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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
For the fiscal year ended December 31, 1997
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from _____________ to ______________
Commission File Number 0-16752
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. [ ]
The number of shares of the Common Stock of the registrant outstanding
as of March 9, 1998 was 5,256,548. The number of shares of voting and non-voting
Common Stock held by non-affiliates on such date was 5,101,820 with an
approximate aggregate market value of $52,293,655.
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TABLE OF CONTENTS
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Page
Item Number and Caption Number
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PART I
Item 1. Business................................................. 1
Item 2. Properties............................................... 7
Item 3. Legal Proceedings........................................ 7
Item 4. Submission of Matters to a Vote of Security Holders...... 7
PART II
Item 5. Market for Registrant's Common Equity
and Related Stockholder Matters........................ 8
Item 6. Selected Financial Data.................................. 9
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations.................... 10
Item 8. Financial Statements and Supplementary Data.............. 15
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure.................... 15
PART III
Item 10. Directors and Executive Officers of the Registrant....... 16
Item 11. Executive Compensation................................... 18
Item 12. Security Ownership of Certain Beneficial
Owners and Management.................................. 21
Item 13. Certain Relationships and Related Transactions........... 22
PART IV
Item 14. Exhibits, Financial Statement Schedules,
and Reports on Form 8-K................................ 23
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PART I
ITEM 1. BUSINESS
INTRODUCTION
Medstone International, Inc., (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
vertically integrated by offering its medical devices directly to providers on a
fee-per-procedure basis. Medstone currently offers lithotripsy services both in
the United States and internationally on a fee-per-procedure basis in both the
fixed and mobile environment. Medstone intends to expand efforts to grow this
medical service side of its business. The Company's consolidated revenues during
fiscal 1997 came primarily 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 of record at 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.
In June 1996 the Company purchased, for $1.35 million cash, a 60%
interest in Northern Nevada Lithotripsy Associates, LLC ("Northern Nevada"), an
operator of lithotripsy services. In March 1997, the Company purchased, for $2.3
million cash, a 60% interest in Southern Idaho Lithotripsy Associates, LLC
("Southern Idaho"), another operator of lithotripsy services. The Company
consolidates the revenues of Northern Nevada and Southern Idaho and reflects
minority interest expense for the portion of profits earned by the minority
partners. These companies' revenues are derived from invoicing patients or
insurers.
United Physicians Resources, Inc. ("UPR") was incorporated as a
majority-owned subsidiary of the Company in June 1996, to expand the Company's
service orientation to the urologist practitioners. UPR provides billing,
practice management, and consulting services as an additional service line once
the initial physician relationship has been established. UPR purchased the
operations of Integrated Healthcare Systems, Inc. in July 1996 for $30,000. The
operating results of UPR are included in the consolidated financial statements
of the Company since its incorporation.
MARKETS
The Company currently operates in the kidney stone treatment market. In
the United States, it is estimated that over 1,500,000 persons per year suffer
from kidney stones and an estimated 375,000 patients per year are hospitalized
with a primary kidney stone. Historically, approximately 180,000 of these
patients have been treated with extra corporeal shockwave lithotripsy each year.
With an estimated installed base of 380 lithotripters in the United States,
there is a sufficient number of lithotripters to respond to this market.
Outside the United States the incidence of kidney stones varies from
country to country. The installed base of extra corporeal shockwave
lithotripters is not as extensive as in the United States. Medstone has sold
systems into Japan, Egypt, Russia, Israel, Saudi Arabia, U.A.E., Hong Kong and
China.
In a joint effort, Medstone and Novartis ("Novartis") formerly known as
Ceiba-Geigy have submitted an application to the U.S. Food and Drug
Administration ("FDA") to non-invasively treat gallstones using the Company's
lithotripter in conjunction with Actigall(R) (ursodiol USP). On March 5, 1998,
the FDA informed Medstone in writing that its Pre-market Approval Application is
considered filed. In the same letter, Medstone was informed that the FDA expects
to take this submission before the Gastroenterology and Urology Device Advisory
Panel on April 30, 1998. If the Medstone lithotripsy system were to receive such
approval, it would be the only system approved to treat
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kidney stones and gallstones on the same equipment in the United States although
no assurance can be given that such approval will ever be given. See
"Governmental Regulation" below.
In the United States, it is estimated that 20,000,000 persons have
gallstones resulting in approximately 600,000 surgeries each year to remove
these gallstones. At this time it is impossible to estimate the number of
procedures that would be performed using the non-invasive lithotripsy/drug
alternative.
Medstone is also investigating the application of shockwave therapy for
various orthopedic applications.
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 pre-market approval ("PMA") from the 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 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.
The Company, as a vertically integrated manufacturer, also offers
fee-for-service lithotripsy in the continental United States. It has placed its
lithotripters in mobile trailers and contracts with hospitals, clinics, and
ambulatory surgery centers to provide the equipment necessary to treat kidney
stones, usually on an outpatient basis. This allows small and mid-size
facilities in wide ranging geographic locations to access equipment and
technology that otherwise would only be economically viable in larger population
centers. There are currently over 90 sites in the United States that are active
sites on the Company's mobile routes. The Company plans to continue to expand
its customer base for lithotripsy services in future years.
KIDNEY STONES AND TREATMENT
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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 provides a non-invasive nonsurgical treatment for
stones in the kidney and ureter called extra corporeal 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 non-invasive 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 its facility in March 1994. Subsequent to that move the
Company was audited by the FDA and received notification from the FDA enabling
it to manufacture and market devices in that facility. The Company has existing
capacity to produce sufficient quantities of its shockwave lithotripters to
support its commercial needs for the foreseeable future.
PRODUCT DEVELOPMENT
The Company has focused its research in 1997 on developments intended
to improve performance and convenience, and also to reduce the size and costs,
of its lithotripter systems. In 1997, the Company devoted a significant portion
of its research and development expenditures on the Medstone STS-T, a smaller,
movable lithotripsy system. This new product, which has been previewed at focus
groups, is scheduled for introduction in 1998, pending FDA approvals and the
Company will continue to invest significantly in product enhancements and
proprietary products. During the years ended December 31, 1995, 1996, and 1997,
the Company's expenditures for research and development totaled $926,665,
$521,793, and $1,021,349, 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 D & O insurance policies provide coverage on a
claims-made basis and are subject to annual renewal.
GOVERNMENT REGULATION
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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 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.
On January 9, 1998, the Health Care Finance Administration (HCFA)
published proposed Stark II regulations with the intent of seeking public
comments regarding the proposal and its effects. Stark II proposes that
lithotripsy would be defined as an "inpatient and outpatient hospital procedure"
and this definition would put physician ownership of lithotripsy units in
violation of HCFA regulations. This would apply to patients covered under
Medicare, Medicaid and Champus health care.
With the completion of the comment period in the beginning of March
1998, no further information is currently available to the Company regarding the
public comments. The regulations, if enacted as first published, could force
physician partnerships to either divest ownership or find a "safe harbor" under
which to operate lithotripsy partnerships.
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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 its lithotripter operating systems.
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.
Future products of 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 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, a subsidiary of a Singapore-based conglomerate, 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.
MOBILE LITHOTRIPSY SERVICES
In the fee-for-service business segment, the Company competes with a
number of service oriented medical businesses, in a fragmented and highly
competitive industry, both nationally and locally. Moreover, certain of the
Company's current and potential competitors have substantially greater financial
resources than the Company and may compete with the Company for acquisitions and
development of operations in markets targeted by the Company. The Company has
experienced competition in the acquisition of existing lithotripsy facilities
and the development of relationships with treating physicians. The Company has
experienced competition from hospitals or treating physicians
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who have opened their own lithotripsy facilities. Such competition could
intensify in the event of a decrease in the purchase price of lithotripters or
if the supply of new or used lithotripters increases over time.
The Company's main competitors in the fee-for-service business are
Prime Medical Services, Inc., a Texas-based mobile lithotripsy provider, the
lithotripsy business of Integrated Health Services, Inc., a Maryland based
healthcare concern, of which one operating entity owns lithotripsy provider
partnerships, and other smaller regional and local providers.
SALES AND MARKETING
The Company's current products and planned future of products are
targeted at the lithotripsy market. Medstone has a direct sales force, covering
the continental 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 owning, 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 $250,000 as of
March 1, 1998 and $480,000 as of March 24, 1997. 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 management services contracts.
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 February 28, 1998, Medstone had 77 employees. Of the 77
employees, 9 are engaged directly in research and development activities, 12 are
engaged in manufacturing, 18 are engaged in mobile operations, 16 are engaged in
field service, 11 are engaged in sales and marketing and 11 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.
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ITEM 2. PROPERTIES
In March 1994, the Company took occupancy of office, manufacturing,
engineering, and warehouse space, and research and development laboratories,
located in Aliso Viejo, California, under an operating lease with an initial
term of two years. Under extensions of the lease, the monthly lease rate was
$12,862 through February 1997 and $13,360 through February 1998. The Company
exercised its option to extend the lease, extending the lease until March 1999
at a monthly lease rate of $13,874. The Company negotiated an extension for a
sixteen month period running from March 1999 to June 2000, at a monthly rate of
$14,410.
United Physicians Resources leases a 1,417 square foot office in
Phoenix, Arizona with a monthly rental expense of $1,990 under an operating
lease which expires in October 1999.
ITEM 3. LEGAL PROCEEDINGS
The Company carries director and officer liability insurance, and has
indemnification agreements with its officers and directors.
The Company was 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 June 20, 1996 the defendants and plaintiffs reached an agreement
whereby a $6 million, non-recapturable settlement fund was established in return
for dismissal of all claims against the Company, its underwriter and current and
former officers and directors. The Company recorded a one-time, $5.5 million
expense in the second quarter of 1996 to cover its portion of the settlement
fund, with the first half paid on July 9, 1996 and the second half paid on
August 15, 1996. All funds for the settlement were remitted by the Company, with
the co-defendants having paid their portions to the Company.
