-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, AO/jREYeHTWpHCSnTu8shU9dZypgm2c23YXheqvRUwUSK45CONQ1rsqRW0+d3WNp g3sLCnulgid47cYun1tRug== 0000950134-97-002374.txt : 19970329 0000950134-97-002374.hdr.sgml : 19970329 ACCESSION NUMBER: 0000950134-97-002374 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 15 CONFORMED PERIOD OF REPORT: 19961231 FILED AS OF DATE: 19970328 SROS: NONE FILER: COMPANY DATA: COMPANY CONFORMED NAME: QUEST MEDICAL INC CENTRAL INDEX KEY: 0000351721 STANDARD INDUSTRIAL CLASSIFICATION: SURGICAL & MEDICAL INSTRUMENTS & APPARATUS [3841] IRS NUMBER: 751646002 STATE OF INCORPORATION: TX FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 000-10521 FILM NUMBER: 97567585 BUSINESS ADDRESS: STREET 1: ONE ALLENTOWN PKWY CITY: ALLEN STATE: TX ZIP: 75002 BUSINESS PHONE: 2143909800 MAIL ADDRESS: STREET 1: ONE ALLENTOWN PARKWAY CITY: ALLEN STATE: TX ZIP: 75002 10-K 1 FORM 10-K FOR YEAR ENDED DECEMBER 31, 1996 1 ================================================================================ SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 ------------------------ FORM 10-K [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 1996 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: 0-10521
------------------------ QUEST MEDICAL, INC. (Exact name of registrant as specified in its charter) TEXAS 75-1646002 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 201 ALLENTOWN PARKWAY, ALLEN, TEXAS 75002 (Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (972) 390-9800 SECURITIES REGISTERED UNDER SECTION 12(B) OF THE EXCHANGE ACT:
TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED ------------------- ----------------------------------------- NONE NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE EXCHANGE ACT: TITLE OF CLASS ----------- Common Stock, $.05 Par Value ------------------------ Indicate by checkmark 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 the S-K is not contained herein, and will not be contained, to the best of 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 10-K. [ ] Aggregate market value of the registrant's Common Stock held by non-affiliates of the registrant as of March 21, 1997:$51,514,600. Number of shares outstanding of the registrant's Common Stock as of March 21, 1997: 8,353,938 ------------------------ DOCUMENTS INCORPORATED BY REFERENCE PORTIONS OF THE REGISTRANT'S DEFINITIVE PROXY STATEMENT FOR THE REGISTRANT'S ANNUAL MEETING OF STOCKHOLDERS TO BE HELD ON JUNE 25, 1997, ARE INCORPORATED BY REFERENCE INTO PART III. ================================================================================ 2 QUEST MEDICAL, INC. ANNUAL REPORT FORM 10-K YEAR ENDED DECEMBER 31, 1996 PART I ITEM 1. BUSINESS GENERAL Quest Medical, Inc., a Texas corporation ("Quest" or the "Company"), designs, develops, manufactures and markets a variety of healthcare products used primarily in cardiovascular surgery, neurostimulation and intravenous fluid delivery applications. The Company operates several stable product lines, including cardiovascular products (such as pressure control valves, filters and surgical retracting tapes), specialized intravenous fluid delivery tubing sets and accessories and pressure monitoring kits used primarily in labor and delivery. The Company has levered these product lines, its existing corporate infrastructure and its core competencies in manufacturing, engineering and regulatory affairs to develop the Quest MPS(R) myocardial protection system, an innovative and sophisticated system designed to manage the delivery of solutions to the heart during open-heart surgery. In addition, the Company, during 1995, entered the neurostimulation market by acquiring Neuromed, Inc. ("Neuromed"), which designs, develops, manufactures and markets a line of electronic spinal cord stimulation ("SCS") devices used to manage chronic severe pain. In November 1996, the Company merged Neuromed into a newly formed subsidiary, Advanced Neuromodulation Systems, Inc., a Texas corporation ("ANS"). References to "Quest" or the "Company" in this Form 10-K include ANS, unless otherwise indicated. In 1991, Quest acquired two companies that manufactured and marketed various cardiovascular products, enhancing the Company's presence in the cardiovascular products marketplace. In 1992, Quest identified a need in this marketplace for an automated and integrated myocardial protection system that would be versatile, easy to use, efficient to monitor and cost-effective. Myocardial protection is the process of arresting and caring for the heart during open-heart surgery. The Quest MPS system is designed to integrate key functions relating to the delivery of solutions to the heart such as varying the rate and ratio of oxygenated blood, crystalloid, potassium and other additives, and controlling temperature, pressure and other variables to allow simpler, more flexible and cost-effective management of this process. The MPS system employs advanced pump, temperature control and microprocessor technologies and includes a line of captive and noncaptive disposable products. The Company received 510(k) market clearance for its MPS system from the FDA in March 1996, and shortly thereafter began clinical validation of the system, which was completed during July 1996. The Company began commercial shipment of MPS in the U.S. during September 1996. In its continuing effort to expand into potentially high growth niche markets in the medical device industry, the Company acquired Neuromed in March 1995. SCS is gaining acceptance as a viable, efficacious and cost-effective treatment alternative to repeat back surgeries for relieving chronic severe back pain. The Company believes that its CompuStim products, which are powered by radio frequency transmitters external to the body, are the technological leaders in the field. The Company in 1996 test marketed PainDoc, a pen-based computer system that works in tandem with the Company's CompuStim devices to assist physicians and their patients in optimizing the performance of the Company's SCS devices both pre- and post-operatively. The Company anticipates full U.S. market release of PainDoc in 1997. Since its founding in 1979, the Company has developed, manufactured and marketed specialized intravenous fluid delivery tubing sets and accessories sold primarily to major hospitals in the United States. Over the last several years, the revenues generated by this product line, a substantial component of the Company's historical base business, have significantly aided the funding of the Company's research and development efforts. The Company manufactures and markets about 50 distinct models of specialized intravenous fluid delivery tubing sets. 1 3 PRODUCTS The following table summarizes certain information with respect to the Company's principal products in commercial distribution.
PRODUCTS DESCRIPTION/USE -------- --------------- Neuromodulation SCS CompuStim Devices Neurostimulation devices used to relieve chronic pain PainDoc(R) Pen-based computer system used to optimize the performance of the Company's implanted SCS devices both pre- and post-operatively Cardiovascular Pressure Control Valves Pressure control valves used during open-heart surgery Arterial Line Filters and Bubble Traps Filters and traps used to remove potentially dangerous air and other matter from the blood during open-heart surgery Retract-O-Tape(R) Surgical tubes used to retract and occlude blood vessels during open-heart surgery MPS System and Related Disposables Cardioplegia delivery system and related fluid delivery catheters and delivery sets Intravenous Fluid Delivery Multiport(R) Sets Intravenous administration sets that allow multiple drug infusions Anesthesia Sets Intravenous administration sets that allow needleless "port" administration Other Intrauterine Pressure Catheters and transducers used to assess Catheters/Transducers the frequency, duration and intensity of contractions during high risk labor
NEUROMODULATION Background. SCS devices employ neurostimulation, the process of electrically stimulating the spinal cord to reduce chronic severe neuropathic (as opposed to acute) pain by "masking" the pain signals sent to the brain. Neuropathic pain usually arises from nerve damage. SCS device implantation manages the pain associated with failed back syndrome (resulting from certain spinal disorders or unsuccessful spinal cord surgery), peripheral neuropathy, phantom limb or stump pain, ischemic pain and reflex sympathetic dystrophy. The market for SCS devices is currently divided between RF-coupled devices, which use an external power source, and fully implantable systems known as internal pulse generator ("IPG") devices. The Company believes that lPG devices currently account for a substantial majority of the number of SCS procedures performed, with RF-coupled devices accounting for the remainder. The Company designs, develops, manufactures and markets RF-coupled SCS devices. The primary advantages of the RF-coupled device include the simple replacement or recharge of the external battery pack, and relatively lower overall cost. IPG devices provide the convenience of a completely internalized system, but involve added cost, complexity and risk because repeat surgeries are required to replace the IPG power source. Moreover, the latest generation SCS devices generally include more electrodes and dual channel receivers, both of which 2 4 consume more electrical energy than an implanted power source can practically deliver over an extended period of time. SCS Devices. The Company's SCS systems consist of three primary components: leads, a receiver and a transmitter. The leads are most commonly placed through the skin into the spinal column's epidural space. This procedure is similar to that employed by physicians to administer drugs for anesthesia and other common medical applications. Typically, one or two leads are inserted, each of which has multiple electrodes that can be used to stimulate the targeted nerve roots of the spinal cord. Each lead is then connected to the receiver, which is implanted under the skin on the side of the abdomen. The receiver contains electronics that receive RF energy and data from a source (the transmitter) outside the body, and delivers the prescribed electrical pulses to the leads. The transmitter is approximately the size of a pager, and is typically worn on a belt. Since it is external to the body, the transmitter can be easily programmed and serviced as needed, and its battery can be simply recharged or replaced. Neuromed introduced its first product, the Multiprogrammable Spinal Cord Stimulator, or Multistim@, in 1979. Since that time, Neuromed has played a significant role in the development of SCS products. Multistim incorporated a quadrapolar electrode system within a single lead, and was considered a major innovation in the field of neurostimulation because it significantly reduced surgical time, cost and risk. Since the launch of Multistim, Neuromed has developed and introduced a wide range of RF-coupled SCS systems with a variety of options to accommodate different applications and degrees of pain. The Company's recently introduced CompuStim systems include four, eight and sixteen electrode leads; specialty leads for peripheral applications; single and dual channel receivers; and rechargeable transmitters and antennae. The Company believes that the CompuStim product line's multi-electrode leads and multiprogrammable electronics technology have changed the manner in which neurostimulation is performed worldwide. For example, Neuromed's "Dual Octrode" device, a system of dual leads with eight electrodes each introduced in 1995, creates a targeted current density that appears to be especially effective in relieving chronic axial (or body trunk) pain. Previously, quadrapolar SCS systems only relieved the leg pain associated with failed back syndrome. Industry sources support the view that the Dual Octrode device provides improved pain relief to both the legs and the back. Consequently, although the Dual Octrode device has only been on the United States market since February 1995, it now accounts for approximately 59 percent of Neuromed's current product revenue and, in the Company's judgment, is the technological leader in the SCS field. The Company believes that the long term results of SCS in the treatment of pain have improved as a result of the flexibility of Neuromed's designs, epitomized by the Dual Octrode product. Moreover, the ease of use of the system has expanded the potential market for these products. Use of the Company's current SCS products in certain operating modes consumes relatively greater amounts of electrical current, reducing the operating time of the rechargeable, externally worn battery packs. In addition, certain of the Company's current SCS products have experienced switch failures attributable in significant part to a specific brand of switches. These switches were replaced by a new switch in April 1996 that have not exhibited the same problems. Patient misuse has also contributed to the switch failures. Finally, the Company's SCS products have exhibited some intermittent stimulation, which the Company believes is attributable to several factors including improper antenna placement, physicians or patients adjusting stimulation below perceptible levels, improper receiver implant placement techniques and lead movement. During 1996, the Company devoted significant engineering resources to refining and enhancing its SCS products to address these matters. While most of these enhancements were implemented during the second half of 1996, a few enhancements are being implemented during the first quarter of 1997. The Company believes these efforts have significantly improved the product quality, reliability and performance of its current SCS products. In addition, during 1996, the Company began designing and implementing improved patient and physician communications and training programs to address certain user problems. The Company expects these efforts to continue throughout 1997. The Company believes its RF-coupled SCS devices represent a strong base for penetration of the broader neuromodulation market. The Company has begun development of an IPG system and a constant rate implantable drug pump to better serve the broad needs of the pain management market. By offering an IPG 3 5 and implantable drug pump, the Company can serve the largest segment of the neuromodulation market, leverage its sales and marketing capabilities and address a number of new indications such as angina, various motor disorders, and Alzheimer's and Parkinson's disease. PainDoc. In addition to its current array of SCS devices, the Company is developing and testing PainDoc, a pen-based computer system that is designed to assist physicians and their patients in optimizing the performance of the Company's SCS devices both pre- and post-operatively. PainDoc interfaces with the Company's CompuStim transmitters to optimize SCS therapy and document treatment outcomes. PainDoc allows the physician to input information regarding the patient's description of the location and intensity of the patient's pain. The resulting "pain map" is then analyzed by the computer to assess and select the most effective stimulation sets, or combination of multi-electrode stimulation arrays, to treat the pain. The selected arrays are uploaded into the patient's CompuStim transmitter. After a trial period, the patient reports to the physician the location and level of pain relief. These trial results are uploaded back into PainDoc for the physician's objective review and analysis. The physician can visually compare the patient's pain map against a stimulation map and assess whether desired levels of pain relief have been obtained and whether excess stimulation has been delivered. This process can be effective in targeting the location of desired pain relief, reducing the patchiness of pain relief delivered by many SCS devices and reducing or eliminating overstimulation. PainDoc enables the physician to program up to 24 different stimulation sets delivering electrical stimulation every 50 milliseconds to expand pain area coverage and relief. The Company believes that PainDoc should also allow physicians to create a broad based database tool that, by using a standardized methodology, will enable physicians to share and compare outcomes data, which can then be used to deliver more efficacious pain relief to individual patients. The Company believes that PainDoc and CompuStim devices used in tandem should significantly enhance the effectiveness, flexibility and precision of managing chronic neuropathic pain. The Company expects PainDoc to promote the selection of the Company's CompuStim devices for SCS procedures, especially as SCS devices become more complex and the pain management process becomes more refined. In October 1995, the Company received 510(k) approval from the FDA to market PainDoc as an interactive medical treatment device. See Item 1: "Business -- Other Business Matters -- Government Regulation." The Company test marketed the product during 1996 and expects full U.S. market release during 1997. During the year ended December 31, 1996 and 1995, the Company's SCS products accounted for $11.4 million and $10.4 million, respectively, of total net revenue. The 1995 period includes revenue for nine months from the date of acquisition of March 31, 1995. CARDIOVASCULAR Valves, Filters and Traps. The Company manufactures and markets a line of proprietary specialized pressure control valves, pre-bypass and arterial line filters and bubble traps, which are used by the perfusionist during cardiopulmonary bypass surgery. Pressure control valves are placed in the suction line to "vent," or decompress, the heart. These valves serve a number of functions, including the maintenance of vacuum at a safe and consistent level to minimize heart muscle tissue damage, as well as the prevention of inadvertent and potentially catastrophic retrograde air flow into the heart. In 1993 and 1994, respectively, the Company introduced to the market two extensions of its pressure control valve technology, the RetroGuard valve and the PlegiaGuard valve. The RetroGuard valve is used with centrifugal pumps to prevent potential retrograde blood flow and possible air embolism. The PlegiaGuard valve is used to relieve overpressure in the cardioplegia line in the event that the line becomes inadvertently clamped or occluded. The Company's arterial line filters and bubble traps are used in the bypass circuit to remove air and other potentially dangerous matter from the blood prior to the blood's return to the patient. The Company's pre-bypass filters are used to flush the circuit external to the patient's body prior to the initiation of the bypass procedure to eliminate man-made debris within the lines. During the years ended December 31, 1996, 1995, and 1994, the Company's valves, filters and traps accounted for $5.4 million, $5.2 million, and $4.2 million, respectively, of total net revenue. 4 6 Surgical Tapes and Other Products. The Company manufactures and markets surgical retracting tapes under the trademark Retract-O-Tape, a product line of silicone elastomer surgical tubing used to apply traction to and occlude blood vessels during surgical procedures. The Company's surgical tapes are hollow tubes, sealed at both ends to trap air, which resist collapsing when they come into contact with a body structure. The Company's ACTester product line consists of instrumentation and associated disposables used to measure the activated clotting time of blood. During the years ended December 31, 1996, 1995, and 1994, the Company's surgical tapes and ACTester products accounted for $2.1 million, $1.8 million, and $1.6 million, respectively, of total net revenue. MPS System. In 1992, based on discussions with perfusionists and cardiovascular surgeons regarding the logistical limitations of existing cardioplegia delivery systems, the Company identified a need for an automated and integrated myocardial protection system that would be versatile, easy to use, efficient and cost-effective. Over the past several years, cardiovascular surgeons have developed advanced myocardial protection protocols for open-heart surgery that significantly complicate the safe and efficient administration of cardioplegia delivery using existing systems. Protocols now call for warm or cold cardioplegia, various levels of potassium, retrograde or antegrade cardioplegia flow, and a number of other variables. Existing cardioplegia delivery systems are limited in their ability to accommodate these evolving protocols, and are also difficult to control and monitor due to the number of different components and protocol variables. Based on its reengineering of the conceptual approach to cardioplegia delivery, the Company designed the MPS system to address the limitations of existing cardioplegia delivery systems. The Company then commissioned an independent research firm to survey over 150 surgeons and perfusionists to confirm the market demand for an automated and integrated approach to managing cardioplegia delivery. The Company subsequently developed, and in August 1995 filed a 510(k) with the FDA for, the MPS system. In March 1996, the Company received clearance from the FDA to market MPS and shortly thereafter began clinical testing of the system. Clinical testing was completed during July 1996 and commercial shipment of MPS began during September 1996. The MPS system, which employs advanced pump, temperature control and microprocessor technologies, is designed to enable the perfusionist to vary the blood/crystalloid ratio and potassium concentration, maintain a constant blood temperature, and maintain a constant delivery pressure through an automated and integrated device. The MPS instrument is designed to provide this flexibility through the simple setting of dials on its control panel. The Company believes that the MPS system will simplify the cardioplegia delivery process and thus improve the safety of this process by reducing the risk of human error. As a part of the MPS system, the Company has designed and developed a "captive" disposable delivery set, which fits into the instrument and is necessary to the operation of the instrument. The Company has also designed and developed additional "non-captive" disposable tubing and other accessories for use with the MPS system. These non-captive disposables are not integral to the operation of the instrument and can be purchased from other manufacturers. The Company has received FDA clearance to market certain of its non-captive disposables through the submission and approval of 510(k)s, and began marketing such products during the fourth quarter of 1996. During the year ended December 31, 1996, the Company's MPS system and related products accounted for $443,000 of total net revenue. INTRAVENOUS FLUID DELIVERY Since its founding in 1979, the Company has developed, manufactured and marketed specialized intravenous fluid delivery tubing sets and accessories sold primarily to major hospitals in the United States. Over the last several years the revenues generated by this product line, a substantial component of the Company's historical base business, have significantly aided the funding of the Company's research and development efforts. The Company's core competencies in medical device manufacturing, engineering and regulatory affairs have largely been developed as a consequence of its experience with intravenous fluid delivery products, including the electronic intravenous pump and associated disposables business that was sold in 1987. 5 7 The Company manufactures and markets about 50 distinct models of specialized intravenous fluid delivery tubing sets, which can be broken down into two major product categories -- Multiport(R) sets and anesthesia sets. Hospitals frequently require specialized disposable intravenous tubing sets for more complex therapy procedures employed in anesthesia administration, intravenous feeding, intensive care and cancer therapy. The Company's intravenous tubing sets generally consist of specialized tubing and connector variations that distinguish them from standard intravenous sets. The Company also manufactures and markets injection sites used in heparin and other medication administrations. The Company has one patented specialized tubing set, purchased primarily by the University of Texas System Cancer Center (M.D. Anderson Hospital), which is used to deliver multiple drugs for complex chemotherapy applications. See Item 1: "Business -- Other Business Matters -- Marketing and Major Customer." During the years ended December 31, 1996, 1995, and 1994 the Company's intravenous fluid delivery products accounted for $5.2 million, $6.0 million, and $6.3 million, respectively, of total net revenue. OTHER PRODUCTS The Company also designs, manufactures and markets other products for the healthcare industry, including pressure monitoring kits used in labor and delivery procedures and various critical care applications. The Company's intrauterine pressure monitoring devices are used to determine pressure within the mother's uterus primarily during high risk labor and delivery. Approximately 25 percent of the nearly four million births occurring annually in the United States are categorized as "high risk" due to factors such as obesity, drug use, disease, age or low fetus weight. During these procedures, a catheter is inserted into the mother's uterus to measure uterine fluid pressure. This information allows the clinician to monitor the progression of labor and to determine whether intervention is necessary or advisable. The Company's intrauterine pressure monitoring devices are marketed as kits containing all of the components required to measure uterine fluid pressure. During the years ended December 31, 1996, 1995, and 1994 the Company's other products (primarily pressure monitoring kits) accounted for $1.6 million, $1.8 million, and $1.9 million, respectively, of total net revenue. OTHER BUSINESS MATTERS MARKETING AND MAJOR CUSTOMER ANS has historically relied on specialty distributors to market its SCS devices. During 1996, however, the Company made the strategic decision to replace certain distributors in specified geographic markets with commissioned sales agents. Currently, the Company has 11 specialty distributors who employ 34 personnel to market the SCS devices. In addition, the Company has eight commissioned sales agents who sell the Company's SCS devices. The Company employs three regional sales managers who oversee these specialty distributors and commissioned sales agents. The primary medical specialists the Company targets in its marketing efforts are anesthesiologists, neurosurgeons, and orthopedic surgeons. Although neurosurgeons were the first practitioners to use SCS applications, anesthesiologists now account for a greater percentage of sales as the relative number of these practitioners has grown and as the understanding and acceptance of SCS treatment has increased. The Company derives 85 percent of net revenues attributable to its SCS devices from domestic sales and approximately 15 percent from European and Australian sales. The Company markets its MPS system and related disposables domestically through a direct sales force operating on a sales team approach. This team consists of nine members who have been involved with the MPS through its final development and clinical validation. The team consists of five regional sales managers, two field clinical specialists, and two inside account representatives. The Company does not plan to add additional sales personnel during 1997. The inside account representatives qualify accounts and assist the regional managers while the clinical specialists in-service and train surgeons, perfusionists, and other personnel on the MPS system. The Company plans to market the MPS system internationally through specialty distributors, although it does not anticipate international market introduction until 1998. Clinical evaluations since the commercial introduction of the MPS in September 1996 have, in management's view, validated that the MPS provides simpler, more flexible and cost-effective management of 6 8 myocardial protection. As a consequence of the current hospital consolidation trend, coupled with the intense pressure hospitals are under to minimize capital expenditures, however, hospitals have been reluctant to make timely purchase decisions on new capital equipment. Therefore, to accelerate the adoption of MPS and shorten the selling process, the Company in early 1997 decided to offer MPS on a one-year rental basis and on a lease/purchase basis. This strategy will decrease short-term revenues because the rental agreement does not qualify as a sale, but should, in management's opinion, accelerate placement of MPS systems and related disposable revenues. The Company believes that once a surgeon changes the cardioplegia protocol using features of MPS, it will be very difficult to return to the old, make-shift system. There can be no assurance that such rental strategy will accelerate placement of MPS systems. The Company markets most of its other cardiovascular products, pressure monitoring kits for labor, and delivery and intravenous fluid delivery tubing sets through direct contact with hospitals, telemarketing, independent sales representatives, marketing arrangements with certain distributors and, to a lesser extent, through direct mail. The Company employs one direct sales manager who oversees the distributors who sell the Company's pressure monitoring kits and three inside sales representatives who primarily sell the Company's intravenous fluid delivery tubing set products through telemarketing. The Company derives approximately 87 percent of net revenues attributable to cardiovascular products, pressure monitoring kits, and intravenous fluid delivery tubing sets from domestic sales and approximately 13 percent from European, Australian and Japanese sales. During 1996, the Company had one major customer that accounted for 10 percent or more of its net revenues. Sun Medical, Inc., a specialty distributor of ANS products, accounted for $2.6 million, or 10 percent, of the Company's net revenues for the year ended December 31, 1996. In addition, the University of Texas Cancer Center (M. D. Anderson Hospital) accounted for $2.3 million, $2.6 million and $2.7 million, or 9 percent, 10 percent and 19 percent of the Company's net revenues for the years ended December 31, 1996, 1995 and 1994, respectively. The Company supplies a patented specialized intravenous tubing set used by M. D. Anderson Hospital for oncology applications. While the Company believes its relations with Sun Medical and M. D. Anderson Hospital are good, the loss of one or both of these customers could have a material adverse effect on the Company's business, financial condition and results of operations. RESEARCH AND DEVELOPMENT Since 1992, the Company has focused a majority of its research and development efforts on designing and developing the MPS system and related products. The Company has spent $11.5 million on the research and development of its MPS system and related products, representing about 80 percent of the Company's research and development expense since 1992. Although the Company plans to continue engaging in ongoing research and development to introduce new products, enhance the effectiveness, ease of use, safety and reliability of existing products and expand the applications for which its products are appropriate, particularly in the cardiovascular and neuromodulation fields, the Company expects research and development expense to decline from peak levels during 1995, as a result of completing development of the MPS system and certain related products. Research and development expense was $3.3 million, $4.6 million and $3.5 million for the years ended December 31, 1996, 1995 and 1994, respectively. The Company has budgeted $2.8 million for research and development during 1997. Management expects about half of such expenditures to be directed to refining current ANS SCS products and designing and developing next generation ANS SCS products, with the other half directed primarily to MPS. As of March 21, 1997, the Company had an in-house research and development staff of 18 engineers, technicians and designers, down from 24 at March 1996. MANUFACTURING The Company manufactures and packages certain ANS SCS products, cardiovascular products (such as pressure control valves, filters, traps, MPS and surgical retracting tapes), pressure monitoring kits, and intravenous fluid delivery products at its primary manufacturing facility in Allen, Texas. This facility received ISO 9001 certification (for design and manufacturing processes) in July 1995. See Item 1. "Business -- Other Business Matters -- Government Regulations." Until the first quarter of 1996, when such operations were moved to the Allen, Texas facility, the Company manufactured its line of SCS devices and related products at 7 9 an ISO 9002 certified (manufacturing only) facility in Fort Lauderdale, FL. Finally, the Company manufactures certain cardiovascular products at a facility in Orange County, California and will continue to do so for the foreseeable future. The Company's manufacturing processes consist of the assembly of standard and custom component parts and the testing of completed products. The Company subcontracts with various suppliers to provide it with the quantity of component parts necessary to assemble its products. Almost all of these components are available from a number of different suppliers, although certain components are purchased from single sources, who manufacture these components from the Company's toolings. For example, the Company relies on single suppliers for two separate components of the specialized oncology intravenous tubing set that the Company supplies to the University of Texas System Cancer Center (M.D. Anderson Hospital), the Company's largest customer. The Company believes that there are alternative and satisfactory sources for single-sourced components, although a sudden disruption in supply from one of these suppliers could adversely affect the Company's ability to deliver the finished product on time. The Company owns its own molds for production of a majority of the components used in specialized tubing sets and cardiovascular products. Consequently, in the event of supply disruption, the Company would be able to fabricate its own components or subcontract with another supplier, albeit after a delay in the production process. The Company devotes significant attention to quality control. Its quality control measures begin at the manufacturing level where components are assembled in a "clean room" environment designed and maintained to reduce product exposure to particulate matter. Products are tested throughout the manufacturing process for adherence to specifications. Finished components are shipped to outside processors for sterilization through radiation or treatment with ethylene oxide gas. After sterilization, the products are quarantined and tested before they are shipped to customers. Skills of assembly workers required for the manufacture of medical products are similar to those required in typical assembly operations. The Company believes that workers with these skills are readily available in the Dallas and Orange County areas. COMPETITION In marketing its products, the Company competes with numerous companies that have substantially greater financial resources and engage in substantially greater research and development efforts than the Company. ANS competes in the market for SCS devices with one other significant supplier, Medtronic, Inc. Medtronic holds a substantial majority share of the market and sells both RF-coupled systems and IPG devices. Numerous competitors exist for the Company's cardiovascular products, specialized tubing sets and pressure monitoring kits. These markets are dominated by established manufacturers that have broader product lines, greater distribution capabilities, substantially greater capital resources and larger marketing, research and development staffs and facilities than the Company. Many of these competitors offer broader product lines within the specific product market and/or in the general field of medical devices and supplies. Broad product lines give many of the Company's competitors the ability to negotiate exclusive, long-term medical device supply contracts and, consequently, the ability to offer comprehensive pricing of their competing products. By offering a broader product line in the general field of medical devices and supplies, competitors may also have a significant advantage in marketing competing products to group purchasing organizations, HMOs and other managed care organizations that are increasingly seeking to reduce costs through centralization of purchasing functions. In addition, the Company's competitors may use price reductions to preserve market share in their product markets. The Company is aware of at least two cardioplegia delivery systems currently being marketed that compete with the MPS system. While these products represent improvements over cardioplegia delivery systems currently in use in that they have partially integrated some of the cardioplegia equipment components, the Company believes that the MPS system will offer a greater range of functionality, flexibility and ease-of-use. In addition, innovations in surgical techniques or medical practices could have the effect of reducing or eliminating market demand for one or more of the Company's products. For example, some cardiovascular 8 10 surgeons and medical device companies are developing techniques, procedures and devices for performing coronary artery bypass surgery without stopping the heart, both through open-heart surgery and minimally invasive procedures, thereby eliminating the need for myocardial protection in these cases and potentially reducing the market for the MPS system. While these techniques, procedures and devices have not to date attained widespread use, there can be no assurance that they will not gain broader market acceptance. While these and other surgical techniques, procedures and devices may reduce the number of coronary artery bypass procedures that require myocardial protection, the Company believes that most, if not all, surgical suites will need to be equipped with a myocardial protection system. The Company believes that the principal competitive factors in the neurostimulation, cardiovascular and intravenous fluid delivery markets are cost-effectiveness, impact on patient outcomes, product performance, quality and ease of use, technical innovation and customer service. The Company intends to continue to compete on the basis of its high performance products, innovative technologies, manufacturing capability, close customer relations and support and its strategy to increase its offerings of products within these markets. PATENTS, TRADEMARKS AND PROPRIETARY INFORMATION The Company owns twenty United States patents relating to products that the Company currently markets. Although one of the Company's patents expired in February 1996, the Company does not believe that such expiration will have a material adverse effect on the Company or its ability to sell the applicable product. ANS currently owns four of the United States patents referred to above and also owns one foreign patent. In management's view, these patents offer reasonable coverage of its SCS devices' electrode, receiver and transmitter technology. These patents cover both RF-coupled devices and IPG systems, although the Company currently manufactures only RF-coupled devices. Pending patent applications concern ANS' PainDoc computer system and its innovative Multistim technology. Twelve of the twenty patents cover the Company's cardiovascular products. From 1993 through 1996, the Company filed five applications for patents relating to the MPS system and related products. Three applications resulted in patents and the remaining two are pending issuance. In the Company's opinion, the MPS related patents broadly cover key elements of the MPS system, including the MPS system's innovative methods of pumping, mixing and heating fluids. Management believes that the issued patents should provide significant protection for its MPS system. The Company also filed various applications regarding its unique line of retrograde catheters which may be used with the MPS system or other cardioplegia delivery systems. The Company also owns three patents relating to its intravenous fluid delivery tubing sets and accessories and other products. The validity of any patents issued to the Company may be challenged by others and the Company could encounter legal and financial difficulties in enforcing its patent rights against infringers. In addition, there can be no assurance that other technologies cannot or will not be developed or that patents will not be obtained by others which would render the Company's patents obsolete. With the possible exception of the patent relating to the specialized tubing sets manufactured for the University of Texas System Cancer Center (M.D. Anderson Hospital), the loss of any one patent would not have a material adverse effect on the Company's current revenue base. Although the Company does not believe that patents are the sole determinant in the commercial success of its products, the loss of a significant percentage of its patents or its patents relating to a specific product line, particularly the MPS system or ANS' SCS product line, could have a material adverse effect on the Company's business, financial condition and results of operations. The Company has developed technical knowledge which, although non-patentable, is considered by the Company to be significant in enabling it to compete. However, the proprietary nature of such knowledge may be difficult to protect. The Company has entered into an agreement with each key employee prohibiting such employee from disclosing any confidential information or trade secrets of the Company and prohibiting that employee from engaging in any competitive business while the employee is working for the Company and for a period of one year thereafter. In addition, these agreements also provide that any inventions or discoveries 9 11 relating to the business of the Company by these individuals will be assigned to the Company and become the Company's sole property. Claims by competitors and other third parties that the Company's products allegedly infringe the patent rights of others could have a material adverse effect on the Company. The medical device industry is characterized by frequent and substantial intellectual property litigation. The cardiovascular device market and the interventional pain management markets are maturing and, as such, are characterized by extensive patent and other intellectual property claims, which can create greater potential than in less developed markets for possible allegations of infringement, particularly with respect to newly developed technology. Intellectual property litigation is complex and expensive and the outcome of this litigation is difficult to predict. Any future litigation, regardless of outcome, could result in substantial expense to the Company and significant diversion of the efforts of the Company's technical and management personnel. An adverse determination in any such proceeding could subject the Company to significant liabilities to third parties, or require the Company to seek licenses from third parties or pay royalties that may be substantial. Furthermore, there can be no assurance that necessary licenses would be available to the Company on satisfactory terms or at all. Accordingly, an adverse determination in a judicial or administrative proceeding or failure to obtain necessary licenses could prevent the Company from manufacturing or selling certain of its products, which could have a material adverse effect on the Company's business, financial condition and results of operations. QUEST, MULTIPORT, RETROGUARD, RETRACT-O-TAPE, ACTest, MPS, DUO-TUBE and PainDoc are among the Company's registered trademarks and COMPUSTIM and ACTester are among its nonregistered trademarks. Registration applications are pending for various trademarks the Company believes have value in the marketplace. GOVERNMENT REGULATION The manufacture and sale of the Company's products are subject to regulation by numerous governmental authorities, principally the FDA and corresponding foreign agencies. The research and development, manufacturing, promotion, marketing and distribution of the Company's products in the United States are governed by the Federal Food, Drug and Cosmetic Act and the regulations promulgated thereunder (the "FDC Act and Regulations"). The Company is subject to inspection by the FDA for compliance with such regulations and procedures. The FDA has traditionally pursued a rigorous enforcement program to ensure that regulated entities such as the Company comply with the FDC Act and Regulations. A company not in compliance may face a variety of regulatory actions, including warning letters, product detentions, device alerts, mandatory recalls or field corrections, product seizures, injunctive actions or civil penalties and criminal prosecutions of the company or responsible employees, officers and directors. The Company was inspected in the summer of 1996 with no major violations found. Under the FDA's requirements, if a manufacturer can establish that a newly developed device is "substantially equivalent" to a legally marketed device, the manufacturer may seek marketing clearance from the FDA to market the device by filing a 510(k) premarket notification with the FDA. The 510(k) premarket notification must be supported by data establishing the claim of substantial equivalence to the satisfaction of the FDA. The process of obtaining a 510(k) clearance typically can take several months to a year or longer. If substantial equivalence cannot be established, or if the FDA determines that the device requires a more rigorous review, the FDA will require that the manufacturer submit a PMA that must be carefully reviewed and approved by the FDA prior to sale and marketing of the device in the United States. The process of obtaining a PMA can be expensive, uncertain and lengthy, frequently requiring anywhere from one to several or more years from the date of FDA submission. Both a 510(k) and a PMA, if granted, may include significant limitations on the indicated uses for which a product may be marketed. FDA enforcement policy strictly prohibits the promotion of approved medical devices for unapproved uses. In addition, product approvals can be withdrawn for failure to comply with regulatory requirements or the occurrence of unforeseen problems following initial marketing. Although all of the Company's currently marketed products have been the subject of successful 510(k) submissions and the Company believes that most of its products currently in 10 12 development will also be eligible for the 510(k) submission process, there can be no assurance that the FDA will agree with this view. The Company is also subject to regulation in each of the foreign countries in which it sells its products with regard to product standards, packaging requirements, labeling requirements, import restrictions, tariff regulations, duties and tax requirements. Many of the regulations applicable to the Company's products in such countries are similar to those of the FDA. The national health or social security organizations of certain countries require the Company's products to be qualified before they can be marketed in those countries. To date, the Company has not experienced significant difficulty in complying with these regulations. To position itself for access to European and other international markets, Quest sought and obtained certification under the ISO 9000 Series of Standards. ISO 9000 is a set of integrated requirements, which when implemented, form the foundation and framework for an effective quality management system. These standards were developed and published by the ISO, a worldwide federation of national standard bodies, founded in Geneva, Switzerland in 1946. ISO has over 92 member countries. ISO certification is widely regarded as essential to enter Western European markets. The Company obtained certification and was registered as an ISO 9001 compliant company on July 1, 1995. The ISO 9001 registration is the most stringent standard in the ISO series and lasts for three years. The German notified body, Landesgewerbeanstalt Bayern ("LGA") issued the certificate. The ISO 9001 standards cover design, production, installation and servicing of products. The Company will be subject to an annual audit by the notified body to maintain the registration. The Company was then certified to be in compliance with the Medical Device Directive ("MDD") as well as ISO 9001 by the notified body TUV Rheinland ("TUV") in July 1996. Subsequently, in December 1996, the Company's ANS implantable products were certified to be in compliance with the Active Implantable Medical Directive ("AIMD") by TUV product services, another notified body. These certifications were sought and obtained for the purpose of getting the CE mark which represents product approval throughout the European Union. As a result, the CE mark was maintained on all ANS products. The Company also received CE mark certification on its line of retrograde and antegrade catheters. The financial arrangements through which the Company markets, sells and distributes its products may be subject to certain federal and state laws and regulations in the United States with respect to the provision of services or products to patients who are Medicare or Medicaid beneficiaries. The "fraud and abuse" laws and regulations prohibit the knowing and willful offer, payment or receipt of anything of value to induce the referral of Medicare or Medicaid patients for services or goods. In addition, the physician anti-referral laws prohibit the referral of Medicare or Medicaid patients for certain "Designated Health Services" to entities in which the referring physician has an ownership or compensation interest. Violations of these laws and regulations may result in civil and criminal penalties, including substantial fines and imprisonment. In a number of states, the scope of fraud and abuse or physician anti-referral laws and regulations, or both, have been extended to include the provision of services or products to all patients, regardless of the source of payment, although there is variation from state to state as to the exact provisions of such laws or regulations. In other states, and on a national level, several health care reform initiatives have been proposed which would have a similar impact. The Company believes that its operations and its marketing, sales and distribution practices currently comply in all respects with all current fraud and abuse and physician anti-referral laws and regulations, to the extent they are applicable. Although the Company does not believe that it will need to undertake any significant expense or modification to its operations or its marketing, sales and distribution practices to comply with federal and state fraud and abuse and physician anti-referral regulations currently in effect or proposed, financial arrangements between manufacturers of medical devices and other health care providers may be subject to increasing regulation in the future. Compliance with such regulation could adversely affect the Company's marketing, sales and distribution practices, and may affect the Company in other respects not presently foreseeable, but which could have an adverse impact on the Company's business, financial condition and results of operations. 11 13 THIRD PARTY REIMBURSEMENT AND COST CONTAINMENT The Company's products are purchased primarily by hospitals and other users, which then bill various third party payors for the services provided to the patients. These payors, which include Medicare, Medicaid, private insurance companies and managed care organizations, reimburse part or all of the costs and fees associated with the procedures performed with these devices. Medicare and Medicaid reimbursement for hospitals is based on a fixed amount for admitting a patient with a specific diagnosis. Because of this fixed reimbursement method, hospitals have incentives to use less costly methods in treating Medicare and Medicaid patients, and will frequently make capital expenditures to take advantage of less costly treatment technologies. Frequently, reimbursement is reduced to reflect the availability of a new procedure or technique, and as a result hospitals are generally willing to implement new cost saving technologies before these downward adjustments take effect. Likewise, because the rate of reimbursement for certain physicians who perform certain procedures has been and may in the future be reduced in the event of further changes in the resource-based relative value scale method of payment calculation, physicians may seek greater cost efficiency in treatment to minimize any negative impact of reduced reimbursement. Any amendments to existing reimbursement rules and regulations which restrict or terminate the reimbursement eligibility (or the extent or amount of coverage) of medical procedures using the Company's products or the eligibility (or the extent or amount of coverage) of the Company's products could have an adverse impact on the Company's business, financial condition and results of operations. Third party payors are increasingly challenging the prices charged for medical products and services and may deny reimbursement if they determine that a device was not used in accordance with cost-effective treatment methods as determined by the payor, was experimental or was used for an unapproved application. The Company's SCS devices, for example, while cost-effective compared to repeat back surgeries, have encountered some resistance to third party reimbursement. Although Medicare, Medicaid and many private insurers reimburse for the SCS device and procedure, especially after repeat back surgeries have failed to relieve the chronic pain, certain payors refuse to reimburse for SCS devices and others, including the Veterans Administration, restrict reimbursement. There can be no assurance that in the future, third party payors will continue to reimburse for the Company's products, or that their reimbursement levels will not adversely affect the profitability of the Company's products. In addition, the cost of health care has risen significantly over the past decade, and there have been and may continue to be proposals by legislators and regulators to curb these costs. Legislative action limiting reimbursement for certain procedures could have a material adverse effect on the Company's business, financial condition and results of operations. In response to the focus of national attention on rising health care costs, a number of changes to reduce costs have been proposed or have begun to emerge. There have been, and may continue to be, proposals by legislators and regulators and third party payors to curb these costs. There has also been a significant increase in the number of Americans enrolling in some form of managed care plan. It has become a typical practice for hospitals to affiliate themselves with as many managed care plans as possible. Higher managed care penetration typically drives down the prices of health care procedures, which in turn places pressure on medical supply prices. This causes hospitals to implement tighter vendor selection and certification processes, by reducing the number of vendors used, purchasing more products from fewer vendors and trading discounts on price for guaranteed higher volumes to vendors. Hospitals have also sought to control and reduce costs over the last decade by joining group purchasing organizations or purchasing alliances. The Company cannot predict what continuing or future impact existing or proposed legislation, regulation or such third party payor measures may have on its future business, financial condition or results of operations. Changes in reimbursement policies and practices of third party payors could have a substantial and material impact on sales of certain of the Company's products. The development or increased use of more cost-effective treatments could cause such payors to decrease or deny reimbursement to favor these other treatments. 12 14 EMPLOYEES As of March 21, 1997, the Company employed 247 full-time employees, 18 in research and development, 43 in sales and marketing, 153 in manufacturing and related operations, and the remainder in executive and administrative positions. None of the Company's employees is represented by a labor union and the Company considers its employee relations to be good. ADVISORY BOARDS The Company has established two Boards of Clinical Advisors (the "Advisory Boards"). The Advanced Neuromodulation Systems Advisory Board (the "ANSAB") is comprised of individuals with substantial expertise in neurostimulation and pain management. Members of the Company's management and scientific and technical staff consult closely with the ANSAB to identify specific areas where techniques are changing and where existing products do not adequately fulfill the needs of the pain physician. The ANSAB helps management evaluate new product ideas and concepts and once a product is approved for development, its subsequent design and development. The ANSAB may also participate in the clinical testing of products developed. The Quest Advisory Board (the "QAB") is comprised of individuals with substantial expertise in the field of myocardial protection who have played instrumental roles in the identification of the market need for MPS system and its subsequent design and development. Members of the Company's management and scientific and technical staff consult closely with the QAB to better understand the technical and clinical requirements of the cardiovascular surgical team and product functionality needed to meet those requirements. The Company anticipates that the QAB will continue to play a similar role with respect to other products, and may assist the Company in educating other physicians in the use of the MPS and related products. Certain members of the Advisory Boards are employed by academic institutions and may have commitments to or consulting or advisory agreements with other entities that may limit their availability to the Company. The members of the Advisory Boards may also serve as consultants to other medical device companies. No members of the ANSAB or QAB are expected to devote more than a small portion of their time to the Company. ITEM 2. PROPERTIES In December 1993, the Company moved into its new manufacturing facility and executive offices in Allen, Texas (located north of Dallas). The facility covers approximately 107,000 square feet and was constructed during 1993 on a 19.2 acre tract that the Company acquired in 1985. The Company borrowed $4.4 million from MetLife Capital Corporation to construct and outfit this facility. This financing is collateralized by the Allen land, the Allen facility and certain equipment of the Company. See Note 5 of the Notes to Consolidated Financial Statements. Management expects the current facility to serve its manufacturing, storage and executive office needs in the Dallas area for the foreseeable future. The Company also currently leases approximately 4,600 square feet of office and manufacturing space in Orange County, California on a month-to-month basis. The Company plans to continue manufacturing certain cardiovascular surgery products at this facility for the foreseeable future. Until February 1996, ANS leased approximately 18,000 square feet of office and manufacturing space in Fort Lauderdale, Florida, where it manufactured and marketed its SCS devices. During late 1995 and early 1996, the Company relocated the ANS operations to the Company's facility in Allen, Texas. ITEM 3. LEGAL PROCEEDINGS As a consequence of the Neuromed Acquisition in March 1995, the Company is a party to product liability claims related to SCS devices sold by Neuromed prior to the acquisition. Product liability insurers have assumed responsibility for defending the Company against these claims, subject to reservation of rights in certain cases. While historically product liability claims against Neuromed have not resulted in significant 13 15 monetary liability for Neuromed beyond its insurance coverage, there can be no assurances that the Company will not incur significant monetary liability to the claimants if such insurance is unavailable or inadequate for any reason, or that the Company's SCS business and new SCS product lines will not be adversely affected by these product liability claims. While the Company seeks to maintain appropriate levels of product liability insurance with coverage that the Company believes is comparable to that maintained by companies similar in size and serving similar markets, there can be no assurance that the Company will avoid significant future product liability claims relating to its SCS, cardiovascular, intravenous fluid delivery or other products. Except for such product liability claims and other ordinary routine litigation incidental or immaterial to its business, the Company is not currently a party to any other pending legal proceeding. The Company maintains general liability insurance against risks arising out of the normal course of business. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS Inapplicable. PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS The Company's common stock is quoted on the Nasdaq National Market under the symbol "QMED." On March 21, 1997, there were approximately 831 holders of record of the Company's common stock. The following table sets forth the quarterly high and low closing sales prices for the Company's common stock. These prices do not include adjustments for retail mark-ups, mark-downs or commissions.
HIGH LOW 1995: ------ ------ First Quarter............................................... $ 8.75 $ 4.88 Second Quarter.............................................. $12.50 $ 7.13 Third Quarter............................................... $14.50 $11.75 Fourth Quarter.............................................. $12.00 $ 9.75
HIGH LOW 1996: ------ ------ First Quarter............................................... $14.50 $10.25 Second Quarter.............................................. $14.38 $ 6.00 Third Quarter............................................... $ 9.13 $ 5.63 Fourth Quarter.............................................. $ 8.25 $ 5.75
HIGH LOW 1997: ------ ------ First Quarter............................................... $ 8.13 $ 6.00 (through March 21, 1997)
To date, the Company has not declared or paid any cash dividends on its common stock, and the present policy of the Board of Directors is to retain any earnings to provide for the Company's growth. Any future determination to pay dividends will be at the discretion of the Board of Directors, and dependent upon the Company's financial condition, results of operations, capital requirements and such other factors as the Board of Directors deems relevant. In addition, the Company's current credit arrangement with NationsBank of Texas, N.A. ("NationsBank") prohibits the payment of cash dividends. On August 26, 1996, the Board of Directors voted to redeem the Company's then outstanding stock purchase rights at $0.01 per share. The redemption price for the outstanding rights was paid on September 27, 14 16 1996 to shareholders of record as of September 12, 1996. See Note 7 of the Notes to Consolidated Financial Statements. Subsequent to December 31, 1996, in connection with borrowing $2.0 million from a stockholder, the Company issued the stockholder five-year warrants to purchase 100,000 shares at an exercise price of $6.50 per share, the closing sales price on the date the indebtedness was incurred. See Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources" and Note 5 of the Notes to Consolidated Financial Statements. The Company relied on the private placement exemptions provided by Regulation D under the Securities Act of 1933, as amended, in issuing the warrants. ITEM 6. SELECTED FINANCIAL DATA
YEARS ENDED DECEMBER 31 ---------------------------------------------------- 1992 1993 1994 1995(1) 1996 ------- ------- ------- -------- ------- (IN THOUSANDS, EXCEPT PER SHARE DATA) Statement of Operations Data: Net revenue............................. $13,612 $13,643 $13,999 $ 25,321 $26,074 Gross profit............................ 6,553 6,591 6,381 14,697 15,069 Research and development expense........ 1,387 1,910 3,542 4,583 3,343 Nonrecurring charges(2)................. 1,247 -- -- 10,500 -- Marketing and general and administrative expense.............................. 4,141 4,400 4,977 8,395 11,626 Earnings (loss) from operations, excluding nonrecurring charges....... 1,025 281 (2,138) 1,719 100 Earnings (loss) from operations......... (222) 281 (2,138) (8,781) 100 Other income (expense), net............. 473 667 419 (1,168) (429) Earnings (loss) from continuing operations before income taxes, extraordinary item and cumulative effect of change in accounting principle............................ 251 948 (1,719) (9,950) (329) Net earnings (loss) 194 816(3) (1,719) (10,374)(4) (412) Net earnings (loss) per share........... $ .03 $ .15 $ (.33) $ (1.56) $ (.05) Weighted average common and common equivalent shares outstanding........ 5,594 5,559 5,257 6,642 8,531(5)
YEARS ENDED DECEMBER 31 ---------------------------------------------------- 1992 1993 1994 1995 1996 ------- ------- ------- -------- ------- (IN THOUSANDS) Balance Sheet Data: Cash, cash equivalents and marketable securities........................... $ 6,693 $ 6,594 $ 5,262 $ 3,914 $ 2,062 Working capital......................... 10,847 9,566 7,411 12,183 11,088 Total assets............................ 20,448 26,739 24,235 44,496 48,992 Short-term notes payable and current maturities of long-term notes payable.............................. 799 2,297 2,759 1,616 2,084 Notes payable, excluding current maturities........................... 242 4,101 4,124 8,558 11,912 Stockholders' equity.................... $17,639 $18,252 $15,931 $ 30,870 $30,993
- --------------- (1) Includes results of Neuromed from April 1, 1995. (2) Nonrecurring charge in 1992 relates to the write-off of assets of a discontinued business and in 1995 relates to purchased research and development incurred in connection with the Neuromed acquisition. (3) Includes an increase in net income of $169, or $.03 per share, relating to the cumulative effect of a change in accounting principle. (4) Includes a decrease in net income of $269 (net of income tax benefit of $139), or $(.03) per share, from the write-off of capitalized debt issuance costs due to early repayment of bank debt. 15 17 (5) The Company completed a public offering of 1,676,667 shares for net proceeds of $15.2 million in the fourth quarter of 1995. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion of the financial condition and results of operations of the Company should be read in conjunction with the Consolidated Financial Statements of the Company and the related Notes thereto. RESULTS OF OPERATIONS Comparison of the Years Ended December 31, 1996 and 1995 Revenues. Net revenue of $26.1 million for the year ended December 31, 1996, was $800,000 above the level for the comparable 1995 period of $25.3 million. This increase during 1996 compared to 1995 was primarily attributable to including a full twelve months of revenue generated by ANS, formerly Neuromed, Inc., which was acquired on March 31, 1995. Revenue of ANS products for 1996 was $11.4 million compared to $10.4 million for the last nine months of 1995. In addition, the Company introduced the next generation of multi-electrode leads in 1996, which prompted delays in purchase commitments. The Company made the strategic decision in 1996 to market its ANS products through commissioned sales agents rather than distributors in certain geographical areas of the United States. This decision resulted in a decrease of approximately $300,000 in ANS revenue during 1996 due to the return of inventories from those distributors whom the Company decided to replace with sales agents. During early 1996, management announced plans to re-build the infrastructure at ANS to transform ANS into an industry leader and compete effectively in the SCS market. Management believes it has taken major steps in improving the current products of ANS and is continuing these efforts into the first quarter of 1997. Management believes that these efforts should return ANS to sustained and profitable revenue growth during 1997. During the third quarter of 1996, the Company completed clinical validation of the MPS system for cardioplegia delivery and began commercial shipments during September 1996, a quarter later than management had expected. Revenue from the MPS system and related disposable products during 1996 was $443,000, significantly below management's expectations. Clinical evaluations since the commercial introduction of the MPS have validated that the MPS provides simpler, more flexible and cost-effective management of myocardial protection. As a consequence of the current hospital consolidation trend, coupled with the intense pressure hospitals are under to minimize capital expenditures, however, hospitals have been reluctant to make timely purchase decisions on new capital equipment. Therefore, to accelerate the adoption of MPS and shorten the selling process, the Company, in early 1997, decided to offer MPS on a one-year rental basis and on a lease/purchase basis. This strategy will decrease short-term revenues because the rental agreement does not qualify as a sale, but should, in management's opinion, accelerate placement of MPS systems and related disposable revenues. The Company believes that once a surgeon changes the cardioplegia protocol using features of MPS, it will be very difficult to return to the old, make-shift system. There can be no assurance that such rental strategy will accelerate placement of MPS systems. Net revenue from sales of the Company's other cardiovascular products, pressure monitoring kits used in labor and delivery and specialized intravenous fluid delivery tubing sets decreased from $14.9 million in 1995 to $14.2 during 1996 due to lower unit sales volume from the Company's specialized intravenous fluid delivery tubing sets. Gross Profit. Gross profit during 1996 increased to $15.1 million compared to $14.7 million in 1995. As a percentage of net revenue, gross profit decreased slightly to 57.7 percent in 1996 compared to 58.0 percent during 1995. This slight decrease in gross profit margin was principally the result of higher manufacturing overhead expense related to the Company's ANS products. Operating Expenses. Research and development expense decreased to $3.34 million in 1996 compared to $4.58 million in 1995, and as a percentage of net revenue, decreased to 12.8 percent in 1996 from 18.1 percent 16 18 during 1995. This decrease was the result of a reduction in salary and contract labor expense from staffing reductions due to the completion of the development of the MPS system. Separately, the Company devoted significant engineering resources and took major steps to improve ANS products during 1996. This effort is continuing into the first quarter of 1997. The Company has budgeted $2.8 million for research and development during 1997. Management expects about half of such expenditures to be directed to refining current ANS products and designing and developing next generation ANS products for market introduction during 1998. The other half of 1997 budgeted expenditures will be directed to continued developments in the MPS system. Management expects that most of its research and development activities during 1997 will continue to be financed through internally-generated funds. Marketing, general and administrative expenses as a percentage of net revenue increased to 44.6 percent during 1996 compared to 33.2 percent during 1995, and the dollar amount increased by $3.23 million. The largest increase occurred in marketing expense with expenditures in 1996 increasing by $2.4 million over the comparable period a year ago and as a percentage of net revenue, increased to 25.3 percent in 1996 compared to 16.6 percent in 1995. Of such increase, $1.6 million was additional marketing expense of ANS related to additional salary, benefit, commission, travel, samples and promotional expense. The 1995 period included only nine months of expense. During 1996, the Company reorganized part of its ANS distribution network for ANS products and replaced several distributors in certain areas of the United States with eight commissioned sales agents and three direct regional managers. Also during 1996, the Company has designed ANS training, customer support and sales and marketing materials and videos and will continue those efforts in early 1997. The Company has also reestablished relationships with key implanters who had discontinued using the ANS products prior to the Company's acquisition. The remainder of the increase in marketing expense of $800,000 in 1996 compared to 1995 was primarily the result of additional salary, benefit and travel expense from four additional direct salespersons hired during the fourth quarter of 1995 in preparation of the commercial introduction of the MPS system. As previously mentioned, the Company began commercial shipments of MPS during September 1996, about a quarter later than it had anticipated at the beginning of 1996. Currently, the Company has five direct salespersons marketing the MPS system and does not anticipate adding additional salespersons during 1997. In early 1997, the Company decided to offer MPS on a one-year rental basis and on a lease/purchase basis to accelerate the adoption of MPS and shorten the selling process. If this strategy is successful, the Company would reevaluate adding salespersons during 1997, as circumstances warrant. Management has decided to focus most of its efforts for MPS during 1997 on the U.S. and Canadian markets, and does not anticipate introduction of the MPS internationally until fiscal 1998. General and administrative expense increased $800,000 during 1996 compared to 1995, and as a percentage of net revenue, increased from 16.6 percent in 1995 to 19.3 percent in 1996. Of such increase, $335,000 was attributable to higher amortization expense of ANS intangibles. In addition, the 1996 period includes $256,000 of expense related to a writeoff of a receivable due from a former ANS distributor who filed bankruptcy and an increase to the Company's reserves for bad debt ($60,000). The remainder of the increase in expense during 1996 compared to 1995 was primarily the result of higher recruiting, relocation and 401(k) Company match expenses. Earnings (Loss) From Operations. Earnings from operations for 1996 totaled $100,000 compared to a net loss from operations in 1995 of $8.78 million. In connection with the Neuromed acquisition, $10.5 million of the aggregate purchase price was identified as purchased in-process research and development, and in accordance with generally accepted accounting principles, was charged to expense with no related tax benefit during 1995. Excluding the 1995 expense for purchased research and development, earnings from operations decreased from $1.72 million in 1995 to $100,000 in 1996, reflecting higher levels of marketing, general and administrative expense discussed above. Other Expense. Other expense decreased to $429,000 in 1996 compared to $1.17 million in 1995 due to lower interest expense. The 1995 period reflects interest expense on $15 million of bank debt incurred in March 1995 in connection with the Neuromed acquisition, which was repaid in November of 1995 from the proceeds of a public offering. Interest income decreased $260,000 from 1995 levels due to reduced funds available for investment. This decrease in interest income was partially offset, however, by a $108,000 increase in gains on the sale of marketable securities. 17 19 Income Taxes. Despite the Company's loss before income tax expense of $329,000 in 1996, the Company recorded income tax expense of $83,000 as a consequence of the nondeductibility of amortization costs in excess of net assets acquired (goodwill). During 1995, the Company similarly recorded income tax expense of $155,000 despite a loss before income tax expense of $9.95 million as a consequence of the nondeductibility of the $10.5 million expense for purchased research and development and amortization costs in excess of net assets acquired. Net Loss. The net loss decreased from $10.4 million in 1995 to $412,000 in 1996 primarily due to the $10.5 million expense during 1995 for purchased in-process research and development incurred in connection with the Neuromed acquisition. Excluding this $10.5 million expense, the Company's net loss of $412,000 in 1996 compared to net earnings of $126,000 in 1995 and resulted from increased operating expenditures, particularly in general and administrative and marketing. Comparison of the Years Ended December 31, 1995 and 1994 Revenues. Net revenue of $25.3 million for the year ended December 31, 1995, was $11.3 million, or 80.7 percent above the level for the comparable 1994 period of $14.0 million. This increase during 1995 compared to 1994 was primarily attributable to revenue generated by Neuromed, which was acquired on March 31, 1995. Net revenue from sales of the Company's other products increased 6.3 percent during 1995 compared to 1994 primarily due to higher unit sales volume from the Company's cardiovascular products. Gross Profit. Gross profit during 1995 increased to $14.7 million compared to $6.4 million in 1994, an increase of 130 percent. As a percentage of net revenue, gross profit increased to 58.0 percent in 1995 compared to 45.6 percent during 1994. This increase in gross profit and gross profit margin during 1995 compared to 1994 was primarily attributable to the revenue generated by Neuromed, since Neuromed's products contribute higher gross profit margins than the Company's other product lines. Operating Expenses. Research and development expense increased to approximately $4.6 million during 1995 compared to the 1994 level of $3.5 million, although such expense decreased as a percentage of net revenue from 25.3 percent during 1994 to 18.1 percent during 1995. These expenditures during 1995 were $2.1 million more than originally budgeted at the beginning of fiscal 1995. Of such overage, $650,000 were expenditures directed toward Neuromed while the remainder represented additional expenditures directed at continued development of the Company's MPS(TM) brand of myocardial protection system. As previously noted, the Company filed for FDA market clearance under a 510(k) during August 1995 and on March 8, 1996 received clearance to commercially market the MPS system, which occurred during the third quarter of 1996. Increased expenditures during 1995 compared to 1994 were primarily the result of additional salary and contract labor expense from staff additions and increased consulting expense. Marketing, general and administrative expenses as a percent of net revenue decreased to 33.2 percent during 1995 compared to 35.6 percent during 1994, while the dollar amount increased $3.4 million. Marketing expense as a percentage of net revenue increased to 16.6 percent in 1995 from 13.7 percent during 1994, and the dollar amount increased by $2.3 million. Of such increase, $1.7 million was Neuromed marketing expense. The remainder of the increase in marketing expense was primarily the result of additional salary and benefit expense from personnel additions, and increased travel, commission, convention and recruiting expense. During the fourth quarter of 1995, the Company hired four additional direct salespersons in anticipation of the 510(k) clearance of its MPS system. General and administrative expense increased $1.1 million during 1995 compared to 1994, but as a percentage of net revenue, decreased from 21.9 percent during 1994 to 16.6 percent during 1995. This increase in expense during 1995 compared to 1994 was attributable to general and administrative expense of Neuromed, including amortization expense of Neuromed intangibles. Loss from Operations. On March 31, 1995, the Company acquired all of the capital stock of Neuromed, Inc. Of the aggregate purchase price for Neuromed, $10.5 million was identified as purchased in-process research and development and in accordance with generally accepted accounting principles was charged to expense, with no related tax benefit, during 1995. As a result, the loss from operations increased from $2.1 million in 1994 to $8.8 million during 1995. Excluding the charge for purchased research and 18 20 development, the Company generated earnings from operations of $1.7 million compared to the $2.1 million loss for the 1994 period, reflecting the positive impact of the Neuromed acquisition. Other Income (Expense). Other income (expense) decreased to an expense of $1.2 million during 1995 compared to income of $419,000 during 1994. This decrease was primarily the result of higher interest expense which increased $1.1 million during 1995 from 1994. The Company incurred $15.0 million of long-term bank debt on March 31, 1995, which was used to fund most of the cash payment of the Neuromed acquisition. Higher overall interest rates on borrowed money also contributed to the increase in interest expense during 1995 compared to 1994. In addition, gains recognized on the sale of the Company's investments was $29,000 for 1995 compared to $464,000 for 1994, also contributing to the decrease in other income. Income Taxes. The Company recorded income tax expense of $155,000 during 1995 as a consequence of the nondeductibility of the $10.5 million expense for purchased research and development and amortization expense of costs in excess of net assets acquired. No income tax benefit was recognized for the Company's 1994 net operating loss. Net Loss. The net loss increased from $1.7 million in 1994 to $10.4 million during 1995 primarily as a result of the aforementioned $10.5 million expense for purchased in-process research and development incurred in connection with the Neuromed acquisition. In addition, the net loss for 1995 reflects an extraordinary charge of $269,000 for the writeoff of capitalized debt issuance costs due to early repayment of the long-term bank debt. LIQUIDITY AND CAPITAL RESOURCES The Company's working capital decreased from $12.2 million at year-end 1995 to $11.1 million at year-end 1996 principally due to an increase of $1.1 million in accounts payable. The ratio of current assets to current liabilities was 3.0:1 at December 31, 1996, compared to 3.7:1 at December 31, 1995. Cash, cash equivalents and marketable securities totaled $2.1 million, a decrease of $1.8 million from year-end 1995. The Company increased its investment in inventories during 1996 by $2.26 million, substantially all of which relates to the MPS system and its related disposables. The Company anticipates a decrease in its investment in inventories of approximately $1.0 million by year-end 1997. During 1996, the Company invested $2.0 million in capital expenditures for additional manufacturing tooling and equipment and an upgraded management information system. The Company expects capital expenditures for fiscal 1997 to decrease to $1.5 million. These capital expenditures, during 1997, are principally for manufacturing tooling and equipment for the Company's current ANS SCS products and next generation neuromodulation products. In connection with the Neuromed acquisition in March 1995, the Company agreed to pay contingent earn-out consideration in January 1996 and January 1997, depending on Neuromed's attainment of certain sales objectives. At yearend 1995, the Company had a note payable in connection with the 1995 earn-out consideration in the amount of $1.5 million, payable in January 1996. The Company withheld payment of the $1.5 million obligation pending arbitration of certain disputes between the Company and Neuromed's former owner. In October 1996, the sales objectives for the 1996 earn-out were reached and the Company recorded a note payable in the amount of $3.37 million which was due and payable in January 1997. The Company similarly withheld payment of this note pending arbitration. In addition, the Company had a short-term note payable to the former owner of Neuromed at December 31, 1996, in the amount of $972,000 due in January 1997, related to certain purchase price adjustments (principally tax refunds and future tax credits) awarded through an arbitration. The Company paid the $972,000 obligation during January 1997 utilizing a portion of its cash reserves. On February 6, 1997, the Company and the former owner of Neuromed reached a settlement (the "Settlement") of all issues between them. Under terms of the Settlement, the Company agreed to pay $500,000 on March 3, 1997, and deliver a promissory note in the amount of $1.0 million payable on February 6, 1998, for full settlement of the contingent earn-out considerations. The promissory note bears interest at the rate of 10 percent per annum with interest due and payable monthly. The Company also agreed to pay $3.0 million on March 3, 1997, to purchase certain patent rights from Neuromed's former owner. On 19 21 March 3, 1997, the Company made payment of the $3.5 million pursuant to the Settlement with borrowed funds discussed below. See Notes 3 and 5 of the Notes to Consolidated Financial Statements. On February 21, 1997, the Company borrowed $2.0 million from a shareholder pursuant to a promissory note. The promissory note is due and payable on February 21, 1998, and bears interest at the rate of 6 percent per annum. In addition, the Company issued the shareholder five-year warrants to purchase 100,000 shares of common stock at an exercise price of $6.50 per share, the closing sales price on the date the indebtedness was incurred. The Company utilized proceeds from the loan to pay a portion of the Settlement discussed above. See Note 5 of the Notes to Consolidated Financial Statements. On March 3, 1997, the Company amended its $5.0 million working capital line of credit with NationsBank of Texas, N.A. Under the third amended agreement, the working capital line of credit was increased to $5.65 million and a $350,000 term loan facility was added. Both facilities expire on January 31, 1998. Borrowings under the working capital line of credit bear interest at prime plus 100 basis points, or at the Company's option, LIBOR plus 275 basis points. Borrowings under the term loan facility bear interest at prime plus 100 basis points, or at the Company's option, LIBOR plus 225 basis points. The facilities are collateralized by all of the Company's assets with the exception of the real property, building, and equipment that collateralize the long-term financing on the Company's facility in Allen, Texas. Under the working capital line, the Company is required to make monthly principal payments of $90,000, with interest payable quarterly. Under the term loan facility, no principal payments are due until maturity and interest is payable quarterly. On March 3, 1997, the Company increased its borrowings under the working capital line of credit by $1.1 million and borrowed $350,000 under the term loan facility. These additional borrowings were utilized to pay a portion of the debt under the Settlement described above. See Note 5 of the Notes to Consolidated Financial Statements. Management believes that its current cash, cash equivalents and marketable securities and funds generated from operations will be sufficient to satisfy normal cash operating requirements, debt service and capital requirements during the remainder of 1997. During the first quarter of 1998, however, $8.1 million of debt will become due and payable. The Company is exploring various means to either refinance or payoff the debt entirely, including without limitation, a new loan facility, alternative debt or equity financing, asset or division sale, technology transfer or other arrangements. CASH FLOWS Net cash used in operating activities in 1996 decreased to $446,000 compared to $1.53 million in 1995. The primary use of cash during 1996 was an increase in the Company's investment in inventories, which increased by $2.26 million, primarily related to building MPS units and manufacturing supplies of related disposables. The Company anticipates that its operating activities during 1997 will provide cash and anticipates a decrease in its investment in inventories of approximately $1.0 million by year-end 1997. During 1995, the net cash used in operating activities of $1.5 million was primarily due to an increase in net working capital, principally in the areas of accounts receivable, inventory and prepaid expenses. Investing activities in 1996 resulted in a net use of cash of $3.5 million compared to a net use of cash during 1995 of $14.1 million. Primary uses of cash in investing activities during 1996 were capital expenditures of $2.0 million for additional manufacturing equipment and office equipment and $3.0 million for the purchase of certain patent rights from the former owner of Neuromed, Inc. See "-- Liquidity and Capital Resources" and Notes 3 and 5 of the Notes to Consolidated Financial Statements. The primary source of cash from investing activities in 1996 was from the sale of certain of the Company's investments in marketable securities, which provided $1.5 million. Primary uses of cash in investing activities during 1995 were $16.0 million utilized to consummate the Neuromed acquisition and capital expenditures of $1.5 million. The primary source of cash from investing activities in 1995 was from the sale of certain of the Company's investments in marketable securities, which provided $3.3 million. Financing activities in 1996 provided $3.3 million of net cash compared to $16.9 million in 1995. Primary sources of cash from financing activities in 1996 consisted of a net increase in notes payable of $3.0 million to fund the purchase of certain patent rights from the former owner of Neuromed and $559,000 from the exercise 20 22 of stock options. The $3.0 million obligation was paid during March 1997. See Note 5 of the Notes to Consolidated Financial Statements. Primary uses of cash in financing activities during 1996 were $151,000 of principal payments for long-term notes payable and $103,000 utilized in the redemption of the Company's shareholder rights plan. Primary sources of cash from financing activities in 1995 consisted of $15.0 million provided from borrowings under a senior-term bank facility which was utilized to fund most of the cash portion of the Neuromed acquisition purchase price, $1.9 million of additional borrowings under the Company's working capital line of credit, and $15.2 million of net proceeds provided by a public offering. In addition, the exercise of stock options in 1995 provided $369,000. Primary uses of cash in financing activities during 1995 were repayment of the $15.0 million senior-term bank indebtedness and $108,000 of principal payments for long-term notes payable. RECENT EVENTS On March 10, 1997, the Company announced that the Company's Board of Directors has engaged Smith Barney and Rauscher Pierce Refsnes to seek strategic alternatives to enhance shareholder value. These strategic alternatives may include a merger, sale of assets, other business combination, or a joint venture or strategic alliance. OUTLOOK AND UNCERTAINTIES Quest does not provide forecasts of potential future financial performance. While Quest management is optimistic about Quest's long-term prospects, the following issues and uncertainties, among others, should be considered in evaluating its growth outlook. Liquidity. The Company's liquidity has been substantially reduced over the course of the preceding year, and in the first quarter of 1998, $8.1 million in debt will become due. The Company's management believes that it will be able to refinance or repay the debt through a new loan facility, alternative debt or equity financing, asset or division sale, technology transfer or other arrangement, but there can be no assurance to this effect. The Company's leverage and debt service requirements could affect its ability to grow and its level of profitability. Search for Strategic Alternatives. The Company has engaged Smith Barney and Rauscher Pierce Refsnes to seek strategic alternatives to enhance shareholder value. Although management is optimistic that it will identify an alternative to pursue, there are many risks and uncertainties inherent in such a process and there can be no assurance that a strategic alternative will be identified or, if identified, will be implemented successfully. Product Development and Market Acceptance. The Company's growth depends in part on the development and market acceptance of new products, including the MPS system and related products and next generation ANS products. There is no assurance that the Company will continue to develop successful products, that delays in product introduction will not be experienced, or that once such products are introduced, the market will accept them. In addition, while management believes that offering the MPS system on a one-year rental basis and a lease/purchase basis should accelerate the placement of MPS units and related disposables, there can be no assurance to this effect. Government Regulation. The Company's business is subject to extensive government regulation, principally by the FDA. The regulatory process, especially as it relates to product approvals, can be lengthy, expensive and uncertain. Competition and Technological Change. The medical device market is highly competitive. The Company competes with many larger companies that have access to greater capital, research and development, marketing, distribution and other resources than the Company. In addition, this market is characterized by extensive research efforts and rapid product development and technological change, which could render the Company's products obsolete or noncompetitive. Intellectual Property Rights. The Company relies in part on patents, trade secrets and proprietary technology to remain competitive. It may be necessary to defend these rights or to defend against claims that 21 23 the Company is infringing the rights of others. Intellectual property litigation and controversies are disruptive and expensive. Cost Pressures on Medical Technology. The overall escalating cost of medical products and healthcare results in significant cost pressure. Third party payors are under intense pressure to challenge the prices charged for medical products and services. Potential Product Liability. The testing, manufacturing, marketing and sale of medical devices entail substantial risks of liability claims or product recalls. Other Uncertainties. Other operating, financial or legal risks or uncertainties are discussed in this Form 10-K in specific contexts and in the Company's other periodic SEC filings. The Company is, of course, also subject to general economic risks, the risk of interruption in the source of supply, the risk of loss of a major customer, dependence on key personnel and other risks and uncertainties. CURRENCY FLUCTUATIONS Substantially all of the Company's international sales are denominated in U.S. dollars. Fluctuations in currency exchange rates in other countries could reduce the demand for the Company's products by increasing the price of the Company's products in the currency of the countries in which the products are sold, although management does not believe currency fluctuations have had a material effect on the Company's results of operations to date. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The information required by this item is set forth in Appendices A and C. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The information required by this item is contained under the captions "Election of Directors" and "Executive Officers" in the definitive proxy material of the Company to be filed in connection with its 1997 annual meeting of stockholders, which information is incorporated herein by reference. ITEM 11. EXECUTIVE COMPENSATION The information required by this item is contained under the captions "Compensation and Committees of the Board of Directors" and "Compensation of Executive Officers" in the definitive proxy material of the Company to be filed in connection with its 1997 annual meeting of stockholders, which information is incorporated herein by reference. Information under the caption titled "Report of the Board of Directors on Annual Compensation" and "Performance Graph" is not incorporated by reference. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information required by this item is contained under the caption "Security Ownership of Management and Principal Shareholders" in the definitive proxy material of the Company to be filed in connection with its 1997 annual meeting of stockholders, which information is incorporated herein by reference. 22 24 ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information required by this item is contained under the caption "Certain Relationships and Related Transactions" in the definitive proxy material of the Company to be filed in connection with its 1997 annual meeting of stockholders, which information is incorporated herein by reference. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (a) 1. Financial Statements: See Index to Financial Statements on the second page of Appendix A. 2. Financial Statement Schedules:* Schedule II -- Valuation and Qualifying Accounts. See Appendix B. * Those schedules not listed above are omitted as not applicable or not required. 3. Exhibits: See (c) below. (b) Reports on Form 8-K: None (c) Exhibits: 2.1 -- Agreement for the Purchase and Sale of All of the Issued Capital Stock of Neuromed, Inc. dated February 10, 1995, between Quest Medical, Inc. and William N. Borkan(5) 2.2 -- Amendment Agreement dated March 17, 1995, between Quest Medical, Inc. and William N. Borkan(5) 2.3 -- Letter Agreement dated as of September 23, 1995, by and between Quest Medical, Inc. and William N. Borkan(6) 3.1 -- Articles of Incorporation, as amended(6) 3.2 -- Bylaws(1) 4.1 -- Rights Agreement dated as of August 30, 1996, between Quest Medical, Inc. and KeyCorp Shareholder Services, Inc. as Rights Agent(7) 10.1 -- Quest Medical, Inc. 1979 Amended and Restated Employees Stock Option Plan(2) 10.2 -- Form of 1979 Employees Stock Option Agreement(3) 10.3 -- Quest Medical, Inc. Directors Stock Option Plan (as amended)(2) 10.4 -- Form of Directors Stock Option Agreement(1) 10.5 -- Quest Medical, Inc. 1987 Stock Option Plan(6) 10.6 -- Form of 1987 Employee Stock Option Agreement(6) 10.7 -- Quest Medical, Inc. 1995 Stock Option Plan(6) 10.8 -- Form of 1995 Employee Stock Option Agreement(6) 10.9 -- Form of Employment Agreement and Covenant Not to Compete, between the Company and key employees(1) 10.10 -- Promissory Note dated December 28, 1993, between Quest Medical, Inc. and MetLife Capital Financial Corporation(4) 10.11 -- Commercial Deed of Trust, Security Agreement and Assignment of Leases and Rents and Fixture Filing dated December 28, 1993, between Quest Medical, Inc. and MetLife Capital Financial Corporation(4)
23 25 10.12 -- Term Promissory Note dated December 28, 1993, between Quest Medical, Inc. and MetLife Capital Corporation(4) 10.13 -- Loan and Security Agreement dated December 28, 1993, between Quest Medical, Inc. and MetLife Capital Corporation(4) 10.14 -- Supplemental Security Agreement Number One dated December 28, 1993, between Quest Medical, Inc. and MetLife Capital Corporation(4) 10.15 -- Third Amended and Restated Credit Agreement dated as of March 3, 1997, between Quest Medical, Inc. and NationsBank of Texas, N.A.(8) 10.16 -- Promissory Note (Facility A. Note) in the original principal amount of $5,650,000 dated March 3, 1997(8) 10.17 -- Promissory Note (Facility B. Note) in the original principal amount of $350,000 dated March 3, 1997(8) 10.18 -- First Amended and Restated Security Agreement dated March 3, 1997, between Quest Medical, Inc. and NationsBank of Texas, N.A.(8) 10.19 -- First Amended and Restated Security Agreement dated March 3, 1997, between Advanced Neuromodulation Systems, Inc. and NationsBank of Texas, N.A.(8) 10.20 -- First Amended and Restated Intellectual Property Security Agreement and Assignment dated as of March 3, 1997, between Quest Medical, Inc. and NationsBank of Texas N.A.(8) 10.21 -- First Amended and Restated Intellectual Property Security Agreement and Assignment dated as of March 3, 1997, between Advanced Neuromodulation Systems, Inc. and NationsBank of Texas, N.A.(8) 10.22 -- First Amended and Restated License Agreement dated as of March 3, 1997, between Quest Medical, Inc. and NationsBank of Texas, N.A.(8) 10.23 -- First Amended and Restated License Agreement dated as of March 3, 1997, between Advanced Neuromodulation Systems, Inc. and NationsBank of Texas, N.A.(8) 10.24 -- Guaranty of Advanced Neuromodulation Systems, Inc. in favor of NationsBank of Texas, N.A. under the Third Amended and Restated Credit Agreement dated as of March 3, 1997(8) 11.1 -- Computation of Earnings Per Share(8) 21.1 -- Subsidiaries(8) 23.1 -- Consent of Independent Auditors(8)
- --------------- (1) Filed as an Exhibit to the Company's Registration Statement on Form S-18, Registration No. 2-71198-FW, and incorporated herein by reference. (2) Filed as an Exhibit to the report of the Company on Form 10-K for the year ended December 31, 1987, and incorporated herein by reference. (3) Filed as an Exhibit to the Company's Registration Statement on Form S-1, Registration No. 2-78186, and incorporated herein by reference. (4) Filed as an Exhibit to the report of the Company on Form 10-KSB for the year ended December 31, 1993, and incorporated herein by reference. (5) Filed as an Exhibit to the report of the Company on Form 10-KSB for the year ended December 31, 1994, and incorporated herein by reference. (6) Filed as an Exhibit to the Company's Registration Statement on Form SB-2, Registration No. 33-62991, and incorporated herein by reference. (7) Filed as an Exhibit to the report of the Company on Form 8-K dated September 3, 1996, and incorporated herein by reference. (8) Filed herewith. 24 26 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. Date: March 28, 1997 QUEST MEDICAL, INC. By: /s/ THOMAS C. THOMPSON ---------------------------------- Thomas C. Thompson, President Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the Company and in the capacities and on the dates indicated:
SIGNATURE TITLE DATE --------- ----- ---- /s/ THOMAS C. THOMPSON President and Director of Quest March 28, 1997 - ----------------------------------------------------- Medical, Inc. (Principal Thomas C. Thompson Executive Officer) /s/ F. ROBERT MERRILL III Senior Vice March 28, 1997 - ----------------------------------------------------- President -- Finance, F. Robert Merrill III Secretary and Treasurer of Quest Medical, Inc. (Principal Financial and Accounting Officer) Director of Quest Medical, Inc. March 28, 1997 - ----------------------------------------------------- Linton E. Barbee Director of Quest Medical, Inc. March 28, 1997 - ----------------------------------------------------- Robert C. Eberhart /s/ HUGH M. MORRISON Director of Quest Medical, Inc. March 28, 1997 - ----------------------------------------------------- Hugh M. Morrison /s/ RICHARD D. NIKOLAEV Director of Quest Medical, Inc. March 28, 1997 - ----------------------------------------------------- Richard D. Nikolaev /s/ MICHAEL J. TORMA Director of Quest Medical, Inc. March 28, 1997 - ----------------------------------------------------- Michael J. Torma
25 27 APPENDIX A CONSOLIDATED FINANCIAL STATEMENTS INDEPENDENT AUDITORS' REPORT THREE YEARS ENDED DECEMBER 31, 1996 FORMING A PART OF THE ANNUAL REPORT FORM 10-K ITEM 8 OF QUEST MEDICAL, INC. AND SUBSIDIARIES (NAME OF ISSUER) FILED WITH THE SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 UNDER THE SECURITIES AND EXCHANGE ACT OF 1934 28 QUEST MEDICAL, INC. AND SUBSIDIARIES TABLE OF CONTENTS TO CONSOLIDATED FINANCIAL STATEMENTS FORM 10-K -- ITEM 8 INDEPENDENT AUDITORS' REPORT................................ CONSOLIDATED FINANCIAL STATEMENTS: Consolidated Balance Sheets -- December 31, 1996 and 1995... Consolidated Statements of Operations -- Three years ended December 31, 1996......................................... Consolidated Statements of Stockholders' Equity -- Three years ended December 31, 1996............................. Consolidated Statements of Cash Flows -- Three years ended December 31, 1996......................................... Notes to Consolidated Financial Statements..................
