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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549 FORM 10-K x
    
    Annual report pursuant to section 13 or 15(d) of the Securities Exchange Act of 1934 for the fiscal
year ended June 30, 2004
 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 0-9407 COMPEX TECHNOLOGIES, INC.  Minnesota
(State of Incorporation)
    
    41-0985318
(I.R.S. Employer Identification No.)
 1811 Old Highway 8
New Brighton, Minnesota 55112-3493
(651) 631-0590 Securities registered under Section 12(b) of the Exchange Act: None Securities registered under Section 12(g) of the Exchange Act: Common Stock, $.10 par value per share Indicate by check mark whether the registrant (1) filed all reports required to
be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such 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 o Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulations S-K is not herein, and will not be contained, to the best of
registrants knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to
this Form 10-K. Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act).
Yes x No o State the aggregate market value of the voting and non-voting common equity
held by non-affiliates computed by reference to the price at which the common
equity was last sold, or the average bid and asked price for such common
equity, as of the last business day of the registrants most recently completed
second fiscal quarter.        $102,503,339 The number of shares outstanding of each of the Companys classes of common
stock, as of September 9, 2004, was: Common Stock, $.10 par value, 12,435,747
shares. Documents incorporated by reference.Certain specified portions of the
Companys definitive proxy statement for the annual meeting of shareholders to
be held November 11, 2004 are incorporated by reference in response to Part
III. 1




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TABLE OF CONTENTS  PART IItem 1. BusinessItem 2. PropertiesItem 3. Legal ProceedingsItem 4. Submission of Matters to a Vote of Security HoldersPART IIItem 5. Market for Common Equity and Related Stockholder MattersItem 6. Selected Financial DataItem 7. Managements Discussion and Analysis of Financial Condition and Results of OperationsItem 7a. Quantitative and Qualitative Disclosures About Market RiskItem 8. Financial Statements.COMPEX TECHNOLOGIES, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS AS OF JUNE 30COMPEX TECHNOLOGIES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE YEARS ENDED JUNE 30CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS EQUITYCONSOLIDATED STATEMENTS OF CASH FLOWNOTES TO CONSOLIDATED FINANCIAL STATEMENTSItem 9. Changes In and Disagreements with Accountants on Accounting and Financial Disclosure.Item 9A. Controls and ProceduresItem 9B. Other Information.PART IIIItem 10. Directors and Executive Officers of the Registrant.Item 11. Executive Compensation.Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.Item 13. Certain Relationships and Related Transactions.Item 14. Principal Accountant Fees and ServicesItem 15. Exhibits, Financial Statement SchedulesSIGNATURESCredit AgreementForm of Restricted Stock AgreementEmployment AgreementConsent of Independent Registered Public Accounting Firm - Ernst & Young LLPCertification of CEO Pursuant to Section 302Certification of CFO Pursuant to Section 302Certification of CEO and CFO Pursuant to Section 906    Table of Contents  CAUTIONARY STATEMENT REGARDING FORWARD LOOKING STATEMENTS Our Annual Report on Form 10-K contains a number of forward-looking
statements where we indicate that we anticipate, believe, expect or
estimate or use similar words to indicate what might happen in the future.
These forward looking statements represent our expectations about future
events, including anticipated product introductions; changes in markets,
customers and customer order rates; changes in third party reimbursement rates;
expenditures for research and development; growth in revenue; taxation levels;
and the effects of pricing decisions. When used in this 10-K, the words
anticipate, believe, expect, estimate and similar expressions are
generally intended to identify forward-looking statements. You should evaluate
these forward-looking statements in the context of a number of factors that may
affect our financial condition and results of operations, including the
following:  
    
    We maintain a reserve against the revenue we record for sales
allowances on the contracted or negotiated sales and rental prices.
Many third party reimbursement entities maintain schedules of the
amount of sales and rental rates for our medical products that they
will reimburse. Because it is difficult to collect from patients the
excess of our contract price over these scheduled rates, and because
our acceptance of the payment from the reimbursement entity in some
cases constitutes acceptance of that rate for our sales or rental
price, we normally do not pursue collection of the excess. The rate
schedules from the various reimbursement entities vary and we do no
know in advance the rates of reimbursement for all of our products from
all of the reimbursement entities that may cover the patients that use
our products. When we record revenue upon billing of a patient or
health care provider, we offset the sales and rental prices, before
recording it as revenue, with an allowance based on our historical
experience of a blended average rate schedule of the reimbursement
entities, weighting our current experience with known rates from larger
entities. Nevertheless, to the extent there is a shift in the
reimbursement entities that pay for sales or rentals of our products,
or to the extent the reimbursement rate schedules of third party
reimbursement entities change, our allowance may be inaccurate and we
may be required to record additional allowances, resulting in a
reduction in our revenue, with a corresponding reduction in net revenue
and income.  
    
    Like many medical device companies that rely on third party
reimbursement entities for payment, we have a large balance of
uncollected accounts receivable. We also have a reserve for the
portion of those receivables that we estimate will not be collected
based on our historical experience. If we cannot collect an amount of
receivables that is consistent with historical collection rates, we
might be required to increase our reserve and charge off the portion of
receivables we cannot collect. This additional provision for
uncollectible accounts could significantly impact our operating
results.  
    
    In the United States, our products are subject to reimbursement by
private and public healthcare reimbursement entities that generally
impose strict rules on applications for reimbursement. Changes in
eligibility or requirements for reimbursement, or failure to comply
with reimbursement requirements, could cause a reduction in our income
from operations.  
    
    Healthcare reform, the expansion of managed care organizations and
buying groups, and continued legislative pressure to control healthcare
costs have all contributed to downward pressure on reimbursement rates
and the prices of our medical products. Under the Medicare
Modernization Act, Medicare is prohibited from increasing reimbursement
rates for durable medical equipment, such as our medical products,
through 2008. Further, this Act requires that Medicare commence a
competitive bidding process for off-the-shelf products, such as our
TENS devices, in 2007. Although this process will not initially be
nationwide and is not binding on private reimbursement entities, we
expect that Medicare and most reimbursement entities will be inclined
to adjust their rate schedules based on the bidding results. Further,
increasing healthcare costs has caused the formation of buying groups
that enter into preferred supplier arrangements with one or more
manufacturers of medical products in return for price discounts. If we
are not able to obtain preferred supplier commitments from major buying
groups or retain those commitments that we currently have, our sales
and profitability could be adversely affected. 2




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
    
    The products we sell in our United States medical products business
may only be sold on physician prescription and, for most of those
products where there is a government sponsored payor, only if we
receive detailed documentation from the physician indicating the
medical necessity of the product, together with forms which we must
submit to the paying agency. In most cases, the reimbursement agency,
including Medicare, requires strict adherence to the requirements of
the form and the failure to properly obtain and maintain the
documentation can result in significant fines, penalties, and civil
litigation. For example, we were subject to a Medicare whistleblower
suit that we settled in 2000 for approximately $1.6 million. Although
we believe we have implemented a compliance program designed to detect
errors in complying with these regulations, if our program fails, our
operations and results could be adversely affected.  
    
    The clinical effectiveness of our electrotherapy products has
periodically been challenged and the effectiveness of electrotherapy
products such as those offered by Compex for fitness and health
applications has sometimes been questioned. Publicity about the
effectiveness of electrotherapy for pain relief or other clinical
applications and continued questions about the effectiveness of
electrotherapy for conditioning could negatively impact revenue and
income from operations.  
    
    We maintain significant amounts of finished goods inventory on
consignment at clinics for distribution to patients. We may not be
able to completely control losses of this inventory and, if inventory
losses are not consistent with historical experience, we might be
required to write off a portion of the carrying value of inventory.  
    
    The manufacture of medical and consumer products, and the labeling
of those products for sale in the United Sates, requires compliance
with quality assurance and labeling regulations of the Food and Drug
Administration. Although we believe our manufacturing facilities and
operations comply with these regulations, a failure to comply could
result in our inability to manufacture, refurbish, and sell products
until compliance is achieved.  
    
    The marketing of our consumer products is subject to regulations
and oversight by both the FDA and the Federal Trade Commission relating
to misleading advertising. The FTC has commenced several enforcement
actions against advertisers of abdominal belts during the past few
years based on unsubstantiated claims. Although we have attempted to
limit the claims made in our advertisements to matters that can be
substantiated, if the FTC were to disagree with our conclusions, it
could enjoin our marketing of these products for a period of time and
impose fines and penalties. Any such actions would have a significant
adverse impact on our operations.  
    
    We operate in both the medical device and consumer products
markets, both of which are subject to a significant amount of
regulation that affects the way we can advertise our products, sell our
products, bill customers for our products and collect payment for our
products.  
    
    We have not sold substantial volumes of consumer products in the
United States, but intend to devote significant resources to market
consumer products for health and fitness applications. The consumer
market for electrical stimulation products is new and developing, and
our success in this market will depend on a number of factors,
including:  
    
    our ability to obtain clearance from the FDA and other
regulatory authorities to market the products for all relevant
consumer applications;  
    
    our ability to maintain distribution rights with, and to
obtain adequate quantities of product from, the manufacturers of
consumer products for which we serve as distributors;  
    
    our ability to establish consumer demand with a limited marketing budget;  
    
    our ability to secure shelf space in the United States with significant retailers; and,  
    
    the effectiveness of our products for their intended applications  
    
    We market and sell several products manufactured by a number of
different companies,
including abdominal belts and other garment-based consumer products,
iontophoresis products, traction devices, and electrodes. We generally have 3




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less control over the quality and reliability of these third-party
products. If these products do not comply with their specifications or
otherwise fail to properly function, we may receive an increased amount
of returns for which we are primarily responsible, may be required to
recall products, may suffer a decrease in product reputation and goodwill
in the marketplace, and may be unable to sell products currently on hand.
Any of these events could negatively impact our operations, particularly
if sale of these third party products becomes a substantial part of our
business.  
    
    The terms of our third party distribution contracts, including our contracts
for Slendertone products, may be altered if we do not meet the contract requirements.
Although we
believe we are currently in compliance with those contracts, we cannot
be certain that we will be able to continue to sell product at the
rates these contracts require. In particular, our contract for sale of
Slendertone product in Europe currently calls for minimum purchases in
excess of what we have budgeted for the coming year. Although we
believe that we will be able to renegotiate this contract if we do not
meet these minimums, we cannot be certain that we will be able to do so
on similar terms, or at all.  
    
    Approximately 39% of our revenue for the year ended June 30, 2004
was generated by Compex SA, a subsidiary headquartered in Switzerland
that does business primarily in Europe. There are risks in doing
business in international markets which could adversely affect our
business, including:  
    
    regulatory requirements;  
    
    export restrictions and controls, tariffs and other trade barriers;  
    
    difficulties in staffing and managing international operations;  
    
    fluctuations in currency exchange rates;  
    
    reduced protection for intellectual property rights;  
    
    changes in political and economic conditions;  
    
    seasonal reductions in business activity; and  
    
    potentially adverse tax assessments.  
    
    Although our products were among the first products sold for muscle
toning and conditioning in Europe, the consumer markets for these
products in some of the geographies have matured, and we have
increasingly become subject to competition from lower cost products.
Although we believe that we have maintained our reputation as the
manufacturer of the highest quality products in these markets, the
introduction and sale of lower cost products has caused some erosion of
our sales volumes in these geographies and pressure on the price we
charge for our products.  
    
    The revenue we have reported during the past two years, and to a
lesser extent the income we have reported, has benefited from the
decreasing value of the dollar in Europe, where Compex S.A operates.
Because we bill for and account for sales in Europe in local currency,
during periods in which US currency is devalued, sales of the same
number of products at the same prices in Europe will result in our
recording increasing sales revenue after conversion to US currency.
Conversely, if US currency increases in value relative to the Euro and
other European currencies in the future, we would report less revenue
and potentially less income even at times when our operations in Europe
continued to perform at historical levels. A large or rapid increase
in the value of the dollar relative to the Euro could have a
significant adverse impact on our reported revenue. 4




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PART I 
 Item 1. Business General Compex Technologies, Inc. designs and manufactures electrical stimulation
products for pain management, rehabilitation, fitness and sports performance
enhancement. Our products are used in clinical, home healthcare, sports and
occupational medicine settings. We were incorporated as Medical Devices, Inc.,
a Minnesota corporation, in 1972. In 1994, we changed our name to Rehabilicare
Inc. and in December 2002, we changed our name to Compex Technologies, Inc.
(NASDAQ: CMPX). Our products are based on electrical stimulation technologies designed to
improve health, wellness, athletic performance, and fitness. More
specifically, we design, manufacture, distribute, sell and rent electrical
stimulation products that use different modalities to deliver electrical
current through electrodes placed on the skin for rehabilitation, edema
reduction, and pain management as medical devices, and for sports performance
enhancement and muscle toning as consumer products. Our portfolio of products
includes neuromuscular electrical stimulation (NMES), pulsed direct current
stimulation (PDC), transcutaneous electrical nerve stimulation (TENS),
interferential stimulation (IF), ultrasound and iontophoresis devices,
accessories and supplies. Our medical device product lines include
rehabilitation, edema reduction, and pain management devices generally used by,
or under the direction of, physicians, nurses, therapists, hospitals and
clinics. For the most part, our products are sold under the
Rehabilicare® name
for prescription medical devices in the United States and the
Compex® name for
medical devices in Europe. In some European countries, our medical devices do
not require a prescription and are sold over-the-counter for rehabilitation and
pain management. Our consumer product line is sold over-the-counter and is
designed for sports performance enhancement, fitness, and health and wellness.
Our consumer products are sold under the Compex® name in both Europe and the
United States. We also distribute complementary medical devices and consumer
products manufactured by others under other name brands, such as Slendertone. During the fiscal year ended June 30, 2004, we worked to consolidate and
integrate into our operations several acquisitions that we had completed in the
fourth quarter of fiscal 2003 and the first quarter of fiscal 2004, expanded
our U.S. medical product sales through increased direct sales efforts and
training, expended significant resources on marketing and generated the first
significant sales of the Slendertone® products we distribute, and introduced
several new products through our European operations. We acquired all of the
operating assets of BMR Neurotech, a subsidiary of Bio-Medical Research
Limited, headquartered in Phoenix, Arizona in May 2003 for approximately $3.3
million and completed integration of its sales staff and customer relationships
during the first half of fiscal 2004. We also acquired all of the capital
stock of Filsport Assistance S.r.l., our Italian distributor, in early July
2003 for approximately $5.5 million and have completed the integration of its
operations into our European operations. Sales in our core medical products business in the US progressed well during
the year, benefiting from the investment we have made to increase our direct
sales staff, and from additional customer relationships added through the
acquisition of BMR Neurotech. Overall, sales of medical products in our United
States Rehabilicare business increased 6% during fiscal 2004. In Europe, although the addition of Filsport and the Slendertone product line
favorably impacted our sales at Compex SA, our sport and fitness line of
consumer products began to receive increased competition from lower priced
products. We offset some of the effect of this competition by the introduction
of several new products and by reducing the prices of some of our existing
products. Although our sales increased in large part because of the declining
strength of the dollar against the Euro, our unit sales growth did not meet our
expectations as a continued weak economy, competition for over-the-counter
sports products in some markets, and management changes in some markets
effected sales. We signed endorsement contracts with several celebrities during fiscal 2004,
including Jerry Rice for our Compex Fitness products, and Sarah Ferguson,
Duchess of York for the Slendertone products, and expended a significant amount
of effort launching these products in the US consumer markets. We received a
favorable report on the effectiveness of the Slendertone Flex abdominal
training belts in January 2004. With the launch of television advertisements
with Sarah Ferguson in May 2004 and our 5




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initial appearance on HSN (Home Shopping Network), we began generating
significant sales of Slendertone belts in the fourth quarter of 2004. Products We offer a full line of medical and consumer electrical stimulation products
for rehabilitation, pain management, sports performance enhancement, fitness,
and health and wellness. All our medical and consumer products are based upon
electrical stimulation technologies designed to deliver an electrical current
to improve health, wellness, athletic performance, and fitness. We offer our Rehabilicare® medical devices primarily in the United States for
home use and the different Compex® line of medical devices primarily for
clinical or professional use in Europe. We also offer an extensive line of
products to consumers over the counter in Europe under the Compex® name for
sports and fitness training, and wellness. In 2003, we introduced certain
Compex® consumer products in the United States and began marketing and
distributing the Slendertone® line of abdominal belts through various retail
distribution channels in the United States. We expanded distribution
operations of the Slendertone® products to include various European markets in
2004. U.S. MEDICAL DIVISION - REHABILICARE Our U.S. medical device operations continue to represent the largest component
of our business, generating $52.0 million or 60% of our net revenue in fiscal
2004. Rehabilicares medical devices consist of hand held, portable,
battery-powered electrical stimulators, which are connected by wires to
electrodes placed on the skin to deliver electrical current using different
modalities for rehabilitation, edema reduction, and pain management. U.S. Medical Devices Rehabilitation and Edema Reduction We offer a wide variety of hand held, portable electrical stimulation devices
for rehabilitation. The modalities generally considered for rehabilitation and
edema reduction, include neuromuscular electrical stimulation devices and
pulsed direct current devices. Some devices incorporate multiple modalities,
referred to as combination devices, to accommodate a patients needs through
the rehabilitation cycle. Neuromuscular Electrical Stimulation (NMES) Devicesare designed to accelerate
recovery and function in diseased or injured muscles. NMES effectively
produces controlled muscle contractions, which assist in increasing the
strength of muscle tissue and the range of motion of a joint. NMES is used
both pre-operatively and post-operatively for muscle re-education, relaxation
of muscle spasms and edema reduction. In the United States, our NMES devices
include: EMS+2is our best selling NMES device. It combines two modes; AC Mode
and DC Mode. The AC Mode is typically selected when treating large
muscles or large muscle groups for increasing or maintaining range of
motion, re-educating muscles for increased function and prevention of
disuse atrophy. Where as, the DC mode either dilates or constricts the
vessels, there by controlling local blood flow to reduce edema and
increase range of motion, thus reducing pain and muscle spasms. The
EMS+2 is typically recommended for treatments following joint surgeries
and nerve injuries, or for various vascular diseases Ortho
DXis designed for pre-surgical and post-surgical rehabilitation.
This patented device combines both the NMES and PDC modalities that can
be used simultaneously during a treatment session. Patients benefit by
minimizing swelling and discomfort while maximizing muscle
rehabilitation, which can accelerate recovery time. In addition, range
of motion, isometric, isotonic and functional exercises can be completed
while using the device. The innovative Ortho DX 6




