and cryosurgical systems provided by Gyne-Tech Instrument Corporation ("Gyne-Tech"), where the regulatory approval and compliance for these products has been obtained and is controlled by the third party vendor. Any FDA regulatory or compliance actions against these companies could affect the third party vendor's ability to supply the Company or require the Company's participation in product recalls, which in turn could have a material adverse impact on the Company. The FDA regulates the export of medical devices that have not been approved or cleared for marketing in the United States. The Company expects to export products directly to the European Union under the provisions of the FDA Export Reform and Enhancement Act of 1996. In certain instances, however, the Company may need to apply for export approval from the FDA. There can be no assurance that required approvals will be granted. Developments such as the enactment of the Safe Medical Devices Act of 1990 and increased enforcement actions reflect a trend toward more stringent product regulation by the FDA. One result is an increase in the typical time elapsed between the filing of an application and the receipt of FDA clearance or approval of commercial release of a medical device. In addition, the FDA often requires clinical data with such applications, which can increase the cost of obtaining such clearance to market. Furthermore, rigorous regulatory action may be taken in response to deficiencies noted in inspections or to any product performance problems. The Food and Drug Administration Modernization Act of 1997 also makes changes to the device provisions and other provisions in the FDC Act affecting the regulation of devices. Among other things, the changes will affect the IDE, 510(k) and PMA processes, and also will affect device standards and data requirements, procedures relating to humanitarian and breakthrough devices, tracking and postmarket surveillance, accredited third party review, and the dissemination of off-label information. The Company cannot predict how or when these changes will be implemented or what effect the changes will have on the regulation of the Company's products. Unanticipated changes in existing regulatory requirements, failure of the Company to comply with such requirements or adoption of new requirements could have a material adverse effect on the Company's business, financial condition and results of operations. The Company also is subject to numerous federal, state and local laws relating to such matters as safe working conditions, manufacturing practices, environmental protection, fire hazard control and hazardous substance disposal. There can be no assurance the Company will not be required to incur significant costs to comply with such laws and regulations in the future or that such laws or regulations will not have a material adverse effect upon the Company's business, financial condition and results of operations. Political, economic and regulatory influences are subjecting the healthcare industry in the United States to fundamental change. The Company anticipates that Congress and state legislatures will continue to review and assess alternative healthcare delivery and payment systems. Legislative debate is expected to continue in the future, and the Company cannot predict what impact 31 the adoption of any federal or state healthcare reform measure or future private sector reform may have on its business. Medical device laws are also in effect in many countries outside the United States in which the Company does business. These range from comprehensive device approval requirements to requests for product data or certifications. The number and scope of these requirements are increasing. This trend toward increasing product regulation is evident in the European Union, where efforts are under way to harmonize the regulatory systems. In January 1995, the MDD was fully implemented in the European Union, which is intended to make regulatory requirements of European Union countries more consistent. The time required to obtain approvals required by foreign countries may be longer or shorter than that required for FDA approval and requirements for licensing may differ from FDA requirements. Under MDD, the Company is subject to "prior notice" of intent to conduct clinical studies in the European Union. This process, similar to the FDA IDE process, requires regulatory documents and test information to be submitted to the governmental agency of each country in which the Company intends to conduct clinical studies. In order to commence commercial marketing of its products in the European Union and the European Free Trade Association, the Company is required to file for a CE Mark approval. Although the Company has obtained a CE Mark for most of its products, including the HTA, which allows the Company to commence marketing of these products in countries that are members of the European Union and the European Free Trade Association, subject to limited regulations in certain countries, there can be no assurance that the Company will be successful in obtaining CE Mark approval for any other products on a timely basis if at all, and any failure to receive or delay in receiving could have a material adverse effect on the Company's business, financial condition and results of operations. See "Business -- Government Regulation." Risks Related to Possible Acquisitions The Company may seek to expand its operations through future acquisitions of other complementary businesses or product lines. There can be no assurance that the Company will be able to identify or acquire additional businesses, or to successfully integrate and profitably manage acquired businesses. In addition, increased competition for acquisition candidates may develop, in which event there may be fewer acquisition opportunities available to BEI Medical as well as higher acquisition prices. Further, acquisitions involve a number of special risks, including possible adverse effects on the Company's operating results, diversion of management's attention, risks related to having adequate corporate and financial controls and procedures to manage and monitor the Company's operations as they expand, risks associated with unanticipated events or liabilities and amortization of acquired intangible assets, some or all of which could have a material adverse effect on the Company's business, financial condition and results of operations, particularly in the fiscal quarters immediately following the consummation of such transactions. There also can be no assurance that businesses acquired in the future will achieve anticipated revenues and earnings. In addition, margins may be negatively impacted to the extent that margins on acquired product lines are lower than BEI Medical's average margins. There can be no assurance that acquisitions can be consummated on acceptable terms, that any acquired businesses can be integrated successfully into the Company's operations, or that any such acquisitions will not have a material adverse 32 effect on BEI Medical's business, financial condition and results of operations. Uncertainty of Market Acceptance The Company's success is dependent upon acceptance by the medical community of the HTA and, to a lesser extent, other new products introduced by the Company as reliable, safe and cost-effective treatments for the medical conditions they are intended to treat. There can be no assurance that the HTA or such other products will gain any significant degree of market acceptance among physicians, patients and healthcare payors, even if the necessary international and United States regulatory approvals are obtained. BEI Medical believes that recommendations and endorsements by physicians will be essential for market acceptance of the HTA and such other products, and there can be no assurance that any such recommendations or endorsements will be obtained. The Company believes that physicians will not use the HTA unless they determine, based on clinical data and other factors, that the HTA is an attractive treatment alternative for excessive menstrual bleeding and offers clinical utility in a cost-effective manner. Although the Company believes that physicians will not require extensive training prior to using the HTA, acceptance among physicians will depend upon the Company's ability to train potential users of the HTA in interventional techniques, and the willingness of such users to learn these new techniques. Failure of BEI Medical to achieve significant market acceptance of the HTA and other new products introduced by the Company would have a material adverse effect on the Company's business, financial condition and results of operations. Any future products developed by the Company that gain regulatory approval will have to compete for market acceptance and market share. The timing of market introduction of competitive products could adversely affect the competitiveness of the Company's products. Accordingly, the relative speed with which the Company can develop new products, complete clinical testing and the regulatory approval process and supply commercial quantities of the product to the market are expected to be important competitive factors. The Company expects that competition in the gynecological device market will be based on many factors, including clinical outcomes, ease of use, relative efficacy, safety, product reliability, physician familiarity with the device, third-party reimbursement policies, patent protection, sales and marketing capability, reputation and price. There can be no assurance that FDA approval will be obtained for the Company's products, that competitors will not introduce new products with similar or more advanced features or that the market will accept the Company's products. See "Business -- New Products and Technologies." Scale-Up Risk In order to commercialize the HTA successfully, BEI Medical must manufacture or assemble the HTA by itself or through third parties in accordance with FDA requirements in commercial quantities, at high quality levels and at commercially reasonable costs. The Company has no experience in manufacturing and assembling the HTA in commercial quantities. The Company has not yet produced the HTA in commercial quantities at commercially reasonable costs, and there can be no assurance that it will be able to do so. As a result, there can be no assurance that BEI Medical will not encounter difficulties in scaling up its manufacturing capabilities, including problems involving production yields, quality control, component supply and shortages of qualified manufacturing personnel. Failure of the Company to produce the 33 HTA in commercial quantities at high quality levels and at commercially reasonable prices would have a material adverse effect on the Company's business, financial condition and results of operations. Limited Direct Sales Experience The Company has only limited experience in direct field sales and marketing of the HTA and other products both domestically and internationally. BEI Medical recently established a direct domestic field sales force of independent manufacturers' representatives to market and sell the HTA (if approved by the FDA) and other products. The Company has no direct international field sales force, and has only a limited number of partnership relationships with international distributors to market the HTA and other products. There can be no assurance that the Company will be successful in establishing additional partnership relationships on commercially reasonable terms, if at all. Achieving market acceptance for the HTA and other products will require BEI Medical to establish additional marketing and direct sales capability sufficient to support sales in commercial quantities. Establishing such capability will require significant resources and there can be no assurance that the Company will be able to recruit and retain additional qualified marketing personnel or direct sales personnel or that future sales efforts of the Company will be successful. The failure to establish and maintain an effective distribution channel for the HTA and other products or to establish and retain qualified and effective sales personnel to support commercial sales of the Company's HTA and other products would have a material adverse effect on the Company's business, financial condition and results of operations. Risks Associated with International Sales The Company markets and sells its products internationally through a network of distributors. The Company's international sales are dependent upon the marketing efforts of, and sales by, these distributors. BEI Medical may also rely on these distributors to assist it in obtaining reimbursement approvals from both government and private insurers in certain international markets. In general, the Company has chosen to operate through small distribution firms because of its belief that these firms will devote greater attention to the Company's products. The use of small distributors increases the risks associated with financial instability of distributors, which includes the risk that distributors will cease operations or will be unable to satisfy financial obligations to the Company. If a distributor were to fail to invest adequate capital promoting the Company's products or were to cease operation, the Company would likely be unable to achieve significant revenues in the territory. In addition, because the Company has only recently commenced international sales, it has only limited sell-through experience with many of its distributors. BEI Medical also does not currently have distributors in a number of significant international markets that it has targeted and will need to establish additional international distribution relationships. There can be no assurance that the Company will engage qualified distributors on commercially reasonable terms in a timely manner. The failure to engage such distributors or the failure of such distributors to achieve significant revenues from sales of the Company's products would have a material adverse effect on the Company's business, financial condition and results of operations. 34 A number of other risks are inherent in international operations and transactions. International revenues and operations may be limited or disrupted by the imposition of government controls, export license requirements, political instability, trade restrictions, changes in tariffs, difficulties in managing international operations and fluctuations in foreign currency exchange rates. There can be no assurance that the Company will be able to successfully commercialize any of its existing or future products in any international market. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." Reliance on Patents and Protection of Proprietary Technology BEI Medical's ability to compete effectively will depend substantially on its ability to develop and maintain the proprietary aspects of its technology. There can be no assurance that any of the Company's issued patents, or any future patents that may be issued, will offer any degree of protection to the Company's products against competitive products. There can be no assurance that any patents that may be issued or licensed to the Company or any of the Company's patent applications will not be challenged, invalidated or circumvented in the future. In addition, there can be no assurance that competitors, many of whom have substantial resources and have made substantial investments in competing technologies, will not seek to apply for and obtain patents that will prevent, limit or interfere with the Company's ability to make, use or sell its products either in the United States or in international markets. The medical device industry has been characterized by extensive litigation regarding patents and other intellectual property disputes, and some companies in the industry have employed intellectual property litigation to gain a competitive advantage. There can be no assurance that the Company will not in the future become subject to patent infringement claims and litigation or interference or other proceedings in the USPTO. The defense and prosecution of intellectual property suits, USPTO proceedings and related legal and administrative proceedings are both costly and time consuming. Litigation may be necessary to enforce patents issued or licensed to the Company, to protect the Company's trade secrets or know-how or to determine the enforceability, scope and validity of the proprietary rights of others. Any litigation or USPTO proceedings involving BEI Medical will result in substantial expense to the Company and significant diversion of effort by the Company's technical and management personnel. An adverse determination in litigation or USPTO proceedings to which the Company may become a party could subject the Company to significant liabilities to third parties or require the Company to seek licenses from third parties. Although some patent and intellectual property disputes in the medical device area have been settled through licensing or similar arrangements, costs associated with such arrangements may be substantial and could include substantial ongoing royalties. Furthermore, there can be no assurance that necessary licenses would be available to the Company on satisfactory terms, if at all. An adverse determination in a judicial or administrative proceeding or failure to obtain necessary licenses could prevent the Company from manufacturing and selling its products, which would have a material adverse effect on the Company's business, financial condition and results of operations. 35 The Company also markets products that are manufactured by third party vendors, where the regulatory approval and compliance for these products has been obtained and is controlled exclusively by the third party vendor. Any FDA regulatory or compliance actions against these companies could affect the third party vendors' ability to supply the Company, which in turn could have a material adverse impact on the Company. In addition to patents, BEI Medical relies on trade secrets and proprietary know-how, which it seeks to protect, in part, through appropriate confidentiality and proprietary information agreements. These agreements generally provide that all confidential information developed or made known to an individual by the Company during the course of the individual's relationship with the Company is to be kept confidential and not disclosed to third parties or utilized by the individual, except in specific circumstances. The agreements also generally provide that all inventions conceived by the individual in the course of rendering services to BEI Medical shall be the exclusive property of the Company. There can be no assurance that the Company's proprietary information will not be misused or confidentiality agreements with employees, consultants and others will not be breached, that the Company will become aware of such breach or will have adequate remedies for any breach, or that the Company's trade secrets will not otherwise become known to or independently developed by competitors. See "Business -- Research and Development; Technology" and "--Licenses, Patents and Proprietary Technology." Uncertainty Relating to Third-Party Reimbursement and Healthcare Reform In the United States, hospitals, physicians and other healthcare providers that purchase medical devices generally rely on third-party payors, such as government health administration authorities and private health insurance plans, to reimburse all or part of the cost associated with the treatment of patients. Although reimbursement for diagnostic and therapeutic procedures to treat uterine disorders such as menorrhagia, or excessive uterine bleeding and fibroid treatment have generally been available in the United States, there is no assurance that it will continue to be the case or that the fees currently allowed for these procedures will not be reduced. Furthermore, there can be no assurance, even if the Company's products are cleared by the FDA for new clinical applications, that full reimbursement will be available for such procedures. BEI Medical could also be adversely affected by changes in reimbursement policies of government or private healthcare payors, particularly to the extent that any such changes affect reimbursement for diagnostic or therapeutic procedures in which the Company's products are used. Failure by physicians, hospitals and other users of the Company's products to obtain sufficient reimbursement from healthcare payors for procedures in which the Company's products are used, or adverse changes in government and private third-party payors' policies toward reimbursement for such procedures, could have a material adverse effect on the Company's business, financial condition and results of operations. Market acceptance of the Company's products in international markets may be dependent in part upon the availability of reimbursement within prevailing healthcare payment systems. Reimbursement and healthcare payment systems in international markets vary significantly by country, and include both government sponsored and private healthcare insurance. Although BEI Medical will seek international reimbursement approvals, obtaining such approvals can 36 require 12 to 18 months or longer and there can be no assurance that any such approvals will be obtained in a timely manner, that the Company will obtain sufficient reimbursement, or that the Company will obtain any reimbursement at all. Failure to receive additional international reimbursement approvals could have a material adverse effect on market acceptance of the Company's products in the international markets in which the Company is seeking approvals and could have a material adverse effect on the Company's business, financial condition and results of operations. See "Business -- Sales and Marketing." The Company expects that there will be continued pressure on cost-containment throughout the United States healthcare system. Reforms may include mandated basic healthcare benefits, controls on healthcare spending through limitations on the growth of private health insurance premiums and Medicare and Medicaid spending, the creation of large insurance purchasing groups and fundamental changes to the healthcare delivery system. The Company anticipates that Congress and state legislatures will continue to review and assess alternative healthcare delivery systems and payment methodologies and public debate of these issues will likely continue in the future. Due to uncertainties regarding the ultimate features of reform initiatives and their enactment and implementation, the Company cannot predict which, if any, of such reform proposals will be adopted, when they may be adopted or what impact they may have on the Company. Competition; Uncertainty of Technology Change The medical device industry is highly competitive and characterized by constant innovation and technological change. Many of the Company's existing competitors have significantly greater financial and manufacturing capabilities, are more established, have larger marketing and sales organizations, and have larger technical staffs than the Company. Such companies are developing and marketing devices directly competitive with the Company's products for the diagnosis and treatment of disorders and conditions of the cervix, uterus and other aspects of the reproductive system, as well as products used to facilitate oncological procedures and perform pelvic reconstructive surgery. The principal competitors for the Company's core gynecology products include Circon Corporation, CooperSurgical, Inc., a subsidiary of The Cooper Companies, Inc., Karl Storz GmbH, Leisegang Medical, Inc., a subsidiary of Galileo Corporation, Olympus Corp., Utah Medical Products, Inc., Wallach Surgical Devices, Inc., and Richard Wolf Medical Instruments Corp. The principal competitors for the Company's Hydro ThermAblator and the bipolar electrosurgical therapy system for fibroid treatment include FemRx, Inc., a subsidiary of Ethicon, Inc./Johnson & Johnson; Gynecare, a subsidiary of Ethicon, Inc./Johnson & Johnson (whose ThermaChoice balloon has been cleared by the FDA to be marketed in the United States), Valleylab, Inc., a subsidiary of U.S. Surgical/Tyco (whose VestaBlate has been cleared by the FDA to be marketed in the United States), and Wallsten Medical SA. See "Business -- Competition." Other large healthcare companies may enter the market for minimally invasive diagnostic and surgical gynecological products in the future. Competing companies may succeed in developing technologies and products that are efficacious or more cost effective than those currently offered or that the Company may develop. There can be no assurance that these companies will not succeed in developing technologies and products that are more effective than any which have been or are being developed by BEI Medical or that would 37 render the Company's technologies or products obsolete or not competitive. The Company also competes with such other companies for clinical sites to conduct trials. Such competition could have a material adverse effect on the Company's business, financial condition and results of operations. The Company expects competition for devices and service to treat excessive menstrual bleeding to increase. See "Business -- Competition." Product Liability Risk; Limited Insurance Coverage The medical device industry has historically been litigious, and BEI Medical faces an inherent business risk of financial exposure to product liability claims in the event that the use of its products results in personal injury. Although the Company has not experienced any claims to date, the Company plans to market new technology and there can be no assurance that the Company will not experience losses due to product liability claims in the future. BEI Medical currently maintains product liability insurance with coverage limits of $1,000,000 per occurrence and $2,000,000 in the aggregate. The Company's products are highly complex and some are, or will be, used in medical procedures and in situations where there is a potential risk of serious injury, adverse side effects or death. As a result, the Company currently carries product liability insurance covering its products with policy limits per occurrence and in the aggregate which the Company has deemed to be sufficient. It cannot be predicted, however, whether such insurance is sufficient, or if not, whether the Company will be able to obtain such insurance as is sufficient, to cover the risks associated with the Company's business or whether such insurance will be available at premiums that are commercially reasonable. A successful claim against - or settlement by - the Company in excess of its insurance coverage or the Company's inability to maintain insurance in the future could have a material adverse effect on the Company's business, financial condition and results of operations. Dependence on Key Employees BEI Medical is dependent upon a number of key management and technical personnel. The loss of the services of one or more key employees would have