UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q (Mark One) [X] Quarterly Report Pursuant to Section 13 or 15 (d) of the Securities Exchange Act of 1934 for the Quarterly Period Ended June 30, 1998. [ ] Transition Report Pursuant to Section 13 or 15 (d) of the Securities Exchange Act of 1934 for the transition period from ______ to ______ 0-16864 ------------------------ (Commission File number) GULL LABORATORIES, INC. ------------------------------------------------------ (Exact Name of Registrant as Specified in its Charter) UTAH 87-0404754 - ------------------------ ------------------------------------ (State of Incorporation) (IRS Employer Identification Number) 1011 East Murray Holladay Road Salt Lake City, Utah 84117 - ---------------------------------------- ---------- (Address of Principal Executive Offices) (Zip Code) (801) 263-3524 - ------------------------------- (Registrant's Telephone Number) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No --- --- The number of shares of common stock outstanding as of August 1, 1998 was 8,016,012. PART 1. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS GULL LABORATORIES, INC. UNAUDITED CONSOLIDATED CONDENSED BALANCE SHEETS June 30, 1998 December 31, 1997 ------------------------ ------------------------ ASSETS Current assets: Cash and cash equivalents $ 569,740 $ 239,993 Receivables-net 3,335,320 1,963,410 Net investment in sales-type leases 249,464 272,125 Income tax refund receivable 307,855 119,499 Inventories 6,901,716 6,197,359 Prepaid expenses 422,133 316,878 ------------------------ ------------------------ Total current assets 11,786,228 9,109,264 Property, plant and equipment - net 4,444,173 4,189,999 Net investment in sales-type leases 582,590 763,412 Deferred taxes 279,569 236,586 Other assets - net 971,897 1,001,812 ------------------------ ------------------------ Total assets $ 18,064,457 $ 15,301,073 ======================== ======================== LIABILITIES AND STOCK- HOLDERS' EQUITY Current liabilities: Notes payable $ 1,664,831 $ 1,498,146 Accounts payable 6,409,155 2,331,126 Accrued expenses 1,791,249 1,853,521 Deferred income taxes 48,177 6,884 Current portion of long term obligations 3,531,381 3,576,085 ------------------------ ----------------------- Total current liabilities 13,444,793 9,265,762 Long-term obligations 749,195 733,082 Other long-term liabilities 375,073 362,278 ------------------------ ------------------------ Total liabilities 14,569,061 10,361,122 ------------------------ ------------------------ Commitments and contingencies Stockholders' equity: Preferred stock Common stock 8,008 7,941 Additional paid-in capital 8,924,782 8,416,335 Foreign currency translation adjustment (443,847) (413,737) Accumulated deficit (4,993,547) (3,070,588) ------------------------ ------------------------ Total stockholders' equity 3,495,396 4,939,951 ------------------------ ------------------------ Total liabilities and stockholders' equity $ 18,064,457 $ 15,301,073 ======================== ======================== 1 GULL LABORATORIES, INC. UNAUDITED CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS Three months ended June 30, 1998 June 30, 1997 ------------------------------ ----------------------------- Sales $ 4,909,146 $ 5,193,226 Cost of good sold 2,910,019 2,069,007 ------------------------------ ----------------------------- Gross Profit 1,999,127 3,124,219 ------------------------------ ----------------------------- Expenses: Selling, general and administrative 3,010,550 2,512,635 Research and development 358,404 367,691 ------------------------------ ------------------------------ Total expenses 3,368,954 2,880,326 ------------------------------ ----------------------------- Operating income (loss) (1,369,827) 243,893 ------------------------------ ----------------------------- Other expense: Interest expense (178,899) (167,863) Other 94,317 59,420 ------------------------------ ----------------------------- Total other expense (84,582) (108,443) ------------------------------ ----------------------------- Income (loss) before provision for income taxes (1,454,409) 135,450 Income tax provision (112,005) 17,370 ------------------------------ ----------------------------- Net income (loss) $ (1,342,404) $ 118,080 ============================== ============================= Net income (loss) per common share: Basic and diluted $ (.17) $ .01 ============================== ============================= 2 GULL LABORATORIES, INC. UNAUDITED CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS Six months ended June 30, 1998 June 30, 1997 ------------------------------ ----------------------------- Sales $ 10,049,552 $ 11,225,000 Cost of good sold 5,457,363 4,453,000 ------------------------------ ----------------------------- Gross Profit 4,592,189 6,772,000 ------------------------------ ----------------------------- Expenses: Selling, general and administrative 5,661,840 5,159,000 Research and development 725,645 769,000 ------------------------------ ----------------------------- Total expenses 6,387,485 5,928,000 ------------------------------ ----------------------------- Operating income (loss) (1,795,296) 844,000 ------------------------------ ----------------------------- Other expense: Interest expense (378,171) (313,000) Other 143,361 56,000 ------------------------------ ----------------------------- Total other expense (234,810) (257,000) ------------------------------ ----------------------------- Income (loss) before provision for income taxes (2,030,106) 587,000 Income tax provision (107,148) 411,000 ------------------------------ ----------------------------- Net income (loss) $ (1,922,958) $ 176,000 ============================== ============================= Net income (loss) per common share: Basic and diluted $ (.24) $ .02 ============================== ============================= 3 GULL LABORATORIES, INC. UNAUDITED CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS Six Months Ended June 30, 1998 June 30, 1997 ----------------------- ----------------------- Cash flows from operating activities: Income from continuing operations $ (1,922,958) $ 176,000 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 621,550 563,514 Stock option exercise compensation expense 238,625 Other 227,351 41,707 Changes in assets and liabilities: Net receivables (1,413,041) (1,654,188) Inventories (842,068) (2,261,889) Prepaid expenses (105,983) (298,643) Other assets/liabilities (37,961) 142,205 Income taxes (receivable) payable (121,790) 267,586 Accounts payable 4,087,232 2,153,807 Deferred income taxes (3,376) 11,000 Accrued expenses (82,434) 316,927 ----------------------- ----------------------- Net cash provided by (used in) operating activities 645,147 (541,974) ----------------------- ----------------------- Cash flows from investing activities: Receipts of sales type lease 184,012 162,454 Disposition of property, plant and equipment 45,520 15,957 Purchase of property, plant and equipment (507,469) (1,171,051) ----------------------- ----------------------- Net cash used in investing activities (277,937) (992,640) ----------------------- ----------------------- Cash flows from financing activities: Proceeds from long-term obligations 1,642,667 Principal payments on long-term obligations (389,688) (537,599) Line of Credit 167,847 496,601 Proceeds from issuance of common stock 203,322 210,424 ----------------------- ----------------------- Net cash provided from financing activities (18,519) 1,812,093 ----------------------- ----------------------- Foreign currency translation adjustment (18,944) (359,460) ----------------------- ------------------------ Net increase/(decrease) in cash 329,747 (81,981) Cash at beginning of period 239,993 301,033 ----------------------- ----------------------- Cash at end of period $ 569,740 $ 219,052 ====================== ======================= 4 GULL LABORATORIES, INC. NOTES TO UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS 1. Basis of presentation The unaudited consolidated condensed financial statements of Gull Laboratories, Inc. (the "Company") as of June 30, 1998 and for the three months and the six months ended June 30, 1998 and 1997 were prepared by the Company without audit pursuant to the rules and regulations of the Securities and Exchange Commission. Income statement amounts for the six months ended June 30, 1997 have been rounded to the nearest $1,000. These financial statements and related notes should be read in conjunction with the Company's audited financial statements for the year ended December 31, 1997 contained in its Annual Report on Form 10-K. 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. In the opinion of management, all necessary adjustments to the financial statements have been made to present fairly the financial position and results of operations and cash flows. The results of operations for the periods presented are not necessarily indicative of the results for the respective complete years. 2. Inventories Inventories consisted of the following: June 30, December 31, 1998 1997 Raw materials $1,878,907 $2,514,522 Work-in-process 1,227,474 889,947 Finished goods 2,121,791 1,576,303 Equipment held for lease or sale 1,673,544 1,216,587 ---------- ---------- Total $6,901,716 $6,197,359 ========== ========== 3. Earnings per share SFAS 128, requires the presentation of basic and diluted income (loss) per share. Basic earnings (loss) per common share is the amount of net income (loss) for the period available to each share of common stock outstanding during the reporting period. Diluted earnings (loss) per common share is the amount of net income (loss) for the period available to each share of common stock outstanding during the reporting period and to each share that would have been outstanding during the period. A total of 147,150 potential common shares (stock options) have not been included in the computation of loss per share for the three months and six months ended June 30, 1998, as they would have had a dilutive effect. 