UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
For the quarterly period ended March 31, 2003.
For The Transiton Period From __________To __________.
COMMISSION FILE NUMBER 0-19271
(Exact name of registrant as specified in its charter)
(Registrant’s telephone number, including area code)
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 [ ]
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes [X] No [ ]
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
As of May 8, 2003, 34,157,410 shares of the registrant’s Common Stock, $.10 par value, were outstanding.
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CONSOLIDATED BALANCE SHEETS(in thousands, except per share amounts)(Unaudited)
The accompanying notes are an integral part of these consolidated financial statements.
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CONSOLIDATED STATEMENTS OF OPERATIONS(in thousands, except per share amounts)(Unaudited)
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CONSOLIDATED STATEMENTS OF CASH FLOWS(in thousands)(Unaudited)
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Unaudited)
The accompanying unaudited, consolidated financial statements of IDEXX have been prepared in accordance with generally accepted accounting principles in the United States for interim financial information and with the requirements of Form 10-Q.
The accompanying interim consolidated financial statements reflect, in the opinion of the Company’s management, all adjustments necessary for a fair presentation of the financial position and results of operations. The results of operations for the three month period ended March 31, 2003 are not necessarily indicative of the results to be expected for the full year or any future period. These financial statements should be read in conjunction with the Company’s 2002 Annual Report on Form 10-K filed with the Securities and Exchange Commission.
Stock-Based Compensation
The Company measures compensation related to employee stock-based compensation plans in accordance with Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB No. 25”), and elects to disclose the pro forma impact of accounting for stock-based compensation plans under the provisions of Statement of Financial Accounting Standards (“SFAS”) No. 123, “Accounting for Stock-Based Compensation” (“SFAS No. 123”). Accordingly, no SFAS No. 123-based employee compensation cost has been recognized for these plans. Had compensation cost for the Company’s employee stock-based compensation and employee stock purchase plans been determined consistent with the provisions of SFAS No. 123, the Company’s net income and net income per common and common equivalent share would have been reduced to the following pro forma amounts(in thousands, except per share amounts):
In order to determine the pro forma impact under SFAS No. 123, the fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions used for the three months ended March 31, 2002 and March 31, 2003, respectively: no dividend yield for all years; expected volatility of 55% for 2002 and 2003; risk-free interest rates of 3.3% and 3.2% for 2002 and 2003, respectively; and expected lives of 6.0 years for 2002 and 6.1 years for 2003. The weighted average fair value of an option granted during the three months ended March 31, 2002 and March 31, 2003 was $14.28 and $18.59 per share, respectively.
In order to determine the pro forma impact under SFAS No. 123, the fair value of the employees’ purchase rights is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions used for the three months ended March 31, 2002 and March 31, 2003, respectively: no dividend yield for all years; an expected life of one year for all years; expected volatility of 40% for 2002 and 2003; and a risk-free interest rate of 1.2% for both 2002 and 2003. Expected volatility of employee stock purchase rights is based on an expected life of only one year because shares are automatically purchased by plan participants at the end of each semiannual offering. The weighted average fair value of those purchase rights granted in 2002 and 2003 was $7.31 and $6.63 per share, respectively.
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Inventories include material, labor and overhead, and are stated at the lower of cost (first-in, first-out) or market. The components of inventories are as follows (in thousands):
Note 3. Comprehensive Income (in thousands):
The following is a reconciliation of shares outstanding for basic and diluted earnings per share (in thousands):
Options to purchase 787,000 and 4,000 shares for 2002 and 2003, respectively, and warrants to purchase 806,000 shares for 2002 have been excluded from the calculation of shares outstanding for diluted earnings per share because they were anti-dilutive.
From time to time, the Company has received notices alleging that the Company’s products infringe third-party proprietary rights, although the Company is not aware of any pending litigation with respect to such claims. Patent litigation frequently is complex and expensive, and the outcome of patent litigation can be difficult to predict. There can be no assurance that the Company will prevail in any infringement proceedings that may be commenced against the Company. If the Company loses any such litigation, it may be stopped from selling certain products and/or it may be required to pay damages as a result of the litigation.
The Company discloses information regarding its segments in accordance with the provisions of SFAS No. 131, “Disclosures about Segments of an Enterprise and Related Information” (“SFAS No. 131”). SFAS No. 131 requires disclosures about operating segments in annual financial statements and requires selected information about operating segments in interim financial statements. Operating segments are defined as components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision maker, or decision making group, in deciding how to allocate resources and in assessing performance. The Company’s chief operating decision maker is the chief executive officer.
