-----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, MTQp7WjHFB5k/F0RpiWUR6/IGTFInKRUzMwJ8/LNMTNEb5dyRl/sRg6axGVwpNpd sTt3n+a7ZecY6F6gQwgcIg== 0000897101-99-001176.txt : 19991220 0000897101-99-001176.hdr.sgml : 19991220 ACCESSION NUMBER: 0000897101-99-001176 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 19990930 FILED AS OF DATE: 19991217 FILER: COMPANY DATA: COMPANY CONFORMED NAME: ROCHESTER MEDICAL CORPORATION CENTRAL INDEX KEY: 0000868368 STANDARD INDUSTRIAL CLASSIFICATION: SURGICAL & MEDICAL INSTRUMENTS & APPARATUS [3841] IRS NUMBER: 411613227 STATE OF INCORPORATION: MN FISCAL YEAR END: 0930 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 000-18933 FILM NUMBER: 99776469 BUSINESS ADDRESS: STREET 1: ONE ROCHESTER MEDICAL DR CITY: STEWARTVILLE STATE: MN ZIP: 55976 BUSINESS PHONE: 5075339600 MAIL ADDRESS: STREET 1: ONE ROCHESTER MEDICAL DR CITY: STEWARTVILLE STATE: MN ZIP: 55976 10-K 1 ================================================================================ SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ----------------- FORM 10-K ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR FISCAL YEAR ENDED SEPTEMBER 30, 1999 Commission File Number: 0-18933 ROCHESTER MEDICAL CORPORATION MINNESOTA 41-1613227 State of Incorporation IRS Employer Identification No. ONE ROCHESTER MEDICAL DRIVE STEWARTVILLE, MINNESOTA 55976 Address of Principal Executive Offices Telephone Number: (507) 533-9600 Securities Registered pursuant to Section 12(b) of the Act: None Securities Registered Pursuant to Section 12(g) of the Act: COMMON STOCK WITHOUT PAR VALUE ----------------- Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter period that the Registrant was required to file such reports), and has been subject to such filing requirements for the past 90 days. Yes __X__ No ____ Check if no disclosure of delinquent filers pursuant to Item 405 of Regulation S-B is contained in this form, and no disclosure will be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. _____ The issuer's revenues for its most recent fiscal year were $7,340,870. The aggregate market value of voting stock held by non-affiliates based upon the closing Nasdaq sale price on November 8, 1999 was $36,482,000. Number of shares outstanding on December 10, 1999 was 5,349,500 Common Shares. DOCUMENTS INCORPORATED BY REFERENCE Portions of Registrant's Proxy Statement for its February 2, 2000 Annual Meeting of Shareholders are incorporated by reference in Part III. ================================================================================ PART I ITEM 1. BUSINESS OVERVIEW Rochester Medical Corporation (the "Company") develops, manufactures and markets a broad line of innovative, technologically enhanced latex-free urinary continence and urine drainage management care products to the home care and acute/extended care markets. The Company's home care products include its FEMSOFT(R) INSERT, a soft, liquid-filled, conformable urethral insert for managing female stress urinary incontinence in adult females, a line of male external catheters for managing male urinary incontinence and a line of intermittent catheters for managing male and female urinary retention. The Company's acute/extended care products include a line of standard Foley catheters and the advanced RELEASE-NF (TM) CATHETER, an antibacterial Foley catheter for the prevention of hospital acquired urinary tract infection ("UTI"). The Company markets its products under its own ROCHESTER MEDICAL(R) brand through a direct field sales force in the United States and independent distributors in international markets. The Company also supplies its products to several large medical product companies for sale under brands owned by these companies. THE CONTINENCE CARE MARKET Urinary dysfunction affects approximately 11 million women and two million men in the United States. Urinary dysfunction can be characterized as either incontinence or retention. Urinary incontinence is the inability to control one's urinary function, leading to involuntary and frequent urine leakage from the bladder. Urinary retention is the inability to voluntarily, spontaneously and completely empty one's bladder. Approximately $15 billion is spent annually in the United States for the medical treatment and management of urinary dysfunction. Of this amount, the Company estimates that $3 billion is spent annually on management products and devices and the remainder is spent on institutionalization and medical treatments, including surgery, pharmaceuticals and behavior therapies. In hospitals and certain other acute care settings, it is often necessary for medical professionals to monitor and manage the urinary functions of patients using a Foley catheter. The Company estimates that sales of Foley catheters and related accessories in the United States are currently approximately $240 million per year. The regular use of Foley catheterization is associated with hospital acquired UTI, which is primarily caused by bacteria that migrate through the urethra along the outside of Foley catheters into the bladder. Hospital acquired UTI has been shown to have a significant impact on increasing morbidity and mortality of hospitalized patients. The cost of treating these infections is estimated at approximately $1 billion annually in the United States. The Company believes that approximately 90% of the Foley catheters sold worldwide are made of latex. Although latex has certain attractive physical characteristics and cost advantages, latex contains natural proteins and allergens that may irritate and damage the surrounding tissue. Healthcare providers now recognize that latex can also cause allergic reactions that may be life-threatening for some patients. Concerns about latex allergies among healthcare workers and the general population have also increased in recent years. As a result, healthcare institutions are increasingly attempting to limit their workers' and patients' exposure to latex, and some are establishing entirely latex-free operating rooms. New FDA rules now require labeling of latex medical devices to warn of possible allergic reactions. The rules require that all medical devices containing natural rubber latex be labeled with the warning, "Caution: This Product Contains Natural Rubber Latex Which May Cause Allergic Reactions." The new rules also require deletion of labeling claims stating that latex medical devices are hypoallergenic. 2 HOME CARE PRODUCTS MALE EXTERNAL CATHETERS. The Company's male external catheters are self-care, disposable devices for managing male urinary incontinence. The Company manufactures and markets three models of silicone male external catheters: the ULTRAFLEX(R), "POP-ON"(R) and WIDE BAND(R) catheters. The UltraFlex catheter has adhesive positioned midway down the catheter sheath. The "POP-ON" catheter has a sheath that is shorter than that of a standard male external catheter and has adhesive applied to the full length of the sheath. It is designed to accommodate patients who require shorter-length external catheters. The Company's WIDE BAND self-adhering male external catheter has an adhesive band which extends over the full length of the sheath, providing approximately 70% more adhesive coverage than other male external catheters currently marketed. The WIDE BAND catheter is designed to reduce adhesive failure and the resulting leakage, which is a common complaint among users of male external catheters. All models of the Company's male external catheters are produced in five sizes for better patient fit. The Company's male external catheters are made from silicone, a non-toxic and biocompatible material that eliminates the risks of latex-related skin irritation. Silicone catheters are also odor free and have greater air permeability than catheters made from other materials, including latex. Air permeability reduces skin irritation and damage from catheter use and thereby increases patient comfort. The Company's silicone catheters are transparent, permitting visual skin inspection without removal of the catheters and aiding proper placement of the catheters. The Company's catheters also have a kink-proof funnel design to ensure uninterrupted urine flow. The self-adhering technology of the Company's catheters simplifies application of the catheters and provides a strong bond to the skin for greater patient confidence and improved wear. The Company also manufactures and sells male external catheters made from a proprietary non-latex, non-silicone material to certain private label customers. Certain of these catheters use the same self-adhesive technology as the Company's silicone male external catheters. Like the silicone male external catheters, these non-silicone catheters eliminate the risk of latex reactions and latex-related skin irritations. The non-silicone catheters also are odor free. PERSONAL CATHETER(TM). The Company's PERSONAL CATHETER is a disposable intermittent catheter manufactured from two different silicones, with a stiff core catheter tube and a softer outer cover. This construction provides sufficient stiffness for ease of insertion, while the softer cover is designed to reduce tissue irritation during insertion. The Company produces the PERSONAL CATHETER in three lengths for male, female and pediatric use and multiple diameters. FEMSOFT INSERT. The FEMSOFT INSERT is a disposable device for the management of stress urinary incontinence in active women. It is a soft, conformable urethral insert that assists the female urethra and bladder neck to control the involuntary loss of urine. The device can be simply inserted, worn and removed for voiding by most women. It requires no inflation, deflation, syringes or valving mechanisms. The Company believes the FEMSOFT INSERT will provide significant advantages in the management of female stress incontinence. The FEMSOFT INSERT is a minimally invasive device that provides a patient with effective control of her urinary function and eliminates the need for collection bags and pads or liners that can cause embarrassment, restrict mobility and compromise lifestyle. In addition, the soft, liquid-filled silicone membrane of the FEMSOFT INSERT has been designed to conform to the irregular shape of the urethra and follow the movements of the urethra during normal activities, thereby reducing leakage without chafing or abrasion of the delicate tissues of the urethra. The FEMSOFT INSERT is a prescription device that requires a woman to visit her physician. The physician will fit the patient with the proper size and instruct the patient on proper application of the FEMSOFT INSERT. The Company received U.S. Food and Drug Administration ("FDA") approval of the FEMSOFT INSERT Premarket Approval ("PMA") application on September 30, 1999. The Company expects to begin commercial introduction of the FEMSOFT INSERT during the second quarter of fiscal 2000. 3 ACUTE/EXTENDED CARE PRODUCTS RELEASE-NF CATHETER. The Company's RELEASE-NF CATHETER is a silicone Foley catheter that has been designed to reduce the incidence of hospital acquired UTI. Using patented technology, the RELEASE-NF CATHETER incorporates nitrofurazone, an effective broad-spectrum antibacterial agent, into the structure of the catheter permitting sustained release of a controlled dosage directly into the urinary tract to prevent the onset of infection. The RELEASE-NF CATHETER received marketing authorization from the FDA in January 1998 pursuant to a 510(k) premarket notification submission. Clinical trials, funded by the Company, have demonstrated that use of the RELEASE-NF CATHETER yielded a six-fold reduction in the incidence of hospital acquired UTI compared to use of a silicone, non-medicated Foley catheter. Study patients were catheterized for one to five days, a period that is typical of approximately 90% of all hospital Foley catheterizations. The RELEASE-NF CATHETER was well-tolerated by the patients using it, and no complications or attributable side-effects were observed. FOLEY CATHETERS. The Company offers Foley catheters in a standard two lumen version for urinary drainage management and in a three lumen version for irrigation of the urinary tract. These Foley catheters are available in all standard adult and pediatric sizes. All of the Company's silicone Foley catheters eliminate the risk of the allergic reactions and tissue irritation and damage associated with latex Foley catheters. The Company's Foley catheters are transparent which enables healthcare professionals to observe urine flow. Unlike the manufacturing processes used by producers of competing silicone Foley catheters, in which the balloon is made separately and attached by hand in a separate process involving gluing, the Company's automated manufacturing processes allow the Company to integrate the balloon into the structure of the Foley catheter, resulting in a smoother, more uniform exterior that may help reduce irritation to urinary tissue. The Company's standard Foley catheters are packaged sterile in single catheter strips and sold under the ROCHESTER MEDICAL brand and under private label arrangements. In addition, the Company sells its standard Foley catheters in bulk under private label arrangements for packaging in kits with tubing, collection bags and other associated materials. TECHNOLOGY The Company uses proprietary, automated manufacturing technologies and processes to manufacture continence care devices cost effectively. The production of the Company's products also depends on its materials expertise and know-how in the formulation of silicone and advanced polymer products. The Company's proprietary liquid encapsulation technology enables it to manufacture innovative products, such as its FEMSOFT INSERT, that have soft, conformable, liquid-filled reservoirs, which cannot be manufactured using conventional technologies. Using this liquid encapsulation technology, the Company can mold and form liquid encapsulated devices in a variety of shapes and sizes in an automated process. The Company's manufacturing technologies and materials know-how also allow the Company to incorporate a sustained release antibacterial agent into its products. The Company believes that its manufacturing technology is particularly well-suited to high unit volume production and that its automated processes enable cost-effective production. The Company further believes that its manufacturing and materials expertise, particularly its proprietary liquid encapsulation technology, may be applicable to a variety of other devices for medical applications. The Company plans to consider, commensurate with its financial and personnel resources, future research and development activities to investigate opportunities provided by the Company's technology and know-how. The Company believes that its proprietary manufacturing processes, materials expertise, custom designed equipment and technical know-how allow it to simplify and further automate traditional catheter manufacturing techniques to reduce the Company's manufacturing costs. In order to manufacture high quality products at competitive costs, the Company concurrently designs and develops new products and the processes and equipment to manufacture them. MARKETING AND SALES To date, the majority of the Company's revenues have been derived from sales of its male external catheters and standard Foley catheters to medical products companies for resale under 4 brands owned by such companies. In fiscal 1999, the Company experienced a significant reduction in sales under these arrangements due to one customer that switched to its own production of silicone male external catheter and another customer that significantly reduced its order volume. These private label arrangements, however, are likely to continue to account for a significant portion of the Company's revenues in the foreseeable future, particularly in international markets where the Company does not maintain a direct sales presence. The Company sells its products in the United States under the ROCHESTER MEDICAL brand name through a nine-person direct sales force. This sales force is organized into six regions across the country and is primarily responsible for sales of the Company's products other than the FEMSOFT INSERT. The primary markets for the Company's products are individual hospitals and healthcare institutions, distributors and extended care facilities. The Company is planning a phased introduction of FEMSOFT INSERT in three metropolitan areas, Denver, Detroit and Iowa City, including the Quad-Cities of Iowa and Illinois, which were among the primary clinical study locations for the insert. The nine-person sales force will be expanded to include a staff dedicated to marketing and selling the FEMSOFT INSERT. The marketing of the FEMSOFT INSERT will require significant physician and clinician education efforts and substantial media advertising to consumers. The Company has formed a distribution and customer service program for the FEMSOFT INSERT with Healthcare Delivery Systems ("HDS"), a business unit of McKesson Corporation. Under this program, HDS will administer a centralized resource center for customer service, product information and nationwide distribution of the FEMSOFT INSERT. The Company relies on arrangements with medical product companies and independent distributors to sell the Company's products in Europe and other international markets. These arrangements are conducted under the ROCHESTER MEDICAL brand name and under brands controlled by the medical product companies. MANUFACTURING The Company designs and builds custom equipment to implement its manufacturing technologies and processes. The Company's manufacturing facilities are located in Stewartville, Minnesota. The Company produces its Foley catheters on one production line and its male external catheters on other lines. The Company has constructed a separate manufacturing facility to house its liquid encapsulation manufacturing operations, and has installed the FEMSOFT INSERT manufacturing line in this facility. The Company maintains a comprehensive quality assurance and quality control program, which includes documentation of all material specifications, operating procedures, equipment maintenance and quality control test methods. The Company has obtained ISO 9001 certification and CE mark quality system certification for its Foley catheter, male external catheter, and FEMSOFT INSERT production lines. The Company's manufacturing facility has been designed to accommodate the specialized requirements for the manufacture of medical devices, including the FDA's requirements for Quality System Regulation ("QSR"). SOURCES OF SUPPLY The Company obtains certain raw materials and components for a number of its products from a sole supplier or limited number of suppliers. The loss of such a supplier or suppliers, or a material interruption of deliveries from such a supplier or suppliers, could have a material adverse effect on the Company. The Company believes that in most, if not all, cases the Company has identified other potential suppliers. In the event that the Company had to replace a supplier, however, the Company may be required to repeat biocompatibility and other testing of its products using the material from the new supplier and may be required to obtain additional regulatory clearances. 