A-1 29 REPORT OF INDEPENDENT AUDITORS The Board of Directors Quest Medical, Inc. We have audited the accompanying consolidated balance sheets of Quest Medical, Inc. and subsidiaries (the Company) as of December 31, 1996 and 1995, and the related consolidated statements of operations, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 1996. Our audit also included the financial statement schedule listed in the Index at Item 14A. These consolidated 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 financial statements referred to above present fairly, in all material respects, the consolidated financial position of Quest Medical, Inc. and subsidiaries at December 31, 1996 and 1995, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1996, 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. /s/ ERNST & YOUNG LLP ------------------------------------ ERNST & YOUNG LLP Dallas, Texas March 14, 1997 A-2 30 QUEST MEDICAL INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS DECEMBER 31, 1996 AND 1995 ASSETS
1996 1995 ----------- ----------- Current assets: Cash and cash equivalents................................. $ 696,196 $ 1,325,630 Marketable securities..................................... 1,366,089 2,588,547 Receivables: Trade accounts, less allowance for doubtful accounts of $174,337 in 1996 and $114,337 in 1995................. 4,829,827 4,955,235 Net investment in sales-type leases.................... 176,875 -- Interest and other..................................... 134,162 128,492 ----------- ----------- Total receivables...................................... 5,140,864 5,083,727 ----------- ----------- Inventories: Raw materials.......................................... 3,931,282 2,743,702 Work-in-process........................................ 1,400,712 1,077,529 Finished goods......................................... 3,032,600 2,285,961 ----------- ----------- Total inventories...................................... 8,364,594 6,107,192 ----------- ----------- Deferred income taxes..................................... 317,276 356,703 Prepaid expenses and other current assets................. 668,808 1,226,268 ----------- ----------- Total current assets................................... 16,553,827 16,688,067 ----------- ----------- Property, plant and equipment: Land...................................................... 1,930,289 1,930,289 Building and improvements................................. 5,296,125 5,271,718 Furniture and fixtures.................................... 3,827,738 2,964,471 Machinery and equipment................................... 4,962,846 3,879,802 ----------- ----------- 16,016,998 14,046,280 Less accumulated depreciation and amortization............ 4,832,468 3,784,510 ----------- ----------- Net property, plant and equipment...................... 11,184,530 10,261,770 ----------- ----------- Cost in excess of net assets acquired, net of accumulated amortization of $817,784 in 1996 and $340,300 in 1995..... 10,931,849 9,546,298 Patents, net of accumulated amortization of $1,311,556 in 1996 and $1,086,433 in 1995............................... 4,063,843 1,288,966 Purchased technology from acquisitions, net of accumulated amortization of $730,775 in 1996 and $413,558 in 1995..... 3,967,225 4,284,442 Tradenames, net of accumulated amortization of $218,750 in 1996 and $93,750 in 1995.................................. 2,281,250 2,406,250 Other assets, net of accumulated amortization of $190,000 in 1996 and $178,667 in 1995................................. 9,931 19,964 ----------- ----------- $48,992,455 $44,495,757 =========== ===========
See accompanying notes to consolidated financial statements. A-3 31 QUEST MEDICAL INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS DECEMBER 31, 1996 AND 1995 LIABILITIES AND STOCKHOLDERS' EQUITY
1996 1995 ----------- ----------- Current liabilities: Accounts payable.......................................... $ 2,269,269 $ 1,210,265 Short-term notes payable and current maturities of long-term notes payable................................ 2,084,122 1,616,311 Accrued salary and employee benefit costs................. 924,309 630,908 Accrued relocation costs.................................. -- 291,370 Other accrued expenses.................................... 188,605 755,976 ----------- ----------- Total current liabilities......................... 5,466,305 4,504,830 ----------- ----------- Notes payable............................................... 11,912,036 8,558,297 Deferred income taxes....................................... 620,631 562,580 Commitments and contingencies Stockholders' equity: Common stock, $.05 par value. Authorized 25,000,000 shares in 1996 and 10,000,000 shares in 1995; issued 8,338,510 shares in 1996 and 8,147,349 shares in 1995.............................. 416,926 407,367 Additional capital........................................ 38,699,517 38,253,670 Retained earnings (deficit)............................... (7,992,082) (7,579,925) Unrealized loss on marketable securities net of tax benefit of $67,423 in 1996 and $108,729 in 1995........ (130,878) (211,062) ----------- ----------- Total stockholders' equity........................ 30,993,483 30,870,050 ----------- ----------- $48,992,455 $44,495,757 =========== ===========
See accompanying notes to consolidated financial statements. A-4 32 QUEST MEDICAL, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS YEARS ENDED DECEMBER 31
1996 1995 1994 ----------- ------------ ----------- Net revenue......................................... $26,073,808 $ 25,320,990 $13,999,165 Cost of revenue..................................... 11,005,260 10,624,215 7,617,932 ----------- ------------ ----------- Gross profit.............................. 15,068,548 14,696,775 6,381,233 ----------- ------------ ----------- Operating expenses: General and administrative........................ 5,027,749 4,199,398 3,063,296 Research and development.......................... 3,342,626 4,582,868 3,542,193 Purchased research and development................ -- 10,500,000 -- Marketing......................................... 6,597,983 4,195,972 1,913,793 ----------- ------------ ----------- 14,968,358 23,478,238 8,519,282 ----------- ------------ ----------- Earnings (loss) from operations........... 100,190 (8,781,463) (2,138,049) Other income (expense): Gain on sale of marketable securities............. 136,975 29,115 464,113 Interest expense.................................. (766,769) (1,657,818) (569,428) Investment and other income, net.................. 200,322 460,282 524,171 ----------- ------------ ----------- (429,472) (1,168,421) 418,856 ----------- ------------ ----------- Loss before income taxes and extraordinary item.................................... (329,282) (9,949,884) (1,719,193) Income taxes........................................ 82,875 155,114 -- ----------- ------------ ----------- Loss before extraordinary item............ (412,157) (10,104,998) (1,719,193) Extraordinary item -- loss on early extinguishment of debt, net of income tax benefit of $138,599.... -- (269,045) -- ----------- ------------ ----------- Net loss.................................. $ (412,157) $(10,374,043) $(1,719,193) =========== ============ =========== Per common and common equivalent share: Loss before extraordinary item.................... $ (.05) $ (1.52) $ (.33) =========== ============ =========== Extraordinary item................................ $ -- $ (.04) $ -- =========== ============ =========== Net loss.......................................... $ (.05) $ (1.56) $ (.33) =========== ============ ===========
See accompanying notes to consolidated financial statements. A-5 33 QUEST MEDICAL, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS YEARS ENDED DECEMBER 31
1996 1995 1994 ----------- ------------ ----------- Cash flows from operating activities: Net loss......................................... $ (412,157) $(10,374,043) $(1,719,193) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation.................................. 1,047,958 952,935 761,174 Amortization.................................. 1,156,157 922,454 362,771 Extraordinary item: write off of debt issuance costs....................................... -- 407,644 -- Deferred income taxes......................... 97,478 200,002 -- Non-operating gains included in net loss...... (139,030) (137,898) (464,113) Purchased research and development............ -- 10,500,000 -- Changes in assets and liabilities, net of effects of acquisition: Receivables................................. (57,137) (2,020,213) 387,347 Inventories................................. (2,257,402) (557,095) 22,471 Prepaid expenses............................ 415,289 (750,284) (128,770) Accounts payable............................ 700,679 (346,134) (325,167) Accrued expenses............................ (998,289) (340,966) (304,894) Other....................................... -- 9,720 (39,701) ----------- ------------ ----------- Net cash used in operating activities.... (446,454) (1,533,878) (1,448,075) ----------- ------------ ----------- Cash flows from investing activities: Net proceeds from marketable securities transactions.................................. 1,480,924 3,317,881 1,346,903 Additions to property, plant and equipment....... (1,972,300) (1,468,732) (1,076,871) Additions to patents............................. (3,000,000) -- -- Acquisition, net of cash acquired................ -- (15,996,910) -- Other............................................ 3,637 6,550 19,510 ----------- ------------ ----------- Net cash provided by (used in) investing activities............................. (3,487,739) (14,141,211) 319,542 ----------- ------------ ----------- Cash flows from financing activities: Net increase (decrease) in short-term notes payable....................................... (1,450,000) -- 500,000 Proceeds of long-term notes payable, net of debt issuance costs................................ 4,450,000 16,431,233 106,978 Payment of long-term notes payable............... (150,647) (15,108,486) (121,977) Exercise of stock options........................ 558,552 369,449 137,047 Net proceeds from public offering of common stock......................................... -- 15,218,815 -- Redemption of rights plan........................ (103,146) -- -- Issuance (purchase) of treasury stock, net....... -- 1,745 -- ----------- ------------ ----------- Net cash provided by financing activities............................. 3,304,759 16,912,756 622,048 ----------- ------------ ----------- Net increase (decrease) in cash and cash equivalents...................................... (629,434) 1,237,667 (506,485) Cash and cash equivalents at beginning of year..... 1,325,630 87,963 594,448 ----------- ------------ ----------- Cash and cash equivalents at end of year........... $ 696,196 $ 1,325,630 $ 87,963 =========== ============ =========== Supplemental cash flow information is presented below: Income taxes paid.................................. $ -- $ -- $ -- =========== ============ =========== Interest paid (net of amounts capitalized)......... $ 668,049 $ 1,571,553 $ 558,337 =========== ============ ===========
See accompanying notes to consolidated financial statements. A-6 34 QUEST MEDICAL, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY THREE YEARS ENDED DECEMBER 31, 1996
UNREALIZED COMMON STOCK RETAINED LOSS ON TOTAL -------------------- ADDITIONAL EARNINGS MARKETABLE TREASURY STOCKHOLDERS' SHARES AMOUNT CAPITAL (DEFICIT) SECURITIES STOCK EQUITY --------- -------- ----------- ------------ ---------- ----------- ------------- Balance at December 31, 1993....... 7,939,441 $396,972 $18,787,628 $ 5,430,286 $(169,308) $(6,193,796) $ 18,251,782 Shares issued upon exercise of stock options.................. 43,057 2,153 134,894 -- -- -- 137,047 Issuance of 1,882 common shares from treasury.................. -- -- 5,595 -- -- 4,075 9,670 Stock dividend................... -- -- 586,054 (916,975) -- 330,921 -- Adjustment to unrealized losses on marketable securities....... -- -- -- -- (748,326) -- (748,326) Net loss......................... -- -- -- (1,719,193) -- -- (1,719,193) --------- -------- ----------- ------------ --------- ----------- ------------ Balance at December 31, 1994....... 7,982,498 399,125 19,514,171 2,794,118 (917,634) (5,858,800) 15,930,980 Shares issued upon exercise of stock options.................. 160,422 8,021 361,429 -- -- -- 369,450 Issuance of 245 common shares from treasury.................. -- -- 1,216 -- -- 529 1,745 Adjustment to unrealized losses on marketable securities....... -- -- -- -- 706,572 -- 706,572 Issuance of 1,033,333 common shares from treasury for acquisition.................... -- -- 6,779,285 -- -- 2,237,246 9,016,531 Sale of treasury and new common shares in public offering, net of offering costs.............. 4,429 221 11,597,569 -- -- 3,621,025 15,218,815 Net loss......................... -- -- -- (10,374,043) -- -- (10,374,043) --------- -------- ----------- ------------ --------- ----------- ------------ Balance at December 31, 1995....... 8,147,349 407,367 38,253,670 (7,579,925) (211,062) -- 30,870,050 Shares issued upon exercise of stock options.................. 159,178 7.959 479,207 -- -- -- 487,166 Adjustment to unrealized losses on marketable securities....... -- -- -- -- 80,184 -- 80,184 Issuance of 31,983 new common shares for employee bonuses and cancellation of a stock option......................... 31,983 1,600 69,786 -- -- -- 71,386 Redemption of rights plan dividend....................... -- -- (103,146) -- -- -- (103,146) Net loss......................... -- -- -- (412,157) -- -- (412,157) --------- -------- ----------- ------------ --------- ----------- ------------ Balance at December 31, 1996....... 8,338,510 $416,926 $38,699,517 $ (7,992,082) $(130,878) -- $ 30,993,483 ========= ======== =========== ============ ========= =========== ============
See accompanying notes to consolidated financial statements. A-7 35 QUEST MEDICAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1996 (1) BUSINESS Quest Medical, Inc. and its subsidiaries (the "Company") design, develop, manufacture and market a variety of healthcare products used primarily in cardiovascular surgery, interventional pain management and intravenous fluid delivery applications. The Company's revenues are derived primarily from sales throughout the United States, Europe and Australia. The research and development, manufacture, sale and distribution of medical devices is subject to extensive regulation by various public agencies, principally the Food and Drug Administration and corresponding state, local and foreign agencies. Product approvals and clearances can be delayed or withdrawn for failure to comply with regulatory requirements or the occurrence of unforeseen problems following initial marketing. In addition, the Company's products are purchased primarily by hospitals and other users which then bill various third party payors including Medicare, Medicaid, private insurance companies and managed care organizations. These third party payors reimburse fixed amounts for services based on a specific diagnosis. The impact of changes in third party payor reimbursement policies and any amendments to existing reimbursement rules and regulations which restrict or terminate the eligibility of the Company's products could have an adverse impact on the Company's financial condition and results of operations. (2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES The consolidated financial statements include the accounts of Quest Medical, Inc. and subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from these estimates. Revenue from product sales is recognized at the time the product is shipped. The Company leases the Quest MPS myocardial protection system to customers under noncancellable leases with terms of five years. The present value of the minimum rentals to be received under such leases is recorded as net sales. The difference between the gross rentals to be received and the present value of the rentals is recorded as unearned finance income and is amortized into income on the interest method over the lease term. The cost of the leased equipment is charged to cost of sales at the time the sale is recorded. The present value of the rentals to be received under such leases is recorded as net investment in sales-type leases. At December 31, 1996, the balance in the net investment in sales-type leases was $176,875. Cash equivalents include certificates of deposit and short-term, highly liquid debt instruments with original maturities of three months or less. The Company's marketable equity and debt securities are classified as available-for-sale and are carried at fair value, with the unrealized gains and losses reported in a separate component of stockholders' equity. The amortized cost of debt securities in this category is adjusted for amortization of premiums and accretion of discounts to maturity. Such amortization is included in investment income. Realized gains and losses and declines in value judged to be other-than-temporary are included in other income. The cost of securities sold is based on the specific identification method. Interest and dividends are included in investment income. Inventories are recorded at the lower of standard cost or market. Standard cost approximates actual cost determined on the first-in, first-out (FIFO) basis. A-8 36 QUEST MEDICAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) Property, plant and equipment are stated at cost. Major renewals and betterments are capitalized; maintenance and repairs are charged to operations as incurred. Provisions for depreciation and amortization of property, plant and equipment are computed using the straight-line method using estimated useful lives of 3 to 30 years. The excess of costs over the net assets of businesses acquired is amortized on a straight line basis over the estimated useful lives of 20 to 25 years. The Company assesses the recoverability of this intangible asset, as well as other intangible assets, primarily based on its current and anticipated future undiscounted cash flows. At December 31, 1996, the Company does not believe there has been any impairment of its intangible assets. Cost of purchased patents is amortized on a straight-line basis over the estimated useful lives (4 to 17 years) of such patents. Costs of patents which are the result of internal development are charged to current operations. The cost of purchased technology related to acquisitions is based on appraised values at the date of acquisition and is amortized on a straight-line basis over the estimated useful lives (10 to 15 years) of such technology. The cost of purchased tradenames is based on appraised values at the date of acquisition and is amortized on a straight-line basis over the estimated useful life (20 years) of such tradenames. Product development costs including start-up, research and development, advertising and promotional costs are charged to operations in the year in which such costs are incurred. Total advertising expense included in marketing was $25,914, $84,978 and $61,388 at December 1996, 1995 and 1994, respectively. Loss per share for 1996, 1995, and 1994 is based upon 8,531,499, 6,642,082 and 5,256,683 common and common equivalent shares outstanding, respectively. Common stock equivalents are outstanding stock options and are included in average common and common equivalent shares outstanding using the treasury stock method except during periods where their effect would be antidilutive. During 1994, the Board of Directors approved a 3 percent stock dividend. The weighted average number of common and common equivalent shares outstanding used in computing loss per share were increased to retroactively reflect the stock dividend. Deferred income taxes are recorded based on the liability method and represent the tax effect of the differences between the financial and tax basis of assets and liabilities other than costs in excess of the net assets of businesses acquired. The Company has elected to follow APB No. 25, "Accounting for Stock Issued to Employees" and related Interpretations in the primary financial statements and to provide supplementary disclosures required by FASB Statement No. 123, "Accounting for Stock-Based Compensation." (See Note 7.) Certain prior period amounts have been reclassified to conform to current year presentation. (3) ACQUISITION On March 31, 1995, the Company acquired for $15,403,263 cash (excluding $1,062,414 of related acquisition and financing costs) and 833,333 shares of Quest common stock valued at $6,458,331, all of the capital stock of Neuromed, Inc. ("Neuromed"). The transaction also provided for contingent consideration over the following two years, payable in a combination of cash and additional shares of Quest common stock in January 1996 and January 1997, depending on sales of Neuromed's products reaching certain objectives. Financing for the cash portion of the purchase price was provided by a bank. (See Note 5.) In July 1995, the sales objectives for 1995 were reached which triggered a liability for the 1995 contingent consideration payments with regard to the Neuromed acquisition. The Company recorded the additional "earn-out" consideration of 200,000 shares of Quest common stock valued at $2,558,200 and a $1,500,000 liability (payable in cash in January 1996). In addition, in September 1995, the Company amended certain A-9 37 QUEST MEDICAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) terms of the acquisition agreement whereby the Company agreed to accelerate issuance of the 200,000 shares for the 1995 earn-out and the seller relinquished certain rights from the previous agreement. The amended agreement set the 1996 contingent consideration, payable in January 1997, at a cash payment equal to $3,370,000, if earned. In January 1996, the Company withheld payment of the $1,500,000 pursuant to the 1995 contingent consideration obligation pending arbitration of certain disputes between the Company and Neuromed's former owner. In October 1996, the sales objectives for the 1996 earn-out were reached and the Company recorded a note payable in the amount of $3,370,000 which was due in January 1997. The Company similarly withheld payment of this note pending arbitration. In addition, the Company had a short-term note payable to the former owner of Neuromed at December 31, 1996, in the amount of $972,000 due in January 1997, related to certain purchase price adjustments (principally tax refunds and future tax credits) awarded through an arbitration. The Company paid the $972,000 obligation during January 1997. On February 6, 1997, the Company and the former owner of Neuromed reached a settlement (the "Settlement") of all issues between them. Under the terms of the Settlement, the Company agreed to pay $500,000 in cash on March 3, 1997, and deliver a promissory note in the amount of $1,000,000 payable on February 6, 1998, for full settlement of the contingent considerations. The Company also agreed to pay $3,000,000 in cash on March 3, 1997, to purchase certain patent rights from Neuromed's former owner. (See Note 5.) The acquisition was accounted for by the purchase method of accounting. The allocation of the purchase price among identifiable tangible and intangible assets was based upon a risk adjusted income approach. The cost in excess of net assets acquired is being amortized on a straight line basis over twenty years. Purchased in-process research and development was identified and valued through extensive interviews and analysis of data concerning Neuromed's products under development. Expected future cash flows for products under development were discounted taking into account economic risks associated with the inherent difficulties and uncertainty in completing the products, and thereby achieving technological feasibility, and risks related to the viability of and potential changes in future target markets. This resulted in $10,500,000 of purchased research and development which had not yet achieved technological feasibility and does not have alternative uses. Therefore, in accordance with generally accepted accounting principles, the $10,500,000, with no related tax benefit, was charged to expense during the year ended December 31, 1995. The purchase price allocation for the acquisition of Neuromed, as of December 31, 1996, is summarized below: Tradenames.................................................. $ 2,500,000 Purchased technology........................................ 4,000,000 Cost in excess of net assets acquired....................... 10,736,427 Purchased research and development.......................... 10,500,000 Excess of liabilities over tangible assets acquired......... (1,222,986) Deferred financing costs.................................... 468,767 ----------- $26,982,208 ===========
In connection with the purchase, the Company determined that the operations of Neuromed would be relocated to the Company's facility in Allen, Texas by the end of the first quarter of 1996. The relocation was completed during the first quarter of 1996 and the Company incurred $1,234,335 of relocation costs which were recorded as an adjustment to cost in excess of net assets acquired. A-10 38 QUEST MEDICAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) The following unaudited pro forma summary presents the results of operations as if the acquisition had occurred on January 1, 1994. This summary does not purport to be indicative of what would have occurred had the acquisition been made as of this date or of results which may occur in the future. This method of combining the companies is for the presentation of unaudited pro forma summary results of operations. Actual statements of operations of Quest Medical and of Neuromed have been combined from the effective date of the acquisition forward.
YEAR ENDED YEAR ENDED DECEMBER 31, DECEMBER 31, 1995 1994 ------------ ------------ Pro forma revenue......................................... $27,728,289 $22,043,518 Pro forma earnings (loss) from operations................. 2,634,499 (86,467) ----------- ----------- Pro forma net earnings (loss) before extraordinary item in 1995.................................................... 584,986 (1,220,055) ----------- ----------- Pro forma net earnings (loss) per common and equivalent share before extraordinary item in 1995................. $ .08 $ (0.20) =========== ===========
The pro forma operations information excludes the charge of $10,500,000 ($1.72 per share) related to purchased in-process research and development which was expensed at the date of acquisition. (4) MARKETABLE SECURITIES The following is a summary of available-for-sale securities at December 31, 1996:
GROSS GROSS UNREALIZED UNREALIZED ESTIMATED COST GAINS LOSSES FAIR VALUE ---------- ---------- ---------- ---------- Investment grade preferred securities... $ 622,596 $4,503 $ 45,817 $ 581,282 Publicly traded limited partnerships.... 263,004 -- 44,019 218,985 Real estate investment trusts........... 297,695 3,498 41,688 259,505 Other................................... 381,095 10 74,788 306,317 ---------- ------ -------- ---------- $1,564,390 $8,011 $206,312 $1,366,089 ========== ====== ======== ==========
At December 31, 1996, no individual security represented more than 20 percent of the total portfolio or 1 percent of total assets. The Company did not have any investments in derivative financial instruments at December 31, 1996. The following is a summary of available-for-sale securities at December 31, 1995:
GROSS GROSS UNREALIZED UNREALIZED ESTIMATED COST GAINS LOSSES FAIR VALUE ---------- ---------- ---------- ---------- Investment grade preferred securities... $ 993,241 $ 252 $135,928 $ 857,565 Publicly traded limited partnerships.... 506,447 -- 39,697 466,750 Real estate investment trusts........... 1,031,417 11,899 96,816 946,500 Other................................... 377,233 3,884 63,385 317,732 ---------- ------- -------- ---------- $2,908,338 $16,035 $335,826 $2,588,547 ========== ======= ======== ==========
At December 31, 1995, no individual security represented more than 15 percent of the total portfolio or 2 percent of total assets. The Company did not have any investments in derivative financial instruments at December 31, 1995. A-11 39 QUEST MEDICAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) (5) CURRENT AND LONG-TERM DEBT On March 31, 1995, the Company entered into a loan agreement (the "Loan Agreement") with a bank providing for $15 million in senior term financing, which was utilized to pay substantially all of the cash portion of the Neuromed purchase price and a working capital line of up to $5 million. Borrowings under both facilities bore interest at prime plus 125 basis points, or at the Company's option, LIBOR plus 300 basis points. During December 1995, the Company repaid in its entirety the senior term loan utilizing net proceeds it received from a public offering. (See Note 7.) At December 31, 1996 and 1995, the Company had advances in the amount of $4,550,000 outstanding under its working capital line with a weighted average interest rate of 7.19 percent and 7.69 percent for 1996 and 1995, respectively. At December 31, 1996, the Company was not in compliance with certain financial covenants in its loan agreement, but has cured the noncompliance through an amended loan agreement described below. On March 3, 1997, the Company amended the $5 million working capital line of credit. Under the amended agreement, the working capital line of credit was increased to $5,650,000 and a $350,000 term loan facility was added. Borrowings under the working capital line of credit bear interest at prime plus 100 basis points, or at the Company's option, LIBOR plus 275 basis points. Borrowings under the term loan bear interest at prime plus 100 basis points, or at the Company's option, LIBOR plus 225 basis points. The facilities are collateralized by all of the Company's assets with the exception of the real property, building, and equipment that collateralize the long-term financing on the Allen facility described below. The Company is subject to certain covenants related to the loan agreement including the maintenance of a minimum fixed charge ratio, a maximum total liabilities to tangible net worth ratio, and a maximum margin ratio (as defined). Under the amended agreement, the Company is prohibited from paying cash dividends. Under the working capital line of credit, the Company is required to make monthly payments of $90,000 with interest payable quarterly. Under the term loan, no principal payments are due until maturity and interest is payable quarterly. These facilities will expire on January 31, 1998. On March 3, 1997, the Company increased its borrowings under the working capital line of credit by $1,100,000 and borrowed $350,000 under the term loan facility. These additional borrowings were utilized to pay a portion of the debt under the February 6, 1997 Settlement discussed below. On February 21, 1997, the Company borrowed $2,000,000 from a shareholder pursuant to a promissory note. The promissory note bears interest at the rate of 6 percent per annum. Under the terms of the promissory note, the Company is required to make quarterly interest payments with a principal payment of $2,000,000 due and payable at the maturity of the note on February 21, 1998. In conjunction with the promissory note, the Company issued the shareholder five-year warrants to purchase 100,000 shares of common stock at an exercise price of $6.50 per share, the closing sales price on the date the indebtedness was incurred. Under the warrant agreement, the shareholder has the right to one demand registration in addition to piggyback registration rights. The loan is subordinated to the bank debt described above and the shareholder has a second lien on all of the assets collateralizing the bank debt. Proceeds of the loan were utilized to pay a portion of the debt under the Settlement described below. At December 31, 1996, the Company had a short-term, noninterest-bearing note payable in the amount of $972,197 due in connection with certain purchase price adjustments (primarily tax refunds and tax credits) awarded through an arbitration to the former owner of Neuromed, Inc. The note was paid during January 1997 from cash reserves. In addition, on February 6, 1997, the Company reached a Settlement (the "Settlement") on all outstanding issues with the former owner of Neuromed relating to the Neuromed acquisition. Under the Settlement, the Company agreed to pay $4.5 million in settlement of the earn-out provisions of the purchase agreement and the purchase of certain patent rights. Of the Settlement, $3.5 million is an interest bearing note at 10.25 percent per annum from February 6, 1997, and is due and payable on March 3, 1997. The Company paid such note on March 3, 1997, utilizing proceeds from the bank debt and shareholder debt described above. In addition, the Company issued the former owner a promissory note in the A-12 40 QUEST MEDICAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) amount of $1,000,000. The promissory note bears interest at the rate of 10 percent per annum with interest due and payable monthly and a principal payment of $1,000,000 due and payable on February 6, 1998. The loan is subordinated to the bank debt described above and is collateralized with a second lien that is pari passu with the shareholder's lien. The Company classified short-term notes payable of $8,100,000 at December 31, 1996, as long-term notes payable due to refinancings that took place during February and March of 1997. Of such amount, $3,650,000 (excluding current maturities of $900,000) relates to borrowings under the Company's working capital line of credit which was amended in March 1997, and the remaining $4,450,000 relates to the February 1997 Settlement with the former owner of Neuromed which was financed through the amended bank agreement which provided funds of $1,450,000, the shareholder promissory note of $2,000,000, and the promissory note due to Neuromed's former owner of $1,000,000, all of which are discussed above. On December 28, 1993, the Company entered into two agreements for long-term financing of its principal office and manufacturing facility in the amount of $4,355,071. The first agreement, in the amount of $3,000,000, is related to the building. This loan bore interest through 1995 at an adjustable rate based on the 30-day commercial paper rate plus 300 basis points. Effective January 1996, the Company fixed the rate of interest for the remainder of the term of the loan at 8.59 percent. This note has a 25-year amortization. The Company has the option of prepaying this note during years 6-10, subject to certain provisions. The loan is collateralized by the Allen facility building and land and has an unpaid balance of $2,923,260 at December 31, 1996. The second agreement, in the amount of $1,355,071, is related to certain equipment and furnishings. This loan bore interest through 1995 at an adjustable rate based on the 30-day commercial paper rate plus 250 basis points. Effective January 1996, the Company fixed the rate of interest for the remainder of the term of the loan at 7.94 percent. This note has a 10-year amortization. This loan is collateralized by the equipment and furnishings purchased with the proceeds and has an unpaid balance of $1,050,702 at December 31, 1996. Scheduled payments of current and long-term debt are as follows: 1997..................................................... $2,084,122 1998..................................................... $8,278,566 1999..................................................... $ 192,082 2000..................................................... $ 208,336 2001..................................................... $ 225,824 Thereafter............................................... $3,007,228 ==========
The carrying value of the Company's debt approximates its fair value. A-13 41 QUEST MEDICAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) (6) FEDERAL INCOME TAXES The significant components of the net deferred tax liability at December 31, were as follows:
1996 1995 ----------- ----------- Deferred tax assets: Tax credit and net operating loss carry forwards........ $ 2,631,362 $ 2,119,781 Accrued expenses and reserves........................... 344,915 377,302 Unrealized loss on marketable securities................ 67,422 108,729 Valuation allowance..................................... (858,835) (271,767) ----------- ----------- Total deferred tax asset........................ 2,184,864 2,334,045 Deferred tax liabilities: Purchased intangible assets............................. (1,976,958) (2,110,125) Excess of tax over book depreciation.................... (335,368) (259,361) Other................................................... (175,893) (170,436) ----------- ----------- Total deferred tax liability.................... (2,488,219) (2,539,922) ----------- ----------- Net deferred tax liability...................... $ (303,355) $ (205,877) =========== ===========
At December 31, 1996 and 1995, $688,895 and $271,767, respectively, of the total valuation allowance is attributable to stock option deductions which, when realized, will be credited to additional capital. The additional valuation allowance at December 31, 1996, is for certain tax credit carryforwards related to the Neuromed acquisition. During 1996, the valuation allowance increased by $587,068. During 1995, the valuation allowance decreased by $1,473,323 which was recorded as a reduction of costs in excess of net assets acquired because the decrease resulted from deferred tax liabilities recorded in connection with the acquisition of Neuromed. The provision for income taxes for the years ended December 31 consists of the following amounts:
1996 1995 1994 -------- -------- -------- Current.............................................. $(14,603) $(44,888) $ -- Deferred............................................. 97,478 200,002 -- -------- -------- -------- $ 82,875 $155,114 $ -- ======== ======== ========
A reconciliation of the provision for taxes on the loss before extraordinary item, to the benefit calculated at the U.S. statutory rate follows:
1996 1995 1994 --------- ----------- --------- Federal income tax benefit at statutory rate... $(111,956) $(3,382,961) $(584,526) Tax effect of: Tax exempt interest.......................... (11,734) (19,949) (52,862) Nondeductible amortization of goodwill....... 163,258 81,855 13,856 Recognition of research and development tax credit benefit............................ -- (109,135) -- Nondeductible writeoff of purchased in-process research and development....... -- 3,570,000 -- Benefit of net operating loss not recognized................................ -- -- 637,308 Other........................................ 43,307 15,304 (13,776) --------- ----------- --------- Income tax expense................... $ 82,875 $ 155,114 $ -- ========= =========== =========
A-14 42 QUEST MEDICAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) At December 31, 1996, general business credits of $1,008,523 and alternative minimum tax credits of $152,620 are available to offset future tax liabilities. If unused, the general business credits expire in various amounts beginning in 1997 through 2010. (7) STOCKHOLDERS' EQUITY On August 26, 1996, the Board of Directors voted to redeem the Company's then outstanding stock purchase rights at $0.01 per share. The redemption price for the outstanding rights was paid on September 27, 1996 to shareholders of record as of September 12, 1996. Also on August 26, 1996, the Board of Directors adopted a new Shareholder's Rights Plan in which rights to purchase shares of the Company's common stock were distributed as a dividend, one right per share, to shareholders of record as of September 12, 1996. The rights are not exercisable or transferable apart from the common stock until ten business days following the date that a person or group acquires more than 15 percent of the Company's common stock or announces a tender or exchange offer for more than 20 percent of the Company's common stock. Upon becoming exercisable, each right entitles the holders to purchase one share of common stock for $30.00. If the rights become exercisable because a person or group acquires more than 15 percent of the common stock (an "Acquiring Person"), however, the purchase price and number of shares purchasable will be adjusted so that the holder will have the right to receive, upon the exercise of the right at the applicable exercise price, that number of shares of the Company's common stock having a market value equal to two times the applicable exercise price of the right. If the Company is acquired in a merger or other business combination transaction, or 50 percent or more of its consolidated assets or earning power are sold, provision will be made so that each holder of a right will have the right to receive, upon the exercise of the right at the applicable exercise price, that number of shares of the acquiring company's common stock having a market value of two times the applicable exercise price of the right. Until a right is exercised, the holder of a right, as such, will have no rights as a stockholder of the Company, including, without limitation, the right to vote as a stockholder or receive dividends. Under the Rights Plan, the number of shares issuable upon exercise of the rights is subject to adjustment by the Company to prevent dilution. After a person becomes an Acquiring Person, the Company's board of directors may exchange the rights, other than those owned by the Acquiring Person, in whole or in part, at an exchange ratio of one share of common stock per right, subject to adjustment. The rights may be redeemed in whole by the Company at a price of $0.01 per right at any time prior to their expiration on September 12, 2006, or prior to the point at which they become exercisable. The Company has various stock option plans pursuant to which stock options may be granted to key employees and officers (the "Employees' Plans") and one plan under which directors and advisory directors of the Company may be granted options (the "Directors' Plan"). The most recent of the Employees' Plans was adopted and approved by shareholders of the Company during 1995 (the "1995 Plan") which reserved for issuance 250,000 shares of Common Stock; provided, however, that on January 1 of each year (commencing in 1996), the aggregate number of shares of Common Stock reserved for issuance under the 1995 Plan shall be increased by the same percentage that the total number of issued and outstanding shares of Common Stock increased from the preceding January 1 to the following December 31 (if such percentage is positive). On January 1, 1996, pursuant to this provision, the Company added 136,000 shares to the 1995 Plan. All options outstanding under the Employees' Plans and Directors' Plan are nonqualified stock options, however, the 1995 Plan allows for the grant of incentive stock options intended to qualify for preferential tax treatment under Section 422 of the Internal Revenue Code of 1986. Under all of the Company's plans, the exercise price of all options granted must equal or exceed the fair market value of the Common Stock at the time of the grant. Options granted under the Employees' Plans expire ten years from the date of grant and for the most part are exercisable one-fourth each year over a four-year period of continuous service. Options under the Directors' Plan expire six years from the date of grant and for the most part are exercisable one-fourth each year over a four-year period of continuous service. Certain options under both the Employees' Plans and Directors' Plan, A-15 43 QUEST MEDICAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) however, have a special two-year vesting schedule. These options are exercisable one-half each year over a two-year period. At December 31, 1996, under all of the Company's stock option plans, 1,175,188 shares have been granted and are outstanding, 1,091,715 shares of Common Stock have been issued upon exercise, and 55,409 shares were reserved for future grants. Data with respect to stock option plans of the Company are as follows:
EXERCISABLE OPTIONS OUTSTANDING OPTIONS - ----------------------------------------------------------------------- ------------------- WEIGHTED WEIGHTED AVERAGE AVERAGE EXERCISE EXERCISE SHARES PRICE SHARES PRICE --------- -------- ------- -------- January 1, 1994................................. 894,455 $2.90 Granted......................................... 252,444 $4.68 3% stock dividend............................... 31,709 -- Exercised....................................... (43,057) $3.18 Rescinded....................................... (47,548) $3.23 --------- ----- December 31, 1994............................... 1,088,003 $3.25 488,590 $2.50 ------- ----- Granted......................................... 239,520 $8.11 Exercised....................................... (160,422) $2.30 Rescinded....................................... (40,540) $4.11 --------- ----- December 31, 1995............................... 1,126,561 $4.33 622,226 $2.84 ------- ----- Granted......................................... 323,000 $8.12 Exercised....................................... (159,178) $3.06 Rescinded....................................... (115,195) $8.36 --------- ----- December 31, 1996 1,175,188 $5.16 663,459 $3.51 --------- ----- ------- -----
OPTIONS OUTSTANDING AT EXERCISABLE OPTIONS AT DECEMBER 31, 1996 DECEMBER 31, 1996 - ------------------------------------------------------------------------- --------------------------- WEIGHTED AVERAGE WEIGHTED AVERAGE WEIGHTED AVERAGE RANGE OF REMAINING LIFE EXERCISE EXERCISE EXERCISE PRICE SHARES (YEARS) PRICE SHARES PRICE -------------- --------- -------------- ---------------- ------- ---------------- $1.45 -- 2.25........ 223,831 2.41 $1.78 223,831 $ 1.78 $2.25 -- 3.50........ 78,893 4.46 $3.17 78,893 $ 3.17 $3.50 -- 5.25........ 411,064 5.27 $4.11 297,910 $ 3.97 $5.25 -- 8.00........ 303,400 7.28 $6.63 47,200 $ 6.71 $8.00 -- 12.25........ 158,000 8.44 $10.74 15,625 $11.27 --------- ---- ------ ------- ------- 1,175,188 5.62 $5.15 663,459 $ 3.51 ========= ==== ====== ======= =======
A-16 44 QUEST MEDICAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) In accordance with APB No. 25, the Company records no compensation expense for its stock option awards. As required by SFAS No. 123, the Company provides the following disclosure of hypothetical values for these awards. The weighted-average fair value of an option granted in 1996 and 1995, was $3.09 and $3.01, respectively. For purposes of fair market value disclosures, the fair market value of an option grant was estimated using the Black-Scholes option pricing model with the following assumptions:
1996 1995 ---- ---- Risk-free interest rate..................................... 6.0% 6.2% Average life of options (years)............................. 3.0 3.0 Volatility.................................................. 48.4% 48.4% Dividend Yield.............................................. -- --
Had the compensation expense been recorded based on these hypothetical values, pro forma net loss for 1996 and 1995 would have been $(541,855) and $(10,466,956), respectively, and pro forma net loss per common share for 1996 and 1995 would have been $(.06) and $(1.58), respectively. In the fourth quarter of 1995, the Company sold 1,676,667 shares in a public offering. Net proceeds to the Company were $15.2 million, of which $13.9 million was used to repay the senior-term bank debt incurred in connection with the Neuromed acquisition. Net loss per share would have been ($1.28) if this transaction had occurred on March 31, 1995, the date at which the debt incurred in connection with the Neuromed acquisition was first outstanding. (8) COMMITMENTS AND CONTINGENCIES The Company has no material commitments under noncancellable operating leases. Total rent expense under operating leases for the years ended December 31, 1996, 1995, and 1994 was $47,476, $127,113 and $24,930, respectively. As a consequence of the Neuromed Acquisition in March 1995, the Company is a party to product liability claims related to SCS devices sold by Neuromed prior to the acquisition. Product liability insurers have assumed responsibility for defending the Company against these claims, subject to reservation of rights in certain cases. While historically product liability claims against Neuromed have not resulted in significant monetary liability for Neuromed beyond its insurance coverage, there can be no assurances that the Company will not incur significant monetary liability to the claimants if such insurance is unavailable or inadequate for any reason, or that the Company's SCS business and new SCS product lines will not be adversely affected by these product liability claims. Except for such product liability claims and other ordinary routine litigation incidental or immaterial to its business, the Company is not currently a party to any other pending legal proceeding. The Company maintains general liability insurance against risks arising out of the normal course of business. (9) FINANCIAL INSTRUMENTS, RISK CONCENTRATION, AND MAJOR CUSTOMERS In the United States, the Company's accounts receivable are due primarily from hospitals and distributors located throughout the country. Internationally, the Company's accounts receivable are due primarily from distributors located in Europe and Australia. The Company generally does not require collateral for trade receivables. The Company maintains an allowance for doubtful accounts based upon expected collectibility. Any losses from bad debts have historically been within management's expectations. Net sales to a major customer for each of the years ended December 31, as a percentage of total net revenues were as follows: 1996 -- 10 percent, 1995 -- 10 percent, and 1994 -- 19 percent. Foreign sales, primarily in Europe and Australia, for the years ended December 31, 1996 and 1995 were approximately 14 percent and 12 percent of total net revenue, respectively. A-17 45 QUEST MEDICAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) (10) EMPLOYEE BENEFIT PLANS The Company has a defined contribution retirement savings plan (the "Plan") available to substantially all employees. The Plan permits employees to elect salary deferral contributions of up to 15 percent of their compensation and requires the Company to make matching contributions equal to 50 percent of the participants' contributions, to a maximum of 6 percent of the participants' compensation. The expense of the Company's contribution was $176,858 in 1996, $142,485 in 1995, and $102,961 in 1994. (11) SUBSEQUENT EVENT On March 10, 1997, the Company announced that the Company's Board of Directors has engaged Smith Barney and Rauscher Pierce Refsnes to seek strategic alternatives to enhance shareholder value. These strategic alternatives may include a merger, sale of assets, other business combination, or a joint venture or strategic alliance. A-18 46 APPENDIX B SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS FORMING A PART OF THE ANNUAL REPORT FORM 10-K ITEM 14 OF QUEST MEDICAL, INC. AND SUBSIDIARIES (NAME OF ISSUER) FILED WITH THE SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 UNDER THE SECURITIES AND EXCHANGE ACT OF 1934 47 SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS QUEST MEDICAL, INC. AND SUBSIDIARIES DECEMBER 31, 1996
BALANCE AT CHARGED BALANCE BEGINNING CHARGED TO TO OTHER AT END OF DESCRIPTION OF PERIOD EXPENSES ACCOUNTS DEDUCTIONS PERIOD ----------- ---------- ---------- -------- ---------- --------- Year ended December 31, 1996: Allowance for doubtful accounts.... $114,337 $ 60,000 $ -- $ -- $174,337 Reserve for obsolete inventory..... 238,679 12,100 -- 20,307(1) 230,472 -------- -------- -------- ------- -------- Total...................... $353,016 $ 72,100 $ -- $20,307 $404,809 ======== ======== ======== ======= ======== Year ended December 31, 1995: Allowance for doubtful accounts.... $ 14,337 $ -- $100,000(2) $ -- $114,337 Reserve for obsolete inventory..... -- 238,679 -- -- 238,679 -------- -------- -------- ------- -------- Total...................... $ 14,337 $238,679 $100,000 $ -- $353,016 ======== ======== ======== ======= ======== Year ended December 31, 1994: Allowance for doubtful accounts.... $ 14,337 $ -- $ -- $ -- $ 14,337 Reserve for obsolete inventory..... 53,927 29,197 -- 83,124(1) -- -------- -------- -------- ------- -------- Total...................... $ 68,264 $ 29,197 $ -- $83,124 $ 14,337 ======== ======== ======== ======= ========
- --------------- (1) Obsolete inventory written off, net of recoveries. (2) Addition to reserve is result of purchase of Neuromed, Inc. B-1 48 APPENDIX C QUARTERLY FINANCIAL DATA (UNAUDITED) FORMING A PART OF THE ANNUAL REPORT FORM 10-K ITEM 8 OF QUEST MEDICAL, INC. AND SUBSIDIARIES (NAME OF ISSUER) FILED WITH THE SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 UNDER THE SECURITIES AND EXCHANGE ACT OF 1934 49
1ST 2ND 3RD 4TH ---------- ------------ ---------- ---------- 1996 Net revenue............................. $6,149,126 $ 6,669,619 $6,486,521 $6,768,542 Gross profit............................ 3,496,976 3,931,915 3,786,638 3,853,019 Earnings (loss) from operations......... 24,796 217,978 124,249 (266,833) Earnings (loss) before income taxes..... (76,225) 122,675 35,564 (411,296) Net earnings (loss)..................... $ (94,572) $ 114,323 $ 6,748 $ (438,656) ---------- ------------ ---------- ---------- Net earnings (loss) per common and common equivalent share............... $ (.01) $ .01 $ -- $ (.05)
1ST 2ND(1)(2) 3RD 4TH(3) ---------- ------------ ---------- ---------- 1995 Net revenue............................. $4,071,640 $ 7,231,494 $6,818,923 $7,198,933 Gross profit............................ 2,044,288 4,348,356 3,968,885 4,335,246 Earnings (loss) from operations......... (336,944) (9,775,378) 543,507 787,352 Earnings (loss) before income taxes..... (364,598) (10,248,708) 90,541 572,881 Earnings (loss) before extraordinary item.................................. (364,598) (10,248,708) 90,541 417,767 Extraordinary item -- loss on early extinguishment of debt................ -- -- -- (269,045) Net earnings (loss)..................... $ (364,598) $(10,248,708) $ 90,541 $ 148,722 ---------- ------------ ---------- ---------- Per common and common equivalent share: Net earnings (loss) before extraordinary item.................................. $ (.07) $ (1.66) $ .01 $ .05 Extraordinary item...................... -- -- -- (.03) ---------- ------------ ---------- ---------- Net earnings (loss)..................... $ (.07) $ (1.66) $ .01 $ .02 ========== ============ ========== ==========
- --------------- (1) Includes results of Neuromed, Inc. from April 1, 1995 (See Note 3) (2) Includes a charge of $10,500,000 for purchased in-process research and development incurred in connection with the acquisition of Neuromed, Inc. (See Note 3) (3) Extraordinary item of $269,045 (net of income tax benefit of $138,599) from write-off of capitalized debt issuance costs due to repayment of bank debt. C-1 50 INDEX TO EXHIBITS
EXHIBIT NO. DESCRIPTION ----------- ----------- 2.1 -- Agreement for the Purchase and Sale of All of the Issued Capital Stock of Neuromed, Inc. dated February 10, 1995, between Quest Medical, Inc. and William N. Borkan(5) 2.2 -- Amendment Agreement dated March 17, 1995, between Quest Medical, Inc. and William N. Borkan(5) 2.3 -- Letter Agreement dated as of September 23, 1995, by and between Quest Medical, Inc. and William N. Borkan(6) 3.1 -- Articles of Incorporation, as amended(6) 3.2 -- Bylaws(1) 4.1 -- Rights Agreement dated as of August 30, 1996, between Quest Medical, Inc. and KeyCorp Shareholder Services, Inc. as Rights Agent(7) 10.1 -- Quest Medical, Inc. 1979 Amended and Restated Employees Stock Option Plan(2) 10.2 -- Form of 1979 Employees Stock Option Agreement(3) 10.3 -- Quest Medical, Inc. Directors Stock Option Plan (as amended)(2) 10.4 -- Form of Directors Stock Option Agreement(1) 10.5 -- Quest Medical, Inc. 1987 Stock Option Plan(6) 10.6 -- Form of 1987 Employee Stock Option Agreement(6) 10.7 -- Quest Medical, Inc. 1995 Stock Option Plan(6) 10.8 -- Form of 1995 Employee Stock Option Agreement(6) 10.9 -- Form of Employment Agreement and Covenant Not to Compete, between the Company and key employees(1) 10.10 -- Promissory Note dated December 28,1993, between Quest Medical, Inc. and MetLife Capital Financial Corporation(4) 10.11 -- Commercial Deed of Trust, Security Agreement and Assignment of Leases and Rents and Fixture Filing dated December 28,1993, between Quest Medical, Inc. and MetLife Capital Financial Corporation(4) 10.12 -- Term Promissory Note dated December 28,1993, between Quest Medical, Inc. and MetLife Capital Corporation(4) 10.13 -- Loan and Security Agreement dated December 28,1993, between Quest Medical, Inc. and MetLife Capital Corporation(4) 10.14 -- Supplemental Security Agreement Number One dated December 28,1993, between Quest Medical, Inc. and MetLife Capital Corporation(4) 10.15 -- Third Amended and Restated Credit Agreement dated as of March 3, 1997, between Quest Medical, Inc. and NationsBank of Texas, N.A.(8) 10.16 -- Promissory Note (Facility A. Note) in the original principal amount of $5,650,000 dated March 3, 1997(8) 10.17 -- Promissory Note (Facility B. Note) in the original principal amount of $350,000 dated March 3, 1997(8) 10.18 -- First Amended and Restated Security Agreement dated March 3, 1997, between Quest Medical, Inc. and NationsBank of Texas, N.A.(8) 10.19 -- First Amended and Restated Security Agreement dated March 3, 1997, between Advanced Neuromodulation Systems, Inc. and NationsBank of Texas, N.A.(8)
51
EXHIBIT NO. DESCRIPTION ----------- ----------- 10.20 -- First Amended and Restated Intellectual Property Security Agreement and Assignment dated as of March 3, 1997, between Quest Medical, Inc. and NationsBank of Texas N.A.(8) 10.21 -- First Amended and Restated Intellectual Property Security Agreement and Assignment dated as of March 3, 1997, between Advanced Neuromodulation Systems, Inc. and NationsBank of Texas, N.A.(8) 10.22 -- First Amended and Restated License Agreement dated as of March 3, 1997, between Quest Medical, Inc. and NationsBank of Texas, N.A.(8) 10.23 -- First Amended and Restated License Agreement dated as of March 3, 1997, between Advanced Neuromodulation Systems, Inc. and NationsBank of Texas, N.A.(8) 10.24 -- Guaranty of Advanced Neuromodulation Systems, Inc. in favor of NationsBank of Texas, N.A. under the Third Amended and Restated Credit Agreement dated as of March 3, 1997(8) 11.1 -- Computation of Earnings Per Share(8) 21.1 -- Subsidiaries(8) 23.1 -- Consent of Independent Auditors(8)
- --------------- (1) Filed as an Exhibit to the Company's Registration Statement on Form S-18, Registration No. 2-71198-FW, and incorporated herein by reference. (2) Filed as an Exhibit to the report of the Company on Form 10-K for the year ended December 31, 1987, and incorporated herein by reference. (3) Filed as an Exhibit to the Company's Registration Statement on Form S-1, Registration No. 2-78186, and incorporated herein by reference. (4) Filed as an Exhibit to the report of the Company on Form 10-KSB for the year ended December 31, 1993, and incorporated herein by reference. (5) Filed as an Exhibit to the report of the Company on Form 10-KSB for the year ended December 31, 1994, and incorporated herein by reference. (6) Filed as an Exhibit to the Company's Registration Statement on Form SB-2, Registration No. 33-62991, and incorporated herein by reference. (7) Filed as an Exhibit to the report of the Company on Form 8-K dated September 3, 1996, and incorporated herein by reference. (8) Filed herewith. EX-10.15 2 3RD AMEND & RESTATED CREDIT AGMT - NATIONSBANK 1 EXHIBIT 10.15 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- THIRD AMENDED AND RESTATED CREDIT AGREEMENT BETWEEN QUEST MEDICAL, INC. AND NATIONSBANK OF TEXAS, N.A. Dated as of March 3, 1997 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- 2 TABLE OF CONTENTS ARTICLE I. DEFINITIONS 1.1 Definitions ................................. 1 1.2 Accounting and Other Terms .................. 16 ARTICLE II. ADVANCES 2.1 (a) Facility A Advances ................... 17 2.2 Manner of Borrowing ......................... 17 2.3 Evidence of Indebtedness .................... 18 2.4 Fees ........................................ 18 2.5 Prepayments ................................. 19 2.6 Repayment ................................... 19 2.7 Reduction of Commitments .................... 20 2.8 Interest .................................... 20 2.9 Default Interest ............................ 21 2.10 Continuation and Conversion Elections ....... 21 2.11 Maximum Amount of Interest .................. 22 2.12 Computations ................................ 23 2.13 Taxes ....................................... 23 2.14 Capital Adequacy; Increased Costs ........... 23 ARTICLE III. CONDITIONS PRECEDENT TO ADVANCES. 3.1 Conditions Precedent to Advances ............ 25 3.2 Conditions Precedent to All Advances ........ 28 3.3 Legal Details ............................... 28 ARTICLE IV. AFFIRMATIVE COVENANTS 4.1 Books, Records and Properties ............... 28 4.2 Financial Statements and Reports ............ 28 4.3 Maintenance of Existence .................... 30 4.4 Insurance ................................... 30 4.5 Compliance with Applicable Laws ............. 30 4.6 Other Information and Documents ............. 30 4.7 Default ..................................... 30 4.8 Taxes ....................................... 30
(i) 3 4.9 Further Assurances .......................... 30 4.10 Filings ..................................... 31 4.11 Maintenance ................................. 31 4.12 ERISA Compliance ............................ 31 4.13 Indemnity by Borrower ....................... 31 ARTICLE V. NEGATIVE COVENANTS 5.1 Liens ....................................... 32 5.2 Transfer of Assets .......................... 32 5.3 New Industry ................................ 32 5.4 Restricted Investments ...................... 33 5.5 Transactions with Affiliates ................ 33 5.6 Fixed Charges Coverage Ratio ................ 33 5.7 Margin Ratio ................................ 33 5.8 Total Liabilities to Tangible Worth Ratio ... 33 5.9 Capital Expenditures ........................ 33 5.10 Merger and Consolidation .................... 33 5.11 Debt ........................................ 33 5.12 Distributions ............................... 34 ARTICLE VI. REPRESENTATIONS AND WARRANTIES 6.1 Organization; Qualification; Authority ...... 34 6.2 Financial Statements ........................ 34 6.3 Conflicting Agreements and Other Matters .... 34 6.4 Governmental Consent ........................ 35 6.5 Enforceability .............................. 35 6.6 Actions Pending ............................. 35 6.7 Outstanding Debt ............................ 35 6.8 Title to Properties ......................... 35 6.9 Taxes ....................................... 36 6.10 Regulation G, etc ........................... 36 6.11 ERISA ....................................... 36 6.12 Disclosure .................................. 36 6.13 Environmental Matters ....................... 36 6.14 Sufficiency of Capital ...................... 37 6.15 Affiliates .................................. 37 6.16 Intellectual Property ....................... 37
ARTICLE VII. DEFAULT (ii) 4 7.1 Events of Default ........................... 37 7.2 Remedies Upon Default ....................... 39 7.3 Performance by Lender ....................... 40 7.4 Lender Not in Control ....................... 40 7.5 Waivers ..................................... 40 7.6 Cumulative Rights ........................... 41 7.7 Expenditures by Lender ...................... 41 ARTICLE VIII. MISCELLANEOUS 8.1 Money ....................................... 41 8.2 Headings .................................... 41 8.3 Articles, Sections, and Exhibits ............ 41 8.4 Notices and Deliveries ...................... 41 8.5 Place of Payment ............................ 43 8.6 Survival of Agreements ...................... 43 8.7 Parties in Interest ......................... 43 8.8 Expenses .................................... 43 8.9 Governing Law ............................... 43 8.10 MANDATORY ARBITRATION ....................... 43 8.11 WAIVER OF JURY TRIAL ........................ 44 8.12 Maximum Amount Limitation ................... 45 8.13 Severability ................................ 45 8.14 Amendment ................................... 45 8.15 Exceptions to Covenants ..................... 46 8.16 Counterparts ................................ 46 8.17 Restatement ................................. 46 8.18 ENTIRE AGREEMENT ............................ 46
