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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended JUNE 30, 2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
--------- ----------
Commission File Number: 000-20997
SRI/SURGICAL EXPRESS, INC.
(Exact name of Registrant as specified in its Charter)
Florida 59-3252632
(State of Incorporation) (I.R.S. Employer
Identification No.)
12425 Race Track Road
Tampa, Florida 33626
(Address of Principal Executive Offices)
(813) 891-9550
(Registrant's Telephone Number)
Indicate by check 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 [ ]
Number of outstanding shares of each class of Registrant's Common Stock as
of July 31, 2002:
Common Stock, par value $.001 - 6,423,277
INDEX
Page
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PART I FINANCIAL INFORMATION
Item 1 Condensed Financial Statements
Condensed Statements of Income for the
three months and six months ended June 30,
2002 (unaudited) and June 30, 2001(unaudited)................ 1
Condensed Balance Sheets as of June 30,
2002 (unaudited) and December 31, 2001....................... 2
Condensed Statements of Cash Flows for the
six months ended June 30, 2002 (unaudited)
and June 30, 2001 (unaudited)................................ 3
Notes to Condensed Financial Statements
(unaudited).................................................. 4
Item 2 Management's Discussion and Analysis of Financial
Condition and Results of Operations...................... 7
PART II OTHER INFORMATION
Item 1 Legal Proceedings........................................... 14
Item 2 Changes in Securities....................................... 14
Item 3 Defaults Upon Senior Securities............................. 14
Item 4 Submission of Matters to a Vote of Security Holders......... 14
Item 5 Other Information........................................... 14
Item 6 Exhibits and Reports on Form 8-K............................ 14
SIGNATURE................................................................ 15
PART I - FINANCIAL INFORMATION
Item 1. Condensed Financial Statements
SRI/SURGICAL EXPRESS, INC.
CONDENSED STATEMENTS OF INCOME
(In thousands, except per share data)
(unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
2002 2001 2002 2001
------- ------- ------- -------
(restated) (restated)
Revenues $21,898 $22,469 $43,653 $43,767
Cost of revenues 15,356 15,015 30,853 29,563
------- ------- ------- -------
Gross profit 6,542 7,454 12,800 14,204
Distribution expenses 1,390 1,339 2,822 2,688
Selling and administrative expenses 3,431 3,183 6,887 5,910
------- ------- ------- -------
Income from operations 1,721 2,932 3,091 5,606
Unrealized gain (loss) on derivative instruments 36 49 101 (173)
Interest expense, net 258 354 496 743
------- ------- ------- -------
Income before income taxes 1,499 2,627 2,696 4,690
Income tax expense 562 1,011 1,011 1,807
------- ------- ------- -------
Income before cumulative effect of change
in accounting policy 937 1,616 1,685 2,883
Cumulative effect of change in accounting policy,
net of tax -- -- -- 113
------- ------- ------- -------
Net income $ 937 $ 1,616 $ 1,685 $ 2,770
======= ======= ======= =======
Dividends on preferred stock -- 5 -- 57
------- ------- ------- -------
Net income available for common shareholders $ 937 $ 1,611 $ 1,685 $ 2,713
======= ======= ======= =======
Income per share-basic:
Income available for common shareholders before
cumulative effect of change in accounting principle $ 0.15 $ 0.26 $ 0.26 $ 0.48
======= ======= ======= =======
Cumulative effect of change in accounting principle $ -- $ -- $ -- $ (0.02)
======= ======= ======= =======
Net income available for common shareholders $ 0.15 $ 0.26 $ 0.26 $ 0.46
======= ======= ======= =======
Income per commom share-diluted:
Income before cumulative effect of change
accounting principle $ 0.14 $ 0.24 $ 0.26 $ 0.44
======= ======= ======= =======
Cumulative effect of change in accounting principle $ -- $ -- $ -- $ (0.02)
======= ======= ======= =======
Net income $ 0.14 $ 0.24 $ 0.26 $ 0.42
======= ======= ======= =======
Weighted average common shares outstanding, basic 6,422 6,160 6,420 5,894
======= ======= ======= =======
Weighted average common shares outstanding, diluted 6,573 6,693 6,596 6,573
======= ======= ======= =======
The accompanying notes are an integral part of these financial statements.
1
SRI/SURGICAL EXPRESS, INC.
