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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-K
|X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 For the Fiscal Year
Ended December 31, 1999
OR
| | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANCE ACT OF 1934
For the transition period from to
Commission File Number: 0-10521
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ADVANCED NEUROMODULATION SYSTEMS, INC.
(Exact name of registrant as specified in its charter)
<TABLE>
<S> <C>
TEXAS 75-1646002
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
6501 WINDCREST DRIVE,
PLANO, TEXAS 75024
(Address of principal executive offices) (Zip Code)
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Registrant's telephone number, including area code: (972) 309-8000
SECURITIES REGISTERED UNDER SECTION 12(b) OF THE EXCHANGE ACT:
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<S> <C>
Title of Each Class Name of Each Exchange on Which Registered
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NONE NONE
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SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE EXCHANGE ACT:
Title of Class
Common Stock, $.05 Par Value
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Indicate by checkmark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes |X| No | |
Indicate by checkmark if disclosure of delinquent filers pursuant to Item
405 of the S-K is not contained herein, and will not be contained, to the best
of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. |X|
Aggregate market value of the registrant's Common Stock held by
non-affiliates of the registrant as of March 20, 2000: $130,982,659
Number of shares outstanding of the registrant's Common Stock as of
March 20, 2000: 7,462,706
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DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's definitive Proxy Statement for the
registrant's Annual Meeting of Stockholders to be held on May 24, 2000, are
incorporated by reference into Part III.
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Advanced Neuromodulation Systems, Inc.
Annual Report
Form 10-K
Year Ended December 31, 1999
PART I
ITEM 1. BUSINESS
General
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Advanced Neuromodulation Systems, Inc. designs, develops, manufactures and
markets advanced implantable neuromodulation devices that improve the quality of
life for people with disabling chronic pain or nervous system disorders.
Neuromodulation is the electrical or chemical modulation of the central nervous
system to significantly reduce chronic pain or improve neurological function.
Until June 1998, ANS was known as Quest Medical, Inc.
Because neuromodulation devices have gained acceptance as a viable, efficacious
and cost-effective treatment alternative for relieving chronic intractable pain
and improving neurological function, we are continuing efforts to expand our
product offerings in the high growth market of neuromodulation. Today, we are a
market share and technology leader in the $42 million radio-frequency
stimulation segment of the neuromodulation market. In 1999, we continued to
accelerate our investment in development projects to position us to participate
in the other larger and more rapidly growing segments of the neuromodulation
market. Excluding vagus nerve stimulation for treating epilepsy, which we do not
currently anticipate addressing, industry analysts expect the neuromodulation
market to grow from $400 million in 1999 to nearly $900 million by 2003.
Recent Developments
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In January 1999, due to the merger of Sofamor Danek and Medtronic, Inc., we
terminated our June 1998 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. Under the terms of the
termination agreement, Sofamor Danek agreed to accelerate payments due to us in
the amount of $8 million. We received the $8 million payment during January 1999
when the merger of Sofamor Danek and Medtronic was consummated. See Item 7:
"Management's Discussion and Analysis of Financial Condition and Results of
Operations-Overview" and Note 10- "Product Development Agreement" of the Notes
to Consolidated Financial Statements.
On February 1, 1999, we sold our principal office and manufacturing facility in
Allen, Texas to Atrion Corporation for $6.5 million. Atrion purchased the
Company's CVS Operations in January 1998. See Note 9- "Sale of CVS
Operations/Discontinued Operations" of the Notes to Consolidated Financial
Statements. The facility was approximately 107,000 square feet and was
constructed during 1993 on 19.2 acres of land that we acquired in 1985. We
repaid the outstanding mortgage debt on the facility of $3.6 million 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 leased space, furniture and equipment from Atrion until May 1999 at the
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monthly rate of $48,125 and paid Atrion fifty percent of certain operating
expenses including utilities, janitorial services, landscaping services,
insurance and property taxes. At that time we moved our operations to a 40,000
square foot leased facility in Plano, Texas, a northeast suburb of Dallas. See
Item 2: "Properties".
In September 1999, the Neurological Devices Panel of the Medical Devices
Advisory Committee recommended that the FDA reclassify Totally Implanted Spinal
Cord Stimulators (IPGs) for treatment of pain of the trunk and/or limbs from a
Class III device to a Class II device. Class III devices typically require a
Pre-Market Approval (PMA), supplemented with clinical trials to prove safety and
effectiveness of the device. Class II devices typically require a Pre-Market
Notification (510(k)) to demonstrate substantial equivalence to an existing
legally marketed device prior to receiving market clearance by the FDA.
According to the FDA's 1999 ODE Annual Report, the average time for PMA's was
12.5 months (excluding the one-year typically required for clinical trials, or
approximately 24 months total). The ODE Annual Report reported the average
elapsed time for a 510(k) approval of 3.4 months in 1999.
We expected to receive a final reclassification decision from the FDA in January
2000 but have experienced a delay that we believe is related to the FDA's
workload. We received a written progress report dated February 25, 2000 in which
the FDA stated that it had received adequate information to move forward toward
a final decision. The agency's letter further indicated that there may be
"special controls" available to ensure the safety and effectiveness of the IPG
device for treating pain of the trunk and/or limbs. We remain optimistic that
the FDA will follow the recommendation of its panel to reclassify the IPG and we
are prepared to move quickly to file the 510(k) Pre-Market Notification for
clearance to market the IPG in the United States if the FDA approves the
reclassification. The IPG segment of the neuromodulation market for spinal cord
stimulation to treat pain of the trunk and/or limbs is expected by industry
analysts to approach $140 million in 2000, is growing at a 25% to 30% annual
rate and is currently dominated by a single competitor, Medtronic, Inc.
The Neuromodulation Market
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The neuromodulation market is comprised of implantable electrical stimulation
systems and fully implantable intrathecal (the fluid-filled area around the
spinal cord) drug pumps that modulate the central nervous system by delivering
precise doses of either electricity or pharmaceuticals directly to targeted
nerve sites.
Four product technology platforms address the chronic intractable pain segment
of the neuromodulation market. These platforms are: (1) radio-frequency
stimulation systems for spinal cord stimulation, (2) implantable pulse generator
stimulation systems for spinal cord and deep brain stimulation, (3) fully
implantable constant rate intrathecal drug pumps and (4) fully implantable
programmable rate intrathecal drug pumps. Industry analysts estimate the market
at $400 million in 1999 and growing to nearly $900 million by 2003 solely on
current FDA approved indications. The growth in the market for stimulation
systems and intrathecal drug pumps is being driven by a number of factors
including:
o New technology is increasing the capability of these devices
o New clinical applications for stimulation systems and intrathecal drug
pumps are being discovered and tested
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o Improved outcomes are being driven by technology, patient selection
and improved techniques
o Stimulation and intrathecal drug pump devices are generally low risk and
cost effective and the therapies are reversible
o Patient awareness and advocacy is generally high
o The base of pain specialists and centers of excellence is growing
Listed below are the estimated units and revenue by market segment in 1999 and
2003 for all manufacturers of such products. These estimates do not consider the
use of neuromodulation technology platforms for applications such as epilepsy,
depression, peripheral nerve stimulation, chronic intractable angina, chronic
headaches, functional stimulation, tens stimulation, peripheral vascular disease
and deep brain applications for disorders other than Parkinson's Disease and
Essential Tremor.
Estimated, for all product manufacturers, by market segment:
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1999 2003
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$ $
Units (000's) Units (000's)
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<S> <C> <C> <C> <C>
Radio-frequency stimulation
systems for spinal cord
stimulation 3,050 $ 42,000 6,100 $ 85,000
Implantable pulse generator
stimulation systems for spinal
cord stimulation 12,850 109,000 26,325 250,000
Implantable pulse generator
stimulation systems for deep brain
stimulation for Parkinson's Disease
and Essential Tremor 3,800 38,000 10,000 105,000
Implantable pulse generator
stimulation systems for sacral nerve
stimulation for incontinence 1,650 14,000 6,325 60,000
Fully implantable constant rate
intrathecal drug pumps 5,300 24,000 15,150 68,000
Fully implantable programmable
rate intrathecal drug pumps 22,125 177,000 39,500 317,000
--------- --------- --------- ---------
Total .................... 48,775 $404,000 103,400 $885,000
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According to industry analysts, there are millions of patients who could benefit
from the use of stimulation or intrathecal drug pump devices. Thus, we believe
the market is under-served and under-penetrated. In 1999, only approximately
49,000 patients benefited from a stimulation system or intrathecal drug pump.
Our growth strategy is to develop and license proprietary product platforms to
expand from our current participation in the radio-frequency stimulation segment
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into the other major market segments of the neuromodulation market. Since most
pain practitioners implant all four of the product platforms (radio-frequency
stimulation systems, implantable pulse generator stimulation systems, fully
implantable constant-rate intrathecal drug pumps and fully implantable
programmable intrathecal drug pumps), we believe we are in a unique position to
leverage our distribution capabilities.
Products
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Stimulation Systems
Stimulation devices electrically stimulate nerve fibers along the spinal cord to
reduce chronic severe neuropathic pain by "masking" the pain signals sent to the
brain. Neuropathic pain usually arises from nerve damage. Stimulation device
implantation manages the pain associated with failed back surgery syndrome
(FBSS), peripheral neuropathy, phantom limb or stump pain, ischemic pain and
reflex sympathetic dystrophy (RSD), also known as complex regional pain syndrome
(CRPS). Stimulation device implantation in the brain is being used to relieve
the effects of various neurological disorders, such as Parkinson's Disease and
Essential Tremor by delivering small electrical impulses to targeted structures
in the brain.
The market for stimulation systems is currently divided between radio-frequency
stimulation systems, which use an external power source, and stimulation systems
that utilize implantable battery driven systems known as implantable pulse
generators (IPGs). According to industry analysts, lPG devices account for
around 80 percent of the number of spinal cord stimulation procedures performed,
with radio-frequency devices accounting for the remainder. We currently design,
develop, manufacture and market radio-frequency stimulation devices and are near
the completion of the development of an IPG device. The primary advantage of the
radio-frequency device revolves around the benefits of the system's external
battery. An external battery system allows the patient to recharge the device by
simply changing a special nine-volt battery. The IPG requires surgical
intervention, revision and replacement after two to four years. Due to its
inexpensive power system, the radio-frequency device can be programmed with a
wide range of amplitude, frequency and pulse width settings for a variety of
programs controlled by the patient. These features make the radio-frequency
devices the most cost efficient for long-term stimulation treatment. On the
other hand, IPG devices provide the convenience of a completely internalized
system, although they involve added long-term cost when repeat surgeries are
required to replace the IPG power source. Both radio-frequency systems and IPG
systems are useful to the pain physician. Radio-frequency systems are most often
prescribed for patients who have complex bilateral pain syndromes or widespread
pain that require high power levels. IPGs are most often prescribed for patients
with simple unilateral and single extremity pain complaints or indications with
low power requirements.
Our radio-frequency stimulation systems consist of four primary components:
leads, a receiver, a transmitter and programmer. The leads are most commonly
placed percutaneously through the skin into the epidural space of the spinal
column. This procedure for lead placement is similar to that employed by
anesthesiologists in routine epidural procedures. Typically, one or two leads
are inserted; each of which has multiple electrodes that can be used to
stimulate the targeted nerve roots of the spinal cord. Laminotomy style (paddle)
leads are also available for neurosurgeons or orthopedic surgeons who prefer to
insert leads in an open surgical procedure approach. The leads are then
connected to a passive receiver, which is implanted under the skin on the side
of the abdomen. The receiver contains electronics that receive radio-frequency
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energy and data from a source (the transmitter) outside the body, and delivers
the prescribed electrical pulses to the leads. The transmitter is approximately
the size of a pager, and is typically worn on a belt. Since it is external to
the body, the transmitter can be easily programmed and serviced as needed, and
its battery can be simply recharged or replaced.
Our CompuStim(R) systems include four, seven, eight and sixteen electrodes on
one, two or more leads; simple and complex receivers; and an external
battery-powered transmitter. We believe that the CompuStim product line's
multi-electrode leads and advanced multiprogrammable technology have changed the
manner in which neuromodulation is performed worldwide. For example, our "Dual
Octrode" device, a system of dual leads with eight electrodes on each lead
introduced in 1995, creates a targeted current density that appears to be
especially effective in relieving complex and multi-extremity pain patterns.
Previously, quadrapolar stimulation systems only relieved the leg pain
associated with FBSS. Many experts support the view that the Dual Octrode device
provides improved pain relief to both the legs and the back. Dual Octrode
systems are enjoying increasing acceptance from the physician community and, in
our judgment, is the technological leader in the stimulation field. We believe
that the long-term results of stimulation in the treatment of pain have improved
as a result of the technological superiority of ANS products. Moreover, the ease
of use of the system has expanded the potential market for these products.
In early 1999, we completed the development of our enhanced radio-frequency
stimulation system, the Renew(TM) System, and introduced the products in the
United States during June 1999. These products include enhancements that
simplify the procedure for implanters while providing improved function. We plan
to introduce the Renew System in international markets during 2000.
In 1998, we licensed the rights to method patents for sacral nerve root
stimulation aimed at relieving the effects of chronic pelvic pain, including
interstitial cystitis. Interstitial cystitis is an extremely painful bladder
disease that afflicts approximately 450,000 people in the United States alone.
We believe our advanced radio-frequency stimulation devices can be effective in
treating pelvic pain indications including interstitial cystitis. In February
1999, we received conditional approval from the FDA to initiate a pilot study to
evaluate the use of our advanced radio-frequency stimulation systems to treat
interstitial cystitis. The pilot study is continuing and if successful, we will
seek approval from the FDA to initiate further clinical studies in the process
to receive a PMA approval to begin marketing in the United States.
We believe our radio-frequency stimulation devices represent a strong base for
penetration of the broader neuromodulation market. We continued development of
an IPG stimulation system during 1999 to better serve the broad needs of the
pain management market. We expect to complete development of our IPG stimulation
system during April 2000. The IPG stimulation system will allow us to
participate in the largest segment of the stimulation market for spinal cord
stimulation and leverage our sales and marketing capabilities. In addition, the
IPG provides us with the opportunity to address a larger number of new
indications such as chronic intractable angina, urinary urge incontinence,
peripheral nerve stimulation and DBS for Essential Tremor and tremor associated
with Parkinson's Disease.
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PainDoc(R)
In early 1997 we began marketing PainDoc, a pen-based computer system that is
designed to assist physicians and their patients in optimizing the performance
of our stimulation devices both pre- and post-operatively. PainDoc interfaces
with our CompuStim and Renew transmitters to optimize stimulation therapy and
document treatment outcomes. PainDoc allows the physician to interact with the
patient to map the location and intensity of the patient's pain. The resulting
"pain map" is then used to assess and select the most effective stimulation
sets, or combination of multi-electrode stimulation arrays, to treat the pain.
The idea is to generate pain coverage that overlaps the patient's pain map. The
selected arrays (programs) are uploaded into the patient's CompuStim or Renew
transmitter. The physician can visually compare the patient's pain map against a
stimulation map and optimize the patient's stimulator setting to address the
patient's needs and assess whether desired levels of pain relief have been
obtained and whether excess stimulation has been delivered.
PainDoc enables the physician to program up to 24 different stimulation sets
delivering electrical stimulation every 50 milliseconds to expand pain area
coverage and relief. We believe that PainDoc should also allow physicians to
create a broad-based database tool that, by using a standardized methodology,
will enable physicians to share and compare outcome data, which can then be used
to deliver more efficacious pain relief to individual patients. We believe that
PainDoc and ANS transmitter devices used in tandem significantly enhance the
effectiveness, flexibility and precision of managing chronic neuropathic pain.
We expect PainDoc to promote the selection of our devices for stimulation
procedures, especially as stimulation devices become more sophisticated and the
pain management process becomes more refined.
We continue to make improvements to PainDoc and will continue to develop systems
that are easier to use and offer more capability.
Intrathecal Drug Pumps
Fully implantable intrathecal drug pumps are designed to deliver pharmaceuticals
directly into the intrathecal space (the fluid-filled area around the spinal
cord). With intrathecal drug delivery, the medication is delivered directly to
its site of action. This contrasts to oral or intravenous drug delivery, where
the medication is distributed systemically throughout the entire body. Since the
drug is being delivered directly to the site of action, a greater therapeutic
effect can be achieved with much lower quantities of medication, which reduces
the common side effects that can occur with oral medications. Today, intrathecal
drug pumps are used to deliver morphine for the treatment of pain and baclofen
for the treatment of spasticity.
