<PAGE>
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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-Q
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[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
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Commission file number 0-21982
Diametrics Medical, Inc.
Incorporated pursuant to the Laws of Minnesota
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Internal Revenue Service -- Employer Identification No. 41-1663185
2658 Patton Road, Roseville, Minnesota 55113
(651) 639-8035
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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, 1999, was 25,550,849.
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Diametrics Medical, Inc.
Page
----
Part I -- FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements (unaudited)
Consolidated Statements of Operations:
Three Months Ended June 30, 1999 and 1998.......................3
Six Months Ended June 30, 1999 and 1998.........................3
Consolidated Balance Sheets as of June 30, 1999
and December 31, 1998.............................................4
Consolidated Statements of Cash Flows:
Six Months Ended June 30, 1999 and 1998.........................5
Notes to Consolidated Financial Statements.........................6
Item 2. Management's Discussion and Analysis of Results of Operations
and Financial Condition............................................8
Item 3. Quantitative and Qualitative Disclosures About Market Risk........14
Part II -- OTHER INFORMATION
Item 1. Legal Proceedings.................................................14
Item 2. Changes in Securities.............................................14
Item 3. Defaults Upon Senior Securities...................................14
Item 4. Submission of Matters to a Vote of Security Holders...............14
Item 5. Other Information.................................................14
Item 6. Exhibits and Reports on Form 8-K..................................15
Signatures.................................................................16
2
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DIAMETRICS MEDICAL, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
1999 1998 1999 1998
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Net sales $ 4,639,746 $ 3,052,048 $ 8,882,933 $ 5,468,751
Cost of sales 3,916,373 2,810,068 7,433,279 5,212,758
------------ ------------ ------------ ------------
Gross profit 723,373 241,980 1,449,654 255,993
------------ ------------ ------------ ------------
Operating expenses:
Research and development 1,345,441 1,613,207 2,881,084 3,179,542
Sales and marketing 1,116,317 1,912,765 3,146,431 3,636,562
General and administrative 980,334 805,879 1,877,100 1,651,709
------------ ------------ ------------ ------------
Total operating expenses 3,442,092 4,331,851 7,904,615 8,467,813
------------ ------------ ------------ ------------
Operating loss (2,718,719) (4,089,871) (6,454,961) (8,211,820)
Other expense, net (63,454) (236,569) (234,954) (417,813)
------------ ------------ ------------ ------------
Net loss $ (2,782,173) $ (4,326,440) $ (6,689,915) $ (8,629,633)
============ ============ ============ ============
Basic and diluted net loss per common share $ (0.11) $ (0.20) $ (0.28) $ (0.41)
============ ============ ============ ============
Weighted average number of
common shares outstanding 24,205,935 21,118,721 23,822,374 21,013,158
============ ============ ============ ============
</TABLE>
See accompanying notes to consolidated financial statements.
3
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DIAMETRICS MEDICAL, INC.
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
<TABLE>
<CAPTION>
June 30, December 31,
1999 1998
------------- -------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 6,982,291 $ 3,432,614
Marketable securities 9,950,774 2,976,443
Accounts receivable 6,410,930 5,420,092
Inventories 4,490,931 4,767,537
Prepaid expenses and other current assets 476,810 454,291
------------- -------------
Total current assets 28,311,736 17,050,977
------------- -------------
Property and equipment 18,761,730 20,077,383
Less accumulated depreciation and amortization (13,024,598) (13,154,590)
------------- -------------
5,737,132 6,922,793
------------- -------------
Other assets 1,134,560 1,372,544
------------- -------------
$ 35,183,428 $ 25,346,314
============= =============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 2,731,505 $ 2,535,343
Accrued expenses 2,207,483 1,855,004
Other current liabilities 4,532,454 1,245,332
------------- -------------
Total current liabilities 9,471,442 5,635,679
------------- -------------
Long-term liabilities:
Long-term liabilities, excluding current portion 7,993,160 8,163,307
Other liabilities, excluding current portion 1,012,934 181,764
------------- -------------
Total liabilities 18,477,536 13,980,750
------------- -------------
Shareholders' equity:
Common stock, $.01 par value: 35,000,000 authorized
25,545,362 and 23,391,597 shares issued and outstanding 255,453 233,916
Additional paid-in capital 142,923,447 130,477,220
Accumulated other comprehensive loss (662,686) (225,165)
Accumulated deficit (125,810,322) (119,120,407)
------------- -------------
Total shareholders' equity 16,705,892 11,365,564
------------- -------------
$ 35,183,428 $ 25,346,314
============= =============
</TABLE>
See accompanying notes to consolidated financial statements.
