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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 September 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 October 31, 1999, was 25,614,033.
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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 September 30, 1999 and 1998................3
Nine Months Ended September 30, 1999 and 1998.................3
Consolidated Balance Sheets as of September 30, 1999
and December 31, 1998...........................................4
Consolidated Statements of Cash Flows:
Nine Months Ended September 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...............................7
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................................14
Signatures..............................................................15
2
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DIAMETRICS MEDICAL, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
1999 1998 1999 1998
----------- ----------- ------------ -----------
<S> <C> <C> <C> <C>
Net sales $ 4,694,294 $ 3,102,430 $ 13,577,227 $ 8,571,181
Cost of sales 4,090,404 2,946,478 11,523,683 8,159,236
----------- ----------- ------------ ------------
Gross profit 603,890 155,952 2,053,544 411,945
----------- ----------- ------------ ------------
Operating expenses:
Research and development 968,693 1,729,984 3,849,777 4,909,526
Sales and marketing 683,416 2,243,197 3,839,572 6,002,781
General and administrative 935,605 888,657 2,812,705 2,540,366
----------- ----------- ------------ ------------
Total operating expenses 2,587,714 4,861,838 10,502,054 13,452,673
----------- ----------- ------------ ------------
Operating loss (1,983,824) (4,705,886) (8,448,510) (13,040,728)
Other income (expense), net 2,637 (86,468) (222,592) (381,259)
----------- ----------- ------------ ------------
Net loss $(1,981,187) $(4,792,354) $ (8,671,102) $(13,421,987)
=========== =========== ============ ============
Basic and diluted net loss per common share $ (0.08) $ (0.21) $ (0.36) $ (0.62)
=========== =========== ============ ============
Weighted average number of
common shares outstanding 25,551,450 22,548,936 24,405,066 21,530,709
=========== =========== ============ ============
</TABLE>
See accompanying notes to consolidated financial statements.
3
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DIAMETRICS MEDICAL, INC.
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
<TABLE>
<CAPTION>
September 30, December 31,
1999 1998
------------- -------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 3,335,993 $ 3,432,614
Marketable securities 12,949,620 2,976,443
Accounts receivable 5,595,862 5,420,092
Inventories 4,614,510 4,767,537
Prepaid expenses and other current assets 392,719 454,291
------------- -------------
Total current assets 26,888,704 17,050,977
------------- -------------
Property and equipment 19,320,002 20,077,383
Less accumulated depreciation and amortization (13,789,744) (13,154,590)
------------- -------------
5,530,258 6,922,793
------------- -------------
Other assets 1,015,868 1,372,544
------------- -------------
$ 33,434,830 $ 25,346,314
============= =============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 3,076,252 $ 2,535,343
Accrued expenses 2,456,860 1,855,004
Other current liabilities 4,778,440 1,245,332
------------- -------------
Total current liabilities 10,311,552 5,635,679
------------- -------------
Long-term liabilities:
Long-term liabilities, excluding current portion 7,904,661 8,163,307
Other liabilities, excluding current portion 389,278 181,764
------------- -------------
Total liabilities 18,605,491 13,980,750
------------- -------------
Shareholders' equity:
Common stock, $.01 par value: 35,000,000 authorized
25,563,283 and 23,391,597 shares issued and outstanding 255,633 233,916
Additional paid-in capital 142,921,790 130,477,220
Accumulated other comprehensive loss (556,575) (225,165)
Accumulated deficit (127,791,509) (119,120,407)
------------- -------------
Total shareholders' equity 14,829,339 11,365,564
------------- -------------
$ 33,434,830 $ 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>
Nine Months Ended
September 30,
1999 1998
------------ ------------
<S> <C> <C>
Cash flows from operating activities:
Net loss $ (8,671,102) $(13,421,987)
Adjustments to reconcile net loss to net
cash used in operating activities:
Depreciation and amortization 1,709,848 2,500,615
Other 4,200 6,952
Changes in operating assets and liabilities:
Accounts receivable (175,770) (1,290,537)
Inventories 153,027 (811,666)
Prepaid expenses and other current assets 61,572 (305,473)
Accounts payable and accrued expenses 1,142,765 (1,078,761)
Deferred credits/revenue 4,640,667 -
------------ ------------
Net cash used in operating activities (1,134,793) (14,400,857)
------------ ------------
Cash flows from investing activities:
