UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q (Mark One) [X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTER ENDED OCTOBER 31, 1997 [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ___________ to ___________ COMMISSION FILE NUMBER 0-13608 INNOSERV TECHNOLOGIES, INC. (Exact name of Registrant as specified in its charter) CALIFORNIA 95-3619990 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 320 WESTWAY, SUITE 530, ARLINGTON, TEXAS 76018 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (817) 468-3377 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 twelve 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 ----- ----- At December 10, 1997, the Registrant had outstanding 3,009,395 shares of its common stock, $.01 par value. INNOSERV TECHNOLOGIES, INC. FORM 10-Q OCTOBER 31, 1997 TABLE OF CONTENTS Page ---- PART I - FINANCIAL INFORMATION Item 1. Financial Statements Consolidated Balance Sheets as of October 31, 1997 and April 30, 1997 3 Consolidated Statements of Operations for the three months ended October 31, 1997 and 1996 4 Consolidated Statements of Operations for the six months ended October 31, 1997 and 1996 5 Consolidated Statements of Cash Flows for the six months ended October 31, 1997 and 1996 6 Notes to Consolidated Financial Statements 7 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 10 PART II - OTHER INFORMATION Item 1. Legal Proceedings 14 Item 4. Submission of Matters to a Vote of Security Holders 14 Item 6. Exhibits and Reports on Form 8-K 14 SIGNATURES 15 INDEX TO EXHIBITS 16 2 INNOSERV TECHNOLOGIES, INC. CONSOLIDATED BALANCE SHEETS (In thousands, except share amounts) October 31, 1997 April 30, (Unaudited) 1997 ----------- --------- ASSETS Current Assets Cash and cash equivalents $ 2,695 $ 1,806 Receivables 3,068 3,693 Inventory: Spare parts and supplies, net 4,547 4,484 Inventory held for sale 1,041 772 Prepaid expenses 251 453 ----------- --------- Total current assets 11,602 11,208 Capital equipment, net 3,802 4,491 Goodwill, net 3,316 3,392 Other assets 7 11 ----------- --------- $ 18,727 $ 19,102 ----------- --------- ----------- --------- LIABILITIES AND SHAREHOLDERS' EQUITY Current Liabilities Current portion of long-term debt $ 657 $ 629 Accounts payable 4,271 3,658 Accrued liabilities 1,762 2,224 Deferred revenues 4,208 3,719 ----------- --------- Total current liabilities 10,898 10,230 Long-term debt, less current portion 155 479 Shareholders' Equity Preferred stock, $.01 par value: 5,000,000 shares authorized; no shares issued -- -- Common stock, $.01 par value: 10,000,000 shares authorized; 5,035,833 issued 51 51 Paid-in capital 17,303 17,303 Accumulated deficit (9,680) (8,961) ----------- --------- Total shareholders' equity 7,674 8,393 ----------- --------- $ 18,727 $ 19,102 ----------- --------- ----------- --------- The accompanying notes are an integral part of these financial statements. 3 INNOSERV TECHNOLOGIES, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited) (In thousands, except per share data) Three Months Ended October 31, ----------------------- 1997 1996 -------- -------- Revenues: Service $ 7,761 $ 8,644 Sale of parts and equipment 1,446 2,040 -------- -------- Total revenues 9,207 10,684 Costs: Cost of service 7,283 7,755 Cost of parts and equipment 651 1,366 -------- -------- Total cost of operations 7,934 9,121 Gross profit 1,273 1,563 Depreciation and amortization 430 505 Selling and administrative expenses 1,307 1,445 -------- -------- Loss from operations (464) (387) Interest expense, net 3 69 -------- -------- Loss before income taxes (467) (456) Provision for income taxes -- -- -------- -------- Net loss $ (467) $ (456) -------- -------- -------- -------- Per share information: Net loss $ (.09) $ (.09) -------- -------- -------- -------- Weighted average shares outstanding 5,036 5,036 -------- -------- -------- -------- The accompanying notes are an integral part of these financial statements. 4 INNOSERV TECHNOLOGIES, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited) (In thousands, except per share data) Six Months Ended October 31, ------------------------ 1997 1996 --------- --------- Revenues: Service $ 15,295 $ 17,783 Sale of parts and equipment 3,056 4,689 --------- --------- Total revenues 18,351 22,472 Costs: Cost of service 14,393 16,165 Cost of parts and equipment 1,142 2,979 --------- --------- Total cost of operations 15,535 19,144 Gross profit 2,816 3,328 Depreciation and amortization 824 1,016 Selling and administrative expenses 2,691 3,299 --------- --------- Loss from operations (699) (987) Interest expense, net 20 96 --------- --------- Loss before income taxes (719) (1,083) Provision for income taxes -- -- --------- --------- Net loss $ (719) $ (1,083) --------- --------- Per share information: Net loss $ (.14) $ (.22) --------- --------- --------- --------- Weighted average shares outstanding 5,036 5,036 --------- --------- --------- --------- The accompanying notes are an integral part of these financial statements. 