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.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Company's annual meeting of shareholders was held on May 1, 1997.
At the meeting Frank R. Pope, David V. Radlinski, Donald Regan and Michael C.
Tibbitts were elected directors and the 1997 Stock Incentive Plan was approved.
EXECUTIVE OFFICERS OF THE REGISTRANT
Information regarding the Company's executive officers is included in
Item 10 of Part III.
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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, 1996 and
December 31, 1997 as reported in the NASDAQ National Market System for the
quarter indicated.
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HIGH LOW
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YEAR ENDED DECEMBER 31, 1996
First quarter $12-1/8 $7-5/8
Second quarter 10-5/8 8
Third quarter 9-3/4 6-1/2
Fourth quarter 9-1/8 6-1/2
YEAR ENDED DECEMBER 31, 1997
First quarter $9-5/8 $7-3/8
Second quarter 9-1/4 7-1/2
Third quarter 10-7/8 9-1/16
Fourth quarter 11-3/8 9-5/8
</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 17, 1998, there were 304 stockholders of record and
approximately 3,200 beneficial owners of the Company's Common Stock.
On February 9, 1996, the Company distributed two stock dividends, 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. Those
companies operate as separate entities as of January 1, 1996. (See Footnote 10
to the Company's Consolidated Financial Statements.)
The Company has not paid any cash dividends during its two most recent
fiscal years. The Company's board of directors does not presently anticipate
that any cash dividends will be paid in the foreseeable future.
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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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1997 1996 1995 1994 1993
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Revenues:
Net equipment sales $ 2,722 $ 2,420 $ 4,588 $ 3,125 $ 2,317
Procedure and maintenance fees,
and management fees 18,476 14,884 12,797 12,538 10,875
Interest and dividends 536 676 1,005 642 481
-------- -------- -------- -------- --------
Total revenues 21,734 17,980 18,390 16,305 13,673
Costs and expenses:
Cost of sales 9,503 8,009 7,633 6,004 5,506
Research and development 1,021 522 927 1,076 2,334
Selling 2,257 2,146 2,050 2,551 2,674
General and administrative 2,231 1,666 1,656 2,105 2,226
Lawsuit settlement cost -- 5,500 -- -- --
Legal and other expense (39) 402 164 35 338
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Total costs and expenses 14,973 18,245 12,430 11,771 13,078
-------- -------- -------- -------- --------
Income (loss) from operations before income taxes 6,761 (265) 5,960 4,534 595
Minority interest 468 143 -- -- --
Provision for (benefit from) income taxes 2,329 (170) 2,086 150 65
-------- -------- -------- -------- --------
Net income (loss) $ 3,964 $ (238) $ 3,874 $ 4,384 $ 530
======== ======== ======== ======== ========
Earnings (loss) per share:(1)
Basic $ .74 $ (.04) $ .74 $ .89 $ .11
======== ======== ======== ======== ========
Diluted $ .72 N/A $ .70 $ .82 $ .10
======== ======== ======== ======== ========
</TABLE>
CONSOLIDATED BALANCE SHEET DATA:
(in thousands)
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------------------------------------------------
1997 1996 1995 1994 1993
-------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
Working capital $ 16,256 $ 14,983 $ 18,465 $ 16,658 $ 12,406
Total assets 27,688 25,395 25,910 22,260 17,709
Total liabilities 3,567 4,230 3,753 2,809 2,935
Stockholders' equity 24,121 21,165 22,157 19,451 14,774
</TABLE>
- ----------
(1) Restated in accordance of SFAS Statement No. 128 "Earnings Per Share".
9
<PAGE> 12
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
GENERAL
Medstone manufactures, markets and maintains lithotripters, and
continues to 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.
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 13 mobile systems and two fixed
sites in the 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.
In June 1996, the Company completed the acquisition of a 60% interest
in Northern Nevada, a lithotripsy partnership which deals directly with patient
and insurers, and also founded UPR as a majority-owned subsidiary of the
Company, to expand the Company's service orientation to the urologist
practitioner. Both entities signify the Company's emphasis on growth through
expansion of relationships and acquisition. In March 1997, the Company completed
the acquisition of a 60% interest in Southern Idaho Lithotripsy Associates LLC,
another operator of "retail" lithotripsy operations in Southern Idaho, and
operating results have been consolidated effective March 1, 1997.
The Company began the year with approximately $11 million in cash and
marketable securities, no debt, inventories of $2.5 million, and total assets of
$25.4 million. After an acquisition, purchase of $1.3 million of treasury stock
and payment of costs relating to the attempted acquisition of the lithotripsy
division of Coram Healthcare, the Company ended the year with approximately $11
million in cash and marketable securities, no debt, inventories of $2.7 million
and total assets of $27.4 million.
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 was 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 June 20, 1996 the defendants and plaintiffs reached an agreement
whereby a $6 million, non-recapturable settlement fund was established in return
for dismissal of all claims against the Company, its underwriter and current and
former officers and directors. The Company recorded and paid a one-time, $5.5
million expense in 1996 to cover its portion of the settlement fund. All funds
for the settlement were remitted by the Company, with the co-defendants paying
their portions to the Company. (See Item 3. Legal Proceedings).
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.
In 1996, the Company negotiated with Coram Healthcare ("Coram") for the
right to purchase the lithotripsy related operations of Coram. In October 1996,
negotiations ceased and, upon Coram's subsequent acquisition by Integrated
Health Services, Inc., a breakup fee clause was enacted and the Company received
reimbursement of $1.25 million of certain documented out-of-pocket expenses
relating to the attempted acquisition and related financing. The Company
received the $1.25 million in 10 installments during 1997.
ASSETS
10
<PAGE> 13
Accounts receivable increased by $434,000 from December 31, 1996 to
December 31, 1997 due to the addition of the Southern Idaho receivables and a
higher number of customers utilizing the fee-for-service program. $3,000 was
written off against the accounts receivable reserves in 1997.
Income taxes receivable increased by $547,000 due to the overpayment of
tax estimates and utilization of net operating loss carryforwards.
Note receivable decreased by $1,250,000 in the current year due to the
Company's reimbursement from Coram Healthcare for certain expenses related to
the Company's 1996 bid to acquire the lithotripsy operations of Coram.
Prepaid expenses and other current assets increased by $299,000 due to
the Company's prepayment of directors and officers liability insurance and
recognition of the value of a van due to the Company.
Goodwill, net, increased by $2,148,000 in the current year due to
$2,223,000 in goodwill recorded in connection with the purchase of Southern
Idaho, offset by amortization expense (see Footnote 2).
LIABILITIES
Customer deposits increased by $133,000 at December 31, 1997 compared
to December 31, 1996 due to receipt of deposits for three equipment orders with
future shipment dates.
Accounts payable at December 31, 1997 decreased by $873,000 compared to
December 31, 1996 due to payment of expenses in connection with the Company's
attempted acquisition of the lithotripsy related operations of Coram.
Accrued income taxes decreased $376,000 in the current year due to over
payment of estimated taxes.
Deferred tax liabilities increased by $258,000 from December 31, 1996
to December 31, 1997 due to a difference between tax and book depreciation and
goodwill amortization expenses.
Minority interest increased by $255,000 due to the acquisition in 1997
of Southern Idaho, of which the Company is a 60% owner.
STOCKHOLDERS' EQUITY
Additional paid-in-capital increased $283,000 in the current year due
to the exercise of common stock options held by employees.
Treasury Stock increased by $1,292,000 due to the Company's repurchase
of 156,000 shares of its common stock under the repurchase program initiated in
1996.
11
<PAGE> 14
RESULTS OF OPERATIONS
YEAR ENDED DECEMBER 31, 1997 COMPARED TO YEAR ENDED DECEMBER 31, 1996
Total revenues increased to $21.7 million, or 21% for the year ended
December 31, 1997 when compared to revenues of $18.0 million in the year ended
December 31, 1996. The revenues from equipment sales increased by 12% as the
number of units sold increased but the average unit selling price decreased due
to competition. Decreasing was the revenue from equipment upgrades when compared
to 1996 as fewer field upgrades are being performed.
Revenue from procedure and maintenance fees, or recurring revenue,
increased by $3.4 million, or 23%, from 1996 levels due to the Company's
continued revenue growth in its fee-for-service business, and the additional
revenue from the Southern Idaho acquisition. Volume on company owned mobile
lithotripsy units increased by 51% in 1997 when compared to 1996 with fees
remaining constant. Procedure revenue on third-party owned equipment was flat in
1997 when compared to 1996 as patient volume increased slightly and per
procedure fees decreased slightly. Revenues acquired with Southern Idaho, when
combined with the previously acquired Northern Nevada, increases per procedure
averages due to the higher fees for direct billings.
Interest income decreased by 21% in 1997 when compared to 1996 due to
lower average invested cash balances which resulted from the payment of Coram
expenses, acquisition costs and treasury stock repurchases.
Cost of equipment sales in 1997 increased by 57% in 1997 from 1996
levels due to the higher number of unit shipments in the year. Gross margins on
equipment and equipment upgrades decreased due to the decrease in average unit
selling prices.
Cost of recurring revenues increased by $752,000, or 11%, in 1997 when
compared to 1996 due to increased activity in staffing costs and van movement
costs for mobile services in correlation with higher patient volume. Gross
margin, as percentage of recurring revenue, increased to 60% in 1997 from 55%
due to higher utilization of existing equipment as fixed costs remain stable.
Research and development costs increased in 1997 by 96% when compared
to 1996 levels due to increased spending on materials, staffing and consultants
as the Company accelerated its development of a portable lithotripter.
