Certain statements in this annual report to shareholders, including statements about the Company's belief or expectations or about whether any particular event or circumstance is likely to occur or continue, are forward-looking statements concerning the future operations of the Company. Such forward-looking statements are subject to risks and uncertainties. Such statements are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. There are many important factors that could cause actual results to differ materially from those in the forward-looking statements contained herein.Results of Operations
The Company's gross profit was 55% of net sales for fiscal year 1997 as compared to 56% of net sales for fiscal year 1996 and 57% of net sales for fiscal year 1995. The decreases in gross margin percentage over the three-year period were primarily caused by reduced average selling prices for certain of the Company's products. These reductions in average selling price, which had been expected, resulted from increasing competition in the Company's primary product lines, particularly in OSA relative to the Company's large, national customers who received lower prices in exchange for volume purchase commitments. In addition, manufacturing support costs grew from fiscal year 1995 to fiscal year 1996 at a rate higher than the overall rate of sales growth.
General and administrative expenses were $21,506,000 (12% of net sales) for fiscal year 1997 as compared to $16,602,000 (13% of net sales) for fiscal year 1996 and $14,050,000 (14% of net sales) for fiscal year 1995. The increase in absolute dollars from fiscal year 1996 to fiscal year 1997 was due primarily to the addition of expenses incurred by the Company's new subsidiaries, Respironics Colorado, Inc. and Stimotron, since their acquisitions on October 21, 1996 and February 26, 1997, respectively. In addition, amortization of the goodwill generated by those acquisitions began on those dates, with the expense being included in general and administrative expenses. Offsetting these increases was a reduction in the provision for year-end profit sharing bonuses for fiscal year 1997 based on financial results achieved. The increase in absolute dollars from fiscal year 1995 to fiscal year 1996 was due primarily to an increased provision for year-end profit sharing bonuses based on financial results achieved and to increased legal fees, including those incurred related to the previously disclosed ResCare patent litigation. The overall increases in absolute dollars for both comparisons were still at rates less than the rate of increase in overall sales.
Sales, marketing and commission expenses were $34,368,000 (19% of net sales) for fiscal year 1997 as compared to $20,845,000 (17% of net sales) for fiscal year 1996 and $17,696,000 (18% of net sales) for fiscal year 1995. The increase from fiscal year 1996 to fiscal year 1997 was due primarily to the addition of expenses incurred by the Company's new subsidiaries, Respironics Colorado, Inc. and Stimotron. Respironics Colorado, Inc. has a network of 19 fully staffed customer satisfaction centers throughout the United States, a portion of the costs of which are included in sales, marketing and commissions. In addition, because Stimotron serves as the Company's exclusive distributor in Germany, most of its operating expenses are included in sales, marketing and commissions. Increased costs were also incurred for the Company's sales and marketing efforts elsewhere in Europe. The increase in absolute dollars from fiscal year 1995 to fiscal year 1996 was due to higher commissions paid to independent sales representatives based on the increased sales levels achieved, increased trade show and related travel expenses, and increased salary expenses, primarily for new employees in sales and marketing management and training and medical education.
Research and development expenses were $10,768,000 (6% of net sales) for fiscal year 1997 as compared to $9,328,000 (7% of net sales) for fiscal year 1996 and $7,077,000 (7% of net sales) for fiscal year 1995. The increase in absolute dollars from fiscal year 1996 to fiscal year 1997 reflects the significant new product development efforts undertaken to support product introductions in the Company's major product groups including the Solo CPAP unit, the BiPAP S/ T-D 30 and the BiPAP DUET system, along with several mask and patient interface products. Major product development work was also done on several new products for which FDA clearance to market in the United States is pending. The increase in absolute dollars from fiscal year 1995 to fiscal year 1996 primarily reflects the costs associated with developing a new family of OSA therapy devices, the Great Performers® line, that was introduced starting in fiscal year 1996. Additional costs were also incurred throughout the three-year period to fund clinical studies and work involving opportunities in other respiratory product areas.
The Company's effective income tax rate was 40% for fiscal year 1997 as compared to 39% for fiscal year 1996 and 37% for fiscal year 1995. Changes in the Company's effective income tax rate are due primarily to changes in the relative proportions of taxable income attributable to its U.S. and European operations versus taxable income attributable to its Hong Kong and Peoples Republic of China operations, because the U.S. and European operations pay income taxes at a higher rate (approximately 41% before available income tax credits) than do the Hong Kong and Peoples Republic of China operations. For the fiscal year 1996 to 1997 comparison, the proportion of taxable income attributable to the U.S. and European operations increased, due in part to taxable income generated by the Company's new subsidiaries, Respironics Colorado, Inc. and Stimotron, since their acquisitions. In addition, the amortization of the goodwill generated by the acquisitions is not a tax-deductible expense and therefore also contributed to the increased effective income tax rate. For the fiscal year 1995 to 1996 comparison, the proportion of taxable income attributable to the U.S. operation also increased, and a research and development tax credit that was available in fiscal year 1995 expired in fiscal year 1996, further contributing to the increased income tax rate (this tax credit was reinstated for fiscal year 1997).
As a result of the factors described above, the Company's net income was $20,316,000 (11% of net sales) or $1.00 per share for fiscal year 1997 as compared to $15,339,000 (12% of net sales) or $0.84 per share for fiscal year 1996 and $11,677,000 (12% of net sales) or $0.67 per share for fiscal year 1995.
