<PAGE> 1
U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-QSB
(MARK ONE)
X QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE
--- SECURITIES EXCHANGE ACT 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 1995
--- TRANSACTION REPORT UNDER SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT 1934
FOR THE TRANSITION PERIOD FROM ____________ TO _________
COMMISSION FILE NUMBER 0-10521
QUEST MEDICAL, INC.
-----------------------------------------------------------------
(Exact name of Small Business Issuer as specified in its charter)
TEXAS 75-1646002
- ------------------------------- -------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
ONE ALLENTOWN PARKWAY, ALLEN, TEXAS 75002
----------------------------------------
(Address of principal executive offices)
(Zip Code)
(214) 390-9800
----------------------------------------
(Issuer's Telephone Number, including area code)
Check whether the issuer: (1) filed all reports required to be filed by Section
13 or 15(d) of the Securities Exchange Act during the past 12 months (or for
such shorter period that the registrant was required to file such reports), and
(2) has been subject to such filing requirements for the past 90 days.
YES X NO
----- -----
State the number of shares outstanding of each of the issuer's classes of
common equity, as of the latest practicable date:
<TABLE>
<CAPTION>
NUMBER OF SHARES OUTSTANDING AT
TITLE OF EACH CLASS APRIL 24, 1995
- ----------------------------- -------------------------------
<S> <C>
COMMON STOCK, $.05 PAR VALUE 6,173,206
</TABLE>
<PAGE> 2
QUEST MEDICAL, INC. AND SUBSIDIARIES
TABLE OF CONTENTS
<TABLE>
<S> <C>
PART I. FINANCIAL INFORMATION 2
Consolidated Balance Sheets
March 31, 1995 and December 31, 1994 3-4
Consolidated Statements of Earnings
For the Three Months ended
March 31, 1995 and 1994 5
Consolidated Statements of Cash Flows
For the Three Months ended
March 31, 1995 and 1994 6
Consolidated Statements of Stockholders'
Equity 7
Notes to Condensed Consolidated
Financial Statements 8-14
Management's Discussion and Analysis of
Financial Condition and Results of
Operations 15-18
PART II. OTHER INFORMATION 19
Item 6. Exhibits and Reports on
Form 8-K 19-22
SIGNATURES 23
</TABLE>
1
<PAGE> 3
PART I
FINANCIAL INFORMATION
2
<PAGE> 4
QUEST MEDICAL, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
MARCH 31, 1995 AND DECEMBER 31, 1994
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31,
1995 1994
ASSETS (UNAUDITED)
- ------ ------------ ------------
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 160,626 $ 87,963
Marketable securities 5,315,373 5,174,470
Receivables:
Trade accounts, less allowance for doubtful accounts of $114,337 in
1995 and $14,337 in 1994 4,051,915 1,671,684
Interest and other 170,919 172,969
------------ ------------
Total receivables 4,222,834 1,844,653
------------ ------------
Inventories:
Raw materials 2,041,220 1,322,498
Work-in-process 955,240 580,432
Finished goods 2,752,358 2,084,522
------------ ------------
Total inventories 5,748,818 3,987,452
------------ ------------
Prepaid expenses and other current assets 734,118 484,406
------------ ------------
Total current assets 16,181,769 11,578,944
------------ ------------
Property, plant and equipment:
Land 1,930,289 1,930,289
Building 5,220,676 5,215,454
Leasehold improvements 43,522 43,522
Furniture and fixtures 2,756,910 2,587,738
Machinery and equipment 3,032,069 2,722,868
------------ ------------
12,983,466 12,499,871
Less accumulated depreciation and
amortization 3,090,173 2,867,453
------------ ------------
Net property, plant and equipment 9,893,293 9,632,418
------------ ------------
Intangible assets related to Neuromed, Inc. acquisition 18,956,463 --
Cost in excess of net assets acquired, net of
accumulated amortization of $110,233 in 1995
and $99,550 in 1994 902,973 913,656
Patents, net of accumulated amortization of
$915,082 in 1995 and $857,965 in 1994 1,460,317 1,517,434
Purchased technology from acquisitions, net of
accumulated amortization of $175,645 in 1995
and $163,007 in 1994 522,355 534,993
Other assets, at cost, less accumulated amortization
of $151,917 in 1995 and $141,167 in 1994 512,769 57,464
------------ ------------
$ 48,429,939 $ 24,234,909
============ ============
</TABLE>
See accompanying notes to condensed consolidated financial statements
3
<PAGE> 5
QUEST MEDICAL, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
MARCH 31, 1995 AND DECEMBER 31, 1994
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31,
1995 1994
(UNAUDITED)
------------ ------------
LIABILITIES AND STOCKHOLDERS' EQUITY
- ------------------------------------
<S> <C> <C>
Current liabilities:
Accounts payable $ 2,235,234 $ 951,208
Loans payable and current maturities
of notes payable 2,450,978 2,759,241
Accrued Salary and Employee Benefit Costs 546,746 392,397
Other accrued expenses 629,416 65,393
------------ ------------
Total current liabilities 5,862,374 4,168,239
------------ ------------
Notes payable 20,193,450 4,123,853
Deferred income taxes 11,837 11,837
Stockholders' equity:
Common stock of $.05 par value. Authorized
10,000,000 shares; issued 8,019,256 shares
in 1995 and 7,982,498 in 1994 400,963 399,125
Additional paid-in capital 24,281,220 19,514,171
Retained earnings 2,429,520 2,794,118
Unrealized loss on marketable securities (694,791) (917,634)
Cost of common shares in treasury;
1,872,483 shares in 1995 and
2,705,816 shares in 1994 (4,054,634) (5,858,800)
------------ ------------
Total stockholders' equity 22,362,278 15,930,980
Commitments and contingencies
------------ ------------
$ 48,429,939 $ 24,234,909
============ ============
</TABLE>
See accompanying notes to condensed consolidated financial statements
4
<PAGE> 6
QUEST MEDICAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF EARNINGS (UNAUDITED)
FOR THE THREE MONTHS ENDED MARCH 31, 1995 AND 1994
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
----------------------------------
1995 1994
------------ ------------
<S> <C> <C>
Net revenue $ 4,071,640 $ 3,481,122
Cost of revenue 2,027,352 2,011,319
------------ ------------
Gross profit 2,044,288 1,469,803
------------ ------------
Operating expenses:
Research and development 1,085,737 638,277
Marketing 528,637 423,160
General and administrative 766,858 712,251
------------ ------------
2,381,232 1,773,688
------------ ------------
Loss from operations (336,944) (303,885)
------------ ------------
Other income (expenses):
Interest expense (157,266) (115,552)
Gain on sale of assets -- 11,456
Interest and other income 123,310 127,945
Gain on sale of marketable securities 6,302 96,675
------------ ------------
(27,654) 20,524
------------ ------------
Loss before income taxes (364,598) (183,361)
Income taxes -- --
------------ ------------
Net loss $ (364,598) $ (183,361)
============ ============
Net loss per common and
common equivalent share:
Primary $ ( .07) $ ( .04)
============ ============
Fully diluted $ ( .07) $ ( .04)
============ ============
Weighted average number of shares
used in computing loss per share:
Primary 5,302,463 5,235,821
============ ============
Fully diluted 5,302,463 5,235,821
============ ============
</TABLE>
See accompanying notes to condensed consolidated financial statements
5
<PAGE> 7
QUEST MEDICAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
FOR THE THREE MONTHS ENDED MARCH 31, 1995 AND 1994
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
------------------------------------
1995 1994
---------- ----------
<S> <C> <C>
Cash flows from operating activities:
Net loss $ (364,598) $ (183,361)
----------- ----------
Adjustments to reconcile net loss to
net cash provided (used) by operating activities:
Depreciation and amortization 313,909 267,998
Gain on sale of assets and marketable
securities (6,302) (108,131)
Changes in assets and liabilities, net of assets acquired
and liabilities assumed:
Receivables (176,998) 112,139
Inventories (251,774) 117,077
Prepaid expenses and other assets (120,862) 186,731
Accounts payable 1,071,382 (440,794)
Other 11,555 --
Accrued expenses 150,014 (152,564)
----------- ----------
Total adjustments 990,924 (17,544)
----------- ----------
Net cash provided (used) by operating activities 626,326 (200,905)
----------- ----------
Cash flows from investing activities:
Purchases of marketable securities (291,875) (3,749,403)
Proceeds from sales of marketable securities 380,117 2,168,634
Receivable due from broker/dealer -- 637,390
Acquisition of Neuromed, Inc. (16,158,188) --
Additions to property, plant and equipment (359,773) (398,694)
Net proceeds from sale of assets -- 11,456
----------- ----------
Net cash used by investing activities (16,429,719) (1,330,617)
----------- ----------
Cash flows from financing activities:
Exercise of stock options 114,722 21,839
Proceeds from short-term obligations 387,907 970,674
Proceeds of long-term debt 15,400,000 106,978
Payment of long-term debt (26,573) (32,130)
----------- ----------
Net cash provided by financing activities 15,876,056 1,067,361
----------- ----------
Net increase (decrease) in cash and cash equivalents 72,663 (464,161)
Cash and cash equivalents at beginning of year 87,963 594,448
----------- ----------
Cash and cash equivalents at March 31 $ 160,626 $ 130,287
=========== ==========
</TABLE>
See accompanying notes to condensed consolidated financial statements
6
<PAGE> 8
QUEST MEDICAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
Unrealized Total
Additional Retained loss on stock-
Common Stock paid-in earnings marketable Treasury holders'
Shares Amount capital (deficit) securities stock equity
--------- --------- ---------- --------- ---------- -------- --------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1991 7,639,668 $ 381,983 17,935,461 4,420,328 -- (5,691,507) 17,046,265
Shares issued upon exercise
of stock options 231,875 11,594 359,351 -- -- -- 370,945
Purchase of 29,519 common
shares, at cost -- -- -- -- -- (160,687) (160,687)
Tax effect of stock option
exercise -- -- 189,219 -- -- -- 189,219
Net earnings -- -- -- 193,613 -- -- 193,613
--------- --------- ---------- ---------- --------- ---------- -----------
Balance at December 31, 1992 7,871,543 393,577 18,484,031 4,613,941 -- (5,852,194) 17,639,355
Shares issued upon exercise
of stock options 67,898 3,395 116,361 -- -- -- 119,756
Purchase of 100,000
common shares, at cost -- -- -- -- -- (349,004) (349,004)
Issuance of 1,490
common shares -- -- -- -- -- 7,402 7,402
Tax effect of stock option
exercise -- -- 187,236 -- -- -- 187,236
Adjustment to unrealized losses
on marketable securities -- -- -- -- (169,308) -- (169,308)
Net earnings -- -- -- 816,345 -- -- 816,345
--------- --------- ---------- ---------- -------- ----------- ----------
Balance at December 31, 1993 7,939,441 396,972 18,787,628 5,430,286 (169,308) (6,193,796) 18,251,782
Shares issued upon exercise
of stock options 43,057 2,153 134,894 -- -- -- 137,047
Issuance of 1,882 common shares
from treasury -- -- 5,595 -- -- 4,075 9,670
Adjustment to unrealized losses
on marketable securities -- -- -- -- (748,236) -- (748,236)
Stock dividend -- -- 586,054 (916,975) -- 330,921 --
Net loss -- -- -- (1,719,193) -- -- (1,719,193)
--------- --------- ---------- ---------- -------- ---------- ---------
Balance at December 31, 1994 7,982,498 399,125 19,514,171 2,794,118 (917,634) (5,858,800) 15,930,980
Shares issued upon exercise
of stock options 36,758 1,838 112,884 -- -- -- 114,722
Adjustment to unrealized losses
on marketable securities -- -- -- -- 222,843 -- 222,843
Issuance of 833,333 common shares
from treasury for acquisition -- -- 4,654,165 -- -- 1,804,166 6,458,331
Net loss -- -- -- (364,598) -- -- (364,598)
--------- --------- ---------- ---------- -------- ---------- ----------
Balance at March 31, 1995
(Unaudited) 8,019,256 $ 400,963 24,281,220 2,429,520 (694,791) (4,054,634) 22,362,278
========= ========= ========== ========= ======== ========== ==========
</TABLE>
See accompanying notes to condensed consolidated financial
statements
7
<PAGE> 9
QUEST MEDICAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(1) CONDENSED FINANCIAL STATEMENTS
The unaudited consolidated financial information contained in this
report reflects all adjustments (consisting of normal recurring
accruals) considered necessary, in the opinion of management, for a
fair presentation of results for the interim periods presented.
