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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2002
OR
¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
Commission file number 0-21982
Diametrics Medical, Inc.
Incorporated pursuant
to the Laws of Minnesota
Internal Revenue Service — Employer Identification No. 41-1663185
2658 Patton Road, Roseville, Minnesota 55113
(651) 639-8035
Indicate by check mark whether the
registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has
been subject to such filing requirements for the past 90 days. Yes x No ¨
The total number of shares of the registrant’s Common Stock, $.01 par value,
outstanding on July 31, 2002, was 26,819,165.
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Page
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| Part I — FINANCIAL INFORMATION |
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| Item 1. |
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Consolidated Financial Statements (unaudited) |
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Three Months Ended June 30, 2002 and 2001 |
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3 |
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Six Months Ended June 30, 2002 and 2001 |
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3 |
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4 |
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Six Months Ended June 30, 2002 and 2001 |
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5 |
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6 |
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| Item 2. |
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9 |
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| Item 3. |
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15 |
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| Part II — OTHER INFORMATION |
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| Item 1. |
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15 |
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| Item 2. |
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15 |
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| Item 3. |
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15 |
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| Item 4. |
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15 |
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| Item 5. |
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15 |
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| Item 6. |
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16 |
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17 |
2
PART I – FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements
(unaudited)
DIAMETRICS MEDICAL, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
| |
|
Three Months Ended June
30,
|
|
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Six Months Ended June
30,
|
|
| |
|
2002
|
|
|
2001
|
|
|
2002
|
|
|
2001
|
|
| Net sales |
|
$ |
5,275,931 |
|
|
$ |
6,127,674 |
|
|
$ |
10,738,805 |
|
|
$ |
11,843,568 |
|
| |
| Cost of sales |
|
|
3,953,497 |
|
|
|
4,452,860 |
|
|
|
7,958,776 |
|
|
|
8,854,013 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
| Gross profit |
|
|
1,322,434 |
|
|
|
1,674,814 |
|
|
|
2,780,029 |
|
|
|
2,989,555 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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| Operating expenses: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Research and development |
|
|
1,298,895 |
|
|
|
1,310,865 |
|
|
|
2,520,532 |
|
|
|
2,471,567 |
|
| Selling, general and administrative |
|
|
1,345,102 |
|
|
|
1,309,286 |
|
|
|
2,529,048 |
|
|
|
2,555,218 |
|
| Restructuring and other charges |
|
|
688,188 |
|
|
|
— |
|
|
|
688,188 |
|
|
|
— |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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| Total operating expenses |
|
|
3,332,185 |
|
|
|
2,620,151 |
|
|
|
5,737,768 |
|
|
|
5,026,785 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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| Operating loss |
|
|
(2,009,751 |
) |
|
|
(945,337 |
) |
|
|
(2,957,739 |
) |
|
|
(2,037,230 |
) |
| |
| Other expense, net |
|
|
(120,837 |
) |
|
|
(81,614 |
) |
|
|
(231,840 |
) |
|
|
(117,621 |
) |
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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| Net loss |
|
$ |
(2,130,588 |
) |
|
$ |
(1,026,951 |
) |
|
$ |
(3,189,579 |
) |
|
$ |
(2,154,851 |
) |
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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| Basic and diluted net loss per common share |
|
$ |
(0.08 |
) |
|
$ |
(0.04 |
) |
|
$ |
(0.12 |
) |
|
$ |
(0.08 |
) |
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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| Weighted average number of common shares outstanding |
|
|
26,813,070 |
|
|
|
26,747,261 |
|
|
|
26,808,785 |
|
|
|
26,735,071 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
See accompanying notes to consolidated financial statements.
3
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
| |
|
June 30, 2002
|
|
|
December 31, 2001
|
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| ASSETS |
|
|
|
|
|
|
|
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| Current assets: |
|
|
|
|
|
|
|
|
| Cash and cash equivalents |
|
$ |
3,598,096 |
|
|
$ |
7,654,845 |
|
| Marketable securities |
|
|
— |
|
|
|
749,141 |
|
| Accounts receivable |
|
|
4,668,191 |
|
|
|
4,556,865 |
|
| Inventories |
|
|
4,455,982 |
|
|
|
4,066,964 |
|
| Prepaid expenses and other current assets |
|
|
442,844 |
|
|
|
247,286 |
|
| |
|
|
|
|
|
|
|
|
| |
| Total current assets |
|
|
13,165,113 |
|
|
|
17,275,101 |
|
| |
|
|
|
|
|
|
|
|
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| Property and equipment |
|
|
23,256,555 |
|
|
|
22,900,450 |
|
| Less accumulated depreciation and amortization |
|
|
(17,732,392 |
) |
|
|
(16,721,645 |
) |
| |
|
|
|
|
|
|
|
|
| |
| |
|
|
5,524,163 |
|
|
|
6,178,805 |
|
| |
|
|
|
|
|
|
|
|
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| Other assets |
|
|
6,700 |
|
|
|
6,700 |
|
| |
|
|
|
|
|
|
|
|
| |
| |
|
$ |
18,695,976 |
|
|
$ |
23,460,606 |
|
| |
|
|
|
|
|
|
|
|
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| LIABILITIES AND SHAREHOLDERS' EQUITY |
|
|
|
|
|
|
|
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| Current liabilities: |
|
|
|
|
|
|
|
|
| Accounts payable |
|
$ |
1,199,620 |
|
|
$ |
1,562,569 |
|
| Accrued expenses |
|
|
1,716,110 |
|
|
|
1,796,390 |
|
| Other current liabilities |
|
|
842,854 |
|
|
|
2,039,686 |
|
| |
|
|
|
|
|
|
|
|
| |
| Total current liabilities |
|
|
3,758,584 |
|
|
|
5,398,645 |
|
| |
|
|
|
|
|
|
|
|
| |
| Long-term liabilities: |
|
|
|
|
|
|
|
|
| Long-term liabilities, excluding current portion |
|
|
7,510,911 |
|
|
|
7,572,752 |
|
| Other liabilities |
|
|
960,300 |
|
|
|
960,300 |
|
| |
|
|
|
|
|
|
|
|
| |
| Total liabilities |
|
|
12,229,795 |
|
|
|
13,931,697 |
|
| |
|
|
|
|
|
|
|
|
| |
| Shareholders' equity: |
|
|
|
|
|
|
|
|
| Common stock, $.01 par value: 45,000,000 authorized
26,819,165 and 26,802,687 shares issued and
outstanding |
|
|
268,192 |
|
|
|
268,027 |
|
| Additional paid-in capital |
|
|
147,631,310 |
|
|
|
147,517,078 |
|
| Accumulated deficit |
|
|
(139,077,049 |
) |
|
|
(135,887,470 |
) |
| Accumulated other comprehensive loss |
|
|
(2,356,272 |
) |
|
|
(2,368,726 |
) |
| |
|
|
|
|
|
|
|
|
| |
| Total shareholders' equity |
|
|
6,466,181 |
|
|
|
9,528,909 |
|
| |
|
|
|
|
|
|
|
|
| |
| |
|
$ |
18,695,976 |
|
|
$ |
23,460,606 |
|
| |
|
|
|
|
|
|
|
|
See accompanying notes to consolidated financial statements.