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device allows users to work harder with less pain, resulting in faster
and better muscle rehabilitation. NT2000combines two modalities, NMES and TENS, to increase muscle
strength, prevent disuse atrophy and reduce chronic or acute pain. We
acquired the U.S. distribution rights for this product from BMR
Neurotech, Inc. The NT2000 offers ten pre-set programs, with the
capability of customizing two programs. The device has a compliance
monitor that provides physicians with patient usage information that can
be used to improve management of patient care paths. NM IIIis a fully adjustable NMES device that features 16 preset
programs. This unique device has the ability to isolate small or large
muscle groups minimizing fatigue and eliminating unwanted muscle
responses. The NMIII provides more comfortable muscle rehabilitation and
gains in range of motion. Pulsed Direct Current (PDC) Devices.PDC devices reduce swelling,
influence local blood circulation and increase range of motion. PDC is
typically used post-operatively and for traumatic injuries. In the
United States, our PDC devices include: GV IIis a high voltage device used primarily to increase blood
flow and reduce edema following trauma due to surgery or injuries,
including sprains and strains. This device may also be used to
reduce muscle spasm, trigger point therapy and pain control. SPORTX® is a versatile, dual purpose device that is particularly
popular with orthopedic surgeons, and professional, collegiate, and
other organized athletic teams. The SporTX features both PDC and
Transcutaneous Electrical Nerve Stimulation modalities. These help
reduce swelling and stiffness to improve range of motion, while
increasing circulation to bring nutrient-rich blood to the injured
area to accelerate the natural healing process. Pain Management We offer a wide variety of electrical stimulation products for acute and
chronic pain management. These include transcutaneous electrical nerve
stimulators, interferential stimulators, and iontophoresis devices. Transcutaneous Electrical Nerve Stimulation (TENS) Devices.TENS devices have
been used as a non-narcotic alternative to drug therapy for the relief of
chronic and acute pain for over 25 years. These devices are most frequently
used to treat persistent conditions such as neck and low back pain. TENS has
also been used in treating pain resulting from a variety of other conditions
including postoperative pain, tendonitis, and phantom limb pain. TENS devices
generally reduce pain during treatment and the effects can continue for an
extended period of time after use. TENS devices relieve pain without the
undesirable side effects and physiological problems of prolonged drug use,
including addiction, depression, disorientation, nausea, and ulcers. In the
United States, our TENS devices include: ProMaxis our best selling, portable TENS device for the U.S. medical
market. This digital unit incorporates a large display screen and easy
programming features. In addition, the ProMax includes two unique
treatment options; the SMP mode  produces a unique cycle to reduce the
bodys ability to build-up a tolerance to the pain management
stimulation, and the SD mode  allows the user to cycle stimulation
between deep nerves and superficial nerves, while maintaining output
intensity to maximize pain relief and comfort. Maxima®is our best selling, portable TENS device for the U.S. wholesale
market. This digital unit was introduced in FY 2003 as a full featured,
high powered alternative to the low cost, off-shore TENS devices. The
Maxima includes the unique SMP mode, although its output current is
slightly less than the ProMax. NuWave®is a TENS device specifically designed for low back pain. This
clinically proven device uses a unique waveform to maximize pain relief
while in use and it creates a tremendous carry- 7




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over effect when the device is not in use. NuWaves simple three-button
design makes it easy-to-use. This product is beneficial to patients with
post-laminectomy or peripheral neuralgic pain. Interferential (IF) Stimulation Devices.Interferential offers similar pain
management benefits as standard TENS devices, although IF devices enable
treatment to be localized to the pain sight. In addition, IF devices create
nearly 40 times more energy than do standard TENS devices. This medium
frequency generates deeper penetration into tissue for more effective pain
control and increases localized blood circulation to help decrease edema and
increase range of motion. In the U.S., we offer the following devices: IF3Waveis our new hand held, portable interferential device that
includes NMES and PDC modalities. This combination device has a digital
interface and includes palm pilot-like menu software for clinicians and
patients. In addition, this device captures patient usage information
and has remote site data downloading capabilities. Physicians can
receive patient compliance reports to help them manage patient care
paths. With three modalities in one device, physicians and physical
therapists can rely on a single medical device for rehabilitation, edema
reduction, and pain management. IF
IIis a hand held, portable, analog interferential device. The IF II
generated the highest revenue of all U.S. medical devices in FY 2003.
Although we distribute fewer IF devices than TENS devices, the IF II
generates significantly higher reimbursement revenues on a per unit
basis. This device combines both IF and NMES modalities. Until the
introduction of the IF3Wave, the IF II was the primary product we
emphasize in the physician market. Iontophoresis. Iontophoresis involves the use of mild electrical current to
deliver medication (usually an anti-inflammatory or a local anesthesia) through
an electrode into tissue. Iontophoresis is noninvasive and does not require the
use of a needle or ingestion of medication. In the United States, we
distribute an iontophoretic drug delivery systems manufactured by IOMED
Corporation under the IOMED brand name to physicians, physical therapists, and
other healthcare specialists treating acute and chronic pain. Cervical and Lumbar Traction Devices.We distribute home-use traction devices
in the United States. The traction devices are manufactured by the Saunders
Group, Inc. and are marketed under The Saunders Cervical
Hometrac® and The
Saunders Lumbar Hometrac® brand names. We distribute the traction devices
through physicians, physical therapists, and other healthcare specialists
treating neck and back pain. These portable traction devices are a
cost-effective option to continuing clinical traction treatments outside the
clinic or office setting. Accessories and Supplies In the U.S. we sell various medical device accessories and supplies,
including self-adhesive and reusable electrode pads, disposable electrodes,
lead wires, batteries, and a power pack that eliminates the need for batteries
in some of our devices. We purchase all of our accessories and supplies from
outside vendors. Distribution and Billing We distribute our medical devices in the United States both on a direct basis
to healthcare providers and their patients and on a wholesale basis to home
healthcare dealers. We focus on direct rather than dealer sales and have a
sales network of employee and independent sales representatives to distribute
our products. In the United States, our sales force has approximately 120
employee and independent sales representatives, calling on about 4,500 active
accounts, including physical and occupational therapists, orthopedic physicians
and surgeons, pain specialists, anesthesiologists, physiatrists, general
practitioners, sports medicine physicians, and other healthcare providers. In
addition, we sell certain medical products on a nonexclusive basis to home
healthcare and durable medical equipment dealers, which amounted to
approximately 4% of our revenue in fiscal 2004. 8




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For our direct rentals and sales of medical products in the United States, we
make consignment inventory available at treating clinics and other dispensing
locations. When a treating clinician determines that a specific device is
beneficial to a patient, a physicians prescription is obtained, and the
patient is trained in the use of the device. The product is then taken home by
the patient for in-home therapy. At the same time, the clinician submits
medical documentation to Rehabilicare and we file a claim on behalf of the
patient to their insurance company or other third party payor. For rentals, the
patient returns the device to us in a prepaid mailer after the treatment period
expires. To conduct business in this manner, we maintain a significant balance
of inventory at clinics and provide telephone support (without charge) to
patients in use of the product. We provide billing and support for our U.S. medical device business through our
offices in Tampa, Florida. These operations include (1) distribution support
staff that provides next day service of products and supplies to providers and
patients; (2) billing and collecting staff that work (without charge) with
physicians, clinicians and reimbursement entities to ensure prompt and accurate
billing and collection of sales and rental fees for our products; (3) a
telemarketing sales staff that follows up with patients to ensure that they
have adequate product and supplies to meet their needs; and (4) patient care
personnel that assist patients in the purchase and reimbursement process. We
also employ clinicians who communicate with patients by phone from a clinical
perspective and respond to calls from patients to ensure products are working
and used properly. This department then reports to the prescribing clinician,
allowing the clinician to contact the patient to alter therapy, as appropriate. In most cases, the rental or purchase price for our medical products in the
United States is paid by an insurance company, health maintenance organization,
or a governmental agency under Medicare, Medicaid, workers compensation or
other programs. These third party reimbursement agencies pay for the use of
our products only after receipt of documentation that they consider adequate
and often subject to specific reimbursement guidelines and limitations. We
discuss some of these limitations under the caption Reimbursement below.
Because the payments from these reimbursement agencies requires submission, and
often resubmission, of documentation, justification based on prescription of
the necessity of the product, and often negotiation with the reimbursement
entity, payment for sale or rental of our medical products normally takes
between 60 and 120 days. Accordingly, we maintain a large balance of accounts
receivable and must carefully estimate the portion of those receivables that
are collectible. We are not dependent upon any single customer for any significant portion of
the sales of our medical devices. As we indicate under the caption
reimbursement below, however, we do receive payment from several insurance
companies and health maintenance organizations and if one of the more
significant of these third party payors changed or curtailed reimbursement for
our products, it would negatively impact our business. Reimbursement Governmental and other efforts to reduce healthcare spending have affected, and
will continue to affect, our operating results. The cost of a significant
portion of medical care in the United States is funded by government and
private insurance programs, such as Medicare, Medicaid, health maintenance
organizations, and private insurers, including Blue Cross/Blue Shield plans.
Government imposed limits on reimbursement of hospitals and other healthcare
providers have significantly curtailed their spending budgets. Under certain
government insurance programs, a healthcare provider is reimbursed a fixed sum
for services rendered in treating a patient, regardless of the actual charge
for such treatment. Private and third-party reimbursement plans are also
developing increasingly sophisticated methods of controlling healthcare costs
through redesign of benefits and exploration of more cost-effective methods of
delivering healthcare. In general, these government and private
cost-containment measures have caused healthcare providers to be more selective
in the purchase of medical products. Under most third-party reimbursement plans, the coverage of an item or service
and the amount of payment that will be made are separate decisions. Efforts to
reduce or control healthcare spending are likely to limit both the coverage of
certain medical devices, especially newly approved products, and the amount of
payment that will be allowed. Restrictions on coverage and payment of our
products by third- 9




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party payors could have an adverse impact on our operations. We attempt to
establish relationships with such payors to assure coverage of our products and
make the timing and extent of reimbursement more predictable. Governmental payers have continued to focus on controlling the costs of
healthcare. In February 2003, the Centers for Medicare and Medicaid Services
(CMS) and the Medicare carriers, the federal agencies which determine
Medicare reimbursement levels, implemented regulations providing authority to
decrease or increase Medicare part B payment amounts when the federal
government believes the existing payment amounts are either grossly excessive
or grossly deficient. Further, on December 8, 2003, the President signed
into law the Medicare Prescription Drug, Improvement, and Modernization Act of
2003, or Medicare Modernization Act. This legislation provides for revisions to
payment methodologies and other standards for durable medical equipment under
the Medicare program. First, beginning in 2004 and continuing through 2008, the
payment amounts for durable medical equipment will no longer be increased on an
annual basis. Second, beginning in 2007, a competitive bidding program that
will apply to off-the-shelf non-Class III devices, including TENS devices, will
be phased in to replace the existing fee schedule payment methodology. The
competitive bidding program will begin in 2007 in ten high population
metropolitan statistical areas and in 2009 will be expanded to 80 metropolitan
statistical areas (and additional areas thereafter). Payments in regions not
subject to competitive bidding may also be adjusted using payment information
from regions subject to competitive bidding. Third, supplier quality standards
are to be established which will be applied by independent accreditation
organizations. Fourth, clinical conditions for payment will be established for
certain products. Although the amount of business we do that is subject to
Medicare reimbursement is small, we expect that many private insurers and
reimbursement agencies will base their reimbursement rates on the Medicare
schedules. In addition to establishing the rates of reimbursement, CMS and the agencies
that administer Medicare reimbursement require compliance with a detailed set
of regulations and forms as a prerequisite to reimbursement. Failure, or
alleged failure, to comply with these regulations can result in administrative
action and civil action under the federal False Claims Act and similar
whistleblower statutes. When an entity is determined to have violated the
False Claims Act, it must pay three times the actual damages sustained by the
government, plus mandatory civil penalties of between $5,500 and $11,000 for
each separate false claim. Suits filed under the False Claims Act, known as
qui tam actions, can be brought by any individual on behalf of the government
and such individuals (known as relators or, more commonly, as
whistleblowers) may share in any amounts paid by the entity to the government
in fines or settlement. In addition, certain states have enacted laws modeled
after the federal False Claims Act. Qui tam actions have increased
significantly in recent years, causing greater numbers of healthcare companies
to have to defend a false claim action, pay fines or be excluded from the
Medicare, Medicaid or other federal or state healthcare programs as a result of
an investigation arising out of such action. We were the subject of a
whistleblower suit in 1999 that we settled with the United States Government by
payment of $1,588,510. As part of this settlement, we also entered into a
five-year corporate integrity agreement with the Office of the Inspector
General. The last three corporate integrity agreement audits performed by an
independent review organization have yielded positive findings and minimal
internal procedure revisions. It is a health care providers responsibility to
formulate policies, procedures, and practices that are tailored to its own
operations and demands, and that are comprehensive enough to ensure compliance
with all applicable Federal health care program requirements. EUROPEAN MEDICAL AND
CONSUMER DIVISION - COMPEX EUROPE We generated $33.3 million in revenue from our European operations during
fiscal 2004, as compared to $26.5 million in 2003 and $25.9 in 2002. Because
the regulatory requirements and the markets differ substantially from the
regulatory requirements and markets in the United States, we sell a completely
different line of both medical and sport, fitness and wellness products over
the counter under the Compex name in Europe. In general, our European products
are slightly larger and are more full-featured to provide a range of therapies,
including sports training, fitness and wellness modes, as well as neuromuscular
stimulation, TENS, and vascularization. We sell a broad line of products
directly to sports and fitness enthusiasts for various muscle training
applications and also sell several products primarily for medical applications.
Whether the user is a professional or amateur athlete, a consumer interested
in general fitness, or a healthcare professional delivering muscle therapy or
pain management, our handheld 10




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electrical stimulators allow users to customize the programs to maximize their
performance and comfort. With the exception of the Compex Sport, these
products are not available for sale in the United States. Although our products in Europe provide functions for many purposes, we group
the products primarily on the basis of their target uses. We have programmed
our devices to provide stimulation regimes designed to maximize their
performance for each use. All of these products currently provide up to four
channels of stimulation and vary primarily in the programming of the
stimulation they provide. Sports Products These products are designed to assist the competitive athlete in increasing the
maximum strength of a muscle, developing muscular volume, increasing the
explosive strength of muscles or improving the capacity of muscle fibers to
sustain effort over long periods of time. Growing out of our ground breaking
Compex Sportproduct, current products designed principally for these functions
include: mi-Sport 500. Our first sport product to include our proprietary muscle
intelligence (or mi) technology, the mi-Sport 500includes all the
features of our Sport 400 for the needs of the professional athlete, as
well as several additional massage and aesthetic shaping functions. Our
muscle intelligence technology utilizes a sensor that analyzes, through
the same electrodes as stimulation is provided, muscle conductivity and
response both before and during use and adjusts stimulation frequency and
strength to provide the maximum benefit to the user. SPORT 400.The Sport 400is targeted for the professional athlete or
competitive amateur and offers programs for endurance, strength training,
resistance, recovery, explosive strength, hypertrophy (muscle building),
stretching, regeneration, and increased capillarization, as well as all
of the analgesic functions of a traditional TENS device and the
rehabilitation functions of a neuromuscular stimulator. Energy. The Energyis a newer product directed to the serious amateur
athlete who requires many, but not all of the features of the Sport 400.
It provides most of the endurance, resistance and recovery programs of
the Sport 400but provides more limited selections for body building and
similar programs designed for professional athletes. Compex Vascular.The Compex Vascularcombines the features of our
original Compex Sport with additional modalities for pain management
(TENS), vascularization (interferential or pulsed galvanic) and recovery. Compex TENS. The Compex TENS provides our basic features for the Compex
Sport with pain management (TENS) features. Fitness Products Products in this category have been programmed to restore, improve or maintain
a good physical condition. They are intended to mimic the muscle work required
for different kinds of physical exercises. Products in this category include: mi-Fitness Trainer. The mi-Fitness Traineris our most full-featured
fitness product, incorporating our muscle intelligence technology with
programs designed to maximize performance in jogging, stepping, cross
training and other fitness training regimens and provides programs for
massage, body shaping and other aesthetics. Top Fitness. The Top Fitnessincludes all of the features of the
mi-Fitness Trainerbut without our muscle intelligence technology and
more limited functionality in massage and cross-training. 11




