<PAGE>
UNITED STATES
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
June 30, 1998
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d)
OF THE EXCHANGE ACT
For the Transition Period From
____________ to ____________
Commission file number 0-19688
DESTRON FEARING CORPORATION
(Exact name of Registrant as specified in its charter)
Delaware 84-1079037
(State or other jurisdiction of incorporation (I.R.S. Employer
or organization) Identification No.)
490 Villaume Avenue
South St. Paul, MN 55075
(612) 455-1621
(Address of principal executive offices)
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 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
As of August 11, 1998, there were 13,353,982 outstanding shares of Common Stock.
<PAGE>
DESTRON FEARING CORPORATION
FORM 10-Q
FOR THE QUARTER ENDED JUNE 30, 1998
INDEX
<TABLE>
<CAPTION>
Page
----
<S> <C>
PART I -- FINANCIAL INFORMATION
Item 1 -- Financial Statements 3
Item 2 -- Management's Discussion and Analysis of Financial Condition
and Results of Operations 9
PART II -- OTHER INFORMATION
Item 1 -- Legal Proceedings 12
Item 6 -- Exhibits and Reports on Form 8-K 13
Signatures 14
</TABLE>
-2-
<PAGE>
PART 1. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
DESTRON FEARING CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (UNAUDITED)
JUNE 30, 1998 AND SEPTEMBER 30, 1997
(in thousands, except share and per share amounts)
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
ASSETS June 30, September 30,
1998 1997
---------- --------------
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents $ 515 $ 1,075
Accounts receivable, net 1,275 1,911
Inventories, net 5,012 5,292
Deposits on purchase commitments 178 162
Prepaid expenses and other current assets 63 49
---------- --------------
Total current assets 7,043 8,489
PROPERTY AND EQUIPMENT, NET 1,934 2,001
GOODWILL, NET 1,938 2,001
OTHER ASSETS, NET 152 191
---------- --------------
$ 11,067 $ 12,682
---------- --------------
---------- --------------
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Line of credit $ 716 $ 373
Accounts payable 645 524
Accrued liabilities 379 472
Current portion of long-term obligations 2,516 1,554
---------- --------------
Total current liabilities 4,256 2,923
LONG-TERM OBLIGATIONS,
net of current portion 1,007 3,121
---------- --------------
Total liabilities 5,263 6,044
---------- --------------
SHAREHOLDERS' EQUITY:
Common stock, $.01 par value;
20,000,000 shares authorized;
13,354,000 issued and outstanding 133 133
Additional paid-in capital 19,847 19,789
Accumulated deficit (14,176) (13,284)
---------- --------------
Total shareholders' equity 5,804 6,638
---------- --------------
$ 11,067 $ 12,682
---------- --------------
---------- --------------
</TABLE>
The accompanying notes are an integral part
of these consolidated financial statements.
- 3 -
<PAGE>
DESTRON FEARING CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
FOR THE QUARTER AND NINE MONTHS ENDED JUNE 30, 1998 AND 1997
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------------------------------------
QUARTER ENDED JUNE 30, NINE MONTHS ENDED JUNE 30,
------------------------ --------------------------
1998 1997 1998 1997
--------- -------- --------- ---------
<S> <C> <C> <C> <C>
NET REVENUE $ 3,123 $ 3,058 $ 10,103 $ 10,272
--------- -------- --------- ---------
COSTS AND EXPENSES:
Cost of sales 2,171 2,054 6,946 6,505
Selling, general and administrative 982 884 2,857 2,621
Research and development 253 247 813 640
Interest expense and other 127 63 379 414
--------- -------- --------- ---------
Total costs and expenses 3,533 3,248 10,995 10,180
--------- -------- --------- ---------
INCOME (LOSS) BEFORE INCOME TAXES (410) (190) (892) 92
PROVISION FOR INCOME TAXES - - - -
--------- -------- --------- ---------
NET INCOME (LOSS) $ (410) $ (190) $ (892) $ 92
--------- -------- --------- ---------
--------- -------- --------- ---------
BASIC AND DILUTED EARNINGS
(LOSS) PER COMMON SHARE $ (0.03) $ (0.01) $ (0.07) $ 0.01
--------- -------- --------- ---------
--------- -------- --------- ---------
</TABLE>
The accompanying notes are an integral part
of these consolidated financial statements.
