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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(Mark One)
[ X ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934 [FEE REQUIRED]
For the fiscal year ended December 31, 1995
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
For the transition period from _____________ to ______________
Commission File Number 0-16752
MEDSTONE INTERNATIONAL, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 66-0439440
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
100 COLUMBIA, SUITE 100, ALISO VIEJO, CALIFORNIA 92656
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (714) 448-7700
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
COMMON STOCK, $.004 PAR VALUE
(TITLE OF CLASS)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
--- ---
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best 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-K. [ X ]
The number of shares of the Common Stock of the registrant outstanding as
of March 11, 1996 was 5,535,909. The number of shares of Common Stock held by
nonaffiliates on such date was 5,312,779 with an approximate aggregate market
value of $47,815,011.
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TABLE OF CONTENTS
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Page
Item Number and Caption Number
PART I
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Item 1. Business.................................................. 1
Item 2. Properties................................................ 5
Item 3. Legal Proceedings......................................... 6
Item 4. Submission of Matters to a Vote of Security Holders....... 6
PART II
Item 5. Market for Registrant's Common Equity
and Related Stockholder Matters......................... 7
Item 6. Selected Financial Data................................... 8
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations..................... 9
Item 8. Financial Statements and Supplementary Data............... 13
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure..................... 13
PART III
Item 10. Directors and Executive Officers of the Registrant........ 14
Item 11. Executive Compensation.................................... 16
Item 12. Security Ownership of Certain Beneficial
Owners and Management................................... 19
Item 13. Certain Relationships and Related Transactions............ 20
PART IV
Item 14. Exhibits, Financial Statement Schedules,
and Reports on Form 8-K................................. 21
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PART I
ITEM 1. BUSINESS
INTRODUCTION
Medstone International, Inc., formerly known as Cytocare, Inc. prior
to its renaming in September 1995 (the "Company" or "Medstone"), a Delaware
corporation formed in October 1984, manufactures, markets and maintains
lithotripters. The Company, as a manufacturer of capital medical devices, has
been vertically integrating by offering its medical devices directly to
providers on a fee-per-procedure basis. Medstone currently offers mobile
lithotripsy services using mobile systems in the Western United States on a
fee-per-procedure basis. Medstone intends to expand efforts to grow this medical
service side of its business. A majority of the Company's consolidated revenues
during fiscal 1995 come from Medstone's lithotripsy business.
In early 1996, the Company completed efforts to separate its operating
business units and revenue streams into independent operations by spinning off
two subsidiaries, Endocare, Inc. ("Endocare") and UroGen Corp. ("UroGen") to the
Company's stockholders as of December 29, 1995. Endocare manufactures equipment
and devices to treat urologic soft tissue diseases. UroGen is a development
stage company in the business of developing pharmaceuticals to treat prostate
cancer. Management hopes that such restructuring will benefit shareholders by
bringing about operational advantages as well as more discriminating and
favorable valuations of Medstone's units.
MARKETS
As a result of the spin-offs of Endocare and UroGen, the Company
operates almost exclusively at present in the market for kidney stone treatment.
In the United States, it is estimated that over 600,000 persons per year suffer
from kidney stones and an estimated 300,000 patients per year are hospitalized
with a primary kidney stone. Historically, approximately 170,000 of these
patients have been treated with shockwave lithotripsy each year.
The share of its markets that the Company will obtain will be
dependent on successful development of new products, obtaining appropriate
regulatory agency approvals, market acceptance of the products, the Company's
ability to market, the alternative sources of equivalent products and future
developments.
PRODUCTS
The Medstone STS ("System") is presently being used to treat kidney
stones, without invasive surgery, in the U.S. and foreign locations. The Company
received a PMA from the United States Food and Drug Administration ("FDA") in
1988 authorizing commercial use of the device for treating patients with kidney
stones.
A series of shockwaves are created outside the patient's body and
focused to travel through water-based fluids until they enter the body and
disintegrate the stone. Each successive shockwave serves to further break apart
the kidney stone into smaller particles until they are small enough to be passed
in the patient's urine. A treatment typically requires 1200-1600 shockwaves in a
procedure which lasts 45 to 60 minutes.
In addition to the shockwave generator, the Medstone STS's components
include a customized X-ray table on which the patient lies horizontally with his
or her kidney positioned above the shockwave generator, a computer, an X-ray
system, an ultrasound system, and an electrocardiogram ("ECG") monitor. The
computer generates information regarding the treatment and monitors the
patient's condition. The X-ray/ultrasound system produces images that are
converted and analyzed by the computer and then used by the physician for proper
positioning and
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to determine when the kidney stone has been sufficiently disintegrated to
terminate the treatment. The ECG monitor supplies the data that allows the
computer to synchronize the shockwaves with phases of the patient's heartbeat.
The Company has developed and copyrighted all the software that
controls the Medstone STS. This software, an integral part of the system and
therefore subject to review by regulatory agencies, is licensed for use on a per
procedure basis.
The Company also has developed and manufactures its own disposable
components for use with the Medstone STS. Electrodes manufactured by the Company
are used to produce electrical sparks in the shockwave generator part of the
device. A disposable coupling bag containing fluid for transmission of the
shockwave is placed between the shockwave generator and the patient's back or
stomach during the treatment. One complete set of the supplies is normally used
in each patient procedure.
KIDNEY STONES AND TREATMENT
A kidney stone develops when the salt and mineral substances in urine
form crystals that stick together and grow in size. In most cases, these
crystals are removed from the body by the flow of urine, but they sometimes
stick to the lining of the kidney or settle in places where the urine flow fails
to carry them away. These crystals may gather and grow into a stone ranging in
size from that of a grain of sand to a golf ball. Most stones start to form in
the kidney. Some may travel to other parts of the urinary system, such as the
ureter or bladder, and grow there.
Stones vary in size, composition, and the ease with which they can be
dissolved. In some cases, certain medications may be used to lower the amount of
acidity or alkalinity in the urine, thereby dissolving the stones. At present,
stones that contain calcium cannot be dissolved. Most stones can be treated with
conservative methods. This includes increased fluid intake, changes in diet, and
medications. About 90 percent of stones that leave the kidney will pass through
the ureter within three to six weeks. Stones that do not pass through the ureter
may be removed with the aid of a grasping device (basket). The device is passed
through a telescopic instrument (cystoscope) that the doctor inserts into the
bladder or ureter (urethroscope). In some cases, the stones are removed whole,
but sometimes they must be broken into smaller pieces with ultrasound before
they can be removed with the basket.
The Medstone STS is a minimally invasive nonsurgical treatment for
stones in the kidney and ureter called extracorporeal shockwave lithotripsy. In
this method, X-rays are used to target the stone, and then high energy
shockwaves are used to break down the stones into gravel which passes out with
urine within a few weeks.
Although most stones can be treated with nonsurgical methods, certain
stones still require conventional surgery, particularly when there is internal
scarring and obstruction. With conventional surgery, an incision is made over
the stone site. The hospital stay and recovery period are several weeks longer
than when more conservative techniques are used. Therefore, stones are treated
with nonsurgical methods when possible.
PRODUCTION
Medstone manufactures, under FDA mandated Good Manufacturing Practice
("GMP") requirements, its devices at its plant in Aliso Viejo, California. The
Company moved into a new facility in March 1994. Subsequent to that move the
Company was audited by the FDA and has received notification from the FDA
enabling it to manufacture and market devices in the new facility. The Company
has existing capacity to produce sufficient quantities of its shockwave
lithotripters to support its commercial needs for the foreseeable future.
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PRODUCT DEVELOPMENT
The Company has focused its research and development on products
believed to have significant commercial potential in the treatment of urological
diseases, as well as developments intended to improve performance and
convenience of the lithotripter system. The Company devotes significant
resources to research and development, and will continue to invest significantly
in proprietary products. During the years ended December 31, 1993, 1994, and
1995, the Company's expenditures for research and development totalled
$2,333,421, $1,076,033, and $926,665 respectively.
PRODUCT LIABILITY AND INSURANCE
The Company currently has in force commercial liability insurance,
with coverage limits of $1 million per incident, and $2 million on an annual
aggregate basis. It also has general umbrella liability insurance with coverage
limits of $4 million per incident for a total aggregate amount of $5,000,000 per
incident. The Company's insurance policies provide coverage on a claims-made
basis and are subject to annual renewal.
GOVERNMENT REGULATION
Governmental regulations in the United States and other countries are
a significant factor affecting the research and development, manufacture and
marketing of the Company's products. In the United States, the FDA has broad
authority under the Federal Food, Drug and Cosmetic Act and the Public Health
Service Act to regulate the distribution, manufacture and sale of drugs,
including biologics, and medical devices. Foreign sales of drugs and medical
devices are subject to foreign governmental regulation and restrictions which
vary from country to country.
DEVICES - Medical devices intended for human use in the United States
are classified into three categories, depending upon the degree of regulatory
control to which they will be subject. Such devices are classified by regulation
into either class I (general controls), class II (performance standards) or
class III (pre-market approval) depending upon the level of regulatory control
required to provide reasonable assurance of the safety and effectiveness of the
device. A class III product, such as the Medstone STS, and class I and II
devices for which a PMA is necessary generally require initial Investigational
Device Exemption ("IDE") approval by the FDA. An IDE permits limited clinical
evaluation of the product under controlled conditions. Extensive reporting and
monitoring of patient treatments made pursuant to the IDE are required. After
the PMA is obtained, the product may be marketed to an unrestricted number of
users in the United States, but general medical device regulations regarding FDA
inspection of facilities, Good Manufacturing Practices, labeling, maintenance of
records and filings with the FDA continue to be applicable.
A subset of medical devices categorized as class I or II and
classified as "old" devices, that is, commercially distributed before March 28,
1976 or substantially equivalent to a device that was in commercial distribution
before that date, may be marketed after the acceptance of the premarket
notification under a 510(k) exemption. The 510(k) section of the Federal Food,
Drug and Cosmetic Act allows an exemption from the requirement of premarket
notification.
Medstone has obtained from the California Department of Health
Services a license to manufacture medical devices and is subject to periodic
inspections and other regulation by that agency.
Certificate of Need ("CON") laws and regulations are in effect in many
states. Under such laws, a CON issued by a governmental agency is generally
required before the introduction of certain new health care services or before a
hospital or other provider can acquire certain new medical equipment or
facilities having values exceeding specified amounts. Failure to obtain a
required CON may prohibit the purchase of desired equipment or cause the denial
of Medicare or other governmental reimbursements or payments for patient
treatments. In recent
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years several states have repealed their CON laws and many other states have
made or are considering possible amendments to the laws. Most of the revisions
involve raising the thresholds for review, eliminating certain types of
facilities or services from review or streamlining the review process.
PATENTS, COPYRIGHTS, TRADE SECRETS AND LICENSES
The Company's policy is to secure and protect intellectual property
rights relating to its technology. While Medstone believes that the protection
of patents or licenses is important to its business, it also relies on trade
secrets, know-how and continuing technological innovation to maintain its
competitive position. The Company has received or filed for certain patents or
copyrights for some of the products described under "Products."
The Company seeks to preserve the confidentiality of its technology by
entering into confidentiality agreements with its employees, consultants,
customers, and key vendors and by other means. No assurance can be given,
however, that these measures will prevent the unauthorized disclosure or use of
such technology.
COMPETITION
The Company's products currently marketed and under development will
be competing with many existing products and therapies for market share. The
Company competes with fully integrated device companies, many of which have
substantially more experience, financial and other resources and superior
expertise in research and development, manufacturing, testing, obtaining
regulatory approvals, marketing and distribution.
Products under development by the Company are expected to address the
urological market. The Company's competition will be determined in part by the
particular urological disease to which the Company's potential products relate.