Certain information and footnote disclosures normally included in
financial statements prepared in accordance with generally accepted
accounting principles have been condensed or omitted. It is suggested
that these financial statements be read in conjunction with the
financial statements and notes thereto included in the Company's
December 31, 1994 Annual Report on Form 10-KSB. The results of
operations for periods ended March 31 are not necessarily indicative
of operations for the full year.
(A) PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of
Quest Medical, Inc. and subsidiaries (the "Company"). All
significant intercompany balances and transactions have been
eliminated in consolidation.
(B) REVENUE RECOGNITION
Revenue from product sales are recognized at the time the
product is shipped.
(C) STATEMENTS OF CASH FLOWS
For purposes of reporting cash flows, the Company considers
all certificates of deposit and short-term, highly liquid debt
instruments, such as U.S. Treasury bills and notes, with
original maturities of three months or less when purchased to
be cash equivalents.
Supplemental cash flow information for the three months ended
March 31, 1995 and 1994 is presented below:
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
----------------------
1995 1994
-------- --------
<S> <C> <C>
Income taxes paid $ -- $ --
======== ========
Interest paid $156,624 $107,117
======== ========
</TABLE>
(Continued)
8
<PAGE> 10
QUEST MEDICAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(D) MARKETABLE SECURITIES
The Company's marketable equity securities and debt securities
are classified as available-for-sale. Available-for-sale
securities are carried at fair value, with the unrealized
gains and losses reported in a separate component of
stockholders' equity. The amortized cost of debt securities
in this category is adjusted for amortization of premiums and
accretion of discounts to maturity. Such amortization is
included in investment income. Realized gains and losses and
declines in value judged to be other-than-temporary are
included in other income. The cost of securities sold is
based on the specific identification method. Interest and
dividends on securities classified as available-for-sale are
included in investment income.
The following is a summary of available-for-sale securities at
March 31, 1995:
<TABLE>
<CAPTION>
Gross Gross
Unrealized Unrealized Estimated
Cost Gains Losses Fair Value
---------- ------ -------- ----------
<S> <C> <C> <C> <C>
Investment grade preferred
securities $2,788,587 870 331,057 2,458,400
Utility stocks 159,138 -- 32,138 127,000
Real estate investment trusts 1,845,054 7,421 191,758 1,660,717
Publicly traded limited
partnerships 598,826 3,000 81,576 520,250
Other 618,559 23,861 93,414 549,006
---------- ------ ------- ---------
$6,010,164 35,152 729,943 5,315,373
========== ====== ======= =========
</TABLE>
At March 31, 1995, no individual security represented more
than 10% of the total portfolio or 1% of total assets. The
Company did not have any investments in derivative financial
instruments at March 31, 1995.
(E) INVENTORIES
Inventories are recorded at the lower of standard cost or
market. Standard cost approximates actual cost determined on
the first-in, first-out (FIFO) basis.
(F) PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment are stated at cost. Major
renewals and betterments are capitalized; maintenance and
repairs are charged to operations as incurred. The cost and
accumulated depreciation of assets sold or retired are removed
from the accounts and any resulting gain or loss is reflected
in the statement of earnings.
Provisions for depreciation and amortization of property,
plant and equipment are computed using the straight-line
method using estimated useful lives of 3 to 30 years.
(Continued)
9
<PAGE> 11
QUEST MEDICAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(G) COSTS IN EXCESS OF NET ASSETS ACQUIRED
The excess of costs over the net assets of a business acquired
is amortized on a straight line basis over the estimated
useful life of 20 to 25 years. The Company assesses the
recoverability of this intangible asset, as well as other
intangible assets, primarily based on its current and
anticipated future undiscounted cash flows. At March 31,
1995, the Company does not believe there has been any
impairment of its intangible assets. Amortization expense was
$10,683 and $8,703 for the three months ended March 31, 1995
and 1994, respectively.
(H) PATENTS
Cost of purchased patents is amortized on a straight-line
basis over the estimated useful lives (4 to 14 years) of such
patents. Amortization expense was $57,117 and $57,117 for the
three months ended March 31, 1995 and 1994, respectively. The
cost and accumulated amortization of fully amortized patents
are removed from the accounts.
Costs of patents which are the result of internal development
are charged to current operations.
(I) PURCHASED TECHNOLOGY RELATED TO ACQUISITIONS
The cost of purchased technology related to acquisitions is
based on appraised values at the date of acquisition and is
amortized on a straight-line basis over the estimated useful
lives (10 to 14 years) of such technology. Amortization
expense was $12,638 and $12,638 for the three months ended
March 31, 1995 and 1994, respectively.
(J) PRODUCT DEVELOPMENT
Start-up, research and development, advertising and
promotional costs are charged to operations in the year in
which such costs are incurred.
(K) EARNINGS PER COMMON AND COMMON EQUIVALENT SHARE
During April 1994, the Board of Directors approved a 3% stock
dividend. The distribution date was May 23, 1994 for
stockholders of record as of May 6, 1994. The weighted average
number of common and common equivalent shares outstanding used
in computing the loss per share for the three months ended
March 31, 1994 were increased to retroactively reflect the 3%
stock dividend.
