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 MARCH 31, 1999
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 May 6, 1999
------------------------ ---------------------------------
<S> <C>
Common stock, $.05 Par Value 7,535,379
</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
March 31, 1999 and December 31, 1998 3-4
Condensed Consolidated Statements of Operations
For the Three Months Ended
March 31, 1999 and 1998 5
Condensed Consolidated Statements of Cash Flows
For the Three Months Ended
March 31, 1999 and 1998 6
Condensed Consolidated Statements of Stockholders'
Equity For the Year Ended December 31, 1998
and the Three Months Ended March 31, 1999 7
Notes to Condensed Consolidated
Financial Statements 8-13
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 14-19
PART II. Other Information 20
Item 6. Exhibits and Reports on Form 8-K 20
SIGNATURES 21
</TABLE>
-1-
<PAGE>
PART I
FINANCIAL INFORMATION
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<PAGE>
ADVANCED NEUROMODULATION SYSTEMS, INC. and SUBSIDIARIES
Condensed Consolidated Balance Sheets
March 31, 1999 and December 31, 1998
<TABLE>
<CAPTION>
March 31,
1999 December 31,
Assets (Unaudited) 1998
- ------ ------------- -------------
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 19,081,986 $ 11,697,209
Marketable securities 536,199 566,072
Receivables:
Trade accounts, less allowance for
doubtful accounts of $161,110 in 1999
and $249,607 in 1998 3,409,416 3,135,615
Interest and other 132,762 124,511
------------- -------------
Total receivables 3,542,178 3,260,126
------------- -------------
Inventories:
Raw materials 1,888,434 1,010,865
Work-in-process 498,683 415,442
Finished goods 1,138,091 1,216,955
------------- ------------
Total inventories 3,525,208 2,643,262
------------- ------------
Net assets of building and land sold in 1999 -- 6,310,985
Deferred income taxes 569,266 887,609
Prepaid expenses and other current assets 843,956 852,025
------------- ------------
Total current assets 28,098,793 26,217,288
------------- -------------
Property, plant and equipment:
Leasehold improvements 98,929 ---
Furniture and fixtures 1,452,007 882,968
Machinery and equipment 2,101,740 2,066,514
------------- ------------
3,652,676 2,949,482
Less accumulated depreciation and amortization 1,194,724 1,060,890
------------- ------------
Net property, plant and equipment 2,457,952 1,888,592
------------- ------------
Cost in excess of net assets acquired, net
of accumulated amortization of $1,873,768
in 1999 and $1,734,617 in 1998 8,937,896 9,077,047
Patents, net of accumulated amortization of
$343,809 in 1999 and $302,281 in 1998 3,012,755 3,054,283
Purchased technology from acquisitions, net
of accumulated amortization of $1,066,667
in 1999 and $1,000,000 in 1998 2,933,333 3,000,000
Tradenames, net of accumulated amortization
of $500,000 in 1999 and $468,750 in 1998 2,000,000 2,031,250
Other assets, net of accumulated amortization
of $86,241 in 1999 and $68,993 in 1998 199,660 216,908
------------- ------------
$ 47,640,389 $ 45,485,368
============= ============
</TABLE>
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<PAGE>
ADVANCED NEUROMODULATION SYSTEMS, INC. and SUBSIDIARIES
Condensed Consolidated Balance Sheets
March 31, 1999 and December 31, 1998
<TABLE>
<CAPTION>
March 31,
1999 December 31,
(Unaudited) 1998
------------- -------------
<S> <C> <C>
Liabilities and Stockholders' Equity
- ------------------------------------
Current liabilities:
Accounts payable $ 704,252 $ 904,899
Short-term notes payable and current maturities
of long-term notes payable --- 3,633,475
Deferred revenue --- 900,000
Accrued salary and employee benefit costs 716,801 562,618
Income taxes payable 3,367,916 2,276,655
Other accrued expenses 1,236,372 1,513,499
------------- ------------
Total current liabilities 6,025,341 9,791,146
------------- ------------
Deferred income taxes 2,357,183 2,390,475
Commitments and contingencies
Stockholders' equity:
Common stock of $.05 par value. Authorized
25,000,000 shares; issued 8,708,367 shares
in 1999 and 8,708,367 in 1998 435,418 435,418
Additional capital 40,344,406 41,156,582
Retained earnings (deficit) 5,137,499 (308,859)
Cost of common shares in treasury; 931,613
shares in 1999 and 1,073,751 in 1998 (6,508,983) (7,848,634)
Accumulated other comprehensive income (loss),
net of tax benefit of $87,078 in 1999
and $67,363 in 1998 (150,475) (130,760)
------------- ------------
Total stockholders' equity 39,257,865 33,303,747
------------- ------------
$ 47,640,389 $ 45,485,368
============= ============
</TABLE>
See accompanying notes to condensed consolidated financial statements.