(iii) 5 EXHIBITS Exhibit A Facility A Note Exhibit B Facility B Note Exhibit C Intentionally Deleted Exhibit D Security Agreement Exhibit E Intellectual Property Security Agreement Exhibit F License Agreement Exhibit G Compliance Certificate Exhibit H Guaranty Agreement Exhibit I Borrowing Notice Exhibit J Conversion or Continuation Notice Exhibit K Borrowing Base Certificate Exhibit L Pledge Agreement Exhibit M Deed of Trust Exhibit N Subordination Agreement SCHEDULES Schedule 1 Affiliates Schedule 2 Allen Property Schedule 3 Litigation Schedule 4 Intellectual Property (iv) 6 THIRD AMENDED AND RESTATED CREDIT AGREEMENT THIRD AMENDED AND RESTATED CREDIT AGREEMENT (this "Agreement") dated as of March 3, 1997, between QUEST MEDICAL, INC., a Texas corporation, having its principal office at One Allentown Parkway, Allen, Texas 75002 ("Borrower"), and NATIONSBANK OF TEXAS, N.A., a national banking association, having its principal office at 901 Main Street, Dallas, Texas 75202 ("Lender"). BACKGROUND Borrower and Lender have entered into (1) the Credit Agreement dated as of October 22, 1993, (2) the First Amended and Restated Credit Agreement dated as of March 31, 1995 (as amended, the "First Restated Credit Agreement") providing for a line of credit in the maximum principal amount of $5,000,000 ("Existing Facility A"), the proceeds of which are to be used for working capital purposes, and a $15,000,000 term facility ("Existing Facility B"), the proceeds of which were used to acquire all capital stock of Neuromed, Inc., a Florida corporation and (3) the Second Amended and Restated Credit Agreement dated as of February 9, 1996 (as amended, the "Second Restated Credit Agreement") which renewed Existing Facility A and restated Existing Facility B. Borrower has requested that Lender renew Existing Facility A and provide a new term facility, the proceeds of which will be used to provide for the working capital needs of Borrower and to make certain arbitration payments, subject to the terms of this Agreement. In consideration of the mutual covenants and agreements contained herein, and other good and valuable consideration, receipt of which is acknowledged by all parties hereto, the parties agree as follows: AGREEMENT. ARTICLE I. DEFINITIONS 1.1 Definitions. The terms defined in this Article I (except as otherwise expressly provided in this Agreement) for all purposes shall have the following meanings: "Account" has the meaning assigned to such term in the UCC. "Additional Costs" has the meaning set forth in Section 2.14. "Advance" means an advance by Lender to Borrower pursuant to Article II, and refers to a Facility A Advance or a Facility B Advance. "Affiliate" means any Person that directly or indirectly through one or more Persons Controls, or is Controlled By or Under Common Control with, Borrower or a Person who Controls or is Controlled by, Borrower. 7 "Allen Property" means the real property described on Schedule 2, together with all improvements and equipment located thereon. "ANS" means Advanced Neuromodulation Systems, Inc., a Texas corporation. "Applicable Law" means the Laws of the United States of America applicable to contracts made or performed in the State of Texas, including, without limitation, 12 USC Section Section 85 and 86 as amended to the date hereof and as the same may be amended at any time and from time to time hereafter and any other statute of the United States of America now or at any time hereafter prescribing maximum rates of interest on loans and extensions of credit, and the Laws of the State of Texas, including, without limitation, Articles 5069-l.04 and 5069-l.07 (a), Title 79, Revised Civil Statutes of Texas, 1925, as amended at any time and from time to time hereafter and any other statute of the State of Texas now or at any time hereafter prescribing maximum rates of interest on loans and extensions of credit ("Art. l.04"). "Applicable Margin" means (a) with respect to Prime Advances, 1.00% per annum, (b) with respect to LIBOR Advances, 2.75% per annum, and with respect to the Facility B Advance, 2.25% per annum. "Art. 1.04" has the meaning given to such term in the definition of Applicable Law in Article I. "Borkan Debt" means the "Subordinated Obligations", as defined in the Borkan Subordination Agreement. "Borkan Subordination Agreement" means the Subordination Agreement date March 3, 1997, among William Borkan, Borrower and Lender. "Borrowing" means a borrowing under Facility A or Facility B of the same Type made on the same day. "Borrowing Base" means, at the time in question, an amount equal to the sum of (a) 80% of Eligible Accounts, plus (b) 25% of Eligible Inventory composed of raw materials and MPS finished goods, plus (c) 50% of Eligible Inventory composed of non-MPS finished goods. "Borrowing Base Certificate" means a certificate, signed by a duly authorized officer of Borrower, in the form of Exhibit K, appropriately completed. "Borrowing Notice" has the meaning set forth in Section 2.2(a). "Business Day" means a day on which banks are open for the transaction of business as required by this Agreement in Dallas, Texas and New York, New York and, with respect to any LIBOR Advance, a domestic business day in London, England and a day on which commercial -2- 8 banks are open for international business in London, England (including dealings in United States dollar deposits), and as otherwise relevant to the determination to be made or the action to be taken. "Capital Leases" means capital leases and subleases, as defined in the Financial Accounting Standards Board Statement of Financial Accounting Standards No. 13, dated November 1976, as amended. "Code" means the Internal Revenue Code of 1986, as amended. "Collateral" means that property of Borrower or any other Person in which Lender shall have Liens to secure payment and performance of the Obligation. "Collateral Documents" means all security agreements, pledge agreements and any other agreements or documents executed or delivered to secure repayment of the Obligation or part thereof. "Compliance Certificate" means a certificate, signed by a duly authorized officer of Borrower, in the form of Exhibit G, appropriately completed. "Consequential Loss" means with respect to (a) Borrower's payment of all or any portion of the then-outstanding principal amount of a LIBOR Advance on a day other than the last day of the related Interest Period, including, without limitation, payments made as a result of the acceleration of the maturity of a Note pursuant to Section 7.2, and (b) any of the circumstances specified in Sections 2.2(e), 2.5, 2.7 and 2.14 on which a Consequential Loss may be incurred, any loss, cost or expense incurred by Lender as a result of the timing of the payment of the Advance or in liquidating, redepositing, redeploying or reinvesting the principal amount so paid or affected by the timing of the Advance or the circumstances described in Sections 2.2(e), 2.5, 2.7 and 2.14, which amount shall be the sum of (i) the interest that, but for the timing of the payment of the Advance, Lender would have earned in respect of that principal amount, reduced, if Lender is able to redeposit, redeploy, or reinvest the principal amount, by the interest earned by Lender as a result of redepositing, redeploying or reinvesting the principal amount plus (ii) any expense or penalty incurred by such Lender by reason of liquidating, redepositing, redeploying or reinvesting the principal amount. Each determination by Lender of any Consequential Loss is, in the absence of manifest error, conclusive and binding. "Continue," "Continuation" and "Continued" each refer to the continuation pursuant to Section 2.10 of a LIBOR Advance from one Interest Period to the next Interest Period. "Control" or "Controlled By" or "Under Common Control" mean possession, direct or indirect, of power to direct or cause the direction of management or policies (whether through ownership of voting securities, by contract or otherwise); provided that, in any event (a) any Person which beneficially owns 20% or more (in number of votes) of the securities having -3- 9 ordinary voting power for the election of directors of a corporation shall be presumed to control such corporation, and (b) no Person shall be deemed to be an Affiliate of a corporation solely by reason of his being an officer or director of such corporation. "Conversion or Continuance Notice" has the meaning set forth in Section 2.10. "Debt" means, with respect to any Person, all debt, obligations and liabilities of such Person, including without limitation, (a) all "liabilities" which would be reflected on a balance sheet of such Person, prepared in accordance with GAAP, (b) all obligations of such Person in respect of any Guaranty, (c) all obligations of such Person in respect of any Capital Lease, (d) all obligations, debt and liabilities secured by any Lien on any property or assets of such Person and (e) all obligations of such Person in respect of letters of credit, acceptances or similar obligations issued or created for the account of such Person. "Debt for Borrowed Money" means, as to any Person, at any date, without duplication, (a) all obligations of such Person for borrowed money, (b) all obligations of such Person evidenced by bonds, debentures, notes or other similar instruments, (c) all obligations of such Person to pay the deferred purchase price of property or services, except trade accounts payable arising in the ordinary course of business, (d) all obligations of such Person in respect of any Guaranty, (e) all obligations of such Person in respect of any Capital Lease, and (f) all obligations, debt and liabilities secured by any Lien on any property or assets of such Person. "Debtor Relief Laws" means any applicable liquidation, conservatorship, bankruptcy, moratorium, rearrangement, fraudulent conveyance, insolvency, reorganization or similar debtor relief Laws relating to the enforcement of creditors' rights generally from time to time in effect. "Default" means any of the events specified in Section 7.1, whether or not there has been satisfied any requirement in connection with such event for the giving of notice, or the lapse of time, or the happening of any further condition, event or act. "Device" has the meaning set forth in the FDA Act. "Distribution" means, as to any Person, (a) any declaration or payment of any distribution or dividend (other than a stock dividend) on, or the making of any pro rata distribution, loan, advance, or investment to or in any holder (in its capacity as a partner, shareholder or other equity holder) of, any partnership interest or shares of capital stock or other equity interest of such Person, or (b) any purchase, redemption, or other acquisition or retirement for value of any shares of partnership interest or capital stock or other equity interest of such Person. "Dollars" and the sign "$" mean lawful money of the United States of America. "Drug" has the meaning set forth in the FDA Act. -4- 10 "EBITDA" means, as of any date of determination, the sum of Borrower's and its Subsidiaries' (a) pre-tax income or deficit, as the case may be (excluding extraordinary items and income from the sale of assets other than in the ordinary course of business), plus (b) cash interest expense paid; amortization of Debt discounts; any payments or fees with respect to letters of credit, bankers' acceptances or similar facilities; fees and expenses with respect to interest rate swap or similar agreements or foreign currency hedge, exchange or similar agreements, plus (c) consolidated depreciation and amortization expense, all calculated on a consolidated basis in accordance with GAAP, determined for the four fiscal quarters preceding the date of calculation. "Effective Date" means March 3, 1997. "Eligible Accounts" means at the time of any determination thereof, the lesser of (a) $3,000,000 and (b) each Account as to which the following requirements have been fulfilled to the satisfaction of Lender: (a) Borrower or a Subsidiary of Borrower has lawful and absolute title to such Account; (b) Such Account is a valid, legally enforceable obligation of the Person who is obligated under such Account (the "account debtor") for goods or services delivered or rendered to such Person; (c) There has been excluded from such Account any portion that is subject to any dispute, offset, counterclaim or other claim or defense on the part of the account debtor or to any claim on the part of the account debtor denying liability under such Account; (d) Borrower or a Subsidiary of Borrower has full and unqualified right to assign and grant a security interest in such Account to Lender as security for the Obligation; (e) Such Account is payable in Dollars and is evidenced by an invoice rendered to the account debtor and such Account is not evidenced by any chattel paper, promissory note or other instrument; (f) Such Account is subject to a fully perfected first priority security interest in favor of Lender pursuant to the Loan Papers, prior to the rights of, and enforceable as such against, any other Person (including holders of a purchase money security interest); (g) If the account debtor in respect of such Account is either located outside the United States of America or primarily conducts business in a jurisdiction outside the -5- 11 United States of America, or if the goods or services sold giving rise to such Account are to be delivered or performed outside of the United States of America, (i) the account debtor is located in a province of the Dominion of Canada in which all actions necessary to perfect a first priority security interest in all Collateral in favor of Lender have occurred, (ii) the entire amount of the payment obligation represented by such Account is secured by either (A) an irrevocable Dollar-denominated commercial letter of credit issued or confirmed by a financial institution (1) the short-term debt obligations of which have the same or higher rating, as established by either Standard & Poor's Corporation or Moody's Investors Service, Inc., as comparable obligations of Lender, (2) the short-term obligations of the holding company of such financial institution have the same or higher rating, as established by Standard & Poor's Corporation or Moody's Investors Service, Inc., as comparable obligations of NationsBank Corporation (if either or both of such financial institution and Lender do not have outstanding comparable short-term obligations or such obligations are not rated), or (3) acceptable to Lender (if (A) either or both of such financial institution and Lender and (B) either or both of the holding company of such financial institution and NationsBank Corporation do not have outstanding comparable short-term obligations or such obligations are not rated), the proceeds of which letter of credit have been assigned to Lender or which letter of credit shall specifically provide that payment thereunder shall be made solely to an account maintained by Borrower at Lender (which account and all property on deposit therein has been assigned to Lender), or (B) a receivables insurance policy issued by ExImBank or a private insurance company acceptable to Lender and ExImBank, in either case, the proceeds of which policy have been assigned to Lender; (h) Such Account is not subject to any Lien in favor of any Person other than the Lien of Lender pursuant to the Loan Papers; (i) Such Account has not been due and payable for more than 90 days from the invoice date; and (j) No account debtor in respect of such Account is (i) any Tribunal, domestic or foreign; provided, for purposes of determining "Eligible Account", "Tribunal" shall not include any government or university, medical department of any government or university or hospital associated with any government or university located in the United States of America, (ii) the subject of a proceeding under any Debtor Relief Laws, or (iii) the United States of America or any state; provided, that, unless Lender agrees otherwise, no Accounts payable by an account debtor shall constitute Eligible Accounts if 10% or more of the aggregate dollar amount of all Accounts owed to Borrower by such account debtor have been due and payable for 91 days or more from their respective invoice dates. -6- 12 "Eligible Inventory" means, at the time of any determination thereof, the lesser of (a) $2,650,000, reduced by $90,000 each calendar month commencing April 1, 1997, and (b) each item of Inventory (excluding work-in-progress) valued at the lower of cost or market value, as to which the following requirements have been fulfilled to the satisfaction of Lender: (i) Borrower or a Subsidiary of Borrower has lawful and absolute title to such Inventory; (ii) Such Inventory is subject to a fully perfected first priority security interest in favor of Lender pursuant to the Loan Papers, prior to the rights of, and enforceable as such against, any other Person (including holders of a purchase money security interest); (iii) Such Inventory is (A) neither adulterated nor misbranded, (B) not the subject of any pending or threatened proceeding or action by FDA or other Tribunal seeking the recall, seizure or condemnation or the prohibition of the sale, use or distribution of such Inventory, (C) properly registered with FDA (if such registration is required), (D) produced at an Establishment registered with FDA (if such registration is required), (E) not subject to any restriction on the distribution, sale or use by Lender or any purchaser at any foreclosure sale or other realization on the Collateral and (F) not a Drug; (iv) Such Inventory was produced in compliance with the FDA Act and the Fair Labor Standards Act and related rules and regulations; (v) Such Inventory is located at 2930-G and 2930-H Grace Lane, Costa Mesa, California or One Allentown Parkway, Allen, Texas. "ERISA" means the Employee Retirement Income Security Act of 1974, as amended from time to time. "Establishment" has the meaning set forth in 21 CFR Section 807.3. "Event of Default" means the occurrence of any of the events specified in Section 7.1, provided there has been satisfied any requirement in connection with such event for the giving of notice, or the lapse of time, or the happening of any further condition, event or act. "ExImBank" means Export-Import Bank of the United States, an agency of the United States of America, and any successor entity. "Existing Facility A" has the meaning set forth in the Background section. "Existing Facility B" has the meaning set forth in the Background section. -7- 13 "Facility A Advance" means an Advance described in Section 2.1(a) to be made from time to time by Lender to Borrower. "Facility A Commitment" means $5,650,000, as the same may be reduced or terminated pursuant to Sections 2.7. "Facility A Commitment Fee" has the meaning set forth in Section 2.4(a). "Facility A Note" means the promissory note of Borrower payable to the order of Lender, in substantially the form of Exhibit A, and any and all renewals, extensions, modifications and amendments thereof and substitutions therefor. "Facility A Termination Date" means January 31, 1998, or such earlier date that the Facility A Commitment is terminated. "Facility B Advance" means the Advance described in Section 2.1(b) to be made on the Effective Date by Lender to Borrower. "Facility B Commitment" means $350,000. "Facility B Interest Rate" means, with respect to the Facility B Advance, a rate per annum equal to the lesser of (a) the sum of (i) the LIBOR Rate, plus (ii) the Applicable Margin and (b) the Highest Lawful Rate. "Facility B Note" means the promissory note of Borrower payable to the order of Lender, in substantially the form of Exhibit B, and any and all renewals, extensions, modifications and amendments thereof and substitutions therefor. "Facility B Termination Date" means January 31, 1998, or such earlier date that the Facility B Commitment is terminated. "FDA" means the Food and Drug Administration and any successor. "FDA Act" means the Federal Food, Drug and Cosmetic Act, 21 USC Section 301, et seq, and all amendments and successors thereto. "Financial Statements" means with respect to Borrower and its Subsidiaries, consolidated and consolidating balance sheets, consolidated and consolidating profit and loss statements, reconciliation of capital and surplus (prepared as to fiscal quarters and fiscal years, only), and statements of cash flow. "First Restated Credit Agreement" has the meaning specified in the Background section. -8- 14 "Fixed Charges" means the sum of, for Borrower and its Subsidiaries, determined in accordance with GAAP on a consolidated basis, (a) interest expense (including interest expense pursuant to Capital Leases), plus (b) lease expense payable for Operating Leases, determined for the four fiscal quarters preceding the date of calculation. "Fixed Charges Coverage Ratio" means the ratio of Net Earnings Available for Fixed Charges to Fixed Charges. "GAAP" means generally accepted accounting principles applied on a consistent basis, set forth in the Opinions of the Accounting Principles Board of the American Institute of Certified Public Accountants and/or in statements of the Financial Accounting Standards Board, which are applicable in the circumstances as of the date in question, and the requirement that such principles be applied on a consistent basis shall mean that the accounting principles observed in a current period are comparable in all material respects to those applied in a preceding period. Unless otherwise indicated herein, all accounting terms will be defined according to GAAP. "Government Securities" means direct obligations of the United States of America or any agency thereof, or obligations fully guaranteed by the United States of America or any agency thereof. "Guaranty" of any Person means any contract, agreement or understanding of such Person pursuant to which such Person guarantees, or in effect guarantees, any Debt of any other Person in any manner, whether directly or indirectly; except that "Guaranty" shall not include the endorsement by such Person in the ordinary course of business of negotiable instruments or documents for deposit or collection. "Guaranty Agreement" means a Guaranty Agreement in the form of Exhibit H, or, if executed in connection with the First Restated Credit Agreement or the Second Restated Credit Agreement, a Guaranty Agreement (as that term is defined in the such credit agreement). "hereof", "hereto", "hereunder" and similar terms refer to this Agreement and not to any particular section or provision of this Agreement. "Highest Lawful Rate" means at the particular time in question the maximum rate of interest which, under Applicable Law, Lender is then permitted to charge on the Obligation. If the maximum rate of interest which, under Applicable Law, Lender is permitted to charge on the Obligation shall change after the date hereof, the Highest Lawful Rate shall be automatically increased or decreased, as the case may be, from time to time as of the effective time of each change in the Highest Lawful Rate without notice to Borrower. For purposes of determining the Highest Lawful Rate under the Applicable Law of the State of Texas, the applicable rate ceiling shall be (a) the indicated rate ceiling described in and computed in accordance with the provisions of Section (a)(l) of Art. l.04; or (b) provided notice is given as required in Section (h)(1) of said Art. l.04, the quarterly ceiling computed pursuant to Section (d) of said Art. l.04; -9- 15 provided, however, that at any time the indicated rate ceiling, the annualized ceiling or the quarterly ceiling, as applicable, shall be less than 18% per annum or more than 24% per annum, the provisions of Sections (b)(1) and (2) of said Art. l.04 shall control for purposes of such determination, as applicable. "Indemnitee" has the meaning set forth in Section 4.13. "Interest Period" means, with respect to any LIBOR Advance, the period beginning on the date the Advance is made or continued as a LIBOR Advance and ending one, two, three or six months thereafter (as Borrower shall select); provided, however, that: (a) Borrower may not select any Interest Period that ends after any principal repayment date (including the Facility A Termination Date and the Facility B Termination Date) unless, after giving effect to such selection, the aggregate principal amount of LIBOR Advances having Interest Periods that end on or prior to such principal repayment date, shall be at least equal to the principal amount of Advances due and payable on and prior to such date; (b) whenever the last day of any Interest Period would otherwise occur on a day other than a Business Day, the last day of such Interest Period shall be extended to occur on the next succeeding Business Day; provided, however, that if such extension would cause the last day of such Interest Period to occur in the next following calendar month, the last day of such Interest Period shall occur on the next preceding Business Day; (c) no Interest Period for a Facility A Advance may extend beyond the Facility A Termination Date; and (d) no Interest Period for the Facility B Advance may extend beyond the Facility B Termination Date. "Inventory" has the meaning assigned to such term in the UCC. "Investment" in any Person means any investment, whether by means of share purchase, loan, advance, extension of credit, capital contribution or otherwise, in or to such Person, the Guaranty of Debt of such Person or the subordination of any claim against such Person to other Debt of such Person. "Laws" means all statutes, laws, ordinances, regulations, orders, writs, injunctions, or decrees of the United States, any state or commonwealth, any municipality, any foreign country, any territory or possession, or any Tribunal. -10- 16 "Lending Office" means, with respect to Lender, its branch or affiliate, (i) initially, the office of Lender, branch or affiliate identified as such in Section 8.4(b), and (ii) subsequently, such other office of Lender, branch or affiliate as Lender may designate to Borrower as the office from which the Advances of Lender will be made and maintained and for the account of which all payments of principal and interest on the Advances and the Commitment Fee will thereafter be made. Lender may have more than one Lending Office for the purpose of making Prime Advances and LIBOR Advances. "LIBOR Advance" means an Advance bearing interest at the LIBOR Rate. "LIBOR Rate" means a simple per annum interest rate equal to the lesser of (a) the Highest Lawful Rate, and (b) sum of the Applicable Margin plus the LIBOR Rate Basis. The LIBOR Rate shall, with respect to LIBOR Advances subject to reserve or deposit requirements under any Law, be subject to premiums assessed therefor by each Lender, which are payable directly to each Lender in an amount sufficient to compensate such Lender for any increased cost or reduced rate of return attributable to such reserve deposit requirements. Any calculation by a Lender of such increased cost or reduced rate of return which is in reasonable detail and submitted to Borrower shall, in the absence of manifest error, be presumptive evidence of the validity of such claim. Once determined for any LIBOR Advance, the LIBOR Rate shall remain unchanged during the applicable Interest Period. "LIBOR Rate Basis" shall mean, for any LIBOR Advance for any Interest Period therefore, the rate per annum (rounded upwards, if necessary, to the nearest one-one hundredth (1/100th) of one percent (1%)) appearing on Telerate Page 3750 (or any successor page) as the London interbank offered rate for deposits in United States dollars at approximately 11:00 a.m. (London time) two Business Days prior to the first day of such Interest Period. If for any reason such rate is not available, the term "LIBOR Rate" shall mean, for any LIBOR Advance for any Interest Period therefor, the rate per annum (rounded upwards, if necessary, to the nearest one-one hundredth (1/100th) of one percent (1%)) appearing on Reuters Screen LIBO page as the London interbank offered rate for deposits in United States dollars at approximately 11:00 a.m. (London time) two Business Days prior to the first day of such Interest Period for a term comparable to such Interest Period; provided, however, if more than one rate is specified on Reuters Screen LIBO Page, the applicable rate shall be the arithmetic mean of all such rates. "Lien" means any mortgage, pledge, security interest, encumbrance, lien or charge of any kind (including any agreement to give or not to give any of the foregoing), any conditional sale or other title retention agreement, any lease in the nature thereof, and the filing of or agreement to give any financing statement. "Listed Debt" means any debt security (the issuer of which is a corporation organized under the laws of any of the United States of America) rated, at any date of determination, any one of the three highest ratings by Standard & Poor's Corporation or Moody's Investors Service, Inc., each regularly traded on the New York Stock Exchange or the American Stock Exchange. -11- 17 "Listed Securities" means any equity security regularly traded on the New York Stock Exchange or the American Stock Exchange. "Litigation" means any proceeding, claim, lawsuit and/or investigation conducted or, to the knowledge of Borrower, threatened by or before any Tribunal, including, but not limited to, proceedings, claims, lawsuits, and/or investigations under or pursuant to any environmental, occupational, safety and health, antitrust, unfair competition, securities, Tax, or other Law, or under or pursuant to any contract, agreement or other instrument. "Loan Papers" means this Agreement, the Notes, the Borkan Subordination Agreement, the Swisher Subordination Agreement, any agreement securing or assuring performance of the Obligation and all other agreements, certificates and documents delivered by Borrower hereunder or any other Person pursuant hereto. "Margin Ratio" means the ratio, as at any date of determination, of (a) the sum of the aggregate unpaid principal of all outstanding Advances, plus all accrued, unpaid interest on all Advances, plus the amount of all other Obligations, to (b) EBITDA. "Material Adverse Change or Effect" means any act or circumstance which (a) would be material and adverse to the combined financial condition, business operations or prospects of Borrower and its Subsidiaries or any other Obligor, (b) in any material manner whatsoever would adversely affect the validity or enforceability of any of the Loan Papers or (c) in any material manner impairs the value of any material portion of the Collateral. "Maximum Amount" means the maximum amount of interest which, under Applicable Law, Lender is permitted to charge on the Obligation. "NationsBank" means NationsBank of Texas, N.A., a national banking association. "Net Earnings Available for Fixed Charges" means, for Borrower and its Subsidiaries, determined in accordance with GAAP on a consolidated basis, (a) Net Income before Taxes, plus (b) extraordinary non-cash charges, plus (c) interest expense (including interest expense pursuant to Capital Leases), plus (d) lease expense pursuant to Operating Leases, determined for the fiscal quarter preceding the date of calculation. "Net Income" means, for Borrower and its Subsidiaries, determined in accordance with GAAP on a consolidated basis, net profit or loss. "Neuromed" means Neuromed, Inc., a Florida corporation. -12- 18 "Neuromed Agreement" means the Agreement for the Purchase and Sale of All of the Issued Capital Stock of Neuromed, Inc. dated February 10, 1995, between Borrower and William Borkan. "Note" or "Notes" means the Facility A Note and the Facility B Note. "Obligations" means all present and future obligations, indebtedness and liabilities, and all renewals and extensions of all or any part thereof, of Borrower and each Obligor to Lender arising from, by virtue of, or pursuant to this Agreement, any of the other Loan Papers and any and all renewals and extensions thereof or any part thereof, or future amendments thereto, all interest accruing on all or any part thereof and reasonable attorneys' fees incurred by Lender for the administration, execution of waivers, amendments and consents, and in connection with any restructuring, workouts or in the enforcement or the collection of all or any part thereof, whether such obligations, indebtedness and liabilities are direct, indirect, fixed, contingent, joint, several or joint and several. Without limiting the generality of the foregoing, "Obligations" includes all amounts would be owed by Borrower, each other Obligor and any other Person (other than Lender) to Lender under any Loan Paper, but for the fact that they are unenforceable or not allowable due to the existence of a bankruptcy, reorganization or similar proceeding involving Borrower, any other Obligor or any other Person (including all such amounts which would become due or would be secured but for the filing of any petition in bankruptcy, or the commencement of any insolvency, reorganization or like proceeding of Borrower, any other Obligor or any other Person under any Debtor Relief Law). "Obligor" means (a) Borrower, (b) each other Person (other than Lender) liable for performance of any of the obligations under the Loan Papers and (c) each other Person the property of which secures the performance of any of the obligations under the Loan Papers. "Operating Leases" means operating leases, as defined in the Financial Accounting Standards Board Statement of Financial Accounting Standards No. 13, dated November 1976, as amended. "PBGC" means the Pension Benefit Guaranty Corporation, and any successor to all or any of the Pension Benefit Guaranty Corporation's functions under ERISA. "Permitted Investments" means Government Securities, Listed Debt, Listed Securities and State Securities; provided Investments in Listed Securities of a single issuer shall not exceed 25% of the outstanding equity having voting rights of such issuer. "Permitted Liens" means: (a) Liens granted to Lender to secure the Obligation, (b) Liens in assets of Borrower or a Subsidiary of Borrower which assets are not required by the Loan Papers to be subject to a Lien in favor of Lender or which are not required by the Loan Papers to not be subject to a Lien in favor of any Person, (c) Liens in the Allen Property to the extent such Liens do not cover or purport to cover any asset of Borrower which is subject to a Lien in -13- 19 favor of Lender, (d) pledges or deposits made to secure payment of worker's compensation or occupational injury insurance (or to participate in any fund in connection with worker's compensation or occupational injury insurance), unemployment insurance, pensions or social security programs or to secure performance of bids, tenders, contracts or leases, or to secure statutory obligations, surety or appeal bonds, or indemnity, performance or similar bonds in the ordinary course of business, (e) Liens imposed by mandatory provisions of law such as for materialmen's, mechanics', warehousemen's and other like Liens arising in the ordinary course of business, securing indebtedness whose payment is not yet due or which are being contested in good faith and as to which adequate cash reserves established in accordance with GAAP have been provided, (f) Liens for taxes, assessments and governmental charges or levies imposed upon a Person or upon such Person's income or profits or property, if the same are not yet due and payable or if the same are being contested in good faith and as to which adequate cash reserves have been provided, (g) Liens in favor of MetLife Capital Corporation or its affiliates upon the Allen Property in existence and of record on March 31, 1995, provided such Liens do not secure Debt in excess of the amount of such Debt on March 31, 1995, as reduced by payments on and after March 31, 1995, (h) Liens to secure Borrower's or any Subsidiary's of Borrower obligations under lease agreements related to the real property and improvements located at 2930-G and 2930-H Grace Lane, Costa Mesa, California, or any reasonably comparable lease agreements entered into as replacements for or expansion of such lease agreements, or (i) Liens permitted by and subject to the Borkan Subordination Agreement and the Swisher Subordination Agreement. "Person" means and includes an individual, a partnership, a joint venture, a corporation, a limited liability company, a trust, an unincorporated organization, and a government or any department, Tribunal, agency or political subdivision thereof. "Plan" means an employee benefit plan or other plan maintained by Borrower for employees of Borrower covered by Title IV of ERISA, or subject to the minimum funding standards under Section 412 of the Internal Revenue Code of 1986, as amended ("Code"). "Prime Advance" means an Advance bearing interest at the Prime Rate. "Prime Base Rate" means the prime interest rate charged by NationsBank as announced or published by NationsBank from time to time as its prime rate, and which may not be the lowest interest rate charged by NationsBank. "Prime Rate" means, with respect to each Prime Advance, a rate per annum equal to the lesser of (a) the sum of (i) the Prime Base Rate, plus (ii) the Applicable Margin and (b) the Highest Lawful Rate. "Principal Office" means the principal office of Lender located at 901 Main Street, Dallas, Texas 75202. -14- 20 "Quarterly Date" means March 31, June 30, September 30 and December 31. "Refinancing Advance" means an Advance which is used to pay the principal of an existing Advance at the end of its Interest Period and which, after giving effect to such application, does not result in an increase in the aggregate outstanding amount of Advances. "Regulatory Modification" has the meaning set forth in Section 2.14. "Reportable Event" has the meaning specified in Title IV of ERISA. "Rights" means rights, remedies, powers and privileges. "Second Restated Credit Agreement" has the meaning specified in the Background section. "Solvent" means, with respect to a particular date, that on such date (a) the fair value of the property of a Person is greater than the total amount of liabilities, including, without limitation, contingent liabilities, of such Person, (b) the present fair salable value of the assets of such Person is not less than the amount that will be required to pay the probable liability of such Person on its debts as they become absolute and matured, (c) such Person is able to realize upon its assets and pay its debts and other liabilities, contingent obligations and other commitments as they mature in the normal course of business, (d) such Person does not intend to, or believe that it will, incur debts or liabilities beyond such Person's ability to pay as such debts and liabilities mature, and (e) such Person is not engaged in business or a transaction, and is not about to engage in business or a transaction, for which such Person's property would constitute unreasonably small capital after giving due consideration to the prevailing practice in the industry in which such Person is engaged. In computing the amount of contingent liabilities at any time, it is intended that such liabilities will be computed at the amount which, in light of all the facts and circumstances existing at such time, represents the amount that can reasonably be expected to become an actual or material liability. "Special Counsel" means the law firm of Donohoe, Jameson & Carroll, P.C., Dallas, Texas, Special Counsel to Lender, and each other attorney or law firm representing Lender. "State Securities" means direct obligations of any state or political subdivision thereof, rated, at any date of determination, A-1 or P-1 by Standard & Poor's Corporation or Moody's Investors Service, Inc. "Subsidiary" of any Person means any corporation, limited liability company, partnership, joint venture, trust or estate of which (or in which) more than 50% of: (a) the outstanding capital stock having voting power to elect a majority of the Board of Directors of such corporation (irrespective of whether at the time capital stock of any other class or classes of such corporation shall or might have voting power upon the occurrence of any contingency), (b) -15- 21 the interest in the capital or profits of such partnership or joint venture, or (c) the beneficial interest of such trust or estate, is at the time directly or indirectly owned by such Person, by such Person and one or more of its Subsidiaries or by one or more of such Person's Subsidiaries. "Swisher Debt" means the "Subordinated Obligations", as defined in the Swisher Subordination Agreement. "Swisher Subordination Agreement" means the Subordination Agreement date March 3, 1997, among Robert Swisher, Borrower and Lender. "Tangible Net Worth" means, with respect to Borrower, shareholders' equity, as shown on a balance sheet prepared in accordance with GAAP on a consolidated basis, less the aggregate book value of intangible assets shown on such balance sheet (provided, goodwill shall not be used in any determination of "Tangible Net Worth" if goodwill is shown on the balance sheet as a negative number, provided further that goodwill shown on the balance sheet as a positive number shall be deducted in determining "Tangible Net Worth"). "Taxes" means all taxes, assessments, fees or other charges from time to time or at any time imposed by any Laws or by any Tribunal. "Term Debt" means debt for borrowed money the original scheduled maturity of the last installment of which was more than twelve months after the date borrowed. "Total Liabilities" means all liabilities of Borrower which would be classified as total liabilities on a balance sheet prepared in accordance with GAAP on a consolidated basis. "Tribunal" means any state, commonwealth, federal, foreign, territorial, or other court or governmental department, commission, board, bureau, agency or instrumentality. "Type" refers to the distinction between Advances bearing interest at the Prime Rate and LIBOR Rate. "UCC" means the Uniform Commercial Code of Texas, as amended. "Unrestricted Cash" means all cash, Government Securities, Listed Debt, Listed Securities and State Securities owned by Borrower which are not subject to any Lien. 1.2 Accounting and Other Terms. All accounting terms used in this Agreement which are not otherwise defined herein shall be construed in accordance with GAAP consistently applied on a consolidated basis for Borrower and its Subsidiaries, unless otherwise expressly stated herein. If after the Effective Date any change in GAAP applicable to Borrower or its Subsidiaries results in a change in the manner of any calculation under the Loan Papers, Borrower and Lender shall negotiate amendments to the Loan Papers to accommodate such -16- 22 changes in GAAP. References herein to one gender shall be deemed to include all other genders. Except where the context otherwise requires, (a) definitions imparting the singular shall include the plural and vice versa and (b) all references to time are deemed to refer to Dallas time. ARTICLE II. ADVANCES 2.1 (a) Facility A Advances. Lender agrees, upon the terms and subject to the conditions of this Agreement, to make Facility A Advances to Borrower from time to time from the Effective Date to the Facility A Termination Date; provided, however, that immediately after giving effect to each Facility A Advance pursuant to this Section 2.1(a), the aggregate principal amount of the Facility A Advances shall at no time exceed the lesser of (a) the Facility A Commitment and (b) the Borrowing Base. (b) Facility B Advance. Lender agrees, upon the terms and subject to the conditions of this Agreement, to make the Facility B Advance to Borrower on the Effective Date. 2.2 Manner of Borrowing. (a) Each Borrowing of Advances shall be made upon the written notice of Borrower, received by Lender (i) not later than 12:00 noon three Business Days prior to the date of the proposed Borrowing, in the case of LIBOR Advances; and (ii) not later than 11:00 a.m. on the date of such Borrowing, in the case of Prime Advances. Each such notice of a Borrowing (a "Borrowing Notice") shall be by telecopy or telex, promptly confirmed by letter, in substantially the form of Exhibit I specifying therein: (i) the date of such proposed Borrowing, which shall be a Business Day; (ii) the amount of such proposed Borrowing which, (A) shall not exceed the unused portion of the Facility A Commitment, (B) shall not, when added to the aggregate principal of outstanding Facility A Advances, exceed the Borrowing Base, (C) shall, in the case of a Borrowing of LIBOR Advances, be in an amount of not less than $50,000 or an integral multiple of $50,000 in excess thereof and (D) in the case of a Borrowing of Prime Advances, be in an amount of not less than $50,000 or an integral multiple of $10,000 in excess thereof; (iii) the Type of Advances of which the Borrowing is to be comprised; and (iv) if the Borrowing is to be comprised of LIBOR Advances, the duration of the initial Interest Period applicable to such Advances. -17- 23 If the Borrowing Notice fails to specify the duration of the initial Interest Period for any Borrowing comprised of LIBOR Advances, such Interest Period shall be one month. (b) Provided that all conditions precedent to the making of such Advance have been satisfied, Lender shall on the date of such Advance (other than a Refinancing Advance) deposit the funds so requested in the deposit account no. 1291792407 of Borrower with Lender. (c) After giving effect to any Borrowing, there shall not be more than five different Interest Periods in effect. (d) No Interest Period for a Borrowing under Facility A or Facility B shall extend beyond the Facility A Termination Date or Facility B Termination Date, respectively. (e) Borrower shall indemnify Lender against any Consequential Loss incurred by Lender as a result of (i) any failure to fulfill, on or before the date specified for the Advance, the conditions to the Advance set forth herein or (ii) Borrower's requesting that an Advance not be made on the date specified in the Borrowing Notice. 2.3 Evidence of Indebtedness. (a) Facility A Advances shall be evidenced by the Facility A Note in the amount of the Facility A Commitment in effect on the Effective Date. The Facility B Advance shall be evidenced by the Facility B Note in the amount of the Facility B Commitment in effect on the Effective Date. (b) Absent manifest error, Lender's records shall be prima facie evidence as to amounts owed Lender under the Notes and this Agreement. 2.4 Fees. (a) Facility A Commitment Fee. Subject to the provisions of Section 8.12, Borrower shall pay to Lender a commitment fee ("Facility A Commitment Fee") at the rate of 3/8% per annum on the average daily unused portion of the Facility A Commitment. The Facility A Commitment Fee shall be payable in arrears (i) on each Quarterly Date, commencing March 31, 1997 and (ii) on the Facility A Termination Date. (b) Origination Fee. Subject to the provisions of Section 8.12, Borrower shall pay to Lender an origination fee of $10,000 with respect to the Facility A Commitment and Facility B Commitment. -18- 24 2.5 Prepayments. (a) Borrower may, upon at least three Business Days prior written notice to Lender stating the proposed date and aggregate principal amount of the prepayment, prepay the outstanding principal amount of any Advances in whole or in part, together with accrued interest to the date of such prepayment on the principal amount prepaid without premium or penalty other than any Consequential Loss; provided, however, that in the case of a prepayment of a Prime Advance, the notice of prepayment may be given by telephone by 11:00 a.m. on the date of prepayment. Each partial prepayment shall, in the case of LIBOR Advances, be in an aggregate principal amount of not less than $50,000 or an integral multiple of $50,000 in excess thereof and, in the case of Prime Advances, be in an aggregate principal amount of not less than $50,000 or an integral multiple of $10,000 in excess thereof. No prepayment of the Facility B Advance can reduce the outstanding principal of the Facility B Advance to less than $50,000 unless the entire outstanding principal of the Facility B Advance is prepaid. If any notice of prepayment is given, the principal amount stated therein, together with accrued interest on the amount prepaid and the amount, if any, due under Section 2.14, shall be due and payable on the date specified in such notice. (b) If at any time the aggregate principal of outstanding Facility A Advances exceeds the lesser of (a) the Facility A Commitment and (b) the Borrowing Base, Borrower shall immediately prepay Facility A Advances then outstanding in the aggregate amount equal to such excess, together with accrued interest to the date of such prepayment on the principal amount prepaid without premium or penalty other than any Consequential Loss. If at any time the aggregate principal of outstanding Facility B Advances exceeds the Facility B Commitment, Borrower shall immediately prepay the Facility B Advance then outstanding in the aggregate amount equal to such excess, together with accrued interest to the date of such prepayment on the principal amount prepaid without premium or penalty other than any Consequential Loss. (c) Unless otherwise specified by Borrower, any prepayment of Advances pursuant to this Section 2.5 shall be applied first to Prime Advances, if any, then outstanding, and second to LIBOR Advances with the shortest remaining Interest Periods outstanding. (d) No prepayments of Facility A Advances made solely pursuant to this Section 2.5 shall cause the Facility A Commitment to be reduced. (e) Any prepayments of the Facility B Advance made solely pursuant to this Section 2.5 shall cause the Facility B Commitment to be reduced by the amount of such prepayment. 2.6 Repayment. (a) Facility A. Borrower shall repay to Lender the outstanding principal amount of the Facility A Advances on the Facility A Termination Date. -19- 25 (b) Facility B. Borrower shall repay to Lender the outstanding principal amount of the Facility B Advance on the Facility B Termination Date. (c) General. The principal amount of each LIBOR Advance is due and payable on the last day of the applicable Interest Period, which principal payment may be made by means of a Refinancing Advance (subject to the other provisions of this Agreement). On the date of a reduction of the Facility A Commitment or Facility B Commitment pursuant to Section 2.7, the aggregate amount of the applicable Advances outstanding on the date of reduction in excess of the Facility A Commitment or Facility B Commitment as reduced shall be due and payable, which principal payment may not be made by means of a Refinancing Advance. 2.7 Reduction of Commitments. (a) Mandatory. The Facility A Commitment shall reduce by $90,000 on the first day of each calendar month, commencing on April 1, 1997. (b) Optional. Borrower shall have the right at any time and from time to time upon not less than three Business Days' notice to Lender not later than 12:00 noon (if telephonic, to be confirmed by telex or in writing on or before the date of reduction or termination), to terminate or reduce the Facility A Commitment or the Facility B Commitment, in whole or in part, provided that each partial termination shall be in an aggregate amount which is an integral multiple of $50,000; provided, any reduction of the Facility B Commitment to less than $50,000 must reduce the Facility B Commitment to zero. Once reduced or terminated, neither the Facility A Commitment nor the Facility B Commitment may be increased or reinstated. On the date of any such reduction, Borrower shall repay such principal amount (together with accrued interest thereon and any Consequential Loss) of outstanding Advances as may be necessary so that after such repayment, the aggregate unpaid principal amount of Advances does not exceed the amount of the Facility A Commitment or the Facility B Commitment, as appropriate, as then reduced. 2.8 Interest. Subject to Sections 2.09 and 8.12, Borrower shall pay interest on the unpaid principal amount of each Advance from the date of such Advance until such principal shall be paid in full, at the following rates per annum: (a) Prime Advances. Prime Advances shall bear interest at a rate per annum equal to the Prime Rate as in effect from time to time. The Facility B Advance may not be a Prime Advance. (b) LIBOR Advances. LIBOR Advances shall bear interest at the rate per annum equal to the LIBOR Rate applicable to such Advance, which at no time shall exceed the Highest Lawful Rate. -20- 26 (c) Payment Dates. Accrued and unpaid interest on Prime Advances shall be paid in arrears on each Quarterly Date, on the Facility A Termination Date. Accrued and unpaid interest in respect of each LIBOR Advance shall be paid on the last day of the appropriate Interest Period and on the date of any prepayment or repayment of such Advance; provided, however, that if any Interest Period for a LIBOR Advance exceeds three months, interest shall also be paid on the date which falls three months after the beginning of such Interest Period. (d) Index. Reference to any particular index or reference rate for determining any applicable interest rate under this Agreement is for purposes of calculating the interest due and is not intended as and shall not be construed as requiring Lender to actually obtain its funds used to make any Advance at any particular index or reference rate. 2.9 Default Interest. During the continuation of any Event of Default, Borrower shall pay, on demand, interest (after as well as before judgment to the extent permitted by Law) on the principal amount of all Advances outstanding and on all other Obligations due and unpaid hereunder for each Advance equal to the Highest Lawful Rate. 2.10 Continuation and Conversion Elections (a) Borrower may upon irrevocable written notice to Lender and subject to the terms of this Agreement: (i) elect to convert, on any Business Day, all or any portion of outstanding Prime Advances (in an aggregate amount not less than $50,000 or an integral multiple of $50,000 in excess thereof) into LIBOR Advances; or (ii) elect to convert, at the end of any Interest Period therefor, all or any portion of outstanding LIBOR Advances comprised in the same Borrowing (in an aggregate amount not less than $50,000 or an integral multiple of $10,000 in excess thereof), into Prime Advances; or (iii) elect to continue, at the end of any Interest Period therefor, any LIBOR Advances; provided, however, that if the aggregate amount of outstanding LIBOR Advances comprised in the same Borrowing shall have been reduced as a result of any payment, prepayment or conversion of part thereof to an amount less than $50,000, the LIBOR Advances comprised in such Borrowing shall automatically convert into Prime Advances at the end of each respective Interest Period; provided, further, that if the aggregate amount of outstanding LIBOR Advances outstanding under Facility B shall have been reduced as a result of any payment, prepayment or conversion of part thereof to an amount less than $50,000, all outstanding -21- 27 principal of the Facility B Advance shall be due and payable at the end of each respective Interest Period and the Facility B Commitment shall terminate on the end of the last Interest Period. (b) Borrower shall deliver a notice of conversion or continuation (a "Conversion or Continuation Notice"), in substantially the form of Exhibit J, to Lender not later than (i) 12:00 noon three Business Days prior to the proposed date of conversion or continuation, if the Advances or any portion thereof are to be converted into or continued as LIBOR Advances; and (ii) 10:00 a.m. on the Business Day of the proposed conversion, if the Advances or any portion thereof are to be converted into Prime Advances. Each such Conversion or Continuation Notice shall be by telecopy or telex, promptly confirmed by letter, specifying therein: (i) the Note to which the proposed conversion or continuation relates; (ii) the proposed date of conversion or continuation; (iii) the aggregate amount of Advances to be converted or continued; (iv) the nature of the proposed conversion or continuation; and (v) the duration of the applicable Interest Period. (c) If, upon the expiration of any Interest Period applicable to LIBOR Advances, Borrower shall have failed to select a new Interest Period to be applicable to such LIBOR Advances or if an Event of Default shall then have occurred and be continuing, Borrower shall be deemed to have elected to convert such LIBOR Advances into Prime Advances effective as of the expiration date of such current Interest Period. (d) Notwithstanding any other provision contained in this Agreement, after giving effect to any conversion or continuation of any Advances, there shall not be outstanding Advances with more than five different Interest Periods. 2.11 Maximum Amount of Interest. In no event shall any interest rate charged hereunder exceed the Highest Lawful Rate. If the amount of interest payable for the account of Lender on any Quarterly Date in respect of the immediately preceding interest computation period would exceed the Maximum Amount, the amount of interest payable on such Quarterly Date shall be automatically reduced to the Maximum Amount. If the amount of interest payable for the account of Lender in respect of any interest computation period is reduced pursuant to the immediately preceding sentence and the amount of interest payable for its account in respect of any subsequent interest computation period would be less than the Maximum Amount, then the amount of interest payable for its account in respect of such subsequent interest computation period shall be automatically increased to such Maximum Amount; provided that at no time shall -22- 28 the aggregate amount by which interest paid for the account of Lender has been increased pursuant to this sentence exceed the aggregate amount by which interest paid for its account has theretofore been reduced pursuant to the immediately preceding sentence. 2.12 Computations. Subject to the provisions of Section 8.12 of this Agreement, interest on all Advances as well as computation of the Facility A Commitment Fee shall be calculated on the basis of actual days elapsed, but computed as if each year consisted of 360 days. All LIBOR Advances shall bear interest from and including the first day of the applicable Interest Period to (but not including) the last day of such Interest Period. All Prime Advances shall bear interest from and including each Quarterly Date to (but not including) the next Quarterly Date. 2.13 Taxes. All payments made by Borrower under this Agreement shall be made free and clear of and without deduction for or on account of any present or future income, stamp or other Taxes (excluding, however, Taxes imposed on the overall net income of Lender or any franchise Taxes). 2.14 Capital Adequacy; Increased Costs. (a) If Lender shall have determined that any change after the Effective Date in any applicable Law or guideline regarding capital adequacy, capital maintenance or similar requirements against loan commitments made by Lender (including any such applicable Law or guideline which may be adopted before the date of this Agreement but which requirements are phased in over a period of time), or any change therein, or any change in the interpretation or administration thereof by any Tribunal, central bank or comparable agency charged with the interpretation or administration thereof, or compliance by Lender (or any Lending Office of Lender) or any corporation controlling Lender with any request or directive regarding capital adequacy, capital maintenance or similar requirements against loan commitments, whether or not having the force of law (each such adoptions or modification and each interpretation or administration being herein called a "Regulatory Modification"), has or would have the effect of increasing the cost of Lender with respect to this Agreement as a result of reducing the rate of return on Lender's or such corporation's capital as a consequence of its obligations hereunder ("Additional Costs") to a level below that which Lender or such corporation could have achieved but for such adoption, change or compliance (taking into consideration Lender's or such corporation's policies with respect to such capital impositions) by an amount deemed by Lender to be material, then from time to time, Borrower shall pay to Lender such Additional Costs as will compensate Lender for such reduction. No failure by Lender to immediately demand payment of Additional Costs payable hereunder shall constitute a waiver of Lender's right to demand payment of such Additional Costs at any subsequent time. Determinations by Lender for purposes of this Section 2.14 shall be presumed correct, provided that such determinations are made reasonably and in good faith. Nothing contained herein shall be construed or so operate as to require Borrower to pay any interest, fees, costs or charges greater than as permitted by Applicable Law. -23- 29 (b) If, after the date hereof, any Tribunal, central bank or other comparable authority, shall at any time impose, modify or deem applicable any reserve (including, without limitation, any imposed by the Board of Governors of the Federal Reserve System), special deposit or similar requirement against assets of, deposits with or for the account of, or credit extended by, Lender, or shall impose on Lender other conditions affecting a LIBOR Advance, the Notes, or its obligation to make a LIBOR Advance; and the result of any of the foregoing is to increase the cost to Lender of making or maintaining LIBOR Advances, or to reduce the amount of any sum received or receivable by Lender under this Agreement or under the Notes by an amount deemed by Lender to be material, then, within five days after demand by Lender, Borrower shall pay to Lender the additional amount or amounts as will compensate Lender for the increased cost or reduction. A certificate of Lender claiming compensation under this Section 2.14 and setting forth in reasonable detail the calculation of the additional amount or amounts to be paid to it hereunder shall be conclusive in the absence of manifest error. If Lender demands compensation under this Section 2.14, Borrower may at any time, upon at least five Business Days' prior notice to Lender either (i) repay in full the then outstanding principal amount of LIBOR Advances, together with accrued interest thereon, or (ii) convert such LIBOR Advances to Prime Advances in accordance with the provisions of this Agreement; provided, however, that Borrower shall be liable for any Consequential Loss arising pursuant to such actions. (c) Notwithstanding any other provision of this Agreement, if the introduction of or any change in or in the interpretation or administration of any Law shall make it unlawful, or any central bank or other Tribunal shall assert that it is unlawful, for Lender to perform its obligations hereunder to make LIBOR Advances or to continue to fund or maintain LIBOR Advances hereunder, then, on notice thereof and demand therefor by Lender to Borrower, (i) each LIBOR Advance will automatically, upon such demand, convert into a Prime Advance and (ii) the obligation of Lender to make, or to convert into or Continue Advances as, LIBOR Advances shall be suspended until Lender notifies Borrower that Lender has determined that the circumstances causing such suspension no longer exist. (d) Upon the occurrence and during the continuance of any Default or Event of Default, (i) each LIBOR Advance will automatically, on the last day of the then existing Interest Period therefor, convert into a Prime Advance and (ii) the obligation of Lender to make, or to convert into or Continue Advance as, LIBOR Advances shall be suspended. (e) Failure on the part of Lender to demand compensation for any increased costs, increased capital or reduction in amounts received or receivable or reduction in return on capital pursuant to this Section 2.14 with respect to any period shall not constitute a waiver of Lender's right to demand compensation with respect to such period or any other period. (f) The obligations of Borrower under this Section 2.14 shall survive any termination of this Agreement; provided that at no time may Lender demand any compensation under Sections 2.14(a) or (b) for any amount with respect to any period prior to the date which is six -24- 30 months prior to the date of the notice or certificate delivered by Lender pursuant to either Section 2.14(a) or (b); provided further that Lender shall not demand any compensation under Section 2.14(a) or (b) except in accordance with Lender's normal policies for administering loans with similar provisions. (g) Determinations by Lender for purposes of this Section 2.14 shall be conclusive, absent manifest error. Any certificate delivered to Borrower by Lender pursuant to this Section 2.14 shall include in reasonable detail the basis for Lender's demand for additional compensation. ARTICLE III. CONDITIONS PRECEDENT TO ADVANCES. 3.1 Conditions Precedent to Advances. The obligation of Lender to make the first Advance to be made by it hereunder is subject to the satisfaction of the following conditions: (a) Laws. The making of the Facility A Commitment and the Facility B Commitment shall not contravene any Law applicable to Lender. (b) No Default. (i) No Material Adverse Change, as determined by Lender, shall have occurred and be continuing since September 30, 1996, and (ii) there shall not be a Default or Event of Default existing. (c) Representations and Warranties. The representations and warranties in Article VI and the other Loan Papers shall be true and correct in all material respects. (d) Certificate. Borrower shall have delivered to Lender an officer's certificate for each Obligor, executed by authorized officers of such Obligor, dated the Effective Date, certifying (A) that attached thereto is a copy of its certificate or articles of incorporation certified by the Secretary of State (or other appropriate officer) of the jurisdiction of its incorporation, which is true and complete, and in full force and effect, without amendment except as shown, (B) that attached thereto is a copy of its bylaws, which is true and complete, and in full force and effect, without amendment except as shown, (C) that attached thereto is a copy of the resolutions of the board of directors of such Obligor authorizing execution, delivery and performance of this Agreement and all other Loan Papers, which are true and complete, are in full force and effect, were duly adopted, have not been amended, modified, or revoked, and constitute all resolutions of such Obligor adopted with respect to this loan transaction, (D) that attached thereto are certificates of good standing and certificates of existence for such Obligor issued not more than ten days prior to the Effective Date, issued by the appropriate officer of the jurisdiction of organization of such Obligor and of each jurisdiction in which the nature of such Obligor's business or properties require such qualification, (E) with respect to Borrower, that the pledged interests in ANS have been issued and are outstanding and a description of the ownership of the pledged interests in ANS, (F) with respect to each Obligor other than Borrower, a description of the ownership of all authorized, issued and outstanding equity interests of such Obligor and -25- 31 (G) to the incumbency, name, and signature of each officer authorized to sign this Agreement and any other Loan Paper on its behalf. Lender may conclusively rely on each certificate delivered pursuant to this Section 3.1(d) until it receives notice from Borrower in writing to the contrary. (e) Proceedings. All corporate proceedings of each Obligor taken in connection with the transactions contemplated by this Agreement and all documents incidental thereto shall be satisfactory in form and substance to Lender and Special Counsel; and Lender shall have received, as of the Effective Date, copies of all documents or other evidence which Lender or Special Counsel may reasonably request in connection with said transactions. (f) Loan Papers. Each Obligor shall have delivered to Lender the Loan Papers to be executed by such Obligor, dated as of the Effective Date, appropriately completed. (g) Existing Facility A. Borrower shall have paid to Lender and Lender shall have received all accrued unpaid interest on and fees (including commitment fees) in respect of advances under Existing Facility A. All outstanding, unpaid principal of advances under Existing Facility A shall be renewed and restated and evidenced by the Facility A Note. (h) Origination Fee. Borrower shall have paid to Lender and Lender shall have received the fee described in Section 2.4(b). (i) Documents. Borrower shall have delivered to Lender the following (in the number of counterpart requested by Lender), all in form and substance satisfactory to Lender: (i) The results of UCC and other Lien searches against the assets of each Obligor, and evidence satisfactory to Lender that all Liens (other than Permitted Liens) in favor of any Person against assets of any Obligor shall have been released and any credit facility related to any of the above shall have been terminated. (ii) Evidence satisfactory to Lender of the perfection and priority of the Liens in the Collateral. (iii) If requested by Lender, reasonable evidence that any Obligor is the rightful owner and has good title to its Collateral, as applicable. (iv) A certificate computed after giving effect to the Initial Advance, but demonstrating compliance on the Effective Date with all financial ratios described in Sections 5.6, 5.7, 5.8 and 5.9 (determined on a pro forma basis as of the Effective Date, based on the unaudited financial statements of Borrower as of December 31, 1996). (v) Copies of insurance binders or certificates covering the assets of each Obligor indicating Lender as a loss payee. -26- 32 (vi) Payment of all fees (including attorneys' fees) incurred by Lender. (vii) Copies of all documentation relating to debt owed by Borrower and each other Obligor to any Person, including without limitation, all credit agreements, notes, collateral documents, bonds, instruments and other documentation in connection with any extension of credit. (viii) Certificates for all of the outstanding capital stock of each Subsidiary of Borrower and stop transfer and Article 8 letters in favor of Lender. (ix) Stock and other powers for all shares of the outstanding capital stock of each Subsidiary of Borrower. (x) Executed UCC financing statements with respect to all furniture, equipment, inventory and stock certificates with respect to the Borrower and each Subsidiary of Borrower. (xi) Executed Pledge Agreement in the form of Exhibit L with respect to all capital stock of Borrower's Subsidiaries, all marketable securities and a $350,000 certificate of deposit or time deposit at NationsBank together with the delivery of such capital stock, securities (excluding certificates evidencing marketable securities), certificate of deposit or time deposit. (xii) The Borkan Subordination Agreement and the Borkan Subordination Agreement, together with copies of each agreement evidencing or securing the Subordinated Obligations (as that term is defined in each such Subordination Agreement). (j) Financial Condition Certificate. Lender shall have received a certificate of each Obligor to the effect that: (i) the fair and saleable value of the assets of such Obligor, after giving effect to this Agreement, the Notes and the other Loan Papers, will exceed amounts that will be required to be paid by such Obligor on or in respect of its existing debts (including contingent liabilities) as they mature; (ii) such Obligor will not have unreasonably small capital to carry out its business as now conducted or as proposed to be conducted, and (iii) such Obligor has not incurred debts beyond its ability to pay such debts as they mature. (k) Opinion of Counsel. Lender shall have received an opinion of Hughes & Luce L.L.P. acceptable to Lender and Special Counsel. (l) Further Documents. As of the Effective Date, Lender shall have received, in form and substance satisfactory to Lender and Special Counsel, such other documents -27- 33 and instruments as Lender may reasonably require to evidence the status, organization or authority of Borrower, and to evidence payment of the Obligation. 3.2 Conditions Precedent to All Advances. Lender shall not be obligated to make any Advance, if (a) there is in existence at such time a Default under Section 4.2, 5.6, 5.7, 5.8, or 5.9; (b) an Event of Default has occurred and is continuing; (c) if any representations and warranties contained in Article VI of this Agreement shall be false or untrue in any material respect on the date of such Advance, as if made on such date except for representations and warranties that are by their express terms limited to a specific date; or (d) any Subsidiary of Borrower has not executed and delivered to Lender a Guaranty Agreement. Each request by Borrower for an Advance shall constitute a representation by Borrower that it is in compliance with the provisions of this Section 3.2. 3.3 Legal Details. All documents executed or submitted pursuant hereto by Borrower shall be satisfactory in form and substance to Lender and Special Counsel. Lender and Special Counsel shall receive all information, and such counterpart originals or certified or other copies of and such materials, as Lender or Special Counsel may reasonably request. All legal matters incident to the transactions contemplated by this Agreement (including, without limitation, matters arising from time to time as a result of changes occurring with respect to any Laws) shall be satisfactory to Special Counsel. ARTICLE IV. AFFIRMATIVE COVENANTS From the date hereof, and so long as this Agreement is in effect and until final payment in full of the Obligation and the performance of all other obligations of Borrower under this Agreement and the other Loan Papers, Borrower agrees and covenants that it shall, and shall cause each Subsidiary of Borrower to, observe, perform, comply and fulfill each and every covenant, term and provision set forth below: 4.1 Books, Records and Properties. Borrower shall, and shall cause each Subsidiary of Borrower to, maintain its books and records in accordance with GAAP. Borrower during normal business hours and after reasonable notice by Lender shall, and shall cause each Subsidiary of Borrower to, permit any of Lender's agents or representatives to have access to and examine its books and records, including statements and schedules with respect to the Collateral, and to copy and make abstracts therefrom, and to inspect any of the properties of Borrower and each Subsidiaries of Borrower to, at any time(s) hereafter during normal business hours; provided, that any such access or inspection shall not disrupt Borrower's operations. 4.2 Financial Statements and Reports. Borrower shall furnish or cause to be furnished to Lender the following Financial Statements and reports: (a) Accounting Period Statements. As soon as practicable after the end of each fiscal quarter of Borrower and in any event within 45 days after the end of each fiscal quarter of -28- 34 Borrower, copies of Financial Statements as of the end of such quarter, all in reasonable detail and certified as complete and correct in all material respects, subject to changes resulting from year-end adjustment, by a financial officer of Borrower or any other Person acceptable to Lender; (b) Annual Statements. As soon as practicable after the end of each fiscal year of Borrower and in any event within 90 days thereafter, copies of annual Financial Statements, setting forth in each case in comparative form the figures for the previous fiscal year, all in reasonable detail and accompanied by an unqualified opinion of independent certified public accountants approved by Borrower's board of directors, which opinion shall state that the Financial Statements have been prepared in accordance with GAAP, that their examination has been made in accordance with generally accepted auditing standards and that said financial statements present fairly the consolidated financial position of Borrower and its Subsidiaries and their results of operations; (c) Compliance Certificate and related reports. Within 45 days after the end of each fiscal quarter, the Compliance Certificate for the last day of such quarter. (d) Borrowing Base Certificate and related reports. Within 15 days after the end of each month: (i) The Borrowing Base Certificate for the last day of such month; (ii) A schedule showing for such month an aging of Accounts of Borrower in categories of current, 30 days past due, 60 days past due and 91 or more days past due; and (iii) A schedule showing for such month Accounts payable by each account debtor of which 10% or more of the aggregate dollar amount of all Accounts owed to Borrower by such account debtor have been due and payable for 91 days or more from their respective invoice dates; (e) Contingent Liabilities Report. Promptly upon becoming aware, written notice of any actual or potential contingent liabilities, including Litigation, against Borrower or any Subsidiary of Borrower involving liability in an amount which must be disclosed in either Borrower's financial statements or filings with the Securities and Exchange Commission. (f) FDA Reports. Promptly upon receipt from FDA, a copy of each inspection report received from FDA and responses from and to FDA. (g) SEC Filings. As soon as filed with the Securities and Exchange Commission, copies of each of Borrower's forms 10-Q, 10-K and 8-K. -29- 35 4.3 Maintenance of Existence. Borrower shall cause to be done all things necessary to preserve and keep in full force and effect Borrower's and each of Borrower's Subsidiaries' existence as a corporation; provided, (a) any Subsidiary of Borrower may merge with and into Borrower if Borrower is the surviving entity and (b) any Subsidiary of Borrower may merge with and into another Subsidiary of Borrower. 4.4 Insurance. Borrower shall maintain, and shall cause each Subsidiary of Borrower to, in force with financially sound and reputable insurers, the insurance policies required pursuant to the Loan Papers in accordance with the provisions thereof and such other policies with respect to its respective property and business against such casualties and contingencies (including fire, worker's compensation or occupational injury insurance, business interruption and public liability) and in such amounts as is customary in the lines of business of comparable size and financial strength, with a loss payee endorsement for casualty insurance in favor of Lender and noncancelable without 30 days prior notice to Lender. Borrower shall supply evidence of such insurance to Lender. 4.5 Compliance with Applicable Laws. Borrower shall, and shall cause each Subsidiary of Borrower to, comply with the requirements of all applicable Laws and orders (including but not limited to the FDA Act, ERISA and environmental laws) of Tribunals or other governmental authorizations necessary to the ownership of Borrower's and each of Subsidiary's of Borrower properties or to the conduct of its business if the result of failure to so comply would have a Material Adverse Effect. 4.6 Other Information and Documents. Borrower shall, and shall cause each Subsidiary of Borrower to, promptly deliver to Lender such information, certificates and documents in addition to those herein mentioned as Lender may from time to time reasonably request. 4.7 Default. Borrower shall report to Lender immediately any Default or Event of Default, and any notice of any claimed default under any other Debt agreement, specifying the default and steps taken or to be taken to cure. 4.8 Taxes. Borrower shall pay any stamp, loan, transaction or similar taxes that may be imposed on this Agreement, the Advances hereunder, the Notes, or any of the transactions hereunder, and shall pay, and shall cause each Subsidiary of Borrower to, all income, ad valorem, and other taxes of Borrower or such Subsidiary before they become delinquent except taxes being contested by appropriate means and in good faith and the levy and execution of which have been stayed and continued to be stayed. Any such taxes must be paid before their nonpayment causes a Lien (other than a Permitted Lien) to be filed on any of the Collateral. 4.9 Further Assurances. Borrower will, and will cause each other Obligor to, on request of Lender, promptly correct any defect, error or omission which may be discovered in the contents of any of the Loan Papers or in the execution or acknowledgment thereof, and will -30- 36 execute, acknowledge and deliver such further instruments and do such further acts as may be necessary or as may be requested by Lender to carry out more effectively the purposes of this Agreement and the Loan Papers and to subject to the Liens any of Borrower's or any other Obligor's properties, rights or interests covered or intended to be covered thereby, and to perfect and maintain all Liens at any time securing all or any part of the debt hereunder. 4.10 Filings. Borrower will pay all expenses incurred in connection with the filing of any of the Loan Papers and every other instrument in addition or supplemental to any thereof that shall be required by Law in order to perfect and maintain the validity and effectiveness of Liens at any time securing all or any part of the debt hereunder. 4.11 Maintenance. Borrower will, and shall cause each Subsidiary of Borrower to, maintain all of Borrower's and such Subsidiary's material property in good condition and repair (wear and tear excepted) and make all necessary replacements thereof, and preserve and maintain all material leases, licenses, privileges, franchises, certificates and the like used in the operation of Borrower's and such Subsidiary's business (other than with respect to any such lease, license, privilege, franchise and certificate which the Board of Directors of Borrower or such Subsidiary of Borrower has determined that the expiration or termination of which is in the best interest of Borrower or such Subsidiary of Borrower, respectively). 4.12 ERISA Compliance. Borrower shall, and shall cause each Subsidiary of Borrower to, (a) at all times, make prompt payment of all contributions required under all Plans and required to meet the minimum funding standard set forth in ERISA with respect to its Plans, (b) notify Lender immediately of any fact, including, but not limited to, any Reportable Event arising in connection with any of its Plans, which might constitute grounds for termination thereof by the PBGC or for the appointment by the appropriate United States District Court of a trustee to administer such Plan, together with a statement, if requested by Lender as to the reason therefor and the action, if any, proposed to be taken with respect thereto, and (c) furnish to Lender, upon its request, such additional information concerning any of its Plans as may be reasonably requested. 