5 In calculating income (loss) per common share, the net income (loss) was the same for both the basic and diluted calculation. Below is a reconciliation between the basic and diluted weighted average common and common-equivalent shares for three months and six months ended June 30, 1998 and 1997. Three Months Ended June 30, 1998 1997 ---- ---- Basic (weighted average common shares outstanding during the period) 8,000,662 7,929,825 Weighted average common stock options outstanding during the period -- 164,591 --------- --------- Diluted 8,000,662 8,094,416 ========= ========= Six Months Ended June 30, 1998 1997 ---- ---- Basic (weighted average common shares outstanding during the period) 7,973,387 7,914,882 Weighted average common stock options outstanding during the period -- 162,459 --------- --------- Diluted 7,973,387 8,077,341 ========= ========= 4. Comprehensive Income The Company adopted Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income", effective January 1, 1998 which establishes standards for reporting and display of comprehensive income and its components in financial statements. The components of the Company's comprehensive income are as follows: 6 Three Months Ended June 30, 1998 1997 ---- ---- Net income/(loss) $(1,342,404) $ 118,080 Foreign currency translation increase/(loss) (4,189) 14,000 ------------ ----------- Comprehensive income/(loss) $(1,346,593) $ 132,080 ============ =========== Six Months Ended June 30, 1998 1997 ---- ---- Net income/(loss) $(1,922,958) $ 176,000 Foreign currency translation loss (30,110) (131,422) ------------ ------------ Comprehensive income/(loss) $(1,953,068) $ 44,578 ============ ============ ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS This Quarterly Report contains both historical facts and forward-looking statements. Any forward-looking statements involve risks and uncertainties, including but not limited to risk of product demand, market acceptance, government regulation, economic conditions, competitive products and pricing, difficulties in product development, commercialization, production and technology and other risks detailed in this filing. Although the Company believes it has the necessary product offerings and resources, future revenue and margin trends cannot be reliably predicted. Factors external to the Company can result in volatility of the Company's Common Stock price. Because of the foregoing factors, recent trends should not be considered reliable indicators of future stock prices or financial performance. CHANGES IN FINANCIAL CONDITIONS The Company's liquidity continued to decrease due to operating losses incurred in the first six months of 1998. In the first six months of 1998, working capital decreased by $1,502,067 to a working capital deficit of $1,658,565, as compared to a working capital deficit of $156,498 at December 31, 1997. The Company's current ratio of current assets divided by current liabilities decreased from .98 at December 31, 1997 to .88 at June 30, 1998 and the Company's ratio of total liabilities to equity increased from 2.1 to 1 at December 31, 1997 to 4.2 to 1 at June 30, 1998. During the first six months of 1998, the Company has funded its operation by increasing its bank borrowings and through cash receipts received through the exercise of stock options totaling approximately $200,000. Additionally, in 1998 Fresenius AG, the Company's majority shareholder, has advanced approximately $3,000,000 to the Company through the payment of vendors in the Company's behalf. Without the advancement of these funds by Fresenius AG, the Company would not have been able to meet its obligations. 7 As a result of the losses and decrease in liquidity, at June 30, 1998, the Company was not in compliance with certain earnings and leverage covenants associated with its long-term debt with two banks and a line of credit that was due August 15, 1998. Upon receipt of a guarantee of certain debt by Fresenius AG, the line of credit has been extended through the earlier of November 15, 1998 or the date the Merger referred to below is closed. Because the banks have not waived the covenants through July 1, 1999, the long-term debt with the banks has been classified as a current liability. The Company experienced increased accounts receivable in the Company's European Operations as customers extended their payments. Finished Goods inventories increased as the Company reestablished safety stocks which had been depleted due to the manufacturing and product quality