<PAGE> 1
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON NOVEMBER 8, 1995
REGISTRATION NO. 33-62991
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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
---------------------
AMENDMENT NO. 1
TO
FORM SB-2
REGISTRATION STATEMENT UNDER
THE SECURITIES ACT OF 1933
---------------------
QUEST MEDICAL, INC.
(Name of small business issuer in its charter)
<TABLE>
<S> <C> <C>
TEXAS 3841 75-1646002
(State or Other Jurisdiction of (Primary Standard Industrial (I.R.S. Employer
Incorporation or Organization) Classification Code Number) Identification No.)
ONE ALLENTOWN PARKWAY THOMAS C. THOMPSON
ALLEN, TEXAS 75002 PRESIDENT AND CHIEF EXECUTIVE OFFICER
(214) 390-9800 ONE ALLENTOWN PARKWAY
(Address and Telephone Number of Principal ALLEN, TEXAS 75002
Executive Offices and Principal Place of (214) 390-9800
Business) (Name, Address and Telephone Number
of Agent for Service)
</TABLE>
---------------------
Copies to:
<TABLE>
<S> <C>
KENNETH G. HAWARI MICHAEL W. HALL
JAMES E. CAHILL PETER COHN
HUGHES & LUCE, L.L.P. VENTURE LAW GROUP
1717 MAIN STREET, SUITE 2800 A PROFESSIONAL CORPORATION
DALLAS, TEXAS 75201 2800 SAND HILL ROAD
(214) 939-5500 MENLO PARK, CALIFORNIA 94025
(415) 854-4488
</TABLE>
---------------------
Approximate date of proposed sale to the public: As soon as practicable
after the effective date of this Registration Statement.
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following box
and list the Securities Act registration statement number of the earlier
effective registration statement for the same offering. / /
If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. / /
If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box. / /
---------------------
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL
FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF
THE SECURITIES ACT OF 1933, AS AMENDED, OR UNTIL THIS REGISTRATION STATEMENT
SHALL BECOME EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID
SECTION 8(A), MAY DETERMINE.
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<PAGE> 2
QUEST MEDICAL, INC.
CROSS REFERENCE SHEET
<TABLE>
<CAPTION>
ITEM OF FORM SB-2 PROSPECTUS CAPTION OR LOCATION
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<C> <S> <C>
1. Front of Registration Statement and Outside
Front Cover Page of Prospectus........... Outside Front Cover Page
2. Inside Front and Outside Back Cover Pages
of Prospectus............................ Inside Front and Outside Back Cover Pages
of the Prospectus; Available Information
3. Summary Information and Risk Factors....... Prospectus Summary; Risk Factors
4. Use of Proceeds............................ Use of Proceeds
5. Determination of Offering Price............ Underwriting
6. Dilution................................... Not Applicable
7. Selling Security Holders................... Principal and Selling Shareholders; Certain
Transactions
8. Plan of Distribution....................... Outside Front Cover Page; Underwriting
9. Legal Proceedings.......................... Business
10. Directors, Executive Officers, Promoters
and Control Persons...................... Management
11. Security Ownership of Certain Beneficial
Owners and Management.................... Principal and Selling Shareholders
12. Description of Securities.................. Description of Capital Stock
13. Interest of Named Experts and Counsel...... Legal Matters; Experts
14. Disclosure of Commission Position on
Indemnification of Securities Act
Liabilities.............................. Not Applicable
15. Organization within Last Five Years........ Certain Transactions
16. Description of Business.................... Prospectus Summary; Business
17. Management's Discussion and Analysis or
Plan of Operation........................ Management's Discussion and Analysis of
Financial Condition and Results of
Operations
18. Description of Property.................... Business
19. Certain Relationships and Related
Transactions............................. Certain Transactions
20. Market for Common Equity and Related
Stockholder Matters...................... Outside Front Cover Page of Prospectus;
Price Range of Common Stock; Dividend
Policy
21. Executive Compensation..................... Management
22. Financial Statements....................... Financial Statements
23. Changes In and Disagreements with
Accountants on Accounting and Financial
Disclosure............................... Not Applicable
</TABLE>
<PAGE> 3
***************************************************************************
* *
* INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. A *
* REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED *
* WITH THE SECURITIES AND EXCHANGE COMMISSION. THESE SECURITIES MAY NOT *
* BE SOLD NOR MAY OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME THE *
* REGISTRATION STATEMENT BECOMES EFFECTIVE. THIS PROSPECTUS SHALL NOT *
* CONSTITUTE AN OFFER TO SELL OR THE SOLICITATION OF AN OFFER TO BUY *
* NOR SHALL THERE BE ANY SALE OF THESE SECURITIES IN ANY STATE IN WHICH *
* SUCH OFFER, SOLICITATION OR SALE WOULD BE UNLAWFUL PRIOR TO *
* REGISTRATION OR QUALIFICATION UNDER THE SECURITIES LAWS OF ANY SUCH *
* STATE. *
* *
***************************************************************************
SUBJECT TO COMPLETION, DATED NOVEMBER 8, 1995
PROSPECTUS
2,600,000 SHARES
LOGO
COMMON STOCK
Of the 2,600,000 shares of Common Stock offered hereby, 1,516,667 shares
are being sold by Quest Medical, Inc. ("Quest" or the "Company") and 1,083,333
shares are being sold by shareholders of the Company (the "Selling
Shareholders"). See "Principal and Selling Shareholders." The Company will not
receive any of the proceeds from the sale of the Common Stock by the Selling
Shareholders. The Company's Common Stock is quoted on the Nasdaq National Market
under the symbol "QMED." On November 6, 1995, the last reported sale price for
the Common Stock was $11.50 per share. See "Price Range of Common Stock."
THE COMMON STOCK OFFERED HEREBY INVOLVES A HIGH DEGREE OF RISK. SEE
"RISK FACTORS," BEGINNING ON PAGE 5.
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS
THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES
COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF
THIS PROSPECTUS. ANY REPRESENTATION TO THE
CONTRARY IS A CRIMINAL OFFENSE.
<TABLE>
<CAPTION>
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UNDERWRITING
DISCOUNTS PROCEEDS TO PROCEEDS TO
PRICE TO PUBLIC AND COMMISSIONS(1) COMPANY(2) SELLING SHAREHOLDERS
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<S> <C> <C> <C> <C>
Per Share...................... $ $ $ $
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Total(3)....................... $ $ $ $
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</TABLE>
(1) See "Underwriting" for indemnification arrangements with the Underwriters.
(2) Before deducting expenses of the Offering payable by the Company, estimated
to be $ .
(3) The Company has granted the Underwriters an option, exercisable within 30
days from the date hereof, to purchase up to 390,000 additional shares of
Common Stock on the same terms and conditions set forth above, solely to
cover over-allotments, if any. If such option is exercised in full, the
total Price to Public, Underwriting Discounts and Commissions, and Proceeds
to Company will be $ , $ and $ , respectively. See
"Underwriting."
---------------------------
The shares of Common Stock offered by the Underwriters are subject to
prior sale, receipt and acceptance by them, and subject to the right of the
Underwriters to reject any order in whole or in part and certain other
conditions. It is expected that delivery of such shares will be made through the
offices of Vector Securities International, Inc., in Deerfield, Illinois on or
about , 1995.
---------------------------
VECTOR SECURITIES INTERNATIONAL, INC. RAUSCHER PIERCE REFSNES, INC.
, 1995
<PAGE> 4
[Artist's renditions of the Company's MPS brand of myocardial protection system
and related disposables; CompuStim spinal cord stimulation device; anesthesia
delivery sets; and operating room scenes]
---------------------
The Company has a number of federally registered trademarks, including
QUEST(R), MULTIPORT(R), RETROGUARD(R), RETRACT-O-TAPE(R), ACTest(R) and
DUO-TUBE(R). MPS(TM), COMPUSTIM(TM), PAINDOC(TM) and ACTester(TM) are among the
Company's non-registered trademarks.
---------------------
IN CONNECTION WITH THIS OFFERING, THE UNDERWRITERS MAY OVER-ALLOT OR EFFECT
TRANSACTIONS WHICH STABILIZE OR MAINTAIN THE MARKET PRICE OF THE COMMON STOCK OF
THE COMPANY AT A LEVEL ABOVE THAT WHICH MIGHT OTHERWISE PREVAIL IN THE OPEN
MARKET. SUCH TRANSACTIONS MAY BE EFFECTED ON THE NASDAQ NATIONAL MARKET, IN THE
OVER-THE-COUNTER MARKET OR OTHERWISE. SUCH STABILIZING, IF COMMENCED, MAY BE
DISCONTINUED AT ANY TIME.
IN CONNECTION WITH THIS OFFERING, THE UNDERWRITERS MAY ENGAGE IN PASSIVE
MARKET-MAKING TRANSACTIONS IN THE COMMON STOCK OF THE COMPANY ON THE NASDAQ
NATIONAL MARKET IN ACCORDANCE WITH RULE 10B-6A UNDER THE SECURITIES EXCHANGE ACT
OF 1934. SEE "UNDERWRITING."
2
<PAGE> 5
PROSPECTUS SUMMARY
The following summary is qualified in its entirety by the more detailed
information and Consolidated Financial Statements and Notes thereto appearing
elsewhere in this Prospectus, including information under "Risk Factors."
THE COMPANY
Quest Medical, Inc. ("Quest" or the "Company") designs, develops,
manufactures and markets a variety of healthcare products used primarily in
cardiovascular surgery, interventional pain management and intravenous fluid
delivery applications. The Company operates several stable and profitable
product lines, including cardiovascular products (such as pressure control
valves, filters and surgical retracting tapes), specialized intravenous fluid
delivery tubing sets and accessories, and pressure monitoring kits used
primarily in labor and delivery. The Company has levered these product lines,
its existing corporate infrastructure and its core competencies in medical
device manufacturing, engineering and regulatory affairs to expand into new
markets as evidenced by the internally funded development of the Quest MPS brand
of myocardial protection system, an innovative and sophisticated system designed
to manage the delivery of solutions to the heart during open-heart surgery. In
addition, the Company recently entered the interventional pain management market
by acquiring Neuromed, Inc. ("Neuromed"), which designs, develops, manufactures
and markets a line of electronic spinal cord stimulation ("SCS") devices used to
manage chronic severe pain.
In 1991, Quest acquired two companies that manufactured and marketed
various cardiovascular products, significantly enhancing the Company's presence
in the cardiovascular products marketplace. In 1992, Quest identified a real and
immediate need in this marketplace for an automated and integrated myocardial
protection system that would be versatile, easy to use, efficient to monitor and
cost-effective. Myocardial protection is the process of arresting and caring for
the heart during open-heart surgery. The Quest MPS system is designed to
integrate key functions relating to the delivery of solutions to the heart such
as varying the rate and ratio of oxygenated blood, crystalloid, potassium and
other additives, and controlling temperature, pressure and other variables to
allow simpler, more flexible and cost-effective management of this process. The
MPS system employs advanced pump, temperature control and microprocessor
technologies and includes a line of captive and non-captive disposable products.
The Company filed a 510(k) pre-market notification for its MPS system with the
United States Food and Drug Administration ("FDA") in August 1995.
In its continuing effort to expand into potentially high growth niche
markets in the medical device industry, the Company acquired Neuromed in March
1995 (the "Neuromed Acquisition"). SCS is gaining increased acceptance as a
viable, efficacious and cost-effective treatment alternative to repeat back
surgeries for relieving chronic severe back pain. The Company believes that its
recently introduced CompuStim products, which are powered by radio frequency
transmitters external to the body, are the technological leaders in the field.
The Company is currently test marketing PainDoc, a pen-based computer system
that works in tandem with the Company's CompuStim devices to assist physicians
and their patients in optimizing the performance of the Company's SCS devices
both pre-and post-operatively.
Since its founding in 1979, the Company has developed, manufactured and
marketed specialized intravenous fluid delivery tubing sets and accessories sold
primarily to major hospitals in the United States. Over the last several years,
the revenues generated by this product line, a substantial component of the
Company's historical base business, have significantly aided the funding of the
Company's research and development efforts. The Company manufactures and markets
over 70 distinct models of specialized intravenous fluid delivery tubing sets.
The Company's business strategy emphasizes the development and
commercialization of new products in niche markets and the enhancement of
existing products, particularly in the myocardial protection and interventional
pain management markets. The Company operates an ISO 9001 certified
manufacturing facility in Allen, Texas, and markets its products through direct
sales and distribution arrangements with independent distributors. Quest intends
to continue pursuing its strategy through internal product development and
acquisitions.
3
<PAGE> 6
THE OFFERING
<TABLE>
<S> <C>
Common Stock offered by:
The Company..................................... 1,516,667
The Selling Shareholders........................ 1,083,333
Total........................................ 2,600,000
Common Stock to be outstanding after the
Offering........................................ 7,954,121(1)
Use of Proceeds by the Company.................... Repayment of bank debt and general
corporate purposes. See "Use of
Proceeds."
Nasdaq National Market symbol..................... QMED
</TABLE>
SUMMARY CONSOLIDATED FINANCIAL DATA
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31, SIX MONTHS ENDED JUNE 30,
--------------------------------------------- -----------------------------
PRO FORMA PRO FORMA
1992 1993 1994 1994(2) 1994 1995(3) 1995(2)
------- ------- ------- --------- ------ -------- ---------
<S> <C> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Net revenue............................. $13,612 $13,643 $13,999 $22,043 $7,223 $ 11,303 $13,710
Gross profit............................ 6,553 6,591 6,381 12,175 3,196 6,393 8,376
Research and development................ 1,387 1,910 3,542 4,402 1,539 2,494 2,729
Non-recurring charges(4)................ 1,247 -- -- -- -- 10,500 --
Marketing, general and administrative... 4,141 4,400 4,977 7,859 2,375 3,511 4,232
Earnings (loss) from operations,
excluding non-recurring charges....... 1,025 281 (2,138) (86) (719) 388 1,415
Earnings (loss) from operations......... (222) 281 (2,138) (86) (719) (10,112) 1,415
Other income (expense), net............. 473 667 419 (1,070) 178 (501) (741)
Net earnings (loss)..................... 194 816 (1,719) (1,220) (540) (10,613) 445
Net earnings (loss) per share........... $ 0.03 $ 0.15(5) $ (0.33) $ (0.20)(6) $(0.10) $ (1.85) $ 0.07(6)
</TABLE>
<TABLE>
<CAPTION>
JUNE 30, 1995
------------------------------------------
AS ADJUSTED
ACTUAL AS ADJUSTED(7) FOR OFFERING(8)
------- -------------- ---------------
<S> <C> <C> <C>
BALANCE SHEET DATA:
Cash, cash equivalents and marketable securities......................... $ 4,707 $ 4,707 $ 4,707
Working capital.......................................................... 10,812 9,312 11,262
Total assets............................................................. 41,652 45,710 45,421
Long-term debt, excluding current maturities............................. 20,830 20,830 6,832
Stockholders' equity..................................................... 12,500 15,058 30,717
</TABLE>
- ---------------
(1) Does not include 1,168,548 shares of Common Stock issuable upon the exercise
of outstanding stock options at a weighted average exercise price of $4.15
per share. See "Management -- Benefit Plans and Other Arrangements."
(2) Assumes the acquisition of Neuromed as of January 1, 1994. See Pro Forma
Condensed Consolidated Statements of Operations and the Notes thereto.
(3) Includes results of Neuromed from April 1, 1995.
(4) Non-recurring charge in 1992 relates to the write-off of assets of a
discontinued business, and for the six months ended June 30, 1995, relates
to purchased in-process research and development incurred in connection with
the Neuromed Acquisition. See Note 2 of the Notes to the Quest Consolidated
Financial Statements.
(5) Includes an increase in net income of $0.03 per share relating to the
cumulative effect of a change in accounting principle. See Note 1(m) of the
Notes to the Quest Consolidated Financial Statements.
(6) If the proceeds of this Offering had been applied to reduce bank debt as of
January 1, 1994 in the manner specified under "Use of Proceeds," then pro
forma earnings per share before extraordinary charge for the year ended
December 31, 1994 would have been $0.02 and pro forma net earnings per share
for the six months ended June 30, 1995 would have been $0.12. An
extraordinary charge resulting from the write-off of capitalized debt
issuance costs associated with the assumed January 1, 1994 repayment of bank
debt would have reduced 1994 pro forma net earnings by $0.03 per share.
(7) Adjusted to reflect the accrual of $1.5 million payable in January 1996 and
the issuance of 200,000 shares of Common Stock concurrently with the closing
of the Offering as contingent "earn-out" consideration relating to the
Neuromed Acquisition. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Overview" and "Certain Transactions."
(8) Adjusted to reflect the sale of 1,516,667 shares of Common Stock offered by
the Company at an assumed public offering price of $11.50 per share and the
application of the estimated net proceeds therefrom. See "Use of Proceeds."
---------------------
Unless otherwise indicated, all information in this Prospectus, including
financial information, share and per share data, (i) reflects a 3% stock
dividend, paid on May 23, 1994 to holders of record on May 6, 1994, and (ii)
assumes no exercise of the Underwriters' over-allotment option. Unless the
context otherwise requires, "Quest" or the "Company" refers to Quest Medical,
Inc. and its subsidiaries, including Neuromed, Inc.
4
<PAGE> 7
RISK FACTORS
In addition to the other information in this Prospectus, the following
factors should be considered carefully by potential investors in evaluating an
investment in the shares of Common Stock offered hereby.
PRODUCT DEVELOPMENT AND MARKET ACCEPTANCE
The Company's business strategy emphasizes the development and
commercialization of new products in niche markets and the enhancement of
existing products, particularly in the myocardial protection and interventional
pain management markets. There can be no assurance that the Company will be able
to continue to develop new products, enhance existing products, obtain required
regulatory approvals, manufacture these new products in a commercially viable
manner or gain satisfactory market acceptance for such products.
In particular, the Company's future growth depends in part on market
acceptance of the MPS system and family of related products and increased market
acceptance of the Company's spinal cord stimulation products. The Company has
committed substantial resources to the development of the MPS system and related
products. Delays in commencing shipment of the MPS system and related products,
or in developing complementary new products, could have an adverse effect on the
Company's growth prospects. There can be no assurance that such products, if
introduced, will gain market acceptance. The Company also recently acquired its
spinal cord stimulation device business. Although the Company believes that this
business will grow in the future, there can be no assurance that these products
will continue to gain increased market acceptance. See "Business -- Research and
Development" and "Business -- Competition."
INTEGRATION OF NEUROMED
The Company recently completed the acquisition of Neuromed. Successful
integration of an acquired company into existing operations can be difficult and
costly. Quest has begun to integrate into the Company certain of Neuromed's
operations, research and development, sales and marketing, and administrative
functions. The desired benefits of the Neuromed Acquisition will not be achieved
unless the separate operations of the Company and Neuromed are successfully
combined in an orderly and timely manner. The transition process will divert
substantial management attention from the Company's other operations and
activities. Any limitations or difficulties encountered in the transition
process could have a material adverse effect on the Company's business,
financial condition and results of operations. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Overview."
GOVERNMENT REGULATION; UNCERTAINTY OF OBTAINING REGULATORY CLEARANCE
The research and development, manufacture, sale and distribution of medical
devices is subject to extensive regulation by various public agencies,
principally the FDA and corresponding state, local and foreign agencies. The
regulatory process is lengthy, expensive and uncertain. Prior to commercial sale
in the United States, most medical devices must be cleared or approved by the
FDA. Current FDA enforcement policy strictly prohibits the promotion of medical
devices for uses other than those for which the product has been approved or
cleared. Product approvals and clearances can be withdrawn for failure to comply
with regulatory requirements or the occurrence of unforeseen problems following
initial marketing.
In August 1995, the Company filed an application for clearance of a
pre-market notification of its intent to market the MPS system and certain
related products under Section 510(k) of the Federal Food, Drug and Cosmetic Act
("510(k)"). Although the Company believes that the 510(k) procedure is the
appropriate basis upon which to seek FDA clearance or approval, there can be no
assurance that the FDA will accept this view and consider the Company's 510(k)
application. If it is not accepted under the 510(k) procedure, the Company will
have to pursue a pre-market approval ("PMA") for the MPS system. This process
would be far more costly and time consuming than 510(k) clearance. Even if
5
<PAGE> 8
the FDA considers the MPS system under the 510(k) procedure, there can be no
assurance that the FDA will approve the Company's application. See
"Business -- Government Regulation."
Significant unforeseen delays in the 510(k) review process or, if
necessary, the PMA approval process could occur as a result of the FDA's
determination that any required clinical data is insufficient to support the
safety and efficacy of these devices for their intended uses, the FDA's failure
to schedule advisory review panels, or changes in the FDA's review guidelines,
procedures, regulations or administrative interpretations. Delays in obtaining
regulatory clearances or approvals, or the failure to obtain required clearances
or approvals, in the United States or other countries, could adversely affect or
prevent the marketing of these products, limit the Company's ability to generate
revenues from these devices and give the Company's competitors a competitive
advantage. There can be no assurance that the Company will be able to obtain
necessary government approvals on a timely basis, if at all.
The Company also must adhere to applicable regulations governing good
manufacturing practices, including testing, control, manufacturing, labeling and
documentation requirements. If violations of the applicable regulations are
noted during inspections of the Company's manufacturing facilities by the FDA or
comparable agencies in other countries, the Company may be required or may elect
to cease manufacturing until the violation is corrected or to recall products
that were manufactured under improper conditions, either of which would have a
material adverse effect on the Company's continued marketing of its products and
on the Company's business, financial condition and results of operations.
In 1991, prior to its acquisition by the Company, Neuromed commenced
clinical trials of a fully implantable SCS device in the United States and
Europe. In late 1993, the FDA cancelled the Investigational Device Exemption
("IDE") relating to this product and rescinded Neuromed's export authority for
this product due to alleged violations by Neuromed, under its prior management,
of applicable rules and regulations, including good manufacturing practices. The
clinical trials were discontinued and the product was withdrawn from the market.
During this period, Neuromed also encountered regulatory difficulties in the
United Kingdom due to alleged noncompliance with applicable rules and
regulations. Quest is engaged in a process intended to restore good relations
with regulatory authorities in the United Kingdom. There can be no assurances
that the Company will not encounter similar difficulties in the future.
A portion of the Company's revenues are dependent upon sales of its
products outside the United States through independent distributors.
International regulatory bodies have established varying regulations governing
product standards, packaging requirements, labeling requirements, import
restrictions, tariff regulations, duties and tax requirements. The Company's
inability or failure to comply with these regulations or the imposition of new
regulations could restrict such distributors' ability to sell the Company's
products internationally and thereby adversely affect the Company's business,
financial condition and results of operations. See "Business -- Government
Regulation."
INTENSE COMPETITION, CONTINUAL TECHNOLOGICAL CHANGE AND NEW SURGICAL TECHNIQUES
The medical device market is highly competitive. The Company currently
competes with many companies in the development and marketing of cardiovascular
products, specialized intravenous fluid delivery tubing sets, pressure
monitoring kits and related medical devices. The Company expects to compete with
at least two major medical device companies in the myocardial protection market,
and competes directly with Medtronic, Inc., one of the largest medical device
manufacturers, in the SCS product market. Many of the Company's competitors have
access to greater capital, research and development, marketing, distribution and
other resources than the Company. Furthermore, the medical device market is
characterized by extensive research efforts and rapid product development and
technological change. The Company's present or future products could be rendered
obsolete and noncompetitive by technological advances by the Company's present
or future competitors. The Company's future success will depend upon its ability
to remain competitive with other developers of medical devices. See
"Business -- Competition."
6
<PAGE> 9
In addition, innovations in surgical techniques or medical practices could
have the effect of reducing or eliminating market demand for one or more of the
Company's products. For example, some cardiovascular surgeons and medical device
companies are developing techniques, procedures and devices for performing
coronary artery bypass surgery without stopping the heart, both through open-
heart surgery and minimally invasive procedures, thereby eliminating the need
for myocardial protection in these cases and potentially reducing the market for
Quest's MPS system. While these techniques, procedures and devices have not to
date attained widespread use, there can be no assurance that they will not gain
broader market acceptance. See "Business -- Competition."
DEPENDENCE ON PATENTS AND PROPRIETARY RIGHTS
The Company owns nineteen United States patents relating to products that
the Company currently sells or develops. One such patent will expire in February
1996 and one will expire in January 1997. In addition, the Company currently has
three United States patent applications pending, including applications relating
to the MPS system and related products. Successful litigation against the
Company regarding its patents or infringement by the Company of the patent
rights of others could have a material adverse effect on the Company's business,
financial condition and results of operations. In addition, there can be no
assurance that pending patent applications will result in issued patents, that
competitors will not challenge or circumvent patents issued to the Company, that
courts will not find the Company's patents invalid, or that the Company's
patents are sufficiently broad to protect the Company's technology or to provide
the Company with a competitive advantage. The Company also relies on trade
secrets and proprietary technology that it seeks to protect, in part, through
confidentiality agreements with employees, consultants and other parties. There
can be no assurance that these parties will not breach these agreements, that
the Company will have adequate remedies for any breach, or that the Company's
trade secrets will not otherwise become known to or independently developed by
competitors.
There has been substantial litigation regarding patent and other
intellectual property rights in the medical device industry. Although the
Company is not currently involved in such litigation, litigation may be
necessary in the future to enforce the Company's patent rights, to protect its
trade secrets or know-how, to defend the Company against claimed infringement of
the rights of others and to determine the scope and validity of the proprietary
rights of others. Any such litigation could result in substantial cost to, and
diversion of effort by, the Company. Adverse determinations in any such
litigation could subject the Company to significant liabilities to third
parties, require the Company to seek licenses from third parties and prevent the
Company from manufacturing, selling or using certain of its products, any of
which could have a material adverse effect on the Company's business, financial
condition and results of operations. See "Business -- Patents, Trademarks and
Proprietary Rights."
COST PRESSURES ON MEDICAL TECHNOLOGY; THIRD PARTY REIMBURSEMENT
The Company believes that the overall escalating cost of medical products
and services has led and will continue to lead to increased pressures on the
healthcare industry to reduce the cost of certain products and services,
including the Company's products. The Company's products are purchased by
hospitals and other users, which bill various third party payors, such as
governmental health programs, private insurance plans, managed care
organizations and other similar programs, for the healthcare products and
services provided to their patients. Third party payors are increasingly
challenging the prices charged for medical products and services and may deny
reimbursement if they determine that a device was not used in accordance with
cost-effective treatment methods as determined by the payor, was experimental or
was used for an unapproved application. Although Medicare, Medicaid and many
health maintenance organizations ("HMOs") generally reimburse for SCS devices
and procedures, especially after repeat back surgeries have failed to relieve
the chronic pain, certain payors refuse to reimburse for SCS devices and others,
including the Veterans Administration, restrict reimbursement. There can be no
assurance that third party payors will continue to reimburse for the Company's
7
<PAGE> 10
products or that their reimbursement levels will not adversely affect the
profitability of the Company's products. See "Business -- Third Party
Reimbursement and Cost Containment."
POTENTIAL PRODUCT LIABILITY AND RECALL; POSSIBLE INSURANCE LIMITATIONS
The testing, manufacturing, marketing and sale of medical devices entail
substantial risks of liability claims or product recalls. The Company's products
are used in cardiovascular applications, spinal cord implant procedures and
intensive care settings in which there is a high risk of serious injury and
death. As a result, the Company faces a risk of exposure to product liability
claims and product recalls if the use of its products or future products are
alleged to have resulted in injury. Such risks may exist with respect to
products that have received, or may receive, regulatory clearance for commercial
sale. In 1993, the FDA cancelled the IDE for a fully implantable SCS device, and
rescinded Neuromed's export authority for this product. See "-- Government
Regulation; Uncertainty of Obtaining Regulatory Clearance" and
"Business -- Government Regulation."
The Company is currently a party to certain product liability claims
relating to SCS devices sold by Neuromed prior to its acquisition by the Company
in March 1995, including one claim regarding the fully implantable SCS device.
Product liability insurers have assumed responsibility for defending the Company
against these claims, subject to reservation of rights in certain cases.
Although the Company is also entitled to contractual indemnification from
Neuromed's former owner with respect to any losses exceeding its product
liability insurance coverage, there can be no assurance that the Company will
not incur significant monetary liability to the claimants if such insurance or
indemnification is unavailable or inadequate for any reason or that the
Company's SCS business or new SCS product lines will not be adversely affected
by these product liability claims. See "Business -- Legal Proceedings."
While the Company seeks to maintain appropriate levels of product liability
insurance with coverage that the Company believes is comparable to that
maintained by companies similar in size and serving similar markets, there can
be no assurance that the Company will avoid significant future product liability
claims and attendant adverse publicity. Furthermore, there can be no assurance
that the Company's product liability insurance will be adequate or that such
insurance coverage will remain available at acceptable costs or at all. A
successful claim brought against the Company for which coverage is denied or in
excess of its insurance coverage could have a material adverse effect on the
Company's business, financial condition and results of operations. Additionally,
adverse product liability actions could adversely affect the Company's ability
to obtain and maintain regulatory clearance for its products or its ability to
attract and retain customers for its products.
DEPENDENCE ON DISTRIBUTOR SALES
Sales to distributors constitute a significant portion of the Company's
business. There can be no assurance that the Company will be able to maintain
its relationships with these distributors, or, in the event of termination of
any of these relationships, that a new distributor will be found. The loss of a
significant distributor could have a material adverse effect on the Company's
business, financial condition and results of operations if a new distributor or
other suitable sales organization in the relevant geographic market could not be
found on a timely basis or at all. See "Business -- Sales and Marketing."
RELIANCE ON MAJOR CUSTOMER
The Company has derived $3.4 million, $3.1 million, $2.7 million and $1.5
million, or 25%, 23%, 19% and 14%, of its net revenue for the years ended
December 31, 1992, 1993 and 1994 and the six months ended June 30, 1995,
respectively, from the University of Texas System Cancer Center (M.D. Anderson
Hospital). The loss of this customer could have a material adverse effect on the
Company's business, financial condition and results of operations. See
"Business -- Sales and Marketing."
8
<PAGE> 11
INTERRUPTION IN SOURCES OF SUPPLY
The Company currently purchases, and will continue to purchase, raw
materials and components for its products from outside vendors. Certain of the
components used in the Company's products are purchased from single sources.
Although the Company has qualified, or is in the process of investigating,
alternate sources of supply for key components, any significant interruption in
supply of these or other components could have a material adverse effect on the
Company's business, financial condition and results of operations. See
"Business -- Manufacturing."
POSSIBLE VOLATILITY OF SHARE PRICE
Market prices for securities of medical device companies are highly
volatile, and the trading price of the Company's Common Stock could be subject
to significant fluctuations in response to quarterly variations in operating
results, announcements of technological innovations by the Company or its
competitors, government regulation and other events or factors. In addition,
market prices of securities of medical device companies, including the Company,
have from time to time experienced extreme price and volume fluctuations which
may be unrelated to the operating performance of particular companies. These
broad market fluctuations could have a material adverse effect on the market
price of the Company's Common Stock.
DEPENDENCE ON KEY PERSONNEL
The Company's success is dependent in large part on the ability of the
Company to attract and retain key management, research and development, sales
and marketing and operational personnel. Competition for such personnel is
intense and the inability to attract and retain additional key personnel, or the
loss of one or more current key employees could have a material adverse effect
on the Company's business, financial condition and results of operations. In
particular, the Company's success will depend on its ability to retain the
services of its executive officers and senior management. In addition, the
Company will have an ongoing need to expand its management personnel and support
staff. None of the executive officers of the Company has an employment agreement
with the Company, and the Company does not maintain life insurance on such
persons. See "Management."
SHAREHOLDERS' RIGHTS PLAN; POTENTIAL ANTI-TAKEOVER EFFECT
The Company's Shareholders' Rights Plan contains provisions which may have
the effect of delaying, deferring or preventing a change in control of the
Company. The Shareholders' Rights Plan grants the holders of rights (other than
rights held by a holder of 20% or more of the Common Stock) the right to buy a
number of shares of Common Stock having a market value equal to two times the
applicable exercise price under certain circumstances, including a person's
acquisition of 20% or more of the outstanding Common Stock. See "Description of
Capital Stock -- Shareholders' Rights Plan."
9
<PAGE> 12
THE COMPANY
The Company was founded in 1979 by current President and Chief Executive
Officer, Thomas C. Thompson, and director John A. Gula. The Company completed an
initial public offering of its Common Stock in 1981 and introduced a line of
electronic intravenous pumps and associated disposables beginning in late 1983.
The Company sold the intravenous pump line in 1987 due to competitive structural
changes in the market. The Company retained a stable and profitable base
business of fluid delivery and other products following the sale and made the
strategic decision to expand into attractive markets in which the Company could
leverage off its base business, corporate infrastructure and core competencies
in medical device manufacturing, engineering and regulatory affairs. In 1991,
Quest acquired two companies that manufactured and marketed various
cardiovascular products, significantly enhancing the Company's presence in the
cardiovascular products marketplace. In 1992, Quest acquired the "ACTester"
product line, consisting of instrumentation and associated disposables used to
measure the activated clotting time of blood, and commenced the research and
development of the MPS system. In March 1995, the Company acquired Neuromed and
its SCS neurostimulation product line, and in August 1995, the Company filed a
510(k) with the FDA for its MPS system and related disposable products.
Quest is a Texas corporation. Its principal executive offices are located
at One Allentown Parkway, Allen, Texas 75002 and its telephone number is
(214) 390-9800.
USE OF PROCEEDS
Assuming an offering price of $11.50 per share (the last reported sale
price for the Common Stock on November 6, 1995 as reported on the Nasdaq
National Market), the net proceeds to the Company from the sale of the 1,516,667
shares of Common Stock to be sold by the Company in the Offering are estimated
to be $15.9 million ($20.1 million if the Underwriters' over-allotment option is
exercised in full), after deducting estimated underwriting discounts and
commissions and estimated offering expenses payable by the Company. The Company
intends to use the net proceeds from the Offering to repay $13.9 million of
senior term bank indebtedness currently outstanding, which was incurred in March
1995 in connection with the Neuromed Acquisition, and as much of its working
capital line of credit as possible ($4.6 million is currently outstanding). Any
excess net proceeds from the Offering will be used for general corporate
purposes. The Company will not receive any of the proceeds from the sale of
shares of Common Stock by the Selling Shareholders.
The senior term debt amortizes $1.95 million per year for the first and
second years, $3.25 million per year for the third and fourth years, and $2.6
million for the fifth year, with a $2.0 million balloon payment due at final
maturity in March 2000. The working capital line matures on May 31, 1997.
Principal installments and interest on the senior term debt and interest on the
working capital line are payable monthly. Currently, the loan bears interest at
prime plus 50 basis points or, at the Company's option, LIBOR plus 200 basis
points, and interest rates can be locked in at the Company's option for varying
periods of time. These interest rates can also be reduced based on the Company
achieving certain ratios of senior bank debt to earnings before interest, taxes,
depreciation and amortization. As of November 6, 1995, the rate of interest on
the senior term loan was 9.25% and the rate of interest on the working capital
indebtedness was 7.87%.
10
<PAGE> 13
PRICE RANGE OF COMMON STOCK
The Company's Common Stock is quoted on the Nasdaq National Market under
the symbol "QMED." On November 6, 1995, the last reported sale price for the
Company's Common Stock on the Nasdaq National Market was $11.50 per share. On
November 6, 1995 there were approximately 850 holders of record of the Company's
Common Stock. The following table sets forth the quarterly high and low closing
sales prices for the Company's Common Stock. These prices do not include
adjustments for retail mark-ups, mark-downs or commissions.
<TABLE>
<CAPTION>
HIGH LOW
------ ------
<S> <C> <C>
1993
First Quarter..................................................... $ 5.56 $ 3.63
Second Quarter.................................................... 4.84 3.63
Third Quarter..................................................... 4.47 3.41
Fourth Quarter.................................................... 5.44 3.75
1994
First Quarter..................................................... $ 4.72 $ 4.13
Second Quarter.................................................... 7.38 4.63
Third Quarter..................................................... 6.38 5.38
Fourth Quarter.................................................... 5.75 4.63
1995
First Quarter..................................................... $ 8.75 $ 4.88
Second Quarter.................................................... 12.50 7.13
Third Quarter..................................................... 14.50 11.75
Fourth Quarter (through November 6, 1995)......................... 12.00 10.63
</TABLE>
DIVIDEND POLICY
To date, the Company has not declared or paid any cash dividends on its
Common Stock, and the present policy of the Board of Directors is to retain any
earnings to provide for the Company's growth. Any future determination to pay
dividends will be at the discretion of the Board of Directors, and dependent
upon the Company's financial condition, results of operations, capital
requirements and such other factors as the Board of Directors deems relevant. In
addition, the Company's current credit arrangement with NationsBank of Texas,
N.A. ("NationsBank") currently limits the payment of dividends to 25% of net
income (as defined in the credit agreement). The Company intends to use the net
proceeds from the Offering to repay this indebtedness, and thus such
restrictions are expected to lapse upon such repayment. See "Use of Proceeds."
The Company has received a commitment letter from NationsBank that provides for
an amendment of the working capital line of credit and the addition of an
acquisition line of credit. Management expects to negotiate a dividend
limitation that would apply if the acquisition line of credit is utilized. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Liquidity and Capital Resources."
The Company has paid one stock dividend on its Common Stock. During April
1994, the Board of Directors approved a 3% stock dividend distributed on May 23,
1994 to shareholders of record as of May 6, 1994. In connection with the
dividend, the Company issued 152,829 shares of Common Stock from its treasury.
The Board of Directors on various occasions, beginning in October 1987 and
as recently as August 1993, approved stock repurchases of up to an aggregate of
3,150,000 shares, of which approximately 2,900,000 have been repurchased to
date. During the year ended December 31, 1994, the Company repurchased no shares
of Common Stock. On March 31, 1995, the Company issued 833,333 shares of Common
Stock from its treasury as partial consideration in the Neuromed Acquisition
and, concurrently with the closing of the Offering, will issue an additional
200,000 shares of Common Stock, which had been earned in July 1995 as additional
"earn-out" consideration. On November 6, 1995, the Company had 1,672,238 shares
in its treasury (after reserving for the issuance of such 200,000 shares) at a
cost of $3.6 million (including commissions). The Company does not anticipate
further repurchases during the foreseeable future.
11
<PAGE> 14
CAPITALIZATION
The following table sets forth at June 30, 1995: (i) the actual
capitalization of the Company on a historical basis; (ii) the capitalization of
the Company as adjusted to give effect to the issuance of 200,000 shares of
Common Stock earned in July 1995 as contingent "earn-out" consideration relating
to the Neuromed Acquisition; and (iii) the capitalization of the Company as
adjusted to give effect to the sale by the Company of 1,516,667 shares of Common
Stock in this Offering at an assumed public offering price of $11.50 per share
(after deducting estimated underwriting discounts and commissions and offering
expenses payable by the Company). This table should be read in conjunction with
the Quest Consolidated Financial Statements and related Notes thereto appearing
elsewhere in this Prospectus. See also "Use of Proceeds," "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
"Certain Transactions."
<TABLE>
<CAPTION>
JUNE 30, 1995
---------------------------------------
AS ADJUSTED
ACTUAL AS ADJUSTED FOR OFFERING
------- ----------- ------------
(IN THOUSANDS)
<S> <C> <C> <C>
Long-term debt, including current portion................. $ 22,892 $ 22,892 $ 6,944
-------- --------- ---------
Stockholders' equity:
Common stock of $.05 par value; authorized 10,000,000
shares; issued 8,072,994 shares(1)................... 404 404 404
Additional paid-in capital.............................. 24,443 26,568 39,233
Retained deficit(2)..................................... (7,819) (7,819) (8,109)
Unrealized loss on marketable securities................ (474) (474) (474)
Cost of common shares in treasury; 1,872,238 shares
actual, 1,672,238 shares as adjusted and 155,571
shares as adjusted for Offering...................... (4,054) (3,621) (337)
-------- --------- ---------
Total stockholders' equity................................ 12,500 15,058 30,717
-------- --------- ---------
Total capitalization...................................... $ 35,392 $ 37,950 $ 37,661
======== ========= =========
</TABLE>
- ---------------
(1) Does not include 1,168,548 shares of Common Stock issuable upon the
exercise of outstanding stock options as of November 6, 1995.
(2) Reflects write-off of $290,000 (net of tax effect) of capitalized debt
issuance costs associated with the Neuromed Acquisition due to the
repayment of bank debt from Offering proceeds.
12
<PAGE> 15
SELECTED CONSOLIDATED FINANCIAL DATA
The selected consolidated statement of operations and balance sheet data
for the five years ended December 31, 1990, 1991, 1992, 1993 and 1994 are
derived from the Company's audited consolidated financial statements. The
selected consolidated statement of operations and balance sheet data set forth
below for the six month periods ended June 30, 1994 and 1995 are derived from
the unaudited consolidated financial statements of the Company and, in the
opinion of management, reflect all adjustments necessary for a fair presentation
of its results of operations and financial condition. All such adjustments are
of a normal recurring nature. The results of operations for an interim period
are not necessarily indicative of results that may be expected for a full year
or any other interim period. This selected financial data should be read in
conjunction with "Management's Discussion and Analysis of Financial Condition
and Results of Operations" and the Consolidated Financial Statements and related
Notes thereto included elsewhere in this Prospectus.
<TABLE>
<CAPTION>
SIX MONTHS ENDED
YEARS ENDED DECEMBER 31, JUNE 30,
------------------------------------------------------- --------------------
1990 1991 1992 1993 1994 1994 1995(1)
------- ------- ------- ------- ------- ------- --------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Net revenue............................. $ 6,209 $10,711 $13,612 $13,643 $13,999 $ 7,223 $ 11,303
Gross profit............................ 2,754 4,827 6,553 6,591 6,381 3,196 6,393
Research and development expense........ 196 668 1,387 1,910 3,542 1,539 2,494
Non-recurring charges(2)................ -- -- 1,247 -- -- -- 10,500
Marketing, general and administrative
expense............................... 2,423 3,145 4,141 4,400 4,977 2,375 3,511
Earnings (loss) from operations,
excluding non-recurring charges....... 136 1,014 1,025 281 (2,138) (719) 388
Earnings (loss) from operations......... 136 1,014 (222) 281 (2,138) (719) (10,112)
Other income (expense), net............. 1,397 326 473 667 419 178 (501)
Earnings (loss) from continuing
operations before income taxes and
cumulative effect of change in
accounting principle.................. 1,533 1,341 251 948 (1,719) (540) (10,613)
Net earnings (loss)..................... 1,456 1,147 194 816 (1,719) (540) (10,613)
Net earnings (loss) per share........... $ 0.26(3) $ 0.21 $ 0.03 $ 0.15(4) $ (0.33) $ (0.10) $ (1.85)
Weighted average common and common
equivalent shares outstanding......... 5,668 5,355 5,594 5,559 5,257 5,240 5,739
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31, JUNE 30,
------------------------------------------------------- --------------------
1990 1991 1992 1993 1994 1994 1995(1)
------- ------- ------- ------- ------- ------- --------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Cash, cash equivalents and marketable
securities............................ $10,364 $ 6,888 $ 6,693 $ 6,594 $ 5,262 $ 7,565 $ 4,707
Working capital......................... 12,656 10,415 10,847 9,566 7,411 8,945 10,812
Total assets............................ 16,803 19,958 20,448 26,739 24,235 26,598 41,652
Long-term debt, excluding current
maturities............................ -- 727 242 4,101 4,124 4,141 20,830
Stockholders' equity.................... 16,248 17,046 17,639 18,252 15,931 17,619 12,500
</TABLE>
- ---------------
(1) Includes results of Neuromed from April 1, 1995.
