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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-Q
(MARK ONE)
/X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JULY 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
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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 July 31, 1999, Registrant had outstanding 20,541,791 shares of Common
Stock, no par value.
(This document contains a total of 28 pages)
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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 Nine-Month
Periods Ended July 4, 1999 and June 28, 1998.......................................... 3
Condensed Consolidated Balance Sheets at July 4, 1999 and September 27, 1998............ 4
Condensed Consolidated Statements of Cash Flows for the Nine-Month Periods Ended July 4,
1999 and June 28, 1998................................................................ 5
Notes to Condensed Consolidated Financial Statements.................................... 6-12
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations...
13-25
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 NINE MONTHS ENDED
--------------------- ----------------------
JULY 4, JUNE 28, JULY 4, JUNE 28,
1999 1998 1999 1998
---------- --------- ---------- ----------
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
REVENUES, NET:
Product.............................................. $ 50,400 $ 49,472 $ 184,826 $ 151,292
Service.............................................. 25,220 20,284 72,466 60,424
---------- --------- ---------- ----------
75,620 69,756 257,292 211,716
---------- --------- ---------- ----------
COST OF REVENUES:
Product.............................................. 37,942 25,986 132,724 82,136
Service.............................................. 16,606 14,402 51,435 40,098
Discontinued product................................. -- -- -- 14,494
---------- --------- ---------- ----------
54,548 40,388 184,159 136,728
---------- --------- ---------- ----------
GROSS PROFIT........................................... 21,072 29,368 73,133 74,988
OPERATING EXPENSES:
Marketing and sales.................................. 15,200 12,289 49,801 35,762
Research and development............................. 4,546 3,669 13,390 12,950
General and administrative........................... 16,584 5,698 40,811 15,758
Goodwill amortization................................ 507 588 1,497 1,625
Restructuring charges................................ 474 -- 3,774 --
---------- --------- ---------- ----------
37,311 22,244 109,273 66,095
---------- --------- ---------- ----------
OPERATING INCOME (LOSS)................................ (16,239) 7,124 (36,140) 8,893
Interest and other expense, net........................ 549 1,579 3,530 3,507
---------- --------- ---------- ----------
INCOME (LOSS) BEFORE (BENEFIT) PROVISION FOR INCOME
TAXES................................................ (16,788) 5,545 (39,670) 5,386
Provision (benefit) for income taxes................... (3,574) 2,163 (9,521) 2,101
---------- --------- ---------- ----------
NET INCOME (LOSS)...................................... $ (13,214) $ 3,382 $ (30,149) $ 3,285
---------- --------- ---------- ----------
---------- --------- ---------- ----------
NET INCOME (LOSS) PER SHARE
Basic............................................ $ (.64) $ .17 $ (1.47) $ .17
---------- --------- ---------- ----------
---------- --------- ---------- ----------
Diluted.......................................... $ (.64) $ .17 $ (1.47) $ .16
---------- --------- ---------- ----------
---------- --------- ---------- ----------
NUMBER OF SHARES USED IN PER SHARE CALCULATIONS
Basic............................................ 20,504 19,681 20,443 19,291
---------- --------- ---------- ----------
---------- --------- ---------- ----------
Diluted.......................................... 20,504 20,443 20,443 20,184
---------- --------- ---------- ----------
---------- --------- ---------- ----------
The accompanying notes are an integral part of these condensed consolidated
financial statements.