- 4 -
<PAGE>
DESTRON FEARING CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
FOR THE NINE MONTHS ENDED JUNE 30, 1998 AND 1997
(in thousands)
<TABLE>
<CAPTION>
Nine Months Ended June 30,
-----------------------------
1998 1997
------------- ------------
------------- ------------
<S> <C> <C>
OPERATING ACTIVITIES:
Net income (loss) $ (892) $ 92
Adjustments to reconcile net income (loss) to net cash
used in operating activities:
Depreciation and amortization 360 377
Changes in operating items:
Accounts receivable 636 (787)
Inventories 280 1,306
Deposits on purchase commitments (16) -
Prepaid expenses and other current assets (14) (39)
Accounts payable and accrued liabilities 28 (872)
------------- -----------
Net cash provided by operating activities 382 77
------------- -----------
INVESTING ACTIVITIES:
Purchases of fixed assets (192) (178)
Change in other assets 1 -
------------- -----------
Net cash used in investing activities (191) (178)
------------- -----------
FINANCING ACTIVITIES:
Issuance of common stock, net 58 3,114
Repayments of long-term obligations (1,152 (130)
Net borrowings on bank line of credit 343 (866)
------------- -----------
Net cash provided by (used in) financing activities (751) 2,118
------------- -----------
NET CHANGE IN CASH (560) 2,017
CASH, BEGINNING OF PERIOD 1,075 39
------------- -----------
CASH, END OF PERIOD $ 515 $ 2,056
------------- -----------
------------- -----------
SUPPLEMENTAL CASH FLOW INFORMATION:
Interest paid $ 386 $ 407
------------- -----------
------------- -----------
NON-CASH FINANCING TRANSACTION:
Conversion of account payable to term loan $ - $ 4,290
------------- -----------
------------- -----------
</TABLE>
The accompanying notes are an integral part
of these consolidated financial statements.
- 5 -
<PAGE>
DESTRON FEARING CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1998 and 1997
(unaudited)
- --------------------------------------------------------------------------------
1. GENERAL
The information included in the accompanying consolidated interim financial
statements is unaudited and should be read in conjunction with the audited
consolidated financial statements and notes thereto contained in the most recent
Annual Report on Form 10-K filed for Destron Fearing Corporation and its
subsidiaries (collectively, the "Company"). In the opinion of management, all
adjustments, consisting of normal recurring items, necessary for a fair
presentation of the financial position and results of operations for the interim
periods presented have been reflected herein. The results of operations for
interim periods are not necessarily indicative of the results to be expected for
the entire fiscal year.
2. INVENTORIES
Inventories are valued at the lower of first in, first out cost or market, and
consist of the following (in thousands):
<TABLE>
<CAPTION>
June 30, 1998 September 30, 1997
------------- ------------------
<S> <C> <C>
Raw materials $2,280 $2,354
Finished goods 2,732 2,938
-------- --------
Total inventories $5,012 $5,292
-------- --------
-------- --------
</TABLE>
3. PRIVATE PLACEMENTS OF COMMON STOCK
In January 1997, the Company sold an aggregate of 650,000 shares of common stock
to two United States investors for gross proceeds of $1.3 million. Also in
January 1997, the Company sold an aggregate of 1,000,000 shares of common stock
in a private placement to three foreign investors pursuant to Regulation S under
the Securities Act of 1933 for gross proceeds of $2,000,000. The proceeds from
these offerings have been used to finance working capital needs and new product
development.
