UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
-----------------------------
FORM 10-Q
(MARK ONE)
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1998
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: 33-93464
DICTAPHONE CORPORATION
(Exact Name of Registrant as Specified in its Charter)
DELAWARE 06-0992637
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
3191 Broadbridge Avenue
Stratford, CT 06614
(203) 381-7000
(Address of principal executive offices, including zip code,
and telephone number, including area code)
----------------------------------------------------
(Former name, former address and former fiscal year,
if changed since last report)
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 [_]
Number of shares of Common Stock, par value $.01 per share, outstanding as of
November 11, 1998: 12,939,000
The Common Stock of the registrant is not publicly traded.
<PAGE>
DICTAPHONE CORPORATION
----------------------
INDEX
-----
Page No.
--------
PART I. FINANCIAL INFORMATION
- -------------------------------
ITEM 1. Condensed Consolidated Financial Statements
Unaudited Condensed Consolidated Statements
of Operations for the Three Months Ended
September 30, 1998 and September 30, 1997 2
Unaudited Condensed Consolidated Statements
of Operations for the Nine Months Ended
September 30, 1998 and September 30, 1997 3
Condensed Consolidated Balance Sheets as of
September 30, 1998 (Unaudited) and December
31, 1997 4
Unaudited Condensed Consolidated Statements
of Cash Flow for the Nine Months Ended
September 30, 1998 and September 30, 1997 5
Notes to Unaudited Consolidated Financial
Statements 6
ITEM 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 19
ITEM 3. Quantitative and Qualitative Disclosures About Market Risk 26
PART II. OTHER INFORMATION
- ---------------------------
ITEM 1. Legal Proceedings 27
ITEM 6. Exhibits and Reports on Form 8-K 27
1
<PAGE>
PART I - FINANCIAL INFORMATION
ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
-------------------------------------------
DICTAPHONE CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
(Dollars in thousands)
<TABLE>
<CAPTION>
THREE MONTHS THREE MONTHS
ENDED ENDED
SEPTEMBER 30, SEPTEMBER 30,
1997 1998
-------- --------
<S> <C> <C>
Revenues:
Product sales and rentals $ 52,416 $ 52,200
Contract manufacturing sales 10,739 11,575
Support services 24,561 22,101
-------- --------
Total revenue 87,716 85,876
-------- --------
Costs and expenses:
Cost of sales, rentals and support services 46,129 45,131
Selling and administrative 26,953 26,776
Amortization of intangibles 8,772 4,679
Research and development 3,813 4,898
-------- --------
Operating profit 2,049 4,392
Interest expense 10,497 9,913
Other expense - net 357 450
-------- --------
Loss before income taxes (8,805) (5,971)
Income tax benefit 2,782 587
-------- --------
Net loss (6,023) (5,384)
Stock dividends on PIK Preferred Stock 681 782
-------- --------
Net loss applicable to Common Stock $ (6,704) $ (6,166)
======== ========
</TABLE>
See accompanying notes to condensed consolidated financial statements.
2
<PAGE>
DICTAPHONE CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
(Dollars in thousands)
<TABLE>
<CAPTION>
NINE MONTHS NINE MONTHS
ENDED ENDED
SEPTEMBER 30, SEPTEMBER 30,
1997 1998
--------- ---------
<S> <C> <C>
Revenues:
Product sales and rentals $ 148,375 $ 153,419
Contract manufacturing sales 30,364 35,067
Support services 70,085 66,200
--------- ---------
Total revenue 248,824 254,686
--------- ---------
Costs and expenses:
Cost of sales, rentals and support services 144,574 137,100
Selling and administrative 84,719 82,105
Amortization of intangibles 27,320 20,393
Research and development 11,146 12,854
--------- ---------
Operating (loss) profit (18,935) 2,234
Interest expense 31,174 29,632
Other expense (income) - net 593 (205)
--------- ---------
Loss before income taxes (50,702) (27,193)
Income tax benefit 17,765 253
--------- ---------
Net loss (32,937) (26,940)
Stock dividends on PIK Preferred Stock 1,994 2,266
--------- ---------
Net loss applicable to Common Stock $ (34,931) $ (29,206)
========= =========
</TABLE>
See accompanying notes to condensed consolidated financial statements.
3
<PAGE>
DICTAPHONE CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(Dollars in thousands)
<TABLE>
<CAPTION>
DECEMBER 31, SEPTEMBER 30,
1997 1998
--------- ---------
(UNAUDITED)
<S> <C> <C>
ASSETS
Current assets:
Cash $ 10,277 $ 4,230
Accounts receivable, less allowances of $810 and $2,639, respectively 71,939 82,981
Inventories 48,779 54,373
Other current assets 11,675 11,056
--------- ---------
Total current assets 142,670 152,640
Property, plant and equipment, net 35,331 31,077
Deferred financing costs, net of accumulated amortization of $12,517
and $13,804, respectively 10,900 9,864
Intangibles, net of accumulated amortization of $99,439 and $119,832, respectively 229,322 204,623
Other assets 51,837 55,253
--------- ---------
Total assets $ 470,060 $ 453,457
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 10,940 $ 9,539
Interest payable 10,144 4,122
Accrued liabilities 32,373 26,492
Advance billings 37,184 42,085
Current portion of long-term debt 795 794
--------- ---------
Total current liabilities 91,436 83,032
Long-term debt 342,816 357,901
Other liabilities 10,547 14,521
--------- ---------
Total liabilities 444,799 455,454
--------- ---------
Contingencies (Note 5)
Stockholders' equity:
Preferred stock ($.01 par value; 10,000,000 shares authorized; 1,500,000
shares of 14% PIK perpetual preferred stock
issued and outstanding, liquidation value at September 30, 1998, $23,107) 20,841 23,107
Common stock ($.01 par value; 20,000,000 shares authorized;
12,952,000 and 12,939,000 shares outstanding at December 31, 1997
and September 30, 1998, respectively) 130 130
Notes receivable from stockholders (831) (766)
Additional paid-in capital 129,870 129,870
Treasury stock, at cost (480) (610)
Accumulated deficit (122,597) (151,774)
Accumulated translation adjustment (1,672) (1,954)
--------- ---------
Total stockholders' equity (deficit) 25,261 (1,997)
--------- ---------
Total liabilities and stockholders' equity $ 470,060 $ 453,457
========= =========
</TABLE>
See accompanying notes to condensed consolidated financial statements.
4
<PAGE>
DICTAPHONE CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOW (UNAUDITED)
(Dollars in thousands)
<TABLE>
<CAPTION>
NINE MONTHS NINE MONTHS
ENDED ENDED
SEPTEMBER 30, SEPTEMBER 30,
1997 1998
-------- --------
<S> <C> <C>
Operating activities:
Net loss $(32,937) $(26,940)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation and amortization (including $1,389
and $17, respectively, of nonrecurring charges) 42,903 31,308
Provision for deferred income taxes (17,804) (393)
Non-cash provision for inventory obsolescence (Note 2) 10,491 --
Changes in assets and liabilities:
Accounts receivable (15,569) (11,354)
Inventories (13) (5,759)
Other current assets (1,841) 874
Accounts payable and accrued liabilities (6,064) (13,240)
Advance billings (443) 5,024
Other assets and other (2,849) (7,867)
-------- --------
Net cash used in operating activities (24,126) (28,347)
-------- --------
Investing activities:
Net investment in fixed assets (3,935) (5,314)
Sale of building -- 14,000
-------- --------
Net cash (used in) provided by investing activities (3,935) 8,686
-------- --------
Financing activities:
Repayment under term loan facility (8,250) (1,800)
Borrowings under revolving credit facility 71,300 54,000
Repayment under revolving credit facility (36,800) (37,000)
Other (1,276) (1,536)
-------- --------
Net cash provided by financing activities 24,974 13,664
-------- --------
Effect of exchange rate changes on cash (123) (50)
-------- --------
Decrease in cash (3,210) (6,047)
Cash, beginning of period 7,927 10,277
-------- --------
Cash, end of period $ 4,717 $ 4,230
======== ========
SUPPLEMENTAL CASH FLOW INFORMATION:
Interest paid $ 34,476 $ 34,369
======== ========
Income taxes paid $ 357 $ 335
======== ========
</TABLE>
See accompanying notes to condensed consolidated financial statements.
