<PAGE>
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(MARK ONE)
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
- -------
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1998
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
ADVANCED NEUROMODULATION SYSTEMS, INC.
------------------------------------------------------
(Exact Name of Registrant as Specified in Its Charter)
Texas 75-1646002
- ------------------------------- ------------------------------------
(State or Other Jurisdiction of (I.R.S. Employer Identification No.)
Incorporation or Organization)
One Allentown Parkway, Allen, Texas 75002
---------------------------------------------------
(Address of Principal Executive Offices) (Zip Code)
(972) 390-9800
----------------------------------------------------
(Registrant's Telephone Number, Including Area Code)
Indicate by check 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 the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
<TABLE>
<CAPTION>
Number of Shares Outstanding at
Title of Each Class October 30, 1998
------------------------ ---------------------------------
<S> <C>
Common stock, $.05 Par Value 7,654,316
</TABLE>
<PAGE>
ADVANCED NEUROMODULATION SYSTEMS, INC. AND SUBSIDIARIES
TABLE OF CONTENTS
<TABLE>
<S> <C>
PART I. Financial Information 2
Item 1. Financial Statements
Condensed Consolidated Balance Sheets
September 30, 1998 and December 31, 1997 3-4
Condensed Consolidated Statements of Operations
For the Three Months and Nine Months Ended
September 30, 1998 and 1997 5
Condensed Consolidated Statements of Cash Flows
For the Nine Months Ended
September 30, 1998 and 1997 6
Condensed Consolidated Statements of Stockholders'
Equity For the Year Ended December 31, 1997
and the Nine Months Ended September 30, 1998 7
Notes to Condensed Consolidated
Financial Statements 8-14
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 15-22
PART II. Other Information 23
Item 6. Exhibits and Reports on Form 8-K 23
SIGNATURES 24
</TABLE>
1
<PAGE>
PART I
FINANCIAL INFORMATION
2
<PAGE>
ADVANCED NEUROMODULATION SYSTEMS, INC. and SUBSIDIARIES
Condensed Consolidated Balance Sheets
September 30, 1998 and December 31, 1997
<TABLE>
<CAPTION>
September 30,
1998 December 31,
Assets (Unaudited) 1997
------------- -------------
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 15,701,501 $ 747,828
Marketable securities 547,817 1,455,864
Receivables:
Trade accounts, less allowance for
doubtful accounts of $224,250 in 1998 2,854,155 2,398,327
and $212,375 in 1997
Interest and other 94,940 209,595
------------- -------------
Total receivables 2,949,095 2,607,922
------------- -------------
Inventories:
Raw materials 1,164,262 1,056,718
Work-in-process 467,753 323,929
Finished goods 1,363,511 1,597,840
------------- ------------
Total inventories 2,995,526 2,978,487
------------- ------------
Net assets of discontinued operations sold in 1998 -- 12,831,318
Deferred income taxes 1,201,932 2,288,192
Prepaid expenses and other current assets 469,490 476,716
------------- ------------
Total current assets 23,865,361 23,386,327
------------- -------------
Property, plant and equipment:
Land 1,927,900 1,927,900
Building and improvements 5,254,945 5,254,945
Furniture and fixtures 832,955 624,753
Machinery and equipment 1,519,899 920,879
------------- ------------
9,535,699 8,728,477
Less accumulated depreciation and amortization 1,770,559 1,317,362
------------- ------------
Net property, plant and equipment 7,765,140 7,411,115
------------- ------------
Cost in excess of net assets acquired, net
of accumulated amortization of $1,595,466 9,216,198 9,633,650
in 1998 and $1,178,014 in 1997
Patents, net of accumulated amortization of
$261,562 in 1998 and $148,958 in 1997 2,988,438 2,851,042
Purchased technology from acquisitions, net
of accumulated amortization of $933,334 3,066,666 3,266,666
in 1998 and $733,334 in 1997
Tradenames, net of accumulated amortization
of $437,500 in 1998 and $343,750 in 1997 2,062,500 2,156,250
Other assets, net of accumulated
amortization of $51,744 in 1998 234,156 277,270
============= ============
$ 49,198,459 $ 48,982,320
============= ============
</TABLE>
3
<PAGE>
ADVANCED NEUROMODULATION SYSTEMS, INC. and SUBSIDIARIES
Condensed Consolidated Balance Sheets
September 30, 1998 and December 31, 1997
<TABLE>
<CAPTION>
September 30,
1998 December 31,
(Unaudited) 1997
------------- -------------
<S> <C> <C>
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable $ 510,293 $ 240,249
Short-term notes payable and current maturities
of long-term notes payable 186,581 8,257,348
Deferred revenue- R&D contract 2,100,000 --
Accrued salary and employee benefit costs 731,287 381,735
Income taxes payable 3,199,703 --
Other accrued expenses 674,717 379,444
------------- ------------
Total current liabilities 7,402,581 9,258,776
------------- ------------
Notes payable 3,492,532 3,635,027
Deferred income taxes 2,082,704 2,182,580
Commitments and contingencies
Stockholders' equity:
Common stock of $.05 par value. Authorized
25,000,000 shares; issued 8,872,941 shares
in 1998 and 8,635,509 in 1997 443,647 431,775
Additional paid-in capital 42,593,241 40,780,717
Retained earnings (deficit) (242,651) (7,268,061)
Cost of common shares in treasury;
806,000 shares in 1998 (6,430,790) --
Accumulated other comprehensive income (142,805) (38,494)
------------- ------------
Total stockholders' equity 36,220,642 33,905,937
------------- ------------
$ 49,198,459 $ 48,982,320
============= ============
</TABLE>
See accompanying notes to condensed consolidated financial statements.