4. LEGAL PROCEEDINGS
Colorado Actions
On January 8, 1996, the Company commenced a patent infringement trial against
four competitors in the United States District Court of Colorado. (The patent
involved is No. 5,211,129, which relates to the Company's injectable
transponder technology.) On January 29, 1996, the jury in the trial returned a
verdict in favor of the Company and found that the defendants had willfully
infringed on the Company's patent and awarded damages of $444,000, including
prejudgment interest. The defendants appealed the judgment against them, and
the Company cross-appealed the failure of the court to increase Destron's
damages. On July 24, 1997, the Court
-6-
<PAGE>
of Appeals for the Federal Circuit handed down its decision in the appeal.
The decision of the Court of Appeals affirmed the trial court's judgment,
holding the Company's patent is valid and was willfully infringed by the
competitors. In addition, the issue of inequitable conduct was remanded to
the trial court for further proceedings as to the Company's intent in
prosecuting the patent application before the United States Patent Office.
On November 7, 1997, the U.S. District Court of Colorado, on remand on the issue
of inequitable conduct, found no intent on the part of the Company to deceive
the Patent Office, and therefore that no inequitable conduct occurred and the
Company's '129 patent was enforceable. On February 9, 1998, the District Court
Judge issued an Order containing findings and conclusions and entered a Third
Amended Judgement confirming the Court's finding of no inequitable conduct. The
defendants have appealed this decision and a decision is not expected until late
1998 or early 1999.
Further, during the pendency of the first appeal, the Company pursued a contempt
action against the defendants for willful violations of the District Court's
permanent injunction. On November 7, 1997, a Magistrate Judge of the District
Court recommended that the defendants be found in willful contempt of the
permanent injunction and that the Company should be awarded double damages,
amounting to $33,000, as well as attorneys' fees and costs. On February 9,
1998, the District Court Judge issued an Order adopting the Magistrate's
recommendation that the defendants were in contempt. This finding of contempt
has also been appealed by the defendants.
On January 23, 1998, the Company filed a second Motion for Contempt against the
defendants. Following a March 27, 1998 hearing, on April 23, 1998 the
Magistrate Judge entered a recommendation that the defendants be held in
contempt a second time, based upon their manufacture, use and sale of the ID-100
Zip Quill transponder product. The Company has requested trebled damages,
attorney's fees, costs and sanctions against the defendants for their contempt
of the District Court permanent injunction. The defendants have objected to the
recommendations of the Magistrate Judge. The Company anticipates that the
District Court will have a hearing and rule on the matter in late 1998.
Minnesota Actions
On December 17, 1996, the same three competitors found to be willful infringers
in the Colorado Actions filed a lawsuit against the Company and its United
States distributor, Schering-Plough, in the United States District Court for the
District of Minnesota. The plaintiffs alleged that the defendants participated
in unfair competition, breached an oral contract and infringed on three of the
plaintiffs' United States patents. On January 24, 1997, the plaintiffs withdrew
this lawsuit in its entirety.
On April 21, 1997, four plaintiffs (including the three competitors identified
in the foregoing paragraph) filed a lawsuit against the Company and Schering-
Plough and another of the Company's competitors in the United States District
Court for the District of Minnesota. The plaintiffs allege that the defendants
participated in unfair competition, breached an oral agreement and infringed on
three of the plaintiffs' United States patents and requested that the Court
award compensatory and treble damages of an unspecified amount.
On May 16, 1997, the plaintiffs amended the lawsuit and, in their complaint as
amended, allege patent infringement, false advertising, unfair competition and
attempted monopolization on the part of the Company, among other matters,
stemming from the ISO standards. This lawsuit has been stayed by agreement of
all parties pending the outcome of the appeal of the Colorado action.
-7-
<PAGE>
While management of the Company is unable, at this time, to estimate the
potential impact of this litigation, the Company and its legal counsel believe
that its products do not infringe any valid asserted claims of the patents owned
by the plaintiffs, that the false advertising and unfair competition claims are
without merit, that the Company is likely to prevail on the attempted
monopolization claim, and that the ultimate outcome of this litigation will not
have a significant adverse impact on the Company's future financial position,
cash flows or result of operations. However, any litigation has an inherent
risk of loss at trial, and there can be no assurance of the ultimate outcome of
this lawsuit.