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Fitness Tens.Based again on our basic Compex Sport Model, but programmed
to enhance fitness regimes, the Fitness Tensis an entry level product
for fitness training with limited pain management features. Wellness Products A new category for Compex SA, our products in this category are designed to
both improve body aesthetics (shape, tone, appearance) and provide an improved
feeling of well being and fitness. These products are targeted primarily to
non-athletic markets for physiological appearance and aesthetics. Products in
this category include: Body.The Compex Bodyis our newest wellness product and features a
sleek attractive design, fun browser screens and clear instructions. It
is an extremely user-friendly device that continues to achieve excellent
results through 197 fitness and wellness programs. Medicompex. The Medicompexis a full featured product similar to the
Top-Fitness and the Sport 400, but with fewer fitness and sport functions
that is designed for customers who wish to improve aesthetics but also
desire to have available the physical training and pain management
features we offer. Professional Products The professional category of products is marketed primarily to health care
professionals and professional physical trainers. Accordingly, these products
emphasize the pain management, vascularization, and neuromuscular
rehabilitation features of our products. Products in this category include: mi-Theta Pro.The mi-Theta Proextends our muscle intelligence
technology into the rehabilitation and pain management markets.
Containing the same programming as the mi-Sport 500and mi-Fitness
Trainer, this device includes more extensive programming to provide
complete TENS features, vascularization and neuromuscular treatment that
can be used by a professional in isolation or in combination to treat a
wide variety of issues. Compex 2. Our most full featured and flexible product, the Compex 2
comes equipped with a programming card that can be used to provide a
range of treatment that includes Neuromuscular rehabilitation, TENS pain
management, Vascularization through IF, denervation, iontophoresis, or
incontinence treatment , as well as sport and fitness functions. It
includes two biofeedback monitors to allow the patient to maximize
treatments. Theta-Stim. The Theta-Stimprovides more limited programming in each of
the major treatment regimes (neuromuscular stimulation, TENS and
vascularization). Theta-Sound.The Theta-Soundis our proprietary ultrasound treatment
device that adjusts ultrasound output based on the thickness and
character of the tissue being treated. Pain Management Products We offer a variety of hand held, portable, electrical stimulation devices for
pain management in Europe. The modalities for pain management include TENS,
ultrasound, and iontophoresis. In Europe, our pain management devices include: Micro Compexoffers the pain management modalities of TENS as well as
endorphic modalities similar to pulsed galvanic or interferential and
modalities to combat disuse atrophy similar to our neuromuscular
stimulation devices. 12




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Micro+ Compexoffers many of the same features as the Micro Compex, plus
modalities for capillarization and iontophoretic modalities. Compex Sport-Poffers training programs for athletes and sports
enthusiasts. Compex 2has all the above features of the Micro Compex and the Micro+
Compex, plus denervation, biofeedback, and the training programs offered
in the Compex Sport-P. SM-plusis a low frequency TENS device designed to treat chronic pain.
Like the ProMax and Maxima, it features two channels allowing use of two
or more electrodes. Ultrasound.The principle underlying the medical use of ultrasound is based on
the interaction between ultrasound and various tissues through which it passes.
During the transmission of ultrasound, the sound energy is converted to
thermal energy, especially in hard tissues such as bones and tendons. In
pulsed mode, the thermal effect can be limited and the ultrasound produces an
oscillation of molecules that is used to treat inflammation, calcification, and
blood accumulations. Ultrasound is also used for iontophoresis. In Europe, we
offer the Compex 0-SOUNDwhich adds to the clinical capabilities of a standard
ultrasound device calibration of the intensity and form of the ultrasound beam
based on patient body composition to maximize therapeutic efficacy. Iontophoresis. Iontophoresis involves the use of mild electrical stimulation
to deliver medication (usually a local anesthesia) through an electrode into
tissue. Iontophoresis is noninvasive and does not require the use of a needle
or ingestion of medication. In Europe, our Compex 2 and our Micro+ Compex
allow effective and safe iontophoresis treatments. We also offer, through a separate distribution arrangement with Bio Medical
Research Limited, the same Slendertoneproducts in Europe that we offer in the
United States, including the Slendertone Flex, Slendertone Gymbody,and
Slendertone Bottoms & Thighs.We also offer the Slendertone Fortex,a
resistance based exercise device, in Europe. Our distribution agreement with
BMR provides us with rights to distribute these products primarily through
sports, fitness and medical stores in Europe. Accessories and Supplies In Europe, the Company sells various medical device accessories and supplies,
including self-adhesive and reusable electrode pads, disposable electrodes,
lead wires, batteries, and a power pack that eliminates the need for batteries
in some of our devices. We purchase all of our accessories and supplies from
outside vendors. Distribution and Marketing In Europe, we market our consumer products through demonstrations at sport
shops, attendance and demonstrations at major athletic events and through
product endorsements by Olympic and other top athletes and teams. Over 60
athletes have endorsed our products in Europe. Our consumer products are sold in Europe principally through employee and
independent sales representatives to sporting goods stores, specialty shops,
pharmacies, and chain stores. Our consumer products are, in general, purchased
by retailers and distributors, and we normally receive payment promptly,
without any obligation to refund or return purchase price. Our consumer business in Europe has been cyclical, with the largest volume of
sales occurring in late Fall and in Spring and with seasonally low sales
occurring during the traditional vacation months of July and August of each
year. Further, our consumer business, which depends to a large extent on the
amount of discretionary income available to retail consumers, is impacted by
economic conditions and our European sales have been negatively impacted by the
economic downturn during the past two years. 13




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We market our professional products primarily to medical professionals and
physical trainers in Europe. Although they do not require a physician
prescription in Europe, a medical referral is normally required for third-party
reimbursement. We market our professional line of products for medical
applications primarily in Switzerland, Italy, France, Spain and Germany. U.S. CONSUMER DIVISION  COMPEX U.S. Because of extensive FDA regulation, the market for electrical-stimulation
products over-the-counter for consumer applications in the United States is in
the development stage. We were one of the first entrants in this market in
fiscal 2003 with our Compex Sportproduct and have expanded our efforts in late
fiscal 2003 with the Slendertoneline of products.Because this is a
developing market, we believe that we will be required to apply significant
resources prior to achieving material revenue from these product lines. We
believe that this is particularly true with products, such as the Slendertone
abdominal belts, that confront consumer resistance because of inferior products
previously marketed in the United States. In fiscal 2004, the first full year
during which we sold any consumer products in the United States, we generated a
total of $0.8 million of revenue from consumer product sales. Sports Products The Compex Sportwas cleared for sale over the counter to enhance muscle
endurance, muscle resistance, muscle strength, explosive muscle strength,
muscle potentiation (or velocity), and muscle recovery in the United States
as a consumer product in April 2002. We started actively marketing this
product in the United States in fiscal 2004, having signed an endorsement
contract with Jerry Rice in late 2003 and recruited several sales
representatives. During fiscal 2004 we established relationships with seven
independent sales groups to market and sell the Compex Sport, retained a
director of sales and a director of marketing for the Compex Sport, launched a
print media advertising campaign and a PR campaign with a number of positive
articles in prominent sports magazines, developed relationships with major
professional sports teams, including the Minnesota Twins, the Chicago White Sox
and the Colorado Rockies that endorse and/or use our Compex Sport product,
developed relationships with several universities that endorse the Compex Sport
and filmed several spot advertisements with Jerry Rice. To support our seven
sales representatives, and to pursue opportunities in sports shops and
professional teams for this product, we are developing micro-teams to provide
customer and sales support. Fitness and Wellness Products We also began marketing in the United States in late fiscal 2003, Slendertone®
electrical stimulation products under a distribution arrangement with
Bio-Medical Research Limited, an Irish company. The Slendertoneproducts
include: Slendertone Flex®. The Slendertone Flex® is a neoprene abdominal belt
that targets groups of abdominal muscles which are difficult to tone with
conventional exercise. It is an easy to use product consisting of a
flexible belt with integrated, battery powered stimulation unit and
positioned electrodes. The FLEXhas built-in memory and intelligent
control that automatically increases exercise levels through 4 programs
with up to 99 intensity levels. Slendertone GymBody®. The Slendertone GymBody®is similar to the Flex,
but with a more limited number of programs (2) and intensity ranges (3). The Slendertone Bottoms & Thighs®. The Slendertone Bottoms &Thighs or
Slendertone Shortsis a pair of flexible neoprene shorts with integrated
stimulation unit and placed electrodes that tones and tightens muscles in
the buttocks and thighs. Like the Flex,it provides exercise levels
through 4 programs with up to 99 intensity levels. 14




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During 2004, we began selectively marketing and selling the Slendertone
products on our website, commenced targeted marketing and sales through direct
response TV, conducted a test marketing of the products through the QVC
shopping channel, and the HSN (Home Shopping Network) shopping channel and
approached a number of large retailers for sale of the products. We also
received a very favorable research report from the University of Wisconsin at
Lacrosse on the efficacy of the Slendertoneproducts in January 2004. Sales of
these products, however, did not show significant improvement until after we
signed an endorsement contract with Sarah Ferguson, Duchess of York, in
February 2004 and began airing television commercials featuring Ms. Ferguson in
May 2004. Although sales of the product on the Home Shopping Network after
these commercials were aired have exceeded our expectations, we continue to
believe we will be required to incur promotional and other expenses
substantially in excess of revenue from these products for the foreseeable
future and until we acquire substantial shelf space at significant retailers in
the United States. We acquired exclusive rights to distribute the Slendertoneproducts in the
United States in February 2003 under a five year agreement, renewable for an
additional five years, subject to satisfaction of sales objectives.
The European distribution agreement, entered into in April 2003, requires
that we purchase a minimum amount of product to maintain exclusive
rights. We are dependent on Bio-Medical Research Limited for manufacture and
supply of these products. Although the agreements provide us with
manufacturing rights in the event of a failure of supply, we might have
difficulty establishing appropriate manufacturing capability quickly. Research and Development Consistent with our business strategy of continuing to develop innovative brand
name products and improving the quality, cost and delivery of products, we
maintain a research and development department in Europe which engages in
product development and the search for new applications. In the U.S., we also
maintain a development staff focused on continuing engineering for our
rehabilitation and pain management products. In Europe, our research and
development staff focuses on introducing new technology for the existing Compex
products that improve performance and enhance comfort and on developing new
products that expand the treatment modalities. Expenditures for research and
development activities totaled approximately $2.5 million in 2004, $2.1 million
in 2003 and $2.1 million in 2002 and were expensed as a part of operating
expenses in the year incurred. Competition Medical Devices The electrical stimulation device market for rehabilitation, edema reduction,
and pain management in both the United States and Europe is relatively mature.
Our devices compete in these markets primarily on the basis of breadth of
features, flexibility, portability and cost. Although there are many companies
that currently manufacture and distribute medical devices, we believe there are
only two primary competitors. For sales through dealers, as opposed to direct
sales, there is also substantial and increasing competition from distributors
of low cost TENS and NMES devices. We compete in these markets primarily on
the basis of the variety and quality of our product offerings, marketing and
distribution presence and service. The electrotherapy market for modalities
other than TENS and NMES, such as interferential current, pulsed direct
current, and micro current, is more fragmented and more difficult to define.
We believe that our ability to offer all of these modalities is in contrast to
the focus of our competitors. We further believe that there are no dominant
competitors for these other modalities and that the variety of modalities we
offer, together with the distinctive features of our products, allow us to
compete favorably in this market. 15




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Consumer The consumer markets for sport and fitness, and health and wellness electrical
stimulation products are less developed and our products are, in many
instances, the first products for these uses. Although our consumer products
are well known in six European countries and one model was recently introduced
into the United States, we expect new market entrants if we become more
successful. Most of our competitors in Europe tend to be smaller companies and
the degree of competition varies considerably by each individual country.
Nevertheless, our consumer products have been subject to increasing competition
on the basis of price in a number of countries in Europe. We compete in part
by continually enhancing our products to offer new features and by reducing
cost on older products. We believe that our products also compete favorably on
the basis of the quality, technology, breadth, and the pricing of our product
line, as well as our first-to-market advantage in the U.S. Manufacturing and Sources of Supply Our U.S. medical devices are manufactured at our headquarters and manufacturing
facility in New Brighton, Minnesota. Manufacturing operations consist
primarily of installing electronic components and materials onto printed
circuit boards and assembling them into the final product. To maximize quality
and reliability and decrease size and weight, most of our products incorporate
surface mount technology and we use automated machinery that surface mounts
components and through-hole circuit board manufacturing. Our European medical devices and consumer products incorporate components
manufactured in other countries and are contract manufactured. Although we
attempt to inspect and test the products, reliance on outside contractors
reduces our control over quality and delivery schedules. If one of these
contractors failed to deliver quality products in a timely manner, our revenue
and our relationships with our customers could be negatively impacted. The medical devices and consumer products that we manufacture or that are
manufactured on our behalf involve electromechanical assemblies and proprietary
electronic circuitry. Most of the raw materials and manufactured components
used in our products are available from a number of different suppliers. We
maintain multiple sources of supply for most significant items and believe that
alternative sources could be developed, if required, for present single supply
sources without a material disruption of our operations. We are dependent on
the manufacturers of the products we distribute, including our Iontophoresis
products, Slendertone® products, and traction devices, for supply and delivery. Patents and Trademarks During the past three fiscal years, we have submitted several patent
applications for approval, which remain pending. Our patent strategy is to
pursue patent protection on the unique features of our new products. We
believe that patent protection does offer a competitive advantage in the
marketplace as we begin to introduce products that combine various modalities
and new technologies to improve use interface. One of the companies that we
acquired maintained a more aggressive approach to patent protection and the
majority of its products are covered by more than 25 U.S. and Canadian patents.
In addition to patent protection, we rely on trade secrets, know-how and
continuing technological innovation to enhance our competitive position. We do,
however, maintain trademark registration for all of our branded product names. We believe that we own or have the right to use all proprietary technology
necessary to manufacture and market our current products and those under
development. We have no knowledge that we are infringing upon any patents held
by others. 16




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Regulation United States. The medical devices and consumer products that we manufacture
and market in the United States are subject to regulation by the Food and Drug
Administration, in the United States. Under the Federal Food, Drug and
Cosmetic Act and regulations issued by the FDA under that act, we must comply
with controls that regulate the design, testing, manufacturing, packaging, and
marketing of our medical devices and consumer products. This system of
regulation creates three classifications for medical devices, each of which is
subject to different levels of regulatory control, with Class I being the least
stringent and Class III being subject to the most control. Class III devices,
which are life supporting or life sustaining, or are of substantial importance
in preventing impairment of human health, are generally subject to a clinical
evaluation program before receiving pre-market approval from the FDA for
commercial distribution. Class II devices are subject in some cases to
performance standards which are typically developed through the joint efforts
of the FDA and manufacturers, but they do not require clinical evaluation and
pre-market approval by the FDA but instead require a pre-market notification to
the FDA and in most cases a showing of substantial equivalence to an existing
product under Section 510(k) of the Federal Food, Drug and Cosmetic Act. Class
I devices are subject only to general controls, such as compliance with
labeling and record-keeping regulations. We believe that all our currently
marketed medical products are Class II products under this classification
system and that they do not require clinical evaluation and pre-market approval
prior to commercial distribution. If a new medical device or consumer product that is a Class I device is
substantially equivalent to a device that was in commercial distribution before
1976 and has been continuously marketed since 1976, pre-market approval
requirements are satisfied through a 510(k) pre-market notification submission
under which the applicant provides product information supporting its claim of
substantial equivalence. This regulatory review typically takes from three to
twelve months. Because TENS and NMS devices were marketed prior to 1976, all
design enhancements since 1976 requiring regulatory approval have been marketed
under this less burdensome form of FDA procedure. Further, the electrical
stimulation products designed for fitness and toning that we market in the
United States for consumer applications, which are based on the same technology
as NMES devices, are also being marketed on the basis of 510(k) pre-market
notifications. We will be required to complete the regulatory review process
of additional 510(k) submissions we have made for other products that we intend
to market over the counter. If we are not able to successfully complete this
process, the products may be limited to sale on physician prescription. As a manufacturer of medical devices, we are also subject to regulation by the
FDA of our design and manufacturing processes and facilities under the FDAs
QSR requirements (formerly Good Manufacturing Practices) and other similar
regulations. These regulations require that we design and manufacture our
products and maintain documents in a prescribed manner with respect to design,
manufacturing, testing and control activities. We believe that our procedures
substantially conform to the requirements of the FDA regulations. The FDA and various state agencies also regulate the labeling of our medical
devices, including any promotional activities sponsored or marketing materials
distributed by us or on our behalf. While the FDA cannot prohibit a licensed
health care professional from using a device for purposes other than indicated
in its labeling (i.e., an off-label use), if the FDA determines that a
manufacturer or seller is engaged in off-label marketing of a product subject
to FDA regulations, the FDA may take administrative, civil or criminal actions
against the manufacturer or seller. The regulations of state agencies with
respect to the advertisement and promotion of medical devices may be even more
restrictive. International. In some of the foreign countries in which we market our medical
products, we are subject to regulations similar to those of the FDA, such as
Germany, but in most of the countries that are member states of the European
Union, the regulations are substantially different. The regulation of our
products in Europe falls primarily within the European Economic Area, which
consists of the fifteen member states of the European Union as well as Iceland,
Liechtenstein and Norway. The legislative bodies of the European Union have
adopted three directives in order to harmonize national provisions regulating
the design, manufacture, clinical trials, labeling and adverse event reporting
for medical devices: the Actives Implantables Directive, the Medical Device
Directive and the In-Vitro-Diagnostics Directive. The member states of the
European Economic Area have implemented the directives into their respective
national law. 17