4
<PAGE>
ADVANCED NEUROMODULATION SYSTEMS, INC. and SUBSIDIARIES
Condensed Consolidated Statements of Operations (Unaudited)
For the Three Months and Nine Months Ended September 30, 1998 and 1997
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
----------------------- -----------------------
1998 1997 1998 1997
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Net revenue-product sales $ 3,706,402 $ 4,220,002 $12,860,529 $10,821,336
Net revenue-contract
research and development 1,300,000 -- 1,900,000 --
----------- ----------- ----------- -----------
Total net revenue 5,006,402 4,220,002 14,760,529 10,821,336
Costs and expenses:
Cost of product sales 1,049,089 1,154,591 3,544,290 3,732,764
Research and development 869,647 207,031 1,940,129 682,808
Marketing 1,223,392 989,495 3,461,254 2,923,907
Amortization of intangibles 292,544 274,256 875,550 811,616
General and administrative 706,726 469,545 1,946,339 1,332,527
----------- ----------- ----------- -----------
4,141,398 3,094,918 11,767,562 9,483,622
----------- ----------- ----------- -----------
Earnings from operations 865,004 1,125,084 2,992,967 1,337,714
----------- ----------- ----------- -----------
Other income (expenses):
Interest expense (78,395) (156,349) (254,133) (456,575)
Interest and other income 250,466 29,194 665,882 74,156
Gain (loss) on sale of assets
and marketable securities (4,300) 9,497 (4,381) (14,982)
----------- ----------- ----------- -----------
167,771 (117,658) 407,368 (397,401)
----------- ----------- ----------- -----------
Earnings from continuing
operations before
income taxes 1,032,775 1,007,426 3,400,335 940,313
Income taxes 419,138 358,326 1,363,866 375,335
----------- ----------- ----------- -----------
Net earnings from
continuing operations 613,637 649,100 2,036,469 564,978
----------- ----------- ----------- -----------
Discontinued Operations:
Loss from discontinued
operations, net of income
tax benefits of $129,711 in
1998 and income tax benefits
of $33,989 and $9,529 in 1997 -- (199,738) (211,634) (55,998)
Gain on sale of assets of
discontinued operations, net
of income tax expense of
$3,037,968 -- -- 5,200,575 --
----------- ----------- ----------- -----------
Net earnings (loss)
from discontinued
operations -- (199,738) 4,988,941 (55,998)
----------- ----------- ----------- -----------
Net earnings $ 613,637 $ 449,362 $ 7,025,410 $ 508,980
=========== =========== =========== ===========
Basic earnings (loss) per share:
Continuing operations $ .07 $ .08 $ .24 $ .07
=========== =========== =========== ===========
Discontinued operations $ -- $ (.03) $ .58 $ (.01)
=========== =========== =========== ===========
Net earnings $ .07 $ .05 $ .82 $ .06
=========== =========== =========== ===========
Diluted earnings (loss) per share:
Continuing operations $ .07 $ .07 $ .23 $ .06
=========== =========== =========== ===========
Discontinued operations $ -- $ (.02) $ .57 $ --
=========== =========== =========== ===========
Net earnings $ .07 $ .05 $ .80 $ .06
=========== =========== =========== ===========
</TABLE>
See accompanying notes to condensed consolidated financial statements.
5
<PAGE>
ADVANCED NEUROMODULATION SYSTEMS, INC. and SUBSIDIARIES
Condensed Consolidated Statements of Cash Flows (Unaudited)
For the Nine Months Ended September 30, 1998 and 1997
<TABLE>
<CAPTION>
Nine Months Ended
September 30,
--------------------------
1998 1997
------------- ------------
<S> <C> <C>
Cash flows from operating activities:
Net earnings from continuing operations $ 2,036,469 $ 564,978
------------- ------------
Adjustments to reconcile net earnings from
continuing operations to net cash provided
by operating activities
Depreciation and amortization 1,328,747 1,117,069
Loss on sale of assets and marketable
securities 4,381 14,982
Increase in inventory reserve -- 478,619
Deferred income taxes (866,377) 365,806
Changes in assets and liabilities:
Receivables (341,173) (318,791)
Inventories (17,039) (320,913)
Prepaid expenses and other assets (1,404) 104,053
Accounts payable 270,044 (478,154)
Deferred revenue 2,100,000 --
Income taxes payable 2,197,942 --
Accrued expenses 576,825 (158,777)
------------- ------------
Total adjustments 5,251,946 803,894
------------- ------------
Net cash provided by
continuing operations 7,288,415 1,368,872
Net cash provided by
discontinued operations 59,049 673,708
------------- ------------
Net cash provided by operating
activities 7,347,464 2,042,580
------------- ------------
Cash flows from investing activities:
Purchases of marketable securities (106,001) (1,181,383)
Proceeds from sales of marketable securities 851,623 1,403,607
Additions to property, plant and equipment
- continuing operations (807,222) (438,874)
Additions to property, plant and equipment
- discontinued operations (12,060) (734,280)
Acquisition of patent rights (250,000) --
Final payments for 1995 acquisition of Neuromed -- (4,472,197)
Net proceeds from sale of discontinued operations
and assets 21,754,179 7,690
------------- ------------
Net cash provided by (used in)
investing activities 21,430,519 (5,415,437)
------------- ------------
Cash flows from financing activities:
Exercise of stock options 819,742 695,248
Purchase of treasury stock (6,430,790) --
Proceeds from short-term obligations -- 3,911,221
Payment of short-term obligations (8,081,763) (1,161,221)
Payment of long-term debt (131,499) (121,263)
------------- ------------
Net cash provided by (used in)
financing activities (13,824,310) 3,323,985
------------- ------------
Net increase (decrease) in cash and cash
equivalents 14,953,673 (48,872)
Cash and cash equivalents at beginning of year 747,828 696,196
============= ============
Cash and cash equivalents at September 30 $ 15,701,501 $ 647,324
============= ============
Supplemental cash flow information is presented
below:
Income taxes paid $ 32,300 $ --
============= ============
Interest paid $ 292,977 $ 707,098
============= ============
</TABLE>
See accompanying notes to condensed consolidated financial statements.
6
<PAGE>
ADVANCED NEUROMODULATION SYSTEMS, INC. and SUBSIDIARIES
Condensed Consolidated Statements of Stockholders' Equity
<TABLE>
<CAPTION>
Additional Retained Other Total
Common Stock Paid-in Earnings Comprehensive Treasury Stockholders'
Share Amount Capital (Deficit) Income (Loss) Stock Equity
------------- ------------- ------------- ------------- ------------- ------------- -------------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at
December 31, 1996 8,338,510 $ 416,926 $ 38,699,517 $ (7,992,082) $ (130,878) -- $ 30,993,483
Net earnings -- -- -- 724,021 -- -- 724,021
Adjustment to
unrealized losses
on marketable
securities -- -- -- -- 92,384 -- 92,384
-------------
Comprehensive Income 816,405
-------------
Shares issued upon
exercise of
stock options 296,999 14,849 907,537 -- -- -- 922,386
Tax benefit from
employee stock
option exercise -- -- 1,173,663 -- -- -- 1,173,663
------------- ------------- ------------- ------------- ------------- ------------- -------------
Balance at December
31, 1997 8,635,509 431,775 40,780,717 (7,268,061) (38,494) -- 33,905,937
Net earnings -- -- -- 7,025,410 -- -- 7,025,410
Adjustment to
unrealized
losses on
marketable
securities -- -- -- -- (104,311) -- (104,311)
-------------
Comprehensive Income 6,921,099
-------------
Shares issued upon
exercise of
stock options 237,432 11,872 807,870 -- -- -- 819,742
Compensation
expense
resulting from
changes to stock
options -- -- 1,004,654 -- -- -- 1,004,654
Purchase of
806,000 common
shares, at cost -- -- -- -- -- (6,430,790) (6,430,790)
------------- ------------- ------------- ------------- ------------- ------------- -------------
Balance at
September 30, 1998 8,872,941 $ 443,647 $ 42,593,241 $ (242,651) $ (142,805) $ (6,430,790) $ 36,220,642
============= ============= ============= ============= ============= ============= =============
</TABLE>
See accompanying notes to condensed consolidated financial statements.