4
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DIAMETRICS MEDICAL, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
Six Months Ended
June 30,
1999 1998
------------ ------------
<S> <C> <C>
Cash flows from operating activities:
Net loss $ (6,689,915) $ (8,629,633)
Adjustments to reconcile net loss to net
cash used in operating activities:
Depreciation and amortization 1,083,798 1,674,868
Common stock and options issued in lieu of cash compensation 4,200 3,150
Gain on disposal of property and equipment -- (1,556)
Changes in operating assets and liabilities:
Receivables, net (990,838) (644,984)
Inventories 276,606 (615,620)
Prepaid expenses and other current assets (22,519) (127,439)
Accounts payable and accrued expenses 548,641 (857,644)
Deferred credits/revenue 5,027,031 --
------------ ------------
Net cash used in operating activities (762,996) (9,198,858)
------------ ------------
Cash flows from investing activities:
Purchases of property and equipment (874,762) (1,241,921)
Sale of evaluation and demonstration instruments 1,031,430 --
Purchases of marketable securities (9,950,774) --
Proceeds from maturities of marketable securities 2,976,443 8,401,642
Other 600 5,735
------------ ------------
Net cash provided by (used in) investing activities (6,817,063) 7,165,456
------------ ------------
Cash flows from financing activities:
Principal payments on borrowings (981,934) (179,696)
Proceeds from short-term borrowings -- 990,000
Net proceeds from the issuance of common stock 12,463,564 1,556,459
Principal payments on capital lease obligations (94,789) (446,609)
------------ ------------
Net cash provided by financing activities 11,386,841 1,920,154
------------ ------------
Effect of subsidiary's year-end change on cash and cash equivalents -- (664,819)
Effect of exchange rate changes on cash and cash equivalents (257,105) 29,657
------------ ------------
Net increase (decrease) in cash and cash equivalents 3,549,677 (748,410)
Cash and cash equivalents at beginning of period 3,432,614 3,358,684
------------ ------------
Cash and cash equivalents at end of period $ 6,982,291 $ 2,610,274
============ ============
Supplemental disclosure of cash flow information:
Cash paid during the period for interest $ 321,727 $ 1,174,581
============ ============
</TABLE>
See accompanying notes to consolidated financial statements.
5
<PAGE>
DIAMETRICS MEDICAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1999
(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 generally accepted accounting principles 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
necessary for a fair presentation of the interim periods presented,
consisting of normal recurring accruals and entries supporting transactions
executed under the Company's Distribution Agreement with Hewlitt-Packard
Company ("HP"), discussed in this Form 10-Q (see note 4). 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.
These statements should be read in conjunction with the financial statements
and related notes which are incorporated by reference in the Company's
Annual Report on Form 10-K for the year ended December 31, 1998.
(2) COMPREHENSIVE LOSS
The following table sets forth the computation of comprehensive loss:
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
1999 1998 1999 1998
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Net loss $(2,782,173) $(4,326,440) $(6,689,915) $(8,629,633)
Change in cumulative translation adjustment (172,654) 35,853 (437,521) 6,276
----------- ----------- ----------- -----------
Comprehensive loss $(2,954,827) $(4,290,587) $(7,127,436) $(8,623,357)
=========== =========== =========== ===========
</TABLE>
(3) INVENTORIES
Inventories are summarized as follows:
June 30, December 31,
1999 1998
---------- ----------
Raw materials $1,353,812 $ 974,886
Work-in-process 475,769 741,719
Finished goods 2,661,350 3,050,932
---------- ----------
$4,490,931 $4,767,537
========== ==========
6
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(4) OTHER CURRENT LIABILITIES
Other current liabilities are summarized as follows:
June 30, December 31,
1999 1998
---------- ----------
Deferred credits $2,515,151 $ --
Deferred revenue 1,678,547 --
Current portion of long-term debt and
capital leases 338,756 416,509
Short-term borrowings -- 828,823
---------- ----------
$4,532,454 $1,245,332
========== ==========
The Company's Distribution Agreement with HP, discussed below, provides for
prepaid funding of sales and marketing costs during a sales transition
period, research and development funding, as well as prepaid royalty
payments over the term of the agreement resulting in deferred credits and
deferred revenue that will be recognized over the periods benefited.