An important factor in competition may be the timing of market introduction of
its or competitive products. Accordingly, the relative speed with which Medstone
can develop products, complete the clinical trials and approval processes and
supply commercial quantities of the products to the market are expected to be
important competitive factors. The Company expects that competition among
products approved for sale will be based on, among other things, product
efficacy, safety, reliability, availability, price, patent position and sales,
marketing and distribution capabilities. The development by others of new
treatment methods could render the Company's products under development
non-competitive or obsolete.
The Company's competitive position also depends upon its ability to
attract and retain qualified personnel, obtain patent protection or otherwise
develop proprietary products or processes and secure sufficient capital
resources for the often substantial period between technological conception and
commercial sales.
SHOCKWAVE LITHOTRIPTERS
The Company's two principal competitors in shockwave lithotripsy are
Dornier, which is part of the Daimler Benz group of German companies, and
Siemens GmbH, a German electronic company. In addition, a number of other
companies, both in the U.S. and foreign countries, have PMAs to sell their
lithotripters for the treatment of kidney stones in the U.S. or are conducting
clinical studies on the use of lithotripters for the treatment of kidney stones.
The Company believes that, in addition to the obtaining of FDA and
other governmental approvals, important competitive factors in the markets for
shockwave lithotripters include the reliability, effectiveness in treating
patients and pricing of particular systems. The Company believes the Medstone
System compares favorably with other lithotripters presently being offered by
competitors with respect to the precision of its imaging systems, its ease of
patient handling, its simplicity of operation design, its safety features and
its success rate in treating patients.
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SALES AND MARKETING
The Company's current products and pipeline of products are targeted
at the urology market. Medstone has a small, direct sales force, as well as
independent sales representatives within the United States. Outside the United
States, the Company uses a network of distributors.
The Company generates revenue from the sale of equipment, and also
from the sale of software licenses, disposable supplies, procedure fees and
service contracts to hospitals, physicians, and other health care providers.
The Company offers to hospitals, surgery centers and physician groups
lithotripsy services on a fee basis. In the current cost conscious healthcare
environment many facilities do not have the patient flow to justify, or the
available capital to purchase a lithotripsy machine. These facilities are
candidates for fee-for-service. In a fee-for-service arrangement the customer
will sign a contract for a period of time, typically one to three years, and
will pay a fixed fee for each patient treated on the lithotripter. Most often
this service is provided by a lithotripter that is in a mobile van so a single
machine can provide service over a wide geographic area. For facilities with
adequate patient flow, fee-for-service can be provided with a fixed unit
installed in that facility.
Marketing for the Company's products is accomplished through
advertisement in medical journals, direct mail, direct physician contact,
company participation in various associations, product exhibition and telephonic
marketing.
BACKLOG - SHOCKWAVE LITHOTRIPSY
The Company's lithotripsy equipment sale backlog was $440,000 as of
March 20, 1995 and $1,375,000 as of March 7, 1994. Due to the high per unit
price of the Medstone Systems, equipment backlog can vary significantly from
period to period based upon the number of systems on order. Backlog consists
only of orders evidenced by signed contracts for equipment scheduled for
delivery and installation within 12 months and does not include revenues for
maintenance and per procedure charges, or ProLase II orders.
With the maturity of Medstone's lithotripsy business, recurring
revenues from fee for service and procedure fees and maintenance services have
become a major source of Medstone's revenue stream. Maintenance services are
generally provided under annual service contracts, and procedure and fee for
service fees are earned based upon usage of the System.
HUMAN RESOURCES
As of March 1, 1996, Medstone had 54 employees. Of the 54 employees, 4
are engaged directly in research and development activities, 10 are engaged in
manufacturing, 8 are engaged in mobile operations, 14 are engaged in field
service, 11 are engaged in sales and marketing and 7 are employed in general and
administrative positions.
Although Medstone conducts most of its research and development using
its own employees, the Company has funded, and plans to continue to fund,
research using consultants. Consultants provide services under written
agreements and are paid based on the amount of time spent on Company matters.
Under their consulting agreements, Medstone's consultants are required to
disclose and assign to the Company any ideas, discoveries and inventions
developed by them in the course of providing consulting services.
ITEM 2. PROPERTIES
In March 1994, the Company took occupancy of new office,
manufacturing, engineering, and warehouse space, and research and development
laboratories, located in Aliso Viejo, California, under an operating lease with
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an initial term of two years. The monthly lease rate is $12,500 through February
1996. The Company has exercised the first one year option, extending the lease
term through March 1997, at a monthly lease rate of $12,862, and retains the
option to extend the lease in one year increments through March 1999 for modest
price increases.
ITEM 3. LEGAL PROCEEDINGS
The Company does not carry director and officer liability insurance,
but does have indemnification agreements with its officers and directors and
reciprocal indemnifications with the underwriter for its initial public
offering.
In October 1989 and January 1990, two lawsuits were filed by two
shareholders of the Company in the United States District Court for the Central
District of California. These lawsuits were filed against the Company, certain
current and former officers and the underwriter for the initial public offering
in June 1988. The complaints, which seek unspecified amounts in damages, allege
principally that adverse material information was not disclosed at the time of
the initial public offering and in subsequent periods. Both of the suits were
consolidated by the District Court in February, 1990 under the case name Kaplan
v. Freeman Rose, et al. ("Kaplan Action"). On May 4, 1992, the district court
granted summary judgment in favor of the Company on all claims. Plaintiffs filed
an appeal of the summary judgment to the Ninth Circuit Court of Appeals.
There is a related shareholder class action alleging claims virtually
identical to those pled in the Kaplan Action discussed above. In this action
entitled Kramer v. Freeman Rose, et al. ("Kramer Action"), however, plaintiff
alleged an additional claim under Section 12(2) of the 1933 Securities Act, 15
U.S.C.S. Section 771(2). The Company sought and obtained a dismissal of the
Kramer Action on October 7, 1991, on the ground that the claims were barred by
the applicable statute of limitations. Plaintiffs filed a First Amendment
Complaint on March 17, 1992. On July 9, 1992, the district court granted the
Company's motion to dismiss the First Amended Complaint in the Kramer Action.
Plaintiffs filed a notice of appeal to the Ninth Circuit Court of Appeals. The
Kramer Action and the Kaplan Action were consolidated for purposes of appeal
only.
In October 1994, the Company received the opinion of the Ninth Circuit
Court of Appeals affirming in part and reversing in part the United States
District Court's decision granting summary judgment in favor of the Company and
several officers. The Company views this lawsuit as an abusive securities suit
diverting resources that could otherwise be used for technical innovation,
capital investment and job creation. In April 1995, the Company filed a Supreme
Court brief, and in October 1995, the Company was informed that the Supreme
Court declined to hear the case, returning the case to the district court for
scheduling of the trial, which has been set by the district court for May 21,
1996.
The Company intends to proceed to trial on any remaining matters. The
ultimate outcome of the litigation cannot presently be determined. Accordingly,
no provision for any liability that may result, if any, has been made in the
financial statements.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Company's annual meeting of shareholders was held on September 21,
1995. At the meeting Frank R. Pope, David V. Radlinski and Donald Regan were
elected directors.
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PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Prior to January 24, 1991, the Company's common stock was traded on
the NASDAQ Stock Market under the symbol MSHK. On January 24, 1991, the Company
changed its name to Cytocare, Inc. and began trading on the NASDAQ Stock Market
under the symbol CYTI. On September 25, 1995, the Company changed its name to
Medstone International, Inc. and began trading on the NASDAQ Stock Market under
the symbol MEDS. The following table sets forth the high and low sales prices of
the Company's common stock for the two years ended December 31, 1994 and
December 31, 1995 as reported in the NASDAQ National Market System for the
quarter indicated.
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HIGH LOW
YEAR ENDED DECEMBER 31, 1994
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First quarter $ 5-9/16 $ 4
Second quarter 4-13/16 3-1/2
Third quarter 5-9/32 3-3/8
Fourth quarter 6-1/8 5
YEAR ENDED DECEMBER 31, 1995
First quarter $ 6-1/8 $ 5
Second quarter 8-5/8 5-1/2
Third quarter 12 7-1/2
Fourth quarter 12-1/2 8-7/8
</TABLE>
The stock markets have experienced extreme price and volume
fluctuations during certain periods. These broad market fluctuations and other
factors may adversely affect the market price of the Company's Common Stock. Any
shortfall in revenue or earnings from levels expected by securities analysts
could have an immediate and significant adverse effect on the trading price of
the Company's common stock in any given period. Additionally, the Company may
not learn of such shortfalls until late in the fiscal quarter, which could
result in an even more immediate and adverse effect on the trading price of the
Company's stock. Finally, the Company participates in a highly dynamic industry,
which often results in significant volatility of the Company's common stock
price.
At March 11, 1996, there were 391 stockholders of record of the
Company's Common Stock.
The Company declared, on December 19, 1995, two stock dividends to
stockholders of record on December 29, 1995. The Company has distributed one
common share of both Endocare and of Urogen for each common share of Medstone to
holders of record at the close of business on December 29, 1995. The shares
represent a distribution of all the assets of these two subsidiaries of the
Company which became separate public companies upon distribution which occurred
on February 9, 1996. Those companies operate as separate entities as of January
1, 1996. (See Distribution to Stockholders in footnotes to the Financial
Statements.)
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ITEM 6. SELECTED FINANCIAL DATA
CONSOLIDATED STATEMENTS OF OPERATIONS DATA:
(in thousands, except per share amounts)
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YEAR ENDED DECEMBER 31,
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1995 1994 1993 1992 1991
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Revenues:
Net equipment sales $ 4,588 $ 3,125 $ 2,317 $ 5,407 $ 2,685
Procedure and maintenance fees
and laser catheters 12,797 12,538 10,875 7,530 6,423
Interest and dividends 1,005 642 481 631 667
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Total revenues 18,390 16,305 13,673 13,568 9,775
Costs and expenses:
Cost of sales 7,633 6,004 5,506 5,994 4,702
Research and development 927 1,076 2,334 2,193 962
Selling 2,050 2,551 2,674 1,619 1,518
General and administrative 1,656 2,105 2,226 1,583 1,524
Other expense 164 35 338 868 106
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Total costs and expenses 12,430 11,771 13,078 12,257 8,812
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Income from operations before income taxes 5,960 4,534 595 1,311 963
Provision for income taxes 2,086 150 65 142 101
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Net income $ 3,874 $ 4,384 $ 530 $ 1,169 $ 862
========== ========= ========= ========= =========
Earnings per share:
Primary net income per share $ .70 $ .82 $ .10 $ .22 $ .18
========== ========= ========= ========= =========
Fully diluted net income per share $ .69 $ .81 $ .10 $ .21 $ .17
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CONSOLIDATED BALANCE SHEET DATA:
(in thousands)
DECEMBER 31
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1995 1994 1993 1992 1991
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Working capital $ 18,465 $ 16,658 $ 12,406 $ 11,434 $ 10,373
Total assets 25,910 22,260 17,709 17,817 17,217
Total liabilities 3,753 2,809 2,935 3,707 4,365
Stockholders' equity 22,157 19,451 14,774 14,110 12,852
</TABLE>
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
GENERAL
Medstone manufactures, markets and maintains lithotripters, and expand
its Fee-for-Service Program to supply lithotripsy equipment to providers on a
per procedure basis. To date, the Company's consolidated revenues have come
primarily from Medstone's lithotripsy business. On December 19, 1995, the
Company declared two stock dividends, payable to stockholders of record on the
close of trading on December 29, 1995. The two dividends represent distribution
of all the assets and operations of the Endocare and Urogen divisions of the
Company. Effective with the start of business on January 1, 1996 these two
companies will no longer be a part of the Medstone International operations, as
Medstone will distribute to its shareholders all outstanding common stock of
each company, retaining only 100,000 shares of each company. These two companies
will become separate, publicly-held companies. The Company will distribute
5,516,528 shares of each company, and as of February 9, 1996, Medstone's
transfer agent has effected the distributions.