7
<PAGE>
ADVANCED NEUROMODULATION SYSTEMS, INC. and SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
(1) Business
Continuing Operations
Advanced Neuromodulation Systems, Inc. (the "Company" or "ANS"),
formerly Quest Medical, Inc., designs, develops, manufactures and
markets implantable neurostimulation systems. 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. 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.
The Company changed its name from Quest Medical, Inc. to Advanced
Neuromodulation Systems, Inc. during June 1998. The Company's NASDAQ
stock symbol was changed from "QMED" to "ANSI" on July 1, 1998.
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. The CVS Operations have been accounted for as discontinued
operations in the Condensed Consolidated Financial Statements for the
three months and nine months ended September 30, 1997 and the nine
months ended September 30, 1998. Net assets of the CVS Operations have
been presented on the Condensed Consolidated Balance Sheet for the
period ending December 31, 1997 as net assets of discontinued
operations.
(2) Condensed Financial Statements
The unaudited consolidated financial information contained in this
report reflects all adjustments (consisting of normal recurring
accruals) considered necessary, in the opinion of management, for a
fair presentation of results for the interim periods presented. The
preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates
8
<PAGE>
and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the
date of the financial statements and the reported amounts of revenues
and expenses during the reporting period. Actual results could differ
from these estimates.
Certain information and footnote disclosures normally included in
financial statements prepared in accordance with generally accepted
accounting principles have been condensed or omitted. These financial
statements should be read in conjunction with the financial statements
and notes thereto included in the Company's December 31, 1997 Annual
Report on Form 10-K. The results of operations for periods ended
September 30, 1998 are not necessarily indicative of operations for the
full year.
The consolidated financial statements include the accounts of Advanced
Neuromodulation Systems, Inc. and subsidiaries. All significant
intercompany balances and transactions have been eliminated in
consolidation.
(3) Marketable Securities
The following is a summary of available-for-sale securities at
September 30, 1998:
<TABLE>
<CAPTION>
Gross Gross
Unrealized Unrealized Estimated
Cost Gains Losses Fair Value
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Investment grade preferred
securities $ 557,596 $ -- $ 141,556 $ 416,040
Publicly traded limited
partnerships 51,875 -- 35,000 16,875
Real estate investment trusts 141,590 -- 27,496 114,094
Other 13,128 -- 12,320 808
=========== =========== =========== ===========
$ 764,189 $ -- $ 216,372 $ 547,817
=========== =========== =========== ===========
</TABLE>
At September 30, 1998, no individual security represented more than 40
percent of the total portfolio or 1 percent of total assets. The
Company did not have any investments in derivative financial
instruments at September 30, 1998.
Accumulated unrealized losses at September 30, 1998 and December 31,
1997 are included as "Accumulated other comprehensive income" as a
component of Stockholders' Equity in the Condensed Consolidated Balance
Sheets. Such amounts are net of tax benefits of $73,567 and $19,831,
respectively.
(4) Notes Payable
Notes payable at September 30, 1998 and December 31, 1997 were as
follows:
<TABLE>
<CAPTION>
September 30, December 31,
1998 1997
------------- ------------
<S> <C> <C>
Notes payable to banks $ -- $ 5,000,000
Notes payable to shareholder -- 2,000,000
Acquisition notes payable -- 1,000,000
9
<PAGE>
Mortgage notes 3,679,113 3,810,612
Other -- 81,763
------------- ------------
3,679,113 11,892,375
Less current maturities (186,581) (8,257,348)
============= ============
Long-term notes payable $ 3,492,532 $ 3,635,027
============= ============
</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"). The Facilities were 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. 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 8 - "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. Under the terms of the
promissory note, the Company was required to make quarterly interest
payments with a principal payment of $2,000,000 due and payable at the
maturity of the note 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 had 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
September 30, 1998, the warrants remain unexercised. The Company repaid
the note on January 30, 1998 with proceeds from the sale of the assets
of its CVS Operations.
In February 1997, the Company issued the former owner of Neuromed, Inc.
a promissory note in the amount of $1,000,000. Under terms of the
promissory note, the Company was required to make monthly interest
payments with a principal payment of $1,000,000 due and payable at
maturity of the note in February 1998. The Company repaid the note on
January 30, 1998 with proceeds from the sale of the assets of its CVS
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 $2,838,509 at September 30, 1998, 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 $840,604 at September 30,
1998, 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.
(5) Commitments and Contingencies
The Company has no material commitments under noncancelable operating
leases at September 30, 1998.
The Company is a party to product liability claims related to ANS
neurostimulation devices. Product liability insurers have assumed
10
<PAGE>
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.
(6) Income Taxes
The Company recorded income tax expense from continuing operations
during the three months and nine months ended September 30, 1998, of
$419,138 and $1,363,866, an overall effective tax rate of 40.6 percent
and 40.1 percent, respectively. 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
compared to the U.S. statutory rate for corporations of 34 percent. The
Company also recorded income tax expense from discontinued operations
of $2,908,257 during the nine months ended September 30, 1998, an
effective tax rate of 36.8 percent. The tax expense from discontinued
operations during the nine months ended September 30, 1998 resulted
from the gain on the sale of the CVS Operations (see Note 8 - "Sale of
CVS Operations/Discontinued Operations"). During the three months ended
September 30, 1997, the Company recorded income tax expense of $358,326
from continuing operations and an income tax benefit of $33,989 from
discontinued operations, an overall effective tax rate of 41.9 percent.
During the nine months ended September 30, 1997, the Company recorded
income tax expense of $375,335 from continuing operations and an income
tax benefit of $9,529 from discontinued operations, an overall
effective tax rate of 41.8 percent. The Company's expense for
amortization of goodwill is not deductible for tax purposes, thus
explaining the higher effective tax rate during the three months and
nine months ended September 30, 1997, compared to the U.S. statutory
rate for corporations of 34 percent.
(7) Earnings Per Share
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 the three months ended September 30, 1998 and 1997
are based upon 8,327,546 and 8,457,354 shares, respectively. Basic
earnings (loss) per share for the nine months ended September 30, 1998
and 1997 are based upon 8,528,789 and 8,390,748 shares, respectively.
