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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Washington, D.C. 20549
Form 10-Q
| þ | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | |
| For the Quarterly Period Ended September 30, 2007 | ||
OR | ||
| o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | |
Commission File Number001-33027
HOME DIAGNOSTICS, INC.
(Exact name of registrant as specified in its charter)
| Delaware (State or other jurisdiction of incorporation or organization) | 22-2594392 (I.R.S. Employer Identification No.) | |
| 2400 Northwest 55th Court Fort Lauderdale, Florida 33309 (Address of principal executive offices) | (954) 677-9201 (Zip Code) |
(Former name, former address and fiscal year, if changed since last report)
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 þ Noo
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” inRule 12b-2 of the Exchange Act (Check one):
Large accelerated filer o Accelerated filer o Non-accelerated filer þ
Indicate by check mark whether the registrant is a shell company (as defined inRule 12b-2 of the Exchange Act). Yes o No þ
Indicate the number of shares outstanding of each of the issuer’s classes of common stock as of the latest practicable date:
Shares of Common Stock outstanding as of November 7, 2007: 18,013,932 .
HOME DIAGNOSTICS, INC
.
INDEX
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HOME DIAGNOSTICS, INC. AND SUBSIDIARIES
| December 31, | September 30, | |||||||
| 2006 | 2007 | |||||||
| (Unaudited) | ||||||||
ASSETS | ||||||||
| Current assets: | ||||||||
| Cash and cash equivalents | $ | 26,487,163 | $ | 33,227,602 | ||||
| Accounts receivable, net | 17,010,471 | 21,163,503 | ||||||
| Inventories, net | 12,389,654 | 14,349,748 | ||||||
| Prepaid expenses and other current assets | 912,117 | 1,268,253 | ||||||
| Income taxes receivable | 1,455,689 | — | ||||||
| Deferred tax asset | 4,709,201 | 4,168,548 | ||||||
| Total current assets | 62,964,295 | 74,177,654 | ||||||
| Property and equipment, net | 17,932,833 | 21,848,331 | ||||||
| Goodwill | 35,573,462 | 35,573,462 | ||||||
| Other intangible assets, net | 1,048,781 | 750,816 | ||||||
| Deferred tax asset | 15,140 | 1,480,684 | ||||||
| Other assets, net | 141,504 | 138,855 | ||||||
| Total assets | $ | 117,676,015 | $ | 133,969,802 | ||||
LIABILITIES AND STOCKHOLDERS’ EQUITY | ||||||||
| Current liabilities: | ||||||||
| Accounts payable | $ | 6,655,728 | $ | 10,481,656 | ||||
| Accrued liabilities | 13,907,664 | 16,394,884 | ||||||
| Accrued income taxes | — | 400,118 | ||||||
| Total current liabilities | 20,563,392 | 27,276,658 | ||||||
| Contingencies (Note 11) | — | — | ||||||
| Stockholders’ equity: | ||||||||
| Common stock, $.01 par value; 60,000,000 shares authorized, 17,697,691 and 17,949,618 shares issued and outstanding at December 31, 2006 and September 30, 2007, respectively | 176,977 | 179,496 | ||||||
| Additional paid-in capital | 93,967,063 | 95,370,954 | ||||||
| Retained earnings | 2,940,376 | 11,107,649 | ||||||
| Accumulated other comprehensive income | 28,207 | 35,045 | ||||||
| Total stockholders’ equity | 97,112,623 | 106,693,144 | ||||||
| Total liabilities and stockholders’ equity | $ | 117,676,015 | $ | 133,969,802 | ||||
The accompanying notes are an integral part of these condensed consolidated financial statements.
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HOME DIAGNOSTICS, INC. AND SUBSIDIARIES
| Three Months Ended | Nine Months Ended | |||||||||||||||
| September 30, | September 30, | |||||||||||||||
| 2006 | 2007 | 2006 | 2007 | |||||||||||||
| (Unaudited) | ||||||||||||||||
Net sales | $ | 30,059,915 | $ | 31,684,101 | $ | 85,761,369 | $ | 87,834,473 | ||||||||
Cost of sales | 11,052,625 | 11,025,302 | 33,517,762 | 34,180,896 | ||||||||||||
| Gross profit | 19,007,290 | 20,658,799 | 52,243,607 | 53,653,577 | ||||||||||||
Operating expenses | ||||||||||||||||
| Selling, general and administrative (including stock-based compensation expense of $145,251 and $149,525 and $1,335,125 and $889,490 for the three and nine months ended September 30, 2006 and 2007, respectively) | 10,647,742 | 12,028,896 | 32,726,928 | 35,136,687 | ||||||||||||
| Research and development | 2,086,096 | 2,231,292 | 5,832,944 | 6,500,479 | ||||||||||||
| Insurance settlement | — | (450,000 | ) | — | (450,000 | ) | ||||||||||
| Total operating expenses | 12,733,838 | 13,810,188 | 38,559,872 | 41,187,166 | ||||||||||||
| Income from operations | 6,273,452 | 6,848,611 | 13,683,735 | 12,466,411 | ||||||||||||
Other income (expense) | ||||||||||||||||
| Change in fair value of warrant put option | 1,334,151 | — | 58,700 | — | ||||||||||||
| Interest (expense) income, net | (33,128 | ) | 447,763 | (194,063 | ) | 1,218,044 | ||||||||||
| Other, net | 129,917 | 12,579 | 28,936 | 64,186 | ||||||||||||
| Total other income (expense) | 1,430,940 | 460,342 | (106,427 | ) | 1,282,230 | |||||||||||
| Income before provision for income taxes | 7,704,392 | 7,308,953 | 13,577,308 | 13,748,641 | ||||||||||||
| Provision for income taxes | 1,336,366 | 2,104,805 | 4,020,876 | 4,229,903 | ||||||||||||
| Net income | $ | 6,368,026 | $ | 5,204,148 | $ | 9,556,432 | $ | 9,518,738 | ||||||||
| Earnings per common share: | ||||||||||||||||
| Basic | $ | 0.45 | $ | 0.29 | $ | 0.69 | $ | 0.53 | ||||||||
| Diluted | $ | 0.30 | $ | 0.27 | $ | 0.57 | $ | 0.48 | ||||||||
| Weighted average shares used in computing earnings per common share: | ||||||||||||||||
| Basic | 14,150,876 | 18,115,897 | 13,857,902 | 17,953,529 | ||||||||||||
| Diluted | 16,899,801 | 19,559,220 | 16,585,288 | 19,706,031 | ||||||||||||
The accompanying notes are an integral part of these condensed consolidated financial statements.
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HOME DIAGNOSTICS, INC. AND SUBSIDIARIES
| Accumulated | ||||||||||||||||||||||||
| Common Stock | Additional | Other | Total | |||||||||||||||||||||
| Number of | Paid-in | Retained | Comprehensive | Stockholders’ | ||||||||||||||||||||
| Shares | Amount | Capital | Earnings | Income (Loss) | Equity | |||||||||||||||||||
| (Unaudited) | ||||||||||||||||||||||||
Balance at December 31, 2006 | 17,697,691 | $ | 176,977 | $ | 93,967,063 | $ | 2,940,376 | $ | 28,207 | $ | 97,112,623 | |||||||||||||
| Cumulative effect of change in accounting for uncertainties in income taxes (Note 8) | — | — | — | 89,279 | — | 89,279 | ||||||||||||||||||
| Deemed capital distribution to stockholders | — | — | (300,000 | ) | — | — | (300,000 | ) | ||||||||||||||||
| Stock-based compensation expense | — | — | 889,490 | — | — | 889,490 | ||||||||||||||||||
| Stock options and warrants exercised, including tax benefit of $820,719 | 615,495 | 6,154 | 2,760,633 | — | — | 2,766,787 | ||||||||||||||||||
| Repurchases of common stock | (363,568 | ) | (3,635 | ) | (1,946,232 | ) | (1,440,744 | ) | — | (3,390,611 | ) | |||||||||||||
| Comprehensive income: | ||||||||||||||||||||||||
| Foreign currency translation adjustment | — | — | — | — | 6,838 | 6,838 | ||||||||||||||||||
| Net income | — | — | — | 9,518,738 | — | 9,518,738 | ||||||||||||||||||
| Total comprehensive income | — | — | — | 9,518,738 | 6,838 | 9,525,576 | ||||||||||||||||||
Balance at September 30, 2007 | 17,949,618 | $ | 179,496 | $ | 95,370,954 | $ | 11,107,649 | $ | 35,045 | $ | 106,693,144 | |||||||||||||
The accompanying notes are an integral part of these condensed consolidated financial statements.
