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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Fiscal Year Ended December 31, 1996 Commission File Number: 0-24866
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ISOLYSER COMPANY, INC.
(Exact Name of registrant as specified in its charter)
GEORGIA 58-1746149
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
650 ENGINEERING DRIVE
TECHNOLOGY PARK
NORCROSS, GEORGIA 30092
(Address of principal executive offices) (Zip Code)
(770) 582-6363
Registrant's telephone number, including area code
Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
common stock, $.001 par value per share
stock purchase rights
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No _______
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
The aggregate market value of common stock held by nonaffiliates of the
registrant based on the sale trade price of the common stock as reported on The
Nasdaq Stock Market on March 27, 1997, was approximately $165.4 million. For
purposes of this computation, all officers, directors and 5% beneficial owners
of the registrant are deemed to be affiliates. Such determination should not be
deemed an admission that such officers, directors or 5% beneficial owners are,
in fact, affiliates of the registrant.
At March 27, 1997, there were outstanding 39,207,668 shares of the registrant's
common stock, $.001 par value per share.
Documents incorporated by reference: Certain exhibits provided in Part IV are
incorporated by reference from the Company's Registration Statements on Form S-1
(File Nos. 33-83474 and 33-97086), Registration Statement on Form S-4 (File No.
333-7977), Registration Statement on Form S-8 (File Nos. 33-85668), annual
report on Form 10-K for the periods ended December 31, 1994, and December 31,
1995, and current reports on Form 8-K dated May 31, 1995, September 18, 1995,
June 4, 1996, August 30, 1996 and December 19, 1996.
420793.1
Note: The discussions in this Form 10-K contain forward looking
statements that involve risks and uncertainties. The actual results of Isolyser
Company, Inc. and subsidiaries (the "Company") could differ significantly from
those set forth herein. Factors that could cause or contribute to such
differences include, but are not limited to, those discussed in "Business",
particularly "Business -- Risk Factors", and "Management's Discussion and
Analysis of Financial Condition and Results of Operations" as well as those
discussed elsewhere in this Form 10-K. Statements contained in this Form 10-K
that are not historical facts are forward looking statements that are subject to
the safe harbor created by the Private Securities Litigation Reform Act of 1995.
A number of important factors could cause the Company's actual results for 1997
and beyond to differ materially from those expressed or implied in any forward
looking statements made by, or on behalf of, the Company. These factors include,
without limitation, those listed in "Business -- Risk Factors" in this Form
10-K.
PART I
ITEM 1. BUSINESS
General
Isolyser Company, Inc. ("Isolyser" or the "Company") believes that it is the
first company to address the health care industry's fundamental needs of patient
care, safety, cost reduction and solid waste reduction by taking a life cycle
approach (from product development through disposal) to disposable products used
in the hospital. Isolyser develops, manufactures and markets proprietary and
other products for patient care, occupational safety and management of
potentially infectious and hazardous waste. The Company's products provide
patient care and safety benefits, including protection from cross-infection, by
providing Point-of-Generation(TM) treatment of potentially infectious and
hazardous waste. Moreover, the Company believes that its products benefit the
environment by reducing the volume of solid waste while significantly reducing
the disposal costs of such waste. Isolyser's products are designed to provide
responsible solutions to regulatory requirements and initiatives and social
concerns. Through its products and services, the Company seeks to provide an
umbrella of protection from potentially infectious and hazardous waste for
patients, staff, the public and the environment. The Company also believes that
its products offer benefits to certain industries whose workers are in contact
with hazardous materials and where contaminated clothing, clean-up and barrier
materials must be incinerated at considerable expense
Trends in the Health Care Industry
The Company's products address a number of important trends in the health
care industry:
Facilitating Environmental Protection and Regulatory Compliance. The disposal
of large volumes of infectious and hazardous solid and liquid waste generated by
the health care and other industries has attracted increasing public awareness
and regulatory attention. The Environmental Protection Agency ("EPA") has issued
for comment regulations regarding incineration of potentially infectious waste
reportedly having the potential of closing many hospital incinerators, and the
Department of Transportation has issued regulations regarding the transportation
of potentially infectious waste. The American Hospital Association has
recommended that bio-hazardous waste be treated the same day it is generated.
Isolyser's products provide responsible compliance solutions to compliance
objectives. For example, OREX(R) Degradables(TM) reduce the volume of solid
waste placed into the environment (OREX(R) Degradables(TM)), LTS(R) converts
liquid waste into solid polymers (LTS(R)) and SMS(R) encapsulates and physically
disinfects sharps.
Meeting Health Care Cost Containment Initiatives. The health care industry is
under increasing pressure to reduce costs and improve efficiency. The Company
believes that its products and services facilitate cost-effective regulatory
compliance, reduce labor intensive disposal processes and reduce the cost of
disposing of infectious and hazardous waste. As a result, a greater portion of
limited health care resources may be devoted directly to patient care. The
Company's procedure trays and equipment drapes facilitate cost containment by
reducing inventory volume and handling costs and by decreasing operating room
setup and clean up time, enabling hospitals to increase the volume of procedures
which may be performed.
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Protecting Staff, Patients and the Public from Infection and Injury. The health
care industry has experienced a substantial increase in the transmission of
infectious diseases (such as HIV/AIDS and hepatitis) through cross- infection. A
1990 conference sponsored by the Centers for Disease Control reported that
hospital-acquired bloodstream infections increased 133% from 1980 to 1989. Many
hospitals have established committees and created new professional positions to
manage this problem and monitor compliance with regulatory requirements. The
Company believes that its products directly and immediately reduce the risk of
cross-infection and promote compliance with professional, industry and
regulatory mandates by providing solutions for safe and effective handling of
potentially infectious and hazardous waste at the Point-of-Generation.
Growth Strategy
The Company's goal is to become a leading manufacturer and supplier of
disposable products to hospitals and industry. The Company intends to grow
through the commercialization of OREX Degradables, increased use and improvement
of manufacturing capabilities, leveraging upon existing marketing and
distribution resources, marketing of OREX Degradables to industries other than
health care and continued new product development. See "Risk Factors".
Commercializing OREX Degradables. The Company intends to penetrate the market
for traditional disposable and reusable products by converting users of those
products to OREX Degradables, and has in the past sought to achieve that
objective with an initial primary focus on the health care industry. The Company
has sought to accomplish this goal by replacing conventional disposable and
reusable products used in procedure trays with OREX Degradables and selling OREX
Degradables on a stand-alone basis and in supplemental packs. The Company is
currently undertaking a thorough review and analysis of the market position of
OREX Degradables within its various market potentials. As a part of such review
and analysis, the Company plans to implement appropriate adjustments to its
marketing plan to seek to improve the Company's operating results. There can be
no assurance that OREX Degradables will achieve or maintain substantial
acceptance in their target markets. See "Risk Factors -- Limited Operating
History; Net Losses" and " Risks of New Products".
Using Manufacturing Capabilities. As an additional key component of its growth
strategy, the Company has followed a strategy of vertically integrating its
manufacturing capabilities through acquisitions and capital expenditures in
order to internally manufacture many of its OREX Degradables products. The
Company believes that such vertical integration gives it more control over its
operations, including product quality, availability and cost. The Company
operates a 108,000 square foot OREX Degradables non-woven fabric plant located
in Arden, North Carolina and a 207,000 square foot OREX Degradables woven
manufacturing plant located in Abbeville, South Carolina. As a result of the
acquisition (the "White Knight Acquisition") of White Knight Healthcare, Inc.
("White Knight") in September, 1995, the Company operates five non-woven
conversion manufacturing plants located in Childersburg, Alabama, Runnemede, New
Jersey, Douglas, Arizona, Agua Prieta, Mexico and Acuna, Mexico. As a result of
the acquisition (the "Microtek Acquisition") of Microtek Medical, Inc.
("Microtek") as of September 1, 1996, the Company operates three conversion
manufacturing plants for its equipment drapes and fluid control products located
in Columbus, Mississippi, the Dominican Republic and Empalme, Mexico. The
Company is currently undertaking measures to consolidate its conversion
manufacturing operations to achieve savings in operating costs and improve
manufacturing efficiencies. The Company is also currently developing a prototype
OREX Degradables film manufacturing operation in its Norcross, Georgia facility.
In addition, the Company uses contract manufacturers for certain OREX film,
instruments and utensils which the Company has not yet commercially marketed.
See "Business -- Manufacturing and Supplies" and "Risk Factors - Manufacturing
and Supply Risks".
Using Marketing and Distribution Resources. An important element of the
Company's growth strategy is the leveraging of its existing marketing resources.
The Company believes that the key to penetrating health care markets is a strong
sales force capable of educating distributors and end users about the unique
characteristics of its products. In connection with the commercialization of
OREX Degradables, the Company has followed a strategy of investing in its sales
and marketing resources through hiring experienced and knowledgeable employees
and through acquisitions. The White Knight Acquisition provided the Company with
marketing resources, sales support and access to markets and accounts not
previously penetrated by the Company through White Knight's operations and
reputation in the non-woven medical products market. The Microtek Acquisition
provided the Company with marketing resources, sales support and access to
medical niche markets (primarily for equipment drapes and fluid control
products) not previously available to the Company. Both the White Knight
Acquisition and Microtek Acquisition provide the Company with increased
opportunities to access international markets. The Company
420793.1
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maintains warehouse and distribution facilities in Jacksonville, Florida and the
United Kingdom in addition to various contract warehouse and distribution
operators. The health care market is dominated by a few large manufacturers and
distributors of disposable medical products and the Company remains dependent
upon those distributors to a significant degree in the purchase and distribution
of its products. The Company plans to continue to strengthen its marketing and
distribution resources through internal growth and strategic alliances. See
"Risk Factors -- Risks of New Products", "-- Risks of Expansion" and "--
Reliance Upon Distributors".
Marketing OREX Degradables Outside the Health Care Industry. The Company plans
to develop and market commercial applications for OREX Degradables to other
industries where protection from infectious or hazardous waste and reduction of
solid waste is important, such as the nuclear power industry. Through the White
Knight Acquisition, the Company acquired an active sales and marketing presence
in industrial markets. Isolyser believes that it is the only company to offer
reusables, disposables and degradables in protective wear to the industrial
market. The Company plans to continue to develop existing and new markets for
its products. Towards such end, the Company continually evaluates possible
strategic alliances to develop new markets for its OREX products. There can be
no assurance that OREX Degradables will achieve or maintain substantial
acceptance in their target markets, or that the Company will be successful in
concluding favorable strategic alliances to add to the Company's target markets.
See "Risk Factors - Risks of New Products".
Continuing New Product Development. The Company plans to continue to improve,
develop and introduce new and innovative products to the marketplace designed to
promote cost-effective achievement of occupational safety, environmental
protection and regulatory compliance objectives through continued research and
development. In addition, the Company will continue to substantiate the safety
and effectiveness of its products with testing and to seek regulatory approval
for use of its products where applicable. See "Risk Factors - Risks of New
Products".
