10QSB 1 0001.txt QUARTERLY REPORT U. S. Securities and Exchange Commission Washington, D.C. 20549 Form 10-QSB [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 2000 For the transaction period from __________ to________ Commission file number 0-28604 ELECTROSCOPE, INC. --------------------------------------------------------------------------- (Exact name of small business issuer as specified in its charter) Colorado 84-1162056 ------------------------------- -------------------------------------- (State or other jurisdiction of (I.R.S. Employer Identification No.) incorporation or organization) 4828 STERLING DRIVE, BOULDER, COLORADO 80301 -------------------------------------------------------------------- (Address of principal executive offices) REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (303) 444-2600 ------------------------------------------------------------------------- (Issuer's telephone number) CHECK WHETHER THE ISSUER (1) FILED ALL REPORTS REQUIRED TO BE FILED BY SECTION 13 OF 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 (2) HAS BEEN SUBJECT TO SUCH FILING REQUIREMENTS FOR THE PAST 90 DAYS. YES X NO --------- -------- STATE THE NUMBER OF SHARES OUTSTANDING OF EACH OF THE ISSUER'S CLASSES OF COMMON EQUITY, AS OF THE LATEST PRACTICABLE DATE: COMMON STOCK, NO PAR VALUE 5,383,507 SHARES ---------------------------------------- ----------------------------- Class (outstanding at July 18, 2000) TRANSITIONAL SMALL BUSINESS DISCLOSURE FORMAT YES NO X --------- -------- 1 ELECTROSCOPE, INC. FORM 10-QSB FOR THE QUARTER ENDED JUNE 30, 2000 INDEX Page Number ------ PART I. UNAUDITED FINANCIAL INFORMATION ------------------------------- ITEM 1 - Condensed Interim Financial Statements....................... 3 - Condensed Balance Sheets as of June 30, 2000 and March 31, 2000................................... 3 - Condensed Statements of Operations for the Three Months Ended June 30, 2000 and 1999............. 4 - Condensed Statements of Cash Flows for the Three Months Ended June 30, 2000 and 1999............. 5 - Notes to Condensed Interim Financial Statements................................................ 6 ITEM 2 - Management's Discussion and Analysis of Financial Condition and Results of Operations.......... 12 PART II. OTHER INFORMATION ITEM 6 - Exhibits and Reports on Form 8-K............................. 17 SIGNATURE............................................................... 18 EXHIBIT INDEX........................................................... 19 2 PART I FINANCIAL INFORMATION ITEM 1 - CONDENSED INTERIM FINANCIAL STATEMENTS ELECTROSCOPE, INC. CONDENSED BALANCE SHEETS ------------------------ (Unaudited)

June 30, March 31, ASSETS 2000 2000 ------ ---------------- --------------- CURRENT ASSETS: Cash and cash equivalents $ 1,055,463 $ 446,473 Short-term investments 678,712 1,727,480 Accounts receivable, net of allowance for doubtful accounts of $7,000 and $7,000, respectively 325,151 286,027 Inventory, net of reserve for obsolescence of $100,000 and $145,000, respectively 689,156 594,514 Prepaid expenses 63,164 22,180 -------------- ------------- Total current assets 2,811,646 3,076,674 -------------- ------------- EQUIPMENT, at cost: Furniture, fixtures and equipment 749,916 745,527 Less- Accumulated depreciation (596,550) (565,769) -------------- ------------- Equipment, net 153,366 179,758 -------------- ------------- PATENTS, net of accumulated amortization of $24,264 and $22,852, respectively 121,802 121,507 OTHER ASSETS 13,472 13,472 -------------- ------------- Total assets $ 3,100,286 $ 3,391,411 ============== ============= LIABILITIES AND SHAREHOLDERS' EQUITY CURRENT LIABILITIES: Accounts payable $ 223,935 $ 179,967 Accrued compensation 103,503 82,530 Other accrued liabilities 211,807 205,388 Other current liabilities 8,060 10,100 -------------- ------------- Total current liabilities 547,305 477,985 -------------- ------------- COMMITMENTS AND CONTINGENCIES (Notes 1 and 3) SHAREHOLDERS' EQUITY: Preferred stock, no par value, 10,000,000 shares authorized, no shares outstanding - - Common stock, no par value, 100,000,000 shares authorized, 5,383,507 and 5,383,507 shares outstanding, respectively 16,941,317 16,941,317 Warrants to purchase common stock 290,400 290,400 Accumulated other comprehensive loss (31,636) (48,642) Accumulated deficit (14,647,100) (14,269,649) -------------- ------------- Total shareholders' equity 2,552,981 2,913,426 -------------- ------------- Total liabilities and shareholders' equity $ 3,100,286 $ 3,391,411 ============== =============

The accompanying notes are an integral part of these financial statements. 3 ELECTROSCOPE, INC. ------------------ CONDENSED STATEMENTS OF OPERATIONS ---------------------------------- AND COMPREHENSIVE INCOME ------------------------ (Unaudited)

