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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 [FEE REQUIRED]
For the fiscal year ended DECEMBER 31, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
For the transition period from to
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Commission file number 0-6906
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MEDICORE, INC.
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(Exact name of registrant as specified in its charter)
FLORIDA 59-0941551
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
2337 WEST 76TH STREET, HIALEAH, FLORIDA 33016
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (305) 558-4000
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Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
Title of each class
Common Stock, $.01 par value
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. [ X ]
The aggregate market value of the voting stock held by non-affiliates
of the registrant based upon the closing price of the common stock on March 12,
1999 was approximately $6,225,000.
As of March 12, 1999 the Company had outstanding 5,715,540 shares of
common stock.
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DOCUMENTS INCORPORATED BY REFERENCE
Part III incorporates information by reference from the Proxy Statement
in connection with the Registrant's Annual Meeting of Shareholders to be held on
June 9, 1999.
Registrant's Annual Reports, Forms 10-K, for the years ended December
31, 1994, 1995 and 1997, Part IV, Exhibits.
Annual Reports for Registrant's Subsidiary, Techdyne, Inc., Forms 10-K
for the years ended December 31, 1991, 1995 and 1997, Part IV, Exhibits.
Registration Statement of Registrant's Subsidiary, Techdyne, Inc., Form
SB-2, effective September 13, 1995, Registration No. 33-94998-A, Part II, Item
27, Exhibits.
Registration Statement of Registrant's Subsidiary, Techdyne, Inc., Form
S-3, Effective December 11, 1996, Registration No. 333-15371, Part II, Item 16,
Exhibits.
Annual Report for Registrant's Subsidiary Dialysis Corporation of
America, Form 10-K for the years ended December 31, 1996, 1997 and 1998, Part
IV, Exhibits.
Registration Statement of Registrant's Subsidiary, Dialysis Corporation
of America, Form SB-2, effective April 17, 1996, Registration No. 333-80877A,
Part II, Item 27, Exhibits.
MEDICORE, INC.
INDEX TO ANNUAL REPORT ON FORM 10-K
YEAR ENDED DECEMBER 31, 1998
Page
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PART I
Item 1. Business.............................................. 1
Item 2. Properties............................................ 19
Item 3. Legal Proceedings..................................... 21
Item 4. Submission of Matters to a Vote of Security Holders... 21
PART II
Item 5. Market for the Registrant's Common Equity
and Related Stockholder Matters....................... 21
Item 6. Selected Financial Data............................... 22
Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operations......... 22
Item 7A. Quantitative and Qualitative Disclosures About
Market Risk........................................... 35
Item 8. Financial Statements and Supplementary Data........... 35
Item 9. Changes in and Disagreements with Accountants
on Accounting and Financial Disclosure................ 35
PART III
Item 10. Directors and Executive Officers of the
Registrant............................................ 36
Item 11. Executive Compensation................................ 36
Item 12. Security Ownership of Certain
Beneficial Owners and Management...................... 36
Item 13. Certain Relationships and Related Transactions........ 37
PART IV
Item 14. Exhibits, Financial Statement Schedules,
and Reports on Form 8-K............................... 38
PART I
CAUTIONARY NOTICE REGARDING FORWARD-LOOKING INFORMATION
The statements contained in this Annual Report on Form 10-K that are
not historical are forward-looking statements within the meaning of Section 27A
of the Securities Act of 1933 ("Securities Act") and Section 21E of the
Securities Exchange Act of the 1934. The Private Securities Litigation Reform
Act of 1995 (the "Reform Act") contains certain safe harbors regarding
forward-looking statements. Certain of the forward-looking statements include
management's expectations, intuitions and beliefs with respect to the growth of
the Company, the nature of the electronics industry in which its 62% owned
public subsidiary, Techdyne, Inc. ("Techdyne") is involved as a manufacturer,
the nature of and future development of the dialysis industry in which its 68%
owned public subsidiary, Dialysis Corporation of America ("DCA"), is engaged,
the Company's business strategies and plans for future operations, its needs for
capital expenditures, capital resources, liquidity and operating results, and
similar matters that are not historical facts. See Item 7, "Management's
Discussion and Analysis of Financial Condition and Results of Operations." Such
forward-looking statements are subject to substantial risks and uncertainties
that could cause actual results to materially differ from those expressed in the
statements, including general economic and business conditions, opportunities
pursued or abandoned, competition, changes in federal and state laws or
regulations affecting the Company and its operations, and other factors
discussed periodically in the Company's filings. Many of the foregoing factors
are beyond the control of the Company. Among the factors that could cause actual
results to differ materially are the factors detailed in the risks discussed in
the "Risk Factors" section included in the Company's Registration Statement,
Form S-3, as filed with the Securities and Exchange Commission ("Commission")
(effective May 15, 1997) and the Registration Statements of the Company's
subsidiaries, Techdyne's Registration Statements as filed with the Commission,
Form SB-2 (effective September 13, 1995) and Forms S-3 (effective November 11,
1996 and November 4, 1997, respectively), and DCA's Registration Statement, Form
SB-2, as filed with the Commission (effective on April 17, 1996). Accordingly,
readers are cautioned not to place undue reliance on such forward-looking
statements which speak only as of the date made and which the Company undertakes
no obligation to revise to reflect events after the date made.
ITEM 1. BUSINESS
GENERAL
Medicore, Inc., incorporated in Florida in 1961, has three business
segments. One is the medical product division which distributes medical
supplies. This division recently initiated its own production of lancets. A
second business segment is the international contract manufacturing of
electronic and electro-mechanical products, primarily for the data processing,
telecommunications, instrumentation and food preparation equipment industries.
This is accomplished through Medicore, Inc.'s 62% owned public subsidiary,
Techdyne, Inc. ("Techdyne"). Techdyne's wholly-owned subsidiaries include Lytton
Incorporated ("Lytton") acquired in July 1997, Techdyne (Scotland) Limited
("Techdyne (Scotland)") and Techdyne Livingston Limited, a subsidiary of
Techdyne (Scotland). The third business segment involves the operation of kidney
dialysis centers through its 68% owned public subsidiary Dialysis Corporation of
America ("DCA"). See Note 6 to "Notes to Consolidated Financial Statements."
Medicore and its subsidiaries are collectively hereinafter referred to
as "Medicore" or the "Company."
The Company's executive offices are located at 2337 West 76th Street,
Hialeah, Florida 33016 and at 777 Terrace Avenue, Hasbrouck Heights, New Jersey
07604. Its telephone number in Florida is (305) 558-4000 and in New Jersey is
(201) 288-8220.
MEDICAL PRODUCTS
The Company develops and distributes medical supplies, primarily
disposables, both domestically and internationally, to hospitals, blood banks,
laboratories and retail pharmacies. Products distributed include exam gloves,
prepackaged swabs and bandages and glass tubing products for laboratories. The
Company additionally distributes a line of blood lancets used to draw blood for
testing. Developed by the Company and previously manufactured by Techdyne, which
lancet manufacturing has recently been taken over by Medicore, the lancets are
distributed under the names Medi-Lance(TM) and Lady Lite(TM) or under a private
label if requested by the customer. Marketing of medical products is conducted
by independent manufacturer representatives and employees of the Company.
ELECTRONIC MANUFACTURING INDUSTRY
Techdyne is an international contract manufacturer of electronic and
electro-mechanical products, primarily manufactured to customer specifications
and designed for original equipment manufacturers ("OEMs") and distributors in
the data processing, telecommunications, instrumentation and food preparation
equipment industries. Included among its customers are several Fortune 500
companies. Approximately 89% of sales are domestic and 11% are effected by
Techdyne's Scottish subsidiary, Techdyne (Scotland) in the European markets and
to a limited extent in the Middle East.
Custom-designed products that the Company produces through Techdyne
primarily include complex printed circuit boards ("PCBs"), conventional and
molded cables and wire harnesses, and electro-mechanical assemblies. Techdyne
also provides OEMs with value-added, turnkey contract manufacturing services and
total systems assembly and integration, and delivers manufacturing and test
engineering services and materials management, with flexible and
service-oriented manufacturing and assembly services for its customers'
high-tech and rapidly changing products.
The Company believes that many OEMs view contract manufacturers as an
integral part of their manufacturing strategy. Outsourcing their manufacturing
of electronic assemblies enables OEMs to focus on product development, reduce
working capital requirements, improve inventory management and marketability.
OEMs are looking more to contract manufacturers, like Techdyne, to provide a
broader scope of value-added services, including manufacturing, engineering and
test services. OEMs rely on contract manufacturers for partial component
assemblies and complete turnkey manufacturing of entire finished products.
Another factor which leads OEMs to utilize contract manufacturers is reduced
time-to-market using the contract manufacturer's expertise and advanced and
automated manufacturing processes.
TECHDYNE'S BUSINESS STRATEGY
In recent years, the electronic contract manufacturing industry has
exhibited substantial growth. The Company believes this growth has resulted from
a vastly increased number of OEMs adopting an external manufacturing philosophy
coupled with the overall growth of the electronics industry. This philosophy is
motivated by the increased capital necessary to acquire modern, highly automated
manufacturing equipment for the OEMs to access leading manufacturing
technologies and capabilities,
2
to reduce inventory, and to realize the cost benefits of the improved purchasing
power, labor efficiency and overall cost benefits of contract manufacturers. In
response to these industry trends, the Company's objective is to become a
stronger competitive force and provider of electronic contract manufacturing
services for OEM customers, particularly in view of constantly changing and
improving technology and therefore, shorter product life cycles. Techdyne will
continue to seek to develop strong, long-term alliances with major-growth OEMs
of complex, market leading products. The Company believes that creating and
maintaining long-term relationships with customers requires providing high
quality, cost-effective manufacturing services marked by a high degree of
customer responsiveness and flexibility. The Company intends to maintain its
high quality of service through expansion of Techdyne's vertically integrated
manufacturing capabilities, final system assemblies and testing.
Management also believes it develops closer and more economically
beneficial relationships with its customers through its geographically diverse
manufacturing and assembly operations, presently located in Florida, Texas,
Massachusetts, Ohio and Scotland. Techdyne's diverse locations help reduce costs
and ensure timely delivery to its customers. Management continues to pursue
expansion in different markets to better serve existing customers and obtain
additional new customers. Techdyne's acquisition of Lytton in 1997 provided the
Company with a new geographic and end user market and continues to complement
Techdyne's operations and further its business strategy by expanding its
customer base, broadening its product line, entering new geographic areas, and
enhancing its manufacturing capabilities.
More emphasis is placed on value-added turnkey business for the
manufacture of complete finished assemblies. This is accomplished with extended
technology, continuous improvement of its processes, and Techdyne's early
involvement in the design process using its computer-aided design ("CAD")
system.