Primary and fully diluted loss per share for the three months
ended March 31, 1995 and 1994 are based upon 5,302,463 and
5,235,821 common and common equivalent shares outstanding,
respectively.
(Continued)
10
<PAGE> 12
QUEST MEDICAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(2) ACQUISITION
On March 31, 1995, the Company acquired for $15.2 million cash
(excluding $958,188 of related acquisition costs) and 833,333 shares
of Quest common stock, all of the capital stock of Neuromed, Inc.
("Neuromed"), a privately held corporation located in Fort Lauderdale,
Florida. The Company also may be required to pay contingent
consideration of up to $6 million over the next two years, payable in
January 1996 and January 1997, depending on sales of Neuromed's
products reaching certain objectives. The contingent consideration may
be paid in a combination of cash and additional shares of Quest common
stock. Financing for the cash portion of the purchase price was
provided by NationsBank of Texas, N.A. (See note 3.)
Neuromed develops, manufactures, and markets electronic
neurostimulation devices for treatment of chronic severe pain.
Neuromed's revenues for the fiscal year ended October 31, 1994, were
approximately $8.0 million.
The acquisition has been accounted for as a purchase and, accordingly,
the acquired assets and liabilities have been recorded at their
estimated fair values at the date of acquisition. Neuromed's
operating results will be included in the consolidated statement of
earnings commencing April 1, 1995. The purchase price and expenses
associated with the acquisition exceed the initial fair value
allocated to the acquired tangible net assets by $18,956,463, which
has been preliminarily included in "Intangible assets related to
Neuromed, Inc. acquisition" on the consolidated balance sheet at March
31, 1995. A valuation and allocation of such intangible assets is
being performed to determine their relative fair value.
The preliminary purchase price allocation is subject to change when
additional information concerning asset and liability valuations is
obtained. Therefore, the final allocation may differ from the
preliminary amounts recorded.
(3) CURRENT AND LONG-TERM DEBT/CREDIT LINES
On March 31, 1995, the Company entered into a First Amended and
Restated Credit Agreement with NationsBank of Texas, N.A. (the "Loan
Agreement"). The Loan Agreement provided for $15 million in senior
term financing, which was utilized to pay the cash portion of the
Neuromed purchase price (See Note 2), and a working capital line of up
to $5 million. Amortization of the senior term debt is $1,950,000 per
year for the first and second years, $3,250,000 per year for the third
and fourth years, and $2,600,000 for the fifth year, with a $2,000,000
balloon payment due at the end of the fifth year. Borrowings under
the working capital line are due and payable on May 31, 1997.
Borrowings under both facilities bear interest at prime plus 125 basis
points, or at the Company's option, LIBOR plus 300 basis points. The
interest rate can be reduced based on the Company achieving certain
ratios of senior bank debt to EBITDA (earnings before interest, taxes,
depreciation, and amortization). At March 31, 1995, the Company had
an outstanding principal balance of $15,000,000 under the senior term
debt, including a current portion of $1,950,000, with a weighted
average interest rate of 9.50%. At March 31, 1995, the Company had
borrowings under the working capital line of $3,050,000 with a
weighted average interest rate of 9.60%.
11 (Continued)
<PAGE> 13
QUEST MEDICAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
The forementioned facilities with NationsBank are secured by certain
of the Company's assets, including without limitation, accounts
receivable, inventory, equipment, furniture and other fixed assets,
patents, trademarks and other intangible property, and the Neuromed
common stock, but excluding marketable securities in excess of $2
million, and excluding the real property, building, and equipment
financed in 1993 by MetLife Capital Corporation. The Company is
subject to certain covenants related to the NationsBank debt.
Significant covenants include the maintenance of a minimum current
ratio, ratio of debt to net worth (as defined) and restrictions on the
payment of cash dividends to 25% of annual net earnings.
On December 28, 1993, the Company entered into two agreements with
MetLife Capital Corporation for permanent financing on the Company's
facility located in Allen, Texas in the amount of $4,248,093 and
during March 1994, amended the second agreement which provided an
additional $106,978 in financing. This brought the total permanent
financing by MetLife Capital Corporation to $4,355,071. The first
agreement, in the amount of $3,000,000, is related to the Allen
facility building. This loan bears interest at an adjustable rate
based on the 30-day commercial paper rate plus 300 basis points, or
the Company has the option at any time from closing through the first
24 months, to fix the rate based on the 10-year Treasury Bill rate
plus 300 basis points. This note has a 25-year amortization. The
Company has the option of prepaying this note during years 6-10,
subject to certain provisions. At March 31, 1995, the Company had not
exercised its option to fix the rate and the principal balance of the
note was $2,975,500, including a current portion of $14,178. The
interest rate in effect at March 31, 1995 was 9.05%. The loan is
collateralized by the Allen facility building and land. The second
agreement, in the amount of $1,355,071, is related to certain
equipment and furnishings purchased for the Allen facility. This loan
bears interest at an adjustable rate based on the 30-day commercial
paper rate plus 250 basis points, or the Company has the option at any
time from closing through the first 24 months, to fix the rate based
on the 5-year Treasury Bill rate plus 250 basis points. This note has
a 10-year amortization. At March 31, 1995, the Company had not
exercised its option to fix the rate under this loan and the principal
balance of the note was $1,231,022, including a current portion of
$98,893. The interest rate in effect at March 31, 1995 was 8.55%.
This loan is collateralized by the equipment and furnishings purchased
with the proceeds.
At March 31, 1995, the Company had a 8.50% note payable for $387,907.
This note was secured by certain of the Company's investments, held by
the investment company, which had a carrying value of $1,396,050.
Borrowings under this note is restricted to 50% of the market value of
certain of the Company's investments held by the investment company.
At March 31, 1995, the amount available for additional borrowing under
this note was $310,343.
(4) FEDERAL INCOME TAXES
In accordance with the provisions of the Statement of Financial
Accounting Standards No. 109, "Accounting for Income Taxes" the
deferred tax asset generated during the current period has been offset
by a corresponding increase in the valuation allowance, and as a
result, no income tax expense or benefit has been recorded during the
three months ended March 31, 1995.
