November 10, 2004
Mr. James Rosenberg
Senior Assistant Chief Accountatn
Securities and Exchange Commission
Division of Corporate Finance
Re: Techne Corporation
Form 10-K for the Year Ended June 30, 2004
File No. 0-17272
Dear Mr. Rosenberg:
This letter is in response to the comment letter received by us dated October
27, 2004, containing comments to our Form 10-K for the year ended June 30,
2004. For your convenience, we have reproduced each of the Staff's comments
from the comment letter. Each item number set forth below is in response to
the corresponding item number in the comment letter.
Short-Term Investments, pg.32
1. Comment:
Please provide, supplementally, management's assessment of compliance to
paragraph 17 of SFAS 115 as amended by SFAS 135, given that the Company
currently characterizes debt instruments with maturities of three months
to three years as short-term.
Response:
We are currently analyzing our classification of investments with
maturities of greater than one year and are discussing it further with our
external auditors. We will respond to this comment within five business
days.
Inventories, pg. 32
2. Comment:
We note that you produce quantities in excess of forecasted usage. Please
tell us and clarify in the filing why you believe your inventory balance
in excess of forecasted usage does not require an impairment. Also, tell
us why you believe a two-years' sales forecast is appropriate and how the
sales forecast is used in determining whether or not impairment exists.
Response:
The portion of Techne inventory for which excess quantities are produced
is the inventory of proteins and antibodies. Inventories of these
products in excess of forecasted usage have been impaired on the balance
sheet. The total value of protein and antibody inventory on hand at June
30, 2004 was $10.4 million of which $8.6 million (as noted on pg. 23) was
determined to be in excess of forecasted usage. Therefore, only $1.8
million of protein and antibody inventory was included in the June 30,
2004 finished goods inventory balance.
A two-year sales volume forecast (in micrograms) is developed for each
individual protein and antibody Techne sells (currently over 4,600
different SKU's) based upon the historical sales of each of the individual
products. Any volume on hand for each product above the forecast is
considered "in excess" and is excluded from the inventory value on the
balance sheet at period end.
Individual sales volumes of proteins and antibodies can be volatile and
difficult to predict, especially on newly released products for which
there is not a lengthy sales history. Sales volumes of products that do
have a longer history can also vary significantly if the product is found
to be of interest in new research areas or interest in an area of research
declines. Techne has used a two-year volume forecast to value protein and
antibody inventory because we feel forecasting beyond that time period is
highly uncertain due to the rapid pace of biotechnology advances. An
analysis at June 30, 2004, of the value of inventory on hand, inventory on
the balance sheet and inventory considered "in excess" based on a two-year
forecast follows:
$ Sales of FY04 Protein/ Value of Valued
Individual # Ab. Sales Inv. on on B/S Excess
Product. of SKU's (millions) Hand (000's) (000's) (000's)
-------------- -------- ------------- ------------ ------- -------
>$71,500 157 $35.5 (58%) $ 1,223 $ 559 $ 664
$25,000-71,500 259 11.0 (18%) 1,035 368 667
$1-25,000 3,497 15.1 (24%) 7,233 824 6,409
$0 749 910 5 905
----- ----- ------- ------ ------
4,662 $61.6 $10,401 $1,756 $8,645
===== ===== ======= ====== ======
The final two lines of the above analysis shows that $7.3 million of the
$8.6 million "excess" inventory was from protein and antibody products
(over 4,200) that, individually, had sales of less than $25,000 in fiscal
2004. These are slow moving and/or newer products for which likelihood of
selling all or a majority of the inventory on hand is highly uncertain and
therefore, based on a two-year forecast, only a small percentage of the
inventory on hand is included on the balance sheet. A small number of
products (157) accounts for 58% of protein and antibody sales. These
products would tend to have more predicable sales patterns and a higher
likelihood of selling more of the inventory on hand and therefore, the two
year forecast results in a higher percentage of on-hand inventory valued
on the balance sheet. We have concluded that we have a significant
portion of protein and antibody inventory on-hand that has low-volume
movement. ARB No. 43, chapter 4, paragraph 8 requires the inventories be
priced at cost or market, whichever is lower, when the utility of the
inventory is no longer as great as its cost. KPMG LLP's local audit
engagement team has reviewed the propriety of the two-year forecast and
our application of ARB No. 43. Based on the above, we believe the use of
a two-year sales volume forecast to value protein and antibody inventory
is appropriate.
