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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON D.C. 20549
FORM 10-Q
(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 1997
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ____________ to _____________
Commission File No. 0-26984
Neuromedical Systems, Inc.
- --------------------------------------------------------------------------------
(Exact Name of Registrant as Specified in its Charter)
Delaware 13-3526980
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(State or other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
Two Executive Boulevard, Suffern, NY 10901-4164
- --------------------------------------------------------------------------------
(Address of Principal Executive Offices)
Registrant's telephone number including area code: (914) 368-3600
- --------------------------------------------------------------------------------
(Former Name, Former Address and Former
Fiscal Year if Changed Since Last Report)
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports) and (2) has been subject to such filing
requirements for the past 90 days.
YES X NO
--- ---
As of April 30, 1997, an aggregate of 30,909,397 shares of common stock were
outstanding.
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NEUROMEDICAL SYSTEMS, INC.
Table of Contents
Form 10-Q for the Quarterly Period Ended March 31, 1997
PART I FINANCIAL INFORMATION PAGE
- ------ --------------------- ----
Item 1. Financial Statements
Condensed Consolidated Balance Sheets
at March 31, 1997 (unaudited) and
December 31, 1996 3
Condensed Consolidated Statements of
Operations for the three months ended
March 31, 1997 and 1996 (unaudited) 4
Statements of Cash Flows for the three
months ended March 31, 1997 and 1996
(unaudited) 5
Notes to Condensed Consolidated
Financial Statements 6
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of
Operations 7
PART II OTHER INFORMATION
- ------- -----------------
Item 1. Legal Proceedings 15
Item 2. Changes in Securities 15
Item 3. Defaults upon Senior Securities 15
Item 4. Submission of Matters to a Vote
of Security Holders 15
Item 5. Other Information 15
Item 6. Exhibits and Reports on Form 8-K 16
2
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PART I FINANCIAL INFORMATION
Item 1. Financial Statements.
Neuromedical Systems Inc. and Subsidiaries
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
<TABLE>
March 31, December 31,
1997 1996
-------------- --------------
(unaudited)
Assets
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 46,883,000 $ 83,391,000
Short-term investments 25,138,000 -
Accounts receivable, net of allowance 1,696,000 1,650,000
Prepaid expenses 745,000 803,000
Other current assets 924,000 732,000
------------- -------------
Total current assets 75,386,000 86,576,000
Restricted cash 1,000,000 1,000,000
Property and equipment 17,102,000 16,388,000
Patent and patent application costs, net of
accumulated amortization (1997-$533,000,
1996-$492,000) 125,000 166,000
Other assets 66,000 74,000
------------- -------------
$ 93,679,000 $ 104,204,000
============= =============
Liabilities and Stockholders' Equity
Current liabilities:
Current portion of notes and bank loans payable $ 1,752,000 $ 1,200,000
Current portion of capital lease obligations 1,967,000 1,972,000
Accounts payable 1,634,000 2,256,000
Accrued liabilities 4,690,000 4,082,000
-------------- --------------
Total current liabilities 10,043,000 9,510,000
Notes and bank loans payable-long-term 4,255,000 4,704,000
Notes payable-stockholder 300,000 600,000
Capital lease obligations, less current portion 5,170,000 5,862,000
Commitments and contingencies
Stockholders' equity:
Preferred stock, $.0001 par value; authorized -
10,000,000 shares; none issued and outstanding -- --
Common stock, $.0001 par value; authorized-
100,000,000 shares; issued and outstanding - 30,907,497
shares in 1997 and 29,795,049 shares in 1996 3,000 3,000
Additional paid-in capital 177,687,000 177,559,000
Accumulated deficit (104,233,000) (94,508,000)
Foreign currency translation 454,000 474,000
------------- --------------
Total stockholders' equity 73,911,000 83,528,000
------------- --------------
$ 93,679,000 $ 104,204,000
============= ==============
</TABLE>
See accompanying notes.
