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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-K
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[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
COMMISSION FILE NUMBER: 0-10521
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QUEST MEDICAL, INC.
(Exact name of registrant as specified in its charter)
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TEXAS 75-1646002
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
201 ALLENTOWN PARKWAY,
ALLEN, TEXAS 75002
(Address of principal executive offices) (Zip Code)
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Registrant's telephone number, including area code: (972) 390-9800
SECURITIES REGISTERED UNDER SECTION 12(b) OF THE EXCHANGE ACT:
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TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED
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NONE NONE
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SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE EXCHANGE ACT:
TITLE OF CLASS
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Common Stock, $.05 Par Value
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Indicate by checkmark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 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 [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of the S-K is not contained herein, and will not be contained, to the best
of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
Aggregate market value of the registrant's Common Stock held by
non-affiliates of the registrant as of March 25, 1998: $70,906,127.
Number of shares outstanding of the registrant's Common Stock as of March
25, 1998: 8,679,470
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DOCUMENTS INCORPORATED BY REFERENCE
PORTIONS OF THE REGISTRANT'S DEFINITIVE PROXY STATEMENT FOR THE
REGISTRANT'S ANNUAL MEETING OF STOCKHOLDERS TO BE HELD ON MAY 28, 1998, ARE
INCORPORATED BY REFERENCE INTO PART III.
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QUEST MEDICAL, INC.
ANNUAL REPORT
FORM 10-K
YEAR ENDED DECEMBER 31, 1997
PART I
ITEM 1. BUSINESS
GENERAL
Quest Medical, Inc., a Texas corporation ("Quest" or the "Company"), designs,
develops, manufactures and markets electronic spinal cord stimulation ("SCS")
devices used to manage chronic intractable pain. The Company's operating
activities are conducted through its wholly-owned subsidiary, Advanced
Neuromodulation Systems, Inc., a Texas corporation ("ANS"). References to
"Quest" or the "Company" in this Form 10-K include ANS, and vice versa, unless
otherwise indicated.
As SCS devices gain acceptance as a viable, efficacious and cost-effective
treatment alternative for relieving chronic intractable pain, the Company is
continuing its effort to expand its product line in the high growth market of
neuromodulation. The neuromodulation market is comprised of implantable
stimulators and drug pumps that modulate the body's nervous system by delivering
either electricity or pharmaceuticals directly to nerve fibers. In 1997, the
Company completed a full U.S. market release of PainDoc(R), a pen-based computer
system that works in tandem with the Company's CompuStim devices to assist
physicians and their patients in optimizing the performance of the Company's SCS
devices both pre- and post-operatively. The Company believes that its CompuStim
products, which are powered by radio frequency transmitters external to the
body, are the technological leaders in the field.
RECENT DEVELOPMENTS
On January 30, 1998, the Company completed the sale of substantially all of the
assets of its cardiovascular and intravenous fluid product lines (the "CVS
Operations") to Atrion Corporation ("Atrion"). The CVS Operations designed,
developed, manufactured and marketed cardiovascular products (including pressure
control valves, filters and surgical retracting tapes), specialized intravenous
fluid delivery tubing sets and accessories and pressure monitoring kits used
primarily in labor and delivery. The cardiovascular products of the CVS
Operations also included the Quest MPS(R) myocardial protection system, a
sophisticated system designed to manage the delivery of solutions to the heart
during open-heart surgery. Revenue for the CVS Operations was $14.3 million,
$14.7 million and $14.9 million for the years ended December 31, 1997, 1996 and
1995, respectively. The Company received approximately $24 million in cash for
the assets of the CVS Operations, subject to post-closing adjustments as defined
in the purchase agreement, which assets included accounts receivable,
inventories, furniture and fixtures, manufacturing tooling and equipment and
intangible assets including patents, trademarks and purchased technology.
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The CVS Operations have been accounted for as discontinued operations in the
Consolidated Statements of Operations for the years ended December 31, 1997,
1996 and 1995. Net assets of the CVS Operations have been presented on the
Consolidated Balance Sheets as net assets of discontinued operations. See Item
7: "Management's Discussion and Analysis of Financial Condition and Results of
Operation" and Note 11 - "Sale of CVS Operations/Discontinued Operations" of the
Notes to Consolidated Financial Statements.
PRODUCTS
BACKGROUND
SCS devices employ neuromodulation, which includes the process of electrically
stimulating nerve fibers along the spinal cord to reduce chronic severe
neuropathic pain by "masking" the pain signals sent to the brain. Neuropathic
pain usually arises from nerve damage. SCS device implantation manages the pain
associated with failed back surgery syndrome (FBSS), peripheral neuropathy,
phantom limb or stump pain, ischemic pain and reflex sympathetic dystrophy
(RSD), also known as complex regional pain syndrome (CRPS).
The market for SCS devices is currently divided between Radio Frequency (RF)
stimulators, which use an external power source, and stimulators that utilize
implantable battery driven systems known as implantable pulse generators (IPGs).
According to Montgomery Securities (Vol. 27, December 5, 1996 report), lPG
devices account for 80 percent of the number of SCS procedures performed, with
RF-coupled devices accounting for the remainder. The Company currently designs,
develops, manufactures and markets RF SCS devices and is in the process of
developing an IPG device. The primary advantage of the RF device revolves around
the benefits of the system's external battery. An external battery system allows
the patient to recharge the device by simply changing out a special nine volt
battery. The IPG requires surgical intervention, revision and replacement after
two to four years. Due to its inexpensive power system, the RF device can be
programmed with a wide range of amplitude, frequency and pulse width settings
for a variety of programs controlled by the patient. These features make the RF
devices the most cost efficient for long-term SCS treatment. On the other hand,
IPG devices provide the convenience of a completely internalized system,
although they involve added long-term cost when repeat surgeries are required to
replace the IPG power source. Both RF and IPG systems have their place in the
pain physician's device armamentarium. RF systems are most often prescribed for
patients who have complex bilateral pain syndromes or large pain topographies
that require high power levels. IPGs are most often prescribed for patient's
with simple unilateral and single extremity pain complaints or indications with
low power requirements.
SCS DEVICES
The Company's RF SCS systems consist of three primary components: leads, a
receiver and a transmitter. The leads are most commonly placed percutaneously
through the skin into the epidural space of the spinal column. This procedure
for lead placement is similar to that employed by anesthesiologists in routine
epidural procedures. Typically, one or two leads are inserted, each of which has
multiple electrodes that can be used to stimulate the targeted nerve roots of
the spinal cord. Laminotomy style (paddle) leads are also available for
neurosurgeons or orthopedic surgeons who prefer to insert leads in an open
surgical
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procedure approach. The leads are then connected to a passive receiver,
which is implanted under the skin on the side of the abdomen. The receiver
contains electronics that receive RF energy and data from a source (the
transmitter) outside the body, and delivers the prescribed electrical pulses to
the leads. The transmitter is approximately the size of a pager, and is
typically worn on a belt. Since it is external to the body, the transmitter can
be easily programmed and serviced as needed, and its battery can be simply
recharged or replaced.
ANS's predecessor, Neuromed, Inc. ("Neuromed"), introduced its first product,
the Multiprogrammable Spinal Cord Stimulator, or Multistim(R), in 1979. Since
that time, the Company has played a significant role in the development of SCS
products. Multistim incorporated a quadrapolar electrode system within a single
lead, and was considered a major innovation in the field of neuromodulation
because it significantly reduced surgical time, cost and risk. Since the launch
of Multistim, the Company has developed and introduced a wide range of RF SCS
systems with a variety of options to accommodate different applications and
degrees of pain.
The Company's CompuStim systems include four, seven, eight and sixteen electrode
leads; simple and complex receivers; and an external battery powered
transmitter. The Company believes that the CompuStim product line's
multi-electrode leads and advanced multiprogrammable technology have changed the
manner in which neuromodulation is performed worldwide. For example, the
Company's "Dual Octrode" device, a system of dual leads with eight electrodes
introduced in 1995, creates a targeted current density that appears to be
especially effective in relieving chronic axial (or body trunk) pain.
Previously, quadrapolar SCS systems only relieved the leg pain associated with
FBSS. Industry sources support the view that the Dual Octrode device provides
improved pain relief to both the legs and the back. Consequently, although the
Dual Octrode device has only been on the United States market since February
1995, it now accounts for approximately 62 percent of the Company's current
units sold and, in the Company's judgment, is the technological leader in the
SCS field. The Company believes that the long term results of SCS in the
treatment of pain have improved as a result of the technological superiority of
ANS products. Moreover, the ease of use of the system has expanded the potential
market for these products.
The Company believes its RF-coupled SCS devices represent a strong base for
penetration of the broader neuromodulation market. The Company has begun
development of an IPG system and a constant rate implantable drug pump to better
serve the broad needs of the pain management market. By offering an IPG and
implantable drug pump, the Company can serve the largest segments of the pain
management market, leverage its sales and marketing capabilities and address a
number of new indications such as chronic intractable angina, urinary urge
incontinence, spasticity, essential tremor and tremor associated with
Parkinson's disease.
PAINDOC
In early 1997 the Company began marketing PainDoc, a pen-based computer system
that is designed to assist physicians and their patients in optimizing the
performance of the Company's SCS devices both pre- and post-operatively. PainDoc
interfaces with the Company's CompuStim transmitters to optimize SCS therapy and
document treatment outcomes. PainDoc allows the physician to input information
regarding the patient's description of the location and intensity of the
patient's pain. The resulting "pain map" is then
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analyzed by the computer to assess and select the most effective stimulation
sets, or combination of multi-electrode stimulation arrays, to treat the pain.
The selected arrays are uploaded into the patient's CompuStim transmitter. After
a trial period, the patient reports to the physician the location and level of
pain relief. These trial results are uploaded back into PainDoc for the
physician's objective review and analysis. The physician can visually compare
the patient's pain map against a stimulation map and assess whether desired
levels of pain relief have been obtained and whether excess stimulation has been
delivered.
PainDoc enables the physician to program up to 24 different stimulation sets
delivering electrical stimulation every 50 milliseconds to expand pain area
coverage and relief. The Company believes that PainDoc should also allow
physicians to create a broad based database tool that, by using a standardized
methodology, will enable physicians to share and compare outcomes data, which
can then be used to deliver more efficacious pain relief to individual patients.
The Company believes that PainDoc and CompuStim devices used in tandem should
significantly enhance the effectiveness, flexibility and precision of managing
chronic neuropathic pain. The Company expects PainDoc to promote the selection
of the Company's CompuStim devices for SCS procedures, especially as SCS devices
become more complex and the pain management process becomes more refined. In
October 1995, the Company received 510(k) approval from the FDA to market
PainDoc as an interactive medical treatment device. See Item 1: "Business-Other
Business Matters-Government Regulation."
OTHER BUSINESS MATTERS
MARKETING AND MAJOR CUSTOMER
ANS historically relied on specialty distributors to market its SCS devices.
During 1996, however, the Company made the strategic decision to replace certain
distributors in specified geographic markets with commissioned sales agents.
Currently, the Company has ten specialty distributors who employ thirty
personnel to market the SCS devices. In addition, the Company has ten
commissioned sales agents and two direct sales representatives who sell the
Company's SCS devices. The Company employs three regional sales managers who
oversee the distributors, sales agents and direct representatives.
Internationally, the Company sells product to 16 specialty distributors who
represent ANS in 21 countries. The primary medical specialists the Company
targets in its marketing efforts are anesthesiologists, neurosurgeons and
orthopedic surgeons. Although neurosurgeons were the first practitioners to use
SCS applications, anesthesiologists now account for a greater percentage of
sales as the relative number of these practitioners has grown and as the
understanding and acceptance of SCS treatment has increased. The Company derives
92 percent of net revenues attributable to its SCS devices from domestic sales
and approximately 8 percent from export sales.
During 1997, 1996 and 1995, the Company had one major customer that accounted
for 10 percent or more of its net revenue. Sun Medical, Inc., a specialty
distributor of ANS products, accounted for $3.7 million, $2.6 million and $2.7
million, or 25 percent, 22 percent and 26 percent of ANS's net revenue for the
years ended December 31, 1997, 1996 and 1995, respectively. While the Company
believes its relations with Sun Medical are good, the loss of this customer
could have a material adverse effect on the Company's business, financial
condition and results of operations.
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RESEARCH AND DEVELOPMENT
In 1997, the Company focused its research and development efforts on the
continued development of SCS devices and ongoing research and development of new
products in the neuromodulation market, such as an IPG system and a constant
rate implantable drug pump. The Company expended $977,000 (6.6 percent of net
revenue) on SCS-related research and development activities in 1997, compared to
$1.3 million (11.5 percent of net revenue) in 1996. The Company expects to
increase its investment in research and development during 1998 and has budgeted
expenditures of $2.7 million. These expenditures will be directed toward
development of next generation RF SCS systems, an implantable constant rate drug
pump, and development of an IPG system. The Company has entered into a
development and manufacturing contract with Hi-tronics Design, Inc., a premier
contract engineering and manufacturing firm, to develop an IPG. IPG systems
currently account for 80 percent of the SCS units sold worldwide. Management
expects the IPG system to be ready for clinical trials in the United States and
market introduction internationally in early 1999. The IPG system will not only
allow the Company to compete in the largest segment of the SCS market but
potentially expand the markets for the Company's products for use in
applications such as deep brain stimulation to treat essential tremor and tremor
associated with Parkinson's disease, epilepsy, urinary incontinence, angina and
peripheral vascular disease. The Company is pursuing strategic alliances that
may partially fund research and development expenditures during 1998. As of
March 1998, ANS had an in-house research and development staff of 13 engineers,
technicians and designers, as compared to 10 in March 1997. The Company
anticipates hiring 3 additional personnel during the remainder of 1998 for its
research and development efforts.
MANUFACTURING
The Company manufactures and packages its SCS products at its manufacturing
facility in Allen, Texas. This facility received ISO 9001 certification (for
design and manufacturing processes) in July 1995. See Item 1. "Business-Other
Business Matters-Government Regulations."
The Company's manufacturing processes consist of the assembly of standard and
custom component parts and the testing of completed products. The Company
subcontracts with various suppliers to provide it with the quantity of component
parts necessary to assemble its products. Almost all of these components are
available from a number of different suppliers, although certain components are
purchased from single sources. For example, the Company currently relies on a
single supplier for a computer chip used in the receiver and transmitter of its
SCS systems. The supplier of this computer chip has indicated its desire to
cease manufacturing and supplying the computer chip in the future, but to date,
has not determined when this will occur. The supplier has agreed to notify the
Company once a date has been determined and allow the Company to place a final
one-time purchase order for the computer chip. In the interim, the Company is
maintaining a higher than normal inventory of the computer chip. In addition,
the Company is developing a custom computer chip under its development agreement
with Hi-tronics Design, Inc. to replace the existing computer chip and expects
such chip to be available during the latter half of 1999. A sudden disruption in
supply from the computer chip supplier or another single-source supplier could
adversely affect the Company's ability to deliver finished products on time.
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The Company devotes significant attention to quality control. Its quality
control measures begin at the manufacturing level where components are assembled
in a "clean room" environment designed and maintained to reduce product exposure
to particulate matter. Products are tested throughout the manufacturing process
for adherence to specifications. Finished components are shipped to outside
processors for ethylene oxide gas sterilization.
Skills of assembly workers required for the manufacture of medical products are
similar to those required in typical assembly operations. The Company believes
that workers with these skills are readily available in the Dallas area.
COMPETITION
In marketing its SCS products, the Company competes with one other significant
supplier, Medtronic, Inc. Medtronic has substantially greater financial
resources and engages in substantially greater research and development and
marketing efforts. Medtronic also holds a substantial majority share of the
market and sells both RF-coupled systems and IPG devices.
The Company believes that the principal competitive factors in the
neuromodulation market are cost-effectiveness, impact on patient outcomes,
product performance, quality and ease of use, technical innovation and customer
service. The Company intends to continue to compete on the basis of its high
performance products, innovative technologies, manufacturing capability, close
customer relations and support and its strategy to increase its offerings of
products within the neuromodulation market.
PATENTS, TRADEMARKS AND PROPRIETARY INFORMATION
The Company currently owns four United States patents and also owns three
foreign patents. In management's view, these patents offer reasonable coverage
of its SCS devices' electrode, receiver and transmitter technology. These
patents cover both RF-coupled devices and IPG systems, although the Company
currently manufactures only RF-coupled devices. Pending patent applications
concern the PainDoc computer system and the Company's innovative Multistim
technology.
The Company also licenses four United States patents and one foreign patent from
the University of Minnesota relating to the implantable constant rate drug pump
the Company is currently developing.
The validity of any patents issued to the Company may be challenged by others
and the Company could encounter legal and financial difficulties in enforcing
its patent rights against infringers. In addition, there can be no assurance
that other technologies cannot or will not be developed or that patents will not
be obtained by others which would render the Company's patents obsolete. The
loss of any one patent would not have a material adverse effect on the Company's
current revenue base. Although the Company does not believe that patents are the
sole determinant in the commercial success of its products, the loss of a
significant percentage of its patents or its patents relating to the SCS product
line could have a material adverse effect on the Company's business, financial
condition and results of operations.
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The Company has developed technical knowledge which, although non-patentable, is
considered by the Company to be significant in enabling it to compete. However,
the proprietary nature of such knowledge may be difficult to protect. The
Company has entered into an agreement with each key employee prohibiting such
employee from disclosing any confidential information or trade secrets of the
Company and prohibiting that employee from engaging in any competitive business
while the employee is working for the Company and for a period of one year
thereafter. In addition, these agreements also provide that any inventions or
discoveries relating to the business of the Company by these individuals will be
assigned to the Company and become the Company's sole property.
Claims by competitors and other third parties that the Company's products
allegedly infringe the patent rights of others could have a material adverse
effect on the Company. The interventional pain management market is
characterized by extensive patent and other intellectual property claims, which
can create greater potential than in less developed markets for possible
allegations of infringement, particularly with respect to newly developed
technology. Intellectual property litigation is complex and expensive and the
outcome of this litigation is difficult to predict. Any future litigation,
regardless of outcome, could result in substantial expense to the Company and
significant diversion of the efforts of the Company's technical and management
personnel. An adverse determination in any such proceeding could subject the
Company to significant liabilities to third parties, or require the Company to
seek licenses from third parties or pay royalties that may be substantial.
Furthermore, there can be no assurance that necessary licenses would be
available to the Company on satisfactory terms or at all. Accordingly, an
adverse determination in a judicial or administrative proceeding or failure to
obtain necessary licenses could prevent the Company from manufacturing or
selling certain of its products, which could have a material adverse effect on
the Company's business, financial condition and results of operations.
MULTISTIM, PAINDOC, UNISTIM and OCTRODE are among the Company's registered
trademarks and COMPUSTIM is among its nonregistered trademarks. Registration
applications are pending for various trademarks the Company believes have value
in the marketplace, including Advanced Neuromodulation Systems and ANS.
GOVERNMENT REGULATION
The manufacture and sale of the Company's products are subject to regulation by
numerous governmental authorities, principally the FDA and corresponding foreign
agencies. The research and development, manufacturing, promotion, marketing and
distribution of the Company's products in the United States are governed by the
Federal Food, Drug and Cosmetic Act and the regulations promulgated thereunder
(the "FDC Act and Regulations"). The Company is subject to inspection by the FDA
for compliance with such regulations and procedures.
The FDA has traditionally pursued a rigorous enforcement program to ensure that
regulated entities such as the Company comply with the FDC Act and Regulations.
A company not in compliance may face a variety of regulatory actions, including
warning letters, product detentions, device alerts, mandatory recalls or field
corrections, product seizures, injunctive actions or civil penalties and
criminal prosecutions of the Company or responsible employees, officers and
directors. The Company was last inspected in the summer of 1996, with no major
violations found.