Selling expenses increased by $111,000, or 5%, in 1997 when compared to
1996 due to higher commission expense in connection with revenue growth, the
cost of a national ad campaign, and bad debt expenses.
General and administrative expenses increased by 34% or $565,000 from
1996 to 1997, due to higher staffing costs associated with a full year's
operations of United Physicians Resources, increased legal expenses and
increased billing service expense for the direct billings done on acquired
entities.
Other income/expense, net decreased by $442,000 in 1997 when compared
to 1996 due to the class action litigation preparation expenses incurred in
1996, partially offset by the gain on the sale of securities held for investment
in 1996.
Lawsuit settlement costs decreased by $5.5 million due to the
settlement of the class action lawsuit in 1996.
Minority interest expense of $468,000 represents the minority
shareholder's interest in the results of operations of Northern Nevada and
Southern Idaho.
12
<PAGE> 15
Provision for (benefit from) income taxes recognizes the tax expense of
the current year's income compared to the operating loss incurred in 1996.
YEAR ENDED DECEMBER 31, 1996 COMPARED TO YEAR ENDED DECEMBER 31, 1995
Total revenues increased slightly to $18.0 million, or 2% for the year
ended December 31, 1996 when compared to revenues of $18.4 million in the year
ended December 31, 1995. The revenues from equipment sales decreased by 47% as
both the number of units and the average unit selling price decreased. Also
decreasing was the revenue from equipment upgrades when compared to 1995.
Revenue from procedure and maintenance fees, or recurring revenue,
increased by $2.1 million, or 16%, from 1995 levels due to the Company's
continued success in its fee-for-service business, continued growth in revenue
from procedure fees on third-party owned equipment, and the addition of the
Northern Nevada "direct" revenues. Volume on company owned mobile lithotripsy
units increased by 43% in 1996 when compared to 1995. Procedure revenue
increased by 9% in 1996 when compared to 1995 as the volume on third party owned
equipment continued to grow. Revenues acquired with Northern Nevada increase the
per patient revenue due to the revenue recognized when billing patients or
insurers when compared to the revenue from billing providers. Partially
offsetting these gains was the loss of the Endocare revenues, which totaled
$951,000 in 1995, which were spun out effective January 1, 1996.
Interest income decreased by 33% in 1996 when compared to 1995 due to
dramatically lower average invested cash balances which resulted from the large
capital expenditures for mobile lithotripsy trailers and the settlement of the
class action lawsuit.
Cost of equipment sales in 1996 decreased by 38% in 1996 from 1995
levels due to the lower number of unit shipments in the year. Gross margins on
equipment and equipment upgrades decreased due to the decrease in average unit
selling prices.
Cost of recurring revenues increased by $1,158,000, or 21%, in 1996
when compared to 1995 due to the additional costs associated with the eight
additional fee-for-service vans placed in service in 1996, which include
depreciation, van movement costs, and staffing costs. Gross margins decreased
due to lower than optimal utilization on the newer vans placed in service.
Research and development costs decreased in 1996 by 44% when compared
to 1995 levels due to 1995's level of expenses associated with numerous Endocare
new product development projects, most of which became salable new product lines
before completion of the spin out of Endocare. In 1996 the Company concentrated
its research efforts on lithotripsy products.
Selling expenses increased by $96,000, or 5%, in 1996 when compared to
1995 due to the additional sales staff and associated expenses for travel, along
with the costs of product brochures as the Company expanded its mobile
fee-for-service program from a Western United States concentration to include
the Southwest, Southeast and Northeastern areas of the country. The Company also
increased its efforts in connection with international sales in 1996.
General and administrative expenses remained constant, with an increase
of less than 1% in 1996 compared to 1995 expenses. Administrative staff expenses
of Endocare, spun out at the end of 1995, were offset by staff expenses for UPR
and Northern Nevada.
Other income/expense, net increased by $239,000 in 1996 when compared
to 1995 due to the litigation preparation expenses for the class action
litigation incurred before settlement of the action, partially offset by the
gain on the sale of securities held for investment.
13
<PAGE> 16
Lawsuit settlement costs increased by $5.5 million due to the expense
recorded for the out-of-court settlement reached by the plaintiffs and
defendants, of which the Company was a co-defendant, on the class action lawsuit
that had been in existence since 1989. This settlement charge represents closure
of all open charges against the Company.
Minority interest expense of $143,000 represents the minority
shareholder's interest in the results of operations of Northern Nevada.
Provision for (benefit from) income taxes recognizes the tax benefit in
1996 of the net operating loss carryforwards generated in 1996 with that
carryforward expected to be utilized in future periods.
LIQUIDITY AND CAPITAL RESOURCES
At December 31, 1997, the Company had cash and short-term investments
of approximately $11.0 million. These funds were generated from operating
activities and from the Company's initial public offering in June 1988.
The Company's long-term capital expenditure requirements and treasury
shares repurchase 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 cost of acquisition and/or new revenue opportunities, 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 1998. See "Safe Harbor
Statement under the Private Securities Litigation Reform Act of 1995."
YEAR 2000
The Company is aware of the issues associated with the programming code
in existing computer systems as the millenium (year 2000) approaches. The "year
2000" problem is pervasive and complex as virtually every computer operation
will be affected in some way by the rollover of the two digit year value to 00.
This issue is whether computer systems will properly recognize date sensitive
information when the year changes to 2000. Systems that do not properly
recognize such information could generate erroneous data or could fail.
During 1997, the Company has conducted a comprehensive review of its
computer systems and lithotripsy equipment to identify areas that could be
affected by the "Year 2000" issue. The Company presently believes that, with
conversion to a newer version of operating software developed in 1996, the year
2000 problem will not materially affect the Company's operations, financial
position or cash flows.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1997, the FASB issued Statement No. 130 (SFAS 130), REPORTING
COMPREHENSIVE INCOME, effective for fiscal years beginning after December 15,
1997, which establishes standards for the reporting and display of comprehensive
income and its components in financial statements. Comprehensive income
generally represents all changes in shareholders' equity except those resulting
from investments by owners and distributions to owners. The Company will adopt
the new standards in 1998 and does not expect the impact on the financial
statement presentation to be significant.
In June 1997, the FASB issued Statement No. 131 (SFAS 131),
DISCLOSURES ABOUT SEGMENTS OF AN ENTERPRISE AND RELATED INFORMATION, effective
for fiscal years beginning after December 15, 1997, which
14
<PAGE> 17
establishes standards for the way that public business enterprises report
information about operating segments in annual financial statements and requires
that those enterprises report information about operating segments in interim
financial reports. SFAS 131 also establishes standards for related disclosures
about products and services, geographic areas and major customers. The Company
will adopt the new standards retroactively in 1998. Management has not completed
its review of SFAS 131.
SAFE HARBOR STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
Forward-looking statements in this report, including without
limitation, statements relating to the Company's plans, strategies, objectives,
expectations, intentions and adequacy of resources, are made pursuant to the
safe harbor provisions of the Private Securities Litigation Reform Act of 1995.
Investors are cautioned that such forward-looking statements involve risks and
uncertainties including without limitation the following: (i) the Company's
plans, strategies, objectives, expectations and intentions are subject to change
at any time at the discretion of the Company, (ii) the Company's plans and
results of operations will be affected by the Company's ability to manage its
growth; (iii) the Company's businesses are highly competitive and the entrance
of new competitors into or the expansion of the operations by existing
competitors in the Company's markets and other changes could adversely affect
the Company's plans and results of operations; and (iv) other risks and
uncertainties indicated from time to time in the Company's filings with the
Securities and Exchange Commission.
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.
15
<PAGE> 18
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
DIRECTORS
The following are the directors of the Company:
<TABLE>
<CAPTION>
NAME AGE PRINCIPAL OCCUPATION
---- --- --------------------
<S> <C> <C>
David V. Radlinski 53 Chairman of the Board and
Chief Executive Officer of the Company
Frank R. Pope 48 Managing Director
Verdigris Capital
Donald John Regan 63 Vice President and General Counsel
Kinsell, O'Neil, Newcomb & De Dios, Inc.
Michael C. Tibbitts 50 Officer and Vice President
Gulf South Medical Supply, Inc.
</TABLE>
Mr. Radlinski has been the Chairman of the Board 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 manufactured computer printers.
Mr. Pope is Managing Director of Verdigris Capital, a private merchant
banking firm. From April 1981 to October 1996, Mr. Pope was a General Partner
with Technology Funding, a venture capital investment firm. He was also the
Executive Vice President, Chief Financial Officer and a director of Technology
Funding Inc. Mr. Pope is also a director of Thermatrix, Inc. and a director and
officer of Advanced BioCatalytics Corp. Mr. Pope is a C.P.A. and a member of the
California Bar. He has been a director of the Company since January 1991.
Mr. Regan is currently the Vice President and General Counsel of Kinsell,
O'Neal, Newcomb & De Dios, Inc., a municipal securities 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 has been a director of the
Company since September 1995.
Mr. Tibbitts, who was elected to the Board of Directors on May 13, 1996,
has been with Gulf South Medical Supply, Inc. since 1991 as an officer and Vice
President. Prior to joining that corporation, he was employed for 19 years by
Johnson & Johnson in two divisions: Sterile Design (which manufactured and
marketed kit packages) and Surgikos (which manufactured and marketed surgical
supplies). He has been a Director of the Company since May 1996.
16
<PAGE> 19
EXECUTIVE OFFICERS
The names, ages and positions of all the executive officers of the Company
as of March 1998 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.