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HOME DIAGNOSTICS, INC. AND SUBSIDIARIES
| Nine Months Ended | ||||||||
| September 30, | ||||||||
| 2006 | 2007 | |||||||
| (Unaudited) | ||||||||
Cash flows from operating activities | ||||||||
| Net income | $ | 9,556,432 | $ | 9,518,738 | ||||
| Adjustments to reconcile net income to net cash provided by operating activities: | ||||||||
| Depreciation and amortization | 3,163,010 | 2,900,746 | ||||||
| Amortization of deferred financing and debt issuance costs | 64,634 | 6,763 | ||||||
| Loss on asset disposal | 53,903 | 33,098 | ||||||
| Bad debt expense | 45,000 | 37,489 | ||||||
| Non-cash impact of insurance settlement | — | (300,000 | ) | |||||
| Deferred income taxes | (1,804,453 | ) | (665,545 | ) | ||||
| Change in fair value of warrant put option | (58,700 | ) | — | |||||
| Stock-based compensation expense | 1,335,125 | 889,490 | ||||||
| Changes in assets and liabilities: | ||||||||
| Accounts receivable | (3,242,233 | ) | (4,190,521 | ) | ||||
| Inventories | 1,152,894 | (1,971,755 | ) | |||||
| Prepaid expenses and other current and non-current assets | (95,119 | ) | (356,135 | ) | ||||
| Income taxes receivable and payable | (960,387 | ) | 2,629,135 | |||||
| Accounts payable | 245,284 | 3,825,929 | ||||||
| Accrued liabilities | 2,649,358 | 1,543,824 | ||||||
| Net cash provided by operating activities | 12,104,748 | 13,901,256 | ||||||
Cash flows from investing activities | ||||||||
| Capital expenditures | (7,388,714 | ) | (6,550,868 | ) | ||||
| Net cash used in investing activities | (7,388,714 | ) | (6,550,868 | ) | ||||
Cash flows from financing activities | ||||||||
| Repayment of term loans and notes payable | (3,749,866 | ) | — | |||||
| Repayment of notes payable to related party | (1,300,000 | ) | — | |||||
| Redemption of mandatorily redeemable preferred stock | (10,371,420 | ) | — | |||||
| Proceeds from issuance of common stock | 35,105,684 | — | ||||||
| Payment of debt financing costs | — | (4,314 | ) | |||||
| Proceeds from exercise of stock options | 13,274 | 1,946,068 | ||||||
| Tax benefit from stock options | — | 820,719 | ||||||
| Repurchases of common stock | — | (3,390,611 | ) | |||||
| Net cash provided by (used in) financing activities | 19,697,672 | (628,138 | ) | |||||
| Effect of exchange rate changes on cash and cash equivalents | 153,293 | 18,189 | ||||||
| Net increase in cash and cash equivalents | 24,566,999 | 6,740,439 | ||||||
Cash and cash equivalents | ||||||||
| Beginning of period | 3,483,424 | 26,487,163 | ||||||
| End of period | $ | 28,050,423 | $ | 33,227,602 | ||||
Supplemental cash flows disclosures: | ||||||||
| Cash paid during the period for: | ||||||||
| Interest | $ | 202,721 | $ | — | ||||
| Income taxes | $ | 6,030,000 | $ | 1,587,778 | ||||
Non-cash supplemental information: | ||||||||
| Deemed capital distribution to stockholders | $ | — | $ | (300,000 | ) | |||
| Issuance of common shares in distribution of deferred compensation obligation | $ | 228,340 | $ | — | ||||
| Exchange of warrant option | $ | 7,371,644 | $ | — | ||||
The accompanying notes are an integral part of these condensed consolidated financial statements.
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HOME DIAGNOSTICS, INC. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
September 30, 2007
(Unaudited)
Notes to Condensed Consolidated Financial Statements
September 30, 2007
(Unaudited)
| 1. | Basis of presentation |
Home Diagnostics, Inc. was founded in 1985 and has focused exclusively on the diabetes market since inception. The Company is a developer, manufacturer and marketer of technologically advanced blood glucose monitoring systems and disposable supplies for diabetics worldwide.
The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with the rules and regulations of the Securities and Exchange Commission (“SEC”) for interim financial information. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. Therefore, these interim financial statements should be read in conjunction with the audited consolidated financial statements and related notes to the financial statements of Home Diagnostics, Inc. and its subsidiaries (the “Company”) included in the Company’s most recent Annual Report onForm 10-K. In the opinion of management, all adjustments consist of normal and recurring adjustments, necessary to present fairly the financial position and results of operations for the interim periods presented herein. The results of operations for the interim periods presented are not necessarily indicative of the results to be expected for the full year.
The condensed consolidated financial statements include the accounts of Home Diagnostics, Inc. and its wholly-owned subsidiaries. All significant intercompany accounts and transactions have been eliminated.
Use of estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Significant estimates include the Company’s allowance for estimated sales returns, legal contingencies, assumptions used to evaluate the impairment of goodwill and long lived assets and income tax uncertainties. Actual amounts could differ from those estimates.
Revenue recognition
Revenue from sales of products is recognized when (1) persuasive evidence of an arrangement exists, (2) delivery has occurred or services have been rendered, (3) the sale price is fixed or determinable, and (4) collection of the related receivable is reasonably assured. The Company recognizes revenue from product sales when goods are shipped or delivered and title and risk of loss pass to the customer.
The Company accepts product returns primarily due to the expiration of product life. Revenue is recorded net of an allowance for estimated returns. Sales returns are generally estimated and recorded based on an analysis of historical sales and returns information, analyzing the actual return date of the product as compared to the original date of sale of the product. The Company has estimated based on historical return experience that a reserve is required for future returns covering the prior 18 to 24 months of sales, driven primarily by the 18 to 24 month expiration of the Company’s test strip products. Products that exhibit unusual sales or return patterns due to dating or other matters are specifically identified and analyzed as part of accounting for the sales return provision.
Volume discount incentives are offered to certain customers. These volume discount incentives are recorded as a reduction of revenue in the same period as the revenue is earned. The Company also offers price reductions for certain retail and distribution customers for designated periods of time in support of customer product promotions. The Company estimates and accrues for these promotional allowances as a reduction of
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HOME DIAGNOSTICS, INC. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements — (Continued)
Notes to Condensed Consolidated Financial Statements — (Continued)
revenue at the later of time of sale or when the incentive is offered. Sales to customers are generally not subject to any price protection rights.
The Company also has reimbursement agreements with certain managed care providers, Medicaid programs and other third-party payors that require payment of rebates for products provided to their members. The Company accrues for these rebates, as a reduction of revenue, at the time of sale. The determination of the rebate allowance is based on the terms of the reimbursement agreements as well as historical payment trends to these providers. In addition, under certain circumstances, the Company offers meters, at no charge, to customers and third-party payors. The cost of these meters is recorded in cost of sales in the period the products are shipped.
Recent accounting pronouncements
In September 2006, the FASB issued Statement of Financial Accounting Standards (“SFAS”) No. 157, “Fair Value Measures.” SFAS No. 157 defines fair value, establishes a framework for measuring fair value and enhances disclosures about fair value measures required under other accounting pronouncements, but does not change existing guidance as to whether or not an instrument is carried at fair value. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007. The Company is currently evaluating the impact that the adoption of SFAS No. 157 will have on its future consolidated financial statements.
In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities — Including an amendment of FASB Statement No. 115.” SFAS No. 159 permits entities to choose to measure many financial instruments and certain other items at fair value. Unrealized gains and losses on items for which the fair value option has been elected will be recognized in earnings at each subsequent reporting date. SFAS No. 159 will be effective for the Company on January 1, 2008. The Company is evaluating the impact that the adoption of SFAS No. 159 will have on its future results of operations and financial position.
In June 2007, the FASB ratified the consensus reached by the Emerging Issues Task Force (“EITF”) related to Issue No. 07 — 03, “Accounting for Non-refundable Advance Payments for Goods or Services Received for Use in Future Research and Development Activities.” EITF IssueNo. 07-03 permits entities to capitalize nonrefundable advance payments for goods or services that will be used or rendered for future research and development activities. Such amounts should be recognized as an expense as the related goods are delivered or the related services are performed. Entities are required to evaluate whether they expect the goods to be delivered or services to be rendered. If an entity does not expect the goods to be delivered or services to be rendered, the capitalized advance payment should be charged to expense. EITF IssueNo. 07-03 will be effective for financial statements issued for fiscal years beginning after December 15, 2007 The Company is evaluating the impact that the adoption of EITF IssueNo. 07-03 will have on its future results of operations and financial position.
Reclassifications
Certain prior year amounts have been reclassified to conform with current year presentation.
| 2. | Stock option plans and warrants |
In July 2006, the Company’s Board of Directors and stockholders approved the 2006 Equity Incentive Plan (the “2006 Plan”). Two million shares of common stock have been reserved for issuance under the 2006 Plan. The term of each option granted under the 2006 Plan cannot exceed ten years from the date of grant. The 2006 Plan authorizes a range of awards including, but not limited to the following: stock options; stock appreciation rights; and restricted stock. Under the 2006 Plan, there were 1,320,300 options available for grant
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HOME DIAGNOSTICS, INC. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements — (Continued)
Notes to Condensed Consolidated Financial Statements — (Continued)
and 679,700 options outstanding at September 30, 2007. These options generally become exercisable on a pro rata basis over a three-year period from the date of grant.