3
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Neuromedical Systems Inc. and Subsidiaries
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
Three Months Ended March 31,
------------ ------------
1997 1996
------------ ------------
Revenues:
Slide processing $ 1,651,000 $ 651,000
------------ ------------
Total revenues 1,651,000 651,000
------------ ------------
Costs and Expenses:
Cost of sales 2,593,000 1,691,000
Marketing 5,478,000 3,517,000
Research and development 1,948,000 1,550,000
General and administrative 1,940,000 1,741,000
------------ ------------
Total costs and expenses 11,959,000 8,499,000
------------ ------------
Loss from operations (10,308,000) (7,848,000)
Other income (expense):
Interest income 992,000 1,483,000
Interest expense (388,000) (248,000)
Foreign exchange (21,000) (234,000)
------------ ------------
Other income (expense) - net 583,000 1,001,000
------------ ------------
Net loss $ (9,725,000) $ (6,847,000)
============ ============
Net loss per share $ (0.32) $ (0.24)
============ ============
Weighted average shares outstanding 30,825,000 28,808,000
============ ============
See accompanying notes.
4
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Neuromedical Systems Inc. and Subsidiaries
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended March 31,
--------------------------------
1997 1996
------------ --------------
<S> <C> <C>
Operating Activities
Net Loss $ (9,725,000) $ (6,847,000)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization 1,144,000 758,000
Foreign exchange loss 11,000 237,000
Changes in operating assets and liabilities:
(Increase) decrease in accounts receivable (46,000) 198,000
(Decrease) in accounts payable (622,000) (442,000)
Increase in accrued liabilities 608,000 67,000
(Increase) in prepaid expenses
and other assets (126,000) (5,000)
------------ ------------
Net cash used in operating activities (8,756,000) (6,034,000)
------------ ------------
Investing Activities
Purchases of short-term investments (25,138,000) --
Purchases of property and equipment (2,040,000) (2,958,000)
------------ ------------
Net cash used in investing activities (27,178,000) (2,958,000)
------------ ------------
Financing Activities
Restricted cash -- --
Issuance of common stock 128,000 1,000
Issuance of convertible preferred stock -- --
Repayments to licensees -- --
Proceeds from notes and bank loans 212,000 399,000
Payment of notes and bank loans (403,000) (398,000)
Payments on capital leases (534,000) (172,000)
Proceeds from capital lease financing -- 822,000
------------ ------------
Net cash (used in) provided by financing activities (597,000) 652,000
------------ ------------
Effect of exchange rate changes on cash 23,000 6,000
------------ ------------
Net decrease in cash and cash equivalents (36,508,000) (8,334,000)
Cash and cash equivalents, beginning of period 83,391,000 114,143,000
------------ ------------
Cash and cash equivalents, end of period $ 46,883,000 $105,809,000
============ ============
</TABLE>
See accompanying notes.
5
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NEUROMEDICAL SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
MARCH 31, 1997
NOTE 1. BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements have been
prepared in accordance with generally accepted accounting principles for interim
financial information and in accordance with the instructions to Form 10-Q and
Article 10 of Regulation S-X. Accordingly, they do 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. Certain prior year amounts have been
reclassified to conform with the current year presentation. These condensed
consolidated financial statements should be read in conjunction with the
consolidated financial statements and footnotes thereto included in the
Neuromedical Systems, Inc. (the "Company" or "NSI") Annual Report on Form 10-K
for the year ended December 31, 1996 (the "1996 Form 10-K"). Operating results
for the three month period ended March 31, 1997 are not necessarily indicative
of the results that may be expected for the year ended December 31, 1997.
NOTE 2. COMMITMENTS AND CONTINGENCIES
On March 28, 1997, Neopath, Inc. filed a patent infringement lawsuit against the
Company in the United States District Court for the Western District of
Washington. The lawsuit seeks to enjoin the Company from allegedly infringing
three of Neopath's patents. Neopath is seeking preliminary and permanent
injunctive relief as well as compensatory damages, including treble damages.
The Company believes that Neopath's claims are without merit and intends to
vigorously defend this action. The Company also believes that an adverse
judgement in this case would not have a material adverse effect on the Company's
operations, financial position or cash flows.
On April 15, 1997, the Company was served with a lawsuit filed by Cytyc
Corporation ("Cytyc") in the United States District Court for the District of
Massachusetts against the Company, certain of its officers and others, which
alleges false and misleading advertising, unfair and deceptive trade practices,
theft of trade secrets, unfair competition, interference with relationships and
defamation. Cytyc is seeking preliminary and permanent injunctive relief as
well as unspecified compensatory damages, including treble damages. The Company
believes that Cytyc's claims are without merit and intends to vigorously defend
this action. The Company also believes that an adverse judgment in this case
would not likely have a material adverse effect on the Company's operations,
financial position or cash flows, but there can be no assurance in this regard.
