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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
/X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED APRIL 4, 1999
OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ______________ TO ______________
COMMISSION FILE NUMBER 0-9428
ADAC LABORATORIES
(Exact name of registrant as specified in its charter)
CALIFORNIA 94-1725806
(State or other jurisdiction of (I.R.S. Employer Identification
incorporation or organization) No.)
540 ALDER DRIVE 95035
MILPITAS, CALIFORNIA (Zip Code)
(Address of principal executive offices)
(408) 321-9100
(Registrant's telephone number including area code)
NOT APPLICABLE
(Former name, former address and former fiscal year, if changed since last
report)
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 / / No /X/
As of May 31, 1999, Registrant had outstanding 20,497,324 shares of Common
Stock, no par value.
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(This document contains a total of 28 pages)
ADAC LABORATORIES
QUARTERLY REPORT ON FORM 10-Q
INDEX
PAGE
-----
Part I Financial Information
Item 1. Financial Statements
Condensed Consolidated Statements of Operations for the Three-Month and
Six-Month Periods Ended April 4, 1999 and March 29, 1998.................................... 3
Condensed Consolidated Balance Sheets at April 4, 1999 and September 27, 1998................. 4
Condensed Consolidated Statements of Cash Flows for the Six-Month Periods
Ended April 4, 1999 and March 29, 1998...................................................... 5
Notes to Condensed Consolidated Financial Statements.......................................... 6
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations......... 13
Part II. Other Information
Item 5. Other Information............................................................................. 26
Item 6. Exhibits and Reports on Form 8-K.............................................................. 26
Signatures.................................................................................... 27
Exhibit Index................................................................................. 28
27 Financial Data Schedule
2
PART I--FINANCIAL INFORMATION
ADAC LABORATORIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
THREE MONTHS ENDED SIX MONTHS ENDED
----------------------- ----------------------
APRIL 4, MARCH 29, APRIL 4, MARCH 29,
1999 1998 1999 1998
---------- ----------- ---------- ----------
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
REVENUES, NET:
Product......................................................... $ 63,520 $ 53,801 $ 134,426 $ 101,820
Service......................................................... 23,873 20,721 47,246 40,140
---------- ----------- ---------- ----------
87,393 74,522 181,672 141,960
---------- ----------- ---------- ----------
COST OF REVENUES:
Product......................................................... 55,697 28,990 94,782 56,150
Service......................................................... 18,250 13,853 34,829 25,696
Discontinued product............................................ -- -- -- 14,494
---------- ----------- ---------- ----------
73,947 42,843 129,611 96,340
---------- ----------- ---------- ----------
GROSS PROFIT...................................................... 13,446 31,679 52,061 45,620
---------- ----------- ---------- ----------
OPERATING EXPENSES:
Marketing and sales............................................. 19,138 11,915 34,601 23,473
Research and development........................................ 4,478 3,963 8,844 9,281
General and administrative...................................... 15,888 5,473 24,227 10,060
Goodwill amortization........................................... 502 545 990 1,037
Restructuring charges........................................... 800 -- 3,300 --
---------- ----------- ---------- ----------
40,806 21,896 71,962 43,851
---------- ----------- ---------- ----------
OPERATING INCOME (LOSS)........................................... (27,360) 9,783 (19,901) 1,769
---------- ----------- ---------- ----------
Interest and other expense, net................................... 1,741 965 2,981 1,928
---------- ----------- ---------- ----------
INCOME (LOSS) BEFORE PROVISION FOR INCOME TAXES................... (29,101) 8,818 (22,882) (159)
Provision (benefit) for income tax................................ (8,310) 3,439 (5,947) (62)
---------- ----------- ---------- ----------
NET INCOME (LOSS)................................................. $ (20,791) $ 5,379 $ (16,935) $ (97)
---------- ----------- ---------- ----------
---------- ----------- ---------- ----------
NET INCOME (LOSS) PER SHARE
Basic........................................................... $ (1.02) $ .28 $ (.83) $ (.01)
---------- ----------- ---------- ----------
---------- ----------- ---------- ----------
Diluted......................................................... $ (1.02) $ .27 $ (.83) $ (.01)
---------- ----------- ---------- ----------
---------- ----------- ---------- ----------
NUMBER OF SHARES USED IN PER SHARE CALCULATIONS
Basic........................................................... 20,456 19,226 20,414 19,097
---------- ----------- ---------- ----------
---------- ----------- ---------- ----------
Diluted......................................................... 20,456 20,223 20,414 19,097
---------- ----------- ---------- ----------
---------- ----------- ---------- ----------
The accompanying notes are an integral part of these condensed consolidated
financial statements.
3
ADAC LABORATORIES
CONDENSED CONSOLIDATED BALANCE SHEETS
APRIL 4, SEPTEMBER 27,
1999 1998
----------- -------------
(UNAUDITED)
(AMOUNTS IN THOUSANDS)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents.......................................................... $ 1,449 $ 4,869
Accounts receivable, net of allowance for returns and doubtful accounts of $11,478 in
1999 and $2,319 in 1998.............................................................. 84,868 55,316
Tax and other receivables.......................................................... 6,861 7,294
Inventories, net................................................................... 54,050 78,311
Prepaid expenses and other current assets.......................................... 6,793 4,928
----------- -------------
TOTAL CURRENT ASSETS............................................................. 154,021 150,718
Service parts, net................................................................. 19,562 18,063
Fixed assets, net.................................................................. 15,882 11,007
Capitalized software, net.......................................................... 15,489 11,770
Intangibles, net................................................................... 24,115 25,336
Deferred income taxes.............................................................. 30,114 24,167
Other assets, net.................................................................. 1,246 2,748
----------- -------------
TOTAL ASSETS..................................................................... $ 260,429 $ 243,809
----------- -------------
----------- -------------
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Notes payable to banks............................................................. $ 39,095 $ 23,396
Accounts payable................................................................... 20,211 22,887
Deferred revenues.................................................................. 18,605 11,591
Customer deposits and advanced billings............................................ 7,919 2,004
Accrued compensation............................................................... 11,836 8,903
Warranty and installation.......................................................... 6,080 6,595
Other accrued liabilities.......................................................... 17,604 14,423
----------- -------------
TOTAL CURRENT LIABILITIES........................................................ 121,350 89,799
Non-current deferred income taxes.................................................... 13,988 14,026
Non-current liabilities and deferred credits......................................... 2,755 3,082
----------- -------------
TOTAL LIABILITIES................................................................ 138,093 106,907
----------- -------------
SHAREHOLDERS' EQUITY:
Preferred stock, no par value:
Authorized: 5,000 shares;
Issued and outstanding: none
Common stock, no par value:
Authorized: 50,000 shares;
Issued and outstanding: 20,476 shares at April 4, 1999 and 20,253 shares at
September 27, 1998............................................................... 153,203 149,599
Accumulated deficit................................................................ (27,201) (10,266)
Translation adjustment............................................................. (3,666) (2,431)
----------- -------------
TOTAL SHAREHOLDERS' EQUITY....................................................... 122,336 136,902
----------- -------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY....................................... $ 260,429 $ 243,809
----------- -------------
----------- -------------
The accompanying notes are an integral part of these condensed consolidated
financial statements.