5
<PAGE>
DICTAPHONE CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(Dollars in thousands, or as otherwise indicated)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The condensed consolidated financial statements of the Company are
unaudited, as of and for the three and nine month periods ended September
30, 1998 and September 30, 1997, but in the opinion of management contain
all adjustments which are of a normal and recurring nature necessary to
present fairly the financial position and results of operations and cash
flows for the periods presented. These financial statements should be
read in conjunction with the financial statements and notes thereto
included in the Company's Annual Report on Form 10-K for the year ended
December 31, 1997. Certain amounts have been reclassified to conform to
current year presentation.
The preparation of financial statements in conformity with
generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amount of assets and
liabilities and disclosure of contingent assets and liabilities at the
date of the financial statements and reported amounts of revenues and
expenses during the reporting period. Actual results could differ from
those estimates.
COSTS AND EXPENSES. Operating expenses of field sales and service
offices which represent the cost of support services revenue are included
in cost of sales.
DERIVATIVE FINANCIAL INSTRUMENTS. The Company has only limited
involvement with derivative financial instruments and does not use them
for trading purposes. The Company enters into interest rate swap
agreements to reduce its exposure to interest rate fluctuations. The net
gain or loss from exchange of interest payments is included in interest
expense in the consolidated financial statements and interest paid in the
condensed consolidated statements of cash flow.
In June 1998, the Financial Accounting Standards Board ("FASB")
issued Statement of Financial Accounting Standards No. 133, "Accounting
for Derivative Instruments and Hedging Activities" ("SFAS 133"). The
statement requires companies to recognize all derivatives as either
assets or liabilities, with the instruments measured at fair value. The
accounting for changes in fair value, gains or losses, depends on the
intended use of the derivative and its resulting designation. The
statement is effective for all fiscal quarters of fiscal years beginning
after June 15, 1999. The Company will adopt SFAS 133 by January 1, 2000.
Adoption of SFAS 133 is not currently expected to have a material impact
on the consolidated financial statements.
In March 1998, the American Institute of Certified Public
Accountants issued Statement of Position 98-1 ("SOP 98-1"), "Accounting
for the Costs of Computer Software Developed or Obtained for Internal
Use." The statement is effective for fiscal years beginning after
December 15, 1998. The statement defines which costs of computer software
developed or obtained for internal use are capital and which costs are
expensed. The Company will adopt SOP 98-1 effective January 1, 1999. The
Company is in the process of evaluating the effect the adoption of SOP
98-1 will have on its consolidated financial statements.
6
<PAGE>
2. INVENTORIES
Inventories consist of the following:
<TABLE>
<CAPTION>
DECEMBER 31, SEPTEMBER 30,
1997 1998
---------- ----------
<S> <C> <C>
Raw materials and work in process $ 18,481 $ 18,642
Supplies and service parts 14,087 14,729
Finished products 16,211 21,002
---------- ----------
Total inventories $ 48,779 $ 54,373
========== ==========
</TABLE>
With the commencement of production of Enterprise Express(TM) in
June 1997, the Company provided for the excess service parts and field
stock inventory associated with the products that Enterprise Express(TM)
was replacing, recording a non-cash charge of $10.5 million.
3. INTANGIBLES
The following summarizes intangible assets, net of accumulated
amortization and writedowns of $99,439 and $119,832 at December 31, 1997
and September 30, 1998, respectively. Amortization expense for the three
and nine months ended September 30, 1997 and 1998 was $8,772, $27,320,
$4,679 and $20,393, respectively.
<TABLE>
<CAPTION>
DECEMBER 31, SEPTEMBER 30,
1997 1998
---------- ----------
<S> <C> <C>
Goodwill $ 135,004 $ 128,356
Tradenames 73,211 71,751
Service contracts 8,920 3,559
Non-compete agreement 11,696 604
Patents 491 353
---------- ----------
$ 229,322 $ 204,623
========== ==========
</TABLE>
4. INCOME TAXES
The income tax benefit for the three and nine months ended
September 30, 1998 is $587 and $253, respectively.
The Company has recorded a gross deferred tax asset of $84.2
million included in other assets reflecting the benefit of net operating
loss carryforwards and various book tax temporary differences. The net
operating loss carryforward for federal income tax purposes as of
September 30, 1998 is $106.1 million of which $13.7 million of the net
operating loss carryforward will expire in the year 2010, $33.2 million
will expire in the year 2011, $39.3 million will expire in the year 2012,
and $19.9 million will expire in the year 2018. In order to fully realize
the deferred tax asset, the Company will need to generate future taxable
income prior to expiration of the net operating loss carryforwards. In
1997, the Company established a valuation allowance of $24.1 million
against the deferred tax assets. During the first nine months of 1998,
the Company increased its valuation allowance by $9.7 million, resulting
in a net deferred tax asset of $50.4 million. Management believes, based
upon the Company's history of prior operating results, its current
circumstances, and its expectations for the future, that taxable income
of the Company will more likely than not be sufficient to fully utilize
the net deferred tax asset of $50.4 million recorded at September 30,
1998, prior to expiration. The amount of the deferred tax asset
considered realizable, however, could be reduced if estimates of future
taxable income during the net operating loss carryforward period are
reduced.
7
<PAGE>
5. CONTINGENCIES
On February 14, 1995, Pitney Bowes, Inc. ("Pitney Bowes") filed a
complaint against Sudbury Systems, Inc. ("Sudbury") in the United States
District court for the District of Connecticut alleging intentional and
wrongful interference with Pitney Bowes's plans to sell the Company. The
complaint seeks damages and a declaratory judgment relating to the
validity of a patent owned by Sudbury entitled "Rapid Simultaneous
Multiple Access Information Storage and Retrieval System" and the alleged
infringement thereof by the Company. Sudbury responded by answering the
complaint and filing a third-party complaint against the Company alleging
patent infringement and seeking preliminary and permanent injunctive
relief and treble damages. The third-party complaint filed by Sudbury did
not quantify the amount of damages sought. The litigation is in the final
stage of discovery. A trial date is likely to be set in 1999. Pitney
Bowes and the Company have not yet received Sudbury's revised damages
report nor has Sudbury's damages expert given deposition testimony.
Accordingly, at this time, the Company cannot make a reasonable estimate
of the amount of damages that will be sought by Sudbury.
Management believes the Company has meritorious defenses to the
claims against it. Consequently, the Company has not provided for any
loss exposure in connection with this complaint. Additionally, regardless
of the outcome of this litigation, Pitney Bowes has agreed to defend this
action and to indemnify the Company for any liabilities arising from such
litigation.
The Company is subject to federal, state and local laws and
regulations concerning the environment and is currently participating in
administrative proceedings as a participant in a group of potentially
responsible parties in connection with two third party disposal sites.
These proceedings are at a preliminary stage, for which it is impossible
to reasonably estimate the potential costs of remediation, the timing and
extent of remedial actions which may be required by governmental
authorities, and the amount of the liability, if any, of the Company
alone or in relation to that of any other responsible parties. When it is
possible to make a reasonable estimate of the Company's liability with
respect to such a matter, a provision will be made as appropriate.
Additionally, the Company has settled and paid its liability at three
other third party disposal sites. At a fourth site, the Company has paid
approximately $11,000 for its share of the costs of the first phase of
the clean up of the site and management believes that it has no
continuing material liability for any later phases of the cleanup.
