<PAGE>
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 September 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.
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(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.)
10 Mountainview Road
Suite C-100
Upper Saddle River, NJ 07458-1933
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(Address of Principal Executive Offices)
Registrant's telephone number including area code: (201) 934-0660
-------------
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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 November 6, 1998, an aggregate of 31,055,846 shares of the Registrant's
common stock, par value $.0001 per share, were outstanding.
<PAGE>
NEUROMEDICAL SYSTEMS, INC.
Table of Contents
Form 10-Q for the Quarterly Period Ended September 30, 1998
PART I FINANCIAL INFORMATION PAGE
- ------ --------------------- ----
Item 1. Financial Statements
Condensed Consolidated Balance Sheets at
September 30, 1998 (unaudited) and December 31, 1997 3
Condensed Consolidated Statements of Operations for the
three months and nine months ended September 30, 1998
and 1997 (unaudited) 4
Condensed Consolidated Statements of Cash Flows for the
nine months ended September 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 10
Item 3. Quantitative and Qualitative Disclosures About Market Risk 19
PART II OTHER INFORMATION
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Item 1. Legal Proceedings 19
Item 2. Changes in Securities 20
Item 3. Defaults upon Senior Securities 20
Item 4. Submission of Matters to a Vote
of Security Holders 20
Item 5. Other Information 20
Item 6. Exhibits and Reports on Form 8-K 20
Signature 21
<PAGE>
Neuromedical Systems, Inc. and Subsidiaries
CONDENSED CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
September 30, December 31,
1998 1997
------------------------ ------------------------
(unaudited)
Assets
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 10,098,000 $ 15,842,000
Short-term investments 10,121,000 30,094,000
Accounts receivable, net of allowance 2,196,000 2,119,000
Inventories 3,859,000 2,942,000
Prepaid and other current assets 1,570,000 1,142,000
------------------------ ------------------------
Total current assets 27,844,000 52,139,000
Restricted cash 1,449,000 638,000
Property and equipment, net 7,594,000 12,092,000
Intangible assets, net of accumulated amortization
(1998-$883,000, 1997-$753,000) 662,000 817,000
Note receivable from employee 600,000 600,000
Other assets 360,000 58,000
------------------------ ------------------------
$ 38,509,000 $ 66,344,000
======================== ========================
Liabilities and Stockholders' Equity
Current liabilities:
Current portion of notes and bank loans payable $ 1,756,000 $ 2,705,000
Current portion of capital lease obligations 2,223,000 2,424,000
Accounts payable 1,665,000 1,149,000
Accrued liabilities 6,185,000 4,247,000
------------------------ ------------------------
Total current liabilities 11,829,000 10,525,000
Notes and bank loans payable, long-term 2,538,000 3,762,000
Capital lease obligations, less current portion 3,134,000 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 - 31,055,521
shares in 1998 and 31,049,510 shares in 1997 3,000 3,000
Additional paid-in capital 178,901,000 178,801,000
Note receivable from officer (146,000) -
Deferred compensation (220,000) (576,000)
Accumulated deficit (157,943,000) (131,089,000)
Accumulated other comprehensive income -
foreign currency translation 413,000 335,000
------------------------ ------------------------
Total stockholders' equity 21,008,000 47,474,000
------------------------ ------------------------
$ 38,509,000 $ 66,344,000
======================== ========================
</TABLE>
See accompanying notes.