(2) Non-recurring charge in 1992 relates to the write-off of assets of a
discontinued business, and for the six months ended June 30, 1995, relates
to purchased in-process research and development incurred in connection with
the Neuromed Acquisition. See Note 2 of the Notes to the Quest Consolidated
Financial Statements.
(3) Includes a decrease in net income of $0.01 per share attributable to a loss
from discontinued operations.
(4) Includes an increase in net income of $0.03 per share relating to the
cumulative effect of a change in accounting principle. See Note 1(m) of the
Notes to the Quest Consolidated Financial Statements.
13
<PAGE> 16
SELECTED PRO FORMA FINANCIAL DATA
The following unaudited pro forma condensed consolidated statements of
operations for the year ended December 31, 1994 and for the six months ended
June 30, 1995 reflect the historical accounts of the Company for those periods,
adjusted to give pro forma effect to the Neuromed Acquisition as if it had
occurred on January 1, 1994. The pro forma condensed consolidated statement of
operations for the year ended December 31, 1994 combines the statement of
operations of the Company for the twelve months ended December 31, 1994 and the
statement of operations of Neuromed for the twelve months ended October 31,
1994. The pro forma condensed consolidated statement of operations for the six
months ended June 30, 1995 combines the statement of operations of the Company
for the six months ended June 30, 1995 (which includes three months of Neuromed
operations since the March 31, 1995 acquisition) and the statement of operations
of Neuromed for the three months ended January 31, 1995.
The pro forma condensed consolidated statements of operations and
accompanying notes should be read in conjunction with the Consolidated Financial
Statements of the Company and Neuromed and the related Notes thereto included
elsewhere in this Prospectus. Management believes the assumptions used in the
following statements provide a reasonable basis on which to present the pro
forma financial data. The pro forma financial data is provided for informational
purposes only and should not be construed to be indicative of the Company's
financial condition or results of operations had the transactions and events
described above been consummated on the date assumed and are not intended to
project the Company's financial condition or results of operations to any future
date or for any future period.
PRO FORMA CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
YEAR ENDED DECEMBER 31, 1994
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
<TABLE>
<CAPTION>
QUEST NEUROMED
MEDICAL, NEUROMED, ACQUISITION
INC. INC. ADJUSTMENTS PRO FORMA(1)
------------ --------- ----------- ------------
<S> <C> <C> <C> <C>
Net revenue.................................... $ 13,999 $ 8,044 $ -- $ 22,043
Cost of revenue................................ 7,618 1,932 146 (2) 9,868
(29)(3)
(27)(4)
228 (5)
-------- ------- ------- --------
Gross profit................................. 6,381 6,112 (318) 12,175
Research and development expense............... 3,542 1,713 (185)(4) 4,402
(668)(6)
Marketing, general and administrative
expense...................................... 4,977 3,417 729 (7) 7,859
(1,212)(4)
(52)(6)
-------- ------- ------- --------
Operating expenses........................... 8,519 5,130 (1,388) 12,261
-------- ------- ------- --------
Earnings (loss) from operations................ (2,138) 982 1,070 (86)
Other income (expense), net.................... 419 (18) (1,471)(8) (1,070)
-------- ------- ------- --------
Earnings (loss) before income taxes and
cumulative effect of change in accounting
principle.................................... (1,719) 964 (401) (1,156)
Income taxes................................... -- 384 (320)(9) 64
-------- ------- ------- --------
Net earnings (loss) before cumulative effect of
change in accounting principle............... $ (1,719) $ 580 $ (81) $ (1,220)
======== ======= ======= ========
Net earnings (loss) per share before cumulative
effect of change in accounting principle..... $ (0.33) $ (0.20)
======== ========
Weighted average common shares outstanding..... 5,257 833 6,090
======== ======= ========
</TABLE>
14
<PAGE> 17
PRO FORMA CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
SIX MONTHS ENDED JUNE 30, 1995
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
<TABLE>
<CAPTION>
QUEST NEUROMED
MEDICAL, NEUROMED ACQUISITION
INC. INC. ADJUSTMENTS PRO FORMA(1)
------------ --------- ----------- ------------
<S> <C> <C> <C> <C>
Net revenue....................................... $ 11,303 $ 2,407 $ -- $ 13,710
Cost of revenue................................... 4,910 577 48(2) 5,334
(7)(3)
(194)(5)
-------- ------- -------- --------
Gross profit.................................... 6,393 1,830 153 8,376
Research and development expense.................. 2,494 296 (61)(6) 2,729
Non-recurring charge.............................. 10,500 (10,500)(1) --
Marketing, general and administrative expense..... 3,511 1,054 182(7) 4,232
(515)(4)
-------- ------- -------- --------
Operating expenses.............................. 16,505 1,350 (10,894) 6,961
-------- ------- -------- --------
Earnings (loss) from operations................... (10,112) 480 11,047 1,415
Other income (expense), net....................... (501) 40 (280)(8) (741)
-------- ------- -------- --------
Earnings (loss) before income taxes and cumulative
effect of change in accounting principle........ (10,613) 520 10,767 674
Income taxes...................................... -- 207 22(9) 229
-------- ------- -------- --------
Net earnings (loss) before cumulative effect of
change in accounting principle.................. $(10,613) $ 313 $ 10,745 $ 445
======== ======= ======== ========
Net earnings (loss) per share before cumulative
effect of change in accounting principle........ $ (1.85) $ 0.07
======== ========
Weighted average common and common equivalent
shares outstanding.............................. 5,739 1,034 6,773
======== ======== ========
</TABLE>
- ---------------
(1) The pro forma condensed consolidated statements of operations exclude a
non-recurring charge of $10.5 million related to purchased in-process
research and development incurred in connection with the Neuromed
Acquisition.
(2) To adjust insurance expense resulting from increased product liability
coverage on Neuromed products.
(3) To adjust depreciation expense related to leasehold improvements of
Neuromed's facility which were revalued at acquisition.
(4) Elimination of salary, benefit, and travel and entertainment expense for two
ex-officers of Neuromed, Mr. William Borkan (the former principal owner of
Neuromed) and Mr. Burt Borkan, who were not retained as employees, and
elimination of deferred compensation and royalty expense under agreements
between Mr. William Borkan and Neuromed, which have been terminated.
(5) To record write-off in 1994 of manufacturing profits capitalized in
inventory at acquisition of Neuromed and, for 1995, reversal of write-off
included in the Company's historical results.
(6) Elimination of expenses pursuant to agreements obligating Neuromed to pay
certain research and development expenses for affiliated companies, which
have been terminated.
(7) To record amortization expense for Neuromed intangible assets which are
being amortized over estimated useful lives of 15 to 20 years computed on a
straight line basis ($545,000 in 1994 and $136,000 in 1995) and adjust
compensation expense resulting from a change in compensation program for key
Neuromed employees.
(8) To record interest expense and amortization expense (for capitalized debt
issuance costs) on debt incurred to consummate the Neuromed Acquisition. The
average interest rate was 9.5% (LIBOR plus 300 basis points).
(9) To adjust income tax expense for the change in taxable income from the
combination of Quest and Neuromed.
15
<PAGE> 18
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion of the financial condition and results of
operations of the Company should be read in conjunction with the Consolidated
Financial Statements of the Company and the related Notes thereto included
elsewhere in this Prospectus.
OVERVIEW
The Company designs, develops, manufactures and markets a variety of
healthcare products used primarily in cardiovascular surgery, interventional
pain management and intravenous fluid delivery applications. The Company
operates several stable and profitable product lines, including cardiovascular
products (such as pressure control valves, filters and surgical retracting
tapes), specialized intravenous fluid delivery tubing sets and accessories, and
pressure monitoring kits used primarily in labor and delivery.
On March 31, 1995, the Company acquired all of the issued and outstanding
capital stock of Neuromed, which was held by Mr. William Borkan and his brother,
Mr. Burt Borkan. The Neuromed Acquisition has been accounted for as a purchase.
The Company paid the Borkans $15.4 million in cash ($200,000 of which was paid
in June 1995 as a purchase price adjustment) and issued them 833,333 shares of
Common Stock valued at $6.5 million. The Company also incurred $927,000 in
acquisition and financing costs. Depending on Neuromed's attainment of certain
sales objectives, the Company also agreed to pay the Borkans contingent
"earn-out" consideration in January 1996 and January 1997, payable in a
combination of cash and Common Stock. In June 1995, Mr. William Borkan was
elected to the Company's Board of Directors.
In September 1995, the Company and Mr. William Borkan amended certain terms
of the Neuromed acquisition agreement. Under the amendment, (i) the Company
agreed to issue Mr. Borkan 200,000 additional shares of Common Stock
concurrently with the closing of the Offering and pay Mr. Borkan $1.5 million in
cash in January 1996 to satisfy the 1996 contingent payment obligation, which
had been earned in July 1995, (ii) the Company agreed to include all of the
Borkans' Common Stock (1,033,333 shares) in this Offering, (iii) Mr. Borkan
resigned from the Company's Board of Directors and relinquished his board
representation and attendance rights, (iv) Mr. Borkan relinquished his
registration rights, and (v) in the event the 1997 contingent earn-out payment
is fully earned, the Company agreed to pay Mr. Borkan an amount in cash equal to
$1.5 million plus the value of 200,000 shares of Common Stock at the net
Offering price. See "Certain Transactions."
In connection with the Neuromed Acquisition, the Company entered into the
First Amended and Restated Credit Agreement dated March 31, 1995, with
NationsBank (the "Loan Agreement"), which provided for $15.0 million in senior
term financing and a $5.0 million working capital line of credit. The senior
term debt was utilized to pay most of the cash portion of the Neuromed purchase
price. The Company has also drawn down $4.5 million on the working capital line
of credit. This bank debt is collateralized 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 $2.0 million. NationsBank's lien also excludes the Company's real
property, building and certain equipment in Allen, Texas, which collateralize
financing provided in 1993 by MetLife Capital Corporation. The Company intends
to use the net proceeds it receives from the Offering to repay the senior term
debt ($13.9 million of which is currently outstanding) and as much of its
working capital indebtedness as possible ($4.6 million of which is currently
outstanding). See "Use of Proceeds." The Company has received a commitment
letter from NationsBank that provides for the amendment of the working capital
line of credit and the addition of an acquisition line of credit if the Offering
is consummated and the proceeds are applied to repay the indebtedness under the
existing facility. See "-- Liquidity and Capital Resources."
16
<PAGE> 19
RESULTS OF OPERATIONS
COMPARISON OF THE SIX MONTHS ENDED JUNE 30, 1995 AND 1994
Revenues. Net revenue of $11.3 million for the six months ended June 30,
1995 was $4.1 million, or 56.5% above the level for the comparable 1994 period
of $7.2 million. This increase in net revenue during the first half of 1995
compared to the first half of 1994 was primarily attributable to revenue
generated by Neuromed, which was acquired on March 31, 1995. See "-- Overview"
and "Selected Pro Forma Financial Data." Net revenue from sales of the Company's
other products increased 8% during the six months ended June 30, 1995 compared
to the same period a year ago, primarily due to higher unit sales volume from
the Company's cardiovascular products. Management expects net revenue for the
remaining two quarters of 1995 to increase over the comparable periods during
1994 as a result of the inclusion of the Neuromed revenues in the Company's
financial statements.
Gross Profit. Gross profit of $6.4 million for the six months ended June
30, 1995 was $3.2 million, or 100%, above the level for the comparable 1994
period. As a percentage of net revenue, gross profit increased during the first
half of 1995 to 56.6% as compared to 44.2% for the comparable 1994 period. This
increase in gross profit margin during the six months ended June 30, 1995
compared to the comparable period during 1994 was primarily attributable to the
revenue generated by Neuromed, since Neuromed's products contribute higher gross
profit margins than the Company's other product lines. Consequently, management
expects the Company's overall gross profit margin for the remaining two quarters
of 1995 to increase compared to the comparable 1994 periods.
Operating Expenses. Research and development expense as a percentage of net
revenue increased from 21.3% during the six months ended June 30, 1994, to 22.1%
for the same period in 1995, and the dollar amount increased by $955,000. During
the first half of 1995, the Company continued development efforts on its MPS
system and related products. During the second quarter of 1995, the Company
assembled pre-production MPS units necessary for the validation testing needed
for the 510(k) filing with the FDA. Validation testing was completed and, as
previously noted, the Company filed the 510(k) with the FDA during August 1995.
There can be no assurance that FDA clearance will be obtained or that it will be
obtained without delay. Of the increase in research and development expense for
the six months ended June 30, 1995, $182,000 was research and development
expense attributable to Neuromed's products. The remainder of the increase
during the first half of 1995 compared to the first half of 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 1995 to decrease from the first
half of 1995's level of $2.5 million because of substantial completion of the
development of the MPS system.
Marketing, general and administrative expenses as a percent of net revenues
decreased to 31.1% for the six months ended June 30, 1995, compared to 32.9% for
the comparable period of 1994, and the dollar amount increased $1.1 million.
Marketing expense as a percentage of net revenue increased to 14.1% for the six
months ended June 30, 1995, compared to 12.3% for the same period during 1994,
and the dollar amount increased by $703,000. Of such increase, $439,000 was
Neuromed marketing expense. The remainder of the increase in marketing expense
was primarily the result of additional salary and benefit expense from personnel
additions, and increased travel, commission and convention expense. In
anticipation of 510(k) clearance, management anticipates hiring four additional
direct salespersons during the second half of 1995, and upon 510(k) clearance,
management expects to add five additional salespersons to market the MPS system
and related products. For the six months ended June 30, 1995, general and
administrative expense increased $433,000 compared to the same period in 1994,
but as a percentage of net revenues, decreased from 20.6% during the first half
of 1994 to 17.0% during the comparable 1995 period. This increase in expense for
the six month period of 1995 compared to 1994 was primarily attributable to
general and administrative expense of Neuromed, including amortization expense
of Neuromed intangibles.
17
<PAGE> 20
Loss from Operations. On March 31, 1995, the Company acquired all of the
capital stock of Neuromed in exchange for $15.4 million cash (excluding $927,000
of related acquisition and financing costs) and 833,333 shares of Common Stock
valued at $6.5 million (plus additional contingent "earn-out" consideration).
See "-- Overview" and "Certain Transactions." Of the cash payment referred to
above, $200,000 was made during June 1995 as a result of a purchase price
adjustment. Of the aggregate purchase price, $10.5 million was identified as
purchased in-process research and development and in accordance with generally
accepted accounting principles was charged to expense as a non-recurring charge,
with no related tax benefit, during the six months ended June 30, 1995. See Note
2 of the Notes to Consolidated Financial Statements. As a result, the loss from
operations increased from $719,000 for the six months ended June 30, 1994, to
$10.1 million for the comparable period during 1995. Excluding this charge, the
Company generated earnings from operations of $388,000 for the six months ended
June 30, 1995 compared to a $719,000 loss for the comparable 1994 period,
reflecting the positive impact of the Neuromed Acquisition. Based on Neuromed's
recent and historical results of operations, management believes that the
Neuromed Acquisition will continue to have a favorable impact on earnings from
operations for the remainder of 1995 as compared to the comparable period during
1994, although there can be no assurances to this effect.
Other Income (Expense). Other income decreased to an expense of $501,000
during the six months ended June 30, 1995 compared to income of $178,000 during
the comparable 1994 period. This decrease was primarily the result of increased
interest expense. The Company incurred $15.0 million of long-term bank debt on
March 31, 1995, which was used to fund most of the cash payment of the Neuromed
Acquisition. See "-- Overview" and Notes 2 and 3 of the Notes to Consolidated
Financial Statements. Higher overall interest rates on borrowed money also
contributed to higher interest expense during the first half of 1995 as compared
to the first half of 1994. In addition, interest income in the first half of
1995 was lower than in the comparable period of 1994 due to reduced funds
available for investment and lower gains recognized on the sale of the Company's
investments. The Company anticipates that it will use the net proceeds from the
Offering to repay the senior term bank debt ($14.0 million outstanding at
September 26, 1995) and as much of working capital indebtedness ($4.5 million
outstanding at September 26, 1995) as is possible. See "Use of Proceeds."
Net Loss. The net loss increased from $540,000 for the six months ended
June 30, 1994 to $10.6 million during the same period in 1995 as a result of the
aforementioned non-recurring charge for purchased in-process research and
development of $10.5 million incurred in connection with the Neuromed
Acquisition. Excluding this charge, the net loss for the six months ended June
30, 1995 was $113,000.
YEARS ENDED DECEMBER 31, 1994 AND 1993
Revenues. Net revenue of $14.0 million for the year ended December 31,
1994, increased 2.6% from $13.6 million for the comparable 1993 period. Three of
the Company's product lines, however, contributed better results than the
overall 2.6% year over year increase. Net revenue of the Company's
cardiovascular products increased $604,000, or 11.5%, due to higher unit sales
volume from the Company's family of pressure control valves. Net revenue
generated by the Company's pressure monitoring kits increased $160,000, or
11.7%, due to higher unit sales volume. Net revenue generated by the Company's
nasogastric feeding tubes increased $108,000, or 48.2%. Of this increase,
$74,000 was due to higher unit sales volume with the remainder due to a price
increase. Net revenue generated by the Company's specialized tubing sets,
however, decreased by $518,500, or 7.7%, reflecting lower unit sales volume
largely attributable to a reduction in sales of specialized tubing sets used in
oncology to the Company's largest customer, the University of Texas System
Cancer Center (M.D. Anderson Hospital), due to lower hospital census.
Gross Profit. Gross profit during 1994 decreased to $6.4 million compared
to $6.6 million in 1993, a reduction of $210,000. As a percentage of net
revenue, gross profit decreased to 45.6% in 1994 compared to 48.3% during 1993.
The decrease in gross profit during 1994 compared to 1993 resulted primarily
from
18
<PAGE> 21
the lower net revenue generated by the Company's specialized tubing sets. Lower
sales volume of this product line led not only to a reduction in actual gross
profit dollars from this product line, but also to a reduction in gross profit
margins for this product line, since manufacturing volumes were reduced, thus
resulting in higher overhead costs per unit.
Operating Expenses. Research and development expense increased to $3.5
million during 1994 compared to the 1993 level of $1.9 million, and as a
percentage of net revenue increased from 14.0% to 25.3%. During 1994, the
Company continued development efforts on its MPS system and related products.
See "Business -- Research and Development." During June 1994, the Company
completed assembly of five MPS prototypes. In September 1994, the Company
determined that more time was needed to redesign the MPS prototypes into
pre-production units and delayed the anticipated December 1994 510(k) filing
with the FDA. The redesign was completed during December 1994. Increases in
research and development expense during 1994 compared to 1993 were primarily the
result of additional salary and contract labor expense from personnel additions,
increased prototype tooling, test material, consulting, and toxicology test
expenses. The Company also hired fourteen additional research and development
personnel during 1994.
Marketing, general and administrative expense as a percent of net revenues
increased to 35.6% for 1994 compared to 32.2% for 1993, and the dollar amount
increased $577,000. Marketing expense remained relatively unchanged during 1994
as compared to 1993 and as a percentage of revenue, decreased from 14.1% during
1993 to 13.7% during 1994. General and administrative expense increased
$582,000, or 23.4%, during 1994 as compared to 1993, and as a percentage of net
revenue, increased from 18.2% during 1993 to 21.9% for 1994. This increase
during 1994 compared to 1993 was primarily the result of higher recruiting and
relocation expense, depreciation and amortization expense, health insurance
expense, employee relations expense and expenses related to a proposed
acquisition that was not consummated.
Earnings (Loss) from Operations. Earnings from operations decreased from
earnings of $281,000 during 1993 to a loss of $2.1 million in 1994 as a result
of the aforementioned increases in research and development and general and
administrative expenses and the decrease in gross profit.
Other Income (Expense). Other income decreased to $419,000 during 1994
compared to other income of $667,000 for the prior year. This decrease resulted
from an increase in interest expense. Interest expense increased during 1994 as
compared to 1993 by $488,000 primarily due to two pieces of debt which were in
place for all of 1994 but only in place during the fourth quarter of 1993.
During December 1993, the Company consummated a financing with MetLife Capital
Corporation which provided $4.4 million of long term financing for the Company's
new corporate headquarters constructed during 1993. In addition, the Company
increased borrowings against its working capital line of credit with NationsBank
during 1994.
No income tax benefit was recognized for the Company's 1994 net operating
loss. Income tax expense during 1993 was $301,000.
Net Earnings (Loss). Net earnings decreased from net earnings of $816,000
during 1993 to a net loss of $1.7 million in 1994 primarily as a result of the
decrease in earnings from operations (caused by lower gross profit and higher
general and administrative and research and development expenses) and the
decrease in other income discussed above. During May 1993, the Financial
Accounting Standards Board issued Statement of Financial Accounting Standards
No. 115, "Accounting for Certain Investments in Debt and Equity Securities." The
Company, as permitted under the Statement, elected to adopt the provisions of
the new standard at the end of fiscal 1993. The cumulative effect as of December
31, 1993 of adopting Statement No. 115 was to increase net income by $169,000,
resulting from the reversal of unrealized losses recorded during 1993. The
ending balance of stockholders' equity was decreased by $169,000 to reflect the
net unrealized holding loss on securities classified as available-for-sale
previously carried at the lower of cost or market.
19
<PAGE> 22
YEARS ENDED DECEMBER 31, 1993 AND 1992
Revenues. Net revenue of $13.6 million for 1993, was approximately the same
as net revenue for 1992. This flat net revenue comparison reflected the then
current weakness in the medical device industry. In the wake of the Clinton
Administration's initiatives on healthcare reform, many of the Company's
customers engaged in cost-cutting during the year and reduced inventories of
medical devices and disposables during 1993, causing what management believed to
be a transient reduction in demand. The Company believes that this weakness in
product demand and the reduction in inventory levels reflected the general
uncertainty in the hospital and health care industry prompted by proposed
federal legislation and the general pressure to reduce healthcare costs. Net
revenue generated by the Company's specialized tubing sets decreased by
$342,000, or 4.8%, during 1993 as compared to 1992, reflecting decreased unit
sales volume. A substantial portion of this decrease resulted from a reduction
in sales of specialized tubing sets used in oncology to the Company's largest
customer, the University of Texas System Cancer Center (M.D. Anderson Hospital).
Net revenue generated by the Company's pressure monitoring kits decreased
$175,000, or 11.4%, during 1993 as compared to 1992 from reduced unit sales
volume of transducers (pressure sensors).
Net revenue generated by the Company's cardiovascular products, however,
increased $593,000, or 12.7%, during 1993 as compared to 1992, as a result of
three factors. First, $273,000 of the increase resulted from twelve months of
sales during 1993 from the ACTester product line while the 1992 period included
revenue only from the acquisition date of June 23, 1992 (six months). Second,
$112,000 of the increase resulted from the Company's introduction of a new
disposable product, Retroguard, during the second quarter of 1993. Finally, the
remainder of the increase resulted from a price increase on certain of the
Company's cardiovascular products.
Gross Profit. Gross profit of $6.6 million for 1993 was approximately the
same as gross profit for 1992. As a percentage of net revenue, gross profit
increased to 48.3% in 1993 from 48.1% during 1992. Lower sales volume in the
Company's specialized tubing sets during 1993 as compared to 1992 led not only
to a reduction in actual gross profit dollars from this product line, but also a
reduction in gross profit margin for this product line since manufacturing
volumes were reduced during 1993, resulting in higher overhead costs per unit.
However, higher net revenue in the Company's cardiovascular products, which
typically generate somewhat higher gross profit margins than most of the
Company's other products, more than offset the shortfall in actual gross profit
dollars of the specialized tubing sets. Gross profit margin in the
cardiovascular product line increased during 1993 as compared to 1992, primarily
as a result of a price increase.
Operating Expenses. Research and development expense increased to $1.9
million during 1993 compared to the 1992 level of $1.4 million, and as a
percentage of net revenue, increased from 10.2% to 14.0%. During 1992, the
Company commenced, and during 1993, continued development efforts on its MPS
brand of myocardial protection system and family of related disposable products.
Increases in expense during 1993 as compared to 1992 were primarily related to
additional salary and contract labor expense from personnel additions, increased
consulting and prototype tooling expense.
Marketing, general and administrative expense as a percent of net revenues
increased to 32.2% for 1993 compared to 30.4% for 1992, and the dollar amount
increased $258,000. Marketing expense increased $270,000, or 16.4%, during 1993
as compared to 1992, and as a percentage of net revenue, increased from 12.1%
during 1992 to 14.1% for 1993. This increase resulted primarily from increased
travel expense, samples expense, and advertising and promotional expense to
support the Company's sales efforts for its perfusion and other cardiovascular
product lines. General and administrative expense remained relatively unchanged
during 1993 as compared to 1992.
Earnings (Loss) from Operations. Earnings from operations increased from a
loss of $222,000 during 1992 to earnings of $281,000 for 1993. Results for the
1992 period included a non-recurring charge of $1.2 million to write-off the
assets of a discontinued business. Excluding this charge, earnings from
operations decreased from $1.0 million during 1992 to $281,000 during 1993 as a
result of the increase in marketing and research and development expense
discussed above.
20
<PAGE> 23
Other Income (Expense). Other income increased to $667,000 during 1993 as
compared to other income of $473,000 for the prior year. During 1993, the
Company recorded an expense of $174,000 related to the move to its new corporate
headquarters in Allen, Texas. This expense was largely comprised of moving costs
(including employee relocation costs) and the cancellation of two facility
leases. The Company also recorded an expense of $169,000 to reduce the value of
its investment portfolio to market value. Results for 1993 include a gain on
sale of marketable securities of $462,000, an increase of $325,000 from 1992.
These gains were generated by the sale of substantially all of the Company's
municipal bond portfolio and other interest rate sensitive investments which had
appreciated in value due to falling interest rates. The Company's decision to
significantly expand its research and development efforts reduced its need for
tax-free investment income.
Income tax expense increased $243,000 in 1993 compared to 1992 primarily as
a result of the increase in earnings.
Net Earnings. Net earnings increased from $194,000 during 1992 to $816,000
during 1993 primarily as a result of the aforementioned non-recurring charge
during 1992 of $1.2 million for the write-off of a discontinued business. Net
earnings for 1993 benefited by the cumulative effect of a change in accounting
principle of $169,000 discussed above.
QUARTERLY OPERATING DATA
The following table sets forth certain unaudited operating data for the
four quarters in 1993 and 1994 and the first and second quarters of 1995. In the
opinion of management, the data includes all adjustments, consisting of only
normal recurring adjustments, necessary to present fairly the information set
forth therein when read in conjunction with the Company's Consolidated Financial
Statements and the Notes thereto. The operating results for any quarter are not
necessarily indicative of results for any future periods.
<TABLE>
<CAPTION>
1993 1994 1995
---------------------------------------- ---------------------------------- -------------------
FIRST SECOND THIRD FOURTH FIRST SECOND THIRD FOURTH FIRST SECOND
QUARTER QUARTER(1) QUARTER QUARTER(2) QUARTER QUARTER QUARTER QUARTER QUARTER QUARTER(3)
------- ---------- ------- ---------- ------- ------- ------- ------- ------- ----------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Net revenue.................... $3,302 $3,447 $3,637 $3,257 $3,481 $3,742 $3,458 $3,318 $4,072 $ 7,231
Gross profit................... 1,569 1,714 1,759 1,549 1,470 1,726 1,629 1,556 2,044 4,348
Research and development
expense....................... 322 376 540 672 638 901 870 1,133 1,086 1,408
Marketing, general and
administrative expense........ 1,081 1,108 1,049 1,162 1,136 1,240 1,270 1,331 1,295 2,217
Earnings (loss) from
operations.................... 166 230 170 (285) (304) (415) (511) (908) (337) (9,775)(4)
Earnings (loss) before income
taxes and cumulative effect of
change in accounting
principle..................... 308 884 300 (544) (183) (357) (489) (690) (365) (10,249)(4)
Earnings (loss) before
cumulative effect of change in
accounting principle.......... 221 635 203 (412) (183) (357) (489) (690) (365) (10,249)(4)
Cumulative effect of change in
accounting principle.......... -- -- -- 169 -- -- -- -- -- --
Net earnings (loss)............ 221 635 203 (243) (183) (357) (489) (690) (365) (10,249)(4)
Net earnings (loss) per
share......................... $ 0.04 $ 0.11 $ 0.04 $ (.04)(5)$(0.04) $(0.07) $(0.09) $(0.13) $(0.07) $ (1.66)(4)
Weighted average common and
common equivalent shares
outstanding................... 5,638 5,595 5,525 5,399 5,236 5,245 5,269 5,277 5,302 6,175
</TABLE>
- ---------------
(1) Includes a pre-tax gain of $524,200 relating to a litigation settlement.
(2) Includes a pre-tax expense of $239,358 relating to a litigation settlement.
(3) Reflects results of Neuromed from April 1, 1995.
(4) Includes non-recurring charge of purchased in-process research and
development incurred in connection with the Neuromed Acquisition in the
amount of $10.5 million or $(1.70) per share.
(5) Includes an increase in net income of $0.03 per share relating to the
cumulative effect of a change in accounting principle.
The level and timing of research and development expenditures for the MPS
system and related products has had a significant effect on the quarterly
results of operations during the past several years.
21
<PAGE> 24
In addition, although the Company's base business (prior to the Neuromed
Acquisition) has been stable on an annual revenue basis for the past few years,
the Company experiences quarterly revenue fluctuations which affect results.
Management currently anticipates results for the remainder of 1995 will compare
favorably to the corresponding periods during 1994 as a result of the Neuromed
Acquisition and a decrease in the level of research and development expenditures
for the second half of 1995 compared to the first half due to the substantial
completion of, and filing of the 510(k) for, the MPS system.
Results of operations on a quarterly basis in the future will continue to
depend upon numerous factors including: (i) base business fluctuations; (ii)
market acceptance of new products; (iii) timing of regulatory approvals; (iv)
marketing expenditures for new product introductions; (v) the Company's ability
to manufacture its products efficiently; (vi) timing of research and development
expenditures; and (vii) acquisitions.
LIQUIDITY AND CAPITAL RESOURCES
Cash, cash equivalents and marketable securities totaled $4.7 million at
June 30, 1995, a decrease of $556,000 from 1994 year-end. Working capital
(current assets less current liabilities) was $10.8 million with a current ratio
of 2.88 to 1 at June 30, 1995.
On March 31, 1995, the Company acquired all of the outstanding capital
stock of Neuromed. The Company paid $15.4 million in cash and 833,333 shares of
Common Stock valued at $6.5 million for the Neuromed stock. Of the cash payment
referred to above, $200,000 was paid in June 1995 as a result of a purchase
price adjustment. The Company also incurred $927,000 in acquisition and
financing costs. In July 1995, the Company recorded additional "earn-out"
consideration of 200,000 shares of Common Stock to be issued upon the closing of
the Offering (or if the Offering is not completed, in January 1996) and $1.5
million in cash payable January 1996. In January 1997 (assuming certain sales
objectives are fully met), the Company is obligated to pay an amount in cash
equal to $1.5 million plus the value of 200,000 shares of Common Stock at the
net Offering price, all as final earn-out consideration. See "-- Overview" and
"Certain Transactions."
In connection with the purchase, the Company determined that the operations
of Neuromed will be relocated to Texas by the end of the first quarter of 1996.
The Company is in the process of finalizing the estimated costs of the
relocation which will be recorded in the third quarter of 1995 as an adjustment
to costs in excess of net assets acquired.
On March 31, 1995, the Company entered into the Loan Agreement with
NationsBank which provided $15.0 million of senior term financing utilized to
pay most of the cash portion of the Neuromed purchase price and a $5.0 million
working capital line. At June 30, 1995, the Company had borrowings under the
working capital line of $4.2 million with a weighted average interest rate of
9.09%. The Company intends to use the net proceeds from the Offering to repay
the senior term debt ($13.9 million of which is currently outstanding) and as
much of the working capital indebtedness as possible ($4.6 million of which is
currently outstanding). Upon repayment, NationsBank would release its liens on
the Company's assets. See "Use of Proceeds."
On September 25, 1995, NationsBank issued the Company a commitment letter
providing for the amendment of the $5.0 million working capital line and the
addition of a $15.0 million acquisition line. Under the commitment letter, the
amended working capital line of credit would be collateralized by the Company's
accounts receivable and inventory and the acquisition line, if drawn upon, would
be collateralized by the Company's remaining unencumbered assets. Management
expects to negotiate a dividend limitation that would apply if the acquisition
line is utilized. There can, of course, be no assurance that a definitive
agreement will be reached with NationsBank or any other financing source or that
any loan agreement would be on the same or comparable terms to the Company's
current indebtedness. The Company has no immediate plans to utilize an
acquisition facility if such facility were indeed obtained.
22
<PAGE> 25
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. 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 than certificates of deposit or treasury bills, but with a higher
market value exposure to interest rate risk. Tightening of monetary policy by
the Federal Reserve during 1994 led to a significant rise in both short- and
long-term interest rates, thereby negatively affecting the value of interest
rate sensitive investments. Consequently, at December 31, 1994, the Company's
investment portfolio had declined in value by $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
half of 1995, interest rates fell, resulting in an increase in the value of the
Company's portfolio of $444,000, thereby decreasing the unrealized loss
component of stockholders' equity to $474,000 at June 30, 1995. During the first
half of 1995, the Company was a net seller of marketable securities in the
amount of $1.2 million. The Company's investment strategy has realized
cumulative net gains on its investments of over $1.0 million during the past
three years while continuously realizing higher interest and dividend yields
compared to certificates of deposit or treasury bills. At June 30, 1995, no
individual security represented more than 10% of the total portfolio or 1 1/4%
of total assets. The Company's investment policies prohibit the use of
derivative financial instruments.
The Company spent $995,000 for additions to property, plant and equipment
during the six months ended June 30, 1995, most of which were for manufacturing
toolings and equipment for the MPS system and related products. Management
expects capital expenditures for the remainder of 1995 to approximate $200,000.
Following the Offering, management believes that current cash, cash
equivalents and marketable securities, funds generated from operations, and if
necessary, funds provided by a working capital line of credit, will be
sufficient to satisfy normal cash operating requirements and capital
requirements through the end of 1996.
CURRENCY FLUCTUATIONS
Substantially all of the Company's international sales are denominated in
U.S. dollars. Fluctuations in currency exchange rates in other countries could
reduce the demand for the Company's products by increasing the price of the
Company's products in the currency of the countries in which the products are
sold, although management does not believe currency fluctuations have had a
material effect on the Company's results of operations.
SUMMARY THIRD QUARTER OF 1995 AND NINE MONTHS OPERATING RESULTS
On November 2, 1995, the Company reported preliminary unaudited results for
the third quarter of 1995. The following preliminary unaudited results for the
third quarter of 1995 and the nine months ended September 30, 1995 include
results of Neuromed from April 1, 1995. Net revenues for the third quarter ended
September 30, 1995 were $6.8 million, compared to $3.5 million for the same
quarter a year ago, a 94.3% increase. Net earnings for the third quarter were
$91,000, or $.01 per share, compared to a net loss of $489,000, or $(.09) per
share for the prior year quarter. Operating results reflected research and
development costs for the 1995 quarter of $1.2 million compared to $870,000 in
the 1994 quarter.
For the nine months ended September 30, 1995, net revenues were $18.1
million compared to $10.7 million for the same period a year ago, which
represents a 69.2% increase. The loss for the nine month period was $10.5
million or $(1.69) per share, after taking into account the $10.5 million non-
recurring charge for purchased in-process research and development incurred in
connection with the Neuromed Acquisition. See "Selected Consolidated Financial
Data" and "Selected Pro Forma Financial Data." This nine month period loss
compares to the 1994 period loss of $1.0 million or $(.20) per share. Research
and development costs for the 1995 period were $3.6 million, compared to $2.4
million for the comparable 1994 period.
23
<PAGE> 26
BUSINESS
GENERAL
Quest designs, develops, manufactures and markets a variety of healthcare
products used primarily in cardiovascular surgery, interventional pain
management and intravenous fluid delivery applications. The Company operates
several stable and profitable product lines, including cardiovascular products
(such as pressure control valves, filters and surgical retracting tapes),
specialized intravenous fluid delivery tubing sets and accessories and pressure
monitoring kits used primarily in labor and delivery. The Company has levered
these product lines, its existing corporate infrastructure and its core
competencies in manufacturing, engineering and regulatory affairs to expand into
new markets as evidenced by the internally funded development of the Quest MPS
myocardial protection system, an innovative and sophisticated system designed to
manage the delivery of solutions to the heart during open-heart surgery. In
addition, the Company recently entered the interventional pain management market
by acquiring Neuromed, which designs, develops, manufactures and markets a line
of electronic SCS devices used to manage chronic severe pain.
In 1991, Quest acquired two companies that manufactured and marketed
various cardiovascular products, significantly enhancing the Company's presence
in the cardiovascular products marketplace. In 1992, Quest identified a real and
immediate need in this marketplace for an automated and integrated myocardial
protection system that would be versatile, easy to use, efficient to monitor and
cost-effective. Myocardial protection is the process of arresting and caring for
the heart during open-heart surgery. The Quest MPS system is designed to
integrate key functions relating to the delivery of solutions to the heart such
as varying the rate and ratio of oxygenated blood, crystalloid, potassium and
other additives, and controlling temperature, pressure and other variables to
allow simpler, more flexible and cost-effective management of this process. The
MPS system employs advanced pump, temperature control and microprocessor
technologies and includes a line of captive and non-captive disposable products.
The Company filed a 510(k) for its MPS system with the FDA in August 1995.
In its continuing effort to expand into potentially high growth niche
markets in the medical device industry, the Company acquired Neuromed in March
1995. SCS is gaining increased acceptance as a viable, efficacious and
cost-effective treatment alternative to repeat back surgeries for relieving
chronic severe back pain. The Company believes that its recently introduced
CompuStim products, which are powered by radio frequency transmitters external
to the body, are the technological leaders in the field. The Company is
currently test marketing PainDoc, a pen-based computer system that works in
tandem with the Company's CompuStim devices to assist physicians and their
patients in optimizing the performance of the Company's SCS devices both
pre- and post-operatively.
Since its founding in 1979, the Company has developed, manufactured and
marketed specialized intravenous fluid delivery tubing sets and accessories sold
primarily to major hospitals in the United States. Over the last several years,
the revenues generated by this product line, a substantial component of the
Company's historical base business, have significantly aided the funding of the
Company's research and development efforts. The Company manufactures and markets
over 70 distinct models of specialized intravenous fluid delivery tubing sets.
BUSINESS STRATEGY
The Company's strategy is to capitalize on its existing corporate
infrastructure and apply its core competencies in medical device manufacturing,
engineering and regulatory affairs to expand its presence in targeted niche
markets. The Company believes that this strategy has enabled it to expand into
new product lines with high growth potential such as the MPS system and family
of disposable products, and into new niche markets such as the spinal cord
stimulation market within the larger interventional pain management marketplace.
The Company has internally funded the research and development expense involved
in designing, developing and pursuing regulatory approval for products such as
the MPS system. The Company believes that the historical stability of the
revenue stream generated by its base business has been an important factor in
the Company's ability to develop new and expanded product lines.
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<PAGE> 27
Quest intends to continue pursuing its strategy through internal product
development and acquisitions, with particular emphasis on the cardiovascular and
interventional pain management markets. This strategy was exemplified by the
Company's acquisition of two companies in 1991 that significantly enhanced the
Company's presence in the cardiovascular market, and its subsequent development
of the MPS system and related disposables. Quest's strategy was further
demonstrated by the Company's entry into the interventional pain management
market through the Neuromed Acquisition.
PRODUCTS
The following table summarizes certain information with respect to the
Company's principal products in commercial distribution and under development.
<TABLE>
<CAPTION>
Products Description/Use Status
- --------------------------------- ----------------------------------- -----------------------
<S> <C> <C>
Cardiovascular
Pressure Control Valves Pressure control valves used during Marketed
open-heart surgery
Arterial Line Filters and Filters and traps used to remove Marketed
Bubble Traps potentially dangerous air and other
matter from the blood during open-
heart surgery
Retract-O-Tape Surgical tubes used to retract and Marketed
occlude blood vessels during open-
heart surgery
MPS System and Related Cardioplegia delivery system and 510(k) filed 8/95;
Disposables related fluid delivery catheters certain related
and delivery sets disposables previously
cleared
for marketing
Interventional Pain Management
SCS CompuStim Devices Neurostimulation devices used to Marketed
relieve chronic pain
PainDoc Pen-based computer system used to Test marketed as a
optimize the performance of the computer-based data
Company's implanted SCS devices recording and
both pre- and post-operatively programming device;
510(k) clearance 10/95
for use as an
interactive medical
treatment device
Intravenous Fluid Delivery
Multiport(R) Sets Intravenous administration sets Marketed
that allow multiple drug infusions
Anesthesia Sets Intravenous administration sets Marketed
that allow needleless "port"
administration
Other
Intrauterine Pressure Catheters and transducers used to Marketed
Catheters/Transducers assess the frequency, duration and
intensity of contractions during
high risk labor
</TABLE>
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<PAGE> 28
CARDIOVASCULAR
BACKGROUND. According to industry sources, approximately 700,000 open-heart
surgeries were performed worldwide in 1994, and approximately 400,000 coronary
bypass surgeries are performed annually in the United States. These complex
procedures require the extensive use of various disposables, which may include
the Company's valves, filters and traps. With pronounced increases in average
cardiovascular patient age, number of repeat open-heart surgical procedures, and
duration and complexity of open-heart surgical procedures, the process of
arresting and caring for the heart ("myocardial protection") has become a focal
point for the cardiovascular surgeon and the perfusionist. The perfusionist is
the clinical specialist who operates the equipment that manages the delivery of
blood and other fluids to the body's tissues during open-heart procedures.
Myocardial protection is accomplished through the controlled delivery to the
heart muscle of cardioplegia, a group of solutions including oxygenated blood,
crystalloid, an arresting agent (usually potassium), medication and nutrients,
and is used in virtually all open-heart procedures performed in the United
States and a majority of the procedures performed worldwide.
VALVES, FILTERS AND TRAPS. The Company manufactures and markets a line of
proprietary specialized pressure control valves, pre-bypass and arterial line
filters and bubble traps, which are used by the perfusionist during
cardiopulmonary bypass surgery. Pressure control valves are placed in the
suction line to "vent," or decompress, the heart. These valves serve a number of
functions, including the maintenance of vacuum at a safe and consistent level to
minimize heart muscle tissue damage, as well as the prevention of inadvertent
and potentially catastrophic retrograde air flow into the heart. In 1993 and
1994, respectively, the Company introduced to the market two extensions of its
pressure control valve technology, the RetroGuard valve and the PlegiaGuard
valve. The RetroGuard valve is used with centrifugal pumps to prevent potential
retrograde blood flow and possible air embolism. The PlegiaGuard valve is used
to relieve overpressure in the cardioplegia line in the event that the line
becomes inadvertently clamped or occluded. The Company's arterial line filters
and bubble traps are used in the bypass circuit to remove air and other
potentially dangerous matter from the blood prior to the blood's return to the
patient. The Company's pre-bypass filters are used to flush the circuit external
to the patient's body prior to the initiation of the bypass procedure to
eliminate man-made debris within the lines.