If the Company is successful in obtaining an affirmance of the judgment of
enforceability in the Colorado action, the Company's exposure in the Minnesota
litigation will not be material. As a result of the favorable ruling in the
Colorado Action on February 9, 1998, and as indicated in the above paragraph,
the Minnesota litigation has been stayed pending the Federal Circuit Court
decision in the Colorado action, which is not expected until late 1998, at the
earliest. Accordingly, it is expected that the Company's legal fees during the
remainder of 1998 and early 1999 in the Minnesota litigation will not be
significant because of the stay that has been entered in the Minnesota
litigation.
5. RECENTLY ISSUED ACCOUNTING PRONOUNCEMENT
In February 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 128, "Earnings Per Share" (SFAS No. 128).
SFAS No. 128 replaces primary EPS with basic EPS. Basic EPS is computed by
dividing reported earnings (loss) by weighted average shares outstanding,
excluding potentially dilutive securities. Fully diluted EPS, termed diluted
EPS under SFAS No. 128, is also to be disclosed. The Company adopted SFAS No.
128 effective in the quarter ended December 31, 1997. As a result, all prior
period EPS data have been restated.
A reconciliation of EPS calculations under SFAS No. 128 is as follows for the
quarters and nine-month periods ended June 30 (in thousands, except per share
amounts):
<TABLE>
<CAPTION>
Quarter Ended June 30 Nine Months Ended June 30
--------------------- -------------------------
1998 1997 1998 1997
---- ---- ---- ----
<S> <C> <C> <C> <C>
Net income (loss) ($410) ($190) ($892) $92
---- ---- ---- ----
---- ---- ---- ----
Weighted average number of
common shares outstanding 13,354 13,294 13,316 12,568
Dilutive effect of stock options
and warrants after application
of the treasury stock method --- --- --- 126
---- ---- ---- ----
13,354 13,294 13,316 12,694
------ ------ ------ ------
------ ------ ------ ------
Basic and diluted earnings
(loss) per common share ($0.03) ($0.01) ($0.07) $0.01
------ ------ ------ ------
------ ------ ------ ------
</TABLE>
-8-
<PAGE>
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
RECENT DEVELOPMENTS
In July 1998, the Company retained a group of investment bankers to assist the
Company in exploring strategic alternatives for increasing shareholder value.
The potential alternatives could include, among others, the sale of the Company
or a division, locating a strategic investor, or making a strategic acquisition.
In addition to engaging the advisors, in August 1998, the Company implemented a
program to reduce expenses by approximately $1.0 million annually. The
reductions included selective layoffs, a reduction in management salaries, the
ending of certain electronic reader promotion programs and anticipated
reductions in legal costs that reflect the winding down of the patent litigation
Also in August 1998, the Company advised a creditor that it would not make a
scheduled payment of $600,000 due in October 1998 (see "Liquidity and Capital
Resources"), due to the Company's limited cash reserves and anticipated
liquidity and resource requirements. The Company has requested that the
creditor restructure the payment schedule, and there has been no definitive
response to this request as of the date of filing of the Quarterly Report on
Form 10-Q.
The Company's August 1998 financial projections forecast that cash flow from
operations, combined with line of credit borrowings, will be sufficient to fund
operations in fiscal 1999. However, if these projections are not achieved, the
Company may be required to obtain additional financing to support its business
requirements. Such funds could be generated from debt or equity offerings, the
sale of all or part of the Company, or other strategic financing arrangements.
However, there can be no assurance that any such financing could be obtained, or
if obtained, would be on terms favorable or acceptable to the Company. (See
additional discussion under "Liquidity and Capital Resources.")