5 INNOSERV TECHNOLOGIES, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) (In thousands) Six Months Ended October 31, ------------------------ 1997 1996 --------- ---------- Cash flows from: Operations - Net loss $ (719) $ (1,083) Adjustments to reconcile net loss to net cash flows from operations: Depreciation and amortization 824 1,016 Changes in assets and liabilities: Receivables 625 1,025 Inventory (332) 1,189 Prepaid expenses 202 (68) Other assets 3 37 Accounts payable 613 (488) Accrued liabilities (462) (609) Deferred revenues 490 (542) --------- ---------- Net cash provided by operations 1,244 477 Investments and acquisitions - Purchase of capital equipment (59) (163) --------- ---------- Net cash used for investments and acquisitions (59) (163) Financing activities - Borrowings from line of credit -- 242 Principal payments of long-term debt (296) (331) --------- ---------- Net cash used for financing activities (296) (89) --------- ---------- Net increase in cash and cash equivalents 889 225 Cash and cash equivalents at beginning of period 1,806 941 --------- ---------- Cash and cash equivalents at end of period $ 2,695 $ 1,166 --------- ---------- --------- ---------- The accompanying notes are an integral part of these financial statements. 6 INNOSERV TECHNOLOGIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS OCTOBER 31, 1997 (UNAUDITED) 1. GENERAL The consolidated financial statements included herein have been prepared by InnoServ Technologies, Inc. ("InnoServ") without audit, include all adjustments which are, in the opinion of management, necessary for a fair presentation of the results of operations for the three months and six months ended October 31, 1997 and 1996, pursuant to the rules and regulations of the Securities and Exchange Commission, and include the accounts of InnoServ and its consolidated subsidiaries. All significant intercompany accounts and transactions have been eliminated. Any and all adjustments made are of a normal and recurring nature in accordance with Rule 10-01(b)(8) of Regulation S-X. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulation, however, InnoServ believes that the disclosures in such financial statements are adequate to make the information presented not misleading. These financial statements should be read in conjunction with InnoServ's annual report on Form 10-K for the fiscal year ended April 30, 1997, filed with the Securities and Exchange Commission. The results of operations for the six months ended October 31, 1997, are not necessarily indicative of the results that may be expected for the year ending April 30, 1998. Certain reclassifications have been made in the prior year's consolidated financial statements to conform to the fiscal 1998 presentation. 2. INTEREST EXPENSE, NET Interest expense is net of interest income of $18,000 and $8,000 for the three months ended October 31, 1997 and 1996, respectively. Interest expense is net of interest income of $34,000 and $23,000 for the six months ended October 31, 1997 and 1996, respectively. 3. SUPPLEMENTAL CASH FLOW DISCLOSURE Interest and income taxes paid in the six months ended October 31, 1997 and 1996 were as follows: Six Months Ended October 31, --------------------- 1997 1996 -------- --------- Interest $ 48,000 $ 124,000 Income taxes $ 5,000 $ 53,000 7 INNOSERV TECHNOLOGIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS OCTOBER 31, 1997 (UNAUDITED) 4. EARNINGS PER SHARE Earnings per share amounts are computed based upon the weighted average shares of common stock and common stock equivalents outstanding during each period. Outstanding stock options are included as common stock equivalents using the treasury stock method. If the computation of fully diluted earnings per share is anti-dilutive, only primary earnings per share amounts are presented. 5. LONG-TERM DEBT On April 14, 1997 InnoServ entered into a new loan agreement with a bank pursuant to which amounts outstanding under InnoServ's prior revolving line of credit and term loan agreements with the bank were converted into a new term loan aggregating $1,198,000. Borrowings under the new term loan bear interest at the rate of prime (8.5% at October 31, 1997) plus 1% per annum. Monthly principal installments of $54,000 plus interest are required through January 8, 1999. Obligations under the loan agreement are secured by a security interest in InnoServ's accounts receivable, inventory and capital equipment. The loan agreement contains financial covenants including maintenance of certain financial ratios, net worth requirements and restrictions on future borrowings and payment of dividends. As a result of the loss for the period, InnoServ failed to meet the net worth covenant under the loan agreement as of October 31, 1997. InnoServ's bank waived this event of default and has amended the net worth covenant effective October 31, 1997 through the expiration date of the loan agreement of January 8, 1999. InnoServ was in compliance with the financial covenants, as amended, at October 31, 1997. 6. SUBSEQUENT EVENT Pursuant to a Stock Purchase Agreement dated November 13, 1997 ("Agreement"), among InnoServ, a California corporation, MEDIQ Incorporated ("MEDIQ") and MEDIQ Investment Services, Inc. ("MIS" and together with MEDIQ, collectively the "Seller"), each a Delaware corporation, InnoServ reacquired from Seller 2,026,438 shares of InnoServ's common stock ("Shares") and a warrant to purchase 325,000 shares of InnoServ's common stock ("Warrant"). Such 2,026,438 shares represented approximately 40% of the then outstanding shares of common stock of InnoServ. The Shares and Warrant had been issued to MEDIQ in connection with InnoServ's acquisition of MEDIQ Equipment and Maintenance Services, Inc., a wholly-owned subsidiary of MEDIQ, in August 1994. 