<TABLE>
<CAPTION>
NAME AGE POSITION
---- --- --------
<S> <C> <C>
David V. Radlinski 53 Chief Executive Officer and Chairman of the Board
Mark Selawski 42 Vice President of Finance,
Chief Financial Officer and Secretary
Eva Novotny 40 Executive Vice President of Sales
and Marketing
</TABLE>
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 manufactured computer printers.
Mr. Selawski has been the Chief Financial Officer, Vice President of
Finance and Secretary of the Company since September 1995. He had previously
served as the Company's Manager of Planning and Analysis since joining the
Company in 1988. Prior to joining the Company he held various finance management
positions with several high-tech manufacturing companies.
Ms. Novotny has been Executive Vice President of Sales and Marketing of
the Company since October 1997. Prior to joining the Company, she was Director
of Marketing for Imagyn Medical, formerly UroHealth, from June 1995 to October
1997. From 1985 to 1995, Mentor Corporation employed her as Marketing Manager
and later as Director of Marketing for Mentor Urology.
SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
The Company is not aware of any director, officer or 10% shareholder who
during 1997 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,
except as follows; Mr. Radlinski, Mr. Selawski and Ms. Novotny did not timely
file Form 5's regarding changes in stock option holdings.
17
<PAGE> 20
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
other executive officers during fiscal 1997.
SUMMARY OF COMPENSATION TABLE
<TABLE>
<CAPTION>
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) 1997 200,300 -- -- -- 100,000 -- --
Chairman of the Board and 1996 200,100 -- -- -- 50,000 -- --
Chief Executive Officer 1995 181,250 -- -- -- 150,000 -- --
Mark Selawski (4) 1997 85,833 11,300 -- -- 20,000 -- --
Chief Financial Officer, Vice 1996 85,600 -- -- -- 20,000 -- --
President of Finance 1995 72,730 7,500 -- -- 20,000 -- --
and Secretary
Thomas W. Gardner (5) 1997 88,387 -- 36,665 -- 20,000 -- --
Executive Vice President of 1996 95,600 -- 35,349 -- -- -- --
Sales and Marketing 1995 83,750 20,000 2,815 -- 40,000 -- --
Eva Novotny (6) 1997 25,300 -- -- -- 50,000 -- --
Executive Vice President of
Sales and Marketing
</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 1997,
1996 and 1995 did not exceed the lesser of $50,000 or 10% of the
executive officer's total salary and bonus for that year.
(2) Options to acquire shares of Common Stock.
(3) Mr. Radlinski served as the Chief Financial Officer and Secretary of
the Company until his election as Chairman of the Board and Chief
Executive Officer on September 21, 1995.
(4) Mr. Selawski was appointed Chief Financial Officer, Vice President of
Finance and Secretary on September 21, 1995.
(5) Mr. Gardner resigned his position with the Company as of October 9,
1997.
(6) Ms. Novotny joined the Company as of October 15, 1997.
18
<PAGE> 21
STOCK OPTION GRANTS DURING 1997
The following table provides information related to the stock options
granted in 1997.
<TABLE>
<CAPTION>
POTENTIAL REALIZABLE
VALUE AT ASSUMED
ANNUAL RATES OF
STOCK PRICE
APPRECIATION FOR
INDIVIDUAL GRANTS OPTION TERM
- ----------------------------------------------------------------------------------------- ---------------------------
% OF TOTAL
SHARES EMPLOYEE
UNDERLYING OPTIONS EXERCISE
OPTIONS GRANTED IN PRICE EXPIRATION
NAME (#) FISCAL YEAR ($/SHARE) DATE 5% ($) 10% ($)
---- --- ----------- --------- ---- ------ -------
<S> <C> <C> <C> <C> <C> <C>
David V. Radlinski 50,000 12% 7.75 1/09/03 131,750 298,375
50,000 12% 7.88 6/10/03 133,960 303,380
Mark Selawski 20,000 5% 7.88 6/10/03 53,584 121,352
Thomas W. Gardner (1) 20,000 5% 7.88 10/09/97 53,584 121,352
Eva Novotny 50,000 12% 10.38 10/15/03 176,460 399,630
</TABLE>
- ----------
(1) Mr. Gardner resigned in October 1997 and forfeited these options.
STOCK OPTIONS HELD AT END OF FISCAL YEAR
The following table provides information related to options
exercised during 1997 and options held by the named executive officers at
December 31, 1997.
<TABLE>
<CAPTION>
NUMBER OF SECURITIES VALUE OF UNEXERCISED
UNDERLYING UNEXERCISED IN-THE-MONEY
OPTIONS AT FY-END (#) OPTIONS AT FY-END ($)(2)
SHARES ACQUIRED VALUE ---------------------------- ------------------------------
NAME ON EXERCISE (#) REALIZED ($)(1) EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
------------------- --------------- --------------- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
David V. Radlinski -- -- 98,333 201,667 130,158 382,832
Mark Selawski -- -- 17,333 42,667 41,581 111,008
Eva Novotny -- -- 0 50,000 -- --
</TABLE>
- ----------
(1) The value is calculated based on the difference between the option
exercise price and the market price for the Company's Common Stock on
the exercise date, multiplied by the number of shares purchased. For
this purpose, the surrender or withholding of shares to pay the
exercise price is not taken into account.
(2) The closing price for the Company's Common Stock as reported by the
National Association of Securities Dealers (NASD) on December 31, 1997
was $10.38. Value is calculated on the basis of the difference between
the option exercise price and $10.38, multiplied by the number of
shares of Common Stock underlying the option.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
During 1997 Donald J. Regan and Frank R. Pope served as the members of
the Company's Compensation Committee. Neither such individual is a current or
former officer or employee of the Company or any of its subsidiaries. During
1997 there were no compensation committee interlocks between the Company and
other entities involving Medstone executive officers serving as directors or
members of compensation or similar committees of such other entities.
19
<PAGE> 22
COMPENSATION OF DIRECTORS
The Company currently compensates Messrs. Regan, Tibbitts and Pope
$1,000 per meeting for their services, in addition to reimbursement to all
directors 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 at $2.38 per share in January 1992,
which were exercised during 1997, Mr. Regan was granted 5,000 shares in
September 1995 at $11.88 and Mr. Tibbitts was granted 5,000 shares at $8.63 per
share in May 1996.
As additional compensation, each current nonemployee director of the
Company has received an option to purchase up to 15,000 shares of the Company's
Common Stock. The options issued to Mssrs. Pope, Tibbitts and Regan were issued
in November 1996 and have exercise prices of $7.13 per share. The options are
exercisable, after six months following their grant dates, in incremental
amounts equal to 1/48 of the underlying shares for each elapsed calendar month
during which the director remains on the Company's board. The terms of the
options are five years, subject to earlier termination related to the director
no longer serving on the board.
20
<PAGE> 23
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 1, 1998
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
in Item 11 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 1, 1998.
<TABLE>
<CAPTION>
NUMBER OF SHARES
BENEFICIALLY PERCENTAGE OF
NAME AND ADDRESS OF BENEFICIAL OWNER OWNED(1) OWNERSHIP
------------------------------------ -------- ---------
<S> <C> <C>
FMR Corp. 561,200 10.7%
82 Devonshire Street
Boston, MA 02109
The Kaufmann Fund 500,000 9.5%
140 E. 45th Street, 43rd Floor
New York, NY 10017
Hathaway & Associates, Ltd. 400,000 7.6%
119 Rowayton Avenue
Rowayton, CT 06853
David V. Radlinski(2)(3) 256,648(4) 4.8%
100 Columbia, Suite 100
Aliso Viejo, CA 92656
Mark Selawski(3) 24,847(6) (10)
100 Columbia, Suite 100
Aliso Viejo, CA 92656
Donald J. Regan(2) 13,246(7) (10)
462 Stevens Avenue, Suite 308
Solana Beach, CA 92075
Michael C. Tibbitts(2) 7,979(9) (10)
27001 La Paz Road, Suite 448B
Mission Viejo, CA 92691
Frank R. Pope(2) 6,063(8) (10)
25 Preston Road
Woodside, CA 94062
Eva Novotny(3) 5,800(5) (10)
100 Columbia, Suite 100
Aliso Viejo, CA 92656
All executive officers and directors
as a group (6 persons) (11) 314,583 5.81%
</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) Executive officer of the Company.
(4) Includes 117,500 shares issuable upon exercise of presently outstanding
stock options.
(5) Includes 5,000 shares issuable upon exercise of presently outstanding
stock options.
(6) Includes 20,667 shares issuable upon exercise of presently outstanding
stock options.
(7) Includes 6,646 shares issuable upon exercise of presently outstanding
stock options.
(8) Includes 4,063 shares issuable upon exercise of presently outstanding
stock options.
(9) Includes 5,979 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 159,855 shares issuable upon exercise of presently outstanding
stock options.
21
<PAGE> 24
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 (pre-split) 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 (pre-split) shares of common stock of Cardiac Science, Inc.
From 1991 through 1996, the Company performed various financings for
Cardiac Science and received warrants to purchase Cardiac Science common stock.
Due to exercise of warrants, common stock issued in lieu of interest and
unsecured advances the Company received 5,619,054 (pre-split) shares of Cardiac
Science.
In April 1997, Cardiac Science effectuated a 1 for 11.42857143 reverse
stock split, reducing the Company's holdings to 546,772 shares, which is the
number of shares held at December 31, 1997. This investment is recorded at a
cost of $750,054 and the Company currently is restricted from trading this
investment, therefore a corresponding valuation reserve has been established,
making the net investment value $0.
The Company also holds warrants to purchase 87,500 (post-split) shares
at $.011 each, with an expiration date of September 2004.
