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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, 2001 Commission File Number: 0-24866
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ISOLYSER COMPANY, INC.
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(Exact Name of registrant as specified in its charter)
GEORGIA 58-1746149
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(State or other Jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
1850-E BEAVER RIDGE CIRCLE
NORCROSS, GEORGIA 30071
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(Address of principal executive offices) (Zip Code)
(770) 806-9898
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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 15, 2002, was approximately $116.4 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 15, 2002, there were outstanding 42,225,382 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-8 (File Nos.
33-85668), annual reports on Form 10-K for the periods ended December 31, 1994,
December 31, 1995, December 31, 1996 and December 31, 2000, quarterly report on
Form 10-Q for the period ended June 30, 2001, Schedule 14A filed on April 14,
1999, and current reports on Form 8-K dated June 4, 1996, December 19, 1996,
June 29, 1999 and July 12, 1999.
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Note: The discussions in this Form 10-K contain forward-looking
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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 2002
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") currently has two
primary operating units. Microtek Medical, Inc. ("Microtek"), an Isolyser
subsidiary, is the centerpiece of Isolyser's infection control business serving
the healthcare industry. OREX Technologies International ("OTI"), a division of
Isolyser, focuses on the commercialization of Isolyser's disposal technologies.
Microtek, a market leading healthcare company within its area of focus,
manufactures and sells infection control products such as equipment drapes and
patient drapes primarily for use in operating rooms and outpatient surgical
centers.
OTI seeks to develop and commercialize contamination control materials
and products coupled with engineered systems for the treatment and disposal of
those materials and products using proprietary technology and know-how. While
OTI has in the past sought to develop and commercialize such products for
healthcare applications, OTI currently focuses primarily on seeking to
commercialize its degradable OREXTM products and technology for disposing of
such products in the nuclear power generating industry.
Business Strategy
The Company intends to improve its operating results through the
following strategies:
Increased Focus on Infection Control Businesses. The Company seeks to
increase sales and earnings from its infection control business by completing
strategic acquisitions, enhancing marketing and distribution efforts both
domestically and internationally, introducing new products, increasing direct
sales representation, employing tele-sales agents for added sales coverage, and
capitalizing on low-cost manufacturing opportunities in the Dominican Republic.
Commercializing OREX Degradables. The Company seeks to commercialize
its OREX Degradable products by improving the product to better satisfy customer
needs and provide added value. The Company seeks to achieve these goals through
offering materials with superior product performance and contamination control
characteristics, while reducing material costs on a life cycle basis from
materials purchasing through disposal, and accomplishing the foregoing in an
ecologically beneficial way. Through OTI, the Company currently focuses
primarily on the nuclear power industry in seeking to commercialize its OREX
Degradable products. There can be no assurance that OREX Degradables will
achieve or maintain substantial acceptance in their target markets. See "Risk
Factors - History of Net Losses" and "-OREX Commercialization Risks".
Reduction of Costs. The Company has implemented a program to reduce its
costs and thereby increase its net income through manufacturing, corporate
overhead and OTI's operating expense reductions.
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Products and Markets
Infection Control Products
Consistent with its niche market strategy, Microtek is actively engaged
in the development of new products and the refinement of its existing products
to respond to the needs of its customers and the changing technology of the
medical products industry. Many of the Company's product innovations have been
generated from requests by the Company's customers and health care professionals
for products to be custom designed to address specified problems in the
operating room environment. The Company also monitors trends in the health care
industry and performs market research in order to evaluate new product ideas. No
assurance can be given that any new product will be successfully developed or
that any newly developed product will achieve or sustain market acceptance.
Microtek's products consist primarily of the following:
Equipment Drapes. Microtek's line of equipment drapes consists 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.
Patient Drapes. Microtek manufactures and sells both non-woven and
plastic patient drapes. Microtek's non-woven patient drapes are limited to
specialty patient drapes with various enhancements, such as fluid collection
pouches, incise and unique procedure-specific designs. Fox example, angiography
drapes are specially designed patient drapes used in angiography procedures.
Microtek acquired its line of angiography drapes as a result of the acquisition
by Microtek from Deka Medical, Inc. ("Deka") of substantially all of the assets
of Deka.
Safety Products. Microtek manufactures and sells a leading line of
encapsulation products for the management of potentially infectious and
hazardous waste. The primary component of this product line, called Liquid
Treatment System or LTS, is a super-absorbent powder which converts potentially
infectious liquid waste to a solid form. LTS is typically added to a suction
canister or other fluid collection device in which fluids are collected during
surgery or in wound drainage after surgery to solidify such fluids, thereby
facilitating handling, transportation and disposal. The Company's LTS Products
are sold in two forms, Isosorb, which solidifies liquid waste without any
germicidal component, and LTS-Plus, which is registered with the Environmental
Protection Administration (EPA) as a medical waste treatment product. This
registration adds the extra benefit to the end-user of being able to dispose of
LTS-Plus treated waste directly in a landfill, where local regulation permits.
See "-Government Regulation".
Other Products. Other products manufactured and sold by Microtek
include its Venodyne pneumatic pumps and disposable compression sleeves used in
reducing deep vein thrombosis, decanters used for sterile transfer of fluids,
specially designed disposable pouches or fluid-control products which are
attached to patient drapes to collect fluids, wound evacuation products, and
kits to facilitate cleanup of operating rooms after use called CleanOp products.
In first quarter 2001, Microtek acquired substantially all of the
assets of Deka used in Deka's drape and CleanOp product lines. These products
are highly compatible with Microtek's product lines. The Company believes this
transaction will benefit the Company by leveraging Deka's revenues on the
existing manufacturing and selling infrastructure in place at Microtek,
improving the diversification of Microtek's customer base and product line, and
adding experienced management to Microtek's existing personnel.
Equipment and patient drapes generated 60.6 percent of Isolyser's
revenues in 2001 as compared to 56.4 percent in 2000 and 55.7 percent in 1999.
Venodyne product revenues represented 6.2 percent, 10.2 percent and 9.4 percent
of Isolyser's revenues in 2001, 2000 and 1999, respectively. Safety product
revenues were 9.6 percent, 14.1 percent and 13.9 percent of Isolyser's revenues
in 2001, 2000 and 1999, respectively. Export sales by Microtek during 1999, 2000
and 2001 were $6.8 million, $5.7 million and $9.9 million, respectively.
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OREX Degradables
OREX Degradables are a combination of materials and products that
provide protection to people and the environment while providing cost effective
solutions to the problems associated with solid waste reduction and disposal.
These materials and products may include woven and nonwoven fabrics; resin; film
and hard plastics and extruded products. 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 OREX Processor after use for disposal through the municipal
sewer system or other specialty engineered treatment and disposal systems. See
"Risk Factors - History of Net Losses", "-OREX Commercialization Risks", "- OREX
Manufacturing and Supply Risks" and "- OTI Regulatory Risks".
Due to a number of factors including the Company's program to reduce
its costs, the Company is currently focused through its OTI division in
commercializing its OREX Degradable products and processing technology primarily
in nuclear power markets. OTI's nuclear products consist of protective clothing
products such as coveralls, hoods and booties, and are marketed in two forms.
One form is designed for single use and the other form may be laundered for a
limited number of repeat uses. These products are used in the nuclear power
industry to help protect people from radioactive contamination, primarily in
connection with periodic maintenance and re-fueling of nuclear power systems. As
a part of such use, the products may become contaminated. As a result, such
products are required to be treated after use as low-level radioactive materials
and thereby become subject to regulations addressing the manner in which they
are processed and disposed. During 2001, OTI acquired a processing system called
MICROBasix which may be used to process OREX products. The MICROBasix processing
system substantially reduces the volume of OREX products, separates radioactive
contaminants and facilitates the disposal of processed by-product material.
While the Company has received favorable responses from large nuclear power
facilities using the Company's products, no significant sales have been made to
date by OTI in the nuclear power industry.
During 2001, OTI entered into a service, marketing and processing
alliance with Eastern Technologies, Inc. (ETI), a small, privately held
enterprise providing protective clothing and laundering services to the nuclear
power industry. Under this relationship, ETI's Alabama facility has become the
site for a centralized MICROBasix processor facility. ETI has agreed to pay OTI
a percentage of the price charged by ETI to its customers for processing
services. Subject to certain conditions, ETI maintains exclusive rights to
process the OREX materials in the United States and Canada through December 31,
2004. Under a License and Supply Agreement between OTI and ETI, ETI serves as a
nonexclusive distributor of single use OREX products to the nuclear power
industry and serves as the exclusive co-marketer with OTI of OREX LaunderablesTM
through December 31, 2004. Under the License and Supply Agreement, ETI has
agreed to pay OTI a fixed price for the supply of the single use and launderable
OREX products and a royalty on the launderable products equal to a percentage of
the single use fees charged by ETI for the supply of launderable products its
customers.
Prior to 2001, the Company was focusing on delivering OREX Degradables
to the healthcare industry. In 1999, Isolyser granted to Allegiance Healthcare
Corporation an exclusive worldwide license to manufacture, use and sell products
made with Isolyser's proprietary degradable materials for use in healthcare
applications. During 2001, the Company and Allegiance Healthcare mutually agreed
to discontinue commercialization efforts in the healthcare market. If at any
time until April 11, 2003, OTI determines that a change in circumstances makes
it advisable to reintroduce degradable products to the healthcare marketplace,
the Company has agreed to offer Allegiance Healthcare the opportunity to enter
into a new agreement with the Company on terms at least as favorable as those
contained in the Company's previous license to Allegiance Healthcare. See "Risk
Factors - Reduced OREX Market Potential".