4
ADAC LABORATORIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
SIX MONTHS ENDED
----------------------
APRIL 4, MARCH 29,
1999 1998
---------- ----------
(AMOUNTS IN THOUSANDS)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss................................................................................. $ (16,935) $ (97)
Adjustments to reconcile net loss to net cash Provided by (used in) operating activities:
Depreciation and amortization........................................................ 7,742 6,216
Provision for product returns and doubtful accounts.................................. 9,758 2,530
Deferred income taxes................................................................ (5,985) (3,729)
Inventory allowance.................................................................. 7,741 433
Discontinued products................................................................ -- 14,494
Restructuring charges................................................................ 3,300 --
Changes in assets and liabilities:
Accounts receivable................................................................ (39,310) (9,908)
Tax and other receivables.......................................................... 433 --
Inventories........................................................................ 16,520 (15,548)
Prepaid expenses and other current assets.......................................... (1,865) (1)
Service parts...................................................................... (2,959) (1,746)
Accounts payable................................................................... (2,676) 6,155
Deferred revenues.................................................................. 7,014 (1,354)
Customer deposits and advance billings............................................. 5,915 (874)
Accrued compensation............................................................... 2,933 (490)
Warranty and other accrued liabilities............................................. (634) 4,919
Non-current liabilities and deferred credits....................................... (327) (21)
---------- ----------
Cash provided by (used in) operating activities.......................................... (9,335) 979
---------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures................................................................... (8,009) (2,362)
Increase in other assets............................................................... (3,909) (2,666)
Intangibles............................................................................ (235) (7,134)
Acquisition assets, net................................................................ -- 807
---------- ----------
Cash used in investing activities........................................................ (12,153) (11,355)
---------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Borrowings (repayments) under short term Debt arrangements, net........................ 15,699 6,496
Proceeds from issuance of common stock, net............................................ 3,604 4,885
---------- ----------
Cash provided by financing activities.................................................... 19,303 11,381
---------- ----------
Effect of exchange rates on cash......................................................... (1,235) (987)
---------- ----------
Net increase (decrease) in cash and cash equivalents..................................... (3,420) 18
Cash and cash equivalents, at beginning of the period.................................... 4,869 5,088
---------- ----------
Cash and cash equivalents, at end of the period.......................................... $ 1,449 $ 5,106
---------- ----------
SUPPLEMENTAL CASH FLOW DISCLOSURE:
Interest paid.......................................................................... $ 1,164 $ 1,928
Income taxes paid...................................................................... $ 445 $ 2,668
5
ADAC LABORATORIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. BASIS OF PRESENTATION
The accompanying unaudited condensed interim consolidated financial
statements have been prepared in accordance with generally accepted accounting
principles for interim financial information and with the instructions to Form
10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of
the information and footnotes required by generally accepted accounting
principles for annual financial statements. In the opinion of management, the
condensed interim consolidated financial statements include all normal recurring
adjustments necessary for a fair presentation of the information required to be
included, however, see Note 16, "South American Operations." Operating results
for the three and six-month periods ended April 4, 1999 are not necessarily
indicative of the results that may be expected for any future periods, including
the full fiscal year. Reference should also be made to the Annual Consolidated
Financial Statements, Notes thereto, and Management's Discussion and Analysis of
Financial Condition and Results of Operations contained in the Company's Annual
Report on Form 10-K for the fiscal year ended September 27, 1998.
2. NET INCOME (LOSS) PER SHARE
Basic net income (loss) per share has been computed using the weighted
average number of common shares outstanding. Diluted net income per share
includes the dilutive effect of common stock options and warrants using the
treasury stock method. The calculation of basic and diluted earnings per share
(EPS) for the three and six-month periods ended April 4, 1999 and March 29, 1998
are as follows:
THREE MONTHS ENDED SIX MONTHS ENDED
----------------------- -----------------------
APRIL 4, MARCH 29, APRIL 4, MARCH 29,
1999 1998 1999 1998
---------- ----------- ---------- -----------
(DOLLAR AMOUNTS IN THOUSANDS EXCEPT PER SHARE
DATA)
Basic EPS: Net Income (loss)...................................... $ (20,791) $ 5,379 $ (16,935) $ (97)
Denominator: Weighted Average Common Shares Outstanding........... 20,456 19,226 20,414 19,097
---------- ----------- ---------- -----------
Basic EPS......................................................... $ (1.02) $ .28 $ (.83) $ (.01)
---------- ----------- ---------- -----------
---------- ----------- ---------- -----------
Diluted EPS: Net Income (loss).................................... $ (20,791) $ 5,379 $ (16,935) $ (97)
Denominator: Weighted Average Common Shares Outstanding........... 20,456 19,226 20,414 19,097
Options........................................................... -- 997 -- --
---------- ----------- ---------- -----------
Total shares...................................................... 20,456 20,223 20,414 19,097
---------- ----------- ---------- -----------
---------- ----------- ---------- -----------
Diluted EPS....................................................... $ (1.02) $ .27 $ (.83) $ (.01)
---------- ----------- ---------- -----------
---------- ----------- ---------- -----------
If the Company had net income in the three-month period ended April 4, 1999,
and the six-month periods ended April 4, 1999 and March 29, 1998, the total
diluted shares would have included options of 290,000, 575,000 and 933,000,
respectively.
3. DEPRECIATION AND AMORTIZATION
Depreciation and amortization was approximately $3.7 million and $2.8
million for the three-month periods ended April 4, 1999 and March 29, 1998,
respectively.
6
ADAC LABORATORIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
4. INVENTORIES
APRIL 4,
1999 SEPTEMBER 27, 1998
------------ ------------------
(DOLLAR AMOUNTS IN THOUSANDS)
Inventories consist of:
Purchased parts and sub-assemblies.............................................. $ 19,061 $ 17,452
Work in process................................................................. 5,496 5,713
Finished goods.................................................................. 39,188 59,217
------------ -------
63,745 82,382
Less reserves................................................................... (9,695) (4,071)
------------ -------
$ 54,050 $ 78,311
------------ -------
------------ -------
5. SERVICE PARTS
APRIL 4,
1999 SEPTEMBER 27, 1998
------------ ------------------
(DOLLAR AMOUNTS IN THOUSANDS)
Service parts consist of:
Field service parts, at cost.................................................... $ 29,286 $ 26,327
Less accumulated depreciation................................................... (9,724) (8,264)
------------ -------
$ 19,562 $ 18,063
------------ -------
------------ -------
6. FIXED ASSETS
APRIL 4,
1999 SEPTEMBER 27, 1998
------------ ------------------
(DOLLAR AMOUNTS IN THOUSANDS)
Fixed assets, at cost, consist of:
Production and test equipment................................................... $ 6,086 $ 4,351
Field service equipment......................................................... 1,127 1,168
Office and demonstration equipment.............................................. 20,610 14,401
Leasehold improvements.......................................................... 1,367 1,261
------------ --------
29,190 21,181
Less accumulated depreciation and Amortization.................................. (13,308) (10,174)
------------ --------
$ 15,882 $ 11,007
------------ --------
------------ --------
7
ADAC LABORATORIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
7. INTANGIBLES
APRIL 4,
1999 SEPTEMBER 27, 1998
------------ ------------------
(DOLLAR AMOUNTS IN THOUSANDS)
Intangibles consist of:
Goodwill........................................................................ $ 21,803 $ 21,849
Acquired technology............................................................. 9,136 8,984
Other........................................................................... 606 510
------------ -------
31,545 31,343
Less accumulated amortization................................................... (7,430) (6,007)
------------ -------
$ 24,115 $ 25,336
------------ -------
------------ -------
8. OTHER ACCRUED LIABILITIES
APRIL 4,
1999 SEPTEMBER 27, 1998
------------ ------------------
(DOLLAR AMOUNTS IN THOUSANDS)
Other accrued liabilities consist of:
Accrued cost of revenue......................................................... $ 2,966 $ 3,354
Accrued restructuring........................................................... 2,514 --
Customer advances............................................................... 2,022 2,775
Accrued legal and accounting.................................................... 1,589 194
Accrued royalties............................................................... 1,540 956
Other accrued expenses.......................................................... 6,973 7,144
------------ -------
$ 17,604 $ 14,423
------------ -------
------------ -------
On September 27, 1998, the Company concluded a comprehensive review of its
international operations and decided to restructure its European and Latin
American businesses. As a result, the Company took charges in the fiscal first
and second quarters of 1999 of $2.5 million and $0.8 million, respectively. The
restructuring costs were comprised of $2.9 million for severance expenses, $.2
million for legal and consulting costs, and $0.2 million for other costs
associated with the restructuring. As of April 4, 1999 $2.5 million remained in
the accrual for restructuring costs comprised of $2.1 million for severance
expenses, $0.2 million for legal and consulting costs, and $0.2 million for
other costs associated with the restructuring. The Company currently anticipates
that these restructuring costs will be paid over the next six months.
9. CREDIT AND BORROWING ARRANGEMENTS
The Company has a $75 million revolving credit facility with a bank
syndicate. The credit facility offers borrowings in either U.S. dollars or in
foreign currencies and expires March 29, 2002. The Company pays interest and
commitment fees on its borrowings based on its debt level in relation to its
cash flow. Commitment fees range from 0.25% to 0.475% of unused commitment and
interest rates are based on the bank's prime rate or Libor plus rates ranging
from 0.875% to 1.5%. At April 4, 1999, the Company had $36 million available for
borrowing under this facility. In February 1999, the Company delayed delivering
8
ADAC LABORATORIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
9. CREDIT AND BORROWING ARRANGEMENTS (CONTINUED)
financial statements and related information to its banks in connection with the
restatement occurring at that time. This constituted a default under the
facility. In May 1999, the Company again delayed delivering financial statements
and related information to its banks in connection with the delayed public
release of second quarter financials for fiscal 1999. This also constituted a
default under the facility. As anticipated in both cases, the banks waived the
defaults and consented to an extension of time required to provide the
information. The Company has since delivered all required information within the
time required by the banks. In addition, the results of the Company's operations
in the first and second quarters caused the Company to be out of compliance with
all financial covenants in the facility, which defaults have been waived through
the end of the second fiscal quarter. It is likely that the results of the
Company's third fiscal quarter also will not comply with these covenants. The
Company will seek a further waiver of the covenants for this period, although
there can be no assurance that such a waiver will be available.