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Under the FDA's requirements, a new medical device cannot be released for
commercial use until a pre-market approval application (a "PMA") has been filed
with the FDA and the FDA has approved the device's release. If a manufacturer
can establish that a newly developed device is "substantially equivalent" to a
legally marketed device, the manufacturer may seek marketing clearance from the
FDA to market the device by filing a 510(k) premarket notification with the FDA,
which usually takes less time than a PMA. The process of obtaining FDA clearance
can be lengthy, expensive and uncertain. Both a 510(k) and a PMA, if granted,
may include significant limitations on the indicated uses for which a product
may be marketed. FDA enforcement policy strictly prohibits the promotion of
approved medical devices for unapproved uses. In addition, product approvals can
be withdrawn for failure to comply with regulatory requirements or the
occurrence of unforeseen problems following initial marketing. Although all of
the Company's currently marketed products have been the subject of successful
510(k) submissions, the Company believes that because the products the Company
currently has in development are more innovative, most of these products will
require the PMA submission process, which is lengthier and more costly than the
510(k) process.
The Company is also subject to regulation in each of the foreign countries in
which it sells its products with regard to product standards, packaging
requirements, labeling requirements, import restrictions, tariff regulations,
duties and tax requirements. Many of the regulations applicable to the Company's
products in such countries are similar to those of the FDA. The national health
or social security organizations of certain countries require the Company's
products to be qualified before they can be marketed in those countries. To
date, the Company has not experienced significant difficulty in complying with
these regulations.
To position itself for access to European and other international markets, Quest
sought and obtained certification under the ISO 9000 Series of Standards. ISO
9000 is a set of integrated requirements, which when implemented, form the
foundation and framework for an effective quality management system. These
standards were developed and published by the ISO, a worldwide federation of
national standard bodies, founded in Geneva, Switzerland in 1946. ISO has over
92 member countries. ISO certification is widely regarded as essential to enter
Western European markets.
The Company obtained certification and was registered as an ISO 9001 compliant
company on July 1, 1995. The ISO 9001 registration is the most stringent
standard in the ISO series and lasts for three years. The German notified body,
Landesgewerbeanstalt Bayern ("LGA") issued the certificate. The ISO 9001
standards cover design, production, installation and servicing of products. The
Company is subject to an annual audit by the notified body to maintain the
registration. The Company was then certified to be in compliance with the
Medical Device Directive ("MDD") as well as ISO 9001 by the notified body TUV
Rheinland ("TUV") in July 1996. Subsequently, in December 1996, ANS's
implantable products were certified to be in compliance with the Active
Implantable Medical Directive ("AIMD") by TUV product services, another notified
body. These certifications were sought and obtained for the purpose of getting
the CE mark which represents product approval throughout the European Union. As
a result, the CE mark is maintained on all ANS products.
The financial arrangements through which the Company markets, sells and
distributes its products may be subject to certain federal and state laws and
regulations in the United States
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with respect to the provision of services or products to patients who are
Medicare or Medicaid beneficiaries. The "fraud and abuse" laws and regulations
prohibit the knowing and willful offer, payment or receipt of anything of value
to induce the referral of Medicare or Medicaid patients for services or goods.
In addition, the physician anti-referral laws prohibit the referral of Medicare
or Medicaid patients for certain "Designated Health Services" to entities in
which the referring physician has an ownership or compensation interest.
Violations of these laws and regulations may result in civil and criminal
penalties, including substantial fines and imprisonment. In a number of states,
the scope of fraud and abuse or physician anti-referral laws and regulations, or
both, have been extended to include the provision of services or products to all
patients, regardless of the source of payment, although there is variation from
state to state as to the exact provisions of such laws or regulations. In other
states, and on a national level, several health care reform initiatives have
been proposed which would have a similar impact. The Company believes that its
operations and its marketing, sales and distribution practices currently comply
in all respects with all current fraud and abuse and physician anti-referral
laws and regulations, to the extent they are applicable. Although the Company
does not believe that it will need to undertake any significant expense or
modification to its operations or its marketing, sales and distribution
practices to comply with federal and state fraud and abuse and physician
anti-referral regulations currently in effect or proposed, financial
arrangements between manufacturers of medical devices and other health care
providers may be subject to increasing regulation in the future. Compliance with
such regulation could adversely affect the Company's marketing, sales and
distribution practices, and may affect the Company in other respects not
presently foreseeable, but which could have an adverse impact on the Company's
business, financial condition and results of operations.
THIRD PARTY REIMBURSEMENT AND COST CONTAINMENT
The Company's products are purchased primarily by hospitals and other users,
which then bill various third party payers for the services provided to the
patients. These payers, which include Medicare, Medicaid, private insurance
companies, managed care and worker's compensation organizations, reimburse part
or all of the costs and fees associated with the procedures performed with these
devices.
Medicare and Medicaid reimbursement for hospitals is based on a fixed amount for
admitting a patient with a specific diagnosis. Because of this fixed
reimbursement method, hospitals have incentives to use less costly methods in
treating Medicare and Medicaid patients, and will frequently make capital
expenditures to take advantage of less costly treatment technologies.
Frequently, reimbursement is reduced to reflect the availability of a new
procedure or technique, and as a result hospitals are generally willing to
implement new cost saving technologies before these downward adjustments take
effect. Likewise, because the rate of reimbursement for certain physicians who
perform certain procedures has been and may in the future be reduced in the
event of further changes in the resource-based relative value scale method of
payment calculation, physicians may seek greater cost efficiency in treatment to
minimize any negative impact of reduced reimbursement. Any amendments to
existing reimbursement rules and regulations which restrict or terminate the
reimbursement eligibility (or the extent or amount of coverage) of medical
procedures using the Company's products or the eligibility (or the extent or
amount of coverage) of the Company's products could have an adverse impact on
the Company's business, financial condition and results of operations. Third
party payers are increasingly challenging the prices charged for medical
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products and services and may deny reimbursement if they determine that a device
was not used in accordance with cost-effective treatment methods as determined
by the payer, was experimental or was used for an unapproved application.
The Company's SCS devices, while cost-effective compared to repeat back
surgeries, have encountered some resistance to third party reimbursement.
Although Medicare, Medicaid and many private insurers reimburse for the SCS
device and procedure, especially after repeat back surgeries have failed to
relieve the chronic pain, some managed care and private payers occasionally
refuse to reimburse for SCS devices or restrict reimbursement. There can be no
assurance that in the future, third party payers will continue to reimburse for
the Company's products, or that their reimbursement levels will not adversely
affect the profitability of the Company's products. In addition, the cost of
health care has risen significantly over the past decade, and there have been
and will continue to be proposals by legislators and regulators to curb these
costs. Legislative action limiting reimbursement for certain procedures could
have a material adverse effect on the Company's business, financial condition
and results of operations.
In response to the focus of national attention on rising health care costs, a
number of changes to reduce costs have been proposed or have begun to emerge.
There have been, and may continue to be, proposals by legislators and regulators
and third party payers to curb these costs. There has also been a significant
increase in the number of Americans enrolling in some form of managed care plan.
It has become a typical practice for hospitals to affiliate themselves with as
many managed care plans as possible. Higher managed care penetration typically
drives down the prices of health care procedures, which in turn places pressure
on medical supply prices. This causes hospitals to implement tighter vendor
selection and certification processes, by reducing the number of vendors used,
purchasing more products from fewer vendors and trading discounts on price for
guaranteed higher volumes to vendors. Hospitals have also sought to control and
reduce costs over the last decade by joining group purchasing organizations or
purchasing alliances. The Company cannot predict what continuing or future
impact existing or proposed legislation, regulation or such third party payer
measures may have on its future business, financial condition or results of
operations.
Changes in reimbursement policies and practices of third party payers could have
a substantial and material impact on sales of certain of the Company's products.
The development or increased use of more cost-effective treatments could cause
such payers to decrease or deny reimbursement to favor these other treatments.
EMPLOYEES
As of March 16, 1998, the Company employed 100 full-time employees, 13 in
research and development, 21 in sales and marketing, 53 in manufacturing and
related operations, and the remainder in executive and administrative positions.
None of the Company's employees is represented by a labor union and the Company
considers its employee relations to be good.
ADVISORY BOARDS
The Company has established the Advanced Neuromodulation Systems Advisory Board
(the "ANSAB"), which is comprised of individuals with substantial expertise in
neuromodulation and pain management. Members of the Company's management and
scientific and technical
-10-
<PAGE> 12
staff consult closely with the ANSAB to identify specific areas where techniques
are changing and where existing products do not adequately fulfill the needs of
the pain physician. The ANSAB helps management evaluate new product ideas and
concepts and once a product is approved for development, its subsequent design
and development. The ANSAB may also participate in the clinical testing of
products developed.
Certain members of the ANSAB are employed by academic institutions and may have
commitments to or consulting or advisory agreements with other entities that may
limit their availability to the Company. The members of the ANSAB may also serve
as consultants to other medical device companies. No members of the ANSAB are
expected to devote more than a small portion of their time to the Company.
ITEM 2. PROPERTIES
The Company owns and occupies a manufacturing facility and executive office in
Allen, Texas (located north of Dallas). The facility covers approximately
107,000 square feet and was constructed during 1993 on a 19.2 acre tract that
the Company acquired in 1985. The Company borrowed $4.4 million from MetLife
Capital Corporation to construct and outfit this facility. This financing is
collateralized by the Allen land, the Allen facility and certain equipment of
the Company (see Note 5 of the "Notes to Consolidated Financial Statements").
In connection with the sale of the CVS Operations, the Company agreed to lease
space in the Allen facility to Atrion for up to one year for $24,606 per month,
and also granted Atrion a nine-month option to purchase the facility for $6.5
million. If Atrion purchases the facility, the Company would receive another
$2.7 million in net proceeds after paying off the mortgage. If Atrion exercises
its option, the Company would lease a facility for its manufacturing, storage
and executive offices in the general vicinity of the Allen, Texas facility.
Management believes that leasing and moving to a new facility would not have a
material adverse effect on the Company. If Atrion does not purchase the
facility, the Company believes it should be able to locate a suitable
replacement tenant to defray a portion of the corporate overhead otherwise
associated with the Allen facility.
ITEM 3. LEGAL PROCEEDINGS
The Company is a party to product liability claims related to ANS's SCS devices.
Product liability insurers have assumed responsibility for defending the Company
against these claims, subject to reservation of rights in certain cases. While
historically product liability claims for ANS SCS devices have not resulted in
significant monetary liability for the Company beyond its insurance coverage,
there can be no assurances that the Company will not incur significant monetary
liability to the claimants if such insurance is unavailable or inadequate for
any reason, or that the Company's current SCS business and future ANS
neuromodulation products will not be adversely affected by these product
liability claims. While the Company seeks to maintain appropriate levels of
product liability insurance with coverage that the Company believes is
comparable to that maintained by companies similar in size and serving similar
markets, there can be no assurance that the Company will avoid significant
future product liability claims relating to its SCS devices.
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
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<PAGE> 13
proceeding. The Company maintains general liability insurance against risks
arising out of the normal course of business.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Inapplicable.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's common stock is currently quoted on the Nasdaq Stock Market under
the symbol "QMED." The Company intends to submit to its shareholders a proposal
to change its name to "Advanced Neuromodulation Systems, Inc." and in connection
with that name change, intends to change its trading symbol to "ANSI" on or
about May 28, 1998. On March 16, 1998, there were approximately 763 holders of
record of the Company's common stock. The following table sets forth the
quarterly high and low closing sales prices for the Company's common stock.
These prices do not include adjustments for retail mark-ups, mark-downs or
commissions.
<TABLE>
<CAPTION>
1996: HIGH LOW
----- ---- ---
<S> <C> <C>
First Quarter $ 14.50 $ 10.25
Second Quarter $ 14.38 $ 6.00
Third Quarter $ 9.13 $ 5.63
Fourth Quarter $ 8.25 $ 5.75
1997: HIGH LOW
----- ---- ---
First Quarter $ 8.13 $ 5.94
Second Quarter $ 9.22 $ 5.75
Third Quarter $ 10.50 $ 8.25
Fourth Quarter $ 10.00 $ 6.38
1998: HIGH LOW
----- ---- ---
First Quarter $ 8.75 $ 6.50
(through March 16, 1998)
</TABLE>
To date, the Company has not declared or paid any cash dividends on its common
stock and the Board of Directors does not anticipate paying cash dividends on
the Company's common stock in the foreseeable future.
During January 1998, the Board of Directors approved a stock repurchase program
of up to 500,000 shares of the Company's common stock. The Company's purchases
may be effected through open market purchases, block transactions, privately
negotiated purchases or otherwise. Purchases of the Company's common stock will
be effected at prices and terms to be determined in light of then current
circumstances, are completely discretionary and may be temporarily or
permanently suspended at any time without notice. Through March 16, 1998, the
Company has repurchased 73,000 shares of its common stock at an aggregate cost
of $508,000 (including commissions).
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<PAGE> 14
ITEM 6. SELECTED FINANCIAL DATA
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------
Years Ended December 31
1997 1996 1995(1) 1994 1993(2)
----------- ---------- -------- --------- --------
(in thousands, except per share data)
<S> <C> <C> <C> <C> <C>
Statement of
Operations Data: (3)
Net revenue $ 14,718 $ 11,403 $ 10,434 $ -- $ --
Gross profit 9,878 8,088 7,682 -- --
Research and
development
expense 977 1,316 808 -- --
Purchased research
and development -- -- 10,500 -- --
Marketing, general
and
administrative
and amortization
expenses 6,815 6,257 3,796 -- --
Earnings (loss)
from operations 2,086 515 (7,421) -- --
Net earnings (loss)
from continuing
operations 818 115 (8,906) -- --
Earnings (loss)
from discontinued
operations (93) (527) (1,199) (1,719) 647
Net earnings (loss) $ 724 $ (412) $(10,374) $ (1,719) $ 816
Diluted earnings
(loss) per share
per share:(4)
Continuing operations $ .09 $ .01 $ (1.42) $ -- $ --
Discontinued
operations $ (.01) $(.06) $ (.19) $ (.33) $ .12
Extraordinary item
(1995) and change in
accounting principle
(1993) $ -- $ -- $ (.05) $ -- $ .03
Net earnings (loss) $ .08 $(.05) $ (1.66) $ (.33) $ .15
</TABLE>
-13-
<PAGE> 15
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------
Years Ended December 31
1997 1996 1995 1994 1993
-------- ------- ------- ------- -------
(in thousands)
<S> <C> <C> <C> <C> <C>
Balance Sheet Data:
Cash, cash equivalents
and marketable
securities $ 2,204 $ 2,206 $ 3,914 $ 5,262 $ 6,594
Working capital 14,128 11,088 12,183 7,411 9,566
Total Assets 48,982 47,188 44,496 24,235 26,739
Short-term notes
payable and
current maturities
of long-term notes
payable 8,257 2,084 1,616 2,759 2,297
Notes payable,
excluding current
maturities 3,635 11,912 8,558 4,124 4,101
Stockholders' equity $33,906 $30,993 $30,870 $15,931 $18,252
</TABLE>
- ----------------------
(1)Includes results of ANS from March 31, 1995. The net loss for 1995 reflects a
charge of $10,500, or $(1.68), for purchased in-process research and development
incurred in connection with the ANS acquisition and an extraordinary charge of
$269, or $(.05) per share, for the write-off of capitalized debt issuance costs
due to early repayment of bank debt with the proceeds from a public offering
completed in November 1995.
(2)Net earnings include a positive cumulative effect of a change in accounting
principle of $169, or $.03 per share, from adoption of Statement of Financial
Accounting Standards No. 115, "Accounting for Certain Investments in Debt and
Equity Securities."
(3)On January 30, 1998, the Company sold its cardiovascular and intravenous
fluid delivery product lines (CVS Operations). The CVS Operations have been
accounted for as discontinued operations. See Note 11 of the Notes to
Consolidated Financial Statements.
(4)Per share amounts for 1993 restated to reflect 3 percent stock dividend.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following discussion of the financial condition and results of
operations of the Company should be read in conjunction with the
Consolidated Financial Statements of the Company and the related Notes.
OVERVIEW
On January 30, 1998, the Company sold the assets of the CVS Operations,
including its MPS(R) myocardial protection system product line, to Atrion
(see Note 11 - "Sale of CVS Operations/Discontinued Operations"). The
Company received approximately $24 million in cash from the sale, subject
to post-closing adjustments as defined in the purchase agreement. The
Company also granted Atrion a nine-month option to acquire the Company's
principal office and manufacturing facility in Allen, Texas for $6.5
million. During the option period, the Company will lease space to Atrion
for the CVS Operations for $24,606 per
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<PAGE> 16
month. In turn, the Company is leasing certain office and computer
equipment from Atrion for $13,175 per month.
Assets of the CVS Operations sold to Atrion primarily consisted of accounts
receivable, inventories, furniture and fixtures, manufacturing tooling and
equipment, and intangible assets including patents, trademarks and
purchased technology. The Company expects to report a pretax gain on the
transaction of $8.3 to $8.5 million, which will be included in the
Company's results for the quarter ended March 31, 1998. This pretax gain is
net of $1,005,000 compensation expense recorded as a result of changes made
to the stock options held by employees of the CVS Operations (see Note 7 -
"Stockholders' Equity"). The Company utilized $9 million of the proceeds
from the sale to retire debt and pay expenses related to the transaction.
The Company intends to utilize the remaining proceeds for working capital
for its expanding ANS business or for the repurchase of issued and
outstanding shares. On January 20, 1998, the Company's Board of Directors
authorized the repurchase of up to 500,000 shares of the Company's common
stock at prices and terms to be determined in light of then current
circumstances. Through March 16, 1998, the Company has repurchased 73,000
shares of its common stock at an aggregate cost of $508,000 (including
commissions).
The CVS Operations have been accounted for as discontinued operations in
the Consolidated Financial Statements for the years ended December 31,
1997, 1996, and 1995.
RESULTS OF OPERATIONS
Comparison of the Years Ended December 31, 1997 and 1996
Revenues. Net revenue from continuing ANS operations of $14.7 million for
the year ended December 31, 1997, was $3.3 million, or 29 percent, above
the level for the comparable 1996 period of $11.4 million. This increase
during 1997 was the result of higher unit sales volume, principally in the
United States. During 1996 and into the first quarter of 1997, the Company
dedicated significant engineering and marketing resources to build the
infrastructure at ANS and improve the current products of ANS to transform
ANS into an industry leader and compete effectively in the SCS market.
Management believes these measures account for the increase in net revenue
during the 1997 period compared to the same period during 1996. Management
expects that ANS revenue during 1998 will continue to increase from 1997
levels and is actively exploring strategic alliances that will improve its
market position through new technologies, additional product offerings, and
enhanced distribution channels.
Gross Profit. Gross profit increased during 1997 to $9.9 million compared
to $8.1 million in 1996. As a percentage of net revenue, however, gross
profit decreased to 67.1 percent in 1997 compared to 70.9 percent during
1996. This decrease in gross profit margin during 1997 was due, for the
most part, to a $479,000 expense for the write-off of ANS inventory of
previous designs. As mentioned above, during 1996 the Company dedicated a
significant amount of time and effort to improve the design and performance
of ANS products. Due to the acceptance and superior performance of the
current design of ANS products, management decided that inventories of
previous designs should be written off and recorded such expense during the
second quarter of 1997.
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<PAGE> 17
Operating Expenses. Total operating expenses of $7.8 million during 1997
increased slightly from the 1996 level of $7.6 million, although as a
percentage of net revenue, such expenses decreased to 52.9 percent during
1997 from 66.4 percent in 1996.
Research and development expense decreased to $977,000 in 1997, or 6.6
percent of 1997 net revenue, from $1.3 million during 1996, or 11.5 percent
of 1996 net revenue. This decrease during 1997 compared to 1996 was the
result of lower salary and benefit expense from personnel reductions, lower
consulting expense, and lower regulatory expense. The Company expects to
increase its investment in research and development during 1998 and has
budgeted expenditures of $2.7 million. These expenditures will be directed
toward development of next generation RF SCS systems, an implantable
constant rate drug pump, and development of an IPG system. The Company has
entered into a development and manufacturing contract with Hi-tronics
Design, Inc., a premier contract engineering and manufacturing firm, to
develop an IPG. IPG systems currently account for 80 percent of the SCS
units sold worldwide. Management expects the IPG system to be ready for
clinical trials in the United States and market introduction
internationally in early 1999. The IPG system will not only allow the
Company to compete in the largest segment of the SCS market but potentially
expand the markets for the Company's products for use in applications such
as deep brain stimulation to treat essential tremor and tremor associated
with Parkinson's disease, epilepsy, urinary incontinence, angina and
peripheral vascular disease. The Company is pursuing strategic alliances
that may partially fund research and development expenditures during 1998.