Management has not been satisfied with the Company's performance to
date in manufacturing and selling OREX Degradables. In particular, the Company
has failed to achieve profitable margins on sales of OREX products. Accordingly,
for the past several years the Company has sought to improve its operating
results by, among other things, reducing its marketing efforts directed towards
the sale of OREX Degradables, divesting itself of underperforming assets,
reducing the amount of its debt, and forming the OTI business unit to provide
increased focus on OREX commercial development. As a result of the Company's
sale of its selling, marketing and manufacturing facilities previously used for
OREX products, OTI now engages in the strategy of relying upon third parties for
such selling, marketing and manufacturing functions. See "- Marketing and
Distribution", "- Manufacturing and Supplies", "Risk Factors - History of Net
Losses", "-OREX Commercialization Risks" and "-OREX Manufacturing and Supply
Risks".
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Marketing and Distribution
Substantially all of the Company's sales in 2001 were made to the
healthcare market.
As of December 31, 2001, the Company's marketing and sales force
consisted of 28 sales representatives, 20 of whom are employed by the Company
and eight of whom are independent representatives; three field sales managers;
one home office sales manager; five marketing managers and 25 persons in
customer support. This marketing and sales force represents the Company's
infection control products and does not market or sell the Company's OREX
products and services.
The Company is dependent upon a few large distributors for the
distribution of its products. The Company's top three customers accounted for
approximately 35% of the Company's total revenues during 2001. Of these
customers, Allegiance Healthcare and Maxxim Medical, Inc. accounted for
approximately 16.6% and 10.6%, respectively, of the Company's total sales during
2001. 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".
The Company sells its infection control products domestically through
two channels or customer categories. The Company sells its products bearing the
Microtek brand directly to hospitals and through large distributors. Microtek
also sells non-branded products (sometimes called OEM products) to custom
procedure tray companies and equipment manufacturers for which Microtek
manufactures equipment drapes.
The Company's total export sales during 1999, 2000 and 2001 were $7.0
million, $5.7 million and $9.9 million, respectively. Outside the United States,
the Company markets its products principally through a network of approximately
185 different dealers and distributors. As of December 31, 2001, the Company
also had three sales representatives operating in international markets, and
maintains an office and warehouse distribution center near Manchester, England.
Manufacturing and Supplies
The Company manufactures its infection control products at its
facilities in Columbus, Mississippi, Tyler, Texas, Athens, Texas and the
Dominican Republic. The Company utilizes a facility in Jacksonville, Florida as
a distribution point for the receipt and shipment of product and for light
manufacturing. The Company also maintains a distribution facility near
Manchester, England, and a small facility in Waynesville, North Carolina used to
manufacture prototypes of surgical drapes. Through the Company's relationship
with Global Resources, Inc., the Company uses contract manufacturers in China
for certain of its infection control products when advantageous.
OREX is manufactured from a family of organic polymers that dissolve or
disperse in hot water and degrade in the wastewater system or in custom designed
OREX processing equipment. Woven and nonwoven products are manufactured using
PVA-based polymer chemistry. PVA is a safe material used widely in a variety of
consumer products such as eye drops, cosmetics and cold capsules. The Company
has more recently begun to develop and commercialize the use of a second
generation polymer system known as its Novel Degradable Polymer or NDP-system.
This system is currently being developed for the manufacture of OREX Degradables
film, composites of film with nonwoven fabric, and extruded, thermoformed or
injection molded solid plastic items. This NDP family of polymers disperses and
then degrades in a processing step which is initiated by the action of hot water
at an elevated pH. 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. See
"Risk Factors - Manufacturing and Supply Risks".
In 1998, the Company sold 4.5 million pounds of excess PVA fiber at a
price of $.45 per pound under an agreement pursuant to which the Company agreed
to repurchase 2.6 million pounds of such fiber (either as fiber or
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converted goods) over a four year period expiring in August, 2002 at a cost of
$.80 per pound of fiber. Through 2001, the Company has paid $1.7 million for
such fiber.
The Company has developed and begun sourcing OREX materials using the
hydroentangled method of nonwoven roll-good material manufacturing. Through
these roll-good material development and manufacturing efforts, both domestic
and internationally, the Company seeks to reduce the cost of producing OREX
non-woven products while simultaneously improving the quality of these products.
The Company currently sources all of these roll goods from outside the United
States. The Company has initially relied on manufacturers in China for its
nonwoven materials and is seeking to reduce its supply risks by sourcing such
materials from manufacturers in other locations. For example, the Company has
recently begun to have manufacturers located in Israel and North America supply
nonwoven materials. The Company relies to a significant extent on manufacturers
located in China to convert roll goods into finished products for sale by the
Company.
The Company now relies exclusively on domestic and foreign independent
manufacturers to supply OREX products to the Company's customers. The Company
uses contractors in the People's Republic of China to manufacture spunlaced OREX
fabric. The Company's requirements (which to date have been modest) for OREX
film products are currently being supplied by a contract manufacturer. See "Risk
Factors - OREX Manufacturing and Supply Risks".
Order Backlog
At December 31, 2001, the Company's order backlog totaled approximately
$1.2 million compared to approximately $473,000 (in each case net of any
cancellations) at December 31, 2000. All backlog orders at December 31, 2001 are
expected to be filled prior to year end 2002. Microtek typically sells its
products pursuant to written purchase orders which generally may be canceled
without penalty prior to shipment of the product. Accordingly, the Company does
not believe that the level of backlog orders at any date is material or
indicative of future results.
Technology and Intellectual Property
The Company seeks to protect its technology by, among other means,
obtaining patents and filing patent applications for technology and 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.
Isolyser holds numerous patents issued by the United States Patent and
Trademark Office relating to several aspects of its OREX line of products,
including several patents concerning methods of manufacture, methods of use,
methods of disposal, and patents covering several of the OREX products
themselves. Specifically, the Company currently holds: (1) U.S. Patent No.
5,661,217, issued in 1997, which covers a method of forming molded packaging and
utensils from OREX materials and methods of forming OREX brand films into a
packaging, drape, cover, overwrap, gown, head cover, face mask, shoe cover, CSR
wrap, tape, underpad or diaper; (2) US Patent 5,871,679, issued in February,
1999, and which covers methods for producing OREX Degradables that are
configured into thermoplastic films and fabrics; (3) U.S. Patent No. 6,048,410,
issued in 2000, which covers a method of disposing PVA garments, linens, drapes
and towels; (4) U.S. Patent No. 5,181,967, issued in 1993 and successfully
reissued (RE 36399) in 1999, and which covers a method of disposing particular
OREX materials utensils such as procedure trays, laboratory ware, and patient
care items; (5) U.S. Patent No. 5,985,443, issued November, 1999, and which
covers the methods of disposing a mop head; (6) U.S. Patent No. 5,885,907,
issued in March, 1999, and covers particular OREX materials configured into a
towel, sponge, or gauze; (7) US Patent 5,650,219, which was issued in 1997 and
covers methods of disposing particular OREX materials configured into garments,
linens, drapes, and towels; (8) U.S. Patent No. 5,207,837, issued in 1993 and
successfully reexamined (B1 5,207,834) by the U.S. Patent Office in 1996, which
covers methods of disposing OREX materials that are configured into a drape,
towel, cover, overwrap, gown, head cover, face mask, shoe covering, sponge,
dressing, tape, underpad, diaper, wash cloth, sheet, pillow cover, or napkin;
(9) U.S. Patent No. 5,181,966, issued in 1993 and successfully reexamined (B1
5,181,966) in 1996, and which covers methods of disposing OREX materials
configured into packaging materials; (10) U.S. Patent No. 5,268,222, issued in
1993 and covers composite fabrics made with an OREX materials; (11) U.S. Patent
No. 5,620,786, issued in 1997 and covering particular OREX materials that are
configured into towels, sponges or gauze; (12) U.S. Patent Nos. 5,470,653 and
5,707,731, issued in 1995 and 1998 respectively, and which cover disposable mop
heads made from OREX materials; (13) U.S. Patent No. 5,891,812, issued in April
of 1999, and covering liquid absorbable non-permeable
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fabrics, and methods of making, using and disposing thereof; and (14) U.S.
Patent No. 5,972,039, issued October, 1999, covering methods for enhancing the
absorbency and hand feel of OREX brand fabrics.
The Company also holds several United States Patents relating to
various other technologies, including its Sharps Management System or SMS line
of infectious waste containment systems and its LTS line of closure delivery
systems, including unique absorbent compositions for use therein.
The Company currently has several applications that are pending before
the U.S. Patent and Trademark Office which relate to OREX brand products
including such products used in nuclear and industrial application.
