** **

**UNITED STATESSECURITIES AND EXCHANGE COMMISSION****Washington, D.C. 20549**

 

**FORM 10-K/A**

 

**Amendment No.1 to**

 

| ý |   | **Annual report pursuant to Section 13 or 15(d) of the Securities  Exchange Act of 1934**                                                                        |
|--------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   | **For the fiscal year ended December  31, 2001, or**                                                                                                             |
|   |   |                                                                                                                                                             |   |   |
| o      |   | **Transition report pursuant to Section 13 or 15(d) of the Securities  Exchange Act of 1934**                                                                    |
|   |   | **For the transition period  from          to            .** |

 

 

**Commission File No. 0-19195**

 

**AMERICAN MEDICAL TECHNOLOGIES, INC.**(Exact name ofregistrant as specified in its charter)

 

| **DELAWARE**                     |   | **38-2905258**         |
|----------------------------------|--------|------------------------|
| (State or other  jurisdiction of |   | (I.R.S. employer       |
| incorporation or  organization)  |   | identification number) |

 

**5555Bear Lane, Corpus Christi, TX 78405**(Address of principal executive offices)(Zip Code)

 

**(361)289-1145**(Registrantstelephone number, including area code)

 

Securitiesregistered pursuant to Section 12(b) of the Exchange Act:

 

| Title of Each Class |   | Name of Exchange on  which registered |
|---------------------|--------|---------------------------------------|
| None                |   | Not Applicable                        |
|                |   |                                  |

Securities registeredpursuant to Section 12(g) of the Act:Common Stock, $.04 par value per share(Title of Class)

 

Indicate by check mark whether the registrant (1) filed all reportsrequired to be filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject to suchfiling requirements for the past 90 days.

 

Yes  ý        No  o

 

Indicate by check mark if disclosure of delinquent filers pursuant toItem 405 of Regulation S-K is not contained herein, and will not be contained,to the best of registrant’s knowledge, in definitive proxy or informationstatements incorporated by reference in Part III of this Form 10-K or anyamendment to this Form 10-K.   o

 

The aggregate market value of the registrant’s Common Stock held bynon-affiliates of the registrant was approximately $2,623,924 as of March 20,2002, based upon the last sales price reported on The Nasdaq National Market onthat date.  For purposes of this calculationonly, all directors, executive officers and owners of more than ten percent ofthe registrant’s Common Stock are assumed to be affiliates.  There were 6,862,348 shares of theregistrant’s Common Stock issued and outstanding on March 20, 2002.

 

DOCUMENTSINCORPORATED BY REFERENCE

 

None.

 

 

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# **PART I**

 

 

# **ITEM1.              DESCRIPTION OF BUSINESS**

 

 

**Introduction**

 

            AmericanMedical Technologies, Inc. (“American Medical” or “Company”) develops,manufactures and markets high technology products designed primarily forgeneral dentistry.  American Medical’sprimary products are pulsed dental lasers, primarily the Diolase andPulseMaster models; the Anthos System line of dental chairs and units, highspeed curing lights (“PAC”); air abrasive kinetic cavity preparation systems(“KCP”), and intra oral cameras (“Ultracam”), which are developed andmanufactured at its manufacturing facility in Corpus Christi, Texas.  American Medical also develops, manufacturesand markets precision air abrasive jet machining (“AJM”) systems for industrialapplications.  American Medical,incorporated in Delaware in November 1989, completed its initial publicoffering in June 1991.  American Medicalchanged its name from American Dental Technologies, Inc. on July 13, 2000.

 

 

# **Products**

 

*LaserProducts*

# ** **

            The PulseMaster 600-IQ is aneodymium yttrium-aluminum-garnet (Nd:YAG) laser that delivers pulses of laserenergy through a flexible fiber optic delivery system that can reach intodifficult recesses of the mouth.  ThePulseMaster can deliver a 100-microsecond energy pulse at rates varying from 10to 200 times per second, and at up to six watts of average power.  The PulseMaster is contained in a movablecabinet the size of a medium suitcase, weighs approximately 75 pounds and plugsinto a standard electrical outlet.

 

            The Diolase is a diode laser thatdelivers a continuous wave or gated continuous wave through a flexible fiberoptic delivery system that can reach difficult recesses of the mouth.  The Diolase delivers up to 6 watts of powerdepending upon the fiber size used.  TheDiolase is compact and portable in size, weighs approximately 11 pounds andplugs into a standard electrical outlet.

 

                The Companyintroduced the “Cavilase”, an Erbium:YAG laser, in late 2001.  The Cavilase delivers pulsed laser energythrough a flexible diamond fiber at pulse rates varying from 20 to 60 times persecond at up to 6 watts of power.  It iscontained in a movable cabinet weighing approximately 160 pounds and can be pluggedinto a standard outlet.  As of March 25,2002, the Company had backlog orders of more than $726,295 for theCavilase.  The Cavilase is in its finalstages of development and the Company cannot predict when it will begin fillingthese orders.

 

            AmericanMedical believes one important feature of its dental lasers is their ability tohelp reduce the pain associated with the procedures for which they are used.Additionally, because the laser is more precise than standard dentalinstruments, its use results in less cellular destruction.  The laser minimizes bleeding during softtissue surgery, creating a cleaner field in which to operate by eliminatingtime-consuming removal of blood from the operative site.  The laser also reduces the risk ofpost-operative infection.

# ** **

            AmericanMedical’s dental lasers are used for both soft tissue and hard tissueapplications.  Soft tissue proceduresinclude removing excess or diseased gum tissue, contouring gums, performingbiopsies, preparing gums for crown and bridge impressions, trimming the gums tofit crowns and bridges, treating gum disease and for hemostasis (control ofbleeding).  Hard tissue applicationsinclude removing early decay from teeth, etching, increasing hardness ofdentin, and desensitizing and anesthetizing teeth.  In 1999, American Medical received FDA clearance to market thePulseMaster for the selective removal of enamel decay.  Additionally, in September of 2001, the Companyreceived clearance to market the Cavilase for general removal of enamel decay.  American Medical has not received clearancefrom the FDA to market dental lasers in the United States for any other hardtissue application, but does market these instruments in certain othercountries for such purposes.  See“Governmental Regulation.”

# ** **

            AmericanMedical’s dental lasers, components and accessories are sold primarily incertain Asian and Pacific markets, Europe and North America.  Lasers represented approximately 52%, 54%and 27% of American Medical’s total revenues during 2001, 2000 and 1999,respectively.

 

 

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## * *

## *Anthos System Dental Chairs and Units*

 

            InMay of 2001, American Medical signed an agreement with CEFLA S.c.r.l. grantingthe Company exclusive rights to distribute, in the United States, the operatoryequipment which CEFLA manufactures in Italy under the Anthos trade name. Theparties also agreed to integrate the five high-tech dental equipment lines ofAmerican Medical into the Anthos chairs and units. The five high-tech dentalequipment lines have been integrated, and it is the only chair and unit in theworld with these technologies built in. In September of 2001 the Company received 510(k) FDA clearance to marketAnthos System dental units and distribution began in the fourth quarter of2001.  Anthos System sales representedless than 5% of American Medical’s total revenues during 2001.  As of March 25, 2002, the Company hadbacklog orders of $320,652 for the Anthos System.

## * *

 

## *Plasma Arc Curing Systems*

 

            AmericanMedical markets a Plasma Arc Curing System (“PAC”) that utilizes a highintensity light source to rapidly cure composite fillings.  Curing occurs in five to ten seconds, or atleast twice as fast as most conventional curing lights.

 

            AmericanMedical’s PAC products, components and accessories are sold primarily in NorthAmerica, certain Asian and Pacific markets, and Europe.  PAC products represented approximately 7%,12% and 26% of American Medical’s total revenues during 2001, 2000 and 1999,respectively.

 

 

## *KCP Cavity Preparation Systems*

 

            AmericanMedical currently offers several KCP models that vary in size, power andfeatures, from the KCP 5 counter top model to the deluxe KCP 1000PACmodel.  American Medical’s KCP productsremove tooth decay and tooth structure, including enamel, by means of a narrowstream of minute particles of alpha alumina propelled at high velocity bycompressed air and delivered to the tooth via a lightweight handpiece.  The KCP shapes restoration sites, removesold composites and modifies underlying hard tissue, often helping to increasebond strength.  It is also used forsealant preparations, stain removal and intraoral porcelain removal andrepair.  The KCP can often be used inplace of a drill and may be used in many cases without anesthesia.  The dentist controls the cutting speed byselecting particle size (27 or 50 micron) and air pressure (40 psi to 160 psi)with touch pads on a control panel.  Theair abrasive stream is activated by a foot pedal.   The KCP floor models (KCP 100 and KCP 1000) are contained in amovable cabinet the size of a medium suitcase and plug into a standardelectrical outlet.

 

            TheKCP is best used in conjunction with modern tooth-colored composite restorationmaterials.  It is not recommended forremoving large amalgam fillings.  Theprecision of the KCP, and the manner in which it prepares surfaces forrestorations, allow for earlier treatment of decay and less destruction of thetooth while restoring it.  In manycases, the KCP may be used without anesthesia, allowing a dentist to treatteeth in different quadrants of the mouth during a single visit.  This is generally not possible whenconventional instruments and anesthesia are used.

 

            AmericanMedical also markets its PAC as an accessory to its KCP.  The KCP1000 PAC combines an air abrasivecavity preparation system together with a composite curing light in a singleinstrument.  This allows dentists toefficiently switch from cavity preparation to curing.

 

            TheKCP is sold primarily in North America, certain Asian and Pacific markets andEurope.  The KCP representedapproximately 8%, 6% and 15% of American Medical’s total revenues in 2001, 2000and 1999, respectively.

 

 

*IntraOral Camera Products*

 

                The Ultracam is asophisticated camera system that allows the dentist to take pictures of apatient’s teeth during an examination. The pictures can be projected on a video monitor in the examination roomfor immediate viewing by the dentist and the patient, and printed or stored ona computer disk.  The Ultracam systemsoffered vary in size from the basic cart system, which is a portable camera andprinter housed in a mobile cart, to a networked system that can be utilized inseveral examination rooms.  Thenetworked systems combine the cart system with central printing stations,digital docking stations and examination room monitors.

 

 

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                The Ultracam isutilized in the dental practice for presentation, education and as a means ofcommunicating their services through multi-media.  The Digital Docking Station, introduced in 1999, greatly enhancesthe value of an intra oral camera by allowing the storage of up to 40 images ona 3 1⁄2 inch computer floppy disk.

 

                Ultracam productsare sold primarily in North America and Europe.  The Ultracam products represented approximately 10%, 14% and 22%of American Medical’s total revenue in 2001, 2000 and 1999, respectively.

 

 

*Probe One and Chart-It*

 

                The Probe One is acomputerized periodontal probe which works with practice management software toautomate and streamline perio-probing and charting.  Chart-It is an automated charting software program used to fullyintegrate a dentist’s operatory with most front office practice managementsystems.  These products representedless than 1% of the Company’s total revenues in 2001, 2000 and 1999,respectively.

 

 

*IndustrialProducts*

# ** **

            American Medical also develops, manufactures and marketsprecision air abrasive jet machining (“AJM”) systems for industrialapplications.  The AJM system has a widerange of applications, including drilling, cutting, abrading, deburring,dressing, beveling, etching, shaping and polishing.  Its principal advantage over conventional machining is that theAJM process, which accomplishes its work through kinetic particle displacement(an erosion process), produces no heat, shock or vibration.  This enables precise work to be done onfragile materials without deburring or further processing.  Generally, the same is not true of drills,saws, laser or other types of conventional machining equipment because all ofthese systems rely on heat and/or friction to perform the work.  These machining techniques generally requirefurther processing and in many instances do not provide the precision availablewith AJM, particularly with fragile materials. AJM systems are often used to remove the slag, burrs and flash resultingfrom conventional machining processes. Some examples include deburring needles, beveling silicon wafers andcutting fiber optics.

# ** **

                Industrialproducts accounted for less than 5% of American Medical’s total revenues in2001, 2000 and 1999, respectively.

 

 

# **Marketing, Sales and Training**

# ** **

            Priorto February 14, 2000, American Medical marketed its dental products throughindependent distributors, primarily Patterson Dental Company and SullivanSchein, Inc., to general dental practitioners and certain other dentalspecialists in the United States. Sales to Patterson Dental Company, a majordomestic distributor of the Company’s kinetic cavity preparation units, wereapproximately 16% of total revenues in 1999.

 

                On February 14,2000, the Company changed its business model and began selling its dentalproducts directly to dentists in the United States through its own salesforce.  The revised business modelcalled for the establishment of dental sales and service centers in largemetropolitan areas throughout the United States.  The centers are staffed with sales personnel, an officecoordinator responsible for scheduling, coordinating local marketing andreporting to corporate headquarters, and service technicians for installationand technical service support.  Outsidethe United States, including Canada, American Medical would continue sellingits dental products through its strong distributor network.

 

Another key facet of the revised business model isthat the Company intends not only to sell the dental products it manufactures,but also to actively pursue OEM or strategic relationships with othermanufacturers of dental and other medical technology products.  Within five years, the Company hopes to beable to offer a line of products representing 80% to 90% of the equipment usedby dentists.

 

                In the thirdquarter of 2001, in response to the apparent downturn in the economy, theCompany made certain changes to the business model.  The Company closed 2 under-performing sales and service centersand 17 sales and sales support positions were eliminated.  The remaining offices were reorganized withthe creation of 5 regional offices each supporting 2 to 3 satellite offices.  As of March 20, 2002, the Company has 5regional offices and 9 additional satellite offices operational.

# ** **

 

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                Internationally,American Medical’s products were exclusively marketed in Japan by Denics Co.Ltd. (“Denics”) or its affiliates through March 2001.  Sales to Denics, the Company’s largest foreign distributor, wereapproximately 9%, 21% and 19% of total revenues in 2001, 2000 and 1999,respectively.  The Company’s contractwith Denics expired on March 31, 2001 and the Company is seeking newdistributor partners in Japan.  InGermany, the Company’s primary European market, American Medical sells directlyto the end user as well as selling through distributors.  In the rest of Europe, American Medical’sproducts are marketed through exclusive dental distributors, such as DLMedicain Italy, Casa Schmidt in Spain and Dentex in Russia.

 

            TheCompany relies heavily on sales made at trade shows, dental exhibitions, anddental society meetings.  In 2001, theSeptember 11th terrorist attacks forced the cancellation of severalsuch trade shows and dental meetings and reduced attendance at several othersas potential attendees were less willing to travel to such events in theaftermath of the terrorist attacks. In general, the Company’s marketingactivities, such as dental exhibitions and meetings, are typically lower in thesummer months, which results in decreased revenues during the third quarter ofthe year.

# ** **

            American Medical presently hasseveral industrial product distributors. Such distributors have been and are anticipated to be the primary sourceof sales for American Medical’s industrial products in the future. Industrialproduct distributors are supported by American Medical primarily through advertisingin the Thomas Register and trade journals, and by participation in trade shows.

# ** **

            American Medical also sells some industrial productsdirectly to customers through advertisements or customer referrals and throughoriginal equipment manufacturers of grinding equipment who purchase AJM systemsto incorporate into their equipment.

