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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 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 Number 0-16752
MEDSTONE INTERNATIONAL, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 66-0439440
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
100 COLUMBIA, SUITE 100, ALISO VIEJO, CALIFORNIA 92656
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (949) 448-7700
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
COMMON STOCK, $.004 PAR VALUE
(TITLE OF CLASS)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form-K. [ ]
The number of shares of the Common Stock of the registrant outstanding as
of March 1, 1999 was 5,064,905 The number of shares of voting and non-voting
Common Stock held by non-affiliates on such date was 4,960,177 with an
approximate aggregate market value of $40,301,438.
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TABLE OF CONTENTS
Page
Item Number and Caption Number
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PART I
Item 1. Business......................................................... 1
Item 2. Properties....................................................... 7
Item 3. Legal Proceedings................................................ 7
Item 4. Submission of Matters to a Vote of Security Holders.............. 8
PART II
Item 5. Market for Registrant's Common Equity
and Related Stockholder Matters................................ 9
Item 6. Selected Financial Data.......................................... 10
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations............................ 11
Item 7A. Quantitative and Qualitative Disclosures About Market Risk....... 16
Item 8. Financial Statements and Supplementary Data...................... 16
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure............................ 16
PART III
Item 10. Directors and Executive Officers of the Registrant............... 17
Item 11. Executive Compensation........................................... 19
Item 12. Security Ownership of Certain Beneficial
Owners and Management.......................................... 23
Item 13. Certain Relationships and Investments............................ 24
PART IV
Item 14. Exhibits, Financial Statement Schedules,
and Reports on Form 8-K........................................ 25
- I -
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PART I
ITEM 1. BUSINESS
INTRODUCTION
Medstone International, Inc., (the "Company" or "Medstone"), a Delaware
corporation formed in October 1984, manufactures, markets and maintains
lithotripters. The Company, as a manufacturer of capital medical devices, has
vertically integrated by offering its medical devices directly to providers on a
fee-per-procedure basis. Medstone currently offers lithotripsy services both in
the United States and internationally on a fee-per-procedure basis in both the
fixed and mobile environment. Medstone intends to expand efforts to grow this
medical service side of its business. The Company's consolidated revenues during
fiscal 1998 came primarily from Medstone's lithotripsy business.
In early 1996, the Company completed efforts to separate its operating
business units and revenue streams into independent operations by spinning off
two subsidiaries, Endocare, Inc. ("Endocare") and Urogen Corp. ("Urogen"), to
the Company's stockholders of record at December 29, 1995. Endocare manufactures
equipment and devices to treat urologic soft tissue diseases. Urogen is a
development stage company in the business of developing pharmaceuticals to treat
prostate cancer.
In June 1996 the Company purchased, for $1.35 million cash, a 60%
interest in Northern Nevada Lithotripsy Associates, LLC ("Northern Nevada"), an
operator of lithotripsy services. In March 1997, the Company purchased, for $2.3
million cash, a 60% interest in Southern Idaho Lithotripsy Associates, LLC
("Southern Idaho"), another operator of lithotripsy services. The Company
consolidates the revenues of Northern Nevada and Southern Idaho and reflects
minority interest expense for the portion of profits earned by the minority
partners. These companies' revenues are derived from invoicing patients or
insurers.
United Physicians Resources, Inc. ("UPR") was incorporated as a
majority-owned subsidiary of the Company in June 1996, to expand the Company's
service orientation to the urologist practitioners. UPR provides billing,
practice management, and consulting services as an additional service line once
the initial physician relationship has been established. UPR purchased the
operations of Integrated Healthcare Systems, Inc. in July 1996 for $30,000. The
operating results of UPR are included in the consolidated financial statements
of the Company since its incorporation.
MARKETS
The Company currently operates in the kidney stone treatment market. In
the United States, it is estimated that over 1,500,000 persons per year suffer
from kidney stones and an estimated 375,000 patients per year are hospitalized
with a primary kidney stone. Historically, approximately 180,000 of these
patients have been treated with extra corporeal shockwave lithotripsy each year.
With an estimated installed base of 380 lithotripters in the United States,
there is a sufficient number of lithotripters to respond to this market.
Outside the United States the incidence of kidney stones varies from
country to country. The installed base of extra corporeal shockwave
lithotripters is not as extensive as in the United States. Medstone has sold
systems into Japan, Egypt, Russia, Israel, Saudi Arabia, U.A.E., Hong Kong and
China.
The share of its markets that the Company will obtain will be dependent
on successful development of new products, obtaining appropriate regulatory
agency approvals, market acceptance of the products, the Company's ability to
market, the alternative sources of equivalent products and future developments.
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PRODUCTS
Lithotripsy Equipment
The Medstone STS ("System") is presently being used to treat kidney
stones, without invasive surgery, in the U.S. and foreign locations. The Company
received a pre-market approval ("PMA") from the U.S. Food and Drug
Administration ("FDA") in 1988 authorizing commercial use of the device for
treating patients with kidney stones.
A series of shockwaves are created outside the patient's body and
focused to travel through water-based fluids until they enter the body and
disintegrate the stone. Each successive shockwave serves to further break apart
the kidney stone into smaller particles until they are small enough to be passed
in the patient's urine. A treatment typically requires 1200-1600 shockwaves in a
procedure which lasts 45 to 60 minutes.
In addition to the shockwave generator, the Medstone STS's components
include a customized X-ray table on which the patient lies horizontally with his
or her kidney positioned above the shockwave generator, a computer, an X-ray
system, an ultrasound system, and an electrocardiogram ("ECG") monitor. The
computer generates information regarding the treatment and monitors the
patient's condition. The X-ray/ultrasound system produces images that are
converted and analyzed by the computer and then used by the physician for proper
positioning and to determine when the kidney stone has been sufficiently
disintegrated to terminate the treatment. The ECG monitor supplies the data that
allows the computer to synchronize the shockwaves with phases of the patient's
heartbeat.
The Company has developed and copyrighted all the software that controls
the Medstone STS. This software, an integral part of the system and therefore
subject to review by regulatory agencies, is licensed for use on a per procedure
basis.
The Company also markets the Medstone STS-T ("STS-T"), its transportable
lithotripter for treatment of kidney stones. The STS-T contains components
similar to the STS, except for the ultrasound unit, with all components built to
be modular, allowing the STS-T to be moved in and out of a hospital surgical
suite. This "in operating room" technology allows hospitals and clinics to set
up the lithotripter for patient treatment in existing surgical operating rooms
and, once complete, the lithotripter can be moved to an equipment holding area
or loaded on to a truck for transportation to another facility. This
transportability allows hospitals and clinics the flexibility of full-time
access to a lithotripter without dedication of a surgical suite to a fixed unit
installation.
The Company received notification from the FDA on September 16, 1998
that its PMA supplement regarding the STS-T was accepted, authorizing the
commercial use of the STS-T to treat patients with kidney stones. As of March 1,
1999, five units have been ordered and deposit checks have been received (see
"Backlog"). The Company expects to commence shipments to customers by the end of
the first quarter of 1999.
The Company also has developed and manufactures its own disposable
components for use with the Medstone STS. Electrodes manufactured by the Company
are used to produce electrical sparks in the shockwave generator part of the
device. A disposable coupling bag containing fluid for transmission of the
shockwave is placed between the shockwave generator and the patient's back or
stomach during the treatment. One complete set of the supplies is normally used
in each patient procedure.
The Company, as a vertically integrated manufacturer, also offers
fee-for-service lithotripsy in the continental United States. It has placed its
lithotripters in mobile trailers and contracts with hospitals, clinics, and
ambulatory surgery centers to provide the equipment necessary to treat kidney
stones, usually on an outpatient basis. This allows small and mid-size
facilities in wide ranging geographic locations to access equipment and
technology that otherwise would only be economically viable in larger population
centers. There are currently over 90 sites in the United States that are active
sites on the Company's mobile routes. The Company plans to continue to expand
its customer base for lithotripsy services in future years.
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Urotable
With its network of physicians and facilities that utilize lithotripsy
products, the Company has begun using that same contact base to market a
urological treatment table, the Medstone "UTS-Series". This urological table,
which is used for various urological procedures, is used both as an in-office
device for physicians and in-facility device in a hospital or clinic setting.
The Company is an integrator of products available on the market and will use
the "UTS-Series" for bundling of urological tables along with lithotripsy
products, or sell the "UTS-Series" as a stand-alone product.
KIDNEY STONES AND TREATMENT
A kidney stone develops when the salt and mineral substances in urine
form crystals that stick together and grow in size. In most cases, these
crystals are removed from the body by the flow of urine, but they sometimes
stick to the lining of the kidney or settle in places where the urine flow fails
to carry them away. These crystals may gather and grow into a stone ranging in
size from that of a grain of sand to a golf ball. Most stones start to form in
the kidney. Some may travel to other parts of the urinary system, such as the
ureter or bladder, and grow there.
Stones vary in size, composition, and the ease with which they can be
dissolved. In some cases, certain medications may be used to lower the amount of
acidity or alkalinity in the urine, thereby dissolving the stones. At present,
stones that contain calcium cannot be dissolved. Most stones can be treated with
conservative methods. This includes increased fluid intake, changes in diet, and
medications. About 90 percent of stones that leave the kidney will pass through
the ureter within three to six weeks. Stones that do not pass through the ureter
may be removed with the aid of a grasping device (basket). The device is passed
through a telescopic instrument (cystoscope) that the doctor inserts into the
bladder or ureter (urethroscope). In some cases, the stones are removed whole,
but sometimes they must be broken into smaller pieces with ultrasound before
they can be removed with the basket.
The Medstone STS provides a non-invasive nonsurgical treatment for
stones in the kidney and ureter called extra corporeal shockwave lithotripsy. In
this method, X-rays are used to target the stone, and then high energy
shockwaves are used to break down the stones into gravel which passes out with
urine within a few weeks.
Although most stones can be treated with nonsurgical methods, certain
stones still require conventional surgery, particularly when there is internal
scarring and obstruction. With conventional surgery, an incision is made over
the stone site. The hospital stay and recovery period are several weeks longer
than when more conservative techniques are used. Therefore, stones are treated
with non-invasive methods when possible.
PRODUCTION
Medstone manufactures, under FDA mandated Good Manufacturing Practice
("GMP") requirements, its devices at its plant in Aliso Viejo, California. The
Company moved into its facility in March 1994. Subsequent to that move the
Company was audited by the FDA and received notification from the FDA enabling
it to manufacture and market devices in that facility. The Company has existing
capacity to produce sufficient quantities of its shockwave lithotripters to
support its commercial needs for the foreseeable future.
PRODUCT DEVELOPMENT
The Company has focused its research in 1998 on developments intended to
improve performance and convenience, and also to reduce the size and costs, of
its lithotripter systems. In 1998, the Company devoted a significant portion of
its research and development expenditures on the Medstone STS-T, a smaller,
movable lithotripsy system. This new product, which has been previewed at focus
groups, was introduced in March 1999. The Company will continue to invest
significantly in product enhancements and proprietary products. During the years
ended December 31, 1996, 1997, and 1998, the Company's expenditures for research
and development totaled $521,793, $1,021,349 and $1,078,792, respectively.
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PRODUCT LIABILITY AND INSURANCE
The Company currently has in force commercial liability insurance, with
coverage limits of $1 million per incident, and $2 million on an annual
aggregate basis. It also has general umbrella liability insurance with coverage
limits of $4 million per incident for a total aggregate amount of $5,000,000 per
incident. The Company's directors and officers' insurance policies provide
coverage on a claims-made basis and are all subject to annual renewals.
GOVERNMENT REGULATION
Governmental regulations in the United States and other countries are a
significant factor affecting the research and development, manufacture and
marketing of the Company's products. In the United States, the FDA has broad
authority under the Federal Food, Drug and Cosmetic Act and the Public Health
Service Act to regulate the distribution, manufacture and sale of drugs,
including biologics, and medical devices. Foreign sales of drugs and medical
devices are subject to foreign governmental regulation and restrictions which
vary from country to country. DEVICES - Medical devices intended for human use
in the United States are classified into three categories, depending upon the
degree of regulatory control to which they will be subject. Such devices are
classified by regulation into either class I (general controls), class II
(performance standards) or class III (pre-market approval) depending upon the
level of regulatory control required to provide reasonable assurance of the
safety and effectiveness of the device. A class III product, such as the
Medstone STS and STS-T, and class I and II devices for which a PMA is necessary
generally require initial Investigational Device Exemption ("IDE") approval by
the FDA. An IDE permits limited clinical evaluation of the product under
controlled conditions. Extensive reporting and monitoring of patient treatments
made pursuant to the IDE are required. After the PMA is obtained, the product
may be marketed to an unrestricted number of users in the United States, but
general medical device regulations regarding FDA inspection of facilities, Good
Manufacturing Practices, labeling, maintenance of records and filings with the
FDA continue to be applicable.
A subset of medical devices categorized as class I or II and classified
as "old" devices, that is, commercially distributed before March 28, 1976 or
substantially equivalent to a device that was in commercial distribution before
that date, may be marketed after the acceptance of the premarket notification
under a 510(k) exemption. The 510(k) section of the Federal Food, Drug and
Cosmetic Act allows an exemption from the requirement of premarket notification.
The Medstone UTS-Series is sold under a 510(k) exemption received by the
original manufacturer of the components used in the equipment.
Medstone has obtained from the California Department of Health Services
a license to manufacture medical devices and is subject to periodic inspections
and other regulation by that agency.
Certificate of Need ("CON") laws and regulations are in effect in many
states. Under such laws, a CON issued by a governmental agency is generally
required before the introduction of certain new health care services or before a
hospital or other provider can acquire certain new medical equipment or
facilities having values exceeding specified amounts. Failure to obtain a
required CON may prohibit the purchase of desired equipment or cause the denial
of Medicare or other governmental reimbursements or payments for patient
treatments. In recent years several states have repealed their CON laws and many
other states have made or are considering possible amendments to the laws. Most
of the revisions involve raising the thresholds for review, eliminating certain
types of facilities or services from review or streamlining the review process.
On January 9, 1998, the Health Care Finance Administration (HCFA)
published proposed Stark II regulations with the intent of seeking public
comments regarding the proposal and its effects. Stark II proposes that
lithotripsy would be defined as an "inpatient and outpatient hospital procedure"
and this definition would put physician ownership of lithotripsy units in
violation of HCFA regulations. This would apply to patients covered under
Medicare, Medicaid and Champus health care.