In March 1994, the Company moved into a smaller, more efficient
facility at a substantial cost saving. This move did require a PMA supplement to
be filed with the FDA and an audit from the FDA. The Company received
notification from the FDA that the PMA Supplement was approved for manufacturing
at the new facility. The Company received the benefit of a full year of cost
savings in 1995 as a result of this move.
The Company as a manufacturer of capital medical devices has been
vertically integrating by offering its medical devices directly to providers. It
currently offers lithotripsy procedures using six mobile systems in the Western
United States on a per procedure basis. With the ability to offer quality
equipment at reasonable prices, Medstone intends to continue the growth of this
manufacturer direct business.
By most financial indicators the Company is in a strong financial
position. The Company has just completed 1995 reporting increased revenue and
pretax income compared to 1994. With a positive cash flow, stable inventories, a
conservative asset acquisition strategy, and no long-term debt, the balance
sheet ratios have improved.
The Company began the year with approximately $14.4 million in cash
and marketable securities, no debt, inventories of $1.6 million, and total
assets of $22.3 million. The Company ended the year with approximately $17.6
million in cash and marketable securities, no debt, inventories of $1.8 million,
total assets of $25.9 million as well as five consecutive profitable years.
Through its continuing research and development, management of the
Company is putting in place the scientific and engineering base it believes is
necessary to carry it through the next phases of its growth plans.
The Company is a defendant in two related class action lawsuits filed
by two shareholders of the Company alleging that adverse material information
was not disclosed at the time of the initial public offering and in subsequent
periods. On May 4, 1992, the district court granted summary judgment in one of
the actions in favor of the Company on all claims. On July 9, 1992, the district
court granted the Company's motion to dismiss the second action. In October
1994, the Company received the opinion of the Ninth Circuit of Appeals affirming
in part and reversing in part the United States District Court's decision
granting summary judgment in favor of the Company and several officers. The
complaints principally allege that adverse material information was not
disclosed at the time of the initial public offering in June 1988. In April
1995, the Company filed a Supreme Court brief, and in October 1995, the Company
was informed that the Supreme Court declined to hear the case, returning the
case to the district court for scheduling of the trial, which has been set by
the district court for May 21, 1996. (See Item 3. Legal Proceedings). The
Company intends to proceed to trial on any remaining matters. The ultimate
outcome of the litigation cannot presently be determined but the Company expects
-9-
<PAGE> 12
to spend in excess of $1 million in defense of these suits. No provision for any
liability that may result, if any, has been made in the financial statements.
From time to time, the Company is subject to legal actions and claims
for personal injuries or property damage related to patients who use its
products. The Company has obtained a liability insurance policy providing
coverage for product liability and other claims. Management does not believe
that the resolution of any current proceedings will have a material financial
impact on the Company or the consolidated financial statements.
ASSETS
Cash and equivalents and short-term investments increased by
$3,193,000 at December 31, 1995 from December 31, 1994 due to the Company's
increased sales and continued efforts to streamline operations. All of the
Company's invested cash balance is invested in U.S. Treasury Bills at rates of
5.1% to 6.7% with staggered maturities through November of 1996.
Accounts receivable decreased by $316,000 from December 31, 1994 to
December 31, 1995 due to the collection of several large receivable balances
from the prior year end and no major unit receivables at the end of 1995.
Receivables of $50,000 were written off against the accounts receivable reserves
during 1995.
Prepaid expenses and other current assets increased by $125,000 in the
current year due to increased interest receivable on the Company's Treasury Bill
investments.
Fixed assets decreased by $194,000 from December 31, 1994 to December
31, 1995 primarily as a result of sales of mobile vans used in the mobile
lithotripsy operations, partially offset by the addition of lower cost vans.
Other assets increased by $393,000 in the current year due to deposits
for the manufacture of new mobile vans to be delivered in 1996.
LIABILITIES
Accounts payable at December 31, 1995 decreased by $128,000 compared
to December 31, 1994 due to payment of past legal fees to the Company's counsel
for the class action litigation.
Accrued expenses decreased by $134,000 from December 31, 1994 to
December 31, 1995 due to the final payment to a former distributor for the
Company's products in fulfillment of a settlement agreement reached in 1992.
Accrued income taxes decreased $500,000 in the current year due to the
recognition of the current year tax provision less prepayments.
Accrued payroll expenses at December 31, 1995 decreased by $203,000
compared to December 31, 1994 due to a decreased bonus pool for the current year
and lower commissions earned in the current year.
Deferred revenue increased $84,000 in the current year due to the
increased number of sites under maintenance contract.
Customer deposits at December 31, 1995 decreased by $39,000 compared
to December 31, 1994 due to the realization of revenue earned in 1995 which had
been deferred previously.
Dividends payable at December 31, 1995 increased by $1,966,000 due to
the declaration of a stock dividend for shareholders of record as of December
29, 1995. Each shareholder of the Company received a share of Common Stock of
both Endocare and Urogen.
-10-
<PAGE> 13
SHAREHOLDERS' EQUITY
Additional paid-in-capital increased $880,000 in the current year due
to the exercise of common stock options held by employees and associated tax
benefits.
Notes receivable for stock purchases increased by $135,000 due to a
note issued by an officer of the Company for payment of stock option exercises.
RESULTS OF OPERATIONS
Year Ended December 31, 1995 Compared to Year ended December 31, 1994
Total revenues increased to $18.4 million for the year ended December
31, 1995, a 13% increase from the 1994 revenues of $16.3 million. The increased
net equipment sales resulted from an increase in both lithotripsy systems
shipped, and an increase in the average lithotripter unit selling price. This
equipment revenue gain was slightly offset by a decline in 1995 of upgrades in
the Company's installed base of lithotripters from 1994 levels.
Revenue from procedure and maintenance fees, or recurring revenue,
increased in 1995 by $.3 million, or 2%, from 1994 levels due to the continued
expansion of the Company's mobile lithotripsy services and increased revenue
from the procedure fees on third-party owned equipment offset by major declines
in the laser catheter revenues. Revenues from mobile lithotripsy services
increased by $1.3 million or 41% as the volume on the Company's vans increased
by 41% in 1995 compared to the number of patients treated in 1994. Procedure
revenue increased by 4% in 1995 as the utilization for the Company's equipment
owned by third parties continued to increase. The number of procedures performed
on third-party owned lithotripters in the United States increased by 13% from
1994 to 1995. Several Endocare product introductions in the fourth quarter of
1995 added $273,000 of revenues for 1995. Offsetting these gains was a 70%
decrease in 1995 revenues from the laser catheters due to both lower unit
shipments and prices, as this market matures.
Interest income in 1995 increased by 56% from 1994 levels due to
increases in both average invested cash balances, due to higher cash flow from
operations, and higher yields due to the interest rate increases as a result of
market conditions.
Cost of equipment sales in 1995 increased by 83% from 1994 due to the
increased number of unit shipments and the sale of higher cost van units. Gross
margins on equipment and equipment upgrades decreased due to the combination of
higher cost units and lower upgrade volume.
Cost of recurring revenues increased in 1995 by $689,000 from 1994 due
to the Company's continued expansion of its mobile lithotripsy services and the
requisite equipment investment and expenses related to their operations.
Maintenance material costs increased by 37% due to the higher number of units
under contract.
Research and development costs decreased in 1995 compared to the same
period in 1994 due to the lower headcount associated with the refined research
group.
Selling expenses decreased in 1995 compared to the same period in the
prior year, due to the decreased commission expenses for the lower laser
catheter product sales and lower training expenses.
General and administrative expenses decreased in 1995 compared to the
same period in 1994 due to the lower headcount and expenses relating to the
scaled down Endocare operation.
Other expenses increased primarily due to the expenses associated with
the Company's increased effort in preparation of defense of the class-action
lawsuit scheduled for trial in May 1996.
-11-
<PAGE> 14
The Company's tax provision increased by $1.9 million from 1994 to
1995 due to the booking in 1994 of deferred tax assets and the Company providing
for taxes at approximately statutory rates in 1995.
Year Ended December 31, 1994 Compared to Year ended December 31, 1993
Total revenue increased to $16.3 million for the year ended December
31, 1994, a 19% increase from the 1993 revenue of $13.7 million. The increased
net equipment sales resulted from an increase in both lithotripsy systems
shipped, and an increase in the average lithotripter unit selling price. This
equipment revenue gain was slightly offset by a decline in 1994 of upgrades in
the Company's installed base of lithotripters from 1993 levels.
Revenue from procedure and maintenance fees, or recurring revenue,
increased in 1994 by $1.7 million, or 15%, from 1993 levels due to the continued
expansion of the Company's mobile lithotripsy services and increased revenue
from the procedure fees on third-party owned equipment. The volume on mobile
lithotripsy services in the Company's vans increased by 81% in 1994 compared to
the number of patients treated in 1993. Procedure revenue increased by 18% in
1994 as the utilization for the Company's equipment owned by third parties
continues to increase. The number of procedures performed on third party-owned
lithotripters in the United States increased by 27% from 1993 to 1994. The
decrease in 1994 revenues from the laser catheters was due to lower unit prices.
Interest income in 1994 increased by 33% from 1993 levels due to
increases in both average invested cash balances due to higher cash flow from
operations, and higher yields due to the interest rate increases as a result of
market conditions.
Cost of equipment sales in 1994 decreased by 31% from 1993 due to the
shipment of lower cost content foreign lithotripsy units. Gross margins on
equipment and equipment upgrades increased due to the combination of lower cost
units and higher average unit selling prices.
Cost of recurring revenues increased in 1994 by $1,015,000 from 1993
due to the Company's expansion of its mobile lithotripsy services and the
requisite equipment investment and expenses related to their operations.
Maintenance expenses also increased by 33% as more sites were under maintenance
contract in 1994.
Research and development costs decreased in 1994 compared to the same
period in 1993 due to the scaling back of the biochemical research.
Selling expenses decreased in 1994 compared to the same period in the
prior year, due to the decreased costs in the sales and marketing effort for the
laser catheter products as the product's introductory stage in the marketplace
has been completed.
General and administrative expenses decreased in 1994 compared to the
same period in 1993 due to the reduced bad debt expenses for the funding of
Cardiac Science advances in the current year.
Other expenses decreased primarily due to the expenses in 1993 for the
write-down to market value of the Company's holdings in a mutual fund and
expenses relating to the class action lawsuit against the Company.
As a result of recognizing deferred tax assets and the utilization of
net operating loss carryforwards, the provision for taxes was minimal in 1994.
The Company expects the tax provision in 1995 to approximate the statutory
rates.
LIQUIDITY AND CAPITAL RESOURCES
At December 31, 1995, the Company had cash and short-term investments
of approximately $17.6 million. These funds were generated from operating
activities and from the Company's initial public offering in June 1988, in which
1,150,000 shares of common stock were issued for net proceeds of approximately
$12.9
-12-
<PAGE> 15
million. Cash generated from the offering and from operations financed
substantial increases in levels of inventory, capital assets and was used to
retire debt.
The Company's long-term capital expenditure requirements will depend
upon numerous factors, including the progress of the Company's research and
development programs, the time required to obtain regulatory approvals, the
resources that the Company devotes to the development of self-funded products,
proprietary manufacturing methods and advanced technologies, the length and
outcome of its existing securities litigation, the ability of the Company to
obtain additional licensing arrangements and to manufacture products under those
arrangements, and the demand for its products if and when approved and possible
acquisitions of products, technologies and companies.