Purchases of property and equipment (1,084,375) (1,846,619)
Sale of evaluation and demonstration instruments 1,031,430 -
Purchases of marketable securities (14,074,620) (6,501,680)
Proceeds from maturities of marketable securities 4,101,443 8,401,642
Other 600 5,735
------------ ------------
Net cash provided by (used in) investing activities (10,025,522) 59,078
------------ ------------
Cash flows from financing activities:
Principal payments on borrowings (1,061,571) (1,232,488)
Proceeds from short-term borrowings - 990,000
Net proceeds from the issuance of common stock 12,462,087 16,684,029
Principal payments on capital lease obligations (96,301) (506,398)
------------ ------------
Net cash provided by financing activities 11,304,215 15,935,143
------------ ------------
Effect of subsidiary's year-end change on cash and cash equivalents - (664,819)
Effect of exchange rate changes on cash and cash equivalents (240,521) (116,743)
------------ ------------
Net increase (decrease) in cash and cash equivalents (96,621) 811,802
Cash and cash equivalents at beginning of period 3,432,614 3,358,684
------------ ------------
Cash and cash equivalents at end of period $ 3,335,993 $ 4,170,486
============ ============
Supplemental disclosure of cash flow information:
Cash paid during the period for interest $ 477,219 $ 1,296,369
============ ============
</TABLE>
See accompanying notes to consolidated financial statements.
5
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DIAMETRICS MEDICAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 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 Hewlett-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.
Certain 1998 amounts have been reclassified from prior reported balances to
conform with the 1999 presentation.
(2) COMPREHENSIVE LOSS
The following table sets forth the computation of comprehensive loss:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
1999 1998 1999 1998
----------- ----------- ----------- ------------
<S> <C> <C> <C> <C>
Net loss $(1,981,187) $(4,792,354) $(8,671,102) $(13,421,987)
Change in cumulative translation adjustment 106,111 (58,443) (331,410) (52,167)
----------- ----------- ----------- ------------
Comprehensive loss $(1,875,076) $(4,850,797) $(9,002,512) $(13,474,154)
=========== =========== =========== ============
</TABLE>
(3) Inventories
Inventories are summarized as follows:
September 30, December 31,
1999 1998
------------- ------------
Raw materials $ 2,807,595 $ 1,989,953
Work-in-process 782,689 741,719
Finished goods 1,024,226 2,035,865
----------- -----------
$ 4,614,510 $ 4,767,537
=========== ===========
6
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(4) OTHER CURRENT LIABILITIES
Other current liabilities are summarized as follows:
September 30, December 31,
1999 1998
------------- ------------
Deferred credits $ 1,878,788 $ -
Deferred revenue 2,553,546 -
Current portion of long-term debt
and capital leases 346,106 416,509
Short-term borrowings - 828,823
----------- ----------
$ 4,778,440 $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) 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 ended 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.
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.
(6) 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 September 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 $945,073.
The Company's exclusive distributors, CODMAN, a Johnson and Johnson
Company, and HP, are shareholders of the Company. Sales to these parties
were approximately $3.3 million and $8.8 million for the three and nine
months ended September 30, 1999.
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
7
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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 September 30, 1999, the primary funding for
the operations of the Company has been approximately $143 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 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 $4,694,294 and $13,577,227 for
the three and nine months ended September 30, 1999, compared to $3,102,430
and $8,571,181 for the same periods in the prior year, increases of 51% and
58%, respectively. The increase in sales for the three and nine months
ended September 30, 1999 over the prior year reflects a 93% and 106%
increase in instrument sales and a 5% decrease and 7% increase in
disposable cartridge and sensor sales, respectively. The significant
increase in instrument sales between periods was impacted primarily by
sales to the Company's new distribution partners, CODMAN and HP, partially
offset by the impact of sales returns from displaced distributors. While
unit sales of disposable cartridges and sensors increased between quarterly
periods, revenues declined slightly due to lower average sales prices under
the HP and CODMAN distribution agreements.
