-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, BqGl8zt0TBrtv4Yoi097ciSxGpMoh6mPLxVK6paWg//QaFyVpsHVA9SZYWsThqGK wq06cIsFfmZXIEPHlQk7IA== 0000950134-02-014481.txt : 20021118 0000950134-02-014481.hdr.sgml : 20021118 20021114181121 ACCESSION NUMBER: 0000950134-02-014481 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 20020930 FILED AS OF DATE: 20021114 FILER: COMPANY DATA: COMPANY CONFORMED NAME: COLORADO MEDTECH INC CENTRAL INDEX KEY: 0000720013 STANDARD INDUSTRIAL CLASSIFICATION: ELECTROMEDICAL & ELECTROTHERAPEUTIC APPARATUS [3845] IRS NUMBER: 840731006 STATE OF INCORPORATION: CO FISCAL YEAR END: 0630 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 000-12471 FILM NUMBER: 02827161 BUSINESS ADDRESS: STREET 1: 6175 LONGBOW DR CITY: BOULDER STATE: CO ZIP: 80301 BUSINESS PHONE: 3035302660 MAIL ADDRESS: STREET 1: 6175 LONGBOW DRIVE CITY: BOULDER STATE: CO ZIP: 80301 FORMER COMPANY: FORMER CONFORMED NAME: CYBERMEDIC INC DATE OF NAME CHANGE: 19920703 10-Q 1 d01120e10vq.txt FORM 10-Q U.S. SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q (Mark One) [X] QUARTERLY REPORT UNDER SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2002 [ ] TRANSITION REPORT UNDER SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM ______ TO _______ Commission file number 0-12471 ------- COLORADO MEDTECH, INC. ---------------------- (Exact name of registrant as specified in its charter) COLORADO 84-0731006 -------- ---------- (State or other jurisdiction of (IRS Employer Identification No.) incorporation or organization) 4801 North 63rd Street, Boulder, Colorado 80301 (Address of principal executive offices) (303) 530-2660 (Registrant's telephone number) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Exchange Act 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 --- --- As of October 31, 2002, the Company had 13,168,783 shares of Common Stock outstanding. COLORADO MEDTECH, INC. FORM 10-Q
PART I FINANCIAL INFORMATION PAGE --------------------- ---- Item 1. Financial Statements: Condensed Consolidated Balance Sheets (Unaudited) - September 30, 2002 and June 30, 2002 3 Condensed Consolidated Statements of Operations (Unaudited) - For the three months ended September 30, 2002 and 2001 5 Condensed Consolidated Statements of Cash Flows (Unaudited) - For the three months ended September 30, 2002 and 2001 6 Notes to Condensed Consolidated Financial Statements (Unaudited) 7 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 16 Item 3. Quantitative and Qualitative Disclosures about Market Risk 37 Item 4. Controls and Procedures 37 PART II OTHER INFORMATION ----------------- Item 1. Legal Proceedings 38 Item 6. Exhibits and Reports on Form 8-K 38
2 PART I FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS COLORADO MEDTECH, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS ASSETS
(UNAUDITED) September 30, 2002 June 30, 2002 ------------------ --------------- CURRENT ASSETS: Cash and cash equivalents $ 5,881,699 $ 6,366,303 Short-term investments 780,129 993,319 Accounts receivable, net 7,961,058 9,644,164 Unbilled receivables 308,887 169,438 Inventories 5,511,371 5,781,665 Income taxes receivable 3,602,150 3,589,907 Deferred income taxes 1,557,803 1,557,803 Prepaid expenses and other 752,789 824,563 --------------- --------------- Total current assets 26,355,886 28,927,162 NON-CURRENT ASSETS: Property and equipment, net 6,112,909 5,700,043 Goodwill and other intangibles, net 5,804,601 5,876,785 Land held for sale 500,000 500,000 Deferred income taxes 1,227,143 1,227,143 Other assets 256,472 302,726 --------------- --------------- Total non-current assets 13,901,125 13,606,697 TOTAL ASSETS $ 40,257,011 $ 42,533,859 =============== ===============
The accompanying notes are an integral part of these consolidated balance sheets. 3 COLORADO MEDTECH, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS LIABILITIES AND SHAREHOLDERS' EQUITY
(UNAUDITED) September 30, 2002 June 30, 2002 ------------------ --------------- CURRENT LIABILITIES: Accounts payable $ 2,991,610 $ 4,878,784 Accrued product service costs 342,921 376,907 Accrued salaries and wages 1,992,799 1,989,815 Other accrued expenses 1,304,733 1,435,222 Customer deposits and deferred revenue 1,767,606 1,733,746 Capital lease obligation 22,550 33,503 --------------- --------------- Total current liabilities 8,422,219 10,447,977 SHAREHOLDERS' EQUITY: Preferred stock, no par value; 5,000,000 shares authorized; none issued -- -- Common Stock, no par value, 25,000,000 shares authorized; 13,168,783 issued and outstanding at September 30, and June 30, 2002, respectively 16,726,748 16,718,092 Accumulated other comprehensive loss (11,318) (7,432) Notes receivable - related parties (617,300) (699,799) Retained earnings 15,736,662 16,075,021 --------------- --------------- Total shareholders' equity 31,834,792 32,085,882 --------------- --------------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 40,257,011 $ 42,533,859 =============== ===============
The accompanying notes are an integral part of these consolidated balance sheets. 4 COLORADO MEDTECH, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2002 AND 2001 (UNAUDITED)
2002 2001 --------------- --------------- NET REVENUE: Outsourcing Services $ 3,597,765 $ 6,334,968 Medical Products 10,535,562 10,684,375 --------------- --------------- Total net revenue 14,133,327 17,019,343 --------------- --------------- COST OF PRODUCTS AND SERVICES: Outsourcing Services 4,041,804 5,555,002 Medical Products 6,448,767 6,633,252 --------------- --------------- Total cost of products and services 10,490,571 12,188,254 --------------- --------------- GROSS PROFIT 3,642,756 4,831,089 --------------- --------------- COSTS AND EXPENSES: Research and development 500,197 832,259 Marketing and selling 1,056,699 987,970 Operating, general and administrative 2,418,947 4,365,497 Other operating expenses 269,806 596,980 --------------- --------------- Total operating expenses 4,245,649 6,782,706 --------------- --------------- LOSS FROM OPERATIONS (602,893) (1,951,617) OTHER INCOME, net 65,534 100,764 --------------- --------------- LOSS BEFORE BENEFIT FOR INCOME TAXES (537,359) (1,850,853) BENEFIT FOR INCOME TAXES (199,000) (705,000) --------------- --------------- NET LOSS $ (338,359) $ (1,145,853) =============== =============== NET LOSS PER SHARE Basic and diluted $ (.03) $ (.09) =============== =============== WEIGHTED AVERAGE SHARES OUTSTANDING Basic and diluted 13,168,783 12,970,726 =============== ===============
The accompanying notes are an integral part of these consolidated statements. 5 COLORADO MEDTECH, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2002 AND 2001 (UNAUDITED)
2002 2001 ------------- ------------- OPERATING ACTIVITIES: Net loss $ (338,359) $ (1,145,853) Adjustment to reconcile net income to net cash flows provided by (used in) by operating activities- Depreciation and amortization 634,388 587,328 Stock-based compensation 8,656 -- Loss (gain) on short-term investments 6,923 (22,787) Changes in operating assets and liabilities- Accounts receivable, net 1,543,657 2,391,477 Inventories, net 270,294 268,968 Prepaid expenses and other assets 108,166 (259,295) Accounts payable and accrued expenses (2,048,665) (1,582,447) Customer deposits 33,860 (680,392) ------------- ------------- Net cash provided by (used in) operating activities 218,920 (443,001) ------------- ------------- INVESTING ACTIVITIES: Capital expenditures (975,070) (592,256) Sales of short-term investments 200,000 -- Repayment of related party notes receivable 82,499 -- ------------- ------------- Net cash used in investing activities (692,571) (592,256) ------------- ------------- FINANCING ACTIVITIES: Issuance of common stock -- 16,823 Repayment of borrowings (10,953) (10,123) ------------- ------------- Net cash (used in) provided by financing activities (10,953) 6,700 ------------- ------------- Net decrease in cash and cash equivalents (484,604) (1,028,557) Cash and cash equivalents, at beginning of period 6,366,303 8,127,076 ------------- ------------- Cash and cash equivalents, at end of period $ 5,881,699 $ 7,098,519 ============= =============
The accompanying notes are an integral part of these consolidated statements. 6 COLORADO MEDTECH, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS THREE-MONTH PERIODS ENDED SEPTEMBER 30, 2002 AND 2001 (UNAUDITED) NOTE 1 - SIGNIFICANT ACCOUNTING POLICIES The financial information is unaudited and should be read in conjunction with the consolidated financial statements and notes thereto filed with the Company's annual report on Form 10-K for the year ended June 30, 2002 (the "Form 10-K"). The accounting policies utilized in the preparation of the financial information herein presented are the same as set forth in the Company's annual consolidated financial statements filed with the Form 10-K, except as modified for interim accounting policies which are within the guidelines set forth in Accounting Principles Board Opinion No. 28. In the opinion of management, the accompanying unaudited condensed consolidated financial statements contain all adjustments necessary to present fairly the Company's financial position as of September 30 and June 30, 2002 and the results of its operations and its cash flows for the three-month periods ended September 30, 2002 and 2001. All of the adjustments were of a normal and recurring nature. Management's Estimates The preparation of financial statements in conformity with accounting principles generally accepted in the United States 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. Actual results could differ from those estimates. Significant estimates and assumptions made by the Company in the preparation of these financial statements include, among other things, the allowance for doubtful accounts receivable, the ability to realize inventory and the related reserve for excess and / or obsolete inventory, estimates on the percent of completion of long-term, fixed price contracts, the impairment of long-lived assets, useful lives of depreciable tangible and intangible assets, the liability accrued for expected warranty costs and the ability to realize deferred tax assets. Concentrations of Credit Risk Financial instruments which potentially subject the Company to concentrations of credit risk are primarily cash and cash equivalents, short-term investments and accounts receivable. The Company maintains its cash and short-term investment balances in the form of bank demand deposits, money market accounts, government securities and commercial paper with financial institutions that management believes are creditworthy. Accounts receivable are typically unsecured and are comprised of amounts due from numerous other entities participating in the medical industry. Due to the significant concentration of revenue among a few customers in the Colorado operations segment, the Company has exposure if any of these significant customers lose their credit worthiness. As of September 30, 2002, the percentage of net accounts receivable represented by amounts due from GE Medical Systems was 37% of the total accounts receivable balance in the Colorado operations. Costs and Estimated Earnings on Uncompleted Contracts Included in unbilled receivables are costs and estimated earnings in excess of billings on uncompleted contracts, which arise when revenues have been earned and recorded but the amounts cannot be billed under the terms of the contracts. 7 Included in customer deposits and deferred revenue are billings in excess of costs and estimated earnings on uncompleted contracts. Costs and estimated earnings on uncompleted contracts and related amounts billed were as follows: (in thousands)
September 30, 2002 June 30, 2002 ------------------ ------------- Costs incurred on uncompleted contracts $ 5,326 $ 4,949 Estimated earnings 363 554 ------------- ------------- Costs and estimated earnings on uncompleted contracts 5,689 5,503 Less: billings to date 5,380 5,421 ------------- ------------- Difference between billings, costs and estimated earnings $ 309 $ 82 ============= =============
Such amounts were included in the accompanying Consolidated Balance Sheets: (in thousands)
September 30, 2002 June 30, 2002 ------------------ ------------- Costs and estimated earnings in excess of billings on uncompleted contracts $ 309 $ 108 Billings in excess of costs and estimated earnings on uncompleted contracts -- (26) ------------- ------------- Difference between billings, costs and estimated earnings $ 309 $ 82 ============= =============