CONDENSED BALANCE SHEETS
(In thousands)
June 30, December 31,
2002 2001
----------- -----------
(unaudited)
ASSETS
Cash and cash equivalents $ 535 $ 538
Accounts receivable, net 10,765 11,896
Inventories, net 6,933 6,737
Prepaid expenses and other assets 2,157 2,631
Reusable surgical products, net 27,225 25,554
Property, plant and equipment, net 30,897 30,085
Goodwill, net 5,244 5,244
------- -------
Total assets $83,756 $82,685
======= =======
LIABILITIES AND SHAREHOLDERS' EQUITY
Notes payable to bank $16,221 $17,612
Accounts payable 6,669 6,479
Employee related accrued expenses 983 943
Other accrued expenses 1,329 1,532
Obligation under capital lease 4,510 4,562
Deferred tax liability, net 1,064 1,064
Unrealized loss on derivative instruments -- 589
------- -------
Total liabilities 30,776 32,781
Shareholders' equity
Preferred stock-authorized 5,000,000 shares of
$0.01 par value; no shares issued and outstanding
at June 30, 2002 and 2001 -- --
Common stock-authorized 30,000,000 shares of
$0.01 par value; issued and outstanding 6,423,277
and 6,318,177 shares at June 30, 2002 and December
31, 2001, respectively 6 6
Additional paid-in capital 30,332 28,941
Retained earnings 22,642 20,957
------- -------
Total shareholders' equity 52,980 49,904
------- -------
Total liabilities and shareholders' equity $83,756 $82,685
======= =======
The accompanying notes are an integral part of these financial statements.
2
SRI/SURGICAL EXPRESS, INC.
CONDENSED STATEMENTS OF CASH FLOWS
(In thousands)
(unaudited)
Six Months Ended June 30,
2002 2001
-------- ----------
(restated)
Cash flows from operating activities
Net income $ 1,685 $ 2,770
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation and amortization 1,526 1,339
Amortization of reusable surgical products 1,802 2,080
Provision for reusable surgical products shrinkage 1,088 923
Deferred income taxes -- (115)
Cumulative effect of change in accounting principle -- 182
Unrealized (gain) loss on derivative instruments (101) 173
Change in assets and liabilities:
Accounts receivable, net 1,136 (1,034)
Inventories (196) (119)
Prepaid expenses and other assets 474 (562)
Accounts payable 190 597
Employee related and other accrued expenses 29 (897)
------- -------
Net cash provided by operating activities 7,633 5,337
------- -------
Cash flows from investing activities
Purchases of property, plant and equipment (2,338) (4,057)
Purchases of reusable surgical products (4,566) (1,795)
------- -------
Net cash used in investing activities (6,904) (5,852)
------- -------
Cash flows from financing activities
Net (repayment) borrowing on notes payable to bank (1,391) 528
Repayment of derivative instrument (488) --
Payments on obligation under capital lease (52) --
Net proceeds from issuance of common stock 1,199 36
Dividends paid -- (76)
------- -------
Net cash (used in) provided by financing activities (732) 488
------- -------
Decrease in cash and cash equivalents (3) (27)
Cash and cash equivalents at beginning of period 538 132
------- -------
Cash and cash equivalents at end of period $ 535 $ 105
======= =======
Supplemental cash flow information
Cash paid for interest $ 362 $ 713
======= =======
Cash paid for income taxes $ 451 $ 2,380
======= =======
Supplemental schedule of non-cash activities
Income tax benefit of stock options exercised $ 192 $ --
======= =======
The accompanying notes are an integral part of these financial statements.
3
SRI/SURGICAL EXPRESS, INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS
(unaudited)
1. BASIS OF PRESENTATION
The accompanying unaudited condensed financial statements of SRI/Surgical
Express, Inc. (the "Company") have been prepared in accordance with the
Securities and Exchange Commission's instructions to Form 10-Q and, therefore,
omit or condense footnotes and certain other information normally included in
financial statements prepared in accordance with accounting principles generally
accepted in the United States. The accounting policies followed for quarterly
financial reporting conform with accounting principles generally accepted in the
United States for interim financial statements and include those accounting
policies disclosed in the Company's Form 10-K for the year ended December 31,
2001 filed with the Securities and Exchange Commission. In the opinion of
management, all adjustments of a normal recurring nature that are necessary for
a fair presentation of the financial information for the interim periods
reported have been made. The results of operations for the three and six months
ended June 30, 2002 are not necessarily indicative of the results that can be
expected for the entire year ending December 31, 2002. The unaudited financial
statements should be read in conjunction with the financial statements and the
notes thereto included in the Form 10-K.
The Company operates on a 52-53 week fiscal year ending the Sunday nearest
December 31. There are 26 weeks included for the six month periods ended June
30, 2002 and June 30, 2001, respectively.
The condensed statements of income and cash flows for the three and six
months ended June 30, 2001 have been restated for the effect of derivative
financial instruments recognized during the fourth quarter of 2001, as
previously disclosed.
