##### 



Exhibit 13 UROPLASTY, INC. AND SUBSIDIARIES Consolidated Financial Statements
March 31, 2004 and 2003 TABLE OF CONTENTS Page(s)Report of Independent Registered Public Accounting Firm
    
    27Financial Statements:Consolidated Balance Sheets
    
    28 - 29Consolidated Statements of Operations
    
    30Consolidated Statements of Shareholders Equity and Comprehensive
Income (Loss)
    
    31Consolidated Statements of Cash Flows
    
    32Notes to Consolidated Financial Statements
    
    33 - 44
 Page 26




---



##### 



REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM The Board of Directors and Shareholders
Uroplasty, Inc.: We have audited the accompanying consolidated balance sheets of Uroplasty, Inc.
and subsidiaries as of March 31, 2004 and 2003, and the related consolidated
statements of operations, shareholders equity and comprehensive income (loss),
and cash flows for the years then ended. These consolidated financial
statements are the responsibility of the Companys management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits. We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we
plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Uroplasty, Inc. and
subsidiaries as of March 31, 2004 and 2003, and the results of their operations
and their cash flows for the years then ended in conformity with accounting
principles generally accepted in the United States of America. As discussed in note 2 to the consolidated financial statements, the Company
has restated its consolidated financial statements for the year ended March 31,
2003. KPMG LLPMinneapolis, Minnesota
July 26, 2004
 Page 27




---



##### 



UROPLASTY, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS
March 31, 2004 and 2003 20032004
    
    (restated)AssetsCurrent assets:Cash and cash equivalents
    
    $
    2,697,670
    
    
    
    3,375,981Accounts receivable, net
    
    
    1,065,176
    
    
    
    969,556Inventories
    
    
    519,130
    
    
    
    455,114Other
    
    
    235,078
    
    
    
    188,192Total current assets
    
    
    4,517,054
    
    
    
    4,988,843Property, plant, and equipment, net
    
    
    1,071,116
    
    
    
    833,234Intangible assets, net of accumulated
amortization of $222,014 and
$198,714, respectively
    
    
    51,495
    
    
    
    48,214Non-current deferred tax assets
    
    
    123,893
    
    
    
    94,159Total assets
    
    $
    5,763,558
    
    
    
    5,964,450
 See accompanying notes to consolidated financial statements. Page 28




---



##### 



UROPLASTY, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS
March 31, 2004 and 2003 20032004
    
    (restated)Liabilities and Shareholders EquityCurrent liabilities:Accounts payable
    
    $
    225,315
    
    
    
    199,673Accrued liabilities:Compensation and payroll taxes
    
    
    197,939
    
    
    
    152,250Income taxes
    
    
    101,562
    
    
    
    Foreign sales tax
    
    
    13,130
    
    
    
    15,604Royalties
    
    
    29,006
    
    
    
    26,419Clinical
    
    
    52,767
    
    
    
    48,228Audit and tax-consulting
    
    
    32,056
    
    
    
    29,771Legal
    
    
    61,663
    
    
    
    800Other
    
    
    89,396
    
    
    
    108,581Current maturities  long-term debt
    
    
    42,301
    
    
    
    37,502Total current liabilities
    
    
    845,135
    
    
    
    618,828Long-term debt  less current maturities:
    
    
    479,720
    
    
    
    462,787Accrued pension liability
    
    
    334,470
    
    
    
    241,208Total liabilities
    
    
    1,659,325
    
    
    
    1,322,823Shareholders equity:Common stock $.01 par value; 20,000,000
shares authorized, 4,584,802 and
4,488,971 shares issued and
outstanding at March 31, 2004 and
2003, respectively
    
    
    45,848
    
    
    
    44,890Additional paid-in capital
    
    
    9,130,580
    
    
    
    8,457,901Accumulated deficit
    
    
    (4,756,622
    )
    
    
    (3,245,329
    )Vendor deposit
    
    
    
    
    
    
    (112,000
    )Accumulated other comprehensive loss
    
    
    (315,573
    )
    
    
    (503,835
    )Total shareholders equity
    
    
    4,104,233
    
    
    
    4,641,627Commitments and contingencies (note 5)Total liabilities and shareholders equity
    
    $
    5,763,558
    
    
    
    5,964,450
 See accompanying notes to consolidated financial statements. Page 29




---



##### 



UROPLASTY, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS
Years ended March 31, 2004 and 2003 20032004
    
    (restated)Net sales
    
    $
    5,714,896
    
    
    
    5,343,656Cost of goods sold
    
    
    1,452,331
    
    
    
    1,594,008Gross profit
    
    
    4,262,565
    
    
    
    3,749,648Operating expensesGeneral and administrative
    
    
    2,069,568
    
    
    
    1,214,300Research and development
    
    
    1,820,690
    
    
    
    2,061,754Selling and marketing
    
    
    1,714,475
    
    
    
    1,136,8635,604,733
    
    
    
    4,412,917Operating loss
    
    
    (1,342,168
    )
    
    
    (663,269
    )Other income (expense)Interest income
    
    
    30,173
    
    
    
    42,497Interest expense
    
    
    (21,995
    )
    
    
    (24,057
    )Foreign currency exchange gain
    
    
    45,882
    
    
    
    530,083Legal settlement (note 5)
    
    
    
    
    
    
    180,000Other
    
    
    6,000
    
    
    
    (157
    )60,060
    
    
    
    728,366Income (loss) before income taxes
    
    
    (1,282,108
    )
    
    
    65,097Income tax expense (benefit)
    
    
    229,185
    
    
    
    (68,121
    )Net income (loss)
    
    $
    (1,511,293
    )
    
    
    133,218Net income (loss) per common share:Basic
    
    $
    (0.33
    )
    
