1 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended MARCH 31, 1998 -------------- or [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from _______________ to _______________ Commission File Number: 0-19271 ------- IDEXX LABORATORIES, INC. (Exact name of registrant as specified in its charter) DELAWARE 01-0393723 (State of incorporation) (I.R.S. Employer Identification No.) ONE IDEXX DRIVE, WESTBROOK, MAINE 04092 (Address of principal executive offices) (Zip Code) (207) 856-0300 (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 the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. As of April 30, 1998, 38,453,688 shares of the registrant's Common Stock, $.10 par value, were outstanding.
2 IDEXX LABORATORIES, INC. AND SUBSIDIARIES INDEX Page PART I -- FINANCIAL INFORMATION Item 1. Financial Statements: Consolidated Balance Sheets March 31, 1998 and December 31, 1997 3 Consolidated Statements of Operations Three Months Ended March 31, 1998 and March 31, 1997 4 Consolidated Statements of Cash Flows Three Months Ended March 31, 1998 and March 31, 1997 5 Notes to Consolidated Financial Statements 6-10 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 11-13 PART II -- OTHER INFORMATION Item 1. Legal Proceedings 14 Item 6. Exhibits and Reports on Form 8-K 15 SIGNATURES 16 FORWARD LOOKING INFORMATION This Quarterly Report on Form 10-Q includes certain forward-looking statements about the business of IDEXX Laboratories, Inc. and its subsidiaries (the "Company") including, without limitation, the belief that the Company's current cash and short-term investments will be sufficient to fund its on-going operations for the foreseeable future, and that the Company has meritorious defenses in certain of its litigation matters. Such forward-looking statements are subject to risk and uncertainties that could cause the Company's actual results to vary materially from those indicated in such forward-looking statements. These risks and uncertainties are discussed in more detail in the section captioned "Management's Discussion and Analysis of Financial Condition and Results of Operations" in Item 2 of Part I of this report. 2
3 PART I -- FINANCIAL INFORMATION Item 1. -- FINANCIAL STATEMENTS IDEXX LABORATORIES, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) (UNAUDITED) <TABLE> <CAPTION> ASSETS March 31, December 31, 1998 1997 --------- ------------ <S> <C> <C> CURRENT ASSETS: Cash and cash equivalents $108,854 $106,972 Short-term investments 28,722 35,502 Accounts receivable, less reserves of $5,079 and $5,082 in 1998 and 1997, respectively 51,657 47,341 Inventories 55,845 60,174 Deferred income taxes 15,396 15,396 Other current assets 4,722 8,832 -------- -------- Total current assets 265,196 274,217 LONG-TERM INVESTMENTS 20,089 11,134 PROPERTY AND EQUIPMENT, AT COST: Land 1,193 1,193 Buildings and improvements 4,486 4,462 Leasehold improvements 16,754 16,596 Machinery and equipment 28,625 26,359 Office furniture and equipment 22,733 22,804 Construction-in-progress 969 1,390 -------- -------- 74,760 72,804 Less - Accumulated depreciation and amortization 33,261 30,387 -------- -------- 41,499 42,417 OTHER ASSETS, Net 48,738 49,280 -------- -------- $375,522 $377,048 ======== ======== LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES: Accounts payable $ 12,963 $ 12,472 Accrued expenses 38,463 42,147 Notes payable 2,597 4,087 Deferred revenue 15,022 15,609 -------- -------- Total current liabilities 69,045 74,315 COMMITMENTS AND CONTINGENCIES (Note 4) STOCKHOLDERS' EQUITY: Common stock, $0.10 par value Authorized 60,000 shares Issued and outstanding 38,403 shares in 1998 and 38,169 shares in 1997 3,840 3,817 Additional paid-in capital 257,707 257,275 Retained earnings 50,017 46,256 Cumulative translation adjustment (5,087) (4,615) -------- -------- Total stockholders' equity 306,477 302,733 -------- -------- $375,522 $377,048 ======== ======== </TABLE> See accompanying notes to consolidated financial statements. 3
4 IDEXX LABORATORIES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) (UNAUDITED) <TABLE> <CAPTION> Three Months Ended ----------------------- March 31, March 31, 1998 1997 --------- --------- <S> <C> <C> Revenue $77,793 $60,534 Cost of revenue 38,852 30,097 ------- ------- Gross Profit 38,941 30,437 Expenses: Sales and marketing 15,839 17,099 General and administrative 13,536 10,135 Research and development 4,976 3,476 ------- ------- Income (loss) from operations 4,590 (273) Interest income, net 1,576 1,764 ------- ------- Income before provision for income taxes 6,166 1,491 Provision for income taxes 2,405 596 ------- ------- Net income $ 3,761 $ 895 ======= ======= Net income per common share: Basic $ 0.10 $ 0.02 ======= ======= Net income per common share: Diluted $ 0.10 $ 0.02 ======= ======= </TABLE> See accompanying notes to consolidated financial statements. 4