Intrathecal drug pump systems consist of the pump itself and a catheter. The
pump is a low profile cylinder shaped device (similar to the size of a hockey
puck) that contains a reservoir into which the drug to be delivered is injected
and mechanisms that regulate the rate of delivery of the drug. The pump is
implanted under the skin generally in the abdominal area and is connected to the
catheter. The catheter is a piece of silastic tubing that is tunneled under the
skin and into the spinal fluid space in the back where it delivers the drug from
the pump. The drug supply in the pump usually lasts one to three months. The
drug pump is refilled using a needle inserted through the skin into the pump's
access port. The drug is then injected through the needle into the reservoir.
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The refill procedure is generally performed on an outpatient basis by a
physician or under the direct supervision of a physician.
In 1999, industry analysts estimated the market for fully implantable
intrathecal drug pumps was $201 million and they expect the market to grow to
$385 million by the year 2003. The market for fully implantable intrathecal drug
pumps is currently divided between constant rate drug pumps and programmable
rate drug pumps. According to industry analysts, the programmable drug pumps
account for 81 percent of the number of intrathecal drug pump procedures
performed, with constant rate drug pumps accounting for the remainder.
Currently, Medtronic, Inc. is the sole worldwide provider of a programmable
intrathecal drug pump.
The programmable rate drug pump is the most versatile type of implantable pump
since it allows the rate of drug delivery to be changed non-invasively to meet
varying patients' needs. Medtronic's programmable pump contains a battery and
motor. The battery delivers pulses of energy to the motor, which pushes the drug
from the pump into the catheter and into the spinal canal. The programmability
feature allows for time-modified delivery of the drug. For example, it can be
non-invasively programmed to deliver more medication at night and less in the
morning. Since the pump is powered with a battery, the entire pump typically
needs to be replaced every four to five years.
Constant rate drug pumps are designed to provide drug infusion at a constant
rate. Once implanted, the medication flow rates remain the same. In order to
change medication rates, different drug concentrations can be mixed and changed
at refill. Constant rate pumps are typically powered by pressurized gas
contained in a compartment of the device. As the gas expands, the medication is
forced out of the drug reservoir through a flow restrictor and catheter and into
the spinal canal. When the drug reservoir is refilled, its power is
automatically recharged. Therefore constant rate pumps are less expensive and
have a longer implant life (eight to ten years) since there is no battery that
can be depleted.
Management believes that the fully implantable intrathecal drug pump market
offers significant opportunity. In August 1998, we completed an agreement with
Tricumed Medizintechnik GmbH, a German corporation, granting ANS rights to
distribute Tricumed's fully implantable intrathecal drug pump products in
international markets including the United States, Canada, the United Kingdom,
France, Spain, Switzerland, South America, Australia and other world markets.
Tricumed manufactures a proprietary constant rate intrathecal drug pump
(Archimedes) that has received the CE mark (European) approval. Tricumed is also
developing a fully implantable programmable intrathecal drug pump (Micromedes).
Tricumed expects to complete development of the Micromedes pump and seek
regulatory approval in Europe (CE mark) during 2000. Both the Archimedes and
Micromedes pumps have proprietary engineered features that improve patient
convenience and reduce costs. If Tricumed successfully completes development of
the Micromedes and obtains the CE mark, we would commence marketing the
Micromedes pump internationally. We would also seek approval from the FDA to
initiate clinical trials in the United States, a step in the PMA process to
receive approval to market the Micromedes domestically. We commenced marketing
the Archimedes pump internationally in the first quarter of 1999.
In 1999, we continued development of our own silastic spring fully implantable
constant rate intrathecal drug pump utilizing proprietary technology licensed
from the University of Minnesota. We expect to complete development of the pump
in the first half of 2000 and will seek approval from the FDA to initiate
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clinical trials in the United States. We will seek CE mark approval to
distribute the pump internationally during the first half of 2000, with
international sales expected to commence by year-end 2000. Management believes
that its value-priced pump will expand the market for fully implantable
intrathecal drug pumps to price-sensitive markets including cancer pain therapy
and third world countries.
Other Business Matters
----------------------
Marketing and Major Customers
Domestically, we utilize independent specialty distributors and commissioned
sales agents who are focused on the chronic pain market to sell our stimulation
systems. Currently, we have seven distributor territories, which employ a total
of forty-four pain specialists who devote the majority of their selling efforts
to ANS products. In addition, we have eleven sales agent territories that employ
twenty-one sales agents who are focused on the pain market and depend upon ANS
products as their flagship product line. We also have one direct sales
territory. We employ four regional sales managers who personally interact with
our customers and oversee the distributors, sales agents and direct
representative. We also employ a Vice-President of North American Sales who
coordinates the sales efforts of our distribution network in North America.
Internationally, we sell product to eleven specialty pain distributors who
represent ANS in twenty-one countries.
The primary medical specialists we target in our marketing efforts are
anesthesiologists, neurosurgeons and orthopedic surgeons. Although neurosurgeons
were the first practitioners to use stimulation systems, anesthesiologists
(specializing in pain medicine) now account for a greater percentage of sales,
as the relative number of these practitioners has grown and as the understanding
and acceptance of stimulation treatment for chronic pain conditions has
increased. We derive 93 percent of net revenues from product sales of our
stimulation systems from domestic sales and approximately 7 percent from export
sales.
During 1999, we had two major customers that accounted for 10 percent or more of
our net revenue from product sales. Sun Medical, Inc. and Primesource Surgical,
Inc., each a specialty distributor of ANS products, accounted for $3.0 million
and $2.3 million, respectively, or 15 percent and 11 percent, respectively, of
our net revenue from product sales for the year ended December 31, 1999. During
1998 and 1997, we had one major customer that accounted for 10 percent or more
of our net revenue from product sales. Sun Medical, Inc., a specialty
distributor of ANS products, accounted for $3.4 million and $3.7 million, or 20
percent and 25 percent of our net revenue from product sales for the years ended
December 31, 1998 and 1997, respectively. While we believe our relations with
Sun Medical and Primesource Surgical are good, the loss of one or both of these
customers could have a material adverse effect on our business, financial
condition and results of operations.
Research and Development
In 1999, we focused our research and development efforts on the continued
development of our enhanced radio-frequency stimulation systems and ongoing
research and development of new products for the neuromodulation market, such as
an implantable pulse generator stimulation system for spinal cord stimulation,
an implantable pulse generator stimulation system for Deep Brain Stimulation
("DBS") and a silastic spring constant rate intrathecal drug pump. We expended
$3.77 million (18.3 percent of net revenue from product sales) on our research
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and development activities in 1999, compared to $2.80 million (16.5 percent of
net revenue from product sales) in 1998. We expect to increase our investment in
research and development and clinical trials during 2000 and expect expenditures
of approximately $4.0 million. These expenditures will be directed toward
completion of our silastic spring constant rate intrathecal drug pump, our
implantable pulse generator stimulation system for spinal cord stimulation, our
implantable pulse generator stimulation system for DBS and for the development
of next generation radio-frequency stimulation systems and implantable pulse
generator stimulation systems. These expenditures also include expenses for
clinical trials that we expect to initiate on several of our new products upon
approval from the FDA. The clinical trials are a necessary process to receive
approval from the FDA to begin marketing the products in the United States. As
of March 20, 2000, we had an in-house research and development staff of 29
personnel as compared to 25 in March 1999.
We may seek strategic partners for DBS to replace our terminated agreement with
Sofamor Danek that could partially fund research and development expenditures
during 2000. In addition to DBS, we believe our implantable pulse generator
stimulation platform has market opportunities outside our focus of chronic pain,
including applications such as epilepsy, urinary incontinence, angina,
peripheral nerve stimulation and peripheral vascular disease. Any such market
expansion, however, would require PMA approvals from the FDA. We may also seek
strategic partners with established distribution systems to develop these market
opportunities outside the chronic pain market area, although there is no
assurance that we will be successful in negotiating and consummating agreements
with strategic partners.
Manufacturing
We manufacture and package our stimulation systems at our manufacturing facility
in Plano, Texas. This facility received ISO 9001 certification (for design and
manufacturing processes) in July 1999. See Item 1. "Business-Other Business
Matters-Government Regulations."
Our manufacturing processes consist of the assembly of standard and custom
component parts and the testing of completed products. We subcontract with
various suppliers to provide us with the quantity of component parts necessary
to assemble our products. Almost all of these components are available from a
number of different suppliers, although certain components are purchased from
single sources. For example, we currently rely on a single supplier for a
computer chip used in the receiver of our stimulation systems. The supplier of
this computer chip has indicated its desire to cease manufacturing and supplying
the computer chip in the future, but to date has not determined when this will
occur. The supplier has agreed to notify us once a date has been determined and
allow us to place a final one-time purchase order for the computer chip. In the
interim, we are maintaining a higher than normal inventory of the computer chip.
In addition, we are developing a new receiver design that does not use any
custom computer chips. A sudden disruption in supply from the computer chip
supplier or another single-source supplier could adversely affect our ability to
deliver finished products on time.
We devote significant attention to quality assurance. Our quality assurance
measures begin at the manufacturing level where components are assembled in a
"clean room" environment designed and maintained to reduce product exposure to
particulate matter. Products are tested throughout the manufacturing process for
adherence to specifications. Finished components are shipped to outside
processors for ethylene oxide gas sterilization.
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Skills of assembly workers required for the manufacture of medical products are
similar to those required in typical assembly operations. We believe that
workers with these skills are readily available in the Dallas area.
Competition
In marketing our stimulation systems, we compete with one other significant
supplier, Medtronic, Inc. Medtronic has substantially greater financial
resources and engages in substantially greater research and development and
marketing efforts. Medtronic holds a substantial majority share of the
stimulation market and sells both radio-frequency stimulation systems and
implantable pulse generator stimulation systems. Medtronic also holds the
substantial majority share of the market for implantable intrathecal drug pumps
and is the sole marketer worldwide of fully implantable programmable intrathecal
drug pumps and implantable pulse generators.
We believe that the principal competitive factors in the neuromodulation market
are cost-effectiveness, impact on patient outcomes, product performance,
quality, ease of use, technical innovation and customer service. We intend to
continue to compete on the basis of our high-performance products, innovative
technologies, manufacturing capabilities, close customer relations and support,
and our strategy to increase our offerings of products within the
neuromodulation market.
Patents, Trademarks and Proprietary Information
We currently own five United States patents and two foreign patents. In
management's view, these patents offer reasonable coverage of our stimulation
devices' electrode, receiver, transmitter and programmer technology as well as
advanced PainDoc computer system technology. These patents, in part, cover both
radio-frequency stimulation systems and implantable pulse generator stimulation
systems for a wide range of current and future applications. Pending patent
applications concern new stimulation lead technology, implant accessories, and
improved connector mechanisms.
We also license four United States patents and one foreign patent from the
University of Minnesota relating to the constant rate intrathecal drug pump we
are currently developing.
Additionally, we are exclusively licensing a patent directed to advanced
placement techniques and a patent directed to methods to facilitate relieving
the effects of chronic pelvic pain such as interstitial cystitis.
The validity of any patents issued to us may be challenged by others and we
could encounter legal and financial difficulties in enforcing our patent rights
against infringers. In addition, there can be no assurance that other
technologies cannot or will not be developed or that patents will not be
obtained by others which would render our patents obsolete. The loss of any one
patent would not have a material adverse effect on our current revenue base.
Although we do not believe that patents are the sole determinant of the
commercial success of our products, the loss of a significant percentage of our
patents could have a material adverse effect on our business, financial
condition and results of operations.
We have developed technical knowledge which, although non-patentable, we
consider as significant in enabling us to compete. However, the proprietary
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nature of such knowledge may be difficult to protect. We have entered into an
agreement with each key employee prohibiting such employee from disclosing any
confidential information or trade secrets of the Company and prohibiting that
employee from engaging in any competitive business while the employee is working
for the Company and for a period of one year thereafter. In addition, these
agreements also provide that any inventions or discoveries by these individuals
relating to the business of the Company will be assigned to the Company and
become the Company's sole property.
Claims by competitors and other third parties that our products allegedly
infringe the patent rights of others could have a material adverse effect on the
Company. The interventional pain management market is characterized by extensive
patent and other intellectual property claims, which can create greater
potential than in less developed markets for possible allegations of
infringement, particularly with respect to newly developed technology.
Intellectual property litigation is complex and expensive and its outcome is
difficult to predict. Any future litigation, regardless of outcome, could result
in substantial expense to the Company and significant diversion of the efforts
of the Company's technical and management personnel. An adverse determination in
any such proceeding could subject the Company to significant liabilities to
third parties, or require the Company to seek licenses from third parties or pay
royalties that may be substantial. Furthermore, there can be no assurance that
necessary licenses would be available to the Company on satisfactory terms or at
all. Accordingly, an adverse determination in a judicial or administrative
proceeding or failure to obtain necessary licenses could prevent the Company
from manufacturing or selling certain of its products, which could have a
material adverse effect on the Company's business, financial condition and
results of operations.
COMPUSTIM(R), MULTISTIM(R), PAINDOC(R), UNISTIM(R) and OCTRODE(R) are among our
registered trademarks. Registration applications are pending for various
trademarks, which we believe, have value in the marketplace, including Advanced
Neuromodulation Systems, ANS and Renew.
Government Regulation
The manufacture and sale of our products are subject to regulation by numerous
governmental authorities, principally the FDA and corresponding foreign
agencies. The research and development, manufacturing, promotion, marketing and
distribution of our products in the United States are governed by the Federal
Food, Drug and Cosmetic Act and the regulations promulgated thereunder (the "FDC
Act and Regulations"). We are subject to inspection by the FDA for compliance
with such regulations and procedures.
The FDA has traditionally pursued a rigorous enforcement program to ensure that
regulated entities such as the Company comply with the FDC Act and Regulations.
A company not in compliance may face a variety of regulatory actions, including
warning letters, product detentions, device alerts, mandatory recalls or field
corrections, product seizures, injunctive actions or civil penalties and
criminal prosecutions of the Company or responsible employees, officers and
directors. We were last inspected in the summer of 1996, and no major violations
were found.
Under the FDA's requirements, a new medical device cannot be released for
commercial use until a pre-market approval application (a "PMA") has been filed
with the FDA and the FDA has approved the device's release. If a manufacturer
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can establish that a newly developed device is "substantially equivalent" to a
legally marketed device, the manufacturer may seek marketing clearance from the
FDA to market the device by filing a 510(k) premarket notification with the FDA,
which usually takes less time than a PMA. The process of obtaining FDA clearance
can be lengthy, expensive and uncertain. Both a 510(k) and a PMA, if granted,
may include significant limitations on the indicated uses for which a product
may be marketed. FDA enforcement policy strictly prohibits the promotion of
approved medical devices for unapproved uses. In addition, product approvals can
be withdrawn for failure to comply with regulatory requirements or the
occurrence of unforeseen problems following initial marketing. Although all of
our currently marketed products have been the subject of successful 510(k)
submissions, we believe that because the products we are currently developing
are more innovative, some of these products will require the PMA submission
process, which is lengthier and more costly than the 510(k) process.
We are also subject to regulation in each of the foreign countries in which we
sell our products with regard to product standards, packaging requirements,
labeling requirements, import restrictions, tariff regulations, duties and tax
requirements. Many of the regulations applicable to our products in such
countries are similar to those of the FDA. The national health or social
security organizations of certain countries require our products to be qualified
before they can be marketed in those countries. To date, we have not experienced
significant difficulty in complying with these regulations.
To position ourselves for access to European and other international markets, we
have maintained certification under the ISO 9000 Series of Standards. ISO 9000
is a set of integrated requirements, which when implemented, form the foundation
and framework for an effective quality management system. These standards were
developed and published by the ISO, a worldwide federation of national standard
bodies, founded in Geneva, Switzerland in 1946. ISO has over 92 member
countries. ISO certification is essential to enter European Community markets.
In July 1999, our quality system was re-certified to ISO 9001/EN 46001
certification. The ISO 9001 registration is the most stringent standard in the
ISO series and lasts for three years. The German notified body TUV Product
Services issued the re-certification certificates. The ISO 9001 standard covers
design, production, installation and servicing of products. The EN 46001 covers
the same elements as the ISO standard; however, the focus is on quality systems
for medical device manufacturing. In addition, we are certified to the Active
Implantable Medical Device Directive allowing us to market devices throughout
the European Community. We are subject to an annual audit by the notified body
to maintain our registrations.