    
    0.04Diluted
    
    $
    (0.33
    )
    
    
    0.03Weighted average common shares outstanding:Basic
    
    
    4,517,979
    
    
    
    3,762,165Diluted
    
    
    4,517,979
    
    
    
    3,847,555
 See accompanying notes to consolidated financial statements. Page 30




---



##### 



UROPLASTY, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS EQUITY AND COMPREHENSIVE INCOME (LOSS)
Years ended March 31, 2004 and 2003 AccumulatedAdditional
    
    
    
    
    
    
    
    
    
    Other
    
    TotalCommon Stock
    
    Paid-in
    
    Accumulated
    
    Vendor
    
    Comprehensive
    
    ShareholdersShares
    
    Amount
    
    Capital
    
    Deficit (restated)
    
    Deposits
    
    Income (Loss)
    
    EquityBalance at March 31, 2002
(as previously reported)
    
    
    2,047,332
    
    
    $
    20,473
    
    
    
    6,149,571
    
    
    
    (3,204,370
    )
    
    
    (51,000
    )
    
    
    (381,868
    )
    
    
    2,532,806Adjustment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (174,177
    )
    
    
    
    
    
    
    
    
    
    
    (174,177
    )Balance at March 31, 2002
(as restated)
    
    
    2,047,332
    
    
    
    20,473
    
    
    
    6,149,571
    
    
    
    (3,378,547
    )
    
    
    (51,000
    )
    
    
    (381,868
    )
    
    
    2,358,629Rights offering, net
    
    
    2,394,639
    
    
    
    23,947
    
    
    
    2,219,022
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,242,969Employee retirement
savings plan
contribution
    
    
    27,000
    
    
    
    270
    
    
    
    27,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    27,270Non-employee stock-based
consulting and
compensation expense
    
    
    
    
    
    
    
    
    
    
    1,508
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,508Vendor deposit
    
    
    20,000
    
    
    
    200
    
    
    
    60,800
    
    
    
    
    
    
    
    (61,000
    )
    
    
    
    
    
    
    Net income (as restated)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    133,218
    
    
    
    
    
    
    
    
    
    
    
    133,218Translation adjustment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (72,533
    )
    
    
    (72,533
    )Additional pension
liability
(net of taxes of
$26,038)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (49,434
    )
    
    
    (49,434
    )Total comprehensive
Income (as restated)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    11,251Balance at March 31, 2003
(as restated)
    
    
    4,488,971
    
    
    $
    44,890
    
    
    
    8,457,901
    
    
    
    (3,245,329
    )
    
    
    (112,000
    )
    
    
    (503,835
    )
    
    
    4,641,627Exercise of stock options
    
    
    23,931
    
    
    
    239
    
    
    
    37,405
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    37,644Warrants conversion
    
    
    23,600
    
    
    
    236
    
    
    
    46,964
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    47,200Employee retirement
savings plan
contribution
    
    
    13,300
    
    
    
    133
    
    
    
    57,647
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    57,780Non-employee stock-based
consulting and
compensation expense
    
    
    35,000
    
    
    
    350
    
    
    
    472,663
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    473,013Vendor deposit
    
    
    
    
    
    
    
    
    
    
    58,000
    
    
    
    
    
    
    
    112,000
    
    
    
    
    
    
    
    170,000Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,511,293
    )
    
    
    
    
    
    
    
    
    
    
    (1,511,293
    )Translation adjustment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    239,323
    
    
    
    239,323Additional pension
liability
(net of taxes of $26,894)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (51,061
    )
    
    
    (51,061
    )Total comprehensive
loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,323,031
    )Balance at March 31, 2004
    
    
    4,584,802
    
    
    $
    45,848
    
    
    
    9,130,580
    
    
    
    (4,756,622
    )
    
    
    
    
    
    
    (315,573
    )
    
    
    4,104,233
 See accompanying notes to consolidated financial statements. Page 31




---



##### 



UROPLASTY, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS
Years ended March 31, 2004 and 2003 20032004
    
    (restated)Cash flows from operating activities:Net income (loss)
    
    $
    (1,511,293
    )
    
    
    133,218Adjustments to reconcile net income (loss) to net cash provided
by (used in) operations:Depreciation and amortization
    
    
    164,184
    
    
    
    183,252Stock-based consulting expense
    
    
    473,013
    
    
    
    1,508Changes in operating assets and liabilities:Accounts receivable
    
    
    31,902
    
    
    
    54,522Inventories
    
    
    40,217
    
    
    
    371,639Other current assets
    
    
    (23,689
    )
    
    
    (40,634
    )Deferred tax assets
    
    
    (29,734
    )
    
    
    (94,159
    )Accounts payable
    
    
    67,125
    
    
    
    68,680Accrued liabilities
    
    
    163,893
    
    
    
    (12,424
    )Accrued pension liability
    
    
    93,262
    
    
    
    29,451Additional pension liability
    
    
    (51,061
    )
    
    
    (49,434
    )Net cash provided by (used in) operating activities
    
    
    (582,181
    )
    
    
    645,619Cash flows from investing activities:Payments for property, plant and equipment
    
    
    (115,352
    )
    
    
    (70,418
    )Payments relating to intangible assets
    
    
    (26,581
    )
    
    
    (675
    )Net cash used in investing activities
    
    
    (141,933
    )
    
    
    (71,093
    )Cash flows from financing activities:Repayment of long-term debt
    
    
    (40,419
    )
    
    
    (43,249
    )Net proceeds from issuance of stock
    
    
    84,844
    
    
    
    2,265,316Net cash provided by financing activities
    
    
    44,425
    
    
    
    2,222,067Effect of exchange rates on cash and cash equivalents
    
    
    1,378
    
    
    
    (466,733
    )Net increase (decrease) in cash and cash equivalents
    
    
    (678,311
    )
    