The Company also has two predecessor stock option plans which have approximately 2.4 million shares outstanding as of September 30, 2007. No additional stock options may be granted under either of these plans.
A summary of the Company’s stock option activity and related information for the three and nine months ended September 30, 2007 is as follows:
| Weighted | ||||||||||||
| Range of | Average | |||||||||||
| Number of | Exercise | Exercise | ||||||||||
| Options | Prices | Prices | ||||||||||
Outstanding at December 31, 2006 | 3,274,756 | $ | 2.99 - 12.00 | $ | 4.40 | |||||||
| Granted | 37,500 | $ | 10.85 | $ | 10.85 | |||||||
| Exercised | (409 | ) | $ | 3.63 | $ | 3.63 | ||||||
| Forfeited/Cancelled | (1,760 | ) | $ | 3.85-12.00 | $ | 8.48 | ||||||
Outstanding at March 31, 2007 | 3,310,087 | $ | 2.99 - 12.00 | $ | 4.47 | |||||||
| Granted | 334,400 | $ | 11.20-11.58 | $ | 11.20 | |||||||
| Exercised | (396,692 | ) | $ | 2.99-4.27 | $ | 3.20 | ||||||
| Forfeited/Cancelled | (3,000 | ) | $ | 11.58-12.00 | $ | 11.72 | ||||||
Outstanding at June 30, 2007 | 3,244,795 | $ | 2.99 - 12.00 | $ | 5.38 | |||||||
| Granted | 71,500 | $ | 9.26-11.07 | $ | 11.03 | |||||||
| Exercised | (190,600 | ) | $ | 2.99-4.27 | $ | 3.46 | ||||||
| Forfeited/Cancelled | (49,447 | ) | $ | 3.85-12.00 | $ | 10.72 | ||||||
Outstanding at September 30, 2007 | 3,076,248 | $ | 2.99 - 12.00 | $ | 5.48 | |||||||
| Exercisable at September 30, 2007 | 2,337,461 | $ | 2.99-12.00 | $ | 3.94 | |||||||
The fair value of stock option grants during the nine months ended September 30, 2006 and 2007 were estimated on the date of grant using the Black-Scholes option-pricing model with assumptions for expected volatility, expected life, risk-free interest rate and dividend yield. The assumptions were as follows:
| Nine Months Ended | ||||||||
| September 30, | September 30, | |||||||
| 2006 | 2007 | |||||||
Weighted average expected term of options(in years) | 6.00 | 4.58 | ||||||
Expected volatility factor(based on peer group volatility) | 30.00 | % | 30.00 | % | ||||
| Expected dividend yield | none | none | ||||||
Weighted average risk-free interest rate(based on applicable U.S. Treasury rates) | 5.06 | % | 4.86 | % | ||||
Estimated forfeitures during the three and nine months ended September 30, 2006 were not significant. The Company’s estimated forfeiture rate during the three and nine months ended September 30, 2007 was approximately 8%.
At September 30, 2006 and 2007, there was $1.9 million and $1.7 million, respectively, of unrecognized share-based compensation expense associated with non-vested stock option grants subject to SFAS 123R. The Company has elected to recognize compensation expense for stock option awards using a graded vesting attribution methodology, whereby compensation expense is recognized on a straight-line basis over the requisite service period for each separately vesting portion of the award as if the award was, in-substance,
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Notes to Condensed Consolidated Financial Statements — (Continued)
Notes to Condensed Consolidated Financial Statements — (Continued)
multiple awards. Stock-based compensation expense is expected to be recognized over a weighted-average period of 3 years.
The Company recognized stock-based compensation expense of $0.1 million during each of the three months ended September 30, 2006 and 2007, respectively. During the three months ended September 30, 2006, the $0.1 million in expense was comprised of approximately $0.2 million related to compensation expense calculated in accordance with SFAS 123R for stock options, partially offset by income of approximately $0.1 million related to the mark-to-market accounting adjustment for variable stock options. The income tax benefit associated with SFAS 123R expense during the three months ended September 30, 2006 was not significant. During the three months ended September 30, 2007, the $0.1 million in expense was comprised of approximately $0.4 million related to compensation expense calculated in accordance with SFAS 123R for stock options, partially offset by income of approximately $0.3 million related to the mark-to-market accounting adjustment for variable stock options. The income tax benefit associated with SFAS 123R expense during the three months ended September 30, 2007 was approximately $0.1 million.
The Company recognized stock-based compensation expense of $1.3 million and $0.9 million during the nine months ended September 30, 2006 and 2007, respectively. During the nine months ended September 30, 2006, the $1.3 million in expense was comprised of approximately $0.4 million related to compensation expense calculated in accordance with SFAS 123R for stock options and approximately $0.9 million related to the mark-to-market accounting adjustment for variable stock options. The income tax benefit associated with SFAS 123R expense during the nine months ended September 30, 2006 was $0.1 million. During the nine months ended September 30, 2007, the $0.9 million in expense was comprised of approximately $1.0 million related to compensation expense calculated in accordance with SFAS 123R for stock options, partially offset by income of approximately $0.1 million related to the mark-to-market accounting adjustment for variable stock options. The income tax benefit associated with SFAS 123R expense during the nine months ended September 30, 2007 was approximately $0.3 million.
During January 2007, the Company issued 27,800 shares of our common stock for a purchase price of $0.01 per share, or $278.00 in the aggregate, pursuant to the exercise of the remaining unexercised portion of a warrant. The warrant was issued in September 2002 as consideration for financing consulting services and was exercisable as of the date of issuance.
3. Inventories, net
Inventories, net consist of the following:
| December 31, | September 30, | |||||||
| 2006 | 2007 | |||||||
| Raw materials | $ | 6,873,057 | $ | 7,709,417 | ||||
| Work-in-process | 3,360,650 | 4,663,110 | ||||||
| Finished goods | 2,155,947 | 1,977,221 | ||||||
| $ | 12,389,654 | $ | 14,349,748 | |||||
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HOME DIAGNOSTICS, INC. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements — (Continued)
Notes to Condensed Consolidated Financial Statements — (Continued)
4. Property and equipment, net
Property and equipment, net consist of the following:
| December 31, | September 30, | |||||||
| 2006 | 2007 | |||||||
| Machinery and equipment | $ | 15,404,014 | $ | 15,612,682 | ||||
| Leasehold improvements | 3,004,636 | 3,229,509 | ||||||
| Furniture, fixtures, and office equipment | 2,841,022 | 2,994,722 | ||||||
| Computer software | 2,069,489 | 1,891,690 | ||||||
| Equipment not yet placed in service | 11,042,883 | 15,335,748 | ||||||
| 34,362,044 | 39,064,351 | |||||||
| Less: Accumulated depreciation and amortization | (16,429,211 | ) | (17,216,020 | ) | ||||
| $ | 17,932,833 | $ | 21,848,331 | |||||
Depreciation expense was approximately $0.9 million and $0.8 million for the three months ended September 30, 2006 and 2007, respectively. Amortization expense of computer software was approximately $0.1 million for the each of the three months ended September 30, 2006 and 2007.
Depreciation expense was approximately $2.6 million and $2.4 million for the nine months ended September 30, 2006 and 2007, respectively. Amortization expense of computer software was approximately $0.2 million for the each of the nine months ended September 30, 2006,and 2007
Equipment not yet placed in service primarily consists of expenditures for custom manufacturing equipment for new product development which is expected to be placed into service during mid 2008.
| 5. | Accrued liabilities |
Accrued liabilities consist of the following:
| December 31, | September 30, | |||||||
| 2006 | 2007 | |||||||
| Accrued salaries and benefits | $ | 3,977,850 | $ | 3,645,012 | ||||
| Sales returns reserve | 5,588,068 | 4,999,068 | ||||||
| Product warranty and customer liabilities | 3,399,119 | 5,344,037 | ||||||
| Other accrued liabilities | 942,627 | 2,406,767 | ||||||
| $ | 13,907,664 | $ | 16,394,884 | |||||
| 6. | Credit facility and long-term debt |
The Company’s credit agreement, originally executed in October 2003 and subsequently amended (the “Amended Credit Facility”), consists of a $7.0 million unsecured revolving line of credit, which matures on November 30, 2008. At September 30, 2007, there was no outstanding balance. Borrowings bear interest at LIBOR plus 0.5% (5.6% at September 30, 2007). The Amended Credit Facility contains a financial covenant and other covenants that restrict the Company’s ability to, among other things, incur liens, repurchase shares and participate in a change in control. The financial covenant requires the Company to maintain a ratio of total liabilities to tangible net worth of not more than 1.0 to 1.0. Failure to comply with this covenant and other restrictions would constitute an event of default. In August 2007, the Company received a waiver of non-compliance from the bank that is a party to the Company’s Amended Credit Facility, which had restricted the Company from retiring or repurchasing its own common stock. The Company believes that it was in compliance with the financial covenant and other restrictions at September 30, 2007.