The Company believes that its existing working capital and funds
anticipated to be generated from operations will be sufficient to meet the cash
needs for continuation of its present operations during 1995.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
See Item 14. "Exhibits, Financial Statement Schedules, and Reports on
Form 8-K."
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE
None.
-13-
<PAGE> 16
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
DIRECTORS
The following are the directors of the Company:
NAME AGE PRINCIPAL OCCUPATION
---- --- --------------------
David V. Radlinski 51 Chairman of the Board and
Chief Executive Officer of the Company
Frank R. Pope 45 General Partner
Technology Funding
Donald J. Regan 61 Vice President and General Counsel
Kinsell, O'Neil, Newcomb & De Dios, Inc.
Mr. Radlinski has been the Chairman and Chief Executive Officer of the
Company since September 1995. He had been the President of the Company's
subsidiary, Medstone International, Inc. and Chief Financial Officer and
Secretary of the Company from January 1991 to September 1995. From July 1987 to
January 1991, he was the Company's Executive Vice President of Finance, Chief
Financial Officer and Secretary. From 1984 to 1987, he was Vice President of
Finance and Chief Financial Officer of Printronix, Inc., a publicly-owned
company which manufactures computer printers.
Mr. Pope is a general partner and officer of the Technology Funding
venture capital management firms. Before joining Technology Funding in March
1981, he was a Tax Manager with the accounting firm of Coopers and Lybrand,
L.L.P. Mr. Pope is a C.P.A. and a member of the California Bar.
Mr. Regan is currently the Vice President and General Counsel of
Kinsell, O'Neal, Newcomb & De Dios, Inc., a municipal investment banking firm.
Mr. Regan has practiced securities, municipal finance, nonprofit corporation,
real estate, and business transactions law for over thirty years. He is a member
of the National Association of Bond Lawyers, has published several articles on
securities law and served as a lecturer for the Practicing Law Institute. He
specializes in revenue and project finance bonds. He is also a founding owner of
and remains as special counsel to ARV Assisted Living, Inc., a developer of
residential retirement facilities and the largest provider of assisted living
services in the United States.
EXECUTIVE OFFICERS
The names, ages and positions of all the executive officers of the
Company as of March 1995 are listed below, followed by a brief account of their
business experience during the past five years. Officers are normally appointed
annually by the Board of Directors at a meeting of the directors immediately
following the Annual Meeting of Shareholders. There are no family relationships
among these officers nor any arrangements or understandings between any officer
and any other person pursuant to which an officer was selected. None of these
officers has been involved in any court or administrative proceeding within the
past five years adversely reflecting on his or her ability or integrity.
-14-
<PAGE> 17
NAME AGE POSITION
---- --- --------
David V. Radlinski 51 Chief Executive Officer and Chairman of the Board
Mark Selawski 40 Chief Financial Officer and Corporate Secretary
Thomas W. Gardner 42 Executive Vice President of Sales
and Marketing
Mr. Radlinski has been currently the Chairman and Chief Executive
Officer of the Company since September 1995. He had been the President of
Medstone International, Inc. and Chief Financial Officer and Secretary of the
Company from January 1991 to September 1995. From July 1987 to January 1991, he
was the Company's Executive Vice President of Finance, Chief Financial Officer
and Secretary. From 1984 to 1987, he was Vice President of Finance and Chief
Financial Officer of Printronix, Inc., a publicly-owned company which
manufactures computer printers.
Mr. Selawski has been the Chief Financial Officer, Vice President of
Finance and Secretary of the Company since September 1995. He had served as the
Company's Manager of Planning and Analysis since joining the Company since 1988.
Prior to joining the Company he held various finance management positions with
several high-tech manufacturing companies.
Mr. Gardner has been the Company's Executive Vice President of Sales and
Marketing since July 1995. He served as President of Endocare, Inc. from January
1995 to July 1995. He served as the President of the Company's Medical Biology
Division from March 1, 1993 to January 1995. He was a Vice President of Domestic
Sales for the Company from November 1990 until February 1993. Prior to that he
had served as the Vice President of Sales since November 1984.
COMPLIANCE WITH SECTION 16(A) OF THE SECURITIES EXCHANGE ACT OF 1934
The Company is not aware of any director, officer, or 10% shareholder
who during 1995 failed to file on a timely basis any report regarding the
Company's securities required by Section 16(a) of the Securities Exchange Act of
1934.
-15-
<PAGE> 18
ITEM 11. EXECUTIVE COMPENSATION
EXECUTIVE COMPENSATION
The following table sets forth certain information regarding
compensation paid by the Company during each of the Company's last three fiscal
years to the Company's Chief Executive Officer and to each of the Company's
executive officers who received salary and bonus payments in excess of $100,000
during fiscal 1995.
<TABLE>
<CAPTION>
SUMMARY OF COMPENSATION TABLE
LONG TERM COMPENSATION
-------------------------------------------------
ANNUAL COMPENSATION AWARDS PAYOUTS
-------------------------------- ----------------------- -----------------------
NAME OTHER RESTRICTED SECURITIES
AND ANNUAL STOCK UNDERLYING LTIP ALL OTHER
PRINCIPAL FISCAL SALARY BONUS COMPENSATION AWARDS(S) OPTIONS PAYOUTS COMPENSATION
POSITION YEAR ($)(1) ($) ($) ($) (#)(2) ($) ($)
--------- ------ ------- ------ ------------ ---------- ---------- ------- ------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
David V. Radlinski (3) 1995 181,250 --- --- --- 150,000 --- ---
Chairman of the Board and 1994 175,000 --- --- --- --- --- ---
Chief Executive Officer 1993 162,500 12,500 --- --- --- --- ---
Errol G. Payne (4) 1995 200,000 --- --- --- --- --- ---
Chairman of the Board 1994 200,000 --- --- --- --- --- ---
and Chief Executive Office 1993 200,000 --- --- --- --- --- ---
(Retired)
Mark Selawski (5) 1995 72,730 7,500 --- --- 20,000 --- ---
Chief Financial Officer, Vice 1994
President of Finance 1993
and Secretary
Thomas W. Gardner 1995 83,750 20,000 2,815 --- 40,000 --- ---
Executive Vice President of 1994 95,000 --- --- --- --- --- ---
Sales and Marketing 1993 127,500 12,500 1,724 --- --- --- ---
</TABLE>
- ---------------------------------
(1) In addition to the cash compensation shown in the table, executive
officers of the Company may receive indirect compensation in the form of
perquisites and other personal benefits. For each of the named executive
officers, the amount of this indirect compensation in 1995, 1994 and 1993
did not exceed the lesser of $50,000 or 10% of the executive officer's
total salary and bonus for that year.
(2) Options to acquire shares of Common Stock.
(3) Mr. Radlinski served as the Chief Financial Officer and Secretary of the
Company until his election as Chairman of the Board and Chief Executive
Officer on September 21, 1995.
(4) Mr. Payne served as Chairman of the Board and Chief Executive Officer
through September 21, 1995 and resigned from the Company effective
December 31, 1995.
(5) Mr. Selawski was appointed Chief Financial Officer, Vice President of
Finance and Secretary on September 21, 1995.
-16-
<PAGE> 19
STOCK OPTION GRANTS AND EXTENSIONS DURING 1995
The following table provides information related to the stock options that
in March 1995 had their expiration date extended one year until April 2, 1996 at
the original exercise price and new options granted in 1995.
<TABLE>
<CAPTION>
POTENTIAL REALIZABLE
VALUE AT ASSUMED
ANNUAL RATES OF
STOCK PRICE
INDIVIDUAL EXTENSIONS AND GRANTS APPRECIATION FOR
OPTION TERM
- --------------------------------------------------------------------------------------- ----------------------------
% OF TOTAL
SHARES EMPLOYEE
UNDERLYING OPTIONS
OPTIONS GRANTED OR EXERCISE
EXTENDED EXTENDED IN PRICE EXPIRATION
NAME (#) FISCAL YEAR ($/SHARE) DATE 5% ($) 10% ($)
---- --- ----------- --------- ---- ------ -------
<S> <C> <C> <C> <C> <C> <C>
Errol G. Payne (1) --- --- --- --- --- ---
David V. Radlinski 11,750 2% 4.43 4/2/96 2,603 5,205
25,000 4% 5.00 4/2/96 6,250 12,500
10,000 2% 5.00 4/2/96 2,500 5,000
50,000 9% 8.50 7/26/01 144,500 327,250
100,000 19% 10.63 9/25/01 361,250 818,125
Thomas W. Gardner 5,000 1% 5.00 4/2/96 1,250 2,500
40,000 7% 8.50 7/26/01 115,600 261,800
Mark Selawski 3,000 1% 5.00 4/2/96 750 1,500
20,000 4% 8.50 7/26/01 57,800 130,900
</TABLE>
- ---------------------------
(1) Mr. Payne retired as Chairman of the Board and Chief Executive Officer on
September 21, 1995.
STOCK OPTIONS HELD AT END OF FISCAL YEAR
The following table provides information related to options exercised
during 1995 and options held by the named executive officers at December 31,
1995.
<TABLE>
<CAPTION>
NUMBER OF SECURITIES VALUE OF UNEXERCISED
UNDERLYING UNEXERCISED IN-THE-MONEY
OPTIONS AT FY-END (#) OPTIONS AT FY-END ($)(1)
SHARES ACQUIRED --------------------------- -------------------------
NAME ON EXERCISE (#) VALUE REALIZED ($) EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
------------------- --------------- ------------------ ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
Errol G. Payne (2) 218,059 2,153,333 --- --- --- ---
David V. Radlinski 100,000 442,200 70,167 140,833 379,045 91,666
Thomas W. Gardner 73,656 465,545 3,333 36,667 6,666 73,334
Mark Selawski 1,504 8,678 6,278 18,333 31,917 36,666
</TABLE>
- --------------------------------------
(1) The closing price for the Company's Common Stock as reported by the
National Association of Securities Dealers (NASD) on December 31, 1995 was
$10.50. Value is calculated on the basis of the difference between the
option exercise price and $10.50, multiplied by the number of shares of
Common Stock underlying the option.
(2) Mr. Payne resigned as Chairman of the Board and Chief Executive Officer on
September 21, 1995 and subsequently exercised all available stock options.
-17-
<PAGE> 20
COMPENSATION OF DIRECTORS
The Company currently compensates Messrs. Regan and Pope for their
services, in addition to reimbursement for expenses incurred by them in
connection with the Company's business.
Under the Nonemployee Director Stock Option Plan, each new nonemployee
director is automatically granted an option to purchase up to 5,000 shares as of
the effective date of his or her first appointment to the Board or first
election to the Board by the shareholders, whichever is earlier. Subject to
acceleration of the option exercises in the event of certain events specified in
the plan, each such option becomes exercisable with respect to 1/60 of the
shares issuable for each elapsed full month during the five-year period after
its grant date, but will not be initially exercisable until six months after the
grant date. The exercise price of each option will equal the fair market value
of the underlying Common Stock on the date the option is granted. Each option
will expire six years after its grant, except that the expiration will be
extended until one year after the optionee's death if it occurs less than one
year before the option's expiration date. An option granted under the plan is
not transferrable during the grantee's lifetime and must be exercised within one
year following his or her death, or within 90 days after the grantee ceases to
be a member of the Board for any other reason, and will only be exercisable to
the extent it is exercisable on the date the grantee leaves the Board. Under
this plan, Mr. Pope was granted 5,000 shares in January 1992 and Mr. Regan was
granted 5,000 shares in September 1995.
-18-
<PAGE> 21
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth the number of shares of the Company's Common
Stock known to the Company to be beneficially owned as of March 11, 1996 by each
person who owns beneficially more than 5 percent of the outstanding shares of
Common Stock, by each of the present directors and nominees for director, by
each of the executive officers named in the Executive Compensation table above
and by all executive officers and directors of the Company as a group, and the
percentage of the total outstanding shares of Common Stock such shares
represented as of March 11, 1996.