12 (Continued)
<PAGE> 14
QUEST MEDICAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(5) COMMITMENTS AND CONTINGENCIES
In conjunction with the acquisition of Neuromed, Inc. on March 31,
1995, the Company assumed a noncancelable lease for approximately
18,000 square feet of office and manufacturing space in Davie (Ft.
Lauderdale), Florida. The lease, which expires on February 28, 1996,
has a monthly rental payment of $11,236. The lease contains a renewal
option.
In addition, the Company rents certain autos under the terms of
noncancelable leases. As of March 31, 1995, future minimum rental
payments under noncancelable auto leases and the aforementioned
facility lease are $110,366 in 1995, $28,946 in 1996, and $3,016 in
1997. Total rent expense under operating leases for the three months
ended March 31, 1995 and 1994 was $10,881 and $10,497, respectively.
The Company is also involved in various lawsuits and claims, the
ultimate disposition of which management believes will not have a
material adverse effect upon the Company's business or consolidated
financial position.
(6) FINANCIAL INSTRUMENTS AND RISK CONCENTRATION
Financial instruments which potentially subject the Company to
concentrations of credit risk are primarily cash investments and
accounts receivable. The Company places its cash investments primarily
in publicly traded investment grade preferred securities, utility
stocks, real estate investment trusts and energy related limited
partnerships and limits the amount of credit exposure to any one
issuer.
The Company manufactures proprietary products for the healthcare
industry. In the United States, the Company's accounts receivable are
due primarily from hospitals and distributors located throughout the
country. Internationally, the Company's accounts receivable are due
primarily from distributors located in Europe and Australia. The
Company generally does not require collateral. The Company maintains
an allowance for doubtful accounts based upon the expected
collectability of all accounts receivable. Any losses from bad debts
have historically been within management's expectations.
(7) EMPLOYEE BENEFIT PLANS
The Company has a defined contribution retirement savings plan (the
"Plan") available to substantially all employees. The Plan permits
employees to elect salary deferral contributions of up to 15% of their
compensation and requires the Company to make
13 (Continued)
<PAGE> 15
QUEST MEDICAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
matching contributions equal to 50% of the participants'
contributions, to a maximum of 6% of the participants' compensation.
The expense of the Company's contribution was $25,050 and $24,750 for
the three months ended March 31, 1995 and 1994, respectively.
(8) STOCK PURCHASE RIGHTS
On October 12, 1989, the Company declared a distribution to
stockholders of record on October 23, 1989, of one common stock
purchase right for each outstanding share of common stock. On
February 9, 1995, the Board of Directors amended two provisions of the
rights agreement. First, the purchase price (as defined in the rights
agreement) for each one-half share of common stock purchased pursuant
to the exercise of the right was increased from $5.00 to $12.50.
Secondly, the definition of acquiring person was amended to exclude
William Borkan or his affiliates so long as their ownership does not
exceed 25% of the common shares outstanding at any time.
Under the rights agreement, the number of shares issuable upon
exercise of the rights are subject to adjustment by the Company in
order to prevent dilution. The rights are not exercisable or
transferable apart from the common stock until ten days after a public
announcement that a person or group, with the exception of William
Borkan or his affiliates (subject to the 25% limitation referred to
above), either (1) has acquired or has obtained the right to acquire
15% or more of the Company's outstanding shares of common stock, or
(2) has commenced or announced an intention to commence a tender offer
or exchange offer for 20% or more of the outstanding shares of common
stock. Until a right is exercised, the holder of a right, as such,
will have no rights as a stockholder of the Company, including,
without limitation, the right to vote as a stockholder or receive
dividends.
The rights may be redeemed in whole by the Company at a price of $.01
per right at any time prior to their expiration on October 12, 1999,
or prior to the point at which they become exercisable.
14
<PAGE> 16
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
Net revenue of $4,071,640 for the three months ended March 31, 1995, was 17%
above the $3,481,122 for the comparable 1994 period. This increase was
primarily the result of higher unit sales volume from the Company's
cardiovascular products. Net revenue in this product line increased by
approximately $514,000, or 35.6%, due to higher unit sales volume from the
Company's family of pressure control valves and higher unit sales volume of the
Actester(TM) instrument and associated disposable used to measure the activated
clotting time of blood.
Management expects net revenue for the remaining three quarters of fiscal 1995
will increase compared to the same periods during 1994 as a result of the
acquisition of Neuromed, Inc. on March 31, 1995. (No revenue from Neuromed was
recognized during the three months ended March 31, 1995, since the acquisition
occurred at the close of business on March 31.) Neuromed develops, manufactures
and markets electronic neurostimulation devices used in the treatment of
chronic pain. For the year ended October 31, 1994, Neuromed's net revenue was
approximately $8 million. See Notes 2 and 3 of the Notes to Condensed
Consolidated Financial Statements and Part II. -- "Other Information." In
addition, management expects that the Company will complete development of its
MPS(TM) brand of myocardial protection system and family of related products
and file for FDA market clearance under a pre-market notification ("510(K)")
during the second quarter of fiscal 1995. Management would then plan to
introduce the MPS system and related products to commercial markets in late
1995 or early 1996 upon the FDA's clearance of such products to market. There
are no assurances that such clearance will be obtained or that it will be
obtained without delay. Management believes that Neuromed and MPS should
enhance the long-range growth objectives of the Company.
Cost of revenue as a percentage of net revenue decreased to 49.8% for the three
months ended March 31, 1995, as compared to 57.8% for the same period a year
ago, thereby resulting in an increase in gross profit margin. This increase in
gross profit margin was primarily the result of the increased revenue generated
by the Company's cardiovascular products discussed above, since these products
contribute higher gross profit margins than the Company's other product lines.
Management expects the Company's overall gross profit margin to continue
improving as a result of the acquisition of Neuromed, since Neuromed's products
contribute higher gross profit margins than most of the Company's other
existing products.
