_________________________________________________________________ SECURITIES AND EXCHANGE COMMISSION Washington D.C. 20549 FORM 10-Q (X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTER ENDED JUNE 28, 1996 OR ( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 Commission File Number 1-9800 INCSTAR CORPORATION (Exact name of Registrant as specified in its charter) Minnesota 41-1254731 (State or other jurisdiction of (I.R.S. Employer Incorporation or Organization) Identification No.) 1990 Industrial Boulevard Stillwater, Minnesota 55082 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (612) 439-9710 N/A Former name, former address and former fiscal year, if changed since last report. Indicate by check mark whether the Registrant (1) has filed 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 the Registrant's Common Stock (par value $.01) outstanding on August 12, 1996 was 16,502,457. __________________________________________________________________________ PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS INCSTAR CORPORATION CONSOLIDATED STATEMENTS OF INCOME (Unaudited) Quarter Ended Six Months Ended June 28, June 30, June 28, June 30, 1996 1995 1996 1995 Net sales $ 11,355,000 $ 11,041,000 $ 22,810,000 $ 22,158,000 Cost of goods sold 5,676,000 5,722,000 11,214,000 11,710,000 Gross profit 5,679,000 5,319,000 11,596,000 10,448,000 Operating expenses: Selling, general and 3,322,000 3,155,000 6,617,000 6,115,000 administrative Research and development 946,000 875,000 2,007,000 1,788,000 Total operating expenses 4,268,000 4,030,000 8,624,000 7,903,000 Operating income 1,411,000 1,289,000 2,972,000 2,545,000 Interest expense (7,000) (53,000) (14,000) (141,000) Other income 63,000 17,000 39,000 12,000 INCOME BEFORE INCOME 1,467,000 1,253,000 2,997,000 2,416,000 TAXES Provision for income 348,000 426,000 719,000 790,000 taxes NET INCOME $ 1,119,000 $ 827,000 $ 2,278,000 $ 1,626,000 INCOME PER SHARE: Net income per share $ 0.07 $ 0.05 $ 0.14 $ 0.10 Weighted average shares and equivalents 16,724,429 16,447,448 16,678,897 16,413,688 The accompanying notes are an integral part of the consolidated financial statements. INCSTAR CORPORATION CONSOLIDATED BALANCE SHEETS (Unaudited) <CATION> June 28, 1996 December 31, 1995 ASSETS CURRENT ASSETS: Cash and cash equivalents $ 1,465,000 $ 460,000 Restricted cash 251,000 251,000 Accounts receivable, net of allowance for doubtful accounts of $88,000 and 7,737,000 7,575,000 $107,000, respectively Other receivables 23,000 24,000 Inventories 13,686,000 13,445,000 Other current assets 555,000 294,000 TOTAL CURRENT ASSETS 23,717,000 22,049,000 PROPERTY AND EQUIPMENT: Land and land improvements 1,573,000 1,573,000 Buildings and improvements 13,279,000 13,252,000 Equipment and furniture 19,108,000 18,170,000 Construction in progress 84,000 6,000 34,044,000 33,001,000 Less allowance for depreciation and (19,216,000) (18,387,000) amortization 14,828,000 14,614,000 INTANGIBLE ASSETS 920,000 1,105,000 OTHER ASSETS 1,043,000 993,000 $ 40,508,000 $ 38,761,000 LIABILITIES AND SHAREHOLDERS' EQUITY CURRENT LIABILITIES: Current portion of long-term debt $ 12,000 $ 76,000 Accounts payable and cash overdraft 2,396,000 1,914,000 Accrued compensation 1,081,000 1,972,000 Accrued expenses 2,572,000 2,928,000 Income taxes payable 270,000 212,000 TOTAL CURRENT LIABILITIES 6,331,000 7,102,000 LONG-TERM DEBT 3,000 3,000 OTHER NON-CURRENT LIABILITIES 3,140,000 3,272,000 SHAREHOLDERS' EQUITY: Undesignated stock, authorized 5,000,000 shares - - - - - - Common stock, par value $.01, authorized 25,000,000 shares; issued and outstanding 165,000 164,000 16,502,457 and 16,363,477 shares, respectively Additional paid-in capital 18,314,000 17,940,000 Foreign currency translation adjustment (154,000) (151,000) Retained earnings 12,709,000 10,431,000 TOTAL SHAREHOLDERS' EQUITY 31,034,000 28,384,000 $ 40,508,000 $ 38,761,000 The accompanying notes are an integral part of the consolidated financial statements. INCSTAR CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) Six Months Ended June 28, 1996 June 30, 1995 OPERATING ACTIVITIES: Net income $ 2,278,000 $ 1,626,000 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 1,411,000 1,511,000 Payment for unusual items (344,000) (331,000) Provision for retirement plans 147,000 136,000 Provision for deferred taxes (221,000) --- Changes in operating assets and liabilities: Accounts receivable (162,000) (459,000) Other receivables 1,000 115,000 Inventories (241,000) (173,000) Other current assets (183,000) 36,000 Accounts payable 482,000 259,000 Accrued compensation (891,000) (28,000) Accrued expenses (148,000) (314,000) Income tax payable 177,000 362,000 Other, net (3,000) (10,000) Net cash provided by operating activities 2,303,000 2,730,000 INVESTING ACTIVITIES: Additions to property and equipment, net (1,251,000) (271,000) Payments for intellectual property and (185,000) (9,000) purchased technology Increase in other assets (54,000) (9,000) Net cash used in investing activities (1,490,000) (289,000) FINANCING ACTIVITIES: Net decrease in cash overdraft --- (405,000) Payments on long-term debt (64,000) (2,242,000) Issuance of common stock 256,000 59,000 Net cash provided by (used in) financing 192,000 (2,588,000) activities Net increase (decrease) in cash and cash 1,005,000 (147,000) equivalents Cash and cash equivalents at beginning of 460,000 153,000 period Cash and cash equivalents at end of period $ 1,465,000 $ 6,000 The accompanying notes are an integral part of the consolidated financial statements. INCSTAR CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1 _ SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Basis of Presentation The consolidated balance sheet as of June 28, 1996 and the related consolidated statements of income and cash flows for the six month periods ended June 28, 1996 and June 30, 1995 are unaudited. In the opinion of management, all adjustments necessary for a fair presentation of such financial statements have been included. Such adjustments consisted only of normal recurring items. The consolidated financial statements and notes should be read in conjunction with the consolidated financial statements and notes included in the Company's 1995 Form 10K. NOTE 2 _ INVENTORIES Inventories consist of the following: June 28, December 31, 1996 1995 Raw materials $ 2,293,000 $ 2,281,000 Work in progress 9,029,000 9,421,000 Finished goods 2,364,000 1,743,000 $ 13,686,000 $ 13,445,000 NOTE 3 _ INTANGIBLE ASSETS Intangible assets consist of the following: June 28, December 31, 1996 1995 Patents $ 717,000 $ 717,000 Trademarks 17,000 17,000 Goodwill 619,000 619,000 Intellectual property and purchased 920,000 734,000 technology Product distribution rights 2,700,000 2,700,000 4,973,000 4,787,000 Less accumulated amortization (4,053,000) (3,682,000) $ 920,000 $ 1,105,000 NOTE 4_ UNUSUAL ITEMS AND INVENTORY VALUATION ADJUSTMENTS In December, 1994 the Company recorded a $750,000 charge related to the write down of excess inventories and a $2,450,000 unusual charge related to the termination of certain distribution and supply agreements ($540,000) as well as severance and other costs related to senior management changes ($1,910,000). The amount remaining to be paid at June 28, 1996, exclusive of amounts included in Note 6, Executive Retirement Plans, is $305,000 and is included in Accrued expenses. NOTE 5 _ LONG-TERM DEBT, LEASE AND ROYALTY COMMITMENTS Long-term debt consists of the following: June 28, December 31, 1996 1995 Capitalized lease obligations, 8.0%, due $ 8,000 $ 72,000 through 1996 Other 7,000 7,000 15,000 79,000 Less current portion (12,000) (76,000) Total long-term debt $ 3,000 $ 3,000 The Company has a revolving line of credit from a bank which provides for maximum borrowings of $1,000,000 through January 31, 1997 at the prime interest rate or LIBOR plus 2.50% and is secured by accounts receivable. In addition, the Company has a $4,500,000 revolving line of credit with Fiat Finance U.S.A., Inc. through April 29, 1997. The Company is obligated to make royalty payments under several distribution and licensing agreements. The majority of these agreements call for payments based on a percentage of sales and contain no minimum royalty clause. Royalty expense under these agreements was $378,000 and $368,000 for the quarters ended June 28, 1996 and June 30, 1995, respectively, and $876,000 and $677,000 for the six month periods ended June 28, 1996 and June 30, 1995, respectively. NOTE 6 _ EXECUTIVE RETIREMENT PLANS The Company has individual retirement agreements with certain executive officers which are intended to provide continued compensation to such officers or their respective beneficiaries upon retirement from the Company. The benefits and terms under these arrangements vary depending upon the officer's position within the Company. In connection with these plans, included in Other non-current liabilities at June 28, 1996 and December 31, 1995 are $3,249,000 and $3,136,000, respectively, representing the present value of the future liability. Also, included in Accrued expenses at June 28, 1996 and December 31, 1995 are $66,000 and $31,000, respectively, representing the current portion of this liability. The Company intends to fund this obligation through the purchase of life insurance contracts on the individual executives. Included in Other assets at June 28, 1996 and December 31, 1995 are $984,000 and $934,000, respectively, representing the cash surrender value of these policies. NOTE 7 _ INCOME TAXES Upon the exercise of certain officer stock options during the year ended December 31, 1990, the Company was entitled to a compensation deduction