(5) OTHER LIABILITIES, EXCLUDING CURRENT PORTION
Other liabilities, excluding current portion are summarized as follows:
June 30, December 31,
1999 1998
---------- ----------
Deferred revenue $ 833,333 $ --
Other 179,601 181,764
---------- ----------
$1,012,934 $ 181,764
========== ==========
(6) SHAREHOLDERS' EQUITY
As part of an exclusive Distribution Agreement initiated on October 1, 1998,
the Company entered into a $5,000,000 Put Option and Stock Purchase
Agreement with Johnson & Johnson Development Corporation ("JJDC") who
committed to purchase up to $5,000,000 of the Company's Common Stock at the
Company's option over the twelve month period ending September 30, 1999.
Effective March 26, 1999, the Company exercised approximately $4 million of
the available Put Option, resulting in the issuance of 773,184 shares of the
Company's Common Stock to JJDC at a per share price of $5.17. Proceeds to
the Company of approximately $4 million will be used for product
development, sales and marketing and other general corporate purposes. The
Company has the option to exercise the remaining available balance of the
Put Option, totaling approximately $1 million, through September 30, 1999.
As part of an exclusive Distribution Agreement initiated on June 6, 1999
between the Company and HP, on June 28, 1999 the Company completed the sale
in a private placement of 1,357,143 shares of Common Stock at a price of
$7.00 per share, resulting in proceeds of approximately $9.5 million. HP
also received a warrant to purchase 452,381 shares of Common Stock at $8.40
per share. The warrant expires on August 4, 2003.
(7) RELATED PARTY TRANSACTIONS
One of the Company's directors is also a director of DVI, Inc., a health
care finance company with which the Company has a credit line and notes
payable. As of June 30, 1999, there were no outstanding advances against the
$1,000,000 receivable backed credit line and the outstanding balance of the
notes payable totaled $1,024,710.
7
<PAGE>
Item 2. Management's Discussion and Analysis of Results of Operations and
-------------------------------------------------------------------------
Financial Condition
-------------------
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, Year 2000
compliance, 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 the availability of capital to finance
growth. These and other risks are discussed in greater detail in Exhibit 99
to the Company's Form 10-K filed with the U.S. Securities and Exchange
Commission, with respect to the Company's fiscal year ended December 31,
1998. When used in the 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.
SUMMARY
-------
Diametrics Medical, Inc. (the "Company"), which began operations in 1990, is
engaged in the development, manufacturing and marketing 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 sales organization. As of June 30, 1999, the primary funding for the
operations of the Company has been approximately $144 million raised through
public and private sales of its equity securities and issuance of
convertible promissory notes.
In October 1998, the Company entered into an exclusive Distribution
Agreement with CODMAN, a Johnson and Johnson Company, for worldwide market
development and distribution of the Company's Neurotrend(TM) system.
Neurotrend allows clinicians to monitor oxygen, carbon dioxide, acidity and
temperature in the brain of a patient who is undergoing surgery or has
experienced severe head injury. Sales of the Neurotrend system to CODMAN
began in fourth quarter 1998.
On June 7, 1999, the Company and HP announced that HP had signed an
exclusive worldwide Distribution Agreement to market, sell and distribute
the Company's Paratrend(R) and Neotrend(TM) continuous blood-gas monitoring
systems and the IRMA(R) SL point-of-care blood analysis system. Under the
terms of the Distribution Agreement, the Company will transfer full
responsibility for marketing, sales and distribution for these products to
HP. The initial term of the Distribution Agreement is three and a half
years, with the option for extensions. Concurrently with the execution of
the Distribution Agreement, HP agreed to acquire $9.5 million of the
Company's Common Stock at $7.00 per share, with a warrant to purchase
452,381 shares of Common Stock at $8.40 per share. The sale of shares of
Common Stock to HP for $9.5 million was completed on June 28, 1999. In
addition to HP's equity investment, the Distribution Agreement also provides
for minimum purchase commitments, market development commitments, research
and development funding and royalty payments over the term of the agreement,
as well as funding of sales and marketing costs during a sales transition
period.