4
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
| |
|
Six Months Ended June
30,
|
|
| |
|
2002
|
|
|
2001
|
|
| Cash flows from operating activities: |
|
|
|
|
|
|
|
|
| Net loss |
|
$ |
(3,189,579 |
) |
|
$ |
(2,154,851 |
) |
| Adjustments to reconcile net loss to net cash used in operating activities: |
|
|
|
|
|
|
|
|
| Depreciation and amortization |
|
|
1,037,610 |
|
|
|
1,244,799 |
|
| Other |
|
|
(2,000 |
) |
|
|
1,506 |
|
| Changes in operating assets and liabilities: |
|
|
|
|
|
|
|
|
| Accounts receivable |
|
|
(111,326 |
) |
|
|
978,581 |
|
| Inventories |
|
|
(389,018 |
) |
|
|
(473,489 |
) |
| Prepaid expenses and other current assets |
|
|
(195,558 |
) |
|
|
52,258 |
|
| Accounts payable |
|
|
(362,949 |
) |
|
|
(859,793 |
) |
| Accrued expenses |
|
|
(80,280 |
) |
|
|
(577,261 |
) |
| Deferred credits and revenue |
|
|
(1,083,333 |
) |
|
|
(250,365 |
) |
| |
|
|
|
|
|
|
|
|
| Net cash used in operating activities |
|
|
(4,376,433 |
) |
|
|
(2,038,615 |
) |
| |
|
|
|
|
|
|
|
|
| |
| Cash flows from investing activities: |
|
|
|
|
|
|
|
|
| Purchases of property and equipment |
|
|
(287,911 |
) |
|
|
(701,688 |
) |
| Purchases of marketable securities |
|
|
— |
|
|
|
(3,569,950 |
) |
| Proceeds from maturities of marketable securities |
|
|
749,141 |
|
|
|
9,851,711 |
|
| Other |
|
|
2,000 |
|
|
|
(1,100 |
) |
| |
|
|
|
|
|
|
|
|
| Net cash provided by investing activities |
|
|
463,230 |
|
|
|
5,578,973 |
|
| |
|
|
|
|
|
|
|
|
| |
| Cash flows from financing activities: |
|
|
|
|
|
|
|
|
| Principal payments on borrowings and capital leases |
|
|
(175,340 |
) |
|
|
(276,951 |
) |
| Proceeds from borrowings |
|
|
— |
|
|
|
487,310 |
|
| Net proceeds from the issuance of common stock |
|
|
114,397 |
|
|
|
176,591 |
|
| |
|
|
|
|
|
|
|
|
| Net cash provided by (used in) financing activities |
|
|
(60,943 |
) |
|
|
386,950 |
|
| |
|
|
|
|
|
|
|
|
| |
| Effect of exchange rate changes on cash and cash equivalents |
|
|
(82,603 |
) |
|
|
(157,708 |
) |
| |
|
|
|
|
|
|
|
|
| Net increase (decrease) in cash and cash equivalents |
|
|
(4,056,749 |
) |
|
|
3,769,600 |
|
| Cash and cash equivalents at beginning of period |
|
|
7,654,845 |
|
|
|
2,431,704 |
|
| |
|
|
|
|
|
|
|
|
| |
| Cash and cash equivalents at end of period |
|
$ |
3,598,096 |
|
|
$ |
6,201,304 |
|
| |
|
|
|
|
|
|
|
|
| |
| Supplemental disclosure of cash flow information: |
|
|
|
|
|
|
|
|
| Cash paid during the period for interest |
|
$ |
271,021 |
|
|
$ |
285,353 |
|
| |
|
|
|
|
|
|
|
|
See accompanying notes to consolidated financial statements.