Inventories Inventories are stated at the lower of cost, using the first-in, first-out method, or market. The cost of inventories includes material, labor and manufacturing overhead. As of September 30, 2002 and June 30, 2002, inventories consisted of: (in thousands)
September 30, 2002 June 30, 2002 ------------------------------------------------- ------------------------------------------------- Colorado CIVCO Total Colorado CIVCO Total ------------- ------------- ------------- ------------- ------------- ------------- Raw materials $ 2,677 $ 548 $ 3,225 $ 2,655 $ 454 $ 3,109 Work in process 472 596 1,068 667 584 1,251 Finished goods -- 1,218 1,218 126 1,296 1,422 ------------- ------------- ------------- ------------- ------------- ------------- Total inventories $ 3,149 $ 2,362 $ 5,511 $ 3,448 $ 2,334 $ 5,782 ============= ============= ============= ============= ============= =============
Other Operating Expenses Other operating expenses relate to legal fees the Company has incurred associated with disputes and other actions deemed to be incremental to the normal course of the Company's operations, severance charges, expenses related to consolidating our Colorado operations into one facility, and costs associated with the general improvement of the Company's quality systems in response to the FDA warning letter, as shown below: 8 (in thousands)
Three months ended September 30, ------------------------------- 2002 2001 ------------- ------------- Legal fees $ -- $ 154 Severance charges 189 141 Financial advisor fees 50 -- Moving expenses 31 -- Quality system consulting -- 302 ------------- ------------- Total $ 270 $ 597 ============= =============
Cash Flow Information The following sets forth the supplemental disclosures of cash flow information for the three-month periods ended September 30: (in thousands)
2002 2001 ------------- ------------- Cash paid for interest $ 7 $ 3
During the periods ended September 30, 2002 and 2001, the Company received non-cash tax benefits of $0 and $1,000, respectively, for the exercise of stock options and warrants in disqualifying stock transactions. There were no payments for income taxes made during the quarter ended September 30, 2002 or 2001. NOTE 2 - BORROWINGS Credit Facility The Company is a party to a credit facility (the "Credit Facility") that provides for a revolving line of credit of $5 million. The Credit Facility matures January 1, 2003 and the interest rate is 2% over the higher of (a) the bank's prime rate (4.75% at September 30, 2002) or (b) the federal funds effective rate (1.75% at September 30, 2002) plus 0.5%. All of the Company's accounts receivable and inventory secure outstanding balances, but no amounts had been advanced under the facility as of September 30, 2002. At September 30, 2002, the applicable interest rate on borrowings was 6.75%. The Company is required to pay a commitment fee equal to 50 basis points on a yearly basis, based upon the unused credit facility balance. The Company is currently in negotiations to extend the credit facility. Capital Leases The Company is obligated under a capital lease agreement that terminates in April 2003 as follows: (in thousands)
September 30, 2002 ------------------ Minimum lease payments Current portion $ 24 Amounts representing interest (7.9%) (1) ------------------ Amount outstanding under capital leases $ 23 ==================
9 NOTE 3 - COMPREHENSIVE LOSS Comprehensive loss includes net income (loss) and all changes in equity during a period that arise from non-owner sources, such as unrealized gains and losses on certain investments in debt and equity securities. Total comprehensive loss and the components of comprehensive loss follow: (in thousands)
Three Months Ended September 30, -------------------------------- 2002 2001 ------------- ------------- Net loss $ (338) $ (1,146) Changes in unrealized loss on available-for-sale investments, net of taxes (4) (11) ------------- ------------- Comprehensive loss $ (342) $ (1,157) ============= =============
NOTE 4 - EARNINGS PER SHARE Basic earnings per share are computed on the basis of the weighted average common shares outstanding during each period. Diluted earnings per share are computed on the basis of the weighted average shares outstanding during each period, including dilutive common equivalent shares for stock options and warrants. The Company's diluted net loss per share was the same as its basic net loss per share because all stock options and warrants were antidilutive and were therefore excluded from the calculation of diluted net loss per share. As of September 30, 2002 and 2001, there were 2,608,000 and 2,461,000 options and warrants outstanding that were excluded from the diluted loss per share calculation because their effect was antidilutive. NOTE 5 - STOCK AND STOCK OPTIONS During the three months ended September 30, 2002, the Company did not grant any options or warrants to purchase shares of the Company's common stock, and no stock options or warrants were exercised. On February 22, 2002, the Company issued a warrant to an outside director of the Company to purchase 15,000 shares of the Company's common stock at $2.79 per share. The warrant vested at the rate of 2,500 shares on each of the six monthly anniversaries of February 22, 2002, beginning March 22, 2002 and ending August 22, 2002. The warrant expires five years from date of grant. The warrant was issued in consideration for consulting services provided by the director to the Company and was recorded as compensation expense over the vesting period based on the fair value of the warrant issued. The warrant was revalued each vesting period, and a final valuation was performed when the warrant was fully vested. The Company computed the fair value of the warrant issued under this agreement using the Black Scholes pricing model, assuming a risk free interest rate of 1.85%, expected life of four years, expected volatility of 85.25%, and 0% dividend rate. When issued, the warrant had a fair value of approximately $26,000. For the three months ended September 30, 2002, the Company recorded compensation expense related to vesting of the warrant of approximately $8,700. NOTE 6 - SEGMENT INFORMATION The Company's business is comprised of two reportable segments, Colorado operations and CIVCO operations. During fiscal 2002, the Company began consolidating its Colorado based operations into one physical location from previously separate locations. As a result of this consolidation, the Company changed its organizational structure and management information reporting to reflect that the Colorado 10 operations are managed separately from the CIVCO operations, which are largely based in Iowa. Prior to this consolidation, the Company operated through an outsourcing services segment and a medical products segment. The current Colorado operations were included in both segments while the CIVCO operations were included only in the medical products segment. For comparative purposes, the Company's segment information for the period ended September 30, 2001 has been restated to reflect the Company's current reportable segments. The following is a breakout of the Company's operating revenue and gross profit by segment for the three-month periods ended September 30, 2002 and 2001:
(in thousands) Colorado CIVCO Reconciling Operations Operations Items Consolidated ------------- ------------- ------------- ------------- SEPTEMBER 30, 2002: Net revenue Outsourcing Services $ 3,598 $ -- $ -- $ 3,598 Medical Products 3,815 6,720 -- 10,535 ------------- ------------- ------------- ------------- Total net revenue 7,413 6,720 -- 14,133 Gross profit Outsourcing Services (444) -- -- (444) Medical Products 758 3,329 -- 4,087 ------------- ------------- ------------- ------------- Total gross profit 314 3,329 -- 3,643 Research and development 342 158 -- 500 Sales and marketing 731 326 -- 1,057 General and administrative 1,033 1,386 -- 2,419 Other operating expenses 270 -- -- 270 ------------- ------------- ------------- ------------- Total operating expenses 2,376 1,870 -- 4,246 Income (loss) from operations (2,062) 1,459 -- (603) Depreciation and amortization 362 272 -- 634 Assets 22,607 17,650 -- 40,257 Expenditures for long-lived assets 127 848 -- 975 SEPTEMBER 30, 2001: Net revenue Outsourcing Services $ 7,050 $ -- $ (715) $ 6,335 Medical Products 5,106 5,652 (74) 10,684 ------------- ------------- ------------- ------------- Total net revenue 12,156 5,652 (789) 17,019 Gross profit Outsourcing Services 780 -- -- 780 Medical Products 1,134 2,917 -- 4,051 ------------- ------------- ------------- ------------- Total gross profit 1,914 2,917 -- 4,831 Research and development 675 157 -- 832 Sales and marketing 707 281 -- 988 General and administrative 3,380 986 -- 4,366 Other operating expenses 597 -- -- 597 ------------- ------------- ------------- ------------- Total operating expenses 5,359 1,424 -- 6,783 Income (loss) from operations (3,445) 1,493 -- (1,952) Depreciation and amortization 434 153 -- 587 Assets 31,573 15,404 -- 46,977 Expenditures for long-lived assets 460 132 -- 592
11 Included in operating revenues for the period ended September 30, 2001 are intersegment operating revenues related to the exchange of engineering personnel between the operating units of the Colorado operations. Due to the consolidation of operations in Colorado and the related change in organization structure, these reconciling items should no longer occur. NOTE 7 - RECENTLY ISSUED ACCOUNTING STANDARDS In July 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities," (effective for the Company on January 1, 2003) which replaces Emerging Issues Task Force (EITF) Issue No. 94-3 "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)." SFAS No. 146 requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred and states that an entity's commitment to an exit plan, by itself, does not create a present obligation that meets the definition of a liability. SFAS No. 146 also establishes that fair value is the objective for initial measurement of the liability. The provisions of this statement are effective for exit or disposal activities initiated after December 31, 2002. The Company believes that SFAS 146 may have a prospective effect on its financial statements for costs associated with future exit or disposal activities it may undertake after December 31, 2002. NOTE 8 - GOODWILL AND OTHER INTANGIBLES Effective July 1, 2001, the Company adopted SFAS No. 142 "Goodwill and Other Intangible Assets." As a result of adopting SFAS 142, the Company stopped amortizing its goodwill. However, goodwill is now subject to an annual assessment for impairment, and more frequently if circumstances warrant. In accordance with SFAS No. 142, the Company will complete its impairment testing of intangible assets during the second quarter of fiscal 2003. The impairment testing is performed in two steps: (i) the Company determines impairment by comparing the fair value of a reporting unit with its carrying value, and (ii) if there is impairment, the Company would measure the amount of impairment loss by comparing the implied fair value of goodwill with the carrying amount of that goodwill. Intangible assets are separately recognized if the benefit of the intangible asset is obtained through contractual or other legal rights, or if the asset can be sold, rented, transferred, licensed, or exchanged, regardless of the acquirer's intent to do so. No amortization expense was recorded related to goodwill for the three months ended September 30, 2002 and 2001, respectively. Goodwill and other intangible assets consist of the following: (in thousands)
As of September 30, 2002 Weighted Average Gross Accumulated Net Amortization Period Amount Amortization Book Value ------------------- ------------- ------------- ------------- Unamortized intangible assets Goodwill, CIVCO operations $ 4,766 $ (93) $ 4,673 Goodwill, Colorado operations 1,128 (1,128) -- ------------- ------------- ------------- Total unamortized intangible assets 5,894 (1,221) 4,673 Amortized intangible assets Business development agreement with ATL, CIVCO operations 5 years 1,000 (350) 650 Patents, CIVCO operations 7.5 years 268 (22) 246 Non-compete agreements, CIVCO operations 5 years 269 (33) 236 ------------- ------------- ------------- Total amortized intangible assets 1,537 (405) 1,132 Total goodwill and intangibles 6.7 years $ 7,431 $ (1,626) $ 5,805 ============= ============= =============