Diluted earnings (loss) per share for the three months ended September
30, 1998 and 1997 are based upon 8,526,627 and 8,935,670 shares,
respectively. Diluted earnings (loss) per share for the nine months
ended September 30, 1998 and 1997 are based upon 8,767,131 and
8,816,297 shares, respectively.
11
<PAGE>
(8) Sale of CVS Operations/Discontinued Operations
On January 30, 1998, the Company sold its cardiovascular and
intravenous fluid product lines, including its MPS(R) myocardial
protection system product line, to Atrion Corporation. The Company
received approximately $23 million from the sale and utilized $8.0
million of the proceeds to retire debt and $1.2 million to pay expenses
related to the transaction. The remaining proceeds will be used for
working capital for the expanding ANS business and stock repurchases as
deemed appropriate by the Board of Directors. The Company reported a
pretax gain from the sale of $8.2 million during the nine months ended
September 30, 1998. This gain is net of $1 million of compensation
expense recorded as a result of changes made to the stock options held
by employees of the CVS Operations. These changes included accelerated
vesting of the unvested portion of these terminated employee options as
a result of the sale and extension of the normal 90-day exercise period
subsequent to termination to one year for these options.
As part of the sale of the CVS Operations to Atrion in January 1998,
the Company granted Atrion a nine-month option to acquire the Company's
principal office and manufacturing facility in Allen, Texas for $6.5
million. On October 29, 1998, Atrion notified the Company of its intent
to exercise the option to acquire the facility. Closing of the
transaction will occur on February 1, 1999. The Company will repay the
mortgage debt on the facility at closing (see Note 4 of the Notes to
Condensed Consolidated Financial Statements). After repayment of the
mortgage debt and expenses related to the transaction, the Company
expects to receive net proceeds of approximately $2.7 million. No
material gain or loss is expected on the sale of the facility. During
the second quarter of 1999, the Company intends to lease a facility in
the North Dallas area and relocate its operations there. The expense
of moving and transitioning into the new facility is expected to be
immaterial.
Operating results of the CVS Operations have been reclassified and
reported as discontinued operations. Summary operating results for the
one month ended January 30, 1998 and the three months and nine months
ended September 30, 1997 for the CVS Operations were as follows (the
1998 period included results until the sale on January 30, 1998):
<TABLE>
<CAPTION>
One Month Three Months Nine Months
Ended Ended Ended
January 30, September 30, September 30,
1998 1997 1997
------------- -------------- --------------
<S> <C> <C> <C>
Net revenue - product sales $ 1,111,992 $ 3,606,976 $ 10,816,494
Gross profit from product sales 206,481 1,351,025 4,948,138
Earnings (loss) from operations (307,120) (123,231) 260,754
Interest expense (34,225) (110,496) (326,281)
------------- -------------- --------------
Earnings (loss) before income tax (341,345) (233,727) (65,527)
Income tax expense (benefit) (129,711) (33,989) (9,529)
------------- -------------- --------------
Net earnings (loss) $ (211,634) $ (199,738) $ (55,998)
============= ============== ==============
</TABLE>
12
<PAGE>
The above operating results of the CVS Operations reflect the revenues
and expenses of the CVS Operations including direct and indirect
expenses of the CVS Operations that are paid by the Company and charged
directly to the CVS Operations. Allocation of 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 at December 31,
1997 were as follows:
<TABLE>
<S> <C>
Current assets:
Accounts receivable $ 2,481,278
Inventories 5,208,676
Prepaid expenses 131,735
--------------
7,821,689
--------------
Noncurrent assets:
Net property, plant, and equipment 3,633,855
Net intangible assets consisting of patents, purchased
technology and costs in excess of net assets acquired 2,043,107
Other assets 8,631
--------------
5,685,593
--------------
Total assets 13,507,282
--------------
Current liabilities:
Accounts payable 410,483
Accrued liabilities 265,481
--------------
675,964
--------------
--------------
Net assets of CVS Operations $ 12,831,318
==============
</TABLE>
(9) Product Development Agreement
On June 22, 1998, the Company announced that it had entered into an
agreement with Sofamor Danek Group, Inc. ("Sofamor Danek") under which
the Company will develop and manufacture for Sofamor Danek, products
and systems for use in Deep Brain Stimulation ("DBS"). DBS products
provide electrical stimulation to certain areas of the brain and are
intended to relieve the effects of various neurological disorders, such
as Parkinson's Disease and Essential Tremor. Under terms of the
agreement, the Company granted Sofamor Danek exclusive worldwide rights
to use, market and sell the DBS products developed and manufactured by
ANS. The Company received a cash payment of $4 million upon execution
13
<PAGE>
of the agreement which is being recognized into income as revenue based
upon the estimated percentage of completion of the development project.
During the three months and nine months ended September 30, 1998, the
Company recognized $1.3 million and $1.9 million, respectively, into
income as revenue. ANS will also receive four additional payments of $2
million each, which will be recognized into income upon the
satisfactory completion of certain domestic and international
regulatory milestones over the next several years, which management
believes will commence in fiscal 1999. In order for Sofamor Danek to
market the DBS products in the United States, FDA clearance will be
necessary, which will require clinical trials. Sofamor Danek has
accepted the responsibility and expense for seeking regulatory
approvals. Sofamor Danek has also agreed to purchase the DBS products
exclusively from ANS and has agreed to pay ANS a royalty on Sofamor
Danek sales of the DBS products.
(10) Comprehensive Income
Statement of Financial Accounting Standards No. 130 - "Reporting
Comprehensive Income" - was adopted by the Company as of January 1,
1998. The new rules require the reporting and display of comprehensive
income and its components; however, the adoption of this statement had
no impact on the Company's net earnings or stockholders' equity. SFAS
No. 130 requires unrealized gains or losses on the Company's available
for sale securities, which prior to adoption were reported separately
in shareholders' equity, to be included in "Other comprehensive
income". Prior period financial statements have been reclassified to
conform to the requirements of SFAS No. 130. Total comprehensive income
for 1997 and for the nine months ended September 30, 1998 is reported
in the Condensed Consolidated Statements of Stockholders' Equity.
Comprehensive income for the three months and nine months ended
September 30, 1998 and 1997 is as follows:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
----------------------- ------------------------
1998 1997 1998 1997
----------- ----------- ----------- ------------
<S> <C> <C> <C> <C>
Net earnings $ 613,637 $ 449,362 $ 7,025,410 $ 508,980
Other comprehensive income (18,557) 28,161 (104,311) 84,355
----------- ----------- ----------- -----------
Comprehensive income $ 595,080 $ 477,523 $ 6,921,099 $ 593,335
----------- ----------- ----------- -----------
</TABLE>
14
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion of the financial condition and results of operations of
the Company should be read in conjunction with the Condensed Consolidated
Financial Statements of the Company and the related Notes thereto.