3
ADAC LABORATORIES
CONDENSED CONSOLIDATED BALANCE SHEETS
JULY 4, 1999 SEPTEMBER 27, 1998
------------------- ---------------------
(UNAUDITED)
(AMOUNTS IN THOUSANDS)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents........................................... $ 4,867 $ 4,869
Trade receivables, net of allowance for returns and doubtful
accounts of $11,361 in 1999 and $2,319 in 1998.................... 77,449 55,316
Tax and other receivables........................................... 2,701 7,294
Inventories, net.................................................... 43,122 78,311
Prepaid expenses and other current assets........................... 5,616 4,928
-------- --------
TOTAL CURRENT ASSETS.................................................. 133,755 150,718
Service parts, net.................................................. 19,157 18,063
Fixed assets, net................................................... 16,552 11,007
Capitalized software, net........................................... 16,575 11,770
Intangibles, net.................................................... 25,895 25,336
Deferred income taxes............................................... 33,687 24,167
Other assets, net................................................... 1,061 2,748
-------- --------
TOTAL ASSETS........................................................ $ 246,682 $ 243,809
-------- --------
-------- --------
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Notes payable to banks.............................................. $ 47,695 $ 23,396
Accounts payable.................................................... 12,072 22,887
Deferred revenues................................................... 18,273 11,591
Customer deposits and advanced billings............................. 4,066 2,004
Accrued compensation................................................ 11,566 8,903
Warranty and installation........................................... 6,171 6,595
Other accrued liabilities........................................... 20,146 14,423
-------- --------
TOTAL CURRENT LIABILITIES............................................. 119,989 89,799
Non-current deferred income taxes..................................... 13,988 14,026
Non-current liabilities and deferred credits.......................... 3,161 3,082
-------- --------
Total Liabilities................................................... 137,138 106,907
-------- --------
-------- --------
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: 20,529 shares at July 4, 1999
and 20,253 shares at September 27, 1998............................. 153,743 149,599
Accumulated deficit................................................. (40,415) (10,266)
Translation adjustment.............................................. (3,784) (2,431)
-------- --------
TOTAL SHAREHOLDERS' EQUITY.......................................... 109,544 136,902
-------- --------
-------- --------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 246,682 $ 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)
NINE MONTHS ENDED
----------------------------
JULY 4, 1999 JUNE 28, 1998
------------ -------------
(AMOUNTS IN THOUSANDS)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss)..................................................... $(30,149) $ 3,285
Adjustments to reconcile net income (loss) to net cash
Provided by (used in) operating activities:
Depreciation and amortization....................................... 10,592 8,751
Provision for product returns and doubtful accounts................. 15,247 3,827
Deferred income taxes............................................... (9,558) (1,871)
Inventory allowance................................................. 11,006 (1,238)
Discontinued products............................................... -- 14,494
Restructuring charges............................................... 3,774 --
Changes in assets and liabilities:
Trade receivables................................................. (37,380) (10,499)
Tax and other receivables......................................... 4,593 --
Inventories....................................................... 24,183 (24,508)
Prepaid expenses and other current assets......................... (688) (234)
Service parts..................................................... (2,288) (1,999)
Accounts payable.................................................. (10,815) 7,639
Deferred revenues................................................. 6,682 (2,747)
Customer deposits and advance billings............................ 2,062 736
Accrued compensation.............................................. 2,663 2,114
Warranty and other accrued liabilities............................ 1,525 1,544
Non-current liabilities and deferred credits...................... 80 193
------------ -------------
Cash used in operating activities..................................... (8,471) (513)
------------ -------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures................................................ (9,815) (3,748)
Increase in other assets............................................ (5,910) (4,655)
Intangibles......................................................... (2,895) (7,273)
Acquisition of assets, net.......................................... -- 807
------------ -------------
Cash used in investing activities..................................... (18,620) (14,869)
------------ -------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Borrowings under short term debt arrangements, net.................. 24,299 9,451
Proceeds from issuance of common stock, net......................... 4,144 10,776
------------ -------------
Cash provided by financing activities................................. 28,443 20,227
------------ -------------
Effect of exchange rates on cash...................................... (1,354) (904)
------------ -------------
Net increase (decrease) in cash and cash equivalents.................. (2) 3,941
Cash and cash equivalents, at beginning of the period................. 4,869 5,088
------------ -------------
Cash and cash equivalents, at end of the period....................... $ 4,867 $ 9,029
------------ -------------
SUPPLEMENTAL CASH FLOW DISCLOSURE:
Interest paid....................................................... $ 3,535 $ 3,160
Income taxes paid................................................... $ 445 $ 5,046
The accompanying notes are an integral part of these condensed consolidated
financial statements.
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. Operating results for the three and nine-month periods ended July 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 nine-month periods ended July 4, 1999 and June 28, 1998
are as follows:
THREE MONTHS ENDED NINE MONTHS ENDED
---------------------------- ----------------------------
JULY 4, 1999 JUNE 28, 1998 JULY 4, 1999 JUNE 28, 1998
------------ ------------- ------------ -------------
(AMOUNTS IN THOUSANDS EXCEPT PER SHARE DATA)
Basic EPS: Net Income (Loss).......................................... $(13,214) $ 3,382 $(30,149) $ 3,285
Denominator: Weighted Average Common Shares Outstanding............... 20,504 19,681 20,443 19,291
Basic EPS............................................................. $ (.64) $ .17 $ (1.47) $ .17
------------ ------------- ------------ -------------
------------ ------------- ------------ -------------
Diluted EPS: Net Income (Loss)........................................ $(13,214) $ 3,382 $(30,149) $ 3,285
Denominator: Weighted Average Common Shares Outstanding............... 20,504 19,681 20,443 19,291
Options............................................................... -- 762 -- 893
------------ ------------- ------------ -------------
Total Shares.......................................................... 20,504 20,443 20,443 20,184
Diluted EPS........................................................... $ (.64) $ .17 $ (1.47) $ .16
------------ ------------- ------------ -------------
------------ ------------- ------------ -------------
If the Company had net income in the three and nine-month periods ended July
4, 1999, the total diluted shares would have included options of 36,000 and
286,000, respectively.