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<PAGE>
ADVANCED NEUROMODULATION SYSTEMS, INC. and SUBSIDIARIES
Condensed Consolidated Statements of Operations (Unaudited)
For the Three Months Ended March 31, 1999 and 1998
<TABLE>
<CAPTION>
Three Months Ended
March 31,
-----------------------
1999 1998
----------- -----------
<S> <C> <C>
Net revenue-product sales $ 4,595,238 $ 4,423,455
Net revenue-contract research and development 8,900,000 ---
----------- -----------
Total net revenue 13,495,238 4,423,455
----------- -----------
Operating expenses:
Cost of product sales 1,360,180 1,257,632
Research and development 886,268 463,948
Marketing 1,503,182 1,119,660
Amortization of intangibles 295,844 291,502
General and administrative 674,609 519,310
----------- -----------
4,720,083 3,652,052
----------- -----------
Earnings from operations 8,775,155 771,403
----------- -----------
Other income (expenses):
Interest expense (44,861) (96,392)
Interest and other income 227,532 172,362
----------- -----------
182,671 75,970
----------- -----------
Earnings from continuing operations before
income taxes 8,957,826 847,373
Income taxes 3,511,468 345,729
----------- -----------
Net earnings from continuing operations 5,446,358 501,644
----------- -----------
Discontinued Operations:
Loss from discontinued operations, net of income
tax benefits of $129,711 in 1998 --- (211,634)
Gain on sale of assets of discontinued operations
net of income tax expense of $3,216,482 --- 5,200,575
----------- -----------
Net earnings from discontinued operations --- 4,988,941
----------- -----------
Net earnings $ 5,446,358 $ 5,490,585
=========== ===========
Basic earnings per share:
Continuing operations $ .70 $ .06
=========== ===========
Discontinued operations $ --- $ .58
=========== ===========
Net earnings $ .70 $ .64
=========== ===========
Diluted earnings per share:
Continuing operations $ .67 $ .06
=========== ===========
Discontinued operations $ --- $ .56
=========== ===========
Net earnings $ .67 $ .62
=========== ===========
</TABLE>
See accompanying notes to condensed consolidated financial statements.
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<PAGE>
ADVANCED NEUROMODULATION SYSTEMS, INC. and SUBSIDIARIES
Condensed Consolidated Statements of Cash Flows (Unaudited)
For the Three Months Ended March 31, 1999 and 1998
<TABLE>
<CAPTION>
Three Months Ended
March 31,
--------------------------
1999 1998
------------- ------------
<S> <C> <C>
Cash flows from operating activities:
Net earnings from continuing operations $ 5,446,358 $ 501,644
------------- ------------
Adjustments to reconcile net earnings from
continuing operations to net cash provided
by operating activities
Depreciation and amortization 444,331 436,665
Deferred income taxes 295,208 (33,292)
Changes in assets and liabilities:
Receivables (282,052) (218,150)
Inventories (881,946) 204,432
Prepaid expenses and other assets 8,069 189,499
Deferred revenue (900,000) ---
Income taxes payable 1,091,261 361,021
Accounts payable (200,647) 77,582
Accrued expenses (181,576) 128,840
------------- ------------
Total adjustments (607,352) 1,146,597
------------- ------------
Net cash provided by
continuing operations 4,839,006 1,648,241
Net cash provided by
discontinued operations --- 59,049
------------- ------------
Net cash provided by operating
activities 4,839,006 1,707,290
------------- ------------
Cash flows from investing activities:
Proceeds from sales of marketable securities --- 350,000
Additions to property, plant and equipment
- continuing operations (703,194) (295,919)
Additions to property, plant and equipment
- discontinued operations --- (12,060)
Net proceeds from sale of discontinued operations 6,354,965 22,460,499
------------- ------------
Net cash provided by investing
activities 5,651,771 22,502,520
------------- ------------
Cash flows from financing activities:
Exercise of stock options 527,475 135,906
Purchase of treasury stock --- (508,008)
Payment of short-term obligations (3,633,475) (8,011,826)
Payment of long-term debt --- (42,948)
------------- ------------
Net cash used in financing activities (3,106,000) (8,426,876)
------------- ------------
Net increase in cash and cash equivalents 7,384,777 15,782,934
Cash and cash equivalents at beginning of year 11,697,209 747,828
------------- ------------
Cash and cash equivalents at March 31 $ 19,081,986 $ 16,530,762
============= ============
Supplemental cash flow information is presented
below:
Income taxes paid $ 2,125,000 $ 18,000
============= ============
Interest paid $ 44,861 $ 135,321
============= ============
</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, 1997 8,635,509 $ 431,775 $ 40,780,717 $ (7,268,061) $ (38,494) --- $ 33,905,937
Net earnings --- --- --- 6,959,202 --- --- 6,959,202
Adjustment to
unrealized losses
on marketable
securities --- --- --- --- (92,266) --- (92,266)
-------------
