<PAGE> 1
U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-QSB
(MARK ONE)
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1996
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT 1934
FOR THE TRANSITION PERIOD FROM _________ TO _________
COMMISSION FILE NUMBER 0-10521
QUEST MEDICAL, INC.
-----------------------------------------------------------------
(Exact name of Small Business Issuer as specified in its charter)
TEXAS 75-1646002
- ------------------------------- -------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
ONE ALLENTOWN PARKWAY, ALLEN, TEXAS 75002
-----------------------------------------
(Address of principal executive offices)
(Zip Code)
(214) 390-9800
------------------------------------------------
(Issuer's Telephone Number, including area code)
Check whether the issuer: (1) filed all reports required to be filed by Section
13 or 15(d) of the Securities Exchange Act during the past 12 months (or for
such shorter period that the registrant was required to file such reports), and
(2) has been subject to such filing requirements for the past 90 days.
YES X NO
------ -----
State the number of shares outstanding of each of the issuer's classes of
common equity, as of the latest practicable date:
NUMBER OF SHARES OUTSTANDING AT
TITLE OF EACH CLASS OCTOBER 26, 1996
- ---------------------------- -------------------------------
COMMON STOCK, $.05 PAR VALUE 8,315,080
<PAGE> 2
QUEST MEDICAL, INC. AND SUBSIDIARIES
TABLE OF CONTENTS
<TABLE>
<S> <C> <C>
PART I. FINANCIAL INFORMATION 2
Consolidated Balance Sheets
September 30, 1996 and December 31, 1995 3-4
Consolidated Statements of Operations
For the Three Months and Nine Months
ended September 30, 1996 and 1995 5
Consolidated Statements of Cash Flows
For the Nine Months ended
September 30, 1996 and 1995 6
Consolidated Statements of Stockholders'
Equity 7
Notes to Condensed Consolidated
Financial Statements 8-15
Management's Discussion and Analysis of
Financial Condition and Results of
Operations 16-21
PART II. OTHER INFORMATION 22
Item 6. Exhibits and Reports on
Form 8-K 22
SIGNATURES 23
</TABLE>
1
<PAGE> 3
PART I
FINANCIAL INFORMATION
2
<PAGE> 4
QUEST MEDICAL, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
SEPTEMBER 30, 1996 AND DECEMBER 31, 1995
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
ASSETS 1996 1995
------ ------------- ------------
(UNAUDITED)
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 358,022 $ 1,325,630
Marketable securities 1,998,102 2,588,547
Receivables:
Trade accounts, less allowance for doubtful accounts of $114,337
in 1996 and $114,337 in 1995 5,031,639 4,955,235
Interest and other 149,057 128,492
------------ ------------
Total receivables 5,180,696 5,083,727
------------ ------------
Inventories:
Raw materials 3,692,992 2,743,702
Work-in-process 1,875,446 1,077,529
Finished goods 3,016,704 2,285,961
------------ ------------
Total inventories 8,585,142 6,107,192
------------ ------------
Deferred income taxes 488,911 356,703
Prepaid expenses and other current assets 854,994 1,226,268
------------ ------------
Total current assets 17,465,867 16,688,067
------------ ------------
Property, plant and equipment:
Land 1,930,289 1,930,289
Building and improvements 5,288,765 5,271,718
Furniture and fixtures 3,746,732 2,964,471
Machinery and equipment 4,580,378 3,879,802
------------ ------------
15,546,164 14,046,280
Less accumulated depreciation and
amortization 4,533,214 3,784,510
------------ ------------
Net property, plant and equipment 11,012,950 10,261,770
------------ ------------
Cost in excess of net assets acquired, net of
accumulated amortization of $686,668 in 1996
and $340,300 in 1995 13,285,693 9,546,298
Patents, net of accumulated amortization of
$1,255,525 in 1996 and $1,086,433 in 1995 1,119,874 1,288,966
Purchased technology from acquisitions, net of
accumulated amortization of $651,471 in 1996
and $413,558 in 1995 4,046,529 4,284,442
Tradenames, net of accumulated amortization
of $187,500 in 1996 and $93,750 in 1995 2,312,500 2,406,250
Other assets, at cost, less accumulated amortization
of $190,000 in 1996 and $178,667 in 1995 9,931 19,964
------------ ------------
$ 49,253,344 $ 44,495,757
============ ============
</TABLE>
See accompanying notes to condensed consolidated financial statements
3
<PAGE> 5
QUEST MEDICAL, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
SEPTEMBER 30, 1996 AND DECEMBER 31, 1995
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
LIABILITIES AND STOCKHOLDERS' EQUITY 1996 1995
------------------------------------ ------------- -------------
(UNAUDITED)
<S> <C> <C>
Current liabilities:
Accounts payable $ 2,101,261 $ 1,210,265
Short-term notes payable and current maturities
of long-term notes payable 9,937,402 1,616,311
Accrued salary and employee benefit costs 748,893 630,908
Accrued relocation costs -- 291,370
Other accrued expenses 953,287 755,976
------------- -------------
Total current liabilities 13,740,843 4,504,830
------------- -------------
Notes payable 3,854,094 8,558,297
Deferred income taxes 462,706 562,580
Stockholders' equity:
Common stock of $.05 par value. Authorized
25,000,000 shares in 1996 and 10,000,000 in 1995;
issued 8,285,080 shares in 1996 and 8,147,349 in 1995 414,254 407,367
Additional paid-in capital 38,548,913 38,253,670
Retained earnings (deficit) (7,553,426) (7,579,925)
Unrealized loss on marketable securities net of
tax benefit of $110,263 in 1996 and $108,729 in 1995 (214,040) (211,062)
------------- -------------
Total stockholders' equity 31,195,701 30,870,050
Commitments and contingencies
------------- -------------
$ 49,253,344 $ 44,495,757
============= =============
</TABLE>
See accompanying notes to condensed consolidated financial statements
4
<PAGE> 6
QUEST MEDICAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
FOR THE THREE MONTHS AND NINE MONTHS ENDED SEPTEMBER 30, 1996 AND 1995
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------------- -----------------------------
1996 1995 1996 1995
---------- ---------- ----------- ------------
<S> <C> <C> <C> <C>
Net revenue $6,486,521 $6,818,923 $19,305,266 $ 18,122,057
Cost of revenue 2,699,883 2,850,038 8,089,737 7,760,528
---------- ---------- ----------- ------------
Gross profit 3,786,638 3,968,885 11,215,529 10,361,529
---------- ---------- ----------- ------------
Operating expenses:
Marketing 1,788,939 1,158,818 4,850,522 2,752,388
General and administrative 1,149,198 1,120,697 3,504,544 3,038,450
Research and development 724,252 1,145,863 2,493,440 3,639,506
Purchased research and development -- -- -- 10,500,000