12 (in thousands)
As of June 30, 2002 Weighted Average Gross Accumulated Net Amortization Period Amount Amortization Book Value ------------------- --------------- --------------- --------------- Unamortized intangible assets Goodwill, CIVCO operations $ 4,766 $ (93) $ 4,673 Goodwill, Colorado operations 1,128 (1,128) -- --------------- --------------- --------------- Total unamortized intangible assets 5,894 (1,221) 4,673 Amortized intangible assets Business development agreement with ATL, CIVCO operations 5 years 1,000 (300) 700 Patents, CIVCO operations 7.5 years 268 (13) 255 Non-compete agreements, CIVCO operations 5 years 269 (20) 249 --------------- --------------- --------------- Total amortized intangible assets 1,537 (333) 1,204 Total goodwill and intangibles 6.7 years $ 7,431 $ (1,554) $ 5,877 =============== =============== ===============
During fiscal 2002, CIVCO acquired 100% of the outstanding common stock of Barzell Whitmore Maroon Bells, Inc. ("Barzell") in a transaction accounted for under the purchase method of accounting. In connection with the purchase of Barzell, CIVCO recorded goodwill of approximately $1,990,000, patents acquired of approximately $268,000, and non-compete agreements of $269,000. Under the terms of the agreement, the former shareholders of Barzell could receive additional cash payments, totaling up to an additional $2,200,000 over five-and-one-half years, based upon achievement of certain predetermined cumulative gross profit targets. In addition, the former shareholders of Barzell entered into employment agreements with CIVCO pursuant to which they could receive additional incentive payments if other predetermined gross profit targets are exceeded. The following unaudited pro forma results of operations of the Company for the quarter ended September 30, 2001 assume that the acquisition of the operating assets of Barzell occurred on July 1, 2001. These unaudited pro forma results are not necessarily indicative of the actual results of operations that would have been achieved nor are they necessarily indicative of future results of operations. Results of operations for the quarter ended September 30, 2002 are shown for comparative purposes. (in thousands, except per share data)
2002 2001 ------------- ------------- (Unaudited) Revenues $ 14,133 $ 17,489 Net loss $ (338) $ (993) Net loss per share (basic and diluted) $ (.03) $ (.08)
NOTE 9 - NOTES RECEIVABLE - RELATED PARTIES In January 2001, the Board of Directors approved a program to loan to officers of the Company up to $1,000,000 in the aggregate to purchase common stock of the Company from persons other than the Company. The loans are full recourse to the borrower and bear interest at the prime rate plus 0.5%. The principal balances are recorded as contra-equity on the face of the balance sheet. Interest is payable annually on the anniversary date of each note. All principal and remaining accrued interest is due five years from the date of the respective note. As of September 30, 2002, accrued interest on the notes was approximately $20,000 and was included in other current assets on the balance sheet. Interest income of approximately $9,000 from the notes was included in interest income and other for the period ended September 30, 2002. During the quarter ended September 30, 2002, a note to a former officer for $75,000 was repaid in full with accrued interest, in cash. 13 NOTE 10 - COMMITMENTS AND CONTINGENCIES Leases The Company leases the majority of its operating facilities and certain computer and test equipment pursuant to noncancellable operating lease arrangements. At September 30, 2002, future minimum lease payments for facilities under leases having an initial or remaining noncancellable term of one year or more, other than for the building mentioned below, were approximately $100,000 in 2003, $6,000 in 2004, and none thereafter. Colorado Building Lease On January 27, 2002 the Company signed a lease for a 10-year term, commencing April 1, 2002, with rental payments beginning July 1, 2002, for 104,000 square feet of office and building space in which to consolidate its Colorado operations. The Company recognizes total rent expense to be paid on a straight-line basis over the term of the lease in accordance with SFAS 13, "Accounting for Leases." Future minimum lease payments under this agreement for the remainder of fiscal year 2003 and subsequent fiscal years ending June 30 are as follows:
Year Amount ---- ------------- 2003 $ 671,000 2004 918,000 2005 942,000 2006 967,000 2007 992,000 2008-2012 6,137,000 ------------- Total minimum lease payments $ 10,627,000 =============
The Company expects its costs to exit currently leased facilities and consolidate its Colorado operations will be approximately $250,000, of which $185,000 had been incurred through September 30, 2002. In addition, approximately $560,000 in capital expenditures was incurred. The Company has signed a letter agreement to lease an additional 50,000 square feet in a building under construction adjacent to its headquarters building, which will also be leased to the Company. The letter agreement contemplates expected lease payments of approximately $6.9 million over a 10-year period. The lease payment figure includes leasehold improvement expenditures. Under the agreement the landlord agreed to finance leasehold improvements in the new building up to approximately $1.3 million. To the extent the Company does not use this leasehold improvement funding, the annual lease payment will decrease by approximately $160 for each $1,000 of funding not utilized. The Company is currently exploring the most cost-effective ways to finish the space. The letter agreement also states that the Company will amend the lease for the 104,000 square foot building to begin a 10-year lease period congruent with the date of occupancy of the 50,000 square foot building. It is expected that construction of the additional facility will be complete during fiscal year 2003. Other Commitments The Company owns the land and building that houses the development and manufacturing facilities of CIVCO in Kalona, Iowa. To accommodate growth of the CIVCO business, the Company purchased a one-acre plot of land adjacent to the CIVCO property and is completing a 23,000 square foot addition to 14 the CIVCO building on such property, bringing the total square footage to 48,000 square feet. The building consists of office and light manufacturing space. When completed, the cost of the land and the addition, which includes a class 7 (10,000) clean room, is expected to be $2,030,000, $1,839,000 of which was expended through September 30, 2002. Employment and Compensation Agreements The Company has entered into employment agreements with certain officers and key employees. The employment agreements establish compensation and generally provide for severance benefits to the employees upon termination of employment upon or after a change in control of the Company. In addition, the Company has approved an arrangement pursuant to which certain officers and employees will be compensated upon the sale of part or all of the Company. IRS Audit The Company is currently under audit by the Internal Revenue Service for its 1998 and 1999 tax returns. If the IRS asserts and sustains an unfavorable audit result, the Company may be required to record additional liability, lose deferred tax assets, and/or make cash payments for additional taxes, penalties and/or interest. Such amounts could be material, and could have an adverse effect on the Company's financial condition, results of operations and liquidity. While management believes at this time that no such adverse result is forthcoming, it is not possible to predict the outcome of the audit with certainty. Strategic Initiatives The Company is exploring strategic alternatives to maximize value for all shareholders, including but not limited to the sale of all or a part of the Company, the discontinuation of certain operations, mergers, and divestitures. Should the Company sell a business operation, it is reasonably possible that, at that time, the fair value of the related assets could be less than the value at which they are carried on the balance sheet, which would result in a charge against the Company's results of operations. If the Company decides to discontinue and close certain operations, it is reasonably likely that the subsequent sale or disposal of the related assets would be at a depressed price, which would result in a charge against the Company's results of operations. In addition, a decision to sell certain assets or close certain operations may impair the Company's ability to recover deferred taxes. 15 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW Colorado MEDtech, Inc. is a provider of advanced medical products and comprehensive design and manufacturing outsourcing services for healthcare companies worldwide. Our products are system components that are sold to medical imaging original equipment manufacturers ("OEMs"), and ultrasound accessories that are sold to OEMs and end-users such as hospitals, clinics and doctors. Our services include development and manufacturing of electronic and electromechanical devices and instrumentation, product definition, rapid prototyping, engineering, risk analysis, agency submissions, validation testing and value engineering. Colorado MEDtech was incorporated in 1977 as a Colorado corporation. In fiscal 2002, we realigned our operating segments to more accurately reflect our current business. We currently conduct our business through two operating segments, our Colorado operations and our CIVCO operations. Through our Colorado operations segment, we provide medical device outsourcing services and manufacture and sell medical products. Through our CIVCO operations, we design, develop, manufacture and distribute specialized medical accessories and supplies for imaging equipment and minimally invasive surgical equipment. Prior to the realignment, we operated through an outsourcing services segment and a medical products segment. The current Colorado operations were operated through both segments while the CIVCO operations were operated through the medical products segment. We have undertaken several initiatives to become more focused in our response to the difficult economic and market environments and become better positioned to capitalize on market opportunities. These initiatives include: o The realignment of our operating segments as discussed above. o A reduction in force at the Colorado operations of over 30% of the employees in fiscal 2002. o Additional strategic cost cutting measures. o Commencement of consolidation of our Colorado operations into one facility. o Commencement of a process of exploring strategic alternatives. Despite the deterioration of the Colorado operations, we have been able to maintain what we believe is a relatively strong balance sheet, with $6.7 million of cash and short-term investments and working capital of $18.0 million as of September 30, 2002. Our Board of Directors and management are actively exploring a full range of strategic alternatives to maximize value for all shareholders, including but not limited to the sale of some or all of our operations, the discontinuation of certain operations, mergers, and divestitures. We have retained an investment banking firm to assist us in this evaluation. While we expect to undertake one or more of these alternatives there can be no assurance as to the outcome. Any action or transaction that we effect as a result of this process will likely have a material effect on our financial condition and results of operations. 16 As an aid to understanding the Company's operating results, the following table indicates the percentage relationships of income and expense items to total revenue for the line items included in the Condensed Consolidated Statements of Operations for the three-month periods ended September 30, 2002 and 2001, and the percentage change in those items for the three-month period ended September 30, 2002, from the comparable period in 2001.