In February 1997, the Financial Accounting Standards Board (FASB) issued Statement No. 128, "Earnings per Share," which is required to be adopted on December 31, 1997. At that time, the Company will be required to change the method currently used to compute earnings per share and to restate all prior periods. Under the new requirements for calculating primary earnings per share, the dilutive effect of stock options will be excluded. The adoption of Statement No. 128 is expected to increase the Company's primary earnings per share (called "basic earnings per share" under the Statement) by less than 10% and is not expected to have a material impact on the Company's fully diluted earnings per share (called "diluted earnings per share" under the Statement).
Financial Condition, Liquidity and Capital Resources
The Company had working capital of $71,038,000 and $99,434,000 at June 30, 1997 and 1996, respectively. Net cash provided by operating activities was $13,388,000, $7,838,000 and $9,469,000 for fiscal years 1997, 1996 and 1995, respectively. The increase in cash provided by operating activities from fiscal year 1996 to fiscal year 1997 was due primarily to higher earnings in fiscal year 1997 and to an increase in accounts receivable in fiscal year 1997 in an amount smaller than the increase in that account in the prior year. The decrease in cash provided by operating activities from fiscal year 1995 to fiscal year 1996 was due primarily to an increase in accounts receivable during fiscal year 1996 in an amount greater than the increase in that account during fiscal year 1995 and to a tax refund received during fiscal year 1995.
The increase in accounts receivable during fiscal year 1996 described above was due to growth in international sales at a rate greater than overall sales growth (all of the Company's international sales are made on extended payment terms), an increase in the portion of the Company's domestic sales that were made on extended payment terms and, to a lesser extent, an increase in the proportion of the Company's sales made late in the fiscal year.
Net cash used by investing activities was $63,063,000, $6,255,000 and $7,711,000 for fiscal years 1997, 1996 and 1995, respectively. Net cash used by investing activities for fiscal year 1997 included $49,208,000 relating to the October 21, 1996 acquisition of LIFECARE International, Inc. and $9,000,000 relating to the February 26, 1997 acquisition of Stimotron. Additional consideration of up to $5,000,000 over the next four years may be due for the Stimotron acquisition based on financial results achieved in Germany. Net cash used by investing activities for fiscal year 1995 included an expenditure of $745,000 representing a portion of the purchase price for the acquisition of Vitalog. The remainder of the purchase price for the Vitalog acquisition was paid with shares of the Company's common stock. See Note K to the Consolidated Financial Statements for additional information regarding these acquisitions.
Net cash used for capital expenditures, consisting primarily of the purchase of production equipment, computer hardware and software, and office equipment, was $4,930,000, $6,220,000 and $6,941,000 for fiscal years 1997, 1996 and 1995, respectively.
Funding for the LIFECARE and Vitalog acquisitions was provided by accumulated cash and short-term investment balances. Funding for the Stimotron acquisition was provided by a $9,000,000 loan received from a commercial bank in February 1997 under the terms of a credit agreement. Funding for a portion of a 46,000-square-foot addition to the Company's manufacturing facility in Murrysville, Pennsylvania, was provided by a $1,133,000 Pennsylvania Industrial Development Authority Loan received in February 1995. See Notes D and K to the Consolidated Financial Statements for additional information about long-term obligations and acquisition financing.
Funding for the other investment activities in fiscal years 1997, 1996 and 1995 was provided by positive cash flows from operating activities and accumulated cash and short-term investment balances.
Net cash provided by financing activities also includes $46,832,000 from a public offering of 2,373,589 shares of common stock completed in April 1996 and proceeds from the issuance of common stock under the Company's stock option plans during each of the years presented. Net cash provided by financing activities also reflects, for fiscal year 1997, the Company's acquisition of 46,000 shares of its common stock for $844,000 in the open market pursuant to a stock buy back program announced in November 1996.
In October 1996, the Company entered into a new line of credit facility with a commercial bank that provides for the availability of $1,250,000 at a maximum interest rate equal to the bank's prime interest rate until the expiration date of the agreement on October 31, 1997. The Company expects that this line of credit facility will be renewed prior to its expiration. See Note D to the Consolidated Financial Statements for a discussion of the line of credit.
In October 1996, the Company announced that its status with Apria Healthcare (Apria) had changed from "primary supplier" to "sole secondary supplier" effective November 1996. This change adversely affected sales levels for the year ended June 30, 1997. Sales to Apria during the fiscal year ended June 30, 1997 were $17,900,000 as compared to $20,500,000 for the fiscal year ended June 30, 1996. Subsequent to the Company's change in status, it focused on demonstrating to Apria superior effort and added value service surrounding its product offerings. In spite of these efforts, sales to Apria of CPAP and bi-level units and related masks during the second half of the fiscal year decreased to approximately 40% of levels anticipated prior to the change in status. While the Company cannot predict with certainty what actions Apria will take relative to future supplier selection (especially in light of Apria's announced intentions to review restructuring alternatives, including a possible merger or sale), it is anticipated that an open bidding process will occur again. The Company plans to participate in this bidding process with the goal of maximizing its share of Apria's business, but there can be no assurance as to the outcome of such a bidding process.
The Company has not provided a valuation allowance for deferred income tax assets because it has determined that it is more likely than not that such assets can be realized, at a minimum, through carrybacks to prior years in which taxable income was generated.
The Company believes that positive cash flow from operating and financing activities, the availability of the full amount of funds under its commercial bank line of credit, commercial bank financing committed for the additional consideration that may be due for the Stimotron acquisition and its accumulated cash and short-term investments will be sufficient to meet its current and presently anticipated future needs for fiscal year 1998 for operating activities, investing activities and financing activities (primarily consisting of payments on long-term debt).
Inflation
Inflation has not had a significant effect on the Company's business during the periods discussed.