10. LITIGATION
Commencing in December 1998, a total of eleven class action lawsuits were
filed in federal court by or on behalf of stockholders who purchased Company
stock between January 10, 1996 and December 28, 1998. These actions name as
defendants the Company and certain of its present and former officers and
directors. The complaints allege various violations of the federal securities
laws in connection with restatement of the Company's financial statements and
seek unspecified but potentially significant damages. The Company intends to
contest these actions vigorously. A stockholder derivative action, purportedly
on behalf of the Company and naming as defendants Company officers and directors
was also filed in state court seeking recovery for the Company based on stock
sales by these defendants during the above time period. The Company is also a
defendant in various legal proceedings incidental to its business.
While it is not possible to determine the ultimate outcome of these actions
at this time, management is of the opinion that any liability resulting from
these claims would not have a material adverse effect on the Company's
consolidated financial position, results of operations or cash flow.
11. INCOME TAXES
The Company uses the deferral method to account for income taxes. Valuation
allowances are established when necessary to reduce deferred tax assets to the
amounts expected to be realized.
The provision (benefit) for income taxes for each of the three- and
six-month periods ended April 4, 1999 and March 29, 1998 are based on the
estimated effective income tax rates for the fiscal years ending October 3, 1999
and September 27, 1998 of 26% and 39.0%, respectively. The effective tax rate
for fiscal 1999 was adjusted in the second quarter from 38% to 26%, resulting in
an effective tax benefit for the second quarter of 29%. The principal reason for
the difference between the statutory tax rate of 35% and the effective tax rate
of 26% is the expiration of tax credits and permanent differences.
12. FISCAL 1998 NON-ORDINARY ITEMS
On February 10, 1998, the Company decided to discontinue the HCIS business
unit's LabStat product while retaining the laboratory support and maintenance
business. The decision was made after the Company's Board of Directors
determined that continuing development and marketing of LabStat was not
9
ADAC LABORATORIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
12. FISCAL 1998 NON-ORDINARY ITEMS (CONTINUED)
in the best interest of the Company and its shareholders and that all meaningful
discussions with possible strategic partners had ceased.
The Company's decision to discontinue LabStat resulted in a non-ordinary
discontinued product charge of $11.6 million. The charge was a consequence of
the Company determining that certain assets utilized in the development and
marketing of LabStat became impaired as a result of the Company's decision. The
discontinued business charge consisted principally of non-cash charges,
including the write off of $4.9 million of capitalized software, $4.7 million of
deferred product costs, $0.9 million of fixed assets that were specifically
utilized in the LabStat product, $1.0 million in legal and other expenses that
were accrued as part of the write-off and $0.1 million in receivables.
In connection with the Company's evaluation of its laboratory information
systems business, the Company also conducted an analysis of it's Digital
Subtraction Angiography ("DSA") product line and determined it was appropriate
to write off the remaining inventory. Accordingly, the Company included an
impairment charge of $2.9 million in its results of operations for the first
quarter of fiscal 1998. The decision to write off the DSA inventories, was a
result of the Company's decision to no longer market the product. The combined
non-ordinary write off for LabStat and DSA was $14.5 million.
13. FISCAL 1999 NON-ORDINARY CHARGES AND EXPENSES
During 1998, the Company began an examination of the performance,
profitability and prospects of its various business units as part of an overall
evaluation of its business and financial controls. In connection with this
examination, the Company identified issues relating to its application of
accounting principles and conducted a review of its asset carrying values,
accruals and expenses in historical financial periods, leading to a restatement
of reported financial results for fiscal 1996, fiscal 1997 and the first three
quarters of fiscal 1998. Following the restatement, the Company continued to
focus on its accounting systems and weaknesses in its internal controls and the
assessment of its business units. As part of this focus and assessment, and
against the background of increasing competition in certain of the Company's
markets, and its customers deferring purchasing decisions due to their perceived
Year 2000 compliance risks, the Company revised its estimates of the
recoverability of the Company's inventory to reflect its lower production
requirements and consequently increased levels of potentially excess and
obsolete inventory, the collectibility of receivables, and the value of certain
other assets carried on the Company's books. The Company's financial statements
for the second quarter of 1999 include the following adjustments and
10
ADAC LABORATORIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
13. FISCAL 1999 NON-ORDINARY CHARGES AND EXPENSES (CONTINUED)
charges based on changes in estimates and revaluations resulting from this
process. The more significant charges are listed on the following pages.
Inventories
Nuclear inventory obsolescence................................................... $ 5,653
AMT inventory reduced to market value............................................ 415
ARS inventory obsolescence....................................................... 877
HCIS inventory obsolescence...................................................... 200
Offsite inventory obsolescence................................................... 746
Engineering obsolescence......................................................... 1,468
European inventory write-off..................................................... 1,073
Excess consumable spares write-off............................................... 788
---------
11,220
---------
Increase in receivable reserves.................................................... 5,960
---------
$ 17,180
---------
---------
These adjustments and charges are reflected in the Statement of Operations
as additional cost of revenues and as operating expenses.
The Company has concentrated resources on continuing to improve its
accounting systems and internal controls, and has retained a nationally
recognized accounting firm as a consultant. That firm has developed a number of
recommendations and has been retained to assist the Company in implementing
them. Among other things, the Company is attempting to integrate more closely
its inventory procurement procedures with the process of developing and
introducing new products in order to reduce the risks of substantial inventories
being obsoleted by product introductions. Furthermore, with respect to
receivables, the Company is improving its sales order and collection procedures
related to field service sales and the sale of ancillary products which sales
resulted in the majority of the additional receivables reserves added during the
period.
14. RECENT PRONOUNCEMENTS
In June 1997, Financial Accounting Standard 131, "Disclosures About Segments
of an Enterprise and Related Information" ("FAS 131"), was issued and is
effective for fiscal years commencing after December 15, 1997. The Company will
comply with the requirements of FAS 131 in fiscal year 1999. The Company is
evaluating alternative formats for presenting this information.
In June 1998, Financial Accounting Standard 133, "Accounting for Derivative
Instruments and Hedging Activities" ("FAS 133"), was issued and is effective for
fiscal years commencing after June 15,2000. The Company will comply with the
requirements of FAS 133 in fiscal year 2000. Currently the Company does not hold
any derivative instruments or engage in any hedging activities.
11
ADAC LABORATORIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
15. COMPREHENSIVE INCOME (LOSS)
Effective September 28, 1998, the Company adopted Statement of Financial
Accounting Standards ("SFAS") No. 130, "Reporting Comprehensive Income." This
Statement establishes standards for reporting and displaying income and its
components (revenue, expenses, gains and losses) in full set of general-purpose
financial statements. This Statement requires the classification of items of
comprehensive income by their nature in a financial statement and the
accumulated balance of other comprehensive income separately accumulated other
comprehensive income in the equity section of the balance sheet. The Company's
accumulated other comprehensive income consists solely of translation
adjustments. Comprehensive income (loss) and net income (loss) including
comprehensive income (loss) for the three and six-month periods ended April 4,
1999 and March 29, 1998 are as follows:
THREE MONTHS ENDED SIX MONTHS ENDED
----------------------- -----------------------
APRIL 4, MARCH 29, APRIL 4, MARCH 29,
1999 1998 1999 1998
---------- ----------- ---------- -----------
(DOLLAR AMOUNTS IN THOUSANDS)
Net Income (loss)................................................. $ (20,791) $ 5,379 $ (16,935) $ (97)
Comprehensive (loss).............................................. (937) (150) (914) (602)
---------- ----------- ---------- -----
Net Income (loss) including comprehensive income (loss)........... $ (21,728) $ 5,229 $ (17,849) $ (699)
---------- ----------- ---------- -----
---------- ----------- ---------- -----
16. SOUTH AMERICAN OPERATIONS
A significant number of the Company's customers in the Company's principal
South American markets of Brazil, Argentina and Columbia are delinquent in
making their periodic payments due under the terms of sales previously made to
them, many of which were supported by financing arrangements that involve full
or partial recourse to the Company. Deteriorating economic conditions, currency
devaluations and currency controls in those markets and ineffective monitoring
of delinquencies and collection efforts by the Company each may have contributed
to the delay in collections. The Company is currently undertaking renewed
collection efforts and a complete evaluation of each receivable balance and
recourse obligation to determine what reserves should be provided; it cannot,
however, make a reasonable estimate until this process is complete. The Company
is dedicating significant resources and working towards completing its
investigation and reporting the results as soon as possible. The Company's
receivables and recourse obligations for South America at April 4, 1999 totals
approximately $15 million against which the Company has reserves of $1.1
million. Any additional reserve requirement that may result from this review
could potentially be charged to the current or previously reported periods
depending on determination of the circumstances that existed in those periods
with respect to the collectibility of the receivables and the Company's
obligations under the recourse provisions.
