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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 June 30, 1998
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.
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
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(Address of Principal Executive Offices)
Registrant's telephone number including area code: (914) 368-3600
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(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 ______
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As of August 7, 1998, an aggregate of 31,055,846 shares of the Registrant's
common stock, par value $.0001 per share, were outstanding.
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NEUROMEDICAL SYSTEMS, INC.
Table of Contents
Form 10-Q for the Quarterly Period Ended June 30, 1998
<TABLE>
<CAPTION>
PART I FINANCIAL INFORMATION PAGE
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Item 1. Financial Statements
Condensed Consolidated Balance Sheets at
June 30, 1998 (unaudited) and December 31, 1997 3
Condensed Consolidated Statements of Operations for the
three months and six months ended June 30, 1998 and 1997
(unaudited) 4
Condensed Consolidated Statements of Cash Flows for the
six months ended June 30, 1998 and 1997 (unaudited) 5
Notes to Condensed Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 9
Item 3. Quantitative and Qualitative Disclosures About Market Risk 16
PART II OTHER INFORMATION
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Item 1. Legal Proceedings 17
Item 2. Changes in Securities 17
Item 3. Defaults upon Senior Securities 17
Item 4. Submission of Matters to a Vote 18
of Security Holders
Item 5. Other Information 19
Item 6. Exhibits and Reports on Form 8-K 19
Safe Harbor Statement 20
Signature 21
</TABLE>
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Neuromedical Systems, Inc. and Subsidiaries
CONDENSED CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
June 30, December 31,
1998 1997
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(unaudited)
Assets
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 8,568,000 $ 15,842,000
Short-term investments 19,878,000 30,094,000
Accounts receivable, net of allowance 1,908,000 2,119,000
Inventories 3,002,000 2,942,000
Prepaid and other current assets 1,398,000 1,142,000
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Total current assets 34,754,000 52,139,000
Restricted cash 1,449,000 638,000
Property and equipment, net 10,354,000 12,092,000
Intangible assets, net of accumulated amortization
(1998-$838,000, 1997-$753,000) 707,000 817,000
Note receivable from employee 600,000 600,000
Other assets 105,000 58,000
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$ 47,969,000 $ 66,344,000
==================== =====================
Liabilities and Stockholders' Equity
Current liabilities:
Current portion of notes and bank loans payable $ 1,819,000 $ 2,705,000
Current portion of capital lease obligations 2,153,000 2,424,000
Accounts payable 1,460,000 1,149,000
Accrued liabilities 4,548,000 4,247,000
-------------------- ---------------------
Total current liabilities 9,980,000 10,525,000
Notes and bank loans payable, long-term 2,857,000 3,762,000
Capital lease obligations, less current portion 3,728,000 4,583,000
Commitments and contingencies
Stockholders' equity:
Preferred stock, $.0001 par value; authorized -
10,000,000 shares; none issued and outstanding --- ---
Common stock, $.0001 par value; authorized-
100,000,000 shares; issued and outstanding - 31,055,846
shares in 1998 and 31,049,510 shares in 1997 3,000 3,000
Additional paid-in capital 178,821,000 178,801,000
Note receivable from officer (146,000) ---
Deferred compensation (293,000) (576,000)
Accumulated deficit (147,079,000) (131,089,000)
Accumulated other comprehensive income -
foreign currency translation 98,000 335,000
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Total stockholders' equity 31,404,000 47,474,000
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$ 47,969,000 $ 66,344,000
==================== =====================
</TABLE>
See accompanying notes.
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Neuromedical Systems, Inc. and Subsidiaries
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended June 30, Six Months Ended June 30,
-------------------------------- ------------------------------
1998 1997 1998 1997
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<S> <C> <C> <C> <C>
Revenues $ 2,122,000 $ 2,230,000 $ 4,696,000 $ 3,881,000
-------------- -------------- ------------- --------------
Costs and Expenses:
Cost of sales 3,285,000 2,659,000 6,405,000 5,252,000
Sales and marketing 2,264,000 4,833,000 4,411,000 10,311,000
Research and development 2,211,000 2,041,000 4,524,000 3,989,000
General and administrative 2,921,000 2,058,000 5,671,000 3,998,000
-------------- -------------- ------------- --------------
Total costs and expenses 10,681,000 11,591,000 21,011,000 23,550,000
-------------- -------------- ------------- --------------
Loss from operations (8,559,000) (9,361,000) (16,315,000) (19,669,000)
Other income (expense):
Interest income 466,000 996,000 1,013,000 1,997,000
Interest expense (316,000) (411,000) (687,000) (800,000)
Foreign exchange 76,000 7,000 (1,000) (22,000)
-------------- -------------- ------------- --------------
Other income (expense) - net 226,000 592,000 325,000 1,175,000
-------------- -------------- ------------- --------------
Net loss $ (8,333,000) $ (8,769,000) $ (15,990,000) $ (18,494,000)
============== ============== ============= ==============
Basic and diluted net loss per share $ (0.27) $ (0.28) $ (0.52) $ (0.60)
============== ============== ============= ==============
Weighted average shares outstanding 31,056,000 30,916,000 31,055,000 30,871,000
============== ============== ============= ==============
</TABLE>
See accompanying notes.