SURGICAL TAPES AND OTHER PRODUCTS. The Company also manufactures and
markets surgical retracting tapes under the trademark Retract-O-Tape, a product
line of silicone elastomer surgical tubing used to apply traction to and occlude
blood vessels during surgical procedures. The Company's surgical tapes are
hollow tubes, sealed at both ends to trap air, which resist collapsing when they
come into contact with a body structure. The Company's ACTester product line
consists of instrumentation and associated disposables used to measure the
activated clotting time of blood.
MPS SYSTEM. In 1992, based on discussions with perfusionists and
cardiovascular surgeons regarding the logistical limitations of existing
cardioplegia delivery systems, the Company identified a real and immediate need
for an automated and integrated myocardial protection system that would be
versatile, easy to use, efficient and cost-effective. Over the past several
years, cardiovascular surgeons have developed advanced myocardial protection
protocols for open-heart surgery that significantly complicate the safe and
efficient administration of cardioplegia delivery using existing systems.
Protocols now call for warm or cold cardioplegia, various levels of potassium,
retrograde or antegrade cardioplegia flow, and a number of other variables.
Existing cardioplegia delivery systems are limited in their ability to
accommodate these evolving protocols, and are also difficult to control and
monitor due to the number of different components and protocol variables. Based
on its reengineering of the conceptual approach to cardioplegia delivery, the
Company designed the MPS system to address the limitations of existing
cardioplegia delivery systems. The Company then commissioned an independent
research firm to survey over 150 surgeons and perfusionists to confirm the
market demand for an automated and integrated approach to managing cardioplegia
delivery.
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<PAGE> 29
The Company subsequently developed, and in August 1995 filed a 510(k) with
the FDA for, the MPS system. This system, which employs advanced pump,
temperature control and microprocessor technologies, is designed to enable the
perfusionist to vary the blood/crystalloid ratio and potassium concentration,
maintain a constant blood temperature, and maintain a constant delivery pressure
through an automated and integrated device. The Quest MPS instrument is designed
to provide this flexibility through the simple setting of dials on its control
panel. The Company believes that the MPS system will simplify the cardioplegia
delivery process and thus improve the safety of this process by reducing the
risk of human error.
As a part of the MPS system, the Company has designed and developed a
"captive" disposable delivery set, which fits into the instrument and is
necessary to the operation of the instrument. The Company has also designed and
developed additional "non-captive" disposable tubing and other accessories for
use with the MPS system. These non-captive disposables are not integral to the
operation of the instrument and can be purchased from other manufacturers. The
Company has received FDA clearance to market certain of its non-captive
disposables through the submission and approval of 510(k)s, and expects to begin
marketing such products in 1995.
INTERVENTIONAL PAIN MANAGEMENT
BACKGROUND. Within the multi-billion dollar worldwide market for
interventional pain management products and services, the market for spinal cord
stimulation products has begun to grow significantly in recent years. SCS
devices employ neurostimulation, the process of electrically stimulating the
spinal cord to reduce chronic severe neuropathic (as opposed to acute) pain by
"masking" the pain signals sent to the brain. Neuropathic pain usually arises
from nerve damage. SCS device implantation manages the pain associated with
failed back syndrome (resulting from certain spinal disorders or unsuccessful
spinal cord surgery), peripheral neuropathy, phantom limb or stump pain,
ischemic pain and reflex sympathetic dystrophy. Traditionally selected as a
treatment alternative after less invasive therapies and repeat spinal cord
surgeries have failed to alleviate pain, SCS is gaining increased acceptance
among prescribing physicians as a treatment alternative because it is
reversible, relatively noninvasive and increasingly effective. The number of
domestic SCS procedures has grown from approximately 4,100 in 1991 to over 5,800
in 1993, representing approximately a 40% increase over two years. A majority of
SCS patients are between 40 and 59 years old, have had three to four previous
back surgeries and have experienced chronic back pain for several years. The
Company believes that there are currently approximately $80 to $90 million in
annual domestic sales of SCS products, based on its assumptions that (i) the
number of annual domestic procedures performed grows at a 20% annual rate, and
(ii) the average SCS device sells to hospitals for approximately $12,500.
Management believes that a number of factors are driving the increased
acceptance and performance of SCS products: technical advances in equipment
leading to more predictable and successful outcomes; physician awareness and
training; an expanding client base; and potential cost containment compared to
other approaches for treating chronic back pain, especially the treatment
alternative of repeat back surgeries. The average SCS procedure, including
device, hospital and physician expense, costs approximately $25,000, and
compared to the expense of three to four repeat back surgeries, is
cost-effective. In addition, most back surgeries are performed in a hospital and
require a hospital stay, while SCS procedures are typically performed on an
out-patient basis.
The market for SCS devices is currently divided between RF-coupled devices,
which use an external power source, and fully implantable systems known as
internal pulse generator ("IPG") devices. The Company believes that IPG devices
currently account for a substantial majority of the number of SCS procedures
performed, with RF-coupled devices accounting for the remainder. The Company
designs, develops, manufactures and markets RF-coupled SCS devices. The primary
advantages of the RF-coupled device include the simple replacement or recharge
of the external battery pack, and relatively lower overall cost. Although an IPG
device provides the convenience of a completely internalized system, IPG devices
involve added cost, complexity and risk because repeat surgeries are required to
replace the IPG power source. The Company believes that managed care and overall
cost
27
<PAGE> 30
sensitivity may lead to increased selection of RF-coupled devices. Moreover, the
latest generation SCS devices generally include more electrodes and dual channel
receivers, both of which consume more electrical energy than an implanted power
source can practically deliver over an extended period of time. Consequently,
the Company believes that RF-coupled devices are beginning to gain market share.
SCS DEVICES. The Company's SCS systems consist of three primary components:
leads, a receiver and a transmitter. The leads are most commonly placed through
the skin into the spinal column's epidural space. This procedure is similar to
that employed by physicians to administer drugs for anesthesia and other common
medical applications. Typically, one or two leads are inserted, each of which
has multiple electrodes that can be used to stimulate the targeted nerve roots
of the spinal cord. Each lead is then connected to the receiver, which is
implanted under the skin on the side of the abdomen. The receiver contains
electronics that receive RF energy and data from a source (the transmitter)
outside the body, and delivers the prescribed electrical pulses to the leads.
The transmitter is approximately the size of a pager, and is typically worn on a
belt. Since it is external to the body, the transmitter can be easily programmed
and serviced as needed, and its battery can be simply recharged or replaced.
Neuromed introduced its first product, the Multiprogrammable Spinal Cord
Stimulator, or Multistim, in 1979. Since that time, Neuromed has played a
significant role in the development of SCS products. Multistim incorporated a
quadrapolar electrode system within a single lead, and was considered a major
innovation in the field of neurostimulation because it significantly reduced
surgical time, cost and risk. Since the launch of Multistim, Neuromed has
developed and introduced a wide range of RF-coupled SCS systems with a variety
of options to accommodate different applications and degrees of pain.
The Company's recently introduced CompuStim systems include four, eight and
sixteen electrode leads; specialty leads for peripheral applications; single and
dual channel receivers; and rechargeable transmitters and antennae. The Company
believes that the CompuStim product line's multi-electrode leads and
multiprogrammable electronics technology have changed the manner in which
neurostimulation is performed worldwide. For example, Neuromed's "Dual Octrode"
device, a recently introduced system of dual leads with eight electrodes each,
creates a targeted current density that appears to be especially effective in
relieving chronic axial (or body trunk) pain. Previously, quadrapolar SCS
systems only relieved the leg pain associated with failed back syndrome.
Industry sources support the view that the Dual Octrode device provides improved
pain relief to both the legs and the back. Consequently, although the Dual
Octrode device has only been on the United States market since February 1995, it
now accounts for approximately 60% of Neuromed's current product revenue and, in
the Company's judgment, is the technological leader in the SCS field. The
Company believes that the long term results of SCS in the treatment of pain have
improved as a result of the flexibility of Neuromed's designs, epitomized by the
Dual Octrode product. Moreover, the ease of use of the system has expanded the
potential market for these products.
Use of the Company's current SCS products in certain operating modes
consumes relatively greater amounts of electrical current, reducing the
operating time of the rechargeable, externally worn battery packs. In addition,
certain of the Company's current SCS products have experienced switch failures
attributable in significant part to a specific brand of switches. These switches
are no longer being purchased and are being replaced by a new switch that
appears not to exhibit the same problems. Patient misuse has also contributed to
the switch failures. Finally, the Company's SCS products have exhibited some
intermittent stimulation, which the Company believes is attributable to several
factors including improper antenna placement, physicians or patients adjusting
stimulation below perceptible levels, improper receiver implant placement
techniques and lead movement. The Company is developing and implementing
improved patient and physician communications and training programs and is
pursuing product design enhancements and improvements to address these matters.
28
<PAGE> 31
PAINDOC. In addition to its current array of SCS devices, the Company is
developing and testing PainDoc, a pen-based computer system that is designed to
assist physicians and their patients in optimizing the performance of the
Company's SCS devices both pre- and post-operatively. PainDoc interfaces with
the Company's CompuStim transmitters to optimize SCS therapy and document
treatment outcomes. PainDoc allows the physician to input information regarding
the patient's description of the location and intensity of the patient's pain.
The resulting "pain map" is then analyzed by the computer to assess and select
the most effective stimulation sets, or combination of multi-electrode
stimulation arrays, to treat the pain. The selected arrays are uploaded into the
patient's CompuStim transmitter. After a trial period, the patient reports to
the physician the location and level of pain relief. These trial results are
uploaded back into PainDoc for the physician's objective review and analysis.
The physician can visually compare the patient's pain map against a stimulation
map and assess whether desired levels of pain relief have been obtained and
whether excess stimulation has been delivered. This process can be effective in
targeting the location of desired pain relief, reducing the patchiness of pain
relief delivered by many SCS devices and reducing or eliminating
overstimulation.
PainDoc enables the physician to program up to 24 different stimulation
sets delivering electrical stimulation every 50 milliseconds to expand pain area
coverage and relief. The Company believes that PainDoc should also allow
physicians to create a broad based database tool that, by using a standardized
methodology, will enable physicians to share and compare outcomes data, which
can then be used to deliver more efficacious pain relief to individual patients.
The Company believes that PainDoc and CompuStim devices used in tandem should
significantly enhance the effectiveness, flexibility and precision of managing
chronic neuropathic pain. The Company expects PainDoc to promote the selection
of the Company's CompuStim devices for SCS procedures, especially as SCS devices
become more complex and the pain management process becomes more refined. In
October 1995, the Company received 510(k) approval from the FDA to market
PainDoc as an interactive medical treatment device. See "-- Government
Regulation."
NEW PRODUCT OPPORTUNITIES. The Company believes that significant
opportunities for its SCS technology exist, both in the expansion of possible
applications of its existing products and in the development of new products,
specifically for patients afflicted with peripheral vascular disease, angina,
Parkinson's disease and motor disorders resulting from spinal cord injury or
paralysis. In addition, the Company currently plans to develop other pain
management products, which may include pumps, catheters, ports, needles and
scopes. In October 1995, the Company licensed certain pump technology that would
allow it to develop, manufacture and market implantable drug pumps that could be
used in interventional pain management applications, as well as in cancer
treatment and other applications. FDA approval for use of these pumps in humans
will be required.
INTRAVENOUS FLUID DELIVERY
Since its founding in 1979, the Company has developed, manufactured and
marketed specialized intravenous fluid delivery tubing sets and accessories sold
primarily to major hospitals in the United States. Over the last several years
the revenues generated by this product line, a substantial component of the
Company's historical base business, have significantly aided the funding of the
Company's research and development efforts. The Company's core competencies in
medical device manufacturing, engineering and regulatory affairs have largely
been developed as a consequence of its experience with intravenous fluid
delivery products, including the electronic intravenous pump and associated
disposables business that was sold in 1987.
The Company manufactures and markets over 70 distinct models of specialized
intravenous fluid delivery tubing sets, which can be broken down into two major
product categories -- Multiport(R) sets and anesthesia sets. Hospitals
frequently require specialized disposable intravenous tubing sets for more
complex therapy procedures employed in anesthesia administration, intravenous
feeding, intensive care and cancer therapy. The Company's intravenous tubing
sets generally consist of specialized
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<PAGE> 32
tubing and connector variations that distinguish them from standard intravenous
sets. The Company also manufactures and markets injection sites used in heparin
and other medication administrations.
The Company has one patented specialized tubing set, purchased primarily by
the University of Texas System Cancer Center (M.D. Anderson Hospital), which is
used to deliver multiple drugs for complex chemotherapy applications. M.D.
Anderson accounted for $3.4 million, $3.1 million, $2.7 million and $1.5
million, or 25%, 23%, 19% and 14%, of the Company's net revenues for the years
ended December 31, 1992, 1993 and 1994 and the six months ended June 30, 1995,
respectively.
OTHER PRODUCTS
The Company also designs, manufactures and markets other products for the
healthcare industry, including pressure monitoring kits used in labor and
delivery procedures and various critical care applications. The Company's
intrauterine pressure monitoring devices are used to determine pressure within
the mother's uterus primarily during high risk labor and delivery. Approximately
25% of the nearly four million births occurring annually in the United States
are categorized as "high risk" due to factors such as obesity, drug use,
disease, age or low fetus weight. During these procedures, a catheter is
inserted into the mother's uterus to measure uterine fluid pressure. This
information allows the clinician to monitor the progression of labor and to
determine whether intervention is necessary or advisable. The Company's
intrauterine pressure monitoring devices are marketed as kits containing all of
the components required to measure uterine fluid pressure.
RESEARCH AND DEVELOPMENT
Since 1992, the Company has focused its research and development efforts on
designing and developing the MPS system and related products. The Company spent
$9.0 million on the research and development of its MPS system and related
products, representing over 92% of the Company's research and development
expense since 1992. Although the Company plans to continue engaging in ongoing
research and development to introduce new products, enhance the effectiveness,
ease of use, safety and reliability of existing products and expand the
applications for which its products are appropriate, particularly in the
cardiovascular and interventional pain management fields, the Company expects
research and development expense to decline in the near term, as a result of
completing development of the MPS system and certain related products in August
1995.
As of November 6, 1995, the Company had an in-house research and
development staff of 22 engineers, technicians and designers, down from a peak
number of 49 in April 1995. This staff has worked closely with cardiothoracic
surgeons and perfusionists, hospital administrators, other healthcare
professionals and software and hardware engineers to understand the market need
for an integrated system dedicated to myocardial protection, and to design and
develop the MPS system and related disposables. The Company expects to continue
engaging in this collaborative effort to identify new niche market opportunities
and to design and develop innovative and cost-effective products and
enhancements, principally in the areas of cardiovascular surgery and
interventional pain management. Research and development expense in 1992, 1993,
1994 and the first half of 1995 was $1.4 million, $1.9 million, $3.5 million and
$2.5 million, respectively.
MANUFACTURING
The Company manufactures and packages certain cardiovascular products (such
as pressure control valves, filters, traps and surgical retracting tapes) and
intravenous fluid delivery products at its primary manufacturing facility in
Allen, Texas. This facility received ISO 9001 certification (for design and
manufacturing processes) in July 1995. See "Business -- Government Regulation."
Although the Company currently manufactures its line of SCS devices and related
products at its ISO 9002 certified (manufacturing only) facility in Fort
Lauderdale, Florida, the Company plans to transition this operation to the Allen
facility during the fourth quarter of 1995 and the first quarter of 1996.
Finally, the
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<PAGE> 33
Company manufactures certain cardiovascular products at a facility in Orange
County, California, and will continue to do so for the foreseeable future.
The Company's manufacturing processes consist of the assembly of standard
and custom component parts and the testing of completed products. The Company
subcontracts with various suppliers to provide it with the quantity of component
parts necessary to assemble its products. Almost all of these components are
available from a number of different suppliers, although certain components are
purchased from single sources, who manufacture these components from the
Company's toolings. For example, the Company relies on single suppliers for two
separate components of the specialized oncology intravenous tubing set that the
Company supplies to the University of Texas System Cancer Center (M.D. Anderson
Hospital), the Company's largest customer. The Company believes that there are
alternative and satisfactory sources for single-sourced components, although a
sudden disruption in supply from one of these suppliers could adversely affect
the Company's ability to deliver the finished product on time. The Company owns
its own molds for production of a majority of the components used in specialized
tubing sets and cardiovascular products. Consequently, in the event of supply
disruption, the Company would be able to fabricate its own components or
subcontract with another supplier, albeit after a delay in the production
process.
The Company devotes significant attention to quality control. Its quality
control measures begin at the manufacturing level where components are assembled
in a "clean room" environment designed and maintained to reduce product exposure
to particulate matter. Products are tested throughout the manufacturing process
for adherence to specifications. Finished components are shipped to outside
processors for sterilization through radiation or treatment with ethylene oxide
gas. After sterilization, the products are quarantined and tested before they
are shipped to customers.
Skills of assembly workers required for the manufacture of medical products
are similar to those required in typical assembly operations. The Company
believes that workers with these skills are readily available in the Dallas,
Fort Lauderdale and Orange County areas.
SALES AND MARKETING
The Company markets most of its cardiovascular products and intravenous
fluid delivery tubing sets through direct contact with hospitals, independent
sales representatives, marketing arrangements with certain distributors and, to
a lesser extent, through telemarketing and direct mail. In addition, the Company
employs two sales managers who oversee the distributors who sell the Company's
cardiovascular products and pressure monitoring kits. The Company plans to
market its MPS system and family of related products domestically through a
direct sales force operating on a sales team approach. In anticipation of 510(k)
clearance, the Company has hired one sales manager and anticipates hiring
approximately four additional sales managers by the end of 1995, and upon 510(k)
clearance, to add approximately five additional salespersons to market the MPS
system and related products. The Company plans to market the MPS system and
related products internationally through specialty distributors. The Company
derives approximately 80% of net revenues attributable to its cardiovascular
products from domestic sales and approximately 20% from European, Australian and
Japanese sales.
Neuromed has historically relied on specialty distributors to market its
SCS devices, and the Company expects to continue this sales and marketing
strategy. The Company employs two sales managers who oversee these specialty
distributors. The primary medical specialists the Company targets in its
marketing efforts are anesthesiologists, neurosurgeons and orthopedic surgeons.
Although neurosurgeons were the first practitioners to use SCS applications,
anesthesiologists now account for a greater percentage of sales as the relative
number of these practitioners has grown and as the understanding and acceptance
of SCS treatment has increased. The Company derives approximately 80% of net
revenues attributable to its SCS devices from domestic sales and approximately
20% from European and Australian sales. See "Risk Factors -- Dependence on
Distributor Sales."
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<PAGE> 34
The University of Texas System Cancer Center (M.D. Anderson Hospital)
accounted for $3.4 million, $3.1 million, $2.7 million and $1.5 million, or 25%,
23%, 19% and 14%, of the Company's net revenues for the years ended December 31,
1992, 1993 and 1994 and the six months ended June 30, 1995, respectively. The
Company supplies a patented specialized tubing set used by M.D. Anderson
Hospital for oncology applications. While the Company believes its relations
with this customer are good, and while net revenues in percentage terms have
declined over time and are expected to decline further as a result of the
Neuromed Acquisition, the loss of this customer could have a material adverse
effect on the Company's business, financial condition and results of operations.
See "Risk Factors -- Reliance on Major Customer."
COMPETITION
In marketing its products, the Company competes with numerous companies
that have substantially greater financial resources and engage in substantially
greater research and development efforts than the Company. Numerous competitors
exist for the Company's cardiovascular products, specialized tubing sets and
pressure monitoring kits. These markets are dominated by established
manufacturers that have broader product lines, greater distribution
capabilities, substantially greater capital resources and larger marketing,
research and development staffs and facilities than the Company. Many of these
competitors offer broader product lines within the specific product market
and/or in the general field of medical devices and supplies. Broad product lines
give many of the Company's competitors the ability to negotiate exclusive, long
term medical device supply contracts and, consequently, the ability to offer
comprehensive pricing of their competing products. By offering a broader product
line in the general field of medical devices and supplies, competitors may also
have a significant advantage in marketing competing products to group purchasing
organizations, HMOs and other managed care organizations that are increasingly
seeking to reduce costs through centralization of purchasing functions. In
addition, the Company's competitors may use price reductions to preserve market
share in their product markets. See "Risk Factors -- Intense Competition,
Continual Technological Change and New Surgical Techniques."
The Company is aware of at least two cardioplegia delivery systems
currently in development or in clinical testing that would compete with the MPS
system. Both products have received FDA 510(k) market clearance. While these
products represent improvements over cardioplegia delivery systems currently in
use, the Company believes that the MPS system will offer a greater range of
functionality, flexibility and ease-of-use. In addition, innovations in surgical
techniques or medical practices could have the effect of reducing or eliminating
market demand for one or more of the Company's products. For example, some
cardiovascular surgeons and medical device companies are developing techniques,
procedures and devices for performing coronary artery bypass surgery without
stopping the heart, both through open-heart surgery and minimally invasive
procedures, thereby eliminating the need for myocardial protection in these
cases and potentially reducing the market for Quest's MPS system. While these
techniques, procedures and devices have not to date attained widespread use,
there can be no assurance that they will not gain broader market acceptance.
While these and other surgical techniques, procedures and devices may reduce the
number of coronary artery bypass procedures that require myocardial protection,
the Company believes that most, if not all, surgical suites will need to be
equipped with a myocardial protection system. See "Risk Factors -- Intense
Competition, Continual Technological Change and New Surgical Techniques."
Neuromed competes in the market for SCS devices with one other significant
supplier, Medtronic, Inc. Medtronic holds a substantial majority share of the
market and sells both RF-coupled systems and IPG devices. See "-- Interventional
Pain Management -- Background."
The Company believes that the principal competitive factors in the
cardiovascular, interventional pain management and intravenous fluid delivery
markets are cost-effectiveness, impact on patient outcomes, product performance,
quality and ease of use, technical innovation and customer service. The Company
intends to continue to compete on the basis of its high performance products,
innovative
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technologies, manufacturing capability, close customer relations and support and
its strategy to increase its offerings of products within these markets.
PATENTS, TRADEMARKS AND PROPRIETARY RIGHTS
The Company owns nineteen United States patents relating to products that
the Company currently sells or develops. Although one such patent is scheduled
to expire in February 1996 and another is scheduled to expire in January 1997,
the Company does not believe that either expiration will have a material adverse
effect on the Company or its ability to sell the applicable products. Twelve of
the nineteen patents cover the Company's cardiovascular products. From 1993
through 1995, the Company filed four applications for patents relating to the
MPS system and related products, one of which was issued in January 1995. The
issued patent contains 69 claims, many of which, in the Company's opinion,
contain broad coverage of key elements of the MPS system, including the MPS
system's innovative methods of pumping, mixing and heating fluids. Management
believes that the issued patent should provide significant protection for its
MPS system. The three other patent applications are pending.
Neuromed currently owns four of the United States patents referred to
above, and also owns five foreign patents. In management's view, these patents
offer reasonable coverage of its SCS devices' electrode, receiver and
transmitter technology. These patents cover both RF-coupled devices and IPG
systems, although the Company currently manufactures only RF-coupled devices.
The Company is assessing whether it will file for patent protection concerning
its PainDoc product. The Company also owns three patents relating to its
intravenous fluid delivery tubing sets and accessories and other products.
The validity of any patents issued to the Company may be challenged by
others and the Company could encounter legal and financial difficulties in
enforcing its patent rights against infringers. In addition, there can be no
assurance that other technologies cannot or will not be developed or that
patents will not be obtained by others which would render the Company's patents
obsolete. With the possible exception of the patent relating to the specialized
tubing sets manufactured for the University of Texas System Cancer Center (M.D.
Anderson Hospital), the loss of any one patent would not have a material adverse
effect on the Company's current revenue base. Although the Company does not
believe that patents are the sole determinant in the commercial success of its
products, the loss of a significant percentage of its patents or its patents
relating to a specific product line, particularly the MPS system or Neuromed's
SCS product line, could have a material adverse effect on the Company's
business, financial condition and results of operations.
The Company has developed significant technical knowledge which, although
non-patentable, is considered by the Company to be significant in enabling it to
compete. However, the proprietary nature of such knowledge may be difficult to
protect. The Company has entered into an agreement with each key employee
prohibiting such employee from disclosing any confidential information or trade
secrets of the Company and prohibiting that employee from engaging in any
competitive business while the employee is working for the Company and for a
period of one year thereafter. In addition, these agreements also provide that
any inventions or discoveries relating to the business of the Company by these
individuals will be assigned to the Company and become the Company's sole
property.
Claims by competitors and other third parties that the Company's products
allegedly infringe the patent rights of others could have a material adverse
effect on the Company. The medical device industry is characterized by frequent
and substantial intellectual property litigation. The cardiovascular device
market and the interventional pain management markets are maturing and, as such,
are characterized by extensive patent and other intellectual property claims,
which can create greater potential than in less developed markets for possible
allegations of infringement, particularly with respect to newly developed
technology. Intellectual property litigation is complex and expensive, and the
outcome of this litigation is difficult to predict. Any future litigation,
regardless of outcome, could
33
<PAGE> 36
result in substantial expense to the Company and significant diversion of the
efforts of the Company's technical and management personnel. An adverse
determination in any such proceeding could subject the Company to significant
liabilities to third parties, or require the Company to seek licenses from third
parties or pay royalties that may be substantial. Furthermore, there can be no
assurance that necessary licenses would be available to the Company on
satisfactory terms or at all. Accordingly, an adverse determination in a
judicial or administrative proceeding or failure to obtain necessary licenses
could prevent the Company from manufacturing or selling certain of its products,
which could have a material adverse effect on the Company's business, financial
condition and results of operations. See "Risk Factors -- Dependence on Patents
and Proprietary Rights."
QUEST, MULTIPORT, RETROGUARD, RETRACT-O-TAPE, ACTest and DUO-TUBE are among
the Company's registered trademarks, and MPS, COMPUSTIM, PAINDOC and ACTester
are among its non-registered trademarks. Registration applications are pending
with respect to MPS, COMPUSTIM and PAINDOC.
GOVERNMENT REGULATION
The manufacture and sale of the Company's products are subject to
regulation by numerous governmental authorities, principally the FDA and
corresponding foreign agencies. The research and development, manufacturing,
promotion, marketing and distribution of the Company's products in the United
States are governed by the Federal Food, Drug, and Cosmetic Act and the
regulations promulgated thereunder (the "FDC Act and Regulations"). The Company
is subject to inspection by the FDA for compliance with such regulations and
procedures.
The FDA has traditionally pursued a rigorous enforcement program to ensure
that regulated entities such as the Company comply with the FDC Act and
Regulations. A company not in compliance may face a variety of regulatory
actions, including warning letters, product detentions, device alerts, mandatory
recalls or field corrections, product seizures, injunctive actions or civil
penalties and criminal prosecutions of the company or responsible employees,
officers and directors.
Under the FDA's requirements, if a manufacturer can establish that a newly
developed device is "substantially equivalent" to a legally marketed device, the
manufacturer may seek marketing clearance from the FDA to market the device by
filing a 510(k) premarket notification with the FDA. The 510(k) premarket
notification must be supported by data establishing the claim of substantial
equivalence to the satisfaction of the FDA. The process of obtaining a 510(k)
clearance typically can take several months to a year or longer. If substantial
equivalence cannot be established, or if the FDA determines that the device
requires a more rigorous review, the FDA will require that the manufacturer
submit a PMA that must be carefully reviewed and approved by the FDA prior to
sale and marketing of the device in the United States. The process of obtaining
a PMA can be expensive, uncertain and lengthy, frequently requiring anywhere
from one to several or more years from the date of FDA submission. Both a 510(k)
and a PMA, if granted, may include significant limitations on the indicated uses
for which a product may be marketed. FDA enforcement policy strictly prohibits
the promotion of approved medical devices for unapproved uses. In addition,
product approvals can be withdrawn for failure to comply with regulatory
requirements or the occurrence of unforeseen problems following initial
marketing. Although all of the Company's currently marketed products have been
the subject of successful 510(k) submissions, and the Company believes that its
products currently in development will also be eligible for the 510(k)
submission process, there can be no assurance that the FDA will agree with this
view.
In the second quarter of 1994, the Company held a pre-submission meeting
with the FDA's Office of Device Evaluation to determine whether the MPS system
qualified for a 510(k) filing. Based on its meeting with the FDA, the Company
concluded that the MPS system would qualify for 510(k) treatment, and opted to
file its application with test data to facilitate the FDA's review. After
compiling test data over the course of 1995, the Company filed its 510(k)
notification in August 1995. The Company expects to introduce MPS and related
products to commercial markets if and when the FDA
34
<PAGE> 37
clears MPS to market. There can be no assurance that the FDA will consider the
MPS system under 510(k), that such clearance will be obtained or that it will be
obtained without delay. See "Risk Factors -- Government Regulation; Uncertainty
of Obtaining Regulatory Clearance."
The Company's PainDoc product has been marketed as a data recording and
programming device for use with the Company's CompuStim devices. In October
1995, the Company received 510(k) clearance from the FDA to market PainDoc as an
interactive medical treatment device as well. As a data recording and
programming device, PainDoc can be used to record important information
regarding the location and intensity of a patient's pain, analyze that data, and
automate the selection of a large number of electrode arrays that would be
difficult to select manually. PainDoc is then used to program the most
efficacious electrode arrays to alleviate the patient's pain. As an interactive
medical treatment device, this data collection, analysis, selection and
programming process can be accomplished while the patient is receiving
neurostimulation, where before, the transmitter had to be disconnected during
the analysis and programming phase. The Company believes that as an interactive
medical treatment device, PainDoc's value is enhanced because the physician can
accelerate the treatment process through "live" testing.
The Company is also subject to regulation in each of the foreign countries
in which it sells its products with regard to product standards, packaging
requirements, labeling requirements, import restrictions, tariff regulations,
duties and tax requirements. Many of the regulations applicable to the Company's
products in such countries are similar to those of the FDA. The national health
or social security organizations of certain countries require the Company's
products to be qualified before they can be marketed in those countries. To
date, the Company has not experienced significant difficulty in complying with
these regulations.
To position itself for access to European and other international markets,
Quest sought and obtained certification under the ISO 9000 Series of Standards.
ISO 9000 is a set of integrated requirements, which when implemented, form the
foundation and framework for an effective quality management system. These
standards were developed and published by the ISO, a worldwide federation of
national standard bodies, founded in Geneva, Switzerland in 1946. ISO has over
92 member countries. ISO certification is widely regarded as essential to enter
Western European markets.
The Company obtained certification and was registered as an ISO 9001
compliant company on July 1, 1995. The ISO 9001 registration is the most
stringent standard in the ISO series and lasts for three years. The German
notified body, Landesgewerbeanstalt Bayern ("LGA") issued the certificate. The
ISO 9001 standards cover design, production, installation and servicing of
products. The Company will be subject to an annual audit by LGA to maintain the
registration. This registration will simplify the process of obtaining the "CE"
mark for its products. This CE mark enables a company's products to be marketed,
sold and used throughout the European Union.
In 1991, prior to its acquisition by the Company, Neuromed commenced
clinical trials of a fully implantable SCS device in the United States and
Europe. In late 1993, the FDA cancelled the IDE relating to this product and
rescinded Neuromed's export authority for this product due to alleged violations
by Neuromed, under its prior management, of applicable rules and regulations,
including good manufacturing practices. The clinical trials were discontinued
and the product was withdrawn from the market. During this period, Neuromed also
encountered regulatory difficulties in the United Kingdom due to alleged
noncompliance with applicable rules and regulations. Quest is engaged in a
process intended to restore good relations with regulatory authorities in the
United Kingdom. There can be no assurances that the Company will not encounter
similar difficulties in the future.
The financial arrangements through which the Company markets, sells and
distributes its products may be subject to certain federal and state laws and
regulations in the United States with respect to the provision of services or
products to patients who are Medicare or Medicaid beneficiaries. The "fraud and
abuse" laws and regulations prohibit the knowing and willful offer, payment or
receipt of anything of value to induce the referral of Medicare or Medicaid
patients for services or goods. In addition, the physician anti-referral laws
prohibit the referral of Medicare or Medicaid patients for certain "Desig-
35
<PAGE> 38
nated Health Services" to entities in which the referring physician has an
ownership or compensation interest. Violations of these laws and regulations may
result in civil and criminal penalties, including substantial fines and
imprisonment. In a number of states, the scope of fraud and abuse or physician
anti-referral laws and regulations, or both, have been extended to include the
provision of services or products to all patients, regardless of the source of
payment, although there is variation from state to state as to the exact
provisions of such laws or regulations. In other states, and, on a national
level, several health care reform initiatives have been proposed which would
have a similar impact. The Company believes that its operations and its
marketing, sales and distribution practices currently comply in all respects
with all current fraud and abuse and physician anti-referral laws and
regulations, to the extent they are applicable. Although the Company does not
believe that it will need to undertake any significant expense or modification
to its operations or its marketing, sales and distribution practices to comply
with federal and state fraud and abuse and physician anti-referral regulations
currently in effect or proposed, financial arrangements between manufacturers of
medical devices and other health care providers may be subject to increasing
regulation in the future. Compliance with such regulation could adversely affect
the Company's marketing, sales and distribution practices, and may affect the
Company in other respects not presently foreseeable, but which could have an
adverse impact on the Company's business, financial condition and results of
operations.
THIRD PARTY REIMBURSEMENT AND COST CONTAINMENT
The Company's products are purchased primarily by hospitals and other
users, which then bill various third party payors for the services provided to
the patients. These payors, which include Medicare, Medicaid, private insurance
companies and managed care organizations, reimburse part or all of the costs and
fees associated with the procedures performed with these devices.
Medicare and Medicaid reimbursement for hospitals is based on a fixed
amount for admitting a patient with a specific diagnosis. Because of this fixed
reimbursement method, hospitals have incentives to use less costly methods in
treating Medicare and Medicaid patients, and will frequently make capital
expenditures to take advantage of less costly treatment technologies.
Frequently, reimbursement is reduced to reflect the availability of a new
procedure or technique, and as a result hospitals are generally willing to
implement new cost saving technologies before these downward adjustments take
effect. Likewise, because the rate of reimbursement for certain physicians who
perform certain procedures has been and may in the future be reduced in the
event of further changes in the resource-based relative value scale method of
payment calculation, physicians may seek greater cost efficiency in treatment to
minimize any negative impact of reduced reimbursement. Any amendments to
existing reimbursement rules and regulations which restrict or terminate the
reimbursement eligibility (or the extent or amount of coverage) of medical
procedures using the Company's products or the eligibility (or the extent or
amount of coverage) of the Company's products could have an adverse impact on
the Company's business, financial condition and results of operations. Third
party payors are increasingly challenging the prices charged for medical
products and services and may deny reimbursement if they determine that a device
was not used in accordance with cost-effective treatment methods as determined
by the payor, was experimental or was used for an unapproved application.
The Company's SCS devices, for example, while cost-effective compared to
repeat back surgeries, have encountered some resistance to third party
reimbursement. Although Medicare, Medicaid and many private insurers reimburse
for the SCS device and procedure, especially after repeat back surgeries have
failed to relieve the chronic pain, certain payors refuse to reimburse for SCS
devices and others, including the Veterans Administration, restrict
reimbursement. There can be no assurance that in the future, third party payors
will continue to reimburse for the Company's products, or that their
reimbursement levels will not adversely affect the profitability of the
Company's products. In addition, the cost of health care has risen significantly
over the past decade, and there have been and may continue to be proposals by
legislators and regulators to curb these costs. Legislative action limiting
reimbursement for certain procedures could have a material adverse effect on the
Company's business, financial condition and results of operations.
36
<PAGE> 39
In response to the focus of national attention on rising health care costs,
a number of changes to reduce costs have been proposed or have begun to emerge.
There have been, and may continue to be, proposals by legislators and regulators
and third party payors to curb these costs. There has also been a significant
increase in the number of Americans enrolling in some form of managed care plan.
It has become a typical practice for hospitals to affiliate themselves with as
many managed care plans as possible. Higher managed care penetration typically
drives down the prices of health care procedures, which in turn places pressure
on medical supply prices. This causes hospitals to implement tighter vendor
selection and certification processes, by reducing the number of vendors used,
purchasing more products from fewer vendors and trading discounts on price for
guaranteed higher volumes to vendors. Hospitals have also sought to control and
reduce costs over the last decade by joining group purchasing organizations or
purchasing alliances. The Company cannot predict what continuing or future
impact existing or proposed legislation, regulation or such third party payor
measures may have on its future business, financial condition or results of
operations.
Changes in reimbursement policies and practices of third party payors could
have a substantial and material impact on sales of certain of the Company's
products. The development or increased use of more cost-effective treatments
could cause such payors to decrease or deny reimbursement to favor these other
treatments. See "Risk Factors -- Cost Pressures on Medical Technology; Third
Party Reimbursement."
EMPLOYEES
As of November 6, 1995, the Company employed approximately 214 full-time
employees, 22 in research and development, 30 in sales and marketing, 120 in
manufacturing and related operations, and the remainder in executive and
administrative positions. The Neuromed Acquisition has added 56 of these
employees to the existing employee base. None of the Company's employees is
represented by a labor union, and the Company considers its employee relations
to be good.
ADVISORY BOARD
The Company has established a Board of Clinical Advisors (the "Advisory
Board") comprised of individuals with substantial expertise in the field of
myocardial protection who have played instrumental roles in the identification
of the market need for the MPS system and its subsequent design and development.
Members of the Company's management and scientific and technical staff consult
closely with the Advisory Board to better understand the technical and clinical
requirements of the cardiovascular surgical team and product functionality
needed to meet those requirements. The Company anticipates that these Advisory
Board members will continue to play similar roles with respect to other
products, and may assist the Company in educating other physicians in the use of
the MPS system and related products.
Certain members of the Advisory Board are employed by academic institutions
and may have commitments to or consulting or advisory agreements with other
entities that may limit their availability to the Company. The members of the
Advisory Board may also serve as consultants to other medical device companies.
No members are expected to devote more than a small portion of their time to the
Company.
FACILITIES
In December 1993, the Company moved into its new manufacturing facility and
executive offices in Allen, Texas (located north of Dallas). The facility covers
approximately 107,000 square feet and was constructed during 1993 on a 19.2 acre
tract that the Company acquired in 1985. The Company borrowed $4.4 million from
MetLife Capital Corporation to construct and outfit this facility. This
financing is collateralized by the Allen land, the Allen facility and certain
equipment of the Company. See Note 3 of the Notes to the Quest Consolidated
Financial Statements. Management expects the
37
<PAGE> 40
current facility to serve its manufacturing, storage and executive office needs
in the Dallas area for the foreseeable future.
The Company also currently leases approximately 4,600 square feet of office
and manufacturing space in Orange County, California on a month-to-month basis.
The Company plans to continue manufacturing certain cardiovascular surgery
products at this facility for the foreseeable future.
Neuromed leases approximately 18,000 square feet of office and
manufacturing space in Fort Lauderdale, Florida, where it manufactures and
markets its SCS devices. The Company plans to transition the SCS manufacturing
and marketing functions to its headquarters in Allen by the end of the first
quarter of 1996. Pending this move, the Company believes this facility will
serve Neuromed's needs.
LEGAL PROCEEDINGS
As a consequence of the Neuromed Acquisition in March 1995, the Company is
currently a party to certain product liability claims relating to SCS devices
sold by Neuromed prior to the acquisition, including one claim relating to a
fully implantable device, which was recalled by Neuromed. Product liability
insurers have assumed responsibility for defending the Company against these
claims, subject to reservation of rights in certain cases. Although the Company
is entitled to contractual indemnification from Neuromed's former owner with
respect to any losses exceeding its product liability insurance coverage, there
can be no assurances that the Company will not incur significant monetary
liability to the claimants if such insurance or indemnification is unavailable
or inadequate for any reason, or that the Company's SCS business and new SCS
product lines will not be adversely affected by these product liability claims.
While the Company seeks to maintain appropriate levels of product liability
insurance with coverage that the Company believes is comparable to that
maintained by companies similar in size and serving similar markets, there can
be no assurance that the Company will avoid significant future product liability
claims relating to its SCS, cardiovascular, intravenous fluid delivery or other
products. See "Risk Factors -- Potential Product Liability and Recall; Possible
Insurance Limitations" and "-- Government Regulation."
Except for such product liability claims and other ordinary routine
litigation incidental or immaterial to its business, the Company is not
currently a party to any other pending legal proceeding. The Company maintains
general liability insurance against risks arising out of the normal course of
business.
38
<PAGE> 41
MANAGEMENT
DIRECTORS AND EXECUTIVE OFFICERS
The following table sets forth information regarding the directors and
executive officers of the Company:
<TABLE>
<CAPTION>
NAME AGE POSITION
-------------------------------------- --- ----------------------------------------
<S> <C> <C>
Thomas C. Thompson.................... 57 President, Chief Executive Officer and
Director
David O. Turner....................... 48 Executive Vice President and Chief
Operating Officer
F. Robert Merrill III................. 45 Senior Vice President-Finance, Chief
Financial Officer, Treasurer and
Secretary
James P. Calhoun...................... 45 Vice President-Human Resources
George L. Carlson..................... 54 Vice President
Eric D. Dufford....................... 37 Vice President-Sales and Marketing
Kenneth A. Jones...................... 39 Vice President-Research and Development
O. Mark Samples....................... 45 Vice President-Manufacturing
W. Lynn Switzer....................... 47 Vice President-Quality Control
John A. Gula(1)(2).................... 55 Director
Linton E. Barbee(3)................... 57 Director
Hugh M. Morrison(1)(2)................ 48 Director
Robert C. Eberhart, Ph.D(3)........... 58 Director
Michael J. Torma, M.D(1).............. 53 Director
</TABLE>
- ---------------
(1) Member of the Compensation Committee of the Board of Directors.
(2) Member of the Stock Option Committee of the Board of Directors.
(3) Member of the Audit Committee of the Board of Directors.
Directors hold office until their term expires and until their successors
have been elected and qualified. Officers are appointed annually and serve at
the discretion of the Board of Directors. There are no family relationships
among executive officers or directors of the Company.
Mr. Thompson co-founded the Company and has been President and Director of
the Company since May 1979 and Chief Executive Officer since May 1984. From
January 1970 to September 1978, Mr. Thompson was President of Vicra Sterile,
Inc. ("Vicra"), a company that developed, manufactured and marketed specialty
medical devices in the field of intravenous therapy. Vicra was acquired by
Baxter Travenol, Inc. in January 1974.
Mr. Turner has been Executive Vice President and Chief Operating Officer of
the Company since April 1994. From August 1972 to April 1994, Mr. Turner was
employed by Texas Instruments in various capacities including Worldwide
Operations Manager of the Consumer Products Division from August 1990 to April
1994, Materials Manager Center Site and Operations Manager for the Defense Group
from October 1989 to August 1990 and as Quality Manager for the Electro-Optics
division of the Defense Group from July 1982 to October 1989.
Mr. Merrill has been Senior Vice President-Finance of the Company since
July 1995, Chief Financial Officer since April 1994, Secretary since February
1989 and Vice President-Finance and Treasurer since February 1981. Mr. Merrill
joined the Company in October 1979 as Director of Manufacturing Operations. Mr.
Merrill was employed by Vicra from October 1975 to October 1979, where he held
several positions including Production Manager, Materials Manager and
Controller.