Techdyne is improving its material acquisition process in an attempt to
better its purchasing power by identifying materials used across customer lines
through installation of a new software program. See "Supplies and Material
Management" and Item 7, "Management's Discussion and Analysis of Financial
Condition and Results of Operations." Management is also attempting to
consolidate vendors to achieve better purchasing power. Techdyne believes these
efforts will provide it with better leverage in material pricing, and permit
Techdyne to be more competitive when bidding for manufacturing work and turnkey
business by allowing it to track actual costs against customer quotes, thereby
enabling it to reduce costs and more accurately manage operating margins.
PRODUCTS AND SERVICES
Approximately 850 products, including complete turnkey finished
products, sub-assemblies, molded and non-molded cable assemblies, wire
harnesses, PCBs, injection molded and electronic assembly products, are
manufactured by Techdyne for over 100 OEM customers.
PRINTED CIRCUIT BOARDS
PCB assemblies are electronic assemblies consisting of a basic printed
circuit laminate with electronic components including diodes, resistors,
capacitors and transistors, inserted and wave soldered. PCBs may be used either
internally within the customer's products or in peripheral devices. The variety
of PCBs produced by Techdyne include pin-through-hole ("PTH") assemblies, low
and medium volume surface mount technology ("SMT") assemblies, and mixed
technology PCBs, which include multilayer PCBs.
3
PTH assembly involves inserting electronic components with pins or
leads through pre-drilled holes in a PCB and soldering the pins to the
electrical circuit.
In SMT production, electronic components are attached and soldered
directly onto the surface of a circuit board rather than inserted through holes.
SMT components are smaller, can be spaced more closely together and, unlike PTH
components, can be placed on both sides of a PCB. This allows for product
miniaturization, while enhancing the electronic properties of the circuit. SMT
manufacturing requires substantial capital investment in expensive, automated
production equipment which requires high usage. Techdyne has computerized
testing for substantially all of its PCBs to verify that components have been
installed properly and meet certain functional standards, that the electrical
circuits have been properly completed, and that the PCB assembly will perform
its intended functions.
Techdyne also produces multilayer PCBs, which consist of three or more
layers of a PCB laminated together and interconnected by plated-through holes
with metallic interconnecting paths on a non-conductive material, typically
laminated epoxy glass. Holes drilled in the laminate and plated through with
conductive material from one surface to another, called plated-through holes,
are used to receive component leads and to interconnect the circuit layers.
Multilayer boards increase packaging density, improve power and ground
distribution, and permit the use of higher speed circuitry. The development of
electronic components with increased speed, higher performance and smaller size
has stimulated a demand for multilayer PCBs, as they provide increased
reliability, density and complexity.
Fiscal 1996 reflected sales revenues of approximately 8% derived from
PCBs. However, 1997 expansions, particularly the acquisition of Lytton, have
resulted in PCB manufacturing yielding approximately 48% of Techdyne's 1998
sales revenues.
CABLE AND HARNESS ASSEMBLIES
A cable is an assembly of electrical conductors insulated from each
other and twisted around a central core and jacketed. Cables may be molded or
non-molded.
Techdyne offers a wide range of custom manufactured cable and harness
assemblies for molded and mechanical applications. These assemblies include
multiconductor, ribbon, co-axial cable assemblies, and discrete wire harness
assemblies. Techdyne uses advanced automated and semi-automated manufacturing
processes, in-line inspection and computer testing.
Techdyne maintains a large assortment of standard tooling for
D-Subminiature ("D-Subs"), DIN connectors and phono connectors. D-Subs are
connectors which are over-molded with the imprint of the customer's name and
part number. DIN connectors are circular connectors with from two to four pairs
of wires used for computer keyboards. Today's computers are multi-media,
providing audio as well as video, such as the CD-ROM.
Flat ribbon cable or ribbon cable assemblies are cables with wires
(conductors) on the same plane with connectors at each end. Flat ribbon cables
are used in computer assemblies and instrumentation.
Discrete cable assemblies are wires with contacts and connectors.
Harnesses are prefabricated wiring with insulation and terminals ready to be
attached to connectors. The cable sales of Techdyne comprised approximately 42%
of its total sales revenue for 1998.
4
CONTRACT MANUFACTURING
Contract manufacturing involves the manufacture of complete finished
assemblies with all sheet metal, power supplies, fans, PCBs as well as complete
sub-assemblies for integration into an OEM's finished products, such as speaker
and lock-key assemblies and diode assemblies that consist of wire, connectors
and diodes that are over-molded, packaged and bar coded for distribution. These
products can be totally designed and manufactured by the Company through its CAD
system, engineering and supply procurement. Techdyne develops manufacturing
processes and tooling and test sequences for new products of its customers. It
also provides design and engineering services in the early stages of product
development thereby assuring mechanical and electrical considerations are
integrated with a total system. Alternatively, the customer may provide
specifications and the Company will assist in the design and engineering or
manufacture to the customer's specifications. Contract manufacturing products
include rack assemblies for data processing and video editing and custom disk
drive enclosures for OEMs.
REWORKING AND REFURBISHING
Customers provide Techdyne with materials and sub-assemblies acquired
from other sources which the customer has determined requires modified design or
engineering changes. Techdyne redesigns, reworks, refurbishes and repairs these
materials and sub-assemblies.
Contract manufacturing, medical product sales, reworking and
refurbishing together amounted to approximately 10% of sales of Techdyne for
1998. Management believes that PCB sales and contract manufacturing will provide
Techdyne with substantial increases in revenues in the next few years.
MANUFACTURING
Components and products are custom designed and developed to fit
specific customer requirements and specifications. Techdyne attempts to develop
a "partnership" relationship with many of its customers by providing a
responsive, flexible, total manufacturing service. Such service includes
computer integrated manufacturing and engineering services, quick-turnaround
manufacturing and prototype development, materials procurement, quality
assurance, inventory management, development of special manufacturing processes
and acquisition of special equipment for that particular customer and its needs,
tooling and test sequences for new products from product designs received from
its customers or developed by Techdyne from customer requirements. The Company's
industrial, electrical and mechanical engineers work in close liaison with its
customers' engineering departments from inception through design, prototypes,
production and packaging. Upon completion of engineering, a prototype or
preproduction samples are produced. Materials procurement includes planning,
purchasing and warehousing electronic components and materials used in the
assemblies and finished products.
Techdyne's PCB assembly operations are geared toward advanced SMT.
Lytton provides Techdyne with increased PCB production through state-of-the-art
manufacturing equipment and processes and a highly trained and experienced
engineering and manufacturing workforce. The manufacturing of PCBs involves
several steps including the attachment of various electronic components, such as
integrated circuits, capacitors, microprocessors and resistors.
Techdyne also offers a wide range of custom manufactured cables and
harnesses for molded and mechanical applications. The Company uses advanced
manufacturing processes, in-line inspection and testing to focus on process
efficiencies and quality. The cable and harness assembly process is accomplished
with automated and semi-automated preparation and insertion equipment and manual
5
assembly techniques. Techdyne maintains a large assortment of standard tooling
and modern state-of-the-art equipment at all of its facilities for crimping,
stripping, terminating, soldering, sonic welding and sonic cleaning which
permits it to produce conventional and complex molded cables.
In addition to assembly operations in the last few years, Techdyne has
become more involved in contract manufacturing of moderate to high volume
turnkey assemblies and sub-assemblies, including injection molded and electronic
assembly products.
The Scottish manufacturing facility, located in Livingston, Scotland,
focuses mainly on the electronics industry producing primarily wire harnesses,
electro-mechanical assemblies, and molded cables, incorporating multifaceted
design and production capabilities.
SUPPLIES AND MATERIALS MANAGEMENT
Materials used in Techdyne's operations consist of metals, electronic
components such as cable, wire, resistors, capacitors, diodes, PCBs and plastic
resins. These materials are readily available from a large number of suppliers
and manufacturers, and Techdyne has not experienced any significant disruptions
from shortages of materials or delivery delays of its suppliers and believes
that its present sources and the availability of its required materials are
adequate. Techdyne utilizes a computerized system of material requirements
planning, purchasing, sales and marketing functions, which is being updated
through the installation of the Visual Manufacturing software in all of its
facilities, most of which has been accomplished, and is expected to be
completely integrated in its Ohio and Scottish facilities by June 30, 1999. This
new software not only has improved its material acquisition process but is also
Year 2000 compliant. See Item 7, "Management's Discussion and Analysis of
Financial Condition and Results of Operations."
Techdyne procures components from a select group of vendors which meet
its standards for timely delivery, high quality and cost effectiveness, and
orders supplies generally when it has a purchase order or commitment from its
customer for the completed assembly. Techdyne's inventory management allows its
customers to increase or decrease volume requirements within established
frameworks and results in reduced obsolescence problems, which in turn improves
overall efficiency. See Item 7, "Management's Discussion and Analysis of
Financial Condition and Results of Operations."
QUALITY AND PROCESS CONTROL
Quality control is essential to Techdyne's operations since low-cost
and high quality production are primary competitive standards and are vital to
the services of the Company. See "Competition" below. In March, 1995 for its
Hialeah, Florida facility Techdyne received from Underwriter's Laboratories, an
independent quality assurance organization, the ISO 9002 quality assurance
designation, which is the international standard of quality with respect to all
systems of operations, including, among others, purchasing, engineering,
manufacturing, sales, inventory control and quality. Techdyne (Scotland)
received its BS 5750 quality assurance designation in 1991 from British
Standards Institute. Lytton received its ISO 9002 quality designation in 1995
from Eagle Registrations, Inc. Product components, assemblies and sub-assemblies
manufactured by Techdyne are thoroughly inspected visually and electronically to
assure all components are made to strict specifications and are functional and
safe. These quality assurance designations are only provided to those
manufacturers which exhibit stringent quality and process control assurances
after extensive evaluation and auditing by these independent quality assurance
organizations.
6
Strict process controls are also standard operating procedure. Process
controls deal with the controls relating to the entire manufacturing process.
Techdyne strives for a CPK of two, i.e., twice as critical as customer
tolerances. During the course of initial qualification and production cycles,
new and existing customers inspect Techdyne and its operations. Over the years
Techdyne's product and manufacturing quality has received excellent ratings.
Management believes it is one of the manufacturers of choice for the major
Fortune 500 companies, certain of which are its customers, based upon its
excellent record of quality production.
Total quality, timely delivery and customer satisfaction is
management's philosophy. High levels of quality in every area of Techdyne's
operations are essential. Quality standards are established for each operation,
performance tracked against those standards, and identifying work flow and
implementing necessary changes to deliver higher quality levels. Techdyne
maintains regular contact with its customers to assure adequate information
exchange and other activities necessary to assure customer satisfaction and to
support its high level of quality and on-time delivery.
CUSTOMERS
Techdyne serves a wide range of businesses from emerging growth
companies to multinational OEMs involved in a variety of markets including
computer networking systems, computer workstations, telecommunications, mass
data storage systems, instrumentation and food preparation equipment industries.
Techdyne's revenue was distributed over the following industry segments:
Year Ended December 31,
--------------------------------------------
1998 1997 1996
-------- -------- --------
Data processing 29% 40% 74%
Telecommunications 20% 7% 9%
Instrumentation 17% 16% 8%
Food preparation equipment (1) 18% 19% --%
(1) Accomplished through Lytton, a Techdyne subsidiary acquired in July, 1997.