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Neuromedical Systems, Inc. and Subsidiaries
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
<TABLE>
<CAPTION>
Six Months Ended June 30,
1998 1997
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Operating Activities
Net Loss $(15,990,000) $(18,494,000)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization 2,319,000 2,380,000
Non cash compensation related to issuance of
common stock warrants and options 303,000 12,000
Foreign exchange loss (gain) 90,000 (8,000)
Changes in operating assets and liabilities:
Decrease (increase) in accounts receivable 211,000 (250,000)
Increase in inventory (60,000) --
(Increase) decrease in prepaid expenses
and other assets (303,000) 320,000
Increase (decrease) in accounts payable 311,000 (725,000)
Increase (decrease) increase in accrued liabilities 301,000 (536,000)
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Net cash used in operating activities (12,818,000) (17,301,000)
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Investing Activities
Purchases of short-term investments (39,876,000) (30,182,000)
Proceeds from maturing short-term investments 50,092,000 --
Purchases of property and equipment (491,000) (2,942,000)
Acquisition of a business -- (1,564,000)
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Net cash provided by (used in) investing activities 9,725,000 (34,688,000)
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Financing Activities
Restricted cash (811,000) 181,000
Issuance of stock pursuant to exercise of options -- 176,000
Proceeds from notes and bank loans -- 456,000
Proceeds from capital lease financing -- 1,619,000
Note receivable from officer (146,000) --
Payments of notes and bank loans (1,792,000) (758,000)
Payments on capital leases (1,162,000) (1,132,000)
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Net cash (used in) provided by financing activities (3,911,000) 542,000
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Effect of exchange rate changes on cash (270,000) 6,000
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Net (decrease) in cash and cash equivalents (7,274,000) (51,441,000)
Cash and cash equivalents, beginning of period 15,842,000 83,391,000
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Cash and cash equivalents, end of period $ 8,568,000 $ 31,950,000
============ ============
</TABLE>
See accompanying notes.
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Neuromedical Systems, Inc. and Subsidiaries
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1998
(Unaudited)
NOTE 1. BASIS FOR CONSOLIDATION
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
the fair presentation have been included. These condensed consolidated
financial statements and footnotes thereto are included in the Neuromedical
Systems, Inc. (the "Company" or "NSI") Annual Report on Form 10-K for the year
ended December 31, 1997 (the "1997 Form 10-K"). Operating results for the
interim periods ended June 30, 1998 are not necessarily indicative of the
results that may be expected for the year ended December 31, 1998.
NOTE 2. RELATED PARTY TRANSACTION
The Company has entered into two agreements, effective as of the first quarter
1998, to provide facilities and engineering services to OralScan(TM)
Laboratories, Inc. ("OralScan"). The President of OralScan is Mark R.
Rutenberg, a non-executive employee and member of the Board of Directors of the
Company, and the former Chief Executive Officer of the Company. The Company
believes that the terms and consideration for such agreements are at fair market
value and are commercially reasonable. The Company believes that individually
and in the aggregate, such agreements are not material to the operation of the
Company's business, financial position or cash flows.
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NOTE 3. INVENTORIES
Inventories are stated at the lower of cost or market, using the first in first
out method and consist of the following major classes as of June 30, 1998 and
December 31, 1997, respectively:
June 30, December 31,
1998 1997
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Raw materials $ 1,084,000 $ 1,124,000
Work in Progress - 202,000
Finished goods 1,918,000 1,616,000
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$ 3,002,000 $ 2,942,000
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NOTE 4. COMPREHENSIVE INCOME (LOSS)
As of January 1, 1998, the Company adopted Statement 130, Reporting
Comprehensive Income. Statement 130 establishes new rules for the reporting and
display of comprehensive income and its components; however, the adoption of
this Statement had no impact on the Company's net loss or stockholders' equity.