---------- ---------- ----------- ------------
3,662,389 3,425,378 10,848,506 19,930,344
---------- ---------- ----------- ------------
Earnings (loss) from operations 124,249 543,507 367,023 (9,568,815)
---------- ---------- ----------- ------------
Other income (expenses):
Interest expense (198,287) (552,002) (571,375) (1,282,973)
Interest and other income 48,250 67,674 162,485 285,630
Gain on sale of marketable securities
and assets 61,352 31,362 123,881 43,393
---------- ---------- ----------- ------------
(88,685) (452,966) (285,009) (953,950)
---------- ---------- ----------- ------------
Earnings (loss) before income taxes 35,564 90,541 82,014 (10,522,765)
Income taxes 28,816 -- 55,515 --
---------- ---------- ----------- ------------
Net earnings (loss) $ 6,748 $ 90,541 $ 26,499 $(10,522,765)
========== ========== =========== ============
Net earnings (loss) per common and
common equivalent share: $ -- $ .01 $ -- $ (1.69)
========== ========== =========== ============
Weighted average number of common and
common equivalent shares used In computing
earnings (loss) per share: 8,707,989 7,158,275 8,601,470 6,211,975
</TABLE>
See accompanying notes to condensed consolidated financial statements
5
<PAGE> 7
QUEST MEDICAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1996 AND 1995
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
------------------------------------
1996 1995
----------- -------------
<S> <C> <C>
Cash flows from operating activities:
Net earnings (loss) $ 26,499 $ (10,522,765)
----------- -------------
Adjustments to reconcile net earnings (loss) to
net cash used by operating activities:
Depreciation and amortization 1,607,160 1,317,294
Purchased research and development -- 10,500,000
Gain on sale of assets and marketable
securities (125,686) (47,373)
Deferred income taxes (99,874) --
Changes in assets and liabilities, net of assets acquired
and liabilities assumed:
Receivables (96,969) (728,839)
Inventories (2,477,950) (906,745)
Prepaid expenses and other assets 371,274 (549,370)
Accounts payable 890,996 (21,029)
Other (1,300) 11,556
Accrued expenses (571,909) 149,025
----------- -------------
Total adjustments (504,258) 9,724,519
----------- -------------
Net cash used in operating activities (477,759) (798,246)
----------- -------------
Cash flows from investing activities:
Purchases of marketable securities (1,231,940) (1,129,896)
Proceeds from sales of marketable securities 1,941,754 3,538,126
Acquisition of Neuromed, Inc. -- (15,947,338)
Additions to property, plant and equipment (1,499,884) (1,313,422)
Net proceeds from sale of assets 1,805 6,626
----------- -------------
Net cash used by investing activities (788,265) (14,845,904)
----------- -------------
Cash flows from financing activities:
Exercise of stock options 405,276 314,210
Proceeds from short-term obligations 328,881 597,787
Proceeds of long-term debt -- 16,900,000
Payment of long-term debt (111,834) (1,057,143)
Payment of short-term obligations (220,761) (474,433)
Debt issuance costs -- (468,767)
Redemption of rights plan (103,146) --
Issuance of treasury stock -- 529
----------- -------------
Net cash provided by financing activities 298,416 15,812,183
----------- -------------
Net increase (decrease) in cash and cash equivalents (967,608) 168,033
Cash and cash equivalents at beginning of year 1,325,630 87,963
----------- -------------
Cash and cash equivalents at September 30 $ 358,022 $ 255,996
----------- -------------
Supplemental cash flow information is presented below:
Income taxes paid $ -- $ --
=========== =============
Interest paid $ 530,600 $ 1,232,999
=========== =============
</TABLE>
See accompanying notes to condensed consolidated financial statements
6
<PAGE> 8
QUEST MEDICAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
Unrealized
Common Stock Additional Retained loss on Total stock-
-------------------- paid-in earnings marketable Treasury holders'
Shares Amount capital (deficit) securities stock equity
--------- -------- ----------- ------------ ---------- ------------ -----------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1992 7,871,543 $393,577 $18,484,031 $ 4,613,941 $ -- $(5,852,194) $17,639,355
Shares issued upon exercise
of stock options 67,898 3,395 116,361 -- -- -- 119,756
Purchase of 100,000 common
shares, at cost -- -- -- -- -- (349,004) (349,004)
Issuance of 1,490 common
shares -- -- -- -- -- 7,402 7,402
Tax effect of stock
option exercise -- -- 187,236 -- -- -- 187,236
Adjustment to unrealized
losses on marketable
securities -- -- -- -- (169,308) -- (169,308)
Net earnings -- -- -- 816,345 -- -- 816,345
--------- -------- ----------- ------------ ---------- ------------ -----------
Balance at December 31, 1993 7,939,441 396,972 18,787,628 5,430,286 (169,308) (6,193,796) 18,251,782
Shares issued upon exercise
of stock options 43,057 2,153 134,894 -- -- -- 137,047
Issuance of 1,882 common
shares from treasury -- -- 5,595 -- -- 4,075 9,670
Adjustment to unrealized
losses on marketable
securities -- -- -- -- (748,236) -- (748,236)
Stock dividend -- -- 586,054 (916,975) -- 330,921 --
Net loss -- -- -- (1,719,193) -- -- (1,719,193)
--------- -------- ----------- ------------ ---------- ------------ -----------
Balance at December 31, 1994 7,982,498 399,125 19,514,171 2,794,118 (917,634) (5,858,800) 15,930,980
Shares issued upon exercise
of stock options 160,422 8,021 361,429 -- -- -- 369,450
Issuance of 245 common --
shares from treasury -- -- 1,216 -- -- 529 1,745
Adjustment to unrealized
losses on marketable
securities -- -- -- -- 706,572 -- 706,572
Issuance of 1,033,333
common shares from
treasury for acquisition -- -- 6,779,285 -- -- 2,237,246 9,016,531
Sale of treasury and new
common shares in public --
offering, net of
offering costs 4,429 221 11,597,569 -- -- 3,621,025 15,218,815
Net loss -- -- -- (10,374,043) -- -- (10,374,043)
--------- -------- ----------- ------------ ---------- ------------ -----------
Balance at December 31, 1995 8,147,349 407,367 38,253,670 (7,579,925) (211,062) -- 30,870,050
Shares issued upon exercise
of stock options 137,731 6,887 398,389 -- -- -- 405,276
Redemption of rights plan -- -- (103,146) -- -- -- (13,146)
Adjustment to unrealized
losses on marketable
securities -- -- -- -- (2,978) -- (2,978)
Net earnings -- -- -- 26,499 -- -- 26,499
--------- -------- ----------- ------------ ---------- ------------ -----------
Balance at September 30, 1996 8,285,080 $414,254 $38,548,913 $(7,553,426) $ (214,040) $ -- $31,195,701
========= ======== =========== =========== ========== ============ ===========