Overview
On January 30, 1998, the Company sold the assets of its CVS Operations,
including its MPS(R) myocardial protection system product line, to Atrion
Corporation (see Note 8 - "Sale of CVS Operations/Discontinued Operations"). The
Company received cash proceeds of approximately $23 million, after 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. On October 29, 1998,
Atrion notified the Company of its intent to exercise the option to acquire the
facility. Closing of the transaction will occur on February 1, 1999. The Company
will repay its outstanding mortgage debt on the facility at closing and expects
to receive net proceeds of $2.7 million after repayment of the mortgage debt and
expenses related to the transaction. No material gain or loss is expected on the
sale of the facility. Until January 31, 1999, the Company is leasing space to
Atrion for the CVS Operations for $24,606 per month. In turn, the Company is
leasing certain office and computer equipment from Atrion for $13,175 per month.
The Company will lease space and certain office and computer equipment from
Atrion for $48,000 per month from February 1 through April 30, 1999, at which
time the Company currently intends to lease a facility in the North Dallas area
and relocate its operations there. The expense of moving and transitioning into
the new facility is expected to be immaterial.
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 intangible assets also included the rights to the name Quest
Medical, Inc. The Company reported a pretax gain on the transaction of $8.2
million ($5.2 million after-tax) which is included in the Company's results for
the nine months ended September 30, 1998. The pretax gain is net of $1 million
compensation expense recorded as a result of certain changes made to stock
options held by employees of the CVS Operations (see Note 8 - "Sale of CVS
Operations/Discontinued Operations"). The Company utilized $9.2 million of the
proceeds from the sale to retire debt and pay expenses related to the
transaction.
The CVS Operations have been accounted for as discontinued operations in the
Condensed Consolidated Statements of Operations for the three months and nine
months ended September 30, 1997 and the nine months ended September 30, 1998.
At its Annual Meeting of Shareholders on May 28, 1998, the shareholders approved
a proposal to change the name of the Company from Quest Medical, Inc. to
Advanced Neuromodulation Systems, Inc. ("ANS"). The name change became effective
upon the filing and recording of the Certificate of Amendment to the Articles of
Incorporation on June 17, 1998. The Company's trading symbol on the Nasdaq Stock
Market was changed to "ANSI" on July 1, 1998.
During June 1998, the Company completed an agreement with Sofamor Danek Group,
Inc. ("Sofamor Danek") under which the Company will develop and manufacture for
Sofamor Danek, products and systems for use in Deep Brain Stimulation ("DBS").
15
<PAGE>
DBS products provide electrical stimulation to certain areas of the brain and
are intended to relieve the effects of various neurological disorders, such as
Parkinson's Disease and Essential Tremor. Under terms of the agreement, the
Company granted Sofamor Danek exclusive worldwide rights to use, market and sell
the DBS products developed and manufactured by ANS. The Company received a cash
payment of $4 million upon execution of the agreement which is being recognized
into income as revenue based upon the estimated percentage of completion of the
development project. During the three months and nine months ended September 30,
1998, the Company recognized $1.3 million and $1.9 million, respectively, into
income as revenue. ANS will also receive four additional payments of $2 million
each, which will be recognized into income upon the satisfactory completion of
certain domestic and international regulatory milestones over the next several
years, which management believes will commence in fiscal 1999. In order for
Sofamor Danek to market the DBS products in the United States, FDA clearance
will be necessary, which will require clinical trials. Sofamor Danek has
accepted the responsibility and expense for seeking regulatory approvals.
Sofamor Danek has also agreed to purchase the DBS products exclusively from ANS
and has agreed to pay ANS a royalty on Sofamor Danek sales of the DBS products.
The agreement with Sofamor Danek fits with the Company's strategy to strengthen
and broaden its neuromodulation technology platforms and to find strategic
partners to leverage ANS' core technology into other significant market segments
beyond the Company's focus on the pain management market.
During August 1998, the Company completed an agreement with Tricumed
Medizintechnik GmbH, a German corporation, granting ANS exclusive rights to
distribute Tricumed's CE mark approved constant rate intraspinal drug pump and a
future programmable rate intraspinal drug pump, which Tricumed is currently
developing, in international markets including the United States, Canada, the
United Kingdom, France, Spain, Switzerland, South America, Australia and other
world markets. The Company expects to begin marketing the constant rate pump in
international markets during the first quarter of 1999.
Also in August 1998, the Company completed an agreement to license exclusive
worldwide rights to method patents for sacral nerve root stimulation aimed at
relieving the effects of chronic pelvic pain including such indications as
interstitial cystitis, an extremely painful bladder disease that affects around
450,000 people worldwide, and vulvodynia, an extremely painful disease of the
vulva which also affects around 450,000 women worldwide. The Company believes
its dual octrode radio frequency electrical stimulation ("RF") systems and its
advanced laminotomy RF systems can be effective in treating pelvic pain
indications such as interstitial cystitis and vulvodynia. The Company expects to
apply for approval from the FDA during the fourth quarter of 1998 to initiate
pilot clinical studies, a necessary step in the process of receiving approval
from the FDA to market the products domestically.
Results of Operations
Comparison of the Three Months and Nine Months Ended September 30, 1998 and 1997
Revenues. Net revenue from continuing ANS operations of $5.01 million for the
three months ended September 30, 1998 was $786,000 above the level for the
comparable 1997 period of $4.22 million. The 1998 period includes $1.3 million
of net revenue associated with the Company's development agreement for DBS
products with Sofamor Danek. Net revenue from ANS product sales decreased 12.2
percent to $3.71 million during the three months ended September 30, 1998 from
$4.22 million during the comparable 1997 period due to lower unit sales volume
16
<PAGE>
resulting from a lower number of implants. For the nine months ended September
30, 1998, net revenue increased to $14.76 million from $10.82 million during
1997, an increase of $3.94 million. The 1998 nine month period includes $1.9
million of net revenue associated with the Sofamor Danek development agreement.
Excluding such revenue, ANS net revenue from product sales increased to $12.86
million during 1998 from $10.82 million in 1997, an increase of $2.04 million,
or 18.9 percent. This increase in net revenue from product sales during the nine
month 1998 period compared to 1997 was primarily the result of higher unit sales
volume of ANS' RF spinal cord stimulation ("SCS") systems used to manage chronic
intractable pain, principally in the United States. Management expects fourth
quarter 1998 revenue from product sales to be flat or grow modestly from the
1997 fourth quarter level of $3.9 million. However, management expects revenue
growth from product sales to resume in fiscal 1999 resulting from new product
introductions from its research and development investments and international
sales of the constant rate implantable drug pump from the Company's recent
distribution agreement with Tricumed. In addition, management continues to
explore ways to improve the Company's market position through new technologies,
additional product offerings, enhanced distribution channels and addressing new
indications.