Investments, pg. 33
3. Comment:
Please tell us your basis for recording your equity pick-up in investees
as research and development expenses instead of equity/loss in investments
on your Statement of Operations.
Response:
Techne's equity method investees are development stage companies, and in
each case, along with the investment, we signed a research agreement,
which gives us rights to develop and sell products in certain markets
based on their discoveries and/or patents. Since the development of
products by these companies and the losses they incur during the
development stage could lead to our development of additional products, we
believe including our percentage of the investees' losses in research and
development during their development stage is appropriate. Our intent was
that, at the point in time when these companies are no longer development
stage, we would include our share of their results in other expense/income
on the Statement of Operations. Historically, the losses included in
research and development expense were not material to the financial
statements of Techne as a whole and were prominently disclosed in
Managements' Discussion and Analysis in all 10-K and 10-Q filings. In the
quarter ended September 30, 2004, losses are no longer be included in
research and development because (i) the investment in Discovery Genomics
was written off as of June 30, 2004, (ii) we accounted for ChemoCentryx on
a cost basis beginning in May 2004 as described in our response to Comment
4 below and (iii) since Hemerus began selling product during the quarter
we will be including our share of their results in other expense/income on
the Statement of Operations.
4. Comment:
Please clarify to us and in the filing why, prior to April 2004, you
believe it was appropriate to record 100% of the losses of CCX in your
financial statements, as disclosed in your March 31, 2004 Form 10-Q.
Please provide to us your analysis as to why your investment in CCX did
not qualify as a variable interest entity, as the Company is absorbing
100% of the operation losses of CCX. Additionally, please explain to us
and in the filing why it was appropriate to account for the Company's
19.9% equity investment in CCX on the cost basis subsequent to April 2004.
Response:
Background:
We invested in the Preferred Stock (Series A) of ChemoCentryx, Inc. (CCX)
beginning in 1997 and from July 1999 through January 2001, had a 49%
interest in CCX. We accounted for this investment under the equity method
of accounting and included 100% of the operating results of CCX in our
consolidated financial statements due to the limited amount of cash
consideration provided by the holders of the common shares of CCX. This
was discussed in our response dated February 26, 2002 to your previous
comment letter dated February 12, 2002.
In February 2001, CCX obtained $23 million in financing through the
issuance of 8.8 million shares of Series B Preferred Stock. After this
financing and through April 2004, the Company held approximately 26% of
the outstanding stock of CCX and accounted for CCX under the equity method
of accounting and included CCX operating results in consolidated
financials statements based on our ownership percentage.
In May and June of 2004, CCX completed a Series B offering and raised
$38.5 million. We participated in this offering and purchased 1.947
million shares at $2.60 per share, or $5.06 million. After this offering,
our ownership percentage dropped to 19.93%. CCX does not anticipate
needing to raise additional funding until 2007 and we do not have any
current plans to provide additional funding to CCX in the near term.
We have been issued warrants to purchase 1,666,665 shares of CCX Preferred
Stock (Series A) at $5.00 per share, which expire on December 31, 2005.
Since a recent financing was effected at $2.60 per share and our right to
demand registration of shares underlying the warrants was adversely
changed in connection with the financing, we have concluded that it is
unlikely that we will exercise the warrants.
Each holder of shares of Preferred Stock (Series A and B) are entitled to
the number of votes equal to the number of shares of Common Stock into
which such shares of Preferred stock could be converted and have the
voting rights and powers equal to the voting rights and powers of Common
Stock. This converts one to one, except with regards to voting for Board
members. Techne's Series A entitles us to designate one director and in
the Series B offerings two venture capital firms are entitled to each
designate a director.
Accounting Analysis:
Per paragraph 17 of APB No. 18, "The Equity Method of Accounting for
Investments in Common Stock," "..an investment of less than 20% of the
voting stock of an investee should lead to a presumption that an investor
does not have the ability to exercise significant influence unless such
ability can be demonstrated." Techne's investment in CCX as of May 2004
was below 20% and thus the Company moved to the next step to analyze the
qualitative factors regarding their investment in CCX.
FIN 35, "Criteria for Applying the Equity Method of Accounting for
Investments in Common Stock". Paragraph 4 of FIN 35 gives examples of
indications that an investor may be unable to exercise significant
influence over the operating and financial policies of an investee. The
following is an analysis of each of the examples:
1. Opposition by the investee, such as litigation or complaints to
governmental regulatory authorities, challenges the investor's ability
to exercise significant influence.