problems that the Company had experienced in the fourth quarter of 1997 and the first quarter of 1998. These increases were financed by proceeds from the exercise of stock options, increases in accounts payable and accrued expenses payable to Fresenius AG and increases in the line of credit and capital leases. At June 30,1998, the Company had approximately $300,000 available under lines of credit with its banks and had no commitments to purchase capital assets. The Company will need to obtain additional financing to fund its operations and instrumentation program. The Company does not have any funding commitments from outside lending institutions and there is no guarantee that it will be able to obtain funding if working capital needs cannot be financed through internally generated funds or additional advances from Fresenius AG. On July 27, 1998, the Company announced that, together with its majority shareholder, Fresenius AG, it had executed a letter of intent to merge with Meridian Diagnostics for a cash consideration of $3.00 per share (the"Merger"). The Merger is subject to the execution of a definitive agreement, the receipt of a fairness opinion from an independent investment banker, recommendation of the merger to the Company's shareholders by an independent committee of the Company's Board of Directors and approval by a majority vote of the Company's shareholders. Fresenius AG, the Company's majority shareholder, has agreed, subject to certain conditions, to vote its shares in favor of the Merger. 8 Results of Operations Sales of the second quarter of 1998 of $4,909,146 were $284,080 or 5% lower than sales in the second quarter of 1997 of $5,193,226. Approximately $125,000 of the sales decrease was due to the strength of the dollar against major European currencies. Sales of the Company's United States' operations decreased approximately $82,000 or 3%. Decreased sales of the Company's reagents in the United States and Australian markets were offset by increased sales of Biodesign. For the six months ended June 30, 1998 sales decreased $1,175,448 or 10% from $11,225,000 to $10,049,552. Approximately $380,000 of the decrease was due to the strength of the dollar against major European currencies. Revenues in the United States decreased due to decreased sales to the College of American Pathologists, more placements of instrumentation being treated as monthly rental agreements rather than sales, decreased sales to OEM customers and decreased sales into export areas, mainly to the Australian market. In Europe, the Company experienced revenue growth in France due to the receipt of product registrations from the Agence du Medicament. Sales in Germany, the largest market in Europe, decreased in all product lines due to a significant increase in pricing pressure caused by changes in Germany's reimbursement system. Additionally, the Company has shown continued loss of market share in its infectious disease products due to back order problems in late 1997 and early 1998. Gross profits as a percentage of sales decreased to 41% and 46% in the second quarter and the first six months of 1998, respectively, compared to 60% in 1997. The decrease in the gross profit margin was caused by changes in product mix between IFA, ELISA and instrumentation products, pricing pressures, particularly in the German market, coupled with lower absorption of overhead due to decreased sales of bloodgrouping and HLA products, manufacturing inefficiencies due to raw material manufacturing and product quality problems in the United States and increased write offs of obsolete inventories. Selling, General and Administrative costs increased approximately $500,000 compared to the prior year. As described below, substantially all of this increase was caused by costs related to the termination of the Company's President and Senior Vice President in the second quarter of 1998. Termination Costs - The Company had employment agreements with its President and a Senior Vice President whose employment has been terminated. Both agreements provided for severance payments ranging from nine months to one year from the date of termination. In the second quarter of 1998, the Company accrued termination costs of approximately $280,000 required to be paid under the terms of these agreements. 