a material adverse effect on the Company's business, financial condition and results of operations. The Company's ability to manage its transition to commercial-scale operations, and hence its success, will depend on the efforts of these individuals. The Company's success will also depend on its ability to attract and retain additional highly qualified management and technical personnel. The Company faces intense competition for qualified personnel, and there can be no assurance that the Company will be able to attract and retain such personnel. The Company does not currently have key person insurance on the life of any employee. Dependence on Third Party Vendors The Company relies on third party vendors for certain of the contract manufacturing services and for certain of the components used in the Company's products. Approximately 54.1% of BEI Medical's fiscal 1998 net revenues were realized from products produced by contract manufacturers. Two contract manufacturers supply products that accounted for approximately 32.8% and 11.9%, respectively, of the Company's net revenues for the 1998 fiscal year. Additionally, a number of significant components, such as thermisters and heater rods, are purchased from sole source suppliers. For certain contract 38 manufactured products and components there are relative few sources of supply, and establishing additional or replacement suppliers for such components or services cannot be accomplished quickly. Although the Company tries to maintain sufficient quantities of inventory of such components to minimize production delays or interruptions, there can be no assurance that the Company will find suitable alternatives at reasonable prices, if at all, or that any such alternatives will remain available to the Company. The Company's inability to obtain acceptable contract manufacturing services or suppliers of components in a timely manner or find and maintain suitable replacement contract manufacturing services or suppliers of components would have a material adverse effect on the Company's business, financial condition and results of operations, including its ability to manufacture its products and supply its customers. Year 2000 Currently, many computer systems and software products are coded to accept only two digit entries in the date code field. These date code fields will need to accept four digit entries to distinguish 21st century dates from 20th century dates. As a result, many companies' software and computer systems may need to be upgraded or replaced in order to comply with such Year 2000 requirements, especially those with internally developed systems. The Company and third parties, with which the Company does business, rely on numerous computer programs in their day-to-day operations. The Company's Year 2000 project is divided into the following major sections: infrastructure and applications software commonly referred to as "IT Systems", third party suppliers and customers commonly referred to as "External Agents", process control and instrumentation and company products. IT Systems. The Company has completed a preliminary assessment of Year 2000 issues as they relate to the Company's IT systems. This analysis includes such activities as order taking, billing, purchasing/accounts payable, general ledger/financial, and inventory. Systems critical to the Company's business are commercial packages available from third party vendors and currently in use with little modification. According to information provided by the suppliers of these products, Year 2000 compliant versions of these systems are available. In some cases, the version of the software the Company is currently using is believed to be compliant in all storage and calculation functions but may have some screens that display a two-digit year. In other cases, the version of the software currently in use is believed to be fully Year 2000 compliant, based upon representation received from the vendors. In still other cases, the version of the software currently being operated by the Company is not Year 2000 compliant. However, for software that is not Year 2000 compliant, the Company has acquired an updated version of the software that is believed to be Year 2000 compliant based upon representations from the vendor. The Company plans to use both internal and external resources to test the versions of the software believed to be Year 2000 compliant and to complete such testing by the middle of calendar year 1999 and plans to implement these versions before the end of fiscal year 1999. The Year 2000 analysis and upgrading of existing systems are being performed as a part of the Company's routine maintenance of computer systems and are not anticipated to be material to the Company's financial results. External Agents. The Company is currently assessing the impact of Year 2000 readiness of External Agents with which the Company relies for critical products and services. The Company is developing questionnaires and letters of inquiry to be sent to the External Agents to assist the Company in assessing the Year 2000 readiness of its External Agents and evaluate the scope of the Company's exposure. The letter to be sent to each External Agent will be 39 tailored to the significance of the contribution each makes to the Company's business. The Company anticipates that the assessment phase of this part of the project will be completed by early calendar year 1999. To date, the Company is not aware of any External Agent with a Year 2000 issue that would materially impact the Company's results of operations, liquidity or capital resources. However, the Company has no means of ensuring that External Agents will be Year 2000 ready. The inability of External Agents to complete their Year 2000 resolution process in a timely fashion could materially impact the Company. The effect of non-compliance by External Agents is not determinable. Process Control and Instrumentation. All other items with potential Year 2000 issues are currently being inventoried and evaluated. These include such items as telephone systems, security systems, HVAC, copiers, FAX machines, production equipment, tools and other process systems. The Company anticipates that the assessment phase of this part of the project will be completed by early calendar year 1999 and anticipates it will utilize both internal and external resources to reprogram, replace and test noncompliant equipment. Although the Company is in the early phases of this portion of the Year 2000 project, based upon a preliminary review the Company does not anticipate costs related to this portion of the project to be material to the financial results of the Company. Company Products. In addition, BEI Medical has reviewed the Year 2000 issue as it relates to the electronic products manufactured for sale by the Company. The Company believes that none of its products are date sensitive or will require modification to become Year 2000 compliant. Accordingly, the Company does not believe the Year 2000 issue presents a material exposure as it relates to the Company's products. While the Company currently believes that it has an effective program in place to resolve the Year 2000 issues in a timely manner, as noted above, the Company has not yet completed all necessary phases of the Year 2000 project. In the event that the Company does not complete any additional phases, the Company would be unable to efficiently take customer orders, manufacture and ship products, invoice customers or collect payments. In addition, disruptions in the economy generally resulting from Year 2000 issues could also materially adversely affect the Company. The Company currently has no contingency plan in place in the event it does not successfully complete all phases of its Year 2000 project. The Company plans to evaluate the status of completion in early calendar year 1999 and determine whether such a plan is necessary. Control by Existing Stockholders and Management The Company's directors, officers and their affiliates beneficially own approximately 28.6% of the outstanding Common Stock (assuming exercise of vested stock options). As a result of such Common Stock ownership, the Company's directors, officers and their affiliates, if they voted together, would be able to exercise significant influence over the election of members of the Company's Board of Directors and other corporate actions requiring stockholder approval. See "Security Ownership of Certain Beneficial Owners and Management." Limitation on New Equity The Company completed the spin-off of BEI Technologies, Inc. ("Technologies") at the end of fiscal year end September 1997. Shortly prior to the transaction, on August 5, 1997, President Clinton signed the Taxpayer Relief Act of 1997 (the "Act"), which would deny tax-free treatment to any spin-off that is "part of a plan (or series of related transactions) pursuant 40 to which one or more persons acquire directly or indirectly" a 50% or greater (measured by vote or value) equity interest in either the distribution corporation of the spun-off corporation. Under the Act, transactions occurring within the period beginning two years before the date of distribution and ending two years after the distribution generally would be presumed to have occurred pursuant to a plan. In response to the new law, and in conjunction with tax counsel's opinion regarding the tax-free nature of the spin-off of Technologies, the management of the Company represented to tax counsel that it had no plan or intention to issue shares after the transaction in an amount such that 50% of the outstanding shares of the Company (measured by vote or value) after such issuance would have been issued during the four-year period beginning two years prior to the date of the spin-off. Anti-Takeover Effects of Delaware Law and Certain Charter Provisions; Stockholder Rights Plan The Company's Board of Directors has the authority to issue up to 2,000,000 shares of Preferred Stock and to determine the price, rights, preferences and privileges of those shares without any further vote or action by the Company's stockholders. The rights of holders of Common Stock will be subject to, and may be adversely affected by, the rights of the holders of any Preferred Stock that may be issued in the future. While the Company has no present intention to issue shares of Preferred Stock, such issuance, while providing desirable flexibility in connection with possible acquisitions and other corporate purposes, could have the effect of making it more difficult for a third party to acquire a majority of the outstanding voting stock of the Company. In addition, the Company is subject to the anti-takeover provisions of Section 203 of the Delaware General Corporation Law (the "Delaware Law"), and the Company's Certificate of Incorporation contains a fair price provision, the combined effect of which prohibits the Company from engaging in a "business combination" with an "interested stockholder" for a period of three years after the date of the transaction in which the person became an interested stockholder, unless the business combination is approved in a prescribed manner. The application of Section 203 and the fair price provision could have the effect of delaying or preventing a change of control of the Company. The Company's Certificate of Incorporation provides for staggered terms for the members of the Board of Directors. The staggered Board of Directors and certain other provisions of the Company's Certificate of Incorporation and Bylaws may have the effect of delaying or preventing changes in control or management of the Company, which could adversely affect the market price of the Company's Common Stock. Furthermore, the Board of Directors of the Company has adopted a Stockholder Rights Plan that has certain anti-takeover effects. Rights issued under the plan will cause substantial dilution to a person or group that attempts to acquire the Company on terms not approved by the Company's Board of Directors. Forward-Looking Statements The statements contained in this Form 10-K Annual Report that are not historical fact are "forward-looking statements" (as such term is defined in the Private Securities Litigation Reform Act of 1995), which can be identified by the use of forward-looking terminology such as "believes," "expects," "may," "will," "should," "would," or "anticipates" or the negative thereof or 41 other variations thereon or comparable terminology, or by discussions of strategy that involve risks and uncertainties. Management wishes to caution the reader that these forward-looking statements contained in this Form 10-K Annual Report regarding matters that are not historical facts are only predictions. The Company's future results of operations and other forward looking statements contained in the Form 10-K Annual Report, in particular the statements concerning revenues, pricing, new products development, future capital needs and Year 2000 issues, involve a number of risks and uncertainties. No assurances can be given that the future results indicated, whether expressed or implied, will be achieved. Forward-looking statements are based upon a variety of assumptions relating to the business of the Company, which, although considered reasonable by the Company, may not be realized. Because of the number and range of the assumptions underlying the Company's forward-looking statements, many of which are subject to significant uncertainties and contingencies that are beyond the reasonable control of the Company, some of the assumptions inevitably will not materialize and unanticipated events and circumstances may occur subsequent to the date of this Form 10-K Annual Report. These forward-looking statements are based on current expectations, and the Company assumes no obligation to update this information. Therefore, the actual experience of the Company and results achieved during the period covered by any particular forward-looking statements may differ substantially from those predicted. Consequently, the inclusion of forward-looking statements should not be regarded as a representation by the Company or any other person that these estimates will be realized, and actual results may vary materially. There can be no assurance that any of these expectations will be realized or that any of the forward-looking statements contained herein will prove to be accurate. 42 Executive Officers and Directors of the Company The directors, executive officers and key employees of the Company and their ages and titles as of December 10, 1998 are as follows: Name Age Title - ---- --- ----- Charles Crocker 59 Chairman of the Board of Directors Herbert H. Spoon 54 President and Chief Executive Officer Samuel Dickstein 58 Vice President, New Business Development and Technology Thomas W. Fry 54 Vice President, Finance and Administration, Secretary and Treasurer Dr. Ralph M. Richart(1) 64 Director Richard W. Turner 52 Director Dr. Lawrence A. Wan(2) 60 Director Gary D. Wrench(1)(2) 65 Director - ---------- (1) Member of the Audit Committee (2) Member of the Compensation Committee Mr. Charles Crocker, a founder of the Company, has served as Chairman of the Board of Directors of the Company since October 1974. Mr. Crocker served as President and Chief Executive Officer of the Company from October 1995 until the Distribution. Mr. Crocker is President and Chief Executive Officer of Technologies. He served as President of Crocker Capital Corporation (a Small Business Investment Company), from 1970 to 1985, and as General Partner of Crocker Associates, a venture capital investment partnership, from 1970 to 1990. He currently serves as a director of Technologies, Fiduciary Trust Company International, Pope & Talbot, Inc. and KeraVision. Mr. Crocker holds a B.S. from Stanford University and an M.B.A. from the University of California, Berkeley. Mr. Herbert H. Spoon has served as President and Chief Executive Officer of the Company since April 1998. Prior to joining the Company, Mr. Spoon was President and Chief Executive Officer of LifeQuest Medical, Inc., a designer, developer, manufacturer and distributor of disposable and reusable gynecological and general surgical devices. Mr. Spoon also served as the President of Gynopharma, Inc., from 1987 to 1991, a company specializing in the development and distribution of gynecological pharmaceuticals, devices and diagnostics which was acquired by Johnson & Johnson. He also served as Vice President and General Manager of Lederle Laboratories, the U. S. pharmaceutical division of American Cyanamid. Prior to that, Mr. Spoon had 15 years of experience with Ciba-Geigy, including senior management positions. Mr. Spoon holds a B.S. degree from Howard Payne University. Mr. Samuel Dickstein served as Vice President, New Business Development and Technology of BEI Medical Systems Company, Inc. from June 1997 until the 43 merger of that entity into Electronics in November 1997. He served as Vice President, Operations, from the acquisition of Meditron Devices, Inc. by the Company in 1992 until June 1997. Prior to the acquisition, Mr. Dickstein, a co-founder of Meditron Devices, Inc., served as a Vice President from 1987 to 1992. From 1970 to 1978 Mr. Dickstein served as Electro-Medical Engineering Manager for American Cystoscope Makers (Circon Corp.). Mr. Dickstein holds a B.S.E.E. from the City College of New York and has also completed graduate level studies in Electrical Engineering at both New York University and the New Jersey Institute of Technology. Mr. Thomas W. Fry served as Vice President, Finance and Administration of BEI Medical Systems Company, Inc. from October 1992 until the merger of the subsidiary into Electronics in November 1997. Mr. Fry was employed by Disctronics Ltd. as Corporate Controller from 1989 to 1992, by Cavitron, Inc./CUSA, a medical device, engineering and manufacturing company, as Controller/CFO from 1986 to 1989, and by Cheeseborough-Ponds International as Manager of Profit Planning and Manufacturing Controller from 1979 to 1986. Prior to that time, Mr. Fry was employed by GTE from 1970 to 1979 in various accounting and financial roles, including three years as the Controller of GTE Sylvania in Caracas, Venezuela. Mr. Fry holds a B.S. from Southeast Missouri State University and an M.B.A. with academic honors from Pace University. Dr. Ralph M. Richart has been a director of the Company since November 1997 and was a director of BEI Medical Systems Company, Inc. from 1996 until that Company's merger into Electronics in November 1997. Dr. Richart is a Professor of Pathology and Obstetrics in Gynecology at the Columbia University College of Physicians and Surgeons and Director of Gynecological Pathology and Cytology at the Sloane Hospital for Women in New York City. He served as a Career Research Development Awardee at the Medical College of Virginia before moving to Columbia-Presbyterian Medical Center in 1963. His professional interests have centered around obstetrical and gynecological pathology and cytology with particular emphasis on the study of cervical neoplasia and, more recently, the relationship of the human papillomavirus to lower genital tract neoplasia. He is the past President of the International Gynecologic Cancer Society. He received his medical training at the University of Rochester School of Medicine and Dentistry, and completed his pathology residency in the Harvard Hospitals system. Mr. Richard W. Turner founded in 1991 what is now the Company as a subsidiary of Electronics. Mr. Turner served as President of that subsidiary from 1991 until it merged into the Company in November 1997, and then as President of the Company until April 1998. He has served as a director of the Company since September 1997. Previously, President of the Healthcare Group for the Cooper Companies, Mr. Turner has held executive leadership positions in the medical industry for over 20 years, including President and Director of Cooper-LaserSonics, Inc., President of CooperVision Inc., President and Chief Executive Officer/Director for Pancretec, Inc. and President of Kay Laboratories. Mr. Turner holds a B.S. from Old Dominion University and an M.B.A. from Pepperdine University. Dr. Lawrence A. Wan has been a director of the Company since November 1997. He served as Vice President and Chief Technical Officer of Electronics from July 1990 to September 1997, and is currently Vice President and Chief Technical Officer of Technologies, and President of SiTek, Inc., a Technologies subsidiary. From 1984 until 1990, he served as Vice President, 44 Engineering, of Systron Donner Corporation, and also held various other technical and general management positions with that company between 1979 and 1984. From 1968 through 1979, he was founder and Chief Executive Officer of Sycom, Inc., a commercial electronics company. Prior to that, he worked for Hughes Aircraft Company where he headed the Radar Systems Section of the Hughes Ground Systems Group. In 1962, Dr. Wan and two other professors established an Engineering School at the University of California, Santa Barbara, where he also taught Engineering. Dr. Wan holds B.S., M.S. and Ph.D. degrees in Engineering and Applied Sciences from Yale University. Mr. Gary D. Wrench has been a director of the Company since 1986. He served as Senior Vice President and Chief Financial Officer of Electronics from July 1993 to September 1997. From April 1985 to July 1993, he served as Vice President of Electronics and President and Chief Executive Officer of Motion Systems Company, Inc., then a wholly owned subsidiary of Electronics that is now a part of Technologies. Previous experience includes 20 years with Hughes Aircraft Company, including an assignment as President of Spectrolab, Inc., a Hughes subsidiary. He currently serves as a director of Technologies. Mr. Wrench holds a B.A. from Pomona College and an M.B.A. from the University of California, Los Angeles. Staggered Board of Directors The Company has a staggered Board of Directors, which may have the effect of deterring hostile takeovers or delaying changes in control or management of the Company. For purposes of determining their term of office, directors are divided into three classes, with the term of office of the first class to expire at the 2001 annual meeting of stockholders, the term of office of the second class to expire at the 1999 annual meeting of stockholders and the term of office of the third class to expire at the 2000 annual meeting of stockholders. Class I consists of Dr. Wan; Class II consists of Mr. Crocker and Dr. Richart; and Class III consists of Mr. Turner and Mr. Wrench. Directors elected to succeed those directors whose term expires will be elected for a three-year term of office. All directors hold office until the next annual meeting of stockholders, at which their term expires, and until their successors have been duly elected and qualified. Executive officers serve at the discretion of the Board. There are no family relationships among any of the officers and directors. Board Committees The Board of Directors of the Company has established an Audit Committee (consisting of Dr. Richart and Mr. Wrench) which reviews the results and the scope of the audit and other services provided by the Company's independent accountants and periodically reviews the results of the Company's internal audit controls, and a Compensation Committee (consisting of Dr. Wan and Mr. Wrench) which makes recommendations concerning salaries, incentives and other forms of compensation for directors, executive officers and other key employees of the Company and administers various incentive compensation and benefits plans. 45 ITEM 2. PROPERTIES The Company's principal executive offices are located in leased office space in Teterboro, New Jersey. The Company operates one other facility in Chatsworth, California, and maintains office space in various locations throughout the United States for sales and technical support. BEI Medical's principal facilities are as follows: Location Description of Facility -------- ----------------------- Teterboro, New Jersey Leased 24,400 square foot manufacturing, engineering, and administrative facility. Chatsworth, California Leased 3,400 square foot administrative and marketing facility. The lease agreement for the Teterboro facility expires on June 8, 2004, and the Company has the option to extend the term of this lease for five additional years. The monthly base rent through February 2000 is approximately $21,445, plus the Company's pro rata share of maintenance expenses and real estate taxes with immaterial increases thereafter through the end of the lease term. The lease agreement for the Chatsworth facility expires on May 31, 1999. The monthly base rent is approximately $4,225, plus the Company's pro rata share of certain operating expenses and real estate taxes. Management believes that the current facilities are adequate and suitable for the current operations of the Company. ITEM 3. LEGAL PROCEEDINGS In July 1998, the Company settled a lawsuit commenced in 1993 by CooperSurgical, Inc., a subsidiary of The Cooper Companies ("CooperSurgical"), for unspecified damages alleging unfair competition due to actions by the Company and its then president Richard Turner, a former employee of The Cooper Companies, and others. In July 1998, the parties signed a final settlement agreement whereby the Company paid $300,000 in cash, net of insurance reimbursement, and agreed to pay up to $100,000 in royalties on future product revenues. From time to time, BEI Medical may become involved in or subject to various litigation and legal proceedings incidental to the normal conduct of the Company's business. The Company is not involved in any material legal proceedings. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None. 46 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS The Company's common stock was initially offered to the public in July 1989 and traded on the Nasdaq National Market System under the Nasdaq symbol "BEII" from August 1, 1989 through the fiscal year end of September 27, 1997. During the period from October 3 to October 7, 1997, the stock traded under the Nasdaq symbol "BEIV". After October 7, 1997, the Company's common stock began trading under the Nasdaq symbol "BMED." On September 27, 1997, having transferred all of its non-medical device businesses to Technologies in exchange for all of Technologies' outstanding common stock, Electronics distributed that stock to its stockholders in a tax-free spin-off of Technologies (the "Distribution"). As a result of the spin-off of Technologies, whose business represented the majority of Electronic's assets and revenues, the market price of the Company's stock adjusted to account for the Distribution. On November 4, 1997, Electronics merged with its subsidiary, BEI Medical Systems Company, Inc., and changed its name to BEI Medical Systems Company, Inc. The closing price of the Company's common stock was $1.875 on December 10, 1998. Set forth below are the high and low closing sale prices on the National Market System for the periods indicated. Such quotations do not reflect retail markups, markdowns or commissions.