Specifically, those applications concern (i) filteration media, (ii) single use
and limited reuse protection clothing and equipment, (iii) finishing
formulations for OREX materials, (iv) disposal process and processor design for
nuclear contaminated waste, (v) a method of absorbing hydrocarbons with OREX
materials and fabrics, (vi) PVA fabric that is made from the spunlace process,
including PVA spunlaced fabrics that are configured into surgical gowns, drapes,
and industrial wipes, (vii) wipes made from any PVA wipes, (viii) equipment
covers made from OREX, and (ix) PVA fabrics that are coated on both sides for
limited repellency. Additionally, the Company also has a pending application
relating to its MicroBasix processing technology, including: (i) methods for the
treatment of waste streams, and (ii) methods for obtaining volume reduction of
wastes. The Company is not aware of any facts at this time that would indicate
that patents sought by these applications would not be issued; however, no
assurances can be provided that patents will issue from these applications. See
"Risk Factors - Risks Affecting Protection of Technologies."
The Company's current U.S. patent holdings will expire between the
years 2007 and 2020. The Company also typically files for foreign counterpart
patents on those technologies that 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. See "Risk Factors - Risks Affecting Protection of Technologies".
The Company has registered as trademarks with the U.S. Patent and
Trademark Office "Isolyser", "LTS", "SMS" and "Enviroguard" in the U.S. Patent
and Trademark Office. The Company has filed U.S. applications to register
various marks it uses in its business seeking to commercialize its OREX products
and services in the nuclear power generating industry. Trademark registrations
for "Isolyser", "OREX" and "LTS" have also been granted in various foreign
countries. Microtek maintains registrations of various trademarks that 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, customer relationship,
and convenience. Many of the Company's competitors have significantly greater
resources than the Company. See "Risk Factors - Competition" and "-Low Barriers
to Entry for Competitive Products".
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 is aware of a
variety of absorber products that are directly competitive with the Company's
LTS products.
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, these products compete with traditional disposable and
reusable products currently marketed and sold by many companies. 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
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Company's ability to successfully penetrate potential customer accounts. See
"Risk Factors - OREX Commercialization Risks" and "- Competition".
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 - Microtek Regulatory Risks" and
"-OTI Regulatory Risks".
The Company's traditional medical products (including, for example,
equipment drapes) and SMS products are regulated by the FDA under medical device
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)
clearances which the Company believes satisfy FDA pre-market notification
requirements. There can be no assurances as to when, or if, other such 510(k)
clearances necessary for the Company to market products developed by it in the
future will be issued by the FDA. 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 also requires healthcare companies to satisfy record-keeping
requirements and the quality system regulation (QSR) which require that
manufacturers have a quality system for the design and production of medical
devices intended for commercial distribution in the United States. 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 require that products being sold within
their jurisdictions obtain a CE mark and be manufactured in compliance with
certain requirements. The Company has CE mark approval to sell its safety and
most of its medical device products in Europe. One of the conditions to
obtaining CE mark status involves the qualification of the Company's
manufacturing plants and corporate offices under certain certification
processes. All of the Company's manufacturing plants and corporate offices have
obtained such certifications, except the domestic manufacturing facilities
acquired from Deka do not hold such certifications. To maintain CE mark
approval, the Company has to satisfy continuing obligations including annual
inspections by European notified bodies as well as satisfy record keeping and
other quality assurance requirements. The notified bodies have the authority to
stop the Company's use of the CE mark if the Company fails to meet these
standards. While the Company believes that its operations at these facilities
are in compliance with requirements to maintain CE mark status, no assurances
are provided that such certifications will be maintained 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 to kill microorganisms through chemical
action must be registered with the EPA. Any product that makes a claim that it
kills microorganisms exclusively via a physical or mechanical means is regulated
as a physical "device" under FIFRA. Pesticide devices do not require EPA
registration, but are subject to some requirements, including labeling and
record keeping. FIFRA affects primarily the Company's fluid encapsulation and
infectious waste treatment products including LTS-Plus, treatment for
encapsulation and disinfection of suction canister waste, and SMS. LTS-Plus is
registered with the EPA as a chemical device and SMS is registered as a physical
device under FIFRA. LTS-Plus replaced the Company's fluid encapsulation product
LTS in April 2001. In 1998, the EPA announced its position that FIFRA required
that products, such as LTS, which hold state approvals related to anti-microbial
efficacy, such as state approval for landfill of LTS-treated waste, impliedly
make claims about killing microorganisms which necessitate registration under
FIFRA. LTS was not registered with the EPA. Since 1998 the Company has marketed
LTS in a manner in which the Company believed complied with FIFRA by not making
claims in product labeling or marketing that LTS treats or disinfects medical
waste or kills microorganisms. The Company discontinued the sale of LTS in
8
April 2001 when it was replaced with LTS-Plus. See "Risk Factors - Microtek
Regulatory Risks" and "- Reliance Upon Distributors".
State and local regulations of the Company's products and services are
highly variable. Individual state registration of LTS-Plus is required for just
over half of the states in the United States as a condition to landfill of
treated suction canisters. The rules for disinfecting infectious waste are being
revised on a National Standard. The outcome of the National Standard will play a
very important part in the life of LTS-Plus. In 1997, as a result of a review of
an existing approval in California for the landfilling in California of waste
treated by LTS, California authorities revoked such approval and have also not
given approval for the use of LTS-Plus. While LTS offers benefits unrelated to
landfilling, such action has adversely affected the Company's ability to sell
LTS-Plus. The Company is continuing the process of obtaining from the various
states approval to landfill waste treated by LTS- Plus, and has obtained such
approval from several states not including California. No assurances can be
provided that the prior regulatory actions or pending regulatory reviews will
not continue to have an adverse effect upon the sales of the Company's
sanitizing liquid absorbent products. See "Risk Factors - Microtek Regulatory
Risks".
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 Degradables will not interfere with the
proper functioning of sewage treatment plants.
As the Company seeks to introduce its OREX products to industries other
than healthcare, the Company will be required to satisfy any applicable
regulatory requirements within such industries for the disposal of contaminated
OREX products. The processing of OREX materials contaminated with nuclear
outfall is classified as hazardous which creates significant engineering
challenges. During 2001 the Company acquired the MICROBasix processor and
related technology to address the engineering challenges associated with the
disposal of OREX materials contaminated with nuclear outfall. The operation of
such processor and the disposal of residual by-products resulting from such
operation are subject to governmental regulation. The Company relies upon the
party (namely, ETI) with which it has contracted to process OREX in order to
comply with such governmental regulations. As the Company and ETI begin
processing of OREX on a commercial scale, additional challenges may arise as a
part of the Company's efforts to commercialize these products and technologies.
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, 2001, the Company employed 1,584 full-time
employees, eight part-time employees and eight people as independent
contractors. Of these, 70 were employed in marketing, sales and customer
support, 1,348 in manufacturing, 16 in research and development, and 158 in
administrative positions. The Company believes its relationship with its
employees is good.
Insurance
The Company maintains commercial general liability insurance which
provides coverage with respect to product liability claims. 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. There can be no
assurance that any future claims will not exceed applicable insurance coverage.
Furthermore, no assurance can be given that such liability
9
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
Risks Affecting Microtek and OTI.
History of Net Losses. While the Company reported net income for the
years ended December 31, 2001 and 1999, the Company has a history of operating
at a net loss. For the year ended December 31, 2000 and for each of the five
years ended December 31, 1998, the Company incurred net losses. The Company
attributes such operating performance in significant part to a failed strategy
to commercialize its OREX Degradables products. The Company has significantly
changed its business strategies, including a substantial reduction of its
emphasis on its OREX Degradables business. Past operating failures may adversely
the impact of the valuation of the Company's common stock and the Company's
ability to successfully implement its other business strategies.
Reliance Upon Microtek. Of the Company's $81.0 million in net revenues
for the year ended December 31, 2001, $78.6 million or 97.1% were comprised of
Microtek's net revenues. OTI contributed $2.2 million of the Company's 2001 net
revenues. Of such amount, $1.5 million represented the non-cash amortization of
deferred licensing revenues resulting from the 1999 license and supply agreement
which the Company entered into with Allegiance Healthcare to market OREX
Degradables products and healthcare markets. These non-cash revenues will cease
to accrue in the fourth quarter of 2002, and the Company has ceased its business
operations to commercialize OREX Degradables products in healthcare markets.
Competition. 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. The
Company seeks to sell its OREX Degradables products to the nuclear power
industry, and the Company has virtually no presence in such industry at this
time. Therefore, the Company will be required to displace sales of competitive
products in this industry to gain market presence. There can be no assurance
that the Company's competitors will not substantially increase the resources
devoted to the development, manufacturing and 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.
Product Liability. The manufacture and sale of the Company's products
entails 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 or
processing systems are alleged to have resulted in injury or other adverse
events, and such claims may involve large amounts of alleged damages and
significant defense costs. Although the Company currently maintains product
liability insurance providing 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".
Stock Price Volatility. The market prices for securities of companies
with a very small market capitalization such as the Company can be highly
volatile. Various factors, including factors that are not related to our
operating performance, may cause significant volume and price fluctuations in
the market, which may limit an investor's liquidity in our common stock and
could result in a loss in the value of such investment.
10
Dependence on Key Personnel. The Company believes that its ability to
succeed will depend to a significant extent upon the continued services of a
limited number of key personnel, and the ability of the Company to attract and
retain key personnel. The Company has only four executive officers, and the loss
of the Company's President or any others of its officers could have a material
adverse effect on the Company. The Company may not be able to attract and retain
a suitable replacement for any of such positions. The Company does not maintain
key man life insurance on any of its executive officers.
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% or more of the common stock ("15%
Acquisition") of the Company 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, subject to certain exceptions. The Rights Agreement may
discourage or make more difficult any attempt by a person or a group of persons
to obtain control of the Company.
