<PAGE>
U. S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-QSB/A
AMENDMENT NO. 1 TO FORM 10-QSB
/X/ QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 For the quarterly period ended September 30, 1998
OR
/ / TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from ___________ to ____________
Commission file number 0-9899
MEDICAL GRAPHICS CORPORATION
(Exact name of small business issuer as specified in its charter)
MINNESOTA 41-1316712
(State of other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
350 OAK GROVE PARKWAY, SAINT PAUL, MINNESOTA 55127-8599
(Address of principal executive offices)
Registrant's telephone number, including area code: (651) 484-4874
Indicate by check mark whether the issuer (1) filed all reports required to
be filed by Section 13 or 15(d) of the Exchange Act during the past 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
------ -----
As of November 12, 1998, the Company had outstanding 5,607,736 shares of
Common Stock, $.05 par value, and 444,445 shares of Class A Stock, $.05 par
value. Each share of Class A Stock is convertible into 3.375 shares of Common
Stock.
Transitional Small Business Disclosure Format: Yes No X
------ ------
<PAGE>
PART I: FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
MEDICAL GRAPHICS CORPORATION
BALANCE SHEETS
(UNAUDITED IN THOUSANDS)
<TABLE>
<CAPTION>
SEPTEMBER 30,
1998
(AS RESTATED DECEMBER 31,
SEE NOTE 6) 1997
<S> <C> <C>
ASSETS
CURRENT ASSETS
Cash and cash equivalents $387
Accounts receivable, net of allowance for doubtful
accounts of $143 and $164 $ 4,157 3,890
Inventories:
Purchased components and work in process 3,586 3,164
Finished goods 1,677 1,636
-------------- ---------------
5,263 4,800
Prepaid expenses 194 272
-------------- ---------------
Total Current Assets 9,614 9,349
-------------- ---------------
EQUIPMENT AND FIXTURES 4,095 4,072
LESS ACCUMULATED DEPRECIATION 3,560 3,110
-------------- ---------------
535 962
SOFTWARE PRODUCTION COSTS, NET OF ACCUMULATED
AMORTIZATION OF $1,023 AND $855 594 602
OTHER ASSETS 8 13
-------------- ---------------
$10,751 $10,926
-------------- ---------------
-------------- ---------------
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable $2,570 $2,261
Accounts payable financed with vendors - current 833 1,145
Line of credit 2,513 2,254
Employee compensation 529 786
Deferred service contract revenue 888 896
Warranty reserve 374 414
Other liabilities and accrued expenses 576 675
-------------- ---------------
Total Current Liabilities 8,283 8,431
COMMITMENTS AND CONTINGENCIES
LONG-TERM ACCOUNTS PAYABLE FINANCED WITH VENDORS 210 807
SHAREHOLDERS' EQUITY
Class A stock; liquidation preference of $3.375 per share 22 22
Common stock 196 148
Additional paid-in capital 15,848 13,727
Retained deficit (13,808) (12,209)
-------------- ---------------
2,258 1,688
-------------- ---------------
$10,751 $10,926
-------------- ---------------
-------------- ---------------
</TABLE>
See accompanying notes to financial statements.
2
<PAGE>
MEDICAL GRAPHICS CORPORATION
STATEMENTS OF OPERATIONS
(UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------------------- ----------------------------
1998 1997 1998 1997
(AS RESTATED (AS RESTATED (AS RESTATED
SEE NOTE 6) SEE NOTE 6) SEE NOTE 6)
<S> <C> <C> <C> <C>
REVENUES:
Equipment sales $3,193 $ 3,062 $11,002 $10,458
Service and supplies revenues 1,295 1,169 3,678 3,543
------------- ------------ ------------ ----------
Total revenues 4,488 4,231 14,680 14,001
COST OF REVENUES 2,762 2,654 9,015 8,958
------------- ------------ ------------ ----------
Gross margin 1,726 1,577 5,665 5,043
OPERATING EXPENSES:
Selling and marketing 1,346 1,511 4,275 4,581
General and administrative 443 586 1,470 1,758
Research and development 351 528 1,207 1,587
Nonrecurring charges 49 1,407
------------- ------------ ------------ ----------
2,140 2,674 6,952 9,333
------------- ------------ ------------ ----------
LOSS FROM OPERATIONS (414) (1,097) (1,287) (4,290)
Interest expense (115) (90) (312) (238)
------------- ------------ ------------ ----------
LOSS BEFORE INCOME TAXES (529) (1,187) (1,599) (4,528)
Income tax benefit 0 0 0 0
------------- ------------ ------------ ----------
NET LOSS (529) (1,187) (1,599) (4,528)
------------- ------------ ------------ ----------
------------- ------------ ------------ ----------
NET LOSS PER WEIGHTED AVERAGE SHARE
Basic $(0.09) $ (0.26) $ (0.28) $ (1.05)
Diluted $(0.09) $ (0.26) $ (0.28) $ (1.05)
------------- ------------ ------------ ----------
------------- ------------ ------------ ----------
WEIGHTED AVERAGE SHARES OUTSTANDING
Basic 5,739 4,575 5,646 4,311
Diluted 5,739 4,575 5,646 4,311
</TABLE>
See accompanying notes to financial statements.