For the Three Months Ended June 30, ------------------------------ 2000 1999 ------------ ---------- REVENUE, NET $ 510,698 $ 459,922 COST OF SALES 286,196 281,047 ----------- ----------- Gross profit 224,502 178,875 ----------- ----------- OPERATING EXPENSES: Sales and marketing 324,901 289,781 General and administrative 183,566 186,283 Research and development 93,308 127,360 ----------- ----------- Total operating expenses 601,775 603,424 ----------- ----------- INCOME (LOSS) FROM OPERATIONS (377,273) (424,549) OTHER INCOME: Interest income 14,756 50,986 Other income (expense) (14,934) (2,551) ----------- ----------- NET INCOME (LOSS) $(377,451) $(376,114) =========== =========== OTHER COMPREHENSIVE INCOME: Short-term investment valuation adjustment 17,006 --- TOTAL COMPREHENSIVE INCOME (LOSS) $(360,445) $(376,114) =========== =========== NET INCOME (LOSS) PER SHARE (Note 2): Basic and diluted net income (loss) per common share $ (0.07) $ (0.07) =========== =========== Basic and diluted weighted average shares used in computing net income (loss) per common share 5,383,507 5,383,507 =========== ===========

The accompanying notes are an integral part of these financial statements. 4 ELECTROSCOPE, INC. ------------------ CONDENSED STATEMENTS OF CASH FLOWS ---------------------------------- (Unaudited)

For the Three Months Ended June 30, -------------------------------- 2000 1999 -------------- -------------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income (loss) $ (377,451) $ (376,114) Adjustments to reconcile net income (loss) to net cash used in operating activities- Depreciation and amortization 32,193 23,441 Amortization of discount (9,226) (19,321) Inventory reserves (45,000) 15,000 Changes in operating assets and liabilities- Accounts receivable (39,124) (118,388) Inventory (49,642) (86,574) Other assets (40,984) (19,309) Accounts payable 43,968 (49,372) Accrued compensation and other accrued liabilities 25,352 (81,384) -------------- -------------- Net cash used in operating activities (459,914) (712,021) -------------- -------------- CASH FLOWS FROM INVESTING ACTIVITIES: Purchases of equipment (4,389) (32,750) Patent costs (1,707) - Purchases of short-term investments, net - (1,058,815) Sale of short-term investments 1,075,000 964,492 -------------- -------------- Net cash provided from (used in) investing activities 1,068,904 (127,073) -------------- -------------- NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 608,990 (839,094) CASH AND CASH EQUIVALENTS, beginning of period 446,473 1,188,867 -------------- -------------- CASH AND CASH EQUIVALENTS, end of period $ 1,055,463 $ 349,773 ============== == ===========

The accompanying notes are an integral part of these financial statements. 5 ELECTROSCOPE, INC. ------------------ NOTES TO CONDENSED INTERIM FINANCIAL STATEMENTS ----------------------------------------------- JUNE 30, 2000 (Unaudited) (1) ORGANIZATION AND NATURE OF BUSINESS ----------------------------------- Electroscope, Inc. (the "Company") was founded in 1991 to address product opportunities created by the increase in minimally invasive surgery ("MIS"). Our specific focus is on laparoscopy, the most common type of MIS procedure, and the widespread preference for electrosurgery devices in these procedures. During laparoscopic surgical procedures, the surgeon operates from outside the patient's body, introducing cameras and instruments through small access ports to perform the surgical intervention. MIS has proven to greatly enhance the patient's post-operative course of recovery and is now the preferred surgical approach in over 50% of abdominal surgeries. The market opportunity was created by the surgeons' continued demand for monopolar electrosurgery tools, which they have preferred using in "open" procedures, combined with certain inherent risks of this technology in MIS. The risk of "unintended" electrosurgical burns to the patient in laparoscopic monopolar electrosurgery has been well documented. The Company's approach to the market opportunity was to design and develop a laparoscopic instrument system that helps to prevent unintended electrosurgical burns. The Company's patented AEM Laparoscopic Instrument System provides the surgeon with the tissue effects they demand while helping to prevent stray electrical energy which can cause unintended and unseen tissue injury. The AEM Instruments incorporate active electrode monitoring technology to dynamically and continuously monitor the flow of electrosurgical current, thereby helping to prevent patient injury. With the AEM System, surgeons are able to perform a broad range of electrosurgical procedures more safely and efficaciously than is possible using conventional laparoscopic instruments. The Company has incurred losses since its inception and has an accumulated deficit of $14,647,100 at June 30, 2000 and its operations have been financed primarily through issuance of equity. The Company's liquidity has substantially diminished because of such continuing operating losses and the Company may be required to seek additional capital to continue operations. The Company's operations are subject to certain risks and uncertainties, including that commercial acceptance of the Company's products will have to occur in the marketplace before the Company can attain profitable operations and that continued operating losses and use of cash resources will continue during fiscal year 2001 which will significantly impact the Company's ongoing operations and business viability. 