<PAGE> 1
U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-QSB
(MARK ONE)
X QUARTERLY REPORT UNDER SECTION 13 OR 15(D) OF THE
- ---- SECURITIES EXCHANGE ACT 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 1996
TRANSACTION REPORT UNDER SECTION 13 OR 15(D) OF THE
- ----- SECURITIES EXCHANGE ACT 1934
FOR THE TRANSITION PERIOD FROM TO
--------- ---------
COMMISSION FILE NUMBER 0-10521
QUEST MEDICAL, INC.
------------------------------------------------
(Exact name of Small Business Issuer as specified in its charter)
TEXAS 75-1646002
------------------------------- ----------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
ONE ALLENTOWN PARKWAY, ALLEN, TEXAS 75002
-------------------------------------------------
(Address of principal executive offices)
(Zip Code)
(214) 390-9800
-------------------------------------------------
(Issuer's Telephone Number, including area code)
Check whether the issuer: (1) filed all reports required to be filed by Section
13 or 15(d) of the Securities Exchange Act during the past 12 months (or for
such shorter period that the registrant was required to file such reports), and
(2) has been subject to such filing requirements for the past 90 days.
YES X NO
----- -----
State the number of shares outstanding of each of the issuer's classes of
common equity, as of the latest practicable date:
NUMBER OF SHARES OUTSTANDING AT
TITLE OF EACH CLASS APRIL 24, 1996
- --------------------------------- ---------------------------------
COMMON STOCK, $.05 PAR VALUE 8,226,399
<PAGE> 2
QUEST MEDICAL, INC. AND SUBSIDIARIES
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION 2
Consolidated Balance Sheets
March 31, 1996 and December 31, 1995 3-4
Consolidated Statements of Operations
For the Three Month ended
March 31, 1996 and 1995 5
Consolidated Statements of Cash Flows
For the Three Months ended
March 31, 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 16-19
PART II. OTHER INFORMATION 20
Item 6. Exhibits and Reports on
Form 8-K 20
SIGNATURES 21
1
<PAGE> 3
PART I
FINANCIAL INFORMATION
2
<PAGE> 4
QUEST MEDICAL, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
MARCH 31, 1996 AND DECEMBER 31, 1995
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31,
1996 1995
ASSETS (UNAUDITED)
- ------ ------------ ------------
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 1,596,089 $ 1,325,630
Marketable securities 3,074,192 2,588,547
Receivables:
Trade accounts, less allowance for doubtful
accounts of $114,337 in 1996 and $114,337 in 1995 4,601,206 4,955,235
Interest and other 211,489 128,492
------------ ------------
Total receivables 4,812,695 5,083,727
------------ ------------
Inventories:
Raw materials 2,956,260 2,743,702
Work-in-process 2,110,413 1,077,529
Finished goods 1,459,387 2,285,961
------------ ------------
Total inventories 6,526,060 6,107,192
------------ ------------
Deferred income taxes 468,685 356,703
Prepaid expenses and other current assets 1,311,119 1,226,268
------------ ------------
Total current assets 17,788,840 16,688,067
------------ ------------
Property, plant and equipment:
Land 1,930,289 1,930,289
Building and improvements 5,298,677 5,271,718
Furniture and fixtures 3,106,785 2,964,471
Machinery and equipment 4,123,540 3,879,802
------------ ------------
14,459,291 14,046,280
Less accumulated depreciation and
amortization 4,026,919 3,784,510
------------ ------------
Net property, plant and equipment 10,432,372 10,261,770
------------ ------------
Cost in excess of net assets acquired, net of
accumulated amortization of $455,756 in 1996
and $340,300 in 1995 9,684,503 9,546,298
Patents, net of accumulated amortization of
$1,142,896 in 1996 and $1,086,433 in 1995 1,232,503 1,288,966
Purchased technology from acquisitions, net of
accumulated amortization of $492,862 in 1996
and $413,558 in 1995 4,205,138 4,284,442
Tradenames, net of accumulated amortization
of $125,000 in 1996 and $93,750 in 1995 2,375,000 2,406,250
Other assets, at cost, less accumulated amortization