5
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2002
(Unaudited)
(1) |
|
UNAUDITED FINANCIAL STATEMENTS |
The interim consolidated financial statements of Diametrics Medical, Inc. (the “Company”) are unaudited and have been prepared by the Company in accordance with accounting principles
generally accepted in the United States of America for interim financial information, pursuant to the rules and regulations of the Securities and Exchange Commission. Pursuant to such rules and regulations, certain financial information and footnote
disclosures normally included in the financial statements have been condensed or omitted. However, in the opinion of management, the financial statements include all adjustments, consisting of normal recurring accruals as well as restructuring and
other charges, necessary for a fair presentation of the interim periods presented. Operating results for these interim periods are not necessarily indicative of results to be expected for the entire year, due to seasonal, operating and other
factors.
The Company has identified certain of its significant accounting policies that it considers particularly
important to the portrayal of the Company’s results of operations and financial position and which may require the application of a higher level of judgment by the Company’s management, and as a result are subject to an inherent level of
uncertainty. These are characterized as “critical accounting policies” and address revenue recognition and accounts receivable, inventories, recognition of research and development funding, foreign currency translation / transactions and
impairment of long-lived assets, each more fully described under “Management’s Discussion and Analysis of Results of Operations and Financial Condition” in the Company’s Annual Report on Form 10-K for the year ended December 31,
2001. Based upon the Company’s review, it has determined that these policies remain its most critical accounting policies for the six months ended June 30, 2002, and has made no changes to these policies during 2002.
These statements should be read in conjunction with the financial statements and related notes which are part of the Company’s Annual
Report on Form 10-K for the year ended December 31, 2001.
(2) |
|
NET LOSS PER COMMON SHARE |
Basic earnings per share (“EPS”) is calculated by dividing net loss by the weighted average common shares outstanding during the period. Diluted EPS reflects the potential dilution to basic
EPS that could occur upon conversion or exercise of securities, options, or other such items, to common shares using the treasury stock method based upon the weighted average fair value of the Company’s common shares during the period. For each
period presented, basic and diluted loss per share amounts are identical, as the effect of potential common shares is antidilutive. The following is a summary of outstanding securities which have been excluded from the calculation of diluted EPS
because the effect on net loss per common share would have been antidilutive:
| |
|
June 30,
|
| |
|
2002
|
|
2001
|
| Common stock options |
|
3,389,055 |
|
2,657,491 |
| Common stock warrants |
|
1,201,667 |
|
1,406,667 |
| Convertible senior secured fixed rate notes |
|
869,047 |
|
869,047 |
6
| |
|
Three Months Ended June
30,
|
|
|
Six Months Ended June
30,
|
|
| |
|
2002
|
|
|
2001
|
|
|
2002
|
|
|
2001
|
|
| Net loss |
|
$ |
(2,130,588 |
) |
|
$ |
(1,026,951 |
) |
|
$ |
(3,189,579 |
) |
|
$ |
(2,154,851 |
) |
| Change in cumulative translation adjustment |
|
|
128,605 |
|
|
|
(88,819 |
) |
|
|
12,454 |
|
|
|
(317,872 |
) |
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Comprehensive loss |
|
$ |
(2,001,983 |
) |
|
$ |
(1,115,770 |
) |
|
$ |
(3,177,125 |
) |
|
$ |
(2,472,723 |
) |
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
June 30, 2002
|
|
December 31, 2001
|
| Raw materials |
|
$ |
2,107,880 |
|
$ |
1,739,134 |
| Work-in-process |
|
|
1,065,605 |
|
|
1,130,307 |
| Finished goods |
|
|
1,282,497 |
|
|
1,197,523 |
| |
|
|
|
|
|
|
| |
|
$ |
4,455,982 |
|
$ |
4,066,964 |
| |
|
|
|
|
|
|
(5) |
|
OTHER CURRENT LIABILITIES |
| |
|
June 30, 2002
|
|
December 31, 2001
|
| Deferred research and development funding |
|
$ |
666,667 |
|
$ |
1,666,667 |
| Current portion of long-term debt |
|
|
176,187 |
|
|
289,686 |
| Other |
|
|
— |
|
|
83,333 |
| |
|
|
|
|
|
|
| |
|
$ |
842,854 |
|
$ |
2,039,686 |
| |
|
|
|
|
|
|
The Company’s distribution agreement with Philips Medical
Systems (“Philips”) provides for prepaid funding of research and development costs. These prepayments are being recognized ratably over the periods earned.
(6) |
|
RELATED PARTY TRANSACTIONS |
In August 1998, the Company completed the sale in a private placement of 2,142,858 shares of Common Stock at a price of $7.00 per share as part of a Common Stock Purchase Agreement, resulting in
aggregate proceeds to the Company of $15,000,006. The purchasers also received five-year warrants to purchase 714,286 shares of Common Stock at $8.40 per share. In addition, the Company issued Convertible Senior Secured Fixed Rate Notes, with
proceeds aggregating $7,300,000, which were used to retire other debt of the Company. The investor group in both transactions was led by BCC Acquisition II LLC.
Two of the directors of the Company are affiliated with BCC Acquisition II LLC, and one of these directors participated in the Common Stock Purchase Agreement and the related sale of Convertible Senior
Secured Fixed Rate Notes. This director is also a director of DVI, Inc., a health care finance company with which the Company has outstanding notes payable and a capital lease. As of June 30, 2002, the outstanding balance of the notes payable and
capital lease debt totaled $11,481 and $333,428, respectively.