3. DEPRECIATION AND AMORTIZATION
Depreciation and amortization was approximately $2.9 million and $2.5
million for the three-month periods ended July 4, 1999 and June 28, 1998,
respectively.
6
ADAC LABORATORIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
4. INVENTORIES
JULY 4, SEPTEMBER 27,
1999 1998
----------- -------------
(DOLLAR AMOUNTS IN
THOUSANDS)
Inventories consist of:
Purchased parts and sub-assemblies.......................................... $ 19,884 $ 17,452
Work in process............................................................. 8,085 5,713
Finished goods.............................................................. 27,623 59,217
----------- -------------
55,592 82,382
Less reserves............................................................... (12,470) (4,071)
----------- -------------
$ 43,122 $ 78,311
----------- -------------
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5. SERVICE PARTS
JULY 4, SEPTEMBER 27,
1999 1998
----------- -------------
(DOLLAR AMOUNTS IN
THOUSANDS)
Service parts consist of:
Field service parts, at cost................................................ $ 28,614 $ 26,327
Less accumulated depreciation............................................... (9,457) (8,264)
----------- -------------
$ 19,157 $ 18,063
----------- -------------
----------- -------------
6. FIXED ASSETS
JULY 4, SEPTEMBER 27,
1999 1998
----------- -------------
(DOLLAR AMOUNTS IN
THOUSANDS)
Fixed assets, at cost, consist of:
Production and test equipment............................................... $ 4,410 $ 4,351
Field service equipment..................................................... 1,082 1,168
Office and demonstration equipment.......................................... 23,855 14,401
Leasehold improvements...................................................... 1,650 1,261
----------- -------------
30,997 21,181
Less accumulated depreciation and amortization.............................. (14,445) (10,174)
----------- -------------
$ 16,552 $ 11,007
----------- -------------
----------- -------------
7
ADAC LABORATORIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
7. INTANGIBLES
JULY 4, 1999 SEPTEMBER 27, 1998
------------ ------------------
(DOLLAR AMOUNTS IN THOUSANDS)
Intangibles consist of:
Goodwill.............................................................. $ 21,803 $ 21,849
Acquired technology................................................... 8,867 8,984
Product development program........................................... 2,693 --
Other................................................................. 841 510
------------ --------
34,204 31,343
Less accumulated amortization......................................... (8,309) (6,007)
------------ --------
$ 25,895 $ 25,336
------------ --------
------------ --------
8. OTHER ACCRUED LIABILITIES
JULY 4, 1999 SEPTEMBER 27, 1998
------------ ------------------
(DOLLAR AMOUNTS IN THOUSANDS)
Other accrued liabilities consist of:
South American recourse obligations................................... $ 3,810 $ --
Accrued cost of revenue............................................... 4,059 3,354
Accrued restructuring................................................. 2,195 --
Customer advances..................................................... 1,822 2,775
Accrued legal and accounting.......................................... 929 194
Accrued royalties..................................................... 1,402 956
Other accrued expenses................................................ 5,929 7,144
------------ -------
$20,146 $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 and $0.8 million, respectively. In the third
quarter of fiscal 1999, the Company also decided to restructure its ADAC Medical
Technologies ("AMT") business and took a charge of $0.5 million, see Note 13
"Fiscal 1999--Non-Ordinary Charges and Expenses". The restructuring costs were
comprised of $2.4 million for severance expenses, $0.8 million for legal and
consulting costs, and $0.6 million for other costs associated with the
restructuring. As of July 4, 1999 $2.2 million remained in the accrual for
restructuring costs comprised of $1.8 million for severance expenses, and $0.4
million for other costs associated with the restructuring. The Company currently
anticipates that these restructuring costs will be paid over the next two
quarters.
9. CREDIT AND BORROWING ARRANGEMENTS
The Company has a $75.0 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
8
ADAC LABORATORIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
9. CREDIT AND BORROWING ARRANGEMENTS (CONTINUED)
bank's prime rate or Libor plus rates ranging from 0.875% to 1.5%. At July 4,
1999, the Company had $27.4 million available for borrowing under this facility.
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.
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, second and third quarters of
fiscal 1999 caused the Company to be out of compliance with all financial
covenants in the facility. The banks waived the defaults for the first and
second quarters of fiscal 1999. The Company is currently negotiating an
amendment to the facility, which will include an upward revision of the
commitment fees to a range of .25% to .75% of unused commitment, an upward
revision of Libor plus rates to a range of 1.0% to 2.5%, a waiver of the
Company's covenants of default in the third quarter of fiscal 1999, and modified
financial covenants more reflective of the Company's recent financial
performance. The Company has reached verbal agreement with the bank syndicate on
the principal terms and conditions of the amendment. The Company expects that
the written amendment will be completed and executed prior to August 31, 1999.
