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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Fiscal Year Ended December 31, 1996 Commission File Number: 0-24866
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ISOLYSER COMPANY, INC.
(Exact Name of registrant as specified in its charter)
GEORGIA 58-1746149
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
650 ENGINEERING DRIVE
TECHNOLOGY PARK
NORCROSS, GEORGIA 30092
(Address of principal executive offices) (Zip Code)
(770) 582-6363
Registrant's telephone number, including area code
Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
common stock, $.001 par value per share
stock purchase rights
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No _______
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best 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. [ ]
The aggregate market value of common stock held by nonaffiliates of the
registrant based on the sale trade price of the common stock as reported on The
Nasdaq Stock Market on March 27, 1997, was approximately $165.4 million. For
purposes of this computation, all officers, directors and 5% beneficial owners
of the registrant are deemed to be affiliates. Such determination should not be
deemed an admission that such officers, directors or 5% beneficial owners are,
in fact, affiliates of the registrant.
At March 27, 1997, there were outstanding 39,207,668 shares of the registrant's
common stock, $.001 par value per share.
Documents incorporated by reference: Certain exhibits provided in Part IV are
incorporated by reference from the Company's Registration Statements on Form S-1
(File Nos. 33-83474 and 33-97086), Registration Statement on Form S-4 (File No.
333-7977), Registration Statement on Form S-8 (File Nos. 33-85668), annual
report on Form 10-K for the periods ended December 31, 1994, and December 31,
1995, and current reports on Form 8-K dated May 31, 1995, September 18, 1995,
June 4, 1996, August 30, 1996 and December 19, 1996.
420793.1
Note: The discussions in this Form 10-K contain forward looking
statements that involve risks and uncertainties. The actual results of Isolyser
Company, Inc. and subsidiaries (the "Company") could differ significantly from
those set forth herein. Factors that could cause or contribute to such
differences include, but are not limited to, those discussed in "Business",
particularly "Business -- Risk Factors", and "Management's Discussion and
Analysis of Financial Condition and Results of Operations" as well as those
discussed elsewhere in this Form 10-K. Statements contained in this Form 10-K
that are not historical facts are forward looking statements that are subject to
the safe harbor created by the Private Securities Litigation Reform Act of 1995.
A number of important factors could cause the Company's actual results for 1997
and beyond to differ materially from those expressed or implied in any forward
looking statements made by, or on behalf of, the Company. These factors include,
without limitation, those listed in "Business -- Risk Factors" in this Form
10-K.
PART I
ITEM 1. BUSINESS
General
Isolyser Company, Inc. ("Isolyser" or the "Company") believes that it is the
first company to address the health care industry's fundamental needs of patient
care, safety, cost reduction and solid waste reduction by taking a life cycle
approach (from product development through disposal) to disposable products used
in the hospital. Isolyser develops, manufactures and markets proprietary and
other products for patient care, occupational safety and management of
potentially infectious and hazardous waste. The Company's products provide
patient care and safety benefits, including protection from cross-infection, by
providing Point-of-Generation(TM) treatment of potentially infectious and
hazardous waste. Moreover, the Company believes that its products benefit the
environment by reducing the volume of solid waste while significantly reducing
the disposal costs of such waste. Isolyser's products are designed to provide
responsible solutions to regulatory requirements and initiatives and social
concerns. Through its products and services, the Company seeks to provide an
umbrella of protection from potentially infectious and hazardous waste for
patients, staff, the public and the environment. The Company also believes that
its products offer benefits to certain industries whose workers are in contact
with hazardous materials and where contaminated clothing, clean-up and barrier
materials must be incinerated at considerable expense
Trends in the Health Care Industry
The Company's products address a number of important trends in the health
care industry:
Facilitating Environmental Protection and Regulatory Compliance. The disposal
of large volumes of infectious and hazardous solid and liquid waste generated by
the health care and other industries has attracted increasing public awareness
and regulatory attention. The Environmental Protection Agency ("EPA") has issued
for comment regulations regarding incineration of potentially infectious waste
reportedly having the potential of closing many hospital incinerators, and the
Department of Transportation has issued regulations regarding the transportation
of potentially infectious waste. The American Hospital Association has
recommended that bio-hazardous waste be treated the same day it is generated.
Isolyser's products provide responsible compliance solutions to compliance
objectives. For example, OREX(R) Degradables(TM) reduce the volume of solid
waste placed into the environment (OREX(R) Degradables(TM)), LTS(R) converts
liquid waste into solid polymers (LTS(R)) and SMS(R) encapsulates and physically
disinfects sharps.
Meeting Health Care Cost Containment Initiatives. The health care industry is
under increasing pressure to reduce costs and improve efficiency. The Company
believes that its products and services facilitate cost-effective regulatory
compliance, reduce labor intensive disposal processes and reduce the cost of
disposing of infectious and hazardous waste. As a result, a greater portion of
limited health care resources may be devoted directly to patient care. The
Company's procedure trays and equipment drapes facilitate cost containment by
reducing inventory volume and handling costs and by decreasing operating room
setup and clean up time, enabling hospitals to increase the volume of procedures
which may be performed.
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Protecting Staff, Patients and the Public from Infection and Injury. The health
care industry has experienced a substantial increase in the transmission of
infectious diseases (such as HIV/AIDS and hepatitis) through cross- infection. A
1990 conference sponsored by the Centers for Disease Control reported that
hospital-acquired bloodstream infections increased 133% from 1980 to 1989. Many
hospitals have established committees and created new professional positions to
manage this problem and monitor compliance with regulatory requirements. The
Company believes that its products directly and immediately reduce the risk of
cross-infection and promote compliance with professional, industry and
regulatory mandates by providing solutions for safe and effective handling of
potentially infectious and hazardous waste at the Point-of-Generation.
Growth Strategy
The Company's goal is to become a leading manufacturer and supplier of
disposable products to hospitals and industry. The Company intends to grow
through the commercialization of OREX Degradables, increased use and improvement
of manufacturing capabilities, leveraging upon existing marketing and
distribution resources, marketing of OREX Degradables to industries other than
health care and continued new product development. See "Risk Factors".
Commercializing OREX Degradables. The Company intends to penetrate the market
for traditional disposable and reusable products by converting users of those
products to OREX Degradables, and has in the past sought to achieve that
objective with an initial primary focus on the health care industry. The Company
has sought to accomplish this goal by replacing conventional disposable and
reusable products used in procedure trays with OREX Degradables and selling OREX
Degradables on a stand-alone basis and in supplemental packs. The Company is
currently undertaking a thorough review and analysis of the market position of
OREX Degradables within its various market potentials. As a part of such review
and analysis, the Company plans to implement appropriate adjustments to its
marketing plan to seek to improve the Company's operating results. There can be
no assurance that OREX Degradables will achieve or maintain substantial
acceptance in their target markets. See "Risk Factors -- Limited Operating
History; Net Losses" and " Risks of New Products".
Using Manufacturing Capabilities. As an additional key component of its growth
strategy, the Company has followed a strategy of vertically integrating its
manufacturing capabilities through acquisitions and capital expenditures in
order to internally manufacture many of its OREX Degradables products. The
Company believes that such vertical integration gives it more control over its
operations, including product quality, availability and cost. The Company
operates a 108,000 square foot OREX Degradables non-woven fabric plant located
in Arden, North Carolina and a 207,000 square foot OREX Degradables woven
manufacturing plant located in Abbeville, South Carolina. As a result of the
acquisition (the "White Knight Acquisition") of White Knight Healthcare, Inc.
("White Knight") in September, 1995, the Company operates five non-woven
conversion manufacturing plants located in Childersburg, Alabama, Runnemede, New
Jersey, Douglas, Arizona, Agua Prieta, Mexico and Acuna, Mexico. As a result of
the acquisition (the "Microtek Acquisition") of Microtek Medical, Inc.
("Microtek") as of September 1, 1996, the Company operates three conversion
manufacturing plants for its equipment drapes and fluid control products located
in Columbus, Mississippi, the Dominican Republic and Empalme, Mexico. The
Company is currently undertaking measures to consolidate its conversion
manufacturing operations to achieve savings in operating costs and improve
manufacturing efficiencies. The Company is also currently developing a prototype
OREX Degradables film manufacturing operation in its Norcross, Georgia facility.
In addition, the Company uses contract manufacturers for certain OREX film,
instruments and utensils which the Company has not yet commercially marketed.
See "Business -- Manufacturing and Supplies" and "Risk Factors - Manufacturing
and Supply Risks".
Using Marketing and Distribution Resources. An important element of the
Company's growth strategy is the leveraging of its existing marketing resources.
The Company believes that the key to penetrating health care markets is a strong
sales force capable of educating distributors and end users about the unique
characteristics of its products. In connection with the commercialization of
OREX Degradables, the Company has followed a strategy of investing in its sales
and marketing resources through hiring experienced and knowledgeable employees
and through acquisitions. The White Knight Acquisition provided the Company with
marketing resources, sales support and access to markets and accounts not
previously penetrated by the Company through White Knight's operations and
reputation in the non-woven medical products market. The Microtek Acquisition
provided the Company with marketing resources, sales support and access to
medical niche markets (primarily for equipment drapes and fluid control
products) not previously available to the Company. Both the White Knight
Acquisition and Microtek Acquisition provide the Company with increased
opportunities to access international markets. The Company
420793.1
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maintains warehouse and distribution facilities in Jacksonville, Florida and the
United Kingdom in addition to various contract warehouse and distribution
operators. The health care market is dominated by a few large manufacturers and
distributors of disposable medical products and the Company remains dependent
upon those distributors to a significant degree in the purchase and distribution
of its products. The Company plans to continue to strengthen its marketing and
distribution resources through internal growth and strategic alliances. See
"Risk Factors -- Risks of New Products", "-- Risks of Expansion" and "--
Reliance Upon Distributors".
Marketing OREX Degradables Outside the Health Care Industry. The Company plans
to develop and market commercial applications for OREX Degradables to other
industries where protection from infectious or hazardous waste and reduction of
solid waste is important, such as the nuclear power industry. Through the White
Knight Acquisition, the Company acquired an active sales and marketing presence
in industrial markets. Isolyser believes that it is the only company to offer
reusables, disposables and degradables in protective wear to the industrial
market. The Company plans to continue to develop existing and new markets for
its products. Towards such end, the Company continually evaluates possible
strategic alliances to develop new markets for its OREX products. There can be
no assurance that OREX Degradables will achieve or maintain substantial
acceptance in their target markets, or that the Company will be successful in
concluding favorable strategic alliances to add to the Company's target markets.
See "Risk Factors - Risks of New Products".
Continuing New Product Development. The Company plans to continue to improve,
develop and introduce new and innovative products to the marketplace designed to
promote cost-effective achievement of occupational safety, environmental
protection and regulatory compliance objectives through continued research and
development. In addition, the Company will continue to substantiate the safety
and effectiveness of its products with testing and to seek regulatory approval
for use of its products where applicable. See "Risk Factors - Risks of New
Products".
Products and Markets
OREX Degradables
OREX Degradables are a line of products that provide protection to the
hospital staff, patient and environment while providing cost effective solutions
to the problems associated with solid waste reduction and disposal. OREX
Degradables are manufactured from a thermoplastic, hot water soluble polymer,
which can be configured into an array of products such as woven fabrics
(including operating room towels, absorbent gauze and laparotomy sponges),
non-woven fabrics (including gowns, surgical drapes, mop heads and surgical
headwear), films (including fluid collection bags, packaging materials and
equipment drapes), thermoformed and extruded items (including syringes, bowls,
instruments and tubing) as well as combinations of these configurations
(including diapers, underpads and laminates). OREX Degradables perform like
traditional disposable and reusable products; however, unlike traditional
products, OREX Degradables can be degraded or dissolved in hot water in a
specially designed washing machine (the OREX Processor) after use for safe
disposal through the municipal sewer system. See "Risk Factors - Risks of New
Products".
The Company believes that its OREX Degradables not only minimize the
quantity and cost of solid waste disposal, but also help to protect against the
transmission of infectious diseases such as HIV/AIDS and hepatitis by providing
disposal at the Point-of-Generation. Additionally, OREX Degradables facilitate
environmental protection by reducing the volume of potentially infectious and
hazardous waste that is either incinerated or transported to landfills. Finally,
the Company believes that OREX Degradables address regulatory compliance
initiatives such as the bloodborne pathogen rule promulgated under OSHA as well
as state initiatives to reduce the volume of solid waste. The Company is
initially focused on delivering OREX Degradables to the health care industry
where, according to a study conducted in 1995 by an independent market research
firm, the United States market for non-woven disposable medical products alone
was estimated to be $1.7 billion in 1995 increasing to approximately $2.0
billion in 2000. While the Company is currently undertaking a thorough review
and analysis of the market position of OREX Degradables, the Company currently
believes that OREX Degradables may be best suited for use at hospitals where the
added benefits of degradable products (such as facilitating environmental
protection, complying with regulations and saving on infectious waste disposal
costs) can be best realized. In addition, management also believes that the
technology used to develop OREX Degradables has broad commercial applications
beyond the health care industry where protection from potentially infectious or
hazardous waste and reduction of solid waste is important, such as the nuclear
power industry.
420793.1
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OREX is manufactured from a variety of organic, degradable polymers that
have been modified to dissolve or degrade only in hot water. The basic compound
used to manufacture OREX Degradables woven and non-woven products is a polymer
known as polyvinyl alcohol ("PVA"), a safe material widely used in a variety of
consumer products such as eye drops, cosmetics and cold capsules. The Company
more recently has begun to develop the use of other polymers to test manufacture
OREX Degradables film and thermoformed and extruded products. Through a
manufacturing process developed by the Company, these polymers are modified so
they will dissolve or degrade only in hot water. See "Risk Factors --
Manufacturing and Supply Risks". Unlike traditional disposable products that
must be disposed of through either incineration or landfill, OREX Degradables
may be disposed of at the Point-of-Generation through the municipal sewer system
by dissolving or degrading them in hot water in an OREX Processor. An OREX
Processor is a standard commercial washing machine specially adapted primarily
by upgrading its water heater and removing the spin cycle. While a number of
suppliers exist for such washing machines, the Company has entered into
arrangements with three washing machine distributors for the supply of OREX
Processors at a retail cost of approximately $2,000 for a low capacity unit,
approximately $8,500 for a mid-capacity unit and approximately $20,000 for a
large capacity unit. Disposal in this manner reduces the need for storage,
handling and off-site transportation of waste, reduces the potential for
cross-infection, reduces the total volume of solid waste and facilitates
regulatory compliance. An industry standard method for disposal of blood, with
or without infectious disease contamination, is through the municipal sewer
system. While the Company makes no claims or representations in its product
advertising or labeling that the disposal method for OREX Degradables renders
the disposal matter non-infectious, independent test results indicate that
dissolving OREX Degradables in hot water inactivates in excess of 99% of tested
microorganisms. Disposal in this manner is not subject to federal regulation but
may be regulated by state and local sewage treatment plants to the extent that
sewer discharges from hospitals or other facilities may interfere with the
proper functioning of such plants. Based on product testing and available
research, the Company believes that OREX Degradables manufactured from PVA will
not interfere with the proper functioning of sewage treatment plants. Based on
such testing and research, the Company has obtained over 100 written and verbal
non-binding concurrences and is in the process of seeking additional non-binding
concurrences with the Company's conclusions from local authorities. While the
Company is undertaking evaluation of OREX Degradables manufactured from polymers
other than PVA, no assurances can be provided that such non-PVA based OREX will
not interfere with the proper functioning of sewage treatment plants. See "-
Government Regulation" and "Risk Factors - Regulatory Risks".
Tests conducted by Isolyser and independent third parties (such as testing
laboratories) indicate that OREX Degradables woven and non-woven fabric and film
can be produced to have the fluid resistance, moisture vapor transmission, flame
retardancy, impact protection and other characteristics of corresponding
conventional disposable and reusable products. To date, the Company has not
successfully completed certain non-woven fabric finishing applications to
lighter weight non-woven fabrics, necessitating the substitution of heavier
weight fabric for certain finished products. The Company has completed limited
field trials and is currently marketing OREX Degradables at more than 250
hospitals. OREX field trials, which consisted of monitored use of one or more of
a limited number of OREX Degradables woven and non-woven products, have
confirmed that such OREX Degradables products perform in a manner substantially
equivalent to similar disposable and reusable products. The Company's marketing
plan for OREX Degradables has been to provide increased focus on a limited
number of hospitals to seek to convert such hospitals from using traditional
disposable and reusable products to OREX Degradables products, first by
conducting product introductions through, for example, field trials and
thereafter by sales follow-through. These marketing efforts have been hindered
by delays in the Company's manufacturing schedule for expanding the OREX product
line and certain product performance issues. See "Risk Factors -- Manufacturing
and Supply Risks". Beginning at the end of 1995 and through 1996, the Company
engaged in a program of actively expanding its line of internally manufactured
OREX Degradables products in order to meet a customer's requirements to justify
conversion to degradable products, including the installation of an OREX
Processor. Approximately 65 hospitals have installed OREX Processors to date.
Under appropriate circumstances, the Company will favorably consider hospital
installation of OREX Processors other than through purchases as the Company
considers the OREX Processor as only one component to an entirely new product
handling cycle by its customers. The Company now offers over 200 OREX catalog
items (including both sterile and non-sterile OREX products) which the Company
believes address substantially all non-woven products most often used by
hospitals. Management of the Company believes approximately 15 hospitals
currently use OREX Degradables for substantially all of their patient draping
requirements. The Company has followed a marketing strategy of initially making
the OREX products available at prices which do not take into account disposal
cost savings provided by the Company's products in order to seek to achieve
market acceptance of OREX products. Such pricing, coupled with manufacturing
costs experienced to date in producing OREX Degradables, has caused the Company
to fail to achieve profitable margins on the sale of OREX Degradables to date.
The Company is currently evaluating its marketing plans for these products, and
plans
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to make appropriate adjustments to such marketing plans to seek to improve its
profit margins on the sale of OREX Degradables. No assurance can be given that
hospitals will use OREX Degradables, that OREX Degradables will achieve or
maintain acceptance in its target markets or that the Company will be successful
in selling OREX Degradables at a price providing satisfactory margins to the
Company. See "Risk Factors - Risks of New Products".
The Company has focused its manufacturing growth and product rollout on OREX
Degradables non-woven and woven products to a more significant extent than with
respect to other OREX Degradables products, based in part on the Company's
strategic considerations relative to market size and relative product demand.
The Company, however, has also marketed a limited number of OREX Degradables
film products, such as kick bucket liners, hamper liners, sponge counters, and
film reinforced drapes and drape sheets. The Company has not been satisfied with
certain aesthetic and user-oriented product performance characteristics of the
film component of its OREX Degradables reinforced gowns, and has to date used
traditional film materials in its reinforced gowns containing OREX non-woven
fabric. In addition, the Company has encountered some dissatisfaction with the
absorbency characteristics of its OREX towels; however, management believes that
the Company has recently solved such concerns through the successful application
on a test basis of certain manufacturing techniques which remain to be
implemented on a full commercial scale. During 1996, the Company recorded $10.0
million of reserves for OREX inventory which the Company believes is the proper
amount to be recorded due to improvements in manufacturing processes realized
during the latter portions of 1996 which rendered certain existing inventories
second quality. See "Management's Discussion and Analysis of Financial Condition
and Results of Operations" and "Risk Factors -- Risks of New Products". The
Company's requirements for its OREX Degradables film roll stock have to date
been supplied by a contract manufacturer. The Company has not yet commenced to
commercially market a full line of OREX Degradables film products or OREX
Degradables thermoformed and extruded products pending implementation of
cost-effective manufacturing techniques. Management of the Company believes that
its research and development group has discerned a methodology through
manufacturing trials that will prove satisfactory for cost-effective commercial
manufacturing of such products which is in part based upon the use of non-PVA
based raw materials. As the Company cannot currently replace all traditional
disposable medical products with OREX Degradables products, potential customers
for the Company's products may not yet justify large-scale conversion to OREX
Degradables products. See "Risk Factors - Risks of New Products".
The Company has not been satisfied with its performance to date in
manufacturing and selling OREX Degradables. The Company began limited commercial
sales of limited quantities of OREX Degradables during the first nine months of
1995 following the Company's receipt of regulatory clearances and the delivery
of contract manufactured operating room towels, sponges and certain other
products in sufficient quantities to commence sales. Meaningful sales of OREX
Degradables, however, began to occur only in the fourth quarter of 1995, during
which approximately $514,000 of such products were sold. Beginning during the
first quarter of 1996, progress continued in introducing OREX Degradables
products to the health care market by including OREX Degradables in the
Company's procedure trays and packs. Through this distribution method, over 400
hospitals were purchasing OREX Degradables in variable volumes in 1996.
Throughout 1996, the Company worked toward improving the quality of its OREX
products while expanding the number of types of OREX products available for
regular supply. Total net sales of OREX Degradables in 1996 approximated $7.1
million, primarily in health care markets. Some of these sales included
distributor stocking orders, and quarter to quarter sales of OREX remained flat
over 1996. Based in part on this flat growth rate, the Company has not enjoyed
sufficient demand for its OREX products to seek to operate its OREX
manufacturing plants at high efficiencies and thereby reduce manufacturing
costs. Such manufacturing inefficiencies, and related unabsorbed manufacturing
overhead, coupled with unit pricing for sales of OREX Degradables at an amount
which does not take into account the disposal cost savings provided by these
products, has caused the Company to fail to achieve profitable margins on the
sales of OREX Degradables to date. The Company anticipates that its
manufacturing costs and other investments in OREX sales volume growth will
continue to adversely impact operating results pending achieving a combination
of significant increases in sales volume, reducing manufacturing costs and
adjusting product unit prices to take into account disposal cost savings on OREX
products.
Procedure Trays
Procedure trays are sterilized packs which include all components
(traditionally conventional disposable or reusable medical products such as, for
example, laparotomy sponges, drapes and suction tubing) used in medical
(primarily surgical) procedures. Custom and standard procedure trays can be
utilized in a wide range of procedures, such as cardiovascular surgery and
angiography, orthopedic surgery, laparoscopic and endoscopic procedures and
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Caesarean-sections. Custom trays are assembled according to the specific
requirements of the hospital end user. Isolyser entered the procedure tray
market with the acquisition (the "Atkins Acquisition") of Charles Atkins and
Company, Ltd. ("Atkins") on February 28, 1993, and currently conducts its
procedure tray business through its subsidiary MedSurg Industries, Inc.
("MedSurg"), which it acquired (the "MedSurg Acquisition") on December 31, 1993.
For 1994, 1995 and 1996, sales of procedure trays and related products accounted
for approximately 55%, 46% and 34% of the Company's total revenue and 34%, 27%
and 28% of gross profit, respectively. The Company made the Atkins and MedSurg
acquisitions because it believes there are synergies between OREX Degradables
and procedure trays, namely (i) the tray business serves as a distribution
channel for OREX Degradables and (ii) OREX Degradables differentiate the
Company's procedure trays from those of its competitors. Moreover, the Company's
sales persons marketing procedure trays are uniquely situated to market OREX
Degradables because of their direct relationship with hospital operating room
personnel who are important to the decision-making process in purchasing OREX
Degradables and such sales persons' knowledge about regulatory and environmental
benefits and issues related to OREX Degradables. The Company estimates that for
a typical open heart tray, OREX Degradables can represent approximately 45% of
the cost and up to 80% of the disposal volume of the tray.
Traditional Products and Markets
Through the Company's acquisitions of White Knight and Microtek, the Company
entered the business of conversion manufacturing and marketing of traditional
medical disposable products such as disposable surgical apparel and equipment
drapes. The Company made the White Knight and Microtek acquisitions because it
believes the conversion manufacturing expertise and capacity of White Knight and
Microtek assists Isolyser in the conversion manufacturing of various OREX
Degradables products, and because those companies provide Isolyser with sales
and marketing support and access to new health care markets. See "Risk Factors
- -- Risks of Expansion".
The Company acquired White Knight as of September 1, 1995. Through White
Knight, the Company manufactures and markets non-woven infection control
products and protective apparel for use primarily in the health care industry.
As an outgrowth of a business founded in the 1950s and evolved over a series of
mergers, acquisitions and restructurings, White Knight pioneered the disposable
medical products market in the early 1970s, and is today a leading manufacturer
and converter (in competition with other larger companies such as Allegiance
Corporation ("Allegiance")) of non-woven sterile and non-sterile products. White
Knight is a Pennsylvania corporation formed in 1991 to acquire substantially all
of the assets of the White Knight Health Care division of Work Wear Corporation,
Inc., which at the time was a debtor-in-possession under Chapter 11 of the
Bankruptcy Code of 1978, as amended.
White Knight categorizes its products and related markets in three partially
overlapping groups. The first and largest, called the medical products division,
manufactures non-woven disposable surgical apparel, drapes and accessory
products (including drapes, gowns, shoe covers, masks and caps) for use in
hospitals and surgical centers. The second product group and related market,
called the specialty apparel division, manufactures disposable and reusable
apparel (such as coveralls, lab coats, frocks, hoods, foot coverings, masks,
caps and isolation gowns) which are in part an extension of White Knight's
medical products and which are marketed for use in clean room environments,
laboratories and other industrial applications (including clean rooms for
pharmaceutical, electronic and biotech industries as well as automotive and
paint industries). The last product group and related market, called the Struble
& Moffitt division, operates semi-autonomously from White Knight and is
described below under "-- Safety Products and Services and Other Products".
For the period from September 1 through December 31, 1995, net sales of
White Knight represented 18% of the Company's total revenue and provided 17% of
the Company's gross profit for the year ended December 31, 1995. Net sales of
White Knight in 1996 represented 35% of the Company's total revenue and 35% of
the Company's gross profit for that year. Included in such sales figures are
$1.4 million and $4.5 million of export sales by White Knight during the last
four months of 1995 and during 1996, respectively. Prior to the Company's
acquisition of White Knight, the Company made no material export sales.
The Company acquired Microtek as of September 1, 1996. Through Microtek, the
Company manufactures and markets equipment drapes and fluid control products.
Microtek is a Delaware corporation which, prior to the Microtek Acquisition,
operated independently following its spin-off from Teknamed Corporation, a
medical products company, in 1984.