of $186,667 in 1996 and $178,667 in 1995 13,264 19,964
------------ ------------
$ 45,731,620 $ 44,495,757
============ ============
</TABLE>
See accompanying notes to condensed consolidated financial statements
3
<PAGE> 5
QUEST MEDICAL, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
MARCH 31, 1996 AND DECEMBER 31, 1995
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31,
1996 1995
LIABILITIES AND STOCKHOLDERS' EQUITY (UNAUDITED)
------------------------------------ -------------- ---------------
<S> <C> <C>
Current liabilities:
Accounts payable $ 1,833,345 $ 1,210,265
Short-term notes payable and current maturities
of long-term notes payable 1,929,440 1,616,311
Accrued salary and employee benefit costs 854,662 630,908
Accrued relocation costs 384,335 291,370
Other accrued expenses 684,810 755,976
------------ ------------
Total current liabilities 5,686,592 4,504,830
------------ ------------
Notes payable 8,485,698 8,558,297
Deferred income taxes 529,289 562,580
Stockholders' equity:
Common stock of $.05 par value. Authorized
10,000,000 shares; issued 8,216,965 shares
in 1996 and 8,147,349 in 1995 410,848 407,367
Additional paid-in capital 38,468,468 38,253,670
Retained earnings (deficit) (7,674,497) (7,579,925)
Unrealized loss on marketable securities net of
tax benefit of $90,037 in 1996 and $108,729 in 1995 (174,778) (211,062)
------------ ------------
Total stockholders' equity 31,030,041 30,870,050
Commitments and contingencies
------------ ------------
$ 45,731,620 $ 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 ENDED MARCH 31, 1996 AND 1995
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
----------------------------
1996 1995
----------- -----------
<S> <C> <C>
Net revenue $ 6,149,126 $ 4,071,640
Cost of revenue 2,652,150 2,027,352
----------- -----------
Gross profit 3,496,976 2,044,288
----------- -----------
Operating expenses:
Research and development 896,343 1,085,737
Marketing 1,411,993 528,637
General and administrative 1,163,844 766,858
----------- -----------
3,472,180 2,381,232
----------- -----------
Earnings (loss) from operations 24,796 (336,944)
----------- -----------
Other income (expenses):
Interest expense (178,080) (157,266)
Interest and other income 66,835 123,310
Gain on sale of marketable securities 10,224 6,302
----------- -----------
(101,021) (27,654)
----------- -----------
Loss before income taxes (76,225) (364,598)
Income taxes (see note 6) 18,347 --
----------- -----------
Net loss $ (94,572) $ (364,598)
=========== ===========
Net loss per common and
common equivalent share: $ (.01) $ (.07)
=========== ===========
Weighted average number of common and
common equivalent shares used in computing
loss per share: 8,185,710 5,302,463
</TABLE>
See accompanying notes to condensed consolidated financial statements
5
<PAGE> 7
QUEST MEDICAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
FOR THE THREE MONTHS ENDED MARCH 31, 1996 AND 1995
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
-----------------------------
1996 1995
------------ ------------
<S> <C> <C>0
Cash flows from operating activities:
Net loss $ (94,572) $ (364,598)
------------ ------------
Adjustments to reconcile net loss to
net cash provided by operating activities:
Depreciation and amortization 532,882 313,909
Gain on sale of assets and marketable
securities (10,724) (6,302)
Deferred income taxes (33,291) --
Changes in assets and liabilities, net of assets acquired
and liabilities assumed:
Receivables 271,032 (176,998)
Inventories (418,868) (251,774)
Prepaid expenses and other assets (86,151) (120,862)
Accounts payable 623,080 1,071,382
Other -- 11,555
Accrued expenses (138,781) 150,014
------------ ------------
Total adjustments 739,179 990,924
------------ ------------
Net cash provided by operating activities 644,607 626,326
------------ ------------
Cash flows from investing activities:
Purchases of marketable securities (742,527) (291,875)
Proceeds from sales of marketable securities 322,081 380,117
Acquisition of Neuromed, Inc. -- (16,158,188)