22
<PAGE> 25
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
<TABLE>
<CAPTION>
Page
----
<S> <C>
(A) INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
1. Consolidated Financial Statements
Report of Independent Auditors 24
Consolidated Balance Sheets at December 31, 1997 and 1996 25
Consolidated Statements of Operations for the
years ended December 31, 1997, 1996 and 1995 26
Consolidated Statements of Stockholders' Equity
for the years ended December 31, 1997, 1996 and 1995 27
Consolidated Statements of Cash Flows for the
years ended December 31, 1997, 1996 and 1995 28
Notes to Consolidated Financial Statements 29
2. Schedule to Consolidated Financial Statements
Schedule II - Valuation and Qualifying Accounts 40
All other schedules are omitted because they are not applicable
or the required information is included in the consolidated
financial statements or notes thereto.
(B) REPORTS ON FORM 8-K
There were no reports on Form 8-K filed with the Commission
during the quarter ended December 31, 1997.
</TABLE>
<TABLE>
<CAPTION>
(C) EXHIBITS
EXHIBIT NO. DESCRIPTION
----------- -----------
<S> <C>
3.1 Certificate of Incorporation of the Company, as amended (1)
3.2 Bylaws of the Company (1)
3.3 Amendment of ByLaws (2)
4.2 Specimen Certificate of the Company's Common Stock (3)
10.26 1989 Stock Incentive Plan (4)(5)
10.27 Non-employee Director Stock Option Plan (4)(5)
10.28 Facility Lease on 100 Columbia (6)
10.29 1997 Stock Incentive Plan (5)(7)
22.1 Subsidiaries (See page 42 hereof)
23.1 Consent of Independent Auditors (see page 43 hereof)
27 Financial Data Schedule
28.2 Form of Cytocare, Inc. Information Statement - Distribution to Shareholders of Stock
of Cardiac Science, Inc. (8)
28.3 Form of Medstone International, Inc. Information Statement - Distribution to
Shareholders of Stock of Endocare, Inc. and Urogen Corp. (9)
</TABLE>
- ----------
(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 10-Q for the quarter
ended September 30, 1997, and incorporated herein by
reference.
(3) 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.
(4) 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.
(5) Compensatory plan or arrangement.
(6) Previously filed with the same exhibit number with the
Company's annual report on Form 10-K for the year ended
December 31, 1993.
(7) Previously filed with the same exhibit number with the
Company's Quarterly Report on Form 10-Q for the quarter ended
June 30, 1997.
(8) 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.
(9) Previously filed with the Company's current report on Form 8-K
dated February 9, 1996, and incorporated herein by reference.
23
<PAGE> 26
Report of Independent Auditors
Stockholders and Board of Directors
Medstone International, Inc.
We have audited the accompanying consolidated balance sheets of Medstone
International, Inc. as of December 31, 1997 and 1996 and the related
consolidated statements of operations, stockholders' equity, and cash flows for
each of the three years in the period ended December 31, 1997. Our 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 consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of
Medstone International, Inc. at December 31, 1997 and 1996, and the consolidated
results of its operations and its cash flows for each of the three years in the
period ended December 31, 1997, in conformity with generally accepted accounting
principles. Also, in our opinion, the related financial statement schedule, when
considered in relation to the basic financial statements taken as a whole,
presents fairly in all material respects the information set forth therein.
ERNST & YOUNG LLP
Orange County, California
February 14, 1998
24
<PAGE> 27
MEDSTONE INTERNATIONAL, INC.
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------------
1997 1996
------------ ------------
<S> <C> <C>
ASSETS
Current assets:
Cash and equivalents $ 1,125,009 $ 3,906,961
Short-term investments 9,900,909 7,102,170
Accounts receivable, less allowance for doubtful accounts of
$534,918 and $220,000 in 1997 and 1996, respectively 3,120,787 2,686,985
Inventories 2,680,220 2,459,779
Deferred tax assets 891,507 1,061,000
Income taxes receivable 632,851 86,271
Note receivable -- 1,250,000
Prepaid expenses and other current assets 455,974 157,000
------------ ------------
Total current assets 18,807,257 18,710,166
Property and equipment:
Lithotripters 8,524,314 7,289,845
Equipment 815,585 876,809
Furniture and fixtures 821,565 1,007,292
Leasehold improvements 138,698 89,764
------------ ------------
10,300,162 9,263,710
Less accumulated depreciation and amortization (4,721,618) (3,740,973)
------------ ------------
Net property and equipment 5,578,544 5,522,737
------------ ------------
Goodwill, net 3,266,162 1,118,583
Other assets, net 36,425 43,805
------------ ------------
$ 27,688,388 $ 25,395,291
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 887,740 $ 1,760,922
Accrued expenses 210,421 209,512
Accrued income taxes -- 376,172
Accrued payroll expenses 239,504 338,461
Customer deposits 132,699 --
Deferred revenue 1,080,899 1,042,043
------------ ------------
Total current liabilities 2,551,263 3,727,110
Deferred tax liabilities 649,524 392,000
Minority interest 366,654 111,172
Commitments and contingencies (Notes 3 and 8)
Stockholders' equity:
Common stock - $.004 par value, 20,000,000 shares authorized,
5,634,788 and 5,578,403 shares issued and outstanding at
December 31, 1997 and 1996, respectively 22,539 22,314
Additional paid-in capital 18,998,260 18,715,068
Accumulated earnings 7,436,263 3,471,965
Stock purchase notes receivable (134,800) (134,800)
Unrealized gain (loss) on short-term investments (579) (1,168)
Treasury stock (268,800 shares at cost at December 31,
1997 and 112,800 shares at December 31, 1996) (2,200,736) (908,370)
------------ ------------
Total stockholders' equity 24,120,947 21,165,009
------------ ------------
$ 27,688,388 $ 25,395,291
============ ============
</TABLE>
See accompanying notes
25
<PAGE> 28
MEDSTONE INTERNATIONAL, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
FOR THE YEAR ENDED DECEMBER 31,
--------------------------------------------------
1997 1996 1995
------------ ------------ ------------
<S> <C> <C> <C>
Revenues:
Net equipment sales $ 2,722,360 $ 2,420,000 $ 4,588,015
Procedures and maintenance fees
and management fees 18,476,342 14,883,598 12,797,608
Interest and dividend income 535,601 675,967 1,004,655
------------ ------------ ------------
Total revenues 21,734,303 17,979,565 18,390,278
Costs and expenses:
Cost of equipment sales 2,040,032 1,298,427 2,080,747
Costs related to procedure
and maintenance fees 7,463,418 6,710,645 5,552,354
Research and development 1,021,349 521,793 926,665
Selling 2,256,933 2,145,759 2,050,109
General and administrative 2,231,006 1,666,164 1,656,455
Lawsuit settlement costs -- 5,500,000 --
Legal and other (income)/expense (39,327) 402,673 163,621
------------ ------------ ------------
Total costs and expenses 14,973,410 18,245,461 12,429,951
------------ ------------ ------------
Income (loss) before provision/
benefit for income taxes 6,760,893 (265,896) 5,960,327
Minority interest in subsidiary income 467,595 142,575 --
Provision (benefit) for income taxes 2,329,000 (170,000) 2,086,000
------------ ------------ ------------
Net income (loss) $ 3,964,298 $ (238,471) $ 3,874,327
============ ============ ============
Net income (loss) per share:
Basic $ .74 $ (.04) $ .74
============ ============ ============
Diluted $ .72 (.04) $ .70
============ ============ ============
Number of shares used in the computation of net income (loss) per share:
Basic 5,390,352 5,517,976 5,256,486
============ ============ ============
Diluted 5,510,668 5,517,976 5,544,831
============ ============ ============
</TABLE>
See accompanying notes
26
<PAGE> 29
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, 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
Common stock options exercised 61,875 248 96,085 --
Income tax benefit from stock options -- -- 63,000 --
Treasury stock repurchased (112,800) -- -- --
Unrealized loss on short-term
investments -- -- -- --
Net loss -- -- -- (238,471)
------------ ------------ ------------ ------------
BALANCE AT DECEMBER 31, 1996 5,465,603 $ 22,314 $ 18,715,068 $ 3,471,965
Common stock options exercised 56,385 225 283,192 --
Income tax benefit from stock options -- -- 0 --
Treasury stock repurchased (156,000) -- -- --
Unrealized loss on short-term
investments -- -- -- --
Net income -- -- -- 3,964,298
------------ ------------ ------------ ------------
BALANCE AT DECEMBER 31, 1997 5,365,988 $ 22,539 $ 18,998,260 $ 7,436,263
============ ============ ============ ============
</TABLE>
<TABLE>
<CAPTION>
UNREALIZED LOSS
STOCK PURCHASE ON SHORT-TERM TREASURY
NOTE RECEIVABLE INVESTMENTS STOCK TOTAL
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
BALANCE AT DECEMBER 31, 1994 $ 0 $ (46,279) $ 0 $ 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 0 22,157,228
Common stock options exercised -- -- -- 96,333
Income tax benefit from stock options -- -- -- 63,000
Treasury stock repurchased -- -- (908,370) (908,370)
Unrealized loss on short-term
investments -- (4,711) -- (4,711)
Net loss -- -- -- (238,471)
------------ ------------ ------------ ------------
BALANCE AT DECEMBER 31, 1996 $ (134,800) $ (1,168) $ (908,370) $ 21,165,009
Common stock options exercised -- -- -- 283,417
Income tax benefit from stock options -- -- -- 0
Treasury stock repurchased -- -- (1,292,366) (1,292,366)
Unrealized loss on short-term
investments -- 589 -- 589
Net income -- -- -- 3,964,298
------------ ------------ ------------ ------------
BALANCE AT DECEMBER 31, 1997 $ (134,800) $ (579) $ (2,200,736) $ 24,120,947
============ ============ ============ ============
</TABLE>
See accompanying notes
27
<PAGE> 30
MEDSTONE INTERNATIONAL, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------------------------
1997 1996 1995
------------ ------------ ------------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income (loss) $ 3,964,298 $ (238,471) $ 3,874,327
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation and amortization 1,613,385 1,244,840 945,050
Provision for doubtful accounts 251,000 60,000 --
Provision for related party loan -- -- 1,315