6
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ITEM 2. 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
cervical Papanicolaou ("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) to the
Company's territorial licensees ("Licensees") and (iii) interest income.
The PAPNET(R) Testing System was approved by the United States Food and Drug
Administration (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 scanning facilities (the "Scanning Centers"), one each in the
United States, The Netherlands and Hong Kong. The Netherlands operation has
scanned slides primarily from customers in Europe while the Hong Kong operation
has scanned slides from Asia and Australia. See Note 5 of Notes to Consolidated
Financial Statements for the year ended December 31, 1996 for information
regarding the Company's revenues, net loss and identifiable assets by geographic
area.
The Company has incurred net losses since inception through March 31, 1997 of
$104,233,000 and has to date generated only limited commercial revenues. Since
the approval of the PAPNET(R) testing system by the FDA, the Company has been
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, although
there can be no assurance in this regard. 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. The forward looking
statements are made pursuant to the safe harbor provisions of the Private
Securities Litigation Reform Act of 1995. Actual results may differ materially
due to a variety of factors which include, but are not limited to, the Company's
continuing negative cash flow, 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 in the Company's Securities and Exchange Commission
filings, including its 1996 Form 10-K and Exhibit 99.1.
7
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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 March 31, 1997, the Company has experienced negative
gross margins due to the significant under-utilization 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 demand resulting
from expansion of the Company's marketing and sales activities since such
approval. Improvement in the Company's future gross margins will be dependent
upon the level of commercial acceptance of the PAPNET(R) Testing System.
The Company expects that its costs and expenses will increase substantially
during 1997, compared to 1996, as the Company continues to expand its commercial
operations, including its marketing, sales, manufacturing, slide processing,
research and administrative activities, to meet the anticipated increase in
market demand for PAPNET(R) testing, expand its clinical claims and develop
enhancements to the PAPNET(R) Testing System. In addition, royalty payments will
increase proportionate to increases in the Company's revenues in the sales
territories of the Licensees.
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's sales and marketing efforts to date in the United States have
generated considerable awareness about PAPNET(R) testing among pathologists,
cytotechnologists, gynecologists and women. The Company believes support and
interest has been highest among women. Medical specialities, however, are often
reluctant to change clinical practice methods and procedures, and early stage
resistance is being experienced in the adoption of PAPNET(R) testing. Among
gynecologists and pathologists there has been, in general, a slow adoption of
the PAPNET(R) technology and some reluctance to use it even if a woman inquires
about or requests the test. The Company believes that this is due to several
factors, including controversy within the medical profession about the public
health consequences of Pap smear false negatives, the relative cost of PAPNET(R)
testing to the Pap smear, limited reimbursement by third-party payers and
confusion in the marketplace about alternative technologies for cervical cancer
screening. In late 1996 and the first quarter of 1997, the Company initiated
medical and other communications designed to address each of these
considerations. During the first quarter the Company promoted certain of its
sales personnel who were regionally successful in translating patient demand
into slide revenue in an effort to replicate their success nationwide. During
the first quarter of 1997, the Company continued its efforts to accelerate the
medical acceptance and commercial success
8
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of PAPNET(R) testing.
In February, the Company announced that Medical Mutual of Ohio (formally Blue
Cross Blue Shield of Northern Ohio), the largest health care insurer in the
state of Ohio with approximately 1.5 million enrollees, will cover the cost of
PAPNET(R) testing for its enrollees. Medical Mutual of Ohio also recommended to
its clinicians and laboratories that all negative Pap smears covered by its
benefit plans be examined using PAPNET(R) testing. The Company expects that
PAPNET(R) testing of covered women in Ohio will increase during the second
quarter of 1997.
Failure to detect abnormal cells on Pap smear slides (i.e., screening false
negatives) are a large source of U.S. medical malpractice litigation. The
general counsel of the College of American Pathologists, in an article published
in the April 1997 edition of its official publication, CAP Today, recommended
that laboratories ensure that all patients be informed of the option of having
their slide computer rescreened using a computer-assisted device.
On March 26, 1997, data was presented at the 28th annual meeting of The Society
of Gynecologic Oncologists ("SGO"). The data showed that "cervical cancer and
precancerous detection can be enhanced by PAPNET(R) testing." According to SGO,
"data from more than 16,000 smears indicate that utilization of the neural
network-based PAPNET(R) test, resulted in the detection of precancerous
abnormality missed by manual microscopic screening. Despite having abnormality
present on the smear, these slides were originally reported as negative, thus
resulting in a false-negative diagnosis."