<TABLE>
<CAPTION>
NUMBER OF SHARES
BENEFICIALLY PERCENTAGE OF
NAME AND ADDRESS OF BENEFICIAL OWNER OWNED(1) OWNERSHIP
------------------------------------ ---------------- -------------
<S> <C> <C>
Frank R. Pope(2) 244,458(3)(4) 4.4%
2000 Alameda de las Pulgas
San Mateo, CA 94402
Technology Funding 237,541(3) 4.3%
2000 Alameda de las Pulgas
San Mateo, CA 94402
Errol G. Payne 459,059 8.3%
100 Columbia, Suite 100
Aliso Viejo, CA 92656
Hathaway & Associates, Ltd. 375,000 6.8%
119 Rowayton Avenue
Rowayton, CT 06853
David V. Radlinski(5) 184,637(6) 3.3%
100 Columbia, Suite 100
Aliso Viejo, CA 92656
Thomas W. Gardner(5) 114,656(7) 2.1%
100 Columbia, Suite 100
Aliso Viejo, CA 92656
Mark Selawski(5) 9,115(8) (10)
100 Columbia, Suite 100
Aliso Viejo, CA 92656
Donald J. Regan(2) 9,083(9) (10)
462 Stevens Avenue, Suite 308
Solana Beach, CA 92075
All executive officers and directors
as a group (5 persons) (11) 324,408 5.76%
</TABLE>
- ---------------
(1) All such shares were held of record with sole voting and investment power,
subject to applicable community property laws, by the named individual
and/or by his wife, except as indicated in the following footnotes.
(2) Director of the Company.
(3) Includes 211,351 shares held by Technology Funding Partners I and 26,190
shares held by Technology Funding Partners II. Technology Funding, Inc.
and Technology Funding Ltd. (together, "Technology Funding"), of which
Frank R. Pope is an officer or general partner, are the managing general
partners of Technology Funding Partners I and II. Technology Funding and
Mr. Pope are entitled to exercise voting and investment power with respect
to all shares owned by Technology Funding Partners I and Technology
Funding Partners II and therefore are deemed to be beneficial owners of
such shares.
(4) Includes 4,917 shares issuable upon exercise of presently outstanding
stock options under the Company's Non-employee Director Stock Option Plan.
(5) Executive officer of the Company.
(6) Includes 80,167 shares issuable upon exercise of presently outstanding
stock options. (7) Includes 6,000 shares issuable upon exercise of
presently outstanding stock options. (8) Includes 7,611 shares issuable
upon exercise of presently outstanding stock options. (9) Includes 2,583
shares issuable upon exercise of presently outstanding stock options.
(10) Percentage information is omitted because the beneficially owned shares
represent less than 1% of the outstanding shares of the Company's Common
Stock
(11) Includes 101,278 shares issuable upon exercise of presently outstanding
stock options.
-19-
<PAGE> 22
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
During 1991, the Company was a party to the formation of Cardiac Science,
Inc., for which the Company purchased 5,353,031 shares of common stock, for a
cash payment of $.0016 per share. This purchase represented 77.3% of the
outstanding stock. As of July 8, 1991, the Company distributed, as a dividend to
its shareholders of record on that date, one share of Cardiac Science, Inc.
stock for each share of Medstone stock held. The Company retained 629,768 shares
of common stock of Cardiac Science, Inc.
In June 1991, the Company agreed to loan Cardiac Science, Inc. up to
$220,000 to provide working capital pursuant to the terms of a revolving note
agreement. The unpaid principal amount of the loan, together with interest
accrued thereon at the rate of 10% per annum, was due and payable to Medstone in
December 1991. Medstone then agreed to extend this note and to loan additional
amounts to Cardiac Science, Inc. As of April 30, 1992, the Company had loaned
Cardiac Science, Inc. approximately $310,000. In April 1992, the Company agreed
to extend its initial loan to Cardiac Science, Inc. and to loan Cardiac Science,
Inc. an additional $200,000. These loans bore interest at a rate of 8% per
annum, payable quarterly, and are secured by Cardiac Science's assets and were
to mature on the earlier of April 1, 1995 or the closing of the initial public
offering of Cardiac Science's Common Stock. Cardiac Science, Inc. has the option
to pay the interest on the notes in either cash or shares of its common stock
valued at $.15 per share. To pay such interest, Cardiac Science, Inc. had issued
419,054 shares of its common stock to the Company as of December 31, 1995. In
connection with such loan extension and the agreement to make additional loans,
Cardiac Science issued to Medstone 3,400,000 warrants to purchase shares of its
common stock at $.15 per share for an aggregate exercise price of up to
$510,000.
In September 1994, Cardiac Science reached an agreement with Medstone
pursuant to which, and concurrently with the closing of a Private Placement of
Cardiac Science's Common Stock, (i) Medstone exercised the warrants to the
extent of 2,720,000 shares, (ii) Cardiac Science utilized the proceeds therefrom
($408,000) to pay an equivalent portion of the note, (iii) the due date for the
remaining principal balance on the note ($102,000) was extended to April 1,
1996, (iv) Medstone maintains its current lien on the assets of the Company
until the balance of the note is paid, (v) the expiration date for the remaining
warrants to purchase 680,000 shares of Cardiac Science common stock was changed
to March 31, 1996, and (vi) all outstanding unsecured obligations owing by
Cardiac Science to Medstone (approximately $270,000) were satisfied by the
issuance to Medstone of 1,800,000 shares of common stock and a ten year warrant
to purchase 1,000,000 shares of common stock at $.001 per share. Per an oral
agreement between the Company and Cardiac Science, interest payment on the note
were suspended in April 1995 due to prior considerations paid during the
renegotiation of the unsecured debt in 1994.
As of December 31, 1995, Cardiac Science's outstanding note balance was
$107,055, including accrued interest. A reserve of $107,055 has been provided
for non-payment of the note.
Separately, the Company advanced amounts to Cardiac Science for health
insurance. These amounts were to be repaid by Cardiac Science on a
month-to-month basis. As of December 31, 1995, $8,290 had been advanced to
Cardiac Science. A reserve of $2,617 has been provided for non-payment of the
advances.
In September 1994, Cardiac Science received additional financing and,
effective October 7, 1994, all Cardiac Science business is conducted at a
location completely independent of Medstone.
-20-
<PAGE> 23
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
<TABLE>
<CAPTION>
(a) INDEX TO CONSOLIDATED FINANCIAL STATEMENTS Page
----
<S> <C> <C>
1. Consolidated Financial Statements
Report of Independent Auditors 22
Consolidated Balance Sheets at December 31, 1995 and 1994 23
Consolidated Statements of Income for the
years ended December 31, 1995, 1994 and 1993 24
Consolidated Statements of Stockholders' Equity
for the years ended December 31, 1995, 1994 and 1993 25
Consolidated Statements of Cash Flows for the
years ended December 31, 1995, 1994 and 1993 26
Notes to Consolidated Financial Statements 27
2. Schedule to Consolidated Financial Statements
Schedule II - Valuation and Qualifying Accounts 37
All other schedules are omitted because they are not
applicable or the required information is included in the
consolidated financial statements or notes thereto.
</TABLE>
(b) REPORTS ON FORM 8-K
There were no reports on Form 8-K filed with the Commission during
the quarter ended December 31, 1995.
(c) EXHIBITS
EXHIBIT NO. DESCRIPTION
----------
3.1 Certificate of Incorporation of the Company, as amended
(1)
3.2 Bylaws of the Company, as amended (1)
4.2 Specimen Certificate of the Company's Common Stock (2)
10.26 1989 Stock Incentive Plan (3)(4)
10.27 Non-employee Director Stock Option Plan (3)(4)
10.28 Facility Lease on 100 Columbia (5)
11.1 Schedule of Computation of Per Share Information (See
page 40 hereof)
23.1 Consent of Independent Auditors (see page 42 hereof)
27 Financial Data Schedule
28.2 Form of Cytocare, Inc. Information Statement -
Distribution to Shareholders of Stock of Cardiac Science,
Inc. (6)
28.3 Form of Medstone International, Inc. Information
Statement - Distribution to Shareholders of Stock of
Endocare, Inc. and UroGen Corp. (7)
---------------------------------------
(1) Previously filed with the same exhibit number with the Company's
Registration Statement on Form S-1 under the Securities Act of
1933, Reg. No 33-16340 and with the Company's Quarterly Report on
Form 10-Q for the quarter ended June 30, 1988, and incorporated
herein by reference.
(2) Previously filed with the same exhibit number with the Company's
Registration Statement on Form S-1 under the Securities Act of
1933, Reg. No. 33-16340 and incorporated herein by reference.
(3) Previously filed with the same exhibit number with the Company's
Quarterly Report on Form 10-Q for the quarter ended June 30,
1989, and incorporated herein by reference.
(4) Compensatory plan or arrangement.
(5) Previously filed with the same exhibit number with the Company's
annual report on Form 10-K for the year ended December 31, 1993.
(6) Previously filed with the same exhibit number with the Company's
current report on Form 8-K dated June 26, 1991, and incorporated
herein by reference.
(7) Previously filed with the Company's current report on Form 8-K
dated February 9, 1996, and incorporated herein by reference.
-21-
<PAGE> 24
Report of Independent Auditors
The Board of Directors
Medstone International, Inc.
We have audited the accompanying consolidated balance sheets of Medstone
International, Inc. as of December 31, 1995 and 1994, and the related
consolidated statements of income, stockholders' equity, and cash flows for each
of the three years in the period ended December 31, 1995. Our audits also
included the financial statement schedule listed in the Index at Item 14(a).
These financial statements and schedule are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements and schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Medstone
International, Inc. at December 31, 1995 and 1994, and the consolidated results
of its operations and its cash flows for each of the three years in the period
ended December 31, 1995, in conformity with generally accepted accounting
principles. Also, in our opinion, the related financial statement schedule, when
considered in relation to the basic financial statements taken as a whole,
presents fairly in all material respects the information set forth therein.
As discussed in the first paragraph of Note 8 to the financial statements, the
Company is a defendant in a class action lawsuit. Management of the Company
believes that the allegations are without merit and intends to continue to
vigorously defend against this action. The ultimate outcome of the litigation
cannot presently be determined. Accordingly, no provision for any liability that
may result, if any, has been made in the financial statements.
ERNST & YOUNG LLP
Orange County, California
February 14, 1996
-22-
<PAGE> 25
MEDSTONE INTERNATIONAL, INC.
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------------------------
1995 1994
--------------- -----------------
ASSETS
------
<S> <C> <C>
Current assets:
Cash and equivalents $ 3,108,741 $ 1,261,596
Short-term investments 14,494,717 13,148,586
Accounts receivable, less allowance for
doubtful accounts of $207,000 and
$257,000 in 1995 and 1994, respectively 1,509,407 1,825,150
Inventories 1,764,636 1,607,090
Deferred tax assets 698,000 1,005,000
Prepaid expenses and other current assets 519,542 394,595
--------------- ----------------
Total current assets 22,095,043 19,242,017
Property and equipment:
Lithotripters 3,627,628 3,775,120
Equipment 1,637,529 1,681,765
Furniture and fixtures 1,174,009 1,176,072
Leasehold improvements 89,764 89,764
--------------- ----------------
6,528,930 6,722,721
Less accumulated depreciation and amortization (3,129,955) (3,727,123)
-------------- ---------------
Net property and equipment 3,398,975 2,995,598
--------------- ----------------
Other assets, net 415,838 22,500
--------------- ----------------
$ 25,909,856 $ 22,260,115
=============== ================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 393,542 $ 521,496
Accrued expenses 235,265 368,942
Accrued income taxes 101,293 601,776
Accrued payroll expenses 206,120 408,884
Deferred revenue 726,260 642,551
Customer deposits 932 40,000
Dividends payable 1,966,216 ---
--------------- ----------------
Total current liabilities 3,629,628 2,583,649
Deferred tax liabilities 123,000 225,000
Commitments and contingencies (Notes 3 and 8)
Stockholders' equity:
Common stock - $.004 par value, 20,000,000
shares authorized, 5,516,528 and 4,944,603
shares issued and outstanding at
December 31, 1995 and 1994, respectively 22,066 19,778
Additional paid-in capital 18,555,983 17,675,642
Accumulated earnings 3,710,436 1,802,325
Stock purchase notes receivable (134,800) ---
Unrealized gain/(loss) on short-term investments 3,543 (46,279)
--------------- ---------------
Total stockholders' equity 22,157,228 19,451,466
--------------- ----------------
$ 25,909,856 $ 22,260,115
=============== ================
</TABLE>
See accompanying notes
-23-
<PAGE> 26
<TABLE>
<CAPTION>
MEDSTONE INTERNATIONAL, INC.