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With the completion of the comment period in the beginning of March
1998, no further information is currently available to the Company regarding the
public comments. The regulations, if enacted as first published, could force
physician partnerships to either divest ownership or find a "safe harbor" under
which to operate lithotripsy partnerships.
PATENTS, COPYRIGHTS, TRADE SECRETS AND LICENSES
The Company's policy is to secure and protect intellectual property
rights relating to its technology. While Medstone believes that the protection
of patents or licenses is important to its business, it also relies on trade
secrets, know-how and continuing technological innovation to maintain its
competitive position. The Company has received or filed for certain patents or
copyrights for its lithotripter operating systems.
The Company seeks to preserve the confidentiality of its technology by
entering into confidentiality agreements with its employees, consultants,
customers, and key vendors and by other means. No assurance can be given,
however, that these measures will prevent the unauthorized disclosure or use of
such technology.
COMPETITION
The Company's products currently marketed and under development will be
competing with many existing products and therapies for market share. The
Company competes with fully integrated device companies, many of which have
substantially more experience, financial and other resources and superior
expertise in research and development, manufacturing, testing, obtaining
regulatory approvals, marketing and distribution.
Future products of the Company are expected to address the urological
market. The Company's competition will be determined in part by the particular
urological disease to which the Company's potential products relate. An
important factor in competition may be the timing of market introduction of its
or competitive products. Accordingly, the relative speed with which Medstone can
develop products, complete the clinical trials and approval processes and supply
commercial quantities of the products to the market are expected to be important
competitive factors. The Company expects that competition among products
approved for sale will be based on, among other things, product efficacy,
safety, reliability, availability, price, patent position and sales, marketing
and distribution capabilities.
The Company's competitive position also depends upon its ability to
attract and retain qualified personnel, obtain patent protection or otherwise
develop proprietary products or processes and secure sufficient capital
resources for the often substantial period between technological conception and
commercial sales.
SHOCKWAVE LITHOTRIPTERS
The Company's two principal competitors in shockwave lithotripsy are
Dornier, a subsidiary of a Singapore-based conglomerate, and Siemens GmbH, a
German electronic company. In addition, a number of other companies, both in the
U.S. and foreign countries, have PMAs to sell their lithotripters for the
treatment of kidney stones in the U.S. or are conducting clinical studies on the
use of lithotripters for the treatment of kidney stones.
The Company believes that, in addition to the obtaining of FDA and other
governmental approvals, important competitive factors in the markets for
shockwave lithotripters include the reliability, effectiveness in treating
patients and pricing of particular systems. The Company believes the Medstone
System compares favorably with other lithotripters presently being offered by
competitors with respect to the precision of its imaging systems, its ease of
patient handling, its simplicity of operation design, its safety features and
its success rate in treating patients.
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MOBILE LITHOTRIPSY SERVICES
In the fee-for-service business segment, the Company competes with a
number of service oriented medical businesses, in a fragmented and highly
competitive industry, both nationally and locally. Moreover, certain of the
Company's current and potential competitors have substantially greater financial
resources than the Company and may compete with the Company for acquisitions and
development of operations in markets targeted by the Company. The Company has
experienced competition in the acquisition of existing lithotripsy facilities
and the development of relationships with treating physicians. The Company has
experienced competition from hospitals or treating physicians who have opened
their own lithotripsy facilities. Such competition could intensify in the event
of a decrease in the purchase price of lithotripters or if the supply of new or
used lithotripters increases over time.
The Company's main competitors in the fee-for-service business are Prime
Medical Services, Inc., a Texas-based mobile lithotripsy provider, the
lithotripsy business of Integrated Health Services, Inc., a Maryland based
healthcare concern, of which one operating entity owns lithotripsy provider
partnerships, and other smaller regional and local providers.
The Company's main competitors in the urological table business are
Liebel Flarsheim Co., a private Ohio-based manufacturer of urology products, and
OEC Medical Systems, Inc., a Utah based publicly-held provider of imaging and
related products.
SALES AND MARKETING
The Company's current products and planned future products are targeted
at the lithotripsy market. Medstone has a direct sales force covering the
continental United States. Outside the United States, the Company uses a network
of distributors.
The Company generates revenue from the sale of equipment, and also from
the sale of software licenses, disposable supplies, procedure fees and service
contracts to hospitals, physicians, and other health care providers.
The Company offers to hospitals, surgery centers and physician groups
lithotripsy services on a fee basis. In the current cost conscious healthcare
environment, many facilities do not have the patient flow to justify owning, or
the available capital to purchase, a lithotripsy machine. These facilities are
candidates for fee-for-service. In a fee-for-service arrangement the customer
will sign a contract for a period of time, typically one to three years, and
will pay a fixed fee for each patient treated on the lithotripter. Most often
this service is provided by a lithotripter that is in a mobile van so a single
machine can provide service over a wide geographic area. For facilities with
adequate patient flow, fee-for-service can be provided with a fixed unit
installed in that facility.
Marketing for the Company's products is accomplished through
advertisement in medical journals, direct mail, direct physician contact,
company participation in various associations, product exhibition and telephonic
marketing.
BACKLOG - SHOCKWAVE LITHOTRIPSY
The Company's lithotripsy equipment sale backlog was $1,875,000 for the
STS-T as of March 1, 1999 and $250,000 for the STS as of March 1, 1998. Due to
the high per unit price of the Medstone Systems, equipment backlog can vary
significantly from period to period based upon the number of systems on order.
Backlog consists only of orders evidenced by signed contracts for equipment
scheduled for delivery and installation within 12 months and does not include
revenues for maintenance and per procedure charges, or management services
contracts.
With the maturity of Medstone's lithotripsy business, recurring revenues
from fee for service and procedure fees and maintenance services have become a
major source of Medstone's revenue stream. Maintenance services are
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generally provided under annual service contracts, and procedure and fee for
service fees are earned based upon usage of the System.
HUMAN RESOURCES
As of February 28, 1999, Medstone had 82 employees. Of the 82 employees,
9 are engaged directly in research and development activities, 15 are engaged in
manufacturing, 20 are engaged in mobile operations, 16 are engaged in field
service, 11 are engaged in sales and marketing and 11 are employed in general
and administrative positions.
Although Medstone conducts most of its research and development using
its own employees, the Company has funded, and plans to continue to fund,
research using consultants. Consultants provide services under written
agreements and are paid based on the amount of time spent on Company matters.
Under their consulting agreements, Medstone's consultants are required to
disclose and assign to the Company any ideas, discoveries and inventions
developed by them in the course of providing consulting services.
ITEM 2. PROPERTIES
In March 1994, the Company took occupancy of office, manufacturing,
engineering, and warehouse space, and research and development laboratories,
located in Aliso Viejo, California, under an operating lease with an initial
term of two years. The Company negotiated an extension of its original lease
with current monthly rent of $13,874 through February 1999, and starting in
March 1999 through June 2000, a sixteen month period, the monthly rent is
$14,410.
United Physicians Resources leases a 1,417 square foot office in
Phoenix, Arizona with a monthly rental expense of $1,990 under an operating
lease which expires in October 1999.
ITEM 3. LEGAL PROCEEDINGS
The Company carries director and officer liability insurance, and has
indemnification agreements with its officers and directors.
The Company was a defendant in two related class action lawsuits filed
by two shareholders of the Company alleging that adverse material information
was not disclosed at the time of the initial public offering and in subsequent
periods. On June 20, 1996 the defendants and plaintiffs reached an agreement
whereby a $6 million, non-recapturable settlement fund was established in return
for dismissal of all claims against the Company, its underwriter and current and
former officers and directors. The Company recorded a one-time, $5.5 million
expense in the second quarter of 1996 to cover its portion of the settlement
fund, with the first half paid on July 9, 1996 and the second half paid on
August 15, 1996. All funds for the settlement were remitted by the Company, with
the co-defendants having paid their portions to the Company.
From time to time, the Company is subject to legal actions and claims
for personal injuries or property damage related to patients who use its
products. The Company has obtained a liability insurance policy providing
coverage for product liability and other claims. Management does not believe
that the resolution of any current proceedings will have a material financial
impact on the Company or the consolidated financial statements.
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ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Company's annual meeting of shareholders was held on June 10, 1998.
At the meeting Frank R. Pope, David V. Radlinski, Donald Regan and Michael C.
Tibbitts were elected directors of the Company.
EXECUTIVE OFFICERS OF THE REGISTRANT
Information regarding the Company's executive officers is included in
Item 10 of Part III.
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PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Prior to January 24, 1991, the Company's common stock was traded on the
NASDAQ Stock Market under the symbol MSHK. On January 24, 1991, the Company
changed its name to Cytocare, Inc. and began trading on the NASDAQ Stock Market
under the symbol CYTI. On September 25, 1995, the Company changed its name to
Medstone International, Inc. and began trading on the NASDAQ Stock Market under
the symbol MEDS. The following table sets forth the high and low sales prices of
the Company's common stock for the two years ended December 31, 1997 and
December 31, 1998 as reported in the NASDAQ National Market System for the
quarter indicated.
HIGH LOW
---------- -------
YEAR ENDED DECEMBER 31, 1998
First quarter $ 10-7/8 $ 8
Second quarter 11-1/2 8-1/4
Third quarter 9-3/8 5-15/16
Fourth quarter 8-1/4 5-1/4
YEAR ENDED DECEMBER 31, 1997
First quarter $ 9-5/8 $ 7-3/8
Second quarter 9-1/4 7-1/2
Third quarter 10-7/8 9-1/16
Fourth quarter 11-3/8 9-5/8
The stock markets have experienced extreme price and volume fluctuations
during certain periods. These broad market fluctuations and other factors may
adversely affect the market price of the Company's Common Stock. Any shortfall
in revenue or earnings from levels expected by securities analysts could have an
immediate and significant adverse effect on the trading price of the Company's
common stock in any given period. Additionally, the Company may not learn of
such shortfalls until late in the fiscal quarter, which could result in an even
more immediate and adverse effect on the trading price of the Company's stock.
Finally, the Company participates in a highly dynamic industry, which often
results in significant volatility of the Company's common stock price.
At March 1, 1999, there were 289 stockholders of record and
approximately 2,800 beneficial owners of the Company's Common Stock.
On February 9, 1996, the Company distributed two stock dividends, one
common share of both Endocare and of Urogen for each common share of Medstone to
holders of record at the close of business on December 29, 1995. The shares
represent a distribution of all the assets of these two subsidiaries of the
Company which became separate public companies upon distribution. Those
companies operated as separate entities as of January 1, 1996. (See Note 6 to
the Company's Consolidated Financial Statements.)
The Company has not paid any cash dividends during its two most recent
fiscal years. The Company's board of directors does not presently anticipate
that any cash dividends will be paid in the foreseeable future.
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ITEM 6. SELECTED FINANCIAL DATA
CONSOLIDATED STATEMENTS OF OPERATIONS DATA:
(in thousands, except per share amounts)
YEAR ENDED DECEMBER 31,
-------------------------------------------------------------------
1998 1997 1996 1995 1994
-------- -------- -------- -------- --------
Revenues:
Net equipment sales ................. $ 2,144 $ 2,722 $ 2,420 $ 4,588 $ 3,125
Procedure, maintenance, and
management fees ................... 21,129 18,476 14,884 12,797 12,538
Interest and dividends .............. 552 536 676 1,005 642
-------- -------- -------- -------- --------
Total revenues .................... 23,825 21,734 17,980 18,390 16,305
Costs and expenses:
Cost of sales ....................... 11,000 9,503 8,009 7,633 6,004
Research and development ............ 1,079 1,021 522 927 1,076
Selling ............................. 1,988 2,257 2,146 2,050 2,551
General and administrative .......... 2,131 2,231 1,666 1,656 2,105
Lawsuit settlement cost ............. -- -- 5,500 -- --
Legal and other (income)/expense .... (61) (39) 402 164 35
-------- -------- -------- -------- --------
Total costs and expenses .......... 16,137 14,973 18,245 12,430 11,771
-------- -------- -------- -------- --------
Income (loss) before provision/(benefit)
for income taxes ................... 7,688 6,761 (265) 5,960 4,534
Minority interest in subsidiary income . 628 468 143 -- --
Provision (benefit) for income taxes ... 2,718 2,329 (170) 2,086 150
-------- -------- -------- -------- --------
Net income (loss) ...................... $ 4,342 $ 3,964 $ (238) $ 3,874 $ 4,384
======== ======== ======== ======== ========
Net income (loss) per share:(1)
Basic ............................. $ .84 $ .74 $ (.04) $ .74 $ .89
======== ======== ======== ======== ========
Diluted ........................... $ .82 $ .72 $ (.04) $ .70 $ .82
======== ======== ======== ======== ========
CONSOLIDATED BALANCE SHEET DATA:
(in thousands)
DECEMBER 31,
-----------------------------------------------------------
1998 1997 1996 1995 1994
------- ------- ------- ------- -------
Working capital .... $18,432 $16,256 $14,983 $18,465 $16,658
Total assets ....... 29,149 27,688 25,395 25,910 22,260
Total liabilities .. 3,216 3,567 4,230 3,753 2,809
Stockholders' equity 25,933 24,121 21,165 22,157 19,451
- ----------------
(1) Restated in accordance of SFAS Statement No. 128 "Earnings Per Share".
10
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
GENERAL
Medstone manufactures, markets and maintains lithotripters, and
continues to expand its Fee-for-Service Program to supply lithotripsy equipment
to providers on a per procedure basis. The Company is also marketing a urology
imaging and treatment table, used for various urological functions. To date, the
Company's consolidated revenues have come primarily from Medstone's lithotripsy
business.
As a manufacturer of medical devices, the Company has been vertically
integrating by offering its medical devices directly to providers. It currently
offers lithotripsy procedures using 15 mobile systems and two fixed sites in the
United States on a per procedure basis. With the ability to offer quality
equipment at reasonable prices, Medstone intends to continue the growth of this
manufacturer direct business.
In June 1996, the Company completed the acquisition of a 60% interest in
Northern Nevada, a lithotripsy partnership which deals directly with patient and
insurers, and also founded UPR as a majority-owned subsidiary of the Company, to
expand the Company's service orientation to the urologist practitioner. Both
entities signify the Company's emphasis on growth through expansion of
relationships and acquisition. In March 1997, the Company completed the
acquisition of a 60% interest in Southern Idaho Lithotripsy Associates LLC,
another operator of "retail" lithotripsy operations in Southern Idaho, and
operating results have been consolidated effective March 1, 1997.
