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Except for historical information, this discussion contains forward-looking statements that involve risks and uncertainties that could cause actual results to differ materially from those projected. Such risk and uncertainties include those described in the "Factors That May Affect Future Operations" section on page 8 of this Form 10-Q.
Results of Operations -
For the third quarter ended September 30, 1999, OEC Medical Systems, Inc. had a net loss of $0.6 million and for the nine months ended September 30, 1999, the Company had net income of $8.3 million, compared with net income of $4.3 million and $11.4 million, respectively, for the same periods in 1998.
During the third quarter, the Company encountered transition issues with the introduction of the Series 9800 Mobile C-arm, which delayed production at the beginning of the quarter. Although these issues were resolved by mid-August, the reduced shipments adversely affected revenue and income.
On August 9, 1999, the Company announced that it had signed a definitive agreement to merge with the GE Medical Systems business of General Electric Company, subject to shareholder approval. During the third quarter, the Company had $1.5 million of merger related costs. Excluding merger expenses, the Company would have earned $0.02 per share for the quarter.
The following table sets forth OEC's operating results as a percentage of net sales:
Quarter Ended September 30, Nine Months Ended September 30,
1999 1998 1999 1998
------------------- -------------------
Net sales:
Product 84.1 87.7 87.2 87.4
Service 15.9 12.3 12.8 12.6
----- ----- ----- -----
Total net sales 100.0 100.0 100.0 100.0
----- ----- ----- -----
Cost of sales:
Product 49.7 48.8 49.4 48.5
Service 13.1 8.7 10.0 9.2
---- ----- ----- -----
Total cost of sales 62.8 57.5 59.4 57.7
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Gross margin 37.2 42.5 40.6 42.3
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Operating expenses:
Research and development 8.4 6.9 7.1 7.1
Marketing and sales 20.8 16.5 18.2 17.1
Administrative, general and other 11.1 5.1 6.7 5.3
----- ----- ----- -----
Total operating expenses 40.3 28.5 32.0 29.5
----- ----- ----- -----
Operating income (loss) (3.1) 14.0 8.6 12.8
----- ----- ----- -----
Net income (loss) (1.7) 9.0 5.8 8.5
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Sales and Markets
-
Net sales for the quarter and nine months ended September 30, 1999, were $39.0 million and $142.3 million, respectively, compared with net sales of $47.9 million and $135.0 million for the comparable periods of 1998. This reflects an 18% decrease and 5% increase, respectively, and is a direct result of transition issues with the introduction of the Series 9800. Product sales for the quarter and nine months ended September 30, 1999 were
$32.8 million and $124.1 million, respectively, compared with product sales of $42.0 million and $118.0 million, respectively, for the same periods last year.
The order rate in the third quarter was down 12% over last year, and for the nine months was up 4%, with strong international bookings partially offsetting the slowdown of domestic orders associated with the introduction of the Series 9800.
Service revenue for the quarter and nine months ended September 30, 1999 was $6.2 million and $18.3 million, respectively, compared with service revenue of $5.9 million for the same quarter last year and $17.1 million for the nine month period in 1998.
International revenue was up 35% for the nine-month period, compared to the prior year. The significant increases are partially due to strong growth in Europe as well as improvements in the economic conditions in Asia.
Margin Analysis -
OEC's gross margin was 37.2% of net sales for the third quarter and 40.6% for the nine months of 1999, compared to 42.5% and 42.3%, respectively, for the same periods in 1998. The decline in margin was due to production start-up costs with the introduction of the Series 9800, the increased international sales that typically have a lower selling price and additional discounting of the Series 9600 as that product nears the end of its product life cycle.
Service expenses increased by $1.0 million in the third quarter and $1.8 million for the nine months, compared to the same periods in 1998. The increases are due to additional personnel and the start-up costs associated with restructuring the Company's service support in Texas, Iowa and Nebraska.
Operating Expenses
Research and development costs were flat for the three-month period and up $0.5 million for the nine months compared to the prior year.