3
<PAGE>
MEDICAL GRAPHICS CORPORATION
STATEMENTS OF CASH FLOWS
(UNAUDITED IN THOUSANDS)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
-----------------------------------
1998 1997
(AS RESTATED (AS RESTATED
SEE NOTE 6) SEE NOTE 6)
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss $(1,599) $(4,528)
Adjustments to reconcile net loss to net cash provided
(used) in operating activities:
Issuance of common stock warrants 608
Depreciation 450 456
Amortization 264 208
Changes in operating assets and liabilities
Accounts receivable (267) 1,549
Inventory (463) 1,677
Prepaid expenses and other assets 83 (29)
Accounts payable and accrued expenses (359) (346)
Warranty reserve (40) 157
Deferred service contract revenue (8) (106)
-------------- ---------------
Net cash used in operating activities (1,939) (374)
-------------- ---------------
CASH FLOWS FROM INVESTING ACTIVITIES
Software production costs (256) (125)
Capital expenditures (23) (107)
-------------- ---------------
Net cash used in investing activities (279) (232)
-------------- ---------------
CASH FLOWS FROM FINANCING ACTIVITIES
Net borrowings (payments) on bank line of credit 259 (843)
Payments on long-term accounts payable financed with vendors (597) (377)
Net proceeds from issuances of common stock 2,169 1,532
-------------- ---------------
Net cash provided by financing activities 1,831 312
-------------- ---------------
NET DECREASE IN CASH (387) (294)
CASH AT BEGINNING OF PERIOD 387 545
-------------- ---------------
CASH AT END OF PERIOD $0 $ 251
-------------- ---------------
-------------- ---------------
CASH PAID FOR INTEREST EXPENSE $ 292 $ 225
-------------- ---------------
-------------- ---------------
</TABLE>
See accompanying notes to financial statements.
4
<PAGE>
NOTES TO FINANCIAL STATEMENTS
September 30, 1998
(Unaudited)
1. BASIS OF PRESENTATION
The accompanying financial statements have been prepared in accordance with
generally accepted accounting principles for interim financial information
and with the instructions to Form 10-QSB and Rule 10-01 of Regulation S-X.
Accordingly, they do not include all of the information and notes required by
generally accepted accounting principles for complete financial statements.
In the opinion of management, all adjustments considered necessary for a fair
presentation of results have been included.
The balance sheet at December 31, 1997 was derived from the audited financial
statements as of that date. Operating results for the three and nine month
periods ended September 30, 1998 are not necessarily indicative of the
results that may be expected for the year ended December 31, 1998. For
further information, refer to the financial statements and notes thereto
included in the Company's Annual Report on Form 10-KSB/A for the fiscal year
ended December 31, 1997.
2. RECLASSIFICATIONS
Certain amounts in the Company's Form 10-QSB for the three and nine month
periods ended September 30, 1997 have been reclassified to conform to the
1998 presentation. These reclassifications had no effect on net loss or
shareholders' equity as previously reported.
3. NON-RECURRING EXPENSES
During the quarter ended March 31, 1997, the Company implemented certain cost
control strategies which included the termination of certain employees and
the renegotiation of the Company's bank line of credit. A total of $1,407,000
in non-recurring expenses were recorded during the nine months ended
September 30, 1997 related to severance, legal, consulting and accounting
expenses.