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Microtek designs, manufactures and markets two principal product lines for
use in niche markets of the health care industry. First, Microtek's infection
control products consist of more than 1,500 specially designed drapes for use in
draping operating room equipment during surgical procedures. This equipment
includes, for example, microscopes, ultrasound probes, endoscopic video cameras,
x-ray cassettes, imaging equipment, lasers and handles attached to surgical
lights. In addition to reducing the risk of cross-infection, these products
increase operating room efficiency by reducing the need to sterilize equipment
between procedures. These disposable sterile products are generally made from
plastic film containing features designed for the operating room environment,
such as low glare and anti-static features. Microtek's second principal product
line, fluid-control products, are specially designed disposable pouches which
are attached to a surgical patient drape (called a substrate), which is placed
around the operative site. For instance, Microtek manufactures a specialty pouch
for knee arthroscopy. This pouch captures not only the bodily fluids that are
discharged from the knee but also the sterile saline that is infused into the
operative site during the arthroscopic procedure. Microtek's fluid control
product line primarily consists of more than 200 different plastic disposable
collection pouches. Prior to July, 1995, Microtek was also engaged in the sale
of specialty otology products.
The Company acquired Microtek in a pooling of interests transaction as of
September 1, 1996, and the Company's financial statements have accordingly been
restated to include Microtek's financial statements. For 1994, 1995 and 1996,
sales of Microtek products accounted for approximately 36%, or 28% and 24% of
the Company's total revenues and 51%, 46% and 49% of gross profit, respectively.
Included in such sales figures are $5.9 million, $7.3 million and $7.9 million,
of export sales by Microtek during 1994, 1995 and 1996, respectively.
Safety Products and Services and Other Products
The Company also offers several other lines of safety products and services
for the management of potentially infectious and hazardous waste. These safety
products and services are described below.
Liquid Treatment System (LTS) is a super-absorbent powder which converts
potentially infectious liquid waste into a solid waste suitable for landfill
disposal. Unlike conventional super-absorbents, LTS products are designed to
work across a wide pH range and electrolyte concentration, and absorb and
solidify without mechanical intervention such as stirring. LTS is typically
added to a suction canister or other fluid collection device in which blood or
other body and irrigation fluids are collected during surgery or in wound
drainage after surgery. Product testing and laboratory analyses indicate that
LTS inactivates over 99% of tested microorganisms. LTS converts liquid waste
into a solid waste, thereby facilitating handling, transportation and disposal.
LTS can also be used to clean up spills of potentially infectious liquid waste.
Regardless of whether LTS is disposed of in landfills or through incineration or
other special process, LTS provides advantageous occupational safety benefits by
Point-of-Generation treatment of potentially infectious liquid waste. The
Company has independent test results verifying product performance, has received
approvals from certain states to landfill LTS-treated waste and has a greater
number of sales representatives than its competitors. Based on the number of
suction canisters and other fluid collection devices sold in the United States,
the Company estimates that at least a $90.0 million market exists for LTS. LTS
may be sold in bulk or packaged separately with a canister or other fluid
collection device.
Sharps Management System (SMS) is designed to encapsulate and physically
disinfect contaminated sharps (such as needles, syringes, scalpels, etc.) at the
Point-of-Generation. The product consists of a puncture- and spill-resistant
plastic container partially filled with a bathing solution for encapsulation.
When full, a small amount of catalyst powder is added. The catalyst creates a
chemical reaction which heats the container and solidifies the contents, thus
encapsulating the sharps and nearly eliminating the risk of accidental
punctures. According to product testing, this process inactivates over 99% of
tested microorganisms. The container of SMS treated sharps is suitable for
handling, transportation and disposal. The Company believes that SMS is the only
product on the market which operates as a physical disinfecting device for
sharps under applicable EPA requirements, rendering the contents safe for
landfill disposal. By comparison, competitive products perform only a collection
function with no disinfection or solid encapsulation capabilities, requiring
disposal at a higher cost.
Onsyte System is a mobile waste treatment unit that utilizes microwave
technology and steam to render infectious waste non-hazardous. The system then
shreds and grinds the material, making it non-recognizable and suitable for
disposal in landfills. In 1993, Isolyser began offering its Onsyte System to
hospitals and other waste generators as part of its umbrella approach to waste
management. In May 1995, the Company acquired SafeWaste Corporation
("SafeWaste") to provide, among other things, improved marketing and management
of the Company's mobile
420793.1
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medical waste treatment services. SafeWaste, based in Charlotte, North Carolina,
operates the Company's three Onsyte Systems and a mobile waste treatment unit
through a joint venture with a customer of SafeWaste.
The Company also manufactures and markets various other products. In April,
1996, Microtek purchased the Venodyne division of Advanced Instruments, Inc.
which manufactures and markets pneumatic pumps and disposable compression
sleeves for use in reducing deep vein thrombosis. Sales of these products have
not been material to the Company's results of operations. Through White Knight's
Struble & Moffitt division, the Company manufactures disposable transportation
products (such as pillow cases and head rest covers) sold to airline and
passenger railroad industries, dental products (such as bracket tray covers and
head rests), and adult incontinence underpads and diapers. This division has
experienced declining revenue and gross profit over a period preceding the White
Knight Acquisition.
Marketing and Distribution
Substantially all of the Company's sales in 1996 were made to the health
care market. Hospitals purchase most of their products from a few large
distributors, many of which provide inventory control services to their
customers. The Company believes that a key to penetrating the health care market
is a strong sales force capable of educating distributors and end users about
the unique characteristics of its products so that distributors will recommend
and end users will request the Company's products. Achieving market penetration
of the Company's products is subject to a number of risks. See "Risk Factors -
Risks of New Products".
As of December 31, 1996, the Company's marketing and sales force consisted
of 69 sales representatives, six field sales managers, ten home office sales
managers and 25 persons in customer support. The Company is dependent upon a few
large distributors for the distribution of its products. The Company's top five
customers accounted for approximately 38% of the Company's total revenues during
1996. Of these customers, only Owens & Minor, Inc. accounted for over 10% of the
Company's total sales during 1996. Because distribution of medical products is
heavily dependent upon large distributors, the Company anticipates that it will
remain dependent upon these customers and others for the distribution of its
products. If the efforts of the Company's distributors prove unsuccessful, or if
such distributors abandon or limit their distribution of the Company's products,
the Company's sales may be materially adversely affected. See "Risk Factors -
Reliance Upon Distributors".
While the Company introduced OREX Degradables to the health care industry on
a limited basis in March, 1994, meaningful sales of OREX Degradables did not
commence to occur until 1996. Over this time, the Company conducted field trials
of certain OREX Degradables products as a method to introduce this new
technology to the health care marketplace. See "Products and Markets -- OREX
Degradables". During 1996, the Company continued to conduct such field trials
while concurrently including various OREX Degradables products, as they became
available, in procedure trays and by selling such products on a stand-alone
basis and in supplemental packs. The Company is currently undertaking a thorough
review and analysis of the market position of OREX Degradables within its
various market potentials. As a part of such review and analysis, the Company
plans to implement appropriate adjustments to its marketing plan to seek to
improve the Company's operating results. There can be no assurance that OREX
Degradables will achieve or maintain substantial acceptance in their target
markets or that the Company will be successful in selling OREX Degradables at a
price providing satisfactory margins to the Company. See "Risk Factors -- Risks
of New Products". Delays experienced by the Company in the availability of OREX
Degradables products may have resulted in the loss of previous or potential
customers. See "Risk Factors -- Manufacturing and Supply Risks".
In connection with the White Knight Acquisition, in September, 1995,
Isolyser entered into a distribution and marketing agreement (the "OREX Supply
Agreement") with Sterile Concepts. Under this agreement, Isolyser agreed to
supply Sterile Concepts with OREX Degradables as they became available for sale
by Sterile Concepts exclusively in its sterile custom procedure trays. Sterile
Concepts agreed in the OREX Supply Agreement to actively promote OREX
Degradables and to sell OREX Degradables only as a component of its sterile
custom procedure trays. As currently in effect, the OREX Supply Agreement does
not restrict the Company in its efforts to independently market its products
(including, without limitation, OREX Degradables) and compete with Sterile
Concepts. In July, 1996, Sterile Concepts was acquired by Maxxim Medical, Inc.
("Maxxim"), a vertically integrated manufacturer and marketer of medical
products competitive with those of the Company. The Company has made no sales
under the OREX Supply Agreement to date. The OREX Supply Agreement expires on
the later of June 30, 1998 or the date of retirement of certain cash flow note
issued by White Knight to Sterile Concepts, unless earlier terminated in
accordance with the terms of the OREX Supply Agreement.
420793.1
9
The Company sells its procedure trays exclusively through independent
distributors with the marketing assistance of the Company's sales force. The
Company's other traditional medical products are sold through distributors and
custom procedure tray companies (including the Company's custom procedure tray
operations). The Company also markets certain of its products to other
manufacturers on a "non-branded" or private label basis. For example, the
Company's fluid control pouches are sold to manufacturers of substrates, and the
Company's equipment drapes are sold to manufacturers of the equipment for which
such drapes were designed. Under an agreement entered into between White Knight
and Sterile Concepts, Sterile Concepts agreed to purchase a yearly minimum of
$5.1 million of products from White Knight until June 30, 1998. A portion of the
purchase price payable for these products by Sterile Concepts to White Knight is
used to amortize certain notes payable by White Knight to Sterile Concepts,
thereby providing certain trade discounts on product sales from White Knight to
Sterile Concepts. To the extent these notes are not entirely satisfied through
these trade discounts, the notes terminate at January 15, 2000 regardless of
whether there remains any unpaid principal or interest outstanding at that time.
While Sterile Concepts has historically purchased more than its minimum purchase
obligation from White Knight, as a result of Maxxim's acquisition of Sterile
Concepts in mid-1996, the Company anticipates that continued purchases by
Sterile Concepts from White Knight will be reduced to the minimum amount
required pursuant to the underlying agreement. Following Maxxim's acquisition of
Sterile Concepts, the Company began to experience declining sales to Sterile
Concepts. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations".
The Company's total export sales during 1994, 1995 and 1996 were $5.9
million, $8.7 million and $12.4 million, respectively. Outside the United
States, the Company markets its products principally through a network of
approximately 80 different dealers and distributors. As of December 31, 1996,
the Company also had seven sales representatives operating in international
markets, and maintains an office and warehouse distribution center near
Manchester, England and an office for one of its sales representatives and
support personnel in Luxembourg, Europe.
The Company markets various woven and non-woven apparel (such as coveralls,
lab coats, frocks, hoods, foot coverings, masks, caps, isolation gowns,
headrests and pillowcases) in industrial markets such as clean room
environments, laboratories, mass transportation industries and automotive
industries. The Company maintains a sales force of seven employees and a
complementary set of independent sales representatives dedicated to direct
selling in this industry. The Company sells its non-woven disposable industrial
products primarily through large distributors and sells the woven reusable
industrial products primarily through direct sales to service providers such as
clean room launderers. Sales of OREX Degradables within industrial markets has
not to date been material to the Company's results of operations. Recently, the
Company entered into a distribution agreement with a large nuclear industry
launderer for the supply of OREX Degradables apparel and ancillary products such
as OREX Degradables towels. However, no sales have occurred to date under such
distribution agreement as processing evaluations continue to perfect means of
removing hazardous and radioactive contaminants from wastewater containing
dissolved OREX Degradables products. Preliminary product evaluations and testing
in the nuclear market have yielded positive results. Until these processing
evaluations prove successful, no assurances can be provided that OREX
Degradables will achieve market acceptance within the nuclear industry.
On March 1, 1992, Isolyser entered into a distribution agreement with
Baxter, a leader in the sale of suction canisters and related apparatus. Under
this agreement, Baxter had an exclusive right in the United States and Canada to
distribute LTS to the hospital and free standing surgery center market and the
nonexclusive right to sell and distribute LTS to the non-hospital health care
market. The agreement expires February 28, 1998 and is subject to renewal for
one-year terms thereafter unless otherwise terminated. Effective at the end of
1994, Isolyser terminated Baxter's exclusive LTS distribution rights in
accordance with the terms of the subject agreement allowing for such termination
if Baxter did not achieve certain minimum purchase requirements. During 1996,
the Company began to distribute LTS through other national distributors.
To further expand its marketing resources, the Company from time to time
seeks to enter into strategic alliances with third parties such as specialty
equipment manufacturers and other non-competitive companies which would enable
it to sell various of its products to non-hospital markets. While the Company
from time to time engages in such discussions, the Company provides no
assurances that any such strategic alliances will be consummated or, if
consummated, that any such alliance will be favorable to the Company.
420793.1
10
Manufacturing and Supplies
OREX is manufactured from a variety of organic, degradable polymers that
have been modified to dissolve or degrade only in hot water. The basic compound
used to manufacture OREX Degradables woven and non-woven products is PVA, a safe
material widely used in a variety of consumer products such as eye drops,
cosmetics and cold capsules. The Company more recently has begun to develop the
use of other polymers to test manufacture OREX Degradables film and thermoformed
and extruded items. Through a manufacturing process developed by the Company,
the Company modifies these polymers so they will dissolve or degrade only in hot
water as a step in manufacturing OREX products. The modified polymers can then
be made into most woven and non-woven fabrics, film, packaging and thermoformed
and extruded products. The Company currently obtains its PVA raw materials from
various foreign suppliers. Risks exist in obtaining the quality and quantity of
PVA at a price that will allow the Company to be competitive with manufacturers
of conventional disposable and reusable products. Prevailing prices of PVA have
adversely affected the Company's manufacturing costs for its OREX products. PVA
fiber is required to manufacture the Company's non-woven and woven OREX
Degradables, while PVA resin is the raw material required to manufacture OREX
Degradables utensils and film products and PVA fiber. PVA resin from Japan,
Taiwan and certain producers in China are subject to anti-dumping duties if
imported into the United States. See "Risk Factors - Manufacturing and Supply
Risks". During 1996, the Company acquired a PVA fiber manufacturing facility
located in Charlotte, North Carolina. This facility remains in the developmental
stages as the Company experiments with PVA fiber manufacture as well as other
compounds.
The Company has followed a strategy of capital equipment purchases and
acquisitions to expand and vertically integrate the Company's manufacturing
capabilities, thereby enabling the Company to manufacture and convert into
finished goods many OREX Degradables internally, giving it more control over its
operations, including product quality, availability and cost. In January 1995,
the Company acquired a 108,000 square foot manufacturing facility located in
Arden, North Carolina which became operational later in 1995 as an OREX
Degradables non-woven fabric manufacturing plant. The Company has experienced
delays in manufacturing OREX Degradables non-woven fabric at the Arden facility.
Effective June 1995, the Company acquired a 207,000 square foot manufacturing
facility located in Abbeville, South Carolina which started operations as an
OREX Degradables woven manufacturing plant at the end of 1995. Manufacturing
capacity at this plant significantly exceeds current product demand, which has
caused the Company to incur overhead costs which have not been absorbed in the
cost of product sales. The Company has not been satisfied with its performance
to date in manufacturing and selling OREX Degradables. For example, the Company
to date has not successfully completed certain non-woven fabric finishing
applications to lighter weight non-woven fabrics, necessitating the substitution
of heavier weight fabric for certain finished products. Based in part on the
excess manufacturing capacity provided by the Company's OREX Degradables
material plants, the Company has not been able to seek to operate these plants
at high efficiencies. These manufacturing inefficiencies, and related unabsorbed
manufacturing overhead, coupled with pricing of OREX Degradables at an amount
which does not take into account disposal cost savings provided by such
products, has caused the Company to fail to achieve profitable margins on the
sale of OREX Degradables to date. See "- Growth Strategy", "- Products and
Markets", "Management's Discussion and Analysis of Financial Condition and
Results of Operations", "Risk Factors - Risks of Expansion" and "- Manufacturing
and Supply Risks". Throughout 1996, the Company worked toward improving the
quality of its OREX products while expanding the number of types of OREX
products available for regular supply. The Company has not yet commenced to
commercially manufacture a full line of OREX Degradables film products or OREX
Degradables thermoformed and extruded products pending implementation of
cost-effective manufacturing techniques which have been successfully used on a
test basis in the Company's research and development department. The Company
plans to commercially offer various products within the line of OREX Degradables
on a staged basis. See "Risk Factors -- Risks of New Products".
In addition to internal conversion manufacturing operations by the Company
for various of its OREX products which are described below, the Company uses
various domestic and foreign independent manufacturers for some OREX Degradables
products for assembling, packaging, sterilizing and shipping by the Company. The
Company uses contractors in the People's Republic of China to manufacture OREX
Degradables sponge products. The Company has used various independent parties
(both domestically and internationally) to manufacture various OREX Degradables
thermoformed and extruded products and composite products, which have not yet
been offered for commercial sale by the Company. The Company's requirements
(which to date have been modest) for OREX Degradables film products are
currently being supplied by a contract manufacturer.
420793.1
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With the consummation of the White Knight Acquisition, the Company
significantly increased its non-woven fabric conversion manufacturing
capabilities. The Company's non-woven conversion manufacturing operations
include conversion manufacturing (i.e., converting roll stock to finished goods)
for both OREX Degradables and traditional products used in health care and other
markets. The Company conducts its non-woven conversion manufacturing operations
in five locations: (i) a 50,000 square foot owned facility in Childersburg,
Alabama, which manufactures medical products and specialty apparel products
including medical and specialty face masks; (ii) a 100,000 square foot facility
under a long-term lease in Douglas, Arizona which manufactures medical products
and specialty apparel; (iii) an 87,000 square foot owned facility in Agua
Prieta, Mexico located adjacent to the Douglas facility to provide labor
intensive post-cutting applications; (iv) a 33,000 square foot leased facility
located in Acuna, Mexico (together with the related leased Del Rio, Texas
facility) to provide labor intensive cutting and sewing operations which the
Company is in the process of consolidating with its Agua Prieta plant; and (v) a
60,000 square foot owned facility in Runnemede, New Jersey which manufactures
products for the semi-autonomous Struble & Moffitt division of White Knight.
Through White Knight, the Company also maintains contracted manufacturing
operations in Texas and the People's Republic of China. Raw materials for White
Knight products are purchased from numerous vendors. White Knight's
relationships with vendors are good, although White Knight maintains no
long-term supply contracts with vendors. Certain medical and specialty apparel
products are impacted by user preference in fabric choice, such as spunlace
non-woven fabric marketed by DuPont under the Sontara trade name and wet-laid
non-woven fabric marketed by Dexter under the Dexter trade name. White Knight,
along with other larger competitors, has access to a full complement of fabric
selections from vendors of choice, although not in all cases with the same
pricing discounts available to larger purchasers.
The Company manufactures its equipment drapes and fluid control products at
its facilities in Columbus, Mississippi and the Dominican Republic. During 1996
the Company also maintained, through Microtek, a facility in Alpharetta, Georgia
at which some products were manufactured. This facility was closed at the end of
1996 as a part of overall consolidation and cost-saving measures. During 1996,
Microtek leased a facility in Empalme, Mexico where it now conducts conversion
manufacturing of equipment drapes and fluid control products.
The Company currently purchases components for procedure trays from a large
number of independent vendors, and assembles custom and standard procedure trays
for use in a wide array of medical procedures, including orthopedic, ophthalmic,
cardiovascular, laparoscopic, obstetric-gynecologic and endoscopic procedures.
The Company's Virginia-based procedure tray manufacturing operation is separated
into four stages: (i) receiving and stocking components for procedure trays,
(ii) assembling trays from these components, (iii) sterilizing and quarantining
and (iv) shipping. Generally, custom trays can be shipped to customers within
approximately 60 days from the date an order is placed.
The Company currently relies upon independent manufacturers for the purchase
of materials and components for most of its safety products. The Company uses,
and expects to continue to use, vendors of stock items to the extent possible to
control direct material costs. The Company's safety products production facility
located in Norcross, Georgia is used for mixing liquid and powdered chemicals,
other light manufacturing and packaging.
Order Backlog
At December 31, 1996, the Company's order backlog totaled approximately $9.6
million compared to approximately $9.9 million (in each case net of any
cancellations) at December 31, 1995. All backlog orders at December 31, 1996 are
expected to be filled prior to year end 1997.
Technology and Intellectual Property
The Company seeks to protect its technology by, among other means, obtaining
patents and filing patent applications for technology or products that it
considers important to its business. The Company also relies upon trade secrets,
technical know-how and innovation and market penetration to develop and maintain
its competitive position. The Company holds patents issued by the U.S. Patent
and Trademark Office relating to its SMS, LTS, and certain other products. The
Company holds a patent issued in 1993 for a combination of (x) a composite
fabric consisting of the material from which OREX Degradables are made, (y)
certain nondegradable material, and (z) the method of disposing of such fabric,
as well as a patent issued in 1995 for OREX Degradables mop heads. The Company
also holds two patents issued by the U.S. Patent and Trademark Office and
reallowed by such office in 1996 concerning methods of disposing of OREX
Degradables garments, fabrics and packaging materials. The Company currently has
applications pending before the U.S. Patent and Trademark Office and which
relate to the
420793.1
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OREX Degradables. Specifically, those applications concern (i) OREX Degradables
towels, sponges and gauzes, (ii) methods of making OREX Degradables molded parts
(such as utensils and packaging) and film (such as gowns, drapes, head and shoe
covers, face masks, CSR wrap, underpads and diapers), (iii) methods of disposing
of garments, linens, drapes, towels and other articles of OREX Degradables, (iv)
methods of producing OREX Degradables drapes, towels, covers, overwraps, gowns,
head covers, face masks, shoe covers, CSR wraps, sponges, dressings, tapes,
underpads, diapers, washcloths, sheets, pillow coverings and napkins and (v)
articles of film, fabric or fiber composed of OREX Degradables which are
configured into drapes, towels, covers, overwraps, gowns, head covers, face
masks, shoe covers, CSR wraps, sponges, dressings, tapes, underpads, diapers,
washcloths, sheets, pillow coverings and napkins, and (vi) methods of disposing
of towels, sponges and gauze produced from OREX Degradables. The U.S. Patent and
Trademark Office has issued a notice of allowance for applications (v) and (vi),
and Isolyser expects to receive the issued patents soon. Application (i) has not
yet been examined while applications (ii) and (iv) have been examined but to
date the examiners at the U.S. Patent and Trademark Office have not allowed
these applications. The Company has not succeeded to date to achieve
allowability of application (iii) and an appeal has been filed before the U.S.
Patent and Trademark Office Board of Patent Appeals and Interferences. The
Company is not aware of any facts at this time that would indicate that patents
sought by these three applications will not be issued. The Company recently
filed applications with the U.S. Patent and Trademark Office for its OREX
Degradables concerning (i) a surgical drape composite article and (ii) a new
class of OREX biodegradable polymers. The Company's U.S. patents expire between
2001 and 2014. The Company files for foreign counterpart patents on those
patents and patent applications which the Company considers to be material to
its business. No assurance can be given that the various components of the
Company's technology protection arrangements utilized by the Company to protect
its technologies, including its patents, will be successful in preventing others
from making products competitive with those offered by the Company, including
OREX Degradables. See "Risk Factors - Protection of Technologies".
Under a five-year license agreement from Microban Products Company entered
into on March 22, 1996, Microtek acquired the exclusive right to incorporate
certain antimicrobial additives to the Company's surgical and equipment drapes
manufactured with film and nonexclusive rights to such additives in non-woven
drape products, subject to the payment of royalties and certain other terms and
conditions specified in the license agreement. To date, such license has not
been material to the Company's operations.
The Company has registered as trademarks with the U.S. Patent and Trademark
Office "Isolyser," "LTS," "SMS" and "OREX". A trademark registration for "OREX"
has also been granted in the United Kingdom. White Knight currently maintains
registrations with the U.S. Patent and Trademark Offices for the trademarks
"White Knight" and "Precept". Microtek maintains registrations of various
trademarks which the Company believes are recognized within their principal
markets.
Competition
The markets in which the Company competes are characterized by competition
on the basis of quality, price, product design and function, environmental
impact, distribution arrangements, service and convenience. Many of the
Company's competitors have significantly greater resources than the Company. See
"Risk Factors Competition".
Although the Company is not aware of any products currently available in the
market place which provide the same disposal and degradable benefits as OREX
Degradables, OREX Degradables compete with traditional disposable and reusable
products currently marketed and sold by many companies. Single use disposable
(as opposed to reusable) drapes and gowns have been available for over 25 years
and according to a 1992 market study account for over 80% of the surgical
market. Competing manufacturers of traditional disposable medical products are
large companies with significantly greater resources than those of the Company.
These competitors have in many instances followed strategies of aggressively
marketing products competitive with OREX Degradables to buying groups resulting
in increasing cost pressures. These factors have adversely affected the
Company's ability to adjust its prices for its OREX products to take into
account disposal cost savings provided by these products, and have adversely
affected the Company's ability to successfully penetrate potential customer
accounts. See "Risk Factors -- Risks of New Products" and "-- Competition".
The market for procedure tray products is highly competitive. Based on
publicly available information, the Company believes that the procedure tray
market is dominated by three companies, who combined have more than 70% of the
United States market thus far converted to using procedure trays.
420793.1
13
The market for the Company's traditional medical and specialty apparel
products is also highly competitive, and is dominated by a few large companies
such as Allegiance, Kimberly-Clark Corporation, Johnson & Johnson and 3M
Corporation. The market for White Knight's transportation and dental products
included in the Struble & Moffitt Division has fewer competitors, and the
Company estimates that White Knight has a significant presence in this market,
although its presence is declining due at least in part to a competitor offering
a broader line of products in this market. Struble & Moffitt has a small (less
than 1%) presence in the adult incontinence market.
Competition for the Company's safety products includes conventional methods
of handling and disposing of medical waste. Contract waste handlers are
competitors which charge premium rates to remove potentially infectious and
hazardous waste and transport it to an incineration or autoclaving site. Many
hospitals utilize their own incinerators to dispose of this waste. In addition,
systems are available that hospitals can purchase for grinding and chemically
disinfecting medical waste at a central location.
The Company believes that its LTS products command a dominant share of a
market that thus far has been marginally penetrated. However, the Company is
aware of a variety of absorber products that are directly competitive with LTS.
The Company estimates that it has only a small (less than 5%) market share for
its SMS products. The market niche for disposal of sharps is dominated by a
number of other companies.
Government Regulation
The Company is subject to a number of federal, state and local regulatory
requirements which govern the marketing of the Company's products and the use,
treatment and disposal of these products utilized in the patient care process.
In addition, various foreign countries in which the Company's products are
currently being distributed or may be distributed in the future impose
regulatory requirements. See "Risk Factors - Regulatory Risks".