    
    2,329,860Cash and cash equivalents at beginning of year
    
    
    3,375,981
    
    
    
    1,046,121Cash and cash equivalents at end of year
    
    $
    2,697,670
    
    
    
    3,375,981Supplemental disclosure of cash flow information:Cash paid during the year for interest
    
    $
    23,517
    
    
    
    25,860Cash paid during the year for income taxes
    
    
    130,282
    
    
    
    Supplemental disclosure of non-cash financing and investing activities:Shares issued for 401(k) plan profit sharing contribution
    
    
    57,780
    
    
    
    27,270Restricted shares issued for mold purchase
    
    
    
    
    
    
    61,000Vesting of restricted shares for mold purchase
    
    
    170,000
    
    
    
    Minimum pension liability, net of tax
    
    
    51,061
    
    
    
    49,434
 See accompanying notes to consolidated financial statements. Page 32




---



##### 



UROPLASTY, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2004 and 2003  1.
    
    Summary of Significant Accounting Policies Nature of Business.Uroplasty, Inc. and subsidiaries (the Company or UPI)
is a manufacturer and distributor of urological, otolaryngology, colon rectal
and plastic surgery implantable medical devices. The primary focus of the
Companys business is the marketing of an implantable device for the treatment
of stress urinary incontinence and vesicoureteral reflux. Currently, all sales
of the Companys products are to customers outside the United States by the
Companys foreign subsidiaries and the Company is undertaking FDA
investigational clinical trials in the United States and Canada. Based on the
Companys current plans, it is anticipated the Company will launch its products
in the U.S. after obtaining FDA approval. Completing clinical trials and
obtaining FDA approval is a costly and time-consuming process. As a result of
the $2.4 million gross proceeds of a Rights Offering completed July 2002,
management believes current resources and the funds generated from sale of the
Companys products outside the U.S. will be adequate to meet the Companys cash
flow needs, including R&D activities, associated with existing products and
markets through fiscal 2005. Ultimately, the Company will need to achieve
profitability and positive cash flows from operations or obtain additional debt
or equity financing to fund its operations. Principles of Consolidation.The consolidated financial statements include the
accounts of the Company and its wholly owned foreign subsidiaries. All
significant intercompany accounts and transactions have been eliminated. Revenue Recognition.The Company recognizes revenue upon shipment of product
to customers. Upon shipment, the risks and rewards of ownership are passed on
to the buyer. There are no customer acceptance provisions. The Company sells
its products to distributors who sell to other distributors and end users, and
to end users in the United Kingdom. Sales to distributors were $3,800,000 and
$3,300,000 in fiscal 2004 and 2003, respectively, or 66% and 62%, respectively,
of net sales. Payment terms range from prepayment to 60 days. The distributor
payment terms are not contingent on the distributor selling the product to
other distributors or end users. Customers do not have the right to return
unsold product to the Company except for warranty claims. The Company offers
customary product warranties. The allowance for doubtful accounts was $33,000
and $46,000 at March 31, 2004 and 2003, respectively. During fiscal 2004, there
were two large customers accounting for approximately 13% and 11% of the
Companys net sales. During fiscal 2003, approximately 12% of the Companys net
sales were to one customer. Cash and Cash Equivalents.The Company considers highly liquid debt
instruments purchased with an original maturity of three months or less to be
cash equivalents. Patents.Patents are stated at cost and are amortized over six years using the
straight-line method. Income Taxes.Deferred tax assets and liabilities are recognized for future
tax consequences attributable to differences between the financial carrying
amounts of existing assets and liabilities and their respective tax bases.
Deferred tax assets and liabilities are measured using enacted tax rates
expected to be applied to taxable income in the years in which those temporary
differences are expected to be recovered or settled. During fiscal 2004 the
Companys Dutch subsidiaries recorded income tax expense of $229,185 as they
have fully utilized their net operating loss carryforwards. As of March 31,
2004, $130,282 of income taxes has been paid and the remaining balance is
included under current liabilities. The U.S. net operating loss carryforwards
cannot be used to offset taxable income in foreign jurisdictions. Use of Estimates.The preparation of financial statements in conformity with
accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements and the reported amounts of
revenues and expenses during the reporting period. Actual results could differ
from these estimates. The Companys significant accounting policies and
estimates include revenue recognition, accounts receivable, valuation of
inventory, foreign currency translation/transactions, and the determination of
recoverability of long-lived and intangible assets. Page 33




---



##### 



Product Warranty. The Company warrants its new products to be free from
defects in material and workmanship under normal use and service for a period
of twelve months after date of sale. The Company warrants its products to be
free from defects in material and workmanship under normal use until its stated
expiration date. Under the terms of these warranties, the Company is obligated
to repair or replace the products it deems to be defective due to material or
workmanship. The Company does not have an accrual for warranty costs, as
warranty claims are infrequent and immaterial. Inventories.Inventories are stated at the lower of cost (first-in, first-out
method) or market (net realizable value) and consist of the following at March
31, 2004 and 2003: 2004
    
    2003Raw materials
    
    $
    138,920
    
    
    
    78,910Work-in-process
    
    
    110,511
    
    
    
    163,989Finished goods
    
    
    269,699
    
    
    
    212,215$
    519,130
    
    
    
    455,114
 Property, Plant, and Equipment.Property, plant, and equipment are carried at
cost and consist of the following at March 31, 2004 and 2003: 2004
    
    2003Land
    
    $
    150,652
    
    
    
    133,560Building
    
    
    656,855
    
    
    
    582,334Equipment
    
    
    1,369,847
    
    
    
    1,191,9822,177,354
    
    
    
    1,907,876Less accumulated depreciation
    
    
    (1,106,238
    )
    