Also during the quarter, the World Health Organization ("WHO") issued a press
release reporting that "Pap tests to detect cervical cancer are missing trouble
signs up to 30 percent of the time." In addition, the WHO and the European
Organization on Genital Infection and Neoplasia recommended "standardization of
analysis techniques, better staff training, and automation of screening systems
where possible."
The Company also announced during the first quarter that a study reported at the
annual meeting of the U.S. and Canadian Academy of Pathology showed that the
unmodified PAPNET(R) Testing System detected cancerous and precancerous cells of
the esophagus on conventionally prepared smears.
The Company trained a significant number of new laboratories during the first
quarter, adding PAPNET(R) availability to several important regions which were
previously underserved. PAPNET(R) testing is now available by physician request
through more than 230 local, regional and national laboratories throughout the
United States. The Company is also marketing to insurers, managed care
organizations and other third-party payers concerning reimbursement for
PAPNET(R) testing, and expects to increase its expenditures in this area during
1997.
NSI also continued to expand its international laboratory distribution. During
the first quarter of 1997, the Company received smears for PAPNET(R) testing
from 44 laboratories in Europe and South Africa and 11 laboratories in
Australia. In Asia, the Company continued to expand its business in Hong Kong,
Taiwan and mainland China. During the quarter, the Company received slide
processing revenue from 42 laboratories and hospitals in these countries.
9
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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 1997 by interest income from the
investment of the Company's cash. The Company expects that its interest income
will decline in 1997, compared to 1996, because of the significant use of cash
in 1996 and the anticipated use of cash in 1997.
The impact of inflation and changing prices on the Company's revenues and costs
has not been significant.
RESULTS FOR THE FIRST QUARTER ENDING MARCH 31, 1997 AND 1996
Revenues for the first quarter were $1,651,000, an increase of 154% from
$651,000 during the first quarter of 1996. Of such revenues, $1,607,000
represented per slide charges for the screening of Pap smears, and the balance
of such revenues represented rental payments on PAPNET(R) Review Stations. The
revenue increase over the first quarter of 1996 was due to a significant
increase in both unit volume and unit pricing.
Unit volume during the first quarter of 1997, compared to the first quarter of
1996, increased in the United States, Asia, Australia and Europe, and declined
in Canada and South America. For United States operations (includes Canada and
South America), unit volume increased 165% over the first quarter of 1996. In
International markets, unit volume increased 54% over the first quarter of 1996.
Unit pricing in the first quarter of 1997 increased by approximately 40% over
the first quarter of 1996 and accounted for the remainder of the worldwide
revenue increase.
Total costs and expenses for the quarter ended March 31, 1997 were $11,959,000,
an increase of $3,460,000 over the first quarter of 1996. This increase was due
primarily to an increase in marketing and sales expenses in the United States
and Australia and to an increase in cost of sales, primarily associated with
increased royalty expenses and the expansion of slide processing capacity in the
United States in anticipation of increased future demand for PAPNET(R) testing.
Sales and marketing expenses increased to $5,478,000 during the first quarter of
1997 from $3,517,000 during the first quarter of 1996, an increase of
$1,961,000. The increase in sales and marketing expenses was due primarily to
costs associated with marketing the PAPNET(R) Testing System in the United
States, including salaries for additional personnel and advertising and
promotion costs of the PAPNET(R) direct-to-consumer campaign, and to expanded
sales and marketing operations in Australia.
The Company's cost of sales increased to $2,593,000 in the first quarter of
1997, compared to $1,691,000 during the first quarter of 1996, an increase of
$902,000. This increase was primarily associated with increased royalty
expenses and the expansion of the Company's slide processing capacity in the
United States. The increase in royalty expense was the result of increases in
the
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Company's revenues in the sales territories of the Licensees during 1997.
Slide processing costs also increased in 1997, compared to the first quarter of
1996, due to the establishment of the Company's new 26,500 square foot scanning
center in New Jersey in October, 1996 along with the additional cost of
increased scanner and manufacturing capacity, which occurred throughout the
fourth quarter of 1996 and the first quarter of 1997, at the Company's three
scanning centers and its manufacturing facility in Israel.