Statement 130 requires unrealized gains or losses on the Company's foreign
exchange translation adjustments, which prior to the adoption were reported
separately in stockholders' equity to be included in other comprehensive income.
Prior year financial statements have been reclassified to conform to the
requirements of Statement 130.
During the second quarter ended June 30, 1998 and 1997 total comprehensive loss
amounted to $8,581,000 and $8,840,000, respectively. During the six months
ended June 30, 1998 and 1997 total comprehensive loss amounted to $16,227,000
and $18,585,000, respectively.
The components of comprehensive loss for the three month periods and six month
periods ended June 30, 1998 and 1997 are as follows:
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<PAGE>
Neuromedial System, Inc. and Subsidiaries
NOTES TO CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS (Unaudited) -- (Continued)
<TABLE>
<CAPTION>
Three Months ended June 30 Six Months ended June 30
1998 1997 1998 1997
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<S> <C> <C> <C> <C>
Net Loss $(8,333,000) $(8,769,000) $(15,990,000) $(18,494,000)
Foreign currency translation
adjustment (248,000) (71,000) (237,000) (91,000)
--------------- ----------------- ------------------- ------------------
Comprehensive loss $(8,581,000) $(8,840,000) $(16,227,000) $(18,585,000)
================= ================== ==================== ===================
</TABLE>
The components of accumulated other comprehensive income at June 30, 1998 and
December 31, 1997 are as follows:
<TABLE>
<CAPTION>
1998 1997
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<S> <C> <C>
Foreign currency translation adjustment and
accumulated other comprehensive income $ 98,000 $ 335,000
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</TABLE>
NOTE 5. SUBSEQUENT EVENT
In July 1998, the Company announced a restructuring of its United States
business unit and some related corporate functions. The restructuring includes
a reduction in the workforce of approximately 30 employees, and a planned
consolidation of the Company's United States facilities into one location. The
restructuring will result in a charge to operations of approximately $3,500,000,
including a write down of impaired assets of approximately $1,700,000.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
OVERVIEW
Neuromedical Systems, Inc., a Delaware corporation (the "Company"), is a
healthcare technology company focused on bringing intelligent vision to
medicine. It is the Company's objective to become the premier supplier of
cytology screening and anatomic pathology diagnostic equipment and services to
laboratories. The Company's first, and to date, only product, the PapNet
Testing System, which has been reintroduced in Europe under the brand name
PAPNET-on-CyteTM , is a sophisticated interactive system that assists the
laboratory professional in the detection of abnormal cells on cervical cytology
specimens (also known as Pap smears). Since its inception, the Company has been
primarily engaged in the development, manufacturing and marketing of the PapNet
Testing System, and the scanning of Pap smears at its slide processing
facilities. The Company's revenues are currently being derived from sales of
PapNet testing services, sales of PapNet Testing Systems under the PAPNET-on-
CyteTM trade name, laboratory services and interest income.
In the United States, the PapNet Testing System is promoted to assist the
cytology professional in the examination of conventionally prepared smears that
have first been assessed by standard manual microscopy to be "negative", "within
normal limits", or evidencing "benign cellular changes." Outside of the United
States, some of the Company's customers use the PapNet Testing System in a
variety of different modes, including to assist in the interpretation of liquid-
based cervical specimens and Pap smears that have not first been assessed by
manual microscopic review.
The PapNet system may be purchased or leased by the customer in its
entirety or individual components, or accessed on a patient by patient basis.
The PapNet 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 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. However, during that time the Company was selling PapNet testing
services for commercial use outside of the United States. The Company
established three scanning facilities (the "Scanning Centers"), one each in the
United States, The Netherlands and Hong Kong. The Netherlands Scanning Center
scanned slides primarily from customers in Europe while the Hong Kong Scanning
Center has scanned slides from Asia and Australia. During the third quarter of
1997, the Company announced a strategic shift in its European business approach
from being a supplier of scanning services via a centralized scanning center to
selling and leasing the PapNet Testing System equipment to customers under the
PAPNET-on-Cyte trade name. During the fourth quarter of 1997 the Company placed
the first PAPNET-on-Cyte system at a customer. During the six months ended June
30, 1998 the
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Company placed five PAPNET-on-Cyte systems under sales arrangements and placed
five PAPNET-on-Cyte systems under lease arrangements and in support of a
clinical study. The Company closed its Netherlands Scanning Center during the
second quarter ended June 30, 1998 and intends to lease or sell that center's
PapNet Systems to customers. The charge to operations resulting from closure of
the Netherlands Scanning Center was immaterial.