Products and Markets
OREX Degradables
OREX Degradables are a line of products that provide protection to the
hospital staff, patient and environment while providing cost effective solutions
to the problems associated with solid waste reduction and disposal. OREX
Degradables are manufactured from a thermoplastic, hot water soluble polymer,
which can be configured into an array of products such as woven fabrics
(including operating room towels, absorbent gauze and laparotomy sponges),
non-woven fabrics (including gowns, surgical drapes, mop heads and surgical
headwear), films (including fluid collection bags, packaging materials and
equipment drapes), thermoformed and extruded items (including syringes, bowls,
instruments and tubing) as well as combinations of these configurations
(including diapers, underpads and laminates). OREX Degradables perform like
traditional disposable and reusable products; however, unlike traditional
products, OREX Degradables can be degraded or dissolved in hot water in a
specially designed washing machine (the OREX Processor) after use for safe
disposal through the municipal sewer system. See "Risk Factors - Risks of New
Products".
The Company believes that its OREX Degradables not only minimize the
quantity and cost of solid waste disposal, but also help to protect against the
transmission of infectious diseases such as HIV/AIDS and hepatitis by providing
disposal at the Point-of-Generation. Additionally, OREX Degradables facilitate
environmental protection by reducing the volume of potentially infectious and
hazardous waste that is either incinerated or transported to landfills. Finally,
the Company believes that OREX Degradables address regulatory compliance
initiatives such as the bloodborne pathogen rule promulgated under OSHA as well
as state initiatives to reduce the volume of solid waste. The Company is
initially focused on delivering OREX Degradables to the health care industry
where, according to a study conducted in 1995 by an independent market research
firm, the United States market for non-woven disposable medical products alone
was estimated to be $1.7 billion in 1995 increasing to approximately $2.0
billion in 2000. While the Company is currently undertaking a thorough review
and analysis of the market position of OREX Degradables, the Company currently
believes that OREX Degradables may be best suited for use at hospitals where the
added benefits of degradable products (such as facilitating environmental
protection, complying with regulations and saving on infectious waste disposal
costs) can be best realized. In addition, management also believes that the
technology used to develop OREX Degradables has broad commercial applications
beyond the health care industry where protection from potentially infectious or
hazardous waste and reduction of solid waste is important, such as the nuclear
power industry.
420793.1
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OREX is manufactured from a variety of organic, degradable polymers that
have been modified to dissolve or degrade only in hot water. The basic compound
used to manufacture OREX Degradables woven and non-woven products is a polymer
known as polyvinyl alcohol ("PVA"), a safe material widely used in a variety of
consumer products such as eye drops, cosmetics and cold capsules. The Company
more recently has begun to develop the use of other polymers to test manufacture
OREX Degradables film and thermoformed and extruded products. Through a
manufacturing process developed by the Company, these polymers are modified so
they will dissolve or degrade only in hot water. See "Risk Factors --
Manufacturing and Supply Risks". Unlike traditional disposable products that
must be disposed of through either incineration or landfill, OREX Degradables
may be disposed of at the Point-of-Generation through the municipal sewer system
by dissolving or degrading them in hot water in an OREX Processor. An OREX
Processor is a standard commercial washing machine specially adapted primarily
by upgrading its water heater and removing the spin cycle. While a number of
suppliers exist for such washing machines, the Company has entered into
arrangements with three washing machine distributors for the supply of OREX
Processors at a retail cost of approximately $2,000 for a low capacity unit,
approximately $8,500 for a mid-capacity unit and approximately $20,000 for a
large capacity unit. Disposal in this manner reduces the need for storage,
handling and off-site transportation of waste, reduces the potential for
cross-infection, reduces the total volume of solid waste and facilitates
regulatory compliance. An industry standard method for disposal of blood, with
or without infectious disease contamination, is through the municipal sewer
system. While the Company makes no claims or representations in its product
advertising or labeling that the disposal method for OREX Degradables renders
the disposal matter non-infectious, independent test results indicate that
dissolving OREX Degradables in hot water inactivates in excess of 99% of tested
microorganisms. Disposal in this manner is not subject to federal regulation but
may be regulated by state and local sewage treatment plants to the extent that
sewer discharges from hospitals or other facilities may interfere with the
proper functioning of such plants. Based on product testing and available
research, the Company believes that OREX Degradables manufactured from PVA will
not interfere with the proper functioning of sewage treatment plants. Based on
such testing and research, the Company has obtained over 100 written and verbal
non-binding concurrences and is in the process of seeking additional non-binding
concurrences with the Company's conclusions from local authorities. While the
Company is undertaking evaluation of OREX Degradables manufactured from polymers
other than PVA, no assurances can be provided that such non-PVA based OREX will
not interfere with the proper functioning of sewage treatment plants. See "-
Government Regulation" and "Risk Factors - Regulatory Risks".
Tests conducted by Isolyser and independent third parties (such as testing
laboratories) indicate that OREX Degradables woven and non-woven fabric and film
can be produced to have the fluid resistance, moisture vapor transmission, flame
retardancy, impact protection and other characteristics of corresponding
conventional disposable and reusable products. To date, the Company has not
successfully completed certain non-woven fabric finishing applications to
lighter weight non-woven fabrics, necessitating the substitution of heavier
weight fabric for certain finished products. The Company has completed limited
field trials and is currently marketing OREX Degradables at more than 250
hospitals. OREX field trials, which consisted of monitored use of one or more of
a limited number of OREX Degradables woven and non-woven products, have
confirmed that such OREX Degradables products perform in a manner substantially
equivalent to similar disposable and reusable products. The Company's marketing
plan for OREX Degradables has been to provide increased focus on a limited
number of hospitals to seek to convert such hospitals from using traditional
disposable and reusable products to OREX Degradables products, first by
conducting product introductions through, for example, field trials and
thereafter by sales follow-through. These marketing efforts have been hindered
by delays in the Company's manufacturing schedule for expanding the OREX product
line and certain product performance issues. See "Risk Factors -- Manufacturing
and Supply Risks". Beginning at the end of 1995 and through 1996, the Company
engaged in a program of actively expanding its line of internally manufactured
OREX Degradables products in order to meet a customer's requirements to justify
conversion to degradable products, including the installation of an OREX
Processor. Approximately 65 hospitals have installed OREX Processors to date.
Under appropriate circumstances, the Company will favorably consider hospital
installation of OREX Processors other than through purchases as the Company
considers the OREX Processor as only one component to an entirely new product
handling cycle by its customers. The Company now offers over 200 OREX catalog
items (including both sterile and non-sterile OREX products) which the Company
believes address substantially all non-woven products most often used by
hospitals. Management of the Company believes approximately 15 hospitals
currently use OREX Degradables for substantially all of their patient draping
requirements. The Company has followed a marketing strategy of initially making
the OREX products available at prices which do not take into account disposal
cost savings provided by the Company's products in order to seek to achieve
market acceptance of OREX products. Such pricing, coupled with manufacturing
costs experienced to date in producing OREX Degradables, has caused the Company
to fail to achieve profitable margins on the sale of OREX Degradables to date.
The Company is currently evaluating its marketing plans for these products, and
plans
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to make appropriate adjustments to such marketing plans to seek to improve its
profit margins on the sale of OREX Degradables. No assurance can be given that
hospitals will use OREX Degradables, that OREX Degradables will achieve or
maintain acceptance in its target markets or that the Company will be successful
in selling OREX Degradables at a price providing satisfactory margins to the
Company. See "Risk Factors - Risks of New Products".
The Company has focused its manufacturing growth and product rollout on OREX
Degradables non-woven and woven products to a more significant extent than with
respect to other OREX Degradables products, based in part on the Company's
strategic considerations relative to market size and relative product demand.
The Company, however, has also marketed a limited number of OREX Degradables
film products, such as kick bucket liners, hamper liners, sponge counters, and
film reinforced drapes and drape sheets. The Company has not been satisfied with
certain aesthetic and user-oriented product performance characteristics of the
film component of its OREX Degradables reinforced gowns, and has to date used
traditional film materials in its reinforced gowns containing OREX non-woven
fabric. In addition, the Company has encountered some dissatisfaction with the
absorbency characteristics of its OREX towels; however, management believes that
the Company has recently solved such concerns through the successful application
on a test basis of certain manufacturing techniques which remain to be
implemented on a full commercial scale. During 1996, the Company recorded $10.0
million of reserves for OREX inventory which the Company believes is the proper
amount to be recorded due to improvements in manufacturing processes realized
during the latter portions of 1996 which rendered certain existing inventories
second quality. See "Management's Discussion and Analysis of Financial Condition
and Results of Operations" and "Risk Factors -- Risks of New Products". The
Company's requirements for its OREX Degradables film roll stock have to date
been supplied by a contract manufacturer. The Company has not yet commenced to
commercially market a full line of OREX Degradables film products or OREX
Degradables thermoformed and extruded products pending implementation of
cost-effective manufacturing techniques. Management of the Company believes that
its research and development group has discerned a methodology through
manufacturing trials that will prove satisfactory for cost-effective commercial
manufacturing of such products which is in part based upon the use of non-PVA
based raw materials. As the Company cannot currently replace all traditional
disposable medical products with OREX Degradables products, potential customers
for the Company's products may not yet justify large-scale conversion to OREX
Degradables products. See "Risk Factors - Risks of New Products".
The Company has not been satisfied with its performance to date in
manufacturing and selling OREX Degradables. The Company began limited commercial
sales of limited quantities of OREX Degradables during the first nine months of
1995 following the Company's receipt of regulatory clearances and the delivery
of contract manufactured operating room towels, sponges and certain other
products in sufficient quantities to commence sales. Meaningful sales of OREX
Degradables, however, began to occur only in the fourth quarter of 1995, during
which approximately $514,000 of such products were sold. Beginning during the
first quarter of 1996, progress continued in introducing OREX Degradables
products to the health care market by including OREX Degradables in the
Company's procedure trays and packs. Through this distribution method, over 400
hospitals were purchasing OREX Degradables in variable volumes in 1996.
Throughout 1996, the Company worked toward improving the quality of its OREX
products while expanding the number of types of OREX products available for
regular supply. Total net sales of OREX Degradables in 1996 approximated $7.1
million, primarily in health care markets. Some of these sales included
distributor stocking orders, and quarter to quarter sales of OREX remained flat
over 1996. Based in part on this flat growth rate, the Company has not enjoyed
sufficient demand for its OREX products to seek to operate its OREX
manufacturing plants at high efficiencies and thereby reduce manufacturing
costs. Such manufacturing inefficiencies, and related unabsorbed manufacturing
overhead, coupled with unit pricing for sales of OREX Degradables at an amount
which does not take into account the disposal cost savings provided by these
products, has caused the Company to fail to achieve profitable margins on the
sales of OREX Degradables to date. The Company anticipates that its
manufacturing costs and other investments in OREX sales volume growth will
continue to adversely impact operating results pending achieving a combination
of significant increases in sales volume, reducing manufacturing costs and
adjusting product unit prices to take into account disposal cost savings on OREX
products.