The financial arrangements through which we market, sell and distribute our
products may be subject to certain federal and state laws and regulations in the
United States with respect to the provision of services or products to patients
who are Medicare or Medicaid beneficiaries. The "fraud and abuse" laws and
regulations prohibit the knowing and willful offer, payment or receipt of
anything of value to induce the referral of Medicare or Medicaid patients for
services or goods. In addition, the physician anti-referral laws prohibit the
referral of Medicare or Medicaid patients for certain "Designated Health
Services" to entities in which the referring physician has an ownership or
compensation interest. Violations of these laws and regulations may result in
civil and criminal penalties, including substantial fines and imprisonment. In a
number of states, the scope of fraud and abuse or physician anti-referral laws
and regulations, or both, have been extended to include the provision of
services or products to all patients, regardless of the source of payment,
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although there is variation from state to state as to the exact provisions of
such laws or regulations. In other states, and on a national level, several
health care reform initiatives have been proposed which would have a similar
impact. We believe that our operations and our marketing, sales and distribution
practices currently comply in all respects with all current fraud and abuse and
physician anti-referral laws and regulations, to the extent they are applicable.
Although we do not believe that we will need to undertake any significant
expense or modification to our operations or our marketing, sales and
distribution practices to comply with federal and state fraud and abuse and
physician anti-referral regulations currently in effect or proposed, financial
arrangements between manufacturers of medical devices and other health care
providers may be subject to increasing regulation in the future. Compliance with
such regulation could adversely affect our marketing, sales and distribution
practices, and may affect us in other respects not presently foreseeable, but
which could have an adverse impact on our business, financial condition and
results of operations.
Third Party Reimbursement and Cost Containment
Our products are purchased primarily by hospitals and ambulatory surgery
centers, which then bill various third-party payers for the services provided to
the patients. These payers, which include Medicare, Medicaid, private insurance
companies, managed care and worker's compensation organizations, reimburse part
or all of the costs and fees associated with the procedures performed with these
devices.
Medicare and Medicaid reimbursement for hospitals is based on a fixed amount for
admitting a patient with a specific diagnosis. Because of this fixed
reimbursement method, hospitals have incentives to use less costly methods in
treating Medicare and Medicaid patients, and will frequently make capital
expenditures to take advantage of less costly treatment technologies.
Frequently, reimbursement is reduced to reflect the availability of a new
procedure or technique, and as a result hospitals are generally willing to
implement new cost-saving technologies before these downward adjustments take
effect. Likewise, because the rate of reimbursement for certain physicians who
perform certain procedures has been and may in the future be reduced in the
event of further changes in the resource-based relative value scale method of
payment calculation, physicians may seek greater cost efficiency in treatment to
minimize any negative impact of reduced reimbursement. Any amendments to
existing reimbursement rules and regulations which restrict or terminate the
reimbursement eligibility (or the extent or amount of coverage) of medical
procedures using our products or the eligibility (or the extent or amount of
coverage) of our products could have an adverse impact on our business,
financial condition and results of operations. Third-party payers are
increasingly challenging the prices charged for medical products and services
and may deny reimbursement if they determine that a device was not used in
accordance with cost-effective treatment methods as determined by the payer, was
experimental or was used for an unapproved application.
Our stimulation systems, while cost-effective compared to repeat back surgeries,
have encountered some resistance to third party reimbursement. Although
Medicare, Medicaid and many private insurers reimburse for the stimulation
systems and procedure, especially after repeat back surgeries have failed to
relieve chronic pain, some managed care and private payers occasionally refuse
to reimburse for stimulation systems or restrict reimbursement. There can be no
assurance that in the future, third-party payers will continue to reimburse for
our products, or that their reimbursement levels will not adversely affect the
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profitability of our products. In addition, health care costs have risen
significantly over the past decade, and there have been and will continue to be
proposals by legislators and regulators to curb these costs. Legislative action
limiting reimbursement for certain procedures could have a material adverse
effect on our business, financial condition and results of operations.
In response to the focus of national attention on rising health care costs, a
number of changes to reduce costs have been proposed or have begun to emerge. In
addition to legislative and regulatory initiatives, there has also been a
significant increase in the number of Americans enrolling in some form of
managed care plan. It has become a typical practice for hospitals to affiliate
themselves with as many managed care plans as possible. Higher managed care
penetration typically drives down the prices of health care procedures, which in
turn places pressure on medical supply prices. This causes hospitals to
implement tighter vendor selection and certification processes, by reducing the
number of vendors used, purchasing more products from fewer vendors and trading
discounts on price for guaranteed higher volumes to vendors. Hospitals have also
sought to control and reduce costs over the last decade by joining group
purchasing organizations or purchasing alliances. We cannot predict what
continuing or future impact existing or proposed legislation, regulation or such
third-party payer measures may have on our future business, financial condition
or results of operations.
Changes in reimbursement policies and practices of third-party payers could have
a substantial and material impact on sales of our products. The development or
increased use of more cost-effective treatments could cause such payers to
decrease or deny reimbursement to favor these other treatments.
Employees
As of March 20, 2000, we employed 108 full-time employees, 29 in research and
development, 23 in sales and marketing, 45 in manufacturing and related
operations, and the remainder in executive and administrative positions. None of
our employees is represented by a labor union and we consider our employee
relations to be good.
Advisory Board
We have established the Advanced Neuromodulation Systems Advisory Board, which
is comprised of individuals with substantial expertise in neuromodulation and
pain management. Members of our management and scientific and technical staff
consult closely with members of the Advisory Board to identify specific areas
where techniques are changing and where existing products do not adequately
fulfill the needs of the pain physician. The Advisory Board helps management
evaluate new product ideas and concepts and once a product is approved for
development, its subsequent design and development. The Advisory Board may also
participate in the clinical testing of products developed.
Certain members of the Advisory Board are employed by academic institutions and
may have commitments to or consulting or advisory agreements with other entities
that may limit their availability to us. The members of the Advisory Board may
also serve as consultants to other medical device companies. No members of the
Advisory Board are expected to devote more than a small portion of their time to
the Company.
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ITEM 2. PROPERTIES
In connection with the January 1998 sale of our cardiovascular products
division, we granted Atrion a nine-month option to acquire our principal office
and manufacturing facility in Allen, Texas for $6.5 million. The facility covers
approximately 107,000 square feet and was constructed during 1993 on 19.2 acres
of land that we acquired in 1985. 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 of $3.6 million at closing
and received net proceeds of $2.7 million after paying expenses related to the
transaction. See Note 9- "Sale of CVS Operations/Discontinued Operations" of the
Notes to Consolidated Financial Statements. No material gain or loss was
realized on the sale of the facility. We leased space, furniture and equipment
from Atrion until May 1999 at the monthly rate of $48,125 and paid Atrion fifty
percent of certain operating expenses including utilities, janitorial services,
landscaping services, insurance and property taxes. At that time we moved our
operations to a 40,000 square foot leased facility in Plano, Texas, a northeast
suburb of Dallas discussed below.
We entered a sixty-three month lease agreement in February 1999 for the Plano
facility. Under terms of the lease agreement, which became effective on June 1,
1999, we received three months of 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. We also have a first right of refusal
to acquire the facility. We spent approximately $2.4 million for furniture and
equipment, leasehold improvements, computer systems, telephone systems and
manufacturing clean room for the leased facility. The expense of moving and
transitioning into the new facility was immaterial.
ITEM 3. LEGAL PROCEEDINGS
We are a party to product liability claims related to ANS' stimulation systems.
Product liability insurers have assumed responsibility for defending us against
these claims, subject to reservation of rights in certain cases. While
historically product liability claims for our stimulation systems have not
resulted in significant monetary liability beyond our insurance coverage, there
can be no assurances that we will not incur significant monetary liability to
the claimants if such insurance is unavailable or inadequate for any reason, or
that our current stimulation business and future neuromodulation products will
not be adversely affected by these product liability claims. While we seek to
maintain appropriate levels of product liability insurance with coverage that we
believe is comparable to that maintained by companies similar in size and
serving similar markets, there can be no assurance that we will avoid
significant future product liability claims relating to our stimulation systems.
Except for such product liability claims and other ordinary routine litigation
incidental or immaterial to our business, we are not currently a party to any
other pending legal proceeding. We maintain general liability insurance against
risks arising out of the normal course of business.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Inapplicable.
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PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Our common stock is currently quoted on the Nasdaq National Market under the
symbol "ANSI." Until June 30, 1998, the common stock was quoted on the Nasdaq
National Market under the symbol "QMED". Our symbol was changed on July 1, 1998
in connection with our name change from Quest Medical, Inc. to Advanced
Neuromodulation Systems, Inc. On March 20, 2000, there were approximately 672
holders of record of our common stock. The following table sets forth the
quarterly high and low closing sales prices for our common stock. These prices
do not include adjustments for retail mark-ups, markdowns or commissions.
<TABLE>
<CAPTION>
1998: High Low
---- -------------- --------------
<S> <C> <C>
First Quarter $ 8.75 $ 6.50
Second Quarter $ 10.00 $ 8.06
Third Quarter $ 10.00 $ 5.75
Fourth Quarter $ 6.75 $ 5.00
1999: High Low
---- -------------- --------------
First Quarter $ 8.19 $ 6.19
Second Quarter $ 9.56 $ 6.50
Third Quarter $ 11.44 $ 7.69
Fourth Quarter $ 9.38 $ 7.00
2000: High Low
---- -------------- --------------
First Quarter $ 19.00 $ 9.94
(through March 20, 2000)
</TABLE>
To date, we have not declared or paid any cash dividends on our common stock and
the Board of Directors does not anticipate paying cash dividends on our common
stock in the foreseeable future.
During January 1998, the Board of Directors approved a stock repurchase program
of up to 500,000 shares of our common stock and during August 1998 approved the
repurchase of up to an additional 1,000,000 shares. In September 1999, the Board
of Directors approved the repurchase of up to an additional 250,000 shares.
During the year ended December 31, 1998, we repurchased 1,258,625 shares of our
common stock at an aggregate cost of $9,411,055, or an average of $7.48 per
share. During the year ended December 31, 1999, we repurchased 404,875 shares of
our common stock at an aggregate cost of $2,952,311, or an average of $7.29 per
share. In the aggregate, we have purchased 1,663,500 shares under the authorized
repurchase programs and 86,500 shares are available for repurchase as of March
20, 2000. During the years ended December 31, 1999 and 1998, we issued 162,068
and 184,874 shares respectively, from the treasury upon the exercise of stock
options. At December 31, 1999, 1,316,558 shares remained in the treasury. Our
purchases may be effected through open market purchases, block transactions,
privately negotiated purchases or otherwise. Purchases of our common stock will
be effected at prices and terms to be determined in light of then current
circumstances, are completely discretionary and may be temporarily or
permanently suspended at any time without notice.
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ITEM 6. SELECTED FINANCIAL DATA
<TABLE>
<CAPTION>
--------------------------------------------------------------------------
Years Ended December 31,
--------------------------------------------------------------------------
1999 1998 1997 1996 1995(1)
-------------- -------------- -------------- -------------- --------------
(in thousands, except per share data)
<S> <C> <C> <C> <C> <C>
Statement of Operations Data: (2)
Net revenue-product sales $ 20,578 $ 17,006 $ 14,718 $ 11,403 $ 10,434
Total net revenue 29,478 20,106 14,718 11,403 10,434
Gross profit-product sales 13,949 12,021 9,878 8,088 7,682
Research and development
expense 3,773 2,801 977 1,316 808
Purchased research and
development -- -- -- -- 10,500
Marketing, general and
administrative and
amortization expenses 10,235 8,486 6,815 6,257 3,796
Earnings (loss) from operations 8,842 3,833 2,086 515 (7,421)
Net earnings (loss) from
continuing operations 6,003 2,586 818 115 (8,906)
Loss from discontinued
operations -- (212) (93) (527) (1,199)
Gain on the sale of assets of
discontinued operations -- 4,585 -- -- --
Net earnings (loss) from
discontinued operations -- 4,373 (93) (527) (1,199)
Net earnings (loss) $ 6,003 $ 6,959 $ 724 $ (412) $ (10,374)
Diluted earnings (loss) per share:
Continuing operations $ .75 $ .30 $ .09 $ .01 $ (1.42)
Discontinued operations $ -- $ .51 $ (.01) $ (.06) $ (.19)
Extraordinary item $ -- $ -- $ -- $ -- $ (.05)
Net earnings (loss) $ .75 $ .81 $ .08 $ (.05) $ (1.66)
</TABLE>
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<TABLE>
<CAPTION>
Years Ended December 31,
---------------- ---------------- ---------------- ----------------- ----------------
1999 1998 1997 1996 1995
---------------- ---------------- ---------------- ----------------- ----------------
(in thousands)
<S> <C> <C> <C> <C> <C>
Balance Sheet Data:
Cash, cash equivalents and
marketable securities $ 8,752 $ 12,263 $ 2,204 $ 2,206 $ 3,914
Working capital 16,178 16,426 14,128 11,088 12,183
Total assets 43,555 45,485 48,982 47,188 44,496
Short-term notes payable and
current maturities of
long-term notes payable -- 3,633 8,257 2,084 1,616
Notes payable, excluding
current maturities -- -- 3,635 11,912 8,558
Stockholders' equity $ 37,038 $ 33,304 $ 33,906 $ 30,993 $ 30,870
</TABLE>
- -----------------------
(1)Includes results of ANS from March 31, 1995. The net loss for 1995 reflects a
charge of $10,500, or $(1.68), for purchased in-process research and development
incurred in connection with the ANS acquisition and an extraordinary charge of
$269, or $(.05) per share, for the write-off of capitalized debt issuance costs
due to early repayment of bank debt with the proceeds from a public offering
completed in November 1995.
(2)On January 30, 1998, the Company sold its cardiovascular and intravenous
fluid delivery product lines (CVS Operations). The CVS Operations have been
accounted for as discontinued operations. See Note 9 of the Notes to
Consolidated Financial Statements.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion of the financial condition and results of operations of
the Company should be read in conjunction with the Consolidated Financial
Statements of the Company and the related Notes.
Overview
On January 30, 1998, we sold the assets of our CVS (cardiovascular) Operations,
including our MPS(R) myocardial protection system product line, to Atrion
Corporation. See Note 9 - "Sale of CVS Operations/ Discontinued Operations" of
the Notes to 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 leased space, furniture and
equipment from Atrion until May 1999 at the monthly rate of $48,125 and paid
Atrion fifty percent of certain operating expenses. At that time we moved our
operations to a 40,000 square foot leased facility in Plano, Texas, a northeast
suburb of Dallas. The expense of moving and transitioning into the new facility
was 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
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Medical, Inc., our former name. We reported a pretax gain on the transaction of
$7.1 million during the year ended December 31, 1998. This pretax gain is net of
$1.0 million of compensation expense recorded as a result of changes made to the
stock options held by employees of the CVS Operations. See Note 5 -
"Stockholders' Equity" of the Notes to Consolidated Financial Statements. The
pretax gain is also net of an expense of $969,000 recorded in connection with
sale of the facility to Atrion which relates to abated property taxes. See Note
9 - "Sale of CVS Operations/Discontinued Operations" of the Notes to
Consolidated Financial Statements. We utilized $9 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
Consolidated Financial Statements for the years ended December 31, 1998 and
1997.
In June 1998, we completed an agreement with 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 Consolidated Financial Statements. We received a payment of $4 million
upon execution of the agreement that was being 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 January 1999 due
to the termination of the agreement with Sofamor Danek as a result of the merger
of Sofamor Danek and Medtronic, Inc. In connection with the termination, we also
received an additional payment of $8 million from Sofamor Danek, which was
recognized into income as revenue during January 1999.
The former agreement with Sofamor Danek fits with our strategy 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 chronic pain segment of the
neuromodulation market. We cannot assure you, however, that we will be
successful in negotiating and consummating research and development agreements
with other strategic partners.