The Company’s exclusive distributors, Philips
and Codman & Shurtleff, a Johnson & Johnson Company (“Codman”), are shareholders of the Company. Additionally, the agreements with both distribution partners provide for minimum annual purchase amounts and market development
commitments, and the Philips agreement provides for research and development funding. Sales to these parties were approximately $5.1 million and $10.2 million for the three months and six months
7
ended June 30, 2002 compared to $5.8 million and $10.9 million for the same periods in the prior year. Outstanding
accounts receivable for these distributors represented 99% and 98% of total outstanding accounts receivable as of June 30, 2002 and December 31, 2001, respectively. Sales and related accounts receivable balances for both periods were primarily
concentrated with Philips. On July 31, 2002, Philips notified the Company that it will not extend the current distribution agreement between the two companies, which ends on October 31, 2002. The Company is currently negotiating a new relationship
with Philips. Additionally, the Company expects to enter into discussions with other companies regarding potential partnerships in the point-of-care diagnostics market. The Company’s transition to these new relationships may negatively impact
the Company’s financial performance during the transition period.
(7) |
|
NEW ACCOUNTING PRONOUNCEMENTS |
In July 2002, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards (“SFAS”) No. 146, “Accounting for Costs Associated with Exit or Disposal
Activities,” which requires that costs associated with an exit or disposal activity be recognized when the liability is incurred, rather than at the date of a commitment to an exit or disposal plan. SFAS No. 146 replaces EITF No. 94-3,
“Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring).” The Company plans to adopt SFAS No. 146 in January 2003. Management believes that
the adoption of this statement will not have a material effect on the Company’s future results of operations.
(8) |
|
RESTRUCTURING AND OTHER CHARGES |
During the first half of 2002, the Company implemented operational changes intended to better align its resources with its evolving strategy, improve efficiency and achieve a more competitive cost
structure. These changes involved a work force reduction impacting 22 employees, including thirteen manufacturing positions in the Company’s U.K. subsidiary and nine positions in the Company’s U.S. operations, including six in
manufacturing, two in research and development and one in general and administration. In addition to these changes, on April 18, the Company announced the resignation of its Chief Executive Officer and President effective June 1, 2002. Charges
associated with the work force reductions and costs resulting from the executive officer resignation consisted primarily of severance and related costs amounting to approximately $688,000, accrued during the second quarter of 2002. The Company has
paid approximately $314,000 of these costs through June 2002 and expects to pay an additional $209,000 in the last half of 2002 and $165,000 in the first half of 2003. The impact of the work force reductions on future operating results and cash
flows is not expected to be material in future periods, as the resulting savings achieved, approximating $800,000 on an annualized basis ($500,000 in manufacturing, $232,000 in research and development and $68,000 in general and administration),
will be reinvested in other areas of the Company, primarily to support new research and development projects and other strategic initiatives.
In late July and early August, the Company implemented further operational changes to better align its resources with its evolving strategy and to contain costs, partially due to the Company’s transition to a new
relationship with Philips and potentially new partnerships with other companies. These changes involved a work force reduction impacting an additional 23 employees, including 14 positions in the Company’s U.K. subsidiary (13 in manufacturing
and one in research and development) and nine positions in the Company’s U.S. operations (two in manufacturing and seven in research and development). Charges associated with the work force reduction will consist primarily of severance and
related costs amounting to approximately $200,000. These costs will be paid and charged to expense in the third quarter 2002, coincidental with the timing of management’s approval of the related restructuring plan and notification of employees.
The Company is currently evaluating the impact of the work force reduction on future operating results and cash flows. Projected savings
8
associated with these changes approximate $1,200,000 on an annualized basis ($400,000 in manufacturing and $800,000 in
research and development), and are currently expected to be reinvested in other areas to support the Company’s transition to new partnership relationships as well as to support other strategic initiatives. Additionally, in July 2002, the
Compensation Committee of the Company’s Board of Directors approved a retention plan for certain of the Company’s key employees. The plan, which became effective August 1, provides for a cash bonus and restricted stock grants for certain
key employees who remain employed by the Company for at least one year from the plan’s effective date. Expenses associated with the cash bonuses and stock grants will be accrued and recognized over the periods earned, and are estimated at
$320,000 in 2002, $605,000 in 2003 and $220,000 in 2004.
Item 2. Management’s Discussion and Analysis of Results of Operations and Financial Condition
The Company has identified certain of its significant accounting policies that it considers particularly important to the portrayal of the Company’s results of operations and financial position and which may require the
application of a higher level of judgment by the Company’s management, and as a result are subject to an inherent level of uncertainty. These are characterized as “critical accounting policies” and address revenue recognition and
accounts receivable, inventories, recognition of research and development funding, foreign currency translation / transactions and impairment of long-lived assets, each more fully described under “Management’s Discussion and Analysis of
Results of Operations and Financial Condition” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2001. Based upon the Company’s review, it has determined that these policies remain its most critical
accounting policies for the six months ended June 30, 2002, and has made no changes to these policies during 2002.
The Company’s
discussion and analysis of results of operations and financial condition, including statements regarding the Company’s expectations about new and existing products, future financial performance, market risk exposure and other forward looking
statements are subject to various risks and uncertainties, including, without limitation, demand and acceptance of new and existing products, technological advances and product obsolescence, competitive factors, stability of domestic and
international financial markets and economies, the performance and continuance of the Company’s distributors and the availability of capital to finance growth. These and other risks are discussed in greater detail in Exhibit 99.3 to this Form
10-Q. When used in this Form 10-Q, and in future filings by the Company with the Securities and Exchange Commission, in the Company’s press releases, presentations to securities analysts or investors, in oral statements made by or with the
approval of an executive officer of the Company, the words or phrases “believes,” “may,” “will,” “expects,” “should,” “continue,” “anticipates,” “intends,” “will
likely result,” “estimates,” “projects,” or similar expressions and variations thereof are intended to identify such forward-looking statements.
Diametrics Medical, Inc.,
which began operations in 1990, is engaged in the development and manufacture of critical care blood and tissue analysis systems which provide immediate or continuous diagnostic results at the point-of-patient care.
