U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-QSB
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended August 31, 1999
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OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT
For the transition period from TO
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Commission file number 1-13527
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DIAGNON CORPORATION
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(Exact name of small business issuer as specified in its charter)
State of Delaware 13-3078199
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
9600 Medical Center Drive, Rockville, Maryland 20850
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(Address of principal executive office) (Zip Code)
Issuer's telephone number, including area code (301) 251-2801
Not Applicable
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(Former name, former address and former fiscal year, if changed since
last report)
Check whether the registrant filed all documents required to be filed by Section
12, 13 or 15(d) of the Exchange Act after the distribution of securities under a
plan confirmed by a court.
Yes [X] No [ ]
Common Stock, $.01 par value per share; authorized 25,000,000 shares; 868,457
shares outstanding as of October 8, 1999.
Convertible Preferred Stock, $1.00 par value per share; authorized 500,000
shares; no shares outstanding as of October 8, 1999.
Transitional Small Business Disclosure Format (Check one): Yes [ ] No [X]
DIAGNON CORPORATION
INDEX
Part I. Financial Information Page
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Item 1. Financial Statements.
Consolidated Balance Sheets, May 31, 1999 and
August 31, 1999 (Unaudited) . . . . . . . . . . . . . . 2
Unaudited Consolidated Statements of Operations for
the Three Months Ended August 31, 1999 and
August 31, 1998 . . . . . . . . . . . . . . . . . . . . 3
Unaudited Consolidated Statements of Cash Flows
for the Three Months Ended August 31, 1999 and
August 31, 1998 . . . . . . . . . . . . . . . . . . . . 4
Notes to Financial Statements . . . . . . . . . . . . . . 5
Item 2. Management's Discussion and Analysis . . . . . . . . . 5
1
DIAGNON CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS, MAY 31, 1999 AND AUGUST 31, 1999 (UNAUDITED)
ASSETS AUGUST 31, 1999 MAY 31, 1999
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CURRENT ASSETS:
Cash and cash equivalents $ 69,516 $ 68,768
Accounts receivable:
Trade 1,287,420 966,354
Unbilled - current 166,609 262,774
Other 27,896 26,867
Prepaid expenses 136,363 91,522
Inventories 281,783 287,596
Loans to Officers 8,156 32,906
Deferred income taxes - current 72,300 77,300
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Total current assets 2,050,043 1,814,087
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FIXED ASSETS:
Leasehold improvements 859,883 832,264
Furniture, fixtures and equipment 3,324,533 3,289,879
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Total 4,184,416 4,122,143
Less accumulated depreciation and amortization 2,733,016 2,649,058
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Fixed assets, net 1,451,400 1,473,085
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DEFERRED INCOME TAXES - NONCURRENT 600,400 600,400
UNBILLED ACCOUNTS RECEIVABLE - NONCURRENT 475,732 493,512
OTHER NONCURRENT ASSETS 282,650 242,650
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TOTAL $ 4,860,225 $ 4,623,734
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LIABILITIES
CURRENT LIABILITIES:
Borrowings under line of credit $ 752,200 $ 275,282
Current maturities of long-term debt 66,093 66,093
Accounts payable 238,745 215,956
Accrued compensation and related costs 254,676 474,597
Accrued income taxes 9,281 24,281
Other accrued liabilities 11,058 15,178
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Total current liabilities 1,332,053 1,071,387
LONG-TERM DEBT 36,392 56,211
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Total liabilities 1,368,445 1,127,598
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STOCKHOLDERS' EQUITY
Convertible preferred stock - par value of $1.00 per share, 500,000 shares
authorized; no shares issued and outstanding
Common stock - par value of $.01 per share; 25,000,000 shares authorized; 1,600,408
shares issued; August 31, 1999, 867,957 shares, May 31, 1999, 872,672 shares outstanding 16,004 16,004
Additional paid-in capital 7,475,035 7,475,035
Accumulated deficit (3,299,020) (3,310,022)
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Total 4,192,019 4,181,017
Less - treasury stock August 31, 1999, 732,451 shares, May 31, 1999, 727,736 shares,
at cost (700,239) (684,881)
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Total stockholders' equity 3,491,780 3,496,136
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TOTAL $ 4,860,225 $ 4,623,734
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See notes to financial statements.