Percentage Change From As a Percentage of Total Revenues Prior Year's Comparable Period --------------------------------- ------------------------------ Three-Month Period Three-Month Period Ended September 30, Ended September 30, ---------------------- ------------------ 2002 2001 LINE ITEMS 2002 ---- ---- ---------- ---- % % % 25.5 37.2 Net Revenue, Outsourcing Services (43.2) 74.5 62.8 Net Revenue, Medical Products (1.4) ----- ----- ------ 100.0 100.0 Total Net Revenue (17.0) ----- ----- ------ 28.6 32.6 Cost of Outsourcing Services (27.2) 45.6 39.0 Cost of Medical Products (2.8) ----- ----- ------ 74.2 71.6 Total Cost of Services and Products (13.9) ----- ----- ------ 25.8 28.4 Gross Profit (24.6) ----- ----- ------ 3.5 5.0 Research and Development (39.9) 7.5 5.8 Marketing and Selling 7.0 17.1 25.7 Operating, Gen'l and Admin (44.6) 1.9 3.5 Other Operating Expenses (54.8) ----- ----- ------ 30.0 40.0 Total Operating Expenses (37.4) ----- ----- ------ (4.2) (11.6) Loss from Operations (69.1) .5 .6 Other Income, Net (35.0) ----- -- ------ (3.7) (11.0) Loss Before Income Taxes (71.0) (1.4) (4.1) Income Tax Benefit (71.8) ----- ----- ------ (2.3) (6.9) Net Loss (70.5) ===== ===== ======
17 RESULTS OF OPERATIONS The following discussion relates to our consolidated results, and is followed by sections discussing results for Colorado and CIVCO operations separately. During the three months ended September 30, 2002, net revenue was down 17% compared to the three months ended September 30, 2001. The decline in sales was primarily due to a 43% reduction in outsourcing services revenue. Outsourcing services revenue decreased in the Colorado operations primarily because customers suspended or delayed orders for manufactured items due to decreased demand in their markets. The decrease was also attributable to certain research and development contracts that we completed without having significant additional sales to replace these contracts. Medical product sales were down 1% during the quarter ended September 30, 2002, compared to the same period in the prior year. This decrease was comprised of a 24% decrease in medical product sales in Colorado operations and a 19% increase in revenue from CIVCO operations. Medical products were approximately 74% of total revenues in the three months ended September 30, 2002, compared to 63% in the same period in 2001. Outsourcing services were approximately 26% of total revenues in three months ended September 30, 2002 and 37% of total revenues in the same period in 2001. The increase in the percentage of medical product revenue to outsourcing services revenue was due to acquisitions and growth in the CIVCO operating segment and declining sales in our Colorado operations. CIVCO accounted for approximately 48% of total net revenue for the three months ended September 30, 2002 compared to 33% during the same period in the prior year. The decrease in outsourcing services was due primarily to the difficulty in obtaining additional contracts to replace those completed during fiscal year 2002, and the slowdown in the general economy. Our consolidated gross profit was 26% in the three months ended September 30, 2002 compared to 28% in the same period of 2001. The decrease in overall gross profit was attributable to the 43% reduction in net revenue from outsourcing services in Colorado. To allow us to stay in compliance with FDA regulations and improve the quality of the products manufactured for our customers, during fiscal years 2002 and 2001 we significantly upgraded our quality systems, processes and procedures. Outsourcing services include FDA-regulated products, which have a higher percentage of fixed overhead costs than other operations. Gross profit from these services will typically fluctuate with sales volumes. Due to the sharp decline in sales in the presence of relatively fixed overhead costs, outsourcing services had negative gross profit during the quarter ended September 30, 2002. Research and development expenses for the three months ended September 30, 2002 decreased by 40% compared to the same period in the prior year. Research and development activities related to RF solid state amplifiers, medical device connectivity, medical imaging systems and ultrasound guidance systems and covers. This decrease was related to cost cutting measures taken during the previous 12 months, which included narrowing the focus of our development activities, and the substantial completion of a solid state amplifier. Research and development expenses were 4% and 5% of total net revenue for the periods ended September 30, 2002 and 2001, respectively. We expect research and development expenses to continue at this rate or decrease slightly during the remainder of fiscal 2003. However, consistent with our ongoing operating plans, we continue to pursue the development or acquisition of new or improved technology or products. If we identify any such opportunities in connection with our current process to explore strategic alternatives, the amount of future research and development expenditures may increase. Marketing and selling expenses increased by 7% for the three months ended September 30, 2002, compared to the same period in the prior year. During the quarter, in an effort to boost sales for Colorado operations, 18 we involved engineering and operational personnel in the proposal and sale process. When involved in the sales process, the salaries of these personnel are charged to marketing and selling expense. Because we continue to work to improve sales and customer relationships, we expect sales and marketing expenditures to continue at this rate during fiscal 2003. Marketing and selling expenses as a percentage of total revenue were 8% and 6% for the periods ended September 30, 2002 and 2001, respectively. Operating, general and administrative expenses decreased by 45% for the period ended September 30, 2002 compared to the same period in the prior year. The decrease was attributable to strategic cost cutting measures undertaken to reduce expenses over the past year, primarily related to employee reductions, consolidation of operations and other actions to better scale expenses to expected revenue. We also focused certain personnel more on obtaining sales and working with customers, which increased cost of sales and sales and marketing expenses, while reducing general and administrative expenses. We continue to look for areas of process and procedure improvement to help reduce costs. As a percentage of net revenue, operating, general and administrative expenses decreased to 17% from 26% in the same period of the prior year. Other operating expenses relate to legal fees incurred associated with disputes and other activities deemed to be incremental to the normal course of operations, severance charges, expenses related to consolidating Colorado operations and consulting costs associated with the general improvement of our quality systems. Other operating expenses for the period ended September 30, 2002 decreased 55% compared to the same period in the prior year. Other income and expense decreased 35% for the period ended September 30, 2002 compared to the same period in the prior year. This decrease was due to lower interest rates and lower average cash and investment balances being lower in the three months ended September 30, 2002 compared to the same period in the previous year. Note balances due from loans to officers were down at September 30, 2002, compared to the prior year, as were the related rates of interest. During the period ended September 30, 2002, compared to the period ended September 30, 2001, our net loss, loss per share and diluted weighted average common equivalent shares outstanding used to calculate loss per share were as follows: (in thousands, except per share data)
2002 2001 ---- ----- Net loss $ (338) $ (1,146) Basic and diluted loss per share $ (.03) $ (.09) Diluted weighted average common equivalent shares outstanding 13,169 12,971
The net loss for the period ended September 30, 2002 decreased by 71% compared to the loss incurred in the same period in the prior year. The smaller net loss was due primarily to the cost cutting measures discussed above, the decrease in other operating expenses and the increase in the percentage of sales related to the CIVCO operations, which typically have better margins than our Colorado operations. Colorado Operations The following section discusses the results of operations of our Colorado operations. The following table provides detail of the elements of sales, net of reconciling items, and gross profit of the Colorado operations for the three-month periods ended September 30, 2002, and 2001, respectively: 19 (in thousands)
2002 2001 % Change ---- ---- -------- Net revenue Outsourcing services $ 3,598 $ 6,335 (43.2)% Medical products 3,815 5,032 (24.2)% ----- ------ Total net revenue 7,413 11,367 (34.8)% ----- ------ Cost of products and services Outsourcing services 4,042 5,555 (27.2)% Medical products 3,057 3,899 (21.6)% ----- ------ Total cost of products and services 7,099 9,454 (24.9)% ----- ------ Gross profit (loss) Outsourcing services (444) 780 (156.9)% Medical products 758 1,134 (33.2)% ----- ------ Total gross profit 314 1,914 (83.6)% ----- ------ Gross profit % 4% 17% Research and development 342 675 (49.3)% Sales and marketing 731 707 3.4 % Operating, general and administrative 1,033 3,380 (69.4)% Other operating expense 270 597 54.8% ------ ------ Total costs and expenses 2,376 5,359 (55.7)% Loss from operations (2,062) (3,445) (40.1)%
Net revenue for Colorado operations, which consist of outsourcing services and medical products, was $7.4 million during the period ended September 30, 2002, compared to $11.4 million for the same period in the prior year, a decrease of 35%. The Colorado operations' outsourcing service revenue was $3.6 million compared to $6.3 million in the prior year, a decrease of 43%. This decrease was attributable to: o suspensions or delays in customers' orders for products, which pushed out production and shipping of certain products; o completion of certain outsource research and development projects; o the difficulties in closing new contracts for outsource research and development projects; and o the adverse effect of the FDA warning letter, received in January 2001, on our sales. The Colorado operations' medical products net revenue was $3.8 million for the period ended September 30, 2002, compared to $5.0 million for the same period in the prior year, a decrease of 24%. The decrease in medical products revenue was primarily due to a sharp reduction in sales of x-ray tube generators caused by Hitachi's cancellation of its supply agreement in the summer of 2001. Prior to 20 Hitachi's cancellation of this agreement, this product line provided significant medical products revenue for the Colorado operations segment. At September 30, 2002 backlog for Colorado operations was approximately $16 million compared to approximately $19 million at June 30, 2002. In the normal course of business in the Colorado operations segment, it is common for a significant amount of revenue to come from a few customers, as shown below:
Percent of Net Revenue for the Quarter Ended September 30, ------------------------------ 2002 2001 ---- ---- GE Medical Systems (GEMS) 40% 26% Genoptix 11% -- Hitachi 1% 15%
This concentration can cause sales and profitability in the Colorado operations segment to fluctuate, based on gaining or losing a significant customer. During the quarter ended September 30, 2002, Colorado operations had less than $100,000 of net revenue from Hitachi compared to $1,689,000 during the same period in the previous year. This concentration may also result in a concentration of accounts receivable, which may increase the risk of collection with respect to a significant portion. GE Medical Systems continues to be our largest customer within the Colorado operations. Of the $5.3 million in Colorado operations accounts receivable, $1.97 million (37%) is attributable to GEMS. Gross margin for Colorado operations was 4% for the period ended September 30, 2002 and 17% for the same period in the prior year. The decrease in gross margin was due to: o the 35% reduction in Colorado operations' revenue, which resulted in overhead being absorbed by a smaller revenue base; o additional expenses to prepare for the upcoming FDA inspection due to the transfer and validation of manufacturing activities to the new facility; o inefficiencies related to the consolidation of Colorado operations into one facility, as operating activities continued at three additional buildings during the quarter; and o although we continue to scale down staff and operating expenses to better match the current business environment and offset some of the reduction in sales, we find it necessary to carry a certain level of personnel to maintain the expertise required to take on additional projects when and if sales increase. Carrying these additional personnel has resulted in lower utilization of employees and has had a negative impact on gross margin. As we continue to consolidate the Colorado operations into one building, we believe we will realize additional cost savings. However, due to the slowdown in the Colorado operations segment, and the commitment to an additional 50,000 square feet of office space, we will have excess capacity that will adversely affect this segment's financial performance. We believe additional sales or the completion of certain strategic alternatives will be needed to cover the costs of the engineering group and related overhead during the remainder of fiscal 2003. Research and development expenses were $342,000 for the quarter ended September 30, 2002 compared to $675,000 in the same period of the prior year, a decrease of 49%. The decrease was due to our cost reduction initiatives applied to two internal research and development programs related to solid state 21 amplifier, the design of which is largely complete, and medical device connectivity. There are continuing efforts on these projects, but the staffing level and expenses have been reduced in connection with the downturn in revenues in our Colorado operations. Marketing and selling expenses were $731,000 during the quarter ended September 30, 2002 compared to $707,000 during the same period in the prior year, an increase of 3%. Although we have focused our Colorado operations on cost reductions, marketing and selling expenses increased, as we continue to market and sell our services to prospective and current clients. During the quarter ended September 30, 2002, we involved engineering and operational personnel in the proposal and sale process. When involved in the sales process, the salaries of these personnel are charged to marketing and selling expense. Based on our announcement regarding strategic alternatives, which may include the sale or discontinuation of certain operations, we may encounter additional difficulty winning new outsource development and manufacturing programs. Operating, general and administrative expenses were $1,033,000 during the quarter ended September 30, 2002, compared to $3,380,000 during the same period in the prior year. The decrease was due primarily to cost saving measures we have put in place over the last 12 months, the allocation of personnel to sales and project related activities, and a change in allocation percentage of corporate expenses. Cost saving measures included the reduction of personnel, the consolidation of operations, and better scaling of expenses to expected revenues for the quarter ended September 30, 2002. As corporate expenses have decreased and the CIVCO operations have become a larger part of our business on a percentage of revenue basis, the allocation of corporate expenses to Colorado declined to $399,000 for the quarter ended September 30, 2002 compared to $1,063,000 in the same period of the previous year,. During the quarter ended September 30, 2001, the Company was involved in two legal disputes and was working to resolve the FDA warning letter, which required additional administrative personnel and expenses. Related to these costs were outside consultants and legal counsel, which were classified in other operating expenses, but the time, expenses and effort of employees are included in operating, general and administrative expenses. Other operating expenses relate to the legal fees we have incurred related to disputes and other activities deemed to be incremental to the normal course of our operations, severance charges, expenses related to consolidating our Colorado operations and consulting costs associated with the general improvement of our quality systems. Other operating expenses for the period ended September 30, 2002 decreased 55% compared to the prior year as shown below: (in thousands)
