**FORM 10-QSB**

 

**Securitiesand Exchange Commission**

**Washington, D. C. 20549**

 

**(Mark One)**
| **ý**                                                                                                                                                                                                                                                                                                                                                                                                                  | ** ** | **QUARTERLY REPORT UNDER  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**        |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------------------------------|
|                                                                                                                                                                                                                                                                                                                                                                                                                        |       |                                                                                                    |
| **For the  quarterly period ended March 31, 2005**                                                                                                                                                                                                                                                                                                                                                                     |
|                                                                                                                                                                                                                                                                                                                                                                                                                        |       |                                                                                                    |
| **OR**                                                                                                                                                                                                                                                                                                                                                                                                                      |
|                                                                                                                                                                                                                                                                                                                                                                                                                        |       |                                                                                                    |
| **o**                                                                                                                                                                                                                                                                                                                                                                                                                       | ** ** | **TRANSITION REPORT PURSUANT TO  SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|                                                                                                                                                                                                                                                                                                                                                                                                                        |       |                                                                                                    |
| **For the  transition period from                                  to                              ** |
| ** **                                                                                                                                                                                                                                                                                                                                                                                                                  | ** ** | ** **                                                                                              |
| **Commission  file number 0-16257**                                                                                                                                                                                                                                                                                                                                                                                         |

 

**PaceMedical, Inc.**

(Exact name of smallbusiness issuer as specified in its charter)

 

| **Massachusetts**                                                | ** ** | **04-2867416**                        |
|------------------------------------------------------------------|------------|---------------------------------------|
| (State or other  jurisdiction of  incorporation or organization) |       | (I.R.S. Employer  identification No.) |

 

**391 Totten Pond Road, Waltham,Massachusetts 02451**

(Address of principalexecutive offices)

 

**(781) 890-5656**

(Issuer’s telephonenumber,including area code)

 

Check whether the issuer (1) filed all reportsrequired to be filed by Section 13 or 15(d) of the Exchange Actduring the past 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days.   Yes   ý   No o

 

Indicate the number of shares outstanding of each ofthe issuer’s classes of common equity, as of May 31, 2005.

 

3,354,870 shares of Common Stock, par value $.01 pershare

 

Transitional Small Business Disclosure format:    Yeso  No  ý

 

 

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**PART I - FINANCIALINFORMATION**

 

**Item 1. Financial Statements.**

 
| a)     | Condensed  Consolidated Balance Sheets                |   |
|--------|-------------------------------------------------------|--------|
|   |                                                  |   |
| b)     | Condensed  Consolidated Statements of Operations      |   |
|   |                                                  |   |
| c)     | Condensed  Consolidated Statements of Cash Flows      |   |
|   |                                                  |   |
| d)     | Notes  to Condensed Consolidated Financial Statements |   |

 

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**PACE MEDICAL, INC. AND SUBSIDIARY**