1998 Fiscal Year Cash Dividend (ended 10/03/98) High Low Declared Fourth Quarter $4.25 $1.06 $0.00 Third Quarter $5.50 $3.13 $0.00 Second Quarter $4.88 $3.69 $0.00 First Quarter (from October 9, 1997) $4.38 $3.50 $0.00 1997 Fiscal Year Cash Dividend (ended 9/27/97) High Low Declared Fourth Quarter $14.50 $10.38 $0.02 Third Quarter $11.00 $8.00 $0.02 Second Quarter $12.38 $10.38 $0.02 First Quarter $11.25 $9.25 $0.02 -----------------------------------------------------------------------------------------------
As of December 10, 1998, there were approximately 1,100 holders of record of the Company's common stock. There are no restrictions on the Company's ability to pay dividends; however, it is currently the intention of the Board 47 of Directors to retain any and all earnings for use in the Company's business and the Company does not anticipate paying cash dividends in the foreseeable future. Any future determination as to the payment of dividends will depend, among other factors, upon the earnings, capital requirements, operating results and financial condition of the Company. The Board of Directors has not declared and the Company did not pay dividends in fiscal 1998. Prior to the Distribution, the Board of Directors declared and the Company paid quarterly cash dividends of $.02 per share of common stock in each quarter of fiscal 1997. 48 ITEM 6. SELECTED FINANCIAL DATA The selected financial data for the five fiscal years presented below is derived from the audited Consolidated Financial Statements of the Company. The data should be read in conjunction with the Consolidated Financial Statements, related notes and other financial information included herein. The data and the accompanying analysis in "Management's Discussion and Analysis of Financial Condition and Results of Operations" cover periods in which the Company's operations include business segments which are now operated by Technologies and include the results of those business segments as discontinued operations by the Company. Continuing operations of the Company are comprised of the medical device business carried on by the Company's majority-owned subsidiary BEI Medical Systems Company, Inc. prior to the Distribution, which subsequent to the Distribution comprised all of the Company's operations. For further information see Note 1 to the Consolidated Financial Statements, Technologies' Form 10, "General Form for Registration of Securities", as amended (File No. 0-22799) and the Technologies Form 10-K for the fiscal year ended September 27, 1997 (File No. 0-22799).
(in thousands, except per share amounts) - ----------------------------------------------------------------------------------------------------------------------------- Year Ended -------------------------------------------------------------------------- October 3, September September September October 1, 1998 28, 1997 27, 1996 30, 1995 1994 - ----------------------------------------------------------------------------------------------------------------------------- Statement of Operations Data: Revenue $ 9,651 $ 10,005 $ 9,357 $ 8,847 $ 8,678 Loss from continuing operations (4,971) (4,348) (2,682) (2,350) (2,458) Income (loss) from discontinued operations -- 4,583 4,571 (2,041) 714 Net income (loss) (4,971) 235 1,889 (4,391) (1,744) Loss from continuing operations per common share, basic and diluted ($ 0.68) ($ 0.64) ($ 0.40) ($ 0.36) ($ 0.38) Earnings (loss) from discontinued operations per common share, basic and diluted -- 0.67 0.68 (0.30) 0.11 Earnings (loss) per common share, basic and diluted ($ 0.68) $ 0.03 $ 0.28 ($ 0.66) ($ 0.27) Cash dividends per common share -- $ 0.08 $ 0.08 $ 0.08 $ 0.08 Weighted average shares outstanding 7,354 6,817 6,737 6,617 6,541 Balance Sheet Data: Cash and cash equivalents $ 3,504 $ 9,271 $ 9,128 $ 9,023 $ 1,103 Working capital (1) 8,284 11,085 38,102 35,923 40,189 Total assets (1) 17,388 22,584 115,011 113,738 112,432 Long-term debt (excluding current portion) -- 22 212 392 560 Stockholders' equity (1) 14,440 17,660 55,972 53,319 57,829
(1) Amounts for working capital, total assets and stockholders' equity include discontinued operations for fiscal years 1996, 1995 and 1994. 49 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Except for the historical information contained herein, the following discussion contains forward-looking statements that involve risks and uncertainties. The Company's actual results could differ materially from those discussed here. Factors that could cause or contribute to such differences include, but are not limited to, those discussed in this section and in "Business." The following table sets forth, for the fiscal periods indicated, the percentage of revenue represented by certain items in the Company's Consolidated Statements of Operations.
Year Ended ------------------------------------------------- 1998 1997 1996 - ------------------------------------------------------------------------------------------------------------- Revenue 100.0% 100.0% 100.0% Cost of sales 58.4 59.7 61.9 - ------------------------------------------------------------------------------------------------------------- Gross profit 41.6 40.3 38.1 Operating expenses: Selling, general and administrative expenses 90.0 78.8 69.6 Research, development and related expenses 29.7 18.6 14.2 - ------------------------------------------------------------------------------------------------------------- Loss from operations (78.1) (57.1) (45.7) Other income 3.2 1.3 3.5 Interest expense (0.2) (0.7) (1.2) - ------------------------------------------------------------------------------------------------------------- Loss before income taxes (75.1) (56.5) (43.4) Income taxes (benefit) (23.6) (13.0) (14.8) Loss from continuing operations (51.5) (43.5) (28.6) Income from discontinued operations -- 45.8 48.8 - ------------------------------------------------------------------------------------------------------------- Net income (loss) (51.5)% 2.3% 20.2% =============================================================================================================
50 Revenue Fiscal years 1998, 1997 and 1996 In fiscal year 1998, the Company's revenues decreased 3.5% to $9,651,000 from $10,005,000 in fiscal year 1997. Revenues from gynecological products in fiscal year 1998 increased approximately 3.8% over fiscal year 1997 reflecting an increase in shipments of disposable catheter products and specialty stainless steel instruments. Additionally, international revenues from the Company's new Hydro ThermAblator grew 40.3% to $275,000 in fiscal year 1998 compared to $196,000 in fiscal year 1997. However, offsetting the above was a decline in OEM shipments from $1,710,000 in fiscal year 1997 to $950,000 in fiscal year 1998 reflecting the Company's decision to reduce marketing efforts related to its lower-margin OEM products in order to focus on its core of higher-margin women's healthcare products. Additionally, sales of several of the Company's OEM products declined on a year to year basis due to increased competition. The Company's revenues increased 6.9% to $10,005,000 in fiscal year 1997 from $9,357,000 in fiscal year 1996. Revenues from gynecology products in fiscal year 1997 increased 3.2% compared to fiscal year 1996 due to higher shipments of disposable catheters and reusable instruments. Additionally, OEM shipments increased to $1,710,000 in fiscal year 1997 compared to $1,360,000 in fiscal year 1996 reflecting shipments of special orders for minimally invasive surgery equipment in fiscal year 1997 and increased shipments of disposable catheters. Sales of the Hydro ThermAblator for endometrial ablation also contributed $196,000 in revenue in fiscal year 1997 following introduction of the system in certain international markets in that year. Partially offsetting the above was a decline in revenue from orthopedic products following the sale of the product line in fiscal year 1996. The Company's revenues from international customers were approximately 15.5%, 14.3% and 13.8% of the Company's revenue for fiscal years 1998, 1997 and 1996, respectively. International revenues can vary significantly as a percentage of revenues depending on the timing of shipments and size of orders. Cost of Sales and Gross Profit Cost of sales as a percentage of revenue was 58.4%, 59.7% and 61.9% in fiscal years 1998, 1997 and 1996, respectively. The decrease in cost of sales as a percentage of revenue in fiscal year 1998 compared to fiscal year 1997 reflects a more favorable product mix resulting primarily from the decline in lower margin OEM revenues compared to the total revenue, plus reduced labor and overhead expenses following the Company's facilities consolidation, which was completed at the end of the third fiscal quarter of 1998. The decrease in cost of sales as a percentage of revenue in fiscal year 1997 from fiscal year 1996 resulted primarily from improved overhead absorption resulting from higher sales volume plus reduced overhead spending resulting from lower personnel costs. 51 Selling, General and Administrative Expenses Selling, general and administrative expenses as a percentage of revenue were 90.0%, 78.8% and 69.6% in fiscal years 1998, 1997 and 1996, respectively. Selling, general and administrative expenses increased from $7,883,000 in fiscal year 1997 to $8,688,000 in fiscal year 1998. The higher expenses reflect: a $531,000 write-down of intangible assets to realizable value associated with the sale of the Company's GyneSys and HysteroSys product lines to Ethicon, Inc.; relocation and plant shutdown expenses of $329,000 associated with the Company's facilities consolidation; increased selling expenses of $354,000 associated with the development of the Company's field sales force of independent sales representatives; and higher legal and administrative expenses associated with the Company's efforts to obtain additional financing. The increase in expenses was partially offset by a benefit of $701,000, net of settlement, representing the reversal of previously expensed legal fees incurred in the completed litigation with CooperSurgical, Inc., which fees were reimbursed by the Company's insurance carrier. Fiscal year 1997 selling, general and administrative expenses increased by $1,366,000 from $6,517,000 in fiscal year 1996 to $7,883,000 in fiscal year 1997. The higher expenses resulted from increased selling expense of $698,000 due to expansion of the domestic sales force, higher marketing and promotional expenses, and the launch of the Hydro ThermAblator in international markets. Fiscal year 1997 expenses also included higher administrative and legal costs primarily associated with the Distribution of the common stock of BEI Technologies to the shareholders of BEI Electronics and other legal matters. See Note 1 of Notes to Consolidated Financial Statements. Research, Development and Related Expenses The Company's internally funded research, development and related expenses as a percentage of revenue were 29.7%, 18.6% and 14.2% for fiscal years 1998, 1997 and 1996, respectively. Development expense increased from $1,864,000 in fiscal year 1997 to $2,866,000 in fiscal year 1998 due to increased spending to support the Phase II and Phase III portions of the HTA clinical trials in the United States. Research and development expenses in fiscal year 1997 increased from fiscal year 1996 primarily because of increased spending for the development of the HTA and other new products and the Phase II clinical trials of the HTA. The Company believes that the continued timely development of new products and enhancements to its existing products is essential to maintaining its competitive position. Accordingly, the Company anticipates that such expenses will continue to increase in absolute amount, but may fluctuate as a percentage of revenue. Interest Expense and Other Income Interest expense as a percentage of revenue decreased to 0.2% in fiscal year 1998 from 0.7% in fiscal year 1997 and decreased to 0.7% in fiscal year 1997 from 1.2% in fiscal year 1996 as existing debt was paid down and no new debt incurred. 52 Other income in fiscal years 1998, 1997, and 1996 was comprised of interest income earned on highly liquid investments. Other income in fiscal year 1998 increased as a percentage of revenue to 3.2% from 1.3% in fiscal year 1997 reflecting the larger average cash balance over the course of fiscal year 1998 compared to fiscal year 1997. Income Tax Benefit The Company's effective tax rate from operations was 31.4%, 23.0% and 34.0%, for fiscal years 1998, 1997 and 1996, respectively. The fiscal year 1998 and fiscal year 1997 tax rate vary from the statutory federal income tax rate as a result of an increase in the valuation allowance due to substantial uncertainties regarding the realizability of certain deferred tax assets and the Company's ability to benefit from the amortization of goodwill. In fiscal year 1998, an income tax benefit of $2,279,000 was derived from the carryback of losses incurred in fiscal year 1998 against taxes paid on the earnings of discontinued operations in fiscal year 1996 and fiscal year 1997. The amount of the carryback available to the Company is limited to the taxes paid on the earnings of the previous two fiscal years and, in fiscal year 1999, any carryback will be limited to approximately $300,000 remaining. In connection with the Distribution, the Company entered into a Tax Allocation and Indemnity Agreement with Technologies, as amended December 15, 1998. Under the terms of the agreement, Technologies and Medical are each responsible for the payment of 100% of the portion of federal and state taxes related to their and their respective subsidiaries activities for the periods prior to the Distribution in which both parties were included in consolidated income tax returns and are entitled to their portion of any income tax refunds for the same periods. For the periods after the Distribution, Medical is entitled to 100% of any carryback of losses or credits to prior years. Discontinued Operations Net income for business segments now operated by BEI Technologies, Inc. was $4.6 million in each of fiscal years 1997 and 1996, respectively. Liquidity and Capital Resources The Company's capital requirements depend on numerous factors, including the progress of the Company's clinical research and product development programs, the timing and receipt of regulatory clearances and approvals, and the resources the Company devotes to developing, manufacturing and marketing its products. The Company's capital requirements also depend on the resources required to expand and develop a direct sales force in the United States and to expand the Company's manufacturing capacity, and the extent to which the Company's products gain market acceptance and sales. The timing and amount of such capital requirements cannot be predicted accurately. The Company is currently seeking additional financing. Consequently, although the Company believes its existing cash balances together with operating revenues, tax refunds and anticipated working capital financing will provide adequate funding to meet the Company's liquidity requirements for the next twelve 53 months, there can be no assurance that additional financing will be available on terms favorable to the Company, or at all. In the event the Company is unable to generate sufficient cash flows from revenues or secure additional sources of capital, its ability to continue as a going concern may be severely impaired. Any additional equity financing may be dilutive to stockholders and debt financing, if available, may involve restrictive covenants, and/or also be dilutive to stockholders. During fiscal 1998, operating activities of continuing operations utilized $6,172,000 in cash. The loss from operations of $4,971,000, plus an increase in refundable income taxes of $2,374,000, inventory purchases of $423,000 and decreases in accounts payable, accrued expenses and other liabilities of $172,000, were partially offset by non-cash charges for depreciation and amortization of $311,000 and $1,115,000, respectively, and a loss on the sale of assets of $545,000. Investing activities, which generated $579,000 in cash, consisted of $975,000 from the sale of a product line offset by purchases of plant and equipment of $372,000 and purchases of patents and licenses of $24,000. Cash used in financing activities consisted primarily of $191,000 in principal payments on long-term debt and other liabilities and proceeds from $17,000 for options exercised. The Company had no material capital or other commitments at October 3, 1998. Year 2000 Currently, many computer systems and software products are coded to accept only two digit entries in the date code field. These date code fields will need to accept four digit entries to distinguish 21st century dates from 20th century dates. As a result, many companies' software and computer systems may need to be upgraded or replaced in order to comply with such Year 2000 requirements, especially those with internally developed systems. The Company and third parties, with which the Company does business, rely on numerous computer programs in their day-to-day operations. The Company's Year 2000 project is divided into the following major sections: infrastructure and applications software commonly referred to as "IT Systems", third party suppliers and customers commonly referred to as "External Agents", process control and instrumentation and company products. IT Systems. The Company has completed a preliminary assessment of Year 2000 issues as they relate to the Company's IT systems. This analysis includes such activities as order taking, billing, purchasing/accounts payable, general ledger/financial, and inventory. Systems critical to the Company's business are commercial packages available from third party vendors and currently in use with little modification. According to information provided by the suppliers of these products, Year 2000 compliant versions of these systems are available. In some cases, the version of the software the Company is currently using is believed to be compliant in all storage and calculation functions but may have some screens that display a two-digit year. In other cases, the version of the software currently in use is believed to be fully Year 2000 compliant, based upon representation received from the vendors. In still other cases, the version of the software currently being operated by the Company is 54 not Year 2000 compliant. However, for software that is not Year 2000 compliant, the Company has acquired an updated version of the software that is believed to be Year 2000 compliant based upon representations from the vendor. The Company plans to use both internal and external resources to test the versions of the software believed to be Year 2000 compliant and to complete such testing by the middle of calendar year 1999 and plans to implement these versions before the end of fiscal year 1999. The Year 2000 analysis and upgrading of existing systems are being performed as a part of the Company's routine maintenance of computer systems and are not anticipated to be material to the Company's financial results. External Agents. The Company is currently assessing the impact of Year 2000 readiness of External Agents with which the Company relies for critical products and services. The Company is developing questionnaires and letters of inquiry to be sent to the External Agents to assist the Company in assessing the Year 2000 readiness of its External Agents and evaluate the scope of the Company's exposure. The letter to be sent to each External Agent will be tailored to the significance of the contribution each makes to the Company's business. The Company anticipates that the assessment phase of this part of the project will be completed by early calendar year 1999. To date, the Company is not aware of any External Agent with a Year 2000 issue that would materially impact the Company's results of operations, liquidity or capital resources. However, the Company has no means of ensuring that External Agents will be Year 2000 ready. The inability of External Agents to complete their Year 2000 resolution process in a timely fashion could materially impact the Company. The effect of non-compliance by External Agents is not determinable. Process Control and Instrumentation. All other items with potential Year 2000 issues are currently being inventoried and evaluated. These include such items as telephone systems, security systems, HVAC, copiers, FAX machines, production equipment, tools and other process systems. The Company anticipates that the assessment phase of this part of the project will be completed by early calendar year 1999 and anticipates it will utilize both internal and external resources to reprogram, replace and test noncompliant equipment. Although the Company is in the early phases of this portion of the Year 2000 project, based upon a preliminary review the Company does not anticipate costs related to this portion of the project to be material to the financial results of the Company. Company Products. In addition, BEI Medical has reviewed the Year 2000 issue as it relates to the electronic products manufactured for sale by the Company. The Company believes that none of its products are date sensitive or will require modification to become Year 2000 compatible. Accordingly, the Company does not believe the Year 2000 issue presents a material exposure as it relates to the Company's products. While the Company currently believes that it has an effective program in place to resolve the Year 2000 issues in a timely manner, as noted above, the Company has not yet completed all necessary phases of the Year 2000 project. In the event that the Company does not complete any additional phases, the Company would be unable to efficiently take customer orders, manufacture and ship products, invoice customers or collect payments. In addition, disruptions in the economy generally resulting from Year 2000 issues could also materially adversely affect the Company. 