Consequently, management believes that its future liability, if any, for
these four sites is not material. In addition, regardless of the outcome
of such matters, Pitney Bowes has agreed to indemnify the Company in
connection with retained environmental liabilities and for breaches of
the environmental representations and warranties in the Stock and Asset
Purchase Agreement, as amended August 11, 1995 (the "Acquisition
Agreement"), subject to certain limitations.
The Company is a defendant in a number of additional lawsuits and
administrative proceedings, none of which will, in the opinion of
management, have a material adverse effect on the Company's consolidated
financial position or results of operations.
The Company does not believe that the ultimate resolution of the
litigation, administrative proceedings and environmental matters
described above in the aggregate will have a material adverse effect on
the Company's consolidated financial position or results of operations.
8
<PAGE>
6. SUPPLEMENTAL CONSOLIDATING FINANCIAL STATEMENTS AND SEGMENT
INFORMATION
The consolidated financial statements include the Company and all
majority-owned subsidiaries as follows: Dictaphone Corporation U.S.
("Dictaphone U.S."), and Dictaphone Canada Ltd/Ltee, Dictaphone Company
Ltd., Dictaphone Deutschland GmbH, Dictaphone Netherlands BV and
Dictaphone International A.G. (together "Dictaphone Non-U.S.").
Dictaphone U.S. has fully and unconditionally guaranteed the
repayment of $200,000 of senior subordinated notes (the "Notes") issued
to finance the acquisition of the Company from Pitney Bowes. The Notes
are subordinate to financing of the Credit Agreement, dated August 7,
1995, as amended by four amendments to Credit Agreement, dated June 28,
1996, June 27, 1997, July 21, 1997 and November 14, 1997 (collectively,
the "Credit Agreement"), and other senior indebtedness as defined in the
indenture pursuant to which the Notes were issued (the "Note Indenture").
The Credit Agreement currently consists of a $75.0 million Tranche B Term
Loan due June 30, 2002 (the "Tranche B Loan"), a $62.75 million Tranche C
Term Loan due June 30, 2003 (the "Tranche C Loan" and together with the
Tranche B Loan, the "Term Loans") and a six-year revolving credit
facility of up to $40.0 million (the "Revolving Credit Facility").
Dictaphone Non-U.S. is not a guarantor of the Notes. In January 1998,
Dictaphone Corporation was merged into Dictaphone Corporation (U.S.),
whereupon the surviving corporation changed its name to "Dictaphone
Corporation".
9
<PAGE>
6. SUPPLEMENTAL CONSOLIDATING FINANCIAL STATEMENTS AND SEGMENT
INFORMATION (CONTINUED)
The following are the supplemental consolidating statements of
operations for the three and nine month periods ended September 30, 1997
and 1998, the supplemental consolidating balance sheet information as of
December 31, 1997 and September 30, 1998, and cash flow information for
the nine month periods ended September 30, 1997 and 1998.
DICTAPHONE CORPORATION
SUPPLEMENTAL CONSOLIDATING STATEMENT OF OPERATIONS INFORMATION
THREE MONTHS ENDED SEPTEMBER 30, 1997
<TABLE>
<CAPTION>
DICTAPHONE DICTAPHONE CONSOLIDATING
CORPORATION NON-U.S. ADJUSTMENTS CONSOLIDATED
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Revenue from:
Product sales and rentals $ 47,939 $ 7,495 $ (3,018) $ 52,416
Contract manufacturing sales 10,739 -- -- 10,739
Support services 22,074 2,487 -- 24,561
-------- -------- -------- --------
Total revenues 80,752 9,982 (3,018) 87,716
-------- -------- -------- --------
Costs and expenses:
Cost of sales, rentals and support services 44,152 5,188 (3,211) 46,129
Selling and administrative 31,520 4,205 -- 35,725
Research and development 3,813 -- -- 3,813
Interest expense - net and other 9,931 923 -- 10,854
-------- -------- -------- --------
Total costs and expenses 89,416 10,316 (3,211) 96,521
-------- -------- -------- --------
Equity earnings (loss) 887 -- (887) --
-------- -------- -------- --------
Loss before income taxes (7,777) (334) (694) (8,805)
Income tax benefit (expense) 3,005 (146) (77) 2,782
-------- -------- -------- --------
Net loss $ (4,772) $ (480) $ (771) $ (6,023)
======== ======== ======== ========
</TABLE>
10
<PAGE>
6. SUPPLEMENTAL CONSOLIDATING FINANCIAL STATEMENTS AND SEGMENT
INFORMATION (CONTINUED)
DICTAPHONE CORPORATION
SUPPLEMENTAL CONSOLIDATING STATEMENT OF OPERATIONS INFORMATION
THREE MONTHS ENDED SEPTEMBER 30, 1998
<TABLE>
<CAPTION>
DICTAPHONE DICTAPHONE CONSOLIDATING
CORPORATION NON-U.S. ADJUSTMENTS CONSOLIDATED
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Revenue from:
Product sales and rentals $ 50,780 $ 3,593 $ (2,173) $ 52,200
Contract manufacturing sales 11,575 -- -- 11,575
Support services 20,222 1,879 -- 22,101
-------- -------- -------- --------
Total revenues 82,577 5,472 (2,173) 85,876
-------- -------- -------- --------
Costs and expenses:
Cost of sales, rentals and support services 43,800 3,445 (2,114) 45,131
Selling and administrative 28,815 2,640 -- 31,455
Research and development 4,898 -- -- 4,898
Interest expense - net and other 9,337 1,026 -- 10,363
-------- -------- -------- --------
Total costs and expenses 86,850 7,111 (2,114) 91,847
-------- -------- -------- --------
Equity (loss) earnings (702) -- 702 --
-------- -------- -------- --------
(Loss) income before income taxes (4,975) (1,639) 643 (5,971)
Income tax (expense) benefit (23) 586 24 587
-------- -------- -------- --------
Net (loss) income $ (4,998) $ (1,053) $ 667 $ (5,384)
======== ======== ======== ========
</TABLE>
11
<PAGE>
6. SUPPLEMENTAL CONSOLIDATING FINANCIAL STATEMENTS AND SEGMENT
INFORMATION (CONTINUED)
DICTAPHONE CORPORATION
SUPPLEMENTAL CONSOLIDATING STATEMENT OF OPERATIONS INFORMATION
NINE MONTHS ENDED SEPTEMBER 30, 1997
<TABLE>
<CAPTION>
DICTAPHONE DICTAPHONE CONSOLIDATING
CORPORATION NON-U.S. ADJUSTMENTS CONSOLIDATED
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Revenue from:
Product sales and rentals $ 132,311 $ 24,706 $ (8,642) $ 148,375
Contract manufacturing sales 30,364 -- -- 30,364
Support services 62,059 8,026 -- 70,085
--------- --------- --------- ---------
Total revenues 224,734 32,732 (8,642) 248,824
--------- --------- --------- ---------
Costs and expenses:
Cost of sales, rentals and support services 133,153 20,385 (8,964) 144,574
Selling and administrative 100,270 11,769 -- 112,039
Research and development 11,146 -- -- 11,146
Interest expense - net and other 29,430 2,337 -- 31,767
--------- --------- --------- ---------
Total costs and expenses 273,999 34,491 (8,964) 299,526
--------- --------- --------- ---------
Equity (loss) earnings (12,430) -- 12,430 --
--------- --------- --------- ---------
(Loss) income before income taxes (61,695) (1,759) 12,752 (50,702)
Income tax benefit (expense) 17,676 219 (130) 17,765
--------- --------- --------- ---------