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The Company is organized into business units by market and customer group. The Company’s reportable operating segments are the Companion Animal Group (“CAG”), the Food and Environmental Group (“FEG”) and other. The CAG develops, designs, and distributes products and performs services for veterinarians. CAG also manufactures certain biology-based test kits for veterinarians and develops products for therapeutic applications in companion animals. FEG develops, designs, manufactures and distributes products and performs services to detect disease and contaminants in food animals, food and water. Other is primarily comprised of corporate research and development, CEO succession charge and interest income.
The accounting policies of the operating segments are the same as those described in the summary of significant accounting policies in the Company’s Annual Report on Form 10-K in Note 10.
The following is the segment information (in thousands):
The Company’s Board of Directors has approved the repurchase of up to 10 million shares of the Company’s Common Stock. The Company may make such purchases in the open market or in negotiated transactions. During the three months ended March 31, 2003, the Company repurchased 257,500 shares for $9.3 million. From the inception of the program in August 1999 to March 31, 2003, the Company had repurchased 8.9 million shares for $186.6 million. In addition, during the three months ended March 31, 2003, the Company received 133,139 shares of stock, which were owned by the holder for greater than six months, with a market value of $4.9 million in payment of the exercise price of outstanding stock options.
In January 2002, the Company’s Founder, Chairman and Chief Executive Officer was succeeded by its current Chairman and Chief Executive Officer. Under an employment agreement, the Company is required to make certain payments to its former Chief Executive Officer and provide certain benefits to him following this succession. During the three months ended March 31, 2002, the Company incurred a pre-tax charge of $2.9 million, $1.8 million of which was non-cash, related to this agreement.
The Company provides for the estimated cost of product warranties at the time revenue is recognized. The Company’s actual warranty obligation is affected by product failure rates and service delivery costs incurred in correcting a product failure. Should actual product failure rates or service delivery costs differ from management’s estimates, which are based on historical data and engineering estimates where applicable, revisions to the estimated warranty liability would be required.
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Below is a summary of changes in accrued warranty expense for products sold to customers for the three month periods ended March 31, 2002 and 2003, respectively (in thousands):
This quarterly report on Form 10-Q includes or incorporates forward-looking statements about our business and expectations within the meaning of the Private Securities Litigation Reform Act of 1995, including statements relating to future earnings, revenue growth rates, FDA and other regulatory approvals of our products, timing of product launches, and expenses. You can generally identify forward-looking statements by the fact that they do not relate strictly to historical or current facts. Words such as “expects,” “may,” “anticipates,” “intends,” “would,” “will,” “plans,” “believes,” “estimates,” “should,” and similar words and expressions are intended to help you identify forward-looking statements. These statements give our current expectations or forecasts of future events, are based on current estimates, projections, beliefs, and assumptions of IDEXX and its management, and are not guarantees of future performance. Actual results may differ materially from those described in the forward-looking statements. These forward-looking statements involve a number of risks and uncertainties as more fully described under the heading “Future Operating Results” in this Form 10-Q and in our Annual Report on Form 10-K for the year ended December 31, 2002. The risks and uncertainties discussed herein and in our Annual Report on Form 10-K for the year ended December 31, 2002 do not reflect the potential future impact of any mergers, acquisitions or dispositions. In addition, any forward-looking statements represent our estimates only as of the day this Quarterly Report was first filed with the Securities and Exchange Commission and should not be relied upon as representing our estimates as of any subsequent date. While we may elect to update forward-looking statements at some point in the future, we specifically disclaim any obligation to do so, even if our estimates change.
We operate primarily through two business segments: the Companion Animal Group (“CAG”) and the Food and Environmental Group (“FEG”). CAG comprises our veterinary diagnostic products and services (rapid assays, instruments, instrument consumables and laboratory and consulting services), veterinary pharmaceuticals, and veterinary information products and services. FEG comprises our services and products for water and dairy testing and our production animal services business (poultry and livestock diagnostics). Other is comprised primarily of corporate research and development, a CEO succession charge and interest income.
Reference is made to the section of our 2002 Annual Report on Form 10-K entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Critical Accounting Policies and Estimates” for a discussion of significant judgments and estimates used in the preparation of our consolidated financial statements.
The following is a discussion of the strategic and operating factors that we believe have the most significant effect on the performance of our business.
Our CAG segment accounts for approximately 80% of our sales and is therefore our most significant business. The largest product lines within our CAG segment are instruments and instrument consumables, laboratory services, and rapid assays. To date, revenues from sales of pharmaceutical products have not been substantial. However, we are investing significantly in a pipeline of companion animal pharmaceutical products. If we are successful in developing, obtaining FDA approval for, and marketing these products, we believe that sales of pharmaceutical products will become a more material component of CAG sales in the future.