5 RESEARCH AND DEVELOPMENT The Company believes that its ability to add new products to its existing continence care product lines is important to the Company's future success. Accordingly, the Company is engaged in ongoing research and development to develop and introduce new products which provide additional features and functionality. In the future, consistent with market opportunities and the Company's financial and personnel resources, the Company intends to perform clinical studies for other of its products in development. Research and development expense for fiscal years 1999, 1998 and 1997, was $1,052,000, $1,384,000 and $1,451,000, respectively. COMPETITION The continence care market is highly competitive. The Company believes that the primary competitive factors include price, product quality, technical capability, breadth of product line and distribution capabilities. The Company's ability to compete is affected by its product development and innovation capabilities, its ability to obtain regulatory clearances, its ability to protect the proprietary technology of its products and manufacturing processes, its marketing capabilities, its ability to attract and retain skilled employees, and, for products sold in managed care environments, its ability to maintain current distribution relationships, to establish new distribution relationships and to secure participation in purchase contracts with group purchasing organizations. The Company believes that it will be important for the Company to differentiate its products in order to attract large customers, such as distributors, dealers, institutions and home care organizations. The Company's products compete with a number of alternative products and treatments for continence care. The Company's ability to compete with these alternative methods for urinary continence care depends on the relative market acceptance of alternative products and therapies and the technological advances in these alternative products and therapies. Any development of a broad-based and effective cure for a significant form of incontinence could have a material adverse effect on sales of continence care devices such as the Company's products. The Company competes directly for sales of continence care devices under the Company's own brand with larger, multi-product medical device manufacturers and distributors such as ConvaTec, C.R. Bard, Inc., Maersk Medical, Kendall Healthcare Products Company, Hollister and Mentor. Many of the competitive alternative products or therapies to the Company's products are distributed by larger competitors including Johnson & Johnson Personal Products Company, Kimberly-Clark Corporation and Proctor & Gamble Company (for adult diapers and absorbent pads), and C.R. Bard, Inc. (for injectable materials). Many of the Company's competitors, potential competitors and providers of alternative products or therapies have significantly greater financial, manufacturing, marketing, distribution and technical resources and experience than the Company. It is possible that other large healthcare and consumer products companies may enter this market in the future. Furthermore, academic institutions, governmental agencies and other public and private research organizations will continue to conduct research, seek patent protection and establish arrangements for commercializing products in this market. Such products may compete directly with products which may be offered by the Company. PATENTS AND PROPRIETARY RIGHTS The Company's success may depend in part on its ability to obtain patent protection for its products and manufacturing processes, to preserve its trade secrets and to operate without infringing the proprietary rights of third parties. The Company may seek patents on certain features of its products and technology based on the Company's analysis of various business considerations, such as the cost of obtaining a patent, the likely scope of patent protection and the benefits of patent protection relative to relying on trade secret protection. The Company also relies upon trade secrets, know-how and continuing technological innovations to develop and maintain its competitive position. The Company owns 17 United States patents and a number of corresponding foreign patents that generally relate to certain of the Company's catheters and devices and certain of the 6 Company's production processes. In addition, the Company owns a number of pending United States and corresponding foreign patent applications. The Company may file additional patent applications for certain of the Company's current and proposed products and processes in the future. There can be no assurance that the Company's patents will be of sufficient scope or strength to provide meaningful protection of the Company's products and technologies. The coverage sought in a patent application can be denied or significantly reduced before the patent is issued. In addition, there can be no assurance that the Company's patents will not be challenged, invalidated or circumvented or that the rights granted thereunder will provide proprietary protection or commercial advantage to the Company. Should attempts be made to challenge, invalidate or circumvent the Company's patents in the United States Patent and Trademark Office and/or courts of competent jurisdiction, including administrative boards or tribunals, the Company may have to participate in legal or quasi-legal proceedings therein, to maintain, defend or enforce its rights in these patents. Any legal proceedings to maintain, defend or enforce the Company's patent rights can be lengthy and costly, with no guarantee of success. There also can be no assurance that the Company will file additional patent applications or that additional patents will issue from the Company's pending patent applications. A claim by third parties that the Company's current products or products under development allegedly infringe their patent rights could have a material adverse effect on the Company. The Company is aware that others have obtained or are pursuing patent protection for various aspects of the design, production and manufacturing of continence care products. The medical device industry is characterized by frequent and substantial intellectual property litigation, particularly with respect to newly developed technology. Intellectual property litigation is complex and expensive, and the outcome of such litigation is difficult to predict. Any future litigation, regardless of outcome, could result in substantial expense to the Company and significant diversion of the efforts of the Company's technical and management personnel. An adverse determination in any such proceeding could subject the Company to significant liabilities to third parties, require disputed rights to be licensed from such parties, if licenses to such rights could be obtained, and/or require the Company to cease using such technology. There can be no assurance that if such licenses were obtainable, they would be obtainable at costs reasonable to the Company. If forced to cease using such technology, there can be no assurance that the Company would be able to develop or obtain alternate technology. Additionally, if third party patents containing claims affecting the Company's technology are issued and such claims are determined to be valid, there can be no assurance that the Company would be able to obtain licenses to such patents at costs reasonable to the Company, if at all, or be able to develop or obtain alternate technology. Accordingly, an adverse determination in a judicial or administrative proceeding or failure to obtain necessary licenses could prevent the Company from manufacturing, using or selling certain of its products, which could have a material adverse effect on the Company's business, financial condition and results of operations. There also can be no assurance that any third party does not currently have, has not applied for, or might not in the future apply for, additional patents in the United States or abroad which, if ultimately granted, might be infringed in such country by any of the Company's products as currently configured or any other product of the Company and provide the basis for an infringement action in such country against the Company. The Company also relies on proprietary manufacturing processes and techniques, materials expertise and trade secrets applicable to the manufacture of its products. The Company seeks to maintain the confidentiality of this proprietary information. There can be no assurance, however, that the measures taken by the Company will provide the Company with adequate protection of its proprietary information or with adequate remedies in the event of unauthorized use or disclosure. In addition, there can be no assurance that the Company's competitors will not independently develop or otherwise gain access to processes, techniques or trade secrets that are similar or 7 superior to the Company's. Finally, as with patent rights, legal action to enforce trade secret rights can be lengthy and costly, with no guarantee of success. GOVERNMENT REGULATION The manufacture and sale of the Company's products are subject to regulation by numerous governmental authorities, principally the FDA and corresponding foreign agencies. In the United States, the medical devices manufactured and sold by the Company are subject to laws and regulations administered by the FDA, including regulations concerning the prerequisites to commercial marketing, the conduct of clinical investigations, compliance with QSR and labeling. A manufacturer may seek from the FDA market authorization to distribute a new medical device by filing a 510(k) Premarket Notification ("510(k)") to establish that the device is "substantially equivalent" to medical devices legally marketed in the United States prior to the Medical Device Amendments of 1976. A manufacturer may also seek market authorization for a new medical device through the more rigorous Premarket Approval ("PMA") application process, which requires the FDA to determine that the device is safe and effective for the purposes intended. The Company received FDA marketing authorization for its FEMSOFT INSERT on September 30, 1999 pursuant to a PMA. As a condition of FDA approval of the Company's PMA filing based on interim clinical study results, the Company will be required to complete the current clinical study of the FEMSOFT INSERT and submit the additional data to the FDA for its further consideration to determine whether such approval should be continued. There can be no assurance that these additional data will be sufficient in the FDA's opinion to permit continued marketing of the device even though the PMA filing for the FEMSOFT INSERT was initially approved by the FDA. All of the Company's other marketed products have received FDA marketing authorization pursuant to 510(k) notifications. The Company is also required to register with the FDA as a medical device manufacturer. As such, the Company's manufacturing facilities are inspected on a routine basis for compliance with QSR. These regulations require that the Company manufacture its products and maintain its documents in a prescribed manner with respect to design, manufacturing, testing and quality control activities. As a medical device manufacturer, the Company is further required to comply with FDA requirements regarding the reporting of adverse events associated with the use of its medical devices, as well as product malfunctions that would likely cause or contribute to death or serious injury if the malfunction were to recur. FDA regulations also govern product labeling and can prohibit a manufacturer from marketing an approved device for unapproved applications. If the FDA believes that a manufacturer is not in compliance with the law, it can institute enforcement proceedings to detain or seize products, issue a recall, enjoin future violations and assess civil and criminal penalties against the manufacturer, its officers and employees. The Company may become subject to future legislation and regulations concerning the manufacture and marketing of medical devices. Such future legislation and regulations could increase the cost and time necessary to begin marketing new products and could affect the Company in other respects not currently foreseeable. The Company cannot predict the effect of possible future legislation and regulations. Sales of medical devices outside the United States are subject to foreign regulatory requirements that vary widely from country to country. These laws and regulations range from simple product registration requirements in some countries to complex clearance and production controls in others. As a result, the processes and time periods required to obtain foreign marketing approval may be longer or shorter than those necessary to obtain FDA approval. These differences may affect the efficiency and timeliness of international market introduction of the Company's products. For countries in the European Union ("EU"), medical devices must display a CE mark before they may be imported or sold. In order to obtain and maintain the CE mark, the Company must comply with the Medical Device Directive and pass an initial and annual facilities audit inspections to ISO 9001 by an EU inspection agency. The Company has obtained ISO 9001 quality system certification for the CE mark for its currently marketed standard products and the FEMSOFT INSERT. The Company is pursuing CE mark certification for the RELEASE-NF CATHETER. In order to maintain 8 certification, if granted, the Company will be required to pass annual facilities audit inspections conducted by EU inspectors. There can be no assurance, however, that the Company will be able to obtain or maintain all necessary regulatory approvals or clearances, including CE mark certification, for its products in foreign countries. In addition, international sales of medical devices manufactured in the United States that have not been approved by the FDA for marketing in the United States are subject to FDA export requirements. These require that the Company obtain documentation from the medical device regulatory authority of the destination country stating that sale of the medical device is not in violation of that country's medical device laws, and, under some circumstances, may require the Company to apply to the FDA for permission to export a device to that country. THIRD PARTY REIMBURSEMENT In the United States, healthcare providers that purchase medical devices generally rely on third party payors, such as Medicare, Medicaid, private health insurance plans and managed care organizations, to reimburse all or a portion of the cost of the devices. The Medicare program is funded and administered by the federal government, while the Medicaid program is jointly funded by the federal government and the states, which administer the program under general federal oversight. The Company believes its currently marketed