55 The Company currently has no contingency plan in place in the event it does not successfully complete all phases of its Year 2000 project. The Company plans to evaluate the status of completion in early calendar year 1999 and determine whether such a plan is necessary. Recent Accounting Pronouncements In June 1997, the Financial Accounting Standards Board issued Statement No. 130 "Reporting Comprehensive Income," ("FAS 130"), and Statement No. 131 "Disclosure about Segments of an Enterprise and Related Information" ("FAS 131"). The Company is required to adopt these statements in fiscal year 1999. FAS 130 establishes new standards for reporting and displaying comprehensive income and its components. FAS 131 requires disclosure of certain information regarding operating segments, products and services, geographic areas of operation and major customers. Adoption of these Statements is expected to have no impact on the Company's consolidated financial position, results of operations or cash flows. In June 1998, the Financial Accounting Standards Board issued Statement No. 133, "Accounting for Derivative Instruments and Hedging Activities" which is required to be adopted in years beginning after June 15, 1999. Because the Company does not enter into financial instruments for trading or speculative purposes and does not currently utilize derivative financial instruments, management does not anticipate that the adoption of the new Statement will have any effect on the Company's consolidated financial position or results of operations. Effects of Inflation Management believes that, for the periods presented, inflation has not had a material effect on the Company's operations. 56 ITEM 7a. QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK The Company does not enter into financial instruments for trading or speculative purposes and does not currently utilize derivative financial instruments. The operations of the Company are conducted primarily in the United States and, as such, are not subject to material foreign currency exchange rate risk and outstanding debt which is not material, is at fixed rates of interest. The Company believes its market risk exposures are not material. 57 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA CONSOLIDATED BALANCE SHEETS BEI Medical Systems Company, Inc. and Subsidiaries - -------------------------------------------------------------------------------- (dollars in thousands except share amounts) October 3, September 27, 1998 1997 - -------------------------------------------------------------------------------- ASSETS Current assets Cash and cash equivalents $3,504 $9,271 Trade receivables, less allowance for doubtful accounts (1998--$174; 1997--$112) 1,897 1,958 Inventories--Note 4 3,087 2,939 Refundable income taxes 2,384 10 Other current assets 186 286 Deferred income taxes--Note 8 174 -- - -------------------------------------------------------------------------------- Total current assets 11,232 14,464 Plant and equipment Equipment 1,569 1,461 Leasehold improvements 31 130 - -------------------------------------------------------------------------------- 1,600 1,591 Less allowances for depreciation and amortization 780 780 - -------------------------------------------------------------------------------- Net plant and equipment 820 811 Other assets Tradenames, patents and related assets, less amortization (1998--$4,560; 1997--$4,142) 1,846 3,708 Goodwill, less amortization (1998--$1,457; 1997--$1,215) 3,353 3,595 Other 137 6 - -------------------------------------------------------------------------------- Total other assets 5,336 7,309 - -------------------------------------------------------------------------------- Total assets $17,388 $22,584 ================================================================================ See notes to consolidated financial statements. 58 CONSOLIDATED BALANCE SHEETS BEI Medical Systems Company, Inc. and Subsidiaries - -------------------------------------------------------------------------------- (dollars in thousands except share amounts) October 3, September 27, 1998 1997 - -------------------------------------------------------------------------------- LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities Trade accounts payable $1,551 $346 Accrued expenses and other liabilities -- Note 6 1,376 2,785 Current portion of long-term debt--Note 7 21 190 Deferred income taxes -- 58 - -------------------------------------------------------------------------------- Total current liabilities 2,948 3,379 Long-term debt, less current portion -- Note 7 -- 22 Minority interest in consolidated subsidiary -- Note 1 -- 1,523 Commitments and contingencies -- Notes 12 and 13 -- -- Stockholders' equity -- Notes 2, 9 and 10 Preferred stock ($.001 par value; authorized 2,000,000 shares; none issued) -- -- Common stock ($.001 par value; authorized 20,000,000 shares; issued and outstanding; 1998--7,778,296 shares; 1997--7,114,513 shares) 10 10 Additional paid-in capital 16,291 14,204 Retained earnings (deficit) (1,525) 3,446 - -------------------------------------------------------------------------------- 14,776 17,660 Less: Unearned restricted stock and other -- Note 10 (336) -- - -------------------------------------------------------------------------------- Total stockholders' equity 14,440 17,660 - -------------------------------------------------------------------------------- Total liabilities and stockholders' equity $17,388 $22,584 ================================================================================ See notes to consolidated financial statements. 59 CONSOLIDATED STATEMENTS OF OPERATIONS BEI Medical Systems Company, Inc. and Subsidiaries
- ------------------------------------------------------------------------------------------------------------------- Year Ended - ------------------------------------------------------------------------------------------------------------------- October 3, September 27, September 28, (dollars in thousands except share and per share amounts) 1998 1997 1996 - ------------------------------------------------------------------------------------------------------------------- Revenue $9,651 $10,005 $9,357 Cost of sales 5,638 5,972 5,792 - ------------------------------------------------------------------------------------------------------------------- Gross profit 4,013 4,033 3,565 Selling, general and administrative expenses 8,688 7,883 6,517 Research, development and related expenses 2,866 1,864 1,328 - ------------------------------------------------------------------------------------------------------------------- 11,554 9,747 7,845 - ------------------------------------------------------------------------------------------------------------------- Loss from operations (7,541) (5,714) (4,280) Other income 312 136 324 Interest expense (21) (70) (110) - ------------------------------------------------------------------------------------------------------------------- Loss before income taxes (7,250) (5,648) (4,066) Income tax benefit -- Note 8 (2,279) (1,300) (1,384) - ------------------------------------------------------------------------------------------------------------------- Loss from continuing operations (4,971) (4,348) (2,682) Income (loss) from discontinued operations, net of income taxes of $1,788 and $1,412, for 1997 and 1996, respectively -- 4,583 4,571 - ------------------------------------------------------------------------------------------------------------------- Net income (loss) ($4,971) $235 $1,889 =================================================================================================================== Loss from continuing operations per common share, basic and diluted ($0.68) ($0.64) ($0.40) Earnings (loss) from discontinued operations per common share, basic and diluted -- 0.67 0.68 - ------------------------------------------------------------------------------------------------------------------- Earnings (loss) per common share, basic and diluted -- Note 2 ($0.68) $0.03 $0.28 - ------------------------------------------------------------------------------------------------------------------- Weighted average shares outstanding -- Note 2 7,354,416 6,816,702 6,737,399 - ------------------------------------------------------------------------------------------------------------------- Dividends per common share -- Note 2 -- $0.08 $0.08 ===================================================================================================================
See notes to consolidated financial statements. 60 CONSOLIDATED STATEMENTS OF CASH FLOWS BEI Medical Systems Company, Inc. and Subsidiaries
- -------------------------------------------------------------------------------------------------------------------- Year Ended - -------------------------------------------------------------------------------------------------------------------- October 3, September 27, September 28, (dollars in thousands) 1998 1997 1996 - -------------------------------------------------------------------------------------------------------------------- Cash flows from operating activities: Loss from continuing operations ($4,971) ($4,348) ($2,682) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation 311 269 217 Amortization 1,115 1,356 1,530 Provision for losses on trade receivables 62 57 39 Loss on sale of assets 545 -- -- Deferred income taxes (233) (261) (26) Changes in operating assets and liabilities, net of acquisitions and dispositions: Trade receivables (1) (302) (187) Inventories (423) (854) (267) Refundable income taxes (2,374) -- -- Other assets (31) (142) 192 Trade accounts payable, accrued expenses and other liabilities (172) 164 (3,955) - -------------------------------------------------------------------------------------------------------------------- Net cash used in operating activities of continuing operations (6,172) (4,061) (5,139) - -------------------------------------------------------------------------------------------------------------------- Cash flows from investing activities: Purchases of plant and equipment (372) (263) (316) Purchases of patents and licenses (24) (186) (136) Proceeds from sale of assets 975 -- -- Other -- 18 (297) - -------------------------------------------------------------------------------------------------------------------- Net cash provided by (used in) investing activities of continuing operations 579 (431) (749) - -------------------------------------------------------------------------------------------------------------------- Cash flows from financing activities: Proceeds from sale of minority interest -- -- 1,488 Principal payments on long-term debt and other liabilities (191) (715) (678) Proceeds from issuance of common stock, net -- 872 1,067 Proceeds from stock option exercises 17 -- -- Repurchase of stock -- (1,303) (154) Payment of cash dividends -- (563) (555) - -------------------------------------------------------------------------------------------------------------------- Net cash provided by (used in) financing activities of continuing operations (174) (1,709) 1,168 - -------------------------------------------------------------------------------------------------------------------- Net cash provided by discontinued operations--Note 3 -- 6,344 4,825 - -------------------------------------------------------------------------------------------------------------------- Net increase (decrease) in cash and cash equivalents (5,767) 143 105 Cash and cash equivalents at beginning of year 9,271 9,128 9,023 - -------------------------------------------------------------------------------------------------------------------- Cash and cash equivalents at end of year $3,504 $9,271 $9,128 ====================================================================================================================
See notes to consolidated financial statements. 61 CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY BEI Medical Systems Company, Inc. and Subsidiaries
- --------------------------------------------------------------------------------------------------------------------- Unearned Additional Retained restricted (dollars in thousands) Common paid-in earnings Treasury stock and Stock capital (deficit) stock other Total - --------------------------------------------------------------------------------------------------------------------- Balances at September 30, 1995 $9 $24,112 $41,721 ($11,793) ($730) $53,319 Net income for 1996 1,889 1,889 Stock options exercised 842 842 Employee Stock Purchase Plan offering--Note 11 225 225 Restricted Stock Plan--Note 10 594 (188) 406 Purchase of treasury stock--(15,000 shares at $10.27 average per share) (154) (154) Cash dividends (555) (555) - --------------------------------------------------------------------------------------------------------------------- Balances at September 28, 1996 9 25,773 43,055 (11,947) (918) 55,972 Net income for 1997 235 235 Stock options exercised 1 866 867 Restricted Stock Plan--Note 10 815 (475) 340 Purchase of treasury stock--(135,000 shares at $9.67 average per share) (1,303) (1,303) Cash dividends (563) (563) Retirement of treasury stock (13,250) 13,250 - --------------------------------------------------------------------------------------------------------------------- Balances at September 27, 1997 before 10 14,204 42,727 -- (1,393) 55,548 Distribution Distribution (39,281) 1,393 (37,888) - --------------------------------------------------------------------------------------------------------------------- Balances at September 27, 1997 10 14,204 3,446 -- -- 17,660 Net loss for 1998 (4,971) (4,971) Restricted Stock Plan--Note 10 329 (250) 79 Deferred Compensation 218 (86) 132 Stock options exercised 17 17 Conversion of minority interest--Note 1 1,523 1,523 - --------------------------------------------------------------------------------------------------------------------- Balances at October 3, 1998 $10 $16,291 ($1,525) -- ($336) $14,440 =====================================================================================================================