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By offering to companion animal veterinarians a broad range and an integrated set of proprietary diagnostic products and services, therapeutics and practice management computer systems, we believe we have developed a strong customer franchise, providing us a strategic advantage over companies with more narrow product or service offerings. Our complementary products and services give us scale in sales and distribution in this market, and permit us to offer programs such as “Practice Developer”, a customer reward that encourages purchases across multiple categories and builds customer loyalty. By offering both point-of-care diagnostics for use in the clinic and outside laboratory services, we are able to develop integrated disease management solutions that leverage the advantages of both point-of-care and laboratory testing. In addition, by integrating our practice management software systems with our instruments and with our reference laboratories, we enhance the veterinary practices of our customers by facilitating the flow of medical information in the clinic.
In the U.S., we sell instrument consumables, rapid assays and pharmaceuticals through distributors, and therefore our reported sales of these products are sales made to distributors, rather than sales to veterinarians, the end users. Because distributor inventory levels and purchasing patterns may fluctuate, sales of a particular product line in a particular period may not always be representative of the underlying customer demand for the product. Therefore, we closely track sales of these products by our distributors to the clinics (“clinic-level sales”), which we think provides a more accurate picture of the real growth rate for these products. In the discussion of results below, we note certain instances where we believe reported sales have been influenced, positively or negatively, by changes in distributor inventories.
Instruments and Instrument Consumables. Our instrument strategy is to provide veterinarians with an integrated set of instruments (called IDEXX VetLab®) that, individually and together, provide superior diagnostic information in the clinic, enabling veterinarians to practice better medicine and build more profitable practices. We derive substantial revenues from the sale of consumables that are used in these instruments. During the early stage of an instrument life cycle, we derive relatively greater revenues from instrument placements, while consumable sales become relatively more significant in later stages as the installed base of instruments increases and instrument placements begin to decline. Our long-term success in this area of our business is dependent on our ability both to develop and sell new instruments with enhanced diagnostic capabilities and to maximize customer utilization of those instruments, which creates more consumables sales.
We have a large installed base of VetTest® chemistry analyzers, and substantially all of our revenues from that product line are now derived from consumables sales, although we continue to place instruments through an active rental program in the U.S. and through sales in Europe and Asia Pacific. As a result, the success of this product line is dependent on increased customer utilization of those instruments. Toward that end, we seek to educate veterinarians about best medical practices that emphasize the importance of blood chemistry testing for a variety of diagnostic purposes.
In the fourth quarter of 2002, we introduced our new hematology analyzer, the LaserCyte™ system, which provides more extensive hematological diagnostic information than our original platform, the QBC® VetAutoread™ system. Our success in growing hematology revenues over the next several years will depend upon our ability to sell LaserCyte instruments, although we intend to continue to sell the QBC® VetAutoread™ system. We do not intend to rent LaserCyte instruments in the foreseeable future. At earlier stages in the life cycle of this product, a substantial portion of LaserCyte placements will be made at veterinary clinics that already own our QBC® VetAutoread™ instruments. As a result, net consumables sales are not likely to grow significantly in the near future, as we expect the increase in LaserCyte consumable sales to be largely offset by declines in sales of QBC® VetAutoread™ consumables. However, we believe that the enhanced diagnostic capabilities of the LaserCyte system will lead veterinarians to perform more in-clinic hematology testing, which will increase consumables sales as our installed base of LaserCyte systems increases. In addition, since we produce the LaserCyte consumables, the profitability of these consumables is greater than the profitability of the QBC® VetAutoread™ consumables, which we purchase as finished products.
With all of our instrument lines, we seek to differentiate our products based on superior system capability, quality of diagnostic information, reliability and customer service. Our equipment and consumables typically are sold at a premium price to competitive offerings. Our success depends on our ability to maintain a premium price strategy. In addition, our in-clinic instrumentation competes with outside laboratory services for similar diagnostic information, and such services are typically offered at a lower cost. Therefore, our success also depends on our ability to market the relative attractiveness of in-clinic diagnostic testing, versus less convenient and timely, but lower priced, laboratory testing.
Laboratory Services. We believe that more than half of all diagnostic testing by U.S. veterinarians is done at outside reference laboratories such as our IDEXX Laboratory Services laboratories. We attempt to differentiate our laboratory testing services from those of our competitors primarily on the basis of quality, customer service and technology. Revenue growth in this business is achieved both through increased sales from existing customers and through the acquisition of new customers. Profitability of this business is largely the result of our ability to achieve efficiencies from both volume and operational improvements.