# ** **

 

# **Training and Service**

# ** **

            BecauseAmerican Medical’s dental products represent new approaches to dentistry,training is a significant aspect of its marketing efforts.  American Medical offers complementarytraining on all of its products. American Medical encourages each purchaser to participate in ongoingcontinuing education regarding the use of American Medical’s dental productsand endeavors to share new developments as soon as reliable scientific supporthas been established.

# ** **

            American Medical provides warrantyand repair service for American Medical’s products in the United States.  To service its dental products, AmericanMedical has full-time service employees in its sales and service centersthroughout the United States and has service arrangements with independentdistributors for products in other markets. If such arrangements are unavailable, certain American Medical sales personnelare trained to make minor service repairs. To date, American Medical has not experienced significant serviceproblems.  American Medical generallyprovides a one-year warranty on all of its products.  Since the introduction of the sales and service centers, theCompany’s revenues related to replacement parts and repair services have risenfrom 8% of revenues in 1999, to 11% of revenues in 2000, and 17% of revenues in2001.

 

            The Company also has a servicecenter in Keltern, Germany that provides installation, training, service andtechnical support for Europe, Russia and the Middle-East.  In other international markets, thedistributors provide installation, training and service with technical supportfrom the United States office.

# ** **

 

## ***Competition***

# ** **

            Ingeneral, American Medical’s products are subject to intense competition, bothfrom other advanced dental technology companies and from makers of conventionaldental equipment.  American Medicalbelieves there are approximately 6 competing companies which presently offerNd:YAG, diode, argon, erbium, holmium or CO2 lasers for use in dentistry.  American Medical has patents in the basictechnologies, which the Company believes provide a competitive advantage.  American Medical believes there areapproximately 3 companies that presently sell competing dental air abrasiveproducts and approximately 13 companies that presently sell competing intraoral camera systems.  American Medical’slaser, PAC and KCP products must also compete with conventional treatmentmethods using dental instruments or equipment that are generally less expensiveand with which dentists are more familiar.

# ** **

 

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                Many of thesecompeting companies, particularly those which manufacture traditional dentalequipment, may have been in business longer, have greater resources and have alarger distribution network than American Medical.  American Medical’s competitive position is dependent upon itspricing and marketing practices, its ability to make ongoing improvements inits existing products, to develop new products, and to successfully promote thecapabilities and treatment benefits of its products.  While American Medical believes its products are competitive interms of capabilities, quality and price, competition has, and may in thefuture, adversely affect American Medical’s business.

# ** **

 

## ***Patents***

# ** **

            AmericanMedical believes its patents provide a competitive advantage in those countrieswhere they have been issued.  AmericanMedical believes its technology patents and other patent rights provide aproprietary means to utilize that technology in dentistry.  In the United States, American Medical haspatents related to dental laser methods and technology patents that haveexpiration dates ranging from 2002 to 2016, dental air abrasive systems andmethods for using an air abrasive stream for dentistry that do not beginexpiring until 2011, technology patents for air abrasive cavity preparationsystems that do not begin expiring until 2004, and industrial air abrasivepatents that have expiration dates ranging from 2004 to 2016.  American Medical also holds severalindustrial air abrasive patents in various other countries.

 

 

**Manufacturing and Suppliers**

 

            American Medical manufactures,assembles and services its products at its ISO 9001-certified facility inCorpus Christi, Texas.  AmericanMedical’s products are manufactured from parts, components and subassembliesobtained from a number of unaffiliated suppliers and/or fabricated internallyat its manufacturing facility. American Medical has modern machining capabilityallowing it to control the production of certain non-standard parts.  American Medical uses numerous suppliers forstandard parts and for fabrication of certain parts.  Although most of the parts and components used in its productsare available from multiple sources, American Medical presently obtains severalparts and components from single sources. Lack of availability of certain parts and components could result inproduction delays.  Management hasidentified alternate suppliers and believes any delays would be minimal.  While the loss of American Medical’srelationship with a particular supplier might result in some production delays,such a loss is not expected to materially affect American Medical’s business.

 

 

# **Research and Development**

 

            Mostresearch and development, prototype production and testing activities takeplace at the Texas facility, although some research and development work isperformed for American Medical by consultants. The Company also maintains researchand development facilities in Wixom, Michigan and Santa Clara, California.  The Texas facility has an engineering andCAD/CAM drafting staff which is capable of producing new product prototypes.  Although American Medical expects tocontinue to conduct most of its own research and development activities,American Medical will continue to work with various domestic and internationaldental schools, consultants and researchers to analyze dental applications andto develop product enhancements and complementary products.

 

            AmericanMedical’s research and development expenditures for 2001, 2000 and 1999 were$796,424, $966,382, and $931,189, respectively.  American Medical’s current research and development efforts arefocused on new complementary products for the dental market.

 

 

# **Governmental Regulation**

 

            AmericanMedical’s dental products are subject to significant governmental regulation inthe United States and certain other countries. In order to conduct clinical tests and to market products for therapeuticuse, American Medical must comply with procedures and standards established bythe FDA and comparable foreign regulatory agencies.  Changes in existing regulations or adoption of additionalregulations may adversely affect American Medical’s ability to market itsexisting products or to market enhanced or new dental products.

 

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## *United States Regulatory Requirements*

 

                The Federal Food,Drug and Cosmetic Act (“FDC Act”) regulates medical devices in the UnitedStates by classifying them into one of three classes based on the extent ofregulation believed necessary to ensure safety and effectiveness. Class Idevices are those devices for which safety and effectiveness can reasonably beensured through general controls, such as device listing, adequate labeling,premarket notification and adherence to the Quality System Regulation (“QSR”)as well as medical device reporting (“MDR”), labeling and other regulatoryrequirements. Some Class I medical devices are exempt from the requirement ofpre-market approval or clearance. Class II devices are those devices for whichsafety and effectiveness can reasonably be ensured through the use of specialcontrols, such as performance standards, post-market surveillance and patientregistries, as well as adherence to the general controls provisions applicableto Class I devices. Class III devices are devices that generally must receivepremarket approval by the FDA pursuant to a premarket approval (“PMA”)application to ensure their safety and effectiveness. Generally, Class IIIdevices are limited to life sustaining, life supporting or implantable devices;however, this classification can also apply to novel technology or new intendeduses or applications for existing devices.

 

                Before they can bemarketed, most medical devices introduced to the United States market arerequired by the FDA to secure either clearance of a pre-market notificationpursuant to Section 510(k) of the FDC Act (a “510(k) Clearance”) or approval ofa PMA. Obtaining approval of a PMA application can take several years. Incontrast, the process of obtaining 510(k) Clearance generally requires asubmission of substantially less data and generally involves a shorter reviewperiod. Most Class I and Class II devices enter the market via the 510(k)Clearance procedure, while new Class III devices ordinarily enter the marketvia the more rigorous PMA procedure. In general, approval of a 510(k) Clearancemay be obtained if a manufacturer or seller of medical devices can establishthat a new device is “substantially equivalent” to a predicate device otherthan one that has an approved PMA. The claim for substantial equivalence mayhave to be supported by various types of information, including clinical data,indicating that the device is as safe and effective for its intended use as itslegally marketed equivalent device. The 510(k) Clearance is required to befiled and cleared by the FDA prior to introducing a device into commercialdistribution. Market clearance for a 510(k) notification submission may take 3to 12 months or longer. If the FDA finds that the device is not substantiallyequivalent to a predicate device, the device is deemed a Class III device, anda manufacturer or seller is required to file a PMA application. Approval of aPMA application for a new medical device usually requires, among other things,extensive clinical data on the safety and effectiveness of the device. PMAapplications may take years to be approved after they are filed. In addition torequiring clearance or approval for new medical devices, FDA rules also 10require a new 510(k) filing and review period, prior to marketing a changed ormodified version of an existing legally marketed device, if such changes ormodifications could significantly affect the safety or effectiveness of thatdevice. FDA prohibits the advertisement or promotion of any approved or cleareddevice for uses other than those that are stated in the device’s approved orcleared application.

 

            The FDA granted 510(k) Clearance tomarket the KCP for hard-tissue applications and the PulseMaster dental lasersfor soft-tissue procedures in late 1992. 510(k) Clearance to market the PAC was granted by the FDA in mid-1995.  The PulseMaster received 510(k) Clearance tomarket for laser curettage in March 1997 and a diode laser was granted softtissue 510(k) Clearance in September 1997. The PulseMaster received 510(k) Clearance to market for selectiveremoval of enamel dental caries in May 1999. The Anthos System line of dental chairs and units received 510(k)Clearance in August of 2001.  InSeptember of 2001, 501(k) Clearance was granted to market the Cavilase forgeneral hard and soft tissue procedures.

 

                Pursuant to FDCAct requirements, the Company has registered its manufacturing facility withthe FDA as a medical device manufacturer, and listed the medical devices itmanufactures. The Company also is subject to inspection on a routine basis forcompliance with FDA regulations. These regulations include those covering theQSR, which, unless the device is a Class I exempt device, require that theCompany manufacture its products and maintain its documents in a prescribedmanner with respect to issues such as design controls, manufacturing, testingand validation activities. Further, the Company is required to comply withother FDA requirements with respect to labeling, and the MDR regulations whichrequire that the Company provide information to the FDA on deaths or seriousinjuries alleged to have been associated with the use of its products, as wellas product malfunctions that are likely to cause or contribute to death orserious injury if the malfunction were to recur. The Company believes that itis currently in material compliance with all relevant QSR and MDR requirements.

 

                In addition, ourproduct are subject to regulatory requirements covering third-partyreimbursement.  Our products aregenerally purchased by dental or medical professionals who then bill variousthird party payors, such as government programs or private insurance plans, forthe procedures conducted using these products. In the United States third partypayors review and frequently challenge the prices charged for medical services.In many foreign 

 

 

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countries, the prices are predetermined through government regulation.Payors may deny coverage and reimbursement if they determine that the procedurewas not medically necessary (for example, cosmetic) or that the device used inthe procedure was investigational. We believe that most of the procedures beingperformed with our current products generally have been reimbursed. Theinability to obtain reimbursement for services using our products could deterdentists and physicians from purchasing or using our products. We cannotpredict the effect of future healthcare reforms or changes in financing forhealth and dental plans. Any such changes could have an adverse effect on theability of a dental or medical professional to generate a return on investmentusing our current or future products. Such changes would act as disincentivesfor capital investments by dental and medical professionals and could have anadverse effect on our business, financial condition and results of operations.

 

## *Foreign Regulatory Requirements*

 

            Internationalsales of medical devices are also subject to the regulatory requirements ofeach country. Regulation of medical devices in foreign countries varies betweencountries such as Japan, which has standards similar to the FDA, to countriesthat have no regulations. The Company, in general, will rely upon itsdistributors and sales representatives in the foreign countries in which itmarkets its products to ensure that the Company complies with the regulatorylaws of such countries.  In Europe, theregulations of the European Union require that a device have a CE mark beforeit can be sold in that market. The KCP, PAC, intraoral cameras and lasers havebeen granted CE mark approvals which are recognized by most European countries,and may be sold in Germany and many other European markets. The PulseMaster andKCP has also been approved for sale in Japan. American Medical’s dental lasers comply with government regulations inmost major countries in Europe, Asia, the Pacific Rim, and North and SouthAmerica and are marketed for both hard and soft tissue applications, except inJapan, where (as in the United States) they have not been cleared for certainhard-tissue procedures.  Additionalforeign authorizations to market its dental products are being sought by theCompany where needed.

 

            Regulationof medical devices in other countries is subject to change and there can be noassurance American Medical will continue to be able to comply with suchrequirements.  The Company believes thatits international sales to date have been in compliance with the laws of theforeign countries in which it has made sales. Failure to comply with the lawsof such country could have a material adverse effect on the Company’soperations and, at the very least, could prevent the Company from continuing tosell products in such countries. Exports of most medical devices are also subject to certain limited FDAregulatory controls.

 

            European regulations required ISO 9001 certification asof July 1998 for all medical products distributed or sold in Europe.  American Medical’s manufacturing facilityinitially received ISO 9001 certification in 1997.

 

 

**Product Liability Exposure**

 

            American Medical’s business involvesthe inherent risk of product liability claims.  If such claims arise, they could have an adverse effect onAmerican Medical.  American Medicalcurrently maintains product liability insurance on a “claims made” basis withcoverage per occurrence of $2,000,000 and in the aggregate annually of$5,000,000.  There is no assurance thatsuch coverage will be sufficient to protect American Medical from all risks towhich it may be subject or that product liability insurance will be availableat a reasonable cost, if at all, in the future.

 

 

**ForeignOperations and Segment Information**

 

            For information regarding theCompany’s foreign operations and business segments, see Note 8 of the Notes toConsolidated Financial Statements.  Suchinformation is incorporated herein by reference.

 

 

###### **Employees**

 

            On March 20, 2002, American Medicalhad 91 full-time employees.  Of theseemployees, 34 were engaged in direct sales and marketing activities and 33 inmanufacturing activities.  The remainingemployees are in finance, administration, customer service, and research anddevelopment.  American Medical has nocollective bargaining agreements with any unions and believes that its overallrelations with its employees are good.

 

 

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**Executive Officers of the Company**

 

                Thefollowing table sets forth information concerning each of the current executiveofficers of American Medical who are elected to serve at the discretion of theBoard of Directors.

 
| **Name**             |   | **Age** |   | **Position**                                                         |
|----------------------|--------|---------|--------|----------------------------------------------------------------------|
|                 |   |    |   |                                                                 |
| Ben J. Gallant       |   | 68      |   | President, Chief Executive Officer, Chair of the  Board of Directors |
| John E. Vickers, III |   | 55      |   | Chief Operating Officer, Secretary and Director                      |
| Justin W. Grubbs     |   | 31      |   | Chief Financial Officer                                              |
| William S. Parker    |   | 56      |   | Senior Vice President — Dental                                  |
| John A. Miller       |   | 42      |   | Executive Vice President — Sales                                |
|                 |   |    |   |                                                                 |

 

*Ben J. Gallant* — Mr. Gallant has been the Company’sPresident and Chief Executive Officer since November 1996 and served as itsChief Operating Officer from September 1996 to May 2000. Mr. Gallant was afounder of Texas Airsonics, Inc., served as a director and chairman of theboard from that company’s inception in 1982, was elected president and chiefexecutive officer in 1991 and served in those positions until that company’sacquisition by American Medical in 1996. He is chiefly responsible for thedesign and development of the Company’s KCP and industrial product lines. Mr.Gallant has been a director of the Company since 1996.

 

*John  E. Vickers III* — Mr. Vickers was appointed ChiefOperating Officer of the Company in May 2000. He previously served the Company as Executive Vice President from August1998 to May 2000 and as Senior Vice President - Operations from November 1996to August 1998.  Mr. Vickers had servedas Texas Airsonics Inc.’s chief financial officer and legal counsel from June 1993until its acquisition by the Company in July 1996 and had various operatingresponsibilities with Texas Airsonics.  Mr. Vickers has practiced law for over 25 years. Mr. Vickers has been adirector of the Company since 1996.

 

*JustinW. Grubbs* — Mr.Grubbs was appointed Chief Financial Officer in July 2000.  Prior to joining the Company he had beenemployed by the public accounting firm of Ernst & Young LLP for sevenyears, specializing in entrepreneurial growth companies in the retail,distribution and manufacturing industries. Mr. Grubbs graduated from Georgetown University in 1993 with dualconcentrations in accounting and finance and is a licensed certified publicaccountant.