12
ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion and analysis should be read in conjunction with the
Company's Condensed Consolidated Financial Statements and related Notes thereto
contained elsewhere within this document. Operating results for the three-month
and six-month periods ended April 4, 1999 are not necessarily indicative of the
results that may be expected for any future periods, including the full fiscal
year. Reference should also be made to the Annual Consolidated Financial
Statements, Notes thereto, and Management's Discussion and Analysis of Financial
Condition and Results of Operations contained in the Company's Annual Report on
Form 10-K for the fiscal year ended September 27, 1998.
RESULTS OF OPERATIONS
THE THREE-MONTH AND SIX-MONTH PERIODS ENDED APRIL 4, 1999 COMPARED TO THE
THREE-MONTH AND SIX-MONTH PERIODS ENDED MARCH 29, 1998
Revenues for the second quarter of fiscal 1999 are $87.4 million, a 17%
increase, or $12.9 million, over the second quarter fiscal 1998 revenues of
$74.5 million. Revenues are primarily generated from the sale and servicing of
medical imaging products. Medical Systems revenues represented 81% and 77% of
the Company's total revenues for the second quarter of fiscal 1999 and 1998,
respectively. The Company's Software Business revenues represented approximately
19% and 23% of the Company's total revenues for the second quarter of fiscal
1999 and 1998, respectively.
Revenues for the six-month period ended April 4, 1999 increased 28%, or
$39.7 million, over the $142.0 million for the same period in fiscal 1998. Gross
profit for the first six months of fiscal 1999 was $52.1 million, a 14% increase
over the $45.6 million generated in the same period in fiscal 1998 which
included the discontinued product charge associated with the write-off of the
LabStat and DSA assets in the first quarter of fiscal 1998
NON-ORDINARY CHARGES AND EXPENSES
During 1998, the Company began an examination of the performance,
profitability and prospects of its various business units as part of an overall
evaluation of its business and financial controls. In connection with this
examination, the Company identified issues relating to its application of
accounting principles and conducted a review of its asset carrying values,
accruals and expenses in historical financial periods, leading to a restatement
of reported financial results for fiscal 1996, fiscal 1997 and the first three
quarters of fiscal 1998. Following the restatement, the Company continued to
focus on its accounting systems and weaknesses in its internal controls and the
assessment of its business units. As part of this focus and assessment, and
against the background of increasing competition in certain of the Company's
markets, and its customers deferring purchasing decisions due to their perceived
Year 2000 compliance risks, the Company decided to restructure its ADAC Medical
Technologies ("AMT") equipment refurbishing business, and revised its estimates
of the recoverability of the Company's inventory to reflect its lower build
plans and consequently increased levels of potentially excess an obsolete
inventory, the collectibility of receivables, and the value of certain other
assets carried on the Company's books. The Company's financial statements
13
for the second quarter of 1999 include the following adjustments and charges
based on changes in estimates and revaluations resulting from this process. The
more significant charges are listed below.
Inventories
Nuclear inventory obsolescence................................................... $ 5,653
AMT inventory reduced to market value............................................ 415
ARS inventory obsolescence....................................................... 877
HCIS inventory obsolescence...................................................... 200
Offsite inventory obsolescence................................................... 746
Engineering obsolescence......................................................... 1,468
European inventory write-off..................................................... 1,073
Excess consumable spares write-off............................................... 788
---------
11,220
---------
Increase in receivable reserves.................................................... 5,960
---------
$ 17,180
---------
---------
These adjustments and charges are reflected in the Statement of Operations
as additional cost of revenues and as operating expenses and also impact the
Company's balance sheet.
The Company has concentrated resources on continuing to improve its
accounting systems and internal controls, and has retained a nationally
recognized accounting firm as a consultant. That firm has developed a number of
recommendations and has been retained to assist the Company in implementing
them. Among other things, the Company is attempting to integrate more closely
its inventory procurement procedures with the process of developing and
introducing new products in order to reduce the risks of substantial inventories
being obsoleted by product introductions. Furthermore, with respect to
receivables, the Company is improving its sales order and collection procedures
related to field service sales and the sale of ancillary products which sales
resulted in the majority of the additional receivables reserves added during the
period.
MEDICAL SYSTEMS
Medical Systems includes revenues from the sale of the Company's nuclear
medicine and ADAC Medical Technologies (AMT) products, as well as customer
service related to those products. Summary information related to Medical
Systems' product and service revenues and gross profit margins for the
14
three and six-month periods ended April 4, 1999 compared to the corresponding
periods in fiscal 1998 are as follows:
THREE MONTHS ENDED SIX MONTHS ENDED
---------------------- ----------------------
APRIL 4, MARCH 29, APRIL 4, MARCH 29,
1999 1998 1999 1998
--------- ----------- ---------- ----------
(DOLLAR AMOUNTS IN THOUSANDS)
Revenues:
Product.......................................................... $ 50,791 $ 40,634 $ 105,844 $ 79,423
Service.......................................................... 20,155 16,514 39,427 31,847
--------- ----------- ---------- ----------
Total.......................................................... $ 70,946 $ 57,148 $ 145,271 $ 111,270
Geographical mix:
North America.................................................... 89.2% 79.2% 88.9% 80.9%
Europe........................................................... 5.2% 12.0% 5.5% 12.1%
Latin America, Japan and Asia.................................... 5.6% 8.8% 5.6% 7.0%
Gross margin after discontinued product charges in
fiscal 1998
Product.......................................................... 2.9% 43.4% 22.3% 38.7%
Service.......................................................... 17.8% 28.9% 20.6% 32.9%
--------- ----------- ---------- ----------
Total.......................................................... 7.1% 39.3% 21.8% 37.0%
Medical Systems' product revenues for the three and six-month periods ended
April 4, 1999 increased 25% and 33%, respectively, over the same period in
fiscal 1998. Product revenue growth was driven by increased installations due to
readiness of customers sites matched with the availability of cameras from the
Company's work-down of finished goods inventory. The proportion of the Company's
revenues derived from North America increased because of the relative
deterioration of economic and business conditions in Europe and Latin America,
and because the Company was able to more quickly complete installations of
ordered products in North America than in those other regions. The Company
anticipates it will continue throughout the balance of fiscal 1999 to experience
rates of revenue growth in the Medical Systems business that are lower than
rates experienced in recent years, due to increasing competition in certain of
the Company's markets, and its customers deferring purchasing decisions due to
their perceived Year 2000 risks.
Gross margins for Medical Systems products decreased 41% and 16% in the
three and six-month periods ending April 4, 1999, respectively, compared to the
corresponding periods of the prior fiscal year. The decreases in gross margins
can be attributed to several factors, the single largest of which were
substantial revised carrying values and book to physical adjustments of the
Company's inventories in this segment. Delays in customer orders coupled with
new product introductions by the Company and competitors caused the Company to
experience substantial obsolescence of inventories, which the Company wrote down
by $5.7 million, in the second quarter of fiscal 1999. In the Company's AMT
equipment refurbishment business, the Company took a further charge of $3.3
million in the second quarter of fiscal 1999, because of a book to physical
inventory adjustment as a result of a physical inventory. The adjustment
resulted from poor inventory control systems. The Company intends to continue
taking a physical inventory at its AMT site at the end of each quarter until
adequate controls are put in place or that facility is closed. The Company had
determined that certain of the materials that were being held for resale have
become obsolete due to rapid changes in the demand for used and refurbished
nuclear medicine cameras, resulting in a charge of $0.4 million in the second
quarter of fiscal 1999, to reduce the carrying value of materials held for
resale. The Company increased its reserve for engineering inventory from $0.8
million to $2.3 million in the second quarter of fiscal 1999, as a result of
book to physical
15
adjustments and obsolescence. See Note 13 "Fiscal 1999--Non-ordinary Charges and
Expenses" of the Notes to Condensed Consolidated Financial Statements.