The Company seeks to serve a sufficiently large number of customers to
avoid dependence on any one customer or industry. Nevertheless, historically a
substantial percentage of Techdyne's net sales have been to multiple locations
of a small number of customers. Significant reductions or delays in sales to any
of those major customers would have a material adverse effect on the Company's
results of operations. In the past, certain customers have terminated their
manufacturing relationship with Techdyne, or otherwise significantly reduced
their product orders. There can be no insurance that any major customer may not
terminate or otherwise significantly reduce or delay manufacturing orders, any
of which such terminations or changes in manufacturing orders could have a
material adverse effect on the Company's results of operations.
Techdyne and consequently the Company are dependent upon the continued
growth, viability and financial stability of Techdyne's customers, which are in
turn substantially dependent on the growth of the personal computer, computer
peripherals, the communications, instrumentation, data processing and food
preparation equipment industries. Most of these industries have been
characterized by rapid technological change, short product life cycles, pricing
and margin pressures. In addition, many of Techdyne's customers in these
industries are affected by general economic conditions. The factors affecting
these industries in general, and/or the Company's customers in particular, could
have a material adverse effect on the Company's results of operations.
7
Techdyne also generates significant accounts receivable in connection
with providing manufacturing services to its customers. If one or more of its
customers were to become insolvent or otherwise were unable to pay for the
manufacturing services provided by Techdyne, the Company's operating results and
financial condition would be adversely affected.
In 1998, 50% of Techdyne's sales were made to numerous locations of
five major customers. The table below sets forth the respective portion of net
sales for the applicable period attributable to customers and related suppliers
who accounted for more than 10% of net sales in any respective period.
Percentage of Net Revenue
1998 1997 1996
---- ---- ----
PMI Food Equipment Group ("PMI") 18% * *
Compaq Computer Corporation ("Compaq") * * 35%
International Business Machines ("IBM") * 19% 18%
EMC * 10% 12%
Motorola, Inc ("Motorola") 10% * *
* less than 10% for that year
Techdyne sells to approximately an additional 100 other companies,
which comprise the remaining 50% of sales. Lytton had approximately 41% of its
sales for fiscal 1998 to PMI. Techdyne (Scotland) had a substantial portion of
its 1998 sales, approximately 26%, to Compaq and related suppliers. During the
last three years, bidding for Compaq orders became more competitive due to Far
Eastern competitors which resulted in substantially reduced sales to that
customer with lower profit margins on remaining sales. See Item 7, "Management's
Discussion and Analysis of Financial Condition and Results of Operations."
MARKETING AND SALES
Techdyne continues to pursue expansion and diversification of its
customer base and it is targeting emerging OEMs in high growth industry
segments. The Company's principal sources of new business are the expansion in
the volume and scope of services provided to existing customers, referrals from
customers and suppliers, direct sales through its sales managers and executive
staff, and through its independent sales representatives. Sales managers,
directed and supported by the executive staff, identify and attempt to develop
relationships with potential customers who exemplify financial stability, a need
for electronic and electro-mechanical component assembly and manufacturing,
anticipated unit volume, and a history of establishing long-term relationships.
Domestic sales are generated by six regional sales managers covering
the Northeast, Southeast, West and Southwest regions of the United States. There
are also 11 in-house sales/marketing personnel, including Barry Pardon, the
President of Techdyne. The regional sales managers have four independent
manufacturer representative agencies who employ approximately 13 sales
representatives. Sales are also generated through catalogues, brochures and
trade shows.
Techdyne (Scotland) has four in-house sales personnel who market its
products, primarily ribbon, harness and cable assemblies, electro-mechanical
products, and molded cable assemblies, as well as its reworked and refurbished
products (see "Business - Electronic Manufacturing Industry - Reworking and
Refurbishing" above) to customers in Scotland, England, Ireland, Germany and the
Middle East.
8
Substantially all of Techdyne's sales and reorders are effected through
competitive bidding. Most sales are accomplished through purchase orders with
specific quantity, price and delivery terms. Some distribution is accomplished
under open purchase orders with components released against customer requests.
BACKLOG
On December 31, 1998, Techdyne's backlog of orders amounted to
approximately $11,817,000, of which approximately $8,354,000 (approximately 71%)
was represented by the orders from its Lytton operations and approximately
$673,000 (approximately 6%) was represented by orders for Techdyne (Scotland)
operations. Last year the backlog was approximately $14,029,000 of which
approximately $7,300,000 was derived from Lytton operations and approximately
$2,054,000 was represented by orders of Techdyne (Scotland) operations.
Management believes, based on past experience and relationships with its
customers and knowledge of its manufacturing capabilities, that substantially
all of Techdyne's backlog orders are firm and should be filled within six
months. The purchase orders that Techdyne has do not provide for cancellation,
but Techdyne occasionally allows cancellations and frequently rescheduling of
deliveries at its discretion. Over the last several years cancellations have
been minimal and management does not believe that any significant amount of the
backlog orders will be canceled. The variations in the size and delivery
schedules of purchase orders received by Techdyne may result in substantial
fluctuations in backlog from period to period. Since orders and commitments may
be rescheduled or cancelled, and customers' lead times may vary, backlog does
not necessarily reflect the timing or amount of future sales.
DIALYSIS OPERATIONS
The Company, through DCA and its subsidiaries, currently operates five
outpatient dialysis treatment centers, four in Pennsylvania and one in New
Jersey, with a current capacity of 41 licensed stations but designed for a
maximum of 71 stations. The Company also provides inpatient dialysis services to
several hospitals where the dialysis facilities are located. The outpatient
dialysis centers in Pennsylvania are located in Carlisle, Lemoyne, Wellsboro and
Chambersburg, Pennsylvania. The New Jersey facility is situated in Manahawkin,
New Jersey, and another facility in Toms River, New Jersey is in development.
Other new dialysis facilities are anticipated, presently through construction
and development of new dialysis centers as opposed to acquisition.
Home patient dialysis services, or Method II patient treatment, which
includes dialysis training for patients at home, primarily for continuous
ambulatory peritoneal dialysis ("CAPD") or continuous cycling peritoneal
dialysis ("CCPD"), which involves providing equipment and supplies, training,
patient monitoring and follow-up assistance to patients who are able to perform
treatment at home. DCA Medical Services, Inc. ("DCAMS") is a wholly owned
subsidiary which operates the homecare operations in Pennsylvania.
ESRD TREATMENT OPTIONS
Kidneys generally act as a filter removing harmful substances and
excess water from the blood, enabling the body to maintain proper and healthy
balances of chemicals and water. Chronic kidney failure, or End-Stage Renal
Disease ("ESRD"), which results from chemical imbalance and buildup of toxic
chemicals, is a state of kidney disease characterized by advanced irreversible
renal impairment. ESRD is a likely consequence of complications resulting from
diabetes, hypertension, advanced age, and
9
specific hereditary, cystic and urological diseases. Without regular treatment
or kidney transplantation ESRD is fatal.
Treatment options for ESRD patients include (1) hemodialysis, performed
either at (i) an outpatient facility, or (ii) inpatient hospital facility, or
(iii) the patient's home; (2) peritoneal dialysis, either CAPD or CCPD, usually
performed at the patient's home; and/or (3) kidney transplant. The significant
portion of ESRD patients receive treatments at non-hospital owned outpatient
dialysis facilities (approximately 83%) with the remaining patients treated at
home through hemodialysis or peritoneal dialysis. Patients treated at home are
monitored by a designated outpatient facility.
The most prevalent form of treatment for ESRD patients is hemodialysis,
which involves the use of an artificial kidney, known as a dialyzer, to perform
the function of removing toxins and excess fluids from the bloodstream. The
toxins and excess fluid pass through a semi-permeable membrane into one chamber
and the dialysis fluid is circulated through the other chamber. On the average,
patients usually receive three treatments per week with each treatment taking
three to five hours. Dialysis treatments are performed by teams of licensed
nurses and trained technicians pursuant to the staff physician's instruction and
supervision.
A second treatment for ESRD patients is peritoneal dialysis, which is
usually performed at home. All forms of peritoneal dialysis use the patient's
peritoneal (abdominal) cavity to eliminate fluid and toxins from the patient.
CAPD utilizes dialysis solution installed manually into the patient's peritoneal
cavity through a surgically-placed catheter remaining in the abdominal cavity
for a three to five hour period and is then drained. The cycle is then repeated.
CCPD is performed in a manner similar to CAPD, but utilizes a mechanical device
to cycle dialysis solution while the patient is sleeping.
The third modality for patients with ESRD is kidney transplantation.
While this is the most desirable form of therapeutic intervention, the scarcity
of suitable donors and possibility of donor rejection limits the availability of
this surgical procedure as a treatment option.
DCA'S BUSINESS STRATEGY
DCA, having 22 years experience in successfully developing and
operating dialysis treatment facilities, plans to use such experience and
expertise to expand its dialysis operations, including provision of ancillary
services to patients. First in DCA's objectives is top quality patient care. In
June, 1998, there were approximately 3,470 Medicare approved ESRD facilities of
which approximately 65% were independent for-profit dialysis centers
(non-hospital centers). A substantial number of these freestanding centers are
owned by physicians or major corporations, certain of which are public
companies. Management intends to continue to establish alliances with physicians
and hospitals and to initiate dialysis service arrangements with nursing homes
and managed care organizations, and to continue to emphasize its high quality
patient care, its smaller size which allows it to focus on each patient's
individual needs while remaining sensitive to the physicians' professional
concerns.
A new Vice President was added to DCA management in 1998 to direct and
supervise the development and acquisition of new dialysis facilities. Under his
direction, DCA is actively seeking and negotiating with several physicians to
establish new outpatient dialysis facilities at several locations. While the
Company is continually pursuing new opportunities, there are no firm agreements,
other than the Toms River, New Jersey facility, to acquire or develop any
additional facilities or to provide inpatient dialysis treatment, and no
assurance can be given that any such agreements will be made or that development
of the Toms River facility will be completed.
10
DCA endeavors to increase same center growth by adding quality staff
and management and attracting new patients to its existing facilities by
rendering high caliber patient care in convenient, safe and serene conditions
for everyone involved. The Company believes that it has existing adequate space
and stations within DCA's facilities to accommodate greater patient volume and
maximize its treatment potential and is working to achieve such increase, to
lower its fixed costs, and operate at a greater efficiency level.
One of the primary elements in acquiring or developing facilities is
locating an area with an existing patient base under the current treatment of a
local nephrologist. Other considerations in evaluating a proposed acquisition or
development of a dialysis facility are the availability and cost of qualified
and skilled personnel, particularly nursing and technical staff, the size and
condition of the facility and its equipment, the atmosphere for the patients,
the area's demographics and population growth estimates, state regulation of
dialysis and healthcare services, and the existence of competitive factors such
as hospital or proprietary non-hospital owned and existing outpatient dialysis
facilities within reasonable proximity to the proposed center.