products, including the RELEASE-NF CATHETER, are generally eligible for coverage under these third party reimbursement programs. The Company is currently in the process of assessing eligibility of the FEMSOFT INSERT for reimbursement. The competitive position of certain of the Company's products may be partially dependent upon the extent of reimbursement for its products. The federal government and certain state governments are currently considering a number of proposals to reform the Medicare and Medicaid health care reimbursement system. The Company is unable to evaluate what legislation may be drafted and whether or when any such legislation will be enacted and implemented. Certain of the proposals, if adopted, could have an adverse effect on the Company's business, financial condition and results of operations. In foreign countries, the policies and procedures for obtaining third party payment of reimbursement for medical devices vary widely. Compliance with such procedures may delay or prevent the eligibility of the Company's branded and/or private label products for reimbursement, and have an adverse effect on the Company's ability to sell its branded or private label products in a particular foreign country. PRIVATE LABEL DISTRIBUTION AGREEMENTS CONVATEC. In April 1998, the Company and ConvaTec entered into a Revised and Restated Distribution Agreement (the "Revised ConvaTec Agreement"), which grants ConvaTec certain rights to market the Company's Foley catheters and male external catheters under the ConvaTec brand. The Revised ConvaTec Agreement provides, subject to certain existing obligations and limitations, that the Company will not appoint any other private label distributor for silicone male external catheters in Central America, South America, Australia, Japan, New Zealand, South Africa, Israel, Iran, Iraq, Lebanon, Oman, Saudi Arabia, Syria, United Arab Emirates and Yemen. ConvaTec has non-exclusive rights to distribute the Company's products in other markets. The Revised ConvaTec Agreement does not include any minimum purchase requirements or require that ConvaTec market any or all of the Company's products. The ConvaTec Agreement also provides in the event that the Company is unable to supply ConvaTec's requirements for products under certain circumstances, ConvaTec will have a license to the Company's technologies for purposes of manufacturing such products for ConvaTec. The Revised ConvaTec Agreement has an initial term expiring April 30, 2006, and may be renewed for successive annual extensions thereafter. Either party may terminate the Revised ConvaTec Agreement upon the other party's material breach of the Revised ConvaTec Agreement, bankruptcy or insolvency, or inability to perform under the Revised ConvaTec Agreement for a period of more than six months. 9 Sales of products to ConvaTec represented 16% of the Company's revenues in fiscal 1999 and 25% of revenues in fiscal 1998. HOLLISTER. The Company is the exclusive supplier of Hollister's requirements of self-adhering non-latex male external catheters which Hollister resells under its own brand. As a part of its agreement with Hollister, the Company has agreed to restrict its ability to sell self-adhering non-silicone male external catheters on a private label basis to other manufacturers and distributors for distribution outside of the United States and Canada. The term of the agreement commenced May 1, 1998 and expires April 30, 2002. During that period, Hollister is subject to a minimum purchase requirement of four million non-silicone catheters at the rate of at least one million catheters per year. Sales of products to Hollister represented 7% of the Company's revenues in fiscal 1999 and 7% of revenues in fiscal 1998. MENTOR. The Company has sold silicone male external catheters to Mentor pursuant to a Male External Catheter License, Sales and Distribution Agreement, as modified in September 1995 (the "MEC Agreement"). In fiscal 1999, Mentor discontinued purchases of male external catheters from the Company under the MEC Agreement after it began to manufacture its own silicone male external catheters. The Company does not anticipate that Mentor will resume any material purchases under the MEC Agreement in fiscal 2000. Sales of products to Mentor represented 10% of the Company's revenues in fiscal 1999 and 21% of revenues in fiscal 1998. EMPLOYEES As of September 30, 1999, the Company employed 135 full-time employees, of whom 98 were in manufacturing, and the remainder in marketing and sales, research and development and administration. The labor market for medical device manufacturing personnel has tightened in Minnesota, and particularly in the Rochester area where the Company's manufacturing facilities are located. This has resulted in upward pressure on wages for production workers but has not, to date, adversely affected the Company's ability to hire and retain capable manufacturing personnel. The Company is not a party to any collective bargaining agreement and believes its employee relations are good. EXECUTIVE OFFICERS OF THE REGISTRANT The executive officers of the Company as of December 20, 1999 are as follows: NAME AGE POSITION - ---- --- -------- Anthony J. Conway 55 Chairman of the Board, Chief Executive Officer, President and Secretary Brian J. Wierzbinski 41 Executive Vice President, Chief Financial Officer, and Treasurer Philip J. Conway 43 Vice President, Production Technologies Richard D. Fryar 52 Vice President, Research and Development Dara Lynn Horner 41 Vice President, Marketing ANTHONY J. CONWAY, a founder of the Company, has served as Chairman of the Board, Chief Executive Officer, President and Secretary of the Company since May 1988. In addition to his duties as Chief Executive Officer, Mr. Anthony Conway actively contributes to the Company's research and development and design activities. From 1979 to March 1988, he was President, Secretary and Treasurer of Arcon Corporation ("Arcon"), a company that he co-founded in 1979 to develop, manufacture and sell latex-based male external catheters and related medical devices. Prior to founding Arcon, Mr. Anthony Conway worked for twelve years for International Business Machines Corporation ("IBM") in various research and development capacities. Mr. Anthony Conway is one of the named inventors on numerous patent applications that have been assigned to the Company, of which to date 17 have resulted in issued United States patents. BRIAN J. WIERZBINSKI has served as the Company's Chief Financial Officer since February 1996, as its Treasurer since September 1997, as a Director since February 1998 and as its 10 Executive Vice President since August 1999. Since February 1996, Mr. Wierzbinski has had principal responsibility for management of the Company's financial and administrative activities, and since August 1999, Mr. Wierzbinski has also had primary functional responsibility for the Company's sales and production activities. From 1986 until joining the Company in 1996, Mr. Wierzbinski was employed in various financial and financial management capacities by Ecolab, Inc., most recently as Asia Pacific Vice President, planning and control. Prior to joining Ecolab, Mr. Wierzbinski was employed for six years in various audit and audit management capacities by KPMG Peat Marwick. Mr. Wierzbinski is a certified public accountant. PHILIP J. CONWAY, a founder of the Company, has served as Vice President of Production Technologies of the Company since August 1999 and as a Director of the Company since May 1988. From 1988 to July 1999, Mr. Philip Conway served as Vice President of Operations of the Company. Mr. Philip Conway is responsible for plant design as well as new product and production processes, research, design and development activities. From 1979 to March 1988, Mr. Philip Conway served as Plant and Production Manager of Arcon, a company that he co-founded. Prior to joining Arcon, Mr. Philip Conway was employed in a production supervisory capacity by AFC Corp., a manufacturer and fabricator of fiberglass, plastics and other composite materials. He is one of the named inventors on numerous patent applications that have been assigned to the Company, of which to date 17 have resulted in issued United States patents. RICHARD D. FRYAR, a founder of the Company, has served as Vice President, Research and Development and as a director of the Company since May 1988. Mr. Fryar is responsible for overseeing the Company's research and development and regulatory affairs activities. From 1984 to March 1988, Mr. Fryar was employed by Arcon, a company that he co-founded, in research and development capacities. From 1969 to 1984, he was employed by IBM in various research and development capacities. He is one of the named inventors on numerous patent applications that have been assigned to the Company, of which to date 17 have resulted in issued United States patents. DARA LYNN HORNER has served as Marketing Director for the Company's FEMSOFT INSERT product line since November 1998, and as Vice President of Marketing of the Company since November 1999. Ms. Horner has principal responsibility for management of the Company's marketing activities. From 1990 until joining the Company in 1998, Ms. Horner was employed by Lake Region Manufacturing, Inc., a medical device manufacturer, most recently as Marketing Director. From 1980 to 1998, she was employed in various marketing and sales capacities with, respectively, Medtronic, Inc., West Central Tribune, and Blue Cross-Blue Shield of Minnesota. Messrs. Anthony J. Conway, Philip J. Conway and Peter R. Conway, a director of the Company, are brothers. ITEM 2. PROPERTIES The Company's administrative offices and liquid encapsulation manufacturing facilities occupy a 52,000 square foot manufacturing and office facility on a 28 acre site owned by the Company and located in an industrial park in Stewartville, Minnesota. The Company's male external and Foley catheter manufacturing facilities consists of a 34,000 square foot manufacturing and office building located on a nearby 3.5 acre site owned by the Company in the same industrial park. ITEM 3. LEGAL PROCEEDINGS The Company is not involved in any material legal proceedings. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted to a vote of security holders during the fourth quarter ended September 30, 1999. 11 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS The Common Stock is quoted on the Nasdaq National Market under the symbol ROCM. The following table sets forth, for the periods indicated, the range of high and low last sale prices for the Common Stock as reported by the Nasdaq National Market. HIGH LOW -------- ------- FISCAL 1998 First Quarter .......................... $ 17.875 $ 11.875 Second Quarter ......................... 16.000 13.125 Third Quarter .......................... 15.375 14.000 Fourth Quarter ......................... 15.000 8.000 FISCAL 1999 First Quarter .......................... $ 15.250 $ 9.625 Second Quarter ......................... 15.500 9.250 Third Quarter .......................... 12.250 9.500 Fourth Quarter ......................... 12.313 8.375 HOLDERS As of December 10, 1999, the Company had 121 shareholders of record. Such number of record holders does not reflect shareholders who beneficially own Common Stock in nominee or street name. The Company has paid no cash dividends on its Common Stock, and it does not intend to pay cash dividends on its Common Stock in the future. 12 ITEM 6. SELECTED FINANCIAL DATA The following selected financial data of the Company as of September 30, 1999 and 1998 and for the three fiscal years ended September 30, 1999, 1998 and 1997 are derived from, and should be read together with, the financial statements of the Company audited by Ernst & Young LLP, independent auditors, included elsewhere in this Form 10-K. The following selected financial data as of September 30, 1997, 1996 and 1995 and for the fiscal years ended September 30, 1996 and 1995 are derived from audited financial statements not included herein. The information set forth below should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations," the Financial Statements and Notes thereto and other financial information included elsewhere in this Form 10-K.
FISCAL YEARS ENDED SEPTEMBER 30, ----------------------------------------------------------------- 1999 1998 1997 1996 1995 --------- --------- --------- --------- --------- (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) Statements of Operations Data: Net sales ............................ $ 7,341 $ 9,518 $ 7,615 $ 5,540 $ 3,131 Cost of sales ........................ 5,602 6,604 4,869 3,788 2,448 --------- --------- --------- --------- --------- Gross profit ........................ 1,739 2,914 2,746 1,752 683 Operating expenses: Marketing and selling ................ 3,944 3,191 2,210 1,351 858 Research and development ............. 1,052 1,384 1,451 1,182 358 General and administrative ........... 1,863 1,445 1,499 1,112 766 --------- --------- --------- --------- --------- Total operating expenses ............ 6,859 6,020 5,160 3,645 1,982 --------- --------- --------- --------- --------- Loss from operations .................. (5,120) (3,106) (2,414) (1,893) (1,299) Interest income ....................... 719 848 657 818 56 Interest expense ...................... -- -- (342) (285) (68) --------- --------- --------- --------- --------- Net loss .............................. $ (4,401) $ (2,258) $ (2,099) $ (1,360) $ (1,311) ========= ========= ========= ========= ========= Net loss per common share -- basic and diluted .................... $ (.83) $ (.44) $ (.51) $ (.35) $ (.49) Weighted average number of common shares outstanding ............ 5,333 5,141 4,132 3,867 2,682 AS OF SEPTEMBER 30, ----------------------------------------------------------------- 1999 1998 1997 1996 1995 --------- --------- --------- --------- --------- (IN THOUSANDS) Balance Sheet Data: Cash, cash equivalents and Marketable securities ............... $ 13,246 $ 16,410 $ 4,639 $ 17,408 $ 2,905 Working capital ...................... 15,486 19,245 7,081 18,861 4,348 Total assets ......................... 28,702 32,736 18,613 23,888 7,163 Long-term debt ....................... -- -- -- 3,321 3,036 Accumulated deficit .................. (14,175) (9,774) (7,516) (5,418) (4,058) --------- --------- --------- --------- --------- Total shareholders' equity ........... $ 27,177 $ 30,918 $ 17,181 $ 19,231 $ 3,672
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Statements other than historical information contained herein constitute "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements may be identified by the use of terminology such as "may," "will," "expect," "anticipate," "predict," "intend," "designed," "estimate," "should" or "continue" or the negatives thereof or other variations thereon or comparable terminology. The forward-looking statements involve known or unknown risks, uncertainties and other factors which may cause the 13 actual results, performance or achievements of the Company, or industry results, to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. Factors that might cause such differences include, but are not limited to, those discussed in the section entitled "Risk Factors" below. GENERAL The Company designs, develops, manufactures and markets urinary continence care products for sale to the home care and hospital care markets. Through fiscal 1992, the Company was a development stage company, engaged primarily in the development of its products and manufacturing operations and systems. In fiscal 1992, the Company began commercial sales under a private label arrangement. In fiscal 1993, the Company also began marketing products under the ROCHESTER MEDICAL brand. RESULTS OF OPERATIONS The following table sets forth, for the periods indicated, certain items from the statements of operations of the Company expressed as a percentage of net sales: FISCAL YEARS ENDED SEPTEMBER 30, ------------------------ 1999 1998 1997 ---- ---- ---- Total net sales ..................... 100% 100% 100% Cost of sales ....................... 76 69 64 --- --- --- Gross margin ........................ 24 31 36 Operating expenses: Marketing and selling .............. 54 34 29 Research and development ........... 14 15 19 General and administrative ......... 26 15 20 --- --- --- Total operating expenses ............ 94 64 68 Loss from operations ................ (70) (33) (32) Interest income, net ................ 10 9 4 --- --- --- Net loss ............................ (60)% (24)% (28)% === === === FISCAL YEAR ENDED SEPTEMBER 30, 1999 COMPARED TO FISCAL YEAR ENDED SEPTEMBER 30, 1998 NET SALES. Net sales decreased 23% to $7.3 million in fiscal 1999 from $9.5 million in the prior fiscal year. Domestic sales decreased 31% in fiscal 1999 from the prior fiscal year, with growth of 41% in ROCHESTER MEDICAL brand product sales offset by a 50% decline in sales to domestic private label customers, primarily Mentor and ConvaTec. International sales decreased 6% in fiscal 1999 from the prior fiscal year compared with the prior year, with 45% growth in European markets offset by a 25% decline in all other international markets. GROSS MARGIN. The Company's gross margin was 24% in fiscal 1999 compared to 31% in fiscal 1998. The fiscal 1999 margin primarily reflects costs associated with continuing underutilized production capacity due to lower sales. Costs associated with increased capacity are anticipated to continue until such time as, if ever, the Company achieves sufficient sales to absorb the additional capacity. MARKETING AND SELLING. Marketing and selling expense increased 24% to $3.9 million in fiscal 1999 from $3.2 million in fiscal 1998. The increase in expense is due to promotional activities for the RELEASE-NF CATHETER and market introduction preparation for the FEMSOFT INSERT. The Company anticipates that marketing and selling expenses will increase in future periods as the Company expands its promotional and market development activities related to Rochester Medical brand products, particularly the Company's FEMSOFT INSERT. 14 RESEARCH AND DEVELOPMENT. Research and development expense decreased 24% to $1.1 million in fiscal 1999 from $1.4 million in fiscal 1998. The decrease in research and development expense primarily reflects a reduction in accruals for costs of the FEMSOFT INSERT clinical trials related to stage of completion. GENERAL AND ADMINISTRATIVE. General and administrative expense increased 29% to $1.9 million in fiscal 1999 from $1.4 million in fiscal 1998. The increase in general and administrative expense is related to upgrading of business systems, including the Year 2000 compliance program, and general increases in administrative support costs. INTEREST INCOME. Interest income decreased 15% to $719,000 in fiscal 1999 from $848,000 in fiscal 1998. The decrease in interest income reflects the comparatively lower average level of invested cash balances in the current quarter due to the utilization of cash for operations and capital expenditures. FISCAL YEAR ENDED SEPTEMBER 30, 1998 COMPARED TO FISCAL YEAR ENDED SEPTEMBER 30, 1997 NET SALES. Net sales increased 25% to $9.5 million in fiscal 1998 from $7.6 million in the prior fiscal year. The increase results from sales growth in both ROCHESTER MEDICAL brand and private label products. Sales of ROCHESTER MEDICAL brand products increased 40% to $2.4 million in fiscal 1998 from $1.7 million in fiscal 1997, reflecting growth of 62% in domestic sales and 16% in international sales. Virtually all of the domestic growth in branded sales was from sales of the Company's standard products, for which marketing efforts have been progressively increased by the recently expanded field sales force. Sales to private label customers increased 20% to $7.1 million in fiscal 1998 from $6.0 million in fiscal 1997. Sales to ConvaTec, Mentor and Hollister accounted for 25%, 21% and 7%, respectively, of fiscal 1998 net sales compared to 24%, 30% and 10%, respectively, in fiscal 1997. GROSS MARGIN. The Company's gross margin was 31% in fiscal 1998 compared to 36% for fiscal 1997. The gross margin rate has been adversely impacted by expansion of production facilities and support operations, shift in product mix toward lower margin products and increases in production wage rates. The Company expects continued downward pressure on gross margins in future periods associated with additional depreciation and other capacity expansion and production scale-up costs. The trend of reduced margins is expected to continue until such time, if ever, the Company is able to increase utilization of the expanded manufacturing facilities, and increase sales levels of its higher margin RELEASE-NF CATHETER product line. MARKETING AND SELLING. Marketing and selling expense increased 44% to $3.2 million in fiscal 1998 from $2.2 million in fiscal 1997. The increased expense is due primarily to market introduction costs for the RELEASE-NF CATHETER, expansion of the domestic field sales force and costs associated with the addition of two new sales and marketing management personnel. RESEARCH AND DEVELOPMENT. Research and development expense decreased 5% to $1.4 million in fiscal 1998 compared to $1.5 million in fiscal 1997. The primary activity affecting research and development expense levels is the ongoing clinical testing for the FEMSOFT INSERT. GENERAL AND ADMINISTRATIVE. General and administrative expense decreased 4% to $1.4 million in fiscal 1998 from $1.5 million in fiscal 1997. The decrease in administrative expense reflects efforts to contain costs, including deferral of planned business system development expenditures until fiscal 1999. INTEREST INCOME (EXPENSE), NET. Net interest income increased to $848,000 in fiscal 1998 compared to $316,000 in fiscal 1997. The increase in net interest income in fiscal 1998 is a result of investment of net proceeds from the Company's November 1997 public stock offering and repayment of a convertible note to ConvaTec (See "Liquidity and Capital Resources"). LIQUIDITY AND CAPITAL RESOURCES The Company has financed its operations primarily through public offerings and private placements of its equity securities, and has raised approximately $40.7 million in net proceeds 15 since its inception. In August 1995, the Company received proceeds of $3.0 million from issuance of a convertible note to ConvaTec. The Company repaid the ConvaTec note on September 30, 1997, with accrued interest, for a total amount of $3.7 million. The Company's cash, cash equivalents and marketable securities were $13.2 million at September 30, 1999 compared with $16.4 million at September 30, 1998. The Company used a net $3.0 million of cash from operating activities during the year, primarily reflecting the net loss before non-cash depreciation. During fiscal 1999, the Company's working capital position, excluding cash and marketable securities, decreased by a net $596,000. Accounts receivable balances decreased 30% or $585,000 during the fiscal year as a result of receivable collections and lower sales. Inventories decreased by 7% or $162,000 during the year, which management expects will be temporarily offset by increased stocking under the Year 2000 contingency plan. Other current assets decreased 29% or $141,000 as a result of the collection of miscellaneous receivables. Current liabilities decreased 16% or $293,000 during the year, reflecting a reduction in raw material purchase volumes related to lower sales levels and payment of clinical trial obligations. Changes in other asset and liability balances related to timing of expense recognition. In December 1999, the Board of Directors authorized a stock repurchase program. Up to one million shares of the Company's outstanding common stock may be repurchased under the program. Purchases may be made from time to time at prevailing prices in the open market and through other customary means. No time limit has been placed on the duration of the stock repurchase program and it may be conducted over an extended period of time as business and market conditions warrant. The Company also may discontinue the stock repurchase program at any time. The repurchased shares will be available for reissuance pursuant to employee stock option plans and for other corporate purposes. The Company intends to fund such repurchases with currently available funds. Although the Company believes that its existing resources and anticipated cash flows from operations will be sufficient to satisfy its capital needs for approximately the next two years, there can be no assurance that the Company will not require additional financing before that time. The Company's actual liquidity and capital requirements will depend upon numerous factors, including the costs and timing of expansion of sales and marketing activities; the amount of revenues from sales of the Company's existing and new products; changes in, termination of, and the success of, existing and new distribution arrangements; the cost of maintaining, enforcing and defending patents and other intellectual property rights; competing technological and market developments; developments related to regulatory and third party reimbursement matters; the cost and progress of the Company's research and development efforts; and other factors. In the event that additional financing is needed, the Company may seek to raise additional funds through public or private financing, collaborative relationships or other arrangements. Any additional equity financing may be dilutive to shareholders, and debt financing, if available, may involve significant restrictive covenants. Collaborative arrangements, if necessary to raise additional funds, may require the Company to relinquish its rights to certain of its technologies, products or marketing territories. Failure to raise capital when needed could have a material adverse effect on the Company's business, financial condition and results of operations. There can be no assurance that such financing, if required, will be available on terms satisfactory to the Company, if at all. IMPACT OF YEAR 2000 The Year 2000 issue is the result of computer programs which were written using two digits rather than four to determine the applicable year. The Year 2000 issue may also affect computer chips embedded in computer hardware and machinery, which process date-sensitive information. Any computer programs and hardware or equipment that have date-sensitive software or chips may recognize a date using "00" as the year 1900 rather than the year 2000. This could result in a system failure or miscalculations causing disruptions to operations, including temporary inability to process transactions, send invoices or engage in similar normal business activities. 16 The Company utilizes a variety of computer programs, primarily purchased software, for its systems of manufacturing, distribution and administration. The Company has made inquiries of its vendors who provide the Company with computer programs and equipment, including hardware and software used in the Company's automated manufacturing processes. The Company has also utilized the services of an outside consultant to assist the Company with an inventory and assessment of its computer programs and equipment and the implementation of a Year 2000 remediation plan. The Company has completed the inventory, assessment, implementation and testing phases of its Year 2000 review. Based upon results of this review to date and upon certifications and assurances received from its software and other vendors, the Company has not identified any material Year 2000 compliance issues related to its core hardware and software systems, manufacturing systems, or communications systems. The Company has implemented its Year 2000 remediation plan at a total cost of approximately $85,000, including costs associated with the replacement of PC computer hardware and software and consulting services to implement the same. The Company has made inquiry to each of its material suppliers, such as banks, payroll processors and vendors who must address their own Year 2000 issues. To date, none of these inquiries has identified any definite Year 2000 issues. The failure of these companies to be Year 2000 compliant may affect the ability of the Company, among other things, to obtain critical supplies or receive payment on outstanding invoices. Depending on the extent of such issues, this could have a material adverse effect on the Company's results of operations and liquidity. The Company has used its own personnel to make inquiries to vendors and to conduct the Year 2000 assessment process. While the Company's Year 2000 compliance program is essentially completed, and although the Company estimates that the total cost of its Year 2000 review will not exceed $100,000, specific factors that might require material expenditures not now anticipated by the Company include, but are not limited to, the availability and cost of trained personnel, the validity of certifications and assurances furnished by software and hardware vendors, the effectiveness of software upgrades received by the Company from its software vendors, the results of the ongoing Year 2000 review and similar uncertainties. The Company has made contingency plans to provide reasonable assurance as to continued supply of key materials and services, where appropriate, from its key vendors. RISK FACTORS UNCERTAINTY OF MARKET ACCEPTANCE OF NEW PRODUCTS Much of the Company's ability to increase revenues and to achieve profitability and positive cash flow will depend on the successful introduction of new products, primarily the RELEASE-NF CATHETER and the FEMSOFT INSERT. Both of these products represent new methods for urinary continence care. There can be no assurance that these products will gain any significant degree of market acceptance among physicians, healthcare payors and patients. Market acceptance of these products, if it occurs, may require lengthy hospital evaluations and/or the training of numerous physicians and clinicians, which could delay or dampen any such market acceptance. Moreover, approval of reimbursement for the Company's products, competing products or alternative medical treatments, and the Company's pricing policies will be important factors in determining market acceptance of these products. Any of the foregoing factors, or other factors, could limit or detract from market acceptance of these products. Insufficient market acceptance of these products could have a material adverse effect on the Company's business, financial condition and results of operations. RISKS ASSOCIATED WITH MARKETING AND SALES OF ROCHESTER MEDICAL BRAND PRODUCTS The Company's success will depend on its ability to overcome established market positions of competitors and to establish its own market presence under the ROCHESTER MEDICAL brand name. One of the challenges facing the Company in this respect is the Company's ability to compete with 17 companies that offer a wider array of products to hospitals and medical care institutions, distributors and end users. The Company may also find it difficult to sell its products due to the limited recognition of its brand name. LIMITED REVENUES; HISTORY OF LOSSES AND ANTICIPATED FUTURE LOSSES The Company has generated only limited revenues to date and has experienced net losses since its inception. Net losses for the fiscal years ended September 30, 1997, 1998 and 1999 were $2.1 million, $2.3 million and $4.4 million, respectively. The Company had an accumulated deficit of approximately $14.2 million at September 30, 1999. The Company's ability to increase revenues and achieve profitability and positive cash flow will depend in part upon the Company's ability to complete development of, and/or successfully introduce, new products, particularly the RELEASE-NF CATHETER and FEMSOFT INSERT, of which there can be no assurance. The Company expects to incur substantial expenses for commercialization of the RELEASE-NF CATHETER, and for clinical testing, development and commercialization of the FEMSOFT INSERT, as well as for other new products and products in development. In addition, the Company anticipates increased operating expenses as it expands its sales and marketing organization and activities. A substantial portion of the expenses associated with the Company's manufacturing facilities are fixed in nature (i.e. depreciation) and will reduce the Company's operating margin until such time, if ever, as the Company is able to increase utilization of its capacity. As a result, the Company expects to incur substantial operating losses for the foreseeable future and there can be no assurance that the Company will ever generate substantial revenues or achieve or sustain profitability. HIGHLY COMPETITIVE MARKETS; ALTERNATIVE TREATMENTS; TECHNOLOGICAL ADVANCEMENTS The medical products market in general is, and the markets for urinary continence care products in particular are, highly competitive. Many of the Company's competitors have greater name recognition than the Company and offer well known and established products, some of which are less expensive than the Company's products. As a result, even if the Company can demonstrate that its products provide greater ease of use, lifestyle improvement or beneficial effects on medical outcomes over the course of treatment, the Company may not be successful in capturing a significant share of the market. In addition, many of the Company's competitors offer broader product lines than the Company, which may be a competitive advantage in obtaining contracts with healthcare purchasing groups, and may adversely affect the Company's ability to obtain contracts with such purchasing groups. Additionally, many of the Company's competitors have substantially more marketing and sales experience than the Company and substantially greater resources to devote to such efforts. There can be no assurance that the Company will be able to compete successfully against such competitors. Urinary continence care can be managed with a variety of alternative medical treatments and management products or techniques, including adult diapers and absorbent pads, surgery, behavior therapy, pelvic muscle exercise, implantable devices, injectable