</TABLE>
See accompanying notes to condensed consolidated financial statements
7
<PAGE> 9
QUEST MEDICAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(1) BUSINESS
Quest Medical, Inc. and its subsidiaries (the "Company") design,
develop, manufacture and market a variety of healthcare products used
primarily in cardiovascular surgery, interventional pain management
and intravenous fluid delivery applications. The Company's revenues
are derived primarily from sales throughout the United States, Europe
and Australia.
The research and development, manufacture, sale and distribution of
medical devices is subject to extensive regulation by various public
agencies, principally the Food and Drug Administration and
corresponding state, local and foreign agencies. Product approvals and
clearances can be delayed or withdrawn for failure to comply with
regulatory requirements or the occurrence of unforeseen problems
following initial marketing. While the Company received clearance for
the MPS system during March 1996, for example, there can be no
assurance that such clearance will not be withdrawn in the future.
In addition, the Company's products are purchased primarily by
hospitals and other users which then bill various third party payors
including Medicare, Medicaid, private insurance companies and managed
care organizations. These third party payors reimburse fixed amounts
for services based on a specific diagnosis. The impact of changes in
third party payor reimbursement policies and any amendments to
existing reimbursement rules and regulations which restrict or
terminate the eligibility of the Company's products could have an
adverse impact on the Company's financial condition and results of
operations.
(2) CONDENSED FINANCIAL STATEMENTS
The unaudited consolidated financial information contained in this
report reflects all adjustments (consisting of normal recurring
accruals) considered necessary, in the opinion of management, for a
fair presentation of results for the interim periods presented. The
preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the
date of the financial statements and the reported amounts of revenues
and expenses during the reporting period. Actual results could differ
from these estimates.
Certain information and footnote disclosures normally included in
financial statements prepared in accordance with generally accepted
accounting principles have been condensed or omitted. These financial
statements should be read in conjunction with the financial statements
and notes thereto included in the Company's December 31, 1995 Annual
Report on Form 10-KSB. The results of operations for periods ended
September 30 are not necessarily indicative of operations for the full
year.
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.
Revenue from product sales is recognized at the time the product is
shipped.
8
<PAGE> 10
QUEST MEDICAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Cash equivalents include certificates of deposit and short-term,
highly liquid debt instruments with original maturities of three
months or less.
The Company's marketable equity and debt securities are classified as
available-for-sale and 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 are included in investment income.
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.
Property, plant and equipment are stated at cost. Major renewals and
betterments are capitalized; maintenance and repairs are charged to
operations as incurred. 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.
The excess of costs over the net assets of businesses acquired is
amortized on a straight line basis over the 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
September 30, 1996, the Company does not believe there has been any
impairment of its intangible assets.
Cost of purchased patents is amortized on a straight-line basis over
the estimated useful lives (4 to 14 years) of such patents. Costs of
patents which are the result of internal development are charged to
current operations.
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.
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.
Product development costs including start-up, research and
development, advertising and promotional costs are charged to
operations in the year in which such costs are incurred.
Primary and fully diluted earnings per share for the three months and
nine months ended September 30, 1996 are based upon 8,707,989 and
8,601,470 common and common equivalent shares outstanding,
respectively. Primary and fully diluted earnings (loss) per share for
the three months and nine months ended September 30, 1995 are based
upon 7,158,275 and 6,211,975 common and common equivalent shares
outstanding, respectively. Common stock equivalents are outstanding
stock options and are included in
9 (Continued)
<PAGE> 11
QUEST MEDICAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
average common and common equivalent shares outstanding using the
treasury stock method except during periods where their effect would
be antidilutive.
Deferred income taxes are recorded based on the liability method and
represent the tax effect of the differences between the financial and
tax basis of assets and liabilities other than costs in excess of the
net assets of businesses acquired.
(3) ACQUISITION
On March 31, 1995, the Company acquired for $15,403,263 cash
(excluding $1,062,414 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"). The transaction also
provided for contingent consideration over the following 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 a bank. (See Note
5.)
In July 1995, the sales objectives for 1995 were reached which
triggered a liability for the 1995 contingent consideration payments
with regard to the Neuromed acquisition. The Company recorded the
additional "earn-out" consideration of 200,000 shares of Quest common
stock valued at $2,558,200 and a $1,500,000 liability. In addition, in
September 1995, the Company amended certain terms of the acquisition
agreement whereby the Company agreed to accelerate issuance of the
200,000 shares for the 1995 earn-out and the seller relinquished
certain rights from the previous agreement.
In October 1996, the sales objectives for 1996 were reached which
triggered a liability for the 1996 contingent consideration payment
with regard to the Neuromed acquisition. The Company recorded the
additional "earn-out" consideration of $3,370,000 on the September 30,
1996 balance sheet. The cash payment is due and payable in January
1997 under the acquisition agreement.