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<PAGE>
Neuromedical Systems, Inc. and Subsidiaries
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
(Unaudited)
Three Months Ended September 30, Nine Months Ended September 30,
--------------------------------- -------------------------------
1998 1997 1998 1997
-------------- ------------- ------------- --------------
<S> <C> <C> <C> <C>
Revenues: $ 1,766,000 $ 2,526,000 $ 6,462,000 $ 6,407,000
-------------- ------------- ------------- --------------
Costs and Expenses:
Cost of sales 2,517,000 3,138,000 8,922,000 8,390,000
Sales and marketing 1,822,000 3,962,000 6,233,000 14,273,000
Research and development 2,251,000 2,207,000 6,775,000 6,196,000
General and administrative 2,667,000 2,817,000 8,338,000 6,815,000
Restructuring and other costs 3,404,000 - 3,404,000 -
-------------- ------------- ------------- --------------
Total costs and expenses 12,661,000 12,124,000 33,672,000 35,674,000
------------- ------------- ------------- --------------
Loss from operations (10,895,000) (9,598,000) (27,210,000) (29,267,000)
Other income (expense):
Interest income 347,000 816,000 1,360,000 2,812,000
Interest expense (351,000) (397,000) (1,038,000) (1,213,000)
Foreign exchange 35,000 (65,000) 34,000 (70,000)
-------------- ------------- ------------- --------------
Other income (expense) - net 31,000 354,000 356,000 1,529,000
-------------- ------------- ------------- --------------
Net loss $ (10,864,000) $ (9,244,000) $(26,854,000) $ (27,738,000)
============== ============= ============= ==============
Basic and diluted net loss per share $ (0.35) $ (0.30) $ (0.86) $ (0.90)
============== ============= ============= ==============
Weighted average shares outstanding 31,056,000 30,931,000 31,056,000 30,891,000
============== ============= ============= ==============
</TABLE>
See accompanying notes.
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Neuromedical Systems, Inc. and Subsidiaries
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
(Unaudited)
Nine Months Ended September 30,
---------------------------------------------------------
1998 1997
------------------------- --------------------------
<S> <C> <C>
OPERATING ACTIVITIES
Net Loss $ (26,854,000) $ (27,738,000)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization 3,904,000 3,738,000
Non cash impairment write down 1,813,000 -
Non cash compensation related to issuance of
common stock warrants and options 456,000 159,000
Foreign exchange loss (gain) 34,000 (70,000)
Changes in operating assets and liabilities:
Increase in accounts receivable (77,000) (705,000)
Increase in inventory (917,000) -
(Increase) decrease in prepaid expenses
and other assets (730,000) 441,000
Increase (decrease) in accounts payable 516,000 (1,043,000)
Increase (decrease) increase in accrued liabilities 1,938,000 (640,000)
------------------------- --------------------------
Net cash used in operating activities (19,917,000) (25,858,000)
------------------------- --------------------------
INVESTING ACTIVITIES
Purchases of short-term investments (49,997,000) (30,182,000)
Proceeds from maturing short-term investments 69,970,000 -
Purchases of property and equipment (928,000) (3,874,000)
Loan to officer - (600,000)
Acquisition of a business - (1,156,000)
------------------------- --------------------------
Net cash provided by (used in) investing activities 19,045,000 (35,812,000)
------------------------- --------------------------
FINANCING ACTIVITIES
Restricted cash (811,000) 181,000
Issuance of stock pursuant to exercise of options - 279,000
Proceeds from notes and bank loans - 1,690,000
Proceeds from capital lease financing - 1,669,000
Note receivable from officer (146,000) -
Payments of notes and bank loans (2,173,000) (1,341,000)
Payments on capital leases (1,650,000) (1,671,000)
------------------------- --------------------------
Net cash (used in) provided by financing activities (4,780,000) 807,000
------------------------- --------------------------
EFFECT OF EXCHANGE RATE CHANGES ON CASH (92,000) 114,000
------------------------- --------------------------
Net (decrease) in cash and cash equivalents (5,744,000) (60,749,000)
Cash and cash equivalents, beginning of period 15,842,000 83,391,000
------------------------- --------------------------
Cash and cash equivalents, end of period $ 10,098,000 $ 22,642,000
========================= ==========================
</TABLE>
See accompanying notes.
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Neuromedical Systems, Inc. and Subsidiaries
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 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 September 30, 1998 are not necessarily indicative of the
results that may be expected for the year ended December 31, 1998.