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HOME DIAGNOSTICS, INC. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements — (Continued)
Notes to Condensed Consolidated Financial Statements — (Continued)
The Company’s foreign manufacturing subsidiary based in Taiwan has the ability to borrow up to $0.8 million under a foreign line of credit at an annual rate of 2.75%. The foreign subsidiary may use these borrowings for normal operating uses and material purchases. There were no outstanding balances under the line of credit at September 30, 2007.
| 7. | Warrant put option |
In connection with the issuance of $5.0 million Senior Subordinated Notes in 2002, the Company issued to the lender a warrant to purchase 614,816 shares of common stock with an exercise price of $0.01 per share (the “Warrant Put Option”). The holder of the Warrant Put Option had the right to put the Warrant Put Option to the Company after the fifth anniversary date at a redemption value as defined in the agreement. The redemption value was based on the greater of the estimated fair value of the Company in a non-liquidation scenario or a value based upon a stated multiple of earnings before interest, taxes, depreciation and amortization, plus cash less certain indebtedness and the redemption value of the Company’s Class F mandatorily redeemable preferred stock, without regard to any marketability or liquidity discount. The Warrant Put Option was considered a free standing derivative financial instrument that required valuation at each balance sheet date with the change in such value recorded within earnings. During the three months and nine months ended September 30, 2006, the estimated fair value of the Warrant Put Option decreased by approximately $1.3 million and $0.1 million, respectively. On September 20, 2006, in connection with the Company’s initial public offering (“IPO”), the holder of the Warrant Put Option exercised its registration rights and exchanged the warrant for 614,303 shares of our common stock. These shares were sold by the warrant holder in the IPO at $12.00 per share for a total of $7.4 million. As a result, the Company reclassed to equity the estimated fair value of the Warrant Put Option of approximately $7.4 million from the previously recorded liability balance during the year ended December 31, 2006.
| 8. | Income taxes |
The Company’s tax provision for interim periods is determined using an estimate of the Company’s annual effective tax rate.
Effective January 1, 2007, the Company adopted FASB Interpretation No. 48 (FIN 48), “Accounting for Uncertainty in Income Taxes.” The adoption of FIN 48 also resulted in a $0.1 million cumulative effect adjustment to increase retained earnings. Under FIN 48, the Company has elected to continue its prior practice of accounting for interest and penalties on unrecognized tax benefits as income tax expense. As of September 30, 2007, the Company has gross unrecognized tax benefits of approximately $2.3 million compared with approximately $2.2 million as of January 1, 2007, representing an increase of approximately $.1 million for the first nine months of fiscal 2007. Of the total unrecognized tax benefits, $1.6 million, if recognized, would reduce our effective tax rate in the period of recognition. Interest did not change significantly during the nine months ended September 30, 2007 and is included in the unrecognized tax benefits.
The Company and its subsidiaries file income tax returns in the U.S. Federal jurisdiction and various state and foreign jurisdictions. In the normal course of business, the Company is subject to examination by taxing authorities in the United States, Taiwan, the United Kingdom, Australia and Canada. In the Company’s most significant jurisdiction, the United States, it is no longer subject to IRS examination for periods prior to 2003, although carry forward attributes that were generated between 1998 and 2002 may still be adjusted upon examination by the IRS if they either have been or will be used in a future periods.
The Company is currently under audit by the Internal Revenue Service for the 2003 and 2004 tax years. It is reasonably possible a change in the unrecognized tax benefits may occur in the next 12 months; however, quantification of an estimated range cannot be made at this time.
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HOME DIAGNOSTICS, INC. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements — (Continued)
Notes to Condensed Consolidated Financial Statements — (Continued)
| 9. | Earnings per common share |
Basic earnings per common share is computed by dividing net income by the weighted average number of common shares outstanding during the period presented. Weighted average shares outstanding includes shares subject to a warrant with a deminimis exercise price of $0.01 per share (46,800 shares for the three and nine months ended September 30, 2006).
Diluted earnings per share is computed using the weighted average number of common shares outstanding during the period plus the effect of dilutive securities outstanding during the period. As described in Note 7, the Company accounted for a Warrant Put Option as a liability carried at fair value. The common shares subject to this warrant have been included in the computation of diluted earnings per share for the three and nine months ended September 30, 2006, because, after considering the effect of the change in fair value of the warrant put option on net income, their effect is dilutive. On September 20, 2006, the holders of the warrant exercised their registration rights and exchanged the warrant for 614,303 shares of common stock.
The calculations of basic and diluted net income per share for the three and nine months ended September 30, 2006 are as follows:
| Three Months Ended | Nine Months Ended | |||||||
| September 30, | September 30, | |||||||
| 2006 | 2006 | |||||||
| Basic: | ||||||||
| Net income applicable to common stock | $ | 6,368,026 | $ | 9,556,432 | ||||
| Weighted average number of common shares outstanding | 14,150,876 | 13,857,902 | ||||||
| Basic net income per share | $ | 0.45 | $ | 0.69 | ||||
| Diluted: | ||||||||
| Net income applicable to common stock | $ | 6,368,026 | $ | 9,556,432 | ||||
| Change in fair value of the warrant put option | (1,334,151 | ) | (58,700 | ) | ||||
| Adjusted net income applicable to common stock | $ | 5,033,875 | $ | 9,497,732 | ||||
| Weighted average number of common shares outstanding | 14,150,876 | 13,857,902 | ||||||
| Effect of dilutive securities: stock options and warrants | 2,748,925 | 2,727,386 | ||||||
| Weighted average number of common and common equivalent shares outstanding | 16,899,801 | 16,585,288 | ||||||
| Diluted net income per share | $ | 0.30 | $ | 0.57 | ||||
The following summarizes the weighted average number of common shares outstanding during the three and nine months ended September 30, 2007, that were used to calculate the basic earnings per common share
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HOME DIAGNOSTICS, INC. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements — (Continued)
Notes to Condensed Consolidated Financial Statements — (Continued)
as well as the dilutive impact of stock options and warrants, using the treasury stock method, as included in the calculation of diluted weighted average shares:
| Three Months Ended | Nine Months Ended | |||||||
| September 30, | September 30, | |||||||
| 2007 | 2007 | |||||||
| Weighted average number of common shares outstanding for basic earnings per share | 18,115,897 | 17,953,529 | ||||||
| Effect of dilutive securities: stock options and warrants | 1,443,323 | 1,752,502 | ||||||
| Weighted average number of common and common equivalent shares outstanding | 19,559,220 | 19,706,031 | ||||||
For the three months and nine months ended September 30, 2007, the Company had 700,430 and 430,007 outstanding employee stock options, respectively, that have been excluded from the computation of diluted earnings per share because they are anti-dilutive. There were no anti-dilutive options for the three and nine months ended 2006.
| 10. | Common stock repurchase program |
On August 7, 2007, the Company’s Board of Directors authorized the Company to repurchase up to $5 million of its common stock (the “Common Stock Repurchase Program”). During the three months ended September 30, 2007, the Company repurchased approximately 364,000 shares at a cost of approximately $3.4 million. All purchases under the Common Stock Repurchase Program were made in the open market, subject to market conditions and trading restrictions.
| 11. | Contingencies |
Litigation
The Company is involved in certain legal proceedings arising in the ordinary course of business. In the opinion of management, except as disclosed below, the outcome of such proceedings will not materially affect the Company’s consolidated financial position, results of operations or cash flows.
Roche Litigation
In February 2004, Roche Diagnostics Corporation filed suit against the Company and three other co-defendants in federal court in Indiana. The three co-defendants settled with Roche in January 2006. The suit alleges that the Company’s TrueTrack Smart System infringes claims in two Roche patents. These patents are related to Roche’s electrochemical biosensors and the methods they use to measure glucose levels in a blood sample. In its suit, Roche seeks damages including its lost profits or a reasonable royalty, or both, and a permanent injunction against the accused products. Roche also alleges willful infringement, which, if proven, could result in an award of up to three times its actual damages, as well as its legal fees and expenses. On June 20, 2005, the Court ruled that one of the Roche patents was procured by inequitable conduct before the Patent Office and is unenforceable. On March 2, 2007, the Court granted the Company’s motion for summary judgment for non-infringement with respect to the second patent and denied the Roche motion for a summary judgment. These rulings are currently subject to appeal by Roche. In the event of an appeal, the Company will vigorously defend itself.