Procedure Trays
Procedure trays are sterilized packs which include all components
(traditionally conventional disposable or reusable medical products such as, for
example, laparotomy sponges, drapes and suction tubing) used in medical
(primarily surgical) procedures. Custom and standard procedure trays can be
utilized in a wide range of procedures, such as cardiovascular surgery and
angiography, orthopedic surgery, laparoscopic and endoscopic procedures and
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Caesarean-sections. Custom trays are assembled according to the specific
requirements of the hospital end user. Isolyser entered the procedure tray
market with the acquisition (the "Atkins Acquisition") of Charles Atkins and
Company, Ltd. ("Atkins") on February 28, 1993, and currently conducts its
procedure tray business through its subsidiary MedSurg Industries, Inc.
("MedSurg"), which it acquired (the "MedSurg Acquisition") on December 31, 1993.
For 1994, 1995 and 1996, sales of procedure trays and related products accounted
for approximately 55%, 46% and 34% of the Company's total revenue and 34%, 27%
and 28% of gross profit, respectively. The Company made the Atkins and MedSurg
acquisitions because it believes there are synergies between OREX Degradables
and procedure trays, namely (i) the tray business serves as a distribution
channel for OREX Degradables and (ii) OREX Degradables differentiate the
Company's procedure trays from those of its competitors. Moreover, the Company's
sales persons marketing procedure trays are uniquely situated to market OREX
Degradables because of their direct relationship with hospital operating room
personnel who are important to the decision-making process in purchasing OREX
Degradables and such sales persons' knowledge about regulatory and environmental
benefits and issues related to OREX Degradables. The Company estimates that for
a typical open heart tray, OREX Degradables can represent approximately 45% of
the cost and up to 80% of the disposal volume of the tray.
Traditional Products and Markets
Through the Company's acquisitions of White Knight and Microtek, the Company
entered the business of conversion manufacturing and marketing of traditional
medical disposable products such as disposable surgical apparel and equipment
drapes. The Company made the White Knight and Microtek acquisitions because it
believes the conversion manufacturing expertise and capacity of White Knight and
Microtek assists Isolyser in the conversion manufacturing of various OREX
Degradables products, and because those companies provide Isolyser with sales
and marketing support and access to new health care markets. See "Risk Factors
- -- Risks of Expansion".
The Company acquired White Knight as of September 1, 1995. Through White
Knight, the Company manufactures and markets non-woven infection control
products and protective apparel for use primarily in the health care industry.
As an outgrowth of a business founded in the 1950s and evolved over a series of
mergers, acquisitions and restructurings, White Knight pioneered the disposable
medical products market in the early 1970s, and is today a leading manufacturer
and converter (in competition with other larger companies such as Allegiance
Corporation ("Allegiance")) of non-woven sterile and non-sterile products. White
Knight is a Pennsylvania corporation formed in 1991 to acquire substantially all
of the assets of the White Knight Health Care division of Work Wear Corporation,
Inc., which at the time was a debtor-in-possession under Chapter 11 of the
Bankruptcy Code of 1978, as amended.
White Knight categorizes its products and related markets in three partially
overlapping groups. The first and largest, called the medical products division,
manufactures non-woven disposable surgical apparel, drapes and accessory
products (including drapes, gowns, shoe covers, masks and caps) for use in
hospitals and surgical centers. The second product group and related market,
called the specialty apparel division, manufactures disposable and reusable
apparel (such as coveralls, lab coats, frocks, hoods, foot coverings, masks,
caps and isolation gowns) which are in part an extension of White Knight's
medical products and which are marketed for use in clean room environments,
laboratories and other industrial applications (including clean rooms for
pharmaceutical, electronic and biotech industries as well as automotive and
paint industries). The last product group and related market, called the Struble
& Moffitt division, operates semi-autonomously from White Knight and is
described below under "-- Safety Products and Services and Other Products".
For the period from September 1 through December 31, 1995, net sales of
White Knight represented 18% of the Company's total revenue and provided 17% of
the Company's gross profit for the year ended December 31, 1995. Net sales of
White Knight in 1996 represented 35% of the Company's total revenue and 35% of
the Company's gross profit for that year. Included in such sales figures are
$1.4 million and $4.5 million of export sales by White Knight during the last
four months of 1995 and during 1996, respectively. Prior to the Company's
acquisition of White Knight, the Company made no material export sales.
The Company acquired Microtek as of September 1, 1996. Through Microtek, the
Company manufactures and markets equipment drapes and fluid control products.
Microtek is a Delaware corporation which, prior to the Microtek Acquisition,
operated independently following its spin-off from Teknamed Corporation, a
medical products company, in 1984.
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Microtek designs, manufactures and markets two principal product lines for
use in niche markets of the health care industry. First, Microtek's infection
control products consist of more than 1,500 specially designed drapes for use in
draping operating room equipment during surgical procedures. This equipment
includes, for example, microscopes, ultrasound probes, endoscopic video cameras,
x-ray cassettes, imaging equipment, lasers and handles attached to surgical
lights. In addition to reducing the risk of cross-infection, these products
increase operating room efficiency by reducing the need to sterilize equipment
between procedures. These disposable sterile products are generally made from
plastic film containing features designed for the operating room environment,
such as low glare and anti-static features. Microtek's second principal product
line, fluid-control products, are specially designed disposable pouches which
are attached to a surgical patient drape (called a substrate), which is placed
around the operative site. For instance, Microtek manufactures a specialty pouch
for knee arthroscopy. This pouch captures not only the bodily fluids that are
discharged from the knee but also the sterile saline that is infused into the
operative site during the arthroscopic procedure. Microtek's fluid control
product line primarily consists of more than 200 different plastic disposable
collection pouches. Prior to July, 1995, Microtek was also engaged in the sale
of specialty otology products.
The Company acquired Microtek in a pooling of interests transaction as of
September 1, 1996, and the Company's financial statements have accordingly been
restated to include Microtek's financial statements. For 1994, 1995 and 1996,
sales of Microtek products accounted for approximately 36%, or 28% and 24% of
the Company's total revenues and 51%, 46% and 49% of gross profit, respectively.
Included in such sales figures are $5.9 million, $7.3 million and $7.9 million,
of export sales by Microtek during 1994, 1995 and 1996, respectively.
Safety Products and Services and Other Products
The Company also offers several other lines of safety products and services
for the management of potentially infectious and hazardous waste. These safety
products and services are described below.
Liquid Treatment System (LTS) is a super-absorbent powder which converts
potentially infectious liquid waste into a solid waste suitable for landfill
disposal. Unlike conventional super-absorbents, LTS products are designed to
work across a wide pH range and electrolyte concentration, and absorb and
solidify without mechanical intervention such as stirring. LTS is typically
added to a suction canister or other fluid collection device in which blood or
other body and irrigation fluids are collected during surgery or in wound
drainage after surgery. Product testing and laboratory analyses indicate that
LTS inactivates over 99% of tested microorganisms. LTS converts liquid waste
into a solid waste, thereby facilitating handling, transportation and disposal.
LTS can also be used to clean up spills of potentially infectious liquid waste.
Regardless of whether LTS is disposed of in landfills or through incineration or
other special process, LTS provides advantageous occupational safety benefits by
Point-of-Generation treatment of potentially infectious liquid waste. The
Company has independent test results verifying product performance, has received
approvals from certain states to landfill LTS-treated waste and has a greater
number of sales representatives than its competitors. Based on the number of
suction canisters and other fluid collection devices sold in the United States,
the Company estimates that at least a $90.0 million market exists for LTS. LTS
may be sold in bulk or packaged separately with a canister or other fluid
collection device.
Sharps Management System (SMS) is designed to encapsulate and physically
disinfect contaminated sharps (such as needles, syringes, scalpels, etc.) at the
Point-of-Generation. The product consists of a puncture- and spill-resistant
plastic container partially filled with a bathing solution for encapsulation.
When full, a small amount of catalyst powder is added. The catalyst creates a
chemical reaction which heats the container and solidifies the contents, thus
encapsulating the sharps and nearly eliminating the risk of accidental
punctures. According to product testing, this process inactivates over 99% of
tested microorganisms. The container of SMS treated sharps is suitable for
handling, transportation and disposal. The Company believes that SMS is the only
product on the market which operates as a physical disinfecting device for
sharps under applicable EPA requirements, rendering the contents safe for
landfill disposal. By comparison, competitive products perform only a collection
function with no disinfection or solid encapsulation capabilities, requiring
disposal at a higher cost.
Onsyte System is a mobile waste treatment unit that utilizes microwave
technology and steam to render infectious waste non-hazardous. The system then
shreds and grinds the material, making it non-recognizable and suitable for
disposal in landfills. In 1993, Isolyser began offering its Onsyte System to
hospitals and other waste generators as part of its umbrella approach to waste
management. In May 1995, the Company acquired SafeWaste Corporation
("SafeWaste") to provide, among other things, improved marketing and management
of the Company's mobile
420793.1
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medical waste treatment services. SafeWaste, based in Charlotte, North Carolina,
operates the Company's three Onsyte Systems and a mobile waste treatment unit
through a joint venture with a customer of SafeWaste.
The Company also manufactures and markets various other products. In April,
1996, Microtek purchased the Venodyne division of Advanced Instruments, Inc.
which manufactures and markets pneumatic pumps and disposable compression
sleeves for use in reducing deep vein thrombosis. Sales of these products have
not been material to the Company's results of operations. Through White Knight's
Struble & Moffitt division, the Company manufactures disposable transportation
products (such as pillow cases and head rest covers) sold to airline and
passenger railroad industries, dental products (such as bracket tray covers and
head rests), and adult incontinence underpads and diapers. This division has
experienced declining revenue and gross profit over a period preceding the White
Knight Acquisition.
Marketing and Distribution
Substantially all of the Company's sales in 1996 were made to the health
care market. Hospitals purchase most of their products from a few large
distributors, many of which provide inventory control services to their
customers. The Company believes that a key to penetrating the health care market
is a strong sales force capable of educating distributors and end users about
the unique characteristics of its products so that distributors will recommend
and end users will request the Company's products. Achieving market penetration
of the Company's products is subject to a number of risks. See "Risk Factors -
Risks of New Products".