Risks Affecting Microtek.
Low Barriers to Entry for Competitive Products. Most of the Company's
infection control products are not protected by patents, and some of such
infection control products that are protected by patents are subject to
competition from products which may be manufactured or used in a way which does
not infringe upon the Company's patents. In addition, other barriers to entry,
such as manufacturing processes and regulatory approvals, may not prevent the
introduction of products competitive with the Company's infection control
products. The introduction of competitive products or other competitive
marketing strategies, including competitive marketing from companies outside the
United States through the internet, could force the Company to lower it prices
for its products or otherwise adversely affect the Company's operating results.
Potential Erosion of Profit Margins. During 2001, Microtek's gross
margin declined from 41.9% in 2000 to 39.3% in 2001 in part due to relatively
higher OEM product revenues which have slightly lower margins than branded
products. In addition, Microtek does not have a significant number of new
products which it plans to introduce at relatively higher profit margins. For
these and other reasons, Microtek is subject to the risks that it may experience
declining profit margins in the future.
Risks of Completing Acquisitions. Part of Microtek's growth strategy
involves completing strategic acquisitions. The Company's ability to complete
strategic acquisitions is subject to a number of variables outside the control
of the Company including the Company's ability to find attractive and
complementary acquisition opportunities at an attractive cost. Failure to
successfully complete strategic acquisitions on favorable terms may adversely
affect the Company's growth rate.
Small Sales and Marketing Force. The Company's marketing and sales
force consists of 70 individuals including 41 people in sales and 29 people in
marketing. Other companies with which the Company competes have substantially
larger sales forces and greater brand awareness, placing the Company at a
competitive disadvantage. For example, the Company may not be able to reach
certain potential customers due to the Company's inability to have its products
included within certain group purchasing organizations' lists of approved
products.
Reliance upon Distributors. The Company has historically relied on
large distributors for the sale of its branded products in healthcare markets.
Hospitals purchase most of their products from a few large distributors. Of
these distributors, only Allegiance Healthcare and Maxxim Medical accounted for
approximately 16.6% and 10.6% respectively, of the Company's total sales during
2001. 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.
11
Microtek 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 and 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 of
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 FDA also requires healthcare companies to
satisfy the quality system regulation. 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.
Developments regarding the Company's LTS products have had and could
continue to have a material adverse effect upon the Company's operating results.
In November, 1997, the State of California revoked its approval for direct
landfill disposal (without sterilization) of LTS-treated waste within such
state. In February 1998 the EPA announced a new policy that FIFRA requires that
products, such as LTS, which hold state approvals related to anti-microbial
efficacy, such as state approvals for landfill of LTS-treated waste, impliedly
make claims about killing microorganisms which would require that LTS be
registered under FIFRA. LTS has not been registered under FIFRA and, based in
part on meetings by the Company with the EPA, the Company continues to sell LTS
without such registration. The Company now is marketing LTS without relying upon
any state approvals for direct landfill disposal. In 2000, the Company obtained
registration under FIFRA by the EPA of a new version of LTS called LTS Plus. The
Company must still seek numerous state and local registrations of LTS Plus to
allow such product to be landfilled in such places. The EPA's change in policy
could cause the Company to become subject to an order to stop sales of the
original version of LTS or be subject to fines, penalties or other regulatory
enforcement procedures, any one or more of which could have a material adverse
effect on the Company and its results of operations.
Risks of Obsolescence. Many companies are engaged in the development of
products and technologies to address the need for safe and cost-effective
prevention of infection in healthcare markets. There can be no assurance that
superior products or technologies will not be developed or that alternative
approaches will not prove superior to the Company's infection control products.
For example, some companies are attempting to develop technologies to sterilize
equipment maintained in the operating room which would compete directly with the
Company's equipment drapes. Any such developments would have a material adverse
effect on the Company's operations and profitability.
Risks affecting the OREX Products and Services.
Reduced OREX Market Potential. During 2001, the Company and Allegiance
jointly agreed to cease further efforts to market the OREX Degradables products
to the healthcare industry. Accordingly, the Company is not making any sales of
OREX products to the healthcare industry, nor is the Company seeking to
commercialize such products in such industry. The Company currently believes
that it will have to reduce its costs to manufacture OREX Degradables products
or the healthcare industry will have to increase the price it is willing to pay
for the Company's OREX Degradables products (such as might occur in the event of
an increase in the cost to dispose of potentially infectious healthcare products
which might be replaced by OREX Degradables) in order to re-introduce the OREX
Degradables products to the healthcare marketplace. If the Company elects to
reenter the healthcare market prior to the expiration in April 2003 of the
Company's exclusive license to Allegiance of OREX Degradables products for use
in healthcare markets, the Company will be required to first offer such
opportunity to Allegiance on terms at least as favorable to Allegiance as those
contained in the Company's prior license and supply agreement with Allegiance.
OREX Commercialization Risks. The Company currently focuses primarily
on the nuclear power industry in its efforts to commercialize it OREX
Degradables products and services. Sales of the Company's products and services
to the nuclear industry during 2001 approximated $200,000. Accordingly, the
Company has only very limited experience in the nuclear industry, and there is
no assurance that the nuclear industry will purchase the Company's products and
services. Among the risks the Company encounters in seeking to commercialize its
products in the nuclear industry are the following:
12
. Commercialization of these products will require the purchaser
and user of these products to change their existing purchasing
patterns;
. Because Isolyser currently has commercially available only a
limited number of OREX Degradable products and therefore
cannot currently replace all traditional products with OREX
Degradables, potential customers may not yet justify a
large-scale conversion to OREX Degradable products;
. To realize the full benefits of OREX Degradables, users of
these products will be required to change the way in which
they dispose of these products by returning such products to
Isolyser's contract processor to incorporate the MICROBasix
dissolution process and disposal procedures;
. Isolyser's sales and marketing force representing the OREX
products and disposal services is limited to very few
individuals at OTI and ETI, some of whom also provide
administrative services;
. Isolyser depends upon its contract processing company, ETI, to
commercialize the disposal service component of the OREX
Degradables product because ETI holds exclusive rights in the
United States and Canada to provide such disposal services
through December 31, 2004, subject to certain performance
related conditions;
. Because ETI is a very small, privately held company with
limited capital resources and personnel, ETI may encounter
difficulties in providing disposal services to users of OREX
Degradables which could adversely affect the Company's
marketing of OREX Degradables products to the nuclear
industry;
. The MICROBasix processor has not been used on a commercial
scale and the Company risks that such processing equipment
will not perform adequately to realize the potential benefits
of OREX Degradables in the nuclear industry;
. While ETI is responsible for obtaining all regulatory
approvals to operate the MICROBasix processor, and while ETI
has advised the Company that it has obtained all such
approvals, difficulties may be encountered in maintaining
existing regulatory approvals in effect and obtaining future
regulatory approvals necessary to process OREX Degradables;
. The Company may have difficulty obtaining a regular supply of
adequate qualities of finished goods OREX Degradable products
having uniformly acceptable performance qualities which may
cause Isolyser to lose customers;
. The Company may have difficulty obtaining an inventory of OREX
Degradables in finished form on acceptable terms and at an
acceptable cost;
. Past concerns with prior OREX Degradables product performance
or future deficiencies in performance of such products may
result in the inability to convert new customers to OREX
Degradables or retain existing customers;
. Competitors may try to sell traditional products to the
nuclear market using aggressive marketing and selling
strategies to protect their market position and discourage the
acceptance of OREX Degradables products and services by the
nuclear market; and
. Long term supply contracts entered into by potential
purchasers of OREX Degradables in the nuclear industry may
prevent such customers from purchasing OREX Degradables.
The Company has not been successful to date in its efforts to obtain
substantial acceptance of its OREX Degradables products in their target markets.
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
13
delays in improvements to products and 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.
OREX Manufacturing and Supply Risks. To relieve itself of the overhead
burden associated with owning its own manufacturing facilities, the Company sold
its former OREX manufacturing facilities and now depends entirely upon third
parties to manufacture its OREX Degradables products. If the Company is not able
to obtain its products from its manufacturers, if such products do not comply
with the specifications or if the prices at which the Company purchases its
products are not competitive with traditional products, the Company's sales and
profits will suffer.
The cost for OREX raw materials has been high relative to raw materials
used in competitive products such as cotton, polyester and nylon. The Company
obtains its raw materials from various sources but 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.
The prices for these raw materials have affected the ability of the Company to
be price competitive with conventional disposable and reusable products, both
reducing sales and adversely affecting profits.
The Company does not have significant experience obtaining large,
commercial quantities of OREX Degradables products to meet its obligations, and
the Company's third party manufacturers have not regularly manufactured these
products in the quantities required for commercial sales. The Company might have
difficulties in receiving adequate quantities of products, receiving such
products on schedule and having such products conform with its requirements. The
Company does not maintain contracts with its suppliers for its OREX Degradables
products. To the extent the Company does not hold a contract for the supply of
its products, the Company may be at a greater risk in obtaining its products and
controlling its costs for products.
Production in China and elsewhere outside the United States exposes the
Company to risks related to currency fluctuations, political instability and
other risks inherent in manufacturing in foreign countries. Certain textiles and
similar products for material (including certain OREX Degradables woven
products) imported from China to the United States are subject to import quotas
which restrict 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.
