<PAGE> 1
================================================================================
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
----------
FORM 10-Q
[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JULY 3, 1999
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 0-20083
--------------------------------
SPACELABS MEDICAL, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 91-1558809
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
15220 N.E. 40TH STREET, P.O. BOX 97013, REDMOND, WASHINGTON 98073
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (425) 882-3700
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
Common stock, par value $.01 per share: 9,443,366 shares outstanding
as of July 30, 1999
Page 1 of 21 sequentially numbered pages
================================================================================
<PAGE> 2
SPACELABS MEDICAL, INC.
FORM 10-Q
FOR THE QUARTERLY PERIOD ENDED JULY 3, 1999
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
<S> <C>
PART I. Financial Information
Item 1. Financial Statements
Condensed Consolidated Balance Sheets
- July 3, 1999 (unaudited) and December 31, 1998.................................. 3
Condensed Consolidated Statements of Operations (unaudited)
- Three and Six Months Ended July 3, 1999 and June 27, 1998........................ 4
Condensed Consolidated Statements of Cash Flows (unaudited)
- Six Months Ended July 3, 1999 and June 27, 1998.................................. 5
Notes to Condensed Consolidated Financial Statements................................... 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations............................................................ 10
Item 3. Quantitative and Qualitative Disclosures About Market Risk............................. 19
PART II. Other Information
Item 4. Submission of Matters to Vote of Security Holders...................................... 20
Item 6. Exhibits and Reports on Form 8-K....................................................... 20
</TABLE>
(2)
<PAGE> 3
PART I.
Item 1. Financial Statements
SPACELABS MEDICAL, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
----------------------------
July 3, December 31,
(in thousands) 1999 1998
-------------------------------------------------------------------------------------------
(unaudited)
<S> <C> <C>
ASSETS
Current assets
Cash and cash equivalents .............................. $ 5,281 $ 1,467
Receivables ............................................ 81,280 82,575
Inventories ............................................ 71,605 65,912
Prepaid expenses ....................................... 2,653 3,387
Deferred income taxes .................................. 26,052 27,171
--------- ---------
Total current assets ....................... 186,871 180,512
Property, plant and equipment, net ........................ 65,381 65,146
Deferred income taxes ..................................... 1,422 1,558
Other assets, net ......................................... 38,356 38,831
--------- ---------
$ 292,030 $ 286,047
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities
Short-term borrowings .................................. $ 1,131 $ 2,666
Current portion of long-term obligations ............... 750 750
Accounts payable and accrued expenses .................. 48,300 48,059
Deferred revenue ....................................... 4,511 5,660
Taxes on income ........................................ 1,642 2,748
--------- ---------
Total current liabilities ................. 56,334 59,883
Long-term obligations ..................................... 71,593 65,143
Shareholders' equity
Common stock and additional paid-in capital ............ 100,511 100,803
Treasury shares at cost ................................ (40,758) (41,239)
Accumulated other comprehensive loss ................... (5,009) (3,556)
Retained earnings ...................................... 109,359 105,013
--------- ---------
Total shareholders' equity ..................... 164,103 161,021
--------- ---------
$ 292,030 $ 286,047
========= =========
Common shares outstanding ................................. 9,440 9,425
========= =========
</TABLE>
See accompanying notes to condensed consolidated financial statements.
(3)
<PAGE> 4
SPACELABS MEDICAL, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
------------------------------------------------------
July 3, June 27, July 3, June 27,
(in thousands, except per share data) 1999 1998 1999 1998
- -------------------------------------------------------------------------------------------------------
(unaudited)
<S> <C> <C> <C> <C>
Revenue .................................... $ 73,843 $ 66,015 $ 144,154 $ 132,521
Cost of Sales .............................. 37,904 38,002 73,844 78,308
--------- --------- --------- ---------
Gross margin ............................... 35,939 28,013 70,310 54,213
--------- --------- --------- ---------
Operating expenses
Selling, general and administrative ... 23,233 22,481 46,035 44,745
Research and development .............. 7,523 7,853 14,834 16,294
Restructuring of operations ........... -- 3,059 -- 3,559
--------- --------- --------- ---------
30,756 33,393 60,869 64,598
--------- --------- --------- ---------
Income (loss) from operations .............. 5,183 (5,380) 9,441 (10,385)
Other income (expense)
Interest income ....................... 69 115 199 260
Interest expense ...................... (1,184) (1,091) (2,416) (2,278)
Other income (expense), net ........... (105) 5,900 (494) 10,573
--------- --------- --------- ---------
Income (loss) before income taxes .......... 3,963 (456) 6,730 (1,830)
Provision (benefit) for income taxes ....... 1,399 (166) 2,384 (669)
--------- --------- --------- ---------
Net income (loss) .......................... $ 2,564 $ (290) $ 4,346 $ (1,161)
========= ========= ========= =========
Basic net income (loss) per share .......... $ 0.27 $ (0.03) $ 0.46 $ (0.12)
========= ========= ========= =========
Diluted net income (loss) per share ........ $ 0.27 $ (0.03) $ 0.46 $ (0.12)
========= ========= ========= =========
Weighted average common shares outstanding -
Basic ................................. 9,387 9,446 9,381 9,453
========= ========= ========= =========
Diluted ............................... 9,436 9,446 9,483 9,453
========= ========= ========= =========
</TABLE>
See accompanying notes to condensed consolidated financial statements.