6 As of June 30, 2000, the Company had $1,734,175 in cash and cash equivalents and short-term investments available to fund future operations. During fiscal year 2000, the Company instituted a cost containment program for its operations as well as reduced its employee head count to conserve its cash resources. The Company has also fully implemented its marketing and sales plan to maintain a certain number of key sales representatives and entered into exclusive agreements with stocking distributors and independent sales representatives to sell the Company's products. These efforts are expected to result in increased sales revenues for fiscal year 2001 and reduced operating expenses. With increased sales in fiscal year 2001, the Company is expecting an increase in the gross profit margin that will ultimately reduce the overall net loss incurred from operations and conserve the Company's cash resources. The fiscal year 2001 budget anticipates the use of approximately $1.2 million in cash and cash equivalents on sales of approximately $2.5 million. This forecast assumes that the Company's gross profit margin will increase from approximately 30% to 50% by the end of the fiscal year with an overall 45% gross profit margin on sales revenues. It is uncertain if the Company will be able to meet the operational and financial requirements of the proposed fiscal year 2001 budget and limit its use of cash and cash equivalents. The Company can not predict the expected revenues, gross profit margin, net loss and usage of cash and cash equivalents for fiscal year 2001. If the Company is able to manage the business operations in line with the budget expectations, the Company believes that its cash resources will be sufficient to fund its operations for the remainder of the fiscal year 2001. If the Company is unable to manage the business operations in line with the budget expectations, it could have a material adverse effect on the Company's business viability, financial position, results of operations and cash flows. If the Company is not successful by the end of fiscal year 2001 in becoming cash flow break even, additional capital resources will be required to maintain ongoing operations. (2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES ------------------------------------------ Use of Estimates in the Preparation of Financial Statements ----------------------------------------------------------- The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions. Such estimates and assumptions affect the reported amounts of assets and liabilities as well as disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expense during the reporting period. Actual results could differ from those estimates. Cash and Equivalents -------------------- For purposes of the statements of cash flows, the Company considers all cash and highly liquid investments with an original maturity of three months or less to be cash equivalents. 7 Fair Value of Financial Instruments ----------------------------------- The Company's financial instruments consist of cash, short-term investments and short-term trade receivables and payables. The carrying values of cash, short-term investments and short-term receivables and payables approximate their fair value. Short-term Investments ---------------------- As required under Statement of Financial Accounts Standards No. 115, "Accounting for Certain Investments in Debt and Equity Securities," (SFAS 115) management determines the appropriate classification of its investments in debt securities at the time of purchase. At June 30, 2000, the Company's short-term investments consist primarily of government securities that the Company classifies as available for sale. Since the Company will be required to sell certain of its debt securities prior to their maturity, the Company has elected to classify its short-term investments as available for sale. As a result, for the quarter ending June 30, 2000, the Company has recorded short-term investment valuation adjustment of $17,006, which is included as a component of Other Comprehensive Income. Inventory --------- Inventory consists primarily of component parts and raw materials, and is valued at the lower of cost (first-in, first-out basis) or market. Inventory consists of the following: June 30, March 31, 2000 2000 ----------- ----------- Raw materials $603,396 $526,195 Finished goods 185,760 213,319 ----------- ----------- 789,156 739,514 Less- Reserve for obsolescence (100,000) (145,000) ----------- ----------- $689,156 $594,514 =========== =========== Patents ------- The costs of applying for patents are capitalized and amortized on a straight-line