materials and other medical devices. Manufacturers of these products or techniques are engaged in research to develop more advanced versions of current products and techniques. Many of the companies that are engaged in such development work have substantially greater capital resources than the Company and greater expertise than the Company in research, development and regulatory matters. There can be no assurance that the Company's products will be able to compete with existing or future alternative products, techniques or therapies, or that advancements in existing products, techniques or therapies will not render the Company's products obsolete. DEPENDENCE ON DISTRIBUTION ARRANGEMENTS A significant portion of the Company's net sales to date have depended on the Company's ability to provide products that meet the requirements of medical product companies that resell or distribute the Company's products, and on the sales and marketing efforts of such entities. Arrangements with these entities are likely to continue to be a significant portion of the Company's revenues in the future. There can be no assurance that the Company's purchasers and distributors will be able to successfully market and sell the Company's products, that they will 18 devote sufficient resources to support the marketing of any of the Company's products, that they will market any of the Company's products at prices which will permit such products to develop, achieve, or sustain market acceptance, or that they will not develop alternative sources of supply. The failure of the Company's purchasers and distributors to continue to purchase products from the Company at levels reasonably consistent with their prior purchases or to effectively market the Company's products could have a material adverse effect on the Company's business, financial condition and results of operations. POSSIBLE NEED FOR ADDITIONAL CAPITAL The Company intends to expend substantial funds for expansion of sales and marketing activities, product education efforts, advertising and other working capital and general corporate purposes. Although the Company believes its existing resources and anticipated cash flows from operations will be sufficient to satisfy its capital needs for approximately the next two years, there can be no assurance that the Company will not require additional financing before that time. The Company's actual liquidity and capital requirements will depend on numerous factors, including the costs and timing of expansion of sales and marketing activities; the amount of revenues from sales of the Company's existing and new products, including the RELEASE-NF CATHETER and FEMSOFT INSERT; changes in, termination of, and the success of, existing and new distribution arrangements; the cost of maintaining, enforcing and defending patents and other intellectual property rights; competing technological and market developments; developments relating to regulatory and third party reimbursement matters; the cost and progress of the Company's research and development efforts; and other factors. In the event that additional financing is needed, the Company may seek to raise additional funds through public or private financing, collaborate relationships or other arrangements. Any additional equity financing may be dilutive to shareholders, and debt financing, if available, may involve significant restrictive covenants. Failure to raise capital when needed could have a material adverse effect on the Company's business, financial condition and results of operations. There can be no assurance that such financing, if required, will be available on terms satisfactory to the Company, if at all. EFFECTS OF GOVERNMENT REGULATION The Company's products, product development activities and manufacturing processes are subject to extensive regulation by the FDA and by comparable agencies in foreign countries. In the United States, the FDA regulates the introduction of medical devices as well as manufacturing, labeling and record keeping procedures for such products. The process of obtaining marketing clearance for new medical products from the FDA can be costly and time consuming, and there can be no assurance that such clearance will be granted timely, if at all, for the Company's products in development, or that FDA review will not involve delays that would adversely affect the Company's ability to commercialize additional products or to expand permitted uses of existing products. Even if regulatory clearance to market a product is obtained from the FDA, this clearance may entail limitations on the indicated uses of the product. Marketing clearance can also be withdrawn by the FDA due to failure to comply with regulatory standards or the occurrence of unforeseen problems following initial clearance. The Company may be required to make further filings with the FDA under certain circumstances, such as the addition of product claims or product reformulation. The FDA could also limit or prevent the manufacture or distribution of the Company's products and has the power to require the recall of such products. FDA regulations depend heavily on administrative interpretation, and there can be no assurance that future interpretation made by the FDA or other regulatory bodies, which may have retroactive effect, will not adversely affect the Company. The FDA and various state agencies inspect the Company and its facilities from time to time to determine whether the Company is in compliance with regulations relating to medical device manufacturing companies, including regulations concerning design, manufacturing, testing, quality control and product labeling practices. A determination that the Company is in material violation of such regulations could lead to the imposition of civil penalties, including fines, product recalls, product seizures, or, in extreme cases, criminal sanctions. A portion of the Company's revenues are dependent upon sales of its products outside the United States. Foreign regulatory bodies have established varying regulations governing product 19 standards, packaging requirements, labeling requirements, import restrictions, tariff regulations, duties and tax requirements. The Company relies on its third-party foreign distributors to comply with certain foreign regulatory requirements. The inability or failure of the Company or such foreign distributors to comply with varying foreign regulations or the imposition of new regulations could restrict the sale of the Company's products internationally and thereby adversely affect the Company's business, financial condition and results of operations. DEPENDENCE ON THIRD PARTY REIMBURSEMENT The Company's products are purchased by medical care institutions and other users, which bill various third party payors, such as government health programs, private health insurance plans, managed care organizations and other similar programs, for the health care products and services provided to their patients. Payors may deny reimbursement if they determine that a product used in a procedure was not used in accordance with established payor protocols regarding cost-efficient treatment methods, was used for an unapproved indication or was not otherwise covered. Third party payors are increasingly challenging the prices charged for medical products and services and, in some instances, have pressured medical suppliers to lower their prices. The Company is unable to predict what changes will be made in the reimbursement methods used by third party health care payors. There can be no assurance that treatments utilizing the Company's products will be considered cost effective by third party payors, that reimbursement for such treatments will be available or, if available, that payor reimbursement levels will not adversely affect the Company's ability to sell its products on a profitable basis. Moreover, Medicare, Medicaid and private third party payors may limit reimbursement for disposable devices such as those manufactured by the Company by implementing fee schedules or by allowing reimbursement for only a fixed number of devices per month. In addition, healthcare costs have risen significantly over the past decade, and there have been and may continue to be proposals by legislators, regulators and third party payors to curb these costs. The Company is currently in the process of assessing the eligibility of the FEMSOFT INSERT for reimbursement. Failure by users of the Company's products to obtain reimbursement from third party payors, changes in third party payors' policies towards reimbursement for the Company's products or legislative action limiting reimbursement for certain procedures or products could have a material adverse effect on the Company's business, financial condition and results of operations. DEPENDENCE ON PATENTS AND PROPRIETARY RIGHTS The Company's success may depend in part on its ability to obtain patent protection for its products and manufacturing processes, to preserve its trade secrets, and to operate without infringing the proprietary rights of third parties. The validity and breadth of claims covered in medical technology patents involve complex legal and factual questions and, therefore, may be highly uncertain. No assurance can be given that the scope of any patent protection under the Company's current patents, or under any patent the Company might obtain in the future, will exclude competitors or provide competitive advantages to the Company; that any of the Company's patents will be held valid if subsequently challenged; or that others will not claim rights in or ownership of the patents and other proprietary rights held by the Company. There can be no assurance that the Company's technology, current or future products or activities will not be deemed to infringe upon the rights of others. Furthermore, there can be no assurance that others have not developed or will not develop similar products or manufacturing processes, duplicate any of the Company's products or manufacturing processes, or design around the Company's patents. The Company also relies upon unpatented trade secrets to protect its proprietary technology, and no assurance can be given that others will not independently develop or otherwise acquire substantially equivalent technology or otherwise gain access to the Company's proprietary technology or disclose such technology or that the Company can ultimately protect meaningful rights to such unpatented proprietary technology. The medical device industry is characterized by frequent and substantial intellectual property litigation, particularly with respect to newly developed technology. Litigation may be necessary to enforce patents issued to the Company, to protect trade secrets or know-how owned by the 20 Company, or to determine the ownership, scope or validity of the proprietary rights of the Company and others. Intellectual property litigation is complex and expensive, and the outcome of such litigation is difficult to predict. Any such litigation, regardless of outcome, could result in substantial expense to the Company and significant diversion of the efforts of the Company's technical and management personnel. As a result, a claim by a third party that the Company's current products or products in development allegedly infringe its patent rights could have a material adverse effect on the Company. Moreover, an adverse determination in any such proceeding could subject the Company to significant liabilities to third parties, require disputed rights to be licensed from such parties, if licenses to such rights could be obtained, and/or require the Company to cease using such technology. If third party patents containing claims affecting the Company's technology were issued and such claims were determined to be valid, there can be no assurance that the Company would be able to obtain licenses to such patents at costs reasonable to the Company, if at all, or be able to develop or obtain alternate technology. Accordingly, an adverse determination in a judicial or administrative proceeding or failure to obtain necessary licenses could prevent the Company from manufacturing, using or selling certain of its products, which could have a material adverse effect on the Company's business, financial condition and results of operations. POSSIBILITY OF PRODUCT LIABILITY LITIGATION; POSSIBLE INADEQUACY OF INSURANCE The medical products industry is subject to substantial product liability litigation, and the Company faces an inherent business risk of exposure to product liability claims in the event that the use of its products is alleged to have resulted in adverse effects to a patient. Although the Company has not experienced any product liability claims to date, any such claims could have a material adverse effect on the Company, including on market acceptance of its products. The Company maintains general insurance policies that include coverage for product liability claims. The policies are limited to an aggregate maximum of $6 million per product liability claim, with an annual aggregate limit of $7 million under the policies. The Company may require increased product liability coverage as new products are developed and commercialized. There can be no assurance that liability claims will not exceed the coverage limits of the Company's policies or that adequate insurance will continue to be available on commercially reasonable terms, if at all. A product liability claim or other claim with respect to uninsured liabilities or in excess of insured liabilities could have a material adverse effect on the Company's business, financial condition and results of operations. 21 ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. The Company's operations are not currently subject to market risks for interest rates, foreign currency exchange rates, commodity prices or other relevant market price risks of a material nature. ITEM 8. FINANCIAL STATEMENTS ROCHESTER MEDICAL CORPORATION FINANCIAL STATEMENTS YEARS ENDED SEPTEMBER 30, 1999, 1998 AND 1997 PAGE ----- Report of Independent Auditors ................................... 23 Audited Financial Statements ..................................... 24-34 Balance Sheets .................................................. 24 Statements of Operations ........................................ 25 Statement of Shareholders' Equity ............................... 26 Statements of Cash Flows ........................................ 27 Notes to Financial Statements ................................... 28 22 REPORT OF INDEPENDENT AUDITORS Shareholders Rochester Medical Corporation We have audited the accompanying balance sheets of Rochester Medical Corporation as of September 30, 1999 and 1998, and the related statements of operations, shareholders' equity and cash flows for each of the three years in the period ended September 30, 1999. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Rochester Medical Corporation at September 30, 1999 and 1998, and the results of its operations and its cash flows for each of the three years in the period ended September 30, 1999, in conformity with generally accepted accounting principles. /s/ Ernst & Young LLP ERNST & YOUNG LLP Minneapolis, Minnesota October 22, 1999 23 ROCHESTER MEDICAL CORPORATION BALANCE SHEETS
SEPTEMBER 30, ----------------------------- 1999 1998 ------------ ------------ ASSETS Current assets: Cash and cash equivalents ...................................... $ 4,216,814 $ 2,864,922 Marketable securities .......................................... 9,029,296 13,545,271 Accounts receivable, less allowance for doubtful accounts ($59,466 -- 1999; $50,000 -- 1998) ............................ 1,369,662 1,955,048 Inventories, net ............................................... 2,047,820 2,209,599 Prepaid expenses and other current assets ...................... 347,860 489,001 ------------ ------------ Total current assets ............................................ 17,011,452 21,063,841 Property, plant and equipment: Land ........................................................... 169,707 169,707 Buildings ...................................................... 5,221,078 5,220,078 Construction in progress ....................................... 1,699,440 3,373,888 Equipment and fixtures ......................................... 7,638,733 5,167,000 ------------ ------------ 14,728,958 13,930,673 Less accumulated depreciation .................................. (3,257,233) (2,510,975) ------------ ------------ Total property, plant and equipment ............................. 11,471,725 11,419,697 Patents, less accumulated amortization ($641,516 -- 1999; $550,441 -- 1998) .............................................. 219,218 252,212 ------------ ------------ Total assets .................................................... $ 28,702,395 $ 32,735,750 ============ ============ LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Accounts payable ............................................... $ 689,475 $ 766,304 Accrued compensation ........................................... 556,329 523,612 Accrued clinical costs ......................................... 45,214 294,495 Accrued expenses ............................................... 234,371 233,610 ------------ ------------ Total current liabilities ....................................... $ 1,525,389 $ 1,818,021 ============ ============ Shareholders' equity: Common Stock, no par value: Authorized shares -- 20,000,000 Issued and outstanding shares; (5,349,500 -- 1999; 5,269,500 -- 1998) ............................................ $ 41,352,202 $ 40,692,202 Accumulated deficit ............................................. (14,175,196) (9,774,473) ------------ ------------ Total shareholders' equity ...................................... 27,177,006 30,917,729 ------------ ------------ Total liabilities and shareholders' equity ...................... $ 28,702,395 $ 32,735,750 ============ ============