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Medical devices that comply with the essential requirements of the national
provisions and the directives will be entitled to bear a CE marking. Unless an
exemption applies, only medical devices which bear a CE marking may be marketed
within the European Economic Area. All of the products we manufacture and
market for medical applications in Europe bear the CE mark. Post market surveillance of medical devices in the European Economic Area is
generally conducted on a country-by-country basis. The requirement within the
member states of the European Economic Area vary. In many countries, such as
Germany, the national health or social security organizations require our
products to be qualified before they can be marketed as medical products with
the benefit of reimbursement eligibility. Due to the movement towards
harmonization of standards in the European Union and the expansion of the
European Union, we expect a changing regulatory environment in Europe
characterized by a shift from a country-by-country regulatory system to a
European Union-wide single regulatory system. Employees We had approximately 432 employees as of June 30, 2004. This includes 306
employees in the U.S., primarily in New Brighton and Tampa, and 126 employees
in Europe, primarily in Switzerland, Italy, France, Spain and Germany. Our employees are not represented by any collective bargaining organization and
we have never experienced a work stoppage. We believe that our relations with
employees generally have been good. 
 Item 2. Properties Our corporate headquarters are located in a 30,000 square foot facility in New
Brighton, Minnesota, a suburb of St. Paul, Minnesota. This facility houses all
of our corporate activities including administration, finance, sales and
marketing, research and development, and manufacturing. We own this facility. We entered into a 10-year lease effective June 1, 1999 for 26,000 square feet
of office space in Tampa, Florida for our direct sales, customer service,
patient support and billing and collection activities. We currently lease five facilities in Europe that total approximately 20,000
square feet of leased space. These leases range in duration from one to three
years and are all renewable. Based on anticipated personnel requirements in both New Brighton and Tampa, we
will likely need to expand our facilities during the year. The company feels
there is additional leasehold space available at favorable rates, if needed.
Based on budgeted headcount for FY2005, we will likely run short of office
space and parking at the headquarters at some point during the year. We also believe that our current facilities near Lausanne, Switzerland are
adequate for our European administrative operations for the coming year. We
believe that additional leasehold space is currently readily available in all
jurisdictions at favorable rates. We are paying rent on an 8,000 square foot warehouse facility in New Brighton.
We are renting additional warehouse space as needed amounting to approximately
10,000 to 15,000 square feet in Eagan, MN. 
 Item 3. Legal Proceedings. In late January 2001, we were served with documents in connection with a
product liability case brought in the California Superior Court for Solano
County. Although we had no record of the proceedings, the action had
progressed to the entry of a default judgment on January 11, 2001. We appealed
the default judgment to the California Court of Appeals in March 2001. On May
10, 2002, the appeals court overturned the default judgment holding that there
was no valid complaint against us. The plaintiff in this case has moved the
court for leave to file an amended complaint, which was granted on
September 20, 2004. 18




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The plaintiff is required to file an
amended
complaint within ten days (prior to September 30, 2004). If the plaintiff
files an amended complaint, Compex intends to contest the matter vigorously. From time to time, we have also been a party to other claims, legal actions and
complaints arising in the ordinary course of our business. We do not believe
that the resolution of such matters has had or will have a material impact on
our results of operations or financial position. 
 Item 4. Submission of Matters to a Vote of Security Holders. There were no matters submitted to a vote of our shareholders during the
quarter ended June 30, 2004. 19




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PART II 
 Item 5. Market for Common Equity and Related Stockholder Matters. Our shares are traded on The NASDAQ Stock Market under the symbol CMPX. The
table below sets forth the high and low closing sale prices of our common stock
for the periods indicated, as quoted by NASDAQ: High
    
    LowFiscal year ended June 30, 2003First Quarter
    
    $
    4.650
    
    
    $
    3.300Second Quarter
    
    
    4.100
    
    
    
    3.151Third Quarter
    
    
    3.770
    
    
    
    2.370Fourth Quarter
    
    
    4.950
    
    
    
    2.700
 High
    
    LowFiscal year ended June 30, 2004First Quarter
    
    $
    8.250
    
    
    $
    4.680Second Quarter
    
    
    12.000
    
    
    
    7.600Third Quarter
    
    
    10.100
    
    
    
    7.550Fourth Quarter
    
    
    9.200
    
    
    
    5.030
 The last sale price reported by NASDAQ on September 7, 2004 was $5.020 per
share. As of September 7, 2004, there were approximately 821 shareholders of
record (not including beneficial holders) and we estimate there were
approximately 4073 beneficial holders. We have never declared or paid a cash dividend on our common stock. We
presently intend to retain all earnings for use in the operation and expansion
of our business and therefore do not anticipate paying any cash dividends in
the foreseeable future. 
 Item 6. Selected Financial Data. For the Years Ended June 30,2000
    
    2001
    
    2002
    
    2003
    
    2004Operating results -Revenue
    
    $
    59,574,612
    
    
    $
    62,957,415
    
    
    $
    72,506,677
    
    
    $
    75,459,916
    
    
    $
    85,960,663Gross profit
    
    
    41,337,561
    
    
    
    43,245,085
    
    
    
    48,972,916
    
    
    
    52,881,653
    
    
    
    57,524,983Net income
    
    
    2,202,777
    
    
    
    3,319,989
    
    
    
    4,942,010
    
    
    
    4,961,555
    
    
    
    3,050,367Per diluted common share -Net income
    
    $
    0.21
    
    
    $
    0.31
    
    
    $
    0.44
    
    
    $
    0.45
    
    
    $
    0.24Financial data/otherCash
    
    $
    2,227,352
    
    
    $
    759,611
    
    
    $
    2,086,650
    
    
    $
    5,056,000
    
    
    $
    3,198,832Working capital
    
    
    21,495,832
    
    
    
    22,391,874
    
    
    
    25,777,799
    
    
    
    26,578,403
    
    
    
    37,483,078Total assets
    
    
    52,707,962
    
    
    
    51,495,871
    
    
    
    57,477,736
    
    
    
    65,652,307
    
    
    
    76,209,396Shareholders equity
    
    
    25,269,554
    
    
    
    28,459,216
    
    
    
    35,281,190
    
    
    
    41,544,644
    
    
    
    56,331,035Long-term obligations
    
    
    13,662,792
    
    
    
    10,433,542
    
    
    
    6,455,209
    
    
    
    1,217,268
    
    
    
    2,436,200
 20




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##### Table of Contents



Item 7. Managements Discussion and Analysis of Financial Condition and
Results of Operations. Overview We discuss the factors that significantly affected our financial results and
our financial condition in this Managements Discussion and Analysis of
Financial Condition and Results of Operations. For a more complete
understanding of these factors, you should also review our consolidated balance
sheets at June 30, 2003 and June 30, 2004, our consolidated statements of
operations, statements of shareholders equity and statement of cash flows for
the three years ended June 30, 2004, and the notes to those financial
statements. These financial statements and the report of Ernst & Young LLP on
our financial statements are included at Item 8 of this Form 10-K. Critical Accounting Policies We prepare our financial statements in accordance with accounting principles
generally accepted in the United States. Nevertheless, the preparation of
these financial statements requires that we make estimates and judgments that
affect the reported amounts of our assets, liabilities, revenues and expenses,
and related disclosure of contingent assets and liabilities. We base these
estimates on historical experience and on various other assumptions that we
believe are reasonable under the circumstances. It is our policy to evaluate
and update these estimates on an ongoing basis. The judgments and policies
that we believe would have the most significant impact on the presentation of
our financial position and results are as follows: Revenue Recognition and Provisions for Credit Allowances and Returns. In our
business, we recognize revenue upon notification from a health care provider
that equipment has been prescribed and provided to a patient and approved by
the patient and/or his/her insurance provider or upon shipment for wholesale
and consumer sales. Many providers reimburse at rates which differ from our
invoice rate based on contracts, buying agreements or negotiated rate
adjustments. In addition, patients sometimes return units after initial
acceptance when they determine that their responsibilities for co-payments,
deductibles or other charges are more than expected. We provide for these
credit allowances and returns by recording such amount as an offset to revenue
and including the provision as a part of the reserve for uncollectible accounts
receivable. We estimate the amount of this provision for credit allowances and
returns based on our historical experience with the various reimbursement
entities, any recent notifications of changes in reimbursement rates and our
historic rates of product returns. Possible changes in the number of units
returned by patients or the rates of reimbursement could cause this provision
for credit allowances and the reserve for uncollectible accounts to be
inadequate. Reserve for Uncollectible Accounts Receivable.Managing our accounts
receivable represents one of our biggest business challenges. The process of
determining what products will be reimbursed by third party payors and the
amounts that they will reimburse is very complex and the reimbursement
environment is constantly changing. We maintain a reserve for uncollectible
receivables, and provide for additions to the reserve, to account for the risk
of nonpayment. We set the amount of the reserve, and adjust the reserve at the
end of each reporting period, based on a number of factors, including
historical rates of collection, trends in the historical rates of collection
and current relationships and experience with insurance companies or other
third party payors. If the rates of collection of past-due receivables
recorded for previous fiscal periods changes, or if there is a trend in the
rates of collection on those receivables, we may be required to change the rate
at which we provide for additions to the reserve. Such a change, even though
small in absolute terms, can significantly affect financial performance in
current periods. A change in the rates of our collection can result from a
number of factors, including turnover in Company personnel, changes in the
reimbursement policies or practices of payors, or changes in industry rates of
reimbursement. Further, the reserve may be affected by significant charge-offs
if a related group of receivables become doubtful that were not previously
anticipated to be doubtful. Accordingly, the provision for uncollectible
accounts recorded in the income statement has fluctuated and may continue to
fluctuate significantly from quarter to quarter as such trends change. 21




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Carrying Value of Inventory.We maintain a large balance of electrical
stimulation devices on consignment at clinics and other health care providers
that are not under our control. In the course of our business, some of this
product is lost. Although we have the right in most cases to seek
reimbursement for the lost product from our sales representatives or the health
care providers, in some instances we forego that right in order to maintain
favorable relationships. We maintain a reserve for the amount of consignment
inventory that may be lost based on our experience as developed through
periodic field audits. We cannot be certain that future rates of product loss
will be consistent with our historical experience and we could be required to
increase the rate at which we provide for such lost inventory, thus adversely
affecting our operating results. Carrying Value of Intangible Assets.We had a balance of intangible assets of
approximately $16.4 million at June 30, 2004, most of which constituted
goodwill and the value of acquired technology, from several acquisitions. We
are required to charge-off the carrying value of identifiable intangibles and
related goodwill to the extent it may not be recoverable. We assess the
impairment of identifiable intangibles and related goodwill annually or
whenever events or changes in circumstances indicate the carrying value may not
be recoverable. Factors we consider important that could trigger an impairment
review include the following:  
    
    significant under-performance relative to expected historical
or projected future operating results;  
    
    significant changes in the manner of use of the acquired assets or our overall business strategy;  
    
    significant negative industry or economic trends; and,  
    
    significant decline in our stock price for a sustained period
and our market capitalization relative to net book value. If we determine that the carrying value of intangibles and related goodwill
might not be recoverable based upon the existence of one or more of the above
indicators of impairment, we would reduce the carrying value to its fair value. 22




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Results of Operations Revenues for our United States medical products business and our European
business grew during the year at a rate that met our expectations. A large
component of the growth in Europe was represented by favorable exchange rates.
Although these exchange rates caused increases in our recorded revenue from
European operations, they also caused corresponding increases in expense from
European operations, impacting our profitability for the year. Without giving
effect to exchange rates, our European operations did not perform to our
expectations during fiscal 2004, reflecting both a very poor economic
environment for consumer goods in Europe and continued difficulty in managing
operations in several geographies. Our United States medical products business performed very well during fiscal
2004, showing both increased revenue and profitability, offset slightly by
pressure on margins because of a change in our product revenue mix. We also
made progress in our United States consumer business during the year, entering
into a celebrity endorsement contract and devoting considerable resources to
market the business. Nevertheless, because it has taken us longer than
anticipated to commence this marketing process, our revenues from the United
States consumer business have lagged behind and did not contribute
substantially to revenue for fiscal 2004. Increased expenditures in consumer products marketing that has not yet been
matched with revenue from consumer products, caused us to substantially miss
our expectations for revenue and income for fiscal 2004. The following table sets forth information from the statements of operations as
a percentage of revenue for the periods indicated: Year Ended June 30,2002
    
    2003
    
    2004Net sales and rental revenue
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %Cost of sales and rentals
    
    
    32.5
    
    
    
    29.9
    
    
    
    33.1Gross profit
    
    
    67.5
    
    
    
    70.1
    
    
    
    66.9Operating expensesSelling, general and administrative
    
    
    52.0
    
    
    
    55.9
    
    
    
    58.1Research and development
    
    
    2.9
    
    
    
    2.8
    
    
    
    3.0Total operating expenses
    
    
    54.9
    
    
    
    58.7
    
    
    
    61.1Income from operations
    
    
    12.6
    
    
    
    11.4
    
    
    
    5.8Other expense, net
    
    
    0.9
    
    
    
    0.4
    
    
    
    0.5Income tax provision
    
    
    4.9
    
    
    
    4.4
    
    
    
    1.8Net income
    
    
    6.8
    %
    
    
    6.6
    %
    
    
    3.5
    %
 Comparison of Year Ended June 30, 2004 to Year Ended June 30, 2003 Our revenue increased by 14% to $86.0 million during fiscal 2004 from $75.5
million during fiscal 2003. Increases in our domestic medical business and our
consumer business in Europe, accounted for 8% of the increase with the
remaining 6% of the increase a result of favorable exchange rates. Revenue from our U.S. medical business
for fiscal 2004 was $51.9 million, up 6% from the $49.1 million
for fiscal 2003. On a sequential basis, U.S. revenue was relatively unchanged
versus the fiscal third quarter. Our gross medical sales business in the
United States posted a revenue increase of 10% for fiscal 2004 as compared to
fiscal 2003. This increase is primarily due to an increase in sales and
rentals of medical devices, reflecting our ongoing expansion of our direct
selling efforts to the physician markets. This is partially offset by a 4%
increase in our 23




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sales credit reserve as compared to our reserve percentage in the comparable
prior period. This increase in credit reserve reflects a shift in our revenue
mix from the higher reimbursement workers compensation/personal injury segment
to the group contract insurance segment. The company monitors the reserve
balances quarterly and makes adjustments to the reserve as deemed necessary.
We continued to expand our direct medical sales and rental business through the
acquisition of BMR-Neurotech, which was included in our results of operations
for fiscal 2004, but only partially included in fiscal 2003, as the acquisition
occurred in mid-May 2003. Our consumer business in the U.S. has seen a very modest, but steady, ramp in
sales. Our U.S. consumer business contributed approximately $800,000, or 1%,
of the growth in fiscal 2004 over prior year. We began actively promoting the
Slendertone line in October 2003, received favorable publicity in December 2003
and January 2004 in two fitness magazine articles, and obtained very favorable
results from a sports study conducted at the University of Wisconsin - La
Crosse in January 2004. We feel we have to overcome what could be conceived as
a negative image for abdominal belt products and do not expect to generate
substantial sales of these products until we have secured sales arrangements
with major retail chains. During the third quarter of fiscal 2004, we entered
into an endorsement contract with Sarah Ferguson, Duchess of York, whose
assistance may help overcome the market image of these products. Our European operations posted a revenue increase of 26% for fiscal 2004.
Approximately 16% was generated by a favorable impact of exchange rates,
reflecting the strength of the euro versus the dollar. The acquisition of
Filsport in Italy accounted for 12% and revenue from the addition of
Slendertone products contributed 6% to our European revenue increase. This
increase was partially offset by a 6% decrease in sales of our Compex line of
products. The actual number of Compex units sold were down 2% when compared to
prior year unit sales. Additionally, the product mix shifted toward our newly
introduced lower-priced models. During the fourth quarter of fiscal 2004, we
introduced the Energy line of products targeted at the health and wellness
markets, an entirely new market opportunity for us. The price points for this
market are below our higher priced models for competitive athletes. Our gross profit was $57.5 million or 66.9% of revenue during fiscal 2004.
This compares to gross profit of $52.9 million or 70.1% of revenue in fiscal
2003. Cost of sales and gross profit for fiscal 2004 also reflect the sale of
inventory that was acquired in the Filsport acquisition which, because Filsport
was a distributor, has a higher cost than inventory we have manufactured and
sold through Filsport after this acquired inventory was sold. All of the
inventory that was acquired as a part of the Filsport acquisition has been
sold. For future periods, our margin in Italy is expected to be consistent
with the margin in our other European countries. The overall decrease in
margin percentage was also impacted by lower average selling prices in Europe
due to the introduction of our fitness line of Compex products during fiscal
2004, our increased sales credit in our medical business, and a decrease in our
higher margin accessories and supplies as a percent of total revenue when
compared to fiscal 2003. We anticipate gross profit to stabilize in the
mid-60% range as our domestic consumer business becomes a greater percentage of
our revenue and as we enter the health and wellness markets in Europe. For fiscal 2004, our selling, general and administrative expenses increased 18%
to $50.0 million or 58.1% of revenue, from $42.2 million or 55.9% of revenue
for fiscal 2003. Selling, general and administrative expenses associated with
the July 2003 acquisition of Filsport and the marketing expenses for our new
consumer products both domestically and in Europe contributed significantly to
the increases in 2004. We have also
increased the number of our direct sales employees to 58 as of June 30, 2004 as
compared to 40 on June 30, 2003. This reflects our commitment to a direct
physician selling model. Additionally, foreign currency exchange rates, which
effectively increase our expenses from our European operations, contributed
approximately 4% of the increase of general and administrative expenses. We
have finalized contracts with several individuals who are endorsing our
products that require specific payments as part of these expenditures. We will
continue to devote substantial resources to marketing our consumer products
during fiscal 2005 and currently expect to increase our promotion and
advertising expenditures for both Slendertone and Compex as these products
require a continuous marketing push. Total promotion and advertising expenses associated
with the introduction of the Compex and Slendertone products in the U.S. and
with Slendertone in Europe totaled approximately $4.4 million. We also incurred administrative expenses
in fiscal 2004 that we did not incur in fiscal 2003 as we work to complete the
documentation of internal controls to meet the requirements of Sarbanes Oxley.
We started this process in the second fiscal quarter of 2004. Although our
timeline for compliance has been deferred by one year to June 30, 2005, we plan
to continue to devote significant resources to this process throughout fiscal
2005. In future periods, internal control compliance expenses will become an
ongoing part of our selling, general, and administrative expenditures. 24