Since its commencement of operations in 1990, the Company has transitioned from a development stage company to a full-scale development, manufacturing and
marketing organization (primarily through distributors). As of June 30, 2002, the primary funding for the operations of the Company has been approximately $148 million raised through public and private sales of its equity securities and issuance of
convertible promissory notes.
Distribution and commercialization of the Company’s products primarily occurs through Philips and
Codman. Philips is the exclusive global distributor of the Company’s critical care blood monitoring products, the IRMA®SL blood analysis system and the Trendcare® continuous blood gas
monitoring systems, including Paratrend® and Neotrend®. Philips also is the exclusive global distributor of the Blood Analysis Portal System, co-developed by the Company and Philips. Codman is the
exclusive worldwide distributor of the Neurotrend® cerebral tissue monitoring system.
9
The Codman distribution agreement was initiated in October 1998, has a term of six years and is renewable for two years. If minimum sales levels
and marketing expenditure levels are not achieved by Codman, certain payments will be due to the Company. Also, Codman has the right of first refusal to market new continuous monitoring products developed for the neuro market. In addition, Johnson
& Johnson Development Corporation has an equity investment in 773,184 shares of the Company’s Common Stock, representing an approximate 3% ownership interest in the Company.
The distribution agreement with Philips was signed in June 1999, initially as an agreement between the Company and Hewlett Packard Company (“HP”). Under the terms of the distribution
agreement, the Company transferred full responsibility for marketing, sales and distribution of the Company’s blood monitoring products described above to HP. The initial term of the agreement is three and a half years, with the option for
extensions. Concurrently with the execution of the agreement, HP made a $9.5 million equity investment, currently representing an approximate 7% ownership interest in the Company. In addition to HP’s equity investment, the agreement also
provides for minimum purchase commitments of the Company’s products, research and development funding and royalty payments. In late 1999, HP assigned the distribution agreement and its equity investment with the Company to Agilent Technologies,
Inc. (“Agilent”), a leading provider of test and measurement solutions and communications components, which was formed as a new company and subsidiary of HP. HP spun off of its ownership in Agilent to HP shareholders during 2000. In August
2001, Agilent completed the sale of its healthcare business to Royal Philips Electronics, including its equity investment in the Company. Also as part of this transaction, the distribution agreement between the Company and Agilent was assigned to
Philips Medical Systems, a division of Royal Philips Electronics. The initial three-and-a half year term of the Company’s distribution agreement with Philips ends on October 31, 2002. On July 31, 2002, Philips notified the Company that it will
not extend the current distribution agreement between the two companies. The Company is currently negotiating a new relationship with Philips in point-of-care diagnostics. The Company’s sales to Philips for the six months ended June 30, 2002
and 2001 were 93% and 89%, respectively, of total sales, and the Company recognized approximately $1 million and $1.2 million of funding from Philips as a reduction in research and development expenses in each of these periods. Sales to Philips
include product purchases by Philips to meet sales demand of its end-user customers and to fulfill its internal product requirements associated with the sales and service processes and customer financing programs, as well as contractual purchase
commitments under the distribution agreement. As a result, the level of the Company’s sales to Philips during any period is not indicative of Philips’ sales to its end-user customers during that period, which are estimated to be
substantially less than the Company’s sales to Philips in each of the periods presented.
Sales. Sales of the Company’s products were $5,275,931 and $10,738,805 for the three and six months ended June 30, 2002, compared to $6,127,674 and $11,843,568 for the same periods in the
prior year, a decrease of 14% and 9% for the three and six-month periods, respectively. The decrease in sales for the three and six months ended June 30, 2002 relative to the prior year reflects an 18% and 12% respective decrease in instrument
revenue and a 4% decrease in disposable cartridge and sensor revenue for both periods. Related unit sales of instruments increased 17% and 16% for the three and six-month periods, respectively, while unit sales of disposable cartridges and sensors
increased 2% for the three-month period and decreased 3% for the six-month period. The increase in disposable unit sales during the three-month period relative to the revenue decline occurred due to a higher mix of intermittent testing cartridge
sales, which carry a lower average selling price than continuous monitoring sensors. The 18% reduction in instrument revenue for the three-month period was largely driven by a reduction in continuous monitoring hardware and accessory sales. The
increase in instrument unit sales during the same period reflects the impact of sales of the recently introduced Blood Analysis Portal System (“Portal”) which
10
carries a substantially lower average selling price than the IRMA analyzer and continuous monitoring instruments. While unit sales of
instruments also increased during the six-month period, related revenues were down 12%, reflecting a shift in the mix of intermittent testing instrument sales from IRMA analyzers to Portals, as well as a reduction in continuous monitoring accessory
sales. Intermittent testing products represented 62% and 61% of total sales for the three and six months ended June 30, 2002, compared to 56% and 60% for the comparable periods in 2001. Continuous monitoring products comprised the remaining sales in
each period.
The Company’s sales to Philips and Codman comprised approximately 96% and 95% of total sales for the three and six
months ended June 30, 2002, compared to 95% and 92% for the same periods in the prior year. Due to the significant purchases of the Company’s products by its distributors for their internal use in the sales and service processes and for
customer financing programs and to meet minimum purchase commitments, the Company’s revenues during any period are not indicative of the distributors’ sales to end-user customers during that period. The distributors’ sales to their
end-user customers during the six months ended June 30, 2002 are estimated to be approximately 50% of the Company’s product sales to those distributors in the same period, compared to an estimated average of 40% over the last three years. While
expected to remain below the level of the Company’s sales to the distributors in 2002, the distributors’ sales to their end-user customers for the full year 2002 are expected to increase as a percentage of the Company’s product sales
to those distributors compared to prior years.