 

*WilliamS. Parker* — Mr.Parker was appointed Senior Vice President — Dental of the Company in August1998 and became a Director in November 1999. He is chiefly responsible for the Company’s product development.  He had been a consultant, then an employeeof the Company in charge of product development since 1991.  From 1976 to 1991, he was the president andco-founder of the New Directions Group, Inc., a management consulting firmwhich had clients such as Ford, Exxon Enterprises, AT&T and RossLaboratories.

 

*JohnA. Miller* — Mr.Miller was appointed Executive Vice President — Sales in June 2001.  Prior to that he had served as the VicePresident — Domestic Sales since June of 2000 and as Vice President — WesternSales from May 1999 until June 2000. Prior to joining American Medical, Mr. Miller was President of SourceOne, a marketing, consulting, planning and research firm he founded in1996.  Mr. Miller has been involved indental equipment related sales for over ten years.

 

 

9

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**ForwardLooking Statements**

 

                The Company makesforward-looking statements in this report and may make such statements infuture filings with the Securities and Exchange Commission.  The Company may also make forward-lookingstatements in its press releases or other public shareholdercommunications.  The Company’sforward-looking statements are subject to risks and uncertainties and includeinformation about its expectations and possible or assumed future results ofoperations.  When the Company uses anyof the words “believes”, “expects”, “anticipates”, “estimates” or similarexpressions, it is making forward-looking statements.

 

                The Company claimsthe protection of the safe harbor for forward-looking statements contained inthe Private Securities Litigation Reform Act of 1995 for all of itsforward-looking statements.  While theCompany believes that its forward-looking statements are reasonable, you shouldnot place undue reliance on any such forward-looking statements, which speakonly as of the date made.  Because theseforward-looking statements are based on estimates and assumptions that aresubject to significant business, economic and competitive uncertainties, manyof which are beyond the Company’s control or are subject to change, actualresults could be materially different. Factors that might cause such a difference include, without limitation,the following:  the possible failure tomaintain the Company’s ability to borrow under its line of credit, thepotential inability of the Company to refinance the line of credit indebtednesscurrently in default prior to the expiration of the bank’s forbearanceagreement and the other line of credit due in October of 2002, the Company’spotential inability to hire and retain qualified sales and service personnel,the potential for an extended decline in sales, the possible failure ofrevenues to offset additional costs associated with its new business model, thepotential lack of product acceptance, the Company’s potential inability tointroduce new products to the market, the potential failure of customers tomeet purchase commitments, the potential loss of customer relationships, thepotential failure to receive or maintain necessary regulatory approvals, theextent to which competition may negatively affect prices and sales volumes or  necessitate increased sales expenses, thefailure of negotiations to conclude OEM agreements or strategic alliances andthe other risks and uncertainties set forth in this report.

 

                Other factors notcurrently anticipated by management may also materially and adversely affectthe Company’s results of operations. Except as required by applicable law, the Company does not undertake anyobligation to publicly release any revisions which may be made to anyforward-looking statements to reflect events or circumstances occurring afterthe date of this report.

 

 

ITEM 2.  DESCRIPTION OF PROPERTIES

 

            American Medical owns anapproximately 45,000 square foot manufacturing facility on 5.2 acres located at5555 Bear Lane, Corpus Christi, Texas 78405, which houses its manufacturing andadministration facilities.  A mortgageon this property secures the Company’s line of credit with ValueBank and theU.S. Small Business Administration and a second mortgage secures the prior lineof credit with Bank One that is currently in default.

 

            American Medical leases 14 sales andservice centers throughout the United States, each approximately 1,500 squarefeet and a total of 2,000 square feet near Santa Clara, California for itsproduct development, clinical and service activities.  The leases are generally for one to three year terms.

 

            American Medical leasesapproximately 600 square feet of office space in Keltern, Germany.

 

 

10

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**PART II**

 

 

ITEM 7.              MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL

                            CONDITIONAND RESULTS OF OPERATIONS

 

 

                The following discussion andanalysis should be read in conjunction with the consolidated financialstatements and the notes thereto included elsewhere in this report.  The discussion contains certainforward-looking statements relating to the Company’s anticipated futurefinancial condition and operating results and its current business plans.  In the future, the Company’s financialcondition and operating results could differ materially from those discussedherein and its current business plans could be altered in response to marketconditions and other factors beyond its control.  Important factors that could cause or contribute to suchdifferences or changes include those discussed elsewhere in this report.  See the disclosures under “Item 1 — Business— Forward-Looking Statements.”

 

 

**Critical Accounting Policies**

 

The preparation of financial statements in conformitywith accounting principles generally accepted in the United States requires theCompany to make estimates and assumptions that affect amounts reported in theaccompanying consolidated financial statements and related footnotes. Theseestimates and assumptions are evaluated on an on-going basis based onhistorical developments, market conditions, industry trends and otherinformation the Company believes to be reasonable under the circumstances.There can be no assurance that actual results will conform to the Company’sestimates and assumptions, and that reported results of operations will not bematerially adversely affected by the need to make accounting adjustments toreflect changes in these estimates and assumptions from time to time.  The following policies are those the Companybelieves to be the most sensitive to estimates and judgments.  The Company’s significant accountingpolicies are more fully described in Note 1 to our consolidated financialstatements.

 

*Revenue Recognition*

 

The Company recognizes revenue when each of thefollowing four criteria are met: 1) a contract or sales arrangement exists; 2)products have been shipped and title has been transferred or services have beenrendered; 3) the price of the products or services is fixed or determinable;and 4) collectibility is reasonably assured. The Company recognizes the related estimated warranty expense when titleis transferred to the customer, generally upon shipment.  The Company recognizes revenue on certainsales to two of its international distributors under terms that requireshipment to a local independent warehouse. There are no significant estimates or assumptions involved indetermining the appropriate recognition of revenues.

 

*Allowance for Doubtful Accounts*

 

The Company evaluates the collectibility of accountsreceivable based on a combination of factors. In circumstances where theCompany is aware of a specific customer’s inability to meet its financialobligations (e.g., bankruptcy filings, substantial down-grading of creditscores), the Company records a specific reserve for bad debts against amountsdue to reduce the net recognized receivable to the amount reasonably believedto be collectible. For all accounts not specifically analyzed, the Companyrecognizes reserves for 80% of all accounts over 90 days past due and 2% forall remaining accounts. If circumstances change (i.e., higher than expecteddefaults or an unexpected material adverse change in a major customer’s abilityto meet its financial obligations), the estimates of the recoverability ofamounts due could be reduced by a material amount.

 

*Inventories — Slow Moving*

 

The Company’s reserve for slow moving inventory isevaluated periodically based on its current and projected sales and usage.  The Company’s inventory reserve iscalculated by comparing on hand quantities as of the measurement date to theprior twelve months’ sales.  The reservecalculation assumes that sales for each unit or part will not be less thansales for the prior twelve months.  Ifsales are significantly different than prior year’s sales for the unit or part,the reserve could be materially impacted.   Changes to the reserves are included in costs of goods 

 

 

11

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sold and have a direct impact on the Company’s financial position andresults of operations.  The reserve iscalculated differently for finished units than it is for parts.  For finished units, in instances where theon hand quantity exceeds the prior twelve months’ sales, the number of units bywhich the on hand quantity exceeds the prior twelve months’ sales is 100%reserved.  For parts, when the on handquantity exceeds the prior twelve months’ sales and usage, the excess inventoryis calculated by subtracting the greater of the prior twelve months’ sales andusage or a base quantity of 50 from the quantity on hand.  This excess is then 100% reserved.  The base quantity of 50 representsmanagement’s determination of the minimum quantity of parts needed to fulfillits service, repair, and warranty obligations. All parts or units with less than twelve months of sales or usagehistory are excluded from the calculation.

 

*Long Lived Assets — Impairment Testing*

 

The Company evaluates its property, plant, andequipment for impairment whenever indicators of impairment exist.  The Company follows the guidance of FASBStatement No. 121 *Accounting for the Impairment of Long-Lived Assets and for Long-LivedAssets to be Disposed Of*, and Statement No. 142 *Goodwill and Other Intangible Assets*,and projects future cash flows for the related products and operating segmentsbased on management’s best estimates of likely future sales, less costs ofgoods sold and selling expenses based on historical data and perceived trendsin the industry.  These results are thencompared to the recorded value of the related assets and intangibles and ifless than the recorded value, am impairment charge is recognized.  If actual results are significantly worsethan management’s estimates, the Company could be required to recognize animpairment, which could have a material adverse effect on its financialposition and results of operations.

 

 

**Results of Operations**

 

Forthe year ended December 31, 2001, the Company’s revenues decreased 26% comparedto 2000.  This decrease in revenues wasprimarily due to a 59% decrease in international revenues due to the expirationof a sales agreement with the Company’s Japanese distributor.  Our Japanese distributor opted not to renewthis agreement indicating that it had too much product in stock.  TheCompany is currently seeking new distributor partners in Japan, however, due toadverse economic conditions in Japan, we have been unable to engage a newdistributor. In 2000 and 1999, sales to this distributor represented 21% and19% of total revenues, respectively.  Ifthe Company is unable to engage a new Japanese distributor, it could lose salesof approximately $1 million in fiscal year 2002.  The decrease in revenues is also attributable to a decline inattendance at dental trade shows subsequent to the September 11th terroristattacks.  The overall decline inrevenues in 2001 is attributable to all product lines, with the largest revenuedecreases in the dental laser, intra-oral camera and plasma arc curinglines.  These three product lines postedrevenue declines in 2001 of approximately $2.5 million, $1.3 million, and $1.1million, respectively.  The Company’sparts and service revenues continued to increase in 2001, growing byapproximately $500,000.  Theintroduction of the Anthos Systems dental chairs added approximately $250,000to revenues in 2001.  As of March 25,2002, the Company had backlog orders of more than $320,652 for the AnthosSystem dental chairs and more than $726,295 for the Cavilase laser.  The Cavilase is in its final stages ofdevelopment and the Company cannot predict when it will begin filling theseorders.

 

 

                For the year endedDecember 31, 2000, the Company’s revenues decreased 18% compared to 1999.  This decrease in revenues was primarily dueto a 38% decrease in revenues in the United States.  The decrease in domestic revenues was primarily due to lowerrevenues during the transition to the new business model.  The new business model attempted to addressdeclining sales and the sale of competitive products by our distributors. Thegeneral decline in revenues in 2000 is the result of significant revenuedeclines in the Company’s plasma arc curing, intra-oral camera and air abrasionproduct lines.  These three productlines generated revenue declines in 2000 of approximately $3.9 million, $2.5million, and $2.2 million, respectively. The decline in air abrasion revenues is due to the continued decline inthe air abrasion market and the declines in plasma arc curing and intra-oralcameras are a result of the change in business model as these items are morecommodity-like items, which dealers sold well. These declines were partially offset by increases in dental laser andparts and service revenues.  Dentallaser revenues increased by approximately $3.5 million as the market acceptanceand popularity of these products continue to increase.  Parts and service revenues increasedapproximately $500,000 due to the establishment of the sales and servicecenters throughout the U.S.

 

                Gross profit as apercentage of revenues was 42% for the year ended December 31, 2001, comparedto 45% in 2000 and 48% in 1999.  Thedecrease in gross margin in 2001 compared to 2000 is the result of the declinein sales, which resulted in an increase in the reserve for slow movinginventory of approximately $588,000 in 2001, and 

 

 

12

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increased discounting domestically subsequent to the September 11thterrorist attacks.  The decrease ingross profit as a percentage of revenues in 2000 was due to the Companyincreasing its reserve for slow-moving inventory in response to the decline inthe air abrasion and camera markets.

 

    Selling, general and administrative expenses were $9,195,306 in2001, $21,226,253 in 2000 and $10,772,746 in 1999.  The amount of expenses in 2000 reflects non-cash impairmentcharges and charges related to demonstration inventory units.  In 2000, the continued decline in sales ofthe Company’s KCP and camera units, and the underperformance of the dentalprobe units, served as indicators of impairment for certain intangible assetsassociated with the previous acquisitions of Texas Airsonics, Inc., DentalVision Direct, Inc., and Dental Probe, Inc. Texas Airsonics, Inc. was theinventor and manufacturer of the Company’s KCP units prior to the merger of thetwo companies in 1996 and certain of our officers and directors were officersand directors of Texas Airsonics, Inc. Following the guidance of FASB Statement No. 121 *Accounting for the Impairment ofLong-Lived Assets and for Long-Lived Assets to be Disposed Of*, theCompany projected future cash flows for these products based on management’sbest estimates of likely future sales, less costs of goods sold and sellingexpenses.  The undiscounted future cashflows were less than the recorded value of the assets related to these productlines, indicating impairment existed. To determine the amount of the impairment, the fair value of the relatedassets was determined by comparing the future cash flows discounted at a rateof 8% to the fair value of the related long-lived assets based on currentmarket selling prices of similar equipment.  The Company recorded an impairment of approximately $9.2 million toreduce the carrying value of the long-lived assets associated with theaforementioned acquisitions to the fair value of those assets.  This impairment expense is included inselling, general and administrative expenses on the statement of operations in2000.

 

In addition, as part ofthe transition in its business model in 2000, the Company decided todiscontinue its demonstration unit sales initiative.  This change resulted in the Company disposing of approximately$1.2 million in demonstration units that had been on loan to sales personnel,universities, and prospective customers that were no longer deemedsalable.  This charge was included in selling,general and administrative expenses in 2000.

 

The decrease in 2001compared to 2000 reflects the non-recurring nature of the items described aboveand reduced expenses resulting from the reorganization of the sales and servicecenters, which resulted in 2001 selling, general and administrative expensesdeclining 15% compared to 2000, after elimination of the effects of thenon-recurring items described above. The increase in 2000 compared to 1999 was almost entirely attributableto the non-recurring items.

 

                Research and development expenseswere $796,424 in 2001, $966,382 in 2000, and $931,189 in 1999.  The expenditures related primarily to thedevelopment of new products and enhancements to current products.  The decrease in 2001 reflects thesubstantial completion of two major projects in 2001, the Cavilase and theAnthos System dental chairs and units. Historically, research and development expenses have been higher in theearlier stages of product development than in the finishing stages..

 

                Non-recurringlicense transfer fees of $665,000 were received in 1999.  These related to the licensing agreementwith ESC Medical Systems, Ltd. for $300,000, a licensing agreement withChart-It for $65,000 and the $300,000 Kreativ patent litigation settlement.

 

                Other income was$118,237 in 2001, $83,773 in 2000, and $857,116 in 1999.  The decrease in 2000 from 1999 is primarilydue to non-recurring items in 1999 such as the receipt of the Kreativ lawsuitsettlement payment of $580,000 and a gain on the sale of the Michigan buildingof $180,000.

 

Interestexpense was $158,909 in 2001, $322,475 in 2000, and $401,438 in 1999.  The steady decrease in interest expense isdue to the reduction of the outstanding debt and, in 2001 declining interestrates.