However, there can be no assurance that such an amendment will be completed.
Failure to secure this amendment to the facility could have a material adverse
effect on the Company.
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 the restatement of the Company's financial statements
and seek unspecified but potentially significant damages. In April 1999, these
actions were ordered consolidated and, in July 1999, the plaintiffs filed a
consolidated amended complaint. The Company intends to contest this action
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. However, no
assurances can be given that an adverse outcome would not have a material
adverse effect.
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
nine-month periods ended July 4, 1999 and June 28, 1998 are based on the
estimated effective income tax rates for the fiscal years ending
9
ADAC LABORATORIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
11. INCOME TAXES (CONTINUED)
October 3, 1999 and September 27, 1998 of 24% and 39.0%, respectively. The
effective tax rate for fiscal 1999 was adjusted in the second quarter from 38%
to 26% and in the third quarter from 26% to 24%, resulting in an effective tax
benefit for the third quarter of 21%. The principal reasons for the difference
between the statutory tax rate of 35% and the effective tax rate of 24% are the
expiration of tax credits, permanent differences and state income taxes.
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 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 product 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
A significant number of the Company's customers in its South American
markets of Brazil, Argentina and Columbia are delinquent in making periodic
payments due under the terms of sales previously made to them, many of which
were supported by third-party financing arrangements that involve full or
partial recourse to the Company. Deteriorating economic conditions and currency
devaluations occurring primarily during fiscal 1999, and ineffective monitoring
of delinquencies and collection efforts by the Company, have all contributed to
delays in the collection of accounts receivable from customers in these markets.
The Company has recently undertaken renewed collection efforts and, during the
quarter ended July 4, 1999, completed an evaluation of each receivable balance
and recourse obligation to determine what reserves for collectibility should be
provided for these customers. As a result of this evaluation, the Company has
revised its estimate of the recoverability of its South American receivables and
recourse obligations and provided additional reserves of $7.1 million during the
quarter ended July 4, 1999, resulting in total reserves of $8.2 million against
total gross receivables and recourse obligations for South America of
approximately $12.9 million. While the Company is continuing to dedicate
significant resources towards its collection efforts and believes these reserves
are adequate at the present time, no assurances can be given that additional
reserves will not be required in the future.
10
ADAC LABORATORIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
13. FISCAL 1999--NON-ORDINARY CHARGES AND EXPENSES (CONTINUED)
In the third quarter of fiscal 1999, the Company also decided to close its
AMT refurbishing facility in Washington, Missouri, and relocate the business to
Milpitas, California. Also in the third quarter of fiscal 1999, the Company
decided to discontinue refurbishment of a number of lines of older nuclear
medicine equipment, the demand for which was declining. These decisions as well
as existing market conditions, rendered obsolete substantial inventories of
equipment and parts, resulting in a non-ordinary charge of $2.4 million in the
third quarter of fiscal 1999.
During fiscal 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, new product introductions by the Company and its competitors, 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 build plans 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 fiscal 1999
and the nine months ended July 4, 1999 include the following adjustments and
charges based on changes in estimates and revaluation's resulting from this
process.
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 for the second quarter
of fiscal 1999 and the nine-month period ending July 4, 1999 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
11
ADAC LABORATORIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
13. FISCAL 1999--NON-ORDINARY CHARGES AND EXPENSES (CONTINUED)
procedures with the process of developing and introducing new products in order
to reduce the risk 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 second quarter of fiscal
1999.
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 2001. Currently the Company does not hold
any derivative instruments or engage in any hedging activities.
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 a 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 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
nine-month periods ended July 4, 1999 and June 28, 1998 are as follows:
THREE MONTHS ENDED NINE MONTHS ENDED
----------------------- -----------------------
JULY 4, JUNE 28, JULY 4, JUNE 28,
1999 1998 1999 1998
---------- ----------- ---------- -----------
(DOLLAR AMOUNTS IN THOUSANDS)
Net Income (loss)..................................................... $ (13,214) $ 3,382 $ (30,149) $ 3,285
Comprehensive (loss).................................................. (94) (280) (1,029) (551)
---------- ----------- ---------- -----------
Net Income (loss) including comprehensive income (loss)............... $ (13,308) $ 3,102 $ (31,178) $ 2,734
---------- ----------- ---------- -----------
---------- ----------- ---------- -----------
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 and
nine-month periods ended July 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 NINE-MONTH PERIODS ENDED JULY 4, 1999 COMPARED TO THE
THREE-MONTH AND NINE-MONTH PERIODS ENDED JUNE 28, 1998
Revenues for the third quarter of fiscal 1999 were $75.6 million, an
increase of 8%, or $5.8 million, over the third quarter fiscal 1998 revenues of
$69.8 million. Revenues are primarily generated from the sale and servicing of
medical imaging products. Medical Systems revenues represented 75% and 72% of
the Company's total revenues for the third quarter of fiscal 1999 and 1998,
respectively. The Company's Software Business revenues represented approximately
25% and 28% of the Company's total revenues for the third quarter of fiscal 1999
and 1998, respectively.