Additions to property, plant and equipment (413,011) (359,773)
Net proceeds from sale of assets 500 --
------------ ------------
Net cash used by investing activities (832,957) (16,429,719)
------------ ------------
Cash flows from financing activities:
Exercise of stock options 218,279 114,722
Proceeds from short-term obligations 277,056 387,907
Proceeds of long-term debt -- 15,400,000
Payment of long-term debt (36,526) (26,573)
------------ ------------
Net cash provided by financing activities 458,809 15,876,056
------------ ------------
Net increase in cash and cash equivalents 270,459 72,663
Cash and cash equivalents at beginning of year 1,325,630 87,963
------------ ------------
Cash and cash equivalents at March 31 $ 1,596,089 $ 160,626
============ ============
Supplemental cash flow information is presented below:
Income taxes paid $ -- $ --
============ ============
Interest paid $ 161,263 $ 156,624
============ ============
</TABLE>
See accompanying notes to condensed consolidated financial statements
6
<PAGE> 8
QUEST MEDICAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
Unrealized Total
Additional Retained loss on stock-
Common Stock paid-in earnings marketable Treasury holders'
Shares Amount capital (deficit) securities stock equity
--------- -------- ------------ ------------ --------- ------------ ------------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at December 31, 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 69,616 3,481 214,798 -- -- -- 218,279
Adjustment to unrealized losses
on marketable securities -- -- -- -- 36,284 -- 36,284
Net loss -- -- -- (94,572) -- -- (94,572)
--------- -------- ------------ ------------ --------- ------------ ------------
Balance at March 31, 1996 8,216,965 $410,848 $ 38,468,468 $ (7,674,497) $(174,778) $ -- $ 31,030,041
========= ======== ============ ============ ========= ============ ============
</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 requirement or the occurrence of unforeseen problems
following initial marketing. While the Company received clearance for
the MPS system during March 1996, 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
March 31 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
March 31, 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 loss per share for the three months ended
March 31, 1996 and 1995 are based upon 8,185,710 and 5,302,463 common
and common equivalent shares outstanding, respectively. Common stock
equivalents are outstanding stock options and are included in average
common and common equivalent shares outstanding using the treasury
stock method except during periods where their effect would be
antidilutive.
9 (Continued)
<PAGE> 11
QUEST MEDICAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
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. The amended
agreement sets the 1996 contingent consideration, payable in January
1997, at a cash payment equal to $3,370,000, if earned.
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 three months ended June 30, 1995.
The purchase price allocation for the acquisition of Neuromed, as of
March 31, 1996, is summarized below:
10 Continued)
<PAGE> 12
QUEST MEDICAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<S> <C>
Tradenames $ 2,500,000
Purchased technology 4,000,000
Cost in excess of net assets acquired 9,127,052
Purchased research and development 10,500,000
Net tangible assets acquired 386,389
Deferred financing costs 468,767
--------------------
$ 26,982,208
====================
</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 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>
THREE MONTHS
ENDED
MARCH 31, 1995
--------------------
<S> <C>
Pro forma revenue $ 6,478,939
Pro forma earnings from operations 579,019
--------------------
Pro forma net earnings 42,052
--------------------
Pro forma net earnings per common and
equivalent share $ .01
====================
</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 was expensed at the date of
acquisition.