5 IDEXX LABORATORIES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS) (UNAUDITED) <TABLE> <CAPTION> Three Months Ended ------------------------- March 31, March 31, 1998 1997 --------- -------- <S> <C> <C> Cash Flows from Operating Activities: Net income $ 3,761 $ 895 Adjustments to reconcile net income to net cash provided by (used in) operating activities, net of acquisitions: Depreciation and amortization 4,572 3,046 Changes in assets and liabilities: Accounts receivable (4,315) 5,942 Inventories 4,230 (11,519) Other current assets 4,111 4,763 Accounts payable 490 (1,581) Accrued expenses (3,595) (4,556) Deferred revenue (587) 225 -------- -------- Net cash provided by (used in) operating activities 8,667 (2,785) -------- -------- Cash Flows from Investing Activities: Purchases of property and equipment (1,938) (5,237) Decrease (increase) in short-term investments 6,780 12,258 Increase in long-term investments (8,955) (11,790) Decrease (increase) in other assets (80) 71 Acquisitions of business, net of cash acquired (986) (9,027) -------- -------- Net cash used in investing activities (5,179) (13,725) -------- -------- Cash Flows from Financing Activities: Payment of notes payable (1,530) (509) Proceeds from the exercise of stock options 396 1,122 -------- -------- Net cash provided by (used in) financing activities (1,134) 613 -------- -------- Net effect of Exchange Rate Changes 472 (2,085) -------- -------- Net increase (decrease) in Cash and Cash Equivalents 1,882 (17,982) Cash and Cash Equivalents, beginning of period 106,972 127,741 ======== ======== Cash and Cash Equivalents, end of period $108,854 $109,759 ======== ======== Supplemental Disclosure of Cash Flow Information: Interest paid during the period $ 106 $ 35 ======== ======== Income taxes paid during the period $ 3,368 $ 3,927 ======== ======== </TABLE> See accompanying notes to consolidated financial statements. 5
6 IDEXX LABORATORIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 1. BASIS OF PRESENTATION The unaudited financial statements included herein have been prepared by IDEXX Laboratories, Inc. and subsidiaries (the "Company") pursuant to the rules and regulations of the Securities and Exchange Commission and include, in the opinion of management, all adjustments which the Company considers necessary for a fair presentation of such information. The December 31, 1997 Balance Sheet was derived from the audited Consolidated Balance Sheets contained in the Company's latest stockholders' annual report. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. These statements should be read in conjunction with the Company's audited consolidated financial statements and notes thereto which are contained in the Company's latest stockholders' annual report. The results for the interim periods presented are not necessarily indicative of results to be expected for the full fiscal year. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES The accompanying consolidated financial statements reflect the application of certain accounting policies described in this and other notes to the consolidated financial statements. a. Principles of Consolidation: The accompanying consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All material intercompany transactions and balances have been eliminated in consolidation. b. Certain reclassifications have been made in the 1997 consolidated financial statements to conform with the current year's presentation. c. The Company accounts for cash equivalents and marketable securities in accordance with Statement of Financial Accounting Standards No. 115 "Accounting for Certain Investments in Debt and Equity Securities". Accordingly, the Company's cash equivalent and short-term investments are classified as held-to-maturity and are recorded at amortized cost which approximates market value. Cash Equivalents and Short-term Investments: Cash equivalents are short-term, highly liquid investments with original maturities of less than three months. Short-term investments are investment securities with original maturities of greater than three months but less than one year and consist of the following (in thousands): <TABLE> <CAPTION> March 31, December 31, 1998 1997 --------- ------------ <S> <C> <C> Government bonds $11,000 -- Municipal bonds 8,175 $ 6,140 U.S. Treasury bills 4,875 20,047 Commercial paper 2,216 2,016 Certificates of deposit -- 6,749 Other short-term investments 2,456 550 ------- ------- $28,722 $35,502 ======= ======= </TABLE> 6
7 Long-term investments are investment securities with original maturities of greater than one year and consist of the following (in thousands): <TABLE> <CAPTION> March 31, December 31, 1998 1997 --------- ------------ <S> <C> <C> Municipal bonds $13,870 $10,165 Government bonds 5,000 -- Other long-term investments 1,219 969 ------- ------- $20,089 $11,134 ======= ======= </TABLE> d. 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): <TABLE> <CAPTION> March 31, December 31, 1998 1997 --------- ------------ <S> <C> <C> Raw materials $ 8,379 $ 9,235 Work-in-process 7,830 8,421 Finished goods 39,636 42,518 ------- ------- $55,845 $60,174 </TABLE> e. In February 1997 the Financial Accounting Standards Board issued the Statement of Financial Accounting Standards No. 128 "Earnings per Share" (SFAS No. 128). SFAS No. 128 was adopted as of December 31, 1997 and all prior earnings per share amounts have been restated. Basic earnings per common share is computed by dividing net income by the weighted average number of shares of common stock outstanding during the quarter. The computation of diluted earnings per common share is similar to the computation of basic earnings per common share except that the denominator is increased for the assumed exercise of dilutive options using the treasury stock method unless the effect is anti-dilutive. The following is a reconciliation of shares outstanding for basic and