Gross Profit from Product Sales. Gross profit from product sales decreased
during the three months ended September 30, 1998 to $2.66 million compared to
$3.07 million in 1997 and as a percentage of net revenue from product sales,
gross profit decreased slightly during the three months ended September 30, 1998
to 71.7 percent compared to 72.6 percent during the comparable 1997 period. This
decrease in gross profit from product sales was primarily attributable to the
decrease in revenue and to a lesser extent the decrease in gross profit margin
from product sales. The decrease in gross profit margin resulted from lower unit
sales volume of the Company's dual octrode systems for the treatment of complex
pain patterns which contribute somewhat higher margins than other ANS systems
marketed by the Company. For the nine months ended September 30, 1998, gross
profit from product sales increased to $9.32 million from $7.09 million in 1997
due to the increased revenue generated by ANS and an increase in gross profit
margin from product sales which increased to 72.4 percent during the nine month
period in 1998 compared to 65.5 percent in 1997 as a result of three factors.
First, the 1997 nine month period includes a write-off of $479,000 for ANS
inventories of previous designs which resulted in a reduction of the 1997 gross
profit margin by 4.4 percentage points (the gross margin without the inventory
write-off was 69.9 percent). Second, the 1998 nine month period included higher
unit sales volume of the Company's dual octrode systems which contribute
somewhat higher margins than other ANS systems marketed by the Company. Third,
the Company implemented certain manufacturing cost improvements during 1998
which reduced manufacturing costs on certain of the Company's products.
Operating Expenses. Total operating expenses of $3.09 million for the three
months ended September 30, 1998 increased from $1.94 million during the same
period in 1997 and as a percentage of net revenue, total operating expenses
increased from 46.0 percent in 1997 to 61.8 percent in 1998. For the nine months
ended September 30, 1998, total operating expenses increased to $8.22 million
from $5.75 million in 1997 and as a percentage of net revenue, total operating
expenses increased from 53.1 percent in 1997 to 55.7 percent in 1998.
Research and development expense increased to $870,000 during the three months
ended September 30, 1998, compared to $207,000 for the same period a year ago,
and increased as a percentage of net revenue from 4.9 percent in 1997 to 17.4
percent in 1998, reflecting the Company's investment in future products to
enhance revenue growth. For the nine months ended September 30, 1998, research
and development expense increased to $1.94 million compared to $683,000 during
the comparable 1997 period, and increased as a percentage of net revenue from
17
<PAGE>
6.3 percent in 1997 to 13.1 percent in 1998. This increase in expense during
both 1998 periods compared to the same periods in 1997 was the result of
additional salary and benefit expense from staffing increases, increased
consulting and contract labor expense and higher expense for test materials.
Management expects research and development expenditures to approximate $800,000
for the remainder of 1998. These expenditures during the first nine months of
1998 and for the final quarter of 1998 are being directed toward development of
improved RF SCS systems which are expected to be introduced in the United States
in the first quarter of fiscal 1999, an implantable constant rate drug pump,
development of an implantable pulse generator ("IPG") system and DBS products.
The Company has entered into a development and manufacturing contract with
Hi-tronics Design, Inc., a contract engineering and manufacturing firm, to
develop an IPG. IPG systems currently account for 80 percent of the SCS units
sold worldwide. Management expects to seek FDA approval in the first quarter of
1999 to begin clinical studies of the IPG systems during the second quarter of
1999, a necessary step toward regulatory approval to commercially market the IPG
domestically. In addition, ANS will seek CE mark approval during the first half
of 1999, which is needed for commercialization of the IPG system in Europe and
other markets worldwide. If successfully developed, the IPG system should allow
ANS to compete in the largest segment of the SCS market as well as to
manufacture and supply products for DBS pursuant to the Company's agreement with
Sofamor Danek. Additionally, the IPG system potentially expands the markets for
ANS products for use in new applications such as urge incontinence, intractable
angina, peripheral vascular disease and peripheral nerve stimulation.
Marketing expense, as a percentage of net revenue, increased to 24.4 percent for
the three months ended September 30, 1998, compared to 23.4 percent for the
comparable period during 1997, while the dollar amount increased from $989,000
during 1997 to $1.22 million in 1998. This increase in marketing expense during
the 1998 period compared to 1997 was attributable to higher training expense for
new users of ANS products and higher convention and promotional expense. For the
nine months ended September 30, 1998, marketing expense as a percentage of net
revenue decreased to 23.4 percent from 27.0 percent in the comparable 1997
period, while the dollar amount increased to $3.46 million in 1998 from $2.92
million during 1997. This dollar increase during the nine month period in 1998
compared to the same period in 1997 was attributable to higher commissions due
to increased revenue, higher training expense for new users of ANS products and
higher convention and promotional expense.
Amortization expense for intangibles increased from $274,000 during the three
months ended September 30, 1997 to $293,000 during the comparable 1998 period.
For the nine months ended September 30, 1998, amortization expense increased to
$876,000 from $812,000 in 1997. This increase during both periods of 1998
compared to 1997 was due, for the most part, to expense associated with a
non-compete agreement with the former president and chief executive officer.
General and administrative expense as a percentage of net revenue increased to
14.1 percent during the three months ended September 30, 1998 compared to 11.1
percent for the same period during 1997, and the dollar amount increased by
$237,000. This increase in expense during 1998 compared to 1997 was primarily
the result of expense relating to the Tricumed distribution agreement, the
sacral nerve root patent license agreement and other agreements, and increased
costs for recruiting and relocation. For the nine months ended September 30,
1998, general and administrative expense as a percentage of net revenue
increased to 13.2 percent from 12.3 percent in the same period during 1997, and
the dollar amount increased by $614,000. This increase in expense during 1998
compared to 1997 was primarily the result of expense relating to the Sofamor
Danek agreement, Tricumed distribution agreement, the sacral nerve root patent
18
<PAGE>
license agreement and other agreements, increased costs for recruiting and
relocation, and increased costs of existing employee benefit plans.
Earnings From Operations. Earnings from operations decreased to $865,000 during
the three months ended September 30, 1998 compared to $1.13 million for the
comparable 1997 period primarily as a result of decreased gross profit from
product sales due to lower sales of ANS products and higher overall operating
expenses. Earnings from operations increased to $2.99 million during the nine
months ended September 30, 1998 compared to $1.34 million for the comparable
1997 period primarily as a result of increased gross profit which was due to (i)
higher sales of ANS products, (ii) revenue recognized from the agreement with
Sofamor Danek, (iii) the expense in 1997 related to the write-off of inventories
of previous design and (iv) manufacturing cost improvements implemented during
1998.