NOTE 2. RELATED PARTY TRANSACTIONS
The Company has entered into agreements, effective as of the first quarter 1998
and the third quarter 1998, to provide facilities and engineering services to
OralScan 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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<PAGE>
Neuromedical System, Inc. and Subsidiaries
NOTES TO CONDENSED CONSOLIDATED
FINANCIAL STATMENTS (Unaudited) - (Continued)
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 September 30, 1998
and December 31, 1997, respectively:
September 30, December 31,
1998 1997
------------ -----------
Raw materials $ 942,000 $ 1,124,000
Work in Progress - 202,000
Finished goods 2,917,000 1,616,000
------------ -----------
$ 3,859,000 $ 2,942,000
============ ===========
As of September 30, 1998, $735,000 of the finished goods balance represent 3
PapNet Scanning System scanners on site at customers under lease agreements.
NOTE 4. RESTRUCTURING AND OTHER CHARGE
In July 1998, the Company announced the restructuring of its United States
business unit and some related corporate functions. The restructuring included
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 resulted in a charge of $3,404,000 in the third quarter ended
September 30, 1998, including severance charges, future lease obligations and a
write-down of impaired long lived assets of $1,813,000.
Assets deemed impaired primarily consisted of PapNet Scanning Systems
("scanners") used in the Company's scanning facility in the United States which
have been written down to estimated fair value.
As of September 30, 1998, 26 employees had left the Company as a result of the
restructuring, and charges amounting to $660,000 have been paid.
NOTE 5. 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 (loss) 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.
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<PAGE>
Neuromedical System, Inc. and Subsidiaries
NOTES TO CONDENSED CONSOLIDATED
FINANCIAL STATMENTS (Unaudited) - (Continued)
During the third quarter ended September 30, 1998 and 1997, total comprehensive
loss amounted to $10,549,000 and $9,211,000, respectively. During the nine
months ended September 30, 1998 and 1997 total comprehensive loss amounted to
$26,776,000 and $27,796,000 respectively.
The components of comprehensive loss, net of related tax, for the three month
periods and nine month periods ended September 30, 1998 and 1997 are as follows:
<TABLE>
<CAPTION>
Three Months ended September 30 Nine Months ended September 30
1998 1997 1998 1997
---- ---- ---- ----
<S> <C> <C> <C> <C>
Net Loss $ (10,864,000) $ (9,244,000) $ (26,854,000) $ (27,738,000)
Foreign currency translation adjustment 315,000 33,000 78,000 (58,000)
-------------------- ------------------- ----------------- ----------------
Comprehensive loss $ (10,549,000) $ (9,211,000) $ (26,776,000) $ (27,796,000)
==================== =================== ================= ================
</TABLE>
The components of accumulated other comprehensive income at September 30, 1998
and December 31, 1997 are as follows:
<TABLE>
<CAPTION>
1998 1997
---- ----
<S> <C> <C>
Foreign currency translation adjustment and
accumulated other comprehensive income $ 413,000 $ 335,000
==================== ===================
</TABLE>
NOTE 6. SUBSEQUENT EVENTS
Under terms of an equipment loan agreement the Company is required to maintain
certain financial covenants throughout the duration of the repayment period.
During October 1998, as a result of the violation of certain financial
covenants, the Company provided a letter of credit and in connection therewith
cash in the amount of $3,180,000 has been restricted. The amount of restricted
cash is to be reduced ratably over the remaining term of the loan.
Under terms of foreign loans guaranteed by the State of Israel, the Company is
required to maintain certain financial covenants throughout the duration of the
repayment period. During November 1998, as a result of the violation of certain
financial covenants, the Company entered into a pledge agreement with an Israeli
bank and in connection therewith cash in the amount of $500,000 has been
restricted. The amount of restricted cash provided under the pledge agreement is
to be reduced ratably over the remaining terms of the loans.
On October 19, 1998, the Company announced the settlement of the litigation
between Cytyc Corporation and the Company. The Company believes that the terms
of the settlement were not material to the operation of the Company's business
or financial position.
