SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (D)
OF THE SECURITIES EXCHANGE ACT OF 1934
For Quarter Ended June 30, 2002 Commission File No. 0-24866
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MICROTEK MEDICAL HOLDINGS, INC.
--------------------------------
(Exact name of Registrant as specified in its charter)
Georgia 58-1746149
- ------------------------------- -----------------
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
512 LEHMBERG ROAD
COLUMBUS, MISSISSIPPI 39702
---------------------------
(Address of principal executive offices)
(662) 327-1863
--------------
(Registrant's telephone number, including area code)
ISOLYSER COMPANY, INC.
Former name of Registrant
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for at least the past 90 days.
Yes X No
----- -----
Indicate the number of shares outstanding of each of the issuer's classes of
common equity, as of the latest practicable date.
Class Outstanding at August 2, 2002
- ----- -----------------------------
Common Stock, $.001 par value 43,085,733
PART I
FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
MICROTEK MEDICAL HOLDINGS, INC.
Condensed Consolidated Balance Sheets
(in thousands)
(unaudited)
ASSETS JUNE 30, 2002 DECEMBER 31, 2001
------ -----------------------------------------------
Current assets
Cash and cash equivalents $ 9,885 $ 10,587
Accounts receivable, net 15,318 16,141
Other receivables 320 587
Inventory, net 26,509 27,022
Prepaid expenses and other assets 805 1,215
-----------------------------------------------
Total current assets 52,837 55,552
-----------------------------------------------
Property and equipment 22,799 21,994
Less accumulated depreciation (15,593) (14,455)
-----------------------------------------------
Property and equipment, net 7,206 7,539
-----------------------------------------------
Intangible assets, net 26,164 26,351
Deferred income taxes 2,018 2,018
Other assets, net 3,366 2,870
-----------------------------------------------
Total assets $ 91,591 $ 94,330
===============================================
LIABILITIES AND SHAREHOLDERS' EQUITY
------------------------------------
Current liabilities
Accounts payable $ 4,867 4,934
Accrued expenses 2,665 3,091
Accrued customer rebates 490 490
Current portion of long-term debt 250 260
Deferred licensing revenue 714 1,427
Product financing agreement - 404
-----------------------------------------------
Total current liabilities 8,986 10,606
-----------------------------------------------
Long-term debt 8,087 12,649
Other long-term liabilities 1,905 1,487
-----------------------------------------------
Total liabilities 18,978 24,742
-----------------------------------------------
Shareholders' equity
Common stock 43 43
Additional paid-in capital 211,184 210,251
Accumulated deficit (136,518) (138,636)
Cumulative translation adjustment (130) (239)
Unrealized loss on available for sale securities (119) (96)
Unearned shares restricted to employee stock
ownership plan (60) (60)
-----------------------------------------------
74,400 71,263
Treasury shares, at cost (1,787) (1,675)
-----------------------------------------------
Total shareholders' equity 72,613 69,588
-----------------------------------------------
Total liabilities and shareholders' equity $ 91,591 $ 94,330
===============================================
See notes to condensed consolidated financial statements.
2
MICROTEK MEDICAL HOLDINGS, INC.
Condensed Consolidated Statements of Operations and Comprehensive Income
(in thousands, except per share data)
(unaudited)
THREE MONTHS ENDED THREE MONTHS ENDED SIX MONTHS ENDED SIX MONTHS ENDED
JUNE 30, 2002 JUNE 30, 2001 JUNE 30, 2002 JUNE 30, 2001
------------------ ------------------ ---------------- ----------------
Net sales $ 20,816 $ 21,339 $ 41,640 $ 37,216
Licensing revenues 356 377 713 756
------------------ ------------------ ---------------- ----------------
Net revenues 21,172 21,716 42,353 37,972
Cost of goods sold 12,707 13,246 25,292 22,839
------------------ ------------------ ---------------- ----------------
Gross profit 8,465 8,470 17,061 15,133
Operating expenses:
Selling, general and administrative 7,173 6,559 13,917 11,938
Research and development 254 445 417 898
Amortization of intangibles 114 378 228 698
------------------ ------------------ ---------------- ----------------
Total operating expenses 7,541 7,382 14,562 13,534
------------------ ------------------ ---------------- ----------------
Income from operations 924 1,088 2,499 1,599
Interest income 38 76 75 189
Interest expense (175) (236) (370) (343)
Equity in earnings of investee 17 - 17 -
Other income 47 - 47 -
------------------ ------------------ ---------------- ----------------
Income before income taxes 851 928 2,268 1,445
Income tax provision 61 83 150 173
------------------ ------------------ ---------------- ----------------
Net income $ 790 $ 845 $ 2,118 $ 1,272
================== ================== ================ ================
Other comprehensive income (loss):
Foreign currency translation gain (loss) 162 (46) 109 (131)
Unrealized loss on available for sale
securities (16) (5) (23) (19)
------------------ ------------------ ---------------- ----------------
Comprehensive income $ 936 $ 794 $ 2,204 $ 1,122
================== ================== ================ ================
Net income per common share - basic
and diluted $ 0.02 $ 0.02 $ 0.05 $ 0.03
================== ================== ================ ================
Basic weighted average number of common
shares outstanding 42,252 41,680 42,184 41,545
================== ================== ================ ================
Diluted weighted average number of common
shares outstanding 43,184 42,024 43,058 41,759
================== ================== ================ ================
See notes to condensed consolidated financial statements.