Comprehensive Income 6,866,936
-------------
Shares issued upon
exercise of
stock options 72,858 3,643 160,554 --- --- --- 164,197
Tax benefit from
employee stock
option exercise --- --- 119,509 --- --- --- 119,509
Compensation
expense resulting
from changes to
stock options --- --- 1,004,654 --- --- --- 1,004,654
Issuance of 184,874
shares from
treasury for stock
option exercises --- --- (908,852) --- --- 1,562,421 653,569
Purchase of
1,258,625 treasury
shares, at cost --- --- --- --- --- (9,411,055) (9,411,055)
------------- ------------- ------------- ------------- ------------- ------------- -------------
Balance at
December 31, 1998 8,708,367 435,418 41,156,582 (308,859) (130,760) (7,848,634) 33,303,747
Net earnings --- --- --- 5,446,358 --- --- 5,466,358
Adjustment to
unrealized
losses on
marketable
securities --- --- --- --- (19,715) --- (19,715)
-------------
Comprehensive Income 5,426,643
-------------
Issuance of
142,138 shares
from treasury
for stock option
exercises --- --- (812,176) --- --- 1,339,651 527,475
------------- ------------- ------------- ------------- ------------- ------------- -------------
Balance at
March 31, 1999 8,708,367 $ 435,418 $ 40,344,406 $ 5,137,499 $ (150,475) $ (6,508,983) $ 39,257,865
============= ============= ============= ============= ============= ============= =============
</TABLE>
See accompanying notes to condensed consolidated financial statements.
-7-
<PAGE>
(1) BUSINESS
Continuing Operations
Advanced Neuromodulation Systems, Inc. (the "Company" or "ANS")
designs, develops, manufactures and markets implantable medical device
systems used to manage chronic intractable pain and other disorders of
the central nervous system. ANS revenues are derived primarily from
sales throughout the United States, Europe and Australia.
The 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.
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 8 - "Sale of CVS Operations/Discontinued Operations"). The
CVS Operations have been accounted for as discontinued operations in
the Condensed Consolidated Financial Statements for the three months
ended March 31, 1998. During October 1998, Atrion also exercised an
option to acquire the Company's land, office and manufacturing facility
for $6.5 million. The transaction was closed on February 1, 1999. Net
assets of the land and facility have been presented on the Condensed
Consolidated Balance Sheet at December 31, 1998, as net assets of
building and land sold in 1999.
(2) CONDENSED FINANCIAL STATEMENTS
The unaudited consolidated financial information contained in this
report reflects all adjustments (consisting of normal recurring
accruals) considered necessary, in the opinion of management, for a
fair presentation of results for the interim periods presented. The
preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the
date of the financial statements and the reported amounts of revenues
and expenses during the reporting period. Actual results could differ
from these estimates.
-8-
<PAGE>
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, 1998 Annual
Report on Form 10-K. The results of operations for periods ended March
31, 1999 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
March 31, 1999:
<TABLE>
<CAPTION>
Gross Gross
Unrealized Unrealized Estimated
Cost Gains Losses Fair Value
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Investment grade preferred
securities $ 557,596 $ -- $ 165,128 $ 392,468
Publicly traded limited
partnerships 51,875 -- 13,125 38,750
Real estate investment trusts 141,590 -- 37,062 104,528
Other 13,134 -- 12,681 453
=========== =========== =========== ===========
$ 764,195 $ -- $ 227,996 $ 536,199
=========== =========== =========== ===========
</TABLE>
At March 31, 1999, 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 March 31, 1999.
(4) NOTES PAYABLE
Notes payable at March 31, 1999 and December 31, 1998 were as follows:
<TABLE>
<CAPTION>
March 31, December 31,
1999 1998
------------- ------------
<S> <C> <C>
Mortgage notes $ --- $ 3,633,475
Less current maturities --- 3,633,475
------------- ------------
Lont-term notes payable $ --- $ ---
============= ============
</TABLE>
In 1993, the Company entered into two mortgage notes relating to its
principal office and manufacturing facility. The first note, in the
amount of $2,825,332 at December 31, 1998, bore interest at 8.59
percent and had a twenty-five year amortization. The Allen facility and
land secured the note. The second note, in the amount of $808,143 at
December 31, 1998, was related to equipment and furnishings and bore
interest at 7.94 percent. The note had a ten-year amortization and was
collateralized by the equipment and furnishings. On February 1, 1999,
the Company repaid the two mortgage notes in connection with the sale
of the land and facility to Atrion Corporation (see Note 8 - "Sale of
CVS Operations/Discontinued Operations").