The Company began the year with approximately $11 million in cash and
marketable securities, no debt, inventories of $2.7 million, and total assets of
$27.7 million. After purchase of $2.7 million of treasury stock, payment of
income taxes of $2.6 million and recurring operating costs, the Company ended
the year with approximately $11.6 million in cash and marketable securities, no
debt, inventories of $3.6 million and total assets of $29.1 million.
Through its continuing research and development, management of the
Company is putting in place the scientific and engineering base it believes is
necessary to carry it through the next phases of its growth plans.
The Company was a defendant in two related class action lawsuits filed
by two shareholders of the Company alleging that adverse material information
was not disclosed at the time of the initial public offering and in subsequent
periods. On June 20, 1996 the defendants and plaintiffs reached an agreement
whereby a $6 million, non-recapturable settlement fund was established in return
for dismissal of all claims against the Company, its underwriter and current and
former officers and directors. The Company recorded and paid a one-time, $5.5
million expense in 1996 to cover its portion of the settlement fund. All funds
for the settlement were remitted by the Company, with the co-defendants paying
their portions to the Company. (See Item 3. Legal Proceedings).
From time to time, the Company is subject to legal actions and claims
for personal injuries or property damage related to patients who use its
products. The Company has obtained a liability insurance policy providing
coverage for product liability and other claims. Management does not believe
that the resolution of any current proceedings will have a material financial
impact on the Company or the consolidated financial statements.
In 1996, the Company negotiated with Coram Healthcare ("Coram") for the
right to purchase the lithotripsy related operations of Coram. In October 1996,
negotiations ceased and, upon Coram's subsequent acquisition by Integrated
Health Services, Inc., a breakup fee clause was enacted and the Company received
reimbursement of $1.25 million of certain documented out-of-pocket expenses
relating to the attempted acquisition and related financing. The Company
received the $1.25 million in 10 installments during 1997.
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RESULTS OF OPERATIONS
YEAR ENDED DECEMBER 31, 1998 COMPARED TO YEAR ENDED DECEMBER 31, 1997
Total revenue increased to $23.8 million, or by 10%, for the year ended
December 31, 1998 when compared to the year ended December 31, 1997. Equipment
revenues decreased by $578,000 in the current year when compared to the prior
year, due to a decline in the number of unit shipments only partially offset by
an increase in average unit selling prices. Also decreasing was revenue from
equipment upgrades when compared to the year ended 1997.
Revenue from procedure, maintenance and management fees, increased by
$2,652,000, or 14%, in the current year when compared to the prior year as the
Company's fee-for-service revenues continue to increase as the number of
patients treated in 1998 increased by 26% when compared to the number of
patients treated in the fee-for-service, Northern Nevada and Southern Idaho
operations in 1997. Higher patient counts in both Northern Nevada and Southern
Idaho, the former due to higher activity and the latter due to full year results
and increased activity, resulted in a 22% increase in revenue for those two
operating entities, even though there was a slight decrease in the average per
patient revenue. Pricing pressures on procedure revenue from third-party owned
equipment resulted in a 7% decrease in the per procedure fee, even though the
number of procedures increased by 5% when compared to 1997.
Interest income increased by 3% for the year ended December 31, 1998
when compared to the prior year as the Company's average invested cash balance
increased slightly, partially offset by a decrease in average investment yield.
Cost of equipment sales decreased to $1,901,000 in 1998 compared to
$2,040,000 in 1997 due to the decline in the number of unit shipments offset by
an increase in the option content needed to complete sales, along with costs
associated with a foreign installation, in the current year.
Cost on recurring revenues increased to $9,099,000 or 43% of revenues in
1998 compared to $7,463,000 or 40% in 1997, due to the addition of several new
vans in new geographic areas in 1998 and the associated overhead needed for
operations. Pricing pressure also contributed to the slight decline in the gross
margins on recurring revenues.
Research and development costs increased in 1998 by $57,000, or 6%, when
compared to the same period of 1997, due to slightly higher spending on payroll
and related costs as the Company completed its development of its new
transportable lithotripter, introduced into the marketplace in March 1999.
Selling expenses decreased $269,000, or 12%, in 1998 compared to 1997
due to lower payroll as the Company refocused its marketing effort and the
associated lower travel expenses and lower bad debt expenses.
General and administrative expenses declined to $2,131,000 in 1998
compared to $2,231,000 in 1997 representing a 4% decrease. This decrease was due
mainly to lower payroll as the United Physician Resources subsidiary was refined
and lower bad debt in the Northern Nevada and Southern Idaho operations. This
was partially offset by an increase in legal expenses.
Legal and other (income)/expense decreased by $22,000 in 1998 compared
to 1997 due to the gain on investment in a joint venture only partially offset
by increased goodwill amortization for a full year on the Southern Idaho
acquisition.
Minority interest expenses of $628,000 in 1998 increased from $468,000
in 1997 due to both a full year's activity for Southern Idaho and increased
activity in both Southern Idaho and Northern Nevada.
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Provision (benefit) for income taxes increased in the current year
compared to the prior year due to both an increase in taxable income and a
higher effective tax rate in 1998.
YEAR ENDED DECEMBER 31, 1997 COMPARED TO YEAR ENDED DECEMBER 31, 1996
Total revenues increased to $21.7 million, or 21% for the year ended
December 31, 1997 when compared to revenues of $18.0 million in the year ended
December 31, 1996. The revenues from equipment sales increased by 12% as the
number of units sold increased but the average unit selling price decreased due
to competition. Decreasing was the revenue from equipment upgrades when compared
to 1996 as fewer field upgrades are being performed.
Revenue from procedure and maintenance fees, or recurring revenue,
increased by $3.4 million, or 23%, from 1996 levels due to the Company's
continued revenue growth in its fee-for-service business, and the additional
revenue from the Southern Idaho acquisition. Volume on company owned mobile
lithotripsy units increased by 51% in 1997 when compared to 1996 with fees
remaining constant. Procedure revenue on third-party owned equipment was flat in
1997 when compared to 1996 as patient volume increased slightly and per
procedure fees decreased slightly. Revenues acquired with Southern Idaho, when
combined with the previously acquired Northern Nevada, increased per procedure
averages due to the higher fees for direct billings.
Interest income decreased by 21% in 1997 when compared to 1996 due to
lower average invested cash balances which resulted from the payment of Coram
expenses, acquisition costs and treasury stock repurchases.
Cost of equipment sales in 1997 increased by 57% in 1997 from 1996
levels due to the higher number of unit shipments in the year. Gross margins on
equipment and equipment upgrades decreased due to the decrease in average unit
selling prices.
Cost of recurring revenues increased by $752,000, or 11%, in 1997 when
compared to 1996 due to increased activity in staffing costs and van movement
costs for mobile services in correlation with higher patient volume. Gross
margin, as percentage of recurring revenue, increased to 60% in 1997 from 55%
due to higher utilization of existing equipment as fixed costs remain stable.
Research and development costs increased in 1997 by 96% when compared to
1996 levels due to increased spending on materials, staffing and consultants as
the Company accelerated its development of a portable lithotripter.
Selling expenses increased by $111,000, or 5%, in 1997 when compared to
1996 due to higher commission expense in connection with revenue growth, the
cost of a national ad campaign, and bad debt expenses.
General and administrative expenses increased by 34% or $565,000 from
1996 to 1997, due to higher staffing costs associated with a full year's
operations of United Physicians Resources, increased legal expenses and
increased billing service expense for the direct billings done on acquired
entities.
Other income/expense, net decreased by $442,000 in 1997 when compared to
1996 due to the class action litigation preparation expenses incurred in 1996,
partially offset by the gain on the sale of securities held for investment in
1996.
Lawsuit settlement costs decreased by $5.5 million due to the settlement
of the class action lawsuit in 1996.
Minority interest expense of $468,000 represents the minority
shareholder's interest in the results of operations of Northern Nevada and
Southern Idaho.
Provision (benefit) for income taxes recognizes the tax expense of the
current year's income compared to the operating loss incurred in 1996.
13
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LIQUIDITY AND CAPITAL RESOURCES
At December 31, 1998, the Company had cash and short-term investments of
approximately $11.6 million. These funds were generated from operating
activities.
The Company's long-term capital expenditure requirements will depend
upon numerous factors, including the progress of the Company's research and
development programs, the time required to obtain regulatory approvals, the
resources that the Company devotes to the development of self-funded products,
proprietary manufacturing methods and advanced technologies, the cost of
acquisition and/or new revenue opportunities, the ability of the Company to
obtain additional licensing arrangements and to manufacture products under those
arrangements, the demand for its products if and when approved and possible
acquisitions of products, technologies and companies.
The Company believes that its existing working capital and funds
anticipated to be generated from operations will be sufficient to meet the cash
needs for continuation of its present operations during 1999. See "Safe Harbor
Statement under the Private Securities Litigation Reform Act of 1995."
YEAR 2000
Impact of the Year 2000
The Year 2000 Issue exists because many computer systems and
applications currently use two-digit date fields to designate a year. As the
century date occurs, computer programs, computers and embedded microprocessors
controlling equipment with date-sensitive systems may recognize Year 2000 as
1900 or not at all. This inability to recognize or properly treat Year 2000 may
result in computer system failures or miscalculations of critical financial and
operational information as well as failures of equipment controlling
date-sensitive microprocessors. In addition, there are two other related issues,
which could also lead to miscalculations or failures: (i) some older systems'
programming assigns special meaning to certain dates, such as 9/9/99 and (ii)
the Year 2000 is a leap year.
State of Readiness
The Company started to formulate a plan to address the Year 2000 Issue
in 1997. To date, the Company's primary focus has been on its own internal
information technology systems, along with date-sensitive subsystems of its
products. The Company has developed a Year 2000 Plan to address all of its Year
2000 Issues. The Year 2000 Plan being developed will involve generally the
following phrases: awareness, assessment, renovation, testing and
implementation.
The Company has completed an assessment of approximately 95% of its
internal information technology systems. The Company has already completed the
renovation of approximately 50% of its information technology systems, including
modifying and upgrading software and developing and purchasing new software, and
continues to renovate the portions of such systems for which assessment is
complete. The Company's goal is to complete testing and implementation phases by
June 30, 1999.
The Company has recently begun to assess the potential for Year 2000
problems with the information systems of its customers and vendors. The Company
is preparing questionnaires that it expects to send to its customers, vendors
and other third parties with which the Company has a material relationship by
March 31, 1999. The Company expects to complete the assessment with respect to
such parties by June 30, 1999, subject to their ability to provide requested
information. The Company does not have sufficient information to provide an
estimated timetable for completion of renovation and testing that such parties
with which the Company has a material relationship may undertake. The Company is
unable to estimate the costs that it may incur to remedy the Year 2000 issues
relating to such parties.
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All of the mission critical date sensitive systems used in the Company's
products have been evaluated for their compliance with Year 2000 issues. The
findings of this evaluation are that, with an upgrade to the computer system of
the equipment, along with an operating system upgrade, the system will be fully
compliant with the Year 2000. The existing customer base of the Company has been
notified of this, and where upgrades have been performed, compliance
certificates have been issued. Customers have also been advised that if an
upgrade is not purchased, a compliance certificate cannot be issued. Any other
date related information contained in systems and software of the equipment that
would not have any impact on the operation and safety of the Company's products
will be addressed with vendors to the Company throughout 1999.
The Company has done an assessment of the potential for Year 2000
problems with the embedded microprocessors in its other equipment and
facilities, including telecommunications systems, utilities, security systems
and HVACs and expects no significant effect on the non-critical functions of the
Company, provided major suppliers of mass consumption items, such as
electricity, telephone and data transmission, gasoline, water, natural gas and
waste disposal, meet their projections of Year 2000 compliance. The Company has
already installed a new telephone system in 1998 to comply with Year 2000.
Costs to Address Year 2000 Issues
The Company estimates on a preliminary basis that the cost of
assessment, renovation, testing and implementation of its internal systems will
not be material to the overall operations of the Company. The major components
of these costs are: consultants, programming, new software and hardware,
software upgrades and travel expenses. The Company expects that such costs will
be funded through operating cash flows. This estimate, based on currently
available information, will be updated as the Company continues its assessment
and proceeds with renovation, testing and implementation and may be adjusted
upon receipt of more information from the Company's vendors, customers and other
third parties and upon the design and implementation of the Company's
contingency plan. In addition, the availability and cost of consultants and
other personnel trained in this area and unanticipated acquisitions might
materially affect the estimated costs.
Risks to the Company
The Company's Year 2000 Issue involves significant risks. There can be
no assurance that the Company will succeed in implementing the Year 2000 Plan it
is developing. The following describes the Company's most reasonably likely
worse-case scenario, given current uncertainties. If the Company's renovated or
replaced internal information technology systems fail the testing phase, or any
software application or embedded microprocessors central to the Company's
operations are overlooked in the assessment or implementing phases, significant
problems including delays may be incurred in billing the Company's major
customers for services performed. If its major customers' systems do not become
year 2000 compliant on a timely basis, the Company will have problems and incur
delays in receiving and processing correct reimbursement. If the systems on the
diagnostic imaging equipment utilized by the Company are not Year 2000
Compliant, the Company may not be able to provide imaging services to patients.
If the Company's vendors or suppliers of the Company's necessary power,
telecommunications, transportation and financial services, fail to provide the
Company with equipment and services, the Company will be unable to provide
services to its customers.
If any of these uncertainties were to occur, the Company's business,
financial condition and results of operations would be adversely affected. The
Company is unable to assess the likelihood of such events occurring or the
extent of the effect on the Company.
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Contingency Plan
The Company has not yet established a contingency plan to address
unavoidable Year 2000 risks with internal information technology systems and
with customers, vendors and other third parties, but it expects to create such a
plan by June 30, 1999.
SAFE HARBOR STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
Forward-looking statements in this report, including without limitation,
statements relating to the Company's plans, strategies, objectives,
expectations, intentions and adequacy of resources, are made pursuant to the
safe harbor provisions of the Private Securities Litigation Reform Act of 1995.