(4) MARKETABLE SECURITIES
The following is a summary of available-for-sale securities at March
31, 1996:
11 (Continued)
<PAGE> 13
QUEST MEDICAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
GROSS GROSS
UNREALIZED UNREALIZED ESTIMATED
COST GAINS LOSSES FAIR VALUE
---- ----- ------ ----------
<S> <C> <C> <C> <C>
Investment grade preferred
securities $ 995,041 $ 1,227 $ 138,904 $ 857,364
Publicly traded limited
partnerships 506,447 16,615 30,000 493,062
Real estate investment
trusts 1,176,227 20,435 87,469 1,109,193
Other 661,292 24,666 71,385 614,573
----------- -------- --------- -----------
$ 3,339,007 $ 62,943 $ 327,758 $ 3,074,192
=========== ======== ========= ===========
</TABLE>
At March 31, 1996, no individual security represented more than 15% of
the total portfolio or 2% of total assets. The Company did not have
any investments in derivative financial instruments at March 31, 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. The interest rate could be reduced based on the
Company achieving certain ratios of senior bank debt to EBITDA
(earnings before interest, taxes, depreciation and amortization). The
facilities were collateralized by certain of the Company's assets,
including 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 which collateralize their long-term financing described
below. The Company was subject to certain covenants related to the
Loan Agreement including the maintenance of a minimum current ratio,
ratio of debt to net worth (as defined) and restrictions on the
payment of cash dividends. 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 will be subject to certain
covenants related to these facilities. Significant covenants include
the maintenance of minimum ratios of current maturities coverage
ratio, fixed charge ratio and total liabilities to tangible net worth
ratio (as defined). The Company will also be restricted
12 (Continued)
<PAGE> 14
QUEST MEDICAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
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. At March 31, 1996, the
Company had advances in the amount of $4,550,000 outstanding under the
working capital line with a weighted average interest rate of 7.13%.
The Company has not drawn upon the acquisition line of credit.
At March 31, 1996, the Company had a note payable in the amount of
$1,500,000 related to "earn-out" consideration for Neuromed, Inc. (See
Note 3). Although the note was due and payable in January 1996 and
was non-interest bearing, the Company has withheld payment of the note
pending arbitration of certain purchase price adjustment disputes
between the Company and Neuromed's former principal owner, Mr. William
Borkan.
On December 28, 1993, the Company entered into two agreements for
long-term financing on their 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 $2,955,871 at
March 31, 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 $1,132,211 at March 31, 1996.
At March 31, 1996, the Company had a 7.75% note payable for $277,056.
This note was secured by certain of the Company's marketable
securities investments, held by an investment company, which had a
carrying value of $731,400. Borrowings under this note are restricted
to 50% of the market value of the Company's marketable securities held
by the investment company. At March 31, 1996, the amount available
for additional borrowing under this note was $88,644.
(6) FEDERAL INCOME TAXES
Although the Company sustained a net operating loss during the three
months ended March 31, 1996, income tax expense of $18,347 was
recorded as a consequence of the nondeductibility of the amortization
expense of goodwill.
At March 31, 1996, general business credits of $842,700 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 2010.
13 (Continued)
<PAGE> 15
QUEST MEDICAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(7) STOCKHOLDERS' EQUITY
At March 31, 1996 the Company has outstanding stock purchase rights
attached to each outstanding share of common stock. The rights are
not exercisable or transferable apart from the common stock until ten
days after a public announcement that a person or group, with certain
exceptions, 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. Under the rights agreement, the number of shares
issuable upon exercise of the rights are subject to adjustment by the
Company in order to prevent dilution. The purchase price (as defined
in the rights agreement) for each one-half share of common stock
purchased pursuant to the exercise of the right is $12.50. Under
certain circumstances described in the rights agreement, the holder
will be entitled to receive, upon exercise of the right at the current
exercise price, that number of shares of common stock of the Company
or acquiring Company having a market value of two times the exercise
price of the right. 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.
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 March 31, 1996 and 1995 was $37,217 and $10,881, respectively.
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.
14 (Continued)
<PAGE> 16
(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 March
31, 1996 and 1995, respectively.