In September 1999, the Neurological Devices Panel of the Medical Devices
Advisory Committee recommended that the FDA reclassify Totally Implanted Spinal
Cord Stimulators (IPGs) for treatment of pain of the trunk and/or limbs from a
Class III device to a Class II device. Class III devices typically require a
Pre-Market Approval (PMA), supplemented with clinical trials to prove safety and
effectiveness of the device, while Class II devices typically require a
Pre-Market Notification (510(k)) to demonstrate substantial equivalence to an
existing legally marketed device prior to receiving market clearance by the FDA.
According to the FDA's 1999 ODE Annual Report, the average time for PMA's was
12.5 months (excluding the one-year typically required for clinical trials, or
approximately 24 months total). The ODE Annual Report reported the average
elapsed time for a 510(k) approval of 3.4 months in 1999.
We expected to receive a final reclassification decision from the FDA in January
2000 but have experienced a delay that we believe is related to the FDA's
workload. We received a written progress report dated February 25, 2000 in which
the FDA stated that it had received adequate information to move forward toward
a final decision. The agency's letter further indicated that there may be
"special controls" available to ensure the safety and effectiveness of the IPG
device for treating pain of the trunk and/or limbs. We remain optimistic that
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the FDA will follow the recommendation of its panel to reclassify the IPG and
are prepared to move quickly to file the 510(k) Pre-Market Notification for
clearance to market the IPG in the United States if the FDA approves the
reclassification. The IPG market for spinal cord stimulation to treat pain of
the trunk and/or limbs is expected by industry analysts to approach $140 million
in 2000, is growing at a 25% to 30% annual rate and is currently dominated by a
single competitor, Medtronic, Inc.
Results of Operations
Comparison of the Years Ended December 31, 1999 and 1998
We reported net earnings of $6.00 million or $.75 per diluted share in 1999
compared to $6.96 million or $.81 per diluted share in 1998. The 1998 results
included net earnings of $4.4 million from the discontinued CVS Operations or
$.51 per diluted share primarily due to an after-tax gain of $4.6 million on the
sale of the discontinued operations. Net earnings from continuing operations
increased to $6.00 million or $.75 per diluted share in 1999 compared to $2.59
million or $.30 per diluted share in 1998. Net earnings from continuing
operations in 1999 and 1998 benefited from $8.9 million and $3.1 million,
respectively, of revenue recorded in connection with our former agreement with
Sofamor Danek.
Total net revenue from continuing ANS operations of $29.48 million for the year
ended December 31, 1999, was $9.37 million, or 46.6 percent, above the
comparable 1998 level of $20.11 million. The 1999 period includes $8.9 million
of net revenue and the 1998 period includes $3.1 million of net revenue
associated with our former development agreement for DBS products with Sofamor
Danek. Net revenue from ANS product sales increased 21.0 percent to $20.58
million during 1999 compared to $17.01 million in 1998. 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. All of
the $3.57 million increase in 1999 was the result of higher sales in the United
States. During June 1999, we launched our enhanced radio-frequency stimulation
system, the Renew(TM) System, in the United States. We will launch the Renew
System in international markets during 2000.
Gross profit from product sales increased to $13.95 million in 1999 from $12.02
million in 1998 due to the increase in net revenue from product sales discussed
above. Gross profit margin from product sales decreased to 67.8 percent in 1999
compared to 70.7 percent in 1998 due to (1) approximately $350,000 of additional
costs we incurred from product transition and unexpected lower manufacturing
yields related to the Renew System during the third quarter of 1999, (2) higher
component costs for the Renew System, and (3) production downtime associated
with our move to our new leased facility in May 1999.
Total operating expenses (the aggregate of research and development, marketing,
amortization of intangibles and administrative expenses) increased to $14.01
million in 1999 compared to $11.29 million in 1998 and as a percentage of net
revenue from product sales increased to 68.1 percent in 1999 from 66.4 percent
in 1998.
Research and development expense increased to $3.77 million in 1999, or 18.3
percent of 1999 net revenue from product sales, from $2.80 million during 1998,
or 16.5 percent of 1998 net revenue from product sales, reflecting our stepped
up commitment to develop products that will expand our presence into other
rapidly growing market segments of the neuromodulation market. This increase
during 1999 compared to 1998 was the result of higher salary and benefit expense
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from staffing additions, increased consulting expense, and higher test material
expense. These expenditures during 1999 were directed toward development of our
Renew System, which we launched in the United States during June 1999, a
silastic spring constant rate intrathecal drug pump, an IPG stimulation system
for spinal cord stimulation and an IPG stimulation system for Deep Brain
Stimulation. We expect to complete the development of our IPG stimulation system
for spinal cord stimulation during April 2000, and if the FDA approves
reclassification of the device, we anticipate obtaining 510(k) pre-market
notification clearance during the second half of 2000 and would launch the IPG
system domestically upon receipt of the clearance. In addition, we expect to
receive CE mark approval for the IPG system in the second half of 2000, at which
time we would launch it in European markets. We also expect to complete the
development of our silastic spring constant rate intrathecal drug pump and begin
clinical trials in the United States by the end of 2000. Similarly, we expect to
receive CE mark approval on the constant-rate intrathecal drug pump by year-end
2000, at which time we would launch it in European markets.
Marketing expense, as a percentage of net revenue from product sales, increased
to 30.6 percent in 1999 from 27.5 percent in 1998, and the absolute dollar
amount increased from $4.68 million during 1998 to $6.29 million in 1999. This
dollar increase during 1999 was attributable to higher commission expense 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, higher expense for education and training of new
implanters and expense related to the launch of our Renew System.
General and administrative expense increased from $2.63 million during 1998 to
$2.76 million in 1999 while as a percentage of net revenue from product sales,
decreased to 13.4 percent in 1999 from 15.5 percent during 1998. The increase in
the absolute dollars of expense of $124,000 during 1999 was principally the
result of higher salary and benefit expense from staffing additions, higher
expense related to investor relations and higher patent legal expense.
Amortization of ANS intangibles increased from $1.17 million in 1998 to $1.19
million during 1999 due to expense for additional patents we have licensed.
Other income increased to $706,000 in 1999 compared to $499,000 in 1998
primarily as a result of a $287,000 reduction in interest expense due to the
repayment of our mortgage debt in February 1999 when we sold our facility to
Atrion Corporation.
Income tax expense from continuing operations increased to $3.55 million in 1999
from $1.75 million in 1998 due to higher earnings from ANS operations. This
represents effective tax rates of 37.1 percent in 1999 and 40.3 percent in 1998.
Our expense for amortization of costs in excess of net assets acquired
(goodwill) is not deductible for tax purposes, and, when combined with a
provision for state taxes, results in the higher effective tax rate during both
1999 and 1998 compared to the U.S. statutory rate for corporations of 34
percent.
Comparison of the Years Ended December 31, 1998 and 1997
We reported net earnings of $6.96 million or $.81 per diluted share in 1998
compared to $724,000 or $.08 per diluted share in 1997. The 1998 results
included net earnings of $4.37 million from the discontinued CVS Operations or
$.51 per diluted share primarily due to an after-tax gain of $4.59 million on
the sale of the discontinued operations while the 1997 results included a loss
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<PAGE>
of $93,000 or $(.01) per diluted share from the discontinued operations. Net
earnings from continuing operations increased to $2.59 million or $.30 per
diluted share in 1998 compared to $818,000 or $.09 per diluted share in 1997.
Total net revenue from continuing ANS operations of $20.11 million for the year
ended December 31, 1998, was $5.39 million, or 37 percent, above the comparable
1997 level of $14.72 million. The 1998 period includes $3.10 million of net
revenue associated with our former development agreement for DBS products with
Sofamor Danek. Net revenue from ANS product sales increased 16 percent to $17.01
million during 1998 compared to $14.72 million in 1997. 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. Of the
$2.29 million increase in 1998, $1.7 million was the result of higher sales in
the United States and the remainder from higher sales internationally.
Gross profit from product sales increased to $12.0 million in 1998 from $9.9
million in 1997 due to the increase in net revenue from product sales discussed
above and an increase in gross profit margin. Gross profit margin from product
sales increased to 70.7 percent in 1998 compared to 67.1 percent in 1997 due,
for the most part, to a $479,000 expense during 1997 for the write-off of ANS
inventory of previous designs. Excluding such write-off in 1997, gross profit
margin remained approximately the same, 70.4 percent in 1997 compared to 70.7
percent in the 1998 period.
Total operating expenses (the aggregate of research and development, marketing,
amortization of intangibles and administrative expenses) increased to $11.3
million in 1998 compared to $7.8 million in 1997 and as a percentage of net
revenue from product sales increased to 66.4 percent in 1998 from 52.9 percent
in 1997.
Research and development expense increased to $2.80 million in 1998, or 16.5
percent of 1998 net revenue from product sales, from $977,000 during 1997, or
6.6 percent of 1997 net revenue from product sales, reflecting our stepped up
commitment to develop products that will expand our presence into other market
segments of the neuromodulation market. This increase during 1998 compared to
1997 was the result of higher salary and benefit expense from staffing
additions, increased consulting expense, and higher test material expense. These
expenditures during 1998 were directed toward development of our enhanced
radio-frequency stimulation systems, which we introduced to the U.S. market in
June 1999, a silastic spring constant rate intrathecal drug pump, an IPG
stimulation system for spinal cord stimulation and an IPG stimulation system for
Deep Brain Stimulation.
Marketing expense, as a percentage of net revenue from product sales, increased
to 27.5 percent in 1998 from 27.0 percent in 1997, and the absolute dollar
amount increased from $3.97 million during 1997 to $4.68 million in 1998. This
dollar increase during 1998 was attributable to higher commissions from
increased product sales, higher training expense for new users of ANS products
and higher convention and promotional expense.
General and administrative expense increased from $1.76 million during 1997 to
$2.63 million in 1998 and as a percentage of net revenue from product sales,
increased to 15.5 percent in 1998 from 12.0 percent during 1997. This increase
in expense during 1998 was principally the result of increased legal expense
related to the various development agreements discussed above, increased
recruiting and relocation expense and increased costs for existing employee
benefit plans.
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<PAGE>
Amortization of ANS intangibles increased from $1.09 million in 1997 to $1.17
million during 1998, mostly due to an expense associated with a non-compete
agreement with the former president and chief executive officer.
Other income increased to $499,000 in 1998 compared to an expense of $536,000 in
1997 primarily as a result of two factors. First, interest expense decreased by
$294,000 during 1998 compared to 1997 as a result of the repayment of short-term
notes payable in January 1998 from the proceeds of the sale of the CVS
Operations. Second, interest income increased by $720,000 in 1998 compared to
1997 due to higher funds available for investment due to the proceeds from the
January 1998 sale of the CVS Operations.
Income tax expense from continuing operations increased to $1.75 million in 1998
from $733,000 in 1997 due to higher earnings from ANS operations. This
represents effective tax rates of 40.3 percent in 1998 and 47.3 percent in 1997.
Our expense for amortization of costs in excess of net assets acquired
(goodwill) is not deductible for tax purposes, and, when combined with a
provision for state taxes, results in the higher effective tax rate during both
1998 and 1997 compared to the U.S. statutory rate for corporations of 34
percent.
Liquidity and Capital Resources
At December 31, 1999 our working capital decreased slightly from $16.43 million
at year-end 1998 to $16.18 million at year-end 1999. The ratio of current assets
to current liabilities was 4.86:1 at December 31, 1999, compared to 2.68:1 at
December 31, 1998. Cash, cash equivalents and marketable securities totaled
$8.75 million at December 31, 1999 compared to $12.26 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 repayment of the mortgage debt and expenses related to
the transaction, we realized net proceeds of $2.7 million.
During September 1999, the Board of Directors authorized increasing our stock
repurchase program by an additional 250,000 shares to a total of 1,750,000
shares. During the year ended December 31, 1999, we repurchased 404,875 shares
of our common stock at an aggregate cost of $2,952,311, or an average of $7.29
per share. In aggregate, we have purchased 1,663,500 shares under the authorized
repurchase programs and 86,500 shares are available for repurchase as of March
17, 2000. During the years ended December 31, 1999 and 1998, we issued 162,068
and 184,874 shares respectively, from our treasury upon the exercise of stock
options. At December 31, 1999, 1,316,558 shares remained in the treasury.
We increased our investment in inventories by $3.36 million to $6.00 million at
December 31, 1999, from $2.64 million at December 31, 1998. While this is a
higher level of inventory than we plan to carry on an ongoing basis, several
factors contributed to the increase. First, we are continuing to transition from
our former radio-frequency systems to the Renew System. We are continuing to
sell the former systems in international markets until the appropriate
regulatory approvals are received. Second, we built inventory of Renew System
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<PAGE>
components as part of a phased product and geographical launch. Third, we
decided to increase our safety stock levels on critical single-sourced
components due to electronic component shortages experienced during 1999.
Fourth, we began building inventory in anticipation of our launch of the IPG in
the second half of 2000. We estimate that our investment in inventory will
decrease by approximately $1.0 million by year-end 2000.
We spent $5.91 million during 1999 for capital expenditures and license fees for
additional patents and intellectual property we are licensing. Of such
expenditures, approximately $2.4 million were for new furniture and equipment,
computer systems, telephone system, manufacturing clean room and leasehold
improvements for our new leased facility. We also spent $1.30 million during
1999 to license additional patents and intellectual property. The remaining
expenditures of $2.21 million relate to manufacturing tooling and equipment for
the Renew System and other new products we are developing. We expect capital
expenditures and patent license fees to be substantially less in fiscal 2000 and
have budgeted expenditures of approximately $1.7 million.
We believe our current cash, cash equivalents and marketable securities and cash
generated from operations will be sufficient to fund all of our operating needs
and capital expenditures for the foreseeable future.
Cash Flows
Net cash provided by continuing operations was $2.22 million in 1999, $6.93
million in 1998 and $2.11 million in 1997. Although net earnings from continuing
operations increased to $6.00 million in 1999 from $2.59 million in 1998, net
cash provided from continuing operations decreased by $4.71 million primarily
due to changes in components of working capital. During 1999, we used cash to
increase our investment in assets such as inventories, account receivable and
prepaid expenses and other assets and to reduce our income taxes payable. For
1998 compared to 1997, net cash provided by continuing operations increased by
$4.82 million reflecting improved operating results, deferred revenue associated
with our former agreement with Sofamor Danek and an increase in our income taxes
payable not due until March 1999. Net cash provided by discontinued operations
decreased to $59,000 in 1998 compared to $391,000 in 1997. The 1998 period
included only one month of results until the sale in January 1998.
Net cash provided by investing activities decreased to $447,000 in 1999 from
$20.81 million in 1998 while we used cash in investing activities in 1997 of
$5.74 million. The 1999 period reflects $6.35 million of net proceeds we
received when we sold our facility to Atrion Corporation. We utilized $5.91
million in 1999 for capital expenditures for leasehold improvements, furnishings
and equipment for our new leased facility, manufacturing tooling and equipment
for our Renew System and new products we are developing and licensing fees for
patents. The 1998 period reflects net proceeds of $21.8 million from the sale of
discontinued operations. We utilized $1.68 million in 1998 for capital
expenditures primarily for manufacturing tooling and equipment for the new
products we are developing and license fees for patents we licensed. Primary
uses of cash during 1997 were capital expenditures of $1.29 million and payments
to the former owner of the neurostimulation business relating to patents and
settlements of $4.47 million.
Net cash used in financing activities decreased to $6.01 million in 1999 from
$16.85 million in 1998 while financing activities provided net cash of $3.29
million in 1997. During 1999, we received net cash of $573,000 from the exercise
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<PAGE>
of stock options while $2.95 million was used for share repurchases and $3.63
million for the repayment of our mortgage debt. During 1998, we received net
cash of $818,000 from the exercise of stock options while $9.41 million was used
for share repurchases and $8.26 million to reduce debt. During 1997, we received
cash of $922,000 from the exercise of stock options and $3.53 million from
additional borrowings under short-term notes. We used $1.16 million during 1997
to repay debt.
Year 2000
We believe our computer software programs, operating systems and manufacturing
equipment are Year 2000 compliant and ready for use beyond the Year 2000.
We are not currently aware of any material Year 2000 problems relating to any of
our material internal software programs, operating systems and manufacturing
equipment. Our internal operations and business are also dependent upon the
computer-controlled systems of third parties such as our suppliers, customers
and other service providers. We believe that absent a systemic failure outside
our control, such as a prolonged loss of electrical or telecommunications
service, Year 2000 problems at third parties will not have a material impact on
our operations. However, the failure of our internal systems or the systems of
third parties to be Year 2000 compliant could result in disruptions to our
operations, including, among other things, a temporary inability to process
transactions, send invoices, manufacture products or engage in similar normal
business activities. Therefore, depending on the scope and nature of the
problems, we could be required to devote significant resources to correcting
such problems. The costs associated with remediating any Year 2000 problems have
not been material to date and although we do not anticipate that these costs
will be material in the future, we cannot assure you that these costs will not
be material.