Quarter Ended Ended September 30, ---------------------- 2002 2001 ------ ------ Legal fees $ - $ 154 Severance charges 189 141 Financial advisor fees 50 - Moving expenses 31 - Quality system consulting - 302 ------ ------ Total $ 270 $ 597 ====== ======
Legal fees during fiscal 2001 related to costs associated with disputes with a former customer and the former owner of CIVCO. These two items were resolved during fiscal 2002 and therefore, no such legal expenses were incurred during the quarter ended September 30, 2002. Quality system consulting 22 expenses were related to our response to the FDA warning letter, which was resolved during fiscal 2002 and therefore, no such fees were incurred during the quarter ended September 30, 2002. CIVCO Operations The following section discusses the results of operations of our CIVCO segment. The following table provides detail of the elements of sales and gross profit of CIVCO for the periods ended September 30, 2002 and 2001, respectively: (in thousands)
2002 2001 % Change ------ ------ -------- Net revenue Medical products $6,720 $5,652 18.9% Cost of products Medical products 3,391 2,735 24.0% ------ ------ Gross profit Medical products 3,329 2,917 14.1% ----- ----- Gross profit % 50% 52% Research and development 158 157 1.0% Sales and marketing 326 281 16.0% Operating, general and administrative 1,386 986 40.6% Other operating expense - - - % ------- ------- Total costs and expenses 1,870 1,424 31.3% Income from operations 1,459 1,493 2.3%
The increase in CIVCO net revenue was due to internal growth of its products business and the acquisition of Barzell in February 2002. The operations acquired in the Barzell purchase produced approximately $684,000 in net revenue in the current quarter. Without the post-acquisition revenue from Barzell, sales for CIVCO increased 7% over the same period in the prior year. In the quarters ended September 30, 2002 and 2001, CIVCO had one customer (GEMS) that accounted for 9% and 10%, respectively, of net revenue, and no other customer accounted for more than 10% of net revenue. CIVCO does not rely on a few customers for a majority of its business. CIVCO's gross margins were 50% for the period ended September 30, 2002, compared to 52% for the same period in the prior year. CIVCO's gross margins were affected by the construction of an additional 23,000 square feet of building space, which is expected to be ready for full occupancy in the second half of fiscal 2003. The addition will give CIVCO opportunities to grow its business, but has required CIVCO to incur additional expenses related to quality enhancements and the validation of a new, larger clean room. Research and development expenses for the three months ended September 30, 2002 increased by 1% compared to the same period in the prior year. Research and development expenses were 2% and 3% of net revenue for the periods ended September 30, 2002, and 2001, respectively. We expect research and development expense related to ultrasound needle guidance systems and covers to remain constant and 23 research and development related to ultrasound positioning systems and minimally invasive products to increase in fiscal year 2003. Marketing and selling expenses increased by 16% for the three months ended September 30, 2002, compared to the same period in the prior year. The increase was primarily a result of personnel and other selling expenses added as part of the acquisition of Barzell. We expect a modest increase in marketing and selling expenses as we focus more on targeted sales to end users. As a percentage of net revenue, marketing and selling expense remained constant at 5% for the periods ended September 30, 2002 and 2001. Operating, general and administrative expenses increased by 41% for the three month period ended September 30, 2002, compared to the same period in 2001. The increase was attributable in part to increases in employee expenses. Over the past year we have added administrative staff to support information technologies, and quality engineers to improve our overall quality system to support the growth of our CIVCO business. We also incurred regulatory consulting expenses in connection with the building addition. Depreciation and amortization expenses increased primarily due to the expansion of the facility and to the amortization of patents and employment agreements obtained as part of the Barzell acquisition. Additionally, as CIVCO has become a larger part of our business, the corporate overhead allocated to CIVCO has increased. Operating, general and administrative expenses were 21% and 17% of revenues for the periods ended September 30, 2002 and 2001, respectively. FINANCIAL CONDITION Working capital decreased to $18.0 million at September 30, 2002 from $18.5 million at June 30, 2002. The ratio of current assets to current liabilities increased to 3.1 to 1 at September 30, 2002, compared to 2.8 to 1 at June 30, 2002. As of September 30, 2002, current assets were $26.4 million compared to $28.9 million at June 30, 2002. The decrease in current assets was primarily due to the reduction in accounts receivable of $1.7 million and a reduction in cash and short-term investments of $700,000. The decrease in accounts receivable was directly related to the $4.1 million decrease in net revenue during the quarter ended September 30, 2002, compared to the quarter ended June 30, 2002. As of September 30, 2002, the average days sales outstanding were 52 days compared to 49 days at June 30, 2002. LIQUIDITY AND CAPITAL RESOURCES Despite the downward trend of the Colorado operations over the past two years, we have been able to maintain what we believe is a relatively strong balance sheet, with $6.7 million of cash and short-term investments and working capital of $18.0 million as of September 30, 2002. Our Board of Directors and management are actively exploring a full range of strategic alternatives to maximize value for all shareholders, including but not limited to the sale of some or all of our operations, the discontinuation of certain operations, mergers and divestitures. We have retained an investment banking firm to assist us in this evaluation. While we expect to undertake one or more of these alternatives there can be no assurance as to the outcome. Our primary sources of liquidity have consisted of cash flows from operations, cash and investments on hand and issuance of stock. We also have a credit facility that provides for a revolving line of credit of $5.0 million. The credit facility expires January 1, 2003, and the interest rate is 2% over the higher of (a) the bank's prime rate (4.75% at September 30, 2002) or (b) the federal funds effective rate (1.75% at September 30, 2002) plus 0.5%. All accounts receivable and inventory secure outstanding balances, but no amounts had been advanced under the facility as of September 30, 2002. At September 30, 2002, the 24 applicable interest rate on borrowings was 6.75%. We are currently in negotiations to extend the credit facility. We have a capital lease agreement with an interest rate of 7.9% that terminates in April 2003. As of September 30, 2002 and 2001, amounts outstanding under our capital lease obligations were $23,000 and $43,000, respectively. We expect costs to exit currently leased facilities and consolidate our Colorado operations to be approximately $250,000, $185,000 of which was incurred through September 30, 2002, and have spent approximately $560,000 in capital expenditures for this facility through September 30, 2002. We have entered into a 10-year lease for our new facilities in Colorado, which calls for rent payments of approximately $10.6 million over the life of the lease. In connection with this lease, we entered into an agreement with the landlord under which the landlord will construct a building adjacent and connected to the leased property which will also be leased to us. The lease for the addition is expected to cost an additional $6.9 million over a 10-year period. The lease payment figure includes leasehold improvement expenditures. Under the agreement the landlord agreed to finance leasehold improvements in the new building up to approximately $1.3 million. To the extent we do not use this leasehold improvement funding, the annual lease payment will decrease by approximately $160 for each $1,000 of funding not utilized. We are currently exploring the most cost-effective ways to finish the space. The addition is under construction and is expected to be completed during fiscal year 2003. Cash generated from operating activities was $219,000, compared to cash used in operations of $443,000 in the same period of the prior year. Cash provided by operating activities was primarily due to the reduction in accounts receivable of $1.5 million and inventory of $270,000. The decrease in accounts receivable was attributable to the $2.9 million decrease in net revenue during the quarter ended September 30, 2002, compared to the quarter ended September 30, 2001. Depreciation and amortization for the periods ended September 30, 2002 and 2001 was $634,000 and $587,000, respectively. Offsetting these additions to operating cash inflows were outflows due to the reduction in accounts payable and accrued expenses of $2.0 million and the net loss for the quarter of $338,000. The reduction in accounts payable and accrued expenses was primarily related to the continued slowdown in outsource manufacturing activities. Cash used in investing activities was $693,000 during the period ended September 30, 2002, compared to cash used of $592,000 during the same period in 2001. This change was due to capital expenditures during the quarter of $1.0 million, offset by cash received of $200,000 from the maturity of a short-term investment. Expenditures for capital assets of $582,000 were primarily related to the expansion of the CIVCO building. We expect to incur an additional $200,000 on the project which would total approximately $2.1 million. Cash used in financing activities was $11,000 for the period ended September 30, 2002, compared to cash provided of $7,000 during the same period in the prior year. The cash outflows were for capital lease obligations. In 2001, $17,000 was received for the exercise of stock options. We believe that our cash, investments, credit facilities and cash projected from operations will be sufficient to meet our working capital needs through the next twelve months and the foreseeable future. However, our projected cash needs may change as a result of acquisitions, divestitures or closures, unforeseen operational difficulties or other factors. In the normal course of our business, we investigate, evaluate and discuss acquisition, joint venture, minority investment, strategic relationships and other business combination opportunities. In the event 25 of any future investment, acquisition or joint venture opportunities, we may consider using then-available liquidity, issuing equity securities or incurring additional indebtedness. Additionally, we have announced that we are exploring other options, such as the sale or closure of all or a portion of our operating businesses, product lines, or assets. Some of these alternatives could result in dilution to existing shareholders, additional interest expense, the write down of assets or other charges to our current capital structure and results of operations. Critical Accounting Policies Our discussion and analysis of financial condition and results of operations is based upon the consolidated financial statements, which have been prepared in accordance with generally accepted accounting principles in the U.S. ("GAAP"). The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities as of the date of the financial statements, and the reported amounts of revenue and expenses during the periods. Estimates have been made by management in several areas, including, but not limited to, the percentage of completion on certain long-term, fixed price projects, the allowance for estimated bad debts, the net realizable value of inventory, income tax valuation allowances, warranty costs to be incurred, and bad debt exposure. These estimates are based on historical experience and various other assumptions that we believe to be reasonable under the circumstances. Actual results may differ materially from these estimates under different assumptions or conditions. In addition to making estimates and assumptions, we must also select and apply accounting policies that are appropriate for our business operations, and that are in compliance with generally accepted accounting principles. Those accounting policies that we believe to be critical in understanding our financial position and results of operations are as follows: Revenue Recognition The Company generates its revenue through sale of products and by providing contract engineering services. The Company's policy is to recognize revenue when the applicable revenue recognition criteria have been met, which generally include: o Persuasive evidence of an arrangement exists; o Delivery has occurred or services have been rendered; o Price is fixed or determinable; and o Collectibility is probable. Revenue from the sale of products is generally recognized after both the goods are shipped and title is transferred, with an appropriate provision for estimated returns and allowances. The terms of the customer arrangements generally pass title and risk of ownership to the customer at the time of shipment. On rare occasion certain arrangements provide for acceptance provisions. Revenue for these arrangements is not recognized until the acceptance has been received or the acceptance period has elapsed. Estimated returns and allowances are established based upon historical experience and current circumstances. Revenue from contract engineering services, which may include the development of customized software, is recognized using either the percentage-of-completion method or completed contract method. In addition the majority of the Company's engineering contracts are billed on a time and materials basis 26 and, as a result, revenue is recognized as the work is performed. On occasion, the Company will enter into long-term contracts with fixed fee arrangements. The revenue