4.13 Indemnity by Borrower. Borrower shall indemnify, save, and hold harmless Lender and its shareholders, directors, officers, agents, attorneys, and employees (collectively, the "Indemnitees") from and against: (a) any and all claims, demands, actions, or causes of action that are asserted by any Person other than Borrower, its shareholders, directors, officers, agents, attorneys, and employees against any Indemnitee if the claim, demand, action or cause of action relates to the Obligations, the use of proceeds of any Advance, or the relationship of Borrower and Lender under this Agreement or any transaction contemplated pursuant to this Agreement or any other Loan Paper, (b) any proceeding or any administrative, investigative or arbitration proceeding by or before any Tribunal or arbitral directly or indirectly related to (i) a claim, demand, action or cause of action described in clause (a) above or (ii) any claim, demand, proceeding, action or cause of action involving Borrower or any Affiliate (including any shareholder) of Borrower in which any Indemnitee incurs costs and expenses as a result of any -31- 37 requirement that such Indemnitee testify or produce records therein (other than as a result of any Litigation commenced by an Indemnitee or Borrower in which such Indemnitee is not a prevailing party), and (c) any and all liabilities, losses, costs, or expenses (including attorneys' fees and disbursements) that any Indemnitee suffers or incurs as a result of any of the foregoing (other than as a result of any Litigation commenced by an Indemnitee or Borrower in which such Indemnitee is not the prevailing party); provided, however, that Borrower shall not have any obligation under this Section 4.13 to a particular Indemnitee or with respect to any of the foregoing arising out of the negligence or willful misconduct of such Indemnitee. If any claim, demand, action or cause of action is asserted against any Indemnitee, such Indemnitee shall promptly notify Borrower, but the failure to so promptly notify Borrower shall not affect Borrower's obligations under this Section 4.13 except to the extent such failure materially impairs Borrower's ability to defend any such claim, demand, action or cause of action. Any obligation or liability of Borrower to any Indemnitee under this Section 4.13 shall survive the expiration or termination of this Agreement and the repayment of the Obligation. ARTICLE V. NEGATIVE COVENANTS From the date hereof and so long as this Agreement is in effect and until final payment in full of the Obligation, and the performance of all other obligations of Borrower under this Agreement and the other Loan Papers, Borrower agrees and covenants that it shall, and shall cause each of its Subsidiaries to, observe, perform, comply and fulfill each and every covenant, term and provision set forth below: 5.1 Liens. Borrower shall not, and shall not permit any Subsidiary of Borrower to, grant, permit or suffer to exist any Lien on any of its property or assets, except (a) Permitted Liens, and (b) Liens granted under the Loan Papers. 5.2 Transfer of Assets. Borrower shall not, and shall not permit any Subsidiary of Borrower to, sell, lease, transfer, or otherwise dispose of assets of Borrower or such Subsidiary, except (a) payments of business expenses of Borrower or such Subsidiary in the ordinary course of business, (b) Inventory and Investments in the ordinary course of business and for full and fair consideration, (c) assets which Borrower or such Subsidiary determines in good faith are worthless or obsolete, (d) assets not subject to a Lien or license in favor of Lender the value of which, individually and in the aggregate, does not exceed 5% of the gross revenue of Borrower and its Subsidiaries (determined on or consolidated basis) during the preceding fiscal year from operations, or (e) in connection with Investments permitted pursuant to Section 5.4. 5.3 New Industry. Borrower shall not, and shall not permit any Subsidiary of Borrower to, enter any industry or type of business which is not directly related to the research, design, development, manufacture and/or marketing of Devices. -32- 38 5.4 Restricted Investments. Borrower shall not make or have outstanding any Investments, except for Permitted Investments. 5.5 Transactions with Affiliates. Borrower shall not, and shall not permit any Subsidiary of Borrower to, enter into any transaction with any Affiliate, except in the ordinary course of the business of Borrower or such Subsidiary, and on fair and reasonable terms no less favorable to Borrower or such Subsidiary than it would obtain in a comparable arm's length transaction with a Person not an Affiliate. 5.6 Fixed Charges Coverage Ratio. Borrower shall not permit the Fixed Charges Coverage Ratio to be less than the following ratios for the fiscal quarters ending as follows: December 31, 1996 0.70 to 1.00 March 31, 1997 1.00 to 1.00 June 30, 1997 1.20 to 1.00 September 30, 1997 1.50 to 1.00 December 31, 1997 1.75 to 1.00 5.7 Margin Ratio. Borrower shall not permit the Margin Ratio to be greater than the following ratios for the fiscal quarters ending as follows: March 31, 1997 2.00 to 1.00 June 30, 1997 1.85 to 1.00 September 30, 1997 1.75 to 1.00 December 31, 1997 1.65 to 1.00 5.8 Total Liabilities to Tangible Worth Ratio. Borrower shall not permit the ratio of Total Liabilities to Tangible Net Worth to be greater than as indicated below, (a) as at the end of each fiscal quarter of Borrower, ending during the period indicated or (b) on the date indicated: Effective Date through December 31, 1996 2.50 to 1.00 March 31, 1997 and thereafter 1.75 to 1.00 5.9 Capital Expenditures. Borrower shall not permit the aggregate amount of Capital Expenditures incurred or paid during calendar year 1997 to exceed $1,500,000. 5.10 Merger and Consolidation. Borrower shall not, and shall not permit any Subsidiary of Borrower to, merge or consolidate with any other Person or allow any other Person to merge or consolidate with it. 5.11 Debt. Borrower shall not, and shall not permit any Subsidiary of Borrower to, create, incur, assume, become or be liable in any manner in respect of, or suffer to exist, any Debt for Borrowed Money, except (a) Debt under the Loan Papers, (b) obligations in respect of -33- 39 trade payables (i) incurred by Borrower or a Subsidiary of Borrower in the ordinary course of business, and (ii) not in excess of $250,000 in the aggregate, (c) Debt the proceeds of which was used solely for the acquisition and construction of the Allen Property not in excess of the amount of such Debt on the Effective Date, as reduced by payments on and after the Effective Date, (d) Debt payable to William Borkan pursuant to Section 1.2(iii) of the Neuromed Agreement and the Borkan Debt, and (e) the Swisher Debt; provided, the aggregate amount of the Borkan Debt and the Swisher Debt shall not exceed $3,000,000. 5.12 Distributions. Borrower shall not declare, pay, make or become liable for any Distribution. ARTICLE VI. REPRESENTATIONS AND WARRANTIES Borrower represents and warrants as follows: 6.1 Organization; Qualification; Authority. Borrower and each Subsidiary of Borrower is a corporation duly organized, validly existing and in good standing under the laws of the state indicated on Schedule 1. Borrower and each Subsidiary of Borrower has the power to own its properties and to carry on its businesses as now being conducted. The Board of Directors of Borrower has duly authorized the execution, delivery and performance of the Loan Papers to be executed by Borrower. No consent of the shareholders of Borrower is required as a prerequisite to the validity and enforceability of any Loan Papers or any other document contemplated hereby. Borrower has full legal right and corporate power, and authority to execute, deliver, and perform its obligations under the Loan Papers to be executed and delivered by it. 6.2 Financial Statements. The unaudited financial statements for the fiscal year ended December 31, 1996 and the unaudited financial statements for the nine months ended September 30, 1996 and for the most recent fiscal quarter (including any related schedules and/or notes) are true and correct in all material respects (subject, as to interim statements, to charges resulting from audits and year-end adjustments) have been prepared in accordance with GAAP (except, as to interim statements, for notes and year-end adjustments) consistently followed throughout the periods specified, and fairly present in accordance with GAAP the financial condition and results of operations of Borrower as at the dates thereof and for the periods indicated. There has been no material adverse change in the business, condition or operations (financial or otherwise) of Borrower since September 30, 1996. 6.3 Conflicting Agreements and Other Matters. Neither Borrower nor any Subsidiary of Borrower is a party to any contract or agreement or subject to any restriction which materially and adversely affects the ability of Borrower to perform its obligations under the Loan Papers. Neither the execution nor delivery of this Agreement, the Notes, or the other Loan Papers, nor fulfillment of nor compliance with the terms and provisions of this Agreement, the Notes or the other Loan Papers will conflict with, or result in a breach of the terms, conditions or provisions -34- 40 of, or constitute a default under, or result in any violation of, or result in the creation of any Lien (except for Liens created by the Loan Papers) upon any of the properties or assets of Borrower or any Subsidiary of Borrower pursuant to the articles of incorporation of Borrower or such Subsidiary, any award of any arbitrator or any agreement, instrument, order, judgment, decree, statute, law, rule or regulation to which Borrower or such Subsidiary is subject. Neither Borrower nor any Subsidiary of Borrower is a party to, or otherwise subject to any provision contained in, any instrument evidencing indebtedness of Borrower or such Subsidiary, any agreement relating thereto or any other contract or agreement which limits the amount of, or otherwise imposes restrictions on the incurring of, Debt of Borrower of the type to be evidenced by the Notes. 6.4 Governmental Consent. Neither the nature of Borrower or any Subsidiary of Borrower, its businesses or properties, nor any relationship between Borrower, any Subsidiary of Borrower and any other Person, nor any circumstance in connection with the execution, delivery and performance of this Agreement, the Loan Papers or the Notes is such as to require any authorization, consent, approval, exemption of other action by or notice to or filing with any court or Tribunal (other than routine filings and recordings to perfect Liens) in connection with the execution and delivery of this Agreement, the Notes, the other Loan Papers, or fulfillment of or compliance with the terms and provisions hereof, of the Notes or of the other Loan Papers. 6.5 Enforceability. This Agreement is, the other Loan Papers are and the Notes when delivered will be legal, valid and binding obligations of Borrower enforceable against Borrower in accordance with their terms, except as limited by Debtor Relief Laws. 6.6 Actions Pending. Other than as described on Schedule 3, there is no Litigation pending or, to the knowledge of Borrower, threatened against Borrower or any Subsidiary of Borrower, or any properties or rights of Borrower or any Subsidiary of Borrower, by or before any court, arbitrator or Tribunal which may reasonably be expected to result in any Material Adverse Effect. There is no Litigation pending or, to the knowledge of Borrower, threatened against Borrower or any Subsidiary of Borrower which purports to affect the validity or enforceability of this Agreement, either Note or any of the other Loan Papers. 6.7 Outstanding Debt. Neither Borrower nor any Subsidiary of Borrower has any outstanding Debt except (a) as described on the balance sheet of Borrower for the nine months ended September 30, 1996, (b) trade payables incurred in the ordinary course of business, (c) Debt for Borrowed Money owed to Lender, (d) Debt of Borrower to William Borkan as described in and subject to the Borkan Security Agreement, and (e) Debt of Borrower to Robert Swisher as described in and subject to the Swisher Security Agreement. There exists no default under the provisions of any instrument evidencing such Debt or of any material agreement relating thereto. 6.8 Title to Properties. Borrower and each Subsidiary of Borrower has good and indefeasible title to its respective real properties (other than properties which it leases) and good -35- 41 title to all of its other material properties and assets used in the operations of its business, subject to no Lien of any kind except Liens permitted by Section 5.1. All leases necessary in any material respect for the conduct of the respective businesses of Borrower are valid and subsisting and are in full force and effect. 6.9 Taxes. Borrower and each Subsidiary of Borrower has paid all taxes and assessments owed by it to the extent that such taxes and assessments have become due, except such taxes as are being contested in good faith by appropriate proceedings for which adequate reserves have been established in accordance with GAAP. 6.10 Regulation G, etc. Neither Borrower nor any Subsidiary of Borrower owns or has any present intention of acquiring any "margin stock" as defined in Regulation G (12 CFR Part 207) of the Board of Governors of the Federal Reserve System (herein called "margin stock"). None of the proceeds of any Advance will be used, directly or indirectly, for the purpose, whether immediate, incidental or ultimate, of purchasing or carrying any margin stock or for the purpose of maintaining, reducing or retiring any indebtedness which was originally incurred to purchase or carry any stock that is currently a margin stock or for any other purpose which might constitute this transaction a "purpose credit" within the meaning of such Regulation G. Neither Borrower nor any agent acting on its behalf has taken or will take any action which might cause this Agreement or the Notes to violate Regulation G, Regulation T, Regulation X or any other regulation of the Board of Governors of the Federal Reserve System or to violate the Securities Exchange Act of 1934, as amended, in each case as in effect now or as the same may hereafter be in effect. 6.11 ERISA. No accumulated funding deficiency (as defined in section 302 of ERISA and section 412 of the Code), whether or not waived, exists with respect to any Plan. No liability to the PBGC has been or is expected by Borrower or any Subsidiary of Borrower to be incurred with respect to any Plan by Borrower or any Subsidiary of Borrower which is or would be materially adverse to Borrower or any Subsidiary of Borrower. Neither Borrower nor any Subsidiary of Borrower has incurred or presently expects to incur any withdrawal liability under Title IV of ERISA with respect to any Multiemployer Plan which is or would be materially adverse to Borrower. 6.12 Disclosure. Neither this Agreement or any other document, certificate or statement furnished, or to be furnished, to Lender by or on behalf of Borrower or any other Obligor in connection herewith or therewith contains any untrue statement of a material fact or omits to state a material fact necessary in order to make the statements contained herein and therein not misleading in any material respect. 6.13 Environmental Matters. Borrower, each Subsidiary of Borrower, the plants and sites each owns, and to the best of Borrower's knowledge after due inquiry of the owners of leased property the plants and sites which each leases have complied with all federal, state, local and regional statutes, ordinances, orders, judgments, rulings and regulations relating to any -36- 42 matters of pollution or of environmental regulation or control except, in any such case, where such failure to comply would not result in a Material Adverse Effect. Without limiting the generality of the preceding sentence, neither Borrower nor any Subsidiary of Borrower has received notice of and does not have actual knowledge of any actual or claimed or asserted failure so to comply which alone or together with any other such failure is material and would result in a Material Adverse Effect. During periods of use, ownership, occupancy or operation by Borrower and each Subsidiary of Borrower, none of Borrower, any Subsidiary of Borrower, or their respective plants or sites have managed, generated, released or disposed of, any hazardous wastes, hazardous substances, hazardous materials, toxic substances or toxic pollutants, as those terms are used or defined in the Resource Conservation and Recovery Act, the Comprehensive Environmental Response Compensation and Liability Act, the Hazardous Materials Transportation Act, the Toxic Substance Control Act, the Clean Air Act and the Clean Water Act, in material violation of or in a manner which would result in liability under such statutes or any regulations promulgated pursuant thereto or any other applicable law, except where such noncompliance or liability would not result in a Material Adverse Effect. 6.14 Sufficiency of Capital. Borrower and each Subsidiary of Borrower are, and after consummation of this Agreement and after giving effect to the Obligation incurred and Liens created by Borrower and each Subsidiary of Borrower in connection herewith will be, Solvent. 6.15 Affiliates. No Affiliate of Borrower exists, except as identified on Schedule 1. 6.16 Intellectual Property. Except as identified on Schedule 4 hereto or patents, trademarks or copyrights for which neither the Borrower nor any Affiliate of Borrower has applied for a copyright registration, trademark registration or patent and no copyright, trademark or patent has been issued or registered on behalf of Borrower or an Affiliate of Borrower, neither Borrower nor any Affiliate of Borrower owns or has any right or interest in any intellectual property, including but not limited to patents, trademarks and copyrights. ARTICLE VII. DEFAULT 7.1 Events of Default. The term "Event of Default" as used herein, means the occurrence and continuance of any one or more of the following events (including the passage of time, if any, specified therefor): (a) Borrower shall fail to pay any amount, whether principal, interest or other amounts, payable hereunder or under the Notes when due and such failure shall continue for three days from the date due; or (b) (i) Any representation or warranty made by Borrower or any other Obligor under or in connection with any Loan Paper shall prove to have been incorrect in any material respect when made or (ii) (A) a breach of any representation or warranty made by any party thereto (other than Borrower) under or in connection with any Acquisition Document is discovered, (B) -37- 43 Lender makes a determination that such breach has caused or will cause a Material Adverse Change or Effect and gives notice thereof to Borrower, and (C) such breach has not already been cured or paid for by such party, or, alternatively, Borrower or such party does not cure such breach or the situation giving rise thereto to the complete satisfaction of Lender within 30 days after receipt of such notice from Lender; or (c) Borrower shall fail to perform or observe any term, covenant or agreement contained in Sections 5.6, 5.7, 5.8, or 5.9 and such failure shall continue for two consecutive months or any other provision of Article V of this Agreement; or (d) Borrower or any other Obligor shall fail to perform or observe any term, covenant or agreement contained in any Loan Paper on its part to be performed or observed, other than described in Section 7.1(a), (b), or (c), and such default has continued for a period of 30 days; or (e) Borrower, any Subsidiary of Borrower or any other Obligor shall fail to pay any Debt (other than under the Loan Papers) which is, singly or in the aggregate, in an amount equal to or greater than $100,000, or any interest or premium thereon, when due (whether by scheduled maturity, required prepayment, acceleration, demand or otherwise) and such failure shall continue after the applicable grace period, if any, specified in the agreement or instrument relating to such Debt; or any other default under any agreement or instrument relating to any such Debt, or any other event, shall occur and shall continue after the applicable grace or cure period, if any, specified in such agreement or instrument, if the effect of such default or event is to accelerate, or to permit the acceleration of, the maturity of such Debt; or any such Debt shall be declared to be due and payable, or required to be prepaid (other than by a regularly scheduled required prepayment), prior to the stated maturity thereof; or (f) Borrower, any Subsidiary of Borrower or any other Obligor shall generally not pay its debts as such debts become due, or shall admit in writing its inability to pay its debts generally, or shall make a general assignment for the benefit of creditors; or any proceeding shall be instituted by or against Borrower, any Subsidiary of Borrower or any other Obligor seeking to adjudicate it a bankrupt or insolvent, or seeking liquidation, winding-up, reorganization, arrangement, adjustment, protection, relief, or composition of it or its debts under any Debtor Relief Laws, or seeking the entry of an order for relief or the appointment of a receiver, trustee, or other similar official for it or for any substantial part of its property; or Borrower, any Subsidiary of Borrower or any other Obligor shall take any action to authorize any of the actions set forth above in this Section 7.1(f); or (g) Any judgment or order for the payment of money in excess of 10% of Unrestricted Cash (calculated as at the date of entry of the judgment or order) shall be rendered against Borrower, any Subsidiary of Borrower or any other Obligor and either (i) enforcement proceedings shall have been commenced by any creditor upon such judgment or order or (ii) -38- 44 there shall be any period of 30 consecutive days during which a stay of enforcement of such judgment or order, by reason of a pending appeal or otherwise, shall not be in effect; or (h) Lender for any reason shall cease to have a valid and perfected first priority security interest in any material portion (as reasonably determined by Lender) of the Collateral purported to be covered thereby; or (i) FDA or any Tribunal shall issue any order resulting in the banning, recall or seizure of any Device of Borrower or any Subsidiary of Borrower the sales of which Device constituted 5% or more of gross sales revenue of Borrower (determined on a consolidated basis) for the twelve months preceding the date such order is issued; or (j) Any Inventory of Borrower or any Subsidiary of Borrower produced in the United States of America is not produced in compliance with the Fair Labor Standards Act and such failure results in the banning, recall or seizure of Inventory constituting 5% or more of the value (valued at the greater of market or book value without giving effect to such ban, recall or seizure or any other write down is the value of such Inventory) of all Inventory of Borrower or such Subsidiary, respectively; or (k) Any material provision of the Loan Papers shall at any time for any reason cease to be valid and binding on Borrower or any other Obligor or shall be declared to be null and void, or the validity or enforceability thereof shall be contested by Borrower or any other Obligor, or a proceeding shall be commenced by any Tribunal having jurisdiction over Borrower, any other Obligor or any Collateral, seeking to establish the invalidity or unenforceability thereof and such proceeding (if commenced by a Person other than Borrower or any other Obligor) shall remain undismissed or unstayed for a period of 30 days, or Borrower or any other Obligor shall deny that it has any or further liability or obligation thereunder; or (l) The occurrence of a default or event of default (howsoever designated) contained in any other Loan Paper and such default or event of default shall continue beyond any applicable grace or cure period. 7.2 Remedies Upon Default. If an Event of Default specified in Section 7.1(f) shall occur and be continuing, the aggregate unpaid principal balance of and accrued interest on the Obligation shall thereupon become due and payable and the Facility A Commitment shall immediately terminate concurrently therewith, without any action by Lender and without diligence, presentment, demand, protest, notice of protest or intent to accelerate, or notice of any other kind, all of which are hereby expressly waived. Should any other Event of Default occur and be continuing, Lender may do any one or more of the following: (a) Acceleration. Declare the entire unpaid balance of the Obligation, or any part thereof, immediately due and payable, whereupon it shall be due and payable without any action -39- 45 by Lender and without diligence, presentment, demand, protest, notice of protest or intent to accelerate or notice of any other kind, all of which are hereby expressly waived. (b) Termination. Terminate the Facility A Commitment. (c) Judgment. Reduce any claim to judgment. (d) Rights. Exercise any and all Rights afforded by the Laws of the State of Texas or any other jurisdiction, including, but not limited to, the UCC, or by any other Loan Papers, or by Law or equity, or otherwise. (e) Offset. Exercise the Rights of offset and/or banker's Lien against the interest of Borrower and each other Obligor in and to every account and other property of Borrower and each other Obligor which is in the possession of Lender, to the extent of the full amount of the Obligation. 7.3 Performance by Lender. Should any covenant, duty or agreement of Borrower fail to be performed in all material respects in accordance with the terms of this Agreement or the Collateral Documents, Lender may, at its option, perform, or attempt to perform, such covenant, duty or agreement on behalf of Borrower. In such event, Borrower shall, at the request of Lender, promptly pay any amount expended by Lender in such performance or attempted performance to Lender at Lender's Principal Office, together with interest thereon at the lesser of (a) the Prime Rate plus 3% and (b) the Highest Lawful Rate from the date of such expenditure by Lender until paid. Notwithstanding the foregoing, it is expressly understood that Lender shall not have any liability or responsibility for the performance of any duties of Borrower hereunder. 7.4 Lender Not in Control. None of the covenants or other provisions contained in this Agreement shall, or shall be deemed to, give Lender the Rights or power to exercise control over the affairs management of Borrower, the power of Lender being limited to the Right to exercise the remedies provided in this Article VII; provided that, if Lender becomes the owner of any interest in Borrower, whether through foreclosure or otherwise, Lender shall be entitled to exercise such legal Rights as it may have by being an owner of such interest in Borrower. 7.5 Waivers. The acceptance by Lender at any time and from time to time of part payment on the Obligation shall not be deemed to be a waiver of any Event of Default or Default then existing. No waiver by Lender of any particular Event of Default or Default shall be deemed to be a waiver of any Event of Default or Default other than said particular Event of Default or Default. No delay or omission by Lender in exercising any Right under any Loan Papers shall impair such Right or be construed as a waiver thereof or an acquiescence therein, nor shall any single or partial exercise of any such Right preclude other or further exercise thereof, or the exercise of any other Right under the Loan Papers or otherwise. -40- 46 7.6 Cumulative Rights. All Rights available to Lender under the Loan Papers shall be cumulative of and in addition to all other Rights granted to Lender at Law or in equity, whether or not the Obligation be due and payable and whether or not Lender shall have instituted any suit for collection or other action in connection with any Loan Paper. 7.7 Expenditures by Lender. Any sums, including reasonable attorneys' fees, spent by Lender pursuant to the exercise of any Right provided in this Article VII shall become part of the Obligation and shall bear interest at a rate per annum equal to the lesser of (a) the Prime Rate plus 3% and (b) the Highest Lawful Rate from the date spent until the date repaid by Borrower. ARTICLE VIII. MISCELLANEOUS 8.1 Money. Unless stipulated otherwise, all references herein to "Dollars", "money", "payments", or other similar financial or monetary terms, are references to currency of the United States of America. 8.2 Headings. The headings, captions and arrangements used in this Agreement and the other Loan Papers are, unless specified otherwise, for convenience only and shall not be deemed to limit, amplify or modify the terms of any Loan Paper, nor affect the meaning thereof. 8.3 Articles, Sections, and Exhibits. All references to "Article", "Sections", "subparagraphs" or "subsections" contained herein are, unless specifically indicated otherwise, references to articles, sections, subparagraphs and subsections of this Agreement. All references to "Exhibits" and "Schedules" contained herein are references to exhibits and schedules attached hereto, all of which are made a part hereof for all purposes, the same as if set forth herein verbatim. If any exhibit or schedule attached hereto which is to be executed and delivered contains blanks or is otherwise required to be updated from time to time, it shall be completed correctly and in accordance with the terms and provisions contained and as contemplated herein prior to, at the time of or after the execution and delivery thereof. 8.4 Notices and Deliveries. (a) Manner of Delivery. All notices, communications and materials (including all Information) to be given or delivered pursuant to this Agreement shall, except in those cases where giving notice by telephone is expressly permitted, be given or delivered in writing. All written notices, communications and materials shall be sent by registered or certified mail, postage prepaid, return receipt requested, by telecopier, or delivered by hand. In the event of a discrepancy between any telephonic notice and any written confirmation thereof, such written confirmation shall be deemed the effective notice except to the extent Lender or Borrower has acted in reliance on such telephonic notice. -41- 47 (b) Addresses. All notices, communications and materials to be given or delivered pursuant to this Agreement shall be given or delivered at the following respective addresses and telecopier and telephone numbers and to the attention of the following individuals or departments: (i) if to Borrower, to it at: Quest Medical, Inc. One Allentown Parkway Allen, Texas 75002 Telephone No: (972) 390-9800 Telecopier No: (972) 390-9687 Attention: F. Robert Merrill III (ii) if to Lender, to it at: NationsBank of Texas, N.A. NationsBank Plaza 901 Main Street 7th Floor Dallas, Texas 75202 Telephone No: (214) 508-0365 Telecopier No: (214) 508-3140 Attention: Commercial Banking or at such other address, telecopier or telephone number or to the attention of such other individual or department as the party to which such information pertains may hereafter specify for the purpose in a notice to the other specifically captioned "Notice of Change of Address". (c) Effectiveness. Each notice, communication and any material to be given or delivered to Lender or Borrower pursuant to this Agreement shall be effective or deemed delivered or furnished (i) if sent by certified mail, return receipt requested, on the fifth Business Day after such notice, communication or material is deposited in the mail, addressed as above provided, (ii) if sent by telecopier, when such notice, communication or material is transmitted to the appropriate number determined as above provided in this Section 8.4 and the appropriate receipt is received or acknowledged, (iii) if sent by hand delivery or overnight courier, when left at the address of the addressee addressed as above provided and the appropriate receipt is received or acknowledged, and (iv) if given by telephone, when communicated to the individual or any member of the department specified as the individual or department to whose attention -42- 48 notices, communications and materials are to be given or delivered except that notices of a change of address, telecopier or telephone number or individual or department to whose attention notices, communications and materials are to be given or delivered shall not be effective until received. 8.5 Place of Payment. All sums payable to Lender hereunder shall be paid to Lender at either Lender's Principal Office or at a branch of Lender within Dallas or Collin Counties, Texas, not later than noon, Dallas time, on the date due, in immediately available funds. Except as provided in Article II, if any payment falls due on other than a Business Day, then such due date shall be extended to the next succeeding Business Day, and interest on such amount (if applicable) shall be payable in respect to such extension. 8.6 Survival of Agreements. All covenants, agreements, representations and warranties made herein shall survive the execution and the delivery of this Agreement, the Notes and the other Loan Papers. 8.7 Parties in Interest. All covenants and agreements contained in the Loan Papers shall bind and inure to the benefit of the respective successors and assigns of the parties hereto, except that Borrower may not assign its rights hereunder without the prior written consent of Lender. 8.8 Expenses. Borrower agrees (a) to pay all out-of-pocket expenses of Lender in connection with the negotiation and preparation of this Agreement, including exhibits and amendments, consents and waivers to any of the other Loan Papers as may from time to time hereafter be requested or required, and the reasonable fees and expenses of Special Counsel from time to time in connection with the negotiation, preparation and execution of the Loan Papers, and (b) to pay or reimburse Lender for all reasonable costs and expenses, including reasonable fees and expenses of counsel to Lender, incurred in connection with the enforcement or preservation of any rights under or the collection of any amounts due pursuant to any of the Loan Papers. The obligations of Borrower under this Section 8.8 shall survive any termination of this Agreement. 8.9 Governing Law. This Agreement and all other Loan Papers shall be deemed contracts made under the Laws of Texas and shall be construed and enforced in accordance with and governed by the Laws of Texas, except to the extent federal Laws govern the validity, construction, enforcement and interpretation of all or any part of the Loan Papers. Without excluding any other jurisdiction, Borrower agrees that the courts of Texas will have jurisdiction over proceedings in connection herewith. Borrower and Lender hereby agree that the provisions of Art. 5069-15.01 et seq. of the Revised Civil Statutes of Texas, 1925, as amended, shall not apply to this Agreement and the Notes. 8.10 MANDATORY ARBITRATION. (A) ANY CONTROVERSY OR CLAIM BETWEEN OR AMONG THE PARTIES HERETO INCLUDING BUT NOT LIMITED -43- 49 TO THOSE ARISING OUT OF OR RELATING TO THIS AGREEMENT OR ANY RELATED AGREEMENTS OR INSTRUMENTS, INCLUDING ANY CLAIM BASED ON OR ARISING FROM AN ALLEGED TORT, SHALL BE DETERMINED BY BINDING ARBITRATION IN ACCORDANCE WITH THE FEDERAL ARBITRATION ACT (OR IF NOT APPLICABLE, THE APPLICABLE STATE LAW), THE RULES OF PRACTICE AND PROCEDURE FOR THE ARBITRATION OF COMMERCIAL DISPUTES OF JUDICIAL ARBITRATION AND MEDIATION SERVICES, INC. ("JAMS"), AND THE "SPECIAL RULES" SET FORTH BELOW. IN THE EVENT OF ANY INCONSISTENCY, THE SPECIAL RULES SHALL CONTROL. JUDGMENT UPON ANY ARBITRATION AWARD MAY BE ENTERED IN ANY COURT HAVING JURISDICTION. ANY PARTY TO THIS AGREEMENT MAY BRING AN ACTION, INCLUDING A SUMMARY OR EXPEDITED PROCEEDING, TO COMPEL ARBITRATION OF ANY CONTROVERSY OR CLAIM TO WHICH THIS AGREEMENT APPLIES IN ANY COURT HAVING JURISDICTION OVER SUCH ACTION. (a) Special Rules. The arbitration shall be conducted in Dallas, Texas and administered by JAMS who will appoint an arbitrator; if JAMS is unable or legally precluded from administering the arbitration, then the American Arbitration Association will serve. All arbitration hearings will be commenced within ninety days of the demand for arbitration; further, the arbitrator shall only, upon a showing of cause, be permitted to extend the commencement of such hearing for up to an additional sixty days. (b) Reservations of Rights. Nothing in this Agreement or any other Loan Paper shall be deemed to (i) limit the applicability of any otherwise applicable statutes of limitation or repose and any waivers contained in this Agreement; or (ii) be a waiver by Lender of the protection afforded to it by 12 U.S.C. Section 91 or any substantially equivalent state law; or (iii) limit the right of Lender hereto (A) to exercise self help remedies such as (but not limited to) setoff, or (B) to foreclose against any real or personal property collateral, or (C) to obtain from a court provisional or ancillary remedies such as (but not limited to) injunctive relief or the appointment of a receiver. Lender may exercise such self help rights, foreclose upon such property, or obtain such provisional or ancillary remedies before, during or after the pendency of any arbitration proceeding brought pursuant to this Agreement. At Lender's option, foreclosure under a deed of trust or mortgage may be accomplished by any of the following: the exercise of a power of sale under the deed of trust or mortgage, or by judicial sale under the deed of trust or mortgage, or by judicial foreclosure. Neither this exercise of self help remedies nor the institution or maintenance of an action for foreclosure or provisional or ancillary remedies shall constitute a waiver of the right of any party, including the claimant in any such action, to arbitrate the merits of the controversy or claim occasioning resort to such remedies. 8.11 WAIVER OF JURY TRIAL. TO THE MAXIMUM EXTENT PERMITTED BY LAW, BORROWER HEREBY WAIVES ANY RIGHT THAT IT MAY HAVE TO A TRIAL BY JURY OF ANY DISPUTE (WHETHER A CLAIM IN TORT, CONTRACT, -44- 50 EQUITY, OR OTHERWISE) ARISING UNDER OR RELATING TO THIS AGREEMENT, THE OTHER LOAN PAPERS, OR ANY RELATED MATTERS, AND AGREES THAT ANY SUCH DISPUTE SHALL BE TRIED BEFORE A JUDGE SITTING WITHOUT A JURY. 8.12 Maximum Amount Limitation. It is not the intention of any of the parties to this Agreement to make an agreement violative of the Laws of any applicable jurisdiction relating to usury. Regardless of any provision in this Agreement, the Notes or any other Loan Paper, Lender shall never be entitled to receive, collect or apply, as interest on the Obligation, any amount in excess of the Maximum Amount. If Lender ever receives, collects or applies, as interest, any such excess, such amount which would be excessive interest shall be deemed a partial repayment of principal and treated hereunder as such; and if principal is paid in full, any remaining excess shall be paid to Borrower. In determining whether or not the interest paid or payable, under any specific contingency, exceeds the Maximum Amount, Borrower and Lender shall, to the maximum extent permitted under Applicable Laws, (a) characterize any nonprincipal payment as an expense, fee or premium rather than as interest, (b) exclude voluntary prepayments and the effect thereof, and (c) amortize, prorate, allocate and spread in equal parts, the total amount of interest throughout the entire contemplated term of the Obligation so that the interest rate is uniform throughout the entire term of the Obligation; provided that if the Obligation is paid and performed in full prior to the end of the full contemplated term thereof, and if the interest received for the actual period of existence thereof exceeds the Maximum Amount, Lender shall refund to Borrower the amount of such excess or credit the amount of such excess against the total principal amount owing, and, in such event, Lender shall not be subject to any penalties provided by any Laws for contracting for, charging or receiving interest in excess of the Maximum Amount. This Section 8.12 shall control every other provision of all agreements among the parties to this Agreement pertaining to the transactions contemplated by or contained in the Notes and the other Loan Papers. 8.13 Severability. If any provision of this Agreement or any other Loan Paper is held to be illegal, invalid or unenforceable under present or future Laws during the term thereof, such provision shall be fully severable, the appropriate agreement or instrument shall be construed and enforced as if such illegal, invalid or unenforceable provision had never comprised a part thereof, and the remaining provisions thereof shall remain in full force and effect and shall not be affected by the illegal, invalid or unenforceable provision or by its severance therefrom. Furthermore, in lieu of such illegal, invalid or unenforceable provision there shall be added automatically as a part of such agreement or instrument a provision as similar in terms to the illegal, invalid or unenforceable provision as may be possible and legal, valid and enforceable. 8.14 Amendment. The provisions of this Agreement and each other Loan Paper may not be amended, modified or waived except by the written agreement of Borrower and Lender. This Agreement embodies the entire agreement among the parties, supersedes all prior agreements and understandings, if any, relating to the subject matter hereof, and may be amended only as provided above. -45- 51 8.15 Exceptions to Covenants. Borrower shall not be deemed to be permitted to take any action or fail to take any action which is permitted as an exception to any of the covenants contained herein or which is within the permissible limits of any of the covenants contained herein if such action or omission would result in the breach of any other covenant contained herein. 8.16 Counterparts. This Agreement may be executed in any number of counterparts, all of which taken together shall constitute one and the same instrument, but in making proof of this Agreement, it shall not be necessary to produce or account for more than one such counterpart. 8.17 Restatement. This Agreement restates in its entirety the Second Restated Credit Agreement. All obligations of each Obligor pursuant to the Second Restated Credit Agreement are amended and restated by this Agreement, which is not intended as a release or novation of any such obligation. 8.18 ENTIRE AGREEMENT. THIS AGREEMENT AND THE LOAN PAPERS REPRESENT THE FINAL AGREEMENT BETWEEN THE PARTIES AND MAY NOT BE CONTRADICTED BY EVIDENCE OF PRIOR, CONTEMPORANEOUS, OR SUBSEQUENT ORAL AGREEMENTS BY THE PARTIES. THERE ARE NO UNWRITTEN ORAL AGREEMENTS BETWEEN THE PARTIES. ========================================== REMAINDER OF PAGE INTENTIONALLY LEFT BLANK ========================================== -46- 52 IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be duly executed as of the day and year first above written. QUEST MEDICAL, INC. By: /s/ F. ROBERT MERRILL III F. Robert Merrill III, Vice President NATIONSBANK OF TEXAS, N.A. By: /s/ BRIAN K. SCHNEIDER Brian K. Schneider, Vice President -47- EX-10.16 3 PROMISSORY NOTE (FACILITY A NOTE) 1 EXHIBIT 10.16 PROMISSORY NOTE (Facility A Note) $5,650,000.00 Dallas, Texas March 3, 1997 QUEST MEDICAL, INC., a Texas corporation, with its principal office located at One Allentown Parkway, Allen, Texas 75002 ("Borrower"), for value received, promises to pay to the order of NATIONSBANK OF TEXAS, N.A. ("Lender"), at its Dallas Banking Center at 901 Main Street, Dallas, Texas 75202, in immediately available funds and in lawful money of the United States of America, the principal sum of Five Million Six Hundred and Fifty Thousand and 00/100 Dollars ($5,650,000.00), or such lesser sum as shall be due and payable from time to time hereunder, on January 31, 1998, or sooner, as provided in the Credit Agreement referred to below. Borrower promises to pay interest on the unpaid principal amount of the Facility A Advances (as defined in the Credit Agreement) from the date made until such principal amount is paid in full, at such interest rates, and payable at such times, as are specified in the Credit Agreement. For the purposes of this Note, the following terms have the respective meanings assigned to them below: "Applicable Law" means the laws of the United States of America applicable to contracts made or performed in the State of Texas, including, without limitation, 12 USC 86, as amended to the date hereof and as the same may be amended at any time and from time to time hereafter and any other statute of the United States of America now or at any time hereafter prescribing maximum rates of interest on loans and extensions of credit, and the laws of the State of Texas, including, without limitation, Article 1.04, Title 79, Revised Civil Statutes of Texas, 1925, as the same may be amended at any time and from time to time hereafter ("Article 1.04") and any other statute of the State of Texas now or at any time hereafter prescribing maximum rates of interest on loans and extensions of credit provided that pursuant to Article 5069-15.10(b), Title 79, Revised Civil Statues, 1925, as amended, Borrower agrees that the provisions of Chapter 15, Title 79, Revised Civil Statutes of Texas, 1925, as amended, shall not apply to this Note. "Highest Lawful Rate" means at the particular time in question the maximum rate of interest which, under Applicable Law, Lender is then permitted to charge on the obligation hereunder. If the maximum rate of interest which, under Applicable Law, Lender is permitted to charge on the obligation hereunder shall change after the date hereof, the Highest Lawful Rate shall be automatically increased or decreased, as the case may be, from time to time as of the effective time of each change in the Highest Lawful Rate without notice to Borrower. For purposes of determining the Highest Lawful Rate under the Applicable Law of the State of Texas, the applicable rate ceiling shall be (i) the indicated rate ceiling described in and computed in accordance with the provisions of Section (a)(1) of Article 1.04, Title 79, Revised Civil Statues of Texas 1925, as amended, or (ii) if the parties subsequently contract as allowed by Applicable Law, the quarterly 2 ceiling or the annualized ceiling computed pursuant to Section (d) of said Article 1.04; provided, however, that if at any time the indicated rate ceiling, the quarterly ceiling or the annualized ceiling, as applicable, shall be less than 18% per annum or more than 24% per annum, the provisions of Sections (b)(1) and (2) of said Article 1.04 shall control for purposes of such determination, as applicable. Notwithstanding the foregoing and all other provisions of this Note and any documents and instruments executed in connection with this Note, in no event shall the interest payable hereon, whether before or after maturity, exceed the Highest Lawful Rate of interest which, under Applicable Law, Lender is permitted to charge to Borrower. All agreements between Borrower and Lender, or any subsequent holder of this Note, whether now existing or hereafter arising and whether written or oral, are expressly limited so that in no contingency or event whatsoever, whether by reason of acceleration of the maturity of this Note or otherwise, shall the amount paid or agreed to be paid to the holder of this Note for the use, forbearance, or detention of the funds advanced pursuant to this Note or for the performance or payment of any covenant or obligation contained herein or in any other document evidencing, securing or pertaining to this Note, exceed the maximum amount permissible under Applicable Law. If from any circumstance whatsoever fulfillment of any provision hereof or of any such other document, at the time performance of such provision shall be due, shall involve transcending the limit of validity prescribed by Applicable Law, then ipso facto, the obligation to be fulfilled shall be reduced to the limit of such validity, and if from any circumstance the holder hereof shall ever receive anything of value deemed excess interest by Applicable Law, an amount equal to any such excess interest shall be applied to the reduction of the principal amount owing under this Note, and not to the payment of interest, or if such excess interest exceeds the unpaid principal balance of this Note, such excess interest shall be refunded to Borrower. All sums paid or agreed to be paid to any holder of this Note for the use, forbearance or detention of any funds advanced pursuant to this Note shall, to the extent permitted by Applicable Law, be amortized, prorated, allocated and spread throughout the full term of this Note until payment in full so that the rate of interest on account of the indebtedness evidenced by this Note is uniform throughout the term hereof. The terms and provisions of this paragraph shall control and supersede every other provision of all agreements between Borrower and any holder of this Note. This Note is issued pursuant to the Third Amended and Restated Credit Agreement between Borrower and Lender dated as of March 3, 1997 (such agreement, together with all amendments and restatements, the "Credit Agreement"), to which reference is made for a statement of the rights and obligations of Lender and the duties and obligations of Borrower in relation thereto; but neither this reference to the Credit Agreement nor any provision thereof shall affect or impair the absolute and unconditional obligation of Borrower to pay unpaid principal of and interest on this Note when due. The Credit Agreement among other things, contains provisions for acceleration of the maturity hereof upon the happening of certain stated events and also for prepayments on account of principal hereof prior to the maturity hereof upon the terms and conditions therein specified. If a breach of or default under the Credit Agreement or any other Loan Paper (as defined in the Credit Agreement) shall occur, unpaid principal of and -2- 3 interest on this Note may be declared due and payable without notice, at the option of the holder of this Note, in the manner and with the effect provided thereunder. Failure to exercise this option shall not constitute a waiver of the right to exercise the same in the event of any subsequent default or event of default. This Note is a renewal and restatement of the promissory note (Facility A Note) dated February 9, 1996 made by Borrower and payable to the order of Lender in the principal amount of $5,000,000.00, and is not a novation or impairment of such note. If this Note is placed in the hands of an attorney for collection after default, or if all or any part of the indebtedness represented hereby is proved, established or collected in any court or in any bankruptcy, receivership, debtor relief, probate or other court proceedings, Borrower and all endorsers, sureties and guarantors of this Note jointly and severally agree to pay reasonable attorneys' fees and collection costs to the holder hereof in addition to the principal and interest payable hereunder. Borrower and all endorsers, sureties and guarantors of this Note hereby severally waive demand, presentment for payment, protest, notice of protest, notice of acceleration of and notice of intention to accelerate the maturity of this Note, diligence in collecting, the bringing of any suit against any party and any notice of or defense on account of any extensions, renewals, partial payments or changes in any manner of or in this Note or in any of its terms, provisions and covenants, or any releases or substitutions of any security, or any delay, indulgence or other act of any trustee or any holder hereof, whether before or after maturity. THIS NOTE AND THE RIGHTS AND DUTIES OF THE PARTIES HEREUNDER SHALL BE GOVERNED BY THE LAWS OF THE STATE OF TEXAS, EXCEPT TO THE EXTENT THE SAME ARE GOVERNED BY THE FEDERAL LAWS OF THE UNITED STATES OF AMERICA APPLICABLE TO NATIONAL BANKS. THE BOOKS AND RECORDS OF LENDER SHALL CONSTITUTE PRIMA FACIE EVIDENCE OF ALL SUMS DUE LENDER HEREUNDER. ========================================== REMAINDER OF PAGE INTENTIONALLY LEFT BLANK ========================================== -3- 4 QUEST MEDICAL, INC. By: /s/ F. ROBERT MERRILL III ------------------------------------ F. Robert Merrill III, Vice President -4- 5 N O T I C E O F F I N A L A G R E E M E N T THIS NOTE AND THE OTHER WRITTEN LOAN PAPERS EXECUTED CONTEMPORANEOUSLY WITH THIS NOTE REPRESENT THE FINAL AGREEMENT BETWEEN THE PARTIES AND MAY NOT BE CONTRADICTED BY EVIDENCE OF PRIOR, CONTEMPORANEOUS, OR SUBSEQUENT ORAL AGREEMENTS OF THE PARTIES. THERE ARE NO UNWRITTEN ORAL AGREEMENTS BETWEEN THE PARTIES. BORROWER REPRESENTS THAT IT TODAY RECEIVED A COPY OF THIS NOTICE. Borrower Lender QUEST MEDICAL, INC. NATIONSBANK OF TEXAS, N.A. By: /s/ F. ROBERT MERRILL III By: /s/ BRIAN K. SCHNEIDER ------------------------------------ ----------------------------------- F. Robert Merrill III, Vice President Brian K. Schneider, Vice President -5- EX-10.17 4 PROMISSORY NOTE (FACILITY B NOTE) 1 EXHIBIT 10.17 PROMISSORY NOTE (Facility B Advance Note) $350,000.00 Dallas, Texas March 3, 1997 QUEST MEDICAL, INC., a Texas corporation, with its principal office located at One Allentown Parkway, Allen, Texas 75002 ("Borrower"), for value received, promises to pay to the order of NATIONSBANK OF TEXAS, N.A. ("Lender"), at its Dallas Banking Center at 901 Main Street, Dallas, Texas 75202, in immediately available funds and in lawful money of the United States of America, the principal sum of Three Hundred and Fifty Thousand and 00/100 Dollars ($350,000.00), or such lesser sum as shall be due and payable from time to time hereunder, on January 31, 1998, or sooner, as provided in the Credit Agreement referred to below. Borrower promises to pay interest on the unpaid principal amount of the Facility B Advances (as defined in the Credit Agreement) from the date made until such principal amount is paid in full, at such interest rates, and payable at such times, as are specified in the Credit Agreement. For the purposes of this Note, the following terms have the respective meanings assigned to them below: "Applicable Law" means the laws of the United States of America applicable to contracts made or performed in the State of Texas, including, without limitation, 12 USC 86, as amended to the date hereof and as the same may be amended at any time and from time to time hereafter and any other statute of the United States of America now or at any time hereafter prescribing maximum rates of interest on loans and extensions of credit, and the laws of the State of Texas, including, without limitation, Article 1.04, Title 79, Revised Civil Statutes of Texas, 1925, as the same may be amended at any time and from time to time hereafter ("Article 1.04") and any other statute of the State of Texas now or at any time hereafter prescribing maximum rates of interest on loans and extensions of credit provided that pursuant to Article 5069-15.10(b), Title 79, Revised Civil Statues, 1925, as amended, Borrower agrees that the provisions of Chapter 15, Title 79, Revised Civil Statutes of Texas, 1925, as amended, shall not apply to this Note. "Highest Lawful Rate" means at the particular time in question the maximum rate of interest which, under Applicable Law, Lender is then permitted to charge on the obligation hereunder. If the maximum rate of interest which, under Applicable Law, Lender is permitted to charge on the obligation hereunder shall change after the date hereof, the Highest Lawful Rate shall be automatically increased or decreased, as the case may be, from time to time as of the effective time of each change in the Highest Lawful Rate without notice to Borrower. For purposes of determining the Highest Lawful Rate under the Applicable Law of the State of Texas, the applicable rate ceiling shall be (i) the indicated rate ceiling described in and computed in accordance with the provisions of Section (a)(1) of Article 1.04, Title 79, Revised Civil Statues of Texas 1925, as amended, 2 or (ii) if the parties subsequently contract as allowed by Applicable Law, the quarterly ceiling or the annualized ceiling computed pursuant to Section (d) of said Article 1.04; provided, however, that if at any time the indicated rate ceiling, the quarterly ceiling or the annualized ceiling, as applicable, shall be less than 18% per annum or more than 24% per annum, the provisions of Sections (b)(1) and (2) of said Article 1.04 shall control for purposes of such determination, as applicable. Notwithstanding the foregoing and all other provisions of this Note and any documents and instruments executed in connection with this Note, in no event shall the interest payable hereon, whether before or after maturity, exceed the Highest Lawful Rate of interest which, under Applicable Law, Lender is permitted to charge to Borrower. All agreements between Borrower and Lender, or any subsequent holder of this Note, whether now existing or hereafter arising and whether written or oral, are expressly limited so that in no contingency or event whatsoever, whether by reason of acceleration of the maturity of this Note or otherwise, shall the amount paid or agreed to be paid to the holder of this Note for the use, forbearance, or detention of the funds advanced pursuant to this Note or for the performance or payment of any covenant or obligation contained herein or in any other document evidencing, securing or pertaining to this Note, exceed the maximum amount permissible under Applicable Law. If from any circumstance whatsoever fulfillment of any provision hereof or of any such other document, at the time performance of such provision shall be due, shall involve transcending the limit of validity prescribed by Applicable Law, then ipso facto, the obligation to be fulfilled shall be reduced to the limit of such validity, and if from any circumstance the holder hereof shall ever receive anything of value deemed excess interest by Applicable Law, an amount equal to any such excess interest shall be applied to the reduction of the principal amount owing under this Note, and not to the payment of interest, or if such excess interest exceeds the unpaid principal balance of this Note, such excess interest shall be refunded to Borrower. All sums paid or agreed to be paid to any holder of this Note for the use, forbearance or detention of any funds advanced pursuant to this Note shall, to the extent permitted by Applicable Law, be amortized, prorated, allocated and spread throughout the full term of this Note until payment in full so that the rate of interest on account of the indebtedness evidenced by this Note is uniform throughout the term hereof. The terms and provisions of this paragraph shall control and supersede every other provision of all agreements between Borrower and any holder of this Note. This Note is issued pursuant to the Second Amended and Restated Credit Agreement between Borrower and Lender dated as of March 3, 1997 (such agreement, together with all amendments and restatements, the "Credit Agreement"), to which reference is made for a statement of the rights and obligations of Lender and the duties and obligations of Borrower in relation thereto; but neither this reference to the Credit Agreement nor any provision thereof shall affect or impair the absolute and unconditional obligation of Borrower to pay unpaid principal of and interest on this Note when due. The Credit Agreement among other things, contains provisions for acceleration of the maturity hereof upon the happening of certain stated events and also for prepayments on account of principal hereof prior to the maturity hereof upon the terms and conditions therein specified. If a breach of or default under the Credit Agreement or any -2- 3 other Loan Paper (as defined in the Credit Agreement) shall occur, unpaid principal of and interest on this Note may be declared due and payable without notice, at the option of the holder of this Note, in the manner and with the effect provided thereunder. Failure to exercise this option shall not constitute a waiver of the right to exercise the same in the event of any subsequent default or event of default. This Note is a renewal and restatement of the promissory note (Facility B Note) dated February 9, 1996 made by Borrower and payable to the order of Lender in the principal amount of $15,000,000.00, and is not a novation or impairment of such note. If this Note is placed in the hands of an attorney for collection after default, or if all or any part of the indebtedness represented hereby is proved, established or collected in any court or in any bankruptcy, receivership, debtor relief, probate or other court proceedings, Borrower and all endorsers, sureties and guarantors of this Note jointly and severally agree to pay reasonable attorneys' fees and collection costs to the holder hereof in addition to the principal and interest payable hereunder. Borrower and all endorsers, sureties and guarantors of this Note hereby severally waive demand, presentment for payment, protest, notice of protest, notice of acceleration of and notice of intention to accelerate the maturity of this Note, diligence in collecting, the bringing of any suit against any party and any notice of or defense on account of any extensions, renewals, partial payments or changes in any manner of or in this Note or in any of its terms, provisions and covenants, or any releases or substitutions of any security, or any delay, indulgence or other act of any trustee or any holder hereof, whether before or after maturity. THIS NOTE AND THE RIGHTS AND DUTIES OF THE PARTIES HEREUNDER SHALL BE GOVERNED BY THE LAWS OF THE STATE OF TEXAS, EXCEPT TO THE EXTENT THE SAME ARE GOVERNED BY THE FEDERAL LAWS OF THE UNITED STATES OF AMERICA APPLICABLE TO NATIONAL BANKS. THE BOOKS AND RECORDS OF LENDER SHALL CONSTITUTE PRIMA FACIE EVIDENCE OF ALL SUMS DUE LENDER HEREUNDER. ========================================== REMAINDER OF PAGE INTENTIONALLY LEFT BLANK ========================================== -3- 4 QUEST MEDICAL, INC. By: /s/ F. ROBERT MERRILL III ------------------------------------ F. Robert Merrill III, Vice President -4- 5 N O T I C E O F F I N A L A G R E E M E N T THIS NOTE AND THE OTHER WRITTEN LOAN PAPERS EXECUTED CONTEMPORANEOUSLY WITH THIS NOTE REPRESENT THE FINAL AGREEMENT BETWEEN THE PARTIES AND MAY NOT BE CONTRADICTED BY EVIDENCE OF PRIOR, CONTEMPORANEOUS, OR SUBSEQUENT ORAL AGREEMENTS OF THE PARTIES. THERE ARE NO UNWRITTEN ORAL AGREEMENTS BETWEEN THE PARTIES. BORROWER REPRESENTS THAT IT TODAY RECEIVED A COPY OF THIS NOTICE. Borrower Lender QUEST MEDICAL, INC. NATIONSBANK OF TEXAS, N.A. By: /s/ F. ROBERT MERRILL III By: /s/ BRIAN K. SCHNEIDER --------------------------- ----------------------------- F. Robert Merrill III, Brian K. Schneider, Vice President Senior Vice President -5- EX-10.18 5 1ST AMENDED & RESTATED SECURITY AGREEMENT 1 EXHIBIT 10.18 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- FIRST AMENDED AND RESTATED SECURITY AGREEMENT dated as of March 3, 1997 Between QUEST MEDICAL, INC. as Debtor and NATIONSBANK OF TEXAS, N.A. as Secured Party - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- 2 TABLE OF CONTENTS Page ---- ARTICLE I. GRANT 1.1 Assignment and Grant of Security ............... 2 1.2 Description of Obligations ..................... 5 1.3 Debtor Remains Liable .......................... 6 1.4 Delivery of Security Collateral ................ 6 ARTICLE II. REPRESENTATIONS AND WARRANTIES 2.1 Representations and Warranties ................. 6 ARTICLE III. COVENANTS 3.1 Further Assurances ............................. 8 3.2 Equipment, Fixtures and Inventory .............. 10 3.3 Insurance ...................................... 11 3.4 Place of Perfection; Records; Collection of Receivables, Chattel Paper and Instruments ..... 11 3.5 Transfers and Other Liens ...................... 12 3.6 Brokerage Agreements ........................... 13 3.7 Rights to Dividends and Distributions .......... 14 3.8 Right of Secured Party to Notify Issuers ....... 14 3.9 Secured Party Appointed Attorney-in-Fact ....... 14 ARTICLE IV. RIGHTS AND POWERS OF SECURED PARTY 4.1 Secured Party May Perform ...................... 15 4.2 Secured Party's Duties ......................... 15 4.3 Remedies ....................................... 16 4.4 Further Approvals Required ..................... 17 4.5 INDEMNITY AND EXPENSES ......................... 18 ARTICLE V. MISCELLANEOUS 5.1 Cumulative Rights .............................. 18 5.2 Modifications; Amendments; Schedules; Etc ...... 18 5.3 Continuing Security Interest ................... 19 5.4 MANDATORY ARBITRATION .......................... 19 5.5 GOVERNING LAW; TERMS ........................... 20 5.6 WAIVER OF JURY TRIAL ........................... 20 5.7 Secured Party's Right to Use Agents ............ 20
i 3 ............................................ 5.8 No Interference, Compensation or Expense ....... 20 5.9 Waivers of Rights Inhibiting Enforcement ....... 20 5.10 Notices and Deliveries ......................... 21 (a) Manner of Delivery........................ 21 (b) Addresses ................................ 21 (c) Effectiveness ............................ 22 5.11 Successors and Assigns ......................... 22 5.12 Loan Paper ..................................... 22 5.13 Definitions .................................... 22 5.14 Severability ................................... 23 5.15 Obligations Not Affected ....................... 23 5.16 Prior Security Agreements ...................... 23 5.17 Counterparts ................................... 23 5.18 ENTIRE AGREEMENT ............................... 23
ii 4 SCHEDULES: Schedule 1 - Inventory Locations Schedule 2 - Required Consents Schedule 3 - Bank Accounts Schedule 4 - Insurance Schedule 5 - Vendor Agreements Schedule 6 - Excluded Equipment and Furnishings Schedule 7 - Brokerage Agreements Schedule 8 - Filing Locations Schedule 9 - Permits