Research and development expense increased as a percentage of net revenue from
18.3% during the three months ended March 31, 1994, to 26.7% for the same
period in 1995, and the dollar amount increased by approximately $447,000.
During the first quarter of fiscal 1995, the Company continued development
efforts on its MPS(TM) brand of myocardial protection system and related
products. This innovative system consists of hardware and disposables that are
designed to automate and systematize certain myocardial protection functions
for the cardiovascular team. The Company is currently assembling 10 beta
(pre-production) units of MPS and expects to file a 510(K) with the FDA during
the second quarter of fiscal 1995. As noted above, the Company expects to
introduce MPS and related products to commercial markets in late 1995 or early
1996 upon the FDA's clearance of such products to market. Again, there are no
assurances that such clearance will be obtained or that it will be obtained
without delay. Increases in R&D expense for
15
<PAGE> 17
the three months ended March 31, 1995, as compared to the same period during
1994 was primarily the result of additional salary and contract labor expense
from personnel additions and increased consulting expense. Management expects
research and development expenditures for the remainder of fiscal 1995 will
approximate $2.4 million, including research and development expense for
Neuromed. Approximately one-half of such expenditures will occur during the
second quarter of fiscal 1995, primarily for the completion of MPS. On January
31, 1995, the Company received its first patent on MPS and has three additional
patent applications pending that can offer further protection.
Marketing expense increased as a percentage of net revenue from 12.2% during
the three months ended March 31, 1994, to 13.0% for the same period in 1995,
and the dollar amount increased by approximately $105,000. This increase
during 1995 as compared to 1994 was primarily the result of additional salary
expense from personnel additions, and increased travel, commission and
convention expense. Management anticipates hiring four additional direct
salespersons during the second half of fiscal 1995 in preparation for the
commercialization of the MPS system and related products upon the FDA's
clearance of such products.
General and administrative expense increased approximately $55,000 during the
three months ended March 31, 1995 compared to the same period in 1994, but as a
percentage of net revenue, decreased from 20.5% during 1994 to 18.8% during the
1995 period. During the remainder of fiscal 1995, general and administrative
expense will reflect the amortization expense of the Neuromed intangibles.
The loss from operations increased from approximately $304,000 for the three
months ended March 31, 1994, to $337,000 for the comparable 1995 period. This
increase in the loss from operations during 1995 as compared to 1994 resulted
primarily from the increase in research and development expense ($447,000)
discussed above. Based on Neuromed's historical results of operations,
management believes that the acquisition of Neuromed should increase earnings
from operations for the remainder of fiscal 1995 as compared to the same
periods during 1994 although there can be no assurances that such improvements
will occur.
Other income decreased from approximately $121,000 during the three months
ended March 31, 1994, to an expense of approximately $28,000 during the same
period in 1995 primarily as a result of two factors. First, interest expense
increased approximately $42,000 for the three months ended March 31, 1995
compared to the same period during 1994 due to higher interest rates on
borrowed money. Second, during the 1994 period, the Company realized gains on
the sale of marketable securities of approximately $97,000 compared to
approximately $6,000 during the comparable 1995 period, a decrease of $91,000.
As a consequence of the Neuromed acquisition and the incurrance of $15 million
in long-term indebtedness, commencing April 1, 1995, interest expense will
increase. See Notes 2 and 3 of the Notes to Condensed Consolidated Financial
Statements. At March 31, 1995, such indebtedness bore interest at the rate of
9.5%. Since the Company has limited opportunity to fix the rate of interest on
such indebtedness, the rate of interest will float and thereby subject the
Company to the risk of higher interest rates, which could have a detrimental
impact on net earnings.
The net loss increased from approximately $183,000 for the three months ended
March 31, 1994 to approximately $365,000 during the same period in 1995 as a
result of the decrease in earnings
16
<PAGE> 18
from operations (primarily caused by higher research and development expense)
and the decrease in other income discussed above. No income tax expense was
incurred for either the three months ended March 31, 1994 or the three months
ended March 31, 1995 as a result of the net loss during both periods.
During April 1994, the Board of Directors approved a 3% stock dividend. The
distribution date was May 23, 1994, for stockholders of record as of May 6,
1994. The weighted average number of common and common equivalent shares
outstanding used in computing the loss per share for the three months ended
March 31, 1994, were increased to retroactively reflect the stock dividend.
Primary and fully diluted loss per share for the three months ended March 31,
1995 and 1994, are based upon 5,302,463 and 5,235,821 common and common
equivalent shares outstanding, respectively.
LIQUIDITY AND FINANCIAL POSITION
Cash, cash equivalents and marketable securities totaled $5,476,000 at March
31, 1995, an increase of $214,000 from 1994 year-end. Working capital (current
assets less current liabilities) was $10,319,000 with a current ratio of 2.76
to 1 at March 31, 1995.
On March 31, 1995, the Company acquired all of the outstanding capital stock of
Neuromed, Inc. The Company paid $15.2 million cash, 833,333 shares of Quest
common stock, and agreed to pay contingent consideration of up to $6 million
over the next two years, payable in January 1996 and January 1997, depending on
sales of Neuromed's products reaching certain objectives. The contingent
consideration may be paid in a combination of cash and additional shares of
Quest common stock. On March 31, 1995, the Company entered into a First
Amended and Restated Credit Agreement with NationsBank of Texas, N.A., which
provided $15 million of senior term financing, which was utilized to pay the
cash portion of the Neuromed purchase price, and a working capital line of up
to $5 million. Amortization of the senior term debt is $1,950,000 per year for
the first and second years, $3,250,000 per year for the third and fourth years,
and $2,600,000 for the fifth year, with a $2,000,000 balloon payment due at the
end of the fifth year. Borrowings under the working capital line are due and
payable on May 31, 1997. Borrowings under both facilities bear interest at
prime plus 125 basis points, or at the Company's option, LIBOR plus 300 basis
points. The interest rate may be reduced based on the Company achieving
certain ratios of senior bank debt to EBITDA (earnings before interest, taxes,
depreciation and amortization). At March 31, 1995, the Company had an
outstanding principal balance of $15,000,000 under the senior term debt,
including a current portion of $1,950,000 with a weighted average interest rate
of 9.50%. At March 31, 1995, the Company had borrowings under the working
capital line of $3,050,000 with a weighted average interest rate of 9.60%.