2. LINE OF CREDIT
The Company's outstanding balance under its $45.0 million revolving credit
facility was approximately $16.2 million and $17.6 million on June 30, 2002 and
December 31, 2001, respectively.
The revolving facility is secured by substantially all of the Company's
assets and has a maturity date of June 30, 2003. The facility's interest rate
varies between 225 and 275 basis points over LIBOR (1.836% as of June 30, 2002),
depending on the Company's leverage. The credit facility requires the Company to
maintain (a) minimum net worth of not less than $37.0 million plus 75% of
cumulative net income for each fiscal quarter beginning with the fiscal quarter
ending March 31, 2000; (b) a leverage ratio of not more than 2.5 to 1.0; and (c)
a fixed charge coverage ratio of 2.25 to 1.0 through December 31, 2002, and 2.35
to 1.0 thereafter. The credit facility restricts the Company in paying
dividends, engaging in acquisition transactions, incurring additional
indebtedness, and encumbering its assets. The Company complied with all
requirements of the credit facility as of June 30, 2002.
The revolving credit facility allows the Company to repurchase up to $5
million of its stock from time to time through open market purchases at
prevailing market prices. As of June 30, 2002, the Company had repurchased
75,400 shares of its common stock, valued at approximately $1.1 million. The
Company has not repurchased shares since the first quarter of 2001, but has
resumed repurchasing shares in the third quarter of 2002.
3. EARNINGS PER SHARE
The following table sets forth the Company's computation of basic and
diluted earnings per share before the cumulative effect of a change in
accounting policy:
4
Three Months Ended Six Months Ended
June 30, June 30,
-------------------- -------------------
2002 2001 2002 2001
------- ---------- ------ ----------
(restated) (restated)
(In thousands, except per share data)
(unaudited)
Basic
Numerator:
Income before cumulative effect of change
in accounting policy $ 937 $1,616 $1,685 $2,883
Less effect of dividends of preferred stock -- (5) -- (57)
------ ------ ------ ------
Income available for common shareholders
before cumulative effect of change in
accounting policy $ 937 $1,611 $1,685 $2,826
====== ====== ====== ======
Denominator:
Weighted average shares outstanding 6,422 6,160 6,420 5,894
====== ====== ====== ======
Income per common share before cumulative
effect of change in accounting policy, basic $ 0.15 $ 0.26 $ 0.26 $ 0.48
====== ====== ====== ======
Diluted
Numerator:
Income before cumulative effect of change
in accounting policy $ 937 $1,616 $1,685 $2,883
====== ====== ====== ======
Denominator:
Weighted average shares outstanding 6,422 6,160 6,420 5,894
Effect of dilutive securities:
Employee stock options 151 471 176 366
Convertible preferred stock -- 62 -- 313
------ ------ ------ ------
6,573 6,693 6,596 6,573
====== ====== ====== ======
Income per common share before
cumulative effect of change in accounting
policy, diluted $ 0.14 $ 0.24 $ 0.26 $ 0.44
====== ====== ====== ======
Options to purchase 341,000 and 12,000 shares of common stock for the six
month periods ended June 30, 2002 and June 30, 2001, respectively, were not
included for all or a portion of the computation of diluted net income per
common share, because the options' exercise prices were greater than the average
market price of the common shares and therefore the effect would be
anti-dilutive.
4. IMPLEMENTATION OF SFAS NO. 142, "GOODWILL AND OTHER INTANGIBLE ASSETS" AND
SFAS NO. 144, "ACCOUNTING FOR THE IMPAIRMENT OR DISPOSAL OF LONG-LIVED
ASSETS".
Issued in October 2001, Statement of Financial Accounting Standard ("SFAS")
No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets",
replaces SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and
for Long-Lived Assets to be Disposed Of". The accounting model for long-lived
assets to be disposed of by sales applies to all long-lived assets, including
discontinued operations, and replaces the provisions of APB Opinion No. 30,
"Reporting Results of Operations - Reporting the Effects of Disposal of a
Segment of a Business" for the disposal of segments of a business. SFAS No. 144
requires that those long-lived assets be measured at the lower of the carrying
amount or fair value less cost to sell, whether reported in continuing
operations or in discontinued operations. Therefore, discontinued operations
will no longer be measured at net realizable value or include amounts for
5
operating losses that have not occurred. SFAS No. 144 also broadens the
reporting for discontinued operations to include all components of an entity
with operations that can be distinguished from the rest of the entity and that
will be eliminated from the ongoing operations of the entity in a disposal
transaction. The Company adopted the provisions of SFAS No. 144 on January 1,
2002. The adoption did not materially affect the results of operations,
financial position or cash flows of the Company.
