SCARY, VERY SCARY. WE COULD SEE LEVELS UNDER $1.00
November 14, 1997
ISOLYSER CO INC /GA/ (OREX)
Quarterly Report (SEC form 10-Q)
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
RESULTS OF OPERATIONS
Net sales for the three months ended September 30, 1997 (the "1997 Quarter") were $41.9 million compared to $42
million for the three months ended September 30, 1996 (the "1996 Quarter"). Net sales for the nine months ended
September 30, 1997 (the "1997 Period") were $124.3 million compared to $123 million for the nine months ended
September 30, 1996 (the "1996 Period"), an increase of 1.1%. Net sales during the 1997 Quarter and 1997 Period
over the corresponding periods of 1996 reflect the 7.3% and 13.6% increase in sales of procedure trays and related
products, respectively, the 7.1% and 10.2% increase in sales of specialty drape and related products, respectively,
and the 15.5% and 8.6% increase in sales of safety products, respectively. The Company believes that increased
sales for procedure trays, safety products and specialty drapes are primarily attributable to a combination of new
business development and increased product usage by existing customers. Management anticipates that sales of
procedure trays and related products will be adversely affected during the fourth quarter by the Company's
implementation of and conversion to an upgraded manufacturing system at the Company's procedure tray operation
during the fourth quarter of 1997, which is the continuation of an implementation process begun in the third quarter
of 1997. Sales of the Company's pack and gown products declined 26.1% and 24.8% during the 1997 Quarter and
1997 Period over the corresponding periods of the previous year, respectively. The decline in sales of pack and
gown healthcare products is attributable in significant part to the acquisition in July, 1996 of Sterile Concepts, a
significant customer of the Company, by Maxxim, which is a product competitor of the Company in the pack and
gown business. While Sterile Concepts remains contractually obligated to purchase from the Company a yearly
minimum of $5.1 million of products until June 30, 1998, such acquisition is expected to continue to adversely affect
the Company's sales for the remainder of 1997 and future periods. The Company also attributes its reduced sales
of pack and gown products to a declining market for the Company's pack and gown products.
As the Company previously reported in its Annual Report, the State of California is reviewing the regulatory
restrictions currently in effect on customer landfilling of LTS-treated waste in California. The Company has also
been made aware that other states, including Florida and Georgia, are reviewing regulatory restrictions applicable
on customer landfilling of LTS-treated waste in those states, possibly as a result of certain efforts of a product
competitor. To date, these regulatory review processes have had no discernable impact on sales of safety products.
In the event such processes result in further restrictions on the landfilling of such waste, such restrictions could
adversely affect the Company's sales of LTS. Gross margin on sales of LTS for the 1997 Quarter and Period were
in excess of 10% of corporate gross margin for such periods.
Included in the foregoing sales figures are $1.5 million in sales of OREX Degradables during the 1997 Quarter and
$5.5 million during the 1997 Period, unchanged from the corresponding periods of 1996. Management believes that
this flat growth rate in OREX Degradable sales is
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attributable to having only a small group of hospitals converted to using degradable versus traditional product and
that the Company's ability to convert additional hospitals to degradable products has been adversely affected by
product performance and quality concerns and delays in bringing OREX catalog items to market. The Company
does not yet manufacture for commercial sale OREX Degradables film (and related laminates of OREX film products
with non-woven products) or thermoformed and extruded products (such as bowls and basins). Sales of OREX
Degradables during the 1997 Quarter and Period did not contribute any gross profits to the Company's operating
results. Management believes the Company will continue to fail to receive profitable margins on sales of OREX
Degradables pending a combination of selling OREX in greater volumes, the operation of the Company's OREX
manufacturing plants at higher efficiencies and increasing the unit price for OREX Degradables to an amount which
takes into account the disposal cost savings provided by such products. The Company is undertaking a thorough
review and analysis of the market position of its OREX Degradables and related modifications to its OREX
operations and growth plans, and has accordingly deemphasized the Company's sales efforts on OREX products on
a temporary basis. The Company's future performance will depend to a substantial degree upon market acceptance
of and the Company's ability to successfully manufacture, market, deliver and expand its OREX Degradables line of
products at acceptable profit margins. The Company's ability to achieve such objectives is subject to a number of
risks described in the Company's Annual Report including, without limitation, those described in such Annual Report
under "Risk Factors - Risks of New Products" and "-Manufacturing and Supply Risks".
At September 30, 1997, the Company recorded $44.6 million of inventory on its balance sheet, net of a reserve of
$23.5 million for excess, slow moving and obsolete inventory. Based on information available to the Company (such
as, without limitation, the quality and aging of and current sales rates for the Company's inventories, their expected
useful life, and existing reserves recorded with respect to such inventory) and judgments and estimates made by the
Company concerning future events (such as, without limitation, the prices and volumes at which the Company will be
able to dispose of such inventory), the Company regularly evaluates the net amounts recorded by the Company for
its inventory to ensure that such amount fairly states the value of such inventory in accordance with generally
accepted accounting principles. The ability of the Company to make accurate judgments and estimates necessary to
establish the fair value of its inventory is inherently subject to certain risks which are exacerbated in the case of the
Company's OREX inventories by the novel aspects of the Company's OREX products and absence of a significant
prior operating history with respect to such products. Various of these risks are described in the Company's Annual
Report including, without limitation, those described in such Annual Report under "Risk Factors - Risks of New
Products" and "Manufacturing and Supply Risks". As a part of the Company's processes for recording the net value
of the Company's inventories at September 30, 1997, the Company recorded a $13.0 million reserve for potentially
excess OREX inventories.