Expansion of the Company's dialysis operations is being approached
presently through the development of its own dialysis facilities. Acquisition of
existing outpatient dialysis centers, which the Company has not done in the
past, is a faster but much more costly means of growth.
To construct and develop a new facility ready for operations may take
an average of four to six months and 12 months or longer to generate income, all
of which are subject to location, size and competitive elements. To construct a
12 station facility may cost in a range of $600,000 to $750,000 depending on
location, size and related services to be provided by the proposed facility.
Acquisition of existing facilities may range from $40,000 to $70,000 per
patient. Therefore, a facility with 30 patients could cost from $1,200,000 to
$2,100,000 subject to location, competition, nature of facility and negotiation.
OPERATIONS OF DIALYSIS FACILITIES
DCA's dialysis facilities are designed specifically for outpatient
hemodialysis and generally contain, in addition to space for dialysis
treatments, a nurses' station, a patient weigh-in area, a supply room, water
treatment space used to purify the water used in hemodialysis treatments, a
dialyzer reprocessing room (where, with both the patient's and physician's
consent, the patient's dialyzer is sterilized for reuse), staff work area,
offices and a staff lounge. DCA's facilities also have a designated area for
training patients in home dialysis. Each facility also offers amenities for the
patients, such as a color television with headsets for each dialysis station, to
ensure the patients are comfortable and relaxed.
In accordance with participation requirements under the Medicare ESRD
program, each facility retains a medical director qualified and experienced in
the practice of nephrology and the administration of a renal dialysis facility.
See "Physician Relationships" below. Each facility is overseen by a nurse
administrator who supervises the daily operations and the staff, which consists
of registered nurses, licensed practical nurses, patient care technicians, a
part-time social worker and a part-time registered dietitian, who all supervise
each aspect of patient treatments. The Company must continue to attract and
retain skilled nurses and other staff, competition for whom is intense.
11
DCA's facilities offer high-efficiency and conventional hemodialysis,
which, in the Company's experience, provides the most viable treatment for most
patients. The Company considers its dialysis equipment to be both modern and
efficient, providing state of the art treatment in a safe and comfortable
environment. In 1998, DCA leased an additional 17 machines which are more
advanced and include better safety features and updated technology. The addition
of the improved equipment enhances DCA's ability to provide more efficient
treatment.
DCA's facilities also offer home dialysis, primarily CAPD and CCPD.
Training programs for CAPD or CCPD generally encompass two to three weeks at
each facility, and such training is conducted by the facility's home training
nurse. After the patient completes training, they are able to perform treatment
at home with equipment and supplies provided by DCA.
Dialysis Services of PA., Inc. - Lemoyne commenced operations in June,
1995 and for the years ended December 31, 1997 and 1998, provided approximately
7,241 and 7,468 dialysis treatments, respectively. Dialysis Services of PA.,
Inc. - Wellsboro commenced operations in September, 1995 and for the years ended
December 31, 1997 and 1998, provided 2,298 and 3,602 dialysis treatments,
respectively. Dialysis Services of PA., Inc. -Carlisle commenced operations in
the third quarter of 1997, providing 1,346 treatments at year end and for the
year ended December 31, 1998, provided 3,483 treatments. From July, 1998 to
December 31, 1998, Dialysis Services of NJ - Manahawkin provided 247 treatments.
The Chambersburg, Pennsylvania facility became operational in January, 1999.
The Company estimates that on average DCA's centers were operating at
approximately 56% of capacity as of December 31, 1998, based on the assumption
that a dialysis center is able to provide up to three treatments a day per
station, six days a week. The Company believes that DCA may increase the number
of dialysis treatments at its centers without making additional capital
expenditures.
DCA sold four of its dialysis centers in 1989, and since that time it
has incurred operational losses. Although DCA has reflected income over the
years, this was due to interest income, including interest on funds received
through advances to the Company.
INPATIENT SERVICES
Management is also seeking to increase acute dialysis care contracts
with hospitals for inpatient dialysis services. The Company provides acute care
inpatient dialysis services to three hospitals in areas serviced by three of the
Company's five dialysis facilities and is in the process of negotiating
additional contracts in the areas surrounding its other facilities and in tandem
with development of future proposed sites. Each of its dialysis facilities
provides training, supplies and on-call support services for home peritoneal
patients. Hospitals are willing to enter into such inpatient care arrangements
to eliminate the administrative burdens of providing dialysis services to their
patients as well as the expense involved in maintaining dialysis equipment,
supplies and personnel. DCA believes that these arrangements are beneficial to
its operations, since the contract rates are negotiated and are not fixed by
government regulation as is the case with Medicare reimbursement fees for ESRD
patient treatment.
ANCILLARY SERVICES
The Company's dialysis facilities provide certain ancillary services to
ESRD patients, including the administration of erythropoietin ("EPO") upon a
physician's prescription. EPO is a bio-engineered protein which stimulates the
production of red blood cells and is used in connection with dialysis to treat
anemia, a medical complication frequently experienced by ESRD patients. EPO
decreases the necessity
12
for blood transfusions in ESRD patients. Other ancillary services that DCA
provides to patients in addition to EPO are electrocardiograms and blood
transfusions, all of which are separately reimbursed by Medicare. See "Medicare
and Medicaid Reimbursement" below.
PHYSICIAN RELATIONSHIPS
An integral element to the success of a facility is its association
with area nephrologists. A dialysis patient generally seeks treatment at a
facility near the patient's home and where such patient's nephrologist has
established practice privileges. Consequently, DCA relies on its ability to
attract and satisfy the needs of referring nephrologists to gain new patients
and to provide quality dialysis care through these referring physicians.
The conditions of a facility's participation in the Medicare ESRD
program mandate that treatment at a dialysis facility be under the general
supervision of a medical director who is a physician. DCA retains by written
agreement qualified physicians or groups of qualified physicians to serve as
medical directors for each of its facilities. Generally, the medical directors
are board eligible or board certified in internal medicine by a professional
board specializing in nephrology and have had at least 12 months of experience
or training in the care of dialysis patients at ESRD facilities. DCA's medical
directors are typically a significant source of referrals to the particular
center served.
Agreements with medical directors are usually for a term of five years
or more with renewal provisions. Each agreement specifies the duties,
responsibilities and compensation of the medical director. Under each agreement,
the medical director or professional association maintains his, her or its own
medical malpractice insurance. The agreements also provide for non-competition
in a limited geographic area surrounding that particular dialysis center during
the term of the agreement and upon termination for a limited period.
The Company's ability to establish a dialysis facility in a particular
area is significantly geared to the availability of a qualified physician or
nephrologist with an existing patient base to serve as the Company's medical
director. The loss of a medical director who could not be readily replaced would
have a material adverse effect on the operations of that facility, DCA and the
Company.
QUALITY ASSURANCE
DCA implements a quality assurance program to maintain and improve the
quality of dialysis treatment and care it provides to its patients in every
facility. Quality assurance activities involve the ongoing examination of care
provided, the identification of deficiencies in that care and any necessary
improvements of the quality of care. DCA's manager of compliance, who is a
registered nurse, oversees this program in addition to ensuring that DCA meets
federal and state compliance requirements for dialysis centers. See "Regulation"
below.
PATIENT REVENUES
DCA's net revenues are derived primarily from four sources: (i)
outpatient hemodialysis services; (ii) home dialysis services, including Method
II services; (iii) inpatient hemodialysis services for acute patient care
provided through agreements with hospitals and other healthcare entities; and
(iv) ancillary services associated with dialysis treatments, primarily certain
tests and the administration of EPO. For each of the two years ended December
31, 1997 and 1998, approximately 74% of DCA's revenues were derived from
Medicare reimbursement. Average net revenue per treatment, which
13
includes all sources of payments, governmental or private, for DCA's in-center
and home patients, including ancillary services, was approximately $205 for the
year ended December 31, 1998, as compared to $206 for the year ended December
31, 1997.
According to statistics published by the Health Care Financing
Administration ("HCFA"), 92% of all ESRD patients who receive dialysis treatment
are funded under the Medicare ESRD Program established by the federal government
under the Social Security Act, and administered in accordance with prescribed
rates set by HCFA of the Department of Health and Human Services ("HHS"). Under
the ESRD Program, payments for dialysis services are determined pursuant to Part
B of the Medicare Act which presently pays approximately 80% of the allowable
charges for each dialysis treatment furnished to patients. The maximum payments
vary based on location of the center. See "Medicare Reimbursement" below. The
remaining 20% may be paid by Medicaid if the patient is eligible, or if not,
from private insurance funds or the patient's personal funds. Pennsylvania and
New Jersey, presently the states in which the Company operate, provide Medicaid
or comparable benefits to qualified recipients to supplement their Medicare
coverage.
Medicare and Medicaid programs are subject to regulatory changes,
statutory limitations and governmental funding restrictions, which may adversely
affect DCA's and the Company's revenues and dialysis services payments. See
"Medicare and Medicaid Reimbursement" below.
The inpatient dialysis services are paid for by the hospital pursuant
to contractual pre-determined fees. Inpatient treatments accounted for
approximately 16% and 11% of DCA's revenues for the years ended December 31,
1997 and 1998, respectively.
MEDICARE AND MEDICAID REIMBURSEMENT
DCA is reimbursed primarily from third party payors including Medicaid,
commercial insurance companies, and substantially by Medicare under a
prospective reimbursement system for chronic dialysis services, including
dialysis treatments, supplies used for such treatments, certain laboratory tests
and medications. Under this system, the reimbursement rates are fixed in advance
and have been adjusted from time to time by Congress. This form of reimbursement
limits the allowable charge per treatment, but provides DCA with predictable and
recurring per treatment revenues and allows it to retain any profit earned.
DCA receives reimbursement for outpatient dialysis services provided to
Medicare-eligible patients at rates that are currently between $122 and $124 per
treatment, depending upon regional wage variations. The Medicare reimbursement
rate is subject to change by legislation and recommendations by the Medicare
Payment Advisory Commission ("MedPAC"), a new commission mandated by the
Balanced Budget Act of 1997 and continuing the work of the Prospective Payment
Assessment Commission ("PROPAC"). Congress increased the ESRD reimbursement
rate, effective January 1, 1991, resulting in an average ESRD reimbursement rate
of $126 per treatment for outpatient dialysis services. The current maximum
composite reimbursement rate is $134 per treatment. In 1990, Congress required
that HHS and PROPAC study dialysis costs and reimbursement and make findings as
to the appropriateness of ESRD reimbursement rates. Any rate increase by
Congress must be considered in the context of Medicare budgetary concerns. In
1998, MedPAC recommended a 2.7% increase in the amount paid to dialysis
facilities for performance of services, which if passed by Congress, would
constitute the second increase that has been approved for the ESRD program since
its inception. Congress is not required to implement such recommendation and
could either raise or lower the reimbursement rate.