diluted earnings per share: <TABLE> <CAPTION> 1998 1997 ------ ------ <S> <C> <C> Shares outstanding for basic earnings per share: Weighted average shares outstanding 38,253 37,932 ====== ====== Shares outstanding for diluted earnings per share: Weighted average shares outstanding 38,253 37,932 Diluted effect of options issued to employees 1,092 1,779 ------ ------ 39,345 39,711 ====== ====== </TABLE> 3. NON-RECURRING OPERATING CHARGE During 1997 the Company recorded a non-recurring operating charge of $34.5 million. The non-recurring operating charge included the write-downs and write-offs of certain assets and accrual of costs related to a significant workforce reduction. The charge consisted of the following (in thousands): <TABLE> <S> <C> Write-off of in-process research and development $13,200 Legal settlement and related costs 8,000 Severance, benefits and related costs 9,000 Idle capacity and lease termination costs 2,700 Asset Impairment 1,600 ------- $34,500 ======= </TABLE> As of March 31, 1998, $7.9 million was included in accrued expense relating to the non-recurring operating charge. 7
8 During 1997 The Company acquired two veterinary practice management software companies (see Note 6). To assist in the allocation of purchase price associated with these acquisitions, the Company obtained an independent appraisal. That appraisal identified approximately $13.2 million as in-process research and development, which has been charged to operations in accordance with FASB Interpretation No. 4 "Applicability of FASB Statement No. 2 to Business Combinations Accounted for by the Purchase Method." In September 1997, the Company settled a patent infringement suit brought by Barnes-Jewish Hospital ("BJH") regarding IDEXX's heartworm diagnostic products. The total costs of the settlement, including certain legal fees, were charged to the non-recurring operating charge. Under the settlement, the Company agreed to pay BJH $5.5 million, a portion of which payment will be creditable against earned royalties on certain products. The Company has terminated the employment of a total of 228 employees. Of this total, 79 employees are associated with the consolidation of the veterinary practice management software business into the Eau Claire, Wisconsin facility, 57 employees are associated with the consolidation of sales, marketing and distribution operations in Europe, 33 employees are associated with reductions in domestic sales and marketing operations, 18 employees are associated with reductions in sales and marketing operations in the Pacific Rim region, 16 employees are associated with the closure of the Sunnyvale, California research and development facility and 25 employees are associated with a reduction in positions in management and financial operations. As of March 31, 1998, approximately 110 employees have left the employment of the Company, and the Company expects that the remainder will leave during the second and third quarters of 1998. As discussed above, the Company is consolidating certain veterinary practice management software operations into the Eau Claire, Wisconsin facility and has closed the leased Sunnyvale, California research and development facility. As a result of these consolidations, the Company has leased facilities which have become excess until the end of their respective lease terms. Additionally, the Company has determined that it will not pursue certain immunoassay technology with respect to which it has invested a total of $1.6 million in fixed assets and license fees. 4. COMPREHENSIVE INCOME In June 1997 the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 130 "Reporting Comprehensive Income" ("SFAS 130"). SFAS 130 must be adopted for fiscal years beginning after December 15, 1997 and all prior periods must be retroactively restated. SFAS 130 also requires application of this statement as the beginning of the Company's fiscal year. Other comprehensive income for the Company consists of foreign currency translation adjustments resulting from the translation of the financial statements of the Company's foreign subsidiaries. Accordingly, below is a summary of comprehensive income in accordance with this statement (in thousands): <TABLE> <CAPTION> March 31, December 31, 1998 1997 --------- ------------ <S> <C> <C> Net income $3,761 $ 895 Other comprehensive income, net of tax Foreign currency translation adjustments (288) (1,251) ------ ------- Comprehensive income (loss) $3,473 $ (356) ====== ======= </TABLE> 5. COMMITMENTS AND CONTINGENCIES From time to time the Company has received notices alleging that the Company's products infringe third-party proprietary rights. In particular, the Company has received notices claiming that certain of the Company's immunoassay products infringe third-party patents. Except as noted below with respect to the patent infringement suit filed by Synbiotics Corporation, the Company is not aware of any pending 8