Brandt Litigation
In March 2007, a settlement in principle was agreed by the parties to a lawsuit against the Company, MIT Development Corp. or MIT, George H. Holley and the Estate of Robert Salem, brought by Leonard Brandt. Mr. Brandt claimed that he was engaged in 1994 to provide financial consulting services for MIT,
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HOME DIAGNOSTICS, INC. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements — (Continued)
Notes to Condensed Consolidated Financial Statements — (Continued)
Mr. George Holley and Mr. Salem. Mr. Brandt claimed he was to receive at least $1,000 per month for consulting services plus 10% of the increase in the value of the assets of MIT, Holley or Robert Salem resulting from cash or other assets received from the Company in connection with any transaction with the Company. In November 1999, the Company acquired MIT from Messrs. Holley and Salem. The settlement provides for a total of $3.0 million of consideration to be paid by the defendants. The Company’s share of the settlement consideration is $0.6 million to be paid in cash, and the remaining $2.4 million will be funded by George H. Holley and the Estate of Robert Salem in common stock of the Company. The Company will grant Mr. Brandt “piggy-back” registration rights with respect to such stock for a period of one year from the date of settlement. In December 2006, pursuant to Staff Accounting Bulletin No. 107, Topic 5T “Accounting for Expenses or Liabilities Paid by Principal Stockholders”, the Company recorded a charge of $3.0 million to operating expense and recorded the $2.4 million funded by the other two defendants as additional paid-in capital. On July 19, 2007 and October 31, 2007, the court arbitrated the final payment terms of the settlement consistent with the foregoing description, and ordered the immediate exchange of mutual releases and payment of cash and stock. In July 2007, the Company reached a settlement agreement with its’ directors and officers insurance provider, whereby, the Company received $450,000 in insurance proceeds relating to a recovery of losses incurred as part of the Brandt matter. The Company’s share of the insurance proceeds was $150,000 and the remaining $300,000 was distributed to George H. Holley and the Estate of Robert Salem. During the three months ended September 30, 2007, the Company recorded a reduction to operating expenses of $450,000 and a distribution of capital of $300,000.
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| ITEM 2. | Management’s discussion and analysis of financial condition and results of operations |
The following discussion highlights the principal factors that have affected our financial condition and results of operations, as well as our liquidity and capital resources for the periods described. This discussion should be read in conjunction with the unaudited condensed consolidated financial statements and the notes thereto included in this Quarterly Report. In addition, reference is made to our audited consolidated financial statements and notes thereto and related Management’s Discussion and Analysis of Financial Condition and Results of Operations included in our most recent Annual Report onForm 10-K. As used in this Quarterly Report, the terms “Home Diagnostics”, the “Company”, “HDI”, “we”, “us” and “our” refer to Home Diagnostics, Inc. and its consolidated subsidiaries. The following discussion contains forward-looking statements. Please see our most recent Annual Report onForm 10-K, including the section entitled “Risk Factors,” for a discussion of the uncertainties, risks and assumptions associated with these forward-looking statements. In addition, please see “Caution concerning forward-looking statements” below.
Company overview
We are a developer, manufacturer and marketer of technologically advanced blood glucose monitoring systems and disposable supplies for diabetics worldwide. We market our blood glucose monitoring systems both under our own HDI brands and through a unique co-branding strategy in partnership with the leading food and drug retailers, mass merchandisers, distributors, mail service providers and third-party payors in the United States and internationally.
Our co-branding distribution strategy allows our customers to leverage their brand strategy with ours and to deliver high quality, low cost blood glucose monitoring systems to their diabetic customers at attractive price points for the consumer and increased profit margins for the retailer or distributor.
Our Company was founded in 1985 and has focused exclusively on the diabetes market since inception. We have two manufacturing facilities, one located in Fort Lauderdale, Florida, and the other in Hsinchu City, Taiwan. We manufacture, test and package our blood glucose test strips at our facility in Fort Lauderdale. Our blood glucose monitors are assembled in our Taiwan facility. Labeling, final assembly, quality control testing and shipment of our blood glucose monitoring systems are conducted in our Fort Lauderdale facility. We have a highly automated manufacturing process with sufficient capacity to continue to grow our business without significant incremental capital investments, other than for new product development.
We sell our products in the following distribution channels:
| • | Retail —the retail channel generates the majority of sales of blood glucose monitoring products in the United States and includes chain drug stores, food stores and mass merchandisers. We sell our products into the retail channel on a direct basis or through domestic distributors. Our retail net sales include products we sell directly into the retail channel for the larger food and drug retailers. | |
| • | Domestic distribution —the domestic distribution channel includes sales to domestic wholesalers, including AmerisourceBergen, Cardinal Health, McKesson, and Invacare, who sell products to independent and chain food and drug retailers, primary and long-term care providers, durable medical equipment suppliers and mail service providers. | |
| • | Mail service —the mail service channel includes sales to leading mail service providers, who market their products primarily to the Medicare population. | |
| • | International —the international channel consists primarily of sales to distributors in Latin America, the United Kingdom, Germany, Australia, Canada and China. In May 2005, we acquired our United Kingdom distributor, and we continually evaluate opportunities to partner with or acquire distributors in other international markets. |
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Our net sales by channel were as follows for the periods indicated:
| Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||||||||||||||||||
| 2006 | 2007 | 2006 | 2007 | |||||||||||||||||||||||||||||
| Net sales by channel: | ||||||||||||||||||||||||||||||||
| Retail | $ | 5,476,177 | 18.2 | % | $ | 5,761,852 | 18.2 | % | $ | 17,508,584 | 20.4 | % | $ | 18,512,802 | 21.1 | % | ||||||||||||||||
| Domestic distribution | 19,013,959 | 63.2 | % | 19,336,111 | 61.0 | % | 50,300,184 | 58.6 | % | 48,402,884 | 55.1 | % | ||||||||||||||||||||
| Mail service | 2,968,047 | 9.9 | % | 3,118,992 | 9.9 | % | 9,417,049 | 11.0 | % | 10,471,405 | 11.9 | % | ||||||||||||||||||||
| International | 2,601,732 | 8.7 | % | 3,467,146 | 10.9 | % | 8,535,552 | 10.0 | % | 10,447,382 | 11.9 | % | ||||||||||||||||||||
| Net sales | $ | 30,059,915 | 100.0 | % | $ | 31,684,101 | 100.0 | % | $ | 85,761,369 | 100.0 | % | $ | 87,834,473 | 100.0 | % | ||||||||||||||||
We strive to maximize our installed base of monitors to drive future sales of our test strips. Monitors, which are sold individually or in a starter kit with a sample of 10 test strips and other supplies, are typically sold at or below cost. It is also common for us to provide monitors free of charge in support of managed care initiatives and other market opportunities. Test strip sales are a significant driver of our overall gross margins. We measure our operating performance in many ways, including the ratio of test strips to monitors sold in a given period. Our gross margins are affected by several factors, including manufacturing cost reductions, the ratio of test strips to monitors, free monitor distributions and product pricing.
Our selling, general and administrative expenses include sales and marketing expenses, legal and regulatory costs, customer and technical service, finance and administrative expenses and stock-based compensation expenses. We have been involved in patent related litigation concerning certain of our products. Our legal costs can be significant, and the timing difficult to predict.
We have made significant investments in our research and development initiatives. Our research and development costs include salaries and related costs for our scientists and staff as well as costs for clinical studies, materials, consulting and other third-party services. Our research and development team is working to develop new technologies that we believe will broaden our product portfolio and enhance our current products.