14
Other ancillary services and items are eligible for separate
reimbursement under Medicare and are not part of the composite rate, including
certain drugs such as EPO. The proposal to reduce the reimbursement rate of EPO
from $10 per 1000 units to $9 per 1000 units could adversely impact DCA's income
from EPO if the proposal is enacted by Congress in 1999. There is no assurance,
though, that Congress will legislate the EPO reduction into law.
Medicaid programs are state administered programs partially funded by
the federal government. These programs are intended to provide coverage for
patients whose income and assets fall below state defined levels and who are
otherwise uninsured. The programs also serve as supplemental insurance programs
for the Medicare co-insurance portion and provide certain coverages (e.g., oral
medications) that are not covered by Medicare. DCA is a licensed ESRD Medicaid
provider in Pennsylvania, and has applied to be an approved Medicaid provider in
New Jersey.
The Company is unable to predict what, if any, future changes may occur
in the rate of reimbursement. Any reduction in the Medicare composite
reimbursement rate or Medicaid reimbursement could have a material adverse
effect on DCA and the Company's business, revenues and net earnings.
REGULATION
TECHDYNE
Techdyne's operations are subject to certain federal, state and local
regulatory requirements relating to environmental waste management and health
and safety matters. These regulations provide for civil and criminal fines,
injunctions and other sanctions and, in certain instances, allow third parties
to sue to enforce compliance. Management believes that Techdyne complies with
applicable regulations pertaining to health and safety in the workplace,
including those promulgated by OSHA, and the use, storage, discharge and
disposal of chemicals used in its manufacturing processes. Techdyne periodically
generates and temporarily handles limited amounts of materials that are
considered hazardous waste. The current costs of compliance are not material to
Techdyne or the Company. Nevertheless, no assurances can be given that
additional or modified requirements will not be imposed in the future, and if so
imposed, will not involve substantial additional expenditures.
DCA
Dialysis treatment centers must comply with various state and federal
health laws which are generally applicable to healthcare facilities. The
dialysis center must meet a variety of governmental standards including but not
limited to maintenance of equipment and proper records, personnel and quality
assurance programs. Each of the dialysis facilities must be certified by HCFA,
and the Company must comply with certain rules and regulations established by
HCFA regarding charges, procedures and policies. Each dialysis center is also
subject to periodic inspections by federal and state agencies to determine if
their operations meet the appropriate regulatory standards. These requirements
have been satisfied by each of the Company's dialysis facilities.
DCA's record of compliance with federal, state and local governmental
laws and regulations remains excellent. DCA regularly reviews legislative
changes and developments and will restructure a business arrangement if
management determines such might place it in material noncompliance with such
law or regulation. To date, none of DCA's business arrangements with physicians,
patients or
15
others have been the subject of investigation by any governmental authority.
No assurance can be given, however, that DCA's business arrangements will not be
the subject of a future investigation or prosecution by a federal or state gov-
ernmental authority which could result in civil and/or criminal sanctions.
The Social Security Act prohibits, as do many state laws, the payment
of patient referral fees for treatments that are otherwise paid for by Medicare,
Medicaid or similar state programs under the Medicare and Medicaid Patient and
Program Protection Act of 1987, or the "Anti-kickback Statute." The
Anti-kickback Statute and similar state laws impose criminal and civil sanctions
on persons who knowingly and willfully solicit, offer, receive or pay any
remuneration, directly or indirectly, in return for, or to include, the referral
of a patient for treatment, among other things. The federal government in 1991
and 1992 published regulations that established exceptions, "safe harbors," to
the Anti-kickback Statute for certain business arrangements that would not be
deemed to violate the illegal remuneration provisions of the federal statute.
All conditions of the safe harbor must be satisfied to meet the exception, but
failure to satisfy all elements does not mean the business arrangement violates
the illegal remuneration provision of the statute.
DCA attempts to structure its arrangements with its physicians to
comply with the Anti-Kickback Statute. However, many of these physicians refer
patients to DCA's facilities, therefore the federal Anti-kickback Statute could
be found to apply to referrals by such physicians to the Company's facilities.
Management believes that the illegal remuneration provisions described above are
primarily directed at abusive practices that increase the utilization and cost
of services covered by governmentally funded programs. The dialysis services
provided by DCA generally cannot, by their very nature, be over-utilized, since
dialysis treatment is not elective and cannot be prescribed unless there is
temporary or permanent kidney failure. However, these relationships do not
satisfy all of the criteria for the safe harbor, and there can be no assurance
that the relationships with DCA's medical directors will not subject DCA and the
Company to investigation or prosecution by enforcement agencies. There can be no
assurance that DCA will not be required to change its practices or experience a
material adverse effect as a result of any such potential challenge. The Company
cannot predict the outcome of the rule-making process or whether changes in the
safe harbor rules will affect the Company's position with respect to the
Anti-kickback Statute, but does believe it will remain in compliance.
The Physician Ownership and Referral Act ("Stark II") was adopted and
incorporated into the Omnibus Budget Reconciliation Act of 1993 and became
effective January 1, 1995. Stark II bans physician referrals, with certain
exceptions, for certain "designated health services" as defined in the statute
to entities in which a physician or an immediate family member has a "financial
relationship" which includes an ownership or investment interest in, or a
compensation arrangement between the physician and the entity. This ban is
subject to several exceptions. If Stark II is found to be applicable to the
facility, the entity is prohibited from claiming reimbursement, will receive
civil penalties and may be excluded from the Medicare program.
Last year, HCFA released proposed rules that interpret the provisions
of Stark II ("Proposed Rules"). Management believes, based upon the Proposed
Rules and the industry practice, that Congress did not intend to include
dialysis services and the services and items provided by DCA incident to
dialysis services within the Stark II prohibitions. There can be no assurance,
though, that final Stark II regulations will adopt such a position.
If the provisions of Stark II were found to apply to DCA's arrangements
with its medical directors, however, the Company believes that it would be in
compliance. DCA compensates its
16
nephrologist-physicians as medical directors of its dialysis centers pursuant to
Medical Director Agreements. Also, acute care inpatient hospital arrangements
for dialysis services are excluded under the Proposed Rules from the prohibition
on physician referrals based upon the fact that the services provided under
these arrangements are rendered under emergency circumstances and are necessary
treatments. The Company believes that DCA's contractual arrangements with hos-
pitals for acute care inpatient dialysis services are in compliance with this
exception.
If HCFA or any other government entity takes a contrary position in the
Stark II final regulations or otherwise, DCA may be required to restructure
certain existing compensation agreements with its medical directors, or, in the
alternative, to refuse to accept referrals for designated health services from
certain physicians. There can be no assurance that such prospective compliance,
if permissible, would not have a material adverse effect on the Company.
In 1996, President Clinton signed the Health Insurance Portability and
Accountability Act of 1996 ("HIPA"), a package of health insurance reforms which
include a variety of provisions important to healthcare providers, such as
significant changes to the Medicare and Medicaid fraud and abuse laws. Under
these programs, these governmental entities will undertake a variety of
monitoring activities which were previously left to providers to conduct,
including medical utilization and fraud review, cost report audits, secondary
payor determinations, reports of fraud and abuse actions against providers will
be shared as well as encouraged by rewarding whistleblowers with money collected
from civil fines.
The Company's dialysis centers are subject to hazardous waste laws and
non-hazardous medical waste regulation. Most of the Company's waste is
non-hazardous. HCFA requires that all dialysis facilities have a contract with a
licensed medical waste handler for any hazardous waste. Medical waste at each of
DCA's facilities is handled by licensed local medical waste sanitation agencies,
who are primarily responsible for compliance.
There are a variety of regulations promulgated under OSHA relating to
employees exposed to blood and other potentially infectious materials requiring
employers, including dialysis centers, to provide protection. The Company
adheres to OSHA's protective guidelines, including regularly testing employees
and patients for exposure to hepatitis B and providing employees subject to such
exposure with hepatitis B vaccinations on an as-needed basis, protective
equipment, a written exposure control plan and training in infection control and
waste disposal.
Although the Company believes that DCA substantially complies with
currently applicable state and federal laws and regulations and to date has not
had any difficulty in maintaining its licenses or its Medicare and Medicaid
authorizations, the healthcare service industry is and will continue to be
subject to substantial and continually changing regulation at the federal and
state levels, and the scope and effect of such and its impact on the Company's
operations cannot be predicted. No assurance can be given that DCA's activities
will not be reviewed or challenged by regulatory authorities.
PATENTS AND TRADE NAMES
The Company sells certain of its medical supplies and products under
the trade name Medicore(TM). Certain of its lancets are marketed under the trade
names Medi-Lance(TM) and Lady Lite(TM).
The Company is the assignee of three patents relating to its lancets.
The issuance of a patent does not assure protection against the development of
similar, if not superior processes, know-how and products. The Company does not
rely on patents or trademarks in its electro-manufacturing operations and
17
manufacturing of medical products. The Company instead places its importance
more upon design, engineering, manufacturing cost containment, quality and
marketing skills to establish or maintain market position.
COMPETITION
The medical supply operations are extremely competitive and the Company
is not a significant competitive factor in this area.
In the electronics manufacturing industry, the Company experiences
substantial competition from many areas including divisions of large electronic
and high-technology firms, as well as from numerous smaller but more specialized
companies. Competitive price advantages may also be available to competitors
with less expensive off-shore operations, especially in the Far East. Techdyne
also competes with in-house manufacturing operations of current and potential
customers. Although Techdyne has been expanding, certain of the Company's
competitors have broader geographic coverage to serve their customers and
attract additional business, and are more established in the industry with
substantially greater financial, manufacturing and marketability resources than
the Company. Management believes the primary competitive factors to be price,
quality of production, manufacturing capability, prompt customer service, timely
delivery, engineering expertise, and technical assistance to customers. The
Company believes it competes favorably in these areas. During downtimes in the
electronics industry, OEMs become more price sensitive and those manufacturers
who have greater direct buying power with component suppliers or who have lower
cost structures are more competitive. In the PCB area major competitors include
SCI Systems, Inc., Jabil Circuit, Sanmina Corporation, Benchmark Electronics,
Inc., ACT Manufacturing, Inc. and others. Major competitors in the cable and
harness assembly market include Volex Interconnect Systems, Inc., Foxconn, ACT
Manufacturing, Inc., Escod Industries and others.
The operation of kidney dialysis centers is extremely competitive and
DCA competes with numerous providers, many of which are facilities owned by
physicians or major corporations, some of which are public. The Company's
operations are small in comparison to these public companies. Many of these
competitors, including Fresenius AG, Renal Care Group, Inc., Total Renal Care
Holdings, Inc., and Everest Healthcare Service Corp., have substantially greater
financial resources and many more centers and patients than DCA, which provides
these larger facilities with a significant advantage in competing for
acquisitions of dialysis facilities and the ability to attract and retain
qualified nephrologists, who are normally a substantial source of patients for
the dialysis center. Hospitals and other outpatient dialysis centers also
compete with the Company's dialysis operations. Competitive factors that are
most significant in dialysis treatment are the quality of care and service,
convenience of location, availability of a local nephrologist, and pleasantness
of environment. The Company is not a significant competitive force in kidney
dialysis services primarily based upon DCA's ownership of a limited number of
centers and the size of each of its facilities.