9 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 have been or may be commenced against the Company. A significant portion of the Company's revenue in the three month period ended March 31, 1998 was attributable to products incorporating certain immunoassay technologies and products relating to the diagnosis of canine heartworm infection. If the Company were to be precluded from selling such products or required to pay damages or make additional royalty or other payments with respect to such sales, the Company's business and results of operations could be materially and adversely affected. On February 24, 1995, CDC Technologies, Inc. ("CDC Technologies") filed suit against the Company in the U.S. District Court for the District of Connecticut. In its complaint, CDC Technologies alleges that the Company's conduct in, and its relationships with its distributors in connection with, the distribution of the Company's hematology products (i) violate federal and state antitrust statutes, (ii) violate Connecticut statutes regarding unfair trade practices, and (iii) constitute a civil conspiracy and interfere with CDC Technologies' business relations. The relief sought by CDC Technologies includes treble damages for antitrust violations as well as compensatory and punitive damages, and an injunction to prevent the Company from interfering with CDC Technologies' relations with distributors. The Company has filed an answer denying the allegations in CDC's complaint. In March 1998, the court granted the Company's motion for summary judgment in the case, however CDC is appealing that ruling. The Company is unable to assess the likelihood of an adverse result or estimate the amount of any damages which the Company may be required to pay. Any adverse outcome resulting in the payment of damages would adversely affect the Company's results of operations. On November 18, 1997, Synbiotics Corporation ("Synbiotics") filed suit against the Company in the U.S. District Court for the Southern District of California for infringement of U.S. Patent No. 4,789,631 issued December 6, 1988 (the "`631 Patent"). The `631 Patent, which is owned by Synbiotics, claims certain assays, methods and compositions for the diagnosis of canine heartworm infection. The primary relief sought by Synbiotics is an injunction against the Company which would prevent the Company from selling canine heartworm diagnostic products which infringe the `631 Patent, as well as treble damages for past infringement. This suit was not served on the Company within the time period specified under applicable court rules and was dismissed without prejudice in April 1998, however Synbiotics is not precluded from filing a new suit in the future. While the Company believes that it has meritorious defenses against claims of infringement of the `631 Patent, the Company is unable to assess the likelihood of an adverse result or estimate the amount of any damages the Company may be required to pay. If the Company is precluded from selling canine heartworm diagnostic products or required to pay damages or make additional royalty or other payments with respect to such sales, the Company's business and results of operations could be materially and adversely affected. On January 9, 1998, a complaint was filed in the U.S. District Court for the District of Maine captioned Robert A. Rose v. David E. Shaw, Erwin F. Workman, Jr., E. Robert Kinney and IDEXX Laboratories, Inc. The plaintiff purports to represent a class of purchasers of the common stock of the Company from July 19, 1996 through March 24, 1997. The complaint claims that the defendants violated Section 10(b) of the Securities Exchange Act of 1934 and Securities and Exchange Commission Rule 10b-5 promulgated pursuant thereto, by virtue of false or misleading statements made during the class period. The complaint also claims that the individual defendants are liable as "control persons" under Section 20(a) of that Act. In addition, the complaint claims that the individual defendants sold some of their own common stock of the Company, during the class period, at times when the market price for the stock allegedly was inflated. While the Company and other defendants deny the allegations and will defend this suit vigorously, the Company is unable to assess the likelihood of an adverse result or estimate the amount of damages which the Company may be required to pay. Any adverse outcome resulting in the payment of damages would adversely affect the Company's results of operations. 6. ACQUISITIONS 1997 ACQUISITIONS The Company's consolidated results of operations include the results of operations of a manufacturing company, a foreign distribution company, a foreign veterinary reference laboratory, and two veterinary practice management companies acquired in 1997. These businesses were acquired for aggregate purchase prices equaling approximately $24.3 million in cash, the issuance of notes payable for $2.1 million and the 9
10 assumption of certain liabilities. In 1998, the Company has paid a total of approximately $750,000 in additional purchase price based on the results of operations of certain acquired businesses described above. The additional payments were recorded as additional goodwill and are being amortized over the remaining life of the respective goodwill. In connection with the acquisition of the businesses described above, the Company entered into non-compete agreements for periods of up to three years with certain of the former stockholders, and may become obligated to pay additional amounts to management of these companies based on achieving certain operating results. The Company has accounted for these acquisitions under the purchase method of accounting. The results of operations of each of these businesses has been included in the Company's consolidated results of