RESULTS OF OPERATIONS
---------------------
Sales. Sales of the Company's products were $4,639,746 and $8,882,933 for
the three and six months ended June 30, 1999, compared to $3,052,048 and
$5,468,751 for the same periods in the prior year, increases of 52% and 62%,
respectively. The increase in sales for the three and six months ended June
30, 1999 over the prior year reflects a 96% and 114% increase in instrument
sales, and a 2% and 12% increase in disposable cartridge and sensor sales,
respectively. The
8
<PAGE>
significant increase in instrument sales between periods was impacted
primarily by sales to the Company's new distribution partners, CODMAN and
HP.
Intermittent testing products represented 41% and 38% of total sales for the
three and six months ended June 30, 1999, compared to 60% for both
comparable periods in 1998. Continuous monitoring products comprised the
remaining sales in each period.
Intermittent blood testing products revenue was comprised of 58% and 49%
instrument related revenue and 42% and 51% disposable cartridge related
revenue for the three and six months ended June 30, 1999, respectively.
Continuous monitoring products revenue was comprised of 76% and 75%
instrument related revenue and 24% and 25% disposable sensor revenue for the
three and six months ended June 30, 1999, respectively. The high
concentration of instrument related revenue was impacted primarily by sales
to CODMAN and HP, the Company's new distribution partners.
The Company's revenues are affected principally by the number of
instruments, both monitors and IRMA analyzers, placed with customers and the
rate at which disposable sensors and cartridges are used in connection with
these products. As of June 30, 1999, the Company has sold approximately
3,800 instruments. Unit sales of instruments for the three and six months
ended June 30, 1999, increased approximately 145% and 115%, respectively,
over unit sales for the same periods in 1998, while disposable sensor and
cartridge unit sales increased 27% and 30%, respectively, over the same
periods in 1998. As the Company grows, it is expected that the Company's
growing customer base will increase its rate of usage of disposable
products, with the result that overall disposable product sales will exceed
that of instrument sales.
The Company expects that the new HP Distribution Agreement will require the
termination of the distribution rights of certain existing distributors of
its products. As such, the Company expects that it will experience some
sales returns for unsold inventory held by displaced distributors. The
Company recorded a reserve against revenue during the first six months of
1999 totaling approximately $600,000 for estimated distributor sales
returns.
The Company anticipates revenue in each of the remaining quarters of 1999 to
be similar to or grow modestly relative to the second quarter of 1999, due
to the impact of replacing the Company's direct sales with HP distribution
resulting in lower average sales prices, partially offset by an expected
increase in unit volumes, and the impact of transitioning certain existing
distributors over to HP.
Cost of Sales. Cost of sales totaled $3,916,373 and $7,433,279, or 84% of
revenue for both the three and six months ended June 30, 1999, compared to
$2,810,068 and $5,212,758 or 92% and 95% of revenue for the same periods in
the prior year. The significant period-to-period improvement in the
Company's cost of sales as a percentage of revenue reflects increased
cartridge sales volumes, improved cartridge yields, and the impact of cost
controls and manufacturing process changes. Also favorably affecting gross
profit in 1999 was a higher mix of instrument sales. The Company expects
gross margin in the second half of 1999 to approximate that of the first
half as a result of expected continued improvements in manufacturing yields
and higher unit volumes being offset by lower average sales prices stemming
from the HP Distribution Agreement.
Operating Expenses. Research and development expenditures totaled $1,345,441
and $2,881,084 for the three and six months ended June 30, 1999, compared to
$1,613,207 and $3,179,542 for the same periods in 1998. The decline in 1999
expenses is primarily due to the recognition of $166,667 in the second
quarter of research and development funding received from HP as part of the
Distribution Agreement, and also due to reduced costs for new product
development.