-9-
<PAGE>
(5) COMMITMENTS AND CONTINGENCIES
In February 1999, the Company entered into a sixty-three month lease
agreement on 40,000 square feet of space located in the North Dallas
area. The Company will relocate its operations to the leased facility
in May 1999. Under the terms of the lease agreement, the Company will
receive three months free rent and the monthly rental rate for the
remaining term of the lease is $48,308. The monthly rental rate
includes certain operating expenses such as property taxes on the
facility, insurance, landscape and maintenance and janitorial services.
The Company also has a first right of refusal to acquire the facility.
The Company expects to spend approximately $2.3 million for furniture
and equipment, leasehold improvements, computer systems, telephone
systems and manufacturing clean room space for the leased facility. The
Company has committed to most of the $2.3 million expenditures at March
31, 1999. Other than the facility lease, the Company has no material
commitments under noncancelable operating leases at March 31, 1999.
The Company is a party to product liability claims related to ANS
implantable stimulation devices. Product liability insurers have
assumed responsibility for defending the Company against these claims.
While historically product liability claims for ANS stimulation 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 stimulation
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 ended March 31, 1999 and 1998, of $3,511,468
and $345,729, an overall effective tax rate of 39.2 percent and 40.8
percent, respectively. The Company's expense for amortization 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. During the three
months ended March 31, 1998, the Company also recorded income tax
expense from discontinued operations of $3,086,771 from the gain on the
sale of the CVS Operations (see Note 8 - "Sale of CVS
Operations/Discontinued Operations").
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<PAGE>
(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 per
share for the three months ended March 31, 1999 and 1998 are based upon
7,746,402 and 8,621,071 shares, respectively. Diluted earnings (loss)
per share for the three months ended March 31, 1999 and 1998 are based
upon 8,109,726 and 8,851,714 shares, respectively. The following table
presents the reconciliation of basic and diluted shares:
<TABLE>
<CAPTION>
Three Months Ended
March 31,
--------------------------
1999 1998
------------- ------------
<S> <C> <C>
Weighted-average shares outstanding
(basic shares) 7,746,402 8,621,071
Effect of dilutive instruments
Stock options 349,775 217,550
Warrants 13,549 13,093
------------- ------------
Dilutive potential common shares 363,324 230,643
------------- ------------
Diluted shares 8,109,726 8,851,714
============= ============
</TABLE>
For the three months ended March 31, 1999 and 1998, the incremental
shares used for dilutive earnings per share relate to stock options and
warrants whose exercise price was less than the average market price in
the underlying quarterly computations. Options to purchase 116,000
shares at an average price of $10.41 were outstanding at March 31, 1998
but were not included in the computation of diluted earnings per share
for the three months ended March 31, 1998 because the options' exercise
prices were greater than the average market price of the common shares
and, therefore, the effect would be antidilutive. For the three months
ended March 31, 1999, all options and warrants were included in the
computation of diluted earnings per share since all exercise prices
were less than the average market price of the common shares for the
three month period in 1999.
(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 Company reported an after tax gain from
the sale of $5.2 million during the three months ended March 31, 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. The Company also reported
an after tax loss of $212,000 during the three months ended March 31,
1998, from operating losses of the CVS Operations prior to the sale to
Atrion.
As part of the sale of the CVS Operations to Atrion, the Company
granted Atrion a nine-month option to acquire the Company's principal
-11-
<PAGE>
office and manufacturing facility for $6.5 million. During October
1998, Atrion exercised its option to acquire the facility. When the
facility was built in 1993, the Company entered a ten-year agreement
with the City of Allen granting tax abatements to the Company if a
minimum job base and personal property base was maintained in the City
of Allen. The agreement provided for the repayment of abated taxes if
the Company defaulted under the agreement. During the fourth quarter
the Company recorded a pretax expense of $969,204 in connection with
the abated taxes. In April 1999, the Company was successful in
petitioning the City of Allen to assign the abatement agreement to
Atrion. If Atrion meets the minimum requirements under the agreement
until 2003, then there may be no payment required.
Operating results of the CVS Operations have been reclassified and
reported as discontinued operations. Summary operating results for the
three months ended March 31, 1998 for the CVS Operations were as
follows (the 1998 period included results until the sale on January 30,
1998):
<TABLE>
<CAPTION>
Three Months Ended
March 31,
--------------------------
1999 1998
------------- ------------
<S> <C> <C>
Revenue $ --- $ 1,111,992
Gross profit --- 206,481
Earnings (loss) from operations --- (307,120)
Interest expense --- (34,225)
------------- ------------
Loss before income tax benefit --- (341,345)
Income tax benefit --- (129,711)
------------- ------------
Net loss $ --- $ (211,634)
============= ============
</TABLE>
On February 1, 1999, the sale of the facility to Atrion was
consummated. The Company repaid the mortgage debt on the facility at
the closing of the transaction (see Note 4 - "Notes Payable"). After
repayment of the mortgage debt and expenses related to the transaction,
the Company received $2.7 million of net proceeds. No material gain or
loss was recorded on the sale of the facility except related to the tax
abatement liability described above. The Company will move its
operations to a 40,000 square foot leased facility in the North Dallas
area during May 1999. Until such time, the Company is leasing space and
equipment from Atrion at a monthly expense of $48,175 and is paying
Atrion fifty percent of certain facility operating expenses. The
Company expects the expense of moving and transitioning into the new
facility to be immaterial.