In the United States, the Company continued laying the groundwork for a
similar transition. However, due to differences in the laboratory marketplace,
reimbursement practice and the regulatory requirements, the Company expects this
transition will extend until at least the end of 1999.
In addition to slide scanning services, the Company's Asia Pacific
operations provide PapNet-assisted screening for customers in Hong Kong, China
and Taiwan through the Company's laboratory business, New System International,
Ltd.
The Company has incurred net losses since inception through June 30, 1998
of $147,079,000 and has to date generated only limited commercial revenues.
Management believes that its existing cash resources will be sufficient to fund
operations and to meet its cash requirements through at least the next twelve
months, although there can be no assurance in this regard. The Company's past
results of operations reflect its early commercial stage and are not necessarily
indicative of the results from operations that may be expected in the future.
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 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 1997 Form 10-K and Exhibit 99.1.
RESULTS OF OPERATIONS
The Company's results of operations have resulted in substantial losses
which have fluctuated from year to year and quarter to quarter, principally due
to the level of expenditures relating to its marketing and sales programs,
clinical trials, research projects and international expansion. The Company's
results of operations are expected to continue to result in substantial losses
for the foreseeable future.
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The Company believes that significant revenue growth during 1998 is
dependent on the success of the strategic shift of its European business
strategy to sell PAPNET-on-Cyte systems directly to customers. The Company does
not expect significant revenue growth in the United States until it obtains FDA
approval for use of the PapNet Testing System as an interactive primary screener
of conventional and liquid-based Pap smear specimens and there is commercial
acceptance for such use.
From inception through June 30, 1998, the Company has experienced negative
gross margins due to the significant underutilization of its scanning and
manufacturing operations. Improvement in the Company's future gross margins
will be dependent upon the level of commercial acceptance of the PapNet Testing
System, and, in particular, during 1998, the degree of success of PAPNET-on-Cyte
sales and leases in Europe.
The Company's costs and expenses decreased during the six months ended June
30, 1998 compared to the six months ended June 30, 1997. The Company
anticipates that aggregate costs and expenses will decrease in 1998 compared to
1997, following the Company's decision to focus sales and marketing efforts on
laboratory customers and opinion leading clinicians, sell equipment in Europe
and consolidate product development in the United States. However, the Company
does not expect total costs and expenses to decrease significantly in 1998
because of the expected increased costs of clinical studies for a primary
screening indication in the United States, a full year of cost associated with
the Company's Asia/Pacific operations versus a partial year of cost in 1997
associated with two mid year acquisitions, uncertainty over the level of costs
associated with ongoing litigation, and higher royalty payments in sales
territories of the Company's territorial licensees ("Licensees") that will
increase proportionate to increases in the Company's revenues in those
territories.
Interest expense is expected to decrease in 1998, compared to 1997, due to
the scheduled repayment of existing debt. Interest income from the Company's
investment of excess funds is expected to offset interest expense in 1998. The
Company expects that interest income will decrease in 1998, compared to 1997, as
a result of the Company's continuing losses in 1997 and through the period ended
June 30,1998.
RESULTS FOR THE SECOND QUARTER ENDED JUNE 30, 1998.
Revenues for the second quarter ended June 30, 1998 were $2,122,000, a
decrease of $108,000 from $2,230,000 during the second quarter ended June 30,
1997. Revenue from European operations increased to $668,000 during the second
quarter ended June 30, 1998 compared to $349,000 in the second quarter ended
June 30,1997. The increase was due primarily to the Company's continued
implementation of its business strategy in Europe of selling and leasing PAPNET-
on-Cyte systems directly to customers. Revenues from United States operations
decreased to $779,000 in the second quarter ended June 30, 1998 compared to
$1,382,000 in the second quarter ended June 30, 1997. The decrease reflected a
number of factors which included reduced slide processing volume, the
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continued challenge surrounding reimbursement for new Pap smear technologies and
a reduction in U.S. marketing and sales expense from $3,534,000 in the second
quarter 1997 to $1,217,000 in the second quarter 1998. Revenues from
Asia/Pacific operations increased to $675,000 in the second quarter ended June
30, 1998 compared to $499,000 in the second quarter ended June 30, 1997. The
increase primarily reflected the acquisition of a laboratory business in June
1997.