Gross profit (loss) for the 1997 Quarter and 1997 Period was ($4.6) million and $14.0 million, respectively,
compared to $10.3 million and $34.5 million for the 1996 Quarter and 1996 Period, respectively. Included in cost of
goods sold for the 1997 Quarter and Period is the aforementioned reserve of $13.0 million for potentially excess
inventories. Exclusive of such
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reserve, gross profit for the 1997 Quarter and Period would have been $8.4 million and $27.0 million, respectively.
Included in cost of goods sold for the 1996 Quarter and Period are charges of $531,000 for inventory shrinkage
related to product quality deficiencies in the OREX non-woven manufacturing operation, and a $1 million reserve for
slow moving and potentially obsolete inventory throughout the Company. In addition to the impact of nonrecurring
charges for inventory reserves, the decline in gross margin is primarily due to excess capacity of the Company's
Abbeville and Arden OREX manufacturing facilities. During the latter portions of 1996, the Company reduced
production at its Abbeville and Arden manufacturing plants to more closely align production with product demand.
During the 1997 Quarter and 1997 Period, the Company sold product from existing inventory, increasing excess
capacities and further negatively affecting margin. Pending increased utilization of the Company's existing
manufacturing capacity at its Abbeville and Arden manufacturing plants, the overhead of the Company incurred
through such plants will continue to negatively impact profit margin. In an effort to improve short-term operating
results and cash flow, the Company has decided to explore the possibilities of converting a portion of these
capacities to manufacture on a short-term basis traditional woven and non-woven products such as polyester and
polypropolene. The Company does not anticipate entering into long-term manufacturing commitments for traditional
products. So long as the Company does not enter into long-term manufacturing commitments for traditional
products, any such conversion should not affect the ability of the Company to satisfy its requirements for OREX
Degradable products. There can be no assurances that the Company will be able to increase utilization of the
Company's manufacturing capacity at its Abbeville and Arden manufacturing plants, either for the manufacture of
OREX Degradables or traditional products. Gross margin was negatively affected by other factors during the 1997
Quarter and Period, as compared to comparable periods in 1996. These other factors include a decline in sales by
the Company's pack and gown operations as a result of the loss of a significant customer and a general decline in
that business which created excess capacity, and start-up expenses incurred by the Company and excess capacity
associated with its Jacksonville distribution and manufacturing facility and its Empalme, Mexico manufacturing facility.
Consistent with Statement of Financial Accounting Standards No. 121, "Accounting for the Impairment of Long-Lived
Assets and Long-Lived Assets to be Disposed of," the Company has reviewed the carrying value of the Company's
Abbeville and Arden manufacturing plants. Based on forecasted usage of such plants, the Company believes that it
would be inappropriate under generally accepted accounting principles to record any impairment charges with
respect to such assets. If, however, the Company were in the future to determine to dispose of such assets or new
information or improved judgments resulted in a reduction of the Company's forecasted usage of such plants
causing the plants to be considered to be impaired, the Company would be required to record an impairment loss
equal to the excess of the carrying value of such assets over their fair value, thereby adversely affecting operating
results.
Selling and marketing expenses were $6.3 million or 15.1% of net sales in the 1997 Quarter compared to $7.2
million or 17.1% of net sales in the 1996 Quarter. Selling and marketing expenses were $19.9 million or 16.0% of net
sales in the 1997 Period compared to $20.2 million
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or 16.5% of net sales in the 1996 Period. The decrease during the 1997 Quarter is a result of decreased salaries
and benefits associated with reducing the Company's sales and marketing personnel.
General and administrative expenses were $3.8 million or 9.2% of net sales in the 1997 Quarter compared to $3.5
million or 8.3% of net sales in the 1996 Quarter. General and administrative expenses were $11.3 or 9.1% of net
sales in the 1997 Period compared to $9.9 million or 8.0% of net sales in the 1996 Period. The increase in general
and administrative expenses was primarily attributed to costs related to several software and hardware installations,
and costs related to the Company's corporate office.
Research and development expenses were $595,000 or 1.4% of net sales in the 1997 Quarter compared to
$580,000 or 1.4% of net sales in the 1996 Quarter. Research and development expenses were $2.0 million or 1.6%
of net sales in the 1997 Period compared to $1.5 million or 1.2% of net sales in the 1996 Period. The increase in
research and development expense was primarily attributed to the Company's development of fiber and
compounding technology.
Amortization of intangibles in the 1997 Quarter and 1996 Quarter was $961,000 and $1.1 million, respectively.
Amortization of intangibles in the 1997 Period and 1996 Period was $2.9 million and $3.2 million, respectively.