(9) COMPREHENSIVE INCOME
Total comprehensive income for 1998 and for the three months ended
March 31, 1999 is reported in the Condensed Consolidated Statements of
Stockholders' Equity. Comprehensive income for the three months ended
March 31, 1999 and 1998 is as follows:
<TABLE>
<CAPTION>
Three Months Ended
March 31,
--------------------------
1999 1998
------------- ------------
<S> <C> <C>
Net earnings $ 5,446,358 $ 6,959,202
Other comprehensive income (19,715) (92,266)
------------- ------------
Comprehensive income $ 5,426,643 $ 6,866,936
============= ============
</TABLE>
-12-
<PAGE>
(10) PRODUCT DEVELOPMENT AGREEMENT
In June 1998, the Company entered an agreement with Sofamor Danek
Group, Inc. ("Sofamor Danek") under which the Company agreed to 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 of the agreement that was
being recognized into income as revenue based upon the estimated
percentage of completion of the development project. During the year
ended December 31, 1998, the Company recognized $3.1 million into
income as revenue. The remaining $900,000 was recognized into income as
revenue during the three months ended March 31, 1999 due to the
termination of the agreement discussed below. The agreement also called
for ANS to receive four additional payments of $2 million each, to be
recognized into income upon the satisfactory completion of certain
domestic and international regulatory milestones over the next several
years.
In December 1998, the Company and Sofamor Danek agreed to terminate the
June 1998 DBS agreement due to the impending merger of Sofamor Danek
and Medtronic, the Company's sole competitor in the DBS market. Under
the termination agreement, Sofamor Danek agreed to accelerate the $8
million in payments due the Company and the Company agreed to release
Sofamor Danek from further contractual obligations. The $8 million
payment was made in January 1999 and recognized into income as revenue
during the three months ended March 31, 1999.
-13-
<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 Consolidated Financial
Statements of the Company and the related Notes.
OVERVIEW
On January 30, 1998, we sold the assets of our CVS Operations, including our
MPS(R) myocardial protection system product line, to Atrion Corporation
("Atrion"). See Note 8 - "Sale of CVS Operations/ Discontinued Operations" of
the Notes to Condensed Consolidated Financial Statements. We received
approximately $23 million in cash from the sale. We also granted Atrion a
nine-month option to acquire our principal office and manufacturing facility in
Allen, Texas for $6.5 million. Atrion exercised the option to acquire the
facility during October 1998 and the transaction closed on February 1, 1999. We
repaid the outstanding mortgage debt on the facility at closing and received net
proceeds of $2.7 million after paying expenses related to the transaction. No
material gain or loss was realized on the sale of the facility. We are leasing
space, furniture and equipment from Atrion until May 1999 at the monthly rate of
$48,125 and are paying Atrion fifty percent of certain operating expenses. At
that time we will move our operations to a 40,000 square foot leased facility in
Plano, Texas, a northeast suburb of Dallas. We expect the expense of moving and
transitioning into the new facility to be immaterial.
We have accounted for the CVS Operations as discontinued operations in the
Consolidated Financial Statements for the three months ended March 31, 1998.
In June 1998, we completed an agreement with Sofamor Danek Group, Inc. ("Sofamor
Danek") under which we would develop and manufacture for Sofamor Danek, products
and systems for use in Deep Brain Stimulation ("DBS"). See Note 10 - "Product
Development Agreement" of the Notes to Condensed Consolidated Financial
Statements. We received a payment of $4 million upon execution of the agreement
that was recognized into income as revenue based upon the estimated completion
of the development project. During the year ended December 31, 1998, we
recognized $3.1 million into income as revenue. The remaining $900,000 was
recognized into income as revenue during the three months ended March 31, 1999.
In January 1999, the agreement with Sofamor Danek was terminated in conjunction
with the merger of Sofamor Danek and Medtronic, Inc. In connection with the
termination, we received an additional payment of $8 million from Sofamor Danek,
which was recognized into income as revenue during the three months ended March
31, 1999.
Our strategy is to strengthen and broaden our neuromodulation technology
platforms and to ally ourselves with strategic partners who can help us leverage
ANS' core technology into other significant market segments beyond our focus on
the pain management market. We are evaluating potential strategic partners for
DBS to replace the terminated relationship with Sofamor Danek.