Investors are cautioned that such forward-looking statements involve risks and
uncertainties including without limitation the following: (i) the Company's
plans, strategies, objectives, expectations and intentions are subject to change
at any time at the discretion of the Company, (ii) the Company's plans and
results of operations will be affected by the Company's ability to manage its
growth; (iii) the Company's businesses are highly competitive and the entrance
of new competitors into or the expansion of the operations by existing
competitors in the Company's markets and other changes could adversely affect
the Company's plans and results of operations; and (iv) other risks and
uncertainties indicated from time to time in the Company's filings with the
Securities and Exchange Commission.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company has no financial instruments which are subject to market
risk. Although the Company's earnings and cash flows are subject to fluctuations
due to changes in the interest rates on its investments, a hypothetical 10%
adverse decrease in the interest rates would not have a material adverse effect
on the results of operations because the majority of the Company's investments
are short-term treasury bills. A 10% reduction in interest rates would reduce
interest income by approximately $50,000 annually. Due to the short period to
maturity, the Company believes that the impact of a 10% reduction in interest
rates would not have a material effect on the carrying value of its
available-for-sale securities.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
See Item 14. "Exhibits, Financial Statement Schedules, and Reports on
Form 8-K."
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
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PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
DIRECTORS
The following are the directors of the Company:
NAME AGE PRINCIPAL OCCUPATION
---- --- --------------------
David V. Radlinski 54 Chairman of the Board and
Chief Executive Officer of the Company
Frank R. Pope 49 Managing Director
Verdigris Capital
Donald John Regan 64 Vice President and General Counsel
Kinsell, O'Neil, Newcomb & De Dios, Inc.
Michael C. Tibbitts 51 Officer and Vice President
Gulf South Medical Supply, Inc.
Mr. Radlinski has been the Chairman of the Board and Chief Executive
Officer of the Company since September 1995. He had been the President of the
Company's subsidiary, Medstone International, Inc., and Chief Financial Officer
and Secretary of the Company from January 1991 to September 1995. From July 1987
to January 1991, he was the Company's Executive Vice President of Finance, Chief
Financial Officer and Secretary. From 1984 to 1987, he was Vice President of
Finance and Chief Financial Officer of Printronix, Inc., a publicly-owned
company which manufactured computer printers.
Mr. Pope is Managing Director of Verdigris Capital, a private merchant
banking firm. From April 1981 to October 1996, Mr. Pope was a General Partner
with Technology Funding, a venture capital investment firm. He was also the
Executive Vice President, Chief Financial Officer and a director of Technology
Funding Inc. Mr. Pope is also a director of Thermatrix, Inc. and a director and
officer of Advanced BioCatalytics Corp. Mr. Pope is a C.P.A. and a member of the
California Bar. He has been a director of the Company since January 1991.
Mr. Regan is currently the Vice President and General Counsel of
Kinsell, O'Neal, Newcomb & De Dios, Inc., a municipal securities investment
banking firm. Mr. Regan has practiced securities, municipal finance, nonprofit
corporation, real estate, and business transactions law for over thirty years.
He is a member of the National Association of Bond Lawyers, has published
several articles on securities law and served as a lecturer for the Practicing
Law Institute. He specializes in revenue and project finance bonds. He has been
a director of the Company since September 1995.
Mr. Tibbitts, has been with Gulf South Medical Supply, Inc. since 1991
as a Vice President. Prior to joining that corporation, he was employed for 19
years by Johnson & Johnson in two divisions: Sterile Design (which manufactured
and marketed kit packages) and Surgikos (which manufactured and marketed
surgical supplies). He has been a director of the Company since May 1996.
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EXECUTIVE OFFICERS
The names, ages and positions of all the executive officers of the
Company as of March 1999 are listed below, followed by a brief account of their
business experience during the past five years. Officers are normally appointed
annually by the Board of Directors at a meeting of the directors immediately
following the Annual Meeting of Shareholders. There are no family relationships
among these officers nor any arrangements or understandings between any officer
and any other person pursuant to which an officer was selected. None of these
officers has been involved in any court or administrative proceeding within the
past five years adversely reflecting on his or her ability or integrity.
NAME AGE POSITION
---- --- --------
David V. Radlinski 54 Chief Executive Officer and Chairman of the Board
Mark Selawski 43 Vice President of Finance,
Chief Financial Officer and Secretary
Eva Novotny 41 Executive Vice President of Sales
and Marketing
Mr. Radlinski has been the Chairman and Chief Executive Officer of the
Company since September 1995. He had been the President of the Company's
subsidiary, Medstone International, Inc., and Chief Financial Officer and
Secretary of the Company from January 1991 to September 1995. From July 1987 to
January 1991, he was the Company's Executive Vice President of Finance, Chief
Financial Officer and Secretary. From 1984 to 1987, he was Vice President of
Finance and Chief Financial Officer of Printronix, Inc., a publicly-owned
company which manufactured computer printers.
Mr. Selawski has been the Chief Financial Officer, Vice President of
Finance and Secretary of the Company since September 1995. He had previously
served as the Company's Manager of Planning and Analysis since joining the
Company in 1988. Prior to joining the Company he held various finance management
positions with several high-tech manufacturing companies.
Ms. Novotny has been Executive Vice President of Sales and Marketing of
the Company since October 1997. Prior to joining the Company, she was Director
of Marketing for Imagyn Medical, formerly UroHealth, from June 1995 to October
1997. From 1985 to 1995, she was employed by Mentor Corporation as a Marketing
Manager and later as Director of Marketing for Mentor Urology.
SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
The Company is not aware of any director, officer or 10% shareholder who
during 1998 failed to file on a timely basis any report regarding the Company's
securities required by Section 16(a) of the Securities Exchange Act of 1934.
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ITEM 11. EXECUTIVE COMPENSATION
EXECUTIVE COMPENSATION
The following table sets forth certain information regarding
compensation paid by the Company during each of the Company's last three fiscal
years to the Company's Chief Executive Officer and to each of the Company's
other executive officers during fiscal 1998.
SUMMARY OF COMPENSATION TABLE
LONG TERM COMPENSATION
-------------------------------------------------
ANNUAL COMPENSATION AWARDS PAYOUTS
------------------------------------ ---------------------- -------
OTHER RESTRICTED SECURITIES
NAME AND ANNUAL STOCK UNDERLYING LTIP ALL OTHER
PRINCIPAL FISCAL SALARY BONUS COMPENSATION AWARDS(S) OPTIONS PAYOUTS COMPENSATION
POSITION YEAR ($)(1) ($) ($) ($) (#)(2) ($) ($)
--------- ------ ------- ------ ------------ ---------- ---------- ------- ------------
David V. Radlinski 1998 219,135 -- 2,426 -- 350,000 -- --
Chairman of the Board and 1997 200,300 -- -- -- 100,000 -- --
Chief Executive Officer 1996 200,100 -- -- -- 50,000 -- --
Mark Selawski 1998 99,038 300 -- -- 80,000 -- --
Chief Financial Officer, Vice 1997 85,833 11,300 -- -- 20,000 -- --
President of Finance 1996 85,600 -- -- -- 20,000 -- --
and Secretary
Eva Novotny(3) 1998 120,000 300 -- -- 70,000 -- --
Executive Vice President of 1997 25,300 -- -- -- 50,000 -- --
Sales and Marketing
- -----------------------
(1) In addition to the cash compensation shown in the table, executive
officers of the Company may receive indirect compensation in the form of
perquisites and other personal benefits. For each of the named executive
officers, the amount of this indirect compensation in 1998, 1997 and
1996 did not exceed the lesser of $50,000 or 10% of the executive
officer's total salary and bonus for that year.
(2) Options to acquire shares of Common Stock granted and repriced. (3) Ms.
Novotny joined the Company as of October 15, 1997.
EMPLOYMENT AGREEMENTS
Mr. Radlinski - On August 13, 1998, the Company entered into an
employment agreement with Mr. Radlinski to assure his continued service to the
Company. The agreement runs for a term of five years, expiring on August 13,
2003. The agreement provides for a base salary of not less that $250,000 per
year, subject to adjustments as authorized by the Board of Directors.
Mr. Radlinski is also eligible for bonuses based on performance of the
Company's Common Stock. The Common Stock's closing price must attain and remain
at or above various levels, ranging from $11 to $21, for a period of 90
consecutive days. If these breakpoint prices are achieved within a set number of
months, the longest which is 48 months, from the commencement of the contract, a
cash bonus will be paid following the achievement period. Each breakpoint bonus
can be earned separately if achieved within the stated achievement period, but
each bonus can only be awarded once.
Concurrent with the commencement of this agreement, the exercise prices
of Mr. Radlinski's existing stock options to purchase up to 350,000 shares of
the Company's Common Stock from $7.13 to $10.63 were reduced to equal $6.37 per
share, the closing price per share of the Company's Common Stock on the
commencement date as reported on the NASDAQ National Market System. Such option
agreements were amended to provide that they shall become
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fully exercisable, regardless of any otherwise applicable vesting requirements,
i) concurrently with any termination of Mr. Radlinski's employment by the
Company without "Good Cause" (as defined), or ii) if there is an acquisition of
substantially all of the Company's assets or business while he is still employed
by the Company and he does not immediately enter into an employment agreement
with a buying or surviving party in the transaction (a "change in control")..
If he is terminated without "Good Cause" or a change of control occurs
within the first three years of the agreement, a severance payment of five times
his then current base salary will be due and payable. If he is terminated
without "Good Cause" or such a change of control occurs within the fourth year
of the agreement, a severance payment of four times his then current base salary
will be due and payable. If he is terminated without "good cause" or a change of
control occurs within the fifth year of the agreement, a severance payment of
three times his then current base salary will be due and payable.
In addition to the preceding paragraph, if Mr. Radlinski is terminated
without Good Cause in the first three years of this agreement, he will become a
consultant to the Company for a period of five years following termination at a
monthly compensation of $16,500 per month. If he is terminated without Good
Cause or there is a change in control in the fourth year of this agreement, he
will become a consultant to the Company for a period of four years following
termination at the same monthly compensation. If he is terminated without Good
Cause or there is a change of control in the fifth year of this agreement, he
will become a consultant to the Company for a period of three years following
termination at the same monthly compensation. The Company, during the consulting
contract, shall provide term life insurance equivalent to the unpaid amount of
the consulting fees as established above, payable to the beneficiary of his
designation.
Mr. Selawski and Ms. Novotny - On August 13, 1998, the Company entered
into employment agreements with both Mr. Selawski and Ms. Novotny to assure
their continued service to the Company. The agreements run for a term of three
years, expiring on August 13, 2001. The agreements provide for a base salary of
not less that $100,000 per year for Mr. Selawski and $120,000 per year for Ms.
Novotny, subject to adjustments as authorized by the Board of Directors.
Concurrent with the commencement of these agreements, the exercise
prices of Mr. Selawski's existing stock options to purchase up to 80,000 shares
of the Company's Common Stock at from $7.13 to $9.68 were reduced to equal $6.37
per share, the closing price per share of the Company's Common Stock on the
commencement date as reported on the NASDAQ National Market System. Ms.
Novotny's existing stock options to purchase up to 70,000 shares of the
Company's Common Stock at from $9.68 to $10.68 were reduced to equal $6.37 per
share, the closing price per share of the Company's Common Stock on the
commencement date as reported on the NASDAQ National Market System. Each such
option agreement was amended to provide that it shall become fully exercisable,
regardless of any otherwise applicable vesting requirements, i) concurrently
with any termination of the officer's employment by the Company without Good
Cause, or ii) if there is an acquisition of substantially all of the Company's
assets or business while such officer is still employed by the Company and he or
she does not immediately enter into an employment agreement with a buying or
surviving party in the transaction. If the officer is terminated without "Good
Cause" or such a change of control occurs within the term of the agreement, a
severance payment of two times his or her then current base salary will be due
and payable.
20
23
STOCK OPTION GRANTS AND REPRICINGS DURING 1998
The following table provides information related to the stock options
that in August 1998 were repriced to the current market value and new options
granted in 1998.
POTENTIAL REALIZABLE
VALUE AT ASSUMED
ANNUAL RATES OF
STOCK PRICE
APPRECIATION FOR
INDIVIDUAL REPRICINGS AND GRANTS OPTION TERM
- ---------------------------------------------------------------------------------------- --------------------
SHARES % OF TOTAL
UNDERLYING EMPLOYEE
OPTIONS OPTIONS
GRANTED OR GRANTED OR EXERCISE
REPRICED REPRICED IN PRICE EXPIRATION
NAME (#)(1) FISCAL YEAR ($/SHARE)(2) DATE 5%($) 10%($)
---- ---------- ----------- ------------ ----------- ------- -------
David V. Radlinski 50,000 5% 6.375 7/26/01 108,375 245,438
100,000 10% 6.375 9/25/01 216,750 490,875
50,000 5% 6.375 7/23/02 108,375 245,438
50,000 5% 6.375 1/9/03 108,375 245,438
50,000 5% 6.375 6/10/03 108,375 245,438
50,000 5% 6.375 4/15/04 108,375 245,438
Mark Selawski 20,000 2% 6.375 7/26/01 43,350 98,175
20,000 2% 6.375 7/23/02 43,350 98,175
20,000 2% 6.375 6/10/03 43,350 98,175
20,000 2% 6.375 4/15/04 43,350 98,175
Eva Novotny 50,000 5% 6.375 10/15/03 108,375 245,438
20,000 2% 6.375 4/15/04 43,350 98,175
(1) The options granted or repriced vest equally over a 60-month period
commencing upon the original grant date. The first six months after a
grant does not allow exercise of the option for the then vested shares.
The options are for a 6-year term, subject to earlier termination in
certain events related to termination of employment. The Compensation
Committee retains discretion, subject to the option plans' limits, to
modify the terms of outstanding options.
2) Subject to certain conditions, the exercise price may be paid by
delivery of already owned shares and the tax withholding obligations
related to exercise may be paid by offset of the underlying shares.
STOCK OPTIONS HELD AT END OF FISCAL YEAR
The following table provides information related to options exercised
during 1998 and options held by the named executive officers at December 31,
1998.
NUMBER OF SECURITIES VALUE OF UNEXERCISED
UNDERLYING UNEXERCISED IN-THE-MONEY
OPTIONS AT FY-END(#) OPTIONS AT FY-END($)(2)
SHARES ACQUIRED VALUE ---------------------------- -----------------------------
NAME ON EXERCISE(#) REALIZED($)(1) EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
- ---- --------------- -------------- ----------- ------------- ----------- -------------
David V Radlinski -- -- 165,000 185,000 29,700 33,300
Mark Selawski -- -- 32,000 48,000 5,760 8,640
Eva Novotny -- -- 14,333 55,667 2,580 10,020
- -------------
(1) The value is calculated based on the difference between the option
exercise price and the market price for the Company's Common Stock on
the exercise date, multiplied by the number of shares purchased. For
this purpose, the surrender or withholding of shares to pay the exercise
price is not taken into account.