Effective January 1, 2002, the Company adopted SFAS No. 142, "Goodwill and
Other Intangible Assets". SFAS No. 142 required the Company to test goodwill and
indefinite-lived tangible assets for impairment rather than amortize them. The
Company completed the impairment analysis of goodwill on June 30, 2002, and
concluded that no impairment charge was necessary. The following table provides
information relating to the Company's goodwill as of June 30, 2002 (in
thousands):
Accumulated
Cost Amortization
----- ------------
Goodwill 6,018 774
Pro forma results for the three and six months ended June 30, 2001,
assuming the discontinuation of amortization of goodwill, are as follows (in
thousands except per share amounts):
Three months Six months
------------ ----------
Ended June 30, 2001
-------------------------
(unaudited)
Reported net income $1,616 $2,770
Goodwill amortization, net of taxes 34 68
------ ------
Adjusted net income $1,650 $2,838
====== ======
6
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Overview
The Company provides hospitals and surgery centers with a comprehensive
surgical procedure-based delivery and retrieval service for reusable gowns,
towels, drapes, basins, and instruments, and provides other disposable products
necessary for surgery. From 11 reprocessing facilities and one disposable
products facility, the Company collects, sorts, cleans, inspects, packages,
sterilizes and delivers its reusable products on a just-in-time basis. The
Company offers an integrated "closed-loop" reprocessing service that uses two of
the most technologically advanced reusable textiles: (i) a GORE(R) Surgical
Barrier Fabric for gowns and drapes that is breathable yet liquidproof and
provides a viral/bacterial barrier and (ii) an advanced microfiber polyester
surgical fabric for gowns and drapes that is liquid and bacterial resistant. The
Company also offers state of the art reusable laparoscopic instruments from
Aesculap, Inc., one of the oldest and largest worldwide suppliers of surgical
instruments. The surgical instruments have been designed either to be taken
apart or with flush ports to allow complete cleaning and decontamination.
The Company's Surgical Express(R) program uses daily delivery and retrieval
to provide customers an expanded program of products and services. Surgical
Express is an outsourced Surgical Case Cart Management Program that the Company
expects will reduce hospital and surgery centers' processing costs and their
investment in surgical products. With its Surgical Express program, the Company
supplements its core reusable products offering with disposable accessory packs
containing smaller surgical items that are not reusable, such as needles,
syringes, and tubing. The Company also offers customers its complete
procedure-based service, Surgical Express for Laparoscopy, which combines the
Company's core reusable products offering with disposable products and
laparoscopic instruments required for laparoscopic surgical procedures.
Aesculap, Inc. furnishes laparoscopic instruments for this program under a joint
marketing arrangement with the Company. The Company continues to introduce
additional instrument procedures. As of June 30, 2002, the Company was servicing
over 40 instrument projects from eight of its facilities. The Company believes
that its unique product and service offerings improve its competitive position
in the marketplace.
The Company's contract with HealthTrust Purchasing Group (HPG), a group
purchasing organization (GPO) representing over 600 hospitals and surgery
centers, designates the Company as its primary outsource vendor for reusable
surgical products, including instruments. In addition, through its relationship
with Standard Textile Co., Inc., the Company has the opportunity to provide
Surgical Express to Novation member hospitals. With its acceptance by HPG and
Novation, Surgical Express is an available contracted alternative for over 2,000
hospitals and surgery centers across the country. The Company continues to
pursue additional group purchasing organization contracts that will allow it to
further penetrate the surgical supply market.
The Company in 2001 made investments in staff, facility expansions, and
additional reusable surgical products in anticipation of revenue growth, but
more recently has endured a period in which its rate of revenue growth has been
affected by the competitive market for its products and services, as well as
delays and obstacles in securing new customers. The Company's revenues for the
three and six months ended June 30, 2002 were below management's expectations.
Because of these delays in revenue growth, management has undertaken cost and
overhead reduction initiatives to bring expenses in line with anticipated
revenues for this year. In the first six months of 2002, the Company incurred
significantly higher insurance and benefit costs that it expects will have an
increasing impact on its results throughout the remainder of 2002.
*GORE(R)Surgical Barrier Fabric is a registered trademark of W.L. Gore &
Associates, Inc.
7
Critical Accounting Policies
The preparation of financial statements and related disclosures in
conformity with accounting principles generally accepted in the United States
requires management to make judgments, assumptions, and estimates that affect
the amounts reported in the Company's financial statements and accompanying
notes. Estimates are used for, but not limited to, the accounting for the
allowance for doubtful accounts, amortization of reusable products, shrinkage
and obsolescence, goodwill impairments, and loss contingencies. Actual results
could differ from these estimates. The following critical accounting policies
are impacted significantly by judgments, assumptions and estimates used in the
preparation of the financial statements.