    
    (1,074,642
    )$
    1,071,116
    
    
    
    833,234
 Depreciation is provided for using the straight-line method over useful lives
of three to seven years for equipment and 40 years for the building.
Maintenance and repairs are charged to expense as incurred. Renewals and
betterments are capitalized and depreciated over their estimated useful service
lives. Impairment of Long-Lived Assets. Long-lived assets at March 31, 2004 consist of
property, plant and equipment. The Company reviews its long-lived assets for
impairment whenever events or business circumstances indicate that the carrying
amount of an asset may not be recoverable. Recoverability of assets to be held
and used is measured by a comparison of the carrying amount of an asset to
future undiscounted net cash flows expected to be generated by the asset. If
such assets are considered to be impaired, the impairment to be recognized is
measured by the amount by which the carrying amount of the assets exceeds the
fair value of the assets. Assets to be disposed of are reported at the lower of
the carrying amount or fair value less costs to sell. Research and Development.Research and development costs are expensed as
incurred and consist of the following for the years ended March 31, 2004 and
2003: 20032004
    
    (restated)FDA regulatory costs
    
    $
    745,684
    
    
    
    1,084,749Other research and development costs
    
    
    1,075,000
    
    
    
    977,005$
    1,820,690
    
    
    
    2,061,754
 Page 34




---



##### 



Foreign Currency Translation.All assets and liabilities are translated using
period-end exchange rates and statements of operations items are translated
using average exchange rates for the period. The resulting translation
adjustment is recorded within accumulated other comprehensive loss, a separate
component of shareholders equity. Foreign currency transaction gains and
losses are recognized currently in the consolidated statement of operations,
including unrealized gains and losses on short-term inter-company obligations
using period-end exchange rates. Unrealized gains and losses on long-term
inter-company obligations are recognized within accumulated other comprehensive
loss, a separate component of shareholders equity. Exchange gains and losses are recognized primarily as a result of fluctuations
in currency rates between the U.S. dollar (the functional reporting currency)
and the euro and British pound (currencies of the Companys subsidiaries), as
well as their effect on the dollar denominated intercompany obligations between
the Company and its foreign subsidiaries. The Company recognized net foreign
currency gains of $45,882 and $530,083 for the years ended March 31, 2004 and
2003, respectively. The currency gain is primarily the result of a weakened
U.S. dollar compared to the euro. In January 2003 the Company recapitalized one
of the Dutch subsidiaries with an investment of 1.5 million euros ($1.6
million). The proceeds from the investment were used to reduce the dollar
denominated intercompany debt at the Dutch subsidiary. Stock-Based Compensation.The Company applies the intrinsic-value method to
account for employee stock-based compensation. As such, compensation expense,
if any, is determined on the date of grant if the current market price of the
underlying stock exceeds the exercise price. The Company accounts for stock-based instruments granted to non-employees under
the fair value method of Statement of Financial Accounting Standards No.123,
Accounting for Stock-Based Compensation(SFAS No. 123) and Emerging Issues Task
Force (EITF) 96-18, Accounting for Equity Instruments That Are Issued to Other
Than Employees for Acquiring, or in Conjunction with Selling, Goods or
Services. Under SFAS No. 123, options are recorded at their fair value on the
measurement date, which is typically the vesting date. Stock Option Plans.Had the Company determined compensation cost based on the
fair value at the grant date for its stock options under SFAS No. 123, the
Companys net income (loss) would have changed to the pro forma amounts shown
below: 20032004
    
    (restated)Net income (loss)  As reported
    
    $
    (1,511,293
    )
    
    $
    133,218Add: Total stock-based employee compensation
expense determined under intrinsic value based
method for all awards
    
    
    
    
    
    
    Deduct: Total stock-based employee compensation
expense determined under fair value based
method for all awards
    
    
    (253,374
    )
    
    
    (370,451
    )Net loss  Pro forma
    
    $
    (1,764,667
    )
    
    
    (237,233
    )Net income (loss) per common share  As reported:Basic
    
    $
    (0.33
    )
    
    $
    0.04Diluted
    
    $
    (0.33
    )
    
    $
    0.03Net loss per common share  Pro forma:Basic
    
    $
    (0.39
    )
    
    $
    (0.06
    )Diluted
    
    $
    (0.39
    )
    
    $
    (0.06
    )
 Page 35




---



##### 



The per share weighted-average fair value of stock options granted during 2004
and 2003 was $1.86 and $1.04, respectively, on the date of grant using the
Black-Scholes option-pricing model with the following weighted-average
assumptions: 2004
    
    2003Expected dividend yield
    
    
    0.00
    %
    
    
    0.00
    %Risk-free interest rate
    
    
    2.93
    %
    
    
    3.00
    %Expected volatility
    
    
    118
    %
    
    
    168
    %Expected life, in years
    
    
    5.00
    
    
    
    5.00
 Reconciliation of Net Income (Loss) and Share Amounts Used in EPS Calculation.
Basic income (loss) per common share is calculated by dividing net income
(loss) by the weighted-average common shares outstanding during the period.
Diluted income (loss) per common share for the fiscal years ended March 31,
2004 and 2003 was calculated using the treasury-stock method to compute the
weighted average common stock outstanding assuming the conversion of dilutive
potential common shares. Basic
    
    
    
    
    
    Dilutedincome (loss)
    
    
    
    
    
    Income (loss)per share
    
    Effect of
    
    per shareto common
    
    dilutive
    
    to commonshareholders
    
    securities
    
    shareholdersYear ended:March 31, 2004Net loss
    
    $
    (1,511,293
    )
    
    
    
    
    
    
    (1,511,293
    )Shares
    
    
    4,517,979
    
    
    
    
    
    
    
    4,517,979Per share amount
    
    $
    (0.33
    )
    
    
    
    
    
    
    (0.33
    )Year ended:March 31, 2003Net income (restated)
    
    $
    133,218
    
    
    
    
    
    
    
    133,218Shares
    
    
    3,762,165
    
    
    
    85,390
    
    
    
    3,847,555Per share amount (restated)
    
    $
    0.04
    
    
    
    
    
    
    
    0.03
 The following options and warrants outstanding at March 31, 2004 and 2003 to
purchase shares of common stock were excluded from diluted loss per share as
their impact would be anti-dilutive as follows: Number of
    
    Range ofOptions/Warrants
    
    exercise pricesYear ended:March 31, 2004
    
    
    1,718,966
    
    
    $
    0.90-10.50March 31, 2003
    
    
    1,246,624
    
    
    $
    1.50-10.50
  2.
    