Mr. Calhoun has been Vice President-Human Resources of the Company since
April 1995. From May 1992 to April 1995, Mr. Calhoun was Executive Director of
Hogan Quality Institute, a management
39
<PAGE> 42
consulting firm. From February 1988 to May 1992, Mr. Calhoun was the Vice
President of Human Resources and Corporate Quality Programs of Harris Adacom
Corporation, a data communications company.
Mr. Carlson has been Vice President of the Company since April 1995. Since
January 1993, Mr. Carlson has served as the President of Neuromed, and from
January 1990 to December 1992, served as its Vice President of Sales and
Marketing. Mr. Carlson has over 15 years of sales and marketing management
experience in electrical stimulation products with Pfizer, Inc., 3M, Medtronic,
Inc. and other medical ventures.
Mr. Dufford has been Vice President-Sales and Marketing of the Company
since June 1994. From January 1991 to May 1994, Mr. Dufford was employed by St.
Jude Medical, Inc., a medical device company, where he held various positions
within the sales and marketing area, including Director of International Sales
from January 1993 to May 1994, and as Domestic Regional Manager from January
1991 to December 1992. From June 1983 to December 1990, Mr. Dufford was employed
by Shiley, Inc. where he held various positions within the Cardiopulmonary
Division, including Regional Manager.
Mr. Jones has been Vice President-Research and Development of the Company
since March 1993. From August 1991 to February 1993, Mr. Jones was Director of
Research and Development of the Company. From March 1978 to July 1991, Mr. Jones
was employed by the Shiley Division of Pfizer, Inc. where he held various
positions in research and development including Manager of New Product
Development for Cardiopulmonary Products from March 1990 to July 1991.
Mr. Samples has been Vice President-Manufacturing of the Company since
March 1990. From November 1983 to February 1990, Mr. Samples was Director of
Manufacturing of the Company. He joined the Company in April 1982 as a project
manager in the research and development group.
Mr. Switzer has been Vice President-Quality of the Company since April 1991
and was Director of Quality of the Company from October 1990 to March 1991. From
September 1971 to September 1990, Mr. Switzer was employed by Baxter
International where he held various positions within the quality assurance area,
including Director of Regulatory Affairs and Quality Assurance.
Mr. Gula co-founded the Company and has been a Director of the Company
since its inception. Since January 1986, Mr. Gula has been an independent
healthcare consultant. Prior to 1986, Mr. Gula served as Executive Vice
President and Secretary of the Company for seven years.
Mr. Barbee has been a Director of the Company since 1983. Since October
1990, Mr. Barbee has been a partner with the law firm of Fulbright & Jaworski,
L.L.P. Prior to October 1990, Mr. Barbee was a partner with the law firm of
Hughes & Luce, L.L.P. for approximately four years.
Mr. Morrison has served as a Director of the Company since 1983. Mr.
Morrison has been engaged as an independent business consultant and investor
since January 1993. From 1989 through 1992, Mr. Morrison served as President and
Chief Executive Officer of American Funeral Services Corporation (formerly
Golden Era Services, Inc.). Mr. Morrison is a director of Owen Healthcare, Inc.,
and Equal Net Holding Corp. From March 1984 to October 1991, Mr. Morrison served
as a director of Dow B. Hickam, Inc., a pharmaceutical company.
Dr. Eberhart has served as Director of the Company since 1994 and also
serves on the Company's Board of Clinical Advisors. Since August 1990, Dr.
Eberhart has served as Chairman of the Board of the Biomedical Engineering
Program at the University of Texas Southwestern Medical Center at Dallas.
Dr. Torma has been a Director of the Company since 1994. Dr. Torma has
served as Chair of Surgical Services of Presbyterian Hospital of Dallas and
Chairman of the Institute for Surgical Sciences of Presbyterian Healthcare
Systems since October 1992. Prior to that time, Dr. Torma served as Command
Surgeon, Strategic Air Command of the USAF from August 1990 to September 1992
and Chief of Professional Affairs and Quality Assurance for the USAF Medical
Services from September 1988 to August 1990.
40
<PAGE> 43
EXECUTIVE COMPENSATION
Summary Compensation. The following table reflects, for the year ended
December 31, 1994, the cash and noncash compensation paid by the Company to the
Company's Chief Executive Officer and any other executive officer of the Company
whose salary and bonuses exceeded $100,000 for services rendered in all
capacities (the "Named Executive Officers").
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
ANNUAL COMPENSATION
---------------------- ALL OTHER
YEAR SALARY BONUS COMPENSATION(1)
---- -------- ------- ---------------
<S> <C> <C> <C> <C>
Thomas C. Thompson 1994 $168,480 $39,206 $ 4,500
Chief Executive Officer 1993 164,077 23,918 4,497
1992 162,000 21,393 4,364
David O. Turner 1994 84,675 18,911 --
Chief Operating Officer 1993 -- -- --
1992 -- -- --
F. Robert Merrill III 1994 92,150 12,185 3,057
Chief Financial Officer 1993 89,449 7,972 2,937
1992 88,320 6,702 2,496
</TABLE>
- ---------------
(1) Reflects matching employer contributions under the Company's Employees
Saving Plan (401K).
None of the Named Executive Officers received personal benefits, securities
or property in excess of the lesser of $50,000 or 10% of such individual's
reported salary and bonus. The Company did not grant any restricted stock
awards, long term incentive plan payouts or stock appreciation rights to the
Named Executive Officers in 1994, 1993 or 1992.
Option Grants. The following table sets forth the number of options granted
and the estimated exercisable value for Mr. Turner during the year ended
December 31, 1994. During such year, no options were granted to Messrs. Thompson
or Merrill and no SARs were granted to any of the Named Executive Officers.
OPTION GRANTS DURING YEAR ENDED DECEMBER 31, 1994
<TABLE>
<CAPTION>
NUMBER OF % OF TOTAL
SECURITIES OPTIONS
UNDERLYING GRANTED TO
OPTIONS EMPLOYEES IN EXERCISE OR EXPIRATION
NAME GRANTED FISCAL YEAR BASE PRICE DATE
------------------------------------ ---------- ------------ ----------- ----------
<S> <C> <C> <C> <C>
David O. Turner..................... 51,500 29% $4.61 April 2004
</TABLE>
The following table provides information related to options exercised by
the Named Executive Officers during the year ended December 31, 1994 and the
number and value of options held at year end. The Company does not have any SARs
outstanding.
AGGREGATE OPTION EXERCISES IN 1994
AND FISCAL YEAR-END 1994 OPTION VALUES
<TABLE>
<CAPTION>
NUMBER OF UNEXERCISED VALUE OF UNEXERCISED
OPTIONS AT FISCAL IN-THE-MONEY OPTIONS AT
SHARES YEAR-END FISCAL YEAR-END(1)
ACQUIRED ON VALUE --------------------------- ---------------------------
NAME EXERCISE REALIZED EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
- -------------------------- ----------- -------- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
Thomas C. Thompson........ 2,000 $10,850 116,170 -- $ 417,863 $ --
David O. Turner........... -- -- -- 51,500 -- 32,960
F. Robert Merrill III..... -- -- 41,457 3,863 140,620 9,039
</TABLE>
- ---------------
(1) Value based on the difference between the fair market value of the shares of
Common Stock at December 31, 1994, and the exercise price of the options.
41
<PAGE> 44
BENEFIT PLANS AND OTHER ARRANGEMENTS
1979 Stock Option Plan. Pursuant to the 1979 Stock Option Plan, officers
and other employees of the Company may receive options to purchase shares of
Common Stock. The 1979 Stock Option Plan was approved by the Board in 1979 and
amended and approved by the shareholders in 1992. The 1979 Stock Option Plan
provides for the grant of both incentive stock options intended to qualify for
preferential tax treatment under Section 422 of the Internal Revenue Code of
1986, as amended, and nonqualified stock options that do not qualify for this
treatment. The exercise price of all options granted under the 1979 Stock Option
Plan must equal or exceed the fair market value of the Common Stock at the time
of grant. The 1979 Stock Option Plan is administered by the Stock Option
Committee.
A total of 1,019,867 shares of Common Stock has been reserved for issuance
under the 1979 Stock Option Plan. As of November 6, 1995, there were outstanding
options to purchase an aggregate of 570,022 shares, at a weighted average
exercise price of $3.36 per share, pursuant to the 1979 Stock Option Plan. Only
7,705 shares of Common Stock remain available under the 1979 Stock Option Plan
for the grant of additional non-qualified stock options. (A total of 442,140
shares had previously been issued upon the exercise of stock options granted
under the plan.)
1987 Stock Option Plan. On December 22, 1987, the Board of Directors
approved the 1987 Stock Option Plan. Pursuant to the 1987 Stock Option Plan,
certain officers of the Company received options to purchase shares of Common
Stock. The 1987 Stock Option Plan provides for the grant of nonqualified stock
options that do not qualify for preferential tax treatment under Section 422 of
the Internal Revenue Code of 1986, as amended. The exercise price of all options
granted under the 1987 Stock Option Plan must equal or exceed the fair market
value of the Common Stock at the time of grant. The 1987 Stock Option Plan is
administered by the disinterested members of the Board of Directors.
A total of 302,910 shares of Common Stock has been reserved for issuance
under the 1987 Stock Option Plan. As of November 6, 1995, there were outstanding
options to purchase an aggregate of 95,910 shares, at a weighted average
exercise price of $1.45 per share pursuant to the 1987 Stock Option Plan. No
shares of Common Stock remain available under the 1987 Stock Option Plan for the
grant of additional stock options. (A total of 207,000 shares have been
previously issued upon the exercise of stock options granted under the plan.)
1995 Stock Option Plan. On March 30, 1995 and June 22, 1995, respectively,
the Board of Directors and shareholders of the Company approved the 1995 Stock
Option Plan. Pursuant to the 1995 Stock Option Plan, officers or other employees
of the Company or any of its subsidiaries (including Neuromed) are eligible to
receive stock option grants under the 1995 Stock Option Plan. The 1995 Stock
Option Plan provides for the grant of both incentive stock options intended to
qualify for preferential tax treatment under Section 422 of the Internal Revenue
Code of 1986, as amended, and nonqualified stock options that do not qualify for
this treatment. The exercise price of all options granted under the 1995 Stock
Option Plan must equal or exceed the fair market value of the Common Stock at
the time of grant. The 1995 Stock Option Plan is administered by the Stock
Option Committee.
A total of 250,000 shares of Common Stock has been reserved for issuance
under the 1995 Stock Option Plan; provided, however, that on January 1 of each
year (commencing on January 1, 1996), the aggregate number of shares of Common
Stock reserved for issuance under the Plan shall be increased by the same
percentage that the total number of issued and outstanding shares of Common
Stock increased from the preceding January 1 to the following December 31 (if
such percentage is positive). As of November 6, 1995, the Company had
outstanding options under the 1995 Stock Option Plan to purchase an aggregate of
207,000 shares, at a weighted average exercise price of $8.09 per share,
pursuant to the 1995 Stock Option Plan.
Directors' Plan. The Quest Medical, Inc. Directors' Stock Option Plan (the
"Directors' Plan") provides for grants of nonqualified stock options, which are
nontransferable, to purchase shares of Common Stock to directors and members of
the Advisory Board of the Company. Options granted
42
<PAGE> 45
under the Directors' Plan vest ratably over a four-year period and the exercise
period for such options cannot exceed six years. Under the Directors' Plan, the
option price per share cannot be less than the fair market value per share on
the date the option is granted. The Company has reserved 557,635 shares of
Common Stock for issuance under the Directors' Plan. As of November 6, 1995, the
Company had outstanding options to purchase an aggregate of 239,716 shares, at a
weighted average exercise price of $3.74 per share pursuant to the Directors'
Plan. Only 67,750 shares of Common Stock remain available under the Directors'
Plan for the grant of additional stock options. (A total of 250,169 shares have
been previously issued upon exercise of stock options granted under the plan.)
The Directors' Plan is administered by the Stock Option Committee.
During the year ended December 31, 1994, two directors were granted options
under the Directors' Plan. Robert C. Eberhart, Ph.D. was granted options to
purchase 15,450 shares of Common Stock at an exercise price of $4.245 and
Michael J. Torma, M.D. was granted options to purchase 15,000 shares of Common
Stock at an exercise price of $6.375. During the year ended December 31, 1994,
no options were exercised under the Directors' Plan; however, during April 1995,
two directors exercised options which were scheduled to expire during May and
August 1995. Linton E. Barbee purchased 15,450 shares of Common Stock at an
exercise price of $2.18. The net value of such securities to Mr. Barbee at the
time of exercise (market value less exercise price) was $78,331. Hugh M.
Morrison purchased 6,180 shares of Common Stock at an exercise price of $1.45.
The net value of such securities to Mr. Morrison was $38,161. In June 1995,
Michael J. Torma, M.D. exercised options to purchase 3,750 shares of Common
Stock at an exercise price of $6.375. The net value of such securities to Dr.
Torma at the time of exercise was $19,688.
As of November 6, 1995, the Company had outstanding options to purchase an
aggregate of 146,324 shares of Common Stock at a weighted average exercise price
of $3.92 per share under the Directors' Plan to the members of the Advisory
Board. Certain members of the Advisory Board also provide consulting services to
the Company for which they are compensated through separate agreements.
Employees Savings Plan. The Company has established a Employees Savings
Plan (the "Savings Plan"), which is qualified under Sections 401(a) and 401(k)
of the Code, pursuant to which all full-time employees of the Company may elect
to have the Company make certain salary reduction contributions on their behalf.
Under the Savings Plan, with certain limited exceptions, an employee may elect
to contribute up to 15% of his total compensation to the plan on a pre-tax
basis, and requires the Company to make matching contributions equal to 50% of a
participant's salary deferral, to a maximum of salary deferral contributions
equal to 6% of the participant's total cash compensation, up to $150,000. The
amount of the matching employer contribution may be increased or decreased at
the discretion of the Board of Directors. During the year ended December 31,
1994, the Company committed to contribute approximately $102,961 to the Savings
Plan.
INDEMNIFICATION AND LIMITATION OF LIABILITY
The Company's Articles of Incorporation include a provision eliminating or
limiting director liability to the Company and its shareholders for monetary
damages arising from acts or omissions in the director's capacity as a director.
Consistent with the Texas Business Corporation Act, the Company's Articles of
Incorporation do not eliminate or limit a director's liability to the extent the
director is found liable for (i) a breach of the director's duty of loyalty to
the Company or its shareholders, (ii) an act or omission not in good faith that
constitutes a breach of duty of the director to the Company or an act or
omission that involves intentional misconduct or a knowing violation of the law,
(iii) a transaction from which the director received an improper benefit,
whether or not the benefit resulted from an action taken within the scope of the
director's office, (iv) an act or omission for which the liability of a director
is expressly provided by an applicable statute, or (v) an act related to an
unlawful stock repurchase or payment of a dividend.
43
<PAGE> 46
In addition, the Company maintains insurance on behalf of its directors and
executive officers insuring them against any liability asserted against them in
their capacities as directors or officers or arising out of such status.
DIRECTORS' COMPENSATION
Non-management directors receive $1,000 for each Board of Directors meeting
attended and reimbursement for expenses incurred in attending such meetings.
Non-management directors who serve on committees do not receive additional
compensation for serving on such committees.
See "-- Benefit Plans and Other Arrangements -- Directors' Plan" for a
description of options granted to and exercises of options by directors of the
Company.
CERTAIN TRANSACTIONS
On March 31, 1995, the Company acquired all of the issued and outstanding
capital stock of Neuromed, which was held by Mr. William Borkan and his brother,
Mr. Burt Borkan. The Neuromed Acquisition has been accounted for as a purchase.
The Company paid the Borkans $15.4 million in cash ($200,000 of which was paid
in June 1995 as a purchase price adjustment) and issued them 833,333 shares of
Common Stock valued at $6.5 million. Depending on Neuromed's attainment of
certain sales objectives, the Company agreed to pay the Borkans' contingent
"earn-out" consideration in January 1996 and January 1997, payable in a
combination of cash and Common Stock. The Company and Mr. William Borkan also
entered into a consulting agreement pursuant to which 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. In June 1995, Mr. William Borkan was elected to the
Company's Board of Directors.
In September 1995, the Company and Mr. William Borkan amended certain terms
of the Neuromed acquisition agreement. Under the amendment, (i) the Company
agreed to issue Mr. Borkan 200,000 additional shares of Common Stock
concurrently with the closing of the Offering and pay Mr. Borkan $1.5 million in
cash in January 1996 to satisfy the 1996 contingent payment obligation, which
had been earned in July 1995, (ii) the Company agreed to include all of the
Borkans' Common Stock (1,033,333 shares) in this Offering, (iii) Mr. Borkan
resigned from the Company's Board of Directors and relinquished his board
representation and attendance rights, (iv) Mr. Borkan relinquished his
registration rights, and (v) in the event the 1997 contingent earn-out payment
is fully earned, the Company agreed to pay Mr. Borkan an amount in cash equal to
$1.5 million plus the value of 200,000 shares of Common Stock at the net
Offering price. In the event the Offering is not consummated, among other
things, Mr. Borkan will regain his board representation and attendance rights
and his registration rights.
The Company has engaged the services of the law firm Fulbright & Jaworski,
L.L.P. located in Dallas, Texas. Mr. Linton E. Barbee, a director of the
Company, is a partner of such firm.
44
<PAGE> 47
PRINCIPAL AND SELLING SHAREHOLDERS
The following table sets forth for certain information with regard to the
beneficial ownership of the Common Stock of the Company as of November 6, 1995,
and as adjusted to reflect the sale of shares offered hereby: (i) each
shareholder who will sell shares of Common Stock in this Offering (the "Selling
Shareholders"); (ii) each shareholder who was known by the Company to be the
beneficial owner of more than 5% of the outstanding Common Stock; (iii) each
director and Named Executive Officer of the Company; and (iv) all directors and
executive officers of the Company as a group.
<TABLE>
<CAPTION>
SHARES SHARES
BENEFICIALLY BENEFICIALLY
OWNED PRIOR TO OWNED AFTER THE
THE OFFERING(1) NUMBER OF SHARES OFFERING(1)(2)
----------------- TO BE SOLD IN -----------------
BENEFICIAL OWNER NUMBER PERCENT THE OFFERING NUMBER PERCENT
- --------------------------------------------- ------- ------- ---------------- ------- -------
<S> <C> <C> <C> <C> <C>
William N. Borkan............................ 989,333 15.4% 989,333 -- --
3364 N.E. 167th Street
North Miami Beach, Florida 33160
John A. Gula(4).............................. 338,098 5.3% 50,000 288,098 3.6%
454 River Road
Fair Haven, New Jersey 07704
Burt Borkan.................................. 44,000 * 44,000 -- --
3031 Prairie Avenue
Miami Beach, Florida 33140
The Equitable Companies Incorporated(3)...... 559,187 8.7% -- 559,187 7.1%
787 Seventh Avenue
New York, New York 10019
Dimensional Fund Advisors,Inc. (5)........... 331,118 5.2% -- 331,118 4.2%
1299 Ocean Avenue, 11th Floor
Santa Monica, California 90401
Thomas C. Thompson(6)........................ 344,570 5.3% -- 344,570 4.3%
One Allentown Parkway
Allen, Texas 75002
Linton E. Barbee(4).......................... 15,300 * -- 15,300 *
Robert C. Eberhart, Ph.D.(7)................. 11,588 * -- 11,588 *
F. Robert Merrill III(8)..................... 43,385 * -- 43,385 *
Hugh M. Morrison(4).......................... 25,750 * -- 25,750 *
Michael J. Torma, M.D........................ -- -- -- -- --
David O. Turner (7).......................... 12,875 * -- 12,875 *
All directors and executive officers as a
group
(14 persons)(9)............................ 902,101 13.5% 50,000 852,101 10.4%
</TABLE>
- ---------------
* Less than 1.0%.
(1) Unless otherwise noted and subject to community property laws, where
applicable, the persons named in the table above have sole voting and
investment power with respect to all shares of Common Stock shown as
beneficially owned by them.
(2) Shares not outstanding but deemed beneficially owned by virtue of the right
of a person or member of a group to acquire them within 60 days are treated
as outstanding only when determining the amount and percent owned by such
person or group.
(3) Based on information obtained by the Company from Schedule 13G filed by The
Equitable Companies Incorporated ("The Equitable"), pursuant to a Joint
Filing Agreement among The Equitable, Alpha Assurances I.A.R.D. Mutuelle,
Alpha Assurances Vie Mutuelle, AXA Assurances
45
<PAGE> 48
I.A.R.D. Mutuelle, AXA Assurances Vie Mutuelle, and Uni Europe Assurance
Mutuelle, and AXA, dated February 10, 1995. Alliance Capital Management
L.P., a subsidiary of The Equitable, is deemed to have beneficial ownership
of 559,187 shares of the Company's Common Stock, as of December 31, 1994.
(4) Includes 10,300 shares subject to options.
(5) Based on information obtained by the Company from Schedule 13G filed by
Dimensional Fund Advisors, Inc. ("Dimensional") dated January 31, 1995.
Dimensional, a registered investment advisor, is deemed to have beneficial
ownership of 331,118 shares of the Company's Common Stock as of December
31, 1994, all of which shares are held in portfolios of DFA Investment
Dimensions Group Inc., a registered open-end investment company, or in
series of the DFA Investment Trust Company, a Delaware business trust, or
the DFA Group Trust and the DFA Participating Group Trust, investment
vehicles for qualified employee benefit plans, all of which Dimensional
serves as investment manager.
(6) Includes 116,170 shares subject to options.
(7) Consists entirely of shares subject to options.
(8) Includes 43,320 shares subject to options.
(9) Includes 294,140 shares subject to options.
DESCRIPTION OF CAPITAL STOCK
COMMON STOCK
The Company is authorized to issue 10,000,000 shares of Common Stock, $.05
par value per share. As of the date of this Prospectus, 6,437,454 shares of
Common Stock are issued and outstanding (excluding treasury shares but including
200,000 shares to be issued to William N. Borkan upon the closing of the
Offering) and held of record by approximately 850 shareholders. An additional
1,287,003 shares are reserved for issuance upon exercise of employee and
director options, of which options to purchase 1,168,548 shares have been
granted at exercise prices ranging from $1.45 to $12.13 per share. See
"Management -- Benefits Plans and Other Arrangements." The Company will hold
155,571 shares in its treasury following the Offering.
Holders of Common Stock are entitled to receive such dividends, if any, as
may be declared by the Board of Directors out of legally available funds. In the
event of the liquidation, dissolution or winding up of the Company, holders of
Common Stock are entitled to share equally and ratably, based on the number of
shares held, in the assets, if any, remaining after payment of all of the
Company's debts and liabilities.
Holders of Common Stock are entitled to one vote per share for each share
held of record on any matter submitted to the holders of Common Stock for a
vote. Because holders of Common Stock do not have cumulative voting rights, the
holders of a majority of the shares of Common Stock represented at a meeting can
elect all the directors. Holders of Common Stock do not have preemptive rights
to subscribe for or purchase any additional shares of capital stock issued by
the Company. All outstanding shares of the Common Stock are, and the shares of
Common Stock offered hereby will be when issued, duly authorized, validly
issued, fully paid and nonassessable.
TRANSFER AGENT AND REGISTRAR
KeyCorp Shareholder Services, Inc. is the transfer agent and registrar for
the Common Stock.
SHAREHOLDERS' RIGHTS PLAN
The Company has a Shareholders' Rights Plan that may make the acquisition
of control of the Company by means of tender offer, open market purchase, proxy
contest or otherwise more difficult.
46
<PAGE> 49
Each share of Common Stock has associated with it one Common Stock purchase
right ("Right") to purchase from the Company one-half a share of Common Stock at
a price of $12.50 (the "Purchase Price"), subject to adjustment. The description
of and terms of the Rights are set forth in a Rights Agreement dated October 12,
1989 between the Company and MTrust Corp., N.A., as amended by that Amendment of
Rights Agreement dated as of February 9, 1995 (as amended, the "Rights
Agreement"), between the Company and KeyCorp Shareholder Services, Inc. (the
"Rights Agent"). Until the earlier to occur of: (i) 10 days following a public
announcement that a person or group of affiliated or associated persons has
acquired, or obtained the right to acquire, beneficial ownership of 15% or more
of the outstanding shares of Common Stock, except the Company, any subsidiary of
the Company, any employee benefit plan of the Company or William Borkan so long
as Mr. Borkan's beneficial ownership does not exceed 25% of the Common Stock
outstanding or any person who acquires beneficial ownership in a Permitted
Transaction or a Qualified Offer (an "Acquiring Person"); or (ii) 10 days (or
such later date as may be determined by action of the Board of Directors prior
to any person becoming an Acquiring Person) following the commencement of, or
announcement of an intention to make, a tender offer or exchange offer, the
consummation of which would result in the beneficial ownership by a person or
group of 20% or more of such outstanding shares of Common Stock (the earlier of
such dates being the "Distribution Date"), the Rights are evidenced by the
Common Stock certificates.
The Rights Agreement provides that, until the Distribution Date, the Rights
will be transferred with and only with the Common Stock. Until the Distribution
Date (or earlier redemption or expiration of the Rights), new Common Stock
certificates issued upon transfer or new issuance of Common Stock will contain
the notation incorporating the Rights Agreement by reference. As soon as
practicable following the Distribution Date, separate certificates evidencing
the Rights (the "Rights Certificates") will be mailed to holders of record of
the Common Stock as of the close of business on the Distribution Date and such
separate Right Certificates alone will evidence the Rights. The Rights are not
exercisable until the Distribution Date and will expire on October 12, 1999 (the
"Final Expiration Date"), unless extended or unless the Rights are earlier
redeemed by the Company.
The Purchase Price payable and the number of shares of Common Stock or
other securities or property issuable upon exercise of the Rights are subject to
adjustment in certain circumstances. In the event any person or entity becomes
an Acquiring Person and one of the following events have occurred, then proper
provision will be made so that each holder of a right, other than Rights
beneficially owned by the Acquiring Person (which will then be void), will have
the right to receive upon exercise that number of shares of Common Stock having
a market value of two times the applicable exercise price of the Right: (i) the
Company is the surviving corporation in a merger with an Acquiring Person and
the Common Stock is not changed or exchanged; (ii) the Acquiring Person engages
in certain self-dealing transactions with the Company; (iii) any person becomes
the beneficial owner of 20% or more of the outstanding shares of Common Stock
(unless the event in which such person acquired 20% or more of the outstanding
shares of Common Stock is a Permitted Transaction or pursuant to a Qualifying
Offer, each of which is defined below); or (iv) the Company engages in a
reclassification or recapitalization that results in an increase of 1% or more
in the Acquiring Person's percentage of ownership of the Company.
A Permitted Transaction is a stock acquisition or tender or exchange offer
pursuant to a definitive agreement which would result in a person beneficially
owning 50% or more of the Common Stock and which was approved by the Directors
(including a majority of the Directors not in association with an Acquiring
Person) prior to the execution of the Agreement or the public announcement of
the offer. A Qualifying Offer is defined as: an all-cash tender offer for 100%
of the outstanding securities of the Company; includes a commitment to pay cash
consideration at least equal to the highest per share consideration paid by the
tender offeror for the Company's securities within the previous 12-month period;
includes the tender offeror's undertaking to complete a second-step, "clean up"
merger in which the tender offeror will pay the same cash consideration as in
the tender offer; and results in the acquisition of a majority of the
outstanding securities of the Company. In the event that the Company is acquired
in a merger or other business combination transaction or 50% or more if its
consolidated
47
<PAGE> 50
assets or earning power are sold, unless such event is a Permitted Transaction
or pursuant to a Qualifying Offer, proper provisions will be made so that each
holder of a Right will have the right to receive, upon the exercise of the Right
at the then applicable exercise price, that number of shares of common stock of
the acquiring company that at the time of such transaction will have a market
value of two times the applicable exercise price of the Right. At any time prior
to the tenth day following an Acquiring Person's acquisition of 15% or more of
the outstanding Common Stock, the Board of Directors of the Company, with
concurrence of a majority of the directors in office at the time the Rights
Agreement was adopted or whose initial election or nomination for election by
the Company's shareholders was approved by a majority of the Continuing
Directors then serving on the Board of Directors (the "Continuing Directors"),
may redeem the Rights in whole, but not in part, at a price of $0.01 per Right.
In addition, the Board of Directors may extend or reduce the period during which
the Rights are redeemable, so long as the Rights are redeemable at the time of
such extension or reduction. Immediately upon any redemption of the Rights, the
right to exercise the Rights will terminate and the only right of the holders of
Rights will be to receive the Redemption Price. The terms of the Rights may be
amended by the Board of Directors of the Company, with concurrence of a majority
of the Continuing Directors, without the consent of the holders of the Rights,
including an amendment to extend the Final Expiration Date, except that from and
after the Distribution Date no such amendment may adversely affect the economic
interests of the holders of the Rights.
UNDERWRITING
Subject to the terms and conditions of the Underwriting Agreement, the
underwriters named below (the "Underwriters") for whom Vector Securities
International, Inc. and Rauscher Pierce Refsnes, Inc. are acting as
representatives (the "Representatives") have severally agreed to purchase from
the Company and the Selling Shareholders the following respective number of
shares of Common Stock.
<TABLE>
<CAPTION>
NUMBER OF
UNDERWRITERS SHARES
------------------------------------------------------------------------- ---------
<S> <C>
Vector Securities International, Inc. ...................................
Rauscher Pierce Refsnes, Inc. ...........................................
---------
Total.......................................................... 2,600,000
=========
</TABLE>
The Underwriting Agreement provides that the obligations of the
Underwriters are subject to certain conditions precedent, including the absence
of any material adverse change in the Company's business and the receipt of
certain certificates, opinions and letters from the Company, the Selling
Shareholders and their respective counsel. The nature of the Underwriters'
obligation is such that they are committed to purchase all shares of Common
Stock offered hereby if any of such shares are purchased. The Underwriting
Agreement contains certain provisions whereby if any Underwriter defaults in its
obligation to purchase shares, and the aggregate obligations of the Underwriters
so defaulting do not exceed 10% of the shares offered hereby, the remaining
Underwriters, or some of them, must assume such obligations.
The Representatives have advised the Company that the Underwriters propose
to offer the shares of Common Stock directly to the public at the public
offering price set forth on the cover of this Prospectus, and to certain dealers
at such price less a concession not in excess of $ per share. The
Underwriters may allow, and such dealers may reallow, a concession not in excess
of $ per share to certain other dealers. After the public offering of
the shares of Common Stock, the offering price and other selling terms may be
changed by the Underwriters.
48
<PAGE> 51
The Company has granted to the Underwriters an option, exercisable no later
than 30 days after the date of this Prospectus, to purchase up to 390,000
additional shares of Common Stock to cover over-allotments, if any, at the
public offering price, less underwriting discounts and commissions, set forth on
the cover page of this Prospectus. To the extent that the Underwriters exercise
this option, each of the Underwriters will have a firm commitment to purchase
approximately the same percentage thereof which the number of shares of Common
Stock to be purchased by it shown in the above table bears to the total number
of shares of Common Stock offered hereby. The Company will be obligated,
pursuant to the option, to sell such shares to the Underwriters to the extent
the option is exercised. If purchased, the Underwriters shall offer such
additional shares on the same terms as those on which the shares are being
offered hereby.
The offering of the shares is made for delivery when, as and if accepted by
the Underwriters and subject to prior sale and to withdrawal, cancellation or
modification of the Offering without notice. The Underwriters reserve the right
to reject an order for the purchase of shares in whole or in part.
The Company and the Selling Shareholders have agreed to indemnify the
Underwriters against certain liabilities, including liabilities under the
Securities Act of 1933, as amended (the "Securities Act") and to contribute to
payments the Underwriters may be required to make in respect thereof.
The executive officers, directors, and certain other employees and
shareholders of the Company have agreed that they will not, without the prior
written consent of the Representatives, offer, sell or otherwise dispose of any
shares of Common Stock, options or warrants to acquire shares of Common Stock or
securities exchangeable for or convertible into shares of Common Stock owned by
them for a period of 120 days after the date of this Prospectus. The Company has
agreed that it will not, without the prior written consent of the
Representatives, offer, sell or otherwise dispose of any shares of Common Stock,
options or warrants to acquire shares of Common Stock or securities exchangeable
for or convertible into shares of Common Stock for a period of 120 days after
the date of this Prospectus, except that the Company may grant additional
options under its stock option plans, or issue shares upon the exercise of
outstanding stock options.
In connection with this offering certain Underwriters and selling group
members (if any) who are qualifying registered market makers on the Nasdaq
National Market may engage in passive market-making transactions in the Common
Stock on the Nasdaq National Market in accordance with Rule 10b-6A under the
Securities Exchange Act of 1934 during the two business day period before
commencement of sales in this offering. The passive market making transactions
must comply with applicable volume and price limits and be identified as such.
In general, a passive market maker may display its bid at a price not in excess
of the highest independent bid for the security. If all independent bids are
lowered below the passive market maker's bid, however, such bid must then be
lowered when certain purchase limits are exceeded. Net purchases by a passive
market maker on each day are generally limited to a specified percentage of the
passive market making average daily trading volume in the Common Stock during a
price period and must be discontinued when such limit is reached. Passive market
making may stabilize the market price of the Common Stock at a level above that
which might otherwise prevail, and, if commenced, may be discontinued at any
time.
LEGAL MATTERS
The validity of the shares of Common Stock offered hereby will be passed
upon for the Company by Hughes & Luce, L.L.P., Dallas, Texas. Certain legal
matters in connection with the sale of shares of Common Stock in the Offering
will be passed upon for the Underwriters by Venture Law Group, A Professional
Corporation, Menlo Park, California.
49
<PAGE> 52
EXPERTS
The Consolidated Financial Statements of the Company at December 31, 1993
and 1994, and for each of the three years in the period ended December 31, 1994,
and the Consolidated Financial Statements of Neuromed at October 31, 1994, and
for each of the two years in the period ended October 31, 1994 appearing in this
Prospectus and Registration Statement have been audited by Ernst & Young LLP,
independent auditors, as set forth in their reports thereon appearing elsewhere
herein and in the Registration Statement, and are included in reliance upon such
reports, given upon the authority of such firm as experts in accounting and
auditing.
The statements in this Prospectus under the captions "Risk
Factors -- Dependence on Patents and Proprietary Rights" and
"Business -- Patents, Trademarks and Proprietary Rights" have been reviewed and
approved by Ross, Clapp, Korn & Montgomery, L.L.P., patent counsel for the
Company, as experts on such matters, and are included herein in reliance upon
that review and approval.
ADDITIONAL INFORMATION
The Company has filed with the Securities and Exchange Commission (the
"Commission") a Registration Statement under the Securities Act, with respect to
the shares of Common Stock offered hereby. This Prospectus does not contain all
the information set forth in the Registration Statement and the exhibits and
schedules thereto. For further information with respect to the Company and the
Common Stock offered hereby, reference is made to the Registration Statement and
to the exhibits and schedules filed therewith. Statements contained in this
Prospectus as to the contents of any contract or other document referred to are
not necessarily complete, and in each instance reference is made to the copy of
such contract or other document filed as an exhibit to the Registration
Statement. The Registration Statement, together with the exhibits and schedules
thereto, may be inspected without charge at the offices of the Commission at 450
Fifth Street, N.W., Washington, D.C. 20549, or at its regional offices located
at 500 West Madison Street, Chicago, Illinois 60661, and copies of all or any
part of the Registration Statement may be obtained from the Public Reference
Section of the Commission, 450 Fifth Street, N.W., Washington, D.C. 20549 at
prescribed rates.
The Company is subject to the information requirements of the Securities
and Exchange Act of 1934, as amended, and in accordance therewith files reports,
proxy statements and other information with the Commission. Such reports, proxy
statements and other information can be inspected and copied at the public
reference facilities of the Commission at Room 1024, 450 Fifth Street N.W.,
Washington, D.C. 20549; and at the Commission's regional offices at Northwestern
Atrium Center, Suite 1400, 500 West Madison Street, Chicago, Illinois 60661 and
14th Floor, 75 Park Place, 14th Floor, New York, New York 10007. Copies of such
material can be obtained from the Public Reference Section of the Commission at
450 Fifth Street N.W., Washington D.C. 20549 at prescribed rates.
50
<PAGE> 53
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
HISTORICAL:
Quest Medical, Inc.:
Report of Ernst & Young LLP, Independent Auditors................................ F-2
Consolidated Balance Sheets as of December 31, 1993 and 1994 and June 30, 1995
(unaudited)..................................................................... F-3
Consolidated Statements of Operations for the years ended December 31, 1992, 1993
and 1994 and for the six months ended June 30, 1994 and 1995 (unaudited)........ F-4
Consolidated Statements of Stockholders' Equity for the years ended December 31,
1992, 1993 and 1994 and for the six months ended June 30, 1995 (unaudited)...... F-5
Consolidated Statements of Cash Flows for the years ended December 31, 1992, 1993
and 1994 and for the six months ended June 30, 1994 and 1995 (unaudited)........ F-6
Notes to Consolidated Financial Statements....................................... F-7
Neuromed, Inc.:
Report of Ernst & Young LLP, Independent Auditors................................ F-18
Consolidated Balance Sheet as of October 31, 1994 and January 31, 1995
(unaudited)..................................................................... F-19
Consolidated Statements of Income and Retained Earnings for the years ended
October 31, 1993 and 1994 and for the three months ended January 31, 1994 and
1995 (unaudited)................................................................ F-20
Consolidated Statements of Cash Flows for the years ended October 31, 1993 and
1994 and for the three months ended January 31, 1994 and 1995 (unaudited)....... F-21
Notes to Consolidated Financial Statements....................................... F-22
PRO FORMA:
Quest Medical, Inc. and Neuromed, Inc.:
Unaudited Pro Forma Condensed Consolidated Statement of Operations for the year
ended December 31, 1994......................................................... F-26
Unaudited Pro Forma Condensed Consolidated Statement of Operations for the six
months ended June 30, 1995...................................................... F-27
Notes to Unaudited Pro Forma Condensed Consolidated Statements of Operations..... F-28
</TABLE>
F-1
<PAGE> 54
REPORT OF INDEPENDENT AUDITORS
The Board of Directors
Quest Medical, Inc.
We have audited the accompanying consolidated balance sheets of Quest
Medical, Inc. and subsidiaries (the Company) as of December 31, 1993 and 1994,
and the related consolidated statements of operations, stockholders' equity, and
cash flows for each of the three years in the period ended December 31, 1994.
These consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Quest Medical,
Inc. and subsidiaries at December 31, 1993 and 1994, and the consolidated
results of their operations and their cash flows for each of the three years in
the period ended December 31, 1994, in conformity with generally accepted
accounting principles.
As discussed in Note 1 to the financial statements, in 1993 the Company
changed its method of accounting for certain investments in debt and equity
securities.