(4)
<PAGE> 5
SPACELABS MEDICAL, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Six Months Ended
-----------------------
July 3, June 27,
(in thousands) 1999 1998
- -------------------------------------------------------------------------------------------------
(unaudited)
<S> <C> <C>
Operating activities
Net income (loss) ................................................ $ 4,346 $ (1,161)
Adjustments to reconcile net income (loss) to net cash provided by
(used in) operating activities
Depreciation and amortization ................................... 5,085 4,773
Gain on sale of assets .......................................... (38) (13,113)
Asset write downs ............................................... -- 4,119
Deferred income tax (benefit) provision ......................... 1,303 (2,324)
Contribution to ISSOP 401(k) plan in common stock ............... 403 321
Changes in operating assets and liabilities
Decrease in receivables ...................................... 280 624
(Increase) decrease in inventories ........................... (6,530) 1,913
Decrease in prepaid expenses ................................. 714 449
Increase in accounts payable and accrued expenses ............ 199 3,438
Increase (decrease) in deferred revenue ...................... (1,199) 673
Decrease in taxes on income .................................. (1,174) (762)
Other ........................................................... (84) 18
-------- --------
Net cash provided (used) by operating activities .................... 3,305 (1,032)
-------- --------
Investing activities
Proceeds on sale of assets ....................................... 96 13,135
Investment in property, plant and equipment ...................... (4,179) (2,885)
Proceeds on maturity of short-term investments, net .............. -- 1,023
Other ............................................................ (209) (189)
-------- --------
Net cash provided (used) by investing activities .................... (4,292) 11,084
-------- --------
Effect of exchange rate changes on cash ............................. (5) (9)
-------- --------
Financing activities
Increase (decrease) in short-term borrowings ..................... (1,402) 1,695
Borrowings against (principal payments on) long-term debt, net ... 6,568 (17,609)
Purchase of treasury stock ....................................... (371) (1,308)
Exercise of stock options ........................................ 11 113
-------- --------
Net cash provided (used) by financing activities .................... 4,806 (17,109)
-------- --------
Increase (decrease) in cash and cash equivalents .................... 3,814 (7,066)
Cash and cash equivalents at beginning of period .................... 1,467 11,911
-------- --------
Cash and cash equivalents at end of period .......................... $ 5,281 $ 4,845
======== ========
</TABLE>
See accompanying notes to condensed consolidated financial statements.
(5)
<PAGE> 6
SPACELABS MEDICAL, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. Basis of Presentation
The accompanying condensed consolidated financial statements include the
accounts of Spacelabs Medical, Inc. and its subsidiaries, collectively
referred to as the "Company." The unaudited interim condensed consolidated
financial statements and related notes have been prepared pursuant to the
rules and regulations of the Securities and Exchange Commission.
Accordingly, certain information and footnote disclosures normally
included in financial statements prepared in accordance with generally
accepted accounting principles have been omitted pursuant to such rules
and regulations. The accompanying condensed consolidated financial
statements and related notes should be read in conjunction with the
consolidated financial statements and notes thereto included in the
Company's 1998 Annual Report to Shareholders.
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the
financial statements and the reported amounts of revenues and expenses
during the reporting period. The information furnished reflects, in the
opinion of management, all adjustments, consisting of normally recurring
items, necessary for a fair presentation of the results for the interim
periods presented. Interim results are not necessarily indicative of
results for a full year.
2. Inventories
<TABLE>
<CAPTION>
-------------------------
July 3, December 31,
(in thousands) 1999 1998
---------------------------------------- ------- ------------
<S> <C> <C>
Raw materials and components ........... $19,526 $18,067
Work in process ........................ 10,413 10,511
Finished products ...................... 20,245 18,468
Demonstration equipment ................ 6,140 5,502
Customer service parts and equipment ... 15,281 13,364
------- -------
$71,605 $65,912
======= =======
</TABLE>
3. Gross Margin
Gross margin through the second quarter of 1998 includes a $1.2 million
charge reflecting the expected cost of addressing year 2000 compliance in
products that were sold to customers during previous periods, $2.0 million
in charges related to the write-off of intangible assets associated with
obsolete product line technology and a $4.0 million charge related to the
write-down of inventory to expected market value in accordance with the
Company's accelerated introduction of certain monitoring products.
4. Restructuring of Operations
(6)
<PAGE> 7
During the first and second quarters of 1998, the Company incurred $3.6
million in restructuring charges associated with initiatives to improve
the Company's cost structure.
5. Other Income (Expense)
During the first and second quarters of 1998, the Company realized gains
totaling $13.1 million related to its equity investment in Physio Control
International Corporation. Other income (expense) for the first and second
quarters of 1998 also includes $2.1 million in charges related to
write-downs on certain investments.
6. Net Income (Loss) per Share
Basic net income (loss) per share is based on the weighted-average number
of common shares outstanding for the period. Diluted net income (loss) per
share includes the effect of dilutive potential common shares outstanding,
consisting of stock options and unvested restricted shares, using the
treasury stock method. Unvested restricted shares and unexercised,
out-of-the-money stock options representing the potential rights to
2,660,325 and 1,800,225 shares for the second quarter of 1999 and first
six months of 1999, respectively, are excluded as their effects would be
antidilutive. For the second quarter and first six months of 1998, the
potential rights to 2,775,820 shares are excluded as their effects would
be antidilutive. The following schedule represents a reconciliation of the
numerators and denominators of basic and diluted net income (loss) per
share calculations on a quarter and year-to-date basis for 1999 and 1998.