    Restatement of Financial Statements During the fiscal 2004 year end close process, the Company determined that its
pension plan, covering 18 employees in The Netherlands, had historically been
reported as a defined contribution plan, but should have been reported as a
defined benefit plan. The Company pays premiums to an insurance company to
fund annuities for these employees, however, the Company is responsible for
funding additional annuities based on continued service and future salary
increases. The Company has restated its March 31, 2003 consolidated balance
sheet and the fiscal 2003 consolidated results of operations and related
footnote disclosures for the impact of accounting for this pension plan as a
defined benefit plan. Furthermore the Company discovered an error in how the
effect of exchange rates on cash and cash equivalents was Page 36




---



##### 



recorded in our Statement of Cash Flows. The Company has restated its March 31,
2003 consolidated balance sheet, the fiscal 2003 consolidated results of
operations, the fiscal 2003 consolidated statement of cash flows and related
footnote disclosures for the impact of accounting for the pension plan as a
defined benefit plan and for the correction of the effect of exchange rates on
cash and cash equivalents as follows: March 31, 2003As previouslyreported
    
    As restatedBALANCE SHEET DATA:Non-current deferred tax assets
    
    $
    
    
    
    
    94,159Total current liabilities
    
    
    587,112
    
    
    

    618,828Accrued pension liability
    
    
    
    
    
    
    241,208Accumulated deficit
    
    
    (3,163,156
    )
    
    
    (3,245,329
    )Accumulated other comprehensive loss
    
    
    (407,243
    )
    
    
    (503,835
    )Total shareholders equity
    
    
    4,820,392
    
    
    
    4,641,627
 Year Ended March 31, 2003As previouslyreported
    
    As restatedSTATEMENT OF OPERATIONS DATA:Cost of goods sold
    
    
    1,599,978
    
    
    
    1,594,008Operating expensesGeneral and administrative
    
    
    1,220,271
    
    
    
    1,214,300Research and development
    
    
    2,067,725
    
    
    
    2,061,754Selling and marketing
    
    
    1,142,834
    
    
    
    1,136,863Operating loss
    
    
    (687,152
    )
    
    
    (663,269
    )Income before income taxes
    
    
    41,214
    
    
    
    65,097Income tax benefit
    
    
    
    
    
    
    (68,121
    )Net income
    
    
    41,214
    
    
    
    133,218Net income per common shareBasic
    
    $
    0.01
    
    
    $
    0.04Diluted
    
    $
    0.01
    
    
    $
    0.03CASH FLOW DATA:Net cash provided by operating activities
    
    
    292,647
    
    
    
    645,619Net cash used in investing activities
    
    
    (72,401
    )
    
    
    (71,093
    )Net cash provided by financing activities
    
    
    2,227,474
    
    
    
    2,222,067Effect of exchange rates on cash and
cash equivalents
    
    
    (117,860
    )
    
    
    (466,733
    )
 Page 37




---



##### 



3.
    
    Notes Payable Notes payable consist of the following at March 31, 2004 and 2003: 2004
    
    2003Mortgage note, monthly payments of $2,982
plus variable rate interest through November
2017 (rate at March 31, 20044.3%)
    
    $
    493,327
    
    
    
    469,075Note payable, monthly payments of $542 plus
fixed rate interest through August 2008
(rate until August 20084.4%)
    
    
    28,694
    
    
    
    31,204522,021
    
    
    
    500,279Less current maturities
    
    
    42,301
    
    
    
    37,492$
    479,720
    
    
    
    462,787
 Future payments of long-term debt for the years ended March 31, are as follows: 2005
    
    $
    42,3012006
    
    
    42,3012007
    
    
    42,3012008
    
    
    42,301Thereafter
    
    
    352,817$
    522,021
  4.
    
    Shareholders Equity Rights Offering.In July 2002, the Company completed its rights offering to
its shareholders in which the Company sold 798,213 units with aggregate
proceeds of $2.4 million. Each unit consisted of three shares of common stock
and a warrant to acquire one additional share of common stock for $2.00 per
share. These warrants expire on July 31, 2004. The allocated relative fair
value of the shares issued in the offering was less than the Companys common
stock price on the offerings closing date, which resulted in a bonus element
to the stockholders who participated in the offering, similar to a stock
dividend. Stock Options.Pursuant to the Companys three stock option plans, the Company
has reserved 1,248,813 shares of its common stock for issuance to employees,
Directors, consultants, and independent contractors. Outstanding options
generally expire five years from date of grant and vest at varying rates
ranging up to five years. Options are granted at the discretion of the
Directors and are exercisable in amounts equal to or greater than the fair
market value of the Companys common stock at date of grant. The plans provide
for the exercise of options during a limited period following termination of
employment, death, or disability. Stock option activity under these plans is summarized as follows: WeightedaverageShares
    
    exercise priceoutstanding
    
    per shareBalance at March 31, 2002
    
    
    470,071
    
    
    $
    4.82Granted
    
    
    446,500
    
    
    