RESULTS OF OPERATIONS
Net revenue for the quarter ending June 30, 1998, of $3,123,000 was 2% higher
than the $3,058,000 reported for the comparable quarter of 1997. For the nine-
month period, fiscal 1998 revenue of $10,103,000 was down 2% from the prior
year's revenue of $10,272,000. Radio Frequency Identification Devices (RFID)
revenue declined 3% in the third quarter and 8% for the nine-month period when
compared to the corresponding periods of fiscal 1997. While the Company
experienced higher sales in the markets of the United States fisheries industry
and the United Kingdom companion animals during these periods, the gains were
offset by lower revenues on the European continent and in Japan. Visual
identification revenue rose 7% in both the third quarter and nine-month period
of fiscal 1998 when compared to the previous year because of increased unit
sales of visual products.
Cost of sales of $2,171,000 for the third quarter and $6,946,000 for the nine-
month period were higher by 6% and 7%, respectively, than the comparable periods
of fiscal 1997. The higher costs were attributable to an unfavorable product
mix and lower manufacturing efficiency in the production of visual
identification products. Additionally, RFID costs increased during the fiscal
1998 nine-month period because of programs 1) to update and retrofit electronic
readers for the improvement of operating performance and 2) to exchange
electronic readers at certain animal shelters in the United States. As a result
of these factors, gross profit margins declined to 30% and 31% of revenue in the
third quarter and nine-month period of fiscal 1998, respectively, from the 33%
and 37% margins reported for the comparable periods of fiscal 1997.
Selling, general and administrative expenses for the third quarter of fiscal
1998 were $982,000 or 11% greater than the $884,000 for the same period last
year. For the nine-month period, these expenses were $2,857,000, which was a 9%
increase over the $2,621,000 reported in fiscal 1997. Selling expenses
increased 31% for the quarter and 32% for the nine-month period over the
respective fiscal 1997 periods while general and administrative expenses
declined 4% and 9%, respectively, during these same periods. During fiscal
1998,
-9-
<PAGE>
sales staff were hired to develop the RFID livestock market and increase RFID
sales in Europe. Although these efforts have not yet produced significant
revenues, the associated salaries and benefits, combined with increased
domestic and international travel, are the principal reasons for the higher
selling expenses during the third quarter and nine-month periods of the
current year. General and administrative expenses declined this year
primarily because of lower investor relations activities and reduced legal
expenses.
Research and development expenses were $253,000 in the third quarter of fiscal
1998 compared to $247,000 last year, an increase of 2%. For the nine-month
period, these expenses increased 27% to $813,000 from $640,000 last year. The
higher spending in fiscal 1998 results primarily from the salary expense of
personnel additions and increased use of outside engineering resources to
develop enhanced scanning products for the United States fisheries industry.
Interest and other of $127,000 in the third quarter of fiscal 1998 was double
the $63,000 reported in fiscal 1997 primarily because of interest expense
incurred on higher average borrowings. For the nine-month period, interest and
other declined 8% to $379,000 principally because 1997 included imputed interest
on an outstanding balance payable to a vendor.
The Company derives a significant portion of its revenue from export sales. The
gross profit and cash requirements of these sales do not vary materially from
the requirements of its domestic sales.
LIQUIDITY AND CAPITAL RESOURCES
Historically, the Company has utilized financing sources such as private and
public equity offerings and borrowings from financial institutions and
individual investors to fund its operating activities. The Company believes
that its cash on hand at June 30, 1998 and funds available under its existing
credit agreement combined with funds generated by operations will provide the
Company with adequate liquidity and capital resources for working capital and
other cash requirements through at least fiscal 1998.
However, the information set forth in the preceding paragraph, and elsewhere in
this Quarterly Report on Form 10-Q, is forward-looking information. Therefore,
if, for any reason (including, without limitation, those described below), the
Company's operations require more capital than anticipated, revenues do not
reach anticipated levels, or cash flow needs are greater than planned, the
Company may need additional financing in order to maintain its operations.