Net (loss) income $ (44,019) $ (1,540) $ 12,622 $ (32,937)
========= ========= ========= =========
</TABLE>
12
<PAGE>
6. SUPPLEMENTAL CONSOLIDATING FINANCIAL STATEMENTS AND SEGMENT
INFORMATION (CONTINUED)
DICTAPHONE CORPORATION
SUPPLEMENTAL CONSOLIDATING STATEMENT OF OPERATIONS INFORMATION
NINE MONTHS ENDED SEPTEMBER 30, 1998
<TABLE>
<CAPTION>
DICTAPHONE DICTAPHONE CONSOLIDATING
CORPORATION NON-U.S. ADJUSTMENTS CONSOLIDATED
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Revenue from:
Product sales and rentals $ 147,103 $ 13,514 $ (7,198) $ 153,419
Contract manufacturing sales 35,067 -- -- 35,067
Support services 60,488 5,712 -- 66,200
--------- --------- --------- ---------
Total revenues 242,658 19,226 (7,198) 254,686
--------- --------- --------- ---------
Costs and expenses:
Cost of sales, rentals and support services 132,359 12,260 (7,519) 137,100
Selling and administrative 93,420 9,078 -- 102,498
Research and development 12,854 -- -- 12,854
Interest expense - net and other 26,978 2,449 -- 29,427
--------- --------- --------- ---------
Total costs and expenses 265,611 23,787 (7,519) 281,879
--------- --------- --------- ---------
Equity (loss) earnings (1,800) -- 1,800 --
--------- --------- --------- ---------
(Loss) income before income taxes (24,753) (4,561) 2,121 (27,193)
Income tax (expense) benefit (1,383) 1,754 (118) 253
--------- --------- --------- ---------
Net (loss) income $ (26,136) $ (2,807) $ 2,003 $ (26,940)
========= ========= ========= =========
</TABLE>
13
<PAGE>
6. SUPPLEMENTAL CONSOLIDATING FINANCIAL STATEMENTS AND SEGMENT
INFORMATION (CONTINUED)
DICTAPHONE CORPORATION
SUPPLEMENTAL CONSOLIDATING BALANCE SHEET INFORMATION
DECEMBER 31, 1997
<TABLE>
<CAPTION>
DICTAPHONE DICTAPHONE CONSOLIDATING
CORPORATION NON-U.S. ADJUSTMENTS CONSOLIDATED
-------- -------- -------- --------
<S> <C> <C> <C> <C>
ASSETS
Current assets:
Cash $ 8,276 $ 2,001 $ -- $ 10,277
Accounts receivable 64,884 8,699 (1,644) 71,939
Inventories 45,962 3,645 (828) 48,779
Other current assets 7,869 3,806 -- 11,675
-------- -------- -------- --------
Total current assets 126,991 18,151 (2,472) 142,670
Investments in subsidiaries 34,170 -- (34,170) --
Property, plant and equipment, net 32,041 3,290 -- 35,331
Intangibles, net 214,070 15,252 -- 229,322
Deferred financing costs 10,900 -- -- 10,900
Other assets 49,131 2,383 323 51,837
-------- -------- -------- --------
Total assets $467,303 $ 39,076 $(36,319) $470,060
======== ======== ======== ========
LIABILITIES AND STOCKHOLDERS'
EQUITY
Current liabilities:
Accounts payable, interest payable
and accrued liabilities $ 48,649 $ 6,602 $ (1,794) $ 53,457
Advance billings 34,252 2,932 -- 37,184
Current portion of long-term debt 628 167 -- 795
-------- -------- -------- --------
Total current liabilities 83,529 9,701 (1,794) 91,436
Long-term debt 342,372 17,935 (17,491) 342,816
Other liabilities 10,477 70 -- 10,547
Stockholders' equity 30,925 11,370 (17,034) 25,261
-------- -------- -------- --------
Total liabilities and stockholders' equity $467,303 $ 39,076 $(36,319) $470,060
======== ======== ======== ========
</TABLE>
14
<PAGE>
6. SUPPLEMENTAL CONSOLIDATING FINANCIAL STATEMENTS AND SEGMENT
INFORMATION (CONTINUED)
DICTAPHONE CORPORATION
SUPPLEMENTAL CONSOLIDATING BALANCE SHEET INFORMATION
SEPTEMBER 30, 1998
<TABLE>
<CAPTION>
DICTAPHONE DICTAPHONE CONSOLIDATING
CORPORATION NON-U.S. ADJUSTMENTS CONSOLIDATED
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
ASSETS
Current assets:
Cash $ 3,363 $ 867 $ -- $ 4,230
Accounts receivable 80,706 5,749 (3,474) 82,981
Inventories 51,342 3,538 (507) 54,373
Other current assets 6,984 3,867 205 11,056
--------- --------- --------- ---------
Total current assets 142,395 14,021 (3,776) 152,640
Investments in subsidiaries 30,763 -- (30,763) --
Property, plant and equipment, net 27,762 3,315 -- 31,077
Intangibles, net 190,868 13,755 -- 204,623
Deferred financing costs, net 9,864 -- -- 9,864
Other assets 51,459 3,794 -- 55,253
--------- --------- --------- ---------
Total assets $ 453,111 $ 34,885 $ (34,539) $ 453,457
========= ========= ========= =========
LIABILITIES AND STOCKHOLDERS'
EQUITY
Current liabilities:
Accounts payable, interest payable
and accrued liabilities $ 37,029 $ 6,929 $ (3,805) $ 40,153
Advance billings 39,442 2,643 -- 42,085
Current portion of long-term debt 628 166 -- 794
--------- --------- --------- ---------
Total current liabilities 77,099 9,738 (3,805) 83,032
Long-term debt 357,572 17,820 (17,491) 357,901
Deferred gain 1,771 -- -- 1,771
Other liabilities 11,945 805 -- 12,750
Stockholders' equity 4,724 6,522 (13,243) (1,997)
--------- --------- --------- ---------
Total liabilities and stockholders' equity $ 453,111 $ 34,885 $ (34,539) $ 453,457
========= ========= ========= =========
</TABLE>
15
<PAGE>
6. SUPPLEMENTAL CONSOLIDATING FINANCIAL STATEMENTS AND SEGMENT
INFORMATION (CONTINUED)
DICTAPHONE CORPORATION
SUPPLEMENTAL CONSOLIDATING STATEMENT OF CASH FLOWS INFORMATION
NINE MONTHS ENDED SEPTEMBER 30, 1997
<TABLE>
<CAPTION>
DICTAPHONE DICTAPHONE CONSOLIDATING
CORPORATION NON-U.S. ADJUSTMENTS CONSOLIDATED
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Operating activities:
Net loss $(31,727) $ (1,540) $ 330 $(32,937)
Adjustments to reconcile net loss
to net cash provided by (used in)
operating activities:
Depreciation and amortization 40,335 2,568 -- 42,903
Provision for deferred income taxes (17,821) (113) 130 (17,804)
Non-cash provision for inventory
obsolescence 9,535 956 -- 10,491
Change in assets and liabilities:
Accounts receivable (10,735) (1,219) (3,615) (15,569)
Inventories (4,232) 4,541 (322) (13)
Other current assets (1,046) (795) -- (1,841)
Accounts payable and accrued
liabilities (6,101) (3,723) 3,760 (6,064)
Advance billings 69 (512) -- (443)
Other assets and other (3,040) 594 (403) (2,849)
-------- -------- -------- --------
Cash (used in) provided by operating
activities (24,763) 757 (120) (24,126)
-------- -------- -------- --------
Investing activities:
Net investment in fixed assets (3,649) (286) -- (3,935)
-------- -------- -------- --------
Cash used in investing activities (3,649) (286) -- (3,935)
-------- -------- -------- --------
Financing activities:
Repayment under term loan facility (8,250) -- -- (8,250)
Borrowing from revolving credit facility 71,300 -- -- 71,300
Repayment under revolving credit facility (36,800) -- -- (36,800)
Other (889) (507) 120 (1,276)
-------- -------- -------- --------
Cash provided by (used in) financing
activities 25,361 (507) 120 24,974
-------- -------- -------- --------
Effect of exchange rate changes on cash -- (123) -- (123)
-------- -------- -------- --------
Decrease in cash (3,051) (159) -- (3,210)
Cash, beginning of period 6,569 1,358 -- 7,927
-------- -------- -------- --------
Cash, end of period $ 3,518 $ 1,199 $ -- $ 4,717
======== ======== ======== ========
</TABLE>
16