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<PAGE>
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/(R)/
Testing System, which has been reintroduced in Europe under the brand name
PAPNET-on-Cyte/TM/ , 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-
Cyte/TM/ 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 Pap 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 to a customer. In the nine months ended
September 30, 1998 the Company placed six PAPNET-on-Cyte systems under sales
arrangements in Europe and placed five PAPNET-on-Cyte systems under lease
arrangements and in support of clinical studies. During the nine months
ended September 30, 1998, the Company has devoted substantial product
development resources to the development of a newly configured scanner for the
European market called PR1MA. The Company announced the commercial launch to
European
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<PAGE>
markets on November 5, 1998 and anticipates its launch to the Asian and
Australian markets in the first quarter of 1999.
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 and other laboratory services for
customers in Hong Kong, China and Taiwan through the Company's laboratory
business, New System, International, Ltd. During the quarter ended September
30, 1998, the Company placed one PAPNET-on-Cyte system under a sales arrangement
in Taiwan.
The Company has incurred net losses since inception through September 30,
1998, of $157,943,000 and has to date generated only limited commercial
revenues. Based on the level of the losses incurred through September 30, 1998,
the cash restricted by certain loan and lease agreements, uncertainty concerning
future operations and the resulting impact on the Company's liquidity and
financial condition, the Company is evaluating a variety of alternatives to
finance operations for the next twelve months and to continue as a going
concern. See "Liquidity and Capital Resources"
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, need to obtain additional financing or capital,
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>
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.
The Company believes that revenue growth during 1998 and 1999 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 September 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 and 1999, the degree of success of
PAPNET-on-Cyte sales and leases in Europe.
The Company's costs and expenses decreased during the nine months ended
September 30, 1998 compared to the nine months ended September 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, costs associated with
the restructuring of United States business unit and related corporate
functions, uncertainty over the level of costs associated with ongoing
litigation, and higher royalty payments under sales territorial licenses that
provide the territorial licensees increased royalties proportionate to increases
in the Company's revenues in those territories or royalties proportionate to
growth in the Company's global revenue, whichever is greater.
In July 1998, the Company announced the restructuring of United States
business unit and some related corporate functions. The restructuring included
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 resulted in a charge of $3,404,000 in the quarter ended September
30, 1998, including severance charges, future lease obligations and a write-down
of impaired long lived assets of $1,813,000. Assets deemed impaired assets
primarily consisted of PapNet Scanning Systems ("scanners") used in the
Company's scanning facility in the United States which have been written down to
estimated fair value.
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
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<PAGE>
decrease in 1998, compared to 1997, as a result of the Company's continuing
losses in 1997 and through the period ended September 30,1998.
RESULTS FOR THE THIRD QUARTER ENDED SEPTEMBER 30, 1998.
Revenues for the third quarter ended September 30, 1998 were $1,766,000, a
decrease of $760,000 from $ 2,526,000 during the third quarter ended September
30, 1997. Revenue from European operations increased to $ 502,000 during the
third quarter ended September 30, 1998 compared to $ 291,000 in the third
quarter ended September 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 $519,000 in the third quarter ended September 30,
1998 compared to $1,501,000 in the third quarter ended September 30, 1997. The
decrease reflected the continued challenge surrounding reimbursement for new Pap
smear technologies and a reduction in United States marketing and sales expense.
Revenues from Asia/Pacific operations increased to $745,000 in the third quarter
ended September 30, 1998 compared to $734,000 in the third quarter ended
September 30, 1997.
Total costs and expenses for the third quarter ended September 30, 1998
were $12,661,000 compared to $12,124,000 for the quarter ended September 30,
1997, an increase of $537,000 or 4%. The increase was primarily due to a charge
of $3,404,000 resulting from the restructuring of United States operations that
was announced in July 1998, as previously mentioned, and increased research and
development expense offset by decreased sales and marketing expense, cost of
sales and general and administrative expense.