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Rapid Assays. Our rapid assay business comprises single-use kits for in-clinic testing and microwell-based kits for large clinic and laboratory testing for canine and feline diseases and conditions. Our two principal product lines are canine heartworm products (which include the SNAP® 3Dx™ heartworm antigen, Ehrlichia canis and Lyme antibody combination test) and the feline SNAP® FIV antibody/FeLV antigen combination test. Our rapid assay strategy is to develop, manufacture, market and sell proprietary tests with superior performance that address important medical needs. As in our other lines of business, we also seek to differentiate our products through superior customer support. These products carry price premiums over competitive products that do not offer equivalent performance and diagnostic capabilities, and which do not include a similar level of support. We augment our product development and customer service efforts with marketing programs that enhance medical awareness and understanding regarding our target diseases and the importance of diagnostic testing.
Water and Dairy Testing. Our strategy in the water testing business is to develop, manufacture, market and sell proprietary products with superior performance, supported by exceptional customer service. Our customers are primarily water utilities to whom strong relationships and customer support are very important. Over the past several years the rate of growth of this product line has slowed from over 20% to approximately 10% in 2002. The decline in growth rate is the result of increased competition and market penetration. International sales of water testing products represent approximately 35% of total water product sales and we expect that future growth in this business will be significantly dependent on our ability to increase international sales. Growth also will be dependent on our ability to enhance and broaden our product line. Most water microbiological testing is driven by regulation, and in many countries a test may not be used for regulatory testing unless it has been approved by the applicable regulatory body. As a result, we maintain an active regulatory program under which we are seeking regulatory approvals in a number of countries, primarily in Europe. We follow a similar strategy in marketing and selling our dairy testing products.
Production Animal Services. We develop, manufacture, market and sell a broad range of tests for various poultry, cattle and swine diseases and conditions, and have an active research and development and in-licensing program in this area. Our strategy is to offer proprietary tests with superior performance characteristics. Disease outbreaks are episodic and unpredictable and certain diseases that are prevalent at one time may be substantially contained or eradicated. In response to outbreaks, testing initiatives may lead to exceptional demand for certain products in certain periods. Conversely, successful eradication programs may result in significantly decreased demand for certain products. The performance of this business, therefore, can be subject to fluctuation. In 2002, approximately 65% of our sales in this business were international. Because of the significant dependence of this business on international sales, the performance of the business is particularly subject to the various risks described below that are associated with doing business internationally.
Total Company. Revenue for the total company increased $12.7 million, or 13%, to $109.2 million from $96.6 million in the same period of the prior year. The following table presents revenue for the Company and its operating segments:
Companion Animal Group. Revenue for CAG increased $11.8 million, or 15%, to $88.2 million from $76.4 million in the same period of the prior year. This increase resulted primarily from increased sales of instrument consumables, sales of our LaserCyte™ system, and increased sales of rapid assay products and laboratory services. The favorable impact of currency exchange rates on sales outside the U.S. contributed an aggregate of $2.5 million to the increase in CAG revenue.
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The increase in sales of instrument consumables (approximately $4.1 million, or 17%) resulted primarily from a positive impact from changes in distributor inventory levels (which decreased $3.2 million in the first quarter of 2002 and decreased $1.9 million in the first quarter of 2003), the favorable impact of currency exchange rates on sales outside of the U.S., and strong volume growth outside of the U.S.
Sales of LaserCyte™, a hematology system introduced in November 2002, contributed $3.0 million to the revenue increase.
The increase in sales of rapid assay products (approximately $2.6 million, or 16%) resulted primarily from increased clinic-level sales of canine heartworm and feline test kits, increased prices including the impact of reduced accruals on sales of canine heartworm kits associated with volume rebate programs, and the favorable impact of currency exchange rates on sales outside of the U.S.
The increase in sales of laboratory services (approximately $2.6 million, or 14%) resulted primarily from higher volume worldwide and, to a lesser extent, the favorable impact of currency exchange rates on sales at our laboratories outside the U.S. and price increases in the U.S.
We estimate that reported total year 2003 CAG revenue growth will be approximately 14%. Sales of our LaserCyte hematology instrument are expected to be a significant component of this growth. We expect reported revenue growth for instrument consumables and rapid assay products to drop in the second half of 2003 as the majority of 2002 distributor inventory reductions (which increase reported growth in 2003) occurred in the first half of 2002.