<PAGE>
6. SUPPLEMENTAL CONSOLIDATING FINANCIAL STATEMENTS AND SEGMENT
INFORMATION (CONTINUED)
DICTAPHONE CORPORATION
SUPPLEMENTAL CONSOLIDATING STATEMENT OF CASH FLOWS INFORMATION
NINE MONTHS ENDED SEPTEMBER 30, 1998
<TABLE>
<CAPTION>
DICTAPHONE DICTAPHONE CONSOLIDATING
CORPORATION NON-U.S. ADJUSTMENTS CONSOLIDATED
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Operating activities:
Net loss $(26,136) $ (2,807) $ 2,003 $(26,940)
Adjustments to reconcile net loss
to net cash provided by (used in)
operating activities:
Depreciation and amortization 29,253 2,055 -- 31,308
Provision for deferred income taxes 1,150 (1,543) -- (393)
Change in assets and liabilities:
Accounts receivable (15,822) 2,638 1,830 (11,354)
Inventories (5,380) (58) (321) (5,759)
Other current assets 885 (129) 118 874
Accounts payable and accrued
liabilities (11,909) 680 (2,011) (13,240)
Advance billings 5,190 (166) -- 5,024
Other assets and other (4,976) 516 (3,407) (7,867)
-------- -------- -------- --------
Cash (used in) provided by operating
activities (27,745) 1,186 (1,788) (28,347)
-------- -------- -------- --------
Investing activities:
Net investment in fixed assets (4,895) (419) -- (5,314)
Sale of building 14,000 -- -- 14,000
-------- -------- -------- --------
Cash provided by (used in) investing
activities 9,105 (419) -- 8,686
-------- -------- -------- --------
Financing activities:
Repayment under term loan facility (1,800) -- -- (1,800)
Borrowing from revolving credit facility 54,000 -- -- 54,000
Repayment under revolving credit facility (37,000) -- -- (37,000)
Other (1,473) (1,851) 1,788 (1,536)
-------- -------- -------- --------
Cash provided by (used in) financing
activities 13,727 (1,851) 1,788 13,664
-------- -------- -------- --------
Effect of exchange rate changes on cash -- (50) -- (50)
-------- -------- -------- --------
Decrease in cash (4,913) (1,134) -- (6,047)
Cash, beginning of period 8,276 2,001 -- 10,277
-------- -------- -------- --------
Cash, end of period $ 3,363 $ 867 $ -- $ 4,230
======== ======== ======== ========
</TABLE>
17
<PAGE>
7. COMPREHENSIVE INCOME
The Company adopted Statement of Financial Accounting Standards No.
130, "Reporting Comprehensive Income" ("SFAS 130") as of January 1, 1998.
SFAS 130 establishes standards for reporting and display of comprehensive
income and its components.
Total comprehensive income for the three and nine months ending
September 30, 1997 and 1998 consists of the following:
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------- -------------------------
1997 1998 1997 1998
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Net loss $ (6,023) $ (5,384) $(32,937) $(26,940)
Foreign currency translation
adjustments (405) 76 (1,154) (282)
-------- -------- -------- --------
Total comprehensive income $ (6,428) $ (5,308) $(34,091) $(27,222)
======== ======== ======== ========
</TABLE>
8. SALE/LEASEBACK AGREEMENT
In May 1998, the Company entered into a sale/leaseback agreement
for the sale of its Stratford, Connecticut land and headquarters facility
(which is included in "property, plant and equipment, net"). Cash
proceeds from the sale totalled $14.0 million. The net proceeds were used
by the Company to reduce amounts outstanding under the Term Loans and the
Revolving Credit Facility. The Company realized a gain of $1.8 million on
the sale, net of a $4.1 million writedown of associated goodwill. The
gain on the sale will be recognized over the term of the lease. The
lease, which was recorded as an operating lease, has a term of 20 years.
Future minimum lease payments are as follows:
YEARS ENDED DECEMBER 31,
1998 $ 919
1999 1,452
2000 1,452
2001 1,452
2002 1,452
Later years 24,796
---------
Total minimum lease payments $ 31,523
=========
18
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
---------------------------------------------------------------
OVERVIEW
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------ --------------------
1997 1998 1997 1998
------- ------- -------- --------
(IN MILLIONS)
(UNAUDITED)
<S> <C> <C> <C> <C>
Total revenue $ 87.7 $ 85.9 $ 248.8 $ 254.7
Cost of sales, rentals and support services 46.1 45.1 144.6 137.1
Selling and administrative (1) 35.8 31.5 112.0 102.5
Research and development 3.8 4.9 11.1 12.9
------- ------- -------- --------
Operating profit (loss) 2.0 4.4 (18.9) 2.2
------- ------- -------- --------
Net interest expense and other 10.8 10.4 31.8 29.4
Income tax benefit 2.8 0.6 17.8 0.3
------- ------- -------- --------
Net loss $ (6.0) $ (5.4) $ (32.9) $ (26.9)
======= ======= ======== ========
EBITDA (2) $ 14.4 $ 10.9 $ 31.9 $ 33.0
======= ======= ======== ========
</TABLE>
- ---------------------
(1) Includes amortization of intangibles.
(2) EBITDA is defined as income before effect of changes in accounting
plus interest, income taxes, depreciation, amortization and other
significant non-cash, non-recurring charges. EBITDA is presented
because it is a widely accepted financial indicator of a company's
ability to incur and service debt. However, EBITDA should not be
considered in isolation or as a substitute for net income or cash
flow data prepared in accordance with generally accepted
accounting principles or as a measure of a company's profitability
or liquidity, and is not necessarily comparable to similarly
titled measures of other companies.
19
<PAGE>
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
----------------- -------------------
1997 1998 1997 1998
------- ------- -------- --------
(IN MILLIONS)
(UNAUDITED)
<S> <C> <C> <C> <C>
Revenue from:
Sales:
Integrated Voice Systems $ 10.4 $ 9.1 $ 33.0 $ 33.1
Integrated Health Systems 9.4 12.3 26.1 32.4
Communication Recording Systems 17.9 19.4 43.5 48.8
Customer Service Parts 4.7 4.2 13.7 13.3
International and Dealer Operations 9.6 6.8 30.7 24.8
Rentals 0.4 0.4 1.4 1.0
------- ------- -------- --------
Product sales and rentals 52.4 52.2 148.4 153.4
Contract Manufacturing 10.7 11.6 30.3 35.1
Support service:
Customer Service 21.3 19.3 60.3 58.5
Application & Training Specialists 0.8 0.9 1.8 2.0
International and Dealer Operations 2.5 1.9 8.0 5.7
------- ------- -------- --------
Total support service 24.6 22.1 70.1 66.2
Total revenue $ 87.7 $ 85.9 $ 248.8 $ 254.7
======= ======= ======== ========
</TABLE>
RESULTS OF OPERATIONS - THIRD QUARTER 1998 VS. THIRD QUARTER 1997
Total revenue decreased 2.1% to $85.9 million in the third quarter of
1998 from $87.7 million for the third quarter of 1997. This decline in revenue
is attributable to lower product sales revenue from Integrated Voice Systems
("I.V.S.") and lower sales and support service revenue from International and
Dealer Operations and Customer Service, partially offset by increased sales
revenue from Integrated Health Systems ("I.H.S."), Communications Recording
Systems ("C.R.S.") and Contract Manufacturing.