3
MICROTEK MEDICAL HOLDINGS, INC.
Condensed Consolidated Statements of Cash Flows
(in thousands)
(unaudited)
SIX MONTHS ENDED SIX MONTHS ENDED
JUNE 30, 2002 JUNE 30, 2001
----------------------------------------
Cash flows from operating activities:
Net income $ 2,118 $ 1,272
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
Depreciation 1,229 1,233
Amortization of intangibles 228 698
Provision for doubtful accounts 113 10
Licensing revenues (713) (756)
Provision for obsolete and slow moving inventory 64 177
Stock option compensation expense 90 -
Loss on disposal of property and equipment 56 -
Equity in earnings of investee (17) -
Other (71) -
Changes in assets and liabilities, net of effects of acquisitions 1,401 (6,164)
----------------------------------------
NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES 4,498 (3,530)
----------------------------------------
Cash flows from investing activities:
Purchase of and deposits for property and equipment (981) (562)
Acquisitions - (11,983)
----------------------------------------
NET CASH USED IN INVESTING ACTIVITIES (981) (12,545)
----------------------------------------
Cash flows from financing activities:
Net (repayments) borrowings under credit agreements (4,556) 10,665
Changes in bank overdraft (83) 540
Net repayments under notes payable (420) (278)
Proceeds from exercise of stock options 483 125
Repurchase of treasury stock (112) (131)
Proceeds from issuance of common stock 360 277
----------------------------------------
NET CASH (USED IN) PROVIDED BY FINANCING ACTIVITIES (4,328) 11,198
----------------------------------------
Effect of exchange rate changes on cash 109 (131)
----------------------------------------
Net decrease in cash and cash equivalents (702) (5,008)
Cash and cash equivalents at beginning of period 10,587 14,379
----------------------------------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 9,885 $ 9,371
========================================
See notes to condensed consolidated financial statements.
4
MICROTEK MEDICAL HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1) In the opinion of management, the information furnished reflects all
adjustments (consisting only of normal recurring adjustments) necessary for a
fair presentation of the financial position, results of operations and cash
flows for the interim periods presented. Results for the interim periods are not
necessarily indicative of results to be expected for the full year. The
consolidated financial statements herein should be read in conjunction with the
consolidated financial statements and notes thereto contained in the Company's
Annual Report on Form 10-K for the year ended December 31, 2001 (the "Annual
Report").
2) On May 22, 2002, the Board of Directors of the Company adopted a resolution
to change the Company's name from Isolyser Company, Inc. to Microtek Medical
Holdings, Inc. Shareholder approval of the name change was not required. This
name change was effective as of July 1, 2002. The name change did not change the
Company's existing structure or ownership.
3) Inventories are stated at the lower of cost or market and are summarized as
follows:
(in thousands) JUNE 30, 2002 DECEMBER 31, 2001
---------------- -----------------
Raw materials and supplies $ 12,579 $ 13,504
Work in process 597 890
Finished goods 15,275 14,634
----------------- ------------------
28,451 29,028
Reserves for slow moving and
obsolete inventories (1,942) (2,006)
----------------- ------------------
Inventory, net $ 26,509 $ 27,022
================= ==================
At June 30, 2002 and December 31, 2001, the net OREX inventory was
approximately $2.6 million.
4) Effective February 2, 2001, Microtek Medical, Inc. ("Microtek"), a subsidiary
of the Company, entered into a definitive agreement to acquire substantially all
of the assets of Deka Medical, Inc. ("Deka") for cash. Concurrently with the
signing of the definitive agreement, Microtek acquired Deka's post-surgical
clean-up product line. Effective March 2, 2001, Microtek concluded the
acquisition by acquiring substantially all of the assets of Deka used in Deka's
patient and medical equipment drape product line. The allocation of the total
purchase price of approximately $11.6 million resulted in an excess of purchase
price over the fair value of the net assets acquired (goodwill) of approximately
$3.3 million.
The above described acquisition was accounted for under the purchase
method, and accordingly, the results of operations related to the acquired
assets have been included in the accompanying condensed consolidated financial
statements from the date of acquisition. The following unaudited pro forma
financial information reflects the Company's results of operations as if the
Deka acquisition had been completed on January 1, 2001:
SIX MONTHS ENDED
(in thousands, except per share data) JUNE 30, 2001
-------------
Net revenues $ 41,722
Net income 1,290
Net income per common share -
basic and diluted $ 0.03
5
The pro forma financial information is based on estimates and assumptions
which management believes are reasonable. However, the pro forma results are not
necessarily indicative of the operating results that would have occurred had the
Deka acquisition been consummated as of the date indicated, nor are they
necessarily indicative of future operating results.
5) The Company maintains a $17.5 million credit agreement (as amended to date,
the "Credit Agreement") with the Chase Manhattan Bank (the "Bank"), consisting
of a revolving credit facility maturing on June 30, 2004. Borrowing availability
under the revolving credit facility is based on the lesser of (i) a percentage
of eligible accounts receivable and inventory or (ii) $17.5 million, less any
outstanding letters of credit issued under the Credit Agreement. Revolving
credit borrowings bear interest, at the Company's option, at either a floating
rate approximating the Bank's prime rate plus an interest margin (5.25% at June
30, 2002) or LIBOR plus an interest margin (4.16% at June 30, 2002). There were
outstanding borrowings under the revolving credit facility of $7.9 million at
June 30, 2002 and $12.4 million at December 31, 2001. Borrowings under the
Credit Agreement are collateralized by the Company's accounts receivable,
inventory, equipment, the Company's stock of its subsidiaries and certain of the
Company's plants and offices. The Credit Agreement contains certain restrictive
covenants, including the maintenance of certain financial ratios and earnings,
and limitations on acquisitions, dispositions, capital expenditures and
additional indebtedness. In addition, the Company is not permitted to pay any
dividends. At June 30, 2002, the Company was in compliance with its financial
covenants under the Credit Agreement.