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Our research and development expenses increased to $2.6 million in fiscal 2004
from $2.1 million in fiscal 2003. We anticipate the R&D spending will
increase slightly in absolute dollars as we continue to pursue new
complementary products, such as our IF3Wave medical device, our Energy and Body
line of consumer products in Europe, and our Fitness Trainer model to be
introduced in the domestic consumer market. Our R&D spending will decrease as
a percentage of revenue in future periods as our revenue from consumer products
increases as a percentage of total revenue. Interest expense increased 16% to $518,000 in fiscal 2004 from $428,000 in
fiscal 2003. In July 2003, we incurred additional borrowings of approximately
$3.8 million with a bank in Switzerland that we used to finance the acquisition
of Filsport. Although we expect, absent additional acquisitions, to reduce
borrowings during fiscal 2005, we expect that a higher level of working capital
borrowings will result to support our consumer marketing expenses and will
therefore result in higher interest expense in fiscal 2005. The provision for income taxes was 33% and 40% for fiscal years 2004 and 2003,
respectively. During the fourth quarter of fiscal 2004, the Company recognized
a reduction in income tax expense of $434,000 as the result of the resolution
of various outstanding tax issues. The Company will continue to release tax
reserves at the time they are determined to be excess, if at all. The tax rate
was lowered in the third quarter of fiscal 2003 from 42% to 40% after a review
of the tax rates in several of our European tax jurisdictions. As a result of the above activity, our net income decreased to $3.1 million in
fiscal 2004 from $5.0 million in fiscal 2003. Diluted earnings per share
decreased to $0.24 for fiscal 2004 from $0.45 for fiscal 2003. Comparison of Year Ended June 30, 2003 to Year Ended June 30, 2002 Our revenue increased 4% from $72.5 million in fiscal 2002 to $75.5 million in
fiscal 2003. Most of the increase resulted from our medical sales business in
the United States, which posted revenue increases of 5% in fiscal 2003 compared
to the same period in fiscal 2002. Our medical sales and rental business in
the United States continues to expand, with all of the growth a result of
increased volume of sales and rentals. Our wholesale business, which has been
declining because of competition from inexpensive imports, was down slightly in
fiscal 2003 as compared to fiscal 2002. Although our European operations, conducted primarily under our Compex SA
subsidiary, also contributed to our revenue growth, that growth was entirely
generated by a favorable impact by exchange rates and the strength of the Euro
versus the Dollar, for the year ended June 30, 2003. Volumes decreased in
Europe by approximately 4%, so an overall consolidated increase of 5% was due
to the favorable exchange rate. Although operations in France, Spain and
Switzerland recorded increases in revenue throughout the fiscal year, revenue
from our Italian distributor, our largest market in Europe, as well as revenue
from our Germany/Austria operations, declined. Subsequent to year-end, we
acquired Filsport Assistance S.r.l., our Italian distributor. Our gross profit as a percentage of revenue increased from 67.5% in fiscal 2002
to 70.1% in fiscal 2003. This increase is largely due to higher sales levels
of accessories and supplies domestically and to the effect of the currency
rates on our European operations. Decreased sales of lower margin consumer
product to our Italian distributor also contributed to our improved gross
margin. Our gains from revenue growth and improved gross margin during the period ended
June 30, 2003 were offset by significantly higher selling, general and
administrative expenses. These expenses increased 12% to $42.2 million or
55.9% of revenue for fiscal 2003, compared to $37.7 million or 52.0% of revenue
during the same period in fiscal 2002. Several factors contributed to the
increase in expense. We had significantly increased staffing in all
departments at our European subsidiary during the second half of fiscal 2002 to
accommodate anticipated growth. Although we reduced staffing in our European
operations during January 2003 after growth in that market did not meet our
expectations, the increased expenditures during the first half of fiscal 2003
combined with the currency translation effect from our European subsidiaries,
resulted in substantially higher selling, general and administrative expense
from our European operations. In the United States, we incurred higher selling
general and administrative expense from an increased staff of direct employee
sales representatives. This new employee sales staff did not immediately
generate 25




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revenue proportionate to their salaries. During the fourth quarter of fiscal
2003, we incurred additional selling and administrative expense at a facility
in Phoenix, Arizona, which we assumed in connection with the acquisition of BMR
Neurotech. This facility will be closed by the end of September 2003.
Finally, we incurred increased marketing expense during the second half of
fiscal 2003 related to the promotion of our new consumer business in the United
States. Research and development expenses increased slightly in fiscal 2003 compared to
the same period in fiscal 2002. This increase is primarily attributable to an
increase of development expenses at Compex SA as compared to prior year. Our interest expense decreased 36.5% to $428,000 in fiscal 2003 from $675,000
during the same period in fiscal 2002. This was primarily due to lower
interest rates and overall lower borrowing levels under our credit facility.
We incurred approximately $2.7 million of additional borrowings in February
2003 to finance the acquisition of Slendertone inventory, and $3.3 million of
additional borrowings in May 2003 to finance the acquisition of BMR Neurotech.
In July 2003, we also incurred additional borrowings of approximately $3.5
million to finance the acquisition of Filsport. Our provision for income taxes was 40% and 42% of pre-tax income for fiscal
2003 and 2002, respectively. This lower effective tax rate was generated after
review of the tax rates in several of our European tax jurisdictions during
fiscal 2003. As a result of the above activity, our net income increased to $5.0 million in
fiscal 2003 from $4.9 million in fiscal 2002. Diluted earnings per share
stayed the same at $.45 for both fiscal 2003 and 2002. Liquidity and Capital Resources On July 3, 2003, we acquired all the capital stock of Filsport Assistance
S.r.l., an independent distributor of the Compex® brand of consumer products in
Italy. The transaction involved an exchange of approximately $4.9 million in
cash for stock, but additional contingent consideration was not paid since
performance milestones were not achieved following the transaction. Based on
performance during fiscal 2004, we will not be required to pay any additional
consideration. The acquisition was financed through a newly-established credit
facility and with existing funds. Prior to the acquisition, Filsport operated
under an exclusive distribution arrangement and accounted for 25% of Compex SA
total sales (10% of consolidated sales) in fiscal 2003. The purchase
consideration exceeded the net fair value of tangible assets by $4.5 million
that was assigned to goodwill. On November 19, 2003, we entered into definitive agreements with three
independent institutional accredited investors for the private placement of
1,000,000 units of our securities at a purchase price of $8.9072 per unit.
Each unit consisted of one share of our common stock, $.10 par value per share,
and an additional right to purchase a quarter of a share of our common stock at
$9.3526 per share. The additional investment rights were exercised on February
18, 2004. The net proceeds, including the proceeds from the exercise of the
additional investor rights, were approximately $10.5 million. We used a
majority of the proceeds to reduce borrowings under our long-term and
short-term credit facilities. For the year ended June 30, 2004, our operating activities used cash of $2.0
million. The $3.1 million that we generated during the period through net
income, after adjustment for non-cash depreciation and amortization, was offset
by a $4.4 million increase in accounts receivable, $1.7 million decrease in
accounts payable and accrued liabilities and prepaid advertising and production
costs associated with our domestic consumer product launch. The increase in
receivables was primarily a result of increased revenue, the translation effect
when converting our European receivables to U.S. dollars, slower collections in
Europe as a result of the slow economy and a slight change in revenue mix in
our U.S. medical product sales.

Our reserve for uncollectible receivables
increased by approximately $2.4 million during the year ended June 30, 2004,
but remained at 38% as a percentage of total receivables.

The reserve as a percentage of receivables is
expected to increase if our revenue mix continues to shift to the lower reimbursement groups or
 until our consumer
business becomes a greater percentage of our overall receivables balance. The
increase in inventory is primarily due to additional purchases of Slendertone
inventory in Europe. The increase in accounts payable and decrease in accrued
liabilities relates to year-end June 30, 2004 timing differences and the
payment of estimated income taxes during the 2004 fiscal year. 26




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We used $4.9 million in investing activities in fiscal 2004, including $3.4
million to fund the net cash purchase price of Filsport Assistance S.r.l. and
$1.6 million for net purchases of property and equipment, primarily clinical
and rental equipment. Our financing activities generated $5.0 million of cash during the year ended
June 30, 2004. We raised $10.5 million through the private placement of
1,250,000 shares of the companys common stock described above and an
additional $3.8 million through borrowings under our Swiss credit line to
finance the July 2003 Filsport Assistance acquisition. We used $10.0 million
to repay borrowings under our U. S. credit facility and to pay-off other
long-term debt. At June 30, 2004, a total of $2.2 million remains outstanding
under the U. S. facility. We recently renegotiated our U. S. credit line up to
a $15.0 million facility with a maturity date of June 30, 2007. We currently expect to invest in sales and marketing, and in inventory and
infrastructure, over the next twelve months to introduce the Slendertone
products and the Compex sport products to the United States markets. We
started this process during fiscal 2004 and intend to invest more in fiscal
2005 based on our experience. We may also apply cash to acquisitions during
future periods. We have engaged several celebrities who have endorsed our consumer products to
act as our spokespersons in promoting those products and have agreed to pay
them for their services in appearing in advertisements and for use of their
names. We have contractual commitments under these agreements totaling
approximately $800,000 for the year ending June 30, 2005, and $900,000 for the
year ending June 30, 2006. The following table shows these and other unconditional contract commitments we
have entered into, as well as commitments we have under long-term debt and
capital and operating leases. Contractual Obligations at June 30, 2004 consist of the following: Payments Due by PeriodLess than
    
    
    
    
    
    
    
    
    
    AfterTotal
    
    1 year
    
    1-3 years
    
    4-5 years
    
    5 yearsLong Term Debt
    
    $
    3,654,300
    
    
    $
    1,218,100
    
    
    $
    2,436,200
    
    
    $
    
    
    
    $
    Notes Payable
    
    
    2,200,000
    
    
    
    2,200,000
    
    
    
    
    
    
    
    
    
    
    
    Capital Lease Obligations
    
    
    50,720
    
    
    
    50,720
    
    
    
    
    
    
    
    
    
    
    
    Operating Leases
    
    
    1,416,808
    
    
    
    317,875
    
    
    
    558,706
    
    
    
    540,227
    
    
    
    Celebrity Endorsements
    
    
    1,700,000
    
    
    
    800,000
    
    
    
    900,000
    
    
    
    
    
    
    
    Total Contractual Cash Obligations
    
    $
    9,021,828
    
    
    $
    4,586,695
    
    
    $
    3,894,906
    
    
    $
    540,227
    
    
    $
    
 At August 31, 2004, we had approximately $13.1 million of unused borrowing
capacity under our credit facilities. Historically, our cash generated from
operations has been adequate to finance most of our operating activities and to
finance debt and capital lease service, even at slightly increased investment
in marketing for new business lines. Accordingly, we believe that cash flow
from operations, with available borrowings under our credit facility, will be
adequate to fund cash requirements for the current fiscal year and the
foreseeable future. 
 Item 7a. Quantitative and Qualitative Disclosures About Market Risk During the year ended June 30, 2004, our revenue originating outside the U.S.
was 39% of total revenue, substantially all of which was denominated in the
local functional currency. Currently, we do not employ currency hedging
strategies to reduce the risks associated with the fluctuation of foreign
currency exchange rates. Our international business is subject to risks typical of an international
business, including, but not limited to: differing economic conditions, changes
in political climate, differing tax structures, other regulations and
restrictions, and foreign exchange rate volatility. Accordingly, our future
results could be materially adversely impacted by changes in these or other
factors. 27




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We are exposed to market risk from changes in the interest rates on certain
outstanding debt. The outstanding loan balance under our $15 million credit
facility bears interest at a variable rate based on the banks prime rate or
LIBOR. Based on the average outstanding bank debt for fiscal 2004, a 100 basis
point change in interest rates would not change interest expense by a material
amount. 
 Item 8. Financial Statements. Financial Statement Index Schedule
    
    PageReport of Ernst & Young LLP
    
    
    29Consolidated Balance Sheets as of June 30, 2004 and 2003
    
    
    30Consolidated Statements of Operations for the years ended June 30, 2004, 2003 and 2002
    
    
    31Consolidated Statements of Changes in Stockholders Equity for the years ended
June 30, 2004, 2003 and 2002
    
    
    32Consolidated Statements of Cash Flows for the years ended June 30, 2004, 2003 and 2002
    
    
    33Notes to Consolidated Financial Statements
    
    
    34-48
 28




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##### Table of Contents



Report of Independent Registered Public Accounting Firm To the Board of Directors and
Stockholders of Compex Technologies, Inc. We have audited the accompanying consolidated balance sheets of Compex
Technologies, Inc. as of June 30, 2004 and 2003 and the related consolidated
statements of operations, stockholders equity, and cash flows for each of the
three years in the period ended June 30, 2004. Our audits also included the
financial statement schedule listed in the index at Item 15(a). These
financial statements and schedule are the responsibility of the Companys
management. Our responsibility is to express an opinion on these financial
statements and schedule based on our audits. We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we
plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Compex
Technologies, Inc. at June 30, 2004 and 2003 and the consolidated results of
its operations and its cash flows for each of the three years in the period
ended June 30, 2004, in conformity with U.S. generally accepted accounting
principles. Also, in our opinion, the related financial statement schedule,
when considered in relation to the basic consolidated financial statements
taken as a whole, presents fairly in all material respects the information set
forth therein. /s/ Ernst & Young LLP Minneapolis, Minnesota
August 30, 2004 29




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##### Table of Contents



COMPEX TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
AS OF JUNE 30 2003
    
    2004ASSETSCURRENT ASSETSCash and cash equivalents
    
    $
    5,056,007
    
    
    $
    3,198,832Receivables, less reserves of $15,200,590 and $17,665,865
at June 30, 2003 and 2004, respectively
    
    
    24,955,130
    
    
    
    28,802,468InventoriesRaw materials
    
    
    1,393,470
    
    
    
    1,037,944Work in process
    
    
    33,670
    
    
    
    10,765Finished goods
    
    
    10,301,198
    
    
    
    11,941,708Deferred tax assets
    
    
    4,675,394
    
    
    
    6,008,936Prepaid expenses
    
    
    2,378,044
    
    
    
    3,646,300Total current assets
    
    
    48,792,913
    
    
    
    54,646,953Property, plant, and equipment, net
    
    
    4,536,804
    
    
    
    4,798,656Goodwill, net
    
    
    10,583,287
    
    
    
    15,501,566Other intangible assets, net
    
    
    883,634
    
    
    
    908,841Deferred tax assets
    
    
    750,926
    
    
    
    224,679Other assets
    
    
    104,743
    
    
    
    128,701Total assets
    
    $
    65,652,307
    
    
    $
    76,209,396LIABILITIES & STOCKHOLDERS EQUITYCURRENT LIABILITIESCurrent maturities of long-term debt
    
    $
    5,363,850
    
    
    $
    1,268,910Notes payable
    
    
    4,500,000
    
    
    
    2,200,000Accounts payable
    
    
    4,028,608
    
    
    
    5,678,181Accrued liabilities -Payroll
    
    
    1,567,710
    
    
    
    1,990,591Commissions
    
    
    679,015
    
    
    
    917,068Income taxes
    
    
    2,725,341
    
    
    
    1,731,444Other
    
    
    3,349,986
    
    
    
    3,377,681Total current liabilities
    
    
    22,214,510
    
    
    
    17,163,875LONG-TERM LIABILITIESLong-term debt
    
    
    1,217,268
    
    
    
    2,436,200Deferred tax liabilities
    
    
    675,885
    
    
    
    278,286Total liabilities
    
    
    24,107,663
    
    
    
    19,878,361STOCKHOLDERS EQUITYCommon stock, $.10 par value: 30,000,000 shares authorized;
issued and outstanding 10,948,469 and 12,425,747 shares
at June 30, 2003 and 2004, respectively
    
    
    1,094,847
    
    
    
    1,242,574Preferred stock, no par value: 5,000,000 shares authorized;
none issued and outstanding
    
    
    
    
    
    
    Additional paid in capital
    
    
    21,650,978
    
    
    
    32,887,912Unearned compensation on restricted stock
    
    
    
    
    
    
    (119,370
    )Accumulated other non-owner changes in equity
    
    
    1,870,183
    
    
    
    2,340,916Retained earnings
    
    
    16,928,636
    
    
    
    19,979,003Total stockholders equity
    
    
    41,544,644
    
    
    
    56,331,035Total liabilities and stockholders equity
    
    $
    65,652,307
    
    
    $
    76,209,396
 The accompanying notes are an integral part of these financial statements. 30




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##### Table of Contents



COMPEX TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED JUNE 30 2002
    
    2003
    
    2004Net sales and rental revenue
    
    $
    72,506,677
    
    
    $
    75,459,916
    
    
    $
    85,960,663Cost of sales and rentals
    
    
    23,533,761
    
    
    
    22,578,263
    
    
    
    28,435,680Gross profit
    
    
    48,972,916
    
    
    
    52,881,653
    
    
    
    57,524,983Operating expenses:Selling, general and administrative
    
    
    37,694,707
    
    
    
    42,170,026
    
    
    
    49,960,356Research and development
    
    
    2,090,110
    
    
    
    2,122,659
    
    
    
    2,554,290Total operating expenses
    
    
    39,784,817
    
    
    
    44,292,685
    
    
    
    52,514,646Income from operations
    
    
    9,188,099
    
    
    
    8,588,968
    
    
    
    5,010,337Other income (expense):Interest expense
    
    
    (674,737
    )
    
    
    (428,467
    )
    
    
    (517,717
    )Other
    
    
    6,648
    
    
    
    109,054
    
    
    
    84,747Income before income taxes
    
    
    8,520,010
    
    
    
    8,269,555
    
    
    
    4,577,367Income tax provision
    
    
    3,578,000
    
    
    
    3,308,000
    
    
    
    1,527,000Net income
    
    $
    4,942,010
    
    
    $
    4,961,555
    
    
    $
    3,050,367Net income per common and common equivalent shareBasic
    
    $
    0.45
    
    
    $
    0.45
    
    
    $
    0.26Diluted
    
    $
    0.44
    
    
    $
    0.45
    
    
    $
    0.24Weighted average number of shares outstandingBasic
    
    
    10,867,744
    
    
    
    10,951,808
    
    
    
    11,804,768Diluted
    
    
    11,115,322
    
    
    
    11,068,860
    
    
    
    12,683,587
 The accompanying notes are an integral part of these financial statements. 31