ERNST & YOUNG LLP
Dallas, Texas
February 24, 1995
F-2
<PAGE> 55
QUEST MEDICAL, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
ASSETS
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------ JUNE 30,
1993 1994 1995
---------- ---------- -----------
(UNAUDITED)
<S> <C> <C> <C>
Current assets:
Cash and cash equivalents............................................................ $ 594,448 $ 87,963 $ 298,886
Marketable securities................................................................ 5,999,701 5,174,470 4,407,627
Receivables:
Trade accounts, less allowance for doubtful accounts of $16,135 in 1993, $14,337 in
1994 and $114,337 in 1995......................................................... 2,047,707 1,671,684 4,464,941
Due from broker on unsettled security transactions................................. 637,390 -- --
Interest and other................................................................. 184,293 172,969 294,805
----------- ----------- -----------
Total receivables.............................................................. 2,869,390 1,844,653 4,759,746
----------- ----------- -----------
Inventories:
Raw materials...................................................................... 1,363,340 1,322,498 2,420,492
Work-in-process.................................................................... 426,138 580,432 1,164,654
Finished goods..................................................................... 2,220,445 2,084,522 2,740,156
----------- ----------- -----------
Total inventories.............................................................. 4,009,923 3,987,452 6,325,302
----------- ----------- -----------
Prepaid expenses and other current assets............................................ 429,131 484,406 781,567
----------- ----------- -----------
Total current assets........................................................... 13,902,593 11,578,944 16,573,128
----------- ----------- -----------
Property, plant and equipment:
Land................................................................................. 1,930,289 1,930,289 1,930,289
Building............................................................................. 5,073,809 5,215,454 5,221,434
Leasehold improvements............................................................... 28,804 43,522 43,522
Furniture and fixtures............................................................... 2,579,121 2,587,738 2,858,236
Machinery and equipment.............................................................. 2,779,836 2,722,868 3,554,697
----------- ----------- -----------
12,391,859 12,499,871 13,608,178
Less accumulated depreciation and amortization....................................... 3,071,368 2,867,453 3,331,750
----------- ----------- -----------
Net property, plant and equipment................................................ 9,320,491 9,632,418 10,276,428
----------- ----------- -----------
Cost in excess of net assets acquired, net of accumulated amortization of $58,797 in
1993, $99,550 in 1994 and $159,359 in 1995........................................... 954,409 913,656 3,929,186
Patents, net of accumulated amortization of $629,498 in 1993, $857,965 in 1994,
and $972,199 in 1995................................................................. 1,745,901 1,517,434 1,403,200
Purchased technology from acquisitions, net of accumulated amortization of $112,457 in
1993, $163,007 in 1994 and $254,950 in 1995.......................................... 585,543 534,993 4,443,050
Tradenames, net of accumulated amortization of $31,250 in 1995......................... -- -- 2,468,750
Deferred income taxes.................................................................. -- -- 2,083,426
Other assets, at cost less accumulated amortization of $98,167 in 1993, $141,167 in
1994, and $185,763 in 1995........................................................... 229,995 57,464 474,801
----------- ----------- -----------
$26,738,932 $24,234,909 $41,651,969
=========== =========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable..................................................................... $ 1,276,375 $ 951,208 $ 2,584,844
Loans payable and current maturities of notes payable................................ 2,297,211 2,759,241 2,307,573
Accrued lease obligation............................................................. 169,129 -- --
Accrued vacations.................................................................... 119,949 125,012 137,557
Accrued contribution to retirement savings plan...................................... 86,903 92,548 142,523
Accrued property taxes............................................................... 136,153 -- 20,105
Other accrued expenses............................................................... 250,550 240,230 568,394
----------- ----------- -----------
Total current liabilities...................................................... 4,336,270 4,168,239 5,760,996
----------- ----------- -----------
Notes payable.......................................................................... 4,100,882 4,123,853 20,830,456
Deferred income taxes.................................................................. 49,998 11,837 2,560,173
Commitments and contingencies
Stockholders' equity:
Common stock, $.05 par value; Authorized 10,000,000 shares; issued 7,939,441 shares
in 1993, 7,982,498 shares in 1994, and 8,072,994 shares in 1995.................... 396,972 399,125 403,650
Additional paid-in capital........................................................... 18,787,628 19,514,171 24,443,640
Retained earnings (deficit).......................................................... 5,430,286 2,794,118 (7,819,188)
Unrealized loss on marketable securities............................................. (169,308) (917,634) (473,653)
Cost of common shares in treasury; 2,860,527 shares in 1993, 2,705,816 shares in
1994, and 1,872,238 shares in 1995 ................................................ (6,193,796) (5,858,800) (4,054,105)
----------- ----------- -----------
Total stockholders' equity..................................................... 18,251,782 15,930,980 12,500,344
----------- ----------- -----------
$26,738,932 $24,234,909 $41,651,969
=========== =========== ===========
</TABLE>
See accompanying notes to consolidated financial statements
F-3
<PAGE> 56
QUEST MEDICAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31, SIX MONTHS ENDED JUNE 30,
--------------------------------------- -------------------------
1992 1993 1994 1994 1995
----------- ----------- ----------- ---------- ------------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Net revenue................................... $13,612,378 $13,642,764 $13,999,165 $7,223,316 $ 11,303,134
Cost of revenue............................... 7,059,045 7,052,157 7,617,932 4,027,812 4,910,490
----------- ----------- ----------- ---------- ------------
Gross profit............................. 6,553,333 6,590,607 6,381,233 3,195,504 6,392,644
----------- ----------- ----------- ---------- ------------
Operating expenses:
General and administrative.................. 2,493,066 2,481,476 3,063,296 1,485,021 1,917,753
Research and development.................... 1,387,237 1,909,589 3,542,193 1,538,856 2,493,643
Non-recurring charges....................... 1,246,913 -- -- -- 10,500,000
Marketing................................... 1,648,252 1,918,285 1,913,793 890,433 1,593,570
----------- ----------- ----------- ---------- ------------
6,775,468 6,309,350 8,519,282 3,914,310 16,504,966
----------- ----------- ----------- ---------- ------------
Earnings (loss) from operations.......... (222,135) 281,257 (2,138,049) (718,806) (10,112,322)
Other income (expense):
Gain on sale of marketable securities....... 136,840 462,178 464,113 167,451 12,031
Unrealized loss on marketable securities.... -- (169,308) -- -- --
Relocation costs............................ -- (174,083) -- -- --
Litigation settlements, net................. -- 167,088 -- -- --
Interest expense............................ (110,466) (81,800) (569,428) (252,724) (730,971)
Investment and other income................. 446,688 462,474 524,171 263,635 217,956
----------- ----------- ----------- ---------- ------------
473,062 666,549 418,856 178,362 (500,984)
----------- ----------- ----------- ---------- ------------
Earnings (loss) before income taxes and
cumulative effect of change in
accounting principle................... 250,927 947,806 (1,719,193) (540,444) (10,613,306)
Income taxes:
Current..................................... 40,730 250,769 -- -- --
Deferred.................................... 16,584 50,000 -- -- --
----------- ----------- ----------- ---------- ------------
57,314 300,769 -- -- --
----------- ----------- ----------- ---------- ------------
Earnings (loss) before cumulative effect
of change in accounting principle...... 193,613 647,037 (1,719,193) (540,444) (10,613,306)
Cumulative effect of change in accounting
principle................................... -- 169,308 -- -- --
----------- ----------- ----------- ---------- ------------
Net earnings (loss)...................... $ 193,613 $ 816,345 $(1,719,193) $ (540,444) $(10,613,306)
=========== =========== =========== ========== ============
Per common and common equivalent share:
Earnings (loss) before cumulative effect of
change in accounting principle........... $ .03 $ .12 $ (.33) $ (.10) $ (1.85)
Cumulative effect of change in accounting
principle................................ -- .03 -- -- --
----------- ----------- ----------- ---------- ------------
Net earnings (loss)...................... $ .03 $ .15 $ (.33) $ (.10) $ (1.85)
=========== =========== =========== ========== ============
</TABLE>
See accompanying notes to consolidated financial statements
F-4
<PAGE> 57
QUEST MEDICAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
UNREALIZED
COMMON STOCK ADDITIONAL RETAINED LOSS ON TOTAL
-------------------- PAID-IN EARNINGS MARKETABLE TREASURY STOCKHOLDERS'
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
from treasury.................. -- -- -- -- -- 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
Stock dividend................... -- -- 586,054 (916,975) -- 330,921 --
Adjustment to unrealized losses
on
marketable securities.......... -- -- -- -- (748,326) -- (748,326)
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.................. 90,496 4,525 274,088 -- -- -- 278,613
Issuance of 245 common shares
from treasury.................. -- -- 1,216 -- -- 529 1,745
Adjustment to unrealized losses
on
marketable securities.......... -- -- -- -- 443,981 -- 443,981
Issuance of 833,333 common shares
from treasury for
acquisition.................... -- -- 4,654,165 -- -- 1,804,166 6,458,331
Net loss......................... -- -- -- (10,613,306) -- -- (10,613,306)
--------- -------- ----------- ------------ --------- ----------- -----------
Balance at June 30, 1995
(unaudited)...................... 8,072,994 $403,650 $24,443,640 $ (7,819,188) $(473,653) $(4,054,105) $ 12,500,344
========= ======== =========== ============ ========= =========== ===========
</TABLE>
See accompanying notes to consolidated financial statements
F-5
<PAGE> 58
QUEST MEDICAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31, SIX MONTHS ENDED JUNE 30,
---------------------------------------- --------------------------
1992 1993 1994 1994 1995
----------- ------------ ----------- ----------- ------------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Cash flows from operating activities:
Net earnings (loss)................................... $ 193,613 $ 816,345 $(1,719,193) $ (540,444) $(10,613,306)
Adjustments to reconcile net earnings (loss) to net
cash provided by (used in) operating activities:
Depreciation........................................ 352,602 464,307 761,174 366,884 464,331
Amortization........................................ 406,550 353,258 362,771 180,396 341,832
Deferred income taxes............................... -- 49,998 -- -- --
Gain on sale of assets & marketable securities...... (136,840) (467,428) (464,113) (178,804) (12,031)
Non-recurring charges............................... 1,246,913 -- -- -- 10,500,000
Net gain on litigation settlements.................. -- (167,088) -- -- --
Changes in assets and liabilities, net of effects of
acquisitions:
Receivables....................................... (58,787) (277,313) 387,347 225,207 (1,173,982)
Inventories....................................... (862,762) (12,032) 22,471 228,827 (564,376)
Federal income tax recoverable.................... 56,146 616,823 -- -- --
Prepaid expenses.................................. (121,680) (71,400) (128,770) 50,300 (297,415)
Other assets...................................... -- 6,774 -- -- 11,555
Accounts payable.................................. 20,927 444,610 (325,167) (180,123) 1,028,402
Accrued expenses.................................. (106,206) (173,059) (304,894) (283,257) 89,835
Other............................................. -- (13,311) (39,701) -- --
----------- ------------ ----------- ----------- ------------
Total adjustments.............................. 796,863 754,139 271,118 409,430 10,388,151
----------- ------------ ----------- ----------- ------------
Net cash provided by (used in) operating
activities................................... 990,476 1,570,484 (1,448,075) (131,014) (225,155)
----------- ------------ ----------- ----------- ------------
Cash flows from investing activities:
Purchases of marketable securities.................... (5,998,843) (13,600,809) (8,244,533) (5,560,866) (1,082,992)
Proceeds from sales of marketable securities.......... 6,163,308 13,782,894 8,984,046 4,331,439 2,305,969
Receivable due from broker............................ -- -- 637,390 637,390 --
Proceeds from notes receivable........................ 43,741 -- -- -- --
Additions to property, plant and equipment............ (629,591) (6,500,560) (1,076,871) (702,448) (994,707)
Acquisitions, net of cash acquired.................... (521,557) -- -- -- (15,868,152)
Net proceeds from litigation settlements.............. -- 42,088 -- -- --
Net proceeds from sale of product lines and
other assets........................................ -- 5,250 19,510 11,350 2,600
----------- ------------ ----------- ----------- ------------
Net cash provided by (used in) investing
activities................................... (942,942) (6,271,137) 319,542 (1,283,135) (15,637,282)
----------- ------------ ----------- ----------- ------------
Cash flows from financing activities:
Proceeds from short-term obligations.................. 1,587,914 6,976,117 2,864,902 970,674 633,588
Payments of short-term obligations.................... (1,527,534) (5,140,017) (2,364,902) (58,022) (387,656)
Proceeds of long-term debt............................ -- 4,248,093 106,978 106,978 16,550,000
Payment of long-term debt............................. (484,666) (726,999) (121,977) (63,862) (540,997)
Debt issuance costs................................... -- -- -- -- (461,933)
Exercise of stock options............................. 370,945 119,756 137,047 41,496 279,829
Purchase of treasury stock, net of issuances.......... (160,687) (349,004) -- -- 529
----------- ------------ ----------- ----------- ------------
Net cash provided by (used in) financing
activities................................... (214,028) 5,127,946 622,048 997,264 16,073,360
----------- ------------ ----------- ----------- ------------
Net increase (decrease) in cash and cash equivalents.... (166,494) 427,293 (506,485) (416,885) 210,923
Cash and cash equivalents at beginning of period........ 333,649 167,155 594,448 594,448 87,963
----------- ------------ ----------- ----------- ------------
Cash and cash equivalents at end of period.............. $ 167,155 $ 594,448 $ 87,963 $ 177,563 $ 298,886
=========== ============ =========== =========== ============
</TABLE>
See accompanying notes to consolidated financial statements
F-6
<PAGE> 59
QUEST MEDICAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(INFORMATION SUBSEQUENT TO DECEMBER 31, 1994, AND INFORMATION
FOR THE SIX MONTHS ENDED JUNE 30, 1994 IS UNAUDITED)
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(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 is presented below:
<TABLE>
<CAPTION>
SIX MONTHS ENDED
YEARS ENDED DECEMBER 31, JUNE 30,
------------------------------- --------------------
1992 1993 1994 1994 1995
-------- ------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
Income taxes paid................ $ -- $46,000 $ -- $ -- $ --
======== ======= ======== ======== ========
Interest paid (net of amounts
capitalized)................... $114,213 $70,757 $558,337 $249,361 $699,953
======== ======= ======== ======== ========
</TABLE>
(d) Marketable Securities
Effective December 31, 1993, 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.
Prior to December 31, 1993, marketable securities were accounted for at the
lower of cost or market.
The following is a summary of available-for-sale securities at December 31,
1994:
<TABLE>
<CAPTION>
GROSS GROSS
UNREALIZED UNREALIZED ESTIMATED
COST GAINS LOSSES FAIR VALUE
--------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Investment grade preferred
securities.......................... $2,788,587 $ -- $522,437 $2,266,150
Utility stocks........................ 328,579 -- 48,704 279,875
Publicly traded limited
partnerships........................ 511,201 -- 80,263 430,938
Real estate investment trusts......... 1,846,566 22,751 150,694 1,718,623
Other................................. 617,171 165 138,452 478,884
---------- -------- -------- ----------
$6,092,104 $ 22,916 $940,550 $5,174,470
========== ======== ======== ==========
</TABLE>
F-7
<PAGE> 60
QUEST MEDICAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
At December 31, 1994, no individual security represented more than 10% of
the total portfolio or 2% of total assets. The Company did not have any
investments in derivative financial instruments at December 31, 1994.
The following is a summary of available-for-sale securities at June 30,
1995:
<TABLE>
<CAPTION>
GROSS GROSS
UNREALIZED UNREALIZED ESTIMATED
COST GAINS LOSSES FAIR VALUE
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Investment grade preferred
securities.......................... $1,604,370 $ 3,002 $204,715 $1,402,657
Utility stocks........................ 159,138 -- 21,638 137,500
Real estate investment trusts......... 1,704,722 6,255 119,989 1,590,988
Publicly traded limited
partnerships........................ 582,822 -- 67,322 515,500
Other................................. 830,228 5,711 74,957 760,982
---------- -------- -------- ----------
$4,881,280 $ 14,968 $488,621 $4,407,627
========== ======== ======== ==========
</TABLE>
At June 30, 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 June 30, 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 retired are removed
from the accounts.
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.
During 1993, the Company constructed a new corporate headquarters and
production facility for its operations in Allen, Texas (the "Allen facility").
The Company's Dallas operations were relocated to such facility during December
1993.
(g) Costs in Excess of Net Assets Acquired
The excess of costs over the net assets of businesses acquired is amortized
on a straight line basis over estimated useful lives 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 December 31, 1994 and June 30, 1995, the Company
does not believe there has been any impairment of its intangible assets.
Amortization expense was $20,806, $30,854 and $40,753 for the years ended
December 31, 1992, 1993, and 1994, respectively. Amortization expense was
$19,387 and $59,809 for the six months ended June 30, 1994 and 1995,
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
$188,854, $228,852, and $228,467 for the years ended December 31, 1992, 1993,
and 1994, respectively. Amortization expense was $114,234 for each of
F-8
<PAGE> 61
QUEST MEDICAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
the six month periods ended June 30, 1994 and 1995. 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 15 years) of such technology.
Amortization expense was $154,897, $50,551, and $50,550 for the years ended
December 31, 1992, 1993, and 1994, respectively. Amortization expense was
$25,275 and $91,943 for the six months ended June 30, 1994 and 1995,
respectively.
(j) Tradenames
The cost of purchased tradenames is based on appraised values at the date
of acquisition and is amortized on a straight-line basis over the estimated
useful life (20 years) of such tradenames. No amortization expense was recorded
during the years ended December 31, 1992, 1993, 1994 or the six months ended
June 30, 1994. Amortization expense was $31,250 for the six months ended June
30, 1995.
(k) Product Development
Start-up, research and development, advertising and promotional costs are
charged to operations in the year in which such costs are incurred.
(l) 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 shareholders of record as of May 6,
1994. The weighted average number of common and common equivalent shares
outstanding used in computing the earnings per share for the years ended
December 31, 1993 and 1992 were increased to retroactively reflect the stock
dividend.
Earnings (loss) per share for the years ended December 31, 1992, 1993, and
1994 are based upon 5,594,141, 5,559,422 and 5,256,683 common and, in 1992 and
1993, common equivalent shares outstanding, respectively. Shares issuable upon
exercise of dilutive stock options are included in average common and common
equivalent shares outstanding except where the result is antidilutive.
Loss per share for the six months ended June 30, 1994 and 1995 is based
upon 5,240,490 and 5,738,825 weighted average common shares outstanding,
respectively.
(m) Accounting Changes
In May 1993 the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 115, "Accounting for Certain Investments in
Debt and Equity Securities." As permitted under the Statement, the Company
elected to adopt the provisions of the new standard as of the end of 1993. In
accordance with the Statement, prior period financial statements were not
restated to reflect the change in accounting principle. The cumulative effect as
of December 31, 1993, of adopting Statement 115, including the reversal of
unrealized losses, increased net income by $169,308. The balance of
stockholders' equity was decreased by $169,308 at December 31, 1993, to reflect
the net unrealized holding loss on securities classified as available-for-sale.
(n) Reclassifications
Certain prior period amounts have been reclassified to conform to current
year presentation.
F-9
<PAGE> 62
QUEST MEDICAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(o) Interim Periods
The consolidated balance sheet at June 30, 1995 and the consolidated
statements of operations and cash flows for the six month periods ended June 30,
1994 and 1995, and the consolidated statement of stockholders' equity for the
six month period ended June 30, 1995, together with the related notes, are
unaudited, but, in the opinion of management of the Company, include all
adjustments (which consist of normal recurring accruals) necessary to present
fairly, in all material respects, the financial condition at June 30, 1995 and
the results of operations and cash flows for the Company for the six month
periods ended June 30, 1994 and 1995.
(2) ACQUISITION AND DISPOSITION OF ASSETS
On June 23, 1992, the Company purchased from McGaw, Inc. (McGaw)
substantially all of the assets related to McGaw's "ACTester(TM)" product line
for approximately $521,557 cash (including $20,719 of related acquisition
costs). The ACTester product line consists of instrumentation and associated
disposables used to measure the activated clotting time (ACT) of blood, a key
parameter in managing patient coagulation status in catheterization, ECMO,
cardiovascular surgery, dialysis and other critical care applications.
The acquisition was accounted for as a purchase and, accordingly, the
acquired assets have been recorded at their estimated fair values at the date of
acquisition. The operating results are included in the 1992 consolidated
statement of operations from the acquisition date. The purchase price and
expenses associated with the acquisition exceeded the fair values of the
acquired assets by $110,179 which has been included in "Costs in excess of net
assets acquired, net" in the consolidated balance sheets. The costs in excess of
net assets acquired is being amortized on a straight-line basis over a 25 year
period.
During December 1992, the Company wrote-off the assets of Clini-Therm
Corporation acquired in July 1991, resulting in a non-recurring, non-cash charge
to operations of $1,246,913. The write-off was initiated by the Company's
intention to focus research and development investments in its core
cardiovascular market.
On March 31, 1995, the Company acquired for $15,403,263 cash (including
$200,000 paid in June 1995 as a purchase price adjustment, and excluding
$926,822 of related acquisition and financing costs) and 833,333 shares of Quest
common stock valued at $6,458,331, all of the capital stock of Neuromed, Inc.
("Neuromed"), a privately held corporation located in Fort Lauderdale, Florida.
The transaction also provided for contingent consideration of up to $6 million
over the next two years, payable in a combination of cash and additional shares
of Quest common stock in January 1996 and January 1997, depending on sales of
Neuromed's products reaching certain objectives. 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 was accounted for by the purchase method of accounting. The
allocation of the purchase price among identifiable tangible and intangible
assets was based on the fair market value of those assets using a risk adjusted
income approach. The cost in excess of net assets acquired is being amortized on
a straight line basis over twenty years.
Purchased in-process research and development was identified and valued
through extensive interviews and analysis of data concerning Neuromed's products
under development. Expected future cash flows for products under development
were discounted taking into account economic risks
F-10
<PAGE> 63
QUEST MEDICAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
associated with the inherent difficulties and uncertainty in completing the
products, and thereby achieving technological feasibility, and risks related to
the viability of and potential changes in future target markets. This resulted
in $10,500,000 of purchased research and development which had not yet achieved
technological feasibility and does not have alternative uses. Therefore, in
accordance with generally accepted accounting principles, the $10,500,000, with
no related tax benefit, was charged to expense during the six month period ended
June 30, 1995.
The preliminary purchase price allocation for the acquisition of Neuromed,
as of June 30, 1995 is summarized below:
<TABLE>
<S> <C>
Tradenames.............................................................. $ 2,500,000
Purchased technology.................................................... 4,000,000
Cost in excess of net assets acquired................................... 3,075,339
Purchased research and development...................................... 10,500,000
Net tangible assets acquired............................................ 2,251,144
-----------
$22,326,483
===========
</TABLE>
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. In connection with the purchase, the Company determined that the
operations of Neuromed will be relocated to Texas by the end of the first
quarter of 1996. The Company is in the process of finalizing the estimated costs
of the relocation which will be recorded in the third quarter of 1995 as an
adjustment to costs in excess of net assets acquired.
The following unaudited pro forma summary presents the results of
operations as if the acquisition had occurred on January 1, 1994. This summary
does not purport to be indicative of what would have occurred had the
acquisition been made as of this date or of results which may occur in the
future. This method of combining the companies is for the presentation of
unaudited pro forma summary results of operations. Actual statements of
operations of Quest Medical, Inc. and of Neuromed, Inc. will be combined from
the effective date of the acquisition forward, with no retroactive restatement.
<TABLE>
<CAPTION>
SIX MONTHS
YEAR ENDED ENDED JUNE
DECEMBER 31, 30,
1994 1995
------------ -----------
<S> <C> <C>
Pro forma revenue......................................... $22,043,518 $13,710,433
Pro forma earnings (loss) from operations................. (86,467) 1,416,077
----------- -----------
Pro forma net earnings (loss) before cumulative effect of
change in accounting principle in 1994.................. (1,220,055) 445,254
----------- -----------
Pro forma net earnings (loss) per common and equivalent
share before cumulative effect of change in accounting
principle in 1994....................................... $ (0.20) $ 0.07
=========== ===========
</TABLE>
The pro forma operations information excludes the non-recurring charge of
$10,500,000 ($1.72 per share) related to purchased in-process research and
development which is expensed at the date of acquisition.
In July 1995, the sales objectives were reached which triggered a liability
for the 1996 contingent consideration payments with regard to the Neuromed
Acquisition. The Company recorded the additional "earn-out" consideration of
200,000 shares of Quest Medical common stock valued at $2,558,200 and a $1.5
million liability (payable in cash in January 1996). In addition, in September
1995, the Company amended certain terms of the acquisition agreement whereby the
Company agreed to
F-11
<PAGE> 64
QUEST MEDICAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
accelerate issuance of the 200,000 shares for the 1996 earn-out and the seller
relinquished certain rights from the previous agreement. The amended agreement
sets the 1997 contingent consideration at a cash payment equal to $1.5 million
plus an amount equal to the value of 200,000 shares of common stock at the net
offering price of shares issued in connection with the Offering contemplated by
the Prospectus in which these financial statements are included.
(3) CURRENT AND LONG-TERM DEBT
At December 31, 1994, the Company has two credit line facilities. These
facilities expire on September 30, 1995, and include a $3,000,000 working
capital line and a $5,000,000 acquisition line. The lines are collateralized by
the Company's accounts receivable, inventories, machinery and equipment, and in
the case of an acquired business, the purchased assets. Advances under the
$3,000,000 working capital line bear interest at the prime rate plus 25 basis
points or the lender's CD rate plus 150 basis points, at the Company's
discretion. Advances under the $5,000,000 acquisition line bear interest at the
prime rate plus 75 basis points or the lender's CD rate plus 200 basis points,
at the Company's discretion. Advances under the acquisition line are immediately
converted to a five-year term loan. At December 31, 1994 the Company had
advances in the amount of $2,650,000 outstanding under the working capital line
and no advances outstanding under the acquisition line. The Company is subject
to certain covenants related to these facilities. Significant covenants include
the maintenance of a minimum current ratio, ratio of debt to net worth (as
defined) and restricts 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 long-term financing on the Allen facility in the amount
of $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. The interest rate in effect at
December 31, 1994 was 9.05% and at June 30, 1995 was 9.07%. The loan is
collateralized by the Allen facility building and land and has an unpaid balance
of $2,978,045 at December 31, 1994 and $2,971,950 at June 30, 1995. 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. The interest rate in effect at
December 31, 1994, was 8.29% and 8.57% at June 30, 1995. This loan is
collateralized by the equipment and furnishings purchased with the proceeds and
has an unpaid balance of $1,255,049 at December 31, 1994 and $1,207,647 at June
30, 1995.
At December 31, 1994, the Company has 8.625% and 8% notes available that
are secured by certain Company marketable securities, held by investment
companies. These marketable securities have a carrying value of $1,083,060 and
$1,212,112, respectively. Borrowings under these notes are restricted to 50% of
the market value of these marketable securities held by investment companies. At
December 31, 1994, the amounts available for total borrowings were $541,530 and
$606,056, respectively. At December 31, 1994, the Company had no advances
outstanding with respect to these notes. At June 30, 1995, the Company had a 9%
note payable for $245,932. This note was collateralized by certain of the
Company's investments, held by the investment company, which had a carrying
value of $1,153,965. Borrowings under this note are restricted to 50% of the
market value of certain of the Company's investments held by the investment
company. At June 30, 1995, the amount available for additional borrowing under
this note was $331,050.
F-12
<PAGE> 65
QUEST MEDICAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Total interest incurred during 1993 was $164,777. Capitalized interest, in
conjunction with the construction of the Allen facility in 1993 was recorded as
part of the building, and is amortized over the building's useful life. In 1993,
$82,977 of interest costs were capitalized. No interest was capitalized in 1994
and 1992.
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 June 30,
1995, the Company had an outstanding principal balance of $14,512,500 under the
senior term debt, including a current portion of $1,950,000, with a weighted
average interest rate of 9.49%. At June 30, 1995, the Company had borrowings
under the working capital line of $4,200,000 with a weighted average interest
rate of 9.09%.
The aforementioned facilities with NationsBank are collateralized 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.
(4) FEDERAL INCOME TAXES
The Company adopted the provisions of the Statement on Financial Accounting
Standards No. 109, "Accounting for Income Taxes" (Statement No. 109), effective
January 1, 1993. The cumulative effect of adopting Statement No. 109 was not
material. Under Statement No. 109, deferred tax assets and liabilities are
recognized using the liability method, whereby tax rates are applied to
cumulative temporary differences based on when and how they are expected to
effect the tax return. Prior to the adoption of Statement No. 109, income tax
expense was determined using the provisions of FAS No. 96.
The significant components of the net deferred tax liability at December
31, were as follows:
<TABLE>
<CAPTION>
1993 1994
--------- ----------
<S> <C> <C>
Deferred tax assets
Tax credit and net operating loss carry forwards......... $ 668,419 $1,664,528
Accrued expenses and reserves............................ 107,276 106,902
Unrealized loss on marketable securities................. 57,565 311,996
Valuation allowance...................................... (673,734) (1,745,090)
--------- -----------
Total deferred tax asset......................... 159,526 338,336
</TABLE>
F-13
<PAGE> 66
QUEST MEDICAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
<TABLE>
<CAPTION>
1993 1994
--------- -----------
<S> <C> <C>
Deferred tax liabilities:
Excess of tax over book depreciation..................... (68,040) (208,644)
Purchase price adjustments deducted for tax and amortized
for book.............................................. (100,322) (95,989)
Other.................................................... (41,162) (45,540)
--------- ----------
Total deferred tax liability..................... (209,524) (350,173)
--------- ----------
Net deferred tax liability....................... $ (49,998) $ (11,837)
========= ==========
</TABLE>
The provision for income taxes for the years ended December 31 consists of
the following amounts:
<TABLE>
<CAPTION>
1992 1993 1994
------- -------- --------
<S> <C> <C> <C>
Current
Federal............................................. $40,730 $250,769 $ --
State............................................... -- -- --
------- -------- --------
40,730 250,769 --
Deferred............................................ 16,584 50,000 --
------- -------- --------
$57,314 $300,769 $ --
======= ======== ========
</TABLE>
A reconciliation of the provision (benefit) for taxes on earnings (loss)
before cumulative effect of change in accounting principle, to the taxes
calculated at the U.S. statutory rate follows:
<TABLE>
<CAPTION>
1992 1993 1994
-------- -------- ---------
<S> <C> <C> <C>
Federal income tax (benefit) at statutory rate.... $ 85,315 $322,254 $(584,526)
Unrecognized deductions........................... 70,309 57,565 --
Tax exempt interest............................... (91,376) (93,720) (52,862)
Nondeductible amortization of goodwill............ 8,863 10,490 13,856
Basis difference of purchase price allocation..... (46,352) (33,073) (27,189)
Alternative minimum tax........................... 23,098 -- --
Other............................................. 7,457 37,253 13,413
Benefit of net operating loss not recognized...... -- -- 637,308
-------- -------- ---------
$ 57,314 $300,769 $ --
======== ======== =========
</TABLE>
During the years ended December 31, 1992 and 1993, the Company realized
$189,219 and $187,236, respectively, of tax benefits from stock option
deductions which has been credited to paid-in capital.
At December 31, 1994, general business credits of $751,912 and alternative
minimum tax credits of $134,284 are available to offset future tax liabilities.
If unused, the general business credits expire in various amounts beginning in
1997 through 2009.
During the period ended June 30, 1995, the Company eliminated the valuation
allowance for deferred tax assets that was recorded in prior years of
$1,745,090. The elimination of the valuation allowance was recorded as a
reduction of costs in excess of net assets acquired because the reduction
resulted from deferred tax liabilities recorded in connection with the
acquisition of Neuromed.
(5) 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. Each right
F-14
<PAGE> 67
QUEST MEDICAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
entitles the holder to purchase one-half of a share of common stock at an
exercise price of $5.00. The purchase price payable and 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 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 $0.01 per
right at any time prior to their expiration on October 12, 1999, or prior to the
point at which they become exercisable.
Under certain circumstances described in the rights agreement, the holder
will be entitled to purchase at the current exercise price that number of shares
of common stock of the acquiring company having a market value of two times the
exercise price of the right.
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 Mr. Borkan or his affiliates so long as
their ownership does not exceed 25% of the common shares outstanding at any
time.
(6) STOCK OPTIONS
At December 31, 1994, under the Company's stock option plans, options may
be granted to purchase 1,999,892 shares of its common stock of which 1,442,257
options may be granted to key employees (Employees' Plan) and 557,635 options
may be granted to directors and advisory directors (Directors' Plan). These
options are exercisable one-fourth each year over a four-year period of
continuous service. Certain options under both the Employees' Plan and
Directors' Plan have a special two year vesting schedule. These options are
exercisable one-half each year over a two-year period. The stock options granted
under the Employee's Plan expire ten years from the date of grant. The stock
options granted under the Directors' Plan expire six years from date of grant.
The changes in the number of common shares issuable under outstanding options,
the number of shares reserved for issuance and the price range of options for
the years ended December 31, 1993 and 1994 were as follows:
<TABLE>
<CAPTION>
1993 1994
-------------- --------------
<S> <C> <C>
Outstanding at beginning of year...................... 838,119 894,455
Granted............................................... 205,664 252,444
Effect of 3% stock dividend........................... -- 31,679
Rescinded............................................. (81,430) (47,548)
Exercised............................................. (67,898) (43,057)
----------- -----------
Outstanding at end of year............................ 894,455 1,087,973
=========== ===========
Exercisable at end of year............................ 427,194 488,590
=========== ===========
Shares reserved for issuance.......................... 256,487 139,804
=========== ===========
Price range of options outstanding at end of year..... $1.50 to $4.75 $1.45 to $6.38
Price range of options exercised during the year...... $1.50 to $3.75 $1.45 to $4.25
</TABLE>
Effective March 30, 1995, the Board of Directors adopted the Quest Medical,
Inc. 1995 Stock Option Plan ("the Plan"). The total number of shares of Common
Stock issuable under the Plan is 250,000.
F-15
<PAGE> 68
QUEST MEDICAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Officers or other key employees of the Company are eligible to receive stock
option grants under the Plan. The per share exercise price of each option is
determined by the Stock Option Committee of the Board of Directors, but in no
event is less than the Fair Market Value of the Common Stock at the time the
option is granted. Generally, each option will be for a term of not less than
five years nor more than ten years from the date of grant. Vesting of the
options will be determined by the Stock Option Committee, although for the most
part, options will become exercisable with respect to 25% of the total number of
shares subject to the option twelve months after the date of grant and with
respect to an additional 25% at the end of each twelve-month period thereafter
on a cumulative basis during the succeeding three years. The plan was approved
by the shareholders of the Company at the Annual Meeting of Shareholders held on
June 22, 1995.
A summary of transactions through June 30, 1995 follows:
<TABLE>
<S> <C>
Granted.................................................................... 167,000
--------
Outstanding at end of period............................................... 167,000
========
Price of options outstanding at end of period.............................. $ 7.125
</TABLE>
(7) COMMITMENTS AND CONTINGENCIES
The Company occupied office and warehouse space under the terms of
cancelable operating leases extending through 1993. During 1993, the Company
canceled two operating leases with a penalty of approximately $68,000. Future
minimum rental payments under noncancelable leases for autos as of December 31,
1994, was $12,323 in 1995, $6,474 in 1996 and $3,393 in 1997. Total rent expense
under operating leases for the years ended December 31, 1992, 1993, and 1994 was
$271,168, $293,221 and $24,930, respectively.
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. As of June 30, 1995, future minimum rental
payments under noncancelable auto leases and the aforementioned facility lease
are $73,577 in 1995, $28,946 in 1996, and $3,016 in 1997. Total rent expense
under operating leases for the six months ended June 30, 1994 and 1995 was
20,047 and 47,670, respectively.
The Company is 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.
(8) FINANCIAL INSTRUMENTS, RISK CONCENTRATION, AND MAJOR CUSTOMERS
The Company designs, develops, manufactures and markets a variety of
healthcare products used primarily in cardiovascular surgery, interventional
pain management and intravenous fluid delivery applications. 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
collectibility of all accounts receivable. Any losses from bad debts have
historically been within management's expectations.
Net sales to a major customer for each of the years ended December 31, as a
percentage of total net revenues were as follows: 1992 -- 25%, 1993 -- 23%, and
1994 -- 19%.
F-16
<PAGE> 69
QUEST MEDICAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(9) 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 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 for the year ended December 31, was $61,530 in
1992, $86,903 in 1993, and $102,961 in 1994. The expense of the Company's
contributions was $49,500 and $50,100 for the six months ended June 30, 1994 and
1995, respectively.
(10) LITIGATION SETTLEMENT
On May 13, 1993, the Company entered into a settlement agreement relating
to the litigation it filed on April 20, 1990, against Kirschner Medical
Corporation, its directors and Alex Brown and Sons, Inc. Under the terms of the
settlement agreement, the Company received $600,000 cash and 100,000 warrants to
purchase Kirschner Medical common stock for three years at an exercise price of
$6.00 per share. Each warrant is convertible into one share of Kirschner Medical
common stock. The Company incurred litigation expenses of approximately
$201,000. The Company recorded a pre-tax gain of $524,200 which is reflected in
"Other income (expenses) -- Litigation settlements, net" in the Consolidated
Statements of Operations.
During October 1993, an agreement was reached to settle a lawsuit filed
against the Company on November 2, 1992, in the United States Bankruptcy Court
for the Northern District of Texas by Jeffery Mims, Trustee for Clini-Therm
Corporation. The complaint alleged the Company fraudulently purchased claims
from Ford Motor Credit Corporation and unfairly rescinded its agreement to
finance Clini-Therm's reorganization. The Company recorded a pre-tax charge of
$357,112 (including $157,112 of litigation expense) which is reflected in "Other
Income (expenses) -- Litigation settlement, net" in the Consolidated Statements
of Operations.
F-17
<PAGE> 70
REPORT OF INDEPENDENT AUDITORS
The Board of Directors
Neuromed, Inc.
We have audited the accompanying consolidated balance sheet of Neuromed,
Inc. and subsidiaries (the "Company") as of October 31, 1994, and the related
consolidated statements of income and retained earnings, and cash flows for each
of the two years in the period ended October 31, 1994. These consolidated
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Neuromed, Inc.
and subsidiaries at October 31, 1994, and the consolidated results of their
operations and their cash flows for each of the two years in the period ended
October 31, 1994, in conformity with generally accepted accounting principles.
As discussed in Note 8 to the financial statements, in fiscal 1994, the
Company changed its method of accounting for income taxes.
ERNST & YOUNG LLP
Dallas, Texas
April 1, 1995
F-18
<PAGE> 71
NEUROMED, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
ASSETS
<TABLE>
<CAPTION>
JANUARY 31,
OCTOBER 1995
31, -----------
1994 (UNAUDITED)
----------
<S> <C> <C>
Current assets:
Cash and cash equivalents......................................... $1,834,399 $ 1,374,390
Accounts receivable, net of allowance for doubtful accounts of
$100,000 in 1994 and 1995...................................... 1,383,178 1,527,183
Inventories....................................................... 1,488,418 1,638,423
Loan receivable, shareholder...................................... 656,586 --
Deferred income tax............................................... 506,493 506,493
Other current assets.............................................. 108,422 100,478
---------- -----------
Total current assets...................................... 5,977,496 5,146,967
---------- -----------
Property, plant and equipment, net.................................. 244,283 243,675
Other assets........................................................ 7,467 2,695
---------- -----------
$6,229,246 $ 5,393,337
========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Loan payable...................................................... $ 1,634 $ 408
Accounts payable and accrued expenses............................. 1,106,581 866,317
Accrued royalty expense........................................... 853,115 218,355
Income taxes payable.............................................. 784,539 511,635
---------- -----------
Total current liabilities................................. 2,745,869 1,596,715
---------- -----------
Deferred income taxes payable....................................... 32,979 32,979
Shareholders' equity:
Common stock, Class A voting; $.004 par value; 9,000,000 shares
authorized; 5,819,250 shares issued in 1994 and 1995........... 23,277 23,277
Common stock, Class B non-voting; $.01 par value; 100,000 shares
authorized; 94,850 shares issued and outstanding in 1994 and
1995........................................................... 948 948
Capital in excess of par value.................................... 48,337 48,337
Retained earnings................................................. 3,397,836 3,711,081
---------- -----------
3,470,398 3,783,643
Less common stock, Class A voting, held in treasury, at cost,
16,926 shares in 1994 and 1995................................. (20,000) (20,000)
---------- -----------
3,450,398 3,763,643
---------- -----------
$6,229,246 $ 5,393,337
========== ===========
</TABLE>
See accompanying notes to consolidated financial statements
F-19
<PAGE> 72
NEUROMED, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME AND RETAINED EARNINGS
<TABLE>
<CAPTION>
THREE MONTHS ENDED
YEARS ENDED OCTOBER 31, JANUARY 31,
----------------------- -----------------------
1993 1994 1994 1995
---------- ---------- ---------- ----------
(UNAUDITED)
<S> <C> <C> <C> <C>
Net sales.................................... $7,182,073 $8,044,353 $1,512,942 $2,407,299
Operating costs and expenses:
Cost of sales.............................. 1,579,647 1,932,763 460,034 577,063
Selling.................................... 1,769,327 1,968,342 437,517 618,643
General and administrative................. 1,500,487 1,448,256 367,641 434,957
Research and development................... 1,530,091 1,713,316 390,417 296,182
---------- ---------- ---------- ----------
6,379,552 7,062,677 1,655,609 1,926,845
---------- ---------- ---------- ----------
Income (loss) from operations................ 802,521 981,676 (142,667) 480,454
Other:
Interest, net.............................. 20,125 62 (23,024) 9,944
Foreign currency transaction loss.......... (8,149) -- -- --
Other income (loss)........................ 215,464 (17,951) (18,059) 29,943
---------- ---------- ---------- ----------
227,440 (17,889) (41,083) 39,887
---------- ---------- ---------- ----------
Income (loss) before income taxes and
cumulative effect of change in accounting
principle.................................. 1,029,961 963,787 (183,750) 520,341
Provision (benefit) for income taxes......... 286,255 383,765 (73,169) 207,096
---------- ---------- ---------- ----------
Income (loss) before cumulative effect of
change in accounting principle............. 743,706 580,022 (110,581) 313,245
Cumulative effect of change in accounting
principle.................................. -- 261,285 -- --
---------- ---------- ---------- ----------
Net income (loss)............................ 743,706 841,307 (110,581) 313,245
Retained earnings, beginning of period....... 1,812,823 2,556,529 2,556,529 3,397,836
---------- ---------- ---------- ----------
Retained earnings, end of period............. $2,556,529 $3,397,836 $2,445,948 $3,711,081
========== ========== ========== ==========
</TABLE>
See accompanying notes to consolidated financial statements
F-20
<PAGE> 73
NEUROMED, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
THREE MONTHS ENDED
YEARS ENDED OCTOBER 31, JANUARY 31,
------------------------ -----------------------
1993 1994 1994 1995
----------- ---------- --------- -----------
(UNAUDITED)
<S> <C> <C> <C> <C>
Cash flows from operating activities
Net income (loss)........................... $ 743,706 $ 841,307 $(110,581) $ 313,245
Adjustments to reconcile net income to net
cash provided by (used in) operating
activities:
Cumulative effect of change in accounting
principle.............................. -- (261,285) -- --
Gain on damaged inventory................ (91,433) -- -- --
Depreciation and amortization............ 90,966 83,001 20,700 20,865
Changes in operating assets and
liabilities:
Accounts receivable.................... (580,947) 398,994 (135,670) (144,005)
Inventory.............................. (53,180) (526,000) (98,076) (150,005)
Other current assets................... 11,069 (50,001) 7,705 7,944
Other assets........................... 28,756 28,985 (25,353) 4,772
Accounts payable and accrued
expenses............................ (127,967) 567,684 (64,080) (240,264)
Accrued royalty expense................ (360,340) 508,182 147,510 (634,760)
Income taxes........................... 211,521 67,886 (389,048) (272,904)
----------- ---------- --------- -----------
Net cash provided by (used in) operating
activities............................... (127,849) 1,658,753 (646,893) (1,095,112)
----------- ---------- --------- -----------
Cash flows from investing activities
Additions to property, plant and
equipment................................ (251,534) (72,008) (4,743) (20,257)
Redemption of preferred stock
investment............................... 88,364 67,336 6,942 --
Insurance proceeds from casualty loss....... 738,311 331,477 331,477 --
----------- ---------- --------- -----------
Net cash provided by (used in) investing
activities............................... 575,141 326,805 333,676 (20,257)
----------- ---------- --------- -----------
Cash flows from financing activities
Loan to Shareholder......................... (6,900) (649,686) -- --
Proceeds from loan receivable,
shareholder.............................. -- -- 1,700 656,586
Proceeds from loans payable................. 2,246,133 857,528 617,651 --
Repayment of loans payable.................. (2,452,886) (864,004) (381,640) (1,226)
----------- ---------- --------- -----------
Net cash provided by (used in) financing
activities............................... (213,653) (656,162) 237,711 655,360
----------- ---------- --------- -----------
Net increase (decrease) in cash............... 233,639 1,329,396 (75,506) (460,009)
Cash and cash equivalents, beginning of
period...................................... 271,364 505,003 505,003 1,834,399
----------- ---------- --------- -----------
Cash and cash equivalents, end of period...... $ 505,003 $1,834,399 $ 429,497 $ 1,374,390
=========== ========== ========= ===========
Supplemental disclosure of cash flow
information:
Cash paid during the period for interest...... $ 18,206 $ 34,969 $ 23,187 $ 7,500
=========== ========== ========= ===========
Cash paid during the period for income
taxes....................................... $ 63,034 $ 364,027 $ 327,436 $ 7,030
=========== ========== ========= ===========
</TABLE>
See accompanying notes to consolidated financial statements
F-21
<PAGE> 74
NEUROMED, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(INFORMATION SUBSEQUENT TO OCTOBER 31, 1994, AND INFORMATION
FOR THE THREE MONTHS ENDED JANUARY 31, 1994 IS UNAUDITED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
General
Neuromed, Inc. and subsidiaries manufacture implantable medical devices
used for neurostimulation. The devices manufactured include multi-programmable
spinal cord stimulators using various electrode types and multi-programmable
deep brain stimulators. They are used primarily for the treatment of chronic
pain.
Basis of Presentation
The consolidated financial statements include the accounts of Neuromed,
Inc. and its wholly-owned subsidiaries ("Neuromed" or the "Company"). All
significant intercompany accounts and transactions have been eliminated in
consolidation.
Cash and Cash Equivalents
For purposes of the statement of cash flows, the Company considers all
highly liquid debt instruments purchased with an original maturity of three
months or less to be cash equivalents. The carrying amount of cash and cash
equivalents approximate their fair value.
Inventories
Inventories are stated at the lower of cost (first-in, first-out) or
market.
Property, Plant and Equipment
Property, plant and equipment are recorded at cost. Depreciation is
computed using straight-line and accelerated methods over the estimated useful
lives of the assets. Amortization of leasehold improvements is computed on a
straight-line basis over the lesser of the useful life of the asset or the term
of the lease.
Income Taxes
Effective November 1, 1993, the Company adopted Statement of Financial
Accounting Standards (SFAS) No. 109, "Accounting for Income Taxes." Under this
statement, deferred tax assets and liabilities are determined based upon the
difference between the financial statement and tax bases of assets and
liabilities using enacted tax rates in effect for the year in which the
differences are expected to reverse.
Interim Periods
The consolidated balance sheet at January 31, 1995 and the consolidated
statements of income and retained earnings and consolidated statements of cash
flows for the three month periods ended January 31, 1994 and 1995, together with
the related notes, are unaudited, but, in the opinion of management of the
Company, include all adjustments (which consist of normal recurring accruals)
necessary to present fairly, in all material respects, the financial condition
at January 31, 1995 and the results of operations and cash flows for the Company
for the three month periods ended January 31, 1994 and 1995.