4. AMENDMENT TO BANK LINE OF CREDIT
The Company amended its line of credit agreement in March, August and
September 1998.
5. NEW ACCOUNTING PRONOUNCEMENTS
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards (SFAS) No. 130, "Reporting Comprehensive
Income", which was adopted by the Company beginning January 1, 1998. SFAS No.
130 requires the disclosure of comprehensive income and its components in the
general-purpose financial statements. The adoption by the Company of SFAS No.
130 did not have a material effect on the Company's financial statements for
the three months ended September 30, 1998 or 1997. Total comprehensive loss
for the three months ended September 30, 1998 and 1997 was $529,000 and
$1,187,000, respectively. Total comprehensive loss for the nine months ended
September 30, 1998 and 1997 was $1,599,000 and $4,528,000, respectively.
Effective January 1, 1998, the Company adopted SFAS No. 131, "Disclosure
about Segments on an Enterprise and Related Information". SFAS No. 131
redefines how operating segments are determined and requires disclosures of
certain financial and descriptive information about a Company's operating
segments. This statement does not have a material impact on results reported
in the financial statements.
5
<PAGE>
6. RESTATEMENT
Subsequent to the issuance of the September 30, 1998 Quarterly Report on Form
10-QSB, the Company determined that inventory write-downs recorded in 1996
were overstated and that certain restructured charges recorded in 1996 and
the nine months ended September 30, 1997 were misclassified and/or recorded
in the wrong period. As a result, the balance sheet at September 30, 1998 has
been restated to increase inventory and the statements of operations for the
three and nine months ended September 30, 1998 and 1997 have been restated to
properly classify charges previously recorded as restructuring, to record
charges previously recorded in 1996 in the first quarter of 1997, and to
eliminate the reversal of certain inventory provisions during the first
quarter of 1998. The effects of these adjustments on the financial statements
at September 30, 1998 and for the three and nine months ended September 30,
1998 and 1997 are as follows:
<TABLE>
<CAPTION>
Three Months
Ended
September 30, 1997
-----------------------
As
Previously As
Reported Restated
<S> <C> <C>
General and administrative $ 574 $ 586
Nonrecurring 61 49
</TABLE>
<TABLE>
<CAPTION>
Nine Months Ended September 30
------------------------------------------------------
1998 1997
------------------------ ------------------------
As As
Previously As Previously As
Reported Restated Reported Restated
<S> <C> <C> <C> <C>
Cost of goods sold $ 8,889 $ 9,015
Selling and marketing 4,076 4,275
General and administrative $ 1,458 $ 1,758
Non-recurring 0 1,407
Restructuring charges 1,557 0
Net (loss) (1,274) (1,599) (4,378) (4,528)
Net income (loss) per share (0.23) (0.28) (1.02) (1.05)
<CAPTION>
As of
September 30, 1998
----------------------------
As
Previously As
Reported Restated
<S> <C> <C>
Inventories $ 5,028 $ 5,263
Retained deficit (14,043) (13,808)
</TABLE>
6
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
FORWARD LOOKING STATEMENTS
Statements included in this Quarterly Report on Form 10-QSB that are not
historical or current facts are "forward-looking statements" made pursuant to
the safe harbor provision of the Private Securities Litigation Reform Act of
1995 and are subject to certain risks and uncertainties that could cause
actual results to differ materially. Among these risks and uncertainties are
(i) the fact that the Company has incurred losses of $1,599,000 for the nine
months ended September 30, 1998, and losses of $5,112,000, $8,361,000 and
$1,731,000 for the fiscal years ended December 31, 1997, 1996 and 1995,
respectively; (ii) the ability of the Company's distributors to successfully
market and sell the Company's product in markets outside the United States;
(iii) the Company's ability to successfully market its product in the United
States at a favorable margin considering significant price competition in the
industry; (iv) the extent to which physicians and health plan administrators
are motivated to use non-invasive diagnostic testing to detect early signs of
disease; (v) the Company's ability to successfully upgrade its product
software systems to a Windows-R- environment; and (vi) the Company's ability
tO develop future products which are technologically advanced and accepted by
the marketplace.