In addition, the Company's research and development and general and
administrative expenses also increased in the first quarter 1997, compared to
the first quarter of 1996, although at a slower rate than marketing and cost of
sales expenses. These increases were due primarily to the expansion of the
technical and administrative infrastructure of the Company to support expanded
commercial activities in both the United States and international markets.
Interest income for the quarter ended March 31, 1997 was $992,000 compared to
$1,483,000 during the first quarter of 1996. This decrease was due primarily to
the lower level of cash, cash equivalents and short term investments available
to the Company during the first quarter of 1997 as a result of the Company's
continuing losses in 1996 and the first quarter of 1997.
Interest expense during the first quarter of 1997 was $388,000 compared to
$248,000 during the first quarter of 1996. This increase was due to higher
levels of debt and capital lease obligations, which the Company entered into in
late 1996, incurred to finance capital equipment additions, primarily related to
the Company's PAPNET(R) Scanning Stations. The Company anticipates higher levels
of interest expense in 1997 resulting from increased levels of debt and capital
lease obligations.
The Company incurred a net loss during the first quarter of 1997 of $9,725,000,
or $0.32 per share, compared to a net loss of $6,847,000, or $0.24 per share
during the first quarter of 1996. The increased net loss during the first
quarter of 1997, was due primarily to an increase in marketing and sales
expenses in the United States and Australia and to an increase in the cost of
sales, primarily associated with increased royalty expenses and the expansion of
slide processing capacity in the United States in anticipation of increased
future demand for PAPNET(R) testing.
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 territorial 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, excluding short term
investments of $25,138,000 totaled $46,883,000 at March 31, 1997, a decrease of
$36,508,000 from December 31, 1996. During the first quarter of 1997, the
Company used $8,756,000 for operating activities, $27,178,000 for investing
activities, including the purchase of $25,138,000 of short term investments and
the Company used $597,000 for financing activities. In addition, the effect of
exchange rate changes on cash was $23,000, which accounted for the remaining
change to the Company's cash balance.
11
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The primary uses of cash and cash equivalents during the first quarter of 1997
were $9,725,000 (inclusive of $1,155,000 of non-cash expenses) to finance the
Company's net loss, $25,138,000 to purchase short term investments, $2,040,000
to purchase capital equipment, primarily for the manufacture of PAPNET(R)
Scanning Stations and related equipment to support the expansion of the
Company's scanning capacity, $937,000 to repay notes, bank loans and capital
lease obligations, and $186,000 for changes in operating assets and liabilities.
The sources of cash and cash equivalents during the first quarter of 1997 were
proceeds of $212,000 from notes and bank loans and proceeds of $128,000 from the
issuance of common stock, associated with the exercise of stock options.
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 substantially in 1997 due to the cost of marketing 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
anticipates that, during 1997, it will invest approximately $5.0 million for
working capital purposes and approximately $7.0 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.
During 1996, the Company entered into a loan agreement with an equipment
financing company to provide the Company with a $5,000,000 line of credit to
finance certain of the Company's equipment purchases. During 1996, the Company
borrowed $2,098,000 under the agreement. The Company is required to maintain
certain financial covenants throughout the duration of the loan. The agreement
stipulates that additional funding can be denied in the event of a material
adverse change in the financial condition, operation or prospects of the
Company. The loan commitment expires on December 31, 1997. There can be no
assurance, however, that these financings, or any other financings, will
ultimately be obtained by the Company or, if they are obtained, that the terms
thereof will not change or 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
through 1998. 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 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.
During the first quarter 1997, the Company continued negotiations for the
acquisition of two of its PAPNET(R) distributors, New System International Ltd.
(a Hong Kong subsidiary of Papnet
12
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(Far East) Ltd.) and New System Taiwan Ltd. No definitive agreements have yet
been reached.
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. On
February 23, 1996, the defendants moved to dismiss the Amended Complaint and on
November 27, 1996, the New York State Supreme Court issued an opinion dismissing
all of the plaintiff's claims that the Company and certain officers and
directors committed fraud and other improper actions that allegedly diminished
the value of the warrants plaintiffs claim they are entitled to receive. The
Court denied the Company's motion to dismiss plaintiffs' breach of contract
claim, and plaintiffs continue to seek $39 million in compensatory damages and
$75 million in punitive damages. The Company intends to continue 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 Inc. ("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 System. The Company
also alleges that NeoPath falsely characterized and made misleading comparisons
to consumers and securities analysts of the AutoPap 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 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 pursuing this
lawsuit will be significant during 1997.