Total costs and expenses for the second quarter ended June 30, 1998 were
$10,681,000 compared to $11,591,000 for the quarter ended June 30, 1997, a
decrease of $910,000 or 8%. The decrease was primarily due to decreased sales
and marketing expense offset by increases in general and administrative expense,
cost of sales and research and development expense.
Cost of sales expense increased to $3,285,000 during the quarter ended June
30, 1998, compared to $2,659,000 during the quarter ended June 30, 1997, an
increase of $626,000. The increase primarily reflected costs associated with
the cost of sales of PAPNET-on-Cyte systems, an inventory write-down as the
Company transitions to selling equipment and costs associated with the acquired
laboratory business in Hong Kong in June 1997.
Sales and marketing expense decreased to $2,264,000 during the quarter
ended June 30, 1998, compared to $4,833,000 during the quarter ended June 30,
1997, a decrease of $2,569,000 or 53%. The decrease was due primarily to a
reduction of sales and marketing expenses in the United States and Australia as
a result of the Company's decision to suspend consumer advertising and instead
channel communications through laboratories which was offset by higher marketing
and sales expenses associated with acquired operations in the Asia/Pacific
region in June of 1997 and in August of 1997.
Research and development expense increased to $2,211,000 during the quarter
ended June 30,1998, compared to $2,041,000 during the quarter ended June
30,1997, an increase of $170,000. The increase in research and development
expense was due primarily to costs associated with preparation for clinical
studies for an interactive primary screening indication in the United States and
costs associated with consolidation of product development operations from
Israel to the United States.
General and administrative expense increased to $2,921,000 during the
second quarter ended June 30,1998, compared to $2,058,000 during the second
quarter ended June 30, 1997, an increase of $863,000. The increase in general
and administrative expense was due to costs associated with the revised
employment agreement of the former CEO, increased costs in Europe to support
operations and costs associated with the acquired laboratory business in Hong
Kong in June 1997.
Interest income decreased to $466,000 for the second quarter ended June 30,
1998, compared to $996,000 for the second quarter ended June 30, 1997, a
decrease of $530,000. The decrease reflected the lower level of cash, cash
equivalents and short-term
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<PAGE>
investments available to the Company during the second quarter of 1998 as a
result of the Company's continuing losses in 1997 and through the period ended
June 30, 1998.
Interest expense decreased to $316,000 for the second quarter ended June
30, 1998, compared to $411,000 for the second quarter ended June 30, 1997, a
decrease of $95,000.
The Company incurred a net loss during the second quarter ended June 30,
1998 of $8,333,000, or $0.27 per share, compared to a net loss of $8,769,000, or
$0.28 per share during the second quarter ended June 30, 1997. The decreased
net loss was due to the factors discussed above.
RESULTS FOR THE SIX MONTH PERIOD ENDED JUNE 30, 1998 AND 1997.
Revenues for the six months ended June 30, 1998 were $4,696,000, an
increase of $815,000 or 21% from $3,881,000 during the six months ended June 30,
1997. Revenue from European operations increased to $1,725,000 during the six
months ended June 30, 1998 compared to $630,000 in the six months ended June
30,1997. The increase was due to the Company's continued implementation of it's
business strategy in Europe of selling and leasing PAPNET-on-Cyte systems
directly to customers. Revenues from United States operations decreased to
$1,670,000 in the six months ended June 30, 1998 compared to $2,373,000 in the
six months ended June 30, 1997. The decrease reflected a number of factors which
included reduced slide processing volume, the continued challenge surrounding
reimbursement for new Pap smear technologies and a reduction in U.S. marketing
and sales expense from $8,233,000 in the six months ended June 30, 1997 to
$2,472,000 in the in the six months ended June 30, 1998. Revenues from
Asia/Pacific operations increased to $1,301,000 in the six months ended June 30,
1998 compared to $878,000 in the six months ended June 30, 1997. The increase
primarily reflected the acquisition of a laboratory business in Hong Kong in
June 1997.
Total costs and expenses for the six months ended June 30, 1998 were
$21,011,000 compared to $23,550,000 for the six months ended June 30, 1997, a
decrease of $2,539,000 or 11%. The decrease was primarily due to decreased
sales and marketing expenses offset by increases in general and administrative
expense, cost of sales and research and development expense.
Cost of sales expense increased to $6,405,000 during the six months ended
June 30, 1998, compared to $5,252,000 during the six months ended June 30, 1997,
an increase of $1,153,000. The increase primarily reflected costs associated
with the cost of sales of PAPNET-on-Cyte systems, an inventory write-down as the
Company transitions to selling equipment and costs associated with the acquired
laboratory business in Hong Kong in June 1997.