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 upon 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 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 nine months ended September 30, 1995.
10 (Continued)
<PAGE> 12
QUEST MEDICAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
The purchase price allocation for the acquisition of Neuromed is
summarized below:
<TABLE>
<S> <C>
Tradenames $ 2,500,000
Purchased technology 4,000,000
Cost in excess of net assets acquired 12,959,154
Purchased research and development 10,500,000
Net tangible assets acquired 174,889
Deferred financing costs 468,767
-----------
$30,602,810
===========
</TABLE>
In connection with the purchase, the Company determined that the
operations of Neuromed would be relocated to the Company's facility in
Allen, Texas by the end of the first quarter of 1996. The relocation
was completed in March 1996 and the Company incurred $1,234,335 of
relocation costs which were recorded as an adjustment to cost in
excess of net assets acquired.
The following unaudited pro forma summary presents the results of
operations for the nine months ended September 30, 1995 as if the
acquisition had occurred on January 1, 1995. 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 and of Neuromed have
been combined from the effective date of the acquisition forward.
<TABLE>
<CAPTION>
NINE MONTHS
ENDED
SEPTEMBER 30, 1995
------------------
<S> <C>
Pro forma revenue $20,529,356
Pro forma earnings from operations 1,847,148
-----------
Pro forma net earnings 167,220
-----------
Pro forma net earnings per common
and equivalent share $ .02
===========
</TABLE>
The pro forma operations information excludes the charge of
$10,500,000 ($1.72 per share) related to purchased in-process research
and development which was expensed at the date of acquisition.
11 (Continued)
<PAGE> 13
QUEST MEDICAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(4) MARKETABLE SECURITIES
The following is a summary of available-for-sale securities at
September 30, 1996:
<TABLE>
<CAPTION>
GROSS GROSS
UNREALIZED UNREALIZED ESTIMATED
COST GAINS LOSSES FAIR VALUE
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Investment grade preferred
securities $885,600 $ 115 $(161,692) $ 724,023
Publicly traded limited
partnerships 200,000 1,250 -- 201,250
Real estate investment
trusts 617,780 -- (103,803) 513,977
Other 619,025 4,188 (64,361) 558,852
---------- ------ --------- ----------
$2,322,405 $5,553 $(329,856) $1,998,102
========== ====== ========= ==========
</TABLE>
At September 30, 1996, no individual security represented more than
15% of the total portfolio or 1% of total assets. The Company did not
have any investments in derivative financial instruments at September
30, 1996.
(5) CURRENT AND LONG-TERM DEBT
On March 31, 1995, the Company entered into a loan agreement (the
"Loan Agreement") with a bank providing for $15 million in senior term
financing, which was utilized to pay substantially all of the cash
portion of the Neuromed purchase price and a working capital line of
up to $5 million. Borrowings under both facilities bore interest at
prime plus 125 basis points, or at the Company's option, LIBOR plus
300 basis points. During December 1995, the Company repaid in its
entirety the senior term loan utilizing net proceeds it received from
a public offering (See Note 7).
In February 1996, the Company amended the working capital line of
credit and added a $15 million acquisition line of credit with the
same bank. Under the amended agreement, the working capital line of
credit is collateralized by the Company's accounts receivable and
inventory and the acquisition line, if drawn upon, will be
collateralized by the Company's remaining unencumbered assets. These
facilities will expire on December 31, 1997 and will bear interest at
the prime rate plus 25 basis points or LIBOR plus 200 basis points, at
the Company's discretion. The interest rate can be reduced based on
the Company achieving certain ratios of senior bank debt to EBITDA.
Advances under the acquisition line are immediately converted to a
five-year term loan. The Company is subject to certain covenants
related to these facilities. Significant covenants include the
maintenance of minimum ratios of current maturities coverage ratio, a
fixed charge ratio and a total liabilities to tangible net worth ratio
(as defined). The Company is also restricted on the payment of cash
dividends to 75% of annual net earnings if no draws exist under the
acquisition line and 25% of annual net earnings if the acquisition
line has been drawn upon. As of September 30, 1996, the Company was
not in compliance with certain financial covenants in its loan
agreement, but NationsBank has waived such non-compliance until
December 31, 1996. As a consequence, the Company has reclassified the
indebtedness in the amount of $4.55 million under the working capital
line of credit from long-term notes payable to short-term notes
payable at September 30, 1996. Such indebtedness would have otherwise
been classified as short-term indebtedness by the terms of the loan
agreement on December 31, 1996. The weighted average interest rate on
such debt was 7.19% at September 30, 1996. The Company and NationsBank
are negotiating an amendment of the loan agreement to provide for
amended financial covenants acceptable to both the bank and the
Company and based on preliminary discussions with the bank, the
Company believes it will be successful in doing so. The Company has
not drawn upon the acquisition line of credit.
12 (Continued)
<PAGE> 14
QUEST MEDICAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
At September 30, 1996, the Company had notes payable in the amounts of
$1,500,000 and $3,370,000 related to "earn-out" consideration for
Neuromed, Inc. (See Note 3). Although the $1,500,000 note was due and
payable in January 1996 and was non-interest bearing, the Company has
withheld payment of the note pending the outcome of arbitration
proceedings related to certain purchase price adjustment disputes
between the Company and Neuromed's former principal owner, Mr. William
Borkan. The $3,370,000 note is due and payable in January 1997 and is
non-interest bearing. Payment of this note will similarly depend on
the resolution of the arbitration.
On December 28, 1993, the Company entered into two agreements for
long-term financing on its principal office and manufacturing facility
in the amount of $4,355,071. The first agreement, in the amount of
$3,000,000, is related to the building. This loan bore interest
through 1995 at an adjustable rate based on the 30-day commercial
paper rate plus 300 basis points. Effective January 1996, the Company
fixed the rate of interest for the remainder of the term of the loan
at 8.59%. 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 loan is collateralized by the Allen facility building
and land and has an unpaid balance of $2,934,364 at September 30,
1996. The second agreement, in the amount of $1,355,071, is related to
certain equipment and furnishings. This loan bore interest through
1995 at an adjustable rate based on the 30-day commercial paper rate
plus 250 basis points. Effective January 1996, the Company fixed the
rate of interest for the remainder of the term of the loan at 7.94%.