During the Series B fund raising process, Techne encountered
opposition from CCX's management team and other board members
regarding Techne's desire to have input on limiting the number of
options authorized for the Employee Stock Option Plan and the price
and terms at which such options were granted. The CCX May 2004 Amended
Articles of Incorporation does have a 5.5 million limit on the number
of authorized shares, but this is a significantly higher number of
shares than what Techne had proposed in the negotiations and
furthermore, there is no directive regarding option grants or pricing.
2. The investor and investee sign an agreement under which the investor
surrenders significant rights as a shareholder.
From the Series A offering to Techne's investment in the Series B
offering, the date to demand registration of shares was extended from
November 15, 2004 to November 15, 2006 (this goes beyond the
expiration date of Techne's Series A warrants which expire on December
31, 2005). Techne considers this to seriously reduce the potential
value of their Series A warrants. Techne negotiated to reprice and
obtain an extension of the expiration date of its warrants, but this
was strongly rejected by CCX's management and the group of venture
capital fund investors. Warrants with a much later expiration date
and exercise price of $2.60 per share were issued to the party, a
director of CCX elected by the holders of Common Stock, who brought in
the venture capital funds.
3. Majority ownership of the investee is concentrated among a small group
of shareholders who operate the investee without regard to the views of
the investor.
Aside from Techne, a group of venture capital firms, some of which are
related and all of which are highly cooperative with each other,
controls approximately 55% of CCX. This group tends to drive the
operations of CCX without regard to Techne's interests. This is the
group which rejected Techne's efforts to modify the terms of its
warrants.
4. The investor needs or wants more financial information to apply the
equity method than is available to the investee's other shareholders
(for example, the investor wants quarterly financial information from
an investee that publicly reports only annually), tries to obtain that
information, and fails.
Techne does receive financial information from CCX, albeit sometimes
late and after substantial effort.
5. The investor tries and fails to obtain representation on the investee's
board of directors.
Prior to the recent financing, Techne had the right to designate one
of five directors. After the financing, Techne has the right to
designate one of six members of the CCX board of directors while the
venture firms have the right to designate two directors plus three
"non-voting" observers. In addition, the individual who was
compensated for bringing in the venture firms as investors is one of
the three remaining directors, all of who are elected by holders of
Common Stock. Techne has no vote in the election of directors by
holders of Common Stock. A Techne board member had participated on
the CCX Compensation Committee prior to the May 2004 CCX financing,
but is no longer a member of the Compensation Committee and does not
anticipate being involved in any other subcommittees of the CCX Board
in the future. Furthermore, as of July 2004, CCX has recruited and
added a 7th Board member. The 7th member of the Board further dilute
Techne's ability to influence the operating decisions of CCX.
In addition to these examples in FIN 35, the Company analyzed EITF 96-16,
"Investor's Accounting for an Investee When the Investor Has a Majority of
the Voting Interest but the Minority Shareholder or Shareholders Have
Certain Approval or Veto Rights." Within EITF 96-16, Techne specifically
reviewed its minority rights in regards to being Protective Rights versus
Substantive Participating Rights. To analyze this, the Company reviewed
Section 6 of CCX's May 2004 Amended Articles of Incorporation which is
entitled "Protective Provisions". Section 6 specifies that CCX may not do
any of the following without first receiving approval from Series A and
Series B each voting as a separate class (Techne owns a 100% of the Series
A stock):
Sell substantially all of the business or consolidate with another
business in which more than 50% of the voting power of CCX is disposed
of.
Alter or change the rights, preferences or privileges of the shares of a
series or class of Preferred Stock so as to affect adversely the share
of such series or class.
Authorize or issue, or obligate itself to issue, any other equity
security, including any other security convertible into or exercisable
for any equity security, having a preference over, or being on a parity
with, the Existing Preferred Stock with respect to voting, dividends or
upon liquidation.
Redeem, purchase or otherwise acquire (or pay into or set funds aside
for a sinking fund for such purpose) any share or shares of Preferred
Stock or Common Stock; provided, however, that this restriction shall
not apply to the repurchase of shares of Common Stock from employees,
officers, directors, consultants or other persons performing services
for the Corporation pursuant to agreements under which the Corporation
has the option to repurchase such shares at cost or at cost upon the
occurrence of certain events, such as the termination of employment.
Increase or decrease the authorized Preferred Stock.
Reclassify or recapitalize the capital stock of CCX
Effect the liquidation of the Corporation
Change the size of the Board of Directors
Issue or authorize or reserve for issuance to employees, consultants and
directors as equity incentive compensation in excess of 5,500,000 shares
of Common Stock, whether or not pursuant to a benefit plan, and taking
into account all such shares that have been so issued, authorized or
reserved as of May 2004.