Marketing expense, as a percentage of net revenue, decreased to 27.0
percent in 1997 from 29.3 percent in 1996, while the dollar amount
increased from $3.3 million during 1996 to $4.0 million in 1997. This
dollar increase during 1997 was attributable to additional expense related
to higher commissions, clinical study and training expense for new users of
ANS products.
General and administrative expense decreased from $2.1 million during 1996
to $1.8 million in 1997 and as a percentage of net revenue, decreased to
12.0 percent in 1997 from 18.3 percent during 1996. This decrease in
expense during 1997 was principally the result of a charge during 1996 of
$198,000 to write off an accounts receivable from a former ANS distributor
who filed bankruptcy.
Amortization of ANS intangibles increased from $826,000 in 1996 to $1.1
million during 1997, mostly due to patents acquired during February 1997
from the former owner of Neuromed.
Earnings From Operations. Earnings from operations for 1997 totaled $2.1
million compared to $515,000 in 1996 due to increased gross profit from
higher sales of ANS products.
Other Expense. Other expense increased to $536,000 in 1997 compared to
$81,000 during 1996 as a result of three factors. First, the Company's
interest expense increased by $207,000 during 1997 compared to 1996 as a
result of higher levels of borrowing and higher overall interest rates on
borrowed money. Second, the Company's interest income declined by $85,000
during 1997 compared to 1996 as a result of lower funds available for
investment combined with overall lower rates of return. Finally, during
1996 the Company realized gains of $137,000 on the sale of marketable
securities compared to a loss of $26,000 during 1997, a reduction of
$163,000.
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<PAGE> 18
Income Taxes. The Company's income tax expense increased to $733,000 during
1997 from $320,000 in 1996 due to higher earnings from operations. This
represents effective tax rates of 47.3 percent in 1997 and 73.6 percent in
1996. The Company's expense for amortization of costs in excess of net
assets acquired (goodwill) is not deductible for tax purposes, thus
explaining the higher effective tax rate during both 1997 and 1996 compared
to the U.S. statutory rate for corporations of 34 percent.
Net Earnings From Continuing Operations. Net earnings from continuing
operations increased to $818,000 in 1997 from $115,000 during 1996 as a
result of the higher earnings from operations due to increased gross profit
from higher sales of ANS products.
Loss From Discontinued Operations. The loss from discontinued operations
decreased to $93,000 during 1997 from $527,000 in 1996. This decrease in
the loss in 1997 compared to 1996 was solely the result of lower operating
expenses which decreased from $7.4 million in 1996 to $6.2 million during
1997 primarily due to lower research and development expense and lower
marketing expense (see Note 11 - "Sale of CVS Operations/Discontinued
Operations").
Net Earnings. Net earnings increased to $724,000 during 1997 compared to a
net loss during 1996 of $412,000 due to increased net earnings from
continuing operations combined with a reduction in the loss from
discontinued operations.
Comparison of the Years Ended December 31, 1996 and 1995
Revenues. Net revenue from ANS products of $11.4 million for the year ended
December 31, 1996, was $1.0 million above the level for the comparable 1995
period of $10.4 million. This increase during 1996 was attributable to
including a full twelve months of revenue compared to only nine months of
revenue in 1995 since ANS, formerly Neuromed, Inc. was acquired on March
31, 1995. Revenue during 1996 was impacted by several factors. First, the
Company made the strategic decision in 1996 to market its ANS products
through commissioned sales agents rather than distributors in certain
geographical areas of the United States. This decision resulted in a
decrease of approximately $300,000 in revenue during 1996 due to the return
of inventories from those distributors whom the Company decided to replace
with sales agents. Second, the Company introduced the next generation of
multi-electrode leads in 1996, which prompted delays in purchase
commitments. Finally, during early 1996, management announced plans to
rebuild the infrastructure at ANS and improve the current products of ANS
to transform ANS into an industry leader and compete effectively in the SCS
market.
Gross Profit. Gross profit during 1996 increased to $8.1 million compared
to $7.7 million in 1995. As a percentage of net revenue, gross profit
decreased to 70.9 percent in 1996 from 73.6 percent during 1995 due to
higher manufacturing overhead expenses as a result of the relocation of ANS
from Florida to the Company's larger Allen, Texas facility.
Operating Expenses. Total operating expenses decreased to $7.6 million
during 1996 from $15.1 million in 1995. In connection with the March 1995
acquisition of Neuromed, Inc., $10.5 million of the aggregate purchase
price was identified as purchased in-process research and development, and
in accordance with generally accepted accounting principles, was charged to
expense with no related tax benefit during 1995. Excluding such expense,
operating
-17-
<PAGE> 19
expenses increased during 1996 to $7.6 million from $4.6 million in 1995.
Part of this increase during 1996 was the result of the 1995 period
including only nine months of expense from the date of acquisition of March
31, 1995.
Marketing expense, as a percentage of net revenue, increased to 29.3
percent in 1996 from 15.7 percent during 1995, and the dollar amount
increased by $1.7 million related to additional salary, benefit,
commission, travel, samples and promotional expense. The 1995 period
included only nine months of expense. During 1996, the Company reorganized
part of its ANS distribution network replacing several distributors in
certain areas of the United States with eight commissioned sales agents and
three direct regional managers. Also during 1996, the Company designed ANS
training, customer support and sales and marketing materials and videos and
continued those efforts into early 1997. During 1996, the Company
reestablished relationships with key implanters who had discontinued using
the ANS products prior to the Company's acquisition.
Research and development expense increased to $1.3 million during 1996 from
$808,000 in 1995 due to significant engineering resources devoted by the
Company during 1996 to improve ANS products and the 1995 period including
only nine months of expense.
General and administrative expense increased to $2.1 million in 1996 from
$1.7 million during 1995 due, for the most part, to an expense during 1996
of $198,000 to write-off an accounts receivable from a former ANS
distributor who filed bankruptcy and the 1995 period including only nine
months of expense.
Amortization of intangibles increased to $826,000 during 1996 from $492,000
in 1995 due to additional goodwill expense.
Earnings From Operations. Earnings from operations for 1996 totaled
$515,000 compared to a loss from operations of $7.4 million in 1995. This
increase during 1996 was primarily the result of the $10.5 million expense
in 1995 for purchased in-process research and development. Excluding such
expense, earnings from operations decreased from $3.1 million in 1995 to
$515,000 in 1996, reflecting higher operating expenses discussed above.
Other Expense. Other expense decreased during 1996 to $81,000 compared to
$574,000 during 1995 due to lower interest expense since the 1995 period
includes interest expense on borrowed money to finance the purchase of ANS,
which was repaid during the fourth quarter of 1995 from the proceeds of a
public offering. Interest income decreased $260,000 from 1995 levels due to
reduced funds available for investment. This decrease was partially offset,
however, by a $108,000 increase in gains on the sale of marketable
securities.
Income Taxes. The Company recorded income tax expense of $320,000 during
1996, an effective tax rate of 73.6 percent which is considerably higher
than the U.S. statutory rate of 34 percent for corporations due to the
nondeductibility of amortization of costs in excess of net assets acquired
(goodwill). During 1995, the Company recorded income tax expense of
$911,000 despite a net loss from continuing operations of $8.0 million as a
consequence of the nondeductibility of the $10.5 million expense for
purchased research and development and amortization of costs in excess of
net assets acquired.
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<PAGE> 20
Net Earnings From Continuing Operations. Net earnings from continuing
operations increased to $115,000 in 1996 from a net loss of $8.9 million in
1995 primarily due to the $10.5 million expense during 1995 for purchased
research and development incurred in connection with the Neuromed
acquisition. Excluding this $10.5 million expense, the Company's net
earnings from continuing operations decreased from $1.6 million in 1995 to
$115,000 due to increased operating expenses discussed above.
Loss From Discontinued Operations. The loss from discontinued operations
decreased to $527,000 in 1996 from $1.2 million during 1995. This decrease
in the loss in 1996 compared to 1995 was primarily the result of lower
operating expenses, which decreased from $8.4 million in 1995 to $7.4
million during 1996 as a consequence of lower research and development
expenditures in 1996 due to the completion of the development of the
Company's Myocardial Protection System product.
Net Loss. The net loss decreased from $10.4 million in 1995 to $412,000 in
1996 primarily due to the $10.5 million expense during 1995 for purchased
research and development incurred in connection with the Neuromed
acquisition. Excluding this $10.5 million expense, the Company's net loss
of $412,000 in 1996 compared to net earnings of $126,000 in 1995 and
resulted from increased ANS operating expenses discussed above.
LIQUIDITY AND CAPITAL RESOURCES
In the sale of assets of the CVS Operations to Atrion, the Company received
cash proceeds of approximately $24 million, subject to post-closing
adjustments as defined in the purchase agreement, which significantly
enhanced the Company's financial position. The Company utilized
approximately $9 million of the proceeds to retire short-term notes payable
and related expenses of the transaction. After such repayment, the Company
at January 31, 1998, had cash in excess of $17 million and no debt other
than its Allen facility mortgage of $3.8 million (see Note 5 - "Notes
Payable" and Note 11 - "Sale of CVS Operations/Discontinued Operations").
The Company also granted Atrion a nine-month option to purchase the Allen
facility for $6.5 million and is leasing space in the Allen facility to
Atrion under a lease agreement which expires on January 31, 1999. If Atrion
exercises the purchase option on the Allen facility, the Company would
receive another $2.7 million in net proceeds after paying off the mortgage.
At December 31, 1997, prior to the CVS sale, the Company's working capital
increased from $11.1 million at year-end 1996 to $14.1 million at year-end
1997. The ratio of current assets to current liabilities was 2.5:1 at
December 31, 1997, compared to 4.0:1 at December 31, 1996. Cash, cash
equivalents and marketable securities totaled $2.2 million at December 31,
1997, a slight increase from the 1996 year end's level of $2.1 million.
During January 1998, the Board of Directors approved a stock repurchase
program of up to 500,000 shares of the Company's common stock. During
February 1998, the Company repurchased 73,000 shares of its common stock at
an aggregate cost of $508,000.
Management expects capital expenditures during 1998 of about $2.2 million.
These expenditures primarily relate to manufacturing tooling and equipment
for the new products that the Company is developing, including next
generation RF SCS systems, an IPG system and a constant rate implantable
drug pump.
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<PAGE> 21
Management believes that its cash, cash equivalents and marketable
securities after the sale of the CVS Operations and funds generated from
operations will be sufficient to satisfy normal cash operating
requirements, capital requirements and stock repurchases for the
foreseeable future.
CASH FLOWS
Net cash provided by continuing operations increased to $2.1 million in
1997 compared to $168,000 in 1996 and a net use of cash during 1995 of
$636,000. This improvement during 1997 compared to 1996 reflects the
improved operating results of ANS. Primary uses of cash in continuing
operations during 1997 were additional investments in inventories, prepaid
expenses and other assets, and a reduction in the level of accounts
payable. Primary uses of cash in continuing operations during 1996 were
additional investments in inventories and a reduction in the level of
accrued expenses. Primary uses of cash in continuing operations during 1995
were related to increased levels of accounts receivable and prepaid
expenses and a reduction in accounts payable and accrued expenses. Net cash
provided by discontinued operations increased to $391,000 in 1997 compared
to net uses of cash during 1996 of $145,000 and $898,000 in 1995.
Net cash used in investing activities was $5.7 million in 1997 compared to
$956,000 in 1996 and $14.1 million during 1995. Primary uses of cash during
1997 were investments in property, plant and equipment of $1.3 million and
payments to the former owner of Neuromed relating to patents and
settlements of $4.5 million (see Note 3 - "Acquisition"). Primary uses of
cash during 1996 were additions to property, plant and equipment of $1.9
million while during 1995 the Company used $16.0 million to acquire
Neuromed and $1.5 million for additions to property, plant and equipment.
Sources of cash from investing activities were $1.5 million in 1996 and
$3.3 million in 1995 from the sale of certain of the Company's marketable
securities.
Net cash provided by financing activities was $3.3 million in 1997 compared
to $305,000 in 1996 and $16.9 million during 1995. During 1997, cash was
provided by the exercise of stock options ($922,000) and additional
borrowings under short-term notes of $3.5 million. The Company used $1.2
million during 1997 to repay debt. During 1996, the primary source of cash
from financing activities was the exercise of stock options ($559,000)
while the Company used cash to repay $151,000 of mortgage debt and $103,000
utilized in the redemption of the Company's shareholder rights plan.
Primary sources of cash during 1995 were $15 million provided from
borrowings under a senior-term bank facility, $1.9 million of additional
borrowings under the Company's working capital line of credit, $369,000
from the exercise of stock options, and $15.2 million of net proceeds
provided by a public offering. Primary uses of cash during 1995 were
repayment of the $15 million senior-term bank indebtedness and $108,000 of
mortgage debt.
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<PAGE> 22
YEAR 2000
The Year 2000 issue results from computer programs being written using two
digits rather than four to identify an applicable year. Computer programs
that have time-sensitive software may recognize a date using "00" as the
year 1900 rather than the year 2000.
Based on recent assessments of its computer systems and programs, the
Company believes that its core manufacturing system software is fully Year
2000 compliant. Lesser internal applications may require minor
modifications or replacement to attain full Year 2000 compliance and the
Company intends to make certain investments in its software systems and
applications to ensure the Company is Year 2000 compliant. Management
believes, however, that the Year 2000 issue does not pose significant
operational problems for the Company's computer systems and that the
financial impact of the issue has not been and should not be material to
the Company's financial position or results of operations in any given
year.
OUTLOOK AND UNCERTAINTIES
The following is a "safe harbor" statement under the Private Securities
Litigation Reform Act of 1995: The matters discussed in this Annual Report
on Form 10-K contain statements that constitute forward-looking statements
within the meaning of Section 21E of the Securities Exchange Act of 1934,
as amended. The words "expect," "estimate," "anticipate," "predict,"
"believe," "plan," "will," "should," "intend" and similar expressions and
variations thereof are intended to identify forward-looking statements.
Such statements appear in a number of places in this Annual Report on Form
10-K and include statements regarding the intent, belief or current
expectations of the Company, its directors or its officers with respect
thereto, among other things: (i) trends affecting the Company's financial
condition or results of operations; (ii) the Company's financing plans; and
(iii) the Company's business growth strategies. Readers are cautioned that
any such forward-looking statements are not guarantees of future
performance and involve risks and uncertainties, and that actual results
may differ materially from those projected in the forward-looking
statements as a result of various factors. These risks and uncertainties
include, but are not limited to, the following:
Product Development and Market Acceptance. The Company's growth depends in
part on the development and market acceptance of new products, including
next generation ANS products. There is no assurance that the Company will
continue to develop successful products, that delays in product
introduction will not be experienced, or that once such products are
introduced, the market will accept them.
Government Regulation. The Company's business is subject to extensive
government regulation, principally by the FDA. The regulatory process,
especially as it relates to product approvals, can be lengthy, expensive
and uncertain.
Single-Sourced Components. The Company relies on a single supplier for the
computer chip used in two components of its SCS systems. The supplier of
this computer chip has indicated its desire to cease manufacturing and
supplying the computer chip in the future, but to date, has not determined
when this will occur. The supplier has agreed to notify the Company once a
date has been determined and allow the Company to place a final one-time
purchase order for the computer chip. In the interim, the Company is
maintaining a higher than normal
-21-
<PAGE> 23
inventory of the computer chip. In addition, the Company is developing a
custom computer chip under its development agreement with Hi-tronics
Design, Inc. to replace the existing computer chip and expects such chip to
be available during the latter half of 1999. A sudden disruption in supply
from the computer chip supplier or another single-source supplier could
adversely affect the Company's ability to deliver finished products on
time.
Competition and Technological Change. The medical device market is highly
competitive. The Company competes with many larger companies that have
access to greater capital, research and development, marketing,
distribution and other resources than the Company. In addition, this market
is characterized by extensive research efforts and rapid product
development and technological change, which could render the Company's
products obsolete or noncompetitive.
Intellectual Property Rights. The Company relies in part on patents, trade
secrets and proprietary technology to remain competitive. It may be
necessary to defend these rights or to defend against claims that the
Company is infringing the rights of others. Intellectual property
litigation and controversies are disruptive and expensive.
Cost Pressures on Medical Technology. The overall escalating cost of
medical products and healthcare results in significant cost pressure. Third
party payers are under intense pressure to challenge the prices charged for
medical products and services. The Company relies heavily on Medicare and
Medicaid reimbursement. Any amendments to existing reimbursement rules and
regulations which restrict or terminate the reimbursement eligibility (or
the extent or amount of coverage) of medical procedures using the Company's
products or the eligibility (or the extent or amount of coverage) of the
Company's products could have an adverse impact on the Company's business,
financial condition and results of operations.
Potential Product Liability. The testing, manufacturing, marketing and sale
of medical devices entail substantial risks of liability claims or product
recalls.
Reliance on Customer/Distributor. During 1997, ANS had one major customer
that accounted for 10 percent or more of its net revenue. Sun Medical,
Inc., a specialty distributor of ANS products, accounted for $3.7 million,
or 25 percent, of ANS's net revenue for the year ended December 31, 1997.
While the Company believes its relations with Sun Medical are good, the
loss of this or any other major customer could have a material adverse
effect on the Company's business, financial condition and results of
operations.
Other Uncertainties. Other operating, financial or legal risks or
uncertainties are discussed in this Form 10-K in specific contexts and in
the Company's other periodic SEC filings. The Company is, of course, also
subject to general economic risks, the risk of interruption in the source
of supply, dependence on key personnel and other risks and uncertainties.
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 ANS products by increasing the price of the
ANS 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 to date.
-22-
<PAGE> 24
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Inapplicable.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The information required by this item is set forth in Appendices A, B and C.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this item is contained under the captions "Election
of Directors" and "Executive Officers" in the definitive proxy material of the
Company to be filed in connection with its 1998 annual meeting of stockholders,
which information is incorporated herein by reference.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this item is contained under the captions
"Compensation and Committees of the Board of Directors" and "Compensation of
Executive Officers" in the definitive proxy material of the Company to be filed
in connection with its 1998 annual meeting of stockholders, which information is
incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this item is contained under the caption "Security
Ownership of Management and Principal Shareholders" in the definitive proxy
material of the Company to be filed in connection with its 1998 annual meeting
of stockholders, which information is incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this item is contained under the caption "Certain
Relationships and Related Transactions" in the definitive proxy material of the
Company to be filed in connection with its 1998 annual meeting of stockholders,
which information is incorporated herein by reference.
-23-
<PAGE> 25
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS
ON FORM 8-K
(a) Documents filed as part of this report.
1. Financial Statements:
See Index to Financial Statements on the second page of Appendix A.
2. Financial Statement Schedules:*
Schedule II - Valuation and Qualifying Accounts.
See Appendix B.
* Those schedules not listed above are omitted as not applicable or
not required.
3. Exhibits: See (c) below.
(b) Reports on Form 8-K.
The Company filed a Form 8-K on December 31, 1997 to report the press
release announcing the Company's entering into a definitive agreement on
December 29, 1997 to sell the CVS Operations to Atrion. On February 13,
1998 the Company filed a Form 8-K to report the consummation of the sale
of the CVS Operations to Atrion on January 30, 1998.