Other Income/Expense. Other income increased to $168,000 during the three months
ended September 30, 1998 compared to an expense of $118,000 for the comparable
1997 period. For the nine months ended September 30, 1998, other income
increased to $407,000 compared to an expense of $397,000 for the comparable 1997
period. This increase during both periods in 1998 compared to the same periods
in 1997 was primarily a result of two factors. First, interest expense decreased
during both 1998 periods compared to 1997 as a result of the repayment of
short-term notes payable during January 1998 utilizing the proceeds from the
sale of the CVS Operations (see Notes 4 and 8 of the Notes to Condensed
Consolidated Financial Statements). Second, interest income increased during
both 1998 periods compared to 1997 due to higher funds available for investment
as a result of the net proceeds from the January 1998 sale of the CVS
Operations.
Income Taxes. The Company's income tax expense for continuing operations
increased to $419,000 for the three months ended September 30, 1998 compared to
$358,000 during the same period in 1997. For the nine months ended September 30,
1998, income tax expense for continuing operations increased to $1.36 million
from $375,000 during the comparable 1997 period due to the improved earnings
from continuing ANS operations in 1998. The effective tax rates during the three
months and nine months ended September 30, 1998 were 40.6 percent and 40.1
percent, respectively, as 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 compared to the U.S.
statutory rate for corporations of 34 percent.
Net Earnings From Continuing Operations. Net earnings from continuing operations
decreased slightly to $614,000 during the three months ended September 30, 1998
compared to $649,000 during the same period a year earlier. For the nine months
ended September 30, 1998, net earnings from continuing operations increased to
$2.04 million compared to $565,000 during the same 1997 period. This increase
during the nine month period in 1998 compared to the same period in 1997 was
primarily the result of the higher earnings from operations due to increased
gross profit from (i) higher sales of ANS products, (ii) revenue recognized from
the Sofamor Danek agreement, (iii) the 1997 expense related to a write-off of
inventories and (iv) manufacturing cost improvements implemented during 1998 and
the increase in other income due to lower interest expense and higher interest
income.
Discontinued Operations. The net loss from discontinued operations during the
three months ended September 30, 1997 was $200,000. No results were recorded
during the similar three months during 1998 since the discontinued operations
were sold during January 1998. Net earnings from discontinued operations
increased to $4.99 million during the nine months ended September 30, 1998
compared to a net loss of $56,000 during the comparable 1997 period. Net
19
<PAGE>
earnings from discontinued operations during 1998 included an after-tax gain of
$5.2 million on the sale of the assets of the discontinued CVS Operations to
Atrion on January 30, 1998. This gain was partially offset by a loss from
discontinued operations of $212,000 from January 1, 1998 until the sale on
January 30, 1998.
Net Earnings. Net earnings increased to $614,000 during the three months ended
September 30, 1998 compared to $449,000 during the comparable 1997 period due to
the loss from discontinued CVS Operations of $200,000 in the 1997 period. For
the nine months ended September 30, 1998, net earnings increased to $7.03
million compared to $509,000 during the comparable 1997 period due to the gain
on the sale of the assets of the discontinued CVS Operations and the increase in
net earnings from continuing operations discussed above.
Liquidity and Financial Position
In the sale of assets of the CVS Operations to Atrion, the Company received cash
proceeds, after post-closing adjustments as defined in the purchase agreement,
of approximately $23 million which significantly enhanced the Company's
financial position. The Company utilized approximately $9.2 million of the
proceeds to retire short-term notes payable and related expenses of the
transaction. After such repayment, the Company has no debt other than its Allen
facility mortgage of $3.7 million. 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
30, 1999. On October 29, 1998, Atrion notified the Company of its intent to
exercise the option to acquire the facility. Closing of the transaction will
occur on February 1, 1999, and after repayment of the mortgage debt and expenses
of the transaction, the Company expects to receive net proceeds of approximately
$2.7 million. The Company will lease space and certain office and computer
equipment from Atrion for $48,000 per month from February 1 through April 30,
1999, at which time the Company currently intends to lease a facility in the
North Dallas area and relocate its operations there. The expense of moving and
transitioning into the new facility is expected to be immaterial.
The Company's working capital increased from $14.1 million at year-end 1997 to
$16.5 million at September 30, 1998. The ratio of current assets to current
liabilities was 3.2:1 at September 30, 1998, compared to 2.5:1 at December 31,
1997. Cash, cash equivalents and marketable securities totaled $16.2 million at
September 30, 1998 compared to $2.2 million at December 31, 1997.
During January 1998, the Board of Directors approved a stock repurchase program
of up to 500,000 shares of the Company's common stock and during August 1998
approved an additional 1,000,000 shares. During the nine months ended September
30, 1998, the Company repurchased 806,000 shares of its common stock at an
aggregate cost of $6,430,790, or an average of $7.98 per share. The Company has
continued to repurchase shares subsequent to September 30, 1998 and through
October 30, 1998, has repurchased a total of 1,218,625 shares at an aggregate
cost of $9,186,095, or an average of $7.54 per share.
During the nine months ended September 30, 1998, capital expenditures totaled
$807,000, primarily for additional manufacturing tooling and equipment.
Management expects capital expenditures for the remainder of fiscal 1998 of
$700,000 primarily related to manufacturing tooling and equipment for the new
products the Company is developing, including improved RF SCS systems, an IPG
system and a constant rate implantable drug pump. During the third quarter of
1998, the Company licensed exclusive worldwide rights to method patents for
sacral nerve root stimulation aimed at relieving the effects of chronic pelvic
20
<PAGE>
pain. The Company made an initial licensing payment of $250,000 upon executing
the licensing agreement and will pay up to an additional $750,000 in licensing
payments upon certain regulatory approvals which the Company anticipates will
occur during 1999 and 2000. The Company will also pay a royalty on future
product sales used in sacral root stimulation. If the Company relocates its
operations to a leased facility during the second quarter of 1999, the Company
expects to spend approximately $1 million for the purchase of office furniture
and equipment, a computer system and cleanroom system for its manufacturing
operations.
During June 1998, the Company received $4 million cash from Sofamor Danek upon
execution of the agreement in which the Company will develop and manufacture
products and systems for Sofamor Danek for use in Deep Brain Stimulation. The
Company will also receive four additional payments of $2 million each from
Sofamor Danek upon the satisfactory completion of certain domestic and
international regulatory milestones over the next several years. Management
believes the Company should earn the next $2 million payment in fiscal 1999.
Management believes that its current cash, cash equivalents and marketable
securities and funds generated from operations will be sufficient to satisfy
normal cash operating requirements, capital expenditures and stock repurchases
for the foreseeable future.