2
DIAGNON CORPORATION AND SUBSIDIARIES
UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE
THREE MONTHS ENDED AUGUST 31, 1999 AND AUGUST 31, 1998
AUGUST 31, AUGUST 31,
1999 1998
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REVENUES AND SALES:
Contract revenues $ 2,734,001 $ 2,711,176
Product sales 31,371 4,118
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Total Revenues and Sales 2,765,372 2,715,294
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OPERATING EXPENSES:
Contract 2,161,246 2,095,359
Cost of goods sold 27,149 5,073
Research and development 53,921 41,272
General and administrative 486,049 454,791
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Total 2,728,365 2,596,495
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OPERATING INCOME 37,007 118,799
INTEREST INCOME 813 948
INTEREST EXPENSE (12,818) (13,543)
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INCOME BEFORE INCOME TAX 25,002 106,204
PROVISION FOR INCOME TAX 14,000 42,500
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NET INCOME $ 11,002 $ 63,704
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BASIC EARNINGS PER SHARE $ 0.01 $ 0.07
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DILUTED EARNINGS PER SHARE $ 0.01 $ 0.07
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WEIGHTED AVERAGE NUMBER OF SHARES
OUTSTANDING FOR BASIC EARNINGS
PER SHARE 872,092 899,590
EFFECT OF DILUTIVE SECURITIES -
OPTIONS 14,715 6,262
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WEIGHTED AVERAGE NUMBER OF SHARES
OUTSTANDING + DILUTIVE OPTIONS FOR
DILUTIVE EARNINGS PER SHARE 886,807 905,852
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See notes to financial statements.
3
DIAGNON CORPORATION AND SUBSIDIARIES
UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE
THREE MONTHS ENDED AUGUST 31, 1999 AND AUGUST 31, 1998
Three Months Three Months
Ended Ended
August 31, 1999 August 31, 1998
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CASH FLOWS FROM OPERATING ACTIVITIES:
Net Income $ 11,002 $ 63,704
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Adjustments to reconcile net income to net cash
used for operating activities:
Depreciation and amortization 83,958 77,724
Deferred income taxes 5,000 29,000
(Increase) decrease in accounts receivable (208,150) 73,537
Increase in prepaid expenses (44,841) (19,214)
Decrease (Increase) in inventories 5,813 (53,877)
(Increase) decrease in other assets (40,000) 18,148
Decrease in accounts payable and accrued expenses (201,252) (158,644)
Common stock gifted to employees 9,392
Decrease in income taxes payable (15,000) (9,000)
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Total Adjustments (405,080) (42,326)
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NET CASH (USED FOR) PROVIDED BY OPERATING ACTIVITIES (394,078) 21,378
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CASH FLOWS USED FOR INVESTING ACTIVITIES:
Capital expenditures (62,273) (78,203)
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NET CASH USED FOR INVESTING ACTIVITIES (62,273) (78,203)
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CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds under line-of-credit agreement 476,918 96,364
Net proceeds from exercise of stock options 81
Principal payments under capital lease obligations (19,819) (38,821)
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NET CASH PROVIDED BY FINANCING ACTIVITIES 457,099 57,624
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NET INCREASE IN CASH AND CASH EQUIVALENTS 748 799
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 68,768 65,730
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CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 69,516 $ 66,529
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SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash paid during the period for:
Interest $ 11,244 $ 12,487
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Income taxes $ 22,500 $ 18,500
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SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING ACTIVITIES:
Treasury stock received for payment of loans to officer $ 24,750
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See notes to financial statements.
4
NOTES TO FINANCIAL STATEMENTS
Interim Financial Statements
In the opinion of management, all adjustments consisting only of normal
recurring accruals necessary for a fair presentation of such amounts have been
included. The results of operations for the quarter are not necessarily
indicative of results for the year.
Inventories
Inventories are stated at the lower of cost or market using the average cost
method.
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS
Summary Analysis
In this first quarter of fiscal year 2000, Diagnon realized net income of
$11,002.
On July 14, 1999, the Board of Directors unanimously approved that Diagnon merge
into itself its wholly owned subsidiary, BIOQUAL, Inc., and assume all of the
subsidiary's assets, liabilities and obligations. Further, in connection with
the merger, Diagnon will change its name to BIOQUAL, Inc. The expected date for
the merger and name change is the close of business on December 31, 1999.
Also on July 14, 1999, the Board of Directors declared a dividend of $0.02 a
share for shareholders of record on September 7, 1999. The dividend was paid on
September 22, 1999. This was the first dividend declared by Diagnon.
On July 9, 1999, the Company, to acknowledge the contributions of its employees,
distributed fifty shares of common stock to each current employee who had been
with the company for at least one year as of May 31, 1999.