The resulting loss from operations during the 1997 Quarter was $16.3 million as compared to loss from operations
of $6.7 million during the 1996 Quarter. Loss from operations was $22.1 million for the 1997 Period as compared to
loss from operations of $5.1 million during the 1996 Period. Included in loss from operations during the 1997
Quarter and Period is $13.0 million in inventory reserves. Included in loss from operations during the 1996 Quarter
and Period are $1.5 million in inventory write-offs and reserves, $1.4 million in restructuring charges associated with
the Microtek merger and $3.2 million in the 1996 Quarter and $3.3 million in the 1996 Period of nonrecurring costs
associated with such merger. After excluding these non-recurring expenses, the resulting loss from operations for
the 1997 Quarter was $3.3 million compared to $500,000 for the 1996 Quarter, and $9.1 million in the 1997 Period
compared to operating income in the 1996 Period of $1.2 million.
Interest income was $118,000 in the 1997 Quarter compared to $337,000 in the 1996 Quarter, and $458,000 in the
1997 Period compared to $1.5 million in the 1996 Period. The decrease in interest income is primarily attributed to a
reduction of the Company's cash position as a result of the acquisition of OREX Degradable inventory and
manufacturing capabilities during 1996.
Interest expense was $946,000 in the 1997 Quarter compared to $689,000 in the 1996 Quarter, and $3.0 million in
the 1997 Period compared to $1.9 million in the 1996 Period. The increase in interest expense is primarily attributed
to the Company's acquisition of OREX Degradable inventory and manufacturing capabilities during 1996.
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Provision for income taxes reflect an expense for the 1997 Quarter of $6,000 compared to a tax benefit of $489,000
for the 1996 Quarter. The provision for income taxes reflects an expense for the 1997 Period of $17,000 as
compared to an expense of $228,000 for the 1996 Period.
The resulting net loss was $17.2 million for the 1997 Quarter compared to net loss of $7.1 million for the 1996
Quarter. The net loss was $24.7 million for the 1997 Period as compared to net loss of $6.4 million for the 1996
Period.
LIQUIDITY AND CAPITAL RESOURCES
At September 30, 1997, the Company's cash and equivalents totaled $9.5 million as compared to $20.9 million at
December 31, 1996.
During the 1997 Period, the Company generated $594,000 of cash in operating activities as compared to a cash
use of $23.7 million in the 1996 Period. Cash generated during the 1997 Quarter and Period is primarily attributable
to better management of working capital. The Company used $4.3 million in investing activities during the 1997
Period, primarily for several computer hardware and software implementations, as compared to $22.1 million used in
investing activities during the 1996 Period. During the 1997 Period, the Company used $7.8 million in cash for
financing activities as compared to cash provided by financing activities of $13.1 million during the 1996 Period. The
Company's use of cash during the 1997 Period for financing activities is primarily due to a net reduction of debt of
$8.9 million between December 31, 1996 and September 30, 1997.
As more fully described in the Company's Annual Report, the Company has a $55 million credit agreement (the
"Credit Agreement") consisting of a $40 million revolving credit facility maturing on August 31, 1999 and a $15
million term loan facility maturing on August 31, 2001. Current additional borrowing availability under the revolving
credit facility at September 30, 1997 was approximately $8.6 million. Outstanding borrowings under the revolving
credit facility were approximately $24.5 million at September 30, 1997. Outstanding borrowings under the term loan
facility were $13 million at September 30, 1997. The Credit Agreement provides for the issuance of up to $3 million
in letters of credit. Outstanding letters of credit were $50,000 at September 30, 1997. At September 30, 1997, the
Company was in violation of covenants contained in the Credit Agreement concerning net income and net worth
primarily as a result of additional inventory reserves recorded at September 30, 1997. The Company has requested
but has not yet received a waiver from its lenders with respect to such violation and has accordingly classified its
indebtedness under the Credit Agreement as short-term debt in the accompanying balance sheet. No assurances
can be provided that the Company will obtain a waiver of the covenant violations, and the failure to obtain such
waiver would have a material adverse effect upon the Company. At September 30, 1997, outstanding indebtedness
under the Credit Agreement exceeded the Company's cash and cash equivalents. The Company has violated
certain financial covenants contained in its Credit Agreement in its prior three fiscal quarters and obtained waivers
of such violations. No assurances can be provided that violations of covenants contained in the Company's Credit
Agreement will not occur in the future or, if such violations occur, that those violations will be waived. In addition,
such Credit Agreement
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currently requires the Company to operate during 1998 on a monthly basis with a positive net income. While the
Company's lenders have agreed to discuss with the Company a modification of such covenant, no assurances can
be provided that such covenant will be modified or that the Company will not default in the future under its Credit
Agreement. Any unwaived default by the Company under the Credit Agreement would be expected to have a
material adverse effect upon the Company.
Based upon its current business plan and assuming the continued availability of its existing credit facility, the
Company currently expects that cash equivalents and short term investments on hand, the Company's existing
credit facility and funds budgeted to be generated from operations will be adequate to meet its liquidity and capital |