There can be no assurance that the Company would be able to obtain any required
additional financing when needed or that such financing, if obtained, would be
on terms favorable or acceptable to the Company. If the Company was unable to
obtain additional financing when needed and under acceptable conditions, it
would be required to significantly scale back plans for growth and perhaps
reduce the scope of its operations. Factors that may affect the Company's
revenues, use of capital, expenses and/or cash flow, and that would cause actual
results to differ materially from those anticipated include, but are not limited
to, the introduction of competing products, a claim (whether or not successfully
made) that the Company's products infringe a patent held by another company or
individual, any performance problems involving the Company's products, changes
in technology that could cause the Company's products to become obsolete, the
departure of key members of management and/or key employees, regulatory
requirements that would make the Company's products difficult or uneconomical to
produce, and general economic conditions.
The Company's operating activities provided $382,000 during the nine-month
period ending June 30, 1998. The net loss incurred during the period was offset
by depreciation and amortization, decreases in accounts receivable and
inventories, and increases in accounts payable and accrued liabilities.
The Company's investing activities used $192,000 during the nine-month period
ended June 30, 1998 for the purchase of fixed assets. Its financing activities
used net cash of $751,000 during the same period for repayments of long-term
obligations of $1,152,000 offset by increases in its net borrowing on its bank
line credit of $343,000.
-10-
<PAGE>
As of June 30, 1998, the Company had net working capital of $2,787,000 with a
current ratio of 1.65 to 1.0, which represents a $2,779,000 decrease in working
capital from September 30, 1997.
In March and April 1996, the Company borrowed a total of $900,000 from private
investors through the issuance of unsecured notes due October 21, 1997 and
bearing interest at the rate of 11% per annum. Funds received from these notes
were used to retire outstanding indebtedness and to provide additional working
capital for operations. These notes were repaid in August 1997.
In April 1996, the Company borrowed $658,000 from a commercial bank through the
issuance of an 8.98% promissory note collateralized by its real estate. The
proceeds of the loan were used to retire a previous bank loan and industrial
development revenue bonds, and to provide additional working capital for
operations.
In January 1997, the Company sold an aggregate of 650,000 shares of common stock
to two United States investors for gross proceeds of $1.3 million. Also in
January 1997, the Company sold an aggregate of 1,000,000 shares of common stock
in a private placement to three foreign investors pursuant to Regulation S under
the Securities Act of 1933 for gross proceeds of $2,000,000.
In June 1997, the Company entered into a $3,000,000 revolving credit facility
with Coast Business Credit, a division of Southern Pacific Thrift & Loan
Association of Los Angeles, California. The credit facility is secured by all
of the Company's receivables, inventories, investment property, equipment and
general intangibles, as defined in the agreement. Borrowings under the facility
are payable on demand and are limited to a portion of eligible accounts
receivable and inventories, as defined in a borrowing formula in the agreement.
The agreement is effective through June 30, 1999, with provisions for automatic
extensions of the maturity date. Interest on the credit facility is paid
monthly at a rate equal to the greater of eight percent (8%) or prime plus one
and three-quarters percent (13/4%). At June 30, 1998, the Company had
outstanding borrowings of $716,000 under the facility and had a maximum
availability under the borrowing formula of $1,381,000.
In June 1997, the Company completed an agreement with a vendor whereby
$4,290,000 of an account payable was converted into a promissory note. The note
provides for monthly payments of $150,000 in fiscal 1998 and $175,000 in fiscal
1999. An additional principal payment of $600,000 is required in October 1998
and further principal payments are called for under certain conditions set forth
in the agreement. The note bears interest at 9.25% per annum as of March 31,
1998, with a scheduled increase to 11.25% per annum on October 1, 1998. The
scheduled term of the note is twenty-seven (27) months, with the final payment
due in August 1999. (See additional discussion regarding this note under
"Recent Developments.")
In July 1998, the Company retained investment bankers to assist the Company in
exploring strategic alternatives for increasing shareholder value. The
potential alternatives could include, among others, the sale of the Company or a
division, locating a strategic investor, or making a strategic acquisition.
YEAR 2000
The Company's internal information systems were upgraded during the first
quarter of fiscal 1998 to ensure year 2000 compliance. The total cost of the
implementation was not significant. Additionally, management believes that
current products offered for sale by the Company, as applicable, are also year
2000 compliant. The Company's operations with respect to the year 2000 may also
be affected by other entities with whom it transacts business. The Company is
currently unable to determine the potential impact, if any, that could result
from such entities' failure to adequately address this issue.