During this quarter, the Company submitted a sole source budgetary proposal to
extend the National Cancer Institute (NCI) contract "Development of New Methods
and Strategies for Diagnosis, Treatment and Prevention of Invasive Fungal
Infection in Patients with Cancer and HIV Infection" for one year to September
30, 2000. On September 27, 1999, the Company was notified by the NCI that the
proposal (totaling $86,227) was accepted and funded.
On September 17, 1999, the Company filed a patent application entitled "High
Throughput Assay Method for Enzymes which Metabolically Hydrolyze Nucleoside
Triphosphates and an Assay System Therefor". This application specifies broad
coverage of the proprietary assay technology known as HT-SANE (High Throughput
Screening Assay for NTP hydrolyzing Enzymes). The emergence of many strains of
antibiotic resistant bacteria and fungus has intensified the search for new
antibiotics. Most antibiotics and antifungal drugs kill by inhibiting the
activity of enzymes that are essential for growth. However, one of the limiting
5
steps in drug discovery is the necessity for a high throughput enzyme assay that
can be used to quickly screen large numbers of potential drugs. HT-SANE
technology introduces the capability to develop high throughput enzyme assays
for a large number of critical enzymes, specifically those that hydrolyze
nucleoside triphosphates (NTPs) in their respective biochemical reactions.
Year 2000
The Company has performed an internal assessment of the scope of the Year 2000
computer systems and software problems and its potential effect on the operation
of the Company. The Company is continuing the assessment of its non-information
systems for Year 2000 compliance. The Company has contacted its major suppliers
of products and services to determine the status of the suppliers' Year 2000
capability. The Company has received assurances from all of the providers of
critical systems that those systems are or will be Year 2000 compliant before
December 31, 1999. There can be no assurance that another company's failure to
ensure Year 2000 compliance and capability will not have an adverse effect on
the Company. The Company spent approximately $20,000 in fiscal year 1999 and
approximately $15,000 to date in fiscal year 2000 to replace non-compliant
computers and software. The Company anticipates spending an additional $10,000
in fiscal year 2000 replacing its remaining Year 2000 non-compliant computers.
Any costs incurred in connection with Year 2000 compliance is expensed as
incurred. It is the opinion of management that the Year 2000 computer problem
will not have a material effect on the Company's operation. However, the Company
is monitoring the progress of its largest customer, the National Institutes of
Health (NIH), toward Year 2000 compliance. The NIH states that all of its
mission critical systems and 98% of its non-mission critical systems are
currently compliant. However, if the NIH does experience Year 2000 related
problems, the Company's financial condition may be adversely affected until such
time that the NIH's non-compliant contingency plan is initiated.
Not all instances of date failure can be anticipated or controlled. In planning
for the most reasonably likely worst-case scenario, (e.g. NIH systems being
non-compliant on January 1, 2000), or in cases in which, despite our efforts,
failures occur, we have developed a contingency plan. The contingency plan
includes the stock piling of critical materials necessary to maintain
operations. The Company plans to have back up power available for critical
equipment in the event of mass power outage.
Results of Operations
For the three months of operations ended August 31, 1999 (the Company's first
quarter), contract revenues increased by .8% compared to the first quarter of
fiscal year 1999. This increase is not as large as anticipated due to a decrease
in the number of commercial contracts compared to the first quarter of fiscal
year 1999, the expiration of a major contract on November 8, 1998, and the
fiscal year 1999 funding of a $34,976 indirect rate variance cost overrun of a
contract that expired in fiscal year 1995 (the contract was administratively
closed out on September 30, 1998). Product sales increased to $31,371 compared
to
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$4,118 in fiscal year 1999. Contract operating expenses increased 3.1% compared
to the first quarter of fiscal year 1999 primarily due to increased government
contract activity offset by the decrease in commercial contracts. Cost of goods
sold increased to $27,149 from $5,073 in the first quarter of fiscal year 1999.
This increase was primarily due to the increase in units sold during this fiscal
year. Research and development (R&D) expenses increased to $53,921 compared to
$41,272 in the first quarter of fiscal year 1999. This increase is primarily due
to costs associated with the development of the high throughput assay system
previously mentioned. General and administrative expenses increased 6.9%
compared to the first quarter of fiscal year 1999 primarily due to inflationary
increases in several items of expense. Total operating expenses increased 5.1%
due to the above.
Operating income decreased to $37,007 compared to $118,799 in the prior year.