Marketing and sales expenses were flat for the quarter and increased $2.8 million or 12% for the nine months compared to the prior year, primarily due to additional commission expense associated with the increased revenue and the start-up costs required for restructuring the Company's product distribution channel in Texas.
Administrative expenses included $1.5 million of merger related costs. Excluding the merger costs, administrative expenses increased 14% for the nine months ended September 30, 1999 compared to the prior year.
Income Taxes
For the first nine months of 1999 and 1998, the Company recorded $4.4 million and $6.4 million of tax expense, respectively. The effective tax rate remains at 35% and it is expected to remain around that level throughout 1999.
Liquidity and Capital Resources -
Cash provided by operations for the nine months ended September 30,1999 and 1998 was $6.4 million and $10.1 million, respectively. During 1999, cash generated from net income was partially offset by inventory increases associated with the production delays of the Series 9800.
At the beginning of the third quarter, the Company increased its minority interest investment in Heartlab, Inc. by an additional $1.1 million.
Factors That May Affect Future Results
Certain statements contained in this document and other written and oral statements made from time to time by the Company do not relate strictly to historical or current facts. As such, they are considered "forward-looking statements" which provide current expectations or forecasts of future events. Such statements can be identified by
the use of terminology such as "anticipate," "believe," "estimate," "expect," "intend," "may," and similar words or expressions. The Company's forward-looking statements generally relate to its growth strategies, financial results, product development and regulatory approval programs, and sales efforts. One must carefully consider forward-looking statements and understand that such statements involve a variety of risks and uncertainties, known and unknown, and actual results may vary materially.
OEC's future operating results are dependent on its ability to develop, manufacture and market innovative products that meet customers' needs. The process of developing new high technology medical products is complex and uncertain and requires innovative designs that anticipate customer needs, technological trends and healthcare shifts. There can be no assurance that the Company will be able to develop and market new products on a cost-effective and timely basis, that such products will compete favorably with products developed by others or that existing technology will not be superceded by new discoveries or breakthroughs.
In May 1999, the Company introduced its new Series 9800 1k x 1k product platform, which is the next generation successor to the Company's Series 9600 platform. As previously reported, the Company has encountered transition issues often associated with new product introductions and the Company experienced a related shortfall in revenue and profits for the third quarter of 1999. Although the Company believes that the significant issues have been resolved, there may be additional issues related with the new product's introduction.
Because of the substantial length of time and expense associated with bringing new products through development and regulatory approval to the marketplace, the medical device industry places considerable importance on obtaining patent, trademark, copyright and trade secret protection for new technologies, products and processes. The loss of such protection could have a material adverse effect on the Company's business.
OEC depends on some significant vendors for certain important component parts for certain products. While the Company believes any of these single-source items could be replaced over time, abrupt disruption in the supply of a part for a product could have an adverse effect on the Company's production and on its financial condition and results of operations in cases where the existing inventory of the components is not adequate to meet the Company's demand for the component during such disruption.
The testing, marketing and sale of human healthcare products entails an inherent risk of product liability. There can be no assurance that product liability claims will not be asserted against OEC. Although OEC has product liability insurance coverage, there can be no assurance that such coverage will provide adequate coverage against all potential claims.
As a manufacturer of medical devices, OEC is subject to extensive and rigorous governmental regulation, principally by the FDA and corresponding state and foreign agencies. Failure to comply with FDA and other regulations could result in sanctions being imposed, including restrictions on the marketing of or recall of the affected products. OEC's facilities and manufacturing processes have been periodically inspected by the FDA and other agencies, but remain subject to further inspections from time to time. OEC continues to devote substantial human and financial resources to regulatory compliance and believes that it remains in substantial compliance with all applicable federal and state regulations. Nevertheless, there can be no assurance that the FDA or a state or foreign agency will agree with OEC's positions, or that its GMP or ISO compliance will not be challenged at some subsequent point in time.
A portion of the Company's research and development activities, some of its single-source vendors, its corporate headquarters and other critical business operations are located near a major earthquake fault. The ultimate impact on the Company, significant suppliers and the general infrastructure is unknown, but operating results could be materially affected in the event of a major earthquake.