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##### Table of Contents



COMPEX TECHNOLOGIES, INC. AND SUBSIDIARIES 
 CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS EQUITY
FOR THE YEARS ENDED JUNE 30
 Common Stock
    
    
    
    
    
    NoteReceivable
    
    UnearnedCompensation
    
    AccumulatedOther Non-
    
    
    
    
    
    TotalAdditional
    
    from Officer/
    
    on Restricted
    
    Owner Changes
    
    Retained
    
    StockholdersShares
    
    Amount
    
    Paid-In Capital
    
    Stockholder
    
    Stock
    
    in Equity
    
    Earnings
    
    EquityBalance, June 30, 2001
    
    
    10,792,060
    
    
    $
    1,079,206
    
    
    $
    21,420,378
    
    
    $
    (189,417
    )
    
    $
    (186,563
    )
    
    $
    (689,459
    )
    
    $
    7,025,071
    
    
    $
    28,459,216Net Income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    4,942,010
    
    
    
    4,942,010Translation adjustments
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,425,023
    
    
    
    
    
    
    
    1,425,023Total comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    6,367,033Exercise of stock options and related tax benefits
    
    
    133,373
    
    
    
    13,337
    
    
    
    291,009
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    304,346Common stock issued through Employee Stock Purchase Plan
    
    
    45,896
    
    
    
    4,590
    
    
    
    107,256
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    111,846Amortization of unearned compensation
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    108,750
    
    
    
    
    
    
    
    
    
    
    
    108,750Stock surrendered in payment of note receivable and other advances
    
    
    (48,711
    )
    
    
    (4,871
    )
    
    
    (254,547
    )
    
    
    189,417
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (70,001
    )Balance, June 30, 2002
    
    
    10,922,618
    
    
    
    1,092,262
    
    
    
    21,564,096
    
    
    
    
    
    
    
    (77,813
    )
    
    
    735,564
    
    
    
    11,967,081
    
    
    
    35,281,190Net Income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    4,961,555
    
    
    
    4,961,555Translation adjustments
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,134,619
    
    
    
    
    
    
    
    1,134,619Total comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    6,096,174Exercise of stock options and related tax benefits
    
    
    58,226
    
    
    
    5,823
    
    
    
    156,485
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    162,308Common stock issued through Employee Stock Purchase Plan
    
    
    5,125
    
    
    
    512
    
    
    
    20,397
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    20,909Amortization of unearned compensation
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (15,937
    )
    
    
    
    
    
    
    
    
    
    
    (15,937
    )Cancelled restricted stock
    
    
    (37,500
    )
    
    
    (3,750
    )
    
    
    (90,000
    )
    
    
    
    
    
    
    93,750
    
    
    
    
    
    
    
    
    
    
    
    Balance, June 30, 2003
    
    
    10,948,469
    
    
    
    1,094,847
    
    
    
    21,650,978
    
    
    
    
    
    
    
    
    
    
    
    1,870,183
    
    
    
    16,928,636
    
    
    
    41,544,644Net Income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3,050,367
    
    
    
    3,050,367Translation adjustments
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    470,733
    
    
    
    
    
    
    
    470,733Total comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3,521,100Exercise of stock options and related tax benefits
    
    
    157,250
    
    
    
    15,725
    
    
    
    447,744
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    463,469Common stock issued through Employee Stock Purchase Plan
    
    
    57,130
    
    
    
    5,713
    
    
    
    195,871
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    201,584Issuance of restricted stock
    
    
    20,498
    
    
    
    2,049
    
    
    
    123,603
    
    
    
    
    
    
    
    (125,652
    )
    
    
    
    
    
    
    
    
    
    
    Amortization of unearned compensation
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    6,282
    
    
    
    
    
    
    
    
    
    
    
    6,282Options granted to Non-Employees
    
    
    
    
    
    
    
    
    
    
    74,007
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    74,007Shares issued in stock offering
    
    
    1,250,000
    
    
    
    125,000
    
    
    
    10,414,498
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    10,539,498Cancelled restricted stock
    
    
    (7,500
    )
    
    
    (750
    )
    
    
    (18,000
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (18,750
    )Cancellation of subsidiary stock
    
    
    (100
    )
    
    
    (10
    )
    
    
    (789
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (799
    )Balance, June 30, 2004
    
    
    12,425,747
    
    
    $
    1,242,574
    
    
    $
    32,887,912
    
    
    $
    
    
    
    $
    (119,370
    )
    
    $
    2,340,916
    
    
    $
    19,979,003
    
    
    $
    56,331,035
 32




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##### Table of Contents



COMPEX TECHNOLOGIES, INC. AND SUBSIDIARIES 
 CONSOLIDATED STATEMENTS OF CASH FLOW
FOR THE YEARS ENDED JUNE 30
 2002
    
    2003
    
    2004OPERATING ACTIVITIES:Net income
    
    $
    4,942,010
    
    
    $
    4,961,555
    
    
    $
    3,050,367Adjustments to reconcile net income to net cash
provided by (used in) operating activitiesDepreciation and amortization
    
    
    1,654,202
    
    
    
    1,617,006
    
    
    
    1,810,754Stock based compensation
    
    
    108,750
    
    
    
    (15,937
    )
    
    
    60,740Change in deferred taxes
    
    
    (644,360
    )
    
    
    80,111
    
    
    
    (1,162,347
    )Changes in current assets and liabilitiesReceivables
    
    
    (4,078,898
    )
    
    
    2,011,498
    
    
    
    (4,416,548
    )Inventories
    
    
    156,731
    
    
    
    (1,799,677
    )
    
    
    776,259Prepaid expenses
    
    
    826,152
    
    
    
    (601,051
    )
    
    
    (462,147
    )Accounts payable
    
    
    (1,246,490
    )
    
    
    394,799
    
    
    
    24,643Accrued liabilities
    
    
    3,155,714
    
    
    
    (1,578,475
    )
    
    
    (1,686,870
    )Net cash provided by (used in) operating activities
    
    
    4,873,811
    
    
    
    5,069,829
    
    
    
    (2,005,149
    )INVESTING ACTIVITIES:Purchase of property and equipment
    
    
    (837,255
    )
    
    
    (1,163,893
    )
    
    
    (1,606,844
    )Cash paid in asset acquisitions, net of cash received
    
    
    
    
    
    
    (3,150,000
    )
    
    
    (3,424,563
    )Sale of fixed assets
    
    
    1,500
    
    
    
    350,027
    
    
    
    Change in other assets, net
    
    
    16,979
    
    
    
    (6,036
    )
    
    
    108,433Net cash used in investing activities
    
    
    (818,776
    )
    
    
    (3,969,902
    )
    
    
    (4,922,974
    )FINANCING ACTIVITIES:Proceeds from new debt financing
    
    
    
    
    
    
    
    
    
    
    3,835,501Principal payments on long-term obligations
    
    
    (3,887,731
    )
    
    
    (2,521,736
    )
    
    
    (7,715,240
    )Proceeds from (payments on) line of credit, net
    
    
    
    
    
    
    4,500,000
    
    
    
    (2,300,000
    )Proceeds from exercise of stock options
    
    
    304,346
    
    
    
    162,308
    
    
    
    463,469Proceeds from employee stock purchase plan
    
    
    111,845
    
    
    
    20,909
    
    
    
    201,584Proceeds from stock offering
    
    
    
    
    
    
    
    
    
    
    10,539,498Net cash provided by (used in) financing activities
    
    
    (3,471,540
    )
    
    
    2,161,481
    
    
    
    5,024,812Effect of exchange rates on cash and cash equivalents
    
    
    743,544
    
    
    
    (292,051
    )
    
    
    46,136Net increase (decrease) in cash and cash equivalents
    
    
    1,327,039
    
    
    
    2,969,357
    
    
    
    (1,857,175
    )Cash and cash equivalents at beginning of year
    
    
    759,611
    
    
    
    2,086,650
    
    
    
    5,056,007Cash and cash equivalents at end of year
    
    $
    2,086,650
    
    
    $
    5,056,007
    
    
    $
    3,198,832Non-cash transactionPurchase of
equipment through capital lease obligation
    
    
    
    
    
    
    126,870
    
    
    
    Repayment of shareholder notes receivable
with existing stock
    
    
    259,417
    
    
    
    
    
    
    
    Supplemental cash flow informationInterest paid
    
    $
    674,432
    
    
    $
    418,121
    
    
    $
    517,719Income taxes paid
    
    $
    3,408,220
    
    
    $
    2,451,062
    
    
    $
    3,105,223
 The accompanying notes are an integral part of these financial statements. 33




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##### Table of Contents



COMPEX TECHNOLOGIES, INC. AND SUBSIDIARIES 
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 1. Summary of Significant Accounting Policies: Revenue Recognition and Provisions for Credit Allowances and Returns Compex Technologies, Inc. (the Company) generates revenue in the United
States from sales of its products to medical equipment dealers and from rental
or sales directly to patients and health care providers and recently from sales
of consumer products to distributors or directly to consumers. The Companys domestic medical business recognizes revenue upon notification
from a health care provider that equipment has been prescribed and provided to
a patient and approved by the patient or his/her insurance provider or upon
shipment for wholesale and consumer sales. Many providers reimburse at rates
which differ from the Companys invoice rate based on contracts, buying
agreements or negotiated rate adjustments. In addition, patients sometimes
return units after initial acceptance when they determine that their
responsibilities for co-payments, deductibles or other charges are more than
expected. The Company provides for these credit allowances and returns by
recognizing only a portion of the invoiced amount and by recording such amount
as part of the reserve for uncollectible accounts receivable. The Company
estimates the amount of this provision for credit allowances and returns based
on their historical experience with the various reimbursement entities, any
recent notifications of changes in reimbursement rates and their historic rates
of product returns. Possible changes in the number of units returned by
patients or the rates of reimbursement could cause this provision for credit
allowances and the reserve for uncollectible accounts to be inadequate. In Europe and other international markets, revenue is generated from sales to
health care providers, sport shops and direct sales to consumers. Revenue is
recognized at the time of shipment to dealers, health care providers and sport
shops, direct sales to consumers or upon notification from a health care
provider that equipment has been prescribed and provided to a patient and
approval by the patient or his/her insurance provider. All revenue is
recognized net of estimated sales allowances and returns. Principles of Consolidation The consolidated financial statements include the accounts of Compex
Technologies, Inc. and its subsidiaries. All significant inter-company
transactions and accounts have been eliminated. Reserve for Uncollectible Accounts Receivable Revenue from rental and sale of products directly to patients and health care
providers accounted for approximately 56 percent of total revenue in fiscal
2004, 61 percent in fiscal 2003 and 61 percent in 2002. A significant portion
of the related receivables are from insurance companies or other third-party
reimbursing agents. The nature of these receivables within this industry has
typically resulted in long collection cycles. The process of determining what
products will be reimbursed by third party payors and the amounts that they
will reimburse is very complex and the reimbursement environment is constantly
changing. The Company maintains a reserve for uncollectible receivables, and
provides for additions to the reserve, to account for the risk of nonpayment.
The Company sets the amount of the reserve, and adjusts the reserve at the end
of each reporting period, based on a number of factors, including historical
rates of collection, trends in the historical rates of collection and current
relationships and experience with insurance companies or other third party
payors. If the rates of collection of past-due receivables recorded for
previous fiscal periods changes, or if there is a trend in the rates of
collection on those receivables, the Company may be required to change the rate
at which they provide for additions to the reserve. A change in the rates of
the Companys collections can result from a number of factors, including
turnover in personnel, changes in the reimbursement policies or practices of
payors, or changes in industry rates of 34




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##### Table of Contents



reimbursement. Further, the reserve may be affected by significant charge-offs
if a related group of receivables become doubtful. Accordingly, the provision
for uncollectible accounts recorded in the income statement has fluctuated and
may continue to fluctuate significantly from quarter to quarter as such trends
change. Such reserves have gradually increased as third-party payors have
delayed payments and restricted amounts to be reimbursed for products and
services provided by the Company. Inventories Inventories are valued at the lower of cost (first-in, first-out basis) or
market. The Company maintains a large balance of electrical stimulation
devices on consignment at clinics and other health care providers that are not
under their control. In the course of the Companys business, some of this
product is lost. Although the Company has the right in most cases to seek
reimbursement for the lost product from their sales representatives or the
health care providers, in some instances the Company foregoes that right in
order to maintain favorable relationships. The Company maintains a reserve for
the amount of consignment inventory that may be lost based on their experience
as developed through periodic field audits. Property and Equipment Property and equipment are stated at cost. Depreciation is computed using the
straight-line method for financial reporting purposes and accelerated methods
for income tax reporting purposes. Estimated useful lives for financial
reporting purposes are as follows: Building
    
    39 yearsOffice furniture and equipment
    
    3-10 yearsProduction equipment
    
    3-5 yearsClinical and rental equipment
    
    5 years
 Goodwill and Intangibles In June 2001, the Financial Accounting Standards Board (FASB) issued Statement
of Financial Accounting Standards (SFAS) No. 142, Goodwill and other
Intangible Assets. SFAS No. 142 requires that goodwill and intangible assets
with indefinite useful lives no longer be amortized but instead be tested for
impairment at least annually. Separable intangible assets that are not deemed
to have an indefinite life will continue to be amortized over their useful
lives. The Company was required to apply the provisions of SFAS No. 142 at the
beginning of fiscal 2002. The Company performed the required impairment test
of goodwill upon adoption, and as of June 30, 2004 and 2003, and determined that no
impairment issues existed. The Company had no intangible assets with
indefinite useful lives as of June 30, 2004 and 2003. At June 30, 2004 and
2003, the Company had $15.5 million and $10.6 million, respectively, of
goodwill on its consolidated balance sheet. Changes in the net carrying amount of goodwill were as follows: Goodwill as of June 30, 2002
    
    $
    9,833,090Acquisition of BMR Neurotech
    
    
    750,197Goodwill as of June 30, 2003
    
    
    10,583,287Acquisition of Filsport Assistance S.r.l.
    
    
    4,165,369Effect of Exchange Rates
    
    
    189,481Elimination of Rehabilicare UK Goodwill
    
    
    (34,999
    )Adjustment of BMR Neurotech Goodwill
    
    
    598,428Goodwill as of June 30, 2004
    
    $
    15,501,566
 During
the current fiscal year, the Company eliminated goodwill related to a subsidiary that was
sold. The Company also adjusted goodwill during the fiscal year related to BMR
Neurotech as a result of revisions to the purchase price allocation. 35




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Other intangible assets included in other assets on the consolidated balance
sheets were as follows: June 30, 2003
    
    June 30, 2004Gross Carrying
    
    Accum.
    
    Net Carrying
    
    Gross Carrying
    
    Accum.
    
    Net CarryingValue
    
    Amortization
    
    Amount
    
    Value
    
    Amortization
    
    AmountAcquired Technology
    
    $
    1,400,000
    
    
    $
    691,047
    
    
    $
    708,953
    
    
    $
    1,400,000
    
    
    $
    866,043
    
    
    $
    533,957Non-Compete
    
    
    850,000
    
    
    
    769,844
    
    
    
    80,156
    
    
    
    850,000
    
    
    
    789,848
    
    
    
    60,152Debt Structure Costs
    
    
    346,970
    
    
    
    274,039
    
    
    
    72,931
    
    
    
    346,970
    
    
    
    343,435
    
    
    
    3,535Patents
    
    
    36,716
    
    
    
    15,122
    
    
    
    21,594
    
    
    
    36,716
    
    
    
    17,745
    
    
    
    18,971Customer List
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    369,754
    
    
    
    77,528
    
    
    
    292,226Total
    
    $
    2,633,686
    
    
    $
    1,750,052
    
    
    $
    883,634
    
    
    $
    3,003,440
    
    
    $
    2,094,599
    
    
    $
    908,841
 Aggregate amortization expense recognized for fiscal 2004, 2003, and 2002 was
$344,547, $267,018, and $267,019 respectively. The aggregate amortization
expense for the five succeeding fiscal years is expected to approximate
$893,000. Intangible assets with a definite life are amortized on a
straight-line basis over estimated useful lives ranging from 3  8 years. Advertising Advertising costs, recorded in selling, general, and administrative expense,
are expensed upon first showing of the related advertising. Total expense was
approximately $2,748,000, $550,000, and $319,000 in 2004, 2003, and 2002
respectively. At June 30, 2004, $381,428 of advertising costs are recorded in
prepaid expenses on the balance sheet related to television commercials that
had not yet aired for the first time. Research and Development Research and development costs are expensed when incurred. Stock-Based Compensation At June 30, 2004, the Company has various stock-based employee compensation
plans which are described more fully in Note 7. The Company has adopted the
disclosure-only provisions of Statement of Financial Accounting Standards No.
123 (Statement No. 123), Accounting for Stock-Based Compensation, as amended
by Statement of Financial Accounting Standards No. 148 but applies Accounting
Principles Board Opinion No. 25 (APB 25) and related interpretations in
accounting for its stock plans. Under APB 25, when the exercise price of an
employee stock option equals the market price of the underlying stock on the
date of grant, no compensation expense is recognized. 36




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Had compensation expense for the Companys stock-based compensation plans been
determined based on the fair value at the grant dates consistent with SFAS No.
123, the Companys net income and earnings per share would have been reduced to
the pro forma amounts indicated below: 2002
    
    2003
    
    2004Net Income
    
    As reported
    
    $
    4,942,010
    
    
    $
    4,961,555
    
    
    $
    3,050,367Pro forma option expense, net of tax
    
    
    (318,216
    )
    
    
    (551,524
    )
    
    
    (827,236
    )Pro forma
    
    $
    4,623,794
    
    
    $
    4,410,031
    
    
    $
    2,223,131Basic earnings per share
    
    As reported
    
    $
    0.45
    
    
    $
    0.45
    
    
    $
    0.26Pro forma
    
    
    0.43
    
    
    
    0.40
    
    
    
    0.19Diluted earnings per share
    
    As reported
    
    $
    0.44
    
    
    $
    0.45
    
    
    $
    0.24Pro forma
    
    
    0.42
    
    
    