The Company's traditional medical products (including, for example, drapes,
gowns and procedure trays), OREX Degradables line of products and SMS products
are regulated by the FDA under medical device and drug provisions of the Federal
Food, Drug and Cosmetic Act (the "FDCA"). FDA regulations classify medical
devices into one of three classes, each involving an increasing degree of
regulatory control from Class I through Class III products. Medical devices in
these categories are subject to regulations which require, among other things,
pre-market notifications or approvals, and adherence to good manufacturing
practices, labeling, record-keeping and registration requirements. Patient care
devices which the Company currently markets are classified as Class I or Class
II devices subject to existing 510(k) orders which the Company believes satisfy
FDA pre-market notification requirements. The FDA has issued to the Company
510(k) orders on OREX Degradables products for surgical sponges, operating room
towels, drapes, gowns, surgeon's caps, surgeon's vests, shoe covers and medical
bedding. The Company is currently developing, evaluating and testing certain
OREX Degradables film and thermoformed or extruded OREX products manufactured
from non-PVA polymers, and it is possible that new 510(k) orders will be
required for such products. There can be no assurances as to when, or if, other
such 510(k) orders necessary for the Company to market products developed by it
in the future will be issued by the FDA. The pharmaceutical products marketed by
the Company as components of certain procedure trays are subject to labeling,
current good manufacturing practices and other general requirements for drugs
under the FDCA, but because these products are produced by other entities, the
Company does not have any independent responsibility for any premarket approvals
required for these drug products. The FDA inspects medical device manufacturers
and distributors, and has broad authority to order recalls of medical devices,
issue stop sale orders, seize non-complying medical devices, enjoin violations,
impose civil and criminal penalties and criminally prosecute violators. The FDA
possesses similar broad inspection and enforcement authority over pharmaceutical
products.
The FDA also requires health care companies to satisfy current good
manufacturing practices and record-keeping requirements. Failure to comply with
applicable regulatory requirements, which may be ambiguous or unclear, can
result in fines, civil and criminal penalties, stop sale orders, loss or denial
of approvals and recalls or seizures of products.
Countries in the European Union are seeking to require that products being
sold within their jurisdictions obtain a CE mark. The failure of a product to
hold such mark does not necessarily prevent the sale of such products within the
European Union until June 1, 1998, by which time products being sold in the
European Union are required to hold such mark as a condition to such sales.
Various of the Company's products are currently being sold in countries within
the European Union without such mark based upon other regulatory authorizations.
One of the conditions to obtaining CE mark status involves the qualification of
the Company's manufacturing plants
420793.1
14
under certain certification processes. Most of the Company's manufacturing
plants have obtained such certifications, although Microtek's plants and the
Company's Herndon, Virginia and Childersburg, Alabama plants have not yet
received such certifications. The Company plans to seek such certifications for
these remaining plants. While the Company does not anticipate any significant
impediments to obtain the certification for these remaining plants or otherwise
timely satisfying requirements for CE mark status, no assurances are provided
that such certifications will be obtained or that other foreign regulatory
requirements will not adversely affect the Company's marketing efforts in
foreign jurisdictions.
Under the Federal Insecticide, Fungicide, and Rodenticide Act ("FIFRA"), any
product which claims that it chemically kills microorganisms must be registered
with the EPA. Any product that makes a claim that it kills microorganisms via a
physical or mechanical means is considered a physical "device" under FIFRA, and
does not require EPA registration. FIFRA affects primarily the Company's LTS and
SMS products, neither of which is required to be registered with the EPA. The
Company believes its SMS product qualifies as a physical disinfecting device
under FIFRA, which permits the Company to advertise that such product physically
disinfects microorganisms without EPA registration. LTS is not registered with
the EPA. The lack of an EPA registration does not prevent the Company from
selling LTS, so long as no claims are made by the Company in product labeling
and marketing that LTS treats or disinfects medical waste or kills
microorganisms, and the absence of such registration does not prevent medical
waste generators from using LTS. The Company markets and labels LTS and SMS in a
manner designed to comply with relevant EPA regulations.
State and local regulations of the Company's products and services is highly
variable. In certain cases, for example, state or local authorizations are
required to landfill Isolyser's SMS or LTS products, or both. Currently Isolyser
believes that SMS-treated waste may be landfilled in 25 states and LTS-treated
waste may be landfilled in 20 states, subject in certain instances to further
local approvals. The Company was recently made aware that California is
reviewing its regulatory restrictions on customer landfilling of LTS-treated
waste. If such review results in restrictions on landfilling of such waste in
California, such restrictions could adversely affect the Company's sales of LTS
in California. State and local sewage treatment plants regulate the sewer
discharge, such as dissolved OREX Degradables, from commercial facilities to the
extent that such discharges may interfere with the proper functioning of sewage
treatment plants. Based on product testing and available research the Company
believes that OREX Degradables manufactured from PVA will not interfere with the
proper functioning of sewage treatment plants. The Company has obtained from
state and local authorities over 100 written and verbal non-binding concurrences
with the Company's conclusions and continues to pursue additional non-binding
concurrences. While the process of obtaining such concurrences is time consuming
and expensive due to the significant number of such authorities and the
educational and testing processes involved, the Company does not believe that
regulations governing sewage and waste water discharges will prevent the use of
OREX Degradables. While the Company is undertaking evaluation of OREX
Degradables manufactured from polymers other than PVA, no assurances can be
provided that such non-PVA based OREX will not interfere with the proper
functioning of sewage treatment plants.
The Resource Conservation and Recovery Act ("RCRA") and regulations
promulgated thereunder and applicable state and local laws governing the
disposal of solid and/or hazardous waste may regulate customers' use of ALDE-X
and raysorb. For example, the California Department of Toxic Substance Control
has refused to classify waste material treated with raysorb as non-hazardous,
effectively preventing the Company from marketing raysorb in California because
of the requirement that raysorb users in California obtain a permit in order to
dispose of material treated with raysorb, significantly increasing the cost of
disposal. The Company has conducted independent testing of raysorb, the results
of which confirm, in management's opinion, that raysorb-treated x-ray fixer and
developer is non-hazardous.
Regulators at the federal, state and local level have imposed, are currently
considering and are expected to continue to impose regulations on medical and
other waste. No prediction can be made of the potential effect of any such
future regulations, and there can be no assurance that future legislation or
regulations will not increase the costs of the Company's products or prohibit
the sale or use of the Company's products, in either event having an adverse
effect on the Company's business.
Employees
As of December 31, 1996, the Company employed approximately 2,800 full-time
employees and approximately 17 people as independent contractor sales
representatives. Of these employees, 162 were employed in marketing, sales and
customer support, 2,224 in manufacturing, 14 in research and development, and
400 in administrative
420793.1
15
positions. The Company believes its relationship with its employees is good.
Approximately 19 and 23 of White Knight's employees located at the Struble &
Moffitt plant and Douglas plant, respectively, were members of and represented
by the United Food and Commercial Workers Union, AFL-CIO. In addition,
approximately 287 of White Knight's employees located at White Knight's Agua
Prieta, Mexico plant are represented by a Mexican labor union.
Insurance
Isolyser maintains commercial general liability protection insurance which
provides coverage with respect to product liability claims of up to $11 million
per occurrence with a $12 million aggregate limit. The manufacture and sale of
the Company's products entail an inherent risk of liability. The Company
believes that its insurance is adequate in amount and coverage. Although the
Company has never been named as a defendant in a product liability lawsuit,
there can be no assurance that any future claims will not exceed applicable
insurance coverage. Furthermore, no assurance can be given that such liability
insurance will be available at a reasonable cost or that the Company will be
able to maintain adequate levels of liability insurance in the future. In the
event that claims in excess of these coverage amounts are incurred, they could
have a material adverse effect on the financial condition or results of
operations of the Company.
Environmental Matters
The Company is not a party to any material environmental regulation
proceedings alleging that the Company has unlawfully discharged materials into
the environment. The Company does not anticipate the need for any material
capital expenditures for environmental control facilities during the next 18 to
24 months.
Risk Factors
Limited Operating History; Net Losses. Isolyser was incorporated in 1987 and
commenced operations in 1988. Its principal products have been available in the
marketplace for a limited period of time. The Company began to commercially
introduce OREX Degradables in 1995 and total net sales of OREX Degradables in
1996 approximated $7.1 million but did not provide any gross profits. The
Company believes that the absence of gross profits on sales of OREX Degradables
to date is due to a combination of factors including the cost of manufacturing
OREX Degradables products (which is related in part to manufacturing
inefficiencies experienced to date in manufacturing such products), coupled with
pricing of OREX Degradables products at an amount which does not take into
account disposal cost savings provided by such products. For the year ended
December 31, 1996 the Company incurred actual net losses of approximately $20.5
million. No assurances can be given that the Company will operate profitably in
the future. The Company anticipates that its OREX materials manufacturing costs
and other investments in OREX sales volume growth will continue to adversely
impact operating results pending achieving significant increases in sales volume
of its OREX Degradables products and adjusting product unit prices for such
products to take into account disposal costs savings on such products. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations".
Risks of New Products. The Company's future performance will depend to a
substantial degree upon market acceptance of and the Company's ability to
successfully and profitably manufacture, market, deliver and expand its OREX
Degradables line of products. The Company has invested and intends to further
invest in the expansion of its manufacturing and marketing resources, primarily
in connection with OREX Degradables. The Company's total sale of OREX
Degradables to date has not been a significant component of the Company's total
sales of all of its products, while the Company's expenses (which in significant
part reflect the Company's investment in the potential for increased sales of
OREX Degradables products) associated with these products have adversely
affected operating results. See "-- Limited Operating History; Net Losses".
The Company's sales of OREX Degradables has occurred and is expected to
continue to occur on a staged basis subject to product availability. In early
1995, the Company began its commercial introduction of OREX Degradables with a
limited number of OREX Degradables products, primarily sponges and towels
purchased from contract manufacturers. Beginning in the third quarter of 1995,
the Company started expanding its line of OREX Degradables products available
for commercial sale as its Arden facility began to manufacture adequate
quantities of non-woven fabric to produce such products. The Company sells only
a limited number of OREX Degradables film products, and the Company has not
commercially marketed any of its OREX Degradables thermoformed and extruded
products. From time to time as the Company has introduced new OREX Degradables
products, the
420793.1
16
Company has encountered concerns with certain product performance
characteristics of those products. For example, the Company has not been
satisfied with the absorbency of its OREX Degradables towels and certain
aesthetic and user-oriented product performance characteristics of the film
component of its OREX Degradables reinforced gowns. To date, the Company has
used traditional film in its reinforced gowns containing OREX non- woven fabric.
See "Business -- Products and Markets". Technological improvements in the
Company's manufacturing capabilities caused the Company to record substantial
reserves in 1996 for certain early generation OREX Degradables inventories.
These reserves had a material adverse affect on the Company's operating results
in 1996. The Company may in the future record inventory reserves based on
currently unforeseen events such as future improvements in manufacturing
technology rendering existing inventories of OREX products less valuable.
The extent and rate at which market acceptance and penetration of the
Company's existing and future products are achieved is a function of many
variables including, but not limited to, product availability, product
selection, price, product performance and reliability, effectiveness of
marketing and sales efforts and ability to meet delivery schedules, as well as
general economic conditions affecting purchasing patterns. Long-term supply
contracts entered into by large hospital chains and smaller collective buying
groups may prohibit the Company from successfully marketing OREX Degradables to
such customers. The leading manufacturers of traditional disposable medical
products are large companies with significantly greater resources than those of
the Company. Those competitors have in many instances followed strategies of
aggressively marketing products competitive with OREX Degradables to buying
groups resulting in pricing pressures for such products. These factors have
adversely affected the Company's ability to adjust its price for OREX products
to take into account disposal cost savings provided by these products and have
adversely affected the Company's ability to successfully penetrate potential
customer accounts. As the Company currently has commercially available only a
limited number of OREX Degradables products and therefore cannot currently
replace all traditional disposable medical products with OREX Degradables
products, potential customers for the Company's products may not yet justify
large-scale conversion to OREX Degradables products. Procedures for the approval
of OREX Degradables in hospitals are complex, including approval from several
departments of each hospital.
There can be no assurance that the Company's products will achieve or
maintain substantial acceptance in their target markets. In addition to market
acceptance, various factors, including delays in new product development and
commercialization, delays in expansion of manufacturing capability, new product
introductions by competitors, price, competition, delays in regulatory
clearances and delays in expansion of sales and distribution channels could
materially adversely affect the Company's operations and profitability. See
"Business - Products and Markets" and "- Marketing and Distribution".
Risks of Expansion. The rapid expansion of the Company's manufacturing and
marketing resources has required and may continue to require the Company to make
significant additions to its fixed assets, equipment and personnel, while
maintaining expenses, product quality and customer service at satisfactory
levels. The White Knight and Microtek Acquisitions, which included the
acquisition of operations in Mexico, the Dominican Republic and United Kingdom,
as well as other expansion into foreign countries, entails additional risks,
including the risks of currency fluctuations and political instability. The
Company may in the future acquire other businesses as part of its growth
strategy. See "Business-Growth Strategy". Any inability of the Company to
successfully manage past or possible future acquisitions and expansions, while
maintaining expenses, product quality and customer service at satisfactory
levels, could have a material adverse effect on the Company and its operations.
Manufacturing and Supply Risks. The Company has recently expanded its
manufacturing capabilities and has begun to manufacture OREX Degradables
non-woven products and OREX Degradables towels in commercial quantities. The
Company, however, has used and continues to remain substantially dependent upon
various domestic and foreign independent manufacturers for manufacturing and
conversion of other of its OREX Degradables products, including its OREX
Degradables film products and sponges. The Company has not commenced
manufacturing for commercial sale any OREX Degradables thermoformed and extruded
products, and commercially offers only a limited number of OREX Degradables film
products. The Company has recently begun to develop the use of new polymers to
test manufacture OREX Degradables film and thermoformed and extruded products.
While the Company is undertaking evaluation of OREX Degradables manufactured
from these new polymers, no assurances can be provided that the Company will be
successful in manufacturing on a commercial basis OREX Degradables products from
these polymers or that such products will comply will all applicable regulatory
requirements. The Company's products must be manufactured in compliance with FDA
and other regulatory requirements while maintaining product quality at
acceptable manufacturing costs. The Company has limited experience in
manufacturing its non-woven and woven OREX products, and no experience in
internally
420793.1
17
manufacturing its other OREX products, in the quantities required for profitable
operations. Prior to the Company's commencement of such manufacturing
operations, no one had manufactured OREX Degradables. There can be no assurance
that manufacturing or quality control problems will not arise at the Company's
manufacturing plants, that the Company will be able to manufacture products at
commercially acceptable costs or that the Company will be able to maintain the
necessary licenses from governmental authorities to continue to manufacture its
OREX Degradables products.
The Company has experienced delays in manufacturing OREX Degradables
non-woven products at its Arden non-woven manufacturing plant. The Company has
also from time to time encountered dissatisfaction with certain quality or
performance characteristics of its products. These delays and quality or
performance issues may have resulted in the loss of certain potential hospital
customers. While management believes that it has identified and is addressing
the causes for such delays and while the Company continually seeks to improve
its products, there can be no assurance that future delays or quality concerns
will not occur. The Company anticipates that its non-woven fabric manufacturing
costs and other investments in OREX sales volume growth will continue to
adversely impact operating results pending a combination of achieving
significant increases in sales volume of its OREX Degradables products,
improving manufacturing efficiencies and adjusting product unit prices for such
products to take into account disposal cost savings on such products. See
"Business - Manufacturing and Supplies".
As a result of the development of the towel production facility in
Abbeville, South Carolina, the Company's towel production capacity significantly
exceeds its current product requirements. The inability of the Company to sell
its towel surplus to third parties at acceptable prices has adversely affected
the Company's profitability and operating margins. Due to existing large
inventories of OREX Degradables towels, the Abbeville plant is currently
operating at very low manufacturing volume. There can be no assurances that the
Company will be able to increase the demand for its OREX Degradables towels or
otherwise resolve these concerns and risks related to its excess towel
manufacturing capacity.
The Company is continually in the process of making improvements to its
technologies and systems for manufacturing its OREX Degradables products, while
simultaneously marketing and supplying various of these products. From time to
time, the Company has invested in inventory of certain OREX Degradables products
which subsequently have been rendered obsolete by improvements in manufacturing
technologies and systems. During 1996, the Company established a reserve of
approximately $10.0 million for potentially obsolete OREX inventories. There can
be no assurances that possible future improvements in manufacturing processes or
products will not render other inventories of product obsolete, thereby
adversely affecting the Company's financial statements.
The Company currently obtains most of the raw materials for OREX
Degradables, primarily polyvinyl alcohol ("PVA") fiber, from suppliers in the
People's Republic of China. The Company does not have any long-term supply
contracts or other formal contractual arrangements with any of its raw materials
suppliers or contract manufacturers. While raw materials and contract
manufacturing for OREX Degradables are also currently available from other
domestic and foreign independent manufacturers, there can be no assurance that
the Company will continue to be able to obtain raw materials and contract
manufacturing for its products on a commercially reasonable basis, if at all.
During 1996, an anti-dumping order was issued which requires that domestic
importers of PVA resin post import bonds or pay cash deposits in the amount of
certain scheduled margins (the "Anti-dumping Margins") of 19% (for PVA imported
from Taiwan), 77% (for PVA imported from Japan), and 116% (for PVA imported from
producers in the People's Republic of China other than Sichuan Vinylon Works
which has been excluded from the case) of the raw material cost upon importing
such raw materials. The anti-dumping order explicitly excludes PVA fiber. PVA
resin, which is subject to the order, is a raw material required to manufacture
OREX Degradables film, extruded and thermoformed OREX Degradables and PVA fiber,
and PVA fiber, which is not subject to the order, is the raw material required
to manufacture OREX Degradables woven and non-woven products. To date, the anti-
dumping order has not had a direct material effect on the Company as the Company
has not to date used substantial quantities of PVA resin. Such anti-dumping
order may have resulted in increases to the Company's costs for raw materials
over that which might otherwise have prevailed. The price of raw materials used
by the Company in manufacturing its OREX Degradables products has been a
significant component to the Company's total manufacturing costs for these
products. Prevailing prices for such raw materials have adversely affected the
Company's ability to achieve profitable gross margins on the Company's sale of
OREX Degradables products. The Company does not currently anticipate any
difficultly in satisfying its requirements for PVA resin as such raw material is
available from a number of suppliers.
420793.1
18
The production of the Company's products is based in part upon technology
that the Company believes to be proprietary. The Company has provided this
technology to contract manufacturers, on a confidential basis and subject to use
restrictions, to enable them to manufacture products for the Company. There can
be no assurance that such manufacturers or other recipients of such information
will abide by any confidentiality or use restrictions. Finally, production in
the People's Republic of China and elsewhere outside the United States exposes
the Company to risks of currency fluctuations, political instability and other
risks inherent in manufacturing in foreign countries. Certain textiles and
similar products or materials (including certain OREX Degradables woven
products) imported from the People's Republic of China to the United States are
subject to import quotas which restrict the total volume of such items available
for import by the Company, creating risks of limited availability and increased
costs for certain OREX Degradables woven products. See "Business - Manufacturing
and Supplies".
Protection of Technologies. The Company's success will depend in part on its
ability to protect its technologies. The Company relies on a combination of
trade secret law, proprietary know-how, non-disclosure and other contractual
provisions and patents to protect its technologies. Failure to adequately
protect its patents and other proprietary technologies, including particularly
the Company's intellectual property concerning its OREX Degradables, could have
a material adverse effect on the Company and its operations. The Company holds
various issued patents and has various patent applications pending relative to
its OREX Degradables products. See "Business -- Technology and Intellectual
Property".
Although management believes that the Company's patents and patent
applications provide or will provide adequate protection, there can be no
assurance that any of the Company's patents will prove to be valid and
enforceable, that any patent will provide adequate protection for the
technology, process or product it is intended to cover or that any patents will
be issued as a result of pending or future applications. Failure to obtain the
patents pursuant to the applications described above could have a material
adverse effect on the Company and its operations. It is also possible that
competitors will be able to develop materials, processes or products, including
other methods of disposing of contaminated waste, outside the patent protection
the Company has or may obtain, or that such competitors may circumvent, or
successfully challenge the validity of, patents issued to the Company. Although
there is a statutory presumption of a patent's validity, the issuance of a
patent is not conclusive as to its validity or as to the enforceable scope of
the claims of the patent. In the event that another party infringes the
Company's patent or trade secret rights, the enforcement of such rights is at
the option of the Company and can be a lengthy and costly process, with no
guarantee of success. Further, no assurance can be given that the Company's
other protection strategies such as confidentiality agreements will be effective
in protecting the Company's technologies. Due to such factors, no assurance can
be given that the various components of the Company's technology protection
arrangements utilized by the Company, including its patents, will be successful
in preventing other companies from making products competitive with those
offered by the Company, including OREX Degradables.
Although to date no claims have been brought against the Company alleging
that its technology or products infringe upon the intellectual property rights
of others, there can be no assurance that such claims will not be brought
against the Company in the future, or that any such claims will not be
successful. If such a claim were successful, the Company's business could be
materially adversely affected. In addition to any potential monetary liability
for damages, the Company could be required to obtain a license in order to
continue to manufacture or market the product or products in question or could
be enjoined from making or selling such product or products if such a license
were not made available on acceptable terms. If the Company becomes involved in
such litigation, it may require significant Company resources, which may
materially adversely affect the Company. See "Business Technology and
Intellectual Property".
Competition. The health care industry is highly competitive. There are many
companies engaged in the development, manufacturing and marketing of products
and technologies that are competitive with the Company's products and
technologies. Many such competitors are large companies with significantly
greater financial resources than the Company. Sellers and purchasers of medical
products have undergone consolidations in recent years, resulting in increasing
concentration of the market for disposable medical products with a few companies
and increasing cost pressures. This industry trend may place the Company at a
competitive disadvantage. The Company believes that these trends have adversely
affected the Company's ability to adjust its prices for its OREX Degradables
products to take into account disposal cost savings provided by such products,
in addition to adversely affecting the Company's ability to successfully
penetrate potential customer accounts. The market for disposable medical
products is very large and important to the Company's competitors. Certain of
the Company's competitors serve as the sole distributor of products to a
significant number of hospitals. There can be no assurance that the Company's
competitors will not substantially increase the resources devoted to the
development, manufacturing and
420793.1
19
marketing of products competitive with the Company's products. The successful
implementation of such strategy by one or more of the Company's competitors
could have a material adverse effect on the Company. See "Business -
Competition".
Risks of Technological Obsolescence. Many companies are engaged in the
development of products and technologies to address the need for safe and
cost-effective disposal of potentially infectious and hazardous waste. There can
be no assurance that superior disposal technologies will not be developed or
that alternative approaches will not prove superior to the Company's products.
The Company's products could be rendered obsolete by such developments, which
would have a material adverse effect on the Company's operations and
profitability.
Reliance Upon Distributors. The Company has historically relied on large
distributors for the distribution of its products. Hospitals purchase most of
their products from a few large distributors. Of these distributors, Owens &
Minor accounted for 10% or more of the Company's total sales during 1996.
Sterile Concepts has historically been a significant customer of White Knight,
based in part on a supply agreement between White Knight and Sterile Concepts
which requires that Sterile Concepts purchase a minimum of $5.1 million of
product from White Knight annually until June 30, 1998. In mid-1996, Sterile
Concepts was acquired by Maxxim, the latter of which is a competitor of White
Knight. While Sterile Concepts remains obligated to satisfy its minimum purchase
requirement under its supply agreement with White Knight until such agreement
expires in 1998, there can be no assurances that Sterile Concepts will in fact
satisfy such obligation. If the efforts of the Company's distributors prove
unsuccessful, or if such distributors abandon or limit their distribution of the
Company's products, the Company's sales may be materially adversely affected.
Regulatory Risks. The development, manufacture and marketing of the
Company's products are subject to extensive government regulation in the United
States by federal, state and local agencies including the EPA, the FDA and state
and local sewage treatment plants. Similar regulatory agencies exist in other
countries with a wide variety of regulatory review processes and procedures,
concerning which the Company relies to a substantial extent on the experience
and expertise of local product dealers, distributors or agents to ensure
compliance with foreign regulatory requirements. The process of obtaining and
maintaining FDA and any other required regulatory clearances or approvals the
Company's products is lengthy, expensive and uncertain, and regulatory
authorities may delay or prevent product introductions or require additional
tests prior to introduction. The Company currently holds 510(k) orders issued by
the FDA which the Company believes satisfy FDA required clearances for marketing
of the Company's existing products. The FDA has issued to the Company 510(k)
orders on OREX Degradables products for surgical sponges, operating room towels,
drapes, gowns, surgeon's caps, surgeon's vests, shoe covers and medical bedding.
The Company is currently developing, evaluating and testing certain OREX
Degradables film and thermoformed or extruded OREX products manufactured from
non-PVA polymers, and it is possible that new 510(k) orders will be required for
such products. There can be no assurance as to when, or if, other such 510(k)
orders necessary for the Company to market products developed by it in the
future will be issued by the FDA. The FDA also requires health care companies to
satisfy current good manufacturing practice and record-keeping requirements.
Failure to comply with applicable regulatory requirements, which may be
ambiguous or unclear, can result in fines, civil and criminal penalties, stop
sale orders, loss or denial of approvals and recalls or seizures of products.
There can be no assurance that changes in existing regulations or the adoption
of new regulations will not occur, which could prevent the Company from
obtaining approval for (or delay the approval of) various products or could
affect market demand for the Company's products.
Users of OREX Processors may be subject to regulation by local sewage
treatment plants to the extent that discharges from OREX Processors may
interfere with the proper functioning of such plants. The Company has approached
numerous sewage treatment plants requesting their approval to dispose of OREX
Degradables through the municipal sewer system. Although the Company has
obtained a total of over 100 non-binding written and verbal concurrences from
sewage treatment plants, certain of the founder hospitals and other hospitals
who have indicated an interest in purchasing OREX Degradables and an OREX
Processor are located in municipalities where such approvals have not been, and
may never be, obtained. While the Company is undertaking evaluation of OREX
Degradables manufactured from polymers other than PVA, no assurances can be
provided that such non-PVA based OREX will not interfere with the proper
functioning of sewage treatment plants thereby adversely affecting the Company's
ability to successfully commercialize such newly developing OREX Degradables
technology. There can be no assurance that disposal of OREX Degradables in areas
where these approvals have not been granted will not result in fines, penalties
or other sanctions against product users or adversely affect market demand for
the Company's products.
420793.1
20
Under the Americans with Disabilities Act of 1990 (the "ADA"), all public
accommodations are required to meet certain federal requirements related to
access and use by disabled persons. In addition, the Company is subject to a
variety of occupational safety and health laws and regulations, including the
Occupational Safety and Health Act of 1973 ("OSHA"). While the Company believes
that its facilities are substantially in compliance with these requirements, a
determination that the Company is not in compliance with the ADA, OSHA or
related laws and regulations could result in the imposition of fines or other
penalties or, with respect to the ADA, an award of damages to private litigants.
See "Business - Government Regulation".
Environmental Matters. The Company is subject to various federal, state,
local and foreign environmental laws and regulations governing the discharge,
storage, handling and disposal of a variety of substances and waste used in or
generated by the Company's operations. There can be no assurance that
environmental requirements will not become more stringent in the future or that
the Company will not incur substantial costs in the future to comply with such
requirements or that future acquisitions by the Company will not present
potential environmental liabilities.