-14-
<PAGE>
RESULTS OF OPERATIONS
Comparison of the Three Months Ended March 31, 1999 and 1998
- ------------------------------------------------------------
We reported net earnings of $5.45 million or $.67 per diluted share for the
three months ended March 31, 1999, compared to $5.49 million or $.62 per diluted
share in the same 1998 period. The 1998 results included net earnings of $4.99
million from the net gain on the sale of the discontinued CVS Operations, or
$.56 per diluted share. Net earnings from continuing operations increased to
$5.45 million or $.67 per diluted share in 1999 compared to $502,000 or $.06 per
diluted share in 1998 due to $8.9 million of revenue recorded in connection with
our former agreement with Sofamor Danek.
Total net revenue from continuing ANS operations of $13.5 million for the three
months ended March 31, 1999, was $9.1 million, or 205 percent, above the
comparable 1998 level of $4.4 million. The 1999 period includes $8.9 million of
net revenue associated with our former development agreement for DBS products
with Sofamor Danek. Net revenue from ANS product sales increased 4 percent to
$4.6 million during the 1999 period compared to $4.4 million in the comparable
1998 period. This increase in net revenue from product sales was the result of
higher unit sales volume of ANS' radio-frequency stimulation systems used to
treat complex pain patterns, primarily in the United States. We expect to launch
our enhanced radio-frequency stimulation systems in the United States market
during the second quarter of 1999. Our strategy is to expand our product
offerings to all segments of the neuromodulation market and therefore we have
increased our investment in research and development. These development projects
include an implantable pulse generator for spinal cord stimulation, an
implantable pulse generator for deep brain stimulation and a low-cost constant
rate intrathecal drug pump. Through a strategic alliance with Tricumed, we are
also developing a programmable rate intrathecal drug pump that we intend to
market in the United States and internationally after receiving the appropriate
regulatory approvals.
Gross profit from product sales increased to $3.24 million in 1999 from $3.17
million in 1998 due to the increase in net revenue from product sales discussed
above. Gross profit margin from product sales decreased to 70.4 percent in 1999
compared to 71.6 percent in 1998 due, for the most part, to an increase in
manufacturing overhead expense in quality assurance and manufacturing
engineering.
Total operating expenses (the aggregate of research and development, marketing,
amortization of intangibles and administrative expenses) increased to $3.36
million in 1999 compared to $2.39 million in 1998.
Research and development expense increased to $886,000 during the three months
ended March 31, 1999 from $464,000 during the same period in 1998, reflecting
our stepped up commitment to develop products that can expand our presence into
all market segments of the neuromodulation market. This increase during 1999
compared to 1998 was the result of higher salary and benefit expense from
staffing additions, higher consulting expense, higher depreciation expense and
higher patent legal expense. We continue to direct these expenditures during
1999 toward development of our enhanced radio-frequency stimulation systems
(which we expect to introduce to the U.S. market in the second quarter of 1999),
a low-cost constant rate intrathecal drug pump, an implantable pulse generator
stimulation system for spinal cord stimulation and an implantable pulse
generator system for deep brain stimulation. We expect to complete the
development of our implantable pulse generator stimulation system for spinal
cord stimulation during the third quarter of 1999 and expect to seek FDA
-15-
<PAGE>
approval in the third quarter of 1999 to initiate clinical trials in the United
States. We will also seek the CE mark (European) approval for the implantable
pulse generator stimulation system for spinal cord stimulation during the second
half of 1999 with market introduction expected internationally in the fourth
quarter of 1999. We also expect to complete development of our low-cost constant
rate intrathecal drug pump during the third quarter of 1999 and expect to seek
approval from the FDA to initiate clinical trials at that time. During February
1999, we received conditional approval from the FDA to initiate a pilot clinical
study to evaluate the use of our advanced radio-frequency stimulation systems to
treat interstitial cystitis, an extremely painful bladder disease that affects
an estimated 500,000 people worldwide. We expect to begin the pilot study in May
1999. If the pilot study is successful, we would seek approval from the FDA to
initiate further clinical studies in the process to receive clearance from the
FDA to begin marketing in the United States. We also are currently evaluating
strategic partners to replace our former relationship with Sofamor Danek for
deep brain stimulation.
Marketing expense increased from $1.12 million during the three months ended
March 31, 1998 to $1.50 million during the same period in 1999. This increase in
expense during 1999 compared to 1998 was attributable to higher commissions from
increased product sales and a change from distributors to commissioned sales
agents in certain United States territories, higher salary and benefit expense
from staffing additions and higher consulting expense.
General and administrative expense increased from $519,000 during the three
months ended March 31, 1998 to $675,000 during the same period in 1999. This
increase in expense during 1999 compared to 1998 was principally the result of
higher salary and benefit expense from staffing additions, including a new Chief
Executive Officer hired in April 1998, higher legal expense related to the
termination agreement with Sofamor Danek and our new facility lease, and higher
investor and public relations expense.