In addition, the Company's statement regarding the Year 2000 issue contained
in the Section, "Year 2000", includes statements regarding the timetable for
Year 2000 compliance, the Company's related costs and capital expenditures,
the success of the Company's efforts and others' efforts to achieve
compliance, and the effects of the Year 2000 issue on the Company's future
financial condition and results of operations. The following important
factors, among others, could affect the accuracy of those statements: (i) the
inherent uncertainty of the costs and timing of achieving compliance on the
wide variety of systems used by the Company; (ii) the reliance on the efforts
of vendors, customers, government agencies and other third parties to achieve
adequate compliance and avoid disruption of the Company's business in early
2000; and (iii) the uncertainty of the ultimate costs and consequences of any
unanticipated disruption in the Company's business resulting from the failure
of one of the Company's applications or of a third party's systems.
For an additional description of these and other factors, see "Management's
Discussion and Analysis of Financial Condition or Plan of Operations,
Forward-Looking Statements," contained in Item 6, Part II, of the Company's
1997 Form 10-KSB/A. In addition, the foregoing list is not exhaustive, and
the Company disclaims any obligation subsequently to revise any
forward-looking statements to reflect events or circumstances after the date
of such statements or to reflect the occurrence of anticipated or
unanticipated events.
RESULTS OF OPERATIONS
Subsequent to the issuance of the September 30, 1998 Quarterly Report on Form
10-QSB, the Company determined that inventory write-downs recorded in 1996
were overstated and that certain restructured charges recorded in 1996 and
the nine months ended September 30, 1997 were misclassified and/or recorded
in the wrong period. As a result, the balance sheet at September 30, 1998 has
been restated to increase inventory and the statements of operations for the
three and nine months ended September 30, 1998 and 1997 have been restated to
properly classify charges previously recorded as restructuring, to record
charges previously recorded in 1996 in the first quarter of 1997, and to
eliminate the reversal of certain inventory provisions during the first
quarter of 1998. The effects of these adjustments on the financial statement
at September 30, 1998 and for the three and nine months ended September 30,
1998 and 1997 are reflected in footnote 6 to the financial statements.
The Company recorded net losses of $529,000 and $1,187,000 for the three
months ended September 30, 1998 and 1997, respectively. Included in the 1997
loss was $49,000 of non-recurring expenses. For the nine months ended
September 30, the Company recorded net losses of $1,599,000 and $4,528,000
for 1998 and 1997, respectively. The nine month loss for 1997 included
$1,407,000 of non-recurring expenses.
7
<PAGE>
REVENUES
Revenues consist of equipment sales and service and supply revenues.
Equipment sales reflect revenues from the Company's pulmonary function
analysis systems, gas exchange testing systems and sleep diagnostic systems.
Service and supply revenues reflect sales of peripherals and supplies,
contract revenues from extended warranties and revenues from non-warranty
service visits.
Third quarter revenues increased 6.1% to $4,488,000 in 1998 compared to
$4,231,000 in 1997. Domestic revenue increased 17.8% to $2,659,000 in 1998
compared to $2,258,000 in 1997. The increase in 1998 domestic revenue was
primarily due to sales of sleep diagnostic systems, which were introduced in
September, 1997. International revenue decreased 33.5% to $534,000 in 1998
from $804,000 in 1997. The strong U. S. Dollar, aggressive competition in
Europe and economic difficulties being experienced by Asian Pacific countries
all contributed to a decline in international revenue. Third quarter service
and supply revenue increased 10.8% to $1,295,000 in 1998 from $1,169,000 in
1997 due to increases in both non-warranty service revenue and supply
revenue, offset by decreased revenue from warranty service contracts.
For the nine months ended September 30, revenues increased 4.9% to
$14,680,000 in 1998 from $14,001,000 in 1997. Year to date domestic revenues
increased 17.9% to $9,044,000 in 1998 from $7,672,000 in 1997 on the strength
of sleep diagnostic systems which were introduced in September, 1997.
Internationally, revenues decreased 29.7% to $1,958,000 in 1998 from
$2,786,000 in 1997 due to a strong U. S. Dollar and aggressive European
competition. Year to date service and supply revenue increased 3.8% to
$3,678,000 in 1998 from $3,543,000 in 1997 reflecting increased non-warranty
service revenue offset by decreases in revenue from warranty service
contracts and supplies.