6) Basic per share income is computed using the weighted average number of
common shares outstanding for the period. Diluted per share income is computed
including the dilutive effect of all contingently issuable shares. The
difference between basic and diluted weighted average shares is attributable to
932,000 and 874,000 dilutive stock options outstanding for the three months and
six months ended June 30, 2002, respectively. There were 344,000 and 214,000
dilutive stock options outstanding for the three months and six months ended
June 30, 2001, respectively.
7) On February 11, 2000, the Company paid $249,000 for approximately 7.5%
interest in Consolidated Ecoprogress Technology, Inc. ("CES"). CES is a Canadian
environmental technology company focused on being a leader in developing and
selling biodegradable and disposable absorbent products such as diapers,
feminine hygiene, adult incontinence and other products. This investment is
classified in accordance with Statement of Financial Accounting Standards
("SFAS") No. 115, Accounting for Certain Investments in Debt and Equity
Securities, as available for sale securities and is stated at market value. Any
change in market value between periods is included as a component of
shareholders' equity. The value of this investment as of June 30, 2002 was
$130,000.
8) At December 31, 2001, the Company had restructuring reserves of $101,000.
Additions and charges against the reserves totaled $145,000 and $162,000,
respectively, during the six months ended June 30, 2002, leaving a balance of
$84,000 in the reserves at June 30, 2002. The activity is shown below:
(in thousands) DECEMBER 31, 2001 JUNE 30, 2002
DESCRIPTION BALANCE ADDITIONS DEDUCTIONS BALANCE
- ----------- ------- --------- ---------- -------
Severance and consulting
arrangements $ 26 $ 145 $ (162) $ 9
Impaired equipment reserve 75 - - 75
--------- --------- ------------- ----------
Total $ 101 $ 145 $ (162) $ 84
========= ========= ============= ==========
6
During the six months ended June 30, 2002, severance and vacation benefits
totaling $145,000 were accrued and paid with respect to the termination of 19
employees of Microtek's Waynesville, North Carolina facility and 4 employees of
the Company's OTI division.
9) In July 2001, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 142, Goodwill and Other Intangible Assets. SFAS No. 142 requires that the
amortization of goodwill cease prospectively upon adoption and instead, the
carrying value of goodwill be evaluated using an impairment approach.
Identifiable intangible assets will continue to be amortized over their useful
lives and reviewed for impairment in accordance with SFAS No. 144, Accounting
for the Impairment or Disposal of Long-Lived Assets. SFAS No. 142 is effective
for fiscal years beginning after December 15, 2001, and was implemented by the
Company on January 1, 2002. The initial step of the Company's transitional
impairment test was completed during the second quarter of 2002, and no
impairment loss was indicated. The Company is required to complete the final
step of the transitional impairment test by the end of the fiscal year.
Management does not believe that a material adjustment will be necessary upon
completion of its final assessment. The information presented below could be
adjusted based on the results of this final assessment.
The Company's goodwill and intangible assets as of June 30, 2002 and
December 31, 2001 are summarized as follows:
(in thousands) JUNE 30, 2002 DECEMBER 31, 2001
------------- -----------------
GROSS CARRYING ACCUMULATED GROSS CARRYING ACCUMULATED
AMOUNT AMORTIZATION AMOUNT AMORTIZATION
------ ------------ ------ ------------
Goodwill $ 29,197 $ 6,732 $ 29,953 $ 7,488
Customer lists 586 75 586 62
Covenants not to compete 575 194 575 124
Patent and license agreements 3,888 1,804 3,847 1,701
Other 887 164 887 122
------------ ------------ ------------ ------------
Total $ 35,133 $ 8,969 $ 35,848 $ 9,497
============ ============ ============ ============
The following financial information is presented as if SFAS No. 142 was
adopted at the beginning of the quarter ended June 30, 2001:
THREE MONTHS ENDED SIX MONTHS ENDED
(in thousands, except per share data) JUNE 30, 2001 JUNE 30, 2001
------------- -------------
Net income as reported $ 845 $ 1,272
Goodwill amortization 264 503
------------ ------------
Adjusted net income $ 1,109 $ 1,775
============ ============
Net income per common share - basic and diluted:
As reported $ 0.02 $ 0.03
Goodwill amortization 0.01 0.01
------------ ------------
As adjusted $ 0.03 $ 0.04
============ ============
Amortization expense related to intangible assets was $114,000 for the
three months ended June 30, 2002 and 2001, and was $228,000 and $195,000 for the
six months ended June 30, 2002 and 2001, respectively. Following is the
estimated annual amortization expense subsequent to December 31, 2001:
7
AMORTIZATION
YEAR EXPENSE
---- -------
2002 - 2004 $ 454,000
2005 431,000
2006 287,500
2007-2011 281,000
2012 161,500
2013 75,000
2014-2015 70,000
2016 24,000
ITEM 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
Net revenues for the three months ended June 30, 2002 (the "2002 Quarter") were
$21.2 million, a decrease of $545,000 or 2.5 percent from the $21.7 million of
net revenues reported for the three months ended June 30, 2001 (the "2001
Quarter"). Net revenues for the six months ended June 30, 2002 (the "2002
Period") were $42.4 million, an increase of $4.4 million or 11.5 percent over
the $38.0 million of net revenues reported for the six months ended June 30,
2001 (the "2001 Period"). Excluding licensing revenues associated with the
amortization of the $10.5 million payment by Allegiance allocated to the
Company's Supply and License Agreement with Allegiance, net revenues in the 2002
Quarter and 2002 Period were $20.8 million and $41.6 million, respectively, as
compared to $21.3 million in the 2001 Quarter and $37.2 million in the 2001
Period. The decrease in net revenues in the 2002 Quarter as compared to the 2001
Quarter is attributable to net revenues in the 2001 Quarter resulting from
Microtek's fulfillment and elimination of backlog assumed in conjunction with
Microtek's acquisition of the drape and CleanOp product lines of Deka in the
first quarter of 2001. The net revenues increase in the 2002 Period as compared
to the 2001 Period is primarily attributable to the drape and CleanOp product
lines acquired from Deka and to substantial growth in Microtek's international
net revenues. In addition, Microtek's CleanOp product line has shown significant
growth since being acquired from Deka.