Results of operations
The following table sets forth, for the periods indicated, certain information related to our operations, expressed in dollars and as a percentage of sales:
| Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||||||||||||||||||
| 2006 | 2007 | 2006 | 2007 | |||||||||||||||||||||||||||||
| Net sales | $ | 30,059,915 | 100.0 | % | $ | 31,684,101 | 100.0 | % | $ | 85,761,369 | 100.0 | % | $ | 87,834,473 | 100.0 | % | ||||||||||||||||
| Cost of sales | 11,052,625 | 36.8 | % | 11,025,302 | 34.8 | % | 33,517,762 | 39.1 | % | 34,180,896 | 38.9 | % | ||||||||||||||||||||
| Gross profit | 19,007,290 | 63.2 | % | 20,658,799 | 65.2 | % | 52,243,607 | 60.9 | % | 53,653,577 | 61.1 | % | ||||||||||||||||||||
| Operating Expenses: | ||||||||||||||||||||||||||||||||
| Selling, general and administrative | 10,647,742 | 35.4 | % | 12,028,896 | 38.0 | % | 32,726,928 | 38.2 | % | 35,136,687 | 40.0 | % | ||||||||||||||||||||
| Research and development | 2,086,096 | 6.9 | % | 2,231,292 | 7.0 | % | 5,832,944 | 6.8 | % | 6,500,479 | 7.4 | % | ||||||||||||||||||||
| Litigation settlement/(insurance proceeds) | — | 0 | % | (450,000 | ) | (1.4 | )% | — | 0 | % | (450,000 | ) | (0.5 | )% | ||||||||||||||||||
| Total operating expenses | 12,733,838 | 42.4 | % | 13,810,188 | 43.6 | % | 38,559,872 | 45.0 | % | 41,187,166 | 46.9 | % | ||||||||||||||||||||
| Income from operations | 6,273,452 | 20.9 | % | 6,848,611 | 21.6 | % | 13,683,735 | 16.0 | % | 12,466,411 | 14.2 | % | ||||||||||||||||||||
| Increase in fair value of warrant put option | 1,334,151 | 4.4 | % | — | 0.0 | % | 58,700 | 0.1 | % | — | 0.0 | % | ||||||||||||||||||||
| Interest (expense) income, net | (33,128 | ) | (0.1 | )% | 447,763 | 1.5 | % | (194,063 | ) | (0.2 | )% | 1,218,044 | 1.4 | % | ||||||||||||||||||
| Other, net | 129,917 | 0.4 | % | 12,579 | (0.0 | )% | 28,936 | (0.0 | )% | 64,186 | 0.1 | % | ||||||||||||||||||||
| Income before income taxes | 7,704,392 | 25.6 | % | 7,308,953 | 23.1 | % | 13,577,308 | 15.8 | % | 13,748,641 | 15.7 | % | ||||||||||||||||||||
| Provision for income taxes | (1,336,366 | ) | (4.4 | )% | (2,104,805 | ) | (6.7 | )% | (4,020,876 | ) | (4.7 | )% | (4,229,903 | ) | (4.9 | )% | ||||||||||||||||
| Net income | $ | 6,368,026 | 21.2 | % | $ | 5,204,148 | 16.4 | % | $ | 9,556,432 | 11.1 | % | $ | 9,518,738 | 10.8 | % | ||||||||||||||||
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Three months ended September 30, 2007 as compared to three months ended September 30, 2006
Net sales increased $1.6 million, or 5.4%, to $31.7 million for the three months ended September 30, 2007, as compared to $30.1 million for the same period in 2006. The increase was due to higher sales volume of $2.0 million and reduced sales returns of $0.2 million, partially offset by increased managed care rebates and other discounts of $0.6 million, a portion of which related to prior periods. The increased volume of $2.0 million reflects the continued trend of increased distribution of our biosensor systems totaling approximately $5.7 million, partially offset by a decrease in our photometric system and other sales of approximately $3.7 million. The $0.2 million reduction in our provision for sales returns resulted primarily from continued favorable return rate trends from our biosensor systems. The increase in managed care rebates was due primarily to increased awareness and acceptance within the third-party payor environment of our products.
Cost of sales decreased $0.1 million, or 0.2%, to $11.0 million for the three months ended September 30, 2007, as compared to $11.1 million for the same period in 2006. This $0.1 million decrease was driven primarily by product cost savings of $1.7 million which relate primarily to reduced manufacturing costs primarily related to test strips, partially offset by increased costs of $1.0 million associated with higher sales volume and $0.6 million of costs associated with increased distribution of free monitors for managed care and other initiatives. As a percentage of net sales, cost of sales decreased to 34.8% for the three months ended September 30, 2007, as compared to 36.8% for the same period in 2006. This 2.0% decrease was due to cost savings driven primarily by test strip manufacturing process improvements which contributed 5.2%, partially offset by an increase in the distribution of free monitors which contributed 2.0%. In addition net revenue decreases from increased managed care and other rebates and product mix, offset by reduced returns, contributed 0.7%.
Gross profit increased $1.7 million, or 8.7%, to $20.7 million for the three months ended September 30, 2007, as compared to $19.0 million for the same period in 2006. The increase is due to higher sales volume of $1.0 million, product cost savings of $1.7 million and reduced sales returns of $0.2 million, partially offset by increased costs of $0.6 million associated with increased distribution of free monitors and increased managed care rebates of $0.6 million. As a percentage of net sales, gross profit increased to 65.2% for the three months ended September 30, 2007, as compared to 63.2% for the same period in 2006. The increase in gross profit percentage is primarily due to the decrease in cost of sales as a percentage of net sales, as noted above.
Selling, general and administrative expenses increased $1.4 million, or 13.0%, to $12.0 million for the three months ended September 30, 2007, as compared to $10.6 million for the same period in 2006. The increase is primarily due to higher sales and marketing costs of $1.5 million to support increased advertising and promotions, managed care and other strategic initiatives, increased audit, tax, and Sarbanes-Oxley related professional fees associated with being a publicly held company of $0.3 million and increases to other general and administrative expenses of $0.2 million to support the continuing growth of our operations. These costs were partially offset by reduced overall legal costs associated with the Roche litigation and other corporate matters of $0.6 million. As a percentage of net sales, selling, general and administrative expenses increased to 38.0% for the three months ended September 30, 2007, as compared to 35.4% for the same period in 2006, primarily due to increased costs described above.
Research and development expenses increased $0.1 million, or 7.0%, to $2.2 million for the three months ended September 30, 2007, as compared to $2.1 million for the same period in 2006. The increase is primarily due to increased participation in various clinical studies and other costs related to new product development. As a percentage of net sales, research and development costs increased slightly to 7.0% for the three months ended September 30, 2007, as compared to 6.9% for the same period in 2006.
Insurance settlement income of $0.5 million for the three months ended September 30, 2007 related to a settlement with our director’s and officer’s insurance carrier in connection with litigation brought by Leonard Brandt in 2001 against us and two of our principal shareholders. Our share of the settlement consideration was $0.2 million and the remaining $0.3 million was paid directly to the two principal shareholders. During the three months ended September 30, 2007, we recorded a reduction to operating expenses of $0.5 million and a distribution of capital of $0.3 million.
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Operating income was $6.8 million, or 21.6% of net sales, for the three months ended September 30, 2007 as compared to $6.3 million, or 20.9% of net sales, for the same period in 2006. The increase in aggregate dollars in operating income and increase as a percentage of net sales was due to increased gross margins offset by increased operating expenses, noted above.
The adjustment to the fair value of the Warrant Put Option resulted in income of $1.3 million for the three months ended September 30, 2006. On September 20, 2006, in connection with the Company’s IPO, the holder of the common stock purchase warrant exercised its registration rights and exchanged the warrant for shares of our common stock.
Interest (expense) income, net was income of $0.4 million for the three months ended September 30, 2007, as compared to expense of ($33,000) for the same period in 2006. The increase in interest (expense) income, net was primarily due to a lower average debt balance outstanding combined with interest income earned on increased cash balances on hand during the three months ended September 30, 2007 as compared to the same period in 2006.
Other, net was income of $0.1 million for the three months ended September 30, 2007, as compared to income of approximately $13,000 for the same period in 2006. These amounts consist primarily foreign exchange gains or losses on transactions with the Company’s foreign subsidiaries.
Our effective tax rates for the three months ended September 30, 2006 and 2007 were 17.3%, and 28.8%, respectively. The effective tax rate for the three months ended September 30, 2007 is lower than the 35% statutory rate primarily due to tax credits and disqualifying dispositions of incentive stock options. The effective tax rate for the three months ended September 30, 2006 is lower than the 35% statutory rate, primarily due to the decrease in the fair value of the Warrant Put Option, which is not taxable, and the recognition of an income tax benefit of approximately $1.2 million. The income tax benefit related primarily to the recognition of previously unclaimed research and development (“R&D”) tax credits associated with tax years 1998 through 2005.
Net income was $5.2 million for the three months ended September 30, 2007 as compared to $6.4 million for the same period in 2006. The Warrant Put Option and tax credit, noted above, increased net income by $2.5 million for the three months ended September 30, 2006. Diluted net income per common share was $0.27 on weighted average shares of 19.6 million for the three months ended September 30, 2007, as compared to $0.30 on weighted average shares of 16.9 million for the same period in 2006.
Nine months ended September 30, 2007 as compared to nine months ended September 30, 2006
Net sales increased $2.1 million, or 2.4%, to $87.8 million for the nine months ended September 30, 2007, as compared to $85.8 million for the same period in 2006. The increase was due to higher sales volume of $3.4 million and reduced sales returns of $1.5 million, partially offset by lower average selling prices of $1.9 million and increased managed care rebates and other discounts of $0.9 million. The increased volume of $3.4 million reflects the continued trend of increased distribution of our biosensor systems totaling approximately $11.5 million, partially offset by a decrease in our photometric system and other sales of approximately $8.1 million. The $1.5 million reduction in our provision for sales returns resulted primarily from continued favorable return rate trends from our biosensor systems. The decrease in our average selling prices of $1.9 million was primarily due to a shift in our revenue mix driven by increased international and mail service volume and shifts in customer and product mix within our domestic distribution channel. The increase in managed care rebates was due primarily to increased awareness and acceptance within the third-party payor environment of our products.
Cost of sales increased $0.7 million, or 2.0%, to $34.2 million for the nine months ended September 30, 2007, as compared to $33.5 million for the same period in 2006. This $0.7 million increase was driven primarily $1.6 million of costs associated with increased distribution of free monitors for managed care and other initiatives and higher sales volume of $1.4 million, partially offset by $2.3 million related to reduced manufacturing costs primarily related to test strips. As a percentage of net sales, cost of sales decreased to 38.9% for the nine months ended September 30, 2007, as compared to 39.1% for the same period in 2006.