**CONDENSED CONSOLIDATED BALANCESHEETS**

 
| ** **                                                                   | ** ** | **MARCH 31, 2005** | ** ** | **DECEMBER 31, 2004** | ** ** |
|------------------------------------------------------------------------------|------------|-------------------------|------------|----------------------------|------------|
| ** **                                                                   | ** ** | **(Unaudited)**         | ** ** | **(See note below)**       | ** ** |
| ASSETS                                                                       |       |                    |       |                       |       |
|                                                                         |       |                    |       |                       |       |
| Current assets:                                                              |       |                    |       |                       |       |
| Cash and cash  equivalents                                                   |       | $                       | 641,437    |                       | $          | 902,198 |   |
| Accounts  receivable                                                         |       | 518,093                 |       | 215,504                    |       |
| Inventories:                                                                 |       |                    |       |                       |       |
| Raw materials                                                                |       | 311,056                 |       | 271,812                    |       |
| Work-in-process                                                              |       | 84,490                  |       | 119,876                    |       |
| Finished goods                                                               |       | 104,809                 |       | 79,707                     |       |
|                                                                         |       | 500,355                 |       | 471,395                    |       |
| Other current  assets                                                        |       | 10,555                  |       | 39,309                     |       |
| Total current  assets                                                        |       | 1,670,440               |       | 1,628,406                  |       |
| Property and  equipment, net                                                 |       | 15,324                  |       | 18,812                     |       |
| Other assets                                                                 |       | 248,625                 |       | 248,626                    |       |
| TOTAL ASSETS                                                                 |       | $                       | 1,934,389  |                       | $          | 1,895,844 |   |
|                                                                         |       |                    |       |                       |       |
| LIABILITIES AND  SHAREHOLDERS’ EQUITY                                   |       |                    |       |                       |       |
|                                                                         |       |                    |       |                       |       |
| Current  liabilities:                                                        |       |                    |       |                       |       |
| Accounts payable                                                             |       | $                       | 330,663    |                       | $          | 241,779 |   |
| Accrued expenses                                                             |       | 51,937                  |       | 118,396                    |       |
| Total current  liabilities                                                   |       | 382,600                 |       | 360,175                    |       |
|                                                                         |       |                    |       |                       |       |
| Shareholders’  equity:                                                  |       |                    |       |                       |       |
| Common stock,  $.01 par value, 5,000,000 shares authorized, 3,400,870 issued |       | 34,009                  |       | 34,009                     |       |
| Additional  paid-in capital                                                  |       | 3,147,151               |       | 3,147,151                  |       |
| Accumulated  other comprehensive income                                      |       | 330,589                 |       | 355,011                    |       |
| Accumulated  deficit                                                         |       | (1,928,213              | )          | (1,968,755                 | )          |
|                                                                         |       | 1,583,536               |       | 1,567,416                  |       |
|                                                                         |       |                    |       |                       |       |
| Less: Treasury  Stock, at Cost, 46,000 shares                                |       | (31,747                 | )          | (31,747                    | )          |
| Total  Shareholders’ Equity                                             |       | 1,551,789               |       | 1,535,669                  |       |
| TOTAL LIABILITIES  AND SHAREHOLDERS’ EQUITY                             |       | $                       | 1,934,389  |                       | $          | 1,895,844 |   |

 

Note:                               Thebalance sheet at December 31, 2004 has been derived from the audited consolidatedfinancial statements at that date.

 

The accompanying notesare an integral part of these condensed consolidated financial statements.

 

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**PACE MEDICAL, INC. AND SUBSIDIARY**

#### **CONDENSEDCONSOLIDATED STATEMENTS OF OPERATIONS**

(Unaudited)

 
| ** **              | ** ** | **For the Three Months  Ended March 31** | ** ** |
|-------------------------|------------|-----------------------------------------------|------------|
| ** **              | ** ** | **2005**                                      | ** ** | **2004** | ** ** |
|                    |       |                                          |       |   |   |
| Net sales               |       | $                                             | 474,093    |   | $ | 381,753 |   |
|                    |       |                                          |       |   |   |
| Cost of sales           |       | 215,590                                       |       | 159,020 |   |
|                    |       |                                          |       |   |   |
|                    |       | 258,503                                       |       | 222,733 |   |
|                    |       |                                          |       |   |   |
| Operating  expenses     |       | 223,171                                       |       | 190,514 |   |
|                    |       |                                          |       |   |   |
| Income from  operations |       | 35,332                                        |       | 32,219 |   |
|                    |       |                                          |       |   |   |
| Other income            |       | 5,210                                         |       | 6,211 |   |
|                    |       |                                          |       |   |   |
| Net income              |       | 40,542                                        |       | $ | 38,430 |   |
|                    |       |                                          |       |   |   |
| Net income per  share:  |       |                                          |       |   |   |
|                    |       |                                          |       |   |   |
| Basic                   |       | $                                             | 0.01       |   | $ | 0.01 |   |
|                    |       |                                          |       |   |   |
| Diluted                 |       | $                                             | 0.01       |   | $ | 0.01 |   |

 

The accompanying notesare an integral part of these condensed consolidated financial statements.

 

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** **

**PACE MEDICAL, INC. AND SUBSIDIARY**

**CONDENSED CONSOLIDATED STATEMENTSOF CASH FLOWS**

(Unaudited)