GROSS MARGIN
Gross margin percentage increased to 38.5% of revenue for the three months
ended September 30, 1998 from 37.3% in 1997. For the nine months ended
September 30, gross margin percentage increased to 38.6% in 1998 from 36.0%
in 1997. The increase for both the three and nine month periods reflects the
Company's ongoing efforts to decrease costs of manufacturing through
increased efficiencies, partially offset by sales of lower margin distributed
sleep diagnostic systems as well as lower pricing associated with
introduction of those new products. In addition, year to date margins were
positively affected by improved average selling prices for pulmonary and gas
exchange systems.
SELLING AND MARKETING
Selling and marketing expenses for the three months ended September 30, 1998
decreased by 10.9% to $1,346,000 in 1998 from $1,511,000 in 1997. Year to
date selling and marketing expenses decreased 6.7% to $4,275,000 in 1998 from
$4,581,000 in 1997. Both the three month and nine month periods reflect
increased commissions on higher domestic revenue and expenses associated with
expanding the Company's domestic sales force. However, these third quarter
increases were offset by savings related to less travel and other cost
containment actions. Year to date selling and marketing increases were also
offset by $299,000 in savings associated with the Company's 1997 decision to
sell its asthma business unit and reduce focus on the sports medicine market.
8
<PAGE>
GENERAL AND ADMINISTRATIVE
General and administrative expenses decreased 24.4% to $443,000 in the third
quarter of 1998 from $586,000 in 1997. Year to date general and
administrative expenses decreased by 16.4% to $1,470,000 in 1998 from
$1,758,000 in 1997. The third quarter decrease is attributed to lower
consulting expenses and lower allowances for doubtful accounts receivable.
The third quarter and year to date decreases are due to lower consulting
expenses associated with 1997 cost reduction activities and lower allowances
for doubtful accounts receivable.
RESEARCH AND DEVELOPMENT
Research and development expenses decreased 33.5% to $351,000 in the third
quarter of 1998 from $528,000 in 1997. For the nine months ended September
30, research and development expenses decreased 23.9% to $1,207,000 in 1998
from $1,587,000 in 1997. These decreases reflect the Company's 1997
restructuring decision to use in-house software engineers rather than
independent software contractors as part of the Company's transition of its
product software to a Windows95-R- platform. The third quarter decrease also
reflects lower costs due to an increasing proficiency of Company employees
developing product software upgrades.
NON-RECURRING EXPENSES
Non-recurring expenses for the three and nine months ended September 30, 1997
were $49,000 and $1,407,000, respectively. They included severance, legal,
accounting and consulting expenses associated with the cost reduction
strategies implemented during 1997.
LIQUIDITY AND FINANCIAL RESOURCES
At September 30, 1998, the Company balance sheet reflected no cash because
the normal amount of outstanding checks offset cash balances deposited in the
company's cash accounts. The Company had working capital of $1,331,000. In
addition, the Company had a balance outstanding under its bank line of credit
of $2,513,000 and additional availability of $608,000.
During the nine months ended September 30, 1998, the Company used $1,939,000
of cash in operating activities, primarily resulting from a net loss of
$1,599,000, increases of $267,000 in accounts receivable and $463,000 in
inventory and a decrease of $359,000 in accounts payable and accrued
expenses. The Company used $279,000 for investing activities, consisting of
software production costs of $256,000 and capital expenditures of $23,000.
The Company generated $1,831,000 from financing activities, primarily from
$2,169,000 in net proceeds from the private placement of its common stock and
net borrowings of $259,000 under its line of credit, offset by a decrease of
$597,000 in long-term accounts payable with vendors.
During the nine months ended September 30, 1997, the Company used $374,000 of
cash in operating activities, primarily resulting from a net loss of
$4,528,000 and a decrease of $346,000 in accounts payable and accrued
expenses, which were partially offset by noncash charges totaling $1,272,000,
a decrease of $1,677,000 in inventory and a decrease of $1,549,000 in
accounts receivable. The Company used $232,000 for investing activities,
consisting of capital expenditures of $107,000 and software production costs
of $125,000. The Company generated $312,000 from financing activities,
primarily from $1,500,000 in proceeds from the private placement of its Class
A Stock and net borrowings of $2,557,000 under its new line of credit,
9
<PAGE>
partially offset by a $3,400,000 payoff of its former bank line of credit and
a decrease of $377,000 in long-term accounts payable with vendors.