operations since each of their dates of acquisition. The purchase prices have been allocated to the net assets acquired on a preliminary basis and are subject to revision. Approximately $13.2 million, identified through independent valuation, of the purchase price related to the acquisition of the software companies has been charged to operations as "in process research and development" in accordance with Financial Accounting Standards Board Interpretation No. 4 "Applicability of FASB Statement No. 2 to Business Combinations Accounted for by the Purchase Method." The Company has not presented pro forma financial information relating to any of these acquisitions because of immateriality. These acquisitions are as follows: o On January 30, 1997, the Company acquired all of the capital stock of Acumedia Manufacturers, Inc., located in Baltimore, Maryland, which specializes in the manufacture of dehydrated cultured media. o On March 13, 1997, the Company acquired all of the capital stock of National Information Systems Corporation, located in Eau Claire, Wisconsin, which supplies practice management computer systems to veterinarians under the trade name Advanced Veterinary Systems. o On July 1, 1997, the Company, through its wholly-owned subsidiary, IDEXX Laboratories (Taiwan), Inc., acquired certain assets and business rights of Wintek Bio-Science Inc., located in Taipei, Taiwan, which distributed diagnostic products to veterinarians and hospitals in Taiwan. o On July 18, 1997, the Company acquired all of the capital stock of Professionals' Software, Inc., located in Effingham, Illinois, which supplies practice management computer systems to veterinarians. o On December 1, 1997, the Company, through its wholly-owned subsidiary IDEXX Laboratories Pty. Ltd., acquired certain assets and assumed certain liabilities of Lording & Friend Pty. Ltd. and Clinpath Pty. Ltd. (operating under the name Central Veterinary Diagnostic Laboratory), which operated a veterinary reference laboratory in Australia. 1998 ACQUISITION The Company's consolidated results of operations include the results of operations of Agri-West Laboratory, a food testing laboratory located in Texas, which was acquired on March 1, 1998. The Company acquired certain assets and assumed certain liabilities of Agri-West Laboratory through its wholly-owned subsidiary IDEXX Food Safety Net Services, Inc. for approximately $250,000 in cash. In connection with the acquisition of this business, the Company entered into non-compete agreements for five years with the former owners, and may become obligated to pay additional amounts to management of the business based on achieving certain operating results. The Company has accounted for this acquisition under the purchase method of accounting. The results of operations of this business have been included in the Company's consolidated results of operations since the date of acquisition. The Company has not presented pro forma financial information relating to this acquisition because of immateriality. 10
11 Item 2. IDEXX LABORATORIES, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS RESULTS OF OPERATIONS Total revenue for the first quarter of 1998 increased 29% to $77.8 million from $60.5 million for the first quarter of 1997. The increase in total revenue was principally attributable to increases in sales of veterinary test kits and consumables, the inclusion of sales of veterinary practice management software systems resulting from the acquisitions of Advanced Veterinary Systems and Professionals' Software, Inc. in March and July 1997, respectively, and increased sales of veterinary reference laboratory services. The higher sales of veterinary test kits and consumables were due in part to a 1997 program to reduce U.S. distributor inventories of these products. These increases were offset in part by lower sales of veterinary instruments, principally due to lower unit sales and, to a lesser extent, lower average sales prices. International revenue decreased 1% to $21.3 million in the first quarter of 1998 compared to $21.5 million in the first quarter of 1997. Revenues increased by 5% to $5.0 million in the Pacific Rim region (Japan, Asia, Australia) for the three months ended March 31, 1998 compared to the same period in 1997. Revenues decreased 3% to $12.9 million in Europe and decreased 3% to $3.3 million in Canada and South America for the same period in 1998 versus 1997. Revenue from the Company's Pacific Rim and European subsidiaries, transacted in local currencies, increased 11% and 2%, respectively, for the three month period ended March 31, 1998 as compared to the same period in 1997. The increase in revenues in the Pacific Rim region is primarily due to increased sales of feline test kits and consumables, veterinary laboratory services and water test kits. These increases were offset in part by lower sales of food test products, canine veterinary test kits and veterinary instruments. Decreased revenue in Europe was principally due to lower unit sales of veterinary instruments and, to a lesser degree, veterinary test kits. These decreases were offset in part by higher sales of veterinary consumables, food and environmental test products and veterinary laboratory services. Gross profit as a percentage of revenue was 50% for the three month periods ended March 31, 1998 and March 31, 1997. Higher sales of higher gross margin