basis over the lesser of the patent's economic or legal life (17 years in the U.S.). Capitalized costs are expensed if patents are not granted. The Company reviews the carrying value of its patents periodically to determine whether the patents have continuing value. In fiscal year 1999 the Company expensed approximately $50,000 of costs that had been previously capitalized as patent application costs after it decided not to pursue development of the related technology in order to focus on the Company's proprietary AEM technology opportunities. Income Taxes ------------ The Company accounts for income taxes under the provisions of Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes" ("SFAS No. 109"). SFAS No. 109 8 requires recognition of deferred income tax assets and liabilities for the expected future income tax consequences, based on enacted tax laws, of temporary differences between the financial reporting and tax bases of assets and liabilities. SFAS No. 109 requires recognition of deferred tax assets for the expected future tax effects of all deductible temporary differences, loss carryforwards and tax credit carryforwards. The Company's deferred tax assets have been completely offset by a valuation allowance because the realization criteria set forth in SFAS 109 are not currently satisfied, primarily due to the Company's history of operating losses. Revenue Recognition ------------------- Revenue from product sales is recorded when the Company ships the product and the earnings process is complete. The Company recognizes revenue from sales to stocking distributors when there is no right of return, other than for normal warranty claims. Stock Based Compensation ------------------------ The Company has adopted the disclosure-only provisions of Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123"), and applies Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB 25"), and related interpretations in accounting for stock options granted to employees. The Company has made pro forma disclosures of what net loss and net loss per common share would have been had the provisions of SFAS 123, based upon the fair value method, been applied to the Company's stock option grants. Comprehensive Income -------------------- The Company adopted the provisions of Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income" ("SFAS 130") as of April 1, 1998. SFAS 130 establishes standards for reporting and display of comprehensive income and its components in a full set of general-purpose financial statements. The components of Other Comprehensive Income are included in the Condensed Statements of Operations and Comprehensive Income and consist of an adjustment to the fair value of short-term investments. Segment Reporting ----------------- The Company adopted the provisions of Statement of Financial Accounting Standards No. 131, "Disclosures About Segments of an Enterprise and Related Information" ("SFAS 131") in the Quarter ended December 31, 1999. SFAS 131 established standards for reporting information about the segments of enterprises' business. The adoption of this statement had no impact on the Company's financial statements as there are no material differences between information reported to management and that contained in the financial statements of the Company. Basic and Diluted Loss per Common Share --------------------------------------- Loss per basic and diluted common share for each period presented is computed using the sum of the weighted average number of shares of common stock outstanding. Fully diluted shares that would result from the exercise of common stock options and warrants would be anti-dilutive and thus are not presented. 9 Recently Issued Accounting Standards ------------------------------------ In June 1999, the FASB issued Statement of Financial Accounting Standards No. 137, "Accounting for Derivative Instruments and Hedging Activities - Deferral of the Effective Date of FASB Statement No. 133 - An Amendment of FASB Statement No. 133" ("SFAS 137"). SFAS 137 delays the effective date of SFAS 133 to financial quarters and financial years beginning after June 15, 2000. SFAS 133 establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activities. It requires that an entity recognizes all derivatives as either assets or liabilities in the statement of financial position and measures those instruments at fair value. Management believes that the adoption of SFAS 133 will not have a significant impact on the Company's financial condition and results of operations. In December 1999, the Securities and Exchange Commission ("SEC") issued Staff Accounting Bulletin No. 101, "Revenue Recognition ("SAB 101"). SAB 101 provides guidance on recognition, presentation, and disclosures related to revenue in the financial statements. The Company is required to adopt this standard as of January 1, 2001. Management does not believe the adoption of SAB 101 will have a significant impact on the results of operations or financial