(2) The closing price for the Company's Common Stock as reported by the
National Association of Securities Dealers (NASD) on December 31, 1998
was $6.56. Value is calculated on the basis of the difference between
the option exercise price and $6.56, multiplied by the number of shares
of Common Stock underlying the option.
21
24
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
During 1998 Donald J. Regan and Frank R. Pope served as the members of
the Company's Compensation Committee. Neither such individual is a current or
former officer or employee of the Company or any of its subsidiaries. During
1998 there were no compensation committee interlocks between the Company and
other entities involving Medstone executive officers serving as directors or
members of compensation or similar committees of such other entities.
COMPENSATION OF DIRECTORS
The Company currently compensates Messrs. Regan, Tibbitts and Pope
$1,000 per meeting for their services, in addition to reimbursement to all
directors for expenses incurred by them in connection with the Company's
business. In addition, the Company has compensated Messrs. Pope and Regan
$11,000 each and Mr. Tibbitts $8,000, for their participation in a Special
Committee of the Board of Directors.
Under the Nonemployee Director Stock Option Plan, each new nonemployee
director is automatically granted an option to purchase up to 5,000 shares as of
the effective date of his or her first appointment to the Board or first
election to the Board by the shareholders, whichever is earlier. Subject to
acceleration of the option exercises in the event of certain events specified in
the plan, each such option becomes exercisable with respect to 1/60 of the
shares issuable for each elapsed full month during the five-year period after
its grant date, but will not be initially exercisable until six months after the
grant date. The exercise price of each option will equal the fair market value
of the underlying Common Stock on the date the option is granted. Each option
will expire six years after its grant, except that the expiration will be
extended until one year after the optionee's death if it occurs less than one
year before the option's expiration date. An option granted under the plan is
not transferrable during the grantee's lifetime and must be exercised within one
year following his or her death, or within 90 days after the grantee ceases to
be a member of the Board for any other reason, and will only be exercisable to
the extent it is exercisable on the date the grantee leaves the Board. Under
this plan, Mr. Regan was granted 5,000 shares in September 1995 at $11.88 and
Mr. Tibbitts was granted 5,000 shares at $8.63 per share in May 1996. These
options were repriced on August 13, 1998 to a price of $6.375.
As additional compensation, each current nonemployee director of the
Company has received an option to purchase up to 15,000 shares of the Company's
Common Stock. The options issued to Mssrs. Pope, Tibbitts and Regan were issued
in November 1996 and have exercise prices of $6.375 after repricing of the
options on August 13, 1998. The options are exercisable, after six months
following their grant dates, in incremental amounts equal to 1/48 of the
underlying shares for each elapsed calendar month during which the director
remains on the Company's board. The terms of the options are five years, subject
to earlier termination related to the director no longer serving on the board.
Additionally, each director was granted options, on August 13, 1998, for 4,000
shares at an exercise price of $6.375. These options vest in incremental amounts
equal to 1/36 of the underlying shares for each elapsed calendar month during
which the Director remains on the Company's board. The term of the options are
four years, subject to early termination related to the director no longer
serving on the board.
22
25
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth the number of shares of the Company's
Common Stock known to the Company to be beneficially owned as of March 1, 1999
by each person who owns beneficially more than 5 percent of the outstanding
shares of Common Stock, by each of the present directors and nominees for
director, by each of the executive officers named in the Executive Compensation
in Item 11 and by all executive officers and directors of the Company as a
group, and the percentage of the total outstanding shares of Common Stock such
shares represented as of March 1, 1999.
NUMBER OF SHARES
BENEFICIALLY PERCENTAGE OF
NAME AND ADDRESS OF BENEFICIAL OWNER OWNED(1) OWNERSHIP
- ------------------------------------ ---------------- ----------------
FMR Corp. 561,200 11.1%
82 Devonshire Street
Boston, MA 02109
The Kaufmann Fund 500,000 9.9%
140 E. 45th Street, 43rd Floor
New York, NY 10017
Hathaway & Associates, Ltd. 440,000 8.7%
119 Rowayton Avenue
Rowayton, CT 06853
David V. Radlinski(2)(3) 276,648 5.3%
100 Columbia, Suite 100
Aliso Viejo, CA 92656
Mark Selawski(3) 40,847(5) (10)
100 Columbia, Suite 100
Aliso Viejo, CA 92656
Eva Novotny(3) 19,800 (10)
100 Columbia, Suite 100
Aliso Viejo, CA 92656
Donald J. Regan(2) 17,996(7) (10)
462 Stevens Avenue, Suite 308
Solana Beach, CA 92075
Frank R. Pope(2) 10,590(8) (10)
25 Preston Road
Woodside, CA 94062
Michael C. Tibbitts(2) 8,757(9) (10)
27001 La Paz Road, Suite 448B
Mission Viejo, CA 92691
All executive officers and directors
as a group (6 persons)(11) 374,638 7.02%
- ---------------
(1) All such shares were held of record with sole voting and investment
power, subject to applicable community property laws, by the named
individual and/or by his wife, except as indicated in the following
footnotes.
(2) Director of the Company. (3) Executive officer of the Company.
(4) Includes 187,500 shares issuable upon exercise of presently outstanding
stock options.
(5) Includes 36,667 shares issuable upon exercise of presently outstanding
stock options.
(6) Includes 19,000 shares issuable upon exercise of presently outstanding
stock options.
(7) Includes 11,396 shares issuable upon exercise of presently outstanding
stock options.
(8) Includes 8,590 shares issuable upon exercise of presently outstanding
stock options.
(9) Includes 6,757 shares issuable upon exercise of presently outstanding
stock options.
(10) Percentage information is omitted because the beneficially owned shares
represent less than 1% of the outstanding shares of the Company's Common
Stock
(11) Includes 269,910 shares issuable upon exercise of presently outstanding
stock options.
23
26
ITEM 13. CERTAIN RELATIONSHIPS AND INVESTMENTS
CARDIAC SCIENCE, INC.
During 1991, the Company was a party to the formation of Cardiac
Science, Inc., for which the Company purchased 5,353,031 (pre-split) shares of
common stock, for a cash payment of $.0016 per share. This purchase represented
77.3% of the outstanding stock. As of July 8, 1991, the Company distributed, as
a dividend to its shareholders of record on that date, one share of Cardiac
Science, Inc. stock for each share of Medstone stock held. The Company retained
629,768 (pre-split) shares of common stock of Cardiac Science, Inc.
From 1991 through 1996, the Company performed various financings for
Cardiac Science and received warrants to purchase Cardiac Science common stock.
Due to exercise of warrants, common stock issued in lieu of interest and
unsecured advances, the Company received 5,619,054 (pre-split) shares of Cardiac
Science.
In April 1997, Cardiac Science effectuated a 1 for 11.42857143 reverse
stock split, reducing the Company's holdings to 546,772 shares, which is the
number of shares held at December 31, 1998. This investment is recorded at a
cost of $750,054.
The Company also holds warrants to purchase 87,500 (post-split) shares
at $.011 each, with an expiration date of September 2004.
DIGITAL IMAGING SYSTEMS, INC.
In 1998, the Company entered into a supply agreement with Digital
Imaging Systems, Inc. ("DIS") for components integral in the Company's new
transportable lithotripsy product. The Company has purchased $300,000, or
300,000 shares, of DIS preferred stock, which represents a 14% ownership
interest. DIS has commenced shipments to the Company as of January 1999. The
Company considers this investment to be temporary in nature.
K. BIOTECH
In 1998, the Company was made aware of an opportunity to invest in a
developmental biotech drug company catering to the members of the International
Centre for Genetic Engineering and Biotechnology ("ICGEB"), a United Nations
sponsored institute. k. Biotech purchased license agreements for formulas,
developed by the ICGEB, for commercialization purposes in the Indian
sub-continent as its primary market. The Company has purchased $225,000 of
preferred stock to assist k. Biotech in establishing itself as a viable business
entity. Two of the Company's directors, Mssrs. Pope and Regan, are investors in
k.Biotech and Mr. Regan serves as k. Biotech's President. Additional funding
from international sources is currently being evaluated.
CHINESE JOINT VENTURE
The Company, along with Acuity International ("Acuity") and Phenix
Optical Ltd ("Phenix"), a Chinese company, created a joint venture, in March
1998, to provide lithotripsy services to inland Chinese areas. Each entity was a
1/3 owner of the joint venture. The Company recognized a gain of $105,000 on its
contribution of equipment to the joint venture in the first quarter of 1998, and
recorded its investment of $92,000 as other assets. In November 1998, a purchase
of the 2/3 ownership, not owned by Phenix, was proposed. In December 1998,
documents were drawn to turn ownership over to Phenix in return for delivery of
optical products to both Acuity and the Company. Subsequent to December 31,
1998, the Company received its optical products in release of its share in the
joint venture and final release documents are being processed. The Company is
carrying the value of the optical products at their estimated fair value, which
is the same value as its investment established in the joint venture, with the
intention of remarketing these products in 1999.
24
27
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
----
1. Consolidated Financial Statements
Report of Independent Auditors.......................................26
Consolidated Balance Sheets at December 31, 1998 and
1997.............................................................27
Consolidated Statements of Operations for the years
ended December 31, 1998, 1997 and 1996...........................28
Consolidated Statements of Stockholders' Equity for the
years ended December 31, 1998, 1997 and 1996.....................29
Consolidated Statements of Cash Flows for the years
ended December 31, 1998, 1997 and 1996...........................30
Notes to Consolidated Financial Statements...........................31
2. Schedule to Consolidated Financial Statements
Schedule II - Valuation and Qualifying Accounts......................43
All other schedules are omitted because they are not
applicable or the required information is included in
the consolidated financial statements or notes thereto.
(b) REPORTS ON FORM 8-K
There were no reports on Form 8-K filed with the Commission
during the quarter ended December 31, 1998.
(c) EXHIBITS
EXHIBIT NO. DESCRIPTION
----------- -----------
3.1 Certificate of Incorporation of the Company, as amended(1)
3.2 Bylaws of the Company(1)
3.3 Amendment of ByLaws(2)
4.2 Specimen Certificate of the Company's Common Stock(3)
10.26 1989 Stock Incentive Plan(4)(5)
10.27 Non-employee Director Stock Option Plan(4)(5)
10.28 Facility Lease on 100 Columbia(6)
10.29 1997 Stock Incentive Plan(5)(7)
10.30 Employment Agreement with David Radlinski(5)
10.31 Employment Agreement with Mark Selawski(5)
10.32 Employment Agreement with Eva Novotny(5)
21 Subsidiaries
23.1 Consent of Independent Auditors
27 Financial Data Schedule
28.2 Form of Cytocare, Inc. Information Statement - Distribution to
Shareholders of Stock of Cardiac Science, Inc.(8)
28.3 Form of Medstone International, Inc. Information Statement -
Distribution to Shareholders of Stock of Endocare, Inc. and Urogen Corp.(9)
- --------------
(1) Previously filed with the same exhibit number with the Company's
Registration Statement on Form S-1 under the Securities Act of 1933,
Reg. No 33-16340 and with the Company's Quarterly Report on Form 10-Q
for the quarter ended June 30, 1988, and incorporated herein by
reference.
(2) Previously filed with the same exhibit number with the Company's
Registration Statement on Form 10-Q for the quarter ended September 30,
1997, and incorporated herein by reference.
(3) Previously filed with the same exhibit number with the Company's
Registration Statement on Form S-1 under the Securities Act of 1933,
Reg. No. 33-16340 and incorporated herein by reference.
(4) Previously filed with the same exhibit number with the Company's
Quarterly Report on Form 10-Q for the quarter ended June 30, 1989, and
incorporated herein by reference.
(5) Compensatory plan or arrangement.
(6) Previously filed with the same exhibit number with the Company's annual
report on Form 10-K for the year ended December 31, 1993.
(7) Previously filed with the same exhibit number with the Company's
Quarterly Report on Form 10-Q for the quarter ended June 30, 1997.
(8) Previously filed with the same exhibit number with the Company's current
report on Form 8-K dated June 26, 1991, and incorporated herein by
reference.
(9) Previously filed with the Company's current report on Form 8-K dated
February 9, 1996, and incorporated herein by reference.
The Company will furnish to a requesting beneficial owner of its securities a
copy of any such exhibits upon payment of a fee equal to $.20 per exhibit page.
25
28
Report of Independent Auditors
Stockholders and Board of Directors
Medstone International, Inc.
We have audited the accompanying consolidated balance sheets of Medstone
International, Inc. as of December 31, 1998 and 1997, and the related
consolidated statements of operations, stockholders' equity, and cash flows for
each of the three years in the period ended December 31, 1998. Our audits also
included the financial statement schedule listed in the Index at Item 14(a).
These financial statements and schedule are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements and schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of
Medstone International, Inc. at December 31, 1998 and 1997, and the consolidated
results of its operations and its cash flows for each of the three years in the
period ended December 31, 1998, in conformity with generally accepted accounting
principles. Also, in our opinion, the related financial statement schedule, when
considered in relation to the basic financial statements taken as a whole,
presents fairly in all material respects the information set forth therein.
ERNST & YOUNG LLP
Orange County, California
February 11, 1999
26
29
MEDSTONE INTERNATIONAL, INC.