CONSOLIDATED STATEMENTS OF INCOME
FOR THE YEAR ENDED DECEMBER 31,
------------------------------
1995 1994 1993
------------ ------------ -------------
<S> <C> <C> <C>
Net equipment sales $ 4,588,015 $ 3,125,495 $ 2,316,805
Procedures and maintenance fees
and laser catheters 12,797,608 12,537,264 10,874,799
Interest and dividend income 1,004,655 642,058 481,319
--------------- --------------- ---------------
Total revenues 18,390,278 16,304,817 13,672,923
Costs and expenses:
Cost of equipment sales 2,080,747 1,139,805 1,657,488
Costs related to procedure
and maintenance fees and
laser catheters 5,552,354 4,863,595 3,848,715
Research and development 926,665 1,076,033 2,333,421
Selling 2,050,109 2,551,088 2,673,794
General and administrative 1,656,455 2,105,324 2,226,293
Other expense 163,621 34,770 337,977
--------------- --------------- ---------------
Total costs and expenses 12,429,951 11,770,615 13,077,688
--------------- --------------- ---------------
Income before provision for
income taxes 5,960,327 4,534,202 595,235
Provision for income taxes 2,086,000 150,000 65,000
--------------- --------------- ---------------
Net income $ 3,874,327 $ 4,384,202 $ 530,235
=============== =============== ===============
Net income per share:
Primary net income $ .70 $ .82 $ .10
=============== =============== ===============
Fully diluted net income $ .69 $ .81 $ .10
=============== =============== ===============
Number of shares used in the computation
of net income per share:
Primary 5,544,831 5,350,404 5,398,257
=============== =============== ===============
Fully diluted 5,618,231 5,427,685 5,398,257
=============== =============== ===============
</TABLE>
See accompanying notes
-24-
<PAGE> 27
MEDSTONE INTERNATIONAL, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
COMMON STOCK ADDITIONAL ACCUMULATED
--------------------
NUMBER OF PAID-IN EARNINGS
SHARES AMOUNT CAPITAL (DEFICIT)
--------- --------- ----------- -----------
<S> <C> <C> <C> <C>
BALANCE AT DECEMBER 31, 1992 4,821,660 $ 19,287 $17,203,207 $(3,112,112)
Common stock options exercised 49,608 198 133,038 ---
Net income --- --- --- 530,235
--------- --------- ----------- -----------
BALANCE AT DECEMBER 31, 1993 4,871,268 19,485 17,336,245 (2,581,877)
Common stock options exercised 73,335 293 139,397 ---
Income tax benefit from stock options --- --- 200,000 ---
Unrealized loss on short-term
investments --- --- --- ---
Net income --- --- --- 4,384,202
--------- --------- ----------- -----------
BALANCE AT DECEMBER 31, 1994 4,944,603 19,778 17,675,642 1,802,325
Common stock options exercised 571,925 2,288 670,341 ---
Income tax benefit from stock options --- --- 210,000 ---
Unrealized gain on short-term investments --- --- --- ---
Dividend declared --- --- --- (1,966,216)
Net income --- --- --- 3,874,327
--------- --------- ----------- -----------
BALANCE AT DECEMBER 31, 1995 5,516,528 $ 22,066 $18,555,983 $ 3,710,436
========= ========= =========== ===========
<CAPTION>
UNREALIZED LOSS
STOCK PURCHASE ON SHORT-TERM
NOTE RECEIVABLE INVESTMENTS TOTAL
--------------- -------------- -----
<S> <C> <C> <C>
BALANCE AT DECEMBER 31, 1992 $ --- $ --- $14,110,382
Common stock options exercised --- --- 133,236
Net income --- --- 530,235
------------ ---------- ----------
BALANCE AT DECEMBER 31, 1993 --- --- 14,773,853
Common stock options exercised --- --- 139,690
Income tax benefit from stock options --- --- 200,000
Unrealized loss on short-term
investments --- (46,279) (46,279)
Net income --- --- 4,384,202
----------- ---------- ----------
BALANCE AT DECEMBER 31, 1994 --- (46,279) 19,451,466
Common stock options exercised (134,800) --- 537,829
Income tax benefit from stock options --- --- 210,000
Unrealized gain on short-term investments --- 49,822 49,822
Dividend declared --- --- (1,966,216)
Net income --- --- 3,874,327
----------- ---------- ----------
BALANCE AT DECEMBER 31, 1995 $ (134,800) $ 3,543 $22,157,228
========== ========== ===========
</TABLE>
See accompanying notes
-25-
<PAGE> 28
MEDSTONE INTERNATIONAL, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------------------------------------
1995 1994 1993
--------------- --------------- ---------------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income $ 3,874,327 $ 4,384,202 $ 530,235
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation and amortization 945,050 914,021 1,078,130
Provision for doubtful accounts --- 140,000 272,900
Provision for related party loan 1,315 34,849 183,551
Unrealized losses on short-term investments --- --- 228,316
Changes in operating assets and liabilities:
Accounts receivable 308,646 (336,390) (538,325)
Inventories (961,695) (616,946) (407,889)
Deferred taxes 205,000 (780,000) ---
Prepaid expenses and other (124,947) 147,257 (214,824)
Accounts payable (127,954) (136,231) (94,561)
Accrued expenses (133,677) (89,759) (853,817)
Accrued income taxes (290,483) (26,962) 23,588
Accrued payroll expenses (202,764) 101,952 (69,131)
Deferred revenue 83,709 140,130 147,810
Customer deposits (39,068) 28,203 (51,131)
--------------- --------------- ---------------
Net cash provided by operating activities 3,144,121 3,763,576 309,475
--------------- --------------- ---------------
Cash flows from investing activities:
Purchases of investments available for sale (18,744,464) (23,165,800) ---
Proceeds from sales of investments available for sale 17,448,155 19,122,614 ---
Related party loan 5,782 (39,774) (112,500)
Purchases of property and equipment (1,220,503) (1,009,218) (998,261)
Disposals of property and equipment 676,225 40,145 451,614
--------------- --------------- ---------------
Net cash used in investing activities (1,834,805) (5,052,033) (659,147)
--------------- -------------- --------------
Cash flows from financing activities-
proceeds from issuance of common stock 537,829 139,690 133,236
Net increase (decrease) in cash and equivalents 1,847,145 (1,148,767) (216,436)
Cash and equivalents at beginning of year 1,261,596 2,410,363 2,626,799
--------------- --------------- ---------------
Cash and equivalents at end of year $ 3,108,741 $ 1,261,596 $ 2,410,363
=============== =============== ===============
Supplemental cash flow disclosures:
Cash paid during the year for:
Income taxes $ 2,173,390 $ 956,962 $ 68,268
Supplemental schedule of noncash investing
and financing activities:
Tax benefit of employee stock options $ 210,000 $ 200,000 $ ---
Dividends declared $ 1,966,216 $ --- $ ---
</TABLE>
See accompanying notes
-26-
<PAGE> 29
MEDSTONE INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1995
1. ORGANIZATION AND OPERATIONS OF THE COMPANY
Medstone International, Inc. ("Medstone"), (formerly Cytocare, Inc. prior
to renaming on September 21, 1995) was incorporated in Delaware in October 1984.
The Company designs, manufactures and markets the Medstone STSTM
Shockwave Therapy System (the "System") for the noninvasive disintegration of
kidney stones in human patients. In addition to sales of the System, Medstone
generates recurring revenue from procedure fees and fee for service arrangements
for use of the System and from repairs and maintenance of the Systems.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of consolidation
The consolidated financial statements include the accounts of the
Company, Endocare, Inc., UroGen, Corp. and Medstone Sales Corporation, a foreign
sales corporation.
Reclassifications
Certain prior period balances have been reclassified to conform with the
December 31, 1995 presentation.
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that effect the reported amounts of assets and liabilities at the
date of the financial statements and the reported amounts of revenue and
expenses during the reporting period. Actual results could differ from those
estimates. Significant estimates made in preparing these financial statements
include the allowance for doubtful accounts.
Statement of cash flows
The Company considers all highly liquid investments with a maturity of
three months or less when purchased to be cash equivalents.
The Company had net non-cash transfers of inventory into fixed assets of
$804,000, $630,000 and $168,000 for the years ended December 31, 1995, 1994 and
1993, respectively.
-27-
<PAGE> 30
Short-term Investments
Effective January 1, 1994, the Company adopted the provisions of
Statement of Financial Accounting Standards No. 115, "Accounting for Certain
Investments in Debt and Equity Securities." The adoption did not have a
significant impact on the Company's consolidated financial statements.
Management determines the appropriate classification of such securities at the
time of purchase and reevaluates such classification as of each balance sheet
date. Based on its intent, the Company's investments are classified as
available-for-sale and are carried at fair value, with unrealized gains and
losses, net of tax, reported as a separate component of stockholders' equity.
The investments are adjusted for amortization of premiums and discounts to
maturity and such amortization is included in interest income. Realized gains
and losses and declines in value judged to be other than temporary are
determined based on the specific identification method and are reported in the
consolidated statements of operations.
The Company invests primarily in U.S. government securities, and
corporate obligations. As of December 31, 1995 and December 31, 1994,
investments are summarized as follows:
<TABLE>
<CAPTION>
GROSS GROSS
UNREALIZED UNREALIZED FAIR
COST GAINS LOSS VALUE
-------------- ---------- ----------- ---------------
<S> <C> <C> <C> <C>
1995
U.S. Treasury Bills $ 14,489,267 $ 5,450 $ --- $ 14,494,717
1994
U.S. Treasury Bills 13,194,865 --- 46,279 13,148,586
</TABLE>
Gross realized gains and losses were $0 and $0, respectively in 1995 and
1994.
The amortized cost and estimated fair value of investments at December
31, 1995 by contractual maturity, are shown below. Expected maturities will
differ from contractual maturities because the issuer of the securities may have
the right to repurchase such securities.
<TABLE>
<CAPTION>
COST FAIR VALUE
-------------- --------------
<S> <C> <C>
Due in one year or less $ 14,489,267 $ 14,494,717
</TABLE>
Concentrations of credit risk
Financial instruments which potentially subject the Company to
concentrations of credit risk consist principally of cash equivalents,
marketable securities and accounts receivable. The Company's marketable
securities consist principally of U.S. Treasury Bills.
The Company sells its products primarily to hospitals worldwide. Credit
is extended based on an evaluation of the customer's financial condition and
collateral generally is not required. The Company's ten largest customers
accounted for approximately 34% of accounts receivable at December 31, 1995.