I.V.S. revenue declined 11.8% to $9.1 million from $10.4 million due to
lower sales of the Company's desktop, Synergy(TM) and Straight Talk(TM)
products. I.V.S. orders in the third quarter of 1998 declined 10.0% to $9.9
million from $11.0 million in the third quarter of 1997. I.H.S. revenue
increased 31.2% to $12.3 million from $9.4 million due to increased Enterprise
Express(TM) sales. I.H.S. orders in the third quarter of 1998 increased 62.5% to
$18.1 million from $11.1 million in the third quarter of 1997. C.R.S. revenue
increased 8.5% to $19.4 million from $17.9 million due to the sale of
Prolog(TM)/Guardian(TM) software upgrades. C.R.S. orders in the third quarter of
1998 declined 1.5% to $16.5 million from $16.8 million in the third quarter of
1997. Customer Service revenue (including sale of parts) declined 9.6% to $23.5
million from $26.0 million due to lower proprietary product service contract
revenue associated with the significant, one-time billing in the third quarter
of 1997 of a backlog of proprietary product service contract renewals, and
reduced third party maintenance revenue partially offset by increased warranty
revenue. Sales and service revenue from International and Dealer Operations
declined 28.8% to $8.7 million from $12.1 million due to lower sales of system,
desktop/portable and C.R.S. products and lower service revenue as well as $0.2
million of unfavorable currency exchange. Orders from International and Dealer
Operations declined 35.4% to $6.9 million in the third quarter of 1998 from
$10.7 million in
20
<PAGE>
the third quarter of 1997. Contract Manufacturing revenue increased 7.8% to
$11.6 million in the third quarter of 1998 from $10.7 million in the third
quarter of 1997 due to additional printed circuit assembly revenue from existing
customers as well as additional revenue from new Contract Manufacturing
customers.
Cost of sales, rentals and support services declined 2.2% to $45.1
million (52.6% of revenue) during the third quarter of 1998 from $46.1 million
(52.6% of revenue) in the third quarter of 1997. Excluding additional
depreciation and amortization expense associated with purchase accounting
adjustments related to the Acquisition, cost of sales, rentals and support
services would have increased by 0.4 percentage points to 52.5%. This increase
is attributable to higher Customer Service field, technical and support services
costs.
Selling and administrative expenses (including amortization of
intangibles) declined 12.0% to $31.5 million (36.6% of revenue) during the third
quarter of 1998 from $35.8 million (40.7% of revenue) in the third quarter of
1997. Excluding additional depreciation and amortization expense associated with
purchase accounting adjustments related to the Acquisition of $4.7 million and
$8.7 million for the third quarter of 1998 and 1997, respectively, selling and
administrative expenses would have declined by $0.2 million from the third
quarter of 1997 to the third quarter of 1998. This decline is attributable to
lower I.V.S. and I.H.S. selling expenses and lower operating expenses for
International and Dealer Operations, partially offset by increased C.R.S.
selling expense and increased telecommunications support costs, management
compensation and project costs associated with the Company's efforts to upgrade
its information systems.
Research and development expenses of $4.9 million (9.4% of product sales
and rental revenue) increased 28.5% from $3.8 million (7.3% of product sales and
rental revenue), reflecting increased staffing and compensation.
The Company recorded an operating profit of $4.4 million during the third
quarter of 1998 compared to an operating profit of $2.0 million for the third
quarter of 1997. Excluding the impact of purchase accounting adjustments
associated with the Acquisition of $4.8 million and $9.2 million for the third
quarter of 1998 and 1997, respectively, operating profit would have declined by
$2.1 million due to lower revenue and higher operating expenses.
The Company has recorded a gross deferred tax asset of $84.2 million
included in other assets reflecting the benefit of net operating loss
carryforwards and various book tax temporary differences. The net operating loss
carryforward for federal income tax purposes as of September 30, 1998 is $106.1
million of which $13.7 million of the net operating loss carryforward will
expire in the year 2010, $33.2 million will expire in the year 2011, $39.3
million will expire in the year 2012, and $19.9 million will expire in the year
2018. In order to fully realize the deferred tax asset, the Company will need to
generate future taxable income prior to expiration of the net operating loss
carryforwards. In 1997, the Company established a valuation allowance of $24.1
million against the deferred tax assets. During the first nine months of 1998,
the Company increased its valuation allowance by $9.7 million resulting in a net
deferred tax asset of $50.4 million. Management believes, based upon the
Company's history of prior operating results, its current circumstances, and its
expectations for the future, that taxable income of the Company will more likely
than not be sufficient to fully utilize the net deferred tax asset of $50.4
million recorded at September 30, 1998, prior to expiration. The amount of the
deferred tax asset considered realizable, however, could be reduced if estimates
of future taxable income during the net operating loss carryforward period are
reduced.
21
<PAGE>
RESULTS OF OPERATIONS - NINE MONTHS ENDED SEPTEMBER 30, 1998 VS. NINE MONTHS
ENDED SEPTEMBER 30, 1997
Total revenue increased 2.4% to $254.7 million for the first nine months
of 1998 from $248.8 million for the first nine months of 1997. This increase in
revenue is attributable to increased product sales revenue from I.V.S., I.H.S.,
and C.R.S., and higher revenue from Contract Manufacturing and Application and
Training Specialists ("A.T.S."), offset in part by lower revenue from Customer
Service (including sale of parts) and International and Dealer Operations.
I.V.S. revenue increased 0.5% to $33.1 million from $33.0 million due to
higher Enterprise Express(TM) sales. I.V.S. orders in the first nine months of
1998 declined 10.8% to $33.7 million from $37.8 million in the first nine months
of 1997. I.V.S. order backlog at September 30, 1998 declined 26.3% to $4.8
million versus order backlog at December 31, 1997. I.H.S. revenue increased
24.4% to $32.4 million from $26.1 million due to increased Enterprise
Express(TM) sales. I.H.S. orders for the first nine months of 1998 increased
36.8% to $38.1 million from $27.9 million in the first nine months of 1997.
I.H.S. order backlog at September 30, 1998 increased 45.2% to $17.2 million
versus order backlog at December 31, 1997. C.R.S. revenue increased 12.2% to
$48.8 million from $43.5 million due to increased Prolog(TM)/Guardian(TM) and
Insight(TM) installations as well as Prolog(TM)/Guardian(TM) software upgrades.
C.R.S. orders for the first nine months of 1998 increased 0.8% to $45.1 million
from $44.7 million in the first nine months of 1997. C.R.S. order backlog at
September 30, 1998 declined 47.7% to $3.9 million versus order backlog at
December 31, 1997. Customer Service revenue (including sale of parts) declined
2.9% to $71.8 million from $74.0 million due to reductions in proprietary
product and third party maintenance revenue. A.T.S. revenue increased 14.7% to
$2.0 million from $1.8 million due to increased customer training in support of
I.V.S., I.H.S. and C.R.S. products. Sales and service revenue from International
and Dealer Operations declined 21.4% to $30.5 million from $38.7 million due to
lower sales of systems, C.R.S. and desktop/portable products and lower service
revenue as well as $0.5 million of unfavorable currency exchange. Orders from
International and Dealer Operations for the first nine months of 1998 declined
26.9% to $22.7 million from $31.1 million in the first nine months of 1997.
International and Dealer Operations order backlog at September 30, 1998 declined
38.0% to $1.3 million versus order backlog at December 31, 1997. Contract
Manufacturing revenue increased 15.5% to $35.1 million from $30.3 million due to
both growth from existing Contract Manufacturing customers and the addition of
new Contract Manufacturing accounts.
