<PAGE>
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON SEPTEMBER 26, 1996
REGISTRATION NO. 33-97722
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- -------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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POST-EFFECTIVE AMENDMENT NO.1
TO
FORM S-1
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
---------------
NEUROMEDICAL SYSTEMS, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
8099 13-3526980
DELAWARE (PRIMARY STANDARD INDUSTRIAL (I.R.S. EMPLOYER
(STATE OR OTHER CLASSIFICATION CODE NUMBER) IDENTIFICATION
JURISDICTION OF NUMBER)
INCORPORATION OR
ORGANIZATION)
TWO EXECUTIVE BOULEVARD
SUFFERN, NEW YORK 10901-4164
(914) 368-3600
(ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE, OF
REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES)
---------------
JOHN B. HENNEMAN, III
VICE PRESIDENT, GENERAL COUNSEL AND SECRETARY
NEUROMEDICAL SYSTEMS, INC.
TWO EXECUTIVE BOULEVARD
SUFFERN, NEW YORK 10901-4164
(914) 368-3600
(NAME, ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE,
OF AGENT FOR SERVICE)
---------------
COPIES TO:
PAUL M. REINSTEIN, ESQ. ROBERT E. BUCKHOLZ, JR., ESQ.
FRIED, FRANK, HARRIS, SHRIVER & SULLIVAN & CROMWELL
JACOBSON 125 BROAD STREET
ONE NEW YORK PLAZA NEW YORK, NEW YORK 10004
NEW YORK, NEW YORK 10004 (212) 558-4000
(212) 859-8000
---------------
APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO PUBLIC: As soon as
practicable after the effective date of this Registration Statement.
If any of the securities being registered on this Form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, other than securities offered only in connection with dividend or
interest reinvestment plans, check the following box. [X]
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following
box and list the Securities Act registration statement number of the earlier
effective registration statement for the same offering. [_]
If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [_]
If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box. [_]
---------------
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT
SHALL FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS
REGISTRATION STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH
SECTION 8(a) OF THE SECURITIES ACT OF 1933 OR UNTIL THE REGISTRATION STATEMENT
SHALL BECOME EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID
SECTION 8(a), MAY DETERMINE.
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<PAGE>
EXPLANATORY NOTE
This Registration Statement includes a prospectus relating to an
indeterminate number of shares of Neuromedical Systems, Inc. (the "Company")
Common Stock which may be sold by Goldman, Sachs & Co. in connection with
market-making transactions. See "Plan of Distribution."
<PAGE>
[LOGO] NSI NEUROMEDICAL SYSTEMS, INC.
COMMON STOCK
(PAR VALUE $0.0001 PER SHARE)
----------------
INVESTMENT IN THE COMMON STOCK OFFERED HEREBY INVOLVES A HIGH DEGREE OF
RISK. SEE "RISK FACTORS" APPEARING ON PAGE 8.
The Common Stock is quoted on the Nasdaq National Market under the symbol
"NSIX."
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THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE
SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION
PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY
REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
----------------
This Prospectus has been prepared for and is to be used by Goldman, Sachs &
Co. in connection with offers and sales of the Common Stock related to market-
making transactions, at prevailing market prices, related prices or negotiated
prices. The Company will not receive any of the proceeds of such sales.
Goldman, Sachs & Co. may act as a principal or agent in such transactions. See
"Plan of Distribution."
GOLDMAN, SACHS & CO.
----------------
The date of this Prospectus is , 1996.
<PAGE>
PROSPECTUS SUMMARY
The following summary is qualified in its entirety by the more detailed
information and consolidated financial statements and notes thereto appearing
elsewhere in this Prospectus. The common stock of the Company, par value
$0.0001 per share, is sometimes referred to herein as "Common Stock" or
"shares."
THE COMPANY
Neuromedical Systems, Inc., a Delaware corporation founded in 1988 (the
"Company" or "NSI"), is a healthcare technology company focused on diagnostic
screening applications to aid in the early detection of certain cancers. During
the past five years, the Company and its subsidiaries have been primarily
engaged in the development, manufacturing and marketing of the PAPNET(R)
Testing System, and the scanning of cervical smears at its slide processing
facilities. The Company's first and, to date, only product, the PAPNET(R)
Testing System, was approved for commercial use in the United States by the
United States Food and Drug Administration (the "FDA") on November 8, 1995 and,
in January 1996, the Company initiated the first two stages of its United
States marketing program, to laboratories and clinicians. As of August 31,
1996, the PAPNET(R) test was available through approximately 140 laboratories
in the United States alone. While continuing to market to laboratories and
clinicians, the Company initiated the third step of its United States marketing
program, direct-to-consumer advertising, in August 1996. See "Business--
Marketing." The Company's objective is to establish the use of its PAPNET(R)
Testing System as the new standard of care in cervical cancer screening.
The PAPNET(R) Testing System is a supplemental test to aid laboratories in
the detection of abnormal cells on cervical Papanicolaou ("Pap") smears which
were not detected by standard manual microscopic inspection. When used to
supplement manual screening of Pap smears, PAPNET(R) testing has been shown to
increase the detection of cervical abnormality by up to 30% when compared to
manual screening with routine manual quality control rescreening. The Company
believes that this improved detection can result in more effective and less
costly early treatment, reduced morbidity and mortality for patients and
reduced possibility of malpractice litigation for the patient's doctor and
laboratory. The PAPNET(R) Testing System can achieve these improvements without
requiring a modification of the standard Pap smear sample due to its use of a
patented combination of algorithmic and adaptive pattern recognition
technology, a form of artificial intelligence. The Company and its subsidiaries
manufacture the PAPNET(R) Testing System and market and provide processing
services which utilize the PAPNET(R) Testing System.
Pap smears are widely used in North America, Europe and other developed areas
to aid in the early detection of cervical cancer and precancerous conditions.
The Company estimates that there are more than 50 million Pap smears screened
annually in the United States alone. Pap smears can reveal early changes in
cervical cells that precede or indicate the development of cancer, thereby
facilitating timely medical intervention. The Company estimates that more than
2,000,000 cases of precancerous cervical abnormalities are diagnosed in the
United States annually. The American Cancer Society projects that, in 1996,
there will be approximately 15,700 new cases of invasive cervical cancer
diagnosed in the United States and projected that, in 1995, there would be
approximately 65,000 cases of cervical carcinoma in situ. Women diagnosed with
carcinoma in situ typically are treated with either extensive conization
(removal of a portion of the uterus) or by hysterectomy, and women diagnosed
with invasive cervical cancer are treated with hysterectomy and/or
radiotherapy. Notwithstanding such treatments, approximately 4,900 women are
expected to die of the disease in the United States in 1996. Outside of the
United States, where cervical cancer screening is less prevalent, more than
450,000 new cases of cervical cancer are diagnosed each year. Almost all deaths
due to cervical cancer could be prevented with early-stage detection and
treatment.
2
<PAGE>
When precancerous conditions are detected on Pap smears, they are usually
treatable using simple procedures in the physician's office. If abnormal cells
on the Pap smear are not detected by the laboratory, however, the patient may
be incorrectly told that her Pap smear is negative, and significant morbidity
(including, for example, hysterectomies) or mortality may occur as a result. In
addition, when a laboratory does fail to diagnose a positive Pap smear
correctly, its defense of any resulting lawsuit may be difficult, because all
Pap smear slides are retained in the laboratory's archive for five years
pursuant to federal law and therefore are available for re-examination.
Unlike most other high-volume laboratory tests, the cytological evaluation
(the visual examination of cells) of the cervical Pap smear is performed
manually. Specially trained medical technicians, known as cytotechnologists,
screen up to 100 Pap smears per day using standard light microscopes, usually
at 100x magnification. Each of these smears may contain hundreds of thousands
of normal cells. The few smears that are abnormal may contain only a small
number of abnormal cells (as few as 20) scattered among the vast number of
normal cells. The manual screening of Pap smears has been appropriately
characterized as extremely taxing and inherently prone to error, and has often
been compared to searching for a needle in a haystack or to proofreading a long
document to find a few spelling errors. As a result, manual screening false-
negative rates ranging from 10% to 40% of true positives have been commonly
reported in the medical literature over the last 20 years. See "Business--The
Cervical Pap Smear Problem."
The PAPNET(R) Testing System is a computerized image processing service
provided to laboratories. The laboratory performs PAPNET(R) testing when
specifically requested by clinicians, patients or third-party payers who wish
to minimize the probability of false negatives and their attendant medical and
legal consequences. Slides first diagnosed by a laboratory as "negative" using
manual inspection are sent to designated Company facilities ("Scanning
Centers") for imaging on a PAPNET(R) Scanning Station, which is designed to
inspect the hundreds of thousands of cells and other objects on the slide. The
PAPNET(R) Scanning Stations' proprietary neural network computers are designed
to select color images of 128 potentially abnormal cells and cell clusters from
each slide for detailed video review (whether or not they are, in fact,
abnormal). These 128 images from each slide are recorded on a digital tape
cassette which is returned to the client laboratory within two to four working
days along with the referred Pap smear slides.
At the laboratory, a certified cytotechnologist specially trained in the use
of the PAPNET(R) Testing System evaluates the 128 color images from each slide
on the PAPNET(R) Review Station. The PAPNET(R) Review Station's software
ensures that the cytotechnologist displays each image at 200x magnification
(twice normal screening power) and permits the user to expand any image to 400x
magnification. If all of the images appear normal, the cytotechnologist
classifies the slide as "negative," and no further examination is required. The
Company has found that cytotechnologists experienced in the use of the
PAPNET(R) Review Station can review negative cases in substantially less time
than it takes to perform a conventional manual re-examination.
If any one of the 128 images appears to the cytotechnologist to be abnormal,
the cytotechnologist classifies the slide as "review." The cytotechnologist
then refers to the "x, y" coordinates provided with each PAPNET(R) image and
uses the coordinates as a reference point to re-examine the slide directly
through the microscope. If, after direct inspection, the cytotechnologist
continues to believe that the slide contains abnormal cells, he or she refers
the slide to the laboratory's pathologist for a final diagnosis. In no case
does the Company or the PAPNET(R) Testing System make a diagnosis of a slide or
smear.
The PAPNET(R) Testing System is used as a supplement to current practice and
does not alter the clinician's procedure for the taking of smears or the
laboratory's method of staining or applying the
3
<PAGE>
coverslip. It provides an additional and complementary level of screening for
the purpose of decreasing false negative Pap smear diagnoses.
The clinical trial conducted to support the Company's FDA application
involved a study of more than 10,000 Pap smears originally classified as
"negative" and retrieved from laboratory archives. The trial measured the
ability of PAPNET(R) testing to detect missed abnormalities on "negative"
smears from a population of women who had negative Pap smear histories but
nevertheless subsequently developed high grade lesions or invasive cervical
cancer (the "Case" group), and was also used to re-examine a series of routine
"negative" smears (the "Control" group). The trial results indicated that, when
used as an adjunct to manual screening, PAPNET(R) testing can increase the
aggregate cervical abnormality detected by up to 30% when compared to the
combination of manual screening and routine manual quality control rescreening.
The trial results also demonstrated that PAPNET(R) testing detected an
abnormality which had been originally missed by manual screening for 31.6% of
the Case patients. For 91.7% of such women, PAPNET(R) testing would have found
the abnormality more than a year prior to the biopsy that confirmed the
patient's disease, and, for 38.9% of such women, more than two years earlier.
See "Business--Clinical Effectiveness of the PAPNET(R) Testing System."
To establish PAPNET(R) testing in the United States as the standard of care
in Pap smear analysis, the Company is executing a three-step sequential
marketing program that targets (i) its direct clients, the clinical
laboratories that perform Pap smear testing, (ii) gynecologists and those
primary care physicians and other clinicians who take Pap smears and can order
PAPNET(R) testing and (iii) women, to encourage them to request PAPNET(R)
testing or to agree to it if it is recommended by a clinician. The Company
believes that significant revenue growth in the United States depends upon
effective marketing to all three target audiences. While continuing its
marketing program to laboratories and clinicians, the Company began direct-to-
consumer advertising in August 1996 after it determined that an adequate
distribution network of laboratories had been established and that clinician
awareness of the PAPNET(R) test was sufficiently high to motivate clinicians to
prescribe or recommend the test. The Company is also marketing to insurers,
managed care organizations and other third-party payers with respect to
reimbursement for PAPNET(R) testing. See "Business--Marketing."
The Company's patents broadly cover the application of neural networks and
other adaptive classifiers to the classification of cytological specimens
generally and of cervical smears in particular. The Company's PAPNET(R) system
is specifically disclosed and claimed. The Company has five issued United
States patents, which do not begin to expire until at least 2008, and several
pending patent applications which relate to technology on which the PAPNET(R)
Testing System is based.
On May 2, 1995, a third party, whose identity is unknown to the Company,
filed with the United States Patent and Trademark Office (the "Patent Office")
requests, which the Patent Office granted, for re-examination of three of the
Company's United States patents. The Patent Office has confirmed or found
patentable each re-examined patent claim in each re-examined patent. See
"Business--Patents and Proprietary Rights."
Management believes that the Company's technology can be adapted for use in
the early detection of cancers occurring at body sites in addition to the
uterine cervix, including the bladder, breast, esophagus, lung, oral cavity and
thyroid. Not all such cancers are commonly the subject of cytological analysis,
and the Company has not yet determined which of these other applications, if
any, it will be able to commercialize. The Company's patents cover application
of its technology to cytological screening for cancers occurring at all body
sites. See "Business--Potential Future Products."
The Company's principal offices are located at Two Executive Boulevard,
Suffern, New York 10901-4164, and its telephone number at that address is (914)
368-3600.
4
<PAGE>
SHARES OUTSTANDING
Common Stock
outstanding(1)........ 29,493,606 shares
Nasdaq National Market
System Symbol......... NSIX
Use of Proceeds.............
The Company will not receive any proceeds
- -------- pursuant to market-making transactions.
(1) As of September 9, 1996. Excludes 4,418,490 shares (including a
performance-based option at an exercise price of $15.00 per share for
813,273 shares of Common Stock; see "Management--Rutenberg Option
Agreement") that may be issued upon the exercise of options and warrants at
a weighted average exercise price of $5.68 per share. See "Risk Factors--
Dilution; Effect of Outstanding Options and Warrants," "Description of
Capital Stock--Options and Warrants," "Management," "Certain Transactions"
and Note 8 to the Company's Consolidated Financial Statements.
RISK FACTORS
Before making an investment in the Common Stock, prospective purchasers
should carefully consider the factors set forth under "Risk Factors" of this
Prospectus, including risks relating to the early commercial stage of the
Company, history of losses, uncertainty of profitability, the need for market
acceptance of the PAPNET(R) Testing System, reliance on a single product,
competition, dependence on key personnel, the impact of territorial license
agreements, dependence on patents and proprietary technology, government
regulation, limited marketing and sales history, international sales and
operational risks, foreign exchange fluctuations, limited slide processing and
manufacturing history, dependence on sole source suppliers, the impact of
Medicare, Medicaid and other third-party reimbursement, healthcare reform,
future capital needs and uncertainty of additional financing, litigation,
potential unavailability of insurance, dilution, the effect of outstanding
options and warrants, anti-takeover provisions, the stockholder rights plan,
control by existing stockholders, shares eligible for future sale, registration
rights, the limited prior public market, liquidity, possible volatility of
stock price, dividend policy and considerations with respect to the Investment
Company Act of 1940, as amended.
5
<PAGE>
SUMMARY FINANCIAL DATA
The following summary financial data of the Company are qualified by
reference to and should be read in conjunction with "Management's Discussion
and Analysis of Financial Condition and Results of Operations" and the
Company's Consolidated Financial Statements and notes thereto included
elsewhere in this Prospectus:
YEAR ENDED DECEMBER 31,
SIX MONTHS ENDED
JUNE 30,
<TABLE>
<CAPTION>
1991 1992 1993 1994 1995 1995 1996
----------- ----------- ----------- ------------ ------------ ----------- ------------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS
DATA:
Revenues
Slide Processing....... $ -- $ 216,000 $ 502,000 $ 1,238,000 $ 2,475,000 $ 1,067,000 $ 1,668,000
License Fees........... 575,000 -- -- -- -- -- --
----------- ----------- ----------- ------------ ------------ ----------- ------------
Total Revenues......... $ 575,000 $ 216,000 $ 502,000 $ 1,238,000 $ 2,475,000 $ 1,067,000 $ 1,668,000
Costs and Expenses
Cost of Sales.......... $ -- $ 607,000 $ 2,045,000 $ 4,503,000 $ 6,478,000 $ 2,894,000 $ 3,624,000
Marketing.............. -- 320,000 615,000 2,878,000 6,268,000 2,112,000 7,373,000
Research and
Development........... 227,000 883,000 1,137,000 4,305,000 5,172,000 2,557,000 3,079,000
General and
Administrative........ 2,659,000 2,638,000 2,984,000 3,151,000 6,017,000 2,366,000 3,556,000
Stock issued pursuant
to a settlement
agreement............. -- -- -- -- 1,652,000 -- --
Vesting of performance
options at initial
public offering....... -- -- -- -- 6,100,000 -- --
----------- ----------- ----------- ------------ ------------ ----------- ------------
Total Costs and
Expenses.............. $ 2,886,000 $ 4,448,000 $ 6,781,000 $ 14,837,000 $ 31,687,000 $ 9,929,000 $ 17,632,000
----------- ----------- ----------- ------------ ------------ ----------- ------------
Loss from Operations... $(2,311,000) $(4,232,000) $(6,279,000) $(13,599,000) $(29,212,000) $(8,862,000) $(15,964,000)
Interest Income......... 6,000 19,000 59,000 170,000 548,000 74,000 2,808,000
Interest Expense........ (579,000) (255,000) (562,000) (393,000) (924,000) (480,000) (484,000)
Foreign Exchange........ -- -- -- 3,000 160,000 348,000 (585,000)
----------- ----------- ----------- ------------ ------------ ----------- ------------
Net Loss................ $(2,884,000) $(4,468,000) $(6,782,000) $(13,819,000) $(29,428,000) $(8,920,000) $(14,225,000)
=========== =========== =========== ============ ============ =========== ============
Pro Forma Net Loss Per
Share (1)............. $ (0.84) $ (1.67) $ (0.53) $ (0.49)
============ ============ =========== ============
Common and common share
equivalents used in
computing per share
amounts............... 16,500,000 17,644,000 16,805,000 28,949,000
============ ============ =========== ============
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31, JUNE 30,
1995 1996
------------ -----------
(UNAUDITED)
<S> <C> <C>
BALANCE SHEET DATA:
Cash and Cash Equivalents............................ $114,143,000 $95,827,000
Working Capital...................................... 109,113,000 91,502,000
Total Assets......................................... 127,348,000 113,932,000
Long-term Debt Less Current Portion.................. 4,036,000 3,942,000
Capital Lease Obligations Less Current Portion....... 2,014,000 2,178,000
Accumulated Deficit.................................. (60,350,000) (74,575,000)
Stockholders' Equity................................. 114,667,000 101,301,000
</TABLE>
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(1) Pro Forma Net Loss Per Share for the years ended December 31, 1994 and 1995
and the six-month period ended June 30, 1995 is set forth on a pro forma
basis to give effect to the conversion of all convertible preferred stock
into Common Stock upon consummation of the Company's initial public
offering in December 1995. The six-month period ended June 30, 1996 is
presented on a historical basis. See Note 1 of the Notes to the Company's
Consolidated Financial Statements.
6
<PAGE>
USE OF PROCEEDS
The Company will not receive any of the proceeds from market-making
transactions.
RISK FACTORS
Investment in the securities being offered hereby involves a high degree of
risk, including, but not limited to, the risk factors described below.
Prospective investors should carefully consider the following risk factors, in
addition to the other information in this Prospectus, in evaluating an
investment in the securities offered hereby.
EARLY COMMERCIAL STAGE COMPANY; HISTORY OF LOSSES; PROFITABILITY UNCERTAIN
The Company is in its early commercial stage and has generated limited
operating revenue to date and has incurred, from incorporation through June
30, 1996, net losses aggregating approximately $74.6 million. The Company does
not expect to generate a positive internal cash flow in the foreseeable future
due to the expected increases in capital expenditures, working capital
requirements and ongoing losses during the next year, including the expected
cost of commercializing the PAPNET(R) Testing System. The likelihood of the
success of the Company must be considered in light of the problems, expenses,
difficulties, complications and delays frequently encountered in connection
with the formation of a new business, the development of new products and the
competitive environment in which the Company operates. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
"Business."
Although the Company is deriving limited operating revenue from its current
operations, there can be no assurance that it will be able to develop
significant additional sources of revenue or that its operations will become
profitable. Results of operations may fluctuate significantly and will depend
upon numerous factors, including regulatory actions, market acceptance of the
Company's products, efficient manufacturing and slide processing operations,
new product introductions and competition.
NEED FOR MARKET ACCEPTANCE OF THE PAPNET(R) TESTING SYSTEM
The Company's future performance will depend to a substantial degree upon
market acceptance of the PAPNET(R) Testing System. The extent of, and rate at
which, market acceptance and penetration are achieved by the PAPNET(R) Testing
System are functions of many variables including, but not limited to, price,
effectiveness, acceptance by patients, physicians and laboratories (including
the ability of laboratories to hire additional cytotechnologists),
manufacturing, slide processing and training capacity, reimbursement practice
and marketing and sales efforts. The Company believes that significant revenue
growth in the United States depends upon effective marketing to three target
audiences: clinical laboratories, clinicians and women. There can be no
assurance that the PAPNET(R) Testing System will achieve or maintain
acceptance in its target markets. Similar risks may confront other products
developed by the Company in the future. See "Business--Marketing" and
"Business--Manufacturing; Research and Development."
RELIANCE ON A SINGLE PRODUCT
The Company has concentrated its efforts primarily on the development of the
PAPNET(R) Testing System and will be dependent upon acceptance of that product
to generate revenues. The Company has performed only limited research on other
applications of its technology. There can be no assurance that the PAPNET(R)
Testing System will be successfully commercialized or that such other
applications will be developed.
7
<PAGE>
COMPETITION
The Company is currently aware of three principal potential competitors, one
of which, NeoPath, Inc. ("NeoPath"), has stated that it is developing a device
for the fully automated primary screening of conventional Pap smears for which
it has submitted to the FDA a pre-market approval supplemental application.
The FDA has announced that the Hematology and Pathology Devices Panel will
hold a public meeting on September 27, 1996 to consider recommending approval
of such supplement. In addition, on September 29, 1995, the FDA granted
approval to NeoPath for the AutoPap(R) 300 QC Automatic Pap Screener System
(the "AutoPap(R) System") to be used in quality control procedures in
laboratories to re-check Pap smear slides initially classified as negative.
The other two competitors, Cytyc Corporation ("Cytyc") and Roche Image
Analysis Systems ("Roche"), have focused on the development of devices for the
production, and, in the case of Roche, automated analysis, of monolayer
slides, a potential alternative to the conventional Pap smear method of
specimen collection and preparation. Cytyc received approval from the FDA in
May 1996 to market its ThinPrep(R) preparation to laboratories, for the
purpose of filtering out blood, mucus and other material from Pap smears. The
Company's known competitors or other companies may develop new products or
technologies that prove to be more effective than the PAPNET(R) Testing
System, that may be viewed by clinical laboratories as reducing operating
costs (for example, by reducing the number of cytotechnologists used in
screening) or that may substitute for or replace conventional Pap smears. In
addition, competitive products and technologies may be manufactured and
marketed more successfully than the PAPNET(R) Testing System. Such
developments could render the PAPNET(R) Testing System less competitive or
possibly obsolete, and could have a material adverse effect on the Company.
The Company will also be required to compete with respect to product
effectiveness, price, manufacturing and slide processing efficiency, marketing
capabilities and customer service and support, areas in which it currently has
limited experience. See "Business--Competition."
DEPENDENCE ON KEY PERSONNEL
The Company's business is highly dependent on the principal members of its
management (including the founder and Chief Executive Officer of the Company,
Mark R. Rutenberg), marketing and technical staffs, and the loss of their
services might impede the achievement of the Company's business objectives. In
addition, the Company's future success will depend in part upon its ability to
retain highly qualified management, scientific, technical and marketing
personnel. There can be no assurance that the Company will be successful in
retaining such qualified personnel or hiring additional qualified personnel.
Losses of key personnel could have a material adverse effect on the Company's
business. The Company has entered into employment contracts with all of its
executive officers.
IMPACT OF TERRITORIAL LICENSE AGREEMENTS
From 1989 through 1991, the Company entered into various long-term
territorial license agreements (the "License Agreements") for the PAPNET(R)
Testing System, relating to certain states and metropolitan areas, which
together account for approximately 20% of the population of the United States.
Pursuant to the License Agreements, each licensee ("Licensee") thereunder is
entitled to receive the greater of (i) royalties equal to 50% of the Net Slide
Revenue (as defined below) generated from participating laboratories within
its territory, not to exceed the Licensee's share of a specified number of
slides annually or (ii) a specified percentage of the Company's annual slide
processing revenues less certain taxes, commissions and other enumerated
expenses, up to specific annual monetary limits for each Licensee. "Net Slide
Revenue" is defined as the gross slide processing revenue minus certain costs
related to asset-based financing for PAPNET(R) Scanning Stations and related
equipment (not to exceed $1.00 per slide) and transportation costs. The
Company estimates that the License Agreements will result in royalty expense
to the Company of approximately 10% of its United States revenues over the
term of the License Agreements, but there can be no assurance that the amount
of such royalties will not be more or less than such percentage.
In addition, the provisions of a promissory note dated October 3, 1990
(which was later converted to Series A Convertible Preferred Stock and
subsequently automatically converted into Common Stock
8
<PAGE>
upon consummation of the Company's initial public offering in December 1995
(the "IPO")) granted the holder of the note certain rights to an agreement to
be the Company's sole licensee for distribution of the PAPNET(R) system in
Canada. The promissory note provides that such "licensee shall be entitled to
terms which are at least as favorable as those in any domestic United States
of America licenses." An agreement has not been negotiated. There can be no
assurance that the terms of such agreement when it is negotiated, or the
activities of the licensee thereunder, will not have a material adverse effect
on the profitability of the Company's business in Canada. Joseph Salamon, a
director of the Company until June 20, 1996, is the agent of the record holder
of the rights to the Canadian license. See "Business--Territorial Licenses"
and "Certain Transactions--Territorial Licenses and Related Agreements."
DEPENDENCE ON PATENTS AND PROPRIETARY TECHNOLOGY
The Company has depended and will continue to depend substantially on its
proprietary technology. The technology underlying the PAPNET(R) Testing System
is protected by five United States patents and similar corresponding foreign
patents granted to the Company. The Company also has filed several additional
patent applications as to certain other aspects of the Company's technology;
however, there can be no assurance that such applications will be granted.
There can be no assurance that the Company's issued patents or other patents
issued in the future will afford protection from material infringement or that
such patents will not be challenged. The Company also relies on trade secrets
and proprietary know-how, which it protects, in part, through confidentiality
agreements with employees, consultants and other parties. There can be no
assurance that these agreements will not be breached, that the Company would
have adequate remedies for any breach or that the Company's trade secrets will
not otherwise become known to, or independently developed by, competitors.
The medical device industry has been the subject of extensive litigation
regarding patents and other intellectual property rights, and the Company may
institute or otherwise be involved in such litigation to enforce its patents,
protect its trade secrets or know-how, challenge the validity of proprietary
rights of others or defend against alleged infringement by the Company of
proprietary rights of others. The Company has instituted such litigation
against NeoPath, a competitor of the Company (see "Business--Competition" and
"Business--Legal Proceedings"). An adverse determination in this or other such
litigations could limit the value of the Company's issued patents or result in
invalidation of those patents, subject the Company to significant liabilities
to third parties, require the Company to seek licenses from third parties or
prevent the Company from manufacturing and selling its products, any of which
could have a material adverse effect on the Company's business, financial
condition and results of operations. See "Business--Patents and Proprietary
Rights."
GOVERNMENT REGULATION
The Company's services, products and manufacturing activities are subject to
extensive and rigorous government regulation, including the provisions of the
Medical Device Amendments to the Federal Food, Drug and Cosmetic Act.
Commercial distribution in certain foreign countries is also subject to
government regulations. The process of obtaining required regulatory approvals
can be lengthy, expensive and uncertain. Moreover, regulatory approvals, if
granted, may include significant limitations on the indicated uses for which a
product may be marketed. The FDA actively enforces regulations prohibiting
marketing without compliance with the premarket approval provisions of
products and conducts periodic inspections to determine compliance with its
Good Manufacturing Practice ("GMP") regulations. Failure to comply with
applicable regulatory requirements can result in, among other things, fines,
suspensions of approvals, seizures or recalls of products, operating
restrictions and criminal prosecutions. Furthermore, changes in existing
regulations or adoption of new regulations could affect the timing of, or
prevent the Company from obtaining, future regulatory
9
<PAGE>
approvals. The effect of government regulation may be to delay for a
considerable period of time or to prevent the marketing and full
commercialization of future products or services that the Company may develop
and/or to impose costly requirements on the Company. There can also be no
assurance that additional regulations will not be adopted or current
regulations amended in such a manner as will materially adversely affect the
Company. See "Business--Government Regulation."
LIMITED MARKETING AND SALES HISTORY
Until it received FDA approval on November 8, 1995, the Company was
prohibited from marketing the PAPNET(R) Testing System in the United States.
Although the Company has begun marketing the PAPNET(R) Testing System, the
Company's worldwide sales and marketing staff as of August 31, 1996 consisted
of only 55 persons, and the Company is still in the process of establishing
commercial scale customer service, training and support capabilities. The
Company intends to market, sell, service and support PAPNET(R) Testing System
services through recruitment of its own direct sales force and through
cooperation with the existing sales personnel of client clinical laboratories.
There can be no assurance that the Company will be able to recruit and retain
skilled sales, marketing, service or support personnel or establish
satisfactory relationships with client laboratories, or that the Company's
marketing and sales efforts will be successful.
INTERNATIONAL SALES AND OPERATIONAL RISKS
The Company markets the PAPNET(R) Testing System to customers outside of the
United States. In addition, the Company manufactures its PAPNET(R) Scanning
Stations in Israel and operates Scanning Centers in Amsterdam and Hong Kong. A
number of risks are inherent in international transactions. International
sales and operations may be limited or disrupted by the regulatory approval
process, governmental controls, export license requirements, political
instability, price controls, trade restrictions, changes in tariffs or
difficulties in staffing and managing international operations. Foreign
regulatory agencies have established, or may establish, product standards
different from those in the United States, and any inability to obtain foreign
regulatory approvals on a timely basis could have an adverse effect on the
Company's international business and its financial condition and results of
operations. In addition, the Company's business, financial condition and
results of operations may be adversely affected by limitations on its ability
to repatriate funds, increases in duty rates and difficulties in obtaining
export licenses. Finally, certain of the Company's operations are located in
Hong Kong. Pursuant to the existing treaty between the Government of the
United Kingdom and the People's Republic of China, Hong Kong will revert to
and become part of China in July 1997. The Company is uncertain as to the
impact that such a change in government will have on its business operations
in Hong Kong. There can be no assurance that the Company will be able to
successfully commercialize the PAPNET(R) Testing System or any future product
in any foreign market. See "Business--Marketing."
FOREIGN EXCHANGE FLUCTUATIONS
To date, the Company's sales of screening services from commercial use of
the PAPNET(R) Testing System have been derived principally from foreign
sources. The Company anticipates that international sales will continue to
represent a significant portion of its net sales as it executes its plan to
establish commercial use of the PAPNET(R) Testing System on a worldwide basis,
including in the United States. Neuromedical Systems, Inc., the United States
parent company, has provided a significant portion of the financing required
for its Netherlands and Hong Kong Scanning Centers through United States
dollar-denominated intercompany loans. The Company also maintains its
PAPNET(R) Testing System manufacturing facility in Israel. As a result of its
international operations and its current financing practices, the Company's
operating results are subject to the impact of fluctuations in exchange rates
of the currencies in which its foreign operations conduct business versus the
United
10
<PAGE>
States dollar. Future currency fluctuations, to the extent not adequately
hedged, could have an adverse effect on the Company's business, financial
condition and results of operations. See "Management's Discussion and Analysis
of Financial Condition and Results of Operations."
LIMITED SLIDE PROCESSING AND MANUFACTURING HISTORY; DEPENDENCE ON SOLE SOURCE
SUPPLIERS
The Company does not have experience with slide processing in commercial-
scale quantities or with the manufacture or assembly of PAPNET(R) Scanning
Stations in the volumes that will be necessary for the Company to generate
significant revenues from the processing of slides on the PAPNET(R) Testing
System. The Company may encounter difficulties in scaling up its slide
processing operations or production or in hiring and training additional
personnel to operate its Scanning Centers or to manufacture its products.
Future interruptions in supply or other production problems could have a
material adverse effect on the Company's business, financial condition and
results of operations. In addition, the Company has qualified only single
sources for certain essential components. Interruptions in the supply of such
components might result in production delays and create the need for
modifications of the design of the various components of the PAPNET(R) Testing
System, either of which could have a material adverse effect on the Company's
business, financial condition and results of operations. See "Business--
Manufacturing; Research and Development."
IMPACT OF MEDICARE, MEDICAID AND OTHER THIRD-PARTY REIMBURSEMENT
In the United States, many Pap smears are currently paid for by the patient,
and the level of reimbursement by third-party payers that do provide
reimbursement varies considerably. Third-party payers (Medicare/Medicaid,
private health insurance, health administration authorities in foreign
countries and other organizations) may affect the pricing or relative
attractiveness of the Company's products and services by regulating the
maximum amount of reimbursement for PAPNET(R) testing provided by such payers
or by not providing any reimbursement at all. Restrictions on reimbursement
may limit the price which the Company can charge for its services or reduce
the demand for PAPNET(R) testing. In addition, if Medicare and Medicaid do not
provide for reimbursement of PAPNET(R) testing, or, if the level of such
reimbursement is significantly below the amount laboratories charge patients
to perform PAPNET(R) testing, the size of the potential market available to
the Company may be reduced. There can be no assurance that costs associated
with PAPNET(R) testing will ever become reimbursable or that the level of
reimbursement to laboratories for PAPNET(R) testing will achieve or be
maintained at levels necessary to permit the Company to generate substantial
revenues. See "Business--Third-Party Reimbursement." In the international
market, reimbursement by private third-party medical insurance providers,
including governmental insurers and payers, varies from country to country. In
certain countries, the Company's ability to achieve significant market
penetration may depend upon the availability of third-party or governmental
reimbursement.
HEALTHCARE REFORM
Recent proposals before Congress have included plans to restructure the
delivery and financing of healthcare services in the United States. Such
proposals focus on the control and reduction of public and private spending on
healthcare, including Medicare and Medicaid, the reform of the methods of
payment for healthcare goods and services by both the public and private
sectors, and the provision of universal access to healthcare. The Company
cannot predict what form such legislation, if any, may take or the effect of
such legislation on its business. It is possible that legislation enacted by
Congress will contain provisions resulting in limitations which may adversely
affect the business, financial position and results of operations of the
Company. It is also possible that future legislation either could result in
modifications to the nation's public and private healthcare insurance systems,
which could affect reimbursement policies in a manner adverse to the Company,
or could encourage integration or reorganization of the healthcare delivery
system in a manner that could adversely affect the Company.
11
<PAGE>
The Company cannot predict what other legislation, if any, relating to its
business or to the healthcare industry may be enacted, including legislation
relating to third-party reimbursement, or what effect any such legislation may
have on its business, financial position and results of operations.
FUTURE CAPITAL NEEDS AND UNCERTAINTY OF ADDITIONAL FINANCING
There can be no assurance that the Company will not be required to seek
additional equity or debt capital to finance its operations in the future. In
addition, there can be no assurance that any such financings, if needed, will
be available to the Company or that adequate funds for the Company's
operations, whether from the Company's revenues, financial markets,
collaborative or other arrangements with corporate partners or from other
sources, will be available when needed or on terms attractive to the Company.
The inability to obtain sufficient funds may require the Company to delay,
scale back or eliminate some or all of its research and product development
programs, sales and marketing efforts, manufacturing and slide processing
operations, clinical studies and/or regulatory activities or to license third
parties to commercialize products or technologies that the Company would
otherwise seek to market and sell itself. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations--Liquidity and
Capital Resources."
LITIGATION; POTENTIAL UNAVAILABILITY OF INSURANCE
The commercial screening of Pap smears has been characterized by significant
malpractice litigation. As a result, the Company faces a risk of exposure to
product liability, errors and omissions or other claims in the event that the
use of its PAPNET(R) Testing System or other future potential products is
alleged to have resulted in a false negative diagnosis. While PAPNET(R) is a
supplemental test and does not purport to diagnose any slide, there can be no
assurance that the Company will avoid significant liability. There also can be
no assurance that the Company will be able to obtain adequate insurance
coverage or that, if obtained, such coverage will continue to be available at
an acceptable cost, if at all. Consequently, such claims could have a material
adverse effect on the business or financial condition of the Company.
On July 15, 1996, the Company filed a lawsuit against NeoPath, a competitor
of the Company (see "Business--Competition"), in the United States District
Court for the Southern District of New York, seeking damages and injunctive
relief for patent infringement, false advertising, unfair competition,
intentional interference with business relations and damage to business
reputation. In the lawsuit, the Company alleges that NeoPath willfully
misappropriated the Company's patented technology and used such technology in
NeoPath's AutoPap(R) System. The Company also alleges that NeoPath falsely
characterized and made misleading comparisons to consumers and securities
analysts of the AutoPap(R) System and the Company's PAPNET(R) Testing System.
NeoPath has denied all allegations and, in addition, it has filed counter-
claims against the Company seeking damages and injunctive relief for false
advertising and unfair competition. In the counter-claims, NeoPath alleges
that statements made by the Company characterizing the performance of the
PAPNET(R) Testing System, and its effectiveness relative to NeoPath's
AutoPap(R) System, as well as other statements, are false and misleading and
constitute misrepresentations. The Company believes that NeoPath's assertions
are without merit. Although the duration, costs and ultimate outcome of this
lawsuit are unknown, the Company expects that the costs of this lawsuit will
be significant during 1996 and 1997.