<TABLE>
<CAPTION>
Weighted
Average
Income / (loss) Shares Income / (loss)
(In thousands, except per share data) (Numerator) (Denominator) Per Share
-------------------------------------------------- --------------- ------------- --------------
<S> <C> <C> <C>
Three months ended July 3, 1999:
Basic net income per share .................. $ 2,564 9,387 $ 0.27
========
Effect of dilutive stock options and unvested
restricted stock .......................... -- 49
------- -----
Diluted net income per share ................ $ 2,564 9,436 $ 0.27
======= ===== ========
Three months ended June 27, 1998:
Basic net loss per share .................... $ (290) 9,446 $ (0.03)
========
Effect of dilutive stock options and unvested
restricted stock .......................... -- --
------- -----
Diluted net loss per share .................. $ (290) 9,446 $ (0.03)
======= ===== ========
Six months ended July 3, 1999:
Basic net income per share .................. $ 4,346 9,381 $ 0.46
========
Effect of dilutive stock options and unvested
restricted stock .......................... -- 102
------- -----
Diluted net income per share ................ $ 4,346 9,483 $ 0.46
======= ===== ========
Six months ended June 27, 1998:
Basic net loss per share .................... $(1,161) 9,453 $ (0.12)
========
Effect of dilutive stock options and unvested
restricted stock .......................... -- --
------- -----
Diluted net loss per share .................. $(1,161) 9,453 $ (0.12)
======= ===== ========
</TABLE>
(7)
<PAGE> 8
7. Business Segments
In accordance with Statement of Financial Accounting Standards ("SFAS")
No. 131, "Disclosures about Segments of an Enterprise and Related
Information," the Company has identified three reportable business
segments: US Monitoring, US Cardiology and International. Business
segments were determined based upon management responsibility using a
combination of product and geographic factors. Segment profit is measured
as operating income less research and development, restructuring charges,
and certain unallocated corporate general and administrative expenses. The
Company has no inter-segment revenue.
The following analysis provides a breakdown of revenue and profit of each
reportable business segment for the three and six month periods ended July
3, 1999 and June 27, 1998.
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
------------------------------------------------------
July 3, June 27, July 3, June 27,
(in thousands) 1999 1998 1999 1998
------------------------------------------------------- -------- --------- --------- ---------
<S> <C> <C> <C> <C>
Revenue:
US Monitoring ...................................... $ 40,909 $ 36,897 $ 80,803 $ 71,159
US Cardiology ...................................... 10,968 10,394 20,460 20,431
International ...................................... 21,966 18,724 42,891 40,931
--------- --------- --------- ---------
Total Revenue ...................................... $ 73,843 $ 66,015 $ 144,154 $ 132,521
========= ========= ========= =========
Segment Profit:
US Monitoring ...................................... $ 10,520 $ 7,096 $ 21,092 $ 12,796
US Cardiology ...................................... 1,219 1,214 1,426 1,888
International ...................................... 2,298 1,867 4,335 4,551
--------- --------- --------- ---------
Total Segment Profit ............................... $ 14,037 $ 10,177 $ 26,853 $ 19,235
Reconciliation of segment profit to income
(loss) before income taxes:
Unallocated general and administrative
expenses ......................................... $ (1,331) $ (1,477) $ (2,578) $ (2,599)
Unallocated cost of sales ......................... -- (3,168) -- (7,168) (a)
Research and development .......................... (7,523) (7,853) (14,834) (16,294)
Restructuring costs ............................... -- (3,059) -- (3,559)
Other income (expense) ............................ (1,220) 4,924 (2,711) 8,555
--------- --------- --------- ---------
Income (loss) before income taxes ................. $ 3,963 $ (456) $ 6,730 $ (1,830)
========= ========= ========= =========
</TABLE>
- ----------
(a) See Note 3.
(8)
<PAGE> 9
8. Comprehensive Income
Comprehensive income, in general, refers to the total change in equity
during a period except those changes that result from investments by
owners and distributions to owners. Comprehensive income includes net
income as well as an other comprehensive income component comprised of
certain revenues, expenses, gains and losses that under generally accepted
accounting principles are reflected in shareholders' equity but excluded
from the determination of net income. The Company has segregated the total
accumulated other comprehensive income (specifically, accumulated foreign
currency translation adjustments and unrealized gains and losses on
investments available-for-sale) from the other components of shareholders'
equity in the accompanying Condensed Consolidated Balance Sheets.