iii 5 FIRST AMENDED AND RESTATED SECURITY AGREEMENT FIRST AMENDED AND RESTATED SECURITY AGREEMENT, dated as of March 3, 1997 (this "Agreement"), made by Quest Medical, Inc., a Texas corporation ("Debtor"), in favor of NationsBank of Texas, N.A., a national banking association ("Secured Party"). BACKGROUND. (1) Secured Party and Debtor have entered into the Credit Agreement dated as of October 22, 1993 (as amended, the "Original Credit Agreement"), the Security Agreement dated May 28, 1993 ("Facility A Security Agreement") as amended and restated from time to time, the Security Agreement dated as of October 22, 1993 ("Existing Security Agreement") as amended and restated from time to time and related agreements. (2) Secured Party and Debtor have entered into the First Amended and Restated Credit Agreement dated as of March 31, 1995 (such agreement, together with all amendments and restatements thereof, the "1995 Credit Agreement") which restates in its entirety the Original Credit Agreement. (3) Secured Party and Debtor have entered into the Second Amended and Restated Credit Agreement dated as of February 9, 1996 (such agreement, together with all amendments and restatements thereof, the "Existing Credit Agreement") which restates in its entirety the 1995 Credit Agreement. (4) Secured Party and Debtor have entered into the Third Amended and Restated Credit Agreement dated as of March 3, 1997 (such agreement, together with all amendments and restatements thereof, the "Credit Agreement") which restates in its entirety the Existing Credit Agreement. (5) It is the intention of the parties hereto that this Agreement create a first priority security interest securing the payment of the obligations set forth in Section 1.2. (6) It is a condition precedent to the effectiveness of the Credit Agreement that Debtor shall have executed and delivered this Security Agreement. AGREEMENT. NOW, THEREFORE, in consideration of the premises set forth herein and for other good and valuable consideration, the receipt and sufficiency of which is hereby acknowledged, and in order to induce Secured Party to make the Advances under the Credit Agreement, Debtor hereby agrees with Secured Party as follows: 6 ARTICLE I. GRANT 1.1 Assignment and Grant of Security. Subject to the last paragraph of this Section 1.1, Debtor hereby assigns and pledges to Secured Party and hereby grants to Secured Party a security interest in, the entire right, title and interest of Debtor, in and to the following assets of Debtor, whether now owned or hereafter acquired ("Collateral"): (a) all inventory in all of its forms, wherever located, now or hereafter existing, including, but not limited to, (i) all raw materials and work in process therefor, finished goods thereof, and materials used or consumed in the manufacture or production thereof, (ii) goods in which Debtor has an interest in mass or a joint or other interest or right of any kind (including, without limitation, goods in which Debtor has an interest or right as consignee), and (iii) goods which are returned to or repossessed by Debtor, and all accessions thereto and products thereof and documents therefor (any and all such inventory, accessions, products and documents being the "Inventory"); (b) other than equipment described in the last paragraph of this Section 1.1, all equipment (as defined in the Uniform Commercial Code) and (whether or not included in such definition), all vehicles, machinery, chattels, tools, parts, furniture, furnishings and supplies, of every nature, wherever located, all additions, accessories and improvements thereto and substitutions therefor and all accessories, parts and equipment which may be attached to or which are necessary for the operation and use of such personal property, together with all accessions thereto, and all rights under or arising out of present or future contracts relating to the foregoing ("Equipment"); (c) all property so related to particular real estate that an interest in it arises under the real estate law of the jurisdiction in which such Collateral is located, including all equipment, fixtures and articles of personal property now or hereafter attached to or used in or about any building or buildings now erected or hereafter to be erected on any real property now or hereafter owned or leased by Debtor (the "Property"), which are necessary to the complete and comfortable use and occupancy of such building or buildings for the purposes for which they were or are to be erected; all materials to be delivered to the Property and used or to be used in connection with the construction of any building to be constructed on the Property, including, but not limited to, all masonry, siding, roof shingles, flooring, doors, windows, tile, shutters, stoves, ovens, awnings, screens, cabinets, shades, blinds, carpets, draperies, furniture, furnishings, plumbing, heating, air conditioning, lighting, ventilating, refrigerating, cooking, laundry and incinerating equipment and all fixtures and appurtenances thereto, and such other goods and chattels and personal property as are ever used or furnished in operating such buildings or the activities conducted therein, and all building materials and equipment now or hereafter delivered to the Property and intended to be installed thereon ("Fixtures"); 2 7 (d) all general intangibles (as defined in the Uniform Commercial Code), and (whether or not included in such definition) all contract rights other than Receivables; all inventions, processes, production methods, proprietary information and know-how; and all licenses or other agreements granted to Debtor with respect to any of the foregoing; all information, customer lists, advertising lists, advertising contracts, identification of suppliers, data, plans, blueprints, specifications, designs, drawings, recorded knowledge, surveys, engineering reports, test reports, manuals, materials standards, processing standards, performance standards, telephone numbers and telephone listings, catalogs, books, records, computer and automatic machinery software and programs, and the like pertaining to operations by or the business of Debtor; all field accounting information and all media in which or on which any of the information or knowledge or data or records may be recorded or stored and all computer programs used for the compilation or printout of such information, knowledge, records or data; all licenses, consents, permits, variances, certifications and approvals of all Tribunals now or hereafter held by Debtor pertaining to operations or business now or hereafter conducted; all rights to receive return of deposits and trust payments; all rights to payment under letters of credit and similar agreements; all tax refunds (including, without limitation, all federal and state income tax refunds and benefits of net operating loss carry forwards); and all causes of action, rights, claims and warranties now or hereafter owned or acquired by Debtor ("General Intangibles"); (e) all of the following, to the extent that not included in "General Intangibles": trade secrets, all know-how, inventions, processes, methods, information, data, plans, blueprints, specifications, designs, drawings, engineering reports, test reports, materials standards, processing standards and performance standards, and all computer and automatic machinery software and programs directly related thereto, and all licenses or other agreements to which Debtor is a party with respect to any of the foregoing ("Trade Secrets"); (f) all instruments and letters of credit (each as defined in the Uniform Commercial Code), and (whether or not included in such definitions) all promissory notes, drafts, bills of exchange and trade acceptances ("Instruments"); (g) all writings which evidence both a monetary obligation and a security interest in or a lease of specific goods ("Chattel Paper"); (h) all documents, warehouse receipts, bills of lading, including, without limitation, documents of title (as defined in the Uniform Commercial Code) or other receipts covering, evidencing or representing any property described in this Section 1.1 ("Documents"); (i) all accounts, contract rights, Chattel Paper, Documents, Instruments, deposit accounts, General Intangibles, tax refunds and other obligations of any kind owing to Debtor, now or hereafter existing, arising out of or in connection with the sale or lease of goods or the 3 8 rendering of services, and all rights now or hereafter existing in and to all security agreements, leases, and other contracts securing or otherwise relating to any such accounts, contract rights, Chattel Paper, Documents, Instruments, deposit accounts, General Intangibles, tax refunds or obligations (any and all such accounts, contract rights, Chattel Paper, Documents, Instruments, deposit accounts, General Intangibles, tax refunds and obligations being the "Receivables"); (j) all licenses, permits and other similar rights now or hereafter owned by Debtor (including but not limited to all licenses, permits and similar rights issued by the FDA) and necessary to the operation of its business, including but not limited to all licenses, permits and other rights listed on Schedule 9; (k) all agreements and accounts of Debtor described on Schedule 7, all interest in any security subject to such agreement or account (including but not limited to all interest in any equity or debt security, option, warrant, put, call, futures agreements, commodity agreements, margin accounts, short positions and partnership interests), all property subject to or maintained in each such account or pursuant to such agreement, each deposit account (time, demand or other) in which any proceeds of or income from the foregoing may be on deposit, all cash maintained with each Person pursuant to any such agreement or account, all general intangibles consisting of the foregoing and each agreement, document or Instrument governing or evidencing any of the foregoing and all amendments and restatements thereof, and all claims of Debtor against any Person with respect to any of the foregoing (all of the foregoing being herein collectively called the "Brokerage Agreements"); (l) all rights, claims and benefits of Debtor against any Person arising out of, relating to or in connection with any property described in this Section 1.1 purchased by Debtor, including, without limitation, any such rights, claims or benefits against any Person storing or transporting any property described in this Section 1.1; (m) the balance of every deposit account of Debtor under control of Secured Party and each of its Affiliates and any other claim of Debtor against Secured Party, now or hereafter existing, liquidated or unliquidated, and all money, Instruments, securities, Documents, Chattel Paper, credits, claims, demands, income, and any other property, rights and interests of Debtor which at any time shall come into the possession or custody or under the control of Secured Party or any of its agents, affiliates or correspondents, for any purpose, and the proceeds of any thereof (Secured Party shall be deemed to have possession of any of the Collateral in transit to or set apart for it or any of its agents, affiliates or correspondents. The holder of any participation in the Obligations shall have a right of setoff with respect to any obligation of such holder to Debtor to satisfy the Obligations); (n) all Acquisition Documents; 4 9 (o) all agreements with vendors and other distributors of Inventory, including but not limited to those described in Schedule 5; (p) all insurance policies and bonds and claims and payments thereunder; (q) all property similar to the above hereafter acquired by Debtor; and (r) all accessions to, substitutions for and replacements, proceeds and products of any and all of the foregoing Collateral (including, without limitation, proceeds which constitute property of the types described in this Section 1.1) and, to the extent not otherwise included, all (i) payments under insurance (whether or not Secured Party is the loss payee thereof), or any indemnity, warranty or guaranty, payable by reason of loss or damage to or otherwise with respect to any of the foregoing Collateral and (ii) cash. Nothing in this Section 1.1 or otherwise in any Loan Paper is intended as a grant of a security interest in any of the following property of Debtor: (i) heating, ventilation or air conditioning systems now or hereafter located on the Allen Property, (ii) the furniture and equipment described on Schedule 6, whether now owned or hereafter acquired, and all accessions to, substitutions for and replacements, proceeds and products of such office furniture and equipment, and (iii) the computer systems described on Schedule 6, whether now owned or hereafter acquired, and all accessions to, substitutions for and replacements, proceeds and products of such computer systems. The assets described in clauses (i) through (iii) of this paragraph shall not constitute Collateral for purposes of this Agreement. Secured Party agrees that, upon request of Debtor, it will execute and deliver to Debtor and MetLife Capital Corporation or its affiliates (collectively, "MetLife") any documents reasonably requested by Debtor or MetLife to evidence that Secured Party does not have a security interest in the assets described in clauses (i) through (iii) of this paragraph. 1.2 Description of Obligations. This Agreement creates a first priority security interest securing the payment and performance of the Obligations, including, but not limited to any and all obligations now or hereafter existing of Debtor and each other Obligor under the Credit Agreement and other Loan Papers, including any extensions, modifications, substitutions, amendments and renewals thereof, whether for principal, interest, fees, premium, expenses, indemnification or otherwise (all such obligations of Debtor and each other Obligor being the "Obligations"). Without limiting the generality of the foregoing, this Agreement secures the 5 10 payment of all amounts which constitute part of the Obligations and would be owed by Debtor and each other Obligor to Secured Party under any Loan Paper, but for the fact that they are unenforceable or not allowable due to the existence of a bankruptcy, reorganization or similar proceeding involving Debtor or any other Person (including all after, or that would have secured but for, the filing of any petition in bankruptcy, or the commencement of any insolvency, reorganization or like proceeding of Debtor or any other Obligor). 1.3 Debtor Remains Liable. Anything herein to the contrary notwithstanding, (a) Debtor shall remain liable under the contracts and agreements included in the Collateral to the extent set forth therein to perform all of its duties and obligations thereunder to the same extent as if this Agreement had not been executed, (b) the exercise by Secured Party of any of the Rights hereunder shall not release Debtor from any of its duties or obligations under the contracts and agreements included in the Collateral, and (c) Secured Party shall not have any obligation or liability under the contracts and agreements included in the Collateral by reason of this Agreement, nor shall Secured Party be obligated to perform any of the obligations or duties of Debtor thereunder or to take any action to collect or enforce any claim for payment assigned hereunder. 1.4 Delivery of Security Collateral. All certificates or instruments representing or evidencing the Collateral and which are issued in the name of Debtor shall be delivered to and held by or on behalf of Secured Party pursuant hereto and shall be in suitable form for transfer by delivery, or shall be accompanied by duly executed instruments of transfer or assignment in blank, all in form and substance satisfactory to Secured Party. If an Event of Default exists, Secured Party shall have the right, at any time during such time in its discretion and without notice to Debtor, to (a) require the issuance in the name of Debtor and delivery to Secured Party of certificates or instruments evidencing the interest owned by Debtor in the issuer of such certificate or instrument (if the security is subject to a Brokerage Agreement and the Brokerage Agreement permits such issuance) and (b) transfer to or to register in the name of Secured Party or any of its nominees any or all of the Collateral. In addition, Secured Party shall have the right at any time to exchange certificates or instruments representing or evidencing Collateral for certificates or instruments of smaller or larger denominations. ARTICLE II. REPRESENTATIONS AND WARRANTIES 2.1 Representations and Warranties. Debtor represents and warrants, with respect to itself and the Collateral, as follows: (a) All of the Equipment, Fixtures and Inventory pledged by Debtor hereunder is located at the places specified on Schedule 1 hereto (as supplemented from time to time by Debtor by written notice to Secured Party) or Inventory in transit to a place specified on Schedule 1 hereto (as supplemented from time to time by Debtor by written notice to Secured 6 11 Party) or Inventory in transit (i) for sale to a third-party purchaser that upon such sale will become the obligor under a Receivable and (ii) pursuant to a sale in the ordinary course of Debtor's business. The chief place of business and chief executive office of Debtor and the office where Debtor keeps all of its records concerning the Receivables, are located at One Allentown Parkway, Allen, Texas 75002. All Chattel Paper, promissory notes or other instruments evidencing the Receivables have been delivered and pledged to Secured Party duly endorsed and accompanied by such duly executed instruments of transfer or assignment as are necessary for such pledge, to be held as pledged collateral. Debtor has possession and control of the Equipment and Inventory pledged by it hereunder. The record owner of the real estate upon which the Equipment, Fixtures and Inventory are located are indicated on Schedule 1. (b) Debtor is the legal and beneficial owner of the Collateral pledged by it free and clear of any Lien, security interest, option or other charge or encumbrance except for the security interest created by this Agreement and Permitted Liens. No effective financing statement or other similar document used to perfect and preserve a security interest under the Laws of any jurisdiction covering all or any part of the Collateral is on file in any recording office, except (i) such as may have been filed in favor of Secured Party relating to this Agreement and (ii) financing statements for which Debtor will provide to Secured Party on the Closing Date proper original executed termination statements. As of the date hereof, Debtor (including any corporate or partnership predecessor) has no trade names and has not existed or operated under any name other than "Quest Medical, Inc.," since March 3, 1987. (c) This Agreement and the pledge of the Collateral pursuant hereto creates a valid and, upon filing of financing statements in the Uniform Commercial Code records described on Schedule 8, perfected first priority security interest in the Collateral (other than deposit accounts in financial institutions which are not Secured Party or subject to a Broker Agreement), securing the payment of the Obligations, and all filings and other actions necessary or desirable to perfect and protect such security interest and such priority have been duly taken (or will be taken). (d) Except as described on Schedule 2, no consent of any other Person and no authorization, approval or other action by, and no notice to or filing with, any Tribunal is required (i) for the pledge by Debtor of the Collateral pledged by it hereunder, for the grant by Debtor of the security interest granted hereby or for the execution, delivery or performance of this Agreement by Debtor, (ii) for the perfection or maintenance of the pledge, assignment and security interest created hereby (including the first priority nature of such pledge, assignment and security interest) or (iii) for the exercise by Secured Party of the Rights provided for in this Agreement or the remedies in respect of the Collateral pursuant to this Agreement. (e) Schedule 3 is a complete and correct list of all deposit accounts (demand, time, special or other) maintained by or in which Debtor has an interest and correctly describes the financial institution in which such account is maintained (including the specific branch), the address and ABA number of such institution, the officer of such institution having primary 7 12 responsibility for Debtor's accounts, the account number and type (as supplemented from time to time by Debtor by written notice to Secured Party). (f) Debtor possesses all licenses and Permits, including but not limited to all applicable certificates of occupancy, licenses and Permits, and all health and sanitation permits, required for the operations of its business. Schedule 9 is a complete and correct description of all of such licenses and Permits. (g) Schedule 4 is a complete and correct list of all insurance policies for which Debtor is an insured or for which Debtor is a loss payee. (h) Schedule 5 is a complete and correct list of all agreements with each Person related to the resale and distribution of Inventory for each Person who, during the preceding fiscal year, sold or distributed $25,000 or more of Debtor's Inventory. (i) All Inventory of Debtor produced by Debtor in the United States of America has been produced in compliance with the Fair Labor Standards Act. (j) Debtor's federal taxpayer identification number is 75-1646002. (k) There are no conditions precedent to the effectiveness of this Agreement that have not been satisfied or waived. ARTICLE III. COVENANTS 3.1 Further Assurances. (a) Debtor agrees that, where any agreement intended to be Collateral existing as of the date hereof or hereafter to which Debtor is a party contains any restriction prohibiting Debtor from granting any security interest under this Agreement, Debtor will use its best efforts to obtain the necessary consent to or waiver of such restriction from any Person so as to enable Debtor to effectively grant to Secured Party such security interest under this Agreement. (b) Debtor agrees that from time to time, at the expense of Debtor, Debtor will promptly execute and deliver all further instruments and documents, and take all further action, that may be reasonably necessary or desirable, or that Secured Party may reasonably request, in order to perfect and protect any pledge, assignment or security interest granted or purported to be granted hereby, and the priority thereof, or to enable Secured Party to exercise and enforce its rights and remedies hereunder with respect to any Collateral. Without limiting the generality of the foregoing, upon written request by Secured Party, Debtor will: (i) mark conspicuously each Chattel Paper included in Receivables, and, at the request of Secured Party, each of its records pertaining to the Collateral with the following legend: 8 13 THIS INSTRUMENT IS SUBJECT TO A SECURITY INTEREST AND LIEN PURSUANT TO A FIRST AMENDED AND RESTATED SECURITY AGREEMENT DATED MARCH 3, 1997 (AS THE SAME MAY BE MODIFIED OR RESTATED) MADE BY QUEST MEDICAL, INC., IN FAVOR OF NATIONSBANK OF TEXAS, N.A. or such other legend, in form and substance satisfactory to and as specified by Secured Party, indicating that such Chattel Paper or Collateral is subject to the pledge, assignment and security interest granted hereby; (ii) if any Collateral shall be evidenced by a promissory note or other Instrument or be Chattel Paper, deliver and pledge to Secured Party hereunder such note, Instrument or Chattel Paper duly indorsed and accompanied by duly executed instruments of transfer or assignment, all in form and substance satisfactory to Secured Party; and (iii) execute and file such financing or continuation statements, or amendments thereto, and such other instruments or notices, as may be necessary or desirable, or as Secured Party may request, in order to perfect and preserve the pledge, assignment and security interest granted (and the priority thereof) or purported to be granted hereby. (c) Debtor hereby authorizes Secured Party to file one or more financing or continuation statements, and amendments thereto, relating to all or any part of the Collateral without the signature of Debtor where permitted by Law. A photocopy or other reproduction of this Agreement or any financing statement covering the Collateral or any part thereof shall be sufficient as a financing statement where permitted by Law. (d) Debtor will furnish to Secured Party from time to time statements and schedules further identifying and describing the Collateral (including information in connection with the protection, preservation, maintenance or enforcement of the security interest) and such other reports in connection with the Collateral as Secured Party may reasonably request, all in reasonable detail; provided, if no Default or Event of Default exists, Secured Party will not make more than one request in any six month period. (e) Debtor shall not establish or maintain any deposit or similar bank account not listed on Schedule 3 unless Secured Party receives prior written notice thereof, Debtor executes and delivers to Secured Party assignments of such account in such form as Secured Party may request and the financial institution in which such account will be maintained delivers to Secured Party acknowledgments of the assignment of such account in form and substance satisfactory to Secured Party. (f) In addition to such other information as shall be specifically provided for herein, Debtor shall, if a Default or an Event of Default exists, furnish to Secured Party such other information with respect to the Collateral as Secured Party may reasonably request from time to time in connection with the Collateral, including, without limitation, all documents and things in 9 14 Debtor's possession, or subject to its demand for possession, related to the production and sale by Debtor, or any subsidiary, licensee or subcontractor thereof, of products or services sold by or under the authority of Debtor, including by way of example, without limiting the interest granted by this Agreement: (i) all lists and ancillary documents which identify and describe any of Debtor's customers, advertisers, or those of its Subsidiaries or licensees, for products sold or services rendered, including without limitation, such existing lists and ancillary documents which contain each customer's full name and address, the identity of the Person or Persons having the principal responsibility on each customer's behalf for ordering products or services of the kind supplied by Debtor, the credit, payment, discount, delivery and other sale terms applicable to such customer, together with detailed information setting forth the total purchases and the patterns of such purchases; (ii) all product and service specification documents and production and quality of services sold; (iii) all documents which reveal the names and addresses of all sources of supply, and all terms of purchase and delivery, for all materials and components used in the production of products or provision of services sold; and (iv) all documents constituting or concerning the then current or proposed advertising and promotion by Debtor or its subsidiaries, licensees or subcontractors of products or services sold, including, by way of example and not in limitation, all documents which reveal the media used or to be used and the cost for all such advertising conducted within the described period or planned for such products or services. In connection with its enforcement of the security interest, Secured Party may use such information or transfer it to any assignee or sublicensee permitted hereunder for such assignee's or sublicensee's use. 3.2 Equipment, Fixtures and Inventory. (a) Debtor shall keep the Equipment, Fixtures and Inventory pledged by it hereunder (other than Inventory sold in the ordinary course of business) at the places therefor specified in Section 2.1(a) or, upon thirty days' prior written notice to Secured Party, at such other places in such jurisdiction where all action required by Section 3.1 shall have been taken with respect to the Equipment, Fixtures and Inventory. (b) Debtor shall cause the Equipment and Fixtures pledged by it hereunder to be maintained and preserved in the same condition, repair and working order as when new, ordinary wear and tear excepted, and shall forthwith, or in the case of any loss or damage to any of the Equipment and Fixtures as quickly as practicable after the occurrence thereof, make or cause to be made all repairs, replacements, and other improvements in connection therewith which are necessary or desirable to such end (if, pursuant to Section 3.3, Secured Party releases to Debtor insurance payments in respect of the loss or damage). Debtor shall promptly furnish to Secured Party a statement respecting any loss or damage which singly equals or exceeds $25,000 to any of the Equipment and Fixtures pledged by it hereunder. (c) Debtor shall pay promptly when due or before penalty all property and other taxes, assessments and governmental charges or levies imposed upon, and all claims (including 10 15 claims for labor, materials and supplies) against, the Collateral pledged by it hereunder, except such taxes as are being contested in good faith by appropriate proceedings for which adequate reserves have been established in accordance with GAAP, except where the failure to file such returns, pay such taxes or establish such reserves does not involve unpaid or allegedly unpaid amounts, in aggregate, in excess of $50,000. Debtor shall comply with, and shall cause its licensees to comply with, all requirements of the FDA Act and the Fair Labor Standards Act. 3.3 Insurance. Debtor shall, at its own expense, maintain insurance with respect to the Collateral in accordance with the terms set forth in Section 4.4 of the Credit Agreement. Debtor further covenants and agrees to keep the Collateral which is Equipment, Fixtures and Inventory and other tangible personal property insured in such amounts, against such risks and with such insurers as Secured Party may reasonably require. All such policies of insurance shall be written for the benefit of Secured Party and Debtor, as their interests may appear, and shall provide for at least thirty Business Days' prior written notice of cancellation to Secured Party. Debtor shall promptly furnish to Secured Party evidence of such insurance in form and content satisfactory to Secured Party. If Debtor fails to perform or observe any applicable covenants as to insurance on any of such Collateral, Secured Party may at its own option obtain insurance on only Secured Party's interest in such Collateral, any premium thereby paid by Secured Party to become part of the Obligations, bear interest prior to the existence of an Event of Default, at the then applicable Prime Base Rate, and during the existence of an Event of Default, at the lesser of (a) the Prime Base Rate, plus 3% and (b) the Highest Lawful Rate. In the event Secured Party maintains such substitute insurance, the additional premium for such insurance shall be due on demand and payable by Debtor to Secured Party in accordance with any notice delivered to Debtor by Secured Party. Debtor hereby grants Secured Party a security interest in any refunds of unearned premiums in connection with any cancellation, adjustment or termination of any policy of insurance required by Secured Party and in all proceeds of such insurance and hereby appoints Secured Party its attorney-in-fact to endorse any check or draft that may be payable to Debtor in order to collect such refunds or proceeds. Any such sums collected by Secured Party shall be credited, except to the extent applied to the purchase by Secured Party of similar insurance, to any amounts then owing on the Obligations in accordance with the Credit Agreement. If no Default under Section 4.2, 5.6, 5.7, 5.8, 5.9 or 5.11 of the Credit Agreement or an Event of Default exists, Lender shall deliver to Debtor all insurance payments in respect of any covered loss and any refund of any premium or other payment; provided Debtor uses the payment in respect of an insured loss to acquire a replacement asset of similar value. 3.4 Place of Perfection; Records; Collection of Receivables, Chattel Paper and Instruments. (a) Debtor shall keep its chief place of business and chief executive office and the office where it keeps its records concerning the Receivables, and the originals of all Chattel Paper, at the location therefor specified in Section 2.1(a) or at such other location in the State of Texas as Debtor shall have given written notice thereof to Secured Party no later than 30 days 11 16 prior to the moving thereto. Debtor shall deliver to Secured Party all original Brokerage Agreements to be held by Secured Party as collateral. Debtor will hold and preserve such records and Chattel Paper and will permit representatives of Secured Party at any time during normal business hours to inspect and make abstracts from and copies of such records and Chattel Paper. Debtor shall deliver to Secured Party all Instruments to be held by Secured Party as collateral. (b) Except as otherwise provided in this Section 3.4(b), Debtor shall continue to collect, at its own expense, all amounts due or to become due Debtor under the Receivables, Chattel Paper and Instruments. In connection with such collections, Debtor may take (and, at Secured Party's direction, shall take) such action as Debtor or Secured Party may deem reasonably necessary or advisable to enforce collection of the Receivables, Chattel Paper and Instruments; provided, however, that Secured Party shall have the right (if an Event of Default exists) (without notice to Debtor) to notify the account debtors or obligors under any Receivables, Chattel Paper and Instruments of the assignment of such Receivables, Chattel Paper and Instruments to Secured Party and to direct such account debtors or obligors to make payment of all amounts due or to become due to Debtor thereunder directly to Secured Party and, at the expense of Debtor, to enforce collection of any such Receivables, Chattel Paper and Instruments, and to adjust, settle or compromise the amount or payment thereof, in the same manner and to the same extent as Debtor might have done. All amounts and proceeds (including Instruments) received by Debtor in respect of the Receivables, Chattel Paper and Instruments shall be received in trust for the benefit of Secured Party hereunder, shall be segregated from other funds of Debtor and shall be forthwith paid over to Secured Party in the same form as so received (with any necessary indorsement) to be held as cash collateral and either (A) released to Debtor so long as no Default under Section 4.2, 5.5, 5.7, 5.8, 5.9 or 5.11 of the Credit Agreement or Event of Default exists or (B) if any Default under Section 4.2, 5.6, 5.7, 5.8, 5.9 or 5.11 of the Credit Agreement or Event of Default exists, applied as provided herein. Debtor shall not adjust, settle or compromise the amount or payment of any Receivable, Chattel Paper or Instrument, release wholly or partly any account debtor or obligor thereof, or allow any credit or discount thereon except in accordance with Debtor's historical operating procedure. 3.5 Transfers and Other Liens. Debtor shall not (i) sell, assign (by operation of Law or otherwise) or otherwise dispose of, or grant any option with respect to, any of the Collateral, except as permitted under the Credit Agreement and this Agreement, or (ii) create or permit to exist any Lien, security interest, option or other charge or encumbrance upon or with respect to any of the Collateral, except for the security interest under this Agreement (and except as provided for in the Credit Agreement). Debtor may sell Inventory in the ordinary course of business. Debtor may sell investments subject to a Brokerage Agreement in which Secured Party has a security interest; provided, that the proceeds of such sale are subject to a Brokerage Agreement in which Secured Party has a perfected, first priority security interest in favor of Secured Party and such sale is in the ordinary course of Debtor's investment portfolio 12 17 management. Debtor shall not permit any amendment, restatement or termination of any Brokerage Agreement without the prior written consent of Secured Party. 3.6 Brokerage Agreements. (a) Debtor shall, if any of the shares, securities, moneys or property previously held by a Person other than Debtor pursuant to a Brokerage Agreement are received by Debtor, forthwith transfer and deliver to Secured Party such shares, securities, moneys or property so received by Debtor (together with the certificates for any such shares and securities duly endorsed in blank or accompanied by undated stock powers duly executed in blank), all of which thereafter shall be held by Secured Party, pursuant to the terms of this Agreement, as part of the Collateral; provided, that if no Event of Default exists, Debtor may receive cash distributions and dividends (not consisting of a distribution of or return of capital) declared and paid with respect to any securities. (b) (i) For the better perfection of Secured Party's Rights in and to the Brokerage Agreements or any part thereof and to facilitate implementation of such Rights, Debtor shall, insofar as possible, if an Event of Default exists and upon the request of Secured Party (if Secured Party deems such action necessary to the perfection or priority of the Liens in the Collateral), cause the Brokerage Agreements to be transferred, registered or otherwise put into the name or names of such nominee or nominees of Secured Party as Secured Party shall from time to time direct. (ii) So long as no Event of Default exists (and after any Event of Default until, by notice to Debtor, Secured Party elects while the Event of Default is continuing to exercise the right to vote or consent), Debtor shall retain the right to exercise all voting, consensual and other power of ownership pertaining to the Brokerage Agreements owned by it for all purposes not inconsistent with the terms of this Agreement or any other Loan Paper; and Secured Party shall execute and deliver to Debtor or cause to be executed and delivered to Debtor all such proxies, powers of attorney, dividend and other orders, and all such instruments, without recourse, as Debtor may reasonably request for the purpose of enabling Debtor to exercise the rights and powers which it is entitled to exercise pursuant to this Section 3.6. (iii) If any Event of Default exists, and whether or not Secured Party exercises any available Right to declare any Obligations due and payable or seeks or pursues any other relief or remedy available under applicable Laws or under any agreement relating to such Obligations, all distributions and dividends on any securities and payments and distributions in respect of each Brokerage Agreement shall be paid directly to Secured Party and retained by it as part of the Collateral subject to the terms of this Agreement, and, if Secured Party shall so request, Debtor agrees to execute and 13 18 deliver to Secured Party appropriate additional dividend, distribution and other orders and documents to that end. 3.7 Rights to Dividends and Distributions. With respect to any certificates, bonds, or other instruments or securities (including but not limited to any certificate or participation issued in any proceeding under any Debtor Relief Law) constituting a part of the Collateral, Secured Party shall have authority if an Event of Default exists, without notice to Debtor, either to have the same registered in Secured Party's name or in the name of a nominee, and, with or without such registration, to demand of the issuer thereof, and to receive and receipt for, any and all distributions (including any stock or similar dividend or distribution) payable in respect thereof, whether they be ordinary or extraordinary. Except for any property maintained in a Brokerage Account, if Debtor shall become entitled to receive or shall receive any interest in or certificate (including, without limitation, any interest in or certificate representing a distribution in connection with any reclassification, increase, or reduction of capital, or issued in connection with any reorganization), or any option or rights arising from or relating to any of the Collateral, whether as an addition to, in substitution of, as a conversion of, or in exchange for any of the Collateral, or otherwise, Debtor agrees to accept the same as Secured Party's agent and to hold the same in trust on behalf of and for the benefit of Secured Party, and to deliver the same immediately to Secured Party in the exact form received, with appropriate undated stock or similar powers, duly executed in blank, to be held by Secured Party, subject to the terms hereof, as Collateral. Unless an Event of Default is in existence, Debtor shall be entitled to receive all cash dividends paid in respect of any of the Collateral (subject to the restrictions of any other Loan Paper). 3.8 Right of Secured Party to Notify Issuers. If an Event of Default exists and at such other times as Secured Party is entitled to receive dividends or distributions and other property in respect of or consisting of Instruments and securities, Secured Party may notify each party to a Brokerage Agreement and issuers of the Instruments and securities to make payments of all dividends and distributions directly to Secured Party and Secured Party may take control of all proceeds of any Instruments and securities. Until Secured Party elects to exercise such Rights, during the continuance of an Event of Default, Debtor, as agent of Secured Party, shall collect and segregate all dividends and distributions and other amounts paid or distributed with respect to the Instruments and securities. 3.9 Secured Party Appointed Attorney-in-Fact. Debtor hereby irrevocably appoints Secured Party Debtor's attorney-in-fact, with full authority in the place and stead of Debtor and in the name of Debtor or otherwise to take any action and to execute any instrument which Secured Party may deem necessary or advisable to accomplish the purposes of this Agreement, including, without limitation (provided that the actions listed in each clause below other than the obtainment of insurance may only be taken or exercised if an Event of Default exists): 14 19 (a) to obtain and adjust insurance required to be paid to Secured Party pursuant to Section 3.3, (b) to ask, demand, collect, sue for, recover, compromise, receive and give acquittance and receipts for moneys due and to become due under or in connection with the Collateral, (c) to receive, indorse, and collect any drafts or other Instruments, documents and Chattel Paper, in connection therewith, and (d) to file any claims or take any action or institute any proceedings which Secured Party may deem necessary or desirable for the collection of any of the Collateral or otherwise to enforce compliance with the terms and conditions of any Collateral or the rights of Secured Party with respect to any of the Collateral. DEBTOR HEREBY IRREVOCABLY GRANTS TO SECURED PARTY DEBTOR'S PROXY (EXERCISABLE IF AN EVENT OF DEFAULT EXISTS) TO VOTE ANY SECURITIES COLLATERAL AND APPOINTS SECURED PARTY DEBTOR'S ATTORNEY-IN-FACT TO PERFORM ALL OBLIGATIONS OF DEBTOR UNDER THIS AGREEMENT AND TO EXERCISE ALL OF SECURED PARTY'S RIGHTS HEREUNDER. THE PROXY AND EACH POWER OF ATTORNEY HEREIN GRANTED, AND EACH STOCK POWER AND SIMILAR POWER NOW OR THEREAFTER GRANTED (INCLUDING ANY EVIDENCED BY A SEPARATE WRITING), ARE COUPLED WITH AN INTEREST AND ARE IRREVOCABLE PRIOR TO FINAL PAYMENT IN FULL OF THE OBLIGATIONS. ARTICLE IV. RIGHTS AND POWERS OF SECURED PARTY 4.1 Secured Party May Perform. If Debtor fails to perform any agreement contained herein, Secured Party may itself perform, or cause performance of, such agreement, and the expenses of Secured Party incurred in connection therewith shall be payable by Debtor under Section 4.5. 4.2 Secured Party's Duties. The powers conferred on Secured Party hereunder are solely to protect its interest in the Collateral and shall not impose any duty upon it or any Secured Party to exercise any such powers. Except for the safe custody of any Collateral in its possession and the accounting for moneys actually received by it hereunder, Secured Party shall have no duty as to any Collateral, as to ascertaining or taking action with respect to calls, conversions, exchanges, maturities, tenders or other matters relative to any Collateral, whether or not Secured Party has or is deemed to have knowledge of such matters, or as to the taking of any necessary steps to preserve rights against prior parties or any other rights pertaining to any reasonable care in the custody and preservation of any Collateral in its possession if such Collateral is accorded treatment substantially equal to that which Secured Party accords its own 15 20 property. Except as provided in this Section 4.2, Secured Party shall not have any duty or liability to protect or preserve any Collateral or to preserve rights pertaining thereto. Nothing contained in this Agreement shall be construed as requiring or obligating Secured Party, and Secured Party shall not be required or obligated, to (a) present or file any claim or notice or take any action, with respect to any Collateral or in connection therewith or (b) notify Debtor of any decline in the value of any Collateral. 4.3 Remedies. If any Event of Default exists: (a) Secured Party may exercise in respect of the Collateral, in addition to other rights and remedies provided for herein or otherwise available to it, all the rights and remedies of a secured party on default under the Uniform Commercial Code in effect in the State of Texas at that time (the "UCC") (whether or not the Uniform Commercial Code applies to the affected Collateral), and also may (i) require Debtor to, and Debtor hereby agrees that it will at its expense and upon request of Secured Party forthwith, assemble all or part of the Collateral as directed by Secured Party and make it available to Secured Party at a place to be designated by Secured Party which is reasonably convenient to both parties at public or private sale, at any of Secured Party's offices or elsewhere, for cash, on credit or for future delivery, and upon such other terms as Secured Party may deem commercially reasonable. Debtor agrees that, to the extent notice of sale shall be required by Law, ten days' notice to Debtor of the time and place of any public sale or the time after which any private sale is to be made shall constitute reasonable notification. Secured Party shall not be obligated to make any sale of Collateral regardless of notice of sale having been given. Secured Party may adjourn any public or private sale from time to time by announcement at the time and place fixed therefor, and such sale may, without further notice, be made at the time and place to which it was so adjourned. (b) All cash proceeds received by Secured Party upon any sale of, collection of, or other realization upon, all or any part of the Collateral shall be applied as follows: First: To the payment of all out-of-pocket costs and expenses incurred in connection with the sale of, collection of or other realization upon Collateral, including reasonable attorneys' fees and disbursements; Second: To the payment of the Obligations in such order and in such manner consistent with applicable Laws as Secured Party in its discretion shall decide (with Debtor remaining liable for any deficiency); and Third: To the extent of the balance (if any) of such proceeds, to Debtor or other Person legally entitled thereto. (c) All payments received by Debtor under or in connection with any Collateral shall be received in trust for the benefit of Secured Party, shall be segregated from other funds of 16 21 Debtor and shall be forthwith paid over to Secured Party in the same form as so received (with any necessary indorsement). (d) Because of the FDA Act, the Securities Act of 1933, as amended ("Securities Act") and other Laws, including without limitation state blue sky Laws, or contractual restrictions or agreements imposed by any licensor or licensee of certain Rights, there may be legal restrictions or limitations affecting Secured Party in any attempts to dispose of the Collateral and the enforcement of its Rights hereunder. For these reasons, Secured Party is hereby authorized by Debtor, but not obligated, if any Event of Default exists, to sell or otherwise dispose of any of the Collateral at private sale, subject to an investment letter, or in any other manner which will be in compliance with the FDA Act, will not require the Collateral, or any part thereof, to be registered in accordance with the Securities Act, and the rules and regulations promulgated under the foregoing, and each other Law applicable to the Collateral. Secured Party is also hereby authorized by Debtor, but not obligated, to take such actions, give such notices, obtain such consents, and do such other things as Secured Party may deem required or appropriate under the FDA Act, Securities Act or other Laws or contractual restrictions or agreements in the event of a sale or disposition of any Collateral. Debtor clearly understands that Secured Party may in its discretion approach a restricted number of potential purchasers and that a sale under such circumstances may yield a lower price for the Collateral than would otherwise be obtainable if same were registered and sold in the open market. No sale so made in good faith by Secured Party shall be deemed to be not "commercially reasonable" because so made. Debtor agrees that in the event Secured Party shall, if an Event of Default exists, sell the Collateral or any portion thereof at any private sale or sales, Secured Party shall have the right to rely upon the advice and opinion of appraisers and other Persons, which appraisers and other Persons are acceptable to Secured Party, as to the best price reasonably obtainable upon such a private sale thereof. In the absence of fraud, such reliance shall be conclusive evidence that Secured Party handled such matter in a commercially reasonable manner under applicable Law. 4.4 Further Approvals Required. (a) In connection with the exercise by Secured Party of its Rights hereunder that effects the disposition of or use of any Collateral, it may be necessary to obtain the prior consent or approval of Tribunals and other Persons to a transfer or assignment of Collateral, including, without limitation, the FDA. (b) Debtor hereby agrees, if an Event of Default exists, to execute, deliver, and file, and hereby appoints (to the extent permitted under applicable Law) Secured Party as its attorney-in-fact, if an Event of Default exists, to execute, deliver, and file on Debtor's behalf and in Debtor's name, all applications, certificates, filings, instruments, and other documents (including without limitation any application for an assignment or transfer of control or ownership) that may be necessary or appropriate, in Secured Party's opinion, to obtain such consents, waivers, or approvals. Debtor further agrees to use its best efforts to obtain the foregoing consents, waivers, 17 22 and approvals, including receipt of consents, waivers, and approvals under applicable agreements prior to a Default or Event of Default. Debtor acknowledges that there is no adequate remedy at Law for failure by it to comply with the provisions of this Section 4.4(b) and that such failure would not be adequately compensable in damages, and therefore agrees that this Section 4.4(b) may be specifically enforced. 4.5 INDEMNITY AND EXPENSES. (A) DEBTOR AGREES TO INDEMNIFY SECURED PARTY FROM AND AGAINST ANY AND ALL CLAIMS, LOSSES AND LIABILITIES (INCLUDING REASONABLE ATTORNEYS' FEES) GROWING OUT OF OR RESULTING FROM THIS AGREEMENT (INCLUDING, WITHOUT LIMITATION, ENFORCEMENT OF THIS AGREEMENT), EXCEPT CLAIMS, LOSSES OR LIABILITIES RESULTING FROM SECURED PARTY'S GROSS NEGLIGENCE OR WILLFUL MISCONDUCT. (b) Debtor will upon demand pay to Secured Party the amount of any and all reasonable expenses, including the reasonable fees and expenses of its counsel and of any experts and agents, which Secured Party may incur in connection with (i) the administration of this Agreement, (ii) the custody, preservation, use or operation of, or the sale of, collection from, or other realization upon, any of the Collateral, (iii) the exercise or enforcement of any of the Rights of Secured Party hereunder or (iv) the failure by Debtor to perform or observe any of the provisions hereof. Any payments so made shall be a part of the Obligation, shall be payable upon demand, and shall bear interest (i) if no Event of Default exists, at the Prime Base Rate, and (ii) if an Event of Default exists, at the lesser of (A) the Prime Base Rate plus 3% and (B) the Highest Lawful Rate. ARTICLE V. MISCELLANEOUS 5.1 Cumulative Rights. All Rights of Secured Party under the Loan Papers are cumulative of each other and of every other Right which Secured Party may otherwise have at Law or in equity or under any other contract or other writing for the enforcement of the security interest herein or the collection of the Obligations. The exercise of one or more Rights shall not prejudice or impair the concurrent or subsequent exercise of other Rights. 5.2 Modifications; Amendments; Schedules; Etc. No amendment or waiver of any provision of this Agreement, and no consent to any departure by Debtor here from, shall in any event be effective unless the same shall be in writing and signed by Secured Party, and then such waiver or consent shall be effective only in the specific instance and for the specific purpose for which given. Upon any change in any material information disclosed on any schedule, Debtor shall promptly prepare and deliver to Secured Party a replacement schedule, indicating its effective date, in form and substance satisfactory to Secured Party and amendments to and 18 23 additional financing statements as Secured Party may require to preserve and perfect a first priority security interest in the Collateral. 5.3 Continuing Security Interest. This Agreement shall create a continuing security interest in the Collateral and shall (a) remain in full force and effect until the later of (i) the final payment in full of the Obligations and all amounts payable under this Agreement and (ii) the expiration or termination of the obligations of Secured Party to extend credit to Debtor, (b) be binding upon Debtor, its successors and assigns, and (c) inure to the benefit of, and be enforceable by, Secured Party and its successors, transferees and assigns. Upon any such termination, Secured Party will, at Debtor's expense, execute and deliver to Debtor such documents as such Debtor shall reasonably request to evidence such termination. 5.4 MANDATORY ARBITRATION. (A) ANY CONTROVERSY OR CLAIM BETWEEN OR AMONG THE PARTIES HERETO INCLUDING BUT NOT LIMITED TO THOSE ARISING OUT OF OR RELATING TO THIS AGREEMENT OR ANY RELATED AGREEMENTS OR INSTRUMENTS, INCLUDING ANY CLAIM BASED ON OR ARISING FROM AN ALLEGED TORT, SHALL BE DETERMINED BY BINDING ARBITRATION IN ACCORDANCE WITH THE FEDERAL ARBITRATION ACT (OR IF NOT APPLICABLE, THE APPLICABLE STATE LAW), THE RULES OF PRACTICE AND PROCEDURE FOR THE ARBITRATION OF COMMERCIAL DISPUTES OF JUDICIAL ARBITRATION AND MEDIATION SERVICES, INC. ("JAMS"), AND THE "SPECIAL RULES" SET FORTH BELOW. IN THE EVENT OF ANY INCONSISTENCY, THE SPECIAL RULES SHALL CONTROL. JUDGMENT UPON ANY ARBITRATION AWARD MAY BE ENTERED IN ANY COURT HAVING JURISDICTION. ANY PARTY TO THIS AGREEMENT MAY BRING AN ACTION, INCLUDING A SUMMARY OR EXPEDITED PROCEEDING, TO COMPEL ARBITRATION OF ANY CONTROVERSY OR CLAIM TO WHICH THIS AGREEMENT APPLIES IN ANY COURT HAVING JURISDICTION OVER SUCH ACTION. (b) Special Rules. The arbitration shall be conducted in Dallas, Texas and administered by JAMS who will appoint an arbitrator; if JAMS is unable or legally precluded from administering the arbitration, then the American Arbitration Association will serve. All arbitration hearings will be commenced within ninety days of the demand for arbitration; further, the arbitrator shall only, upon a showing of cause, be permitted to extend the commencement of such hearing for up to an additional sixty days. (c) Reservations of Rights. Nothing in this Agreement or any other Loan Paper shall be deemed to (i) limit the applicability of any otherwise applicable statutes of limitation or repose and any waivers contained in this Agreement; or (ii) be a waiver by Secured Party of the protection afforded to it by 12 U.S.C. Section 91 or any substantially equivalent state law; or (iii) limit the right of Secured Party hereto (A) to exercise self help remedies such as (but not limited to) 19 24 setoff, or (B) to foreclose against any real or personal property collateral, or (C) to obtain from a court provisional or ancillary remedies such as (but not limited to) injunctive relief or the appointment of a receiver. Secured Party may exercise such self help rights, foreclose upon such property, or obtain such provisional or ancillary remedies before, during or after the pendency of any arbitration proceeding brought pursuant to this Agreement. At Secured Party's option, foreclosure under a deed of trust or mortgage may be accomplished by any of the following: the exercise of a power of sale under the deed of trust or mortgage, or by judicial sale under the deed of trust or mortgage, or by judicial foreclosure. Neither this exercise of self help remedies nor the institution or maintenance of an action for foreclosure or provisional or ancillary remedies shall constitute a waiver of the right of any party, including the claimant in any such action, to arbitrate the merits of the controversy or claim occasioning resort to such remedies. 5.5 GOVERNING LAW; TERMS. THIS AGREEMENT SHALL BE GOVERNED BY AND CONSTRUED IN ACCORDANCE WITH THE LAWS OF THE STATE OF TEXAS, EXCEPT TO THE EXTENT THAT THE VALIDITY OR PERFECTION OF THE SECURITY INTEREST HEREUNDER, OR REMEDIES HEREUNDER, IN RESPECT OF ANY PARTICULAR COLLATERAL ARE GOVERNED BY THE LAWS OF A JURISDICTION OTHER THAN THE STATE OF TEXAS. UNLESS OTHERWISE DEFINED HEREIN OR IN THE CREDIT AGREEMENT, TERMS USED IN ARTICLE 9 OF THE UCC ARE USED HEREIN AS THEREIN DEFINED. 5.6 WAIVER OF JURY TRIAL. SECURED PARTY AND DEBTOR HEREBY WAIVE TRIAL BY JURY IN ANY JUDICIAL PROCEEDINGS INVOLVING, DIRECTLY OR INDIRECTLY, ANY MATTER (WHETHER IN TORT, CONTRACT OR OTHERWISE) IN ANY WAY ARISING OUT OF, RELATED TO, OR CONNECTED WITH THIS AGREEMENT OR THE RELATIONSHIP ESTABLISHED HEREUNDER. 5.7 Secured Party's Right to Use Agents. Secured Party may exercise its Rights under this Agreement through an agent or other designee. 5.8 No Interference, Compensation or Expense. Secured Party may exercise its Rights under this Agreement without payment of any rent, license fee or compensation of any kind to Debtor. 5.9 Waivers of Rights Inhibiting Enforcement. Debtor waives (a) any claim that, as to any part of the Collateral, a public sale, should the Secured Party elect so to proceed, is, in and of itself, not a commercially reasonable method of sale for such Collateral, (b) except as otherwise provided in this Agreement, TO THE EXTENT PERMITTED BY APPLICABLE LAW, NOTICE OR JUDICIAL HEARING IN CONNECTION WITH SECURED PARTY'S DISPOSITION OF ANY OF THE COLLATERAL INCLUDING ANY AND ALL PRIOR NOTICE AND HEARING FOR ANY PREJUDGMENT REMEDY OR 20 25 REMEDIES AND ANY SUCH RIGHT THAT DEBTOR WOULD OTHERWISE HAVE UNDER THE CONSTITUTION OR ANY STATUTE OF THE UNITED STATES OR OF ANY STATE, AND ALL OTHER REQUIREMENTS AS TO THE TIME, PLACE AND TERMS OF SALE OR OTHER REQUIREMENTS WITH RESPECT TO THE ENFORCEMENT OF SECURED PARTY'S RIGHTS HEREUNDER and (c) all rights of redemption, appraisal or valuation. 5.10 Notices and Deliveries. (a) Manner of Delivery. All notices, communications and materials to be given or delivered pursuant to this Agreement shall, except in those cases where giving notice by telephone is expressly permitted, be given or delivered in writing. All written notices, communications and materials shall be sent by registered or certified mail, postage prepaid, return receipt requested, by telecopier, or delivered by hand. In the event of a discrepancy between any telephonic notice and any written confirmation thereof, such written confirmation shall be deemed the effective notice except to the extent Secured Party or Debtor has acted in reliance on such telephonic notice. (b) Addresses. All notices, communications and materials to be given or delivered pursuant to this Agreement shall be given or delivered at the following respective addresses and telecopier and telephone numbers and to the attention of the following individuals or departments: (i) if to Debtor, to it at: Quest Medical, Inc. One Allentown Parkway Allen, Texas 75002 Telecopier No.: (972) 390-9687 Telephone No.: (972) 390-9800 Attention: F. Robert Merrill III 21 26 (ii) if to Secured Party, to it at: NationsBank of Texas, N.A. NationsBank Plaza 901 Main Street 7th Floor Dallas, Texas 75202 Telecopier No.: (214) 508-3140 Telephone No.: (214) 508-2825 Attention: Commercial Banking or at such other address or, telecopier or telephone number or to the attention of such other individual or department as the party to which such information pertains may hereafter specify for the purpose in a notice to the other specifically captioned "Notice of Change of Address". (c) Effectiveness. Each notice, communication and any material to be given or delivered to Secured Party or Debtor pursuant to this Agreement shall be effective or deemed delivered or furnished (i) if sent by certified mail, return receipt requested, on the fifth Business Day after such notice, communication or material is deposited in the mail, addressed as above provided, (ii) if sent by telecopier, when such notice, communication or material is transmitted to the appropriate number determined as above provided in this Section 5.10 and the appropriate receipt is received or otherwise acknowledged, (iii) if sent by hand delivery or overnight courier, when left at the address of the addressee addressed as above provided, and (iv) if given by telephone, when communicated to the individual or any member of the department specified as the individual or department to whose attention notices, communications and materials are to be given or delivered except that notices of a change of address, telecopier or telephone number or individual or department to whose attention notices, communications and materials are to be given or delivered shall not be effective until received. 5.11 Successors and Assigns. All of the provisions of this Agreement shall be binding and inure to the benefit of the parties thereto and their respective successors and assigns. 5.12 Loan Paper. This Agreement is a Loan Paper executed pursuant to the Credit Agreement and shall (unless otherwise expressly indicated herein) be construed, administered and applied in accordance with the terms and provisions thereof. 5.13 Definitions. Capitalized terms not otherwise defined herein have the meaning specified in the Credit Agreement and, to the extent of any conflict, terms as defined in the Credit Agreement shall control (provided, that a more expansive or explanatory definition shall not be deemed a conflict). 22 27 5.14 Severability. If any provision of any Loan Paper is held to be illegal, invalid, or unenforceable under present or future Laws during the term thereof, such provision shall be fully severable, the appropriate Loan Paper shall be construed and enforced as if such illegal, invalid, or unenforceable provision had never comprised a part thereof, and the remaining provisions thereof shall remain in full force and effect and shall not be affected by the illegal, invalid, or unenforceable provision or by its severance therefrom. Furthermore, in lieu of such illegal, invalid, or unenforceable provision there shall be added automatically as a part of such Loan Paper a legal, valid, and enforceable provision as similar in terms to the illegal, invalid, or unenforceable provision as may be possible. 5.15 Obligations Not Affected. To the fullest extent permitted by applicable Law, the obligations of Debtor under this Agreement shall remain in full force and effect without regard to, and shall not be impaired or affected by: (a) any amendment or modification or addition or supplement to any Loan Paper, any instrument delivered in connection therewith or any assignment or transfer thereof; (b) any exercise, non-exercise, or waiver by Secured Party of any Right, remedy, power or privilege under or in respect of, or any release of any guaranty, any collateral or the Collateral or any part thereof provided pursuant to, this Agreement or any Loan Paper; (c) any waiver, consent, extension, indulgence or other action or inaction in respect of this Agreement or any Loan Paper or any assignment or transfer of any thereof; or (d) any bankruptcy, insolvency, reorganization, arrangement, readjustment, composition, liquidation or the like of Debtor, or any other Person, whether or not Debtor shall have notice or knowledge of any of the foregoing. 5.16 Prior Security Agreements. This Agreements restates in their entirety each of the Facility A Security Agreement and the Existing Security Agreement. 5.17 Counterparts. This Agreement may be executed in any number of counterparts, each of which when so executed and delivered shall be deemed an original, but all such counterparts together shall constitute but one and the same instrument. 5.18 ENTIRE AGREEMENT. THIS WRITTEN AGREEMENT, TOGETHER WITH THE OTHER LOAN PAPERS, REPRESENT THE FINAL AGREEMENT BETWEEN THE PARTIES AND MAY NOT BE CONTRADICTED BY EVIDENCE OF PRIOR, CONTEMPORANEOUS, OR SUBSEQUENT ORAL AGREEMENTS OF THE PARTIES. THERE ARE NO UNWRITTEN ORAL AGREEMENTS AMONG THE PARTIES. 23 28 =============================================================================== REMAINDER OF PAGE INTENTIONALLY LEFT BLANK =============================================================================== 24 29 IN WITNESS WHEREOF, Debtor and Secured Party have caused this Agreement to be duly executed and delivered as of the date first above written. DEBTOR: QUEST MEDICAL, INC. By: /s/ F. ROBERT MERRILL III ------------------------------------- F. Robert Merrill III, Vice President SECURED PARTY: NATIONSBANK OF TEXAS, N.A. By: /s/ BRIAN K. SCHNEIDER ------------------------------------- Brian K. Schneider, Vice President 25 EX-10.19 6 1ST AMENDED & RESTATED SECURITY AGREEMENT 1 EXHIBIT 10.19 ================================================================================ FIRST AMENDED AND RESTATED SECURITY AGREEMENT dated as of March 3, 1997 Between ADVANCED NEUROMODULATION SYSTEMS, INC. as Debtor and NATIONSBANK OF TEXAS, N.A. as Secured Party ================================================================================ 2 TABLE OF CONTENTS
Page ---- ARTICLE I. GRANT 1.1 Assignment and Grant of Security . . . . . . . . . . . . . . 2 1.2 Description of Obligations . . . . . . . . . . . . . . . . . 5 1.3 Debtor Remains Liable . . . . . . . . . . . . . . . . . . . 6 1.4 Delivery of Security Collateral . . . . . . . . . . . . . . 6 ARTICLE II. REPRESENTATIONS AND WARRANTIES 2.1 Representations and Warranties . . . . . . . . . . . . . . . 6 ARTICLE III. COVENANTS 3.1 Further Assurances . . . . . . . . . . . . . . . . . . . . . 8 3.2 Equipment, Fixtures and Inventory . . . . . . . . . . . . . 10 3.3 Insurance . . . . . . . . . . . . . . . . . . . . . . . . . 11 3.4 Place of Perfection; Records; Collection of Receivables, Chattel Paper and Instruments . . . . . . . . . . . . . . . 12 3.5 Transfers and Other Liens . . . . . . . . . . . . . . . . . 12 3.6 Brokerage Agreements . . . . . . . . . . . . . . . . . . . . 13 3.7 Rights to Dividends and Distributions . . . . . . . . . . . 14 3.8 Right of Secured Party to Notify Issuers . . . . . . . . . . 14 3.9 Secured Party Appointed Attorney-in-Fact . . . . . . . . . . 14 ARTICLE IV. RIGHTS AND POWERS OF SECURED PARTY 4.1 Secured Party May Perform . . . . . . . . . . . . . . . . . 15 4.2 Secured Party's Duties . . . . . . . . . . . . . . . . . . . 15 4.3 Remedies . . . . . . . . . . . . . . . . . . . . . . . . . . 16 4.4 Further Approvals Required . . . . . . . . . . . . . . . . . 17 4.5 INDEMNITY AND EXPENSES . . . . . . . . . . . . . . . . . . . 18 ARTICLE V. MISCELLANEOUS 5.1 Cumulative Rights . . . . . . . . . . . . . . . . . . . . . 18 5.2 Modifications; Amendments; Schedules; Etc. . . . . . . . . . 18 5.3 Continuing Security Interest . . . . . . . . . . . . . . . . 19 5.4 MANDATORY ARBITRATION . . . . . . . . . . . . . . . . . . . 19 5.5 GOVERNING LAW; TERMS . . . . . . . . . . . . . . . . . . . . 20 5.6 WAIVER OF JURY TRIAL . . . . . . . . . . . . . . . . . . . . 20 5.7 Secured Party's Right to Use Agents . . . . . . . . . . . . 20
i 3 5.8 No Interference, Compensation or Expense . . . . . . . . . . 20 5.9 Waivers of Rights Inhibiting Enforcement . . . . . . . . . . 20 5.10 Notices and Deliveries . . . . . . . . . . . . . . . . . . . 21 (a) Manner of Delivery . . . . . . . . . . . . . . . . . 21 (b) Addresses . . . . . . . . . . . . . . . . . . . . . . 21 (c) Effectiveness . . . . . . . . . . . . . . . . . . . . 22 5.11 Successors and Assigns . . . . . . . . . . . . . . . . . . . 22 5.12 Loan Paper . . . . . . . . . . . . . . . . . . . . . . . . . 22 5.13 Definitions . . . . . . . . . . . . . . . . . . . . . . . . 22 5.14 Severability . . . . . . . . . . . . . . . . . . . . . . . . 23 5.15 Obligations Not Affected . . . . . . . . . . . . . . . . . . 23 5.16 Prior Security Agreements . . . . . . . . . . . . . . . . . 23 5.17 Counterparts . . . . . . . . . . . . . . . . . . . . . . . . 23 5.18 ENTIRE AGREEMENT . . . . . . . . . . . . . . . . . . . . . . 23
ii 4 SCHEDULES: Schedule 1 - Inventory Locations Schedule 2 - Required Consents Schedule 3 - Bank Accounts Schedule 4 - Insurance Schedule 5 - Vendor Agreements Schedule 6 - Excluded Equipment and Furnishings Schedule 7 - Brokerage Agreements Schedule 8 - Filing Locations Schedule 9 - Permits iii 5 FIRST AMENDED AND RESTATED SECURITY AGREEMENT FIRST AMENDED AND RESTATED SECURITY AGREEMENT, dated as of March 3, 1997 (this "Agreement"), made by Advanced Neuromodulation Systems, Inc., a Texas corporation ("Debtor"), in favor of NationsBank of Texas, N.A., a national banking association ("Secured Party"). BACKGROUND. (1) Secured Party and Quest Medical, Inc. ("Borrower") have entered into the Credit Agreement dated as of October 22, 1993 (as amended, the "Original Credit Agreement"), pursuant to which Debtor, successor by merger to Neuromed, Inc., each a wholly-owned Subsidiary of Borrower entered in a Security Agreement dated May 28, 1993 ("Facility A Security Agreement") as amended and restated from time to time, the Security Agreement dated as of October 22, 1993 ("Existing Security Agreement") as amended and restated from time to time and related agreements. (2) Secured Party and Borrower have entered into the First Amended and Restated Credit Agreement dated as of March 31, 1995 (such agreement, together with all amendments and restatements thereof, the "1995 Credit Agreement") which restates in its entirety the Original Credit Agreement. (3) Secured Party and Borrower have entered into the Second Amended and Restated Credit Agreement dated as of February 9, 1996 (such agreement, together with all amendments and restatements thereof, the "Existing Credit Agreement") which restates in its entirety the 1995 Credit Agreement. (4) Secured Party and Borrower have entered into the Third Amended and Restated Credit Agreement dated as of March 3, 1997 (such agreement, together with all amendments and restatements thereof, the "Credit Agreement") which restates in its entirety the Existing Credit Agreement. (5) It is the intention of the parties hereto that this Agreement create a first priority security interest securing the payment of the obligations set forth in Section 1.2. (6) It is a condition precedent to the effectiveness of the Credit Agreement that Debtor shall have executed and delivered this Security Agreement. 6 AGREEMENT. NOW, THEREFORE, in consideration of the premises set forth herein and for other good and valuable consideration, the receipt and sufficiency of which is hereby acknowledged, and in order to induce Secured Party to make the Advances under the Credit Agreement, Debtor hereby agrees with Secured Party as follows: ARTICLE I. GRANT 1.1 Assignment and Grant of Security. Subject to the last paragraph of this Section 1.1, Debtor hereby assigns and pledges to Secured Party and hereby grants to Secured Party a security interest in, the entire right, title and interest of Debtor, in and to the following assets of Debtor, whether now owned or hereafter acquired ("Collateral"): (a) all inventory in all of its forms, wherever located, now or hereafter existing, including, but not limited to, (i) all raw materials and work in process therefor, finished goods thereof, and materials used or consumed in the manufacture or production thereof, (ii) goods in which Debtor has an interest in mass or a joint or other interest or right of any kind (including, without limitation, goods in which Debtor has an interest or right as consignee), and (iii) goods which are returned to or repossessed by Debtor, and all accessions thereto and products thereof and documents therefor (any and all such inventory, accessions, products and documents being the "Inventory"); (b) other than equipment described in the last paragraph of this Section 1.1, all equipment (as defined in the Uniform Commercial Code) and (whether or not included in such definition), all vehicles, machinery, chattels, tools, parts, furniture, furnishings and supplies, of every nature, wherever located, all additions, accessories and improvements thereto and substitutions therefor and all accessories, parts and equipment which may be attached to or which are necessary for the operation and use of such personal property, together with all accessions thereto, and all rights under or arising out of present or future contracts relating to the foregoing ("Equipment"); (c) all property so related to particular real estate that an interest in it arises under the real estate law of the jurisdiction in which such Collateral is located, including all equipment, fixtures and articles of personal property now or hereafter attached to or used in or about any building or buildings now erected or hereafter to be erected on any real property now or hereafter owned or leased by Debtor (the "Property"), which are necessary to the complete and comfortable use and occupancy of such building or buildings for the purposes for which they were or are to be erected; all materials to be delivered to the Property and used or to be used in connection with the construction of any building to be constructed on the Property, including, but not limited to, all masonry, siding, roof shingles, flooring, doors, windows, tile, shutters, stoves, ovens, awnings, screens, cabinets, shades, blinds, carpets, draperies, furniture, furnishings, plumbing, heating, air conditioning, lighting, ventilating, refrigerating, cooking, 2 7 laundry and incinerating equipment and all fixtures and appurtenances thereto, and such other goods and chattels and personal property as are ever used or furnished in operating such buildings or the activities conducted therein, and all building materials and equipment now or hereafter delivered to the Property and intended to be installed thereon ("Fixtures"); (d) all general intangibles (as defined in the Uniform Commercial Code), and (whether or not included in such definition) all contract rights other than Receivables; all inventions, processes, production methods, proprietary information and know-how; and all licenses or other agreements granted to Debtor with respect to any of the foregoing; all information, customer lists, advertising lists, advertising contracts, identification of suppliers, data, plans, blueprints, specifications, designs, drawings, recorded knowledge, surveys, engineering reports, test reports, manuals, materials standards, processing standards, performance standards, telephone numbers and telephone listings, catalogs, books, records, computer and automatic machinery software and programs, and the like pertaining to operations by or the business of Debtor; all field accounting information and all media in which or on which any of the information or knowledge or data or records may be recorded or stored and all computer programs used for the compilation or printout of such information, knowledge, records or data; all licenses, consents, permits, variances, certifications and approvals of all Tribunals now or hereafter held by Debtor pertaining to operations or business now or hereafter conducted; all rights to receive return of deposits and trust payments; all rights to payment under letters of credit and similar agreements; all tax refunds (including, without limitation, all federal and state income tax refunds and benefits of net operating loss carry forwards); and all causes of action, rights, claims and warranties now or hereafter owned or acquired by Debtor ("General Intangibles"); (e) all of the following, to the extent that not included in "General Intangibles": trade secrets, all know-how, inventions, processes, methods, information, data, plans, blueprints, specifications, designs, drawings, engineering reports, test reports, materials standards, processing standards and performance standards, and all computer and automatic machinery software and programs directly related thereto, and all licenses or other agreements to which Debtor is a party with respect to any of the foregoing ("Trade Secrets"); (f) all instruments and letters of credit (each as defined in the Uniform Commercial Code), and (whether or not included in such definitions) all promissory notes, drafts, bills of exchange and trade acceptances ("Instruments"); (g) all writings which evidence both a monetary obligation and a security interest in or a lease of specific goods ("Chattel Paper"); (h) all documents, warehouse receipts, bills of lading, including, without limitation, documents of title (as defined in the Uniform Commercial Code) or other receipts covering, evidencing or representing any property described in this Section 1.1 ("Documents"); 3 8 (i) all accounts, contract rights, Chattel Paper, Documents, Instruments, deposit accounts, General Intangibles, tax refunds and other obligations of any kind owing to Debtor, now or hereafter existing, arising out of or in connection with the sale or lease of goods or the rendering of services, and all rights now or hereafter existing in and to all security agreements, leases, and other contracts securing or otherwise relating to any such accounts, contract rights, Chattel Paper, Documents, Instruments, deposit accounts, General Intangibles, tax refunds or obligations (any and all such accounts, contract rights, Chattel Paper, Documents, Instruments, deposit accounts, General Intangibles, tax refunds and obligations being the "Receivables"); (j) all licenses, permits and other similar rights now or hereafter owned by Debtor (including but not limited to all licenses, permits and similar rights issued by the FDA) and necessary to the operation of its business, including but not limited to all licenses, permits and other rights listed on Schedule 9; (k) all agreements and accounts of Debtor described on Schedule 7, all interest in any security subject to such agreement or account (including but not limited to all interest in any equity or debt security, option, warrant, put, call, futures agreements, commodity agreements, margin accounts, short positions and partnership interests), all property subject to or maintained in each such account or pursuant to such agreement, each deposit account (time, demand or other) in which any proceeds of or income from the foregoing may be on deposit, all cash maintained with each Person pursuant to any such agreement or account, all general intangibles consisting of the foregoing and each agreement, document or Instrument governing or evidencing any of the foregoing and all amendments and restatements thereof, and all claims of Debtor against any Person with respect to any of the foregoing (all of the foregoing being herein collectively called the "Brokerage Agreements"); (l) all rights, claims and benefits of Debtor against any Person arising out of, relating to or in connection with any property described in this Section 1.1 purchased by Debtor, including, without limitation, any such rights, claims or benefits against any Person storing or transporting any property described in this Section 1.1; (m) the balance of every deposit account of Debtor under control of Secured Party and each of its Affiliates and any other claim of Debtor against Secured Party, now or hereafter existing, liquidated or unliquidated, and all money, Instruments, securities, Documents, Chattel Paper, credits, claims, demands, income, and any other property, rights and interests of Debtor which at any time shall come into the possession or custody or under the control of Secured Party or any of its agents, affiliates or correspondents, for any purpose, and the proceeds of any thereof (Secured Party shall be deemed to have possession of any of the Collateral in transit to or set apart for it or any of its agents, affiliates or correspondents. The holder of any participation in the Obligations shall have a right of setoff with respect to any obligation of such holder to Debtor to satisfy the Obligations); 4 9 (n) all Acquisition Documents; (o) all agreements with vendors and other distributors of Inventory, including but not limited to those described in Schedule 5; (p) all insurance policies and bonds and claims and payments thereunder; (q) all property similar to the above hereafter acquired by Debtor; and (r) all accessions to, substitutions for and replacements, proceeds and products of any and all of the foregoing Collateral (including, without limitation, proceeds which constitute property of the types described in this Section 1.1) and, to the extent not otherwise included, all (i) payments under insurance (whether or not Secured Party is the loss payee thereof), or any indemnity, warranty or guaranty, payable by reason of loss or damage to or otherwise with respect to any of the foregoing Collateral and (ii) cash. Nothing in this Section 1.1 or otherwise in any Loan Paper is intended as a grant of a security interest in any of the following property of Debtor: (i) heating, ventilation or air conditioning systems now or hereafter located on the Allen Property, (ii) the furniture and equipment described on Schedule 6, whether now owned or hereafter acquired, and all accessions to, substitutions for and replacements, proceeds and products of such office furniture and equipment, and (iii) the computer systems described on Schedule 6, whether now owned or hereafter acquired, and all accessions to, substitutions for and replacements, proceeds and products of such computer systems. The assets described in clauses (i) through (iii) of this paragraph shall not constitute Collateral for purposes of this Agreement. Secured Party agrees that, upon request of Debtor, it will execute and deliver to Debtor and MetLife Capital Corporation or its affiliates (collectively, "MetLife") any documents reasonably requested by Debtor or MetLife to evidence that Secured Party does not have a security interest in the assets described in clauses (i) through (iii) of this paragraph. 1.2 Description of Obligations. This Agreement creates a first priority security interest securing the payment and performance of the Obligations, including, but not limited to any and all obligations now or hereafter existing of Debtor and each other Obligor under the Credit Agreement and other Loan Papers, including any extensions, modifications, substitutions, 5 10 amendments and renewals thereof, whether for principal, interest, fees, premium, expenses, indemnification or otherwise (all such obligations of Debtor and each other Obligor being the "Obligations"). Without limiting the generality of the foregoing, this Agreement secures the payment of all amounts which constitute part of the Obligations and would be owed by Debtor and each other Obligor to Secured Party under any Loan Paper, but for the fact that they are unenforceable or not allowable due to the existence of a bankruptcy, reorganization or similar proceeding involving Debtor or any other Person (including all after, or that would have secured but for, the filing of any petition in bankruptcy, or the commencement of any insolvency, reorganization or like proceeding of Debtor or any other Obligor). 