At September 30, 1998 the Company had no material commitments for capital
expenditures.
The Company believes that cash generated from operations, together with cash
and borrowings available under its line of credit facility will be adequate
to satisfy its liquidity and capital resource needs for the next twelve
months.
YEAR 2000
The Year 2000 issue is the result of computer programs being written using
two digits rather than four to define the applicable year. The Company's
computer equipment, software, devices and products with imbedded technology
that are time-sensitive may recognize a date using "00" as the year 1900
rather than the year 2000. This could result in a system failure or
miscalculations causing disruptions of operations, including, among other
things, a temporary inability to process transactions, send invoices or
engage in similar normal business activities.
STATE OF READINESS
In late 1997, the Audit Committee of the Board of Directors of the Company
directed the Company's management to initiate a Year 2000 compliance plan. By
March 1998, management implemented a formal program to address the Company's
Year 2000 compliance by forming a Year 2000 staff consisting of personnel
from cross-functional areas of the Company, including information systems,
marketing, research and development, technical support, quality assurance and
regulatory affairs and administration (the "Y2K Project Team"). A Project
Manager, who reports to the Audit Committee of the Board, leads the Y2K
Project Team to ensure that it meets time deadlines, objectives and documents
remedial action.
As part of its compliance plan, the Company's Y2K Project Team is taking
inventory of the Company's operations and dividing areas for assessment into
three categories:
- - VITAL - computer-controlled systems, programs, equipment and products
that the Company needs to function day-to-day;
- - CRITICAL - those systems which must be repaired or replaced prior to
the millennium but are not necessary for the Company's day-to-day
operations; and
- - MARGINAL - those systems for which repair and replacement are not
material to the Company's operations.
The Y2K Project Team has also identified five areas covering the entire scope
of the Company's business and has committed to completing an 8-step program
for each area. The diagram below identifies the five areas as well as the
current and projected schedule of the 8-step program for each area.
10
<PAGE>
<TABLE>
<CAPTION>
------------------ ------------------ ------------------ ------------------ ------------------
Company Products OEM Products Internal Business Vendors &
Programming Information Suppliers
Systems
- --------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Team Formation & Completed Completed Completed Completed Completed
Assignment
- --------------------------------------------------------------------------------------------------------------------
Inventory Assessment Completed 80% Completed 90% 35%
- --------------------------------------------------------------------------------------------------------------------
Compliance Completed 80% Completed 90% 35%
Assessment
- --------------------------------------------------------------------------------------------------------------------
Risk Assessment Completed Completed Completed 90% 0%
- --------------------------------------------------------------------------------------------------------------------
Resolution & Completed 80% Completed 30% 0%
Remediation
- --------------------------------------------------------------------------------------------------------------------
Validation Completed 80% Completed 30% 0%
- --------------------------------------------------------------------------------------------------------------------
Contingency Plans Completed Completed Completed 30% 0%
- --------------------------------------------------------------------------------------------------------------------
Certification & Completed 10% 10% 20% 5%
Sign-off
- --------------------------------------------------------------------------------------------------------------------
</TABLE>
With respect to the Company's relationships with third parties, the Company
relies both domestically and internationally upon various vendors,
governmental agencies, utility companies, telecommunications service
companies, delivery service companies and other service providers. Although
these service providers are outside of the Company's control, the Company has
mailed letters to those with whom it believes its relationships are material
and has verbally communicated with some of its strategic business partners to
determine the extent to which electronic interfaces with such entities are
vulnerable to Year 2000 issues and whether products and services purchased
from or by such entities are Year 2000 ready. As of November 1, 1998, the
Company had received responses from 5% of such third parties, and all of the
companies that have responded have provided written assurances indicating
that their Year 2000 issues will be addressed on a timely basis. The Company
intends to complete follow-up activities, including but not limited to phone
surveys and mailings, with significant vendors and service providers as part
of completing validation of these parties' compliance.