Revenues for the nine-month period ended July 4, 1999 were $257.3 million,
an increase of 22%, or $45.6 million, over the $211.7 million for the same
period in fiscal 1998. Gross profit for the first nine months of fiscal 1999 was
$73.1 million, a 3% decrease from the $75.0 million generated in the same period
in fiscal 1998, which included the $14.5 million 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
A significant number of the Company's customers in its South American
markets of Brazil, Argentina and Columbia are delinquent in making periodic
payments due under the terms of sales previously made to them, many of which
were supported by third-party financing arrangements that involve full or
partial recourse to the Company. Deteriorating economic conditions and currency
devaluations occurring primarily during fiscal 1999, and ineffective monitoring
of delinquencies and collection efforts by the Company, have all contributed to
delays in the collection of accounts receivable from customers in these markets.
The Company has recently undertaken renewed collection efforts and, during the
quarter ended July 4, 1999, completed an evaluation of each receivable balance
and recourse obligation to determine what reserves for collectibility should be
provided for these customers. As a result of this evaluation, the Company has
revised its estimate of the recoverability of its South American receivables and
recourse obligations and provided additional reserves of $7.1 million during the
quarter ended July 4, 1999, resulting in total reserves of $8.2 million against
total gross receivables and recourse obligations for South America of
approximately $12.9 million. While the Company is continuing to dedicate
significant resources towards its collection efforts and believes these reserves
are adequate at the present time, no assurances can be given that additional
reserves will not be required in the future.
In the third quarter of fiscal 1999, the Company also decided to close its
AMT refurbishing facility in Washington, Missouri, and relocate the business to
Milpitas, California. Also in the third quarter of fiscal 1999, the Company
decided to discontinue refurbishment of a number of lines of older nuclear
medicine equipment, the demand for which was declining. These decisions as well
as existing market conditions, rendered obsolete substantial inventories of
equipment and parts, resulting in a non-ordinary charge of $2.4 million in the
third quarter of fiscal 1999.
13
During fiscal 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, new product introductions by the Company and its competitors, 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 build plans 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 fiscal 1999
and the nine months ended July 4, 1999 include the following adjustments and
charges based on changes in estimates and revaluation's resulting from this
process.
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 for the second quarter
of fiscal 1999 and the nine-month period ending July 4, 1999 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 risk 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
second quarter of fiscal 1999.
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 nine-month periods ended July 4, 1999 compared to the corresponding
periods in fiscal 1998 are as follows:
THREE MONTHS ENDED NINE MONTHS ENDED
-------------------- ----------------------
JULY 4, JUNE 28, JULY 4, JUNE 28,
1999 1998 1999 1998
--------- --------- ---------- ----------
(DOLLAR AMOUNTS IN THOUSANDS)
Revenues:
Product................................................ $ 34,755 $ 34,132 $ 140,599 $ 113,555
Service................................................ 21,558 16,240 60,985 48,087
--------- --------- ---------- ----------
Total................................................ $ 56,313 $ 50,372 $ 201,584 $ 161,642
Geographical mix:
North America.......................................... 92.4% 86.0% 89.9% 82.4%
Europe................................................. 6.9% 11.0% 5.9% 11.8%
Latin America, Japan and Asia.......................... 0.7% 3.0% 4.2% 5.8%
Gross margin after discontinued product charges in fiscal
1998
Product................................................ 13.4% 43.2% 20.1% 40.1%
Service................................................ 31.3% 24.1% 24.4% 29.9%
--------- --------- ---------- ----------
Total................................................ 20.2% 37.0% 21.4% 37.0%
Medical Systems' product revenues for the three and nine-month periods ended
July 4, 1999 increased 2% and 24%, respectively, over the same period in fiscal
1998. The 24% increase for the nine-month period ended July 4, 1999 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
in the first two quarters of fiscal 1999. In the third quarter of fiscal 1999
revenue growth declined to 2% due to a slow down in installation caused by
customer sites not being ready, increased competition in certain of the
Company's markets, and customers deferring purchasing decisions due to their
perceived Year 2000 risks. The Company anticipates this trend will continue
throughout the balance of fiscal 1999. 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.
Gross margins for Medical Systems products decreased 30% and 20% in the
three and nine-month periods ended July 4, 1999, respectively, compared to the
corresponding periods of the prior fiscal year. In the third fiscal quarter of
fiscal 1999, the Company decided to discontinue refurbishment of a number of
lines of older nuclear medicine equipment, the demand for which was declining.