(c) Exhibit:
2.1 Agreement for the Purchase and Sale of All of the Issued Capital
Stock of Neuromed, Inc. dated February 10, 1995, between Quest
Medical, Inc. and William N. Borkan(5)
2.2 Amendment Agreement dated March 17, 1995, between Quest Medical,
Inc. and William N. Borkan(5)
2.3 Letter Agreement dated as of September 23, 1995, by and between
Quest Medical, Inc. and William N. Borkan(6)
2.4 Asset Purchase Agreement, dated December 29, 1997, by and among
Quest Medical, Inc., QMI Medical, Inc. (formerly known as QMI
Acquisition Corp.) and Atrion Corporation (including exhibits and
schedules 2.1.1, 2.1.2, 2.3(a) and 2.3.(b))(9)
3.1 Articles of Incorporation, as amended(6)
3.2 Bylaws(1)
4.1 Rights Agreement dated as of August 30, 1996, between Quest Medical,
Inc. and KeyCorp Shareholder Services, Inc. as Rights Agent(7)
10.1 Quest Medical, Inc. 1979 Amended and Restated Employees Stock Option
Plan(2)
10.2 Form of 1979 Employees Stock Option Agreement(3)
10.3 Quest Medical, Inc. Directors Stock Option Plan (as amended)(2)
10.4 Form of Directors Stock Option Agreement(1)
10.5 Quest Medical, Inc. 1987 Stock Option Plan(6)
-24-
<PAGE> 26
10.6 Form of 1987 Employee Stock Option Agreement(6)
10.7 Quest Medical, Inc. 1995 Stock Option Plan(6)
10.8 Form of 1995 Employee Stock Option Agreement(6)
10.9 Form of Employment Agreement and Covenant Not to Compete, between
the Company and key employees(1)
10.10 Promissory Note dated December 28,1993, between Quest Medical, Inc.
and MetLife Capital Financial Corporation(4)
10.11 Commercial Deed of Trust, Security Agreement and Assignment of
Leases and Rents and Fixture Filing dated December 28,1993, between
Quest Medical, Inc. and MetLife Capital Financial Corporation(4)
10.12 Term Promissory Note dated December 28,1993, between Quest Medical,
Inc. and MetLife Capital Corporation(4)
10.13 Loan and Security Agreement dated December 28,1993, between Quest
Medical, Inc. and MetLife Capital Corporation(4)
10.14 Supplemental Security Agreement Number One dated December 28,1993,
between Quest Medical, Inc. and MetLife Capital Corporation(4)
10.15 Third Amended and Restated Credit Agreement dated as of March 3,
1997, between Quest Medical, Inc. and NationsBank of Texas, N.A.(8)
10.16 Promissory Note (Facility A. Note) in the original principal amount
of $5,650,000 dated March 3, 1997(8)
10.17 Promissory Note (Facility B. Note) in the original principal amount
of $350,000 dated March 3, 1997(8)
10.18 First Amended and Restated Security Agreement dated March 3, 1997,
between Quest Medical, Inc. and NationsBank of Texas, N.A.(8)
10.19 First Amended and Restated Security Agreement dated March 3, 1997,
between Advanced Neuromodulation Systems, Inc. and NationsBank of
Texas, N.A.(8)
10.20 First Amended and Restated Intellectual Property Security Agreement
and Assignment dated as of March 3, 1997, between Quest Medical,
Inc. and NationsBank of Texas N.A.(8)
10.21 First Amended and Restated Intellectual Property Security Agreement
and Assignment dated as of March 3, 1997, between Advanced
Neuromodulation Systems, Inc. and NationsBank of Texas, N.A.(8)
10.22 First Amended and Restated License Agreement dated as of March 3,
1997, between Quest Medical, Inc. and NationsBank of Texas, N.A.(8)
10.23 First Amended and Restated License Agreement dated as of March 3,
1997, between Advanced Neuromodulation Systems, Inc. and NationsBank
of Texas, N.A.(8)
10.24 Guaranty of Advanced Neuromodulation Systems, Inc. in favor of
NationsBank of Texas, N.A. under the Third Amended and Restated
Credit Agreement dated as of March 3, 1997(8)
10.25 Form of License Agreement, dated January 30, 1998, by and between
Quest Medical, Inc. and QMI Medical, Inc. (formerly known as QMI
Acquisition Corp.)(9)
10.26 Form of Lease Agreement, dated January 30, 1998, by and between
Quest Medical, Inc. and QMI Medical, Inc. (formerly known as QMI
Acquisition Corp.)(9)
10.27 Form of Option Agreement, dated January 30, 1998, by and between
Quest Medical, Inc. and QMI Medical, Inc. (formerly known as QMI
Acquisition Corp.)(9)
10.28 Agreement, dated December 31, 1997, by and among Quest Medical,
Inc., its subsidiaries and affiliates and Thomas C. Thompson(10)
11.1 Computation of Earnings Per Share(10)
-25-
<PAGE> 27
21.1 Subsidiaries(10)
23.1 Consent of Independent Auditors(10)
27.1 Financial Data Schedule - December 31, 1997(10)
27.2 Restated Financial Data Schedule - December 31, 1996(10)
27.3 Restated Financial Data Schedule - December 31, 1995(10)
- -----------------------------------
(1) Filed as an Exhibit to the Company's Registration Statement on Form S-18,
Registration No. 2-71198-FW, and incorporated herein by reference.
(2) Filed as an Exhibit to the report of the Company on Form 10-K for the
year ended December 31, 1987, and incorporated herein by reference.
(3) Filed as an Exhibit to the Company's Registration Statement on Form S-1,
Registration No. 2-78186, and incorporated herein by reference.
(4) Filed as an Exhibit to the report of the Company on Form 10-KSB for the
year ended December 31, 1993, and incorporated herein by reference.
(5) Filed as an Exhibit to the report of the Company on Form 10-KSB for the
year ended December 31, 1994, and incorporated herein by reference.
(6) Filed as an Exhibit to the Company's Registration Statement on Form SB-2,
Registration No. 33-62991, and incorporated herein by reference.
(7) Filed as an Exhibit to the report of the Company on Form 8-K dated
September 3, 1996, and incorporated herein by reference.
(8) Filed as an Exhibit to the report of the Company on Form 10-K dated for
the year ended December 31, 1996, and incorporated herein by reference.
(9) Filed as an Exhibit to the report of the Company on Form 8-K dated
February 13, 1998, and incorporated herein by reference. Upon request,
the Company will furnish a copy of any omitted schedule to the
Commission.
(10) Filed herewith.
-26-
<PAGE> 28
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Company has duly caused this report to be signed on its behalf
by the undersigned, thereunto duly authorized.
Date: March 30, 1998
QUEST MEDICAL, INC.
By: /s/ F. ROBERT MERRILL III
-----------------------------------------
F. Robert Merrill III, Chief Executive
Officer, President, Executive Vice
President-Finance, Treasurer and
Secretary
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed by the following persons on behalf of the Company and in the
capacities and on the dates indicated:
<TABLE>
<CAPTION>
Signature Title Date
--------- ----- ----
<S> <C> <C>
/s/ F. ROBERT MERRILL III Chief Executive Officer, President, March 30, 1998
-------------------------------------- Executive Vice President-Finance, Treasurer and
F. Robert Merrill III Secretary (Principal Executive Officer)
/s/ F. ROBERT MERRILL III Chief Executive Officer, President,
-------------------------------------- Executive Vice President-Finance, Treasurer and
F. Robert Merrill III Secretary (Principal Financial and Accounting March 30, 1998
Officer)
/s/ HUGH M. MORRISON Chairman of the Board and March 30, 1998
-------------------------------------- Director of Quest Medical, Inc.
Hugh M. Morrison
/s/LINTON E. BARBEE Director of Quest Medical, Inc. March 30, 1998
--------------------------------------
Linton E. Barbee
</TABLE>
-27-
<PAGE> 29
<TABLE>
Signature Title Date
--------- ----- ----
<S> <C> <C>
/s/ ROBERT C. EBERHART Director of Quest Medical, Inc. March 30, 1998
--------------------------------------
Robert C. Eberhart
/s/ RICHARD D. NIKOLAEV Director of Quest Medical, Inc. March 30, 1998
--------------------------------------
Richard D. Nikolaev
/s/ MICHAEL J. TORMA Director of Quest Medical, Inc. March 30, 1998
--------------------------------------
Michael J. Torma
</TABLE>
-28-
<PAGE> 30
APPENDIX A
CONSOLIDATED FINANCIAL STATEMENTS
INDEPENDENT AUDITORS' REPORT
THREE YEARS ENDED DECEMBER 31, 1997
FORMING A PART OF THE ANNUAL REPORT
FORM 10-K
ITEM 8
OF
QUEST MEDICAL, INC. AND SUBSIDIARIES
(NAME OF ISSUER)
FILED WITH THE
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
UNDER
THE SECURITIES AND EXCHANGE ACT OF 1934
<PAGE> 31
QUEST MEDICAL, INC. AND SUBSIDIARIES
TABLE OF CONTENTS
TO
CONSOLIDATED FINANCIAL STATEMENTS
FORM 10-K - ITEM 8
INDEPENDENT AUDITORS' REPORT
CONSOLIDATED FINANCIAL STATEMENTS:
Consolidated Balance Sheets - December 31, 1997 and 1996
Consolidated Statements of Operations - Three years ended December 31, 1997
Consolidated Statements of Stockholders' Equity - Three years ended December 31,
1997
Consolidated Statements of Cash Flows - Three years ended December 31, 1997
Notes to Consolidated Financial Statements
<PAGE> 32
Report of Independent Auditors
The Board of Directors
Quest Medical, Inc.
We have audited the accompanying consolidated balance sheets of Quest Medical,
Inc. and subsidiaries (the Company) as of December 31, 1997 and 1996, and the
related consolidated statements of operations, stockholders' equity, and cash
flows for each of the three years in the period ended December 31, 1997. Our
audit also included the financial statement schedule listed in the Index at Item
14A. These consolidated financial statements and schedule are the responsibility
of the Company's management. Our responsibility is to express an opinion on
these financial statements and schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Quest Medical,
Inc. and subsidiaries at December 31, 1997 and 1996, and the consolidated
results of their operations and their cash flows for each of the three years in
the period ended December 31, 1997, in conformity with generally accepted
accounting principles. Also, in our opinion, the related financial statement
schedule, when considered in relation to the basic financial statements taken as
a whole, presents fairly in all material respects the information set forth
therein.
/s/ERNST & YOUNG LLP
------------------------
ERNST & YOUNG LLP
Dallas, Texas
February 25, 1998
<PAGE> 33
QUEST MEDICAL, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1997 AND 1996
<TABLE>
<CAPTION>
ASSETS 1997 1996
- ------ ----------- -----------
Current assets:
<S> <C> <C>
Cash and cash equivalents $ 747,828 $ 696,196
Marketable securities 1,455,864 1,366,089
Receivables:
Trade accounts, less allowance for doubtful
accounts of $212,375 in 1997 and $160,000 in 1996 2,398,327 2,418,714
Interest and other 209,595 134,162
----------- -----------
Total receivables 2,607,922 2,552,876
----------- -----------
Inventories:
Raw materials 1,056,718 1,181,147
Work-in-process 323,929 692,199
Finished goods 1,597,840 1,136,851
----------- -----------
Total inventories 2,978,487 3,010,197
----------- -----------
Deferred income taxes 2,288,192 317,276
Net assets, in 1997, and net current assets, in 1996, of
discontinued operations sold in 1998 12,831,318 6,356,543
Prepaid expenses and other current assets 476,716 450,128
----------- -----------
Total current assets 23,386,327 14,749,305
----------- -----------
Property, plant and equipment:
Land 1,927,900 1,930,289
Building and improvements 5,254,945 5,251,853
Furniture and fixtures 624,753 605,899
Machinery and equipment 920,879 407,254
----------- -----------
8,728,477 8,195,295
Less accumulated depreciation and
amortization 1,317,362 889,841
----------- -----------
Net property, plant and equipment 7,411,115 7,305,454
----------- -----------
Cost in excess of net assets acquired, net of
accumulated amortization of $1,178,014 in 1997
and $632,768 in 1996 9,633,650 10,103,659
Patents, net of accumulated amortization
of $148,958 in 1997 2,851,042 3,000,000
Purchased technology from acquisitions, net of
accumulated amortization of $733,334 in 1997 and
$466,667 in 1996 3,266,666 3,533,333
Tradenames, net of accumulated amortization of
$343,750 in 1997 and $218,750 in 1996 2,156,250 2,281,250
Noncurrent assets of discontinued operations sold in 1998 -- 6,213,632
Other assets 277,270 1,300
----------- -----------
$48,982,320 $47,187,933
=========== ===========
</TABLE>
See accompanying notes to consolidated financial statements.
<PAGE> 34
QUEST MEDICAL, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1997 AND 1996
<TABLE>
<CAPTION>
LIABILITIES AND STOCKHOLDERS' EQUITY 1997 1996
- ------------------------------------ -------------- ------------
Current liabilities:
<S> <C> <C>
Accounts payable $ 240,249 $ 753,953
Short-term notes payable and current maturities of
long-term notes payable 8,257,348 2,084,122
Accrued salary and employee benefit costs 381,735 747,573
Other accrued expenses 379,444 76,135
------------ ------------
Total current liabilities 9,258,776 3,661,783
------------ ------------
Notes payable 3,635,027 11,912,036
Deferred income taxes 2,182,580 620,631
Commitments and contingencies
Stockholders' equity:
Common stock, $.05 par value
Authorized 25,000,000 shares in 1997 and 1996;
issued 8,635,509 shares in 1997 and
8,338,510 shares in 1996 431,775 416,926
Additional capital 40,780,717 38,699,517
Retained earnings (deficit) (7,268,061) (7,992,082)
Unrealized loss on marketable securities net of
tax benefit of $19,831 in 1997 and $67,423 in 1996 (38,494) (130,878)
------------ ------------
Total stockholders' equity 33,905,937 30,993,483
------------ ------------
$ 48,982,320 $ 47,187,933
============ ============
</TABLE>
See accompanying notes to consolidated financial statements.
<PAGE> 35
QUEST MEDICAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31
<TABLE>
<CAPTION>
1997 1996 1995
------------ ------------ ------------
<S> <C> <C> <C>
Net revenue $ 14,717,721 $ 11,403,144 $ 10,434,384
Cost of revenue 4,839,261 3,315,255 2,752,108
------------ ------------ ------------
Gross profit 9,878,460 8,087,889 7,682,276
------------ ------------ ------------
Operating expenses:
General and administrative 1,760,061 2,083,763 1,662,788
Research and development 976,900 1,315,953 807,560
Amortization of intangibles 1,085,871 826,418 491,767
Purchased research and development -- -- 10,500,000
Marketing 3,969,320 3,346,450 1,641,043
------------ ------------ ------------
7,792,152 7,572,584 15,103,158
------------ ------------ ------------
Earnings (loss) from operations 2,086,308 515,305 (7,420,882)
Other income (expense):
Gain (loss) on sale of marketable securities (25,659) 136,975 29,115
Interest expense (625,321) (418,246) (1,063,367)
Investment and other income, net 115,197 200,322 460,282
------------ ------------ ------------
(535,783) (80,949) (573,970)
------------ ------------ ------------
Earnings (loss) from continuing operations
before income taxes 1,550,525 434,356 (7,994,852)
Income taxes 733,014 319,842 911,480
------------ ------------ ------------
Net earnings (loss) from continuing operations 817,511 114,514 (8,906,332)
Loss from discontinued operations,
net of income tax benefits of $15,909 in 1997,
$236,967 in 1996 and $756,366 in 1995 (93,490) (526,671) (1,198,666)
Extraordinary item - loss on early extinguishment of debt,
net of income tax benefit of $138,599 -- -- (269,045)
------------ ------------ ------------
Net earnings (loss) $ 724,021 $ (412,157) $(10,374,043)
============ ============ ============
Basic earnings (loss) per share:
Continuing operations $ .10 $ .01 $ (1.42)
============ ============ ============
Discontinued operations $ (.01) $ (.06) $ (.19)
============ ============ ============
Extraordinary item $ -- $ -- $ (.05)
============ ============ ============
Net earnings (loss) $ .09 $ (.05) $ (1.66)
============ ============ ============
Diluted earnings (loss) per share:
Continuing operations $ .09 $ .01 $ (1.42)
============ ============ ============
Discontinued operations $ (.01) $ (.06) $ (.19)
============ ============ ============
Extraordinary item $ -- $ -- $ (.05)
============ ============ ============
Net earnings (loss) $ .08 $ (.05) $ (1.66)
============ ============ ============
</TABLE>
See accompanying notes to consolidated financial statements.
<PAGE> 36
QUEST MEDICAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31
<TABLE>
<CAPTION>
1997 1996 1995
-------------- --------------- ------------
Cash flows from operating activities:
<S> <C> <C> <C>
Net earnings (loss) from continuing operations $ 817,511 $ 114,514 $ (8,906,332)
Adjustments to reconcile earnings (loss) from continuing
operations to net cash provided by (used in) operating activities:
Depreciation 438,056 312,245 306,677
Amortization 1,085,871 826,417 563,203
Deferred income taxes 717,104 97,478 338,601
Non-operating loss (gains) included in net earnings (loss) 25,655 (139,030) (137,898)
Purchased research and development -- -- 10,500,000
Increase in inventory reserve 534,619 -- --
Changes in assets and liabilities, net of effects of acquisition:
Receivables (130,283) 658,980 (1,820,825)
Inventories (500,835) (1,385,149) (62,403)
Prepaid expenses and other assets (302,558) 239,755 (661,673)
Accounts payable (513,704) 57,849 (416,074)
Accrued expenses (62,529) (615,315) (349,221)
Other -- -- 9,720
------------ ------------ ------------
Net cash provided by (used in) continuing operations 2,108,907 (167,744) (636,225)
Net cash provided by (used in) discontinued operations 391,096 (145,431) (897,653)
------------ ------------ ------------
Net cash provided by (used in) operating activities 2,500,003 22,313 (1,533,878)
------------ ------------ ------------
Cash flows from investing activities:
Net proceeds from marketable securities transactions 24,542 1,480,924 3,317,881
Additions to property, plant and equipment, continuing operations (545,193) (391,832) (275,759)
Additions to property, plant and equipment, discontinued operations (745,729) (1,580,468) (1,192,973)
Acquisition, net of cash acquired (4,472,197) (468,767) (15,996,910)
Other (594) 3,637 6,550
------------ ------------ ------------
Net cash used in investing activities (5,739,171) (956,506) (14,141,211)
------------ ------------ ------------
Cash flows from financing activities:
Net increase (decrease) in short-term obligations 3,531,763 -- --
Proceeds of long-term notes payable, net of debt issuance costs -- -- 16,431,233
Payment of long-term notes payable (1,163,349) (150,647) (15,108,486)
Exercise of stock options 922,386 558,552 369,449
Net proceeds from public offering of common stock -- -- 15,218,815
Redemption of rights plan -- (103,146) --
Issuance (purchase) of treasury stock, net -- -- 1,745
------------ ------------ ------------
Net cash provided by (used in) financing activities 3,290,800 304,759 16,912,756
------------ ------------ ------------
Net increase (decrease) in cash and cash equivalents 51,632 (629,434) 1,237,667
Cash and cash equivalents at beginning of year 696,196 1,325,630 87,963
------------ ------------ ------------
Cash and cash equivalents at end of year $ 747,828 $ 696,196 $ 1,325,360
============ ============ ============
Supplemental cash flow information is presented below:
Income taxes paid $ -- $ -- $ --
============ ============ ============
Interest paid (net of amounts capitalized) $ 994,294 $ 668,049 $ 1,571,553
============ ============ ============
</TABLE>
See accompanying notes to consolidated financial statements.