Cost of sales expense decreased to $2,517 ,000 during the quarter ended
September 30, 1998, compared to $3,138,000 during the quarter ended September
30, 1997, a decrease of $621,000. The decrease primarily reflected lower
amortization of scanning equipment related to the restructuring of United States
operations offset by costs associated with the cost of sales of PAPNET-on-Cyte
systems, and costs associated with the acquired laboratory business in Hong Kong
in June 1997.
Sales and marketing expense decreased to $1,822,000 during the quarter
ended September 30, 1998, compared to $3,962,000 during the quarter ended
September 30, 1997, a decrease of $2,140,000 or 54%. The decrease was due
primarily to a reduction of sales and marketing expenses in the United States as
a result of lower salary costs related to the restructuring of United States
operations in July 1998 and the Company's decision to suspend consumer
advertising in the United States and Europe, and instead channel communications
through laboratories. This decrease was offset by higher marketing and sales
expense associated with acquired operations in the Asia/Pacific region in June
of 1997 and in August of 1997.
Research and development expense increased to $2,251,000 during the quarter
ended September 30,1998, compared to $2,207,000 during the quarter ended
September 30, 1997, an increase of $44,000. The increase in research and
development expense was due primarily to costs associated with the clinical
studies for an interactive primary screening indication in the United States
offset by decreased costs resulting from consolidation of product development
operations from Israel to the United States.
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<PAGE>
General and administrative expense decreased to $2,667,000 for the third
quarter ended September 30, 1998, compared to $2,817,000 for the third quarter
ended September 30, 1997, a decrease of $150,000. The decrease in general and
administrative expense was due primarily to lower salary and facility costs
related to the restructuring of United States operations and some related
corporate functions announced in July 1998 offset by increased costs in Europe
to support operations.
Interest income decreased to $347,000 for the third quarter ended September
30, 1998, compared to $816,000 for the third quarter ended September 30, 1997, a
decrease of $469,000. The decrease reflected the lower level of cash, cash
equivalents and short term investments available to the Company during the third
quarter of 1998 as a result of the Company's continuing losses in 1997 and
through the period ended September 30, 1998.
Interest expense decreased to $351,000 for the third quarter ended
September 30, 1998, compared to $397,000 for the third quarter ended September
30, 1997, a decrease of $46,000. The decrease in interest expense was due to
the payment of debt and capital lease obligations.
The Company incurred a net loss during the third quarter ended September
30, 1998 of $10,864,000, or $0.35 per share, compared to a net loss of
$9,244,000, or $0.30 per share, during the third quarter ended September 30,
1997. The increased net loss and net loss per share were due to the factors
discussed above.
RESULTS FOR THE NINE MONTH PERIOD ENDED SEPTEMBER 30, 1998 AND 1997.
Revenues for the nine months ended September 30, 1998 were $6,462,000, an
increase of $55,000 from $6,407,000 during the nine months ended September 30,
1997. Revenue from European operations increased to $2,226,000 during the nine
months ended September 30, 1998 compared to $921,000 in the nine months ended
September 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 laboratory customers. Revenues from United
States operations decreased to $2,189,000 in the nine months ended September 30,
1998 compared to $3,873,000 in the nine months ended September 30, 1997. The
decrease reflected the continued challenge surrounding reimbursement for new Pap
smear technologies and a reduction in United States marketing and sales expense.
Revenues from Asia/Pacific operations increased to $2,047,000 in the nine months
ended September 30, 1998 compared to $1,613,000 in the nine months ended
September 30, 1997. The increase primarily reflected the acquisition of a
laboratory business in Hong Kong in June 1997.
Total costs and expenses for the nine months ended September 30, 1998 were
$33, 672,000 compared to $35,674,000 for the nine months ended September 30,
1997, a decrease of $2,002,000 or 6%. The decrease was primarily due to
decreased sales and marketing expenses offset by a charge of $3,404,000
resulting from the restructuring of United States operations that was announced
in July 1998, as previously mentioned, and increases in general and
administrative expense, cost of sales and research and development expense.