15
<PAGE> 17
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 ENDED MARCH 31, 1996 AND 1995
Revenues. Net revenue of $6.15 million for the three months ended March 31,
1996, was $2.08 million or 51% above the level for the comparable 1995 period
of $4.07 million. This increase during 1996 compared to 1995 was attributable
to revenue generated by Neuromed, Inc. ("Neuromed") which was acquired on March
31, 1995. See Note 3 of the Notes to Condensed Consolidated Financial
Statements. Neuromed develops, manufactures and markets a line of electronic
spinal cord stimulation ("SCS") devices used to manage chronic severe pain.
Net revenue from sales of the Company's other products decreased 9%, or
$367,000, during the three months ended March 31, 1996 compared to the same
period a year ago, primarily due to lower unit sales volume from the Company's
specialized tubing sets.
During March 1996, the Company received clearance from the FDA to commercially
market the Company's MPS(TM) brand of myocardial protection system and related
products. The Company is clinically validating the system at selected medical
institutions, has successfully performed 21 open-heart procedures and expects
commercial release of the system during June 1996.
Since the acquisition of Neuromed, the Company has engaged in a systematic
program to improve Neuromed's products to assure quality standards consistent
with those set for the Company's other products. Consistent with that goal, in
April 1996, the Company introduced the next generation multi-electrode lead.
However, due to this impending release, distributors and customers delayed
purchase commitments in the first quarter of 1996, resulting in lower than
expected revenue.
Gross Profit. Gross profit of $3.50 million for the three months ended March
31, 1996 was $1.45 million, or 71.1% above the level for the comparable 1995
period. As a percentage of net revenue, gross profit increased during the
three months ended March 31, 1996 to 56.9% as compared to 50.2% for the
comparable 1995 period. This increase in gross profit and gross profit margin
during 1996 compared to 1995 was attributable to the revenue generated by
Neuromed, since Neuromed's products contribute higher gross profit margins than
the Company's other product lines.
Operating Expenses. Research and development expense decreased to $896,000
during the three months ended March 31, 1996, compared to $1.09 million for the
same period a year ago, and decreased as a percentage of net revenue from 26.7%
in 1995 to 14.6% in 1996. This decrease in expense during 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 MPS system. Management expects
research and development expenditures to approximate $2.4 million for the
16
<PAGE> 18
remainder of 1996 and expects that about 60% of such expenditures will be
directed to the refining and redesigning of Neuromed products, with the
remainder directed primarily to continued development of MPS and related
products. Management expects that most of its research and development
activities in 1996 will be financed through internally generated funds.
Marketing, general and administrative expenses as a percentage of net revenue
increased to 41.9% for the three months ended March 31, 1996, compared to 31.8%
for the comparable period during 1995, while the dollar amount increased by
$1.28 million. Marketing expense as a percentage of net revenue increased to
23.0% for the 1996 period compared to 13.0% during the same period in 1995, and
the dollar amount increased by $883,000. Of such increase, $688,000 was
Neuromed marketing expense. The remainder of the increase in marketing expense
was primarily the result of additional salary and benefit expense and travel
expense from additional direct salespersons hired in preparation for the
commercial introduction of MPS during June 1996. General and administrative
expense as a percentage of net revenue remained approximately the same at 18.9%
for the three months ended March 31, 1996, compared to 18.8% for the same
period during 1995, while the dollar amount increased by $397,000. This
increase in expense during 1996 compared to 1995 was attributable to general
and administrative expense of Neuromed, including amortization expense of
Neuromed intangibles.
Earnings (Loss) from Operations. Earnings from operations increased to $25,000
during the three months ended March 31, 1996 compared to a net loss from
operations of $337,000 for the comparable 1995 period, reflecting the positive
impact of the Neuromed acquisition.
Other Income (Expense). Other expense increased to $101,000 during the three
months ended March 31, 1996 compared to $28,000 for the same 1995 period. This
increase was the result of higher interest expense ($21,000) due to higher
levels of borrowings under the Company's working capital line of credit and
lower interest income ($56,000) due to reduced funds available for investment.