Comprehensive income (loss) for the three and six month periods ended July
3, 1999 and June 27, 1998 are detailed below:
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
-----------------------------------------------
July 3, June 27, July 3, June 27,
(in thousands) 1999 1998 1999 1998
------------------------------------------------------- ------- -------- ------- --------
<S> <C> <C> <C> <C>
Net income (loss) ..................................... $ 2,564 $ (290) $ 4,346 $(1,161)
Other comprehensive income (loss), net of tax:
Foreign currency translation adjustments .......... (403) (439) (1,453) (624)
Reclassification adjustment for portion of net
realized gain included in results of operations and
previously reported in other comprehensive income . -- (3,984) -- (6,392)
------- ------- ------- -------
Comprehensive income (loss), net of tax ............... $ 2,161 $(4,713) $ 2,893 $(8,177)
======= ======= ======= =======
</TABLE>
9. Supplemental Cash Flow Information
The following provides additional information concerning cash flow
activities:
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
-------------------------------------------------
July 3, June 27, July 3, June 27,
(in thousands) 1999 1998 1999 1998
---------------------- ------ ------ ------ ------
<S> <C> <C> <C> <C>
Interest paid ........ $1,143 $1,058 $2,920 $2,590
====== ====== ====== ======
Income taxes paid..... $ 295 $ 520 $2,690 $2,574
====== ====== ====== ======
</TABLE>
(9)
<PAGE> 10
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
RESULTS OF OPERATIONS
<TABLE>
<CAPTION>
------------------------------------------- -------------------------------------------
Three months ended Six months ended
------------------------------------------- -------------------------------------------
July 3, June 27, Dollar Percent July 3, June 27, Dollar Percent
(dollars in millions, except per share 1999 1998 Change Change 1999 1998 Change Change
data)
- ---------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Revenue................................. $73.8 $66.0 $7.8 11.9% $144.2 $132.5 $11.6 8.8%
Gross margin............................ 35.9 28.0 7.9 28.3% 70.3 54.2 16.1 29.7%
As a % of revenue..................... 48.7% 42.4% 48.8% 40.9%
Operating expenses:
Selling, general and administrative. 23.2 22.5 0.8 3.3% 46.0 44.7 1.3 2.9%
As a % of revenue................. 31.5% 34.1% 31.9% 33.8%
Research and development............ 7.5 7.9 (0.3) (4.2%) 14.8 16.3 (1.5) (9.0%)
As a % of revenue................. 10.2% 11.9% 10.3% 12.3%
Restructuring of operations......... - 3.1 (3.1) (100.0%) - 3.6 (3.6) (100.0%)
Provision (benefit) for income taxes.... 1.4 (0.2) 1.6 NM 2.4 (0.7) 3.1 NM
Effective tax rate.................... 35.3% 36.4% 35.4% 36.6%
Net income (loss)....................... $2.6 $(0.3) $2.9 NM $4.3 $(1.2) $5.5 NM
Basic and diluted net income (loss)
per share............................ $0.27 $(0.03) $0.30 NM $0.46 $(0.12) $0.58 NM
- ---------------------------------------------------------------------------------------------------------------------------------
NM - Not meaningful
</TABLE>
Revenue
Worldwide revenue for the second quarter of 1999 was $73.8 million, an increase
of 11.9% when compared to the second quarter of 1998.
Second quarter 1999 US revenue increased 9.7% to $51.9 million from $47.3
million in the same quarter of 1998. Current quarter US Monitoring revenue
increased 10.9% to $40.9 million from $36.9 million during the same quarter of
the prior year. The increase in US Monitoring revenue reflects continued
customer interest in the Ultraview Care Network products introduced in 1998.
Second quarter 1999 US Cardiology revenue increased 5.5% to $11.0 million from
$10.4 million in 1998. While management is encouraged by these results, the US
market continues to be extremely competitive as a result of changes in the US
healthcare delivery system. At this time, management sees no identifiable factor
in the environment that would definitively signal an end to this condition.
In the second quarter of 1999, International revenue, including export sales,
increased by 17.3% to $22.0 million, from $18.7 million in the same quarter of
1998. For the 1999 quarter, International revenue comprised 29.7% of total
revenue as compared to 28.4% of total revenue in the second quarter
(10)
<PAGE> 11
of 1998. The increase in International revenue is attributable to strong growth
in Canada, the Middle East and parts of Europe.
On a year-to-date basis, worldwide revenue was $144.2 million, an increase of
8.8% when compared to the same period a year ago.
Total US revenue for the first six months of 1999 increased 10.6% to $101.3
million as compared to $91.6 million during the same period of 1998. US
Monitoring revenue increased 13.6% to $80.8 million in 1999 versus $71.2 million
during the first six months of 1998. The increase in US Monitoring revenue
reflects continued customer interest in the Ultraview Care Network products
introduced in 1998. US Cardiology revenue totaled $20.5 million for the first
six months of 1999 versus $20.4 million in the same period in 1998.
International revenue for the first six months increased 4.8% to $42.9 million,
or 29.8% of current year revenue, as compared to $40.9 million, or 30.9% of
total revenue during the first six months of 1998.
The Company's ability to produce consistent future revenue growth is, to a
certain extent, dependent on its backlog of currently shippable orders. Backlog
is subject to seasonal variations and generally has been greater in the fourth
fiscal quarter of the year. There is no guarantee that the Company will have
sufficient backlog in any given quarter to meet its revenue objectives. In
addition, international revenue is subject to a higher degree of uncertainty
from quarter to quarter than is US revenue due to the need for foreign
government approvals, more complex financing arrangements, greater variability
in the financial stability of the customers and instability of currencies in
parts of the world.
Gross Margin
Gross margin was 48.7% of revenue in the second quarter of 1999 as compared to
42.4% during the same quarter a year ago. Current quarter gross margin was
favorably impacted, when compared to the prior year quarter, by various factors
including: continued customer interest in the higher-margin Ultraview Care
Network product line introduced during 1998; the realization of cost savings as
a result of restructuring initiatives implemented during the first half of 1998;
and the effect of increased revenue on the fixed components of the Company's
cost of sales. While the Company's gross margin showed improvement when compared
to prior year results, the Company continues to experience the adverse effect of
increasing worldwide pricing pressures attributable to higher levels of
competition and changes in the healthcare environment. The Company believes that
pressure on gross margin from aggressive worldwide competitive pricing will
continue in the foreseeable future.
Gross margin for the second quarter of 1998 was negatively impacted by a $1.2
million charge related to the expected cost of addressing year 2000 compliance
in products sold to customers during previous periods and a $2.0 million charge
related to the write-off of intangible assets associated with obsolete product
line technology. Excluding these charges, the Company's gross margin for the
second quarter of 1998 would have been 47.2%.