 

In2001, the Company had no income tax expense. In 2000, the Company recorded a $4,744,000 charge for income tax.  The Company’s income taxes at U.S. statutoryrates, differs from its recorded income tax expense primarily due tonondeductible goodwill amortization. With the loss incurred in 2000 and the continued downturn in the dentalproducts industry, uncertainties exist as to the future realization of thedeferred tax asset under the criteria set forth under FASB Statement No.109.  Therefore, the Company re-establishedthe tax asset valuation allowance, which resulted in a non-cash tax expense ofapproximately $5.7 million in 2000.  AtDecember 31, 2001, the Company had approximately $15.4 million of net operatingloss carryforwards.  These net operatingloss carryforwards expire in various amounts in the years 2006 through 2021.

 

 

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**Liquidity and Capital Resources**

 

                The Company’s operatingactivities used $130,332 in cash resources in 2001.  Cash used by operating activities in 2001 was due largely to thenet loss of $3,978,259 and the increase in inventory of $988,914.  This increase was due to the Companybuilding inventory to prepare for the fall trade shows, as the fourth quarteris typically the Company’s highest sales volume quarter.  After the September 11, 2001 terroristattacks, several trade shows were canceled and those that were not canceled hadsignificant declines in attendance.  Asa result, the Company has more inventory on hand that it would have normallyanticipated.  Operating cash flows werereduced by the decrease in accounts receivable of $2,095,015, the increase inaccounts payable of $1,119,524, and non-cash expenses such as depreciation andamortization.  Accounts receivable hassteadily decreased due to the change to selling direct rather than throughdealers and the decline in international sales.  The direct sales are often paid for using cash, credit cards, orthrough outside financing rather than the open account terms offered to the dealers.  The increase in payables is due to theCompany’s decreased cash flows in the fourth quarter.

 

                The Company’s investingactivities provided $35,100 in cash resources in 2001. The cash provided byinvesting activities in 2001 related primarily to collections on notesreceivable, reduced by purchases of property and equipment.

 

                The Company’s financingactivities used $868,944 in cash resources in 2001, representing amounts usedto reduce borrowings on the Company’s lines of credit by a net amount of$540,925 and to repurchase the Company’s common stock.

 

In 2000 and 2001, after comparing thebook value of the Company’s shares of its common stock to the trading price,the Company’s Board of Directors authorized and implemented a stock repurchaseprogram pursuant to which it would repurchase up to $1 million of its commonstock.  At the time of authorization,the Company was generating cash flows and the Board of Directors perceived therepurchase program to be in the best interests of the Company.  During 2001, the Company repurchased 219,749shares of its common stock, representing approximately $328,000 of the $1million repurchase authorized by the Board of Directors.  The repurchased shares constituteapproximately 3% of the total number of shares of common stock currentlyoutstanding.  As sales continued todecline and cash flow became a concern, the Board of Directors decided to ceaserepurchasing shares.  The last dateshares of common stock were repurchased by the Company was July 17, 2001.

 

                During 2001, the Company had a$7,500,000 revolving line of credit from a bank which was to expire inSeptember 2002.  The Company’sborrowings under that line are secured by a pledge of the Company’s accountsreceivable, inventory, equipment, instruments, patents, copyrights andtrademarks.

 

                The Company was not incompliance with one of the financial covenants in the agreement as of September30, 2001, and was in default.  Thecovenant required the Company to maintain a ratio of EBITDA, as defined in theagreement, to debt service, as defined in the agreement, of not less than 2 to1 for the most recent twelve months. Due to the net loss sustained over the previous twelve months, theCompany did not meet this covenant. On November 6, 2001, the Company and thebank signed a Forbearance Agreement that increases the interest rate on theoutstanding borrowings to the prime rate plus 4%, forbids additionalborrowings, grants the bank a second mortgage on the Company’s real property,and requires the bank to forego the exercise of its legal remedies untilDecember 20, 2001.  The ForbearanceAgreement was amended to extend the termination date to September 15, 2002, inorder to give the Company additional time to secure a suitable replacement forthe credit facility.  Under the terms ofthe Forbearance Agreement, the Company will make principal payments of $30,000per month beginning on April 15, 2002. Starting on July 15, 2002, the monthly principal payment will increaseto $40,000.  Monthly interest paymentsare also required.  The Company iscurrently working with an independent consultant to acquire a new creditfacility to refinance the existing debt. The Forbearance Agreement also requires the Company to submit monthlyfinancial statements to the Bank and that the Company maintain a minimumtangible net worth, defined as net assets less intangibles, of at least $4.5million.  Should the new credit facilitynot be in place by September 15, 2002, the Company will be forced to pay a$50,000 penalty and the bank will have the right to accelerate the outstandingindebtedness and exercise its remedies under the related legal documents. As ofDecember 31, 2001, the outstanding principal on this line of credit is$1,745,656 and the Company was in compliance with all terms of the forbearanceagreement.

 

                On October 3, 2001, in order toobtain working capital, the Company entered into a $750,000 line of credit withValueBank Texas and the U.S. Small Business Administration.  The loan is secured by a primary lien on theCompany’s building and real property and is personally guaranteed by BenGallant, the Company’s Chairman and Chief Executive Officer.  The loan expires on October 3, 2002 andbears interest at the prime rate plus 2%. As of December 31, 2001, the outstanding principal on this line ofcredit is $213,419.

 

 

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            The Company’s independent auditorshave expressed substantial doubt about the Company’s ability to continue as agoing concern.  While the Companybelieves that it will be successful in refinancing the defaulted line ofcredit, there can be no assurance that the Company will be able to accomplishthis.  If the Company is unable torefinance the line of credit it intends to explore other sources of financingwhich may include the sale of equity or debt securities to privateinvestors.  The Company’s ability tocontinue operations is dependent on its ability to successfully refinance thedefaulted line of credit or obtain a sufficient amount of additional financingto repay the outstanding indebtedness and provide additional working capital.While the Company expects to be able to refinance the defaulted line of creditor otherwise obtain such additional financing, there is no assurance that theCompany will be successful in doing so. The Company anticipates that it can continue operations only through thecurrent fiscal year if it is unable to refinance the defaulted line of creditor obtain additional financing.  If theCompany is not able to repay the outstanding indebtedness on the lines ofcredit and the banks enforce their security interest in the Company assetssecuring the debt, the Company may be forced to cease operations.

 

**New Accounting Standards andDisclosures**

 

                In July 2001, the Financial Accounting StandardsBoard issued Statement No. 141, “Business Combinations” (“FASB 141”), andStatement No. 142, “Goodwill and Other Intangible Assets” (“FASB 142”). FASB141 requires all business combinations initiated after June 30, 2001 to beaccounted for using the purchase method. Under FASB 142, goodwill is no longersubject to amortization over its estimated useful life. Rather, goodwill issubject to at least an annual assessment for impairment applying a fair-valuebased test. Additionally, any acquired intangible assets should be separately recognizedif the benefit of the intangible asset is obtained through contractual or otherlegal rights, or if the intangible asset can be sold, transferred, licensed,rented, or exchanged, regardless of the acquirer’s intent to do so.  Amortization expense related to goodwill wasapproximately $368,000, $476,000 and $1,077,000 in 2001, 2000 and 1999,respectively.  The Company adopted bothstatements on January 1, 2002.

 

                The FASB issued Statement No. 144, “Accountingfor the Impairment or Disposal of Long-Lived Assets,” in August 2001. FASB144 supersedes FASB 121, “Accounting for the Impairment of Long-Lived Assetsand for Long-Lived Assets to Be Disposed Of,” and other related accountingguidance. FASB 144 is effective for financial statements issued for fiscalyears beginning after December 15, 2001, and interim periods within thosefiscal years, with early application encouraged. The provisions of thisstatement generally are to be applied prospectively. The adoption of thispronouncement is not expected to have a material effect on earnings or theconsolidated financial position of the Company.

 

 

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ITEM 8.  FINANCIAL STATEMENTS ANDSUPPLEMENTARY DATA

 

 

 

 

 

 

 

**Report of Independent Auditors**

 

 

 

 

 

 

Stockholders and Board ofDirectors

American Medical Technologies, Inc.

 

We have audited the accompanying consolidated balancesheets of American Medical Technologies, Inc. as of December 31, 2001 and 2000,and the related consolidated statements of operations, stockholders’ equity,and cash flows for each of the three years in the period ended December 31,2001. Our audits also included the financial statement schedule listed in theIndex at Item 14(a).  These financialstatements and schedule are the responsibility of the Company’smanagement.  Our responsibility is toexpress an opinion on these financial statements and schedule based on ouraudits.

 

We conducted our audits in accordance with auditingstandards generally accepted in the United States.  Those standards require that we plan and perform the audit toobtain reasonable assurance about whether the financial statements are free ofmaterial misstatement.  An auditincludes examining, on a test basis, evidence supporting the amounts anddisclosures in the financial statements. An audit also includes assessing the accounting principles used andsignificant estimates made by management, as well as evaluating the overallfinancial statement presentation.  Webelieve that our audits provide a reasonable basis for our opinion.

 

In our opinion, the consolidated financial statementsreferred to above present fairly, in all material respects, the consolidatedfinancial position of American Medical Technologies, Inc. at December 31, 2001and 2000, and the consolidated results of its operations and its cash flows foreach of three years in the period ended December 31, 2001, in conformity withaccounting principles generally accepted in the United States.  Also, in our opinion, the related financialstatement schedule, when considered in relation to the basic financialstatements taken as a whole, presents fairly, in all material respects theinformation set forth therein.

 

Theaccompanying consolidated financial statements have been prepared assuming thatthe Company will continue as a going concern. As discussed in Note 1 to the consolidated financial statements, theCompany was in technical default on certain financial covenants in connectionwith its line of credit.  The Companyand its bank have entered into a forbearance agreement, under which the bankhas agreed not to exercise its remedies under the defaulted line of credituntil September 15, 2002.   Accordingly,the entire amount outstanding under the line of credit of approximately$1,750,000 has been classified as a current liability in the accompanyingconsolidated financial statements. Management’s plans in regard to these matters are described in Note 1 tothe consolidated financial statements. These matters raise substantial doubt about the Company’s ability tocontinue as a going concern.  Theconsolidated financial statements do not include any adjustments to reflect thepossible future effect on the recoverability and classification of assets orthe amounts and classification of liabilities that may result from the outcomeof this uncertainty.

 

 

 

 

                                                                                                                                                Ernst& Young llp

 

 

San Antonio, Texas

March 1, 2002

 

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American MedicalTechnologies, Inc.

ConsolidatedStatements of Operations

 

 

 

 
|                                           |   | **Year Ended  December 31** |       |
|------------------------------------------------|--------|-----------------------------|------------|
|                                           |   | **2001**                    |       | **2000** |   | **1999** |   |
| Revenues                                       |   | $                           | 14,473,051 |   | $ | 19,685,222 |   | $ | 24,201,163 |   |
| Royalties                                      |   | 215,635                     |       | 217,024 |   | 168,364 |   |
|                                           |   | 14,688,686                  |       | 19,902,246 |   | 24,369,527 |   |
|                                           |   |                        |       |   |   |   |   |
| Cost of sales                                  |   | 8,634,543                   |       | 11,130,379 |   | 12,778,664 |   |
| Gross profit                                   |   | 6,054,143                   |       | 8,771,867 |   | 11,590,863 |   |
|                                           |   |                        |       |   |   |   |   |
| Selling, general  and administrative           |   | 9,195,306                   |       | 21,226,253 |   | 10,772,746 |   |
| Research and  development                      |   | 796,424                     |       | 966,382 |   | 931,189 |   |
| Income (loss)  from operations                 |   | (3,937,587                  | )          | (13,420,768 | ) | (113,072 | ) |
| Other income  (expense)                        |   |                        |       |   |   |   |   |
| License transfer  fees                         |   | —                      |       | — |   | 665,000 |   |
| Other income                                   |   | 118,237                     |       | 83,773 |   | 857,116 |   |
| Interest expense                               |   | (158,909                    | )          | (322,475 | ) | (401,438 | ) |
| Income (loss)  before income taxes             |   | (3,978,259                  | )          | (13,659,470 | ) | 1,007,606 |   |
| Income tax  (benefit) expense                  |   | —                      |       | 4,744,000 |   | 616,000 |   |
| Net income  (loss)                             |   | $                           | (3,978,259 | ) | $ | (18,403,470 | ) | $ | 391,606 |   |
|                                           |   |                        |       |   |   |   |   |
| Net income  (loss) per share                   |   | ($0.57                      | )          | ($2.53 | ) | $ | 0.05 |   |
|                                           |   |                        |       |   |   |   |   |
| Net income  (loss) per share assuming dilution |   | ($0.57                      | )          | ($2.53 | ) | $ | 0.05 |   |

 

See accompanyingnotes.

 

 

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American Medical Technologies, Inc.

Consolidated Balance Sheets

 

 

 

 
|                                                                           |   | **December  31** |       |
|--------------------------------------------------------------------------------|--------|------------------|------------|
|                                                                           |   | **2001**         |       | **2000** |   |
| ASSETS                                                                         |   |             |       |   |   |
| Current assets:                                                                |   |             |       |   |   |
| Cash                                                                           |   | $                | 579,667    |   | $ | 1,549,747 |   |
| Accounts  receivable, less allowance of  $176,000 in 2001 and $230,000 in 2000 |   | 1,272,703        |       | 3,371,341 |   |
| Inventories                                                                    |   | 7,182,780        |       | 6,897,157 |   |
| Prepaid expenses  and other current assets                                     |   | 310,669          |       | 440,077 |   |
| Notes receivable                                                               |   | —           |       | 243,593 |   |
| Total current  assets                                                          |   | 9,345,819        |       | 12,501,915 |   |
|                                                                           |   |             |       |   |   |
| Property and  equipment, net                                                   |   | 2,090,970        |       | 2,389,951 |   |
| Intangible  assets, net:                                                       |   |             |       |   |   |
| Goodwill                                                                       |   | 2,175,238        |       | 2,295,966 |   |
| Other                                                                          |   | 584,403          |       | 1,103,165 |   |
|                                                                           |   | 2,759,641        |       | 3,399,131 |   |
|                                                                           |   |             |       |   |   |
| Total assets                                                                   |   | $                | 14,196,430 |   | $ | 18,290,997 |   |

 

 

See accompanying notes.

 

 

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American Medical Technologies, Inc.