Sales and marketing expense decreased to $4,411,000 during the six months
ended June 30, 1998, compared to $10,311,000 during the six months ended June
30,
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1997, a decrease of $5,900,000. The decrease was due primarily to a reduction of
sales and marketing expenses in the United States and Australia as a result of
the Company's decision to suspend consumer advertising and instead channel
communications through laboratories which was offset by higher marketing and
sales expenses associated with acquired operations in the Asia/Pacific region in
June of 1997 and Taiwan in August of 1997 and increased costs in Europe to
support implementation of the Company's business strategy.
Research and development expense increased to $4,524,000 during the six
months ended June 30,1998, compared to $3,989,000 during the six months ended
June 30,1997, an increase of $535,000. The increase in research and development
expense was due primarily to costs associated with preparation for clinical
studies for an interactive primary screening indication in the United States and
costs associated with consolidation of product development operations from
Israel to the United States.
General and administrative expense increased to $5,671,000 during the six
months ended June 30,1998, compared to $3,998,000 during the six months ended
June 30, 1997, an increase of $1,673,000. The increase in general and
administrative expense was due to costs associated with the revised employment
agreement of the former CEO, costs associated with management changes, increased
costs in Europe to support operations and costs associated with the acquired
laboratory business in Hong Kong in June 1997.
Interest income decreased to $1,013,000 for the six months ended June 30,
1998, compared to $1,997,000 for the six months ended June 30, 1997, a decrease
of $984,000. The decrease reflected the lower level of cash, cash equivalents
and short-term investments available to the Company during the six months ended
June 30, 1998 as a result of the Company's continuing losses in 1997 and the six
months ended June 30, 1998.
Interest expense decreased to $687,000 for the six months ended June 30,
1998, compared to $800,000 for the six months ended June 30, 1997, a decrease of
$113,000.
The Company incurred a net loss during the six months ended June 30, 1998
of $15,990,000, or $0.52 per share, compared to a net loss of $18,494,000, or
$0.60 per share during the six months ended June 30, 1997. The decreased net
loss was due to the factors discussed above.
LIQUIDITY AND CAPITAL RESOURCES
The Company has financed its operations since its inception primarily
through the issuance of equity securities; sales of PapNet Testing System
services; sales of PAPNET-on-Cyte systems; 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 agreements.
-14-
<PAGE>
The Company's combined cash, cash equivalents and short-term investments
totaled $28,446,000 at June 30, 1998, a decrease of $17,490,000 from December
31, 1997. During the first six months of 1998, the Company used $12,818,000 for
operating activities; $491,000 for investing activities (excluding net proceeds
of $10,216,000 from the sale of short-term investments); and $3,911,000 for
financing activities.
The primary use of cash for operating activities during the six months
ended June 30, 1998 was the net loss of $15,990,000, inclusive of non cash items
totaling $2,712,000, offset by increased working capital of $460,000.
The primary uses of cash for financing activities were payment of $811,000
of restricted cash related to a capital lease covenant, payment of $600,000
under a note payable to a stockholder, $1,192,000 of payments under bank and
equipment loans, a loan of $146,000 to the President and Chief Executive Officer
secured by 70,000 shares of the Company's common stock and $1,162,000 of
payments under capital lease obligations.
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 be substantial in 1998 due to the cost of marketing and sales
in both the United States and internationally, the expansion of research and
development programs for potential additional clinical indications and claims,
potential additional products, and the cost of ongoing litigation. The Company
currently anticipates that during 1998 it will invest approximately $1.0 million
for working capital purposes and approximately $1.1 million for capital
expenditures and 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 such capital expenditures through additional debt or capital
lease obligations. There can be no assurance, however, that such financing can
be obtained or, if obtained, that the terms thereof will be reasonable.
During 1995, 1996 and 1997, the Company entered into a number of equipment
loan and capital lease agreements with financing companies to provide the
Company with lines of credit to finance certain of the Company's equipment
purchases. Certain of these loan and lease lines of credit commitments expired
on December 31, 1997. Under the terms of certain of these loan agreements, the
loans are secured by a first priority interest in the financed equipment. These
loan and lease agreements require that the Company maintain certain financial
covenants throughout the duration of the repayment period. During the six
months ended June 30, 1998 the Company, under certain of these financial
covenants, provided a letter of credit and restricted cash of $811,000.
Additionally, during 1998 the Company anticipates that it will be required,
under certain of these financial covenants, to provide additional letters of
credit or restricted cash estimated to be approximately $2,900,000.