See notes to consolidated financial statements. 62 BEI MEDICAL SYSTEMS COMPANY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 1 Basis of Presentation On September 27, 1997, BEI Electronics, Inc. ("Electronics") distributed to holders of Electronics common stock one share of common stock of BEI Technologies, Inc. ("Technologies"), a newly formed subsidiary, for each share of Electronics common stock held ("the Distribution"). In connection with the Distribution, Electronics transferred to Technologies all of the assets, liabilities and operations of its BEI Sensors & Systems Company, Inc. ("Sensors") and Defense Systems Company, Inc. ("Defense") business segments. Accordingly, the results of operations of the segments have been presented as discontinued operations for all periods presented. As of September 27, 1997, the sole asset of BEI Electronics was its investment in BEI Medical Systems Company, Inc. On November 4, 1997, Electronics merged with its subsidiary, BEI Medical Systems Company, Inc. ("Medical"), and became one company with Electronics as the surviving corporation (the "Merger"). As a result of the Merger, each outstanding share of common stock of Medical at that date (other than shares held by Electronics) was automatically converted into the right to receive 5.51615 shares of Electronics common stock. Certificates for Electronics common stock were issued, rounded down to the nearest whole number of shares. Fractional shares of Electronics common stock that would have otherwise been issued in connection with the Merger have been redeemed by Electronics pro rata based on the last reported sale price of Electronics common stock on the last trading day preceding the merger. After the Merger, Electronics changed its name to BEI Medical Systems Company, Inc. (the "Company"). The following table shows the conversion as of November 4, 1997 of the 6% minority interest in Medical common stock to Electronics common stock at a conversion rate of 5.51615 shares of Electronics common stock for every one share of Medical common stock held. Common Shares Pre-Merger Post-Merger Medical Electronics Common Stock Common Stock --------------------------------------------------------------------------- Johnson & Johnson 52,131 287,561 Management 12,650 69,778 Others 15,721 86,716 --------------------------------------------------------------------------- 80,502 444,055 =========================================================================== Prior to the merger of Medical with Electronics, Medical had shares of Series A and B preferred stock outstanding which were converted to Medical common stock on a share-for-share basis. 63 BEI MEDICAL SYSTEMS COMPANY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued Note 2 Summary of Significant Accounting Policies Operations: The Company is a manufacturer of diagnostic and therapeutic products focused on gynecology and women's health issues. In the U.S., the Company utilizes independent manufacturers' representative organizations, direct sales representatives, telemarketers and domestic distributors to market its products directly to end users, hospitals, surgical centers and doctors' offices. Products are also sold through a network of international distributors. Medical's operations consist of Zinnanti Surgical Instruments in Chatsworth, California and Xylog Corporation, Meditron Devices, Inc., and BEI Medical Systems International, Inc. in Teterboro, New Jersey. The Company is currently seeking additional financing. Consequently, although the Company believes its existing cash balances together with operating revenues, tax refunds and anticipated working capital financing will provide adequate funding to meet the Company's liquidity requirements for the next twelve months, there can be no assurance that additional financing will be available on terms favorable to the Company, or at all. In the event the Company is unable to generate sufficient cash flows from revenues or secure additional sources of capital, its ability to continue as a going concern may be severely impaired. Any additional equity financing may be dilutive to stockholders and debt financing, if available, may involve restrictive covenants and/or also be dilutive to stockholders. Fiscal Year: The Company's fiscal year ends on the Saturday nearest September 30. Fiscal year 1998 contained 53 weeks. Fiscal years 1997 and 1996 each contained 52 weeks. Consolidation: The consolidated financial statements include the accounts of the Company and its wholly and majority owned subsidiaries. All significant intercompany accounts and transactions have been eliminated. Cash and Cash Equivalents: The Company considers all highly liquid investments with a maturity of three months or less when purchased to be cash equivalents. Concentration of Credit Risk: The Company's products are sold to commercial customers throughout the United States and in various foreign countries. The Company performs ongoing credit evaluations of its commercial customers and generally does not require collateral. The Company maintains reserves for potential credit losses. Historically, such losses have been within the expectations of management. Use of Estimates: The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and the accompanying notes. Actual results could differ from these estimates. Revenue Recognition: Revenue is recognized as units are shipped. Inventories: Inventories are carried at the lower of cost (first-in, first-out method) or market. 64 BEI MEDICAL SYSTEMS COMPANY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued Depreciation and Amortization: Plant and equipment are recorded at cost. Depreciation and amortization are provided in amounts sufficient to amortize the cost of such assets over their estimated useful lives, which range from three to ten years, using the straight-line method. Long-Lived Assets: The Company accounts for any impairment of its long-lived assets using Financial Accounting Standards Board Statement of Financial Accounting Standards No. 121 ("FAS No. 121") "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of." Long-lived assets consists of plant and equipment, patents, and trade names, related non-competition agreements and goodwill acquired in purchase acquisitions. Patents and non-competition agreements are being amortized on a straight-line basis over their terms. Trade names are amortized on a straight-line basis over ten to twenty-five years. Goodwill consists of the excess of cost over fair value of net tangible assets acquired in purchase acquisitions. Goodwill is amortized by the straight-line method over twenty years. The carrying value of long-lived assets will be reviewed if the facts and circumstances suggest that they may be impaired. Impairment is determined based on undiscounted future cash flows over the expected period of use. If impairment is indicated, the carrying value of long-lived assets would be reduced to fair value. In connection with the sale of the Company's GyneSys and HysteroSys product lines, intangible assets of $1,133,000 were sold. Stock Option Plan: The Company has elected to continue to follow Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB 25") and related interpretations in accounting for its employee stock options. Under APB No. 25, if the exercise price of the Company's employee stock options equals the market price of the underlying stock on the date of grant, no compensation expense is recognized. Per Share Information: During the fiscal year ended October 3, 1998, the Company adopted SFAS No. 128, "Earnings Per Share." SFAS No. 128 requires the dual presentation of basic and diluted earnings per share ("EPS"). Basic EPS excludes dilution and is computed by dividing net income or loss available to common stockholders by the weighted average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur if stock options or other contracts to issue common stock were exercised and resulted in the issuance of common stock that then shared in the earnings or loss of the Company. Diluted EPS is computed using the treasury stock method when the effect of common stock equivalents would be dilutive. All prior periods have been restated to comply with the provisions of SFAS No. 128. As a result of the net loss from continuing operations for all periods presented, weighted average shares used in the calculation of basic and diluted loss per share are the same. Weighted average shares exclude unvested restricted stock which amounted to approximately 184,000, 211,000 and 190,000 shares for 1998, 1997 and 1996, respectively. Common stock equivalents are excluded from the loss per share calculation for all periods presented because the effect would be anti-dilutive. Research and Development Costs: Company-sponsored product development costs are charged to expense when incurred. 65 BEI MEDICAL SYSTEMS COMPANY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued Advertising Costs: Advertising costs are charged to expense when incurred and were approximately $489,000, $412,000 and $423,000 in fiscal years 1998, 1997 and 1996, respectively. Recent Accounting Pronouncements: In June 1997, the Financial Accounting Standards Board issued Statement No. 130 "Reporting Comprehensive Income," ("FAS 130"), and Statement No. 131 "Disclosure about Segments of an Enterprise and Related Information" ("FAS 131"). The Company is required to adopt these statements in fiscal year 1999. FAS 130 establishes new standards for reporting and displaying comprehensive income and its components. FAS 131 requires disclosure of certain information regarding operating segments, products and services, geographic areas of operation and major customers. Adoption of these Statements is expected to have no impact on the Company's consolidated financial position, results of operations or cash flows. In June 1998, the Financial Accounting Standards Board issued Statement No. 133, "Accounting for Derivative Instruments and Hedging Activities" which is required to be adopted in years beginning after June 15, 1999. Because the Company does not enter into financial instruments for trading or speculative purposes and does not currently utilize derivative financial instruments, management does not anticipate that the adoption of the new Statement will have any effect on the Company's consolidated financial position or results of operations. Note 3 Discontinued Operations Technologies was incorporated on June 30, 1997 in the State of Delaware, as a wholly owned subsidiary of Electronics. On September 27, 1997, Electronics distributed to holders of Electronics common stock one share of common stock of Technologies for each share of Electronics common stock held on September 24, 1997. In connection with the Distribution, Electronics transferred to Technologies all of the assets, liabilities and operations of its Sensors and Defense business segments. Accordingly, the financial position and results of operations of Sensors and Defense are shown as discontinued operations for all periods presented. Note 4 Inventories (dollars in thousands) 1998 1997 --------------------------------------------------------------------------- Finished products $2,128 $1,843 Work in process 196 230 Materials 763 866 --------------------------------------------------------------------------- Inventories $3,087 $2,939 =========================================================================== 66 BEI MEDICAL SYSTEMS COMPANY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued Included in fiscal year 1998 finished goods is $245,000 of inventory which is currently subject to FDA approval prior to its sale in the United States. Note 5 Bank Credit Agreements The Company had no bank credit agreements at October 3, 1998 and September 27, 1997. Note 6 Accrued Expenses and Other Liabilities (dollars in thousands) 1998 1997 -------------------------------------------------------------------------- Insurance reimbursement $ -- $946 Noncompetition contract -- 562 Professional fees 134 205 Employee compensation 268 337 Taxes 141 136 Commissions 180 127 Royalties and related costs 130 102 Tax refund payable to BEI Technologies 327 -- Other 196 370 -------------------------------------------------------------------------- Accrued Expenses and Other Liabilities $1,376 $2,785 ========================================================================== Note 7 Long-Term Debt (dollars in thousands) 1998 1997 ------------------------------------------------------------------------ Note payable to the previous owner of Zinnanti Surgical Instruments, Inc. with interest at 5.0%; payable in monthly installments of $10,883 through December 1998 $21 $147 Note payable to a related party -- 60 Asset purchase agreement with zero interest; payable in monthly installments through 1998 -- 5 ------------------------------------------------------------------------ $21 $212 Less current portion 21 190 ------------------------------------------------------------------------ Long-term debt $-- $22 ======================================================================== 67 BEI MEDICAL SYSTEMS COMPANY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued Interest of approximately $7,000, $11,000 and $31,000 was paid on long-term debt by Medical during fiscal 1998, 1997 and 1996, respectively. Interest of approximately $35,000, $50,000 and $96,000 was paid on noncompetition agreements by Medical during fiscal 1998, 1997 and 1996, respectively. In connection with the Distribution, Technologies assumed Electronics' obligations related to the service and repayment of $22.4 million in Senior Notes. The interest expense related to the notes was allocated to Technologies for fiscal years 1996 and 1997. Note 8 Income Taxes Deferred income taxes reflect the net tax effects of temporary differences between carrying amounts of assets and liabilities for financial reporting purposes and amounts used for income tax purposes. Significant components of the Company's deferred tax liabilities and assets as of October 3, 1998 and September 27, 1997 are as follows: (dollars in thousands) 1998 1997 ---------------------------------------------------------------------------- Deferred tax liabilities Depreciation and property basis difference $20 $12 Accrued expenses -- 213 ---------------------------------------------------------------------------- Total deferred tax liabilities 20 225 Deferred tax assets Intangibles 465 536 Other 193 98 Inventory valuation 92 85 State net operating loss carryovers 1,177 1,177 Allowance for bad debt 51 55 ---------------------------------------------------------------------------- Total deferred tax assets 1,978 1,951 Valuation allowance for deferred tax assets (1,784) (1,784) ---------------------------------------------------------------------------- Net deferred tax assets/(liabilities) $174 ($58) ============================================================================ The valuation allowance reflects uncertainties regarding realizability of deferred tax assets related to certain intangibles and state net operating loss carryovers. As of October 3, 1998, the Company has net operating loss carryforwards for state income tax purposes of approximately $19.6 million, which expire from 2001 through 2004. The Company has no net operating loss carryforwards for federal income tax purposes. 68 BEI MEDICAL SYSTEMS COMPANY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued Significant components of the benefit for income taxes from continuing operations are as follows: (dollars in thousands) 1998 1997 1996 ------------------------------------------------------------------------- Current (credit) Federal ($2,046) ($1,039) ($1,358) State -- -- -- ------------------------------------------------------------------------- Total Current (2,046) (1,039) (1,358) Deferred (credit) Federal (233) (261) (23) State -- -- (3) ------------------------------------------------------------------------- Total Deferred (233) (261) (26) ------------------------------------------------------------------------- Total income tax (benefit) ($2,279) ($1,300) ($1,384) ========================================================================= A reconciliation of the statutory federal income tax rate to the Company's effective rate from continuing operations is presented below.
(dollars in thousands) 1998 1997 1996 ---------------------------------------------------------------------------------------------------------- Income tax credit at the statutory rate of 34% ($2,465) ($1,920) ($1,382) Federal income tax effect of state income taxes -- -- 1 Goodwill amortization 131 81 81 Increase in federal valuation allowance -- 607 -- Other 55 (68) (81) ---------------------------------------------------------------------------------------------------------- Federal income taxes (credit) (2,279) (1,300) (1,381) State income tax credit, net of increase in state valuation allowance -- -- (3) ---------------------------------------------------------------------------------------------------------- Provision (credit) for income taxes ($2,279) ($1,300) ($1,384) ==========================================================================================================
In connection with the Distribution, the Company entered into a Tax Allocation and Indemnity Agreement with Technologies as amended December 15, 1998. Under the terms of the agreement, Technologies and Medical are each responsible for the payment of 100% of the portion of federal and state taxes related to their and their respective subsidiaries activities for the periods prior to the Distribution in which both parties were included in consolidated income tax returns and are entitled to their portion of any income tax refunds for the same periods. For the periods after the Distribution, Medical is entitled to 100% of any carryback of losses or credits to prior years. 69 BEI MEDICAL SYSTEMS COMPANY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued Note 9 Stockholders' Equity The Company's preferred stock may be issued from time to time in one or more series. The Board of Directors is authorized to establish from time to time the number of shares to be included in each series, and to designate the dividend rights, dividend rate, conversion rights, voting rights, rights and terms of redemption, redemption price or prices and liquidation preferences. During fiscal 1992 and 1990, the Board of Directors of the Company authorized the purchase from time to time in open market transactions of up to 300,000 and 500,000 shares of common stock, respectively. During fiscal year 1996, the Board approved an additional repurchase of up to 200,000 shares on the open market. At the end of fiscal year 1997, 934,424 shares had been repurchased at a cost of $6,969,178 under this program. The treasury stock shares were then retired at September 27, 1997. Note 10 Stock Option and Restricted Stock Plans In 1982, the Company's stockholders voted to adopt an incentive stock option plan. The plan provided for option prices based on the fair market value of the stock on the date the option is granted. The Incentive Stock Option Plan of 1982 terminated December 15, 1991. The remaining 24,000 options outstanding under the plan at an exercise price of $3.75 were exercised during fiscal year 1997. No shares were outstanding or available for grant at September 27, 1997. In November 1987, the Company's stockholders voted to adopt an additional incentive stock option plan and a supplemental (nonqualified) stock option plan. The incentive stock option plan provides for option prices based on the fair market value of the stock on the date the option is granted, as determined by the Board of Directors. The supplemental stock option plan requires that the exercise price of each option shall not be less than 50% of the fair market value on the date the option is granted. Under both plans the options are generally exercisable in three approximately equal installments commencing one year from the date of grant with accumulation privileges. In January 1997, the Board combined the Incentive and Supplemental Plans into one plan, and amended it to change the name to the Amended 1987 Stock Option Plan (the "Amended Plan"), provide for the granting of both incentive and non-statutory stock options, provide for grants to non-employee consultants to the Company, and increase the share reserve for option grants by 100,000. In March 1997, the shareholders approved an increase in the share reserve for option grants by 250,000 so that shares issued pursuant to options granted under the Amended Plan cannot exceed 1,600,000 in the aggregate. As a result of the Distribution, all the outstanding options for common stock of the Company at the date of the Distribution, both vested and 70 BEI MEDICAL SYSTEMS COMPANY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued unvested, were converted to options for common stock of Technologies, at a rate of approximately 1.07 options for Technologies stock for every 1.0 Electronics option held and the Electronics options were cancelled. The exercise price of the options was also adjusted so that the aggregate value of all outstanding options was the same after the Distribution as before. See Note 1 -- Basis of Presentation for more information. Transactions relating to the Amended 1987 Stock Option Plan are summarized as follows:
Weighted Average Number of Exercise Exercise Common Price Price Shares Per Share Per Share - ----------------------------------------------------------------------------------------------------------- Options outstanding at September 30, 1995 610,395 $2.88 - $9.13 $5.71 Granted 11,000 $6.00 - $7.13 $6.42 Exercised (115,922) $2.88 - $9.13 $6.27 Terminated (48,511) $5.00 - $9.13 $7.80 - ----------------------------------------------------------------------------------------------------------- Options outstanding at September 28, 1996 456,962 $2.88 - $9.13 $5.36 Exercised (137,866) $2.88 - $7.25 $5.33 Terminated (3,500) $3.75 - $9.13 $7.95 - ----------------------------------------------------------------------------------------------------------- Options outstanding prior to Distribution 315,596 $2.88 - $9.13 $5.35 Distribution conversion to Technologies options (315,596) $2.88 - $9.13 $5.35 - ----------------------------------------------------------------------------------------------------------- Options outstanding as of September 27, 1997 -- -- -- Conversion of BEI Medical 595,739 $0.31 - $3.74 $0.48 Granted 203,489 $1.94 - $4.00 $3.04 Exercised (55,161) $0.31 $0.31 - ----------------------------------------------------------------------------------------------------------- Options outstanding at October 3, 1998 744,067 $0.31 - $4.00 $1.19 ===========================================================================================================