The decrease is primarily due to several factors: 1) the increase in contract
expenses without a comparative increase in related contract revenues resulting
in a decrease in the gross margin percentage on contracts this fiscal year, 2)
the increase in R&D expenses and 3) $34,976 increased funding to cover an
indirect cost overrun for an expired contract during the previous fiscal year as
mentioned above.
For this quarter, Diagnon had interest expense of $12,818 compared to interest
expense of $13,543 in the prior year.
In accordance with SFAS No. 109, "Accounting for Income Taxes", the Company
reported a deferred federal income tax expense of $5,000 for the three months
ended August 31, 1999. The Company provided for state income tax which is
estimated at $9,000. State income tax expense is reimbursable under government
contracting regulations.
Earnings Per Share (EPS) - For the three month comparison, options to purchase
38,504 shares of common stock at prices ranging from $2.52 per share to $3.375
per share were outstanding at August 31, 1999 but were not included in the
computation of diluted EPS because the options' exercise prices were greater
than the market price of the common shares. Options to purchase 63,179 shares of
common stock at prices ranging from $1.50 per share to $3.375 per share were
outstanding at August 31, 1998 but were not included in the computation of
diluted EPS because the options' exercise prices were greater than the market
price of the common shares.
Liquidity and Capital Resources
Assets
The changes in cash and cash equivalents are detailed in the Statements of
Consolidated Cash Flows on page 4. Total assets increased $236,491. This amount
was primarily attributable to an increase to accounts receivable of $208,150
consisting mainly of 1) an increase of $321,066 in trade accounts receivable
reflecting a slower collection rate compared to the previous fiscal year end, 2)
a $113,945 decrease in unbilled accounts receivable (current plus noncurrent)
primarily resulting from a $24,252 decrease in reimbursable indirect rate
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variances for the current fiscal year, a $172,949 decrease in prior year
unbilled direct costs that were billed in June 1999 offset by a $76,785 accrual
of current period unbilled direct costs to be billed during the second quarter
of fiscal year 2000, and the recording of $6,471 unbilled contract fee retention
to be billed at the completion of the respective contracts, and 3) a $1,029
increase in other accounts receivable. Other noncurrent assets increased $40,000
representing a deposit on a nonhuman primate housing unit order. Prepaid
expenses increased $44,841 primarily due to the prepayment of business liability
and life insurance premiums.
The increase above is partially offset by 1) an decrease in loans to officers of
$24,750 due to a payment made this quarter, 2) deferred income taxes decreased
by $5,000 primarily as a result of utilizing a portion of the federal income tax
loss carryforward, and 3) a decrease in fixed assets, net of accumulated
depreciation and amortization of $21,685 reflecting depreciation and
amortization of $83,958 offset by fixed asset purchases of $62,273 (mainly lab
equipment and facility improvements). The balance of the increase was due to
other miscellaneous factors.
Liabilities
In the first three months of operations, total liabilities increased $240,847 as
compared to May 31, 1999. This increase is primarily attributable to 1) an
increase to borrowings under line-of-credit of $476,918 reflecting the slow
collection of trade accounts receivable and the payment of accrued bonuses, and
2) an increase in accounts payable of $22,789.
The above increase is partially offset by a decrease in accrued compensation and
related costs of $219,921 reflecting a shorter accrual period this quarter when
compared to the prior year end and the payment of accrued bonuses from fiscal
year 1999 during this quarter, and 2) payments totaling $19,819 on capital
leases reducing long-term debt. The balance of the increase was due to other
miscellaneous factors.
The Company believes it has sufficient cash and financing sources to provide for
its ongoing operations and the Company continues to believe that the impact of
inflation, or the absence of it, will have no significant effect on its
operations.
Forward Looking Information
Statements herein that are not descriptions of historical facts are
forward-looking and subject to risk and uncertainties. Actual results could
differ materially from those currently anticipated due to a number of factors
including those set forth in Diagnon's Securities and Exchange Commission
filings under "Risk Factors", including risks relating to the early stage of
products under development; uncertainties relating to clinical trials;
dependence on third parties' future capital needs; and risks relating to the
commercialization, if any, of Diagnon's proposed products (such as marketing,
safety, regulatory, patent, product liability, supply, competition and other
risks).
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused the report to be signed on its behalf by the
undersigned thereunto duly authorized.
DIAGNON CORPORATION
DATE October 14, 1999 /s/ John C. Landon
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Chairman of the Board,
President and Chief Executive
Officer
DATE October 14, 1999 /s/ Michael P. O'Flaherty
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Chief Operating Officer and
Secretary
DATE October 14, 1999 /s/ David A. Newcomer
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Chief Financial Officer
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