.
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934
For the Quarter ended September 30, 1997
Commission File Number 0-19943
PROTOCOL SYSTEMS, INC.
- ------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
Oregon 93-0913130
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
8500 SW Creekside Place, Beaverton, OR 97008
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(Address of principal executive offices) (Zip Code)
(503) 526-8500
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(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days.
[X] Yes [ ] No
Number of shares of common stock outstanding as of
November 10, 1997
8,923,410 shares, $.01 par value per share
------------------------------------------
<PAGE>2
PROTOCOL SYSTEMS, INC.
Index to Form 10-Q
PART I FINANCIAL INFORMATION Page No.
- ----------------------------- --------
Item 1. Financial Statements
Condensed Consolidated Statements of
Operations for the three months and nine months
ended September 30, 1997 and 1996 3
Condensed Consolidated Balance Sheets
as of September 30, 1997 and December 31, 1996 4
Consolidated Statements of Cash Flows for
the nine months ended September 30, 1997 and 1996 5
Notes to Condensed Consolidated Financial
Statements 6-7
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 8-11
PART II OTHER INFORMATION
- --------------------------
Item 2. Changes in Securities 12
Item 4. Submission of Matters to a Vote of Security Holders 12
Item 6. Exhibits and Reports on Form 8-K 12
SIGNATURES 13
- ----------
<PAGE>3
<TABLE>
PROTOCOL SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands except per share amounts)
(unaudited)
Three months ended Sept. 30, Nine months ended Sept. 30,
1997 1996 1997 1996
------- ------- ------- -------
<S> <C> <C> <C> <C>
Sales $17,158 $16,193 $46,460 $49,529
Cost of sales 8,095 7,239 22,824 22,001
------- ------- ------- -------
Gross profit 9,063 8,954 23,636 27,528
Operating expenses:
Research and development
expenses 2,244 2,235 6,408 6,726
Selling, general and
administrative expenses 5,292 5,073 15,158 15,312
Acquisition related charges - 2,097 - 2,097
Litigation settlement charges - 275 - 275
------- ------- ------- -------
Total operating expenses 7,536 9,680 21,566 24,410
------- ------- ------- -------
Income (loss) from
operations 1,527 (726) 2,070 3,118
Other income 291 257 803 761
------- ------- ------- -------
Income (loss) before
income taxes 1,818 (469) 2,873 3,879
Provision for income taxes 441 441 747 1,646
------- ------- ------- -------
Net Income (loss) $ 1,377 $ (910) $ 2,126 $ 2,233
======= ======= ======= =======
Net income (loss) per
common and common
equivalent share $ 0.15 $ (0.10) $ 0.23 $ 0.24
======= ======= ======= =======
Weighted average number
of common and common
equivalent shares
outstanding 9,431 9,433 9,323 9,410
See accompanying notes to condensed consolidated financial statements
</TABLE>
<PAGE>4
<TABLE>
PROTOCOL SYSTEMS, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands)
(unaudited)
September 30, December 31,
1997 1996
------- -------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $12,206 $6,903
Short-term investments 6,010 14,787
Accounts receivable - net 15,569 15,456
Inventories 13,284 12,416
Deferred taxes 1,224 1,320
Prepaid expenses and other 219 166
------- -------
Total current assets 48,512 51,048
Long-term investments 6,833 1,013
Property and equipment - net 4,555 4,478
Other assets 2,263 2,506
------- -------
$62,163 $59,045
======= =======
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $2,667 $2,480
Accrued salaries, wages and related
liabilities 2,356 2,514
Other accrued liabilities 518 739
Income taxes payable 762 405
Reserve for warranties 988 985
Deferred revenue and customer deposits 105 142
------- -------
Total current liabilities 7,396 7,265
Deferred taxes 440 471
Shareholders' equity:
Common Stock, $.01 par value. Authorized 30,000
shares; issued and outstanding 8,907 at 1997
and 8,744 at 1996 89 87
Additional paid-in capital 35,341 34,363
Unrealized holding gain on investments 32 32
Retained earnings 18,847 16,721
Foreign currency translation adjustment 18 106
------- -------
Total shareholders' equity 54,327 51,309
------- -------
$62,163 $59,045
======= =======
See accompanying notes to condensed consolidated financial statements
</TABLE>
<PAGE>5
<TABLE>
PROTOCOL SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