    1.10Exercised
    
    
    
    
    
    
    Cancelled
    
    
    (74,660
    )
    
    
    4.56Balance at March 31, 2003
    
    
    841,911
    
    
    $
    2.87Granted
    
    
    80,000
    
    
    
    2.59Exercised
    
    
    (23,931
    )
    
    
    1.57Cancelled
    
    
    (53,627
    )
    
    
    4.12Balance at March 31, 2004
    
    
    844,353
    
    
    $
    2.80
 Page 38




---



##### 



The following table summarizes information concerning currently outstanding and
exercisable options by price. WeightedaverageNumber
    
    remainingof shares
    
    life in
    
    NumberPrice
    
    outstanding
    
    years
    
    exercisable$  0.90
    
    
    1,200
    
    
    
    3.58
    
    
    
    1.10
    
    
    406,200
    
    
    
    3.42
    
    
    
    155,1001.50
    
    
    26,666
    
    
    
    0.67
    
    
    
    26,6662.25
    
    
    30,000
    
    
    
    9.00
    
    
    
    6,0002.40
    
    
    146,158
    
    
    
    2.50
    
    
    
    146,1582.80
    
    
    50,000
    
    
    
    4.00
    
    
    
    50,0003.00
    
    
    6,668
    
    
    
    0.08
    
    
    
    6,6685.25
    
    
    3,333
    
    
    
    1.33
    
    
    
    3,3336.75
    
    
    35,000
    
    
    
    1.30
    
    
    
    35,0006.96
    
    
    19,999
    
    
    
    0.83
    
    
    
    19,9997.50
    
    
    114,129
    
    
    
    0.67
    
    
    
    114,12910.50
    
    
    5,000
    
    
    
    1.17
    
    
    
    5,000844,353
    
    
    
    
    
    
    
    568,053
 Warrants.In connection with the fiscal 2003 Rights Offering, warrants to
purchase 798,213 shares of common stock were issued at an exercise price of
$2.00 per share. At March 31, 2004, 774,613 of these warrants were outstanding
and expire on July 31, 2004. As part of a consulting agreement with C.C.R.I.
Corporation (CCRI), a warrant to purchase 50,000 shares of common stock at a
price of $3.00 per share was issued on April 1, 2003, and an additional warrant
to purchase 50,000 shares at a price of $5.00 was issued on November 2, 2003.
At March 31, 2004 all of these warrants were outstanding and expire five years
from date of issue. Vendor Deposits.In September 2001, the Company executed an agreement with a
vendor to manufacture a mold for one of the Companys products. As
consideration, the Company issued to the vendor 20,000 shares of its common
stock in September 2001. The Company amended the agreement in September 2002
and issued an additional 20,000 shares of common stock to be held in escrow
until completion of the mold. On November 3, 2003, the Company accepted the
mold and recorded the fair value of the vested common stock aggregating
$170,000 as an addition to property, plant and equipment. Consulting Agreements.On April 1, 2003, the Company executed a consulting
agreement with C.C.R.I. Corporation (CCRI) to provide investor relations and
development services. The Company pays the Consultant a monthly fee of $4,000
plus expenses. CCRI received 35,000 shares of fully vested restricted common
stock, and vested warrants to purchase 50,000 shares of common stock at an
exercise price of $3.00 per share, and received vested warrants to purchase
50,000 shares of common stock at an exercise price of $5.00 per share on
November 2, 2003. The Company recorded the fair value of the common stock and
the warrants aggregating $212,974, as of April 1, 2003, in shareholders equity
as additional paid in capital and deferred compensation, which was fully
amortized as of April 30, 2003. The balance is amortized over the 1-year
service period. Also, the Company recorded the fair value of the additional
warrants to acquire 50,000 of common stock aggregating $144,200, as of
November 2, 2003, as deferred compensation in shareholders equity. This
balance is amortized over the remaining 5 months of the 1-year service period.
Stock-based compensation expense for CCRI agreement for the year ended March
31, 2004 aggregated $357,174. On April 1, 2003, the Company executed a consulting agreement with Executive
Advisory Group (EAG) to perform services for and on behalf of the Company. Mr.
Sam B. Humphries, a Director of the Company, is President of EAG. Page 39




---



##### 



The Company pays EAG a monthly fee of $6,000 plus expenses. EAG also received
stock options to purchase 50,000 shares of common stock, exercisable at $2.80
per share. The Company recorded the fair value of the stock options aggregating
$115,839, as of April 1, 2003, as a deferred compensation in shareholders
equity. The balance is amortized over the 1-year service period. Stock-based
compensation expense for the EAG agreement for the year ended March 31, 2004
aggregated $115,839. The options and warrants issued to EAG and CCRI to acquire an aggregate of
150,000 shares of common stock were fully vested upon issuance. The fair value
of these instruments was determined using the Black-Scholes options pricing
model with the following variables: April 1, 2003
    
    November 2, 2003Expected dividend yield
    
    
    0.00
    %
    
    
    0.00
    %Risk-free interest rate
    
    
    2.93
    %
    
    
    3.29
    %Expected volatility
    
    
    118
    %
    
    
    113
    %Expected life, in years
    
    
    5.00
    
    
    
    5.00
  5.
    