Intermittent testing products revenue was comprised of 68% and 69% instrument related
revenue and 32% and 31% disposable cartridge related revenue for the three and six months ended June 30, 2002. Continuous monitoring products revenue was comprised of 62% and 67% instrument related revenue and 38% and 33% disposable sensor revenue
for the three and six months ended June 30, 2002. The Company’s revenues are affected principally by the number of instruments, consisting of continuous monitoring instruments and accessories, IRMA analyzers and Portal systems, sold to
distributors, the extent to which the distributors sell these instruments to end-user customers, and the rate at which disposable sensors and cartridges are used in connection with these products. As of June 30, 2002, the Company has sold
approximately 12,600 instruments. As the Company grows, it is expected that the Company’s growing end-user customer base will increase the usage and rate of usage of disposable products, with the result that overall disposable product sales
will exceed that of instrument sales.
Cost of Sales. Cost of sales totaled $3,953,497 and
$7,958,776, or 75% and 74% of revenue for the three and six months ended June 30, 2002, compared to $4,452,860 and $8,854,013 or 73% and 75% of revenue for the same periods in the prior year. Cost of sales as a percentage of revenue for the three
months ended June 30, 2002 reflects a lower ratio of continuous monitoring product line sales (which currently have higher gross margins than the intermittent testing product line) to total sales. Manufacturing work force reductions initiated early
in the second quarter, along with improvements in disposable cartridge yields, resulted in reductions in cartridge and IRMA analyzer unit manufacturing costs during the quarter. These improvements partially offset the impact of the change in product
mix for the three-month period, and along with cartridge and sensor disposable cost reductions achieved in the first quarter, helped drive the improvement in cost of sales as a percentage of revenue for the six-month period.
Operating Expenses. Research and development expenditures totaled $1,298,895 and $2,520,532 for the three and six months
ended June 30, 2002, compared to $1,310,865 and $2,471,567 for the same periods in 2001. Expenses in the first six months of 2002 increased slightly, primarily due to increased investments to support new research and development projects and a
decline in the Company’s recognition of funding from Philips, from $1.2 million in the first half of 2001 to $1 million for the same period in 2002. These increases were partially offset by the favorable impact of the completion in the fourth
quarter 2001 of the amortization of purchased completed technology and other related intangible assets associated with the Company’s purchase
11
of Biomedical Sensors, Ltd. (now known as Diametrics Medical, Ltd.) in 1996, resulting in a reduction in expense of approximately $237,000.
Selling, general and administrative expenses totaled $1,345,102 and $2,529,048 for the three and six months ended June 30, 2002,
compared to $1,309,286 and $2,555,218 for the same periods in 2001. Expenses for the three and six-month periods were comparable, reflecting cost savings from a reduction in personnel offset by additional costs to support new strategic initiatives.
Restructuring and Other Charges. During the first half of 2002, the Company implemented operational
changes intended to better align its resources with its evolving strategy, improve efficiency and achieve a more competitive cost structure. These changes involved a work force reduction impacting 22 employees, including thirteen manufacturing
positions in the Company’s U.K. subsidiary and nine positions in the Company’s U.S. operations, including six in manufacturing, two in research and development and one in general and administration. In addition to these changes, on April
18, the Company announced the resignation of its Chief Executive Officer and President effective June 1, 2002. Charges associated with the work force reductions and costs resulting from the executive officer resignation consisted primarily of
severance and related costs amounting to approximately $688,000, accrued during the second quarter of 2002. The Company has paid approximately $314,000 of these costs through June 2002 and expects to pay an additional $209,000 in the last half of
2002 and $165,000 in the first half of 2003. The impact of the work force reductions on future operating results and cash flows is not expected to be material in future periods, as the resulting savings achieved, approximating $800,000 on an
annualized basis ($500,000 in manufacturing, $232,000 in research and development and $68,000 in general and administration), will be reinvested in other areas of the Company, primarily to support new research and development projects and other
strategic initiatives.
Other Income (Expense). Net other expense totaled $120,837 and $231,840 for
the three and six months ended June 30, 2002, compared to net other expense of $81,614 and $117,621 for the same periods in 2001. The Company realized interest income of $21,733 and $53,970 for the three and six months ended June 30, 2002, compared
to $78,080 and $202,584 for the same periods in 2001. The period-to-period decrease in interest income reflects the impact of lower average cash and investment balances and lower average interest rates.
Interest expense totaled $135,282 and $271,021 for the three and six months ended June 30 2002, compared to $144,034 and $285,353 for the same periods in 2001.
The period-to-period decrease in interest expense primarily reflects the impact of lower average debt balances.
Net
Loss. The net loss, including restructuring and other charges, for the three and six months ended June 30, 2002 was $2,130,588 and $3,189,579, respectively. Excluding the impact of restructuring and other charges, the
net loss was $1,442,400 and $2,501,391 for the three and six-month periods compared to $1,026,951 and $2,154,852 for the same periods in 2001. The primary contributors to the increase in net loss before restructuring and other charges were lower
revenues in the 2002 periods, and for this year’s six-month period, lower interest income.
For the third quarter of 2002, the
Company expects its net sales and net loss to be similar to levels achieved in the second quarter of the year, excluding restructuring and other charges, as any growth in disposable revenue is expected to be offset by reductions in instrument
revenue, due to the expected impact on revenues of an increased mix of lower priced Portal sales relative to IRMA analyzer sales. Given the early stage of negotiations with Philips regarding a new relationship between the two companies, the Company
has limited visibility at this time as to its projected financial performance for the fourth quarter 2002. The Company’s transition to a new relationship with Philips and potentially new partnerships with other companies may negatively impact
the Company’s financial performance during the transition period.