As of October 3, 1998, 243,687 shares were available for grant under the Amended Plan. Details of the 744,067 options outstanding as of October 3, 1998 were as follows: 71 BEI MEDICAL SYSTEMS COMPANY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
Weighted Average Weighted Weighted Remaining Average Average Contractual Exercise Exercise Exercise Options Life Price Per Number Price Prices Outstanding (Years) Share Exercisable Per Share - --------------------------------------------------------------------------------------------------------- $0.31 366,821 6.8 $0.31 366,821 $0.31 $0.54 52,403 7.3 $0.54 28,960 $0.54 $0.70 107,564 7.6 $0.70 53,782 $0.70 $1.94 95,000 9.5 $1.94 -- -- $3.74 13,790 8.4 $3.74 3,448 $3.74 $4.00 108,489 9.1 $4.00 -- -- - --------------------------------------------------------------------------------------------------------- $0.31 - $4.00 744,067 7.7 $1.19 453,011 $0.40 =========================================================================================================
In July 1995, Medical's stockholders adopted an incentive stock option plan and a supplemental (nonqualified) stock option plan for Medical stock. The incentive stock option plan provided for option prices based on Medical's fair market value of the stock on the date the option is granted, as determined by Medical's Board of Directors. The supplemental stock option plan required that the exercise price of each option shall not be less than 85% of the fair market value on the date the option is granted. Transactions related to the incentive and supplemental Medical stock option plans of 1995 are summarized as follows:
Weighted Number of Exercise Average Common Price Exercise Price Shares Per Share Per Share - ---------------------------------------------------------------------------------------------------------- Options outstanding at September 30, 1995 85,500 $1.72 $1.72 Granted 34,800 $3.00 - $3.85 $3.48 - ---------------------------------------------------------------------------------------------------------- Options outstanding at September 28, 1996 120,300 $1.72 - $3.85 $2.23 Granted 2,500 $20.65 $20.65 Exercised (9,000) $1.72 $1.72 Terminated (5,800) $3.00 $3.00 - ---------------------------------------------------------------------------------------------------------- Options outstanding at September 27, 1997 108,000 $1.72 - $20.65 $2.66 Options converted to Electronics (108,000) $1.72 - $20.65 $2.66 - ---------------------------------------------------------------------------------------------------------- Options outstanding at October 3, 1998 -- -- -- ==========================================================================================================
72 BEI MEDICAL SYSTEMS COMPANY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued On November 4, 1997, Medical and Electronics merged with Electronics as the surviving legal entity. As a result of the Merger, options outstanding under the Medical stock option plans of 1995 were converted to Electronics options at a rate of approximately 5.51615 Electronics options for every one Medical option outstanding. Electronics' outstanding options increased to 595,739 after the Merger from zero outstanding at September 27, 1997. Medical's outstanding options decreased to zero and the Medical stock option plans of 1995 were cancelled as a result of the Merger. In February 1992, the Company's Board of Directors approved the 1992 Restricted Stock Plan (the "Restricted Plan"), ratified by the Company's shareholders in February 1993, and authorized up to 350,000 shares to be issued to certain key individuals subject to forfeiture if employment terminated prior to the end of prescribed periods. In January 1997, the Restricted Plan was amended to increase the shares reserved for issuance under the plan from 350,000 to 700,000. As of October 3, 1998, 589,926 shares had been granted and of these, 517,850 shares were outstanding and are included in the Company's total common stock outstanding. Of the outstanding shares, 197,801 had vested. There are 182,150 shares reserved for future issue. The market value at the date of grant of shares awarded under the plan is recorded as unearned restricted stock. The market value of shares granted is amortized to compensation expense over the periods of vesting. No compensation expense for Medical was recorded in fiscal 1997 or 1996. In fiscal 1998, $79,000 of compensation expenses was recorded. Pro forma information regarding net loss and net loss per common share, basic and diluted is required by SFAS No. 123, and has been determined as if the Company had been accounting for its employee stock options under the fair value method of that Statement. The fair value of these options was estimated at the date of grant using a Black-Scholes option pricing model with the following assumptions for 1998: weighted-average risk-free interest rate of 4.92%; no dividends; volatility factors of the expected market price of the Company's common stock of 0.562 for 1998 and a weighted average expected life of the options of 9.3 years for 1998. The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable. In addition, option valuation models require the 73 BEI MEDICAL SYSTEMS COMPANY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued input of highly subjective assumptions including the expected stock price volatility. Because the Company's employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options. For purposes of pro forma disclosures, the estimated fair value of the options granted in 1998 is amortized to expense over the options' vesting period. The weighted-average grant date fair value of options granted during fiscal year 1998 was $2.10. The Company's pro forma net loss was $5,036,000 for 1998 and pro forma net loss per common share, basic and diluted was $0.68. The pro forma disclosures presented for fiscal year 1998 may not necessarily be indicative of the pro forma effect of SFAS No. 123 for future periods in which options may be granted. The impact of the calculation required by FAS No. 123 on pro forma results of operations and earnings (loss) per share was determined to be immaterial for fiscal years 1997 and 1996. Note 11 Employee Benefit Plans The Company has a defined contribution retirement plan for the benefit of all eligible employees. The plan qualifies under Section 401(k) of the Internal Revenue Code thereby allowing eligible employees to make tax-deductible contributions to the plan. Non-discretionary employer contributions are based on a fixed percentage of total eligible employee compensation and a formula based matching of the participant's contribution to the plan. Additional contributions are at the discretion of the Board of Directors. The Company's contributions to the plan for fiscal 1998, 1997 and 1996 for the benefit of the employees of continuing operations were approximately $76,000, $62,000 and $54,000, respectively. The Company also has an employee stock purchase plan. The purchase plan qualifies as an employee stock purchase plan under Section 423 of the Internal Revenue Code. Under the purchase plan, the Board of Directors may authorize the participation by employees (excluding certain highly compensated employees) in offerings of its common stock. Under the purchase plan, employees may have up to 10% of their salary withheld to be used to purchase shares of common stock at a price equal to not less than 85% of the fair market value of the stock at specified applicable dates. The purchase plan was suspended as of August 1, 1996, due to efforts to simplify the Company's equity accounts to support analysis of various organizational alternatives. At that date, 459,174 shares had been issued and 140,826 shares were reserved for purchase over the ten-year life of the purchase plan. This plan will terminate May 31, 1999 unless extended. 74 BEI MEDICAL SYSTEMS COMPANY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued Note 12 Lease and Other Commitments Leases: Operating leases consist principally of leases for structures and land. Certain of the operating leases contain various options for renewal and/or purchase of the related assets for amounts approximating their fair market value at the date of exercise of the option. The future minimum payments for operating leases consisted of the following at October 3, 1998: (dollars in thousands) ------------------------------------------------------------------ 1999 $355 2000 318 2001 312 2002 311 2003 306 Thereafter 204 ------------------------------------------------------------------ Total minimum lease payments $1,806 ================================================================== Total rental expense attributable to property, plant and equipment for continuing operations amounted to approximately $297,000, $268,000, and $228,000 for fiscal 1998, 1997 and 1996, respectively. Minimum Purchase Requirements: In 1997, the Company entered into an agreement with Valley Forge Scientific Corporation giving the Company worldwide marketing rights for distribution of the bipolar electrosurgical therapy systems, in the field of gynecology. The agreement is for 63 months from the date the product first becomes available and includes minimum requirements for the first fifteen-month period and is subject to negotiating annual minimum requirements in subsequent twelve-month periods. As of October 3, 1998, future minimum purchases for the initial fifteen-month period of approximately $80,000 are still required. Minimum Royalty Payments: In 1993, the Company entered into a license agreement for the HTA endometrial ablation technology whereby royalty payments of 10% are payable on net revenues of certain disposal components. The agreement is subject to minimum royalty payments for a period of three years following the first shipment of product for revenue. The minimum royalty payments during the next two fiscal years are as follows: (dollars in thousands) --------------------------------------------------------------- 1999 $33 2000 33 --------------------------------------------------------------- Total minimum royalty payments $66 =============================================================== The Company has also entered into a number of other license and royalty agreements that require payments based upon revenues on the sales of certain products ranging from 4% to 10% of revenue. Except for the endometrial ablation technology agreement 75 BEI MEDICAL SYSTEMS COMPANY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued mentioned above, there are no minimum requirements. Total royalty expense attributable to various license agreements amounted to approximately $314,000, $270,000 and $238,000 for fiscal 1998, 1997 and 1996, respectively. Other Commitments: In connection with a $1.5 million equity investment in Medical in February 1996, Johnson & Johnson Development Corporation ("J&J") received a right of first negotiation to manufacture and/or distribute any product primarily intended for use in endometrial ablation acquired or developed after the date of the agreement ("Ablation Products") and the right to consult in connection with FDA applications with respect to such Ablation Products. The right of first negotiation is effective for a ninety-day period commencing on the earlier of i.) J&J's notice to the Company of its desire to manufacture and/or distribute an Ablation Product and ii.) the date the Company notifies J&J of approval from the FDA to market an Ablation Product. In the event that the parties are unable to agree upon mutually acceptable terms, then the Company may either manufacture and/or distribute the Ablation Product itself or enter into an agreement with a third party on terms that in the aggregate are not materially less favorable to the Company than those offered by J&J. In addition, the Company may enter into agreements with third parties prior to the J&J negotiation period, provided such agreements are terminable by the Company within two years after the Company and J&J enter into a manufacturing and/or distribution agreement. Depending upon the timing and progress of clinical trials, the Company expects that the HTA system may be subject to J&J's right of negotiation and consultation. The Company entered into a consulting agreement with a director of the Company to assist with medical research and clinical information. In consideration for these services, the Company has issued 50,000 shares of restricted stock, approximately 20,000 of which vested immediately upon issuance and the remainder will vest ratable from October 1998 through March 2000. The agreement also provides for commissions on sales of the HTA in the Far East and Latin America territories at $1,000 per unit and a 2% commission on certain disposable units sold. Note 13 Contingencies and Litigation In July 1998, the Company settled a lawsuit commenced in 1993 by CooperSurgical, Inc., a subsidiary of The Cooper Companies ("CooperSurgical"), for unspecified damages alleging unfair competition due to actions by the Company and its then president Richard Turner, a former employee of The Cooper Companies, and others. In July 1998, the final settlement agreement was signed whereby the Company paid $300,000 in cash, net of insurance reimbursement, and agreed to pay up to $100,000 in royalties on future product revenues. From time to time, BEI Medical may become involved in or subject to various litigation and legal proceedings incidental to the normal conduct of the Company's business. The Company is not involved in any material legal proceedings. The Company has developed a Company-wide Year 2000 plan (the "Plan") to, among other things, prepare its computer equipment and software and devices with date-sensitive embedded technology for the year 2000. The estimated dates by which the Company believes it will have completed the Plan, are based upon management's best estimates, which rely upon numerous assumptions regarding future events, including vendor supplied software, the availability of certain resources, third-party remediation plans and other factors. 76 BEI MEDICAL SYSTEMS COMPANY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued These estimates, however, may prove not to be accurate, and results could differ materially from those anticipated. Factors that could result in material differences include, without limitation, the availability of personnel with appropriate training and experience, the ability to identify, assess, remediate and test all relevant computer codes and embedded technology, and similar uncertainties. In addition, Year 2000-related issues may lead to possible third-party claims, the impact of which cannot yet be estimated. No assurance can be given that the aggregate cost of defending and resolving such claims, if any, would not have a material adverse effect on the Company. Note 14 Sales Revenue from continuing operations to customers in foreign countries amounted to $1,500,000, $1,430,000 and $1,287,000 in fiscal 1998, 1997 and 1996, respectively. In fiscal 1998, 1997 and 1996, foreign revenue did not exceed 10% of consolidated revenue in any individual geographic area. 77 BEI MEDICAL SYSTEMS COMPANY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued Note 15 Quarterly Results of Operations (Unaudited) The tables below present unaudited quarterly financial information for fiscal 1998 and 1997:
Three months ended (dollars in thousands except per share amounts) ---------------------------------------------------------------------------------------------------------- Dec. 27, Mar. 28, Jun. 27, Oct. 3, 1997 1998 1998 1998 ---------------------------------------------------------------------------------------------------------- Revenue $2,418 $2,535 $2,293 $2,405 Gross profit 923 1,141 943 1,006 Loss from continuing operations (1,196) (1,151) (977) (1,647) Net loss ($1,196) ($1,151) ($977) ($1,647) Loss from continuing operations per common share, basic and diluted ($0.17) ($0.16) ($0.13) ($0.22) Earnings from discontinued operations per common share, basic and diluted -- -- -- -- Loss per common share, basic and diluted ($0.17) ($0.16) ($0.13) ($0.22) ---------------------------------------------------------------------------------------------------------- Dec. 28, Mar. 29, Jun. 28, Sep. 27, 1996 1997 1997 1997 ---------------------------------------------------------------------------------------------------------- Revenue $2,584 $2,550 $2,472 $2,399 Gross profit 1,152 1,090 938 853 Loss from continuing operations (746) (833) (1,136) (1,633) Income from discontinued operations 35 1,452 1,696 1,400 Net income (loss) ($711) $619 $560 ($233) Loss from continuing operations per common share, basic and diluted ($0.11) ($0.12) ($0.17) ($0.24) Earnings from discontinued operations per common share, basic and diluted $0.01 $0.21 $0.25 $0.21 Earnings (loss) per common share, basic and diluted ($0.10) $0.09 $0.08 ($0.03)
78 Report of Independent Auditors The Board of Directors and Stockholders BEI Medical Systems Company, Inc. We have audited the accompanying consolidated balance sheets of BEI Medical Systems Company, Inc. (formerly BEI Electronics, Inc.) as of October 3, 1998 and September 27, 1997, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the three years in the period ended October 3, 1998. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of BEI Medical Systems Company, Inc. at October 3, 1998 and September 27, 1997, and the consolidated results of their operations and their cash flows for each of the three years in the period ended October 3, 1998 in conformity with generally accepted accounting principles. Ernst & Young LLP Hackensack, New Jersey November 13, 1998 79 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None 80 PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT Certain information with respect to directors and executive officers is set forth in Part I of this Report. Additional information required by this Item is incorporated herein by reference to the section entitled "Compliance with Section 16(a) of the Securities Exchange Act of 1934" of the Proxy Statement related to the Company's 1998 Annual Meeting of Stockholders to be filed by the Company with the Securities and Exchange Commission (the "Definitive Proxy Statement"). ITEM 11. EXECUTIVE COMPENSATION The information required by this Item is incorporated herein by reference to the sections entitled "Executive Compensation" and "Certain Relationships and Related Transactions" of the Company's Definitive Proxy Statement. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information required by this Item is incorporated herein by reference to the section entitled "Security Ownership of Certain Beneficial Owners and Management" of the Company's Definitive Proxy Statement. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information required by this Item is incorporated herein by reference to the sections entitled "Executive Compensation" and "Certain Relationships and Related Transactions" of the Definitive Proxy Statement. 81 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K The following documents are filed as part of this Form 10-K.