veterinary test kits and consumables were offset by lower average unit prices of veterinary instruments sold and, to a lesser extent, higher sales of lower gross margin veterinary practice management software products and veterinary laboratory services. In the accompanying financial statements, the Company has reclassified certain 1997 courier costs in its veterinary laboratory business from sales and marketing into cost of sales to conform to 1998 presentation. Sales and marketing expenses were 20% of revenue for the three month period ended March 31, 1998 compared to 28% in the first quarter of 1997. The decrease as a percentage of revenue and the dollar decrease of $1.3 million were principally attributable to a decrease in salary and related expenses resulting from workforce reductions. Research and development expenses were 6% of revenue for the three month periods ended March 31, 1998 and March 31, 1997. The dollar increase of $1.5 million reflected additional resources and related overhead to support product development and the addition of software development expenses associated with the acquisition of the veterinary practice management software businesses discussed above. General and administrative expenses were 17% of revenue for the three month periods ended March 31, 1998 and March 31, 1997. The dollar increase of $3.4 million in the first quarter of 1998 compared to the same period in 1997 is principally attributable to additional operating expenses and amortization of goodwill and other intangibles associated with the acquisition of the veterinary practice management software and other businesses, an increase in management incentive compensation and an increase in consulting expenses associated with business restructuring. Net interest income was $1.6 million for the three month period ended March 31, 1998 compared to $1.8 million for the same period in 1997. The decrease in interest income over the prior year is due to the use of previously invested cash in completing acquisitions since the first quarter of 1997. 11
12 The Company's effective tax rate was 39% for the three month period ended March 31, 1998 compared to 40% for the same period in 1997. The decrease in the effective tax rate was principally attributable to income generated in states with lower state income tax rates. LIQUIDITY AND CAPITAL RESOURCES As of March 31, 1998, the Company had cash, cash equivalents, and short-term investments of $137.6 million and $196.2 million of working capital. The Company believes that current cash and short-term investments and funds expected to be generated from operations will be sufficient to fund the Company's operations for the foreseeable future. FUTURE OPERATING RESULTS The future operating results of the Company are subject to a number of factors, including without limitation the following: The Company's business has grown significantly over the past several years as a result of both internal growth and acquisitions of products and businesses. The Company has consummated a number of acquisitions since 1992, including five acquisitions in 1997 and one acquisition to date in 1998, and may make additional acquisitions. Identifying and pursuing acquisition opportunities, integrating acquired products and businesses, and managing growth requires a significant amount of management time and skill. There can be no assurance that the Company will be effective in identifying and effecting attractive acquisitions, assimilating acquisitions or managing future growth. The Company has experienced and may experience in the future significant fluctuations in its quarterly operating results. Factors such as the introduction and market acceptance of new products and services, the demand for existing products and services, the mix of products and services sold and the mix of domestic versus international revenue could contribute to this quarterly variability. The Company operates with relatively little backlog and has few long-term customer contracts and substantially all of its product and service revenue in each quarter results from orders received in that quarter, which makes the Company's financial performance more susceptible to an unexpected downturn in business and more unpredictable. In addition, the Company's expense levels are based in part on expectations of future revenue levels, and a shortfall in expected revenue could therefore result in a disproportionate decrease in the Company's net income. The markets in which the Company competes are subject to rapid and substantial technological change. The Company encounters, and expects to continue to encounter, intense competition in the sale of its current and future products and services. Many of the Company's competitors and potential competitors have substantially greater capital, manufacturing, marketing, and research and development resources than the Company. The Company's future success will depend in part on its ability to continue to develop new products and services both for its existing markets and for any new markets the Company may enter in the future. The Company believes that it has established a leading position in many of the markets for its animal health diagnostic products and services, and the maintenance and any future growth of its position in these markets is dependent upon the successful development and introduction of new products and