allowable for income tax purposes. No compensation expense was required for financial reporting purposes because the option price on the original grant date equaled the then fair market value of the shares. Upon realization of the benefit relating to the compensation deduction for tax purposes, the benefit is credited to additional paid in capital. The Company recognized credits of $58,000 and $110,000, respectively, to Additional paid in capital relating to these stock options for the quarters ended June 28, 1996 and June 30 ,1995 and $119,000 and $110,000, respectively, for the six month periods ended June 28, 1996 and June 30, 1995. NOTE 8 _ RELATED PARTY TRANSACTIONS As part of the ongoing operations of the Company, various transactions were entered into with its affiliates, Sorin Biomedica Diagnostics S.p.A. ("Sorin") and its subsidiaries and Fiat Finance U.S.A., Inc. The following tables summarize these transactions and related balances. Sorin Fiat Finance U.S.A., Inc. Six Months Ended Six Months Ended June 28, June 30, June 28, June 30, 1996 1995 1996 1995 Product sales $ 4,045,000 $ 3,822,000 $ - - - $ - - - Product purchases 1,251,000 424,000 - - - - - - Royalty expense 307,000 83,000 - - - - - - Interest expense - - - - - - 6,000 128,000 June 28, December 31, June 28, December 31, 1996 1995 1996 1995 Assets Trade accounts $ 2,229,000 $1,965,000 $ - - - $ - - - receivable Other receivables 22,000 6,000 - - - - - - Liabilities Accounts payable $ 555,000 $ 675,000 $ - - - $ - - - Accrued royalty 745,000 480,000 - - - - - - Accrued interest - - - - - - - - - 4,000 NOTE 9 _ SUPPLEMENTARY CASH FLOW INFORMATION Six Months Ended June 28, June 30, 1996 1995 Supplemental disclosures of cash flow information: Cash paid during the period for: Interest $ 14,000 $ 54,000 Income taxes, net 763,000 428,000 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS QUARTER ENDED JUNE 28, 1996 VS. QUARTER ENDED JUNE 30, 1995 Sales for the quarter ended June 28, 1996 increased 3% to $11,355,000 from $11,041,000 for the same period a year earlier. The Company experienced sales growth in its autoimmune, infectious disease and serum proteins product lines. Additionally, contributing to the increase were sales from the Company's hepatitis assays, as discussed below. Sales continue to be negatively impacted by declines in the Company's endocrinology and transplantation markets due to the continued shift in the diagnostic industry from isotopic, manual testing to non-isotopic, automated and semi-automated testing. As these trends are expected to continue, the Company continues to focus development efforts on automated and semi-automated tests which are non-isotopic. Sales levels continue to be highly dependent upon the success of these efforts. Domestic sales declined 2% to $5,568,000 for the quarter ended June 28, 1996 from $5,660,000 for the same period in the prior year. The Company generated $552,000 in sales during the second quarter of 1996 from one of its hepatitis assays due to a competitor's kit becoming unavailable to the market in June 1995. While the competitor reentered the market during late February, the Company has been able to maintain a certain portion of these sales. In addition, the Company realized continued growth in its autoimmune, infectious disease and serum protein product lines. However, as discussed above, offsetting these increases were continuing declines in the Company's endocrinology product offerings. International sales increased 8% to $5,787,000 for the quarter ended June 28, 1996 from $5,381,000 for the same period in the prior year. International revenues continue to be favorably impacted in the infectious disease segment by sales of the Company's second generation tests for Epstein Barr Virus. In addition, sales were favorably impacted by increases in the Company's autoimmune and serum protein product lines. Sales were negatively impacted by declines in the transplantation market segment as this market continues to shift away from manual, isotopic testing as discussed above. Gross margins for the second quarter of 1996 improved to 50.0% of sales compared to 48.2% of sales for the same period in the prior year. This improvement is due in part to a change in the mix of sales, discussed above, compared to the same period a year earlier as well as efficiencies derived from a restructuring of operations in the second quarter of 1995. Notwithstanding this improvement, the Company's margins continue to be highly sensitive to product mix and volume changes. Selling, general and administrative ("SG&A") expenses increased 5% to $3,322,000 in the second quarter of 1996 from $3,155,000 in the second quarter of 1995 due to costs associated with the introduction of new products. These expenses have remained at 29% of sales and are expected to remain relatively consistent