Sales and marketing expenses totaled $1,116,317 and $3,146,431 for the three
and six months ended June 30, 1999, compared to $1,912,765 and $3,636,562
for the same periods in 1998.
9
<PAGE>
The period-to-period decreases are primarily due to the recognition of
$818,182 in the second quarter of sales and marketing funding received from
HP, partially offset in the year-to-date period by higher travel costs
associated with an increase in direct sales and increased sales support
costs for placement of the Company's products with new customers.
General and administrative expenses totaled $980,334 and $1,877,100 for the
three and six months ended June 30, 1999, compared to $805,879 and
$1,651,709 for the same periods in 1998. The period-to-period increases are
primarily due to additional travel and support services incurred in
completing the HP transaction and increased headcount between periods.
Operating expense run rates for the remaining half of 1999 are expected to
decrease relative to the first half of 1999, due primarily to funding from
HP for sales and marketing and research and development costs and a
reduction in selling expenses of the Company due to the HP Distribution
Agreement.
Other Expense. Net other expense totaled $63,454 and $234,954 for the three
and six months ended June 30, 1999, compared to $236,569 and $417,813 for
the same periods in 1998. The Company realized interest income of $51,338
and $93,652 for the three and six months ended June 30, 1999, compared to
$70,943 and $181,813 for the same periods in 1998. The period-to-period
decrease reflects the impact of lower average cash balances, primarily due
to the timing of the Company's financing activities, and lower interest
rates.
Interest expense totaled $156,313 and $321,727 for the three and six months
ended June 30, 1999, compared to $212,130 and $437,831 for the same periods
in 1998. The period-to-period decrease reflects the impact of lower average
debt balances and a reduction in the amount of higher interest bearing
capital lease debt relative to total debt outstanding.
Net Loss. The net loss for the three and six months ended June 30, 1999 was
$2,782,173 and $6,689,915, compared to $4,326,440 and $8,629,633 for the
same periods in 1998. Compared to the three and six months ended June 30,
1998, the net loss decreased by 36% and 22%, respectively for the same
periods in 1999. These decreases reflect the revenue growth previously
discussed; improved margins, influenced by higher unit volumes, changes in
product mix and improved manufacturing yields; and reduced operating
expenses due primarily to research and development and sales and marketing
funding received from HP. The Company targets net losses for the second half
of 1999 to decline at a rate exceeding the decline in the first half of
1999.
LIQUIDITY AND CAPITAL RESOURCES
-------------------------------
At June 30, 1999, the Company had working capital of $18,840,294, an
increase of $7,424,996 from the working capital reported at December 31,
1998. The increase is impacted primarily by financing proceeds of
approximately $13.5 million consisting of $4 million from the Company's
exercise in the first quarter of a Put Option under a Put Option and Stock
Purchase Agreement with JJDC, and a $9.5 million equity investment by HP in
June. Additionally, the Company received $6 million of prepayments from HP
in June representing funding for royalties and research and development and
sales and marketing expenses. These increases were partially offset by net
cash used in operating activities.
Net cash used in operating activities totaled $762,996 for the six months
ended June 30, 1999, compared to $9,198,858 for the same period in 1998.
This was the result of net losses of $6,689,915 and $8,629,633 for these
same periods in 1999 and 1998, respectively, adjusted by changes in key
operating assets and liabilities, primarily accounts receivable, inventories
and accounts payable, accrued expenses and deferred credits and revenue.
Net accounts receivable increased $990,838 for the six months ended June 30,
1999, compared to $644,984 for the same period in 1998. The larger increase
in the current period was primarily due to increased sales in the first six
months of 1999 compared to the same period in the prior year and the timing
of sales and related customer payments.
10
<PAGE>
Inventories decreased $276,606 for the six months ended June 30, 1999,
compared to an increase of $615,620 for the same period in 1998. The
increase in 1998 was primarily due to an increase in cartridge raw material
and work-in-process inventory levels as the Company transitioned from its
adhesive cartridge to its new snapfit cartridge platform, as well as
increased inventories of analyzer components in anticipation of beginning
internal assembly of analyzers in the third quarter of 1998. The decrease in
1999 primarily reflects significant sales of instruments.