Food and Environmental Group. Revenue for FEG increased $0.9 million, or 5%, to $21.1 million from $20.1 million for the same period of the prior year. The increase was due to an increase in sales of water testing products, and poultry and livestock tests, offset in part by a decrease in sales of dairy testing products. The favorable impact of currency exchange rates on sales outside the U.S. contributed an aggregate of $1.1 million to the increase in FEG revenue.
The increase in sales of water testing products (approximately $0.7 million, or 8%) resulted primarily from increased average unit prices as a result of higher relative volumes in regions where our products sell at higher average prices, and the favorable impact of currency exchange rates on sales outside of the U.S.
The increase in sales of poultry and livestock tests (approximately $0.5 million, or 8%) resulted from the favorable impact of currency exchange rates on sales outside of the U.S.
The decrease in sales of dairy testing products (approximately $0.3 million, or 8%) was attributable primarily to lower unit sales volume as a result of lost market share, offset partially by the favorable impact of currency exchange rates on sales outside of the U.S.
Total Company. Gross profit for the total company increased $8.4 million, or 20%, to $51.5 million from $43.1 million for the same period in the prior year. As a percentage of total company revenue, gross profit increased from 45% to 47%. The following table presents gross profit and gross profit percentage for the Company and its operating segments:
Companion Animal Group. Gross profit for CAG increased $7.7 million, or 24%, to $39.4 million from $31.7 million in the same period of the prior year, primarily due to an increase in the gross profit percentage and increased sales volume across the CAG product lines. As a percentage of CAG revenue, gross profit increased to 45% from 41% for the same period in the prior year. The increase in gross profit percentage was attributable primarily to reduced inventory writedowns; higher relative sales of high margin rapid assay products; higher prices, primarily on laboratory services and heartworm test kits; productivity improvements across CAG product lines, partly due to fixed costs spread against a higher revenue base; and reduced amortization of VetTest instruments in our rental and trade-up programs as units become fully amortized. These factors were offset partially by higher cost of VetTest® slides purchased in 2002 and sold in 2003 as a result of the 2002 renegotiation of our VetTest slide supply agreement with Ortho-Clinical Diagnostics. We expect that VetTest slides purchased in 2002 will be fully sold by the end of the third quarter of 2003, at which time the associated cost of sales will be reduced to levels more comparable with the first nine months of 2002. Foreign currency exchange rates had only a minor impact on gross margin percentage, as the positive impact of the strengthening of foreign currencies on sales denominated in those currencies was almost fully offset by foreign exchange hedge contract losses in the current period.
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Food and Environmental Group. Gross profit for FEG increased $0.7 million, or 6%, to $12.1 million from $11.4 million for the same period in the prior year, primarily due to a small increase in the gross profit percentage. The increase in gross profit percentage was attributable primarily to a favorable mix of higher margin poultry, livestock and water testing products, increased average unit prices as a result of higher relative volumes in regions where our products sell at higher average prices, and reduced inventory writedowns. These factors were offset partially by higher royalty expenses and unfavorable manufacturing costs. Foreign currency exchange rates had only a minor impact on gross margin percentage, as the positive impact of the strengthening of foreign currencies on sales denominated in those currencies was more than offset by foreign exchange hedge contract losses in the current period.
Total Company. Total company operating expenses increased $1.3 million to $34.0 million from $32.7 million for the same period of the prior year. As a percentage of revenues, operating expenses declined to 31% from 34%. The following tables present operating expenses and operating income for the Company and its operating segments:
Companion Animal Group. Operating expenses for CAG increased $3.0 million, or 13%, to $26.7 million from $23.7 million in the same period of the prior year. This increase resulted primarily from increased spending on sales, marketing, and administration (including the unfavorable impact of foreign currency denominated expenses) to support higher sales volumes, and increased staffing for research and development projects. These increases were offset partially by a favorable impact from currency related transaction gains, reduced research and development expenses related to LaserCyte™, a reduction in bad debt expense, and the impact of certain non-recurring expenses related to rapid assay development efforts in 2002.
Food and Environmental Group. Operating expenses for FEG increased $1.1 million, or 21%, to $6.5 million from $5.4 million in the same period of the prior year. This increase resulted primarily from increased spending on sales, marketing, and administration (including the unfavorable impact of foreign currency denominated expenses) to support anticipated higher sales volumes, and increased spending on research and development projects. These increases were offset partially by reduced legal spending.
Other. Operating expenses for other decreased $2.8 million to $0.8 million from $3.6 million in the same period of the prior year. The decrease resulted primarily from non-recurring severance and related benefits provided in connection with the retirement of our Founder, Chairman and Chief Executive Officer in January 2002.