<PAGE> 37
QUEST MEDICAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
THREE YEARS ENDED DECEMBER 31, 1997
<TABLE>
<CAPTION>
UNREALIZED
COMMON STOCK RETAINED LOSS ON
------------------------ ADDITIONAL EARNINGS MARKETABLE
SHARES AMOUNT CAPITAL (DeFICIT) SECURITIES
----------- ---------- --------- ----------- ------------
<S> <C> <C> <C> <C> <C>
Balance at December 31, 1994 7,982,498 $ 399,125 $19,514,171 $ 2,794,118 $(917,634)
Shares issued upon exercise of
stock options 160,422 8,021 361,429 -- --
Issuance of 245 common shares from
treasury -- -- 1,216 -- --
Adjustment to unrealized losses on
marketable securities -- -- -- -- 706,572
Issuance of 1,033,333 common shares from
treasury for acquisition -- -- 6,779,285 -- --
Sale of treasury and new common shares in
public offering, net of offering costs 4,429 221 11,597,569 -- --
Net loss -- -- -- (10,374,043) --
------------ --------- ----------- ------------ ---------
Balance at December 31, 1995 8,147,349 407,367 38,253,670 (7,579,925) (211,062)
Shares issued upon exercise of
stock options 159,178 7,959 479,207 -- --
Adjustment to unrealized losses on
marketable securities -- -- -- -- 80,184
Issuance of 31,983 new common shares for
employee bonuses and cancellation of
a stock option 31,983 1,600 69,786 -- --
Redemption of rights plan dividend -- -- (103,146) -- --
Net loss -- -- -- (412,157) --
------------ --------- ----------- ------------ ---------
Balance at December 31, 1996 8,338,510 416,926 38,699,517 (7,992,082) (130,878)
Shares issued upon exercise of
stock options 296,999 14,849 907,537 -- --
Adjustment to unrealized losses on
marketable securities -- -- -- -- 92,384
Tax benefit from employee stock option
exercises -- -- 1,173,663 -- --
Net earnings -- -- -- 724,021 --
------------ --------- ----------- ------------ ---------
Balance at December 31, 1997 8,635,509 $ 431,775 $40,780,717 $ (7,268,061) $ (38,494)
============ ========= =========== ============ =========
<CAPTION>
TOTAL
TREASURY STOCKHOLDERS'
STOCK EQUITY
-------- ----------
<S> <C> <C>
Balance at December 31, 1994 $ (5,858,800) $ 15,930,980
Shares issued upon exercise of
stock options -- 369,450
Issuance of 245 common shares from
treasury 529 1,745
Adjustment to unrealized losses on
marketable securities -- 706,572
Issuance of 1,033,333 common shares from
treasury for acquisition 2,237,246 9,016,531
Sale of treasury and new common shares in
public offering, net of offering costs 3,621,025 15,218,815
Net loss -- (10,374,043)
------------ ------------
Balance at December 31, 1995 -- 30,870,050
Shares issued upon exercise of
stock options -- 487,166
Adjustment to unrealized losses on
marketable securities -- 80,184
Issuance of 31,983 new common shares for
employee bonuses and cancellation of
a stock option -- 71,386
Redemption of rights plan dividend -- (103,146)
Net loss -- (412,157)
------------ ------------
Balance at December 31, 1996 -- 30,993,483
Shares issued upon exercise of
stock options -- 922,386
Adjustment to unrealized losses on
marketable securities -- 92,384
Tax benefit from employee stock option
exercises -- 1,173,663
Net earnings -- 724,021
------------ ------------
Balance at December 31, 1997 $ -- $ 33,905,937
============ ============
</TABLE>
<PAGE> 38
- 1 -
QUEST MEDICAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) BUSINESS
CONTINUING OPERATIONS
Quest Medical, Inc. (the "Company") designs, develops, manufactures and
markets implantable neurostimulation systems through its wholly owned
subsidiary Advanced Neuromodulation Systems, Inc. ("ANS"). ANS devices
are used primarily to manage chronic severe pain. ANS revenues are
derived primarily from sales throughout the United States, Europe and
Australia.
The neurostimulation systems business, described above, was acquired in
March 1995 (see Note 3 -"Acquisition"). All other businesses of the
Company were sold in January 1998 as described below under Discontinued
Operations.
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.
In addition, ANS products are purchased primarily by hospitals and
other users who then bill various third-party payers including
Medicare, Medicaid, private insurance companies and managed care
organizations. These third-party payers reimburse fixed amounts for
services based on a specific diagnosis. The impact of changes in
third-party payer reimbursement policies and any amendments to existing
reimbursement rules and regulations that restrict or terminate the
eligibility of ANS products could have an adverse impact on the
Company's financial condition and results of operations.
DISCONTINUED OPERATIONS
On January 30, 1998, the Company sold its cardiovascular and
intravenous fluid product lines ("CVS Operations"), including its
MPS(R) myocardial protection system product line, to Atrion Corporation
(see Note 11 - "Sale of CVS Operations/Discontinued Operations"). The
CVS Operations have been accounted for as discontinued operations in
the Consolidated Statements of Operations for the years ended December
31, 1997, 1996 and 1995. Net assets of the CVS Operations have been
presented on the Consolidated Balance Sheets as net assets of
discontinued operations.
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of Quest
Medical, Inc. and all of its subsidiaries. All significant intercompany
transactions and accounts have been eliminated in consolidation.
<PAGE> 39
- 2 -
QUEST MEDICAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates
and assumptions that affect the amounts reported in the financial
statements and accompanying notes. Actual results could differ from
those estimates.
CASH EQUIVALENTS
The Company considers temporary cash investments with maturities of
three months or less from the date of purchase to be cash equivalents.
REVENUE RECOGNITION
The Company recognizes revenue from product sales when the goods are
shipped to its customers.
MARKETABLE SECURITIES
The Company's marketable securities 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
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
Property, plant and equipment are stated at cost. Additions and
improvements extending asset lives are capitalized while maintenance
and repairs are expensed as incurred. Depreciation is provided using
the straight-line method over the estimated useful lives of the various
assets ranging from 3 to 30 years.
INTANGIBLE ASSETS
The excess of cost over the net assets of acquired businesses
("goodwill") is amortized on a straight-line basis over the estimated
useful life of 20 years.
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 life (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.
<PAGE> 40
- 3 -
QUEST MEDICAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The cost of purchased patents is amortized on a straight-line basis
over the estimated useful life (17 years) of such patents. Costs of
patents that are the result of internal development are charged to
current operations.
The Company assesses the recoverability of all its intangible assets
primarily based on its current and anticipated future undiscounted cash
flows. At December 31, 1997, the Company does not believe there has
been any impairment of its intangible assets.
RESEARCH AND DEVELOPMENT
Product development costs including start-up and research and
development are charged to operations in the year in which such costs
are incurred.
ADVERTISING
Advertising expense is charged to operations in the year in which such
costs are incurred. Total advertising expense included in marketing
expense from continuing operations was $14,746, $5,615 and $54,335 at
December 31, 1997, 1996 and 1995, respectively.
DEFERRED TAXES
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.
STOCK-BASED COMPENSATION
The Company has elected to follow APB No. 25, "Accounting for Stock
Issued to Employees" in the primary financial statements and to provide
supplementary disclosures required by FASB Statement No. 123,
"Accounting for Stock-Based Compensation" (see Note 7 - "Stockholders'
Equity").
EARNINGS PER SHARE
In February 1997, the Financial Accounting Standards Board issued
Statement No. 128, "Earnings Per Share," which is required to be
adopted on December 31, 1997. The Company adopted provisions of
Statement No. 128 at that time and accordingly has restated all prior
periods. Under Statement No. 128, basic earnings per share is computed
based only on the weighted average number of common shares outstanding
during the period, and the dilutive effect of stock options and
warrants is excluded. Diluted earnings per share is computed using the
additional dilutive effect, if any, of stock options and warrants using
the treasury stock method based on the average market price of the
stock during the period. Basic earnings (loss) per share for 1997, 1996
and 1995 are based upon 8,428,393, 8,259,129 and 6,267,210 shares,
respectively. Diluted earnings (loss) per share for 1997, 1996 and 1995
are based upon 8,858,086, 8,809,583 and 6,267,210 shares, respectively.
For 1997 and 1996, the incremental shares used for dilutive earnings
(loss) per share relate to stock options and warrants whose exercise
price was less than the average market price in the
<PAGE> 41
- 4 -
QUEST MEDICAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
underlying quarterly computations. Options to purchase 148,313 shares
at an average price of $10.80 per share were outstanding in 1997, and
options to purchase 128,812 shares at an average price of $9.82 per
share were outstanding in 1996 but were not included in the computation
of diluted earnings (loss) per share because the options' exercise
prices were greater than the average market price of the common shares
and, therefore, the effect would be antidilutive.
RECLASSIFICATION
Certain prior period amounts have been reclassified to conform to
current-year presentation.
(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 depending on
sales of Neuromed's products reaching certain objectives.
In 1995, the Company recorded additional "earn-out" consideration of
200,000 shares of Quest common stock valued at $2,558,200 and a
$1,500,000 liability. In 1996, the Company recorded a note payable in
the amount of $3,370,000 for additional "earn out" consideration. In
addition, the Company recorded a short-term note payable to the former
owner of Neuromed in the amount of $972,197 related to certain purchase
price adjustments (principally tax refunds and future tax credits)
awarded through an arbitration. The Company paid the $972,197
obligation during January 1997. In February 1997, the Company and the
former owner of Neuromed reached a settlement (the "Settlement") of all
issues between them. Under the terms of the Settlement, the Company
agreed to pay $500,000 in cash and deliver a promissory note in the
amount of $1,000,000 payable on February 6, 1998, for full settlement
of the contingent consideration liabilities net of claims made by the
Company. The Company also agreed to pay $3,000,000 in cash to purchase
certain patent rights from Neuromed's former owner.
The acquisition was accounted for by the purchase method of accounting.
Purchased in-process research and development was identified and
valued. 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 year ended December 31,
1995.
In connection with the purchase, the Company determined that the
operations of Neuromed would be relocated to the Company's facility in
Allen, Texas and recorded liabilities of $1,234,335 for relocation
costs.
The purchase price allocation for the acquisition of Neuromed, as of
December 31, 1996, is summarized below:
<PAGE> 42
- 5 -
QUEST MEDICAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<S> <C>
Tradenames $ 2,500,000
Purchased patents 3,000,000
Purchased technology 4,000,000
Cost in excess of net assets acquired 10,736,427
Purchased research and development 10,500,000
Excess of liabilities over tangible assets acquired (250,789)
Deferred financing costs 468,767
------------
$ 30,954,405
============
</TABLE>
(4) MARKETABLE SECURITIES
The following is a summary of available-for-sale securities at December
31, 1997:
<TABLE>
<CAPTION>
Gross Gross
Unrealized Unrealized Estimated
Cost Gains Losses Fair Value
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Investment grade preferred
securities $ 557,596 $ 1,870 $ 4,802 $ 554,664
Publicly traded limited
partnerships 51,875 -- 10,315 41,560
Real estate investment
trusts 241,590 312 12,465 229,437
Other 663,128 -- 32,925 630,203
---------- ---------- ---------- ----------
$1,514,189 $ 2,182 $ 60,507 $1,455,864
========== ========== ========== ==========
</TABLE>
At December 31, 1997, no individual security represented more than 25
percent of the total portfolio or 1 percent of total assets. The
Company did not have any investments in derivative financial
instruments at December 31, 1997.
The following is a summary of available-for-sale securities at December
31, 1996:
<TABLE>
<CAPTION>
Gross Gross
Unrealized Unrealized Estimated
Cost Gains Losses Fair Value
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Investment grade preferred
securities $ 622,596 $ 4,503 $ 45,817 $ 581,282
Publicly traded limited
partnerships 263,004 -- 44,019 218,985
Real estate investment trusts 297,695 3,498 41,688 259,505
Other 381,095 10 74,788 306,317
---------- ---------- ---------- ----------
$1,564,390 $ 8,011 $ 206,312 $1,366,089
========== ========== ========== ==========
</TABLE>
At December 31, 1996, no individual security represented more than 20
percent of the total portfolio or 1 percent of total assets. The
Company did not have any investments in derivative financial
instruments at December 31, 1996.
<PAGE> 43
- 6 -
QUEST MEDICAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(5) NOTES PAYABLE
Notes payable for the years ended December 31 consisted of the
following:
<TABLE>
<CAPTION>
1997 1996
----------- -----------
<S> <C> <C>
Notes payable to banks $ 5,000,000 $ 4,550,000
Note payable to shareholder 2,000,000 --
Acquisition notes payable 1,000,000 5,472,197
Mortgage notes 3,810,612 3,973,961
Other 81,763 --
----------- -----------
11,892,375 13,996,158
Less current maturities 8,257,348 2,084,122
----------- -----------
Long-term portion of notes payable $ 3,635,027 $11,912,036
=========== ===========
</TABLE>
At December 31, 1997, the Company's notes payable to banks were under a
$5,650,000 working capital line of credit and a $350,000 term loan
facility (the "Facilities"). Borrowings under the Facilities bear
interest at prime plus 100 basis points, or at the Company's option,
LIBOR plus 225 or 275 basis points. The Facilities are collateralized
by all of the Company's assets with the exception of the real property,
building and equipment that collateralize the mortgage notes described
below. The Company is subject to specified financial covenants and is
prohibited from paying cash dividends. The Company is required to make
monthly principal payments of $90,000 with interest payable quarterly.
At December 31, 1997, the Company has advances in the amount of
$4,650,000 outstanding under its working capital line with a weighted
average interest rate of 7.50 percent and advances in the amount of
$350,000 under the term loan facility with a weighted average interest
rate of 8.25 percent. On January 30, 1998, the Company repaid all notes
payable under the Facilities with proceeds from the sale of the assets
of its CVS Operations (see Note 11 - "Sale of CVS
Operations/Discontinued Operations") and the Facilities expired.
In February 1997, the Company borrowed $2,000,000 from a nonaffiliate
shareholder pursuant to a promissory note that bears interest at the
rate of 6 percent per annum. The Company is required to make quarterly
interest payments with the principal due at maturity in February 1998.
The Company issued the shareholder five-year warrants to purchase
100,000 shares of common stock at an exercise price of $6.50 per share,
the closing sales price on the date the indebtedness was incurred.
Under the warrant agreement, the shareholder has the right to one
demand registration in addition to piggyback registration rights.
During November 1997, upon demand of the shareholder, the Company filed
a registration statement on Form S-3. At February 25, 1998, the
warrants remain unexercised. The loan is subordinated to the bank debt
described above and the shareholder has a second lien on all of the
assets collateralizing the bank debt. The Company repaid the note on
January 30, 1998 with proceeds from the sale of the assets of its CVS
Operations (see Note 11 - "Sale of CVS Operations/Discontinued
Operations").
At December 31, 1996, the Company had a short-term, noninterest-bearing
note payable in the amount of $972,197 due in connection with purchase
price adjustments awarded through an arbitration to the former owner of
Neuromed, Inc. (see Note 3 - "Acquisition"). The note was paid during
January 1997. In February 1997, the Company issued the former owner of
Neuromed a promissory note in the amount of $1.0 million that bears
interest at the rate of 10 percent per annum with interest payable
monthly and the principal due in February 1998. The loan is
subordinated to the bank debt described above and is collateralized
with a second lien that is pari passu with the shareholder's lien. The
Company repaid the note on January 30, 1998, with
<PAGE> 44
- 7 -
QUEST MEDICAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
proceeds from the sale of the assets of its CVS Operations (see Note 11
- "Sale of CVS Operations/Discontinued Operations").
In 1993, the Company entered into two mortgage notes relating to its
principal office and manufacturing facility. The first note, in the
amount of $2,876,391 at December 31, 1997, bears interest at 8.59
percent and has a twenty-five year amortization. The Company has the
option of prepaying this note during years six through ten subject to
certain provisions. The loan is collateralized by the Allen facility
and land. The second note, in the amount of $934,221 at December 31,
1997, is related to equipment and furnishings and bears interest at
7.94 percent. The note has a ten-year amortization and is
collateralized by the equipment and furnishings.
The carrying value of the Company's debt approximates its fair value.
(6) FEDERAL INCOME TAXES
The significant components of the net deferred tax liability at
December 31, were as follows:
<TABLE>
<CAPTION>
Deferred tax assets: 1997 1996
----------- -----------
<S> <C> <C>
Tax credit and net operating loss carry forwards $ 2,488,573 $ 2,631,362
Accrued expenses and reserves 278,387 344,915
Unrealized loss on marketable
securities 19,831 67,422
Valuation allowance -- (858,835)
----------- -----------
Total deferred tax asset 2,786,791 2,184,864
Deferred tax liabilities:
Purchased intangible assets (1,843,792) (1,976,958)
Excess of tax over book depreciation (566,296) (335,368)
Other (271,091) (175,893)
----------- -----------
Total deferred tax liability (2,681,179) (2,488,219)
----------- -----------
Net deferred tax asset (liability) $ 105,612 $ (303,355)
=========== ===========
</TABLE>
At December 31, 1996, $688,895 of the total valuation allowance was
attributable to stock option deductions. This amount was credited to
additional capital in 1997 when the valuation allowance was removed.
The remaining portion of the valuation allowance at December 31, 1996,
was for tax credit carry forwards. During 1996, the valuation allowance
increased by $587,068.
The provision for income taxes on earnings (loss) from continuing
operations for the years ended December 31 consists of the following:
<TABLE>
<CAPTION>
1997 1996 1995
-------- -------- --------
<S> <C> <C> <C>
Current $ -- $ -- $ --
Deferred 733,014 319,842 911,480
-------- -------- --------
$733,014 $319,842 $911,480
======== ======== ========
</TABLE>
<PAGE> 45
- 8 -
QUEST MEDICAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
A reconciliation of the provision for income taxes on earnings (loss)
from continuing operations to the expense (benefit) calculated at the
U.S. statutory rate follows:
<TABLE>
<CAPTION>
1997 1996 1995
--------------- --------------- ---------------
<S> <C> <C> <C>
Income tax expense (benefit) at statutory rate $ 527,179 $ 147,681 $ (2,718,250)
Tax effect of:
Nondeductible amortization of goodwill 185,200 147,999 67,326
Nondeductible write-off of purchased
in-process research and development -- -- 3,570,000
Other 20,635 24,162 (7,596)
--------------- --------------- ---------------
Income tax expense $ 733,014 $ 319,842 $ 911,480
=============== =============== ===============
</TABLE>
At December 31, 1997 net operating loss carry forwards of $4,354,724
are available to offset future taxable income. Such net operating loss
carry forwards expire in various amounts beginning in 2009 through
2012. At December 31, 1997, general business credits of $855,347 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 1998 through 2010.
(7) STOCKHOLDERS' EQUITY
The Company has a Shareholder's Rights Plan, adopted in August 1996,
which permits shareholders to purchase shares of the Company's common
stock at significant discounts in the event a person or group acquires
more than 15 percent of the Company's common stock or announces a
tender or exchange offer for more than 20 percent of the Company's
common stock. Previously outstanding rights were redeemed in August
1996 at $.01 per share.
The Company has various stock option plans pursuant to which stock
options may be granted to key employees and officers (the "Employees'
Plans") and one plan under which directors and advisory directors of
the Company may be granted options (the "Directors' Plan"). The most
recent of the Employees' Plans, which was adopted during 1995 (the
"1995 Plan"), reserved 250,000 shares of common stock for options under
the plan; provided, however, that on January 1 of each year (commencing
in 1996), the aggregate number of shares of common stock reserved for
options under the 1995 Plan shall be increased by the same percentage
that the total number of issued and outstanding shares of common stock
increased from the preceding January 1 to the following December 31 (if
such percentage is positive). On January 1, 1996 and 1997, pursuant to
this provision, the Company added 136,000 and 575, respectively, to the
shares available under the 1995 Plan. All options outstanding under the
Employees' Plans and Directors' Plan are nonqualified stock options;
however, the 1995 Plan allows for the grant of incentive stock options
intended to qualify for preferential tax treatment under Section 422 of
the Internal Revenue Code of 1986. Under all of the Company's plans,
the exercise price of all options granted must equal or exceed the fair
market value of the common stock at the time of the grant. Options
granted under the Employees' Plans expire ten years from the date of
grant and for the most part are exercisable one-fourth each year over a
four-year period of continuous service. Options under the Directors'
Plan expire six years from the date of grant and for the most part are
exercisable one-fourth each year over a four-year period of continuous
service. Certain options under both the Employees' Plans and Directors'
Plan, however, have a special two-year vesting schedule.
<PAGE> 46
- 9 -
QUEST MEDICAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
At December 31, 1997, under all of the Company's stock option plans,
833,272 shares have been granted and are outstanding, 1,388,714 shares
of common stock have been issued upon exercise, and 100,901 shares were
reserved for future grants.