CONSOLIDATED BALANCE SHEETS
DECEMBER 31,
-------------------------------
1998 1997
------------ ------------
ASSETS
Current assets:
Cash and cash equivalents $ 1,128,463 $ 1,125,009
Short-term investments 10,494,075 9,900,909
Accounts receivable, less allowance for doubtful accounts of
$602,564 and $534,918 in 1998 and 1997, respectively 3,535,581 3,120,787
Inventories 3,595,906 2,680,220
Deferred tax assets 1,139,903 891,507
Income taxes receivable -- 632,851
Prepaid expenses and other current assets 719,598 455,974
------------ ------------
Total current assets 20,613,526 18,807,257
Property and equipment:
Lithotripters 9,054,296 8,524,314
Equipment 1,077,352 815,585
Furniture and fixtures 788,457 821,565
Leasehold improvements 145,007 138,698
------------ ------------
11,065,112 10,300,162
Less accumulated depreciation and amortization (6.362,955) (4,721,618)
------------ ------------
Net property and equipment 4,702,157 5,578,544
------------ ------------
Goodwill, net 3,182,096 3,266,162
Other assets, net 651,494 36,425
------------ ------------
$ 29,149,273 $ 27,688,388
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 389,589 $ 887,740
Accrued expenses 485,108 210,421
Accrued income taxes 183,593 --
Accrued payroll expenses 303,687 239,504
Customer deposits 86,125 132,699
Deferred revenue 733,889 1,080,899
------------ ------------
Total current liabilities 2,181,991 2,551,263
Deferred tax liabilities 714,737 649,524
Minority interest 319,868 366,654
Commitments and contingencies (Notes 8 and 9)
Stockholders' equity:
Common stock - $.004 par value, 20,000,000 shares authorized, 5,650,505 and
5,578,403 shares issued and outstanding at
December 31, 1998 and 1997, respectively 22,602 22,539
Additional paid-in capital 19,076,104 18,998,260
Accumulated earnings 11,778,357 7,436,263
Stock purchase notes receivable -- (134,800)
Accumulated other comprehensive loss (1,177) (579)
Treasury stock 587,100 shares at cost at December 31,
1998 and 268,800 shares at December 31, 1997 (4,943,209) (2,200,736)
------------ ------------
Total stockholders' equity 25,932,677 24,120,947
------------ ------------
$ 29,149,273 $ 27,688,388
============ ============
See accompanying notes
27
30
MEDSTONE INTERNATIONAL, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEAR ENDED DECEMBER 31,
--------------------------------------------------
1998 1997 1996
------------ ------------ ------------
Revenues:
Procedures and maintenance fees,
and management fees $ 21,128,586 $ 18,476,342 $ 14,883,598
Net equipment sales 2,144,500 2,722,360 2,420,000
Interest and dividend income 551,723 535,601 675,967
------------ ------------ ------------
Total revenues 23,824,809 21,734,303 17,979,565
Costs and expenses:
Costs related to procedures
and maintenance fees 9,098,822 7,463,418 6,710,645
Cost of equipment sales 1,900,803 2,040,031 1,298,427
Research and development 1,078,792 1,021,349 521,793
Selling 1,988,331 2,256,933 2,145,759
General and administrative 2,131,373 2,231,006 1,666,164
Lawsuit settlement costs -- -- 5,500,000
Legal and other (income)/expense (61,045) (39,327) 402,673
------------ ------------ ------------
Total costs and expenses 16,137,076 14,973,410 18,245,461
------------ ------------ ------------
Income (loss) before provision/
(benefit) for income taxes 7,687,733 6,760,893 (265,896)
Minority interest in subsidiary income 627,639 467,595 142,575
Provision (benefit) for income taxes 2,718,000 2,329,000 (170,000)
------------ ------------ ------------
Net income (loss) $ 4,342,094 $ 3,964,298 $ (238,471)
============ ============ ============
Net income (loss) per share:
Basic $ .84 $ .74 $ (.04)
============ ============ ============
Diluted .82 $ .72 $ (.04)
============ ============ ============
Number of shares used in the computation of
net income (loss) per share:
Basic 5,162,112 5,390,352 5,517,976
============ ============ ============
Diluted 5,286,967 5,510,668 5,517,976
============ ============ ============
See accompanying notes
28
31
MEDSTONE INTERNATIONAL, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
COMMON STOCK
--------------------- ADDITIONAL ACCUMULATED
NUMBER OF PAID-IN EARNINGS
SHARES AMOUNT CAPITAL (DEFICIT)
---------- ------- ----------- ------------
BALANCE AT DECEMBER 31, 1995 5,516,528 $22,066 $18,555,983 $ 3,710,436
Net loss -- -- -- (238,471)
Other comprehensive income/(loss):
Unrealized loss on short-term
investments -- -- -- --
Total Comprehensive income/(loss)
Common stock options exercised 61,875 248 96,085 --
Income tax benefit from stock options -- -- 63,000 --
Treasury stock repurchased (112,800) -- -- --
---------- ------- ----------- ------------
BALANCE AT DECEMBER 31, 1996 5,465,603 22,314 18,715,068 3,471,965
Net income -- -- -- 3,964,298
Other comprehensive income/(loss):
Unrealized gain on short-term
investments -- -- -- --
Total Comprehensive income/(loss)
Common stock options exercised 56,385 225 283,192 --
Income tax benefit from stock options -- -- -- --
Treasury stock repurchased (156,000) -- -- --
---------- ------- ----------- ------------
BALANCE AT DECEMBER 31, 1997 5,365,988 22,539 18,998,260 7,436,263
Net income -- -- -- 4,342,094
Other comprehensive income/(loss):
Unrealized loss on short-term
investments -- -- -- --
Total Comprehensive income/(loss)
Common stock options exercised 15,717 63 77,844 --
Repayment of stock purchase note -- -- -- --
Treasury stock repurchased (318,300) -- -- --
---------- ------- ----------- ------------
BALANCE AT DECEMBER 31, 1998 5,063,405 $22,602 $19,076,104 $ 11,778,357
========== ======= =========== ============
ACCUMULATED
STOCK PURCHASE OTHER
NOTE COMPREHENSIVE TREASURY
RECEIVABLE INCOME (LOSS) STOCK TOTAL
-------------- ------------- -------- ------------
BALANCE AT DECEMBER 31, 1995 $(134,800) $ 3,543 $ -- $ 22,157,228
Net loss -- -- -- (238,471)
Other comprehensive income/(loss):
Unrealized loss on short-term
investments -- (4,711) -- (4,711)
------------
Total Comprehensive income/(loss) (243,182)
------------
Common stock options exercised -- -- -- 96,333
Income tax benefit from stock options -- -- -- 63,000
Treasury stock repurchased -- -- (908,370) (908,370)
--------- ------- ----------- ------------
BALANCE AT DECEMBER 31, 1996 (134,800) (1,168) (908,370) 21,165,009
Net income -- -- -- 3,964,298
Other comprehensive income/(loss):
Unrealized gain on short-term
investments -- 589 -- 589
------------
Total Comprehensive income/(loss) 3,964,887
------------
Common stock options exercised -- -- -- 283,417
Income tax benefit from stock options -- -- -- --
Treasury stock repurchased -- -- (1,292,366) (1,292,366)
--------- ------- ----------- ------------
BALANCE AT DECEMBER 31, 1997 (134,800) (579) (2,200,736) 24,120,947
Net income -- -- -- 4,342,094
Other comprehensive income/(loss):
Unrealized loss on short-term
investments -- (598) -- (598)
------------
Total Comprehensive income/(loss) 4,341,496
------------
Common stock options exercised -- -- -- 77,907
Repayment of stock purchase note 134,800 -- -- 134,800
Treasury stock repurchased -- -- (2,742,473) (2,742,473)
--------- ------- ----------- ------------
BALANCE AT DECEMBER 31, 1998 $ -- $(1,177) $(4,943,209) $ 25,932,677
========= ======= =========== ============
See accompanying notes
29
32
MEDSTONE INTERNATIONAL, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEAR ENDED DECEMBER 31,
--------------------------------------------
1998 1997 1996
------------ ------------ ------------
Cash flows from operating activities:
Net income (loss) $ 4,342,094 $ 3,964,298 $ (238,471)
Adjustments to reconcile net income (loss) to net
cash provided by operating activities:
Depreciation and amortization 1,946,746 1,613,385 1,244,840
Provision for doubtful accounts 130,000 251,000 60,000
Provision for excess inventories -- -- (136,884)
Minority interest in partnership 627,639 467,595 142,575
Changes in operating assets and liabilities:
Accounts receivable (544,794) (684,802) (934,923)
Inventories (915,686) (220,441) (777,557)
Deferred taxes (183,183) 427,017 (94,000)
Note receivable -- 1,250,000 (1,250,000)
Prepaid expenses and other (263,624) (298,974) 355,207
Accounts payable (498,151) (873,182) 1,356,997
Accrued expenses 274,687 909 (25,753)
Accrued income taxes 816,444 (922,752) 251,608
Accrued payroll expenses 64,183 (98,957) 132,341
Deferred revenue (347,010) 38,856 317,411
Customer deposits (46,574) 132,699 --
Other, net 124,616 10,862 (211,912)
------------ ------------ ------------
Net cash provided by operating activities 5,527,387 5,057,513 191,479
------------ ------------ ------------
Cash flows from investing activities:
Purchases of investments available for sale (25,798,243) (42,258,678) (16,918,215)
Proceeds from sales of investments available for sale 25,205,077 39,460,528 24,306,051
Investments in non-public companies (617,369) -- --
Purchase of subsidiary -- (2,300,000) (1,350,000)
Investment by minority in partnership -- 193,179 (162,028)
Distribution of minority interest (676,800) (328,000) (64,403)
Purchases of property and equipment (1,106,832) (1,597,545) (3,392,627)
------------ ------------ ------------
Net cash provided by (used in)
investing activities (2,994,167) (6,830,516) 2,418,778
------------ ------------ ------------
Cash flows from financing activities:
Proceeds from issuance of common stock 77,907 283,417 96,333
Proceeds from stock purchase note 134,800 -- --
Purchase of treasury stock (2,742,473) (1,292,366) (908,370)
Dividends paid -- -- (1,000,000)
------------ ------------ ------------
Net cash used in financing activities (2,529,766) (1,008,949) (1,812,037)
Net increase (decrease) in cash and cash equivalents 3,454 (2,781,952) 798,220
Cash and equivalents at beginning of year 1,125,009 3,906,961 3,108,741
------------ ------------ ------------
Cash and equivalents at end of year $ 1,128,463 $ 1,125,009 $ 3,906,961
============ ============ ============
Supplemental cash flow disclosures:
Cash paid during the year for:
Income taxes $ 2,588,819 $ 2,911,351 $ 554,136
============ ============ ============
See accompanying notes
30
33
MEDSTONE INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998
1. ORGANIZATION AND OPERATIONS OF THE COMPANY
Medstone International, Inc. ("Medstone" or "the Company"), designs,
manufactures and markets the Medstone STSTM Shockwave Therapy System (the
"System") for the noninvasive disintegration of kidney stones in human patients.
The Company also generates revenues from use of the System under procedure fees
and fee for service arrangements and from repairs and maintenance. The Company
operations occur mainly with customers located in the United States.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of consolidation
The consolidated financial statements include the accounts of the
Company, United Physicians Resources, an 80% owned physicians practice
management operation, incorporated in June 1996, Northern Nevada Lithotripsy
Associates, LLC, a 60% owned Nevada Limited Liability Company, Southern Idaho
Lithotripsy Associates, LLC, a California Limited Liability Company, also 60%
owned, (See Note 3), and Medstone Sales Corporation, a 100% owned foreign sales
corporation. All majority-owned subsidiaries are consolidated and all material
intercompany accounts and transactions are eliminated. Investments in less than
20% owned affiliates are accounted for on the cost method, unless the Company is
able to exercise significant influence over the affiliates operating and
financial policies, in which case the investments are accounted for on the
equity method.
Reclassifications
Certain prior year balances have been reclassified to conform with the
December 31, 1998 presentation.
Use of estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities at the
date of the financial statements and the reported amounts of revenue and
expenses during the reporting period. Actual results could differ from those
estimates. Significant estimates made in preparing these financial statements
include the allowance for doubtful accounts.
Statement of cash flows
The Company considers all highly liquid investments with a maturity of
three months or less when purchased to be cash equivalents.
The Company had net non-cash transfers of inventory into fixed assets of
$0, $250,000 and $1,376,000 for the years ended December 31, 1998, 1997 and
1996, respectively.
The Company had net non-cash transfers of accounts receivable,
inventory, prepaid expenses, fixed assets, accounts payable, accrued expenses
and deferred revenue totaling $966,000 in 1996 in the form of a dividend as a
result of the spinout of the Endocare, Inc. and Urogen, Inc. subsidiaries.
31
34
Short-term Investments
The Company applies the provisions of Statement of Financial Accounting
Standards No. 115, "Accounting for Certain Investments in Debt and Equity
Securities" to its short-term investments. Under this statement, management
determines the appropriate classification of such securities at the time of
purchase and reevaluates such classification as of each balance sheet date.
Based on its intent, the Company's investments are classified as
available-for-sale and are carried at fair value, with unrealized gains and
losses, net of tax, reported as a separate component of stockholders' equity.
The investments are adjusted for amortization of premiums and discounts to
maturity and such amortization is included in interest income. Realized gains
and losses and declines in value judged to be other than temporary are
determined based on the specific identification method and are reported in the
consolidated statements of operations.
The Company invests primarily in U.S. government securities and
corporate obligations. As of December 31, 1998 and December 31, 1997,
investments are summarized as follows:
GROSS
UNREALIZED FAIR
COST LOSS VALUE
----------- ---------- -----------
1998 U.S. Treasury Bills $10,496,037 $1,962 $10,494,075
1997 U.S. Treasury Bills $ 9,901,828 $ 919 $ 9,900,909
No gains or losses were realized in 1998 and 1997.
The amortized cost and estimated fair value of investments at December
31, 1998 by contractual maturity, are shown below. Expected maturities will
differ from contractual maturities because the issuer of the securities may have
the right to repurchase such securities.
COST FAIR VALUE
----------- -----------
Due in one year or less $10,496,037 $10,494,075
Comprehensive income
As of January 1, 1998, the Company adopted Statement of Financial
Accounting Standards No. 130, Reporting Comprehensive Income (SFAS 130). SFAS
No. 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 income or stockholders' equity. SFAS No. 130 requires
unrealized gains or losses on available-for-sale securities, which prior to
adoption were reported separately in shareholders' equity, to be included in
other comprehensive income. Prior financial statements have been reclassified to
conform to the requirements of SFAS No. 130.
Concentrations of credit risk
Financial instruments which potentially subject the Company to
concentrations of credit risk consist principally of cash and cash equivalents,
and short term investments, which are not federally insured, and accounts
receivable. The Company's short term investments consist principally of U.S.
Treasury Bills.
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35
The Company sells its products primarily to hospitals worldwide. Credit
is extended based on an evaluation of the customer's financial condition and
collateral generally is not required. The Company's ten largest customers
accounted for approximately 16% of accounts receivable at December 31, 1998.
Inventories
Inventories are stated at the lower of cost (first-in, first-out) or
market and consist of the following:
DECEMBER 31,
------------------------------
1998 1997
---------- ----------
Raw materials $2,449,877 $1,645,902
Work in process 203,540 260,773
Finished goods 942,489 773,545
---------- ----------
$3,595,906 $2,680,220
========== ==========
Property and equipment
Property and equipment are carried at cost. Depreciation and
amortization are computed on the straight-line method over the following
estimated useful lives:
Lithotripters 5 years
Equipment 5 years
Furniture and fixtures 5 years
Leasehold improvements Life of lease
Depreciation expense for the years ended December 31, 1998, 1997 and
1996 was $1,863,000, $1,538,000 and $1,223,000, respectively.