Outlook and Uncertainties
The following is a "safe harbor" statement under the Private Securities
Litigation Reform Act of 1995: The matters discussed in this Annual Report on
Form 10-K contain statements that constitute forward-looking statements within
the meaning of Section 21E of the Securities Exchange Act of 1934, as amended.
The words "expect," "estimate," "anticipate," "predict," "believe," "plan,"
"will," "should," "intend" and similar expressions and variations thereof are
intended to identify forward-looking statements. Such statements appear in a
number of places in this Annual Report on Form 10-K and include statements
regarding 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:
Product Development and Market Acceptance. Our growth depends in part on our
ability to develop and gain market acceptance of new products, including next
generation ANS products. We cannot assure you that we will continue to develop
successful products, that delays in product introduction will not be
experienced, or that once such products are introduced, the market will accept
them.
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<PAGE>
Government Regulation. Our business is subject to extensive government
regulation, principally by the FDA. The regulatory process, especially as it
relates to product approvals, can be lengthy, expensive and uncertain. See
Item 1-"Business-Government Regulation".
Single-Sourced Components. We rely on a single supplier for the computer chip
used in the receiver of our stimulation systems. The supplier of this computer
chip has indicated its desire to cease manufacturing and supplying the computer
chip in the future, but to date, has not determined when this will occur. The
supplier has agreed to notify us when a date has been determined and allow us to
place a final one-time purchase order for the computer chip. In the interim, we
are maintaining a higher than normal inventory of the computer chip and are
developing a new receiver design that does not use a custom computer chip. A
sudden disruption in supply from the computer chip supplier or another
single-source supplier could adversely affect our ability to deliver finished
products on time.
Competition and Technological Change. The medical device market is highly
competitive. We compete with many larger companies that have access to greater
capital, research and development, marketing, distribution and other resources
than we do. In addition, our market is characterized by extensive research
efforts and rapid product development and technological change, which could
render our products obsolete or noncompetitive.
Intellectual Property Rights. We rely in part on patents, trade secrets and
proprietary technology to remain competitive. It may be necessary to defend
these rights or to defend against claims that we are infringing the rights of
others. Intellectual property litigation and controversies are disruptive and
expensive.
Cost Pressures on Medical Technology. The overall escalating cost of medical
products and healthcare results in significant cost pressure. Third-party payers
are under intense pressure to challenge the prices charged for medical products
and services. We rely heavily on Medicare and Medicaid reimbursement. Any
amendments to existing reimbursement rules and regulations which restrict or
terminate the reimbursement eligibility (or the extent or amount of coverage) of
medical procedures using our products or the eligibility (or the extent or
amount of coverage) of our products could adversely impact our business,
financial condition and results of operations.
Potential Product Liability. The testing, manufacturing, marketing and sale of
medical devices entail substantial risks of liability claims or product recalls.
Reliance on Customer/Distributor. During 1999, we had two major customers that
accounted for 10 percent or more of our net revenue. Sun Medical, Inc. and
Primesource Surgical, Inc., each a specialty distributor of ANS products,
accounted for $3.0 million and $2.3 million, respectively, or 14.6 percent and
11.2 percent, respectively, of ANS' net revenue from product sales for the year
ended December 31, 1999. While we believe our relations with Sun Medical and
Primesource Surgical are good, the loss of one or both of these customers could
have a material adverse effect on our business, financial condition and results
of operations.
Year 2000 Compliance. Although our Year 2000 readiness efforts were successful
and we have not experienced any Year 2000 issues to date, we cannot assure you
that Year 2000 issues will not occur at a later date that would have a material
adverse impact on our results of operations, financial condition and cash flows.
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<PAGE>
Other Uncertainties. We discuss other operating, financial or legal risks or
uncertainties in this Form 10-K in specific contexts and in the Company's other
periodic SEC filings. The Company is, of course, also subject to general
economic risks, the risk of interruption in the source of supply, dependence on
key personnel and other risks and uncertainties.
Currency Fluctuations
Substantially all of 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.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We do not use derivative financial instruments to manage the impact of interest
rate changes on our investments or debt instruments.
We invest our cash reserves in high quality short-term liquid money market
instruments with major financial institutions. At December 31, 1999, we had
$7,192,687 invested in money market funds and $1,012,106 in a certificate of
deposit with a maturity date of 90 days from the purchase date. The rate of
interest earned on these investments will vary with overall market rates. A
hypothetical 100-basis point change in the interest rate earned on these
investments would not have a material effect on our income or cash flows.
We also have certain investments in available-for-sale securities. These
investments primarily consist of real estate investment trusts and investment
grade corporate preferred securities that are traded on the New York Stock
Exchange. The cost of these investments is $764,195 and had a fair value at
December 31, 1999 of $398,208. The investments are subject to overall stock
market and interest rate risk. A hypothetical 20 percent decrease in the share
prices of these investments from the prices at December 31, 1999 would decrease
the fair value by $79,642.
At December 31, 1999, we had no debt instruments.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The information required by this item is set forth in Appendices A, B and C.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this item is contained under the captions "Election
of Directors" and "Executive Officers" in our definitive proxy material which
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<PAGE>
will be filed in connection with our 2000 annual meeting of stockholders, which
information is incorporated herein by reference.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this item is contained under the captions
"Compensation and Committees of the Board of Directors" and "Compensation of
Executive Officers" in our definitive proxy material which will be filed in
connection with our 2000 annual meeting of stockholders, which information is
incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this item is contained under the caption "Security
Ownership of Management and Principal Shareholders" in our definitive proxy
material which will be filed in connection with our 2000 annual meeting of
stockholders, which information is incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this item is contained under the caption "Certain
Relationships and Related Transactions" in our definitive proxy material which
will be filed in connection with our 2000 annual meeting of stockholders, which
information is incorporated herein by reference.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) Documents filed as part of this report.
1. Financial Statements:
See Index to Financial Statements on the second page of
Appendix A.
2. Financial Statement Schedules:*
Schedule II - Valuation and Qualifying Accounts.
See Appendix B.
* Those schedules not listed above are omitted as not applicable or not
required.
3. Exhibits: See (c) below.
(b) Reports on Form 8-K.
None.
(c) Exhibits:
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2.1 Asset Purchase Agreement, dated December 29, 1997, by and
among Quest Medical, Inc., QMI Medical, Inc. (formerly
known as QMI Acquisition Corp.) and Atrion Corporation
(including exhibits and schedules 2.1.1, 2.1.2, 2.3(a) and
2.3(b))(7)
3.1 Articles of Incorporation, as amended and restated(4)
3.2 Bylaws(1)
4.1 Rights Agreement dated as of August 30, 1996, between Quest
Medical, Inc. and KeyCorp Shareholder Services, Inc. as
Rights Agent(5)
10.1 Quest Medical, Inc. 1979 Amended and Restated Employees Stock
Option Plan(2)
10.2 Form of 1979 Employees Stock Option Agreement(3)
10.3 Quest Medical, Inc. Directors Stock Option Plan (as amended)
(2)
10.4 Form of Directors Stock Option Agreement(1)
10.5 Quest Medical, Inc. 1987 Stock Option Plan(4)
10.6 Form of 1987 Employee Stock Option Agreement(4)
10.7 Quest Medical, Inc. 1995 Stock Option Plan(4)
10.8 Form of 1995 Employee Stock Option Agreement(4)
10.9 Quest Medical, Inc. 1998 Stock Option Plan(9)
10.10 Employment Agreement dated April 9, 1998 between Christopher
G. Chavez and Quest Medical, Inc.(8
10.11 Employment Agreement dated April 9, 1998 between Scott F.
Drees and Quest Medical, Inc.(8)
10.12 Employment Agreement dated April 9, 1998 between F. Robert
Merrill III and Quest Medical, Inc.(8)
10.13 Form of Employment Agreement and Covenant Not to
Compete, between the Company and key employees(1)
10.14 Form of License Agreement, dated January 30, 1998, by and
between Quest Medical, Inc. and QMI Medical, Inc. (formerly
known as QMI Acquisition Corp.)(6)
10.15 Form of Lease Agreement, dated January 30, 1998, by and
between Quest Medical, Inc. and QMI Medical, Inc. (formerly
known as QMI Acquisition Corp.)(6)
10.16 Form of Option Agreement, dated January 30, 1998, by and
between Quest Medical, Inc. and QMI Medical, Inc. (formerly
known as QMI Acquisition Corp.)(6)
10.17 Agreement, dated December 31, 1997, by and among Quest
Medical, Inc., its subsidiaries and affiliates and Thomas C.
Thompson(7)
10.18 Lease Agreement dated as of February 4, 1999, between Advanced
Neuromodulation Systems, Inc. and Legacy Lincoln I, LTD.(10)
11.1 Computation of Earnings Per Share(11)
21.1 Subsidiaries(11)
23.1 Consent of Independent Auditors(11)
27.1 Financial Data Schedule - December 31, 1999(11)
- -------------------------------------
(1) Filed as an Exhibit to the Company's Registration Statement on Form
S-18, Registration No. 2-71198-FW, and incorporated herein by
reference.
(2) Filed as an Exhibit to the report of the Company on Form 10-K for the
year ended December 31, 1987, and incorporated herein by reference.
(3) Filed as an Exhibit to the Company's Registration Statement on Form
S-1, Registration No. 2-78186, and incorporated herein by reference.
(4) Filed as an Exhibit to the Company's Registration Statement on Form
SB-2, Registration No. 33-62991, and incorporated herein by reference.
(5) Filed as an Exhibit to the report of the Company on Form 8-K dated
September 3, 1996, and incorporated herein by reference.
(6) Filed as an Exhibit to the report of the Company on Form 8-K dated
February 13, 1998, and incorporated herein by reference. Upon request,
the Company will furnish a copy of any omitted schedule to the
Commission.
(7) Filed as an Exhibit to the report of the Company on Form 10-K dated for
the year ended December 31, 1997, and incorporated herein by reference.
(8) Filed as an Exhibit to the report of the Company on Form 10-Q dated for
the quarterly period ended March 31, 1998, and incorporated herein by
reference.
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<PAGE>
(9) Filed as an Exhibit to the Definitive Proxy Statement on Schedule 14A
dated April 27, 1998, and incorporated herein by reference.
(10) Filed as an Exhibit to the report of the Company on Form 10-K dated for
the year ended December 31, 1998, and incorporated herein by reference.
(11) Filed herewith.
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Signatures
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Company has duly caused this report to be signed on its behalf
by the undersigned, thereunto duly authorized.
Date: March 27, 2000
ADVANCED NEUROMODULATION SYSTEMS, INC.
By: /s/Christopher G. Chavez
------------------------
Christopher G. Chavez
President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed by the following persons on behalf of the Company and in the
capacities and on the dates indicated:
<TABLE>
<CAPTION>
Signature Title Date
--------- ----- ----
<S> <C> <C>
/s/Christopher G. Chavez Chief Executive Officer, President March 27, 2000
- ---------------------------- and, Director of Advanced
Christopher G. Chavez Neuromodulation Systems, Inc.
(Principal Executive Officer)
/s/F. Robert Merrill III Executive Vice President-Finance, March 27, 2000
- ---------------------------- Treasurer and Secretary of
F. Robert Merrill III Advanced Neuromodulation Systems,
Inc. (Principal Financial and
Accounting Officer)
/s/Hugh M. Morrison Chairman of the Board and March 27, 2000
- ---------------------------- Director of Advanced
Hugh M. Morrison Neuromodulation Systems, Inc.
/s/Robert C. Eberhart Director of Advanced March 27, 2000
- ---------------------------- Neuromodulation Systems, Inc.
Robert C. Eberhart
/s/Joseph E. Laptewicz, Jr. Director of Advanced March 27, 2000
- ---------------------------- Neuromodulation Systems, Inc.
Joseph E. Laptewicz, Jr.
/s/A. Ronald Lerner Director of Advanced March 27, 2000
- ---------------------------- Neuromodulation Systems, Inc.
A. Ronald Lerner
/s/Richard D. Nikolaev Director of Advanced March 27, 2000
- ---------------------------- Neuromodulation Systems, Inc.
Richard D. Nikolaev
/s/Michael J. Torma Director of Advanced March 27, 2000
- ---------------------------- Neuromodulation Systems, Inc.
Michael J. Torma
</TABLE>
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<PAGE>
Appendix A
----------
Consolidated Financial Statements
Independent Auditors' Report
Three Years Ended December 31, 1999
Forming a Part of the Annual Report
Form 10-K
Item 8
of
ADVANCED NEUROMODULATION SYSTEMS, INC.
(Name of issuer)
Filed with the
Securities and Exchange Commission
Washington, D.C. 20549
under
The Securities and Exchange Act of 1934
<PAGE>
Advanced Neuromodulation Systems, Inc. and Subsidiaries
Table of Contents
to
Consolidated Financial Statements
Form 10-K - Item 8
Independent Auditors' Report
Consolidated Financial Statements:
Consolidated Balance Sheets - December 31, 1999 and 1998
Consolidated Statements of Operations - Years ended December 31, 1999, 1998 and
1997
Consolidated Statements of Stockholders' Equity - Years ended December 31,
1999, 1998 and 1997
Consolidated Statements of Cash Flows - Years ended December
31, 1999, 1998 and 1997
Notes to Consolidated Financial Statements
<PAGE>
Report of Independent Auditors
The Board of Directors
Advanced Neuromodulation Systems, Inc.
We have audited the accompanying consolidated balance sheets of Advanced
Neuromodulation Systems, Inc. and subsidiaries (the Company) as of December 31,
1999 and 1998, and the related consolidated statements of operations,
stockholders' equity and cash flows for each of the three years in the period
ended December 31, 1999. Our audits also included the financial statement
schedule listed in the Index at Item 14A. These consolidated financial
statements and schedule are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements and
schedule based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Advanced
Neuromodulation Systems, Inc. and subsidiaries at December 31, 1999 and 1998,
and the consolidated results of their operations and their cash flows for each
of the three years in the period ended December 31, 1999, in conformity with
accounting principles generally accepted in the United States. Also, in our
opinion, the related financial statement schedule, when considered in relation
to the basic financial statements taken as a whole, presents fairly in all
material respects the information set forth therein.
/s/ERNST & YOUNG LLP
--------------------
ERNST & YOUNG LLP
Dallas, Texas
February 25, 2000
<PAGE>
Advanced Neuromodulation Systems, Inc. and Subsidiaries
Consolidated Balance Sheets
December 31, 1999 and 1998
<TABLE>
<CAPTION>
Assets 1999 1998
- ------ ------------ ------------
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 8,353,658 $ 11,697,209
Marketable securities 398,208 566,072
Receivables:
Trade accounts, less allowance for doubtful accounts
of $140,824 in 1999 and $249,607 in 1998 3,785,719 3,135,615
Interest and other 70,965 124,511
------------ ------------
Total receivables 3,856,684 3,260,126
------------ ------------
Inventories:
Raw materials 3,014,908 1,010,865
Work-in-process 626,402 415,442
Finished goods 2,357,907 1,216,955
------------ ------------
Total inventories 5,999,217 2,643,262
------------ ------------
Deferred income taxes 654,086 887,609
Prepaid expenses and other current assets 1,107,380 852,025
Net assets of building and land sold in 1999 -- 6,310,985
------------ ------------
Total current assets 20,369,233 26,217,288
------------ ------------
Equipment and fixtures:
Furniture and fixtures 3,240,322 882,968
Machinery and equipment 3,599,338 2,066,514
Leasehold improvements 711,271 --
------------ ------------
7,550,931 2,949,482
Less accumulated depreciation and amortization 1,862,361 1,060,890
------------ ------------
Net equipment and fixtures 5,688,570 1,888,592
------------ ------------
Cost in excess of net assets acquired, net of accumulated
amortization of $2,291,220 in 1999 and $1,734,617
in 1998 8,520,444 9,077,047
Patents and licenses, net of accumulated amortization
of $472,708 in 1999 and $302,281 in 1998 4,071,196 3,054,283
Purchased technology from acquisitions, net of accumulated
amortization of $1,266,667 in 1999 and
$1,000,000 in 1998 2,733,333 3,000,000
Tradenames, net of accumulated amortization of
$593,750 in 1999 and $468,750 in 1998 1,906,250 2,031,250
Other assets, net of accumulated amortization of
$137,985 in 1999 and $68,993 in 1998 265,748 216,908
------------ ------------
$ 43,554,774 $ 45,485,368
============ ============
</TABLE>
See accompanying notes to consolidated financial statements.