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Net interest income was $0.7 million for the three months ended March 31, 2003 compared to $0.6 million for the same period in the prior year. The increase was due to higher invested cash balances partially offset by lower effective interest rates.
Our effective tax rate was 33.5% for the three-month period ended March 31, 2003 compared with 34% for the three-month period ended March 31, 2002. The reduction in the effective tax rate was due to increased benefits resulting from U.S. and international planning initiatives.
In November 2002, the Financial Accounting Standards Board (“FASB”) issued FIN No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others, an interpretation of FASB Statements No. 5, 57 and 107 and rescission of FASB Interpretation No. 34” (“FIN No. 45”). FIN No. 45 requires that a guarantor recognize, at the inception of a guarantee, a liability for the fair value of the obligation undertaken by issuing the guarantee. FIN No. 45 also requires additional disclosures to be made by a guarantor in its interim and annual financial statements about its obligation under certain guarantees it has issued. The accounting requirements for the initial recognition of guarantees are applicable on a prospective basis for guarantees issued or modified after December 31, 2002. The disclosure requirements are effective for all guarantees outstanding, regardless of when they were issued or modified, for financial statements for interim or annual periods ending after December 15, 2002. We have adopted the additional disclosure provisions of this statement required for the year ended December 31, 2002 and the recognition provisions for the quarter ended March 31, 2003. There were no impacts of the adoption of this statement.
In November 2002, the FASB’s Emerging Issues Task Force reached consensus on EITF No. 00-21, “Accounting for Revenue Arrangements with Multiple Deliverables” (“EITF No. 00-21”). EITF No. 00-21 addresses the accounting treatment for arrangements that provide for the delivery or performance of multiple products or services where the delivery of a product, system or separation of the multiple deliverables that meet certain requirements into individual units of accounting that are accounted for separately under the appropriate authoritative accounting literature. EIFT No. 00-21 is applicable to revenue arrangements entered into in fiscal periods beginning after June 15, 2003. The Company does not expect the provisions of EIFT No. 00-21 to have a material impact on its results of operations or financial position.
We fund the capital needs of our business through our existing cash, cash equivalents and investments and cash generated from operations. At March 31, 2003, we had $175.4 million of cash, cash equivalents and short-term investments, and working capital of $239.9 million. As of March 31, 2003, we also had long-term investments in debt securities of $8.7 million.
In connection with the acquisition of Genera Technologies Limited in August 2000, we issued $8.3 million in notes payable to a former shareholder of Genera, of which $7.0 million was secured by cash in escrow, and the remaining $1.3 million was unsecured. In April 2002, we repaid $7.5 million, of which $7.0 million was paid from the cash held in escrow. The remaining unsecured portion of $1.0 million is noninterest bearing, has been discounted to yield 6% and is due in three annual installments, beginning in August 2002. The noteholder elected to defer the August 2002 payment of $0.5 million, which bore interest at 3% until we repaid the installment in April 2003.
In January 2003, we entered into a $15.0 million uncommitted line of credit with a large multi-national bank. Under the terms of this agreement, the bank will retain the right to approve all borrowings and all borrowings will be due on demand. Any borrowings under this line will bear interest at the mutually agreed upon rate at the time of borrowing.
Effective January 1, 2003, the Company entered into a workers’ compensation insurance policy where the Company retains the first $250,000 in claim liability per incident and up to $1.2 million in claim liability in the aggregate. The insurance company administers and pays these claims and the Company reimburses the insurance company for the Company’s portion of these claims. The Company also issued a $450,000 letter of credit to the insurance company as security for these claims. Previously, the Company was fully insured for workers’ compensation liabilities. We do not expect that this change in insurance coverage will have an unfavorable impact on our total workers’ compensation costs.
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We purchased approximately $3.1 million in fixed assets during the quarter ended March 31, 2003, principally related to the CAG segment. Our total capital budget for 2003 is approximately $19.8 million. Research and development expense as a percentage of revenue for 2003 is expected to be consistent with 2002 levels.
Cash provided by operating activities was $29.5 million during the quarter ended March 31, 2003. Cash of $7.6 million was provided by an increase in accounts payable for contractual supply agreements related to instrument consumables. Cash of $5.8 million was used to fund the increase of accounts receivable. Cash of $5.7 million was generated from the decrease in inventory, principally due to a reduction in VetTest slide inventory.
During 1999 and 2000, the Board of Directors authorized the purchase of up to ten million shares of our Common Stock in the open market or in negotiated transactions. During the quarter ended March 31, 2003, the Company repurchased 257,500 shares of stock for $9.3 million. As of March 31, 2003, we had repurchased an aggregate of 8.9 million shares, leaving 1.1 million shares remaining under the repurchase authorization. During the quarter ended March 31, 2003, the Company received 133,139 shares of stock, which were owned by the holder for greater than six months, in lieu of cash for the exercise of stock options. The shares of stock had a fair market value of $4.9 million. See Note 7 to the consolidated financial statements.