position of the Company. In March 2000, The Financial Accounting Standards Board Issued FASB Interpretation No. 44, "Accounting for Certain Transactions Involving Stock Compensation" ("FIN No. 44"). FIN No. 44 clarifies the application of APB No. 25 for certain issues related to equity-based instruments issued to employees. FIN No. 44 is effective on July 1, 2000, except for certain transactions, and will be applied on a prospective basis. Management believes that FIN No. 44 will not have a significant impact on its financial statements. (3) COMMITMENTS AND CONTINGENCIES ----------------------------- The Company is subject to regulation by the United States Food and Drug Administration ("FDA"). The FDA provides regulations governing the manufacture and sale of the Company's products and regularly inspects the Company and other manufacturers to determine their compliance with these regulations. As of June 30, 2000 the Company believes it was in substantial compliance with all known regulations. The Company was last inspected in November 1998 and has not, at June 30, 2000, been notified of any deficiencies from that inspection. FDA inspections are conducted approximately every two years or on a more frequent basis at the discretion of the FDA. Because of seasonal and other factors including the continuing development of the sales force discussed in Item 2, Historical Perspective and Outlook and Results of Operations, the results of operations for the quarter ended June 30, 2000 should not be taken as an indication of the results of operations for all or any part of the balance of the year. The accounts receivable balance at June 30, 2000 of $325,151 included $32,282 (10%) and $26,257 (8%) from two customers. The Company's accounts receivable balances are primarily domestic. 10 (4) MANAGEMENT'S REPRESENTATIONS ---------------------------- The condensed interim financial statements included herein have been prepared by the Company, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations, although the Company believes that the disclosures made are adequate to make the information presented not misleading. The condensed interim financial statements and notes thereto should be read in conjunction with the financial statements and the notes thereto, included in the Company's Annual Report to the Securities and Exchange Commission for the fiscal year ended March 31, 2000, filed on Form 10-KSB on June 29, 2000. The accompanying condensed interim financial statements have been prepared, in all material respects, in conformity with the standards of accounting measurements set forth in Accounting Principles Board Opinion No. 28 and reflect, in the opinion of management, all adjustments, which are of a normal recurring nature, necessary to summarize fairly the financial position and results of operations for such periods. The results of operations for the most recent interim period are not necessarily indicative of the results to be expected for the full year. 11 ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS GENERAL ------- The Company was incorporated as a Colorado corporation on February 1, 1991. The Company designs, develops, manufactures and markets patented electrosurgical instruments, which are designed to provide greater safety to patients who undergo minimally-invasive surgery. The products can be used with most electrosurgical generator systems available today in the U.S. The Company has developed and is marketing its own line of integrated, shielded five-millimeter electrosurgical instruments that incorporate the Company's proprietary technology. These products monitor for stray electrical energy during laparoscopy and deactivate the electrosurgical unit when this energy is detected under potentially dangerous conditions. The Company's sales to date have been made principally in the U.S. The Company has incurred losses since its inception and has an accumulated deficit of $14,647,100 at June 30, 2000 and its operations have been financed primarily through issuance of equity. The Company's liquidity has substantially diminished because of such continuing operating losses and the Company may be required to seek additional capital to continue operations. The Company's operations are subject to certain risks and uncertainties, including that commercial acceptance of the Company's products will have to occur in the marketplace before the Company can attain profitable operations and that continued operating losses and use of cash resources will continue during fiscal year ended March 31, 2001 ("FY 2001") which will significantly impact the Company's ongoing operations and business viability. As of June 30, 2000, the Company had $1,734,175 in cash and cash equivalents and short-term investments available to fund future operations. HISTORICAL PERSPECTIVE AND OUTLOOK ---------------------------------- The Company was organized in February 1991 and in the first two years developed the AEM system and protective sheaths to adapt to traditional