On March 28, 1997, Neopath, Inc. filed a patent infringement lawsuit against the
Company in the United States District Court for the Western District of
Washington. The lawsuit seeks to enjoin
13
<PAGE>
the Company from allegedly infringing three of Neopath's patents. Neopath is
seeking preliminary and permanent injunctive relief as well as compensatory
damages, including treble damages. The Company believes that Neopath's claims
are without merit and intends to vigorously defend this action. The Company also
believes that an adverse judgement in this case would not have a material
adverse effect on the Company's operations, financial position or cash flows.
On April 15, 1997, the Company was served with a lawsuit filed by Cytyc
Corporation ("Cytyc") in the United States District Court for the District of
Massachusetts against the Company, certain of its officers and others, which
alleges false and misleading advertising, unfair and deceptive trade practices,
theft of trade secrets, unfair competition, interference with relationships and
defamation. Cytyc is seeking preliminary and permanent injunctive relief as
well as unspecified compensatory damages, including treble damages. The Company
believes that Cytyc's claims are without merit and intends to vigorously defend
this action. The Company also believes that an adverse judgment in this case
would not likely have a material adverse effect on the Company's operations,
financial position or cash flows, but there can be no assurance in this regard.
14
<PAGE>
PART II OTHER INFORMATION
Item 1. Legal Proceedings.
See Management's Discussion and Analysis of Financial Condition and
Results of Operation in Part I herein for disclosure concerning legal
proceedings.
Item 2. Changes in Securities.
Not applicable.
Item 3. Defaults upon Senior Securities.
Not applicable.
Item 4. Submission of Matters to a Vote of Security Holders.
Not applicable.
Item 5. Other Information.
Not applicable.
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits.
Exhibit
Number Exhibit
-------- -------
11.0 Statement Regarding Computation of Per Share
Earnings
27.1 Financial Data Schedule*
99.1 Cautionary Statement for Purposes of the Safe
Harbor Provisions of the Private Securities
Litigation Reform Act of 1995**
* Previously filed as an exhibit to the Form 8-K filed
by the Company with the Commission on May 1, 1997
and incorporated herein by reference thereto.
** Previously filed as an exhibit to the Company's 1996
Annual Report on Form 10-K and incorporated herein
by reference thereto.
(b) Reports on Form 8-K.
No reports on Form 8-K were filed during the quarter for which
this report is filed.
15
<PAGE>
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, a duly authorized officer and the Company's principal financial
officer.
NEUROMEDICAL SYSTEMS, INC.
Dated: May 14, 1997 By: /s/ David Duncan, Jr.
David Duncan, Jr.
Vice President, Finance and
Administration, Chief Financial
Officer
16
<PAGE>
Exhibit 11.0
NEUROMEDICAL SYSTEMS, INC.
COMPUTATION OF PRIMARY EARNINGS PER SHARE
<TABLE>
<CAPTION>
Three Months Ended March 31,
--------------------------------------
1997 1996
----------------- -----------------
<S> <C> <C>
Weighted average number of common shares outstanding 30,825,319 28,808,485
Net loss for period $ (9,725,000) $ (6,847,000)
-------------- --------------
Net loss per share $ (0.32) $ (0.24)
============== ==============
</TABLE>
<PAGE>
NEUROMEDICAL SYSTEMS, INC.
COMPUTATION OF FULLY DILUTED EARNINGS PER SHARE
<TABLE>
<CAPTION>
Three Months Ended March 31,
---------------------------------------
1997 1996
------------------- -------------------
<S> <C> <C>
Weighted average number of common shares outstanding 30,825,319 28,808,485
Assumed exercise of stock options and warrants using
the treasury stock method (1) 2,778,917 3,849,787
-------------- --------------
Weighted average number of common and common
equivalent shares outstanding 33,604,236 32,658,272
============== ==============
Net loss for period $ (9,725,000) $ (6,847,000)
-------------- --------------
Net loss per share $ (0.29) $ (0.21)
============== ==============
</TABLE>
(1) For purposes of calculating the number of shares issuable upon exercise of
outstanding stock options and warrants, daily average closing stock price of
$10.13 was used for 1997, and the closing stock price of $20.75 was used for
1996.