-15-
<PAGE>
The Company anticipates that its current cash, cash equivalents and short-
term investments will be sufficient to enable it to meet its future operating
requirements through at least the next twelve months, although there can be no
assurance in this regard. The Company does not expect to generate a positive
cash flow in the foreseeable future due to continued working capital
requirements and capital expenditures, repayment of debt and capital lease
obligations and ongoing losses from operations. The Company may need to arrange
additional equity or debt financing for future operation of its business. Given
the Company's current operating losses, uncertainty relating to the outcome of
its primary screening trial and its lawsuits with competitors, there can be no
assurance that such financing can be obtained or, if it is obtained, that the
terms thereof will not be at high rates of interest, contain burdensome terms or
will not result in substantial dilution to stockholders. The Company invests
excess funds in short-term instruments, including money market funds.
To date, the Company has not implemented a program to hedge its foreign
currency risk, but may do so in the future.
During July 1998, the Company announced a restructuring of its United
States business unit and some related corporate functions. These changes will
allow the Company to more efficiently service its customers and continue to
implement strategies developed to support its laboratory oriented business plan.
The restructuring is predicated on the Company's goals of being more responsive
to its marketplace and of becoming a platform for laboratory diagnosis. The
restructuring includes a reduction in the United States based workforce of
approximately 30 employees and a planned consolidation of the Company's United
States based facilities into one location. The restructuring will result in
charges of approximately $3,500,000, including a write-down of impaired assets
of approximately $1,700,000.
As previously disclosed in the Company's Annual Report on Form 10-K, the
Company believes that it has identified the necessary steps to avoid disruption
from inaccurate processing of date related information by its computer systems
after December 31, 1999 (often referred to as the "Year 2000 Issue"). However,
the Company cannot assure that these steps will be sufficient to avoid any
adverse effects from the Year 2000 Issue.
The Company is involved in several lawsuits. See "Legal Proceedings" under
Item I of Part II herein for a complete discussion of the legal proceedings in
which the Company is involved, which discussion is incorporated herein by
reference thereto.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Not applicable.
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<PAGE>
PART II OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
On July 15, 1996, the Company filed a lawsuit against NeoPath Inc., 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) 300 QC System.
NeoPath has denied all allegations and, in addition, it filed a counterclaim
against the Company seeking declaration that NSI's patents are invalid and other
counterclaims relating to false advertising and unfair competition. The Company
believes that NeoPath's assertions are without merit. In the second half of
1997, the Company filed, briefed and argued a motion for a preliminary
injunction against further manufacture of the AutoPap(R) 300 QC System. That
motion was denied in May 1998. In July 1998, the court permitted NSI to amend
its complaint to assert that Neopath's primary screening device infringes NSI's
patents. The court has set a deadline of October 30, 1998 to complete discovery.
In July 1998, the parties agreed to drop all non-patent claims and non-patent
counterclaims from the lawsuit. 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 1998.
ITEM 2. CHANGES IN SECURITIES.
Not Applicable.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.
Not applicable.
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<PAGE>
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
At the Annual Meeting of Stockholders of the Company, held on May 7, 1998,
the following matters were submitted to a vote of the holders of the Company's
common stock, $.0001 par value per share:
1. For the following persons to serve as directors of the Company until
the year 2001 Annual Meeting of Stockholders and until their respective
successors are duly elected and qualified:
For Election Withheld Total
Mark R. Rutenberg 24,671,186 201,151 24,872,337
Elizabeth Cogan Fascitelli 24,660,936 211,401 24,872,337
No broker non-votes were submitted in the election balloting for the
foregoing directors.
2. To ratify the appointment of Ernst & Young LLP by the Board of
Directors as independent public accountants to audit the books and records of
the Company for the fiscal year ending December 31, 1998:
For the Against the
Resolution Resolution Abstaining Total Votes
24,820,083 29,939 22,315 24,872,337
In addition to the foregoing directors duly elected at the Annual
Meeting of Stockholders, the following directors are continuing in their
capacity as directors of the Company for their respective terms of office: Carl
Genberg, Arthur L. Herbst, M.D., Uzi Ish-Hurwitz, C. Raymond Larkin, Jr., Paul
R. Sohmer, M.D. and Stuart M. Essig.
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<PAGE>
ITEM 5. OTHER INFORMATION.