Although OEC believes that it has the product offerings and resources needed for continuing success, future revenue and margin trends cannot be reliably predicted and may cause the Company to adjust its operations. Factors external to the Company can result in volatility of the Company's common stock price.
Foreign Currency Rate Exposure
The Company has operating subsidiaries located in Europe and utilizes forward exchange contracts with durations generally less than six months to hedge against the effect of exchange rate fluctuations of European income. The Company's forward exchange contracts are not material. The Company also has other customers located throughout the world; however, these customers' invoices are denominated in U.S. dollars. As a result, the Company has not incurred material gains or losses resulting from foreign currency fluctuations. However, adverse fluctuations of exchange rates can affect the purchasing power of international customers that can result in volatility of international demand.
Interest Rate Risk Exposure
The Company has purchased certain debt obligations of the U.S. government and various corporations with original maturities of less than one year. As of September 30, 1999, such investments totaled approximately $11.6 million and the difference between fair market value and amortized cost is immaterial. Interest rate risk and default risk underlying these securities is not considered to be significant.
Other Exposures
The Company has not entered into any speculative derivatives and does not foresee utilizing such instruments in the future. The Company does not utilize commodities in the normal course of its manufacturing process. Accordingly, the Company does not believe it has any significant commodity risks or exposures.
Year 2000 Readiness Disclosure
The Company has completed a review of its business information systems with respect to Year 2000 compliance and will either replace or correct those computer systems that have been found to have date-related deficiencies. New integrated business information systems for the order administration, financial and manufacturing processes were put in place in 1997. A few minor corrective actions are required to make these systems Year 2000 compliant and these corrections had been completed by the end of the third quarter 1999. The business information system for the service operations is being replaced with a planned completion date of November 1999.
The Company's products being shipped today have been assessed and found to be Year 2000 compliant provided that the user perform a reset of the date upon first use in the Year 2000. The Company believes that products previously shipped are either Year 2000 compliant or can be made Year 2000 compliant with the purchase of an upgrade or a date reset performed upon first use in the Year 2000.
The Company is also assessing facility and telecommunications systems and systems used to support the product design and manufacturing processes to ensure that these will be Year 2000 ready. It is anticipated that any required corrective actions will be complete by mid fourth quarter 1999.
The Company relies on third party providers for materials and services such as telecommunications, utilities, financial services and other key services. Interruption of those materials or services due to Year 2000 issues could affect the Company's operations. The Company has completed the process of contacting its major suppliers and has determined that all major suppliers are in the process of ensuring Year 2000 compliance. However, since the Company is dependent on key third parties, there can be no guarantee that the Company's efforts will prevent a material adverse impact on its financial position, results of operations or liquidity in future periods in the event that a significant number of suppliers and/or customers experience business disruptions as a result of their lack of Year 2000 readiness.
The Company estimates that it has incurred costs of approximately $4 million, to date, in external and internal costs to address its Year 2000 readiness issues, the majority of which are the new business information systems installed in 1997. The Company currently estimates that it will incur additional costs of approximately less than $1 million to complete its Year 2000 readiness projects.
Both the Company's cost estimates and completion time frames could be influenced by its ability to successfully identify all Year 2000 issues, the nature and amount of corrective action required, the availability and cost of trained personnel in this area and the Year 2000 success that key third parties and customers attain. While these and other unforeseen factors could have a material adverse impact on the Company's financial position, results of operations or liquidity in future periods, management believes that it has implemented an effective Year 2000 compliance program that will minimize the possible negative consequences to the Company.
Throughout 1999, the Company has determined areas where contingency planning is needed. The planning efforts have included, but are not limited to, identification and mitigation of potential serious business interruptions, adjustments of inventory levels to meet customer needs, and establishing crisis response processes to address unexpected problems. Due to the November 1999 completion date for the replacement of the business information system for service operations, the Company has developed contingency plans for the potential business interruptions if this system fails. The contingency plan includes utilizing current existing systems, instituting manual processes and utilizing increased inventory levels. In addition, the Company has increased inventory levels to mitigate the risk of an interruption in the delivery of materials by its suppliers for current production as well as service support.