Based upon advances in surgical techniques, immune suppression and
computerized tissue typing, cross-matching of donor cells and donor organ
availability, renal transplantation instead of dialysis is becoming a
competitive factor. It is presently the second most commonly used modality in
ESRD therapy.
EMPLOYEES
The Company and its subsidiaries employ approximately 560 full time
employees of which 14 are administrative, 42 are with the dialysis operations, 6
are engaged in the medical supply operations, and 503 are with Techdyne's
electronic manufacturing operations (domestic and Scotland). In addition,
Techdyne
18
utilizes approximately 70 temporary workers, retained through local agencies,
on a regular basis, and DCA employs 16 part-time and 9 part-time contract
employees.
ITEM 2. PROPERTIES
The Company leases 2,800 square feet for its executive offices in
Hialeah, Florida, and at a different location in Hialeah, Florida, leases 5,000
square feet for its medical supply operations, each lease through December 31,
2002. It also leases 3,900 square feet of space for other executive offices in
Hasbrouck Heights, New Jersey through March 31, 2001.
DCA owns two properties, one located in Lemoyne, Pennsylvania, and the
second in Easton, Maryland. The Maryland property consists of approximately
7,400 square feet which is leased to the purchaser (in 1989) of one of DCA's
dialysis centers and a competitor of DCA, through March 31, 2003. The Lemoyne
property of approximately 15,000 square feet houses DCA's dialysis center of
approximately 5,400 square feet and 2,500 square feet of its space for its
executive offices. DCA's subsidiary leases this facility from DCA under a five
year lease that commenced December 23, 1998, with two renewal periods of five
years. The Easton, Maryland and Lemoyne, Pennsylvania properties are subject to
mortgages from a Maryland banking institution extending through November, 2003.
As of December 31, 1998, the remaining principal amount of the mortgage on the
Lemoyne property was approximately $160,000 and on the Easton property was
approximately $200,000. Each mortgage bears interest at 1% over the prime rate
and is secured by the real property and DCA's personal property at each
location. The bank has a lien on rents due DCA and security deposits from the
leases. The bank has to approve all leases, subleases, alterations, improvements
and sales relating to the properties. See Item 7, "Management's Discussion and
Analysis of Financial Condition and Results of Operations."
As lessor, DCA also leases space at its Lemoyne, Pennsylvania property
to one other unrelated party for their own business activities unrelated to
dialysis services or to the Company. The lease is for approximately 1,500 square
feet through December 31, 2002.
The dialysis facility in Wellsboro, Pennsylvania consists of
approximately 3,500 square feet, leased by DCA's subsidiary in Wellsboro for
five years through September, 27, 2000 with two renewals of five years each. The
Carlisle, Pennsylvania 4,340 square foot dialysis facility is leased under a
five year lease through June 30, 2002, with two renewals of five years each.
DCA's subsidiary in Manahawkin, New Jersey signed a five year lease for its new
dialysis facility for approximately 3,700 square feet, renewable for two
consecutive five year periods commencing December 1, 1998, with an additional
940 square feet of space free of rent until June 30, 2000, after which time
DCA's subsidiary will pay the agreed per square foot price as stipulated in the
original lease. The facility in Chambersburg, Pennsylvania, consisting of 7,000
square feet of space, is leased for a five year term with two renewal periods of
five years each commencing January 1, 1999. Approximately 1,800 square feet was
sublet to a medical practice.
DCA's new subsidiary in Toms River signed a lease agreement to
construct a new facility in Toms River, New Jersey for a term of five years from
December 8, 1998, with two renewal periods of five years each.
The Lemoyne and Wellsboro, Pennsylvania facilities, both of which
initiated operations in 1995, are currently operating at approximately 72% and
68% capacity, respectively, and Carlisle, Pennsylvania has operated at 47%
capacity for 1998. Since DCA's subsidiaries in Manahawkin, New Jersey and
19
Chambersburg, Pennsylvania, recently commenced operations, an accurate
operational capacity is not known at this point. The existing dialysis
facilities could accommodate greater patient volume subject to obtaining
appropriate governmental approval.
The dialysis stations are equipped with modern dialysis equipment under
a November, 1996 master-lease/purchase agreement ("1996 Master Lease") with a
$1.00 purchase option at the end of the term. DCA leased new equipment for its
Manahawkin, New Jersey and Chambersburg, Pennsylvania facilities beginning May
and November, 1998, respectively, under the 1996 Master Lease in addition to the
1997 leases for equipment at the Lemoyne and Carlisle, Pennsylvania facilities.
Techdyne's domestic operations are headquartered in Hialeah, Florida
which consists of 16,000 square feet of space for its executive offices and
12,000 square feet for its manufacturing facilities and warehousing, leased from
the Company under five year leases expiring March 31, 2000. These facilities are
located in two adjacent buildings acquired by the Company from Techdyne in 1990
which also included the purchase of a parcel of land adjacent to these buildings
used for parking. See "Certain Relationships and Related Transactions" of the
Company's Proxy Statement relating to the Annual Meeting of Shareholders to be
held on June 9, 1999 incorporated herein by reference. The Company also owns a
small parcel of land near Techdyne's offices in Hialeah, Florida which is used
as a parking lot, and a small, undeveloped parcel adjacent to Techdyne's
warehouse available for future expansion.
Techdyne leases manufacturing, warehousing and office facilities in (i)
Houston, Texas for 15,000 square feet, leased until April, 2002, (anticipates
subleasing certain non-manufacturing space), (ii) Austin, Texas for 18,225
square feet under a lease to May, 2002, and (iii) Milford, Massachusetts for
5,500 square feet of space through March, 2002. Each lease has one five year
renewal. Techdyne is using the additional space at its Austin, Texas facility by
combining its Houston non-manufacturing and part of its Houston manufacturing
operations. A minimal portion of the Austin facility has been sublet on a
month-to-month basis. The Company keeps a sales representative at its
manufacturing facility in Houston, Texas.
In July, 1997, Techdyne acquired Lytton in Dayton, Ohio and with that
acquisition leased a 77,800 square foot manufacturing and office facility under
a lease to July 31, 2002 with two renewals of five years each. The landlord, a
limited liability company, is owned by the former president of Lytton. See
"Certain Relationships and Related Transactions" of the Company's Proxy
Statement relating to the Annual Meeting of Shareholders to be held on June 9,
1999, incorporated herein by reference. Techdyne has a right of first refusal
and an option to purchase these premises. This lease is guaranteed by the
Company.
Techdyne (Scotland) owns an approximately 31,000 square foot facility
in Livingston, Scotland subject to a 15-year mortgage due July, 2009 which has a
U.S. dollar equivalency of approximately $545,000 at December 31, 1998. See Item
7, "Management's Discussion and Analysis of Financial Condition and Results of
Operations."
Techdyne maintains state-of-the-art manufacturing, quality control,
testing and packaging equipment at all of these facilities and believes that its
equipment and facilities are adequate for Techdyne's current operations.
20
ITEM 3. LEGAL PROCEEDINGS
The Company is not involved in or subject to any claims or litigation
of a material nature or that any adverse outcome would have a material adverse
effect on the Company's financial condition. See Note 7 to "Notes to
Consolidated Financial Statements."
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matter was submitted during the fourth quarter of the Company's
fiscal year to a vote of security holders through the solicitation of proxies or
otherwise.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's common stock traded on the American Stock Exchange until
June 3, 1996 when its Common Stock commenced trading on the Nasdaq National
Market under the symbol "MDKI." The table below reflects for the periods
indicated the high and low closing sales prices for the Company's common stock
as reported by the Nasdaq National Market.
SALE PRICE
----------
HIGH LOW
---- ---
1997
1st Quarter................. $5.00 $2.63
2nd Quarter................. 4.50 2.00
3rd Quarter................. 3.38 2.13
4th Quarter................. 3.00 1.88
HIGH LOW
---- ---
1998
1st Quarter................. $2.38 $1.94
2nd Quarter................. 2.88 1.84
3rd Quarter................. 2.13 1.25
4th Quarter................. 1.56 0.94
The high and low sales price of Medicore common stock at March 15, 1999
were $1.88 and $1.25, respectively.
As of March 15, 1999, there were 1,266 shareholders of record. The
Company estimates, based upon its 1997 proxy solicitation, that its common stock
is beneficially held by approximately 2,100 shareholders.
21
The Company has not paid any cash dividends in the last two years.
Dividends are paid at the discretion of the board of directors, and no such
payments are expected to be made in the future. Any earnings of the Company will
be retained for use in the business.
ITEM 6. SELECTED FINANCIAL DATA
The following selected financial data should be read in conjunction
with the consolidated financial statements, related notes and other financial
information included herein.
CONSOLIDATED STATEMENTS OF OPERATIONS DATA
(in thousands except per share amounts)
YEARS ENDED DECEMBER 31
-------------------------------------------------------------------------
1998 1997(1) 1996(2) 1995 1994
---- ---- ---- ---- ----
Revenues $50,149 $44,119 $34,719 $36,660 $24,552
Net income 98 2,241 2,417 2,251 864
Income per common share:
Basic $.02 $.39 $.44 $.41 $.17
Diluted $.01 $.36 $.39 $.37 $.16
CONSOLIDATED BALANCE SHEET DATA
(in thousands)
DECEMBER 31
-------------------------------------------------------------------------
1998 1997(1) 1996(2) 1995 1994
---- ---- ---- ---- ----
Working capital $15,421 $18,857 $13,844 $ 7,034 $ 4,871
Total assets 36,310 40,862 27,085 21,247 15,955
Long-term debt 5,127 5,240 1,677 964 1,667
Stockholders' equity 15,368 16,077 13,021 9,754 8,027
(1) REFLECTS (I) FIVE MONTHS OPERATIONS OF LYTTON, AND ITS ASSETS,
LIABILITIES AND STOCKHOLDERS' EQUITY, WHICH COMPANY WAS ACQUIRED BY
TECHDYNE ON JULY 31, 1997; AND (II) THE SALE OF THE FLORIDA DIALYSIS
OPERATIONS ON OCTOBER 31, 1997 FOR $5,065,000 CONSISTING OF $4,585,000
OF CASH WITH THE BALANCE CONSISTING OF 13,873 SHARES OF COMMON STOCK OF
THE PURCHASER. SEE ITEM 7, "MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS" AND NOTE 12 TO "NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS."