8 INNOSERV TECHNOLOGIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS OCTOBER 31, 1997 (UNAUDITED) Under the terms of the Agreement, no cash payment was made for the reacquisition of the Shares and Warrant. However, in the event of a change of control of InnoServ prior to April 1, 1998, Seller will be entitled to certain payments from the acquiring party as if 100% of the Shares remained outstanding. In the event of a change of control of InnoServ from and after April 1, 1998 and through September 30, 1998, Seller will be entitled to certain payments as if 50% of the Shares remained outstanding. Additionally, in connection with the transaction, MEDIQ and InnoServ agreed to terminate certain continuing arrangements including the right to designate two directors. Consequently, Thomas E. Carroll, President and Chief Executive Officer of MEDIQ, who had been serving at MEDIQ's designation, resigned from InnoServ's Board of Directors. Michael Sandler, the former Chief Financial Officer of MEDIQ, who also had been serving at MEDIQ's designation, will continue as a director of InnoServ. 9 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS RESULTS OF OPERATIONS SECOND QUARTER FISCAL 1998 COMPARED TO SECOND QUARTER FISCAL 1997 Consolidated revenues for the second quarter of fiscal 1998 were $9,207,000 as compared to $10,684,000 in the same period of fiscal 1997, a decline of $1,477,000, or 14 percent. The decline in revenues is primarily attributable to a decrease of $1,200,000 resulting from the disposition of substantially all of the revenue producing assets of Advanced Imaging Technologies ("AIT"), a wholly owned subsidiary of InnoServ, on March 17, 1997. Revenues from computerized tomography ("CT") maintenance service agreements decreased approximately $650,000 primarily as a result of the continued decline in the number and average contract amount of CT maintenance service agreements in effect as older equipment is being upgraded or removed from service by customers and InnoServ's decision to not renew certain CT maintenance agreements in unprofitable locations. Offsetting these declines, revenues from comprehensive asset management services ("Asset Management") and multi-vendor services increased approximately $290,000 as InnoServ continues to focus on the growing market for these type services. In addition, after taking into effect the disposal of AIT, sales of spare parts increased by approximately $170,000. Cost of operations decreased $1,187,000 from the same period in the prior fiscal year primarily as a result of the disposition of AIT. As a percent of on-going revenues, cost of operations for the second quarter of 1998 was 85%, unchanged from the same period of fiscal 1997. Selling and administrative expenses decreased $138,000, or 10 percent, from the prior year primarily as a result of reductions in InnoServ's administrative functions resulting from the disposal of AIT. Depreciation and amortization expenses decreased by $75,000 due to the completed depreciation of certain capital equipment and a change in the estimated remaining life of certain other assets. The loss before income taxes for the second quarter of fiscal 1998 was $467,000 as compared to a loss of $456,000 in the second quarter of fiscal 1997. The loss for fiscal 1998 was primarily the result of unfavorable operating margins associated with InnoServ's maintenance business. Because InnoServ employs field service engineers over a wide geographic area, the current level of revenues are not sufficient in certain locations to cover the direct and indirect costs of providing maintenance and repair services. In February 1997, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 128, "Earnings per Share". InnoServ is required to adopt SFAS No. 128 in the third quarter of fiscal 1998. The adoption of this standard is not expected to materially impact InnoServ's earnings per share calculations. The adoption will have no impact on InnoServ's results of operations. 10 In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive Income", and No. 131, "Disclosures about Segments of an Enterprise and Related Information." SFAS No. 130 requires that an enterprise report, by major component and as a single total, the change in its equity during the period from nonshareholder sources, and SFAS No. 131 establishes annual and interim reporting requirements for an enterprise's operating segments and related disclosures about its products and services, geographical areas in which it operates and major customers. Both statements are effective for fiscal years beginning after December 15, 1997, with earlier application permitted. Adoption of these statements is not expected to materially impact InnoServ's consolidated financial position or statements of operations, shareholders' equity and cash flows. Effects of the adoption of these statements, if any, will primarily be limited to the form and content of InnoServ's