Intermittent testing products represented 42% and 39% of total sales for
the three and nine months ended September 30, 1999, compared to 72% and 64%
for the comparable periods in 1998. Continuous monitoring products
comprised the remaining sales in each period.
8
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Intermittent blood testing products revenue was comprised of 64% and 55%
instrument related revenue and 36% and 45% disposable cartridge related
revenue for the three and nine months ended September 30, 1999,
respectively. Continuous monitoring products revenue was comprised of 80%
and 77% instrument related revenue and 20% and 23% disposable sensor
revenue for the three and nine months ended September 30, 1999,
respectively. The high concentration of instrument related revenue was
impacted primarily by sales to CODMAN and HP in the year-to-date period and
by sales to HP in the third quarter.
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 September 30, 1999, the Company has sold
approximately 4,400 instruments. Unit sales of instruments for the three
and nine months ended September 30, 1999, increased approximately 90% and
104%, respectively, over unit sales for the same periods in 1998, while
disposable sensor and cartridge unit sales increased 36% and 32%,
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 anticipates revenue in the fourth quarter of 1999 to grow
modestly relative to the third quarter of 1999, due to the impact of
replacing the Company's direct sales with HP distribution and transitioning
certain existing distributors over to HP, partially offset by an expected
increase in unit volumes. Unit volume growth is expected to continue, with
resulting increased revenue growth in 2000.
Cost of Sales. Cost of sales totaled $4,090,404 and $11,523,683, or 87% and
85% of revenue for the three and nine months ended September 30, 1999,
compared to $2,946,478 and $8,159,236 or 95% of revenue for both of the
comparable 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. These improvements were partially offset by the impact of lower
average sales prices under the HP Distribution Agreement and the impact of
sales returns from displaced distributions. The Company expects gross
margin as a percentage of revenue in the fourth quarter of 1999 to improve
slightly relative to the third quarter, and to continue to improve during
2000, as a result of expected continued improvements in manufacturing
yields, higher unit volumes and product mix.
Operating Expenses. Research and development expenditures totaled $968,693
and $3,849,777 for the three and nine months ended September 30, 1999,
compared to $1,729,984 and $4,909,526 for the same periods in 1998. The
decline in 1999 expenses is primarily due to the recognition of $166,667
and $500,000 in the second and third quarters, respectively, of research
and development funding received from HP as part of the Distribution
Agreement.
Sales and marketing expenses totaled $683,416 and $3,839,572 for the three
and nine months ended September 30, 1999, compared to $2,243,197 and
$6,002,781 for the same periods in 1998. The period-to-period decreases are
primarily due to the recognition of $818,182 and $1,386,364 in the second
and third quarters of 1999, respectively, of sales and marketing funding
received from HP.
General and administrative expenses totaled $935,605 and $2,812,705 for the
three and nine months ended September 30, 1999, compared to $888,657 and
$2,540,366 for the same periods in
9
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1998. The period-to-period increases are primarily due to additional costs
incurred in completing the HP transaction and increased headcount between
periods.
Operating expense run rates for the fourth quarter of 1999 are expected to
approximate or decrease slightly relative to the third quarter of 1999. The
Company targets a decrease in operating expense run rates in 2000 relative
to 1999.
Other Expense. Net other income totaled $2,637 for the three months ended
September 30, 1999 and net other expense totaled $222,592 for the nine
months ended September 30, 1999, compared to net other expense of $86,468
and $381,259 for the same periods in 1998. The Company realized interest
income of $218,643 and $312,295 for the three and nine months ended
September 30, 1999, compared to $119,420 and $301,233 for the same periods
in 1998. The period-to-period increase reflects the impact of higher
average cash balances, primarily due to the timing of the Company's
financing activities.