Provision for excess inventories -- (136,884) --
Minority interest in partnership 467,595 142,575 --
Changes in operating assets and liabilities:
Accounts receivable (684,802) (934,923) 308,646
Inventories (220,441) (777,557) (961,695)
Deferred taxes 427,017 (94,000) 205,000
Note receivable 1,250,000 (1,250,000) --
Prepaid expenses and other (298,974) 355,207 (124,947)
Accounts payable (873,182) 1,356,997 (127,954)
Accrued expenses 909 (25,753) (133,677)
Accrued income taxes, net (922,752) 251,608 (290,483)
Accrued payroll expenses (98,957) 132,341 (202,764)
Deferred revenue 38,856 317,411 83,709
Customer deposits 132,699 -- (39,068)
Other, net 7,380 (216,995) (393,338)
------------ ------------ ------------
Net cash provided by operating activities 5,054,031 186,396 3,144,121
------------ ------------ ------------
Cash flows from investing activities:
Purchases of investments available for sale (42,258,678) (16,918,215) (18,744,464)
Proceeds from sales of investments available for sale 39,460,528 24,306,051 17,448,155
Related party loan -- -- 5,782
Purchase of subsidiary (2,300,000) (1,350,000) --
Investment by minority in partnership 193,179 (162,028) --
Distribution of minority interest (328,000) (64,403) --
Purchases of property and equipment (1,597,545) (3,392,627) (1,220,503)
Disposals of property and equipment 3,482 5,083 676,225
------------ ------------ ------------
Net cash provided by (used in)
investing activities (6,827,034) 2,423,861 (1,834,805)
------------ ------------ ------------
Cash flows from financing activities:
Proceeds from issuance of common stock 283,417 96,333 537,829
Purchase of treasury stock (1,292,366) (908,370) --
Dividends paid -- (1,000,000) --
------------ ------------ ------------
Net cash provided by (used in)
financing activities (1,008,949) (1,812,037) 537,829
Net increase (decrease) in cash and equivalents (2,781,952) 798,220 1,847,145
Cash and equivalents at beginning of year 3,906,961 3,108,741 1,261,596
------------ ------------ ------------
Cash and equivalents at end of year $ 1,125,009 $ 3,906,961 $ 3,108,741
============ ============ ============
Supplemental cash flow disclosures:
Cash paid during the year for:
Income taxes $ 2,911,351 $ 554,136 $ 2,173,390
============ ============ ============
Supplemental schedule of noncash investing
and financing activities:
Tax benefit of employee stock options -- $ 63,000 $ 210,000
Dividends declared -- $ -- $ 1,966,216
</TABLE>
See accompanying notes
28
<PAGE> 31
MEDSTONE INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997
1. ORGANIZATION AND OPERATIONS OF THE COMPANY
Medstone International, Inc. ("Medstone" or "the Company"), 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 System.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of consolidation
The consolidated financial statements include the accounts of the
Company, United Physicians Resources, an 80% owned physicians practice
management operation, incorporated in June 1996, Northern Nevada Lithotripsy
Associates, LLC, a 60% owned Nevada Limited Liability Company, Southern Idaho
Lithotripsy Associates, LLC, a California Limited Liability Company, also 60%
owned, (See Note 3), and Medstone Sales Corporation, a 100% owned
foreign sales corporation. All material intercompany transactions and accounts
have been eliminated.
Reclassifications
Certain prior year balances have been reclassified to conform
with the December 31, 1997 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 $250,000, $1,376,000 and $804,000 for the years ended December 31,
1997, 1996 and 1995, respectively.
The Company had net non-cash transfers of accounts receivable,
inventory, prepaid expenses, fixed assets, accounts payable accrued expenses and
deferred revenue totaling $966,000 in 1996 in the form of a dividend as a result
of the spinout of the Endocare, Inc. and Urogen, Inc. subsidiaries.
Short-term Investments
The Company applies the provisions of Statement of Financial
Accounting Standards No. 115, "Accounting for Certain Investments in Debt and
Equity Securities." Under this statement, management determines the appropriate
29
<PAGE> 32
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, 1997 and December 31, 1996,
investments are summarized as follows:
<TABLE>
<CAPTION>
GROSS GROSS
UNREALIZED UNREALIZED FAIR
COST GAINS LOSS VALUE
---- ----- ---- -----
<S> <C> <C> <C> <C>
1997
U.S. Treasury Bills $ 9,901,828 $ -- $ 919 $ 9,900,909
1996
U.S. Treasury Bills $ 7,104,024 $ -- $ 1,854 $ 7,102,170
</TABLE>
No gains or losses were realized in 1997 and 1996.
The amortized cost and estimated fair value of investments at
December 31, 1997 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 $9,901,828 $9,900,909
</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 15% of accounts receivable at December 31, 1997.
Inventories
Inventories are stated at the lower of cost (first-in, first-out)
or market and consist of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------------------
1997 1996
---------- ----------
<S> <C> <C>
Raw materials $1,645,902 $1,353,993
Work in process 260,773 255,776
Finished goods 773,545 850,010
---------- ----------
$2,680,220 $2,459,779
========== ==========
</TABLE>
30
<PAGE> 33
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:
<TABLE>
<S> <C>
Lithotripters 5 years
Equipment 5 years
Furniture and fixtures 5 years
Leasehold improvements Life of lease
</TABLE>
Depreciation expense for the years ended December 31, 1997, 1996
and 1995 was $1,538,000, $1,223,000 and $945,000, respectively.
Goodwill
The Company recorded goodwill resulting from the excess of the
purchase prices of Northern Nevada and Southern Idaho over the fair market value
of the net assets. Goodwill is being amortized over a period not to exceed forty
years using the straight-line basis. Accumulated amortization at December 31,
1997 and 1996 is $96,503 and $21,374, respectively.
Long-Lived Assets
Long-lived assets and certain identifiable intangibles held and
used by the Company are reviewed for impairment whenever events or changes in
circumstances indicate that the carrying amount of an asset may not be
recoverable. Based upon the Company's analysis, the Company believes no material
impairment of the carrying value of its long-lived assets, inclusive of
intangible assets, existed at December 31, 1997. The Company's analysis was
based on a comparison of the carrying amount of such assets to the Company's
historical actual cash flows and to an estimate of future undiscounted cash
flows.
Earnings (Loss) Per Share
The Company has adopted SFAS 128 "Earnings Per Share," and
applied this pronouncement to all periods presented. This statement requires the
presentation of both basic and diluted net income (loss) per share for financial
statement purposes. Basic net income (loss) per share is computed by dividing
income (loss) available to common stockholders by the weighted average number of
common shares outstanding. Diluted net income (loss) per share includes the
effect of the potential shares outstanding, including dilutive stock options and
warrants using the treasury stock method. Because the impact of options and
warrants are antidilutive, there is no difference between the loss per share
amount computed for basic and diluted purposes for 1996. All earnings (loss) per
share amounts for all periods have been restated to conform with the Statement
No. 128 requirements and the accounting rules set forth in Staff Accounting
Bulletin 98 issued by the Securities and Exchange Commission on February 3,
1998.
31
<PAGE> 34
The following table sets forth the computation of earnings (loss)
per share:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------------------------------
1997 1996 1995
----------- ----------- -----------
<S> <C> <C> <C>
Numerator: Net income (loss) ...... $ 3,964,298 $ (238,471) $ 3,874,327
Denominator for weighted
average shares outstanding 5,390,352 5,517,976 5,256,486
----------- ----------- -----------
Basic earnings (loss) per share ... $ .74 $ (.04) $ .74
=========== =========== ===========
Effect of dilutive securities:
Weighted average shares
outstanding ......... 5,390,352 5,517,976 5,256,486
Stock options ............ 120,316 -- 288,345
----------- ----------- -----------
Denominator for diluted earnings
per share ................ 5,510,668 5,517,976 5,544,831
=========== =========== ===========
Diluted earnings (loss) per share . $ .72 $ (.04) $ .70
=========== =========== ===========
</TABLE>
Stock Compensation
The Company has elected to follow Accounting Principles Board
Opinion No. 25, Accounting for Stock Issued to Employees (APB 25) and related
Interpretations in accounting for its employee stock options because, as
discussed below, the alternative fair value accounting provided for under FASB
Statement No. 123, Accounting for Stock-Based Compensation, requires the use of
option valuation models that were not developed for use in valuing employee
stock options. Under APB 25, because the exercise price of the Company's
employee stock options equals the market price of the underlying stock on the
date of grant, no compensation expense is recognized.
To calculate the pro forma information required by Statement 123,
the Company uses the Black-Scholes option pricing model. The Black-Scholes model
was developed for use in estimating the fair value of traded options which have
no vesting restrictions and are fully transferable. In addition, option
valuation models require the input of highly subjective assumptions including
the expected stock price volatility. Because the Company's employee stock
options have characteristics significantly different from those of traded
options, and because changes in the subjective input assumptions can materially
affect the fair value estimate, in management's opinion, the existing models do
not necessarily provide a reliable single measure of the fair value of its
employee stock options.
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.
32
<PAGE> 35
Advertising
The Company expenses advertising costs including promotional
literature, brochures and trade shows as incurred. Advertising expense was
$126,000, $107,000 and $124,000 for the years ended December 31, 1997, 1996 and
1995, respectively.