As of December 31, 1996, the Company's marketing and sales force consisted
of 69 sales representatives, six field sales managers, ten home office sales
managers and 25 persons in customer support. The Company is dependent upon a few
large distributors for the distribution of its products. The Company's top five
customers accounted for approximately 38% of the Company's total revenues during
1996. Of these customers, only Owens & Minor, Inc. accounted for over 10% of the
Company's total sales during 1996. Because distribution of medical products is
heavily dependent upon large distributors, the Company anticipates that it will
remain dependent upon these customers and others for the distribution of its
products. If the efforts of the Company's distributors prove unsuccessful, or if
such distributors abandon or limit their distribution of the Company's products,
the Company's sales may be materially adversely affected. See "Risk Factors -
Reliance Upon Distributors".
While the Company introduced OREX Degradables to the health care industry on
a limited basis in March, 1994, meaningful sales of OREX Degradables did not
commence to occur until 1996. Over this time, the Company conducted field trials
of certain OREX Degradables products as a method to introduce this new
technology to the health care marketplace. See "Products and Markets -- OREX
Degradables". During 1996, the Company continued to conduct such field trials
while concurrently including various OREX Degradables products, as they became
available, in procedure trays and by selling such products on a stand-alone
basis and in supplemental packs. The Company is currently undertaking a thorough
review and analysis of the market position of OREX Degradables within its
various market potentials. As a part of such review and analysis, the Company
plans to implement appropriate adjustments to its marketing plan to seek to
improve the Company's operating results. There can be no assurance that OREX
Degradables will achieve or maintain substantial acceptance in their target
markets or that the Company will be successful in selling OREX Degradables at a
price providing satisfactory margins to the Company. See "Risk Factors -- Risks
of New Products". Delays experienced by the Company in the availability of OREX
Degradables products may have resulted in the loss of previous or potential
customers. See "Risk Factors -- Manufacturing and Supply Risks".
In connection with the White Knight Acquisition, in September, 1995,
Isolyser entered into a distribution and marketing agreement (the "OREX Supply
Agreement") with Sterile Concepts. Under this agreement, Isolyser agreed to
supply Sterile Concepts with OREX Degradables as they became available for sale
by Sterile Concepts exclusively in its sterile custom procedure trays. Sterile
Concepts agreed in the OREX Supply Agreement to actively promote OREX
Degradables and to sell OREX Degradables only as a component of its sterile
custom procedure trays. As currently in effect, the OREX Supply Agreement does
not restrict the Company in its efforts to independently market its products
(including, without limitation, OREX Degradables) and compete with Sterile
Concepts. In July, 1996, Sterile Concepts was acquired by Maxxim Medical, Inc.
("Maxxim"), a vertically integrated manufacturer and marketer of medical
products competitive with those of the Company. The Company has made no sales
under the OREX Supply Agreement to date. The OREX Supply Agreement expires on
the later of June 30, 1998 or the date of retirement of certain cash flow note
issued by White Knight to Sterile Concepts, unless earlier terminated in
accordance with the terms of the OREX Supply Agreement.
420793.1
9
The Company sells its procedure trays exclusively through independent
distributors with the marketing assistance of the Company's sales force. The
Company's other traditional medical products are sold through distributors and
custom procedure tray companies (including the Company's custom procedure tray
operations). The Company also markets certain of its products to other
manufacturers on a "non-branded" or private label basis. For example, the
Company's fluid control pouches are sold to manufacturers of substrates, and the
Company's equipment drapes are sold to manufacturers of the equipment for which
such drapes were designed. Under an agreement entered into between White Knight
and Sterile Concepts, Sterile Concepts agreed to purchase a yearly minimum of
$5.1 million of products from White Knight until June 30, 1998. A portion of the
purchase price payable for these products by Sterile Concepts to White Knight is
used to amortize certain notes payable by White Knight to Sterile Concepts,
thereby providing certain trade discounts on product sales from White Knight to
Sterile Concepts. To the extent these notes are not entirely satisfied through
these trade discounts, the notes terminate at January 15, 2000 regardless of
whether there remains any unpaid principal or interest outstanding at that time.
While Sterile Concepts has historically purchased more than its minimum purchase
obligation from White Knight, as a result of Maxxim's acquisition of Sterile
Concepts in mid-1996, the Company anticipates that continued purchases by
Sterile Concepts from White Knight will be reduced to the minimum amount
required pursuant to the underlying agreement. Following Maxxim's acquisition of
Sterile Concepts, the Company began to experience declining sales to Sterile
Concepts. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations".
The Company's total export sales during 1994, 1995 and 1996 were $5.9
million, $8.7 million and $12.4 million, respectively. Outside the United
States, the Company markets its products principally through a network of
approximately 80 different dealers and distributors. As of December 31, 1996,
the Company also had seven sales representatives operating in international
markets, and maintains an office and warehouse distribution center near
Manchester, England and an office for one of its sales representatives and
support personnel in Luxembourg, Europe.
The Company markets various woven and non-woven apparel (such as coveralls,
lab coats, frocks, hoods, foot coverings, masks, caps, isolation gowns,
headrests and pillowcases) in industrial markets such as clean room
environments, laboratories, mass transportation industries and automotive
industries. The Company maintains a sales force of seven employees and a
complementary set of independent sales representatives dedicated to direct
selling in this industry. The Company sells its non-woven disposable industrial
products primarily through large distributors and sells the woven reusable
industrial products primarily through direct sales to service providers such as
clean room launderers. Sales of OREX Degradables within industrial markets has
not to date been material to the Company's results of operations. Recently, the
Company entered into a distribution agreement with a large nuclear industry
launderer for the supply of OREX Degradables apparel and ancillary products such
as OREX Degradables towels. However, no sales have occurred to date under such
distribution agreement as processing evaluations continue to perfect means of
removing hazardous and radioactive contaminants from wastewater containing
dissolved OREX Degradables products. Preliminary product evaluations and testing
in the nuclear market have yielded positive results. Until these processing
evaluations prove successful, no assurances can be provided that OREX
Degradables will achieve market acceptance within the nuclear industry.
On March 1, 1992, Isolyser entered into a distribution agreement with
Baxter, a leader in the sale of suction canisters and related apparatus. Under
this agreement, Baxter had an exclusive right in the United States and Canada to
distribute LTS to the hospital and free standing surgery center market and the
nonexclusive right to sell and distribute LTS to the non-hospital health care
market. The agreement expires February 28, 1998 and is subject to renewal for
one-year terms thereafter unless otherwise terminated. Effective at the end of
1994, Isolyser terminated Baxter's exclusive LTS distribution rights in
accordance with the terms of the subject agreement allowing for such termination
if Baxter did not achieve certain minimum purchase requirements. During 1996,
the Company began to distribute LTS through other national distributors.
To further expand its marketing resources, the Company from time to time
seeks to enter into strategic alliances with third parties such as specialty
equipment manufacturers and other non-competitive companies which would enable
it to sell various of its products to non-hospital markets. While the Company
from time to time engages in such discussions, the Company provides no
assurances that any such strategic alliances will be consummated or, if
consummated, that any such alliance will be favorable to the Company.
420793.1
10
Manufacturing and Supplies
OREX is manufactured from a variety of organic, degradable polymers that
have been modified to dissolve or degrade only in hot water. The basic compound
used to manufacture OREX Degradables woven and non-woven products is PVA, a safe
material widely used in a variety of consumer products such as eye drops,
cosmetics and cold capsules. The Company more recently has begun to develop the
use of other polymers to test manufacture OREX Degradables film and thermoformed
and extruded items. Through a manufacturing process developed by the Company,
the Company modifies these polymers so they will dissolve or degrade only in hot
water as a step in manufacturing OREX products. The modified polymers can then
be made into most woven and non-woven fabrics, film, packaging and thermoformed
and extruded products. The Company currently obtains its PVA raw materials from
various foreign suppliers. Risks exist in obtaining the quality and quantity of
PVA at a price that will allow the Company to be competitive with manufacturers
of conventional disposable and reusable products. Prevailing prices of PVA have
adversely affected the Company's manufacturing costs for its OREX products. PVA
fiber is required to manufacture the Company's non-woven and woven OREX
Degradables, while PVA resin is the raw material required to manufacture OREX
Degradables utensils and film products and PVA fiber. PVA resin from Japan,
Taiwan and certain producers in China are subject to anti-dumping duties if
imported into the United States. See "Risk Factors - Manufacturing and Supply
Risks". During 1996, the Company acquired a PVA fiber manufacturing facility
located in Charlotte, North Carolina. This facility remains in the developmental
stages as the Company experiments with PVA fiber manufacture as well as other
compounds.
The Company has followed a strategy of capital equipment purchases and
acquisitions to expand and vertically integrate the Company's manufacturing
capabilities, thereby enabling the Company to manufacture and convert into
finished goods many OREX Degradables internally, giving it more control over its
operations, including product quality, availability and cost. In January 1995,
the Company acquired a 108,000 square foot manufacturing facility located in
Arden, North Carolina which became operational later in 1995 as an OREX
Degradables non-woven fabric manufacturing plant. The Company has experienced
delays in manufacturing OREX Degradables non-woven fabric at the Arden facility.
Effective June 1995, the Company acquired a 207,000 square foot manufacturing
facility located in Abbeville, South Carolina which started operations as an
OREX Degradables woven manufacturing plant at the end of 1995. Manufacturing
capacity at this plant significantly exceeds current product demand, which has
caused the Company to incur overhead costs which have not been absorbed in the
cost of product sales. The Company has not been satisfied with its performance
to date in manufacturing and selling OREX Degradables. For example, the Company
to date has not successfully completed certain non-woven fabric finishing
applications to lighter weight non-woven fabrics, necessitating the substitution
of heavier weight fabric for certain finished products. Based in part on the
excess manufacturing capacity provided by the Company's OREX Degradables
material plants, the Company has not been able to seek to operate these plants
at high efficiencies. These manufacturing inefficiencies, and related unabsorbed
manufacturing overhead, coupled with pricing of OREX Degradables at an amount
which does not take into account disposal cost savings provided by such
products, has caused the Company to fail to achieve profitable margins on the
sale of OREX Degradables to date. See "- Growth Strategy", "- Products and
Markets", "Management's Discussion and Analysis of Financial Condition and
Results of Operations", "Risk Factors - Risks of Expansion" and "- Manufacturing
and Supply Risks". Throughout 1996, the Company worked toward improving the
quality of its OREX products while expanding the number of types of OREX
products available for regular supply. The Company has not yet commenced to
commercially manufacture a full line of OREX Degradables film products or OREX
Degradables thermoformed and extruded products pending implementation of
cost-effective manufacturing techniques which have been successfully used on a
test basis in the Company's research and development department. The Company
plans to commercially offer various products within the line of OREX Degradables
on a staged basis. See "Risk Factors -- Risks of New Products".
In addition to internal conversion manufacturing operations by the Company
for various of its OREX products which are described below, the Company uses
various domestic and foreign independent manufacturers for some OREX Degradables
products for assembling, packaging, sterilizing and shipping by the Company. The
Company uses contractors in the People's Republic of China to manufacture OREX
Degradables sponge products. The Company has used various independent parties
(both domestically and internationally) to manufacture various OREX Degradables
thermoformed and extruded products and composite products, which have not yet
been offered for commercial sale by the Company. The Company's requirements
(which to date have been modest) for OREX Degradables film products are
currently being supplied by a contract manufacturer.