Cost of sales, rentals and support services declined 5.2% to $137.1
million (53.8% of revenue) during the first nine months of 1998 from $144.6
million (58.1% of revenue) for the first nine months of 1997. Excluding
additional depreciation and amortization expense associated with purchase
accounting adjustments related to the Acquisition, cost of sales, rentals and
support services would have declined by 3.5 percentage points to 53.7%. This
decline is attributable to a $10.5 million charge in the second quarter of 1997
for inventory obsolescence, offset in part by higher Customer Service field,
technical and support costs and a higher content of low margin Contract
Manufacturing revenue.
Selling and administrative expenses (including amortization of
intangibles) declined 8.5% to $102.5 million (40.2% of revenue) during the first
nine months of 1998 from $112.0 million (45.0% of revenue) for the first nine
months of 1997. Excluding additional depreciation and amortization expense
associated with purchase accounting adjustments related to the Acquisition of
$20.4 million and $27.7 million for the first nine months of 1998 and 1997,
respectively, selling and administrative expenses would have declined by $2.3
million from the first nine months of 1997 to the first nine months of 1998.
This decline is attributable to a $2.3 million severance provision in the second
quarter of 1997, and lower I.V.S. and I.H.S. selling expenses, partially offset
by increased C.R.S. selling costs, start-up costs associated with the Company's
Milford assembly facility, and project costs associated with the Company's
efforts to upgrade its information systems.
22
<PAGE>
Research and development expenses of $12.9 million (8.9% of product sales
and rental revenue) increased 15.3% from $11.1 million (7.5% of product sales
and rental revenue), reflecting increased staffing and compensation.
The Company recorded an operating profit of $2.2 million during the first
nine months of 1998 compared to an operating loss of $18.9 million for the first
nine months of 1997. Excluding the impact of purchase accounting adjustments
associated with the Acquisition of $20.7 million and $29.9 million for the first
nine months of 1998 and 1997, respectively, operating profit would have
increased by $12.0 million due to 1997 charges for inventory obsolescence and
severance, and higher revenue.
LIQUIDITY AND CAPITAL RESOURCES
The Company's liquidity requirements consists primarily of scheduled
payments of principal and interest on its indebtedness, working capital needs
and capital expenditures. At September 30, 1998, the Company had outstanding
Term Loans of $132.2 million, a $26.0 million loan outstanding under the $40.0
million Revolving Credit Facility and $200.0 million of Notes. Availability
under the Revolving Credit Facility at September 30, 1998 was $14.0 million.
Scheduled annual principal payments on the Term Loans are $0.6 million in 1998,
1999 and 2000. There are no scheduled reductions in the Revolving Credit
Facility over the next three years.
In May 1998, the Company entered into a sale/leaseback agreement for the
sale of its Stratford, Connecticut land and headquarters facility. Cash proceeds
from the sale totalled $14.0 million. The net proceeds were used by the Company
to reduce amounts outstanding under the Term Loans and the Revolving Credit
Facility. A gain of $1.8 million was recorded on the sale, which is being
amortized over the lease term of twenty years.
In connection with the terms of the Credit Agreement, the Company entered
into interest rate swap agreements in November 1995, effective February 16,
1996, with an aggregate notional principal amount equivalent to $75.0 million
maturing on February 16, 1999. The swap effectively converts that portion of the
Term Loans to a fixed rate component of 5.8%; thus, reducing the impact of
changes in interest rates, converting the total effective interest rate on fifty
percent of the initial outstanding Term Loans to 9.3%. No funds under the swap
agreements are actually borrowed or are to be repaid. Amounts due to or from the
counterparties are reflected in interest expense in the periods in which they
accrue.
In addition, the Credit Agreement contains covenants that significantly
limit or prohibit, among other things, the ability of the Company to incur
indebtedness, make prepayments of certain indebtedness, pay dividends on Common
Stock, make investments, engage in transactions with stockholders and
affiliates, create liens, sell assets and engage in mergers and consolidations
and requires that the Company maintain certain financial ratios.
The Company had $200.0 million of Notes outstanding as of September 30,
1998. The Notes are subordinated to the Credit Agreement financings and other
senior indebtedness, as defined in the Note Indenture. The Notes contain
covenants similar to the Credit Agreement and provide for each noteholder to
have the right to require that the Company repurchase the Notes at 101% of the
principal amount upon a change of control as defined in the Note Indenture. The
Notes bear interest of 11-3/4% per annum, payable semi-annually on each February
1 and August 1. The Notes mature on August 1, 2005. At September 30, 1998, the
fair value of the Notes was favorable $18.0 million based on dealer quotes.
23
<PAGE>
Capital expenditures for the first nine months of 1998 totaled $8.9
million. The Company does not expect that the limitation on capital expenditures
contained in the Credit Agreement will limit, in any material respects, the
Company's ability to fund capital expenditures.
The Company's quarterly revenues and other operating results have been
and will continue to be affected by a wide variety of factors that could have a
material adverse effect on the Company's financial performance during any
particular quarter. Such factors include, but are not limited to, the level of
orders that are received and shipped by the Company in any given quarter, the
rescheduling and cancellation of orders by customers, availability and cost of
materials, the Company's ability to enhance its existing products and to
develop, manufacture and successfully introduce and market new products, new
product developments by the Company's competitors, market acceptance of products
of both the Company and its competitors, competitive pressures on prices,
significant damage to or prolonged delay in operations at the Company's sole
manufacturing facility, and interest rate and foreign exchange fluctuations. The
Company introduced a number of new products in its target markets in 1997 and
1998 and plans to introduce additional new products in 1999 which are expected
to enhance future revenues and liquidity of the Company. However, there can be
no assurance that the Company will be able to implement its plans to introduce
such products in a timely fashion, or that such products will meet the
expectations of the Company for either revenues or profitability. Primarily as a
result of the timing of new product delivery and lower international
performance, the Company, at this time is uncertain as to whether, in the near
term, it will be able to meet certain existing financial covenants contained in
the Credit Agreement. Although the Company is in compliance with all aspects of
the Credit Agreement, it anticipates that it may need to obtain waivers or
amendments in respect of the Credit Agreement. There can be no assurance,
however, that such waivers or amendments, if necessary, can be obtained. The
Company is actively exploring strategic alternatives regarding its manufacturing
facility in Melbourne, Florida, including a potential divestiture of such
facility, for the purpose of re-allocating capital resources, improving
liquidity, and achieving greater focus on its core business. Subject to the
foregoing, the Company believes that cash flows from operating activities, the
successful introduction of its new products, and provisions under the Credit
Agreement for the sale or financing of certain assets, as well as its ability to
borrow under the Revolving Credit Facility, will be adequate to meet the
Company's debt service obligations, working capital needs and planned capital
expenditures for the foreseeable future.
YEAR 2000 READINESS
General
- -------
Most businesses are facing a challenge at the turn of the century due to
a common computer-related practice employed since the 1960's of representing a
year with just two digits rather than four digits. The problem is not restricted
to system hardware components but will be manifested within many operating
systems, firmware, application software and equipment used throughout an
organization. Dictaphone has been and continues to be actively engaged in
resolving its Year 2000 issues. The Company has established a Year 2000 Project
Office charged with evaluating the Company's Year 2000 issues and identifying
and developing appropriate remedies and action plans with respect to the
Company's internal systems and the Company's products to ensure a smooth
transition into the new millennium.
The Year 2000 Project Office has adopted a five phase program to address
the Company's Year 2000 issues consisting of Phase I - review and inventory of
existing systems, products, equipment and suppliers that may be affected by the
Year 2000 issue; Phase II - assessment of the impact of the Year 2000 issue on
systems, products, equipment and suppliers; Phase III - remediation or
replacement of non-compliant systems, products and equipment and determination
and implementation of solutions to address non-compliant suppliers and vendors;
Phase IV - testing of systems, product and equipment following remediation; and
Phase V - contingency planning.
The Company's Year 2000 efforts have been concentrated into two major
areas: 1) internal use systems, equipment and third party products used in the
Company's operations and 2) products sold by the Company to its customers.