Accounts payable and accrued expenses increased $548,641 for the six months
ended June 30, 1999, compared to a decrease of $857,644 for the same period
in 1998. The increase in 1999 was primarily due to accrued financing and
other costs associated with the HP Distribution Agreement and Common Stock
Purchase Agreement. The decrease in 1998 was primarily due to a reduction in
accrued interest payable, due to the timing of interest payments, combined
with timing of payments to vendors and employees.
Deferred credits and revenue increased $5,027,031 for the six months ended
June 30, 1999. This increase primarily reflects the receipt of $6 million of
prepaid funding from HP under the terms of the Distribution Agreement. This
prepayment represents partial funding of current and future sales and
marketing and research and development expenses, as well as royalty
payments. During the second quarter 1999, approximately $1 million of these
receipts were recorded as reductions to second quarter expenses.
Net cash used in investing activities totaled $6,817,063 for the six months
ended June 30, 1999, compared to net cash provided by investing activities
of $7,165,456 for the same period in 1998. This change was affected
primarily by the amounts and timing of private equity placements, which
affected the amount of proceeds from maturities of marketable securities and
purchases of marketable securities. Purchases of property and equipment,
totaling $874,762 in 1999 and $1,241,921 in 1998, also affected net cash
used in investing activities in each period. In 1999, the Company expects
capital expenditures and new lease commitments to approximate $2.4 million,
primarily reflecting investments to support new product development and
production.
Net cash provided by financing activities totaled $11,386,841 for the six
months ended June 30, 1999, compared to $1,920,154 for the same period in
1998. In 1999, net cash provided by financing activities consisted primarily
of proceeds of approximately $4 million from the issuance of common stock as
a result of the exercise of a Put Option under a Put Option and Stock
Purchase Agreement with JJDC described below, and the previously described
$9.5 million private equity placement with HP, partially offset by principal
payments on borrowings and capital lease obligations. Net cash provided by
financing activities in 1998 was primarily due to proceeds from employee
stock plans, warrant exercises and a draw-down on a line of credit,
partially offset by principal payments on borrowings and capital lease
obligations.
At June 30, 1999, the Company had U.S. net operating loss and research and
development tax credit carryforwards for income tax purposes of
approximately $110,000,000 and $939,000, respectively. Pursuant to the Tax
Reform Act of 1986, use of the Company's net operating loss carryforwards
are limited due to a "change in ownership". The Company estimates that the
use of the U.S. net operating losses incurred prior to August 4, 1995 are
subject to annual limitations of approximately $9.8 million per year. Net
operating losses incurred since August 4, 1995 are not currently subject to
the "change in ownership" limitations. If not used, these net operating loss
carryforwards begin to expire in 2005.
The Company's foreign subsidiary also has net operating loss carryforwards
of approximately $46,000,000 which can be carried forward indefinitely.
As part of an exclusive Distribution Agreement initiated on October 1, 1998,
the Company entered into a $5,000,000 Put Option and Stock Purchase
Agreement with JJDC who committed to purchase up to $5,000,000 of the
Company's Common Stock at the Company's option over the twelve month period
ending September 30, 1999. Effective March 26, 1999, the Company exercised
approximately $4 million of the available Put Option resulting in the
issuance of 773,184
11
<PAGE>
shares of the Company's Common Stock to JJDC at a per share price of $5.17.
As part of an exclusive Distribution Agreement and Common Stock Purchase
Agreement with HP completed in June 1999, the Company issued 1,357,143
shares of Common Stock to HP at a price of $7.00 per share, for aggregate
proceeds of $9.5 million. HP also received a warrant to purchase 452,381
shares of Common Stock at $8.40 per share, providing additional funding
potential of $3.8 million. In addition, HP has agreed to minimum purchase
commitments, market development commitments, research and development
funding and royalty payments which, with the stock purchase commitment,
aggregate in excess of $100 million.
The Company believes proceeds from the funding agreements with HP and
currently available funds and cash generated from projected operating
revenues, supplemented by proceeds from employee stock plans, warrant
exercises and asset based credit will meet the Company's working capital
needs. If the amount or timing of funding from these sources or cash
requirements vary materially from those currently planned, the Company could
require additional capital. The Company's long-term capital requirements
will depend upon numerous factors, including the rate of market acceptance
of the Company's products and the level of resources devoted to expanding
the Company's business, manufacturing capabilities and 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 if needed.