Cost of sales expense increased to $8,922,000 during the nine months ended
September 30, 1998, compared to $8,390,000 during the nine months ended
September 30, 1997, an increase of $532,000. The increase primarily reflected
costs associated with the cost of sales of
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<PAGE>
PAPNET-on-Cyte systems, and costs associated with the acquired laboratory
business in Hong Kong in June 1997.
Sales and marketing expense decreased to $6,233,000 during the nine months
ended September 30, 1998, compared to $14,273,000 during the nine months ended
September 30, 1997, a decrease of $8,040,000. The decrease was due primarily in
the United States as a result of lower salary costs related to the restructuring
of United States operations in July 1998, and the Company's decision to suspend
consumer advertising in the United States and Europe and instead channel
communications through laboratories. These decreases were 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.
Research and development expense increased to $6,775,000 during the nine
months ended September 30,1998, compared to $6,196,000 during the nine months
ended September 30,1997, an increase of $579,000. The increase in research and
development expense was due primarily to costs associated with the clinical
studies for an interactive primary screening indication in the United States,
costs associated with the development of a newly configured scanner, PR1MA, for
the European market and costs associated with consolidation of product
development operations from Israel to the United States.
General and administrative expense increased to $8,338,000 during the nine
months ended September 30,1998, compared to $6,815,000 during the nine months
ended September 30, 1997, an increase of $1,523,000. 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 $1,360,000 for the nine months ended
September 30, 1998, compared to $2,812,000 for the nine months ended September
30, 1997, a decrease of $1,452,000. The decrease reflected the lower level of
cash, cash equivalents and short term investments available to the Company
during the nine months ended September 30, 1998 as a result of the Company's
continuing losses in 1997 and the nine months ended September 30, 1998.
Interest expense decreased to $1,038,000 for the nine months ended
September 30, 1998, compared to $1,213,000 for the nine months ended September
30, 1997, a decrease of $175,000. The decrease in interest expense was due to
the payment of debt and capital lease obligations.
The Company incurred a net loss during the nine months ended September
30, 1998 of $26,854,000, or $0.86 per share, compared to a net loss of
$27,738,000, or $0.90 per share during the nine months ended September 30,
1997. The decreased net loss and net loss per share were 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
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<PAGE>
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.
The Company's combined cash, cash equivalents, and short-term investments
totaled $20,219,000 at September 30, 1998, a decrease of $25,717,000 from
December 31, 1997. During the first nine months of 1998, the Company used $19,
917,000 for operating activities; $928,000 for investing activities (excluding
net proceeds of $19,973,000 from the sale of short-term investments); and
$4,780,000 for financing activities.
The primary use of cash for operating activities during the nine months
ended September 30, 1998 was the net loss of $26,854,000, inclusive of non cash
items totaling $6,207,000, offset by increased working capital of $730,000.
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 stockholder, $1,573,000 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 $1,650,000 of
payments under capital lease obligations.
The Company plans to invest excess funds in short term instruments,
including money market funds.
The Company has incurred net losses since inception through September 30,
1998, of $157,943,000 and has to date generated only limited commercial
revenues. Based on the level of the losses incurred through September 30, 1998,
the cash restricted by certain loan and lease agreements and the resulting
impact on the Company's liquidity and financial condition, management believes
that the Company will require additional capital to finance operations for the
next twelve months and to continue as a going concern. The Company is
evaluating a variety of strategic alternatives and plans including further cost
reduction measures, future sales growth in Europe and Asia/Pacific from
introduction of PR1MA and other available alternatives, as well as financing
alternatives to obtain additional equity or debt financing. However, based on
the Company's current significant negative cash flow, future committed cash
requirements for the repayment of existing debt, the recent share price of the
Company's common stock as quoted on the NASDAQ Stock Exchange, uncertainty
relating to the outcome of its United States primary screening trial,
uncertainty relating to market acceptance of the PR1MA product, and its ongoing
lawsuit with a competitor, there can be no assurance that such strategic
alternatives will be successful or 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 of stockholder's
equity.
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 and 1999 due to the cost of marketing
and sales in both the United States and internationally, continuing 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.