-28-
<PAGE> 31
Inventories
Inventories are stated at the lower of cost (first-in, first-out) or
market and consist of the following:
<TABLE>
<CAPTION>
December 31,
-------------------------------------
1995 1994
----------------- ----------------
<S> <C> <C>
Raw materials $ 1,235,161 $ 1,194,369
Work in process 190,002 181,416
Finished goods 339,473 231,305
----------------- ----------------
$ 1,764,636 $ 1,607,090
================= ================
</TABLE>
Property and equipment
Property and equipment are carried at cost. Depreciation and amortization
are computed on the straight-line method over the following estimated useful
lives:
Lithotripters 5 years
Equipment 5 years
Furniture and fixtures 5 years
Leasehold improvements Life of lease
Revenue recognition
Revenues are recognized in accordance with the underlying contractual
terms of each sale. Typically, revenue recognition requires the transfer of
title upon shipment, customer acceptance, receipt of specified down payments and
performance of all significant contractual obligations. All foreign sales
contracts are negotiated with payment terms in U.S. dollars so the Company has
no exposure to foreign currency price fluctuations.
Service and maintenance contract revenues are deferred and amortized over
the terms of the related contracts.
Advertising
The Company expenses advertising costs including promotional literature,
brochures and trade shows, as incurred. Advertising expense was $124,000,
$156,000 and $298,000 for the years ended December 31, 1995, 1994 and 1993,
respectively.
Per share information
Per share information is presented in the accompanying consolidated
statements of income based upon the weighted average number of common and common
equivalent shares outstanding. Common equivalent shares result from the assumed
exercise of outstanding dilutive securities
-29-
<PAGE> 32
when applying the treasury stock method. Fully diluted per share information is
not presented for periods in which the effect is antidilutive.
Stock options
In October 1995, the Financial Accounting Standards Board issued FASB
Statement No. 123 "Accounting for Stock-based Compensation." The Company
currently accounts for stock options per the requirements contained in APB
Opinion No. 25, "Accounting for Stock Issued to Employees" and the Company will
make its election in 1996 as to its method of accounting for stock-based
compensation.
3. COMMITMENTS
In March 1994, the Company took occupancy of new office, manufacturing,
engineering, warehouse space, and research and development laboratories under an
operating lease with an initial term of two years. The monthly lease rate is
$12,500 through February 1996. The Company has exercised the first one year
option, extending the lease term through March 1997, at a monthly lease rate of
$12,862, and retains the option to extend the lease in one year segments through
March 1999 for modest price increases. The future minimum lease payments under
the lease are as follows:
<TABLE>
<CAPTION>
Minimum Rental
--------------
<S> <C>
1996 $ 155,000
1997 $ 26,000
</TABLE>
Total net rent expense under all operating leases for the years ended
December 31, 1995, 1994 and 1993 was $152,000, $237,000, and $495,000,
respectively.
4. INCOME TAXES
The provision for income taxes consists of the following:
<TABLE>
<CAPTION>
YEAR ENDED YEAR ENDED YEAR ENDED
DECEMBER 31, 1995 DECEMBER 31, 1994 DECEMBER 31, 1993
----------------- ----------------- -----------------
<S> <C> <C> <C>
Current:
Federal $ 1,631,000 $ 1,256,000 $ 84,000
State 299,000 45,000 15,000
Utilization of tax credits (49,000) (373,000) (34,000)
---------------- ---------------- -----------------
Total Current 1,881,000 928,000 65,000
----------------- ----------------- ------------------
Deferred:
Federal 55,000 (484,000) ---
State 150,000 (294,000) ---
----------------- ---------------- ------------------
Total deferred 205,000 (778,000) ---
----------------- ---------------- ------------------
Provision for
income taxes $ 2,086,000 $ 150,000 $ 65,000
================= ================= ==================
</TABLE>
-30-
<PAGE> 33
The following is a reconciliation of the provision (benefit) for income
taxes at the federal statutory rate compared to the Company's effective tax
rate:
<TABLE>
<CAPTION>
YEAR ENDED YEAR ENDED YEAR ENDED
DECEMBER 31, 1995 DECEMBER 31, 1994 DECEMBER 31, 1993
------------------ ------------------ -----------------
<S> <C> <C> <C>
Income tax (benefit) at the
statutory rate $ 2,027,000 $ 1,542,000 $ 202,000
State income taxes
(net of federal benefit) 264,000 (164,000) 36,000
Change in valuation allowance --- (775,000) ---
Losses (with) current
tax benefit --- --- (121,000)
Tax credits (with) current benefit --- (373,000) (34,000)
Accruals (with) tax benefit (211,000) --- (29,000)
Other 6,000 (80,000) 11,000
----------------- ---------------- ------------------
Provision for income
taxes $ 2,086,000 $ 150,000 $ 65,000
================= ================= ==================
</TABLE>
The tax effect of temporary differences that give rise to significant
portions of the deferred tax assets and deferred tax liabilities are as follows:
<TABLE>
<CAPTION>
DECEMBER 31, 1995 DECEMBER 31, 1994
----------------- ------------------
<S> <C> <C>
DEFERRED TAX ASSETS:
Accruals not currently deductible for tax $ 684,000 $ 888,000
Net operating loss carryforward --- 58,000
Credit for increasing research activities --- 50,000
Depreciation --- ---
Other credits 14,000 9,000
-------------- --------------
Net deferred assets 698,000 1,005,000
-------------- --------------
Depreciation 123,000 225,000
-------------- --------------
Total gross deferred tax liabilities 123,000 225,000
-------------- --------------
Net deferred tax assets and liabilities $ 575,000 $ 780,000
============== ==============
</TABLE>
5. STOCK OPTIONS
In 1987, the Company adopted the 1987 Stock Option Plan (1987 Plan) under
which options could be granted to key employees or directors of the Company by a
committee appointed by the Company's Board of Directors (the Committee) to
purchase up to 476,323 shares of the Company's common stock. The exercise prices
for options granted under the 1987 Plan were equal to the fair market value of
the common stock on the date of grant. During 1988 and 1989, the Committee
granted options which generally become exercisable with respect to 1/60th of the
issuable shares for each elapsed month during the five-year period commencing
with dates determined by the Committee. All options granted in 1988 and 1989
terminate one year after the end of the five-year period. In June 1989, the
Company terminated the 1987 Plan as to the granting of additional options. In
February 1995, the termination date of the remaining
-31-
<PAGE> 34
39,750 options exercisable under this Plan was extended for an additional year
from the previously extended termination date.
In June 1989, the Company's stockholders approved the 1989 Stock
Incentive Plan which provides for the granting of a variety of stock-related
securities, including shares of common stock, stock options and stock
appreciation rights to employees and other selected individuals. In May 1991,
the Company's stockholders amended the Plan to increase the number of shares
issuable to 1,593,783 and eliminated the provision for an automatic increase in
the number of shares issuable on January 1 of each year by one percent of the
then outstanding shares. As of December 31, 1995, 633,998 options for shares of
common stock had been granted and are outstanding under this plan.
In June 1989, the Company's stockholders also approved the Nonemployee
Director Stock Option Plan. This plan provides for the issuance of up to 50,000
shares of the Company's common stock upon exercise of options granted under the
plan. As of December 31, 1995, 10,000 options for shares of common stock had
been granted under this plan.
Stock option activity under the Company's plans is summarized as follows:
<TABLE>
<CAPTION>
YEAR ENDED YEAR ENDED YEAR ENDED
NUMBER OF OPTIONS DECEMBER 31, 1995 DECEMBER 31, 1994 DECEMBER 31, 1993
----------------- ------------------ ------------------ ------------------
<S> <C> <C> <C>
Outstanding, beginning of year 839,948 946,251 997,079
Granted 535,500 43,000 119,834
Exercised (571,925) (73,335) (49,608)
Cancelled (119,775) (75,968) (121,054)
---------------- --------------- ----------------
Outstanding, end of year 683,748 839,948 946,251
================ =============== ================
OPTION PRICE PER SHARE
Granted $8.50 - $11.88 $5.47 $5.00 - $5.50
Exercised $1.31 - $5.50 $1.31 - $5.00 $1.31 - $5.00
Outstanding, end of year $1.31 - $11.88 $1.31 - $5.50 $1.31 - $5.50
</TABLE>
At December 31, 1995, 1994 and 1993, the number of unoptioned shares
reserved and available for issuance under the plans was 999,785, 880,085 and
776,782, respectively. Outstanding options for 181,753 shares were exercisable
at December 31, 1995.
6. EMPLOYEE BENEFIT PLAN
In January 1990, the Company established a defined contribution profit
sharing 401(k) plan for all eligible employees. The plan provides for the
deferral of up to 15% of an employee's qualifying compensation under Section
401(k) of the Internal Revenue Code. Contributions by the Company may be made to
the plan at the discretion of the Board of Directors. No such contributions were
made to the plan during the years ended December 31, 1995, 1994 and 1993.
-32-
<PAGE> 35
7. MAJOR CUSTOMERS AND FOREIGN SALES
During the year ended December 31, 1995 no single customer accounted for
10% or more of total revenues and the Company derived 9% of its total revenues
from sales to foreign customers. During the year ended December 31, 1994, one
foreign customer accounted for 10% of total revenues of the Company and the
Company derived 13% of its total revenues from sales to foreign customers.
During the year ended December 31, 1993, no single customer accounted for 10% or
more of the total revenues and the Company derived 8% of its total revenues from
sales to foreign customers.
8. CONTINGENCIES
The Company is a defendant in two related class action lawsuits filed by
two shareholders of the Company alleging that adverse material information was
not disclosed at the time of the initial public offering and in subsequent
periods. On May 4, 1992, the district court granted summary judgment in one of
the actions in favor of the Company on all claims. On July 9, 1992, the district
court granted the Company's motion to dismiss the second action. In October
1994, the Company received the opinion of the Ninth Circuit of Appeals affirming
in part and reversing in part the United States District Court's decision
granting summary judgment in favor of the Company and several officers. The
complaints allege principally that adverse material information was not
disclosed at the time of the initial public offering in June 1988. In April
1995, the Company filed a Supreme Court brief, and in October 1995, the Company
was informed that the Supreme Court declined to hear the case, returning the
case to the district court for scheduling of the trial, which has been set by
the district court for May 21, 1996. The Company intends to proceed to trial on
any remaining matters. The ultimate outcome of the litigation cannot presently
be determined. Accordingly, no provision for any liability that may result, if
any, has been made in the financial statements.
From time to time, the Company is subject to legal actions and claims for
personal injuries or property damage related to patients who use its products.
The Company has obtained a liability insurance policy providing coverage for
product liability and other claims. Management does not believe that the
resolution of any current proceedings will have a material financial impact on
the Company or the consolidated financial statements.
9. RELATED PARTY TRANSACTIONS
During 1991, the Company was a party to the formation of Cardiac Science,
Inc., for which the Company purchased 5,353,031 shares of common stock, for a
cash payment of $.0016 per share. This purchase represented 77.3% of the
outstanding stock. As of July 8, 1991, the Company distributed a dividend to its
shareholders of record on that date, one share of Cardiac Science, Inc. stock
for each share of Medstone stock held. The Company retained 629,768 shares of
common stock of Cardiac Science, Inc.
-33-
<PAGE> 36
In June 1991, the Company agreed to loan Cardiac Science, Inc. up to
$220,000 to provide working capital pursuant to the terms of a revolving note
agreement. The unpaid principal amount of the loan, together with interest
accrued thereon at the rate of 10% per annum, was due and payable to Medstone in
December 1991. Medstone then agreed to extend this note and to loan additional
amounts to Cardiac Science, Inc. As of April 30, 1992, the Company had loaned
Cardiac Science, Inc. approximately $310,000. In April 1992, the Company agreed
to extend its initial loan to Cardiac Science, Inc. and to loan Cardiac Science,
Inc. an additional $200,000. These loans bore interest at a rate of 8% per
annum, payable quarterly, are secured by Cardiac Science's assets and were to
mature on the earlier of April 1, 1995 or the closing of the initial public
offering of Cardiac Science's common stock.