-11-
<PAGE>
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
Colorado Actions
On January 8, 1996, the Company commenced a patent infringement trial
against four competitors in the United States District Court of
Colorado. (The patent involved is No. 5,211,129, which relates to
the Company's injectable transponder technology.) On January 29,
1996, the jury in the trial returned a verdict in favor of the Company
and found that the defendants had willfully infringed on the Company's
patent and awarded damages of $444,000, including prejudgment
interest. The defendants appealed the judgment against them, and the
Company cross-appealed the failure of the court to increase Destron's
damages. On July 24, 1997, the Court of Appeals for the Federal
Circuit handed down its decision in the appeal. The decision of the
Court of Appeals affirmed the trial court's judgment, holding the
Company's patent is valid and was willfully infringed by the
competitors. In addition, the issue of inequitable conduct was
remanded to the trial court for further proceedings as to the
Company's intent in prosecuting the patent application before the
United States Patent Office.
On November 7, 1997, the U.S. District Court of Colorado, on remand on
the issue of inequitable conduct, found no intent on the part of the
Company to deceive the Patent Office, and therefore that no
inequitable conduct occurred and the Company's '129 patent was
enforceable. On February 9, 1998, the District Court Judge issued an
Order containing findings and conclusions and entered a Third Amended
Judgment confirming the Court's finding of no inequitable conduct.
The defendants appealed this decision and a decision is not expected
until late 1998 or early 1999.
Further, during the pendency of the first appeal, the Company pursued
a contempt action against the defendants for willful violations of the
District Court's permanent injunction. On November 7, 1997, a
Magistrate Judge of the District Court recommended that the defendants
be found in willful contempt of the permanent injunction and that the
Company should be awarded double damages, amounting to $33,000, as
well as attorneys' fees and costs. On February 9, 1998, the District
Court Judge issued an Order adopting the Magistrate's recommendation
that the defendants were in contempt. This finding of contempt has
also been appealed by the Defendants.
On January 23, 1998, the Company filed a second Motion for Contempt
against the defendants. Following a March 27, 1998 hearing, on
April 23, 1998 the Magistrate Judge entered a recommendation that
the defendants be held in contempt a second time, based upon their
manufacture, use and sale of the ID-100 Zip Quill transponder
product. The Company has requested trebled damages, attorney's
fees, costs and sanctions against the defendants for their contempt
of the District Court permanent injunction. The defendants have
objected to the recommendations of the Magistrate Judge. The
Company anticipates that the District Court will have a hearing and
rule on the matter in late 1998.
-12-
<PAGE>
Minnesota Actions
On December 17, 1996, the same three competitors found to be willful
infringers in the Colorado Actions filed a lawsuit against the Company
and its United States distributor, Schering-Plough, in the United
States District Court for the District of Minnesota. The plaintiffs
alleged that the defendants participated in unfair competition,
breached an oral contract and infringed on three of the plaintiffs'
United States patents. On January 24, 1997, the plaintiffs withdrew
this lawsuit in its entirety.
On April 21, 1997, four plaintiffs (including the three competitors
identified in the foregoing paragraph) filed a lawsuit against the
Company and Schering-Plough and another of the Company's competitors
in the United States District Court for the District of Minnesota.
The plaintiffs allege that the defendants participated in unfair
competition, breached an oral agreement and infringed on three of the
plaintiffs' United States patents and requested that the Court award
compensatory and treble damages of an unspecified amount.
On May 16, 1997, the plaintiffs amended the lawsuit and, in their
complaint as amended, allege patent infringement, false advertising,
unfair competition and attempted monopolization on the part of the
Company, among other matters, stemming from the ISO standards. This
lawsuit has been stayed by agreement of all parties pending the
outcome of the appeal of the Colorado action.