SEE ACCOMPANYING NOTES. 24 ROCHESTER MEDICAL CORPORATION STATEMENTS OF OPERATIONS
FISCAL YEARS ENDED SEPTEMBER 30, ------------------------------------------- 1999 1998 1997 ----------- ----------- ----------- Net sales .......................................... $ 7,340,870 $ 9,518,311 $ 7,615,439 Cost of sales ...................................... 5,602,042 6,604,201 4,869,646 ----------- ----------- ----------- Gross profit ....................................... 1,738,828 2,914,110 2,745,793 Operating expenses: Marketing and selling ............................. 3,943,589 3,190,642 2,209,747 Research and development .......................... 1,052,090 1,384,210 1,450,883 General and administrative ........................ 1,863,194 1,445,167 1,499,696 ----------- ----------- ----------- Total operating expenses ........................... 6,858,873 6,020,019 5,160,326 Loss from operations ............................... (5,120,045) (3,105,909) (2,414,533) Other income (expense): Interest income ................................... 719,322 847,662 657,622 Interest expense .................................. -- -- (341,753) ----------- ----------- ----------- Net loss ........................................... $(4,400,723) $(2,258,247) $(2,098,664) =========== =========== =========== Net loss per common share -- basic and diluted ..... $ (.83) $ (.44) $ (.51) =========== =========== =========== Weighted average number of common shares outstanding ....................................... 5,332,868 5,140,670 4,131,600 =========== =========== ===========
SEE ACCOMPANYING NOTES. 25 ROCHESTER MEDICAL CORPORATION STATEMENT OF SHAREHOLDERS' EQUITY
COMMON STOCK ---------------------------- ACCUMULATED SHARES AMOUNT DEFICIT TOTAL ------------ ------------ ------------ ------------ Balance at September 30, 1997 .......... 4,133,500 $ 24,697,199 $ (7,516,226) $ 17,180,973 Common Stock issued in public offering ............................. 1,125,000 15,862,253 -- 15,862,253 Exercise of common stock options ...... 11,000 132,750 -- 132,750 Net loss for the year ................. -- -- (2,258,247) (2,258,247) ------------ ------------ ------------ ------------ Balance at September 30, 1998 .......... 5,269,500 40,692,202 (9,774,473) 30,917,729 Exercise of common stock options ...... 80,000 660,000 -- 660,000 Net loss for the year ................. -- -- (4,400,723) (4,400,723) ------------ ------------ ------------ ------------ Balance at September 30, 1999 .......... 5,349,500 $ 41,352,202 $(14,175,196) $ 27,177,006 ============ ============ ============ ============
SEE ACCOMPANYING NOTES. 26 ROCHESTER MEDICAL CORPORATION STATEMENTS OF CASH FLOWS
FISCAL YEARS ENDED SEPTEMBER 30, ---------------------------------------------- 1999 1998 1997 ------------ ------------ ------------ OPERATING ACTIVITIES Net loss .............................................. $ (4,400,723) $ (2,258,247) $ (2,098,664) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation and amortization ....................... 837,331 776,699 538,523 Changes in operating assets and liabilities: Accounts receivable ................................ 585,386 12,146 (453,617) Inventories ........................................ 161,779 (555,866) (462,450) Other current assets ............................... 141,141 (235,216) (169,591) Accounts payable ................................... (76,829) 308,740 (500,386) Other current liabilities .......................... (215,803) 76,882 597,022 ------------ ------------ ------------ Net cash used in operating activities ................. (2,967,718) (1,874,862) (2,549,163) INVESTING ACTIVITIES Capital expenditures .................................. (798,285) (2,305,258) (6,880,833) Patents ............................................... (58,081) (43,579) (66,905) Purchase of marketable securities ..................... (54,892,037) (50,871,767) (18,388,824) Sales and maturities of marketable securities ......... 59,408,013 40,773,957 23,954,885 ------------ ------------ ------------ Net cash provided by (used in) investing activities ... 3,659,610 (12,446,647) (1,381,677) FINANCING ACTIVITIES Interest expense added to note payable ................ -- 341,826 Proceeds from sale of Common Stock .................... 660,000 15,995,003 48,286 Payments on long-term debt ............................ -- -- (3,662,451) ------------ ------------ ------------ Net cash provided by (used in) financing activities ........................................... 660,000 15,995,003 (3,272,339) ------------ ------------ ------------ Increase (decrease) in cash and cash equivalents .......................................... 1,351,892 1,673,494 (7,203,179) Cash and cash equivalents at beginning of period ..... 2,864,922 1,191,428 8,394,607 ------------ ------------ ------------ Cash and cash equivalents at end of period ............ $ 4,216,814 $ 2,864,922 $ 1,191,428 ============ ============ ============
SEE ACCOMPANYING NOTES. 27 ROCHESTER MEDICAL CORPORATION NOTES TO FINANCIAL STATEMENTS SEPTEMBER 30, 1999 1. BUSINESS ACTIVITY Rochester Medical Corporation (the "Company") develops, manufactures and markets innovative urinary continence care products for urinary dysfunction management and urine drainage management. The Company currently manufactures and markets a broad line of functionally and technologically enhanced latex-free versions of standard continence care products, including male external catheters, Foley catheters and intermittent catheters. The Company is also developing innovative and technologically advanced products designed to provide clinically and commercially attractive solutions to continence care needs. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES CASH EQUIVALENTS The Company considers all highly liquid investments with a remaining maturity of three months or less when purchased to be cash equivalents. MARKETABLE SECURITIES Marketable securities are classified as available for sale and are carried at cost which approximates fair value as determined by published market data. The balance at September 30, 1999 consists of $8,000,000 of bonds maturing from 2000 to 2001 and $1,000,000 of commercial paper. At September 30, 1998, the balance consisted entirely of U.S. Treasury Bills and certificates of deposit. MANUFACTURING AND SALES The Company manufactures and sells its products to a full range of companies in the medical industry on a worldwide basis. There is a concentration of sales to larger medical wholesalers and distributors. Sales of products are recorded upon shipment. The Company performs periodic credit evaluations of its customers' financial condition. The Company requires irrevocable letters of credit on sales to certain foreign customers. Receivables generally are due within 30 days. Credit losses relating to customers consistently have been within management expectations. INVENTORIES Inventories, consisting of material, labor and manufacturing overhead, are stated at the lower of cost or market. Cost is determined by the first-in, first-out (FIFO) method. PROPERTY AND EQUIPMENT Property and equipment are stated at cost less accumulated depreciation. Depreciation is based on estimated useful lives of 4 -- 35 years computed using the straight-line method. PATENTS Capitalized costs include costs incurred in connection with making patent applications for the Company's products and are amortized on a straight-line basis over eight years. The Company periodically reviews its patents for impairment of value. Any adjustment from the analysis is charged to operations. RESEARCH AND DEVELOPMENT COSTS Research and development costs are charged to operations as incurred. Research and development costs include clinical testing costs, certain salary and related expenses, other labor costs, materials and an allocation of certain overhead expenses. INCOME TAXES Income taxes are accounted for under the liability method. Deferred income taxes are provided for temporary differences between financial reporting and tax bases of assets and liabilities. 28 ROCHESTER MEDICAL CORPORATION NOTES TO FINANCIAL STATEMENTS (CONTINUED) 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) STOCK-BASED COMPENSATION The Company follows Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB 25"), and related interpretations in accounting for its stock options. Under APB 25, when the exercise price of stock options equals the market price of the underlying stock on the date of grant, no compensation expense is recognized. The Company has adopted the disclosure-only provisions of Statement of Financial Accounting Standards No 123, "Accounting for Stock-Based Compensation." USE OF ESTIMATES The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. IMPAIRMENT OF LONG-LIVED ASSETS The Company will record impairment losses on long-lived assets used in operations when indicators of impairment are present and the undiscounted cash flows estimated to be generated by those assets are less than the assets' carrying amount. NET LOSS PER SHARE Basic net loss per share is computed using the weighted average number of common shares outstanding during the period. Fully diluted and basic net loss per share are the same because the effect of common equivalent shares from stock options and convertible debt are excluded from the computation as their effect is antidilutive. 3. ADVERTISING COSTS The Company incurred advertising expenses of $779,000, $414,000 and $185,000 for the years ended September 30, 1999, 1998 and 1997, respectively. All advertising costs are charged to operations as incurred. 4. INVENTORIES Inventories are summarized as follows: SEPTEMBER 30, -------------------------- 1999 1998 ---------- ---------- Raw materials ................................... $ 652,229 $1,351,628 Work-in-process ................................. 1,058,716 630,945 Finished goods .................................. 445,605 277,059 Reserve for inventory obsolescence .............. (108,730) (50,033) ---------- ---------- $2,047,820 $2,209,599 ========== ========== 5. SHAREHOLDERS' EQUITY STOCK OPTIONS In August 1998, the 1991 Stock Option Plan (the Plan) was amended to increase by 300,000 shares the number of shares authorized for issuance to 1,000,000 shares. Under terms of the Plan, the Board of Directors may grant employee incentive stock options equal to fair market value of the Company's Common Stock or employee non-qualified options at a price which cannot be less than 85% of the fair market value. Automatic non-employee director options are also covered 29 ROCHESTER MEDICAL CORPORATION NOTES TO FINANCIAL STATEMENTS (CONTINUED) 5. SHAREHOLDERS' EQUITY (CONTINUED) under the Plan, under which 1,000 shares are granted at fair market value to non-employee directors on the date of each of the Company's Annual Meetings. The 1995 Non-Statutory Stock Option Plan authorizes the issuance of up to 50,000 shares of Common Stock. In September 1995, Medical Advisory Board members were granted options to purchase 12,000 shares of the Company's Common Stock at an exercise price of $15.75 per share. In April 1999, one member of the Medical Advisory Board was granted options to purchase 6,000 shares of the Company's Common Stock at an exercise price of $10.125 per share. Option activity is summarized as follows:
AVERAGE SHARES WEIGHTED EXERCISE RESERVED OPTIONS PRICE PER FOR GRANT OUTSTANDING SHARE --------- ----------- --------- Balance as of September 30, 1996 .................... 280,500 469,500 11.57 Options granted ..................................... (79,000) 79,000 17.26 Options exercised ................................... -- (6,000) 11.42 Options canceled .................................... 7,500 (7,500) 15.70 -------- -------- -------- Balance as of September 30, 1997 .................... 209,000 535,000 12.35 Options granted ..................................... (226,000) 226,000 14.90 Options exercised ................................... -- (11,000) 12.07 Options canceled .................................... 27,000 (27,000) 14.13 Increase in authorized shares ....................... 300,000 -- -- -------- -------- -------- Balance as of September 30, 1998 .................... 310,000 723,000 $ 13.09 Options granted ..................................... (173,500) 173,500 11.40 Options exercised ................................... -- (80,000) 8.25 Options canceled .................................... 70,000 (70,000) 13.80 -------- -------- -------- Balance as of September 30, 1999 .................... 206,500 746,500 $ 13.15 ======== ======== ========
The weighted average fair value of options granted in 1999 and 1998 was $11.40 and $14.90 per share, respectively. The exercise price of options outstanding at September 30, 1999 ranged from $6.75 to $20.00 per share as summarized in the following table:
NUMBER WEIGHTED AVERAGE NUMBER WEIGHTED AVERAGE OUTSTANDING REMAINING EXERCISABLE EXERCISE PRICE RANGE OF EXERCISE PRICES AT 9/30/99 CONTRACTUAL LIFE AT 9/30/99 PER SHARE - ------------------------ ----------- ---------------- ----------- ---------------- $6.75 -- $10.75 .......... 203,500 6.7 years 101,000 $ 7.71 10.76 -- 14.75 ........... 387,750 5.6 years 192,750 13.99 14.76 -- 20.00 ........... 155,250 7.3 years 73,250 16.66 ------- ------- 746,500 6.3 years 367,000 $ 12.80 ======= =======
The number of stock options exercisable at September 30, 1999, 1998 and 1997 was 367,000, 307,500 and 192,750 at a weighted average exercise price of $12.80, $9.68 and $11.19 per share, respectively. The Company has elected to follow Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees ("APB 25") and related interpretations in accounting for its employee stock options because, as discussed below, the alternative fair value accounting provided under FASB Statement No. 123, "Accounting for Stock-Based Compensation" ("Statement 123"), requires use of option valuation models that were not developed for use in valuing employee stock 30 ROCHESTER MEDICAL CORPORATION NOTES TO FINANCIAL STATEMENTS (CONTINUED) 5. SHAREHOLDERS' EQUITY (CONTINUED) options. Under APB 25, when the exercise price of the Company's employee stock options equals the market price of the underlying stock on the date of grant, no compensation expense is recognized. Pro forma information regarding net loss and loss per share is required by Statement 123, and has been determined as if the Company had accounted for its employee stock options under the fair value method of Statement 123. The fair value of these options was estimated at the date of grant using the Black-Scholes option pricing model with the following weighted average assumptions: risk-free interest rate of 6.08%; volatility factor of the expected market price of the Company's common stock of .524 and a weighted average expected life of the option of seven years. The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions. Because the Company's employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options. For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the option's vesting period. The Company's pro forma information is as follows:
YEAR ENDED SEPTEMBER 30, ---------------------------------------------- 1999 1998 1997 ------------ ------------ ------------ Pro forma net loss .......................... $ (5,934,181) $ (3,796,025) $ (3,102,702) Pro forma net loss per common share ......... $ (1.11) $ (.74) $ (.75)