Health Care Reform. The federal government and the public have recently
focused considerable attention on reforming the health care system in the United
States. The current administration has pledged to bring about a reform of the
nation's health care system and, in September 1993, the President outlined the
administration's plan for health care reform. Included in the proposal were
calls to control or reduce public and private spending on health care, to reform
the payment methodology for health care goods and services by both the public
(Medicare and Medicaid) and private sectors, which may include overall
limitations on federal spending for health care benefits, and to provide
universal access to health care. A number of other health care proposals have
been advanced by members of both Houses of Congress. The Company cannot predict
the health care reforms that ultimately may be enacted nor the effect any such
reforms may have on its business. No assurance can be given that any such
reforms will not have a material adverse effect on the Company.
Product Liability. The manufacture and sale of the Company's products entail
an inherent risk of liability. Product liability claims may be asserted against
the Company in the event that the use of the Company's products are alleged to
have resulted in injury or other adverse effects, and such claims may involve
large amounts of alleged damages and significant defense costs. Although the
Company currently maintains product liability insurance providing $12.0 million
in aggregate coverage for such claims, there can be no assurance that the
liability limits or the scope of the Company's insurance policy will be adequate
to protect against such potential claims. In addition, the Company's insurance
policies must be renewed annually. While the Company has been able to obtain
product liability insurance in the past, such insurance varies in cost, is
difficult to obtain and may not be available on commercially reasonable terms in
the future, if it is available at all. A successful claim against the Company in
excess of its available insurance coverage could have a material adverse effect
on the Company. In addition, the Company's business reputation could be
adversely affected by product liability claims, regardless of their merit or
eventual outcome. See "Business - Insurance".
Dependence on Key Personnel. The Company believes that its continued success
will depend to a significant extent upon the continued services of a limited
number of key personnel, including the management skills of Messrs. Robert L.
Taylor and Dan R. Lee and the technical research and development skills of Mr.
Travis W. Honeycutt. The loss of the services of these individuals could have a
material adverse effect upon the Company. Certain of these executives, including
Messrs. Taylor, Honeycutt and Lee, are not parties to employment agreements with
the Company. While the Company currently maintains key-man insurance on Messrs.
Taylor and Honeycutt, the Company is not required to continue to maintain such
insurance and may not continue to do so.
Anti-Takeover Provisions. On December 19, 1996, the Company's Board of
Directors adopted a Shareholder Protection Rights Agreement (the "Rights
Agreement"). Under the Rights Agreement, a dividend of one right ("Right") to
purchase a fraction of a share of a newly created class of preferred stock was
declared for each share of common stock outstanding at the close of business on
December 31, 1996. The Rights, which expire on December 31, 2006, may be
exercised only if certain conditions are met, such as the acquisition (or the
announcement of a tender offer the consummation of which would result in the
acquisition) of beneficial ownership of 15 percent or more of the Common Stock
("15% Acquisition") by a person or affiliated group. The Rights, if exercised,
would cause substantial dilution to a person or group of persons that attempts
to acquire the Company without the prior approval of the Board of Directors. The
Board of Directors may cause the Company to redeem the Rights for nominal
consideration. The Rights Agreement may discourage or make more difficult any
attempt by a person or group of persons to obtain control of the Company.
420793.1
21
Liquidity Risks. While the Company believes that, based on its current
business plan, the Company's cash equivalents, existing credit facilities and
funds budgeted to be generated from operations in the future will be adequate to
meet its liquidity and capital requirements through 1997, currently unforeseen
future developments and possible increased working capital requirements may
require that the Company seek to obtain additional debt financing or issue
common stock. The Company's cash equivalents diminished from a $54.8 million at
December 31, 1995 to $20.9 million at December 31, 1996. In addition, the
Company had outstanding at December 31, 1996 approximately $42.9 million under
its long term credit facility with the Chase Manhattan Bank. In the past, the
Company has violated certain covenants of such credit facility, all of which
covenant violations have been waived. Recently, the Company negotiated certain
modifications of such covenants in a manner which the Company believes it will
satisfy in the future. No assurances can be provided that other violations of
such credit facility will not occur in the future or that, if such violations
occur, those violations will be waived. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Liquidity and
Capital Resources".
ITEM 2. PROPERTIES
The Company maintains its principal place of business in a 25,000 square
foot office building located in a light industrial park in Norcross, Georgia
which it acquired in 1996. As a result of the Microtek Acquisition, the Company
leases from a local economic development authority a 13,300 square foot
administrative building located in Columbus, Mississippi.
The Company maintains approximately 31,600 square feet of office,
manufacturing, production, research and development and warehouse space located
in Norcross, Georgia under a lease which expires December 31, 1997. Such lease
may be renewed at the Company's option for two periods of three years each. The
Company's custom procedure tray business is located in Herndon, Virginia, a
suburb of Washington, D.C., where it occupies approximately 69,100 square feet
of space for office and production facilities, pursuant to a lease agreement
which expires December 31, 2003. The Company also leases approximately 60,000
square feet of space for its sterilization facilities and warehouse space
pursuant to a lease agreement which expires January 31, 2004, subject to a
renewal option through January 31, 2009. Effective January 5, 1995, the Company
acquired a 108,000 square-foot manufacturing facility located in Arden, North
Carolina which manufactures OREX Degradables non-woven fabric. The Company has
since added approximately 20,000 square feet of warehouse space to its Arden
facility. Effective June 1995, the Company acquired a 207,000 square foot
manufacturing facility located in Abbeville, South Carolina which began to
manufacture OREX Degradables towels at the end of 1995. The Company occupies an
approximately 10,000 square foot building on a short term basis in Charlotte,
North Carolina where the Company operates its prototype fiber manufacturing
operations.
The Company operates five existing non-woven conversion manufacturing
facilities, three of which are owned. The owned facilities include (i) a 50,000
square foot facility in Childersburg, Alabama which manufactures medical
products and specialty apparel products including medical and specialty face
masks, (ii) an 87,000 square foot facility in Agua Prieta, Mexico located
adjacent to the Company's Douglas, Arizona plant which provides labor intensive
post-cutting manufacturing applications, and (iii) a 60,000 square foot facility
in Runnemede, New Jersey which manufactures products for the semi-autonomous
Struble & Moffitt Division of White Knight. The Company's Douglas, Arizona plant
manufactures medical products and specialty apparel in a 100,000 square foot
facility held under a lease expiring August 31, 2034. White Knight also operates
a facility in Acuna, Mexico which houses cutting and sewing manufacturing
operations under a lease expiring on June 30, 1997, and maintains a 12,000
square foot warehouse located in Del Rio, Texas under a lease expiring June 30,
1998 to serve such manufacturing operations. The Company is in the process of
relocating its Acuna, Mexico and Del Rio, Texas manufacturing operations to
achieve operating cost savings, and plans to combine such operations with its
existing operations in Agua Prieta, Mexico and Douglas, Arizona. The Company
conducts its equipment drape and fluid control manufacturing business from three
locations. The Company owns two manufacturing buildings totaling approximately
80,000 square feet located in Columbus, Mississippi. The Company leases three
manufacturing facilities totaling 62,000 square feet located in the Dominican
Republic. During 1996, the Company also entered into a lease of a 32,000 square
foot facility located in Empalme, Mexico.
The Company also leases a facility in Jacksonville, Florida that comprises
approximately 45,000 square feet of warehouse and distribution space.
420793.1
22
Through a subsidiary, the Company leases approximately 9,000 square feet of
space near Manchester, England, approximately 7,000 of which is used for
warehouse space and 2,000 of which is used for office space. SafeWaste leases a
facility located in Charlotte, North Carolina containing approximately 4,500
square feet of office and 5,500 square feet of warehouse space.
The Company believes that its present facilities are adequate for its
current requirements.
ITEM 3. LEGAL PROCEEDINGS
From time to time the Company is involved in litigation and legal
proceedings in the ordinary course of business. Such litigation and legal
proceedings have not resulted in any material losses to date, and the Company
does not believe that the outcome of any existing lawsuits will have a material
adverse effect on its business.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no submissions of matters to a vote of the Company's shareholders
during the three months ended December 31, 1996.
420793.1
23
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
The common stock is traded and quoted on The Nasdaq Stock Market under
the symbol "OREX". The following table shows the quarterly range of high and low
sales prices of the common stock during the periods indicated since December 31,
1996.
Common Stock(1)
Quarter Ended High Low
1995
First Quarter.................................................................. $ 9.63 $ 8.13
Second Quarter................................................................. $17.88 $ 8.38
Third Quarter.................................................................. $21.06 $15.38
Fourth Quarter................................................................. $23.00 $10.00
1996
First Quarter.................................................................. $18.25 $11.50
Second Quarter................................................................. $21.00 $10.50
Third Quarter.................................................................. $12.88 $ 7.75
Fourth Quarter................................................................. $ 9.50 $ 6.13
- -----------
(1) On September 1, 1995, the Company declared a two-for-one stock split. The
stock split was effected in the form of a share dividend paid on October 2, 1995
to shareholders of record on September 15, 1995. The high and low prices per
share of common stock have been retroactively adjusted to reflect the stock
split.
On March 27, 1997, the closing sales price for the common stock as
reported by The Nasdaq Stock Market was $5.00 per share.
As of March 18, 1997, the Company had approximately 32,850
shareholders, including approximately 1,350 shareholders of record and 31,500
persons or entities holding the Company's common stock in nominee name.
The Company has never declared or paid any cash dividends on its common
stock. The Company currently intends to retain any future earnings to finance
the growth and development of its business and therefore does not anticipate
paying any cash dividends in the foreseeable future. Moreover, the Company's
credit facility prohibits the Company from declaring or paying cash dividends
without the prior written consent its lenders. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations - Liquidity and
Capital Resources". Accordingly, the Company does not intend to pay cash
dividends in the foreseeable future.
ITEM 6. SELECTED FINANCIAL DATA
The following table sets forth summary historical financial data for
each of the five years in the period ended December 31, 1996. As a result of the
Microtek Acquisition, which was accounted for as a pooling of interests, the
Company's financial statements have been restated to include the results of
Microtek for all periods presented. The operations data for the year ended
December 31, 1993 does not give effect to the December 31, 1993 MedSurg
Acquisition and includes only partial operating results of Atkins because the
Atkins Acquisition occurred on February 28, 1993. The operations data for the
year ended December 31, 1995 includes only partial operating results of
SafeWaste and White Knight because these acquisitions occurred effective May 31,
1995 and September 1, 1995, respectively. On July 1, 1995, the Company acquired
the infection control drape line of Xomed in exchange for Microtek's otology
product line and the operations data for the year ended December 31, 1995
therefore includes only partial operating results for such acquisition
transaction. The operations data for the year ended December 31, 1995 does not
give effect to the November 30, 1995 acquisition of Medi-Plast International,
Inc. ("Medi-Plast"), as such acquisition was consummated at Microtek's fiscal
year end on November 30, 1995. In April, 1996, Microtek purchased the Venodyne
division of Advanced Instruments, Inc., and the Company's results of operations
include the results of Venodyne only from the April 27, 1996 acquisition date.
420793.1
24
The summary historical financial data should be read in conjunction with the
historical consolidated financial statements of the Company and the related
notes thereto, "Management's Discussion and Analysis of Financial Condition and
Results of Operations" and other financial data appearing elsewhere in this Form
10-K. The summary historical financial data for each of the five years in the
period ended December 31, 1996 has been derived from the Company's audited
consolidated financial statements.
Year Ended December 31,
1992 1993 1994 1995 1996
---- ---- ---- ---- ----
(in thousands, except per share data)
Statement of Operations Data:
Net sales ........................................ 31,255 38,769 73,382 104,874 165,738
Cost of goods sold ............................... 14,812 20,837 49,928 74,953 128,610
-------- -------- -------- -------- --------
Gross Profit ..................................... 16,443 17,932 23,454 29,921 37,128
Selling and marketing ............................ 7,318 9,482 14,100 18,234 28,298
General and administrative ....................... 2,793 3,803 7,396 9,503 13,903
Research and development ......................... 820 920 1,246 1,127 2,173
Amortization of intangibles ...................... 1.294 1,358 1,505 2,411 4,290
Restructuring charge ............................. 0 0 140 0 4,410
Costs associated with merger ..................... 0 0 0 0 3,372
-------- -------- -------- -------- --------
Total operating expenses ............................ 12,255 15,563 24,387 31,275 56,446
-------- -------- -------- -------- --------
Income (loss) from operations ....................... 4,218 2,369 (933) (1,354) (19,318)
Net other income .................................... (1,228) 473 49 1,790 (1,316)
-------- -------- -------- -------- --------
Income (loss) before tax, extraordinary item and
cumulative effect of change in accounting
principle ........................................ 2,990 2,842 (884) 436 (20,634)
Income tax provision (benefit) ...................... 1,171 1,199 455 980 (639)
-------- -------- -------- -------- --------
Income (loss) before extraordinary item and
cumulative effect of change in accounting
principle ........................................ 1,819 1,643 (1,339) (544) (19,995)
Extraordinary item .................................. (296)(1) 24 0 0 457(3)
Cumulative effect of change in accounting
principle ........................................ 0 0 57(2) 0 0
-------- -------- -------- -------- --------
Net income (loss) ................................ 1,523 1,667 (1,282) (544) (20,452)
======== ======== ======== ======== ========
Periodic accretion of redeemable preferred stock
to redemption value ................................. 215 0 0 0 0
-------- -------- -------- -------- --------
Net income (loss) applicable to common stock .... 1,308 1,667 (1,282) (544) (20,452)
======== ======== ======== ======== ========
Income (loss) per common and common equivalent share:
Income (loss) before extraordinary item and
cumulative effect of change in accounting
principle ..................................... 0.09 0.07 (0.05) (0.02) (0.52)
Extraordinary item ............................... (0.01) 0.00 0.00 0.00 (0.01)
Cumulative effect of change in accounting
principle ..................................... 0.00 0.00 0.00 0.00 0.00
-------- -------- -------- -------- --------
Net income (loss) ............................. 0.08 0.07 (0.05) (0.02) (0.53)
======== ======== ======== ======== ========
Weighted average number of common and
common equivalent shares outstanding ............. 19,801 24,400 27,030 33,704 38,763
======== ======== ======== ======== ========
420793.1
25
- -------
(1) Gives effect to the extraordinary benefits from net operating loss
carryforwards in 1992.
(2) The change in accounting principle reflects the adoption on January 1, 1994
of Statement of Financial Accounting Standards ("SFAS") No. 115, "Accounting for
Certain Investments in Debt and Equity Securities.
(3) Gives effect to the loss from refinancing of Isolyser's and Microtek's
credit facilities, net of tax benefits of $332,000.
Year Ended December 31,
1992 1993 1994 1995 1996
---- ---- ---- ---- ----
(in thousands)
Balance Sheet Data:
Working Capital.............................. $ 14,485 $ 35,366 $ 88,527 $ 101,022 $ 90,100
Intangible assets, net....................... 9,190 19,364 17,994 60,004 57,627
Total assets................................. 31,472 74,995 132,973 253,261 250,935
Long-term debt............................... 2,958 4,436 6,779 26,413 47,029
Redeemable common stock...................... 0 26,150 1,717 0 0
Total shareholders' equity................... $ 25,168 $ 30,398 $ 110,662 $ 195,298 178,804
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
General
The Company's net sales have grown from $38.8 million in 1993 to $165.7
million in 1996, a compound annual growth rate of 62%. This growth resulted
primarily from strategic acquisitions of established companies which Isolyser
believes are complementary to the Company's objectives to become a leading
supplier of disposable and degradable products for use in hospitals and other
industries for patient care, occupational safety and management of potentially
infectious and hazardous waste.
The Company was incorporated in 1987 and commenced operations in 1988
with the introduction of its SMS products. In 1990, the Company introduced its
LTS products and thereafter introduced others of its safety products and
services. During 1993, the Company completed the Atkins Acquisition and the
MedSurg Acquisition and began to sell standard and custom procedure trays.
Because these acquisitions have been accounted for using the purchase method,
the Company's 1993 operating results include the operations of Atkins from
February 28, 1993, but do not include any of the operating results of MedSurg
which was acquired on December 31, 1993.
On July 1, 1995, the Company acquired the infection control drape line
of Xomed, in exchange for Microtek's otology product line, thereby providing
Microtek greater concentration on its core business. On September 1, 1995,
Isolyser completed the White Knight Acquisition and began the conversion
manufacturing of non-woven fabric into finished goods such as drapes and gowns.
On November 30, 1995, Microtek acquired Medi- Plast, a manufacturer of equipment
drapes. Because of all of these acquisitions were accounted for using the
purchase method, the Company's operating results do not include the operating
results of the acquired operations for periods prior to these respective
acquisition dates.
In April, 1996, Microtek purchased the Venodyne division of Advanced
Instruments, Inc., which manufactures and markets pneumatic pumps and disposable
compression sleeves for use in reducing deep vein thrombosis, and the Company's
results of operations include the results of Venodyne only from the April 27,
1996 acquisition date. Effective September 1, 1996, Isolyser completed its
acquisition of Microtek, which was accounted for as a pooling of interests.
Accordingly, the Company's financial statements have been restated for all
periods to combine the financial statements of each of Isolyser and Microtek.
420793.1
26
Year Ended December, 1996 Compared to Year Ended December 31, 1995
Net sales for 1996 were $165.7 million compared to $104.9 million for
1995, an increase of 60%. The 1996 increase of $60.8 million reflects primarily
a 220% increase in net sales by White Knight as compared to comparable sales by
the Company in 1995 as a result of the September 1, 1995 White Knight
Acquisition, a 36.3% increase in net sales of Microtek primarily as a result of
the Medi-Plast, Xomed and Venodyne acquisitions, and a 15% increase in net sales
of procedure trays and related products primarily as a result of increased
market penetration. Sales of safety products and services increased 31% in 1996
as compared to 1995. This increase reflects primarily increased sales of LTS
during 1996 resulting from opening sales of LTS to more than one national
distributor and increased revenues from the Company's Onsyte System during 1996
resulting from an acquisition transaction consummated during 1995.
Sales by White Knight decreased during the latter half of 1996, which
may be attributable to the acquisition in July, 1996 of Sterile Concepts, a
significant customer of White Knight, by Maxxim, which is a product competitor
of the Company. While Sterile Concepts remains contractually obligated to
purchase a yearly minimum of $5.1 million of products until June 30, 1998, such
acquisition is expected to continue to adversely affect the Company's sales in
1997 and future periods. Sales by Microtek during the fourth quarter were
adversely affected by a decision made during the fourth quarter to immediately
change the method of selling Microtek products by switching to direct sales
through the Company's sales force and immediately cease sales through
independent representatives as part of a strategy to seek to promote long term
sales growth.
Included in the foregoing sales figures are $7.1 million in sales of
OREX Degradables during 1996. Quarter to quarter sales of OREX Degradables
during 1996 were flat, which management of the Company believes is attributable
to having only a small group of hospitals converted to using degradable versus
traditional products during 1996. Management believes that the rate of growth in
OREX sales has been adversely affected by delays in bringing new OREX catalog
items to market in quantities sufficient for commercial supply and product
performance or quality concerns for certain of the Company's OREX Degradables
products. While management believes that the Company's group of OREX products
currently includes substantially all non-woven products most often used in the
operating room, the Company does not yet manufacture for commercial sale OREX
Degradables film or thermoformed and extruded products such as bowls, basins and
utensils. Sales of OREX Degradables during 1996 did not contribute any gross
profits to the Company's operating results. Management believes that the Company
will continue to fail to receive profitable margins on sales of OREX Degradables
pending a combination of selling OREX Degradables in greater volumes, the
operation of the Company's OREX manufacturing plant at higher efficiencies and
increasing the unit price for OREX Degradables to an amount which takes into
account the disposal cost savings provided by such products. The Company is
currently undertaking a thorough review and analysis of the market position of
OREX Degradables within its various market potentials. As a part of such review
and analysis, the Company plans to implement appropriate adjustments to its
marketing plan to seek to improve the Company's operating results in connection
with the sale of OREX Degradables. The Company's future performance will depend
to a substantial degree upon market acceptance of and the Company's ability to
successfully manufacture, market, deliver and expand its OREX Degradables line
of products at acceptable profit margins. The Company's ability to achieve such
objectives is subject to a number of risks described under "Business - Risk
Factors".
Gross profit in 1996 was $37.1 million or 22.4% of net sales compared
to $29.9 million or 28.5% of net sales in 1995. Included in costs of goods sold
during 1996 was $10.0 million in reserves for OREX inventory with no comparable
charges recorded in 1995. These reserves were recognized due to improvements in
manufacturing processes realized during the latter portions from 1996 rendering
various existing inventories obsolete or second quality. After adjusting gross
profits by eliminating these charges, gross profit for 1996 would have been
28.4%. Also negatively impacting gross profit during 1996 was unabsorbed
overhead included in cost of goods sold by reason of underutilization of
manufacturing capacity at the Company's Arden and Abbeville manufacturing
plants. During the latter portions of 1996, the Company reduced production at
its Abbeville plant to more closely align production with product demand.
Pending increased utilization of the Company's existing manufacturing capacity
at its Arden and Abbeville manufacturing plants and adjusting pricing of OREX
Degradables to take into account disposal cost savings over traditional
products, the overhead of the Company incurred through its Arden and Abbeville
plants will continue to negatively impact profit margins. The Company's ability
to achieve such objectives is subject to a number of risks described under
"Business - Risk Factors" including without limitation "- Risks of New Products"
and "- Manufacturing and Supply Risks".
420793.1
27
Selling and marketing expenses were $28.3 million or 17.1% of net sales
in 1996 as compared to $18.2 million or 17.4% of net sales in 1995. This
increase was primarily due to the increase in commissions on increased sales,
increased travel and promotional expenses and the acquisition of White Knight.
General and administrative expenses were $13.9 million or 8.4% of net
sales in 1996 as compared to $9.5 million or 9.1% of net sales in 1995. This
increase reflects the White Knight acquisition.
Research and development expenses were $2.2 million or 1.3% of net
sales in 1996 as compared to $1.1 million or 1.1% of net sales in 1995. This
increase reflects expenses incurred during 1996 associated with the Company's
developmental PVA fiber plant.
Amortization of intangibles was $4.3 million or 2.6% of net sales in
1996 as compared to $2.4 million or 2.3% of net sales in 1995. This increase was
primarily due to the White Knight and other acquisitions.
Restructuring charges were $4.4 million in 1996 with no comparable
charges in 1995. This charge was a result of decisions made by the Company
during 1996 to divest certain non-core businesses and consolidate certain
operations. During 1996, the Company also incurred transactional costs
associated with the Microtek acquisition of $3.4 million with no comparable
charges during 1995.
The resulting loss from operations was $19.3 million in 1996 as
compared to $1.4 million in 1995. After adjusting the operating loss to exclude
$19.1 million of charges for inventory reserves, restructuring and the Microtek
transaction expenses, the operating loss would have been approximately $200,000
for 1996.
Interest expense net of interest income was $1.3 million in 1996 as
compared to interest income net of interest expense of $1.8 million in 1995. The
increase in interest expense was primarily due to interest on debt incurred in
connection with the Microtek Acquisition and inventory purchases and to
decreased interest income reflecting a reduction in short term investments
during 1996 and a lower interest rate on those investments.
Losses from joint venture was $34,000 and $44,000 in 1996 and 1995,
respectively.
Provisions for income taxes reflect a benefit for 1996 of $640,000
compared to a tax expense of $980,000 in 1995. The effective tax rate in 1996
differs from the statutory rate due primarily to the amortization of a portion
of goodwill which is not deductible for tax purposes, non-deductible Microtek
acquisition costs and certain reserves for inventory considered temporary
differences for tax purposes.
The Company recorded a $457,000 extraordinary loss from the refinancing
of Isolyser's and Microtek's credit facilities, net of a $332,000 tax benefit.
The resulting net loss was $20.5 million in 1996 as compared to a net
loss of $544,000 in 1995.
Year Ended December 31, 1995 Compared to Year Ended December 31, 1994
Net sales for 1995 were $104.9 million compared to $73.4 million for
1994, an increase of 43.0%. The 1995 increase in net sales of $31.5 million
reflects primarily the net sales of White Knight of $18.5 million from the
September 1, 1995 acquisition date, a net increase in 1995 in sales of procedure
trays and related products of 27.7% over corresponding 1994 sales and an
increase of 12% in Microtek net sales during 1995 over 1994. The increase in
sales of procedure trays and related products is net of a $1.9 million decrease
in sales of bone marrow needles resulting from the loss of the then-sole
customer for bone marrow needles. The Company believes that the increase in
sales of procedure trays and related products reflect increased sales to
customers seeking to participate in the anticipated increases in the
availability of OREX Degradables products as well as the Company's strategy to
aggressively market and price new procedure tray business to build market share.
The rate of increase for sales of procedure trays and related products decreased
during the latter portions of 1995 as the Company's distributors reduced
inventory carrying levels of such products. The Company believes that its major
distributors have substantially completed these inventory adjustments. On July
1, 1995, Microtek completed the exchange of Microtek's otology product line for
Xomed's drape line. Primarily as a result of such exchange, sales of the
Company's equipment drapes increased 31.8% during 1995 as compared to 1994 and
sales of otology products decreased by 39% during 1995 as compared to 1994. In
addition, sales of fluid control products decreased by 18%
420793.1
28
during 1995 as compared to 1994, which decrease was primarily the result of
lower prices and timing of certain sales contracts. Safety products and services
sales increased 28.8% during 1995 over 1994. The major portion of such increase
reflects increased revenues from the Company's Onsyte system during 1995 over
1994 following the acquisition of SafeWaste, as well as the completion by Baxter
of its adjustments for inventory levels and sales by the Company of LTS to other
distributors following the expiration of Baxter's exclusive rights to market
LTS. Although small quantities of OREX Degradables were sold in the first three
quarters of 1995, the Company's production facility for producing non-woven
fabric was not producing commercial quantities until into the third quarter, and
therefore related finished products were not available until the fourth quarter,
during which $514,000 of OREX Degradables products were sold in custom procedure
trays and sterile packs. Sales of OREX Degradables in 1995 did not have a
material impact on the Company's results of operations. The Company's future
performance will depend to a substantial degree upon market acceptance of and
the Company's ability to successfully manufacture, market, deliver and expand
its OREX Degradables line of products. See "Business - Risk Factors".