Nine months ended September 30,
1997 1996
------ ------
<S> <C> <C>
Cash flows from operating activities:
Net income $ 2,126 $ 2,233
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 1,813 1,595
Amortization of bond premium 267 293
Provision for deferred taxes (9) (147)
Increase (decrease) in cash resulting from
changes in:
Accounts receivable (129) 2,263
Inventories (879) (2,371)
Prepaid expenses and other assets (11) 124
Accounts payable and accrued liabilities (22) 1,009
Income taxes payable 358 (929)
Reserve for warranties 3 (12)
Deferred revenue and customer deposits (37) 9
------- -------
Net cash provided by operating activities 3,480 4,067
Cash flows from investing activities:
Purchase of investments (12,024) (9,674)
Proceeds from maturity of investments 14,715 12,534
Acquisition of property and equipment (1,722) (1,915)
Acquisition of intangible assets (10) (200)
Expenditures for software development - (80)
------- -------
Net cash provided by investing activities 959 665
Cash flows from financing activities:
Proceeds from exercise of stock options
and stock purchase plans and related tax benefits 888 1,111
Repurchase of common stock - (1,042)
Payments of long-term debt - (1,882)
------- -------
Net cash provided by financing activities 888 (1,813)
------- -------
Effect of exchange rates on cash and cash equivalents (24) 4
------- -------
Net increase in cash and cash equivalents 5,303 2,923
Cash and cash equivalents at beginning of period 6,903 3,974
------- -------
Cash and cash equivalents at end of period $12,206 $ 6,897
======= =======
Supplemental disclosure of cash flow information:
Cash paid for interest $ - $ 119
Cash paid for income taxes $ 295 $ 2,323
Supplemental schedule of noncash transactions:
Increase in investment in Protocol Medical Systems Ltd.
due to release of compensatory shares of common
stock from escrow $ 91 $ 91
See accompanying notes to condensed consolidated financial statements
</TABLE>
<PAGE>6
PROTOCOL SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
BASIS OF PRESENTATION
The accompanying condensed consolidated financial statements have been
prepared by the Company without audit and in conformity with generally
accepted accounting principles for interim financial information.
Accordingly, certain financial information and footnotes have been omitted or
condensed. In the opinion of management, the condensed consolidated financial
statements include all necessary adjustments (which are of a normal and
recurring nature) for the fair presentation of the results of the interim
periods presented. These financial statements should be read in conjunction
with the Company's audited consolidated financial statements for the year
ended December 31, 1996. The results of operations for the interim period
shown in this report are not necessarily indicative of results for any future
interim period or the entire fiscal year.
INVENTORIES
Inventories are valued at the lower of cost or market with cost determined on
the first-in, first-out basis (FIFO). The components of inventories are as
follows:
September 30, December 31,
(in thousands) 1997 1996
- -------------------------------------------------------------------------
Raw materials $ 4,929 $ 4,921
Work in process 2,655 2,307
Finished goods 3,883 3,396
Demonstration instruments 1,817 1,792
------- ------
Total inventories $13,284 $12,416
======= ======
PROPERTY AND EQUIPMENT
Property and equipment is stated at cost and includes the following:
September 30, December 31,
(in thousands) 1997 1996
- -------------------------------------------------------------------------
Equipment $11,364 $10,180
Furniture and fixtures 1,739 1,419
Leasehold improvements 670 654
------ ------
13,773 12,253
Less accumulated depreciation and amortization 9,218 7,775
------ ------
Property and equipment - net $ 4,555 $ 4,478
====== ======
<PAGE>7
INCOME TAXES
The provision for income taxes has been recorded based on the current estimate
of the Company's annual effective tax rate. This rate differs from the
Federal statutory rate primarily because of the provision for state income
taxes, the benefit of the Company's foreign sales corporation, the utilization
of research and experimentation tax credits and tax-exempt interest income
earned on investments. See Management's Discussion and Analysis of Financial
Condition and Results of Operations for further discussion of income taxes.