This note has a 10-year amortization. This loan is collateralized by
the equipment and furnishings purchased with the proceeds and has an
unpaid balance of $1,078,410 at September 30, 1996.
At September 30, 1996, the Company had a 7.75% note payable for
$108,120. This note was secured by certain of the Company's marketable
securities investments, held by an investment company, which had a
carrying value of $755,688. Borrowings under this note are restricted
to 50% of the market value of the Company's marketable securities held
by the investment company. At September 30, 1996, the amount available
for additional borrowing under this note was $269,724.
(6) FEDERAL INCOME TAXES
At September 30, 1996, general business credits of $838,582 and
alternative minimum tax credits of $152,620 are available to offset
future tax liabilities. If unused, the general business credits expire
in various amounts beginning in 1997 through 2010.
(7) STOCKHOLDERS' EQUITY
On August 26, 1996, the Board of Directors voted to redeem the
Company's then outstanding stock purchase rights at $0.01 per share.
The redemption price for the outstanding rights was paid on September
27, 1996 to shareholders of record as of September 12, 1996.
13 (Continued)
<PAGE> 15
QUEST MEDICAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Also on August 26, 1996, the Board of Directors adopted a new
Shareholder's Rights Plan in which rights to purchase shares of the
Company's common stock were distributed as a dividend, one right per
share, to shareholders of record as of September 12, 1996. The rights
are not exercisable or transferable apart from the common stock until
ten business days following the date that a person or group acquires
more than 15% of the Company's common stock or announces a tender or
exchange offer for more than 20% of the Company's common stock. Upon
becoming exercisable generally, each right entitles the holders to
purchase one share of common stock for $30.00. If the rights become
exercisable because a person or group acquires more than 15% of the
common stock (an "Acquiring Person"), however, the purchase price and
number of shares purchasable will be adjusted so that the holder will
have the right to receive, upon the exercise of the right at the
applicable exercise price, that number of shares of the Company's
common stock having a market value equal to two times the applicable
exercise price of the right. If the Company is acquired in a merger or
other business combination transaction, or 50% or more of its
consolidated assets or earning power are sold, provision will be made
so that each holder of a right will have the right to receive, upon
the exercise of the right at the applicable exercise price, that
number of shares of the acquiring company's common stock having a
market value of two times the applicable exercise price of the right.
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.
Under the Rights Plan, the number of shares issuable upon exercise of
the rights is subject to adjustment by the Company to prevent
dilution. After a person becomes an Acquiring Person, the Company's
board of directors may exchange the rights, other than those owned by
the Acquiring Person, in whole or in part, at an exchange ratio of one
share of common stock per right, subject to adjustment. 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 September 12, 2006, or prior to
the point at which they become exercisable.
In the fourth quarter of 1995, the Company sold 1,676,667 shares in a
public offering. Net proceeds to the Company were $15.2 million of
which $13.9 million was used to repay the senior term bank debt
incurred in connection with the Neuromed acquisition.
(8) COMMITMENTS AND CONTINGENCIES
The Company has no material commitments under noncancellable operating
leases. Total rent expense under operating leases for the three months
ended September 30, 1996 and 1995 was $13,923 and $36,789,
respectively, and $65,548 and $84,459 for the nine months ended
September 30, 1996 and 1995, respectively.
14 (Continued)
<PAGE> 16
As a consequence of the Neuromed Acquisition in March 1995, the
Company is currently a party to certain product liability claims
related to SCS devices sold by Neuromed prior to the acquisition.
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.
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.
(9) FINANCIAL INSTRUMENTS, RISK CONCENTRATION, AND MAJOR CUSTOMERS
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 for trade receivables.
The Company maintains an allowance for doubtful accounts based upon
expected collectibility. Any losses from bad debts have historically
been within management's expectations.
(10) 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 was $38,250 and $25,050 for the three months ended
September 30, 1996 and 1995, respectively, and $114,750 and $75,150
for the nine months ended September 30, 1996 and 1995, respectively.
15
<PAGE> 17
ITEM 2. 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 Condensed Consolidated
Financial Statements of the Company and the related Notes thereto.
RESULTS OF OPERATIONS
COMPARISON OF THE THREE MONTHS AND NINE MONTHS ENDED SEPTEMBER 30, 1996
AND 1995
Revenues. Net revenue of $6.49 million for the three months ended September 30,
1996, was $332,000, or 4.9% below the level for the comparable 1995 period of
$6.82 million. This decrease was primarily the result of lower unit sales
volume at the Company's Advanced Neuromodulation Systems, Inc. ("ANS")
subsidiary, formerly Neuromed, which was acquired on March 31, 1995, and
provides electronic spinal cord stimulation ("SCS") devices used to manage
chronic severe pain. See Note 3 of the Notes to Condensed Consolidated
Financial Statements. SCS revenue decreased 10.3%, or $334,000, during the
three months ended September 30, 1996 compared to the prior year same period.
Of such decrease, approximately $191,000 resulted from the return of
inventories from certain stocking distributors of ANS products whose
distributor agreements the Company decided to terminate early. The Company made
the strategic decision to market its products through commissioned sales agents
rather than distributors in certain areas of the United States. During the
third quarter of 1996, the Company completed clinical validation of the MPS
brand of myocardial system and began commercial shipments during September
1996. Revenue from sales of the MPS system and related products was $170,000
during the three months ended September 30, 1996, and management believes such
sales should begin to ramp up during the fourth quarter of 1996. Net revenue
from sales of the Company's other products decreased 4.7%, or $168,000, during
the three months ended September 30, 1996 compared to the corresponding period
a year ago, primarily due to lower unit sales volume from the Company's
specialized tubing sets. For the nine months ended September 30, 1996, net
revenue of $19.31 million was $1.18 million, or 6.5%, above the comparable 1995
level of $18.12 million. This increase during 1996 compared to 1995 was
attributable to revenue generated by ANS, which provided nine months of revenue
during the 1996 period compared to only six months during the 1995 period. Net
revenue from sales of the Company's other products decreased 5.3%, or $602,000,
primarily due to lower unit sales volume from the Company's specialized tubing
sets.