disclosures. SIX MONTHS FISCAL 1998 COMPARED TO SIX MONTHS FISCAL 1997 Consolidated revenues for the first six months of fiscal 1998 were $18,351,000 as compared to $22,472,000 in the same period of fiscal 1997, a decline of $4,121,000, or 18 percent. The decline in revenues is primarily attributable to a decrease of $2,900,000 resulting from the disposition of substantially all of the revenue producing assets of AIT on March 17, 1997. Revenues from CT maintenance service agreements decreased approximately $1,800,000 primarily as a result of the continued decline in the number and average contract amount of CT maintenance service agreements in effect as older equipment is being upgraded or removed from service by customers and InnoServ's decision to not renew certain CT maintenance agreements in unprofitable locations. Offsetting these declines, revenues from Asset Management and multi-vendor services increased approximately $370,000 as InnoServ continues to focus on the growing market for these type services. In addition, after taking into effect the disposal of AIT, sale of spare parts increased by approximately $420,000. Cost of operations decreased $3,609,000 from the same period in the prior fiscal year, primarily as a result of the disposition of AIT and the decline in on-going revenues. As a percent of on-going revenues, cost of operations for the first six months of 1998 was 85%, unchanged from the first six months of fiscal 1997. Selling and administrative expenses decreased $608,000, or 18 percent, from the prior year primarily as a result of reductions in InnoServ's administrative functions resulting from the disposal of AIT and cost containment activities. Depreciation and amortization expenses decreased $192,000 from fiscal 1997 due to the completed depreciation of certain capital equipment and a change in the estimated remaining life of certain other assets. The loss before income taxes for the first six months of fiscal 1998 was $719,000 as compared to a loss of $1,083,000 in the first six months of fiscal 1997. The loss in fiscal 1998 was primarily the result of unfavorable operating margins associated with InnoServ's maintenance business. Because InnoServ employs field service engineers over a wide geographic area, the current level of revenues are not sufficient in certain locations to cover the direct and indirect costs of providing maintenance and repair services. InnoServ is continuing to implement plans to reorganize its service operations to more cost effectively provide the services required by its customers and to discontinue service in selected locations upon the expiration of the existing maintenance agreements in those locations. InnoServ believes these actions, coupled with strategic changes it is making in the operations of the CT and Asset Management business and efforts to expand the revenue base, will improve InnoServ's operations. 11 InnoServ did not recognize a tax benefit from the operating loss for the first six months of fiscal 1998. Under SFAS No. 109, "Accounting for Income Taxes", net operating losses enter into the calculation of deferred tax assets and liabilities. At October 31, 1997, InnoServ had an estimated net deferred tax asset of $5,800,000, primarily as a result of net operating losses. In accordance with SFAS No. 109, InnoServ recorded a valuation allowance for the full amount of the net deferred tax asset. The ultimate realization of the deferred tax asset depends on the ability of InnoServ to generate sufficient taxable income in the future. While InnoServ believes the deferred tax asset will be substantially realized by future operating results, due to the cumulative losses incurred in recent years the deferred tax assets do not currently meet the criteria for recognition under SFAS No. 109. LIQUIDITY AND CAPITAL RESOURCES At October 31, 1997, InnoServ had working capital of $704,000, of which $2,695,000 was in cash and cash equivalents. Operations provided $1,244,000 of cash for the six months ended October 31, 1997, primarily as a result of a $625,000 reduction in accounts receivable due to successful collection activities and lower revenues, an increase in accounts payable of $613,000 due to the timing of cash disbursements, and an increase in deferred revenues of $490,000 as payments received for services to be provided exceeded services provided during the period. These cash increases were offset by a reduction of accrued liabilities of $462,000 and an increase in inventory of $332,000 due to the purchase of spare parts and x-ray tubes required to service newer technology CT and magnetic resonance imaging scanners. Cash provided by operations was used to fund $59,000 of capital equipment purchases and $296,000 of principal payments of long-term debt during the period. InnoServ's allowance for doubtful accounts at October 31, 1997 was $851,000, or 22 percent of gross accounts receivable. InnoServ's customers include hospitals, physician practices, outpatient clinics and entrepreneurial operations. Some of these customers are thinly capitalized, operate on small margins and experience cash flow difficulties due to the lengthy time required to receive reimbursements from Medicare and insurance companies. Factors impacting InnoServ's