Recent Accounting Pronouncements
In June 1997, the FASB issued Statement No. 130 (SFAS 130),
REPORTING COMPREHENSIVE INCOME, effective for fiscal years beginning after
December 15, 1997, which establishes standards for the reporting and display of
comprehensive income and its components in financial statements. Comprehensive
income generally represents all changes in shareholders' equity except those
resulting from investments by owners and distributions to owners. The Company
will adopt the new standards in 1998 and does not expect the impact on the
financial statement presentation to be significant.
In June 1997, the FASB issued Statement No. 131 (SFAS 131),
DISCLOSURES ABOUT SEGMENTS OF AN ENTERPRISE AND RELATED INFORMATION, effective
for fiscal years beginning after December 15, 1997, which establishes standards
for the way that public business enterprises report information about operating
segments in annual financial statements and requires that those enterprises
report information about operating segments in interim financial reports. SFAS
131 also establishes standards for related disclosures about products and
services, geographic areas and major customers. The Company will adopt the new
standards retroactively in 1998. Management has not completed its review of SFAS
131.
3. ACQUISITIONS
Purchase of Northern Nevada
The Company acquired, in the second quarter of 1996, a 60%
interest in Northern Nevada, an operator of a "retail" lithotripsy operation
which bills patients or insurers for their services. The assets acquired,
accounted for on the purchase method, consisted of the accounts receivable and
contracts to provide service to insurers. The Company acquired this 60% interest
for $1.35 million cash. The operating results of Northern Nevada are included in
the consolidated financial statements of the Company since April 1, 1996.
Purchase of Southern Idaho
On March 18, 1997, the Company completed the acquisition of a 60%
interest in Southern Idaho Lithotripsy Associates, LLC, an operator of a
"retail" lithotripsy operation in southern Idaho, for a purchase price of $2.3
million in cash. The assets acquired, accounted for on the purchase method,
consisted of the accounts receivable and contracts to provide services to
insurers. The operating results of Southern Idaho are included in the
consolidated financial statements of the Company since March 1, 1997.
4. INCOME TAXES
The Company provides for income taxes under the liability method.
Accordingly, deferred income tax assets and liabilities are computed for
differences between the financial statement and tax bases of assets and
liabilities that will result in taxable or deductible amounts in the future
based on enacted tax laws and rates applicable to the periods in which the
differences are expected to affect taxable income. Valuation allowances are
established when necessary to reduce deferred tax assets to amounts which are
more likely than not to be realized.
The provision (benefit) for income taxes consists of the
following:
33
<PAGE> 36
<TABLE>
<CAPTION>
YEAR ENDED YEAR ENDED YEAR ENDED
DECEMBER 31, 1997 DECEMBER 31, 1996 DECEMBER 31, 1995
----------------- ----------------- -----------------
<S> <C> <C> <C>
Current:
Federal $ 1,454,000 $ (34,000) $ 1,631,000
State 448,000 (42,000) 299,000
Utilization of tax credits 0 0 (49,000)
------------ ------------ ------------
Total current 1,902,000 (76,000) 1,881,000
------------ ------------ ------------
Deferred:
Federal 338,000 (129,000) 55,000
State 89,000 35,000 150,000
------------ ------------ ------------
Total deferred 427,000 (94,000) 205,000
------------ ------------ ------------
Provision (benefit) for
income taxes $ 2,329,000 $ (170,000) $ 2,086,000
============ ============ ============
</TABLE>
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, 1997 DECEMBER 31, 1996 DECEMBER 31, 1995
----------------- ----------------- -----------------
<S> <C> <C> <C>
Income tax (benefit) at the
statutory rate $ 2,299,000 $ (90,000) $ 2,027,000
State income taxes
(net of federal benefit) 354,000 (48,000) 264,000
Minority interest (159,000) (49,000) --
Accruals (with) tax benefit -- -- (211,000)
Other (165,000) 17,000 6,000
------------ ------------ ------------
Provision (benefit) for income taxes $ 2,329,000 $ (170,000) $ 2,086,000
============ ============ ============
</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, 1997 DECEMBER 31, 1996
----------------- -----------------
DEFERRED TAX ASSETS:
<S> <C> <C>
State taxes $ 150,000 $ --
Cardiac investment reserve 299,000 293,000
Inventory reserve 134,000 172,000
Bad debt reserve 223,000 110,000
Accruals not currently deductible for tax 85,000 103,000
Net operating loss carryforward -- 369,000
Other credits 0 14,000
------------ ------------
Net deferred assets 891,000 1,061,000
------------ ------------
Depreciation and amortization 649,000 392,000
------------ ------------
Total gross deferred tax liabilities 649,000 392,000
------------ ------------
Net deferred tax assets and liabilities $ 242,000 $ 669,000
============ ============
</TABLE>
At December 31, 1997 and 1996 there was no valuation allowance
recognized to offset to Company's deferred tax assets since it is more likely
than not that the assets will be fully utilized.
5. STOCK OPTIONS
34
<PAGE> 37
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 price 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 terminated 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 April 1996, the remaining options outstanding under this Plan were
exercised and the Plan is now terminated.
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. In May 1997 the Company terminated the 1989 Plan as to
the granting of additional options. As of December 31, 1997, 673,803 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, 1997, 15,000 options for shares of
common stock had been granted under this plan and 5,000 shares have been
exercised. In addition, three outside directors have each been granted separate
options to purchase 15,000 shares.
In May 1997, the Company's stockholders approved the 1997 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. The Plan allows
for the issuance of up to 800,000 shares, with increases each January 1 that the
Plan is in effect by a number of shares equal to one percent of the total number
of outstanding shares of Common Stock on that date. As of December 31, 1997,
242,000 options for shares of common stock had been granted and are outstanding
under this plan.
Stock option activity under the Company's plans is summarized as
follows:
<TABLE>
<CAPTION>
YEAR ENDED YEAR ENDED YEAR ENDED
DECEMBER 31, 1997 DECEMBER 31, 1996 DECEMBER 31, 1995
------------ ------------ ------------
<S> <C> <C> <C>
Outstanding, beginning of year 743,926 683,748 839,948
Granted 422,000 212,000 535,500
Exercised (56,385) (61,875) (571,925)
Canceled (138,738) (89,947) (119,775)
------------ ------------ ------------
Outstanding, end of year 970,803 743,926 683,748
============ ============ ============
Available for future grants 593,000 152,041 251,490
============ ============ ============
</TABLE>
35
<PAGE> 38
A summary of the Company's stock option plans as of the end of
1997 and 1996 and changes during the years is presented below:
<TABLE>
<CAPTION>
DECEMBER 31, 1997 DECEMBER 31, 1996
--------------------------------- ---------------------------------
WEIGHTED-AVERAGE WEIGHTED-AVERAGE
SHARES EXERCISE PRICE SHARES EXERCISE PRICE
----------- ---------------- ----------- ----------------
<S> <C> <C> <C> <C>
Outstanding, beginning of year 743,926 $ 8.22 683,748 $ 7.76
Granted 422,000 8.08 212,000 $ 8.12
Exercised (56,385) 5.03 (61,875) $ 4.15
Canceled (138,738) 8.23 (89,947) $ 7.29
----------- ----------- ----------- -----------
Outstanding, end of year 970,803 $ 8.34 743,926 $ 8.22
=========== =========== =========== ===========
Exercisable at end of year 316,899 216,179
=========== ===========
Weighted-average fair value of options
granted during the year $ 8.02 $ 4.59
=========== ===========
</TABLE>
The following table summarizes information about stock options outstanding at
December 31, 1997:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
------------------------------- --------------------------------
NUMBER NUMBER
RANGE OF OUTSTANDING WEIGHTED-AVERAGE EXERCISABLE WEIGHTED-AVERAGE
EXERCISE PRICES AT 12/31/97 EXERCISE PRICE AT 12/31/96 EXERCISE PRICE
--------------- ----------- ---------------- ----------- ----------------
<S> <C> <C> <C> <C>
$0 to $5.47 38,321 $ 4.55 61,108 $ 3.69
$5.50 to $7.50 156,914 $ 7.07 17,115 $ 6.58
$7.75 to $7.88 290,133 $ 7.83 -- --
$8.50 to $9.50 295,851 $ 8.53 99,457 $ 8.50
$10.00 to $11.88 189,584 $ 10.64 38,499 $ 10.64
- ---------------- ------- ------- ------- -------
$1.31 to $11.88 970,803 $ 8.34 216,179 $ 7.37
================ ======= ======= ======= =======
</TABLE>
In calculating pro forma information regarding net income and net
income per share, as required by Financial Accounting Standards Board Statement
No. 123, Accounting for Stock-Based Compensation, the fair value was estimated
at the date of grant using a Black-Scholes option pricing model with the
following weighted-average assumptions for the options on the Company's common
stock for the years ended December 31, 1997 and 1996, respectively: risk free
interest rates of 6% and 6.5%; dividend yields of 0% and 0%; volatility of the
expected market prices of the Company's common stock of 2.303 and .543; and
expected life of the options of 5.5 years for both periods.
For purposes of pro forma disclosures, the estimated fair value
of the options is amortized to expense over the options' vesting period. The
Company's proforma information for the years ended December 31, 1997 and 1996
follows (in thousands, except per share information):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------
1997 1996
-------- --------
<S> <C> <C>
Pro forma net income (loss) $ 3,381 $ (571)
Pro forma net income (loss) per share $ .63 $ (.10)
</TABLE>
These pro forma amounts reflect only the cumulative effect of the
expense of options granted during the years ended December 31, 1997, 1996 and
1995, and does not give effect to options granted prior to January 1, 1995.
6. DISTRIBUTION TO SHAREHOLDERS
36
<PAGE> 39
On February 9, 1996, the Company distributed 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 were no longer a part of the
Medstone operations, as Medstone distributed to its shareholders all outstanding
common stock of each company, retaining only 100,000 shares of each company.