In addition to inventory-related issues, gross margins were also adversely
affected in the these periods by a smaller build plan for the second quarter of
fiscal 1999, due to the Company's effort to reduce finished goods inventory.
With fewer units manufactured the cost per unit increased. Gross margins were
also adversely affected by competitive pricing pressures and investments in
infrastructure.
Following the conclusion of its second fiscal quarter in 1999, the Company
decided to restructure its AMT business by discontinuing refurbishment of a
number of lines of older nuclear medicine equipment the demand for which is
declining. In connection with this decision the Company will close its
refurbishing facility in Washington, Missouri and relocate the business to
Milpitas, California. The Company anticipates that substantial inventories of
equipment and parts will be rendered obsolete by this decision and market
conditions. The Company presently believes that charges associated with these
AMT inventories in the third quarter of fiscal 1999 will total at least $2.4
million.
Medical Systems service revenues for the three and six-month periods ended
April 4, 1999 increased 22% and 24%, respectively, over the same periods in
fiscal 1998. The increases resulted from a higher number of customers under
service contract. The second quarter of fiscal 1999 also had additional revenues
from work to make customers equipment Year 2000 compliant. Gross margins for
Medical Systems services decreased by 11% and 12% respectively for the three and
six-month periods ended April 4, 1999 when compared to same periods of fiscal
1998. The principal reason for the decline was a write-off of approximately $0.8
million of consumable spare parts held in the field for use in providing
services following the Company's determination in the second quarter that
inventories of these spares were excessive. Margins also declined by
approximately 3% for the three and 4% for the six-month period due to increased
staffing and higher retrofit costs.
The Company is in the process of reviewing the composition of the
capitalized field service inventory and the estimated collective useful life of
this asset. The Company will take a physical inventory of its spares early in
the fourth quarter of fiscal 1999 which may result in a change to its safety
stock levels and removal of obsolete and excess parts. The Company will continue
to monitor recoverability of the collective asset under SFAS No. 121 "Accounting
for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed
Of".
SOFTWARE BUSINESS
ADAC's Software Business includes RTP and HCIS. RTP revenues are generated
primarily from the sale and support of the Company's Pinnacle(3)-TM- radiation
therapy planning system. HCIS historically generated revenues from the sale of
radiology, laboratory and cardiology information systems as well as from
providing support for these products. In the first quarter of fiscal 1998, the
Company took a one-time charge of $11.6 million to discontinue development and
marketing of its LabStat product. See Note 12 "Fiscal 1998 Non-ordinary Items"
of the Notes to Condensed Consolidated Financial Statements. Summary information
related to the Software Business product and service revenues and gross profit
margins
16
for the three and six-month periods ended April 4, 1999 compared to the
corresponding periods in fiscal 1998 are as follows:
THREE MONTHS ENDED SIX MONTHS ENDED
---------------------- ----------------------
APRIL 4, MARCH 29, APRIL 4, MARCH 29,
1999 1998 1999 1998
--------- ----------- --------- -----------
(DOLLAR AMOUNTS IN THOUSANDS)
Revenues:
Product........................................................... $ 12,729 $ 13,167 $ 28,581 $ 22,397
Service........................................................... 3,718 4,208 7,820 8,294
--------- ----------- --------- -----------
Total........................................................... $ 16,447 $ 17,375 $ 36,401 $ 30,691
Gross margin after discontinued product charges
Product........................................................... 49.8% 54.4% 56.1% 1.9%
Service........................................................... 54.9% 49.6% 54.8% 47.9%
--------- ----------- --------- -----------
Total........................................................... 51.0% 53.2% 55.8% 14.3%
Software Business product revenues decreased 3% and increased 28% for the
three and six-month periods ended April 4, 1999, respectively, over the same
period in fiscal 1998. The decrease in the three-month period resulted primarily
from the HCIS product lines due to a change in revenue recognition to
percentage-of-completion in compliance with Statement of Position ("SOP") 97-2
"Software Revenue Recognition". The HCIS decrease was partially offset by higher
RTP sales of the Pinnacle product. The increase for the six-month period is
primarily driven by the RTP Pinnacle product.
Gross margin percentage before discontinued product charges for the six
months ended April 4, 1999 increased 5% over the prior year period. The increase
is attributed to increased sales of the higher margin Pinnacle and QuadRIS
products, and cost reductions associated with the LabStat write-off in fiscal
1998. See Note 12 "Fiscal 1998 Non-ordinary Items" of the Notes to Condensed
Consolidated Financial Statements.
Software Business service revenues decreased for the three and six-month
periods ended April 4, 1999 from the corresponding periods in fiscal 1998 due
principally to lower legacy HCIS laboratory service revenues. However, service
gross margins increased for the three and six-month periods ended April 4, 1999,
from the corresponding periods in fiscal 1998 due to improved third party
maintenance fees.
OPERATING AND OTHER EXPENSES:
Summary information showing the Company's operating and other expenses as a
percentage of revenue for the three and six-month periods are as follows:
THREE MONTHS ENDED SIX MONTHS ENDED
-------------------------- --------------------------
APRIL 4, MARCH 29, APRIL 4, MARCH 29,
1999 1998 1999 1998
----------- ------------- ----------- -------------
Operating costs and expenses:
Marketing and sales................................................ 21.9% 16.0% 19.0% 16.5%
Research and development, net of software capitalization........... 5.1% 5.3% 4.9% 6.5%
General and administrative......................................... 18.2% 7.3% 13.3% 7.1%
Goodwill amortization.............................................. 0.6% 0.7% 0.5% 0.7%
Restructuring charge............................................... 0.9% -- 1.8% --
--- --- --- ---
46.7% 29.4% 39.6% 30.9%
--- --- --- ---
--- --- --- ---
Interest and other expense, net...................................... 2.0% 1.3% 1.6% 1.4%
17
Marketing and sales expenses for the three and six-month periods ended April
4, 1999 increased $7.2 and $11.1 million, respectively, over the corresponding
periods in the prior fiscal year as a result of higher compensation costs
associated with increasing revenues and orders and additional bad debt reserves
in the Company's European operations incurred in the second quarter of fiscal
1999.
Research and development expenditures, net of software capitalization,
totaled $4.5 and $4.0 million in the second quarter of fiscal 1999 and 1998,
respectively. The increase in the second quarter of fiscal 1999 compared to
fiscal 1998 is due to increased spending in RTP to support product growth.
Capitalized software costs were $2.1 million in both the second quarters of
fiscal 1999 and 1998. For the first six months of fiscal 1999 and 1998, research
and development expenditures, net of software capitalization, were $8.8 million
and $9.3 million in fiscal 1999 and 1998, respectively. Expenses for research
and development before capitalized software costs increased $1.0 million for the
first six months of fiscal 1999 when compared to 1998 due to increased product
development activities for RTP. Capitalized software costs were $5.1 and $3.6
million for the first six months of fiscal 1999 and 1998, respectively.
General and administrative expenses for the three and six-month periods
ended April 4, 1999 increased $10.4 and $14.2 million over the corresponding
periods in the prior fiscal year primarily as a result of an increase in bad
debt reserves of $4.4 million in the second quarter following a review of all
receivables on the Company's books (other than Latin American receiveables, a
review of which is continuing, see Note 16 "South American Operations"), but
also due to an increase in expenses payable to outside legal, accounting and
other service providers, an overall increase in infrastructure costs and an
increase in expense accruals.
Goodwill amortization decreased slightly in the three and six-month periods
of fiscal 1999 compared to the corresponding periods of fiscal 1998 due to
termination of the ADAC Radiology Services amortization partially offset by
goodwill amortization generated from the acquisition of ONES in January, 1998.
The Company took restructuring charges in the first and second quarters of
fiscal 1999 of $2.5 and $0.8 million, respectively. See Note 12 "Fiscal 1998
Non-ordinary Items" of the Notes to Condensed Consolidated Financial Statements.