electrosurgical instruments. During this period, the Company applied for patents with the United States Patent Office and conducted product trials. As the Company evolved, it was clear that the active electrode monitoring technology needed to be integrated into the standard laparoscopic instrument design. As the development program proceeded, it also became apparent that the merging of electrical and mechanical engineering skills in the instrument development process for the Company's patented, integrated electrosurgical instruments was more complex than expected. As a result, instruments with integrated AEM technology were not completed until many years later. It was not until fiscal year ended March 31, 2000 ("FY 2000") that a sufficiently broad AEM instrument line was introduced to provide the operating rooms with a Standard of Care -- AEM instruments for all of their electrified monopolar instrumentation in laparoscopic surgery. Prior to offering the full breadth of laparoscopic instrumentation, it was difficult for hospitals to commit to converting to the AEM solution, as there were not adequate comparable surgical instrument options to match what the surgeon demanded. 12 With the broad array of AEM instruments now available, the surgeon has a full choice of instrument options and does not have to change surgical technique. The hospital can now universally convert, thus providing all of their laparoscopic patients the highest level of safety. The Company's Plans in FY 2001: In February, 2000 the Company appointed James A. Bowman as President & CEO and implemented an expense reduction program to take effect by the start of the new fiscal year, April 1, 2000. The expense constraints were implemented across all of the Company's operations and resulted in a 21% reduction in headcount and 20% reduction in the operating expense budget compared to FY 2000. These budget constraints resulted in an expense structure appropriate with the ongoing sales achievements while still allowing the Company to move forward with a progressive plan in the marketplace. To lay a foundation for future growth within the constraints of the Company's financial resources, during FY 2000 the Company focused on: expansion of its product line, expansion of independent clinical endorsements of the Company's technology and an improved sales infrastructure. PRODUCT LINE EXPANSIONS - The Company believes that its strategy of incorporating AEM technology into the standard laparoscopic instrument styles ensures that surgeons do not have to change their operative techniques. This strategy advanced forward in late-FY 2000 with new AEM product line extensions. These new products filled holes in the product line that were very important to the General and Gynecologic Surgeons. Management believes that the AEM Laparoscopic Instrument line now, for the first time, includes a full array of instrument styles to meet the surgeons' demands and allows them to implement AEM technology without changing their surgical techniques or operating room protocols. SALES INFRASTRUCTURE IMPROVEMENTS - In early FY 2000 the Company recognized the need to improve its sales network of independent distributors by developing relationships with distributors who represent synergistic products and whose primary focus is Electrosurgery & MIS. This network was substantially overhauled during FY 2000 and those new representatives are now trained and active in the field. The Company believes that having the sales infrastructure efficiently active for the entire FY 2001 will allow the Company the best opportunity for sales growth. With the improved network of Independent Distributors, the Company has also hired an experienced team of Regional Sales Managers to manage, motivate, educate and direct the individual distributor sales representatives. These new business managers were hired in mid-FY 2000 to focus on optimizing the sales function in the field, to accelerate the sales accomplishments and maximize revenue growth. CLINICAL ENDORSEMENTS - FY 2000 represented the culmination of a series of independent clinical endorsements of the Company's proprietary technology. With its recent recognition as an AORN RECOMMENDED PRACTICE (by the Association of Operating Room Nurses) the Company's technology is now recommended by sources representing all groups involved with minimally-invasive surgery: Surgeons, Nurses, Biomed Engineers, Medicolegal professionals and other electrosurgery device manufacturers. The Company believes that gaining broad clinical endorsements is a demonstrated and successful process for surgical technology to traditionally advance in the marketplace. From a concern or problem in surgery, the medical device industry develops a technological solution and this solution evolves to gain the breadth of endorsements. Once this occurs the technology is then employed by the hospital to benefit the patient, surgeon and operating room staff. Management 13 believes that AEM technology is following