The acquisition of Neuromed significantly altered the debt structure of the
Company. Management believes, however, that its current cash, cash equivalents
and marketable securities, its working capital line, and funds generated from
the combined operations will be sufficient to service the acquisition related
debt and satisfy normal cash operating requirements.
The Company's investment strategy is to maximize its dividend and interest
yields on cash not currently employed in operating activities by investing in
highly liquid investments. As such, the Company's current investment portfolio
consists primarily of interests in publicly traded real estate investment
trusts and publicly traded investment grade corporate preferred stocks (which
qualify for 70% dividend exclusion for tax purposes). These investments
generally yield higher returns
17
<PAGE> 19
than certificates of deposit or treasury bills, but with a higher market value
exposure to interest rate risk. Tightening of the monetary policy by the
Federal Reserve during 1994 to moderate economic growth and thus thwart
inflation pressures led to a significant rise in both short-term and long-term
interest rates, thereby negatively affecting the value of interest sensitive
investments. Consequently, at December 31, 1994, the Company's investment
portfolio had declined in value by approximately $918,000. As required by FAS
115, this decline is reflected as a decrease in stockholders' equity through
the component entitled "unrealized loss on marketable securities." During the
first quarter of fiscal 1995, interest rates fell modestly, resulting in an
increase in the value of the Company's portfolio of $223,000, thereby
decreasing the unrealized loss component of stockholders' equity to $695,000 at
March 31, 1995. The Company's investment strategy has resulted in realized
gains on its investments of over $1 million during the past three fiscal years
while continuously realizing higher interest and dividend yields compared to
certificates of deposit or treasury bills. At March 31, 1995, no individual
security represented more than 10% of the total portfolio or 1% of total
assets. The Company's investment policies prohibit the use of derivative
financial instruments.
The Company spent approximately $360,000 for additions to property, plant and
equipment during the three months ended March 31, 1995. The Company
anticipates capital expenditures for the remainder of fiscal 1995 will
approximate $840,000, largely for tooling and manufacturing equipment for the
myocardial protection products the Company is developing.
Under the terms of the NationsBank credit agreement, without NationsBank
consent, the Company is not permitted to acquire additional product lines or
companies during the twelve months ended March 31, 1996. However, the Company
intends to continue seeking such acquisitions, and if the Company identifies an
attractive acquisition candidate, management would expect to pursue such
acquisition, subject to NationsBank approval. No assurances can be given that
the Company will identify attractive candidates or be able to consummate
acquisitions on favorable terms.
18
<PAGE> 20
PART II
OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) None
(b) (1) The Company filed a current report on Form 8-K, dated February
17, 1995, reporting pursuant to Item 5. "Other Events," that
on February 16, 1995, the Company announced that it had
entered into a purchase agreement to acquire all of the
capital stock of Neuromed, Inc. The following is the text of
the press release made by the Company relating to such
acquisition:
QUEST MEDICAL, INC. SIGNS PURCHASE
AGREEMENT TO ACQUIRE NEUROMED, INC.
Dallas, Texas, February 16, 1995 ... Quest Medical, Inc.
(NASDAQ:QMED), a manufacturer of proprietary products for the
healthcare industry, today announced it has entered into a
purchase agreement to acquire all of the capital stock of
Neuromed, Inc. Neuromed, a privately-held corporation located
in Fort Lauderdale, Florida, develops, manufactures, and
markets spinal cord stimulators for the treatment of chronic
pain. The transaction's completion is subject to a number of
conditions, including the completion of due diligence and
financing. Terms were not announced.
Quest Medical, Inc. develops, manufactures and markets
proprietary products used in cardiovascular surgery, oncology,
anesthesiology and obstetrics.
(2) The Company filed a current report on Form 8-K, dated April
13, 1995, reporting pursuant to Item 2. "Acquisition or
Disposition of Assets," that on March 31, 1995, pursuant to
the terms of an Agreement for the Purchase and Sale of All of
the Issued Capital Stock of Neuromed, Inc. between the Company
and Mr. William Borkan, dated February 10, 1995, the Company
acquired all of the issued and outstanding capital stock of
Neuromed, Inc. ("Neuromed"), all of which was held by Mr.
Borkan and his brother, Burt Borkan. The assets of Neuromed
consist principally of accounts receivable; inventory;
equipment, furniture and other fixed assets;
19
<PAGE> 21
and United States and foreign patents, trademarks and other
intellectual property. In addition, Neuromed leases
approximately 18,000 square feet in an office and
manufacturing facility in Davie (Ft. Lauderdale), Florida.
In consideration for its purchase of the Neuromed capital
stock, the Company paid the Borkans $15.2 million in cash, and
issued and delivered to the Borkans 833,333 shares of Quest
common stock, par value $.05. These shares were issued from
the Company's treasury. Depending on Neuromed's attainment of
certain sales objectives (as set forth in Schedule 1.2 to the
Agreement), the Company may be required to pay the Borkans up
to $3.0 million of additional consideration in January 1996
and up to $3.0 million in January 1997. The contingent
consideration will be paid one-half in cash and one-half in
Quest common stock (valued prior to issuance). Depending on
the trading price of Quest common stock at the time of
issuance, however, the allocation between cash and stock may
vary at the time of payment. The determination of the amount
of consideration resulted from arms-length negotiations
between the Company and William Borkan, based on such factors
as Neuromed's historical and projected revenues and cash flow,
Neuromed's current and potential customer base and certain
other financial and operating information of Neuromed. There
was no material relationship between Quest and the Borkans or
any of their respective affiliates or associates prior to the
transaction. Financing for the cash portion of the purchase
consideration was provided by NationsBank of Texas, N.A.,
through $15 million of senior debt financing.