F-22
<PAGE> 75
NEUROMED, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
2. INVENTORIES
Inventories as of October 31, 1994 and January 31, 1995 are comprised of
the following:
<TABLE>
<CAPTION>
OCTOBER 31, JANUARY 31,
1994 1995
----------- -----------
<S> <C> <C>
Raw materials................................................. $ 753,903 $ 804,873
Work in process............................................... 187,100 205,164
Finished goods................................................ 547,415 628,386
---------- ----------
$1,488,418 $1,638,423
========== ==========
</TABLE>
3. PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment as of October 31, 1994 is comprised of the
following:
<TABLE>
<S> <C>
Furniture and fixtures................................................... $ 154,496
Machinery and equipment.................................................. 507,392
Leasehold improvements................................................... 408,584
Vehicles................................................................. 44,666
---------
1,115,138
Less accumulated depreciation and amortization........................... 870,855
---------
$ 244,283
=========
</TABLE>
4. COMMITMENTS AND CONTINGENCIES
Neuromed occupies its manufacturing facility and administrative office
under the terms of a noncancelable operating lease. The lease expires on
February 28, 1996 and provides for annual rental payments of $92,380. The
following is a schedule of the future rental payments:
<TABLE>
<CAPTION>
YEAR ENDING OCTOBER 31
----------------------
<S> <C>
1995.................................... $ 92,380
1996.................................... 30,794
--------
$123,174
========
</TABLE>
Rent expense under all operating leases was $108,640 and $127,568 for the
years ended October 31, 1993 and 1994, respectively.
Neuromed has an employment agreement with its principal shareholder. Among
other things, the agreement entitles the employee to additional compensation
equal to 10% of net operating income before income taxes between $250,000 and
$1,000,000, and 5% on such income above $1,000,000. This deferred compensation
aggregates approximately $373,000 at October 31, 1994 and is included in
accounts payable and other accrued expenses in the accompanying balance sheet.
General and administrative expenses include approximately $83,000 and $112,000
in 1993 and 1994, respectively, related to this agreement.
Neuromed has agreed to pay its principal shareholder, the inventor of its
medical devices, royalties of 10% of net sales of such devices for the
acquisition of the patents and technology. Included in selling expenses is
$725,674 and $824,290 of royalty expense for the years ended October 31, 1993
and 1994, respectively, related to this agreement.
F-23
<PAGE> 76
NEUROMED, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Under its defined contribution pension plan, Neuromed's required
contributions to the plan are 2% of each eligible participant's compensation up
to $37,800, plus 7.6% of compensation in excess of such amount, and totaled
$43,641 and $56,576 for the years ended October 31, 1993 and 1994, respectively.
All employees, other than commissioned employees, are eligible for the plan
after meeting a minimum hours of service requirement with the Company.
Under agreements with affiliated companies, Neuromed agreed to pay certain
research and development expenses for products being developed. Research and
development expense includes $374,721 and $668,051 of such expenses for the
years ended October 31, 1993 and 1994, respectively.
The Company is 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.
5. COMMON STOCK
Neuromed has issued 4,750 incentive stock shares to certain key employees.
Under the terms of the agreements pertaining to these shares, the employees are
entitled to receive 100% of the excess of the fair market value, as defined, of
a share of common stock of Neuromed on the date the right is exercised, over
$1.96 per share. All of the issued incentive stock shares are exercisable.
Amounts due from the exercise of the incentive stock shares are payable in cash,
common stock of Neuromed or both over the twelve months following the month they
are exercised. Management of the Company has estimated that aggregate
appreciation of the shares approximates $14,250 and $17,520 as of October 31,
1993 and 1994, respectively.
6. RELATED PARTIES
During fiscal year 1994, the Company advanced approximately $650,000 to its
major shareholder. The advances, with interest at 5% per annum, are due on
demand. The advance was repaid in full January 1995.
7. OTHER INCOME
During March 1993, Neuromed sustained damage to its primary production
facility from a tornado. Neuromed collected insurance proceeds attributable to
the tornado of $200,000 during the year ended October 31, 1993 and an additional
$331,477 during December 1993. Included in other income for fiscal year 1993 is
approximately $91,000 attributable to inventory damage.
8. INCOME TAXES
The components of income tax expense are as follows:
<TABLE>
<CAPTION>
YEARS ENDED OCTOBER 31
----------------------
1993 1994
-------- --------
<S> <C> <C>
Current:
Federal...................................................... $183,099 $616,757
State........................................................ 18,319 64,074
-------- --------
201,418 680,831
Deferred..................................................... 84,837 (297,066)
-------- --------
$286,255 $383,765
======== ========
</TABLE>
F-24
<PAGE> 77
NEUROMED, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Effective November 1, 1993, the Company changed its method of accounting
for income taxes from the deferred method to the liability method required by
SFAS No. 109. As permitted under the new rules, prior years' financial
statements have not been restated. The cumulative effect of adopting SFAS No.
109 as of November 1, 1993 was to increase net income by $261,285.
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amount of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Significant components of
the Company's deferred tax assets and liabilities as of October 31, 1994 are as
follows:
<TABLE>
<S> <C>
Deferred tax assets
Accounts receivable..................................................... $ 16,971
Allowance for doubtful accounts......................................... 35,800
Accrued royalties....................................................... 296,696
Accrued salaries........................................................ 23,657
Deferred compensation................................................... 133,369
--------
506,493
Deferred tax liabilities
Depreciable property.................................................... 32,979
--------
Net deferred tax asset.................................................... $473,514
========
</TABLE>
In 1993, the Company's effective tax rate was less than the federal
statutory rate of 34% primarily because of the utilization of research and
development credits. The Company's effective tax rate for 1994 and for the three
months ended January 31, 1994 and 1995 differs from the federal statutory rate
of 34% primarily because of state income taxes.
9. MAJOR CUSTOMER
In 1993 a major customer accounted for 13% of sales. The Company's major
customer in 1994 accounted for 18% of sales. During 1993 and 1994, a company in
which the principal shareholder of Neuromed holds a minority interest accounted
for 18% and 7% of sales, respectively.
10. SUBSEQUENT EVENT
On March 31, 1995, the sale of all the capital stock of the Company to
Quest Medical, Inc. was closed. Pursuant to the agreement, all of the cash on
hand at that date was distributed to the principal shareholder of the Company.
Also pursuant to such closing, the agreement by Neuromed to pay certain research
and development expenses for an affiliated company was terminated and the
deferred compensation described in Note 4 was cancelled.
F-25
<PAGE> 78
QUEST MEDICAL, INC. AND SUBSIDIARIES
PRO FORMA CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
YEAR ENDED DECEMBER 31, 1994
(UNAUDITED)
<TABLE>
<CAPTION>
QUEST NEUROMED, PRO FORMA PRO FORMA
MEDICAL, INC. INC. ADJUSTMENTS COMBINED
------------- --------- ----------- ----------
<S> <C> <C> <C> <C>
Net revenue............................ $ 13,999,165 $8,044,353 $ -- $22,043,518
Cost of revenue........................ 7,617,932 1,932,763 145,603 (1) 9,867,828
(29,400)(2)
(27,300)(3)
228,230 (4)
------------ ---------- ----------- -----------
Gross Profit...................... 6,381,233 6,111,590 (317,133) 12,175,690
------------ ---------- ----------- -----------
Operating Expenses:
General and administrative........... 3,063,296 1,448,256 4,856,654
545,434 (5)
184,000 (6)
(112,032)(7)
(51,500)(8)
(220,800)(3)
Marketing............................ 1,913,793 1,968,342 (824,290)(9) 3,002,845
(55,000)(3)
Research and development............. 3,542,193 1,713,316 (184,800)(3) 4,402,658
(668,051)(8)
------------ ---------- ----------- -----------
8,519,282 5,129,914 (1,387,039) 12,262,157
------------ ---------- ----------- -----------
Earnings (loss) from operations... (2,138,049) 981,676 1,069,906 (86,467)
------------ ---------- ----------- -----------
Other income (expense):
Gain on sale of marketable
securities........................ 464,113 -- -- 464,113
Interest expense..................... (569,428) -- (1,378,094)(10) (2,039,909)
(92,387)(11)
Interest income and other............ 524,171 (17,889) -- 506,282
------------ ---------- ----------- -----------
418,856 (17,889) (1,470,481) (1,069,514)
------------ ---------- ----------- -----------
Earnings (loss) before income
taxes and cumulative effect of
change in accounting
principle....................... (1,719,193) 963,787 (400,575) (1,155,981)
Income taxes........................... -- 383,765 (319,691)(12) 64,074
------------ ---------- ----------- -----------
Earnings (loss) before cumulative
effect of change in accounting
principle....................... $ (1,719,193) $ 580,022 $ (80,884) $(1,220,055)
============ ========== =========== ===========
Loss before cumulative effect of change
in accounting principle per share.... $ (0.33) $ (0.20)
============ ===========
Weighted average common shares
outstanding.......................... 5,256,683 833,333 6,090,016
============ =========== ===========
</TABLE>
F-26
<PAGE> 79
QUEST MEDICAL, INC. AND SUBSIDIARIES
PRO FORMA CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
SIX MONTHS ENDED JUNE 30, 1995
(UNAUDITED)
<TABLE>
<CAPTION>
QUEST NEUROMED, PRO FORMA PRO FORMA
MEDICAL, INC. INC. ADJUSTMENTS COMBINED
------------- ---------- ----------- -----------
<S> <C> <C> <C> <C>
Net revenue.......................... $ 11,303,134 $2,407,299 $ -- $13,710,433
Cost of revenue...................... 4,910,490 577,063 48,115 (1) 5,334,352
(193,966)(4)
(7,350)(2)
------------ ---------- ----------- -----------
Gross Profit.................... 6,392,644 1,830,236 153,201 8,376,081
------------ ---------- ----------- -----------
Operating Expenses:
General and administrative......... 1,917,753 434,957 136,358 (5) 2,308,268
46,000 (6)
(226,800)(3)
Marketing.......................... 1,593,570 618,643 (265,345)(9) 1,923,358
(23,510)(3)
Research and development........... 2,493,643 296,182 (61,447)(8) 2,728,378
Non-recurring charge............... 10,500,000 -- (10,500,000)(13) --
------------ ---------- ----------- -----------
16,504,966 1,349,782 (10,894,744) 6,960,004
------------ ---------- ----------- -----------
Earnings (loss) from
operations.................... (10,112,322) 480,454 11,047,945 1,416,077
------------ ---------- ----------- -----------
Other income (expense):
Gain on sale of marketable
securities...................... 12,031 -- -- 12,031
Interest expense................... (730,971) (7,500) (257,255)(10) (1,018,823)
(23,097)(11)
Interest income and other.......... 217,956 47,387 -- 265,343
------------ ---------- ----------- -----------
(500,984) 39,887 (280,352) (741,449)
------------ ---------- ----------- -----------
Earnings (loss) before income
taxes......................... (10,613,306) 520,341 10,767,593 674,628
Income taxes......................... -- 207,096 22,278(12) 229,374
------------ ---------- ----------- -----------
Net earnings (loss)............. $(10,613,306) $ 313,245 $10,745,315 $ 445,254
============ ========== =========== ===========
Net earnings (loss) per share........ $ (1.85) $ 0.07
============ ===========
Weighted average common and common
equivalent shares outstanding...... 5,738,825 1,034,443 6,773,268
============ =========== ===========
</TABLE>
F-27
<PAGE> 80
QUEST MEDICAL, INC.
NOTES TO UNAUDITED PRO FORMA
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
NOTE A. BASIS OF PRESENTATION
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 Quest
Medical, Inc. ("the Company") and Mr. William Borkan dated February 10, 1995,
the Company acquired all of the issued and outstanding stock of Neuromed, Inc.
("Neuromed"). In consideration for its purchase of the Neuromed capital stock,
the Company paid $15,403,265 in cash and 833,333 shares of Quest common stock
valued at $6,458,331. The Company may also 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 established objectives. The contingent considerations may be paid in a
combination of cash and additional shares of Quest Common stock. In addition,
the Company incurred $926,824 of acquisition-related expenses (including debt
issuance cost). In connection with the acquisition of Neuromed, 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
provided the Company with $15 million in senior term financing, which was
utilized to pay most of the cash portion of the Neuromed purchase price. The
Loan Agreement also expanded the Company's existing $3 million working capital
line of credit to $5 million. The acquisition has been accounted for using the
purchase method of accounting.
The pro forma condensed consolidated statements of operations for the year
ended December 31, 1994 and the six months ended June 30, 1995 have been
prepared as if the acquisition of Neuromed had occurred on January 1, 1994. The
pro forma condensed consolidated statement of operations for the year ended
December 31, 1994 combines the statement of operations of Quest Medical for the
twelve months ended December 31, 1994 and the statement of income of Neuromed
for the twelve months ended October 31, 1994. The pro forma condensed
consolidated statement of operations for the six months ended June 30, 1995
combines the statement of operations of Quest Medical for the six months ended
June 30, 1995 and the statement of income of Neuromed for the three months ended
January 31, 1995.
The unaudited pro forma condensed consolidated financial statements have
been prepared based on estimates and assumptions deemed by the Company to be
appropriate and do not purport to be indicative of the financial position or
results of operations which would actually have been obtained had the
acquisition occurred as presented in such statements or which may be obtained in
the future. The unaudited pro forma condensed consolidated financial statements
should be read in conjunction with the financial statements of Neuromed, Inc.
included elsewhere herein, the consolidated financial statements and related
notes of the Company, included herein and in its Annual Report on Form 10-KSB
for the year ended December 31, 1994 and the Company's Quarterly Report on Form
10-QSB for the quarterly and year-to-date periods ended June 30, 1995.
See Note 2 to the Company's Consolidated Financial Statements included
elsewhere herein for a description of additional "earn-out" consideration earned
in July 1995 and amendments to the terms of the acquisition agreement. Because
of the prospective nature of these items, no effect has been given in these pro
forma financial statements.
NOTE B. PRO FORMA ADJUSTMENTS
The accompanying unaudited pro forma condensed consolidated statements of
operations reflect the following adjustments:
(1) To adjust insurance expense resulting from increased products
liability coverage on Neuromed products.
F-28
<PAGE> 81
QUEST MEDICAL, INC.
NOTES TO UNAUDITED PRO FORMA
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS -- (CONTINUED)
(2) To adjust depreciation expense related to leasehold improvements of
Neuromed's facility which were revalued at acquisition.
(3) Elimination of salary, benefit, and travel and entertainment expense
for two ex-officers of Neuromed, Mr. William Borkan (former principal
owner of Neuromed) and Mr. Burt Borkan, who were not retained as
employees.
(4) To record write-off in 1994 of manufacturing profits capitalized in
inventory at acquisition of Neuromed and, for 1995, reversal of
write-off included in the Company's historical results.
(5) To record amortization expense for Neuromed intangible assets which
are being amortized over estimated useful lives of 15 to 20 years
computed on a straight line method. The preliminary purchase price
allocation is subject to change when additional information concerning
asset and liability valuations is obtained. Therefore, the final
allocation will differ from the preliminary amounts recorded.
(6) To adjust compensation expense resulting from a change in compensation
program for key Neuromed employees.
(7) Elimination of deferred compensation program for Mr. William Borkan,
which has been terminated.
(8) Elimination of expenses pursuant to agreements obligating Neuromed to
pay certain research and development expenses for affiliated
companies, which has been terminated.
(9) Elimination of royalty expense under an agreement between Mr. William
Borkan and Neuromed, which has been terminated.
(10) To record interest expense for borrowings utilized to purchase
Neuromed, Inc. Average interest rate of approximately 9.50% (LIBOR
plus 300 basis points).
(11) To record amortization expense for capitalized financing costs
incurred in securing financing to consummate the Neuromed Acquisition.
(12) To adjust income tax expense for the change in financial taxable
income from the combination of Neuromed and Quest.
(13) To eliminate material non-recurring charge related to purchased
in-process research and development incurred in connection with the
Neuromed Acquisition.
F-29
<PAGE> 82
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
No person is authorized in connection with any offering made hereby to give
any information or to make any representation not contained herein and, if given
or made, such information or representation must not be relied upon as having
been authorized by the Company or the Underwriters. This Prospectus does not
constitute an offer to sell or a solicitation of an offer to buy any security
other than the Common Stock offered hereby, nor does it constitute an offer to
sell or a solicitation of an offer to buy any of the securities offered hereby
to any person in any jurisdiction in which it is unlawful to make such an offer
or solicitation. Neither the delivery of this Prospectus nor any sale made
hereunder shall under any circumstances create any implication that there has
been no change in the affairs of the Company since the date hereof or that the
information contained herein is correct as of any date subsequent to the date
hereof.
---------------------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Prospectus Summary......................... 3
Risk Factors............................... 5
The Company................................ 10
Use of Proceeds............................ 10
Price Range of Common Stock................ 11
Dividend Policy............................ 11
Capitalization............................. 12
Selected Consolidated Financial Data....... 13
Selected Pro Forma Financial Data.......... 14
Management's Discussion and Analysis of
Financial Condition and Results of
Operations............................... 16
Business................................... 24
Management................................. 39
Certain Transactions....................... 44
Principal and Selling Shareholders......... 45
Description of Capital Stock............... 46
Underwriting............................... 48
Legal Matters.............................. 49
Experts.................................... 50
Additional Information..................... 50
Index to Consolidated Financial
Statements............................... F-1
</TABLE>
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
2,600,000 SHARES
LOGO
COMMON STOCK
---------------------------
PROSPECTUS
---------------------------
VECTOR SECURITIES INTERNATIONAL, INC.
RAUSCHER PIERCE REFSNES, INC.
, 1995
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE> 83
PART II
ITEM 24. INDEMNIFICATION OF DIRECTORS AND OFFICERS.
Consistent with the Texas Business Corporation Act, the Company's Articles
of Incorporation include a provision limiting director liability to the Company
or its shareholders for monetary damages arising from certain acts or omissions
in the director's capacity as a director. In addition, the Company maintains
insurance on behalf of its directors and executive officers insuring them
against any liability asserted against them in their capacities as directors or
officers or arising out of such status. See "Management -- Indemnification and
Limitation of Liability."
The Underwriting Agreement filed as Exhibit 1.1 hereto contains reciprocal
agreements of indemnity between the Company, the Selling Shareholders and the
Underwriters as to certain liabilities, including liabilities under the
Securities Act and in certain circumstances provides for indemnification of the
Company's directors and officers.
ITEM 25. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION.
The following table indicates the estimated expenses to be incurred in
connection with the Offering, all of which will be paid by the Company.
<TABLE>
<S> <C>
Registration fee.......................................................... $ 13,533
NASD fee.................................................................. 4,425
Accounting fees and expenses.............................................. 77,000
Legal fees and expenses................................................... 140,000
Printing and engraving.................................................... 120,000
Transfer Agent's fees..................................................... 5,000
Blue Sky fees and expenses (including counsel fees)....................... 12,000
Miscellaneous expenses.................................................... 75,000
--------
Total........................................................... $446,958
========
</TABLE>
ITEM 26. RECENT SALES OF UNREGISTERED SECURITIES.
The following sets forth information as of November 6, 1995 regarding all
sales of unregistered securities of the Registrant during the past three years.
All such shares were exempt from registration under the Securities Act by reason
of Section 4(2) of the Securities Act.
On March 31, 1995, the Company issued 833,333 shares of Common Stock to Mr.
William Borkan and Mr. Burt Borkan in connection with the Neuromed Acquisition.
Concurrently with the closing of the Offering, the Company will issue the
Borkans an additional 200,000 shares as additional "earn-out" consideration,
which was earned in July 1995. See "Certain Transactions."
In connection with this transaction, the Borkans were provided access to
all relevant information regarding the Company and represented to the Company
that they were "sophisticated" investors purchasing the shares for investment
purposes only and with no view toward distribution.
II-1
<PAGE> 84
ITEM 27. EXHIBITS.
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF EXHIBIT
- -------------------- ------------------------------------------------------------------------
<C> <S>
1.1 -- Form of Underwriting Agreement**
2.1 -- Agreement for the Purchase and Sale of All of the Issued Capital
Stock of Neuromed, Inc. dated February 10, 1995, between Quest
Medical, Inc. and William N. Borkan(1)
2.2 -- Amendment Agreement dated March 17, 1995, between Quest Medical, Inc.
and William N. Borkan(1)
2.3 -- Letter Agreement dated as of September 23, 1995 by and between Quest
Medical, Inc. and William N. Borkan*
3.1 -- Articles of Incorporation, as amended*
3.2 -- Bylaws(2)
4.1 -- Rights Agreement between Quest Medical, Inc. and MTrust Corp., N.A.
as Rights Agent dated as of October 12, 1989*
4.2 -- Amendment of Rights Agreement dated as of February 9, 1995, between
Quest Medical, Inc. and KeyCorp Shareholder Services, Inc. as Rights
Agent(1)
5.1 -- Opinion of Hughes & Luce, L.L.P.*
10.1 -- Quest Medical, Inc. 1979 Amended and Restated Employees Stock Option
Plan, as amended*
10.2 -- Form of 1979 Employees Stock Option Agreement*
10.3 -- Quest Medical, Inc. Directors Stock Option Plan, as amended*
10.4 -- Form of Directors Stock Option Agreement(2)
10.5 -- Quest Medical, Inc. 1987 Stock Option Plan*
10.6 -- Form of 1987 Employee Stock Option Agreement*
10.7 -- Quest Medical, Inc. 1995 Stock Option Plan*
10.8 -- Form of 1995 Employee 1995 Stock Option Agreement*
10.9 -- Form of Employment Agreement and Covenant Not to Compete, between the
Company and key employees(2)
10.10 -- Sublease Agreement dated July 2, 1992, effective September 1, 1992,
between the Company and Unistor Corporation(3)
10.11 -- Promissory Note dated December 28, 1993, between Quest Medical, Inc.
and MetLife Capital Financial Corporation(4)
10.12 -- Commercial Deed of Trust, Security Agreement and Assignment of Leases
and Rents and Fixture Filing dated December 28, 1993, between Quest
Medical, Inc. and MetLife Capital Financial Corporation(4)
10.13 -- Term Promissory Note dated December 28, 1993, between Quest Medical,
Inc. and MetLife Capital Corporation(4)
10.14 -- Loan and Security Agreement dated December 28, 1993, between Quest
Medical, Inc. and MetLife Capital Corporation(4)
10.15 -- Supplemental Security Agreement Number One dated December 28, 1993,
between Quest Medical, Inc. and MetLife Capital Corporation(4)
10.16 -- First Amended and Restated Credit Agreement dated as of March 31,
1995 between Quest Medical, Inc. and NationsBank of Texas, N.A.(5)
</TABLE>
II-2
<PAGE> 85
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF EXHIBIT
- -------------------- ------------------------------------------------------------------------
<C> <S>
10.17 -- Promissory Note (Facility A Note) in the original principal amount of
$5 million dated March 31, 1995(5)
10.18 -- Promissory Note (Facility B Note) in the original principal amount of
$15 million dated March 31, 1995(5)
10.19 -- Security Agreement dated as of March 31, 1995 between Quest Medical,
Inc. and NationsBank of Texas, N.A.(5)
10.20 -- Security Agreement dated as of March 31, 1995 between Neuromed, Inc.
and NationsBank of Texas, N.A.(5)
10.21 -- Intellectual Property Security Agreement and Assignment dated as of
March 31, 1995 between Quest Medical, Inc. and NationsBank of Texas,
N.A.(5)
10.22 -- Intellectual Property Security Agreement and Assignment dated as of
March 31, 1995 between Neuromed, Inc. and NationsBank of Texas,
N.A.(5)
10.23 -- License Agreement dated as of March 31, 1995 between Quest Medical,
Inc. and NationsBank of Texas, N.A.(5)
10.24 -- License Agreement dated as of March 31, 1995 between Neuromed, Inc.
and NationsBank of Texas, N.A.(5)
10.25 -- Guaranty of Neuromed, Inc. in favor of NationsBank of Texas, N.A.
under the First Amended and Restated Credit Agreement dated as of
March 31, 1995(5)
10.26 -- Commitment Letter dated September 25, 1995 from NationsBank of Texas,
N.A. relating to the proposed working capital and acquisition lines
of credit*
11.1 -- Computation of Earnings Per Share*
21.1 -- Subsidiaries*
23.1 -- Consent of Hughes & Luce, L.L.P. (contained in Exhibit 5.1)*
23.2 -- Consent of Ross, Clapp, Korn & Montgomery, L.L.P.**
23.3 -- Consent of Independent Auditors**
25.1 -- Powers of Attorney*
</TABLE>
- ---------------
* Previously filed.
** Filed herewith.
(1) Filed as an Exhibit to the Report of the Company on Form 10-KSB for the
year ended December 31, 1994, and incorporated herein by reference.
(2) Filed as an Exhibit to the Company's Registration Statement on Form S-18,
Registration No. 2-71198-FW, and incorporated herein by reference.
(3) Filed as an Exhibit to the Report of the Company on Form 10-KSB for the
year ended December 31, 1992, and incorporated herein by reference.
(4) Filed as an Exhibit to the Report of the Company on Form 10-KSB for the
year ended December 31, 1993, and incorporated herein by reference.
(5) Filed as an Exhibit to the Report of the Company on Form 8-K dated April
13, 1995, and incorporated herein by reference.
ITEM 28. UNDERTAKINGS.
Insofar as indemnification for liabilities arising under the Securities Act
may be permitted to directors, officers and controlling persons of the
Registrant by the Registrant pursuant to the underwriting agreements, the
Company's Articles of Incorporation, Bylaws, Texas law or otherwise, the
II-3
<PAGE> 86
Registrant has been advised that in the opinion of the Securities and Exchange
Commission such indemnification is against public policy as expressed in the
Securities Act and is, therefore, unenforceable. In the event that a claim for
indemnification against such liabilities (other than the payment by the
Registrant of expenses incurred or paid by a director, officer or controlling
person of the Registrant in the successful defense of any action, suit or
proceeding) is asserted by such director, officer or controlling person in
connection with the securities being registered, the Registrant will, unless in
the opinion of its counsel the matter has been settled by controlling precedent,
submit to a court of appropriate jurisdiction the question whether such
indemnification by it is against public policy as expressed in the Securities
Act and will be governed by the final adjudication of such issue.
The undersigned Registrant hereby undertakes that:
(1) For purposes of determining any liability under the Securities
Act, the information omitted from the form of prospectus filed as part of
this Registration Statement in reliance upon Rule 430A and contained in a
form of prospectus filed by the Registrant pursuant to Rule 424(b)(1) or
(4) or 497(h) under the Securities Act shall be deemed to be part of this
Registration Statement as of the time it was declared effective.
(2) For the purpose of determining any liability under the Securities
Act, each post-effective amendment that contains a form of prospectus shall
be deemed to be a new registration statement relating to the securities
offered therein, and the offering of such securities at that time shall be
deemed to be the initial bona fide offering thereof.
II-4
<PAGE> 87
SIGNATURES
In accordance with the requirements of the Securities Act of 1993, the
Registrant certifies that it has reasonable grounds to believe that it meets all
the requirements for filing on Form SB-2 and has duly caused this Amendment No.
1 to the Registration Statement to be signed on its behalf by the undersigned,
thereunto duly authorized, in the City of Allen, State of Texas, on November 7,
1995.
QUEST MEDICAL, INC.
By: /s/ THOMAS C. THOMPSON
------------------------------
Thomas C. Thompson,
President and Chief Executive
Officer
Pursuant to the requirements of the Securities Act of 1933, as amended,
this Amendment No. 1 to the Registration Statement on Form SB-2 has been signed
below by the following persons on behalf of the Registrant in the capacities
indicated on November 7, 1995.
<TABLE>
<CAPTION>
SIGNATURE TITLE
- ----------------------------------------------- -----------------------------------------------
<S> <C>
/s/ THOMAS C. THOMPSON President and Chief Executive Officer and
- ----------------------------------------------- Director (Principal Executive Officer)
Thomas C. Thompson
/s/ F. ROBERT MERRILL III Chief Financial Officer (Principal Financial
- ----------------------------------------------- and Accounting Officer)
F. Robert Merrill III
* Director
- -----------------------------------------------
Linton E. Barbee
* Director
- -----------------------------------------------
Robert C. Eberhart, Ph.D.
* Director
- -----------------------------------------------
John A. Gula
* Director
- -----------------------------------------------
Hugh M. Morrison
* Director
- -----------------------------------------------
Michael J. Torma, M.D.
*By /s/ F. Robert Merrill III
- -----------------------------------------------
F. Robert Merrill III, Attorney-in-Fact
</TABLE>
II-5
<PAGE> 88
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF EXHIBIT PAGE
- ---------- ---------------------------------------------------------------------- -----------
<C> <S> <C>
1.1 -- Form of Underwriting Agreement**
2.1 -- Agreement for the Purchase and Sale of All of the Issued Capital
Stock of Neuromed, Inc. dated February 10, 1995, between Quest
Medical, Inc. and William N. Borkan(1)
2.2 -- Amendment Agreement dated March 17, 1995, between Quest Medical,
Inc. and William N. Borkan(1)
2.3 -- Letter Agreement dated as of September 23, 1995 by and between
Quest Medical, Inc. and William N. Borkan*
3.1 -- Articles of Incorporation, as amended*
3.2 -- Bylaws(2)
4.1 -- Rights Agreement between Quest Medical, Inc. and MTrust Corp., N.A.
as Rights Agent dated as of October 12, 1989*
4.2 -- Amendment of Rights Agreement dated as of February 9, 1995, between
Quest Medical, Inc. and KeyCorp Shareholder Services, Inc. as
Rights Agent(1)
5.1 -- Opinion of Hughes & Luce, L.L.P.*
10.1 -- Quest Medical, Inc. 1979 Amended and Restated Employees Stock
Option Plan, as amended*
10.2 -- Form of 1979 Employees Stock Option Agreement*
10.3 -- Quest Medical, Inc. Directors Stock Option Plan, as amended*
10.4 -- Form of Directors Stock Option Agreement(2)
10.5 -- Quest Medical, Inc. 1987 Stock Option Plan*
10.6 -- Form of 1987 Employee Stock Option Agreement*
10.7 -- Quest Medical, Inc. 1995 Stock Option Plan*
10.8 -- Form of 1995 Employee 1995 Stock Option Agreement*
10.9 -- Form of Employment Agreement and Covenant Not to Compete, between
the Company and key employees(2)
10.10 -- Sublease Agreement dated July 2, 1992, effective September 1, 1992,
between the Company and Unistor Corporation(3)
10.11 -- Promissory Note dated December 28, 1993, between Quest Medical,
Inc. and MetLife Capital Financial Corporation(4)
10.12 -- Commercial Deed of Trust, Security Agreement and Assignment of
Leases and Rents and Fixture Filing dated December 28, 1993,
between Quest Medical, Inc. and MetLife Capital Financial
Corporation(4)
10.13 -- Term Promissory Note dated December 28, 1993, between Quest
Medical, Inc. and MetLife Capital Corporation(4)
10.14 -- Loan and Security Agreement dated December 28, 1993, between Quest
Medical, Inc. and MetLife Capital Corporation(4)
10.15 -- Supplemental Security Agreement Number One dated December 28, 1993,
between Quest Medical, Inc. and MetLife Capital Corporation(4)
10.16 -- First Amended and Restated Credit Agreement dated as of March 31,
1995 between Quest Medical, Inc. and NationsBank of Texas, N.A.(5)
</TABLE>
<PAGE> 89
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF EXHIBIT PAGE
---------- ---------------------------------------------------------------------- -----------
<C> <S> <C>
10.17 -- Promissory Note (Facility A Note) in the original principal amount
of $5 million dated March 31, 1995(5)
10.18 -- Promissory Note (Facility B Note) in the original principal amount
of $15 million dated March 31, 1995(5)
10.19 -- Security Agreement dated as of March 31, 1995 between Quest
Medical, Inc. and NationsBank of Texas, N.A.(5)
10.20 -- Security Agreement dated as of March 31, 1995 between Neuromed,
Inc. and NationsBank of Texas, N.A.(5)
10.21 -- Intellectual Property Security Agreement and Assignment dated as of
March 31, 1995 between Quest Medical, Inc. and NationsBank of
Texas, N.A.(5)
10.22 -- Intellectual Property Security Agreement and Assignment dated as of
March 31, 1995 between Neuromed, Inc. and NationsBank of Texas,
N.A.(5)
10.23 -- License Agreement dated as of March 31, 1995 between Quest Medical,
Inc. and NationsBank of Texas, N.A.(5)
10.24 -- License Agreement dated as of March 31, 1995 between Neuromed, Inc.
and NationsBank of Texas, N.A.(5)
10.25 -- Guaranty of Neuromed, Inc. in favor of NationsBank of Texas, N.A.
under the First Amended and Restated Credit Agreement dated as of
March 31, 1995(5)
10.26 -- Commitment Letter dated September 25, 1995 from NationsBank of
Texas, N.A. relating to the proposed working capital and
acquisition lines of credit*
11.1 -- Computation of Earnings Per Share*
21.1 -- Subsidiaries*
23.1 -- Consent of Hughes & Luce, L.L.P. (contained in Exhibit 5.1)*
23.2 -- Consent of Ross, Clapp, Korn & Montgomery, L.L.P.**
23.3 -- Consent of Independent Auditors**
25.1 -- Powers of Attorney*
</TABLE>
- ---------------
* Previously filed.
** Filed herewith.
(1) Filed as an Exhibit to the Report of the Company on Form 10-KSB for the year
ended December 31, 1994, and incorporated herein by reference.
(2) Filed as an Exhibit to the Company's Registration Statement on Form S-18,
Registration No. 2-71198-FW, and incorporated herein by reference.
(3) Filed as an Exhibit to the Report of the Company on Form 10-KSB for the year
ended December 31, 1992, and incorporated herein by reference.
(4) Filed as an Exhibit to the Report of the Company on Form 10-KSB for the year
ended December 31, 1993, and incorporated herein by reference.
(5) Filed as an Exhibit to the Report of the Company on Form 8-K dated April 13,
1995, and incorporated herein by reference.
<PAGE> 1
2,600,000 Shares
QUEST MEDICAL, INC.
Common Stock
UNDERWRITING AGREEMENT
November ___, 1995
VECTOR SECURITIES INTERNATIONAL, INC.
RAUSCHER PIERCE REFSNES, INC.
As Representatives of the Several Underwriters
c/o VECTOR SECURITIES INTERNATIONAL, INC.
1751 Lake Cook Road, Suite 350
Deerfield, Illinois 60015
Dear Sirs:
Quest Medical, Inc., a Texas corporation (the "Company"), proposes to
issue and sell an aggregate of 1,516,667 shares of its common stock, par value
$0.05 per share, and the persons named in Schedule I hereto (the "Selling
Stockholders") propose to sell an aggregate of 1,083,333 shares of common stock
of the Company (together with the 1,516,667 shares of common stock to be issued
and sold by the Company, the "Initial Securities") to the several Underwriters
named in Schedule II hereto (the "Underwriters") for whom Vector Securities
International, Inc. ("Vector") and Rauscher Pierce Refsnes, Inc. are acting as
representatives (collectively the "Representatives"). In addition, solely for
the purpose of covering over-allotments, the Company proposes to grant to the
several Underwriters, upon the terms and conditions set forth in Section 2
hereof, an option to purchase up to an additional 390,000 shares of Common
Stock of the Company (the "Option Securities"). The Company and the Selling
Stockholders are hereinafter sometimes referred to as the "Sellers." The
Initial Securities and the Option Securities are hereinafter collectively
referred to as the "Securities." The Company's common stock, par value $0.05
per share, including the Securities, is hereinafter referred to as the "Common
Stock." The Company and the Selling Stockholders wish to confirm as follows
their agreements with you and the other Underwriters on whose behalf you are
acting in connection with the several purchases by the Underwriters of the
Securities:
1. REGISTRATION STATEMENT, PROSPECTUS AND OFFERING MEMORANDUM.
The Company has prepared and filed with the Securities and Exchange Commission
(the "Commission") a registration statement on Form SB-2 covering the
registration of the Securities under the Securities Act of 1933, as amended
(the "1933 Act"), including the related preliminary prospectus, or
prospectuses, and either (A) has prepared and filed, prior to the effective
date of such registration statement, an amendment to such registration
statement, including a final prospectus or (B) if the Company has elected to
rely upon Rule 430A ("Rule 430A") of the rules
<PAGE> 2
and regulations of the Commission under the 1933 Act (the "1933 Act
Regulations"), will prepare and file a prospectus, in accordance with the
provisions of Rule 430A and Rule 424(b) ("Rule 424(b)") of the 1933 Act
Regulations, promptly after execution and delivery of this Agreement.
Additionally, if the Company has elected to rely upon Rule 434 ("Rule 434") of
the 1933 Act Regulations, the Company will prepare and file a term sheet (a
"Term Sheet") in accordance with the provisions of Rule 434 and Rule 424(b),
promptly after execution and delivery of this Agreement. The information, if
any, included in such prospectus that was omitted from the prospectus included
in such registration statement at the time it becomes effective but that is
deemed, (i) pursuant to paragraph (b) of Rule 430A, to be part of such
registration statement at the time it becomes effective is referred to herein
as the "Rule 430A Information," and (ii) pursuant to paragraph (d) of Rule 434,
to be part of such registration statement at the time it becomes effective is
referred to herein as the "Rule 434 Information." Each prospectus used before
the time such registration statement becomes effective is herein called a
"preliminary prospectus." Such registration statement, including the exhibits
thereto, at the time it becomes effective and including, if applicable, the
Rule 430A Information or the Rule 434 Information, is herein called the
"Original Registration Statement." Any registration statement filed pursuant
to Rule 462(b) of the 1933 Act Regulations is herein referred to as the "Rule
462(b) Registration Statement," and the Original Registration Statement and any
Rule 462(b) Registration Statement are herein referred to collectively as the
"Registration Statement." The prospectus included in the Original Registration
Statement at the time it becomes effective is herein called the "Prospectus,"
except that, (i) if the final prospectus furnished to the Underwriters after
the execution of this Agreement for use in connection with the offering of the
Securities differs from the prospectus included in the Original Registration
Statement at the time it becomes effective (whether or not such prospectus is
required to be filed pursuant to Rule 424(b)), the term "Prospectus" shall
refer to the final Prospectus first furnished to the Underwriters for such use,
and (ii) if Rule 434 is relied upon, the term "Prospectus" shall refer to the
preliminary prospectus last furnished to the Underwriters in connection with
the offering of the Securities, together with the Term Sheet.
The Company has prepared a confidential offering memorandum (the
"Offering Memorandum") which consists of the Prospectus and a Canadian wrapper
for use by the Underwriters in connection with the private placement of the
Securities in Canada.
2. AGREEMENTS TO SELL AND PURCHASE. Upon the basis of the
representations, warranties and agreements contained herein and subject to all
the terms and conditions set forth herein and to such adjustments as you may
determine to avoid fractional shares, the Company hereby agrees to issue and
sell to each Underwriter and each Underwriter agrees, severally and not
jointly, to purchase from the Company, at a purchase price of $_____ per share
(the "purchase price per share"), the number of Initial Securities set forth in
Schedule II opposite the name of such Underwriter under the column "Number of
Initial Securities to be Purchased from the Company" (or such number of Initial
Securities increased as set forth in Section 12 hereof).
Upon the basis of the representations, warranties and agreements
contained herein and subject to all the terms and conditions set forth herein
and to such adjustments as you may determine to avoid fractional shares, each
Selling Stockholder agrees to sell to each Underwriter
-2-
<PAGE> 3
and each Underwriter agrees, severally and not jointly, to purchase from each
Selling Stockholder, at the purchase price per share, that number of Initial
Securities as is equal to the product of (i) the number of Initial Securities
set forth in Schedule I opposite such Selling Stockholder's name multiplied by
(ii) the percentage of Initial Securities that such Underwriter is purchasing
from the Company as set forth in Schedule II (or such number of Initial
Securities increased as set forth in Section 12 hereof).
Upon the basis of the representations, warranties and agreements
contained herein and subject to all the terms and conditions set forth herein,
the Company hereby grants an option (the "over-allotment option") to the
Underwriters to purchase from the Company, at the purchase price per share, up
to an aggregate of 390,000 Option Securities. Option Securities may be
purchased solely for the purpose of covering over-allotments made in connection
with the offering of the Securities. Such option shall expire at 5:00 P.M.,
Chicago time, on the 30th day after the date of this Agreement (or, if such
30th day shall be a Saturday or Sunday or a holiday, on the next business day
thereafter when the New York Stock Exchange is open for trading). Such
over-allotment option may be exercised at any time until its expiration, but
only once, upon written, facsimile or telegraphic notice by you to the Company
. Upon any exercise of the over-allotment option, each Underwriter, severally
and not jointly, agrees to purchase from the Company that proportion of the
total number of Option Securities as is equal to the percentage of Initial
Securities that such Underwriter is purchasing from the Company and the Selling
Stockholders (or such number of Initial Securities increased as set forth in
Section 12 hereof), subject to such adjustments as you may determine to avoid
fractional shares.
Certificates in transferable form for the Securities that each of the
Selling Stockholders agrees to sell pursuant to this Agreement have been placed
in custody with F. Robert Merrill III (the "Custodian") for delivery under this
Agreement pursuant to a Custodian Agreement and Power of Attorney
(collectively, the "Custodian Agreement") executed by each of the Selling
Stockholders appointing Thomas C. Thompson and F. Robert Merrill III as agents
and attorneys-in-fact (the "Attorneys-in-Fact"). Each Selling Stockholder
agrees that (i) the Securities represented by the certificates held in custody
pursuant to the Custodian Agreement are subject to the interests of the
Underwriters, the Company and each other Selling Stockholder, (ii) the
arrangements made by the Selling Stockholders for such custody are, except as
specifically provided in the Custodian Agreement, irrevocable and (iii) the
obligations of the Selling Stockholders hereunder and under the Custodian
Agreement shall not be terminated by any act of such Selling Stockholder or by
operation of law, whether by the death or incapacity of any Selling Stockholder
or the occurrence of any other event or, if the Selling Stockholder is not a
natural person, upon any dissolution, winding up, distribution of assets or
other event affecting the legal existence of such Selling Stockholder. If any
Selling Stockholder shall die or be incapacitated or if any other event shall
occur before the delivery of the Securities hereunder or if the Selling
Stockholder is not a natural person and shall dissolve, wind up, distribute
assets or if any other event affecting the legal existence of such Selling
Stockholder shall occur before the delivery of the Securities hereunder,
certificates for the Securities of such Selling Stockholder shall be delivered
to the Underwriters by the Custodian, or any of them, in accordance with the
terms and conditions of this Agreement and the Custodian Agreement as if such
death or incapacity, dissolution, winding up or distribution of assets or other
event had not occurred,
-3-
<PAGE> 4
regardless of whether or not the Custodian or any Underwriter shall have
received notice of such death, incapacity, dissolution, winding up or
distribution of assets or other event. Each Attorney-in-Fact is authorized, on
behalf of each of the Selling Stockholders, to execute this Agreement and any
other documents necessary or desirable in connection with the sale of the
Securities to be sold hereunder by such Selling Stockholder, and the Custodian
is authorized on behalf of each of the Selling Stockholders to make delivery of
the certificates for such Securities. The Custodian and the Attorneys-in-Fact
are authorized to take such other action as may be necessary or desirable in
connection with the transactions contemplated by this Agreement. The Custodian
and each Attorney-in-Fact agree to perform their duties under the Custodian
Agreement.
3. TERMS OF PUBLIC OFFERING. The Sellers have been advised by
you that the Underwriters propose to make a public offering in the United
States and a private placement in Canada of their respective portions of the
Securities as soon after the Registration Statement and this Agreement have
become effective as in your judgment is advisable and initially to offer the
Securities upon the terms set forth in the Prospectus.