In connection with this decision the Company closed its refurbishing facility in
Washington, Missouri in August of 1999, and relocated the business to Milpitas,
California. This decision, combined with existing market conditions, rendered
obsolete substantial inventories of equipment and parts, resulting in a charge
of $2.4 million in the third quarter.
The decline in gross margin for the nine-month period ended July 4, 1999 is
attributable to adjustments and charges taken in the second quarter of fiscal
1999. Delays in customer orders coupled with increasing competition in certain
of the Company's markets and 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 also determined that certain materials that were being held for
resale had become obsolete due to rapid changes in the demand for used and
refurbished nuclear medicine cameras. This resulted in a charge of $0.4 million
in the second quarter of fiscal 1999 to reduce the carrying value of materials
held for resale. In addition, the Company also 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 adjustments and obsolescence. See
Note 13 "Fiscal 1999-- Non-Ordinary Charges and Expenses" of the Notes to
Condensed Consolidated Financial Statements.
15
Gross margins for the three and nine-month periods ended July 4, 1999 were
also adversely effected by a smaller build plan for the second and third
quarters 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 further adversely affected by competitive pricing pressures,
transitions to new products and investments in infrastructure.
Medical Systems service revenues for the three and nine-month periods ended
July 4, 1999 increased 33% and 27%, respectively, over the same periods in
fiscal 1998. The increases resulted from a higher number of customers under
service contract. The third quarter of fiscal 1999 also included revenues from
services provided to bring customer's equipment into Year 2000 compliance. Gross
margins increased 7% for the three-month period ended July 4, 1999 compared to
the same period in fiscal 1998, due to the high margins from the Year 2000
compliance services. Gross margins decreased 6% for the nine-month period ended
July 4, 1999 compared to the same period of fiscal 1998. The principal reason
for the decline was a second quarter of fiscal 1999 write-off of approximately
$0.8 million of excess inventory of consumable spare parts held in the field.
Margins also declined due to increased staffing and higher retrofit costs.
The Company is in the process of reviewing the composition of its
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 for the three and nine-month periods ended July 4, 1999 compared to the
corresponding periods in fiscal 1998 are as follows:
THREE MONTHS ENDED NINE MONTHS ENDED
-------------------- --------------------
JULY 4, JUNE 28, JULY 4, JUNE 28,
1999 1998 1999 1998
--------- --------- --------- ---------
(DOLLAR AMOUNTS IN THOUSANDS)
Revenues:
Product................................................... $ 15,645 $ 15,340 $ 44,227 $ 37,737
Service................................................... 3,662 4,044 11,481 12,337
--------- --------- --------- ---------
Total................................................... $ 19,307 $ 19,384 $ 55,708 $ 50,074
Geographical mix:
North America............................................. 93.6% 89.7% 92.8% 91.1%
Europe.................................................... 3.8% 6.5% 4.0% 6.9%
Latin America, Japan and Asia............................. 2.6% 3.8% 3.2% 2.0%
Gross margin after discontinued product charges
Product................................................... 49.9% 57.0% 53.9% 24.3%
Service................................................... 50.9% 48.7% 53.6% 48.1%
--------- --------- --------- ---------
Total................................................... 50.1% 55.3% 53.8% 30.2%
16
Software Business product revenues increased 2% and 17% for the three and
nine-month periods ended July 4, 1999, respectively, over the same periods in
fiscal 1998. The increase in the three-month period resulted primarily from
additional sales of HCIS QuadRIS-TM- upgrades for Year 2000 compliance. This was
partially offset by decreased RTP revenue in Europe due to the adoption of the
American Institute of Certified Public Accountants (AICPA) Statement of Position
("SOP 97-2"), "Software Revenue Recognition." The increase for the nine-month
period is primarily driven by increased unit volume of the RTP Pinnacle product.
Gross margins for the three and nine-months ended July 4, 1999 decreased 7%
and 2%, respectively, from the corresponding periods in fiscal 1998 before
discontinued product charges. The decrease in the three-months ended July 4,
1999 was due principally to RTP pricing pressures from increasing competition.