On December 4, 1995, the Company was served with a Summons and Complaint in
an action entitled Herbst et al. v. Neuromedical Systems, Inc. et al., in the
Supreme Court of the State of New York. The plaintiffs in this suit allege,
among other things, that, pursuant to written contracts, which they claim the
Company has breached, they were entitled to be issued warrants exercisable for
the
12
<PAGE>
purchase of approximately 128,000 shares of Common Stock at various prices.
They further allege that the Company and certain of its officers and directors
made fraudulent misrepresentations and took other allegedly improper actions
that diminished the value of the warrants to which they claim they are
entitled under such contracts. On January 31, 1996, the plaintiffs served the
Company with an Amended Complaint alleging legal claims similar to those in
the original Summons and Complaint served on the Company, but adding one of
the Company's directors as a defendant and specifying that the plaintiffs are
seeking compensatory damages from the Company and certain of its officers and
directors totaling $114 million and punitive damages totaling $175 million.The
defendants have moved to dismiss the Amended Complaint, and such motion is
currently under consideration by the court. The Company intends to defend
vigorously this action. The Company believes that, in any event, the damages
claimed bear no relation to the harm alleged and believes that an adverse
judgment in this case would not have a material adverse effect on the Company.
See "Business--Legal Proceedings" and Note 10 to the Company's Consolidated
Financial Statements.
DILUTION; EFFECT OF OUTSTANDING OPTIONS AND WARRANTS
The Company has outstanding options and warrants to purchase Common Stock at
prices that may be below the per share price to purchasers of the Company's
Common Stock in the market. The exercise of such options and warrants may have
a dilutive effect on the purchaser's investment. As of September 9, 1996, the
Company had 29,493,606 issued and outstanding shares of Common Stock and
outstanding options and warrants which are exercisable into 4,418,490
additional shares of Common Stock. See "Description of Capital Stock--Options
and Warrants."
ANTI-TAKEOVER PROVISIONS; STOCKHOLDER RIGHTS PLAN
The Company's Amended and Restated Certificate of Incorporation (the
"Certificate") and By-Laws (the "By-Laws") contain provisions that may have
the effect of discouraging a third party from making an acquisition proposal
for the Company. The Certificate and By-Laws, among other things, (i) classify
the Board of Directors of the Company (the "Board") into three classes, with
directors of each class serving for a staggered three-year period, (ii)
provide that directors may be removed only for cause and only upon the
affirmative vote of at least 66 2/3% of the voting power of all the then
outstanding shares of stock entitled to vote, (iii) prohibit action by
stockholders by written consent, (iv) require advance notice of stockholder
nominations and proposals and (v) preclude stockholders from calling a special
meeting of stockholders. Such provisions would make the removal of incumbent
directors more difficult and time-consuming and may have the effect of
discouraging a tender offer or other takeover attempt not previously approved
by the Board. The Board has the authority to issue up to 10,000,000 shares of
preferred stock in one or more series and to fix the powers, preferences and
rights of any such series without stockholder approval. In addition, the
Company has adopted a stockholder rights plan. The stockholder rights plan, as
well as the Certificate and By-Laws provisions described above, could have the
effect of discouraging unsolicited acquisition proposals or making it more
difficult for a third party to gain control of the Company and could otherwise
adversely affect the market price of the Common Stock. See "Description of
Capital Stock" and "Certain Charter and By-Laws Provisions."
CONTROL BY EXISTING STOCKHOLDERS
As of September 9, 1996, officers and directors of the Company and
stockholders owning more than 5.0% of the Common Stock of the Company,
together with entities affiliated with them, beneficially owned approximately
50.3% of the Common Stock of the Company. As of September 9, 1996, Goldman,
Sachs & Co., and certain of its affiliates (including certain investment
limited partnerships), owned 22.9% of the Common Stock of the Company
(excluding shares held in managed accounts, shares acquired in the ordinary
course of business and shares issuable upon the exercise of warrants and
options to acquire Common Stock). In the event that certain entities
affiliated with Goldman, Sachs
13
<PAGE>
& Co. own in excess of 25% of the Common Stock of the Company (but not
including certain securities), Goldman, Sachs & Co. would be precluded from
making a market in the Common Stock. Officers and directors of the Company and
stockholders owning more than 5.0% of the Common Stock of the Company may be
able to control the election of all members of the Board and determine
corporate actions. Such concentration of ownership may have the effect of
delaying, deferring or preventing a change in control of the Company. See
"Principal Stockholders."
SHARES ELIGIBLE FOR FUTURE SALE; REGISTRATION RIGHTS
Sales of substantial amounts of Common Stock in the public market could have
an adverse effect on the price of the Common Stock. As of September 9, 1996,
the Company had outstanding 29,493,606 shares of Common Stock of which
21,290,433 shares of Common Stock were eligible for sale and not subject to
restriction. The remaining 8,203,173 shares of Common Stock, issued prior to
the IPO, have become or will become eligible for sale from time to time under
Rule 144 ("Rule 144") promulgated under the Securities Act of 1933, as amended
(the "Securities Act"). In addition, the Company has filed a registration
statement under the Securities Act, covering Common Stock issued pursuant to
the Neuromedical Systems, Inc. 1993 Stock Incentive Plan, as amended and
restated October 25, 1995 (the "Incentive Plan"). See "Management--Stock
Incentive Plan" and "Shares Eligible for Future Sale."
The Company may, and it may be obligated to, register 12,535,546 shares of
Common Stock for sale pursuant to registration rights which have been granted
to certain holders of the Company's securities. These registration rights
could prevent or limit the ability of the Company to sell shares for its own
account, could adversely affect the market price of the Common Stock and could
require the Company to incur significant expenses. See "Shares Eligible for
Future Sale--Registration Rights."
LIMITED PRIOR PUBLIC MARKET; LIQUIDITY; POSSIBLE VOLATILITY OF STOCK PRICE
Prior to the IPO, there was no public market for the Common Stock. The
Common Stock is quoted on the Nasdaq National Market System, under the symbol
"NSIX." There can be no assurance that an active public market for the Common
Stock can be sustained. The market price of the Common Stock could fluctuate
significantly as a result of the Company's financial results, regulatory
approval filings, clinical studies, technological innovations or new
commercial products introduced by the Company or its competitors, developments
concerning patents or proprietary rights, trends in the healthcare industry or
in healthcare generally, litigation, the adoption of new laws or regulations
or new interpretations of existing laws or regulations and other factors. The
underwriters of the Company's IPO have informed the Company that, subject to
applicable laws and regulations, they intend to make a market in the Common
Stock. They are not obligated to do so, however, and any such market-making
may be discontinued at any time without notice. Moreover, because of the
affiliation of Goldman, Sachs & Co. with the Company, Goldman, Sachs & Co. is
required to deliver a current prospectus and otherwise comply with the
requirements of the Securities Act in connection with any secondary market
sale of the Common Stock, which may affect their ability to continue market-
making activities. See "Plan of Distribution."
DIVIDEND POLICY
The Company has not paid and does not anticipate paying any cash dividends
in the foreseeable future and intends to retain future earnings for the
development and expansion of its business. Any future determination to pay
dividends will be at the discretion of the Company's Board of Directors and
subject to certain limitations under the General Corporation Law of the State
of Delaware and will depend upon the Company's results of operations,
financial condition, other contractual restrictions and other factors deemed
relevant by the Board. See "Price Range of Common Stock and Dividend Policy."
14
<PAGE>
INVESTMENT COMPANY ACT CONSIDERATIONS
The Investment Company Act of 1940, as amended (the "1940 Act"), requires
the registration of, and imposes various substantive restrictions on, certain
companies that engage primarily, or propose to engage primarily, in the
business of investing, reinvesting or trading in securities, or that fail
certain statistical tests regarding the composition of assets and sources of
income, and are not primarily engaged in businesses other than investing,
holding, owning or trading securities. The Company believes that it is, and
intends to remain, primarily engaged in businesses other than investing,
reinvesting, owning, holding or trading in securities. The Company has
temporarily invested the net proceeds of the IPO, pending their use, in a
manner so as to avoid becoming subject to the registration requirements of the
1940 Act. Such investment may result in the Company's obtaining lower yields
on the funds invested than might be available in the securities market
generally. There can be, however, no assurance that such investments and
utilization can be maintained, or that any other exemption would be available,
so as to enable the Company to avoid the registration requirements of the 1940
Act. If the Company were required to register as an investment company under
the 1940 Act, it would become subject to substantial regulations with respect
to its capital structure, management, operations, transactions with affiliated
persons (as defined in the 1940 Act) and other matters. Application of the
provisions of the 1940 Act would have a material adverse effect on the
Company.
PRICE RANGE OF COMMON STOCK AND DIVIDEND POLICY
The Company priced the IPO on December 7, 1995. Since that date, the Common
Stock has traded on the Nasdaq National Market System under the symbol "NSIX."
The following table sets forth the price range of high and low last sale
prices per share for the Common Stock on the Nasdaq National Market System for
the periods indicated. Such quotations reflect inter-dealer prices, without
retail mark-up, mark-down or commission, and do not necessarily represent
actual transactions.
<TABLE>
<CAPTION>
HIGH LOW
--------- -------
<S> <C> <C>
Fourth Quarter 1995 (since December 7, 1995)........... $ 20 7/16 $18 3/4
First Quarter 1996..................................... 26 1/2 18 7/8
Second Quarter 1996.................................... 23 1/8 15
Third Quarter 1996 through September 9, 1996........... 16 5/8 11 3/8
</TABLE>
On September 9, 1996, the last reported sale price of the Common Stock was
$14 7/8 per share. On September 9, 1996, there were 361 holders of record of
the Common Stock.
The Company has not paid and does not anticipate paying any cash dividends
in the foreseeable future and intends to retain future earnings for the
development and expansion of its business. Any future determination to pay
dividends will be at the discretion of the Board and subject to certain
limitations under the General Corporation Law of the State of Delaware and
will depend upon the Company's results of operations, financial condition,
other contractual restrictions and other factors deemed relevant by the Board.
15
<PAGE>
CAPITALIZATION AND CASH POSITION
The following table sets forth the capitalization and cash position of the
Company as of June 30, 1996 (unaudited). This table should be read in
conjunction with the Company's Consolidated Financial Statements and the Notes
thereto included elsewhere in this Prospectus.
<TABLE>
<CAPTION>
AS OF
JUNE 30, 1996
-------------
(UNAUDITED)
<S> <C>
Cash and cash equivalents........................................ $ 95,827,000
============
Current portion of long-term debt and capital lease obligations.. $ 1,510,000
============
Long-term debt and capital lease obligations..................... $ 6,120,000
Stockholders' equity:
Preferred Stock, $0.0001 par value; authorized 10,000,000
shares; none issued and outstanding........................... --
Common Stock, $0.0001 par value; authorized 100,000,000 shares;
29,319,203 issued and outstanding............................. 3,000
Additional paid-in capital..................................... 175,562,000
Accumulated deficit............................................ (74,575,000)
Foreign currency translation................................... 311,000
------------
Total stockholders' equity....................................... $101,301,000
------------
Total capitalization............................................. $107,421,000
============
</TABLE>
16
<PAGE>
SELECTED CONSOLIDATED FINANCIAL DATA
The following selected consolidated financial data of the Company are
qualified by reference to and should be read in conjunction with "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
the Company's Consolidated Financial Statements and notes thereto included
elsewhere in this Prospectus. The selected consolidated financial data for the
years ended December 31, 1993, 1994 and 1995 are derived from the Company's
consolidated financial statements for those years which have been audited by
Ernst & Young LLP, independent auditors, whose report thereon appears
elsewhere in this Prospectus. The selected consolidated financial data for the
six-month period ended June 30, 1995 are derived from the Company's audited
consolidated financial statements not included herein. The selected
consolidated financial data for the year ended December 31, 1992 are derived
from the Company's financial statements for that year which have been audited
by other independent auditors. The selected consolidated financial data for
the year ended December 31, 1991 are derived from the Company's unaudited
financial statements. The selected consolidated financial data for the six-
month period ended June 30, 1996 are derived from the unaudited consolidated
financial statements of the Company included elsewhere in this Prospectus and
include, in the opinion of the Company, all adjustments (consisting only of
normal recurring accruals) necessary for a fair and consistent presentation of
such information.
<TABLE>
<CAPTION>
SIX MONTHS ENDED
YEAR ENDED DECEMBER 31, JUNE 30,
------------------------------------------------------------------ -------------------------
1991 1992 1993 1994 1995 1995 1996
----------- ----------- ------------ ------------ ------------ ----------- ------------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS
DATA:
Revenues
Slide Processing...... $ -- $ 216,000 $ 502,000 $ 1,238,000 $ 2,475,000 $ 1,067,000 $ 1,668,000
License Fees.......... 575,000 -- -- -- -- -- --
----------- ----------- ------------ ------------ ------------ ----------- ------------
Total Revenues........ $ 575,000 $ 216,000 $ 502,000 $ 1,238,000 $ 2,475,000 $ 1,067,000 $ 1,668,000
Costs and Expenses
Cost of Sales......... $ -- $ 607,000 $ 2,045,000 $ 4,503,000 $ 6,478,000 $ 2,894,000 $ 3,624,000
Marketing............. -- 320,000 615,000 2,878,000 6,268,000 2,112,000 7,373,000
Research and
Development.......... 227,000 883,000 1,137,000 4,305,000 5,172,000 2,557,000 3,079,000
General and
Administrative....... 2,659,000 2,638,000 2,984,000 3,151,000 6,017,000 2,366,000 3,556,000
Stock issued pursuant
to a settlement
agreement............ -- -- -- -- 1,652,000 -- --
Vesting of performance
options at initial
public offering...... -- -- -- -- 6,100,000 -- --
----------- ----------- ------------ ------------ ------------ ----------- ------------
Total Costs and
Expenses............. $ 2,886,000 $ 4,448,000 $ 6,781,000 $ 14,837,000 $ 31,687,000 $ 9,929,000 $ 17,632,000
----------- ----------- ------------ ------------ ------------ ----------- ------------
Loss from Operations.. $(2,311,000) $(4,232,000) $ (6,279,000) $(13,599,000) $(29,212,000) $(8,862,000) $(15,964,000)
Interest Income........ 6,000 19,000 59,000 170,000 548,000 74,000 2,808,000
Interest Expense....... (579,000) (255,000) (562,000) (393,000) (924,000) (480,000) (484,000)
Foreign Exchange....... -- -- -- 3,000 160,000 348,000 (585,000)
----------- ----------- ------------ ------------ ------------ ----------- ------------
Net Loss............... $(2,884,000) $(4,468,000) $ (6,782,000) $(13,819,000) $(29,428,000) $(8,920,000) $(14,225,000)
=========== =========== ============ ============ ============ =========== ============
Pro Forma Net Loss Per
Share(1)............. $ (0.84) $ (1.67) $ (0.53) $ (0.49)
============ ============ =========== ============
Common and common
share equivalents
used in computing per
share amounts........ 16,500,000 17,644,000 16,805,000 28,949,000
============ ============ =========== ============
<CAPTION>
DECEMBER 31,
------------------------------------------------------------------ JUNE 30,
1991 1992 1993 1994 1995 1996
----------- ----------- ------------ ------------ ------------ ------------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Cash and Cash
Equivalents........... $ 101,000 $ 337,000 $ 5,825,000 $ 1,235,000 $114,143,000 $ 95,827,000
Working Capital
(Deficit)............. (1,896,000) (1,798,000) 6,703,000 (2,451,000) 109,113,000 91,502,000
Total Assets........... 3,375,000 3,758,000 12,863,000 13,173,000 127,348,000 113,932,000
Long-term Debt Less
Current Portion....... 2,989,000 250,000 635,000 2,769,000 4,036,000 3,942,000
Capital Lease
Obligations Less
Current Portion....... 341,000 163,000 60,000 1,421,000 2,014,000 2,178,000
Accumulated Deficit.... (5,853,000) (10,321,000) (17,103,000) (30,922,000) (60,350,000) (74,575,000)
Stockholders' Equity
(Deficit)............. (1,955,000) 1,176,000 9,846,000 3,806,000 114,667,000 101,301,000
</TABLE>
- -------
(1) Pro Forma Net Loss Per Share for the years ended December 31, 1994 and
1995 and the six-month period ended June 30, 1995 is set forth on a pro
forma basis to give effect to the conversion of all convertible preferred
stock into Common Stock upon consummation of the IPO. The six-month period
ended June 30, 1996 is presented on a historical basis. See Note 1 of the
Notes to the Company's Consolidated Financial Statements.
17
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
OVERVIEW
The Company's principal activities since its founding in 1988 have been
research and product and organizational development. The Company was
established to develop, manufacture and market systems for computer-assisted
screening of Pap smears and other cytological specimens. The Company's
revenues have been derived primarily from (i) sales of PAPNET(R) testing
services, (ii) sales of License Agreements (prior to 1992) and (iii) interest
income.
The PAPNET(R) Testing System was approved by the FDA for commercial use in
the United States on November 8, 1995. Prior to that time, the PAPNET(R)
Testing System was permitted to be utilized in the United States on an
investigational basis only, and the Company was permitted to derive revenue
with respect thereto only to recover certain of its costs. The Company,
however, was previously selling PAPNET(R) testing services for commercial use
outside of the United States. The Company has established three designated
facilities (the "Scanning Centers"), one each in the United States, The
Netherlands and Hong Kong. The Netherlands operation has scanned slides from
customers in Europe, South Africa and Canada, while the Hong Kong operation
has scanned slides from Asia and Australia. See Note 5 to the Company's
Consolidated Financial Statements for the year ended December 31, 1995,
included herein, for information regarding the Company's revenues, net loss
and identifiable assets by geographic area.
The Company has incurred net losses since inception through June 30, 1996 of
$74,575,000 and has to date generated only limited commercial revenues.
Because the PAPNET(R) Testing System has now been approved by the FDA, the
Company is increasing the scale of its operations to commercial levels in the
United States. Management of the Company believes that its existing cash
resources will be sufficient to fund the increase in the scale of the
Company's operations and to meet its cash requirements during the
commercialization process. The Company's past results of operations reflect
its developmental or early commercial stage and are not necessarily indicative
of the results from operations that may be expected as the scale of its
operations increases.
Statements in this discussion which are not historical facts, including
statements about the Company's confidence and strategies and its expectations
about demand for and acceptance of the PAPNET(R) Testing System are forward
looking statements that involve risks and uncertainties. These include, but
are not limited to, the Company's reliance on a single product, competition,
dependence on key personnel, the impact on the Company of its territorial
license agreements, dependence on patents and proprietary technology,
government regulation of both products and advertising, limited marketing and
sales history, the impact of third-party reimbursement decisions, risk of
litigation and other risks detailed herein. See "Risk Factors."
RESULTS OF OPERATIONS
The Company's results of operations have fluctuated significantly from year
to year and quarter to quarter, principally due to variations in the level of
expenditures relating to its clinical trials, research projects, marketing and
sales programs and international expansion. The Company's results of
operations are expected to continue to fluctuate significantly and may
continue to result in substantial losses.
From inception through June 30, 1996, the Company experienced negative gross
margins due to the significant underutilization of its scanning and
manufacturing operations which occurred as a result of the need to establish
these capabilities prior to FDA approval and the anticipated expansion of the
Company's marketing and sales activities since such approval.
18
<PAGE>
The Company expects that costs and expenses will increase significantly in
the second half of 1996 and during 1997 as the Company expands its commercial
operations, including marketing, sales, manufacturing, slide processing,
royalty payments, research and administrative activities, to meet the
anticipated increase in market demand.
To establish PAPNET(R) testing in the United States as the standard of care
in Pap smear analysis, the Company is executing a three-step sequential
marketing approach that targets (i) its direct clients, the clinical
laboratories that perform Pap smear testing, (ii) gynecologists and those
primary care physicians and other clinicians who take Pap smears and can order
PAPNET(R) testing and (iii) women, to encourage them to request PAPNET(R)
testing or to agree to it if it is recommended by a clinician. The Company
believes that significant revenue growth in the United States depends upon
effective marketing to all three target audiences.
The Company planned to begin direct-to-consumer advertising after it
determined that an adequate distribution network of laboratories was
established and that clinician awareness of the PAPNET(R) test was sufficiently
high to motivate clinicians to prescribe or recommend the test. During the
second quarter of 1996 the Company made significant progress in building
laboratory distribution and physician awareness. Accordingly, the Company
initiated direct-to-consumer advertising in August of 1996, while continuing to
market to laboratories and clinicians. The Company is also marketing to
insurers, managed care organizations and other third-party payers concerning
reimbursement for PAPNET(R) testing.
In addition, in September 1996, the Company entered into a co-promotion
agreement with the Women's Healthcare Group of the Parke-Davis division of
Warner-Lambert Company. According to the terms of that agreement, members of
the Parke-Davis field sales force will present PAPNET(R) testing promotional
materials to physicians when making sales calls regarding Parke-Davis
Loestrin(R) oral contraceptives. Although the Company does not expect that
Parke-Davis's activities will have a significant direct impact on sales, the
Company anticipates that this program will increase awareness of PAPNET(R)
testing in the clinician's office, and that interested doctors will contact the
Company's own sales representatives for more detailed presentations. Activities
under the agreement are scheduled to begin in October 1996 after the Parke-
Davis sales force has been provided with PAPNET(R) product training and
educational materials. The co-promotional effort is expected to continue into
early 1997.
Interest expense is expected to increase in the future as the Company borrows
to fund expansion of its manufacturing, slide processing and marketing
capabilities, including the installation of additional PAPNET(R) Scanning
Stations at the Company's Scanning Centers. It is expected that this increase
will continue to be substantially offset during 1996 by the interest income
from the investment of the Company's cash, including the proceeds of the
Company's IPO.
The impact of inflation and changing prices on the Company's revenues and
costs has not been significant.
FOR THE SIX-MONTH PERIODS ENDED JUNE 30, 1996 AND 1995
Total revenues for the six months ending June 30, 1996 were $1,668,000, an
increase of 56% from $1,067,000 during the corresponding period of 1995. This
increase was due primarily to higher unit pricing in 1996 compared to 1995 and
to increased unit volume in the United States.
The Company's efforts during the first half of 1996 were focused on building
distribution for PAPNET(R) testing in the United States, which involves
training cytotechnologists and pathologists and equipping laboratories, as well
as educating gynecologists in areas where there are laboratories that can
provide PAPNET(R) testing. During the quarter ended June 30, 1996, PAPNET(R)
testing became available through 49 additional laboratories, bringing the total
number of sites able to provide the PAPNET(R) test to 138 by the end of the
quarter.
During the second quarter of 1996, in the United States, the Company scanned
Pap smears from 75 different laboratories in 34 states. The Company increased
its world-wide marketing and sales
19
<PAGE>
headcount by twelve to a total of 53 persons during the quarter. The Company
expects to continue to expand its marketing and sales personnel during the
second half of 1996, which will increase the number of sales personnel calling
on both laboratories and clinicians.
Revenue increased during the six-month period ending June 30, 1996, compared
to the corresponding period of 1995, in the United States and internationally.
The rate of increase internationally was reduced by a decline in revenue in
Canada that was due primarily to a decision by the Company's client
laboratories in Ontario, Canada to begin processing slides only for patients
who would pay for the PAPNET(R) test, rather than testing a specified minimum
number of slides each month.
Total costs and expenses for the six-month period ending June 30, 1996 were
$17,632,000, compared to $9,929,000 during the corresponding period of 1995,
an increase of $7,703,000. This increase was primarily the result of higher
sales and marketing expenses, which increased to $7,373,000 in 1996 from
$2,112,000 during the corresponding period of 1995. The increase in sales and
marketing expenses of $5,261,000 was due primarily to costs associated with
the launch of the PAPNET(R) Testing System in the United States, including
salaries for additional personnel, advertising and promotion costs. In
addition, the Company's cost of sales, research and development and general
and administrative expenses also increased during the first six months of 1996
as compared to the corresponding period of 1995, although at a slower rate
than sales and marketing expenses. These increases were due primarily to the
expansion of the administrative and technical infrastructure of the Company to
support commercial activities in both the United States and overseas, along
with the additional costs of being a public company following the Company's
IPO.
Interest income for the first six months of 1996 was $2,808,000 compared to
$74,000 during the first six months of 1995. This increase was due primarily
to the Company's significantly higher levels of cash and cash equivalent
balances in 1996 as a result of the IPO, equity sales to private investors
during the third quarter of 1995 and the exercise of certain warrants by
investors in December 1995.
Interest expense during the first six months of 1996 was $484,000 compared
to $480,000 during the corresponding period of 1995. There were no material
changes to the level of debt and capital lease obligations between the two
periods.
The Company incurred an unfavorable foreign exchange loss of $585,000 during
the first six months of 1996 compared to a foreign exchange gain of $348,000
during the corresponding period of 1995. Both the 1996 loss and the 1995 gain
were caused by fluctuations in exchange rates on dollar-denominated
intercompany loans.
The Company incurred a net loss during the first six months of 1996 of
$14,225,000 compared to a net loss of $8,920,000 during the same period of
1995. The increased net loss was due primarily to the increase in marketing
and sales expenses and to the expansion of the Company's administrative and
technical infrastructure relating to the commercial launch of the PAPNET(R)
Testing System in the United States.
FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993
Total revenues for the year ended December 31, 1995 were $2,475,000, an
increase of $1,237,000 from the 1994 level of $1,238,000. This increase was
due to the expansion of the Company's sales in international markets and
expanded investigational use of the PAPNET(R) Testing System in the United
States. Total revenues for the year ended December 31, 1994 were $1,238,000
compared to $502,000 for 1993. This increase primarily reflects the
establishment of new marketing operations in Europe, Hong Kong, Canada and
Mexico and the generation of limited investigational revenues in the United
States.
Total costs and expenses for the year ended December 31, 1995 were
$31,687,000 compared to $14,837,000 in 1994. This increase was the result of
increases in research and clinical development
20
<PAGE>
programs associated with the support of the Company's FDA application,
expansion of the Company's marketing, slide processing and manufacturing
capabilities in anticipation of launching the PAPNET(R) Testing System in the
United States and other countries, expansion of the administrative
infrastructure needed to support commercial activities, approximately $800,000
of employee bonus awards and the expense of two non-cash charges totaling
$7,752,000 that were recognized in the fourth quarter of 1995. One of these
non-cash charges, in the amount of $1,652,000, resulted from the terms of a
settlement agreement entered into with the Licensees in December 1995. The
other non-cash charge, in the amount of $6,100,000, related to the vesting of
568,058 employee performance stock options upon the completion of the IPO.
Total costs and expenses were $14,837,000 for the year ended December 31, 1994
compared to $6,781,000 for 1993. This increase was the result of higher
expenses for research and development of the Company's PAPNET(R) Testing
System and costs associated with filing the Company's FDA application, higher
manufacturing costs due to increased production volumes of the Company's
PAPNET(R) Testing System and the establishment of the manufacturing facility
in Israel, increased sales and marketing expenses associated with the
establishment of operations in Europe and Hong Kong and additions to the
Company's management team in various functional areas.
Interest income for the year ended December 31, 1995 was $548,000 compared
to $170,000 in 1994. This change was primarily related to higher average cash
and cash equivalent balances during 1995, mostly associated with the IPO,
equity sales to private investors and the exercise of certain warrants by
investors. Interest income was $170,000 in 1994 compared to $59,000 in 1993.
This increase was due primarily to corresponding fluctuations in the levels of
cash, cash equivalents and short-term investments resulting from the issuance
of equity securities.
Interest expense for the year ended December 31, 1995 was $924,000 compared
to $393,000 in 1994. This increase was primarily the result of additional debt
incurred to finance capital equipment additions, primarily related to the
Company's PAPNET(R) Scanning Stations and to government guaranteed loans
received under the State of Israel "Approved Enterprise" program. Interest
expense was $393,000 for the year ended December 31, 1994 compared to $562,000
for 1993. This decrease was primarily due to the recognition of $300,000 of
interest expense in 1993 in connection with a settlement agreement under which
the Company repurchased shares of its common stock from certain former
stockholders, offset partially by an increase primarily associated with
additional debt incurred to finance the Company's production and installation
of PAPNET(R) Scanning Stations.
The Company recorded a foreign exchange gain of $160,000 during 1995
compared to $3,000 in 1994. Both the 1995 gain and the 1994 gain were caused
by fluctuations in exchange rates on dollar-denominated intercompany loans.
LIQUIDITY AND CAPITAL RESOURCES
The Company has financed its operations since its inception primarily by the
issuance of equity securities, sales of PAPNET(R) Testing System services,
funds received for the License Agreements (prior to 1992), interest earned on
cash, cash equivalents and short-term investments and proceeds from notes,
bank loans and equipment leasing arrangements.
The Company's combined cash and cash equivalents totaled $95,827,000 at June
30, 1996, a decrease of $18,316,000 from December 31, 1995. During the first
six months of 1996, the Company used $13,305,000 for operating activities,
$5,126,000 for investing activities and a net use of $481,000 for financing
activities, including the deposit of $1,250,000 of cash into a restricted
certificate of deposit as security collateral on a letter of credit for the
lease of the Company's new scanning facility in New Jersey.
The primary uses of cash and cash equivalents during the first six months of
1996 were $14,225,000 (inclusive of $1,628,000 of non-cash expenses) to
finance the Company's net loss,
21
<PAGE>
$5,126,000 to purchase capital equipment, primarily for the manufacture of
PAPNET(R) Scanning Stations to support the expansion of the Company's
commercial activities, $1,113,000 to repay notes, bank loans and capital lease
obligations, the aforementioned deposit of $1,250,000 of cash into a
restricted certificate of deposit as security collateral on a letter of credit
and $708,000 to finance changes in operating assets and liabilities.
The primary sources of cash and cash equivalents during the first six months
of 1996 were $962,000 from proceeds of lease finance transactions (sale/lease-
backs), proceeds of $595,000 from notes and bank loans and $325,000 from the
issuance of common stock, primarily associated with the exercise of Common
Stock warrants and options. Changes to the components of working capital and
other items accounted for the remainder of the net change in cash and cash
equivalents.
During the year ended December 31, 1995, the Company used $16,799,000 for
operating activities and $5,008,000 for investing activities, while generating
$134,950,000 from financing activities, primarily from the sale of equity
securities and the exercise of certain warrants by investors. The primary uses
of cash and cash equivalents during the year ended December 31, 1995 were
$29,428,000 (inclusive of $10,898,000 of non-cash expenses) to finance the
Company's net loss, $5,008,000 to purchase capital equipment, primarily for
the manufacture of PAPNET(R) Scanning Stations to support the expansion of the
Company's commercial activities and $1,647,000 to repay notes, bank loans and
capital lease obligations. The primary sources of cash and cash equivalents
during 1995 were $19,325,000 from the issuance of convertible preferred stock
to private investors (all of which automatically converted into Common Stock
upon the consummation of the IPO), $18,500,000 from the exercise of warrants
by investors, $1,354,000 from proceeds of lease finance transactions
(sale/lease-backs), $1,774,000 from notes and bank loans and $94,725,000 from
the IPO. Changes to the components of working capital and other items
accounted for the remainder of the net change in cash and cash equivalents.
During the year ended December 31, 1994, the Company used $10,962,000 for
operating activities, primarily to fund the 1994 net loss of $13,819,000
(inclusive of $1,915,000 of non-cash expenses). In addition, the Company
invested $7,295,000 to purchase property and equipment, primarily related to
the expansion of the Company's overseas facilities and the manufacture of
PAPNET(R) Scanning Stations and related equipment. The Company was able to
offset partially its operating and investing cash requirements through various
financing activities, including the issuance of $7,500,000 of convertible
preferred stock to investors (all of which automatically converted into Common
Stock upon the consummation of the IPO) and proceeds from additional debt and
equipment financing arrangements of $4,675,000. Changes to the components of
working capital and other items accounted for the remainder of the net change
in cash and cash equivalents.
The significant increase in cash used for operations during 1994 and 1995,
when compared with earlier years, is primarily the result of higher expenses
for research and clinical development programs associated with the filing and
support of the Company's FDA application, expansion of the Company's
marketing, slide processing and manufacturing capabilities in anticipation of
launching the PAPNET(R) Testing System in the United States and other
countries, expansion of the administrative infrastructure needed to support
commercial activities, higher manufacturing costs due to increased production
volumes of the Company's PAPNET(R) Testing System and the establishment of the
Company's manufacturing facility in Israel and slide processing centers in The
Netherlands and Hong Kong.
As of December 31, 1995, the Company's debt and capital lease obligations
totaled $7,313,000. The amount of combined payments of the outstanding debt
and capital lease obligations including related interest for the five years
succeeding December 31, 1995 was approximately $1,558,000 in 1996, $2,037,000
in 1997, $2,941,000 in 1998, $1,166,000 in 1999 and $111,000 in 2000. The
Company's commitments for payments under non-cancelable operating leases for
the five years succeeding December 31, 1995 are approximately $1,176,000 in
1996, $1,156,000 in 1997, $828,000 in 1998, $585,000 in 1999 and $219,000 in
2000.
22
<PAGE>
The Company anticipates that its use of cash will be substantial for the
foreseeable future. In particular, the Company anticipates that expenditures
will continue to increase significantly in 1996 and 1997 due to the cost of
the marketing launch of the PAPNET(R) Testing System in the United States, the
increased cost of marketing and sales programs in overseas markets and the
expansion of research and development programs for additional clinical
indications and claims. The Company estimates that, during 1996, it will
invest approximately $5.0 million for working capital purposes and
approximately $13.0 million for capital expenditures and leasehold
improvements, primarily associated with the manufacture or purchase of
PAPNET(R) Scanning Stations and related equipment, PAPNET(R) Review Stations
and facility leasehold improvements. Although funding for these capital
expenditures is expected to be available out of the Company's cash resources,
management of the Company believes that it may be desirable for the Company to
finance certain of such capital expenditures through additional debt or
capital lease obligations. There can be no assurance, however, that such
financing can be obtained by the Company or, if it is obtained, that the terms
thereof will be reasonable.
The Company anticipates that its current cash and cash equivalents will be
sufficient to enable the Company to meet its future operating requirements.
The Company, however, does not expect to generate a positive internal cash
flow in the foreseeable future due to the expected increases in capital
expenditures, working capital requirements and ongoing losses during the next
year, including the expected cost of commercializing the PAPNET(R) Testing
System. The Company may need to arrange additional equity or debt financing
for the future operation of its business. There can be no assurance that such
financing can be obtained or, if it is obtained, that the terms thereof will
be reasonable. The Company plans to invest excess funds in short-term
instruments, including money market funds.
For the six months ending June 30, 1996, the Company's operating results
reflect foreign exchange losses of $585,000 and its financial position as of
that date reflects a foreign currency translation effect of $311,000. As
discussed in detail below, the Company is subject to foreign currency exchange
rate risk because (i) it has investments in its foreign subsidiaries, (ii) it
derives a significant portion of its revenues and incurs a significant portion
of its costs and expenses in the local currencies of the countries in which
its subsidiaries are transacting business and (iii) it finances the operations
of such subsidiaries substantially through dollar-denominated intercompany
loans which are recorded on the books of the subsidiaries in their respective
local currencies. Fluctuations in exchange rates have not had a material
impact on the Company's revenues or costs and expenses, but have affected the
value of its equity investments and intercompany loans.
At December 31, 1995, the Company had available United States net operating
loss carryforwards of approximately $39,600,000 that will expire in the years
2004 through 2010 and cumulative deductible temporary differences of
approximately $8,000,000. The Company also has foreign net operating losses of
approximately $5,000,000 that are available to offset the separate taxable
incomes of certain foreign subsidiaries. These losses may be carried forward
indefinitely. In addition, at December 31, 1995, the Company also had
approximately $950,000 of United States research and development credits
available which will expire in the years 2004 through 2010. The Tax Reform Act
of 1986 enacted a complex set of rules limiting the potential utilization of
United States net operating loss carryforwards and tax credit carryforwards in
periods following a corporate "ownership change." In general, an ownership
change is deemed to occur if the percentage of stock of a loss corporation
owned (actually, constructively and, in some cases, deemed) by one or more "5%
Stockholders" has increased by more than 50 percentage points over the lowest
percentage of such stock owned during a three-year testing period. As a result
of changes in the Company's ownership, the utilization of a substantial
portion of the Company's available United States net operating loss
carryforwards and tax credit carryforwards will be subject to annual
limitations. It is management's belief, however, that, since such annual
limitations are determined based on the value of the Company immediately prior
to the ownership changes, a significant portion of the carryforwards will be
available annually should the Company become profitable in future tax years.
23
<PAGE>
From inception through June 30, 1996, the Company's sales of PAPNET(R)
testing services for commercial use have been derived principally from foreign
sources. Although the Company expects United States revenues to increase
faster than non-United States revenues, the Company anticipates that
international sales will continue to represent a significant portion of its
net sales as it executes its plan to establish commercial use of the PAPNET(R)
Testing System on a worldwide basis. In addition, Neuromedical Systems, Inc.,
the United States parent company, has provided a significant portion of the
financing required for its subsidiaries in the Netherlands, Australia, Israel
and Hong Kong through intercompany loans and equity investments denominated in
United States dollars. As a result of its international operations and its
current financing approach, the Company's operating results are subject to the
impact of fluctuations in exchange rates of the currencies in which its
foreign operations conduct business versus the United States dollar. The
Company is exposed to gains and losses with respect to Australian dollars and
several European currencies (predominately Dutch guilders) because the
Company's subsidiaries invoice for slide processing services and incur costs
and expenses in local currencies. Certain of the Company's and its
subsidiaries' revenues and expenses are in Hong Kong dollars and Israeli
shekels, the values of which are presently tied to the United States dollar
and, therefore, are not currently subject to material fluctuations. There can
be no assurance, however, that the exchange rate between the United States
dollar and these currencies will not fluctuate in the future. To date, the
Company has not implemented a program to hedge its foreign currency risk, but
may do so in the future.