These pro forma amounts may not be indicative of future years' amounts since the statement provides for a phase in of option values beginning with those granted in fiscal 1997. WARRANTS In connection with the November 1995 public offering, the Company sold to the underwriters for a nominal purchase price five-year warrants to purchase 75,000 shares of Common Stock at $14.85 per share. The warrants can be exercised any time through November 2000. 31 ROCHESTER MEDICAL CORPORATION NOTES TO FINANCIAL STATEMENTS (CONTINUED) 6. INCOME TAXES Deferred income taxes are due to temporary differences between the carrying values of certain assets and liabilities for financial reporting and income tax purposes. Significant components of deferred income taxes are as follows: SEPTEMBER 30, --------------------------- 1999 1998 ----------- ----------- Deferred assets: Net operating loss ............................ $ 5,466,000 $ 3,496,000 Research and development credits .............. 143,000 123,000 Allowance for uncollectible accounts .......... 22,000 17,000 Inventory reserves ............................ 40,000 17,000 Inventory capitalization ...................... 37,000 46,000 Accrued expenses .............................. 61,000 31,000 ----------- ----------- Subtotal ...................................... 5,769,000 3,750,000 Deferred liability: Depreciation and amortization ................. 386,000 350,000 ----------- ----------- Net deferred income tax assets ................ 5,383,000 3,380,000 Valuation allowance ........................... (5,383,000) (3,380,000) ----------- ----------- Net deferred income taxes ..................... $ -- $ -- =========== =========== The Company will be subject to federal income taxes when operations become profitable. The Company's tax operating loss carryforwards of approximately $14,925,000 can be carried forward to offset future taxable income, may be limited due to changes in ownership under the net operating loss limitation rules, and expire in years 2005 through 2019. 7. LEASES Rent expense from operating leases for the years ended September 30, 1999, 1998, and 1997 was $5,000, $7,000 and $69,000, respectively. 8. RELATED PARTY TRANSACTIONS The brother-in-law of the CEO and President, the Vice President of Production Technologies and a member of the board of directors of the Company has performed legal services for the Company. During the years ended September 30, 1999, 1998, and 1997, the Company incurred legal fees and expenses of approximately $46,000, $71,000 and $90,000, respectively, to such counsel for services rendered in connection with litigation and for general legal services. Management believes the fees paid for the services rendered to the Company were on terms at least as favorable to the Company as could have been obtained from an unrelated party. The Company entered into an agreement with Halcon, Inc. to purchase office furniture valued at $406,000. During the years ended September 30, 1999, 1998 and 1997, payments made under this agreement were $2,500, $4,000 and $316,000, respectively. The chief executive officer of Halcon, Inc. is a director of the Company and the brother of the CEO and President and the Vice President of Production Technologies of the Company. Management believes that the terms of the agreement are at least as favorable to the Company as could have been obtained from an unrelated party. The Company contracts with Petersen Blacksmith Company for the fabrication of customized, proprietary manufacturing equipment used in the Company's automated production lines. During 1999, 1998 and 1997, the Company paid Petersen Blacksmith Company the sum of $46,000, $231,000 and $252,000, respectively. Michael Petersen, the proprietor of Petersen Blacksmith 32 ROCHESTER MEDICAL CORPORATION NOTES TO FINANCIAL STATEMENTS (CONTINUED) 8. RELATED PARTY TRANSACTIONS (CONTINUED) Company, is the brother-in-law of a Director and Vice President, Research and Development of the Company. Management believes that the terms of the agreement are at least as favorable to the Company as could have been obtained from an unrelated party. 9. CONVATEC AGREEMENT On August 11, 1995, the Company entered into a Distribution and Co-Development Agreement (the "Distribution Agreement") with ConvaTec, a division of E.R. Squibb & Sons, Inc., a wholly-owned subsidiary of Bristol-Myers Squibb Company ("ConvaTec"), for the purpose of marketing and distributing the Company's incontinence and urological devices. Under the Distribution Agreement, the Company has granted ConvaTec, subject to obligations and limitations imposed by the Company's other distribution agreements, worldwide rights to market the Company's current products and products in development. The Company is obligated to offer ConvaTec rights of first and last refusal to market all products developed after the date of the Distribution Agreement. Under the Distribution Agreement, the Company retains worldwide marketing rights to its products under the Rochester Medical brand. In April 1998, the Company and ConvaTec entered into a Revised and Restated Distribution Agreement (the "Revised Agreement") which grants ConvaTec limited territorial rights to market certain of the Company's standard male external catheter and Foley catheter products under the ConvaTec name. In addition to retaining worldwide marketing rights for Rochester Medical brand products, the Revised Agreement provides the Company exclusive marketing rights for its advanced products and products in development. 10. SIGNIFICANT CUSTOMERS Significant customers, measured as a percentage of sales, are summarized as follows: SEPTEMBER 30, ----------------------- 1999 1998 1997 ---- ---- ---- Significant customers: ConvaTec ................................... 16% 25% 24% Hollister .................................. 7 7 10 Maersk ..................................... 18 15* 4* Mentor ..................................... 10 21 30 -- -- -- Total ........................................ 51 68% 68% == == == - ------------------ * 1998 and 1997 includes sales to Euromedical Industries SdN., which was acquired by Maersk in July of 1998. In May 1998, Mentor advised the Company of its intention to manufacture its own silicone male external catheters under the royalty-free license it holds from the Company. There have been no sales of male external catheters to Mentor since the first quarter of fiscal 1999. 33 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT Incorporated herein by reference to portions of the Proxy Statement for Annual Meeting of Shareholders to be filed with the Securities and Exchange Commission within 120 days of the close of the fiscal year ended September 30, 1999, and "Executive Officers of the Registrant" in Part I of this report. ITEM 11. EXECUTIVE COMPENSATION Incorporated herein by reference to portions of the Proxy Statement for Annual Meeting of Shareholders to be filed with the Securities and Exchange Commission within 120 days of the close of the fiscal year ended September 30, 1999. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT Incorporated herein by reference to portions of the Proxy Statement for Annual Meeting of Shareholders to be filed with the Securities and Exchange Commission within 120 days of the close of the fiscal year ended September 30, 1999. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Incorporated herein by reference to portions of the Proxy Statement for Annual Meeting of Shareholders to be filed with the Securities and Exchange Commission within 120 days of the close of the fiscal year ended September 30, 1999. ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a)(1) The following financial statements are filed herewith in Item 8. (i) Balance Sheets as of September 30, 1999 and 1998. (ii) Statements of Operations for the years ended September 30, 1999, 1998 and 1997. (iii) Statement of Shareholders' Equity for the years ended September 30, 1999 and 1998. (iv) Statements of Cash Flows for the years ended September 30, 1999, 1998 and 1997. (v) Notes to financial statements at September 30, 1999. (a)(2) Financial Statement Schedules. None (b) Exhibits The following exhibits are submitted herewith: 3.1 Articles of Incorporation of the Company, as amended. (Incorporated by reference to Exhibit 4.1 of Registrant's Registration Statement on Form S-2, Registration Number 33-97788). 3.2 Restated Bylaws of the Company. (Incorporated by reference to Exhibit 3.2 of Registrant's Registration Statement on Form S-18, Registration Number 33-36362-C). 3.3 Amendment to Restated Bylaws of the Company. (Incorporated by reference to Exhibit 4.3 of Registrant's Registration Statement on Form S-2, Registration Number 33-97788). 34 4.1 Specimen of Common Stock Certificate. (Incorporated by reference to Exhibit 4.4 of Registrant's Annual Report on Form 10-KSB for fiscal year ended September 30, 1995). 4.2 The Company's 1991 Stock Option Plan as amended (Incorporated by reference to Exhibit 4.5 of Registrant's Registration Statement on Form S-8, Registration Number 333-10261). 4.3 Amendment to the Company's 1991 Stock Option Plan as amended (Incorporated by reference to Exhibit 4.3 of Registrant's Annual Report on Form 10-K for fiscal year ended September 30, 1998). 10.1 Employment Agreement, dated August 31, 1990 between the Company and Anthony J. Conway. (Incorporated by reference to Exhibit 10.13 of Registrant's Registration Statement on Form S-18, Registration Number 33-36362-C). 10.2 Employment Agreement, dated August 31, 1990 between the Company and Philip J. Conway. (Incorporated by reference to Exhibit 10.14 of Registrant's Registration Statement on Form S-18, Registration Number 33-36362-C). 10.3 Change of Control Agreement dated December 4, 1998, between the Company and Philip J. Conway (Incorporated by reference to Exhibit 10.3 of Registrant's Annual Report on Form 10-K for fiscal year ended September 30, 1998). 10.4 Employment Agreement, dated August 31, 1990 between the Company and Richard D. Fryar. (Incorporated by reference to Exhibit 10.15 of Registrant's Registration Statement on Form S-18, Registration Number 33-36362-C). 10.5 Change of Control Agreement dated December 4, 1998, between the Company and Richard D. Fryar (Incorporated by reference to Exhibit 10.5 of Registrant's Annual Report on Form 10-K for fiscal year ended September 30, 1998). 10.6 Employment Agreement dated February 1, 1996 between the Company and Brian J. Wierzbinski. (Incorporated by reference to Exhibit 10.10 to Registrant's Annual Report on Form 10-KSB for the fiscal year ended September 30, 1996). 10.7 Change of Control Agreement dated December 4, 1998, between the Company and Brian J. Wierzbinski (Incorporated by reference to Exhibit 10.7 of Registrant's Annual Report on Form 10-K for fiscal year ended September 30, 1998). 10.8 Employment Agreement, dated November 16, 1998 between the Company and Dara Lynn Horner.* 10.9 Male External Catheter License, Sales and Distribution Agreement dated April 24, 1991, between the Company and Mentor Corporation. (Incorporated by reference to Exhibit 10.7 of Registrants Registration Statement on Form S-1, Registration Number 33-40934). 10.10 Amended UF Catheter Exclusive OEM/Private Label Agreement dated March 18, 1994, between the Company and Hollister Incorporated. (Incorporated by reference to Exhibit (a)(i) of Registrant's Quarterly Report on Form 10-QSB for the quarter ended March 31, 1994). 10.11 First Amendment to Amended UF Catheter Exclusive OEM/Private Label Agreement dated May 7, 1997, between the Company and Hollister Incorporated. (Incorporated by reference to Exhibit 10.13 of Registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 1997). 35 10.12 Revised and Restated Distribution Agreement, dated as of May 6, 1998, between the Company and E. R. Squibb & Sons, Inc. (through its ConvaTec division). (Incorporated by reference to Exhibit 10.17 of Registrant's Quarterly Report on Form 10-Q for the quarter ended March 31, 1998). 23 Consent of Ernst & Young LLP.* 24 Power of Attorney.* 27 Financial Data Schedule.* - --------------------- * Filed herewith. (c) Registrant filed no Report on Form 8-K during its fourth fiscal quarter. 36 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. ROCHESTER MEDICAL CORPORATION Dated: December 17, 1999 By: /s/ ANTHONY J. CONWAY ------------------------------------- Anthony J. Conway CHAIRMAN OF THE BOARD, PRESIDENT, CHIEF EXECUTIVE OFFICER AND SECRETARY Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons in the capacities and on the dates indicated. SIGNATURE TITLE --------- ----- /s/ ANTHONY J. CONWAY Chairman of the Board, President, - ------------------------------ Chief Executive Officer, and Secretary Anthony J. Conway (PRINCIPAL EXECUTIVE OFFICER) /s/ BRIAN J. WIERZBINSKI Executive Vice President, Chief Financial - ------------------------------ Officer, Treasurer and Director Brian J. Wierzbinski (PRINCIPAL FINANCIAL AND ACCOUNTING OFFICER) * Vice President, Production Technologies - ------------------------------ and Director Philip J. Conway * Vice President, Research and Development - ------------------------------ and Director Richard D. Fryar * Director - ------------------------------ Darnell L. Boehm * Director - ------------------------------ Peter R. Conway * Director - ------------------------------ Roger W. Schnobrich *By /s/ BRIAN J. WIERZBINSKI Dated: December 17, 1999 -------------------------- Brian J. Wierzbinski ATTORNEY-IN-FACT 37 INDEX TO EXHIBITS EXHIBIT PAGE - ------- ---- 10.8 Employment Agreement, dated November 16, 1998 between the Company and Dara Lynn Horner ........................................... 23 Consent of Ernst & Young LLP .................................... 24 Power of Attorney ............................................... 27 Financial Data Schedule ......................................... EX-10.8 2 EMPLOYMENT AGREEMENT EXHIBIT 10.8 EMPLOYMENT AGREEMENT AGREEMENT, made and entered into as of the 16th of November, 1998, by and between Rochester Medical Corporation, a Minnesota corporation (the "Company"), and Dara Lynn Horner ("Employee"). WHEREAS, the Company and the Employee desire to record the terms of Employee's employment by the Company; NOW, THEREFORE, in consideration of the premises and mutual covenants contained herein and for other good and valuable consideration, the parties agree as follows: 1. TERM OF EMPLOYMENT. Subject to the terms and conditions of this Agreement, the Company hereby employs Employee and Employee hereby accepts employment for the period commencing November 16, 1998, and continuing thereafter until the employment is terminated according to the provisions of this Agreement. 2. DUTIES. During the term of this Agreement, Employee shall perform the duties of Marketing Director, Femsoft(R) Product Line, and such additional duties as may be prescribed from time to time by the Board of Directors, the Company's Chief Executive Officer or the Company's Vice President Marketing and Sales. 3. BASE SALARY; OTHER COMPENSATION. 3.1 Base Salary. The Corporation shall pay Employee an initial Base Salary ("Base Salary") of Ninety Five Thousand Dollars ($95,000) per annum commencing November 16, 1998. The Base Salary shall be paid according to the Corporation's regular payroll procedure, in equal increments not less frequently than monthly. The Base Salary shall be subject to annual review and merit increase adjustment in accordance with the Corporation's customary practices, as may be then in effect, for salary planning and administration. 3.2 Incentive Bonuses. Employee shall be entitled to receive an initial bonus payment in the amount of Seven Thousand Five Hundred Dollars ($7,500) payable with her first regular payroll. Employee shall also be eligible to participate in the Corporation's bonus incentive plan with a targeted bonus ("Bonus") determined in accordance with the Corporation's Executive Bonus Program. The targets and performance necessary to earn the Bonus or any portion thereof shall be set annually by the Corporation; provided, that the Bonus payable to Employee for the Corporation's Dara Lynn Horner Employment Agreement November 16, 1998 fiscal quarter ending December 31, 1998, shall be in the amount of Eighteen Thousand Five Hundred Dollars ($18,500). 3.3 Relocation Allowance. Upon Employee's election to relocate to the Rochester, Minnesota area, then in addition to any other compensation to which Employee may be entitled by this agreement, the Corporation shall pay Employee a Relocation Allowance (the "Relocation Allowance") consisting of (i) all direct moving costs and expenses incurred by Employee in connection with Employee's associated relocation to the Rochester, Minnesota, area, (ii) reimbursement of all realtor's commissions and closing costs paid by Employee in connection with the sale of his present home, (iii) reimbursement of closing costs paid by Employee in connection with the purchase of his new home, (iv) reimbursement of all expenses for meals and lodging, not to exceed eight days, in connection with Employee's travel to the Rochester, Minnesota, area for purposes of finding a new home, and (v) income tax gross-up to the extent any payments to or on behalf of employee hereunder are taxable as income to Employee. 3.4 Temporary Housing Allowance. Until Employee elects to relocate to the Rochester, Minnesota area, the Corporation shall pay Employee a Temporary Housing Allowance consisting of (i) housing allowance in amount of Seven Hundred Dollars ($700) per month through and including September 2000, and (ii) to the extent Employee's rent and utilities exceed Seven Hundred Dollars ($700) per month, an additional amount sufficient to pay all monthly utility charges. 3.5 Incentive Stock Option. In addition to any other compensation to which Employee may be entitled by this agreement, Employee shall be entitled to receive an Incentive Stock Option for Twenty Thousand (20,000) shares of the Corporation under the Corporation's 1991 Stock Option Plan according to the Incentive Stock Option Agreement appended hereto as Exhibit 1. The exercise price of the Incentive Stock Option shall be fair market value, as determined according to the 1991 Stock Option Plan, as of the close of business on the date of grant by the Corporation's Board of Directors. Employee acknowledges receiving a copy of the 1991 Stock Option Plan. 4. BENEFITS. 