Software Business service revenues decreased 9% and 7% for the three and
nine-month periods ended July 4, 1999, respectively, from the corresponding
periods in fiscal 1998 due principally to lower legacy HCIS laboratory service
revenues. Service gross margins increased 2% and 6% for the three and nine-month
periods ended July 4, 1999, respectively, 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 nine-month periods are as follows:
THREE MONTHS ENDED NINE MONTHS ENDED
------------------------ ------------------------
JULY 4, JUNE 28, JULY 4, JUNE 28,
1999 1998 1999 1998
----------- ----------- ----------- -----------
Operating costs and expenses:
Marketing and sales............................................. 20.1% 17.6% 19.4% 16.9%
Research and development, net of software capitalization........ 6.0% 5.3% 5.2% 6.1%
General and administrative...................................... 21.9% 8.2% 15.8% 7.4%
Goodwill amortization........................................... 0.7% 0.8% 0.6% 0.8%
Restructuring charge............................................ 0.6% -- 1.5% --
--- --- --- ---
49.3% 31.9% 42.5% 31.2%
--- --- --- ---
--- --- --- ---
Interest and other expense, net................................. 0.7% 2.3% 1.4% 1.7%
Marketing and sales expenses for the three and nine-month periods ended July
4, 1999 increased $2.9 and $14.0 million, respectively, over the corresponding
periods in the prior fiscal year. This was a result of higher additional bad
debt reserves for the Company's European operations, in the second quarter of
fiscal 1999, and compensation costs associated with increasing revenues.
Research and development expenses, net of software capitalization, for the
three and nine-month periods ended July 4, 1999 increased $0.9 and $0.4 million,
respectively, over the corresponding periods in the prior fiscal year as a
result of increased spending in RTP to support product growth. These increases
were partially offset by increases in the amounts of capitalized software costs.
Capitalized software costs were $2.1 and $1.9 million, respectively in third
quarters of fiscal 1999 and 1998. Capitalized software costs were $7.3 and $5.5
million for the first nine months of fiscal 1999 and 1998, respectively.
General and administrative expenses for the three and nine-month periods
ended July 4, 1999 increased $10.9 and $25.1 million over the corresponding
periods in the prior fiscal year. In the third quarter of fiscal 1999, the
Company revised its estimates of the recoverability of its South American
receivables and provided additional reserves of $7.1 million. See Note 13
"Fiscal 1999--Non-Ordinary Charges and Expenses" of the Notes to Condensed
Consolidated Financial Statements. In the second
17
quarter of fiscal 1999, following a review of all receivables on the Company's
books other than Latin American receivables, the Company increased its bad debt
reserves by $4.4 million. In addition, increases in expenses payable to outside
legal, accounting and other service providers, an overall increase in
infrastructure costs and an increase in expense accruals have occurred in the
three and nine-month periods ended July 4, 1999, when compared to the
corresponding periods of the prior fiscal year.
Goodwill amortization decreased slightly in the three and nine-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, second and third
quarters of fiscal 1999 of $2.5, $0.8 and $0.5 million, respectively, related to
Europe, Latin America, and AMT operations. See Note 8 "Other Accrued
Liabilities" 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, decreased as a
percentage of revenue for the three and nine-month periods ended July 4, 1999
when compared to corresponding periods in the prior fiscal year, primarily from
increased sales revenue and decreases in accounts receivable sold and foreign
exchange losses.
INCOME TAXES:
The provision (benefit) for income taxes for each of the three and
nine-month periods ended July 4, 1999 and June 28, 1998 are based on the
estimated effective income tax rates for the fiscal years ending October 3, 1999
and September 27, 1998 of 24% and 39.0%, respectively. The effective tax rate
for fiscal 1999 was adjusted in the second quarter from 38% to 26%, and again in
the third quarter from 26% to 24%, resulting in an effective tax benefit for the
third quarter of 21%. The principal reasons for the difference between the
statutory tax rate of 35% and the effective tax rate of 24% are the expiration
of tax credits, permanent differences and state income taxes.
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, subject to execution of the amendment to its credit
facility described below. 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 on terms acceptable to the Company, if at all.
The Company's ratio of current assets to current liabilities at July 4, 1999
was 1.1 to one, while working capital at July 4, 1999 decreased $47.1 million to
$13.8 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
other accrued liabilities of $24.3, $6.7 and $5.7 million, respectively, and
decreases in inventories, and tax and other receivables of $35.2 and $4.6
million, respectively. The decrease in working capital was offset by a $22.1
million increase in accounts receivable, net, and a $10.8 million decrease in
accounts payable. Notes payable to banks increased to meet the Company's
operating needs for cash. Deferred revenues increased due to the Company's more
stringent revenue recognition policy requiring up-front customer deposits with
orders. Other accrued liabilities increased from South American recourse
obligations. 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. Tax and other receivables decreased as the Company received income
tax refunds. Accounts receivable, net increased due to a decrease in accounts
receivable sold, increased sales for the first nine-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. Accounts
payable decreased due to payment process improvements. The Company's ratio of
current assets to current liabilities at June 28, 1998 was 1.5 to one, while
working capital at June 28, 1998 increased $6.6 million to $47.4 million from
$40.8 million at September 28, 1997.