Consolidated Balance Sheets

 

 
|                                                                                                                                 |   | **December  31** |       |
|--------------------------------------------------------------------------------------------------------------------------------------|--------|------------------|------------|
|                                                                                                                                 |   | **2001**         |       | **2000** |   |
| LIABILITIES  AND STOCKHOLDERS’ EQUITY                                                                                           |   |             |       |   |   |
| Current  liabilities:                                                                                                                |   |             |       |   |   |
| Accounts payable                                                                                                                     |   | $                | 2,751,270  |   | $ | 1,627,496 |   |
| Compensation and  employee benefits                                                                                                  |   | 262,703          |       | 286,211 |   |
| Other accrued  liabilities                                                                                                           |   | 518,916          |       | 702,459 |   |
| Current notes  payable                                                                                                               |   | 1,959,075        |       | — |   |
| Total current  liabilities                                                                                                           |   | 5,491,964        |       | 2,616,166 |   |
|                                                                                                                                 |   |             |       |   |   |
| Other  non-current liabilities                                                                                                       |   | 78,048           |       | 172,964 |   |
| Notes payable                                                                                                                        |   | —           |       | 2,500,000 |   |
|                                                                                                                                 |   |             |       |   |   |
| Stockholders’  equity:                                                                                                          |   |             |       |   |   |
| Preferred stock,  $.01 par value, authorized  10,000,000 shares; none outstanding                                                    |   |             |       |   |   |
| Common stock,  $.04 par value, authorized  12,500,000 shares; outstanding: 6,862,348  shares in 2001; and 7,081,097   shares in 2000 |   | 274,497          |       | 283,247 |   |
| Additional  paid-in capital                                                                                                          |   | 41,615,342       |       | 41,934,608 |   |
| Warrants and  options                                                                                                                |   | 801,000          |       | 801,000 |   |
| Accumulated  deficit                                                                                                                 |   | (33,503,353      | )          | (29,525,094 | ) |
| Foreign currency  translation                                                                                                        |   | (561,068         | )          | (491,894 | ) |
| Total  stockholders’ equity                                                                                                     |   | 8,626,418        |       | 13,001,867 |   |
| Total  liabilities and stockholders’ equity                                                                                     |   | $                | 14,196,430 |   | $ | 18,290,997 |   |

 

 

See accompanying notes.

 

 

19

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American MedicalTechnologies, Inc.

ConsolidatedStatements of Cash Flows

 

 
|                                                                                                 |   | **Year ended  December 31** |       |
|------------------------------------------------------------------------------------------------------|--------|-----------------------------|------------|
|                                                                                                 |   | **2001**                    |       | **2000** |   | **1999** |   |
| OPERATING  ACTIVITIES                                                                                |   |                        |       |   |   |   |   |
| Net income  (loss)                                                                                   |   | $                           | (3,978,259 | ) | $ | (18,403,470 | ) | $ | 391,606 |   |
| Adjustments to  reconcile net income (loss) to net  cash provided by (used in) operating activities: |   |                        |       |   |   |   |   |
| Depreciation                                                                                         |   | 423,102                     |       | 502,624 |   | 413,977 |   |
| Amortization                                                                                         |   | 486,473                     |       | 1,466,407 |   | 1,454,401 |   |
| Impairment of  intangible assets                                                                     |   | 213,181                     |       | 9,233,907 |   | — |   |
| Deferred taxes                                                                                       |   | —                      |       | 4,744,000 |   | 558,619 |   |
| Provision for  slow-moving inventory                                                                 |   | 588,026                     |       | 873,298 |   | 256,615 |   |
| Provision for  doubtful accounts                                                                     |   | —                      |       | 42,000 |   | 13,000 |   |
| Net (gain) loss  on disposal of assets                                                               |   | 1,541                       |       | 1,243,887 |   | (179,368 | ) |
| Changes in  operating assets and liabilities:                                                        |   |                        |       |   |   |   |   |
| Accounts  receivable                                                                                 |   | 2,095,015                   |       | 1,282,575 |   | 198,110 |   |
| Inventories                                                                                          |   | (886,251                    | )          | 864,588 |   | 1,144,392 |   |
| Prepaid expenses  and other current assets                                                           |   | 109,741                     |       | 111,056 |   | 400,884 |   |
| Accounts payable                                                                                     |   | 1,119,524                   |       | (689,035 | ) | (556,620 | ) |
| Compensation and  employee benefits                                                                  |   | (23,605                     | )          | 68,535 |   | (187,112 | ) |
| Other accrued  liabilities                                                                           |   | (183,904                    | )          | 130,164 |   | (248,727 | ) |
| Other  non-current liabilities                                                                       |   | (94,916                     | )          | (50,314 | ) | (798,880 | ) |
| Net cash  provided by (used in) operating activities                                                 |   | (130,332                    | )          | 1,420,222 |   | 2,860,897 |   |
|                                                                                                 |   |                        |       |   |   |   |   |
| INVESTING  ACTIVITIES                                                                                |   |                        |       |   |   |   |   |
| Purchases of  property, plant & equipment                                                        |   | (130,821                    | )          | (399,981 | ) | (986,982 | ) |
| Proceeds from  sales of assets                                                                       |   | 1,300                       |       | 1,000 |   | 769,367 |   |
| Collections on  notes receivable                                                                     |   | 224,785                     |       | 531,407 |   | 300,000 |   |
| Increase in  intangible assets                                                                       |   | (60,164                     | )          | (173,544 | ) | (231,480 | ) |
| Net cash  provided by (used in) investing activities                                                 |   | 35,100                      |       | (41,118 | ) | (149,095 | ) |
|                                                                                                 |   |                        |       |   |   |   |   |
| FINANCING  ACTIVITIES                                                                                |   |                        |       |   |   |   |   |
| Payments on note  payable                                                                            |   | (754,344                    | )          | (2,650,000 | ) | (800,000 | ) |
| Proceeds from  note payable                                                                          |   | 213,419                     |       | — |   | — |   |
| Repurchase of  common stock                                                                          |   | (328,019                    | )          | (389,498 | ) | (91,339 | ) |
| Proceeds from  exercise of stock options                                                             |   | —                      |       | — |   | 42,903 |   |
| Net cash used in  financing activities                                                               |   | (868,944                    | )          | (3,039,498 | ) | (848,436 | ) |
| Increase  (decrease) in cash                                                                         |   | (964,176                    | )          | (1,660,394 | ) | 1,863,366 |   |
| Effect of  exchange rates on cash                                                                    |   | (5,904                      | )          | (20,506 | ) | (42,123 | ) |
| Increase  (decrease) in cash                                                                         |   | (970,080                    | )          | (1,680,900 | ) | 1,821,243 |   |
|                                                                                                 |   |                        |       |   |   |   |   |
| Cash at  beginning of year                                                                           |   | 1,549,747                   |       | 3,230,647 |   | 1,409,404 |   |
|                                                                                                 |   |                        |       |   |   |   |   |
| Cash at end of  year                                                                                 |   | $                           | 579,667    |   | $ | 1,549,747 |   | $ | 3,230,647 |   |

 

 

See accompanyingnotes.

 

20

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American MedicalTechnologies, Inc

Consolidated Statementsof Stockholders’ Equity

 

 

 
|                                            |   |              |   |        |    | **Additional**    |   |            |   |         |    | **Foreign**     |   |        |   |
|-------------------------------------------------|--------|-------------------|--------|-------------|---------|-------------------|--------|-----------------|--------|--------------|---------|-----------------|--------|-------------|--------|
|                                            |   | **Common  Stock** |   | **Paid-In** |    | **Warrants  and** |   | **Accumulated** |   | **Currency** |    |            |   |
|                                            |   | **Shares**        |   | **Amount**  |    | **Capital**       |   | **Options**     |   | **Deficit**  |    | **Translation** |   | **Total**   |   |
| Balance at  December 31, 1998                   |   | 7,419,259         |   | $           | 296,773 |              | $      | 42,359,016      |   | $            | 772,500 |            | $      | (11,513,230 | )      | $ | (105,757 | ) | $ | 31,809,302 |   |
| Net income for  1999                            |   |              |   |        |    |              |   |            |   | 391,606      |    |            |   | 391,606     |   |
| Foreign currency  translation                   |   |              |   |        |    |              |   |            |   |         |    | (162,589        | )      | (162,589    | )      |
| Comprehensive  income                           |   |              |   |        |    |              |   |            |   |         |    |            |   | 229,017     |   |
| Exercise of  stock options                      |   | 12,788            |   | 512         |    | 42,391            |   |            |   |         |    |            |   | 42,903      |   |
| Issuance of  common stock for intangible assets |   |              |   |        |    |              |   | 28,500          |   |         |    |            |   | 28,500      |   |
| Repurchase of  common stock                     |   | (64,200           | )      | (2,568      | )       | (88,771           | )      |            |   |         |    |            |   | (91,339     | )      |
| Balance at  December 31, 1999                   |   | 7,367,847         |   | 294,717     |    | 42,312,636        |   | 801,000         |   | (11,121,624  | )       | (268,346        | )      | 32,018,383  |   |
| Net loss for  2000                              |   |              |   |        |    |              |   |            |   | (18,403,470  | )       |            |   | (18,403,470 | )      |
| Foreign currency  translation                   |   |              |   |        |    |              |   |            |   |         |    | (223,548        | )      | (223,548    | )      |
| Comprehensive  loss                             |   |              |   |        |    |              |   |            |   |         |    |            |   | (18,627,018 | )      |
| Repurchase of  common stock                     |   | (286,750          | )      | (11,470     | )       | (378,028          | )      |            |   |         |    |            |   | (389,498    | )      |
| Balance at  December 31, 2000                   |   | 7,081,097         |   | 283,247     |    | 41,934,608        |   | 801,000         |   | (29,525,094  | )       | (491,894        | )      | 13,001,867  |   |
| Net loss for  2001                              |   |              |   |        |    |              |   |            |   | (3,978,259   | )       |            |   | (3,978,259  | )      |
| Foreign currency  translation                   |   |              |   |        |    |              |   |            |   |         |    | (69,174         | )      | (69,174     | )      |
| Comprehensive  loss                             |   |              |   |        |    |              |   |            |   |         |    |            |   | (4,047,433  | )      |
| Repurchase of  common stock                     |   | (218,749          | )      | (8,750      | )       | (319,266          | )      |            |   |         |    |            |   | (328,016    | )      |
| Balance at  December 31, 2001                   |   | 6,862,348         |   | $           | 274,497 |              | $      | 41,615,342      |   | $            | 801,000 |            | $      | (33,503,353 | )      | $ | (561,068 | ) | $ | 8,626,418 |   |

 

 

Seeaccompanying notes.

 

21

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Notes toConsolidated Financial Statements

December 31, 2001

 

 

1.         Organization and Significant Accounting Policies

 

 

##### *Principles of Consolidation*

 

American Medical Technologies, Inc. (the “Company”)develops, manufactures, markets and sells high technology products primarilyfor dentistry.  The consolidatedfinancial statements include the accounts and operations of the Company and itssubsidiary.  All intercompanytransactions and balances have been eliminated.

 

*Going Concern*

 

The Company’s financial statements are prepared using generallyaccepted accounting principles applicable to a going concern, whichcontemplates the realization of assets and the satisfaction of liabilities in thenormal course of business.  As discussedin Note 3, the Company has a line of credit with Bank One (the “Bank”).  The line of credit agreement containscovenants that, among other things, require maintenance of certain financialratios.  The covenants are required tobe calculated at the end of each quarter.

 

The Company was not in compliance with some of the financial covenantsin the agreement as of September 30, 2001, and was in default.  On November 6, 2001, the Company and thebank signed a Forbearance Agreement that increases the interest rate on theoutstanding borrowings to the prime rate plus 4%, forbids additionalborrowings, grants the bank a second mortgage on the Company’s real property,and requires the bank to forego the exercise of its legal remedies untilDecember 20, 2001.  The ForbearanceAgreement was amended to extend the termination date to September 15, 2002, inorder to give the Company additional time to secure a suitable replacement forthe credit facility.  Under the terms ofthe Forbearance Agreement, the Company will make principal payments of $30,000per month beginning on April 15, 2002. Starting on July 15, 2002, the monthly principal payment will increaseto $40,000.  Monthly interest paymentsare also required.  The Company iscurrently working with an independent consultant to acquire a new creditfacility to refinance the existing debt. The Forbearance Agreement also requires the Company to submit monthlyfinancial statements to the Bank and that the Company maintain a minimumtangible net worth, defined as net assets less intangibles, of at least $4.5million.  Should the new credit facilitynot be in place by September 15, 2002, the Company will be forced to pay a$50,000 penalty and the bank will have the right to accelerate the outstandingindebtedness and exercise its remedies under the related legal documents.  As of December 31, 2001, the outstandingprincipal on this line of credit is $1,745,656.

 

Whilethe Company believes that it will be successful in refinancing the defaultedline of credit, there can be no assurance that the Company will able accomplishthis.  If the Company is unable torefinance the line of credit it intends to explore other sources of financingwhich may include the sale of equity or debt securities to privateinvestors.  While the Company expects tobe able to refinance the defaulted line of credit or otherwise obtainadditional financing, there is no assurance that management will be successfulin its efforts.  The Company’s abilityto operate as a going concern is dependent on its ability to successfullynegotiate a new credit facility or find other sources of financing.  (See Note 3)

 

##### *Inventories*

 

Inventories are stated at the lower of cost,determined by the first-in first-out method, or market.  At December 31, inventories consisted of thefollowing:

 

|                               |   | **2001**  |      | **2000**  |   |
|------------------------------------|--------|-----------|-----------|-----------|--------|
| Finished goods                     |   | $         | 2,719,012 |      | $      | 1,277,189 |   |
| Raw materials,  parts and supplies |   | 4,463,768 |      | 5,619,968 |   |
|                               |   | $         | 7,182,780 |      | $      | 6,897,157 |   |

 

Inventories at December31, 2001 and 2000 are net of valuation allowances of $2,273,039 and $1,685,013,respectively.  The increase in thevaluation allowance for 2002 is attributable to the recent decline in saleswhich resulted in uncertainty as to whether or not significant portions of theCompany’s inventory costs will be recoverable.

 

 

 

22

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##### *Property and Equipment*

 

Propertyand equipment are stated at cost less accumulated depreciation.  Depreciation is computed by thestraight-line method over the estimated useful lives of the related assets,which range from three to thirty-nine years. At December 31, property and equipment consisted of the following:

 

|                            |   | **2001**   |      | **2000**   |   |
|---------------------------------|--------|------------|-----------|------------|--------|
| Building and  improvements      |   | $          | 1,567,939 |       | $      | 1,561,219 |   |
| Machinery and  equipment        |   | 1,446,614  |      | 1,357,287  |   |
| Office furniture  and computers |   | 864,522    |      | 843,140    |   |
| Vehicles                        |   | 119,316    |      | 118,144    |   |
|                            |   | 3,998,391  |      | 3,879,790  |   |
| Accumulated  depreciation       |   | (1,907,421 | )         | (1,489,839 | )      |
|                            |   | $          | 2,090,970 |       | $      | 2,389,951 |   |

##### * *

 

*Revenue Recognition*

 

TheCompany recognizes revenue when each of the following four criteria are met: 1)a contract or sales arrangement exists; 2) products have been shipped and titlehas been transferred or services have been rendered; 3) the price of theproducts or services is fixed or determinable; and 4) collectibility isreasonably assured.  The Companyrecognizes the related estimated warranty expense when title is transferred tothe customer, generally upon shipment. The Company recognizes revenue on certain sales to two of its largestdistributors under terms that require shipment to a local independentwarehouse.  In September 2000, theEmerging Issues Task Force issued EITF 00-10 which requires disclosure ofshipping and handling costs that are not included in costs of goods sold.  The Company’s policy is to include shippingand handling costs, net of the related revenues, in costs of goods sold.

 

 

*Intangible Assets*

 

Intangibleassets consist of goodwill, patents, distribution rights and other intangiblesand are stated at cost less accumulated amortization.  The Company amortized goodwill over periods ranging from 15 to 25years, patents and distribution agreements over their respective lives, andother intangible assets over lives ranging from 5 to 17 years.  Accumulated amortization was $3,544,828 and$3,097,675 at December 31, 2001 and 2000, respectively.