services. The Company also plans to devote significant resources to the growth of its veterinary laboratory business and its business in the food, hygiene and environmental markets and to the development of an animal pharmaceutical product business, where the Company's operating experience and product and technology base are more limited than in its animal health diagnostic product markets. There can be no assurance that the Company will successfully complete the development and commercialization of products and services for existing and new businesses. The Company's success is heavily dependent upon its proprietary technologies. The Company relies on a combination of patent, trade secret, trademark and copyright law to protect its proprietary rights. There can be no assurance that patent applications filed by the Company will result in patents being issued, that any patents of the Company will afford protection against competitors with similar technologies, or that the Company's non-disclosure agreements will provide meaningful protection for the Company's trade secrets and other proprietary information. 12
13 Moreover, in the absence of patent protection, the Company's business may be adversely affected by competitors who independently develop substantially equivalent technologies. In addition, the Company licenses certain technologies used in its products from third parties, and the Company may be required to obtain licenses to additional technologies in order to continue to sell certain products. There can be no assurance that any technology licenses which the Company desires or is required to obtain will be available on commercially reasonable terms. From time to time the Company receives notices alleging that the Company's products infringe third party proprietary rights. 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 have been or may be commenced against the Company, and an adverse outcome may preclude the Company from selling certain products or require the Company to pay damages or make additional royalty or other payments with respect to such sales. In addition, from time to time other types of lawsuits are brought against the Company, wherein an adverse outcome could adversely affect the Company's results of operations. Certain components used in the Company's products are currently available from only one source and others are available from only a limited number of sources. The Company's inability to develop alternative sources if and as required in the future, or to obtain sufficient sole or limited source components as required, could result in cost increases or reductions or delays in product shipments. Certain technologies licensed by the Company and incorporated into its products are also available from a single source, and the Company's business may be adversely affected by the expiration or termination of any such licenses or any challenges to the technology rights underlying such licenses. In addition, the Company currently purchases or is contractually required to purchase certain of the products that it sells from one source. Failure of such sources to supply product to the Company may have a material adverse effect on the Company's business. In the three months ended March 31, 1998, international revenue was $21.3 million, or 27% of total revenue, and the Company expects that its international business will continue to account for a significant portion of its total revenue. Foreign regulatory bodies often establish product standards different from those in the United States, and designing products in compliance with such foreign standards may be difficult or expensive. Other risks associated with foreign operations include possible disruptions in transportation of the Company's products, the differing product and service needs of foreign customers, difficulties in building and managing foreign operations, fluctuations in the value of foreign currencies, import/export duties and quotas, and unexpected regulatory, economic or political changes in foreign markets. The development, manufacturing, distribution and marketing of certain of the Company's products and provision of its services, both in the United States and abroad, are subject to regulation by various domestic and foreign governmental agencies. Delays in obtaining, or the failure to obtain, any necessary regulatory approvals could have a material adverse effect on the Company's future product and service sales and operations. Any acquisitions of new products, services and technologies may subject the Company to additional areas of government regulations. The Company is conducting an evaluation of its information technology systems and its products for Year 2000 compliance. The Company's worldwide accounting system is Year 2000 compliant, and Year 2000 issues related to its other information technology systems will be addressed through planned upgrades prior to 2000. A substantial majority of the Company's products, including its instrument-based diagnostic systems and a majority of its installed base of veterinary practice management software systems, already are Year 2000 compliant. The Company expects that by the end of 1998 all practice management systems offered by the Company will be Year 2000 compliant. The costs of upgrading the Company's information technology systems and its practice management systems are not expected to be material to the Company's financial condition or results of operations. The Company has commenced an evaluation of the Year 2000 compliance of its vendors, but at this time cannot predict the extent to which its vendors will have Year 2000 problems and the impact of any such problems on the Company. The development, manufacture, distribution and marketing of the Company's products and provision of its services involve an inherent risk of product liability claims and associated adverse publicity. Although the Company currently maintains liability insurance, there can be no assurance that the coverage limits of the Company's insurance policies will be adequate. Such insurance is expensive, difficult to obtain and may not be available in the future on acceptable terms or at all. 13