from these fixed fee arrangements is recognized on either the percentage-of-completion method or on the completed contract method, depending on management's determination of its ability to make reasonable estimates with regard to each specific contract. Under the percentage-of-completion method, management considers contract costs to be the best available measure of progress on uncompleted contracts. Contract costs include all direct labor costs and any other direct costs related to contract performance. Provisions for estimated losses on incomplete contracts are made in the period in which such losses are determined. Changes in contract performance and estimated profitability, including final contract settlements, may result in revisions to costs and revenues and are recognized in the period in which the revisions are determined. Unbilled receivables on contracts are comprised of costs plus estimated earnings on certain contracts in excess of billing on such contracts. Billings in excess of revenue earned are classified as deferred revenue. Inventories We value inventory at the lower of cost or market using the first-in, first-out method. We assess the recoverability of inventory based on types and levels of inventory held, forecasted demand, changes in customer viability and changes in technology. These assessments require management judgments and estimates, and valuation adjustments for excess and obsolete inventory are recorded based on these assessments. Estimates of future product demand or judgments related to changes in technology may prove to be inaccurate, in which case the carrying value of inventory could be overstated or understated. In the event of any such inaccuracies, an adjustment would be recognized in cost of goods sold at the time of such determination. Unexpected changes in customer relationships could also impact the valuation adjustment for inventory. Warranty We warrant our outsource manufacturing and medical products against defects in materials and workmanship, generally for three to 12 months, but in limited cases for up to 24 months. Estimated costs of materials and labor for product service are accrued at the time of sale. These estimates are based on the unit sales volumes and review of past expenses incurred for warranty work performed on specific products. Bad Debt We have established a reserve against our accounts receivable for amounts billed that management estimates our customers will likely be unable to fulfill their legal obligations to pay. The reserve is comprised of specific accounts and a general amount based on our historical experience. We continuously monitor the financial status of our customers and the status of our relationship with our customers to minimize the exposure to uncollectible receivables, but uncollectible receivables may exceed our reserves. Long-Lived Assets, Goodwill and Intangibles Long-lived assets, goodwill and intangibles are recorded at the lower of historical net book value or fair value. This requires management to assess the fair value of long-lived assets, goodwill, intangibles and reporting units. Should any significant event occur that causes the value of long-lived assets, goodwill or intangibles to decrease, we would be required to review the asset's fair value relative to its carrying cost. If an asset is deemed to be impaired, the resulting charge could have a material adverse affect on our results of operations. 27 We are exploring various strategic alternatives, which may include the sale or other disposition of all or some of our business operations and related assets. As of the date of this Form 10-Q, no decisions had been made regarding any action we may take, if at all. Should we sell or close a business operation, it is reasonably possible that, at that time, the fair value of the related assets could be less than the value at which they are carried on our balance sheet, which would result in a charge against our results of operations. Deferred Taxes Each reporting period requires that we estimate our ability to realize our net deferred tax assets. The primary factor in this determination is our ability to generate future taxable income, or carry back current losses to previous years' taxable income. As a result, we are required to assess and estimate our ability to generate sufficient taxable income in the future, in the appropriate taxing jurisdiction, to recover the recorded amount of net deferred tax assets. To the extent that actual experience is different than our estimates, the recorded valuation allowance may need to be revised. New Accounting Pronouncements In July 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities," (effective January 1, 2003) which replaces Emerging Issues Task Force (EITF) Issue No. 94-3 "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)." SFAS No. 146 requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred and states that an entity's commitment to an exit plan, by itself, does not create a present obligation that meets the definition of a liability. SFAS No. 146 also establishes that fair value is the objective for initial measurement of the liability. We believe SFAS No. 146 may have a prospective effect on our financial statements for costs associated with future exit or disposal activities we may undertake. In October 2002, the EITF reached a tentative consensus on Issue No. 00-21. The Company is currently analyzing the impact, if any, on the Company's current revenue recognition policies. FORWARD - LOOKING STATEMENTS AND RISK FACTORS The statements in this report that are not historical facts are forward-looking statements that represent management's beliefs and assumptions based on currently available information. Forward-looking statements can be identified by the use of words such as "believes", "intends", "estimates", "may", "will", "should", "anticipated", "expected" or comparable terminology or by discussions of strategy. Although we believe that the expectations reflected in such forward-looking statements are reasonable, we cannot assure you that these expectations will prove to be correct. Such statements involve risks and uncertainties including, but not limited to, the risk that our existing level of orders may not be indicative of the level or trend of future orders, the risk that we may not successfully complete the work encompassed by current or future orders, the risk that unforeseen technical or production difficulties may adversely impact project timing and financial performance, the risk of potential litigation and the risk that acquired companies cannot be successfully integrated with our existing operations. Should one or more of these risks, as well as others not known to us or not considered to be material at this time, materialize (or the consequences of such a development worsen), or should the underlying assumptions prove incorrect, actual results could differ materially from those forecasted or expected. These factors are more fully described below and in our documents filed from time to time with the Securities and Exchange Commission. We disclaim any intention or obligation to update publicly or revise such statements whether as a result of new information, future events or otherwise. 28 OUR ANNOUNCEMENT THAT WE ARE EXPLORING STRATEGIC ALTERNATIVES MAY HAVE AN ADVERSE IMPACT ON OUR BUSINESS. We have announced that our Board of Directors is exploring strategic alternatives to maximize value for all shareholders, including but not limited to the sale of all or a part of Colorado MEDtech, the discontinuation of certain operations, mergers, and divestitures. We have retained an investment banking firm to assist the Board of Directors in its strategic review process. The announcement and the exploration of strategic alternatives process may cause uncertainty for our customers, which could have several adverse effects, including without limitation, that existing customers may terminate their product development or manufacturing projects. In addition, although sales and bookings for the Colorado operations segment of our business have been well below past levels for reasons discussed in this report, the announcement and the process may create more difficulties than we already have generating new product development or manufacturing sales. The announcement and the exploration of strategic alternatives process may create uncertainty for our employees, which may make it more difficult or expensive to retain them. If the announcement or the strategic alternatives process creates any of these effects, or other unforeseen effects, it may have an adverse impact on our business, and may adversely affect our stock price. As of the date of this Form 10-Q, no decisions have been made regarding any action we may take, if at all. A DECISION TO SELL CERTAIN ASSETS OR CLOSE CERTAIN OPERATIONS COULD RESULT IN A CHARGE AGAINST OUR RESULTS OF OPERATIONS OR AFFECT OR ABILITY TO UTILIZE TAX BENEFITS. Our Board of Directors is exploring strategic alternatives to maximize value for all shareholders, including but not limited to the sale of all or a part of Colorado MEDtech, the discontinuation of certain operations, mergers, and divestitures. Should we sell a business operation, it is reasonably possible that, at that time, the fair value of the related assets could be less than the value at which they are carried on our balance sheet, which would result in a charge against our results of operations. If we decide to discontinue and close certain operations, it is reasonably likely that the subsequent sale or disposal of the related assets would be at a depressed price, which would result in a charge against our results of operations. In addition, a decision to sell certain assets or close certain operations may impair our ability to recover deferred taxes. OUR FINANCIAL RESULTS CAN FLUCTUATE FROM QUARTER TO QUARTER AND YEAR TO YEAR, WHICH CAN AFFECT OUR STOCK PRICE. Our quarterly and annual operating results are affected by a number of factors, primarily the volume and timing of revenue from customer orders. The volume and timing of our revenue from customer orders varies due to: o variation in demand for the customer's products as a result of, among other things, product life cycles, competitive conditions and general economic conditions; o suspension or cancellation of a customer's development project for reasons that may or may not be related to project performance; o suspension or cancellation of a customer's research and development budget for reasons that may or may not be related to the project; o a change in a customer's research and development strategy as a result of sale or merger of the customer to another company; o delays in projects associated with the approval process for changes to a project; and, o discounts extended to customers for reasons related to project size, performance or schedule. 29 Our outsourcing services business organization and its related cost structure is designed to support a certain minimum level of revenues. As such, if we experience a temporary decrease in project revenues, our ability to adjust our short-term cost structure is limited, and we may incur negative gross profit in certain operations, as we did this quarter. This limitation may compound the adverse effect of any significant revenue reduction we may experience. Any one of the factors listed above or a combination of them could result in a material adverse effect on our business, results of operations and financial condition. Due to the foregoing factors, it is possible that our operating results may from time to time be below the expectations of public market analysts and investors. In such event, the price of our stock would likely be adversely affected. OUR SALES CYCLES ARE LONG. The sales cycle for our Colorado products and services is lengthy and unpredictable. As a result, the time it takes our business to recover from a slow sales period may be lengthy. Our sales cycle varies from customer to customer, but it often ranges from six to nine months or more for outsourcing services projects. And while the sales cycle for our medical products can be shorter, to the extent it involves a relationship with a large original equipment manufacturer, the sales cycle can also be quite lengthy. Our pursuit of sales leads typically involves an analysis of our prospective customer's needs, preparation of a written proposal, one or more presentations, and contract negotiations. Our sales cycle may also be affected by a prospective customer's budgetary constraints and internal acceptance reviews, over which we have little or no control. During fiscal year 2002 we experienced decreased bookings of medical device development services, and if such decreased bookings continue it could have a material adverse effect on our outsourcing services. OUR CUSTOMERS MAY CANCEL THEIR ORDERS, CHANGE PRODUCTION QUANTITIES, DELAY PRODUCTION OR TERMINATE THEIR CONTRACTS; WE MAY HAVE INVENTORY RISK. Medical device development and manufacturing service providers must provide product output that matches the needs of their customers, which can change from time to time. We generally do not obtain long-term commitments from our customers and we continue to experience reduced lead times in customer orders. Customers may cancel their orders, change production quantities, delay production, or terminate their contracts for a number of reasons. In certain situations, cancellations, reductions in quantities, delays or terminations by a significant customer could adversely affect our operating results. Such cancellations, reductions or delays have occurred and may continue to occur in response to slowdowns in our customers' businesses or for other reasons. In addition, we make significant decisions, including determining the levels of business that we will seek and accept, production schedules, parts procurement commitments, and personnel needs based on our estimates of customer requirements. Because many of our costs and operating expenses are relatively fixed, a reduction in customer demand or a termination of a contract by a customer could adversely affect our gross margins and operating results. Most of our contract manufacturing services are provided on a turnkey basis, where we purchase some or all of the materials required for product assembling and manufacturing. We bear varying amounts of inventory risk in providing services in this manner. In manufacturing operations, we need to order parts and supplies based on customer forecasts, which may be for a larger quantity of product than is included in the firm orders ultimately received from those customers. While many of our customer agreements include provisions that require customers to reimburse us for excess inventory which we specifically order to meet their forecasts, we may not actually be reimbursed or be able to collect on these obligations. In that case, we could have excess inventory and/or cancellation or return charges 30 from our suppliers. Our imaging and medical device manufacturing customers continue to experience fluctuating demand for their products, and in response they may ask us to reduce or delay production. If we delay production, our financial performance may be adversely affected. A SIGNIFICANT PORTION OF OUR REVENUE COMES FROM A SMALL NUMBER OF MAJOR CUSTOMERS. We have historically obtained a significant share of our revenue from a small number of customers, but the identity of those major customers tends to change from year to year. In the quarter ended