YEAR 2000 COMPLIANCE
--------------------
The Company is addressing the issues associated with computing difficulties
that may affect existing computer systems as a result of programming code
malfunction in distinguishing 21st century dates from 20th century dates
(the "Year 2000" issue). The Year 2000 issue is a pervasive problem
affecting many information technology systems and embedded technologies in
all industries. The Company has identified teams of internal staff to review
its products; its internal financial, manufacturing and other process
control systems; and its interface with major customers and suppliers in
order to assess and remediate Year 2000 concerns.
The Company's information technology ("IT") systems consist of computer
hardware systems and software supplied by third parties. IT systems in the
Company's U.S. operations are Year 2000 compliant. The Company has
identified and is implementing necessary software and hardware upgrades to
achieve compliance for IT systems in its U.K. operations, with completion
scheduled for August 1999, allowing adequate time for testing and training.
The Company's assessment of internal systems includes a review of non IT
systems (systems that contain embedded technology in manufacturing or
process control equipment containing microprocessors or other similar
circuitry). This assessment includes a review of the Company's internal
manufacturing equipment and facilities (including building maintenance,
security, electrical, lighting, fire protection, telephone, heating and
cooling systems). Based upon this review, the Company believes that its
manufacturing processes and equipment and internal process control equipment
are Year 2000 compliant company wide.
The Company has assessed Year 2000 compliance of its products offered for
sale to customers, and believes that all are currently compliant. Contacts
have been made with the Company's customers regarding test procedures they
can apply to verify compliance of the Company's products.
The Company has identified third parties with which it has material
relationships, including suppliers of components for its products and
providers of critical utility services. The majority of the raw materials
and purchased components used to manufacture the Company's products are
readily available. Most of the raw materials are or may be obtained from
more than one source. A small number of these materials, however, are unique
in their nature, and are therefore single sourced. The Company has contacted
all major third party suppliers and has received representations that if not
currently compliant, each has plans in place to ensure that products
purchased by the Company from such suppliers will function properly in the
Year 2000 and that such suppliers'
12
<PAGE>
internal systems will be Year 2000 compliant no later than November 1999. To
minimize the impact of any potential temporary delay in the ability of the
Company's key suppliers to provide components for its products in early
2000, the Company plans to have sufficient buffer inventory on hand to
maintain normal production during such a delay period. The Company is also
currently evaluating alternative supplier sources, where appropriate, in
cases where it is single sourced. These actions are intended to help
mitigate the possible external impact of the Year 2000 problem. Even
assuming that all material third parties confirm that they are or expect to
be Year 2000 compliant by December 31, 1999, it is not possible to state
with certainty that such parties will be so compliant. It is impossible to
fully assess the potential consequences in the event service interruptions
from component suppliers occur or in the event that there are disruptions in
such infrastructure areas as utilities, communications, transportation,
banking and government.
The total estimated incremental cost required to address the Company's Year
2000 compliance is approximately $150,000, including the cost of software
and hardware upgrades. The majority of this cost will be incurred in 1999.
The actual cost, however, could exceed this estimate. These costs are not
expected to have a material effect on the Company's financial position,
results of operations or cash flows.
Based upon its assessments to date, the Company believes it will not
experience any material disruption in its operations as a result of Year
2000 problems in its products, in its internal financial, manufacturing and
other process control systems, or in its interface with major customers and
suppliers. However, if major suppliers, including those providing component
parts, electricity, communications and transportation services, experience
difficulties resulting in disruption of critical supplies or services to the
Company, a shutdown of the Company's operations could occur for the duration
of the disruption. As previously noted, the Company is working on minimizing
the component supply risk by maintaining adequate buffer inventories of
component parts and by evaluating alternative suppliers, where appropriate,
in cases where it is single-sourced. Based upon the results of survey
feedback from its major suppliers of component parts and critical services,
the Company believes the risk of a material disruption in its operations due
to third party issues is very small. Assuming no major disruption in service
from critical third party providers, the Company believes that it will be
able to manage the Year 2000 transition without any material effect on the
Company's results of operations or financial position. There can be no
assurance, however, that unexpected difficulties will not arise and, if so,
that the Company will be able to timely develop and implement a contingency
plan.