NET INCOME PER COMMON AND COMMON EQUIVALENT SHARE
Net income per common and common equivalent share is computed using the
weighted average number of common and dilutive common equivalent shares
assumed to be outstanding during the period. Common equivalent shares consist
of options to purchase common stock.
NEW ACCOUNTING PRONOUNCEMENTS
In February 1997, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards ("SFAS") No. 128, "Earnings per
Share." SFAS 128 establishes a different method of computing net income per
share than is currently required under the provisions of Accounting Principles
Board Opinion No. 15. Under SFAS No. 128, the Company will be required to
present both basic net income per share and diluted net income per share.
Basic net income per share is expected to be comparable or slightly higher
than the currently presented net income per share as the effect of dilutive
stock options will not be considered in computing basic net income per share.
Diluted net income per share is expected to be comparable to the currently
presented net income per share.
The Company plans to adopt SFAS 128 in its quarter ending December 31, 1997
and at that time all historical net income per share data presented
will be restated to conform to the provisions of SFAS No. 128.
In June 1997, the Financial Accounting Standards Board issued SFAS No. 130,
Reporting Comprehensive Income. The Statement establishes standards for the
reporting and display of comprehensive income and its components. The
Statement requires that all items that are income be reported in a financial
statement that is displayed with the same prominence as other financial
statements. The Statement is effective for financial statements for fiscal
years beginning after December 15, 1997. The Statement was only recently
issued, and the Company has not yet determined the impact of adoption on its
disclosure requirements.
In June 1997, the Financial Accounting Standards Board issued SFAS No. 131,
Disclosures about Segments of an Enterprise and Related Information. The
Statement changes the way public companies report segment information in
annual financial statements and also requires those companies to report
selected segment information in interim financial reports to shareholders.
The Statement is effective for financial statements for fiscal years beginning
after December 15, 1997. The Statement was only recently issued, and the
Company has not yet determined the impact of adoption on its disclosure
requirements.
<PAGE>8
MANAGEMENT'S DISCUSSION AND ANALYSIS
LIQUIDITY AND CAPITAL RESOURCES
The Company maintained its strong financial position as of September 30, 1997
with working capital balances of $41.1 million and a current ratio of 6.6:1 as
compared to working capital of $43.8 million and a current ratio of 7.0:1 at
December 31, 1996. Cash flow from operating activities for the first nine
months of 1997 was $3.5 million as compared to cash flow from operating
activities of $4.1 million for the first nine months of 1996. Management
believes that current cash and investment balances and future cash flows from
operations will be sufficient to meet the Company's liquidity and capital
needs for the foreseeable future.
FORWARD-LOOKING STATEMENTS
This Management's Discussion and Analysis and other sections of this Quarterly
Report contain forward-looking statements within the meaning of the Securities
Litigation Reform Act of 1995 that are based on current expectations,
estimates and projections about the Company's business, management's beliefs
and assumptions made by management. Words such as "expects," "anticipates,"
"intends," "plans," "believes," "seeks," "estimates" and variations of such
words and similar expressions are intended to identify such forward-looking
statements. These statements are not guarantees of future performance and
involve certain risks, uncertainties and assumptions that are difficult to
predict. Therefore, actual outcomes and results may differ materially from
what is expressed or forecasted in such forward-looking statements due to
numerous factors, including, but not limited to those discussed in this
Quarterly Report and from time to time in the Company's other Securities and
Exchange Commission filings and reports. In addition, such statements could
be affected by general industry and market conditions and growth rates, and
general domestic and international economic conditions.