In connection with the acquisition, the Company granted
William Borkan certain registration rights. During calendar
1996, Mr. Borkan may make a single written request that the
Company register his shares under Form S-3 and Rule 415 under
the Securities Act of 1933. In addition, if the Company files
a registration statement to register its or another
shareholder's sale of Quest common stock (other than under a
Form S-4, Form S-8 or other limited purpose form), Mr. Borkan
is entitled to include his shares in such offering, subject to
the managing underwriter's right to reduce the number of
shares to be included in the offering or to exclude such
shares from the offering.
Under the Agreement, the Company also agreed that for three
years following the closing, and thereafter so long as William
Borkan owns at least 5% of the then issued and outstanding
shares of Quest common stock, William Borkan will be entitled
to designate himself or another nominee for election as a
member of the Company's Board
20
<PAGE> 22
of Directors, and the Company will use its best efforts to
cause Mr. Borkan or his nominee to be so elected. It is
expected that Mr. Borkan will be nominated and considered for
election as a director at the Company's next annual meeting.
The Company and William Borkan also entered into a consulting
agreement whereby Mr. Borkan agreed to provide certain
consulting services to the Company at the rate of $1,000 per
day. The Company is required to pay Mr. Borkan for a minimum
of five days per month ($5,000) until October 31, 1995 and two
days per month ($2,000) thereafter until October 31, 1996.
The Company also reported pursuant to Item 5. "Other Events,"
that in connection with the acquisition of Neuromed, Inc., the
Company entered into the First Amended and Restated Credit
Agreement dated March 31, 1995, with NationsBank of Texas,
N.A. (the "Loan Agreement"). The Loan Agreement provides for
$15 million in senior term financing, which was utilized to
pay the cash portion of the Neuromed purchase price.
Amortization of the senior term debt is $1,950,000 per year
for the first and second years, $3,250,000 per year for the
third and fourth years, and $2,600,000 for the fifth year,
with a $2,000,000 balloon payment due at the end of the fifth
year. The senior term loan bears interest at prime plus 125
basis points, or at the Company's option, LIBOR plus 300 basis
points. The interest rate can be reduced based on the Company
achieving certain ratios of senior bank debt to EBITDA
(earnings before interest, taxes, depreciation and
amortization). NationsBank also agreed to expand the
Company's existing $3 million working capital line of credit
to $5 million.
The Loan Agreement contains restrictive covenants which impose
limitations on the Company and its subsidiaries with respect
to, among other things: (i) the creation or incurrence of
liens, (ii) consolidations, mergers, sales, leases or
conveyances of assets, (iii) entering new industries or types
of business, (iv) the incurrence of additional indebtedness;
or (v) making loans or certain investments. In addition, the
Loan Agreement restricts the Company from declaring and paying
cash dividends on its common stock in excess of 25% of the
prior year's net income or from repurchasing Quest capital
stock in excess of $1 million in any calendar year. The Loan
Agreement also requires the Company to satisfy certain
financial tests and maintains certain financial ratios.
The Loan Agreement contains customary default provisions,
including defaults resulting from nonpayment of principal when
due, nonpayment of interest and fees, material
misrepresentations,
21
<PAGE> 23
default in performance of any covenant, bankruptcy or
insolvency, FDA bans, recalls or seizures involving 5% or more
of gross sales revenue, and judgments. The Loan Agreement is
secured by certain of the Company's assets, including without
limitation, accounts receivable, inventory, equipment,
furniture and other fixed assets, patents, trademarks and
other intangible property, and the Neuromed common stock, but
excluding marketable securities in excess of $2 million, and
excluding the real property, building and equipment financed
in 1993 by MetLife Capital Corporation.
The Company also reported pursuant to Item 7. "Financial
Statements, Pro Forma Financial Information and Exhibits,"
that as of the date this report on Form 8-K is being filed
(April 13, 1995), it is impracticable for the Company to
provide the financial statements of Neuromed or the pro forma
financial information of Neuromed required by Item 310(a) of
Regulation S-B. The Company expects that the required
financial statements and pro forma financial information will
be available and will be filed by June 1, 1995, but in any
event, not later than 60 days after the date that this report
on Form 8-K was filed.
22
<PAGE> 24
SIGNATURES
In accordance with the requirements of the Exchange Act, the registrant caused
this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
QUEST MEDICAL, INC.
DATE: MAY 12, 1995 BY: /S/ F. ROBERT MERRILL III
------------------------------
F. ROBERT MERRILL III
VICE PRESIDENT FINANCE/
TREASURER
23
<PAGE> 25
EXHIBIT INDEX
Exhibit No. Description
- ----------- -----------
27 Financial Data Schedule
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<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1995
<PERIOD-START> JAN-01-1995
<PERIOD-END> MAR-31-1995
<CASH> 160,626
<SECURITIES> 5,315,373
<RECEIVABLES> 4,337,171
<ALLOWANCES> (114,337)
<INVENTORY> 5,748,818
<CURRENT-ASSETS> 16,181,769
<PP&E> 12,983,466
<DEPRECIATION> (3,090,173)
<TOTAL-ASSETS> 48,429,939
<CURRENT-LIABILITIES> 5,862,374
<BONDS> 0
<COMMON> 400,963
0
0
<OTHER-SE> 21,961,315
<TOTAL-LIABILITY-AND-EQUITY> 48,429,939
<SALES> 4,071,640
<TOTAL-REVENUES> 4,071,640
<CGS> 2,027,352
<TOTAL-COSTS> 2,027,352
<OTHER-EXPENSES> 2,381,232
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 157,266
<INCOME-PRETAX> (364,598)
<INCOME-TAX> 0
<INCOME-CONTINUING> (364,598)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (364,598)
<EPS-PRIMARY> (.07)
<EPS-DILUTED> (.07)
</TABLE>