 
| ** **                                                                            | ** ** | **THREE MONTHS ENDED MARCH 31,** | ** ** |
|---------------------------------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                                            | ** ** | **2005**                              | ** ** | **2004** | ** ** |
|                                                                                  |       |                                  |       |   |   |
| CASH FLOWS FROM  OPERATING ACTIVITIES:                                                |       |                                  |       |   |   |
| Net income  (loss)                                                                    |       | $                                     | 40,542     |   | $ | 38,430 |   |
| Adjustments to  reconcile net income (loss) to net cash used in operating activities: |       |                                  |       |   |   |   |   |
| Depreciation and  amortization                                                        |       | 3,488                                 |       | 3,228 |   |
| Change in assets  and liabilities, net:                                               |       | (304,791                              | )          | (92,613 | ) |
|                                                                                  |       |                                  |       |   |   |
| Net cash used in  operating activities                                                |       | (260,761                              | )          | (50,955 | ) |
|                                                                                  |       |                                  |       |   |   |
| CASH FLOWS FROM  INVESTING ACTIVITIES -                                               |       |                                  |       |   |   |
|                                                                                  |       |                                  |       |   |   |
| Purchases of  property and equipment                                                  |       | —                                |       | 5,345 |   |
|                                                                                  |       |                                  |       |   |   |
| NET DECREASE IN  CASH AND CASH EQUIVALENTS                                            |       | (260,761                              | )          | (56,300 | ) |
|                                                                                  |       |                                  |       |   |   |
| CASH AND CASH  EQUIVALENTS AT BEGINNING OF PERIOD                                     |       | $                                     | 902,198    |   | $ | 1,060,791 |   |
|                                                                                  |       |                                  |       |   |   |
| CASH AND CASH  EQUIVALENTS AT END OF PERIOD                                           |       | $                                     | 641,437    |   | $ | 1,004,491 |   |

 

The accompanying notesare an integral part of these condensed consolidated financial statements.

 

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**PACE MEDICAL, INC. AND SUBSIDIARY**

**NOTES TO CONDENSED CONSOLIDATEDFINANCIAL STATEMENTS**

 

1.             The accompanyingunaudited consolidated financial statements and these notes have been condensedand do not contain all disclosures required by generally accepted accountingprinciples.  See notes to auditedconsolidated financial statements contained in the Company’s annual report.

 

2.             In the opinion of theCompany, the accompanying unaudited condensed financial statements contain alladjustments, all of which are normal and recurring, necessary to present fairlythe financial position of the Company and its subsidiary as of March 31,2005 and the results of their operations for the three months ended March 31,2005 and March 31, 2004 and their cash flows for the three months ended March 31,2005 and March 31, 2004.

 

3.             The results ofoperations for the three months ended March 31, 2005 are not necessarilyindicative of the results to be expected for the full year.

 

4.             Basic net income per share is computed bydividing net income by the weighted average number of common shares outstandingduring the period.  Diluted net income(loss) per share is computed by dividing net income by the weighted average numberof common and dilutive common equivalent shares outstanding during the period,except where the effect would be anti-dilutive. The number of dilutive common equivalent shares outstanding during theperiod has been determined in accordance with the treasury-stock method.  Common equivalent shares consist of commonstock issuable upon the exercise of outstanding options.

 
| ** **                           | ** ** | **Three Months Ended  March 31** | ** ** |
|--------------------------------------|------------|---------------------------------------|------------|
| ** **                           | ** ** | **2005**                              | ** ** | **2004** | ** ** |
| ** **                           | ** ** | ** **                            | ** ** | ** ** | ** ** |
|                                 |       |                                  |       |   |   |
| Net Income                           |       | $                                     | 40,542     |   | $ | 38,430 |   |
|                                 |       |                                  |       |   |   |
| Weighted-average  shares outstanding |       | 3,354,870                             |       | 3,354,870 |   |
| Effect of  dilutive securities       |       | 102,647                               |       | 7,000 |   |
| Total shares                         |       | 3,457,517                             |       | 3,361,870 |   |
|                                 |       |                                  |       |   |   |
| Basic net income  per share          |       | $                                     | 0.01       |   | $ | 0.01 |   |
|                                 |       |                                  |       |   |   |
| Diluted net  income per share        |       | $                                     | 0.01       |   | $ | 0.01 |   |
|                                      |            |                                       |            |  |  |  |  |  |

 

For the three months ended March 31, 2005 and 2004, options topurchase 10,000 and 305,000 common shares, respectively, were outstanding butnot included in the diluted weighted average common share calculation as theeffect would have been antidilutive.

 

5.             Comprehensive income(loss) includes net income (loss) and foreign currency translationadjustments.  Comprehensive income (loss)for the three months ended March 31, 2005 and 2004 was as follows:

 

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| ** **                         | ** ** | **Three Months Ended  March 31,** | ** ** |
|------------------------------------|------------|----------------------------------------|------------|
| ** **                         | ** ** | **2005**                               | ** ** | **2004** | ** ** |
|                               |       |                                   |       |   |   |
| Net Income  (Loss)                 |       | $                                      | 40,542     |   | $ | 38,430 |   |
|                               |       |                                   |       |   |   |
| Currency  Translation Adjustment   |       | (22,425                                | )          | (45,443 | ) |
|                               |       |                                   |       |   |   |
| Total  Comprehensive Income (Loss) |       | $                                      | 18,117     |   | $ | (7,013 | ) |
|                                    |            |                                        |            |  |  |  |  |  |