On December 4, 1995, the Company was served with a Summons and Complaint in
an action entitled Herbst et al. v. Neuromedical Systems, Inc. et al., in the
Supreme Court of the State of New York. The plaintiffs in this suit allege,
among other things, that pursuant to written contracts, which they claim the
Company has breached, they were entitled to be issued warrants exercisable for
the purchase of approximately 128,000 shares of common stock at various
prices. They further allege that the Company and certain of its officers and
directors made fraudulent misrepresentations and took other allegedly improper
actions that diminished the value of the warrants they claim they are entitled
to under these contracts. On January 31, 1996, the plaintiffs served the
Company with an Amended Complaint alleging legal claims similar to those in
the original Summons and Complaint served on the Company, but adding one of
the Company's former directors as a defendant and specifying that the
plaintiffs are seeking compensatory damages from the Company and one of its
officers and a former director totaling $114 million and punitive damages
totaling $175 million. The defendants have moved to dismiss the Amended
Complaint. Such motion is currently under consideration by the court. The
Company intends to vigorously defend this action. The Company believes that,
in any event, the damages claimed bear no relation to the harm alleged and
believes an adverse judgment in this case would not have a material adverse
effect on the Company's operations, financial position or cash flows.
On July 15, 1996, the Company filed a lawsuit against NeoPath, a competitor
of the Company (see "Business--Competition"), in the United States District
Court for the Southern District of New York, seeking damages and injunctive
relief for patent infringement, false advertising, unfair competition,
intentional interference with business relations and damage to business
reputation. In the lawsuit, the Company alleges that NeoPath willfully
misappropriated the Company's patented technology and used such technology in
NeoPath's AutoPap(R) System. The Company also alleges that NeoPath falsely
characterized and made misleading comparisons to consumers and securities
analysts of the AutoPap(R) System and the Company's PAPNET(R) Testing System.
NeoPath has denied all allegations and, in addition, it has filed counter-
claims against the Company seeking damages and injunctive relief for false
advertising and unfair competition. In the counter-claims, NeoPath alleges
that statements made by the Company characterizing the performance of the
PAPNET(R) Testing System, and its effectiveness relative to NeoPath's
AutoPap(R) System, as well as other statements, are false and misleading and
constitute misrepresentations. The Company believes that NeoPath's assertions
are without merit. Although the duration, costs and ultimate outcome of this
lawsuit are unknown, the Company expects that the costs of this lawsuit will
be significant during 1996 and 1997.
24
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BUSINESS
OVERVIEW
Neuromedical Systems, Inc. is a healthcare technology company focused on
diagnostic screening applications to aid in the early detection of certain
cancers. During the past five years, the Company and its subsidiaries have
been primarily engaged in the development, manufacturing and marketing of the
PAPNET(R) Testing System, and the scanning of cervical smears at its slide
processing facilities. The Company's first and, to date, only product, the
PAPNET(R) Testing System, was approved for commercial use in the United States
by the FDA on November 8, 1995 and, in January 1996, the Company initiated the
first two stages of its United States marketing program, to laboratories and
clinicians. As of August 31, 1996, the PAPNET(R) test was available through
approximately 140 laboratories in the United States alone. While continuing to
market to laboratories and clinicians, the Company initiated the third stage
of its United States marketing program, direct-to-consumer advertising, in
August 1996. See "--Marketing." The Company's objective is to establish the
use of its PAPNET(R) Testing System as the new standard of care in cervical
cancer screening.
The PAPNET(R) Testing System is a supplemental test to aid laboratories in
the detection of abnormal cells on Pap smears which were not detected by
standard manual microscopic inspection. When used to supplement manual
screening of Pap smears, PAPNET(R) testing has been shown to increase the
detection of cervical abnormality by up to 30% when compared to manual
screening with routine manual quality control rescreening. The Company
believes that this improved detection can result in more effective and less
costly early treatment, reduced morbidity and mortality for patients and
reduced possibility of malpractice litigation for the patient's doctor and
laboratory. The PAPNET(R) Testing System can achieve these improvements
without requiring a modification of the standard Pap smear sample due to its
use of a patented combination of algorithmic and adaptive pattern recognition
technology, a form of artificial intelligence. The Company and its
subsidiaries manufacture the PAPNET(R) Testing System and market and provide
processing services which utilize the PAPNET(R) Testing System.
Pap smears are widely used in North America, Europe and other developed
areas to aid in the early detection of cervical cancer and precancerous
conditions. The Company estimates that there are more than 50 million Pap
smears screened annually in the United States alone. Pap smears can reveal
early changes in cervical cells that precede or indicate the development of
cancer, thereby facilitating timely medical intervention. The Company
estimates that more than 2,000,000 cases of precancerous cervical
abnormalities are diagnosed in the United States annually. The American Cancer
Society projects that, in 1996, there will be approximately 15,700 new cases
of invasive cervical cancer diagnosed in the United States and projected that,
in 1995, there would be approximately 65,000 cases of cervical carcinoma in
situ. Women diagnosed with carcinoma in situ typically are treated with either
extensive conization (removal of a portion of the uterus) or by hysterectomy,
and women diagnosed with invasive cervical cancer are treated with
hysterectomy and/or radiotherapy. Notwithstanding such treatments,
approximately 4,900 women are expected to die of the disease in the United
States in 1996. Outside of the United States, where cervical cancer screening
is less prevalent, more than 450,000 new cases of cervical cancer are
diagnosed each year. Almost all deaths due to cervical cancer could be
prevented with early-stage detection and treatment.
When precancerous conditions are detected on Pap smears, they are usually
treatable using simple procedures in the physician's office. If abnormal cells
on the Pap smear are not detected by the laboratory, however, the patient may
be incorrectly told that her Pap smear is negative, and significant morbidity
(including, for example, hysterectomies) or mortality may occur as a result.
In addition, when a laboratory does fail to diagnose a positive Pap smear
correctly, its defense of any resulting lawsuit may be difficult, because all
Pap smear slides are retained in the laboratory's archive for five years
pursuant to federal law and therefore are available for re-examination.
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Unlike most other high-volume laboratory tests, the cytological evaluation
(the visual examination of cells) of the cervical Pap smear is performed
manually. Specially trained medical technicians, known as cytotechnologists,
screen up to 100 Pap smears per day using standard light microscopes, usually
at 100x magnification. Each of these smears may contain hundreds of thousands
of normal cells. The few smears that are abnormal may contain only a small
number of abnormal cells (as few as 20) scattered among the vast number of
normal cells. The manual screening of Pap smears has been appropriately
characterized as extremely taxing and inherently prone to error, and has often
been compared to searching for a needle in a haystack or to proofreading a
long document to find a few spelling errors. As a result, manual screening
false-negative rates ranging from 10% to 40% of true positives have been
commonly reported in the medical literature over the last 20 years. See "--The
Cervical Pap Smear Problem."
The PAPNET(R) Testing System is a computerized image processing service
provided to laboratories. The laboratory performs PAPNET(R) testing when
specifically requested by clinicians, patients or third-party payers who wish
to minimize the probability of false negatives and their attendant medical and
legal consequences. Slides first diagnosed by a laboratory as "negative" using
manual inspection are sent to Scanning Centers for imaging on a PAPNET(R)
Scanning Station, which is designed to inspect the hundreds of thousands of
cells and other objects on the slide. The PAPNET(R) Scanning Stations'
proprietary neural network computers are designed to select color images of
128 potentially abnormal cells and cell clusters from each slide for detailed
video review (whether or not they are, in fact, abnormal). These 128 images
from each slide are recorded on a digital tape cassette which is returned to
the client laboratory within two to four working days along with the referred
Pap smear slides.
At the laboratory, a certified cytotechnologist specially trained in the use
of the PAPNET(R) Testing System evaluates the 128 color images from each slide
on the PAPNET(R) Review Station. The PAPNET(R) Review Station's software
ensures that the cytotechnologist displays each image at 200x magnification
(twice normal screening power) and permits the user to expand any image to
400x magnification. If all of the images appear normal, the cytotechnologist
classifies the slide as "negative," and no further examination is required.
The Company has found that cytotechnologists experienced in the use of the
PAPNET(R) Review Station can review negative cases in substantially less time
than it takes to perform a conventional manual re-examination.
If any one of the 128 images appears to the cytotechnologist to be abnormal,
the cytotechnologist classifies the slide as "review." The cytotechnologist
then refers to the "x, y" coordinates provided with each PAPNET(R) image and
uses the coordinates as a reference point to re-examine the slide directly
through the microscope. If, after direct inspection, the cytotechnologist
continues to believe that the slide contains abnormal cells, he or she refers
the slide to the laboratory's pathologist for a final diagnosis. In no case
does the Company or the PAPNET(R) Testing System make a diagnosis of a slide
or smear.
The PAPNET(R) Testing System is used as a supplement to current practice and
does not alter the clinician's procedure for the taking of smears or the
laboratory's method of staining or applying the coverslip. It provides an
additional and complementary level of screening for the purpose of decreasing
false negative Pap smear diagnoses.
The clinical trial conducted to support the Company's FDA application
involved a study of more than 10,000 Pap smears originally classified as
"negative" and retrieved from laboratory archives. The trial measured the
ability of PAPNET(R) testing to detect missed abnormalities on "negative"
smears from a population of women who had negative Pap smear histories but
nevertheless subsequently developed high grade lesions or invasive cervical
cancer (the "Case" group), and was also used to re-examine a series of routine
"negative" smears (the "Control" group). The trial results indicated that,
when used as an adjunct to manual screening, PAPNET(R) testing can increase
the aggregate cervical
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abnormality detected by up to 30% when compared to the combination of manual
screening and routine manual quality control rescreening. The trial results
also demonstrated that PAPNET(R) testing detected an abnormality which had
been originally missed by manual screening for 31.6% of the Case patients. For
91.7% of such women, PAPNET(R) testing would have found the abnormality more
than a year prior to the biopsy that confirmed the patient's disease, and, for
38.9% of such women, more than two years earlier. See "--Clinical
Effectiveness of the PAPNET(R) Testing System."
The Company is planning additional clinical trials during 1996 for the
purpose of broadening the indicated uses of, and claims that may be made for,
the PAPNET(R) Testing System. In addition, the Company has submitted a pre-
market approval application supplement to the FDA which, if approved, would
permit the Company to claim that PAPNET(R) rescreening detects a greater
number of cervical abnormalities than does routine manual rescreening. There
can be no assurance that such clinical trials will result in new indicated
uses and/or claims or that such pre-market approval application will be
approved.
Management believes that the Company's technology can be adapted for use in
the early detection of cancers occurring at body sites in addition to the
uterine cervix, including the bladder, breast, esophagus, lung, oral cavity
and thyroid. Not all such cancers are commonly the subject of cytological
analysis, and the Company has not yet determined which of these other
applications, if any, it will be able to commercialize. The Company's patents
cover application of its technology to cytological screening for cancers
occurring at all body sites. See "--Potential Future Products."
THE CERVICAL PAP SMEAR PROBLEM
Cancer of the uterine cervix is preceded by a series of precancerous,
curable stages that may progress without symptoms over a period of years until
reaching an invasive stage. Treating uterine cervical cancer after it has
reached the invasive stage becomes more difficult and expensive, and may not
be successful. The Pap test, developed in the 1940s by Dr. George N.
Papanicolaou, is an effective manual screening procedure for the early
detection of precancerous and cancerous conditions of the uterine cervix. The
Pap test's goal is to identify abnormalities that may progress to a life-
threatening condition, thereby triggering medical procedures to prevent or
treat cervical cancer. With early detection, treatment is relatively
inexpensive and almost always successful. According to the American Cancer
Society, the Pap test has been the primary factor in a 70% reduction in the
United States death rate from cervical cancer over the past 40 years.
To obtain a Pap smear, a gynecologist, general practitioner or other
healthcare provider scrapes the surface of a woman's uterine cervix to collect
a sample of cells. The specimen is smeared onto a 1"x 3" glass slide and
preserved with a fixative agent such as alcohol. This Pap smear, along with
patient information, is then sent to a laboratory for staining, the
application of a coverslip, screening and diagnosis.
The most clinically significant type of error in manual Pap smear screening
is the failure to detect abnormal cells on a slide, and the resulting
erroneous classification of the smear as "negative." Studies have indicated
that the false negative rate varies widely, and in some laboratories may be as
high as 40% of true positive smears.
The high rate of false negative Pap smear screening errors is considered to
be a serious women's health problem. Screening errors may result in delayed
treatment for lesions, and may be especially dangerous for women who, for one
reason or another, do not undergo routine Pap smear testing at the recommended
intervals. A false negative smear report for these women, in particular, may
delay diagnosis and may allow the disease to progress with potentially tragic
consequences.
Current federal law requires laboratories to rescreen slides from at least
10% of the laboratory's Pap smears interpreted to be "negative" on initial
manual screening. Such rescreened slides must
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include negative cases selected at random from the total caseload and from
patients or groups of patients that are identified as having a high
probability of developing cervical cancer based on available patient
information.
In addition, when a laboratory does fail to diagnose a positive Pap smear
containing an abnormality correctly, its defense of any resulting lawsuit may
be difficult. Because slides are retained in the laboratory's archive for five
years pursuant to federal law and therefore are available for re-examination,
it is not difficult for a plaintiff to demonstrate that her smear was
misdiagnosed and that she suffered damage as a consequence. Although she must
also establish that the laboratory was negligent in its misdiagnosis,
laboratories often settle such cases rather than argue to a jury that the
misdiagnosis was not the result of negligence.
RECENT TRENDS IN CERVICAL CANCER
Rather than continuing their historical downward trend, invasive cervical
cancer rates in the United States have increased approximately 3% per year
since 1986 among the presumably well-screened population of young, white
women. The National Cancer Institute's report on this new trend states that
the increased cervical cancer rate does not seem to be related to any
systematic change in the method of collection or screening of Pap smears.
Scientists are uncertain what the reasons are for the reversal of this
downward trend. There are several potential explanations for this increased
incidence of and mortality from cervical cancer, any one of which increases
the need for accurate screening of Pap smears. These include (i) increased
exposure to Human Papilloma Virus ("HPV"), (ii) emergence of a new subset of
cervical neoplasia (i.e., precancerous or cancerous abnormality) which is more
virulent and/or more easily escapes Pap smear detection and (iii) screening
failures, due to changes in the presentation of abnormal cells on the slide,
causing detection by means of conventional screening to be more difficult,
resulting in false negative smears and delayed diagnoses.
The global spread of infection with HPV is implicated as one causal agent in
cervical cancer. In 1993, it was reported that HPV was the most commonly
diagnosed viral sexually transmitted disease in the United States and that it
was the most prevalent sexually transmitted disease among adolescents.
The second potential cause for this increase in cervical cancer rates
relates to the possible emergence of new cervical cancer variants which
progress more rapidly and/or more easily escape detection with current,
conventional screening techniques. In the 1980s, investigators described a
purportedly new type of cervical cancer termed "rapid onset" in which patients
with invasive cervical cancer had a "negative" Pap smear within the prior
three years. Some of these studies reported that a significant and growing
proportion of invasive cervical cancers, from 25% to 33%, followed such a
"rapid onset" pattern.
Certain investigators have questioned whether this new type of cancer
exists. Their studies reviewed the prior, reportedly negative smears from
supposed "rapid onset" cases and found that, in from 25% to 60% of these
cases, these smears contained missed abnormalities (that is, they were false
negatives). Two reported characteristics of these missed abnormalities were
few abnormal cells and very small abnormal cells. These attributes are not
uncommon in serious, advanced precancerous or cancerous lesions, yet may make
detection by conventional, manual screening very difficult.
Regardless of the causes for the increase in cervical cancer in the screened
population, there is an increasing need for greater accuracy in the screening
of Pap smears. The PAPNET(R) Testing System is intended to provide this
capability as a supplemental test for the rescreening of cervical smears
previously reported as "negative" on manual screening.
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THE PAPNET(R) TESTING SYSTEM
The PAPNET(R) Testing System utilizes both algorithmic and adaptive computer
technologies, including neural networks. Neural networks represent a
relatively new computer technology. Instead of the serial (single) path of
programming utilized by conventional computers, neural computers have
thousands of adaptively-formed paths linked in parallel, comprising a network
conceptually similar to the network of neurons in the human brain. Neural
networks can process immense quantities of information while mimicking the
neurological ability to learn from experience. After training on images of a
series of "abnormal" and "normal" cells, a neural network can recognize
abnormal cells even though they differ considerably from the training set.
Neural networks excel at solving complex pattern-recognition problems. Because
the PAPNET(R) Testing System includes neural networks, it can differentiate
abnormal cells from the overlapping normal cells, debris, lymphocytes, blood
and neutrophils found on the conventionally prepared Pap smear slide.
The PAPNET(R) Testing System searches for abnormal cells which may have been
missed on initial, manual screening. By isolating, magnifying and centering
for review 128 potentially abnormal cells and cell clusters, the PAPNET(R)
Testing System addresses an aspect of the cervical smear screening process
which affects the false negative rate: fatigue associated with the needle in a
haystack, repetitive search for a small number of abnormal cells distributed
among the hundreds of thousands of normal cells. The PAPNET(R) Testing System
is designed to be inherently safe, because it is to be used only to aid in the
rescreening of slides which are diagnosed by manual inspection to be
"negative" and which would otherwise be sent to the laboratory's archive
without further examination. The system is semi-automated in that it does not
attempt to provide a diagnosis, but only points out potentially abnormal cells
to the cytotechnologist, thus enhancing the ability of trained
cytotechnologists to evaluate and interpret cytological evidence.
The PAPNET(R) Testing System includes two major subsystems: the PAPNET(R)
Scanning Station (and related equipment) and the PAPNET(R) Review Station. The
PAPNET(R) Scanning Stations are all located at Scanning Centers owned and
operated by the Company. The PAPNET(R) Review Stations are located at the
customers' laboratories.
The PAPNET(R) Scanning Station is the largest and most important component
of the PAPNET(R) Testing System. It scans each barcoded and labeled slide to
select and record color images of 128 cells and cell clusters deemed by the
Scanning Station's algorithmic and neural network computers to be among the
most potentially abnormal (whether or not the slide in fact contains
abnormality). The images are copied onto digital tape and returned with the
slides to the laboratory.
The PAPNET(R) Review Station is based upon personal computer technology and
includes a large, high-resolution monitor, digital tape drive and the
Company's proprietary PAPNET(R) Review Station software.
CLINICAL EFFECTIVENESS OF THE PAPNET(R) TESTING SYSTEM
Federal law requires laboratories to retain all Pap smears in their archives
for at least five years after the initial screening of the Pap smear. Because
the PAPNET(R) Testing System examines conventional smears and is generally
unaffected by differences in staining, it was possible to retrieve archived
smears that were years old and rescreen them as the basis for clinical trials.
The Company designed a study using archived Pap smears (i) to estimate the
percentage of women with high grade or malignant cervical lesions who could
have had an abnormality identified earlier using PAPNET(R) testing, (ii) to
estimate how many months prior to the positive biopsy an earlier abnormality
could have been detected by PAPNET(R) testing and (iii) to measure the
increased detection of abnormal smears afforded by supplementing conventional
microscopic screening with PAPNET(R) testing.
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The principal PAPNET(R) clinical trial demonstrated the system's sensitivity
to missed cervical abnormality on smears originally diagnosed as "negative"
from the Case group and the Control group. This clinical trial formed the
basis of the Company's FDA application, and its results therefore directly
support clinical claims for the PAPNET(R) Testing System. The trial was
longitudinal (i.e., tracked the same group of women over time) and
retrospective (i.e., investigators reviewed archived specimens from prior
years). In addition, the study utilized the "gold standard" of certainty for a
clinical outcome, a biopsy confirmation of high grade or invasive cervical
lesions.
The trial was conducted at nine academic institutions and one commercial
laboratory, all within the United States. The clinical trial was monitored and
its results were analyzed by the Company's outside contract research
organization.
Patients with a high grade or invasive lesion from 1985 to 1992 and a
cervical smear originally diagnosed as "negative" were included as Case
patients. All available "negative" smears from each Case patient prior to the
positive biopsy were included in the trial. For each such Case "negative"
smear, the subsequent 20 "negative" smears in the laboratory's archive were
collected and included as Control smears. This 20 to one ratio was designed to
hide from the reviewing cytotechnologists the status of the Case or Control
patient slides.
There were over 10,000 "negative" smears included in the trial. The smears
were randomized and their identities masked. The smears were scanned on
PAPNET(R) Scanning Stations and returned with PAPNET(R) digital image tapes to
the originating institution. A cytotechnologist at each institution used a
PAPNET(R) Review Station to evaluate the images selected from each smear and
microscopically examined those smears classified for "review." Finally, if the
smear was judged by the cytotechnologist to display sufficient abnormality
upon microscopic examination, it was referred to the institution's
investigating pathologist for final diagnosis.
The trial results indicated that, when used as an adjunct to manual
screening, PAPNET(R) testing can increase the aggregate cervical abnormality
detected by up to 30% when compared to the combination of manual screening and
routine manual quality control rescreening. The trial results also
demonstrated that PAPNET(R) testing detected an abnormality which had been
originally missed by manual screening for 31.6% of Case patients. For 91.7% of
such women, PAPNET(R) testing would have found the abnormality more than a
year prior to the biopsy that confirmed the patient's disease, and, for 38.9%
of such women, more than two years earlier.
MARKETING
The Company's objective is to establish the use of PAPNET(R) testing as the
new standard of care in cervical cancer screening. The Company believes that
the PAPNET(R) system's design, clinical claims and performance distinguish it
from both current practice and competitive products. Specifically, the Company
intends to market the system to laboratories, clinicians and women as a
separate, adjunctive test that, when combined with conventional manual Pap
smear screening, increases the aggregate detection of cancer and pre-cancerous
conditions of the cervix.
UNITED STATES MARKETING. The Company believes that the United States
represents the single largest market for PAPNET(R) testing. To establish
PAPNET(R) testing in the United States as the standard of care in Pap smear
analysis, the Company is executing a three-step sequential marketing program
that targets (i) its direct clients, the clinical laboratories that perform
Pap smear testing, (ii) gynecologists and those primary care physicians and
other clinicians who take Pap smears and can order PAPNET(R) testing and (iii)
women, to encourage them to request PAPNET(R) testing or to agree to it if it
is recommended by a clinician. The Company believes that significant revenue
growth in the United States depends upon effective marketing to all three
target audiences. The Company has also
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begun discussions with insurers, managed care organizations and other third-
party payers concerning reimbursement for PAPNET(R) testing.
In order to make PAPNET(R) testing available to patients nationwide, the
Company first marketed PAPNET(R) testing to its prospective direct clients,
the laboratories in the United States that screen Pap smears. In January 1996,
the Company initiated its marketing program to laboratories following FDA
approval. In order for a laboratory to provide PAPNET(R) testing to its
clients, gynecologists and other clinicians who take Pap smears, the
laboratory must purchase or lease a PAPNET(R) Review Station and arrange for
its cytotechnologists and pathologists to take the Company's training course
in the use of the PAPNET(R) system. The Company's strategy is to establish
prices for the Review Station and training so that it will be feasible for
laboratories of virtually any size to become providers of PAPNET(R) testing.
Accordingly, the Company anticipates that its primary source of revenue will
be the per-slide charge that it will receive from laboratories for each Pap
smear rescreened on the PAPNET(R) Testing System.
As of August 31, 1996, approximately 140 laboratories in the United States
had been equipped with a PAPNET(R) Review Station and had trained
cytotechnologists to perform PAPNET(R) testing, or are affiliated with other
laboratories that can perform PAPNET(R) testing on a reference basis.
PAPNET(R) rescreening is not yet readily available in all parts of the United
States since the Company has not yet trained cytotechnologists and equipped
laboratories in several metropolitan areas. However, the Company believes that
PAPNET(R) testing is now accessible to women in most parts of the United
States.
In general, the Company does not expect to request that laboratories sign
contracts to provide minimum quantities of slides. Because PAPNET(R)
rescreening is an additional, separate test, however, laboratories will be
able to charge for it in addition to charging for a Pap smear. The Company
believes that, in order for PAPNET(R) testing to emerge as a significant
source of revenue for laboratories that provide it, the Company must create
demand for PAPNET(R) testing among gynecologists, other primary care
physicians and women. Since PAPNET(R) testing will be requested specifically
by clinicians in much the same way that pharmaceutical products are
prescribed, the Company markets directly to gynecologists and other relevant
clinicians. In January 1996, the Company also began marketing directly to
physicians and providing them with educational and promotional materials with
the objective of establishing PAPNET(R) testing as a routinely prescribed
test. The Company expects that physicians will be motivated to prescribe
PAPNET(R) testing in order to provide their patients with the highest level of
care.
In addition, in September 1996, the Company entered into a co-promotion
agreement with the Women's Healthcare Group of the Parke-Davis division of
Warner-Lambert Company. According to the terms of that agreement, members of
the Parke-Davis field sales force will present PAPNET(R) testing promotional
materials to physicians when making sales calls regarding Parke-Davis
Loestrin(R) oral contraceptives. Although the Company does not expect that
Parke-Davis's activities will have a significant direct impact on sales, the
Company anticipates that this program will increase awareness of PAPNET(R)
testing in the clinician's office, and that interested doctors will contact
the Company's own sales representatives for more detailed presentations.
Activities under the agreement are scheduled to begin in October 1996 after
the Parke-Davis sales force has been provided with PAPNET(R) product training
and educational materials. The co-promotional effort is expected to continue
into early 1997.
After the Company began to create awareness and a base of support for
PAPNET(R) rescreening among gynecologists and other primary care physicians,
the Company began marketing to women in August 1996 through direct-to-consumer
advertising while continuing to market to laboratories and clinicians. The
Company believes that many women will be willing to pay the expected
additional cost for PAPNET(R) rescreening in order to obtain the greater
accuracy demonstrated in the PAPNET(R) Testing System's clinical trials.
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Finally, the Company believes that it may be better able to generate demand
for PAPNET(R) rescreening among clinicians and women if the cost to the
patient is reimbursed in whole or in part. Accordingly, the Company is also
marketing directly to insurers, managed care organizations and other third
party payers with the goal of persuading these entities to reimburse patients
for PAPNET(R) testing. The Company believes that its efforts in this regard
may be aided by recent efforts to measure the quality of care provided by
health maintenance organizations. The Health Plan Employer Data and
Information Set (known as "HEDIS"), a rating system established by corporate
healthcare purchasers to evaluate managed care services, includes prevention
of cervical cancer as a benchmark to measure the quality of care provided by
health maintenance organizations.
INTERNATIONAL MARKETING. The Company intends to continue to promote
PAPNET(R) testing in international markets in a manner essentially similar to
the plan for the United States market, although the success of PAPNET(R)
testing in certain non-United States markets may depend upon the extent to
which government payers reimburse for PAPNET(R) rescreening. In addition, the
Company will be limited in its ability to advertise directly to women in
certain markets, including most of western Europe. In June 1994, the Company
established its European base of operations in Amsterdam. The Company has a
Vice President of Marketing and Sales for Europe and has hired managers to
direct sales efforts for several Western European markets. A country manager
has also been appointed in Australia/New Zealand. Finally, the Company has
also established marketing arrangements with representatives in Asia and South
Africa.
THIRD-PARTY REIMBURSEMENT
Some private third-party medical insurance payers and government agencies
offer reimbursement for laboratory testing associated with routine medical
examinations, including Pap smears. In the United States, many Pap smears are
currently paid for by the patient, and the level of reimbursement by third-
party payers that do provide reimbursement varies considerably. Third-party
payers (Medicare/Medicaid, private health insurance, health administration
authorities in foreign countries and other organizations) may affect the
pricing or relative attractiveness of the Company's products and services by
regulating the maximum amount of reimbursement for PAPNET(R) testing provided
by such payers or by not providing any reimbursement at all. Restrictions on
reimbursement may limit the price which the Company can charge for its
services or reduce the demand for PAPNET(R) testing. In addition, if Medicare
and Medicaid do not provide for reimbursement of PAPNET(R) testing, or, if the
level of reimbursement is significantly below the amount laboratories charge
patients to perform PAPNET(R) testing, the size of the potential market
available to the Company may be reduced. There can be no assurance that costs
associated with PAPNET(R) testing will ever become reimbursable or that the
level of reimbursement to clinical laboratories for PAPNET(R) testing will
achieve or be maintained at levels necessary to permit the Company to generate
substantial revenues. In the international market, reimbursement by third-
party medical insurance payers, including governmental insurers and providers,
varies from country to country. In certain countries, the Company's ability to
achieve significant market penetration may depend upon whether private third-
party or governmental reimbursement is available.
MANUFACTURING; RESEARCH AND DEVELOPMENT
The Company's subsidiary, Neuromedical Systems Israel, Ltd. ("NSIL"), based
in Rehovot, Israel, manufactures the Scanning Stations, related equipment and
software. NSIL assembles components, optically aligns the automated
microscope, installs all software (including the Company's proprietary image
processing algorithm and neural network-based classifier) and tests the
completed system. Components of the Scanning Stations are either purchased
"off-the-shelf" or are manufactured by subcontractors to the Company's
specifications.
NSIL has been designated as an "Approved Enterprise" by the Investment
Center, a government agency of the Ministry of Industry and Commerce and the
Ministry of Finance of the Government of
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Israel. Such status makes NSIL eligible to receive government guaranteed loans
under certain terms and conditions. The outstanding amount as of June 30, 1996
under long-term loans derived from this program was approximately $2.2
million.
The PAPNET(R) Review Station is based on "off-the-shelf" personal computer
technology manufactured by third-party vendors and shipped to laboratories
unfinished. Final assembly is done at the laboratories by Company personnel
who install software, affix applicable labels and align the laboratory's
microscope to the "x, y" coordinates associated with the PAPNET(R) Testing
System.
The Company expended approximately $1,137,000, $4,305,000, $5,172,000 and
$3,079,000, in the years ended 1993, 1994, 1995 and in the six-month period
ended June 30, 1996, respectively, on research and development related to the
PAPNET(R) Testing System.
PATENTS AND PROPRIETARY RIGHTS
The Company's first U.S. patent issued on October 23, 1990. The Company's
patents cover various technologies applicable to the Company's current and
planned businesses. Some of the technologies covered by the Company's patents
include the application of neural networks and adaptive classifiers to the
classification of cytological specimens generally and the interactive
screening of specimens in which certain cells from a specimen are
automatically selected and displayed for focused human review. The Company's
PAPNET(R) Testing System is specifically disclosed and claimed.
The Company has five issued United States patents and several pending patent
applications. The Company's issued United States patents do not begin to
expire until at least 2008. The Company also has been issued patents in
several foreign countries, including certain European countries, Canada and
Australia, and has applied for patent protection in numerous other foreign
countries, including Japan and certain European countries.
The Company is not aware of any patents held by others that would prevent
the Company from manufacturing and commercializing, in the United States and
abroad, the PAPNET(R) Testing System as it currently exists.
The Company has trademark/service mark registrations for "Neuromedical
Systems," "NSI," "PAPNET," "Advancing the Vision of Cytology," "The Objective
Difference in Pap Smear Screening" and the Company's logo design and other
marks in the United States. Applications to register several of these marks
have been filed in several foreign countries, and the registrations for many
of these already issued. One other United States application is pending.
In May of 1995, a third party, whose identity is unknown to the Company,
filed with the Patent Office requests, which the Patent Office granted, for
re-examination of three of the Company's issued United States patents which
relate to technology on which the PAPNET(R) Testing System is based. The re-
examination process has been completed for each of the re-examined patents and
Re-examination Certificates have been received by the Company confirming or
finding patentable all claims of the re-examined patents. The Company also
added claims to one patent during the re-examination process.
TERRITORIAL LICENSES
From 1989 through 1991, the Company entered into various License Agreements
for the states of Ohio, Kentucky, Nevada, Missouri, Georgia, North Carolina,
Utah, Arizona and the metropolitan areas of Chicago and San Diego, which
together account for approximately 20% of the population of the United States.
Each license expires on the later of (i) 17 years after its execution and (ii)
the expiration of the initial patent granted for the PAPNET(R) system, and is
renewable for an additional 17-year term at the Licensee's option. The Company
received net proceeds of approximately $3.5 million from the sale of the
License Agreements.
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Pursuant to the License Agreements, each Licensee is obligated to use its
best efforts to promote diligently the use of the PAPNET(R) Testing System in
its territory at the Licensee's expense. Each Licensee is entitled to receive
the greater of (i) royalties equal to 50% of the Net Slide Revenue generated
from participating laboratories within its territory, not to exceed the
Licensee's share of a specified number of slides annually (ranging from
175,000 to 3,000,000, and aggregating 12,175,000 among all of the Licensees);
or (ii) a specified percentage (ranging from 0.15% to 1.0%, and aggregating
4.15% for all the Licensees) of the Company's annual slide processing revenues
less certain taxes, commissions and other enumerated expenses, up to specific
annual monetary limits for each Licensee (aggregating $23,000,000). The
Company estimates that the License Agreements will result in royalty expense
to the Company of approximately 10% of its United States revenues over the
term of the License Agreements, but there can be no assurance that the amount
of such royalties will not be more or less than such percentage. See "Certain
Transactions--Territorial Licenses and Related Agreements."
In December 1995, the Company and the Licensees entered into a settlement
agreement (the "Settlement Agreement"), the effects of which included the
clarification of previously disputed elements of prior license agreements, the
requirement for the Company to make payments of stock having a fair market
value equivalent to approximately $1,652,000 and the irrevocable election by
the Licensees and acceptance by the Company for the cashless exercise of
826,032 outstanding warrants into 715,894 shares of Common Stock in connection
with the closing of the IPO. Pursuant to the Settlement Agreement and such
election by the Licensees, the Company issued, in the aggregate, 118,406
shares of Common Stock to such persons and consented to the merger of all
Licensees and related parties. Following such merger, the Licensees and the
Company have agreed to enter into a new license (or, if such merger does not
occur, each Licensee has agreed to enter into a new license) (the "Merger
License") pursuant to which the rights and obligations of the parties have
been clarified but with respect to which the economic terms of the License
Agreements will not be materially altered. The Merger License will provide,
however, that a slide received from Multistate National Laboratories, as
defined in the Merger License, will be deemed to have been received from
licensed territories pro rata according to each territory's population and the
percentage of United States population. The Company and the Licensees
(including such related parties) have also executed mutual general releases,
which include, among other things, the release of the claims previously made
by the Licensees.
In addition, the provisions of a promissory note dated October 3, 1990
(which was later converted to Series A Convertible Preferred Stock and
subsequently converted into Common Stock upon consummation of the IPO) granted
the holder of the note certain rights to an agreement to be the Company's sole
licensee for distribution of the PAPNET(R) system in Canada. The promissory
note provides that such "licensee shall be entitled to terms which are at
least as favorable as those in any domestic United States of America
licenses." An agreement has not been negotiated. There can be no assurance
that the terms of such agreement, when it is negotiated, or the activities of
the licensee thereunder, will not have a material adverse effect on the
profitability of the Company's business in Canada. Joseph Salamon, a director
of the Company until June 20, 1996, is the agent of the record holder of the
rights to the Canadian license. See "Certain Transactions--Territorial
Licenses and Related Agreements."
DISTRIBUTION AGREEMENTS AND OTHER EXCLUSIVE ARRANGEMENTS
In addition to the exclusive customer relationships described above, the
Company has entered into an exclusive representation agreement with PAPNET
(Far East) Ltd., a Cayman Islands corporation based in Hong Kong and
controlled by certain direct and indirect stockholders of the Company
("PFEL"). The president and an 18% stockholder of PFEL is Dr. Stephen Ng, a
director of the Company. See "Management" and "Certain Transactions."
The representation agreement with PFEL (the "PFEL Agreement") provides that
PFEL will, in concert with the Company but at its own expense, market and sell
PAPNET(R) testing services in Hong
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Kong, Taiwan, Singapore, Thailand and the cities of Beijing, Shanghai and
Guangzhou in the People's Republic of China (the "PFEL Territories"). During
the term of the PFEL Agreement, the Company will pay PFEL specified
commissions in the form of a percentage of revenues received by the Company
from the PFEL Territories (generally 15%, but ranging up to 50%, depending on
price and other factors), regardless of whether such revenues are derived from
the efforts of PFEL or the Company. In addition, PFEL has the non-exclusive
right to market and sell PAPNET(R) testing elsewhere in the People's Republic
of China, but will receive commissions only to the extent that revenues
received by the Company are attributable to its efforts. The Company incurred
expenses of $136,295 in 1995 with respect to the PFEL Agreement.
The term of the PFEL Agreement and PFEL's rights thereunder are variable in
duration, depending on the volume of sales from the various PFEL Territories.
Assuming all performance objectives are met, PFEL's rights may continue until
July 2000.
In addition, the PFEL Agreement provides that the Company will pay PFEL fees
for management assistance in connection with the establishment of its Asia-
Pacific Scanning Center. The Company paid PFEL $100,000 during 1994 and
$75,000 during 1995, and is obligated to pay $75,000 in 1996 in consideration
for such assistance. See "Certain Transactions."
Pursuant to the existing treaty between the Government of the United Kingdom
and the People's Republic of China, Hong Kong will revert to and become part
of China in July 1997. The Company is uncertain as to the impact that such a
change in government will have on its business operations in Hong Kong.
From time to time in certain foreign markets, the Company has agreed to do
business exclusively with one or two local laboratories for a limited period
of time. The Company has entered into such commitments to secure certain
minimum quantities of business from such laboratories and investment from such
laboratories in local marketing and sales efforts. The only such agreement
presently outstanding relates to Indonesia.
LEGAL PROCEEDINGS
On July 15, 1996, the Company filed a lawsuit against NeoPath, a competitor
of the Company (see "--Competition"), in the United States District Court for
the Southern District of New York, seeking damages and injunctive relief for
patent infringement, false advertising, unfair competition, intentional
interference with business relations and damage to business reputation. In the
lawsuit, the Company alleges that NeoPath willfully misappropriated the
Company's patented technology and used such technology in NeoPath's AutoPap(R)
System. The Company also alleges that NeoPath falsely characterized and made
misleading comparisons to consumers and securities analysts of the AutoPap(R)
System and the Company's PAPNET(R) Testing System. NeoPath has denied all
allegations and, in addition, it has filed counter-claims against the Company
seeking damages and injunctive relief for false advertising and unfair
competition. In the counter-claims, NeoPath alleges that statements made by
the Company characterizing the performance of the PAPNET(R) Testing System,
and its effectiveness relative to NeoPath's AutoPap(R) System, as well as
other statements, are false and misleading and constitute misrepresentations.
The Company believes that NeoPath's assertions are without merit. Although the
duration, costs and ultimate outcome of this lawsuit are unknown, the Company
expects that the costs of this lawsuit will be significant during 1996 and
1997.