Interest and other expense, net, which primarily consists of interest
expense and foreign currency transaction gains and losses, increased as a
percentage of revenue for the three and six-month periods ended April 4, 1999
when compared to corresponding periods in the prior fiscal year, primarily from
foreign currency losses during the second quarter of fiscal 1999 related to the
Company's European operations.
INCOME TAXES:
The provision (benefit) for income taxes for each of the three- and
six-month periods ended April 4, 1999 and March 29, 1998 are based on the
estimated effective income tax rates for the fiscal years ending October 3, 1999
and September 27, 1998 of 26% and 39.0%, respectively. The effective tax rate
for fiscal 1999 was adjusted in the second quarter from 38% to 26%, resulting in
an effective tax benefit for the second quarter of 29%. The principal reason for
the difference between the statutory tax rate of 35% and the effective tax rate
of 26% is the expiration of tax credits and permanent differences.
LIQUIDITY AND CAPITAL RESOURCES
The Company believes its available cash resources, generated primarily from
its credit lines, will provide adequate funds to finance the Company's
operations in fiscal 1999. If necessary, the Company will seek to increase its
credit line to support the Company's future growth. There can be no assurance
that credit lines sufficient to satisfy the Company's cash requirements will be
available if needed.
18
The Company's ratio of current assets to current liabilities at April 4,
1999 was 1.3 to one, while working capital at April 4, 1999 decreased $28.2
million to $32.7 million from $60.9 million at September 27, 1998. This decrease
was primarily due to the increases in notes payable to banks, deferred revenues,
and customer deposits and advanced billings of $15.7, $7.0 and $5.9 million,
respectively, and decreases in inventories and cash of $24.3 and $3.4 million,
respectively, partially offset by a $29.6 million increase in accounts
receivable, net. Notes payable to banks increased to meet the Company's
operating needs for cash. Deferred revenues, and customer deposits and advanced
billings increased due to the Company's more stringent revenue recognition
policy requiring up-front customer deposits with orders. Inventories decreased
primarily from the charges in the second quarter of fiscal 1999 of $11.2 million
and a work-down of finished goods inventory. Accounts receivable, net, increased
due to a decrease in accounts receivable sold, increased sales for the first
six-months of fiscal 1999 and a lengthening of customer payment terms to meet
competitive conditions. This was partially offset by the increase in accounts
receivable reserve. The Company's ratio of current assets to current liabilities
at March 29, 1998 was 1.4 to one, while working capital at March 29, 1998
decreased $3.6 million to $37.2 million from $40.8 million at September 28,
1997.
The primary uses of cash in operations for the first six months of fiscal
1999 were increases of $39.3 and $6.0 million in accounts receivable and
deferred income taxes, partially offset by a decrease of $16.5 million in
inventories and increases of $7.0 and $5.9 million in deferred revenues and
customer deposits and advanced billings. The deferred income tax asset increased
due to the net loss for the six-month period ended April 4, 1999. The primary
uses of cash in operations for the first six months of fiscal 1998 was a $9.9
million increase in accounts receivable and a $15.5 million increase in
inventory.
Cash of $12.2 million was used for investing activities in the first six
months of fiscal 1999. This activity consisted primarily of $8.0 and $3.9
million for capital equipment expenditures and an increase in other assets,
respectively. Capital expenditures were primarily for computer equipment to
support new enterprise software being installed for the sales and service
groups, and the addition of internal use engineering and sales demo equipment.
The increase in other assets is primarily from the capitalization of development
costs related to software products. Cash of $11.4 million was used for investing
activities in the first six months of fiscal 1998. This activity consisted
principally of the acquisitions of CT Solutions and ONES.
Financing activities provided $19.3 million of cash in the first six months
of fiscal 1999. This was attributable to $15.7 million of increased borrowings
to meet operational needs and $3.6 million of proceeds from common stock issued
to employees under the Company's employee stock purchase and option plans.
Financing activities provided $11.4 million of cash in the first six months of
fiscal 1998. This was primarily attributable to $6.5 million of increased
borrowings for the purchase of CT Solutions and ONES and $4.9 million of
proceeds from common stock issued to employees under the Company's employee
stock purchase and option plans.
The Company presently has a $75 million revolving credit facility with a
bank syndicate. In February 1999, the Company delayed delivering financial
statements and related information to its banks in connection with the
restatement occurring at that time. This constituted a default under the
facility. In May 1999, the Company again delayed delivering financial statements
and related information to its banks in connection with the delayed public
release of second quarter financials for fiscal 1999. This also constituted a
default under the facility. As anticipated in both cases, the banks waived the
defaults and consented to an extension of time required to provide the
information. The Company has since delivered all required information within the
time required by the banks. In addition, the results of the Company's operations
in the first and second quarters caused the Company to be out of compliance with
all financial covenants in the facility, which defaults have been waived through
the end of the second fiscal quarter. It is likely that the results of the
Company's third fiscal quarter also will not comply with these covenants. The
Company will seek a further waiver of the covenants for this period, although
there can be no assurance that such a waiver will be available.
19
The Company's liquidity is affected by many factors, some based on the
normal ongoing operations of the business and others related to the
uncertainties of the industry and global economies. Although the Company's cash
requirements will fluctuate based on the timing and extent of these factors,
management believes that cash generated from operations, together with the
liquidity provided by existing cash balances and borrowing capability, will be
sufficient to satisfy commitments for capital expenditures and other cash
requirements for the next fiscal year. However, the Company may need to increase
its sources of capital through additional borrowings or the sale of securities
in response to changing business conditions or to pursue new business
opportunities. There can be no assurance that such additional sources of capital
will be available on terms favorable to the Company, if at all.
SOUTH AMERICAN OPERATIONS
A significant number of the Company's customers in the Company's principal
South American markets of Brazil, Argentina and Columbia are significantly
delinquent in making their periodic payments due under the terms of sales
previously made to them, many of which were supported by financing arrangements
that involve full or partial recourse to the Company. Deteriorating economic
conditions, currency devaluations and currency controls in those markets and
ineffective monitoring of delinquencies and collection efforts by the Company
each may have contributed to the delay in collections. The Company is currently
undertaking renewed collection efforts and a complete evaluation of each
receivable balance and recourse obligation to determine what reserves should be
provided; it cannot, however, make a reasonable estimate until this process is
complete. The Company is dedicating significant resources and working towards
completing its investigation and reporting the results as soon as possible. The
Company's receivables and recourse obligations for South America at March 31,
1999 totals approximately $15 million against which the Company has reserves of
$1.1 million. Any additional reserve requirement that may result from this
review could potentially be charged to the current or previously reported
periods depending on determination of the circumstances that existed in those
periods with respect to the collectibility of the receivables and the Company's
obligations under the recourse provisions.
BUSINESS CONSIDERATIONS
From time to time, the Company may disclose, through press releases, filings
with the SEC or otherwise, certain matters that constitute forward looking
statements within the meaning of the Federal securities laws. These statements,
including the forward looking statements contained in this Form 10-Q, are
subject to a number of risks and uncertainties, which could cause actual results
to differ materially from those projected, including without limitation those
set forth below. These forward looking statements include statements concerning
the Company's future bookings, revenue, expenses and earnings, the establishment
of additional reserves and the taking of Non-ordinary charges. Factors that
could cause actual results to differ materially from those contained in such
forward-looking statements include, but are not limited to, the existence of
significant competition in each of the business segments in which the Company
conducts business; the impact of Year 2000 on the Company's results; the
Company's dependence on successfully developing, introducing and commercializing
new products and developing enhancements to existing products; the
collectibility of the Company's receivables, changes to the Company's operating
structure and charges and dislocations that may result therefrom; the impact of
international economic conditions on the Company's business; and a number of
factors that can introduce variability in the Company's operating results,
including the timing of product orders, shipments, and installations. Further
information on these and other factors is found below. All forward-looking
statements are based on information available to the Company on the date hereof,
and the Company assumes no obligation to update such statements.
20
LITIGATION
Commencing in December 1998, a total of eleven class action lawsuits were
filed in federal court by or on behalf of stockholders who purchased Company
stock between January 10, 1996 and December 28, 1998. These actions name as
defendants the Company and certain of its present officers and directors. The
complaints allege various violations of the federal securities laws in
connection with restatement of the Company's financial statements and seek
unspecified but potentially significant damages. The Company intends to contest
these actions vigorously. A stockholder derivative action, purportedly on behalf
of the Company and naming as defendants Company officers and directors was also
filed in state court seeking recovery for the Company based on stock sales by
these defendants during the above time period. The Company is also a defendant
in various legal proceedings incidental to its business.