(2) IN 1996, THE COMPANY RECORDED ESTIMATED COSTS OF $305,000 FOR SHUTDOWN
OF ITS DURABLE MEDICAL EQUIPMENT OPERATIONS.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
GENERAL
Techdyne's electronic and electro-mechanical manufacturing operations
continue to depend upon a relatively small number of customers for a significant
percentage of its net revenue. Significant reductions in sales to any of
Techdyne's large customers would have a material adverse effect on Techdyne's
and the Company's results of operations. The level and timing of orders placed
by a customer vary due to the customer's attempts to balance its inventory,
changes in a customer's manufacturing strategy, acquisitions of or consolida-
tions among customers, and variation in demand for a customer's products due to,
among other things, product life cycles, competitive conditions and general
economic conditions. Any terminations of manufacturing relationships or
changes, reductions or delays in orders could have an
22
adverse effect on the Company's results of operations or financial condition.
The Company's and Techdyne's results also depend to a substantial extent on the
success of Techdyne's OEM customers in marketing their products. Techdyne is
always seeking to diversify its customer base to reduce its reliance on its few
major customers. See "Techdyne's Business Strategy" and "Customers" under Item
1, "Business - Electronic Manufacturing Industry."
The industry segments served by Techdyne and the electronics industry
generally are subject to rapid technological change and product obsolescence.
Discontinuance or modification of products containing components manufactured by
Techdyne could adversely affect the Company's and Techdyne's results of
operations. The electronics industry is also subject to economic cycles and has
in the past experienced, and is likely in the future to experience, recessionary
periods, which could have a material adverse effect on the Company's and
Techdyne's business, financial condition and results of operations. To continue
to grow and be a successful competitor, the Company must be able to maintain and
enhance its technological capabilities, develop and market manufacturing
services which meet changing customer needs and successfully anticipate or
respond to technological changes in manufacturing processes on a cost-effective
and timely basis.
Techdyne must continuously develop improved manufacturing procedures to
accommodate customer needs for increasingly complex products. To continue to
grow and be a successful competitor, the Company must be able to maintain and
enhance its technological capabilities, develop and market manufacturing
services which meet changing customer needs and successfully anticipate or
respond to technological changes in manufacturing processes on a cost-effective
and timely basis. There can be no assurance that the Company's process
development efforts will be successful or that the emergence of new
technologies, industry standards or customer requirements will not render the
Company's technology, equipment or processes obsolete or uncompetitive. Further,
to the extent that the Company determines that new assembly and testing
technologies and equipment are required to remain competitive, the acquisition
and implementation of such technologies and equipment are likely to require
significant capital investment.
Techdyne uses enterprise resource planning through its Visual
Manufacturing system (see Item 1, "Business - Electronic Manufacturing Industry
- - Supplies and Materials Management" and "Year 2000 Readiness" below) in its
efforts to continuously develop accurate forecasts of customer volume
requirements. Techdyne is dependent on the timely availability of many
components. Component shortages could result in manufacturing and shipping
delays or increased component prices which could have a material adverse effect
on Techdyne's and the Company's results of operations. It is paramount that
Techdyne efficiently manages inventory, follows proper timing of expenditures
and allocates physical and personnel resources in anticipation of future sales,
the evaluation of economic conditions in the electronics industry, and the mix
of products for manufacture. See "Manufacturing" and "Supplies and Materials
Management" under Item 1, "Business - Electronic Manufacturing Industry."
Techdyne continues to seek to expand its geographic and customer base
through establishment of new manufacturing facilities and operations in areas to
better serve existing customers and to attract new OEMs, as well as direct
acquisition of contract manufacturing businesses complimentary to Techdyne's
operations. For such expansion opportunities, the Company competes with much
larger electronic manufacturing entities. Further, in order to effectuate any
such transactions, it may result in potentially dilutive issuance of equity se-
curities, the Company's incurrence of debt and amortization expenses related to
goodwill and other intangible assets, as well as other costs and expenses, all
of which could materially adversely affect the Company's and Techdyne's finan-
cial results. Any expansion may also involve numerous business risks, including
difficulties in successfully integrating acquired operations, technologies and
products or formalizing anticipated synergies, which would require the diversion
of management's attention
23
from other business concerns. In the event that any such transaction does occur,
there can be no assurance that there would be a beneficial effect on Techdyne
and the Company's business and financial results.
Techdyne's, and in turn, the Company's results of operations are also
affected by other factors, including price competition, the level and timing of
customer orders, fluctuations in material costs, the overhead efficiencies
achieved in managing the costs of its operations, experience in manufacturing a
particular product, the timing of expenditures in anticipation of increased
orders, and selling, general and administrative expenses. Accordingly, gross
margins and operating income margins have generally improved during periods of
high volume and high capacity utilization. Techdyne generally has idle capacity
and reduced operating margins during periods of lower-volume production.
With respect to the Company's dialysis operations engaged in through
DCA, essential to the Company's profitability is Medicare reimbursement, which
is at a fixed rate determined by HCFA. The level of DCA's, and therefore, the
Company's revenues and profitability may be adversely affected by any potential
legislation resulting in rate cuts. Operating costs of the Company in treatment
tend to increase over the years with the commencement of treatment at new
centers. There also may be reductions in commercial third-party reimbursement
rates.
The healthcare and in particular, the dialysis industry, is subject to
extensive regulations of federal and state authorities. There are a variety of
fraud and abuse measures promulgated by the government to combat government
waste, which include anti-kickback regulations, extensive prohibitions relating
to self-referrals, violations of which are punishable by criminal or civil
penalties, including exclusion from Medicare and other governmental programs.
Although DCA and the Company have never been challenged under these regulations
and believe that DCA complies in all material respects with such laws and
regulations, there can be no assurance that there will not be unanticipated
changes in healthcare programs or laws or that DCA will not be required to
restructure its practice and will not experience material adverse effects as a
result of any such challenges or changes.
DCA's future growth depends primarily on the availability of suitable
dialysis centers for development or acquisition in appropriate and acceptable
areas, and DCA's ability to develop these new potential dialysis centers at
costs within its budget while competing with larger companies, some of which are
public companies or divisions of public companies with greater personnel and
financial resources who have a significant advantage in acquiring and/or
developing facilities in areas targeted by the Company. Additionally, there is
intense competition for retaining qualified nephrologists, who are a
significant, if not the sole, source of patient referrals and are responsible
for the supervision of the dialysis centers. There is no certainty as to when
any new centers or inpatient service contracts with hospitals will be
implemented, or the number of stations, or patient treatments such may involve,
or if such will ultimately be profitable. Newly established dialysis centers,
although contributing to increased revenues, also adversely affect results of
operations due to start-up costs and expenses with a smaller developing patient
base.
RESULTS OF OPERATIONS
1998 COMPARED TO 1997
Consolidated revenues increased by approximately $6,029,000 (14%) in
1998 compared to the previous year. Sales revenues increased by approximately
$10,494,000 (27%) compared to the preceding year. 1997 revenues included both
a gain of $4,431,000 on the sale of certain assets of DCA's
24
subsidiaries and a gain of $90,000 on subsidiary warrant exercises. See Note
12 to "Notes to Consolidated Financial Statements."
Techdyne sales increased approximately $11,647,000 (35%) for the year
December 31, 1998 compared to the preceding year. The increase was attributable
principally to the inclusion of sales of Lytton for which sales of $20,062,000
were included during the current year compared to $7,170,000 for the preceding
year commencing with the Company's acquisition of Lytton on July 31, 1997. There
was an overall increase in domestic sales of $13,771,000 (52%), including
Lytton, and a decrease in European sales of $2,125,000 (31%) compared to the
preceding year. The decline in European-based sales was mainly attributable to a
decrease of approximately $1,656,000 (58%) in sales to Compaq (Europe) by
Techdyne (Scotland) which was partially offset by sales to new customers and
increased sales to existing customers.
Approximately 50% of Techdyne's consolidated sales and 45% of the
Company's consolidated sales for 1998 were made to five customers. Customers
generating in excess of 10% of Tecdyne's consolidated sales with their
respective portions of Techdyne's and the Company's consolidated sales include
Motorola, which accounted for 10% and 9%, and PMI Food Group, which accounted
for 18% and 17%, respectively. Approximately $8,183,000 (41%) of Lytton's sales
for 1998 were to PMI Food Group, its major customer. The loss of, or substan-
tially reduced sales to any of Techdyne's major customers would have a material
adverse effect on Techdyne's and the Company's operations if such sales are not
replaced.
Revenues of Techdyne's Scotland-based subsidiary Techdyne (Scotland)
continue to be highly dependent on sales to Compaq, which accounted for
approximately 26% of sales for the current year compared to 42% in the preceding
year. The bidding for Compaq orders has become more competitive which has
continued to result in substantial reductions in Compaq sales and lower profit
margins on remaining Compaq sales. Techdyne (Scotland) is pursuing new business
development and has offset some of the lost Compaq business with sales to other
customers. However there can be no assurance as to the success of such efforts.
Medical product sales revenues decreased by approximately $373,000
(22%) for 1998 compared to the previous year due to decreased sales of the
principal product of this division. This was due to substantially reduced
government purchase and foreign competition. Management is attempting to be more
competitive in lancet sales through overseas production and expansion of its
customer base. The Medical Products Division is also expanding its product line
with several diabetic disposable products. No assurance can be given that said
efforts will be successful.
Medical service revenues, represented by the revenues of the Company's
dialysis division, DCA, decreased approximately $823,000 (19%) for the year
ended December 31, 1998 compared to the preceding year. This decrease reflects
a decrease of approximately $1,663,000 compared to the preceding year
attributable to the sale of the Company's Florida dialysis operations on October
31, 1997, which was offset to some degree by increased revenues of the Company's
Pennsylvania dialysis centers of approximately $782,000 including increased
revenues of approximately $510,000 at the Company's dialysis center located in
Carlisle, Pennsylvania, which commenced operations in July, 1997, and $58,000
from a new dialysis center located in Manahawkin, New Jersey, which received
regulatory approval in December, 1998. Although the operations of these centers
have resulted in additional revenues, they are in the developmental stage and,
accordingly, their operating results will adversely affect DCA's and the
Company's results of operations until they achieve a sufficient patient count to
cover fixed operating costs.
25
Cost of goods sold as a percentage of consolidated sales increased to
86% for the year ended December 31, 1998 compared to 83% for the preceding year.
Cost of goods sold for Techdyne as a percentage of sales remained
relatively stable amounting to 88% for the year ended December 31, 1998 compared
to 87% for the preceding year.
Cost of goods sold by the medical products division increased to 69%
for 1998 compared to 65% for the preceding year, as a result of a change in
product mix due to decreased sales of the principal product of the division.
Cost of medical services sales increased to 71% in 1998 compared to 62%
in 1997 reflecting increases in healthcare salaries and supply costs as a
percentage of sales, including the operations of the Company's centers in
Carlisle, PA and Manahawkin, NJ which are still in their developmental stage.
The preceding year included higher hospital treatment revenues, which have a
substantially lower cost of sales, with the Company's Florida hospital
operations having been sold on October 31, 1997.