1.3 Debtor Remains Liable. Anything herein to the contrary notwithstanding, (a) Debtor shall remain liable under the contracts and agreements included in the Collateral to the extent set forth therein to perform all of its duties and obligations thereunder to the same extent as if this Agreement had not been executed, (b) the exercise by Secured Party of any of the Rights hereunder shall not release Debtor from any of its duties or obligations under the contracts and agreements included in the Collateral, and (c) Secured Party shall not have any obligation or liability under the contracts and agreements included in the Collateral by reason of this Agreement, nor shall Secured Party be obligated to perform any of the obligations or duties of Debtor thereunder or to take any action to collect or enforce any claim for payment assigned hereunder. 1.4 Delivery of Security Collateral. All certificates or instruments representing or evidencing the Collateral and which are issued in the name of Debtor shall be delivered to and held by or on behalf of Secured Party pursuant hereto and shall be in suitable form for transfer by delivery, or shall be accompanied by duly executed instruments of transfer or assignment in blank, all in form and substance satisfactory to Secured Party. If an Event of Default exists, Secured Party shall have the right, at any time during such time in its discretion and without notice to Debtor, to (a) require the issuance in the name of Debtor and delivery to Secured Party of certificates or instruments evidencing the interest owned by Debtor in the issuer of such certificate or instrument (if the security is subject to a Brokerage Agreement and the Brokerage Agreement permits such issuance) and (b) transfer to or to register in the name of Secured Party or any of its nominees any or all of the Collateral. In addition, Secured Party shall have the right at any time to exchange certificates or instruments representing or evidencing Collateral for certificates or instruments of smaller or larger denominations. ARTICLE II. REPRESENTATIONS AND WARRANTIES 2.1 Representations and Warranties. Debtor represents and warrants, with respect to itself and the Collateral, as follows: 6 11 (a) All of the Equipment, Fixtures and Inventory pledged by Debtor hereunder is located at the places specified on Schedule 1 hereto (as supplemented from time to time by Debtor by written notice to Secured Party) or Inventory in transit to a place specified on Schedule 1 hereto (as supplemented from time to time by Debtor by written notice to Secured Party) or Inventory in transit (i) for sale to a third-party purchaser that upon such sale will become the obligor under a Receivable and (ii) pursuant to a sale in the ordinary course of Debtor's business. The chief place of business and chief executive office of Debtor and the office where Debtor keeps all of its records concerning the Receivables, are located at One Allentown Parkway, Allen, Texas 75002. All Chattel Paper, promissory notes or other instruments evidencing the Receivables have been delivered and pledged to Secured Party duly endorsed and accompanied by such duly executed instruments of transfer or assignment as are necessary for such pledge, to be held as pledged collateral. Debtor has possession and control of the Equipment and Inventory pledged by it hereunder. The record owner of the real estate upon which the Equipment, Fixtures and Inventory are located are indicated on Schedule 1. (b) Debtor is the legal and beneficial owner of the Collateral pledged by it free and clear of any Lien, security interest, option or other charge or encumbrance except for the security interest created by this Agreement and Permitted Liens. No effective financing statement or other similar document used to perfect and preserve a security interest under the Laws of any jurisdiction covering all or any part of the Collateral is on file in any recording office, except (i) such as may have been filed in favor of Secured Party relating to this Agreement and (ii) financing statements for which Debtor will provide to Secured Party on the Closing Date proper original executed termination statements. As of the date hereof, Debtor (including any corporate or partnership predecessor) has no trade names and has not existed or operated under any name other than "Advanced Neuromodulation Systems, Inc." or "Neuromed, Inc.," since March 3, 1987. (c) This Agreement and the pledge of the Collateral pursuant hereto creates a valid and, upon filing of financing statements in the Uniform Commercial Code records described on Schedule 8, perfected first priority security interest in the Collateral (other than deposit accounts in financial institutions which are not Secured Party or subject to a Broker Agreement), securing the payment of the Obligations, and all filings and other actions necessary or desirable to perfect and protect such security interest and such priority have been duly taken (or will be taken). (d) Except as described on Schedule 2, no consent of any other Person and no authorization, approval or other action by, and no notice to or filing with, any Tribunal is required (i) for the pledge by Debtor of the Collateral pledged by it hereunder, for the grant by Debtor of the security interest granted hereby or for the execution, delivery or performance of this Agreement by Debtor, (ii) for the perfection or maintenance of the pledge, assignment and security interest created hereby (including the first priority nature of such pledge, assignment and security interest) or (iii) for the exercise by Secured Party of the Rights provided for in this Agreement or the remedies in respect of the Collateral pursuant to this Agreement. 7 12 (e) Schedule 3 is a complete and correct list of all deposit accounts (demand, time, special or other) maintained by or in which Debtor has an interest and correctly describes the financial institution in which such account is maintained (including the specific branch), the address and ABA number of such institution, the officer of such institution having primary responsibility for Debtor's accounts, the account number and type (as supplemented from time to time by Debtor by written notice to Secured Party). (f) Debtor possesses all licenses and Permits, including but not limited to all applicable certificates of occupancy, licenses and Permits, and all health and sanitation permits, required for the operations of its business. Schedule 9 is a complete and correct description of all of such licenses and Permits. (g) Schedule 4 is a complete and correct list of all insurance policies for which Debtor is an insured or for which Debtor is a loss payee. (h) Schedule 5 is a complete and correct list of all agreements with each Person related to the resale and distribution of Inventory for each Person who, during the preceding fiscal year, sold or distributed $25,000 or more of Debtor's Inventory. (i) All Inventory of Debtor produced by Debtor in the United States of America has been produced in compliance with the Fair Labor Standards Act. (j) Debtor's federal taxpayer identification number is 59-2071994. (k) There are no conditions precedent to the effectiveness of this Agreement that have not been satisfied or waived. ARTICLE III. COVENANTS 3.1 Further Assurances. (a) Debtor agrees that, where any agreement intended to be Collateral existing as of the date hereof or hereafter to which Debtor is a party contains any restriction prohibiting Debtor from granting any security interest under this Agreement, Debtor will use its best efforts to obtain the necessary consent to or waiver of such restriction from any Person so as to enable Debtor to effectively grant to Secured Party such security interest under this Agreement. (b) Debtor agrees that from time to time, at the expense of Debtor, Debtor will promptly execute and deliver all further instruments and documents, and take all further action, that may be reasonably necessary or desirable, or that Secured Party may reasonably request, in order to perfect and protect any pledge, assignment or security interest granted or purported to 8 13 be granted hereby, and the priority thereof, or to enable Secured Party to exercise and enforce its rights and remedies hereunder with respect to any Collateral. Without limiting the generality of the foregoing, upon written request by Secured Party, Debtor will: (i) mark conspicuously each Chattel Paper included in Receivables, and, at the request of Secured Party, each of its records pertaining to the Collateral with the following legend: THIS INSTRUMENT IS SUBJECT TO A SECURITY INTEREST AND LIEN PURSUANT TO A FIRST AMENDED AND RESTATED SECURITY AGREEMENT DATED MARCH 3, 1997 (AS THE SAME MAY BE MODIFIED OR RESTATED) MADE BY ADVANCED NEUROMODULATION SYSTEMS, INC., IN FAVOR OF NATIONSBANK OF TEXAS, N.A. or such other legend, in form and substance satisfactory to and as specified by Secured Party, indicating that such Chattel Paper or Collateral is subject to the pledge, assignment and security interest granted hereby; (ii) if any Collateral shall be evidenced by a promissory note or other Instrument or be Chattel Paper, deliver and pledge to Secured Party hereunder such note, Instrument or Chattel Paper duly indorsed and accompanied by duly executed instruments of transfer or assignment, all in form and substance satisfactory to Secured Party; and (iii) execute and file such financing or continuation statements, or amendments thereto, and such other instruments or notices, as may be necessary or desirable, or as Secured Party may request, in order to perfect and preserve the pledge, assignment and security interest granted (and the priority thereof) or purported to be granted hereby. (c) Debtor hereby authorizes Secured Party to file one or more financing or continuation statements, and amendments thereto, relating to all or any part of the Collateral without the signature of Debtor where permitted by Law. A photocopy or other reproduction of this Agreement or any financing statement covering the Collateral or any part thereof shall be sufficient as a financing statement where permitted by Law. (d) Debtor will furnish to Secured Party from time to time statements and schedules further identifying and describing the Collateral (including information in connection with the protection, preservation, maintenance or enforcement of the security interest) and such other reports in connection with the Collateral as Secured Party may reasonably request, all in reasonable detail; provided, if no Default or Event of Default exists, Secured Party will not make more than one request in any six month period. (e) Debtor shall not establish or maintain any deposit or similar bank account not listed on Schedule 3 unless Secured Party receives prior written notice thereof, Debtor executes and delivers to Secured Party assignments of such account in such form as Secured Party may request and the financial institution in which such account will be maintained delivers to Secured 9 14 Party acknowledgments of the assignment of such account in form and substance satisfactory to Secured Party. (f) In addition to such other information as shall be specifically provided for herein, Debtor shall, if a Default or an Event of Default exists, furnish to Secured Party such other information with respect to the Collateral as Secured Party may reasonably request from time to time in connection with the Collateral, including, without limitation, all documents and things in Debtor's possession, or subject to its demand for possession, related to the production and sale by Debtor, or any subsidiary, licensee or subcontractor thereof, of products or services sold by or under the authority of Debtor, including by way of example, without limiting the interest granted by this Agreement: (i) all lists and ancillary documents which identify and describe any of Debtor's customers, advertisers, or those of its Subsidiaries or licensees, for products sold or services rendered, including without limitation, such existing lists and ancillary documents which contain each customer's full name and address, the identity of the Person or Persons having the principal responsibility on each customer's behalf for ordering products or services of the kind supplied by Debtor, the credit, payment, discount, delivery and other sale terms applicable to such customer, together with detailed information setting forth the total purchases and the patterns of such purchases; (ii) all product and service specification documents and production and quality of services sold; (iii) all documents which reveal the names and addresses of all sources of supply, and all terms of purchase and delivery, for all materials and components used in the production of products or provision of services sold; and (iv) all documents constituting or concerning the then current or proposed advertising and promotion by Debtor or its subsidiaries, licensees or subcontractors of products or services sold, including, by way of example and not in limitation, all documents which reveal the media used or to be used and the cost for all such advertising conducted within the described period or planned for such products or services. In connection with its enforcement of the security interest, Secured Party may use such information or transfer it to any assignee or sublicensee permitted hereunder for such assignee's or sublicensee's use. 3.2 Equipment, Fixtures and Inventory. (a) Debtor shall keep the Equipment, Fixtures and Inventory pledged by it hereunder (other than Inventory sold in the ordinary course of business) at the places therefor specified in Section 2.1(a) or, upon thirty days' prior written notice to Secured Party, at such other places in such jurisdiction where all action required by Section 3.1 shall have been taken with respect to the Equipment, Fixtures and Inventory. (b) Debtor shall cause the Equipment and Fixtures pledged by it hereunder to be maintained and preserved in the same condition, repair and working order as when new, ordinary wear and tear excepted, and shall forthwith, or in the case of any loss or damage to any of the Equipment and Fixtures as quickly as practicable after the occurrence thereof, make or cause to be made all repairs, replacements, and other improvements in connection therewith 10 15 which are necessary or desirable to such end (if, pursuant to Section 3.3, Secured Party releases to Debtor insurance payments in respect of the loss or damage). Debtor shall promptly furnish to Secured Party a statement respecting any loss or damage which singly equals or exceeds $25,000 to any of the Equipment and Fixtures pledged by it hereunder. (c) Debtor shall pay promptly when due or before penalty all property and other taxes, assessments and governmental charges or levies imposed upon, and all claims (including claims for labor, materials and supplies) against, the Collateral pledged by it hereunder, except such taxes as are being contested in good faith by appropriate proceedings for which adequate reserves have been established in accordance with GAAP, except where the failure to file such returns, pay such taxes or establish such reserves does not involve unpaid or allegedly unpaid amounts, in aggregate, in excess of $50,000. Debtor shall comply with, and shall cause its licensees to comply with, all requirements of the FDA Act and the Fair Labor Standards Act. 3.3 Insurance. Debtor shall, at its own expense, maintain insurance with respect to the Collateral in accordance with the terms set forth in Section 4.4 of the Credit Agreement. Debtor further covenants and agrees to keep the Collateral which is Equipment, Fixtures and Inventory and other tangible personal property insured in such amounts, against such risks and with such insurers as Secured Party may reasonably require. All such policies of insurance shall be written for the benefit of Secured Party and Debtor, as their interests may appear, and shall provide for at least thirty Business Days' prior written notice of cancellation to Secured Party. Debtor shall promptly furnish to Secured Party evidence of such insurance in form and content satisfactory to Secured Party. If Debtor fails to perform or observe any applicable covenants as to insurance on any of such Collateral, Secured Party may at its own option obtain insurance on only Secured Party's interest in such Collateral, any premium thereby paid by Secured Party to become part of the Obligations, bear interest prior to the existence of an Event of Default, at the then applicable Prime Base Rate, and during the existence of an Event of Default, at the lesser of (a) the Prime Base Rate, plus 3% and (b) the Highest Lawful Rate. In the event Secured Party maintains such substitute insurance, the additional premium for such insurance shall be due on demand and payable by Debtor to Secured Party in accordance with any notice delivered to Debtor by Secured Party. Debtor hereby grants Secured Party a security interest in any refunds of unearned premiums in connection with any cancellation, adjustment or termination of any policy of insurance required by Secured Party and in all proceeds of such insurance and hereby appoints Secured Party its attorney-in-fact to endorse any check or draft that may be payable to Debtor in order to collect such refunds or proceeds. Any such sums collected by Secured Party shall be credited, except to the extent applied to the purchase by Secured Party of similar insurance, to any amounts then owing on the Obligations in accordance with the Credit Agreement. If no Default under Section 4.2, 5.6, 5.7, 5.8, 5.9 or 5.11 of the Credit Agreement or an Event of Default exists, Lender shall deliver to Debtor all insurance payments in respect of any covered loss and any refund of any premium or other payment; provided Debtor uses the payment in respect of an insured loss to acquire a replacement asset of similar value. 11 16 3.4 Place of Perfection; Records; Collection of Receivables, Chattel Paper and Instruments. (a) Debtor shall keep its chief place of business and chief executive office and the office where it keeps its records concerning the Receivables, and the originals of all Chattel Paper, at the location therefor specified in Section 2.1(a) or at such other location in the State of Texas as Debtor shall have given written notice thereof to Secured Party no later than 30 days prior to the moving thereto. Debtor shall deliver to Secured Party all original Brokerage Agreements to be held by Secured Party as collateral. Debtor will hold and preserve such records and Chattel Paper and will permit representatives of Secured Party at any time during normal business hours to inspect and make abstracts from and copies of such records and Chattel Paper. Debtor shall deliver to Secured Party all Instruments to be held by Secured Party as collateral. (b) Except as otherwise provided in this Section 3.4(b), Debtor shall continue to collect, at its own expense, all amounts due or to become due Debtor under the Receivables, Chattel Paper and Instruments. In connection with such collections, Debtor may take (and, at Secured Party's direction, shall take) such action as Debtor or Secured Party may deem reasonably necessary or advisable to enforce collection of the Receivables, Chattel Paper and Instruments; provided, however, that Secured Party shall have the right (if an Event of Default exists) (without notice to Debtor) to notify the account debtors or obligors under any Receivables, Chattel Paper and Instruments of the assignment of such Receivables, Chattel Paper and Instruments to Secured Party and to direct such account debtors or obligors to make payment of all amounts due or to become due to Debtor thereunder directly to Secured Party and, at the expense of Debtor, to enforce collection of any such Receivables, Chattel Paper and Instruments, and to adjust, settle or compromise the amount or payment thereof, in the same manner and to the same extent as Debtor might have done. All amounts and proceeds (including Instruments) received by Debtor in respect of the Receivables, Chattel Paper and Instruments shall be received in trust for the benefit of Secured Party hereunder, shall be segregated from other funds of Debtor and shall be forthwith paid over to Secured Party in the same form as so received (with any necessary indorsement) to be held as cash collateral and either (A) released to Debtor so long as no Default under Section 4.2, 5.5, 5.7, 5.8, 5.9 or 5.11 of the Credit Agreement or Event of Default exists or (B) if any Default under Section 4.2, 5.6, 5.7, 5.8, 5.9 or 5.11 of the Credit Agreement or Event of Default exists, applied as provided herein. Debtor shall not adjust, settle or compromise the amount or payment of any Receivable, Chattel Paper or Instrument, release wholly or partly any account debtor or obligor thereof, or allow any credit or discount thereon except in accordance with Debtor's historical operating procedure. 3.5 Transfers and Other Liens. Debtor shall not (i) sell, assign (by operation of Law or otherwise) or otherwise dispose of, or grant any option with respect to, any of the Collateral, except as permitted under the Credit Agreement and this Agreement, or (ii) create or permit to exist any Lien, security interest, option or other charge or encumbrance upon or with respect to 12 17 any of the Collateral, except for the security interest under this Agreement (and except as provided for in the Credit Agreement). Debtor may sell Inventory in the ordinary course of business. Debtor may sell investments subject to a Brokerage Agreement in which Secured Party has a security interest; provided, that the proceeds of such sale are subject to a Brokerage Agreement in which Secured Party has a perfected, first priority security interest in favor of Secured Party and such sale is in the ordinary course of Debtor's investment portfolio management. Debtor shall not permit any amendment, restatement or termination of any Brokerage Agreement without the prior written consent of Secured Party. 3.6 Brokerage Agreements. (a) Debtor shall, if any of the shares, securities, moneys or property previously held by a Person other than Debtor pursuant to a Brokerage Agreement are received by Debtor, forthwith transfer and deliver to Secured Party such shares, securities, moneys or property so received by Debtor (together with the certificates for any such shares and securities duly endorsed in blank or accompanied by undated stock powers duly executed in blank), all of which thereafter shall be held by Secured Party, pursuant to the terms of this Agreement, as part of the Collateral; provided, that if no Event of Default exists, Debtor may receive cash distributions and dividends (not consisting of a distribution of or return of capital) declared and paid with respect to any securities. (b) (i) For the better perfection of Secured Party's Rights in and to the Brokerage Agreements or any part thereof and to facilitate implementation of such Rights, Debtor shall, insofar as possible, if an Event of Default exists and upon the request of Secured Party (if Secured Party deems such action necessary to the perfection or priority of the Liens in the Collateral), cause the Brokerage Agreements to be transferred, registered or otherwise put into the name or names of such nominee or nominees of Secured Party as Secured Party shall from time to time direct. (ii) So long as no Event of Default exists (and after any Event of Default until, by notice to Debtor, Secured Party elects while the Event of Default is continuing to exercise the right to vote or consent), Debtor shall retain the right to exercise all voting, consensual and other power of ownership pertaining to the Brokerage Agreements owned by it for all purposes not inconsistent with the terms of this Agreement or any other Loan Paper; and Secured Party shall execute and deliver to Debtor or cause to be executed and delivered to Debtor all such proxies, powers of attorney, dividend and other orders, and all such instruments, without recourse, as Debtor may reasonably request for the purpose of enabling Debtor to exercise the rights and powers which it is entitled to exercise pursuant to this Section 3.6. (iii) If any Event of Default exists, and whether or not Secured Party exercises any available Right to declare any Obligations due and payable or seeks or 13 18 pursues any other relief or remedy available under applicable Laws or under any agreement relating to such Obligations, all distributions and dividends on any securities and payments and distributions in respect of each Brokerage Agreement shall be paid directly to Secured Party and retained by it as part of the Collateral subject to the terms of this Agreement, and, if Secured Party shall so request, Debtor agrees to execute and deliver to Secured Party appropriate additional dividend, distribution and other orders and documents to that end. 3.7 Rights to Dividends and Distributions. With respect to any certificates, bonds, or other instruments or securities (including but not limited to any certificate or participation issued in any proceeding under any Debtor Relief Law) constituting a part of the Collateral, Secured Party shall have authority if an Event of Default exists, without notice to Debtor, either to have the same registered in Secured Party's name or in the name of a nominee, and, with or without such registration, to demand of the issuer thereof, and to receive and receipt for, any and all distributions (including any stock or similar dividend or distribution) payable in respect thereof, whether they be ordinary or extraordinary. Except for any property maintained in a Brokerage Account, if Debtor shall become entitled to receive or shall receive any interest in or certificate (including, without limitation, any interest in or certificate representing a distribution in connection with any reclassification, increase, or reduction of capital, or issued in connection with any reorganization), or any option or rights arising from or relating to any of the Collateral, whether as an addition to, in substitution of, as a conversion of, or in exchange for any of the Collateral, or otherwise, Debtor agrees to accept the same as Secured Party's agent and to hold the same in trust on behalf of and for the benefit of Secured Party, and to deliver the same immediately to Secured Party in the exact form received, with appropriate undated stock or similar powers, duly executed in blank, to be held by Secured Party, subject to the terms hereof, as Collateral. Unless an Event of Default is in existence, Debtor shall be entitled to receive all cash dividends paid in respect of any of the Collateral (subject to the restrictions of any other Loan Paper). 3.8 Right of Secured Party to Notify Issuers. If an Event of Default exists and at such other times as Secured Party is entitled to receive dividends or distributions and other property in respect of or consisting of Instruments and securities, Secured Party may notify each party to a Brokerage Agreement and issuers of the Instruments and securities to make payments of all dividends and distributions directly to Secured Party and Secured Party may take control of all proceeds of any Instruments and securities. Until Secured Party elects to exercise such Rights, during the continuance of an Event of Default, Debtor, as agent of Secured Party, shall collect and segregate all dividends and distributions and other amounts paid or distributed with respect to the Instruments and securities. 3.9 Secured Party Appointed Attorney-in-Fact. Debtor hereby irrevocably appoints Secured Party Debtor's attorney-in-fact, with full authority in the place and stead of Debtor and in the name of Debtor or otherwise to take any action and to execute any instrument which 14 19 Secured Party may deem necessary or advisable to accomplish the purposes of this Agreement, including, without limitation (provided that the actions listed in each clause below other than the obtainment of insurance may only be taken or exercised if an Event of Default exists): (a) to obtain and adjust insurance required to be paid to Secured Party pursuant to Section 3.3, (b) to ask, demand, collect, sue for, recover, compromise, receive and give acquittance and receipts for moneys due and to become due under or in connection with the Collateral, (c) to receive, indorse, and collect any drafts or other Instruments, documents and Chattel Paper, in connection therewith, and (d) to file any claims or take any action or institute any proceedings which Secured Party may deem necessary or desirable for the collection of any of the Collateral or otherwise to enforce compliance with the terms and conditions of any Collateral or the rights of Secured Party with respect to any of the Collateral. DEBTOR HEREBY IRREVOCABLY GRANTS TO SECURED PARTY DEBTOR'S PROXY (EXERCISABLE IF AN EVENT OF DEFAULT EXISTS) TO VOTE ANY SECURITIES COLLATERAL AND APPOINTS SECURED PARTY DEBTOR'S ATTORNEY-IN-FACT TO PERFORM ALL OBLIGATIONS OF DEBTOR UNDER THIS AGREEMENT AND TO EXERCISE ALL OF SECURED PARTY'S RIGHTS HEREUNDER. THE PROXY AND EACH POWER OF ATTORNEY HEREIN GRANTED, AND EACH STOCK POWER AND SIMILAR POWER NOW OR THEREAFTER GRANTED (INCLUDING ANY EVIDENCED BY A SEPARATE WRITING), ARE COUPLED WITH AN INTEREST AND ARE IRREVOCABLE PRIOR TO FINAL PAYMENT IN FULL OF THE OBLIGATIONS. ARTICLE IV. RIGHTS AND POWERS OF SECURED PARTY 4.1 Secured Party May Perform. If Debtor fails to perform any agreement contained herein, Secured Party may itself perform, or cause performance of, such agreement, and the expenses of Secured Party incurred in connection therewith shall be payable by Debtor under Section 4.5. 4.2 Secured Party's Duties. The powers conferred on Secured Party hereunder are solely to protect its interest in the Collateral and shall not impose any duty upon it or any Secured Party to exercise any such powers. Except for the safe custody of any Collateral in its possession and the accounting for moneys actually received by it hereunder, Secured Party shall have no duty as to any Collateral, as to ascertaining or taking action with respect to calls, conversions, exchanges, maturities, tenders or other matters relative to any Collateral, whether 15 20 or not Secured Party has or is deemed to have knowledge of such matters, or as to the taking of any necessary steps to preserve rights against prior parties or any other rights pertaining to any reasonable care in the custody and preservation of any Collateral in its possession if such Collateral is accorded treatment substantially equal to that which Secured Party accords its own property. Except as provided in this Section 4.2, Secured Party shall not have any duty or liability to protect or preserve any Collateral or to preserve rights pertaining thereto. Nothing contained in this Agreement shall be construed as requiring or obligating Secured Party, and Secured Party shall not be required or obligated, to (a) present or file any claim or notice or take any action, with respect to any Collateral or in connection therewith or (b) notify Debtor of any decline in the value of any Collateral. 4.3 Remedies. If any Event of Default exists: (a) Secured Party may exercise in respect of the Collateral, in addition to other rights and remedies provided for herein or otherwise available to it, all the rights and remedies of a secured party on default under the Uniform Commercial Code in effect in the State of Texas at that time (the "UCC") (whether or not the Uniform Commercial Code applies to the affected Collateral), and also may (i) require Debtor to, and Debtor hereby agrees that it will at its expense and upon request of Secured Party forthwith, assemble all or part of the Collateral as directed by Secured Party and make it available to Secured Party at a place to be designated by Secured Party which is reasonably convenient to both parties at public or private sale, at any of Secured Party's offices or elsewhere, for cash, on credit or for future delivery, and upon such other terms as Secured Party may deem commercially reasonable. Debtor agrees that, to the extent notice of sale shall be required by Law, ten days' notice to Debtor of the time and place of any public sale or the time after which any private sale is to be made shall constitute reasonable notification. Secured Party shall not be obligated to make any sale of Collateral regardless of notice of sale having been given. Secured Party may adjourn any public or private sale from time to time by announcement at the time and place fixed therefor, and such sale may, without further notice, be made at the time and place to which it was so adjourned. (b) All cash proceeds received by Secured Party upon any sale of, collection of, or other realization upon, all or any part of the Collateral shall be applied as follows: First: To the payment of all out-of-pocket costs and expenses incurred in connection with the sale of, collection of or other realization upon Collateral, including reasonable attorneys' fees and disbursements; Second: To the payment of the Obligations in such order and in such manner consistent with applicable Laws as Secured Party in its discretion shall decide (with Debtor remaining liable for any deficiency); and 16 21 Third: To the extent of the balance (if any) of such proceeds, to Debtor or other Person legally entitled thereto. (c) All payments received by Debtor under or in connection with any Collateral shall be received in trust for the benefit of Secured Party, shall be segregated from other funds of Debtor and shall be forthwith paid over to Secured Party in the same form as so received (with any necessary indorsement). (d) Because of the FDA Act, the Securities Act of 1933, as amended ("Securities Act") and other Laws, including without limitation state blue sky Laws, or contractual restrictions or agreements imposed by any licensor or licensee of certain Rights, there may be legal restrictions or limitations affecting Secured Party in any attempts to dispose of the Collateral and the enforcement of its Rights hereunder. For these reasons, Secured Party is hereby authorized by Debtor, but not obligated, if any Event of Default exists, to sell or otherwise dispose of any of the Collateral at private sale, subject to an investment letter, or in any other manner which will be in compliance with the FDA Act, will not require the Collateral, or any part thereof, to be registered in accordance with the Securities Act, and the rules and regulations promulgated under the foregoing, and each other Law applicable to the Collateral. Secured Party is also hereby authorized by Debtor, but not obligated, to take such actions, give such notices, obtain such consents, and do such other things as Secured Party may deem required or appropriate under the FDA Act, Securities Act or other Laws or contractual restrictions or agreements in the event of a sale or disposition of any Collateral. Debtor clearly understands that Secured Party may in its discretion approach a restricted number of potential purchasers and that a sale under such circumstances may yield a lower price for the Collateral than would otherwise be obtainable if same were registered and sold in the open market. No sale so made in good faith by Secured Party shall be deemed to be not "commercially reasonable" because so made. Debtor agrees that in the event Secured Party shall, if an Event of Default exists, sell the Collateral or any portion thereof at any private sale or sales, Secured Party shall have the right to rely upon the advice and opinion of appraisers and other Persons, which appraisers and other Persons are acceptable to Secured Party, as to the best price reasonably obtainable upon such a private sale thereof. In the absence of fraud, such reliance shall be conclusive evidence that Secured Party handled such matter in a commercially reasonable manner under applicable Law. 4.4 Further Approvals Required. (a) In connection with the exercise by Secured Party of its Rights hereunder that effects the disposition of or use of any Collateral, it may be necessary to obtain the prior consent or approval of Tribunals and other Persons to a transfer or assignment of Collateral, including, without limitation, the FDA. (b) Debtor hereby agrees, if an Event of Default exists, to execute, deliver, and file, and hereby appoints (to the extent permitted under applicable Law) Secured Party as its attorney- 17 22 in-fact, if an Event of Default exists, to execute, deliver, and file on Debtor's behalf and in Debtor's name, all applications, certificates, filings, instruments, and other documents (including without limitation any application for an assignment or transfer of control or ownership) that may be necessary or appropriate, in Secured Party's opinion, to obtain such consents, waivers, or approvals. Debtor further agrees to use its best efforts to obtain the foregoing consents, waivers, and approvals, including receipt of consents, waivers, and approvals under applicable agreements prior to a Default or Event of Default. Debtor acknowledges that there is no adequate remedy at Law for failure by it to comply with the provisions of this Section 4.4(b) and that such failure would not be adequately compensable in damages, and therefore agrees that this Section 4.4(b) may be specifically enforced. 4.5 INDEMNITY AND EXPENSES. (A) DEBTOR AGREES TO INDEMNIFY SECURED PARTY FROM AND AGAINST ANY AND ALL CLAIMS, LOSSES AND LIABILITIES (INCLUDING REASONABLE ATTORNEYS' FEES) GROWING OUT OF OR RESULTING FROM THIS AGREEMENT (INCLUDING, WITHOUT LIMITATION, ENFORCEMENT OF THIS AGREEMENT), EXCEPT CLAIMS, LOSSES OR LIABILITIES RESULTING FROM SECURED PARTY'S GROSS NEGLIGENCE OR WILLFUL MISCONDUCT. (b) Debtor will upon demand pay to Secured Party the amount of any and all reasonable expenses, including the reasonable fees and expenses of its counsel and of any experts and agents, which Secured Party may incur in connection with (i) the administration of this Agreement, (ii) the custody, preservation, use or operation of, or the sale of, collection from, or other realization upon, any of the Collateral, (iii) the exercise or enforcement of any of the Rights of Secured Party hereunder or (iv) the failure by Debtor to perform or observe any of the provisions hereof. Any payments so made shall be a part of the Obligation, shall be payable upon demand, and shall bear interest (i) if no Event of Default exists, at the Prime Base Rate, and (ii) if an Event of Default exists, at the lesser of (A) the Prime Base Rate plus 3% and (B) the Highest Lawful Rate. ARTICLE V. MISCELLANEOUS 5.1 Cumulative Rights. All Rights of Secured Party under the Loan Papers are cumulative of each other and of every other Right which Secured Party may otherwise have at Law or in equity or under any other contract or other writing for the enforcement of the security interest herein or the collection of the Obligations. The exercise of one or more Rights shall not prejudice or impair the concurrent or subsequent exercise of other Rights. 5.2 Modifications; Amendments; Schedules; Etc. No amendment or waiver of any provision of this Agreement, and no consent to any departure by Debtor here from, shall in any event be effective unless the same shall be in writing and signed by Secured Party, and then such 18 23 waiver or consent shall be effective only in the specific instance and for the specific purpose for which given. Upon any change in any material information disclosed on any schedule, Debtor shall promptly prepare and deliver to Secured Party a replacement schedule, indicating its effective date, in form and substance satisfactory to Secured Party and amendments to and additional financing statements as Secured Party may require to preserve and perfect a first priority security interest in the Collateral. 5.3 Continuing Security Interest. This Agreement shall create a continuing security interest in the Collateral and shall (a) remain in full force and effect until the later of (i) the final payment in full of the Obligations and all amounts payable under this Agreement and (ii) the expiration or termination of the obligations of Secured Party to extend credit to Debtor, (b) be binding upon Debtor, its successors and assigns, and (c) inure to the benefit of, and be enforceable by, Secured Party and its successors, transferees and assigns. Upon any such termination, Secured Party will, at Debtor's expense, execute and deliver to Debtor such documents as such Debtor shall reasonably request to evidence such termination. 5.4 MANDATORY ARBITRATION. (A) ANY CONTROVERSY OR CLAIM BETWEEN OR AMONG THE PARTIES HERETO INCLUDING BUT NOT LIMITED TO THOSE ARISING OUT OF OR RELATING TO THIS AGREEMENT OR ANY RELATED AGREEMENTS OR INSTRUMENTS, INCLUDING ANY CLAIM BASED ON OR ARISING FROM AN ALLEGED TORT, SHALL BE DETERMINED BY BINDING ARBITRATION IN ACCORDANCE WITH THE FEDERAL ARBITRATION ACT (OR IF NOT APPLICABLE, THE APPLICABLE STATE LAW), THE RULES OF PRACTICE AND PROCEDURE FOR THE ARBITRATION OF COMMERCIAL DISPUTES OF JUDICIAL ARBITRATION AND MEDIATION SERVICES, INC. ("JAMS"), AND THE "SPECIAL RULES" SET FORTH BELOW. IN THE EVENT OF ANY INCONSISTENCY, THE SPECIAL RULES SHALL CONTROL. JUDGMENT UPON ANY ARBITRATION AWARD MAY BE ENTERED IN ANY COURT HAVING JURISDICTION. ANY PARTY TO THIS AGREEMENT MAY BRING AN ACTION, INCLUDING A SUMMARY OR EXPEDITED PROCEEDING, TO COMPEL ARBITRATION OF ANY CONTROVERSY OR CLAIM TO WHICH THIS AGREEMENT APPLIES IN ANY COURT HAVING JURISDICTION OVER SUCH ACTION. (b) Special Rules. The arbitration shall be conducted in Dallas, Texas and administered by JAMS who will appoint an arbitrator; if JAMS is unable or legally precluded from administering the arbitration, then the American Arbitration Association will serve. All arbitration hearings will be commenced within ninety days of the demand for arbitration; further, the arbitrator shall only, upon a showing of cause, be permitted to extend the commencement of such hearing for up to an additional sixty days. 19 24 (c) Reservations of Rights. Nothing in this Agreement or any other Loan Paper shall be deemed to (i) limit the applicability of any otherwise applicable statutes of limitation or repose and any waivers contained in this Agreement; or (ii) be a waiver by Secured Party of the protection afforded to it by 12 U.S.C. Section 91 or any substantially equivalent state law; or (iii) limit the right of Secured Party hereto (A) to exercise self help remedies such as (but not limited to) setoff, or (B) to foreclose against any real or personal property collateral, or (C) to obtain from a court provisional or ancillary remedies such as (but not limited to) injunctive relief or the appointment of a receiver. Secured Party may exercise such self help rights, foreclose upon such property, or obtain such provisional or ancillary remedies before, during or after the pendency of any arbitration proceeding brought pursuant to this Agreement. At Secured Party's option, foreclosure under a deed of trust or mortgage may be accomplished by any of the following: the exercise of a power of sale under the deed of trust or mortgage, or by judicial sale under the deed of trust or mortgage, or by judicial foreclosure. Neither this exercise of self help remedies nor the institution or maintenance of an action for foreclosure or provisional or ancillary remedies shall constitute a waiver of the right of any party, including the claimant in any such action, to arbitrate the merits of the controversy or claim occasioning resort to such remedies. 5.5 GOVERNING LAW; TERMS. THIS AGREEMENT SHALL BE GOVERNED BY AND CONSTRUED IN ACCORDANCE WITH THE LAWS OF THE STATE OF TEXAS, EXCEPT TO THE EXTENT THAT THE VALIDITY OR PERFECTION OF THE SECURITY INTEREST HEREUNDER, OR REMEDIES HEREUNDER, IN RESPECT OF ANY PARTICULAR COLLATERAL ARE GOVERNED BY THE LAWS OF A JURISDICTION OTHER THAN THE STATE OF TEXAS. UNLESS OTHERWISE DEFINED HEREIN OR IN THE CREDIT AGREEMENT, TERMS USED IN ARTICLE 9 OF THE UCC ARE USED HEREIN AS THEREIN DEFINED. 5.6 WAIVER OF JURY TRIAL. SECURED PARTY AND DEBTOR HEREBY WAIVE TRIAL BY JURY IN ANY JUDICIAL PROCEEDINGS INVOLVING, DIRECTLY OR INDIRECTLY, ANY MATTER (WHETHER IN TORT, CONTRACT OR OTHERWISE) IN ANY WAY ARISING OUT OF, RELATED TO, OR CONNECTED WITH THIS AGREEMENT OR THE RELATIONSHIP ESTABLISHED HEREUNDER. 5.7 Secured Party's Right to Use Agents. Secured Party may exercise its Rights under this Agreement through an agent or other designee. 5.8 No Interference, Compensation or Expense. Secured Party may exercise its Rights under this Agreement without payment of any rent, license fee or compensation of any kind to Debtor. 5.9 Waivers of Rights Inhibiting Enforcement. Debtor waives (a) any claim that, as to any part of the Collateral, a public sale, should the Secured Party elect so to proceed, is, in and 20 25 of itself, not a commercially reasonable method of sale for such Collateral, (b) except as otherwise provided in this Agreement, TO THE EXTENT PERMITTED BY APPLICABLE LAW, NOTICE OR JUDICIAL HEARING IN CONNECTION WITH SECURED PARTY'S DISPOSITION OF ANY OF THE COLLATERAL INCLUDING ANY AND ALL PRIOR NOTICE AND HEARING FOR ANY PREJUDGMENT REMEDY OR REMEDIES AND ANY SUCH RIGHT THAT DEBTOR WOULD OTHERWISE HAVE UNDER THE CONSTITUTION OR ANY STATUTE OF THE UNITED STATES OR OF ANY STATE, AND ALL OTHER REQUIREMENTS AS TO THE TIME, PLACE AND TERMS OF SALE OR OTHER REQUIREMENTS WITH RESPECT TO THE ENFORCEMENT OF SECURED PARTY'S RIGHTS HEREUNDER and (c) all rights of redemption, appraisal or valuation. 5.10 Notices and Deliveries. (a) Manner of Delivery. All notices, communications and materials to be given or delivered pursuant to this Agreement shall, except in those cases where giving notice by telephone is expressly permitted, be given or delivered in writing. All written notices, communications and materials shall be sent by registered or certified mail, postage prepaid, return receipt requested, by telecopier, or delivered by hand. In the event of a discrepancy between any telephonic notice and any written confirmation thereof, such written confirmation shall be deemed the effective notice except to the extent Secured Party or Debtor has acted in reliance on such telephonic notice. (b) Addresses. All notices, communications and materials to be given or delivered pursuant to this Agreement shall be given or delivered at the following respective addresses and telecopier and telephone numbers and to the attention of the following individuals or departments: (i) if to Debtor, to it at: Advanced Neuromodulation Systems, Inc. c/o Quest Medical, Inc. One Allentown Parkway Allen, Texas 75002 Telecopier No.: (972) 390-9687 Telephone No.: (972) 390-9800 Attention: F. Robert Merrill III 21 26 (ii) if to Secured Party, to it at: NationsBank of Texas, N.A. NationsBank Plaza 901 Main Street 7th Floor Dallas, Texas 75202 Telecopier No.: (214) 508-3140 Telephone No.: (214) 508-2825 Attention: Commercial Banking or at such other address or, telecopier or telephone number or to the attention of such other individual or department as the party to which such information pertains may hereafter specify for the purpose in a notice to the other specifically captioned "Notice of Change of Address". (c) Effectiveness. Each notice, communication and any material to be given or delivered to Secured Party or Debtor pursuant to this Agreement shall be effective or deemed delivered or furnished (i) if sent by certified mail, return receipt requested, on the fifth Business Day after such notice, communication or material is deposited in the mail, addressed as above provided, (ii) if sent by telecopier, when such notice, communication or material is transmitted to the appropriate number determined as above provided in this Section 5.10 and the appropriate receipt is received or otherwise acknowledged, (iii) if sent by hand delivery or overnight courier, when left at the address of the addressee addressed as above provided, and (iv) if given by telephone, when communicated to the individual or any member of the department specified as the individual or department to whose attention notices, communications and materials are to be given or delivered except that notices of a change of address, telecopier or telephone number or individual or department to whose attention notices, communications and materials are to be given or delivered shall not be effective until received. 5.11 Successors and Assigns. All of the provisions of this Agreement shall be binding and inure to the benefit of the parties thereto and their respective successors and assigns. 5.12 Loan Paper. This Agreement is a Loan Paper executed pursuant to the Credit Agreement and shall (unless otherwise expressly indicated herein) be construed, administered and applied in accordance with the terms and provisions thereof. 5.13 Definitions. Capitalized terms not otherwise defined herein have the meaning specified in the Credit Agreement and, to the extent of any conflict, terms as defined in the Credit Agreement shall control (provided, that a more expansive or explanatory definition shall not be deemed a conflict). 22 27 5.14 Severability. If any provision of any Loan Paper is held to be illegal, invalid, or unenforceable under present or future Laws during the term thereof, such provision shall be fully severable, the appropriate Loan Paper shall be construed and enforced as if such illegal, invalid, or unenforceable provision had never comprised a part thereof, and the remaining provisions thereof shall remain in full force and effect and shall not be affected by the illegal, invalid, or unenforceable provision or by its severance therefrom. Furthermore, in lieu of such illegal, invalid, or unenforceable provision there shall be added automatically as a part of such Loan Paper a legal, valid, and enforceable provision as similar in terms to the illegal, invalid, or unenforceable provision as may be possible. 5.15 Obligations Not Affected. To the fullest extent permitted by applicable Law, the obligations of Debtor under this Agreement shall remain in full force and effect without regard to, and shall not be impaired or affected by: (a) any amendment or modification or addition or supplement to any Loan Paper, any instrument delivered in connection therewith or any assignment or transfer thereof; (b) any exercise, non-exercise, or waiver by Secured Party of any Right, remedy, power or privilege under or in respect of, or any release of any guaranty, any collateral or the Collateral or any part thereof provided pursuant to, this Agreement or any Loan Paper; (c) any waiver, consent, extension, indulgence or other action or inaction in respect of this Agreement or any Loan Paper or any assignment or transfer of any thereof; or (d) any bankruptcy, insolvency, reorganization, arrangement, readjustment, composition, liquidation or the like of Debtor, or any other Person, whether or not Debtor shall have notice or knowledge of any of the foregoing. 5.16 Prior Security Agreements. This Agreement restates in their entirety each of the Facility A Security Agreement and the Existing Security Agreement. 5.17 Counterparts. This Agreement may be executed in any number of counterparts, each of which when so executed and delivered shall be deemed an original, but all such counterparts together shall constitute but one and the same instrument. 5.18 ENTIRE AGREEMENT. THIS WRITTEN AGREEMENT, TOGETHER WITH THE OTHER LOAN PAPERS, REPRESENT THE FINAL AGREEMENT BETWEEN THE PARTIES AND MAY NOT BE CONTRADICTED BY EVIDENCE OF PRIOR, CONTEMPORANEOUS, OR SUBSEQUENT ORAL AGREEMENTS OF THE PARTIES. THERE ARE NO UNWRITTEN ORAL AGREEMENTS AMONG THE PARTIES. 23 28 REMAINDER OF PAGE INTENTIONALLY LEFT BLANK 24 29 IN WITNESS WHEREOF, Debtor and Secured Party have caused this Agreement to be duly executed and delivered as of the date first above written. DEBTOR: ADVANCED NEUROMODULATION SYSTEMS, INC. By: /s/ F. ROBERT MERRILL III ------------------------------------ F. Robert Merrill III, Vice President SECURED PARTY: NATIONSBANK OF TEXAS, N.A. By: /s/ BRIAN K. SCHNEIDER ------------------------------------ Brian K. Schneider, Vice President 25 EX-10.20 7 1ST AMENDED & RESTATED INTELLECTUAL PROPERTY AGRMT 1 EXHIBIT 10.20 ================================================================================ FIRST AMENDED AND RESTATED INTELLECTUAL PROPERTY SECURITY AGREEMENT AND ASSIGNMENT dated as of March 3, 1997 Between QUEST MEDICAL, INC. as Debtor and NATIONSBANK OF TEXAS, N.A. as Secured Party ================================================================================ 2 TABLE OF CONTENTS
Page ---- ARTICLE I. ASSIGNMENT AND GRANT OF SECURITY INTEREST 1.1 Assignment and Grant of Security Interest . . . . . . . . . 2 1.2 Security for Obligations . . . . . . . . . . . . . . . . . . 2 1.3 Validity and Priority of Security Interest . . . . . . . . . 2 1.4 Maintenance of Status of Security Interest, Collateral and Rights . . . . . . . . . . . . . . . . . . . . . . . . . 2 (a) Required Action . . . . . . . . . . . . . . . . . . . 2 (b) Protection of Collateral . . . . . . . . . . . . . . 3 (c) Authorized Action . . . . . . . . . . . . . . . . . . 3 (d) State Registrations . . . . . . . . . . . . . . . . . 3 1.5 Debtor Remains Obligated; Secured Party Not Obligated . . . 3 1.6 Termination . . . . . . . . . . . . . . . . . . . . . . . . 3 1.7 Security Interest Absolute . . . . . . . . . . . . . . . . . 4 ARTICLE II. REPRESENTATIONS AND WARRANTIES 2.1 Organization; Power . . . . . . . . . . . . . . . . . . . . 4 2.2 Authorization; Enforceability; Required Consents; Absence of Conflicts . . . . . . . . . . . . . . . . . . . . . . . . . 4 2.3 Accuracy of Questionnaire . . . . . . . . . . . . . . . . . 5 2.4 Rights of Debtor . . . . . . . . . . . . . . . . . . . . . . 5 2.5 Perfection . . . . . . . . . . . . . . . . . . . . . . . . . 5 2.6 State Registrations . . . . . . . . . . . . . . . . . . . . 5 ARTICLE III. COVENANTS 3.1 Certain Matters Relating to Preservation of Status of Security Interest . . . . . . . . . . . . . . . . . . . . . . . . . . 5 (a) Chief Executive Office . . . . . . . . . . . . . . . 5 (b) Change of Name, Identity, etc. . . . . . . . . . . . 5 3.2 Preservation of Existence and Preservation of Enforceability 5 3.3 Requested Information . . . . . . . . . . . . . . . . . . . 6 3.4 No Disposition of Collateral . . . . . . . . . . . . . . . . 6 3.5 Additional Property . . . . . . . . . . . . . . . . . . . . 6 ARTICLE IV. EVENT OF DEFAULT 4.1 Application of Proceeds . . . . . . . . . . . . . . . . . . 7 4.2 Remedies . . . . . . . . . . . . . . . . . . . . . . . . . . 7 (a) Power of Sale . . . . . . . . . . . . . . . . . . . . 7 (b) Receiver . . . . . . . . . . . . . . . . . . . . . . 8
- i - 3 (c) Enforcement by Secured Party . . . . . . . . . . . . 8 (d) Other Loan Papers; Laws . . . . . . . . . . . . . . . 8 (e) Sale Restrictions . . . . . . . . . . . . . . . . . . 8 4.3 INDEMNITY AND EXPENSES . . . . . . . . . . . . . . . . . . . 8 ARTICLE V. INTERPRETATION 5.1 Definitional Provision . . . . . . . . . . . . . . . . . . . 9 (a) Certain Terms Defined by Reference . . . . . . . . . 9 (b) Other Defined Terms . . . . . . . . . . . . . . . . . 9 (c) Other Definitional Provisions . . . . . . . . . . . . 12 5.2 Power of Attorney . . . . . . . . . . . . . . . . . . . . . 12 ARTICLE VI. MISCELLANEOUS 6.1 Expenses of Debtor's Agreements and Duties . . . . . . . . . 12 6.2 Secured Party's Right to Perform on Debtor's Behalf . . . . 12 6.3 Secured Party's Right to Use Agents . . . . . . . . . . . . 13 6.4 No Interference, Compensation or Expense . . . . . . . . . . 13 6.5 Limitation of Secured Party's Obligations With Respect to Collateral . . . . . . . . . . . . . . . . . . . . . . . . . 13 6.6 Rights of Secured Party under UCC and Applicable Law . . . . 13 6.7 Waivers of Rights Inhibiting Enforcement . . . . . . . . . . 13 6.8 Notices and Deliveries . . . . . . . . . . . . . . . . . . . 14 (a) Manner of Delivery . . . . . . . . . . . . . . . . . 14 (b) Addresses . . . . . . . . . . . . . . . . . . . . . . 14 (c) Effectiveness . . . . . . . . . . . . . . . . . . . . 15 (d) Designation of Notice . . . . . . . . . . . . . . . . 15 6.9 Rights and Remedies Cumulative . . . . . . . . . . . . . . . 15 6.10 Amendments; Waivers . . . . . . . . . . . . . . . . . . . . 15 6.11 Assignments . . . . . . . . . . . . . . . . . . . . . . . . 15 6.12 MANDATORY ARBITRATION . . . . . . . . . . . . . . . . . . . 16 6.13 GOVERNING LAW . . . . . . . . . . . . . . . . . . . . . . . 17 6.14 WAIVER OF JURY TRIAL . . . . . . . . . . . . . . . . . . . . 17 6.15 Consent to Jurisdiction; Waiver of Immunities . . . . . . . 17 6.16 Severability of Provisions . . . . . . . . . . . . . . . . . 17 6.17 Counterparts . . . . . . . . . . . . . . . . . . . . . . . . 18 6.18 Successors and Assigns . . . . . . . . . . . . . . . . . . . 18 6.19 Loan Papers . . . . . . . . . . . . . . . . . . . . . . . . 18 6.20 Obligations Not Affected . . . . . . . . . . . . . . . . . . 18 6.21 ENTIRE AGREEMENT . . . . . . . . . . . . . . . . . . . . . . 18
- ii - 4 FIRST AMENDED AND RESTATED INTELLECTUAL PROPERTY SECURITY AGREEMENT AND ASSIGNMENT FIRST AMENDED AND RESTATED INTELLECTUAL PROPERTY SECURITY AGREEMENT AND ASSIGNMENT, dated as of March 3, 1997, between Quest Medical, Inc., a Texas corporation ("Debtor"), and NationsBank of Texas, N.A., a national banking association ("Secured Party"). BACKGROUND. (1) Secured Party and Debtor have entered into the First Amended and Restated Credit Agreement dated as of March 31, 1995 (such agreement, together with all amendments and restatements thereof, being the "1995 Credit Agreement"). (2) Secured Party and Debtor have entered into the Second Amended and Restated Credit Agreement dated as of February 9, 1996 (such agreement, together with all amendments and restatements thereof, the "Existing Credit Agreement") which restates in its entirety the 1995 Credit Agreement. (3) Secured Party and Debtor have entered into the Third Amended and Restated Credit Agreement dated as of March 3, 1997 (such agreement, together with all amendments and restatements thereof, the "Credit Agreement") which restates in its entirety the Existing Credit Agreement. (4) It is the intention of the parties hereto that this Agreement create a first priority security interest securing the payment of the obligations set forth in Section 1.2. (5) It is a condition precedent to the effectiveness of the Credit Agreement that Debtor shall have executed and delivered this Agreement. AGREEMENT. NOW, THEREFORE, in consideration of the premises set forth herein and for other good and valuable consideration, the receipt and sufficiency of which is hereby acknowledged, and in order to induce Secured Party to make Advances under the Credit Agreement, Debtor hereby agrees with Secured Party as follows: 5 ARTICLE I. ASSIGNMENT AND GRANT OF SECURITY INTEREST 1.1 Assignment and Grant of Security Interest. Debtor hereby assigns, pledges and grants to Secured Party a security interest in the entire right, title and interest of Debtor in and to the Collateral. Debtor is assigning the marks in the above identified applications as part of the entire business or portion thereof to which the marks pertain as required by 15 U.S.C. Section 1060. 1.2 Security for Obligations. This Agreement creates a first priority security interest securing the payment and performance of any and all obligations now or hereafter existing of Debtor and each other Obligor under the Credit Agreement and the other Loan Papers, including any extensions, modifications, substitutions, amendments and renewals thereof, whether for principal, interest, fees, expenses, indemnification or otherwise (all such obligations of Debtor and each other Obligor being the "Obligations"). Without limiting the generality of the foregoing, this Agreement secures the payment, of all amounts which constitute part of the Obligations and would be owed by Debtor or any other Obligor to Secured Party under any Loan Papers, but for the fact that they are unenforceable or not allowable due to the existence of a bankruptcy, reorganization or similar proceeding involving Debtor or any other Obligor (including all interest accruing after, or that would have accrued but for, the filing of any petition in bankruptcy, or the commencement of any insolvency, reorganization or like proceeding of Debtor or any other Obligor). 1.3 Validity and Priority of Security Interest. Debtor agrees that the Security Interest shall at all times be valid, perfected, continuing and binding and enforceable against Debtor and all other Persons, in accordance with the terms hereof, as security for the Obligations, and that the Collateral shall not at any time be subject to any Lien, except as provided in the Loan Papers. 1.4 Maintenance of Status of Security Interest, Collateral and Rights. (a) Required Action. Debtor shall take all action that may be necessary or that Secured Party may reasonably request, so as at all times (i) to maintain the validity, perfection, enforceability and priority of the Security Interest in the Collateral in conformity with the requirements of Section 1.3, and (ii) to protect and preserve, and to enable the exercise or enforcement of, the rights of Secured Party hereunder, including (A) immediately discharging all Liens, (B) executing and delivering the notice in the form of Schedule 1.04(a)(ii)(B)-A, (C) executing and delivering the notice in the form of Schedule 1.04(a)(ii)(B)-B, (D) executing and delivering the notice in the form of Schedule 1.04(a)(ii)(B)-C and (E) executing and delivering financing or continuation statements, instruments of pledge, notices and instructions in each case in form and substance reasonably satisfactory to Secured Party. - 2 - 6 (b) Protection of Collateral. Debtor shall protect, preserve, renew and maintain, in each case in a manner consistent with reasonably responsible business and legal practices all rights of Debtor in the Collateral, including the duty to prosecute and/or defend against any and all suits concerning infringement or dilution of the Collateral, any suits against Debtor asserting the invalidity of the Collateral and any suits claiming injury to the goodwill associated with any of the Collateral. Any expenses incurred in protecting, preserving, renewing and maintaining the Collateral shall be borne by Debtor. To the maximum extent permitted by Laws, if a Default or Event of Default exists, Secured Party shall have the right, without taking title to any Collateral, to bring suit to enforce any or all Collateral or its Security Interest in any or all of the Collateral, in which event Debtor shall, at the request of Secured Party, do any and all lawful acts and execute any and all proper documents required by Secured Party in aid of such enforcement. All costs, expenses and other moneys advanced by Secured Party in connection with the foregoing shall, whether or not there are then outstanding any amounts under the Credit Agreement, be treated as Obligations, but the making of any advances by Secured Party shall not relieve Debtor of any default hereunder. (c) Authorized Action. Secured Party is hereby authorized to file one or more financing or continuation statements or amendments thereto and instruments of pledge, notices and instructions without the signature of or in the name of Debtor. A carbon, photographic or other reproduction of this Agreement or of any financing statement filed in connection with this Agreement shall be sufficient as a financing statement. (d) State Registrations. Debtor shall renew or maintain, as specified in any applicable Law and shall make any filings necessary to renew or maintain each registration described in Section 2.6. 1.5 Debtor Remains Obligated; Secured Party Not Obligated. The grant by Debtor to Secured Party of the Security Interest shall not relieve Debtor from the performance of any term, covenant, condition or agreement on its part to be performed or observed (including by virtue of the exercise by Secured Party of any of its Rights hereunder), or from any liability to any Person, under or in respect of any of the Collateral or impose any obligation on Secured Party or impose any liability on Secured Party for any act or omission on the part of Debtor relative thereto. 1.6 Termination. (a) In the event that (i) the License Agreement shall have been terminated pursuant to a written termination by Secured Party delivered to Debtor, and (ii) the Obligations shall have been finally paid in full, and all commitments by Secured Party to extend credit shall have been terminated and Secured Party shall have delivered to Debtor a written termination agreement, then this Agreement shall also terminate and be of no further force and effect (except as provided in Section 1.6(b)). - 3 - 7 (b) Debtor agrees that, if at any time all or any part of any payment theretofore applied by Secured Party to any of the Obligations is or must be rescinded or returned by any Person for any reason whatsoever (including the insolvency, bankruptcy or reorganization of Debtor or any other Person), such Obligations shall, for the purposes of this Agreement, to the extent that such payment is or must be rescinded or returned, be deemed to have continued in existence, notwithstanding such application by Secured Party, and the Security Interest granted hereunder shall continue to be effective or be reinstated, as the case may be, as to such Obligations, all as though such application by Secured Party had not been made. 1.7 Security Interest Absolute. All Rights of Secured Party and the Security Interest granted to Secured Party hereunder, and all obligations of Debtor hereunder, shall, to the extent permitted by Laws, be absolute and unconditional, irrespective of (a) any lack of validity or enforceability of any Loan Papers; (b) any change in the time, manner or place of payment or performance of, or in any other term of, all or any of the Obligations or any other amendment to or waiver of or any consent to departure from any Loan Papers; (c) any exchange, release or non-perfection of any collateral (including the Collateral or any part thereof), or any release of or amendment to or waiver of or consent to departure from any guaranty, for all or any of the Obligations; or (d) any other circumstances which might otherwise constitute a defense available to, or a discharge of, Debtor, any other Obligor or any other Person. ARTICLE II. REPRESENTATIONS AND WARRANTIES Debtor represents and warrants as follows: 2.1 Organization; Power. Debtor is a corporation duly organized, validly existing and in good standing under the laws of Texas and has the corporate power and authority to own its property and to carry on its business as now being and hereafter proposed to be conducted. 2.2 Authorization; Enforceability; Required Consents; Absence of Conflicts. Debtor has the power, and has taken all necessary action (including any necessary corporate action) to authorize it, to execute, deliver and perform in accordance with its terms this Agreement and to execute and deliver all financing statements and other filings contemplated hereby. This Agreement has been duly executed and delivered by Debtor and is the legal, valid and binding obligation of Debtor, enforceable in accordance with its terms. The execution, delivery and performance in accordance with its terms by Debtor of this Agreement does not and (absent any change in any Law) will not (a) require any Governmental Approval or any other consent or approval, including any consent or - 4 - 8 approval of any partner of Debtor, other than those Governmental Approvals, consents and approvals listed on Schedule 2.02 hereto which have been duly obtained and remain in full force and effect, or (b) violate or conflict with, result in a breach of, constitute a default under, or result in or require the creation of any Lien (other than the Security Interest) upon any assets of Debtor under any such contract or agreement or applicable Laws. 2.3 Accuracy of Questionnaire. The Questionnaire is, as of the date hereof, complete and correct in all respects. 2.4 Rights of Debtor. Debtor is the legal and beneficial owner of the Collateral free and clear of any Lien or other charge or encumbrance, including, without limitation, pledges, assignments, licenses, shop rights and covenants by Debtor not to sue any Person, except for the security interests and assignment created by this Agreement. No effective financing statement or other instrument similar in effect naming Debtor as "debtor" covering all or any part of the Collateral is on file in any recording office, except such as may have been filed in favor of Secured Party relating to this Agreement. 2.5 Perfection. This Agreement will create in favor of Secured Party valid and perfected security interests in the Collateral upon making the filing of Schedules 1.04(a)(ii)(B)-A,-B and-C and the financing statements described on Schedule 2.02 and such security interests will be a first priority security interest. 2.6 State Registrations. Schedule 2.06 lists each and all registrations and applications of Debtor with the applicable authority of each indicated state with respect to any Trademarks, Goodwill, Patents, Copyrights and Trade Secrets. ARTICLE III. COVENANTS 3.1 Certain Matters Relating to Preservation of Status of Security Interest. (a) Chief Executive Office. Debtor shall maintain its chief executive office and the office where the books and records relating to the Collateral are kept only at One Allentown Parkway, Allen, Texas 75002. (b) Change of Name, Identity, etc. Debtor shall not change its name without (i) giving Secured Party thirty days' prior written notice thereof and (ii) performing all acts required by Secured Party to preserve the Liens herein granted and the priority and perfection thereof. 3.2 Preservation of Existence and Preservation of Enforceability. Debtor shall, so long as any of the Obligations remain outstanding, (a) preserve and maintain its corporate existence and (b) take all action and obtain all consents and Government Approvals required so - 5 - 9 that its obligations under this Agreement will at all times be legal, valid and binding and enforceable in accordance with its terms. 3.3 Requested Information. In addition to such other Information as shall be specifically provided for herein, Debtor shall furnish to Secured Party such other Information with respect to the Collateral as Secured Party may reasonably request from time to time in connection with the Collateral, or the protection, preservation, maintenance or enforcement of the Security Interest or the Collateral including, without limitation, all documents and things in Debtor's possession, or subject to its demand for possession, related to the production and sale by Debtor, or any subsidiary, licensee or subcontractor thereof, of products or services sold by or under the authority of Debtor in connection with the Collateral, including by way of example, without limiting the interest granted by this Agreement: (i) all lists and ancillary documents which identify and describe any of Debtor's customers, or licensees, for products sold or services rendered under or in connection with the Collateral, including without limitation, such existing lists and ancillary documents which contain each customer's full name and address, the full name and address of all of its warehouses and branches, the identity of the Person or Persons having the principal responsibility on each customer's behalf for ordering products or services of the kind supplied by Debtor, the credit, payment, discount, delivery and other sale terms applicable to such customer, together with detailed information setting forth the total purchases, by brand, product, style and size, and the patterns of such purchases; (ii) all product and service specification documents and production and quality of services sold under or in connection with the Collateral; (iii) all documents which reveal the names and addresses of all sources of supply, and all terms of purchase and delivery, for all materials and components used in the production or products or provision of services, sold under or in connection with the Collateral; and (iv) all documents constituting or concerning the then current or proposed advertising and promotion by Debtor, licensees or subcontractors of products or services sold under or in connection with the Collateral, including, by way of example and not in limitation, all documents which reveal the media used or to be used and the cost for all such advertising conducted within the described period or planned for such products or services. In connection with its enforcement of the Security Interest, Secured Party may use such Information or transfer it to any assignee or sublicensee permitted hereunder for such assignee's or sublicensee's use. 3.4 No Disposition of Collateral. Debtor shall not sell, transfer or otherwise dispose of any of the Collateral or any interest therein, or grant any license thereunder except for and as permitted by the License Agreement. 3.5 Additional Property. Prior to the application for, use or acquisition or any interest in any property which is within the definition of "Collateral" or modification, reformulation or other alteration to any such interest (and, with respect to Collateral with respect to which Debtor's sole interest is as a licensee, if allowed by the applicable license agreement), Debtor shall execute and deliver to Secured Party all documents and instruments Secured Party may require to grant to Secured Party a perfected first priority Lien therein and to subject to all of such interest to this Agreement, including but not limited to any new, supplementary or - 6 - 10 additional filings in the form of Schedule 1.04(a)(ii)(B)-A,-B,or -C. Debtor shall execute and deliver to Secured Party such license agreements and amendments thereto as Secured Party may require. ARTICLE IV. EVENT OF DEFAULT Upon the occurrence and during the continuance of an Event of Default: 4.1 Application of Proceeds. All cash proceeds received by Secured Party upon any sale of, collection of, or other realization upon, all or any part of the Collateral shall be applied as follows: First: To the payment of all out-of-pocket costs and expenses incurred in connection with the sale of, collection of or other realization upon Collateral, including attorneys' fees and disbursements; Second: To the payment of the Obligations as provided in the Credit Agreement (with Debtor remaining liable for any deficiency); and Third: To the extent of the balance (if any) of such proceeds, to the payment to Debtor or other Person entitled thereto. 