September 30, 2002, three customers accounted for approximately 38% of our consolidated revenues. This concentration is much more pronounced in our Colorado operations segment, where the top three customers accounted for 60% of our revenue. The concentration of business in such a small number of customers means that such a customer may be in a position to exert significant leverage over us and force us to grant to such customer commercial terms that we would not otherwise provide. The concentration of business in such a small number of customers also means that the loss of any one of these customers or a significant reduction or delay in orders or payments from any of these customers could have a material adverse effect on our business, liquidity and results of operations. RISKS THAT AFFECT OUR CUSTOMERS CAN DIRECTLY IMPACT OUR BUSINESS. Our success is dependent on the success of our customers and the products that we develop or manufacture for them. Any unfavorable developments or adverse effects on the sales of those products or on our customers' businesses could have a corresponding adverse effect on our business. We believe that our customers and their products are generally subject to the risks listed below. To the extent the factors set forth below affect our customers, there may be a corresponding impact on our business. OUR CUSTOMERS OPERATE IN A COMPETITIVE ENVIRONMENT The medical products industry is highly competitive and is subject to significant and rapid technological change. It requires ongoing investment to keep pace with technological developments and quality and regulatory requirements. The medical products industry consists of numerous companies, ranging from start-up to well-established companies. Our customers' competitors may succeed in developing or marketing technologies and products that will be better accepted in the marketplace than the products we design and manufacture for our customers or that would render our customers' technology and products obsolete or noncompetitive. Some of our customers are emerging medical technology companies that have competitors and potential competitors with substantially greater capital resources, research and development staffs and facilities, and substantially greater experience in developing and commercializing new products. Our customers may not be successful in marketing or distributing their products, or may not respond to pricing, marketing or other competitive pressures or the rapid technological innovation demanded by the marketplace. As a result, they may experience a drop in product sales, which would have an adverse effect on our business, results of operations and financial condition. OUR CUSTOMERS' BUSINESS SUCCESS DEPENDS ON MARKET ACCEPTANCE OF NEW PRODUCTS. We design and manufacture medical devices for other companies. We also sell proprietary products to other companies and end-user customers. For products we manufacture (manufactured for others, or those we sell directly), our success is dependent on the acceptance of those products in their markets. Market acceptance may depend on a variety of factors, including educating the target market regarding the use of a new procedure and convincing healthcare payers that the benefits of the product and its related treatment regimen outweigh its costs. Market acceptance and market share are also affected by the timing of market introduction 31 of competitive products. Some of our customers, especially emerging medical technology companies, have limited or no experience in marketing their products and may be unable to establish effective sales and marketing and distribution channels to rapidly and successfully commercialize their products. If our customers are unable to gain any significant market acceptance for the products we develop or manufacture for them, our business will be affected. IF OUR CUSTOMERS DON'T PROMPTLY OBTAIN REGULATORY APPROVAL FOR THE PRODUCTS WE DESIGN AND MANUFACTURE FOR THEM, OUR PROJECTS AND REVENUE CAN BE AFFECTED. The FDA regulates many of the products we develop and manufacture, and requires certain clearances or approvals before new medical devices can be marketed. As a prerequisite to any introduction of a new device into the medical marketplace, our customers or we must obtain necessary product clearances or approvals from the FDA or other regulatory agencies. This can be a slow and uncertain process and there can be no assurance that such clearances or approvals will be obtained on a timely basis, if at all. Certain medical devices we manufacture may be subject to the need to obtain premarket approval from the FDA, which requires substantial preclinical and clinical testing, and may cause delays and prevent introduction of such instruments. Other instruments can be marketed only by establishing "substantial equivalence" to a pre-existing device in a procedure called a 510(k) premarket notification. In addition, products intended for use in foreign countries must comply with similar requirements and be certified for sale in those countries. A customer's failure to comply with the FDA's requirements can result in the delay or denial of approval to proceed with the device. Delays in obtaining regulatory approval are frequent and, in turn, can result in delaying or canceling customer orders. There can be no assurance that we or our customers will obtain or be able to maintain all required clearances or approvals for domestic or exported products on a timely basis, if at all. The delays and potential product cancellations inherent in the regulatory approval and ongoing regulatory compliance of products we develop or manufacture may have a material adverse effect on our business, reputation, results of operations and financial condition. OUR CUSTOMERS' FINANCIAL CONDITION MAY ADVERSELY AFFECT THEIR ABILITY TO CONTINUE OR PAY FOR A PROJECT. Some of our customers, especially the smaller and newer emerging medical technology companies, are not profitable, may have little or no revenues or may have limited working capital available to fund a development project. Adequate funds for their operations or for a development project may not be available when needed. A customer's financial difficulties may require a customer to suspend its research and development spending, delay development of a product, clinical trials (if required) or the commercial introduction of a product. Depending on the significance of a customer's product to our revenues or profitability, any adverse effect on a customer resulting from insufficient funds could result in an adverse effect on our business, results of operations and financial condition. GOVERNMENT OR INSURANCE COMPANY REIMBURSEMENT FOR OUR CUSTOMERS' PRODUCTS OR SERVICES MAY CHANGE AND CAUSE A REDUCED DEMAND FOR THE PRODUCT WE PROVIDE TO THE CUSTOMER. Governmental and insurance industry efforts to reform the healthcare industry and reduce healthcare spending have affected, and will continue to affect, the market for medical devices. 32 There have been several instances of changes in governmental or commercial insurance reimbursement policies that have significantly impacted the markets for certain types of products or services or which have impacted entire industries, such as recent policies affecting payment for nursing home and home care services. Adverse governmental regulation relating to our products or our customers' products that might arise from future legislative, administrative or insurance industry policy cannot be predicted and the ultimate effect on private insurer and governmental healthcare reimbursement is unknown. Government and commercial insurance companies are increasingly vigorous in their attempts to contain healthcare costs by limiting both coverage and the level of reimbursement for new therapeutic products even if approved for marketing by the FDA. If government and commercial payers do not provide adequate coverage and reimbursement levels for uses of our products and our customers' products, the market acceptance of these products and our revenues and profitability would be adversely affected. OUR BUSINESS SUCCESS DEPENDS ON HIRING AND RETAINING KEY PERSONNEL. Our success depends to a significant extent on the continued service of certain of our key managerial, technical and engineering personnel. Our future success will be dependent on our continuing ability to attract, train, assimilate and retain highly qualified engineering, technical and managerial personnel experienced in commercializing medical products. The competition for these individuals is intense, and the loss of key employees, could harm our business. Periods of contraction such as we are currently experiencing in our Colorado operations segment create tensions and challenges related to retaining important technical and engineering personnel. Our decisions on how to reduce costs and capacity can affect our results in the short- and long-term. The loss of any of our key personnel or our inability to hire, train, assimilate or retain qualified personnel could have a material adverse effect on our business, results of operations and financial condition. WE OPERATE IN A REGULATED INDUSTRY, AND OUR PROJECTS AND REVENUE ARE SUBJECT TO REGULATORY RISK. We are subject to a variety of regulatory agency requirements in the United States and foreign countries relating to many of the products that we develop and manufacture. The process of obtaining and maintaining required regulatory approvals and otherwise remaining in regulatory compliance can be lengthy, expensive and uncertain. The FDA inspects manufacturers of certain types of devices before providing a clearance to manufacture and sell such device, and the failure to pass such an inspection could result in delay in moving ahead with a product or project. We are in the process of consolidating our Colorado manufacturing facilities into one central facility, and before we begin certain types of manufacturing activities at the new facility we must pass an FDA audit of the procedures in place at the new facility. We expect the audit to take place during the second quarter of fiscal year 2003. If we do not pass the audit our ability to manufacture certain products may be adversely impacted, our customer relations would likely be adversely affected, we would likely have increased expenses to address deficiencies, and the financial performance of our Colorado operations would be adversely affected. We are required to comply with the FDA's QSR for the development and manufacture of medical products. In addition, in order for devices we design or manufacture to be exported and for us and our customers to be qualified to use the "CE" mark in the European Union, we maintain ISO 9001/EN 46001 certification which, like the QSR, subjects our operations to periodic surveillance audits. To ensure compliance with various regulatory and quality requirements, we expend significant time, resources and effort in the areas of training, production and quality assurance. If we fail to comply with regulatory or quality regulations or 33 other FDA or applicable legal requirements, the governing agencies can issue warning letters, impose government sanctions and levy serious penalties. Noncompliance or regulatory action could have a negative impact on our business, including the increased cost of coming into compliance, and an adverse effect on the willingness of customers and prospective customers to do business with us. Such noncompliance, as well as any increased cost of compliance, could have a material adverse effect on our business, results of operations and financial condition. WE ARE SUBJECT TO AN INTERNAL REVENUE SERVICE AUDIT AND WE CANNOT PREDICT THE OUTCOME. We are currently under audit by the IRS for certain items in our fiscal year 1998 and 1999 tax returns. While we believe we have responded fully to the requests of the IRS and while we believe we do not have material exposure, it is reasonably possible that the IRS could deliver an assessment to us that could have an adverse impact on our results of operations. A SHIFT IN MARKET DEMAND MAY DECREASE DEMAND FOR OUR PRODUCTS AND SERVICES. The markets for our services are characterized by rapidly changing technology and evolving changes in the needs of the medical device market. The continued success of our business depends on our ability to recognize and quickly react to changes in the medical device market and our ability to hire, retain, and expand our qualified engineering and technical personnel, and maintain and enhance our technological capabilities in a timely and cost-effective manner. Although we believe that our operations currently utilize the technology, processes and equipment required by our customers, we cannot be certain that we will develop the capabilities required by our customers in the future. The emergence of new technology, industry standards or customer requirements may render our capabilities and services obsolete or noncompetitive. We may have to acquire new technologies and personnel in order to remain competitive. This acquisition and implementation of these new technologies and personnel may require significant capital investment, which could reduce our operating margins and operating results. Our failure to anticipate our customers' changing needs could have an adverse effect on our business. CONSOLIDATION OF CUSTOMERS CAN ELIMINATE CUSTOMERS OR NEED FOR PRODUCT. Due to the nature of the medical device business, especially in the imaging field, the possibility exists that any of our customers may merge with, or be acquired by, other companies that may also be our customers or customers of our competitors. Such consolidation of our customers' operations could eliminate the customer or, alternatively, the customer's need for our products. We cannot predict how many (if any) of our customers may merge, or how many of our customers may no longer require certain of our products, due to such mergers and acquisitions. Such elimination of customers or their need for our products may negatively impact our business. WE ARE MOVING OUR OPERATIONS, WHICH MAY NEGATIVELY IMPACT OUR BUSINESS. We are currently moving our Colorado operations from their six former locations to one central location (at October 31, 2002 we were operating in three locations) and expect to complete the move in fiscal 2003. The move involves numerous business risks, including the risk associated with integrating the operations at our separate locations into one facility; decreased utilization and efficiency of revenue-generating personnel during the move period; the risk of delays in the implementation of the move to the new facility; diversion of management's attention from other business areas during the planning and implementation of the move; strain placed on our operational, financial, management, technical and information systems and resources; disruption in manufacturing operations; and incurrence of significant costs and expenses associated with moving the facilities. After the move we expect to have excess 34 capacity in our Colorado operations, which will likely produce downward pressure on our gross profit from these operations. CIVCO has recently expanded its warehouse, manufacturing and office space. If we cannot generate sufficient business to utilize this space, or fail to realize the anticipated improved efficiencies or the expanded facility, the increased expenses of owning and operating the facility could have an adverse effect on the financial performance of the CIVCO operations. Any