During the third quarter of 1996, management continued to execute its
previously announced plans of building the infrastructure at ANS, which
management believes is necessary to transform ANS into an industry leader and
compete effectively in the SCS market. Management believes it has taken major
steps in improving the current products of ANS. This effort is continuing
through the remainder of this year and into the first quarter of 1997.
Management believes that these efforts should return ANS to sustained and
profitable revenue growth during 1997.
16
<PAGE> 18
Gross Profit. Gross profit of $3.79 million for the three months ended
September 30, 1996 was $182,000, or 4.6% below the level for the comparable
1995 period of $3.97 million. As a percentage of net revenue, gross profit
remained level during the three months ended September 30, 1996 as compared to
1995, 58.4% in 1996 compared to 58.2% during 1995. The dollar decrease in gross
profit during 1996 compared to 1995 was attributable to the decrease in revenue
generated by ANS as discussed above. For the nine months ended September 30,
1996, gross profit increased to $11.22 million from $10.36 million for the
comparable 1995 period. As a percentage of net revenue, gross profit increased
during the nine months ended September 30, 1996 to 58.1% as compared to 57.2%
for the comparable 1995 period. This increase in gross profit and gross profit
margin during the nine-month period of 1996 compared to 1995 was attributable
to the revenue generated by ANS, since the 1996 period includes nine months of
revenue, while the 1995 period includes only six months of revenue from the
acquisition date of March 31, 1995, and ANS products contribute higher gross
profit margins than the Company's other product lines.
Operating Expenses. Research and development expense decreased to $724,000
during the three months ended September 30, 1996, compared to $1.15 million for
the same period a year ago, and decreased as a percentage of net revenue from
16.8% in 1995 to 11.2% in 1996. Research and development expense decreased to
$2.49 million during the nine months ended September 30, 1996, compared to
$3.64 million for the same period during 1995, and decreased as a percentage of
net revenue from 20.1% in 1995 to 12.9% in 1996. This decrease during both
periods of 1996 compared to 1995 was the result of a reduction in salary and
contract labor expense from staffing reductions due to the completion of the
development of the MPS system. Separately, the Company has devoted significant
engineering resources and has taken major steps in improving the current ANS
products during the past two quarters of 1996. This effort is continuing
through the remainder of 1996 and into the first quarter of 1997. Management
expects research and development expenditures to approximate $800,000 for the
remainder of 1996. The Company plans to focus 60% of the $3.0 million it is
budgeting for fiscal 1997 on developing the next generation of ANS products for
market introduction during 1998. The remainder of the planned 1997 expenditures
will be directed toward continued developments in the myocardial protection
system. Management expects that most of its research and development activities
will continue to be financed through internally-generated funds.
In connection with the March 31, 1995 acquisition of Neuromed, $10.5 million of
the aggregate purchase price was identified as purchased, in-process research
and development. In accordance with generally accepted accounting principles,
an expense of $10.5 million was recorded during the nine-month period ending
September 30, 1995, with no related tax benefit.
Marketing, general and administrative expenses, as a percentage of net revenue,
increased to 45.3% for the three months ended September 30, 1996, compared to
33.4% for the comparable period during 1995, while the dollar amount increased
by $659,000. Marketing expense, as a percentage of net revenue, increased to
27.6% for the 1996 period compared to 17.0% during the same period in 1995, and
the dollar amount increased by $630,000. Of such increase, $335,000 was
additional marketing expense of ANS primarily related to higher salary, benefit
and commission expense from personnel additions, increased travel, and samples
and promotional expense. During 1996, the Company has reorganized part of its
distribution network for ANS products and replaced several distributors in
certain areas of the United States, replacing them with seven direct
salespersons and sales agents who are principally
17
<PAGE> 19
compensated on commission. The Company has also begun designing training,
customer support and sales and marketing materials and videos and will continue
those efforts during the remainder of 1996 and early 1997. The Company has
recently reestablished relationships with key implanters who had discontinued
using the ANS products prior to the Company's acquisition. The remainder of the
increase in marketing expense during the 1996 period compared to 1995 was
primarily the result of additional salary, benefit and travel expense from four
additional direct salespersons hired during the fourth quarter of 1995 in
preparation of the commercial introduction of the MPS system. The Company
currently employs five direct salespersons to market the MPS system and related
products. As previously mentioned, the Company began commercial shipments
during September 1996. Currently, the Company has evaluations in twelve
hospitals and expects evaluations to begin in seven additional hospitals during
mid-November 1996. Over 400 surgical cases have been performed using MPS to
date. Management believes that initial trends indicate that cardiovascular
surgeons who have used or seen the system are ready to change protocols quickly
to take advantage of the MPS features, and that hospitals with multiple
surgical suites, if adopting the MPS system, will purchase multiple systems.
One major challenge, in the opinion of management, is controlling the
purchasing approval process post-clinical evaluation of the MPS. Management
anticipates hiring additional salespersons during 1997 to market the MPS system
and related products as circumstances warrant. Management has decided to focus
most of its efforts for MPS during 1997 on the U.S. and Canadian markets, and
does not anticipate introduction of MPS internationally until fiscal 1998. For
the nine months ended September 30, 1996, marketing expense increased as a
percentage of net revenue to 25.1% compared to 15.2% for the same period during
1995, and the dollar amount increased by $2.1 million. Of such increase, $1.47
million was additional marketing expense of ANS, again primarily related to
additional salary, benefit, commission, travel, samples and promotional
expense. The 1995 nine-month period included only six months of marketing
expense of ANS since the acquisition date occurred on March 31, 1995, while the
1996 period included nine months of expense. The remainder of the increase in
marketing expense during the nine-month 1996 period compared to 1995 of
$624,000, was primarily the result, as mentioned earlier, of additional salary,
benefit and travel expense from four additional direct salespersons hired
during the fourth quarter of 1995 in preparation for the commercial
introduction of the MPS system and related products.