 

6.               Stock-Based Compensation

 

The Company applies Statement of FinancialAccounting Standards (“SFAS”) No. 123, *Accounting for Stock-BasedCompensation*, as amended by SFAS No. 148, *Accountingfor Stock Based Compensation Transition and Disclosure, an amendment to FASBStatement No. 123*, to its stock compensation arrangements,which requires entities to recognize as expense over the vesting period thefair value of stock-based awards on the date of grant or measurement date.  For employee stock-based awards, however,SFAS Nos. 123 and 148 allow entities to continue to apply the intrinsic valuemethod under the provisions of Accounting Principles Board (“APB”) Opinion No. 25and provide pro forma net earnings disclosures as if the fair-value-basedmethod defined in SFAS No. 123 had been applied.  The Company has elected to apply the provisionsof APB Opinion No. 25 and provide the pro forma disclosures of SFAS Nos.123 and 148.

 

Had compensation expense for awards under theCompany’ s Stock Option Plans been determined based on the fair value methodset forth in SFAS No. 123, the effect on the Company’s net income and pershare amounts would have been as follows (in thousands, except per share data):

 

| ** **                                                                              | ** ** | **Three Months Ended March 31** | ** ** |
|-----------------------------------------------------------------------------------------|------------|--------------------------------------|------------|
| ** **                                                                              | ** ** | **2005**                             | ** ** | **2004** | ** ** |
|                                                                                    |       |                                 |       |   |   |
| Net income, as  reported                                                                |       | $                                    | 40,542     |   | $ | 38,430 |   |
| Less:  Compensation expense for option awards determined under fair value based  method |       | (27,954                              | )          | — |   |
|                                                                                    |       |                                 |       |   |   |
| Pro forma net  income                                                                   |       | $                                    | 12,588     |   | $ | 38,430 |   |
|                                                                                    |       |                                 |       |   |   |
| Net income per  share:                                                                  |       |                                 |       |   |   |
| As reported –  basic and diluted                                                   |       | $                                    | 0.01       |   | $ | 0.01 |   |
|                                                                                    |       |                                 |       |   |   |
| Pro forma –  basic and diluted                                                     |       | $                                    | 0.01       |   | $ | 0.01 |   |
|                                                                                         |            |                                      |            |  |  |  |  |  |

 

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** **

**Item 2.****            Management’sDiscussion and Analysis of Financial Condition and Results of Operations.**

 

**General**

 

As described in the Company’s AnnualReport on Form 10-KSB for the fiscal year ended December 31, 2004, theCompany’s business was adversely affected in 2003 and 2004 by a number offactors, including a shortage of components, its voluntary suspension of productionof Model 4170 in the second quarter of 2004 in response to a medical issue raisedby the Products Regulatory Agency (England) in May, 2004, and consolidation inthe OEM market resulting in fewer U.S. distributors.  The Company has taken steps to address eachof these issues and has began to show improved results in the first quarter of2005.   Net sales were 24% higher and netincome increased 5.5% over the first quarter of 2004.  Assuming the Company remains on schedule withthe release of new products under development, operating results are expectedto show continued improvement in 2005 and beyond.

 

### **Liquidity andCapital Resources**

### ** **

As of March 31, 2005, the Company had cash and cash equivalents of$ 641,437 and working capital of $1,287,840. The working capital at March 31, 2005 was approximately $20,000 higherthan the amount at December 31, 2004, owing to the net income fromoperations.  The Company’s cash flowshave historically tracked its operating results.

 

Management believes that its working capital,should suffice to ensure that its on-going operations are financed adequately.   In the short term, however, additionalequity and or debt financing may be sought to continue funding research anddevelopment, capital equipment, replacement inventories, and to expand theCompany’s marketing operation.  Theobtaining of additional capital through the issuance of equity securities mayresult in dilution of existing shareholders’ interests.

 

**Results of Operations - Three Months ended March 31,2005 versus Three Months ended March 31, 2004**

 

Net sales in the first quarter of 2005 increased 24% from the sales inthe first quarter of 2004.   While the Company has had success inaddressing the component shortages in the first quarter of 2005, there can beno assurance that the Company will not encounter component shortages in futurequarters.

 

The Company’s margins in the first quarter were lower than those seenin 2004 (58% in 2004 verses 55% in 2005).  This occurred due to a change in product mix.  It should be noted that pricing has remainedfirm on all products.