allowance for doubtful accounts include the changes occurring in the healthcare industry, primarily the move to managed care, which has weakened healthcare providers' ability to honor their debts and have forced some of the providers out of business. On April 14, 1997 InnoServ entered into a new loan agreement with a bank pursuant to which amounts outstanding under InnoServ's prior revolving line of credit and term loan agreements with the bank were converted into a new term loan aggregating $1,198,000. Borrowings under the new term loan bear interest at the rate of prime (8.5% at October 31, 1997) plus 1% per annum. Monthly principal installments of $54,000 plus interest are required through January 8, 1999. Obligations under the loan agreement are secured by a security interest in InnoServ's accounts receivable, inventory and capital equipment. The loan agreement contains financial covenants including maintenance of certain financial ratios, net worth requirements and restrictions on future borrowings and payment of dividends. As a result of the loss for the period, InnoServ failed to meet the net worth covenant under the loan agreement as of October 31, 1997. InnoServ's bank waived this event of default and has amended the net worth covenant effective October 31, 1997 through the expiration date of the loan agreement of January 8, 1999. InnoServ was in compliance with the financial covenants, as amended, at October 31, 1997. 12 InnoServ does not foresee the need to make significant amounts of capital purchases in the next twelve months and believes sufficient funds will be available from its operations to meet its working capital requirements. Should cash flows from operations not be sufficient to meet all of InnoServ's cash requirements, InnoServ would attempt to obtain a line of credit to provide the necessary funds. CAUTIONARY STATEMENT The statements in this Management's Discussion and Analysis and elsewhere in this report that are forward looking are based on current expectations which involve numerous risks and uncertainties. InnoServ's future results of operations and financial condition may differ materially due to many factors including InnoServ's ability to attract and retain Asset Management contracts, competitive and regulatory conditions in the healthcare industry generally, and other factors, many of which are beyond the control of InnoServ. 13 PART II - OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS InnoServ is party to a lawsuit filed on April 12, 1995 in Superior Court in the County of Riverside, California, by two former employees who have claimed wrongful termination in retaliation for filing a claim with the U.S. Department of Labor. The plaintiffs have sought damages in the amount of approximately $1,000,000 in the aggregate. In July 1997, one of the plaintiffs accepted an offer of compromise made by InnoServ for significantly less than the damages sought by such plaintiff. InnoServ funded this settlement in early September 1997. The amount of the settlement was accrued in a previous period and did not impact the earnings of the three months and six months ended October 31, 1997. InnoServ continues to defend itself against the other plaintiff and believes the ultimate liability related to this matter will not exceed amounts currently accrued in the financial statements. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS The annual meeting of shareholders was held on September 15, 1997. At the annual meeting the shareholders elected directors to hold office until the 1998 annual meeting of shareholders and until their successors are elected and qualified. The following directors were elected: VOTES CAST ------------------------- DIRECTOR FOR WITHHELD ------------------- --------- -------- Thomas E. Carroll 3,651,302 9,025 Bernard J. Korman 3,651,902 8,425 Michael G. Puls 3,651,902 8,425 Dudley A. Rauch 3,651,902 8,425 Michael M. Sachs 3,651,902 8,425 Samuel Salen, M.D. 3,651,902 8,425 Michael F. Sandler 3,651,302 9,025 David A. Wegmann 3,651,902 8,425 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K. (a) Exhibits: The information required by this portion of Item 6 is set forth in the Index to Exhibits beginning on page 16. (b) Reports on Form 8-K: During the three months ended October 31, 1997 no reports were filed by the Registrant on Form 8-K. 14 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. DATED: December 10, 1997 INNOSERV TECHNOLOGIES, INC. By: /s/ Thomas Hoefert ------------------------ Thomas Hoefert Vice President and Chief Financial Officer (Duly Authorized Officer and Principal Financial and Accounting Officer) 15 INDEX TO EXHIBITS Exhibit No. Description of Exhibit --- ---------------------- 10.1 Letter Agreement of Employment dated September 10, 1997 by and between Registrant and Thomas E. Hoefert. 10.2 Indemnity Agreement dated as of September 29, 1997 by and between Registrant and Thomas E. Hoefert. 10.3 Bonus Agreement dated as of September 29, 1997 between Registrant and Thomas E. Hoefert. 10.4 Letter Agreement dated December 5, 1997 amending the Loan Agreement dated as of April 14, 1997, by and between Registrant and Overton Bank & Trust, N.A. 11.1 Computation of Per Share Earnings. 27.1 Financial Data Schedule. 16