Gross margin for the first six months of 1999 was 48.8% of revenue compared to
40.9% during the same period a year ago. The increase in year-to-date gross
margin was primarily due to the factors discussed above and the fact that prior
year margins were negatively impacted by a $4.0 million write-down of inventory
during the first quarter as a result of the accelerated introduction of certain
monitoring products. Excluding the first quarter inventory write-down and the
second quarter charges related to
(11)
<PAGE> 12
year 2000 compliance and obsolete product line technology, the gross margin for
the first six months of 1998 would have been 46.3% of that period's revenue.
Operating Expenses
During the second quarter of 1999, selling, general and administrative expenses
increased $0.8 million to $23.2 million from $22.5 million in the second quarter
of 1998. Selling, general and administrative expenses as a percentage of revenue
were 31.5% in the second quarter of 1999 as compared to 34.1% in the second
quarter of 1998. On a year-to-date basis, selling, general and administrative
expenses increased $1.3 million to $46.0 million from $44.7 million during the
first six months of 1998. As a percentage of revenue, first half 1999 selling,
general and administrative expenses were 31.9% versus 33.8% in the first half of
1998. The increase in expenses on a dollar basis is due primarily to an increase
in variable selling expenses attributable to greater worldwide revenue. The
decline in selling, general and administrative expenses as a percentage of
revenue reflects the impact of higher revenue relative to the fixed cost
components of these activities.
Research and development expenses decreased $0.3 million to $7.5 million in the
second quarter of 1999 from $7.9 million during the same quarter of the prior
year. On a year-to-date basis, research and development expenses decreased $1.5
million to $14.8 million, or 10.3% of revenue, as compared to $16.3 million, or
12.3% of revenue, during the first six months in 1998. In the first half of
1999, the Company continued to invest in the development of its anesthesia
delivery system and other future products and programs including an internet
initiative. These expenditures were offset by cost reduction efforts initiated
during the first half of 1998 and a continued focus on cost containment. The
Company has not capitalized software development costs in its existing product
line, however, the development of certain newer products may require such
treatment.
During the first half of 1998, the Company incurred approximately $3.6 million
in charges associated with various restructuring programs in order to improve
the Company's cost structure. The charges represent the cost of employee
severance benefits and related expenses, office closure and moving costs
associated with closing two research offices and three sales offices and related
asset impairment charges.
Segment Profit
The Company measures segment profit as operating income before research and
development, restructuring charges, and certain unallocated corporate general
and administrative expenses. During the second quarter of 1999, segment profit
for the Company's US Monitoring business increased 48.3% to $10.5 million from
$7.1 million during the second quarter of 1998. On a year-to-date basis, US
Monitoring segment profit increased 64.8% to $21.1 million during the first six
months of 1999 as compared to $12.8 million during the first six months of the
prior year. The growth in segment profit on both a quarter and year-to-date
basis was primarily attributable to increased revenue, the realization of cost
savings related to new generation products and cost reduction initiatives
implemented during the first half of 1998.
For the second quarter of 1999, segment profit for the US Cardiology segment
totaled $1.2 million compared to $1.2 million for the second quarter of 1998. On
a year-to-date basis, US Cardiology segment profit was $1.4 million as compared
to $1.9 million during the first six months of 1998. The change in year-to-date
segment profitability is primarily the result of changes in product mix.
During the second quarter of 1999, segment profit for the Company's
International business unit increased to $2.3 million from $1.9 million for the
second quarter of 1998, which is attributable to increased revenue in the 1999
quarter. Year-to-date 1999 International segment profit totaled $4.3 million
versus $4.6 million during the same period in 1998. This decline in segment
profitability is
(12)
<PAGE> 13
primarily due to competitive pricing pressures in certain overseas markets and
the strengthening of the US dollar relative to other currencies.
Other Income (Expense)
Interest expense for the second quarter of 1999 was approximately $1.2 million,
an 8.5% increase from the same period of 1998. On a year-to-date basis, interest
expense totaled approximately $2.4 million during 1999 as compared to $2.3
million during the first six months of the prior year. The increase was due to
higher average borrowing levels during the 1999 period. Interest income was
approximately $69,000 for the second quarter of 1999 compared to $115,000 during
the second quarter of 1998. On a year-to-date basis, interest income totaled
approximately $199,000 in 1999 versus approximately $260,000 during the first
six months of 1998.
The Company recognized a $22,000 loss from foreign currency exchange rate
fluctuations in the second quarter of 1999 compared to an $88,000 loss during
the same quarter a year ago. On a year-to-date basis, the Company experienced
exchange losses totaling $351,000 during 1999 versus $125,000 during the first
six months of 1998. The exchange rate losses reflect the impact of the
strengthening US dollar against the currencies of the Company's foreign
operations.
During the second quarter of 1998, the Company recognized a $6.8 million gain on
the sale of its investment in Physio Control International Corporation
("Physio") common stock, which was partially offset by charges primarily related
to the write-down of an investment. Through the first six months of 1998, the
Company recognized $13.1 million in gains on the sale of its investment in
Physio common stock and incurred $2.1 million in charges primarily related to
the write-down of certain investments.
Taxes and Net Income (Loss)
The effective tax rate for the second quarter of 1999 was 35.3% versus 36.4% in
the same period a year ago. On a year-to-date basis, the effective tax rate for
1999 was 35.4% as compared to 36.6% during 1998. The decline in the effective
tax rates, both on a quarterly and year-to-date basis, reflect the Company's
efforts to minimize its tax burden by implementing various international tax
strategies.
As a result of the above, the Company reported net income of $2.6 million, or
$0.27 per share, during the second quarter of 1999 as compared to a net loss of
$0.3 million, or $0.03 per share, during the second quarter of 1998. During the
first six months of 1999, the Company reported net income of $4.3 million, or
$0.46 per share, as compared to a net loss of $1.2 million, or $0.12 per share,
during the first six months of the prior year.