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This 0.2% decrease was due primarily to cost savings which contributed 2.6%, and sales returns which contributed 0.4%, partially offset by an increase in the distribution of free monitors which contributed 1.8% and pricing which contributed 0.8%.
Gross profit increased $1.4 million, or 2.7%, to $53.7 million for the nine months ended September 30, 2007, as compared to $52.2 million for the same period in 2006. The increase is due to higher sales volume of $2.0 million, product cost savings of $2.3 million and reduced sales returns of $1.5 million, partially offset by $1.6 million associated with increased distribution of free monitors, lower average selling prices of $1.9 million and increased managed care rebates and other discounts of $0.9 million. As a percentage of net sales, gross profit increased to 61.1% for the nine months ended September 30, 2007, as compared to 60.9% for the same period in 2006. The increase in gross profit percentage is due to the decreases in cost of sales as a percentage of net sales, as noted above.
Selling, general and administrative expenses increased $2.4 million, or 7.4%, to $35.1 million for the nine months ended September 30, 2007, as compared to $32.7 million for the same period in 2006. The increase is primarily due to higher sales and marketing costs of $1.8 million to support continued sales growth, increased audit, tax, and Sarbanes-Oxley related professional fees associated with being a publicly held company of $1.1 million, an increase of $0.4 million in salaries and benefits related to increased sales and administrative personnel to support our continued growth and increases to other general and administrative expenses of $0.7 million to support the continuing growth of our operations. These costs were partially offset by a decrease of $0.4 million in stock-based compensation and reduced overall legal costs associated with the Roche litigation and other corporate matters of $1.2 million. As a percentage of net sales, selling, general and administrative expenses increased to 40.0% for the nine months ended September 30, 2007, as compared to 38.2% for the same period in 2006, primarily due to increased costs described above.
Research and development expenses increased $0.7 million, or 11.4%, to $6.5 million for the nine months ended September 30, 2007, as compared to $5.8 million for the same period in 2006. As a percentage of net sales, research and development costs increased to 7.4%, as compared to 6.8% for the nine months ended September 30, 2007 and 2006, respectively. The increase is primarily due to increased participation in various clinical studies and other costs related to new product development.
Insurance settlement income of $0.5 million for the nine months ended September 30, 2007 related to a settlement with the our director’s and officer’s insurance carrier in connection with litigation brought by Leonard Brandt in 2001 against us and two of our principal shareholders.
Operating income was $12.5 million, or 14.2% of net sales, for the nine months ended September 30, 2007 as compared to $13.7 million, or 16.0% of net sales, for the same period in 2006. The decrease in aggregate dollars in operating income and decrease as a percentage of net sales was due to increased operating expenses, partially offset by higher gross margins, noted above.
The adjustment to the fair value of the Warrant Put Option resulted in income of $0.1 million for the nine months ended September 30, 2006. On September 20, 2006, in connection with the Company’s IPO, the holder of the common stock purchase warrant exercised its registration rights and exchanged the warrant for shares of our common stock.
Interest (expense) income, net was income of $1.2 million for the nine months ended September 30, 2007, as compared to expense of ($0.2) million for the same period in 2006. The increase in interest (expense) income, net was primarily due to a lower average debt balance outstanding combined with interest income earned on increased cash balances on hand during the nine months ended September 30, 2007 as compared to the same period in 2006.
Other, net was income of $0.1 million for the nine months ended September 30, 2007, as compared to income of approximately $35,000 for the same period in 2006. These amounts consist primarily foreign exchange gains or losses on transactions with the Company’s foreign subsidiaries.
Our effective tax rates for the nine months ended September 30, 2006 and 2007 were 29.6% and 30.8%, respectively. The effective tax rate for the nine months ended September 30, 2007 is lower than the 35%
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statutory rate primarily due to tax credits and disqualifying dispositions of incentive stock options. The effective tax rate for the nine months ended September 30, 2006 is lower than the 35% statutory rate primarily due to the increase in the fair value of the Warrant Put Option and stock-based compensation expense for incentive stock options, both of which are not deductible for income tax purposes and the $1.2 million research and development tax credit previously discussed.
Net income decreased to $9.5 million for the nine months ended September 30, 2007, as compared to $9.6 million for the same period in 2006. Diluted net income per common share was $0.48 on weighted average shares of 19.7 million for the nine months ended September 30, 2007, as compared to $0.57 on weighted average shares of 16.6 million for the same period in 2006.
Liquidity and capital resources
On September 30, 2007, we had approximately $33.2 million of cash and cash equivalents on hand, no debt outstanding and $7.0 million of capacity under our revolving line of credit. Our primary capital requirements are to fund capital expenditures and to fund common stock repurchases under our board approved Common Stock Repurchase Program, as described below. Significant sources of liquidity are cash on hand, cash flows from operating activities, working capital and borrowings from our revolving line of credit.
Under our Fourth Amended and Restated Revolving Credit and Security Agreement (the “Credit Facility”), we have a $7.0 million unsecured revolving line of credit (“the Revolver”) which matures on November 30, 2008. At September 30, 2007, there was no outstanding balance under the Revolver. Borrowings under the Credit Facility bear interest at the LIBOR plus 0.5%. Our Credit Facility contains a financial covenant and other covenants that restrict our ability to, among other things, incur liens, repurchase shares and participate in a change in control. Our financial covenant requires us to maintain a ratio of total liabilities to total tangible net worth of not more than 1.0 to 1.0. Failure to comply with this covenant and other restrictions would constitute an event of default under our Credit Facility. We believe we were in compliance with the financial covenant and other restrictions applicable to us under the Credit Facility at September 30, 2007.
On August 7, 2007, our Board of Directors authorized a Common Stock Repurchase Program, authorizing us to repurchase up to $5 million of our common stock. In conjunction with the authorization of the Common Stock Repurchase Program, our lender under the Credit Facility waived the covenant which had restricted us from retiring or repurchasing shares of our common stock. During the three months ended September 30, 2007, we repurchased approximately 364,000 shares at a cost of approximately $3.4 million. All purchases under the Common Stock Repurchase Program made in the open market, subject to market conditions and trading restrictions.
Cash flows provided by operating activities were $12.1 million and $13.9 million for the nine months ended September 30, 2006 and 2007, respectively. The increase in cash provided by operating activities was due to changes in our working capital components, which includes a decrease in taxes paid of $4.4 million.
Cash flows used in investing activities were $7.4 million and $6.6 million for the nine months ended September 30, 2006 and 2007, respectively. These amounts consist primarily of capital expenditures relating to manufacturing equipment for a new blood glucose monitoring system under development. We expect our full year 2007 capital expenditures to be in the range of $9.0 million to $10.0 million which includes approximately $4.1 million related to the new test strip manufacturing equipment.
Cash flows provided by (used in) financing activities were $19.7 million and ($0.6) million for the nine months ended September 30, 2006 and 2007, respectively. Cash flows provided by financing activities for the nine months ended September 30, 2006 include IPO net proceeds of $35.1 million offset by payments to redeem our preferred stock of $10.4 million. Cash flows used in financing activities for the nine months ended September 30, 2007 consisted primarily of $3.4 million in purchases of common stock under our Common Stock Repurchase Program, noted above, partially offset by $2.8 million in proceeds received from the exercise of options. There were no borrowings or outstanding amounts under our $7 million Revolver at September 30, 2006 and 2007, respectively.
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We expect that funds generated from operations, our current cash on hand and funds available under our revolving line of credit, will be sufficient to finance our working capital requirements, fund capital expenditures, and meet our contractual obligations for at least the next twelve months.
Recent accounting pronouncements
In September 2006, the FASB issued Statement of Financial Accounting Standards (“SFAS”) No. 157,” Fair Value Measures.” SFAS No. 157 defines fair value, establishes a framework for measuring fair value and enhances disclosures about fair value measures required under other accounting pronouncements, but does not change existing guidance as to whether or not an instrument is carried at fair value. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007. We currently are evaluating the impact that the adoption of SFAS No. 157 will have on our future consolidated financial statements.
In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities — Including an amendment of FASB Statement No. 115.” SFAS No. 159 permits entities to choose to measure many financial instruments and certain other items at fair value. Unrealized gains and losses on items for which the fair value option has been elected will be recognized in earnings at each subsequent reporting date. SFAS No. 159 will be effective for the Company on January 1, 2008. We are evaluating the impact that the adoption of SFAS No. 159 will have on our future results of operations and financial position.
In June 2007, the FASB ratified the consensus reached by the Emerging Issues Task Force (“EITF”) related to Issue No. 07 — 03, “Accounting for Nonrefundable Advance Payments for Goods or Services Received for Use in Future Research and Development Activities.” EITF IssueNo. 07-03 permits entities to capitalize nonrefundable advance payments for goods or services that will be used or rendered for future research and development activities. Such amounts should be recognized as an expense as the related goods are delivered or the related services are performed. Entities are required to evaluate whether they expect the goods to be delivered or services to be rendered. If an entity does not expect the goods to be delivered or services to be rendered, the capitalized advance payment should be charged to expense. EITF IssueNo. 07-03 will be effective for financial statements issued for fiscal years beginning after December 15, 2007 We are evaluating the impact that the adoption of EITF IssueNo. 07-03 will have on our future results of operations and financial position.