To date, the Company has been unable to manufacture OREX Degradables
film and thermoformed and extruded products at an acceptable cost. The Company
has recently begun to develop the use of new polymers, called NDP, to test
manufacture OREX Degradables film and thermoformed and extruded products. While
the Company has undertaken an evaluation of these new products, 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 with applicable regulatory requirements.
The Company has from time to time experienced delays in manufacturing
certain OREX Degradables products. 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 have resulted in
the loss of customers. There can be no assurance that future delays or quality
concerns will not occur or that past customer relations on these products will
not adversely affect future customer relations and operating results.
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. There can be no assurances that possible future
improvements in manufacturing processes or products, or abandonment or reduction
of selling efforts, will not render other inventories of product obsolete,
thereby adversely affecting the Company's financial condition and operating
results.
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.
14
Risks Affecting 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 Company's patent applications 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 right is
generally 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".
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.
OTI Regulatory Risks. Introduction of the Company's OREX Degradables
products into non-healthcare industries will require compliance with additional
regulatory requirements. While the Company seeks to engage the services of
companies having expertise in engineering systems to comply with these
regulatory requirements, the Company or its independent contractors may not be
able to develop satisfactory solutions to regulatory requirements at an
acceptable cost. The Company currently relies upon ETI, its independent
contractor holding exclusive OREX processing rights in the U.S. and Canadian, to
comply with applicable regulations affecting such industry. Until the Company
commences commercial sales of products, the Company may not be able to
anticipate all requirements to successfully commercialize OREX Degradables in
these other industries. Accordingly, no assurances can be provided that OREX
Degradables will be an attractive product to non-healthcare industries.
ITEM 2. PROPERTIES
The Company maintains approximately 10,800 square feet of office,
manufacturing, production, research and development and warehouse space located
in Norcross, Georgia under a sub-lease agreement which expires January 30,
15
2005. The Company also leases from a local economic development authority a
13,000 square foot administrative building located in Columbus, Mississippi
under a lease which expires December 31, 2007.
The Company conducts its equipment drape and fluid control
manufacturing business from three locations. In Columbus, Mississippi the
Company owns an 80,000 square foot manufacturing building and leases on a
month-to-month basis a 40,000 square foot warehouse facility. The Company leases
five manufacturing facilities totaling 123,500 square feet located in the
Dominican Republic which expire at various dates through 2007. The Company
leases a 37,700 square foot facility in Tyler, Texas where it manufactures
equipment drapes and materials for other drape converters under a lease which
expires July 31, 2002, subject to two renewal options for five years each. The
Company leases a 7,500 square foot manufacturing facility in Athens, Texas where
it manufactures equipment drapes under a lease that expires on April 1, 2004.
The Company also leases a 5,000 square foot manufacturing and warehouse facility
in Waynesville, North Carolina where it produces prototypes of surgical drapes
under a month-to-month lease.
The Company also leases approximately 69,000 square feet of warehouse
and distribution space in Jacksonville, Florida. The Company uses this facility
for distribution of finished products, distribution of materials to the
Company's Dominican Republic facility and light manufacturing under a lease
expiring April 30, 2003.
Through a subsidiary, the Company leases approximately 9,000 square
feet of space near Manchester, England, approximately 7,000 of which is used for
warehouse space and 2,000 of which is used for office space.
The Company believes that its present facilities are adequate for its
current requirements.
ITEM 3. LEGAL PROCEEDINGS
From time to time the Company is involved in litigation and legal
proceedings in the ordinary course of business. Such litigation and legal
proceedings have not resulted in any material losses to date, and the Company
does not believe that the outcome of any existing lawsuits will have a material
adverse effect on its business.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no submissions of matters to a vote of the Company's
shareholders during the three months ended December 31, 2001.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
The common stock is traded and quoted on The Nasdaq Stock Market under
the symbol "OREX". The following table shows the quarterly range of high and low
sales prices of the common stock during the periods indicated since December 31,
1999.
Common Stock
Quarter Ended High Low
- ------------- ---- ---
2001
First Quarter $1.47 $0.69
Second Quarter $2.60 $0.75
Third Quarter $1.98 $1.09
Fourth Quarter $2.74 $1.35
2000
First Quarter $6.97 $2.88
Second Quarter $5.47 $3.00
Third Quarter $3.50 $1.88
Fourth Quarter $2.47 $0.50
16
On March 15, 2002, the closing sales price for the common stock as
reported by The Nasdaq Stock Market was $2.97 per share.
As of March 15, 2002, the Company had approximately 1,300 shareholders
of record.
The Company has never declared or paid any cash dividends on its common
stock. The Company currently intends to retain any future earnings to finance
the growth and development of its business and therefore does not anticipate
paying any cash dividends in the foreseeable future. Moreover, the Company's
credit facility prohibits the Company from declaring or paying cash dividends
without the prior written consent of its lenders. See "Management's Discussion
and Analysis of Financial Condition and Results of Operations - Liquidity and
Capital Resources". Accordingly, the Company does not intend to pay cash
dividends in the foreseeable future.
ITEM 6. SELECTED FINANCIAL DATA
The following table sets forth summary historical financial data for
each of the five years in the period ended December 31, 2001. During the first
quarter of 2001, the Company acquired the drape and CleanOp product lines of
Deka Medical and acquired the MICROBasix processor equipment and related
technology. In October, 2000, Microtek acquired the urology drape product line
of Lingeman Medical Products, Inc. During 1999, the Company disposed of its
former corporate headquarters, substantially all of the assets of its MedSurg
Industries, Inc. subsidiary and all of its capital stock in its White Knight
Healthcare, Inc. subsidiary, and during 1998 the Company disposed of its Arden
and Charlotte, North Carolina and Abbeville, South Carolina manufacturing
facilities, its industrial and Struble & Moffitt divisions of its White Knight
subsidiary, and substantially all of the net assets of its SafeWaste subsidiary.
The summary historical financial data should be read in conjunction with the
historical consolidated financial statements of the Company and the related
notes thereto, "Management's Discussion and Analysis of Financial Condition and
Results of Operations" and other financial data appearing elsewhere in this Form
10-K. The summary historical financial data for each of the five years in the
period ended December 31, 2001 has been derived from the Company's audited
consolidated financial statements.
17
Year Ended December 31,
Statement of Operations Data 1997 1998 1999 2000 2001
(in thousands, except per share data)
Net sales ...................................... $ 159,940 $ 147,643 $ 97,554 $ 53,931 $ 79,470
Licensing revenues ............................. - - 1,500 2,433 1,497
--------- --------- --------- --------- ---------
Total revenues ........................... 159,940 147,643 99,054 56,364 80,967
Cost of goods sold ............................. 142,094 109,936 61,970 35,938 48,497
--------- --------- --------- --------- ---------
Gross profit ............................. 17,846 37,707 37,084 20,426 32,470
Operating expenses
Selling, general and administrative ...... 43,422 40,182 26,596 21,246 25,166
Research and development ................. 2,601 3,906 3,724 4,098 1,644
Amortization of intangibles .............. 3,847 2,052 1,440 1,780 1,520
Impairment charge ........................ 57,310 7,445 769 - -
Restructuring charge ..................... - - - 1,555 -
Gain on dispositions ..................... - - (628) (21) -
--------- --------- --------- --------- ---------
Total operating expenses ............. 107,180 53,585 31,901 28,658 28,330
--------- --------- --------- --------- ---------
(Loss) income from operations ........ (89,334) (15,878) 5,183 (8,232) 4,140
Net other expense .............................. (3,415) (3,223) (1,195) (3,755) (489)
--------- --------- --------- --------- ---------
(Loss) income before tax, extraordinary items
and cumulative effect of change in
accounting principle ........................ (92,749) (19,101) 3,988 (11,987) 3,651
Income tax provision (benefit) ................. 354 540 1,291 155 (1,138)
--------- --------- --------- --------- ---------
(Loss) income before extraordinary item and
cumulative effect of change in accounting
principle ................................... (93,103) (19,641) 2,697 (12,142) 4,789
Extraordinary item (1) ......................... - (1,404) - - -
Cumulative effect of change
in accounting principle (2) ................. 800 - - - -
--------- --------- --------- --------- ---------
Net (loss) income ........................... $ (93,903) $ (18,237) $ 2,697 $ (12,142) $ 4,789
========= ========= ========= ========= =========
Net (loss) income per share - Basic and Diluted
(Loss) income before extraordinary item
and cumulative effect of change in
accounting principle ..................... $ (2.37) $ (0.49) $ 0.07 $ (0.29) $ 0.11
Extraordinary items ...................... - 0.04 - - -
Cumulative effect of change in accounting
principle ............................... (0.02) - - - -
--------- --------- --------- --------- ---------
Net (loss) income per share - Basic and Diluted $ (2.39) $ (0.45) $ 0.07 $ (0.29) $ 0.11
========= ========= ========= ========= =========
Weighted average number of common and
common equivalent shares outstanding ........ 39,273 39,655 40,318 41,269 41,651
- Basic
Weighted average number of common and
common equivalent shares outstanding
- Diluted ................................... 39,273 39,655 41,158 43,221 41,842
- -----------------
(1) Gives effect to the gain from the extinguishment of debt in 1998.
(2) Reflects the adoption of Emerging Issues Task Force ("EITF") Consensus No.