of these could have a negative impact on our operations, financial results or stock price. AN UNSOLICITED ACQUISITION PROPOSAL MAY ADVERSELY AFFECT OUR PERFORMANCE. We have been the subject of an unsolicited acquisition proposal in the past. This was expensive and disruptive to our business. The possibility exists that we may be the subject of such an action in the future. If so, we may incur significant expenses in responding to any such action and any such increased expenses would divert resources otherwise available for our operations and could have a negative effect on our reported earnings. Such activities could also distract our management and employees from carrying out the day-to-day operations of the business, and may create uncertainties about our future in the minds of our customers, employees and vendors. Any of these could have a negative impact on our operations, financial results or stock price. THE PRODUCTS WE DESIGN AND MANUFACTURE MAY BE SUBJECT TO PRODUCT RECALLS AND MAY SUBJECT US TO PRODUCT LIABILITY CLAIMS. Most of the products we design or manufacture are medical devices, many of which may be used in life-sustaining or life-supporting roles. The tolerance for error in the design, manufacture or use of these products may be small or nonexistent. If a product we designed or manufactured is found to be defective, whether due to design or manufacturing defects, to improper use of the product or to other reasons, the product may need to be recalled, possibly at our expense. Furthermore, the adverse effect of a product recall on our business might not be limited to the cost of the recall. Recalls, especially if accompanied by unfavorable publicity or termination of customer contracts, could result in substantial costs, loss of revenues and damage to our reputation, each of which would have a material adverse effect on our business, results of operations and financial condition. The manufacture and sale of the medical devices we develop and manufacture involves the risk of product liability claims. Although we generally obtain indemnification from our customers for products we manufacture to the customers' specifications and we maintain product liability insurance, there can be no assurance that the indemnities will be honored or the coverage of our insurance policies will be adequate. In addition, although we carry product liability insurance, we are not indemnified with respect to our products which are sold directly to end-users. Further, we generally provide a design defect warranty and indemnify our customers for failure of a product to conform to design specifications and against defects in materials and workmanship. Product liability insurance is expensive and in the future may not be available on acceptable terms, in sufficient amounts, or at all. A successful product liability claim in excess of our insurance coverage or any material claim for which insurance coverage was denied or limited and for which indemnification was not available could have a material adverse effect on our business, results of operations and financial condition. OUR MARKETS ARE COMPETITIVE. Our competition with respect to outsourcing services comes from a variety of sources, including consulting, commercial product development and manufacturing companies. Competition also comes from commercial and university research laboratories and from current and prospective customers who evaluate our capabilities and costs against the merits of designing, engineering or manufacturing 35 products internally. Many of our competitors are larger and have substantially greater financial, research and development and manufacturing resources. Competition from any of the foregoing sources could place pressure on us to accept lower margins on our contracts or lose existing or potential business, which could result in a material adverse effect on our business, results of operations and financial condition. We sell our medical products principally in the markets of the United States, Japan and Europe. Our competition with respect to medical products comes from two principal sources: original equipment manufacturers who may have in-house capabilities similar to ours, and other medical outsourcing and products companies that sell to original equipment manufacturers or directly to customers. Many of our competitors are larger and have substantially greater financial, research and development and manufacturing resources. Price and quality are the primary competitive factors in the markets in which we compete. As competition in the market for medical products continues to increase, we may experience pricing pressure, which could result in a material adverse effect on our business, results of operation and financial condition. SALES OF SHARES ISSUABLE UPON EXERCISE OF STOCK OPTIONS AND WARRANTS MAY ADVERSELY AFFECT STOCK PRICE. As of September 30, 2002, there were a total of approximately 13.2 million shares of our common stock outstanding. In addition, there were outstanding warrants and stock options to purchase approximately 2.5 million shares of common stock, approximately 1.2 million of which are currently exercisable or become exercisable by October 31, 2002. As of October 31, 2002, the exercise prices of the outstanding options were between $2.22 and $17.13, which were above the closing value of our stock price on that date of $1.95 per share. As such, it is unlikely that options would be exercised until the stock price rises above $2.22. Shares issued upon the exercise of warrants and options to purchase our stock generally are available for sale in the open market. The future issuance or sale of the shares of common stock referred to above could adversely affect the market price of our common stock. COMPETITIVE ISSUES BETWEEN OUR CUSTOMERS MAY LIMIT OUR ABILITY TO PURSUE NEW BUSINESS IN ATTRACTIVE AREAS. There is a great deal of competition in the medical technology industry, especially with respect to new product introductions. Our outsourcing services customers invest heavily in the development of new products and it is important to them to protect their new technology and to hold a technology edge over their competitors as long as possible. Although we generally do not enter into non-competition agreements, on occasion our development contracts prohibit us from working for certain competitors of our customers. When and if we do this, our growth may be adversely affected because such contracts would prevent us from developing or manufacturing instruments for our customers' competitors. Any conflicts among our customers could prevent or deter us from obtaining contracts to develop or manufacture instruments, which could result in a material adverse effect on our business, results of operations and financial condition. POTENTIAL OR PENDING LITIGATION MAY AFFECT OUR BUSINESS. During fiscal year 2002 we were involved in two material pieces of litigation. We incurred significant costs and liabilities related to the defense and settlement of the litigation, including legal and expert fees, and settlement payments. The defense or resolution of any future litigation could have a negative impact on our financial position and results of operations. 36 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK As part of our cash management strategy, we had short-term investments at September 30, 2002 consisting of approximately $780,000 in investment grade securities. We classify these investments as available-for-sale assets, which are stated at Fair Market Value on the accompanying balance sheets. All of the short-term investments mature in less than one year. We have completed a market risk sensitivity analysis of these short-term investments based upon an assumed 1% increase in interest rates at October 1, 2002. Based on amounts invested in high grade commercial paper, if markets were to experience an increase in rates of 1% on October 1, 2002, we would have had an approximate $5,000 realized loss on these short-term investments. Because this is only an estimate, any actual loss due to an increase in interest rates could differ from this estimate. We have a line of credit that bears interest on outstanding balances at 2% over the higher of (a) the lender's prime rate or (b) the federal funds effective rate plus 0.5%. Because we have yet to draw upon our line of credit, an increase in interest rates would not have had an effect on our financial condition or results of operations as of October 1, 2002. We have a capital lease agreement with an interest rate of 7.9% that terminates in April 2003. As of September 30, 2002, $23,000 remains outstanding under this obligation. ITEM 4. CONTROLS AND PROCEDURES. Within the 90 days prior to the filing date of this report, we carried out an evaluation, under the supervision and with the participation of our management, including the Chief Executive Officer and the Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Exchange Act Rule 13a-15. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective. Disclosure controls and procedures are controls and procedures that are designed to ensure that information required to be disclosed in our reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission's rules and forms. There have been no significant changes in our internal controls or in other factors that could significantly affect internal controls subsequent to the date we carried out this evaluation. 37 PART II OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS. The Company is involved in legal actions arising in the ordinary course of business. Management does not believe the outcome of such legal actions will have a material adverse effect on the Company's consolidated financial position or results of operations. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits 3.1 Articles of Incorporation; Complete Copy, as Amended.(A) 3.2 Bylaws, as Amended.(B) 4.2 Specimen of Common Stock Certificate.(C) 4.3 Rights Agreement between Colorado MEDtech, Inc. and American Securities Transfer & Trust, Inc. dated January 14, 1999, as amended.(D) 99.1 Certificate of Chief Executive Officer 99.2 Certificate of Chief Financial Officer
- ----------------------- (A) Filed as an exhibit to the Company's Annual Report on Form 10-K for the year ended June 30, 1999. (B) Filed as an exhibit to the Company's Annual Report on Form 10-K for the year ended June 30, 2002. (C) Filed with Registration Statement (No. 2-83841-D) on Form S-18 on May 17, 1983. (D) Filed with Registration Statement on Form 8-A/A dated June 27, 2000. (b) Reports on Form 8-K during the quarter ended September 30, 2002: The company filed a current report on Form 8-K dated July 9, 2002 reporting the issuance of a press release regarding election of a new member of the board of directors. The company filed a current report on Form 8-K dated July 17, 2002 reporting a change in the company's certifying accountant. The company filed a current report on Form 8-K dated September 16, 2002 regarding investor presentation materials of the President and Chief Executive Officer, and the Chief Financial Officer. 38 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. Colorado MEDtech, Inc. --------------------------- (Registrant) DATE: November 13, 2002 /s/ Stephen K. Onody --------------------------- Stephen K. Onody Chief Executive Officer DATE: November 13, 2002 /s/ Gregory A. Gould --------------------------- Gregory A. Gould Chief Financial Officer 39 CERTIFICATIONS I, Stephen K. Onody, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Colorado MEDtech, Inc. (the "registrant"). 2. Based on my knowledge, this quarterly report does not contain any untrue statement of material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report. 3. Based on my knowledge, the financial statements, and other information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report. 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) Designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) Evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) Presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent function): a) All significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: November 13, 2002 /s/ Stephen K. Onody - ---------------------- Name: Stephen K. Onody Title: Chief Executive Officer and President 40 I, Gregory A. Gould, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Colorado MEDtech, Inc. (the "registrant"). 2. Based on my knowledge, this quarterly report does not contain any untrue statement of material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report. 3. Based on my knowledge, the financial statements, and other information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report. 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) Designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) Evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) Presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent function): a) All significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: November 13, 2002 /s/ Gregory A. Gould - ------------------------------ Name: Gregory A. Gould Title: Chief Financial Officer 41 EXHIBIT INDEX ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits 3.1 Articles of Incorporation; Complete Copy, as Amended.(A) 3.2 Bylaws, as Amended.(B) 4.2 Specimen of Common Stock Certificate.(C) 4.3 Rights Agreement between Colorado MEDtech, Inc. and American Securities Transfer & Trust, Inc. dated January 14, 1999, as amended.(D) 99.1 Certificate of Chief Executive Officer 99.2 Certificate of Chief Financial Officer
- ----------------------- (A) Filed as an exhibit to the Company's Annual Report on Form 10-K for the year ended June 30, 1999. (B) Filed as an exhibit to the Company's Annual Report on Form 10-K for the year ended June 30, 2002. (C) Filed with Registration Statement (No. 2-83841-D) on Form S-18 on May 17, 1983. (D) Filed with Registration Statement on Form 8-A/A dated June 27, 2000. 42 EX-99.1 3 d01120exv99w1.txt CERTIFICATE OF CHIEF EXECUTIVE OFFICER Exhibit 99.1 CERTIFICATION PURSUANT TO 18.U.S.C. SECTION 1350 AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 I, Stephen K. Onody, Chief Executive Officer and President of Colorado MEDtech, Inc. (the "Company"), certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that: 1. The Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 2002, as filed with the Securities and Exchange Commission on the date hereof (the "Report"), fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and 2. The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. Date: November 14, 2002 /s/ Stephen K. Onody - ---------------------------------- Name: Stephen K. Onody Title: Chief Executive Officer and President EX-99.2 4 d01120exv99w2.txt CERTIFICATE OF CHIEF FINANCIAL OFFICER Exhibit 99.2 CERTIFICATION PURSUANT TO 18.U.S.C. SECTION 1350 AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 I, Gregory A. Gould, Chief Financial Officer of Colorado MEDtech, Inc. (the "Company"), certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that: 1. The Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 2002, as filed with the Securities and Exchange Commission on the date hereof (the "Report"), fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and 2. The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. Date: November 14, 2002 /s/ Gregory A. Gould - ------------------------------ Name: Gregory A. Gould Title: Chief Financial Officer -----END PRIVACY-ENHANCED MESSAGE-----