Amortization of ANS intangibles increased from $292,000 during the three months
ended March 31, 1998 to $296,000 during the same period in 1999, mostly due to
amortization expense for licensed patents related to sacral nerve stimulation,
which we licensed in August 1998.
Other income increased to $183,000 for the three months ended March 31, 1999
from $76,000 during the same period in 1998. This increase was the result of two
factors. First, interest expense decreased by $52,000 during 1999 compared to
1998 due to the repayment of our mortgage debt on February 1, 1999. Second,
interest income increased by $55,000 in 1999 compared to 1998 due to higher
funds available for investment.
Income tax expense from continuing operations increased to $3.5 million for the
three months ended March 31, 1999 from $346,000 during the same period a year
ago due to higher earnings from ANS operations. This represents effective tax
rates of 39.2 percent in 1999 and 40.8 percent in 1998. Our 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 1999 and 1998 compared to the U.S.
statutory rate for corporations of 34 percent.
LIQUIDITY AND CAPITAL RESOURCES
At March 31, 1999 our working capital increased from $16.4 million at year-end
1998 to $22.1 million. The ratio of current assets to current liabilities was
-16-
<PAGE>
4.66:1 at March 31, 1999, compared to 2.68:1 at December 31, 1998. Cash, cash
equivalents and marketable securities totaled $19.6 million at March 31, 1999
compared to $12.3 million at December 31, 1998.
In January 1999, we received the $8 million payment in connection with the
termination of the DBS agreement with Sofamor Danek.
During February 1999, we completed the sale of our corporate facility to Atrion
for $6.5 million. After we repaid the mortgage debt on the facility and paid
expenses related to the transaction, we realized net proceeds of $2.7 million.
During the first quarter of 1999, we did not repurchase any additional shares of
our stock under our share repurchase program. At March 31, 1999, we had
repurchased a total of 1,258,625 shares of our common stock at an aggregate cost
of $9,411,055 and 241,375 shares remained authorized under our repurchase
program. During the second quarter of 1999 we purchased the remaining 241,375
shares which were authorized under the stock repurchase program at a cost of
$1,673,672, or $6.93 per share.
We spent $703,000 on capital expenditures during the first quarter of 1999 and
expect capital expenditures for the remainder of 1999 of approximately $2.8
million. Of the $3.5 million in expenditures, approximately $2.3 million is
budgeted for new furniture and equipment, computer systems, telephone system,
manufacturing clean-room and leasehold improvements for our relocation to our
new leased facility in May 1999. The remaining expenditures primarily relate to
manufacturing tooling and equipment for the new products we are developing and
sacral nerve root patent licensing fees.
We believe our current cash, cash equivalents and marketable securities and cash
generated from our operations will be sufficient to fund all of our operating
needs, including capital expenditures and share repurchases for the foreseeable
future.
CASH FLOWS
Net cash provided by continuing operations was $4.8 million for the three months
ended March 31, 1999 compared to $1.6 million during the comparable period in
1998. This improvement during 1999 compared to 1998 reflects the improved
operating results of ANS from revenue recorded in connection with our former
agreement with Sofamor Danek. During the first quarter of 1999, we used $882,000
to increase our investment in inventory primarily for raw materials in
preparation for manufacturing our enhanced radio-frequency stimulation systems
that will be introduced in the United States market during the second quarter of
1999. Net cash provided by discontinued operations was $59,000 for the three
months ended March 31, 1998, which included only one month of results until the
sale in January 1998.
Net cash provided by investing activities was $5.7 million for the three months
ended March 31, 1999 compared to $22.5 million during the comparable period in
1998. The 1998 period reflects net proceeds from the sale of our discontinued
operations of $22.5 million and the 1999 period reflects $6.4 million of net
proceeds from the sale of our facility in February 1999.
Net cash used in financing activities was $3.1 million for the three months
ended March 31, 1999 compared to $8.4 million during the comparable period in
1998. During 1999, we received cash of $527,000 from the exercise of stock
-17-
<PAGE>
options while we used $3.6 million to repay our mortgage debt when we sold our
facility to Atrion in February 1999. During the three months ended March 31,
1998, we received cash of $136,000 from the exercise of stock options while we
used $8.1 million to repay borrowings under short-term notes and $508,000 to
repurchase 73,000 shares of our common stock.
YEAR 2000
The Year 2000 issue results from computer programs being written using two
digits rather than four to define the applicable year. Computer programs or
hardware that have date-sensitive software or embedded chips may recognize a
date using "00" as the Year 1900 rather than the Year 2000. This could result in
a system failure or miscalculations causing disruptions of operations,
including, among other things, a temporary inability to process transactions,
send invoices, manufacture products or engage in similar normal business
activities.