 

TheCompany periodically evaluates intangible assets for indicators of impairmentin value.  When impairment is indicated,the Company revalues the assets based on their estimated fair value.  In 2000, the continued decline in sales ofthe Company’s KCP and camera units, and the underperformance of the dentalprobe units, served as indicators of impairment for certain intangible assetsassociated with the previous acquisitions of Texas Airsonics, Inc., DentalVision Direct, Inc., and Dental Probe, Inc. Following the guidance of FASB Statement No.  121 *Accounting for the Impairment of Long-Lived Assets and for Long-LivedAssets to be Disposed Of*, the Company projected future cash flowsfor these products based on management’s best estimates of likely future sales,less costs of goods sold and selling expenses. The undiscounted future cash flows were less than the recorded value of theassets related to these product lines, indicating impairment existed.  To determine the amount of the impairment,the fair value of the related assets was determined by comparing the futurecash flows discounted at a rate of 8% to the fair value of the relatedlong-lived assets based on current market selling prices of similarequipment.   The Company recorded animpairment of approximately $9.2 million to reduce the carrying value of thelong-lived assets associated with the aforementioned acquisitions to the fairvalue of those assets.  This impairmentexpense is included in Selling General and Administrative Expenses on theStatement of Operations. In the fourth quarter of 2001, the Company decided notto enter the digital dental x-ray market. The Company had previously purchased the rights to a digital dentalx-ray technology for $252,500.  With thedecision not to enter the digital dental x-ray market at this time, theunamortized balance of $213,181 related to this asset was determined to beimpaired.

 

 

23

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##### *Net Income Per Share*

##### * *

The following table sets forth the computation forbasic and diluted earnings per share:

 
|                                                                                                                             |   | **2001**  |       | **2000**  |   | **1999**    |   |
|----------------------------------------------------------------------------------------------------------------------------------|--------|-----------|------------|-----------|--------|-------------|--------|
| Numerator:                                                                                                                       |   |      |       |      |   |        |   |
| Net  income (loss)                                                                                                               |   | $         | (3,978,258 | )         | $      | (18,403,470 | )      | $ | 391,606 |   |
|                                                                                                                             |   |      |       |      |   |        |   |
| Numerator  for basic and diluted earnings per   share — income available to common   stockholders after assumed conversions |   | $         | (3,978,258 | )         | $      | (18,403,470 | )      | $ | 391,606 |   |
|                                                                                                                             |   |      |       |      |   |        |   |
| Denominator:                                                                                                                     |   |      |       |      |   |        |   |
| Denominator  for basic earnings per share —  weighted-average shares                                                        |   | 6,923,347 |       | 7,284,443 |   | 7,424,433   |   |
|                                                                                                                             |   |      |       |      |   |        |   |
| Effect  of dilutive securities:                                                                                                  |   | —    |       | —    |   | 21,736      |   |
| Employee  stock options                                                                                                          |   | —    |       | —    |   | —      |   |
| Warrants                                                                                                                         |   |      |       |      |   |        |   |
|                                                                                                                             |   |      |       |      |   |        |   |
| Dilutive  potential common shares                                                                                                |   |      |       |      |   |        |   |
| Denominator  for diluted earnings per  share — adjusted weighted-average   shares after assumed conversions                 |   | 6,923,347 |       | 7,284,443 |   | 7,446,169   |   |
|                                                                                                                             |   |      |       |      |   |        |   |
| Net  income (loss) per share                                                                                                     |   | $         | (.57       | )         | $      | (2.53       | )      | $ | 0.05 |   |
| Net  income (loss) per share assuming dilution                                                                                   |   | $         | (.57       | )         | $      | (2.53       | )      | $ | 0.05 |   |

 

##### * *

##### * *

##### *Comprehensive Income (Loss)*

 

The Financial AccountingStandards Board’s Statement 130, *Reporting Comprehensive Income* requiresforeign currency translation adjustments to be included, along with net income,in comprehensive income.  For 2001,2000, and 1999 the Company’s Comprehensive Income (Loss) was ($4,047,433),($18,627,018), and $229,017, respectively.

The components ofAccumulated Other Comprehensive Income (Loss) are as follows:

|                                      |   | **2001** |     | **2000** |   | **1999** |   |
|-------------------------------------------|--------|----------|----------|----------|--------|----------|--------|
| Foreign currency  translation adjustments |   | $        | (69,174  | )        | $      | (223,548 | )      | $ | (162,589 | ) |
| Accumulated  other comprehensive income   |   | $        | (561,068 | )        | $      | (491,894 | )      | $ | (268,346 | ) |

 

 

##### *Translation of non-U.S. currency amounts*

##### * *

##### *Fornon-U.S. subsidiaries that operate in a local currency environment, assets andliabilities are translated to U.S. dollars at the current exchange rates at thebalance sheet date.  Income and expenseitems are translated at average rates of exchange prevailing during theyear.  Translation adjustments areaccumulated in a separate component of stockholders’ equity.*

 

 

24

----

 

 

 

##### *Stock Based Compensation*

 

The Company grants stock options for a fixed number ofshares to employees with an exercise price no less than the fair value of theshares at the date of grant.  The Companyaccounts for stock option grants in accordance with APB Opinion No. 25, *Accountingfor Stock Issued to Employees,* and, accordingly, recognizes nocompensation expense for the stock option grants.

 

 

##### *Advertising*

 

TheCompany expenses advertising costs as incurred.  Advertising expense approximated $417,000, $867,000, and$1,544,000 in 2001, 2000 and 1999, respectively.

 

 

##### *Use of Estimates*

 

The preparation of financial statements in conformitywith generally accepted accounting principles requires management to makeestimates and assumptions that affect the amounts reported in the financialstatements and accompanying notes. Actual results could differ from these estimates.

 

##### * *

##### *Fair Value of Financial Instruments*

 

The fair value of the Company’s cash, accountsreceivable, note receivable and accounts payable approximates their carryingvalue due to their short term nature. The fair value of the Company’s notepayable to the bank approximates its carrying value due to the variableinterest rate.

 

##### *New Accounting Standards and Disclosures*

 

                                In July 2001, the FinancialAccounting Standards Board issued Statement No. 141, “Business Combinations”(“FASB 141”), and Statement No. 142, “Goodwill and Other Intangible Assets”(“FASB 142”). FASB 141 requires all business combinations initiated after June30, 2001 to be accounted for using the purchase method. Under FASB 142,goodwill is no longer subject to amortization over its estimated useful life.Rather, goodwill is subject to at least an annual assessment for impairmentapplying a fair-value based test. Additionally, any acquired intangible assetsshould be separately recognized if the benefit of the intangible asset isobtained through contractual or other legal rights, or if the intangible assetcan be sold, transferred, licensed, rented, or exchanged, regardless of theacquirer’s intent to do so. Amortization expense related to goodwill was approximately $368,000,$476,000 and $1,077,000 in 2001, 2000 and 1999, respectively.  The Company adopted both statements on January1, 2002.

 

                The FASB issued Statement No. 144, “Accountingfor the Impairment or Disposal of Long-Lived Assets,” in August 2001. FASB144 supersedes FASB 121, “Accounting for the Impairment of Long-Lived Assetsand for Long-Lived Assets to Be Disposed Of,” and other related accountingguidance. FASB 144 is effective for financial statements issued for fiscalyears beginning after December 15, 2001, and interim periods within thosefiscal years, with early application encouraged. The provisions of thisstatement generally are to be applied prospectively. The adoption of thispronouncement is not expected to have a material effect on earnings or theconsolidated financial position of the Company.

 

 

25

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2.         Agreementswith Related Parties

 

*Denics Co., Ltd.*

 

In December 1999, the Company agreed to convert$675,000 of outstanding accounts receivable from Denics to a note receivable,with interest payable at 8.5%, due February 2001.  The note was paid in full in 2001.

 

Denics previously owned 4.89% of the Company’s common stock and hadwarrants to acquire an additional 1.43% of the Company’s common stock.  These warrants expired in 1999 without beingexercised and Denics is no longer considered a “related party.”  Accordingly, trade sales and accountsreceivable balances with Denics are no longer presented as a “related party” onthe face of the financial statements for all periods presented to provideconsistent disclosure.

 

 

3.         Line of Credit and Other Non-Current Liabilities

 

During2001, the Company had a $7,500,000 revolving line of credit from a bank whichwas to expire in September 2002.  TheCompany’s borrowings under that line are secured by a pledge of the Company’saccounts receivable, inventory, equipment, instruments, patents, copyrights andtrademarks.

 

TheCompany was not in compliance with some of the financial covenants in theagreement as of September 30, 2001, and was in default.  On November 6, 2001, the Company and thebank signed a Forbearance Agreement that increases the interest rate on theoutstanding borrowings to the prime rate plus 4%, forbids additionalborrowings, grants the bank a second mortgage on the Company’s real property,and requires the bank to forego the exercise of its legal remedies untilDecember 20, 2001.  The ForbearanceAgreement was amended to extend the termination date to September 15, 2002, inorder to give the Company additional time to secure a suitable replacement forthe credit facility.  Under the terms ofthe Forbearance Agreement, the Company will make principal payments of $30,000per month beginning on April 15, 2002. Starting on July 15, 2002, the monthly principal payment will increaseto $40,000.  Monthly interest paymentsare also required.  The Company iscurrently working with an independent consultant to acquire a new creditfacility to refinance the existing debt. The Forbearance Agreement also requires the Company to submit monthlyfinancial statements to the Bank and that the Company maintain a minimumtangible net worth, defined as net assets less intangibles, of at least $4.5million.  Should the new credit facilitynot be in place by September 15, 2002, the Company will be forced to pay a$50,000 penalty and the bank will have the right to accelerate the outstandingindebtedness and exercise its remedies under the related legal documents.  As of December 31, 2001, the outstandingprincipal on this line of credit is $1,745,656.

 

OnOctober 3, 2001, in order to obtain working capital, the Company entered into a$750,000 line of credit with ValueBank Texas and the U.S. Small BusinessAdministration.  The loan is secured bya primary lien on the Company’s building and real property and is personallyguaranteed by Ben Gallant, the Company’s Chairman and Chief ExecutiveOfficer.  The loan expires on October 3,2002 and bears interest at the prime rate plus 2%.  As of December 31, 2001, the outstanding principal on this lineof credit is $213,419.

 

The Company leases certain manufacturing equipmentunder capital leases.  Equipment relatedto capital leases had a total cost of $286,179 and $489,179 and accumulateddepreciation of $205,096 and $311,560 at December 31, 2001 and 2000,respectively.  Amortization related toassets held under capital leases is included in depreciation expense.  The Company leases office space, vehicles,and office machines under operating leases. Future minimum lease payments under capital and operating leases as ofDecember 31, 2001 are as follows:

 

|                               |   | **Operating** |    | **Capital** |    |
|------------------------------------|--------|---------------|---------|-------------|---------|
| **Year**                           |   | **Leases**    |    | **Leases**  |    |
| 2002                               |   | $             | 351,687 |        | $       | 79,066 |   |
| 2003                               |   | 122,334       |    | 47,777      |    |
| 2004                               |   | 23,908        |    | —      |    |
|                               |   | $             | 497,929 |        | 126,843 |   |
| Less amount  representing interest |   |          |    | (12,174     | )       |
|                               |   |          |    | $           | 114,669 |   |

 

 

26

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Capital lease obligations at December 31, 2001consisted of the following:

 

| Current portion                  |   | $      | 69,347  |   |
|----------------------------------|--------|--------|---------|--------|
| Non-current  portion             |   | 45,322 |    |
| Total capital  lease obligations |   | $      | 114,669 |   |

 

Rental expense for operating leases in 2001, 2000 and1999 approximated $497,000, $344,000, and $94,000, respectively.

 

The Company paid interest of approximately $170,000,$322,000 and $401,000 in 2001, 2000 and 1999, respectively.

 

 

4.     Stockholders’ Equity, Stock Options and Warrants

 

The Company has authorized three stock option plansfor employees, officers, directors, consultants and other key personnel.  As of December 31, 2001, the NonqualifiedStock Option Plan has 287,500 shares reserved, 59,336 shares available forissuance and 189,127 shares outstanding; the Long-Term Incentive Plan has625,000 shares reserved, 88,062 shares available for issuance and 466,052shares outstanding; and the Stock Option Plan for Employees has 17,405 sharesreserved, 2,401 shares available and 13,536 shares outstanding.

 

The Company also authorized and granted 81,392 stockoptions exclusive of the above described plans, none of which were everexercised prior to their expiration in 2000.

 

The Company has elected to follow AccountingPrinciples Board Opinion No. 25, “Accounting for Stock Issued to Employees” (APB25) and related Interpretations in accounting for its employee stock optionsbecause, as discussed below, the alternative fair value accounting provided forunder FASB Statement No. 123, “Accounting for Stock-Based Compensation,”requires use of option valuation models that were not developed for use invaluing employee stock options.  UnderAPB 25, because the exercise price of the Company’s employee stock optionsequals the market price of the underlying stock on the date of grant, nocompensation expense is recognized.

 

Pro forma information regarding net income andearnings per share is required by Statement 123 and has been determined as ifthe Company had accounted for its employee stock options under the fair valuemethod of that Statement.  The fairvalue for these options was estimated at the date of grant using aBlack-Scholes option pricing model with the following weighted-averageassumptions for 1999, 2000 and 2001, respectively: risk-free interest rate of6.5%, 6.5%, and 4.4%; dividend yield of 0%; volatility factors of the expectedmarket price of the Company’s common stock of 1.437, .771 and .913 and aweighted-average expected life of the option of five years.

 

The Black-Scholes option valuation model was developedfor use in estimating the fair value of traded options that have no vestingrestrictions and are fully transferable. In addition, option valuation models require the input of highlysubjective assumptions including the expected stock price volatility.  Because the Company’s employee stock optionshave characteristics significantly different from those of traded options, andbecause changes in the subjective input assumptions can materially affect thefair value estimate, in management’s opinion, the existing models do not necessarilyprovide a reliable single measure of the fair value of its employee stockoptions.