Data with respect to stock option plans of the Company are as follows:
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------------------------------
Options Outstanding Exercisable Options
- ------------------------------------------------------------------------ --------------------------------------
Weighted Average
Weighted Average Exercise Price
Shares Exercise Price Shares
- ---------------------------- ----------------- ------------------------- -------------- -----------------------
<S> <C> <C> <C> <C>
January 1, 1995 1,088,003 $ 3.25 488,590 $ 2.50
Granted 239,520 $ 8.11
Exercised (160,422) $ 2.30
Rescinded (40,540) $ 4.11
- ---------------------------- ----------------- ------------------------- -------------- -----------------------
January 1, 1996 1,126,561 $ 4.33 622,226 $ 2.84
Granted 323,000 $ 8.12
Exercised (159,178) $ 3.06
Rescinded (115,195) $ 8.36
- ---------------------------- ----------------- -------------------------
-------------- -----------------------
January 1, 1997 1,175,188 $ 5.16 663,459 $ 3.51
Granted 66,500 $ 6.16
Exercised (296,999) $ 3.35
Rescinded (111,417) $ 6.36
-------------- -----------------------
- ---------------------------- ----------------- -------------------------
December 31, 1997 833,272 $ 5.68 568,285 $ 4.66
- ---------------------------- ----------------- ------------------------- -------------- -----------------------
</TABLE>
<TABLE>
<CAPTION>
---------------------------------------------------------------------------------------------------------------
Options Outstanding At Exercisable Options At December
December 31, 1997 31, 1997
------------------------------------------------------------------------- -----------------------------------
Weighted Average Weighted Weighted Average
Remaining Life Average Exercise
Range of (Years) Exercise Price
Exercise Price Shares Price Shares
- ------------------------------------------------------------------------ --------------------------------
<S> <C> <C> <C> <C> <C>
$1.45--2.25 87,348 1.41 $ 1.90 87,348 $ 1.90
$2.25--3.50 65,593 1.64 $ 3.19 65,593 $ 3.19
$3.50--5.25 267,181 1.99 $ 4.01 263,319 $ 4.01
$5.25--8.00 270,150 6.13 $ 6.44 98,150 $ 6.44
$8.00--12.25 143,000 7.53 $ 10.79 53,875 $ 10.92
- -------------------------------------------------------------------------- --------------------------------
833,272 4.19 $ 5.68 568,285 $ 4.66
- ------------------------------------------------------------------------------------------------------------
</TABLE>
Exercisable options at December 31 included options for 306,297 shares
with a weighted average exercise price of $4.22 per share, which are
held by employees who terminated employment with the Company on January
30, 1998 in connection with the sale of the CVS Operations (see Note 11
- "Sale of CVS Operations/Discontinued Operations"). The Company
accelerated the vesting of the unvested portion of these terminated
employee options as a result of the sale. The Company also extended the
normal 90-day exercise period subsequent to termination to one year for
these options.
In accordance with APB No. 25, the Company has not recorded
compensation expense for its stock option awards. As required by SFAS
No. 123, the Company provides the following disclosure
<PAGE> 47
- 10 -
QUEST MEDICAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
of hypothetical values for these awards. The weighted-average fair
value of an option granted in 1997, 1996 and 1995 was $2.37, $3.09 and
$3.01, respectively. For purposes of fair market value disclosures, the
fair market value of an option grant was estimated using the
Black-Scholes option pricing model with the following assumptions:
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Risk-free interest rate 6.1% 6.0% 6.2%
Average life of options (years) 3.0 3.0 3.0
Volatility 48.0% 48.4% 43.4%
Dividend Yield -- -- --
</TABLE>
Had the compensation expense been recorded based on these hypothetical
values, pro forma net earnings (loss) for 1997, 1996 and 1995 would
have been $519,731, $(541,855) and $(10,466,956), respectively, and pro
forma diluted net earnings (loss) per common share for 1997, 1996 and
1995 would have been $.06, $(.06) and $(1.67), respectively. Because
option grants prior to 1995 are not considered in the pro forma
amounts, as permitted by SFAS No. 123, the pro forma effects on net
earnings (loss) are not likely to be representative of the effects on
reported amounts in future years.
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. Diluted net loss
per share would have been ($1.28) if this transaction had occurred on
March 31, 1995, the date at which the debt incurred in connection with
the Neuromed acquisition was first outstanding.
(8) COMMITMENTS AND CONTINGENCIES
The Company has no material commitments under non cancelable operating
leases. Total rent expense under operating leases included in
continuing operations for the years ended December 31, 1997, 1996 and
1995 was $8,617, $32,493 and $113,815, respectively.
The Company is a party to product liability claims related to ANS
neurostimulation devices. Product liability insurers have assumed
responsibility for defending the Company against these claims. While
historically product liability claims for ANS neurostimulation devices
have not resulted in significant monetary liability for the Company
beyond its insurance coverage, there can be no assurances that the
Company will not incur significant monetary liability to the claimants
if such insurance is inadequate or that the Company's neurostimulation
business and future ANS 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
<PAGE> 48
- 11 -
QUEST MEDICAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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.
Net sales of implantable neurostimulation systems to a major customer
for each of the three years ended December 31, as a percentage of net
revenues from continuing operations, were as follows: 1997 - 25
percent, 1996 - 22 percent and 1995 - 26 percent. Foreign sales,
primarily Europe and Australia, for the years ended December 31, 1997,
1996 and 1995 were approximately 8 percent, 15 percent and 16 percent
of net revenues from continuing operations, respectively.
(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 percent of
their compensation and requires the Company to make matching
contributions equal to 50 percent of the participants' contributions to
a maximum of 6 percent of the participants' compensation. The Board of
Directors may change the percentage of matching contribution at their
discretion. The expense of the Company's contribution for continuing
operations was $72,635 in 1997, $81,885 in 1996 and $66,968 in 1995.
(11) SALE OF CVS OPERATIONS/DISCONTINUED OPERATIONS
On January 30, 1998, the Company sold its cardiovascular and
intravenous fluid product lines, including its Myocardial Protection
System product line, to Atrion Corporation. The Company received
approximately $24 million from the sale and utilized $8.0 million of
the proceeds to retire debt. The remaining proceeds will be used for
working capital for the expanding ANS business. Management expects to
report a pretax gain from the sale of approximately $8.3 to $8.5
million. This gain is net of $1,004,654 of compensation expense
recorded as a result of changes made to the options held by employees
of the CVS Operations (see Note 7 - "Stockholders' Equity"). The
Company also expects operating losses for the CVS Operations of
approximately $250,000 in January 1998 prior to the sale.
Operating results of the CVS Operations have been reclassified and
reported as discontinued operations. Summary operating results for the
years ended December 31, 1997, 1996 and 1995 for the CVS Operations
were as follows:
<TABLE>
<CAPTION>
1997 1996 1995
----------------- ----------------- -----------------
<S> <C> <C> <C>
Revenue $ 14,306,127 $ 14,670,664 $ 14,886,606
Gross profit 6,500,654 6,980,659 7,014,499
Earnings (loss) from operations 333,200 (415,115) (1,360,581)
Interest expense (442,599) (348,523) (594,451)
----------------- ----------------- -----------------
Loss before income tax benefit (109,399) (763,638) (1,955,032)
Income tax benefit (15,909) (236,967) (756,366)
----------------- ----------------- -----------------
Net loss $ (93,490) $ (526,671) $ (1,198,666)
================= ================= =================
</TABLE>
<PAGE> 49
- 12 -
QUEST MEDICAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The above operating results of the CVS Operations reflect the revenues
and expenses of the CVS Operations including direct and indirect
expenses of the Operations that are paid by the Company and charged
directly to the CVS Operations. Allocation of the general overhead from
the Company includes charges for regulatory, general corporate
management, accounting and payroll services, human resources,
management information systems and facilities expenses based on
revenues of the CVS Operations to total revenues of the Company.
Management believes that the expenses charged to the CVS Operations on
this basis are not materially different from the costs that would have
been incurred had the CVS Operations borne such expenses on a direct
basis.
Interest expense on the Company's corporate facility has been allocated
to the CVS Operations based on space utilization. Interest expense on
the Company's general credit facilities was allocated to the CVS
Operations based on the ratio of the net assets of the CVS Operations
to the total net assets of the Company.
Assets and liabilities of discontinued CVS Operations for the years
ended December 31, 1997 and 1996 were as follows:
<TABLE>
<CAPTION>
1997 1996
------------------ ------------------
<S> <C> <C>
Current assets:
Accounts receivable $ 2,481,278 $ 2,587,988
Inventories 5,208,676 5,354,397
Prepaid expenses 131,735 218,680
------------------ ------------------
7,821,689 8,161,065
------------------ ------------------
Noncurrent assets:
Net property, plant and equipment 3,633,855 3,879,076
Net intangible assets consisting of patents,
purchased technology and costs in
excess of net assets acquired 2,043,107 2,325,925
Other assets 8,631 8,631
------------------ ------------------
5,685,593 6,213,632
------------------ ------------------
Total assets 13,507,282 14,374,697
------------------ ------------------
Current liabilities:
Accounts payable 410,483 1,515,316
Accrued liabilities 265,481 289,206
------------------ ------------------
675,964 1,804,522
------------------ ------------------
Net assets of CVS Operations $ 12,831,318 $ 12,570,175
================== ==================
</TABLE>
<PAGE> 50
APPENDIX B
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
FORMING A PART OF THE ANNUAL REPORT
FORM 10-K
ITEM 14
OF
QUEST MEDICAL, INC. AND SUBSIDIARIES
(NAME OF ISSUER)
FILED WITH THE
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
UNDER
THE SECURITIES AND EXCHANGE ACT OF 1934
<PAGE> 51
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
QUEST MEDICAL, INC. AND SUBSIDIARIES
DECEMBER 31, 1997
<TABLE>
<CAPTION>
Balance at Charged to Balance at
Beginning of Charged to Other End of
Description Period Expenses Accounts Deductions Period
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Year ended December 31, 1997:
Continuing Operations:
----------------------
Allowance for doubtful accounts $ 160,000 $ 64,453 $ -- $ 12,078 $ 212,375
Reserve for obsolete inventory -- 534,619 -- 478,614 56,005
---------------------------------------------------------------------------------
Total $ 160,000 $ 599,072 $ -- $ 490,692 $ 268,380
=================================================================================
Discontinued Operations:
------------------------
Allowance for doubtful accounts $ 14,337 $ 54,098 $ -- $ 37,825 $ 30,610
Reserve for obsolete inventory 230,472 151,168 -- 227,293 154,347
---------------------------------------------------------------------------------
Total $ 244,809 $ 205,266 $ -- $ 265,118 $ 184,957
=================================================================================
Year ended December 31, 1996:
Continuing Operations:
----------------------
Allowance for doubtful accounts $ 100,000 $ 60,000 $ -- $ -- $ 160,000
Reserve for obsolete inventory -- -- -- -- --
---------------------------------------------------------------------------------
Total $ 100,000 $ 60,000 $ -- $ -- $ 160,000
=================================================================================
Discontinued Operations:
------------------------
Allowance for doubtful accounts $ 14,337 $ -- $ -- $ -- $ 14,337
Reserve for obsolete inventory 238,679 12,100 -- 20,307 230,472
---------------------------------------------------------------------------------
Total $ 253,016 $ 12,100 $ -- $ 20,307 $ 244,809
=================================================================================
Year ended December 31, 1995:
Continuing Operations:
----------------------
Allowance for doubtful accounts $ -- $ -- $100,000(1) $ -- $ 100,000
Reserve for obsolete inventory -- -- -- -- --
---------------------------------------------------------------------------------
Total $ -- $ -- $ 100,000 $ -- $ 100,000
=================================================================================
Discontinued Operations:
------------------------
Allowance for doubtful accounts $ 14,337 $ -- $ -- $ -- $ 14,337
Reserve for obsolete inventory -- 238,679 -- -- 238,679
---------------------------------------------------------------------------------
Total $ 14,337 $ 238,679 $ -- $ -- $ 253,016
=================================================================================
</TABLE>
(1) Addition to reserve is result of purchase of Neuromed, Inc.
<PAGE> 52
APPENDIX C
QUARTERLY FINANCIAL DATA
(UNAUDITED)
FORMING A PART OF THE ANNUAL REPORT
FORM 10-K
ITEM 8
OF
QUEST MEDICAL, INC. AND SUBSIDIARIES
(NAME OF ISSUER)
FILED WITH THE
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
UNDER
THE SECURITIES AND EXCHANGE ACT OF 1934
<PAGE> 53
<TABLE>
<CAPTION>
1997 1st 2nd 3rd 4th
- -------------------------------------------- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Net revenue $ 3,135,581 $ 3,465,753 $ 4,220,002 $ 3,896,385
Gross profit 2,218,003 1,805,158 3,065,411 2,789,888
Earnings (loss) from operations 361,973 (149,343) 1,125,084 748,594
Earnings (loss) from continuing
operations before income taxes 202,041 (269,154) 1,007,426 610,212
Net earnings (loss) from continuing
operations 137,891 (222,013) 649,100 252,533
Earnings (loss) from discontinued
operations (43,525) 187,265 (199,738) (37,492)
- -------------------------------------------- ----------- ----------- ----------- -----------
Net earnings (loss) $ 94,366 $ (34,748) $ 449,362 $ 215,041
- -------------------------------------------- ----------- ----------- ----------- -----------
Basic earnings (loss) per share:
Continuing operations $ 0.02 $ (0.03) $ 0.08 $ 0.03
Discontinued operations (0.01) 0.03 (0.03) --
- -------------------------------------------- ----------- ----------- ----------- -----------
Net earnings (loss) $ 0.01 $ -- $ 0.05 $ 0.03
- -------------------------------------------- ----------- ----------- ----------- -----------
Diluted earnings (loss) per share:
Continuing operations $ 0.02 $ (0.03) $ 0.07 $ 0.03
Discontinued operations (0.01) 0.03 (0.02) (0.01)
- -------------------------------------------- ----------- ----------- ----------- -----------
Net earnings (loss) $ 0.01 $ -- $ 0.05 $ 0.02
- -------------------------------------------- ----------- ----------- ----------- -----------
<CAPTION>
1996 1st 2nd 3rd 4th
- -------------------------------------------- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Net revenue $ 2,444,685 $ 3,005,846 $ 2,894,539 $ 3,058,074
Gross profit 1,743,195 2,253,821 2,031,026 2,059,847
Earnings (loss) from operations 102,720 378,523 166,396 (132,334)
Earnings (loss) from continuing
operations before income taxes 84,489 371,586 166,986 (188,705)
Net earnings (loss) from continuing
operations 16,270 285,994 97,388 (285,138)
Earnings (loss) from discontinued
operations (110,842) (171,671) (90,640) (153,518)
- -------------------------------------------- ----------- ----------- ----------- -----------
Net earnings (loss) $ (94,572) $ 114,323 $ 6,748 $ (438,656)
- -------------------------------------------- ----------- ----------- ----------- -----------
Basic and diluted earnings (loss) per share:
Continuing operations $ -- $ 0.03 $ 0.01 $ (0.03)
Discontinued operations (0.01) (0.02) (0.01) (0.02)
- -------------------------------------------- ----------- ----------- -----------------------------
Net earnings (loss) $ (0.01) $ 0.01 $ -- $ (0.05)
- -------------------------------------------- ----------- ----------- ----------- -----------
</TABLE>
<PAGE> 54
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<S> <C>
2.1 Agreement for the Purchase and Sale of All of the Issued Capital Stock of Neuromed, Inc. dated February 10, 1995,
between Quest Medical, Inc. and William N. Borkan(5)
2.2 Amendment Agreement dated March 17, 1995, between Quest Medical, Inc. and William N. Borkan(5)
2.3 Letter Agreement dated as of September 23, 1995, by and between Quest Medical, Inc. and William N. Borkan(6)
2.4 Asset Purchase Agreement, dated December 29, 1997, by and among Quest Medical, Inc., QMI Medical, Inc. (formerly
known as QMI Acquisition Corp.) and Atrion Corporation (including exhibits and schedules 2.1.1, 2.1.2, 2.3(a) and
2.3.(b))(9)
3.1 Articles of Incorporation, as amended(6)
3.2 Bylaws(1)
4.1 Rights Agreement dated as of August 30, 1996, between Quest Medical, Inc. and KeyCorp Shareholder Services, Inc. as
Rights Agent(7)
10.1 Quest Medical, Inc. 1979 Amended and Restated Employees Stock Option Plan(2)
10.2 Form of 1979 Employees Stock Option Agreement(3)
10.3 Quest Medical, Inc. Directors Stock Option Plan (as amended)(2)
10.4 Form of Directors Stock Option Agreement(1)
10.5 Quest Medical, Inc. 1987 Stock Option Plan(6)
10.6 Form of 1987 Employee Stock Option Agreement(6)
10.7 Quest Medical, Inc. 1995 Stock Option Plan(6)
10.8 Form of 1995 Employee Stock Option Agreement(6)
10.9 Form of Employment Agreement and Covenant Not to Compete, between the Company and key employees(1)
10.10 Promissory Note dated December 28,1993, between Quest Medical, Inc. and MetLife Capital Financial Corporation(4)
10.11 Commercial Deed of Trust, Security Agreement and Assignment of Leases and Rents and Fixture Filing dated December
28,1993, between Quest Medical, Inc. and MetLife Capital Financial Corporation(4)
10.12 Term Promissory Note dated December 28,1993, between Quest Medical, Inc. and MetLife Capital Corporation(4)
10.13 Loan and Security Agreement dated December 28,1993, between Quest Medical, Inc. and MetLife Capital Corporation(4)
10.14 Supplemental Security Agreement Number One dated December 28,1993, between Quest Medical, Inc. and MetLife Capital
Corporation(4)
10.15 Third Amended and Restated Credit Agreement dated as of March 3, 1997, between Quest Medical, Inc. and NationsBank of
Texas, N.A.(8)
10.16 Promissory Note (Facility A. Note) in the original principal amount of $5,650,000 dated March 3, 1997(8)
10.17 Promissory Note (Facility B. Note) in the original principal amount of $350,000 dated March 3, 1997(8)
10.18 First Amended and Restated Security Agreement dated March 3, 1997, between Quest Medical, Inc. and NationsBank of
Texas, N.A.(8)
10.19 First Amended and Restated Security Agreement dated March 3, 1997, between Advanced Neuromodulation Systems, Inc. and
NationsBank of Texas, N.A.(8)
10.20 First Amended and Restated Intellectual Property Security Agreement and Assignment dated as of March 3, 1997, between
Quest Medical, Inc. and NationsBank of Texas N.A.(8)
</TABLE>
<PAGE> 55
<TABLE>
<S> <C>
10.21 First Amended and Restated Intellectual Property Security Agreement and Assignment dated as of March 3, 1997, between
Advanced Neuromodulation Systems, Inc. and NationsBank of Texas, N.A.(8)
10.22 First Amended and Restated License Agreement dated as of March 3, 1997, between Quest Medical, Inc. and NationsBank
of Texas, N.A.(8)
10.23 First Amended and Restated License Agreement dated as of March 3, 1997, between Advanced Neuromodulation Systems,
Inc. and NationsBank of Texas, N.A.(8)
10.24 Guaranty of Advanced Neuromodulation Systems, Inc. in favor of NationsBank of Texas, N.A. under the Third Amended and
Restated Credit Agreement dated as of March 3, 1997(8)
10.25 Form of License Agreement, dated January 30, 1998, by and between Quest Medical, Inc. and QMI Medical, Inc. (formerly
known as QMI Acquisition Corp.)(9)
10.26 Form of Lease Agreement, dated January 30, 1998, by and between Quest Medical, Inc. and QMI Medical, Inc. (formerly
known as QMI Acquisition Corp.)(9)
10.27 Form of Option Agreement, dated January 30, 1998, by and between Quest Medical, Inc. and QMI Medical, Inc. (formerly
known as QMI Acquisition Corp.)(9)
10.28 Agreement, dated December 31, 1997, by and among Quest Medical, Inc., its subsidiaries and affiliates and Thomas C.
Thompson(10)
11.1 Computation of Earnings Per Share(10)
21.1 Subsidiaries(10)
23.1 Consent of Independent Auditors(10)
27.1 Financial Data Schedule - December 31, 1997(10)
27.2 Restated Financial Data Schedule - December 31, 1996(10)
27.3 Restated Financial Data Schedule - December 31, 1995(10)
</TABLE>
- --------------------------------------
(1) Filed as an Exhibit to the Company's Registration Statement on Form S-18,
Registration No. 2-71198-FW, and incorporated herein by reference.