On December 4, 1995, the Company was served with a Summons and Complaint in
an action entitled Herbst et al. v. Neuromedical Systems, Inc. et al., in the
Supreme Court of the State of New York. The plaintiffs in this suit allege,
among other things, that, pursuant to written contracts, which they claim the
Company has breached, they were entitled to be issued warrants exercisable for
the purchase of approximately 128,000 shares of Common Stock at various
prices. They further allege that
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the Company and certain of its officers and directors made fraudulent
misrepresentations and took other allegedly improper actions that diminished
the value of the warrants to which they claim they are entitled under these
contracts. On January 31, 1996, the plaintiffs served the Company with an
Amended Complaint alleging legal claims similar to those in the original
Summons and Complaint served on the Company, but adding one of the Company's
directors as a defendant and specifying that the plaintiffs are seeking
compensatory damages from the Company and certain of its officers and
directors totaling $114 million and punitive damages totaling $175 million.
The defendants have moved to dismiss the Amended Complaint. Such motion is
currently under consideration by the court. The Company intends to defend
vigorously this action. The Company believes that, in any event, the damages
claimed bear no relation to the harm alleged and believes that an adverse
judgment in this case would not have a material adverse effect on the Company.
The Company is a defendant in a lawsuit asserting a claim for finders' fees
relating to equity financing received by the Company from two specified
individuals between 1990 and 1994. The case, Myer Botnick, Yehuda Rosenblatt
and Ursula Lehmann v. Neuromedical Systems, Inc., was commenced against the
Company on April 10, 1995 in Ontario Court (General Division) in the Province
of Ontario, Canada. The Company believes that it has valid legal and factual
defenses, and that, even if liability is found, such proceeding will not have
a material adverse effect on the Company.
GOVERNMENT REGULATION
UNITED STATES. The PAPNET(R) Testing System is a medical device subject to
extensive regulation in the United States by the FDA and by other federal,
state and local authorities. The FDA regulates the research, development,
clinical studies, manufacturing, processing, packaging, labeling,
distribution, promotion and post-market surveillance of medical devices in the
United States.
Preclinical and clinical trials of medical devices must be conducted in
conformity with all applicable FDA regulations, including, with respect to
preclinical trials, the FDA's Good Laboratory Practice regulations. In
addition, state and local permits may be required under regulations relating
to clinical activities.
Under the Federal Food, Drug and Cosmetic Act, the PAPNET(R) Testing System
is a Class III medical device, subject to the most stringent FDA review of any
medical devices to ensure that the device is safe and effective before
commencement of marketing, sales and distribution for clinical use in the
United States. A maker of Class III devices (such as the Company) must
generally subject its product to clinical trials, and thereafter submit to the
FDA an application supported by extensive data, including clinical trial data,
to prove the safety and effectiveness of the product. As part of the FDA
application, the device maker must submit a full description of the device and
its components, a full description of the methods, facilities and controls
used for manufacturing, and proposed labeling.
Because the PAPNET(R) Testing System has now been approved by the FDA, the
Company is increasing the scale of its operations to commercial levels. The
Company is required to register with the FDA and to submit device listing
information for products in commercial distribution, and is subject to
periodic reinspection by the FDA for compliance with GMP regulations with
respect to manufacturing, testing, distribution, storage and control
activities. Labeling and promotional activities are also regulated by the FDA.
The Company will be required to provide the FDA with periodic reports
containing safety and effectiveness information.
Although the Company has received approval for the PAPNET(R) Testing System
from the FDA, there can be no assurance that the Company will obtain the
required regulatory approval for any future product that it may develop, on a
timely basis, if at all. Furthermore, additional regulatory requirements could
be imposed by legislation or regulation.
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If the FDA believes that the Company is not in compliance with the law, the
FDA can take one or more of the following actions: withdraw previously approved
applications; require notification to users regarding newly found, unreasonable
risks; request repair, refund or replacement of faulty devices; request
corrective advertisements, formal recalls or temporary marketing suspension;
refuse to review or approve applications to market any of the Company's future
products in the United States or to allow the Company to enter into government
supply contracts; or institute legal proceedings to detain or seize products,
enjoin future violations or assess criminal penalties against the Company, its
officers or employees. Civil penalties for Food, Drug and Cosmetic Act
violations may be assessed by the FDA in lieu of or in addition to instituting
legal action. Any such action by the FDA could result in disruption of the
Company's operations for an indeterminate period of time. Various states in
which the Company's products may be sold in the future may impose additional
regulatory requirements.
In May 1996, the FDA issued a "warning letter" to Papnet of Ohio, Inc. (a
Licensee of the Company) concerning certain material posted on Papnet of Ohio's
site on the World Wide Web. Papnet of Ohio has responded to the warning letter.
Papnet of Ohio is unrelated to the Company other than as a Licensee. Although
the warning letter is addressed to Papnet of Ohio, it is possible that, as a
result of the resolution of this matter the Company may be required to modify
certain of its promotional materials. See "--Territorial Licenses."
INTERNATIONAL MARKETS. The Company's products are subject to a variety of
regulations in certain international markets, including Europe. Some European
countries have established national regulations relating to in vitro diagnostic
medical devices, such as the PAPNET(R) system. These regulations do not
typically require premarket approval, but may impose other requirements.
In vitro diagnostic medical devices such as the PAPNET(R) system are not
currently subject to medical device directives issued by the European Union
("EU"). The Company anticipates, however, that the EU will soon propose a
directive for in vitro diagnostic medical devices that would establish a basis
for harmonized regulation of such devices among EU member states. Such a
directive would likely establish a deadline for compliance. If enacted, the
directive would apply only to member states of the EU and the European Economic
Area. Other European countries, however, may enact national laws that would
conform to the directive. There can be no assurance that the PAPNET(R) Testing
System or any other product that the Company may develop will obtain any
required regulatory clearance or approval on a timely basis, if at all.
REGULATION OF CERVICAL PAP SMEAR ANALYSIS
In 1988, Congress adopted the Clinical Laboratory Improvement Amendments of
1988 ("CLIA"). CLIA directed the Department of Health and Human Services to
promulgate regulations to improve the quality of biomedical analytic services,
particularly the examination of Pap smears. The CLIA regulations require
laboratories to rescreen slides from at least 10% of the laboratory's Pap
smears interpreted to be "negative" on initial manual screening. Such
rescreened slides must include negative cases selected at random from the total
caseload and from patients or groups of patients that are identified as having
a high probability of developing cervical cancer based on available patient
information.
In addition, the Company's direct clients, clinical laboratories, are subject
to state regulation, inspection and licensing. In recent years, a number of
states, including New York and California, have adopted regulations limiting
the number of slides which can be manually examined by a cytotechnologist in a
given period. To the Company's knowledge, none of these regulations explicitly
limits the number of slides that may be examined in connection with PAPNET(R)
rescreening. There can be no assurance, however, that such states or other
states will not limit the number of slides which may be examined using
PAPNET(R) testing during any particular time period, or that any such
limitations will not have an adverse effect on the acceptance of PAPNET(R)
Testing System in the marketplace.
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COMPETITION
The Company is currently aware of three principal competitors which are
engaged in efforts to automate one or more aspects of cervical smear
screening. Two competitors, Cytyc and Roche, have focused on the development
of devices for the production, and, in the case of Roche, automated analysis,
of monolayer slides, a potential alternative to the conventional Pap smear
method of specimen collection and preparation. Cytyc received approval from
the FDA in May 1996 to market its ThinPrep(R) preparation to laboratories, for
the purpose of filtering out blood, mucus and other material from Pap smears.
However, according to published reports, Cytyc has not received approval to
promote its ThinPrep(R) system as a means to improve diagnostic accuracy in
cervical cancer screening. With monolayer techniques, clinicians are required
to prepare special slides, and only a fraction of the cells and background
information displayed on the conventional slide is retained for analysis.
Because the PAPNET(R) Testing System uses the well-established methods of
sample collection, it does not require clinicians to deviate from standard
practice.
The other competitor of which the Company is aware, NeoPath, has stated that
it is developing a device for the fully automated primary screening of
conventional Pap smears, for which it has submitted to the FDA a pre-market
approval supplemental application.The FDA has announced that the Hematology
and Pathology Devices Panel will hold a public meeting on September 27, 1996
to consider recommending approval of such supplement. In addition, on
September 29, 1995, the FDA granted approval to NeoPath for the AutoPap(R)
System to be used as part of a laboratory's quality control procedures.
According to NeoPath, the AutoPap(R) System is designed to sort purportedly
"negative" Pap smear slides into two groups, one classified as "negative" and
one classified for "review." The group of slides classified for review, which
constitutes a specified percentage of the whole, is again reviewed manually by
the cytotechnologist through a conventional microscope. In contrast,
cytotechnologists trained in the use of the PAPNET(R) Testing System evaluate
the 128 color images from each purportedly negative slide on the PAPNET(R)
Review Station. If all of the images appear normal, the cytotechnologist
classifies the slide as "negative," and no further examination is required. If
any one of the 128 images appears to the cytotechnologist to be abnormal, the
cytotechnologist classifies the slide as "review." The cytotechnologist then
refers to the "x, y" coordinates provided with each PAPNET(R) image and uses
the coordinates as a reference point to re-examine the slide directly through
the microscope. Every slide rescreened using the PAPNET(R) system receives a
directed, professional human analysis, either of the PAPNET(R) images or of
both the images and the slide.
The Company's known competitors or other companies may develop new products
and technologies that prove to be more effective than the PAPNET(R) Testing
System or that may be viewed by clinical laboratories as reducing operating
costs (for example, by reducing the number of cytotechnologists used in
screening). In addition, competitive products and technologies may be
manufactured and marketed more successfully than the PAPNET(R) Testing System.
Such developments could render the PAPNET(R) Testing System less competitive
or possibly obsolete, and could have a material adverse effect on the Company.
The Company will be required to compete with respect to product effectiveness,
price, manufacturing and slide processing efficiency, marketing capabilities
and customer service and support, areas in which it currently has limited
experience.
In addition to competitors attempting to develop fully automated or semi-
automated systems for the screening or rescreening of cervical samples, there
may in the future be alternate techniques or technologies for the detection or
prevention of cervical cancer. Although no such technique has been
demonstrated to be useful as a substitute for the Pap smear, there can be no
assurance that new techniques or technologies will not one day supplant or
replace the Pap smear in medical practice.
POTENTIAL FUTURE PRODUCTS
The Company believes that its technology can be adapted for use in the early
detection of cancers occurring at body sites in addition to the uterine
cervix, including the bladder, breast, esophagus, lung,
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oral cavity and thyroid. Not all such cancers are commonly the subject of
cytological analysis, and the Company has not yet determined which of these
applications, if any, it will be able to commercialize. The Company's patents
cover applications of its technology to cytological screening for cancers
occurring at all body sites.
EMPLOYEES
As of August 31, 1996, the Company employed 210 persons, including 33
persons in product development and engineering, 11 persons in medical and
regulatory affairs, 46 persons in slide processing operations, 20 persons in
manufacturin, 61 persons in marketing, sales and customer training and 39
persons in administrative capacities. The Company is not subject to any
collective bargaining agreements and believes that its relationship with its
employees is good.
CUSTOMERS
The Company's customer base is broadly diversified, and no single customer
accounts for a significant portion of its revenues. At present, the largest
single United States customer of the Company is Laboratory Corporation of
America.
FACILITIES
The Company's executive offices are located in Suffern, New York, in
approximately 23,500 square feet of space. The Company leases such space at an
annual rent of approximately $371,000.
In order to meet the anticipated initial marketing demand of the PAPNET(R)
Testing System launch in the United States, during the third quarter of 1996,
the Company moved its United States Scanning Center from Suffern, New York to
Upper Saddle River, New Jersey. The New Jersey Scanning Center occupies
approximately 26,500 square feet and has an approximate annual rent of
$563,000. The former 7,700 square foot Suffern Scanning Center will be used
for product development and administrative purposes. The New Jersey Scanning
Center became operational during the third quarter of 1996 and the Company
believes that it will be adequate to meet anticipated demand for PAPNET(R)
testing through 1997. The Company anticipates that it will be required to
continue to expand its administrative offices and slide processing facilities
in future years as the expected market demand for PAPNET(R) testing increases.
The European Scanning Center and the Company's European sales and marketing
staff are located in approximately 16,300 square feet of space in Amsterdam,
The Netherlands. The annual rent for such space is approximately $198,000. The
Company believes that its existing facility is adequate to meet its
requirements through 1997.
NSIL's manufacturing facility occupies approximately 18,500 square feet at
Kiryat Weizmann, Rehovot, Israel. NSIL leases such space at an annual rent of
approximately $313,000. The Company believes that its existing facility is
adequate to meet the anticipated demand for PAPNET(R) scanners and related
equipment through 1996, although expansion of the facility may be required in
1997. The Company believes that, based on current market conditions,
additional manufacturing space that it may require will be readily available
on terms similar to those of its current facility. Any new manufacturing
facility is subject to regulation by the FDA and may require a facility
inspection before it can be used to manufacture medical devices for use in the
United States.
The Asia-Pacific Scanning Center is located in the Hong Kong Institute of
Biotechnology, an affiliate of the Chinese University of Hong Kong in Shatin,
the New Territories, Hong Kong. The Hong Kong center occupies 5,925 square
feet of space, at an annual fee of approximately $233,000. The Company
anticipates that its existing facility is adequate to meet its requirements
for the foreseeable future.
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MANAGEMENT
EXECUTIVE OFFICERS AND DIRECTORS
The executive officers and directors of the Company are as follows:
<TABLE>
<CAPTION>
NAME AGE POSITION
---- --- --------
<S> <C> <C>
Mark R. Rutenberg................ 45 Chairman of the Board, President and Chief
Executive Officer; Class III Director
Uzi Ish-Hurwitz.................. 53 Executive Vice President, Chief of Technical
Operations; President, Neuromedical Systems
Israel Ltd.; Class I Director
David Duncan, Jr. ............... 47 Vice President, Finance and Administration, Chief
Financial Officer
Zeev Hadass...................... 63 Vice President, Processing Operations
John B. Henneman, III............ 34 Vice President of Corporate Development, General
Counsel and Secretary
James M. Herriman................ 41 Vice President of Product Development
Laurie J. Mango, M.D. ........... 34 Vice President and Medical Director
Andrew C. Panagy................. 45 Vice President, Marketing and Sales
Stuart M. Essig.................. 35 Class II Director
Elizabeth Cogan Fascitelli....... 38 Class III Director
Carl Genberg..................... 44 Class I Director
Arthur L. Herbst, M.D. .......... 65 Class I Director
C. Raymond Larkin, Jr. .......... 48 Class II Director
Stephen K.C. Ng, M.D. ........... 48 Class II Director
</TABLE>
The term of office of Class I directors will expire at the 1999 Annual
Meeting of Stockholders, the term of office of Class II directors will expire
at the 1997 Annual Meeting of Stockholders, and the term of office of Class
III directors will expire at the 1998 Annual Meeting of Stockholders.
Commencing with the 1996 Annual Meeting of Stockholders, one class of
directors is to be elected each year for a three-year term. All directors hold
office until their successors are duly elected and qualified. Officers are
appointed by the Board and serve at the discretion thereof.
MARK R. RUTENBERG invented the PAPNET(R) Testing System in 1987 and founded
the Company in 1988. He has served as the Company's Chairman, President and
Chief Executive Officer since its inception. From 1980 to 1988, Mr. Rutenberg
was responsible for the management and marketing of several advanced defense
programs. Mr. Rutenberg is an inventor named in patents in the areas of
reliable system design, image analysis and cancer cell detection. Mr.
Rutenberg holds a B.A. from Oberlin College in neuropsychology, and received
an M.S. in Electrical Engineering from Cleveland State University.
UZI ISH-HURWITZ is Executive Vice President, Chief of Technical Operations
of the Company and President of Neuromedical Systems Israel, Ltd., a
subsidiary of the Company, and has served as a Director of the Company since
June 20, 1996. Mr. Ish-Hurwitz joined the Company in April 1993 and, during
the period from November 1992 to April 1993, acted as an independent
consultant. Mr. Ish-Hurwitz was the co-founder of Indigo Graphic Systems, Ltd.
(Rehovot, Israel), and served as its President from 1987 to 1992. From 1973 to
1986, Mr. Ish-Hurwitz served as Vice President-Operations of Scitex
Corporation, Ltd. Mr. Ish-Hurwitz is also a member of the board of directors
of Breasy Medical
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Equipment (U.S.) Inc. Mr. Ish-Hurwitz is a graduate of the Technion-Israeli
Institute of Technology with a B.Sc. in Electrical Engineering and has
completed fellowship programs at the London Business School and the Harvard
Business School, Advanced Management Program, Fall 1986.
DAVID DUNCAN, JR. is Vice President, Finance and Administration and Chief
Financial Officer. Mr. Duncan joined the Company in November 1994. Prior to
joining the Company, Mr. Duncan served as Vice President, Finance and Chief
Financial Officer of Telios Pharmaceuticals (and held other financial
positions) since September 1988. He received his B.S. in 1971 and an M.B.A. in
1973, both from Indiana University.
ZEEV HADASS, PH.D. has been Vice President, Processing Operations of the
Company since March 1994. From 1991 to 1994, Mr. Hadass was Executive Project
Director of MedLink Europe, BV, a master distribution company that establishes
and manages European distribution networks for medical companies based in the
United States. From 1990 to 1991, Mr. Hadass was President of Abiomed, Inc., a
Danvers, Massachusetts maker of cardiac assist and periodontal screening
devices. Mr. Hadass received his Ph.D. in Aeronautical Engineering from
Stanford University, his M.Sc. in Nuclear Engineering from INSTN, France, and
his B.Sc. in Mechanical Engineering from the Technion-Israeli Institute of
Technology.
JOHN B. HENNEMAN, III is Vice President of Corporate Development, General
Counsel and Secretary of the Company. For more than seven years prior to
joining the Company in February 1994, Mr. Henneman practiced law with the
Chicago office of Latham & Watkins. Mr. Henneman received his A.B. in Politics
from Princeton University and his J.D. from the University of Michigan Law
School.
JAMES M. HERRIMAN is Vice President of Product Development of the Company.
Mr. Herriman joined the Company in November 1992. Mr. Herriman was President
of Aspex Incorporated from 1983, when it was founded, until November 1992.
While at Aspex, Mr. Herriman was the chief designer of the PIPE(R) image
processor used in the first generation PAPNET(R) Scanning Station. Mr.
Herriman received his B.A. from Emory University.
LAURIE J. MANGO, M.D. is Vice President and Medical Director of the Company.
Prior to joining the Company in 1990, Dr. Mango was a resident in anatomic
pathology at the University of California, San Francisco and served as a
Cytology Fellow at Montefiore Medical Center under Dr. Leopold G. Koss. Dr.
Mango graduated from Rice University with a B.S. in electrical engineering and
received her M.D. from Baylor College of Medicine.
ANDREW C. PANAGY is Vice President, Marketing and Sales of the Company.
Prior to joining the Company in February 1994, Mr. Panagy served as Executive
Vice President and Chief Operating Officer of the MEDED Healthcare Group, a
healthcare marketing and consulting company. Prior to that, Mr. Panagy held
numerous marketing and sales positions with Ayerst Laboratories, a
pharmaceutical division of American Home Products Corp., including as head of
the female healthcare marketing group. Mr. Panagy received his B.S. in Biology
from Wagner College, and has participated in post-graduate business programs
at Long Island University in New York.
STUART M. ESSIG has served as a Director of the Company since 1993. Mr.
Essig has been employed by the investment banking firm of Goldman, Sachs & Co.
since 1988, and, since 1992, has served as a Vice President in their
Investment Banking Division, Mergers and Acquisitions Department.
ELIZABETH COGAN FASCITELLI has served as a Director of the Company since
1993. Ms. Fascitelli has been employed by the investment banking firm of
Goldman, Sachs & Co. since 1984 and, since 1988, has served as a Vice
President in their Investment Banking Division, Principal Investment Area. Ms.
Fascitelli also serves on the Boards of Directors of Globe Manufacturing Co.,
Whole Foods Market, Inc. and The Cosmetics Plus Group Ltd.
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CARL GENBERG has served as a Director of the Company since 1990. Mr. Genberg
is currently President of Cytology West, Inc. ("CWI"). CWI is the territorial
licensee of the PAPNET(R) technology for the states of Nevada and Arizona and
San Diego County, California. Until June 1993, Mr. Genberg was General Counsel
of the Company.
ARTHUR L. HERBST, M.D. has served as a Director of the Company since June
20, 1996. Dr. Herbst has served since 1976 as Chairman, OB-GYN Department and
Joseph Bolivar DeLee Distinguished Service Professor, University of Chicago.
C. RAYMOND LARKIN, JR. has served as a Director of the Company since
February 1996. Mr. Larkin has been an officer of Nellcor Puritan Bennett Inc.
("Nellcor") and its predecessors since 1983, serving as Vice President, Sales
and Marketing and, since 1989, as President and Chief Executive Officer. Mr.
Larkin is a director of Nellcor, Ventritex, Inc. and ArthroCare Corporation.
STEPHEN K.C. NG, M.D. has served as a Director of the Company since 1994.
Since November 1993, Dr. Ng has been the President of PFEL, a distributor of
the Company's services, and President of Compuscreen Medical Diagnostic
Centre, a laboratory located in Hong Kong ("Compuscreen"). Prior to
establishing PFEL and Compuscreen, Dr. Ng served Columbia University in
various capacities as an epidemiologist. He has also served as Chief, Division
of Epidemiology, American Health Foundation.
Messrs. Rutenberg and Genberg are first cousins.
COMPENSATION OF DIRECTORS
On June 1, 1995, each non-employee director received fully-vested options to
purchase 1,250 shares of Common Stock of the Company, at an exercise price of
$6.00 per share, as compensation for his or her prior service on the Board. On
October 25, 1995, each non-employee director received options to purchase
1,250 shares of Common Stock of the Company, at an exercise price of $7.00 per
share, as compensation for service on the Board, which options vested on June
1, 1996. The Incentive Plan also provides for the non-discretionary grant of
options to each of the Company's non-employee directors ("Director Options")
(i) with respect to 2,500 shares of Common Stock to each non-employee director
who becomes a member of the Board after October 25, 1995 upon election or
appointment and (ii) with respect to an additional 2,500 shares of Common
Stock, annually on the first business day following the annual meeting of
stockholders to all non-employee directors who are members of the Board at
that time. See "--Stock Incentive Plan--Director Options."
Other than as set forth above, compensation to non-employee directors for
future services has not yet been determined. The Company expects, however,
that, in addition to reimbursement of expenses and the granting of Director
Options, non-employee directors will be provided cash compensation for future
services that is consistent with that provided to non-employee directors of
similarly situated companies. The Company anticipates that such cash
compensation will not exceed $25,000 per year for any one director.
COMMITTEES OF THE BOARD
In December 1995, the Board created an Audit Committee, currently consisting
of Stuart M. Essig, C. Raymond Larkin, Jr. and Stephen K.C. Ng, M.D., and a
Compensation Committee, currently consisting of Elizabeth Cogan Fascitelli,
Carl Genberg and Arthur L. Herbst, M.D. The Audit Committee is charged with
reviewing the Company's annual audit and meeting with the Company's
independent accountants to review the Company's internal controls and
financial management practices. The Compensation Committee recommends to the
Board compensation for the Company's key employees.
42
<PAGE>
EXECUTIVE COMPENSATION
The Summary Compensation Table below provides certain compensation
information for the Chief Executive Officer and the four most highly
compensated key executive officers ("Named Executive Officers") serving at the
end of the fiscal year ended December 31, 1995 for services rendered in all
capacities during the fiscal years ended December 31, 1995 and 1994. The table
includes the dollar value of base salary, bonus earned, option awards (shown
in number of shares) and certain other compensation, whether paid or deferred.
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
LONG-TERM
ANNUAL COMPENSATION COMPENSATION AWARDS
------------------------------ -----------------------
OTHER SECURITIES
ANNUAL UNDERLYING
NAME AND COMPEN- RESTRICTED OPTIONS/SARS ALL OTHER
PRINCIPAL POSITION YEAR SALARY BONUS SATION(1) STOCK (#) COMPENSATION
- ------------------ ---- -------- -------- --------- ---------- ------------ ------------
<S> <C> <C> <C> <C> <C> <C> <C>
Mark R. Rutenberg....... 1995 $175,000 $131,000 -- -- 813,273 $20,467(2)
Chief Executive Officer 1994 179,583 50,000 -- -- -- 21,473(2)
Uzi Ish-Hurwitz......... 1995 150,000 90,000(4) -- -- -- 5,971(3)
Executive Vice Presi-
dent 1994 150,000 33,300 -- -- -- 4,800(3)
Laurie J. Mango, M.D. .. 1995 125,000 80,000(4) -- -- -- 3,211(3)
Vice President and 1994 129,197 -- -- -- -- 3,907(3)
Medical Director
James M. Herriman....... 1995 125,000 68,400(4) -- -- -- 4,482(3)
Vice President of Prod-
uct 1994 129,197 -- -- -- -- 836(3)
Development
John B. Henneman, III... 1995 125,000 57,600(4) -- -- 25,000 5,116(3)
Vice President of 1994 104,167 -- -- -- -- 4,185(3)
Corporate Development
and General Counsel
</TABLE>
- --------
(1) Excludes certain perquisites which do not exceed the lesser of $50,000 or
10% of the named individual's aggregate salary and bonus.
(2) The amount shown represents $13,066 and $9,607, respectively, in Company-
paid life insurance premiums, $4,124 and $6,286, respectively, in
disability insurance premiums, $3,175 and $5,580, respectively, of imputed
value of a Company-provided automobile and $102 and $0, respectively, in
group life insurance benefits.
(3) The amount shown represents the imputed value of a Company-provided
automobile and group life insurance benefits.
(4) One-half of the bonus amounts shown were paid, at the election of the
named individual, in the form of shares of Common Stock. See "--Annual
Bonus Plan."
EMPLOYMENT AGREEMENTS
Each of the Company's executive officers, including the Named Executive
Officers, has entered into an Employment Agreement with the Company (each, an
"Employment Agreement" and, collectively, the "Employment Agreements"). The
Employment Agreement for Mr. Rutenberg commenced in November 1993 and is for a
five-year term. Each of the Employment Agreements for Dr. Mango and Messrs.
Herriman and Ish-Hurwitz commenced in November 1993 and is for a three-year
term. Each of the Employment Agreements for Messrs. Duncan, Hadass, Henneman
and Panagy is for a three-year term and commenced on November 21, 1994, April
1, 1994, March 1, 1994 and February 14, 1994, respectively. The Employment
Agreements provide for annual base salaries of the Named Executive Officers
during the terms of the Employment Agreements, which base salaries in 1996 are
as follows: Mr. Rutenberg, $175,000, Mr. Ish-Hurwitz, $150,000, and Mr.
Herriman, Dr. Mango and Mr. Henneman, $125,000. The base salaries are reviewed
at least annually with a view to the increase thereof based on the employees'
and the Company's performance, inflation, industry salary scales and other
relevant factors.
43
<PAGE>
Pursuant to the terms of their respective Employment Agreements, each of the
covered employees has received an option to purchase a designated number of
shares of Common Stock under the Incentive Plan. Each of the Employment
Agreements was amended as of October 25, 1995 to provide that, in the event
that an employee is terminated other than for "Cause" or "Disability" (as
those terms are defined in the applicable Employment Agreement), and, in Mr.
Rutenberg's case, also if he terminates for "Good Reason" (as defined in his
Employment Agreement), a portion of the employee's stock option will become
vested and exercisable to the extent that it would have become vested and
exercisable had the employee remained employed by the Company for a one-year
period following his termination of employment and, subject to the employee's
compliance with the restrictive covenants in his Employment Agreement. Options
held by the employee as of the date of the termination of employment (other
than the option granted to Mr. Rutenberg on October 1, 1995 which is described
below) will remain exercisable (to the extent those options either are vested
on termination of employment or become vested over the succeeding year) until
the earlier of the date one year following the termination of employment or
the expiration of the option's term. "Good Reason" is defined for purposes of
the Rutenberg Employment Agreement to include (i) any circumstance that has
the effect of significantly reducing Mr. Rutenberg's duties or authority, (ii)
a breach by the Company of its material obligations under the Employment
Agreement, (iii) the relocation of the principal executive offices of the
Company in excess of 35 miles from their present location not consented to by
Mr. Rutenberg, (iv) the occurrence of a "Change in Control" (as defined in the
Incentive Plan) in a transaction to which Mr. Rutenberg does not consent, (v)
the disposition by the Company (whether direct or indirect, by sale of assets
or stock, merger, consolidation or otherwise) of all or substantially all of
its business and/or assets in a transaction to which Mr. Rutenberg does not
consent or (vi) any circumstance whereby, without Mr. Rutenberg's consent, any
of the Company's offices or facilities is caused to operate on the Jewish
Sabbath or on any Jewish holiday, and as a result thereof, Mr. Rutenberg
reasonably determines that he would be prohibited under Jewish law from
continuing as the Chief Executive Officer of the Company, provided that any of
the events described in clauses (i), (ii) or (vi) will constitute Good Reason
only if Mr. Rutenberg has notified the Board in writing of the existence and
particulars of such circumstance and the Board has failed to remedy such
circumstance within thirty days of such notice.
RUTENBERG EMPLOYMENT AGREEMENT. Mr. Rutenberg's Employment Agreement
provides that, in addition to his base salary, Mr. Rutenberg will be entitled
to an annual bonus in an amount to be determined at the discretion of the
Board, subject to performance objectives established by the Board, and the use
of a Company-provided car. The Employment Agreement provides that, in the
event that Mr. Rutenberg's employment is terminated by the Company other than
for "Cause" or "Disability" or by Mr. Rutenberg for "Good Reason," the Company
will (i) pay Mr. Rutenberg a lump sum severance amount equal to 2.99 times his
annual base salary in effect as of the date of such termination and (ii)
continue the health, accident and life insurance benefits and other disability
plans and programs provided to him immediately prior to such termination for
the shorter of one year or the balance of the term of his Employment
Agreement. If Mr. Rutenberg's employment is terminated by the Company for
Cause or by Mr. Rutenberg without Good Reason, Mr. Rutenberg will be entitled
to receive his salary through his date of termination, and his entitlement to
any other compensation or benefits beyond the term of his employment will be
determined in accordance with the Company's general plans, policies and
practices as in effect from time to time. If Mr. Rutenberg's employment is
terminated due to his death, the Company will continue, for the shorter of one
year following his death or the balance of the term of his Employment
Agreement, the health, accident and life insurance benefits and other
disability plans and programs provided to his dependents immediately prior to
his death. If Mr. Rutenberg's employment is terminated due to "Disability" (as
defined in his Employment Agreement), for the shorter of one year following
his termination or the balance of the term of his Employment Agreement, the
Company will (i) continue to pay his salary, reduced by the amount of his
disability benefits, if any, and (ii) continue the health, accident and life
insurance benefits and other disability plans and programs provided to Mr.
Rutenberg immediately prior to such termination. If necessary, the payments
44
<PAGE>
and benefits provided above will be reduced to the extent required so that no
payment to Mr. Rutenberg will be an "excess parachute payment" under the
Internal Revenue Code of 1986, as amended (the "Code"), Section 280G.
Under his Employment Agreement, Mr. Rutenberg has assigned to the Company
all rights to inventions, discoveries, improvements and patentable and
copyrightable works conceived by him in the course of his employment with the
Company and related to the business or activities of the Company. Mr.
Rutenberg has agreed not to disclose to others trade secrets and other
confidential information of the Company during the term of his employment and
for a five-year period thereafter. Mr. Rutenberg has also agreed that, during
the term of his employment under his Employment Agreement and for a period of
three years thereafter, he will not engage in activity which is competitive
with the business of the Company; however, in the event that his employment is
terminated without Cause or he terminates his employment for Good Reason, the
non-competition period is reduced to two years.
OTHER EMPLOYMENT AGREEMENTS. The Employment Agreements covering the other
executive officers contain provisions generally similar to those in Mr.
Rutenberg's Employment Agreement, except that (i) upon a voluntary termination
for good reason, the entitlement of an executive officer to any other
compensation or benefits shall be determined in accordance with the Company's
plans, policies and practices as in effect from time to time, (ii) upon a
termination of an executive officer's employment by the Company without Cause,
for a period of one year thereafter the executive officer will be entitled to
continue to receive his or her base salary in effect at the time of
termination and continued coverage under health, accident and life insurance
and other disability plans and programs, (iii) the non-competition restriction
is for a two-year period following their respective termination of employment
and (iv) there is no provision for a reduction under Code Section 280G, but
the severance payments provided under the Employment Agreements will be
reduced by any income received by the executive officer from other sources
during such severance period.
RUTENBERG OPTION AGREEMENT
The Company has granted to Mr. Rutenberg a performance-based option under
the Incentive Plan at an exercise price of $15.00 per share and covering
813,273 shares of Common Stock that is designed to produce an option value of
$12.5 million if at any time during the option's ten-year term either of the
following events (the "Performance Goal") occurs: (i) the Company's share
price over any 90 consecutive day period reaches $30.37 (the "Target Price")
or (ii) all or substantially all of the Company's shares of Common Stock are
acquired (an "Acquisition") at or above the Target Price. If the Performance
Goal is attained, the option will become exercisable as to one-third of the
number of shares of Common Stock subject thereto on the later of (i) the third
anniversary of the IPO or (ii) the date that the Performance Goal is attained
(the "Initial Vesting Date"), and will become exercisable as to an additional
one-third of the shares of Common Stock subject thereto on each of the first
two anniversaries of the Initial Vesting Date; provided, however, that, if Mr.
Rutenberg's employment is terminated by the Company without Cause following an
Acquisition that occurs following or simultaneously with the attainment of the
Performance Goal, the option will be fully exercisable. No additional vesting
will occur following Mr. Rutenberg's termination of employment under any other
circumstances or the expiration of the option's ten-year term. Following Mr.
Rutenberg's termination of employment by the Company for any reason other than
for Cause, the option, to the extent vested and exercisable at the time of
such termination, may be exercised within six months of the termination of
employment. The option provides for equitable adjustments to the Performance
Goal, the number of shares of Common Stock subject to the option and the
exercise price in the event of a Change in Capitalization (as defined in the
Incentive Plan). The exercisability of the option will not accelerate upon the
occurrence of a Change in Control (as defined in the Incentive Plan), and the
option will terminate in connection with an Acquisition if the Performance
Goal is not attained prior to or in connection with the Acquisition.
45
<PAGE>
STOCK INCENTIVE PLAN
GENERAL. On November 17, 1993, the Board adopted the Neuromedical Systems,
Inc. 1993 Stock Option Plan (the "Option Plan"), which was amended and
restated October 25, 1995 as the Incentive Plan. The Company's stockholders
approved the Option Plan at the Annual Meeting of Stockholders on June 24,
1994 and approved an amendment to the Option Plan on July 12, 1995 increasing
the maximum number of shares of Common Stock for which options may be granted
under the Option Plan to 2,475,754 shares, subject to adjustment in the event
of a Change in Capitalization. Pursuant to a consent solicitation dated
November 1, 1995, the Incentive Plan as amended and restated was approved by
the Company's stockholders. This amendment and restatement increased the
maximum number of shares with respect to which awards can be granted under the
Incentive Plan to 4,140,000 shares, subject to adjustment in the event of a
Change in Capitalization, with no more than one-third of the total number of
authorized shares to be issued as grants of restricted stock and, provided
that, over the term of the Incentive Plan, the maximum number of shares with
respect to which awards may be granted to any individual is 2,000,000 and the
maximum that any individual may be awarded in respect of United States dollar-
denominated performance units is $5,000,000. As of September 9, 1996, the
Board had granted 3,050,898 options under the Incentive Plan, of which
2,848,986 options were outstanding. As of September 9, 1996, 1,624,013 options
were immediately exercisable into 1,624,013 shares of Common Stock and
1,224,973 options were exercisable into 1,224,973 shares of Common Stock at
future dates.
The purpose of the Incentive Plan is to strengthen the Company by providing
an incentive to its employees, officers, consultants and directors through the
granting of incentive and nonqualified stock options, stock appreciation and
dividend equivalent rights, restricted stock, performance units, and
performance shares to employees, officers, directors (other than non-employee
directors), consultants and advisors and the granting of options to non-
employee directors of the Company (collectively or individually, "Awards"),
thereby encouraging them to devote their abilities and industry to the success
of the Company. The Incentive Plan will terminate on the day preceding the
tenth anniversary of the date of its adoption, unless earlier terminated by
the Board.
The Incentive Plan is to be administered either by the entire Board or by a
committee consisting of at least two directors of the Company, each of whom is
a "non-employee director" within the meaning of Rule 16b-3 promulgated under
the Securities Exchange Act of 1934, as amended (the "Exchange Act") (the
"Plan Administrators"). To the extent necessary for any Award to qualify as
performance-based compensation under Section 162(m) of the Code, each member
of the Board or the committee administering the Incentive Plan, as applicable,
shall be an "outside director" within the meaning of Section 162(m) of the
Code. Presently, the Incentive Plan is administered by the entire Board.
Each Award under the Incentive Plan will be evidenced by an agreement that
sets forth the terms of the grant. Under the Incentive Plan, the Plan
Administrators have the authority to, among other things: (i) select the
employees to whom Awards will be granted, (ii) determine the type, size and
the terms and conditions of Awards and (iii) establish the terms for treatment
of Awards upon a termination of employment. Awards are generally not
transferable by the grantee, other than by will or the laws of descent and
distribution or under certain other limited conditions, except that options
may be transferable if the terms of the option so provide.