9 Additionally, at termination, both individuals held stock options to purchase an aggregate of 187,400 shares of the Company's common stock at a weighted average price per share of $4.63. These options expire 90 days from the date that their employment terminated. Under the terms of the Company's stock option plan, stock option holders are entitled to exercise their stock options by surrendering shares of previously issued stock as payment for the exercise price of the stock option. United States Generally Accepted Accounting Principles require that compensation expense equal to the excess of the fair value of the stock received over the exercise price of the option must be recorded if stock that has been held for less than six months ("Immature Stock") is used to exercise stock options. While the recognition of compensation expense does not have an impact on the liquidity of the Company because a corresponding credit is recorded in the Company's equity section, it can have an impact on the earnings of the Company and the impact may be material. In the second quarter of 1998, stock options for a total of 42,625 shares of the Company's stock were exercised using Immature Stock, resulting in the recognition of compensation expense of approximately $238,000 and a related income tax benefit of approximately $82,000. Options to purchase 151,375 shares of the Company's common stock held by the former president of the Company expired in the second quarter of 1998. Options to purchase a total of 31,400 shares of the Company's common stock at a weighted average price per share of $5.25 remain outstanding with the Company's former Senior Vice President. These options expire August 19, 1998. Clinical Trial Costs - The Company has recently introduced its new Herpes Type Specific IgG ELISA tests in several foreign markets and is seeking clearance to market the products in the United States from the FDA. Because there is no in vitro diagnostic device that is able to differentiate between Type 1 and Type 2 Herpes infections that has been cleared to market in the United States by the FDA, the Company has been required by the FDA to perform more extensive clinical trials on individuals at risk for a sexually transmitted infection or disease. These clinical trials are currently in process and the patient enrollment is finished. These clinical trials are significantly more extensive than the trials the Company has been required to perform for other new product submissions to the FDA and the Company expects to incur clinical trial costs in excess of $200,000, approximately $40,000 of which was incurred in the second quarter of 1998. The FDA submission will be finalized after receipt of the final clinical trial data and the Company expects to file the submission in the fourth quarter. At this time, the Company believes that it should be possible to launch HSV 1 IgG and HSV 2 IgG Type Specific products in the United States by the first quarter of 1999. 10 There were no other material changes in the Company's operations during the second quarter and first six months of 1998. PART Ill. OTHER INFORMATION ITEM 5: OTHER INFORMATION Dr. Silke Humberg was elected as CEO & President of the Company on April 6, 1998. Dr. Humberg continues to be an employee of Fresenius AG while she obtains necessary work permits and governmental authorizations. The Company, by vote of its Board of Directors, including members of the Compensation Committee, has agreed to reimburse Fresenius AG for the direct expenses incurred by Fresenius AG in compensating Dr. Humberg until the work permits and authorization are obtained. Dr. Humberg is working for the Company on a full time basis during the time that she is being compensated by Fresenius AG. The Company has received six U.S. patents and two European patents on its GeneSTAR(TM) technology. GeneSTAR, as a new generation of DNA-based technology, will require more development and preliminary evaluation before it is ready for commercial applications. Gull is collaborating with the Centers for Disease Control on the development of both an EHEC (enterohemorrhagic E. coli) panel and a gastrointestinal bacterial panel of tests using its GeneSTAR technology. The products are currently only available in a format for use in an experimental laboratory and not in a commercially feasible format. The Company is conducting preclinical trials on its EHEC panel in both Europe and in the United States. The clinical trials in Europe have been suspended until certain necessary enhancements to the product have been completed. The limited market distribution of the EHEC product in Europe, which was initiated in May, has also been suspended until the enhancements have been completed. The Company does not expect to generate revenues from its GeneSTAR technology in 1998. ITEM 6: EXHIBITS AND REPORTS ON FORM 8-K The following exhibit is filed as part of this report: 10(a) Reimbursement agreement with Fresenius. No other material matter occurred during the quarter ended June 30, 1998 that requires disclosure as part of Part II of the quarterly report on Form 10Q. 11 SIGNATURES 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. Gull Laboratories, Inc. Date 8-14-98 /s/ Michael B. Malan -------------------------------- -------------------- Michael B. Malan, CPA Secretary/Treasurer and V.P. of Finance (Duly authorized officer and principal financial officer) 12