420793.1
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With the consummation of the White Knight Acquisition, the Company
significantly increased its non-woven fabric conversion manufacturing
capabilities. The Company's non-woven conversion manufacturing operations
include conversion manufacturing (i.e., converting roll stock to finished goods)
for both OREX Degradables and traditional products used in health care and other
markets. The Company conducts its non-woven conversion manufacturing operations
in five locations: (i) a 50,000 square foot owned facility in Childersburg,
Alabama, which manufactures medical products and specialty apparel products
including medical and specialty face masks; (ii) a 100,000 square foot facility
under a long-term lease in Douglas, Arizona which manufactures medical products
and specialty apparel; (iii) an 87,000 square foot owned facility in Agua
Prieta, Mexico located adjacent to the Douglas facility to provide labor
intensive post-cutting applications; (iv) a 33,000 square foot leased facility
located in Acuna, Mexico (together with the related leased Del Rio, Texas
facility) to provide labor intensive cutting and sewing operations which the
Company is in the process of consolidating with its Agua Prieta plant; and (v) a
60,000 square foot owned facility in Runnemede, New Jersey which manufactures
products for the semi-autonomous Struble & Moffitt division of White Knight.
Through White Knight, the Company also maintains contracted manufacturing
operations in Texas and the People's Republic of China. Raw materials for White
Knight products are purchased from numerous vendors. White Knight's
relationships with vendors are good, although White Knight maintains no
long-term supply contracts with vendors. Certain medical and specialty apparel
products are impacted by user preference in fabric choice, such as spunlace
non-woven fabric marketed by DuPont under the Sontara trade name and wet-laid
non-woven fabric marketed by Dexter under the Dexter trade name. White Knight,
along with other larger competitors, has access to a full complement of fabric
selections from vendors of choice, although not in all cases with the same
pricing discounts available to larger purchasers.
The Company manufactures its equipment drapes and fluid control products at
its facilities in Columbus, Mississippi and the Dominican Republic. During 1996
the Company also maintained, through Microtek, a facility in Alpharetta, Georgia
at which some products were manufactured. This facility was closed at the end of
1996 as a part of overall consolidation and cost-saving measures. During 1996,
Microtek leased a facility in Empalme, Mexico where it now conducts conversion
manufacturing of equipment drapes and fluid control products.
The Company currently purchases components for procedure trays from a large
number of independent vendors, and assembles custom and standard procedure trays
for use in a wide array of medical procedures, including orthopedic, ophthalmic,
cardiovascular, laparoscopic, obstetric-gynecologic and endoscopic procedures.
The Company's Virginia-based procedure tray manufacturing operation is separated
into four stages: (i) receiving and stocking components for procedure trays,
(ii) assembling trays from these components, (iii) sterilizing and quarantining
and (iv) shipping. Generally, custom trays can be shipped to customers within
approximately 60 days from the date an order is placed.
The Company currently relies upon independent manufacturers for the purchase
of materials and components for most of its safety products. The Company uses,
and expects to continue to use, vendors of stock items to the extent possible to
control direct material costs. The Company's safety products production facility
located in Norcross, Georgia is used for mixing liquid and powdered chemicals,
other light manufacturing and packaging.
Order Backlog
At December 31, 1996, the Company's order backlog totaled approximately $9.6
million compared to approximately $9.9 million (in each case net of any
cancellations) at December 31, 1995. All backlog orders at December 31, 1996 are
expected to be filled prior to year end 1997.
Technology and Intellectual Property
The Company seeks to protect its technology by, among other means, obtaining
patents and filing patent applications for technology or products that it
considers important to its business. The Company also relies upon trade secrets,
technical know-how and innovation and market penetration to develop and maintain
its competitive position. The Company holds patents issued by the U.S. Patent
and Trademark Office relating to its SMS, LTS, and certain other products. The
Company holds a patent issued in 1993 for a combination of (x) a composite
fabric consisting of the material from which OREX Degradables are made, (y)
certain nondegradable material, and (z) the method of disposing of such fabric,
as well as a patent issued in 1995 for OREX Degradables mop heads. The Company
also holds two patents issued by the U.S. Patent and Trademark Office and
reallowed by such office in 1996 concerning methods of disposing of OREX
Degradables garments, fabrics and packaging materials. The Company currently has
applications pending before the U.S. Patent and Trademark Office and which
relate to the
420793.1
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OREX Degradables. Specifically, those applications concern (i) OREX Degradables
towels, sponges and gauzes, (ii) methods of making OREX Degradables molded parts
(such as utensils and packaging) and film (such as gowns, drapes, head and shoe
covers, face masks, CSR wrap, underpads and diapers), (iii) methods of disposing
of garments, linens, drapes, towels and other articles of OREX Degradables, (iv)
methods of producing OREX Degradables drapes, towels, covers, overwraps, gowns,
head covers, face masks, shoe covers, CSR wraps, sponges, dressings, tapes,
underpads, diapers, washcloths, sheets, pillow coverings and napkins and (v)
articles of film, fabric or fiber composed of OREX Degradables which are
configured into drapes, towels, covers, overwraps, gowns, head covers, face
masks, shoe covers, CSR wraps, sponges, dressings, tapes, underpads, diapers,
washcloths, sheets, pillow coverings and napkins, and (vi) methods of disposing
of towels, sponges and gauze produced from OREX Degradables. The U.S. Patent and
Trademark Office has issued a notice of allowance for applications (v) and (vi),
and Isolyser expects to receive the issued patents soon. Application (i) has not
yet been examined while applications (ii) and (iv) have been examined but to
date the examiners at the U.S. Patent and Trademark Office have not allowed
these applications. The Company has not succeeded to date to achieve
allowability of application (iii) and an appeal has been filed before the U.S.
Patent and Trademark Office Board of Patent Appeals and Interferences. The
Company is not aware of any facts at this time that would indicate that patents
sought by these three applications will not be issued. The Company recently
filed applications with the U.S. Patent and Trademark Office for its OREX
Degradables concerning (i) a surgical drape composite article and (ii) a new
class of OREX biodegradable polymers. The Company's U.S. patents expire between
2001 and 2014. The Company files for foreign counterpart patents on those
patents and patent applications which the Company considers to be material to
its business. No assurance can be given that the various components of the
Company's technology protection arrangements utilized by the Company to protect
its technologies, including its patents, will be successful in preventing others
from making products competitive with those offered by the Company, including
OREX Degradables. See "Risk Factors - Protection of Technologies".
Under a five-year license agreement from Microban Products Company entered
into on March 22, 1996, Microtek acquired the exclusive right to incorporate
certain antimicrobial additives to the Company's surgical and equipment drapes
manufactured with film and nonexclusive rights to such additives in non-woven
drape products, subject to the payment of royalties and certain other terms and
conditions specified in the license agreement. To date, such license has not
been material to the Company's operations.
The Company has registered as trademarks with the U.S. Patent and Trademark
Office "Isolyser," "LTS," "SMS" and "OREX". A trademark registration for "OREX"
has also been granted in the United Kingdom. White Knight currently maintains
registrations with the U.S. Patent and Trademark Offices for the trademarks
"White Knight" and "Precept". Microtek maintains registrations of various
trademarks which the Company believes are recognized within their principal
markets.
Competition
The markets in which the Company competes are characterized by competition
on the basis of quality, price, product design and function, environmental
impact, distribution arrangements, service and convenience. Many of the
Company's competitors have significantly greater resources than the Company. See
"Risk Factors Competition".
Although the Company is not aware of any products currently available in the
market place which provide the same disposal and degradable benefits as OREX
Degradables, OREX Degradables compete with traditional disposable and reusable
products currently marketed and sold by many companies. Single use disposable
(as opposed to reusable) drapes and gowns have been available for over 25 years
and according to a 1992 market study account for over 80% of the surgical
market. Competing manufacturers of traditional disposable medical products are
large companies with significantly greater resources than those of the Company.
These competitors have in many instances followed strategies of aggressively
marketing products competitive with OREX Degradables to buying groups resulting
in increasing cost pressures. These factors have adversely affected the
Company's ability to adjust its prices for its OREX products to take into
account disposal cost savings provided by these products, and have adversely
affected the Company's ability to successfully penetrate potential customer
accounts. See "Risk Factors -- Risks of New Products" and "-- Competition".
The market for procedure tray products is highly competitive. Based on
publicly available information, the Company believes that the procedure tray
market is dominated by three companies, who combined have more than 70% of the
United States market thus far converted to using procedure trays.
420793.1
13
The market for the Company's traditional medical and specialty apparel
products is also highly competitive, and is dominated by a few large companies
such as Allegiance, Kimberly-Clark Corporation, Johnson & Johnson and 3M
Corporation. The market for White Knight's transportation and dental products
included in the Struble & Moffitt Division has fewer competitors, and the
Company estimates that White Knight has a significant presence in this market,
although its presence is declining due at least in part to a competitor offering
a broader line of products in this market. Struble & Moffitt has a small (less
than 1%) presence in the adult incontinence market.
Competition for the Company's safety products includes conventional methods
of handling and disposing of medical waste. Contract waste handlers are
competitors which charge premium rates to remove potentially infectious and
hazardous waste and transport it to an incineration or autoclaving site. Many
hospitals utilize their own incinerators to dispose of this waste. In addition,
systems are available that hospitals can purchase for grinding and chemically
disinfecting medical waste at a central location.
The Company believes that its LTS products command a dominant share of a
market that thus far has been marginally penetrated. However, the Company is
aware of a variety of absorber products that are directly competitive with LTS.
The Company estimates that it has only a small (less than 5%) market share for
its SMS products. The market niche for disposal of sharps is dominated by a
number of other companies.
Government Regulation
The Company is subject to a number of federal, state and local regulatory
requirements which govern the marketing of the Company's products and the use,
treatment and disposal of these products utilized in the patient care process.
In addition, various foreign countries in which the Company's products are
currently being distributed or may be distributed in the future impose
regulatory requirements. See "Risk Factors - Regulatory Risks".