(13)
<PAGE> 14
CAPITAL RESOURCES & LIQUIDITY
<TABLE>
<CAPTION>
---------------------------------------------------
July 3, December 31, Dollar Percent
(dollars in millions) 1999 1998 Change Change
- ------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Cash and cash equivalents ...... $ 5.3 $ 1.5 $ 3.8 260.0%
Working capital ................ 130.5 120.6 9.9 8.2%
Long-term obligations .......... 71.6 65.1 6.5 9.9%
Shareholders' equity ........... 164.1 161.0 3.1 1.9%
- ------------------------------------------------------------------------------------
</TABLE>
Capital Resources and Liquidity
As of July 3, 1999, cash and cash equivalents totaled $5.3 million compared to
$1.5 million on December 31, 1998. The increase in cash is attributable to the
receipt of customer payments near the end of the quarter that, due to the timing
of their receipt, were not used to reduce the Company's outstanding long-term
debt. Similarly, working capital increased by $9.9 million during the first six
months of 1999 to $130.5 million as compared to $120.6 million as of prior year
end. The increase in working capital is primarily due to the increase in cash
and an increase in inventory to support Year 2000 customer update activity,
product line expansion, the anticipated introduction of a new anesthesia
delivery system and the Company's continued transition to a newer generation
product line.
During the first six months of 1999, the Company generated $3.3 million in cash
from operations as compared to using $1.0 million from operations during the
same period a year ago. Net income after adjustment for certain non-cash charges
represented the main source of operating cash during the six-month period ended
July 3, 1999. The Company's primary use of operating cash during the first and
second quarters of 1999 related to the increase in inventories as discussed
above.
The Company used $4.3 million in cash in investing activities during the first
six months of 1999 as compared to generating $11.1 million in cash from
investing activities during the same period in 1998. On a year-to-date basis,
capital expenditures totaled $4.2 million during the current year versus $2.9
million during the first six months of 1998. Management expects capital
expenditures for the second half of 1999 to be comparable to first-half levels.
Prior year cash provided by investing activities included $13.1 million in
proceeds on the sale of the Company's investment in Physio common stock.
During the first six months of 1999, the Company generated approximately $4.8
million in cash through financing activities as compared to using $17.1 million
in financing activities during the same period a year ago. Advances on the
Company's $65 million long-term credit facility increased $6.6 million during
the current year. Significant financing uses of cash during the current year
included repayments of approximately $1.4 million of short-term borrowings,
scheduled payments of $0.4 million on its other long-term debt and $0.4 million
in Company stock repurchases. As of July 3, 1999, approximately 848,600 shares
remain authorized for repurchase under the share repurchase
(14)
<PAGE> 15
programs approved by the Company's Board of Directors in 1995 and 1997. Shares
acquired under the repurchase programs are being used to service the Company's
various employee benefit plans and may be used for other purposes the Company
deems appropriate. The primary use of cash during the first six months of 1998
related to the net paydown of approximately $17.6 million in long-term debt.
Future Cash Flow and Liquidity
As of July 3, 1999, the Company had approximately $8.1 million available for
future borrowings under its $65.0 million long-term credit facility; a US
unsecured bank line of credit totaling $5.0 million for issuances of letters of
credit, banker's acceptances and performance bonds; and approximately $4.1
million available under several small international credit lines used to meet
the operating requirements of its international subsidiaries.
Given the nature of the current worldwide economic environment, the Company is
subject to a certain degree of liquidity risk with respect to the collectability
of customer accounts and the cash flow impact of unfavorable changes in foreign
exchange rates. However, management believes that existing cash and cash flow
from operations, together with available credit facilities, will continue to be
sufficient to meet ongoing operating requirements as well as the Company's
investment in capital additions and research and development activities for the
foreseeable future. In connection with research and development, cash may be
used from time to time to acquire technology or to fund strategic ventures.
The Year 2000 Issue
The "Year 2000 Issue" refers to various problems that may result from the
improper processing of dates and date-sensitive calculations by computers and
other machinery as we enter the year 2000. These problems generally arise from
the fact that many computer programs and embedded microchips in equipment use
only two-digits to identify the year in a date. This may result in a computer or
information system component failing to distinguish or properly characterize
dates in the twenty-first century. This could cause system failures or
miscalculations leading to disruptions including, but not limited to, the
operations of the Company, data and financial information management, the
receipt of goods from the Company's suppliers and the provision of goods and
services to the Company's customers.
State of Readiness
The Company has implemented a comprehensive program in an effort to properly
address Year 2000 issues with its internal systems, its products and with its
third party suppliers and service providers. Components of this program include:
(1) an inventory of material computer systems and embedded technologies produced
or used by the Company; (2) assessment of Year 2000 compliance with material
information technology ("IT") and non-IT systems; (3) repair or replacement of
items that are determined not to be Year 2000 compliant; (4) test for material
Year 2000 compliance; and (5) design, where necessary, of appropriate
contingency plans.
Internal systems: During 1998, the Company completed the inventory and
assessment phase of the program with respect to its material internal computer
systems and embedded technologies. This
(15)
<PAGE> 16
assessment revealed non-compliance with respect to several significant systems,
which have been repaired or replaced. In July 1999, the Company completed the
replacement of accounting and business software used by the Company's
international subsidiaries with compliant financial software. This software will
also assist the Company in accounting for Euro-currency transactions. The
Company also completed the replacement of its primary service call tracking
software with a new compliant system in July 1999. The Company's primary
business and manufacturing software (Maxcim) required minor Year 2000
modifications, which were completed in 1998. The Company's Spacelabs Burdick
operation completed the process of upgrading to compliant versions of its
business, manufacturing and service call tracking software in 1998. In addition,
the Company has completed the upgrade of certain of its mainframe and network
operating systems to Year 2000 compliant versions. The Company continues to
repair or replace certain other non-critical software applications, which are
not fully Year 2000 compliant.