97-13, "Accounting for Costs in Connection with a Consulting Contract or an
Internal Process that Combines Processing Reeingineering and Information
Technology Costs Transformation."
18
Year Ended December 31,
--------------------------------------------------------
Balance Sheet Data: 1997(1) 1998(2) 1999 2000 2001
(in thousands)
Working capital ............................. $ 72,408 $ 39,124 $ 44,090 $ 34,372 $ 44,946
Intangible assets, net ...................... 30,803 29,128 23,071 23,057 26,351
Total assets ................................ 144,334 109,518 95,339 76,969 94,330
Long-term debt .............................. 37,546 19,376 4,059 1,673 13,313
Total shareholders' equity .................. 86,117 68,675 74,722 63,598 69,588
(1) Pursuant to SFAS No. 121 the Company classified $35.8 million of net
assets related to its OREX manufacturing facilities and White Knight
subsidiary as held for sale, and included such amount in current
assets.
(2) Pursuant to SFAS No. 121 the Company classified $9.9 million of net
assets related to its White Knight subsidiary and its former
headquarters building as held for sale, and included such amounts in
current assets.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
General
On March 31, 1999, the Company disposed of its former corporate
headquarters in Norcross, Georgia. Effective May 31, 1999, the Company disposed
of the stock of its former White Knight subsidiary, which manufactured and sold
non-woven products primarily to healthcare markets. On July 12, 1999, the
Company sold to Allegiance substantially all of the assets of the Company's
MedSurg Industries subsidiary, which assembled and sold custom procedure trays
to hospitals. On July 12, 1999, the Company also granted to Allegiance an
exclusive worldwide license to the Company's proprietary technologies to
manufacture, use and sell products made from its OREX material for healthcare
applications. In October, 2000, Microtek acquired the urology drape product line
of Lingeman Medical Products, a former customer of Microtek. During first
quarter 2001, the Company acquired the drape and CleanOp product lines of Deka
Medical and acquired the MICROBasix processor equipment and related technology.
Also during 2001, the Company and Allegiance mutually agreed to discontinue
efforts to commercialize the OREX products and technology in the healthcare
market.
Year Ended December 31, 2001 Compared to Year Ended December 31, 2000
Net revenues in 2001 were $81.0 million, an increase of $24.6 million
or 43.7 percent over the $56.4 million of net revenues reported in 2000.
Excluding licensing revenues associated with the amortization of the $10.5
million payment by Allegiance allocated to the Company's Supply and License
Agreement with Allegiance, net revenues in 2001 were $79.5 million as compared
to $53.9 million in 2000, an increase of 47.4 percent. The increase in net
revenues is due to Microtek's acquisition of the drape and CleanOp product lines
of Deka Medical in the first quarter of 2001, internal growth in Microtek's core
product revenues, and products newly introduced by Microtek.
For 2001, Microtek's net revenues totaled $78.6 million, an increase of
$26.5 million or 50.9 percent over net revenues of $52.1 million reported in
2000. Microtek's domestic revenues, which were $68.7 million or 87.3 percent of
Microtek's total net revenues in 2001, increased by $22.3 million or 47.9
percent over 2000. Microtek's domestic revenues are generated through two
primary channels or customer categories, hospital branded and contract
manufacturing (commonly referred to as OEM). Hospital branded revenues were 55.3
percent and OEM revenues were 44.7 percent of total domestic revenues in 2001 as
compared to 72.1 percent and 27.9 percent, respectively, in 2000. Hospital
branded revenues in 2001 increased by $4.5 million to $38.0 million from $33.5
million in 2000. The single most significant contributor to the increase in
hospital branded revenues was the CleanOp product line acquired from Deka
Medical. Additionally, Microtek's core hospital branded revenues demonstrated
internal growth in 2001 of greater than 10 percent. OEM revenues in 2001
increased by $17.8 million to $30.7 million from $12.9 million in 2000. The
significant contributors to the increase in OEM revenues in 2001 were sales of
the angiography drape products acquired from Deka Medical and internal growth of
greater than 10 percent.
19
Microtek's international revenues, which accounted for the remaining
12.7 percent of its 2001 net revenues, strengthened in the latter half of the
year to reach $9.9 million for the year, an increase of $4.2 million or 74.3
percent over 2000. The improvements in 2001 are attributable to international
revenues stemming from the Deka Medical acquisition and internal growth in
excess of 10 percent.
OTI's net revenues were $2.2 million in 2001, approximately $1.9
million less than 2000. Licensing revenues in 2001 were $1.5 million as compared
to $2.4 million in 2000. The reduction in OTI's net revenues in 2001 is due to
this non-cash reduction in licensing revenues in 2001 of $900,000 and lower
healthcare and automotive product sales. OTI will cease to recognize the
non-cash licensing revenues in December 2002. The declines in OTI's product
sales reflect in part the Company's increased focus on the more profitable
Microtek business and the cessation of marketing efforts with respect to OTI's
products and services in the healthcare and automotive industries. Slightly
offsetting the above noted declines were OTI's first significant revenues in the
nuclear power industry of approximately $200,000 during 2001. The Company's
commercialization efforts and relationships within the nuclear power industry
continue to strengthen with continued favorable customer response to product
usage of the OREXTM protective clothing.
Gross margins in 2001 were 40.1 percent, as compared with 36.2 percent
for 2000. The 2000 margins were negatively impacted by a $3.5 million OTI
inventory impairment charge recorded in the fourth quarter of 2000. Excluding
the impact of this impairment charge, the 2000 gross margins would have been
42.4 percent. Microtek's gross margin declined slightly from 41.9 percent in
2000 to 39.3 percent in 2001 as a result of relatively higher OEM product
revenues which have slightly lower margins than branded products, costs incurred
in the first three quarters of the year related to transitioning production from
Microtek's former plant in Mexico to its facility in the Dominican Republic, and
costs to integrate the product lines acquired from Deka Medical.
Operating expenses as a percentage of net revenues in 2001 were 35.0
percent, down from 50.8 percent in 2000. Included in operating expenses for 2000
are $1.6 million of restructuring charges recorded in 2000.
Selling, general and administrative expenses were $25.2 million or 31.1
percent of net revenues in 2001, versus $21.2 million or 37.7 percent of net
revenues for 2000. The overall increase in the absolute dollar amount of
selling, general and administrative expenses is due in part to product lines
acquired from Deka Medical and increases in variable selling costs resulting
from increased net revenues in 2001. The improvements in selling, general and
administrative expenses as a percentage of net revenues in 2001 result from
increased revenues in 2001 and cost control and expense reduction efforts,
particularly in corporate overhead expenses, begun in the fourth quarter of
2000.
Microtek's operating expenses, which include corporate administrative
expenses, as a percentage of net revenues decreased to 31.5 percent for 2001
from 39.3 percent in 2000. This improvement as a percentage of net revenues is
directly attributable to increased revenues and corporate cost reductions
implemented during 2001 and to the impact of a fourth quarter 2000 charge of
$711,000 for plant closures and severance packages. OTI's operating expenses in
2001 decreased by $4.7 million or 59.0 percent from 2000. Included in OTI's
operating expenses for 2000 was approximately $844,000 in restructuring and
impairment charges. The improvements in operating expenses result from the
impact of the 2000 restructuring and impairment charges, together with OTI's
focus during 2001 on cost reductions.
Research and development expenses were $1.6 million in 2001 as compared
to $4.1 million in 2000. Significant reductions in product development costs in
2001 have resulted in savings of $2.5 million in research and development
expenses as compared to 2000. This reduction in research and development
expenses reflects the Company's more narrow focus on new market opportunities,
for example the nuclear power industry for its OREX Degradable products.
Amortization of intangibles in 2001 was $1.5 million, a decrease of
$260,000 from amortization expenses in 2000. This decrease results from the
effect of the write-off in 2000 of intangible assets related to operations that
were disposed of which was partially offset by increased amortization in 2001
with respect to intangible assets acquired in the Deka and MICROBasixTM
acquisitions during the first quarter of 2001.
20
Income from operations for 2001 was $4.1 million, versus a loss from
operations of $8.2 million in 2000. For 2001, Microtek's operating profit in
2001 was $6.2 million, a 361.5 percent increase over the operating profit of
$1.3 million recorded in 2000. The operating losses recorded by the Company's
OTI division in 2001 were $1.8 million, which represents an 80.5 percent
improvement over the $9.4 million in operating losses recorded in 2000.
Interest expense, net of interest income, was $489,000 in 2001 as
compared to interest income, net of interest expense, of $349,000 in 2000. The
increase in net interest expense is the result of higher interest expense in
2001 and lower interest income on cash and cash equivalents which are
attributable to borrowings on the Company's line of credit facility in 2001 and
lower cash balances as a result of the 2001 acquisitions.
The Company's provision for income taxes in 2001 reflects a net income
tax benefit of approximately $1.1 million which is comprised of a $1.5 million
benefit related to the decrease in the Company's valuation allowance with
respect to certain of its deferred tax assets, principally its net operating
loss carryforwards, and the offsetting state and foreign income tax provision
for 2001 of approximately $413,000.
The resulting net income for 2001 was $4.8 million, or $0.11 per basic
and diluted share. This result reflect significant improvement over the net
losses of $12.1 million, or $.29 per basic and diluted share reported for 2000,
which included impairment and restructuring charges totaling $9.1 million.