The allowance for doubtful accounts is based on SRI's assessment of the
collectibility of specific customer accounts and the aging of the accounts
receivable. If there is a deterioration of a major customer's creditworthiness
or actual defaults are higher than historical experience, the Company's
estimates of the recoverability of amounts due could be adversely affected.
The Company states its reusable surgical products at cost and computes
amortization on a basis similar to the units of production method. SRI's
estimates of the useful lives of these products are based on the estimated total
number of available uses for each product. The expected total available usage
for the Company's products using the three principal fabrics (accounting for 85%
of its products) is 75, 100, and 125 uses based on several factors, including
the Company's actual experience with these products over the past ten years. If
its actual use experience with these products is shorter than these assumptions,
the Company's amortization rates for reusable products could increase.
SRI determines its reserves for shrinkage and obsolescence of its
reusable products by tracking those products with its bar-coding system. The
Company presumes that any products not scanned by the system for a 210 day
period have been lost. If actual losses exceed these estimates, the Company's
shrinkage reserve would increase.
8
Results of Operations
The following table sets forth for the periods shown the percentage of
revenues represented by certain items reflected in the statement of income of
the Company.
Three Months Ended Six Months Ended
June 30, June 30,
-------------------- ------------------
2002 2001 2002 2001
------- ---------- ----- ----------
(restated) (restated)
Revenues 100.0% 100.0% 100.0% 100.0%
Cost of revenues 70.1 66.8 70.7 67.5
----- ----- ----- -----
Gross profit 29.9 33.2 29.3 32.5
Distribution expenses 6.3 6.0 6.4 6.2
Selling and administrative expenses 15.7 14.2 15.8 13.5
----- ----- ----- -----
Income from operations 7.9 13.0 7.1 12.8
Unrealized gain (loss) on derivative instruments 0.1 0.2 0.2 (0.4)
Interest expense, net 1.2 1.5 1.1 1.7
----- ----- ----- -----
Income before income taxes 6.8 11.7 6.2 10.7
Income tax expense 2.5 4.5 2.3 4.1
----- ----- ----- -----
Income before cumulative effect of change
in accounting policy 4.3 7.2 3.9 6.6
Cumulative effect of change in accounting
policy, net of tax 0.0 0.0 0.0 0.3
----- ----- ----- -----
Net income 4.3% 7.2% 3.9% 6.3%
===== ===== ===== =====
Three and Six Months Ended June 30, 2002 Compared to Three and Six Months Ended
June 30, 2001
Revenues. Revenues decreased $571,000, or 2.5%, to $21.9 million in the
three months ended June 30, 2002, from $22.5 million in the three months ended
June 30, 2001. In the six months ended June 30, 2002, the Company's revenues
decreased $114,000, or 0.3%, to $43.7 million, from $43.8 million in the six
months ended June 30, 2001. Revenue from new customers in 2002 only partially
offset business lost in the second half of last year. Additionally, the Company
continued to develop new sales slower than expected.
Gross Profit. Gross profit decreased $912,000, or 12.2%, to $6.5 million in
the three months ended June 30, 2002, from $7.5 million in the three months
ended June 30, 2001; and $1.4 million, or 9.9%, to $12.8 million in the six
months ended June 30, 2002, from $14.2 million in the six months ended June 30,
2001. As a percentage of revenues, gross profit decreased by 3.3% to 29.9% in
the three months ended June 30, 2002, from 33.2% in the three months ended June
30, 2001; and decreased 3.2% to 29.3% in the six months ended June 30, 2002,
from 32.5% in the six months ended June 30, 2001.
9
The decrease in gross profit sales and resolution of a contract issue and
negotiation of a new, expanded relationship with a customer. The Company
instituted cost cutting measures in the second quarter, reducing its overhead.
Distribution Expenses. Distribution expenses increased $51,000, or 3.8%, to
$1.4 million in the three months ended June 30, 2002, from $1.3 million in the
three months ended June 30, 2001; and $134,000, or 5.0%, to $2.8 million in the
six months ended June 30, 2002, from $2.7 million in the three months ended June
30, 2001. As a percentage of revenues, distribution expenses increased by 0.3%
to 6.3% in the three months ended June 30, 2002, from 6.0% in the three months
ended June 30, 2001; and by 0.2% to 6.4% in the six months ended June 30, 2002,
from 6.2% in the six months ended June 30, 2001. The increase in distribution
expenses resulted primarily from increased vehicle lease expense.