 

For purposes of pro formadisclosures, the estimated fair value of the option is amortized to expenseover the options’ vesting period.  TheCompany’s pro forma information follows:

 

|                                                      |   | **2001** |       | **2000** |   | **1999**    |   |
|-----------------------------------------------------------|--------|----------|------------|----------|--------|-------------|--------|
| Pro forma net  income (loss)                              |   | $        | (3,994,931 | )        | $      | (18,429,417 | )      | $ | 366,875 |   |
| Pro forma net  income (loss) per share                    |   | $        | (0.58      | )        | $      | (2.53       | )      | $ | 0.05 |   |
| Pro forma net  income (loss) per share  assuming dilution |   | $        | (0.58      | )        | $      | (2.53       | )      | $ | 0.05 |   |

 

 

27

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Stock option activity is summarized as follows:

 

|                              |   | **Number**    |   | **Weighted-Average** |   |
|-----------------------------------|--------|---------------|--------|----------------------|--------|
|                              |   | **of Shares** |   | **Exercise  Price**  |   |
| Outstanding at  January 1, 1999   |   | 739,108       |   | 5.57                 |   |
| Exercisable at  January 1, 1999   |   | 535,598       |   | 5.63                 |   |
|                              |   |          |   |                 |   |
| Options granted                   |   | 111,872       |   | 3.47                 |   |
| Options  exercised                |   | (12,788       | )      | 3.36                 |   |
| Options canceled                  |   | (182,928      | )      | 6.29                 |   |
|                              |   |          |   |                 |   |
| Outstanding at  December 31, 1999 |   | 655,264       |   | 5.06                 |   |
| Exercisable at  December 31, 1999 |   | 535,598       |   | 6.19                 |   |
|                              |   |          |   |                 |   |
| Options granted                   |   | 401,248       |   | 1.38                 |   |
| Options  exercised                |   | —        |   | —               |   |
| Options canceled                  |   | (359,621      | )      | 4.49                 |   |
|                              |   |          |   |                 |   |
| Outstanding at  December 31, 2000 |   | 696,891       |   | 3.24                 |   |
| Exercisable at  December 31, 2000 |   | 309,786       |   | 5.49                 |   |
|                              |   |          |   |                 |   |
| Options granted                   |   | 76,560        |   | 0.61                 |   |
| Options  exercised                |   | —        |   | —               |   |
| Options canceled                  |   | (104,736      | )      | 4.64                 |   |
|                              |   |          |   |                 |   |
| Outstanding at  December 31, 2001 |   | 668,715       |   | 2.12                 |   |
| Exercisable at  December 31, 2001 |   | 215,112       |   | 3.93                 |   |

 

The weighted-average fair value of options granted during the year was$.43, $.92 and $3.46 in 2001, 2000 and 1999, respectively.

 

A summary of optionsoutstanding as of December 31, 2001 is as follows:

 

|   |                |   |            |   |            |   |                |   | **Weighted**          |   |
|--------|---------------------|--------|-----------------|--------|-----------------|--------|---------------------|--------|-----------------------|--------|
|   |                |   | **Number of**   |   | **Number of**   |   | **Weighted**        |   | **Average**           |   |
|   | **Range of**        |   | **Options**     |   | **Options**     |   | **Average**         |   | **Remaining**         |   |
|   | **Exercise Prices** |   | **Outstanding** |   | **Exercisable** |   | **Exercise  Price** |   | **Contractual  Life** |   |
|   | $50.00 - $10.75     |   | 4,999           |   | 4,999           |   | $                   | 26.34  |                  |   | .51 years |   |
|   | $9.50 - $5.38       |   | 181,792         |   | 51,792          |   | $                   | 5.59   |                  | 5      | .34 years |   |
|   | $4.00 - $2.00       |   | 25,693          |   | 25,303          |   | $                   | 3.65   |                  | 2      | .36 years |   |
|   | $1.38 - $0.60       |   | 456,231         |   | 133,018         |   | $                   | 1.25   |                  | 8      | .84 years |   |

 

 

28

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Warrant activity issummarized as follows:

 

|                              |   |       |   | **Weighted-Average** |   |
|-----------------------------------|--------|------------|--------|----------------------|--------|
|                              |   | **Shares** |   | **Exercise  Price**  |   |
| Outstanding at  January 1, 1999   |   | 2,930,868  |   | 5.46                 |   |
| Exercisable at  January 1, 1999   |   | 2,930,868  |   | 5.46                 |   |
|                              |   |       |   |                 |   |
| Warrants issued                   |   | 50,000     |   | 4.13                 |   |
| Warrants  exercised               |   | —     |   | —               |   |
| Warrants  canceled                |   | (2,232,618 | )      | 5.50                 |   |
| Outstanding at  December 31, 1999 |   | 748,250    |   | 5.21                 |   |
| Exercisable at  December 31, 1999 |   | 748,250    |   | 5.21                 |   |
|                              |   |       |   |                 |   |
| Warrants issued                   |   | —     |   | —               |   |
| Warrants  exercised               |   | —     |   | —               |   |
| Warrants  canceled                |   | —     |   | —               |   |
| Outstanding at  December 31, 2000 |   | 748,250    |   | 5.21                 |   |
| Exercisable at  December 31, 2000 |   | 748,250    |   | 5.21                 |   |
|                              |   |       |   |                 |   |
| Warrants issued                   |   | —     |   | —               |   |
| Warrants  exercised               |   | —     |   | —               |   |
| Warrants  canceled                |   | —     |   | —               |   |
| Outstanding at  December 31, 2001 |   | 748,250    |   | 5.21                 |   |
| Exercisable at  December 31, 2001 |   | 748,250    |   | 5.21                 |   |

 

 

29

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There were no warrants granted in 2000 or 2001.  The weighted average fair value of warrantsgranted during 1999 was $4.13.  Exerciseprices for warrants outstanding as of December 31, 2001 ranged from $4 to$5.50.  The weighted-average remainingcontractual life of those warrants is 2.2 years.

 

 

5.   Transfer of License

 

In June 1997, the Companyagreed to the transfer of the licenses for the sales of dental lasers and airabrasive instruments from Sunrise Technologies, Inc. (“Sunrise”) to Lares Co.(“Lares”) in connection with the sale of Sunrise’s dental business to Lares.  The Company received a payment of $275,000and a note receivable for $100,000, due in June 2000.  The Company will also continue to receive royalties on airabrasive and dental lasers from Lares. The Company received Sunrise stock with a market value of $81,192 in2001.  This amount was applied againstthe note and the remaining amount was deemed uncollectible.

 

In 1999, the Company solda license to ESC Medical Systems, Ltd. for $300,000 for the use of certainpatents.  The Company delivered thelicense to ESC Medical Systems, Ltd. in 1999 and recorded the income in 1999 asa license transfer fee since the Company has no additional requirements underthis license.

 

 

6.               Income Taxes

 

At December 31, 2001, the Company had approximately$15,359,000 million of net operating loss carryforwards for federal income taxpurposes, which expire in various amounts in the years 2006 through 2021.

 

Deferred taxes represent the net tax effects oftemporary differences between the carrying amounts of assets and liabilitiesfor financial reporting purposes and amounts used for income tax purposes.  Significant components of the Company’sdeferred tax assets are as follows:

|                                         |   | **December  31** |   |
|----------------------------------------------|--------|------------------|--------|
|                                         |   | **2001**         |   | **2000** |   |
| Allowance for  doubtful accounts             |   | $                | 60,000 |   | $ | 78,000 |   |
| Inventory valuation  reserves                |   | 807,000          |   | 611,000 |   |
| Depreciation                                 |   | 326,000          |   | 322,000 |   |
| Compensation and  employee benefits          |   | 50,000           |   | 72,000 |   |
| Alternative  minimum tax credit carryforward |   | 236,000          |   | 195,000 |   |
| Warranty reserve                             |   | 54,000           |   | 88,000 |   |
| Other                                        |   | 250,000          |   | 266,000 |   |
| Net operating  loss carryforwards            |   | 5,222,000        |   | 4,064,000 |   |
| Deferred tax  asset                          |   | 7,005,000        |   | 5,696,000 |   |
|                                         |   |             |   |   |   |
| Deferred tax  liabilities                    |   | (54,000          | )      | (47,000 | ) |
|                                         |   |             |   |   |   |
| Net deferred tax  asset                      |   | 6,951,000        |   | $ | 5,649,000 |   |
|                                         |   |             |   |   |   |
| Valuation  allowance                         |   | 6,951,000        |   | 5,649,000 |   |
|                                         |   |             |   |   |   |
| Net deferred tax  asset                      |   | $                | — |   | $ | — |   |

 

 

30

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The Company’sincome tax provision included the following:

 

|                          |   | **2001**  |       | **2000**  |   | **1999**   |   |
|-------------------------------|--------|-----------|------------|-----------|--------|------------|--------|
| Current expense               |   | $         | —     |      | $      | —     |   | $ | 58,000 |   |
| Deferred expense  (benefit)   |   | —    |       | 4,744,000 |   | 558,000    |   |
|                          |   | $         | —     |      | $      | 4,744,000  |   | $ | 616,000 |   |
|                          |   |      |       |      |   |       |   |
| Income taxes  (benefit) at    |   |      |       |      |   |       |   |
| US statutory  rate            |   | $         | (1,353,000 | )         | $      | (4,644,000 | )      | $ | 343,000 |   |
| State taxes                   |   | —    |       | —    |   | 58,000     |   |
| Non-deductible  amortization  |   | —    |       | 3,248,000 |   | 251,000    |   |
| Deferred tax asset  valuation |   |      |       |      |   |       |   |
| allowance adjustment          |   | 1,302,000 |       | 5,649,000 |   | —     |   |
| Other                         |   | 51,000    |       | 491,000   |   | (36,000    | )      |
|                          |   | $         | —     |      | $      | 4,744,000  |   | $ | 616,000 |   |

 

 

In 2000,uncertainties existed as to the future realization of the deferred tax assetunder the criteria set forth under FASB Statement No. 109.  Therefore, the Company established avaluation allowance for the deferred tax asset of $6,951,000 at December 31,2000.

 

The Company paidno federal income tax during 2000 or 2001. Income taxes paid were approximately $134,000 in 1999.

 

The Company’s investment in its foreign subsidiary isconsidered to be permanently invested and no provision for U.S. federal andstate income taxes on these translation adjustments have been provided.

 

 

7.               Operations by Industry Segment, Geographic Area andSignificant Customers

 

SFAS No. 131, Disclosures about Segments of anEnterprise and Related Information, established standards for reportinginformation about operating segments in annual financial statements andrequires selected information about operating segments in interim financialreports issued to stockholders.  It alsoestablished standards for related disclosures about products and services, andgeographic areas.  Operating segmentsare defined as components of the enterprise about which separate financialinformation is available that is evaluated regularly by the chief operatingdecision maker, or decision making group, in deciding how to allocate resourcesand in assessing performance.

 

The Company develops, manufactures, markets and sellshigh technology dental products, such as air abrasive equipment, lasers, curinglights and intra oral cameras. Domestically, prior to the adoption of its new business model inFebruary 2000, the Company maintained a nationwide sales force to generatesales and assist its dealer network. Subsequent to the adoption of the new business model, the Company sellsits products direct to the consumer through its nationwide network of sales andservice branch offices. Internationally, with the exception of a small numberof personnel in Germany, the Company has not maintained its own sales force andcontinues to sell its products through regional dental distributors.  The reportable segments are reviewed and managedseparately because selling techniques and market environments differ fromselling domestically versus selling through international distributornetworks.  The remaining revenues of theCompany, which are reported as “Other”, include industrial products and royaltyincome.

 

 

31

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The accounting policies of the business segments areconsistent with those described in Note 1.

 

|                                           |   | **2001**   |       | **2000**    |   | **1999**    |   |
|------------------------------------------------|--------|------------|------------|-------------|--------|-------------|--------|
| Revenues:                                      |   |       |       |        |   |        |   |
| Domestic                                       |   | $          | 10,430,196 |        | $      | 10,646,392  |   | $ | 15,174,499 |   |
| International                                  |   | 3,459,628  |       | 8,339,465   |   | 8,309,990   |   |
|                                           |   | $          | 13,889,824 |        | $      | 18,985,857  |   | $ | 23,484,489 |   |
| Reconciliation  of revenues:                   |   |       |       |        |   |        |   |
| Total segment  revenues                        |   | $          | 13,889,824 |        | $      | 18,985,857  |   | $ | 23,484,489 |   |
| Other                                          |   | 798,862    |       | 916,389     |   | 885,038     |   |
| Total revenues                                 |   | $          | 14,688,686 |        | $      | 19,902,246  |   | $ | 24,369,527 |   |
|                                           |   |       |       |        |   |        |   |
| Operational  earnings (loss):                  |   |       |       |        |   |        |   |
| Domestic                                       |   | $          | (733,584   | )           | $      | (2,085,460  | )      | $ | 1,295,036 |   |
| International                                  |   | 660,017    |       | 3,088,126   |   | 2,896,915   |   |
|                                           |   | $          | (73,567)   |        | $      | 1,002,666   |   | $ | 4,191,951 |   |
|                                           |   |       |       |        |   |        |   |
| Reconciliation  of operational earnings        |   |       |       |        |   |        |   |
| (loss) to loss  from operations:               |   |       |       |        |   |        |   |
| Total segment  operational earnings            |   | $          | (73,567    | )           | $      | 1,002,666   |   | $ | 4,191,951 |   |
| Other  operational earnings (loss)             |   | 493,946    |       | 563,755     |   | 529,038     |   |
| Research &  development expenses           |   | (796,424   | )          | (966,382    | )      | (931,189    | )      |
| Administrative  expenses                       |   | (3,561,542 | )          | (14,024,076 | )      | (3,902,872  | )      |
| Loss from  operations                          |   | $          | (3,937,587 | )           | $      | (13,420,768 | )      | $ | (113,072 | ) |
|                                           |   |       |       |        |   |        |   |
| International  revenues by country:            |   |       |       |        |   |        |   |
| Japan                                          |   | $          | 1,260,492  |        | $      | 3,890,017   |   | $ | 4,496,398 |   |
| Germany                                        |   | 831,472    |       | 1,601,502   |   | 1,717,379   |   |
| Italy                                          |   | 909,520    |       | 1,269,305   |   | 717,502     |   |
| Canada                                         |   | 71,772     |       | 315,343     |   | 396,201     |   |
| Other                                          |   | 146,611    |       | 914,528     |   | 653,940     |   |
|                                           |   | $          | 3,219,867  |        | $      | 7,990,695   |   | $ | 7,981,420 |   |
|                                           |   |       |       |        |   |        |   |
| Long lived  assets (excluding deferred taxes): |   |       |       |        |   |        |   |
| Domestic                                       |   | $          | 2,075,082  |        | $      | 2,370,204   |   | $ | 2,436,122 |   |
| International                                  |   | 15,888     |       | 19,747      |   | 11,784      |   |
|                                           |   | $          | 2,090,970  |        | $      | 2,389,951   |   | $ | 2,447,906 |   |

 

 

Salesto Patterson Dental Company, a major domestic distributor of the Company’sproducts, were approximately 2%, 3% and 16% of total revenues in 2001, 2000 and1999, respectively. Sales to Denics for certain Asian and Pacific markets,primarily Japan, were approximately 9%, 21% and 19% of total revenues in 2001,2000 and 1999, respectively.

 

 

32

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8.         Litigation and Contingencies

 

In July 2000, the Company filed a lawsuit in theDistrict Court of Nueces County, Texas against Henry Schein, Inc. to recoverapproximately $293,000 of past due receivables plus interest and cost ofcollection.  In September 2001, theCompany settled this lawsuit out of court. Under the provisions of the settlement agreement, the terms of thesettlement cannot be disclosed.

 

All of the litigation involving Kreativ, Inc. wassettled during 1999 as previously disclosed. The Company received a $580,000 settlement from Kreativ, Inc. in thefalse advertising suit and received $300,000 in exchange for a paid-up licensein settlement of the two patent suits. The proceeds from the false advertising suit are included in otherincome in the Statement of Operations and the proceeds from the patent suitsare included in the license transfer fees in the Statement of Operations.