-15-
<PAGE>
Funding for these capital expenditures and increases in working capital are
expected to be available out of the Company's cash resources through 1998.
Management of the Company believes that it will 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 nine
months ended September 30, 1998 the Company, as a result of violations of
certain of these financial covenants, provided a letter of credit and restricted
cash of $811,000. During October and November 1998 the Company provided a
letter of credit and a pledge agreement which restricted $3,180,000 and $500,000
as a result of violations of financial covenants related to equipment loans in
the United States and foreign loans guaranteed by the State of Israel,
respectively.
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 included 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 resulted in
charges of $3,404,000, including a write down of impaired long lived assets of
$1,813,000.
On September 15, 1998, the Company received notice from The NASDAQ Stock
Market, Inc. ("NASDAQ") that it was not in compliance with Marketplace Rule
4450(a)(5) in that its shares of common stock had traded at less than $1.00 per
share for thirty (30) consecutive days. The Company has been informed that it
has ninety (90) days to achieve compliance with Marketplace Rule 4450(a)(5)
which requires that the Company's common stock close at or above $1.00 per share
for ten (10) consecutive days during such ninety (90) day period. If compliance
with Marketplace Rule 4450(a)(5) is not achieved by such time, the Company's
common stock may be delisted from the NASDAQ national stock market in which case
trading in the Company's Common Stock would likely be conducted in the over-the-
counter market in the so-called "pink sheets" published by the National
Quotation Bureau or the OTC Bulletin Board of the National Association of
Securities Dealers Inc. As a consequence of such delisting, a shareholder may
find it more difficult to sell or to obtain quotations to prices of the
Company's Common Stock.
The Company has an ongoing program to review, test and insure that its
computer systems will not suffer catastrophic failures in connection with the
change in the calendar on January 1, 2000. The Company believes that the costs
of year 2000 related corrections will not have a material effect on the
Company's business, operations or financial condition. The Company licenses
most of the software it uses in common functions other than in its slide
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<PAGE>
processing operations and slide processing related functions. Although this
practice has minimized the Company effort and cost needed to make the Company
year 2000 compliant, it places greater reliance on the outside firms that
provide the software. Because most of the Company's software is licensed, the
Company's main internal compliance tasks are auditing software and hardware,
reviewing internal and external applications, prioritizing applications by risk,
creating a communications program to raise awareness levels and enable
correction of all existing application solutions, and installation of vendor
provided year 2000 software fixes. The Company believes that the majority of
the major software applications it uses are either year 2000 compliant or
contain only minor problems. The Company is in the process of, or intends to
contact vendors of its major software applications to confirm year 2000
compliance. The slide processing and financial reporting applications have been
identified as not being year 2000 compliant. With regard to the slide
processing application (the failure of which to make year 2000 compliant would
not be material to the Company), the Company is evaluating options identified to
cause the slide processing application to be year 2000 compliant. With regard
to the financial reporting system, the Company has identified a financial
reporting application from an external party which is year 2000 compliant and
expects to install the new financial reporting application during the first
quarter of 1999. The costs of causing the slide processing and financial
reporting applications to be year 2000 compliant are forecast to be
approximately $450,000, including approximately $200,000 of software application
purchases and consultant related expense and approximately $250,000 of internal
staff related expense.
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.
PART II OTHER INFORMATION
Item 1. Legal Proceedings.
On October 19, 1998, the Company announced the settlement of the litigation
between Cytyc Corporation and the Company. The Company believes that the terms
of the settlement were not material to the operation of the Company's business
or financial position.
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<PAGE>
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.
Number Exhibit
------ -------
27.1 Financial Data Schedule
(b) Reports on Form 8-K during quarter for which this report is filed:
Date Subject of Report
---- -----------------
July 8, 1998 Management Changes
September 8, 1998 Principal Executive Office Address and
Telephone Number Changes
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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: November 13, 1998 By: /s/ Mark L. Smith
-------------------------------
Mark L. Smith
Vice President, Finance and
Administration, Chief Financial
Officer
-19-
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