4. DELIVERY OF THE SECURITIES AND PAYMENT THEREFOR. Delivery to
the Underwriters of and payment for the Initial Securities shall be made at the
office of ________________________ at 9:00 A.M., Chicago time, on November ___,
1995 (the "Closing Date"). The place of closing for the Initial Securities and
the Closing Date may be varied by agreement among you, the Company and the
Attorneys-in-Fact.
Delivery to the Underwriters of and payment for any Option Securities
to be purchased by the Underwriters shall be made at the aforementioned office
of ________________________ at such time on such date (the "Option Closing
Date"), which may be the same as the Closing Date but shall in no event be
earlier than the Closing Date nor earlier than two nor later than seven
business days after the giving of the notice hereinafter referred to, as shall
be specified in a written notice from you on behalf of the Underwriters to the
Company of the Underwriters' determination to purchase a number, specified in
such notice, of Option Securities. The place of closing for any Option
Securities and the Option Closing Date for such Option Securities may be varied
by agreement between you and the Company.
Certificates for the Initial Securities and for any Option Securities
to be purchased hereunder shall be registered in such names and in such
denominations as you shall request by written notice (it being understood that
a facsimile transmission shall be deemed written notice) prior to 9:30 A.M.,
Chicago time, on the second business day preceding the Closing Date or any
Option Closing Date, as the case may be. Such certificates shall be made
available to you in Chicago, Illinois or New York, New York, as requested by
you in the aforesaid notice, for inspection and packaging not later than 9:30
A.M., Chicago time, or New York City time, as the case may be, on the business
day next preceding the Closing Date or an Option Closing Date, as the case may
be. The certificates and stock powers evidencing the Initial Securities and
any Option Securities to be purchased hereunder shall be delivered to you on
the Closing Date or the applicable Option Closing Date, as the case may be,
against payment of the purchase price therefor by certified or official bank
check or checks payable in New York Clearing House (next
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<PAGE> 5
day) funds to the order of the Company and the Attorneys-in-Fact. It is
understood that each Underwriter has authorized you, for its account, to accept
delivery of, acknowledge receipt of, and make payment of the purchase price
for, the Initial Securities and the Option Securities, if any, which it has
agreed to purchase. Vector, individually and not as representative of the
Underwriters, may (but shall not be obligated to) make payment of the purchase
price for the Initial Securities or the Option Securities, if any, to be
purchased by any Underwriter whose check has not been received by the Closing
Date or the applicable Option Closing Date, as the case may be, but such
payment shall not relieve such Underwriter from its obligations hereunder.
5. AGREEMENTS OF THE COMPANY. The Company covenants and agrees
with the several Underwriters as follows:
a. The Company will notify the Representatives
immediately, and confirm the notice in writing, (i) of the effectiveness of the
Registration Statement and any amendment thereto, (ii) of the receipt of any
comments from the Commission, (iii) of any request by the Commission for any
amendment to the Registration Statement or any amendment or supplement to the
Prospectus or for additional information, (iv) of the issuance by the
Commission of any stop order suspending the effectiveness of the Registration
Statement or the suspension of qualification of the Securities for offering or
sale in any jurisdiction or the initiation of any proceedings for such purpose
and (v) during the period when the Prospectus is required to be delivered under
the 1933 Act or Securities Exchange Act of 1934, as amended (the "1934 Act"),
of any change, or any event or occurrence which reasonably could result in such
a change, in the Company's condition, financial or otherwise, or the earnings,
business affairs or business prospects of the Company or the happening of any
event, including the filing of any information, documents or reports pursuant
to the 1934 Act, that makes any statement of a material fact made in the
Registration Statement, the Prospectus or the Offering Memorandum (as then
amended or supplemented) untrue or which requires the making of any amendments
of or supplements to the Registration Statement, the Prospectus or the Offering
Memorandum in order to state a material fact required by the 1933 Act or the
1933 Act Regulations to be stated therein or necessary in order to make the
statements therein not misleading, or of the necessity to amend or supplement
the Prospectus to comply with the 1933 Act, the 1933 Act Regulations or any
other law. The Company shall use its best efforts to prevent the issuance of
any stop order or order suspending the qualification or exemption of the
Securities under any state securities or Blue Sky laws, and, if at any time the
Commission shall issue any stop order suspending the effectiveness of the
Registration Statement, or any state securities commission or other regulatory
authority shall issue an order suspending the qualification or exemption of the
Securities under any state securities or Blue Sky laws, the Company shall use
its best efforts to obtain the withdrawal or lifting of such order at the
earliest possible time.
b. The Company will give the Underwriters notice of its
intention to prepare or file any amendment to the Registration Statement
(including any post-effective amendment), any Rule 462(b) Registration
Statement, any Term Sheet or any amendment or supplement to the Prospectus
(including any revised prospectus or Term Sheet and preliminary prospectus
which the Company proposes for use by the Underwriters in connection with the
offering of the Securities which differs from the prospectus on file at the
Commission at the time the
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<PAGE> 6
Registration Statement becomes effective, whether or not such revised
prospectus or Term Sheet and preliminary prospectus is required to be filed
pursuant to Rule 424(b)), whether pursuant to the 1933 Act, the 1934 Act or
otherwise, will furnish the Underwriters with copies of any Rule 462(b)
Registration Statement, Term Sheet, amendment or supplement a reasonable amount
of time prior to such proposed filing or use, as the case may be, and will not
file any such Rule 462(b) Registration Statement, Term Sheet, amendment or
supplement or use any such prospectus to which the Underwriters or counsel for
the Underwriters shall reasonably object.
c. The Company will deliver to the Underwriters as many
signed and conformed copies of the Registration Statement as originally filed
and of each amendment thereto (including exhibits filed therewith or
incorporated by reference therein) as the Underwriters may reasonably request.
d. The Company will furnish to each Underwriter, from
time to time during the period when the Prospectus is required to be delivered
under the 1933 Act or the 1934 Act, such number of copies of the Prospectus (as
amended or supplemented) as such Underwriter may reasonably request for the
purposes contemplated by the 1933 Act or the 1934 Act or the respective
applicable rules and regulations of the Commission thereunder. The Company
will furnish to each Underwriter such number of copies of the Offering
Memorandum as such Underwriter may reasonably request for the purpose of
effecting a private placement of the Securities in Canada.
e. If any event shall occur as a result of which it is
necessary, in the opinion of counsel for the Underwriters, to amend or
supplement the Prospectus or the Offering Memorandum in order to make the
Prospectus or Offering Memorandum as applicable not misleading in the light of
the circumstances existing at the time it is delivered to a purchaser, the
Company will forthwith amend or supplement the Prospectus or Offering
Memorandum as applicable (in form and substance satisfactory to counsel for the
Underwriters) so that, as so amended or supplemented, the Prospectus or
Offering Memorandum as applicable will not include an untrue statement of a
material fact or omit to state a material fact necessary in order to make the
statements therein, in the light of the circumstances existing at the time it
is delivered to a purchaser, not misleading, and the Company will furnish to
the Underwriters a reasonable number of copies of such amendment or supplement.
f. During the period of five years hereafter, the
Company will furnish to you (i) as soon as available, a copy of each report of
the Company mailed to stockholders or filed with the Commission or Nasdaq
National Market ("NASDAQ"); and (ii) from time to time such other information
concerning the Company as you may reasonably request, subject to appropriate
confidentiality and indemnification provisions with respect to any material
nonpublic information so furnished.
g. The Company will endeavor, in cooperation with
counsel to the Underwriters, to qualify the Securities for offering and sale
under the applicable securities or Blue Sky laws of such states and other
jurisdictions of the United States and in the province of Ontario and Quebec as
the Underwriters may designate; provided, however, that the Company
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<PAGE> 7
shall not be obligated to qualify as a foreign corporation in any jurisdiction
in which it is not so qualified, or to execute a general consent to service of
process in any jurisdiction or make any undertaking with respect to the conduct
of its business. In each jurisdiction in which the Securities have been so
qualified, the Company will file such statements and reports as may be required
by the laws of such jurisdiction to continue such qualification in effect for
such period as you may reasonably request for distribution of the Securities or
as may be required by law.
h. The Company will make generally available to its
security holders as soon as practicable, but not later than 90 days after the
close of the period covered thereby, an earnings statement (in form complying
with the provisions of Rule 158 of the 1933 Act Regulations) covering a
twelve-month period beginning not later than the first day of the Company's
fiscal quarter next following the "effective date of the Registration
Statement" (as defined in said Rule 158).
i. The Company will use the net proceeds received by it
from the sale of the Securities in the manner specified in the Prospectus and
the Offering Memorandum under "Use of Proceeds."
j. If, at the time that the Registration Statement
becomes effective, any Rule 430A Information or Rule 434 Information shall have
been omitted therefrom, then immediately following the execution of this
Agreement, the Company will prepare, and file or transmit for filing with the
Commission in accordance with Rule 430A or Rule 434 and Rule 424(b), copies of
a Prospectus or Term Sheet containing such Rule 430A Information and Rule 434
Information, respectively, or, if required by Rule 430A, a post-effective
amendment to the Registration Statement (including an amended Prospectus and
Offering Memorandum), containing such Rule 430A Information.
k. If the Company elects to rely upon Rule 462(b), the
Company shall both file a Rule 462(b) Registration Statement with the
Commission in compliance with Rule 462(b) and pay the applicable fees in
accordance with Rule 111 of the 1933 Act Regulations by the earlier of (i)
10:00 P.M. Eastern Time on the date hereof and (ii) the time confirmations are
sent or given, as specified by Rule 462(b)(2).
l. The Company, during the period when the Prospectus is
required to be delivered under the 1933 Act or the 1934 Act, will file all
documents required to be filed with the Commission pursuant to Section 13, 14
or 15 of the 1934 Act within the time periods required by the 1934 Act and the
rules and regulations of the Commission under the 1934 Act (the "1934 Act
Regulations").
m. During a period of 120 days from the date of the
Prospectus, the Company will not, without prior written consent of the
Representatives on behalf of the Underwriters, directly or indirectly, sell,
offer to sell, grant any option for the sale of, or otherwise dispose of,
Common Stock or any security convertible into Common Stock (except for Common
Stock issued pursuant to this Agreement or pursuant to reservations,
agreements, conversions or employee or director benefit plans or the exercise
of convertible securities referred to in the Prospectus.
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<PAGE> 8
n. The Company shall not, during the 120 days following
the effective date of the Registration Statement, except with the prior written
consent of the Representatives, file a registration statement covering any of
its shares of capital stock, except that one or more registration statements on
Form S-8 may be filed at any time following the effective date of the
Registration Statement relating to issuances under its employee or director
benefit plans referred to in the Prospectus.
o. The Company has furnished or will furnish to you
"lock-up" letters, in form and substance satisfactory to you, signed by each of
its current officers and directors and each of its stockholders designated by
you.
p. The Company will supply the Underwriters with copies
of all correspondence to and from, and all documents issued to and by, the
Commission in connection with the registration of the Securities under the 1933
Act.
q. Prior to the Closing Date, the Company shall furnish
to the Underwriters, as soon as they have been prepared, copies of any
unaudited interim consolidated financial statements of the Company and its
subsidiaries, for any periods subsequent to the periods covered by the
financial statements appearing in the Registration Statement and the
Prospectus.
r. Prior to the Closing Date, the Company will issue no
press release or other communications directly or indirectly and hold no press
conference with respect to the Company or any of its subsidiaries, the
condition, financial or otherwise, or the earnings, business affairs or
business prospects of any of them, or the offering of the Securities, without
the prior written consent of the Representatives unless in the judgment of the
Company and its counsel, and after notification to the Representatives, such
press release or communication is required by law.
s. The Company has not taken, nor will it take, directly
or indirectly, any action designed to, or that might reasonably be expected to,
cause or result in stabilization or manipulation of the price of the Common
Stock to facilitate the sale or resale of the Securities.
t. The Company will use its best efforts to maintain the
quotation of the Common Stock on NASDAQ.
6. AGREEMENTS OF THE SELLING STOCKHOLDERS. Each of the Selling
Stockholders severally covenants and agrees with the several Underwriters as
follows:
a. Such Selling Stockholder will cooperate to the extent
necessary to cause the Registration Statement or any post-effective amendment
thereto to become effective at the earliest possible time.
b. Such Selling Stockholder will pay all Federal, state
and other taxes, if any, on the transfer or sale of such Securities that are
sold by the Selling Stockholder to the Underwriters. In order to document the
Underwriters' compliance with the reporting and withholding provisions of the
Tax Equity and Fiscal Responsibility Act of 1982 and the Interest and Dividend
Tax Compliance Act of 1983 with respect to the transaction herein contemplated
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<PAGE> 9
each of the Selling Stockholders agrees to deliver to you prior to or at the
Closing Date a properly completed and executed United States Treasury
Department Form W-9 (or other applicable form or statement specified by
Treasury Department regulations in lieu thereof).
c. Such Selling Stockholder will do or perform all
things required to be done or performed by such Selling Stockholder prior to
the Closing Date to satisfy all conditions precedent to the delivery of the
Securities pursuant to this Agreement relating to such Selling Stockholder.
d. Such Selling Stockholder will not for a period of 120
days after the date of the Prospectus, without the prior written consent of the
Representatives, on behalf of the Underwriters, directly or indirectly, sell,
offer to sell, grant any option for the sale of, or otherwise dispose of,
Common Stock or any security convertible into Common Stock, except for
Securities sold pursuant to this Agreement.
e. Such Selling Stockholder has not taken, nor will it
take, directly or indirectly, any action designed to, or that might reasonably
be expected to, cause or result in stabilization or manipulation of the price
of the Common Stock to facilitate the sale or resale of the Securities.
f. Such Selling Stockholder promptly will advise you on
behalf of the several Underwriters, and immediately confirm such advice in
writing, (i) of receipt by such Selling Stockholder or by any representative or
agent of such Selling Stockholder, of any communication from the Commission
relating to the Registration Statement or the Prospectus, or any notice or
order of the Commission relating to the Company or such Selling Stockholder in
connection with the transactions contemplated by this Agreement and (ii) of the
occurrence of any event which makes or may make any statement made in the
Registration Statement or the Prospectus untrue or that requires the making of
any change in the Registration Statement or Prospectus in order to make any
such statement, in the light of the circumstances in which it was made, not
misleading or to comply with the 1933 Act, the 1934 Act or any other law.
7. REPRESENTATIONS AND WARRANTIES OF THE COMPANY. The Company
represents and warrants to each Underwriter that:
a. When the Registration Statement becomes effective,
including at the date of any post-effective amendment, at the date of the
Prospectus, if different, and at the Closing Date and the Option Closing Date,
as the case may be, (i) the Registration Statement complied or will comply in
all material respects with the requirements of the 1933 Act and the 1933 Act
Regulations and will not contain any untrue statement of a material fact or
omit to state a material fact required to be stated therein or necessary to
make the statements therein not misleading. The Prospectus and any supplements
or amendments thereto will not at the date of the Prospectus, at the date of
any such supplements or amendments, and at the Closing Date and the Option
Closing Date, if any, include an untrue statement of a material fact or omit to
state a material fact necessary in order to make the statements therein, in the
light of the circumstances under which they were made, not misleading;
provided, however, that the representations and warranties in this subsection
shall not apply to statements in or omissions from the Registration
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<PAGE> 10
Statement or Prospectus relating to any Underwriter made in reliance upon and
in conformity with information furnished to the Company in writing by any
Underwriter, through the Representatives, expressly for use in the Registration
Statement, the Prospectus or the Offering Memorandum. The Company has not
distributed any offering materials in connection with the offering or sale of
the Securities other than the Registration Statement, the preliminary
prospectus, the Prospectus, the Term Sheet, if applicable, or any other
materials, if any, permitted by the 1933 Act or the 1933 Act Regulations.
b. The accountants who certified the financial
statements included in the Registration Statement are independent public
accountants with regard to the Company as required by the 1933 Act and the 1933
Act Regulations.
c. The financial statements included in the Registration
Statement, the Prospectus and the Offering Memorandum present fairly the
financial position of the Company and its consolidated subsidiaries as of the
dates indicated and the results of their operations for the periods specified;
except as otherwise stated in the Registration Statement, said financial
statements have been prepared in conformity with generally accepted accounting
principles applied on a consistent basis; and no supporting schedules are
required to be included in the Registration Statement. The historical
financial information and statistical data set forth in the Prospectus and the
Offering Memorandum are prepared on an accounting basis consistent with such
financial statements. The pro forma financial information included in the
Prospectus and the Offering Memorandum presents fairly the information shown
therein, has been properly compiled on the pro forma bases described therein,
and, in the opinion of the Company, the assumptions used in the preparation
thereof are reasonable and the adjustments used therein are appropriate to give
effect to the transactions or circumstances referred to therein.
d. Since the respective dates as of which information is
given in the Registration Statement, the Prospectus and the Offering
Memorandum, except as otherwise stated therein, (i) there has been no material
adverse change or any development involving a prospective material adverse
change in or affecting the condition, financial or otherwise, or in the
earnings, business affairs or business prospects of the Company and its
subsidiaries considered as one enterprise, whether or not arising in the
ordinary course of business, (ii) there have been no transactions entered into
by the Company or any of its subsidiaries, other than those in the ordinary
course of business, which are material with respect to the Company and its
subsidiaries considered as one enterprise, and (iii) there has been no dividend
or distribution of any kind declared, paid or made by the Company on any class
of its capital stock. The Company has no material contingent obligations which
are not disclosed in the Registration Statement.
e. The Company has been duly incorporated and is validly
existing as a corporation in good standing under the laws of the State of Texas
with corporate power and authority to own, lease and operate its properties and
to conduct its business as described in the Prospectus and to enter into and
perform its obligations under this Agreement; and the Company is duly qualified
as a foreign corporation to transact business and is in good standing in each
jurisdiction in which such qualification is required, whether by reason of the
ownership or leasing of property or the conduct of business, except where the
failure to so qualify would not,
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<PAGE> 11
singly or in the aggregate, have a material adverse effect on the condition,
financial or otherwise, or the earnings or business affairs of the Company and
its subsidiaries considered as one enterprise.
f. Each subsidiary of the Company has been duly
incorporated and is validly existing as a corporation in good standing under
the laws of the jurisdiction of its incorporation, has corporate power and
authority to own, lease and operate its properties and to conduct its business
as described in the Prospectus and the Offering Memorandum and is duly
qualified as a foreign corporation to transact business and is in good standing
in each jurisdiction in which such qualification is required, whether by reason
of the ownership or leasing of property or the conduct of business, except
where the failure to so qualify would not have a material adverse effect on the
condition, financial or otherwise, or the earnings, business affairs or
business prospects of the Company and its subsidiaries considered as one
enterprise; and all of the issued and outstanding capital stock of each such
subsidiary has been duly authorized and validly issued, is fully paid and
non-assessable and is owned by the Company, directly or through subsidiaries,
free and clear of any security interest, mortgage, pledge, lien, charge,
encumbrance, claim or equity except as described in the Prospectus and the
Offering Memorandum. There are no outstanding subscriptions, options,
warrants, commitments, convertible or exchangeable securities or other rights
granted by the Company or any subsidiary to acquire any shares of capital stock
of or ownership interests in any subsidiary of the Company and there are no
commitments, plans or arrangements to do so. Except as described in the
Prospectus and the Offering Memorandum, the Company does not own, directly or
indirectly, any shares of stock or any other equity or long-term debt
securities of any corporation or have any equity interest in any firm,
partnership, joint venture, association or other entity.
g. The authorized, issued and outstanding capital stock
of the Company is as set forth in the Prospectus under "Capitalization" (except
for subsequent issuances, if any, pursuant to this Agreement or pursuant to
reservations, agreements, employee or director benefit plans or the exercise of
convertible securities referred to in the Prospectus and the Offering
Memorandum); the shares of issued and outstanding capital stock of the Company
have been duly authorized and validly issued and are fully paid and
non-assessable and have not been issued in violation of or are not otherwise
subject to any preemptive or other similar rights; the Securities have been
duly authorized for issuance and sale to the Underwriters pursuant to this
Agreement and, when issued and delivered by the Company pursuant to this
Agreement against payment of the consideration set forth herein, will be
validly issued and fully paid and non-assessable; the certificates evidencing
the Securities upon delivery will be in due and proper form under Texas law;
the authorized capital stock of the Company, including the Securities, conforms
to all statements relating thereto contained in the Prospectus; and the
issuance of the Securities is not subject to preemptive or other similar
rights. There are no outstanding subscriptions, options, warrants, convertible
or exchangeable securities or other rights granted to or by the Company to
purchase shares of Common Stock or other securities of the Company and there
are no commitments, plans or arrangements to issue any shares of Common Stock
or any security convertible into Common Stock, in each case other than as
described in the Prospectus and the Offering Memorandum.
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<PAGE> 12
h. Except as disclosed in the Registration Statement and
except as would not, singly or in the aggregate, reasonably be expected to have
a material adverse effect on the condition, financial or otherwise, or the
earnings and business affairs of the Company and its subsidiaries considered as
one enterprise, (A) the Company and its subsidiaries are each in compliance
with all applicable Environmental Laws, (B) the Company and its subsidiaries
have all permits, authorizations and approvals required under any applicable
Environmental Laws and are each in compliance with the requirements of such
permits authorizations and approvals, (C) there are no pending or, to the best
knowledge of the Company, threatened Environmental Claims against the Company
or any of its subsidiaries and (D) under applicable law, there are no
circumstances known to us with respect to any property or operations of the
Company or its subsidiaries that are reasonably likely to form the basis of an
Environmental Claim against the Company or its subsidiaries.
For purposes of this Agreement, the following terms shall have the
following meanings: "Environmental Law" means any United States (or other
applicable jurisdiction's) Federal, state, local or municipal statute, law,
rule, regulation, ordinance, code, policy or rule of common law and any
judicial or administrative interpretation thereof, including any judicial or
administrative order, consent decree or judgment, relating to the environment,
health, safety or any chemical, material or substance, exposure to which is
prohibited, limited or regulated by any governmental authority. "Environmental
Claims" means any and all administrative, regulatory or judicial actions,
suits, demands, demand letters, claims, liens, notices of noncompliance or
violation, investigations or proceedings relating in any way to any
Environmental Law.
i. Neither the Company nor any of its subsidiaries is in
violation of its charter or bylaws. Neither the Company nor any of its
subsidiaries is in default in the performance or observance of any material
obligation, agreement, covenant or condition contained in any material
contract, indenture, mortgage, loan agreement, deed, trust, note, lease,
sublease, voting agreement, voting trust, or other instrument or agreement to
which the Company or any of its subsidiaries is a party or by which it or any
of them may be bound, or to which any of the property or assets of the Company
or any of its subsidiaries is subject except where such defaults will not
result in a material adverse change in the earnings or condition (financial or
otherwise) of the Company and its subsidiaries considered as one enterprise.
The execution, delivery and performance of this Agreement and the consummation
of the transactions contemplated herein and compliance by the Company with its
obligations hereunder: (i) have been duly authorized by all necessary corporate
action; (ii) will not conflict with or constitute a breach of, or default
under, or result in the creation or imposition of any lien, charge or
encumbrance upon any property or assets of the Company or any of its
subsidiaries pursuant to, any contract, indenture, mortgage, loan agreement,
deed, trust, note, lease, sublease, voting agreement, voting trust or other
instrument or agreement to which the Company or any of its subsidiaries is a
party or by which it or any of them may be bound, or to which any of the
property or assets of the Company or any of its subsidiaries is subject except
where such conflicts, breaches, defaults or creations or assumptions will not
result in a material adverse change in the earnings or condition (financial or
otherwise) of the Company and its subsidiaries considered as one enterprise,
and (iii) will not result in any violation of the provisions of the
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<PAGE> 13
charter or bylaws of the Company or any applicable statute, law, rule,
regulation, ordinance, decision, directive or order.
j. No labor dispute with the employees of the Company or
any of its subsidiaries exists or, to the best knowledge of the Company, is
threatened; and the Company is not aware of any existing or threatened labor
disturbance by the employees of any of its principal suppliers, manufacturers
or contractors which might, singly or in the aggregate, be expected to result
in any material adverse change in the condition, financial or otherwise, or in
the earnings, business affairs or business prospects of the Company and its
subsidiaries considered as one enterprise.
k. There is no action, suit or proceeding before or by
any court or governmental agency or body, domestic or foreign, now pending, or,
to the knowledge of the Company, threatened, against or affecting the Company
or any of its subsidiaries, which is required to be disclosed in the
Registration Statement (other than as disclosed therein), or which, singly or
in the aggregate, might result in any material adverse change in the condition,
financial or otherwise, or in the earnings, business affairs or business
prospects of the Company and its subsidiaries considered as one enterprise, or
which, singly or in the aggregate, might materially and adversely affect the
properties or assets thereof or which might materially and adversely affect the
consummation of this Agreement; all pending legal or governmental proceedings
to which the Company or any of its subsidiaries is a party or of which any of
their respective property or assets is the subject which are not described in
the Registration Statement, including ordinary routine litigation incidental to
the business, are, considered in the aggregate, not material; and there are no
contracts or documents of the Company or any of its subsidiaries which are
required to be filed as exhibits to the Registration Statement by the 1933 Act
or by the 1933 Act Regulations which have not been so filed.
l. The Company and its subsidiaries own or are licensed
to use all patents, patent applications, inventions, trademarks, tradenames,
applications for registration of trademarks, service marks, service mark
applications, copyrights, know-how, manufacturing processes, formulae, trade
secrets, licenses and rights in any thereof and any other intangible property
and assets which are described in or filed as exhibits to the Registration
Statement or which are material to the businesses of the Company and its
subsidiaries as now conducted and as proposed to be conducted, in each case as
described in the Prospectus and the Offering Memorandum (herein called the
"Proprietary Rights"). The description of the Proprietary Rights is correct in
all material respects and fairly and correctly describes the Company's and its
subsidiaries rights with respect thereto. The Company does not have any
knowledge of, and the Company has not given or received any notice of, any
pending conflicts with or infringement of the rights of others with respect to
any Proprietary Rights or with respect to any license of Proprietary Rights.
No action, suit, arbitration, or legal, administrative or other proceeding, or
investigation is pending, or, to the best knowledge of the Company, threatened,
which involves any Proprietary Rights. Neither the Company nor any subsidiary
is subject to any judgment, order, writ, injunction or decree of any court or
any Federal, state, local, foreign or other governmental department,
commission, board, bureau, agency or instrumentality, domestic or foreign, or
any arbitrator, or has entered into or is a party to any contract which
restricts or
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<PAGE> 14
impairs the use of any such Proprietary Rights in a manner which would have a
material adverse effect on the use of any of the Proprietary Rights. To the
best knowledge of the Company, no Proprietary Rights used by the Company or any
of its subsidiaries, and no services or products sold by the Company or any of
its subsidiaries, conflict with or infringe upon any proprietary rights
available to any third party. Neither the Company nor any subsidiary has
received written notice of any pending conflict with or infringement upon such
third party proprietary rights. Neither the Company nor any subsidiary has
entered into consent, indemnification, forbearance to sue or settlement
agreement with respect to Proprietary Rights other than in the ordinary course
of business. No claims have been asserted by any person with respect to the
validity of the Company's or any of its subsidiaries' ownership or right to use
the Proprietary Rights and, to the best knowledge of the Company, there is no
reasonable basis for any claim to be successful. Nothing has come to their
attention which might reasonably indicate that any of the Proprietary Rights
are invalid or unenforceable and no registration relating thereto has lapsed,
expired or been abandoned or cancelled or is the subject of cancellation or
other adversarial proceedings, and all applications therefore are pending and
are in good standing. The Company and its subsidiaries have complied, in all
material respects, with their respective contractual obligations relating to
the protection of the Proprietary Rights used pursuant to licenses. To the
best knowledge of the Company, no person is infringing on or violating the
Proprietary Rights owned or used by the Company or any of its subsidiaries
except where such infringement or violation would not have a material adverse
effect on the business, affairs, condition (financial or otherwise), or results
of operations of the Company and the subsidiaries considered as one enterprise.
m. No registration, authorization, approval,
qualification or consent of any court or governmental authority or agency is
necessary in connection with the offering, issuance or sale of the Securities
hereunder, except such as may be required under the 1933 Act or the 1933 Act
Regulations, state securities or Blue Sky laws, or foreign securities laws (or
such as may be required by the National Association of Securities Dealers, Inc.
("NASD")).
n. The Company and each of its subsidiaries (i) owns or
possesses and is operating in compliance with the terms, provisions and
conditions of all authorizations, approvals, orders, licenses, registrations,
certificates and permits (collectively, "permits") of and from all governmental
regulatory officials and bodies necessary to conduct their respective
businesses, (ii) has made all necessary filings required under any Federal,
state or foreign law, rule or regulation and (iii) has obtained all necessary
authorizations, consents and approvals (collectively, "approvals") from other
persons or governmental agencies in each case that are necessary to own or
lease its properties and assets and to the conduct of its business, except
where the failure to so own or possess, comply, file or obtain, would not,
singly or in the aggregate, reasonably be expected to have a material adverse
effect on the condition, financial or otherwise, or the earnings or business
affairs of the Company and its subsidiaries considered as one enterprise. As
to the Company and each of its subsidiaries, each such permit is valid and in
full force and effect and there is no proceeding pending or, to the best
knowledge of the Company, threatened (or any basis therefor) that could cause
any such permit, filing or approval to be revoked, withdrawn, canceled,
suspended or not renewed, except where such revocation, withdrawal,
cancellation, suspension or failure to renew would not, singly or in the
aggregate,
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<PAGE> 15
reasonably be expected to have a material adverse effect on the condition,
financial or otherwise, or the earnings or business affairs of the Company and
its subsidiaries considered as one enterprise.
o. This Agreement has been duly executed and delivered
by the Company and constitutes a valid and binding obligation of the Company,
enforceable against the Company in accordance with its terms, except as rights
to indemnity and contribution hereunder may be limited by Federal, state or
applicable foreign securities laws or the public policy underlying such laws
and except as enforceability may be limited by bankruptcy, insolvency,
fraudulent conveyance, moratorium or other laws affecting creditors rights
generally and by general equitable principles.
p. Except as described in the Prospectus and the
Offering Memorandum, there are no persons with registration or other similar
rights to have any securities registered pursuant to the Registration Statement
or otherwise registered by the Company under the 1933 Act.
q. No order preventing or suspending the use of any
preliminary prospectus has been issued and no proceedings for that purpose are
pending or, to the best knowledge of the Company, threatened by the Commission;
and to the best knowledge of the Company, no order suspending the offering of
the Securities in any jurisdiction designated by the Underwriters pursuant to
Section 5(g) of this Agreement has been issued and no proceedings for that
purpose have been instituted or threatened.
r. Except as described in the Prospectus and the
Offering Memorandum: the Company and each of its subsidiaries have good and
marketable title to their respective properties, free and clear of all material
security interests, mortgages, pledges, liens, charges, encumbrances, claims
and equities of record; the properties of the Company and its subsidiaries are,
in the aggregate, in good repair (reasonable wear and tear excepted), and
suitable for their respective uses; any real properties held under lease by the
Company and its subsidiaries are held by them under valid, subsisting and
enforceable leases with such exceptions as are not material and do not
interfere in any material respect with the conduct of the business of the
Company and its subsidiaries considered as one enterprise.
s. The Company and Neuromed, Inc. maintain a system of
internal accounting controls sufficient to provide reasonable assurances that
(i) transactions are executed in accordance with management's general or
specific authorization, (ii) transactions are recorded as necessary to permit
preparation of financial statements in conformity with generally accepted
accounting principles and to maintain accountability for assets, (iii) access
to cash, funds in bank or other accounts, securities or other similar assets is
permitted only in accordance with management's general or specific
authorization, and (iv) the recorded accountability for inventory is compared
with the existing inventory at reasonable intervals and appropriate action is
taken with respect to any differences.
t. The Company and its subsidiaries have conducted and
are conducting their business in compliance with all applicable Federal, state,
local and foreign statutes, laws, rules,
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<PAGE> 16
regulations, ordinances, codes, decisions, decrees, directives and orders,
including, but not limited to, those administered or promulgated by the FDA and
any foreign regulatory authorities performing functions similar to those
performed by the FDA, except where the failure to do so would not, singly or in
the aggregate, have a material adverse effect on the condition, financial or
otherwise, or on the earnings or business affairs of the Company and its
subsidiaries considered as one enterprise.
u. To the Company's knowledge, none of the Company, any
of its subsidiaries, or any employee or agent of the Company or any subsidiary
has made any payment of funds of the Company or any subsidiary or received or
retained any funds in violation of any law, rule or regulation, which payment,
receipt or retention of funds is of a character required to be disclosed in the
Prospectus.
v. The Company is not now, and after sale of the
Securities to be sold by it hereunder and application of the net proceeds from
such sale as described in the Prospectus and the Offering Memorandum under the
caption "Use of Proceeds" will not be, an "investment company" within the
meaning of the Investment Company Act of 1940, as amended.
w. All offers and sales of capital stock of the Company
prior to the date hereof were at all relevant times duly registered or exempt
from the registration requirements of the 1933 Act and were duly registered or
subject to an available exemption from the registration requirements of the
applicable state securities or Blue Sky laws.
x. The Company has complied and will comply with all
provisions of Florida H.B. 1771, codified as Section 517.075 of the Florida
statutes, and all regulations promulgated thereunder relating to issuers doing
business with Cuba.
y. The Common Stock is registered pursuant to Section
12(g) of the 1934 Act. The Securities have been duly authorized for quotation
on NASDAQ subject to notice of issuance. The Company has taken no action
designed to, or likely to have the effect of, terminating the registration of
the Common Stock under the 1934 Act or delisting the Common Stock from the
NASDAQ, nor has the Company received any notification that the Commission or
NASDAQ is contemplating terminating such registration or listing.
z. Neither the Company nor any of its subsidiaries, nor,
to its knowledge, any of its officers, directors or affiliates has taken, and
at the Closing Date and at any later Option Closing Date, neither the Company
nor any of its subsidiaries nor, to its knowledge, any of its officers,
directors or affiliates will have taken, directly or indirectly, any action
which has constituted, or might reasonably be expected to constitute, the
stabilization or manipulation of the price of sale or resale of the Securities.
aa. The Company and each of the subsidiaries maintain
insurance of the types and in the amounts adequate for its business and
consistent with insurance coverage maintained by similar companies in similar
business, including but not limited to, insurance covering clinical trial
liability, product liability and real and personal property owned or leased
against theft,
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<PAGE> 17
damage, destruction, acts of vandalism and all other risks customarily insured
against, all of which insurance is in full force and effect.
ab. The Company and each of its subsidiaries have filed
all material tax returns required to be filed, which returns are true and
correct in all material respects, and neither the Company nor any of its
subsidiaries is in default in the payment of any taxes, including penalties and
interest, assessments, fees and other charges, shown thereon due or otherwise
assessed, other than those being contested in good faith and for which adequate
reserves have been provided or those currently payable without interest which
were payable pursuant to said returns or any assessments with respect thereto.
8. REPRESENTATIONS AND WARRANTIES OF THE SELLING STOCKHOLDERS.
Each Selling Stockholder severally represents and warrants to each Underwriter
that:
a. Such Selling Stockholder now has, and on the Closing
Date will have, good and marketable title to the Securities to be sold by such
Selling Stockholder, free and clear of any security interest, mortgage, pledge,
lien, charge, encumbrance, claim or equity, including, without limitation, any
restriction on transfer.
b. Such Selling Stockholder now has, and on the Closing
Date will have, full legal right, power and authorization to sell, assign,
transfer and deliver such Securities in the manner provided in this Agreement,
and upon delivery of and payment for such Securities hereunder, the several
Underwriters will acquire good and marketable title to such Securities free and
clear of any security interest, mortgage, pledge, charge, encumbrance, claim,
equity or adverse claim assuming such Underwriters are purchasers in good faith
who are unaware of any such security interest, mortgage, pledge, loan,
encumbrance, claim, equity or adverse claim.
c. Such Selling Stockholder has all requisite legal
capacity to enter into this Agreement and the Custodian Agreement and to
perform its obligations hereunder and thereunder. This Agreement and the
Custodian Agreement have been duly authorized, executed and delivered by or on
behalf of such Selling Stockholder and are the valid and binding agreements of
such Selling Stockholder enforceable against such Selling Stockholder in
accordance with their terms, except as to rights to indemnity and contribution
thereunder may be limited by Federal or state securities laws or the public
policy underlying such laws and except as enforceability may be limited by
bankruptcy, insolvency, fraudulent conveyance, moratorium or other laws
affecting creditors rights generally and by general equitable principles.
d. Neither the sale of the Securities, the execution,
delivery or performance of this Agreement or the Custodian Agreement by or on
behalf of such Selling Stockholder, nor the consummation by or on behalf of
such Selling Stockholder of the transactions contemplated hereby and thereby:
(i) requires any registration, authorization, approval, qualification or
consent of or with any governmental authority, court or person by such Selling
Stockholder (except such as may be required under the 1933 Act or the 1933 Act
Regulations or state securities or Blue Sky laws or foreign securities laws of
various jurisdictions in which the Securities are being distributed or as may
be required by the NASD); or (ii) conflicts or will conflict with or
constitutes or will constitute a breach of, or a default under, any contract,
indenture, mortgage,
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<PAGE> 18
loan agreement, deed, trust, note, lease, sublease, voting agreement, voting
trust or other instrument or agreement to which such Selling Stockholder is a
party or by which such Selling Stockholder is or may be bound, or violates or
will violate any statute, law, rule, regulation, ordinance, code, decision,
directive or order applicable to such Selling Stockholder, or will result in
the creation or imposition of any security interest, mortgage, pledge, charge,
encumbrance, claim or equity upon any property or assets of such Selling
Stockholder pursuant to the terms of any contract, indenture, mortgage, loan
agreement, deed, trust, note, lease, sublease, voting agreement, voting trust
or other instrument or agreement to which such Selling Stockholder is a party
or by which such Selling Stockholder may be bound or to which any of the
property or assets of such Selling Stockholder is subject except where such
conflicts, defaults or breaches will not result in a material adverse effect on
such Selling Stockholder.
e. The Registration Statement, the Prospectus and the
Offering Memorandum insofar as they relate to such Selling Stockholder, do not
and will not contain an untrue statement of a material fact or omit to state
any material fact required to be stated therein or necessary to make the
statements therein not misleading.
f. The representations and warranties of such Selling
Stockholder in the Custodian Agreement are, and on the Closing Date will be,
true and correct.
g. Such Selling Stockholder has not taken and will not
take, directly or indirectly, any action designed to, or that might reasonably
be expected to cause or result in stabilization or manipulation of the price of
the Common Stock to facilitate the sale or resale of the Securities; and such
Selling Stockholder has not distributed and will not distribute any prospectus
or other offering material in connection with the offering and sale of the
Securities other than the preliminary prospectus filed with the Commission or
other materials permitted by the 1933 Act and the 1933 Act Regulations and the
Offering Memorandum.
h. Such Selling Stockholder does not have any knowledge
or any reason to believe that the Registration Statement, the Prospectus or the
Offering Memorandum (or any amendment or supplement thereto) contains any
untrue statement of a material fact or omits to state any material fact
required to be stated therein or necessary to make the statements therein not
misleading.
9. INDEMNIFICATION AND CONTRIBUTION.
a. The Company and the Selling Stockholders, jointly and
severally, agree to indemnify and hold harmless (i) each Underwriter and (ii)
each person, if any, who controls any Underwriter within the meaning of Section
15 of the 1933 Act (any of the persons referred to in this clause (ii) being
hereinafter referred to as a "controlling person") and (iii) the respective
directors, officers, partners and employees of any of the Underwriters or any
controlling person (any person referred to in clause (i), (ii) or (iii) may
hereinafter be referred to as an "Indemnified Person") to the fullest extent
lawful, from and against any and all losses, claims, damages, liabilities and
expenses whatsoever (including, without limitation, all reasonable costs of
pursuing, investigating and defending any claim, suit or action or any
investigation or proceeding by any governmental agency or body, commenced or
threatened, including the
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<PAGE> 19
reasonable fees and expenses of counsel to any Indemnified Person), directly or
indirectly, caused by, related to, based upon or arising out of or in
connection with any untrue statement or alleged untrue statement of a material
fact contained in the Registration Statement or any amendment thereto,
including the Rule 430A Information and Rule 434 Information, if applicable, or
any omission or alleged omission to state therein a material fact required to
be stated therein or necessary to make the statements therein not misleading or
caused by, related to, based upon, arising out of or in connection with any
untrue statement or alleged untrue statement of a material fact contained in
any preliminary prospectus, the Prospectus or the Offering Memorandum (or any
amendment or supplement to any of them) or any omission or alleged omission to
state therein a material fact required to be stated therein or necessary to
make the statements therein, in the light of the circumstances under which they
were made, not misleading, except insofar as such losses, claims, damages,
liabilities or expenses arise out of or are based upon any untrue statement or
omission or alleged untrue statement or omission which has been made therein or
omitted therefrom in reliance upon and in conformity with the information
relating to such Underwriter furnished in writing to the Company by or on
behalf of any Underwriter through you expressly for use in connection
therewith.
b. If any action, suit or proceeding shall be brought
against any Indemnified Person in respect of which indemnity may be sought
against the Company or any Selling Stockholder, such Indemnified Person shall
promptly notify the parties against whom indemnification is being sought (the
"indemnifying parties"), and such indemnifying parties shall assume the defense
thereof, including the employment of counsel and payment of all reasonable fees
and expenses. Such Indemnified Person shall have the right to employ separate
counsel in any such action, suit or proceeding and to participate in the
defense thereof, but the fees and expenses of such counsel shall be at the
expense of such Indemnified Person unless (i) the indemnifying parties have
agreed in writing to pay such fees and expenses, (ii) the indemnifying parties
have failed to assume the defense and employ counsel or (iii) the named parties
to any such action, suit, investigation or proceeding (including any impleaded
parties) include both such Indemnified Person and the indemnifying parties and
representation of such Indemnified Person and any indemnifying party by the
same counsel would, in the reasonable judgment of the indemnified person, be
inappropriate due to actual or potential differing interests between them (in
which case the indemnifying party shall not have the right to assume the
defense of such action, suit or proceeding on behalf of such Indemnified
Person). It is understood, however, that the indemnifying parties shall, in
connection with any one such action, suit or proceeding or separate but
substantially similar or related actions, suits or proceedings in the same
jurisdiction arising out of the same general allegations or circumstances, be
liable for the reasonable fees and expenses of only one separate firm of
attorneys (in addition to any local counsel reasonably acceptable to the
Company for such purposes) at any time for all such Indemnified Persons not
having actual or potential differing interests with you or among themselves,
which firm shall be designated in writing by Vector, and that all such fees and
expenses shall be reimbursed as they are incurred. The indemnifying parties
shall not be liable for any settlement of any such action, suit or proceeding
effected without their written consent, which consent shall not be unreasonably
withheld, but if settled with such written consent, or if there be a final
judgment for the plaintiff in any such action, suit or proceeding, the
indemnifying parties agree to indemnify and hold harmless any Indemnified
Person, to the extent provided in the preceding paragraph,
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<PAGE> 20
from and against any loss, claim, damage, liability or expense by reason of
such settlement or judgment.
c. Each Underwriter agrees, severally and not jointly,
to indemnify and hold harmless the Company, its directors, its officers who
sign the Registration Statement, any person who controls the Company within the
meaning of Section 15 of the 1933 Act and the Selling Stockholders, to the same
extent as the foregoing indemnity from the Company and the Selling Stockholders
to each Underwriter, but only with respect to information relating to such
Underwriter furnished in writing by or on behalf of such Underwriter through
the Representatives expressly for use in the Registration Statement, the
Prospectus, the Offering Memorandum or any preliminary prospectus, or any
amendment or supplement thereto. If any action, suit, investigation or
proceeding shall be brought against the Company, any of its directors, any such
officer, any such controlling person or any Selling Stockholder based on the
Registration Statement, the Prospectus, the Offering Memorandum or any
preliminary prospectus, or any amendment or supplement thereto, and in respect
of which indemnity may be sought against any Underwriter pursuant to this
paragraph (c), such Underwriter shall have the rights and duties given to the
Company and the Selling Stockholders by paragraph (b) above, and the Company,
its directors, any such officer, any such controlling person, and the Selling
Stockholders, shall have the rights and duties given to the Indemnified Persons
by paragraph (b) above.
d. If the indemnification provided for in this Section 9
is unavailable to or insufficient to hold harmless an Indemnified Person under
paragraphs (a) or (c) hereof in respect of any losses, claims, damages,
liabilities or expenses referred to therein, then each indemnifying party, in
lieu of indemnifying such Indemnified Person, shall contribute to the amount
paid or payable by such Indemnified Person as a result of such losses, claims,
damages, liabilities or expenses (i) in such proportion as is appropriate to
reflect the relative benefits received by the Company and the Selling
Stockholders on the one hand and the Underwriters on the other hand from the
offering of the Securities or (ii) if the allocation provided by clause (i)
above is not permitted by applicable law or judicial determination, in such
proportion as is appropriate to reflect not only the relative benefits referred
to in clause (i) above but also the relative fault of the Company and the
Selling Stockholders on the one hand and the Underwriters on the other hand, as
well as any other relevant equitable considerations. The relative benefits
received by the Company and the Selling Stockholders on the one hand and the
Underwriters on the other hand shall be deemed to be in the same proportion as
the total net proceeds from the offering (before deducting expenses) received
by the Company and the Selling Stockholders bear to the total underwriting
discounts and commissions received by the Underwriters, in each case as set
forth in the table on the cover page of the Prospectus or, if Rule 434 is used,
the corresponding location on the Term Sheet. The relative fault of the
Company and the Selling Stockholders on the one hand and the Underwriters on
the other hand shall be determined by reference to, among other things, whether
the untrue or alleged untrue statement of a material fact or the omission or
alleged omission to state a material fact relates to information supplied by
the Company or the Selling Stockholders on the one hand or by the Underwriters
on the other hand and the parties' relative intent, knowledge, access to
information and opportunity to correct or prevent such statement or omission.