For the 2002 Quarter, Microtek's net revenues totaled $20.7 million, a decrease
of $514,000 or 2.4 percent from net revenues of $21.3 million reported in the
2001 Quarter. Microtek's net revenues for the 2002 Period were $41.3 million,
approximately $4.4 million more than the $36.9 million reported in the 2001
Period. The following tables depict Microtek's domestic and international
revenues and the relative percentage of each to Microtek's total revenues for
the 2002 Quarter and 2001 Quarter and for the 2002 Period and the 2001 Period:
THREE MONTHS ENDED JUNE 30, 2002 THREE MONTHS ENDED JUNE 30, 2001
AMOUNT % OF TOTAL AMOUNT % OF TOTAL
Domestic $ 17.7 85.3% $ 18.6 87.5%
International 3.0 14.7% 2.7 12.5%
---------- ---------- ----------- ----------
Total $ 20.7 100.0% $ 21.3 100.0%
========== ========== =========== ==========
SIX MONTHS ENDED JUNE 30, 2002 SIX MONTHS ENDED JUNE 30, 2001
AMOUNT % OF TOTAL AMOUNT % OF TOTAL
Domestic $ 35.5 85.8% $ 32.5 88.1%
International 5.8 14.2% 4.4 11.9%
---------- ---------- ----------- ----------
Total $ 41.3 100.0% $ 36.9 100.0%
========== ========== =========== ==========
8
Microtek's domestic revenues are generated through two primary channels or
customer categories, hospital branded and contract manufacturing (commonly
referred to as OEM). Included in the Company's OEM revenues are sales of
products to custom procedure tray companies and other "non-branded" or private
label customers. Microtek's domestic revenues in the 2002 Quarter decreased by
$900,000 from the 2001 Quarter. Of this amount, $788,000 was attributable to OEM
revenue declines in the 2002 Quarter. As discussed above, OEM net revenues for
the 2001 Quarter included a substantial amount of backlog assumed in conjunction
with the Deka acquisition. Revenues from such backlog was not recurring in the
2002 Quarter. Hospital branded net revenues for the 2002 Quarter declined by
$112,000 from the 2001 Quarter. This decline was due primarily to a $694,000
decrease in safety product revenues resulting from increased competitive
pressures. Lower safety product revenues were partially offset by a $542,000
increase in revenues from the CleanOp product line acquired from Deka.
Microtek's core hospital branded revenues in the 2002 Quarter were about the
same as the corresponding revenue in the 2001 Quarter.
On a year-to-date basis, OEM revenues in the 2002 Period increased by $2.4
million or 17.5 percent from the 2001 Period due primarily to revenues from the
angiography drape and equipment drape product lines acquired from Deka. Hospital
branded net revenues in the 2002 Period were approximately $534,000 higher than
in the 2001 Period due primarily to a $1.2 million increase in revenues from the
CleanOp product line acquired from Deka and to modest growth in Microtek's core
hospital branded product lines. These increases in hospital branded net revenues
were offset by a decrease of $1.0 million in safety products revenues in the
2002 Period.
Microtek's international net revenues were $3.0 million for the 2002 Quarter, an
increase of $300,000 or 14.5 percent over the 2001 Quarter. International
revenues for the 2002 Period were $5.8 million, or $1.4 million more than the
$4.4 million reported for the 2001 Period. The improvements in the 2002 Quarter
and 2002 Period are attributable to international revenues stemming from the
Deka acquisition and internal growth of approximately 18 percent.
OTI's net revenues were $417,000 in the 2002 Quarter versus $420,000 in the 2001
Quarter. OTI's net revenues were approximately $1.0 million in both the 2002
Period and 2001 Period. Licensing revenues in the 2002 Quarter and 2002 Period
were $356,000 and $713,000, respectively, as compared to $377,000 and $756,000
in the 2001 Quarter and 2001 Period, respectively. The Company will cease to
recognize the non-cash licensing revenues in December 2002. Included in OTI's
net revenues for the 2002 Quarter and 2002 Period were revenues related to its
nuclear operations of approximately $25,000 and $115,000, respectively. As
announced in May 2002, the Company has entered into an agreement with Eastern
Technologies, Inc. ("ETI") and has transferred most of the sales and marketing
responsibilities for its OREX nuclear product line to ETI. Under this agreement,
ETI serves as the exclusive licensee of OREX LaunderableTM products for sale in
the United States and Canada and a nonexclusive licensee of OTI's Certified
SolubleTM products in that territory. Additionally ETI serves as the exclusive
operator of processing services to the nuclear power industry for these products
in the United States and Canada.