<PAGE>
Advanced Neuromodulation Systems, Inc. and Subsidiaries
Consolidated Balance Sheets
December 31, 1999 and 1998
<TABLE>
<CAPTION>
Liabilities and Stockholders' Equity 1999 1998
- ------------------------------------ ------------ ------------
<S> <C> <C>
Current liabilities:
Accounts payable $ 1,765,377 $ 904,899
Accrued salary and employee benefit costs 793,275 562,618
Accrued tax abatement liability 969,204 969,204
Income taxes payable 511,848 2,276,655
Other accrued expenses 151,372 544,295
Deferred revenue -- 900,000
Mortgage notes on building and land sold in 1999 -- 3,633,475
------------ ------------
Total current liabilities 4,191,076 9,791,146
------------ ------------
Deferred income taxes 2,325,403 2,390,475
Commitments and contingencies
Stockholders' equity:
Common stock, $.05 par value
Authorized-25,000,000 shares;
Issued-8,708,367 shares 435,418 435,418
Additional capital 40,423,457 41,156,582
Retained earnings (deficit) 5,694,422 (308,859)
Accumulated other comprehensive income (loss), net of
tax benefit of $124,437 in 1999 and $67,363 in 1998 (241,550) (130,760)
Cost of common shares in treasury; 1,316,558 shares
in 1999 and 1,073,751 shares in 1998 (9,273,452) (7,848,634)
------------ ------------
Total stockholders' equity 37,038,295 33,303,747
------------ ------------
$43,554,774 $45,485,368
============ ============
</TABLE>
See accompanying notes to consolidated financial statements.
<PAGE>
Advanced Neuromodulation Systems, Inc. and Subsidiaries
Consolidated Statements of Operations
Years Ended December 31
<TABLE>
<CAPTION>
1999 1998 1997
------------ ------------ ------------
<S> <C> <C> <C>
Net revenue-product sales $20,578,384 $17,006,407 $14,717,721
Net revenue-contract research and development 8,900,000 3,100,000 --
------------ ------------ ------------
Total net revenue 29,478,384 20,106,407 14,717,721
------------ ------------ ------------
Operating expenses:
Cost of product sales 6,628,983 4,985,887 4,839,261
General and administrative 2,756,931 2,633,250 1,760,061
Research and development 3,772,579 2,801,175 976,900
Amortization of intangibles 1,187,689 1,170,585 1,085,871
Marketing 6,290,004 4,682,423 3,969,320
------------ ------------ ------------
20,636,186 16,273,320 12,631,413
------------ ------------ ------------
Earnings from operations 8,842,198 3,833,087 2,086,308
Other income (expense):
Loss on sale of marketable securities -- (4,381) (25,659)
Interest expense (44,861) (331,468) (625,321)
Investment and other income, net 751,238 834,772 115,197
------------ ------------ ------------
706,377 498,923 (535,783)
------------ ------------ ------------
Earnings from continuing operations
before income taxes 9,548,575 4,332,010 1,550,525
Income taxes 3,545,294 1,746,304 733,014
------------ ------------ ------------
Net earnings from continuing operations 6,003,281 2,585,706 817,511
------------ ------------ ------------
Loss from discontinued operations, net of income
tax benefits of $129,711 in 1998 and $15,909 in 1997 -- (211,634) (93,490)
Gain on sale of assets of discontinued operations, net of
income tax expense of $2,473,293 in 1998 -- 4,585,130 --
------------ ------------ ------------
Net earnings (loss) from discontinued operations -- 4,373,496 (93,490)
------------ ------------ ------------
Net earnings $ 6,003,281 $ 6,959,202 $ 724,021
============ ============ ============
Basic earnings (loss) per share:
Continuing operations $ .79 $ .31 $ .10
============ ============ ============
Discontinued operations $ -- $ .53 $ (.01)
============ ============ ============
Net earnings $ .79 $ .84 $ .09
============ ============ ============
Diluted earnings (loss) per share:
Continuing operations $ .75 $ .30 $ .09
============ ============ ============
Discontinued operations $ -- $ .51 $ (.01)
============ ============ ============
Net earnings $ .75 $ .81 $ .08
============ ============ ============
</TABLE>
See accompanying notes to consolidated financial statements.
<PAGE>
Advanced Neuromodulation Systems, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
Years Ended December 31
<TABLE>
<CAPTION>
1999 1998 1997
------------ ------------ ------------
<S> <C> <C> <C>
Cash flows from operating activities:
Net earnings from continuing operations $ 6,003,281 $ 2,585,706 $ 817,511
Adjustments to reconcile earnings from continuing
operations to net cash provided by operating activities:
Depreciation 816,125 615,388 438,056
Amortization 1,187,689 1,170,585 1,085,871
Deferred income taxes 225,525 103,267 717,104
Non-operating loss included in net earnings -- 4,381 25,655
Increase in inventory reserve -- 52,818 534,619
Changes in assets and liabilities
Receivables (596,558) (748,442) (130,283)
Inventories (3,355,955) 200,834 (500,835)
Prepaid expenses and other current assets (254,427) (383,940) (302,558)
Income taxes payable (1,543,713) 1,605,319 --
Accounts payable 860,478 649,802 (513,704)
Accrued expenses (220,897) 177,904 (62,529)
Deferred revenue (900,000) 900,000 --
------------ ------------ ------------
Net cash provided by continuing operations 2,221,548 6,933,622 2,108,907
Net cash provided by discontinued operations -- 59,049 391,096
------------ ------------ ------------
Net cash provided by operating activities 2,221,548 6,992,671 2,500,003
------------ ------------ ------------
Cash flows from investing activities:
Net proceeds from sales of marketable securities -- 851,621 1,403,607
Purchases of marketable securities -- (106,001) (1,379,065)
Additions to property, plant , equipment and patent
licenses - continuing operations (5,907,550) (1,678,842) (545,193)
Additions to property, plant and equipment -
discontinued operations -- (12,060) (745,729)
Net proceeds from sale of assets of discontinued
operations 6,354,965 21,754,181 --
Payments related to 1995 acquisition -- -- (4,472,197)
Other -- -- (594)
------------ ------------ ------------
Net cash provided by (used in) investing
activities 447,415 20,808,899 (5,739,171)
------------ ------------ ------------
Cash flows from financing activities:
Net increase (decrease) in short-term obligations (3,633,475) (8,081,763) 3,531,763
Payment of long-term notes -- (177,137) (1,163,349)
Exercise of stock options 573,272 817,766 922,386
Purchase of treasury stock (2,952,311) (9,411,055) --
------------ ------------ ------------
Net cash provided by (used in) financing
activities (6,012,514) (16,852,189) 3,290,800
------------ ------------ ------------
Net increase (decrease) in cash and cash equivalents (3,343,551) 10,949,381 51,632
Cash and cash equivalents at beginning of year 11,697,209 747,828 696,196
------------ ------------ ------------
Cash and cash equivalents at end of year $ 8,353,658 $11,697,209 $ 747,828
============ ============ ============
Supplemental cash flow information is presented below:
Income taxes paid $ 4,863,482 $ 37,715 $ --
============ ============ ============
Interest paid $ 44,861 $ 370,304 $ 994,294
============ ============ ============
</TABLE>
See accompany notes to consolidated financial statements.
<PAGE>
Advanced Neuromodulation Systems, Inc. and Subsidiaries
Consolidated Statements of Stockholders' Equity
Three Years Ended December 31, 1999
<TABLE>
<CAPTION>
Retained Other Total
Common Stock Additional Earnings Comprehensive Treasury Stockholders'
Shares 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
exercises -- -- 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 -- -- -- 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
exercises -- -- 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 -- -- -- 6,003,281 -- -- 6,003,281
Adjustment to unrealized
losses on marketable
securities -- -- -- -- (110,790) -- (110,790)
-------------
Comprehensive income 5,892,491
-------------
Tax benefit from employee
stock option exercises -- -- 221,096 -- -- -- 221,096
Issuance of 162,068
shares from treasury
for stock option
exercises -- -- (954,221) -- -- 1,527,493 573,272
Purchase of 404,875
treasury shares,
at cost -- -- -- -- -- (2,952,311) (2,952,311)
Balance at ------------- ------------- ------------- ------------- ------------- ------------- -------------
December 31, 1999 8,708,367 $ 435,418 $ 40,423,457 $ 5,694,422 $ (241,550) $ (9,273,452) $ 37,038,295
============= ============= ============= ============= ============= ============= =============
</TABLE>
See accompanying notes to consolidated financial statements.
<PAGE>
Advanced Neuromodulation Systems, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(1) Business
Continuing Operations
Advanced Neuromodulation Systems, Inc. (the "Company" or "ANS") designs,
develops, manufactures and markets implantable neuromodulation devices. 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 neuromodulation 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 9 - "Sale of CVS
Operations/Discontinued Operations"). The CVS Operations have been accounted for
as discontinued operations in the Consolidated Statements of Operations for the
years ended December 31, 1998 and 1997. 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 Consolidated Balance
Sheet at December 31, 1998 as net assets of building and land sold in 1999.
(2) Summary of Significant Accounting Policies
Principles of Consolidation
The consolidated financial statements include the accounts of Advanced
Neuromodulation Systems, Inc. and all of its subsidiaries. All significant
inter-company transactions and accounts have been eliminated in consolidation.
-1-
<PAGE>
Advanced Neuromodulation Systems, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
Use of Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the amounts reported in the financial statements and accompanying notes.
Actual results could differ from those estimates.
Cash Equivalents
The Company considers all highly liquid investments with maturities of three
months or less at the time of purchase to be cash equivalents.
Revenue Recognition
The Company recognizes revenue from product sales when the goods are shipped to
its customers. The Company recognizes revenue from research and development
contracts based upon the estimated percentage of completion of the development
project which is determined by hours completed as a percentage of the total
estimated hours under the product development plan.
Marketable Securities
The Company's marketable securities and debt securities are classified as
available-for-sale and are carried at fair value with the unrealized gains and
losses reported in a separate component of stockholders' equity entitled "Other
comprehensive income". The amortized cost of debt securities in this category is
adjusted for amortization of premiums and accretion of discounts to maturity.
Such amortization is included in investment income. Realized gains and losses
and declines in value judged to be other than temporary are included in other
income. The cost of securities sold is based on the specific identification
method. Interest and dividends are included in investment income.
Inventories
Inventories are recorded at the lower of standard cost or market. Standard cost
approximates actual cost determined on the first-in, first-out ("FIFO") basis.
Cost includes the acquisition cost of raw materials and components, direct labor
and overhead.
Equipment and Fixtures
Equipment and fixtures are stated at cost. Additions and improvements extending
asset lives are capitalized while maintenance and repairs are expensed as
incurred. The cost and accumulated depreciation of assets sold or retired are
removed from the accounts and any gain or loss is reflected in the Statement of
Operations.
Depreciation is provided using the straight-line method over the estimated
useful lives of the various assets as follows:
Leasehold improvements 5 years
Furniture and fixtures 2 to 10 years
Machinery and equipment 3 to 10 years
-2-
<PAGE>
Advanced Neuromodulation Systems, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
Intangible Assets
The excess of cost over the net assets of acquired businesses ("goodwill") is
amortized on a straight-line basis over the estimated useful life of 20 years.
The cost of purchased technology related to acquisitions is based on appraised
values at the date of acquisition and is amortized on a straight-line basis over
the estimated useful life (15 years) of such technology.
The cost of purchased tradenames is based on appraised values at the date of
acquisition and is amortized on a straight-line basis over the estimated useful
life (20 years) of such tradenames.
The cost of purchased patents is amortized on a straight-line basis over the
estimated useful life (17 years) of such patents. The cost of certain licensed
patents is amortized on a straight-line basis over the estimated useful life (20
years) of such patents while the cost of certain other licensed patents is
amortized on a units of production method. Costs of patents that are the result
of internal development are charged to current operations.
The Company assesses the recoverability of all its intangible assets primarily
based on its current and anticipated future undiscounted cash flows. At December
31, 1999, the Company does not believe there has been any impairment of its
intangible assets.
Research and Development
Product development costs including start-up and research and development are
charged to operations in the year in which such costs are incurred.
Advertising
Advertising expense is charged to operations in the year in which such costs are
incurred. Total advertising expense included in marketing expense from
continuing operations was $40,440, $21,843 and $14,746 at December 31, 1999,
1998 and 1997, respectively.
Deferred Taxes
Deferred income taxes are recorded based on the liability method and represent
the tax effect of the differences between the financial and tax basis of assets
and liabilities other than costs in excess of the net assets of businesses
acquired.
Stock-Based Compensation
The Company has adopted the disclosure-only provisions of SFAS No. 123,
"Accounting for Stock-Based Compensation", which disclosures are presented in
Note 5, "Stockholders' Equity". Because of this election, the Company continues
to account for its stock-based compensation plans under APB No. 25, "Accounting
for Stock Issued to Employees". All of the Company's stock option grants are at
exercise prices equal to the fair market value of the Company's stock on the
date of grant, and therefore, no compensation expense is recorded.
-3-
<PAGE>
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 1999, 1998 and 1997 are based upon
7,583,159, 8,314,290 and 8,428,393 shares, respectively. Diluted earnings (loss)
per share for 1999, 1998 and 1997 are based upon 8,003,087, 8,544,040 and
8,858,086 shares, respectively. The following table presents the reconciliation
of basic and diluted shares:
<TABLE>
<CAPTION>
1999 1998 1997
--------- --------- ---------
<S> <C> <C> <C>
Weighted-average shares outstanding
(basic shares) 7,583,159 8,314,290 8,428,393
Effect of dilutive instruments(1)
Stock options 401,292 214,806 412,996
Warrants 18,636 14,944 16,697
--------- --------- ---------
Dilutive potential common shares 419,928 229,750 429,693
--------- --------- ---------
Diluted shares 8,003,087 8,544,040 8,858,086
========= ========= =========
</TABLE>
(1) See Note 5 for a description of these instruments.
For 1999, 1998 and 1997, the incremental shares used for dilutive earnings
(loss) per share relate to stock options and warrants whose exercise price was
less than the average market price in the underlying quarterly computations.
Options to purchase 250 shares at an average price of $8.94 per share were
outstanding in 1999, 215,981 shares at an average price of $9.02 per share were
outstanding in 1998, and options to purchase 148,313 shares at an average price
of $10.80 per share were outstanding in 1997 but were not included in the
computation of diluted earnings (loss) per share because the options' exercise
prices were greater than the average market price of the common shares and,
therefore, the effect would be antidilutive.
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 is
reported in the Consolidated Statements of Stockholders' Equity.
Reclassification
Certain prior period amounts have been reclassified to conform to current-year
presentation.
-4-
<PAGE>
Advanced Neuromodulation Systems, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(3) Marketable Securities
The following is a summary of available-for-sale securities at December 31,
1999:
<TABLE>
<CAPTION>
Gross Gross
Unrealized Unrealized Estimated
Cost Gains Losses Fair Value
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Investment grade preferred securities $ 554,596 $ -- $ 275,107 $ 279,489
Publicly traded limited partnerships 51,875 -- 27,815 24,060
Real estate investment trusts 141,590 -- 47,143 94,447
Other 16,134 -- 15,922 212
---------- ---------- ---------- ----------
$ 764,195 $ -- $ 365,987 $ 398,208
========== ========== ========== ==========
</TABLE>
Estimated fair value is determined by the closing prices of the respective
available-for-sale securities as reported on the New York and NASDAQ stock
exchange markets at each financial reporting period.
At December 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 December 31, 1999.
The following is a summary of available-for-sale securities at December 31,
1998:
<TABLE>
<CAPTION>
Gross Gross
Unrealized Unrealized Estimated
Cost Gains Losses Fair Value
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Investment grade preferred securities $ 557,596 $ -- $ 127,763 $ 429,833
Publicly traded limited partnerships 51,875 -- 28,440 23,435
Real estate investment trusts 141,590 -- 29,232 112,358
Other 13,134 -- 12,688 446
---------- ---------- ---------- ----------
$ 764,195 $ -- $ 198,123 $ 566,072
========== ========== ========== ==========
</TABLE>
At December 31, 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 December 31, 1998.