12
LIQUIDITY AND CAPITAL RESOURCES
At June 30, 2002, the Company had working capital of $9,406,529, a decrease of $2,469,927 from the working capital reported at December 31, 2001. The decrease is impacted primarily by the year-to-date net loss before depreciation and
amortization of approximately $2,152,000 and purchases of property and equipment of approximately $288,000.
Net cash used in operating
activities totaled $4,376,433 for the six months ended June 30, 2002, compared to $2,038,615 for the same period in 2001. This was the result of net losses of $3,189,579 and $2,154,851 for these same periods in 2002 and 2001, respectively, adjusted
by changes in operating assets and liabilities, primarily accounts receivable, inventories, accounts payable, accrued expenses and deferred credits and revenue, discussed below.
Net accounts receivable increased $111,326 for the six months ended June 30, 2002, compared to a $978,581 decrease for the same period in 2001. A significantly larger accounts receivable balance
existed at December 31, 2000 relative to December 31, 2001, resulting in higher accounts receivable collections in the first half of 2001, facilitated by the Company’s success in achieving reductions in days sales outstanding during 2001.
Further improvements were achieved in days sales outstanding during the first half of 2002; however, these improvements had a smaller impact on the amount of accounts receivable collections.
Inventories increased $389,018 for the six months ended June 30, 2002, compared to an increase of $473,489 for the same period in 2001. The increase in 2002 was primarily due to a ramp up of
intermittent testing raw material inventories to facilitate third quarter production requirements for Portal units and IRMA analyzers. This was partially offset by a decline in continuous monitoring instrument inventory resulting from sales of these
products during the period. The increase in 2001 was primarily due to an increase in continuous monitoring instrument inventory resulting from lower than anticipated sales of these products during the first half of 2001 and an increase in
intermittent testing raw materials inventory to ramp up for third quarter production. The Company’s inventory balances are expected to generally decline over the remainder of 2002 as current inventory levels will allow a reduction in third and
fourth quarter inventory purchases to meet sales requirements for those quarters.
Accounts payable and accrued expenses decreased
$443,229 and $1,437,054 for the six months ended June 30, 2002 and 2001, respectively. The accounts payable balance at December 31, 2000 was approximately $836,000 higher than at December 31, 2001, resulting in higher payments to vendors during the
first half of 2001.
Deferred credits and revenue decreased $1,083,333 and $250,365 for the six months ended June 30, 2002 and 2001,
respectively. The decrease in 2001 represents the recognition of funding from Philips for research and development costs, partially offset by the receipt of $1 million of prepaid research and development funding. The decrease in 2002 represents the
recognition of funding from Philips for research and development costs and no prepaid funding.
Net cash provided by investing activities
totaled $463,230 and $5,578,973 for the six months ended June 30, 2002 and 2001, respectively. This change was affected primarily by the amounts and timing of equity funding, funding received from Philips and operating cash flow requirements, which
all affected the amount of cash available for the purchase of marketable securities. Purchases of property and equipment, totaling $287,911 in 2002 and $701,688 in 2001, also affected net cash used in investing activities in each period. In 2002,
the Company expects capital expenditures and new lease commitments to range from $500,000 to $750,000, primarily reflecting investments to support new product development and production.
13
Net cash used by financing activities totaled $60,943 for the six months ended June 30, 2002, compared to net cash provided by financing
activities of $386,950 for the same period in the prior year. The period-to-period change was primarily impacted by net proceeds from borrowings of $210,000 in 2001, compared to principal payments on borrowings of $175,000 in 2002.
As a result of the changes discussed above, the Company’s total cash and marketable securities balance decreased by approximately $4.8 million
and $2.5 million during the six months ended June 30, 2002 and 2001, respectively. The declines in both periods reflect additional cash requirements for purchases of inventories for production and sale in the following quarters and the timing of
payments, including payments related to restructuring and other charges for the 2002 year-to-date period. Consequently, the average rate of cash usage for the remainder of 2002 is expected to be less than that of the first half of the year. The
Company is monitoring its cash position carefully and is evaluating its future operating cash requirements in the context of its strategy, business objectives and expected business performance. As part of this, the Company is currently reviewing
various options for raising additional capital during 2002, including the use of asset-based credit, strategic partner funding and the issuance of debt or equity securities. Additionally, the full principal balance of the Company’s $7.3 million
Convertible Senior Fixed Rate Notes become due August 4, 2003, unless the note holders elect prior to that date to convert the notes into shares of the Company’s Common Stock at a conversion price of $8.40 per share. The Company is currently
discussing with the note holders a potential extension of the notes under modified terms. If the note holders do not elect to extend the due date or exercise the conversion option, the Company plans to refinance the notes with debt or equity to the
extent cash flows from operations or partnering activities are not sufficient to retire the notes. There is no assurance that the Company will be able to refinance the notes or be able to refinance under favorable terms. The Company’s long-term
capital requirements will depend upon numerous factors, including the rate of market acceptance of the Company’s products, the level of resources devoted to expanding the Company’s business and manufacturing capabilities, and the level of
research and development activities. While there can be no assurance that adequate funds will be available when needed or on acceptable terms, management believes that the Company will be able to raise adequate funding to meet its operational
requirements.
At June 30, 2002, the Company had U.S. tax net operating loss and research and development tax credit carryforwards for
income tax purposes of approximately $124 million and $1.4 million, respectively. Pursuant to the Tax Reform Act of 1986, use of a portion of the Company’s net operating loss carryforwards are limited due to a “change in ownership.”