Gross profit in 1995 was $29.9 million or 28.5% of net sales, compared
to $23.5 million or 32.0% of net sales in 1994. The gross profit on procedure
trays decreased in 1995 as result of aggressive marketing efforts and pricing
strategies to capture increasing procedure tray business in an industry where
margins have generally declined in recent months. Further negatively impacting
1995 gross profit margins were the start-up costs associated with the Arden
non-woven fabric and Abbeville woven production facilities, and loss of the
relatively low volume but high margin bone marrow needle business in mid-year
1995. Partially offsetting these margin declines was the effect of Microtek and
White Knight net sales which had a 46% and 27.9% gross profit margin,
respectively.
Selling and marketing expenses were $18.2 million or 17.3% of net sales
in 1995 compared to $14.1 million or 19.2% of net sales in 1994. The Company
invested in increased selling and marketing expenses in late 1994 and early 1995
in anticipation of the OREX rollout early in 1995, which was delayed due to the
aforementioned delay in the availability of OREX Degradables product from the
Company's non-woven fabric facility. The major components of these increases was
commissions on increased sales, increased travel and promotional expenses and
the selling and marketing expenses of White Knight following September 1, 1995.
General and administrative expenses were $9.5 million or 9.1% of net
sales in 1995 compared to $7.4 million or 10.1% of net sales in 1994. The major
portion of the increase reflects the acquisition of White Knight effective
September 1, 1995.
Research and development expenses for 1995 were $1.1 million or 1.0% of
net sales compared to $1.2 million or 1.6% of net sales in 1994. The slight
dollar decrease in 1995 reflects the winding down of significant developmental
efforts in bringing the OREX Degradables products to market.
Amortization of intangibles increased to $2.4 million in 1995 compared
to $1.5 million in 1994, reflecting the continued amortization expenses
resulting from the acquisitions of MedSurg and Atkins and additional
amortization expenses in 1995 as a result of the White Knight and SafeWaste
acquisitions. Amortization expenses will continue to materially impact results
of operations in the future.
The resulting loss from operations was $1.4 million in 1995 compared to
$932,000 in 1994.
Interest income, net of $1.4 million of interest expense, was $1.8
million in 1995, compared to $662,000 million in 1994, net of $694,000 of 1994
interest expense. The foregoing reflects the significant increase in cash
equivalents after the October 1994 initial public offering. At December 31, 1995
all of the investments were in U. S. government or government-backed securities
which mature in 90 days or less. The increase in interest expense reflects the
financing of a portion of the capital expenditures relating to the non-woven
facility in Arden, North Carolina in January 1995 and additional indebtedness
incurred in connection with the acquisition of White Knight. Interest rates on
both interest income and interest expense have declined slightly from the
comparable prior year periods.
Provision for income taxes reflected an expense in 1995 of $980,000
compared to $455,000 in 1994. The effective tax rate in 1995 differs from the
statutory tax rate due to the amortization of a portion of goodwill which is not
deductible for tax purposes and the allocation of certain tax benefits to reduce
goodwill in connection with the acquisition of White Knight.
420793.1
29
The resulting net loss was $544,000 in 1995 compared to a net loss of
$1.3 million before cumulative effect of change in accounting principles in
1994. On January 1, 1994, the Company adopted SFAS No. 115, "Accounting for
Certain Investments in Debt and Equity Securities." The cumulative effect of
this change in accounting principle was to reduce the net loss by $57,000 in
1994.
Liquidity and Capital Resources
As of December 31, 1996, the Company's cash and cash equivalents
totalled $20.9 million compared to $54.8 million at December 31, 1995. The
Company completed a public offering effective November 17, 1995 raising net
proceeds of $74.4 million and completed its initial public offering effective
October 20, 1994 raising net proceeds of $58.7 million.
During 1996, the Company utilized cash and borrowings under the
Company's credit facility to finance working capital requirements and to finance
the purchase of property, equipment and businesses. For 1996, net cash used in
operating activities was approximately $33.7 million; net cash used in investing
activities was approximately $25.0 million; and net cash provided by financing
activities was approximately $24.7 million. The $33.9 million use of cash in
operating activities in 1996 results principally from a $25.5 million increase
in inventory, a $4.1 million increase in accounts receivable and a $5.5 million
decrease in accounts payable, net of effects of acquisitions. Including the
effects of acquisitions, during 1995 accounts receivable increased from
approximately $22.1 million to $27.4 million, inventory (including of prepaid
inventory) increased from approximately $47.2 million to $63.8 million
reflecting principally stocking of inventory in OREX Degradables products, and
accounts payable decreased from approximately $15.8 million to $10.2 million.
Cash used in investing activities during these periods include funds used to
expand and equip the Arden non-woven and Abbeville woven plants, to acquire the
Company's administration headquarters and for the acquisitions of Venodyne and
other smaller businesses. During 1996, cash expenditures for property and
equipment and deposits on machinery and equipment were $19.1 million, down from
$46.5 million in 1995. Additionally, approximately $5.9 million of cash was used
to acquire Venodyne and other smaller businesses.
The Company believes it has substantially completed required capital
expenditures to support the manufacture and sale of the Company's OREX
Degradables based on the Company's existing available manufacturing capacity.
New manufacturing techniques or technology could cause the Company to incur
capital expenditures for manufacturing capabilities not currently planned. At
December 31, 1996, the Company had outstanding commitments to purchase
approximately $311,000 of equipment, and additional commitments of approximately
$3.4 million for the purchase of OREX inventory (primarily PVA fiber). During
1996, the Company acquired a PVA fiber manufacturing facility located in
Charlotte, North Carolina. This facility remains in the developmental stages as
the Company experiments with PVA fiber manufacturing as well as other compounds.
The Company is currently substantially dependent upon third party manufacturers
and suppliers located in the People's Republic of China and outside the United
States for the raw materials and certain of the finished goods comprising the
OREX Degradables line. Such dependence exposes the Company to various risks
concerning the costs and availability of raw materials and finished products.
See "Risk Factors - Manufacturing and Supply Risks". To the extent that the
Company may, in the future, incur commitments for material capital expenditures
not currently envisioned, the Company anticipates that such capital expenditures
may require additional term loan financing or issuances of common stock to the
extent not funded from available cash.
The Company also anticipates needing cash for the foreseeable future to
finance working capital requirements resulting from the Company's expansion of
its manufacturing and marketing capabilities. In connection with the Microtek
Acquisition, the Company replaced its existing $24.5 million Isolyser credit
agreement and $17 million Microtek credit agreement with a $55 million credit
agreement (the "Credit Agreement") between the Company and The Chase Manhattan
Bank (the "Bank"), as agent, consisting of a $40 million revolving credit
facility maturing on August 31, 1999 and a $15 million term loan facility
maturing on August 31, 2001. In connection with this replacement, the Company
recorded an extraordinary loss of $457,000, net of a tax benefit of $332,000
relating to the extinguishment of the former credit agreements. Borrowing
availability under the revolving credit facility is based on the lesser of a
percentage of eligible accounts receivable and inventory of $40 million less any
outstanding letters of credit issued under the Credit Agreement. Current
additional borrowing availability under the revolving facility at December 31,
1996 was $8.6 million and at March 27, 1997 was $3.5 million. Revolving credit
borrowings bear interest, at the Company's option, at either a floating rate
approximating the Bank's prime rate or LIBOR plus 1 1/2% (7.09% at December 31,
1996). Outstanding borrowings under the revolving credit
420793.1
30
facility was $28.4 million at December 31, 1996 and was $31.9 at March 27, 1997.
Commencing on December 31, 1996, the term loan facility is repayable in
quarterly principal payments of $500,000 through September 1998 and $750,000
through June 2001, with any remaining indebtedness due on August 31, 2001. The
term loan bears interest, at the Company's option, at either a floating rate
approximating the Bank's prime rate plus 1/2% or LIBOR plus 2%. Outstanding
borrowings under the term loan facility were $14.5 million at December 31, 1996.
The Credit Agreement provides for the issuance of up to $3 million in letters of
credit. Outstanding letters of credit at December 31, 1996 were $50,000. The
Credit Agreement provides for a fee of 0.25% per annum on the unused commitment,
an annual collateral monitoring fee of $50,000, and an outstanding letter of
credit fee of up to 2% per annum. The Company is also subject to prepayment
penalties through the third year of the Credit Agreement equal to 1% of the
amount of the aggregate commitment terminated or reduced. Borrowings under the
Credit Agreement are collateralized by the Company's accounts receivable,
inventory, equipment, Isolyser's stock of its subsidiaries and certain of the
Company's plants. The Credit Agreement contains certain restrictive covenants,
including the maintenance of certain financial ratios and net income, and
limitations on acquisitions, dispositions, capital expenditures and additional
indebtedness. The Company also is not permitted to pay any dividends. From time
to time as the Company's working capital requirements increase, the Company
anticipates increasing its revolving line of credit to the extent such
requirements are not otherwise satisfied out of available cash flow or
borrowings under the Company's existing line of credit. There can be no
assurances that such an increase to the Company's revolving credit facility will
be available to the Company.
At December 31, 1996, the Company was not in compliance with the net
income and leverage covenants. These covenant violations were waived by the Bank
on March 28, 1997. In connection with the waiver of these covenant violations,
the Bank and the Company amended the Credit Agreement to revise certain
covenants including certain of the financial ratios and the net income and
capital expenditures covenants, and added a net worth covenant. Such amendment
also provides for the addition of certain of the Company's property as
collateral for the credit facility and revises the interest rate under the
Credit Agreement. The revised interest rate varies depending on the Company's
ratio of long-term debt as compared to funds generated from operations. The rate
options will vary between the rate options currently in effect as described
above and such rates plus 0.75%. While the Company does not currently anticipate
that it will violate the covenants of the Credit Agreement in the future, no
assurances can be provided that these or other violations of the Credit
Agreement will not occur in the future or that, if such violations occur, that
the Bank will not elect to pursue its remedies under the Credit Agreement.
Based on its current business plan, the Company currently expects that
cash equivalents and short term investments on hand, the Company's existing
credit facility and funds budgeted to be generated from operations will be
adequate to meet its liquidity and capital requirements through 1997. As
described above, however, currently unforeseen future developments and increased
working capital requirements may require additional debt financing or issuances
of common stock in 1997 and subsequent years.
Inflation and Foreign Currency Translation. Inflation has not had a
material effect on the Company's operations. If inflation increases, the Company
will attempt to increase its prices to offset its increased expenses. No
assurance can be given, however, that the Company will be able to adequately
increase its prices in response to inflation.
The assets and liabilities of the Company's Mexican and United Kingdom
subsidiaries are translated into U.S. dollars at current exchange rates and
revenues and expenses are translated at average exchange rates. The effect of
foreign currency transactions was not material to the Company's results of
operations for the year ended December 31, 1996. Export sales by the Company
during 1996 were $12.4 million. Currency translations on export sales could be
adversely affected in the future by the relationship of the U.S. Dollar with
foreign currencies.
Newly Issued Accounting Standards. In March 1995, SFAS No. 121,
"Accounting for the Impairment of Long-Lived Assets and Long-Lived Assets to be
Disposed of," was issued. This statement requires that long-lived assets and
certain identifiable intangibles be reviewed for impairment when events or
changes in circumstances indicate that the carrying amount of an asset may not
be recoverable, with any impairment losses being reported in the period on which
the recognition criteria are first applied based on the fair value of the asset.
Long-lived assets and certain intangibles to be disposed of are required to be
reported at the lower of carrying amount or fair value less cost to sell. The
Company adopted SFAS No. 121 on January 1, 1996. Such adoption did not have any
impact on the Company's financial position or results of operations.
420793.1
31
In October 1995, SFAS No. 123, "Accounting for Stock-Based
Compensation," was issued. The adoption of the new recognition provisions for
stock-based compensation expense included in SFAS No. 123 is optional; however,
the pro forma effects on net income had the new recognition provisions been
elected is required in financial statements. The Company will continue to follow
the requirements of APB No. 25, "Accounting for Stock Issued to Employees," in
its accounting for employee stock options; therefore, no impact on the Company's
financial position and results of operations has occurred.
In February, 1997, SFAS No. 128, "Earnings per Share" was issued. This
Statement simplifies the standards for computing earnings per share (EPS)
previously found in APB Opinion No. 15, "Earnings per Share", by replacing the
presentation of primary EPS with basic EPS. It also requires dual presentation
of basic and diluted EPS on the face of the income statement for all entities
with complex capital structures and requires a reconciliation of the numerator
and denominator of the basic EPS computation to the numerator and denominator of
the diluted EPS computation. Basic EPS is computed by dividing income available
to common shareholders by the weighted-average number of common shares
outstanding for the period. Diluted EPS is computed similarly to fully diluted
EPS under Opinion No. 15. The Company intends to adopt this Statement in 1997.
Forward Looking Statements
Statements made in this Management's Discussion and Analysis of
Financial Condition and Results of Operations and elsewhere in this Annual
Report on Form 10-K that state the Company's or management's intentions, hopes,
beliefs, expectations or predictions of the future are forward looking
statements within the meaning of the Private Securities Litigation Reform Act of
1995. Such forward looking statements include, without limitation, statements
regarding the Company's planned capital expenditure requirements, cash and
working capital requirements, the Company's expectations regarding the adequacy
of current financing arrangements, product demand and market growth, debt
covenant compliance, and other statements regarding future plans and strategies,
anticipated events or trends, and similar expressions concerning matters that
are not historical facts. It should be noted that the Company's actual results
could differ materially from those contained in such forward looking statements
mentioned above due to adverse changes in any number of factors that affect the
Company's business including, without limitation, risks associated with
investing in and the marketing of the Company's OREX Degradables products,
manufacturing and supply risks, risks concerning the protection of the Company's
technologies, risks of technological obsolescence, reliance upon distributors,
regulatory risks, risks of expansion, product liability and other risks
described in this Annual Report on Form 10-K. See "Business -- Risk Factors".
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The consolidated financial statements and supplementary data are listed
under Item 14(a) and filed as part of this report on the pages indicated.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE
The Company had no disagreements on accounting or financial disclosure
matters with its accountants, nor did it change accountants, during the two
fiscal years ended December 31, 1996.
420793.1
32
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Directors and Executive Officers
The current directors and executive officers of the Company are as
follows:
Name Position
Robert L. Taylor Chairman of the Board of Directors, President and
Chief Executive Officer
Travis W. Honeycutt Executive Vice President, Secretary and Director
Dan R. Lee Vice President of Finance and Administration,
Chief Financial Officer, Treasurer and Director
Lester J. Berry Vice President
James S. Asip Vice President of Sales
Richard Setian Vice President of Marketing
Rosdon Hendrix Director
Jamal Silim Director
Kenneth F. Davis Director
Robert L. Taylor (age 57) has been Chairman of the Board of Directors,
President and Chief Executive Officer of the Company since its inception in
1987. Prior to founding the Company with Mr. Honeycutt in 1987, Mr. Taylor
served in various executive positions, including chief executive officer, with
various health care companies.
Travis W. Honeycutt (age 54) has been Executive Vice President, Secretary and
a Director of the Company since its inception in 1987. Prior to founding the
Company with Mr. Taylor, Mr. Honeycutt had over 20 years of experience in new
product development for the industrial and health care markets.
Dan R. Lee (age 49) became an executive officer of the Company following the
conclusion of the Microtek Acquisition, and became a director of the Company in
December, 1996. Prior to accepting such positions with the Company, Mr. Lee had
served as the Vice President and Chief Operating and Financial Officer of
Microtek since 1987. Previous to that time, he was engaged in the public
accounting practice, including more than five years with KPMG Peat Marwick.
James S. Asip (age 48) has served as Vice President of Sales since February
1992. Mr. Asip has 21 years of experience in sales, with the last 20 years being
in the health care market. Prior to his employment with the Company, he was
National Sales Manager for Collagen Corporation, a manufacturer of tissue repair
products.
Lester J. Berry (age 63) became an executive officer of the Company following
the conclusion of the Microtek Acquisition. Prior to that time, Mr. Berry had
served as a director and officer of Microtek since 1994. From 1987 through 1993,
Mr. Berry served in various capacities at 3M Corporation, including service as a
National Sales and Marketing Manager, Medical Specialties, and as the National
Sales Manager, Health Care Specialties.
420793.1
33
Richard Setian (age 37) was elected Vice President of Marketing in May, 1996,
after working with the Company's marketing department since his association with
the Company in April, 1995. Between December, 1992 and March, 1995, Mr. Setian
served as Executive Vice President of Maxxim in its Boundary division. Prior to
his joining Maxxim, Mr. Setian held various sales and marketing positions with
Kendall Healthcare Products.
Rosdon Hendrix (age 57) was elected a Director of the Company in December
1994. Until he retired in June 1992, Mr. Hendrix served for approximately 30
years in various financial positions for General Motors Corporation, including
serving as Resident Comptroller from 1975 until his retirement. Since June 1992,
Mr. Hendrix has engaged in efficiency consulting studies with various
governmental authorities and businesses in Georgia.
Jamal Silim (age 42) was elected a Director of the Company in January 1996.
Mr. Silim is the Senior Vice President and Chief Financial Officer of Balsam
Healthcare Corp. Prior to accepting such position, Mr. Silim served as the
Assistant Vice President and later Vice President of the National Commercial
Bank from January 1990 to July 1992.
Kenneth F. Davis (age 46) was elected a Director of the Company in January
1996. Dr. Davis has been a practicing surgeon on the staff of the Harbin Clinic
and Redmond Regional Medical Center, Rome, Georgia since 1986. In addition, Dr.
Davis serves on the Board of AmSouth Bank of Georgia, a publicly owned bank, as
well as various other companies, including a privately held hospital consulting
firm.
The Company's Articles of Incorporation adopt the provisions of the Georgia
Business Corporation Code (the "Corporation Code") providing that no member of
the Company's Board of Directors shall be personally liable to the Company or
its shareholders for monetary damages for any breach of his duty of care or any
other duty he may have as a director, except liability for any appropriation, in
violation of the director's duties, of any business opportunity of the Company,
for any acts or omissions that involve intentional misconduct or a knowing
violation of law, for liability under the Corporation Code for unlawful
distributions to shareholders, and for any transaction from which the director
receives an improper personal benefit.
The Company's Bylaws provide that each officer and director shall be
indemnified for all losses and expenses (including attorneys' fees and costs of
investigation) arising from any action or other legal proceeding, whether civil,
criminal, administrative or investigative, including any action by and in the
right of the Company, because he is or was a director, officer, employee or
agent of the Company or, at the Company's request, of any other organization. In
the case of action by or in the right of the Company, such indemnification is
subject to the same exceptions, described in the preceding paragraph, that apply
to the limitation of a director's monetary liability to the Company. The Bylaws
also provide for the advancement of expenses with respect to any such action,
subject to the officer's or director's written affirmation of his good faith
belief that he has met the applicable standard of conduct, and the officer's or
director's written agreement to repay any advances if it is determined that he
is not entitled to be indemnified. The Bylaws permit the Company to enter into
agreements providing to each officer or director indemnification rights
substantially similar to those set forth in the Bylaws, and such agreements have
been entered into between the Company and each of the members of its Board of
Directors. Although the form of indemnification agreement offers substantially
the same scope of coverage afforded by provisions in the Articles of
Incorporation and Bylaws, it provides greater assurances to officers and
directors that indemnification will be available, because, as a contract, it
cannot be modified unilaterally in the future by the Board of Directors or by
the shareholders to eliminate the rights it provides. Such indemnification
provisions applied to any losses and expenses (including defense costs) incurred
by Mr. Taylor and C. Fred Harlow, the Company's former Chief Financial Officer
prior to his retirement from such position in 1996, as named defendants in a
suit styled Salit vs. Isolyser Company, Inc., et al. which was dismissed with
prejudice on the defendants' motion for dismissal in September 1996. Defense
counsel for the Company also served as defense counsel for Messrs. Taylor and
Harlow in such suit. Accordingly, the Company did not advance any expenses by
way of indemnification in such matter.
Section 16(a) Beneficial Ownership Reporting Compliance.
Pursuant to Section 16(a) of the Securities Exchange Act of 1934 and the rules
issued thereunder, Isolyser's executive officers and directors and any persons
holding more than ten percent of the Company's common stock are required to file
with the Securities and Exchange Commission and The Nasdaq Stock Market reports
of their initial ownership of the Company's common stock and any changes in
ownership of such common stock. Specific
420793.1
34
due dates have been established and the Company is required to disclose in its
Annual Report on Form 10-K and Proxy Statement any failure to file such reports
by these dates. Copies of such reports are required to be furnished to Isolyser.
Based solely on its review of the copies of such reports furnished to Isolyser,
or written representations that no reports were required, Isolyser believes
that, during 1996, all of its executive officers (including the Named Executive
Officers), directors and persons owning more than 10% of its common stock
complied with the Section 16(a) requirements, except James S. Asip amended a
timely filed report to report late one exempt option exercise, Richard Setian
amended two timely filed reports to correct a typographical error on the
expiration and vesting data of an exempt option grant, C. Fred Harlow amended a
timely filed report to correct a typographical omission naming the issuer, and
Jamal Silim filed a report late to report an exempt option grant.
ITEM 11.EXECUTIVE COMPENSATION
The following table sets forth the cash and non-cash compensation paid by the
Company (or Microtek for services rendered during the years ended December 31,
1996, 1995 and 1994) to its Chief Executive Officer and each of the four most
highly compensated executive officers of the Company other than such Chief
Executive Officer who were serving as such an executive officer at December 31,
1996 and who received compensation in excess of $100,000 during the year ended
December 31, 1996 (the "Named Executive Officers").
420793.1
35
SUMMARY COMPENSATION TABLE
Long-Term
Annual Compensation Compensation
Other Annual Awards All Other
Name and Principal Position Year Salary Bonus Compensation Options (#) Compensation
- --------------------------- ---- ------ ----- ------------ ----------- ------------
Robert L. Taylor,................. 1996 $150,000 - - 40,000 $2,453(1)
Chairman, President and Chief 1995 $150,000 - - $2,570(1)
Executive Officer 1994 $150,975 - - - $2,125(2)
Travis W. Honeycutt............... 1996 $156,250 - - 40,000 $3,235(2)
Executive Vice President 1995 $150,000 - - - $3,235(2)
1994 $149,234 - - - $3,235(2)
Dan R. Lee ...................... 1996 $150,000 $100,000 - 50,000 $4,417(4)
Vice President - Finance and 1995 $150,000 $100,000 - 41,250 $5,093(4)
Administration, Chief Financial 1994 $112,500 - - $4,243(4)
Officer (3)
Lester J. Berry................... 1996 $150,000 $ 100,000 - - $7,539(5)
Vice President (3) 1995 $150,000 $ 74,000 - 16,500 $6,427(5)
1994 $137,500 - - 66,000 $3,009(5)
James S. Asip,.................... 1996 $110,000 $ 4,703 - 25,000 $ 637(6)
Vice President of Sales 1995 $110,352 $10,000 - - $ 229(6)
1994 $ 90,411 - - - $ 119(6)
- -----------
(1) This amount represents the Company's payment ($2,125) for $500,000 of term
life insurance and contributions to a 401(k) plan ($328 in 1996 and $445 in
1995).
(2) This amount represents the Company's payment, on Messrs. Taylor and
Honeycutt's behalf, respectively, for $500,000 term life insurance policies.
(3) Compensation earned by Messrs. Lee and Berry stated in the table is based
upon compensation plans of Microtek as these individuals were executive officers
of Microtek prior to the Microtek Acquisition effected September 1, 1996.
(4) This amount represents payment ($2,036) for $250,000 term life insurance and
contributions to a 401(k) plan for the balance of the amounts stated.
(5) This amount represents payment ($15,158 in 1995 and 1996 and $3,009 in 1994)
for $250,000 term life insurance and contributions of $1,269 and $2,381 in 1995
and 1996, respectively to a 401(k) plan.
(6) This amount represents the Company's payment on Mr. Asip's behalf for a
$100,000 term life insurance policy ($239 in 1996 and $119 in 1995 and 1994) and
a contribution in 1995 to a 401(k) plan ($398 in 1996 and $110 in 1995).
420793.1
36
Employment Arrangements
The Company is not a party to an employment agreement with any of its
Named Executive Officers, except Lester J. Berry. Mr. Berry is a party to an
employment agreement with Microtek expiring on January 3, 1999. Such employment
agreement specifies a minimum salary and benefits payable to him during the term
of the employment agreement and, in consideration therefore, contains certain
provisions restricting his ability to compete against the Company after
termination of the agreement or to use or disclose confidential information. In
connection with the Microtek Acquisition, Mr. Berry agreed to delete certain
compensatory provisions of such agreement otherwise arising in the event of
certain events constituting a change of control.
Employee Benefit Plans
Stock Option Plan. In April 1992, the Board of Directors and
shareholders of the Company adopted a Stock Option Plan (the "Plan"). The Plan
currently provides for the issuance of options to purchase up to 4,400,000
shares of common stock (subject to appropriate adjustments in the event of stock
splits, stock dividends and similar dilutive events). Options may be granted
under the Plan to employees, officers or directors of, and consultants and
advisors to, the Company who, in the opinion of the Compensation Committee, are
in a position to contribute materially to the Company's continued growth and
development and to its long-term financial success. The Plan is administered by
a committee appointed by the Board of Directors. The Compensation Committee has
been designated by the Board of Directors as the committee to administer the
Plan. The purposes of the Plan are to ensure the retention of existing executive
personnel, key employees and consultants of the Company, to attract and retain
new executive personnel, key employees and consultants and to provide additional
incentives by permitting such individuals to participate in the ownership of the
Company.
Options granted to employees may either be incentive stock options (as
defined in the Internal Revenue Code (the "Code")) or nonqualified stock
options. The exercise price of the options shall be determined by the Board of
Directors or the committee at the time of grant, provided that the exercise
price may not be less than the fair market value of the Company's common stock
on the date of grant as determined in accordance with the limitations set forth
in the Code. The terms of each option and the period over which it vests are
determined by the committee, although no option may be exercised more than ten
years after the date of grant and all options become exercisable upon certain
events defined to constitute a change of control. To the extent that the
aggregate fair market value, as of the date of grant, of shares with respect to
which incentive stock options become exercisable for the first time by an
optionee during the calendar year exceeds $100,000, the portion of such option
which is in excess of the $100,000 limitation will be treated as a nonqualified
stock option. In addition, if an optionee owns more than 10% of the total voting
power of all classes of the Company's stock at the time the individual is
granted an incentive stock option, the purchase price per share cannot be less
than 110% of the fair market value on the date of grant and the term of the
incentive stock option cannot exceed five years from the date of grant. Upon the
exercise of an option, payment may be made by cash, check or, if provided in the
option agreement, by delivery of shares of the Company's common stock having a
fair market value equal to the exercise price of the options, or any other means
that the Board or the committee determines. Options are non-transferable during
the life of the option holder. The Plan also permits the grant of alternate
rights defined as the right to receive an amount of cash or shares of common
stock having an aggregate fair market value equal to the appreciation in the
fair market value of a stated number of shares of common stock from the grant
date to the date of exercise. No alternate rights have been granted under the
Plan.