Gross margins in the 2002 Quarter and 2002 Period were 40.0 percent and 40.3
percent, respectively, and are slightly higher than the margins of 39.0 percent
recorded in the 2001 Quarter and 39.9 percent recorded in the 2001 Period.
Operating expenses as a percentage of net revenues in the 2002 Quarter were 35.6
percent versus 34.0 percent in the 2001 Quarter. For the 2002 Period, operating
expenses as a percentage of net revenues were 34.4 percent as compared to 35.6
percent for the 2001 Period. Selling, general and administrative expenses were
$7.2 million or 33.9 percent of net revenues in the 2002 Quarter, versus $6.6
million or 30.2 percent of net revenues in the 2001 Quarter. For the 2002
Period, selling, general and administrative expenses were $13.9 million or 32.9
percent of net revenues, as compared to $11.9 million or 31.4 percent of net
revenues in the 2001 Period. During the second quarter of 2002, the Company
9
recorded additional severance and reorganization costs related to the
restructure of its OTI division and its alliance with ETI. The aggregate of
these restructuring expenses was approximately $0.01 per basic and diluted share
and increased selling, general and administrative expenses as a percentage of
net revenues in the 2002 Quarter by approximately 1.4 percent. Additionally, the
increases noted in the absolute dollar amount of selling, general and
administrative expenses and in selling, general and administrative expenses as a
percentage of net revenues in 2002 result from the Company's expansion of its
marketing focus and allocation of additional resources to marketing its branded
products.
Research and development expenses decreased by $191,000 and $481,000 in the 2002
Quarter and 2002 Period, respectively, as compared to the 2001 Quarter and 2001
Period, due to significant reductions in product development costs. The
reduction in research and development expenses reflects the Company's more
narrow focus on new market opportunities in the nuclear power industry for its
OREX Degradable products and new healthcare market opportunities for Microtek.
Amortization of intangibles in the 2002 Quarter and 2002 Period was $114,000 and
$228,000, respectively, a decrease of $264,000 from the 2001 Quarter and
$470,000 from the 2001 Period. These decreases result primarily from the
Company's adoption of Statement of Financial Accounting Standards ("SFAS") No.
142, Goodwill and Other Intangible Assets, on January 1, 2002. Upon adoption,
the Company ceased to amortize goodwill and instead will evaluate the carrying
value of its goodwill using an impairment approach. Identifiable intangible
assets will continue to be amortized over their useful lives and reviewed for
impairment on a periodic basis. Had the provisions of SFAS No. 142 been in
effect beginning on January 1, 2001, amortization of intangibles for the 2001
Quarter and 2001 Period would have decreased by approximately $264,000 and
$503,000, respectively. The decrease attributable to non-amortization of
goodwill in the 2002 Period was offset slightly by the amortization of
identifiable intangible assets acquired in the Deka and MICROBasix acquisitions
which were completed in the 2001 Period.
Income from operations for the 2002 Quarter and 2002 Period was $924,000 and
$2.5 million, respectively, versus $1.1 million in the 2001 Quarter and $1.6
million in the 2001 Period. For the 2002 Quarter, Microtek's operating profit of
$1.3 million declined by $400,000 from the $1.7 million recorded in the 2001
Quarter. For the 2002 Period, Microtek's operating profit was $3.1 million, a
modest increase over the operating profit of $2.9 million recorded in the 2001
Period. The operating losses recorded by the Company's OTI division in the 2002
Quarter and 2002 Period were $369,000 and $516,000, respectively, which
represent a 37.5 percent improvement over the $591,000 in operating losses
recorded in the 2001 Quarter and a 57.4 percent improvement over the $1.2
million in operating losses recorded in the 2001 Period. As discussed above, the
operating losses in the 2002 Quarter and 2002 Period would have been further
reduced if not for the severance and restructuring charges which were recorded
in the 2002 Quarter.
Interest expense, net of interest income, was $137,000 and $295,000 in the 2002
Quarter and 2002 Period, respectively, as compared to $160,000 and $154,000 in
the 2001 Quarter and 2001 Period, respectively. The $23,000 decrease in net
interest expense in the 2002 Quarter as compared to the 2001 Quarter is due to
reduced borrowings on the Company's lines of credit facility and lower interest
rates during the 2002 Quarter. The $141,000 increase in net interest expense in
the 2002 Period as compared to the 2001 Period is the result of increased
interest expense resulting from higher average borrowings and lower interest
income on cash and cash equivalents due to lower average cash balances during
2002.
The Company's provision for income taxes in the 2002 Quarter reflects an expense
of $61,000. Due to the Company's federal net operating loss carryforwards, this
expense consists primarily of state and foreign income taxes.
10
The resulting net income for the 2002 Quarter was $790,000, or $0.02 per basic
and diluted share, bringing the Company's net income for the 2002 Period to $2.1
million, or $0.05 per basic and diluted share. While the Company's net income
for the 2002 Quarter is consistent with the $0.02 per basic and diluted share
reported for the 2001 Quarter, the Company's earnings for the 2002 Period
represent an increase of approximately $846,000, or $0.02 per basic and diluted
share, over the net income reported for the 2001 Period.