OPTIONS. The per share exercise price of an option granted under the
Incentive Plan is fixed by the Plan Administrators at the time of grant and
must not be less than 100% of the fair market value of the Common Stock of the
Company subject to the option at the date of grant (110% in the case of an
incentive stock option granted to a Ten Percent Stockholder (as defined in the
Incentive Plan)). The Plan Administrators will determine whether any option is
a non-qualified or incentive stock option at the time of grant. Each option
will be exercisable at such dates and in such installments as determined by
the Plan Administrators. Unless otherwise provided in the applicable option
agreement, all outstanding options will become fully exercisable upon a Change
in Control. In addition, the Plan
46
<PAGE>
Administrators reserve the authority to accelerate the exercisability of any
option. Each option terminates at the time determined by the Plan
Administrators provided that the term of each option may not exceed ten years
(five years in the case of any incentive stock options granted to a Ten
Percent Stockholder). Options may be exercised during the grantee's lifetime
only by the grantee or his guardian or legal representative. In the discretion
of the Plan Administrators, the purchase price for shares may be paid (i) in
cash, (ii) by transferring shares of Common Stock to the Company or (iii) by a
combination of the foregoing. In addition, options may be exercised through a
registered broker-dealer pursuant to such cashless exercise procedures which
are, from time to time, deemed acceptable by the Plan Administrators. If an
optionee's employment is terminated by the Company following a Change in
Control, options which were exercisable as of the date of the termination of
employment will remain exercisable until the earlier of (i) the first
anniversary of the date of termination or (ii) the expiration of the stated
term of the option.
DIRECTOR OPTIONS. The Incentive Plan also provides for the non-discretionary
grant of Director Options to each of its non-employee directors (i) with
respect to 2,500 shares of Common Stock of the Company to each non-employee
director who becomes a member of the Board after October 25, 1995 upon
election or appointment and (ii) with respect to 2,500 shares of Common Stock,
annually on the first business day following the annual meeting of
stockholders to all non-employee directors who are members of the Board at
that time. Director Options are granted at an exercise price equal to the fair
market value of the Common Stock of the Company subject to such Director
Options on the date of grant and vest as of the date six months and one day
after such date of grant, provided that the director remains in service at
that time. Director Options generally have ten-year terms, unless earlier
terminated in accordance with the provisions of the Incentive Plan.
STOCK APPRECIATION RIGHTS ("SARS"). The Incentive Plan permits the granting
of SARs either in connection with the grant of an option (other than a
Director Option), or as a separate right. A SAR permits a grantee to receive
upon exercise cash and/or shares, at the discretion of the Plan
Administrators, in an amount calculated pursuant to formulas in the Incentive
Plan. When a SAR is granted, however, the Plan Administrators may establish a
limit on the maximum amount a grantee may receive on exercise. The Plan
Administrators will decide at the time the SAR is granted the date or dates at
which it will become vested and exercisable; however, in the event of a Change
in Control of the Company, all SARs become immediately exercisable, unless
otherwise provided in the applicable agreement at the date of such grant.
DIVIDEND EQUIVALENT RIGHTS ("DERS"). DERs may be granted in tandem with any
Award under the Incentive Plan and may be payable currently or deferred until
the lapsing of the restrictions on the DERs or until the vesting, exercise,
payment or other lapse of restrictions on the related Award. DERs may be
settled in cash or shares of Common Stock or a combination thereof, in a
single payment or multiple installments.
RESTRICTED STOCK. The Plan Administrators will determine the terms of each
restricted stock Award at the date of grant, including the price, if any, to
be paid by the grantee, the restrictions placed on the shares and the time or
times when the restrictions will lapse. In addition, at the time of grant, the
Plan Administrators, in their discretion, may decide: (i) whether dividends
paid on the restricted stock will be held for the account of the grantee or
deferred until the restrictions thereon lapse, (ii) whether any deferred
dividends will be invested in additional shares of Common Stock, (iii) whether
interest will be accrued on any dividends not reinvested in additional shares
of restricted stock and (iv) whether any stock dividends paid will be subject
to the restrictions applicable to the restricted stock Award. Unless otherwise
provided at the time of grant, the restrictions on the restricted stock will
lapse upon a Change in Control.
PERFORMANCE UNITS AND PERFORMANCE SHARES. Performance units and performance
shares will be awarded as the Plan Administrators determine, and the vesting
of these Awards will be based upon the Company's attainment within an
established period of specified performance objectives to be
47
<PAGE>
determined by the Plan Administrators from among the following: earnings per
share, share price, pre-tax profits, net earnings, return on equity or assets,
revenues, EBITDA, market share or market penetration or any combination of the
foregoing. The agreements evidencing the Award of performance shares or units
will set forth the terms and conditions thereof. Performance units may be
denominated in dollars or in shares of Common Stock, and payments in respect
of performance units will be made in cash, shares, shares of restricted stock
or any combination of the foregoing, as determined by the Plan Administrators.
Performance shares are initially denominated in shares of Common Stock, but
the Compensation Committee may ultimately settle performance share awards in
cash, shares of Common Stock or a combination thereof, at its discretion. The
Plan Administrators will determine the treatment of performance Awards upon a
Change in Control at the time of grant.
The Board may at any time and from time to time amend or terminate the
Incentive Plan; provided, however, that, to the extent required by applicable
law, no such change will be effective without the requisite approval of the
Company's stockholders. In addition, no such change may alter or adversely
impair any rights or obligations under any Awards previously granted, except
with the written consent of the grantee.
CERTAIN FEDERAL INCOME TAX CONSEQUENCES. The following discussion is
generally a summary of the principal United States federal income tax
consequences under current federal income tax laws relating to option grants
to employees under the Incentive Plan. This summary is not intended to be
exhaustive and, among other things, does not describe state, local or foreign
income and other tax consequences.
An optionee will not recognize any taxable income upon the grant of a non-
qualified option and the Company will not be entitled to a tax deduction with
respect to such grant. Generally, upon exercise of a non-qualified option, the
excess of the fair market value of the Common Stock on the exercise date over
the exercise price will be taxable as compensation income to the optionee.
Subject to the discussion below with respect to Section 162(m) of the Code and
the optionee including such compensation in income or the Company satisfying
applicable reporting requirements, the Company will be entitled to a tax
deduction in the amount of such compensation income. The optionee's tax basis
for the Common Stock received pursuant to such exercise will equal the sum of
the compensation income recognized and the exercise price.
Special rules may apply in the case of an optionee who is subject to Section
16 of the Exchange Act.
In the event of a sale of Common Stock received upon the exercise of a
nonqualified option, any appreciation or depreciation after the exercise date
generally will be taxed to the optionee as capital gain or loss and will be
long-term capital gain or loss if the holding period for such Common Stock was
more than one year.
Subject to the discussion below, an optionee will not recognize taxable
income at the time of grant or exercise of an "incentive stock option" and the
Company will not be entitled to a tax deduction with respect to such grant or
exercise. The exercise of an "incentive stock option" generally will give rise
to an item of tax preference that may result in alternative minimum tax
liability for the optionee.
Generally, a sale or other disposition by an optionee of shares acquired
upon the exercise of an "incentive stock option" more than one year after the
transfer of the shares to such optionee and more than two years after the date
of grant of the "incentive stock option" will result in any difference between
the amount realized and the exercise price being treated as long-term capital
gain or loss to the optionee, with no deduction being allowed to the Company.
Generally, upon a sale or other disposition of shares acquired upon the
exercise of an "incentive stock option" within one year after the transfer of
the shares to the optionee or within two years after the date of grant of the
"incentive stock option," any excess of (i) the lesser of (a) the fair market
value of the shares at the time of
48
<PAGE>
exercise of the option and (b) the amount realized on such sale or other
disposition over (ii) the exercise price of such option will constitute
compensation income to the optionee. Subject to the discussion below with
respect to Section 162(m) of the Code and the optionee including such
compensation in income or the Company satisfying applicable reporting
requirements, the Company will be entitled to a deduction in the amount of
such compensation income. The difference between the amount realized on such
sale or disposition and the fair market value of the shares at the time of the
exercise of the option generally will constitute short-term or long-term
capital gain or loss, as the case may be, and will not be deductible by the
Company.
Section 162(m) of the Code disallows a federal income tax deduction to any
publicly held corporation for compensation paid in excess of $1,000,000 in any
taxable year to the chief executive officer or any of the four other most
highly compensated executive officers who are employed by the corporation on
the last day of the taxable year. Under regulations proposed under Code
Section 162(m), the deduction limitation of Section 162(m) does not apply to
any compensation paid pursuant to a plan that existed during the period in
which the corporation was not publicly held, to the extent the prospectus
accompanying the initial public offering disclosed information concerning such
plan that satisfied all applicable securities laws. However, the foregoing
exception may be relied upon only for Awards made before the earliest of (i)
the expiration of the plan, (ii) the material modification of the plan, (iii)
the issuance of all stock allocated under the plan, or (iv) the first meeting
of stockholders at which directors are elected occurring after the close of
the third calendar year following the calendar year in which the initial
public offering occurs (the "Reliance Period"). The Company has structured and
intends to implement the Incentive Plan so that compensation attributable to
Awards granted thereunder during the Reliance Period is not subject to the
deduction limitation of Code Section 162(m). The Company intends to consider
whether to structure and implement the Incentive Plan in a manner so that
compensation attributable to Awards made after the Reliance Period will not be
subject to the deduction limitation. The foregoing discussion is based on
proposed regulations which may be amended upon adoption in their final form.
The following table sets forth the number of options outstanding and held by
the persons or groups of persons listed below under the Incentive Plan as of
September 9, 1996:
<TABLE>
<CAPTION>
NUMBER OF
NAME AND POSITION OPTIONS
----------------- ---------
<S> <C>
Mark R. Rutenberg........................................... 1,313,273(1)
Chief Executive Officer
Uzi Ish-Hurwitz............................................. 250,000
Executive Vice-President
James M. Herriman........................................... 100,000
Vice President of Product Development
Laurie J. Mango, M.D........................................ 125,000
Vice President and Medical Director
John B. Henneman, III....................................... 100,000
Vice President, Secretary and General Counsel
Executive Officers as a Group............................... 2,138,273(1)
Non-Executive Directors as a Group.......................... 30,000
Non-Executive Officer Employees as a Group.................. 566,150
</TABLE>
- --------
(1) Includes the 813,273 shares of Common Stock subject to the performance-
based option granted to Mr. Rutenberg on October 1, 1995 described above.
See "--Rutenberg Option Agreement."
49
<PAGE>
OPTION GRANTS IN LAST FISCAL YEAR. The following table sets forth stock
options granted to the Named Executive Officers during the fiscal year ended
December 31, 1995. All such options are for the purchase of Common Stock.
<TABLE>
<CAPTION>
POTENTIAL REALIZABLE VALUE
AT ASSUMED ANNUAL RATES
OF STOCK PRICE APPRECIATION
INDIVIDUAL GRANTS FOR OPTION TERM(1)
------------------------------------------ ---------------------------
% OF TOTAL
NUMBER OF OPTIONS
SECURITIES GRANTED TO
UNDERLYING EMPLOYEES EXERCISE
OPTIONS IN FISCAL OR BASE EXPIRATION
NAME GRANTED YEAR PRICE DATE 5% 10%
---- ---------- ----------- -------- ---------- ---------------------------
<S> <C> <C> <C> <C> <C> <C>
Mark R. Rutenberg....... 813,273 66.7% $15.00 10/01/05 -- $ 19,445,000
Uzi Ish-Hurwitz......... -- -- -- -- -- --
James M. Herriman....... -- -- -- -- -- --
Laurie J. Mango, M.D. .. -- -- -- -- -- --
John B. Henneman, III... 25,000 2.1% 6.00 2/27/05 $ 94,000 239,000
</TABLE>
- --------
(1) These columns show the hypothetical gains or "option spreads" of the
outstanding options granted based on assumed annual compound stock
appreciation rates of 5% and 10% over the options' terms. The 5% and 10%
assumed rates of appreciation are mandated by the rules of the Securities
and Exchange Commission and do not represent the Company's estimate or
projections of future prices of the Common Stock. The Rutenberg option has
no potential realizable value under the 5% stock price appreciation rate
since at such rate the stock price never achieves the Target Price of
$30.37. See "--Rutenberg Option Agreement."
AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR-END OPTION
VALUES. The following table sets forth the number of shares covered by both
exercisable and unexercisable options on Common Stock held by the Named
Executive Officers as of December 31, 1995. Each of these options was granted
at exercise prices ranging from $4.00 to $15.00 per share. Each is a non-
qualified option with a ten-year term, subject to earlier termination in the
event of the optionee's termination of employment. The unexercisable options
issued to Mark R. Rutenberg are subject to vesting in accordance with the
terms of his performance-based option and the unexercisable options issued to
John B. Henneman, III vest over a five-year period.
<TABLE>
<CAPTION>
NUMBER OF SECURITIES VALUE OF UNEXERCISED
UNDERLYING UNEXERCISED IN-THE-MONEY OPTIONS
OPTIONS AT FISCAL YEAR-END(1) AT FISCAL YEAR-END(2)
-------------------------------- -------------------------
NAME EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
- ---- -------------- --------------- ----------- -------------
<S> <C> <C> <C> <C>
Mark R. Rutenberg....... 500,000 813,273 $8,062,500 $4,168,024
Uzi Ish-Hurwitz......... 250,000 -- 4,031,250 --
James M. Herriman....... 100,000 -- 1,612,500 --
Laurie J. Mango, M.D. .. 125,000 -- 2,015,625 --
John B. Henneman, III... 75,000 25,000 1,209,375 353,125
</TABLE>
- --------
(1) As of December 31, 1995, none of the options granted under the Incentive
Plan had been exercised.
(2) Values for "in-the-money" outstanding options represent the positive
spread between the respective exercise prices of the outstanding options
and the last closing price of the Common Stock as of December 31, 1995,
which was $20.125.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION. Decisions with
respect to compensation for the 1995 fiscal year were made by the entire
Board, on the advice of Elizabeth
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<PAGE>
Cogan Fascitelli and Mark R. Rutenberg and of Joseph Salamon and John E. Fox,
who were members of the Board until June 20, 1996. Mr. Rutenberg is the
Company's Chief Executive Officer. Mr. Rutenberg excused himself from all
deliberations relating to his own compensation. In December 1995, the Board
created a Compensation Committee, which recommends to the Board compensation
for the Company's key employees. In the opinion of the Board, the directors
serving on the Compensation Committee are independent of management and free
of any relationship that would interfere with their exercise of independent
judgment as members of the Compensation Committee.
ANNUAL BONUS PLAN
During October 1995, the Company awarded bonuses in respect of 1995 to
Messrs. Rutenberg, Ish-Hurwitz, Herriman and Henneman and to Dr. Mango in the
amounts of $131,000, $90,000, $68,400, $57,600 and $80,000, respectively. The
Named Executive Officers, other than Mr. Rutenberg, were permitted to elect to
have up to 50% of their 1995 bonuses paid in the form of shares of Common
Stock valued at a price of $7.00 per share. Each of those Named Executive
Officers elected to have 50% of their bonuses (representing 21,143 shares in
total) paid in shares of Common Stock.
CONSULTING AGREEMENTS
The Company has entered into consulting agreements with various individuals
prominent in the field of cytology, pathology and gynecologic oncology
including Dr. Arthur Herbst, one of the Company's directors. These agreements
provide the Company with additional intellectual resources in the areas of
product development and clinical studies of PAPNET(R) Testing System
performance. In addition, certain of the Company's medical consultants are
advising the Company in connection with its introduction of the PAPNET(R)
Testing System.
INDEMNIFICATION MATTERS
The Certificate contains a provision that eliminates the personal liability
of its directors for monetary damages arising from a breach of their fiduciary
duties in certain circumstances to the fullest extent permitted by law. The
Certificate also authorizes the Company to indemnify its directors and
officers to the fullest extent permitted by law. Such limitation of liability
does not affect the availability of equitable remedies such as injunctive
relief or rescission. Insofar as indemnification for liabilities arising under
the Securities Act may be permitted to directors, officers and controlling
persons of the Company pursuant to the foregoing provisions, or any charter
provision, by-laws, contracts, arrangements, statute or otherwise, the Company
has been advised that, in the opinion of the Securities and Exchange
Commission (the "Commission"), such indemnification is against public policy
as expressed in the Securities Act and is, therefore, unenforceable.
In addition, the Company has entered into indemnification agreements (the
"Indemnification Agreements") with each of its directors/officers of the
Company. The Indemnification Agreements (i) confirm to officers and directors
the indemnification provided to them in the Certificate, (ii) provide officers
and directors with procedural protections in the event that they are sued in
their capacity as director or officer, (iii) provide additional
indemnification rights, and (iv) provide contribution rights in the event that
indemnification is unavailable or insufficient.
The Company maintains directors' and officers' liability insurance with a
liability limitation of $5,000,000.
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<PAGE>
PRINCIPAL STOCKHOLDERS
The following table sets forth, as of September 9, 1996, information
regarding the beneficial ownership of the Company's Common Stock by the
directors and executive officers of the Company and by each person known by
the Company to beneficially own 5% or more of the outstanding shares of Common
Stock.
<TABLE>
<CAPTION>
AMOUNT
NAME AND ADDRESS OF BENEFICIAL BENEFICIALLY
TITLE OF CLASS OWNER OWNED(1) % OF CLASS
-------------- ------------------------------ ------------ ----------
<C> <S> <C> <C>
Common Stock......... The Goldman Sachs Group, 8,133,661 27.5%
L.P. .........................
and related investors(2)
85 Broad Street
New York, NY 10004
Common Stock......... H and S Trust(3).............. 3,872,068 12.7%
Suite 3C, Centre Plaza
Horseback Lane
Gibraltar
Common Stock......... Edelson Technology Partners 1,594,215 5.4%
II, L.P.(4)...................
Whiteweld Centre
Woodcliff Lake, NJ 07675
Common Stock......... Mark R. Rutenberg(5).......... 1,541,304 5.2%
c/o Neuromedical Systems, Inc.
Two Executive Boulevard
Suffern, NY 10901
Common Stock......... Stuart M. Essig(6)............ -- *
Common Stock......... Elizabeth Cogan Fascitelli(6). -- *
Common Stock......... Carl Genberg(7)............... 43,272 *
Common Stock......... Arthur L. Herbst, M.D.(8)..... 1,200 *
Common Stock......... Uzi Ish-Hurwitz(9)............ 256,429 *
Common Stock......... C. Raymond Larkin, Jr.(10).... 2,500 *
Common Stock......... Stephen K.C. Ng, M.D.(11)..... 409,328 1.4%
Common Stock......... All directors and executive
officers as a group (14
persons, including those
listed above)(12)............. 2,749,973 9.0%
</TABLE>
- --------
* Less than 1%
(1) The words "group" and "beneficial" are as defined in regulations issued
by the Commission. Beneficial ownership under such definition means
possession of sole voting power, shared voting power, sole dispositive
power or shared dispositive power. Except as indicated in the footnotes
to this table, the persons named have sole voting and investment power
with respect to all shares of Common Stock shown as beneficially owned by
them.
(2) Includes shares beneficially owned by certain investment limited
partnerships of which affiliates of The Goldman Sachs Group, L.P. ("GS
Group") are the general partners or the managing general partners. GS
Group owns 125,000 shares of Common Stock. Also includes 1,272,275 shares
held in managed accounts ("Managed Accounts") for which Goldman, Sachs &
Co. exercises voting or investment authority, or both. In addition,
includes 3,100 shares owned by Goldman, Sachs & Co. which were acquired in
the ordinary course of market making. Also
52
<PAGE>
includes options for 5,000 shares of Common Stock in respect of Ms.
Fascitelli's and Mr. Essig's service on the Board. GS Capital Partners,
L.P. ("GSCP") owns 5,382,629 shares of Common Stock; Stone Street Fund
1993, L.P. ("Stone Street") owns 635,958 shares of Common Stock; and Bridge
Street Fund 1993, L.P. ("Bridge Street," and, together with Stone Street
and GSCP, the "Limited Partnerships") owns 709,699 shares of Common Stock.
The foregoing amounts reported as owned by the Limited Partnerships include
an aggregate of 87,328 shares which are subject to the exercise of options
and warrants. GS Group disclaims beneficial ownership of shares held (i) by
the Limited Partnerships to the extent partnership interests in such
partnerships are held by persons other than GS Group and its affiliates and
(ii) in Managed Accounts. GS Group shares voting and dispositive power with
respect to all shares reported as beneficially owned, other than the
125,000 shares owned by GS Group.
(3) Includes an aggregate of 2,781,533 shares of Common Stock and a warrant
to purchase 1,090,535 shares of Common Stock which are owned by Tehila
Holdings A.V.V., Marineland A.V.V. and Leadville A.V.V., each of which is
an Aruba corporation wholly owned by H and S Trust, a Gibraltar trust.
Joseph Salamon, a director of the Company until June 20, 1996, and other
members of his family are potential beneficiaries of the H and S Trust.
Mr. Salamon disclaims beneficial ownership of all of such shares.
(4) Includes 215,400 shares of Common Stock held of record by Edelson
Technology Partners III, L.P., a limited partnership under common control
with Edelson Technology Partners II, L.P.
(5) Includes an option for the purchase of 500,000 shares of Common Stock.
Such amount does not include the performance-based option (See
"Management--Rutenberg Option Agreement") exercisable for 813,273 shares
of Common Stock.
(6) Mr. Essig and Ms. Fascitelli are officers of Goldman, Sachs & Co. Share
data shown for such individuals excludes shares shown as held by The
Goldman Sachs Group, L.P. and related investors as to which such
individuals disclaim beneficial ownership.
(7) Includes options for 2,500 shares of Common Stock granted in respect of
Mr. Genberg's service on the Board.
(8) Includes 1,000 shares of Common Stock held directly by Dr. Herbst and 200
shares of Common Stock held by Dr. Herbst's wife.
(9) Includes options for 250,000 shares of Common Stock of which 125,000 of
such options are subject to transfer pursuant to a personal settlement
agreement.
(10) Includes options for 2,500 shares of Common Stock granted in respect of
Mr. Larkin's service on the Board.
(11) Includes (i) 25,000 shares of Common Stock held directly by Dr. Ng, (ii)
25,000 shares of Common Stock issuable upon exercise of warrants held of
record by Dr. Ng, (iii) 12,500 shares of Common Stock held of record by
Dr. Ng's wife, (iv) 1,562 shares of Common Stock issuable upon exercise
of warrants held of record jointly with Dr. Ng's wife, (v) 337,766 shares
of Common Stock owned of record by PFEL (of which Dr. Ng owns 18.3% and
as to which shares Dr. Ng disclaims beneficial ownership), (vi) 5,000
shares of Common Stock held of record by Bluehill Holdings, Ltd., a
corporation over which Dr. Ng has voting control and (vii) options for
2,500 shares of Common Stock in respect of Dr. Ng's service on the Board.
(12) All shares shown with respect to directors and executive officers include
options exercisable within 60 days at exercise prices ranging from $4.00
to $22.63 per share, all of which shares were deemed outstanding for
purposes of computing the percentage of Common Stock outstanding and
beneficially owned. Directors and executive officers also hold options
that are not presently exercisable with respect to an additional 900,773
shares of Common Stock which, in accordance with the rules of the
Commission, are not included in the table.
53
<PAGE>
CERTAIN TRANSACTIONS
TERRITORIAL LICENSES AND RELATED AGREEMENTS
From 1989 through 1991, the Company entered into the License Agreements for
the PAPNET(R) Testing System. The Company received net proceeds of
approximately $3,500,000 from the sale of these territorial licenses. Each
license expires on the later of (i) 17 years after its execution or (ii) the
expiration of the initial patent granted for the PAPNET(R) Testing System, and
is renewable for an additional 17-year term at the Licensee's option. Carl
Genberg, a director of the Company, is an officer or has significant direct or
indirect ownership interests in four of the Licensees (the "Related
Licensees") and is a director of Cytology West, Inc., the Related Licensee
that holds the License Agreement relating to Arizona, Nevada and San Diego
County. Carl Genberg is the first cousin of Mark R. Rutenberg, the Chairman of
the Board, President and Chief Executive Officer of the Company. In connection
with the sale of the License Agreements, GRK, a now-dissolved Ohio general
partnership, was instrumental in arranging such sales and received warrants
exercisable for 93,124 shares of Common Stock. Such warrants were exercised,
pursuant to a Settlement Agreement and a Warrant Exercise Agreement, the
effect of which included the clarification of previously disputed elements of
the License Agreements, simultaneously with the completion of the IPO in a
"cashless exercise." GRK received 80,708 shares of Common Stock pursuant to
such exercise, of which Mr. Genberg received 26,903 shares of Common Stock
upon the dissolution of GRK in 1995. In addition, the Company issued an
aggregate of 89,020 shares of Common Stock pursuant to the Settlement
Agreement to Carl Genberg individually and the Related Licensees. Under the
License Agreements, the Licensees receive royalties on an annual basis which
the Company estimates will be approximately 10% of its United States revenues
over the term of the License Agreements, but there can be no assurance that
the amount of such royalties will not be more or less than such percentage. In
1995, such royalty expense for the Related Licensees was approximately
$87,000.
UNDERWRITING FEES
The Goldman Sachs Group, L.P. and certain of its investment limited
partnership affiliates are the beneficial owners of approximately 22.9% of the
Company's outstanding Common Stock as of September 9, 1996 (excluding shares
held in managed accounts, shares acquired in the ordinary course of business
and shares issuable upon the exercise of warrants and options to acquire
Common Stock). See "Principal Stockholders." Two of the Company's directors
are officers of Goldman, Sachs & Co., an affiliate of The Goldman Sachs Group,
L.P. Goldman, Sachs & Co. acted as one of the representatives of the
underwriters in the Company's IPO in which all such underwriters received
aggregate underwriting discounts and commissions of approximately $7,245,000
from the Company.
PFEL AGREEMENT
The Company has entered into an exclusive representation agreement with PFEL
under which the Company incurred aggregate expenses of $136,295 in 1995 and
$116,000 in 1994. The Company is obligated to pay PFEL $75,000 in management
fees, in addition to any commissions, in 1996. Dr. Stephen Ng, a director of
the Company, is the President and an 18.3% stockholder of PFEL. Dr. Ng is also
the President of Compuscreen, a subsidiary of PFEL and a customer of the
Company. In 1994 and 1995, the Company recorded approximately $18,000 and
approximately $259,000, respectively, in revenue from Compuscreen. In
addition, PFEL was the record holder of 1,351,064 shares of the Company's
Convertible Preferred Stock, all of which automatically converted into 337,766
shares of Common Stock upon consummation of the IPO in December 1995. PFEL
purchased such shares of Convertible Preferred Stock in May 1994 and January
1995, in each case concurrently with other unaffiliated investors which paid
the same prices per share and received the same terms and conditions.
54
<PAGE>
OTHER
Since 1994, Dr. Herbst has served as a consultant to the Company in the
field of gynecological oncology. In such capacity, Dr. Herbst was paid
approximately $33,000, $55,000 and $22,500 in 1994, 1995 and 1996 through
September 25, 1996, respectively, in consideration of his consulting services
plus certain expenses incurred in connection therewith. The term of his
consulting agreement ends on December 31, 1997.
In January 1994, the Company loaned Mr. Rutenberg $200,000, which loan was
free of interest charges and was approved by the Board. Such amount was repaid
in full by Mr. Rutenberg in March 1994.
In January 1995, the Company issued 21,276 shares of Series Preferred Stock,
all of which automatically converted into 5,319 shares of Common Stock upon
consummation of the IPO, to Frank Ng, the brother of Dr. Stephen Ng, a
director of the Company, in consideration for assisting the Company in raising
approximately $1,000,000 in equity capital.
The Company has, in the past, utilized the services of Insight Graphics and
Design ("Insight"), the sole proprietor of which is Ellen Rutenberg, wife of
Mark Rutenberg, the President, Chairman and Chief Executive Officer of the
Company. Insight provides graphic design consulting services to the Company,
and has been responsible for the creative design of the Company's domestic and
international marketing materials since 1993. In 1994 and 1995, the Company
paid Insight approximately $48,000 and $57,700, respectively, for such
services. In May 1996, Mrs. Rutenberg became an employee of the Company at an
annual salary of approximately $42,000. The Company does not anticipate
utilizing Insight for any further services.
The Company believes that the terms of the transactions described in this
section are no less favorable to the Company than the terms it would have
received if the transactions were entered into with parties unaffiliated with
the Company.
55
<PAGE>
DESCRIPTION OF CAPITAL STOCK
The following brief description of the Company's capital stock does not
purport to be complete and is subject in all respects to the General
Corporation Law of the State of Delaware and other applicable Delaware law
(the "Delaware Law") and to the provisions of the Company's Certificate and
By-Laws, copies of which have been filed as exhibits to the Registration
Statement of which this Prospectus is a part.
The authorized capital stock of the Company consists of 100,000,000 shares
of Common Stock, par value $.0001 per share, and 10,000,000 shares of
preferred stock, par value $.0001 per share (the "Preferred Stock"). As of
September 9, 1996, there were 29,493,606 shares of Common Stock outstanding
and 4,418,490 shares of Common Stock issuable upon exercise of outstanding
options and warrants. All outstanding shares of Common Stock are fully paid
and non-assessable. As of September 9, 1996, there were no shares of Preferred
Stock issued or outstanding.
COMMON STOCK
The holders of Common Stock are entitled to one vote for each share on all
matters voted on by stockholders, including the election of directors and,
except as otherwise required by law or provided in any resolution adopted by
the Board with respect to any series of Preferred Stock, will exclusively
possess all voting power. The holders of Common Stock do not have any
cumulative voting, conversion, redemption or preemptive rights. The Board is
classified in accordance with the Certificate. See "Certain Charter and By-
Laws Provisions--Classified Board of Directors." Subject to any preferential
rights of any outstanding series of Preferred Stock designated by the Board
from time to time, the holders of Common Stock are entitled to such dividends
as may be declared from time to time by the Board from funds available
therefor, and upon liquidation are entitled to receive pro rata all assets of
the Company available for distribution to such holders. See "Price Range of
Common Stock and Dividend Policy."
The Common Stock is quoted on the Nasdaq National Market System under the
symbol "NSIX."
PREFERRED STOCK
The Board is authorized to provide for the issuance of shares of the
Preferred Stock, in one or more series, and to fix for each such series such
voting powers, designations, preferences and relative, participating, optional
and other special rights, and such qualifications, limitations or
restrictions, as are stated in the resolution adopted by the Board providing
for the issuance of such series and as are permitted by the Delaware Law. In
connection with the Stockholder Rights Plan adopted by the Company (the
"Stockholder Rights Plan"), the Company has authorized a series of 450,000
shares of Preferred Stock designated Series A Participating Preferred Stock
(the "Series A Preferred Stock"). For a description of the terms of the Series
A Preferred Stock, see "--Preferred Stock Purchase Rights." The Board could
authorize the issuance of shares of Preferred Stock with terms and conditions
which could have the effect of impeding or delaying a merger, tender offer or
other transaction or a change of control of the Company that some, or a
majority, of the Company's stockholders might believe to be in their best
interests. See "Risk Factors--Control by Existing Stockholders; Need for
Qualified Independent Underwriter" and "Certain Charter and By-Laws
Provisions--Preferred Stock." Other than the Series A Preferred Stock, the
Company has no present plans to issue any Preferred Stock.
OPTIONS AND WARRANTS
The Company has sold or granted options and warrants to purchase its capital
stock at various exercise prices over various periods of time. As of September
9, 1996, excluding the options granted under the Incentive Plan (under which
options to purchase 3,050,898 shares have been granted of
56
<PAGE>
which 2,848,986 are outstanding), the Company has outstanding warrants to
purchase an aggregate of 1,569,504 shares of Common Stock at exercise prices
ranging from nominal to $12.00 per share. If all of such warrants were
exercised by payment of cash to the Company, the aggregate proceeds to the
Company would be approximately $2,024,000.
Most of the Company's outstanding warrants and options contain provisions
allowing for the conversion of such warrants and options into a lesser number
of shares without the payment of cash to the Company (so-called "cashless
exercise" provisions). Accordingly, there can be no assurance that, even if
all of such options and warrants are exercised, the Company will receive any
cash proceeds from the exercise of warrants or options.
PREFERRED STOCK PURCHASE RIGHTS
The Board has adopted the Stockholder Rights Plan, pursuant to which there
has been issued with respect to each share of Common Stock issued and
outstanding as of or following the consummation of the IPO one Preferred Stock
Purchase Right (a "Right"). Each Right entitles the registered holder to
purchase from the Company one one-hundredth of a share of Series A Preferred
Stock at a price of $60.00 per one one-hundredth of a share, subject to
adjustment. The description and terms of the Rights are set forth in a form of
Rights Agreement (the "Rights Agreement"), a copy of which is filed as an
exhibit to the Registration Statement of which this Prospectus is a part.
The Rights have certain anti-takeover effects. The Rights will cause
substantial dilution to a person or group that attempts to acquire the Company
without conditioning the offer on the Rights being redeemed or a substantial
number of Rights being acquired. However, the Rights should not interfere with
any tender offer or merger approved by the Company (other than with an
Acquiring Person (as defined below)) because the Rights (i) do not become
exercisable in the event of a Permitted Offer (as defined below) and expire
automatically upon the consummation of a merger in which the form of
consideration is the same as, and the price is not less than the price paid
in, the Permitted Offer and (ii) are redeemable in connection with an approved
merger in which all holders of Common Stock are treated alike.
The Rights are or will be attached to all certificates representing shares
of Common Stock issued prior to the Rights Distribution Date (as defined
below). Initially, no separate Rights certificates will be distributed. Until
the earlier to occur of (i) the first date (the "Stock Acquisition Date") of a
public announcement that a person or group of affiliated or associated persons
(an "Acquiring Person"), other than persons who would be an Acquiring Person
solely by reason of ownership of stock upon the completion of the IPO (a
"Grandfathered Stockholder"), has acquired, or obtained the right to acquire,
beneficial ownership of securities having 15% (or, with respect to a
Grandfathered Stockholder, such stockholder's ownership of stock upon
completion of the IPO plus 1%) or more of the voting power of all outstanding
voting securities of the Company or (ii) ten days (unless such date is
extended by the Board) following the commencement of (or a public announcement
of an intention to make) a tender offer or exchange offer which would result
in any person or group of related persons becoming an Acquiring Person (in
either case, except as a result of Permitted Offer) (the earlier of such dates
being called the "Rights Distribution Date"), the Rights will be evidenced by
the certificates representing shares of Common Stock. Until the Rights
Distribution Date, the Rights will be transferred with and only with
certificates representing shares of Common Stock. Certificates issued upon
transfer or new issuance of shares of Common Stock will contain a notation
incorporating the Rights Agreement by reference. Until the Rights Distribution
Date (or earlier redemption or expiration of the Rights), the surrender for
transfer of any certificates for shares of Common Stock will also constitute
the transfer of the Rights associated with the shares represented by such
certificate. As soon as practicable following the Rights Distribution Date,
separate certificates evidencing the Rights ("Rights
57
<PAGE>
Certificates") will be mailed to holders of record of shares of Common Stock
as of the close of business on the Rights Distribution Date, and the separate
Rights Certificates alone will evidence the Rights.
The Rights are not exercisable until the Rights Distribution Date. The
Rights will expire on the earliest of (i) December 7, 2005, (ii) consummation
of a merger transaction with a person or group who acquired shares of Common
Stock pursuant to a Permitted Offer, and is offering in the merger the same
form of consideration, and not less than the price per share of Common Stock
paid pursuant to the Permitted Offer or (iii) redemption by the Company as
described below.
The purchase price payable per one one-hundredth of a share of Series A
Preferred Stock (the "Purchase Price"), as set forth in the Rights
Certificates, and the number of shares of Series A Preferred Stock or other
securities issuable upon exercise of the Rights is subject to adjustment from
time to time to prevent dilution (i) in the event of a stock dividend on, or a
subdivision, combination or reclassification of, the Series A Preferred Stock,
(ii) upon the grant to holders of the Series A Preferred Stock of certain
rights or warrants to subscribe for Series A Preferred Stock, certain
convertible securities or securities having rights, privileges and preferences
the same as, or more favorable than, the Series A Preferred Stock at less than
the current market price of the Series A Preferred Stock or (iii) upon the
distribution to holders of the Series A Preferred Stock of evidences of
indebtedness, cash (excluding regular quarterly cash dividends out of earnings
or retained earnings), assets (other than a dividend payable in Series A
Preferred Stock) or of subscription rights or warrants (other than those
referred to above).
With certain exceptions, no adjustments in the Purchase Price will be
required until cumulative adjustments require an adjustment of at least 1% in
such Purchase Price. No fractions of shares of Common Stock will be issued
and, in lieu thereof, an adjustment in cash will be made based on the market
price of the Common Stock on the last trading date prior to the date of
exercise.
In the event that, after the first date of public announcement by the
Company or an Acquiring Person that an Acquiring Person has become such, the
Company is involved in a merger or other business combination transaction in
which shares of Common Stock are exchanged or changed (other than a merger
with a person or group who acquired shares of Common Stock pursuant to a
Permitted Offer and is offering in the merger not less than the price paid
pursuant to the Permitted Offer and the same form of consideration paid in the
Permitted Offer), or 50% or more of the Company's assets or earning power are
sold (in one transaction or a series of transactions), proper provision shall
be made so that each holder of a Right (other than such Acquiring Person)
shall thereafter have the right to receive, upon the exercise thereof at the
then current exercise price of the Right, that number of shares of common
stock of the acquiring company (or, in the event that there is more than one
acquiring company, the acquiring company receiving the greatest portion of the
assets or earning power transferred) which at the time of such transaction
would have a market value of two times the exercise price of the Right (such
right being called the "Merger Right"). "Permitted Offer" means a tender offer
or exchange offer for all outstanding shares of Common Stock at a price and on
terms determined, prior to the purchase of shares under such tender offer or
exchange offer, by at least a majority of the members of the Board who are not
officers of the Company or Acquiring Persons to be both adequate and otherwise
in the best interests of the Company, its stockholders (other than the person
on whose behalf the offer is being made) and other relevant constituencies.
In the event that an Acquiring Person becomes such, each holder of a Right
(other than such Acquiring Person) will for a 60-day period thereafter have
the right to receive upon exercise that number of shares of Common Stock
having a market value of two times the exercise price of the Right, to the
extent available, and then (after all authorized and unreserved shares of
Common Stock have been issued) a common stock equivalent (such as Series A
Preferred Stock or another equity security with at least the same economic
value as the Common Stock) having a market value of two times the
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<PAGE>
exercise price of the Right, with shares of Common Stock to the extent
available being issued first (such right being called the "Subscription
Right").
The holder of a Right will continue to have the Merger Right whether or not
such holder exercises the Subscription Right. Upon the occurrence of any of
the events giving rise to the exercisability of the Merger Right or the
Subscription Right, any Rights that are or were at any time owned by an
Acquiring Person shall become void insofar as they relate to the Merger Right
or the Subscription Right.