Interest expense totaled $155,492 and $477,219 for the three and nine
months ended September 30, 1999, compared to $202,988 and $640,819 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 nine months ended September 30,
1999 was $1,981,187 and $8,671,102, compared to $4,792,354 and $13,421,987
for the same periods in 1998. Compared to the three and nine months ended
September 30, 1998, the net loss decreased by 59% and 35%, 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, partially offset by costs incurred to
transition the selling process to HP. The Company targets continued
improvement in net loss for the fourth quarter of 1999, and further
significant improvements in 2000 relative to 1999.
LIQUIDITY AND CAPITAL RESOURCES
- -------------------------------
At September 30, 1999, the Company had working capital of $16,577,152, an
increase of $5,161,854 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 $7.5 million of prepayments from
HP 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 $1,134,793 for the nine
months ended September 30, 1999, compared to $14,400,857 for the same
period in 1998. This was the result of net losses of $8,671,102 and
$13,421,987 for these same periods in 1999 and 1998, respectively, adjusted
by changes in key operating assets and liabilities, primarily accounts
receivable, inventories, accounts payable, accrued expenses and deferred
credits and revenue.
Net accounts receivable increased $175,770 for the nine months ended
September 30, 1999, compared to $1,290,537 for the same period in 1998. The
smaller increase in the current period was primarily due to an improvement
in days sales outstanding on increased sales, and the timing of sales and
related customer payments.
Inventories decreased $153,027 for the nine months ended September 30,
1999, compared to an increase of $811,666 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
10
<PAGE>
inventories of analyzer components in anticipation of beginning internal
assembly of analyzers. The decrease in 1999 primarily reflects a decrease
in finished goods inventory due to significant sales of instruments,
partially offset by an increase in raw material inventory to meet
anticipated production requirements in the fourth quarter.
Accounts payable and accrued expenses increased $1,142,765 for the nine
months ended September 30, 1999, compared to a decrease of $1,078,761 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 $4,640,667 for the nine months ended
September 30, 1999. This increase primarily reflects the receipt of $7.5
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. As of September 30, 1999, approximately $2.9 million of
these receipts were recorded as reductions to second and third quarter
expenses.
Net cash used in investing activities totaled $10,025,522 for the nine
months ended September 30, 1999, compared to net cash provided by investing
activities of $59,078 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 $1,084,375 in 1999 and $1,846,619 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 $1.5 million, primarily reflecting investments to support new
product development and production.
Net cash provided by financing activities totaled $11,304,215 for the nine
months ended September 30, 1999, compared to $15,935,143 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 a private placement of common stock of
approximately $15 million, 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 September 30, 1999, the Company had U.S. net operating loss and research
and development tax credit carryforwards for income tax purposes of
approximately $112,000,000 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 $48,000,000 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
ended 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. As part of an
11
<PAGE>
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, total 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 has addressed 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 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. The Company's IT
systems are Year 2000 compliant company wide.
The Company's assessment of internal systems included 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 included 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' 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
12
<PAGE>
hand to maintain normal production during such a delay period. These
actions are intended to help mitigate the risk of 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 has been incurred in 1999.
These or any potential additional 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 minimizing
the component supply risk by maintaining adequate buffer inventories of
component parts. 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 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
13
<PAGE>
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, Diametrics Medical,
Ltd., are translated into U.S. dollars in consolidation. The Company's
exposure to foreign exchange rate fluctuations also arises from
transferring funds to its U.K. subsidiary in British pounds sterling. 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
None
Item 3. Defaults Upon Senior Securities
None
Item 4. Submission of Matters to a Vote of Security Holders
None
Item 5. Other Information
None
Item 6. Exhibits and Reports on Form 8-K
a. Exhibits
Exhibit Method
No. Description of Filing
------- ----------- ---------
27 Financial Data Schedule Filed herewith
b. Reports on Form 8-K.
On July 23, 1999, the Company filed a Current Report on Form 8-K
relating to the Distribution Agreement and Common Stock Purchase
Agreement, both dated June 6, 1999, between the Company and
Hewlett-Packard Company.
14
<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: November 12, 1999
15
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