RESULTS OF OPERATIONS
Third Quarter 1997 vs. Third Quarter 1996
- -------------------------------------------
Sales. Sales for the third quarter of 1997 increased 6.0% to $17.2 million
from $16.2 million for the third quarter of 1996. Acuity system sales
increased by $1.2 million or 221.3% as a result of an increase in the number
of systems sold as well as higher average selling prices due to an increase in
the size and scale of individual system sales. Additionally, sales of the
QuikSigns spot-check monitor, accessories, service and Pryon's CO2 monitoring
products increased by a total of $1.4 million or 39.3% from the prior year's
third quarter. Instrument sales (including the Propaq and Propaq Encore
monitors and monitor options) decreased $1.5 million or 12.7% from the prior
year's third quarter. The decline in instrument sales resulted primarily from
decreased unit sales of Propaq monitors and monitor options. Although overall
sales of instruments decreased, both unit sales and average selling prices of
the Propaq Encore monitor increased from the prior year's third quarter.
Domestic sales increased 27.1% to $11.7 million (68.2% of total sales) in the
third quarter of 1997 from $9.2 million (56.8% of total sales) in the third
quarter of 1996. The Company attributes this increase primarily to an
increase in Acuity system sales as well as Propaq Encore monitors sold with
these systems. This increase was partially offset by a reduction in military
shipments, which declined to $609,000 in the third quarter of 1997 from $1.6
million in the third quarter of 1996
<PAGE>9
International sales decreased 35.8% to $3.4 million (19.7% of total sales) in
the third quarter of 1997 from $5.3 million (32.5% of total sales) in the
third quarter of 1996. The Company attributes the decrease in international
sales to soft international market conditions caused largely by a significant
strengthening of the U.S. dollar against foreign currencies as well as a
decrease in sales to NEC, the Company's exclusive distributor in Japan.
Original equipment manufacturer ("OEM") sales increased to $2.1 million (12.2%
of total sales) in the third quarter of 1997 from $1.7 million (10.7% of total
sales) in the prior year's third quarter. The increase in OEM sales was
primarily the result of an increase in sales of Pryon's CO2 monitoring
products in the third quarter of 1997.
Gross profit. As a percentage of sales, gross profit decreased to 52.8% in
the third quarter of 1997 from 55.3% in the third quarter of 1996. The
decrease in gross profit as a percentage of sales was primarily due to higher
sales discounts as well as an increase in the percentage of sales of lower
margin products including service, accessories and QuikSigns monitors.
Research and development. Research and development expenses remained steady
at $2.2 million in the third quarters of 1997 and 1996. As a percentage of
sales, research and development expenses decreased to 13.1% in the third
quarter of 1997 from 13.8% in the third quarter of 1996.
Selling, general and administrative. Selling, general and administrative
expenses increased 4.3% to $5.3 million in the third quarter of 1997 compared
to $5.1 million in the third quarter of 1996 primarily due to higher
commissions expense related to the increase in domestic sales. As a
percentage of sales, selling, general and administrative expenses decreased to
30.8% in the third quarter of 1997 from 31.3% in the third quarter of 1996.
Acquisition related charges and litigation settlement charges. In the third
quarter of 1996, the Company incurred charges of $2.1 million in connection
with the acquisition of Pryon. Additionally, the Company incurred charges of
$275,000 in the same quarter related to the settlement of litigation regarding
the 1991 termination of the Company's former Canadian distributor. No such
charges were incurred during the third quarter of 1997.
Other income. Other income increased 13.4% to $291,000 in the third quarter
of 1997 from $257,000 in the third quarter of 1996 primarily as a result of an
increase in interest income due to higher cash and investment balances in the
third quarter of 1997.