Year Ended December 31, 2000 Compared to Year Ended December 31, 1999
Net revenues in 2000 were $56.4 million compared to $99.1 million for
1999, a decline of 43.1%. Excluding sales of businesses sold during 1999, net
revenues in 2000 decreased 6.7 percent from net revenues in 1999.
Included in 2000 revenues are $2.4 million of licensing revenues
associated with the amortization of the $10.5 million payment by Allegiance
Healthcare allocated to the Company's Supply and License Agreement with
Allegiance Healthcare. During 2000, the license fee amortization was reduced
proportionately by the settlement of indemnification claims by Allegiance and
other adjustments totaling $3.5 million, of which $2.5 million was satisfied by
the application of funds in escrow. License revenues in 1999 were $1.5 million.
Sales of Microtek products decreased 9.7 percent to $52.1 million
during 2000 as compared to $57.7 million during 1999. This decease was primarily
a result of increased sales in 1999 from a short-term manufacturing contract
arrangement with Allegiance as well as continuing reductions in purchases of
safety products by Allegiance Healthcare during 2000. Excluding the
non-recurring business with Allegiance Healthcare in 1999, Microtek sales
increased 0.8 percent from $51.7 million in 1999 to $52.1 million in 2000.
In 2000, Microtek's domestic revenues totaled $46.4 million, or 89.1
percent of Microtek's total net revenues for the year, a decrease of $4.5
million or 8.8 percent from the $50.9 million recorded in 1999. Microtek's 2000
domestic revenues were generated through two primary channels or customer
categories, hospital branded and contract manufacturing (commonly referred to as
OEM). Hospital branded revenues were 72.1 percent and OEM revenues were 27.9
percent of total domestic revenues in 2000, as compared to 63.5 percent and 36.5
percent, respectively, in 1999. Hospital branded revenues in 2000 increased by
approximately $1.2 million to $33.5 million from $32.3 million in 1999. This
increase is due primarily to the net effect of higher hospital sales and lower
safety product sales in 2000. During 2000, sales of the Company's safety
products continued to be materially adversely affected by the substantial
reduction in purchases of LTS products by Allegiance Healthcare, the largest
distributor of such products, and adverse regulatory developments related to the
change in policy by the EPA requiring registration of the new LTS-Plus product
prior to its introduction into the market. This policy change by EPA also forced
the withdrawal of all landfill approvals for conventional LTS products in
mid-1998. LTS-Plus, the new generation treatment product, has now been
registered by the EPA as a treatment for liquid medical waste and subsequent
approvals for direct landfill disposal have been issued by many states. The
Company introduced LTS-Plus into the market during the first quarter of 2001.
OEM revenues decreased by $5.7 million in 2000 to $12.9 million from $18.6
million in 1999 primarily due to the one-time manufacturing contract arrangement
with Allegiance Healthcare in 1999 described above. Microtek's acquisition of
the urology drape product line of Lingeman Medical Products in 2000 did not have
a material impact on Microtek's operating results because Lingeman Medical
Products was formerly an OEM private label customer of Microtek.
21
Microtek's international revenues, which accounted for the remaining
10.9 percent of its 2000 net revenues, totaled $5.7 million, as compared to $6.8
million or 11.8 percent of its 1999 net revenues. The decline in international
revenues in 2000 is attributable to weakening market conditions, a change in
international sales channels and increased competitive and pricing pressures
abroad which adversely impacted Microtek's net revenues.
OTI's net revenues totaled $4.0 million in 2000 as compared to $2.7
million in 1999, an increase of 50.9 percent. Excluding license revenues, OTI's
net revenues in 2000 and 1999 were $1.6 million and $1.2 million, respectively,
an increase of 36.6 percent. Sales of OREX Degradables in 2000 did not
contribute any gross profit to the Company's operating results.
Gross profit in 2000 was $20.4 million or 36.2 percent of net revenues
compared to $37.1 million or 37.4 percent of net revenues in 1999. Excluding
gross profits from the amortization of licensing revenues, gross margin was 33.4
percent in 2000 as compared to 36.5 percent in 1999. Included in cost of goods
sold in 2000 was a charge of $3.5 million related to increased reserves for
excess and obsolete OREX inventories, with no similar expense in 1999.
Microtek's gross margins declined from 46.0 percent in 1999 to 41.9 percent in
2000. This decline was primarily attributable to reduced efficiencies resulting
from the termination of a short-term manufacturing contract arrangement with
Allegiance Healthcare in 1999.
Operating expenses as a percentage of net revenues in 2000 were 50.8
percent as compared to 32.2 percent in 1999. The Company recorded operating
expense restructuring charges during 2000 of $1.6 million compared to $769,000
of impairment charges in 1999. Included in the 2000 charges were severance
payments to former officers and employees, write-offs related to consulting
arrangements, write-off of lease payments for closed offices and the impairment
of equipment. The 1999 impairment charges were attributed to the disposition of
the Company's interests in its White Knight subsidiary of $1.6 million partially
offset by a $821,000 adjustment of a previous impairment charge associated with
the 1998 sale of its White Knight industrial business.
Selling, general and administrative expenses were $21.2 million or 37.7
percent of net sales in 2000 as compared to $26.6 million or 26.8% of net sales
in 1999. The decrease in the absolute dollar amount of selling, general and
administrative expenses is due to operations sold during 1999, partially offset
by a $3.2 million increase in these expenses incurred with respect to the
Company's continuing operations. Expense categories with significant increases
included legal, audit and tax services, consulting and investor relations.
Additionally, the Company incurred higher distribution freight expense due to
rising fuel costs.
Microtek's operating expenses, which include corporate administrative
expenses, totaled $20.5 million, or 39.3 percent of Microtek's net revenues in
2000, as compared to $16.5 million in 1999, or 30.1 percent of Microtek's net
revenues. The increases in the absolute dollar amount of operating expenses and
in operating expenses as a percentage of net revenues are attributable to higher
corporate administrative costs in 2000, the fourth quarter 2000 charge of
$711,000 related to plant closures and severance packages and lower net revenues
in 2000. OTI's operating expenses in 2000 totaled $8.0 million, a $3.0 million
increase over the $5.0 million recorded in 1999. The increase in 2000 was
comprised of $1.3 million in additional selling, general and administrative
costs, $609,000 in additional amortization of intangibles related to operations
that were disposed of, and $330,000 in additional research and development
costs. Also included in the 2000 amount were restructuring and impairment
charges of $844,000.
Research and development expenses were $4.1 million in 2000 as compared
to $3.7 million in 1999. Included in the increased research and development
expenditures were costs for accelerated development of manufacturing fabrication
technologies for the Company's line of Enviroguard products for healthcare. The
Company also experienced unplanned expenditures for the design and development
of its OREX processing units following the default of a vendor for the
fabrication of such units.
Amortization of intangibles was $1.8 million or 3.2 percent of net
sales in 2000. This compares to $1.4 million or 1.5 percent of net sales in
1999. The increase in 2000 is primarily due to the write-off of intangibles that
related to operations that were disposed of.
Loss from operations in 2000 of $8.2 million compares with income from
operations in 1999 of $5.2 million. Without the restructuring charges and
provision for excess and obsolete OREX inventories described above, the Company
would have reported a loss from operations in 2000 of $3.2 million.
22
Interest income, net of interest expense, in 2000 was $349,000 as
compared to net interest expense of $1.2 million in 1999. The decline in net
interest expense was primarily attributable to the elimination of the Company's
outstanding balance in its revolver and term loan facility from proceeds of
divestitures coupled with higher interest income on the Company's cash and cash
equivalents.
During 2000, the Company decided to discontinue additional investment
in Thantex Specialties and concluded that the recovery of the investment was
unlikely. Accordingly, the investment was written off in 2000. The write-off of
this investment amounted to $4.1 million, which included a $500,000 note
receivable from Thantex.
The Company's provision for income taxes was $155,000 for 2000 compared
to $1.3 million in 1999. Due to the Company's federal net operating loss
carryforwards, the Company's 2000 income tax provision is comprised primarily of
state and foreign income taxes.
The resulting net loss for 2000 was $12.1 million, or $0.29 per basic
and diluted share as compared to net income of $2.7 million, or $.07 per basic
and diluted share, in 1999.
Liquidity and Capital Resources
As of December 31, 2001, the Company's cash and cash equivalents
totaled $10.6 million compared to $14.4 million at December 31, 2000.
During 2001, the Company utilized cash to finance the purchase of the
drape and CleanOp product lines from Deka Medical and certain OREXTM processing
equipment and related technology from MICROBasix LLC, to purchase other property
and equipment, to make scheduled debt repayments related to previous
acquisitions of businesses, to make payments under equipment and capital leases,
and to fund working capital requirements. For 2001, net cash used in operating
activities was $2.5 million; net cash used in investing activities was $13.4
million and net cash provided by financing activities was $12.1 million. The
$2.5 million used in operating activities in 2001 results principally from the
Company's significant increases in inventories and accounts receivable resulting
from increased sales and the Deka Medical transaction. Also contributing to the
use of cash in operating activities in 2001 were the decreases in accounts
payable and the increases in prepaid expenses and other assets, which were
partially offset by increases in accrued compensation and other liabilities.