Income Taxes. The Company recorded income tax expense of $18,000 during the
three months ended March 31, 1996 as a consequence of the nondeductibility of
amortization expense of costs in excess of net assets acquired. No income tax
benefit was recognized for the Company's net operating loss for the three
months ended March 31, 1995.
Net Loss. The net loss decreased from $365,000 during the three months ended
March 31, 1995 to $95,000 during the comparable 1996 period due to the increase
in earnings from operations attributable to the Neuromed acquisition.
LIQUIDITY AND FINANCIAL POSITION
Cash, cash equivalents and marketable securities totaled $4.67 million at March
31, 1996, an increase of $760,000 from 1995 year-end. Working capital (current
assets less current liabilities) was $12.10 million with a current ratio of 3.1
to 1 at March 31, 1996.
In connection with the acquisition of Neuromed, Inc. on March 31, 1995, the
Company agreed to pay contingent consideration over the following two years,
payable in January 1996 and January 1997, depending on sales of Neuromed's
products reaching certain 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 withheld payment of the
$1.5
17
<PAGE> 19
million pending arbitration of certain purchase price adjustment disputes
between the Company and Neuromed's former principal owner, William Borkan. The
1996 contingent consideration, if earned, could total up to $3.37 million cash
which would be payable during January 1997.
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 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 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 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. At March 31, 1996, the Company had advances in the amount of
$4,550,000 outstanding under the working capital line of credit with a weighted
average interest rate of 7.13%. The Company has not drawn upon the acquisition
line of credit.
The Company spent approximately $413,000 for additions to property, plant and
equipment during the three months ended March 31, 1996, most of which were for
manufacturing tooling and equipment for the myocardial protection products the
Company is preparing to introduce. Management expects capital expenditures for
the remainder of 1996 will approximate $1.3 million.
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 during the remainder of 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 and gain
market acceptance for new products, including the MPS system, the new
generation of Neuromed multi-electrode leads and other products; order
placement for the new Neuromed leads picking up in the second quarter as
expected; 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.
18
<PAGE> 20
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 declined 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.
19
<PAGE> 21
PART II
OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibit 27 -- Financial Data Schedule
(b) No reports on Form 8-K have been filed during the quarter
ended March 31, 1996.
20
<PAGE> 22
SIGNATURES
In accordance with the requirements of the Exchange Act, the registrant caused
this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
QUEST MEDICAL, INC.
DATE: MAY 14, 1996 BY: /S/ F. ROBERT MERRILL III
---------------------------------
F. ROBERT MERRILL III
SENIOR VICE PRESIDENT FINANCE/CHIEF
FINANCIAL OFFICER AND TREASURER
21
<PAGE> 23
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
Exhibit No. Description
----------- -----------
<S> <C>
27 - Financial Data Schedule
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> MAR-31-1996
<CASH> 1,596,089
<SECURITIES> 3,074,192
<RECEIVABLES> 4,715,543
<ALLOWANCES> 114,337
<INVENTORY> 6,526,060
<CURRENT-ASSETS> 17,788,840
<PP&E> 14,459,291
<DEPRECIATION> 4,026,919
<TOTAL-ASSETS> 45,731,620
<CURRENT-LIABILITIES> 5,686,592
<BONDS> 0
<COMMON> 410,848
0
0
<OTHER-SE> 30,620,193
<TOTAL-LIABILITY-AND-EQUITY> 45,731,620
<SALES> 6,149,126
<TOTAL-REVENUES> 6,149,126
<CGS> 2,652,150
<TOTAL-COSTS> 3,472,180
<OTHER-EXPENSES> 101,021
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 178,080
<INCOME-PRETAX> (76,225)
<INCOME-TAX> 18,347
<INCOME-CONTINUING> (94,572)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (94,572)
<EPS-PRIMARY> (.01)
<EPS-DILUTED> (.01)
</TABLE>