LIQUIDITY AND CAPITAL RESOURCES
As of June 30, 2002, the Company's cash and cash equivalents totaled $9.9
million as compared to $10.6 million at December 31, 2001.
During the 2002 Period, the Company's operating activities provided cash of $4.5
million as compared to cash used in operating activities of $3.5 million in the
2001 Period. The increase in cash provided by operating activities in the 2002
Period is attributable to the Company's increased profitability in the 2002
Period and improved working capital management, particularly in accounts
receivable and inventories. Cash used in investing activities in the 2002 Period
was $981,000, as compared to $12.5 million in the 2001 Period. Investing
activities in the 2002 Period consisted of the purchase of property and
equipment. Investing activities in the 2001 Period included the Deka and
MICROBasix acquisitions which consumed approximately $12.0 million in cash and
purchases of property and equipment of $562,000. During the 2002 Period, cash
used in financing activities was $4.3 million. Repayments under the Company's
Credit Agreement and other long-term debt agreements in the 2002 Period totaled
$5.0 million. Included in this amount was a lump sum payment to Thantex of
$341,000 under the product financing agreement described in the Company's Annual
Report. This payment satisfied in full the Company's remaining obligation under
this agreement. During the 2002 Period, the Company received $843,000 in
proceeds from the exercise of stock options and issuance of stock and purchased
45,000 shares of treasury stock for $112,000. Cash provided by financing
activities in the 2001 Period was $11.2 million which consisted primarily of
borrowings under the Company's Credit Agreement of $10.7 million.
The Company maintains a $17.5 million credit agreement (as amended to date, the
"Credit Agreement") with the Chase Manhattan Bank (the "Bank"), consisting of a
revolving credit facility maturing on June 30, 2004. Borrowing availability
under the revolving credit facility is based on the lesser of (i) a percentage
of eligible accounts receivable and inventory or (ii) $17.5 million, less any
outstanding letters of credit issued under the Credit Agreement. Outstanding
borrowings under the revolving credit facility were $7.9 million and $12.4
million at June 30, 2002 and December 31, 2001, respectively. As of June 30,
2002, the Company had additional borrowing availability under the revolving
facility of $6.3 million. As of August 2, 2002, the Company's borrowing
availability under the revolving facility was $13.8 million, of which the
Company had borrowed $7.6 million. Revolving credit borrowings bear interest, at
the Company's option, at either a floating rate approximating the Bank's prime
rate plus an interest margin (5.25% at August 2, 2002) or LIBOR plus an interest
margin (4.16% at August 2, 2002). At June 30, 2002, the Company was in
compliance with its financial covenants under the Credit Agreement.
Based on its current business plan, the Company expects that cash equivalents
and short term investments on hand, the Company's credit facility, as amended,
and funds budgeted to be generated from operations will be adequate to meet its
liquidity and capital requirements for the next year. The Company's liquidity is
not dependent upon the use of off-balance sheet financing arrangements. There
has been no significant change in the Company's contractual obligations since
December 31, 2001. Currently unforeseen future developments and increased
working capital requirements may require additional debt financing or issuance
of common stock in 2002 and subsequent years.
11
CRITICAL ACCOUNTING POLICIES.
While the listing below is not inclusive of all of the Company's accounting
policies, the Company's management believes that the following policies are
those which are most critical and embody the most significant management
judgments and the uncertainties affecting their application and the likelihood
that materially different amounts would be reported under different conditions
or using different assumptions. These critical policies are:
Revenue Recognition. The Company's revenues are derived from the sale of its
products and are recognized at the time of shipment (i) when persuasive evidence
of a sale arrangement exists, (ii) delivery has occurred, (iii) the price is
fixed and determinable, and (iv) collectibility of the associated receivable is
reasonably assured. As discussed below, significant management judgments and
estimates must be made and used in connection with the revenue recognized in any
accounting period. Material differences may result in the amount and timing of
the Company's revenues for any period if management made different judgments or
utilized different estimates.
All sales of the Company's products are evidenced by a binding purchase order as
evidence of a sale arrangement. Sales through the Company's distributors are
evidenced by a master agreement which governs the relationship together with a
binding purchase order on a transaction by transaction basis. Delivery generally
occurs when the Company's products are delivered to a common carrier.
At the time of a sale transaction, the Company assesses whether the related
sales price is fixed and determinable based on the payment terms associated with
the transaction. Sales prices due within the Company's normal payment terms,
which are 30 to 60 days from the invoice date for its domestic customers and 90
to 120 days from the invoice date for international customers, are considered
fixed and determinable. The Company does not generally extend payment terms
outside its normal guidelines. The Company also assesses whether collection is
reasonably assured at the time of the sale transaction based on a number of
factors, including past transaction history with the customer and the
creditworthiness of the customer.
Sales Returns and Other Allowances and Allowance for Doubtful Accounts. The
preparation of financial statements requires management to make estimates and
assumptions that affect the reported amount of assets 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.
Specifically, management must make estimates of potential future product returns
related to current period product revenues. The Company's sales arrangements do
not generally include acceptance provisions or clauses. Additionally, the
Company does not typically grant its distributors or other customers price
protection rights or rights to return products bought, other than normal and
customary rights of return for defects in materials or workmanship, and is not
obligated to accept product returns for any other reason. Actual returns have
not historically been significant. Management analyzes historical returns,
current economic trends and changes in customer demand when evaluating the
adequacy of its sales returns and other allowances.