Selling and Administrative Expenses. Selling and administrative expenses
increased $248,000, or 7.8%, to $3.4 million in the three months ended June 30,
2002, from $3.2 million in the three months ended June 30, 2001; and increased
$977,000, or 16.5%, to $6.9 million in the six months ended June 30, 2002, from
$5.9 million in the six months ended June 30, 2001. As a percentage of revenues,
selling and administrative expenses increased 1.5% to 15.7% in the three months
ended June 30, 2002, from 14.2% in the three months ended June 30, 2001; and
increased 2.3% to 15.8% in the six months ended June 30, 2002, from 13.5% in the
six months ended June 30, 2001. The Company's selling and administrative
expenses increased due to significant legal fees incurred in pending legal
proceedings and marketing and administrative fees for GPO contracts.
Income from Operations. Income from operations decreased $1.2 million, or
41.3%, to $1.7 million in the three months ended June 30, 2002, from $2.9
million in the three months ended June 30, 2001; and decreased $2.5 million, or
44.9%, to $3.1 million in the six months ended June 30, 2002, from $5.6 million
in the six months ended June 30, 2001. As a percentage of revenues, income from
operations decreased 5.1% to 7.9% for the three months ended June 30 2002, from
13.0% for the three months ended June 30, 2001; and decreased 5.7% to 7.1% for
the six months ended June 30, 2002, from 12.8% for the six months ended June 30,
2001.
Derivative Instruments. Pursuant to SFAS No. 133, the Company in the three
months ended June 30, 2002 and June 30, 2001 recognized current unrealized gains
of $36,000 and $49,000, respectively, on two interest rate swaps of a third
party that it guaranteed, and for the six months ended June 30, 2002 recognized
a current unrealized gain of $101,000 on these swaps, compared to an unrealized
loss of $173,000 recognized for the six months ended June 30, 2001. See --
"Liquidity and Capital Resources." The swaps were terminated in April 2002.
Interest Expense, Net. Interest expense decreased $96,000 to $258,000 in
the three months ended June 30, 2002, from $354,000 in the three months ended
June 30, 2001; and decreased $247,000 to $496,000 in the six months ended June
30, 2002, from $743,000 in the six months ended June 30, 2001, primarily due to
lower interest rates on the Company's credit facility.
Income Tax Expense. Income tax expense decreased $449,000 to $562,000 in
the three months ended June 30, 2002, compared to $1.0 million in the three
months ended June 30, 2001; and decreased $796,000 to $1.0 million in the six
months ended June 30, 2002, from $1.8 million in the six months ended June 30,
2001. The Company's effective tax rate was 37.5%.
Cumulative Effect of Change in Accounting Policy. The Company accrued a
cumulative effect of change in accounting principle of $113,000 in the first six
months of 2001, which is net of tax of $69,000, from initially adopting SFAS 133
on January 1, 2001.
10
Liquidity and Capital Resources
The Company's principal sources of capital have been cash flows from
operations and borrowings under its working capital loan facility.
The Company's positive cash flow provided by operating activities was $7.6
million during the first six months of 2002, compared to $5.3 million during the
first six months of 2001. A substantial reduction in net income before
amortization, provision for shrinkage and depreciation was more than offset by
significant increases in accounts receivable and prepaid expenses.
The Company's net cash used in investing activities increased to $6.9
million in the six months ended June 30, 2002 from $5.9 million in the six
months ended June 30, 2001. These expenditures were funded from cash provided by
operating activities and borrowings under the Company's revolving credit
facility. The increase is primarily due to purchases of reusable surgical
products.
The Company spent $2.4 million in the six months ended June 30, 2002, as it
substantially completed the facility equipment and expansion projects that it
began in 2001. The Company estimates that its expenditures for new carts and
reusable surgical products will be approximately $250,000 per month for the
remainder of the year, although this amount will fluctuate depending on the
growth of business. The Company's purchase requirements are lower than previous
estimates due to the purchase of over $3 million in reusable surgical products
in the second quarter of 2002.
The Company leases two of its processing facilities through a form of
off-balance sheet financing in which a third-party purchased property and leased
the asset to the Company as lessee. Lease payments are based on the
approximately $10.6 million aggregate cost of the facilities and are adjusted as
the LIBOR fluctuates. The lessor's interest rate swaps, which were secured to
reduce the impact of interest rates on the floating rate operating leases, were
terminated in April 2002, thus converting the facilities back to floating rate
leases. The Company's obligations under the leases are secured by a letter of
credit issued by First Union National Bank. When the lease terms end in February
2003, the Company may extend the lease terms, replace them with other leasing
arrangements, or purchase the facilities for their cost (approximately $10.6
million). The Company has not determined which option it will pursue. The
Company reflects rent payments as an expense on its statement of income. If it
purchases the facilities, the Company would reflect the costs as assets on its
balance sheet, its rent expense would terminate, and the Company would record
depreciation expense for the buildings over their estimated useful lives.