throughout 1996. Research and development ("R&D") expenditures increased 8% to $946,000 in the second quarter of 1996 from $875,000 for the same period in the prior year and remained flat at 8% of sales. This increase is mainly due to costs associated with new product development efforts, clinical costs and external costs associated with the Company's scientific networks. Interest expense decreased to $7,000 compared to $53,000 for the same period in the prior year. This decrease is attributable to lower average debt levels. Income tax expense for the quarter was $348,000, or 24% of income before taxes, compared with income tax expense of $426,000, or 34% of income before taxes, in the second quarter of 1995. The decline in the effective tax rate is due to the recognition of certain deferred tax assets. The Company expects the effective tax rate to remain at approximately 24% during the remainder of 1996. SIX MONTHS ENDED JUNE 28, 1996 VS. SIX MONTHS ENDED JUNE 30, 1995 Sales for the six month period ended June 28, 1996 increased 3% to $22,810,000 from $22,158,000 for the same period a year earlier. The Company experienced growth in its autoimmune, infectious disease and serum protein market segments. In addition, sales were favorably impacted by sales of the Company's hepatitis assays, as discussed below. Sales continue to be negatively impacted by declines in the Company's endocrinology and transplantation market segments due to the continued shift in the diagnostic industry from isotopic, manual testing to non- isotopic, automated and semi-automated testing. As these trends are expected to continue, the Company continues to focus development efforts on automated and semi-automated tests which are non-isotopic. Sales levels continue to be highly dependent upon the success of these efforts. Domestic sales increased 4% to $11,730,000 for the sixth month period ended June 28, 1996 from $11,227,000 for the same period in the prior year. As discussed above, the Company continues to experience an increase in demand for one of its hepatitis assays due to a competitor's kit becoming unavailable to the market in June 1995. This opportunity resulted in approximately $1.7 million in sales during the first six months of 1996. The competitor reentered the market place in late February, which has resulted in a decline of these product sales from their levels during the second half of 1995. In addition, the Company realized significant growth in its TheratestTM product line and increases in its serum protein product line. However, as discussed above, offsetting these increases were continuing declines in the Company's endocrinology product offerings. International sales increased 1% to $11,080,000 for the six month period ended June 28, 1996 compared to $10,931,000 for the same period in the prior year. International revenues continue to be favorably impacted in the infectious disease segment by sales of the Company's second generation tests for Epstein Barr Virus. Sales were negatively impacted, however, in the routine endocrinology and transplantation segments as these market continue to shift away from manual, isotopic testing as discussed above. Gross margins for the first six months of 1996 improved to 50.8% of sales compared to 47.2% of sales for the same period in the prior year. This improvement is due in part to a change in the mix of sales, discussed above, compared to the same period a year earlier as well as efficiencies derived from a restructuring of operations in the second quarter of 1995. Notwithstanding this improvement, the Company's margins continue to be highly sensitive to product mix and volume changes. SG&A expenses increased to $6,617,000, or 29% of sales, in the first six months of 1996 from $6,115,000, or 28% of sales, for the same period in the prior year. The increase in expenditures is due to costs associated with the introduction of new products. These expenses, as a percentage of sales, are expected to remain relatively consistent throughout 1996. R&D expenditures increased 12% to $2,007,000 in the first six months of 1996 from $1,788,000 for the same period in the prior year and increased as a percentage of sales to 9% compared to 8% in the prior year. This increase is mainly due to increased emphasis on new product development, including the establishment of scientific advisory panels for the Company's autoimmune and bone and mineral metabolism segments. These panels are intended to enhance and strengthen the Company's ties with the scientific community. Interest expense decreased to $14,000 compared to $141,000 for the same period in the prior year. This decrease is attributable to lower average debt levels. Income tax expense for the six months ended June 28, 1996 was $719,000, or 24% of income before taxes, compared with income tax expense of $790,000, or 