At any time prior to the earlier to occur of (i) a person becoming an
Acquiring Person or (ii) the expiration of the Rights, the Company may redeem
the Rights in whole, but not in part, at a price of $.01 in cash per Right
(the "Redemption Price"), which redemption shall be effective upon the action
of the Company's Board in the exercise of its sole discretion. Additionally,
the Company may, following the Stock Acquisition Date, redeem the then
outstanding Rights in whole, but not in part, at the Redemption Price provided
that such redemption is (i) in connection with a merger or other business
combination transaction or series of transactions involving the Company in
which all holders of Common Stock are treated alike but not involving an
Acquiring Person or any person who was an Acquiring Person or (ii) following
an event giving rise to, and the expiration of the exercise period for, the
Subscription Right if and for as long as no person beneficially owns
securities representing 15% or more of the voting power of the Company's
voting securities. Upon the effective date of the redemption of the Rights,
the right to exercise the Rights will terminate and the only right of the
holders of Rights will be to receive the Redemption Price.
Any of the provisions of the Rights Agreement may be amended by the Board
prior to the Rights Distribution Date. After the Rights Distribution Date, the
provisions of the Rights Agreement may be amended by the Board in order to
cure any ambiguity, defect or inconsistency, or to make changes which do not
adversely affect the interest of holders of the Rights (excluding the
interests of any Acquiring Person).
The Series A Preferred Stock purchasable upon exercise of the Rights will be
nonredeemable and junior to any other series of preferred stock the Company
may issue (unless otherwise provided in the terms of such stock). Each share
of Series A Preferred Stock will have a preferential quarterly dividend in an
amount equal to 100 times the dividend declared on each share of Common Stock,
but in no event less than $1.00. In the event of liquidation, the holders of
Series A Preferred Stock will, subject to the availability of assets for
distribution (including the rights of securityholders of the Company having
priority in liquidation to the holders of shares of Series A Preferred Stock),
receive a preferred liquidation payment equal to $100 per share, plus an
amount equal to accrued and unpaid dividends thereon to the date of such
payment, and thereafter, once holders of shares of Common Stock have received
an equivalent liquidation payment, the holders of shares of Series A Preferred
Stock and shares of Common Stock will receive their ratable share of any
remaining assets to be distributed. Each share of Series A Preferred Stock
will have 100 votes, voting together with holders of shares of Common Stock.
In the event of any merger, consolidation or other transaction in which shares
of Common Stock are exchanged, each share of Series A Preferred Stock will be
entitled to receive 100 times the amount and type of consideration received
per share of Common Stock. The rights of the Series A Preferred Stock as to
dividends, liquidation and voting, and in the event of mergers and
consolidations, are protected by customary anti-dilution provisions.
Fractional shares of Series A Preferred Stock will be issuable; however, the
Company may elect to distribute depositary receipts in lieu of such fractional
shares. In lieu of fractional shares other than fractions that are multiples
of one one-hundredth of a share, an adjustment in cash will be made based on
the market price of the Series A Preferred Stock on the last trading date
prior to the date of exercise.
After such time as any person becomes an Acquiring Person (provided that no
person owns 50% or more of the Common Stock), the Board, at its option, may
exchange Rights for Common Stock at the ratio of one share per Right. Such an
exchange of Rights must be authorized by a majority of the
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<PAGE>
entire Board. The share exchange option permits stockholders to receive Common
Stock under the Stockholder Rights Plan without the expenditure of funds
otherwise necessary to exercise such Rights. Any such share exchange would
deny the Company the benefits of additional capital that it might otherwise
receive under the Stockholder Rights Plan.
Until a Right is exercised, the holder thereof, as such, will have no rights
as a stockholder of the Company, including, without limitation, the right to
vote or to receive dividends.
REGISTRAR AND TRANSFER AGENT
The registrar and transfer agent for the Common Stock is American Stock
Transfer and Trust Company.
60
<PAGE>
CERTAIN CHARTER AND BY-LAWS PROVISIONS
The following brief description of certain provisions of the Certificate and
By-Laws does not purport to be complete and is subject in all respects to the
provisions of the Certificate and By-Laws, copies of which have been filed as
exhibits to the Registration Statement of which this Prospectus is a part.
CLASSIFIED BOARD OF DIRECTORS
The Certificate provides that the Board is divided into three classes of
directors, as nearly equal in number as reasonably possible, except for any
directors elected separately by the holders of any one or more series of
Preferred Stock. The Board consists of the persons referred to as directors
under "Management--Executive Officers and Directors." The Certificate provides
that the term of office of the first class of directors expired at the 1996
Annual Meeting of Stockholders, the term of office of the second class of
directors will expire at the 1997 Annual Meeting of Stockholders, and the term
of office of the third class of directors will expire at the 1998 Annual
Meeting of Stockholders. Starting with the 1996 Annual Meeting of
Stockholders, one class of directors is being elected each year for a three-
year term.
The classification of directors has the effect of making it more difficult
for stockholders to change the composition of the Board. At least two annual
meetings of stockholders, instead of one, will generally be required to effect
a change in a majority of the Board. Such a delay may help ensure that the
Company's directors, if confronted by a holder attempting to force a proxy
contest, a tender or exchange offer or other extraordinary corporate
transaction, would have sufficient time to review the proposal as well as any
available alternatives to the proposal and to act in what they believe to be
the best interests of the stockholders.
The classification provisions could also have the effect of discouraging a
third party from initiating a proxy contest, making a tender offer or
otherwise attempting to obtain control of the Company, even though such an
attempt might be beneficial to the Company and its stockholders. The
classification of the Board could thus increase the likelihood that incumbent
directors will retain their positions.
NUMBER OF DIRECTORS; REMOVAL; FILLING VACANCIES
The Certificate provides that, subject to any rights of holders of Preferred
Stock to elect additional directors under specified circumstances, the number
of directors will be fixed from time to time by action of not less than a
majority of the Board then in office, but in no event shall be less than four
or more than 11. In addition, the Certificate provides that, subject to any
rights of holders of Preferred Stock, newly created directorships resulting
from an increase in the authorized number of directors or vacancies on the
Board resulting from death, resignation, disqualification or removal of
directors may be filled only by a majority of the directors then in office,
though less than a quorum. Accordingly, the Board could prevent any
stockholder from enlarging the Board and filling the new directorships with
such stockholder's own nominees.
Under the Delaware Law, unless otherwise provided in the certificate of
incorporation, directors serving on a classified board may only be removed by
the stockholders for cause. The Certificate provides that, except for any
directors elected separately by holders of one or more series of Preferred
Stock, directors may be removed only for cause and only upon the affirmative
vote of holders of at least 66 2/3% of the voting power of all the then
outstanding shares of stock entitled to vote generally in the election of
directors ("Voting Stock"), voting together as a single class.
The provisions of the Certificate governing the number of directors, their
removal and the filling of vacancies may have the effect of discouraging a
third party from initiating a proxy contest, making a tender offer or
otherwise attempting to gain control of the Company, or of attempting to
change the
61
<PAGE>
composition or policies of the Board, even though either such attempt might be
beneficial to the Company or its stockholders. These provisions of the
Certificate could thus increase the likelihood that incumbent directors will
retain their positions.
NO STOCKHOLDER ACTION BY WRITTEN CONSENT; SPECIAL MEETINGS
The Certificate provides that, subject to the rights of holders of any
series of Preferred Stock, stockholder action can be taken only at an annual
or special meeting of stockholders called by the Board to elect directors, and
it prohibits stockholder action by written consent in lieu of a meeting. The
By-Laws provide that, subject to the Delaware Law, special meetings of
stockholders can be called only by the Board, and stockholders will not be
permitted to call a special meeting or to require that the Board call a
special meeting of stockholders. Moreover, pursuant to the Certificate and the
By-Laws, the business permitted to be conducted at any special meeting of
stockholders will be limited to the business brought before the meeting
pursuant to the notice of meeting given by the Company.
The provisions of the Certificate prohibiting stockholder action by written
consent may have the effect of delaying consideration of a stockholder
proposal until the next annual meeting unless a special meeting is called by
the Board. These provisions also prevent the holders of a majority of the
voting power of the Voting Stock from unilaterally using the written consent
procedure to take stockholder action. Moreover, a stockholder could not force
stockholder consideration of a proposal over the opposition of the Board by
calling a special meeting of the stockholders prior to the time the Board
believes such consideration to be appropriate.
ADVANCE NOTICE PROVISIONS FOR STOCKHOLDER NOMINATIONS AND STOCKHOLDER
PROPOSALS
The Certificate establishes an advance notice procedure for stockholders to
make nominations of candidates for election as director, or to bring other
business before an annual meeting of stockholders of the Company (the
"Stockholder Notice Procedure").
The Stockholder Notice Procedure provides that, subject to the rights of any
holders of Preferred Stock, only persons who are nominated by, or at the
direction of, the Board, or by a stockholder who has given timely written
notice to the Secretary of the Company prior to the meeting at which directors
are to be elected, will be eligible for election as directors of the Company.
The Stockholder Notice Procedure provides that at an annual meeting only such
business may be conducted as has been brought before the meeting by, or at the
direction of, the Board or by a stockholder who has given timely written
notice to the Secretary of the Company of such stockholder's intention to
bring such business before such meeting. Under the Stockholder Notice
Procedure, to be timely, notice of stockholder nominations or proposals to be
made at an annual or special meeting must be received by the Company not less
than 60 days nor more than 90 days prior to the scheduled date of the meeting
(or, if less than 70 days' notice or prior public disclosure of the date of
the meeting is given, the tenth day following the earlier of (i) the day such
notice was mailed or (ii) the day such public disclosure was made).
Under the Stockholder Notice Procedure, a stockholder's notice to the
Company proposing to nominate a person for election as a director must contain
certain information about the nominating stockholder and the proposed nominee.
Under the Stockholder Notice Procedure, a stockholder's notice relating to the
conduct of business other than the nomination of directors must contain
certain information about such business and about the proposing stockholder.
If the Chairman of the Board or other officer presiding at a meeting
determines that a person was not nominated, or other business was not brought
before the meeting, in accordance with the Stockholder Notice Procedure, such
person will not be eligible for election as a director, or such business will
not be conducted at such meeting, as the case may be.
62
<PAGE>
By requiring advance notice of nominations by stockholders, the Stockholder
Notice Procedure affords the Board an opportunity to consider the
qualifications of the proposed nominees and, to the extent deemed necessary or
desirable by the Board, to inform stockholders about such qualifications. By
requiring advance notice of other proposed business, the Stockholder Notice
Procedure also provides an orderly procedure for conducting annual meetings of
stockholders and, to the extent deemed necessary or desirable by the Board,
provides the Board with an opportunity to inform stockholders, prior to such
meetings, of any business proposed to be conducted at such meetings, together
with any recommendations as to the Board's position regarding action to be
taken with respect to such business, so that stockholders can better decide
whether to attend such a meeting or to grant a proxy regarding the disposition
of any such business.
Although the Certificate does not give the Board any power to approve or
disapprove stockholder nominations for the election of directors or proposals
for action, the foregoing provisions may have the effect of precluding a
contest for the election of directors or the consideration of stockholder
proposals if the proper procedures are not followed, and of discouraging or
deterring a third party from conducting a solicitation of proxies to elect its
own slate of directors or to approve its own proposal, without regard to
whether consideration of such nominees or proposals might be harmful or
beneficial to the Company and its stockholders.
PREFERRED STOCK
Pursuant to the Certificate, the Board is authorized, subject to the
limitations prescribed by law, to provide for the issuance of shares of
Preferred Stock in one or more series, to establish the number of shares of
each such series and to fix the designations, voting powers, preferences and
rights of the shares of each such series, and any qualifications, limitations
or restriction thereof.
The Company believes that the ability of the Board to issue one or more
series of Preferred Stock provides the Company with flexibility in structuring
possible future financing and acquisitions, and in meeting other corporate
needs which might arise. The authorized shares of Preferred Stock, as well as
shares of Common Stock, will be available for issuance without further action
by the Company's stockholders, unless such action is required by applicable
law or the rules of any stock exchange or automated quotation system on which
the Company's securities may be listed or traded. The Nasdaq National Stock
Market System currently requires stockholder approval as a prerequisite to
quotation and trading of shares in several instances, including where the
present or potential issuance of shares could result in an increase in the
number of shares of common stock, or in the amount of voting securities,
outstanding by at least 20%. If the approval of the Company's stockholders is
not required for the issuance of shares of Preferred Stock or shares of Common
Stock, the Board may determine not to seek stockholder approval.
Although the Board has no intention at the present time of doing so, it
could issue a series of Preferred Stock that could, depending on the terms of
such series, impede the completion of a merger, tender offer or other takeover
attempt. The Board will make any determination to issue such shares based on
its judgment as to the best interests of the Company and its stockholders. The
Board, in so acting, could issue Preferred Stock having terms that could
discourage an acquisition attempt through which an acquiror may be able to
change the composition of the Board, including a tender offer or other
transaction that some, or a majority, of the Company's stockholders might
believe to be in their best interests or in which stockholders might receive a
premium for their stock over the then current market price of such stock.
In connection with the Stockholder Rights Plan adopted by the Company, the
Company has authorized the issuance of Series A Preferred Stock. For a
description of the terms of the Series A Preferred Stock, see "Description of
Capital Stock--Preferred Stock" and "--Preferred Stock Purchase Rights."
63
<PAGE>
OTHER PROVISIONS
The Certificate provides that, in discharging their respective duties under
applicable law and in determining what they believe to be in the best
interests of the Company and its stockholders, the Board, each committee of
the Board and each director may take into account the effects, both long- and
short-term, of the proposed action on the employees, distributors, customers,
suppliers and creditors of the Company and the communities in which the
Company conducts its business, to the extent such persons believe pertinent
(including the possibility that the interests of the Company may best be
served by remaining independent).
The Certificate also authorizes the Board and any committee authorized by
the Board to take such action as it may determine to be reasonably necessary
or desirable to encourage any person or entity to enter into negotiations with
the Board and management regarding any transaction which may result in a
change of control of the Company, and to contest or oppose any such
transaction which the Board determines to be unfair, abusive or otherwise
undesirable to the Company, its businesses or stockholders. The Board or any
such committee is specifically authorized to adopt plans or to issue
securities of the Company (including shares of Common Stock or Preferred
Stock, Rights or debt securities), which securities may be exchangeable or
convertible into cash or other securities on such terms as the Board or any
such committee determines and may provide for differential and unequal
treatment of different holders or classes of holders. The existence of this
authority or the actions which may be taken by the Board pursuant thereto are
intended to give the Board flexibility in order to act in the best interests
of stockholders in the event of a potential change of control transaction.
Such provisions may, however, deter potential acquirors from proposing
unsolicited transactions not approved by the Board and might enable the Board
to hinder or frustrate such a transaction if proposed.
AMENDMENT OF THE CERTIFICATE OF INCORPORATION AND BY-LAWS
The Certificate contains provisions requiring the affirmative vote of the
holders of at least 66 2/3% of the voting power of the Voting Stock to amend
certain provisions of the Certificate (including the provisions discussed
above relating to directors, action by written consent, special stockholder
meetings and Stockholder Notice Procedures) or to amend any provision of the
By-Laws by action of stockholders. An affirmative vote of at least 66 2/3% of
the voting power of the Voting Stock is also required to amend provisions in
the Certificate setting forth the extent of liability and indemnification of
officers and directors, the ability of the Board to consider constituent
interests when discharging its duties, the authorization for the Board to take
steps to encourage or oppose, as the case may be, transactions which may
result in a change of control of the Company, and the provisions regarding the
amendment of the Certificate. These provisions make it more difficult for
stockholders to make changes in the Certificate and the By-Laws, including
changes designed to facilitate the exercise of control over the Company.
SECTION 203 OF THE DELAWARE LAW
Section 203 of the Delaware Law provides that, subject to certain exceptions
specified therein, a corporation shall not engage in any business combination
with any "interested stockholder" for a three-year period following the date
that such stockholder becomes an "interested stockholder" unless (i) prior to
such date, the board of directors of the corporation approved either the
business combination or the transaction which resulted in the stockholder
becoming an "interested stockholder," (ii) upon consummation of the
transaction which resulted in the stockholder becoming an interested
stockholder, the interested stockholder owned at least 85% of the voting stock
of the corporation outstanding at the time the transaction commenced
(excluding certain shares) or (iii) on or subsequent to such date, the
business combination is approved by the board of directors of the corporation
and by the affirmative vote of at least 66 2/3% of the outstanding voting
stock which is not owned by the "interested
64
<PAGE>
stockholder." Except as specified in Section 203 of the Delaware Law, an
interested stockholder is defined to include (x) any person that is the owner
of 15% or more of the outstanding voting stock of the corporation or is an
affiliate or associate of the corporation and was the owner of 15% or more of
the outstanding voting stock of the corporation, at any time within three
years immediately prior to the relevant date and (y) the affiliates and
associates of any such person.
Under certain circumstances, Section 203 of the Delaware Law may make it
more difficult for a person who would be an "interested stockholder" to effect
various business combinations with a corporation for a three-year period,
although the stockholders may elect to exclude a corporation from the
restrictions imposed thereunder. The Certificate provides that the Company
elects to be subject to the restrictions imposed under Section 203 of the
Delaware Law. It is anticipated that the provisions of Section 203 of the
Delaware Law may encourage companies interested in acquiring the Company to
negotiate in advance with the Board, since the stockholder approval
requirement would be avoided if the board of directors then in office approves
either the business combination or the transaction which results in the
stockholder becoming an interested stockholder.
LIMITATION OF LIABILITY OF DIRECTORS
The Certificate provides that a director will not be personally liable to
the Company or its stockholders for monetary damages for breach of fiduciary
duty as a director, except for liability (i) for any breach of the director's
duty of loyalty to the corporation or its stockholders, (ii) for acts or
omissions not in good faith or which involve intentional misconduct or a
knowing violation of law, (iii) under Section 174 of the Delaware Law, which
concerns unlawful payments of dividends, stock purchases or redemptions or
(iv) for any transaction from which the director derived an improper personal
benefit. If Delaware Law is subsequently amended to permit further limitation
of the personal liability of directors, the liability of a director of the
Company will be eliminated or limited to the fullest extent permitted by the
Delaware Law as amended.
While these provisions provide directors with protection from awards for
monetary damages for breaches of their duty of care, they do not eliminate
such duty. Accordingly, these provisions have no effect on the availability of
equitable remedies such as an injunction or rescission based on a director's
breach of his or her duty of care. The provisions described above apply to an
officer of the Company only if he or she is a director of the Company and is
acting in his or her capacity as director, and do not apply to officers of the
Company who are not directors.
INDEMNIFICATION OF DIRECTORS AND OFFICERS
The Certificate provides that each person who is involved in any actual or
threatened action, suit or proceeding, whether civil, criminal, administrative
or investigative by reason of the fact that he or she is or was a director or
officer of the Company or is or was serving at the request of the Company as a
director or officer of another corporation or of a partnership, joint venture,
trust or other enterprise, including service with respect to an employee
benefit plan, will be indemnified by the Company to the full extent permitted
by the Delaware Law, as the same exists or may hereafter be amended (but, in
the case of any such amendment, only to the extent that such amendment permits
the Company to provide broader indemnification rights than said law permitted
prior to such amendment) or by other applicable laws then in effect. The
Certificate provides that the expenses incurred by any director or officer in
the defense of any such action, suit or proceeding shall be paid by the
Company in advance of final disposition for such action, suit or proceeding
upon receipt of an undertaking by such director or officer to repay all
amounts so advanced in the event that it shall ultimately be determined that
such director or officer is not entitled to indemnification. The
indemnification rights conferred by the Certificate are not exclusive of any
other right to which a person seeking indemnification may be entitled under
any law, by-law, agreement, vote of stockholders or disinterested directors or
otherwise.
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<PAGE>
The Company will be authorized to purchase and maintain (and the Company
expects to maintain) insurance on behalf of its directors or officers.
In addition, the Company has entered into indemnification agreements (the
"Indemnification Agreements") with each of the directors/officers of the
Company. The Indemnification Agreements (i) confirm to officers and directors
the indemnification provided to them in the Certificate, (ii) provide officers
and directors with procedural protections in the event that they are sued in
their capacity as director or officer, (iii) provide additional indemnification
rights and (iv) provide contribution rights in the event that indemnification
is unavailable or insufficient.
66
<PAGE>
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
NEUROMEDICAL SYSTEMS, INC. AND SUBSIDIARIES
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Report of Independent Auditors............................................ 68
Consolidated Balance Sheets at December 31, 1994 and 1995 and at June 30,
1996
(unaudited).............................................................. 69
Consolidated Statements of Operations for the years ended December 31,
1993, 1994, 1995, for the six months ended June 30, 1995 and for the six
months ended June 30, 1996 (unaudited)................................... 70
Consolidated Statements of Stockholders' Equity for the years ended Decem-
ber 31, 1993, 1994, 1995 and for the six months ended June 30, 1996 (un-
audited)................................................................. 71
Consolidated Statements of Cash Flows for the years ended December 31,
1993, 1994, 1995, for the six months ended June 30, 1995 and for the six
months ended June 30, 1996 (unaudited)................................... 72
Notes to Consolidated Financial Statements................................ 73
</TABLE>
67
<PAGE>
Report of Independent Auditors
To the Stockholders and the Board of Directors
Neuromedical Systems, Inc.:
We have audited the accompanying consolidated balance sheets of Neuromedical
Systems, Inc. and subsidiaries as of December 31, 1995 and 1994, and the
related consolidated statements of operations, stockholders' equity and cash
flows for each of the three years in the period ended December 31, 1995. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Neuromedical
Systems, Inc. and subsidiaries at December 31, 1995 and 1994, and the
consolidated results of their operations and their cash flows for each of the
three years in the period ended December 31, 1995 in conformity with generally
accepted accounting principles.
Ernst & Young LLP
Hackensack, New Jersey
February 12, 1996
68
<PAGE>
NEUROMEDICAL SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------- JUNE 30,
1994 1995 1996
------------ ------------ ------------
(UNAUDITED)
ASSETS
<S> <C> <C> <C>
Current assets:
Cash and cash equivalents............ $ 1,235,000 $114,143,000 $ 95,827,000
Accounts receivable, net of allow-
ance (Note 2)..................... 648,000 900,000 1,127,000
Prepaid expenses................... 188,000 596,000 345,000
Receivable due from capital leases
(Note 3).......................... 402,000 -- --
Other current assets............... 253,000 105,000 714,000
------------ ------------ ------------
Total current assets................. 2,726,000 115,744,000 98,013,000
Restricted cash...................... 1,016,000 -- 1,000,000
Property and equipment (Note 3)...... 8,820,000 11,216,000 14,608,000
Patent and patent application costs,
net of accumulated amortization
(1994-$159,000, 1995-$325,000,
1996-$408,000)...................... 499,000 333,000 250,000
Other assets......................... 112,000 55,000 61,000
------------ ------------ ------------
$ 13,173,000 $127,348,000 $113,932,000
============ ============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Notes and bank loans payable--
short-term (Note 6)............... $ 1,146,000 $ 583,000 $ 529,000
Current portion of capital lease
obligations (Note 4).............. 351,000 680,000 981,000
Accounts payable................... 2,154,000 2,045,000 1,555,000
Accrued liabilities (Note 2)....... 1,526,000 3,323,000 3,446,000
------------ ------------ ------------
Total current liabilities............ 5,177,000 6,631,000 6,511,000
Notes and bank loans payable--long-
term (Note 6)....................... 2,169,000 3,436,000 3,342,000
Notes payable--stockholder (Note 6).. 600,000 600,000 600,000
Capital lease obligations, less cur-
rent portion (Note 4)............... 1,421,000 2,014,000 2,178,000
Commitments and contingencies
(Notes 4, 7 and 10)
Stockholders' equity (Note 8):
Convertible preferred stock, $.0001
par value; authorized--94,500,000
shares in 1994, 10,000,000 shares
in 1995 and 1996; issued and out-
standing--40,616,153 shares in
1994, 0 in 1995 and 1996.......... 30,442,000 -- --
Common stock, $.0001 par value; au-
thorized-126,000,000 in 1994 and
100,000,000 shares in 1995 and
1996; issued and outstanding--
4,131,447 in 1994, 28,804,828
shares in 1995 and 29,319,203
shares in 1996.................... -- 3,000 3,000
Additional paid-in capital......... 4,286,000 175,237,000 175,562,000
Accumulated deficit................ (30,922,000) (60,350,000) (74,575,000)
Foreign currency translation....... -- (223,000) 311,000
------------ ------------ ------------
Total stockholders' equity........... 3,806,000 114,667,000 101,301,000
------------ ------------ ------------
$ 13,173,000 $127,348,000 $113,932,000
============ ============ ============
</TABLE>
See accompanying notes.
69
<PAGE>
NEUROMEDICAL SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
SIX MONTHS
YEAR ENDED DECEMBER 31, ENDED JUNE 30,
--------------------------------------- -------------------------
1993 1994 1995 1995 1996
----------- ------------ ------------ ----------- ------------
(UNAUDITED)
<S> <C> <C> <C> <C> <C> <C>
Revenues:
Slide processing (Note $ 502,000 $ 1,238,000 $ 2,475,000 $ 1,067,000 $ 1,668,000
1).................... ----------- ------------ ------------ ----------- ------------
Total revenues....... 502,000 1,238,000 2,475,000 1,067,000 1,668,000
----------- ------------ ------------ ----------- ------------
Costs and Expenses:
Cost of sales.......... 2,045,000 4,503,000 6,478,000 2,894,000 3,624,000
Marketing.............. 615,000 2,878,000 6,268,000 2,112,000 7,373,000
Research and develop-
ment.................. 1,137,000 4,305,000 5,172,000 2,557,000 3,079,000
General and adminis-
trative............... 2,984,000 3,151,000 6,017,000 2,366,000 3,556,000
Stock issued pursuant
to a settlement
agreement............. -- -- 1,652,000 -- --
Vesting of performance
options at initial
public offering....... -- -- 6,100,000 -- --
----------- ------------ ------------ ----------- ------------
Total costs and ex- 6,781,000 14,837,000 31,687,000 9,929,000 17,632,000
penses.............. ----------- ------------ ------------ ----------- ------------
Loss from operations.... (6,279,000) (13,599,000) (29,212,000) (8,862,000) (15,964,000)
Other income (expense):
Interest income........ 59,000 170,000 548,000 74,000 2,808,000
Interest expense....... (562,000) (393,000) (924,000) (480,000) (484,000)
Foreign exchange....... -- 3,000 160,000 348,000 (585,000)
----------- ------------ ------------ ----------- ------------
Other income (ex- (503,000) (220,000) (216,000) (58,000) 1,739,000
pense)--net......... ----------- ------------ ------------ ----------- ------------
Net loss................ $(6,782,000) $(13,819,000) $(29,428,000) $(8,920,000) $(14,225,000)
=========== ============ ============ =========== ============
Net loss per share
(amounts for 1994 and
1995 are on a pro forma
basis) (Note 1)........ $ (0.84) $ (1.67) $ (0.53) $ (0.49)
============ ============ =========== ============
Shares used in computa-
tion of net loss per
share.................. 16,500,000 17,644,000 16,805,000 28,949,000
============ ============ =========== ============
</TABLE>
See accompanying notes.
70
<PAGE>
NEUROMEDICAL SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
COMMON STOCK CONVERTIBLE ADDITIONAL FOREIGN TOTAL
------------------ PREFERRED PAID-IN CURRENCY ACCUMULATED STOCKHOLDERS'
SHARES AMOUNT STOCK CAPITAL TRANSLATION DEFICIT EQUITY
---------- ------ ----------- ------------- ----------- ------------- -------------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at January 1,
1993................... 4,299,810 -- $ 6,661,000 $ 4,836,000 $(10,321,000) $ 1,176,000
Repurchase of shares
pursuant to a settle-
ment agreement......... (247,650) (938,000) (938,000)
Shares issued for serv-
ices rendered.......... 33,428 124,000 124,000
Exercise of stock op-
tions and stock grants. 23,438 --
Repurchase of shares.... (7,500) (15,000) (15,000)
Sale of 6,451,550 shares
of Series D Convertible
Preferred Stock, net of
expenses............... 6,409,000 6,409,000
Sale of 10,500,000
shares of Series E Con-
vertible Preferred
Stock, net of expenses. 9,872,000 9,872,000
Net loss for the year
ended December 31, (6,782,000) (6,782,000)
1993................... ---------- ------ ----------- ------------- --------- ------------- ------------
Balance at December 31,
1993................... 4,101,526 -- 22,942,000 4,007,000 (17,103,000) 9,846,000
Conversion of debt to
common stock........... 26,596 250,000 250,000
Shares issued for serv-
ices rendered.......... 3,325 29,000 29,000
Sale of 2,500,000 shares
of Series F Convertible
Preferred Stock........ 5,000,000 5,000,000
Sale of 1,063,830 shares
of Series G Convertible
Preferred Stock........ 2,500,000 2,500,000
Net loss for the year
ended December 31, (13,819,000) (13,819,000)
1994................... ---------- ------ ----------- ------------- --------- ------------- ------------
Balance at December 31,
1994................... 4,131,447 -- 30,442,000 4,286,000 (30,922,000) 3,806,000
Sale of 7,782,634 shares
of Series G Convertible
Preferred Stock plus a
related share grant is-
suance cost of 119,092
shares, net of cash
expenses............... 17,890,000 17,890,000
Compensation expense re-
lated to stock options. 17,000 17,000
Sale of 610,574 shares
of Series H Convertible
Preferred Stock plus a
related share grant is-
suance cost of 17,018
shares, net of cash
expenses............... 1,435,000 1,435,000
Exercise of 15,500,000
Series E
Preferred Stock war-
rants.................. 15,500,000 15,500,000
Shares issued pursuant
to executive compensa-
tion................... 27,679 193,000 193,000
Exercise of stock war-
rants.................. 750,000 3,000,000 3,000,000
Initial public offering
net of
expenses............... 6,900,000 $1,000 94,724,000 94,725,000
Stock issued pursuant to
a settlement agreement
and cashless
exercise of warrants... 834,300 1,652,000 1,652,000
Vesting of performance
options at
initial public offer-
ing.................... 6,100,000 6,100,000
Conversion of preferred
stock to
common at initial pub-
lic offering........... 16,161,402 2,000 (65,267,000) 65,265,000 --
Net loss for period end-
ing December 31, 1995.. (29,428,000) (29,428,000)
Foreign currency trans- -- $(223,000) -- (223,000)
lation................. ---------- ------ ----------- ------------- --------- ------------- ------------
Balance at December 31, 28,804,828 3,000 -- 175,237,000 (223,000) (60,350,000) 114,667,000
1995................... ---------- ------ ----------- ------------- --------- ------------- ------------
Stock issued pursuant to
exercise of
warrants............... 438,563 8,000 8,000
Stock issued pursuant to
exercise of
options................ 75,812 317,000 317,000
Net loss for the period
ending June 30, 1996... (14,225,000) (14,225,000)
Foreign currency trans- 534,000 534,000
lation................. ---------- ------ ----------- ------------- --------- ------------- ------------
Balance at June 30, 1996 29,319,203 $3,000 $ -- $ 175,562,000 $ 311,000 $ (74,575,000) $101,301,000
(unaudited)............ ========== ====== =========== ============= ========= ============= ============
</TABLE>
See accompanying notes.
71
<PAGE>
NEUROMEDICAL SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
SIX MONTHS
YEAR ENDED DECEMBER 31, ENDED JUNE 30,
--------------------------------------- -------------------------
1993 1994 1995 1995 1996
----------- ------------ ------------ ----------- ------------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
OPERATING ACTIVITIES
Net Loss................ $(6,782,000) $(13,819,000) $(29,428,000) $(8,920,000) $(14,255,000)
Adjustments to reconcile
net loss to net cash
used in
operating activities:
Depreciation and amor-
tization.............. 1,252,000 1,886,000 2,936,000 1,617,000 1,628,000
Shares issued in con-
sideration for serv-
ices rendered......... 124,000 29,000 210,000 -- --
Stock issued pursuant
to a settlement
agreement............. -- -- 1,652,000 -- --
Vesting of performance
options at initial
public offering....... -- -- 6,100,000 -- --
Changes in operating as-
sets and liabilities:
(Increase) decrease in
accounts receivable... (97,000) (521,000) (252,000) 51,000 (227,000)
Increase (decrease) in
accounts payable...... 833,000 806,000 (110,000) (351,000) (490,000)
(Decrease) increase in
accrued liabilities... (115,000) 1,077,000 1,894,000 100,000 123,000
(Decrease) increase in
prepaid expenses and
other
assets................ (49,000) (420,000) 199,000 507,000 (114,000)
----------- ------------ ------------ ----------- ------------
Net cash used in oper- (4,834,000) (10,962,000) (16,799,000) (6,996,000) (13,305,000)
ating activities...... ----------- ------------ ------------ ----------- ------------
INVESTING ACTIVITIES
Proceeds from the matu-
rity of investments.... -- 2,996,000 -- -- --
Purchase of investments. (2,996,000) -- -- -- --
Purchases of property
and equipment.......... (1,652,000) (7,295,000) (5,008,000) (2,640,000) (5,126,000)
Increase in patent and
patent application (64,000) (127,000) -- -- --
costs.................. ----------- ------------ ------------ ----------- ------------
Net cash used in in- (4,712,000) (4,426,000) (5,008,000) (2,640,000) (5,126,000)
vesting activities.... ----------- ------------ ------------ ----------- ------------
FINANCING ACTIVITIES
Restricted cash......... -- (1,016,000) 1,016,000 1,016,000 (1,250,000)
Exercise of stock war-
rants.................. -- -- 18,500,000 -- --
Issuance of common
stock.................. -- -- 94,725,000 861,000 325,000
Repurchases of common
stock.................. (954,000) -- -- -- --
Issuance of convertible
preferred stock........ 16,281,000 7,500,000 19,325,000 7,146,000 --
Repayments of loans from
directors.............. (782,000) -- -- -- --
Loans to officer........ -- (200,000) -- -- --
Repayment of loans from
officer................ -- 200,000 -- -- --
Repayments to licensees. (50,000) (80,000) (97,000) (40,000) --
Proceeds from notes and
bank loans............. 728,000 3,326,000 1,774,000 956,000 595,000
Payment of notes and
bank loans............. -- (139,000) (1,082,000) (969,000) (735,000)
Payments on capital
leases................. (189,000) (142,000) (565,000) (249,000) (378,000)
Proceeds from capital -- 1,349,000 1,354,000 1,313,000 962,000
lease financing........ ----------- ------------ ------------ ----------- ------------
Net cash provided by 15,034,000 10,798,000 134,950,000 10,034,000 (481,000)
financing activities.. ----------- ------------ ------------ ----------- ------------
EFFECT OF EXCHANGE RATE -- -- (235,000) (474,000) 596,000
CHANGES ON CASH........ ----------- ------------ ------------ ----------- ------------
Net increase (de-
crease) in cash and
cash equivalents...... 5,488,000 (4,590,000) 112,908,000 (76,000) (18,316,000)
Cash and cash equiva-
lents, beginning of pe- 337,000 5,825,000 1,235,000 1,235,000 114,143,000
riod................... ----------- ------------ ------------ ----------- ------------
Cash and cash equiva- $ 5,825,000 $ 1,235,000 $114,143,000 $ 1,159,000 $ 95,827,000
lents, end of period... =========== ============ ============ =========== ============
SUPPLEMENTAL DISCLO-
SURES:
NON-CASH FINANCING AC-
TIVITIES:
Conversion of debt to
common stock........ -- $ 250,000 -- -- --
CASH PAID FOR INTER-
EST................... $ 562,000 $ 393,000 $ 893,000 $ 480,000 $ 483,000
</TABLE>
See accompanying notes.
72
<PAGE>
NEUROMEDICAL SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1995
(AMOUNTS AND DISCLOSURES APPLICABLE TO JUNE 30, 1996 ARE UNAUDITED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
NATURE OF OPERATIONS. The Company was organized in 1988 and commenced
operations January 1, 1989. The Company was established to develop,
manufacture and market systems for computer-assisted screening of cervical pap
smears and other cytological specimens. The Company's principal activities to
date have been research and development, recruiting of key personnel, seeking
to obtain required Food and Drug Administration ("FDA") approval, and
manufacturing and marketing the PAPNET(R) Testing System. The PAPNET(R)
Testing System was approved by the FDA for commercial use in the United States
on November 8, 1995. Prior to November 1995, the Company was considered a
development stage company.
BASIS OF PRESENTATION. The preparation of financial statements in conformity
with generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates.
The consolidated interim financial information for the six-month period
ended June 30, 1996 is unaudited and has been prepared in accordance with
generally accepted accounting principles for interim financial information and
Article 10 of Regulation S-X. Accordingly, it does not include all of the
information and footnotes required by generally accepted accounting principles
for complete financial statements. In the opinion of management, all
adjustments (consisting of normal recurring accruals) considered necessary for
a fair presentation have been included. Operating results for the six-month
period ended June 30, 1996 are not necessarily indicative of the results that
may be expected for the year ended December 31, 1996.
PRINCIPLES OF CONSOLIDATION. The consolidated financial statements include
the accounts of Neuromedical Systems, Inc. and all of its wholly-owned
subsidiaries. All significant intercompany transactions have been eliminated
in consolidation.
REVENUE RECOGNITION. To date, the Company's revenue has been earned
principally from the processing of PAPNET(R) tests on a fee per slide basis
and the sale of territorial licenses. Slide processing service revenue is
recognized upon delivery of processed slides to third-party common carriers or
shipping services since the earning process is completed upon the performance
of these processing services.
RESEARCH AND DEVELOPMENT COSTS. Research and development costs are expensed
as incurred.
CASH EQUIVALENTS. Cash equivalents consist of highly liquid investments with
a maturity of three months or less when purchased. As of December 31, 1995 and
June 30, 1996, the Company had approximately $112,000,000 and $95,000,000,
respectively, in two money market mutual funds.