If not used, these net operating loss carryforwards begin to expire in 2005 ($500,000) and at increasing amounts between 2010 and 2022 ($31.6 million between 2010 and 2013 and $91.9 million thereafter). The Company’s foreign subsidiary also has
a net operating loss carryforward of approximately $48.1 million, which can be carried forward indefinitely, subject to review by the governmental taxing authority.
SUBSEQUENT EVENT
In late July and early August, the Company implemented further
operational changes to better align its resources with its evolving strategy and to contain costs, partially due to the Company’s transition to a new relationship with Philips and potentially new partnerships with other companies. These changes
involved a work force reduction impacting an additional 23 employees, including 14 positions in the Company’s U.K. subsidiary (13 in manufacturing and one in research and development) and nine positions in the Company’s U.S. operations
(two in manufacturing and seven in research and development). Charges associated with the work force reduction will consist primarily of severance and related costs amounting to approximately $200,000. These costs will be paid and charged to expense
in the third quarter 2002, coincidental with the timing of management’s approval of the related restructuring plan and notification of employees. The Company is currently evaluating the impact of the work force reduction on future operating
results and cash flows. Projected savings associated with these changes approximate $1,200,000 on an annualized basis ($400,000 in manufacturing and
14
$800,000 in research and development), and are currently expected to be reinvested in other areas to support the Company’s transition to
new partnership relationships as well as to support other strategic initiatives. Additionally, in July 2002, the Compensation Committee of the Company’s Board of Directors approved a retention plan for certain of the Company’s key
employees. The plan, which became effective August 1, provides for a cash bonus and restricted stock grants for certain key employees who remain employed by the Company for at least one year from the plan’s effective date. Expenses associated
with the cash bonuses and stock grants will be accrued and recognized over the periods earned, and are estimated at $320,000 in 2002, $605,000 in 2003 and $220,000 in 2004.
Item 3. Quantitative and Qualitative Disclosure About Market Risk
The Company’s
primary market risk exposure is foreign exchange rate fluctuations of the British pound sterling to the U.S. dollar as the financial position and operating results of the Company’s U.K. subsidiary, Diametrics Medical, Ltd., are translated into
U.S. dollars for consolidation. The Company’s exposure to foreign exchange rate fluctuations also arises from transferring funds to its U.K. subsidiary in British pounds sterling. Effective November 1, 1999 most of the Company’s sales are
made to distributors and denominated in U.S. dollars, thereby significantly mitigating the risk of exchange rate fluctuations on trade receivables. The effect of foreign exchange rate fluctuations on the Company’s financial results for the
periods presented were not material. The Company does not currently use derivative financial instruments to hedge against exchange rate risk or manage interest rate risk. The Company’s exposure to interest rate risk is limited to short-term
borrowings under a bank loan. As of June 30, 2002 the balance of the bank loan was less than $28,000. Based upon currently available information, management does not believe that the effect of foreign exchange rate fluctuations and interest rate
risk will have a material impact on the Company’s financial condition or overall trends in results of operations. There have been no material changes in market risk faced by the Company from what has been previously reported in the
Company’s Annual Report on Form 10-K for the year ended December 31, 2001.
PART II—OTHER INFORMATION
Item 1. Legal Proceedings
None
Item 2. Changes in Securities
None
Item 3. Defaults Upon Senior Securities
None
Item 4. Submission of Matters to a Vote of Security Holders
The Annual Meeting of the
Company’s shareholders was held on May 22, 2002. At the meeting, shareholders voted on the reelection of one director, André de Bruin. Mr. de Bruin was reelected by a vote as follows: 15,355,465 votes “For” and 4,262,531 votes
“Against”. The term for Mr. de Bruin will expire at the Company’s Annual Meeting in 2005.
In addition, the Company’s
shareholders voted to increase the number of shares authorized for issuance under the Company’s 1990 Stock Option Plan. This amendment was approved as follows: 13,902,935 votes “For”, 5,664,629 votes “Against” and 50,432
votes “Abstained”.
Item 5. Other Information
None
15
Item 6. Exhibits and Reports on Form 8-K
| Exhibit
No.
|
|
|
|
Method
of Filing
|
| 10.1 |
|
Separation Agreement and Release, dated April 17, 2002, between the Company and David T. Giddings |
|
Filed herewith |
| 10.2 |
|
1990 Stock Option Plan, as amended and restated |
|
Filed herewith |
| 99.1 |
|
Certification of the Chief Financial Officer, dated August 14, 2002, pursuant to 18 U.S.C. §1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002 |
|
Filed herewith |
| 99.2 |
|
Certification of the interim Chief Executive Officer, dated August 14, 2002, pursuant to 18 U.S.C. §1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002 |
|
Filed herewith |
| 99.3 |
|
Cautionary Statements Under the Private Securities Litigation Reform Act |
|
Filed herewith |
On April 18, 2002, the Company filed a Current Report on Form 8-K under Item 5 relating to the Company’s announcement of a change in its Chief Executive Officer, as presented in a press release dated April 18, 2002.
On May 9, 2002, the Company filed a Current Report on Form 8-K under Item 9 relating to the Company’s
announcement of earnings results for the quarter ended March 31, 2002, as presented in a press release dated May 9, 2002.
16
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
| DIAMETRICS MEDICAL, INC. |
| |
|
|
| By: |
|
/s/ LAURENCE L. BETTERLEY |
| |
|
|
| |
|
Laurence L. Betterley |
| |
|
Senior Vice President |
| |
|
and Chief Financial Officer |
| |
|
(and Duly Authorized Officer) |
Dated: August 14, 2002
17