Caution concerning forward-looking statements
Certain information included or incorporated by reference in this Quarterly Report may be deemed to be forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Forward-looking statements may include, but are not limited to, statements relating to our objectives, plans and strategies, and all statements (other than statements of historical facts) that address activities, events or developments that we intend, expect, project, believe or anticipate will or may occur in the future are forward-looking statements. These statements are often characterized by terminology such as “believe,” “hope,” “may,” “anticipate,” “should,” “intend,” “plan,” “will,” “expect,” “estimate,” “project,” “positioned,” “strategy” and similar expressions and are based on assumptions and assessments made by our management in light of their experience and their perception of historical trends, current conditions, expected future developments and other factors they believe to be appropriate. Any forward-looking statements in this Quarterly Report are made as of the date hereof, and we undertake no duty to update or revise any such statements, whether as a result of new information, future events or otherwise. Forward-looking statements are not guarantees of future performance and are subject to risks and uncertainties. Important factors that could cause actual results, developments and business decisions to differ materially from forward-looking statements are described in the Company’s most recent Annual Report onForm 10-K, including the section entitled “Risk Factors.”
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| Item 3. | Quantitative and qualitative disclosures about market risk |
Our Credit Facility is subject to market risk and interest rate changes. The Revolver under the Credit Facility bears interest at LIBOR plus 0.5%. At September 30, 2007, we did not have any borrowings outstanding under our Revolver.
| Item 4T. | Controls and procedures |
Evaluation of Disclosure Controls and Procedures
We evaluated, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, the effectiveness of our disclosure controls and procedures (as defined in Exchange ActRules 13a-15(e) and15d-15(e)) as of the end of the period covered by this Quarterly Report. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of the end of the period covered by this Quarterly Report.
Changes in Internal Control
There were no changes in internal control over financial reporting that occurred during the quarter ended September 30, 2007, that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
| Item 1. | Legal Proceedings |
We are involved in litigation from time to time in the ordinary course of our business. Except for the litigation described below, we do not believe that any litigation in which we are currently involved, individually or in the aggregate, is material to our financial condition or results of operations.
Roche Litigation
In February 2004, Roche Diagnostics Corporation filed suit against us and three other co-defendants in federal court in Indiana. The three co-defendants settled with Roche in January 2006. The suit alleges that HDI’s TrueTrack Smart System infringes claims in two Roche patents. These patents are related to Roche’s electrochemical biosensors and the methods they use to measure glucose levels in a blood sample. In its suit, Roche sought damages including its lost profits or a reasonable royalty, or both, and a permanent injunction against the accused products. Roche also alleged willful infringement, which, if proven, could result in an award of up to three times its actual damages, as well as its legal fees and expenses. On June 20, 2005, the Court ruled that one of the Roche patents was procured by inequitable conduct before the Patent Office and is unenforceable. On March 2, 2007, the Court granted our motion for summary judgment for non-infringement with respect to the second patent and denied the Roche motion for a summary judgment. These rulings are currently subject to appeal by Roche. In the event of an appeal, we will vigorously defend ourselves.
Brandt Litigation
In March 2007, a settlement in principle was agreed by the parties to a lawsuit against us, MIT Development Corp. or MIT, George H. Holley and the Estate of Robert Salem, brought by Leonard Brandt. Mr. Brandt claimed that he was engaged in 1994 to provide financial consulting services for MIT, Mr. Holley and Mr. Salem. Mr. Brandt claimed he was to receive at least $1,000 per month for consulting services plus 10% of the increase in the value of the assets of MIT, George Holley or Robert Salem resulting from cash or other assets received from us in connection with any transaction with us. In November 1999, we acquired MIT from Messrs. Holley and Salem. The settlement provides for a total of $3.0 million of consideration to be paid by the defendants. Our share of the settlement consideration is $0.6 million, to be paid in cash, and the remaining $2.4 million will be funded by George H. Holley and the Estate of Robert Salem in common stock of the Company. We will grant Mr. Brandt “piggy-back” registration rights with respect to such stock for a
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period of one year from the date of settlement. In December 2006, pursuant to Staff Accounting Bulletin No. 107, Topic 5T “Accounting for Expenses or Liabilities Paid by Principal Stockholders,” we recorded a charge of $3.0 million to operating expense and recorded the $2.4 million funded by the other two defendants as additional paid-in capital. On July 19, 2007 and October 31, 2007, the court arbitrated the final payment terms of the settlement consistent with the foregoing description, and ordered the immediate exchange of mutual releases and payment of cash and stock. In July 2007, we reached a settlement agreement with our directors and officers insurance provider, whereby, we received $450,000 in insurance proceeds relating to a recovery of losses incurred as part of the Brandt matter. Our share of the insurance proceeds was $150,000 and the remaining $300,000 was distributed to George H. Holley and the Estate of Robert Salem. During the three months ended September 30, 2007, we recorded a reduction to operating expenses of $450,000 and a distribution of capital of $300,000.
| Item 1A. | Risk Factors |
There have been no material changes from the risk factors previously disclosed in the Company’s most recent Annual Report onForm 10-K and in itsForm 10-Q for the period ending June 30, 2007.
| Item 2. | Unregistered Sales of Equity Securities and Use of Proceeds |
Use of Proceeds from Sales of Registered Securities
On September 26, 2006, we closed an initial public offering of 6,599,487 shares of our common stock. Of these shares, 3,300,000 were newly issued shares sold by us and 3,299,487 were existing shares sold by certain of our stockholders. On October 4, 2006, an additional 989,923 shares of existing common stock were sold by certain of such selling stockholders pursuant to the exercise by the underwriters of their over-allotment option. The offering was effected pursuant to a Registration Statement onForm S-1 (FileNo. 333-133713), which the SEC declared effective on September 20, 2006, and a final prospectus filed pursuant to Rule 424(b) under the Securities Act on September 22, 2006 (Reg.No. 333-133713).
During the three months ended September 30, 2007, we used $0.4 million of the net proceeds to us from our initial public offering to make payments on the purchase of certain manufacturing equipment for new product development (out of a total purchase price of approximately $14.8 million).
Of the remaining $19.7 million of the net proceeds to us from our initial public offering, we intend to use approximately $2.8 million to complete the purchase of such manufacturing equipment and the remainder for working capital and general corporate purposes. Pending such use, we have deposited such remaining net proceeds of our initial public offering in a money market fund.
Purchases of Equity Securities by the Issuer and Affiliated Purchasers
During the three months ended September 30, 2007, the Company repurchased approximately 364,000 shares of its common stock at a cost of approximately $3.4 million under a $5 million repurchase program approved by its Board of Directors in August 2007. All purchases were made in the open market, subject to market conditions and trading restrictions.
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ISSUER PURCHASES OF EQUITY SECURITIES
| Total Number | Approximate | |||||||||||||||
| of Shares | Dollar Value of | |||||||||||||||
| Purchased as | Shares that May | |||||||||||||||
| Total Number | Part of the | yet be Purchased | ||||||||||||||
| of Shares | Average Price | Repurchase | Under the | |||||||||||||
Period | Purchased | Paid per Share | Program | Repurchase Program | ||||||||||||
| July 1, 2007 to July 31, 2007 | — | — | — | $ | — | |||||||||||
| August 1, 2007 to August 31, 2007 | 265,268 | $ | 9.20 | 265,268 | $ | 2,558,255 | ||||||||||
| September 1, 2007 to September 30, 2007 | 98,300 | $ | 9.65 | 98,300 | $ | 1,609,389 | ||||||||||
Total at September 30, 2007 | 363,568 | $ | 9.33 | 363,568 | ||||||||||||
| Item 6. | Exhibits |
See exhibit index.
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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.
| HOME DIAGNOSTICS, INC. | ||
| Date: November 12, 2007 | By: /s/ J. RICHARD DAMRON, JR. J. Richard Damron, Jr. President and Chief Executive Officer (principal executive officer) and Director | |
| Date: November 12, 2007 | By: /s/ RONALD L. RUBIN Ronald L. Rubin Vice President and Chief Financial Officer (principal financial and accounting officer) |
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| Exhibit | ||||||
Number | Description | |||||
| 10 | .1* | — | Separation Agreement dated September 13, 2007 between the Registrant and a former employee. | |||
| 31 | .1* | — | Certification of Chief Executive Officer pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934. | |||
| 31 | .2* | — | Certification of Chief Financial Officer pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934. | |||
| 32 | .1* | — | Certification of Chief Executive Officer, Pursuant to 18 U.S.C. Section 1350. | |||
| 32 | .2* | — | Certification of Chief Financial Officer, Pursuant to 18 U.S.C. Section 1350. | |||
| * | Filed herewith |
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