(2) Filed as an Exhibit to the report of the Company on Form 10-K for the year
ended December 31, 1987, and incorporated herein by reference.
(3) Filed as an Exhibit to the Company's Registration Statement on Form S-1,
Registration No. 2-78186, and incorporated herein by reference.
(4) Filed as an Exhibit to the report of the Company on Form 10-KSB for the
year ended December 31, 1993, and incorporated herein by reference.
(5) Filed as an Exhibit to the report of the Company on Form 10-KSB for the
year ended December 31, 1994, and incorporated herein by reference.
(6) Filed as an Exhibit to the Company's Registration Statement on Form SB-2,
Registration No. 33-62991, and incorporated herein by reference.
(7) Filed as an Exhibit to the report of the Company on Form 8-K dated
September 3, 1996, and incorporated herein by reference.
(8) Filed as an Exhibit to the report of the Company on Form 10-K dated for the
year ended December 31, 1996, and incorporated herein by reference.
(9) Filed as an Exhibit to the report of the Company on Form 8-K dated February
13, 1998, and incorporated herein by reference. Upon request, the Company
will furnish a copy of any omitted schedule to the Commission.
(10) Filed herewith.
<PAGE> 1
EXHIBIT 10.28
AGREEMENT
This Agreement (this "Agreement") is made and entered into as of December 31,
1997 by and among Quest Medical, Inc., a Texas corporation, its subsidiaries and
affiliates (other than Thomas C. Thompson) (collectively, the "Company"), and
Thomas C. Thompson, a resident of the State of Texas ("Employee").
RECITALS
Employee is presently employed by the Company and serves as an officer and
director. The continuation of the employment, officer and director relationships
is no longer desired by Employee, on the one hand, or the Company, on the other
hand.
Employee and the Company mutually wish to fully and finally resolve any
potential existing or potential disputes arising out of the employment
relationship among Employee and the Company.
The Company desires to retain Employee as a Consultant for a two-year period.
Employee agrees and acknowledges that the Company has special expertise in its
businesses that has enabled it to provide unique career opportunities for its
employees, and its growth depends, to a significant degree, on its possession of
certain information that may not be available to its competitors concerning a
number of matters, including but not limited to, medical device manufacturing,
engineering, regulatory affairs, clinical testing and studies of healthcare
products, the marketing of these products, management processes and other
information not generally known to others in its industry. To obtain such
information and use it successfully, the Company has made significant
investments in research, business development, quality assurance, customer
satisfaction methods and techniques, manufacturing and business process
improvements and other developments in marketing methods and providing services
to their customers.
Employee agrees and acknowledges that a covenant not to compete and a
restriction on disclosure of confidential information is essential to the
continued growth and stability of the Company's businesses and to the continuing
viability of such businesses as expressly permitted under the terms and
limitations of this Agreement.
NOW, THEREFORE, in consideration of the mutual acts, payments and promises
described and agreed to be performed herein, Employee and the Company agree as
follows:
1. Resignation. Employee hereby tenders his resignation from all positions
that he holds with the Company and its subsidiaries and affiliates, including
without limitation his position as Chairman of the Board, which will be
effective on December 31, 1997 (such date being referred to as the "Resignation
Date"). The Company accepts Employee's resignations.
2. Severance from Employment. It is understood and agreed that with the
full and complete agreement of Employee and the Company, Employee's employment
by the Company will cease as of the Resignation Date. Except as otherwise
expressly provided for herein, as of the Resignation Date, Employee shall cease
to accrue any rights under any pension or compensation plan of the Company
(including without limitation any stock option plan, grant or agreement).
<PAGE> 2
3. Payment of Wages and Earned Benefits. Employee acknowledges the receipt
of all wages and sick pay to which Employee is entitled as of the Resignation
Date, and further acknowledges that he has been fully paid for all hours worked
with the exception of vacation accrued and outstanding expense reimbursements
and other payments set forth below. Until the Resignation Date, Employee will
continue to be paid at his annualized salary level of $183,980.00, payable in
accordance with the Company's standard payroll practices (but not less than two
times each month), and will be entitled to medical and dental benefits
(including coverage for Employee's spouse) on the same terms and conditions as
provided to Employee immediately prior to the Resignation Date. Employee will be
paid for 15 days' vacation which he has accrued but not taken during his
employment with the Company. Such accrued vacation shall be paid to Employee in
January, 1998. Any outstanding reimbursable expenses will be paid to Employee
upon submission and approval of those expenses in accordance with the Company's
customary practices.
4. Consulting and Other Payments to Employee.
(a) In consideration of this Agreement (including, without limitation, the
services provided pursuant to Section 5 and the covenants and agreements made in
Sections 6, 7 and 8), the Company agrees to pay Employee the sum of $191,056.20
per year, payable in equal monthly installments on the first of each month, at
the address specified in Section 16 of this Agreement until the second
anniversary of the Resignation Date. In addition, the Company shall pay to
Employee the 1997 Company performance bonus, if any, in accordance with the
Executive Bonus Plan currently in effect and consistent with bonuses paid to
other executives. Such bonuses shall be less applicable withholding for social
security, Medicare, and income taxes, however, all cash consideration paid to
Employee after the Resignation Date shall be made without any withholdings or
deductions, including without limitation, deductions or withholdings for social
security, Medicare or income taxes, unless otherwise required to do so by law.
(b) In the event the Company's cardiovascular, myocardial protection and
pressuring business segment (the "CVS Business") is sold to Atrion Corporation
pursuant to a purchase agreement acceptable to the Company (the "Purchase
Agreement") and such sale closes by June 30, 1998, the Company agrees to pay to
Employee a commission of $100,000.00. Provided, however, as a condition to the
payment of such commission, Employee agrees to execute a covenant not to compete
with Atrion Corporation in the CVS Business for a period of four (4) years as
part of the Purchase Agreement or related transaction.
(c) In the event the Purchase Agreement does not close and if Employee
plays a substantial role in the sale of the Company's "M.D. Anderson" business,
and if such sale is approved by the Company for a sale price of at least Three
Million Dollars ($3,000,000.00) and is closed on or before June 30, 1998, then
Employee shall receive a commission of Fifty Thousand Dollars ($50,000.00) on
such sale.
(d) In the event the Purchase Agreement does not close and if Employee
plays a substantial role in the sale of the Company's myocardial protection
system ("MPS") business, and if such sale is approved by Company at a price
acceptable to the Company and is closed on or before June 30, 1998, the Employee
shall receive a commission of Fifty Thousand Dollars ($50,000.00) on such sale.
(e) To the extent available under the Company's current medical and dental
plans, the Company shall provide Employee with medical and dental benefits
(including coverage for Employee's spouse) until the second anniversary of the
Resignation Date on the same terms and conditions as provided to
<PAGE> 3
Employee immediately prior to the Resignation Date. If such medical and dental
benefits are not available to Employee during such two year period, Employee
shall be entitled to COBRA continuation benefits at the Company's expense for
such two-year period. To the extent that Employee's life insurance benefits can
be included in the Company's general benefit policy, the Company shall continue
to pay the premiums for the life insurance provided to Employee under such
policy.
(f) The Employee and the Company have entered into stock option agreements
(the "Option Agreements"), pursuant to which the Employee received options to
purchase an aggregate of 141,170 shares of the Company's common stock (the
"Options"). The Company hereby extends to March 31, 1998 the period during which
the Employee and F. Robert Merrill III (the only remaining recipients) may
exercise the options granted on or about December 22, 1987. If during the time
period between the Resignation Date and March 31, 1998, Employee possesses
material confidential information which would prohibit him from trading Company
stock under the Securities and Exchange Commission's insider trading
regulations, then the Company will, upon reasonable request, extend the time
period for exercising such options for an additional three month period.
Notwithstanding anything to the contrary in the Option Agreements and any stock
option plans related thereto, all unvested Options shall immediately vest upon
the Resignation Date and no Options shall lapse or terminate as a result of this
Agreement, the transactions contemplated hereby or otherwise.
5. Consulting Agreement. Notwithstanding the foregoing, for the period
from the Resignation Date to the second anniversary of the Resignation Date,
Employee shall serve as a consultant to the Company; provided, however, Employee
shall in no case be deemed to be an employee of the Company but instead shall
serve as an independent contractor for all purposes. Employee agrees to be
available for consulting upon the request of the Company by telephone and in
person, during normal business hours, but in no event in excess of an average of
fifty (50) hours per month during any consecutive three months. In connection
with the services to be rendered by Employee to the Company as set forth in this
Section 5 (the "Services"), Employee will not, without the consent or direction
of the Company, act or attempt to act or represent himself; directly or by
implication, as an agent of the Company or in any manner assume or create, or
attempt to create, any obligation on behalf of; or in the name of the Company.
In the event that the Company requests Employee to incur any expenses in
connection with the Services, the Company agrees to pay, in accordance with the
Company's normal reimbursement policies, all reasonable expenses actually
incurred by Employee in connection with providing the Services, including
without limitation, travel, meals and lodging expenses.
Employee further agrees that following the Resignation Date, Employee will
cooperate with and assist the Company in the prosecution or defense of any
litigation, including providing truthful testimony as a witness upon reasonable
request. Any time spent in excess of fifty hours per month in such work shall be
compensated at a reasonable rate to be mutually agreed upon by the parties.
The cash and other consideration paid to Employee under Section 4 shall also
constitute sufficient consideration for the Services after the Resignation Date
pursuant to this Section 5 and the covenants and agreements in Sections 6 and 7
and in other Sections of this Agreement, and the Company shall have no other
compensation obligations to Employee with respect to the Services.
6. Non-Competition Agreement. Employee understands that during the course
of his employment by the Company, Employee has had access to and the benefit of
the information referred to in the Recitals above, and represented the Company
and its affiliates and developed contacts and relationships with other persons
and entities on behalf of such entities, including but not limited to
<PAGE> 4
customers, potential customers and other employees of such entities. To protect
such entities' interest in this information and in these contacts and
relationships and in consideration of the promises made by the Company in this
Agreement, Employee agrees and covenants that for a period beginning on the
Resignation Date and ending on the fourth anniversary of the Resignation Date,
without the prior written approval of the Company, Employee will not, in
connection with any business that is engaged in, or is about to be engaged in,
by the Company as of the date of execution of this Agreement, which is defined
as the research, development, manufacture, sale or marketing of products,
devices, instruments, methods or techniques (or any related services or
activities) substantially similar to any products, devices, instruments, methods
or techniques which the Company is engaged in the research of; development of;
manufacture, selling, or marketing, or has under active consideration to do the
same as to which the Employee has actual knowledge (the "Business"), directly or
indirectly, either as an individual or as an employee, partner, officer,
director, shareholder, advisor, or consultant or in any other capacity
whatsoever, of any person (other than providing the services to the Company
pursuant to Section 5 and the ownership of less than 5% of the issued and
outstanding securities of an entity): (a) recruit, hire, assist others in
recruiting or hiring, discuss employment with, or refer to others for employment
any person who is, or within the three month period immediately preceding the
date of any such activity was, an employee of the Company or its affiliates; or
(b) conduct or assist others in conducting any business or activity that
competes with the Business in the United States, its territories or possessions,
Europe, Australia or the Pacific Rim. Provided, however, that in the event the
Company sells any segment of its business to some purchaser, the foregoing shall
not preclude Employee from being involved in the segment sold as an employee or
consultant of such purchaser, except that Employee will still be bound by
subparagraph (a) above.
Employee understands and agrees that the scope of the foregoing covenant is
reasonable as to time, area and persons and is necessary to protect the
legitimate business interests of the Company and its affiliates. Employee
further agrees that such covenant will be regarded as divisible and will be
operative as to time, area and persons to the extent that it may be so
operative, and if any part of such covenant is declared invalid, unenforceable,
or void as to time, area or persons, the validity and enforceability of the
remainder will not be affected.
If Employee violates the restrictive covenants of this Section 6 and the Company
brings legal action for injunctive or other relief; the Company shall not be
deprived of the benefit of the full period of the restrictive covenant as a
result of the time involved in obtaining the relief in the event the Company is
successful in its actions. Accordingly, Employee agrees that the regularly
scheduled expiration date of such covenant shall be extended by the same amount
of time that Employee is determined to have violated such covenant.
7. Confidentiality. Employee acknowledges that he has learned and will
learn Confidential Information (as defined below) relating to the Business. In
consideration of the promises made in this Agreement by the Company, Employee
agrees that he will not disclose or use or authorize any third party to disclose
or use any such Confidential Information, without prior written approval of the
Company, if such disclosure or use is reasonably likely to be materially
detrimental to the Company or may give a material competitive advantage to a
competitor or potential competitor. As used in this Section 7, "Confidential
Information" shall mean information disclosed to or known to Employee as a
direct or indirect consequence of or through his employment with the Company,
about the Business, the Company's methods, business plans, operations, products,
processes and services, including, but not limited to, information relating to
research, development, inventions, recommendations, programs, systems, and
systems analyses, flow charts, finances, and financial statements, marketing
plans and
<PAGE> 5
strategies, merchandising, pricing strategies, merchandise sources, client
sources, system designs, procedure manuals, automated data programs, financing
methods, financial projections, terms and conditions of arrangements of any
business, computer software, terms and conditions of business arrangements with
clients or suppliers, reports, personnel procedures, supply and services
resources, names and addresses of clients, the Company's contacts, names of
professional advisors, and all other information pertaining to clients and
suppliers of the Business, including, but not limited to assets, business
interests, personal data and all other information pertaining to the Business,
clients or suppliers whatsoever, including all accompanying documentation
therefor. All information disclosed to Employee, or to which Employee had access
or will have access during the period of his employment with or consulting for
the Company, for which there is any reasonable basis to be believed is, or which
appears to be treated by the Company as Confidential Information, shall be
presumed to be Confidential Information hereunder. Confidential Information
shall not, however, include information that (a) is publicly known or becomes
publicly known through no fault of Employee, or (b) is generally or readily
obtainable by the public, or (c) constitutes general skills, knowledge and
experience acquired by Employee during his employment with the Company and this
provision shall terminate with respect to a particular portion of the
Confidential Information when (i) (a) it enters the public domain through no
fault of the Employee, (b) it is in the Employee's possession free of any
confidentiality obligation, or (c) it was developed independently of and without
reference to any Confidential Information or other information disclosed in
confidence to any third party; or (ii) when it is communicated to a third party
free of any confidentiality obligation, or (iii) in any event, three years after
communication.
Employee agrees that all documents of any nature pertaining to activities of the
Company or its affiliates, or that include any Confidential Information, in his
possession now or at any time during the term of his employment with or
consulting for the Company, including without limitation, memoranda, notebooks,
notes, data sheets, records and computer programs, are and shall be the property
of such entity. All copies of such Confidential Information in Employee's
possession shall be surrendered to the appropriate entity within thirty days of
the Resignation Date and upon termination of his consulting services to the
Company, as applicable.
8. Inventions Developments. Employee represents and warrants that he has
notified and will notify the Company of all discoveries, inventions,
innovations, or improvements which are related to the Business (collectively
called "Developments") conceived or developed by Employee during the term of
Employee's employment with or consulting for the Company. Developments shall
include, without limitation, the Quest MPS(R) myocardial protection system and
related disposables, ANS's electronic spinal cord stimulation devices and any or
all other intellectual properties related to the Company's business. All
Developments, including but not limited to all written documents pertaining
thereto, shall be the exclusive property of the Company, as the case may be, and
shall be considered Confidential Information subject to the terms of this
Agreement. Employee agrees that within seven days of any request from the
Company, he shall execute all requested assignments and conveyances necessary to
vest in the Company all discoveries, inventions, innovations, patents, marks,
copyrights, patent applications and any other intellectual property of whatever
kind and character, any right, title or interest that he may hold in such
property. Employee agrees that when appropriate, and upon written request of the
Company, as the case may be, the Employee will acknowledge that Developments are
"works for hire" and will file at the Company's expense for tradenames,
trademarks, patents or copyrights with regard to any or all Developments and
will sign documentation reasonably necessary to evidence ownership of
Developments in the Company, as the case may be. Employee further agrees to
cooperate fully, and at the expense of the Company, with the Company in
connection with the filing, prosecution or obtaining of any patent, copyright,
or trademark registration or application in any
<PAGE> 6
country, existing as of the date of this Agreement. Employee further agrees to
cooperate with and assist the Company at the expense of the Company in the
prosecution or defense of any litigation involving any intellectual property
claimed by the Company, including providing truthful testimony as a witness upon
reasonable request.
9. Complete Releases. In consideration of the promises made in this
Agreement, Employee RELEASES, ACQUITS, and FOREVER DISCHARGES the Company and
each of its past and present parents, subsidiaries, affiliates, shareholders,
directors, officers, attorneys, accountants, agents, employees and
representatives, from ANY and ALL causes of action, claims, damages, including
attorney's fees, Employee may have against the Company which could have arisen
out of Employee's employment or separation from employment with the Company or
his service as an officer or director of the Company or any other matter related
to his association with the Company, whether known or unknown, existing as of
the date of this Agreement. Employee hereby irrevocably, unconditionally and
fully releases, acquits and forever discharges the Company, and its respective
officers, directors, partners, shareholders, employees, attorneys, and agents,
past and present, from any and all charges, complaints, claims, liabilities,
obligations, costs, losses, debts, and expenses (including attorney's fees and
costs actually incurred), of any nature whatsoever (excluding any felonious
acts) known or unknown, suspected or unsuspected, including without limitation
any rights arising out of alleged violations of any contract, express or
implied, written or verbal, any covenant of good faith and fair dealing, express
or implied, any tort, any legal restrictions on the right of the Company to
terminate, discipline, or otherwise manage employees or any federal, state or
other governmental statute, regulation, or ordinance. Notwithstanding the
foregoing, nothing herein shall constitute a release of the Company from causes
of action, claims or damages, including attorney's fees, that may arise from
acts or omissions by the Company after the Resignation Date.
These releases and waivers include, but are not limited to, Title VII of the
Civil Rights Act of 1954, the Civil Rights Act of 1991, The Age Discrimination
in Employment Act, the Employee Retirement Income Security Act of 1974, the
Americans with Disabilities Act, the Rehabilitation Act of 1973, the Equal Pay
Act, the False Claims Act, the Civil Rights Act of 1966, the Fair Labor
Standards Act, the Occupational Safety and Health Act, the Family and Medical
Leave Act, the Texas Commission on Human Rights Act, the Texas Payday Law, the
Texas Workers' Compensation Act, any causes of action or claims arising under
analogous state laws or local ordinances or regulations, any common law
principle or public policy, including all suits in tort or contract, or under
the Company's personnel policies or any contract of employment that may exist
between Employee and the Company.
Employee knowingly and voluntarily waives any existing rights he may have
pursuant to the Age Discrimination in Employment Act of 1967 and the Older
Workers Benefit Protection Act. Further, Employee acknowledges the receipt of
good and valuable consideration set forth in this Agreement in exchange for this
waiver of potential claims.
In consideration of the promises made in this Agreement, the Company RELEASES,
ACQUITS, and FOREVER DISCHARGES Employee from ANY and ALL causes of action,
claims and damages, including attorney's fees, the Company may have against
Employee which could have arisen out of Employee's employment or separation from
employment with the Company or his service as an officer or director of the
Company or any other matter related to his association with the Company, whether
known or unknown. The Company hereby irrevocably, unconditionally and fully
releases, acquits and forever discharges Employee from any and all charges,
complaints, claims, liabilities, obligations, costs, losses, debts and expenses
(including attorney's fees and costs actually incurred), of any nature
<PAGE> 7
whatsoever (excluding any felonious acts) known or unknown, suspected or
unsuspected, including without limitation any rights arising out of alleged
violations of any contract, express or implied, written or verbal, any covenant
of good faith and fair dealing, express or implied, or any tort, or any federal,
state or other governmental statute, regulation, or ordinance. Notwithstanding
the foregoing, nothing herein shall constitute a release of Employee from causes
of action, claims, or damages, including attorney's fees, that may arise after
the Resignation Date relating to Employee's service as a consultant to the
Company pursuant to Section 5.