The Company's revolving credit facility allows the Company to repurchase up
to $5 million of its stock from time to time through open market purchases at
prevailing market prices. As of June 30, 2002, the Company had repurchased
75,400 shares of its common stock, valued at approximately $1.1 million. The
Company has not repurchased shares since the first quarter of 2001, but has
resumed repurchasing shares in the third quarter of 2002.
As of June 30, 2002, the Company had cash of approximately $535,000. The
Company believes that its cash flows from operating activities and funds
available under its credit facility will be sufficient to fund its growth and
anticipated capital requirements for the next twelve months.
Quantitative And Qualitative Disclosures About Market Risk
The Company's outstanding balance under its $45.0 million revolving credit
facility was approximately $16.2 million and $17.6 million as of June 30, 2002
and 2001, respectively. The credit facility's interest rate varies between 225
and 275 basis points over LIBOR (1.836% as of June 30, 2002), depending on the
Company's leverage. The Company is subject to changes in its interest expense on
this facility based on fluctuations in interest rates. Assuming an outstanding
balance on this credit facility of $17 million, if the LIBOR were to increase
(decrease) by 100 basis points, the Company's interest payments would increase
(decrease) by $42,500 per quarter.
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The lessor of two of the Company's facilities was a party to interest rate
swaps with a notional amount of $9.7 million, which effectively changed the
interest rate exposure on those leases from a floating rate to a fixed rate. In
April 2002, these swap arrangements were terminated. The Company's payments
following termination of these swaps are now determined based on a rate equal to
LIBOR. If the LIBOR were to increase (decrease) by 100 basis points, the
Company's lease payments would increase (decrease) by $24,250 per quarter.
The Company does not have any other material market risk sensitive
instruments.
Certain Considerations
This report, other documents that are publicly disseminated by the Company,
and oral statements that are made on behalf of the Company contain or might
contain both statements of historical fact and forward-looking statements.
Examples of forward-looking statements include: (a) projections of revenue,
earnings, capital structure, and other financial items, (b) statements of the
plans and objectives of the Company and its management, (c) statements of future
economic performance, and (d) assumptions underlying statements regarding the
Company or its business. The cautionary statements set forth below discuss
important factors that could cause actual results to differ materially from any
forward-looking statements. The Company assumes no obligation to update these
forward-looking statements.
Sales Process and Market Acceptance of Products and Services. The Company's
future performance depends on its ability to increase revenues to new and
existing customers. The Company's sales process for new customers is typically
between six and eighteen months in duration from initial contact to purchase
commitment. The extended sales process is typically due to the complicated
approval process within hospitals for purchases from new suppliers, the long
duration of existing supply contracts, and implementation delays pending
termination of a hospital's previous supply relationships. The long sales
process inhibits the ability of the Company to quickly increase revenues from
new and existing customers or enter new markets. The Company's future
performance will also depend on market acceptance of its combination of reusable
surgical products, disposable accessory packs, and direct delivery and retrieval
service.
Need for Capital. The Company's business is capital intensive and will
require substantial capital expenditures for additional surgical products and
equipment during the next several years to achieve its operating and expansion
plans. To adequately service a new customer, the Company typically makes an
investment in new reusable surgical products and carts of approximately 40% of
the projected new annual revenue from the customer. The Company's inability to
obtain adequate capital could have a material adverse effect on the Company. See
- -- "Liquidity and Capital Resources."
New Product Offering; Dependence on a Supplier. The Company is regularly
developing new instrument processing programs. The Company is subject to a risk
that the market will not broadly accept them. Further, the Company relies on
Aesculap, Inc. as its major source of supply of laparoscopic instruments for its
Surgical Express for Laparoscopy program. The Joint Marketing Agreement between
the Company and Aesculap provides for Aesculap to furnish instruments to the
Company for at least three years, subject to terms and conditions stated in the
agreement. Any failure of Aesculap to furnish instruments for any reason would
materially and adversely affect the Company's ability to service this program.
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Dependence on Significant Customers and Market Consolidation. During the
six months ended June 30, 2002, Novation, Premier, Inc., and HPG hospitals
accounted for approximately 34%, 11%, and 14% of the Company's sales, compared
to 32%, 13%, and 13% in the six months ended June 30, 2001, respectively.
Although each Novation, Premier, and HPG hospital currently makes its purchasing
decisions on an individual basis, and no single hospital accounted for more than
6% of the Company's sales, the loss of a substantial portion of the Novation,
Premier, or HPG hospitals' business would have a material adverse effect on the
Company.