    0.40
    
    
    
    0.18
 The fair value of each option grant is estimated on the date of grant using the
Black-Scholes option-pricing model with the following weighted-average
assumptions used for grants in 2004, 2003, and 2002: dividend yield of 0%;
expected volatility of 61.0%, 57.6% and 57.6%; risk-free interest rate of
3.60%, 2.94% and 4.82%; and expected lives of 6 years. The weighted-average fair value per option at the date of grant for options
granted in 2004, 2003, and 2002 was $3.43, $2.04, and $2.25, respectively. The Black-Scholes option-pricing 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 pricing models require the input of highly
subjective assumptions. Because our 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, the existing models may not necessarily provide a reliable
single measure of the fair value of our employee stock options. The Company loaned a total of $237,500 to an officer, $189,417 of which was
outstanding as of June 30, 2001, for the exercise of certain stock options.
This loan was repaid in full on April 24, 2002 using 35,748 shares of the
Companys common stock held by the officer. Earnings Per Share Net income per share is calculated in accordance with Financial Accounting
Standards Board Statement No. 128, Earnings Per Share. Potential common
shares are included in the diluted net income per share calculation when
dilutive. Potential common shares consisting of common stock issuable upon
exercise of outstanding common stock options are computed using the treasury
stock method. Basic net income per share is computed by dividing net income by
the weighted average number of common shares outstanding during the period.
Diluted net income per share is computed by dividing net income by the weighted
average number of common shares outstanding during the period, increased to
include dilutive potential common shares issuable upon the exercise of stock
options that were outstanding during the period. The table below is a
reconciliation of the numerator and denominator in the basic and diluted net
income per share calculation. 37




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##### Table of Contents



Twelve Months Ended June 302002
    
    2003
    
    2004NumeratorNet Income
    
    $
    4,942,010
    
    
    $
    4,961,555
    
    
    $
    3,050,367DenominatorDenominator for basic net income per share
- weighted average shares outstanding
    
    
    10,867,744
    
    
    
    10,951,808
    
    
    
    11,804,768Effect of
dilutive stock options and restricted stock
    
    
    247,577
    
    
    
    117,051
    
    
    
    878,818Denominator for diluted net income per share
- weighted average shares outstanding
    
    
    11,115,322
    
    
    
    11,068,860
    
    
    
    12,683,587Basic net income per share
    
    $
    0.45
    
    
    $
    0.45
    
    
    $
    0.26Diluted net income per share
    
    
    0.44
    
    
    
    0.45
    
    
    
    0.24
 Employee stock options of 107,393, 441,781, and 6,757 for the years ended June
30 2004, 2003, and 2002, respectively, have been excluded from the diluted net
income per share calculation because their effect would be anti-dilutive. Fair Value of Financial Instruments The Companys financial instruments primarily consist of cash, receivables and
payables for which current carrying amounts approximate fair market value.
Additionally, interest rates on outstanding borrowings are at rates which
approximate market rates for borrowings with similar terms and average
maturities, resulting in the carrying value of the Companys debt approximating
fair value. Foreign Currency Translation Assets and liabilities denominated in foreign currency are translated to United
States dollars at year-end exchange rates. Elements of the statement of
operations are translated at average exchange rates in effect during the year.
Foreign currency transaction gains and losses are included in net income.
Adjustments arising from the translation of most net assets located outside the
United States (gains and losses) are recorded as a component of accumulated
other non-owner changes in equity. Shipping and Handling Costs Shipping and handling costs related to unit and supplies fulfillment services
are included in cost of goods sold. Reclassification Certain prior year items have been reclassified to conform with the current
year presentation. 38




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Use of Estimates Preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions
that affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenue and expenses during the reporting period.
Ultimate results could differ from those estimates. The most significant
management estimates used in the preparation of the financial statements are
associated with the reserves established for sales allowances and returns,
uncollectible accounts, lost consignment inventory and inventory obsolescence. Selected Financial Statement Data 2003
    
    2004Property, plant and equipment -Land
    
    $
    150,000
    
    
    $
    150,000Buildings
    
    
    1,683,614
    
    
    
    1,683,614Clinical and rental equipment
    
    
    1,227,021
    
    
    
    1,401,842Production equipment
    
    
    3,693,298
    
    
    
    4,454,729Office furniture and equipment
    
    
    8,903,069
    
    
    
    10,594,573$
    15,657,002
    
    
    $
    18,284,758Less accumulated depreciation
    
    
    (11,120,198
    )
    
    
    (13,486,102
    )Net property, plant and equipment
    
    $
    4,536,804
    
    
    $
    4,798,656
 Included in the Companys consolidated balance sheet at June 30, 2004 and 2003
are net property, plant and equipment of the Companys foreign operations,
which are located in Europe and which total $1,274,130 and $1,112,452,
respectively. 39




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##### Table of Contents



2. Business Acquisition Acquisition of Filsport Assistance S.r.l.: On July 3, 2003, the Company acquired substantially all the capital stock of
Filsport Assistance S.r.l., an independent distributor of the Compex® brand of
consumer products in Italy. The transaction involved an exchange of
approximately $4.9 million in cash for stock. The acquisition was financed
through a newly-established credit facility and with existing funds. Prior to
the acquisition, Filsport operated under an exclusive distribution arrangement
and accounted for 25% of Compex SA total sales (10% of consolidated sales) in
fiscal 2003. The purchase consideration exceeded the net fair value of tangible
assets by $4,165,369 and was assigned to goodwill. Pro forma operating results as if Filsport had been acquired at the beginning
of fiscal 2003 are as follows (unaudited): 2003Net sales
    
    $
    81,343,139Income before taxes
    
    
    8,698,815Net income
    
    
    5,180,533Earnings per shareBasic
    
    
    .47Diluted
    
    
    .47
 The Company used existing cash, a new term loan and a credit line to finance
this business acquisition. The fair value of the assets and liabilities of the
acquired company are presented as follows: Accounts Receivable
    
    $
    2,193,589Inventories
    
    
    1,775,876Prepaid Expenses
    
    
    681,888Property and equipment, net
    
    
    135,748Goodwill
    
    
    4,165,369Other long-term assets
    
    
    12,401Accounts payable
    
    
    (1,007,062
    )Accrued liabilities
    
    
    (1,179,090
    )Liabilities forgiven
    
    
    (2,563,870
    )Long-term liabilities
    
    
    (790,286
    )Net assets acquired
    
    $
    3,424,563
 Acquisition of the Assets of BMR Neurotech, Inc.: On May 15, 2003, the Company acquired certain assets
of BMR Neurotech, Inc., for total consideration of approximately
$3.3 million. The acquisition was financed using the existing credit line.
The acquisition was accounted for using the purchase method of accounting with the purchase
price allocated to the fair value of the net assets acquired, which included accounts
receivable, inventory and fixed assets. The excess of the purchase price over the fair
value of the underlying assets acquired of $1,348,625 has been allocated to goodwill
and thus is not amortizable. Pro forma information related to this acquisition
is not included as the impact is not deemed to be material. 3. Stock Offering Compex received net proceeds from the sale of common stock to certain
shareholders in a private placement, completed on November 20, 2003, of
approximately $8.3 million and approximately $2.2 million of additional
investment rights exercised on February 18, 2004. Compex has used these
proceeds to reduce indebtedness, and intends to use the balance of the proceeds
for marketing and other expenses incurred in expanding its consumer business,
and for other general working capital requirements. On December 4, 2003, the Company filed a registration statement on Form S-3 to
register the sale of 1,250,000 shares of common stock held by three
shareholders who purchased these securities in the previously mentioned private
placements plus exercising their additional investment rights. 40




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4. Comprehensive Income SFAS No. 130, Reporting Comprehensive Income, establishes standards for the
reporting and display of comprehensive income and its components. Adjustments
to comprehensive income for the years ended June 30, 2004, 2003, and 2002
consisted solely of gains on translation of its foreign subsidiary financial
statements from the functional currency to US dollars of $470,733, $1,134,619,
and $1,425,023, respectively, resulting in total comprehensive income of
$3,521,100, $6,096,174, and $6,367,033, respectively. 5. Notes Payable and Long-Term Debt: On June 2, 2004, the Company initiated a new $15,000,000 credit facility, which
provides for revolving borrowings at varying rates based either on the banks
prime rate or LIBOR. Borrowings under the facility are secured by
substantially all assets of the Company. There were borrowings under the Companys revolving line of credit of
$2,200,000 as of June 30, 2004. There were borrowings of $4,500,000 under the
Companys revolving line of credit as of June 30, 2003. The revolving line of
credit expires on March 31, 2007. Selected data on the Companys borrowings under its revolving line of
credit is shown below: 2003
    
    2004Average balance outstanding
    
    $
    1,179,000
    
    
    $
    1,764,000Maximum balance outstanding
    
    
    4,950,000
    
    
    
    4,400,000Weighted average interest rate
    
    
    4.34
    %
    
    
    4.00
    %
 The Company was in compliance with all financial covenants in its U. S. credit
agreement as of June 30, 2004 and for the year then ended. The Company was in compliance with all financial covenants in its Swiss Credit
agreement as of June 30, 2004 and for the year then ended. 41




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##### Table of Contents



6. Long-Term Debt: Long-term obligations at June 30 consisted of the following: 2003
    
    2004Term loan, principal
payments due on a
quarterly basis and
interest due in monthly
installments through
June 2004; interest at
the back reference rate
or LIBOR plus a margin);
collateralized by
substantially all assets
of the Company other
than those pledged as
collateral on existing
lease or mortgage
obligations.
    
    $
    5,097,000
    
    
    $
    Mortgage note payable,
principle and interest
due in monthly
installments through May
2015; interest at 7.37%;
collateralized by the
Companys land and
building.
    
    
    590,640
    
    
    
    Mortgage note payable,
principal and interest
due in monthly
installments through May
2005 and a balloon
payment at that date;
interest at 9.56%;
collateralized by the
Companys land and
building.
    
    
    609,231
    
    
    
    Swiss credit facility
that provides for a
three-year term loan at
varying rates.
Borrowings under the
Swiss credit facility
are secured by all of
the equity interest held
by the Companys Swiss
subsidiary in Filsport.
The first advance on the
loan bears interest at
3.69%, the second
advance bears interest
at 4.09%, and the third
and final advance bears
interest at 4.40%.
    
    
    
    
    
    
    3,654,300Capital lease obligations
    
    
    241,535
    
    
    
    50,810Other
    
    
    42,712
    
    
    
    6,581,118
    
    
    
    3,705,110Less current maturities
    
    
    (5,363,850
    )
    
    
    (1,268,910
    )$
    1,217,268
    
    
    $
    2,436,200
 Under terms of the various loan agreements, the Company must meet certain
financial covenants, including maintaining certain levels of stockholders
equity and meeting or exceeding certain financial ratios. As of June 30, 2004,
the Company was in compliance with all such covenants. Future maturities due in each fiscal year with respect to long-term debt,
excluding obligations under capital leases, are as follows: 2005
    
    $
    1,218,1002006
    
    
    1,218,1002007
    
    
    1,218,1002008
    
    
    2009
    
    
    $
    3,654,300
 42




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##### Table of Contents



Leases The Company has commitments under various operating and capital leases which
bear interest at various rates and are payable in monthly installments through
various dates. Future minimum lease payments under non-cancelable operating
and capital leases are as follows: Capital
    
    OperatingLeases
    
    Leases2005
    
    $
    51,511
    
    
    $
    317,8752006
    
    
    
    
    
    
    288,6022007
    
    
    
    
    
    
    270,1042008
    
    
    
    
    
    
    278,208Thereafter
    
    
    
    
    
    
    262,019Total future minimum lease payments
    
    
    51,511
    
    
    $
    1,416,808Less amount representing interest
    
    
    (701
    )Present value of net minimum lease payments
    
    
    50,810Less current portion
    
    
    50,810Long-term capital lease obligation
    
    $
    0
 Rent expense under operating leases for fiscal 2004, 2003, and 2002 was
$398,466, $433,529 and $332,307, respectively. 7. Income Taxes: Deferred income taxes represent the tax effects of timing differences in the
recognition of revenue and expenses for financial reporting and income tax
purposes. Federal tax credits are recorded as a reduction of income tax
expense in the year the credits are utilized. The following summarizes the components of income before taxes: 2002
    
    2003
    
    2004Domestic
    
    $
    5,698,384
    
    
    $
    6,602,158
    
    
    $
    4,035,087Foreign
    
    
    2,821,626
    
    
    
    1,667,397
    
    
    
    542,280$
    8,520,010
    
    
    $
    8,269,555
    
    
    $
    4,577,367
 The following summarizes the components of the provision for taxes: 2002
    
    2003
    
    2004Currently payable -Federal
    
    $
    2,724,140
    
    
    $
    2,293,758
    
    
    $
    2,227,768State
    
    
    398,787
    
    
    
    345,061
    
    
    
    380,186Foreign
    
    
    1,099,433
    
    
    
    596,510
    
    
    
    445,755Deferred
    
    
    (644,360
    )
    
    
    72,671
    
    
    
    (1,526,709
    )$
    3,578,000
    
    
    $
    3,308,000
    
    
    $
    1,527,000
 43




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##### Table of Contents



A reconciliation of income tax computed at the U.S. statutory rate to the
effective income tax rate is as follows: 2002
    
    2003
    
    2004Statutory rate
    
    $
    2,982,004
    
    
    $
    2,894,344
    
    
    $
    1,602,078State taxes
    
    
    316,258
    
    
    
    347,688
    
    
    
    211,502Foreign
    
    
    131,835
    
    
    
    80,507
    
    
    
    78,821Resolution of tax issue
    
    
    
    
    
    
    
    
    
    
    (433,635
    )Other
    
    
    147,903
    
    
    
    (14,539
    )
    
    
    68,234Total
    
    $
    3,578,000
    
    
    $
    3,308,000
    
    
    $
    1,527,000
 During the fourth quarter of fiscal 2004, the Company recognized a reduction in
income tax expense of $433,635 as the result of the resolution of various
outstanding tax issues. Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Significant components
of the Companys deferred income tax liabilities and assets as of June 30, 2004
and 2003 are as follows: 2003
    
    2004Deferred tax assets -Reserve for uncollectible accounts
    
    $
    4,003,904
    
    
    $
    5,258,588Inventory
    
    
    507,700
    
    
    
    552,467Accruals and other reserves
    
    
    193,790
    
    
    
    197,881Other
    
    
    47,554
    
    
    
    224,679Total
    
    $
    4,752,948
    
    
    $
    6,233,615Deferred tax liabilities -Depreciation
    
    $
    (2,513
    )
    
    $
    (278,286
    )Net deferred tax assets
    
    $
    4,750,435
    
    
    $
    5,955,329
 Realization of the future tax benefits related to the net deferred tax assets
is dependent on many factors, including the Companys ability to generate
taxable income. Management believes that, at a minimum, it is more likely than
not that future taxable income will be sufficient to realize the recorded
asset. 44




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##### Table of Contents



8. Stockholders Equity: Stock Options The Company has 925,000 shares of its common stock reserved under its 1988
Restated Stock Option Plan and 1,400,000 shares reserved under its 1998 Stock
Incentive Plan for issuance to key employees, consultants, or other persons
providing valuable services to the Company. Options are granted at prices not
less than the fair market value on the date of grant and are exercisable in
cumulative installments over a term of five years. They expire seven to ten
years after grant. The Company also granted options to purchase a total of
650,000 shares of common stock to executives outside these plans in 2002 as an
inducement to their initial employment. These non-plan options were also
granted at prices equal to fair market value on the date of grant and expire
seven to ten years after grant. The following table summarizes information with respect to options granted
under and outside the plans as of June 30, 2004: Weighted Average
    
    Number ofExercise
    
    SharesBalance outstanding at June 30, 2001
    
    $
    2.93
    
    
    
    768,026Granted
    
    
    3.28
    
    
    
    400,000Exercised
    
    
    2.90
    
    
    
    (168,125
    )Cancelled
    
    
    2.93
    
    
    
    (197,829
    )Balance outstanding at June 30, 2002
    
    $
    3.11
    
    
    
    802,072Granted
    
    
    3.63
    
    
    
    1,247,000Exercised
    
    
    2.82
    
    
    
    (80,000
    )Cancelled
    
    
    3.28
    
    
    
    (189,073
    )Balance outstanding at June 30, 2003
    
    $
    3.46
    
    
    
    1,780,000Granted
    
    
    7.27
    
    
    
    510,998Exercised
    
    
    2.95
    
    
    
    (157,250
    )Cancelled
    
    
    3.21
    
    
    
    (115,000
    )Balance outstanding at June 30, 2004
    
    $
    4.50
    
    
    
    2,018,748Exercisable at June 30, 2004
    
    $
    3.94
    
    
    
    703,750Available for grant at June 30, 2004
    
    
    
    
    
    
    334,384
 Stock Options Outstanding
    
    Stock Options ExercisableWeighted
    
    
    
    
    
    WeightedAverage
    
    
    
    
    
    AverageWeighted Average
    
    Exercise
    
    
    
    
    
    ExerciseRange of
    
    
    
    
    
    Remaining
    
    Price
    
    
    
    
    
    PriceExercise Price
    
    Shares
    
    Contractual Life
    
    Per Share
    
    Shares
    
    Per Share$2.19 to $  2.25
    
    
    28,000
    
    
    1.6 Years
    
    $
    2.23
    
    
    
    28,000
    
    
    $
    2.23$2.39 to $  3.06
    
    
    142,500
    
    
    2.9 Years
    
    
    2.64
    
    
    
    101,250
    
    
    
    2.73$3.30 to $  3.85
    
    
    1,182,250
    
    
    5.1 Years
    
    
    3.63
    
    
    
    439,500
    
    
    
    3.63$3.87 to $10.75
    
    
    665,998
    
    
    6.6 Years
    
    
    6.53
    
    
    
    135,000
    
    
    
    6.172,018,748
    
    
    