In September 1994, Cardiac Science completed a private placement
offering, and in conjunction with that offering, the Company exercised warrants
to purchase 2,720,000 shares of Cardiac Science Common Stock at $.15 per share.
The proceeds of $408,000 were used to pay down a portion of the loans described
above. The due date for the remaining principal balance of $102,000 has been
extended to April 1, 1996. The expiration date for the remaining warrants was
changed to March 31, 1996. In addition, the Company was issued 1,800,000 shares
of Cardiac Science Common Stock and a ten year warrant to purchase 1,000,000
shares at $.001 per share in full payment of unsecured obligations of
approximately $176,000. At December 31, 1995, $107,055, which includes accrued
interest, has been loaned to Cardiac Science. A reserve of $107,055 has been
provided for non-payment of the loan.
As of December 31, 1995, the Company held warrants to purchase 680,000
shares of Cardiac Science's common stock at $.15 per share which expire March
31, 1996 and warrants to purchase 1,000,000 shares at $.001 per share, which
expire September 10, 2004.
Separately, the Company advanced amounts to Cardiac Science for health
insurance. These amounts are to be repaid by Cardiac Science on a month-to-month
basis. As of December 31, 1995, $8,290 had been advanced to Cardiac Science. A
reserve of $2,617 has been provided for non-payment of the advances.
Effective March 15, 1994, all Cardiac Science business is conducted at a
location completely independent of Medstone. This will insure that Cardiac
Science cannot be perceived as lacking autonomy over its own business and
technical operations.
10. DISTRIBUTION TO SHAREHOLDERS
On December 19, 1995, the Company declared two stock dividends, payable
to stockholders of record on the close of trading on December 29, 1995. The two
dividends represent distribution of all the assets and operations of the
Endocare and Urogen divisions of the Company. Effective with the start of
business on January 1, 1996 these two companies will no longer be a part of the
Medstone International operations, as Medstone will distribute to its
shareholders all outstanding common stock of each company, retaining only
100,000 shares of each company. These two companies will become separate,
publicly-held companies. The
-34-
<PAGE> 37
Company will distribute 5,516,528 shares of each company, and as of February 9,
1996, Medstone's transfer agent has effected the distributions.
Endocare develops, manufacturers and markets devices to treat urological
diseases. Endocare began as a department and was later formed as a division of
Medstone International, Inc. to continue the research and development efforts of
Medstone in the treatment of urological disorders and to focus on new product
development. In addition to enhancing Medstone's existing lithotripsy products,
the research and development conducted by Endocare has produced several products
outside of Medstone's core business of lithotripsy. Products include its
Prolase(R) side firing laser catheter and electrosurgical devices designed to
treat urological tissue and its CryoCare(TM) System, which is currently in
clinical trials. The common theme for all Endocare product development is
innovative design, minimally invasive and outpatient-oriented procedures, and
cost effective solutions for the marketplace. Endocare's goal is to continue to
find better surgical solutions for better patient care in the area of urologic
disease. Following the Distribution, Endocare will also continue to perform
research and development for Medstone.
Urogen was formed from the medical biology and small molecule
pharmaceuticals division of Medstone to continue the effort, started in 1991, to
develop pharmaceuticals to treat diseases in urology, with a particular interest
in prostate cancer. In conjunction with leading cancer research centers and
universities, UroGen will pursue opportunities to develop new therapies
including drugs to stimulate the immune systems, and novel small molecules. To
assist urologists in effective disease management, Urogen will also seek
opportunities in diagnostics, particularly prostate cancer.
Medstone, as part of the distribution of Endocare, will forgive
intercompany debt of $2,831,364 and contribute $500,000 in cash and net other
assets of $803,133 to Endocare. As part of the distribution of Urogen, Medstone
will forgive intercompany debt of $3,888,875 and contribute $500,000 in cash and
net other assets of $163,082 to UroGen.
11. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
The tables below set forth selected quarterly financial information for
1995 and 1994 (in thousands, except per share amounts).
<TABLE>
<CAPTION>
1995 1ST QUARTER 2ND QUARTER 3RD QUARTER 4TH QUARTER
---- ------------ ------------ ----------- ------------
<S> <C> <C> <C> <C>
Net sales $ 4,814 $ 4,268 $ 5,284 $ 4,025
Gross profit 2,884 2,562 3,043 2,269
Net income 1,093 916 1,211 654
Earnings per share $ .20 $ .17 $ .22 $ .12
</TABLE>
-35-
<PAGE> 38
<TABLE>
<CAPTION>
1994 1ST QUARTER 2ND QUARTER 3RD QUARTER 4TH QUARTER
---- ------------ ------------ ----------- ------------
<S> <C> <C> <C> <C>
Net sales $ 4,492 $ 3,828 $ 4,000 $ 3,985
Gross profit 2,811 2,468 2,485 2,538
Net income 965 652 1,479 1,288
Earnings per share $ .18 $ .12 $ .28 $ .24
</TABLE>
In 1994, the Company's effective tax rate was reduced by the use of net
operating loss carryforwards, which were exhausted in the fourth quarter of
1994. In 1995, the Company's tax rate approximated statutory rates. (See Note
4).
-36-
<PAGE> 39
MEDSTONE INTERNATIONAL, INC.
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
<TABLE>
<CAPTION>
ADDITIONS
-----------------------------
BALANCE AT CHARGED TO CHARGED TO BALANCE AT
BEGINNING COSTS AND OTHER END
DESCRIPTION OF YEAR EXPENSES ACCOUNTS DEDUCTIONS OF YEAR
- ----------- ---------- ---------- ---------- ---------- ----------
FOR THE YEAR ENDED
DECEMBER 31, 1995:
- -----------------
<S> <C> <C> <C> <C> <C>
Allowance for
doubtful accounts $ 257,418 $ --- $ --- $ 50,158 $ 207,260
=========== ============= ============= ============== ==============
Allowance for
inventory obsolescence $ 665,549 $ --- $ --- $ 88,665 $ 576,884
=========== ============= ============= ============== ==============
Allowance for
related party loan $ 108,357 $ 1,315 $ --- $ --- $ 109,672
=========== ============= ============= ============== ==============
Allowance for investment
in related party $ 643,000 $ --- $ --- $ --- $ 643,000
=========== ============= ============= ============== ==============
FOR THE YEAR ENDED
DECEMBER 31, 1994:
Allowance for
doubtful accounts $ 168,390 $ 140,000 $ --- $ 50,972 $ 257,418
=========== ============= ============= ============== ==============
Allowance for
inventory obsolescence $ 668,111 $ --- $ --- $ 2,562(a) $ 665,549
=========== ============= ============= ============== ==============
Allowance for
related party loan $ 693,072 $ 34,849 $ --- $ 619,564(c) $108,357
=========== ============= ============= ============== ==============
Allowance for investment
in related party $ 23,436 $ --- $ --- $ (619,564)(c) $643,000
=========== ============= ============= ============== ==============
FOR THE YEAR ENDED
DECEMBER 31, 1993:
Allowance for
doubtful accounts $ 746,368 $ 272,900 $ --- $ 850,878(b) $ 168,390
=========== ============= ============= ============== ==============
Allowance for
inventory obsolescence $ 678,123 $ --- $ --- $ 10,012(a) $ 668,111
=========== ============= ============= ============== ==============
Allowance for
related party loan $ 509,521 $ 183,551 $ --- $ --- $ 693,072
=========== ============= ============= ============== ==============
Allowance for investment
in related party $ --- $ 23,436 $ --- $ --- $ 23,436
=========== ============= ============= ============== ==============
</TABLE>
(a) Write-off of inventory
(b) Write-off of bad debt including $642,000 for one significant customer (c)
Reserve transferred from loan provision to investment provision due to
restructuring.
(c) Reserve transferred from loan provision to investment provision due to
restructuring.
-37-
<PAGE> 40
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of Securities
Exchange Act of 1934, the Registrant has duly caused this Report to be signed on
its behalf by the undersigned, thereunto duly authorized.
MEDSTONE INTERNATIONAL, INC.
By: DAVID V. RADLINSKI
---------------------------
David V. Radlinski
Chief Executive Officer
Dated: March 22, 1996
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities indicated on March 22, 1996.
SIGNATURE TITLE
--------- -----
Chairman of the Board and
Chief Executive Officer
DAVID V. RADLINSKI and Director
--------------------------- (Principal Executive Officer)
David V. Radlinski
MARK SELAWSKI Chief Financial Officer
--------------------------- (Principal Financial and Accounting Officer)
Mark Selawski
DONALD REGAN Director
---------------------------
Donald Regan
FRANK POPE Director
---------------------------
Frank Pope
-38-
<PAGE> 41
MEDSTONE INTERNATIONAL, INC.
COMPUTATION OF PER SHARE INFORMATION
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------------------------
1995 1994 1993
------------ ------------ ------------
<S> <C> <C> <C>
Earnings:
Net income ............................... $ 3,874,327 $ 4,384,202 $ 530,235
============ ============ ============
Computation of primary per share information:
Shares:
Weighted average number
of shares outstanding............... 5,256,486 4,912,620 4,851,779
Add effect of outstanding
options and warrants (a)............ 288,345 437,784 546,478
------------ ------------ ------------
Number of shares outstanding, as
adjusted............................... 5,544,831 5,350,404 5,398,257
============ ============ ============
Primary earnings per share............. $ .70 $ .82 $ .10
============ ============ ============
Computation of fully diluted per
share information:
Shares:
Weighted average number
of shares outstanding............... 5,256,486 4,912,620 4,851,779
Add effect of outstanding
options and warrants (a)............ 361,745 515,065 546,478
------------ ------------ ------------
Number of shares outstanding as
adjusted............................ 5,618,231 5,427,685 5,398,257
============ ============ ============
Fully diluted earnings per share ...... $ .69 $ .81 $ .10
============ ============ ============
</TABLE>
- -----------
(a) As determined by the application of the treasury stock method.
-39-
<PAGE> 42
Exhibit 23.1
CONSENT OF INDEPENDENT AUDITORS
We consent to the incorporation by reference in the Registration Statements
(Form S-8 Nos. 33-32890, 33-32891, 33-45470 and 33-32892) pertaining to the 1987
Stock Option Plan and the 1989 Stock Incentive Plan (as amended), and the
Nonemployee Director Stock Option Plan of Medstone International, Inc. of our
report dated February 14, 1996, with respect to the consolidated financial
statements and schedule of Medstone International, Inc. included in this Annual
Report (Form 10-K) for the year ended December 31, 1995.
ERNST & YOUNG LLP
Orange County, California
February 14, 1996
-40-
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1995
<PERIOD-START> JAN-01-1995
<PERIOD-END> DEC-31-1995
<CASH> 3108741
<SECURITIES> 14494717
<RECEIVABLES> 1509407
<ALLOWANCES> 207260
<INVENTORY> 1764636
<CURRENT-ASSETS> 22095044
<PP&E> 6528930
<DEPRECIATION> 3129955
<TOTAL-ASSETS> 25909856
<CURRENT-LIABILITIES> 3629628
<BONDS> 0
0
0
<COMMON> 22066
<OTHER-SE> 22135162
<TOTAL-LIABILITY-AND-EQUITY> 25909856
<SALES> 17385623
<TOTAL-REVENUES> 18390278
<CGS> 7633101
<TOTAL-COSTS> 4633229
<OTHER-EXPENSES> 163621
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 5960327
<INCOME-TAX> 2086000
<INCOME-CONTINUING> 3874327
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 3874327
<EPS-PRIMARY> .70
<EPS-DILUTED> .69
</TABLE>