While it is not possible to determine the ultimate outcome of these actions
at this time, management is of the opinion that any liability resulting from
these claims would not have a material adverse effect on the Company's
consolidated financial position, results of operations or cash flow.
GOVERNMENT REGULATION
The design, clinical activities, manufacturing, labeling, distribution,
sale, marketing, advertising and promotion of the company's products are subject
to extensive and rigorous governmental regulation in the United States and
foreign countries. In the United States and certain foreign countries, the
process of obtaining and maintaining required regulatory clearances or approvals
is lengthy, expensive and uncertain. There can be no assurance that any
necessary clearance or approval will be granted the Company or that FDA or other
regulatory agency review will not involve delays adversely affecting the
Company. In addition, a failure to comply with applicable regulatory
requirements could result in enforcement actions including Warning Letters, as
well as civil penalties, injunctions, suspensions or losses of regulatory
clearances, product recalls, seizure or administrative detention of products,
operating restrictions through consent decrees or otherwise, and criminal
prosecution, which could have a material adverse effect upon the Company.
Following an inspection in mid-1997, Cortet, Inc., which the Company
acquired in May 1997, received a Warning Letter from the FDA concerning
inspectional observations relating to the adequacies of Cortet's quality
assurance system. Cortet responded to the observations and the Warning Letter
and received correspondence from the FDA's Florida District Office indicating
that Cortet's responses appeared to adequately address the FDA's concerns. In
mid-1998, the State of California, under a contract with the FDA, completed a
routine inspection of ADAC's facility in Milpitas, California. The state
investigator issued a FDA Form 483 containing observations of non-compliance of
the recently implemented QSR. The state investigator also placed a temporary
shipment hold on Pinnacle3 pending the Company satisfactorily responding to the
State's concerns regarding the Company's quality systems. The Company promptly
responded to the FDA and the State and initiated a number of corrective actions.
The State lifted the Pinnacle3 shipment hold on August 28, 1998 and, in
September 1998, ADAC received a letter from the FDA indicating that the Company
had adequately responded to the FDA's concerns. Although the Company was deemed
to have adequately responded to the State and FDA following the foregoing
inspections, the Company is responsible for the full implementation of all
corrective actions. In addition, as all companies are, the Company remains
subject to periodic inspections in the future and there can be no assurance as
to the timing or outcome of any subsequent inspection. The scope of any
re-inspection could be more comprehensive than the inspections of Cortet and the
Company's Milpitas facility, and there can be no assurance that the FDA, upon
re-inspection, will deem the Company's corrective actions to be adequate or that
additional corrective action, in areas not addressed in the Warning Letter or
the Form 483, will not be required. Any failure by the Company to fully
implement the required corrective actions or to comply with any other applicable
regulatory requirements could have a material adverse effect on the Company's
ability to continue to manufacture and distribute its products,
21
and in more serious cases, could result in seizure, recall, injunction and/or
civil fines. Any of the foregoing, would have a material adverse effect on the
Company.
The Company is also subject to FTC restrictions on advertising and numerous
federal, state and local laws relating to such matters as safe working
conditions, manufacturing practices, environmental protection and disposal of
hazardous substances. Changes in existing requirements, adoption of new
requirements or failure to comply with applicable requirements could have a
material adverse effect on the Company.
COMPETITION
The markets served by the Company are characterized by rapidly evolving
technology, intense competition and pricing pressure. There are a number of
companies that currently offer, or are in the process of developing, products
that compete with products offered by the Company. Some of the Company's
competitors have substantially greater capital, engineering, manufacturing and
other resources than the Company. These competitors could develop technologies
and products that are more effective than those currently used or marketed by
the Company or that could render the Company's products obsolete or
noncompetitive, which could have a material adverse effect on the Company's
business.
DEPENDENCE ON NEW PRODUCTS AND PRODUCT ENHANCEMENTS
ADAC's success is dependent upon the successful development, introduction
and commercialization of new products and the development of enhancements to
existing products. Because the markets in which the Company competes are highly
competitive, the Company must continue to develop and successfully commercialize
innovative new products and product enhancements such as Forte, MCDPET, MCD/
ACPET and ENVOI in order to pursue its growth strategy. The development of new
products and product enhancements entails considerable time and expense,
including research and development costs, and the time, expense and uncertainty
involved in obtaining any necessary regulatory clearances. Failure of the
Company to develop, market and sell new products and enhancements effectively in
future periods could have a material adverse effect on the Company's results of
operations and financial condition.
FUTURE OPERATING RESULTS
The Company's future operating results may vary substantially from period to
period. The timing and amount of revenues are subject to a number of factors
that make estimation of revenues and operating results prior to the end of the
quarter uncertain. The timing of revenues can be affected by delays in product
introductions, shipments and installation scheduling, as well as general
economic and industry conditions. Furthermore, of the orders received by the
Company in any fiscal quarter, a disproportionately large percentage has
typically been received and shipped toward the end of that quarter, which is
typical for the industry. Accordingly, results for a given quarter can be
adversely affected if there is a substantial order shortfall late in that
quarter. In addition, the Company's bookings and backlog cannot necessarily be
relied upon as an accurate predictor of future revenues as the timing of such
revenues is dependent upon completion of customer site preparation and
construction, installation scheduling, receipt of applicable regulatory
approvals, customer financing and other factors. Accordingly, there can be no
assurance that orders will mature into revenue. The Company has accounts
receivable due from customers in Latin America. Recent changes in economic
conditions in that region, including the devaluation of Brazilian currency, may
adversely affect the Company's ability to collect these accounts receivable. If
the Company were unable to collect a substantial majority of these accounts
receivable, the Company's results of operations for a quarterly period could be
adversely affected.
22
MATERIAL WEAKNESSES IN INTERNAL CONTROLS
After completion of their audit of the results of the Company's 1998 fiscal
year, the Company's independent accountants reported to the Company's audit
committee that they had found material weaknesses in the Company's internal
accounting controls. Following receipt of this report, the Company retained a
nationally recognized accounting firm other than its independent auditors to
review its controls. The Company has further engaged this firm to recommend to
the Company suggested improvements in these controls and to assist the Company
in implementing them. The Company believes that it has already taken steps to
remedy certain weaknesses in its control functions, and that improvements
already in place, coupled with improvements the Company plans to make in the
near future, should substantially improve the timeliness and accuracy of the
Company's internal financial reporting and monitoring functions.
RISKS RELATED TO ACQUISITIONS
In the past two years, the Company has acquired a number of small
businesses, and anticipates that it may continue to acquire businesses whose
products and services complement the Company's businesses. Acquisitions involve
numerous risks, including, among other things, difficulties in successfully
integrating the businesses (including products and services, as well as sales
and marketing efforts), failure to retain existing customers or attract new
customers to the acquired business operations, failure to retain key technical
and management personnel, coordinating geographically separated organizations,
and diversion of ADAC management attention. These risks, as well as liabilities
of any acquired business (whether known or unknown at the time of acquisition),
could have a material adverse effect on the results of operations and financial
condition of the Company, including adverse short-term effects on its reported
operating results. The Company seeks to mitigate these risks by taking reserves
when appropriate in connection with these acquisitions. In addition, the Company
has in the past and may in the future issue stock as consideration for
acquisitions. Future sales of shares of the Company's stock issued in such
acquisitions could adversely affect or cause fluctuations in the market price of
the Company's Common Stock.
YEAR 2000 COMPLIANCE
The following statements are a "Year 2000 Readiness Disclosure" within the
meaning of the Year 2000 Information and Readiness Disclosure Act. Many
currently installed computer systems and software products are coded to accept
only 2 digit entries in the date code field. Beginning in the Year 2000, these
date code fields will need to accept 4 digit entries to distinguish 21st century
dates from 20th century dates. Systems that do not properly recognize such
information could generate erroneous data or cause a system to fail. As a
result, computer systems and/or software used by many companies may need to be
upgraded to comply with such Year 2000 requirements. The Company is utilizing
both internal and external resources to identify, correct or reprogram, and test
its internal systems, for Year 2000 compliance. Although management is
continuing to assess the expense associated with internal Year 2000 compliance,
the Company does not believe such compliance will have a material adverse effect
on the Company's results of operations or financial condition.
The Company has completed an assessment and analysis of its internal
information technology systems, software and manufacturing equipment. The
Company has implemented the majority of system changes needed to correct its
internal Year 2000 issues. While the Company currently expects that the Year
2000 will not pose significant internal operational problems, delays in the
implementation of new information systems, or a failure to fully identify all
Year 2000 dependencies in the Company's systems, could have a material adverse
effect on the Company's results of operations.