While management of the Company is unable, at this time, to estimate
the potential impact of this litigation, the Company and its legal
counsel believe that its products do not infringe any valid asserted
claims of the patents owned by the plaintiffs, that the false
advertising and unfair competition claims are without merit, that the
Company is likely to prevail on the attempted monopolization claim,
and that the ultimate outcome of this litigation will not have a
significant adverse impact on the Company's future financial position,
cash flows or result of operations. However, any litigation has an
inherent risk of loss at trial, and there can be no assurance of the
ultimate outcome of this lawsuit.
If the Company is successful in obtaining an affirmance of the
judgment of enforceability in the Colorado Action, the Company's
exposure in the Minnesota litigation will likely not be material. As
a result of the favorable ruling in the Colorado Action on February 9,
1998, and as indicated in the above paragraph, the Minnesota
litigation has been stayed pending the Federal Circuit Court decision
in the Colorado action, which is not expected until late 1998, at the
earliest. Accordingly, it is expected that the Company's legal fees
during the remainder of 1998 and early 1999 in the Minnesota
litigation will not be significant because of the stay that has been
entered in the Minnesota litigation.
Item 6. Exhibits and Reports on Form 8-K
a. Exhibits:
Exhibit 11.1 Calculation of Net Income (Loss) Per
Common and Common Equivalent Share
b. Reports on Form 8-K
No current reports on Form 8-K were filed during the quarter
ended June 30, 1998 or since June 30, 1998 and to the date
of this Quarterly Report on Form 10-Q.
-13-
<PAGE>
SIGNATURES
In accordance with 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.
DESTRON FEARING CORPORATION
(Registrant)
Dated: August 12, 1998 /s/ Thomas J. Ahmann
-----------------------------------
By Thomas J. Ahmann
Vice President Finance,
Chief Financial Officer
and Principal Accounting Officer
-14-
<PAGE>
Exhibit 11.1
DESTRON FEARING CORPORATION
Calculation of Basic And Diluted Earnings (Loss)
Per Common and Common Equivalent Share
(in thousands, except per share amounts)
<TABLE>
<CAPTION>
Quarter Ended June 30, Nine Months Ended June 30,
1998 1997 1998 1997
---- ---- ---- ----
<S> <C> <C> <C> <C>
Net income (loss) $ (410) $ (190) $ (892) $ 92
-------- -------- -------- -------
-------- -------- -------- -------
Weighted average number of common
and common equivalent shares
outstanding:
Weighted average number of
common shares outstanding 13,354 13,294 13,316 12,568
Dilutive effect of stock options and
warrants after application of the
treasury stock method - - - 126
-------- -------- -------- -------
13,354 13,294 13,316 12,694
-------- -------- -------- -------
-------- -------- -------- -------
Basic and diluted earnings (loss) per
common and common equivalent share $ (0.03) $ (0.01) $ (0.07) $ 0.01
-------- -------- -------- -------
-------- -------- -------- -------
</TABLE>
-15-
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> SEP-30-1998
<PERIOD-START> OCT-01-1997
<PERIOD-END> JUN-30-1998
<CASH> 515
<SECURITIES> 0
<RECEIVABLES> 1,411
<ALLOWANCES> (136)
<INVENTORY> 5,012
<CURRENT-ASSETS> 7,043
<PP&E> 3,173
<DEPRECIATION> (1,239)
<TOTAL-ASSETS> 11,067
<CURRENT-LIABILITIES> 4,256
<BONDS> 0
0
0
<COMMON> 19,980
<OTHER-SE> (14,176)
<TOTAL-LIABILITY-AND-EQUITY> 11,067
<SALES> 10,103
<TOTAL-REVENUES> 10,103
<CGS> 6,946
<TOTAL-COSTS> 6,946
<OTHER-EXPENSES> 3,663
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 386
<INCOME-PRETAX> (892)
<INCOME-TAX> 0
<INCOME-CONTINUING> (892)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (892)
<EPS-PRIMARY> (0.07)
<EPS-DILUTED> (0.07)
</TABLE>