    Commitments and Contingencies License Agreement.In December 1995, the Company obtained a license from a
British surgeon, which became superseded by a subsequent agreement entered into
by the parties in October 1998. Pursuant to this subsequent agreement, the
Company received an absolute assignment of a patent relating to the
Macroplastique Implantation System in return for a royalty for each unit sold
during the life of the patent. The aggregate amount of royalty expense
recognized by the Company pursuant to such royalty agreement during the fiscal
years ended March 31, 2004 and 2003 was $13,802 and $15,620, respectively. Royalties.Under the terms of an agreement with former Officers and Directors
of the Company, the Company pays royalties equal to between three percent and
five percent of the net sales of certain products, subject to a specified
monthly minimum of $4,500. The royalties payable under this agreement will
continue until the patent referenced in the agreement expires in 2010. Total
expense recognized under the agreement was $162,047 and $160,192 for the fiscal
years ended March 31, 2004 and 2003, respectively. In 1992, the Company agreed to settle alleged patent infringement claims by
Collagen Corporation (now Inamed Corporation). Under the settlement agreement,
the Company pays Collagen a royalty of 5% of net sales in the U.S. of
Macroplastique products with a minimum of $50,000 per year. The agreement is
through May 1, 2006. Operating Lease Commitments.The Company leases office, warehouse, and
production space under three operating leases and leases various automobiles
for its European employees. At March 31, 2004, minimum lease payments under
noncancelable operating leases with an initial term in excess of one year for
the ensuing years ending March 31 are as follows: 2005
    
    $
    332,1472006
    
    
    234,8472007
    
    
    73,0332008
    
    
    16,1072009
    
    
    4,395$
    660,529
 Total rent expense paid for operating leases was $383,624 and $306,301 in
fiscal 2004 and 2003, respectively. Legal Proceedings.On October 26, 2001, the Company reached a litigation
settlement with a third party. Net proceeds from the Settlement, totaling
$388,000, were recognized upon receipt of cash. In May 2002, the Company
received the final payment and recorded a $180,000 gain related to this
settlement. Page 40




---



##### 



Employment Agreements.The Company entered into employment agreements with
certain Officers, the terms of which, among other things, specify a base salary
subject to annual adjustment by mutual agreement of the parties, and a
severance payment to the employee upon employment termination without cause.
Any severance amounts payable under the agreement shall be limited to the
employees base salary for not less than four months and not longer than twelve
months after employment termination, depending on the employees years of
service. Contemporaneously with the execution of the employment agreement,
each of the Officers executed an Employee Confidentiality, Inventions,
Non-Solicitation, and Non-Compete Agreement, certain terms of which specify the
Employee shall not disclose confidential information, shall assign to the
Company without charge all intellectual property relating to the Companys
business which is created or conceived during the term of employment, shall not
encourage Employees to leave the employment of the Company for any reason and
shall not compete with the Company during the term of employment and for a
period of eighteen months thereafter. Also in connection with the execution of
these Agreements, some Officers were granted varying amounts of stock options
to purchase the Companys common stock at the fair market value at date of
grant of $7.50 per share. In all cases the options are exercisable for five
years or until one year after employment termination (subject to certain
termination provisions), whichever date is earlier, and vest in three equal
amounts on each one-year anniversary date subsequent to the option grant date.  6.
    
    Savings and Retirement Plans The Company sponsors various plans for eligible employees in the United States,
the United Kingdom (UK), and The Netherlands. The Companys retirement savings
plan in the United States conforms to Section 401(k) of the Internal Revenue
Code and participation is available to substantially all employees. The
Company may also make discretionary contributions ratably to all eligible
employees. The Companys contributions in fiscal 2004 and 2003 in the United
States were made in the form of Company common stock and became fully vested
when made. The total contribution expense associated with these plans in the
United States was $30,156 and $28,282 for the fiscal years ended March 31, 2004
and 2003, respectively. The Companys international subsidiaries have defined
benefit retirement plans for eligible employees. These plans provide benefits
based on the employees years of service and compensation during the years
immediately preceding retirement, termination, disability, or death, as defined
in the plans. The Companys UK subsidiary defined benefit plan accrued pension
liability and periodic pension cost are not material to the Companys
consolidated financial statements. Pension plan assets are invested in
insurance contracts. The cost for the Companys plan in The Netherlands include the following
components for the years ended March 31, 2004 and 2003: 20032004
    
    (restated)Gross service cost, net of employee contribution
    
    $
    80,388
    
    
    
    63,365Interest cost
    
    
    52,714
    
    
    
    32,009Expected return on assets
    
    
    (30,560
    )
    
    
    (17,732
    )Amortization
    
    
    8,098
    
    
    
    1,818Net periodic retirement cost
    
    $
    110,640
    
    
    
    79,460
 The following summarizes the change in benefit obligation and the change in
plan assets for the years ended March 31, 2004 and 2003: 20032004
    
    (restated)Projected benefit obligation, beginning of year
    
    $
    841,406
    
    
    
    467,557Service cost
    
    
    80,388
    
    
    
    63,365Interest cost
    
    
    52,714
    
    
    
    32,009Other
    
    
    16,591
    
    
    
    11,970Actuarial result

    
    
    33,284
    
    
    
    125,673Foreign currency translation
    
    
    116,145
    
    
    
    140,832
 Page 41




---



##### 



20032004
    
    (restated)Projected benefit obligation, end of year
    
    $
    1,140,528
    
    
    
    841,406Plan assets, beginning of year
    
    $
    478,942
    
    
    
    185,263Contributions to plan
    
    
    162,782
    
    
    
    182,291Actual return on assets
    
    
    (30,802
    )
    
    
    42,782Foreign currency translation
    
    
    67,399
    
    
    
    68,606Plan assets, end of year
    
    $
    678,321
    
    
    
    478,942
 The funded status of the Companys pension retirement plans at March 31, 2004
and 2003, are as follows: 20032004
    
    (restated)Funded status
    
    $
    (462,207
    )
    
    
    (362,464
    )Unrecognized net loss
    
    
    312,556
    
    
    
    196,815Minimum pension liability
    
    
    (153,525
    )
    
    
    (75,559
    )Accrued pension liability
    
    $
    (303,176
    )
    
    
    (241,208
    )
 Major assumptions used in the above calculations include: 2004
    
    2003Discount rate
    
    
    5.25
    %
    
    
    5.25
    %Expected return on assets
    
    
    4.50
    %
    
    
    4.50
    %Expected rate of increase in future compensation- general
    
    
    3
    %
    
    
    3
    %- individual
    
    
    0%-3
    %
    
    
    0%-3
    %
  7.
    