Goodwill
The Company recorded goodwill resulting from the excess of the purchase
prices of Northern Nevada and Southern Idaho over the fair market value of the
net assets. Goodwill is being amortized over a period not to exceed forty years
using the straight-line method. Accumulated amortization at December 31, 1998
and 1997 is $180,569 and $96,503, respectively.
Long-Lived Assets
Long-lived assets and certain identifiable intangibles held and used by
the Company are reviewed for impairment whenever events or changes in
circumstances indicate that the carrying amount of an asset may not be
recoverable. Based upon the Company's analysis, the Company believes no material
impairment of the carrying value of its long-lived assets, inclusive of
intangible assets, existed at December 31, 1998 and 1997. The Company's analysis
was based on a comparison of the carrying amount of such assets to the Company's
historical actual cash flows and to an estimate of future undiscounted cash
flows.
Earnings (Loss) Per Share
The Company has adopted SFAS No. 128 "Earnings Per Share," and applied
this pronouncement to all periods presented. This statement requires the
presentation of both basic and diluted net income (loss) per share for financial
statement purposes. Basic net income (loss) per share is computed by dividing
income (loss) available to common stockholders by the weighted average number of
common shares outstanding. Diluted net income (loss) per share includes the
effect of the potential shares outstanding, including dilutive stock options and
warrants using the treasury
33
36
stock method. Because the impact of options and warrants are antidilutive, there
is no difference between the loss per share amount computed for basic and
diluted purposes for 1996. All earnings (loss) per share amounts for all periods
have been restated to conform with the SFAS No. 128 requirements.
The following table sets forth the computation of earnings (loss) per
share:
YEAR ENDED DECEMBER 31,
---------------------------------------------
1998 1997 1996
---------- ----------- -----------
Numerator: Net income (loss) $4,342,094 $ 3,964,298 $ (238,471)
========== =========== ===========
Denominator for weighted
average shares outstanding 5,162,112 5,390,352 5,517,976
========== =========== ===========
Basic earnings (loss) per share $ .84 $ .74 $ (.04)
========== =========== ===========
Effect of dilutive securities:
Weighted average shares
outstanding 5,162,112 5,390,352 5,517,976
Stock options 124,855 120,316 --
---------- ----------- -----------
Denominator for diluted earnings
per share 5,286,967 5,510,668 5,517,976
========== =========== ===========
Diluted earnings (loss) per share $ .82 $ .72 $ (.04)
========== =========== ===========
Stock Compensation
The Company has elected to follow Accounting Principles Board Opinion
No. 25, Accounting for Stock Issued to Employees (APB 25) and related
Interpretations in accounting for its employee stock options because, as
discussed below, the alternative fair value accounting provided for under FASB
Statement No. 123, Accounting for Stock-Based Compensation, requires the use of
option valuation models that were not developed for use in valuing employee
stock options. Under APB 25, because the exercise price of the Company's
employee stock options equals the market price of the underlying stock on the
date of grant, no compensation expense is recognized.
To calculate the pro forma information required by Statement 123, the
Company uses the Black-Scholes option pricing model. The Black-Scholes model was
developed for use in estimating the fair value of traded options which have no
vesting restrictions and are fully transferable. In addition, option valuation
models require the input of highly subjective assumptions including the expected
stock price volatility. Because the Company's employee stock options have
characteristics significantly different from those of traded options, and
because changes in the subjective input assumptions can materially affect the
fair value estimate, in management's opinion, the existing models do not
necessarily provide a reliable single measure of the fair value of its employee
stock options.
Revenue recognition
Revenues are recognized in accordance with the underlying contractual
terms of each sale. Typically, revenue recognition requires the transfer of
title upon shipment, customer acceptance, receipt of specified down payments and
performance of all significant contractual obligations. All foreign sales
contracts are negotiated with payment terms in U.S. dollars so the Company has
no exposure to foreign currency price fluctuations.
Service and maintenance contract revenues are deferred and amortized
over the terms of the related contracts.
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37
Advertising
The Company expenses advertising costs including promotional literature,
brochures and trade shows as incurred. Advertising expense was $135,000,
$126,000 and $107,000 for the years ended December 31, 1998, 1997 and 1996,
respectively.
Business Segments
Effective January 1, 1998, the Company adopted Statement of Financial
Accounting Standards No. 131, Disclosures about Segments of an Enterprise and
Related Information (SFAS 131), which superseded Statement of Financial
Accounting Standards No. 14, Financial Reporting of Segments of a Business
Enterprise. SFAS No. 131 also establishes standards for related disclosures
about products and services, geographic areas and major customers. The adoption
of SFAS 131 did not affect results of operations or financial position, but did
affect the following disclosure of segment information.
The Company operates in two business segments, equipment sales and fees
for procedures, maintenance and management. The equipment sales segment is not
significant. The fees for procedures, maintenance and management segment
represents recurring revenue from procedure fees and fee for service
arrangements for use and the maintenance of lithotripter equipment. The
accounting policies of these segments are the same as those described in the
summary of significant accounting policies except that certain expenses, such as
amortization of certain intangibles and certain corporate expenses, are not
allocated to the segments and costs related to the class action lawsuit settled
in 1996 are not included. Asset categories used for allocation to segment
reporting include net accounts receivable, net inventory, net property and
equipment and net goodwill.
Selected financial information for the Company's reportable segments as
of and for the years ended December 31, 1998, 1997 and 1996 follows (in
thousands):
1998 1997 1996
-------- ------- -------
Revenues for reportable segment $ 21,129 $18,476 $14,884
Operating income (loss)
Reportable segment $ 7,751 $ 6,121 $ 4,572
Nonreportable segment (63) 640 1,431
-------- ------- -------
$ 7,688 $ 6,761 $ 6,003
======== ======= =======
Assets
Reportable segment $ 13,252 $13,117 $10,448
Nonreportable segment 1,764 1,529 1,340
-------- ------- -------
$ 15,016 $14,646 $11,788
======== ======= =======
Depreciation and amortization
Reportable segment $ 1,798 $ 1,517 $ 1,159
Nonreportable segment 149 96 86
-------- ------- -------
$ 1,947 $ 1,613 $ 1,245
======== ======= =======
Expenditures for long-lived assets
Reportable segment $ 864 $ 2,934 $ 3,823
Nonreportable segment 199 963 920
-------- ------- -------
$ 1,063 $ 3,897 $ 4,743
======== ======= =======
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3. ACQUISITIONS AND INVESTMENTS IN JOINT VENTURES
Purchase of Northern Nevada
The Company acquired, in the second quarter of 1996, a 60% interest in
Northern Nevada, an operator of a "retail" lithotripsy operation which bills
patients or insurers for their services. The assets acquired, accounted for on
the purchase method, consisted of the accounts receivable and contracts to
provide service to insurers. The Company acquired this 60% interest for $1.35
million cash. The operating results of Northern Nevada are included in the
consolidated financial statements of the Company since April 1, 1996.
Purchase of Southern Idaho
On March 18, 1997, the Company completed the acquisition of a 60%
interest in Southern Idaho Lithotripsy Associates, LLC, an operator of a
"retail" lithotripsy operation in southern Idaho, for a purchase price of $2.3
million in cash. The assets acquired, accounted for on the purchase method,
consisted of the accounts receivable and contracts to provide services to
insurers. The operating results of Southern Idaho are included in the
consolidated financial statements of the Company since March 1, 1997.
Digital Imaging Systems, Inc.
In 1998, the Company entered into a supply agreement with Digital
Imaging Systems, Inc. ("DIS") for components integral in the Company's new
transportable lithotripsy product. DIS commenced shipments of that product to
the Company in January 1999. The Company has purchased 300,000 shares of DIS
preferred stock for $300,000, which represents a 14% ownership interest, which
is accounted for under the cost method. The value is recorded in other assets,
and the Company considers this investment to be temporary in nature.
k. Biotech
In 1998, the Company was made aware of an opportunity to invest in a
developmental biotech drug company catering to the members of the International
Centre for Genetic Engineering and Biotechnology ("ICGEB"), a United Nations
sponsored institute. k. Biotech purchased license agreements for formulas,
developed by the ICGEB, for commercialization purposes in the Indian
sub-continent as its primary market. The Company has purchased $225,000 of
preferred stock, which represents a 15.3% ownership interest, to assist k.
Biotech in establishing itself as a viable business entity. The investment in k.
Biotech is accounted for under the equity method because the Company has the
ability to exercise significant influence over k.Biotech and is included in
other assets. k. Biotech is seeking additional funding from international
sources to finance its required investment in plant and equipment.
Chinese Joint Venture
The Company, along with Acuity International ("Acuity") and Phenix
Optical Ltd ("Phenix"), a Chinese company, created a joint venture in March 1998
to provide lithotripsy services to inland Chinese areas. Each entity was a 1/3
owner of the joint venture. The Company recorded its investment of $92,000 as
other assets. In November 1998, a purchase of the 2/3 ownership, not owned by
Phenix, was proposed. In December 1998, documents were drawn to turn ownership
over to Phenix in return for delivery of optical products to both Acuity and the
Company. Subsequent to December 31, 1998, the Company received its optical
products in release of its share in the joint venture and final release
documents are being processed. The Company estimates the resale value of the
optical products approximates the value of the investment established in the
joint venture. The Company intends to sell these products in 1999.
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39
4. INCOME TAXES
The Company provides for income taxes under the liability method.
Accordingly, deferred income tax assets and liabilities are computed for
differences between the financial statement and tax bases of assets and
liabilities that will result in taxable or deductible amounts in the future
based on enacted tax laws and rates applicable to the periods in which the
differences are expected to affect taxable income. Valuation allowances are
established when necessary to reduce deferred tax assets to amounts which are
more likely than not to be realized.
The provision (benefit) for income taxes consists of the following:
YEAR ENDED YEAR ENDED YEAR ENDED
DECEMBER 31, 1998 DECEMBER 31, 1997 DECEMBER 31, 1996
----------------- ----------------- ------------------
Current:
Federal $ 2,270,000 $ 1,454,000 $ (34,000)
State 631,000 448,000 (42,000)
----------- ----------- -----------
Total current 2,901,000 1,902,000 (76,000)
----------- ----------- -----------
Deferred:
Federal $ (153,000) 338,000 (129,000)
State (30,000) 89,000 35,000
----------- ----------- -----------
Total deferred (183,000) 427,000 (94,000)
----------- ----------- -----------
Provision (benefit) for
income taxes $ 2,718,000 $ 2,329,000 $ (170,000)
=========== =========== ===========
The following is a reconciliation of the provision (benefit) for income
taxes at the federal statutory rate compared to the Company's effective tax
rate:
YEAR ENDED YEAR ENDED YEAR ENDED
DECEMBER 31, 1998 DECEMBER 31, 1997 DECEMBER 31, 1996
----------------- ----------------- -----------------
Income tax (benefit) at the
statutory rate $ 2,400,000 $ 2,140,000 $ (139,000)
State income taxes
(net of federal benefit) 398,000 354,000 (48,000)
Other (80,000) (165,000) 17,000
----------- ----------- -----------
Provision (benefit) for
income taxes $ 2,718,000 $ 2,329,000 $ (170,000)
=========== =========== ===========
The tax effect of temporary differences that give rise to significant
portions of the deferred tax assets and deferred tax liabilities are as follows:
DECEMBER 31, 1998 DECEMBER 31, 1997
----------------- -----------------
DEFERRED TAX ASSETS (LIABILITIES):
State taxes $ 199,000 $ 150,000
Cardiac investment reserve 321,000 321,000
Inventory reserve 145,000 134,000
Bad debt reserve 204,000 223,000
Accruals not currently deductible for tax 74,000 63,000
Inventory adjustment 55,000 --
Product reserves 141,000 --
----------- -----------
Deferred tax assets 1,139,000 891,000
Depreciation and amortization (714,000) (649,000)
----------- -----------
Deferred tax liabilities (714,000) (649,000)
----------- -----------
Net deferred tax assets (liabilities) $ 425,000 $ 242,000
=========== ===========
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5. STOCK OPTIONS
In 1987, the Company adopted the 1987 Stock Option Plan (1987 Plan)
under which options could be granted to key employees or directors of the
Company by a committee appointed by the Company's Board of Directors (the
Committee) to purchase up to 476,323 shares of the Company's common stock. The
exercise price for options granted under the 1987 Plan were equal to the fair
market value of the common stock on the date of grant. During 1988 and 1989, the
Committee granted options which generally become exercisable with respect to
1/60th of the issuable shares for each elapsed month during the five-year period
commencing with dates determined by the Committee. All options granted in 1988
and 1989 terminated one year after the end of the five-year period. In June
1989, the Company terminated the 1987 Plan as to the granting of additional
options. In April 1996, the remaining options outstanding under this Plan were
exercised and the Plan is now terminated.
In June 1989, the Company's stockholders approved the 1989 Stock
Incentive Plan which provides for the granting of a variety of stock-related
securities, including shares of common stock, stock options and stock
appreciation rights to employees and other selected individuals. In May 1991,
the Company's stockholders amended the Plan to increase the number of shares
issuable to 1,593,783 and eliminated the provision for an automatic increase in
the number of shares issuable on January 1 of each year by one percent of the
then outstanding shares. In May 1997 the Company terminated the 1989 Plan as to
the granting of additional options. As of December 31, 1998, 610,052 options for
shares of common stock had been granted and remain outstanding under this plan.
In June 1989, the Company's stockholders also approved the Nonemployee
Director Stock Option Plan. This plan provides for the issuance of up to 50,000
shares of the Company's common stock upon exercise of options granted under the
plan. As of December 31, 1998, 15,000 options for shares of common stock had
been granted under this plan and 5,000 shares have been exercised. In addition,
three outside directors have each been granted separate options to purchase
15,000 shares.
In May 1997, the Company's stockholders approved the 1997 Stock
Incentive Plan which provides for the granting of a variety of stock-related
securities, including shares of common stock, stock options and stock
appreciation rights to employees and other selected individuals. The Plan allows
for the issuance of up to 800,000 shares, with increases each January 1 that the
Plan is in effect by a number of shares equal to one percent of the total number
of outstanding shares of Common Stock on that date. As of January 1, 1998 the
number of shares authorized by the plan increased to 853,660. As of December 31,
1998, 417,850 options for shares of common stock had been granted and are
outstanding under this plan.
Effective August 13, 1998, the Company repriced all outstanding options
granted under all plans with exercise prices exceeding the closing market value
of the stock on that date. Accordingly, the exercise price of these options was
reduced to $6.375 per share.