We believe that current cash, short-term investments, long-term investments, debt facilities and funds generated from operations will be sufficient to fund our operations for the foreseeable future.
The future operating results of IDEXX involve a number of risks and uncertainties. Actual events or results may differ materially from those discussed in this report. Factors that could cause or contribute to such differences include, but are not limited to, the factors discussed below as well as those discussed elsewhere in this report.
IDEXX’s Future Growth Depends on Several Factors
Our ability to grow our business in the future depends upon our ability to successfully implement various strategies, including:
However, we may not be able to successfully implement some or all of these strategies and increase or sustain our rate of growth.
The Markets in Which IDEXX Competes are Competitive and Subject to Rapid and Substantial Technological Change
We face intense competition within the markets in which we sell our products and services. We expect that future competition will become even more intense, and that we will have to compete with changing and improving technologies. Some of our competitors and potential competitors, including large pharmaceutical companies, have substantially greater capital, manufacturing, marketing and research and development resources than we do.
IDEXX’s Products and Services Are Subject to Various Government Regulations
In the U.S., the manufacture and sale of our products are regulated by agencies such as the U.S. Department of Agriculture (“USDA”), U.S. Food and Drug Administration (“FDA”) and the U.S. Environmental Protection Agency (“EPA”). Most diagnostic tests for animal health applications, including our canine, feline, poultry and livestock tests, must be approved by the USDA prior to sale. Our water testing products must be approved by the EPA before they may be used by customers in the U.S. as a part of a water quality monitoring program required by the EPA. Our pharmaceutical and dairy testing products require approval by the FDA. Any failure to comply with regulatory requirements relating to the manufacture and sale of our products could result in fines and sanctions against us or removals of our products from the market, which could have a material adverse effect on our results of operations.
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We have entered into an agreement with the FDA under which we have agreed, among other things, to perform specified lot release and stability testing of our SNAP® Beta-lactam products and to provide related data to the FDA. If the FDA were to determine that one or more lots of product failed to meet applicable criteria for product performance or stability, the FDA could take various actions, including requiring us to recall products or restricting our ability to sell SNAP Beta-lactam products. Sales of dairy antibiotic residue testing products were $16.3 million in 2002 and $3.8 million in the three months ended March 31, 2003.
Commercialization of animal health pharmaceuticals in the U.S. requires prior approval by the FDA. To obtain such approvals we are required to submit substantial clinical, manufacturing and other data to the FDA. Regulatory approval for products submitted to the FDA may take several years and following approval, the FDA continues to regulate all aspects of the manufacture, labeling, storage, record keeping and promotion of pharmaceutical products. We have several animal pharmaceutical products in registration with the FDA, including a nitazoxanide product for treatment of equine protozoal myeloencephalitis and a non-steroidal anti-inflammatory for the treatment of lameness in horses. Failure to obtain, or delays in obtaining, FDA approval for these products would have a negative impact on our future growth.
IDEXX’s Future Operating Results May Be Negatively Impacted by Various Factors
Factors such as the introduction and market acceptance of new products and services, the mix of products and services sold and the mix of domestic versus international revenue could negatively impact our future operating results.
We sell many of our products, including substantially all of the rapid assays and instrument consumables sold in the U.S., through distributors. As a result, changes in the timing and size of distributor purchases can result in lower revenue for us because our revenue for each quarter is usually generated from orders received during that quarter. Our financial performance, therefore, is subject to an unexpected downturn in product demand and may be unpredictable.
While our pharmaceutical products are under development, we may carry related active ingredients, other raw materials and finished goods as assets on our balance sheet when recovery of the asset value from future sales is deemed probable. To the extent that these inventories become unusable due to unanticipated delays in obtaining FDA approval for these products, or to our failure to obtain such approvals, we may be required to write down those inventories, which could have a material adverse effect on our results of operations.
We are actively developing new diagnostic platforms, including new instrument systems. In connection with these programs, we are developing production machinery and equipment. As of March 31, 2003, we had $5.1 million of these fixed assets on our balance sheet and commitments to purchase an additional $1.0 million. Were we to discontinue any such programs or to substantially change the design of the new platform, we might be required to write off some or all of the associated production machinery and equipment. Such a write-off could have a material adverse effect on our results of operations.