Competition. The Company's business is highly competitive. Competitors
include a number of distributors and manufacturers, as well as the in-house
reprocessing operations of hospitals. Certain of the Company's existing and
potential competitors possess substantially greater resources than the Company.
Some of the Company's competitors, including Allegiance Corporation, serve as
the sole supplier of a wide assortment of products to a significant number of
hospitals. While the Company has a substantial array of surgical products, many
of its competitors have a greater number of products for the entire hospital,
which in some instances is a competitive disadvantage for the Company. There is
no assurance that the Company will be able to compete effectively with existing
or potential competitors.
Pending Securities Litigation and SEC Investigation. The Company is
vigorously defending a pending securities class action lawsuit and is
cooperating with a pending investigation by the Securities and Exchange
Commission, which the Company believes is primarily focused on the Company's
accounting for transactions underlying its restatement of its financial results
announced during the fourth quarter of 2001. The Company cannot predict the
outcome of these matters. These matters might in the future result in
substantial costs, divert management's attention and other resources, and have a
material and adverse effect on the Company. See "Legal Proceedings."
Government Regulation. Significant aspects of the Company's businesses are
subject to state and federal statutes and regulations governing, among other
things, medical waste-disposal and workplace health and safety. In addition,
most of the products furnished or sold by the Company are subject to regulation
as medical devices by the U.S. Food and Drug Administration (FDA), as well as by
other federal and state agencies. The Company's facilities are subject to
quality systems inspections by FDA officials. The FDA has the power to enjoin
future violations, seize adulterated or misbranded devices, require the
manufacturer to remove products from the market, and publicize relevant facts.
Federal or state governments might impose additional restrictions or adopt
interpretations of existing laws that could materially adversely affect the
Company.
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PART II - OTHER INFORMATION
Item 1. Legal Proceedings
Class Action Litigation. Beginning on November 30, 2001, several
substantially identical Class Action Complaints were filed in the United States
District Court for the Middle District of Florida against the Company and
certain of its officers and directors. The court consolidated these actions into
one case and appointed lead plaintiffs and lead counsel. On June 4, 2002, the
plaintiffs filed a Consolidated Amended Class Action Complaint purporting to
assert claims for a class of purchasers of the Company's common stock during the
period from March 30, 2001 through April 1, 2002. The actions claim violations
of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule
10b-5 promulgated under that act, alleging among other things, that during the
class period the Company and the individual defendants made materially false
statements concerning the Company's financial condition and its future
prospects. The actions seek compensatory and other damages, and costs and
expenses associated with the litigation. On August 5, 2002, the Company filed
with the court a motion asking the court to dismiss the Amended Complaint with
prejudice. This motion filing postpones any discovery in this case until after
the court rules on the motion.
The Company believes that it has substantial defenses to this matter, which
it will assert vigorously. However, the Company cannot determine the impact that
this matter will have on the Company.
SEC Investigation. On February 21, 2002, the Securities and Exchange
Commission issued to the Company a Formal Order of Private Investigation. The
Company believes the SEC's investigation primarily concerns the Company's
accounting for transactions underlying the Company's restatement of its
financial results announced during the fourth quarter of 2001. The Company is
cooperating with the investigation. The Company cannot determine the impact that
this matter will have on the Company.
Item 2. Changes in Securities
None.
Item 3. Defaults Upon Senior Securities
None.
Item 4. Submission of Matters to a Vote of Security Holders
At the annual meeting of the Company's shareholders on May 15, 2002, the
shareholders approved a proposal to elect James M. Emanuel and Richard T. Isel
as directors of the Company to serve until the 2005 annual meeting. The
following sets forth the votes in this election:
Director Votes For Votes Against or Withheld
-------- --------- -------------------------
James M. Emanuel 4,984,644 128,475
Richard T. Isel 4,983,344 129,775
James T. Boosales, Lee R. Kemberling, Wayne R. Peterson, and N. John Simmons,
Jr. continue to serve as directors. Shareholders also approved the appointment
of Ernst & Young LLP as the Company's independent certified public accountants
for the 2002 year.
Item 5. Other Information
None.
Item 6. Exhibits and Reports on Form 8-K
None.
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SIGNATURE
Pursuant to the requirements of the Securities and Exchange Act of 1934,
the Registrant has duly caused this Report to be signed on its behalf by the
undersigned thereunto duly authorized.
SRI/SURGICAL EXPRESS, INC.
Date: August 14, 2002 By: /s/ James T. Boosales
---------------------------------
Executive Vice President
Chief Financial Officer
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