73
<PAGE>
NEUROMEDICAL SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1995
(AMOUNTS AND DISCLOSURES APPLICABLE TO JUNE 30, 1996 ARE UNAUDITED)
CONCENTRATION OF CREDIT RISK. The Company provides computer-assisted
screening of Pap smears to laboratory facilities. Revenues are from all
regions of the United States as well as many foreign countries. The Company
performs periodic credit evaluations of its customers' financial condition.
Credit losses have been minimal and within management's expectations. There is
no significant concentration of the Company's accounts receivable portfolio in
any customer or geographical region that presents a risk to the Company based
on that concentration.
PROPERTY AND EQUIPMENT. Property and equipment are stated at cost.
Depreciation is computed using the straight line method over the estimated
useful lives of the assets ranging from 2 1/2 to 10 years. PAPNET(R) Testing
Systems are depreciated over their useful life, generally 5 years. Assets
acquired pursuant to capital lease arrangements and leasehold improvements are
amortized over the estimated useful life of the asset or the lease term,
whichever is less.
PATENTS. Effective January 1, 1995, additions to patent and patent
application costs are amortized over a twelve-month period. The net book value
of patent and patent application costs at January 1, 1995 is being amortized
over 3 years using the straight-line method. Prior to 1995, the amortization
period was 12 years or the estimated life of the patent, if less, using the
straight-line method. These changes in accounting estimates resulted in an
immaterial increase in amortization expense and net loss in 1995.
FOREIGN EXCHANGE. Each of the Company's foreign subsidiaries (with the
exception of its Israeli subsidiary, whose functional currency is the United
States dollar) uses its local currency as the functional currency and
translates all assets and liabilities at current exchange rates and all income
and expenses at average exchange rates. The adjustment resulting from this
translation is included in a separate component of stockholders' equity. Gains
or losses resulting from foreign currency transactions are included in the
consolidated statement of operations.
RECLASSIFICATIONS. Certain prior year amounts have been reclassified to
conform with the current year presentation.
NET LOSS PER SHARE. Historical net loss per share information through
December 31, 1995 is not considered meaningful due to the significant changes
in the Company's capital structure which occurred upon the closing of the
Company's initial public offering. Accordingly, such per share information is
not presented.
PRO FORMA NET LOSS PER SHARE. All common share and per share information
reflects a four-for-one reverse stock split that was effective at the
completion of the Company's initial public offering. Except as noted below,
net loss per share and pro forma net loss per share are computed using the
weighted average number of shares of common stock and convertible preferred
stock outstanding. Common equivalent shares from stock options and warrants
are excluded from the computation as their effect is anti-dilutive, except
that, pursuant to the Securities and Exchange Commission Staff Accounting
Bulletins, common and common equivalent shares issued at prices below the
offering price during the twelve-month period prior to the initial public
offering have been included in the calculation as if they were outstanding for
all periods prior to the initial public offering (using the treasury stock
74
<PAGE>
NEUROMEDICAL SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1995
(AMOUNTS AND DISCLOSURES APPLICABLE TO JUNE 30, 1996 ARE UNAUDITED)
method and the initial public offering price). Additionally, the effect of
common shares issuable upon conversion of convertible preferred stock is
included in pro forma net loss per share as outstanding since January 1, 1994
or from the date of issuance, if later.
EMPLOYEE STOCK BASED COMPENSATION. The Company follows Accounting Principles
Board Statement No. 25 with regard to the accounting for stock issued as
compensation for employees.
INCOME TAXES. The liability method is used in accounting for income taxes.
Under this method, deferred tax assets and liabilities are determined based on
differences between financial reporting and tax bases of assets and
liabilities and are measured using the enacted tax rates and laws that will be
in effect when the differences are expected to reverse.
2. BALANCE SHEET
The allowance for doubtful accounts at December 31, 1995 was approximately
$114,000, all of which was provided for in 1995. No amounts were charged to
the reserve in 1995. As of December 31, 1993 and 1994, no allowance for
doubtful accounts was required based on the Company's experience with bad
debts.
Accrued liabilities consist of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------
1994 1995
----------- -----------
<S> <C> <C>
Compensation expenses........................... $ 461,000 $ 1,223,000
Professional fees............................... 364,000 993,000
Stock issuance cost............................. -- 544,000
Other liabilities............................... 701,000 563,000
----------- -----------
Total......................................... $ 1,526,000 $ 3,323,000
=========== ===========
3. PROPERTY AND EQUIPMENT
Property and equipment consists of the following:
<CAPTION>
DECEMBER 31,
------------------------
1994 1995
----------- -----------
<S> <C> <C>
PAPNET(R) systems and related equipment......... $ 9,915,000 $11,799,000
PAPNET(R) systems and related equipment
under construction............................. 705,000 2,297,000
Furniture, fixtures and related equipment....... 1,892,000 3,595,000
----------- -----------
12,512,000 17,691,000
Accumulated depreciation and amortization....... (3,692,000) (6,475,000)
----------- -----------
$ 8,820,000 $11,216,000
=========== ===========
</TABLE>
Substantially all of the Company's property and equipment has been pledged
as collateral in connection with outstanding borrowings.
75
<PAGE>
NEUROMEDICAL SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1995
(AMOUNTS AND DISCLOSURES APPLICABLE TO JUNE 30, 1996 ARE UNAUDITED)
Equipment under capital leases totaled approximately $2,350,000 and
$3,356,000 at December 31, 1994 and 1995, respectively, and consists
principally of PAPNET(R) systems and related equipment. Included in
accumulated depreciation and amortization is approximately $702,000 and
$854,000 related to assets under capital leases at December 31, 1994 and 1995,
respectively.
The receivable due from capital leases amounting to $402,000 as of December
31, 1994 represents equipment which was sold in a sale lease-back arrangement
for which the title transferred; however, the proceeds of the sale were not
received until 1995.
4. LEASES
The Company leases facilities and equipment under leases accounted for as
operating leases. Rent expense for the years ended December 31, 1993, 1994 and
1995 approximated $280,000, $560,000 and $1,099,000, respectively.
Minimum future lease payments under capital leases and non-cancelable
operating leases at December 31, 1995, are as follows:
<TABLE>
<CAPTION>
CAPITAL OPERATING
LEASES LEASES
---------- ----------
<S> <C> <C>
1996.................................................. $ 975,000 $1,176,000
1997.................................................. 966,000 1,156,000
1998.................................................. 1,015,000 828,000
1999.................................................. 352,000 585,000
2000.................................................. -- 219,000
---------- ----------
Total minimum lease payments.......................... 3,308,000 $3,964,000
==========
Less amount representing interest..................... 614,000
----------
Present value of minimum lease payments............... $2,694,000
==========
</TABLE>
The facility leases include escalation clauses for operating expenses and
real estate taxes. Two of the office facility leases include renewal options
for an additional three-year period.
Minimum future lease payments under capital leases and non-cancelable
operating leases at June 30, 1996 totaled $3,690,000 and $8,430,000,
respectively.
76
<PAGE>
NEUROMEDICAL SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1995
(AMOUNTS AND DISCLOSURES APPLICABLE TO JUNE 30, 1996 ARE UNAUDITED)
5. BUSINESS SEGMENTS
The Company operates in a single industry segment. The Company's operations
by geographic area for the years ended December 31, 1993, 1994 and 1995 and
the six months ended June 30, 1996 are presented below:
<TABLE>
<CAPTION>
IDENTIFIABLE
TOTAL SALES NET LOSS ASSETS
----------- ------------ ------------
<S> <C> <C> <C>
Year ended December 31, 1993
United States...................... $ 502,000 $ (6,672,000) $ 12,799,000
Europe............................. -- -- --
Israel............................. -- (110,000) 266,000
Asia and Australia................. -- -- --
Interarea Eliminations............. -- -- (202,000)
----------- ------------ ------------
$ 502,000 $ (6,782,000) $ 12,863,000
=========== ============ ============
Year ended December 31, 1994
United States...................... $ 1,094,000 $ (9,656,000) $ 13,054,000
Europe............................. 143,000 (2,100,000) 6,217,000
Israel............................. 3,498,000 (943,000) 3,394,000
Asia and Australia................. 18,000 (765,000) 1,029,000
Interarea Eliminations............. (3,515,000) (355,000) (10,521,000)
----------- ------------ ------------
$ 1,238,000 $(13,819,000) $ 13,173,000
=========== ============ ============
United States...................... $ 760,000 $(21,445,000) $133,399,000
Europe............................. 969,000 (3,976,000) 4,828,000
Israel............................. 2,133,000 (2,294,000) 4,341,000
Asia and Australia................. 740,000 (1,213,000) 2,111,000
Interarea Eliminations............. (2,127,000) (500,000) (17,331,000)
----------- ------------ ------------
$ 2,475,000 $(29,428,000) $127,348,000
=========== ============ ============
Six months ended June 30, 1996 (unau-
dited)
United States...................... $ 693,000 $ (9,155,000) $124,389,000
Europe............................. 453,000 (2,605,000) 4,701,000
Israel............................. 2,654,000 (1,115,000) 6,417,000
Asia and Australia................. 522,000 (654,000) 1,985,000
Interarea Eliminations............. (2,654,000) (696,000) (23,560,000)
----------- ------------ ------------
$ 1,668,000 $(14,225,000) $113,932,000
=========== ============ ============
</TABLE>
Year ended December 31, 1995
Transfers between geographic areas are accounted for at amounts which are
generally above cost and consistent with rules and regulations of governing
tax authorities. Such transfers are eliminated in the Consolidated Financial
Statements. Substantially all sales, with the exception of those originating
in Israel which are interarea, are to unaffiliated customers.
77
<PAGE>
NEUROMEDICAL SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1995
(AMOUNTS AND DISCLOSURES APPLICABLE TO JUNE 30, 1996 ARE UNAUDITED)
6. DEBT
The Company's debt consists of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------
1994 1995
---------- ----------
<S> <C> <C>
Notes:
Note payable at 18% due in monthly installments of
$37,000,
including interest, with a final payment of $188,000
due
July 1998............................................. $1,260,000 $1,004,000
Note payable at 16% due in monthly installments of
$15,000,
including interest, with a final payment of $77,000
due
March 1999............................................ -- 496,000
Note payable at 10%, with interest payable monthly,
principal due in March 1998........................... 300,000 300,000
Note payable at 10%, with interest payable monthly,
principal due in June 1998............................ 300,000 300,000
Conditional grant...................................... -- 235,000
Bank loans:
Foreign note payable at 8.375% with interest and prin-
cipal due in quarterly installments of $11,000, with a
final payment of $65,000 due June 1997................ 163,000 129,000
Foreign loans payable at annual rates between 7.9% and
9.1%, guaranteed by the State of Israel and linked to
the United States dollar, payments due quarterly
through 2002.......................................... 1,086,000 2,065,000
Short-term borrowings payable on demand................ 806,000 90,000
---------- ----------
3,915,000 4,619,000
Less current portion..................................... 1,146,000 583,000
---------- ----------
$2,769,000 $4,036,000
========== ==========
</TABLE>
Maturities of the outstanding debt for the five years succeeding December
31, 1995 are $583,000 in 1996, $1,071,000 in 1997, $1,926,000 in 1998,
$814,000 in 1999, and $111,000 in 2000.
Each of the $300,000 notes is payable to a stockholder of the Company and
convertible into common stock at a conversion rate of $12.00 per share at the
option of the noteholder.
Short-term bank borrowings are primarily Israeli bank loans linked to the
United States dollar which bear interest at annual rates ranging from LIBOR
plus 2% to 3.125%.
The conditional grant was received in July and August 1995 from a private
foundation to finance certain product development projects. Repayment is
required if the project becomes a commercial success over a period of 2 to 6
years at approximately 8% per annum.
78
<PAGE>
NEUROMEDICAL SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1995
(AMOUNTS AND DISCLOSURES APPLICABLE TO JUNE 30, 1996 ARE UNAUDITED)
7. TERRITORIAL LICENSE AGREEMENTS
From 1989 through 1991, the Company entered into various long-term
territorial license agreements (the "License Agreements") for its semi-
automated classifier, the PAPNET(R) system. The Company received net proceeds
of approximately $3,500,000 from the sale of these territorial licenses. Each
license expires on the later of (i) 17 years after its execution or (ii) the
expiration of the initial patent granted for the PAPNET(R) system, and is
renewable for an additional 17-year term at the licensee's option. The Company
does not expect to enter into any additional territorial license agreements.
Pursuant to the License Agreements, as amended, each licensee is obligated
to use its best efforts to promote the use of the PAPNET(R) system, in its
territory at the licensee's expense. Each licensee is entitled to receive
royalties equal to the greater of (i) 50% of the territory's net slide revenue
(as defined) generated from participating laboratories within its territory,
not to exceed the licensee's share of a specified number of slides annually
(ranging from 175,000 to 3,000,000, and aggregating 12,175,000 among all of
the licensees); or (ii) a specified percentage (ranging from 0.15% to 1.0%,
and aggregating 4.15% for all the licensees) of the net annual slide revenues
(as defined) up to specified annual monetary limits for each licensee
(aggregating $23,000,000).
In December 1995, the Company and the entities which hold the United States
licenses (the "Licensees") entered into a Settlement Agreement and a Warrant
Exercise Agreement (the "Territorial Agreements"), the effect of which
included the clarification of previously disputed elements of prior license
agreements, the requirement for the Company to make payments of stock having a
fair market value equivalent to approximately $1,652,000 and the irrevocable
election by the Licensees and acceptance by the Company for the cashless
exercise of 826,032 outstanding warrants into 715,894 shares of common stock
in connection with the closing of the Company's initial public offering.
Pursuant to the Settlement Agreement, the Company has consented to the
merger of all United States licensees and related parties. Following such
merger, the Licensees and the Company have agreed to enter into a new license
(or, if the merger does not occur, each Licensee has agreed to enter into a
new license) pursuant to which the rights and obligations of the parties have
been clarified but, with respect to which, the economic terms of the License
Agreements will not be materially altered. The Company and the Licensees have
also executed mutual general releases, which include, among other things, the
claims previously made by the Licensees. The new licenses will expire on
December 31, 2025.
Provisions of a promissory note, dated October 3, 1990 (which was later
converted to Series A Convertible Preferred Stock), granted the holder of the
note certain rights to be the Company's sole licensee for distribution of the
PAPNET(R) system in Canada. Such promissory note provides that the licensee
shall be entitled to terms which are at least as favorable as those in any
domestic United States of America licenses. No agreement has been reached on
the terms of the license with the holder.
One of the Company's directors also holds beneficial interests in entities
which hold United States territorial licenses and another acts as agent for
the holders of the rights of the Canadian agreement.
79
<PAGE>
NEUROMEDICAL SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1995
(AMOUNTS AND DISCLOSURES APPLICABLE TO JUNE 30, 1996 ARE UNAUDITED)
8. CAPITAL STOCK
GENERAL. The authorized capital stock of the Company consists of 100,000,000
shares of common stock, par value $.0001 per share, and 10,000,000 shares of
preferred stock, par value $.0001 per share.
INITIAL PUBLIC OFFERING/CONVERSION OF PREFERRED STOCK. In December 1995, the
Company completed an initial public offering of 6,900,000 shares of common
stock at $15.00 per share and converted all 64,645,608 shares of outstanding
Series A through H Convertible Preferred Stock into 16,161,402 shares of
common stock. As a result of the Company's recapitalization in connection with
its initial public offering, the number of authorized shares of preferred
stock was reduced to 10,000,000, none of which are issued or outstanding as of
December 31, 1995.
REGISTRATION RIGHTS. Certain of the former preferred stockholders have
registration rights under an agreement which continues to apply to the shares
of common stock into which such preferred stock was converted or which may be
issued upon the exercise of warrants. In addition, certain holders of common
stock issued upon conversion of preferred stock have limited rights to require
the Company to register their shares in a public offering commencing six
months after the Company's initial public offering.
STOCKHOLDER RIGHTS PLAN. The Board of Directors has adopted a Stockholder
Rights Plan, pursuant to which there has been issued with respect to each
share of common stock issued and outstanding one Preferred Stock Purchase
Right (a "Right"). Each Right entitles the registered holder to purchase from
the Company one one-hundredth of a share of Series A Preferred Stock at a
price of $60.00 per one one-hundredth of a share, subject to adjustment. These
Rights may have the effect of discouraging a tender offer or other takeover
attempts not previously approved by the Board of Directors.
COMMON SHARES RESERVED. As of December 31, 1995, the Company had reserved
shares of common stock for issuance as follows:
<TABLE>
<CAPTION>
NUMBER OF
SHARES
---------
<S> <C>
Exercise of common stock options................................ 4,140,000
Exercise of common stock warrants............................... 2,133,280
</TABLE>
80
<PAGE>
NEUROMEDICAL SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1995
(AMOUNTS AND DISCLOSURES APPLICABLE TO JUNE 30, 1996 ARE UNAUDITED)
WARRANTS. At December 31, 1995, the Company had 2,133,280 outstanding common
stock warrants at exercise prices ranging from $.04 to $12.00 per share. The
following summarizes these outstanding common stock warrants, exercise prices
and expiration dates:
<TABLE>
<CAPTION>
NUMBER OF EXERCISE EXPIRATION
WARRANTS PRICE DATE
--------- ------------ ----------
<S> <C> <C> <C>
Warrants issued in connection with Preferred
Series A Stock.............................. 1,090,535 $.04 2/98
Warrants issued in connection with Preferred
Series C Stock.............................. 833,163 $1.98$-1.80 9/97-10/97
Warrants issued in connection with Preferred
Series D Stock.............................. 51,876 $4.00 6/98
Warrants issued in connection with equipment
financing arrangements....................... 68,232 $5.19-$8.00 4/98-3/02
Other warrants issued........................ 89,474 _2.00-_12.00$2/96-1/00$
---------
Total warrants outstanding................... 2,133,280
=========
</TABLE>
Most of the Company's outstanding warrants contain provisions allowing for
the conversion of such warrants into a lesser number of shares without the
payment of cash to the Company (so-called "cashless exercise" provisions).
Accordingly, there can be no assurance that, even if all of such warrants are
exercised, the Company will receive the proceeds from their exercise.
At June 30, 1996, the Company had 1,655,989 outstanding common stock
warrants with exercise prices ranging from $.04 to $12.00 per share.
STOCK INCENTIVE PLAN. On November 17, 1993, the Board of Directors of the
Company adopted the Neuromedical Systems, Inc. 1993 Stock Option Plan which
was amended and restated October 25, 1995 as the Neuromedical Systems, Inc.
1993 Stock Incentive Plan (the "Plan"). This amendment and restatement
increased the maximum number of shares with respect to which awards can be
granted under the Plan to 4,140,000 shares, subject to adjustment in the event
of a change in capitalization, with no more than one-third of the total number
of authorized shares to be issued as grants of restricted stock and, provided
that, over the term of the Plan, the maximum number of shares with respect to
which awards may be granted to any individual is 2,000,000 and the maximum per
individual award of dollar-denominated performance units is $5,000,000. The
Plan provides for award grants in the form of non-qualified or incentive stock
options, non-discretionary director options, stock appreciation rights,
dividend equivalent rights, restricted stock performance units and performance
shares.
Under the terms of the Plan, a committee of the Company's Board of Directors
may grant options to purchase shares of the Company's common stock to
employees, directors and consultants of the Company at such prices as may be
determined by the Committee, principally equal to or greater than fair value
at date of grant. Options granted under the Plan vest over periods from
immediate vesting to five years at various rates and expire after ten years.
81
<PAGE>
NEUROMEDICAL SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1995
(AMOUNTS AND DISCLOSURES APPLICABLE TO JUNE 30, 1996 ARE UNAUDITED)
The Company's stock option activity under the Plan is as follows:
<TABLE>
<CAPTION>
OPTIONS EXERCISE
OPTIONS AVAILABLE PRICE PER
OUTSTANDING FOR GRANT SHARE
----------- ---------- ------------
<S> <C> <C> <C>
Balance at January 1, 1993............. -- --
Options authorized..................... -- 1,975,000
Options granted........................ 1,050,000 (1,050,000) $4.00
--------- ----------
Balance at December 31, 1993........... 1,050,000 925,000 $4.00
Options granted........................ 662,000 (662,000) $4.00-$6.00
--------- ----------
Balance at December 31, 1994........... 1,712,000 263,000 $4.00-$6.00
Options authorized..................... -- 2,165,000
Options granted........................ 1,218,898 (1,218,898) $4.00-$15.00
Options canceled....................... (10,250) 10,250 $4.00
--------- ----------
Balance at December 31, 1995........... 2,920,648 1,219,352 $4.00-$15.00
========= ==========
</TABLE>
At December 31, 1995, 1,747,375 options have become vested and are
exercisable.
At June 30, 1996, the Company had 2,952,236 options outstanding of which
1,720,013 have become vested and are exercisable.
During 1995, the Company granted to its Chief Executive Officer a
performance-based option, under the Plan, for 813,273 shares of common stock
at a per share exercise price of $15.00 per share. The grant is designed to
produce an option value of $12.5 million if at any time during the option's
ten-year term either of the following events occurs: (i) the Company's share
price over any 90 consecutive day period reaches a target price of $30.37 or
(ii) all or substantially all of the Company's shares are acquired at or above
the target price. The option provides for equitable adjustments to the
performance goal, the number of shares subject to the option and exercise
price in the event of a change in capitalization as defined in the Plan. The
exercisability of the option will not accelerate upon the occurrence of a
change in control, and the option will terminate in connection with a change
in control if the performance goal is not attained prior to or in connection
with the change in control.
If the performance goal is attained, the option will become exercisable as
to one-third of the number of shares subject thereto on the later of (i)
December 7, 1998 or (ii) the date that the performance goal is attained (the
"Initial Vesting Date"), and will become exercisable as to an additional one-
third of the shares subject thereto on each of the first two anniversaries of
the Initial Vesting Date; provided, however, that, if the CEO's employment is
terminated by the Company without cause following a change in control that
occurs following or simultaneously with the attainment of the performance
goal, the option will be fully exercisable. No additional vesting will occur
following the CEO's termination of employment under any other circumstances or
the expiration of the option's ten-year term. If the performance goal is
attained, the option will result in a non-cash charge of $12.5 million to
operations recognized over the vesting period.
82
<PAGE>
NEUROMEDICAL SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1995
(AMOUNTS AND DISCLOSURES APPLICABLE TO JUNE 30, 1996 ARE UNAUDITED)
9. INCOME TAXES
The Company's pre-tax income (loss) is made up of the following:
<TABLE>
<CAPTION>
1993 1994 1995
------------ ------------- -------------
<S> <C> <C> <C>
U.S............................. $ (6,672,000) $ (10,011,000) $ (21,945,000)
Foreign......................... (110,000) (3,808,000) (7,483,000)
------------ ------------- -------------
$ (6,782,000) $ (13,819,000) $ (29,428,000)
============ ============= =============
A reconciliation of the Company's income tax expense (benefit) computed at
U.S. federal statutory tax rates to recorded income tax expense (benefit) is as
follows:
<CAPTION>
1993 1994 1995
------------ ------------- -------------
<S> <C> <C> <C>
Tax at U.S. statutory rate...... $ (2,204,000) $ (4,698,000) $ (10,005,000)
State income taxes.............. (580,000) (882,000) (1,290,000)
Effect of lower foreign effec-
tive tax rates................. 25,000 1,063,000 1,435,000
Valuation allowance recorded.... 2,759,000 4,517,000 9,860,000
------------ ------------- -------------
Recorded tax provision.......... $ -- $ -- $ --
============ ============= =============
The components of the Company's deferred tax assets are as follows:
<CAPTION>
DECEMBER 31,
------------------------------------------
1993 1994 1995
------------ ------------- -------------
<S> <C> <C> <C>
Deferred tax assets:
Cash (tax) versus accrual ba-
sis of accounting............ $ 626,000 $ 321,000 $ 340,000
Employee stock options........ -- -- 2,500,000
Research and development cred-
its.......................... 400,000 900,000 950,000
Tax benefit of net operating
loss
carryforwards................ 5,825,000 10,100,000 17,245,000
Other......................... 7,000 54,000 200,000
------------ ------------- -------------
Total deferred tax assets....... 6,858,000 11,375,000 21,235,000
Less valuation allowance........ (6,858,000) (11,375,000) (21,235,000)
------------ ------------- -------------
Net deferred tax asset.......... $ -- $ -- $ --
============ ============= =============
</TABLE>
At December 31, 1995, the Company had available net U.S. operating loss
carryforwards of approximately $39,600,000 that will expire in the years 2004
through 2010 and cumulative deductible temporary differences of approximately
$8,000,000. For financial reporting purposes, a valuation allowance has been
recognized to offset the deferred tax asset related to these carryforwards and
temporary differences.
The Company also has foreign net operating losses of $5.0 million which are
available to offset the separate company taxable incomes of certain foreign
subsidiaries. These losses may be carried forward indefinitely. Certain
foreign subsidiaries qualify for tax incentives in the countries of
incorporation. In order to realize these benefits, these foreign subsidiaries
will need to be profitable in future tax years. For financial reporting
purposes a valuation allowance has been recorded for these credits.
83
<PAGE>
NEUROMEDICAL SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1995
(AMOUNTS AND DISCLOSURES APPLICABLE TO JUNE 30, 1996 ARE UNAUDITED)
In addition, at December 31, 1995, the Company also had approximately
$950,000 of U.S. research and development credits available, which will expire
in 2004 through 2010. For financial reporting purposes, a valuation allowance
has been established for the full amount of the deferred tax asset recorded
for these credits.
The Tax Reform Act of 1986 enacted a complex set of rules limiting the
potential utilization of United States net operating loss carryforwards and
tax credit carryforwards in periods following a corporate "ownership change."
In general, an ownership change is deemed to occur if the percentage of stock
of a loss corporation owned (actually, constructively and, in some cases,
deemed) by one or more "5% stockholders" has increased by more than 50
percentage points over the lowest percentage of such stock owned during a
three-year testing period. As a result of changes in the Company's ownership,
the utilization of a substantial portion of the Company's available United
States net operating loss carryforwards, and tax credit carryforwards will be
subject to annual limitations. It is management's belief, however, that, since
this annual limitation is determined based on the value of the Company
immediately prior to the ownership change, a significant portion of these
carryforwards will be available annually should the Company become profitable
in future tax years.
10. COMMITMENTS AND CONTINGENCIES
The Company has entered into an employment agreement with its Chief
Executive Officer for a period of five years. In addition to other provisions,
the agreement provides for a severance payment of 2.99 times base salary upon
termination other than for cause.
Each of the Company's executive officers has entered into a three-year
employment agreement with the Company. Each of the employment agreements was
amended as of October 25, 1995 to provide that, in the event that an employee
is terminated other than for "cause" or "disability" (as those terms are
defined in the applicable agreement), a portion of the employee's stock
options will become vested and exercisable to the extent that it would have
had the employee remained employed by the Company for a one-year period
following his termination of employment, and, subject to the employee's
compliance with restrictive covenants in his employment agreement, options
held by the employee as of the date of the termination of employment will
remain exercisable (to the extent those options either are vested on
termination of employment or vest over the succeeding year) until the earlier
of the date one year following the termination of employment or the expiration
of the option's term. In addition, the employment agreements provide for the
continuation of salary for one year after termination other than for cause.
On December 4, 1995, the Company was served with a Summons and Complaint
alleging breach of contract and asserting that the plaintiffs are entitled to
be issued warrants exercisable for the purchase of approximately 128,000
shares of common stock at various prices and unspecified damages. On January
31, 1996, the plaintiffs served the Company with an Amended Complaint alleging
similar legal claims as in the original Summons and Complaint served on the
Company, but adding one of the Company's directors as a defendant and
specifying that the plaintiffs are seeking compensatory damages from the
Company and certain of its officers and directors totaling $114 million and
punitive damages totaling $175 million. The Company intends to defend
vigorously this action and, in any event, believes an adverse judgment in this
case would not have a material adverse effect on the Company's operations,
financial position or cash flows.
84
<PAGE>
NEUROMEDICAL SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1995
(AMOUNTS AND DISCLOSURES APPLICABLE TO JUNE 30, 1996 ARE UNAUDITED)
On July 15, 1996, the Company filed a lawsuit against NeoPath, a competitor
of the Company, in the United States District Court for the Southern District
of New York, seeking damages and injunctive relief for patent infringement,
false advertising, unfair competition, intentional interference with business
relations and damage to business reputation. In the lawsuit, the Company
alleges that NeoPath willfully misappropriated the Company's patented
technology and used such technology in NeoPath's AutoPap(R) System. The
Company also alleges that NeoPath falsely characterized and made misleading
comparisons to consumers and securities analysts of the AutoPap(R) System and
the Company's PAPNET(R) Testing System. NeoPath has denied all allegations
and, in addition, it has filed counter-claims against the Company seeking
damages and injunctive relief for false advertising and unfair competition. In
the counter-claims, NeoPath alleges that statements made by the Company
characterizing the performance of the PAPNET(R) Testing System, and its
effectiveness relative to NeoPath's AutoPap(R) System, as well as other
statements, are false and misleading and constitute misrepresentations. The
Company believes that NeoPath's assertions are without merit. Although the
duration, costs and ultimate outcome of this lawsuit are unknown, the Company
expects that the costs of this lawsuit will be significant during 1996 and
1997.
11. RELATED PARTY TRANSACTIONS
In January 1995, the Company issued 21,276 shares of Series G Stock to the
brother of a director of the Company, in consideration for assisting the
Company in raising approximately $1,000,000 in equity capital.
The Company has entered into an exclusive representation agreement with
PAPNET (Far East) Ltd. ("PFEL"), a Cayman Islands corporation based in Hong
Kong and controlled by certain direct and indirect stockholders of the
Company. A director of the Company is the president and a major stockholder of
PFEL and is also the President of Compuscreen Medical Diagnostic Centre, a
subsidiary of PFEL and a customer of the Company. In addition, PFEL is the
record holder of approximately 338,000 shares of the Company's common stock.
The representation agreement with PFEL (the "PFEL Agreement") provides that
PFEL will, in concert with the Company but at its own expense, market and sell
PAPNET(R) testing services in Hong Kong, Taiwan, Singapore, Thailand and the
cities of Beijing, Shanghai and Guangzhou in the People's Republic of China
(the "PFEL Territories"). During the term of the PFEL Agreement, the Company
will pay PFEL specified commissions in the form of a percentage of revenues
received by the Company from PFEL Territories, regardless of whether such
revenues are derived from the efforts of PFEL or the Company. In addition,
PFEL has the non-exclusive right to market and sell PAPNET(R) testing
elsewhere in the People's Republic of China, but will receive commissions only
to the extent that revenues received by the Company are attributable to its
efforts.
The term of the PFEL Agreement and PFEL's rights thereunder are variable in
duration, depending on the volume of sales from the various PFEL Territories.
Assuming all performance objectives are met, PFEL's rights may continue for up
to five years from July 1995.
In addition, the PFEL Agreement provides that the Company will pay PFEL fees
for management assistance in connection with the establishment of its Asia-
Pacific Scanning Center. The Company paid PFEL $100,000 during 1994 and
$75,000 during 1995 and is obligated to pay PFEL $75,000 during 1996 in
consideration for such assistance.
85
<PAGE>
NEUROMEDICAL SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1995
(AMOUNTS AND DISCLOSURES APPLICABLE TO JUNE 30, 1996 ARE UNAUDITED)
In January 1994, the Company loaned its President, Chairman and Chief
Executive Officer $200,000, which loan was free of interest charges and
approved by the Board of Directors. Such amount was repaid in full in March
1994.
12. EMPLOYEE SAVINGS PLAN
The Company established a defined contribution savings plan (401k plan) for
its domestic employees retroactive to January 1, 1995. The plan allows
participating employees to contribute up to 15% of their salary, subject to
annual limits. The Board may, at its sole discretion, approve Company
contributions. Through December 31, 1995, the Company has made no
contributions to the plan.
86
<PAGE>
VALIDITY OF COMMON STOCK
The validity of the shares of Common Stock offered hereby has been passed
upon for the Company by Fried, Frank, Harris, Shriver & Jacobson (a
partnership including professional corporations), New York, New York and for
the underwriters of the Company's IPO by Sullivan & Cromwell, New York, New
York. Fried, Frank, Harris, Shriver & Jacobson has from time to time
represented Goldman, Sachs & Co. and its affiliates, including in connection
with the initial investment of certain affiliates of Goldman, Sachs & Co. in
the Company.
EXPERTS
The consolidated financial statements of the Company as of December 31, 1994
and 1995, and for each of the three years in the period ended December 31,
1995, appearing in this Prospectus and Registration Statement, have been
audited by Ernst & Young LLP, independent auditors, as set forth in their
report thereon appearing elsewhere herein and in the Registration Statement,
and are included in reliance upon such report given upon the authority of such
firm as experts in accounting and auditing.
On August 1, 1995, the Company, with the approval of the Board, dismissed
Igal Brightman & Co., a member of Deloitte Touche Tohmatsu International, as
the independent accountants of NSIL, a wholly owned subsidiary, the financial
statements of which reflect total assets constituting 11% at December 31, 1994
and net loss constituting 9% of the respective consolidated total for the year
then ended. The report of Igal Brightman & Co. on the financial statements of
NSIL for the year ended December 31, 1994 did not contain an adverse opinion
or disclaimer of opinion and was not qualified or modified as to uncertainty,
audit scope or accounting principle. During the year ended December 31, 1994
and during the period between December 31, 1994 and the date on which Igal
Brightman & Co. was dismissed, there was no disagreement between the Company
and Igal Brightman & Co. on any matter of accounting principles or practices,
financial statement disclosure or auditing scope or procedure, which
disagreements, if not resolved to the satisfaction of Igal Brightman & Co.,
would have caused Igal Brightman & Co. to make reference to the subject matter
of such disagreement in connection with its report on NSIL's financial
statements. The Company engaged Kost Levary & Forer, a member of Ernst & Young
International, as the new independent auditors of NSIL as of August 17, 1995.
87
<PAGE>
ADDITIONAL INFORMATION
The Company has filed with the Commission a registration statement on Form
S-1 (the "Registration Statement") (which term includes any amendments
thereto), under the Securities Act with respect to the Common Stock being
offered by this Prospectus. This Prospectus, which constitutes a part of the
Registration Statement, does not contain all the information set forth in the
Registration Statement and in the exhibits and schedules thereto to which
reference is hereby made. For further information regarding the Company and
the Common Stock, reference is hereby made to the Registration Statement and
to the exhibits and schedules filed as a part thereof. As to statements made
in this Prospectus with respect to the contents of any contract, agreement or
other current document filed as an exhibit to the Registration Statement,
reference is hereby made to such exhibit for a more complete description of
the matter involved, and each statement shall be deemed qualified in its
entirety by such reference.
The Company files periodic reports and other information with the Commission
complying with the informational requirements of the Exchange Act. This
Registration Statement, including exhibits and schedules thereto, and the
reports and proxy statements filed by the Company and other information may be
inspected and copied at the public reference facilities maintained by the
Commission at 450 Fifth Street, N.W., Room 1024, Washington, D.C. 20549, and
at the Regional Offices of the Commission located at 500 West Madison Street,
Suite 1400, Chicago, Illinois 60661 and Seven World Trade Center, Suite 1300,
New York, New York 10048. Copies of such material can also be obtained from
the Commission at prescribed rates by addressing written requests for such
copies to the Public Reference Section of the Commission at 450 Fifth Street,
N.W., Washington, D.C. 20549. The Commission maintains a Web site at
http://www.sec.gov that contains reports, proxy and information statements and
other information regarding registrants that file electronically with the
Commission. In addition, material filed by the Company may be inspected at the
offices of the National Association of Securities Dealers, Inc., Reports
Section, 1735 K Street, N.W., Washington, D.C. 20006.
88
<PAGE>
SHARES ELIGIBLE FOR FUTURE SALE
Sales of substantial amounts of Common Stock in the public market could have
an adverse effect on the price of the Common Stock. As of September 9, 1996,
the Company had outstanding 29,493,606 shares of Common Stock, of which
21,290,433 shares of Common Stock were eligible for sale and not subject to
restriction. The remaining 8,203,173 shares of Common Stock, issued prior to
the IPO, will become eligible for sale from time to time in the future under
Rule 144. In addition, the Company has filed a registration statement under
the Securities Act, covering Common Stock issued pursuant to the Incentive
Plan. See "Management--Stock Incentive Plan."
In general, under Rule 144, as currently in effect, a person (or persons
whose shares are aggregated) who has beneficially owned shares for at least
two years, including a person who may be deemed an "affiliate" of the Company,
is entitled to sell within any three-month period commencing 90 days after the
date of this Prospectus a number of shares that does not exceed the greater of
(i) 1% of the then outstanding shares of Common Stock or (ii) the average
weekly trading volume during the four calendar weeks preceding such sale,
subject to the filing of a Form 144 with respect to such sale. Sales under
Rule 144 are also subject to certain manner of sale provisions and notice
requirements and to availability of current public information about the
Company. A person (or persons whose shares are aggregated) who is not deemed
to have been an affiliate of the Company at any time during the 90 days
immediately preceding the sale who has beneficially owned his or her shares
for at least three years is entitled to sell such shares pursuant to Rule 144
without regard to the volume, notice or current public information
requirements described above. Persons deemed to be affiliates must always sell
pursuant to Rule 144, even after the applicable holding periods have been
satisfied.
In April 1996, the Company filed a registration statement on Form S-8
covering 4,140,000 shares of Common Stock and associated Preferred Stock
Purchase Rights, issuable under the Incentive Plan. The S-8 became effective
immediately upon filing. As of September 9, 1996, the Board had granted
3,050,898 options under the Incentive Plan, of which 2,848,986 were
outstanding. As of September 9, 1996, 1,624,013 options were immediately
exercisable into 1,624,013 shares of Common Stock and 1,224,973 options will
be exercisable into 1,224,973 shares of Common Stock at future dates. Future
grants under the Incentive Plan will generally be subject to restrictions on
exercisability or transferability which will be determined at the time of the
grant. Any shares of Common Stock issuable upon exercise of options issued
pursuant to the Incentive Plan to employees, consultants and directors will
generally be eligible for immediate sale in the public market.
As of September 9, 1996, the Company had outstanding warrants to purchase an
aggregate of 1,569,504 shares of Common Stock.