 

Operating expenses increased 17% during the three months ended March 31,2005 versus the three months ended March 31, 2004, primarily due to thehiring of additional management personnel. Management anticipates some increase in its operating expendituresduring the balance of 2005.

 

No tax provision was recorded for the three months ended March 31,2005 owing to the Company’s ability to use net operating loss carryforwards inthe United States.

Net income for thequarter was $40,542 or $.01 per share in contrast to net income of $38,430

 

8

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or $.01 per share in thefirst quarter of 2004.

 

**Factors That May Affect Future Results**

 

From time to time, information provided by the Company or statementsmade by its employees may contain “forward-looking” information which involvesrisks and uncertainties.  In particular,statements contained in this report which are not historical facts (includingbut not limited to the Company’s expectations regarding business strategy, newproduct availability, pricing, anticipated operating results, market share, therate at which backlogs of orders can be filled, operating expenses andanticipated working capital) may be “forward-looking” statements.  The Company’s actual results may differ fromthose stated in any forward-looking statements. Factors that may cause such differences include, but are not limited to,risks associated with the introduction of new products including supplierperformance, risks associated with the manufacture of existing products,including supplier performance, development of markets for new products andexisting products offered by the Company, personnel requirements, the Company’srelationships with distributors and OEM’s, the economic health of such OEM’s,government regulation, competition and general economic conditions.

 

**Item 3. Controls and Procedures**

 

As of the end of the period covered by thisreport, our President and Chief Executive Officer and our Treasurer performedan evaluation of the effectiveness of the design and operation of the Company’sdisclosure controls and procedures pursuant to Exchange Act Rule 13a-14.  Based upon that evaluation, the President andChief Executive Officer and the Treasurer concluded that the Company’sdisclosure controls and procedures are effective in ensuring the reporting ofmaterial information required to be included in the Company’s periodic filingswith the Securities and Exchange Commission. There were no significant changes in the Company’s internal controlsover financial reporting or in other factors that could significantly affectthese internal controls over financial reporting subsequent to the date of themost recent evaluation.

 

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**PART II - OTHER INFORMATION**

 

**Item 6.****    Exhibits**

 

Exhibits:

 
| 31.1     |   | Certification of the President and Chief Executive  Officer pursuant to Rules 13a -14 and 15d -14 promulgated under the  Securities Exchange Act of 1934, as amended, as adopted pursuant to  section 302 of the Sarbanes-Oxley Act of 2002. |
|----------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|     |   |                                                                                                                                                                                                                                                   |
| 31.2     |   | Certification of the Treasurer pursuant to  Rules 13a -14 and 15d -14 promulgated under the Securities Exchange Act  of 1934, as amended, as adopted pursuant to section 302 of the  Sarbanes-Oxley Act of 2002.                             |
|     |   |                                                                                                                                                                                                                                                   |
| 32  |   | Certifications pursuant to 18 U.S.C.  Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002.                                                                                                                   |

 

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**SIGNATURES**

 

Pursuant to the requirements of the SecuritiesExchange Act of 1934, the registrant has duly caused this report to be signedon its behalf by the undersigned thereunto duly authorized.

 
|   |                      | **PACE MEDICAL, INC.**                                   |
|--------|---------------------------|----------------------------------------------------------|
|   |                      |                                                     | (Registrant) |
|   |                      |                                                     |
|   |                      |                                                     |
| Date:  |   June 20, 2005 |                                                     |   | /s/ Steven E. Hanson |   |
|   |                      | Steven E. Hanson, President and  Chief Executive Officer |
|        |                           |                                                          |  |  |  |  |

 

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EXHIBIT INDEX

 
| **Exhibit No.** | ** ** | **Description**                                                                                                                                                                                                                                    |
|----------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** **           | ** ** | ** **                                                                                                                                                                                                                                         |
| 31.1                 |       | Certification of President and Chief Executive  Officer pursuant to Rules 13a -14 and 15d -14 promulgated under the  Securities Exchange Act of 1934, as amended, as adopted pursuant to  section 302 of the Sarbanes-Oxley Act of 2002. |
|                 |       |                                                                                                                                                                                                                                               |
| 31.2                 |       | Certification of Treasurer pursuant to  Rules 13a -14 and 15d -14 promulgated under the Securities Exchange Act  of 1934, as amended, as adopted pursuant to section 302 of the Sarbanes-Oxley  Act of 2002.                             |
|                 |       |                                                                                                                                                                                                                                               |
| 32                   |       | Certifications pursuant to 18 U.S.C.  Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002.                                                                                                               |

 

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