Amend or alter the number of shares of Series A or Series B required in
connection with the foregoing actions.
Upon review of these provisions in CCX's May 2004 Amended Articles of
Incorporation, Techne has concluded that none of these provisions of would
be considered Substantive Participating Rights. All of these provisions
are standard protections of a preferred class of equity and none provide
"significant influence over operating and financial policies."
Techne has also considered the important considerations articulated in APB
No. 18. With regard to representation on the board of directors, Techne,
as discussed above, has the right to designate one of seven directors and
no voice in the selection of the other six. With regard to participation
in policy making processes, Techne has no role beyond that of the one
director and CCX has an extremely capable and assertive CEO/founder and
management team who control the ordinary course of business. With regard
to intercompany transactions, in the fiscal year ended June 30, 2004, CCX
purchased approximately $58,000 in products from Techne. In fact, CCX
negotiates very hard on its purchases from Techne and also purchases
products from Techne's direct competitors. With regard to interchange of
management personnel, there has been none. With regard to technological
interdependency, CCX received from Techne without charge and for
development purposes products with a customary price of approximately
$49,000 and a cost to Techne of approximately $7,000. With regard to
concentration of other shareholdings, approximately 55% of all shares are
held by related or cooperating venture capital funds as discussed above.
Furthermore, Techne has not provided any loans to CCX and does not have
any other commitments to provide funding for CCX's operations.
As a final issue, Techne has considered what has changed in respect to CCX
since the closings in May and June on the $38.5 million financing. Prior
to the recent financing, CCX had since 2001 failed in efforts to sell
additional equity, had depleted most of its cash and did not have
sufficient funds to continue on its business plan. Of the $38.1 million
raised, $28.1 million came from venture capital funds. The venture funds
contractually gained only one director position (over the one previously
held) and two non-voting observer positions, but this strengthens the
relative influence of the venture funds. Their investment will allow CCX
to operate without raising additional equity capital well into 2007, a
long time for a venture stage company and in particular for CCX given the
milestones it has reached and will reach by 2007 in its drug development
program. There is no contribution that Techne can any longer make which
will give it leverage to exercise significant influence over CCX. The
independence of CCX for at least several years has been assured, and
contributors of much larger amounts of capital than Techne have secured
for themselves the dominant voice in speaking with management.
Conclusion:
Based on analysis of the qualitative examples of FIN 35 and Techne's
protective rights in relation to EITF 96-16, Techne has concluded that
their 19.93% interest in CCX as of May 2004 should prospectively be
accounted for on the cost method of accounting. The KPMG local engagement
team has reviewed the Company's analysis and concurs with the Company's
conclusion. We will clarify our conclusion for using the cost method
for accounting for CCX in future filings.
5. Comment:
Please clarify to us and in the filing why you believe it is appropriate
to account for your 10% interest in Hemerus under the equity method.
Response:
Hemerus is a limited liability corporation (LLC) for which specific
ownership accounts are maintained for each investor. At the November 12-
13, 2003 EITF meeting, on Issue No. 03-16, the Task Force reached a
tentative conclusion that investments in an LLC that maintains a "specific
ownership account" for each investor should be viewed as similar to a
limited partnership for purposes of determining whether a noncontrolling
investment in an LLC should be accounted for using the cost method or
equity method of accounting. AICPA Statement of Position 78-9 requires
noncontrolling investments in limited partnerships to be accounted for
using the equity method unless the limited partner's interest is "so minor
that the limited partner may have virtually no influence over partnership
operating and financial policies." EITF Abstracts, Topic D-46,
"Accounting for Limited Partnership Investments," clarifies that
investments of more than 3 to 5% are considered to be more than minor and,
therefore, should be accounted for using the equity method. .
Techne accounts for its 10% interest in Hemerus based upon the guidance of
EITF Issue No 03-16. The local KPMG engagement team concurs with the
Company's conclusion. We will clarify our conclusion in future filings.
******
We hope that we have adequately addressed items No. 2-5 in the Comment Letter
and the additional disclosures and information sought by the Staff. Please
contact me at 612-379-6580 (fax) with any questions or comments. We will be
responding to comment #1 within the next 5 business days.
Sincerely,
/s/ Thomas E. Oland
----------------------
Thomas E. Oland
President and Chief Executive Officer
Cc: Andy LaFrence, KPMG
Melodie Rose, Fredrikson & Byron