Form 10-K Page Number (a)(1) Index to Consolidated Financial Statements. The following Consolidated Financial Statements of BEI Medical Systems Company, Inc. are filed as part of this Form 10-K: Consolidated Balance Sheets - Years ended October 3, 1998 and September 27, 1997 58 Consolidated Statements of Operations Years ended October 3, 1998, September 27, 1997 and September 28, 1996 60 Consolidated Statements of Cash Flows Years ended October 3, 1998, September 27, 1997 and September 28, 1996 61 Consolidated Statements of Stockholders' Equity Years ended October 3, 1998, September 27, 1997 and September 28, 1996 62 Notes to Consolidated Financial Statements - October 3, 1998 63 Report of Independent Auditors S-2
(a)(2) Index to Financial Statement Schedule. The following Consolidated Financial Statement Schedule of BEI Medical Systems Company, Inc. (formerly BEI Electronics, Inc.) for each of the years ended October 3, 1998, September 27, 1997 and September 28, 1996 is filed as part of this Form 10-K: Schedule II Valuation and Qualifying Accounts S-1 Report of Independent S-2 Auditors as to Schedule Schedules not listed above have been omitted because they are not applicable or are not required or the information required to be set forth therein is included in the Consolidated Financial Statements or Notes thereto. 82 (a)(3) Listing of Exhibits
Exhibit Numbers Description Footnote --------------- ----------- -------- 2.1 Distribution Agreement between BEI Electronics, Inc. and BEI Technologies, Inc. dated September 26, 1997 (i) 2.2 Corporate Services Agreement between BEI Technologies, Inc. and BEI Electronics, Inc. dated as of September 26, 1997 (i) 2.3 Tax Allocation and Indemnity Agreement between BEI Electronics, Inc. and BEI Technologies, Inc. dated as of September 26, 1997 (i) 2.4 Assumption of Liabilities and Indemnity Agreement between BEI Electronics, Inc. and BEI Technologies, Inc. dated as of September 26, 1997 (i) 2.5 Technology Transfer and License Agreement by and between BEI Electronics, Inc. and BEI Technologies, Inc. dated as of September 26, 1997 (i) 2.6 Trademark Assignment and Consent Agreement by and between BEI Electronics, Inc. and BEI Technologies, Inc. dated as of September 26, 1997 (i) 2.7 Agreement Regarding Certain Representations and Covenants by and between BEI Electronics, Inc. and BEI Technologies, Inc. dated as of September 26, 1997 (i) 3.1 Restated Certificate of Incorporation (ii) 3.2 Amended Bylaws of the Company as of June 30, 1997 (iii)
83
Exhibit Numbers Description Footnote --------------- ----------- -------- 3.3 Certificate of Designation of Series A Junior Participating Preferred Stock (iii) 4.1 Reference is made to exhibits 3.1, 3.2 and 3.3 (iii) 4.2 Form of Rights Certificate (iii) 4.3 Summary of Rights to Purchase Preferred Shares (iii) 10.2 * Registrant's Amended 1987 Stock Option Plan (iv) 10.3 * Standard option grant form used in connection with Registrant's Amended 1987 Stock Option Plan (v) 10.6 * Description of Management Incentive Bonus Plan (ii) 10.8 * Registrant's 1992 Restricted Stock Plan, as amended (iv) 10.14 1989 Employee Stock Purchase Plan, adopted June 1, 1989, as Amended through November 18, 1993 (vi) 10.27 Rights Agreement dated June 30, 1997 between the Registrant and ChaseMellon Shareholder Services, LLC (vi) 10.28 * Consulting Agreement between the Registrant and Ralph Richart, M.D. dated as of March 1, 1998 10.29 * Employment agreement between the Registrant and Herbert H. Spoon dated February 27, 1998 10.30 * Severance Agreement between the Registrant and Thomas W. Fry dated February 12, 1997 10.31 Amendment to Tax Allocation and Indemnity Agreement dated December 15, 1998 between the Registrant and BEI Technologies dated September 1997
84 21.1 Subsidiaries of the Registrant 23.1 Consent of Independent Auditors 24.1 Power of Attorney 27.1 Financial Data Schedule (EDGAR only) * Indicates management contracts or compensatory plans or arrangements filed pursuant to Item 601(b)(10) of regulation S-K. (i) Incorporated by reference. Previously filed as an exhibit to the Registrant's Current Report on Form 8-K, dated September 27, 1997. (ii) Incorporated by reference. Previously filed as an exhibit to the Registrant's Registration Statement on Form S-1 (File No. 33-29032). (iii) Incorporated by reference. Previously filed as an exhibit to the Registrant's Current Report on Form 8-K, dated June 30, 1997. (iv) Incorporated by reference. Previously filed as an exhibit to the Registrant's Registration Statement on Form S-8 (File No. 333-64155). (v) Incorporated by reference. Previously filed as an exhibit to Amendment No. 1 to the Registrant's Registration Statement on Form S-1 (No. 33-29032). (vi) Incorporated by reference. Previously filed as an exhibit to the Registrant's Report on Form 10-K, dated October 2, 1993. 85 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. BEI MEDICAL SYSTEMS COMPANY, INC. By: /s/ Thomas W. Fry ------------------------------ Thomas W. Fry Vice President of Finance and Administration, Secretary & Treasurer January 4, 1999 86 SCHEDULE II BEI MEDICAL SYSTEMS COMPANY, INC. ---------------- VALUATION AND QUALIFYING ACCOUNT
Column C Column A Column B Additions Column D Column E - ------------------------------------- ------------- ------------------------------ ------------- ------------- Balance at Charged to Charged to Balance at Beginning Costs and Other End of Description of Period Expenses Accounts Deductions Period - ------------------------------------- ------------- ------------- ------------- ------------- ------------- (dollars in thousands) Year ended October 3, 1998: - --------------------------- Deducted from asset accounts: Allowance for doubtful accounts $112 $76 $-- $14 (B) $174 Valuation allowances of deferred tax assets 1,784 -- -- -- 1,784 ------------- ------------- ------------- ------------- ------------- Total $1,896 $76 $-- $14 $1,958 ============= ============= ============= ============= ============= Year ended September 27, 1997: - ------------------------------ Deducted from asset accounts: Allowance for doubtful accounts $236 $57 $-- $181 (B) $112 Valuation allowances of deferred tax assets 929 855 (A) -- -- 1,784 Valuation allowances of discontinued operations 701 75 (94) 682 -- ------------- ------------- ------------- ------------- ------------- Total $1,866 $987 ($94) $863 $1,896 ============= ============= ============= ============= ============= Year ended September 28, 1996: - ------------------------------ Deducted from asset accounts: Allowance for doubtful accounts $56 $39 $162 (D) $21 (B) $236 Valuation allowance for deferred tax assets 1,077 -- (148)(C) -- 929 Valuation allowances of discontinued operations 538 282 (49) 70 701 ------------- ------------- ------------- ------------- ------------- Total $1,671 $321 ($35) $91 $1,866 ============= ============= ============= ============= =============
(A) Allowance adjustment resulting from evaluation of the realizability of the related deferred tax assets (B) Uncollectible accounts written off (C) Adjustment based on evaluation of uncertainties in the realization of state net operating loss carryovers (D) Purchased allowance from acquisition S-1 REPORT OF INDEPENDENT AUDITORS, AS TO SCHEDULE The Board of Directors and Shareholders BEI Medical Systems Company, Inc. We have audited the consolidated financial statements of BEI Medical Systems Company, Inc. (formerly BEI Electronics, Inc.) as of October 3, 1998 and September 27, 1997, and for each of the three years in the period ended October 3, 1998, and have issued our report thereon dated November 13, 1998. Our audits also included the financial statement schedule listed in Item 14(a)(2) of this Form 10-K. This schedule is the responsibility of the Company's management. Our responsibility is to express an opinion based on our audits. In our opinion, the financial statement schedule referred to above, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects, the information set forth therein. Ernst & Young LLP Hackensack, New Jersey November 13, 1998 S-2 23.1 CONSENT OF INDEPENDENT AUDITORS We consent to the incorporation by reference in the Registration Statement (Form S-8 No. 333-82867), pertaining to the 1987 Stock Option Plan and the Restricted Stock Plan of BEI Medical Systems Company, Inc. (formerly BEI Electronics, Inc.), of our reports dated November 13, 1998, with respect to the consolidated financial statements and schedule of BEI Medical Systems Company, Inc. included in this Annual Report (Form 10-K) for the year ended October 3, 1998, filed with the Securities and Exchange Commission. Ernst & Young LLP Hackensack New Jersey December 29, 1998 INDEX TO EXHIBITS Exhibit Number 10.28 Consulting Agreement between the Registrant and Ralph Richart, M.D. dated as of March 1, 1998 10.29 Employment Agreement between the Registrant and Herbert Spoon dated February 27, 1998 10.30 Severance Agreement between the Registrant and Thomas W. Fry dated February 12, 1997 10.31 Amendment to Tax Allocation and Indemnity Agreement dated December 15, 1998 between the Registrant and BEI Technologies dated September 1997 21.1 Subsidiaries of the Registrant 23.1 Consent of Independent Auditors 24.1 Power of Attorney 27.1 Financial Data Schedule EX-10.28 2 CONSULTING AGREEMENT BEI MEDICAL SYSTEMS COMPANY, INC. CONSULTING AGREEMENT THIS AGREEMENT is made by BEI MEDICAL SYSTEMS, INC., ("BEI") and RALPH RICHART, M.D., an individual residing at 350 Shore Drive, Oakdale, New York 11769 ("Contractor"), effective March 1, 1998, for the purpose of setting forth the exclusive terms and conditions by which BEI will acquire Contractor's services on a temporary basis. In consideration of the mutual obligations specified in this Agreement and any compensation paid to Contractor for her or his services, the parties agree to the following: 1. Work To Be Performed. (a) Contractor will use his "best efforts" to consult with the Company on matters that may come before the management team in areas of medical research and clinical information, including but not limited to: (i) the review of protocol(s) and method(s) for clinical studies within the Territory defined on Schedule A (the "Territory"); (ii) participation in planning and preparation for and participation in BEI-sponsored workshops, anticipated to be scheduled at rate of six per twelve month period and to require up to twelve man-days of Consultant's time per twelve month period; (iii) participation in the preparation and submission of abstracts for presentation at major clinical meetings within the Territory (AAGL/ACOG type meetings); (iv) communicating with Federal Drug Administration ("FDA") officials; (v) reviewing documents to be submitted to the FDA for accuracy, completeness and scientific consistency; (vi) reviewing and interpreting tissue samples in response to FDA inquiries; (vii) reviewing clinical and scientific papers and reports presented to BEI concerning BEI products; and (viii) representing BEI in communications with FDA investigators for scientific affairs, clinical affairs and historical procedural issues in connection with the FDA's Phase 3 investigation of the HydroThermAblator(R) (the "HTA(R)"). 1. (b) BEI is not obligated to issue any additional orders for work by Contractor under this Agreement. Contractor should not commence services under this Agreement until this Agreement is signed and delivered by an authorized representative of BEI. (c) It is understood that Contractor is presently affiliated with Columbia University (the "Institution"). Services performed pursuant to this Agreement shall be performed during such hours and on such terms as shall not conflict with Contractor's responsibilities and obligations to the Institution. 2. Rate and Method of Payment. As full and complete compensation for Contractor's services and for the discharge of all Contractor's obligations hereunder, BEI shall: (a) Subject to approval of the Board of Directors or BEI's Compensation Committee, as applicable, award Contractor fifty thousand (50,000) shares of BEI common stock in exchange for services to be rendered under this Agreement, subject to the following conditions: (i) ten thousand (10,000) of the shares of BEI common stock shall be granted outright in consideration of prior service and shall not be subject to vesting or forfeiture to BEI if this Agreement were terminated prior to the end of the Initial Term (as hereinafter defined); (ii) forty thousand (40,000) of the shares of BEI common stock shall vest at the rate of 1,666 shares per month for 23 months with 1,682 shares vesting in the 24th month such that all 40,000 shares shall be fully vested at the end of 24 months; (iii) the unvested shares of BEI common stock shall revert to BEI upon any termination of this Agreement prior to the end of the Initial Term; (iv) the unvested shares of BEI common stock shall be placed in escrow with BEI and Contractor shall execute and deliver to BEI two stock assignments, duly endorsed (with date and number of shares blank), to facilitate the transfer of unvested shares of BEI upon termination of this Agreement prior to the end of the Initial Term; (v) Contractor and BEI shall execute a stock purchase agreement containing the provisions identified above and any other terms reasonably necessary in the judgment of BEI within 21 days after the execution of this Agreement. (b) In accordance with BEI's travel policy, reimburse Contractor for travel and other out-of-pocket costs reasonably incurred by him in the course of performing services under this Agreement; provided however, that BEI shall not be obligated hereunder unless (i) BEI has agreed in advance to reimburse such costs and (ii) Contractor provides BEI with appropriate receipts or other relevant documentation for all such costs as part of any submission by Contractor for reimbursement. 2. (c) Pay Contractor a commission of one thousand dollars ($1,000.00) by the thirtieth day after the end of each calendar quarter for each HTA Hardware Unit sold and shipped in the Territory by BEI and paid for by the customer prior to the termination or expiration of this Agreement. This commission is payable in arrears in U.S. Dollars on cash amounts actually paid to and received by BEI during the immediately preceding calendar quarter for orders solicited from parties in the Territory, accepted by BEI and delivered by BEI within the Territory. (d) Within 30 days after the end of each calendar quarter, pay Contractor a commission equal to two percent (2%) of the Net Invoice Price of HTA Disposables (as hereinafter defined on Schedule B) included in orders solicited and received by BEI prior to the first anniversary of the termination or expiration of this Agreement. This commission is payable in arrears in U.S. Dollars on cash amounts actually paid to and received by BEI during the immediately preceding calendar quarter for orders solicited from parties within the Territory, accepted by BEI and delivered by BEI to users within the Territory. "Net Invoice Price" shall mean BEI's billing price less refunds, returns, commissions payable to third parties, packaging, insurance, duty, shipping costs, taxes, and allowances granted. (e) Make and keep full and accurate books and records in sufficient detail to enable commissions payable hereunder to be determined. On seven (7) days prior written notice to BEI, independent certified public accountants nominated and paid by Contractor shall have full access to the books and records of BEI pertaining to activities under this Agreement and shall have the right to make copies therefrom at Contractor's expense. Said certified public accounts shall have such access at all commercially reasonable times during normal business hours. Prompt adjustment shall be made by BEI to compensate for any errors or omissions disclosed by such audit and agreed to by BEI. Contractor agrees to hold confidential all information learned in the course of any examination of BEI's books and records hereunder, except when it is necessary for Contractor to reveal such information in order to enforce his rights under this Agreement in court, or similar dispute resolution or enforcement proceeding or action, or when compelled by law, and shall take all reasonable steps necessary to prevent the public dissemination of such information given BEI's status as a publicly-traded company. Contractor shall not be entitled to a commission on any order solicited by Contractor which is rejected by BEI, regardless of the reason for BEI's rejection, and no commission shall be payable on any orders that are canceled or terminated for any reason. Subject to the provisions of Section 2(d), Contractor shall not be entitled to a commission on any order solicited by Contractor which is received by BEI after the termination or expiration of this Agreement. If, after a commission has been paid to Contractor for a product, BEI refunds any or all of the purchase price of such product to the customer for any reason, BEI may deduct from future commissions all or the proper proportionate amount of the commission previously paid to Contractor for such product or, at BEI's election, require Contractor to repay BEI such amount within thirty (30) days after receiving notice of such election. Notwithstanding anything in this Agreement to the contrary, any part of any amount payable to Contractor hereunder may be reduced due to any counterclaim, set-off, adjustment or other right which BEI might have against Contractor. 3. All payments of commissions not disputed as to correctness by Contractor within two (2) years after receipt thereof shall thereafter conclusively be deemed correct for all purposes. 3. Nondisclosure And Trade Secrets. (a) During the term of this Agreement and in the course of Contractor's performance hereunder, Contractor may receive and otherwise be exposed to confidential and proprietary information relating to BEI's business practices, strategies and technologies. Such confidential and proprietary information may include but not be limited to confidential and proprietary information supplied to Contractor with the legend "BEI Confidential and Proprietary", or equivalent. The confidential and proprietary information may include, but is not limited to, BEI's marketing and customer support strategies, BEI's financial information, including sales, costs, profits and pricing methods, BEI's internal organization, employee information and customer lists, BEI's technology, including discoveries, inventions, research, clinical data, test data, and development efforts, processes, samples, methods, product know-how and show-how, and all derivatives, improvement and enhancements to any of the above and information of third parties as to which BEI has an obligation of confidentiality (collectively referred to as "Information"). (b) Contractor acknowledges the confidential and secret character of the Information, and agrees that the Information is the sole, exclusive and extremely valuable property of BEI. Accordingly, Contractor agrees not to use the Information except in the performance of this Agreement, and not to disclose all or any part of the Information in any form to any third party, either during or after the term of this Agreement, unless necessary to perform the tasks which are the subject of this Agreement. Upon termination of this Agreement for any reason, including expiration of term, Contractor agrees to cease usage and to return to BEI all whole and partial copies and derivatives of the Information, whether in Contractor's possession or under Contractor's direct or indirect control. (c) Contractor shall not disclose or otherwise make available to BEI in any manner any confidential information of Contractor or confidential information received by Contractor from third parties that Contractor is not entitled to disclose. (d) Contractor agrees not to export, directly or indirectly, any U.S. source technical data acquired from BEI or any products utilizing such data to any counties outside the United States which export may be in violation of the United States Export Laws or Regulations. Nothing in this section releases Contractor from any obligation stated elsewhere in this Agreement not to disclose such data. (e) At all times, both during the term of this Agreement and after its termination, Contractor will keep in confidence and trust all Information and shall not use or disclose and Information or anything related to such information without the written consent of the Company, except as may be required in the ordinary course of performing services as a Contractor to the Company. 4. (f) Notwithstanding subsection (e) above, Contractor shall not be obliged to keep in Confidential Information which: (i) prior or after the time of disclosure becomes part of the public knowledge or literature, not as a result of any inaction or action of Contractor, or (ii) is approved in writing for release by the Company. (g) This Section 3 shall survive the termination of this Agreement for any reason, including expiration of term. 4. Additional Activities. (a) During the period in which Contractor provides advisory, consulting and related services to and for the Company (the "Consulting Period"), Contractor will not directly or indirectly (whether for compensation or without compensation): (i) as an individual, proprietor, partner, stockholder, officer, employee, consultant, director, joint venture, investor, lender, or in any other capacity whatsoever (other than as the holder of not more than one percent (1%) of the total outstanding stock of a publicly held company), engage in any business activity that involves the development, production, marketing or selling of products, processes or techniques which are, directly or indirectly, identical to, substantially similar to, or competitive with products and processes or techniques of the Company or other businesses involved in the design or production of medical devices utilized in gynecology, obstetrics or reproductive medicine (the "Field"); (ii) recruit, solicit or induce, or attempt to induce, any employee of or consultant to the Company to terminate their employment or consultancy or otherwise cease their relationship with the Company; or (iii) solicit, divert or take away, or attempt to divert or to take away, the business or patronage of any of the clients, customers or accounts of the Company, or prospective clients, customer or accounts, if any, of the Company that were contact, solicited or served by Contractor during the term of this Agreement. (b) During the 180 days following termination of the Consulting Period, Contractor will not directly or indirectly (whether for compensation or without compensation) engage in the activities identified in paragraph 4(a)(i)-(iii), above. For purposes of the prior sentence, the definition of the term "Field" shall mean engaging in any business activity that involves the development, production, marketing or selling of products, processes or techniques which are, directly or indirectly, identical to, substantially similar to, or competitive with products, processes or techniques of the Company or other businesses involved in the design or production of endometrial ablation products. (c) The restrictions set forth in paragraphs 4(a) and (b) are considered by the parties to be reasonable for the purposes of protecting the business of the Company. However, if 5. any such restriction is found by any court of competent jurisdiction to be unenforceable because it extends for too long a period of time or over too great a range of activities or m too broad a geographic area, it shall be interpreted to extend only over the maximum period of time, range of activities or geographic areas as to which it may be enforceable. (d) After termination of this Agreement, Contractor will disclose all patent applications filed by him within a year after such termination. At the time of each such disclosure, Contractor will advise BEI in writing of any Inventions that Contractor believes are not subject to the assignment provisions of Section 8; and Contractor will at that time provide to BEI in writing all evidence necessary to substantiate that belief. 