14 PART II -- OTHER INFORMATION Item 1. -- LEGAL PROCEEDINGS On February 24, 1995, CDC Technologies, Inc. ("CDC Technologies") filed suit against the Company in the U.S. District Court for the District of Connecticut. In its complaint, CDC Technologies alleges that the Company's conduct in, and its relationships with its distributors in connection with, the distribution of the Company's hematology products (i) violate federal and state antitrust statutes, (ii) violate Connecticut statutes regarding unfair trade practices, and (iii) constitute a civil conspiracy and interfere with CDC Technologies' business relations. The relief sought by CDC Technologies includes treble damages for antitrust violations, as well as compensatory and punitive damages, and an injunction to prevent the Company from interfering with CDC Technologies' relations with distributors. The Company has filed an answer denying the allegations in CDC Technologies' complaint. In March 1998, the court granted the Company's motion for summary judgment in the case, however CDC is appealing that ruling. The Company is unable to assess the likelihood of an adverse result or estimate the amount of any damages which the Company may be required to pay. Any adverse outcome resulting in the payment of damages would adversely affect the Company's results of operations. On November 18, 1997, Synbiotics Corporation ("Synbiotics") filed suit against the Company in the U.S. District Court for the Southern District of California for infringement of U.S. Patent No. 4,789,631 issued December 6, 1988 (the "`631 Patent"). The `631 Patent, which is owned by Synbiotics, claims certain assays, methods and compositions for the diagnosis of canine heartworm infection. The primary relief sought by Synbiotics is an injunction against the Company which would prevent the Company from selling canine heartworm diagnostic products which infringe the `631 Patent, as well as treble damages for past infringement. This suit was not served on the Company within the time period specified under applicable court rules and was dismissed without prejudice in April 1998, however Synbiotics is not precluded from filing a new suit in the future. While the Company believes that it has meritorious defenses against claims of infringement of the `631 Patent, the Company is unable to assess the likelihood of an adverse result or estimate the amount of any damages the Company may be required to pay. If the Company is precluded from selling canine heartworm diagnostic products or required to pay damages or make additional royalty or other payments with respect to such sales, the Company's business and results of operations could be materially and adversely affected. On January 9, 1998, a complaint was filed in the U.S. District Court for the District of Maine captioned Robert A. Rose v. David E. Shaw, Erwin F. Workman, Jr., E. Robert Kinney and IDEXX Laboratories, Inc. The plaintiff purports to represent a class of purchasers of the common stock of the Company from July 19, 1996 through March 24, 1997. The complaint claims that the defendants violated Section 10(b) of the Securities Exchange Act of 1934 and Securities and Exchange Commission Rule 10b-5 promulgated pursuant thereto, by virtue of false or misleading statements made during the class period. The complaint also claims that the individual defendants are liable as "control persons" under Section 20(a) of that Act. In addition, the complaint claims that the individual defendants sold some of their own common stock of the Company, during the class period, at times when the market price for the stock allegedly was inflated. While the Company and other defendants deny the allegations and will defend this suit vigorously, the Company is unable to assess the likelihood of an adverse result or estimate the amount of damages which the Company may be required to pay. Any adverse outcome resulting in the payment of damages would adversely affect the Company's results of operations. 14
15 Item 6. -- EXHIBITS AND REPORTS ON FORM 8-K Page ---- (a) Exhibits 27. Financial Data Schedule for the Quarterly Report on Form 10-Q for the three-month period ended March 31, 1998. 17 (b) Reports on Form 8-K The Company filed no reports on Form 8-K during the fiscal quarter for which this report is filed. 15
16 SIGNATURE Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. IDEXX LABORATORIES, INC. Date: May , 1998 /s/ Ralph K. Carlton ----------------------------------------- Ralph K. Carlton, Senior Vice President, Finance and Administration and Chief Financial Officer (Principal Financial Officer) 16