-5-
<PAGE>
Advanced Neuromodulation Systems, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(4) Federal Income Taxes
The significant components of the net deferred tax liability at December 31,
were as follows:
<TABLE>
<CAPTION>
Deferred tax assets: 1999 1998
------------ ------------
<S> <C> <C>
Tax credit and net operating loss carry forwards $ 36,649 $ --
Deferred revenue -- 306,000
Accrued expenses and reserves 496,213 572,030
Unrealized loss on marketable securities 124,437 67,362
------------ ------------
Total deferred tax asset 657,299 945,392
Deferred tax liabilities:
Purchased intangible assets (1,670,250) (1,710,625)
Excess of tax over book depreciation (597,425) (602,383)
Other (60,940) (135,250)
------------ ------------
Total deferred tax liability (2,328,615) (2,448,258)
------------ ------------
Net deferred tax asset (liability) $(1,671,316) $(1,502,866)
============ ============
</TABLE>
The provision for income taxes on earnings from continuing operations for the
years ended December 31 consists of the following:
<TABLE>
<CAPTION>
1999 1998 1997
----------- ----------- -----------
<S> <C> <C> <C>
Current $ 3,682,727 $ 2,005,713 $ --
Deferred (137,433) (259,409) 733,014
----------- ----------- -----------
$ 3,545,294 $ 1,746,304 $ 733,014
=========== =========== ===========
</TABLE>
A reconciliation of the provision for income taxes on earnings from continuing
operations to the expense calculated at the U.S. statutory rate follows:
<TABLE>
<CAPTION>
1999 1998 1997
----------- ----------- -----------
<S> <C> <C> <C>
Income tax expense at statutory rate $ 3,246,515 $ 1,472,883 $ 527,179
Tax effect of:
State taxes 183,625 117,900 --
Nondeductible amortization of goodwill 189,211 189,245 185,200
Other (74,057) (33,724) 20,635
----------- ----------- -----------
Income tax expense $ 3,545,294 $ 1,746,304 $ 733,014
=========== =========== ===========
</TABLE>
In 1998, the Company utilized net operating loss carry forwards of $4,277,540
and general business credits and alternative minimum tax credits of $1,038,669
to reduce its tax liabilities. At December 31, 1999, the Company had general
business credits of $36,649 to reduce its tax liabilities.
-6-
<PAGE>
Advanced Neuromodulation Systems, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(5) Stockholders' Equity
The Company has a Shareholder's Rights Plan, adopted in 1996, which permits
shareholders to purchase shares of the Company's common stock at significant
discounts in the event a person or group acquires more than 15 percent of the
Company's common stock or announces a tender or exchange offer for more than 20
percent of the Company's common stock.
During the year ended December 31, 1998, the Company repurchased 1,258,625
shares of its common stock at an aggregate cost of $9,411,055 and during the
year ended December 31, 1999, the Company repurchased 404,875 shares of its
common stock at an aggregate cost of $2,952,311. During the years ended December
31, 1999 and 1998, the Company issued 162,068 and 184,874 shares respectively,
from its treasury upon the exercise of stock options. At December 31, 1999,
1,316,558 shares remained in the treasury.
In 1998, the Company issued a five-year warrant to purchase 100,000 shares of
common stock at an exercise price of $6.50 per share in connection with a
$2,000,000 loan from a nonaffiliate shareholder. The warrant is outstanding at
December 31, 1999.
The Company has various stock option plans pursuant to which stock options may
be granted to key employees, officers, directors and advisory directors of the
Company. The most recent of the plans, approved by the shareholders during 1998
(the "1998 Plan"), reserved 800,000 shares of common stock for options under the
plan; provided, however, that on January 1 of each year (commencing in 1999),
the aggregate number of shares of common stock reserved for options under the
1998 Plan shall be increased by the same percentage that the total number of
issued and outstanding shares of common stock increased from the preceding
January 1 to the following December 31 (if such percentage is positive). No
additional options were added to the 1998 Plan on January 1, 1999 or January 1,
2000. Several of the plans allow for the grant of incentive stock options to key
employees and officers intended to qualify for preferential tax treatment under
Section 422 of the Internal Revenue Code of 1986. Under all of the Company's
plans, the exercise price of options granted must equal or exceed the fair
market value of the common stock at the time of the grant. Options granted to
employees and officers expire ten years from the date of grant and for the most
part are exercisable one-fourth each year over a four-year period of continuous
service. Options granted to directors and advisory directors expire six years
from the date of grant and for the most part are exercisable one-fourth each
year over a four-year period of continuous service. Certain options, however,
have a two-year vesting schedule.
At December 31, 1999, under all of the Company's stock option plans, 1,220,647
shares have been granted and are outstanding, 1,808,514 shares of common stock
have been issued upon exercise, and 94,601 shares were reserved for future
grants.
-7-
<PAGE>
Advanced Neuromodulation Systems, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
Data with respect to stock option plans of the Company are as follows:
<TABLE>
<CAPTION>
----------------------------- -----------------------------
Options Outstanding Exercisable Options
----------------------------- -----------------------------
Weighted Weighted
Average Average
Shares Exercise Price Shares Exercise Price
------------ -------------- ------------ --------------
<S> <C> <C> <C> <C>
January 1, 1997 1,175,188 $ 5.16 663,459 $ 3.51
Granted 66,500 $ 6.16
Exercised (296,999) $ 3.35
Rescinded (111,417) $ 6.36
------------ -------------- ------------ --------------
January 1, 1998 833,272 $ 5.68 568,285 $ 4.66
Granted 1,352,800 $ 6.12
Exercised (257,732) $ 3.49
Rescinded (860,125) $ 8.10
------------ -------------- ------------ --------------
January 1, 1999 1,068,215 $ 4.82 465,340 4.58
Granted 332,500 $ 6.73
Exercised (162,068) $ 3.99
Rescinded (18,000) $ 8.14
------------ -------------- ------------ ---------------
December 31, 1999 1,220,647 $ 5.40 499,397 $ 4.83
------------ -------------- ------------ --------------
</TABLE>
<TABLE>
<CAPTION>
Exercisable Options at
Options Outstanding at December 31, 1999 December 31, 1999
- -------------------------------------------------------- -----------------------
Weighted
Average Weighted Weighted
Range of Remaining Average Average
Exercise Price Shares Life (Years) Exercise Price Shares Exercise Price
- -------------- --------- ------------ -------------- -------- --------------
<S> <C> <C> <C> <C> <C>
$ 1.45 - 2.25 1 030 1.18 $ 1.94 1 030 $ 1.94
$ 2.25 - 3.50 15,450 1.18 $ 2.91 15,450 $ 2.91
$ 3.50 - 5.25 870,167 8.48 $ 4.94 480,417 $ 4.88
$ 5.25 - 8.00 333,000 9.27 $ 6.72 2,500 $ 7.13
$ 8.00 - 12.25 1,000 9.61 $ 8.94 -- $ --
--------- ----------- -------------- -------- --------------
1,220,647 8.60 $ 5.40 499,397 $ 4.83
--------- ----------- -------------- -------- --------------
</TABLE>
Exercisable options at January 1, 1999 and 1998 included options for 134,904 and
306,297 shares, respectively, with a weighted average exercise price of $4.53
per share at January 1, 1999 and $4.22 per share at January 1, 1998, which were
held by employees who terminated employment with the Company on January 30, 1998
in connection with the sale of the CVS Operations (see Note 9 - "Sale of CVS
Operations/Discontinued Operations"). The Company accelerated the vesting of the
unvested portion of these terminated employee options as a result of the sale.
The Company also extended the normal 90-day exercise period subsequent to
termination to January 30, 1999 for these options.
In November 1998, the Board of Directors authorized the repricing of options for
certain employees, advisory directors and directors under several of the Plans.
Stock options were rescinded for these participants and a new option was granted
at the then fair market value of the common stock of $5.00 per share. Data with
respect to the option repricing during November 1998 is as follows:
-8-
<PAGE>
Advanced Neuromodulation Systems, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
<TABLE>
<CAPTION>
1998 Option Repricing Data
--------------------------------------------------------------
Range of Exercise Weighted Average
Price Before Exercise Price
Repricing Shares Before Repricing
--------------------- ------------------ ---------------------
<S> <C> <C>
$ 5.75 - 7.75 293,000 $ 6.28
$ 7.75 - 9.75 408,500 $ 8.58
$ 9.75 - 11.75 77,000 $ 10.25
$ 11.75 - 12.25 15,000 $ 12.13
------------------ ---------------------
793,500 $ 7.96
------------------ ---------------------
</TABLE>
In accordance with APB No. 25, the Company has not recorded compensation expense
for its stock option awards. As required by SFAS No. 123, the Company provides
the following disclosure of hypothetical values for these awards. The
weighted-average fair value of an option granted in 1999, 1998 and 1997 was
$2.73, $2.30 and $2.37, respectively. For purposes of fair market value
disclosures, the fair market value of an option grant was estimated using the
Black-Scholes option pricing model with the following assumptions:
<TABLE>
<CAPTION>
1999 1998 1997
------ ------ ------
<S> <C> <C> <C>
Risk-free interest rate ....... 5.5% 4.6% 6.1%
Average life of options (years) 3.0 3.0 3.0
Volatility .................... 49.1% 49.2% 48.0%
Dividend Yield ................ -- -- --
</TABLE>
Had the compensation expense been recorded based on these hypothetical values,
pro forma net earnings for 1999, 1998 and 1997 would have been $5,047,706,
$6,457,825 and $519,731, respectively, and pro forma diluted net earnings per
common share for 1999, 1998 and 1997 would have been $.63, $.76 and $.06,
respectively. Because option grants prior to 1995 are not considered in the pro
forma amounts, as permitted by SFAS No. 123, the pro forma effects on net
earnings (loss) are not likely to be representative of the effects on reported
amounts in future years.
(6) Commitments and Contingencies
On February 1, 1999, the Company sold its principal office and manufacturing
facility in Allen, Texas to Atrion Corporation. Atrion leased space to the
Company at the rate of $48,125 per month from February 1, 1999 through May 31,
1999. The Company entered into a sixty-three month lease agreement on 40,000
square feet of space located in the North Dallas area during February 1999. The
Company relocated its operations to the leased facility in May 1999 and the
rental period under the lease commenced on June 1, 1999. Under the terms of the
lease agreement, the Company received 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 the first right of refusal to acquire the facility. Future minimum rental
payments relating to the leased facility for the years ended December 31 are
$579,696 in 2000, 2001, 2002 and 2003 and $386,464 in 2004.
-9-
<PAGE>
Advanced Neuromodulation Systems, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
In addition, the Company leases transportation equipment under non-cancelable
operating leases. Future minimum rental payments under non-cancelable
transportation leases for the years ended December 31 are $17,667 in 2000 and
2001 and $5,104 in 2002.
Total rent expense included in continuing operations for the years ended
December 31, 1999, 1998 and 1997 was $533,600, $8,782 and $8,617, respectively.
The Company is a party to product liability claims related to ANS
neurostimulation devices. Product liability insurers have assumed responsibility
for defending the Company against these claims. While historically product
liability claims for ANS neurostimulation devices have not resulted in
significant monetary liability for the Company beyond its insurance coverage,
there can be no assurances that the Company will not incur significant monetary
liability to the claimants if such insurance is inadequate or that the Company's
neurostimulation business and future ANS product lines will not be adversely
affected by these product liability claims.
Except for such product liability claims and other ordinary routine litigation
incidental or immaterial to its business, the Company is not currently a party
to any other pending legal proceeding. The Company maintains general liability
insurance against risks arising out of the normal course of business.
(7) Financial Instruments, Risk Concentration and Major Customers
In the United States, the Company's accounts receivable are due primarily from
hospitals and distributors located throughout the country. Internationally, the
Company's accounts receivable are due primarily from distributors located in
Europe and Australia. The Company generally does not require collateral for
trade receivables. The Company maintains an allowance for doubtful accounts
based upon expected collectibility. Any losses from bad debts have historically
been within management's expectations.
Net sales of implantable neurostimulation systems to two major customers for the
year ended December 31, 1999, as a percentage of net revenue from product sales
from continuing operations, were 15 percent and 11 percent, respectively. Net
sales of implantable neurostimulation systems to one major customer for each of
the years ended December 31, as a percentage of net revenue from product sales
from continuing operations were as follows: 1998 - 20 percent and 1997- 25
percent. Foreign sales, primarily Europe and Australia, for the years ended
December 31, 1999, 1998 and 1997 were approximately 7 percent, 10 percent and 8
percent of net revenue from product sales from continuing operations,
respectively.
(8) Employee Benefit Plans
The Company has a defined contribution retirement savings plan (the "Plan")
available to substantially all employees. The Plan permits employees to elect
salary deferral contributions of up to 15 percent of their compensation and
requires the Company to make matching contributions equal to 50 percent of the
participants' contributions to a maximum of 6 percent of the participants'
compensation. The Board of Directors may change the percentage of matching
contribution at their discretion. The expense of the Company's contribution for
continuing operations was $158,842 in 1999, $119,543 in 1998 and $72,635 in
1997.
-10-
<PAGE>
Advanced Neuromodulation Systems, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(9) Sale of CVS Operations/Discontinued Operations
On January 30, 1998, the Company sold its cardiovascular and intravenous fluid
product lines, including its Myocardial Protection System product line, to
Atrion Corporation. The Company received approximately $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 are being used for
working capital for the expanding ANS business and stock repurchases as deemed
appropriate by the Board of Directors. The Company reported a net gain (after
income tax expense) from the sale of $4.6 million. This gain is net of a pre-tax
expense of $969,204, discussed below, recorded in connection with the sale of
the corporate facility to Atrion in February 1999. The gain is also net of a
pre-tax compensation expense of $1,004,654 recorded as a result of changes made
to the options held by employees of the CVS Operations (see Note 5 -
"Stockholders' Equity"). The Company also reported a net loss for the CVS
Operations of approximately $211,634 in January 1998 prior to the sale.
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 office and manufacturing
facility in Allen Texas 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 were
maintained in the City of Allen. The agreement provided for the repayment of
abated taxes if the Company defaulted under the agreement. As mentioned above,
during 1998 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. In July 1999, the
Company, Atrion and the City of Allen executed an assignment agreement under
which Atrion (as successor in interest to the Company) must continue to meet the
conditions of the original tax abatement agreement until August 2003. The City
preserved its rights to collect previously abated taxes if Atrion fails to
comply with its obligations any time prior to August 2003. The Company retains
monetary liability for the amount of abated taxes, even after assignment,
because pursuant to the purchase and sale agreement with Atrion, the Company
indemnified Atrion from any tax abatement liabilities that accrued to the City
of Allen prior to the sale of the CVS Operations in January 1998. If Atrion
meets the minimum requirements under the agreement until August 2003, then no
payment will be required. If no payment is required, the Company intends to
reverse the obligation of $969,204 in September 2003.
On February 1, 1999, the sale of the facility to Atrion was consummated. Net
assets of the facility sold to Atrion have been presented on the Consolidated
Balance Sheet at December 31, 1998, as "Net assets of building and land sold in
1999". The Company repaid the mortgage debt on the facility at the closing of
the transaction. 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 moved its operations to a
40,000 square foot leased facility in the North Dallas area during May 1999.
Until such time, the Company leased space from Atrion at a monthly expense of
$48,175 and paid Atrion fifty percent of certain operating expenses. The expense
of moving and transitioning into the new leased facility was immaterial.
Operating results of the CVS Operations have been reclassified and reported as
discontinued operations. Summary operating results for the years ended December
31, 1998 and 1997 for the CVS Operations were as follows (the 1998 period
includes results for one month until the sale on January 30, 1998):
-11-
<PAGE>
Advanced Neuromodulation Systems, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
<TABLE>
<CAPTION>
1998 1997
------------ ------------
<S> <C> <C>
Revenue ....................... $ 1,111,992 $ 14,306,127
Gross profit .................. 206,481 6,500,654
Earnings (loss) from operations (307,120) 333,200
Interest expense .............. (34,225) (442,599)
------------ ------------
Loss before income tax benefit (341,345) (109,399)
Income tax benefit ............ (129,711) (15,909)
------------ ------------
Net loss ...................... $ (211,634) $ (93,490)
============ ============
</TABLE>
The above operating results of the CVS Operations reflect the revenues and
expenses of the CVS Operations including direct and indirect expenses of the
Operations that are paid by the Company and charged directly to the CVS
Operations. General overhead of the Company includes charges for regulatory,
general corporate management, accounting and payroll services, human resources,
management information systems and facilities expenses. These expenses were
charged to the CVS Operations in amounts that approximate the discreet
identifiable costs of the CVS Operations that will not continue after the sale.