COSTS TO ADDRESS YEAR 2000 ISSUES
To date, the Company has not incurred any material expenditures in connection
with identifying or evaluating Year 2000 compliance issues. The Company has
incurred the majority of its costs from the recent installation of updated
internal computer systems as well as the labor cost and opportunity cost of
time spent by employees of the Company evaluating Year 2000 compliance
matters generally. Because the Company upgraded its internal computer systems
as part of its regularly planned software and hardware upgrade efforts, it
does not consider the costs related thereto to be charges for Year 2000
compliance. The Company presently estimates the labor costs of its Year 2000
compliance efforts to date to be approximately $50,000. With respect to
future costs, the Company estimates it will spend approximately $25,000 for
remediation and validation of products and programs which the Company
presently knows are not compliant and another $50,000 for future staff time
for such remediation. In addition, the Company estimates
11
<PAGE>
that it may spend no more than another $100,000 on remediation and validation
of products and programs which have not yet been assessed. The Company
believes that these estimates are reasonable and presently expects such to be
within the Company's fiscal 1999 budget. At this time, the Company does not
possess information necessary to estimate the overall potential financial
impact of Year 2000 compliance issues relating to its Year 2000 compliance
program. Such impact, including the effect of a Year 2000 business
disruption, could have a material adverse impact on the Company's financial
condition and results of operations.
RISKS OF YEAR 2000 ISSUES
Because the Company is still in the discovery and evaluation phase of
assessing its overall Year 2000 exposure, it cannot at this time state with
certainty that the Year 2000 issues will not have a material adverse impact
on its financial condition, results of operations and liquidity. Although the
Company considers them unlikely, the Company believes that the following
several situations, not in any particular order, make up the Company's "most
reasonably likely worst case Year 2000 scenarios:"
1. CUSTOMER LITIGATION.
The Company has developed a program to advise all customers of Year 2000
compliance of its products and has identified upgrade and replacement
products for its customers affected by Year 2000 compliance issues. These
efforts pertain not only to the Company's internally developed products but
also to externally acquired products. Although the Company believes that its
efforts will ensure no disruption in the business or operations of its
customers, the possibility exists that some customers may experience problems
that may motivate such customers to commence litigation against the Company
for restitution and damages that may be related to such problems.
2. DISRUPTION OF SUPPLY MATERIALS.
Several months ago, the Company began an ongoing process of surveying its
vendors with regard to their Year 2000 readiness and is now in the process of
assessing and cataloging the first responses to the survey. The Company is
hopeful of receiving adequate responses from critical vendors and many
non-critical vendors by January 31, 1999. The Company presently expects to
work with vendors that show a need for assistance or that provide inadequate
responses, and in many cases expects that survey results will be refined
significantly by such work. Where ultimate survey results show that the need
arises, the Company will arrange for back-up vendors before the changeover
date.
3. DISRUPTION OF THE COMPANY'S INTERNAL COMPUTER SYSTEMS.
The Company has completed a scheduled upgrade of its current hardware and
software systems and such process has required Year 2000 compliance in all
areas. Year 2000 testing occurred as the upgrade process proceeded and, in
addition, will continue to occur prior to the changeover date. For this
reason, the Company considers that disruption of its internal computer
systems is unlikely.
4. DISRUPTION OF THE COMPANY'S NON-COMPUTER SYSTEMS.
The Company is currently conducting a comprehensive assessment of all
non-computer systems, including utility, telecommunications, delivery and
other services. Although the Company intends to work with any third party
providers of such services to ensure that there will be no disruption in the
Company's operations, the Company believes that if any disruptions do occur,
such will be dealt with promptly and will be no more severe with respect to
correction or impact than would be an unexpected breakdown of such services
and related equipment.
12
<PAGE>
CONTINGENCY PLANS
While the Company recognizes the need for contingency planning, it has not
yet developed any specific contingency plans for potential Year 2000
disruptions. The aforementioned 8-step program, however, does include
contingency planning by the Y2K Project Team and such plans, as developed,
will be carefully reviewed by the Company. The Company believes that details
of such plans will depend on the Company's final assessment of the problem as
well as the evaluation and success of its remediation efforts. Future
disclosures will include contingency plans as they become available.