As of March 12, 1997, options to purchase 3,716,905 shares of common
stock were outstanding under the Plan.
Employee Stock Purchase Plan. In February 1995 the Board approved and
in April 1995 the Company's shareholders ratified, the adoption of the Company's
Employee Stock Purchase Plan for employees of the Company and its subsidiaries
(the "Stock Purchase Plan"). The Stock Purchase Plan was established pursuant to
the provisions of Section 423 of the Code. The purpose of the Stock Purchase
Plan is to provide a method whereby all eligible employees of the Company may
acquire a proprietary interest in the Company through the purchase of common
stock. Under the Stock Purchase Plan payroll deductions are used to purchase the
Company's common stock.
420793.1
37
An aggregate of 300,000 shares of common stock of the Company have been
reserved for issuance under the Stock Purchase Plan, and an aggregate of 61,608
shares of common stock have been purchased and issued under the Stock Purchase
Plan. All employees (including officers of the Company) who have been
continuously employed for three months or more by the Company or its designated
subsidiaries (during which such employee's hours of employment were 1,000 or
more) as of the commencement of any offering period under the Stock Purchase
Plan are eligible to participate in the Stock Purchase Plan. An employee
electing to participate in the Stock Purchase Plan must authorize a whole
percentage (not less than 1% nor more than 10%) of the employee's compensation
to be deducted by the Company from the employee's pay during each pay period.
The price for common stock which is purchased under the Stock Purchase Plan is
equal to 85% of the fair market value of the common stock on either the first
business day or last business day of the applicable offering period, whichever
is lower.
A participant may voluntarily withdraw from the Stock Purchase Plan at
any time by giving at least 30 days notice to the Company prior to the end of
the offering period and will receive on withdrawal the cash balance, without
interest, then held in the participant's account. Upon termination of employment
for any reason, including resignation, discharge, disability or retirement, or
upon the death of a participant, the balance of the participant's account,
without interest, will be paid to the participant or his or her designated
beneficiary. However, in the event of the participant's death, the participant's
beneficiary may elect to exercise the participant's option to purchase such
number of full shares which such participant's accumulated payroll deductions
will purchase at the applicable purchase price.
Stock Options
The Company granted options to its Named Executive Officers in 1996 as
set forth in the following table. The Company has no stock appreciation rights
("SARs") outstanding.
OPTION/SAR GRANTS IN LAST FISCAL YEAR
Individual Grants
-------------------------------------------------------------
Percent of xpiration
Number of Total Date
Securities Options/SARs Exercise Potential Realizable Value at
Underlying Granted to or Base Assumed Annual rates of Stock
Options/SARs Employees in Price Price Appreciation for Option
Name Granted (#) Fiscal Year ($/Sh) E Term(1)
----------------------------------
5% ($) 10% ($)
--------------- ---------------- ------------ ------------- ----------------- ----------------
Robert L. Taylor 40,000 4.7% $ 14.45 01/15/01 $ 159,691(1) $ 352,875(1)
Travis W. Honeycutt 40,000 4.7% $ 14.45 01/15/01 $ 159,691(1) $ 352,875(1)
Dan R. Lee 50,000 5.9% $ 7.125 11/01/01 $ 98,425(1) $ 217,494(1)
James S. Asip 25,000 3.0% $ 7.125 01/15/01 $ 49,213(1) $ 108.747(1)
(1) These amounts represent certain assumed rates of appreciation only. Actual
gains, if any, on stock option exercises are dependent on the future
performance of the Common Stock and overall market conditions.
The following table sets forth the value of options exercised during 1996
and of unexercised options held by the Company's Named Executive Officers at
December 31, 1996.
420793.1
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AGGREGATED OPTION/SAR EXERCISES IN THE LAST FISCAL YEAR
AND FISCAL YEAR-END OPTION/SAR VALUES
Number of
Securities
Underlying Value of Unexercised
Unexercised in-the-Money
Options/SARs at Options/SARs at
FY-End (#) FY-End ($)
Shares Acquired Value Exercisable/ Exercisable/
Name On Exercise (#) Realized ($) Unexercisable Unexercisable
- ---- --------------- ------------ ------------- -------------
Robert L. Taylor................. -0- -0- 0/40,000 0/0(1)
Travis W. Honeycutt.............. -0- -0- 0/40,000 0/0(1)
Dan R. Lee....................... 41,250 $375,953 292,545/50,000 1,695,278/0(2)
James S. Asip.................... 99,000 $242,256 0/25,000 0/0(3)
- -----------
(1) The indicated value is based on an exercise price of $14.45 per share and
value per share at December 31, 1996 of $7.00. (2) The indicated value is based
on exercise prices of $0.83 per share on 251,295 shares and $3.49 per share on
41,250 shares for exercisable options and $7.125 per share on 50,000
unexercisable options, and a value per share on December 31, 1996 of $7.00. (3)
The indicated value is based upon an exercise price of $7.125 per share and
value per share at December 31, 1996 of $7.00.
On November 1, 1996, the Company repriced previously outstanding options held
by its executive officers as follows:
TEN-YEAR OPTION/SAR REPRICINGS
- ---------------------------------------------------------------------------------------------------------------------
Length of
original option
Number of arket Price of Exercise price term remaining
Options/SARs Mtock at time of at time of at date of
repriced or s repricing or repricing or New exercise repricing or
Name Date amended (#) amendment ($) amendment ($) price ($) amendment
- ---------------------------------------------------------------------------------------------------------------------
James S. Asip 11/01/96 25,000 $7.125 $13.13 $7.125 4.2 years
Richard Setian 11/01/96 54,000 $7.125 $9.00 $7.125 3.5 years
Director Compensation
Nonemployee directors of the Company who are not affiliated with greater than
five percent shareholders of the Company ("Nonemployee Directors") are
compensated $1,000.00 and $250.00 for each meeting of the Board of Directors and
Committee of the Board of Directors, respectively, requiring travel for
attendance and are reimbursed upon request for the reasonable expenses incurred
in attending Board of Directors or committee meetings. In addition, the
Company's 1995 Nonemployee Director Stock Option Plan (the "Director Option
Plan") provides for automatic grants to each Nonemployee Director of
nonqualified stock options covering 2,000 shares of common stock at an exercise
price equal to the fair market value of the Company's common stock on the date
of grant. The date of grant under the Director Option Plan for each Nonemployee
Director then serving as such is at each of the following times: (1) on the
effective date of adoption of the Director Option Plan, (2) on the election of a
Nonemployee Director to the Board of Directors (except at an annual meeting of
shareholders) and (3) following each annual meeting of shareholders occurring
subsequent to the first anniversary of the effective date of the Director Option
Plan and the date of any option granted to such Nonemployee Director under the
Director Option Plan. Options granted under the Director Option Plan may be
exercised only by the optionee beginning six months after the date of grant
until the earliest of five years after the date of grant, 30 days after ceasing
to be a director of the Company (other than due to death or disability) and one
year after death or disability.
420793.1
39
During 1996, the Board of Directors, with each Nonemployee Director
abstaining, adopted a policy to increase the equity interest of its Nonemployee
Directors in the Company by awarding to each such director a stock option for
25,000 shares of Company common stock provided such director had attended at
least 75% of the sum of all meetings of the Board of Directors and any
committees on which that director served during the first year following his or
her election to the Board. Accordingly, each Nonemployee Director was awarded at
the end of 1996 a non-qualified stock option under the Company's Stock Option
Plan covering 25,000 shares of the Company's common stock at an exercise price
of $8.00 per share (being the fair market value of the Company's common stock on
the grant date) and being exercisable immediately upon the date of grant until
the earliest of five years after the grant date or one year after ceasing to be
a director of the Company.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth, as of March 27, 1997, certain information
regarding the beneficial ownership of common stock by (i) each person known by
the Company to be the beneficial owner of more than five percent of the
outstanding shares of common stock, (ii) each director and Named Executive
Officer, and (iii) all directors and executive officers as a group:
Percentage of
Common
Shares Beneficially Stock Beneficially
Name of Beneficial Owner Owned Owned
- ------------------------- ----- -----
Robert L. Taylor (1)............................................ 3,037,483 7.7%
Travis W. Honeycutt (2)......................................... 3,028,055 7.7%
Dan R. Lee (3).................................................. 302,610 *
James S. Asip (4)............................................... 8,533 *
Lester J. Berry (5)............................................. 92,974 *
Rosdon Hendrix (6).............................................. 75,000 *
Kenneth Davis (7)............................................... 48,000 *
Jamal Silim (8)................................................. 27,000 *
All directors and executive officers as a group (9 persons) (9). 6,673,855 16.8%
- -----------
* Represents less than 1% of the common stock
(1) Includes 2,600 shares of common stock over which Mr. Taylor acts as
custodian under the Georgia Transfers to Minors Act, and options to acquire
13,333 shares exercisable within 60 days.
(2) Includes options to acquire 13,333 shares exercisable within 60 days.
(3) Includes options to acquire 292,545 shares exercisable within 60 days.
(4) Includes options to acquire 8,333 shares exercisable within 60 days.
(5) Includes options to acquire 82,500 shares exercisable within 60 days.
(6) Includes options to acquire 29,000 shares exercisable within 60 days.
(7) Includes options to acquire 27,000 shares exercisable within 60 days.
(8) Includes options to acquire 27,000 shares exercisable within 60 days.
(9) Includes options to acquire 547,044 shares exercisable within 60 days.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The Company has no information to report pursuant to this Item.
420793.1
40
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) (1) and (2) - Financial Statements and Schedules
The following financial statements and schedules included on pages
F-1 through F-23 are filed as part of this annual report.
Consolidated Financial Statements and Independent Auditors' Report:
Independent Auditors' Report Consolidated Balance Sheets as of
December 31, 1996 and 1995 Consolidated Statements of Operations for the
years ended December 31, 1996, 1995 and 1994 Consolidated Statements of
Changes in Shareholders' Equity for the years ended December 31, 1996, 1995
and 1994 Consolidated Statements of Cash Flows for the years ended December
31, 1996, 1995 and 1994 Notes to the Consolidated Financial Statements
Financial Statement Schedules:
Schedule II - Valuation and Qualifying Accounts
Other schedules are omitted because they are not applicable,
not required or because required information is included in the
consolidated financial statements or notes thereto.
(3) Exhibits
2.1 Articles of Merger of MedSurg Industries, Inc. and MedSurg Acquisition Corp. dated December 31, 1993 (incorporated by
reference to Exhibit 2.1 filed with the Company's Registration Statement on Form S-1, File No. 33-83474)
2.2 Plan and Agreement of Merger dated December 31, 1993 of MedSurg Industries, Inc. and MedSurg Acquisition Corp.
(incorporated by reference to Exhibit 2.2 filed with the Company's Registration Statement on Form S-1, File No. 33-83474)
2.3 Certificate of Merger and Name Change of MedSurg Industries, Inc. and MedSurg Acquisition Corp. dated January 7, 1994
(incorporated by reference to Exhibit 2.3 filed with the Company's Registration Statement on Form S-1, File No. 33-84374)
2.4 Articles of Merger of Creative Research and Manufacturing, Inc. and Creative Acquisition Corp. dated December 31, 1993
(incorporated by reference to Exhibit 2.4 filed with the Company's Registration Statement on Form S-1, File No. 33-83474)
2.5 Plan and Agreement of Merger dated December 31, 1993 of Creative Research and Manufacturing, Inc. and Creative Acquisition
Corp. (incorporated by reference to Exhibit 2.5 filed with the Company's Registration Statement on Form S-1, File No. 33-
83474)
2.6 Certificate of Merger and Name Change of Creative Research and Manufacturing, Inc. and Creative Acquisition Corp. dated
January 7, 1994 (incorporated by reference to Exhibit 2.6 filed with the Company's Registration Statement on Form S-1, File
No. 33-83474)
2.7 Agreement and Plan of Merger dated as of July 28, 1995 among the Company, White Knight Acquisition Corp. and White Knight
Healthcare, Inc. (incorporated by reference to Exhibit 2.1 to the Company's Current Report on Form 8-K filed October 3, 1995)
2.8 Agreement and Plan of Merger dated as of May 1, 1995 among the Company, Isolyser/SafeWaste Acquisition Corp. and
SafeWaste Corporation (incorporated by reference to Exhibit 2.1 to the Company's Current Report on Form 8-K filed on June
15, 1995)
2.9 Articles of Merger dated May 31, 1995 of SafeWaste Corporation With
and Into Isolyser/SafeWaste Acquisition Corp. (incorporated by
reference to Exhibit 2.2 to the Company's Current Report on Form
8-K filed on June 15, 1995)
2.10 Certificate of Merger dated May 31, 1995 of Isolyser/SafeWaste Acquisition Corp. and SafeWaste Corporation (incorporated by
reference to Exhibit 2.3 to the Company's Current Report on Form 8-K filed on June 15, 1995)
2.11 Articles of Merger of White Knight Healthcare, Inc., and White
Knight Acquisition Corp., dated September 18, 1995 (incorporated by
reference to Exhibit 2.2 to the Company's Current Report on Form
8-K filed on October 3, 1995)
2.12 Certificate of Merger of White Knight Healthcare, Inc., and White
Knight Acquisition Corp., dated September 18, 1995 (incorporated by
reference to Exhibit 2.3 to the Company's Current Report on Form
8-K filed October 3, 1995)
2.13 Stock Purchase Agreement dated December 31, 1993 between the Company, MedSurg Acquisition Corp., Creative Acquisition
Corp., MedSurg Industries, Inc., Creative Research and Manufacturing, Inc. and MedInvest Enterprises, Inc. (incorporated by
reference to Exhibit 2.7 to the Company's Registration Statement on Form S-1, File No. 33-83474)
2.14 Agreement and Plan of Merger dated March 15, 1996 among the Company, Microtek Medical, Inc. and MMI Merger Corp.
(incorporated by reference to the Joint Proxy Statement/Prospectus included in the Company's Registration Statement on Form
S-4, File No. 333-7977).
3.1 Articles of Incorporation of Isolyser Company, Inc. (incorporated by reference to Exhibit 3.1 filed with the Company's
Registration Statement on Form S-1, File No. 33-83474).
3.2 Articles of Amendment to Articles of Incorporation of Isolyser Company, Inc.
3.3 Amended and Restated Bylaws of Isolyser Company, inc. (incorporated by reference to Exhibit 3.2 filed with the Company's
Registration Statement on Form S-1, File No. 33-83474)
420793.1
41
3.4 First Amendment to Amended and Restated Bylaws of Isolyser Company, Inc. (incorporated by reference to Exhibit 3.1 to the
Company's Current Report on Form 8-K filed July 29, 1996).
3.5 Second Amendment of Amended and Restated Bylaws (incorporated by reference to Exhibit 3.1 to the Company's Current Report
on Form 8-K filed December 20, 1996).
4.1 Specimen Certificate of Common Stock (incorporated by reference to Exhibit 4.1 filed with the Company's Registration
Statement on Form S-1, File No. 33-83474)
4.2 Shareholder Protection Rights Agreement dated as of December 20, 1996 between Isolyser Company, Inc. and SunTrust Bank
(incorporated by reference to Exhibit 4.1 to the Company's Current Report on Form 8-K filed on December 20, 1996).
10.1 Stock Option Plan and First Amendment to Stock Option Plan (incorporated by reference to Exhibit 4.1 filed with the Company's
Registration Statement on Form S-8, File No. 33-85668)
10.2 Second Amendment to Stock Option Plan (incorporated by reference to Exhibit 4.1 filed with the Company's Registration
Statement on Form S-8, File No. 33-85668)
10.3 Form of Third Amendment to Stock Option Plan (incorporated by reference to Exhibit 10.37 filed with the Company's Annual
Report on Form 10-K for the period ended December 31, 1994)
10.4 Form of Fourth Amendments to the Stock Option Plan (incorporated by reference to Exhibit 10.59 filed with the Company's
Annual Report on Form 10-K for the period ended December 31, 1995).
10.5 Form of Fifth Amendment to Stock Option Plan.
10.6 Form of Incentive Stock Option Agreement pursuant to Stock Option Plan (incorporated by reference to Exhibit 4.2 filed with
the Company's Registration Statement on Form S-8, File No. 33-85668)
10.7 Form of Non-Qualified Stock Option Agreement pursuant to Stock Option Plan (incorporated by reference to Exhibit 4.3, filed
with the Company's Registration Statement on Form S-8, File No. 33-85668)
10.8 Form of Option for employees of the Company outside of Stock Option Plan (incorporated by reference to Exhibit 10.6 filed
with the Company's Registration Statement on Form S-1, File No. 33-83474)
10.9 Employment Agreement of Lester J. Berry.
10.10 Lease Agreement, dated July 29, 1993, between Richard E. Curtis, Trustee and MedSurg Industries, Inc. (incorporated by
reference to Exhibit 10.25 filed with the Company's Registration Statement on Form S-1, File No. 33-83474)
10.11 First Lease Amendment, dated February 28, 1994, between Richard E. Curtis, Trustee and MedSurg Industries, Inc.
(incorporated by reference to Exhibit 10.26 filed with the Company's Registration Statement on Form S-1, File No. 33-83474)
10.12 Lease Agreement, dated October 21, 1991, between Weeks Master Partnership, L.P. and the Company (incorporated by reference
to Exhibit 10.27 filed with the Company's Registration Statement on Form S-1, File No. 33-83474)
10.13 Lease, dated September 28, 1984, between M.S.I. Limited Partnership and MedSurg Industries, Inc. (incorporated by reference
to Exhibit 10.28 filed with the Company's Registration Statement on Form S-1, File No. 33-83474)
10.14 Amendment No. 1 to Lease, dated October 10, 1984, between M.S.I. Limited Partnership and MedSurg Industries, Inc.
(incorporated by reference to Exhibit 10.29 filed with the Company's Registration Statement on Form S-1, File No. 33-83474)
10.15 Agreement and Second Amendment to Lease, dated December 31, 1993, between M.S.I. Limited Partnership and MedSurg
Industries, Inc. (incorporated by reference to Exhibit 10.30 filed with the Company's Registration Statement on Form S-1,
File No. 33-83474)
10.16 Third Amendment to Lease, dated September 9, 1994, between M.S.I. Limited Partnership nd Medsurg Industries, Inc.
(incorporated by reference to Exhibit 10.31 filed with the Company's Registration Statement on Form S-1, File No. 33-83474)
10.17 Lease Agreement, dated October 4, 1990, between Minnetonka Business Associates and Creative Research and Manufacturing,
Inc. (incorporated by reference to Exhibit 10.35 filed with the Company's Registration Statement on Form S-1, File No. 33-
83474)
10.18 Agreement to Extend Lease, dated October 7, 1991, between Minnetonka Business Associates and Creative Research and
Manufacturing, Inc. (incorporated by reference to Exhibit 10.36 filed with the Company's Registration Statement on Form S-1,
File No. 33-83474)
10.19 Agreement to Extend Lease, dated June 23, 1993, between Minnetonka Business Associates and Creative Research and
Manufacturing, Inc. (incorporated by reference to Exhibit 10.37 filed with the Company's Registration Statement on Form S-1,
File No. 33-83474)
10.20 Agreement to Extend Lease dated June 27, 1995, between 7100 Building Company Limited Partnership and Creative Research
and Manufacturing, Inc. (incorporated by reference to Exhibit 10.27 filed with the Company's Registration Statement on Form
S-1 File No. 33-97086)
10.21 Form of Indemnity Agreement entered into between the Company and certain of its officers and directors (incorporated by
reference to Exhibit 10.45 filed with the Company's Registration Statement on Form S-1, File No. 33-83474)
10.22 Amended and Restated Credit Agreement dated as of August 30, 1996,
among the Company, MedSurg, Microtek, White Knight, the Guarantors
named therein, the Lenders named therein and The Chase Manhattan
Bank (incorporated by referenced to Exhibit 10.1 of the Company's
Current Report on Form 8-K filed on September 13, 1996).
10.23 Lease Agreement, dated November 18, 1994, between Weeks Realty,
L.P. and the Company (incorporated by reference to Exhibit 10.38
filed with the Company's Annual Report on Form 10-K for the period
ended December 31, 1994)
10.24 1995 Nonemployee Director Stock Option Plan (incorporated by reference to Exhibit 10.39 filed with the Company's Annual
Report on Form 10-K for the period ended December 31, 1994)
10.25 Agreement and Lease dated October 1, 1992 between Industrial Development Authority of the City of Douglas, Arizona and
White Knight Healthcare, Inc. (incorporated by reference to Exhibit 10.41 filed with the Company's Registration Statement on
Form S-1 File No. 33-97086)
10.26 Product Purchase and Supply Agreement dated February 8, 1993 between White Knight Healthcare, Inc. and Sterile Concepts,
Inc. (incorporated by reference to Exhibit 10.42 filed with the Company's Registration Statement on Form S-1 File No.
33-97086)
10.27 Non-Negotiable Promissory Note in the original principal amount of $2,304,000.00 dated February 8, 1993 between White
Knight Healthcare, Inc. and Sterile Concepts, Inc. (incorporated by reference to Exhibit 10.43 filed with the Company's
Registration Statement on Form S-1 File No. 33-97086)
420793.1
42
10.28 Non-Negotiable Promissory Note in the original principal amount of $1,278,500.00 dated February 8, 1993 between White
Knight Healthcare, Inc. and Sterile Concepts, Inc. (incorporated by reference to Exhibit 10.44 filed with the Company's
Registration Statement on Form S-1 File No. 33-97086)
10.29 Form of Non-Negotiable Promissory Note in the original Principal
amount of $750,000 dated September 15, 1995 between the Company and
Ali R. Momtaz (incorporated by reference to Exhibit 10.46 filed
with the Company's Registration Statement on Form S-1 File No.
33-97086)
10.30 Distribution and Marketing Agreement dated September 15, 1995 between the Company and Sterile Concepts, Inc. (incorporated
by reference to Exhibit 10.48 filed with the Company's Registration Statement on Form S-1 File No. 33-97086)
10.31 Agreement, dated November 1, 1992 between Struble & Moffitt Company
and United Food and Commercial Workers Union Local 1360, chartered
by United Food and Commercial Workers, AFL-CIO (incorporated by
reference to Exhibit 10.49 filed with the Company's Registration
Statement on Form S-1 File No. 33-97086)
10.32 Agreement, dated March 18, 1995 between White Knight Hospital
Disposables and United Food and Commercial Workers Local 99R
(incorporated by reference to Exhibit 10.50 filed with the
Company's Registration Statement on Form S-1 File No. 33- 97086)
10.33 Labor Contract, dated July 22, 1994, between Union of Industrial, Related and Similar Workers of the Municipality of Agua
Prieta, Sonora, C.R.O.M. and Industrias Apson, S.A. de C.V. (incorporated by reference to Exhibit 10.51 filed with the
Company's Registration Statement on Form S-1 File No. 33-97086)
10.34 Lease Agreement dated June 21, 1995 between Caballeros Blanca, S.A. de C.V. and Constuctora Immobiliaria del Norte de
Doahuila, S.A. de C.V. (incorporated by reference to Exhibit 10.53 filed with the Company's Registration Statement on Form
S-1 File No. 33-97086)
10.35 Lease, dated August 1, 1987, between HARP, a division of M.B. Haynes Electric Corporation, and Mars/White Knight, a
division of Work Wear Corporation, Inc., as amended by Addendum No. 1 dated July 6, 1987, Addendum No. 2 dated July 6,
1987, Addendum No. 3 dated May 14, 1990, Addendum No. 4, dated June 17, 1992, second Addendum No.4 dated June 28,
1993, Addendum No. 5 dated May 26, 1994, Addendum No. 6 dated July 11, 1995, and Addendum No. 7 dated September 202,
1995 (incorporated by reference to Exhibit 10.55 filed with the Company's Registration Statement on Form S-1 File No.
33-97086)
10.36 Lease, dated October 1, 1995, between SafeWaste Corporation and Highwoods/Forsyth Limited Partnership (incorporated by
reference to Exhibit 10.56 filed with the Company's Registration Statement on Form S-1 File No. 33-97086)
10.37 1995 Employee Stock Purchase Plan, as amended by First Amendment dated July 1, 1995 (incorporated by reference to Exhibit
10.57 filed with the Company's Registration Statement on Form S-1 File No. 33-97086)
10.38 Second Amendment to 1995 Employee Stock Purchase Plan (incorporated by reference to Exhibit 10.58 to the Company vs.
Annual Report on Form 10-K for the period ended December 31, 1995)
10.39 Third Amendment to 1995 Employee Stock Purchase Plan
10.40 Asset Exchange Agreement dated July, 1995 between Microtek and Xomed, Inc. (incorporated by reference to Exhibit 10.9 to
Microtek's Annual Report on Form 10-K for the period ended November 30, 1995).
10.41 Asset Purchase Agreement dated November 30, 1995 among Microtek, Medi-Plast International, Inc. and certain affiliates of
Medi-Plast International, Inc. (incorporated by reference to Microtek's Current Report on Form 8-K dated December 8, 1995).
10.42 Asset Purchase Agreement dated April 27, 1996 between Microtek and Advanced Instruments, Inc. (incorporated by reference
to Exhibit 2.1 to Microtek's Current Report on Form 8-K dated May 15, 1996).
11.1 Statement re: computation of per share earnings
21.1 Subsidiaries of the Company
23.1 Consent of Deloitte & Touche LLP
23.2 Consent of KPMG Peat Marwick LLP
27.1 Financial Data Schedule
(b) Reports on Form 8-K:
(1) Form 8-K, dated December 19, 1996, regarding Other Events
420793.1
43
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized on March 31, 1997.
ISOLYSER COMPANY, INC.
By: /s/ Robert L. Taylor
Robert L. Taylor, President and Chief
Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed by the following persons on behalf of the registrant
in the capacities indicated on March 31, 1997.
SIGNATURE TITLE
/s/ Robert L. Taylor President, Chief Executive
Robert L. Taylor Officer and Chairman of the Board of
Directors (principal executive officer)
/s/ Travis W. Honeycutt Executive Vice President,
Travis W. Honeycutt Secretary and Director
/s/ Dan R. Lee Vice President of Finance and Administration,
Dan R. Lee Chief Financial Officer, Treasurer and
Director(principal financial and accounting
officer)
/s/ Rosdon Hendrix Director
Rosdon Hendrix
/s/ Jamal Silim Director
Jamal Silim
Director
Kenneth F. Davis
420793.1
44
INDEPENDENT AUDITORS' REPORT
Board of Directors of Isolyser Company, Inc.:
We have audited the consolidated balance sheets of Isolyser Company, Inc. and
subsidiaries (the "Company") as of December 31, 1996 and 1995, and the related
consolidated statements of operations, changes in shareholders' equity, and cash
flows for each of the three years in the period ended December 31, 1996. Our
audits also included the financial statement schedule listed in the index at
Item 14. These consolidated financial statements and financial statement
schedule are the responsibility of the Company's management. Our responsibility
is to express an opinion on the consolidated financial statements and financial
statement schedule based on our audits. The consolidated financial statements
give retroactive effect to the merger of the Company and Microtek Medical, Inc.