Similarly, the Company's management must make estimates of the uncollectibility
of its accounts receivables. Management specifically analyzes accounts
receivable, historical bad debts, customer concentrations, customer
creditworthiness, current economic trends and changes in its customers' payment
terms when evaluating the adequacy of its allowance for doubtful accounts. The
Company's accounts receivables at June 30, 2002 totaled $15.3 million, net of
the allowance for doubtful accounts of $941,000.
Inventory Valuation. The preparation of the Company's financial statements
requires careful determination of the appropriate dollar amount of the Company's
inventory balances. Such amount is presented as a current asset in the Company's
balance sheet and is a direct determinant of cost of goods sold in the statement
of operations and therefore has a significant impact on the amount of net income
reported in an accounting period. The basis of accounting for inventories is
cost, which is the sum of expenditures and charges, both direct and indirect,
incurred to bring the inventory quantities to their existing condition and
12
location. The Company's inventories are stated at the lower of cost or market,
with cost determined using the first-in, first-out ("FIFO") method, which
assumes that inventory quantities are sold in the order in which they are
manufactured or purchased. The Company utilizes standard costs as a management
tool. The Company's standard cost valuation of its inventories is adjusted at
regular intervals to reflect the approximate cost of the inventory under FIFO.
The determination of the indirect charges and their allocation to the Company's
work-in-process and finished goods inventories is complex and requires
significant management judgment and estimates. Material differences may result
in the valuation of the Company's inventories and in the amount and timing of
the Company's cost of goods sold and resulting net income for any period if
management made different judgments or utilized different estimates.
On a periodic basis, management reviews its inventory quantities on hand for
obsolescence, physical deterioration, changes in price levels and the existence
of quantities on hand which may not reasonably be expected to be used or sold
within the normal operating cycles of the Company's operations. To the extent
that any of these conditions are believed to exist or the utility of the
inventory quantities in the ordinary course of business is no longer as great as
their carrying value, a reserve against the inventory valuation is established.
To the extent that this reserve is established or increased during an accounting
period, an expense is recorded in the Company's statement of operations,
generally in cost of good sold. Significant management judgment is required in
determining the amount and adequacy of this reserve. In the event that actual
results differ from management's estimates or these estimates and judgments are
revised in future periods, the Company may need to establish additional reserves
which could materially impact the Company's financial position and results of
operation.
As of June 30, 2002, the Company's inventories totaled $26.5 million, net of
reserves for slow moving and obsolete inventories of $1.9 million. Management
believes that the Company's inventory valuation, together with the recorded
reserves for slow moving and obsolete inventories, results in carrying the
inventory at the lower of cost or market.
Accounting for Income Taxes. In conjunction with preparing the Company's
consolidated financial statements, management is required to estimate the
Company's income tax liability in each of the jurisdictions in which the Company
operates. This process involves estimating the Company's actual current tax
exposure together with assessing temporary differences resulting from differing
treatment of items, such as goodwill amortization, for tax and accounting
purposes. These differences result in deferred tax assets or liabilities which
are reflected in the Company's consolidated balance sheet. Management must also
assess the likelihood that the Company's deferred tax assets will be recovered
from future taxable income. To the extent that management believes that recovery
is not likely, a valuation allowance must be established and reviewed in each
accounting period. Increases in the valuation allowance in an accounting period
requires that the Company record an expense within its tax provision in its
consolidated statement of operations.
Significant management judgment is required in determining the Company's
provision for income taxes, its deferred tax assets and liabilities and any
valuation allowance recorded against the Company's net deferred tax assets. At
June 30, 2002, the Company's net deferred tax assets totaled $2.0 million. The
Company has recorded a valuation allowance of $40.4 million as of June 30, 2002,
due to uncertainties related to the Company's ability to utilize some of its
deferred tax assets, primarily consisting of net operating loss carryforwards,
before they expire. The valuation allowance is based on management's estimates
of taxable income by jurisdiction in which the Company operates and the period
over which the deferred tax assets will be recoverable. In the event that actual
results differ from these estimates or these estimates are adjusted in future
periods, the Company may need to adjust this valuation allowance which could
materially impact the Company's financial position and results of operation.
13
Valuation of Long-Lived and Intangible Assets and Goodwill. The Company assesses
the impairment of identifiable intangibles, long-lived assets and related
goodwill whenever events or changes in circumstances indicate that the carrying
value may not be recoverable. Factors that are considered by management in
performing this assessment include, but are not limited to, the following:
o The Company's performance relative to historical or projected future
operating results;
o The Company's intended use of acquired assets or the Company's
strategy for its overall business; and
o Industry or economic trends.
In the event that the carrying value of intangibles, long-lived assets and
related goodwill is determined to be impaired, such impairment is measured using
a discount rate determined by management to be commensurate with the risk
inherent in the Company's current business model. At June 30, 2002, the net book
value of goodwill approximated $22.5 million and the net book value of other
intangible assets approximated $3.7 million.