The Company's traditional medical products (including, for example, drapes,
gowns and procedure trays), OREX Degradables line of products and SMS products
are regulated by the FDA under medical device and drug provisions of the Federal
Food, Drug and Cosmetic Act (the "FDCA"). FDA regulations classify medical
devices into one of three classes, each involving an increasing degree of
regulatory control from Class I through Class III products. Medical devices in
these categories are subject to regulations which require, among other things,
pre-market notifications or approvals, and adherence to good manufacturing
practices, labeling, record-keeping and registration requirements. Patient care
devices which the Company currently markets are classified as Class I or Class
II devices subject to existing 510(k) orders which the Company believes satisfy
FDA pre-market notification requirements. The FDA has issued to the Company
510(k) orders on OREX Degradables products for surgical sponges, operating room
towels, drapes, gowns, surgeon's caps, surgeon's vests, shoe covers and medical
bedding. The Company is currently developing, evaluating and testing certain
OREX Degradables film and thermoformed or extruded OREX products manufactured
from non-PVA polymers, and it is possible that new 510(k) orders will be
required for such products. There can be no assurances as to when, or if, other
such 510(k) orders necessary for the Company to market products developed by it
in the future will be issued by the FDA. The pharmaceutical products marketed by
the Company as components of certain procedure trays are subject to labeling,
current good manufacturing practices and other general requirements for drugs
under the FDCA, but because these products are produced by other entities, the
Company does not have any independent responsibility for any premarket approvals
required for these drug products. The FDA inspects medical device manufacturers
and distributors, and has broad authority to order recalls of medical devices,
issue stop sale orders, seize non-complying medical devices, enjoin violations,
impose civil and criminal penalties and criminally prosecute violators. The FDA
possesses similar broad inspection and enforcement authority over pharmaceutical
products.
The FDA also requires health care companies to satisfy current good
manufacturing practices and record-keeping requirements. Failure to comply with
applicable regulatory requirements, which may be ambiguous or unclear, can
result in fines, civil and criminal penalties, stop sale orders, loss or denial
of approvals and recalls or seizures of products.
Countries in the European Union are seeking to require that products being
sold within their jurisdictions obtain a CE mark. The failure of a product to
hold such mark does not necessarily prevent the sale of such products within the
European Union until June 1, 1998, by which time products being sold in the
European Union are required to hold such mark as a condition to such sales.
Various of the Company's products are currently being sold in countries within
the European Union without such mark based upon other regulatory authorizations.
One of the conditions to obtaining CE mark status involves the qualification of
the Company's manufacturing plants
420793.1
14
under certain certification processes. Most of the Company's manufacturing
plants have obtained such certifications, although Microtek's plants and the
Company's Herndon, Virginia and Childersburg, Alabama plants have not yet
received such certifications. The Company plans to seek such certifications for
these remaining plants. While the Company does not anticipate any significant
impediments to obtain the certification for these remaining plants or otherwise
timely satisfying requirements for CE mark status, no assurances are provided
that such certifications will be obtained or that other foreign regulatory
requirements will not adversely affect the Company's marketing efforts in
foreign jurisdictions.
Under the Federal Insecticide, Fungicide, and Rodenticide Act ("FIFRA"), any
product which claims that it chemically kills microorganisms must be registered
with the EPA. Any product that makes a claim that it kills microorganisms via a
physical or mechanical means is considered a physical "device" under FIFRA, and
does not require EPA registration. FIFRA affects primarily the Company's LTS and
SMS products, neither of which is required to be registered with the EPA. The
Company believes its SMS product qualifies as a physical disinfecting device
under FIFRA, which permits the Company to advertise that such product physically
disinfects microorganisms without EPA registration. LTS is not registered with
the EPA. The lack of an EPA registration does not prevent the Company from
selling LTS, so long as no claims are made by the Company in product labeling
and marketing that LTS treats or disinfects medical waste or kills
microorganisms, and the absence of such registration does not prevent medical
waste generators from using LTS. The Company markets and labels LTS and SMS in a
manner designed to comply with relevant EPA regulations.
State and local regulations of the Company's products and services is highly
variable. In certain cases, for example, state or local authorizations are
required to landfill Isolyser's SMS or LTS products, or both. Currently Isolyser
believes that SMS-treated waste may be landfilled in 25 states and LTS-treated
waste may be landfilled in 20 states, subject in certain instances to further
local approvals. The Company was recently made aware that California is
reviewing its regulatory restrictions on customer landfilling of LTS-treated
waste. If such review results in restrictions on landfilling of such waste in
California, such restrictions could adversely affect the Company's sales of LTS
in California. State and local sewage treatment plants regulate the sewer
discharge, such as dissolved OREX Degradables, from commercial facilities to the
extent that such discharges may interfere with the proper functioning of sewage
treatment plants. Based on product testing and available research the Company
believes that OREX Degradables manufactured from PVA will not interfere with the
proper functioning of sewage treatment plants. The Company has obtained from
state and local authorities over 100 written and verbal non-binding concurrences
with the Company's conclusions and continues to pursue additional non-binding
concurrences. While the process of obtaining such concurrences is time consuming
and expensive due to the significant number of such authorities and the
educational and testing processes involved, the Company does not believe that
regulations governing sewage and waste water discharges will prevent the use of
OREX Degradables. While the Company is undertaking evaluation of OREX
Degradables manufactured from polymers other than PVA, no assurances can be
provided that such non-PVA based OREX will not interfere with the proper
functioning of sewage treatment plants.
The Resource Conservation and Recovery Act ("RCRA") and regulations
promulgated thereunder and applicable state and local laws governing the
disposal of solid and/or hazardous waste may regulate customers' use of ALDE-X
and raysorb. For example, the California Department of Toxic Substance Control
has refused to classify waste material treated with raysorb as non-hazardous,
effectively preventing the Company from marketing raysorb in California because
of the requirement that raysorb users in California obtain a permit in order to
dispose of material treated with raysorb, significantly increasing the cost of
disposal. The Company has conducted independent testing of raysorb, the results
of which confirm, in management's opinion, that raysorb-treated x-ray fixer and
developer is non-hazardous.
Regulators at the federal, state and local level have imposed, are currently
considering and are expected to continue to impose regulations on medical and
other waste. No prediction can be made of the potential effect of any such
future regulations, and there can be no assurance that future legislation or
regulations will not increase the costs of the Company's products or prohibit
the sale or use of the Company's products, in either event having an adverse
effect on the Company's business.
Employees
As of December 31, 1996, the Company employed approximately 2,800 full-time
employees and approximately 17 people as independent contractor sales
representatives. Of these employees, 162 were employed in marketing, sales and
customer support, 2,224 in manufacturing, 14 in research and development, and
400 in administrative
420793.1
15
positions. The Company believes its relationship with its employees is good.
Approximately 19 and 23 of White Knight's employees located at the Struble &
Moffitt plant and Douglas plant, respectively, were members of and represented
by the United Food and Commercial Workers Union, AFL-CIO. In addition,
approximately 287 of White Knight's employees located at White Knight's Agua
Prieta, Mexico plant are represented by a Mexican labor union.
Insurance
Isolyser maintains commercial general liability protection insurance which
provides coverage with respect to product liability claims of up to $11 million
per occurrence with a $12 million aggregate limit. The manufacture and sale of
the Company's products entail an inherent risk of liability. The Company
believes that its insurance is adequate in amount and coverage. Although the
Company has never been named as a defendant in a product liability lawsuit,
there can be no assurance that any future claims will not exceed applicable
insurance coverage. Furthermore, no assurance can be given that such liability
insurance will be available at a reasonable cost or that the Company will be
able to maintain adequate levels of liability insurance in the future. In the
event that claims in excess of these coverage amounts are incurred, they could
have a material adverse effect on the financial condition or results of
operations of the Company.
Environmental Matters
The Company is not a party to any material environmental regulation
proceedings alleging that the Company has unlawfully discharged materials into
the environment. The Company does not anticipate the need for any material
capital expenditures for environmental control facilities during the next 18 to
24 months.
Risk Factors
Limited Operating History; Net Losses. Isolyser was incorporated in 1987 and
commenced operations in 1988. Its principal products have been available in the
marketplace for a limited period of time. The Company began to commercially
introduce OREX Degradables in 1995 and total net sales of OREX Degradables in
1996 approximated $7.1 million but did not provide any gross profits. The
Company believes that the absence of gross profits on sales of OREX Degradables
to date is due to a combination of factors including the cost of manufacturing
OREX Degradables products (which is related in part to manufacturing
inefficiencies experienced to date in manufacturing such products), coupled with
pricing of OREX Degradables products at an amount which does not take into
account disposal cost savings provided by such products. For the year ended
December 31, 1996 the Company incurred actual net losses of approximately $20.5
million. No assurances can be given that the Company will operate profitably in
the future. The Company anticipates that its OREX materials manufacturing costs
and other investments in OREX sales volume growth will continue to adversely
impact operating results pending achieving significant increases in sales volume
of its OREX Degradables products and adjusting product unit prices for such
products to take into account disposal costs savings on such products. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations".
Risks of New Products. The Company's future performance will depend to a
substantial degree upon market acceptance of and the Company's ability to
successfully and profitably manufacture, market, deliver and expand its OREX
Degradables line of products. The Company has invested and intends to further
invest in the expansion of its manufacturing and marketing resources, primarily
in connection with OREX Degradables. The Company's total sale of OREX
Degradables to date has not been a significant component of the Company's total
sales of all of its products, while the Company's expenses (which in significant
part reflect the Company's investment in the potential for increased sales of
OREX Degradables products) associated with these products have adversely
affected operating results. See "-- Limited Operating History; Net Losses".
The Company's sales of OREX Degradables has occurred and is expected to
continue to occur on a staged basis subject to product availability. In early
1995, the Company began its commercial introduction of OREX Degradables with a
limited number of OREX Degradables products, primarily sponges and towels
purchased from contract manufacturers. Beginning in the third quarter of 1995,
the Company started expanding its line of OREX Degradables products available
for commercial sale as its Arden facility began to manufacture adequate
quantities of non-woven fabric to produce such products. The Company sells only
a limited number of OREX Degradables film products, and the Company has not
commercially marketed any of its OREX Degradables thermoformed and extruded
products. From time to time as the Company has introduced new OREX Degradables
products, the
420793.1
16
Company has encountered concerns with certain product performance
characteristics of those products. For example, the Company has not been
satisfied with the absorbency of its OREX Degradables towels and certain
aesthetic and user-oriented product performance characteristics of the film
component of its OREX Degradables reinforced gowns. To date, the Company has
used traditional film in its reinforced gowns containing OREX non- woven fabric.
See "Business -- Products and Markets". Technological improvements in the
Company's manufacturing capabilities caused the Company to record substantial
reserves in 1996 for certain early generation OREX Degradables inventories.
These reserves had a material adverse affect on the Company's operating results
in 1996. The Company may in the future record inventory reserves based on
currently unforeseen events such as future improvements in manufacturing
technology rendering existing inventories of OREX products less valuable.