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A summary of the Company's stock option plans as of the end of 1998 and
1997 and changes during the years is presented below:
DECEMBER 31, 1998 DECEMBER 31, 1997 DECEMBER 31, 1996
---------------------------- ---------------------------- ----------------------------
WEIGHTED-AVE. WEIGHTED-AVE. WEIGHTED-AVE.
SHARES EXERCISE PRICE SHARES EXERCISE PRICE SHARES EXERCISE PRICE
---------- -------------- ---------- -------------- ---------- ---------------
Outstanding, beginning of year 970,803 $8.34 743,926 $8.22 683,748 $7.76
Granted 230,000 6.52 422,000 8.08 212,000 8.12
Exercised (15,717) 4.95 (56,385) 5.03 (61,875) 4.15
Canceled (102,184) 7.90 (138,738) 8.23 (89,947) 7.29
---------- ----- ---------- ----- ---------- -----
Outstanding, end of year 1,082,902 $6.39 970,803 $8.34 743,926 $8.22
========== ===== ========== ===== ========== =====
Available for future grants 470,810 593,000 152,04
========== ========== ==========
Exercisable at end of year 474,446 316,899 216,179
========== ========== ==========
Weighted-average fair value
of options granted during
the year $6.52 $8.02 $4.59
===== ===== =====
The following table summarizes information about stock options outstanding at
December 31, 1998:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
------------------------------------------------------ ---------------------------------
NUMBER NUMBER WEIGHTED-
RANGE OF OUTSTANDING WEIGHTED-AVERAGE WEIGHTED-AVERAGE EXERCISABLE AVERAGE
EXERCISE PRICES AT 12/31/98 EXERCISE PRICE REMAINING TERM AT 12/31/98 EXERCISE PRICE
--------------- ----------- -------------- ---------------- ----------- --------------
$ 0 to $5.47 15,035 $5.47 1.9 years 8,615 $5.47
$5.50 to $7.50 1,067,284 $6.40 3.8 years 465,248 $6.37
$8.50 to $9.50 583 $8.50 2.6 years 583 $8.50
-------------- --------- ----- --------- ------- -----
$1.31 to $9.50 1,082,902 $6.39 3.8 years 474,446 $6.65
-------------- --------- ----- --------- ------- -----
In calculating pro forma information regarding net income and net income
per share, as required by Financial Accounting Standards Board Statement No.
123, Accounting for Stock-Based Compensation, the fair value was estimated at
the date of grant using a Black-Scholes option pricing model with the following
weighted-average assumptions for the options on the Company's common stock for
the years ended December 31, 1998, 1997, and 1996, respectively: risk free
interest rates of 6%, 6%, and 6.5%; dividend yields of 0% for all periods;
volatility of the expected market prices of the Company's common stock of .542,
.316 and .543; and expected life of the options of 5.5 years for all periods.
For purposes of pro forma disclosures, the estimated fair value of the
options is amortized to expense over the options' vesting period. The Company's
proforma information for the years ended December 31, 1998, 1997 and 1996
follows (in thousands, except per share information):
YEAR ENDED DECEMBER 31,
-----------------------------------
1998 1997 1996
------ ------ ------
Pro forma net income (loss) $4,077 $3,381 $ (571)
Pro forma diluted net income
(loss) per share $ .77 $ .61 $ (.10)
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42
These pro forma amounts reflect only the cumulative effect of the
expense of options granted during the years ended December 31, 1998, 1997 and
1996, and does not give effect to options granted prior to January 1, 1995.
6. DISTRIBUTION TO SHAREHOLDERS
On February 9, 1996, the Company distributed two stock dividends,
payable to stockholders of record on the close of trading on December 29, 1995.
The two dividends represent distribution of all the assets and operations of the
Endocare and Urogen divisions of the Company. Effective with the start of
business on January 1, 1996 these two companies were no longer a part of the
Medstone operations, as Medstone distributed to its shareholders all outstanding
common stock of each company, retaining only 100,000 shares of each company.
These two companies are separate, publicly-held companies.
Medstone, as part of the distribution of Endocare, forgave intercompany
debt of $2,831,364 and contributed $500,000 in cash and net other assets of
$803,133 to Endocare. As part of the distribution of Urogen, Medstone forgave
intercompany debt of $3,888,875 and contributed $500,000 in cash and net other
assets of $163,082 to Urogen.
In October 1996, the Company liquidated its position in Endocare. The
average sales price was $5.53 per share, net of commissions, for the 100,000
shares that were owned by the Company. A $553,372 gain was recognized in the
fourth quarter of 1996.
7. STOCK REPURCHASE PLAN
On March 29, 1996, the Company announced a Stock Repurchase Program of
up to 500,000 shares of its Common Stock. In August 1998, the Company announced
an additional stock purchase plan for up to 100,000 shares of its common stock.
Both programs were fulfilled by November 1998. For the year ended December 31,
1998, the Company had repurchased a total of 318,300 shares at a total cost of
$2,742, 473 under the two repurchase programs. For the year ended December 31,
1997, the Company repurchased a total of 156,000 shares at a cost of $1,292,366.
For the year ended December 31, 1996, the Company repurchased a total of 112,800
shares at a cost of $908,370. The Company has repurchased 587,100 shares at a
total cost of $4,943,209 since the inception of the repurchase programs with all
amounts recorded as treasury stock. The Company does not have any active
repurchase programs in place as of December 31, 1998.
8. COMMITMENTS
In March 1994, the Company took occupancy of office, manufacturing,
engineering, warehouse space, and research and development laboratories under an
operating lease with an initial term of two years. Under lease extensions, the
monthly lease rate was $13,360 through February 1998 and $13,874 through
February 1999. The Company has negotiated an extension for a sixteen month
period from March 1999 to June 2000, at a monthly rate of $14,410.
The future minimum lease payments under all operating leases are as
follows:
Minimum Rental
--------------
1999 $197,000
2000 $ 91,000
2001 $ 5,000
2002 $ 3,000
Total net rent expense under all operating leases for the years ended
December 31, 1998, 1997 and 1996 was $194,000, $182,000 and $156,000,
respectively.
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9. CONTINGENCIES
In June 1996, the Company negotiated a settlement of the two related
class action lawsuits filed by two shareholders of the Company. The settlement
in the third quarter of 1996 totaled $6.0 million, with $500,000 paid by the
Company's underwriter and $5.5 million paid by the Company. The $5.5 million was
charged against earnings in the second quarter of 1996.
From time to time, the Company is subject to legal actions and claims for
personal injuries or property damage related to patients who use its products.
The Company has obtained a liability insurance policy providing coverage for
product liability and other claims. Management does not believe that the
resolution of any current proceedings will have a material financial impact on
the Company or the consolidated financial statements.
10. RELATED PARTY TRANSACTIONS
CARDIAC SCIENCE, INC.
During 1991, the Company was a party to the formation of Cardiac
Science, Inc., for which the Company purchased 5,353,031 (pre-split) shares of
common stock, for a cash payment of $.0016 per share. This purchase represented
77.3% of the outstanding stock. As of July 8, 1991, the Company distributed, as
a dividend to its shareholders of record on that date, one share of Cardiac
Science, Inc. stock for each share of Medstone stock held. The Company retained
629,768 (pre-split) shares of common stock of Cardiac Science, Inc. This
investment has been recorded at a net investment value of $0 due to Cardiac
Science's historical financial performance.
From 1991 through 1996, the Company performed various financings for
Cardiac Science and received warrants to purchase Cardiac Science common stock.
Due to exercise of warrants, common stock issued in lieu of interest and
unsecured advances the Company received 5,619,054 (pre-split) shares of Cardiac
Science.
In April 1997, Cardiac Science effectuated a 1 for 11.42857143 reverse
stock split, reducing the Company's holdings to 546,772 shares, which is the
number of shares held at December 31, 1998. This investment has been recorded at
a net investment value $0 due to Cardiac Science's historical financial
performance.
The Company also holds warrants to purchase 87,500 (post-split) shares
of Cardiac Science at $.011 each, with an expiration date of September 2004.
K. BIOTECH
During the year, the Company obtained a 15.3% ownership interest in
k.Biotech, Inc. for $225.000. Two members of the Board of Directors of the
Company are also shareholders of k.Biotech, Inc. and one member is the President
of k.Biotech.
DIGITAL IMAGING SYSTEMS
During the year, the Company obtained a 14% ownership interest in
Digital Imaging Systems, Inc. ("DIS") for $300,000 and entered into a supplier
agreement whereby the Company will purchase equipment up to $1.1 million from
DIS.
11. EMPLOYEE BENEFIT PLAN
In January 1990, the Company established a defined contribution profit
sharing 401(k) plan for all eligible employees. The plan provides for the
deferral of up to 15% of an employee's qualifying compensation under Section
401(k) of the Internal Revenue Code. Contributions by the Company may be made to
the plan at the discretion of the
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Board of Directors. During 1997, the Company's Board of Directors elected to
match employee contributions $.25 on a dollar, up to a maximum company
contribution of $2,000. In 1998 and 1997, the Company's contribution totaled
$44,430 and $37,991, respectively. No such contributions were made to the plan
during the year ended December 31, 1996.
12. MAJOR CUSTOMERS AND FOREIGN SALES
During the 12 months ended December 31, 1998 no single customer
accounted for 10% or more of total revenues and the Company derived 4% of its
total revenues from sales to foreign customers. During the year ended December
31, 1997 no single customer accounted for 10% or more of total revenues and the
Company derived 2% of its total revenues from sales to foreign customers. During
the year ended December 31, 1996, no single customer accounted for 10% of total
revenues of the Company and the Company derived 11% of its total revenues from
sales to foreign customers.
13. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
The tables below set forth selected quarterly financial information for
1998 and 1997 (in thousands, except per share amounts).
1998 1ST QUARTER 2ND QUARTER 3RD QUARTER 4TH QUARTER
- ---- ----------- ----------- ----------- -----------
Net sales $5,852 $6,268 $6,263 $5,442
Gross profit 2,964 3,441 3,425 2,995
Net income 956 1,195 1,273 918
Basic earnings
per share $ .18 $ .23 $ .25 $ .18
1997 1ST QUARTER 2ND QUARTER 3RD QUARTER 4TH QUARTER
- ---- ----------- ----------- ----------- -----------
Net sales $4,962 $5,665 $5,655 $5,452
Gross profit 2,692 3,329 3,353 2,857
Net income 860 1,022 1,150 932
Basic earnings
per share $ .16 $ .19 $ .21 $ .17
14. SUBSEQUENT EVENTS
On February 17, 1999, the Company announced that it had retained J.P.
Morgan Securities, Inc. to advise the Company with respect to strategic
alternatives to the Company's current business plan. These strategic plans
include, but are not limited to, acquisitions, partnerships, or sale of all or
part of the Company's assets or operations. Any or all of these plans could have
a material effect on the financial position, results of operations, or cash
flows of the Company in future operating periods.
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MEDSTONE INTERNATIONAL, INC.
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
ADDITIONS
-----------------------------
BALANCE AT CHARGED TO CHARGED TO BALANCE AT
BEGINNING COSTS AND OTHER END
DESCRIPTION OF YEAR EXPENSES ACCOUNTS DEDUCTIONS OF YEAR
---------- ---------- ---------- ---------- ---------
FOR THE YEAR ENDED
DECEMBER 31, 1998:
Allowance for
doubtful accounts $534,918 $ 130,000 $ $ 62,354(c) $ 602,564
======== ========== ========= ========= =========
Allowance for
inventory obsolescence $337,437 $ -- $ -- $ -- $ 337,437
======== ========== ========= ========= =========
Allowance for
related party loan $ 0 $ -- $ -- $ -- $ 0
======== ========== ========= ========= =========
Allowance for investment
in related party $750,054 $ -- $ -- $ -- $ 750,054
======== ========== ========= ========= =========
FOR THE YEAR ENDED
DECEMBER 31, 1997:
Allowance for
doubtful accounts $220,312 $ 251,000 $ 66,606 $ 3,000(c) $ 534,918
======== ========== ========= ========= =========
Allowance for
inventory obsolescence $440,000 $ -- $ -- $ 102,563(b) $ 337,437
======== ========== ========= ========= =========
Allowance for
related party loan $ 0 $ -- $ -- $ -- $ 0
======== ========== ========= ========= =========
Allowance for investment
in related party $750,054 $ -- $ -- $ -- $ 750,054
======== ========== ========= ========= =========
FOR THE YEAR ENDED
DECEMBER 31, 1996:
Allowance for
doubtful accounts $207,260 $ 60,000 $ -- $ 46,948(a) $ 220,312
======== ========== ========= ========= =========
Allowance for
inventory obsolescence $576,884 $ (136,884) $ -- $ -- $ 440,000
======== ========== ========= ========= =========
Allowance for
related party loan $109,672 $ -- $ -- $ 109,672(d) $ 0
======== ========== ========= ========= =========
Allowance for investment
in related party $643,000 $ -- $ -- $(107,054)(d) $ 750,054
======== ========== ========= ========= =========
- ----------
(a) Reserve transferred to Endocare with the spinout.
(b) Write-off of inventory
(c) Write-off of bad debt
(d) Reserve transferred from loan provision to investment provision due to
restructuring.
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SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of Securities
Exchange Act of 1934, the Registrant has duly caused this Report to be signed on
its behalf by the undersigned, thereunto duly authorized.
MEDSTONE INTERNATIONAL, INC.
By: DAVID V. RADLINSKI
------------------------------------
David V. Radlinski
Chief Executive Officer
Dated: March 26, 1999
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
Registrant and in the capacities indicated on March 26, 1999.
SIGNATURE TITLE
--------- -----
DAVID V. RADLINSKI Chairman of the Board,
----------------------------- Chief Executive Officer
David V. Radlinski and Director
(Principal Executive Officer)
MARK SELAWSKI Chief Financial Officer
----------------------------- (Principal Financial and
Mark Selawski Accounting Officer)
DONALD J. REGAN Director
-----------------------------
Donald J. Regan
FRANK R. POPE Director
-----------------------------
Frank R. Pope
MICHAEL C. TIBBITTS Director
-----------------------------
Michael C. Tibbitts
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EXHIBIT INDEX
EXHIBIT NUMBER DESCRIPTION
- -------------- -----------
10.30 Employment Agreement with David Radlinski
10.31 Employment Agreement with Mark Selawski
10.32 Employment Agreement with Eva Novotny
21 Subsidiaries
23.1 Consent of Independent Auditors
27 Financial Data Schedule
45