    Income Taxes The components of income tax expense (benefit) for each of the years in the
two-year period ended March 31, 2004 consist of the following: 20032004
    
    (restated)Income tax provision:Current:U.S. and state
    
    $
    
    
    
    
    Foreign
    
    
    232,025
    
    
    
    Deferred:U.S. and state
    
    
    
    
    
    
    Foreign
    
    
    (2,840
    )
    
    
    (68,121
    )Total income tax expense (benefit)
    
    $
    229,185
    
    
    
    (68,121
    )
 Page 42




---



##### 



Effective tax rates differ from statutory federal income tax rates for the year
ended March 31, 2004 and 2003 as follows: 20032004
    
    (restated)Statutory federal income tax
    
    $
    (435,917
    )
    
    
    22,133State tax
    
    
    (56,658
    )
    
    
    9,000Valuation allowance increase (decrease)
    
    
    715,023
    
    
    
    (101,317
    )Other
    
    
    6,737
    
    
    
    2,063$
    229,185
    
    
    
    (68,121
    )
 Deferred taxes as of March 31, 2004 and 2003 consist of the following: 20032004
    
    (restated)Deferred tax assets:Pension liability
    
    $
    133,916
    
    
    
    94,159Other reserves and accruals
    
    
    35,000
    
    
    
    31,000Deferred profit on intercompany sales
    
    
    166,000
    
    
    
    124,000Net operating loss carryforwards
    
    
    3,280,000
    
    
    
    2,621,0003,614,916
    
    
    
    2,870,159Less valuation allowance
    
    
    (3,491,023
    )
    
    
    (2,776,000
    )$
    123,893
    
    
    
    94,159
 At March 31, 2004 the Company had U.S. net operating loss carryforwards (NOL)
of approximately $8,787,000 for U.S. income tax purposes, which expire in 2012
through 2023, and NOLs in the U.K. of approximately $228,000, which can be
carried forward indefinitely. U.S. net operating loss carryforwards cannot be
used to offset taxable income in foreign jurisdictions. In addition, U.S. tax
rules impose limitations on the use of net operating losses following certain
changes in ownership. Such a change in ownership may limit the amount of these
benefits that would be available to offset future taxable income each year,
starting with the year of ownership change. A valuation allowance is provided when it is more likely than not a portion of
the deferred tax assets will not be realized. The Company has established a
valuation allowance for U.S. and certain foreign deferred tax assets due to the
uncertainty that enough income will be generated in those taxing jurisdictions
to utilize the assets. Therefore, the Company has not reflected any benefit of
such net operating loss carryforwards in the accompanying financial statements.
The deferred tax assets and related valuation allowance increased by $715,000
and $85,000, respectively, in 2004 and 2003.  8.
    
    Business Segment Information The Company sells Macroplastique and the related ancillary products for use in
augmenting soft tissues for the purpose of treating urinary incontinence and
vesicoureteral reflux. At this time, sales are only made outside the United
States because the Company has not yet made submissions to the FDA for
regulatory approval to market its products in the United States. The Companys
current objectives are to focus on sales and marketing activities designed to
increase market penetration and sales of Macroplastique for SUI, VUR, and of
PTQ Implants in countries outside the U.S., and to efficiently and effectively
execute the Macroplastique human clinical study for treatment of female SUI
within the U.S. The Company also sells injectable implant products outside the
United States for soft-tissue augmentation for specific indications in
otolaryngology and plastic surgery applications under the name Bioplastique in
limited markets. In addition, the Company sells specialized wound care products
in The Netherlands and United Kingdom as a distributor. The Macroplastique
product line accounts for 81% to 85%, respectively, of total net sales during
fiscal 2004 and 2003. Page 43




---



##### 



Based upon the above, the Company has identified one reportable operating
segment consisting of medical products primarily for the urology market. Information regarding operations in different geographies for the years ended
March 31, 2004 and 2003 is as follows: AdjustmentsUnited
    
    The
    
    United
    
    andStates
    
    Netherlands
    
    Kingdom
    
    eliminations
    
    ConsolidatedFiscal 2004Sales to customers
    
    $
    
    
    
    
    5,156,440
    
    
    
    1,524,953
    
    
    
    (966,497
    )
    
    
    5,714,896Income tax expense
    
    $
    
    
    
    
    220,672
    
    
    
    
    
    
    
    8,513
    
    
    
    229,185Net income (loss)
    
    $
    (1,808,753
    )
    
    
    448,497
    
    
    
    (26,970
    )
    
    
    (124,067
    )
    
    
    (1,511,293
    )Long-lived assets
At March 31, 2004
    
    $
    263,019
    
    
    
    788,343
    
    
    
    19,754
    
    
    
    
    
    
    
    1,071,116Fiscal 2003 (restated)Sales to customers
    
    $
    
    
    
    
    4,648,981
    
    
    
    1,841,460
    
    
    
    (1,146,785
    )
    
    
    5,343,656Income tax benefit
(restated)
    
    $
    
    
    
    
    
    
    
    
    
    
    
    
    (68,121
    )
    
    
    (68,121
    )Net income (loss)
(restated)
    
    $
    (1,568,643
    )
    
    
    1,577,017
    
    
    
    (117,660
    )
    
    
    242,504
    
    
    
    133,218Long-lived assets
At March 31, 2003
    
    $
    101,844
    
    
    
    706,086
    
    
    
    25,304
    
    
    
    
    
    
    
    833,234
 Page 44