4.2 Remedies. (a) Power of Sale. Secured Party (i) may sell the Collateral at public or private sale, at any of its offices or elsewhere, for cash (including for this purpose, should Secured Party be the successful purchaser at any such sale, the cancellation of any of the Obligations) or on credit or for future delivery, and at such price or prices and upon such other terms as it may deem commercially reasonable, (ii) shall not be obligated to make any sale of Collateral regardless of notice of sale having been given, and (iii) may adjourn any public or private sale from time to time by announcement at the time and place fixed therefor, and such sale may, without further notice, be made at the time and place to which it was so adjourned; provided, however, that, if any item of the Collateral constituting a Trademark is assigned or sold, rather than licensed, it shall be assigned or sold only as an entirety. Secured Party may be the purchaser at any sale of the Collateral and may pay all or any part of the purchase price thereof by canceling part or all of the Obligations. To the fullest extent permitted by applicable Law, Debtor hereby waives the right to object to the manner of sufficiency of advertising, refurbishing of the Collateral, or solicitation of bids in connection with any sales or other disposition of the Collateral. Debtor hereby expressly waives and releases, to the fullest extent permitted by applicable Law, any right of redemption on the part of Debtor. If any notification of intended disposition of any of the Collateral is required by law, such notification, if mailed, shall be deemed reasonably and properly given if mailed at least ten days before such disposition, postage prepaid, addressed to - 7 - 11 Debtor either at the address shown below, or at any other address of Debtor appearing on the records of Secured Party. (b) Receiver. Secured Party may obtain the appointment of a receiver of the Collateral. (c) Enforcement by Secured Party. Secured Party may without notice to Debtor (except that if no Event of Default exists Secured Party shall give at least 10 days' notice) and at such time or times as Secured Party in its sole discretion may determine, exercise any or all of Debtor's rights in, to and under, or in any way connected with or related to, any or all of the Collateral, including (i) enforcing the performance of, and exercising any or all of Debtor's rights with respect to the Collateral, in each case by legal proceedings or otherwise and (ii) settling, adjusting, compromising, extending, renewing, discharging and releasing any or all of, and any legal proceedings brought with respect to any or all of, Debtor's rights with respect to the Collateral. (d) Other Loan Papers; Laws. Secured Party may exercise any other right or remedy available under any other Loan Paper or Laws. (e) Sale Restrictions. Debtor agrees that, in any sale of any of the Collateral, Secured Party is authorized to comply with any limitation or restriction in connection with such sale as counsel may advise Secured Party is necessary in order to avoid any violation of applicable Law (including compliance with such procedures as may restrict the number of prospective bidders or purchasers, require that such prospective bidders and purchasers have certain qualifications, and restrict such prospective bidders and purchasers to Persons who will represent and agree that they are purchasing for their own account or investment and not with a view to the distribution or resale of such Collateral), or in order to obtain any required approval of the sale or of the purchase by any governmental or regulatory authority or official, and Debtor further agrees that such compliance shall not result in such sale being considered or deemed not to have been made in a commercially reasonable manner, nor shall Secured Party be liable or accountable to Debtor for any discount allowed by reason of the fact that such Collateral was sold in compliance with any such limitation or restriction. 4.3 INDEMNITY AND EXPENSES. (a) DEBTOR AGREES TO INDEMNIFY (WHICH SHALL BE PAYABLE FROM TIME TO TIME ON DEMAND) SECURED PARTY FROM AND AGAINST ANY AND ALL CLAIMS, LOSSES AND LIABILITIES GROWING OUT OF OR RESULTING FROM THIS AGREEMENT (INCLUDING ENFORCEMENT OF THIS AGREEMENT), EXPRESSLY INCLUDING SUCH CLAIMS, LOSSES, OR LIABILITIES ARISING OUT OF MERE NEGLIGENCE OF SECURED PARTY, EXCEPT CLAIMS, LOSSES OR LIABILITIES RESULTING FROM SECURED PARTY'S GROSS NEGLIGENCE OR WILLFUL MISCONDUCT. - 8 - 12 (b) Debtor will upon demand pay to Secured Party the amount of any and all reasonable expenses, including the reasonable fees and disbursements of its counsel and of any experts and agents, which Secured Party may incur in connection with (i) the administration of this Agreement, (ii) the custody, preservation, use or operation of, or the sale of, collection from, or other realization upon, any of the Collateral, (iii) the exercise or enforcement of any of the Rights of Secured Party hereunder, or (iv) the failure by Debtor to perform or observe any of the provisions hereof. ARTICLE V. INTERPRETATION 5.1 Definitional Provision. (a) Certain Terms Defined by Reference. The terms "collateral", "inventory", "rights", and "security interest" shall have the meanings ascribed thereto in the UCC, or, when capitalized, the meanings specified in subsection (b) below. (b) Other Defined Terms. For purposes of this Agreement: "Agreement" means this Agreement, including all schedules, annexes and exhibits hereto. "Bankruptcy Code" means 11 U.S.C.Sections 101-1330 (1995), as amended, or any successor statute. "Collateral" means Debtor's rights, title and interests (whatever they may be), in each of the following, in each case whether now or hereafter existing or now owned or hereafter acquired by Debtor and whether or not the same is subject to Article 9 of the UCC, and wherever the same may be located: i) the Trademarks and Goodwill; ii) the Copyrights; iii) the Patents; iv) the Trade Secrets; v) each state registration and application listed on Schedule 2.06; vi) any renewal, reissue, re-examination certificate, extension or the like with respect to the Trademarks, Patents, Copyrights and Trade Secrets (as applicable); - 9 - 13 vii) all rights to use the Trademarks as trade names or assumed names in all aspects of its business; and viii) all proceeds and products of the foregoing together with any license in favor of or from Debtor of any of the foregoing in whatever form. The inclusion of "proceeds" of Collateral in the definition of "Collateral" shall not be deemed a consent by Secured Party to any sale or other disposition of any Collateral not otherwise specifically permitted by the terms hereof. "Copyright" means any copyright, copyright registration and applications for such registration, including but not limited to the copyrights listed on Annex C-1 attached hereto, all subject matter related to such copyrights, in any and all forms, and all copyrights and applications for copyrights related to such copyrights, including those copyrights and applications listed in Annex C-2 attached hereto. "Credit Agreement" is defined in the Background. "Event of Default" means (i) those events described as a "Default" or an "Event of Default" in the Credit Agreement, or (ii) the Rejection of the License Agreement. "Goodwill" means the goodwill of the businesses connected with the use of (or associated with) and symbolized by the Trademarks, but not any other goodwill. "Governmental Approval" means any authorization, consent, approval, license or exemption of, registration or filing with, or report or notice to, any Tribunal. "Information" means data, certificates, reports, statements (including financial statements), documents and other information in form (including electronic media) acceptable to Secured Party. "License Agreement" means the License Agreement dated March 31, 1995 between Debtor and Secured Party, including any renewal, extension, modification or restatement thereof. "Lien" means, with respect to any property or asset (or any income or profits therefrom) of any Person (in each case whether the same is consensual or nonconsensual or arises by contract, operation of law, legal process or otherwise) (i) any mortgage, lien, pledge, attachment, levy, priority or other security interest or encumbrance of any kind thereupon or in respect thereof and (ii) any arrangement, express or implied, under which the same is subordinated, transferred, sequestered or otherwise identified so as to subject the same, or make the same available for, the payment or performance of any obligation in priority to the payment of the ordinary, unsecured creditors of such Person. - 10 - 14 "Loan Papers" means the Credit Agreement and each agreement, certificate and other documents delivered to any Person pursuant to the Credit Agreement. "Obligations" is defined in Section 1.2. "Patents" means all patents, all inventions and subject matter related to such patents, in any and all forms, and all patents and applications for patents related to such patents, including but not limited to the patents listed on Annex A-1 attached hereto, all inventions and all subject matter related to such patents, in any and all forms, and all patents and applications for patents related to such patents, including those patents and applications listed on Annex A-2 attached hereto. "Person" means an individual, firm, corporation, partnership, association, joint venture, trust or any other entity or organization or Tribunal. "Questionnaire" means the Questionnaire in the form attached hereto as Schedule 5.01 executed and delivered by Debtor to Secured Party in connection with this Agreement. "Rejection" means, with respect to the License Agreement in respect of any item of Collateral, the entry of an order in any proceeding authorizing the rejection by Debtor (or a trustee for Debtor or Debtor as debtor-in-possession) of the License Agreement or any analogous event in any proceeding under the laws of any jurisdiction; provided, however, that nothing contained in this Agreement shall be deemed to be an acknowledgment or an agreement by any party hereto that the License Agreement may be rejected under any Debtor Relief Law or subject to any analogous event under any similar law of any jurisdiction other than the United States. "Security Interest" means the continuing security interest of Secured Party and assignment to Secured Party in the Collateral intended to be effected by the terms of this Agreement or any financing and continuation statements or other filings contemplated hereby. "Trade Secrets" means those general intangibles (sometimes known as "trade secrets"). "Trademarks" means all trademarks, all designs and logotypes related to such trademarks, in any and all forms, and all trademark registrations and applications for registration related to such trademarks, including but not limited to the trademarks listed on Annex B-1 attached hereto, all designs and logotypes related to such trademarks, in any and all forms, and all trademark registrations and applications for registration related to such trademarks, including those registrations and applications listed on Annex B-2 attached hereto. "UCC" means Chapter 9 of the Texas Business and Commerce Code as in effect from time to time in the State of Texas. - 11 - 15 (c) Other Definitional Provisions. i) Except as otherwise specified herein, all references herein (A) to any Person shall be deemed to include such Person's successors and assigns, (B) to any applicable Law referred to herein shall be deemed references to such applicable Law as the same may have been or may be amended or supplemented from time to time and (C) to this Agreement or other agreement defined or referred to herein shall be deemed a reference to this Agreement or other agreement as the terms thereof may have been or may be amended, supplemented, waived or otherwise modified from time to time. ii) Whenever the context so requires, the neuter gender includes the masculine or feminine, the masculine gender includes the feminine, and the singular number includes the plural, and vice versa. iii) Except as otherwise indicated, any reference herein to the "Collateral", the "Obligations" or any other collective or plural term shall be deemed to be a reference to each and every item included within the category described by such collective or plural term, so that a reference to the "Collateral" or the "Obligations" shall be deemed a reference to any or all of the Collateral or the Obligations, as the case may be. iv) Capitalized Terms not otherwise defined herein have the meaning specified in the Credit Agreement, and, to the extent of any conflict, terms as defined in the Credit Agreement shall control (provided, that a more expansive or explanatory definition shall not be deemed a conflict). 5.2 Power of Attorney. Each power of attorney, license and other authorization in favor of Secured Party or any other Person granted by or pursuant to this Agreement shall be deemed to be irrevocable and coupled with an interest. ARTICLE VI. MISCELLANEOUS 6.1 Expenses of Debtor's Agreements and Duties. Secured Party shall not be liable for the costs and expenses of Debtor arising out of Debtor's performance or observance of the terms, conditions, covenants and agreements to be observed or performed by Debtor under this Agreement. 6.2 Secured Party's Right to Perform on Debtor's Behalf. If Debtor shall fail to observe or perform any of the terms, conditions, covenants and agreements to be observed or performed by it under this Agreement, Secured Party may (but shall not be obligated to) do the same or cause it to be done or performed or observed, either in its name or in the name and on behalf of Debtor, and in the event that Debtor shall have failed to observe or perform any of the terms, conditions, covenants and agreements to be observed or performed by it under this Agreement, then Debtor hereby authorizes Secured Party to do so, and Debtor hereby appoints - 12 - 16 Secured Party, and any other Person Secured Party may designate, as Debtor's attorney-in-fact to do, or cause to be done, in the name, place and stead of Debtor in any way in which Debtor itself could do, or cause to be done, any or all things necessary to observe or perform the terms, conditions, covenants and agreements to be observed or performed by Debtor under this Agreement. In addition, Debtor hereby irrevocably appoints Secured Party as Debtor's attorney-in-fact to execute and deliver in Debtor's name and stead to any purchaser at any sale held under Section 4.2 any and all documents and instruments of assignment, transfer and conveyance necessary or appropriate to transfer to such purchaser the Collateral sold at such sale. 6.3 Secured Party's Right to Use Agents. Secured Party may exercise its rights under this Agreement through an agent or other designee. 6.4 No Interference, Compensation or Expense. Secured Party may exercise its rights under this Agreement (a) without resistance or interference by Debtor and (b) without payment of any rent, license fee or compensation of any kind to Debtor. 6.5 Limitation of Secured Party's Obligations With Respect to Collateral. (a) Except as provided in the License Agreement, Secured Party shall not have any duty or liability to protect or preserve any Collateral or to preserve rights pertaining thereto. (b) Nothing contained in this Agreement shall be construed as requiring or obligating Secured Party, and Secured Party shall not be required or obligated, to (i) present or file any claim or notice or take any action, with respect to any Collateral or in connection therewith or (ii) notify Debtor of any decline in the value of any Collateral. 6.6 Rights of Secured Party under UCC and Applicable Law. Secured Party shall have, with respect to the Collateral, in addition to all of its rights under this Agreement, (a) the rights of a secured party under the UCC, whether or not the UCC would otherwise apply to the collateral in question, and (b) the rights of a secured party under all other applicable Laws. 6.7 Waivers of Rights Inhibiting Enforcement. Debtor waives (a) any claim that, as to any part of the Collateral, a public sale, should Secured Party elect so to proceed, is, in and of itself, not a commercially reasonable method of sale for such Collateral, (b) except as otherwise provided in this Agreement, TO THE EXTENT PERMITTED BY APPLICABLE LAW, NOTICE OR JUDICIAL HEARING IN CONNECTION WITH SECURED PARTY'S DISPOSITION OF ANY OF THE COLLATERAL INCLUDING ANY AND ALL PRIOR NOTICE AND HEARING FOR ANY PREJUDGMENT REMEDY OR REMEDIES AND ANY SUCH RIGHT THAT DEBTOR WOULD OTHERWISE HAVE UNDER THE CONSTITUTION OR ANY STATUTE OF THE UNITED STATES OR OF ANY STATE, AND ALL OTHER REQUIREMENTS AS TO THE TIME, PLACE AND TERMS OF SALE OR OTHER REQUIREMENTS WITH RESPECT TO THE ENFORCEMENT OF - 13 - 17 SECURED PARTY'S RIGHTS HEREUNDER and (c) all rights of redemption, appraisement or valuation. 6.8 Notices and Deliveries. (a) Manner of Delivery. All notices, communications and materials (including all Information) to be given or delivered pursuant to this Agreement shall, except in those cases where giving notice by telephone is expressly permitted, be given or delivered in writing. All written notices, communications and materials shall be sent by registered or certified mail, postage prepaid, return receipt requested, by telecopier, or delivered by hand. In the event of a discrepancy between any telephonic notice and any written confirmation thereof, such written confirmation shall be deemed the effective notice except to the extent Secured Party or Debtor has acted in reliance on such telephonic notice. (b) Addresses. All notices, communications and materials to be given or delivered pursuant to this Agreement shall be given or delivered at the following respective addresses and telecopier and telephone numbers and to the attention of the following individuals or departments: (i) if to Debtor, to it at: Quest Medical, Inc. One Allentown Parkway Allen, Texas 75002 Telephone No: (214) 390-9800 Telecopier No: (214) 390-9687 Attention: F. Robert Merrill III (ii) if to Secured Party, to it at: NationsBank of Texas, N.A. NationsBank Plaza 901 Main Street 7th Floor Dallas, Texas 75202 Telephone No: (214) 508-2825 Telecopier No: (214) 508-3140 Attention: Commercial Banking - 14 - 18 or at such other address, telecopier or telephone number or to the attention of such other individual or department as the party to which such information pertains may hereafter specify for the purpose in a notice to the other specifically captioned "Notice of Change of Address". (c) Effectiveness. Each notice, communication and any material to be given or delivered to Secured Party or Debtor pursuant to this Agreement shall be effective or deemed delivered or furnished (i) if sent by mail, on the fifth Business Day after such notice, communication or material is deposited in the mail, addressed as above provided, (ii) if sent by telecopier, when such notice, communication or material is transmitted to the appropriate number determined as above provided in this Section 6.8 and the appropriate receipt is received or acknowledged, (iii) if sent by hand delivery or overnight courier, when left at the address of the addressee addressed as above provided and the appropriate receipt is received or acknowledged, and (iv) if given by telephone, when communicated to the individual or any member of the department specified as the individual or department to whose attention notices, communications and materials are to be given or delivered except that notices of a change of address, telecopier or telephone number or individual or department to whose attention notices, communications and materials are to be given or delivered shall not be effective until received. (d) Designation of Notice. No notice shall be effective under Section 3.1(a) or (b) unless it is specifically designated and, in the case of a notice under Section 3.1(a), "Notice of Change of Executive Office and Books and Records." 6.9 Rights and Remedies Cumulative. Each of Secured Party's rights and remedies under this Agreement shall be in addition to all of its other rights and remedies under this Agreement and applicable Law, and nothing herein shall be construed as limiting any such rights or remedies. 6.10 Amendments; Waivers. Any term, covenant, agreement or condition of this Agreement may be amended, and any right under this Agreement may be waived, if, but only if, such amendment or waiver is in writing and is signed by Secured Party and, in the case of an amendment, by Debtor. Unless otherwise specified in such waiver, a waiver of any right under this Agreement shall be effective only in the specific instance and for the specific purpose for which given. No election not to exercise, failure to exercise or delay in exercising any right, nor any course of dealing or performance, shall operate as a waiver of any right of the Secured Party under this Agreement or applicable Law, nor shall any single or partial exercise of any such right preclude any other or further exercise thereof or the exercise of any other right of Secured Party under this Agreement or applicable Law. 6.11 Assignments. (a) Debtor may not assign any of its rights or obligations under this Agreement without the prior written consent of Secured Party. - 15 - 19 (b) Secured Party may, in connection with any assignment under and in accordance with the License Agreement to any Person of any or all of the licensee's rights and obligations under such License Agreement, assign to such Person, or any agent(s) or representative(s) on behalf of such licensee and its sublicenses, any or all of Secured Party's rights and obligations under this Agreement and any other document or instrument, including financing and continuation statements and other filings, contemplated hereby and with respect to the Collateral without the consent of Debtor. In addition, Secured Party may assign or otherwise transfer (in whole or in part) to any other Person all of its rights and obligations under any Loan Papers (including this Agreement) or otherwise. 6.12 MANDATORY ARBITRATION. (a) ANY CONTROVERSY OR CLAIM BETWEEN OR AMONG THE PARTIES HERETO INCLUDING BUT NOT LIMITED TO THOSE ARISING OUT OF OR RELATING TO THIS AGREEMENT OR ANY RELATED AGREEMENTS OR INSTRUMENTS, INCLUDING ANY CLAIM BASED ON OR ARISING FROM AN ALLEGED TORT, SHALL BE DETERMINED BY BINDING ARBITRATION IN ACCORDANCE WITH THE FEDERAL ARBITRATION ACT (OR IF NOT APPLICABLE, THE APPLICABLE STATE LAW), THE RULES OF PRACTICE AND PROCEDURE FOR THE ARBITRATION OF COMMERCIAL DISPUTES OF JUDICIAL ARBITRATION AND MEDIATION SERVICES, INC. ("JAMS"), AND THE "SPECIAL RULES" SET FORTH BELOW. IN THE EVENT OF ANY INCONSISTENCY, THE SPECIAL RULES SHALL CONTROL. JUDGMENT UPON ANY ARBITRATION AWARD MAY BE ENTERED IN ANY COURT HAVING JURISDICTION. ANY PARTY TO THIS AGREEMENT MAY BRING AN ACTION, INCLUDING A SUMMARY OR EXPEDITED PROCEEDING, TO COMPEL ARBITRATION OF ANY CONTROVERSY OR CLAIM TO WHICH THIS AGREEMENT APPLIES IN ANY COURT HAVING JURISDICTION OVER SUCH ACTION. (b) Special Rules. The arbitration shall be conducted in Dallas, Texas and administered by JAMS who will appoint an arbitrator; if JAMS is unable or legally precluded from administering the arbitration, then the American Arbitration Association will serve. All arbitration hearings will be commenced within ninety days of the demand for arbitration; further, the arbitrator shall only, upon a showing of cause, be permitted to extend the commencement of such hearing for up to an additional sixty days. (c) Reservations of Rights. Nothing in this Agreement or any other Loan Paper shall be deemed to (i) limit the applicability of any otherwise applicable statutes of limitation or repose and any waivers contained in this Agreement; or (ii) be a waiver by Secured Party of the protection afforded to it by 12 U.S.C. Section 91 or any substantially equivalent state law; or (iii) limit the right of Secured Party hereto (A) to exercise self help remedies such as (but not limited to) setoff, or (B) to foreclose against any real or personal property collateral, or (C) to obtain from a - 16 - 20 court provisional or ancillary remedies such as (but not limited to) injunctive relief or the appointment of a receiver. Secured Party may exercise such self help rights, foreclose upon such property, or obtain such provisional or ancillary remedies before, during or after the pendency of any arbitration proceeding brought pursuant to this Agreement. At Secured Party's option, foreclosure under a deed of trust or mortgage may be accomplished by any of the following: the exercise of a power of sale under the deed of trust or mortgage, or by judicial sale under the deed of trust or mortgage, or by judicial foreclosure. Neither this exercise of self help remedies nor the institution or maintenance of an action for foreclosure or provisional or ancillary remedies shall constitute a waiver of the right of any party, including the claimant in any such action, to arbitrate the merits of the controversy or claim occasioning resort to such remedies. 6.13 GOVERNING LAW. THIS AGREEMENT SHALL BE GOVERNED BY AND CONSTRUED IN ACCORDANCE WITH THE INTERNAL LAWS OF THE STATE OF TEXAS (WITHOUT REFERENCE TO PRINCIPALS OF CONFLICTS OF LAWS), EXCEPT TO THE EXTENT THAT THE VALIDITY OR PERFECTION OF THE SECURITY INTEREST HEREUNDER, OR REMEDIES HEREUNDER, IN RESPECT OF ANY PARTICULAR COLLATERAL ARE REQUIRED TO GOVERNED BY THE LAWS OF A JURISDICTION OTHER THAN THE STATE OF TEXAS. 6.14 WAIVER OF JURY TRIAL. SECURED PARTY AND DEBTOR HEREBY WAIVE TRIAL BY JURY IN ANY JUDICIAL PROCEEDINGS INVOLVING, DIRECTLY OR INDIRECTLY, ANY MATTER (WHETHER IN TORT, CONTRACT OR OTHERWISE) IN ANY WAY ARISING OUT OF, RELATED TO, OR CONNECTED WITH THIS AGREEMENT OR THE RELATIONSHIP ESTABLISHED HEREUNDER. 6.15 Consent to Jurisdiction; Waiver of Immunities. (a) Debtor hereby irrevocably submits to the non-exclusive jurisdiction of any United States Federal or Texas State courts sitting in Dallas County in any action or proceeding arising out of or relating to this Agreement, and Debtor hereby irrevocably waives any objection it may now or hereafter have as to the venue of any such suit, action or proceeding brought in such court or that such court is an inconvenient forum. (b) Nothing in this section shall limit the right of Secured Party to bring any action or proceeding against Debtor or its property in the courts of any other jurisdictions. (c) Any judicial proceeding by Debtor against Secured Party involving, directly or indirectly, any matter in any way arising out of, related to, or connected with this Agreement shall be brought only in a court in Dallas County, Texas to the extent that jurisdiction may be effected against such Person in Dallas County, Texas. 6.16 Severability of Provisions. Any provision of this Agreement that is prohibited or unenforceable in any jurisdiction shall, as to such jurisdiction, be ineffective to the extent of such - 17 - 21 prohibition or unenforceability without invalidating the remaining provisions hereof in that jurisdiction or affecting the validity or enforceability of such provision in any other jurisdiction. In the event that any change in applicable Law would render invalid or unenforceable any provision of this Agreement, Debtor agrees to enter into such amendments or modifications to this Agreement to provide Secured Party with benefits intended to be granted by such provision. 6.17 Counterparts. This Agreement may be signed in any number of counterparts, each of which shall be an original, with the same effect as if the signatures thereto were upon the same instrument. 6.18 Successors and Assigns. All of the provisions of this Agreement shall be binding and inure to the benefit of the parties thereto and their respective successors and assigns; provided, Debtor may not assign its rights or obligations under this Agreement. 6.19 Loan Papers. This Agreement is a Loan Papers executed pursuant to the Credit Agreement and shall (unless otherwise expressly indicated herein) be construed, administered and applied in accordance with the terms and provisions thereof. 6.20 Obligations Not Affected. To the fullest extent permitted by applicable Law, the obligations of Debtor under this Agreement shall remain in full force and effect without regard to, and shall not be impaired or affected by: (a) any amendment or modification or addition or supplement to any Loan Papers or any instrument delivered in connection therewith or any assignment or transfer thereof; (b) any exercise, non-exercise, or waiver by Secured Party of any right, remedy, power or privilege under or in respect of, or any release of any guaranty or the Collateral or any part thereof provided pursuant to, this Agreement or any Loan Papers; (c) any waiver, consent, extension, indulgence or other action or inaction in respect of this Agreement, any Loan Papers or any assignment or transfer of any thereof; or (d) any bankruptcy, insolvency, reorganization, arrangement, readjustment, composition, liquidation or the like of Debtor or any other Person, whether or not Debtor shall have notice or knowledge of any of the foregoing. 6.21 ENTIRE AGREEMENT. THIS WRITTEN AGREEMENT, TOGETHER WITH THE OTHER LOAN PAPERS, REPRESENT THE FINAL AGREEMENT BETWEEN THE PARTIES AND MAY NOT BE CONTRADICTED BY EVIDENCE OF PRIOR, CONTEMPORANEOUS, OR SUBSEQUENT ORAL AGREEMENTS OF THE PARTIES. THERE ARE NO UNWRITTEN ORAL AGREEMENTS BETWEEN THE PARTIES. REMAINDER OF PAGE INTENTIONALLY LEFT BLANK - 18 - 22 IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be executed by their duly authorized officers all as of the date first above written. DEBTOR: QUEST MEDICAL, INC. By: /s/ F. ROBERT MERRILL III --------------------------------- F. Robert Merrill III, Vice President SECURED PARTY: NATIONSBANK OF TEXAS, N.A. By: /s/ BRIAN K. SCHNEIDER --------------------------------- Brian K. Schneider, Vice President - 19 - EX-10.21 8 1ST AMENDED & RESTATED INTELLECTUAL PROPERTY AGRMT 1 EXHIBIT 10.21 ================================================================================ FIRST AMENDED AND RESTATED INTELLECTUAL PROPERTY SECURITY AGREEMENT AND ASSIGNMENT dated as of March 3, 1997 Between ADVANCED NEUROMODULATION SYSTEMS, INC. as Debtor and Successor by Merger and Successor in Interest to Neuromed, Inc. and NATIONSBANK OF TEXAS, N.A. as Secured Party ================================================================================ 2 TABLE OF CONTENTS
Page ---- ARTICLE I. ASSIGNMENT AND GRANT OF SECURITY INTEREST 1.1 Assignment and Grant of Security Interest . . . . . . . . . 2 1.2 Security for Obligations . . . . . . . . . . . . . . . . . . 2 1.3 Validity and Priority of Security Interest . . . . . . . . . 2 1.4 Maintenance of Status of Security Interest, Collateral and Rights . . . . . . . . . . . . . . . . . . . 2 (a) Required Action . . . . . . . . . . . . . . . . . . . 2 (b) Protection of Collateral . . . . . . . . . . . . . . 3 (c) Authorized Action . . . . . . . . . . . . . . . . . . 3 (d) State Registrations . . . . . . . . . . . . . . . . . 3 1.5 Debtor Remains Obligated; Secured Party Not Obligated . . . 3 1.6 Termination . . . . . . . . . . . . . . . . . . . . . . . . 4 1.7 Security Interest Absolute . . . . . . . . . . . . . . . . . 4 ARTICLE II. REPRESENTATIONS AND WARRANTIES 2.1 Organization; Power . . . . . . . . . . . . . . . . . . . . 4 2.2 Authorization; Enforceability; Required Consents; Absence of Conflicts . . . . . . . . . . . . . . . . . . . . 5 2.3 Accuracy of Questionnaire . . . . . . . . . . . . . . . . . 5 2.4 Rights of Debtor . . . . . . . . . . . . . . . . . . . . . . 5 2.5 Perfection . . . . . . . . . . . . . . . . . . . . . . . . . 5 2.6 State Registrations . . . . . . . . . . . . . . . . . . . . 5 ARTICLE III. COVENANTS 3.1 Certain Matters Relating to Preservation of Status of Security Interest . . . . . . . . . . . . . . . . . . . . . 5 (a) Chief Executive Office . . . . . . . . . . . . . . . 5 (b) Change of Name, Identity, etc. . . . . . . . . . . . 6 3.2 Preservation of Existence and Preservation of Enforceability . . . . . . . . . . . . . . . . . . . . . . . 6 3.3 Requested Information . . . . . . . . . . . . . . . . . . . 6 3.4 No Disposition of Collateral . . . . . . . . . . . . . . . . 6 3.5 Additional Property . . . . . . . . . . . . . . . . . . . . 7 ARTICLE IV. EVENT OF DEFAULT 4.1 Application of Proceeds . . . . . . . . . . . . . . . . . . 7 4.2 Remedies . . . . . . . . . . . . . . . . . . . . . . . . . . 7 (a) Power of Sale . . . . . . . . . . . . . . . . . . . . 7 (b) Receiver . . . . . . . . . . . . . . . . . . . . . . 8
- i - 3 (c) Enforcement by Secured Party . . . . . . . . . . . . 8 (d) Other Loan Papers; Laws . . . . . . . . . . . . . . . 8 (e) Sale Restrictions . . . . . . . . . . . . . . . . . . 8 4.3 INDEMNITY AND EXPENSES . . . . . . . . . . . . . . . . . . . 9 ARTICLE V. INTERPRETATION 5.1 Definitional Provision . . . . . . . . . . . . . . . . . . . 9 (a) Certain Terms Defined by Reference . . . . . . . . . 9 (b) Other Defined Terms . . . . . . . . . . . . . . . . . 9 (c) Other Definitional Provisions . . . . . . . . . . . . 12 5.2 Power of Attorney . . . . . . . . . . . . . . . . . . . . . 12 ARTICLE VI. MISCELLANEOUS 6.1 Expenses of Debtor's Agreements and Duties . . . . . . . . . 12 6.2 Secured Party's Right to Perform on Debtor's Behalf . . . . 13 6.3 Secured Party's Right to Use Agents . . . . . . . . . . . . 13 6.4 No Interference, Compensation or Expense . . . . . . . . . . 13 6.5 Limitation of Secured Party's Obligations With Respect to Collateral . . . . . . . . . . . . . . . . . . . 13 6.6 Rights of Secured Party under UCC and Applicable Law . . . . 13 6.7 Waivers of Rights Inhibiting Enforcement . . . . . . . . . . 13 6.8 Notices and Deliveries . . . . . . . . . . . . . . . . . . . 14 (a) Manner of Delivery . . . . . . . . . . . . . . . . . 14 (b) Addresses . . . . . . . . . . . . . . . . . . . . . . 14 (c) Effectiveness . . . . . . . . . . . . . . . . . . . . 15 (d) Designation of Notice . . . . . . . . . . . . . . . . 15 6.9 Rights and Remedies Cumulative . . . . . . . . . . . . . . . 15 6.10 Amendments; Waivers . . . . . . . . . . . . . . . . . . . . 15 6.11 Assignments . . . . . . . . . . . . . . . . . . . . . . . . 16 6.12 MANDATORY ARBITRATION . . . . . . . . . . . . . . . . . . . 16 6.13 GOVERNING LAW . . . . . . . . . . . . . . . . . . . . . . . 17 6.14 WAIVER OF JURY TRIAL . . . . . . . . . . . . . . . . . . . . 17 6.15 Consent to Jurisdiction; Waiver of Immunities . . . . . . . 17 6.16 Severability of Provisions . . . . . . . . . . . . . . . . . 18 6.17 Counterparts . . . . . . . . . . . . . . . . . . . . . . . . 18 6.18 Successors and Assigns . . . . . . . . . . . . . . . . . . . 18 6.19 Loan Papers . . . . . . . . . . . . . . . . . . . . . . . . 18 6.20 Obligations Not Affected . . . . . . . . . . . . . . . . . . 18 6.21 ENTIRE AGREEMENT . . . . . . . . . . . . . . . . . . . . . . 19
- ii - 4 FIRST AMENDED AND RESTATED INTELLECTUAL PROPERTY SECURITY AGREEMENT AND ASSIGNMENT FIRST AMENDED AND RESTATED INTELLECTUAL PROPERTY SECURITY AGREEMENT AND ASSIGNMENT, dated as of March 3, 1997, between Advanced Neuromodulation Systems, Inc., a Texas corporation ("Debtor") and successor by merger and successor in interest to Neuromed, Inc., formerly a Florida corporation, and NationsBank of Texas, N.A., a national banking association ("Secured Party"). BACKGROUND. (1) Secured Party and Quest Medical, Inc., a Texas corporation ("Borrower"), have entered into the First Amended and Restated Credit Agreement dated as of March 31, 1995 (such agreement, together with all amendments and restatements thereof, being the "1995 Credit Agreement"). (2) In connection with the 1995 Credit Agreement, Neuromed, Inc., formerly a Florida corporation, executed an Intellectual Property Security Agreement and Assignment dated as of March 31, 1995, as amended, restated and modified from time to time, (the "Original Agreement") (3) Secured Party and Borrower have entered into the Second Amended and Restated Credit Agreement dated as of February 9, 1996 (such agreement, together with all amendments and restatements thereof, the "Existing Credit Agreement") which restates in its entirety the 1995 Credit Agreement. (4) In October 1996, Neuromed, Inc. merged into Debtor, and Debtor assumed all obligations of Neuromed, Inc., including but not limited to the obligations under the Original Agreement, and Debtor succeeded to all the assets, including, but not limited to the intellectual property assets of Neuromed, Inc. (5) Secured Party and Borrower have entered into the Third Amended and Restated Credit Agreement dated as of March 3, 1997 (such agreement, together with all amendments and restatements thereof, the "Credit Agreement") which restates in its entirety the Existing Credit Agreement. (6) It is the intention of the parties hereto that this Agreement create a first priority security interest securing the payment of the obligations set forth in Section 1.2. (7) It is a condition precedent to the effectiveness of the Credit Agreement that Debtor shall have executed and delivered this Agreement, expressly succeeding to the obligations of Neuromed, Inc. in connection with the Original Agreement. 5 AGREEMENT. NOW, THEREFORE, in consideration of the premises set forth herein and for other good and valuable consideration, the receipt and sufficiency of which is hereby acknowledged, and in order to induce Secured Party to make Advances under the Credit Agreement, Debtor hereby agrees with Secured Party as follows: ARTICLE I. ASSIGNMENT AND GRANT OF SECURITY INTEREST 1.1 Assignment and Grant of Security Interest. Debtor hereby assigns, pledges and grants to Secured Party a security interest in the entire right, title and interest of Debtor in and to the Collateral. Debtor is assigning the marks in the above identified applications as part of the entire business or portion thereof to which the marks pertain as required by 15 U.S.C. Section 1060. 1.2 Security for Obligations. This Agreement creates a first priority security interest securing the payment and performance of any and all obligations now or hereafter existing of Debtor and each other Obligor under the Credit Agreement and the other Loan Papers, including any extensions, modifications, substitutions, amendments and renewals thereof, whether for principal, interest, fees, expenses, indemnification or otherwise (all such obligations of Debtor and each other Obligor being the "Obligations"). Without limiting the generality of the foregoing, this Agreement secures the payment, of all amounts which constitute part of the Obligations and would be owed by Debtor or any other Obligor to Secured Party under any Loan Papers, but for the fact that they are unenforceable or not allowable due to the existence of a bankruptcy, reorganization or similar proceeding involving Debtor or any other Obligor (including all interest accruing after, or that would have accrued but for, the filing of any petition in bankruptcy, or the commencement of any insolvency, reorganization or like proceeding of Debtor or any other Obligor). 1.3 Validity and Priority of Security Interest. Debtor agrees that the Security Interest shall at all times be valid, perfected, continuing and binding and enforceable against Debtor and all other Persons, in accordance with the terms hereof, as security for the Obligations, and that the Collateral shall not at any time be subject to any Lien, except as provided in the Loan Papers. 1.4 Maintenance of Status of Security Interest, Collateral and Rights. (a) Required Action. Debtor shall take all action that may be necessary or that Secured Party may reasonably request, so as at all times (i) to maintain the validity, perfection, enforceability and priority of the Security Interest in the Collateral in conformity with the requirements of Section 1.3, and (ii) to protect and preserve, and to enable the exercise or - 2 - 6 enforcement of, the rights of Secured Party hereunder, including (A) immediately discharging all Liens, (B) executing and delivering the notice in the form of Schedule 1.04(a)(ii)(B)-A, (C) executing and delivering the notice in the form of Schedule 1.04(a)(ii)(B)-B, (D) executing and delivering the notice in the form of Schedule 1.04(a)(ii)(B)-C and (E) executing and delivering financing or continuation statements, instruments of pledge, notices and instructions in each case in form and substance reasonably satisfactory to Secured Party. (b) Protection of Collateral. Debtor shall protect, preserve, renew and maintain, in each case in a manner consistent with reasonably responsible business and legal practices all rights of Debtor in the Collateral, including the duty to prosecute and/or defend against any and all suits concerning infringement or dilution of the Collateral, any suits against Debtor asserting the invalidity of the Collateral and any suits claiming injury to the goodwill associated with any of the Collateral. Any expenses incurred in protecting, preserving, renewing and maintaining the Collateral shall be borne by Debtor. To the maximum extent permitted by Laws, if a Default or Event of Default exists, Secured Party shall have the right, without taking title to any Collateral, to bring suit to enforce any or all Collateral or its Security Interest in any or all of the Collateral, in which event Debtor shall, at the request of Secured Party, do any and all lawful acts and execute any and all proper documents required by Secured Party in aid of such enforcement. All costs, expenses and other moneys advanced by Secured Party in connection with the foregoing shall, whether or not there are then outstanding any amounts under the Credit Agreement, be treated as Obligations, but the making of any advances by Secured Party shall not relieve Debtor of any default hereunder. (c) Authorized Action. Secured Party is hereby authorized to file one or more financing or continuation statements or amendments thereto and instruments of pledge, notices and instructions without the signature of or in the name of Debtor. A carbon, photographic or other reproduction of this Agreement or of any financing statement filed in connection with this Agreement shall be sufficient as a financing statement. (d) State Registrations. Debtor shall renew or maintain, as specified in any applicable Law and shall make any filings necessary to renew or maintain each registration described in Section 2.6. 1.5 Debtor Remains Obligated; Secured Party Not Obligated. The grant by Debtor to Secured Party of the Security Interest shall not relieve Debtor from the performance of any term, covenant, condition or agreement on its part to be performed or observed (including by virtue of the exercise by Secured Party of any of its Rights hereunder), or from any liability to any Person, under or in respect of any of the Collateral or impose any obligation on Secured Party or impose any liability on Secured Party for any act or omission on the part of Debtor relative thereto. - 3 - 7 1.6 Termination. (a) In the event that (i) the License Agreement shall have been terminated pursuant to a written termination by Secured Party delivered to Debtor, and (ii) the Obligations shall have been finally paid in full, and all commitments by Secured Party to extend credit shall have been terminated and Secured Party shall have delivered to Debtor a written termination agreement, then this Agreement shall also terminate and be of no further force and effect (except as provided in Section 1.6(b)). (b) Debtor agrees that, if at any time all or any part of any payment theretofore applied by Secured Party to any of the Obligations is or must be rescinded or returned by any Person for any reason whatsoever (including the insolvency, bankruptcy or reorganization of Debtor or any other Person), such Obligations shall, for the purposes of this Agreement, to the extent that such payment is or must be rescinded or returned, be deemed to have continued in existence, notwithstanding such application by Secured Party, and the Security Interest granted hereunder shall continue to be effective or be reinstated, as the case may be, as to such Obligations, all as though such application by Secured Party had not been made. 1.7 Security Interest Absolute. All Rights of Secured Party and the Security Interest granted to Secured Party hereunder, and all obligations of Debtor hereunder, shall, to the extent permitted by Laws, be absolute and unconditional, irrespective of (a) any lack of validity or enforceability of any Loan Papers; (b) any change in the time, manner or place of payment or performance of, or in any other term of, all or any of the Obligations or any other amendment to or waiver of or any consent to departure from any Loan Papers; (c) any exchange, release or non-perfection of any collateral (including the Collateral or any part thereof), or any release of or amendment to or waiver of or consent to departure from any guaranty, for all or any of the Obligations; or (d) any other circumstances which might otherwise constitute a defense available to, or a discharge of, Debtor, any other Obligor or any other Person. ARTICLE II. REPRESENTATIONS AND WARRANTIES Debtor represents and warrants as follows: 2.1 Organization; Power. Debtor is a corporation duly organized, validly existing and in good standing under the laws of Texas and has the corporate power and authority to own its property and to carry on its business as now being and hereafter proposed to be conducted. - 4 - 8 2.2 Authorization; Enforceability; Required Consents; Absence of Conflicts. Debtor has the power, and has taken all necessary action (including any necessary corporate action) to authorize it, to execute, deliver and perform in accordance with its terms this Agreement and to execute and deliver all financing statements and other filings contemplated hereby. This Agreement has been duly executed and delivered by Debtor and is the legal, valid and binding obligation of Debtor, enforceable in accordance with its terms. The execution, delivery and performance in accordance with its terms by Debtor of this Agreement does not and (absent any change in any Law) will not (a) require any Governmental Approval or any other consent or approval, including any consent or approval of any partner of Debtor, other than those Governmental Approvals, consents and approvals listed on Schedule 2.02 hereto which have been duly obtained and remain in full force and effect, or (b) violate or conflict with, result in a breach of, constitute a default under, or result in or require the creation of any Lien (other than the Security Interest) upon any assets of Debtor under any such contract or agreement or applicable Laws. 2.3 Accuracy of Questionnaire. The Questionnaire is, as of the date hereof, complete and correct in all respects. 2.4 Rights of Debtor. Debtor is the legal and beneficial owner of the Collateral free and clear of any Lien or other charge or encumbrance, including, without limitation, pledges, assignments, licenses, shop rights and covenants by Debtor not to sue any Person, except for the security interests and assignment created by this Agreement. No effective financing statement or other instrument similar in effect naming Debtor as "debtor" covering all or any part of the Collateral is on file in any recording office, except such as may have been filed in favor of Secured Party relating to this Agreement. 2.5 Perfection. This Agreement will create in favor of Secured Party valid and perfected security interests in the Collateral upon making the filing of Schedules 1.04(a)(ii)(B)-A,-B and-C and the financing statements described on Schedule 2.02 and such security interests will be a first priority security interest. 2.6 State Registrations. Schedule 2.06 lists each and all registrations and applications of Debtor with the applicable authority of each indicated state with respect to any Trademarks, Goodwill, Patents, Copyrights and Trade Secrets. ARTICLE III. COVENANTS 3.1 Certain Matters Relating to Preservation of Status of Security Interest. (a) Chief Executive Office. Debtor shall maintain its chief executive office and the office where the books and records relating to the Collateral are kept only at One Allentown Parkway, Allen, Texas 75002. - 5 - 9 (b) Change of Name, Identity, etc. Debtor shall not change its name without (i) giving Secured Party thirty days' prior written notice thereof and (ii) performing all acts required by Secured Party to preserve the Liens herein granted and the priority and perfection thereof. 3.2 Preservation of Existence and Preservation of Enforceability. Debtor shall, so long as any of the Obligations remain outstanding, (a) preserve and maintain its corporate existence and (b) take all action and obtain all consents and Government Approvals required so that its obligations under this Agreement will at all times be legal, valid and binding and enforceable in accordance with its terms. 3.3 Requested Information. In addition to such other Information as shall be specifically provided for herein, Debtor shall furnish to Secured Party such other Information with respect to the Collateral as Secured Party may reasonably request from time to time in connection with the Collateral, or the protection, preservation, maintenance or enforcement of the Security Interest or the Collateral including, without limitation, all documents and things in Debtor's possession, or subject to its demand for possession, related to the production and sale by Debtor, or any subsidiary, licensee or subcontractor thereof, of products or services sold by or under the authority of Debtor in connection with the Collateral, including by way of example, without limiting the interest granted by this Agreement: (i) all lists and ancillary documents which identify and describe any of Debtor's customers, or licensees, for products sold or services rendered under or in connection with the Collateral, including without limitation, such existing lists and ancillary documents which contain each customer's full name and address, the full name and address of all of its warehouses and branches, the identity of the Person or Persons having the principal responsibility on each customer's behalf for ordering products or services of the kind supplied by Debtor, the credit, payment, discount, delivery and other sale terms applicable to such customer, together with detailed information setting forth the total purchases, by brand, product, style and size, and the patterns of such purchases; (ii) all product and service specification documents and production and quality of services sold under or in connection with the Collateral; (iii) all documents which reveal the names and addresses of all sources of supply, and all terms of purchase and delivery, for all materials and components used in the production or products or provision of services, sold under or in connection with the Collateral; and (iv) all documents constituting or concerning the then current or proposed advertising and promotion by Debtor, licensees or subcontractors of products or services sold under or in connection with the Collateral, including, by way of example and not in limitation, all documents which reveal the media used or to be used and the cost for all such advertising conducted within the described period or planned for such products or services. In connection with its enforcement of the Security Interest, Secured Party may use such Information or transfer it to any assignee or sublicensee permitted hereunder for such assignee's or sublicensee's use. 3.4 No Disposition of Collateral. Debtor shall not sell, transfer or otherwise dispose of any of the Collateral or any interest therein, or grant any license thereunder except for and as permitted by the License Agreement. - 6 - 10 3.5 Additional Property. Prior to the application for, use or acquisition or any interest in any property which is within the definition of "Collateral" or modification, reformulation or other alteration to any such interest (and, with respect to Collateral with respect to which Debtor's sole interest is as a licensee, if allowed by the applicable license agreement), Debtor shall execute and deliver to Secured Party all documents and instruments Secured Party may require to grant to Secured Party a perfected first priority Lien therein and to subject to all of such interest to this Agreement, including but not limited to any new, supplementary or additional filings in the form of Schedule 1.04(a)(ii)(B)-A,-B,or -C. Debtor shall execute and deliver to Secured Party such license agreements and amendments thereto as Secured Party may require. ARTICLE IV. EVENT OF DEFAULT Upon the occurrence and during the continuance of an Event of Default: 4.1 Application of Proceeds. All cash proceeds received by Secured Party upon any sale of, collection of, or other realization upon, all or any part of the Collateral shall be applied as follows: First: To the payment of all out-of-pocket costs and expenses incurred in connection with the sale of, collection of or other realization upon Collateral, including attorneys' fees and disbursements; Second: To the payment of the Obligations as provided in the Credit Agreement (with Debtor remaining liable for any deficiency); and Third: To the extent of the balance (if any) of such proceeds, to the payment to Debtor or other Person entitled thereto. 4.2 Remedies. (a) Power of Sale. Secured Party (i) may sell the Collateral at public or private sale, at any of its offices or elsewhere, for cash (including for this purpose, should Secured Party be the successful purchaser at any such sale, the cancellation of any of the Obligations) or on credit or for future delivery, and at such price or prices and upon such other terms as it may deem commercially reasonable, (ii) shall not be obligated to make any sale of Collateral regardless of notice of sale having been given, and (iii) may adjourn any public or private sale from time to time by announcement at the time and place fixed therefor, and such sale may, without further notice, be made at the time and place to which it was so adjourned; provided, however, that, if any item of the Collateral constituting a Trademark is assigned or sold, rather than licensed, it shall be assigned or sold only as an entirety. Secured Party may be the purchaser at any sale of the Collateral and may pay all or any part of the purchase price thereof by canceling part or all - 7 - 11 of the Obligations. To the fullest extent permitted by applicable Law, Debtor hereby waives the right to object to the manner of sufficiency of advertising, refurbishing of the Collateral, or solicitation of bids in connection with any sales or other disposition of the Collateral. Debtor hereby expressly waives and releases, to the fullest extent permitted by applicable Law, any right of redemption on the part of Debtor. If any notification of intended disposition of any of the Collateral is required by law, such notification, if mailed, shall be deemed reasonably and properly given if mailed at least ten days before such disposition, postage prepaid, addressed to Debtor either at the address shown below, or at any other address of Debtor appearing on the records of Secured Party. (b) Receiver. Secured Party may obtain the appointment of a receiver of the Collateral. (c) Enforcement by Secured Party. Secured Party may without notice to Debtor (except that if no Event of Default exists Secured Party shall give at least 10 days' notice) and at such time or times as Secured Party in its sole discretion may determine, exercise any or all of Debtor's rights in, to and under, or in any way connected with or related to, any or all of the Collateral, including (i) enforcing the performance of, and exercising any or all of Debtor's rights with respect to the Collateral, in each case by legal proceedings or otherwise and (ii) settling, adjusting, compromising, extending, renewing, discharging and releasing any or all of, and any legal proceedings brought with respect to any or all of, Debtor's rights with respect to the Collateral. (d) Other Loan Papers; Laws. Secured Party may exercise any other right or remedy available under any other Loan Paper or Laws. (e) Sale Restrictions. Debtor agrees that, in any sale of any of the Collateral, Secured Party is authorized to comply with any limitation or restriction in connection with such sale as counsel may advise Secured Party is necessary in order to avoid any violation of applicable Law (including compliance with such procedures as may restrict the number of prospective bidders or purchasers, require that such prospective bidders and purchasers have certain qualifications, and restrict such prospective bidders and purchasers to Persons who will represent and agree that they are purchasing for their own account or investment and not with a view to the distribution or resale of such Collateral), or in order to obtain any required approval of the sale or of the purchase by any governmental or regulatory authority or official, and Debtor further agrees that such compliance shall not result in such sale being considered or deemed not to have been made in a commercially reasonable manner, nor shall Secured Party be liable or accountable to Debtor for any discount allowed by reason of the fact that such Collateral was sold in compliance with any such limitation or restriction. - 8 - 12 4.3 INDEMNITY AND EXPENSES. (a) DEBTOR AGREES TO INDEMNIFY (WHICH SHALL BE PAYABLE FROM TIME TO TIME ON DEMAND) SECURED PARTY FROM AND AGAINST ANY AND ALL CLAIMS, LOSSES AND LIABILITIES GROWING OUT OF OR RESULTING FROM THIS AGREEMENT (INCLUDING ENFORCEMENT OF THIS AGREEMENT), EXPRESSLY INCLUDING SUCH CLAIMS, LOSSES, OR LIABILITIES ARISING OUT OF MERE NEGLIGENCE OF SECURED PARTY, EXCEPT CLAIMS, LOSSES OR LIABILITIES RESULTING FROM SECURED PARTY'S GROSS NEGLIGENCE OR WILLFUL MISCONDUCT. (b) Debtor will upon demand pay to Secured Party the amount of any and all reasonable expenses, including the reasonable fees and disbursements of its counsel and of any experts and agents, which Secured Party may incur in connection with (i) the administration of this Agreement, (ii) the custody, preservation, use or operation of, or the sale of, collection from, or other realization upon, any of the Collateral, (iii) the exercise or enforcement of any of the Rights of Secured Party hereunder, or (iv) the failure by Debtor to perform or observe any of the provisions hereof. ARTICLE V. INTERPRETATION 5.1 Definitional Provision. (a) Certain Terms Defined by Reference. The terms "collateral", "inventory", "rights", and "security interest" shall have the meanings ascribed thereto in the UCC, or, when capitalized, the meanings specified in subsection (b) below. (b) Other Defined Terms. For purposes of this Agreement: "Agreement" means this Agreement, including all schedules, annexes and exhibits hereto. "Bankruptcy Code" means 11 U.S.C.Sections 101-1330 (1995), as amended, or any successor statute. "Collateral" means Debtor's rights, title and interests (whatever they may be), in each of the following, in each case whether now or hereafter existing or now owned or hereafter acquired by Debtor and whether or not the same is subject to Article 9 of the UCC, and wherever the same may be located: i) the Trademarks and Goodwill; ii) the Copyrights; iii) the Patents; - 9 - 13 iv) the Trade Secrets; v) each state registration and application listed on Schedule 2.06; vi) any renewal, reissue, re-examination certificate, extension or the like with respect to the Trademarks, Patents, Copyrights and Trade Secrets (as applicable); vii) all rights to use the Trademarks as trade names or assumed names in all aspects of its business; and viii) all proceeds and products of the foregoing together with any license in favor of or from Debtor of any of the foregoing in whatever form. The inclusion of "proceeds" of Collateral in the definition of "Collateral" shall not be deemed a consent by Secured Party to any sale or other disposition of any Collateral not otherwise specifically permitted by the terms hereof. "Copyright" means any copyright, copyright registration and applications for such registration, including but not limited to the copyrights listed on Annex C-1 attached hereto, all subject matter related to such copyrights, in any and all forms, and all copyrights and applications for copyrights related to such copyrights, including those copyrights and applications listed in Annex C-2 attached hereto. "Credit Agreement" is defined in the Background. "Event of Default" means (i) those events described as a "Default" or an "Event of Default" in the Credit Agreement, or (ii) the Rejection of the License Agreement. "Goodwill" means the goodwill of the businesses connected with the use of (or associated with) and symbolized by the Trademarks, but not any other goodwill. "Governmental Approval" means any authorization, consent, approval, license or exemption of, registration or filing with, or report or notice to, any Tribunal. "Information" means data, certificates, reports, statements (including financial statements), documents and other information in form (including electronic media) acceptable to Secured Party. "License Agreement" means the License Agreement dated March 31, 1995 between Debtor and Secured Party, including any renewal, extension, modification or restatement thereof. - 10 - 14 "Lien" means, with respect to any property or asset (or any income or profits therefrom) of any Person (in each case whether the same is consensual or nonconsensual or arises by contract, operation of law, legal process or otherwise) (i) any mortgage, lien, pledge, attachment, levy, priority or other security interest or encumbrance of any kind thereupon or in respect thereof and (ii) any arrangement, express or implied, under which the same is subordinated, transferred, sequestered or otherwise identified so as to subject the same, or make the same available for, the payment or performance of any obligation in priority to the payment of the ordinary, unsecured creditors of such Person. "Loan Papers" means the Credit Agreement and each agreement, certificate and other documents delivered to any Person pursuant to the Credit Agreement. "Obligations" is defined in Section 1.2. "Patents" means all patents, all inventions and subject matter related to such patents, in any and all forms, and all patents and applications for patents related to such patents, including but not limited to the patents listed on Annex A-1 attached hereto, all inventions and all subject matter related to such patents, in any and all forms, and all patents and applications for patents related to such patents, including those patents and applications listed on Annex A-2 attached hereto. "Person" means an individual, firm, corporation, partnership, association, joint venture, trust or any other entity or organization or Tribunal. "Questionnaire" means the Questionnaire in the form attached hereto as Schedule 5.01 executed and delivered by Debtor to Secured Party in connection with this Agreement. "Rejection" means, with respect to the License Agreement in respect of any item of Collateral, the entry of an order in any proceeding authorizing the rejection by Debtor (or a trustee for Debtor or Debtor as debtor-in-possession) of the License Agreement or any analogous event in any proceeding under the laws of any jurisdiction; provided, however, that nothing contained in this Agreement shall be deemed to be an acknowledgment or an agreement by any party hereto that the License Agreement may be rejected under any Debtor Relief Law or subject to any analogous event under any similar law of any jurisdiction other than the United States. "Security Interest" means the continuing security interest of Secured Party and assignment to Secured Party in the Collateral intended to be effected by the terms of this Agreement or any financing and continuation statements or other filings contemplated hereby. "Trade Secrets" means those general intangibles (sometimes known as "trade secrets"). "Trademarks" means all trademarks, all designs and logotypes related to such trademarks, in any and all forms, and all trademark registrations and applications for registration - 11 - 15 related to such trademarks, including but not limited to the trademarks listed on Annex B-1 attached hereto, all designs and logotypes related to such trademarks, in any and all forms, and all trademark registrations and applications for registration related to such trademarks, including those registrations and applications listed on Annex B-2 attached hereto. "UCC" means Chapter 9 of the Texas Business and Commerce Code as in effect from time to time in the State of Texas. (c) Other Definitional Provisions. i) Except as otherwise specified herein, all references herein (A) to any Person shall be deemed to include such Person's successors and assigns, (B) to any applicable Law referred to herein shall be deemed references to such applicable Law as the same may have been or may be amended or supplemented from time to time and (C) to this Agreement or other agreement defined or referred to herein shall be deemed a reference to this Agreement or other agreement as the terms thereof may have been or may be amended, supplemented, waived or otherwise modified from time to time. ii) Whenever the context so requires, the neuter gender includes the masculine or feminine, the masculine gender includes the feminine, and the singular number includes the plural, and vice versa. iii) Except as otherwise indicated, any reference herein to the "Collateral", the "Obligations" or any other collective or plural term shall be deemed to be a reference to each and every item included within the category described by such collective or plural term, so that a reference to the "Collateral" or the "Obligations" shall be deemed a reference to any or all of the Collateral or the Obligations, as the case may be. iv) Capitalized Terms not otherwise defined herein have the meaning specified in the Credit Agreement, and, to the extent of any conflict, terms as defined in the Credit Agreement shall control (provided, that a more expansive or explanatory definition shall not be deemed a conflict). 5.2 Power of Attorney. Each power of attorney, license and other authorization in favor of Secured Party or any other Person granted by or pursuant to this Agreement shall be deemed to be irrevocable and coupled with an interest. ARTICLE VI. MISCELLANEOUS 6.1 Expenses of Debtor's Agreements and Duties. Secured Party shall not be liable for the costs and expenses of Debtor arising out of Debtor's performance or observance of the - 12 - 16 terms, conditions, covenants and agreements to be observed or performed by Debtor under this Agreement. 6.2 Secured Party's Right to Perform on Debtor's Behalf. If Debtor shall fail to observe or perform any of the terms, conditions, covenants and agreements to be observed or performed by it under this Agreement, Secured Party may (but shall not be obligated to) do the same or cause it to be done or performed or observed, either in its name or in the name and on behalf of Debtor, and in the event that Debtor shall have failed to observe or perform any of the terms, conditions, covenants and agreements to be observed or performed by it under this Agreement, then Debtor hereby authorizes Secured Party to do so, and Debtor hereby appoints Secured Party, and any other Person Secured Party may designate, as Debtor's attorney-in-fact to do, or cause to be done, in the name, place and stead of Debtor in any way in which Debtor itself could do, or cause to be done, any or all things necessary to observe or perform the terms, conditions, covenants and agreements to be observed or performed by Debtor under this Agreement. In addition, Debtor hereby irrevocably appoints Secured Party as Debtor's attorney-in-fact to execute and deliver in Debtor's name and stead to any purchaser at any sale held under Section 4.2 any and all documents and instruments of assignment, transfer and conveyance necessary or appropriate to transfer to such purchaser the Collateral sold at such sale. 6.3 Secured Party's Right to Use Agents. Secured Party may exercise its rights under this Agreement through an agent or other designee. 6.4 No Interference, Compensation or Expense. Secured Party may exercise its rights under this Agreement (a) without resistance or interference by Debtor and (b) without payment of any rent, license fee or compensation of any kind to Debtor. 6.5 Limitation of Secured Party's Obligations With Respect to Collateral. (a) Except as provided in the License Agreement, Secured Party shall not have any duty or liability to protect or preserve any Collateral or to preserve rights pertaining thereto. (b) Nothing contained in this Agreement shall be construed as requiring or obligating Secured Party, and Secured Party shall not be required or obligated, to (i) present or file any claim or notice or take any action, with respect to any Collateral or in connection therewith or (ii) notify Debtor of any decline in the value of any Collateral. 6.6 Rights of Secured Party under UCC and Applicable Law. Secured Party shall have, with respect to the Collateral, in addition to all of its rights under this Agreement, (a) the rights of a secured party under the UCC, whether or not the UCC would otherwise apply to the collateral in question, and (b) the rights of a secured party under all other applicable Laws. 6.7 Waivers of Rights Inhibiting Enforcement. Debtor waives (a) any claim that, as to any part of the Collateral, a public sale, should Secured Party elect so to proceed, is, in and of - 13 - 17 itself, not a commercially reasonable method of sale for such Collateral, (b) except as otherwise provided in this Agreement, TO THE EXTENT PERMITTED BY APPLICABLE LAW, NOTICE OR JUDICIAL HEARING IN CONNECTION WITH SECURED PARTY'S DISPOSITION OF ANY OF THE COLLATERAL INCLUDING ANY AND ALL PRIOR NOTICE AND HEARING FOR ANY PREJUDGMENT REMEDY OR REMEDIES AND ANY SUCH RIGHT THAT DEBTOR WOULD OTHERWISE HAVE UNDER THE CONSTITUTION OR ANY STATUTE OF THE UNITED STATES OR OF ANY STATE, AND ALL OTHER REQUIREMENTS AS TO THE TIME, PLACE AND TERMS OF SALE OR OTHER REQUIREMENTS WITH RESPECT TO THE ENFORCEMENT OF SECURED PARTY'S RIGHTS HEREUNDER and (c) all rights of redemption, appraisement or valuation. 6.8 Notices and Deliveries. (a) Manner of Delivery. All notices, communications and materials (including all Information) to be given or delivered pursuant to this Agreement shall, except in those cases where giving notice by telephone is expressly permitted, be given or delivered in writing. All written notices, communications and materials shall be sent by registered or certified mail, postage prepaid, return receipt requested, by telecopier, or delivered by hand. In the event of a discrepancy between any telephonic notice and any written confirmation thereof, such written confirmation shall be deemed the effective notice except to the extent Secured Party or Debtor has acted in reliance on such telephonic notice. (b) Addresses. All notices, communications and materials to be given or delivered pursuant to this Agreement shall be given or delivered at the following respective addresses and telecopier and telephone numbers and to the attention of the following individuals or departments: (i) if to Debtor, to it at: Advanced Neuromodulation Systems, Inc. c/o Quest Medical, Inc. One Allentown Parkway Allen, Texas 75002 Telephone No: (214) 390-9800 Telecopier No: (214) 390-9687 Attention: F. Robert Merrill III - 14 - 18 (ii) if to Secured Party, to it at: NationsBank of Texas, N.A. NationsBank Plaza 901 Main Street 7th Floor Dallas, Texas 75202 Telephone No: (214) 508-2825 Telecopier No: (214) 508-3140 Attention: Commercial Banking or at such other address, telecopier or telephone number or to the attention of such other individual or department as the party to which such information pertains may hereafter specify for the purpose in a notice to the other specifically captioned "Notice of Change of Address". (c) Effectiveness. Each notice, communication and any material to be given or delivered to Secured Party or Debtor pursuant to this Agreement shall be effective or deemed delivered or furnished (i) if sent by mail, on the fifth Business Day after such notice, communication or material is deposited in the mail, addressed as above provided, (ii) if sent by telecopier, when such notice, communication or material is transmitted to the appropriate number determined as above provided in this Section 6.8 and the appropriate receipt is received or acknowledged, (iii) if sent by hand delivery or overnight courier, when left at the address of the addressee addressed as above provided and the appropriate receipt is received or acknowledged, and (iv) if given by telephone, when communicated to the individual or any member of the department specified as the individual or department to whose attention notices, communications and materials are to be given or delivered except that notices of a change of address, telecopier or telephone number or individual or department to whose attention notices, communications and materials are to be given or delivered shall not be effective until received. (d) Designation of Notice. No notice shall be effective under Section 3.1(a) or (b) unless it is specifically designated and, in the case of a notice under Section 3.1(a), "Notice of Change of Executive Office and Books and Records." 6.9 Rights and Remedies Cumulative. Each of Secured Party's rights and remedies under this Agreement shall be in addition to all of its other rights and remedies under this Agreement and applicable Law, and nothing herein shall be construed as limiting any such rights or remedies. 