 

 

9.         SelectedQuarterly Financial Data (unaudited)

 

 
|                                           |   | **Three  Months Ended** |      |
|------------------------------------------------|--------|-------------------------|-----------|
|                                           |   | **March 31**

**2001**  |      | **June 30**

**2001** |   | **September  30**

**2001** |   | **December  31**

**2001** |   |
| Revenues                                       |   | $                       | 4,495,770 |   | $ | 3,697,468 |   | $ | 2,605,788 |   | $ | 3,889,660 |   |
| Gross profit                                   |   | 2,512,819               |      | 1,718,325 |   | 1,107,738 |   | 715,261 | (1), (2) |
| Net income  (loss)                             |   | 104,833                 |      | (806,699 | ) | (1,209,242 | ) | (2,067,151 | ) |
| Net income  (loss) per share assuming dilution |   | $                       | 0.01      |   | $ | (0.12 | ) | $ | (0.18 | ) | $ | (.28 | ) |

 

 
|                                           |   | **Three Months Ended** |      |
|------------------------------------------------|--------|------------------------|-----------|
|                                           |   | **March 31**

**2000** |      | **June 30**

**2000** |   | **September  30**

**2000** |   | **December 31**

**2000** |   |
| Revenues                                       |   | $                      | 4,700,106 |   | $ | 5,489,878 |   | $ | 4,557,731 |   | $ | 5,154,532 |   |
| Gross profit                                   |   | 1,955,616              |      | 3,126,379 |   | 2,589,671 |   | 1,100,202 | (1) |
| Net income  (loss)                             |   | (745,980               | )         | 138,117 |   | (247,908 | ) | (17,547,669 | )(3) |
| Net income  (loss) per share assuming dilution |   | $                      | (0.10     | ) | $ | 0.02 |   | $ | (0.03 | ) | $ | (2.43 | ) |

----

(1)       In the fourth quarter of each year theCompany conducts its annual physical inventory count.  Any expense or loss booked in association with the physical countis booked in the fourth quarter. Inventory count adjustments charged to expense in the fourth quarterwere approximately $360,000 and $777,000 in 2001 and 2000, respectively.

(2)          In thefourth quarter of 2001, the Company reassessed its slow moving inventoryreserve based on the events of September 11 and the decline in revenues.  This reassessment resulted in a charge ofapproximately $650,000 in the fourth quarter of 2001.

(3)      Includesimpairment charges of $9.2 million related to intangibles associated with theair abrasion and camera product lines, a charge to increase the reserve forslow moving inventory by $.8 million, a write off of demonstration inventory of$1.2 million related to the change in the business model, and a deferred incometax valuation allowance of $5.6 million. Such adjustments were booked in the fourth quarter, as the effects ofthe implementation of the new business model could not be evaluated untilmanagement deemed the transition to the new business model was substantiallycompleted.

 

 

33

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**PARTIII**

 

 

ITEM 13.            CERTAIN RELATIONSHIPS AND RELATEDTRANSACTIONS

 

            The Company’s $750,000 line of credit with ValueBankTexas and the U.S. Small Business Administration is personally guaranteed byBen J. Gallant, the Company’s Chairman and Chief Executive Officer.

 

 

**PARTIV**

 

 

ITEM 14.        EXHIBITS,FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K

 

          (a)   1.     Financial Statements:  The following financial statements ofAmerican Medical Technologies, Inc. are included in Item 8, “Financial Statementsand Supplementary Data”:

 

          Report of Independent Auditors

          Consolidated Statements of Operationsfor the Years Ended December 31, 2001, 2000, and 1999

          Consolidated Balance Sheets as ofDecember 31, 2001 and 2000

          Consolidated Statements of Stockholders’Equity for the Years Ended December 31, 2001, 2000, and 1999

          Consolidated Statements of Cash Flowsfor the Years Ended December 31, 2001, 2000, and 1999

          Notes to Consolidated FinancialStatements

 

                  2.     Financial Statement Schedules: The following financial statementschedule is attached to this report.

 

                Schedule II - Valuation and Qualifying Accounts

 

All other schedules are omitted because they are not applicable, notrequired, or the information is included in the financial statements or thenotes thereto.

 

                    3.     Exhibits:The exhibits included as part of this report are listed in the attached Exhibit Index, which is incorporated herein by reference.

 

            (b) Reports on Form 8-K: No reportson Form 8-K were filed during the quarter ended December 31, 2001.

 

 

34

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**SCHEDULE II - VALUATION ANDQUALIFYING ACCOUNTS**

**American Dental Technologies, Inc.**

 

 

 
| **Column A**                                 |   | **Column B**   |   | **Column C**   |   | **Column D**   |   | **Column E**  |   |
|----------------------------------------------|--------|----------------|--------|----------------|--------|----------------|--------|---------------|--------|
|                                         |   |           |   |           |   |           |   |          |   |
|                                         |   |           |   | **Additions**  |   |           |   |          |   |
|                                         |   | **Balance at** |   | **Charged to** |   |           |   | **Balance**   |   |
|                                         |   | **Beginning**  |   | **Costs and**  |   | **Deductions** |   | **at End**    |   |
| **Description**                              |   | **of Period**  |   | **Expenses**   |   | **Describe**   |   | **of Period** |   |
| Year Ended  December 31, 1999                |   |           |   |           |   |           |   |          |   |
|                                         |   |           |   |           |   |           |   |          |   |
| Valuation  allowance for accounts receivable |   | 175,000        |   | 13,000(1       | )      | —         |   | 188,000       |   |
| Valuation  allowance for inventories         |   | 555,000        |   | 257,000(2      | )      | —         |   | 812,000       |   |
| Valuation  allowance for deferred taxes      |   | —         |   | —         |   | —         |   | —        |   |
|                                         |   |           |   |           |   |           |   |          |   |
| Year Ended  December 31, 2000                |   |           |   |           |   |           |   |          |   |
|                                         |   |           |   |           |   |           |   |          |   |
| Valuation  allowance for accounts receivable |   | 188,000        |   | 42,000(3       | )      | —         |   | 230,000       |   |
| Valuation  allowance for inventories         |   | 812,000        |   | 873,000(4      | )      | —         |   | 1,685,000     |   |
| Valuation  allowance for deferred taxes      |   | —         |   | 5,649,000(5    | )      | —         |   | 5,649,000     |   |
|                                         |   |           |   |           |   |           |   |          |   |
| Year Ended  December 31, 2001                |   |           |   |           |   |           |   |          |   |
|                                         |   |           |   |           |   |           |   |          |   |
| Valuation  allowance for accounts receivable |   | 230,000        |   | —         |   | 54,000(6       | )      | 176,000       |   |
| Valuation  allowance for inventories         |   | 1,685,000      |   | 588,000(7      | )      | —         |   | 2,273,000     |   |
| Valuation  allowance for deferred taxes      |   | 5,649,000      |   | 1,302,000(8    | )      |           |   | 6,951,000     |   |
|                                              |        |                |        |                |        |                |        |               |        |  |

 

(1)         Increasein accounts receivable valuation allowance.

(2)         Increasein inventory valuation allowance.

(3)         Increasein accounts receivable valuation allowance.

(4)         Increasein inventory valuation allowance.

(5)         Recordingof valuation allowance.

(6)         Reductionin accounts receivable allowance due to collection of reserved accounts.

(7)         Increasein inventory valuation allowance.

(8)         Increasein deferred tax valuation allowance.

 

 

35

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Signatures

 

 

                Pursuant to the requirements of Section13 or 15(d) of the Securities Exchange Act of 1934, the registrant has dulycaused this annual report to be signed on its behalf by the undersigned,thereunto duly authorized, in the City of Corpus Christi, State of Texas, onthe 12th day of July, 2002.

 
|   |   |   |   |   |   | AMERICAN MEDICAL  TECHNOLOGIES, INC.         |
|--------|--------|--------|--------|--------|--------|----------------------------------------------|
|   |   |   |   |   |   |                                         |
|   |   |   |   |   |   | /s/ John E. Vickers III                      |
|   |   |   |   |   |   | John E. Vickers III  Chief Operating Officer |

 

 

 

 

36

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**EXHIBIT INDEX**

 

 

Certain of the followingexhibits have been previously filed with the Securities and Exchange Commissionpursuant to the requirements of the Securities Act of 1933 and the SecuritiesExchange Act of 1934.  Such exhibits areidentified by the parenthetical references following the listing of each suchexhibit and are incorporated herein by reference.  The Company’s Commission file number is 0-19195.

 
| **Exhibit Number** |   | **Description of Document**                                                                                                                                                                                                                   |
|--------------------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|               |   |                                                                                                                                                                                                                                          |
| 3.1                |   | First Restated Certificate of Incorporation, as  amended (Form 10-Q for quarter ended September 30, 2000)                                                                                                                                     |
|               |   |                                                                                                                                                                                                                                          |
| 3.4                |   | Amended and Restated Bylaws (Form 10-K for year  ended December 31, 1998)                                                                                                                                                                     |
|               |   |                                                                                                                                                                                                                                          |
| 4.1                |   | Nontransferable Common Stock Purchase Warrant, dated  August 5, 1998, 540,000 shares (Form 8-K filed August 20, 1998)                                                                                                                         |
|               |   |                                                                                                                                                                                                                                          |
| 4.2                |   | Nontransferable Common Stock Purchase Warrant, dated  August 5, 1998, 60,000 shares (Form 8-K filed August 20, 1998)                                                                                                                          |
|               |   |                                                                                                                                                                                                                                          |
| 4.3                |   | Line of Credit of Agreement between Bank One and  American Medical Technologies, Inc. effective September 21, 2000 (Form 10-Q  for quarter ended September 30, 2000)                                                                          |
|               |   |                                                                                                                                                                                                                                          |
| 4.4                |   | Revolving Business Credit Note (LIBOR — Based  Interest Rate) between Bank One and American Medical Technologies, Inc.  effective September 21, 2000 (Form 10-Q for quarter ended September 30, 2000)                                    |
|               |   |                                                                                                                                                                                                                                          |
| 4.5                |   | Non-transferable Common Stock Purchase Warrant dated  March 24, 1999 (Form 10-Q for quarter ended March 31, 1999)                                                                                                                             |
|               |   |                                                                                                                                                                                                                                          |
| 4.6                |   | Non-transferable Common Stock Purchase Warrant dated  March 24, 1999 (Form 10-Q for quarter ended March 31, 1999)                                                                                                                             |
|               |   |                                                                                                                                                                                                                                          |
| 4.7                |   | Amendment to Revolving Business Credit Note (LIBOR —  Based Interest Rate) and Line of Credit Agreement between Bank One and  American Medical Technologies, Inc. dated March 23, 2001 (Form 10-K for the  year ended December 31, 2000) |
|               |   |                                                                                                                                                                                                                                          |
| 4.8                |   | Amendment to Revolving Business Credit Note (LIBOR —  Based Interest Rate) and Line of Credit Agreement between Bank One and  American Medical Technologies, Inc. dated June 25, 2001 (Form 10-Q for the  period ended June 30, 2001)    |
|               |   |                                                                                                                                                                                                                                          |
| 4.9                |   | Loan Agreement between ValueBank Texas and American  Medical Technologies, Inc., dated October 3, 2001 (Form 10-Q for the period  ended September 30, 2001)                                                                                   |
|               |   |                                                                                                                                                                                                                                          |
| 4.10               |   | Note Agreement between U.S. Small Business  Administration and American Medical Technologies, Inc., dated October 3, 2001  (Form 10-Q for the period ended September 30, 2001)                                                                |
|               |   |                                                                                                                                                                                                                                          |
| 4.11               |   | Deed of Trust, Security Agreement and Assignment of  Rents between American Medical Technologies, Inc. and ValueBank Texas, dated  October 3, 2001 (Form 10-Q for the period ended September 30, 2001)                                        |
|               |   |                                                                                                                                                                                                                                          |
| 4.12               |   | Deed of Trust, Assignment of Rents and Leases and  Security Agreement between American Medical Technologies, Inc. and Bank One,  dated November 8, 2001 (Form 10-Q for the period ended September 30, 2001)                                   |
|               |   |                                                                                                                                                                                                                                          |
| 4.13               |   | Second Amended and Restated Forbearance Agreement  between Bank One and American Medical Technologies, Inc., effective February  18, 2002 (Form 10-K for the year ended December 31, 2002)                                                    |
|               |   |                                                                                                                                                                                                                                          |

 

 

37

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| 10.1*  |   | Amended and Restated Nonqualified Stock Option  Plan  (Registration No. 33-40140)                                                                                                      |
|--------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                        |
| 10.2*  |   | Stock Option Plan for Employees (Registration No.  33-40140)                                                                                                                                |
|   |   |                                                                                                                                                                                        |
| 10.3*  |   | Amended and Restated Long-Term Incentive Plan (Form  10-Q for quarter ended September 30, 1996)                                                                                             |
|   |   |                                                                                                                                                                                        |
| 10.4*  |   | Employment Agreement dated August 1, 1996 between  American Medical Technologies, Inc. and Ben J. Gallant (Form 10-K for year  ended December 31, 1996)                                     |
|   |   |                                                                                                                                                                                        |
| 10.5   |   | License Agreement between Texas Airsonics, Inc., a  wholly owned subsidiary of American Medical Technologies, Inc. and Texas  Airsonics, L.P. (Form 10-K for year ended December 31, 1996)  |
|   |   |                                                                                                                                                                                        |
| 10.6** |   | Patent License Agreement dated October 18, 1997  between Danville Engineering, Inc. and American Medical Technologies, Inc.  (Form 10-Q for quarter ended September 30, 1997)               |
|   |   |                                                                                                                                                                                        |
| 10.7   |   | Assignment from Sunrise Technologies International,  Inc. to Lares Research dated June 24, 1997 (Form 10-K for year ended December  31, 1997)                                               |
|   |   |                                                                                                                                                                                        |
| 10.8   |   | Patent License Agreement dated June 29, 1998  Prep-Technology Corp. and American Medical Technologies, Inc. (Form 10-Q for  quarter ended June 30, 1998)                                    |
|   |   |                                                                                                                                                                                        |
| 10.9** |   | Patent License Agreement dated as of January 21,  1999 between ESC Medical Systems, Ltd. and American Medical Technologies,  Inc. (Form 10-Q for quarter ended March 31, 1999)              |
|   |   |                                                                                                                                                                                        |
| 10.10  |   | Patent licensing agreement dated June 10, 1999 between  American Medical Technologies, Inc. and Kreativ, Inc. (Form 10-Q for quarter  ended June 30, 1999)                                  |
|   |   |                                                                                                                                                                                        |
| 10.11* |   | First Amendment, dated August 1, 1999 to Employment  Agreement between American Medical Technologies, Inc. and Ben J. Gallant  (Form 10-K for the year ended December 31, 1999)             |
|   |   |                                                                                                                                                                                        |
| 10.12* |   | Second Amendment, effective August 1, 2001 to  Employment Agreement between American Medical Technologies, Inc. and Ben J.  Gallant  (Form 10-K for the year ended  December 31, 2000) |
|   |   |                                                                                                                                                                                        |
| 21.1   |   | Subsidiaries of the Registrant (Form 10-K for year  ended December 31, 1999)                                                                                                                |
|   |   |                                                                                                                                                                                        |
| 23.1   |   | Consent of Independent Auditors                                                                                                                                                             |

----

  *Identifies current management contracts orcompensatory plans or arrangements.

 

**Portions of thisagreement were filed separately with the Commission pursuant to Rule 24b-2 ofthe Securities Act of 1934 governing requests for confidential treatment ofinformation.

 

 

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