("Microtek") which has been accounted for as a pooling of interests as described
in Note 2 to the consolidated financial statements. We did not audit the balance
sheet of Microtek as of November 30, 1995, or the related statements of
operations, changes in shareholders' equity, and cash flows of Microtek for the
years ended November 30, 1995 and 1994 which statements reflect total assets of
$45,226,563 as of November 30, 1995, and total revenues of $30,058,999 and
$26,893,875 for the years ended November 30, 1995 and 1994, respectively. Those
statements were audited by other auditors whose report has been furnished to us,
and our opinion, insofar as it relates to the amounts included for Microtek for
1995 and 1994, is based solely on the report of such other auditors.
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 and the report of the other auditors provide a
reasonable basis for our opinion.
In our opinion, based on our audits and the report of the other auditors, the
consolidated financial statements referred to above present fairly, in all
material respects, the financial position of the Company as of December 31, 1996
and 1995, and the results of its operations and its 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 such financial statement
schedule, when considered in relation to the basic consolidated financial
statements taken as a whole, presents fairly, in all material respects, the
information set forth therein.
As discussed in Note 1 to the consolidated financial statements, effective
January 1, 1994, the Company changed its method of accounting for investments to
conform with Statement of Financial Accounting Standards No. 115.
DELOITTE & TOUCHE LLP
Atlanta, Georgia
February 7, 1997
(March 28, 1997 as to the 7th paragraph of Note 4)
Independent Auditors' Report
The Board of Directors
Microtek Medical, Inc.:
We have audited the accompanying consolidated balance sheets of Microtek
Medical, Inc. and subsidiaries as of November 30, 1995 and 1994 and the related
consolidated statements of earnings, stockholders' equity, and cash flows for
each of the years in the three-year period ended November 30, 1995. These
consolidated financial statements (not presented separately herein) are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Microtek Medical,
Inc. and subsidiaries as of November 30, 1995 and 1994, and the results of their
operations and their cash flows for each of the years in the three-year period
ended November 30, 1995, in conformity with generally accepted accounting
principles.
As discussed in notes 2 and 9 to the consolidated financial statements, the
Company adopted the provisions of Statement of Financial Accounting Standards
No. 109, Accounting for Income Taxes, as of December 1, 1993.
Jackson, Mississippi KPMG PEAT MARWICK LLP
January 17, 1996
ISOLYSER COMPANY, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1996 AND 1995
- ---------------------------------------------------------------------------------------
ASSETS 1996 1995
CURRENT ASSETS:
Cash and cash equivalents $20,925,485 $54,818,852
Accounts receivable, net of allowance
for doubtful accounts of $1,702,069
and $1,175,597, respectively 27,369,258 22,088,901
Inventories, net 62,823,765 46,077,033
Prepaid inventories 932,784 1,177,900
Deferred income taxes 2,601,331
Prepaid expenses and other assets 2,731,565 1,425,592
Total current assets 114,782,857 128,189,609
PROPERTY AND EQUIPMENT:
Land 2,842,390 2,120,389
Building and leasehold improvements 24,541,979 19,404,536
Equipment 51,460,525 41,301,695
Furniture and fixtures 4,821,744 4,014,946
Construction-in-progress 1,967,451
85,634,089 66,841,566
Less accumulated depreciation 11,883,053 5,860,017
Property and equipment, net 73,751,036 60,981,549
DEPOSITS ON MACHINERY
AND EQUIPMENT 2,003,573 3,058,985
ASSETS HELD FOR SALE 1,642,082
INTANGIBLE ASSETS:
Goodwill 57,411,281 55,484,049
Customer lists 5,559,410 5,623,512
Patent and license agreements 2,526,063 1,880,451
Noncompete agreements 485,000 910,000
Other 717,886 1,612,247
66,699,640 65,510,259
Less accumulated amortization 9,145,022 5,506,526
Intangible assets, net 57,554,618 60,003,733
INVESTMENT IN JOINT VENTURE 154,463 218,591
OTHER ASSETS - Net 1,045,970 808,082
$ 250,934,599 $253,260,549
See notes to consolidated financial statements.
- -----------------------------------------------------------------------------
LIABILITIES AND SHAREHOLDERS' EQUITY 1996 1995
CURRENT LIABILITIES:
Accounts payable $ 10,227,378 $ 15,759,268
Bank overdraft 3,229,216 1,800,042
Accrued compensation 3,149,073 3,583,635
Other accrued liabilities 3,580,440 1,983,067
Current portion of long-term debt 4,496,623 4,041,503
Total current liabilities 24,682,730 27,167,515
LONG-TERM DEBT 47,028,592 26,412,514
DEFERRED INCOME TAXES 3,958,813
OTHER LIABILITIES 419,741 423,269
COMMITMENTS AND CONTINGENCIES
SHAREHOLDERS' EQUITY:
Participating preferred stock, no par,
500,000 shares authorized, none issued
Common stock, $.001 par; 100,000,000
shares authorized; 39,341,832 and
38,352,649 shares issued, respectively 39,342 38,353
Additional paid-in capital 203,345,978 199,607,972
Accumulated deficit (21,839,927) (1,414,278)
Unearned shares restricted to employee
stock ownership plan (360,000) (420,000)
Cumulative translation adjustment 14,723 (42,344)
181,200,116 197,769,703
Treasury shares, at cost
(319,544 and 329,502 shares,
respectively) (2,396,580) (2,471,265)
------------ -----------
Total shareholders' equity 178,803,536 195,298,438
$ 250,934,599 $ 253,260,549
ISOLYSER COMPANY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 1996, 1995, AND 1994
- ----------------------------------------------------------------------------------------------------------------------
1996 1995 1994
NET SALES $165,737,685 $104,874,417 $73,382,287
COST OF GOODS SOLD 128,610,449 74,953,378 49,927,857
------------- ------------ ----------
Gross profit 37,127,236 29,921,039 23,454,430
OPERATING EXPENSES:
Selling and marketing expenses 28,298,033 18,234,438 14,099,819
General and administrative expenses 13,902,758 9,503,179 7,396,187
Amortization of intangibles 4,289,850 2,411,090 1,504,785
Research and development 2,172,910 1,126,873 1,246,076
Restructuring Charge 4,410,536 140,000
Costs associated with merger 3,371,546
Total operating expenses 56,445,633 31,275,580 24,386,867
------------ ------------ ----------
LOSS FROM OPERATIONS (19,318,397) (1,354,541) (932,437)
INTEREST INCOME 1,708,766 3,212,838 1,356,043
INTEREST EXPENSE (2,990,147) (1,378,621) (694,092)
LOSS ON SALE OF INVESTMENTS (613,595)
LOSS FROM JOINT VENTURE (34,246) (43,810)
LOSS BEFORE INCOME TAX PROVISION
(BENEFIT), EXTRAORDINARY ITEM,
AND CUMULATIVE EFFECT OF CHANGE
IN ACCOUNTING PRINCIPLE (20,634,024) 435,866 (884,081)
INCOME TAX PROVISION (BENEFIT) (639,120) 979,615 454,616
---------- --------- -------
LOSS BEFORE EXTRAORDINARY ITEM
AND CUMULATIVE EFFECT OF CHANGE
IN ACCOUNTING PRINCIPLE (19,994,904) (543,749) (1,338,697)
EXTRAORDINARY ITEM - Loss from
refinancing of credit facilities,
net of tax benefit of $332,041 (457,465)
CUMULATIVE EFFECT OF CHANGE IN
ACCOUNTING PRINCIPLE 56,719
NET LOSS $ (20,452,369) (543,749) (1,281,978)
============= ========== ===========
LOSS PER COMMON SHARE:
Loss before extraordinary item
and cumulative effect of change in
accounting principle $ (0.52) $ (0.02) $ (0.05)
Extraordinary item (0.01)
Cumulative effect of change
in accounting principle - - -
-------- -------- --------
NET LOSS $ (0.53) $ (0.02) $ (0.05)
======= ======= ======
WEIGHTED AVERAGE NUMBER OF COMMON
SHARES OUTSTANDING 38,762,750 33,704,310 27,029,761
============ ============ ==========
See notes to consolidated financial statements.
- ----------------------------------------------------
ISOLYSER COMPANY, INC. AND SUBSIDIARIES
- ----------------------------------------------------
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
- -----------------------------------------------------------------------------------------------------------------------------------
COMMON STOCK ISSUED ADDITIONAL RETAINED LOSS ON
--------------------- PAID-IN EARNINGS TRANSLATION SHORT-TERM ESOP TREASURY
SHARES AMOUNT CAPITAL (DEFICIT) ADJUSTMENT INVESTMENT SHARES SHARES EQUITY
BALANCE - December 31, 1993 21,494,980 21,495 30,505,371 $ 411,449 $ (66) $(540,000) $30,398,249
Issuance of common stock
to acquire business 9,264 9 69,471 69,480
Issuance of common stock
at $9 per share for
cash in conjunction
with the Company's
initial public offering
(net of transaction costs
of $5,893,678) 7,170,000 7,170 58,629,152 58,636,322
Reclassification of
redeemable common shares
to common shares 3,000,000 3,000 22,497,000 22,500,000
Exercise of stock options
and warrants 209,822 210 213,115 213,325
Contribution of 16,500
shares to ESOP 16,500 17 59,983 60,000
Release of 16,500
shares reserved for ESOP (8,750) 60,000 51,250
Tax benefits related
to stock options 23,765 23,765
Currency translation loss (8,519) (8,519)
Unrealized loss on
short-term investments $(56,719) (56,719)
Change in unrealized loss
56,719 56,719
Net loss
(1,281,978) (1,281,978)
BALANCE - December 31, 1994 31,900,566 31,901 111,989,107 (870,529) (8,585) - (480,000) 110,661,894
Issuance of common stock
to acquire businesses 528,292 528 8,925,458 8,925,986
Issuance of common stock
at $14.50 per share for
cash in conjunction with
the Company's secondary
public offering
(net of transaction
costs of $5,288,360) 5,492,970 5,493 74,354,213 74,359,706
Reclassification of
redeemable common shares
to common shares 495,930 496 3,718,979 3,719,475
Exercise of stock
options and warrants 318,348 318 1,224,595 1,224,913
Purchase and retirement
of common stock (383,457) (383) (1,281,476) (1,281,859)
Release of 16,500 shares
reserved for ESOP 11,125 60,000 71,125
Tax benefits related
to stock options 665,971 665,971
Currency translation loss (33,759) (33,759)
Purchase of 329,502
treasury shares $(2,471,265) (2,471,265)
Net loss (543,749) (543,749)
BALANCE - December 31, 1995 38,352,649 38,353 199,607,972 (1,414,278) (42,344) - (420,000) (2,471,265) 195,298,438
Microtek net income for
December, 1995 26,720 26,720
Exercise of stock
options and warrants 989,183 989 3,118,021 3,119,010
Issuance of 9,985 shares
of common stock from
treasury pursuant to ESPP 43,860 74,685 118,545
Vesting of performance
stock options 500,000 500,000
Release of 16,500
shares reserved for ESOP 76,125 60,000 136,125
Currency translation gain
57,067 57,067
Net loss
(20,452,369) (20,452,369)
BALANCE - December 31, 1996 39,341,832 $39,342 $203,345,978 $(21,839,927) $14,723 $ - $(360,000)$(2,396,580)$178,803,536
See notes to consolidated financial statements.
ISOLYSER COMPANY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1996, 1995, AND 1994
- ----------------------------------------------------------------------------------------------------------------------
1996 1995 1994
OPERATING ACTIVITIES:
Net loss $(20,452,369) $(543,749) $(1,281,978)
Adjustments to reconcile loss to
net cash used in operating activities:
Microtek net income for December 1995 26,720
Depreciation 6,552,416 2,552,817 1,286,138
Amortization 4,289,850 2,336,383 1,504,330
Provision for doubtful accounts 145,092 82,832 12,970
Provision for obsolete and slow moving inventory 9,479,426 372,611 195,356
Tax benefits relating to stock options 665,971 23,765
Loss on sale of investments 613,595
Loss on disposal of property and equipment 207,252 25,646 1,783
Translation gain (loss) 57,067 (33,759) (8,519)
Impairment loss 2,169,934
Losses from joint ventures 34,426 44,236
Compensation expense related to ESOP 136,125 71,125 111,250
Compensation expense related to vesting
of variable options 500,000
Cumulative effect of change in
accounting principle (56,719)
Changes in assets and liabilities, net of effects
from purchased businesses:
Accounts receivable (4,128,080) (296,003) (861,560)
Inventories (25,708,431) (16,995,068) (915,929)
Prepaid inventories 245,116 (819,476) (358,424)
Prepaid expenses and other assets (1,305,973) (447,744) (542,215)
Deferred income taxes (1,357,482) (794,346) 111,424
Other assets (185,977) (1,425,325) (458,483)
Accounts payable (5,531,890) 8,244,677 (601,294)
Accrued compensation (434,562) (48,457) 158,912
Other liabilities (3,528) (96,387) 347,023
Other accrued liabilities 1,597,373 (366,141) 481,801
----------- ---------- -------
Net cash used in operating activities (33,667,495) (7,470,157) (236,774)
------------- ------------ ---------
INVESTING ACTIVITIES:
Purchase of and deposits for property and equipment (19,081,793) (46,494,427) (7,846,422)
Purchase of businesses, net of cash acquired (5,873,503) (33,455,465) (861,055)
Proceeds from the sale of property and equipment 125,703 16,037
Purchase of short-term investments (28,436,168)
Sale of short-term investments 47,920,660
Investment in joint venture (1,613)
Proceeds from disposition of joint venture 298,248
Net cash provided by (used in) investing
activities (24,955,296) (79,525,941) 10,791,439
------------- ------------- ----------
(Continued)
ISOLYSER COMPANY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1996, 1995, AND 1994
- -------------------------------------------------------------------------------------------------------------------------
1996 1995 1994
FINANCING ACTIVITIES:
Borrowings under line of credit agreements $74,943,720 $18,527,411 $33,561,933
Repayments under line of credit agreements (52,264,517) (33,388,630) (32,182,677)
Increase (decrease) in bank overdraft 1,429,174 728,837 (421,998)
Proceeds from notes payable 13,844,872 18,177,688 1,335,065
Repayment of notes payable (16,461,380) (6,075,497) (1,350,725)
Proceeds from issuance of common stock 79,648,066 64,530,000
Direct costs related to issuance of common stock (5,288,360) (5,829,586)
Purchase of treasury stock (3,753,124)
Issuance of treasury stock 118,545
Proceeds from exercise of stock options and warrants 3,119,010 1,224,913 213,325
----------- ----------- -------
Net cash provided by financing activities 24,729,424 69,801,304 59,855,337
------------ ------------ ----------
NET INCREASE (DECREASE) IN CASH AND
CASH EQUIVALENTS (33,893,367) (17,194,794) 70,410,002
CASH AND CASH EQUIVALENTS:
Beginning of year 54,818,852 72,013,646 1,603,644
------------ ------------ ---------
End of year $20,925,485 $54,818,852 $72,013,646
============ ============ ==========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW
INFORMATION:
Cash paid during the year for:
Interest (net of interest capitalized) $ 2,797,865 $1,350,731 $675,350
=========== =========== =======
Income taxes $ 1,922,656 $1,302,386 $775,449
=========== =========== =======
SUPPLEMENTAL DISCLOSURES OF NONCASH
INVESTING AND FINANCING ACTIVITIES:
Liabilities assumed in conjunction with the purchase
of businesses $30,214,399
Equipment acquired through capital leases $ 1,008,503
See notes to consolidated financial statements.
(Concluded)
ISOLYSER COMPANY, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
AS OF DECEMBER 31, 1996 AND 1995 AND FOR EACH OF THE
THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1996
- -------------------------------------------------------------------------------
1. NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES
Isolyser Company, Inc. and subsidiaries (the "Company") develop,
manufacture, and market proprietary and other products and services for
patient care, occupational safety, and management of potentially
infectious and hazardous waste primarily for the domestic health care
market. The Company's products provide an umbrella of protection from
potentially infectious and hazardous waste for patients, staff, the
public, and the environment by facilitating the safe and cost-effective
disposal of such waste at the Point-of-Generation(TM). The Company markets
its products to hospitals and other end users through distributors and
directly through its own sales force.
The Company's future performance will depend to a substantial degree upon
its ability to successfully market its patented OREX Degradables (TM)
products ("OREX") in commercial quantities. The Company's sales of OREX
products were $7,079,000 for the year ended December 31, 1996.
Consolidation Policy - The consolidated financial statements include the
accounts of the Company and its wholly owned subsidiaries. All significant
intercompany balances and transactions have been eliminated in
consolidation.
Revenue Recognition - Revenues from the sale of the Company's products are
recognized at the time of shipment. The Company generally only accepts
product returns for damaged products. Actual returns have not been
significant.
Use of Estimates - The preparation of financial statements in conformity
with generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities 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
those estimates.
Inventories - Inventories are stated at the lower of cost or market. The
first-in first-out ("FIFO") valuation method is used to determine the cost
of inventories except for the inventories held by the Company's
subsidiary, White Knight Healthcare, Inc. ("White Knight"). White Knight
uses the last-in first-out ("LIFO") inventory valuation method. Cost
includes material, labor, and manufacturing overhead for manufactured and
assembled goods and materials only for goods purchased for resale.
Inventories are stated net of an allowance for obsolete and slow-moving
inventory.
Property and Equipment - Property and equipment is stated at cost less
accumulated depreciation and is depreciated using the straight-line method
over the estimated useful lives of the related assets. During 1996 and
1995, the Company capitalized as part of property and equipment $220,000
and $920,000 of interest, respectively.
Intangible Assets - Intangible assets consist primarily of goodwill,
customer lists, and noncompete agreements. Goodwill represents the excess
of the cost of acquired businesses over the fair value of net identifiable
assets acquired and is amortized using the straight-line method over 10 to
40 years. Customer lists and noncompete agreements are amortized using the
straight-line method over three to seven years.
Joint Venture - Investment in the joint venture is accounted for using the
equity method of accounting. The joint venture investment represents a 50%
ownership interests in a mobile waste treatment operation.
Research and Development Costs - Research and development costs are
charged to expense as incurred.
Cash Equivalents - Cash equivalents are short-term, highly liquid
investments with original maturities of three months or less consisting
entirely of U.S. government securities or government backed securities.
These investments are classified in accordance with Statement of Financial
Accounting Standards ("SFAS") 115, "Accounting for Certain Investments in
Debt and Equity Securities," as available for sale securities and are
stated at cost which approximates market.
Short-Term Investments - Effective January 1, 1994, the Company adopted
SFAS 115. The Statement addresses the accounting for investments in equity
securities that have readily determinable fair values and for all
investments in debt securities. The Company classified its existing
short-term investment securities as available-for-sale securities which,
under the Statement, are reported at fair value with unrealized gains and
losses excluded from earnings and reported in a separate component of
shareholders' equity. The cumulative effect of this change in accounting
principle was to increase 1994 income by $56,719.
Income Taxes - Deferred tax assets and liabilities are determined based on
the difference between financial statement and tax bases of assets and
liabilities using enacted tax rates in effect for the year in which the
differences are expected to reverse. Valuation allowances are established
when necessary to reduce deferred tax assets to the amounts expected to be
realized (Note 6).
Foreign Currency Translation - The assets and liabilities of the Company's
United Kingdom and Mexican subsidiaries are translated into U.S. dollars
at current exchange rates and revenues and expenses are translated at
average exchange rates. As the Mexican subsidiaries' operations are an
extension of the Company's operations, the U.S. dollar is considered to be
the functional currency and any exchange gains or losses are included in
net income. The effect of foreign currency transactions was not material
to the Company's results of operations for the years ended December 31,
1995 and 1996.
Newly Issued Accounting Standards - In March 1995, SFAS 121, "Accounting
for the Impairment of Long-Lived Assets and Long-Lived Assets to Be
Disposed of," was issued. This Statement requires that long-lived assets
and certain identifiable intangibles be reviewed for impairment when
events or changes in circumstances indicate that the carrying amount of an
asset may not be recoverable, with any impairment losses being reported in
the period in which the recognition criteria are first applied based on
the fair value of the asset. Long-lived assets and certain intangibles to
be disposed of are required to be reported at the lower of carrying amount
or fair value less cost to sell. The Company adopted SFAS 121 effective
January 1, 1996. The adoption of SFAS 121 had no effect on the Company's
financial position or results of operations.
In October 1995, SFAS 123, "Accounting for Stock-Based Compensation," was
issued. The adoption of the new recognition provisions for stock-based
compensation expense included in SFAS 123 is optional; however, the pro
forma effects on net income had the new recognition provisions been
elected is required in financial statements (Note 9). The Company will
continue to follow the requirements of Accounting Principles Board Opinion
No. 25, "Accounting for Stock Issued to Employees," in its accounting for
employee stock options; therefore, there was no impact on the Company's
financial position and results of operations.
In February 1997, SFAS 128, "Earnings Per Share," was issued. This
Statement simplifies the standards for computing earnings per share
("EPS") previously found in APB Opinion 15, "Earnings Per Share," ("APB
15") by replacing the presentation of primary EPS with basic EPS. It also
requires dual presentation of basic and diluted EPS on the face of the
income statement for all entities with complex capital structures and
requires a reconciliation of the numerator and denominator of the basic
EPS computation to the numerator and denominator of the diluted EPS
computation. Basic EPS is computed by dividing income available to common
stockholders by the weighted average number of common shares outstanding
for the period. Diluted EPS is computed similarly to fully diluted EPS
under APB 15. The Company intends to adopt this Statement in 1997.
2. ACQUISITIONS
On August 30, 1996, the Company merged with Microtek Medical, Inc.
("Microtek"), a manufacturer and marketer of a broad range of medical and
surgical supplies, and, in connection therewith, issued 7,722,965 shares
of common stock for all of Microtek's outstanding common stock. Costs
related to the merger of $3,372,000 were charged to expense primarily in
the third quarter of fiscal 1996. The merger was accounted for as a
pooling of interests and, accordingly, the Company's financial statements
have been restated to include the results of Microtek for all periods
presented. In conjunction with the merger, certain stock options issued to
officers of Microtek became fully vested, and, accordingly, $500,000 of
compensation expense related to this vesting was recognized as additional
paid-in capital. Combined and separate results of the Company and Microtek
for the periods prior to the merger are as follows:
ISOLYSER MICROTEK ELIMINATIONS COMBINED
NINE MONTHS ENDED SEPTEMBER 30, 1996
Net sales 93,886 30,516 (804) 123,598
Extraordinary item (292) (283) (575)
Net income (loss) (6,406) 2 (6,404)
YEAR ENDED DECEMBER 31, 1995
(MICROTEK AS OF NOVEMBER 30, 1995)
Net sales 75,414 30,059 (599) 104,874
Net income (loss) (2,851) 2,307 (544)
YEAR ENDED DECEMBER 31, 1994
(MICROTEK AS OF NOVEMBER 30, 1995)
Net sales 46,624 26,894 (136) 73,382
Net income (loss) (1,862) 580 (1,282)
Note : All eliminations are related to intercompany sales and purchases.
In connection with the merger, Microtek changed its fiscal year-end from
November 30 to December 31, which conforms to Isolyser's fiscal year-end.
Microtek's separate results for fiscal 1996 have been restated to a
December 31 year-end. Microtek's separate results of operations for the
month of December 1995, therefore, are not reflected in the consolidated
statement of operations. The following is a condensed statement of income
for Microtek for the month of December 1995 (in thousands):
Net sales $ 2,701
Cost of goods sold 1,423
Gross profit 1,278
Operating expenses 939
Income from operations 339
Interest expense 105
Income before income tax provision 234
Income tax provision 207
Net income $ 27
The consolidated financial statements for all periods prior to 1996 have
not been restated for the change in fiscal years. They include the
Company's result of operations on a December 31 fiscal year basis, and
Microtek's on a November 30 fiscal year basis.
On April 28, 1996, the Company acquired substantially all of the assets of
Venodyne, a manufacturer and marketer of medical products for $4,000,000
in cash financed by Microtek's credit facility, a $1,750,000 note payable
(Note 4), and additional consideration not to exceed $1,000,000, based on
sales of certain of Venodynes' products through April 1999. Through
December 31, 1996, $124,000 in additional consideration has been paid.
Goodwill arising from this acquisition is being amortized using the
straight-line method over 25 years.
On May 31, 1995, the Company acquired SafeWaste Corporation ("SafeWaste"),
a mobile waste management company, for $3,105,000, consisting of
$1,179,000 in cash and 169,318 shares of common stock valued at
$1,926,000. Goodwill arising from this acquisition is being amortized
using the straight-line method over ten years.
On June 27, 1995, the Company acquired the infection control drape line of
Xomed, Inc. ("Xomed"), in exchange for the assets of the Company's otology
product line, $1,316,000 in cash financed by Microtek's credit facility
and $1,314,000 in notes payable (Note 4). Goodwill arising from the
acquisition is being amortized using the straight-line method over 25
years.
Effective September 1, 1995, the Company acquired White Knight, a
manufacturer, packager, and distributor of medical supplies for
$30,888,000, including $1,388,000 in expenses, consisting of $23,889,000
in cash and 359,000 shares of common stock valued at $6,994,000. In
conjunction with the purchase, the Company allocated $4,124,000 to a
customer list and $22,355,000 to goodwill, which are being amortized using
the straight-line method over 7 and 20 years, respectively.
On November 30, 1995, the Company acquired substantially all of the assets
and assumed certain liabilities of Medi-Plast International, Inc.,
("Mediplast"), a manufacturer and marketer of medical supplies for
$11,119,000 consisting of $7,519,000 in cash financed by the Company's
credit facility and a $3,600,000 note payable (Note 4). Goodwill arising
from the acquisition is being amortized using the straight-line method
over 25 years.
These acquisitions have been accounted for using the purchase method of
accounting. The consolidated statements of operations include the
operations of the businesses since their respective acquisition dates.
The following unaudited pro forma information for 1996 and 1995 gives
effect to these acquisitions as if they had occurred on January 1, 1995:
1996 1995
Net sales $ 166,492,000 $ 147,783,000
Net loss (20,697,000) (1,071,000)
Net loss per share (0.53) (0.03)
The pro forma consolidated information is not necessarily indicative of
the results that would have been reported had such acquisitions occurred
on such dates, nor is it indicative of the Company's future operations.