The Company has established a program to assess its products to ensure that
they are Year 2000 compliant. To monitor this program and to inform customers
about the Year 2000 issues with respect to its products, the Company has created
a website at www.adaclabs.com/about/year20001.html. This website
23
identifies the status of Year 2000 compatibility of its products, including
products that are Year 2000 compliant, products that need free software updates,
products that require hardware upgrades, and products that cannot be made Year
2000 compliant. This list is periodically updated as analysis of additional
products is completed.
The Company will sell, or provide under warranty or service contracts,
software license upgrades to update the majority of its installed base to make
the products Year 2000 compliant, and anticipates completing development of such
upgrades in 1999. For older equipment which the Company no longer manufactures,
the Company will sell hardware upgrades to its customers which will address the
Year 2000 compliance where possible. The Company is contacting by mail customers
which require computer hardware upgrades, and is also posting information
relating to Year 2000 compliance for its products on the Company's website as
described above.
The Company is gathering information from its suppliers and vendors to
determine the extent to which the Company's capabilities are vulnerable to
failure by those third parties to remedy their own Year 2000 issues. The Company
is currently receiving responses to those inquiries and anticipates that the
analysis of this information will be completed by the end of 1999. The Company
will proceed with further analysis or testing of its vendors' systems as needed.
However, there is no guarantee that the systems and products of other companies
on which the Company relies will be timely converted or that they will not have
a material adverse effect on the Company.
The Company is in the process of developing a contingency plan. This plan is
expected to be in place in late 1999. The inability of the Company to develop
and implement a contingency plan could result in a material adverse effect on
the Company.
The Company currently estimates that total Year 2000 costs will be
approximately $1.2 million, of which $0.5 million has already been incurred.
These cost estimates do not include any potential costs related to any customer
or other claim. In addition, these cost estimates are based on current
assessments of the ongoing activities described above, and are subject to
changes as the Company continuously monitors these activities. The Company
believes any modifications deemed necessary will be made on a timely basis and
does not believe that the costs of such modifications will have a material
adverse effect on the Company's operating results; however, the Company's
expectations as to the extent and timeliness of any modifications required in
order to achieve Year 2000 compliance and the costs related thereto are
forward-looking statements subject to risks and uncertainties. Actual results
may vary as a result of number of factors, including those described herein.
There can be no assurance that the Company will be able to successfully modify
on a timely basis such products, services and systems to comply with Year 2000
requirements, which failure could have a material adverse effect on the
Company's operating results.
In addition, the Company is currently seeking to ensure that the software
included in its products and other systems is Year 2000 compliant. Failure (or
perceived failure) of such products to be Year 2000 compliant could
significantly adversely affect sales of such products, which could have a
material adverse effect on the Company's results of operations and financial
condition. In addition, the Company believes that the purchasing patterns of
customers and potential customers may be affected by Year 2000 issues in a
variety of ways. Many potential customers may choose to defer purchasing Year
2000 compliant products until they believe it is absolutely necessary, thus
resulting in potentially stalled market sales within the industries in which the
Company competes. Conversely, Year 2000 issues may cause other companies to
accelerate purchases, thereby causing an increase in short-term demand and a
consequent decrease in long-term demand for the Company's products.
Additionally, Year 2000 issues could cause a significant number of companies,
including current Company customers, to reevaluate their current system needs,
and as a result consider switching to other systems or suppliers. Any of the
foregoing could result in a material adverse effect on the Company's business,
operating results and financial condition.
24
HEALTH CARE REFORM; REIMBURSEMENT AND PRICING PRESSURE
There is significant concern today about the availability and rising cost of
healthcare in the United States. Cost containment initiatives, market pressures
and proposed changes in applicable laws and regulations may have a dramatic
effect on pricing or potential demand for medical devices, the relative costs
associated with doing business and the amount of reimbursement by both
government and third party payors, which could have a material adverse effect on
the Company's results of operations.
INTELLECTUAL PROPERTY RIGHTS
The Company's success depends in part on its continued ability to obtain
patents, to preserve its trade secrets and to operate without infringing the
proprietary rights of third parties. There can be no assurance that pending
patent applications will mature into issued patents or that third parties will
not make claims of infringement against the Company's products or technologies
or will not be issued patents that may require payment of license fees by the
Company or prevent the sale of certain products by the Company.
RELIANCE ON SUPPLIERS
Certain components used by the Company to manufacture its products such as
the sodium iodide crystals used in the Company's nuclear medicine systems are
presently available from only one supplier. The Company also relies on several
significant vendors for hardware and software components for its healthcare
information systems products. The loss of any of these suppliers, including any
single-source supplier, would require obtaining one or more replacement
suppliers as well as potentially requiring a significant level of hardware and
software development to incorporate the new parts into the Company's products.
Although the Company has obtained insurance to protect against loss due to
business interruption from these and other sources, there can be no assurance
that such coverage would be adequate.
PRODUCT LIABILITY
Although the Company maintains product liability insurance coverage in an
amount that it deems sufficient for its business, there can be no assurance that
such coverage will ultimately prove to be adequate or that such coverage will
continue to remain available on acceptable terms, if at all.
VOLATILITY OF STOCK PRICE
The market price of the Company's Common Stock is and is expected to
continue to be subject to significant fluctuations in response to variations in
anticipated or actual operating results, market speculation, announcements of
new products or technology by the Company or its competitors, changes in
earnings estimates by the Company's analysts, trends in the health care industry
in general and other factors, many of which are beyond the control of the
Company. In addition, broad market fluctuations as well as general economic or
political conditions or initiatives, such as health care reform, may adversely
impact the market price of the Common Stock regardless of the Company's
operating results.
25
PART II--OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Not applicable.
ITEM 2. CHANGES IN SECURITIES
Not applicable.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not applicable.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
(a) The Company held its 1998 Annual Meeting of Shareholders on May 6, 1999
(the "Annual Meeting").
(b) At the Annual Meeting, the following directors were duly elected:
Stanley D. Czerwinski, R. Andrew Eckert, Graham O. King, David L. Lowe,
F. David Rollo, and Edmund H. Shea Jr.
(c) At the Annual Meeting, the following votes were cast for each of the
items voted upon at the meeting:
1) Election of Directors:
IN FAVOR WITHHELD
------------ ---------
Stanley D. Czerwinski...................................... 17,598,106 312,478
R. Andrew Eckert........................................... 17,625,665 284,919
Graham O. King............................................. 17,639,546 271,038
David L. Lowe.............................................. 17,633,180 277,404
F. David Rollo............................................. 17,634,163 276,421
Edmund H. Shea, Jr......................................... 17,600,859 309,725
2) Proposal to approve the 1999 Long-Term Incentive Plan and reserve
920,000 shares of stock for issuance there under, subject to
additional shareholder approval: FOR--8,622,925; AGAINST--5,526,619;
ABSTAIN--496,399; and BROKER NON-VOTES--3,264,641.
3) Proposal to approve an amendment to the Company's 1999 Long-Term
Incentive Plan to increase shares reserved for issuance on an annual
basis: FOR--4,460,805; AGAINST-- 9,611,027; ABSTAIN--574,111; and
BROKER NON-VOTES--3,264,641.
4) Proposal to approve an amendment to the Company's 1994 Employee Stock
Purchase Plan to increase the shares authorized thereunder by
100,000: FOR--12,777,928; AGAINST-- 1,319,430; ABSTAIN--481,655; and
BROKER NON-VOTES--3,331,571.
ITEM 5. OTHER INFORMATION
Not applicable.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
10.23 1999 Long-Term Incentive Plan
10.24 Amendment No. 3 to Employee Stock Purchase Plan (1994)
27 Financial Data Schedule
(b) Form 8-K Reports:
None filed during the fiscal quarter described in this Report on Form
10-Q.
26
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.
Date: July 1, 1999 ADAC LABORATORIES
(Registrant)
By: /s/ R. ANDREW ECKERT
-----------------------------------------
R. Andrew Eckert
CHIEF EXECUTIVE OFFICER AND CHAIRMAN OF
THE BOARD OF DIRECTORS
27
EXHIBIT INDEX
10.23 1999 Long-Term Incentive Plan
10.24 Amendment No. 3 to Employee Stock Purchase Plan (1994)
27 Financial Data Schedule
28