Cash Flows
Net cash provided by continuing operations increased to $7.29 million during the
nine months ended September 30, 1998, from $1.37 million for the same period a
year ago primarily due to the improved operating results of ANS, deferred
revenue associated with the Company's agreement with Sofamor Danek and income
taxes payable which are not due until 1999. The primary use of cash in
continuing operations during the nine months ended September 30, 1998 was an
increase in the level of accounts receivable of $341,000. Net cash provided by
discontinued operations decreased to $59,000 during the nine months ended
September 30, 1998 compared to $674,000 for the comparable 1997 period as the
1998 period included only one month of results until the sale to Atrion
Corporation on January 30, 1998.
Net cash provided by investing activities increased to $21.4 million during the
nine months ended September 30, 1998, compared to a net use of cash during 1997
of $5.4 million. This increase resulted primarily from two factors. First, the
Company received $21.8 million of net proceeds during the 1998 period from the
sale of its CVS Operations on January 30, 1998. Second, during the 1997 period
the Company used $4.5 million of cash for payments to the former owner of
Neuromed, Inc. for the purchase of certain patents and the settlement of certain
purchase price issues.
Net cash used in financing activities for the nine months ended September 30,
1998 was $13.8 million while financing activities during the same period in 1997
provided net cash of $3.3 million. This decrease was primarily due to the use of
$8.1 million in 1998 to reduce debt under short-term notes payable and $6.4
million used in 1998 for the repurchase of 806,000 shares of the Company's
common stock while the 1997 period included additional net borrowings under
short-term notes of $2.8 million.
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.
21
<PAGE>
Based on recent assessments of its computer systems and programs, the Company
believes that its core manufacturing system software is 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 that these
systems and applications are 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.
Forward-Looking Statements
The following is a "safe harbor" statement under the Private Securities
Litigation Reform Act of 1995: Statements contained in this document that are
not based on historical facts are "forward-looking statements". Terms such as
"plan", "should", "anticipate", "believe", "intend", "estimate", "expect",
"predict", "new market", "potential", "potential new market applications" and
similar expressions are intended to identify forward-looking statements. Such
statements are by nature subject to uncertainties and risks, including but not
limited to: the resumption of growth in ANS revenues in 1999 and continued
market acceptance of ANS products consistent with management expectations;
completion of research and development and capital expenditure projects in an
efficient and timely manner; obtaining regulatory approvals on a timely and cost
efficient basis to permit the introduction of new products; the satisfactory
completion of clinical trials and/or market tests prior to the introduction of
new products; the adequacy, acceptability and timeliness of component supply;
continued reimbursement for medical procedures using the Company's existing
products by medical reimbursement agencies like insurance companies, HMOs,
Medicare and Medicaid without material adverse changes in reimbursement amounts,
qualifications or requirements; the approval of new products by reimbursement
agencies; retention of major customers; the efficacy of the Company's products
for proposed or potential new applications; competition and technological
changes that may render the Company's products obsolete or noncompetitive;
general domestic and international economic conditions; and other risks detailed
from time to time in the Company's SEC public filings. Consequently, if such
management assumptions prove to be incorrect or such risks or uncertainties
materialize, anticipated results could differ materially from those forecast in
forward-looking statements.
Currency Fluctuations
Substantially all of the Company's international sales are denominated in U.S.
dollars. Fluctuations in currency exchange rates in other countries could reduce
the demand for the Company's products by increasing the price of the Company's
products in the currency of the countries in which the products are sold,
although management does not believe currency fluctuations have had a material
effect on the Company's results of operations.
22
<PAGE>
PART II
OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibit 27.1 -- Financial Data Schedule
Exhibit 27.2 -- Restated Financial Data Schedule
(b) No reports on Form 8-K have been filed during the quarter ended
September 30, 1998.
23
<PAGE>
SIGNATURES
In accordance with the requirements of the Exchange Act, the registrant caused
this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
ADVANCED NEUROMODULATION SYSTEMS, INC.
Date: November 12, 1998 By: /s/ F. Robert Merrill III
----------------------------------
F. Robert Merrill III
Executive Vice President, Finance
Chief Financial Officer and Treasurer
24
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
Exhibit 27.1, Financial Data Sheet
</LEGEND>
<CIK> 0000351721
<NAME> Advanced Neuromodulation Systems, Inc.
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> SEP-30-1998
<CASH> 15,701,501
<SECURITIES> 547,817
<RECEIVABLES> 3,078,405
<ALLOWANCES> 224,250
<INVENTORY> 2,995,526
<CURRENT-ASSETS> 23,865,361
<PP&E> 9,535,699
<DEPRECIATION> 1,770,559
<TOTAL-ASSETS> 49,198,459
<CURRENT-LIABILITIES> 7,402,581
<BONDS> 0
0
0
<COMMON> 443,647
<OTHER-SE> 35,776,995
<TOTAL-LIABILITY-AND-EQUITY> 49,198,459
<SALES> 12,860,529
<TOTAL-REVENUES> 14,760,529
<CGS> 3,544,290
<TOTAL-COSTS> 8,223,272
<OTHER-EXPENSES> (661,501)
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 254,133
<INCOME-PRETAX> 3,400,335
<INCOME-TAX> 1,363,866
<INCOME-CONTINUING> 2,036,469
<DISCONTINUED> 4,988,941
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 7,025,410
<EPS-PRIMARY> .82
<EPS-DILUTED> .80
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
Exhibit 27.2, Restated Financial Data Sheet
</LEGEND>
<CIK> 0000351721
<NAME> Advanced Neuromodulation Systems, Inc.
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> SEP-30-1997
<CASH> 997,324
<SECURITIES> 896,018
<RECEIVABLES> 2,782,095
<ALLOWANCES> 160,000
<INVENTORY> 2,848,344
<CURRENT-ASSETS> 20,776,216
<PP&E> 8,624,547
<DEPRECIATION> 1,178,537
<TOTAL-ASSETS> 46,405,388
<CURRENT-LIABILITIES> 9,412,796
<BONDS> 0
0
0
<COMMON> 425,553
<OTHER-SE> 31,856,513
<TOTAL-LIABILITY-AND-EQUITY> 46,405,388
<SALES> 10,821,336
<TOTAL-REVENUES> 10,821,336
<CGS> 3,732,764
<TOTAL-COSTS> 5,750,858
<OTHER-EXPENSES> (59,174)
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 456,575
<INCOME-PRETAX> 940,313
<INCOME-TAX> 375,335
<INCOME-CONTINUING> 564,978
<DISCONTINUED> (55,998)
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 508,980
<EPS-PRIMARY> .06
<EPS-DILUTED> .06
</TABLE>