the same path as previous revolutions in electrosurgery. As with "Isolated" ESU generators in the 1970s and with "REM" technology in the 1980s, AEM technology is receiving the broad clinical endorsements that drove previous new technology to market acceptance. The Company believes the unique performance of the AEM technology and its breadth of clinical endorsements provides an opportunity for market growth. Management feels that the market visibility and awareness of the AEM technology and its independent surgical endorsements was substantially improved in late FY 2000 and that this will benefit the sales efforts in FY 2001. In addition to the above, the Company has been informed that CE accreditation is expected in mid-fiscal year 2001 and this allows the Company to launch into new markets in Europe. The market for the Company's products internationally represents incremental sales opportunities during FY 2001. Management believes that the Company heads into FY 2001 having achieved improvements in expense controls, sales infrastructure, product line expansion and the clinical credibility of its technology. Management's focus and commitment in FY 2001 is to maintain expense controls while optimizing sales execution in the field, developing widespread market awareness of the technology and expanding into the International market. RESULTS OF OPERATIONS --------------------- FOR THE THREE MONTHS ENDED JUNE 30, 2000 COMPARED TO THE THREE MONTHS ENDED JUNE 30, 1999. NET REVENUES. Revenues for the quarter ended June 30, 2000, were $510,698, compared to $459,922 for the quarter ended June 30, 1999, an increase of 11%. The increase is attributable to the Company continuing to develop the effectiveness of the independent distributor sales network and a visible marketing campaign. The Company has developed a number of relationships with "stocking" distributors. While there can be no assurance that the arrangement with the stocking distributors will result in recurring business, the Company believes that the distributors will be effective marketing partners in their territories. GROSS PROFIT. The gross profit for the quarter ended June 30, 2000, of $224,502 increased by 26% from the quarter ended June 30, 1999, gross profit of $178,875. Gross profit as a percentage of revenue (gross margin) increased from 39% for the quarter ended June 30, 1999, to 44% in the quarter ended June 30, 2000. The increase in gross profit is due to the reduced impact of fixed operations costs at the higher revenue, the increasing margins on the core AEM products and a reversal of an inventory reserve. Gross profit and gross margin can be expected to fluctuate from quarter to quarter, as a result of product sales mix and sales volume. Gross margins, while improved, are expected to be higher at higher levels of production and sales. SALES AND MARKETING EXPENSES. Sales and marketing expenses of $324,901 for the quarter ended June 30, 2000, increased by 12% compared to $289,781 for the quarter ended June 30, 1999. The increase is primarily the result of increased headcount in Sales Management. 14 GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses of $183,566 for the quarter ended June 30, 2000, decreased by 2% compared to $186,283 for the quarter ended June 30, 1999. This decrease is the result of lower headcount and other spending constraints. RESEARCH AND DEVELOPMENT EXPENSES. Research and development expenses of $93,308 for the quarter ended June 30, 2000, decreased by 27% compared to $127,360 for the quarter ended June 30, 1999. This decrease is the result of reduced development projects and the costs associated with them. LIQUIDITY AND CAPITAL RESOURCES ------------------------------- The Company has historically satisfied its cash requirements principally through sales of Common Stock which approximated $17.3 million through June 30, 2000, and, to a substantially lesser degree, funds provided by sales of the Company's products. Historically, these funds have been used for working capital and general corporate purposes including research and development. The Company may use working capital to build inventories, to ensure that orders can be filled in a timely manner, to support the sales efforts of the Company's sales force and to accommodate anticipated growth. While the remaining net proceeds from the Company's initial public offering are currently invested primarily in money market instruments and government securities, the Company may also use a substantial portion of the net proceeds for the acquisition or development of complementary products or businesses, if such acquisition or development opportunities arise. The Company currently has no understanding, commitment or agreement with respect to any such acquisition or development program. Capital expenditures historically have been relatively minor, and have consisted of specialized equipment, manufacturing equipment, office equipment and leasehold improvements. The Company anticipates that its cash on