We began our assessment of our computer software, hardware, manufacturing
equipment and other non-critical systems in early 1998 and are substantially
complete. The assessment determined that most of our computer hardware and
software and manufacturing equipment were Year 2000 compliant. Certain personal
computers, non-critical internal software programs and manufacturing equipment
will need modifications or replacement and we expect the costs associated with
the replacement and modifications to approximate $125,000. We estimate the costs
incurred in the assessment of our systems since early 1998 to be under $100,000,
which have been expensed in our current operations.
When we sold our facility to Atrion on February 1, 1999, Atrion also acquired
our mainframe computer and software applications. In moving to a new leased
facility in May 1999, we will purchase new computer hardware and software that
is similar to our current systems. We will also purchase a new telephone system.
We have received assurances from the providers of the new systems that they are
Year 2000 compliant. We expect to spend approximately $500,000 for these new
systems (in addition to the $125,000 for modifications and replacements
discussed above), which is included in the $2.3 million we have budgeted for the
relocation. We will fund these costs from our current cash reserves and expect
most of the costs will be capitalized.
When we relocate to our new facility and install our new computer hardware and
software systems, we will test the systems to ensure compliance with Year 2000.
We expect to complete the testing by the end of the third quarter of 1999. We
also plan to complete the modifications necessary to non-critical software
applications and manufacturing equipment by the end of the third quarter of
1999.
We have contacted the third-party vendors and suppliers of products and services
that we consider critical to our operations to ascertain their level of Year
2000 readiness. We have no means of ensuring that all vendors and suppliers will
be Year 2000 compliant. The inability of these parties to complete their Year
2000 resolution process could materially impact us. As a result, we will
consider new business relationships with alternate providers of products and
services as necessary and to the extent alternatives are available.
-18-
<PAGE>
Our goal is to ensure all critical systems and processes under our control
remain operational. However, because certain systems and processes may be linked
with systems outside our control, we cannot guarantee that all implementations
will be successful. As a result, we are developing a contingency plan to respond
to any failures that may occur. We do not expect the costs of our Year 2000
project to have a material adverse effect on our financial position or results
of operations. However, any unanticipated failures by critical third party
suppliers and vendors, as well as our own failure to execute our Year 2000 plan,
could have a material adverse impact on the Company.
FORWARD-LOOKING STATEMENTS
The following is a "safe harbor" statement under the Private Securities
Litigation Reform Act of 1995: The matters discussed in this Quarterly Report on
Form 10-Q 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", "potential", "new market applications" and similar
expressions and variations thereof are intended to identify forward-looking
statements. Such statements appear in a number of places in this Quarterly
Report on Form 10-Q and include statements regarding our intent, belief or
current expectations with respect to, among other things: (i) trends affecting
our financial condition or results of operations; (ii) our financing plans; and
(iii) our business growth strategies. We caution our readers that any
forward-looking statements are not guarantees of future performance and involve
risks and uncertainties. Actual results may differ materially from those
projected in the forward-looking statements as a result of various factors.
These risks and uncertainties include the following: completion of research and
development projects in an efficient and timely manner; obtaining regulatory
approvals on a timely and cost efficient basis to permit the introduction of new
products; entering into suitable strategic alliances (for example, with respect
to DBS) that enable us to leverage our technology into other markets; 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; the approval of new products by reimbursement agencies like
insurance companies, HMOs, Medicare and Medicaid; the efficacy of our products
for new applications; the uncertainty that we will be able to negotiate and
consummate a new deep brain stimulation partnership agreement; timely completion
of our Year 2000 readiness efforts on budget; and other risks detailed from time
to time in our SEC public filings. Consequently, if our assumptions prove to be
incorrect or such risks or uncertainties materialize, anticipated results could
differ materially from those forecasted in forward-looking statements.
CURRENCY FLUCTUATIONS
Substantially all of our international sales are denominated in U.S. dollars.
Fluctuations in currency exchange rates in other countries could reduce the
demand for our products by increasing the price of our products in the currency
of the countries in which the products are sold, although we do not believe
currency fluctuations have had a material effect on the Company's results of
operations to date.
-19-
<PAGE>
PART II
OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibit 27.1- Financial Data Schedule
(b) No reports on Form 8-K have been filed during the quarter ended
March 31, 1999.
-20-
<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: May 10, 1999 By:/s/ F. Robert Merrill III
----------------------------
F. Robert Merrill III
Executive Vice President, Finance
Chief Financial Officer and Treasurer
-21-
<PAGE>
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<ARTICLE> 5
<LEGEND>
Exhibit 27.1, Financial Data Sheet
</LEGEND>
<CIK> 0000351721
<NAME> Advanced Neuromodulation Systems, Inc.
<S> <C>
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<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
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<SECURITIES> 536,199
<RECEIVABLES> 3,570,526
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<INVENTORY> 3,525,208
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