18
The primary uses of cash in operations for the first nine months of fiscal
1999 were an increase of $37.4 million in accounts receivable, and a decrease of
$10.8 million in accounts payable. This was partially offset by a decreases of
$24.2 and $4.6 million in inventories and tax and other receivables,
respectively, and an increase of $6.7 million in deferred revenues. The primary
uses of cash in operations for the first nine months of fiscal 1998 was a $10.5
million increase in accounts receivable and a $24.5 million increase in
inventory.
Cash of $18.6 million was used for investing activities in the first nine
months of fiscal 1999. This activity consisted primarily of $9.8 and $5.9
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 demonstration
equipment. The increase in other assets is primarily from the capitalization of
development costs related to software products. Cash of $14.9 million was used
for investing activities in the first nine months of fiscal 1998. This activity
consisted principally of the acquisitions of CT Solutions and ONES.
Financing activities provided $28.4 million of cash in the first nine months
of fiscal 1999. This was attributable to $24.3 million of increased borrowings
to meet operational needs and $4.1 million of proceeds from common stock issued
to employees under the Company's employee stock purchase and option plans.
Financing activities provided $20.2 million of cash in the first nine months of
fiscal 1998. This was primarily attributable to $9.5 million of increased
borrowings and $10.8 million of proceeds from common stock issued to employees
under the Company's employee stock purchase and option plans.
The Company has a $75.0 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 July 4, 1999, the Company had $27.4 million available
for borrowing under this facility. 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. 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, second and third quarters of fiscal 1999 caused the Company to be
out of compliance with all financial covenants in the facility. The banks waived
the defaults for the first and second quarters of fiscal 1999. The Company is
currently negotiating an amendment to the facility, which will include an upward
revision of the commitment fees to a range of .25% to .75% of unused commitment,
an upward revision of Libor plus rates to a range of 1.0% to 2.5%, a waiver of
the Company's covenants of default in the third quarter of fiscal 1999, and
modified financial covenants more reflective of the Company's recent financial
performance. The Company has reached verbal agreement with the bank syndicate on
the principal terms and conditions of the amendment. The Company expects that
the written amendment will be completed and executed prior to August 31, 1999.
However, there can be no assurance that such an amendment will be completed.
Failure to secure this amendment to the facility could have a material adverse
effect on the Company.
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
19
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.
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.
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 the restatement of the Company's financial statements
and seek unspecified but potentially significant damages. In April, 1999, these
actions were ordered consolidated and, in July 1999, the plaintiffs filed a
consolidated amended complaint. The Company intends to contest this action
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. However, no
assurances can be given that an adverse outcome would not have a material
adverse effect.
SOUTH AMERICAN OPERATIONS
A significant number of the Company's customers in its South American
markets of Brazil, Argentina and Columbia are delinquent in making periodic
payments due under the terms of sales previously made to them, many of which
were supported by third-party financing arrangements that involve full or
partial recourse to the Company. Deteriorating economic conditions and currency
devaluations occurring primarily during fiscal 1999, and ineffective monitoring
of delinquencies and collection efforts by the Company, have all contributed to
delays in the collection of accounts receivable from customers in these markets.
The Company has recently undertaken renewed collection efforts and, during the
quarter ended July 4, 1999,
20
completed an evaluation of each receivable balance and recourse obligation to
determine what reserves for collectibility should be provided for these
customers. As a result of this evaluation, the Company has revised its estimate
of the recoverability of its South American receivables and recourse obligations
and provided additional reserves of $7.1 million during the quarter ended July
4, 1999, resulting in total reserves of $8.2 million against total gross
receivables and recourse obligations for South America of approximately $12.9
million. While the Company is continuing to dedicate significant resources
towards its collection efforts and believes these reserves are adequate at the
present time, no assurances can be given that additional reserves will not be
required in the future.
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, 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.
21
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.
22
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. The Company is in the process of reviewing the composition
of its 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."
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
22
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 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
23
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 $0.7 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.
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.
24
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
See Note 10 "Litigation" of the Notes to Condensed Consolidated Financial
Statements.
ITEM 2. CHANGES IN SECURITIES
Not applicable.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
See Note 9 "Credit and Borrowing Arrangements" of the Notes to Condensed
Consolidated Financial Statements.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
ITEM 5. OTHER INFORMATION
Not applicable.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
10.25 1999 Supplemental Incentive Plan
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: August 18, 1999 ADAC LABORATORIES
(REGISTRANT)
By: /s/ ROBERT P. BUNJE
-----------------------------------------
Robert P. Bunje
INTERIM CHIEF FINANCIAL OFFICER
By: /s/ R. ANDREW ECKERT
-----------------------------------------
R. Andrew Eckert
CHIEF EXECUTIVE OFFICER AND
CHAIRMAN OF THE BOARD OF DIRECTORS
27
EXHIBIT INDEX
10.25 1999 Supplemental Incentive Plan
27 Financial Data Schedule
28