The extent and rate at which market acceptance and penetration of the
Company's existing and future products are achieved is a function of many
variables including, but not limited to, product availability, product
selection, price, product performance and reliability, effectiveness of
marketing and sales efforts and ability to meet delivery schedules, as well as
general economic conditions affecting purchasing patterns. Long-term supply
contracts entered into by large hospital chains and smaller collective buying
groups may prohibit the Company from successfully marketing OREX Degradables to
such customers. The leading manufacturers of traditional disposable medical
products are large companies with significantly greater resources than those of
the Company. Those competitors have in many instances followed strategies of
aggressively marketing products competitive with OREX Degradables to buying
groups resulting in pricing pressures for such products. These factors have
adversely affected the Company's ability to adjust its price for OREX products
to take into account disposal cost savings provided by these products and have
adversely affected the Company's ability to successfully penetrate potential
customer accounts. As the Company currently has commercially available only a
limited number of OREX Degradables products and therefore cannot currently
replace all traditional disposable medical products with OREX Degradables
products, potential customers for the Company's products may not yet justify
large-scale conversion to OREX Degradables products. Procedures for the approval
of OREX Degradables in hospitals are complex, including approval from several
departments of each hospital.
There can be no assurance that the Company's products will achieve or
maintain substantial acceptance in their target markets. In addition to market
acceptance, various factors, including delays in new product development and
commercialization, delays in expansion of manufacturing capability, new product
introductions by competitors, price, competition, delays in regulatory
clearances and delays in expansion of sales and distribution channels could
materially adversely affect the Company's operations and profitability. See
"Business - Products and Markets" and "- Marketing and Distribution".
Risks of Expansion. The rapid expansion of the Company's manufacturing and
marketing resources has required and may continue to require the Company to make
significant additions to its fixed assets, equipment and personnel, while
maintaining expenses, product quality and customer service at satisfactory
levels. The White Knight and Microtek Acquisitions, which included the
acquisition of operations in Mexico, the Dominican Republic and United Kingdom,
as well as other expansion into foreign countries, entails additional risks,
including the risks of currency fluctuations and political instability. The
Company may in the future acquire other businesses as part of its growth
strategy. See "Business-Growth Strategy". Any inability of the Company to
successfully manage past or possible future acquisitions and expansions, while
maintaining expenses, product quality and customer service at satisfactory
levels, could have a material adverse effect on the Company and its operations.
Manufacturing and Supply Risks. The Company has recently expanded its
manufacturing capabilities and has begun to manufacture OREX Degradables
non-woven products and OREX Degradables towels in commercial quantities. The
Company, however, has used and continues to remain substantially dependent upon
various domestic and foreign independent manufacturers for manufacturing and
conversion of other of its OREX Degradables products, including its OREX
Degradables film products and sponges. The Company has not commenced
manufacturing for commercial sale any OREX Degradables thermoformed and extruded
products, and commercially offers only a limited number of OREX Degradables film
products. The Company has recently begun to develop the use of new polymers to
test manufacture OREX Degradables film and thermoformed and extruded products.
While the Company is undertaking evaluation of OREX Degradables manufactured
from these new polymers, no assurances can be provided that the Company will be
successful in manufacturing on a commercial basis OREX Degradables products from
these polymers or that such products will comply will all applicable regulatory
requirements. The Company's products must be manufactured in compliance with FDA
and other regulatory requirements while maintaining product quality at
acceptable manufacturing costs. The Company has limited experience in
manufacturing its non-woven and woven OREX products, and no experience in
internally
420793.1
17
manufacturing its other OREX products, in the quantities required for profitable
operations. Prior to the Company's commencement of such manufacturing
operations, no one had manufactured OREX Degradables. There can be no assurance
that manufacturing or quality control problems will not arise at the Company's
manufacturing plants, that the Company will be able to manufacture products at
commercially acceptable costs or that the Company will be able to maintain the
necessary licenses from governmental authorities to continue to manufacture its
OREX Degradables products.
The Company has experienced delays in manufacturing OREX Degradables
non-woven products at its Arden non-woven manufacturing plant. The Company has
also from time to time encountered dissatisfaction with certain quality or
performance characteristics of its products. These delays and quality or
performance issues may have resulted in the loss of certain potential hospital
customers. While management believes that it has identified and is addressing
the causes for such delays and while the Company continually seeks to improve
its products, there can be no assurance that future delays or quality concerns
will not occur. The Company anticipates that its non-woven fabric manufacturing
costs and other investments in OREX sales volume growth will continue to
adversely impact operating results pending a combination of achieving
significant increases in sales volume of its OREX Degradables products,
improving manufacturing efficiencies and adjusting product unit prices for such
products to take into account disposal cost savings on such products. See
"Business - Manufacturing and Supplies".
As a result of the development of the towel production facility in
Abbeville, South Carolina, the Company's towel production capacity significantly
exceeds its current product requirements. The inability of the Company to sell
its towel surplus to third parties at acceptable prices has adversely affected
the Company's profitability and operating margins. Due to existing large
inventories of OREX Degradables towels, the Abbeville plant is currently
operating at very low manufacturing volume. There can be no assurances that the
Company will be able to increase the demand for its OREX Degradables towels or
otherwise resolve these concerns and risks related to its excess towel
manufacturing capacity.
The Company is continually in the process of making improvements to its
technologies and systems for manufacturing its OREX Degradables products, while
simultaneously marketing and supplying various of these products. From time to
time, the Company has invested in inventory of certain OREX Degradables products
which subsequently have been rendered obsolete by improvements in manufacturing
technologies and systems. During 1996, the Company established a reserve of
approximately $10.0 million for potentially obsolete OREX inventories. There can
be no assurances that possible future improvements in manufacturing processes or
products will not render other inventories of product obsolete, thereby
adversely affecting the Company's financial statements.
The Company currently obtains most of the raw materials for OREX
Degradables, primarily polyvinyl alcohol ("PVA") fiber, from suppliers in the
People's Republic of China. The Company does not have any long-term supply
contracts or other formal contractual arrangements with any of its raw materials
suppliers or contract manufacturers. While raw materials and contract
manufacturing for OREX Degradables are also currently available from other
domestic and foreign independent manufacturers, there can be no assurance that
the Company will continue to be able to obtain raw materials and contract
manufacturing for its products on a commercially reasonable basis, if at all.
During 1996, an anti-dumping order was issued which requires that domestic
importers of PVA resin post import bonds or pay cash deposits in the amount of
certain scheduled margins (the "Anti-dumping Margins") of 19% (for PVA imported
from Taiwan), 77% (for PVA imported from Japan), and 116% (for PVA imported from
producers in the People's Republic of China other than Sichuan Vinylon Works
which has been excluded from the case) of the raw material cost upon importing
such raw materials. The anti-dumping order explicitly excludes PVA fiber. PVA
resin, which is subject to the order, is a raw material required to manufacture
OREX Degradables film, extruded and thermoformed OREX Degradables and PVA fiber,
and PVA fiber, which is not subject to the order, is the raw material required
to manufacture OREX Degradables woven and non-woven products. To date, the anti-
dumping order has not had a direct material effect on the Company as the Company
has not to date used substantial quantities of PVA resin. Such anti-dumping
order may have resulted in increases to the Company's costs for raw materials
over that which might otherwise have prevailed. The price of raw materials used
by the Company in manufacturing its OREX Degradables products has been a
significant component to the Company's total manufacturing costs for these
products. Prevailing prices for such raw materials have adversely affected the
Company's ability to achieve profitable gross margins on the Company's sale of
OREX Degradables products. The Company does not currently anticipate any
difficultly in satisfying its requirements for PVA resin as such raw material is
available from a number of suppliers.
420793.1
18
The production of the Company's products is based in part upon technology
that the Company believes to be proprietary. The Company has provided this
technology to contract manufacturers, on a confidential basis and subject to use
restrictions, to enable them to manufacture products for the Company. There can
be no assurance that such manufacturers or other recipients of such information
will abide by any confidentiality or use restrictions. Finally, production in
the People's Republic of China and elsewhere outside the United States exposes
the Company to risks of currency fluctuations, political instability and other
risks inherent in manufacturing in foreign countries. Certain textiles and
similar products or materials (including certain OREX Degradables woven
products) imported from the People's Republic of China to the United States are
subject to import quotas which restrict the total volume of such items available
for import by the Company, creating risks of limited availability and increased
costs for certain OREX Degradables woven products. See "Business - Manufacturing
and Supplies".
Protection of Technologies. The Company's success will depend in part on its
ability to protect its technologies. The Company relies on a combination of
trade secret law, proprietary know-how, non-disclosure and other contractual
provisions and patents to protect its technologies. Failure to adequately
protect its patents and other proprietary technologies, including particularly
the Company's intellectual property concerning its OREX Degradables, could have
a material adverse effect on the Company and its operations. The Company holds
various issued patents and has various patent applications pending relative to
its OREX Degradables products. See "Business -- Technology and Intellectual
Property".
Although management believes that the Company's patents and patent
applications provide or will provide adequate protection, there can be no
assurance that any of the Company's patents will prove to be valid and
enforceable, that any patent will provide adequate protection for the
technology, process or product it is intended to cover or that any patents will
be issued as a result of pending or future applications. Failure to obtain the
patents pursuant to the applications described above could have a material
adverse effect on the Company and its operations. It is also possible that
competitors will be able to develop materials, processes or products, including
other methods of disposing of contaminated waste, outside the patent protection
the Company has or may obtain, or that such competitors may circumvent, or
successfully challenge the validity of, patents issued to the Company. Although
there is a statutory presumption of a patent's validity, the issuance of a
patent is not conclusive as to its validity or as to the enforceable scope of
the claims of the patent. In the event that another party infringes the
Company's patent or trade secret rights, the enforcement of such rights is at
the option of the Company and can be a lengthy and costly process, with no
guarantee of success. Further, no assurance can be given that the Company's
other protection strategies such as confidentiality agreements will be effective
in protecting the Company's technologies. Due to such factors, no assurance can
be given that the various components of the Company's technology protection
arrangements utilized by the Company, including its patents, will be successful
in preventing other companies from making products competitive with those
offered by the Company, including OREX Degradables.
Although to date no claims have been brought against the Company alleging
that its technology or products infringe upon the intellectual property rights
of others, there can be no assurance that such claims will not be brought
against the Company in the future, or that any such claims will not be
successful. If such a claim were successful, the Company's business could be
materially adversely affected. In addition to any potential monetary liability
for damages, the Company could be required to obtain a license in order to
continue to manufacture or market the product or products in question or could
be enjoined from making or selling such product or products if such a license
were not made available on acceptable terms. If the Company becomes involved in
such litigation, it may require significant Company resources, which may
materially adversely affect the Company. See "Business Technology and
Intellectual Property".