Provision for income taxes. The provision for income taxes was $441,000 in
the third quarters of both 1997 and 1996. Excluding the effect of non-
deductible acquisition related charges, the effective tax rate decreased to
24.3% in the third quarter of 1997 from 27.1% in third quarter of 1996. This
decrease was primarily due to the expectation of greater benefits from the
extension of the research and experimentation tax credit and the announcement
of a state tax rebate credit in the third quarter of 1997.
<PAGE>10
Nine Months Ended September 30, 1997 vs. Nine Months Ended September 30, 1996
- -----------------------------------------------------------------------------
Sales. Sales for the first nine months of 1997 decreased 6.2% to $46.5
million from $49.5 million for the first nine months of 1996. Instrument
sales (including the Propaq and Propaq Encore monitors and monitor options)
decreased by $5.6 million or 15.6% from the first nine months of the prior
year. The decline in these instrument sales resulted from decreased overall
unit sales as well as a decrease in average selling prices due to higher sales
discounts. Although overall sales of instruments decreased, unit sales of the
Propaq Encore monitor increased from the first nine months of the prior year.
Sales of OEM products decreased $1.0 million or 13.6% from the first nine
months of the prior year primarily due to decreased sales of GenESA devices.
These sales reductions were partially offset by increased sales of Acuity
systems, accessories, service and the introduction of the QuikSigns spot-check
monitor in the first nine months of 1997.
Domestic sales decreased 6.4% to $27.4 million (58.9% of total sales) in the
first nine months of 1997 from $29.2 million (59.0% of total sales) in the
first nine months of 1996. The Company attributes this decrease primarily to
a significant reduction in military shipments, which declined to $2.0 million
in the first nine months of 1997 from $7.9 million in the first nine months of
1996. The decrease in military sales was partially offset by an increase in
Acuity system sales as well as Propaq Encore monitors sold with these systems.
International sales decreased 1.8% to $12.9 million (27.8% of total sales) in
the first nine months of 1997 from $13.1 million (26.5% of total sales) in the
first nine months of 1996. The decrease in international sales was driven by
decreased sales to NEC, the Company's exclusive distributor in Japan. This
decrease was partially offset by strong sales in the European market in the
first six months of 1997.
OEM sales decreased 13.6% to $6.2 million (13.3% of total sales) in the first
nine months of 1997 from $7.2 million (14.5% of total sales) in the first nine
months of 1996. The decrease in OEM sales was primarily the result of a
$838,000 decrease in sales of GenESA devices to Gensia, Inc. Gensia began
shipments of the GenESA devices to Europe in early 1995 and in the third
quarter of 1997 Gensia received clearance from the Food and Drug
Administration (FDA) to market the GenESA devices in the United States. Also
contributing to the decrease in OEM sales was a slight decrease in sales of
Pryon's CO2 monitoring products in the first nine months of 1997 primarily due
to reductions in orders from certain of its OEM customers.
Gross profit. As a percentage of sales, gross profit decreased to 50.9% in
the first nine months of 1997 from 55.6% in the first nine months of 1996. The
decrease in gross profit as a percentage of sales was partially due to
increased sales discounts, including discounts related to sales of refurbished
instruments and an enterprise-wide upgrade of Massachusetts General Hospital's
monitoring systems. As a co-developer of the Company's Acuity central
monitoring system, Massachusetts General Hospital had the right to purchase
certain monitoring equipment for a small markup over cost. This right expired
in October 1997. Gross profit was also negatively impacted by additional
warranty expense incurred as a result of the Company's voluntary decision to
replace a defective component in certain Propaq Encore monitors in the first
nine months of 1997, as well as an increase in the percentage of sales of
lower margin products including service, accessories and QuikSign monitors.
<PAGE>11
Research and development. Research and development expenses decreased 4.7% to
$6.4 million in the first nine months of 1997 from $6.7 million in the first
nine months of 1996. The decrease in research and development expenses
resulted from lower development and testing costs in the first nine months of
1997 primarily related to the Acuity system. In the first quarter of 1996
there were significant development and testing costs for a new release of
Acuity system software that was introduced in March 1996. As a percentage of
sales, research and development expenses increased to 13.8% in the first nine
months of 1997 from 13.6% in the first nine months of 1996.