We believe that more than half of all veterinary diagnostic testing occurs in laboratories. Although we have a significant laboratory business, our in-clinic testing business is more material to our results of operations. If testing by companion animal veterinarians generally were to shift towards increased laboratory testing and away from in-clinic testing, this shift could have a material adverse effect on our results of operations.
Our expense levels are based in part on expectations of future revenue levels. Therefore, a loss in expected revenue could result in a disproportionate decrease in our net income.
IDEXX’s Success Is Heavily Dependent Upon Its Proprietary Technologies
We rely on a combination of patent, trade secret, trademark and copyright law to protect our proprietary rights. If we do not have adequate protection of our proprietary rights, our business may be affected by competitors who develop substantially equivalent technologies that compete with us.
We cannot assure that we will obtain issued patents, that any patents issued or licensed to us will remain valid, or that any patents owned or licensed by us will provide protection against competitors with similar technologies. Even if our patents cover products sold by our competitors, the time and expense of litigating to enforce our patent rights could be substantial, and could have a material adverse effect on our results of operations.
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In the past we have received notices claiming that our products infringe third-party patents and we may receive such notices in the future. Patent litigation is complex and expensive and the outcome of patent litigation can be difficult to predict. We cannot assure that we will win a patent litigation case or negotiate an acceptable resolution to such a case. If we lose, we may be stopped from selling certain products and/or we may be required to pay damages and/or ongoing royalties as a result of the lawsuit. Any such adverse result could have a material adverse effect on our results of operations.
IDEXX Purchases Materials for Its Products From a Limited Number of Sources
We currently purchase certain products and materials from single sources or a limited number of sources. Some of the products that we purchase from these sources are proprietary, and therefore may not be available from other sources. These products include our chemistry and QBC® VetAutoread™ hematology analyzers and related consumables, active ingredients for pharmaceutical products and certain components of our SNAP® devices, water testing products, and LaserCyte™ system components. If we are unable to obtain adequate quantities of these products in the future, then we could face cost increases or reductions or delays in product shipments, which could have a material adverse effect on our results of operations.
The slides sold for use in our VetTest® instruments are purchased under an agreement with Ortho-Clinical Diagnostics at fixed prices. Under this agreement we are required to purchase a minimum of $226.2 million of slides over the remaining life of the contract. To the extent that slides purchased under the contract exceed demand for the slides, we may incur losses in the future under this agreement. To the extent that we are unable to maintain current pricing levels on sales of slides to our customers, our profits on slide sales would decline because we purchase slides at fixed prices.
International Revenue Accounts for a Significant Portion of IDEXX’s Total Revenue
Various risks associated with foreign operations may impact our international sales. Possible risks include fluctuations in the value of foreign currencies, disruptions in transportation of our products, the differing product and service needs of foreign customers, difficulties in building and managing foreign operations, import/export duties and quotas, and unexpected regulatory, economic or political changes in foreign markets. Prices that we charge to foreign customers may be different than the prices we charge for the same products in the U.S. due to competitive, market or other factors. As a result, the mix of domestic and international sales in a particular period could have a material impact on our results for that period.
The Company’s financial market risk consists primarily of foreign currency exchange risk. The Company operates subsidiaries in 13 foreign countries and transacts business in local currencies. The Company attempts to hedge its cash flow on intercompany sales to minimize foreign currency exposure.
The primary purpose of the Company’s foreign currency hedging activities is to protect against the volatility associated with foreign currency transactions. Corporate policy prescribes the range of allowable hedging activity. The Company primarily utilizes forward exchange contracts with a duration of less than 12 months. Gains and losses related to qualifying hedges of foreign currency from commitments or anticipated transactions are deferred in prepaid expenses or accruals and are included in the basis of the underlying transaction. Our hedging strategy is consistent with prior periods and we believe our risk with respect to foreign currency exchange fluctuations is not materially different than at December 31, 2002.
(a) Evaluation of disclosure controls and procedures. Based on their evaluation of the Company’s disclosure controls and procedures (as defined in Rules 13a-14(c) and 15d-14(c) under the Securities Exchange Act of 1934) as of a date within 90 days of the filing date of this Quarterly Report on Form 10-Q, the Company’s chief executive officer and chief financial officer have concluded that the Company’s disclosure controls and procedures are designed to ensure that information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and are operating in an effective manner.
(b) Changes in internal controls. There were no significant changes in the Company’s internal controls or in other factors that could significantly affect these controls subsequent to the date of their most recent evaluation.
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(a) Exhibits
(b) Reports on Form 8-K
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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.
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I, Jonathan W. Ayers, certify that:
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I, Merilee Raines, certify that:
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