The indemnity and contribution obligations of the Company and the
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<PAGE> 21
Selling Stockholder set forth herein shall be in addition to any liability or
obligation the Company or the Selling Stockholders may otherwise have to any
Indemnified Person.
e. The Company, the Selling Stockholders and the
Underwriters agree that it would not be just and equitable if contribution
pursuant to this Section 9 were determined by a pro rata allocation (even if
the Underwriters were treated as one entity for such purpose) or by any other
method of allocation that does not take account of the equitable considerations
referred to in the immediately preceding paragraph. The amount paid or payable
by an Indemnified Person as a result of the losses, claims, damages,
liabilities and expenses referred to in the immediately preceding paragraph
shall be deemed to include, subject to the limitations set forth above, any
legal or other expenses reasonably incurred by such Indemnified Person in
connection with investigating any claim or defending any such action, suit or
proceeding. Notwithstanding the provisions of this Section 9, no Underwriter
(or any of its related Indemnified Persons) shall be required to contribute
(whether pursuant to subsection (a) or (c) or otherwise) any amount in excess
of the underwriting discounts and commissions applicable to the Securities
underwritten by such Underwriter. Notwithstanding the provisions of the
Section 9, no Selling Stockholders shall be required to contribute (whether
pursuant to subsection (a) or (c) or otherwise) any amount in excess of the net
proceeds received by such Selling Stockholder from the sale of the Securities
contemplated hereby. No person guilty of fraudulent misrepresentation (within
the meaning of Section 11(f) of the 1933 Act) shall be entitled to contribution
from any person who was not guilty of such fraudulent misrepresentation. The
Underwriters' obligations to contribute pursuant to this Section 9 are several
in proportion to the respective numbers of Securities set forth opposite their
names in Schedule II hereto (or such numbers of Securities increased as set
forth in Section 12 hereof) and not joint.
f. No indemnifying party shall, without the prior
written consent of the Indemnified Person, effect any settlement of any pending
or threatened action, suit or proceeding in respect of which any Indemnified
Person is or could have been a party and indemnity could have been sought
hereunder by such Indemnified Person, unless such settlement includes an
unconditional release of such Indemnified Person from all liability on claims
that are the subject matter of such action, suit or proceeding.
g. Any losses, claims, damages, liabilities or expenses
for which an Indemnified Person is entitled to indemnification or contribution
under this Section 9 shall be paid by the indemnifying party to the Indemnified
Person as such losses, claims, damages, liabilities or expenses are incurred.
The indemnity and contribution agreements contained in this Section 9 and the
representations and warranties of the Company and the Selling Stockholders set
forth in this Agreement shall remain operative and in full force and effect,
regardless of (i) any investigation made by or on behalf of any Indemnified
Person, the Company, its directors or officers or the Selling Stockholders, any
director, officer or partner of a Selling Stockholder or any person controlling
the Company or any Selling Stockholder, (ii) acceptance of any Securities and
payment therefor hereunder and (iii) any termination of this Agreement.
h. The parties to this Agreement hereby acknowledge that
they are sophisticated business persons who were represented by counsel during
the negotiations
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<PAGE> 22
regarding the provisions hereof, including without limitation the provisions of
this Section 9 and are fully informed regarding said provisions. They further
acknowledge that the provisions of this Section 9 fairly allocate the risks in
light of the ability of the parties to investigate the Company and its business
in order to assure that adequate disclosure is made in the Registration
Statement and Prospectus as required by the 1933 Act and the 1934 Act and in
the Offering Memorandum under applicable foreign securities laws.
10. CONDITIONS OF UNDERWRITERS' OBLIGATIONS. The several
obligations of the Underwriters to purchase the Initial Securities hereunder
are subject to the following conditions:
a. The Original Registration Statement shall have become
effective not later than 5:30 P.M. on the date hereof, or with the consent of
the Representatives, at a later time and date, and if the Company has elected
to rely upon Rule 462(b), the Rule 462(b) Registration Statement shall have
become effective not later than the earlier of (i) 9:00 P.M. Chicago time on
the date hereof and (ii) the time confirmations are sent or given, as specified
by Rule 462(b)(2), or, with respect to the Rule 462(b) Registration Statement,
at such later time and date as may be approved by Vector; no stop order
suspending the effectiveness of the Registration Statement shall have been
issued under the 1933 Act or proceedings therefor initiated or threatened by
the Commission. If the Company has elected to rely upon Rule 430A, Rule 430A
Information previously omitted from the effective Registration Statement
pursuant to Rule 430A shall have been transmitted to the Commission for filing
pursuant to Rule 424(b) within the prescribed time period and the Company shall
have provided evidence satisfactory to the Underwriters of such timely filing,
or a post-effective amendment providing such information shall have been
promptly filed and declared effective in accordance with the requirements of
Rule 430A. If the Company has elected to rely upon Rule 434, a Term Sheet
shall have been transmitted to the Commission for filing pursuant to Rule
424(b) within the prescribed time period.
b. The Underwriters shall have received:
(i) The favorable opinion, dated as of the
Closing Date, of Hughes & Luce, L.L.P., counsel for the Company, in form and
substance satisfactory to counsel for the Underwriters, to the effect that:
A. The Company has been duly incorporated
and is validly existing as a corporation in good standing under the laws of the
State of Texas.
B. The Company has all requisite corporate
power and corporate authority to own, lease and operate its properties and to
conduct its business as described in the Registration Statement and the
Prospectus and to enter into and perform its obligations under this Agreement.
C. To their knowledge, the Company is duly
qualified as a foreign corporation to transact business and is in good standing
in each jurisdiction in which the ownership or leasing of property or the
conduct of its business or other activities requires such qualification except
where the failure to be so qualified would not have a material adverse effect
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<PAGE> 23
on the business, condition (financial or otherwise) or results of operations of
the Company and its subsidiaries considered as one enterprise.
D. To their knowledge, the authorized issued
and outstanding capital stock of the Company is as set forth in the Prospectus
under "Capitalization" (except for subsequent issuances, if any, pursuant to
reservations, agreements, employee benefit plans or the exercise of convertible
securities referred to in the Prospectus), the shares of issued and outstanding
capital stock of the Company, including the Common Stock, have been duly
authorized and validly issued and are fully paid and non-assessable and have
not been issued in violation of or are not otherwise subject to any preemptive
rights or other similar rights.
E. The Securities to be issued by the
Company have been duly authorized for issuance and sale to the Underwriters
pursuant to this Agreement and, when issued and delivered by the Company
pursuant to this Agreement against payment of the consideration set forth
herein, will be validly issued and fully paid and non-assessable; and the
issuance of the Securities is not subject to preemptive or, to their knowledge,
other similar rights.
F. Neuromed, Inc. ("Neuromed") is the only
significant subsidiary of the Company required to be listed on Exhibit 21 of
the Registration Statement pursuant to Item 601 of Regulation S-K under the
1934 Act. Neuromed has been duly incorporated and is validly existing as a
corporation in good standing under the laws of the jurisdiction of its
incorporation, has all requisite corporate power and corporate authority to
own, lease and operate its properties and to conduct its business as described
in the Registration Statement and, to their knowledge, is duly qualified as a
foreign corporation to transact business and is in good standing in each
jurisdiction in which the ownership or leasing of property or the conduct of
its business or other activities requires such qualification except where the
failure to be so qualified would not have a material adverse effect on the
business, condition (financial or otherwise) or results of operations of the
Company and its subsidiaries considered as one enterprise; to their knowledge,
all of the issued and outstanding capital stock of Neuromed has been duly
authorized and validly issued, is fully paid and non-assessable and is owned by
the Company, directly or through subsidiaries, free and clear of any security
interest, mortgage, pledge, lien, encumbrance, claim or equity except as
disclosed in the Prospectus.
G. To their knowledge, except as described
in the Prospectus, there are no outstanding options, warrants or other rights
granted to or by the Company to purchase shares of Common Stock or other
securities of the Company and there are no commitments, plans or arrangements
to issue any shares of Common Stock or other securities.
H. This Agreement has been duly authorized,
executed and delivered by the Company and constitutes the legal, valid, binding
and enforceable agreement of the Company except as rights to indemnity and
contribution hereunder may be limited by Federal, applicable state or
applicable foreign securities laws or the public policy underlying such laws
and except as enforceability may be limited by bankruptcy, insolvency,
fraudulent conveyance, fradulent transfer, moratorium or other laws affecting
creditors rights generally and by general equitable principles.
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<PAGE> 24
I. The Registration Statement is effective
under the 1933 Act and, to their knowledge, no stop order suspending the
effectiveness of the Registration Statement has been issued under the 1933 Act
nor have proceedings therefor been initiated or threatened by the Commission.
J. At the time the Registration Statement
became effective and at the Closing Date, the Registration Statement (other
than the financial statements and other financial and statistical information
included therein, as to which no opinion need be rendered) complied as to form
in all material respects with the requirements of the 1933 Act and the 1933 Act
Regulations.
K. The form of certificate used to evidence
each of the Securities is in due and proper form and complies with all
applicable statutory requirements.
L. To their knowledge, there are no legal or
governmental proceedings pending or threatened which are required to be
disclosed in the Registration Statement other than those disclosed therein; to
their knowledge, the Company is not party or subject to provisions of any
injunction, judgment, order or decree of any court, regulatory body,
administrative agency or other governmental body or agency the effect of which
could be material and adverse to the business, condition (financial or
otherwise), or results of operations of the Company and its subsidiaries
considered as one enterprise.
M. The information in the Prospectus under
"Business - Legal Proceedings," "Management - Benefit Plans and Other
Arrangements," "Management - Indemnification and Limitation of Liability," and
"Description of Capital Stock," to the extent that it constitutes matters of
law, summaries of legal matters, documents or proceedings, or legal
conclusions, has been reviewed by them and is correct in all material respects
and fairly and correctly presents the information called for with respect
thereto.
N. To their knowledge, there are no
contracts, indentures, mortgages, loan agreements, deeds, trusts, notes,
leases, subleases, voting trusts, voting agreements or other instruments or
agreements required to be described or referred to in the Registration
Statement or to be filed as exhibits thereto other than those described or
referred to therein or filed as exhibits thereto; the descriptions thereof or
references thereto are correct; and to their knowledge, no default by the
Company exists in the due performance or observance of any material obligation,
agreement, covenant or condition contained in any material contract, indenture,
mortgage, loan agreement, deed, trust, note, lease, sublease, voting trust,
voting agreement or other instrument or agreement of the Company or any of its
subsidiaries.
O. No authorization, approval, consent or
order of any court or governmental authority or agency is required in
connection with the offering, issuance or sale of the Securities to the
Underwriters, except such as may be required under the 1933 Act or the 1933 Act
Regulations, state securities or Blue Sky laws, foreign securities laws or such
as may be required by the NASD; and the execution, delivery and performance of
this Agreement and the consummation of the transactions contemplated herein and
compliance by the Company with its obligations hereunder will not conflict with
or constitute a breach of, or default under, or
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<PAGE> 25
result in the creation or imposition of any lien, charge or encumbrance upon
any property or assets of the Company or any of its subsidiaries pursuant to,
any material contract, indenture, mortgage, loan agreement, note, deed, trust,
lease, sublease, voting trust, voting agreement or other instrument or
agreement to which the Company or any of its subsidiaries is a party or by
which it or any of them may be bound, or to which any of the property or assets
of the Company or any of its subsidiaries is subject, nor will such action
result in any violation of the provisions of the charter or bylaws of the
Company, or any applicable statute, law, rule, regulation, ordinance, code,
decision, directive or order.
P. Except as described in the Prospectus, to
their knowledge, there are no persons with registration or other similar rights
to have any securities registered pursuant to the Registration Statement or
otherwise registered by the Company under the 1933 Act.
Q. The Company is not an "investment
company" or a company "controlled" by an "investment company" within the
meaning of the Investment Company Act of 1940, as amended.
R. The issuance of 833,333 shares of capital
stock on March 31, 1995 in connection with the acquisition of Neuromed, Inc.
and the issuance of an additional 200,000 shares of capital stock in connection
with such transaction were duly registered or exempt from the registration
requirements of the 1933 Act. To their knowledge, during the three years
immediately prior to the date hereof there were no other issuances of capital
stock other than stock issued pursuant to the Company's 1979 Stock Option Plan,
1987 Stock Option Plan, 1995 Stock Option Plan, the Directors Stock Option
Plan, the Company's quality education and training program and pursuant to a 3%
stock dividend paid on May 23, 1994 to holders of record on May 6, 1994.
S. To their knowledge, the Company and its
subsidiaries are in compliance with, and conduct their respective businesses in
conformity with, all applicable laws and regulations relating to the operation
of its business as described in the Registration Statement, except to the
extent that any failure so to comply or conform would not have a material
adverse effect upon the business, condition (financial or otherwise) or results
of operations of the Company and its subsidiaries considered as one enterprise.
T. The Registration Statement has become
effective under the 1933 Act; any required filing of the Prospectus, and any
supplements thereto or the Term Sheet, pursuant to Rule 424(b) and if
applicable, Rule 434, has been made in the manner and within the time period
required; and to their knowledge, no stop order suspending the effectiveness of
the Registration Statement or any part thereof has been issued and no
proceedings therefor have been instituted or are pending or contemplated under
the 1933 Act.
(ii) The favorable opinion, dated as of the
Closing Date, of Ross, Clapp, Korn & Montgomery, L.L.P., special patent counsel
for the Company, in form and substance satisfactory to counsel for the
Underwriters, to the effect that:
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A. To their knowledge, there are no legal or
governmental proceedings pending or threatened relating to patents, patent
rights, trade secrets, trademarks, service marks, or other proprietary
information or materials which are required to be disclosed in the Registration
Statement other than those disclosed therein, and all pending legal or
governmental proceedings relating to such matters to which the Company or any
subsidiary is a party or to which any of their property is subject which are
not described in the Registration Statement, considered in the aggregate, will
not have a material adverse effect on the business, condition (financial or
otherwise) or results of operations of the Company and its subsidiaries
considered as one enterprise.
B. The information in the Prospectus under
"Risk Factors -- Dependence on Patents and Proprietary Rights" and "Business --
Patents, Trademarks and Proprietary Rights," to the extent that it constitutes
matters of law, summaries of legal matters, documents or proceedings, or legal
conclusions, has been reviewed by them and is correct in all material respects
and fairly and correctly presents the information called for with respect
thereto.
C. To the best of their knowledge and
information, there are no contracts, instruments or agreements relating to
patents, patent rights, trade secrets, trademarks, service marks or other
proprietary information or materials required to be described or referred to in
the Registration Statement or to be filed as exhibits thereto other than those
described or referred to therein or filed as exhibits thereto; the descriptions
thereof or references thereto are correct; to the best of their knowledge and
information, no default exists in the due performance or observance of any
material obligation, agreement, covenant or condition contained in any such
contracts, instruments or agreements.
D. To the best of their knowledge and
information, the Company is not infringing or otherwise violating any patents,
patent rights, trade secrets, trademarks, service marks, or other proprietary
information or materials, of others, and to the best of their knowledge and
information, there are no infringements by others of any of the Company's
patents, trade secrets, trademarks, service marks, or other proprietary
information or materials which in their judgment could affect materially the
use thereof by the Company.
E. They have no knowledge of any facts which
would preclude the Company from having valid license rights or clear title to
the patents referenced in the Prospectus. They have no knowledge that the
Company lacks or will be unable to obtain any rights or licenses to use all
patents and other material intellectual property and assets necessary to
conduct the business now conducted or proposed to be conducted by the Company
as described in the Prospectus, except as described in the Prospectus. They
are unaware of any facts which form a basis for a finding of unenforceability
or invalidity of any of the Company's patents and other material intangible
property and assets.
F. Subject to any disclosure to the contrary
in the Prospectus, they are not aware of any material fact with respect to the
patent applications of the Company presently on file that (i) would preclude
the issuance of patents with respect to such applications
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<PAGE> 27
or (ii) would lead them to conclude that such patents, when issued, would not
be valid and enforceable in accordance with applicable regulations.
(iii) The favorable opinion, dated as of the
Closing Date, of McKenna & Cuneo, special regulatory counsel for the Company,
in form and substance satisfactory to counsel for the Underwriters, to the
effect that the information in the Prospectus under "Risk Factors -- Government
Regulation; Uncertainty of Obtaining Regulatory Clearance," "Risk Factors --
Cost Pressures on Medical Technology; Third Party Reimbursement," "Business --
Government Regulation," "Business -- Third Party Reimbursement and Cost
Containment" to the extent that it constitutes matters of law relating to the
Federal Food, Drug and Commerce Act, and Federal law and regulations relating
to third party reimbursement are accurate and complete statements or summaries
of the law and fairly and correctly presents the information called for with
respect thereto.
(iv) The favorable opinion, dated as of the
Closing Date, of Hughes & Luce, L.L.P., counsel for the Selling Stockholders in
form and substance satisfactory to counsel for the Underwriters, to the effect
that:
A. This Agreement has been duly executed and
delivered on behalf of each Selling Stockholder by the Attorneys-in-Fact, or
any of them. The Custodian Agreement has been duly executed and delivered by
each Selling Stockholder. This Agreement and the Custodian Agreement
constitute legal, valid, binding and enforceable agreements or instruments of
each of the Selling Stockholders except as rights to indemnity and contribution
thereunder or hereunder may be limited by Federal, state or applicable foreign
securities laws or the public policy underlying such laws and except as
enforceability may be limited by bankruptcy, insolvency, fraudulent conveyance,
moratorium or other laws affecting creditors rights generally and by general
equitable principles.
B. To their knowledge, each Selling
Stockholder has all legal capacity required to sell, transfer and deliver the
Securities to be offered by such Selling Stockholder pursuant to this
Agreement.
C. The Securities to be sold by the Selling
Stockholders have been duly authorized and are validly issued, fully paid and
non-assessable. By delivery of a certificate or certificates representing the
Securities to be offered by a Selling Stockholder pursuant to this Agreement,
and upon the receipt of payment therefor as contemplated herein, such Selling
Stockholder will transfer to the Underwriters who have purchased such
Securities good and marketable title to such Securities, free and clear of any
security interest, mortgage, pledge, lien, encumbrance, claim, equity or
adverse claim, assuming such Underwriters are purchasers in good faith who are
unaware of any such security interest, mortgage, pledge, loan, encumbrance,
claim, equity or adverse claim.
(v) The favorable opinion, dated as of the
Closing Date, of Venture Law Group, A Professional Corporation, counsel for the
Underwriters with respect to the issuance and sale of the Securities, the
Registration Statement and the Prospectus and such other related matters as the
Underwriters shall reasonably request.
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<PAGE> 28
(vi) In giving their opinions required by
subsections (b)(i), (b)(iv) and (b)(v), respectively, of this Section 10,
Hughes & Luce, L.L.P. and Venture Law Group, A Professional Corporation, shall
each additionally state that nothing has come to their attention that leads
them to believe that the Registration Statement (except for financial
statements, notes thereto and other financial information and statistical data
included therein, as to which counsel need make no statement), at the time it
became effective, contained an untrue statement of a material fact or omitted
to state a material fact required to be stated therein or necessary to make the
statements therein not misleading or that the Prospectus or the Offering
Memorandum (except for financial statements, notes thereto and other financial
information and statistical data included therein, as to which counsel need
make no statement), as of their respective dates (unless the term "Prospectus"
refers to a prospectus which has been provided to the Underwriters by the
Company for use in connection with the offering of the Securities which differs
from the Prospectus on file at the Commission at the time the Registration
Statement becomes effective, in which case at the time it is first provided to
the Underwriters for such use) or at the Closing Date or the Option Closing
Date, as the case may be, included or includes an untrue statement of a
material fact or omitted or omits to state a material fact necessary in order
to make the statements therein, in the light of the circumstances under which
they were made, not misleading.
(vii) In giving their opinion required by
subsection (b)(ii) of this Section 10, Ross, Clapp, Korn & Montgomery, L.L.C.
shall additionally state that nothing has come to their attention that leads
them to believe that the Registration Statement (except for financial
statements, notes thereto and other financial information and statistical data
included therein, as to which counsel need make no statement) under "Risk
Factors -- Dependence on Patents and Proprietary Rights" and "Business --
Patents, Trademarks and Proprietary Rights," at the time it became effective,
contained an untrue statement of a material fact or omitted to state a material
fact required to be stated therein or necessary to make the statements therein
not misleading or that the Prospectus or the Offering Memorandum (except for
financial statements, notes thereto and other financial information and
statistical data included therein, as to which counsel need make no statement),
as of their respective dates (unless the term "Prospectus" refers to a
prospectus which has been provided to the Underwriters by the Company for use
in connection with the offering of the Securities which differs from the
Prospectus on file at the Commission at the time the Registration Statement
becomes effective, in which case at the time it is first provided to the
Underwriters for such use) or at the Closing Date or the Option Closing Date,
as the case may be, included or includes an untrue statement of a material fact
or omitted or omits to state a material fact necessary in order to make the
statements therein, in the light of the circumstances under which they were
made, not misleading.
(viii) In giving their opinion required by
subsection (b)(iii) of this Section 10, McKenna & Cuneo shall additionally
state that nothing has come to their attention that leads them to believe that
the Registration Statement (except for financial statements, notes thereto and
other financial information and statistical data included therein, as to which
counsel need make no statement) under "Risk Factors -- Government Regulation;
Uncertainty of Obtaining Regulatory Clearance," "Risk Factors -- Cost Pressures
on Medical Technology; Third Party Reimbursement," "Business -- Government
Regulation," and "Business -- Third Party Reimbursement and Cost Containment,"
at the time it became effective, contained an
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<PAGE> 29
untrue statement of a material fact or omitted to state a material fact
required to be stated therein or necessary to make the statements therein not
misleading or that the Prospectus or the Offering Memorandum (except for
financial statements, notes thereto and other financial information and
statistical data included therein, as to which counsel need make no statement),
as of their respective dates (unless the term "Prospectus" refers to a
prospectus which has been provided to the Underwriters by the Company for use
in connection with the offering of the Securities which differs from the
Prospectus on file at the Commission at the time the Registration Statement
becomes effective, in which case at the time it is first provided to the
Underwriters for such use) or at the Closing Date or the Option Closing Date,
as the case may be, included or includes an untrue statement of a material fact
or omitted or omits to state a material fact necessary in order to make the
statements therein, in the light of the circumstances under which they were
made, not misleading.
c. (i) There shall not have been, since the date hereof
or since the respective dates as of which information is given in the
Registration Statement, the Prospectus and the Offering Memorandum, any
material adverse change or any development involving a prospective material
adverse change in or affecting the condition, financial or otherwise, or in the
earnings, business affairs or business prospects of the Company and its
subsidiaries considered as one enterprise, whether or not arising in the
ordinary course of business, (ii) the representations and warranties of the
Company in Section 7 hereof shall be true and correct with the same force and
effect as though expressly made at and as of the Closing Date, except to the
extent that any such representation or warranty relates to a specific date,
(iii) the Company shall have complied in all material respects with all
agreements and satisfied all conditions on its part to be performed or
satisfied at or prior to the Closing Date, (iv) no stop order suspending the
effectiveness of the Registration Statement has been issued and no proceedings
for that purpose have been initiated or threatened by the Commission and (v)
the Representatives shall have received a certificate, dated the Closing Date
and signed by the President or any Vice President and the chief financial or
accounting officer of the Company to the effect set forth in clauses (i), (ii),
(iii) and (iv) above.
d. At the time of the execution of this Agreement, the
Underwriters shall have received from Ernst & Young L.L.P. a letter dated such
date, in form and substance satisfactory to the Underwriters, to the effect
that (i) they are independent public accountants with respect to the Company
and its subsidiaries within the meaning of the 1933 Act and the 1933 Act
Regulations, (ii) it is their opinion that the financial statements included in
the Registration Statement and covered by their opinions therein comply as to
form in all material respects with the applicable accounting requirements of
the 1933 Act and the 1933 Act Regulations, (iii) based upon limited procedures
set forth in detail in such letter, and except as specifically indicated in
such letter, nothing has come to their attention which causes them to believe
that (A) the unaudited financial statements and supporting schedules of the
Company and its subsidiaries included in the Registration Statement do not
comply as to form in all material respects with the applicable accounting
requirements of the 1933 Act and the 1933 Act Regulations or are not presented
in conformity with generally accepted accounting principles applied on a basis
substantially consistent with that of the audited financial statements included
in the Registration Statement or (B) at a specified date not more than five
days prior to the date of this Agreement, there has been any change in the
capital stock of the Company or any increase
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<PAGE> 30
in the consolidated long-term debt of the Company and its subsidiaries or any
decrease in consolidated net current assets or stockholders equity as compared
with the amounts shown in the June 30, 1995 balance sheet included in the
Registration Statement or, during the period from June 30, 1995 to a specified
date not more than five days prior to the date of this Agreement, there were
any decreases, as compared with the corresponding period in the preceding year,
in consolidated revenues, net income or net income per share of the Company and
its subsidiaries, except in all instances for changes, increases or decreases
which the Registration Statement and the Prospectus disclose have occurred or
may occur, (iv) they do not express any opinion on the pro forma financial
information included in the Registration Statement or on the pro forma
adjustments applied to the historical amounts included in the pro forma
information; however, for purposes of such letter they have: (A) read the pro
forma information; (B) made inquiries of certain officials of the Company who
have responsibility for financial and accounting matters about the basis for
their determination of the pro forma adjustments and whether the pro forma
information above complies in form in all material respects with the applicable
accounting requirements of Rule 11-02 of Regulation S-X; and (C) proved the
arithmetic accuracy of the application of the pro forma adjustments to the
historical amounts in the pro forma information; and on the basis of such
procedures, and such other inquiries and procedures as may be specified in such
letter, nothing came to their attention that caused them to believe that the
pro forma information included in the Registration Statement does not comply in
form in all material respects with the applicable requirements of Rule 11-02 of
Regulation S-X and that the pro forma adjustments have not been properly
applied to the historical amounts in the compilation of the statement; and (v)
in addition to the examination referred to in their opinions and the limited
procedures referred to in clause (iii) above, they have carried out certain
specified procedures, not constituting an audit, with respect to certain
amounts, percentages and financial information which are included in the
Registration Statement, the Prospectus and the Offering Memorandum and which
are specified by the Underwriters, and have found such amounts, percentages and
financial information to be in agreement with or able to be derived from the
relevant audited annual or unaudited interim consolidated financial statements,
or accounting, financial and other records or analyses prepared from such
records of the Company and its subsidiaries identified in such letter.
e. The Underwriters shall have received from Ernst &
Young L.L.P. a letter, dated as of the Closing Date, to the effect that they
reaffirm the statements made in the letter furnished pursuant to subsection (d)
of this Section, except that the specified date referred to shall be a date not
more than five days prior to the Closing Date.
f. The Securities shall have been approved for quotation
on NASDAQ subject to notice of issuance.
g. The representations and warranties of each Selling
Stockholder in Section 8 shall be true and correct in all material respects
with the same force and effect as though expressly made at and as of the
Closing Date, except to the extent that any such representation or warranty
relates to a specific date; and each Selling Stockholder shall have complied in
all material respects with all agreements and satisfied all conditions on its
part to be performed or satisfied at or prior to the Closing Date. The
Representatives shall have received a
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<PAGE> 31
certificate, dated as of the Closing Date and signed by each Selling
Stockholder, to the effect set forth in this subsection g.
h. In the event that the Underwriters exercise their
option provided in Section 2 hereof to purchase all or any portion of the
Option Securities, the representations and warranties of the Company contained
herein and the statements in any certificates furnished by the Company
hereunder shall be true and correct as of the relevant Option Closing Date and,
at the relevant Option Closing Date, the Underwriters shall have received:
(1) A certificate, dated such Option Closing Date,
of the President or any Vice President of the Company and of the chief
financial or accounting officer of the Company confirming that the certificate
delivered at the Closing Date pursuant to Section 10(c) hereof remains true and
correct as of such Option Closing Date.
(2) The favorable opinion of counsel for the
Company, in form and substance satisfactory to counsel for the Underwriters,
dated such Option Closing Date, relating to the Option Securities to be
purchased on such Option Closing Date and otherwise to the same effect as the
opinion required by Sections 10(b)(i), 10(b)(ii), 10(b)(iii), 10(b)(vi),
10(b)(vii) and 10(b)(viii) hereof.
(3) The favorable opinion of Venture Law Group, A
Professional Corporation, counsel for the Underwriters, dated such Option
Closing Date, relating to the Option Securities to be purchased on such Option
Closing Date and otherwise to the same effect as the opinion required by
Sections 10(b)(v) and 10(b)(vi) hereof.
(4) A letter from Ernst & Young, L.L.P. in form and
substance satisfactory to the Underwriters and dated such Option Closing Date,
substantially the same in form and substance as the letter furnished to the
Underwriters pursuant to Section 10(e) hereof, except that the "specified date"
in the letter furnished pursuant to this Section 10(h)(4) shall be a date not
more than five days prior to such Option Closing Date.
i. Counsel for the Underwriters shall have been
furnished with such documents and opinions as they may require for the purpose
of enabling them to pass upon the issuance and sale of the Securities as herein
contemplated and related proceedings, or in order to evidence the accuracy of
any of the representations or warranties or the fulfillment of any of the
conditions herein contained; and all proceedings taken by the Company in
connection with the issuance and sale of the Securities as herein contemplated
shall be satisfactory in form and substance to the Underwriters and counsel for
the Underwriters.
Any certificate or document signed by any officer of the
Company or any Attorney-in-Fact or any Selling Stockholder and delivered to
you, as Representatives of the Underwriters, or to counsel for the
Underwriters, shall be deemed a representation and warranty by the Company, the
Selling Stockholders or the particular Selling Stockholder, as the case may be,
to each Underwriter as to the statements made therein.
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<PAGE> 32
11. EXPENSES. The Company agrees to pay the following costs and
expenses and all other costs and expenses incident to the performance by it and
the Selling Stockholders of their respective obligations hereunder: (i) the
preparation, printing or reproduction, and filing with the Commission of the
Registration Statement (including financial statements and exhibits thereto),
each preliminary prospectus, the Prospectus, the Offering Memorandum and each
amendment or supplement to any of them; (ii) the printing (or reproduction) and
delivery (including postage, air freight and charges for counting and
packaging) of such copies of the Registration Statement, each preliminary
prospectus, the Prospectus, the Offering Memorandum and all amendments or
supplements to any of them as may be reasonably requested for use in connection
with the offering and sale of the Securities; (iii) the preparation, printing,
authentication, issuance and delivery of certificates for the Securities,
including any stamp taxes in connection with the original issuance and sale of
the Securities; (iv) the printing (or reproduction) and delivery of this
Agreement, the preliminary and supplemental Blue Sky Memoranda and all other
agreements or documents printed (or reproduced) and delivered in connection
with the original issuance and sale of the Securities; (v) any filings under
the 1934 Act and the quotation of the Securities on NASDAQ; (vi) the
registration or qualification of the Securities for offer and sale under the
securities or Blue Sky laws of the several states and the provinces of Canada
as provided in Section 5(g) hereof (including the reasonable fees, expenses and
disbursements of counsel for the Underwriters relating to the preparation,
printing or reproduction, and delivery of the preliminary and supplemental Blue
Sky Memoranda and such registration and qualification and the preparation,
printing or reproduction and delivery of the Offering Memorandum, regulatory
filings and fees payable in Canada); (vii) the filing fees incident to securing
any required review by the NASD; and (vii) the fees and expenses of the
Company's accountants and the fees and expenses of counsel (including local and
special counsel) for the Company and the Selling Stockholders.
If this Agreement shall terminate or shall be terminated after
execution pursuant to any provisions hereof (otherwise than pursuant to the
second paragraph of Section 12 or pursuant to clauses (ii), (iii), (iv) and (v)
of Section 13 hereof) or if this Agreement shall be terminated by the
Underwriters because of any failure or refusal on the part of the Company or
any of the Selling Stockholders to comply, in any material respect, with the
terms or fulfill, in any material respect, any of the conditions of this
Agreement, the Company agrees to reimburse the Representatives for all
reasonable out-of-pocket expenses (including reasonable fees and expenses of
counsel for the Underwriters) incurred by you in connection herewith.
12. EFFECTIVE DATE OF AGREEMENT. This Agreement shall become
effective: (i) upon the execution and delivery hereof by or on behalf of the
parties hereto; or (ii) if, at the time this Agreement is executed and
delivered, it is necessary for the Registration Statement or a post-effective
amendment thereto to be declared effective before the offering of the
Securities may commence, when notification of the effectiveness of the
Registration Statement or such post-effective amendment has been released by
the Commission. Until such time as this Agreement shall have become effective,
it may be terminated by the Company, by notifying you, or by you, as
Representatives of the several Underwriters, by notifying the Company and the
Selling Stockholders.
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<PAGE> 33
If one or more of the Underwriters shall fail on the Closing Date to purchase
the Initial Securities which it or they are obligated to purchase under this
Agreement (the "Defaulted Securities"), the Representatives shall have the
right, within 24 hours thereafter, to make arrangements for one or more of the
non-defaulting Underwriters, or any other underwriters, to purchase all, but
not less than all, of the Defaulted Securities in such amounts as may be agreed
upon and upon the terms herein set forth; if, however, the Representatives
shall not have completed such arrangements within such 24-hour period, then:
a. if the number of Defaulted Securities does not exceed
10% of the number of Initial Securities, the non-defaulting Underwriters shall
be obligated to purchase the full amount thereof in the proportions that their
respective underwriting obligations hereunder bear to the underwriting
obligations of all non-defaulting Underwriters, or
b. if the number of Defaulted Securities exceeds 10% of
the number of Initial Securities, this Agreement shall terminate without
liability on the part of any non-defaulting Underwriter.
No action taken pursuant to this Section shall relieve any defaulting
Underwriter from liability in respect of its default.
In the event of any such default which does not result in a
termination of this Agreement, either the Representatives or the Company shall
have the right to postpone the Closing Date for a period not exceeding seven
days in order to effect any required changes in the Registration Statement,
Prospectus or Offering Memorandum or in any other documents or arrangements.
As used herein, the term "Underwriter" includes any person substituted for an
Underwriter under this Section 12.
Any notice under this Section 12 may be given by telegram, telecopy or
telephone but shall be subsequently confirmed by letter.
13. TERMINATION OF AGREEMENT. The Underwriters may terminate this
Agreement, by notice to the Company, at any time at or prior to the Closing
Date or Option Closing Date, as the case may be, (i) if there has been, since
the date of this Agreement or since the respective dates as of which
information is given in the Registration Statement, any material adverse change
or any development involving a prospective material adverse change in or
affecting the condition, financial or otherwise, or in the earnings, business
affairs or business prospects of the Company and its subsidiaries considered as
one enterprise, whether or not arising in the ordinary course of business, (ii)
if there has occurred any change in the financial markets in the United States
or elsewhere or any outbreak of hostilities or escalation thereof or other
calamity or crisis the effect of which is such as to make it, in your
reasonable judgment, impracticable or inadvisable to market the Securities or
to enforce contracts for the sale of the Securities, (iii) if trading in the
Common Stock has been suspended by the Commission, or if trading generally on
the American Stock Exchange, the New York Stock Exchange or in the
over-the-counter markets has been suspended, or minimum or maximum prices for
trading have been fixed, or maximum ranges for prices for securities have been
required, by such exchange or markets or by order of the Commission or any
other governmental authority, or if a banking moratorium has been
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<PAGE> 34
declared by either Federal, New York, Texas or Illinois authorities, (iv) the
enactment, publication, decree or other promulgation of any Federal or state
statute, regulation, rule or order of any court or other governmental authority
which in your judgment materially and adversely affects or may materially or
adversely affect the business or operations of the Company and its subsidiaries
or (v) the taking of any action by any Federal, state or local government or
agency in respect of its monetary or fiscal affairs which in your judgment has
a material adverse effect on the securities markets in the United States, and
would in your judgment make it impracticable or inadvisable to market the
Securities or to enforce any contract for the sale thereof.
Notice of such termination may be given by telegram, telecopy or
telephone and shall be subsequently confirmed by letter.
14. INFORMATION FURNISHED BY THE UNDERWRITERS. The statements set
forth in the last paragraph on the cover page, the stabilization legend on the
inside front cover page, and the statements under the caption "Underwriting" in
any preliminary prospectus and in the Prospectus and the Offering Memorandum
constitute the only information furnished by or on behalf of the Underwriters
through you as such information is referred to in Sections 7(a) and 9 hereof.
15. MISCELLANEOUS. Except as otherwise provided in Sections 5, 12
and 13 hereof, notice given pursuant to any provision of this Agreement shall
be in writing and shall be delivered (i) if to the Company or the Selling
Stockholders at the office of the Company at, Quest Medical, Inc., One
Allentown Parkway, Allen, Texas 75002, Attention: Thomas C. Thompson, Chairman;
or (ii) if to you, as Representatives of the several Underwriters, care of
Vector Securities International, Inc., 1751 Lake Cook Road, Suite 350,
Deerfield, Illinois 60015, Attention: D. Theodore Berghorst.
This Agreement has been and is made solely for the benefit of the
several Underwriters, the Company, its directors and officers, the other
persons referred to in Section 9 hereof and the Selling Stockholders and their
respective successors and assigns, to the extent provided herein, and no other
person shall acquire or have any right under or by virtue of this Agreement.
Neither the term "successor" nor the term "successors and assigns" as used in
this Agreement shall include a purchaser from any Underwriter of any of the
Securities in his status as such purchaser.
16. APPLICABLE LAW; COUNTERPARTS. This Agreement shall be
governed by and construed in accordance with the laws of the State of Illinois
applicable to contracts made and to be performed within the State of Illinois.
17. SUCCESSORS. This Agreement will inure to the benefit of and
be binding upon the parties hereto and their respective successors and the
officers and directors and other persons referred to in Section 9, and no other
person will have any right or obligation hereunder.
This Agreement may be signed in various counterparts which together
constitute one and the same instrument. If signed in counterparts, this
Agreement shall not become effective unless at least one counterpart hereof
shall have been executed and delivered on behalf of each party hereto.
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<PAGE> 35
Please confirm that the foregoing correctly sets forth the agreement
among the Company, the Selling Stockholders and the several Underwriters.
Very truly yours,
QUEST MEDICAL, INC.
By_______________________________________
President and Chief Executive Officer
WILLIAM N. BORKAN
By_______________________________________
Attorney-in-Fact
BURT BORKAN
By_______________________________________
Attorney-in-Fact
JOHN A. GULA
By_______________________________________
Attorney-in-Fact
Confirmed as of the date first above mentioned
on behalf of themselves and the other several
Underwriters named in Schedule II hereto.
VECTOR SECURITIES INTERNATIONAL, INC.
RAUSCHER PIERCE REFSNES, INC.
As Representatives of the Several Underwriters
By VECTOR SECURITIES INTERNATIONAL, INC.
By_______________________________________
Vice President
-35-
<PAGE> 36
SCHEDULE I
QUEST MEDICAL, INC.
<TABLE>
<CAPTION>
Number of
Selling Stockholders Initial Securities
-------------------- ------------------
<S> <C>
William N. Borkan . . . . . . . . . . . . . . . . . . . . . . 989,333
Burt Borkan . . . . . . . . . . . . . . . . . . . . . . . . . 44,000
John A. Gula . . . . . . . . . . . . . . . . . . . . . . . . 50,000
--------------
Total . . . . . . 1,083,333
--------------
</TABLE>
-36-
<PAGE> 37
SCHEDULE I
QUEST MEDICAL, INC.
<TABLE>
<CAPTION>
Number of
Underwriters Initial Securities
------------ ------------------
<S> <C>
Vector Securities International, Inc. . . . . . . . . . . . .
Rauscher Pierce Refsnes, Inc. . . . . . . . . . . . . . . . .
--------------
Total . . . . . . 2,600,000
--------------
</TABLE>
-37-
<PAGE> 1
EXHIBIT 23.2
CONSENT OF ROSS, CLAPP, KORN & MONTGOMERY, L.L.P.
We consent to the reference to our firm under the caption "Experts" in
the Registration Statement on Form SB-2 (Commission File No. 33-62991) and
related Prospectus of Quest Medical, Inc. for the registration of 2,990,000
shares of its common stock.
Ross, Clapp, Korn & Montgomery, L.L.P.
Dallas, Texas
November 7, 1995
<PAGE> 1
EXHIBIT 23.3
CONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
We consent to the reference to our firm under the caption "Experts"
and to the use of our reports dated February 24, 1995 and April 1, 1995 related
to the consolidated financial statements of Quest Medical, Inc. and
subsidiaries and Neuromed, Inc. and subsidiaries, respectively, in the
Registration Statement on Form SB-2 (Commission File No. 33-62991) and related
Prospectus of Quest Medical, Inc. for the registration of 2,990,000 shares of
its common stock.
Ernst & Young LLP
Dallas, Texas
November 7, 1995