As discussed in the footnotes to the condensed consolidated financial
statements, on January 1, 2002, the Company implemented SFAS No. 142, and as a
result, discontinued the periodic amortization of approximately $22.5 million of
goodwill but will continue to amortize other intangible assets. Goodwill
amortization for the full year of 2001 and the 2001 Period amounted to
approximately $1.1 million, or $0.026 per share, and $503,000, or $0.012 per
share, respectively. In lieu of amortization, the Company will be required to
perform an initial impairment review of its goodwill in 2002 and an impairment
review thereafter at least annually. The Company completed its initial
impairment review in the 2002 Quarter and no impairment charge was indicated.
FORWARD LOOKING STATEMENTS
Statements made in this Quarterly Report include forward-looking statements made
under the provisions of the Private Securities Litigation Reform Act of 1995
including, but not limited to, expected adjustments to the Company's financial
statements upon completion of the transitional impairment tests under SFAS No.
142, expected amortization expenses in 2002 and future periods, the ability of
the Company to meet its liquidity and capital requirements, and management
judgments about future events in the application of its critical accounting
policies as described under "Critical Accounting Policies" above. The Company's
actual results could differ materially from such forward-looking statements and
such results will be affected by risks described in the Company's Annual Report
including, without limitation, those described under "Risk Factors -History of
Net Losses", "-Reliance upon Microtek", "-Competition", "-Product Liability",
"-Stock Price Volatility", "-Dependence on Key Personnel", "-Anti-takeover
Provisions", "-Low Barriers to Entry for Competitive Products", "-Potential
Erosion of Profit Margins", "-Risks of Completing Acquisitions", "-Small Sales
and Marketing Force", "-Reliance upon Distributors", "-Microtek Regulatory
Risks", "-Risks of Obsolescence", "-Reduced OREX Market Potential", "-OREX
Commercialization Risks", "-OREX Manufacturing and Supply Risks", "-Risks
Affecting Protection of Technology", "-Risks of Technological Obsolescence" and
"-OTI Regulatory Risks". We do not undertake to update our forward-looking
statements to reflect future events or circumstances.
ITEM 3.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company's greatest sensitivity with respect to market risk is to changes in
the general level of U.S. interest rates and its effect upon the Company's
interest expense. At June 30, 2002, the Company had $8.3 million long-term or
short-term debt bearing interest at floating rates. Because these rates are
variable, a 1% increase in interest rates would have resulted in additional
14
interest expense of approximately $48,000 for the six months ended June 30, 2002
and a 1% reduction in interest rates would have resulted in reduced interest
expense of approximately $48,000 for the six months ended June 30, 2002.
PART II
OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Not applicable.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
During the quarter for which this report is filed, there were no material
modifications in the instruments defining the rights of shareholders. During the
quarter for which this report is filed, none of the rights evidenced by the
shares of the Company's common stock were materially limited or qualified by the
issuance or modification of any other class of securities.
ITEM 3. DEFAULT UPON SENIOR SECURITIES
Not applicable.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITYHOLDERS
During the period covered by this report, the Company filed with the Securities
and Exchange Commission and delivered to its shareholders the Company's Proxy
Statement for its Annual Meeting of Shareholders held May 23, 2002.
(a) The Company's annual meeting of shareholders was held on May 23, 2002.
(b) The nominees for the Board of Directors of the Company are identified
below.
(c) With respect to the election of directors, the inspector of election
tabulated the following votes:
Nominee for Office Number of Votes Number of Votes Abstention
------------------ --------------- --------------- ----------
For Withheld
--- --------
Gene R. McGrevin 39,350,680 1,015,612 -
Dan R. Lee 40,022,090 344,202 -
Rosdon Hendrix 40,186,520 179,772 -
Kenneth F. Davis 40,195,076 171,216 -
John E. McKinley 40,201,336 164,956 -
Ronald L. Smorada 40,164,286 202,006 -
(d) With respect to the approval of the amendment to the Company's 1999
Long-Term Incentive Plan increasing the number of shares for the award
stock options and other stock awards to 3,200,000 shares, the inspector
of election tabulated the following votes:
For 36,884,991
15
Against 3,275,706
Abstention 205,595
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
Exhibit
No. Description
- --- -----------
3.1(1) Articles of Incorporation of Isolyser Company, Inc.
3.2(2) Articles of Amendment to Articles of Incorporation of Isolyser
Company, Inc.
3.3(3) Amended and Restated Bylaws of Isolyser Company, Inc.
4.1(1) Specimen Certificate of Common Stock
99.1 Certification of Periodic Financial Reports by the Chairman, Chief
Executive Officer and President
99.2 Certification of Periodic Financial Reports by the Chief Financial
Officer, Treasurer and Assistant Secretary
- ------------------
(1) Incorporated by reference to the Company's Registration Statement on Form
S-1 (File No. 33-83474).
(2) Incorporated by reference to Exhibit 3.2 of the Company's Annual Report on
Form 10-K for the year ended December 31, 1996.
(3) Incorporated by reference to Exhibit 3.1 to the Company's Current Report on
Form 8-K filed April 23, 2002.
(b) The Company filed a Current Report on Form 8-K on April 23, 2002 reporting
under Item 5 thereof an amendment to the Company's Amended and Restated
Bylaws.
16
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has caused this quarterly report on Form 10-Q to be signed on its
behalf by the undersigned thereunto duly authorized on August 13, 2002.
MICROTEK MEDICAL HOLDINGS, INC.
By: /s/ Dan R. Lee
---------------------------------
Dan R. Lee
President & CEO
(principal executive officer)
By: /s/ R.G. Wilson
--------------------------------
R. G. Wilson
Chief Financial Officer
(principal financial officer)
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