3. INVENTORIES
Inventories are summarized by major classification at December 31, 1996
and 1995 as follows:
1996 1995
Raw materials $ 20,936,000 $ 20,145,000
Work-in-process 23,267,000 8,143,000
Finished goods 29,346,000 18,409,000
------------ ----------------
73,549,000 46,697,000
Less reserves for:
Slow moving and obsolete inventory 10,041,000 613,000
LIFO inventory 684,000 7,000
$ 62,824,000 $ 46,077,000
=============== =============
At December 31, 1996 and 1995, LIFO inventories approximated $28,324,000
and $13,675,000, respectively.
The Company currently obtains most of the raw materials for its OREX
degradable products from suppliers in the People's Republic of China. The
Company does not have any long-term supply contracts or other formal
contractual arrangements with any of its OREX raw materials suppliers.
While OREX raw materials are currently available from other domestic and
foreign independent manufacturers, there can be no assurance that the
Company will continue to be able to obtain these raw materials on a
commercially reasonable basis.
At December 31, 1996, inventory includes approximately $34,716,199 of
OREX, of which $10,693,726 represents raw materials. Additionally, at
December 31, 1996, the Company had commitments to purchase $3,374,000 of
OREX raw materials.
4. LONG-TERM DEBT
In conjunction with the August 30, 1996 Microtek merger, the Company
replaced its existing $24,500,000 Isolyser credit agreement and
$17,000,000 Microtek credit agreement with a $55,000,000 credit agreement
(the "Credit Agreement") between the Company and a bank, consisting of a
$40,000,000 revolving credit facility through August 31, 1999 and a
$15,000,000 term loan facility. In conjunction with this replacement, the
Company recorded an extraordinary loss of $457,000, net of a tax benefit
of $332,000 relating to the extinguishment of the former credit
agreements.
Borrowings under the revolving credit facility are based on the lesser of
a percentage of eligible accounts receivable and inventory or $40,000,000
less any outstanding letters of credit issued under the Credit Agreement.
Current additional borrowing availability under the facility at December
31, 1996 was $8,646,000. Revolving credit borrowings bear interest, at the
Company's option, at either the Alternate Base Rate, as defined or LIBOR
plus 1 1/2% (7.09% at December 31, 1996). Outstanding borrowings under the
revolving credit facility were $28,447,000 and $5,879,000 at December 31,
1996 and 1995, respectively.
Commencing on December 31, 1996, the term loan facility is repayable in
quarterly principal payments of $500,000 through September 1998 and
$750,000 through June 2001, with any remaining indebtedness due on August
31, 2001. The term loans bear interest, at the Company's option, at either
the Alternate Base Rate plus 1/2% or LIBOR plus 2%. Outstanding borrowings
under the term loan facility were $14,500,000 and $17,000,000 at December
31, 1996 and 1995, respectively.
The Credit Agreement provides for the issuance of up to $3,000,000 in
letters of credit. Outstanding letters of credit at December 31, 1996 were
$50,000.
The Credit Agreement provides for a fee of .25% per annum on the unused
commitment, an annual collateral monitoring fee of $50,000, and an
outstanding letter of credit fee of up to 2% per annum. The Company is
also subject to prepayment penalties through the third year of the Credit
Agreement equal to 1% of the amount of the aggregate commitment terminated
or reduced, as defined.
Borrowings under the Credit Agreement are collateralized by the Company's
accounts receivable, inventory, property and equipment, and general
intangibles, as defined and are guaranteed by the Company. The Credit
Agreement contains certain restrictive covenants, including the
maintenance of certain financial ratios and net income, and limitations on
acquisitions, dispositions, capital expenditures, and additional
indebtedness. The Company also is not permitted to pay any dividends.
At December 31, 1996, the Company was not in compliance with the net
income and leverage covenants. These existing covenant violations were
waived by the bank on March 28, 1997. In connection with the waiver of
these covenant violations, the Bank and the Company amended the Credit
Agreement to revise certain covenants including certain of the
financial ratios and the net income and capital expenditures covenants
and added a net worth covenant. Such amendment also provides for the
addition of certain of the Company's property as collateral for the
credit facility and revises the interest rate under the Credit Agreement.
The revised interest rate varies depending on the Company's ratio of
long-term debt as compared to funds generated from operations. The rate
options will vary between the rate options currently in effect as
described above and such rates plus 0.75%.
As a result of the Microtek merger, the Company is also obligated under
certain other long-term notes payable, relating primarily to Microtek
acquisitions, which aggregated $5,238,000 and $5,278,000 at December 31,
1996 and 1995, respectively. These obligations bear interest at rates
ranging from 6.09% to 9.5% and mature through November 2000. Two of the
acquisition notes payable aggregating $4,638,000 at December 31, 1996 are
subordinated to the Credit Agreement.
As a result of the White Knight acquisition, the Company is also obligated
under certain other long-term notes payable and capital leases which
aggregated approximately $1,906,000 and $2,387,000 at December 31, 1996
and 1995, respectively. These obligations bear interest at rates ranging
from 6.06% to 13.25% and mature through August 2003.
The Company has a $250,000 overdraft protection credit facility with
another bank which was unused at December 31, 1996.
During 1996, the Company acquired certain equipment under capital leases
aggregating $822,000 at December 31, 1996.
At December 31, 1996, aggregate maturities of long-term debt, including
amounts due under capital leases, are summarized below:
1997 $ 4,497,000
1998 3,925,000
1999 32,899,000
2000 5,509,000
2001 4,312,000
Thereafter 383,000
$ 51,525,000
The carrying value of long-term debt at December 31, 1996 approximates
fair value based on interest rates that are believed to be available to
the Company for debt with similar provisions provided for in the existing
debt agreements.
5. LEASES
The Company leases office, manufacturing and warehouse space, and
equipment under operating lease agreements expiring through 2004. Rent
expense was $2,549,000, $1,728,000, and $1,239,000 in 1996, 1995, and
1994, respectively. At December 31, 1996, minimum future rental payments
under these leases are as follows:
OPERATING
YEAR LEASES
1997 $ 2,052,000
1998 1,680,000
1999 1,628,000
2000 1,586,000
2001 1,537,000
Thereafter 14,066,000
Total minimum payments $ 22,549,000
=============
The Company may, at its option, extend certain of its office,
manufacturing, and warehouse facilities lease terms through various dates.
6. INCOME TAXES
The income tax provision (benefit) is summarized as follows:
1996 1995 1994
Current:
Federal $ 349,000 $ 852,000 $249,000
State 67,000 140,000 49,000
Foreign 179,000 380,000 57,000
--------- --------- ------
595,000 1,372,000 355,000
Deferred:
Federal (1,039,000) (1,483,000) 69,000
State (195,000) (68,000) 7,000
---------- --------- -----
(1,234,000) (1,551,000) 76,000
Tax expense resulting
from allocating employee
stock option tax benefits
to additional paid-in capital 666,000 24,000
Tax expense resulting from
allocating certain tax
benefits to reduce goodwill,
including $252,000 of
previously unrecognized tax
benefits at December 31, 1994 493,000
(639,000) 980,000 455,000
Income tax benefit related
to extraordinary item (332,000)
---------- ---------- -------
Total income tax
provision (benefit) $ (971,000) $ 980,000 $455,000
========== ========= =======
During 1995 and 1994, the Company recognized $666,000 and $24,000,
respectively, in income tax benefits associated with the exercise of
employee stock options. Of the benefit recognized in 1995, $125,000
related to compensation expense deductions generated during 1994. These
income tax benefits were recorded in the accompanying consolidated
financial statements as additional paid-in capital.
In connection with the recording of the acquisition of White Knight, the
Company recognized $377,000 in previously unrecognized deferred tax assets
at December 31, 1994 through a reduction of goodwill or through an
increase in additional paid-in capital.
The income tax provision (benefit) allocated to continuing operations
using the federal statutory tax rate differs from the actual income tax
provision (benefit) as follows:
DECEMBER 31,
---------------------------------------------------------------------
1996 1995 1994
=====================================================================
Federal statutory rate $(7,016,000) $(34)% $ 148,000 34% (299,000) (34)%
State income taxes 86,000 20 45,000 5
Items not deductible for tax
purposes, primarily
goodwill and merger
costs 2,881,000 14 504,000 116 302,000 35
Tax benefit allocated to
reduce goodwill 242,000 56
Other, net 124,000 1
Valuation allowance 3,372,000 16 407,000 47
----------- ---- --------- ---- ------- ---
$ (639,000) (3)% $980,000 226% $455,000 53%
=========== ==== ========= ==== ======== ===
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amount of assets and liabilities for financial
reporting purposes and the amounts used for income tax purposes.
The following items comprise the Company's deferred taxes at December 31,
1996 and 1995:
1996 1995
Deferred income tax assets (liabilities):
Allowance for doubtful accounts $ 585,000 $ 438,000
Inventory 4,727,000 500,000
Operating loss carryforward 1,484,000
Accrued compensation 324,000 579,000
Credit carryforward 101,000
Other 156,000 (13,000)
Valuation allowance (5,792,000) (488,000)
---------- -----------
Net deferred income tax assets - current - 2,601,000
Operating loss carryforward 3,143,000
Capital loss carryforward 230,000 230,000
Intangible assets (1,000,000) (1,473,000)
Property and equipment (2,554,000) (2,513,000)
Credit carryforward 157,000
Other 24,000 (143,000)
Valuation allowance (60,000)
--------------- --------------
Net deferred income tax
liabilities - noncurrent - (3,959,000)
--------------- --------------
Net deferred income tax
assets (liabilities) $ $ (1,358,000)
=============== ==============
Gross deferred income tax assets and liabilities equaled $9,346,000 and
$3,554,000, respectively, at December 31, 1996 and $3,332,000 and
$4,142,000, respectively, at December 31, 1995.
During 1994, the Company established a valuation allowance of $644,000
with respect to deferred tax assets. Remaining net deferred tax assets at
December 31, 1994 of $354,000 were recoverable through the carryback of
such deductible temporary differences to taxable income in prior years.
During 1995, the Company reduced the valuation allowance by $96,000 to
$548,000. During 1996, the Company increased the valuation allowance by
$5,244,000 to $5,792,000.
At December 31, 1996, the Company had a net operating loss of $8,279,000
which, if not utilized, expires through 2011. $3,385,000 of the loss
relates to compensation cost deductions associated with the exercise of
employee stock options. The tax benefit relating to these deductions will,
when realized, be recorded as additional paid in capital.
7. COMMITMENTS AND CONTINGENCIES
The following items comprise the Company's outstanding purchase
commitments at December 31, 1996:
OREX degradable inventory $ 3,374,000
Equipment for Abbeville,
South Carolina manufacturing plant 147,000
Equipment for Arden,
North Carolina manufacturing plant 65,000
Other equipment 109,000
===========
$ 3,695,000
A complaint was filed against the Company, as well as its President and
Chief Financial Officer on December 13, 1995 on behalf of Peter Salit in
the United States District Court for the Northern District of Georgia. In
the complaint, the plaintiff sought class certification and damages
related to certain alleged wrongful disclosures and omissions in various
of the Company's filings with the Securities and Exchange Commission,
including allegations that certain OREX Degradables do not dissolve as
represented and cannot be manufactured as represented. On September 25,
1996, a judgment was entered by the District Court dismissing the
complaint with prejudice.
On March 22, 1995, the Internal Revenue Service ("IRS") issued a report
proposing certain adjustments to White Knight's income tax return for 1992
which approximated $864,000 in federal taxes without penalties and
interest. During 1996, the Company reached a settlement with the IRS under
which White Knight paid $229,843 in federal taxes and $75,415 in related
interest. All taxes and interest ensuing from this settlement are the
subject matter of provisions indemnifying the Company negotiated between
the Company and the sellers of White Knight as a part of the White Knight
acquisition. Such indemnification provisions provide that all payments in
the way of indemnities (including, without limitation, indemnification
payments for such taxes and interest) are subject to an aggregate
deductible amount of $250,000.
The Company is involved in routine litigation and proceedings in the
ordinary course of business. Management believes that pending litigation
matters will not have a material adverse effect on the Company's financial
position or results of operations.
The Company's SafeWaste subsidiary is a co-guarantor for a $303,000
capital lease obligation of Safewaste's joint venture, Safe Horizon.
8. REDEEMABLE COMMON STOCK
In connection with the sale of 3,000,000 shares of common stock at $7.50
per share in April 1993, the Company issued warrants to purchase 600,000
of its common shares at $7.50 per share. These warrants expired
unexercised in March 1995. The share purchaser also had an option to
require the Company to repurchase the common shares at $7.50 per share
which, in accordance with the purchase agreement, expired concurrent with
the Company's October 20, 1994 initial public offering of common stock.
Accordingly, on October 20, 1994, the carrying value of these shares was
reclassified as a component of shareholders' equity.
In connection with the December 31, 1993 acquisition of MedSurg and
Creative Research, the Company issued 991,860 shares of common stock at
$7.50 per share to Medinvest. In accordance with the terms of the
acquisition agreement, Medinvest had the option to require the Company to
repurchase up to 50% of the common shares, 495,930 shares, at $7.50 per
share exercisable between January 2, 1995 and March 31, 1995.
On January 24, 1995, the Company received notice from Medinvest of its
election to require the Company to repurchase 267,006 of the redeemable
common shares at $7.50 per share. The closing of this redemption took
place on February 24, 1995. On April 28, 1995, an additional 62,496 shares
were repurchased for $468,720, pursuant to a March 30, 1995 final
redemption election from Medinvest. The carrying value of the remaining
166,428 unredeemed shares was reclassified as a component of shareholders'
equity.
9. SHAREHOLDERS' EQUITY
Preferred Stock - On April 24, 1994, the Company authorized for future
issuance in one or more series or classes 10,000,00 shares of no par value
preferred stock. On December 19, 1996, the Company allocated 500,000 of
the authorized shares to a series of stock designated as Participating
Preferred Stock.
Common Stock and Warrants - In November 1995, the Company completed a
secondary public offering of 5,492,970 shares of its $.001 par value
common stock at $14.50 per share for proceeds of $74,359,706, net of
transaction costs of $5,288,360. A portion of the proceeds of this
offering was used to repay all of Isolyser's revolving credit borrowings.
Had this repayment been made on January 1, 1995, net income per share
would have been $0.
On August 31, 1995, the Company's Board of Directors approved a 2-for-1
stock split effected in the form of a 100% stock dividend to shareholders
of record on September 15, 1995. All share and per share data have been
adjusted to give retroactive effect to this stock split.
In November 1994, the Company completed an initial public offering of
7,170,000 shares of its $.001 par value common stock at $9 per share for
proceeds of $58,636,322, net of transaction costs of $5,893,678.
In connection with the sale of 1,255,600 shares of common stock at $3 per
share in 1991, the Company issued currently exercisable warrants to
purchase, in whole or in part, 83,708 of its common shares at $3 per
share, subject to adjustment to prevent dilution. In September 1995,
warrants to purchase 41,854 shares of common stock were exercised. On
March 7, 1996, the remaining warrants were exercised.
Stock Options - On April 28, 1992, the Company adopted the Stock Option
Plan (the "Plan") which, as amended, authorizes the issuance of up to
4,800,000 shares of common stock to certain employees, consultants, and
directors of the Company under incentive and/or nonqualified options
and/or alternate rights. An alternate right is defined as the right to
receive an amount of cash or shares of stock having an aggregate market
value equal to the appreciation in the market value of a stated number of
shares of the Company's common stock from the alternate right grant date
to the exercise date. The Plan Committee may grant alternate rights in
tandem with an option, but the grantee must exercise either the right or
the option. Options and/or rights under the Plan may be granted through
April 27, 2002 at prices not less than 100% of the market value at the
date of grant. Options and/or rights become exercisable based upon a
vesting schedule determined by the Plan Committee and become fully
exercisable upon a change in control, as defined. Options expire not more
than ten years from the date of grant and alternate rights expire at the
discretion of the Plan Committee. Through December 31, 1996, no alternate
rights had been issued.
The Company has also granted nonqualified stock options to certain
employees, nonemployees, consultants, and directors to purchase shares of
the Company's common stock outside of the Plan. Options granted expire in
various amounts through 2001.
In April 1995, the Company adopted a Director Stock Option Plan, which
authorizes the issuance of up to 30,000 shares of common stock. At
December 31, 1996, currently exercisable options for 8,000 shares were
outstanding under this plan.
A summary of option activity during the three years ended December 31,
1996 is as follows:
WEIGHTED
AVERAGE
SHARES EXERCISE
PRICE
Outstanding - December 31, 1993 2,604,783 $ 2.65
Granted 1,259,600 7.80
Exercised (259,322) 0.98
Canceled (51,080) 3.07
---------
Outstanding - December 31, 1994 3,553,981 4.59
Granted 751,613 10.30
Exercised (233,663) 4.94
Canceled (38,932) 8.39
---------
Outstanding - December 31, 1995 4,032,999 5.60
Granted 1,875,016 7.95
Exercised (983,165) 3.19
Canceled (1,111,819) 11.50
------------
Outstanding - December 31, 1996 3,813,031 5.65
============
The following table summarizes information pertaining to options
outstanding and exercisable at December 31, 1996:
WEIGHTED
AVERAGE WEIGHTED
REMAINING AVERAGE AVERAGE
RANGE OF NUMBER CONTRACTUAL EXERCISE NUMBER EXERCISE
EXERCISE PRICES OUTSTANDING LIFE (YEARS) PRICE EXERCISABLE PRICE
$.83 to $3.79 1,304,281 3.6 2.52 1,304,281 2.52
$4.64 to $9.00 2,421,917 3.1 7.03 1,325,320 6.94
$13.13 to $18.00 86,833 4.0 14.40 6,833 13.87
The fair value of options granted in 1996 and 1995 were $6.93 and $8.94,
respectively, using the Black Sholes option pricing model with the
following assumptions:
1996 1995
Dividend yield 0.00% 0.00%
Expected volatility 53.90% 53.00%
Risk free interest rate 6.03% 6.06%
Forfeiture rate 3.00% 3.00%
Expected life, in years 4.05 3.25
In April 1995, the Company adopted an Employee Stock Purchase Plan
("ESPP") which authorizes the issuance of up to 300,000 shares of common
stock. Under the ESPP, eligible employees may contribute up to 10% of
their compensation toward the purchase of common stock at each year-end.
The employee purchase price is derived from a formula based on fair market
value of the Company's common stock. At December 31, 1996 and 1995, 9,958
and 51,650 rights to purchase shares had been granted, respectively. Pro
forma compensation costs associated with the rights granted under the ESPP
is estimated based on fair market value.
Had compensation cost for the Company's stock-based compensation plans
been determined based on the fair value at the grant dates consistent with
the method of SFAS 123, the Company's pro forma net loss and net loss per
share for 1996 and 1995 would have been as follows (in thousands, except
per share amounts):
1996 1995
Net loss $ (24,577,000) $ (5,335,000)
================ ==============
Net loss per share (0.63) (0.16)
======= ======
At December 31, 1996 and 1995, shares reserved for future issuance upon
the granting and/or exercise of stock options and warrants or the purchase
of shares under the ESPP totaled 3,874,639 and 4,660,866 shares,
respectively.
Employee Stock Ownership Plan - Effective December 1, 1992, Microtek
adopted an Employee Stock Ownership Plan ("ESOP") to which the Company has
the option to contribute cash or shares of the Company's common stock.
During 1993, the Company contributed 16,500 common shares to the ESOP. On
November 29, 1993, the Company reserved an additional 148,500 common
shares at $3.64 per share for issuance to the ESOP. As consideration for
the 148,500 reserved shares, the ESOP issued a $540,000 purchase loan (the
"ESOP Loan") to the Company, payable in equal annual installments of
$79,000, including interest at 6% commencing November 29, 1994. 16,500
reserved shares have been released during each of 1996, 1995, and 1994,
resulting in compensation expense of $136,000, $71,000, and $51,250,
respectively. At December 31, 1996, 99,000 common shares with a market
value of $693,000 remain unearned under the ESOP.
The Company's contributions to the ESOP each plan year will be determined
by the Board of Directors provided that for any year in which the ESOP
Loan remains outstanding, the contributions by the Company may not be less
than the amount needed to provide the ESOP with sufficient cash to pay
installments under the ESOP Loan. The Company contributed $79,392 to the
ESOP during each of 1996, 1995, and 1994.
The unearned shares reserved for issuance under the ESOP are accounted for
as a reduction of shareholder's equity. The ESOP Loan is not recorded in
the accompanying financial statements.
Shareholder Rights Plan - On December 19, 1996, the Company adopted a
shareholder rights plan under which one common stock purchase right is
presently attached to and trades with each outstanding share of the
Company's common stock. The rights become exercisable and transferable
apart from the common stock ten days after a person or group, without the
Company's consent, acquires beneficial ownership of, or the right to
obtain beneficial ownership of, 15% or more of the Company's common stock
or announces or commences a tender offer or exchange offer that could
result in 15% ownership. Once exercisable, each right entitles the holder
to purchase one one-hundredth of a share of Participating Preferred Stock
at a price of $60.00 per one one-hundredth of a Preferred Share, subject
to adjustment to prevent dilution. The rights have no voting power and,
until exercised, no dilutive effect on net income per common share. The
rights expire on December 31, 2006, and are redeemable at the discretion
of the Board of Directors at $.001 per right.
If a person acquires 15% ownership, except in an offer approved by the
Company under the plan, then each right not owned by the acquiror or
related parties will entitle its holder to purchase, at the right's
exercise price, common stock or common stock equivalents have a market
value immediately prior to the triggering of the right of twice that
exercise price. In addition, after an acquiror obtains 15% ownership, if
the Company is involved in certain mergers, business combinations, or
asset sales, each right not owned by the acquiror or related persons will
entitle its holder to purchase, at the right's exercise price, shares of
common stock of the other party to the transaction having a market value
immediately prior to the triggering of the right of twice that exercise
price.
10. RESTRUCTURING
During 1996, the Company approved a plan to consolidate and or dispose of
certain of its noncore businesses and to consolidate certain of its
administrative functions and services (the "Restructuring"). As part of
this Restructuring, the Company recorded the following charges:
Write-down of intangible assets $ 2,623,000
Employee severance 1,113,000
Other 675,000
---------------
$ 4,411,000
In conjunction with the Restructuring, the Company recorded an impairment
loss of $2,623,000 relating to valuation adjustments on certain intangible
assets of the Company's noncore businesses to be sold. As a result of the
Restructuring, certain long-lived assets, primarily equipment with a
carrying value of $1,642,000 at December 31, 1996, are being held for
sale. The Company expects to dispose of these noncore businesses and other
assets in 1997. In accordance with SFAS 121, these assets should be
recorded at the lower of their carrying value or their fair value less
costs of disposal. The Company believes that the carrying value of these
assets approximates the fair value less costs of disposal.
11. SIGNIFICANT CUSTOMERS AND CERTAIN CONCENTRATIONS
For the year ended December 31, 1996, approximately 17%, of the Company's
sales were to one customer. Accounts receivable from this customer was
$2,688,000 at December 31, 1996. For the year ended December 31, 1995, 21%
and 11% of the Company's sales were to two customers. Accounts receivable
from such customers were $2,450,000 and $2,411,000 at December 31, 1995.
During the year ended December 31, 1994, 20%, 13%, and 10% of the
Company's sales were to three customers. Accounts receivable from these
customers at December 31, 1994 were $1,740,000, $1,011,000, and
$1,071,000.
Included in Company's consolidated balance sheet at December 31, 1996 are
the net assets of the Company's manufacturing facilities located in the
United Kingdom, Mexico, and the Dominican Republic, which total
$6,006,000.
At December 31, 1996, approximately 11% of the Company's labor force is
covered under three collective bargaining agreements none of which expire
within one year.
12. RETIREMENT PLANS
The Company maintains four 401(k) retirement plans covering employees who
meet certain age and length of service requirements, as defined. The
Company matches a portion of employee contributions to the plans. Vesting
in the Company's matching contributions are based on years of continuous
service. The Company contributed $140,391 and $102,203 to the plans during
1996 and 1995, respectively. Effective January 1, 1997, the Company merged
the existing 401(k) plans into one master 401(k) plan.
13. UNAUDITED QUARTERLY FINANCIAL INFORMATION
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
QUARTER
-----------------------------------------------------------
FIRST SECOND THIRD FOURTH
YEAR ENDED
DECEMBER 31,
1996
Net sales $ 40,334 $ 41,098 $ 42,165 $ 42,141
Gross profit 11,694 12,918 10,429 2,085
Loss before extraordinary item 438 266 (6,532) (14,166)
Net income (loss) 438 266 (7,107) (14,048)
Net income (loss) per common share 0.01 0.01 (0.18) (0.37)
1995
Net sales $ 19,134 $ 22,791 $ 26,543 $ 36,406
Gross profit 5,529 7,198 7,360 9,834
Net income (loss) 389 276 (1,090) (118)
Net income (loss) per common share 0.01 0.01 (0.03) -
ISOLYSER COMPANY, INC.
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
- -----------------------------------------------------------------------------------------------------------------
CHARGED TO
BALANCE AT CHARGED TO OTHER
BEGINNING COSTS AND ACCOUNTS DEDUCTIONS BALANCE AT
DESCRIPTION OF PERIOD EXPENSES (NOTE 1) (NOTE 2) END OF PERIOD
YEAR ENDED DECEMBER 31, 1994:
Allowance for doubtful trade
accounts receivable $ 441,605 $ 15,981 $ - $(201,041) $256,545
========= ======== =============== ========== ========
Reserve for obsolete and
slow-moving inventories $ 702,572 $195,356 $ - $(203,868) $694,060
========= ========= =============== ========== ========
YEAR ENDED DECEMBER 31, 1995:
Allowance for doubtful
trade accounts receivable $ 256,545 $ 82,832 $ 836,210 $ - $1,175,597
========= ======== ============== =========== ==========
Reserve for obsolete
and slow-moving inventories $ 694,060 $ 372,611 $ - $(454,074) $ 612,597
========= ========= =============== ========== =========
YEAR ENDED DECEMBER 31, 1996:
Allowance for doubtful trade
accounts receivable $1,175,597 $ 145,092 $ 381,390 $(4,049,233) $1,702,069
=========== ========= ============= ============ ==========
Reserve for obsolete
and slow-moving inventories $ 612,597 $9,479,426 $ - $ (51,180) $10,040,843
=========== ========== =============== ============ ============
-
Note 1: Represents allowance for doubtful accounts and reserves for
slow-moving and obsolete inventories of acquired businesses at date of
acquisition.
Note 2: "Deductions" represent amounts written off during the period less
recoveries of amounts previously written off.