During 2001, cash used in investing activities included acquisition costs of
$11.6 million for the drape and CleanOp product lines from Deka Medical and
$675,000 for certain OREXTM processing equipment and related technology from
MICROBasix LLC. Also during 2001, the Company invested $1.1 million in capital
property and equipment, an amount comparable to the $1.1 million expended in
2000. The 2001 expenditures were primarily associated with the Company's
expanded manufacturing operations in the Dominican Republic following the Deka
Medical acquisition and investments to improve the Company's internal management
information systems. During 2000, the Company purchased a portion of the assets
of Lingeman Medical Products, Inc. for $1.8 million, consisting of $1.1 million
in cash and a $675,000 note, and invested $249,000 in Consolidated EcoProgress
and $44,000 in Global Resources, Inc. Cash provided by financing activities in
2001 was $12.1 million as compared to cash used in financing activities of $1.3
million in 2000. In 2001, borrowings under the Company's credit agreement
provided $12.4 million, and proceeds from the exercise of stock options provided
$820,000. Repayments of notes payable in 2001 totaled $778,000, and the Company
repurchased 213,500 shares of common stock in 2001 for an aggregate amount of
$343,000. In 2000, the Company repaid notes payable totaling $3.1 million,
repurchased 496,000 shares of common stock for an aggregate of $898,000, and
generated $2.0 million in proceeds from the exercise of stock options.
The Company maintains a credit agreement (as amended to date, the
"Credit Agreement") with The Chase Manhattan Bank (the "Bank"), consisting of a
$17.5 million revolving credit facility, maturing on June 30, 2004. Borrowing
availability under the revolving credit facility is based on the lesser of (i) a
percentage of eligible accounts receivable and inventory or (ii) $17.5 million,
less any outstanding letters of credit issued under the Credit Agreement.
Current borrowing availability under the revolving facility at December 31, 2001
was $1.9 million. Revolving credit borrowings bear interest, at the Company's
option, at either a floating rate approximating the Bank's prime rate plus an
interest margin (5.25% at December 31, 2001) or LIBOR plus an interest margin
(4.16% at December 31, 2001). There was $12.4 million of outstanding borrowings
under the revolving credit facility at December 31, 2001, and no outstanding
borrowings under the revolving credit facility at December 31, 2000. On March
15, 2002, outstanding borrowings under the revolving credit facility were $9.7
million and borrowing
23
availability was $4.4 million. The Credit Agreement provides for the issuance of
up to $1.0 million in letters of credit. There were no outstanding letters of
credit at December 31, 2001 or 2000. The Credit Agreement provides for a fee of
0.375% per annum on the unused commitment, an annual collateral monitoring fee
of $35,000, and an outstanding letter of credit fee of 2.0% per annum.
Borrowings under the Credit Agreement are collateralized by the Company's
accounts receivable, inventory, equipment, Isolyser's stock of its subsidiaries
and certain of the Company's plants and offices. The Credit Agreement contains
certain restrictive covenants, including the maintenance of certain financial
ratios and earnings, and limitations on acquisitions, dispositions, capital
expenditures and additional indebtedness. The Company also is not permitted to
pay any dividends. At December 31, 2001, the Company was in compliance with all
of its financial covenants under the Credit Agreement.
The Company has entered into a contract requiring that it purchase
certain minimum quantities of PVA fiber at a fixed price over a four year period
expiring in August 2002. The Company prepaid its remaining purchase obligation
under this contract is at a discounted amount in first quarter 2002.
During 2001, the Company had adequate cash and cash equivalents to fund
its working capital requirements. If such requirements increase in the future,
the Company anticipates seeking an increase to its revolving line of credit to
the extent such requirements are not otherwise satisfied out of available cash
flow or borrowings under the Company's existing line of credit. There can be no
assurances that such an increase to the Company's revolving credit facility will
be available to the Company.
Based on its current business plan, the Company currently expects that
cash equivalents and short term investments on hand, the Company's existing
credit facility and funds budgeted to be generated from operations will be
adequate to meet its liquidity and capital requirements through 2002. However,
currently unforeseen future developments and increased working capital
requirements may require additional debt financing or issuances of common stock
in 2002 and subsequent years.
Inflation and Foreign Currency Translation. Inflation has not had a
material effect on the Company's operations. If inflation increases, the Company
will attempt to increase its prices to offset its increased expenses. No
assurance can be given, however, that the Company will be able to adequately
increase its prices in response to inflation.
The assets and liabilities of the Company's United Kingdom subsidiary
are translated into U.S. dollars at current exchange rates and revenues and
expenses are translated at average exchange rates. The effect of foreign
currency transactions was not material to the Company's results of operations
for the year ended December 31, 2001. Export sales by the Company during 2001
were $9.9 million. Currency translations on export sales could be adversely
affected in the future by the relationship of the U.S. Dollar with foreign
currencies. In the future, the Company may import significant amounts of
products from foreign manufacturers, exposing the Company to risks on
fluctuations in currency exchange rates.
Critical Accounting Policies.
While the listing below is not inclusive of all of the Company's
accounting policies, the Company's management believes that the following
policies are those which are most critical and embody the most significant
management judgments and the uncertainties affecting their application and the
likelihood that materially different amounts would be reported under different
conditions or using different assumptions. These critical policies are:
Revenue Recognition. The Company's revenues are derived from the
sale of its products and are recognized at the time of shipment (i) when
persuasive evidence of a sale arrangement exists, (ii) delivery has occurred,
(iii) the price is fixed and determinable, and (iv) collectibility of the
associated receivable is reasonably assured. As discussed below, significant
management judgments and estimates must be made and used in connection with the
revenue recognized in any accounting period. Material differences may result in
the amount and timing of the Company's revenues for any period if management
made different judgments or utilized different estimates.
All sales of the Company's products are evidenced by a binding
purchase order as evidence of a sale arrangement. Sales through the Company's
distributors are evidenced by a master agreement which governs the
24
relationship together with a binding purchase order on a transaction by
transaction basis. Delivery generally occurs when the Company's products are
delivered to a common carrier.
At the time of a sale transaction, the Company assesses whether the
related sales price is fixed and determinable based on the payment terms
associated with the transaction. Sales prices due within the Company's normal
payment terms, which are 30 to 60 days from the invoice date for its domestic
customers and 90 to 120 days from the invoice date for international customers,
are considered fixed and determinable. The Company does not generally extend
payment terms outside its normal guidelines. The Company also assesses whether
collection is reasonably assured at the time of the sale transaction based on a
number of factors, including past transaction history with the customer and the
credit-worthiness of the customer.
Sales Returns and Other Allowances and Allowance for Doubtful
Accounts. The preparation of financial statements requires management to make
estimates and assumptions that affect the reported amount of assets and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Specifically, management must make estimates of potential
future product returns related to current period product revenues. The Company's
sales arrangements do not generally include acceptance provisions or clauses.
Additionally, the Company does not typically grant its distributors or other
customers price protection rights or rights to return products bought, other
than normal and customary rights of return for defects in materials or
workmanship, and is not obligated to accept product returns for any other
reason. Actual returns have not historically been significant. Management
analyzes historical returns, current economic trends and changes in customer
demand when evaluating the adequacy of its sales returns and other allowances.
Similarly, the Company's management must make estimates of the
uncollectibility of its accounts receivables. Management specifically analyzes
accounts receivable, historical bad debts, customer concentrations, customer
credit worthiness, current economic trends and changes in its customers' payment
terms when evaluating the adequacy of its allowance for doubtful accounts. The
Company's accounts receivables at December 31, 2001 totaled $16.1 million, net
of the allowance for doubtful accounts of $894,000.
Inventory Valuation. The preparation of the Company's financial
statements requires careful determination of the appropriate dollar amount of
the Company's inventory balances. Such amount is presented as a current asset in
the Company's balance sheet and is a direct determinant of cost of goods sold in
the statement of operations and therefore has a significant impact on the amount
of net income reported in an accounting period. The basis of accounting for
inventories is cost, which is the sum of expenditures and charges, both direct
and indirect, incurred to bring the inventory quantities to their existing
condition and location. The Company's inventories are stated at the lower of
cost or market, with cost determined using the first-in, first-out ("FIFO")
method, which assumes that inventory quantities are sold in the order in which
they are manufactured or purchased. The Company utilizes standard costs as a
management tool. The Company's standard cost valuation of its inventories is
adjusted at regular intervals to reflect the approximate cost of the inventory
under FIFO. The determination of the indirect charges and their allocation to
the Company's work-in-process and finished goods inventories is complex and
requires significant management judgment and estimates. Material differences may
result in the valuation of the Company's inventories and in the amount and
timing of the Company's cost of goods sold and resulting net income for any
period if management made different judgments or utilized different estimates.
On a periodic basis, management reviews its inventory quantities on
hand for obsolescence, physical deterioration, changes in price levels and the
existence of quantities on hand which may not reasonably be expected to be used
or sold within the normal operating cycles of the Company's operations. To the
extent that any of these conditions are believed to exist or the utility of the
inventory quantities in the ordinary course of business is no longer as great as
their carrying value, a reserve against the inventory valuation is established.
To the extent that this reserve is established or increased during an accounting
period, an expense is recorded in the Company's statement of operations,
generally in cost of good sold. Significant management judgment is required in
determining the amount and adequacy of this reserve. In the event that actual
results differ from management's estimates or these estimates and judgments are
revised in future periods, the Company may need to establish additional reserves
which could materially impact the Company's financial position and results of
operation.
As of December 31, 2001, the Company's inventories totaled $27.0
million, net o