    
    
    
    
    
    
    
    
    703,750
 45




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##### Table of Contents



Included in the options reflected in the foregoing tables are options to
purchase a total of 80,000 shares granted to two consultants during the year
ended June 30, 2004, all of which are exercisable to purchase common stock at a
price equal to fair market value on the date of grant and expire in five years. The options
vest over three years. Stock Purchase Plan The Company has reserved 200,000 authorized shares of its common stock for
issuance under its Employee Stock Purchase Plan. All full-time employees are
eligible to participate in the plan by having amounts deducted from their
earnings. After the issuance of shares under the Employee Stock Purchase Plan
with respect to the plan period ended June 30, 2004, there remained 114,510
shares available for future issuance under the Employee Stock Purchase Plan. Restricted Stock Grants On July 19, 2000, the Company issued 180,000 shares of restricted stock grants
to certain key employees under its 1998 Stock Incentive Plan. The restricted
shares were issued at $2.50 per share, which was the fair market value of the
Companys stock on the date of grant. The effect of the restricted stock grant
is to increase the issued and outstanding shares of the Companys common stock.
Deferred compensation was recorded for the restricted stock grants on the date
of grant and was amortized over the restricted stock vesting period.
Restricted stock awarded may not be voluntarily or involuntarily sold,
assigned, transferred, pledged or encumbered during the restricted period. Of
the restricted shares, 25% vested immediately, and the remaining shares vested
25% per year over a four-year period. During the years ended June 30, 2003 and
2002, the Company recognized $(15,937) and $108,750, respectively, in selling,
general and administrative expense associated with the restricted stock grant.
During fiscal 2004 and 2003, 7,500 and 37,500 shares, respectively, of
restricted stock were cancelled as the employees were terminated prior to the
shares becoming fully vested, causing a reversal of $18,750 and $93,750,
respectively, of previously recorded expense during the year. On June 6, 2004, the Company issued 20,498 shares of restricted stock grants to
certain key employees under its 1998 Stock Incentive Plan. The restricted
shares were issued at $6.13 per share, which was the fair market value of the
Companys stock on the date of the grant. These restricted shares vest 33% per
year over a three-year period. During the year ended June 30, 2004, the
Company recognized $6,282 in selling, general, and administrative expense
associated with the restricted stock grant. The Company records compensation
expense for those fixed awards granted to non-employees on a straight-line
basis over the related vesting period. 9.  Commitments and Contingencies: Litigation In late January 2001, the Company was served with documents in connection with
a product liability case brought in the California Superior Court for Solano
County. Although the Company had no record of the proceedings, the action had
progressed to the entry of a default judgment on January 11, 2001. The Company
appealed the default judgment to the California Court of Appeals in March 2001.
On May 10,
2002, the appeals court overturned the default judgment holding that there was
no valid complaint against the Company. The plaintiff in this case has moved
the court for leave to file an amended complaint, which was granted
on September 20, 2004. The plaintiff is required to file an amended complaint within
ten days (prior to September 30, 2004). If the plaintiff files an amended
complaint, the Company intends to contest the matter vigorously. 46




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##### Table of Contents



From time to time, the Company has also been a party to other claims, legal
actions and complaints arising in the ordinary course of our business. The
Company does not believe that the resolution of such matters has had or will
have a material impact on the Companys results of operations or financial
position. Commitments The Company has engaged several celebrities who have endorsed our consumer
products to act as the Companys spokespersons in promoting those products and
have agreed to pay them for their services in appearing in advertisements and
for use of their names. The Company has contractual commitments under these
agreements totaling approximately $800,000 for the year ending June 30, 2005,
and $900,000 for the year ending June 30, 2006. 401(k) Plan The Company has a 401(k) plan in which substantially all employees are eligible
to participate. Participants may contribute from 1% to 20% of eligible
earnings to the plan. Company contributions are 50% of the first 6%
contributed by the employee. In addition, the Company may make additional
discretionary contributions to the plan as determined annually. The Company
contributed $248,022, $212,581 and $204,024 to the plan for the years ended
June 30, 2004, 2003 and 2002, respectively. 10.  Segment Information: Compex Technologies and its consolidated subsidiaries operate in one reportable
segment, the manufacture and distribution of electromedical pain management,
rehabilitation and sports training products. The Companys chief operating
decision makers use consolidated results to make operating and strategic
decisions. Net revenue from United States and foreign sources (primarily
Europe) was as follows: Year ended June 302002
    
    2003
    
    2004U.S. revenue
    
    $
    46,640,968
    
    
    $
    48,947,023
    
    
    $
    52,626,316Foreign revenue
    
    
    25,865,709
    
    
    
    26,512,893
    
    
    
    33,334,347Total
    
    $
    72,506,677
    
    
    $
    75,459,916
    
    
    $
    85,960,663
 Net revenue by product line was as follows: Year ended June 302002
    
    2003
    
    2004Rehabilitation products
    
    $
    14,639,997
    
    
    $
    15,085,264
    
    
    $
    17,693,448Pain management
    
    
    14,440,064
    
    
    
    15,431,708
    
    
    
    16,652,988Consumer products
    
    
    19,273,748
    
    
    
    19,364,142
    
    
    
    26,116,237Accessories and supplies
    
    
    24,152,868
    
    
    
    25,578,802
    
    
    
    25,497,990Total
    
    $
    72,506,677
    
    
    $
    75,459,916
    
    
    $
    85,960,663
 During fiscal 2003 and 2002, one customer accounted for approximately 10% and
14%, respectively, of consolidated revenue. 47




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##### Table of Contents



11.
    
    Quarterly Data (Unaudited): Year ended June 30, 20031st Quarter
    
    2nd Quarter
    
    3rd Quarter
    
    4th Quarter
    
    TotalRevenue
    
    $
    17,737,740
    
    
    $
    18,735,080
    
    
    $
    19,143,348
    
    
    $
    19,843,748
    
    
    $
    75,459,916Gross profit
    
    
    12,290,313
    
    
    
    12,957,825
    
    
    
    13,437,688
    
    
    
    14,195,827
    
    
    
    52,881,653Net Income
    
    
    987,007
    
    
    
    942,252
    
    
    
    1,355,442
    
    
    
    1,676,854
    
    
    
    4,961,555Net income per
common share -Basic
    
    
    0.09
    
    
    
    0.09
    
    
    
    0.12
    
    
    
    0.15
    
    
    
    0.45Diluted
    
    
    0.09
    
    
    
    0.08
    
    
    
    0.12
    
    
    
    0.15
    
    
    
    0.45
 Certain quarterly items have been reclassified to conform with the current year
presentation. Year ended June 30, 20041st Quarter
    
    2nd Quarter
    
    3rd Quarter
    
    4th Quarter
    
    TotalRevenue
    
    $
    19,156,266
    
    
    $
    22,464,599
    
    
    $
    21,651,597
    
    
    $
    22,688,201
    
    
    
    85,960,663Gross profit
    
    
    12,719,020
    
    
    
    15,304,092
    
    
    
    14,571,045
    
    
    
    14,930,826
    
    
    
    57,524,983Net Income
    
    
    354,157
    
    
    
    1,228,583
    
    
    
    428,735
    
    
    
    1,038,892
    
    
    
    3,050,367Net income per
common share -Basic
    
    
    0.03
    
    
    
    0.11
    
    
    
    0.03
    
    
    
    0.09
    
    
    
    0.26Diluted
    
    
    0.03
    
    
    
    0.10
    
    
    
    0.03
    
    
    
    0.08
    
    
    
    0.24
 
 Item 9. Changes In and Disagreements with Accountants on Accounting and Financial
Disclosure. None 
 Item 9A. Controls and Procedures. Under the supervision and with the participation of our management, including
our Chief Executive Officer and Chief Financial Officer, we evaluated the
effectiveness of the design and operation of our disclosure controls and
procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of
1934 (the Exchange Act)). Based upon that evaluation, the Chief Executive
Officer and Chief Financial Officer concluded that, as of the end of the period
covered by this report, our disclosure controls and procedures were effective
in timely alerting them to the material information relating to us (or our
consolidated subsidiaries) required to be included in the reports we file or
submit under the Exchange Act. During the quarter ended June 30, 2004, there has been no change in our
internal control over financial reporting (as defined in Rule 13a-15(f) under
the Exchange Act) that has materially affected, or is reasonably likely to
materially affect, our internal control over financial reporting. 
 Item 9B. Other Information. Not applicable 48




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##### Table of Contents



PART III 
 Item 10. Directors and Executive Officers of the Registrant. The information contained under the headings Proposal I: Election of
Directors, Executive Officers Who Are Not Directors, Information About Our
Board Of Directors And Its Committees, And Other Corporate Governance
MattersAudit Committee and -Compliance with section 16(a) of the Securities
Exchange Act of 1934 of our definitive proxy statement for our annual meeting
of shareholders to be held November 11, 2004 (hereafter the Proxy Statement),
is incorporated herein by reference. 
 Item 11. Executive Compensation. The information under the heading Executive Compensation and Performance
Graph of the Proxy Statement is incorporated herein by reference. 
 Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters. The information under the heading Security Ownership of Certain Beneficial
Owners and Management of the Proxy Statement is incorporated herein by
reference. 
 Item 13. Certain Relationships and Related Transactions. Not applicable 
 Item 14. Principal Accountant Fees and Services The information contained under the heading Relationship with Independent
Accountants of the Proxy Statement is incorporated herein by reference. 
 Item 15. Exhibits, Financial Statement Schedules (a) 1. Financial Statements The consolidated financial statements required by this item are listed in
the Index to Consolidated Financial Statements set forth in Item 8 of this
Form 10-K. 2. Financial Statement Schedules Schedule II  Valuation and Qualifying Accounts. Such schedule should be
read in conjunction with the consolidated financial statements. All other
schedules have been omitted because they are not applicable or not
required, or because the required information is included in the financial
statements or the notes thereto. 49




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##### Table of Contents



3. Exhibits Number
    
    Description3.1
    
    Restated Articles of Incorporation, as amended (incorporated by reference to Exhibit 3.1
to our Annual Report on Form 10-K for the year ended June 30, 2002 filed September 30,
2003 (File Number 0-9407))3.2
    
    Articles of Merger changing the name of the Registrant to Compex Technologies, Inc.
(Incorporated by reference to Exhibit 4.2 to our Registration Statement on Form S-8
filed March 14, 2003 (File No. 333-103817))3.3
    
    Restated Bylaws of Compex Technologies, Inc., as amended (incorporated by reference to
Exhibit 3.2 to our Quarterly Report on Form 10-Q for the Quarter ended March 31, 2003
(File Number 0-9407))4.1
    
    1988 Restated Stock Option Plan, as amended (incorporated by reference to Exhibit 4.1 to
our Annual Report on Form 10-K for the year ended June 30, 2002 filed September 30, 2003
(File Number 0-9407))4.2
    
    1993 Employee Stock Purchase Plan (Incorporated by reference to Exhibit 4.4 to our
Registration Statement on Form S-8 filed March 14, 2003 (File No. 333-103817))4.3
    
    Compex Technologies, Inc. 1998 Stock Incentive Plan (Incorporated by reference to
Appendix E to the final prospectus included in Amendment No. 1 to the our Registration
Statement on Form S-4 filed February 2, 1998 (file no. 333-44139))4.4
    
    Rights Agreement dated as of February 17, 2003 between Compex Technologies, Inc. and
Registrar and Transfer Company (incorporated by reference to our Form 8-A filed February
18, 2003 (File Number 0-9407))+10.1
    
    Form of Severance Pay Agreement (Incorporated by reference to our Form 10-KSB for the
year ended June 30, 1997 (File Number 0-9407))*10.2
    
    Credit Agreement dated June 2, 2004 between Compex Technologies, Inc. and U.S. Bank
National Association.10.3
    
    Security Agreement dated July 14, 1999 between Compex Technologies, Inc. and U.S. Bank
National Association. (Incorporated by reference to the Companys Current Report on Form
8-K filed August 2, 1999 (File No. 0-9407)10.4
    
    Stock Pledge Agreement dated July 19, 1999 between Rehabilicare Inc. and U.S. Bank
National Association covering all shares of capital stock in Compex SA owned by
Rehabilicare Inc. (Incorporated by reference to the Companys Current Report on Form 8-K
filed August 2, 1999 (File No. 0-9407))+10.5
    
    Employment Agreement dated as of August 12, 2002 between Rehabilicare Inc. and Dan
Gladney (incorporated by reference to Exhibit 10.10 to our Annual Report on Form 10-K
for the year ended June 30, 2002 filed September 30, 2003)+10.6
    
    Employment Agreement Amendment dated February 5, 2003 between Compex Technologies, Inc.
and Dan Gladney (incorporated by reference to Exhibit 10.11 to our Annual Report on Form
10-K for the year ended June 30, 2003)+10.7
    
    Non-Incentive Option Agreement dated August 12, 2003 between Compex Technologies, Inc.
and
 50




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##### Table of Contents



Dan Gladney (incorporated by reference to Exhibit 10.12 to our Annual Report on Form
10-K for the year ended June 30, 2003)+10.8
    
    Non-Incentive Option Agreement (with acceleration) dated August 12, 2003 between Compex
Technologies, Inc. and Dan Gladney (incorporated by reference to Exhibit 10.13 to our
Annual Report on Form 10-K for the year ended June 30, 2003)+10.9
    
    Employment Agreement dated as of December 2, 2002 between Rehabilicare Inc. and Scott
Youngstrom (incorporated by reference to Exhibit 10.14 to our Annual Report on Form 10-K
for the year ended June 30, 2003)+10.10
    
    Employment Agreement dated as of November 25, 2002 between Rehabilicare Inc. and
Marshall Masko ( incorporated by reference to Exhibit 10.15 to our Annual Report on Form
10-K for the year ended June 30, 2003)+10.11
    
    Employment Agreement dated as of September 1, 2003 between Rehabilicare Inc. and G.
Michael Goodpaster+10.12
    
    Form of Incentive Option Agreement granted to Scott Youngstrom, Marshall Masko and G.
Michael Goodpaster.*+10.13
    
    Form of Restricted Stock Agreement for restricted stock grants to Dan Gladney, Scott
Youngstrom, Marshall Masko, and G. Michael Goodpaster*+10.14
    
    Employment Agreement dated as of July 29, 2002 between Compex Medical SA and Serge Darcy.21
    
    Subsidiaries (Incorporated by reference to Exhibit 21 to Rehabilicares Annual Report on
Form 10-K for the year ended June 30, 2001 (File No. 0-9407))* 23.1
    
    Consent of Independent Registered Public Accounting Firm  Ernst & Young LLP*31.1
    
    Certification of Chief Executive Officer pursuant to Rule 15d-14(a)(17 CFR
240.15d-14(a)) and Section 302 of the Sarbanes-Oxley Act of 2002*31.2
    
    Certification of Chief Financial Officer pursuant to Rule 15d-14(a)(17 CFR
240.15d-14(a)) and Section 302 of the Sarbanes-Oxley Act of 2002*32
    
    Certification of Chief Executive Officer and Chief Financial Officer Pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002 (Furnished but not filed)
   +
    
    Management compensatory plan or agreement*
    
    Filed with this Form 10-K 51




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##### Table of Contents



SIGNATURES In accordance with 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, hereunto duly authorized. COMPEX TECHNOLOGIES, INC.Dated: September 28, 2004
    
    By:
    
    /s/ Dan W. GladneyDan W. GladneyPresident and Chief Executive Officer
 In accordance with the Securities Exchange Act of 1934, this report has been
signed below by the following persons on behalf of the registrant and in the
capacities and on the dates indicated. NAME
    
    TITLE
    
    DATE/s/ Dan W. Gladney
    
    President, Chief Executive Officer
    
    September 28, 2004Dan W. Gladney/s/ Scott P. Youngstrom
    
    Vice President of Finance
(PrincipalFinancial and
Accounting Officer)
    
    September 28, 2004Scott P. Youngstrom/s/ John H.P. Maley
    
    Chairman and Director
    
    September 28, 2004John H.P. Maley/s/ Frederick H. Ayers
    
    Director
    
    September 28, 2004Frederick H. Ayers/s/ Richard E. Jahnke
    
    Director
    
    September 28, 2004Richard E. Jahnke/s/ Jack Smith
    
    Director
    
    September 28, 2004Jack Smith
 52




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Schedule II  Valuation and Qualifying Accounts Accounts ReceivableReserve DeductionsCharged toBalance at
    
    
    
    
    
    allowance for
    
    Charged tobeginning of
    
    
    
    
    
    doubtful
    
    credit
    
    Balance atDescription
    
    period
    
    Additions
    
    accounts
    
    reserve
    
    end of periodAccount Receivable ReserveJune 30, 2004
    
    $
    15,200,590
    
    
    $
    19,119,698
    
    
    $
    2,994,826
    
    
    $
    13,659,597
    
    
    $
    17,665,865June 30, 2003
    
    
    12,891,864
    
    
    
    17,992,096
    
    
    
    3,826,318
    
    
    
    11,851,052
    
    
    
    15,200,590June 30, 2002
    
    
    11,141,407
    
    
    
    13,952,724
    
    
    
    2,973,695
    
    
    
    9,228,571
    
    
    
    12,891,864
 Inventory Reserve DeductionsBalance at
    
    
    
    
    
    Charged to
    
    Charges tobeginning of
    
    
    
    
    
    inventory
    
    other
    
    Balance atDescription
    
    period
    
    Additions
    
    reserve
    
    accounts
    
    end of periodInventory ReserveJune 30, 2004
    
    $
    838,413
    
    
    $
    527,075
    
    
    $
    424,157
    
    
    
    
    
    
    $
    941,331June 30, 2003
    
    
    515,013
    
    
    
    835,562
    
    
    
    512,162
    
    
    
    
    
    
    
    838,413June 30, 2002
    
    
    596,306
    
    
    
    824,442
    
    
    
    905,735
    
    
    
    
    
    
    
    515,013
 53