33% of income before taxes, for the same period in 1995. The decline in the effective tax rate is due to the recognition of certain deferred tax assets. The Company expects the effective tax rate to remain at approximately 24% during the remainder of 1996. LIQUIDITY AND CAPITAL RESOURCES The Company's operating cash flow in the first six months of 1996 was $2,303,000 and $2,730,000 for the same period in the prior year. Free cash flow (operating cash flow less investment activities) decreased to $813,000 in the first six months of 1996 from $2,441,000 in the comparable period of the prior year. This decrease is attributable to increased capital spending associated with instrumentation, manufacturing improvements and computer upgrades. Net working capital increased to $17,386,000 at June 28, 1996 from $14,947,000 at December 31, 1995. At June 28, 1996, the Company's primary sources of liquidity are a $1 million revolving bank credit line secured by Company assets and a $4.5 million unsecured credit line with Fiat Finance U.S.A., Inc. At June 28, 1996, the Company had no outstanding borrowings under these credit lines. The Company believes that its operating cash flow and existing credit lines will provide ample sources of liquidity for all planned capital expenditures and research and development activities. Capital spending for the remainder of 1996 is anticipated to be approximately $1,500,000, primarily for manufacturing improvements and laboratory equipment. PART II. OTHER INFORMATION ITEM 4. The Company held its Regular Meeting of Shareholders on May 21, 1996 and solicited proxies for the purpose of electing ten directors for the ensuing year and for the amendment of the INCSTAR Stock Option Plan. The votes with respect to the election of directors were: For Withheld Pierre M. Galletti 15,189,555 22,793 John J. Booth 15,190,555 21,893 Ennio Denti 15,151,655 60,793 George H. Dixon 15,190,055 22,393 Franco Fornasari 15,189,755 29,893 Ezio Garibaldi 15,189,755 29,893 D. Ross Hamilton 15,190,555 21,893 Umberto Rosa 15,151,655 60,793 Michael W. Steffes 15,190,555 21,893 Carlo Vanoli 15,189,855 22,593 The results of the voting with respect to the following additional item were as follows: Amendments to the Company's Stock Option Plan, as follows: (a) Amendment to allow the issuance of non-qualified stock options to consultants or independent contractors of the Company or any of its subsidiaries. (b) Addition of a provision to allow each member of the Company's Scientific Advisory Board to automatically receive, upon execution of an SAB agreement, a five-year non-qualified stock option to purchase 4,000 shares of the Company's Common Stock. (c) Addition of a provision to allow each member of one of the Company's Scientific Advisory Panels to automatically receive, upon execution of an SAP agreement, a five-year non-qualified stock option to purchase 2,000 shares of the Company's Common Stock. For Against 15,001,055 211,393 There were no abstentions or broker nonvotes. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits 3.1 Restated Articles of Incorporation of INCSTAR Corporation, as amended to date [incorporated by reference to Exhibit 4.1 to the Registrant's Registration Statement on Form S-8 (File No. 33- 84498)]. 3.2 Bylaws of INCSTAR Corporation, as amended to date [incorporated by reference to Exhibit 4.2 to the Registrant's Registration Statement on Form S-8 (File No. 33-84498)]. 4.1 Specimen Certificate representing the Registrant's Common Stock [incorporated by reference to Exhibit 4.1 to the Registrant's Registration Statement on Form S-3 (File No. 33- 37805)]. 4.2 Note Purchase Agreement, dated December 27, 1991 between the Registrant and Fiat Finance, U.S.A. Inc. [incorporated by reference to Exhibit 4.2 to the Registrant's Report on Form 10-K for the year ended December 31, 1991 (File No. 1-9800)] 4.3 Form of Warrant Certificate issued by the Registrant in favor of Bioengineering International B.V. (now BioFin Holding International B.V.) [incorporated by reference to Exhibit 10.11 of the Registrant's Registration Statement on Form S-4 (File No. 33- 30785)]. 4.4 Form of Purchase Rights Agreement between Bioengineering International B.V. (now BioFin Holding International B.V.) and the Registrant [incorporated by reference to Exhibit 10.12 of the Registrant's Registration Statement on Form S-4 (File No. 33- 30785)]. 11 Computation of Net Income per Common Share 27 Financial Data Schedule (b) Reports on Form 8-K - There were no reports on Form 8-K filed during the quarter ended June 28, 1996. 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. INCSTAR CORPORATION (Registrant) Date: 8/9/96 /S/John J. Booth President (Principal Executive Officer) Date: 8/9/96 /S/Thomas P. Maun Vice President and Chief Financial Officer (Principal Financial and Accounting Officer)