It is expressly agreed and understood by Employee and the Company that this
Agreement is a general release.
The Company shall indemnify and hold harmless the Employee in respect of acts or
omissions as a director, officer, employee or consultant occurring up to and
including the Resignation Date to the same extent and with the same limitations
as if he was an officer of the Company to the fullest extent permitted by the
Texas Business Corporation Act, as amended, and the Company's articles of
incorporation and bylaws in effect on the date of this Agreement, and will
indemnify and hold harmless the Employee in respect of any claims, liabilities,
obligations or expenses in respect of or relating to this Agreement and the
transactions contemplated hereby.
10. Promise Not to Sue. Employee represents that Employee has not
heretofore filed any charges or complaints against the Company with any federal,
state or local governmental agencies. Employee further agrees that Employee will
not file any charges or complaints against the Company based on Employee's
employment with the Company or the severance therefrom.
In consideration of the promises made by the Company in this Agreement, Employee
promises and agrees never to voluntarily join in, or commence any action, or
proceeding on behalf of himself; or any other person, or entity before any
court, administrative agency, or other forum against the Company, pertaining in
any way to or arising out of his employment or association with the Company, his
resignation or employment, or any other event that occurs on or before the
Resignation Date, except as may be necessary to enforce: (a) this Agreement; (b)
Employee's rights under state worker's compensation laws (for occupational
illness or injury only) or unemployment compensation laws; or (c) Employee's
rights under the Company's medical or dental benefit plans.
Further, Employee agrees to withdraw with prejudice any previously filed charges
or suits arising out of his employment or association with or resignation and
termination from the Company. Employee further agrees not to actively or
materially encourage or aid any person in contemplating, filing, or prosecuting
any action or proceeding against the Company in any way related to matters that
occur during the course of Employee's employment or association with the Company
prior to the Resignation Date, except to the extent the Employee is required to
do so by Court, regulatory agency or similar order.
The Company represents that it has not heretofore filed any charges or
complaints against Employee with any federal, state or local governmental
agencies. The Company further agrees that it will not file any charges or
complaints against Employee based on Employee's employment with the Company or
the severance therefrom.
<PAGE> 8
In consideration of the promises made by Employee in this Agreement, the Company
promises and agrees never to voluntarily join in, or commence any action, or
proceeding on behalf of itself; or any other person, or entity before any court,
administrative agency, or other forum against Employee, pertaining in any way to
or arising out of Employee's employment or association with the Company, his
resignation or employment, or any other event that occurs on or before the
Resignation Date, except as may be necessary to enforce this Agreement.
Further, the Company agrees to withdraw with prejudice any previously filed
charges or suits arising out of Employee's employment or association with or
resignation and termination from the Company. The Company further agrees not to
actively or materially encourage or aid any person in contemplating, filing, or
prosecuting any action or proceeding against Employee in any way related to
matters that occur during the course of Employee's employment or association
with the Company prior to the Resignation Date.
11. No Admission. Each of Employee and the Company understands and
acknowledges that by entering into this Agreement, neither of Employee or the
Company admits to any unlawful conduct or wrongdoing in connection with
Employee's employment with the Company or the termination thereof.
12. Remedies for Breach. Notwithstanding Section 1 9(b)-(e) of this
Agreement, each of the Company and Employee hereby acknowledges that a violation
or attempted violation of any of the covenants contained in Sections 6, 7 and 8
of this Agreement will cause irreparable damage to the other parties, and
accordingly each party agrees that the other parties shall be entitled as a
matter of right to an injunction, out of any court of competent jurisdiction,
restraining any violation or further violation of such agreements by the
violating party or any employees, partners or agents of the violating party;
such right to an injunction, however, shall be cumulative and in addition to
whatever other remedies the injured party may have.
13. Nature of the Agreement. This Agreement and all its provisions are
contractual, not mere recitals, and shall continue in permanent force and
effect, unless revoked as provided herein. In the event that any portion of this
Agreement is found to be unenforceable for any reason whatsoever, the
unenforceable provision shall be severed and the remainder of the Agreement
shall continue in full force and effect.
14. Reliance. The Company has advised Employee to seek the advice of legal
counsel prior to signing this Agreement. The parties hereto acknowledge, warrant
and represent that (a) they have relied solely on their own judgment and that of
their attorneys and representatives regarding the consideration for, and the
terms of this Agreement, (b) they have been given a reasonable period to
consider this Agreement, (c) they have read and understand the Agreement, (d)
they understand that it includes a general release of claims against each other,
and (e) no statements made by the other have in any way coerced or unduly
influenced the execution of this Agreement. Employee acknowledges that Hughes &
Luce, L.L.P. represents the Company in connection with the negotiation and
preparation of this Agreement and that he has been advised by Hughes & Luce and
the Company's board of directors to obtain independent legal counsel regarding
the legal, tax and other consequences of this Agreement.
Employee further acknowledges that Linton E. Barbee, acting in his capacity as a
member of the Company's board of directors and not as an attorney, is acting as
the Board's intermediary in regard to this Agreement. Employee acknowledges that
although Mr. Barbee is an attorney and a member of the
<PAGE> 9
law firm of Fulbright & Jaworski, L.L.P., neither Mr. Barbee nor Fulbright &
Jaworski are acting as the attorney for any party in this matter. Employee also
hereby waives any potential conflict of interest claims against Mr. Barbee
and/or Fulbright & Jaworski in connection with this Agreement even though Mr.
Barbee and Fulbright & Jaworski have in the past represented Employee,
individually, and the Company.
The Company acknowledges that Wood, Exall & Bonnet, L.L.P. ("Wood, Exall &
Bonnet") (i) has been retained by the Employee in connection with this Agreement
and the transactions contemplated hereby, and (ii) that the partners and/or
attorneys of Wood, Exall & Bonnet were formerly attorneys with Hughes & Luce,
L.L.P. and may have in the past represented the Company. The Company hereby
waives any potential conflicts of interest claims against Wood, Exall & Bonnet
and the partners and attorneys of Wood, Exall & Bonnet in connection with this
Agreement and otherwise, even though the partners and/or attorneys of Wood,
Exall & Bonnet may have in the past represented the Company.
Furthermore, Employee acknowledges that in accordance with the Age
Discrimination in Employment Act and the Older Workers Benefit Protection Act,
he has been given the opportunity to review this Agreement for at least
twenty-one (21) days and if Employee executes this Agreement prior to the end of
such twenty-one (21) day period, Employee knowingly and voluntarily waives any
rights he may have with respect thereto. The Company further advises Employee
that in accordance with the Age Discrimination in Employment Act and the Older
Workers Benefit Protection Act, he has seven (7) days after execution of this
Agreement to revoke this Agreement.
15. Attorneys Fees. Each party shall be responsible for his or its own
expenses, including attorney's fees incurred in connection with the negotiation,
preparation and execution of this Agreement. Provided, however, the Company
agrees to reimburse the Employee for his legal and accounting fees incurred in
connection with this Agreement up to a maximum amount of Five Thousand Dollars
($5,000.00).
16. Notices. Any notice, demand or request required or permitted to be
given or made under this Agreement shall be in writing and shall be deemed given
or made when delivered in person, when sent by United States registered or
certified mail, or postage prepaid, or when faxed to a party at its address or
facsimile number specified below:
If to the Company: Quest Medical, Inc.
201 Allentown Parkway
Allen, Texas 75002
Facsimile number: (972) 390-9687
Attention: F. Robert Merrill III
with a copy to: Hughes & Luce, L.L.P.
1717 Main Street
Suite 2800
Dallas, Texas 75201
Facsimile number: (214) 939-6100
Attention: James Hunter Birch
If to Employee: Thomas C. Thompson
501 Lakewood Drive
McKinney, Texas 75069
Facsimile number: (972) 562-0520
<PAGE> 10
with a copy to: Wood, Exall & Bonnet, L.L.P.
12222 Merit Drive, Suite 880
Dallas, Texas 75251
Facsimile number: (972) 991-9261
Attention: David A. Wood
The parties to this Agreement may change their addresses for notice in the
manner provided above.
17. Counterparts and Photocopies. This Agreement may be executed in
counterparts and each executed counterpart shall be as effective as a signed
original. Photographic copies of such signed counterparts may be used in lieu of
the originals for any purpose.
18. Paragraph Titles Not Binding. The use of section titles in this
Agreement is for ease of reference only. Such titles are not to be considered
terms of this Agreement.
19. Governing Law: Arbitration.
(a) THIS AGREEMENT SHALL BE CONSTRUED IN ACCORDANCE WITH AND GOVERNED BY
THE LAWS OF THE STATE OF TEXAS, WITHOUT REGARD TO THE PRINCIPLES OF CONFLICTS OF
LAW.
(b) The matters, claims, rights, and obligations subject to these
arbitration provisions include all rights, claims and obligations arising out of
or relating to this Agreement or to the employee's employment and/or its
termination, including, without limitation, any and all claims, rights or causes
of action which may ever arise or be asserted under any federal, state, local or
foreign statutory, regulatory or common law, and including, without limitation,
claims of discrimination under Title VII of the Civil Rights of 1964, Age
Discrimination in Employment Act, the Americans with Disabilities Act, the Civil
Rights Act of 1991 and the Texas Commission on Human Rights Act, wrongful
discharge or termination, breach of contract, tort (such as intentional
infliction of emotional distress, libel, slander, wrongful invasion of privacy
or person injury), workers compensation or unemployment compensation. All of the
foregoing types of matters, claims, rights and obligations subject to these
arbitration provisions are herein called "Subject Claims." In the event of a
dispute relating to any Subject Claim, then, upon notice by any party to the
other parties (an "Arbitration Notice") and to American Arbitration Association
("AAA"), 13455 Noel Road, Suite 1750, Two Galleria Plaza, Dallas, Texas 75240
[telephone (972) 702-8222], the controversy or dispute shall be submitted to a
sole arbitrator who is independent and impartial, for binding arbitration in
Dallas, Texas, in accordance with AAA's National Rules for the Resolution of
Employment Disputes (the "Rules") as modified or supplemented hereby. The
parties agree that they will faithfully observe this agreement and the Rules and
that they will abide by and perform any award rendered by the arbitrator. The
arbitration shall be governed by the Federal Arbitration Act, 9 U.S.C. Section
1-16 (or by the same principles enunciated by such Act in the event it may not
be technically applicable. The award or judgment of the arbitrator shall be
final and binding on all parties and judgment upon the award or judgment of the
arbitrator may be entered and enforced by any court having jurisdiction. If any
party becomes the subject of a bankruptcy, receivership or other similar
proceeding under the laws of the United States of America, any state or
commonwealth or any other national or political subdivision thereof; then, to
the extent permitted or not prohibited by applicable law, any factual or
substantive legal issues arising in or during the pendency of any such
<PAGE> 11
proceeding shall be subject to all of the foregoing mandatory mediation and
arbitration provisions and shall be resolved in accordance therewith. The
agreements contained herein have been given for valuable consideration, are
coupled with an interest and are not intended to be executory contracts. The
fees and expenses of the arbitrator will be shared equitably (as determined by
the arbitrator) by all parties engaged in the dispute or controversy.
(c) Promptly after the Arbitration Notice is given, AAA will select five
possible arbitrators, to whom AAA will give the identities of the parties and
the general nature of the controversy. If any of those arbitrators disqualifies
himself or declines to serve, AAA shall continue to designate potential
arbitrators until the parties have five to select from. After the panel of five
potential arbitrators has been completed, a two-page summary of the background
of each of the potential arbitrators will be given to each of the parties, and
the parties will have a period of 10 days after receiving the summaries in which
to attempt to agree upon the arbitrator to conduct the arbitration. If the
parties are unable to agree upon an arbitrator, then one of the parties shall
notify AAA and the other party, and AAA will notify each party that it has five
days from the AAA notice to strike two names from the list and advise AAA of the
two names stricken. After expiration of the strike period, if all but one
candidate has been stricken, the remaining one will be the arbitrator, but, if
two or more have not been stricken, AAA shall select the arbitrator from one of
those not stricken. The decision of AAA with respect to the selection of the
arbitrator will be final and binding in such case.
(d) Unless and only to the extent mandatory arbitration is validly
prohibited or limited by applicable statute or regulation, no litigation or
other proceeding may ever be instituted at any time in any court or before any
administrative agency or body for the purpose of adjudicating, interpreting or
enforcing any of the rights, duties, liabilities or obligations of the parties
hereto or any rights, duties, liabilities or obligations relating to any Subject
Claim, whether or not covered by the express terms of this Agreement, or for the
purpose of adjudicating a breach or determination of the validity of this
Agreement, or for the purpose of appealing any decision of an arbitrator, except
a proceeding instituted (i) for the purpose of having the award or judgment of
an arbitrator entered and enforced or (ii) to seek an injunction or restraining
order (but not damages in connection therewith) in circumstances where such
relief is available. Unless and only to the extent a limitation of damages is
validly prohibited or limited by applicable statute or regulation, no punitive,
exemplary or consequential damages may ever be awarded by the arbitrator or
anyone else, and each of the parties hereby waives any and all rights to make,
claim or recover any such damages.
(e) The arbitration and any discovery conducted in connection therewith
will be conducted in accordance with the AAA's National Rules for the Resolution
of Employment Disputes in effect at the time of the arbitration, including
without limitation the expedited procedures set forth therein (the "AAA Rules").
The decision of the arbitrator will be final and binding on all parties and
their successors and permitted assignees. The judgment upon the award rendered
by the arbitrator may be entered by any court having jurisdiction thereof. The
arbitration hearing will commence no later than 60 days after the arbitrator is
selected. The arbitrator will render a decision no later than 30 days after the
close of the hearing, in accordance with AAA Rules.
20. Death of Employee. In the event Employee should die before all of the
payments referred to in Section 4 are paid, the Company shall continue to make
such payments to Employee's spouse, or if the Employee's spouse predeceases
Employee, to Employee's estate.
<PAGE> 12
21. Assignment. The obligations and duties of the parties set forth in this
Agreement may not be assigned or delegated; provided, however, that nothing in
this Agreement shall preclude the Company from consolidating or merging with, or
transferring all or substantially all of its assets to, another corporation,
person or entity ("Entity"). Upon such a consolidation, merger or transfer of
assets, the term the "Company" shall mean such other Entity or Entities that the
Company consolidates or merges into or with, or transfer all or substantially
all of the assets of the Company to, and in any such event, the Entity or
Entities shall be bound and automatically assume, without any specific action on
the part of the Entity or Entities, this Agreement and all obligations and
undertakings of the Company set forth in this Agreement, and this Agreement
shall continue in full force and effect, including but not limited to the
obligation of the Company to make the payments set forth in Section 4. The
obligations and duties of Employee hereunder shall be personal and not
assignable or delegable by the Employee in any manner whatsoever.
Notwithstanding the foregoing, the Company in its sole discretion shall have the
right to assign its rights under Sections 6 7 and 8 of this Agreement to any
entity or entities (including Atrion Corporation) which may purchase any part or
all of the Company's business (whether by asset purchase, stock sale, merger or
otherwise).
22. Entire Agreement. This Agreement constitutes the entire and exclusive
statement of the agreement between the parties with respect to its subject
matter and there are no oral or written representations, understandings or
agreements relating to this Agreement which are not fully expressed herein. The
parties agree that any other terms or conditions included in written or verbal
exchanges or representations made by the parties shall not be incorporated
herein or be binding unless expressly agreed upon in writing by authorized
representatives of the parties subsequent to the date hereof.
23. Authorization. The Company represents and warrants to Employee that
the persons executing this Agreement on behalf of the Company are duly
authorized to act for and on behalf of the Company to execute and deliver this
Agreement and that this Agreement is a valid, binding and enforceable agreement
of the Company.
PLEASE READ THIS AGREEMENT CAREFULLY. IT CONTAINS A RELEASE OF ALL KNOWN AND
UNKNOWN CLAIMS.
THE UNDERSIGNED ACKNOWLEDGE THAT WE HAVE CAREFULLY READ THE FOREGOING
AGREEMENT, THAT WE UNDERSTAND ALL OF ITS TERMS, AND THAT WE ARE ENTERING INTO IT
VOLUNTARILY.
Executed at Dallas, Texas by Employee, acting in his individual capacity,
and by an authorized representative of the Company as of the date first stated
above.
QUEST MEDICAL, INC.
By: /s/ F. Robert Merrill III
------------------------------------
Name: F. Robert Merrill III
----------------------------------
Title: Senior Vice President/CFO
--------------------------------
/s/ Thomas C. Thompson
----------------------------------------
Thomas C. Thompson
<PAGE> 1
EXHIBIT 11.1
QUEST MEDICAL, INC.
COMPUTATION OF EARNINGS PER SHARE
YEARS ENDED DECEMBER 31
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Basic earnings (loss) per share:
Weighted average common
shares outstanding 8,428,393 8,259,129 6,267,210
------------ ------------ ------------
Net earnings (loss) from continuing operations $ 817,511 $ 114,514 $ (8,906,332)
Loss from discontinued operations (93,490) (526,671) (1,198,666)
Extraordinary item--loss on early extinguishment
of debt -- -- (269,045)
------------ ------------ ------------
Net earnings (loss) $ 724,021 $ (412,157) $(10,374,043)
------------ ------------ ------------
Net earnings (loss) from continuing operations
per share $ 0.10 $ 0.01 $ (1.42)
Loss from discontinued operations
per share (0.01) (0.06) (0.19)
Extraordinary item per share -- -- (0.05)
------------ ------------ ------------
Net earnings (loss) per share $ 0.09 $ (0.05) $ (1.66)
------------ ------------ ------------
Diluted earnings (loss) per share:
Weighted average common
shares outstanding 8,428,393 8,259,129 6,267,210
Stock options and warrants--based on the treasury
stock method using average market price 429,693 550,454 --
------------ ------------ ------------
Diluted common and common equivalent
shares outstanding 8,858,086 8,809,583 6,267,210
------------ ------------ ------------
Net earnings (loss) from continuing operations $ 817,511 $ 114,514 $ (8,906,332)
Loss from discontinued operations (93,490) (526,671) (1,198,666)
Extraordinary item--loss on early extinguishment
of debt -- -- (269,045)
------------ ------------ ------------
Net earnings (loss) $ 724,021 $ (412,157) $(10,374,043)
------------ ------------ ------------
Net earnings (loss) from continuing operations
per share $ 0.09 $ 0.01 $ (1.42)
Loss from discontinued operations
per share (0.01) (0.06) (0.19)
Extraordinary item per share -- -- (0.05)
------------ ------------ ------------
Net earnings (loss) per share $ 0.08 $ (0.05) $ (1.66)
------------ ------------ ------------
</TABLE>
<PAGE> 1
EXHIBIT 21.1
SUBSIDIARIES
Advanced Neuromodulation Systems, Inc. Texas
<PAGE> 1
EXHIBIT 23.1
Consent of Independent Auditors
We consent to the incorporation by reference in the Registration Statements
(Form S-8 - Nos. 2-82414, 2-91410, 33-235312, and 33-00967, and Form S-3 - No.
33-40927) pertaining to the Quest Medical, Inc. 1979 Amended and Restated
Employees' Stock Option Plan; the Quest Medical, Inc. Directors' Stock Option
Plan; the Quest Medical, Inc. 1987 Employees' Stock Option Plan; the Quest
Medical, Inc. 1995 Stock Option Plan; the Quest Medical, Inc. Sales and
Marketing Employees Stock Option Plan; the Heaton Stock Option Plan; the
registration of 100,000 shares of Common Stock issued pursuant to a Common Stock
Purchase Warrant between Quest Medical, Inc. and Robert L. Swisher, Jr. and the
related Prospectuses of our report dated February 25, 1998, with respect to the
consolidated financial statements of Quest Medical, Inc. and Subsidiaries,
included in the Annual Report (Form 10-K) for the year ended December 31, 1997.
/s/ Ernst & Young LLP
-----------------------------------
Ernst & Young LLP
Dallas, Texas
March 27, 1998
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