Selling, general and administrative expenses increased $508,000 for
1998 compared to the preceding year. This increase reflected inclusion of the
selling, general and administrative expenses of Lytton for all of 1998 versus
five months in 1997, as well as inclusion of the new dialysis center in
Carlisle, Pennsylvania for all of 1998, expenses in connection with the startup
of a new dialysis center in Manahawkin, New Jersey, a new center in
Chambersburg, Pennsylvania, which commenced operations in January, 1999, and
another center presently under construction in New Jersey, which was offset by
the decline in expenses resulting from DCA's sale of its Florida dialysis
operations on October 31, 1997. Included in 1997 was stock compensation expense
that occurred during the fourth quarter of 1997 in the amount of $322,000 in
conjunction with forgiveness of notes from option exercises of DCA common stock.
Interest expense increased by approximately $199,000 for 1998 compared
to the preceding year. This increase included additional interest of $122,000
associated with the financing the Lytton acquisition and increases in Lytton's
financing and debt agreements of approximately $81,000 which was partially
offset from DCA's reduced average outstanding borrowings.
The Company recorded an adjustment to the valuation allowance relating
to its deferred tax asset of approximately $300,000 during the fourth quarter of
1998 and $700,000 during the fourth quarter of 1997 which offset taxes of
approximately $1,700,000 of DCA which resulted from the sale of its Florida
dialysis operations.
A substantial portion of the Company's outstanding borrowings are tied
to the prime interest rate. The prime rate was 7.75% at December 31, 1998 and
8.25% at December 31, 1997.
1997 COMPARED TO 1996
Consolidated revenues increased by approximately $9,400,000 (27%) in
1997 compared to the previous year. Sales revenues increased by $9,208,000 (31%)
compared to the preceding year. 1997 revenues included a $4,431,000 gain on the
sale of certain assets of DCA's subsidiaries with 1996 having included a
$1,521,000 gain on securities offering of DCA, and a gain of $2,584,000 on the
sale of marketable securities attributable to the sale of Viragen (a former sub-
sidiary of the Company) common stock for which the carrying value had been
written-off in previous periods. See Note 2 to "Notes to Consolidated Financial
Statements." Other income decreased by $273,000 for 1997 compared to the
26
previous year which included $140,000 from a litigation settlement and $228,000
on the Viragen note recovery.
Techdyne sales increased approximately $8,903,000 (37%) for the year
ended December 31, 1997 compared to the preceding year. The increase was
attributable principally to the inclusion of sales
by Lytton totaling $7,170,000 since August 1, 1997. There was an increase in
domestic sales of $12,184,000 (87%) that was offset by a decrease in European
sales of $3,281,000 (33%) compared to the same period of the preceding year. The
decrease in European-based sales was largely attributable to a decrease of
approximately $5,580,000 in sales to Compaq which was partially offset by sales
to new and existing customers.
Approximately 63% of Techdyne's consolidated sales and 54% of the
Company's consolidated sales for 1997 were made to six customers. Customers
generating in excess of 10% of Techdyne's consolidated sales with their
respective portions of Techdyne's and the Company's consolidated sales include
IBM which accounted for 19% and 17% and EMC and its related suppliers for 10%
and 8%, respectively. Approximately $2,727,000 (38%) of Lytton's sales since its
acquisition by Techdyne on July 31, 1997 were to its major customer. Significant
reductions in sales to any of Techdyne's major customers would have a material
effect on the Company's results of operation if such sales are not replaced.
Revenues of Techdyne's Scottish-based subsidiary Techdyne (Scotland)
continue to be highly dependent on sales to Compaq, which accounted for
approximately 42% and 84% of the sales of Techdyne (Scotland) for 1997 and 1996,
respectively. The bidding for Compaq orders has become more competitive which
has resulted in substantially reduced Compaq sales and lower profit margins on
remaining Compaq sales. Techdyne (Scotland) is pursuing new business development
and has offset some of the lost Compaq business with sales to other customers
and is also continuing cost reduction efforts to remain competitive on Compaq
business. However, there can be no assurance as to the success of such efforts.
Medical product sales revenues decreased by approximately $304,000
(18%) for 1997 compared to the previous year. The decrease reflected lost
revenues from All American Medical & Supply Corp. ("All American"), the
Company's home healthcare durable subsidiary which discontinued operations in
March, 1997.
Medical services revenues, represented by the revenues of the Company's
dialysis division, DCA, increased approximately $544,000 (14%) for the year
ended December 31, 1997 compared to the preceding year. This growth was largely
attributable to increased revenues of approximately $533,000 at the Company's
Lemoyne, Pennsylvania facility, which commenced operations in June 1995 and
$329,000 from a new dialysis center located in Carlisle, Pennsylvania, which
commenced operations in July 1997. These increased revenues were offset by
approximately $312,000 of lost revenues from the sale of the Company's Florida
dialysis operations on October 31, 1997. Although the operations of the new
Carlisle center have resulted in additional revenues during 1997, it is in the
developmental stage and, accordingly, its operating results will likely
adversely affect the Company's results of operations until they achieve a
sufficient patient count to cover fixed operating costs.
Cost of goods sold as a percentage of consolidated sales remained
relatively stable, increasing to 83% for the year ended December 31, 1997
compared to 82% for the preceding year. The net increase in cost of goods sold
is primarily attributable to the reasons noted above for fluctuations in sales.
27
Cost of goods sold for Techdyne as a percentage of sales remained
relatively stable, increasing to 87% for the year ended December 31, 1997
compared to 86% for the preceding year. The net increase in cost of goods sold
is primarily attributable to the reasons noted above for fluctuations in sales.
Cost of goods sold by the medical products division decreased to 63%
for 1997 compared to 68% for the preceding year, which reflects relatively low
margins in 1996 for the Company's medical durable subsidiary, All American in
the preceding year. The Company decided to shutdown the medical durable subsidi-
ary during the first quarter of 1997 due to its unprofitable operations.
Selling, general and administrative expenses increased $404,000 for
1997 compared to the preceding year. This increase reflected the selling,
general and administrative expenses of Lytton commencing August 1, 1997
($730,000) after Lytton was acquired by Techdyne on July 31, 1997, as well as
substantially increased operations of Techdyne's Round Rock, Texas and
Massachusetts facilities. The increase also reflected DCA's opening of a new
Pennsylvania dialysis center in Carlisle and its expansion of the facility in
Lemoyne, Pennsylvania, which was offset by the decline in costs resulting from
DCA's sale of its Florida dialysis operations on October 31, 1997 and the
shutdown of All American ($652,000 including shutdown costs of approximately
$305,000). Included in 1997 was stock compensation expense that occurred during
the fourth quarter of 1997 in the amount of $322,000 in conjunction with
forgiveness of notes from option exercises of DCA common stock compared to a
similar expense of $344,000 in the preceding year.
Interest expense increased by approximately $175,000 for 1997 compared
to the preceding year. This increase included interest of $100,000 associated
with Techdyne's financing of the Lytton acquisition and interest from Lytton's
financing and debt agreements of $71,000.
The Company recorded an adjustment to the valuation allowance relating
to its deferred tax assets of approximately $700,000 in the fourth quarter of
1997 which offset taxes of approximately $1,700,000 of DCA which resulted from
the sale of its Florida dialysis operations.
A substantial portion of the Company's outstanding borrowings are tied
to the prime interest rate. The prime rate was 8.50% at December 31, 1997 and
8.25% at December 31, 1996.
During 1998, the Company adopted the provisions of Financial Accounting
Standards Board Statements No. 130, "Reporting Comprehensive Income" and No.
131, "Disclosure About Segments of an Enterprise and Related Information." The
adoption of FAS 130 and FAS 131 did not have a material effect on the Company's
consolidated financial statements and did not significantly change its segment
reporting disclosures. See Note 1 to "Notes to Consolidated Financial State-
ments."
LIQUIDITY AND CAPITAL RESOURCES
Working capital totaled $15,421,000 at December 31, 1998, which
reflected a decrease of $3,436,000 (18%) during 1998. Included in the changes in
components of working capital was a decrease of $3,805,000 in cash and cash
equivalents, which included net cash used in operating activities of $28,000
(including a decrease in income taxes payable of $1,356,000 largely from tax
payments on the gain on the Florida dialysis operations sale), net cash used in
investing activities of $3,397,000 (including funds used for redemption of
minority interest of dialysis subsidiaries of $385,000, additions to property,
plant and equipment of $1,776,000, additional consideration of $154,000
regarding the Lytton acquisition, $253,000 proceeds from the sale of securities,
and an advance of $1,278,000 toward the Lytton stock price guarantee) and net
cash used in financing activities of $380,000 (including stock
28
purchases of $205,000, borrowings on Techdyne's line of credit of $600,000 to
fund the advance on the subsidiary acquisition price guarantee, borrowings under
Lytton's line of credit of $414,000, and payments on long-term debt of
$1,082,000).
Techdyne has a five-year $1,500,000 ("notional amount under interest
rate swap agreement") commercial term loan with monthly principal payments of
$25,000 plus interest at 8.60%, which had an outstanding balance of $1,200,000
at December 31, 1998 and $1,500,000 at December 31, 1997; and a $1,600,000
commercial revolving line of credit with interest at prime which was fully drawn
down as of December 31, 1998 with an outstanding balance of $1,000,000 as of De-
cember 31, 1997. The commercial term loan matures December 15, 2002 and the
commercial line of credit, no longer a demand line, matures May 1, 2000. See
Note 3 to "Notes to Consolidated Financial Statements."
Techdyne had obtained in 1996 two other term loans from its Florida
bank. One is a $712,500 term loan, which had a remaining principal balance of
$636,000 at December 31, 1998 and $663,000 at December 31, 1997, and is secured
by two buildings and land owned by the Company. The second term loan for
$200,000, which had a remaining principal balance of $87,000 at December 31,
1998 and $127,000 at December 31, 1997, is secured by the Techdyne's tangible
personal property, goods and equipment. The Company has guaranteed these loans
and subordinated the intercompany indebtedness due it from Techdyne, provided
that Techdyne may make payments to the Company on this subordinated debt from
additional equity that is injected into the Techdyne and from earnings.
See Note 3 to "Notes to Consolidated Financial Statements."
Techdyne has outstanding borrowings of $145,000 from a local bank
with interest payable monthly with the note, which was renewed during 1997,
maturing April 2000. Techdyne (Scotland) had a line of credit with a Scottish
bank, with a U.S. dollar equivalency of approximately $330,000 at December 31,
1997 that was secured by assets of Techdyne (Scotland) and guaranteed by the
Techdyne. This line of credit, which was not renewed, operated as an overdraft
facility. No amounts were drawn on this line of credit during 1998 and no
amounts were outstanding at December 31, 1997. In July, 1994 Techdyne (Scotland)
purchased the facility housing its operations for approximately $730,000,
obtaining a 15-year mortgage which had a U.S. dollar equivalency of
approximately $545,000 at December 31, 1998 and $569,000 at December 31, 1997,
based on exchange rates in effect at each of these dates. See Note 3 to "Notes
to Consolidated Financial Statements."
On July 31, 1997, the Techdyne acquired Lytton, which is engaged in the
ma