Competition. The health care industry is highly competitive. There are many
companies engaged in the development, manufacturing and marketing of products
and technologies that are competitive with the Company's products and
technologies. Many such competitors are large companies with significantly
greater financial resources than the Company. Sellers and purchasers of medical
products have undergone consolidations in recent years, resulting in increasing
concentration of the market for disposable medical products with a few companies
and increasing cost pressures. This industry trend may place the Company at a
competitive disadvantage. The Company believes that these trends have adversely
affected the Company's ability to adjust its prices for its OREX Degradables
products to take into account disposal cost savings provided by such products,
in addition to adversely affecting the Company's ability to successfully
penetrate potential customer accounts. The market for disposable medical
products is very large and important to the Company's competitors. Certain of
the Company's competitors serve as the sole distributor of products to a
significant number of hospitals. There can be no assurance that the Company's
competitors will not substantially increase the resources devoted to the
development, manufacturing and
420793.1
19
marketing of products competitive with the Company's products. The successful
implementation of such strategy by one or more of the Company's competitors
could have a material adverse effect on the Company. See "Business -
Competition".
Risks of Technological Obsolescence. Many companies are engaged in the
development of products and technologies to address the need for safe and
cost-effective disposal of potentially infectious and hazardous waste. There can
be no assurance that superior disposal technologies will not be developed or
that alternative approaches will not prove superior to the Company's products.
The Company's products could be rendered obsolete by such developments, which
would have a material adverse effect on the Company's operations and
profitability.
Reliance Upon Distributors. The Company has historically relied on large
distributors for the distribution of its products. Hospitals purchase most of
their products from a few large distributors. Of these distributors, Owens &
Minor accounted for 10% or more of the Company's total sales during 1996.
Sterile Concepts has historically been a significant customer of White Knight,
based in part on a supply agreement between White Knight and Sterile Concepts
which requires that Sterile Concepts purchase a minimum of $5.1 million of
product from White Knight annually until June 30, 1998. In mid-1996, Sterile
Concepts was acquired by Maxxim, the latter of which is a competitor of White
Knight. While Sterile Concepts remains obligated to satisfy its minimum purchase
requirement under its supply agreement with White Knight until such agreement
expires in 1998, there can be no assurances that Sterile Concepts will in fact
satisfy such obligation. If the efforts of the Company's distributors prove
unsuccessful, or if such distributors abandon or limit their distribution of the
Company's products, the Company's sales may be materially adversely affected.
Regulatory Risks. The development, manufacture and marketing of the
Company's products are subject to extensive government regulation in the United
States by federal, state and local agencies including the EPA, the FDA and state
and local sewage treatment plants. Similar regulatory agencies exist in other
countries with a wide variety of regulatory review processes and procedures,
concerning which the Company relies to a substantial extent on the experience
and expertise of local product dealers, distributors or agents to ensure
compliance with foreign regulatory requirements. The process of obtaining and
maintaining FDA and any other required regulatory clearances or approvals the
Company's products is lengthy, expensive and uncertain, and regulatory
authorities may delay or prevent product introductions or require additional
tests prior to introduction. The Company currently holds 510(k) orders issued by
the FDA which the Company believes satisfy FDA required clearances for marketing
of the Company's existing products. The FDA has issued to the Company 510(k)
orders on OREX Degradables products for surgical sponges, operating room towels,
drapes, gowns, surgeon's caps, surgeon's vests, shoe covers and medical bedding.
The Company is currently developing, evaluating and testing certain OREX
Degradables film and thermoformed or extruded OREX products manufactured from
non-PVA polymers, and it is possible that new 510(k) orders will be required for
such products. There can be no assurance as to when, or if, other such 510(k)
orders necessary for the Company to market products developed by it in the
future will be issued by the FDA. The FDA also requires health care companies to
satisfy current good manufacturing practice and record-keeping requirements.
Failure to comply with applicable regulatory requirements, which may be
ambiguous or unclear, can result in fines, civil and criminal penalties, stop
sale orders, loss or denial of approvals and recalls or seizures of products.
There can be no assurance that changes in existing regulations or the adoption
of new regulations will not occur, which could prevent the Company from
obtaining approval for (or delay the approval of) various products or could
affect market demand for the Company's products.
Users of OREX Processors may be subject to regulation by local sewage
treatment plants to the extent that discharges from OREX Processors may
interfere with the proper functioning of such plants. The Company has approached
numerous sewage treatment plants requesting their approval to dispose of OREX
Degradables through the municipal sewer system. Although the Company has
obtained a total of over 100 non-binding written and verbal concurrences from
sewage treatment plants, certain of the founder hospitals and other hospitals
who have indicated an interest in purchasing OREX Degradables and an OREX
Processor are located in municipalities where such approvals have not been, and
may never be, obtained. While the Company is undertaking evaluation of OREX
Degradables manufactured from polymers other than PVA, no assurances can be
provided that such non-PVA based OREX will not interfere with the proper
functioning of sewage treatment plants thereby adversely affecting the Company's
ability to successfully commercialize such newly developing OREX Degradables
technology. There can be no assurance that disposal of OREX Degradables in areas
where these approvals have not been granted will not result in fines, penalties
or other sanctions against product users or adversely affect market demand for
the Company's products.
420793.1
20
Under the Americans with Disabilities Act of 1990 (the "ADA"), all public
accommodations are required to meet certain federal requirements related to
access and use by disabled persons. In addition, the Company is subject to a
variety of occupational safety and health laws and regulations, including the
Occupational Safety and Health Act of 1973 ("OSHA"). While the Company believes
that its facilities are substantially in compliance with these requirements, a
determination that the Company is not in compliance with the ADA, OSHA or
related laws and regulations could result in the imposition of fines or other
penalties or, with respect to the ADA, an award of damages to private litigants.
See "Business - Government Regulation".
Environmental Matters. The Company is subject to various federal, state,
local and foreign environmental laws and regulations governing the discharge,
storage, handling and disposal of a variety of substances and waste used in or
generated by the Company's operations. There can be no assurance that
environmental requirements will not become more stringent in the future or that
the Company will not incur substantial costs in the future to comply with such
requirements or that future acquisitions by the Company will not present
potential environmental liabilities.
Health Care Reform. The federal government and the public have recently
focused considerable attention on reforming the health care system in the United
States. The current administration has pledged to bring about a reform of the
nation's health care system and, in September 1993, the President outlined the
administration's plan for health care reform. Included in the proposal were
calls to control or reduce public and private spending on health care, to reform
the payment methodology for health care goods and services by both the public
(Medicare and Medicaid) and private sectors, which may include overall
limitations on federal spending for health care benefits, and to provide
universal access to health care. A number of other health care proposals have
been advanced by members of both Houses of Congress. The Company cannot predict
the health care reforms that ultimately may be enacted nor the effect any such
reforms may have on its business. No assurance can be given that any such
reforms will not have a material adverse effect on the Company.
Product Liability. The manufacture and sale of the Company's products entail
an inherent risk of liability. Product liability claims may be asserted against
the Company in the event that the use of the Company's products are alleged to
have resulted in injury or other adverse effects, and such claims may involve
large amounts of alleged damages and significant defense costs. Although the
Company currently maintains product liability insurance providing $12.0 million
in aggregate coverage for such claims, there can be no assurance that the
liability limits or the scope of the Company's insurance policy will be adequate
to protect against such potential claims. In addition, the Company's insurance
policies must be renewed annually. While the Company has been able to obtain
product liability insurance in the past, such insurance varies in cost, is
difficult to obtain and may not be available on commercially reasonable terms in
the future, if it is available at all. A successful claim against the Company in
excess of its available insurance coverage could have a material adverse effect
on the Company. In addition, the Company's business reputation could be
adversely affected by product liability claims, regardless of their merit or
eventual outcome. See "Business - Insurance".
Dependence on Key Personnel. The Company believes that its continued success
will depend to a significant extent upon the continued services of a limited
number of key personnel, including the management skills of Messrs. Robert L.
Taylor and Dan R. Lee and the technical research and development skills of Mr.
Travis W. Honeycutt. The loss of the services of these individuals could have a
material adverse effect upon the Company. Certain of these executives, including
Messrs. Taylor, Honeycutt and Lee, are not parties to employment agreements with
the Company. While the Company currently maintains key-man insurance on Messrs.
Taylor and Honeycutt, the Company is not required to continue to maintain such
insurance and may not continue to do so.
Anti-Takeover Provisions. On December 19, 1996, the Company's Board of
Directors adopted a Shareholder Protection Rights Agreement (the "Rights
Agreement"). Under the Rights Agreement, a dividend of one right ("Right") to
purchase a fraction of a share of a newly created class of preferred stock was
declared for each share of common stock outstanding at the close of business on
December 31, 1996. The Rights, which expire on December 31, 2006, may be
exercised only if certain conditions are met, such as the acquisition (or the
announcement of a tender offer the consummation of which would result in the
acquisition) of beneficial ownership of 15 percent or more of the Common Stock
("15% Acquisition") by a person or affiliated group. The Rights, if exercised,
would cause substantial dilution to a person or group of persons that attempts
to acquire the Company without the prior approval of the Board of Directors. The
Board of Directors may cause the Company to redeem the Rights for nominal
consideration. The Rights Agreement may discourage or make more difficult any
attempt by a person or group of persons to obtain control of the Company.
420793.1
21
Liquidity Risks. While the Company believes that, based on its current
business plan, the Company's cash equivalents, existing credit facilities and
funds budgeted to be generated from operations in the future will be adequate to
meet its liquidity and capital requirements through 1997, currently unforeseen
future developments and possible increased working capital requirements may
require that the Company seek to obtain additional debt financing or issue
common stock. The Company's cash equivalents diminished from a $54.8 million at
December 31, 1995 to $20.9 million at December 31, 1996. In addition, the
Company had outstanding at December 31, 1996 approximately $42.9 million under
its long term credit facility with the Chase Manhattan Bank. In the past, the
Company has violated certain covenants of such credit facility, all of which
covenant violations have been waived. Recently, the Company negotiated certain
modifications of such covenants in a manner which the Company believes it will
satisfy in the future. No assurances can be provided that other violations of
such credit facility will not occur in the future or that, if such violations
occur, those violations will be waived. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Liquidity and
Capital Resources".
ITEM 2. PROPERTIES
The Company maintains its principal place of business in a 25,000 square
foot office building located in a light industrial park in Norcross, Georgia
which it acquired in 1996. As a result of the Microtek Acquisition, the Company
leases from a local economic development authority a 13,300 square foot
administrative building located in Columbus, Mississippi.
The Company maintains approximately 31,600 square feet of office,
manufacturing, production, research and development and warehouse space located
in Norcross, Georgia under a lease which expires December 31, 1997. Such lease
may be renewed at the Company's option for two periods of three years each. The
Company's custom procedure tray business is located in Herndon, Virginia, a
suburb of Washington, D.C., where it occupies approximately 69,100 square feet
of space for office and production facilities, pursuant to a lease agreement
which expires December 31, 2003. The Company also leases approximately 60,000
square feet of space for its sterilization facilities and warehouse space
pursuant to a lease agreement which expires January 31, 2004, subject to a
renewal option through January 31, 2009. Effective January 5, 1995, the Company
acquired a 108,000 square-foot manufacturing facility located in Arden, North
Carolina which manufactures OREX Degradables non-woven fabric. The Company has
since added approximately