Selling, general and administrative. Selling, general and administrative
expenses decreased 1.0% to $15.2 million in the first nine months of 1997 from
$15.3 million in the first nine months of 1996 primarily due to reduced
incentive compensation. As a percentage of sales, selling, general and
administrative expenses increased to 32.6% in the first nine months of 1997
from 30.9% in the first nine months of 1996.
Acquisition related charges and litigation settlement charges. In the third
quarter of 1996, the Company incurred charges of $2.1 million in connection
with the acquisition of Pryon. Additionally, the Company incurred charges of
$275,000 in the same quarter related to the settlement of litigation regarding
the 1991 termination of the Company's former Canadian distributor. No such
charges were incurred during 1997.
Other income. Other income increased 5.5% to $803,000 in the first nine
months of 1997 from $761,000 in the first nine months of 1996 primarily due to
an increase in interest income related to a slightly higher rate of return on
investments.
Provision for income taxes. The provision for income taxes decreased to
$747,000 in the first nine months of 1997 from $1,646,000 in the first nine
months of 1996. Excluding the effect of non-deductible acquisition related
charges, the effective tax rate decreased to 26.0% in the first nine months of
1997 from 27.5% in the first nine months of 1996. This decrease was primarily
due to the expectation of greater benefits from the extension of the research
and experimentation tax credit and the announcement of a state tax rebate
credit in the third quarter of 1997.
<PAGE>12
PART II. OTHER INFORMATION
Item 2. Changes in Securities
During the quarter ended September 30, 1997, the Company sold securities
without registration under the Securities Act of 1933, as amended (the
"Securities Act") upon the exercise of certain stock options granted under the
Company's stock option plans. An aggregate of 1,640 shares of Common Stock
were issued at exercise prices ranging from $1.32 to $2.55. These
transactions were effected in reliance upon the exemption from registration
under the Securities Act provided by Rule 701 promulgated by the Securities
and Exchange Commission pursuant to authority granted under Section 3 (b) of
the Securities Act.
Item 4. Submission of Matters to a Vote of Security Holders.
No matters were submitted to a vote of security holders during the quarter
ended September 30, 1997.
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits: 27.1 Financial Data Schedule
(b) No reports were filed on Form 8-K during the quarter for which
this report is filed.
<PAGE>13
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
PROTOCOL SYSTEMS, INC.
(Registrant)
Date: November 12, 1997 By /s/ James B. Moon
---------------------
James B. Moon
President and
Chief Executive Officer
By /s/ Craig M. Swanson
---------------------
Craig M. Swanson
Vice-President and
Chief Financial Officer
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from Protocol
Systems, Inc. Condensed Consolidated Balance Sheet as of September 30, 1997 and
Condensed Consolidated Statement of Operations for the nine months ended
September 30, 1997.
</LEGEND>
<CIK> 0000883322
<NAME> PROTOCOL SYSTEMS, INC.
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> SEP-30-1997
<CASH> 12,206
<SECURITIES> 12,843
<RECEIVABLES> 15,569<F1>
<ALLOWANCES> 267
<INVENTORY> 13,284
<CURRENT-ASSETS> 48,512
<PP&E> 13,773
<DEPRECIATION> 9,218
<TOTAL-ASSETS> 62,163
<CURRENT-LIABILITIES> 7,396
<BONDS> 0
0
0
<COMMON> 89
<OTHER-SE> 54,238
<TOTAL-LIABILITY-AND-EQUITY> 62,163
<SALES> 46,460
<TOTAL-REVENUES> 46,460
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<TOTAL-COSTS> 22,824
<OTHER-EXPENSES> 21,566
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<EPS-PRIMARY> 0.23
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<FN>
<F1>Net of Allowance
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