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.
(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. Due to the termination of the
agreement discussed below, the remaining $900,000 was recognized into income as
revenue during January 1999 and is included in the Statements of Operations for
the year ended December 31, 1999. 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 payments due the Company in the
amount of $8 million and the Company agreed to release Sofamor Danek from
further contractual obligations. The Company received the $8 million payment
from Sofamor Danek on January 28, 1999, the day after the completion of the
merger. The $8 million payment was recognized into revenue during January 1999
and is included in the Statements of Operations for the year ended December 31,
1999.
-12-
<PAGE>
Appendix B
----------
Schedule II - Valuation and Qualifying Accounts
Forming a Part of the Annual Report
Form 10-K
Item 14
of
ADVANCED NEUROMODULATION SYSTEMS, INC.
(Name of issuer)
Filed with the
Securities and Exchange Commission
Washington, D.C. 20549
under
The Securities and Exchange Act of 1934
<PAGE>
Schedule II - Valuation and Qualifying Accounts
Advanced Neuromodulation Systems, Inc. and Subsidiaries
December 31, 1999
<TABLE>
<CAPTION>
Balance at Charged to Balance
Beginning of Charged to Other at End of
Description Period Expenses Accounts Deductions Period
- ----------------------------------- ----------- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C>
Year ended December 31, 1999:
Continuing Operations:
---------------------
Allowance for doubtful accounts $ 249,607 $ 35,756 $ -- $ 144,539 $ 140,824
Reserve for obsolete inventory 86,599 -- -- -- 86,599
----------- ----------- ----------- ----------- -----------
Total $ 336,206 $ 35,756 $ -- $ 144,539 $ 227,423
=========== =========== =========== =========== ===========
Year ended December 31, 1998:
Continuing Operations:
---------------------
Allowance for doubtful accounts $ 212,375 $ 25,000 $ -- $ (12,232)(1) $ 249,607(1)
Reserve for obsolete inventory 56,005 50,709 -- 20,115 86,599
----------- ----------- ----------- ----------- -----------
Total $ 268,380 $ 75,709 $ -- $ 7,883 $ 336,206
=========== =========== =========== =========== ===========
Discontinued Operations:
-----------------------
Allowance for doubtful accounts $ 30,610 $ 96,238 $ -- $ 126,848 $ --
Reserve for obsolete inventory 154,347 -- -- 154,347 --
----------- ----------- ----------- ----------- -----------
Total $ 184,957 $ 96,238 $ -- $ 281,195 $ --
=========== =========== =========== =========== ===========
Year ended December 31, 1997:
Continuing Operations:
---------------------
Allowance for doubtful accounts $ 160,000 $ 64,453 $ -- $ 12,078 $ 212,375
Reserve for obsolete inventory -- 534,619 -- 478,614 56,005
----------- ----------- ----------- ----------- -----------
Total $ 160,000 $ 599,072 $ -- $ 490,692 $ 268,380
=========== =========== =========== =========== ===========
Discontinued Operations:
-----------------------
Allowance for doubtful accounts $ 14,337 $ 54,098 $ -- $ 37,825 $ 30,610
Reserve for obsolete inventory 230,472 151,168 -- 227,293 154,347
----------- ----------- ----------- ----------- -----------
Total $ 244,809 $ 205,266 $ -- $ 265,118 $ 184,957
=========== =========== =========== =========== ===========
</TABLE>
(1) Includes $96,238 transferred from discontinued operations for accounts
remaining with the Company.
<PAGE>
Appendix C
----------
Quarterly Financial Data
(unaudited)
Forming a Part of the Annual Report
Form 10-K
Item 8
of
ADVANCED NEUROMODULATION SYSTEMS, INC.
(Name of issuer)
Filed with the
Securities and Exchange Commission
Washington, D.C. 20549
under
The Securities and Exchange Act of 1934
<PAGE>
<TABLE>
<CAPTION>
1999 1st Qtr. 2nd Qtr. 3rd Qtr. 4th Qtr.
- --------------------------------------------- ------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Net revenue- product sales $ 4,595,238 $ 5,169,614 $ 5,488,479 $ 5,325,053
Total net revenue 13,495,238 5,169,614 5,488,479 5,325,053
Gross profit- product sales 3,235,058 3,583,979 3,413,948 3,716,416
Earnings (loss) from operations 8,775,155 161,881 (70,851) (23,987)
Earnings from operations before income taxes 8,957,826 375,382 97,758 117,609
- --------------------------------------------- ------------- ------------- ------------- -------------
Net earnings $ 5,446,358 $ 222,494 $ 216,135 $ 118,294
- --------------------------------------------- ------------------ ------------------- ----------------
Basic earnings per share:
- --------------------------------------------- ------------- ------------- ------------- -------------
Net earnings $ 0.70 $ 0.03 $ 0.03 $ 0.02
- --------------------------------------------- ------------- ------------- ------------- -------------
Diluted earnings per share:
- --------------------------------------------- ------------- ------------- ------------- -------------
Net earnings $ 0.67 $ 0.03 $ 0.03 $ 0.02
- --------------------------------------------- ------------- ------------- ------------- -------------
1998 1st Qtr. 2nd Qtr. 3rd Qtr. 4th Qtr.
- --------------------------------------------- ------------- ------------- ------------- -------------
Net revenue- product sales $ 4,423,455 $ 4,730,672 $ 3,706,402 $ 4,145,878
Total net revenue 4,423,455 5,330,672 5,006,402 5,345,878
Gross profit- product sales 3,165,823 3,493,103 2,657,313 2,704,281
Earnings from operations 771,403 1,356,560 865,004 840,120
Earnings from continuing operations before
income taxes 847,373 1,520,187 1,032,775 931,675
Net earnings from continuing operations 501,644 921,188 613,637 549,237
Net earnings (loss) from discontinued
operations 4,988,941 -- -- (615,445)
- --------------------------------------------- ------------- ------------- ------------- -------------
Net earnings (loss) $ 5,490,585 $ 921,188 $ 613,637 $ (66,208)
- --------------------------------------------- ------------- ------------- ------------- -------------
Basic earnings (loss) per share:
Continuing operations $ 0.06 $ 0.11 $ 0.07 $ 0.07
Discontinued operations $ 0.58 $ -- -- $ (0.08)
------------- ------------- ------------- -------------
Net earnings (loss) $ 0.64 $ 0.11 0.07 $ (0.01)
- --------------------------------------------- ------------- ------------- ------------- -------------
Diluted earnings (loss) per share:
Continuing operations $ 0.06 $ 0.10 0.07 $ 0.07
Discontinued operations $ 0.56 $ -- -- $ (0.08)
- --------------------------------------------- ------------- ------------- ------------- -------------
Net earnings (loss) $ 0.62 $ 0.10 $ 0.07 $ (0.01)
- --------------------------------------------- ------------- ------------- ------------- -------------
</TABLE>
<PAGE>
INDEX TO EXHIBITS
Exhibit
Number Description
------- -----------
2.1 Asset Purchase Agreement, dated December 29, 1997, by and among
Quest Medical, Inc., QMI Medical, Inc. (formerly known as QMI
Acquisition Corp.) and Atrion Corporation (including exhibits and
schedules 2.1.1, 2.1.2, 2.3(a) and 2.3.(b))(7)
3.1 Articles of Incorporation, as amended and restated(4)
3.2 Bylaws(1)
4.1 Rights Agreement dated as of August 30, 1996, between Quest
Medical, Inc. and KeyCorp Shareholder Services, Inc. as Rights
Agent(5)
10.1 Quest Medical, Inc. 1979 Amended and Restated Employees Stock
Option Plan(2)
10.2 Form of 1979 Employees Stock Option Agreement(3)
10.3 Quest Medical, Inc. Directors Stock Option Plan (as amended)(2)
10.4 Form of Directors Stock Option Agreement(1)
10.5 Quest Medical, Inc. 1987 Stock Option Plan(4)
10.6 Form of 1987 Employee Stock Option Agreement(4)
10.7 Quest Medical, Inc. 1995 Stock Option Plan(4)
10.8 Form of 1995 Employee Stock Option Agreement(4)
10.9 Quest Medical, Inc. 1998 Stock Option Plan(9)
10.10 Employment Agreement dated April 9, 1998 between Christopher G.
Chavez and Quest Medical, Inc.(8)
10.11 Employment Agreement dated April 9, 1998 between Scott F. Drees
and Quest Medical, Inc.(8)
10.12 Employment Agreement dated April 9, 1998 between F. Robert
Merrill III and Quest Medical, Inc.(8)
10.13 Form of Employment Agreement and Covenant Not to Compete, between
the Company and key employees(1)
10.14 Form of License Agreement, dated January 30, 1998, by and between
Quest Medical, Inc. and QMI Medical, Inc. (formerly known as QMI
Acquisition Corp.)(6)
10.15 Form of Lease Agreement, dated January 30, 1998, by and between
Quest Medical, Inc. and QMI Medical, Inc. (formerly known as QMI
Acquisition Corp.)(6)
10.16 Form of Option Agreement, dated January 30, 1998, by and between
Quest Medical, Inc. and QMI Medical, Inc. (formerly known as QMI
Acquisition Corp.)(6)
10.17 Agreement, dated December 31, 1997, by and among Quest Medical,
Inc., its subsidiaries and affiliates and Thomas C. Thompson(7)
10.18 Lease Agreement dated as of February 4, 1999, between Advanced
Neuromodulation Systems, Inc. and Legacy Lincoln I, LTD.(10)
11.1 Computation of Earnings Per Share(11)
21.1 Subsidiaries(11)
23.1 Consent of Independent Auditors(11)
27.1 Financial Data Schedule - December 31, 1999(11)
- -------------------------------------
(1) Filed as an Exhibit to the Company's Registration Statement on Form S-18,
Registration No. 2-71198-FW, and incorporated herein by reference.
(2) Filed as an Exhibit to the report of the Company on Form 10-K for the year
ended December 31, 1987, and incorporated herein by reference.
(3) Filed as an Exhibit to the Company's Registration Statement on Form S-1,
Registration No. 2-78186, and incorporated herein by reference.
(4) Filed as an Exhibit to the Company's Registration Statement on Form SB-2,
Registration No. 33-62991, and incorporated herein by reference.
(5) Filed as an Exhibit to the report of the Company on Form 8-K dated
September 3, 1996, and incorporated herein by reference.
(6) Filed as an Exhibit to the report of the Company on Form 8-K dated
February 13, 1998, and incorporated herein by reference.
Upon request, the Company will furnish a copy of any omitted schedule to
the Commission.
(7) Filed as an Exhibit to the report of the Company on Form 10-K dated for
the year ended December 31, 1997, and incorporated herein by reference.
(8) Filed as an Exhibit to the report of the Company on Form 10-Q dated for
the quarterly period ended March 31, 1998, and incorporated herein by
reference.
(9) Filed as an Exhibit to the Definitive Proxy Statement on Schedule 14A
dated April 27, 1998, and incorporated herein by reference.
(10) Filed as an Exhibit to the report of the Company on Form 10-K dated for
the year ended December 31, 1998, and incorporated herein by reference.
(11) Filed herewith.
<PAGE>
EXHIBIT 11.1
<PAGE>
Advanced Neuromodulation Systems, Inc.
Computation of Earnings Per Share
Years Ended December 31
<TABLE>
<CAPTION>
1999 1998 1997
------------ ------------ ------------
<S> <C> <C> <C>
Basic earnings (loss) per share:
Weighted average common
shares outstanding 7,583,159 8,314,290 8,428,393
------------ ------------ ------------
Net earnings from continuing operations $ 6,003,281 $ 2,585,706 $ 817,511
Net earnings (loss) from discontinued operations -- 4,373,496 (93,490)
------------ ------------ ------------
Net earnings $ 6,003,281 $ 6,959,202 $ 724,021
------------ ------------ ------------
Net earnings from continuing operations
per share $ 0.79 $ 0.31 $ 0.10
Net earnings (loss) from discontinued operations
per share -- 0.53 (0.01)
------------ ------------ ------------
Net earnings per share $ 0.79 $ 0.84 $ 0.09
------------ ------------ ------------
Diluted earnings (loss) per share:
Weighted average common
shares outstanding 7,583,159 8,314,290 8,428,393
Stock options and warrants--based on the treasury
stock method using average market price 419,928 229,750 429,693
------------ ------------ ------------
Diluted common and common equivalent
shares outstanding 8,003,087 8,544,040 8,858,086
------------ ------------ ------------
Net earnings from continuing operations $ 6,003,281 $ 2,585,706 $ 817,511
Net earnings (loss) from discontinued operations -- 4,373,496 (93,490)
------------ ------------ ------------
Net earnings $ 6,003,281 $ 6,959,202 $ 724,021
------------ ------------ ------------
Net earnings from continuing operations
per share $ 0.75 $ 0.30 $ 0.09
Net earnings (loss) from discontinued operations
per share -- 0.51 (0.01)
------------ ------------ ------------
Net earnings per share $ 0.75 $ 0.81 $ 0.08
------------ ------------ ------------
</TABLE>
<PAGE>
EXHIBIT 21.1
<PAGE>
SUBSIDIARIES
The Company has no "significant subsidiaries" as defined in Rule 1-02 (w) of
Regulation S-X.
<PAGE>
EXHIBIT 23.1
<PAGE>
Consent of Independent Auditors
We consent to the incorporation by reference in the Registration Statements
(Form S-8 - Nos. 2-82414, 2-91410, 33-235312, 33-00967 and 333-75879, and Form
S-3 - No. 33-40927) pertaining to the Advanced Neuromodulation Systems, Inc.
1979 Amended and Restated Employees' Stock Option Plan; the Advanced
Neuromodulation Systems, Inc. Directors' Stock Option Plan; the Advanced
Neuromodulation Systems, Inc. 1987 Employees' Stock Option Plan; the Advanced
Neuromodulation Systems, Inc. 1995 Stock Option Plan; the Advanced
Neuromodulation Systems, Inc. Sales and Marketing Employees Stock Option Plan;
the Heaton Stock Option Plan; the Advanced Neuromodulation Systems, Inc. 1998
Stock Option Plan; the registration of 100,000 shares of Common Stock issued
pursuant to a Common Stock Purchase Warrant between Advanced Neuromodulation
Systems, Inc. and Robert L. Swisher, Jr. and the related Prospectuses of our
report dated February 25, 2000, with respect to the consolidated financial
statements of Advanced Neuromodulation Systems, Inc. and Subsidiaries, included
in the Annual Report (Form 10-K) for the year ended December 31, 1999.
/s/ Ernst & Young LLP
---------------------
Ernst & Young LLP
Dallas, Texas
March 27, 2000
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
Exhibit 27.1, Financial Data Sheet
</LEGEND>
<CIK> 0000351721
<NAME> Advanced Neuromodulation Systems, Inc.
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> DEC-31-1999
<CASH> 8,353,658
<SECURITIES> 398,208
<RECEIVABLES> 3,926,543
<ALLOWANCES> 140,824
<INVENTORY> 5,999,217
<CURRENT-ASSETS> 20,369,233
<PP&E> 7,550,931
<DEPRECIATION> 1,862,361
<TOTAL-ASSETS> 43,554,774
<CURRENT-LIABILITIES> 4,191,076
<BONDS> 0
0
0
<COMMON> 435,418
<OTHER-SE> 36,602,877
<TOTAL-LIABILITY-AND-EQUITY> 43,554,774
<SALES> 20,578,384
<TOTAL-REVENUES> 29,478,384
<CGS> 6,628,983
<TOTAL-COSTS> 14,007,203
<OTHER-EXPENSES> (751,238)
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 44,861
<INCOME-PRETAX> 9,548,575
<INCOME-TAX> 3,545,294
<INCOME-CONTINUING> 6,003,281
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 6,003,281
<EPS-BASIC> .79
<EPS-DILUTED> .75
</TABLE>