These two companies are separate, publicly-held companies.
Medstone, as part of the distribution of Endocare, forgave
intercompany debt of $2,831,364 and contributed $500,000 in cash and net other
assets of $803,133 to Endocare. As part of the distribution of Urogen, Medstone
forgave intercompany debt of $3,888,875 and contributed $500,000 in cash and net
other assets of $163,082 to Urogen.
In October 1996, the Company liquidated its position in Endocare.
The average sales price was $5.53 per share, net of commissions, for the 100,000
shares that were owned by the Company. A $553,372 gain was recognized in the
fourth quarter of 1996.
7. STOCK REPURCHASE PLAN
On March 29, 1996, the Company announced a Stock Repurchase
Program of up to 500,000 shares of its Common Stock. For the year ended December
31, 1997, the Company has repurchased a total of 156,000 shares at a cost of
$1,292,366, For the year ended December 31, 1996, the Company repurchased a
total of 112,800 shares at a cost of $908,370. The Company has repurchased
268,800 shares at a total cost of $2,200,736 since the inception of the
repurchase program with all amounts recorded as treasury stock.
As of March 17, 1998, the Company has repurchased an additional
110,400 shares at a total cost of $1,052,825.
8. 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. Under
lease extensions, the monthly lease rate was $12,862 through February 1997 and
$13,360 through February 1998. The Company has exercised its option to lease
through February 1999 at a monthly lease rate of $13,874. The Company has
negotiated an extension for a sixteen month period from March 1999 to June 2000,
at a monthly rate of $14,410. The future minimum lease payments under the lease
are as follows:
<TABLE>
<CAPTION>
Minimum Rental
--------------
<S> <C>
1998 $192,000
1999 $195,000
2000 $ 89,000
2001 $ 3,000
2002 $ 1,000
</TABLE>
Total net rent expense under all operating leases for the years
ended December 31, 1997, 1996 and 1995 was $182,000, $156,000 and $152,000,
respectively.
9. CONTINGENCIES
In June 1996, the Company negotiated a settlement of the two
related class action lawsuits filed by two shareholders of the Company. The
settlement in the third quarter of 1996 totaled $6.0 million, with $500,000 paid
by the Company's underwriter and $5.5 million paid by the Company. The $5.5
million was charged against earnings in the second quarter of 1996.
37
<PAGE> 40
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.
10. 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 (pre-split) 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 (pre-split) shares of common stock of Cardiac Science, Inc.
From 1991 through 1996, the Company performed various financings
for Cardiac Science and received warrants to purchase Cardiac Science common
stock. Due to exercise of warrants, common stock issued in lieu of interest and
unsecured advances the Company received 5,619,054 (pre-split) shares of Cardiac
Science.
In April 1997, Cardiac Science effectuated a 1 for 11.42857143
reverse stock split, reducing the Company's holdings to 546,772 shares, which is
the number of shares held at December 31, 1997. This investment has been
recorded at a net investment value $0 due to Cardiac Science's historical
financial performance and significant fluctuations in its stock price. The
Company's investment in Cardiac Science is currently restricted from trading.
The Company also holds warrants to purchase 87,500 (post-split)
shares of Cardiac Science at $.011 each, with an expiration date of September
2004.
11. 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. During 1997, the Company's
Board of Directors elected to match employee contributions $.25 on a dollar, up
to a maximum company contribution of $2,000. In 1997, the Company's contribution
totaled $37,991. No such contributions were made to the plan during the years
ended December 31, 1996 and 1995.
12. MAJOR CUSTOMERS AND FOREIGN SALES
During the 12 months ended December 31, 1997 no single customer
accounted for 10% or more of total revenues and the Company derived 2% of its
total revenues from sales to foreign customers. During the year ended December
31, 1996 no single customer accounted for 10% or more of total revenues and the
Company derived 11% of its total revenues from sales to foreign customers.
During the year ended December 31, 1995, no single customer accounted for 10% of
total revenues of the Company and the Company derived 9% of its total revenues
from sales to foreign customers.
38
<PAGE> 41
13. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
The tables below set forth selected quarterly financial
information for 1997 and 1996 (in thousands, except per share amounts).
<TABLE>
<CAPTION>
1997 1ST QUARTER 2ND QUARTER 3RD QUARTER 4TH QUARTER
---- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Net sales $ 4,962 $ 5,665 $ 5,655 $ 5,452
Gross profit 2,692 3,329 3.353 2,857
Net income 860 1,022 1,150 932
Basic earnings
per share $ .16 $ .19 $ .21 $ .17
<CAPTION>
1996 1ST QUARTER 2ND QUARTER 3RD QUARTER 4TH QUARTER
---- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Net sales $ 4,102 $ 4,330 $ 4,349 $ 5,199
Gross profit 2,269 2,341 2,396 2,964
Net income 617 (3,031) 812 1,362
Basic earnings (loss)
per share $ .11 $ (.55) $ .15 $ .25
</TABLE>
In 1997 and 1996, the Company's effective income tax rate
approximated statutory rates. (See Note 4).
39
<PAGE> 42
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, 1997:
- ------------------
<S> <C> <C> <C> <C> <C>
Allowance for
doubtful accounts $ 220,312 $ 251,000 $ 66,606 $ 3,000 (c) $ 534,918
============= ============= ============= ============= =============
Allowance for
inventory obsolescence $ 440,000 $ -- $ -- $ 102,563 (b) $ 337,437
============= ============= ============= ============= =============
Allowance for
related party loan $ 0 $ -- $ -- $ -- $ 0
============= ============= ============= ============= =============
Allowance for investment
in related party $ 750,054 $ -- $ -- $ -- $ 750,054
============= ============= ============= ============= =============
FOR THE YEAR ENDED
DECEMBER 31, 1996:
- ------------------
Allowance for
doubtful accounts $ 207,260 $ 60,000 $ -- $ 46,948 (a) $ 220,312
============= ============= ============= ============= =============
Allowance for
inventory obsolescence $ 576,884 $ (136,884) $ -- $ -- $ 440,000
============= ============= ============= ============= =============
Allowance for
related party loan $ 109,672 $ -- $ -- $ 109,672 (d) $ 0
============= ============= ============= ============= =============
Allowance for investment
in related party $ 643,000 $ -- $ -- $ (107,054) (d) $ 750,054
============= ============= ============= ============= =============
FOR THE YEAR ENDED
DECEMBER 31, 1995:
- ------------------
Allowance for
doubtful accounts $ 257,418 $ -- $ -- $ 50,158(c) $ 207,260
============= ============= ============= ============= =============
Allowance for
inventory obsolescence $ 665,549 $ -- $ -- $ 88,665(b) $ 576,884
============= ============= ============= ============= =============
Allowance for
related party loan $ 108,357 $ 1,315 $ -- $ -- $ 109,672
============= ============= ============= ============= =============
Allowance for investment
in related party $ 643,000 $ -- $ -- $ -- $ 643,000
============= ============= ============= ============= =============
</TABLE>
(a) Reserve transferred to Endocare with the spinout.
(b) Write-off of inventory
(c) Write-off of bad debt
(d) Reserve transferred from loan provision to investment provision due to
restructuring.
40
<PAGE> 43
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 24, 1998
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 24, 1997.
SIGNATURE TITLE
--------- -----
DAVID V. RADLINSKI Chairman of the Board,
------------------ Chief Executive Officer
David V. Radlinski and Director
(Principal Executive Officer)
MARK SELAWSKI Chief Financial Officer
------------- (Principal Financial and Accounting Officer)
Mark Selawski
DONALD J. REGAN Director
---------------
Donald J. Regan
FRANK R. POPE Director
-------------
Frank R. Pope
MICHAEL C. TIBBITTS Director
-------------------
Michael C. Tibbitts
41
<PAGE> 1
EXHIBIT 22.1
MEDSTONE INTERNATIONAL, INC.
SUBSIDIARIES
<TABLE>
<CAPTION>
NAME JURISDICTION
---- ------------
<S> <C>
United Physicians Resources, Inc. Delaware
Northern Nevada Lithotripsy Associates, LLC Nevada
Southern Idaho Lithotrispy Associates, LLC California
</TABLE>
42
<PAGE> 1
Exhibit 23.1
CONSENT OF INDEPENDENT AUDITORS
We consent to the incorporation by reference in the Registration Statements
(Form S-8 Nos. 33- 32891, 33-45470, 33-32892 and 33-36707) pertaining to the
1989 Stock Incentive Plan (as amended), the Nonemployee Director Stock Option
Plan and the 1997 Stock Incentive Plan of Medstone International, Inc. of our
report dated February 14, 1998, 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, 1997.
ERNST & YOUNG LLP
Orange County, California
March 24, 1998
43
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> DEC-31-1997
<CASH> 1,125,009
<SECURITIES> 9,900,909
<RECEIVABLES> 3,120,787
<ALLOWANCES> 534,918
<INVENTORY> 2,680,220
<CURRENT-ASSETS> 18,807,257
<PP&E> 10,300,162
<DEPRECIATION> 4,721,618
<TOTAL-ASSETS> 27,688,388
<CURRENT-LIABILITIES> 2,551,263
<BONDS> 0
0
0
<COMMON> 22,539
<OTHER-SE> 24,098,633
<TOTAL-LIABILITY-AND-EQUITY> 27,688,388
<SALES> 21,198,702
<TOTAL-REVENUES> 21,734,303
<CGS> 9,503,449
<TOTAL-COSTS> 5,509,288
<OTHER-EXPENSES> 428,268
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 6,293,298
<INCOME-TAX> 2,329,000
<INCOME-CONTINUING> 3,964,298
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 3,964,298
<EPS-PRIMARY> .74
<EPS-DILUTED> .72
</TABLE>