General and administrative expense as a percentage of net revenue increased to
17.7% for the three months ended September 30, 1996, compared to 16.4% for the
comparable period during 1995, and the dollar amount increased by $29,000
solely due to additional amortization expense of ANS intangibles. For the nine
months ended September 30, 1996, general and administrative expense increased
$466,000 compared to the same period in 1995, and as a percentage of net
revenue, increased from 16.8% in 1995 to 18.2% during 1996. Of such increase,
$318,000 was attributable to higher amortization expense of ANS intangibles,
and the 1995 period included amortization expense for only six months since the
acquisition occurred on March 31, 1995, while the 1996 period included nine
months of amortization expense. The remainder of the increase during 1996
compared to 1995 was primarily the result of higher recruiting, relocation,
franchise tax and 401(k) Company match expenses.
Earnings (Loss) from Operations. Earnings from operations decreased to $124,000
during the three months ended September 30, 1996, compared to $544,000 for the
comparable 1995 period. Lower revenue and gross profit from the ANS subsidiary,
combined with increased marketing expense, led to this decrease. For the nine
months ended September 30, 1996, earnings from operations increased to $367,000
compared to a loss from operations of $9.57
18
<PAGE> 20
million during the comparable period during 1995, due to the $10.5 million
expense in 1995 for purchased research and development incurred in connection
with the Neuromed acquisition. Excluding such charge, however, earnings from
operations decreased from $931,000 in 1995 to $367,000 during 1996 primarily
due to higher marketing expense.
Other Income (Expense). Other expense decreased to $89,000 during the three
months ended September 30, 1996, compared to an expense of $453,000 during the
same 1995 period, a reduction of $364,000. For the nine months ended September
30, 1996, other expense decreased to $285,000 compared to $954,000 for the same
period in 1995, a reduction of $669,000. This decrease in other expense during
both periods of 1996 compared to the 1995 periods was attributable, for the
most part, to lower levels of interest expense, since the 1995 periods included
interest expense on $15 million of bank debt incurred in connection with the
Neuromed acquisition, which was repaid in the fourth quarter of 1995 from the
proceeds of a public offering. See Notes 3 and 5 of the Notes to Condensed
Consolidated Financial Statements. Interest income decreased $19,000 and
$123,000, respectively, for the three months and nine months ended September
30, 1996 compared to the same periods in 1995 due to reduced funds available
for investment.
Income Taxes. The Company recorded income tax expense of $29,000 and $56,000
for the three months and nine months ended September 30, 1996, respectively.
The amortization expense of costs in excess of net assets acquired (goodwill)
is not deductible for tax purposes, thus explaining the relatively high rate of
tax for the 1996 periods compared to the U.S. statutory income tax rate
applicable to corporations of 34%. No income tax expense or benefit was
recorded during the 1995 periods.
Net Earnings (Loss). Net earnings decreased to $6,700 for the three months
ended September 30, 1996, compared to net earnings of $91,000 for the
comparable 1995 period, primarily due to the decrease in revenue and gross
profit contributed by ANS and the increased level of marketing expense. Net
earnings increased to $26,000 for the nine months ended September 30, 1996,
compared to a net loss of $10.52 million for the comparable 1995 period due to
the expense of $10.5 million for purchased research and development incurred in
connection with the Neuromed acquisition during 1995. Excluding such charge,
net earnings would have been equivalent during the nine month periods, $26,000
in 1996 compared to $23,000 in 1995.
LIQUIDITY AND FINANCIAL POSITION
The Company's working capital of $3.73 million at September 30, 1996 decreased
from the December 31, 1995 level of $12.18 million principally due to increased
short-term notes payable from the second "earn-out" consideration related to
the Neuromed acquisition, the reclassification of $4.55 million indebtedness
under the Company's working capital line from long-term to short-term and a
reduction in the Company's cash, cash equivalents and marketable securities
(see "Cash Flows" below). The ratio of current assets to current liabilities
was 1.27:1 at September 30, 1996, compared to 3.7:1 at December 31, 1995. Cash,
cash equivalents and marketable securities totaled $2.36 million at September
30, 1996, a decrease of $1.56 million from 1995 year end.
In connection with the acquisition of Neuromed, the Company agreed to pay
contingent consideration in January 1996 and January 1997 depending on
Neuromed's attainment of certain sales objectives. At year end 1995, the
Company had a note payable in connection with the 1995 earn-out consideration
in the amount of $1.5 million, payable in January 1996. The Company has
19
<PAGE> 21
withheld payment of the $1.5 million pending arbitration of certain purchase
price and other disputes between the Company and Neuromed's former principal
owner, William Borkan. In October 1996, the sales objectives for the 1996 earn-
out were reached and the Company recorded a note payable in the amount of $3.37
million at September 30, 1996, which is due and payable in January 1997.
Payment of this note will similarly depend on the resolution of the
arbitration. With NationsBank's assent, which, based on preliminary
discussions with the bank, management believes it could obtain, the Company may
utilize a portion of its acquisition line of credit to fund the payment of any
necessary earn-out payments.
In February 1996, the Company amended its working capital line of credit and
added a $15 million acquisition line of credit with NationsBank of Texas, N.A.
Under the amended agreement, the working capital line of credit is
collateralized by the Company's accounts receivable and inventory. The
acquisition line, if drawn upon, is collateralized by the Company's remaining
unencumbered assets. Both facilities will expire on December 31, 1997, and bear
interest at the prime rate plus 25 basis points or LIBOR plus 200 basis points,
at the Company's discretion. The interest rate can be reduced based upon the
Company achieving certain ratios of senior bank debt to EBITDA. Advances under
the acquisition line are immediately converted to a five-year term loan. The
Company is subject to certain covenants related to the facilities, including a
current maturities coverage ratio, fixed charge ratio and total liabilities to
tangible net worth ratio (as defined). The Company is also restricted on the
payment of dividends to 75% of annual net earnings if no draws exist under the
acquisition line and 25% of annual net earnings if the acquisition line has
been drawn upon. As of September 30, 1996, the Company was not in compliance
with certain of the financial covenants under the loan agreement, but
NationsBank has waived such non-compliance until December 31, 1996. As a
consequence, the Company has reclassified the indebtedness in the amount of
$4.55 million under the working capital line of credit from long-term notes
payable to short-term notes payable at September 30, 1996. Such indebtedness
would have otherwise been classified as short-term indebtedness by the terms of
the loan agreement on December 31, 1996. The weighted average interest rate on
such debt was 7.19% at September 30, 1996. The Company and NationsBank are
negotiating an amendment of the loan agreement to provide for amended financial
covenants acceptable to both the bank and the Company and based on preliminary
discussions with the bank, the Company believes it will be successful in doing
so. The Company has not drawn upon the acquisition line of credit.