Products: The Company has completed the inventory and assessment phases with
respect to products shipped since January 1, 1985 which contain software or
embedded microchips. Each of the Company's products have been assigned to one of
three categories as defined by the Company: "Year 2000 Compliant," "Year 2000
Compliant - software upgrade required," and "Not Year 2000 Compliant." The
Company maintains a list of these products and their current status on its web
site, which is periodically updated as new information becomes available or as
corrections to previous status updates become known. In addition, registered
customers receive periodic customer service bulletins which provide information
on assessing Year 2000 compliance of the Company's products and obtaining and
installing fixes where necessary. As of July 3, 1999, the Company was
approximately 95% complete with the development and testing of software upgrades
for its products that will be made Year 2000 compliant. Software upgrades to
correct Year 2000 issues are provided free of charge to the Company's customers.
Installation services are provided free for products shipped after October 1,
1996 and for customers with current maintenance agreements. Certain older
products will not be made Year 2000 Compliant and those products have been and
are being identified by the Company. In the second quarter of 1998, the Company
accrued approximately $1.2 million related to the costs of replacing
non-compliant embedded microchips with compliant microchips in certain older
monitors covered under service agreements. The Company began making these
updates in the fourth quarter of 1998 and expects to be substantially complete
with this program by the end of 1999.
Suppliers and service providers: The Company's Year 2000 program includes
contacting the Company's significant suppliers who provide both IT assets and
non-IT related goods and services. The Company has initiated this program to (1)
evaluate such suppliers' or service providers' Year 2000 compliance plans and
state of readiness and (2) determine the extent to which the Company is
vulnerable to those third parties' failure to remediate their Year 2000
compliance issues. During the fourth quarter of 1998 and the first part of 1999,
the Company expanded this program to include a broader analysis of suppliers and
service providers throughout all areas of the corporation. To date, the Company
has obtained information on Year 2000 compliance from all of its critical
suppliers and has obtained written certifications or acceptable responses from
approximately 80% of such suppliers of their Year 2000 compliance. The Company
is evaluating responses from the remaining 20% of its critical suppliers. The
Company will continue its efforts to monitor the progress of its key suppliers
and continue efforts to obtain and evaluate responses from them throughout 1999.
(16)
<PAGE> 17
Costs to Address the Year 2000 Issue
The total cost to the Company of achieving Year 2000 compliance currently is
expected to range between $6.0 and $6.5 million. The total includes, but is not
limited to: (1) the cost of identifying, assessing and repairing or replacing
internal IT and non-IT systems, including capitalizable costs of approximately
$2.6 million associated with implementation of the Company's new international
business and accounting software and new service call tracking software, which
projects were accelerated in order to be available as Year 2000 solutions; (2)
the cost of developing and testing software and hardware fixes for non-compliant
products; (3) customer satisfaction costs associated with communication,
delivery and installation of product fixes; (4) costs associated with evaluating
the Year 2000 compliance status of suppliers and service providers; and (5) the
cost of developing contingency plans. Included in the total costs of $6.0 to
$6.5 million is $1.2 million relating to the Year 2000 upgrade of products
previously sold to customers, which was accrued for in the second quarter of
1998. Expenditures through July 3, 1999, totaled approximately $4.2 million.
Risks and Contingency Plans
The Company is continuing its assessment of the risks associated with the Year
2000 issue and its program to address such issues is ongoing. The Company's
determination is not complete and there are no assurances that it will be
completed in a timely manner or, if it is completed, that it will be completely
accurate. Based on the results of this evaluation to date, the Company has
developed preliminary contingency plans for its critical systems and processes.
These contingency plans include selection of backup suppliers, increases in
inventory levels of certain key components, expanded customer support in early
January 2000 and the replacement of IT systems with manual systems. Such
contingency plans will continue to be developed and refined throughout the
remainder of 1999. There are no assurances that such plans will be adequate or
completed in a timely manner. If the Company is unable to remediate its Year
2000 issues in a timely manner, the Company's manufacturing operations may be
unable to build and deliver products due to internal system failures, and
vendors may be unable to deliver services, raw materials, and components. The
failure to remediate material systems, suppliers, or products may have a
material adverse effect on the operations of the Company. Additionally, the
Company and many other businesses have potential unquantifiable exposure arising
from third-party systems outside of the general operational control of the
Company, which may be effected by Year 2000 issues. These include, but are not
limited to, such systems as the national and worldwide banking information
systems, transportation, governmental systems, and utilities. It may not be
possible to develop adequate or any risk assessment and contingency plans for
such widespread systems failures. Finally, this Year 2000 disclosure contains
estimates and forward-looking statements. Those estimates and statements are
subject to inherent uncertainty and there is no guaranty that they are accurate.
The Euro Conversion
As of January 1, 1999, the authority to direct monetary policy for certain
participating countries in the European Union is now exercised by the new
European Central Bank. During a transition period between January 1, 1999 and
January 1, 2002, private parties may pay for goods and services using either the
Euro or the participating country's legacy currency on a "no compulsion, no
prohibition" basis. Beginning January 1, 2002 the participating countries will
only use new Euro-denominated bills and coins.