hand will be sufficient to fund its operations, working capital and capital requirements until it reaches break-even cash flow, but no assurances can be made that this will be the case, or that break-even cash flow will be achieved. During late fiscal year 2000, the Company instituted a cost containment program for its operations as well as reduced its employee head count to conserve its cash resources. The Company has also fully implemented its marketing and sales plan to maintain a certain number of key sales representatives and entered into exclusive agreements with stocking distributors and independent sales representatives to sell the Company's products. These efforts are expected to result in increased sales revenues for fiscal year 2001 and reduced operating expenses. With increased sales in fiscal year 2001, the Company is expecting an increase in the gross profit margin that will ultimately reduce the overall net loss incurred from operations and conserve the Company's cash resources. The fiscal year 2001 budget anticipates the use of approximately $1.2 million in cash and cash equivalents on sales of approximately $2.5 million. This forecast assumes that the Company's gross profit margin will increase from approximately 30% to 50% by the end of the fiscal year with an overall 45% gross profit margin on sales revenues. It is uncertain if the Company will be able to meet the operational and financial requirements of the proposed fiscal year 2001 budget and limit its use of cash and cash equivalents to approximately $1.2 million out of the approximately available $2.2 million. The Company used $459,914 in cash and cash equivalents for its operations for the quarter ending June 30, 2000. The 15 Company can not predict the expected revenues, gross profit margin, net loss and usage of cash and cash equivalents for fiscal year 2001. If the Company is able to manage the business operations in line with the budget expectations, the Company believes that its cash resources will be sufficient to fund its operations until it reaches break-even cash flow. If the Company is unable to manage the business operations in line with the budget expectations, it could have a material adverse effect on the Company's business viability, financial position, results of operations and cash flows. If the Company is not successful by the end of fiscal year 2001 in becoming cash flow break-even additional capital resources will be required to maintain ongoing operations. There can be no assurance such resources will be available in sufficient amounts or on terms acceptable to the Company. Such additional capital resources may result in substantial dilution to existing shareholders. The Company has not yet pursued the possibility of obtaining additional financing to fund its future operations. It is uncertain that the Company will be able to obtain additional funding through a private placement of its common stock or loans from financial institutions or other third parties. If additional capital is unavailable, it could have a material adverse effect on the Company's business viability, financial position, results of operations and cash flows. As a result of the above factors, the report of independent public accountants which accompany the Fiscal Year 2000 Financial Statements expresses substantial doubt regarding the Company's ability to continue as a going concern. The Company's common stock is traded on the Over The Counter Bulletin Board (OTC Bulletin Board: ESCP.OB). INCOME TAXES ------------ Net operating loss carryforwards totaling approximately $14.6 million are available to reduce taxable income as of June 30, 2000. The net operating loss carryforwards expire, if not previously utilized, at various dates beginning in the year 2011. The Company has not paid income taxes since its inception. The Tax Reform Act of 1986 and other income tax regulations contain provisions which may limit the net operating loss carryforwards available to be used in any given year, if certain events occur, including changes in ownership interests. The Company has established a valuation allowance for the entire amount of its deferred tax asset since inception due to its history of operating losses. 16 PART II. OTHER INFORMATION ----------------- ITEM 1 Not Applicable ITEM 2 Not Applicable ITEM 3 Not Applicable ITEM 4 - Not Applicable ITEM 5 - Not Applicable ITEM 6 - EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits 27 - Financial Data Schedule. 17 SIGNATURE Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, Electroscope has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. Name Title Date ------------------------- ---------------------------- ------------------------- /s/ Marcia McHaffie Controller July 18, 2000 ------------------------ (Principal Accounting Officer) Marcia McHaffie EXHIBIT INDEX Sequentially Exhibit No. Description Numbered Page -------------------- ---------------------------------------- ----------------- 27 Financial Data Schedule 17 19