Prior to the IPO, there was no public market for the Common Stock. The
Common Stock is listed on the Nasdaq National Market System, under the symbol
"NSIX." No prediction can be made as to the effect, if any, that future sales
of shares, or the availability of shares for future sale, will have on the
market price prevailing from time to time. However, sales of substantial
amounts of Common Stock, or the perception that such sales could occur, could
adversely affect prevailing market prices of the Common Stock and could impair
the Company's future ability to raise capital through an offering of its
equity securities. See "Risk Factors--Shares Eligible for Future Sale;
Registration Rights."
The Commission has recently proposed reducing the Rule 144 holding periods.
If enacted, such modification will have a material effect on the timing of
when shares of the Common Stock become eligible for resale.
89
<PAGE>
REGISTRATION RIGHTS
The Company may, and it may be obligated to, register shares of Common Stock
for sale pursuant to registration rights which have been granted to certain
holders of the Company's securities. These registration rights are held by The
Goldman Sachs Group, L.P. and related investors, the H and S Trust, Edelson
Technology Partners II, L.P., certain holders of the Company's Series C
Convertible Preferred Stock, certain holders of Unit Purchase Options issued
by the Company and the holders of warrants issued by the Company in connection
with an asset-based financing transaction. The aggregate number of shares
which the Company may, or may be required to, register pursuant to these
registration rights is 12,535,546 shares of Common Stock. The Company will pay
the expenses of any such registration.
The exercise of any of the foregoing registration rights could adversely
affect the market price of the Common Stock and could impair the Company's
future ability to raise capital through an offering of its equity securities.
90
<PAGE>
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY
REPRESENTATIONS OTHER THAN THOSE CONTAINED IN THIS PROSPECTUS, AND, IF GIVEN
OR MADE, SUCH INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING
BEEN AUTHORIZED. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR THE
SOLICITATION OF AN OFFER TO BUY ANY SECURITIES OTHER THAN THE SECURITIES TO
WHICH IT RELATES OR AN OFFER TO SELL OR THE SOLICITATION OF AN OFFER TO BUY
SUCH SECURITIES IN ANY CIRCUMSTANCES IN WHICH SUCH OFFER OR SOLICITATION IS
UNLAWFUL. NEITHER THE DELIVERY OF THIS PROSPECTUS NOR ANY SALE MADE HEREUNDER
SHALL, UNDER ANY CIRCUMSTANCES, CREATE ANY IMPLICATION THAT THERE HAS BEEN NO
CHANGE IN THE AFFAIRS OF THE COMPANY SINCE THE DATE HEREOF OR THAT THE
INFORMATION HEREIN IS CORRECT AS OF ANY TIME SUBSEQUENT TO ITS DATE.
-----------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Prospectus Summary........................................................ 2
Use of Proceeds........................................................... 7
Risk Factors.............................................................. 7
Price Range of Common Stock and Dividend Policy........................... 15
Capitalization and Cash Position.......................................... 16
Selected Consolidated Financial Data...................................... 17
Management's Discussion and Analysis of Financial Condition and Results of
Operations............................................................... 18
Business.................................................................. 25
Management................................................................ 40
Principal Stockholders.................................................... 52
Certain Transactions...................................................... 54
Description of Capital Stock.............................................. 56
Certain Charter and By-Laws Provisions.................................... 61
Consolidated Financial Statements......................................... 67
Validity of Common Stock.................................................. 87
Experts................................................................... 87
Additional Information.................................................... 88
Shares Eligible for Future Sale........................................... 89
Plan of Distribution...................................................... 91
</TABLE>
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
NEUROMEDICAL SYSTEMS, INC.
COMMON STOCK
(PAR VALUE $0.0001 PER SHARE)
-----------
NSI LOGO
-----------
GOLDMAN, SACHS & CO.
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
<PAGE>
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION
The following table shows the expenses, other than underwriting discounts
and commissions, incurred by the Company in connection with the initial sale
and distribution of securities registered by the Company on December 7, 1995:
<TABLE>
<S> <C>
SEC Registration Fee.......................................... $ 35,742
NASD Filing Fee............................................... 10,160
Nasdaq National Market System Additional Listing Fee.......... 51,667
Blue Sky Fees and Expenses.................................... 2,369
Legal Fees and Expenses....................................... 798,337
Accounting Fees and Expenses.................................. 356,715
Printing Expenses............................................. 275,000
----------
Total....................................................... $1,530,000
==========
</TABLE>
ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS
The Company, as a Delaware corporation, is empowered by Section 145 of the
General Corporation Law of the State of Delaware (the "Delaware Law"), subject
to the procedures and limitations stated therein, to indemnify any person
against expenses (including attorneys' fees), judgments, fines and amounts
paid in settlement actually and reasonably incurred by him in connection with
any threatened, pending or completed action, suit or proceeding in which such
person is made or threatened to be made a party by reason of his being or
having been a director, officer, employee or agent of the Company. The
Delaware Law provides that indemnification pursuant to its provisions is not
exclusive of other rights of indemnification to which a person may be entitled
under any by-law, agreement, vote of stockholders or disinterested directors,
or otherwise.
The Company's Amended and Restated Certificate of Incorporation (the
"Certificate") provides that a director will not be personally liable to the
Company or its stockholders for monetary damages for breach of fiduciary duty
as a director, except for liability (i) for any breach of the director's duty
of loyalty to the corporation or its stockholders, (ii) for acts or omissions
not in good faith or which involve intentional misconduct or a knowing
violation of law, (iii) under Section 174 of the Delaware Law, which concerns
unlawful payments of dividends, stock purchases or redemptions or (iv) for any
transaction from which the director derived an improper person benefit. If the
Delaware Law is subsequently amended to permit further limitation of the
personal liability of directors, the liability of a director of the Company
will be eliminated or limited to the fullest extent permitted by the Delaware
Law as amended.
The Certificate provides that each person who is involved in any actual or
threatened action, suit or proceeding, whether civil, criminal, administrative
or investigative by reason of the fact that he or she is or was a director or
officer of the Company or is or was serving at the request of the Company as a
director or officer of another corporation or of a partnership, joint venture,
trust or other enterprise, including service with respect to an employee
benefit plan, will be indemnified by the Company to the full extent permitted
by the Delaware Law, as the same exists or may hereafter be amended (but, in
the case of any such amendment, only to the extent that such amendment permits
the Company to provide broader indemnification rights than said law permitted
prior to such amendment) or by other applicable laws then in effect. The
Certificate provides that the expenses incurred by any director or officer in
the defense of any such action, suit or proceeding shall be paid by the
Company in advance of final disposition for such action, suit or proceeding
upon receipt of an undertaking by such director or officer to repay all
amounts so advanced in the event that it shall ultimately be determined that
such director or officer is not entitled to indemnification. The
indemnification rights conferred by the
II-1
<PAGE>
Certificate are not exclusive of any other right to which a person seeking
indemnification may be entitled under any law, by-law, agreement, vote of
stockholders or disinterested directors or otherwise. The Company is
authorized to purchase and maintain (and the Company expects to maintain)
insurance on behalf of its directors or officers.
In addition, the Company has entered into indemnification agreements (the
"Indemnification Agreements") with each of its directors/officers of the
Company. The Indemnification Agreements (i) confirm to officers and directors
the indemnification provided to them in the Certificate, (ii) provide officers
and directors with procedural protections in the event that they are sued in
their capacity as director or officer, (iii) provide additional
indemnification rights and (iv) provide contribution rights in the event that
indemnification is unavailable or insufficient.
ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES.
Since November 1, 1992, the Registrant issued and sold unregistered
securities in the following transactions, each of which was exempt pursuant to
Section 4(2) of the Securities Act of 1933, as amended (the "Securities Act").
In connection with each such sale, all purchasers represented that they were
sophisticated and that they were "accredited investors" as such term is
defined in Regulation D under the Securities Act.
1. Between March 1993 and November 1993, the Company issued to 82 investors
6,408,500 shares of Series D Convertible Preferred Stock ("Series D Stock")
for a purchase price of $1.00 per share. Eight persons received an aggregate
of 43,050 shares of Series D Stock and seven persons received an aggregate of
33,428 shares of Common Stock as finders' fees in connection with the issuance
of the Series D Stock. Such issuances included an issuance of 150,000 shares
to Dr. Stephen K.C. Ng.
2. On November 22, 1993, the Company issued, for aggregate consideration of
$10,000,000, 10,500,000 shares of its Series E Convertible Preferred Stock
("Series E Stock") and a warrant to purchase an additional 15,500,000 shares
of Series E Stock ("Series E Warrant") to four partnerships controlled by an
affiliate of Goldman, Sachs & Co. On December 7, 1995, Goldman, Sachs & Co.
exercised their Series E Warrant for a purchase price of $15,500,000.
3. On May 25 and June 15, 1994, the Company issued to four investors
2,500,000 shares of Series F Convertible Preferred Stock for a purchase price
of $2.00 per share, including the issuance of 1,500,000 shares to PAPNET (Far
East) Ltd.
4. Between October 1994 and July 1995, the Company issued to 25 investors an
aggregate of 8,846,464 shares of Series G Convertible Preferred Stock ("Series
G Stock") for a purchase price of $2.35 per share. Three persons received an
aggregate of 114,836 shares of Series G Stock as commissions in connection
with the issuance of the Series G Stock. In addition, in December 1995, the
Company issued 4,256 shares of Series G stock to an individual as commission
in connection with the issuance of Series G stock.
5. On November 1, 1994, the Company issued 26,596 shares of Common Stock to
a single investor, Avrom Silver, upon the conversion of a $250,000 note
payable.
6. In December 1994, the Company issued an aggregate of 3,325 shares of
Common Stock to two persons affiliated with Lechner & Associates, Inc. in
consideration for recruitment services rendered.
7. On May 17, 1995, the Company issued 215,400 shares of Common Stock to
Edelson Technology Partners III, L.P. for $861,600 in connection with the
exercise of a previously-issued warrant.
II-2
<PAGE>
8. Between July 27 and August 4, 1995, the Company issued to twelve
investors 610,574 shares of Series H Convertible Preferred Stock ("Series H
Stock") for a purchase price of $2.35 per share. Two persons received an
aggregate of 17,018 shares of Series H Stock as finders' fees in connection
with the issuance of Series H Stock.
9. In connection with a settlement agreement, the Company issued 715,894
shares of Common Stock in December 1995 upon the cashless exercise of 826,032
warrants held by certain entities which control, or are affiliated with,
holders of the Company's territorial licenses.
10. In December 1995, the Company issued 4,409,600 shares of Common Stock
upon the exercise of outstanding options and warrants.
11. From January 1, 1996 through September 9, 1996, the Company issued
516,966 shares of Common Stock pursuant to the exercise and conversion of
certain warrants.
12. From January 1, 1996 through September 9, 1996, the Company issued
171,812 shares of Common Stock pursuant to the exercise of employee stock
options.
The issuance of the above securities was deemed to be exempt from
registration under the Securities Act in reliance on Section 4(2) of the
Securities Act as transactions not involving a public offering. The purchasers
of securities in each such transaction, except with respect to the warrant
conversions described in items 9 and 10 above, represented their intentions to
acquire the securities for investment only and not with a view to or for sale
in connection with any distribution thereof and appropriate legends were
affixed to the share certificates and other securities issued in such
transactions. All purchasers had adequate access to information about the
Registrant through their relationships with the Company and appropriate
disclosure documents.
In addition, during October 1995, the Company awarded bonuses to certain
employees in respect of 1995 of which an aggregate of $193,750 could be paid,
at the election of such employees, in the form of Common Stock. In this
regard, 27,679 shares of Common Stock were issued in reliance upon Rule 701
under the Securities Act.
II-3
<PAGE>
ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES.
(a) Exhibits.
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF DOCUMENT
------- -----------------------
<C> <S>
1.3 Form of Underwriting Agreement+
3.1 Amended and Restated Certificate of Incorporation++
3.2 By-Laws++
4.1 Form of Rights Agreement+
4.2 Form of Stock Certificate+
5.1 Opinion of Fried, Frank, Harris, Shriver & Jacobson re Legality+
10.1 Neuromedical Systems, Inc. 1993 Stock Incentive Plan as Amended and
Restated
October 25, 1995+
10.2 Employment Agreement, dated November 19, 1993, between Neuromedical
Systems, Inc. and Mark R. Rutenberg+
10.3 Employment Agreement, dated November 18, 1993, between Neuromedical
Systems, Inc. and Uzi Ish-Hurwitz+
10.4 Employment Agreement, dated November 10, 1994, between Neuromedical
Systems, Inc. and David Duncan, Jr.+
10.5 Employment Agreement, dated April 1, 1994, between Neuromedical
Systems, Inc. and Zeev Hadass+
10.6 Employment Agreement, dated March 1, 1994, between Neuromedical
Systems, Inc. and John B. Henneman, III+
10.7 Employment Agreement, dated November 19, 1993, between Neuromedical
Systems, Inc. and James M. Herriman+
10.8 Employment Agreement, dated November 19, 1993, between Neuromedical
Systems, Inc. and Laurie J. Mango, M.D.+
10.9 Employment Agreement, dated February 14, 1994, between Neuromedical
Systems, Inc. and Andrew C. Panagy+
10.10 Amendment to Employment Agreement between Neuromedical Systems, Inc.
and Mark R. Rutenberg, dated as of October 25, 1995+
10.11 Amendment to Employment Agreement between Neuromedical Systems, Inc.
and Uzi
Ish-Hurwitz, dated as of October 25, 1995++
10.12 Amendment to Employment Agreement between Neuromedical Systems, Inc.
and David Duncan, Jr., dated as of October 25, 1995+
10.13 Amendment to Employment Agreement between Neuromedical Systems, Inc.
and Zeev Hadass, dated as of October 25, 1995+
10.14 Amendment to Employment Agreement between Neuromedical Systems, Inc.
and John B. Henneman, III, dated as of October 25, 1995+
10.15 Amendment to Employment Agreement between Neuromedical Systems, Inc.
and James M. Herriman, dated as of October 25, 1995+
</TABLE>
II-4
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF DOCUMENT
------- -----------------------
<C> <S>
10.16 Amendment to Employment Agreement between Neuromedical Systems, Inc.
and Laurie J. Mango, M.D., dated as of October 25, 1995+
10.17 Amendment to Employment Agreement between Neuromedical Systems, Inc.
and Andrew C. Panagy, dated as of October 25, 1995+
10.18 Employee Stock Bonus Plan+
10.19 Form of Rutenberg Nonqualified Stock Option Agreement+
10.20 Form of Indemnification Agreement between the Company and its
directors and officers+
10.21 Exclusive Representation Agreement between Neuromedical Systems, Inc.
and PAPNET (Far East) Ltd.+
10.22 Territorial License Agreement between Neuromedical Systems, Inc. and
Papnet of Ohio, Inc. (for the Territory of Ohio)+
10.23 Territorial License Agreement between Neuromedical Systems, Inc. and
Papnet of Ohio, Inc. (for the Territories of Kentucky, Indiana and
Chicago)+
10.24 Territorial License Agreement between Neuromedical Systems, Inc. and
ER Group, Inc.+
10.25 Territorial License Agreement between Neuromedical Systems, Inc. and
Carolina Cytology, Inc.+
10.26 Territorial License Agreement between Neuromedical Systems, Inc. and
Cytology West, Inc.+
10.27 Territorial License Agreement between Neuromedical Systems, Inc. and
I-A Cytology+
10.28 Settlement Agreement, dated as of December 4, 1995, among Neuromedical
Systems, Inc. and Papnet of Ohio, Inc., Cytology Indiana, Inc.,
Indiana Cytology Review Company, ER Group, Inc., Cytology West, Inc.,
Carolina Cytology Licensing Company, Papnet Utah, Inc., Carolina
Cytology Warrant Partnership and GRK Partners+
10.29 Warrant Exercise Agreement, dated as of December 4, 1995, among
Neuromedical Systems, Inc. and Papnet of Ohio, Inc., Cytology
Indiana, Inc., Indiana Cytology Review Company, ER Group, Inc.,
Carolina Cytology Warrant Partnership and GRK Partners+
10.30 Consulting Agreement between Neuromedical Systems, Inc. and Dr. Arthur
C. Herbst, dated April 7, 1995
11.0 Computation of Earnings per Share+++
16.0 Letter re: change in certifying accountant+
21.1 Subsidiaries of the Registrant
23.1 Consent of Ernst & Young LLP, Independent Auditors
23.3 Consent of Fried, Frank, Harris, Shriver & Jacobson (included in
Exhibit 5.1)+
24.1 Powers of Attorney+
</TABLE>
- --------
+ Incorporated by reference to the Company's Registration Statement on Form
S-1 (File No. 33-97722).
++Incorporated by reference to the Company's 1995 Annual Report on Form 10-K.
+++ Incorporated by reference to the Company's Quarterly Report in Form 10-Q
for the period ended June 30, 1996 and by reference to the Company's 1995
Annual Report on Form 10-K.
II-5
<PAGE>
(b) Financial Statement Schedules.
All schedules are omitted because they are not applicable or are not
required, or because the required information is included in the financial
statements or notes thereto.
ITEM 17. UNDERTAKINGS.
(a) Insofar as indemnification for liabilities arising under the Securities
Act of 1933 may be permitted to directors, officers and controlling
persons of the registrant pursuant to the foregoing provisions, or
otherwise, the registrant has been advised that in the opinion of the
Securities and Exchange Commission such indemnification is against
public policy as expressed in the Act and is, therefore, unenforceable.
In the event that a claim for indemnification against such liabilities
(other than the payment by the registrant of expenses incurred or paid
by a director, officer or controlling person of the registrant in the
successful defense of any action, suit or proceeding) is asserted by
such director, officer or controlling person in connection with the
securities being registered, the registrant will, unless in the opinion
of its counsel the matter has been settled by controlling precedent,
submit to a court of appropriate jurisdiction the question whether such
indemnification by it is against public policy as expressed in the Act
and will be governed by the final adjudication of such issue.
(b) The undersigned registrant hereby undertakes that:
(1) For purposes of determining any liability under the Securities Act
of 1933, the information omitted from the form of prospectus filed
as part of this registration statement in reliance upon Rule 430A
and contained in a form of prospectus filed by the registrant
pursuant to Rule 424(b)(1) or (4) or 497(h) under the Securities
Act shall be deemed to be part of this registration statement as of
the time it was declared effective.
(2) For the purpose of determining any liability under the Securities
Act of 1933, each post-effective amendment that contains a form of
prospectus shall be deemed to be a new registration statement
relating to the securities offered therein, and the offering of
such securities at that time shall be deemed to be the initial bona
fide offering thereof.
(3) It will file, during any period in which offers or sales are being
made, a post-effective amendment to this registration statement:
(i)To include any prospectus required by section 10(a)(3) of the
Securities Act of 1933;
(ii) To reflect in the prospectus any facts or events arising after
the effective date of the registration statement (or the most
recent post-effective amendment thereof) which, individually or
in the aggregate, represent a fundamental change in the
information set forth in the registration statement.
Notwithstanding the foregoing, any increase or decrease in
volume of securities offered (if the total dollar value of
securities offered would not exceed that which was registered)
and any deviation from the low or high end of the estimated
maximum offering range may be reflected in the form of
prospectus filed with the Securities and Exchange Commission
pursuant to Rule 424(b) if, in the aggregate, the changes in
volume and price represent no more than a 20 percent change in
the maximum aggregate offering price set forth in the
"Calculation of Registration Fee" table in the effective
registration statement;
(iii) To include any material information with respect to the plan
of distribution not previously disclosed in the registration
statement or any material change to such information in the
registration statement.
(4) It will remove from registration by means of a post-effective
amendment any of the securities being registered which remain
unsold at the termination of the offering.
II-6
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, as amended, the
Registrant has duly caused this Post-Effective Amendment to the Registration
Statement to be signed on its behalf by the undersigned, thereunto duly
authorized, in Suffern, New York on this 26th day of September, 1996.
NEUROMEDICAL SYSTEMS, INC.
By: /s/ David Duncan, Jr.
----------------------------------
David Duncan, Jr., Vice President,
Finance and Administration, Chief
Financial Officer and Principal
Accounting Officer
Pursuant to the requirements of the Securities Act of 1933, as amended, this
Registration Statement has been signed by the following persons in the
capacities and on the dates indicated:
SIGNATURE TITLE
Chairman of the
* Board, President
- ------------------------------------- and Chief Executive
(MARK R. RUTENBERG) Officer; Director
Vice President,
/s/ David Duncan, Jr. Finance and
- ------------------------------------- Administration,
(DAVID DUNCAN, JR.) Chief Financial
Officer and
Principal
Accounting Officer
Director
*
- -------------------------------------
(ELIZABETH COGAN FASCITELLI)
Director
*
- -------------------------------------
(STUART M. ESSIG) September 26,
1996
Director
*
- -------------------------------------
(CARL GENBERG)
Director
- -------------------------------------
(ARTHUR L. HERBST, M.D.)
Director
- -------------------------------------
(UZI ISH-HURWITZ)
Director
*
- -------------------------------------
(DR. STEPHEN K.C. NG)
Director
- -------------------------------------
(C. RAYMOND LARKIN, JR.)
/s/ David Duncan, Jr.
*By: ___________________________
(DAVID DUNCAN, JR. ATTORNEY-IN-
FACT)
II-7
<PAGE>
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF DOCUMENT PAGE NO.
------- ----------------------- --------
<C> <S> <C>
1.3 Form of Underwriting Agreement+
3.1 Amended and Restated Certificate of Incorporation++
3.2 By-Laws++
4.1 Form of Rights Agreement+
4.2 Form of Stock Certificate+
5.1 Opinion of Fried, Frank, Harris, Shriver & Jacobson re
Legality+
10.1 Neuromedical Systems, Inc. 1993 Stock Incentive Plan as
Amended and Restated October 25, 1995+
10.2 Employment Agreement, dated November 19, 1993, between
Neuromedical Systems, Inc. and Mark R. Rutenberg+
10.3 Employment Agreement, dated November 18, 1993, between
Neuromedical Systems, Inc. and Uzi Ish-Hurwitz+
10.4 Employment Agreement, dated November 10, 1994, between
Neuromedical Systems, Inc. and David Duncan, Jr.+
10.5 Employment Agreement, dated April 1, 1994, between
Neuromedical Systems, Inc. and Zeev Hadass+
10.6 Employment Agreement, dated March 1, 1994, between
Neuromedical Systems, Inc. and John B. Henneman, III+
10.7 Employment Agreement, dated November 19, 1993, between
Neuromedical Systems, Inc. and James M. Herriman+
10.8 Employment Agreement, dated November 19, 1993, between
Neuromedical Systems, Inc. and Laurie J. Mango, M.D.+
10.9 Employment Agreement, dated February 14, 1994, between
Neuromedical Systems, Inc. and Andrew C. Panagy+
10.10 Amendment to Employment Agreement between Neuromedical
Systems, Inc. and Mark R. Rutenberg, dated as of October
25, 1995+
10.11 Amendment to Employment Agreement between Neuromedical
Systems, Inc. and Uzi Ish-Hurwitz, dated as of October 25,
1995++
10.12 Amendment to Employment Agreement between Neuromedical
Systems, Inc. and David Duncan, Jr., dated as of October
25, 1995+
10.13 Amendment to Employment Agreement between Neuromedical
Systems, Inc. and Zeev Hadass, dated as of October 25,
1995+
10.14 Amendment to Employment Agreement between Neuromedical
Systems, Inc. and John B. Henneman, III, dated as of
October 25, 1995+
10.15 Amendment to Employment Agreement between Neuromedical
Systems, Inc. and James M. Herriman, dated as of October
25, 1995+
10.16 Amendment to Employment Agreement between Neuromedical
Systems, Inc. and Laurie J. Mango, M.D., dated as of
October 25, 1995+
10.17 Amendment to Employment Agreement between Neuromedical
Systems, Inc. and Andrew C. Panagy, dated as of October
25, 1995+
10.18 Employee Stock Bonus Plan+
10.19 Form of Rutenberg Nonqualified Stock Option Agreement+
10.20 Form of Indemnification Agreement between the Company and
its directors and officers+
10.21 Exclusive Representation Agreement between Neuromedical
Systems, Inc. and PAPNET (Far East) Ltd.+
10.22 Territorial License Agreement between Neuromedical Systems,
Inc. and Papnet of Ohio, Inc. (for the Territory of Ohio)+
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF DOCUMENT PAGE NO.
------- ----------------------- --------
<C> <S> <C>
10.23 Territorial License Agreement between Neuromedical Systems,
Inc. and Papnet of Ohio, Inc. (for the Territories of
Kentucky, Indiana and Chicago)+
10.24 Territorial License Agreement between Neuromedical Systems,
Inc. and ER Group, Inc.+
10.25 Territorial License Agreement between Neuromedical Systems,
Inc. and Carolina Cytology, Inc.+
10.26 Territorial License Agreement between Neuromedical Systems,
Inc. and Cytology West, Inc.+
10.27 Territorial License Agreement between Neuromedical Systems,
Inc. and I-A Cytology+
10.28 Settlement Agreement, dated as of December 4, 1995, among
Neuromedical Systems, Inc. and Papnet of Ohio, Inc.,
Cytology Indiana, Inc., Indiana Cytology Review Company,
ER Group, Inc., Cytology West, Inc., Carolina Cytology
Licensing Company, Papnet Utah, Inc., Carolina Cytology
Warrant Partnership and GRK Partners+
10.29 Warrant Exercise Agreement, dated as of December 4, 1995,
among Neuromedical Systems, Inc. and Papnet of Ohio, Inc.,
Cytology Indiana, Inc., Indiana Cytology Review Company,
ER Group, Inc., Carolina Cytology Warrant Partnership and
GRK Partners+
10.30 Consulting Agreement between Neuromedical Systems, Inc. and
Dr. Arthur C. Herbst, dated April 7, 1995
11.0 Computation of Earnings per Share+++
16.0 Letter re: change in certifying accountant+
21.1 Subsidiaries of the Registrant
23.1 Consent of Ernst & Young LLP, Independent Auditors
23.3 Consent of Fried, Frank, Harris, Shriver & Jacobson
(included in Exhibit 5)+
24.1 Powers of Attorney+
</TABLE>
- --------
+ Incorporated by reference to the Company's Registration Statement on Form
S-1 (File No. 33-97722).
++Incorporated by reference to the Company's 1995 Annual Report on Form 10-K.
+++ Incorporated by reference to the Company's Quarterly Report on Form 10-Q
for the period ended June 30, 1996 and by reference to the Company's 1995
Annual Report on Form 10-K.
<PAGE>
EXHIBIT 10.30
NEUROMEDICAL SYSTEMS, INC.
Advancing the Vision of Cytology(R)
NSI [LOGO]
- --------------------------------------------------------------------------------
April 7, 1995
Dr. Arthur L. Herbst
1234 North State Street
Chicago, Illinois 60610
RE: CONSULTING AGREEMENT
Dear Dr. Herbst:
This letter sets forth the Consulting Agreement (the "Agreement") regarding
your performance of personal, professional consulting services to Neuromedical
Systems, Inc., a Delaware corporation (together with its subsidiaries, "NSI"),
under the terms and conditions set forth herein.
1. STATEMENT OF WORK. You agree to serve as NSI's Medical Consultant and to
provide medical and technical consulting services to NSI in connection with
NSI's products and services directed toward the early detection of pre-cancerous
and cancerous lesions in the female patient. NSI acknowledges your other current
professional commitments and agrees to make reasonable efforts to structure the
work to be performed by you hereunder so as not to conflict or interfere with
those commitments.
2 PERIOD OF PERFORMANCE. The term of this Agreement shall be deemed to have
coMmenced as of January 1, 1995, and shall end on December 31, 1997, subject to
Paragaph 14 of this Agreement.
3. CONSULTING FEE. In consideration for your performance of the services to be
provided hereunder, you shall be entitled to an annual base consulting fee (the
"Consulting Fee") of Twenty Thousand Dollars ($20,000) payable quarterly, in
arrears. In addition, in the event that NSI engages you for a particular special
project likely to consume all or substantially all of your time for more than
one day (including applicable travel time), you shall be entitled to a daily
consulting fee of One Thousand Dollars ($1,000). If, from time to time, the
level of your services becomes more extensive than that which is currently
<PAGE>
NSI [LOGO]
anticipated by the parties, NSI in its sole discretion, may elect to provide you
with additional compensation. Payment shall be made by check to the address set
forth beneath your name in Paragraph 13 of this Agreement.
4. REIMBURSEMENT OF EXPENSES. Travel and other expenses incurred by you in
connection with your performance under this Agreement, and agreed upon in
advance, shall be reimbursed directly to you by NSI. NSI's travel policy for
employees and consultants at your level is to reimburse air fare for Business
Class on international and transcontinental flights and Full Coach Class on all
other flights.
5. INTELLECTUAL PROPERTY. All rights to intellectual property including,
without limitation, technology developments, patents, copyrights and trademarks,
inventions, discoveries, improvements, designs, processes, formulae, trade
secrets, proprietary rights and data, confidential informaton, ideas or other
Proprietary Information (as hereinafter defined), created in whole or in part
as a result of this Agreement or in connection with or relating to your
consulting services under this Agreement, provided for you, or created in whole
or in part by you and relating to NSI's technology or business, shall be and
remain the property of NSI. Nothing in this Agreement shall be construed to
restrict or otherwise interfere with your ability to continue your research in
matters unrelated to NSI's technology or business.
6. PUBLICATION. It is the intention of the partes that you may, but shall not
be required to, publish information in connection with any NSI system of
cytological classification. Your decision to publish and the contents of any
such publication shall be made by you alone, with total independence from NSI
and its management. You will consult with NSI prior to any publication of any
such results, which consultation shall include provisions to NSI of any
drafts, manuscripts or articles.
7. PROPRIETARY INFORMATION. You agree not to release any Proprietary
Information (as defined below) regarding NSI's systems, technology or business
strategy or any other NSI property either orally or in writing without the
prior written consent or approval of NSI. "Proprietary Information" means
all proprietary, commercial and technical information relating to NSI's
business or technology, including, without limitation, all lists and particulars
of customers, product features, circuit diagrams, layouts, designs and
specifications, methods of manufacture, techniques, correspondence with
suppliers and customers, and all informaton relating to the technology of NSI's
Business, whether or not disclosed in any part or form to any third party.
8. TITLE TO EQUIPMENT. Any property provided to you by NSI during the term of
this Agreement shall remain the property of NSI.
9. NO COMPETING INVOLVEMENT. You represent that as of the commencement
date of this Agreement, you are, to the best of your knowledge, not involved
with any individual, group, company or other entity with a commercial interest
which competes
<PAGE>
NSI [LOGO]
with NSI. You agree to give NSI Sixty (60) days prior written notice before
undertaking any such involvement.
10. USE OF YOUR NAME. NSI agrees that unless authorized by you, its public use
of your name will be limited to a statement that you are a medical consultant
to NSI and that, as such, you are involved in the evaluation and testing of its
technology.
11. INDEMNIFICATION. (a) NSI hereby indemnifies and holds you harmless from
all claims, liabilities, damages, losses, costs and expenses (including without
limitation, reasonable attorneys' fees and expenses) (collectively, "Losses")
which you may sustain or incur by reason of or relating to your performance of
consulting services hereunder. Losses as defined above include the cost incurred
by you in responding to any proceeding whether as a party or witness and
regardless of its nature. NSI will promptly reimburse all Losses as and when
incurred by you without awaiting the outcome of any proceeding wherein they are
being considered. Notwithstanding the foregoing undertaking, NSI shall be under
no obligation to indemnify you for Losses arising from your gross negligence or
willful misconduct, determination of the same to be made in accordance with the
finding of the tribunal where the proceeding is being conducted. Should the
Losses not be subject to indemnification, you shall promptly reimburse NSI for
any expenditures made to you or in your behalf for the non-indemnifyable Losses.
If any claim is made against you for which indemnification is sought hereunder,
written notice shall be given to NSI as promptly as practicable; provided, that
--------
your failure to give timely notice shall not affect rights to indemnification
hereunder except to the extent that NSI demonstrates actual damage caused by
such failure. If within 30 days of receipt of such notice NSI acknowledges in
writing to you that NSI shall be obligated under the terms of its indemnity
hereunder in connection with such claim, then NSI shall be entitled, if it so
elects, to take control of its own defense and investigation of such claim and
to employ and engage attorneys of its own choice to handle and defend the same,
at NSI's cost, risk and expenses; provided that NSI and its counsel shall
--------
proceed with diligence and in good faith with respect thereto; and provided
--------
further, that you may, at your own cost, participate in the investigaton, trial
- -------
and defense of such lawsuit or action and any appeal arising therefrom. If NSI
does elect to control such defense and investigation, (i) NSI shall not settle
any claim against you without your consent if such settlement includes any
admission of liability or wrongdoing of any sort on your part or any restriction
of any sort by which you are bound and (ii) NSI's responsibility as to any
settlement of any claim against you shall be limited to the amount consented to
by NSI. If NSI does not elect to control such defense and investigation, then
you shall control such defense and investigation and NSI shall periodically
reimburse you for your Losses (in the case of professional fees and expenses
within 45 days of invoice). Each party shall cooperate in all reasonable
respects with the other party and its attorneys in the investigation, trial and
defense of such lawsuit or action and any appeal arising therefrom.
(b) You hereby indemnify and hold NSI, its officers, directors, stockholders,
agents, employees and assigns (each, an "Indemnified Party") harmless from any
Losses which the Idemnified Party may sustain or incur by reason of or relating
to (i)
<PAGE>
any failure by you to perform any agreement, covenant, obligation or duty
required to be performed by you under any provision of this Agreement or (ii)
any material breach by you of this Agreement.
(c) In addition to the agreement to indemnify you, NSI agrees to use its
reasonable best efforts have you named as a party insured on any comprehensive
liability insurance NSI may maintain insuring NSI and its officers and employees
against claims relating to its business and the conduct thereof, provided,
---------
that NSI shall be under no obligation to obtain such coverage if the incremental
cost of including you exceeds $1,000 per year. You shall be provided with
currently valid certificates of said coverage, when and if it is obtained. In
the event that NSI does not obtain such coverage, NSI will reimburse you for up
to $3,000.00 per year in premium if you obtain you own applicable liability
coverage.
12. STATUS AS INDEPENDENT CONTRACTOR. You shall not be considered an employee
or agent of NSI, nor shall you have authority to act for NSI except as
specifically authorized in writing by NSI. You shall at all times be an
independent contractor with respect to NSI.
13. NOTICE. Any notices given pursuant to this Agreement shall be given in
writing and sent certified mail, return receipt requested, as follows:
If to NSI:
Neuromedical Systems, Inc.
Two Executive Boulevard
Suffern, NY 10901
Attention: John B. Henneman, III
Vice President of Corporate Development
and General Counsel
If to Dr. Herbst:
Dr. Arthur L. Herbst
Professor and Chairman of Department of
OB/GYN
University of Chicago
5841 S. Maryland Avenue
Chicago, Illinois 60637
14. TERMINATION. This Agreement shall be termninated before the end of the
term thereof (i) as set forth in Paragraph 4 herein, (ii) upon your death or
(iii) at any time by
<PAGE>
NSI [LOGO]
either party upon sixty (60) days written notice to the other party. The
provisions of Paragraphs 5, 6, 7, 8, and 11 shall continue and survive any such
termination.
15. CONFIDENTIALITY. You agree to keep this Agreement and its substantive
terms confidential; provided, that you may disclose same to your attorney, your
--------
employer and otherwise if counseled by a court or other tribunal with the
authority to order such disclosure.
16. GOVRERNING LAW. This Agreement shall be governed by and construed in
accordance with the laws of the State of Illinois.
17. ENTIRE AGREEMENT. This Agreement embodies the entire understanding between
the parties with respect to the subject matter hereof. No amendments or
modifications shall be effective unless made in writing and signed by the
parties.
If the foregoing accurately sets forth our agreement, please execute the attach-
ed copy of this letter in the space indicated and return it to NSI in the
attached envelope which we have enclosed for your convenience.
Sincerely,
/s/ Andrew C. Panagy
Andrew C. Panagy
Vice President
Marketing and Sales
Agreed and Accepted:
- --------------------------
Dr. Arthur L. Herbst
Date: April 7, 1995
<PAGE>
EXHIBIT 21.1
SUBSIDIARIES OF NEUROMEDICAL SYSTEMS, INC.
------------------------------------------
<TABLE>
<CAPTION>
UNNAMED WHOLLY-OWNED
SUBSIDIARIES OF NAMED
SUBSIDIARIES CARRYING
JURISDICTION IN WHICH PERCENTAGE OF VOTING ON THE SAME LINE OF
NAME ORGANIZED PARENT OR INVESTOR SECURITIES OWNED BUSINESS
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
NSI Netherlands, B.V. The Netherlands Neuromedical Systems, Inc. 100% None
NSI Europe, B.V. The Netherlands NSI Netherlands, B.V. 100% None
Advanced Cytology Europe, The Netherlands NSI Limited Partner I, Inc. 50%
C.V.
NSI Limited Partner II, Inc. 50% None
NSI Italy Srl. Italy NSI Netherlands, B.V. 75%
NSI Europe, B.V. 25% None
NSI France S.A.R.L. France NSI Netherlands, B.V. 99.99%
NSI Europe, B.V. 0.01% None
NSI Australia Pty Ltd. Australia Neuromedical Systems, Inc. 100% None
NSI (Hong Kong) Ltd. Hong Kong Neuromedical Systems, Inc. 50%
NSI Netherlands, B.V. 50% None
Neuromedical Systems Israel NSI Netherlands, B.V. 100% None
Israel, Ltd.
Atlantic Cytology, Inc. Delaware Neuromedical Systems, Inc. 100% None
Cytology Europe, Inc. Delaware Neuromedical Systems, Inc. 100% None
NSI Overseas Holdings, Inc. Delaware Neuromedical Systems, Inc. 100% None
NSI Overseas Group, Inc. Delaware Neuromedical Systems, Inc. 100% None
</TABLE>
<PAGE>
EXHIBIT 23.1
CONSENT OF INDEPENDENT AUDITORS
We consent to the reference to our firm under the headings "Selected
Consolidated Financial Data" and "Experts" and to the use of our report dated
February 12, 1996 in Post-Effective Amendment No. 1 to the Registration
Statement (Form S-1 No. 33-97722) and related Prospectus of Neuromedical
Systems, Inc. for the registration of shares of its Common Stock.
Hackensack, New Jersey /s/ Ernst & Young LLP
September 19, 1996