Management believes that its current cash, cash equivalents and marketable
securities, funds generated from operations, and if necessary, funds provided
by the working capital line of credit will be sufficient to satisfy normal cash
operating requirements and capital requirements for the remainder of 1996, with
the exception of the earn-out payments discussed above.
CASH FLOWS
Net cash used by operating activities for the nine months ended September 30,
1996 was $478,000. During 1996, the Company increased its investment in
inventories by $2.48 million substantially all of which relates to the MPS
system and related disposables. As previously mentioned, the Company began
commercial shipments of MPS during September 1996 and expects inventories to
decrease during the next two quarters due to this market introduction.
Investing activities for the first nine months of 1996 resulted in a net use of
cash of $788,000. The Company used cash of $1.5 million for capital
expenditures for additional manufacturing tooling and equipment and an upgraded
management information system. The Company anticipates capital expenditures of
$200,000 for the remainder of 1996. The Company was a net seller of marketable
securities during the nine months ended September 30, 1996, which provided net
cash of $710,000.
Financing activities during the first nine months of 1996 provided $298,000 of
cash. Primary sources of cash from financing activities was $405,000 from the
exercise of stock options and net
20
<PAGE> 22
short-term borrowings of $108,000. The Company utilized $112,000 for repayment
of long-term debt during the first nine months of 1996 and $103,000 was
utilized for redemption of the rights outstanding under the 1989 Shareholder
Rights Plan during September 1996.
FORWARD LOOKING STATEMENTS
The following is a "safe harbor" statement under the Private Securities
Litigation Reform Act of 1995: Other than historical information, the matters
discussed in this Management's Discussion and Analysis of Financial Condition
and Results of Operations are forward-looking statements that are based on
management assumptions and involve risks and uncertainties, including but not
limited to the Company's ability to develop, clinically validate or gain market
acceptance for new products, including the MPS system, new generation ANS
products and other products; successfully developing the infrastructure at ANS,
redirecting ANS marketing efforts and redesigning ANS products such that the
Company will be able to grow the business into a solid player in the SCS
market; government regulation; competition and technological changes that may
render the Company's products obsolete or noncompetitive; general domestic and
international economic conditions; and other risks detailed from time to time
in the Company's SEC public filings. Consequently, if such management
assumptions prove to be incorrect or such risks or uncertainties materialize,
the Company's actual results could differ materially from the results
forecasted in the forward-looking statements.
IMPACT OF INFLATION AND CHANGING PRICES
The Company attempts to minimize the impact of inflation on manufacturing and
operating costs through on-going quality and productivity programs. The Company
considers the impact of inflation on its operations to be insignificant as the
rate of inflation has remained low in recent years. When material price
increases have been experienced by the Company, it has generally attempted to
pass such cost increases on to customers through its prices, to the extent
permitted by competition.
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.
21
<PAGE> 23
PART II
OTHER INFORMATION
<TABLE>
<CAPTION>
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
--------------------------------
<S> <C>
(a) Exhibits
27.1 -- Financial Data Schedule
(b) The Company filed a current report on Form 8-K, dated September 3, 1996, reporting pursuant to Item 5.
"Other Events," that on August 26, 1996, the Company's Board of Directors voted to redeem the rights
outstanding under the Rights Agreement between the Company and KeyCorp Shareholder Services, Inc. dated
October 12, 1989 (as amended), and adopted a new Rights Agreement pursuant to which Rights to purchase
shares of the Company's Common Stock were distributed as a dividend, one Right per share, to record
owners of the Company's Common Stock as of the close of business on September 12, 1996. The Rights
Agreement was not adopted in response to any known offers for the Company. See Note 7 of the Notes to
Condensed Consolidated Financial Statements.
The Company also filed pursuant to Item 7. "Financial Statements, Pro Forma Financial Information and
Exhibits," the following documents as exhibits to the report:
Exhibit 4.1 Rights Agreement between Quest Medical, Inc. and KeyCorp Shareholder
Services, Inc. as Rights Agent.
Exhibit 20.1 Press Release dated August 30, 1996.
Exhibit 20.2 Letter to Shareholders of Quest Medical, Inc. dated August 30, 1996,
including attached Summary of Rights to Purchase Shares of Quest
Medical, Inc. Common Stock.
</TABLE>
22
<PAGE> 24
SIGNATURES
In accordance with the requirements of the Exchange Act, the registrant caused
this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
QUEST MEDICAL, INC.
DATE: NOVEMBER 14, 1996 BY: /S/ F. ROBERT MERRILL III
-------------------------------------
F. ROBERT MERRILL III
SENIOR VICE PRESIDENT FINANCE
CHIEF FINANCIAL OFFICER AND TREASURER
23
<PAGE> 25
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
<S> <C>
27 -- Financial Data Schedule
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> SEP-30-1996
<CASH> 358,022
<SECURITIES> 1,998,102
<RECEIVABLES> 5,145,975
<ALLOWANCES> 114,336
<INVENTORY> 8,585,142
<CURRENT-ASSETS> 17,465,867
<PP&E> 15,546,164
<DEPRECIATION> 4,533,214
<TOTAL-ASSETS> 49,253,344
<CURRENT-LIABILITIES> 13,740,843
<BONDS> 0
0
0
<COMMON> 414,254
<OTHER-SE> 30,781,447
<TOTAL-LIABILITY-AND-EQUITY> 49,253,344
<SALES> 19,305,266
<TOTAL-REVENUES> 19,305,266
<CGS> 8,089,737
<TOTAL-COSTS> 8,089,737
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</TABLE>