5. No Conflicting Obligation. (a) Contractor represents that Contractor's performance of all of the terms of this Agreement and Contractor's services as a consultant to BEI do not and will not breach any agreement to keep in confidence any proprietary information of another entity. (b) Contractors represents and warrants that his performance of all terms of this Consulting Agreement and Contractor's services as a consultant to BEI do not and will not conflict with any written or oral agreement. 6. Reports. Contractors shall keep the President of BEI fully informed of the Contractor's activities under this Consulting Agreement and, at the request of the President of BEI, shall discuss all matters relating to the conduct of the Contractor's activities hereunder with the Vice President of International Sales and the Director, Quality and Regulatory Affairs, or with any other personnel designated by the President of BEI. If requested by the President of BEI, Contractor shall provide the President of BEI with written reports describing Contractor's activities under this Consulting Agreement. A final written report shall be rendered to BEI within a reasonable period subsequent to termination of the Agreement. 7. Current Employment and Consulting Relationships. Contractor represents that he is not currently a director, employee, consultant, advisor, partner or stockholder of any third party in the Field. 8. Ownership Of Work Product. (a) Contractor shall specifically describe and identify in Exhibit C to this Agreement all technology (i) which Contractor intends to use in performing under this Agreement (ii) which is either owned solely by Contractor or licensed to Contractor with a right to sublicense, and (iii) which is in existence in the form of a writing or working prototype prior to the effective date of this Agreement ("Background Technology"). (b) Contractor agrees that any and all ideas, improvements, inventions and works of authorship conceived, written, created or first reduced to practice in the performance of work under this Agreement shall be the sole and exclusive property of BEI and hereby assigns to BEI 6. all its right, title and interest in and to any and all such ideas, improvements, inventions and works of authorship. (c) Contractor further agrees that except for Contractor's rights in Background Technology, BEI is and shall be vested with all rights, title and interests including patent, copyright, trade secret and trademark rights in all of Contractor's work product under this Agreement. Contractor hereby grants to BEI a non-exclusive, royalty free and worldwide right to use and sublicense the use of Background Technology for the purpose of developing and marketing BEI products, but not for the purpose of marketing Background Technology separate from BEI products. (d) Contractor shall execute all papers, including patent applications, invention assignments and copyright assignments, and otherwise shaft assist BEI as reasonably required to perfect BEI the rights, title and other interests in Contractor's work product expressly granted to BEI under this Agreement. Costs related to such assistance, if required, shall be paid by BEI. 9. Indemnification. (a) Contractor agrees to take all necessary precautions to prevent injury to any persons (including employees of BEI) or damage to property (including BEI's property) during the term of this Agreement and shall indemnify and hold harmless BEI and its officers, agents, directors and employees against any claim, loss judgment, liability, expense (including reasonable attorneys' and expert witnesses' fees and costs) and injury to person or property (including death) resulting in any way from Contractor's willful misconduct, breach of contract or negligence in the performance or failure to perform Contractor's obligations under this Agreement. (b) BEI agrees to indemnify and hold Contractor harmless against any claim, loss, judgment, liability, expense (including reasonable attorneys' and expert witnesses' fees and costs) and injury to person or property (including death) to the extent of any act, omission or negligence on the part of BEI resulting during the performance of the Contractor's duties under this Agreement. (c) In the event of the assertion or commencement by an person of any claim or legal proceeding (whether against BEI or against any other person) with respect to which Contractor may become obligated to hold harmless, indemnify, compensate or reimburse BEI or its affiliates pursuant to this Section 9, BEI shall have the right, at its election, to proceed with the defense of such claim or legal proceeding on its own. If BEI so proceeds with the defense of any such claim or legal proceeding: (i) all reasonable expenses relating to the defense of such claim or legal proceeding shall be borne and paid exclusively by Contractor; (ii) Contractor shall make available to BEI any documents and materials in his possession or control that may be necessary to the defense of such claim or legal proceeding; and 7. (iii) BEI shall have the right to settle, adjust or compromise such claim or legal proceeding with the consent of Contractor provided, however, that such consent shall not be unreasonably withheld. (d) No indemnitee (other than BEI or any successor thereto or assign thereof) shall be permitted to assert any indemnification claim or exercise any other remedy under this Agreement unless BEI (or any successor thereto or assign thereof) shall have consented to the assertion of such indemnification claim or the exercise of such other remedy. BEI shall give the Contractor prompt notice of the commencement of any such legal proceeding against BEI; provided, however, that any failure on the part of BEI to so notify Contractor shall not limit any of the obligations of Contractor under this Section 9 (except to the extent such failure materially prejudices the defense of such legal proceeding). 10. Term and Termination. (a) The initial term of this Agreement shall be two (2) years ("Initial Term"). The Initial Term may be extended for additional twelve (12) month periods (a "Subsequent Term") only upon the mutual written consent of BEI and Contractor, executed no less than sixty (60) days prior to the termination of the current term. (b) Either BEI or Contractor may terminate this Agreement with or without cause with thirty (30) days' advance written notice. In such event, Contractor shall cease work immediately after receiving notice from BEI, unless otherwise advised by BEI, and shall notify BEI of expenses incurred up to the termination date. 11. Effect of Termination. Unless otherwise state herein, upon the termination of this Agreement, each party shall be released from all obligations and liabilities to the other occurring or arising after the date of such termination, except that any termination of this Agreement shall not relieve Contractor of Contractor's obligations under sections 3, 4, 6, 8, 9, 11 and 14 hereof, nor shall any such termination relieve Contractor or BEI from any liability arising from any breach of this Agreement. Upon termination of this Agreement for any reason whatsoever, Contractor shall promptly surrender and deliver to BEI all documents, notes, laboratory notebooks, drawings, specification, calculations, sequences, data and other materials of any nature pertaining to Contractor's work with BEI, and any documents or data of any description (or any reproduction of any documents or data) containing or pertaining to any Information. Contractor agrees that in the event of such termination, Contractor will cooperate with BEI in completing and signing BEI's termination statement for consultants. 12. Compliance with Applicable Laws. Contractor warrants that all material supplied and work performed under this Agreement complies with or will comply with all applicable United States and foreign laws and regulations. 13. Independent Contractor. Contractor is an independent contractor, is not an agent or employee of BEI and is not authorized to act on behalf of BEI, except as expressly stated in this Agreement or mutually agreed by the President of BEI and Contractor. Contractor 8. will not be eligible for any employee benefits, nor will BEI make deductions from any amounts payable to Contractor for taxes or other employee withholdings. Taxes and such withholdings shall be the sole responsibility of Contractor. 14. Legal and Equitable Remedies. Contractor hereby acknowledges and agrees that in the event of any breach of this Agreement by Contractor, including, without limitation, the actual or threatened disclosure of Information without the prior express written consent of BEI, BEI will suffer an irreparable injury, such that no remedy at law will afford it adequate protection against, or appropriate compensation for, such injury. Accordingly, Contractor hereby agrees that BEI shall be entitled to specific performance of Contractor's obligations under this Agreement, as well as such further relief as may be granted by a court of competent jurisdiction. 15. General. The parties' rights and obligations under this Agreement will bind and insure to the benefit of their respective successors, heirs, executors, and administrators and permitted assigns. This Agreement and the Schedules attached hereto and hereby incorporated herein constitute the parties' final, exclusive and complete understanding and agreement with respect to the subject matter hereof, and supersede all prior and contemporaneous understandings and agreements relating to its subject matter. This Agreement may no be waived, modified, amended or assigned unless mutually agreed upon in writing by both parties. In the event any provision of this Agreement is found to be legally unenforceable, such unenforceability shall not prevent enforcement of any other provision of the Agreement. This Agreement shall be governed by the laws of the State of New Jersey, excluding its conflict of laws principles. Any notices required or permitted hereunder shall be given to the appropriate party, at the address specified below or at such other address as the party shall specify in writing. Such notice shall be deemed given: (a) upon personal delivery; (b) or sent by certified or registered mail, postage prepaid, three (3) days after the date of mailing; (c) when sent by confirmed facsimile or telex if sent during normal business hours of the recipient, if not, then on the next business day; or (d) one day after deposit with a nationally recognized overnight courier, specifying next day delivery, with written verification of receipt. 9. IN WITNESS WHEREOF, the parties hereto have executed this Agreement as of the date first set forth above. BEI MEDICAL SYSTEMS COMPANY, INC. CONTRACTOR By: /s/ Herb Spoon By: /s/ Ralph Richart, M.D. ------------------------------ ------------------------------ Herb Spoon Ralph Richart, M.D. (Print Name) President & CEO - ----------------------------------- ----------------------------------- (Title) Social Security Number Address: __________________________ Address: __________________________ ___________________________________ ___________________________________ ___________________________________ ___________________________________ 10. SCHEDULE A TERRITORY LATIN AMERICA (Including: MEXICO, CENTRAL AMERICA, SOUTH AMERICA AND THE CARIBBEAN) FAR EAST (Including: INDIA, CHINA, AUSTRALIA AND THE PACIFIC RIM) SCHEDULE B PRODUCTS HTA(R) HARDWARE Hydro ThermAblator(R) System for Hysteroscopic Endometrial Ablation (Reorder Numbers: 55000 & 55001 per attached pages 1 & 2) HTA(R) Disposables Procedure Set, Sterile, Single Patient use (Reorder Number 55015 per attached page 3) SCHEDULE C BACKGROUND TECHNOLOGY EX-10.29 3 EMPLOYMENT AGREEMENT [BEI LETTERHEAD] February 27, 1998 Personal and Confidential ------------------------- Mr. Herb Spoon 9114 Fire Water San Antonio, TX 78255 Dear Herb: This letter will constitute a formal offer to you to become President and Chief Executive Officer of BEI Medical Systems Company beginning on or about March 30, 1998. The compensation would include the following: o A base salary of $175,000 per year; o A moving allowance combined with a sign-up bonus designed to compensate, in part, you for real estate expenses, consisting in total of a one-time payment of $20,000; o An annual bonus payable to you in either cash or a combination of cash and stock of up to 50% of your salary for the attainment of pre-agreed upon annual objectives. This bonus would be made after the Company's audited results following the end of our fiscal year each September 30th; o Finally, the Company would offer you 240,000 shares of stock, one-half in the form of Restricted stock and one-half in the form of Stock Options at the current market price. These shares would vest over a four-year period. In the event the Company were sold, the unvested shares would vest on sale. Under minor detail, Herb, I have changed your start date to Monday, March 30, 1998 to allow us to make the announcement at our Annual Meeting on March 28 or immediately thereafter, based on advice from the lawyers. Also, the Company does not have sufficient restricted shares currently authorized to meet your commitment. I expect to get approval for additional shares at our Annual Shareholders meeting, and authorization is in the proxy (enclosed for your review.) Mr. Herb Spoon February 27, 1998 Page 2 of 2 You will report to the Company's Board of Directors, and it is my intent to continue as Chairman of the Board. You are eligible to be covered by our life, medical, dental and disability plans on the first of the month following the month in which you begin employment (or on the first day of employment if your employment begins on the 1st of the month). You will also be eligible to participate in BEI's 401K Retirement Savings Plan on the first entry date following three months of employment. We will provide additional information at the time of your enrollment. The above referenced terms and conditions are contingent upon your execution of an Employment Propietary Information and Inventions Agreement (sample enclosed). Herb, I hope these points cover the major topics we discussed in our very pleasant meeting of last Thursday, February 19. I very much look forward to working with you. I believe there is a real opportunity to build Medical Systems into a premier company. Please signify your acceptance of this position and the corresponding conditions by countersigning this letter where indicated below. With kind regards. Yours sincerely, BEI MEDICAL SYSTEMS COMPANY /s/ CHARLES CROCKER - --------------------------- Charles Crocker Chairman of the Board CC:jc Enclosures Acceptance: /s/ HERB SPOON 3/2/98 -------------------- -------------------- Herb Spoon Date EX-10.30 4 SEVERANCE AGREEMENT [BEI LETTERHEAD] February 12, 1997 CONFIDENTIAL Mr. Thomas W. Fry 45 Hunter Lane Ridgefield, Connecticut 06877 Dear Tom, As approved by Charles Crocker, Chairman of the Board, and because of the employment uncertainties resulting from the current financing and acquisition activities, the potential for a change in control of BEI Medical Systems Company, Inc., and the important role you have in effecting these changes, I am pleased to confirm our mutual understanding and agreement that the six-month severance compensation package outlined in my "Offer of Employment" letter to you dated September 11, 1992 has been extended form six months to twelve months. BEI Medical Systems Company, Inc. and/or its successor company will provide you with a severance package equal to twelve months of your current compensation should you be asked to terminate your employment with the Company or if you elect to terminate your employment as a result of any of the following reasons: i) there is significant reduction in your authority or duties; ii) your aggregate compensation is reduced so that it as a whole falls below its current value; iii) the benefits available to you are materially reduced; iv) the company requires you to relocate the principal place where you perform services for the Company without your agreement. Sincerely, APPROVED: /s/ RICHARD W. TURNER /s/ GARY D. WRENCH - ----------------------------- ----------------------------- Richard W. Turner Gary D. Wrench Senior Vice President and Chief Financial Officer RWT/em Feb 18, 1997 ----------------------------- Date [SEAL] EX-10.31 5 FIRST AMENDMENT TO TAX ALLOCATION FIRST AMENDMENT TO TAX ALLOCATION AND INDEMNITY AGREEMENT This First Amendment to Tax Allocation and Indemnity Agreement is entered into this 15th day of December 1998, by and between BEI Electronics, Inc., a Delaware corporation ("Electronics"), and BEI Technologies, Inc., a Delaware corporation ("Technologies"). RECITALS 1. Electronics and Technologies entered into a Tax Allocation and Indemnity Agreement on September 26, 1997, in connection with the distribution of Technologies stock to Electronics' shareholders (the "Agreement"). 2. In order better to reflect the parties' original intentions, the parties to the Agreement wish to amend and restate certain provisions of the Agreement as if they had been originally incorporated therein. 3. All defined terms used below shall have the same meaning as defined in the agreement. AMENDMENTS A. Article III Section 3.1(a) is hereby amended and restated to read as follows: 3.1 Federal Income Taxes: (a) For each taxable year (or portion thereof) in which Technologies and any other members of the Technologies Subgroup are included in the Electronics Affiliated Group consolidated federal income tax return, the Technologies Subgroup (1) shall be allocated and Technologies shall be responsible for the payment of 100% of the Electronics Affiliated Group's federal income tax liability for the year (including any alternative minimum tax or environment tax, as determined under this Section 3.1), subject to the Subsequent Adjustments provisions of Article V of this agreement, and (2) shall be entitled to the receipt of any federal income tax refunds (including any alternative minimum tax or environment tax, as determined under this Section 3.1) received by Electronics for the taxable year. B. Article III Section 3.2(a) is hereby amended and restated to read as follows: 3.2 State Income and Franchise Taxes: (a) For each taxable year (or portion thereof) for which Technologies and/or any other members of the Technologies Subgroup are included in any combined state income or franchise tax return filed by the Electronics Unitary Group, the Technologies Subgroup (1) shall be allocated and Technologies shall be responsible for the payment of all state income and franchise taxes (including any alternative minimum tax) per any state income and franchise tax returns in Technologies and/or any other members of the Technologies Subgroup are included, subject to Subsequent Adjustments provisions of Article V of this agreement, and (2) shall be entitled to the receipt of any state income and franchise tax refunds (including any alternative minimum tax) received by Electronics for the taxable year in which Technologies and/or any other members of the Technologies Subgroup are included in any combined state income or franchise tax return filed by Electronics Unitary Group. IN WITNESS WHEREOF, the parties hereto have caused this Tax Allocation and Indemnity Agreement to be executed by their duly authorized representatives. Electronics By: /s/ Thomas W. Fry ------------------------------------ Name: Thomas W. Fry ---------------------------------- Title: Vice President of Finance and Administration Secretary & Treasurer --------------------------------- Technologies By: /s/ Robert R. Corr ------------------------------------ Name: Robert R. Corr ---------------------------------- Title: Secretary, Treasurer and Controller --------------------------------- EX-21.1 6 SUBSIDIARIES OF THE REGISTRANT (Exhibit 21.1) SUBSIDIARIES OF THE REGISTRANT Meditron Devices, Inc. XYLOG Corporation BEI Medical Systems International Inc. Zinnanti Surgical Instruments OvaMed Corporation Calculus Instruments Company, Inc. EX-24.1 7 POWER OF ATTORNEY POWER OF ATTORNEY KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Charles Crocker and Thomas W. Fry, and each of them, as his true and lawful attorneys-in-fact and agents, with full power of substitution and resubstitution, for him and in his name, place, and stead, in any and all capacities, to sign any and all amendments to this Report and to file the same, with all exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite and necessary to be done in connection therewith, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents, or any of them, or their or his substitute or substitutes, may lawfully do or cause to be done by virtue hereof. Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
Signature Title Date - --------- ----- ---- /S/Charles Crocker Chairman of the Board of January 4, 1999 - --------------------------------------- Directors (Charles Crocker) Vice President of Finance and /S/Thomas W. Fry Administration, Secretary and January 4, 1999 - --------------------------------------- Treasurer (Thomas W. Fry) (Principal Financial and Accounting January 4, 1999 Officer) /S/Ralph M. Richart Director January 4, 1999 - --------------------------------------- (Ralph M. Richart) /S/Herbert H. Spoon President and Chief Executive Officer January 4, 1999 - --------------------------------------- (principal executive officer) (Herbert H. Spoon) /S/Richard W. Turner Director January 4, 1999 - --------------------------------------- (Richard W. Turner) /S/Lawrence A. Wan Director January 4, 1999 - --------------------------------------- (Lawrence A. Wan) /S/Gary D. Wrench Director January 4, 1999 - --------------------------------------- (Gary D. Wrench)
EX-27 8 FDS --
5 THIS SCHEDULE COMNTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS FOR THE PERIOD ENDED OCT. 3, 1998 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 12-MOS OCT-03-1998 SEP-28-1997 OCT-03-1998 3,504 0 2,071 174 3,087 11,232 1,600 780 17,388 2,948 0 0 0 10 14,430 17,388 9,651 9,651 5,638 5,638 11,554 0 21 (7,250) (2,279) (4,971) 0 0 0 (4,971) (0.68) (0.68)
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