13
<PAGE>
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Company is a defendant in various claims and litigation which are
incidental to its business. Management is of the opinion that ultimate
settlement of these matters will not have a material impact on its financial
statements.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
In September 1998, the Company closed on a private offering with FAMCO II
LLC, (FAMCO) a private institutional investor, and Compumedics Sleep Pty Ltd,
(Compumedics) an Australian manufacturer of sleep diagnostic products and a
supplier to the Company. In the offering, the Company sold 550,000 shares of
Common Stock at a price of $1.00 per share. FAMCO purchased 300,000 shares
for $300,000 in cash and Compumedics purchased 250,000 shares through
conversion of $250,000 of accounts payable by the Company to Compumedics. The
Company believes that the sales were exempt pursuant to Section 4(2) of the
Securities Act of 1933, as amended, and Regulation D, promulgated thereunder.
The Company's Class A Stock issued to FAMCO in March and April 1997 contained
anti-dilution provisions. As a result of the September 1998 offering, FAMCO's
444,445 shares of Class A Stock are now convertible into 1,500,000 shares of
Common Stock.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits List
Exhibit 10.1 Fourth Amendment to Credit and Security Agreement
dated August 14, 1998 between the Company and Norwest
Business Credit, Inc.
Exhibit 10.2 Fifth Amendment to Credit and Security Agreement
dated September 10, 1998 between the Company and
Norwest Business Credit, Inc.
Exhibit 27 Financial Data Schedule
(b) Reports on Form 8-K
There were no Reports on Form 8-K filed during the quarter ended
September 30, 1998.
14
<PAGE>
SIGNATURES
In accordance with the requirements of the Exchange Act, the registrant
caused this report to be signed on its behalf by the undersigned, thereunto
duly authorized.
Medical Graphics Corporation
- ----------------------------------
(Registrant)
Date April 15, 1999 /s/ Richard E. Jahnke
------------------------ ------------------------------------------
Richard E. Jahnke, President and Chief
Executive Officer (Principal Executive
Officer)
Date April 15, 1999 /s/ Dale H. Johnson
------------------------ ------------------------------------------
Dale H. Johnson, Chief Financial Officer
(Chief Accounting Officer)
15
<PAGE>
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
Exhibit
Number Description
- ------ -----------
<S> <C>
10.1 Fourth Amendment to Credit and Security Agreement dated August
14, 1998 between the Company and Norwest Business Credit, Inc.
10.2 Fifth Amendment to Credit and Security Agreement dated
September 10, 1998 between the Company and Norwest Business
Credit, Inc.
27 Financial Data Schedule.
</TABLE>
16
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED FINANCIAL STATEMENTS AS OF AND FOR THE THREE MONTHS ENDED
SEPTEMBER 30, 1998 AND 1997, AND IS QUALIFIED IN ITS ENTIRETY BY
REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C> <C>
<PERIOD-TYPE> 3-MOS 3-MOS
<FISCAL-YEAR-END> DEC-31-1998 DEC-31-1997
<PERIOD-START> JUL-01-1998 JUL-01-1997
<PERIOD-END> SEP-30-1998 SEP-30-1997
<CASH> 0 251
<SECURITIES> 0 0
<RECEIVABLES> 4,300 3,463
<ALLOWANCES> (143) (198)
<INVENTORY> 5,263 5,516
<CURRENT-ASSETS> 9,614 9,259
<PP&E> 4,095 3,964
<DEPRECIATION> (3,560) (2,967)
<TOTAL-ASSETS> 10,751 10,660
<CURRENT-LIABILITIES> 8,283 8,433
<BONDS> 0 0
0 0
0 0
<COMMON> 218 153
<OTHER-SE> 2,040 715
<TOTAL-LIABILITY-AND-EQUITY> 10,751 10,660
<SALES> 3,193 3,062
<TOTAL-REVENUES> 4,488 4,231
<CGS> 2,762 2,654
<TOTAL-COSTS> 4,902 5,328
<OTHER-EXPENSES> 0 0
<LOSS-PROVISION> 0 45
<INTEREST-EXPENSE> 115 90
<INCOME-PRETAX> (529) (1,187)
<INCOME-TAX> 0 0
<INCOME-CONTINUING> (529) (1,187)
<DISCONTINUED> 0 0
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> (529) (1,187)
<EPS-PRIMARY> (0.09) (0.26)
<EPS-DILUTED> (0.09) (0.26)
</TABLE>