(17)
<PAGE> 18
The Euro conversion may create technical challenges to adapt information
technology and other systems to accommodate Euro-denominated transactions. The
participating countries' adoption of a single currency may result in greater
transparency of pricing for the Company's products, making Europe a more
competitive environment. Currently, the effects of the Euro conversion on the
operations of the Company are uncertain. The Company has initiated but not yet
completed an analysis to facilitate the development of a plan for the
conversion. While management currently believes that it will complete an
adequate analysis, plan and implement the plan in a timely manner, and avoid any
material adverse effect, there is the possibility that this may not occur.
Forward Looking Information
Statements that are not based on historical facts are forward-looking statements
subject to uncertainties and risks, including, but not limited to, product and
service demand and acceptance, adverse economic conditions, adverse exchange
rate fluctuations and political risks, the impact of competition on pricing,
capacity and supply constraints or difficulties, the failure to achieve product
development objectives, reliance on single-source vendors for important
component products, and other risks detailed in this document and other of the
Company's Securities and Exchange Commission filings.
(18)
<PAGE> 19
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Foreign Currency
Substantially all of the revenue and operating expenses of the Company's foreign
subsidiaries are denominated in local currencies and translated into US dollars
at rates of exchange approximating those existing at the date of the
transactions. Foreign currency translation impacts primarily revenue and
operating expenses as a result of foreign exchange rate fluctuations. Because
the Company's inventories are manufactured in the United States, foreign
currency fluctuations generally do not affect its cost of goods sold. The
Company's foreign currency transaction risk is primarily limited to current
amounts receivable from its foreign subsidiaries, which are denominated in local
currencies (approximately $8.7 million at July 3, 1999). To minimize foreign
currency transaction risk, the Company ensures that its foreign subsidiaries
remit amounts to the US parent in a timely manner. Foreign country short-term
borrowing facilities are utilized where necessary to ensure prompt payments. The
Company does not currently utilize foreign currency hedging contracts.
Interest Rates
The Company's earnings are affected by changes in short-term interest rates as a
result of its short and long term borrowings. To limit the potential effects of
interest rate changes, the Company has entered into interest rate swap
agreements to convert a portion of its variable interest rate debt into fixed
rates. The Company does not enter into derivative or interest rate transactions
for speculative purposes. At July 3, 1999, the Company's variable rate long-term
debt totaled $69.3 million and variable rate short-term borrowings totaled $1.1
million. The Company has interest rate swap agreements with a notional amount
aggregating $42.4 million, effectively converting $12.4 million and $30.0
million of its variable rate long-term debt to fixed rates of 6.66% and 7.07%,
respectively.
(19)
<PAGE> 20
PART II.
Item 4. Submission of Matters to a Vote of Security Holders
The annual meeting of Spacelabs Medical, Inc.'s shareholders was held on May 7,
1999. The following proposals were submitted to a vote:
a) The election of seven directors, each to hold office for a term of one year
and each of whom were previously a director of Spacelabs Medical, Inc. This
proposal passed with the following number of votes:
<TABLE>
<CAPTION>
Affirmative Abstentions
----------- -----------
<S> <C> <C>
Gilbert W. Anderson 8,305,649 71,558
Thomas J. Dudley, D.B.A. 8,310,003 67,204
Harvey Feigenbaum, M.D. 8,306,692 70,515
Carl A. Lombardi 8,261,936 115,271
Andrew R. Nara, M.D., Ph.D. 8,309,591 67,616
Phillip M. Nudelman, Ph.D. 8,309,416 67,791
Peter H. van Oppen 8,310,617 66,590
</TABLE>
b) Ratification of the appointment of KPMG LLP as auditors for Spacelabs
Medical, Inc. for 1999. This proposal passed with 8,338,672 affirmative
votes, 15,060 negative votes, and 23,475 abstentions.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits:
<TABLE>
<CAPTION>
Number Description
------ -----------
<S> <C>
27.1 Financial Data Schedule
</TABLE>
(b) Reports on Form 8-K:
There were no reports on Form 8-K filed during the three months ended
July 3, 1999.
(20)
<PAGE> 21
SIGNATURE
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.
SPACELABS MEDICAL, INC.
(Registrant)
DATE: August 16, 1999
BY: /s/ Carl A. Lombardi
-------------------------------------
Carl A. Lombardi
Chairman of the Board and
Chief Executive Officer
BY: /s/ James A. Richman
-------------------------------------
James A. Richman
Vice President and
Corporate Controller
(21)
<PAGE> 22
SPACELABS MEDICAL, INC.
EXHIBIT INDEX
Exhibits:
<TABLE>
<CAPTION>
Number Description
------ -----------
<S> <C>
27.1 Financial Data Schedule
</TABLE>
(22)
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> JUL-03-1999
<CASH> 5,281
<SECURITIES> 0
<RECEIVABLES> 84,334
<ALLOWANCES> 3,054
<INVENTORY> 71,605
<CURRENT-ASSETS> 186,871
<PP&E> 135,867
<DEPRECIATION> 70,486
<TOTAL-ASSETS> 292,030
<CURRENT-LIABILITIES> 56,334
<BONDS> 68,503
0
0
<COMMON> 113
<OTHER-SE> 163,990
<TOTAL-LIABILITY-AND-EQUITY> 292,030
<SALES> 144,154
<TOTAL-REVENUES> 144,154
<CGS> 73,844
<TOTAL-COSTS> 73,844
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 207
<INTEREST-EXPENSE> 2,416
<INCOME-PRETAX> 6,730
<INCOME-TAX> 2,384
<INCOME-CONTINUING> 4,346
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 4,346
<EPS-BASIC> .46
<EPS-DILUTED> .46
</TABLE>