EURO CONVERSION
---------------
Effective January 1, 1999, 11 of the 15 member countries of the European
Union (EU) adopted the euro as their common legal currency. On that date,
the participating countries established fixed euro conversion rates between
their existing local currencies and the euro. During the three-and-a-half
year transition period following its introduction, participating countries
will be allowed to transact business both in the euro and in their local
currencies. On July 1, 2002, the euro will be the sole official currency in
participating EU countries.
While the Company will continue to evaluate the impact of the euro
conversion over time, based upon currently available information, management
does not believe that the conversion to the euro currency 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 the
anticipated impact of euro conversion issues faced by the Company from those
previously reported in the Company's Annual Report on Form 10-K for the year
ended December 31, 1998.
NEW ACCOUNTING PRONOUNCEMENTS
-----------------------------
In 1998, the Financial Accounting Standards Board ("FASB") issued SFAS No.
133, "Accounting for Derivative Instruments and Hedging Activities". SFAS
No. 133 establishes accounting and reporting standards for derivative
instruments, including certain derivative instruments embedded in other
contracts and for hedging activities. The statement requires that an entity
recognize all
13
<PAGE>
derivatives as either assets or liabilities in the statement of financial
position and measure those instruments at fair value. SFAS No. 133 is
effective for fiscal years beginning after June 15, 1999; however, in 1999
the FASB issued SFAS No. 137 "Accounting for Derivative Instruments and
Hedging Activities // Deferral of the Effective Date of FASB Statement No.
133, an Amendment of Statement No. 133" which defers the effective date of
SFAS No. 133 to fiscal years beginning after June 15, 2000. The Company is
currently evaluating SFAS No. 133, but does not expect that it will have a
material effect on its financial statements.
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 results of the Company's U.K. subsidiary, DML, are translated into
U.S. dollars in consolidation. The Company's exposure to foreign exchange
rate fluctuations also arises from certain intercompany payable or
receivable balances which are expected to be settled in the foreseeable
future under the terms of the Company's intercompany agreement. The Company
does not currently use derivative financial instruments to hedge against
exchange rate risk. The Company's exposure to interest rate risk is limited
to short-term borrowings under its $1,000,000 receivable backed credit line.
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 had been previously reported in
the Company's Annual Report on Form 10-K for the year ended December 31,
1998.
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
None
Item 2. Changes in Securities
On June 28, 1999, the Company completed the sale in a private placement
of 1,357,143 shares of the Company's Common Stock, par value of $.01
per share at a price of $7.00 per share, for aggregate proceeds of
$9,500,000. The purchaser of Common Stock also received a warrant to
purchase 452,381 shares of Common Stock at $8.40 per share. The
warrant expires on August 4, 2003. The securities were sold pursuant to
Section 4(2) of the Securities Act of 1933, as amended.
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 12,
1999. At the meeting, shareholders voted on the reelection of three
directors for terms expiring at the Annual Meeting of the Company in
2002.
David T. Giddings, Andre' de Bruin and Richard A. Norling were all
reelected and each received 19,030,882 votes "For", 147,029 votes
"Withheld" and no broker non-votes.
Item 5. Other Information
None
14
<PAGE>
Item 6. Exhibits and Reports on Form 8-K
a. Exhibits
Exhibit Method
No. Description of Filing
--- ----------- ---------
10.1 Distribution Agreement, dated June 6, 1999, between (1)
Diametrics Medical, Inc. and Hewlett-Packard Company
10.2 Common Stock Purchase Agreement, dated June 6, 1999, (1)
between Diametrics Medical, Inc. and Hewlett-Packard
Company
10.3 Stock Purchase Warrant, dated effective as of June (1)
28, 1999
27 Financial Data Schedule Filed herewith
(1) Incorporated by reference to the Company's Current Report on
Form 8-K filed July 23, 1999.
b. Reports on Form 8-K.
None
15
<PAGE>
DIAMETRICS MEDICAL, INC.
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, 1999
16
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