In July 1998, the Company commenced a prospective multi-center PapNet-
assisted primary screening trial in the U.S., designed to include conventional
and liquid-based preparations, as well as high-risk patients. The Company
expects the data collection to take approximately six months for each of the
conventional smear track and liquid-based preparation track. The Company
anticipates approval from the FDA for both tracks by the end of 1999, however,
there can be no assurance in this regard.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits.
Number Exhibit
----------- -------
10.47 Schedule Addendum to Exhibit 10.33
27.1 Financial Data Schedule
(b) Reports on Form 8-K during the quarter for which this report is filed:
Date Subject of Report
----------- -----------------
May 6, 1998 First Quarter 1998 Financial Results
June 22, 1998 Refiling of Exhibits 10.30 and 10.31.
July 8, 1998 US Business Unit Restructuring
-19-
<PAGE>
SAFE HARBOR STATEMENT
Statements in this Quarterly Report of the Company on Form 10-Q 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
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 1997 Form 10-K and
Exhibit 99.1.
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<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: August 12, 1998 By: /s/ Mark L. Smith
---------------------------------
Mark L. Smith
Vice President, Finance and
Administration, Chief Financial
Officer
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<PAGE>
Exhibit 10.47
-------------
SCHEDULE ADDENDUM
Pursuant to the General Instructions to Item 601 of Regulation SK of the
Securities Act of 1933, as amended, the Company's Executive Employment
Agreements (the, "Executive Agreements") entered into by certain of the
Company's executive employees, the form of which is substantially identical as
to each such executive in all material respects, except as to the parties
thereto, executive position, compensation, and certain additional terms, the
Company has filed only one copy of such document (the "Form of Executive
Agreement"), with an attached schedule identifying the material details in which
such documents differ from the form. The Form of Executive Agreement was filed
with the Commission as Exhibit 10.33 to the Company's Form 10-Q for the
quarterly period ended September 30, 1997 and is herein incorporated by
reference thereto.
The Schedule to Exhibit 10.33 is hereby updated with respect to the following
employees who have entered into Executive Agreements with the Company:
<TABLE>
<CAPTION>
Employee,
Executive Position and
Annual Compensation Additional Terms
- ------------------------------------ -------------------------------------------------------
<S> <C>
Mark L. Smith Reimbursement of Relocation Expenses
Vice President, Finance and
Administration, Chief Financial
Officer, $151,000
Elise A. Ecanow
Vice President, General Counsel and
Secretary, $150,000
Moti Greisas One time bonus of 25% of base salary after first year;
Vice President Israel Operations of Grant of 20,000 stock options;
NSI, and General Manager of NSI Additional and substitute Company benefits provided in
Israel, Ltd., $125,000 Israel: Managers Insurance, Sick Leave and Disability
Insurance, Keren Hishtalmut Fund, Telephone
Reimbursement, Company Car, Contribution Adjustments.
Non-Duplication of Benefits provisions
</TABLE>
1
<PAGE>
<TABLE>
<S> <C>
Uri Avni One time bonus of 25% of base salary after first year;
Vice President Manufacturing and Grant of 20,000 stock options;
Field Operations of NSI, Vice Additional and substitute Company benefits provided in
President Manufacturing NSI Israel: Managers Insurance, Sick Leave and Disability
Israel, Ltd., $125,000 Insurance, Keren Hishtalmut Fund, Telephone
Reimbursement, Company Car, Contribution Adjustments.
Non-Duplication of Benefits provisions
</TABLE>
2
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM FORM 10-Q
FOR THE PERIOD ENDING JUNE 30, 1998 AND IS QUALIFIED IN ITS ENTIRETY BY
REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> APR-01-1998
<PERIOD-END> JUN-30-1998
<CASH> 28,446
<SECURITIES> 0
<RECEIVABLES> 2,258
<ALLOWANCES> (350)
<INVENTORY> 3,002
<CURRENT-ASSETS> 34,754
<PP&E> 26,874
<DEPRECIATION> (16,520)
<TOTAL-ASSETS> 47,969
<CURRENT-LIABILITIES> 9,980
<BONDS> 6,585
0
0
<COMMON> 3
<OTHER-SE> 31,401
<TOTAL-LIABILITY-AND-EQUITY> 47,969
<SALES> 0
<TOTAL-REVENUES> 4,696
<CGS> 0
<TOTAL-COSTS> 6,405
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 687
<INCOME-PRETAX> (15,990)
<INCOME-TAX> 0
<INCOME-CONTINUING> (15,990)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (15,990)
<EPS-PRIMARY> (0.52)
<EPS-DILUTED> (0.52)
</TABLE>