24
<PAGE>
State of Readiness
- ------------------
The Company is utilizing both internal and external resources to perform
Year 2000 testing on its internal systems and equipment. The Company has
completed Phase I of the program and has made substantial progress on Phases II,
III and IV for all of its critical systems and equipment. The Company
anticipates completion of the work required on the remaining systems and
equipment by mid 1999. In connection with the Company's efforts to make its
internal systems Year 2000 compliant, the Company has accelerated the
implementation of a new enterprise-wide computer system in certain areas. The
implementation timetable for the components of the new system is currently on
schedule and will be completed by mid 1999.
With respect to third party suppliers, in early 1998 the Company began
the process of identifying and prioritizing critical suppliers and vendors and
initiated communication concerning their plans to address the Year 2000 issue.
This process is continuing and the Company believes efforts in this area will
continue throughout 1999 as more information becomes available from these third
parties.
With respect to products sold to the Company's customers, the Company has
completed Phase I of the program and is actively engaged in Phases II, III and
IV. The Company has identified certain products which require remediation and is
actively involved in the development and communication of such remediations to
the Company's customers. Based on current estimates, the Company anticipates
completion of these phases by mid 1999.
Many of the Company's products rely on third party hardware, software and
firmware. The Company has been diligently working with all such third parties to
ascertain their readiness and the affect, if any, of their products' compliance
status on the efficient and effective operation and use of the Company's
products. Generally, all software, hardware and firmware are supplied to the
Company by leading software companies that have Year 2000 programs of their own.
A majority of these vendors have provided information to the Company as to their
products' Year 2000 compliance status. However, there can be no guarantee that
the software, hardware or firmware certified by third parties, on which the
Company's products may rely, will operate effectively and efficiently during and
after the millennium. The Company has, however, conducted its own Year 2000
testing on integrated products and believes that the risk of material operating
failures associated with the components provided by these third parties is
consistent with their product representations concerning Year 2000 compliance.
Costs
- -----
The Company estimates that the aggregate costs of its Year 2000 program
will be approximately $12.0 million, including $8.0 million of costs already
incurred. Of the total program costs, approximately $9.0 million represents new
software and hardware purchases for internal Company systems which have been
accelerated in connection with the Year 2000 issue. A significant portion of the
remaining $3.0 million in costs have not been and will not consist of
incremental costs, but rather will represent the redeployment of existing
Company resources. This redeployment of resources is not expected to have a
significant impact on the day-to-day operations of the Company. Based on current
estimates and information, the Company does not anticipate that these costs
associated with Year 2000 issues will have a material adverse effect on the
Company's consolidated financial position, results of operations or cash flows
in future periods. However, these cost estimates, as well as the project
timetables previously mentioned are based on management's best estimates, and
there can be no guarantee that these estimates will be achieved or that actual
results will not materially differ from these estimates.
25
<PAGE>
Risks
- -----
With respect to the Company's internal systems, the most reasonably likely
worst case scenario for the Company's failure to identify or remediate a Year
2000 problem could be an interruption in, or failure of, certain normal business
activities or operations. Such failures could materially and adversely affect
the Company's results of operations, liquidity and financial condition. In
addition, due to the uncertainty of the Year 2000 readiness of third parties and
suppliers and customers, the Company is unable to determine at this time whether
the consequences of the Year 2000 failures by these parties will have a material
impact on the Company's consolidated financial position, results of operations
or cash flows.
The Company's Year 2000 program, however, is expected to significantly
reduce the Company's exposure to these types of failures. The Company believes
that the implementation of new systems and the timely completion of the Year
2000 program should reduce the risk of internal business interruption and
adverse financial impact.
With respect to products sold to customers, the most reasonably likely
worst case scenario for Year 2000 related product failures could include the
suspension of use of such product, or continued use of the product with reduced
functionality or operating ability. If this were to occur, customers could
attempt to assert liability claims against the Company. However, the Company
believes that, based on the level of Year 2000 testing performed to date, the
product remedies expected to be made available to its customers, the time
remaining to implement such remedies, and the legal defenses available to the
Company, the likelihood of the occurrence of such worst case scenario is
minimized.
Contingency Plans
- -----------------
Contingency plans are being prepared so that critical business functions
will continue to operate. These plans will address the Company's internal
systems and equipment, products sold by the Company to customers and third party
supplier relationships. The contingency plans will include manual alternatives
to electronic processes, repair or replacement of products and systems and
changes in suppliers. The Company expects that contingency planning will
continue into mid 1999, and will further evolve as the Company obtains
additional information on the state of its Year 2000 readiness.
The Company may, from time to time, provide estimates as to future
performance. Such estimates would be "forward-looking" statements within the
meaning of Section 27A of the Securities Act of 1933 and Section 21E of the
Securities Exchange Act of 1934. Because such statements include risks and
uncertainties, actual results may differ materially from those estimates
provided. The Company undertakes no duty to update such forward looking
statements. Factors that could cause actual results to differ from these forward
looking statements include, but are not limited to, those previously discussed
herein.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
----------------------------------------------------------
Not currently applicable to the Company.
26
<PAGE>
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
-----------------
See Note 5 to the Company's Condensed Consolidated Statements of
Operations (Unaudited) which is incorporated herein by reference.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
--------------------------------
(a) Exhibits
--------
27 -- Financial Data Schedule.
UNDERTAKING:
The undersigned, Dictaphone Corporation, hereby undertakes, pursuant to
Regulation S-K, Item 601(b), paragraph (4) (iii), to furnish to the Securities
and Exchange Commission upon request all constituent instruments defining the
rights of holders of long-term debt of Dictaphone Corporation and its
consolidated subsidiaries not filed herewith for the reason that the total
amount of securities authorized under any of such instruments does not exceed 10
percent of the total consolidated assets of Dictaphone Corporation and its
consolidated subsidiaries.
(b) Reports On Form 8-K
-------------------
There were no Reports on Form 8-K filed by the Company
during the three months ended September 30, 1998.
27
<PAGE>
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.
Dated: November 12, 1998 Dictaphone Corporation
---------------------------------
(Registrant)
By: /s/ John H. Duerden
---------------------------------
Name: John H. Duerden
Title: Chairman, Chief Executive Officer
and President
(Principal Executive Officer)
By: /s/ Joseph D. Skrzypczak
---------------------------------
Name: Joseph D. Skrzypczak
Title: Chief Operating Officer
and Director (Principal
Financial and Accounting Officer)
28
<PAGE>
EXHIBIT INDEX
Sequentially
Exhibits Description Numbered Page
- -------- ----------- -------------
27 Financial Data Schedule
29
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information
extracted from the condensed consolidated balance sheet
of Dictaphone Corporation at September 30, 1998 and the
condensed consolidated statement of operations for the
9 months ended September 30, 1998 and is qualified in
its entirety by reference to such financial statements.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> SEP-30-1998
<CASH> 4,230
<SECURITIES> 0
<RECEIVABLES> 85,620
<ALLOWANCES> 2,639
<INVENTORY> 54,373
<CURRENT-ASSETS> 152,640
<PP&E> 63,889
<DEPRECIATION> 32,812
<TOTAL-ASSETS> 453,457
<CURRENT-LIABILITIES> 83,032
<BONDS> 357,901
23,107
0
<COMMON> 130
<OTHER-SE> (25,234)
<TOTAL-LIABILITY-AND-EQUITY> 453,457
<SALES> 153,419
<TOTAL-REVENUES> 245,686
<CGS> 137,100
<TOTAL-COSTS> 252,452
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 29,632
<INCOME-PRETAX> (27,193)
<INCOME-TAX> 253
<INCOME-CONTINUING> (26,940)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (26,940)
<EPS-PRIMARY> 0
<EPS-DILUTED> 0
</TABLE>