4.1 Vacation. During each year of employment, Employee will be entitled to reasonable vacations, holidays and sick leave in accordance with the Company's standard policies as may be adopted or amended from time to time hereafter. Employee shall be entitled to four (4) weeks' vacation during each of the Company's fiscal years, prorated for any part of a fiscal year. Vacations shall be at such time or times and for such periods as Company and Employee shall agree; provided that vacations must be taken by Employee during the year earned or be forfeited. 2 Dara Lynn Horner Employment Agreement November 16, 1998 4.2 Benefit Programs, Insurance. Employee shall be entitled to participate in customary employee benefit programs as may be from time to time determined by the Board of Directors including, but not limited to, life insurance, hospitalization, surgical and major medical coverage, and long-term disability as are or may be made available from time to time to other salaried employees of the Company. 4.3 Expenses. Employee shall be reimbursed weekly against expense reports for ordinary and necessary expenses incurred in the performance of her duties. 5. TERMINATION. 5.1 Events of Termination. This Agreement may be terminated upon the occurrence of any one of the following events: (a) Voluntary. Employee may terminate this Agreement at any time during the term of this Agreement by giving two weeks' prior written notice of termination to the Company. (b) Involuntary Without Cause. The Company may terminate this Agreement at any time during the term of this Agreement by giving 30 days' prior written notice of termination to the Employee. (c) Death or Disability. This Agreement shall automatically terminate upon the death or permanent disability of the Employee. For the purposes of this Agreement, Employee shall be deemed permanently disabled if any ailment, illness or other incapacity prevents her from performing her duties as specified in this Agreement for a period of three consecutive months or for an aggregate of three months in any twelve month period from the date of this Agreement. 5.2 Consequences of Termination. In the event of the termination of this Agreement, Employee or her estate, as the case may be, shall be entitled to Base Salary and the Commissions earned by her prior to the date of termination as provided herein computed on a pro rata basis to and including such date of termination. In addition, Employee shall also be reimbursed for her reasonable business expenses incurred prior to the date of termination. 6. NON-COMPETITION; INVENTIONS. 6.1 Definitions. For purposes of this Section 6, the following words and phrases have the meanings ascribed to them, respectively. 3 Dara Lynn Horner Employment Agreement November 16, 1998 (a) "Confidential Information" means all formulas, processes, customer lists, computer user identifiers and passwords, and all purchasing, engineering, accounting, marketing and other information that is proprietary to the Company and not generally known or readily ascertainable by proper means, relating to research, development, manufacture or sale of the Company's products, as well as formulas, processes and other information received by the Company from third parties under an obligation of secrecy. All information disclosed to Employee or to which Employee has access during the period of her employment, which she has reasonable basis to believe to be Confidential Information, or which is treated by the Company as being Confidential Information, shall be presumed to be Confidential Information. (b) "Inventions" means all formulas, processes, discoveries, improvements, ideas and works of authorship, whether patentable or copyrightable or not, which Employee learns, has access to, has a part in developing, first conceives or first reduces to practice alone or with others (1) that are developed on the Company's time, or (2) that relate directly to the Company's business or actual or anticipated research, or (3) for which any of the Company's property, including Confidential Information, is used or (4) that result from any of Employee's work for the Company. 6.2 Disclosure and Assignment. Except as provided elsewhere in this Agreement, Employee shall treat as for the Company's sole benefit and fully and promptly disclose to the Company, without additional compensation, all ideas, discoveries, inventions and improvements, whether patentable or not, which, while the Employee is employed by the Company, are made, conceived or reduced to practice by Employee, alone or with others, during or after usual working hours, either on or off the job, and Employee hereby assigns to the Company all such ideas, discoveries, inventions and improvements to be the Company's exclusive property. 6.3 Further Documents. Employee will acknowledge and deliver promptly without charge all documents to the Company, and will do such other acts as may be necessary in the Company's opinion to obtain and maintain patents (including divisional, reissued or extended Letters Patent) or copyrights and to vest the entire right and title in the Company to such patents, copyrights and Inventions in all countries. 4 Dara Lynn Horner Employment Agreement November 16, 1998 6.4 Confidentiality. Employee will not use or disclose any Confidential Information, either during or after employment by the Company, except as required by her duties to the Company, and Employee acknowledges and understands that the obligation to maintain the confidentiality of the Company's Confidential Information is unconditional and shall not be excused by any conduct on the part of the Company except its prior voluntary disclosure of the information. Upon termination of employment, Employee agrees that (a) all Confidential Information, including all copies, excerpts and summaries in her possession or control (whether prepared by the Company, the Employee or others), and also all other Company property, including keys, credit cards, software, reports and the like, shall be left with the Company and (b) Employee will stop use of all Confidential Information. Employee shall not at any time during the term of this Agreement or thereafter, or in any manner, either directly or indirectly, divulge, disclose or communicate to any person, firm or corporation in any manner whatsoever any information concerning any matters affecting or relating to the business of the Company, including without limiting the generality of the foregoing, any of its customers, the prices it obtains or has obtained from the sale of, or at which it sells or has sold, its products, or any other information concerning the business of the Company, its manner of operation, its plans, processes, or other data without regard to whether all of the foregoing matters will be deemed confidential, material, or important, the parties hereto stipulating that as between them, the same are important, material, and confidential and gravely affect the effective and successful conduct of the business of the Company, and the Company's good will, and that any breach of the terms of this Section 6 shall be a material breach of this Agreement. 6.5 Limitation; First Refusal. The obligations of Section 6.2 and 6.3 shall not apply to any ideas, discoveries, inventions and improvements for which no equipment, supplies, facility or trade secret information of the Company was used, and which was developed entirely on Employee's own time, and (1) which does not relate (a) directly to the business of the Company or (b) to the Company's actual or demonstrably anticipated research or development, or (2) which does not result from any work performed by Employee for the Company. Employee will, nonetheless, promptly disclose all such ideas, discoveries, inventions and improvements to the Company and offer to the Company the right of first refusal to enter into a license or purchase agreement covering the subject idea, discovery, invention or improvement on terms mutually agreed to by Employee and the Company. In the event the Company and Employee cannot agree on terms and Employee receives an offer to enter into a license or purchase agreement with some other party on terms more favorable to that other party than the terms offered to the Company, then the Company shall have the right and Employee shall have the obligation to offer to the Company the idea, discovery, invention or improvement on such favorable terms. When such an offer is made to the Company pursuant to the preceding sentence, it must be accepted by the Company 5 Dara Lynn Horner Employment Agreement November 16, 1998 within thirty (30) days; or if not accepted, the right of first refusal hereunder as to that offer shall terminate. NOTICE: SECTION 6 HEREOF REQUIRES EMPLOYEE TO ASSIGN RIGHTS TO INVENTIONS TO THE COMPANY OR ITS SUCCESSORS. MINNESOTA STATUTES SS. 181.78 LIMITS THE SCOPE OF AGREEMENTS REQUIRING THE INVENTIONS BE ASSIGNED TO EMPLOYERS. THE STATUTE STATES THAT SUCH ASSIGNMENT AGREEMENTS DO NOT APPLY: "TO AN INVENTION FOR WHICH NO EQUIPMENT, SUPPLIES, FACILITY OR TRADE SECRET INFORMATION OF THE EMPLOYER WAS USED AND WHICH WAS DEVELOPED ENTIRELY ON THE EMPLOYEE'S OWN TIME, AND (1) WHICH DOES NOT RELATE (a) DIRECTLY TO THE BUSINESS OF THE EMPLOYER OR (b) TO THE EMPLOYER'S ACTUAL OR DEMONSTRABLY ANTICIPATED RESEARCH OR DEVELOPMENT, OR (2) WHICH DOES NOT RESULT FROM ANY WORK PERFORMED BY THE EMPLOYEE FOR THE EMPLOYER. PLEASE NOTE THAT SECTION 6 OF THIS AGREEMENT USES THESE STATUTORY TERMS TO DEFINE THE INVENTIONS WHICH ARE NOT AUTOMATICALLY ASSIGNED TO THE COMPANY BUT INSTEAD ARE SUBJECT TO A RIGHT OF FIRST REFUSAL IN FAVOR OF THE COMPANY. 6.6 Assistance to the Company. Employee shall give the Company, at the Company's expense, all assistance the Company reasonably requires to perfect, protect, and exercise the rights to all ideas, discoveries, inventions or improvements acquired by the Company pursuant to the assignment provisions or the right of first refusal provisions of this Section 6. 6.7 Remedies. The Employee's obligations set forth in Section 6 of this Agreement shall continue to be binding upon Employee, notwithstanding the termination of her employment with the Company for any reason whatsoever. Such obligations shall be deemed and construed as separate agreements independent of any other provisions of this Agreement. The existence of any claim or cause of action by Employee against the Company, whether predicated on this Agreement or otherwise, shall not constitute a defense to the enforcement by the Company or any or all of such obligations. It is expressly agreed that the remedy at law for the breach of any such obligation is inadequate and that temporary and permanent injunctive relief shall be available to prevent the breach or any threatened breach thereof, without the necessity of proof of actual damages. 7. NOTICES. Any notices to be given hereunder by either party to the other may be effected either by personal delivery in writing or by mail, registered or certified, postage prepaid, with return receipt requested. Personal delivery to the Company shall mean personal delivery to the Chief Executive Officer of the Company. Mailed notices 6 Dara Lynn Horner Employment Agreement November 16, 1998 shall be addressed to the respective addresses shown below. Either party may change its address for notice by giving written notice according to the terms of this Section 7. (a) If to Employee: Dara Lynn Horner 5105 Stony Bridge Court Minnetonka, Minnesota 55345 (b) If to the Company: Rochester Medical Company One Rochester Medical Drive Stewartville, Minnesota 55976 Attention: Chief Executive Officer 8. GENERAL PROVISIONS. 8.1 Law Governing. This Agreement shall be governed by and construed according to the laws of the State of Minnesota, except the conflicts of laws provisions thereof. 8.2 Invalid Provisions. If any provision of this Agreement is held to be illegal, invalid, or unenforceable under present or future laws effective during the term hereof, such provision shall be fully severable and this Agreement shall be construed and enforced as if such illegal, invalid, or unenforceable provision had never comprised a part hereof; and the remaining provisions hereof shall remain in full force and effect and shall not be affected by the illegal, invalid, or unenforceable provision or by its severance herefrom. Furthermore, in lieu of such illegal, invalid, or unenforceable provision there shall be added automatically as a part of this Agreement a provision as similar in terms to such illegal, invalid, or unenforceable provision as may be possible and still be legal, valid or enforceable. 8.3 Entire Agreement. This Agreement sets forth the entire understanding of the parties and supersedes all prior agreements or understandings, whether written or oral, with respect to the subject matter hereof. No terms, conditions, warranties, other than those contained herein, and no amendments or modifications hereto shall be binding unless made in writing and signed by the parties hereto. 7 Dara Lynn Horner Employment Agreement November 16, 1998 8.4 Binding Effect. This Agreement shall extend to and be binding upon and inure to the benefit of the parties hereto, their respective heirs, representatives, successors and assigns. This Agreement may not be assigned by Employee. 8.5 Waiver. The waiver by either party hereto of a breach of any term or provision of this Agreement shall not operate or be construed as a waiver of a subsequent breach of the same provision by any party or of the breach of any other term or provision of this Agreement. 8.7 Titles. Titles of the paragraphs herein are used solely for convenience and shall not be used for interpretation or construing any word, clause, paragraph, or provision of this Agreement. 8.8 Counterparts. This Agreement may be executed in two or more counterparts, each of which shall be deemed an original, but which together shall constitute one and the same instrument. IN WITNESS WHEREOF, the Company and Employee have executed this Agreement as of the date and year first written above. "Employee" Rochester Medical Corporation /s/ Dara Lynn Horner By: /s/ Anthony Conway - --------------------------------- ----------------------------------- Dara Lynn Horner Anthony Conway, Chief Executive Officer 8 EX-23 3 CONSENT OF ERNST & YOUNG LLP EXHIBIT 23 CONSENT OF ERNST & YOUNG LLP We consent to the incorporation by reference in the Registration Statement (Form S-8 No. 333-10261) pertaining to the 1991 Stock Option Plan of Rochester Medical Corporation, of our report dated October 22, 1999, with respect to the financial statements of Rochester Medical Corporation included in this Annual Report (Form 10-K) for the year ended September 30, 1999. /s/ Ernst & Young LLP Minneapolis, Minnesota December 13, 1999 EX-24 4 POWER OF ATTORNEY EXHIBIT 24 POWER OF ATTORNEY KNOW ALL BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints each of Anthony J. Conway and Brian J. Wierzbinski, with full power to each to act without the other, his or her true and lawful attorney-in-fact and agent with full power of substitution, for him or her and in his or her name, place and stead, in any and all capacities, to sign the Annual Report on Form 10-K of Rochester Medical Corporation (the "Company") for the Company's fiscal year ended September 30, 1999, and any or all amendments to said Annual Report, and to file the same, with all exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, and to file the same with such other authorities as necessary, granting unto each such attorney-in-fact and agent full power and authority to do and perform each and every act and thing requisite and necessary to be done in and about the premises, as fully to all intents and purposes as he or she might or could do in person, hereby ratifying and confirming all that each such attorney-in-fact and agent, or his substitute, may lawfully do or cause to be done by virtue hereof. IN WITNESS WHEREOF, this Power of Attorney has been signed on this 5th day of December, 1999, by the following persons. /s/ ANTHONY J. CONWAY /s/ DARNELL L. BOEHM ----------------------------- ----------------------------- Anthony J. Conway Darnell L. Boehm /s/ BRIAN WIERZBINSKI /s/ PETER CONWAY ----------------------------- ----------------------------- Brian Wierzbinski Peter Conway /s/ PHILIP CONWAY /s/ ROGER SCHNOBRICH ---------------------------- ----------------------------- Philip Conway Roger Schnobrich /s/ RICHARD FRYAR ---------------------------- Richard Fryar EX-27 5 FINANCIAL DATA SCHEDULE
5 12-MOS SEP-30-1999 OCT-01-1998 SEP-30-1999 4,216,814 9,029,296 1,429,128 59,466 2,047,820 17,011,452 14,728,958 3,257,233 28,702,395 1,525,389 0 0 0 41,352,202 0 28,702,395 7,340,870 7,340,870 5,602,042 12,460,915 0 0 0 (4,400,723) 0 (4,400,723) 0 0 0 (4,400,723) (0.83) (0.83)
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