6.10 Amendments; Waivers. Any term, covenant, agreement or condition of this Agreement may be amended, and any right under this Agreement may be waived, if, but only if, such amendment or waiver is in writing and is signed by Secured Party and, in the case of an - 15 - 19 amendment, by Debtor. Unless otherwise specified in such waiver, a waiver of any right under this Agreement shall be effective only in the specific instance and for the specific purpose for which given. No election not to exercise, failure to exercise or delay in exercising any right, nor any course of dealing or performance, shall operate as a waiver of any right of the Secured Party under this Agreement or applicable Law, nor shall any single or partial exercise of any such right preclude any other or further exercise thereof or the exercise of any other right of Secured Party under this Agreement or applicable Law. 6.11 Assignments. (a) Debtor may not assign any of its rights or obligations under this Agreement without the prior written consent of Secured Party. (b) Secured Party may, in connection with any assignment under and in accordance with the License Agreement to any Person of any or all of the licensee's rights and obligations under such License Agreement, assign to such Person, or any agent(s) or representative(s) on behalf of such licensee and its sublicenses, any or all of Secured Party's rights and obligations under this Agreement and any other document or instrument, including financing and continuation statements and other filings, contemplated hereby and with respect to the Collateral without the consent of Debtor. In addition, Secured Party may assign or otherwise transfer (in whole or in part) to any other Person all of its rights and obligations under any Loan Papers (including this Agreement) or otherwise. 6.12 MANDATORY ARBITRATION. (a) ANY CONTROVERSY OR CLAIM BETWEEN OR AMONG THE PARTIES HERETO INCLUDING BUT NOT LIMITED TO THOSE ARISING OUT OF OR RELATING TO THIS AGREEMENT OR ANY RELATED AGREEMENTS OR INSTRUMENTS, INCLUDING ANY CLAIM BASED ON OR ARISING FROM AN ALLEGED TORT, SHALL BE DETERMINED BY BINDING ARBITRATION IN ACCORDANCE WITH THE FEDERAL ARBITRATION ACT (OR IF NOT APPLICABLE, THE APPLICABLE STATE LAW), THE RULES OF PRACTICE AND PROCEDURE FOR THE ARBITRATION OF COMMERCIAL DISPUTES OF JUDICIAL ARBITRATION AND MEDIATION SERVICES, INC. ("JAMS"), AND THE "SPECIAL RULES" SET FORTH BELOW. IN THE EVENT OF ANY INCONSISTENCY, THE SPECIAL RULES SHALL CONTROL. JUDGMENT UPON ANY ARBITRATION AWARD MAY BE ENTERED IN ANY COURT HAVING JURISDICTION. ANY PARTY TO THIS AGREEMENT MAY BRING AN ACTION, INCLUDING A SUMMARY OR EXPEDITED PROCEEDING, TO COMPEL ARBITRATION OF ANY CONTROVERSY OR CLAIM TO WHICH THIS AGREEMENT APPLIES IN ANY COURT HAVING JURISDICTION OVER SUCH ACTION. - 16 - 20 (b) Special Rules. The arbitration shall be conducted in Dallas, Texas and administered by JAMS who will appoint an arbitrator; if JAMS is unable or legally precluded from administering the arbitration, then the American Arbitration Association will serve. All arbitration hearings will be commenced within ninety days of the demand for arbitration; further, the arbitrator shall only, upon a showing of cause, be permitted to extend the commencement of such hearing for up to an additional sixty days. (c) Reservations of Rights. Nothing in this Agreement or any other Loan Paper shall be deemed to (i) limit the applicability of any otherwise applicable statutes of limitation or repose and any waivers contained in this Agreement; or (ii) be a waiver by Secured Party of the protection afforded to it by 12 U.S.C. Section 91 or any substantially equivalent state law; or (iii) limit the right of Secured Party hereto (A) to exercise self help remedies such as (but not limited to) setoff, or (B) to foreclose against any real or personal property collateral, or (C) to obtain from a court provisional or ancillary remedies such as (but not limited to) injunctive relief or the appointment of a receiver. Secured Party may exercise such self help rights, foreclose upon such property, or obtain such provisional or ancillary remedies before, during or after the pendency of any arbitration proceeding brought pursuant to this Agreement. At Secured Party's option, foreclosure under a deed of trust or mortgage may be accomplished by any of the following: the exercise of a power of sale under the deed of trust or mortgage, or by judicial sale under the deed of trust or mortgage, or by judicial foreclosure. Neither this exercise of self help remedies nor the institution or maintenance of an action for foreclosure or provisional or ancillary remedies shall constitute a waiver of the right of any party, including the claimant in any such action, to arbitrate the merits of the controversy or claim occasioning resort to such remedies. 6.13 GOVERNING LAW. THIS AGREEMENT SHALL BE GOVERNED BY AND CONSTRUED IN ACCORDANCE WITH THE INTERNAL LAWS OF THE STATE OF TEXAS (WITHOUT REFERENCE TO PRINCIPALS OF CONFLICTS OF LAWS), EXCEPT TO THE EXTENT THAT THE VALIDITY OR PERFECTION OF THE SECURITY INTEREST HEREUNDER, OR REMEDIES HEREUNDER, IN RESPECT OF ANY PARTICULAR COLLATERAL ARE REQUIRED TO GOVERNED BY THE LAWS OF A JURISDICTION OTHER THAN THE STATE OF TEXAS. 6.14 WAIVER OF JURY TRIAL. SECURED PARTY AND DEBTOR HEREBY WAIVE TRIAL BY JURY IN ANY JUDICIAL PROCEEDINGS INVOLVING, DIRECTLY OR INDIRECTLY, ANY MATTER (WHETHER IN TORT, CONTRACT OR OTHERWISE) IN ANY WAY ARISING OUT OF, RELATED TO, OR CONNECTED WITH THIS AGREEMENT OR THE RELATIONSHIP ESTABLISHED HEREUNDER. 6.15 Consent to Jurisdiction; Waiver of Immunities. (a) Debtor hereby irrevocably submits to the non-exclusive jurisdiction of any United States Federal or Texas State courts sitting in Dallas County in any action or proceeding arising out of or relating to this Agreement, and Debtor hereby irrevocably waives any objection it may - 17 - 21 now or hereafter have as to the venue of any such suit, action or proceeding brought in such court or that such court is an inconvenient forum. (b) Nothing in this section shall limit the right of Secured Party to bring any action or proceeding against Debtor or its property in the courts of any other jurisdictions. (c) Any judicial proceeding by Debtor against Secured Party involving, directly or indirectly, any matter in any way arising out of, related to, or connected with this Agreement shall be brought only in a court in Dallas County, Texas to the extent that jurisdiction may be effected against such Person in Dallas County, Texas. 6.16 Severability of Provisions. Any provision of this Agreement that is prohibited or unenforceable in any jurisdiction shall, as to such jurisdiction, be ineffective to the extent of such prohibition or unenforceability without invalidating the remaining provisions hereof in that jurisdiction or affecting the validity or enforceability of such provision in any other jurisdiction. In the event that any change in applicable Law would render invalid or unenforceable any provision of this Agreement, Debtor agrees to enter into such amendments or modifications to this Agreement to provide Secured Party with benefits intended to be granted by such provision. 6.17 Counterparts. This Agreement may be signed in any number of counterparts, each of which shall be an original, with the same effect as if the signatures thereto were upon the same instrument. 6.18 Successors and Assigns. All of the provisions of this Agreement shall be binding and inure to the benefit of the parties thereto and their respective successors and assigns; provided, Debtor may not assign its rights or obligations under this Agreement. 6.19 Loan Papers. This Agreement is a Loan Papers executed pursuant to the Credit Agreement and shall (unless otherwise expressly indicated herein) be construed, administered and applied in accordance with the terms and provisions thereof. 6.20 Obligations Not Affected. To the fullest extent permitted by applicable Law, the obligations of Debtor under this Agreement shall remain in full force and effect without regard to, and shall not be impaired or affected by: (a) any amendment or modification or addition or supplement to any Loan Papers or any instrument delivered in connection therewith or any assignment or transfer thereof; (b) any exercise, non-exercise, or waiver by Secured Party of any right, remedy, power or privilege under or in respect of, or any release of any guaranty or the Collateral or any part thereof provided pursuant to, this Agreement or any Loan Papers; - 18 - 22 (c) any waiver, consent, extension, indulgence or other action or inaction in respect of this Agreement, any Loan Papers or any assignment or transfer of any thereof; or (d) any bankruptcy, insolvency, reorganization, arrangement, readjustment, composition, liquidation or the like of Debtor or any other Person, whether or not Debtor shall have notice or knowledge of any of the foregoing. 6.21 ENTIRE AGREEMENT. THIS WRITTEN AGREEMENT, TOGETHER WITH THE OTHER LOAN PAPERS, REPRESENT THE FINAL AGREEMENT BETWEEN THE PARTIES AND MAY NOT BE CONTRADICTED BY EVIDENCE OF PRIOR, CONTEMPORANEOUS, OR SUBSEQUENT ORAL AGREEMENTS OF THE PARTIES. THERE ARE NO UNWRITTEN ORAL AGREEMENTS BETWEEN THE PARTIES. REMAINDER OF PAGE INTENTIONALLY LEFT BLANK - 19 - 23 IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be executed by their duly authorized officers all as of the date first above written. DEBTOR: ADVANCED NEUROMODULATION SYSTEMS, INC., as Debtor and successor by merger and successor in interest of Neuromed, Inc. By: /s/ F. ROBERT MERRILL III ------------------------------ F. Robert Merrill III, Vice President SECURED PARTY: NATIONSBANK OF TEXAS, N.A. By: /s/ BRIAN K. SCHNEIDER ------------------------------ Brian K. Schneider, Vice President - 20 - EX-10.22 9 1ST AMENDED & RESTATED LICENSE AGREEMENT 1 EXHIBIT 10.22 ================================================================================ FIRST AMENDED AND RESTATED LICENSE AGREEMENT Dated as of March 3, 1997 Between QUEST MEDICAL, INC. as Licensor and NATIONSBANK OF TEXAS, NATIONAL ASSOCIATION as Licensee ================================================================================ 2 FIRST AMENDED AND RESTATED LICENSE AGREEMENT FIRST AMENDED AND RESTATED LICENSE AGREEMENT, dated March 3, 1997, by and between Quest Medical, Inc., a Texas corporation ("Licensor") and NationsBank of Texas, National Association, a national banking association ("Licensee"). W I T N E S S E T H: WHEREAS, Licensor presently owns and will hereafter acquire right, title, and interest (including rights and interests pursuant to licenses) throughout the world in various Trademarks, Patents, Copyrights and Trade Secrets (hereinafter, collectively, the "Intellectual Property"); WHEREAS, Licensee and Licensor have entered into the First Amended and Restated Credit Agreement dated as of March 31, 1995 (such agreement, together with all amendments and restatements thereof, being the "1995 Credit Agreement"); WHEREAS, Licensee and Licensor have entered into the Second Amended and Restated Credit Agreement dated as of February 9, 1996 (such agreement, together with all amendments and restatements thereof, the "Existing Credit Agreement") which restates in its entirety the 1995 Credit Agreement. WHEREAS, Licensee and Licensor have entered into the Third Amended and Restated Credit Agreement dated as of March 3, 1997 (such agreement, together with all amendments and restatements thereof, the "Credit Agreement") which restates in its entirety the Existing Credit Agreement. WHEREAS, as security for the payment and performance of the Obligations which are owed by Licensor and each other Obligor to Licensee pursuant to the Loan Papers, Licensor has agreed to grant or cause to be granted to Licensee, security interests in, and pledges and assignments of, all assets of Licensor, including all cash, Inventory, Receivables, Equipment, Permits and the Intellectual Property, a license to use the Intellectual Property and Permits and certain other collateral, to secure the Obligations; WHEREAS, Licensee desires a license to use the Intellectual Property and Permits in all countries of the world solely if an Event of Default exists to enable Licensee to exercise its rights and remedies with respect to the Collateral under the Security Agreement; WHEREAS, Licensor desires to grant Licensee the foregoing license to so use the Intellectual Property and Permits; and WHEREAS, the parties acknowledge the excellent reputation for quality of products sold under the Intellectual Property and Permits, and desire to safeguard, promote and enhance that 3 reputation by ensuring the future quality of materials, workmanship, and performance of the Inventory with respect to which Licensee has been granted a security interest, pledge and assignment and may exercise its rights and remedies under the Security Agreement and Intellectual Property Agreement, if an Event of Default exists. AGREEMENT. NOW, THEREFORE, in consideration of the above premises and of the mutual covenants herein contained, and other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, and intending to be legally bound, the parties hereto agree as follows: ARTICLE I. DEFINITIONS 1.1 "Collateral" has the same definition provided in the Security Agreement. 1.2 "Effective Date" means March 3, 1997. 1.3 "Equipment" has the same definition provided in the Security Agreement. 1.4 "Intellectual Property Agreement" means the Amended and Restated Intellectual Property Security Agreement and Assignment dated March 3, 1997 between Licensor and Licensee. 1.5 "Inventory" has the same definition provided in the Security Agreement. 1.6 "Permits" means all licenses, permits and other similar rights now or hereafter owned by Licensor (including but not limited to all licenses, permits and similar rights issued by the FDA) and necessary to the operation of its business, including but not limited to all licenses, permits and other rights listed on Schedule 2. 1.7 "Receivables" has the same definition provided in the Security Agreement. 1.8 "Security Agreement" means the Amended and Restated Security Agreement dated March 3, 1997 between Licensor and Licensee. 1.9 Unless otherwise defined in this Agreement, all capitalized terms herein shall have the same definition provided in the Credit Agreement, the Intellectual Property Agreement and the Security Agreement. -2- 4 ARTICLE II. GRANTS TO LICENSEE AND RELATED MATTERS 2.1 Licensor hereby grants to Licensee an irrevocable, non-exclusive royalty-free right and license to use the Intellectual Property and Permits worldwide including, without limitation, the Intellectual Property identified in Schedule 1 and Permits identified on Schedule 2, if an Event of Default exists, and to enable Licensee to exercise its rights and remedies under the Security Agreement and Intellectual Property Agreement with respect to Collateral, including, without limitation, the right to use the Intellectual Property and Permits on or in connection with the operation and disposition of any Collateral and the disposition, maintenance or further production, manufacturing or processing of the Inventory, the operation and maintenance of the Equipment and the collection of Receivables as Licensee reasonably deems necessary or appropriate in the exercise of its rights and remedies under the Security Agreement and Intellectual Property Agreement with respect to Collateral. The parties acknowledge and agree that the Intellectual Property and Permits are the sole and exclusive property of Licensor, subject to the terms and conditions stated in this Agreement, the Security Agreement and the Intellectual Property Agreement. Other than in connection with any security interest in the Intellectual Property and Permits that Licensor has granted to Licensee pursuant to the Security Agreement and the Intellectual Property Agreement or any rights and remedies of Licensee under the Security Agreement or the Intellectual Property Agreement, Licensee shall not challenge Licensor's ownership of the Intellectual Property and Permits. Licensor expressly retains all rights to license third parties to use the Intellectual Property and Permits for any purpose whatsoever not in violation of the Loan Papers and which are not exclusive as to prevent Licensee from using any of the Intellectual Property and Permits as provided in the Security Agreement and Intellectual Property Agreement. 2.2 The license granted to Licensee hereunder shall include the right of Licensee to grant sublicenses to others to use the Intellectual Property and Permits if an Event of Default exists, and to enable such sublicensees to exercise any rights and remedies of Licensee under the Security Agreement and the Intellectual Property Agreement with respect to Collateral, including, without limitation, the right to grant sublicenses to others to use the Intellectual Property and Permits on or in connection with the operation and disposition of any Collateral, the disposition, maintenance or further production, manufacturing or processing of Inventory, the operation and maintenance of the Equipment and the collection of Receivables as Licensee reasonably deems necessary or appropriate in the exercise of the rights and remedies of Licensee under the Security Agreement and the Intellectual Property Agreement. In any country where sublicenses are incapable of registration or where registration of a sublicense will not satisfactorily protect the rights of Licensor and Licensee, Licensee shall also have the right to designate other parties as direct licensees of Licensor to use the Intellectual Property and Permits if an Event of Default exists and to enable such direct licensees to exercise any rights and remedies of Licensee under the Security Agreement and the Intellectual Property Agreement including, without limitation, the right to use the Intellectual Property and Permits on or in connection with the operation and disposition of any Collateral, the disposition, maintenance or further production, manufacturing or processing of Inventory, the operation and maintenance of the Equipment and the collection of Receivables as such licensees reasonably deem necessary or -3- 5 appropriate and Licensor agrees to enter into direct written licenses with the parties as designated on the same terms as would be applicable to a sublicense, and any such direct license may, depending on the relevant local requirements, be either (a) in lieu of a sublicense or (b) supplemental to a sublicense. In either case, the parties hereto shall cooperate to determine what shall be necessary or appropriate in the circumstances. For each sublicense to a sublicensee and direct license to a licensee, Licensor appoints Licensee its agent for the purpose of exercising quality control over the sublicensee. Licensor shall execute this Agreement in any form, content and language suitable for recordation, notice and/or registration in all available and appropriate agencies of foreign countries as Licensee may require. 2.3 In connection with the assignment or other transfer (in whole or in part) of its obligations under the Security Agreement and the Intellectual Property Agreement to any other Person, Licensee may assign the license granted herein without Licensor's consent and upon such assignment or transfer such other Person shall thereupon become vested with all rights and benefits in respect thereof granted to Licensee under this Agreement. 2.4 The parties hereto shall take reasonable action to preserve the confidentiality of the Intellectual Property and Permits which is not otherwise public information; provided, that Licensee shall not have any liability to any Person for any disclosure of the Intellectual Property or Permits upon and after any realization upon Collateral under the Security Agreement or the Intellectual Property Agreement or otherwise as part of Licensee's enforcement of remedies under the Loan Papers. ARTICLE III. QUALITY CONTROL 3.1 Licensor shall refrain from using the Intellectual Property and Permits in a form and manner or for a subject matter as to (a) reduce the value of the Intellectual Property or Permits or (b) cause injury to Licensor's business, reputation or goodwill. 3.2 If an Event of Default exists and Licensee exercises its rights or remedies under the license granted herein: (a) Licensee may use the Trademarks licensed hereby in such form and manner as previously used by Licensor, and shall need not notify Licensor of any change in the form or substance of the display of a Trademark licensed hereby. Licensee shall take reasonable action to apply trademark notice or other marking as may be required under applicable Law of each territory and country where each Trademark is used, or as otherwise appropriate, in connection with use of each of the Trademarks licensed hereunder. Licensee shall have the right to register any and all Trademarks in any and all countries on and after the Effective Date. (b) Licensee may dispose of any Inventory and any other manufactured products under any of the Intellectual Property or Permits licensed hereby, provided the Inventory and any -4- 6 other manufactured products so disposed of by it or any other Person acting on behalf of Licensee shall comply in any material respect with (i) quality standards and specifications, including labelling specifications, employed by Licensor in commerce prior to the Effective Date, or, where no such standards and specifications exist, a level of quality comparable to the quality standards generally accepted for other leading competitive brands of the same item of Inventory in the same markets from time to time; or (ii) a level of quality comparable to that which may be adopted by Licensor for its or its other licensees' products. Licensee shall maintain quality control commensurate with the quality standards of Licensor at the Effective Date or, if quality control improves after the Effective Date, commensurate with such improved quality standards. ARTICLE IV. TERM AND TERMINATION 4.1 This Agreement is effective as of the Effective Date and, unless sooner terminated under the provisions set forth in this Article IV, is perpetual and irrevocable. 4.2 The license granted in Article II with respect to any Intellectual Property and Permits may be terminated only upon the event that the Obligations which are owed by Licensor and each other Obligor to Licensee, and which are secured in part by the Collateral of Licensor under the Security Agreement and the Intellectual Property Agreement and by the license granted herein, are finally and fully satisfied and paid in accordance with all terms and conditions of the Loan Papers at the time of such termination. If after termination of this Agreement, there occurs a rescission of payment of any of the Obligations or the restoration of such payments by Licensee or any other Person upon the insolvency, bankruptcy or reorganization of Licensor or any other Person, this Agreement shall be reinstated as though such payment had not been made and remain in full force and effect in accordance with the terms of the preceding sentence. 4.3 Upon termination of this Agreement, Licensee shall, and shall cause any sublicensee, to cease all use of any and all of the Intellectual Property and Permits and not thereafter use any of them in any other manner whatsoever, subject to reinstatement under Section 4.2. 4.4 Upon termination (or reinstatement) of this Agreement, the parties shall perform all other acts which may be necessary or useful to render effective the termination (or reinstatement) of the interest of Licensee in the Intellectual Property and Permits, including but not limited to the cancellation of any registration or recordation (or the reinstatement by registration or recordation) of this Agreement, or any summary thereof. -5- 7 ARTICLE V. RECORDATION OF AGREEMENT 5.1 The parties shall cooperate to determine what may or shall be required to satisfy the laws or regulations throughout the world with respect to the recordation and validation of this Agreement, or otherwise to render this Agreement and the Intellectual Property and Permits effective, and shall execute all documents which may be necessary or desirable to implement this Section 5.1, including registered user statements or other documents suitable for filing with the appropriate government authorities of any country. ARTICLE VI. REPRESENTATION AND WARRANTIES 6.1 Licensor represents and warrants that it is the owner of the Intellectual Property identified in Schedule 1 and Permits identified on Schedule 2 and has the right to grant the rights and license granted herein. ARTICLE VII. PRODUCT LIABILITY INSURANCE 7.1 Licensor shall maintain product liability insurance covering liabilities for its activities pursuant to this Agreement, of at least such amounts as is required by the Loan Papers. ARTICLE VIII. MISCELLANEOUS 8.1 Failure of either party to insist upon strict performance of the terms, conditions, and provisions of this Agreement shall not be deemed a waiver of such terms, conditions or provisions or a waiver of future compliance therewith. No waiver of any terms, conditions, or provisions hereof shall be deemed to have been made unless expressed in writing and signed by the waiving party. 8.2 Any sale, transfer or other disposition of ownership of any Intellectual Property or Permits by Licensor shall be subject to this Agreement and the Intellectual Property Agreement and any purchaser or transferee shall specifically state in writing that it is assuming this Agreement and that it will be bound by all of the terms and conditions of this Agreement and the Intellectual Property Agreement (this sentence is not a consent by Licensee to any sale, transfer or other disposition (other than the grant of a license permitted pursuant to Section 2.1) of any interest in Intellectual Property or Permits). After giving effect to such sale, transfer or other disposition, this Agreement and the Intellectual Property Agreement shall be valid, binding, and enforceable in accordance with its terms against such purchaser or transferee. A sale, transfer or other disposition of any shares of the capital stock of Licensor shall not be deemed to be a sale, transfer or other disposition of ownership of any Intellectual Property or Permits. -6- 8 8.3 Except as otherwise may be expressly provided in this Agreement or any other Loan Paper, Licensee shall not be construed to be and shall not represent itself as an agent of Licensor. 8.4 (a) All notices, communications and materials to be given or delivered pursuant to this Agreement shall, except in those cases where giving notice by telephone is expressly permitted, be given or delivered in writing. All written notices, communications and materials shall be sent by registered or certified mail, postage prepaid, return receipt requested, by telecopier, or delivered by hand. In the event of a discrepancy between any telephonic notice and any written confirmation thereof, such written confirmation shall be deemed the effective notice except to the extent Licensor or Licensee has acted in reliance on such telephonic notice. (b) All notices, communications and materials to be given or delivered pursuant to this Agreement shall be given or delivered at the following respective addresses and telecopier and telephone numbers and to the attention of the following individuals or departments: To Licensor: Quest Medical, Inc. One Allentown Parkway Allen, Texas 75002 U.S.A. Attention: F. Robert Merrill III To Licensee: NationsBank of Texas, National Association NationsBank Plaza 901 Main Street, 7th Floor Dallas, Texas 75202 U.S.A. Attention: Commercial Banking 8.5 This Agreement shall be governed by and construed in accordance with the internal laws of the State of Texas, U.S.A. 8.6 (a) Licensor hereby irrevocably submits to the non-exclusive jurisdiction of any United States Federal or Texas State court sitting in Dallas County, Texas, U.S.A. in any action or proceeding arising out of or relating to this Agreement, and Licensor hereby irrevocably agrees that all claims in respect of such action or proceeding may be heard or determined in any such court and hereby irrevocably waives any objection it may now or hereafter have as to the venue of any such suit, action or proceeding brought in such court or that such court is an inconvenient forum. -7- 9 (b) Nothing in this Section 8.6 shall limit the right of Licensee to bring any action or proceeding against Licensor or its property in the courts of any other jurisdiction or any party's rights under Section 8.10 of the Credit Agreement. (c) Any judicial proceeding by Licensor against Licensee involving, directly or indirectly, any matter in any way arising out of, related to, or connected with this Agreement shall be brought only in a court in Dallas County, Texas, U.S.A. REMAINDER OF PAGE INTENTIONALLY LEFT BLANK -8- 10 IN WITNESS WHEREOF, the parties have caused this Agreement to be executed by their respective duly authorized officers as of the date written above. QUEST MEDICAL, INC. - ---------------------------- Witness By: /s/ F. ROBERT MERRILL III --------------------------------- F. Robert Merrill III, Vice President - ---------------------------- Witness NATIONSBANK OF TEXAS, NATIONAL ASSOCIATION - ---------------------------- Witness By: /s/ BRIAN K. SCHNEIDER --------------------------------- Brian K. Schneider, Vice President - ---------------------------- Witness -9- EX-10.23 10 1ST AMEND & RESTATED LICENSE AGREEMENT 1 EXHIBIT 10.23 ================================================================================ FIRST AMENDED AND RESTATED LICENSE AGREEMENT Dated as of March 3, 1997 Between ADVANCED NEUROMODULATION SYSTEMS, INC. as Licensor and Successor by Merger and Successor in Interest to Neuromed, Inc. and NATIONSBANK OF TEXAS, NATIONAL ASSOCIATION as Licensee ================================================================================ 2 FIRST AMENDED AND RESTATED LICENSE AGREEMENT FIRST AMENDED AND RESTATED LICENSE AGREEMENT, dated March 3, 1997, by and between Advanced Neuromodulation Systems, Inc., a Texas corporation ("Licensor") as successor by merger and successor in interest to the assets of Neuromed, Inc., and NationsBank of Texas, National Association, a national banking association ("Licensee"). W I T N E S S E T H: WHEREAS, Licensor presently owns and will hereafter acquire right, title, and interest (including rights and interests pursuant to licenses) throughout the world in various Trademarks, Patents, Copyrights and Trade Secrets (hereinafter, collectively, the "Intellectual Property"); WHEREAS, Licensee and Quest Medical, Inc., a Texas corporation ("Borrower"), have entered into the First Amended and Restated Credit Agreement dated as of March 31, 1995 (such agreement, together with all amendments and restatements thereof, being the "1995 Credit Agreement") pursuant to which Neuromed, Inc. entered into a license agreement (the "Original Agreement"); WHEREAS, Borrower has entered into the Second Amended and Restated Credit Agreement dated as of February 9, 1996 (such agreement, together with all amendments and restatements thereof, the "Existing Credit Agreement") which restates in its entirety the 1995 Credit Agreement. WHEREAS, in October 1996, Neuromed, Inc. merged into Licensor, and Licensor assumed all obligations of Neuromed, Inc., including but not limited to the obligations under the Original Agreement, and Licensor succeeded to all the assets, including, but not limited to the intellectual property assets of Neuromed, Inc. WHEREAS, Licensee and Borrower have entered into the Third Amended and Restated Credit Agreement dated as of March 3, 1997 (such agreement, together with all amendments and restatements thereof, the "Credit Agreement") which restates in its entirety the Existing Credit Agreement. WHEREAS, Licensor is a wholly-owned subsidiary of Borrower; WHEREAS, as security for the payment and performance of the Obligations which are owed by Licensor and each other Obligor to Licensee pursuant to the Loan Papers, Licensor has agreed to grant or cause to be granted to Licensee, security interests in, and pledges and assignments of, all assets of Licensor, including all cash, Inventory, Receivables, Equipment, Permits and the Intellectual Property, a license to use the Intellectual Property and Permits and certain other collateral, to secure the Obligations; 3 WHEREAS, Licensee desires a license to use the Intellectual Property and Permits in all countries of the world solely if an Event of Default exists to enable Licensee to exercise its rights and remedies with respect to the Collateral under the Security Agreement; WHEREAS, Licensor desires to grant Licensee the foregoing license to so use the Intellectual Property and Permits; and WHEREAS, the parties acknowledge the excellent reputation for quality of products sold under the Intellectual Property and Permits, and desire to safeguard, promote and enhance that reputation by ensuring the future quality of materials, workmanship, and performance of the Inventory with respect to which Licensee has been granted a security interest, pledge and assignment and may exercise its rights and remedies under the Security Agreement and Intellectual Property Agreement, if an Event of Default exists. AGREEMENT. NOW, THEREFORE, in consideration of the above premises and of the mutual covenants herein contained, and other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, and intending to be legally bound, the parties hereto agree as follows: ARTICLE I. DEFINITIONS 1.1 "Collateral" has the same definition provided in the Security Agreement. 1.2 "Effective Date" means March 3, 1997. 1.3 "Equipment" has the same definition provided in the Security Agreement. 1.4 "Intellectual Property Agreement" means the Amended and Restated Intellectual Property Security Agreement and Assignment dated March 3, 1997 between Licensor and Licensee. 1.5 "Inventory" has the same definition provided in the Security Agreement. 1.6 "Permits" means all licenses, permits and other similar rights now or hereafter owned by Licensor (including but not limited to all licenses, permits and similar rights issued by the FDA) and necessary to the operation of its business, including but not limited to all licenses, permits and other rights listed on Schedule 2. 1.7 "Receivables" has the same definition provided in the Security Agreement. -2- 4 1.8 "Security Agreement" means the Amended and Restated Security Agreement dated March 3, 1997 between Licensor and Licensee. 1.9 Unless otherwise defined in this Agreement, all capitalized terms herein shall have the same definition provided in the Credit Agreement, the Intellectual Property Agreement and the Security Agreement. ARTICLE II. GRANTS TO LICENSEE AND RELATED MATTERS 2.1 Licensor hereby grants to Licensee an irrevocable, non-exclusive royalty-free right and license to use the Intellectual Property and Permits worldwide including, without limitation, the Intellectual Property identified in Schedule 1 and Permits identified on Schedule 2, if an Event of Default exists, and to enable Licensee to exercise its rights and remedies under the Security Agreement and Intellectual Property Agreement with respect to Collateral, including, without limitation, the right to use the Intellectual Property and Permits on or in connection with the operation and disposition of any Collateral and the disposition, maintenance or further production, manufacturing or processing of the Inventory, the operation and maintenance of the Equipment and the collection of Receivables as Licensee reasonably deems necessary or appropriate in the exercise of its rights and remedies under the Security Agreement and Intellectual Property Agreement with respect to Collateral. The parties acknowledge and agree that the Intellectual Property and Permits are the sole and exclusive property of Licensor, subject to the terms and conditions stated in this Agreement, the Security Agreement and the Intellectual Property Agreement. Other than in connection with any security interest in the Intellectual Property and Permits that Licensor has granted to Licensee pursuant to the Security Agreement and the Intellectual Property Agreement or any rights and remedies of Licensee under the Security Agreement or the Intellectual Property Agreement, Licensee shall not challenge Licensor's ownership of the Intellectual Property and Permits. Licensor expressly retains all rights to license third parties to use the Intellectual Property and Permits for any purpose whatsoever not in violation of the Loan Papers and which are not exclusive as to prevent Licensee from using any of the Intellectual Property and Permits as provided in the Security Agreement and Intellectual Property Agreement. 2.2 The license granted to Licensee hereunder shall include the right of Licensee to grant sublicenses to others to use the Intellectual Property and Permits if an Event of Default exists, and to enable such sublicensees to exercise any rights and remedies of Licensee under the Security Agreement and the Intellectual Property Agreement with respect to Collateral, including, without limitation, the right to grant sublicenses to others to use the Intellectual Property and Permits on or in connection with the operation and disposition of any Collateral, the disposition, maintenance or further production, manufacturing or processing of Inventory, the operation and maintenance of the Equipment and the collection of Receivables as Licensee reasonably deems necessary or appropriate in the exercise of the rights and remedies of Licensee -3- 5 under the Security Agreement and the Intellectual Property Agreement. In any country where sublicenses are incapable of registration or where registration of a sublicense will not satisfactorily protect the rights of Licensor and Licensee, Licensee shall also have the right to designate other parties as direct licensees of Licensor to use the Intellectual Property and Permits if an Event of Default exists and to enable such direct licensees to exercise any rights and remedies of Licensee under the Security Agreement and the Intellectual Property Agreement including, without limitation, the right to use the Intellectual Property and Permits on or in connection with the operation and disposition of any Collateral, the disposition, maintenance or further production, manufacturing or processing of Inventory, the operation and maintenance of the Equipment and the collection of Receivables as such licensees reasonably deem necessary or appropriate and Licensor agrees to enter into direct written licenses with the parties as designated on the same terms as would be applicable to a sublicense, and any such direct license may, depending on the relevant local requirements, be either (a) in lieu of a sublicense or (b) supplemental to a sublicense. In either case, the parties hereto shall cooperate to determine what shall be necessary or appropriate in the circumstances. For each sublicense to a sublicensee and direct license to a licensee, Licensor appoints Licensee its agent for the purpose of exercising quality control over the sublicensee. Licensor shall execute this Agreement in any form, content and language suitable for recordation, notice and/or registration in all available and appropriate agencies of foreign countries as Licensee may require. 2.3 In connection with the assignment or other transfer (in whole or in part) of its obligations under the Security Agreement and the Intellectual Property Agreement to any other Person, Licensee may assign the license granted herein without Licensor's consent and upon such assignment or transfer such other Person shall thereupon become vested with all rights and benefits in respect thereof granted to Licensee under this Agreement. 2.4 The parties hereto shall take reasonable action to preserve the confidentiality of the Intellectual Property and Permits which is not otherwise public information; provided, that Licensee shall not have any liability to any Person for any disclosure of the Intellectual Property or Permits upon and after any realization upon Collateral under the Security Agreement or the Intellectual Property Agreement or otherwise as part of Licensee's enforcement of remedies under the Loan Papers. ARTICLE III. QUALITY CONTROL 3.1 Licensor shall refrain from using the Intellectual Property and Permits in a form and manner or for a subject matter as to (a) reduce the value of the Intellectual Property or Permits or (b) cause injury to Licensor's business, reputation or goodwill. 3.2 If an Event of Default exists and Licensee exercises its rights or remedies under the license granted herein: -4- 6 (a) Licensee may use the Trademarks licensed hereby in such form and manner as previously used by Licensor, and shall need not notify Licensor of any change in the form or substance of the display of a Trademark licensed hereby. Licensee shall take reasonable action to apply trademark notice or other marking as may be required under applicable Law of each territory and country where each Trademark is used, or as otherwise appropriate, in connection with use of each of the Trademarks licensed hereunder. Licensee shall have the right to register any and all Trademarks in any and all countries on and after the Effective Date. (b) Licensee may dispose of any Inventory and any other manufactured products under any of the Intellectual Property or Permits licensed hereby, provided the Inventory and any other manufactured products so disposed of by it or any other Person acting on behalf of Licensee shall comply in any material respect with (i) quality standards and specifications, including labelling specifications, employed by Licensor in commerce prior to the Effective Date, or, where no such standards and specifications exist, a level of quality comparable to the quality standards generally accepted for other leading competitive brands of the same item of Inventory in the same markets from time to time; or (ii) a level of quality comparable to that which may be adopted by Licensor for its or its other licensees' products. Licensee shall maintain quality control commensurate with the quality standards of Licensor at the Effective Date or, if quality control improves after the Effective Date, commensurate with such improved quality standards. ARTICLE IV. TERM AND TERMINATION 4.1 This Agreement is effective as of the Effective Date and, unless sooner terminated under the provisions set forth in this Article IV, is perpetual and irrevocable. 4.2 The license granted in Article II with respect to any Intellectual Property and Permits may be terminated only upon the event that the Obligations which are owed by Licensor and each other Obligor to Licensee, and which are secured in part by the Collateral of Licensor under the Security Agreement and the Intellectual Property Agreement and by the license granted herein, are finally and fully satisfied and paid in accordance with all terms and conditions of the Loan Papers at the time of such termination. If after termination of this Agreement, there occurs a rescission of payment of any of the Obligations or the restoration of such payments by Licensee or any other Person upon the insolvency, bankruptcy or reorganization of Licensor or any other Person, this Agreement shall be reinstated as though such payment had not been made and remain in full force and effect in accordance with the terms of the preceding sentence. 4.3 Upon termination of this Agreement, Licensee shall, and shall cause any sublicensee, to cease all use of any and all of the Intellectual Property and Permits and not thereafter use any of them in any other manner whatsoever, subject to reinstatement under Section 4.2. -5- 7 4.4 Upon termination (or reinstatement) of this Agreement, the parties shall perform all other acts which may be necessary or useful to render effective the termination (or reinstatement) of the interest of Licensee in the Intellectual Property and Permits, including but not limited to the cancellation of any registration or recordation (or the reinstatement by registration or recordation) of this Agreement, or any summary thereof. ARTICLE V. RECORDATION OF AGREEMENT 5.1 The parties shall cooperate to determine what may or shall be required to satisfy the laws or regulations throughout the world with respect to the recordation and validation of this Agreement, or otherwise to render this Agreement and the Intellectual Property and Permits effective, and shall execute all documents which may be necessary or desirable to implement this Section 5.1, including registered user statements or other documents suitable for filing with the appropriate government authorities of any country. ARTICLE VI. REPRESENTATION AND WARRANTIES 6.1 Licensor represents and warrants that it is the owner of the Intellectual Property identified in Schedule 1 and Permits identified on Schedule 2 and has the right to grant the rights and license granted herein. ARTICLE VII. PRODUCT LIABILITY INSURANCE 7.1 Licensor shall maintain product liability insurance covering liabilities for its activities pursuant to this Agreement, of at least such amounts as is required by the Loan Papers. ARTICLE VIII. MISCELLANEOUS 8.1 Failure of either party to insist upon strict performance of the terms, conditions, and provisions of this Agreement shall not be deemed a waiver of such terms, conditions or provisions or a waiver of future compliance therewith. No waiver of any terms, conditions, or provisions hereof shall be deemed to have been made unless expressed in writing and signed by the waiving party. 8.2 Any sale, transfer or other disposition of ownership of any Intellectual Property or Permits by Licensor shall be subject to this Agreement and the Intellectual Property Agreement and any purchaser or transferee shall specifically state in writing that it is assuming this Agreement and that it will be bound by all of the terms and conditions of this Agreement and the Intellectual Property Agreement (this sentence is not a consent by Licensee to any sale, -6- 8 transfer or other disposition (other than the grant of a license permitted pursuant to Section 2.1) of any interest in Intellectual Property or Permits). After giving effect to such sale, transfer or other disposition, this Agreement and the Intellectual Property Agreement shall be valid, binding, and enforceable in accordance with its terms against such purchaser or transferee. A sale, transfer or other disposition of any shares of the capital stock of Licensor shall not be deemed to be a sale, transfer or other disposition of ownership of any Intellectual Property or Permits. 8.3 Except as otherwise may be expressly provided in this Agreement or any other Loan Paper, Licensee shall not be construed to be and shall not represent itself as an agent of Licensor. 8.4 (a) All notices, communications and materials to be given or delivered pursuant to this Agreement shall, except in those cases where giving notice by telephone is expressly permitted, be given or delivered in writing. All written notices, communications and materials shall be sent by registered or certified mail, postage prepaid, return receipt requested, by telecopier, or delivered by hand. In the event of a discrepancy between any telephonic notice and any written confirmation thereof, such written confirmation shall be deemed the effective notice except to the extent Licensor or Licensee has acted in reliance on such telephonic notice. (b) All notices, communications and materials to be given or delivered pursuant to this Agreement shall be given or delivered at the following respective addresses and telecopier and telephone numbers and to the attention of the following individuals or departments: To Licensor: Advanced Neuromodulation Systems, Inc. c/o Quest Medical, Inc. One Allentown Parkway Allen, Texas 75002 U.S.A. Attention: F. Robert Merrill III To Licensee: NationsBank of Texas, National Association NationsBank Plaza 901 Main Street, 7th Floor Dallas, Texas 75202 U.S.A. Attention: Commercial Banking 8.5 This Agreement shall be governed by and construed in accordance with the internal laws of the State of Texas, U.S.A. -7- 9 8.6 (a) Licensor hereby irrevocably submits to the non-exclusive jurisdiction of any United States Federal or Texas State court sitting in Dallas County, Texas, U.S.A. in any action or proceeding arising out of or relating to this Agreement, and Licensor hereby irrevocably agrees that all claims in respect of such action or proceeding may be heard or determined in any such court and hereby irrevocably waives any objection it may now or hereafter have as to the venue of any such suit, action or proceeding brought in such court or that such court is an inconvenient forum. (b) Nothing in this Section 8.6 shall limit the right of Licensee to bring any action or proceeding against Licensor or its property in the courts of any other jurisdiction or any party's rights under Section 8.10 of the Credit Agreement. (c) Any judicial proceeding by Licensor against Licensee involving, directly or indirectly, any matter in any way arising out of, related to, or connected with this Agreement shall be brought only in a court in Dallas County, Texas, U.S.A. REMAINDER OF PAGE INTENTIONALLY LEFT BLANK -8- 10 IN WITNESS WHEREOF, the parties have caused this Agreement to be executed by their respective duly authorized officers as of the date written above. ADVANCED NEUROMODULATION SYSTEMS, INC., as successor by merger and successor in interest to the assets of Neuromed, Inc. - -------------------------------- Witness By: /s/ F. ROBERT MERRILL III --------------------------------- F. Robert Merrill III, Vice President - -------------------------------- Witness NATIONSBANK OF TEXAS, NATIONAL ASSOCIATION - -------------------------------- Witness By: /s/ BRIAN K. SCHNEIDER --------------------------------- Brian K. Schneider, Vice President - -------------------------------- Witness -9- EX-10.24 11 RESTATED CREDIT AGREEMENT 1 EXHIBIT 10.24 GUARANTY THIS GUARANTY is entered into as of this 3rd day of March, 1997 by Advanced Neuromodulation Systems, Inc., a Texas corporation, SPAC Acquisition Corp., a Delaware corporation, Hug Centers of America I., Inc., a Delaware corporation and Quest Acquisition Corporation, a Delaware corporation (collectively, the "Guarantor"), in favor of NationsBank of Texas, N.A. ("Lender") under the Third Amended and Restated Credit Agreement dated as of March 3rd, 1997 (such agreement, together with all amendments and restatements thereof, the "Credit Agreement") between Quest Medical, Inc. ("Borrower") and Lender. RECITALS: Pursuant to the Credit Agreement and the other Loan Papers, Borrower may from time to time be indebted to Lender; and Lender is not willing to make Advances under the Credit Agreement or otherwise extend credit to Borrower unless Guarantor unconditionally guarantees payment of all present and future indebtedness and obligations of Borrower to Lender; and Guarantors are wholly-owned subsidiaries of Borrower and will directly benefit from Lender's making loans to Borrower. AGREEMENT: NOW, THEREFORE, as an inducement to Lender to enter into the Credit Agreement and to make loans to Borrower thereunder, and to extend such additional credit as Lender may from time to time agree to extend, and for other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the parties do hereby agree as follows: Guarantor hereby unconditionally guarantees to Lender the prompt payment at the time provided in Section 5 of this Guaranty, at maturity (by acceleration or otherwise), and at all times thereafter, of the Guaranteed Indebtedness (hereinafter defined), this guaranty being upon the following terms and conditions: 1. Definitions. Unless defined herein, all capitalized terms have the meanings ascribed to such terms in the Credit Agreement. As used herein, the following terms are defined as follows: "Borrower" includes, without limitation, Borrower, Borrower as a debtor-in-possession, and any receiver, trustee, liquidator, conservator, custodian, or similar party appointed for Borrower or all or substantially all of its assets pursuant to any Debtor Relief Law. 2 "Guaranteed Indebtedness" means any and all obligations now or hereafter existing of Borrower, each other Obligor and any other Person under the Credit Agreement and the other Loan Papers, including any extensions, modifications, substitutions, amendments and renewals thereof, whether for principal, interest, fees, premium, expenses, indemnification or otherwise (all such obligations of Borrower and each other Obligor being the "Obligations"), together with all amounts which constitute part of the Obligations and would be owed by Borrower or any other Person to Lender under any Loan Paper, but for the fact that they are unenforceable or not allowable due to the existence of a bankruptcy, reorganization or similar proceeding involving Borrower, each other Obligor or any other Person (including all such amounts which would become due but for the operation of the automatic stay under Section 362(a) of the United States Bankruptcy Code, 11 U.S.C. Section 362(a), and the operation of Sections 502(b) and 506(b) of the United States Bankruptcy Code, 11 U.S.C. Section 502(b) and Section 506(b) or any analogous stay under any foreign Law), and any and all costs, attorneys' fees, and expenses incurred by Lender by reason of Borrower's, Guarantor's or any other Person's default in payment of any of the foregoing indebtedness. "Maximum Guaranteed Indebtedness" means, with respect to Guarantor as of the date of determination, the lesser of (a) the Guaranteed Indebtedness, and (b) the maximum amount for which Guarantor may be liable under this Guaranty without such amount and Guarantor's obligations under this Guaranty with respect to such amount being deemed a fraudulent transfer, as determined by a bankruptcy or similar court. 2. Maximum Guaranteed Indebtedness. Notwithstanding any contrary provision herein or in any other Loan Paper, Guarantor's maximum liability hereunder shall not exceed the Maximum Guaranteed Indebtedness. Guarantor agrees that the Guaranteed Indebtedness may at any time exceed the aggregate Maximum Guaranteed Indebtedness of all Obligors (excluding Borrower) on all or any part of the Guaranteed Indebtedness, without affecting or impairing the obligation of Guarantor. 3. Continuing Guaranty. This instrument shall be an absolute and continuing guaranty of payment, and the circumstances that at any time or from time to time the Guaranteed Indebtedness may be paid in full shall not affect the obligation of Guarantor with respect to indebtedness or obligations of Borrower to Lender thereafter incurred pursuant to the Credit Agreement, any other Loan Paper, or otherwise. 4. Other Debt. If Guarantor becomes liable for any indebtedness owing by Borrower to Lender by endorsement or otherwise, other than this Guaranty, such liability shall not be in any manner impaired or affected hereby, and the Rights of Lender hereunder shall be cumulative of any and all other Rights which Lender may ever have against Guarantor. The -2- 3 exercise by Lender of any Right or remedy hereunder or under any other instrument shall not preclude the concurrent or subsequent exercise of any other Right or remedy. 5. Payment. If an Event of Default exists, Guarantor shall, on demand by Lender and without further notice of dishonor, without any notice having been given to Guarantor previous to such demand of acceptance by Lender of this Guaranty, and without any notice having been given to Guarantor previous to such demand of the creating or incurring of the Guaranteed Indebtedness, pay the entire amount of the Guaranteed Indebtedness to Lender at the Principal Office of Lender, and it shall not be necessary for Lender, in order to enforce such payment by Guarantor, first to institute suit or exhaust its remedies against Borrower, or other Person liable for the Guaranteed Indebtedness, or to enforce its Rights against any security which shall ever have been given to secure the Guaranteed Indebtedness, this Guaranty being a guaranty of payment and not of collection, and in no way conditional or contingent. Guarantor hereby irrevocably and unconditionally covenants and agrees that it is liable for the Guaranteed Indebtedness as primary obligor. 6. Obligation Not Impaired. Guarantor hereby agrees that its obligations under the terms of this Guaranty shall not be released, diminished, impaired, reduced, or affected by the occurrence of any one or more of the following events: (a) the taking or accepting of any other security or guaranty for any or all of the Guaranteed Indebtedness; (b) any release, surrender, exchange, subordination, or loss of any security at any time existing in connection with any or all of the Guaranteed Indebtedness; (c) the modification of, amendment to, or waiver of compliance with any terms of the Credit Agreement or any other Loan Paper without the notification of Guarantor (the right to such notification being herein specifically waived by Guarantor); (d) the insolvency, bankruptcy, or lack of corporate or other power of Borrower or any other Person at any time liable for the payment of any or all of the Guaranteed Indebtedness, whether now existing or hereafter occurring; (e) any renewal, extension, and/or rearrangement of the payment of any or all of the Guaranteed Indebtedness, either with or without notice to or consent of Guarantor, or any adjustment, indulgence, forbearance, or compromise that may be granted or given by Lender to Borrower, Guarantor or any Person at any time liable for the payment of any or all of the Guaranteed Indebtedness; (f) any neglect, delay, omission, failure, or refusal of Lender to take or prosecute any action for the collection of any of the Guaranteed Indebtedness or to foreclose or take or prosecute any action in connection with any instrument or agreement evidencing or securing all or any part of the Guaranteed Indebtedness; (g) any failure of Lender to notify Guarantor of any renewal, extension, or assignment of the Guaranteed Indebtedness or any part thereof, or the release of any security, or of any other action taken or refrained from being taken by Lender, it being understood that Lender shall not be required to give Guarantor any notice of any kind under any circumstances whatsoever with respect to or in connection with the Guaranteed Indebtedness; (h) the unenforceability of all or any part of the Guaranteed Indebtedness against Borrower or any Person at any time liable for the payment of any or all of the Guaranteed Indebtedness by reason of the fact that the Guaranteed Indebtedness, and/or the interest paid or payable with respect thereto, exceeds the amount permitted by Law, the act of creating the Guaranteed Indebtedness, or any part thereof, is ultra vires, or the officers creating same acted in excess of their authority, or for any other reason; or (i) any payment by -3- 4 Borrower to Lender is held to constitute a preference under any Debtor Relief Law or if for any other reason Lender is required to refund such payment or pay the amount thereof to another Person. 7. Waivers. Guarantor hereby waives all Rights by which it might be entitled to require suit on an accrued right of action in respect of any of the Guaranteed Indebtedness or require suit against Borrower or others, whether arising pursuant to Section 34.02 of the Texas Business and Commerce Code, as amended, Section 17.001 of the Texas Civil Practice and Remedies Code, as amended, and Rule 31 of the Texas Rules of Civil Procedure, as amended, or otherwise. 8. Guarantor Insolvency. Should Guarantor become insolvent, fail to pay its debts generally as they become due, voluntarily seek, consent to, or acquiesce in the benefits of any Debtor Relief Law or become a party to or be made the subject of any proceeding provided for by any Debtor Relief Law (other than as a creditor or claimant) that could suspend or otherwise adversely affect the Rights of Lender granted hereunder, then, the Guaranteed Indebtedness shall be, as between Guarantor and Lender, a fully matured, due, and payable obligation of Guarantor to Lender (without regard to whether Borrower is then in default under the Credit Agreement or any other Loan Paper or whether any part of the Obligation is then due and owing by Borrower to Lender), payable in full by Guarantor to Lender upon demand, which shall be the estimated amount owing in respect of the contingent claim created hereunder. 9. Representations and Warranties. Guarantor represents and warrants to Lender that: (a) Guarantor is a corporation duly organized and validly existing under the Laws of the State of Texas or Delaware, as the case may be; (b) Guarantor is qualified to do business in all jurisdictions where the nature of its business or properties require such qualification; (c) the board of directors of Guarantor has duly authorized the execution, delivery, and performance of this Guaranty and the other Loan Papers to be executed by Guarantor and no consent of any shareholder of Guarantor is required to authorize such execution, delivery or performance; (d) Guarantor has full legal right, power, and authority to execute, deliver, and perform under this Guaranty and the Loan Papers to be executed and delivered by it; (e) this Guaranty and the other Loan Papers to be executed by Guarantor constitute the legal, valid, and binding obligations of Guarantor enforceable in accordance with their terms (subject as to enforcement of remedies to any applicable Debtor Relief Laws); -4- 5 (f) the execution or delivery of any Loan Papers to be executed by Guarantor and performance thereunder, does not conflict with, or result in a breach of the terms, conditions, or provisions of, or constitute a default under, or result in any violation of, or result in the creation of any Lien upon any properties of Guarantor (other than rights of setoff in favor of Lender) under, or require any consent (other than consents already obtained), approval, or other action by, notice to, or filing with any Tribunal or Person pursuant to, the corporate governance documents of Guarantor, any award of any arbitrator, or any agreement, instrument, or Law to which Guarantor or any of its properties is subject; (g) the financial statements of Guarantor and its subsidiaries dated December 31, 1996 delivered to Lender fairly present its financial condition and the results of operations as of the dates and for the periods shown, all in accordance with GAAP (subject to audit adjustments) and such financial statements reflect all material liabilities, direct and contingent, of Guarantor that are required to be disclosed in accordance with GAAP (subject to audit adjustments); (h) as of the date of such financial statements, there were no contingent liabilities, liabilities for Taxes currently due and payable, forward or long-term commitments, or unrealized or anticipated losses from any unfavorable commitments that are substantial in amount and that are not reflected on such financial statements or otherwise disclosed in writing to Lender; (i) Guarantor is Solvent; (j) there is no pending or, to Guarantor's best knowledge, threatened Litigation or any claim related to the release of any toxic or hazardous waste or substance or alleged violation of any federal, state or local environmental, health or safety law against Guarantor that could constitute a Material Adverse Change as to Guarantor; (k) the value of the consideration received and to be received by Guarantor is reasonably worth at least as much as the liability and obligation of Guarantor hereunder, and such liability and obligation may reasonably be expected to benefit Guarantor directly or indirectly; (l) Guarantor is familiar with, and has independently reviewed books and records regarding, the financial condition of Borrower and is familiar with the value of any and all collateral intended to be created as security for the payment of the Guaranteed Indebtedness; and (m) neither Lender nor any of its officers or agents has made any representation, warranty or statement to Guarantor in order to induce Guarantor to execute this Guaranty. -5- 6 10. Affirmative Covenants. So long as any of the Facility A Commitment or the Facility B Commitment or any Advance under the Credit Agreement or any portion of the Obligation is outstanding, or Borrower owes any amount under any Loan Paper, Guarantor: (a) shall furnish to Lender: (i) As soon as available and in any event within 45 days after the end of each of Guarantor's fiscal quarters, consolidated and consolidating balance sheets of Guarantor as of the end of such quarter, and consolidated and consolidating statements of income, and a consolidated statement of changes in cash flow of Guarantor and its subsidiaries for such quarter and for the portion of the fiscal year ending with such quarter, setting forth, in comparative form, figures for the corresponding periods in the previous fiscal year, all in reasonable detail, and certified by an authorized officer of Guarantor as prepared in accordance with GAAP, and fairly presenting the financial condition and results of operations of Guarantor and its subsidiaries; (ii) As soon as available and in any event within 90 days after the end of each fiscal year of Guarantor, a consolidated balance sheet of Guarantor and its subsidiaries as at the end of such fiscal year, and consolidated statements of income and changes in cash flow of Guarantor and its subsidiaries for such fiscal year, all in reasonable detail, prepared in accordance with GAAP, and accompanied by an unqualified opinion of the auditor, which opinion shall state that said financial statements were prepared in accordance with GAAP, that the examination by the auditor in connection with such financial statements was made in accordance with generally accepted auditing standards, and that said financial statements present fairly the financial condition and results of operations of Guarantor and its subsidiaries; (iii) Promptly upon becoming aware, written notice of any actual or potential contingent liabilities, including Litigation, against Guarantor involving liability in an amount which must be disclosed in either Borrower's or Guarantor's financial statements or filings with the Securities and Exchange Commission; (iv) Promptly after filing or receipt thereof by an officer of Guarantor, copies of all reports and notices that Guarantor or any of its Subsidiaries furnishes to or receives from any holders of any Debt or Contingent Liability, if any information or dispute referred to therein could result in a Default or an Event of Default; (v) As soon as possible and in any event within 10 days after Guarantor knows that any Reportable Event has occurred with respect to any Plan of Guarantor, a statement, signed by an authorized officer, describing said -6- 7 Reportable Event and the action which Guarantor proposes to take with respect thereto; (vi) As soon as possible, and in any event within 10 days after receipt by Guarantor, a copy of (A) any notice or claim to the effect that Guarantor or any of its subsidiaries is or may be liable to any Person as a result of the release by Guarantor, any of its subsidiaries or any other Person of any toxic or hazardous waste or substance into the environment, and (B) any notice alleging any violation of any federal, state or local environmental, health or safety law or regulation by Guarantor or any of its subsidiaries, which could, in either case, cause a Material Adverse Change as to Guarantor; and (vii) Promptly upon request, such other information concerning the condition or operations of any of Guarantor, its subsidiaries, and its Affiliates, financial or otherwise, as Lender may from time to time reasonably request. (b) (i) shall cause to be done all things necessary to preserve and keep in full force and effect Guarantor's existence as a corporation; (ii) shall comply with the requirements of all applicable Laws and orders (including but not limited to the FDA Act, ERISA and environmental laws) of Tribunals or other governmental authorizations necessary to the ownership of Guarantor's properties or to the conduct of its business if the result of failure to so comply would have a Material Adverse Effect as to Guarantor; and (iii) will, on request of Lender, promptly correct any defect, error or omission which may be discovered in the contents of any of the Loan Papers to which it is a party or in the execution or acknowledgment thereof, and will execute, acknowledge and deliver such further instruments and do such further acts as may be necessary or as may be requested by Lender to carry out more effectively the purposes of this Guaranty and the Loan Papers to which it is a party. 11. Setoff. Guarantor grants to Lender a right of setoff and Lien upon each deposit account (time, demand, special and other) of Guarantor maintained with Lender and any of its Affiliates to secure performance of Guarantor's obligations hereunder. If an Event of Default exists, Lender may setoff and otherwise apply any and all amounts in any such deposit account to all amounts due hereunder. 12. Benefit; Binding Obligation. This Guaranty is for the benefit of Lender and its successors and assigns, and in the event of an assignment of the Guaranteed Indebtedness, or any part thereof, the Rights and benefits hereunder, to the extent applicable to the Guaranteed -7- 8 Indebtedness so assigned, may be transferred with such indebtedness. This Guaranty is binding not only on Guarantor, but on its successors and assigns. 13. Defenses. The Guaranteed Indebtedness shall not be reduced, discharged, or released because or by reason of any existing or future offset, claim or defense of Borrower or any other Person against Lender or against payment of the Guaranteed Indebtedness, whether such offset, claim, or defense arises in connection with the Guaranteed Indebtedness or otherwise. 14. Change of Borrower Status. Should the status of Borrower change through merger, consolidation, or otherwise, this Guaranty shall continue and shall cover Guaranteed Indebtedness under the new status. 15. Fees. Guarantor agrees to pay reasonable attorneys' fees and collection costs if this Guaranty is placed in the hands of an attorney for collection. 16. Governing Law. This Guaranty shall be governed by and construed according to the substantive Laws of the State of Texas. The unenforceability or invalidity, as determined by a court of competent jurisdiction, of any provision of this Guaranty shall not render unenforceable or invalid any other provision of this Guaranty. 17. Waiver of Subrogation. Guarantor shall not assert, enforce, or otherwise exercise (i) any right of subrogation to any of the rights or liens of Lender or any other beneficiary of any Lien against Borrower or any other obligor on the Guaranteed Indebtedness or any collateral or other security, or (ii) any right of recourse, reimbursement, contribution, indemnification, or similar right against Borrower or any other obligor on all or any part of the Guaranteed Indebtedness or any guarantor thereof, and Guarantor hereby waives any and all of the foregoing rights and the benefit of, and any right to participate in, any collateral or other security given to Lender or any other beneficiary of any Lien to secure payment of the Guaranteed Indebtedness. The provisions of this Section 17 shall survive the termination of this Guaranty, and any satisfaction and discharge of Borrower by virtue of any payment, court order, or Law. 18. LOAN PAPERS. THIS GUARANTY AND THE OTHER LOAN PAPERS REPRESENT THE FINAL AGREEMENT BETWEEN THE PARTIES AND MAY NOT BE CONTRADICTED BY EVIDENCE OF PRIOR, CONTEMPORANEOUS, OR SUBSEQUENT ORAL AGREEMENTS OF THE PARTIES. THERE ARE NO UNWRITTEN ORAL AGREEMENTS BETWEEN THE PARTIES. REMAINDER OF PAGE INTENTIONALLY LEFT BLANK -8- 9 EXECUTED as of March 3rd, 1997. ADVANCED NEUROMODULATION SYSTEMS, INC. By: /s/F. Robert Merrill III --------------------------------------- F. Robert Merrill III, Vice President SPAC ACQUISITION CORP. HUG CENTERS OF AMERICA I., INC. QUEST ACQUISITION CORPORATION By: /s/F. Robert Merrill III --------------------------------------- F. Robert Merrill III, Secretary of each corporation -9- EX-11.1 12 COMPUTATION OF EARNINGS PER SHARE 1 EXHIBIT 11.1 QUEST MEDICAL, INC. COMPUTATION OF EARNINGS PER SHARE YEARS ENDED DECEMBER 31
1996 1995 1994 ---------- ------------ ----------- Primary and fully diluted: Weighted average common shares outstanding........ 8,259,129 6,267,439 5,256,683 Stock options and warrants(1) -- based on the treasury stock method using average market price (which was higher than the year end price)......................................... 272,370 374,643 -- ---------- ------------ ----------- Primary weighted average common and common equivalent shares outstanding.................. 8,531,499 6,642,082 5,256,683 ========== ============ =========== Loss before extraordinary item.................... $ (412,157) $(10,104,998) $(1,719,193) ---------- ------------ ----------- Extraordinary item -- loss on early extinguishment of debt........................................ $ -- $ (269,045) $ -- ---------- ------------ ----------- Net loss.......................................... $ (412,157) $(10,374,043) $(1,719,193) ========== ============ =========== Loss before extraordinary item per share.......... $ (.05) $ (1.52) $ (.33) ---------- ------------ ----------- Extraordinary item per share...................... $ -- $ (.04) $ -- ---------- ------------ ----------- Net loss per share................................ $ (.05) $ (1.56) $ (.33) ========== ============ ===========
- --------------- (1) The effect of stock options and warrants was included in the quarterly calculations in those quarters where the effect was dilutive. Weighted average common and common equivalent shares for the full year represent the average of the quarterly computations. EX-21.1 13 SUBSIDIARIES OF THE REGISTRANT 1 EXHIBIT 21.1 SUBSIDIARIES Advanced Neuromodulation Systems, Inc......................................Texas EX-23.1 14 CONSENT OF INDEPENDENT AUDITORS 1 EXHIBIT 23.1 CONSENT OF INDEPENDENT AUDITORS We consent to the incorporation by reference in the Registration Statements (Form S-8 -- Nos. 2-82414, 2-91410, 33-235312, and 33-00967) pertaining to the Quest Medical, Inc. 1979 Amended and Restated Employees' Stock Option Plan; the Quest Medical, Inc. Directors' Stock Option Plan; the Quest Medical, Inc. 1987 Employees' Stock Option Plan; and the Quest Medical, Inc. 1995 Stock Option Plan, the Quest Medical, Inc. Sales and Marketing Employees Stock Option Plan, and the Heaton Stock Option Plan and the related Prospectuses of our report dated March 14, 1997, with respect to the consolidated financial statements of Quest Medical, Inc. and subsidiaries, included in the Annual Report (Form 10-K) for the year ended December 31, 1996. /s/ ERNST & YOUNG LLP ------------------------------------ Ernst & Young LLP Dallas, Texas March 26, 1997 EX-27 15 FINANCIAL DATA SCHEDULE
5 YEAR DEC-31-1996 JAN-01-1996 DEC-31-1996 696,196 1,366,089 5,181,039 174,337 8,364,594 16,553,827 16,016,998 4,832,468 48,992,455 5,466,305 0 0 0 416,926 30,576,557 48,992,455 26,073,808 26,073,808 11,005,260 14,968,358 429,472 0 766,769 (329,282) 82,875 (412,157) 0 0 0 (412,157) (.05) (.05)
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