ITEM 1. BUSINESS
THE COMPANY
Except for the historical information contained herein, the following discussion contains “forward-looking” statements. For this purpose, any statements that are not statements of historical fact may be deemed to be forward-looking statements. Words such as “believes,” “anticipates,” “plans,” “predicts,” “expects,” “estimates,” “intends,” “will,” “continue,” “may,” “potential,” “should” and similar expressions are intended to identify forward-looking statements. There are a number of important factors that could cause our results to differ materially from those indicated by these forward-looking statements, including, among others, those discussed in this section under “Business Risks” as well as under “Qualitative and Quantitative Disclosures about Market Risk” and the risks detailed from time to time in the Company’s SEC reports, including this Annual Report on Form 10-K for the year ended December 31, 2002.
We are a leading supplier of high-performance bioanalytical measurement systems that accelerate and improve drug discovery and other life sciences research. Our systems and consumables enable pharmaceutical and biotechnology companies to leverage advances in genomics, proteomics and combinatorial chemistry by facilitating the high-throughput and cost-effective identification and evaluation of drug candidates. Our solutions are based on our advanced core technologies that integrate our expertise in engineering, molecular and cell biology and chemistry. We enable our customers to improve research productivity and effectiveness, which ultimately accelerates the complex process of discovering and developing new drugs.
We were incorporated in California in 1983 and reincorporated in Delaware in 1995.
INDUSTRY BACKGROUND
Life sciences research, particularly drug discovery, is currently undergoing a revolution as a result of two converging trends. Aided by the sequencing of the human genome, researchers have begun to identify a large number of previously unknown natural molecules that play a role in disease and thus are likely targets for new therapeutic products. Until recently, only a few hundred disease targets were available to drug discovery researchers. In 2000, researchers completed the sequencing of the human genome; the estimated 30,000 genes that were revealed suggest the existence of thousands of previously unknown drug targets. At the same time, advances in combinatorial chemistry have provided chemists with techniques that allow them to synthesize a greater number of and diversity of compounds than ever before. Pharmaceutical companies previously maintained “libraries” of hundreds of thousands of compounds to test against disease targets to determine their potential as drugs; now, drug researchers have access to millions of such compounds.
The identification of disease targets and synthesis of chemical compounds are key first steps in the drug discovery process. Prior to entering clinical development, researchers undertake additional steps to determine which compounds are the most promising drug candidates. Among the most important downstream steps in the drug discovery process are assay development, drug candidate screening and lead optimization.
Assay Development. Once a disease target has been identified, researchers must develop a test, or assay, to determine whether a particular compound has a desired effect on the target. Most assays involve creating a biochemical reaction that takes place in a microplate, which is a plate containing an array of small wells that are similar to miniature test tubes. The plate is inserted into a microplate reader, which measures the light absorbed or emitted by the sample in each well. Depending upon its underlying technology, the reader detects light in the form of absorption, fluorescence or luminescence. The type of assay developed depends upon the characteristics of the disease target and the type of information the researcher is seeking. Two major categories of assays are cell-based assays and biochemical assays. A cell-based assay measures how a target on or inside a living cell responds to a compound; in a biochemical assay, the target is isolated from the cell environment. Cell-based assays are often considered particularly valuable in predicting how well a compound is likely to function as a drug because they mimic the target’s natural function.
Drug Candidate Screening. Once an assay has been developed, it is performed repeatedly to test the effects of a variety of compounds on the disease target, a process known as screening. Primary screening identifies “hits,” or compounds that exhibit significant activity against a target; secondary screening gathers more information on the hits to confirm and characterize their activity. Because drug companies now have a rapidly increasing number of compounds to test, they are interested in high-throughput screening, or HTS, to reduce the amount of time that is required for primary and secondary screening. Traditional bioanalytical instruments and methods were not designed for high-throughput screening, which has contributed to a bottleneck at this stage of the drug discovery process.
Lead Optimization. Compounds that emerge from the secondary screening process, now called “leads,” are next subjected to successive rounds of additional testing and chemical manipulations to make them even more suitable as drug candidates. This process, known as lead optimization, involves a variety of tests, such as cell-based assays, that yield a higher level of biological information
than screening assays. As drug companies generate increasing numbers of leads, bottlenecks have emerged in this stage, resulting in demand for more efficient lead optimization tools.
After optimization, a lead compound must pass a lengthy and expensive set of pre-clinical and clinical trials before becoming a drug. Because of the substantial resources required to conduct such trials, the cost of failure is high; thus, companies are interested in tools which allow more accurate assessment of a compound’s probability of success as early as possible in the drug discovery process.
To reduce the length and cost of the drug discovery process, researchers increasingly need tools that speed up the steps described above and increase the value of the information generated by them. Traditional bioanalytical instruments and methods do not adequately address these needs because of several limitations, including:
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Low sensitivity. One way to increase the speed of drug development is to conduct assays in high-density microplates, such that many samples can be analyzed in one equipment run. Microplates are now made in standard formats with either 96, 384 or 1,536 wells; the more wells there are, the smaller the sample volume in each well. Reading very small-volume samples requires a higher level of sensitivity than is available in most traditional detection equipment.
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Lack of automation. Throughput is often enhanced by incorporating automation into the drug discovery process. Some assays that provide high levels of information, such as live cell-based assays, require a particularly high degree of automation to run efficiently. For example, gaining certain kinetic data from a live cell assay, which is valuable in lead optimization, requires integrated liquid handling equipment so that compounds can be added to the cells and the detector can read the result of the assay almost instantaneously. Traditionally, many bioanalytical instruments have not been designed to integrate easily with automation equipment.
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Assay complexity. Many assays in use today are performed in a complex, multi-step process and are expensive, time-consuming and difficult to adapt to a high-throughput mode of operation. Thus, researchers are interested in assay formats that yield as much information as traditional assays but follow simplified protocols.
The proliferation in disease targets and chemical compounds coupled with the limitations of traditional technologies have created bottlenecks at each of the downstream steps of the drug discovery process which our products are specifically designed to address.
THE MOLECULAR DEVICES SOLUTION
We offer a full range of high-performance bioanalytical systems that address the sensitivity, automation and assay complexity challenges currently faced by researchers. We had revenues of $102.2 million in 2002, $92.2 million in 2001, and $96.0 million in 2000. Our major products possess levels of detection sensitivity that enable the analysis of high-density microplates, thereby increasing throughput. These products also include, or are easily integrated with, automation equipment to further enhance throughput and allow complex assays to be performed with high efficiency. Additionally, we develop novel assays that simplify the process of obtaining key information about the activity of drug candidates; in particular, we are an industry leader in providing technologies for performing information-rich live cell assays in high-throughput mode.
We group our product offerings into two categories based on the markets that are primarily served by each. Our Drug Discovery products include four major families of products: our Fluorometric Imaging Plate Reader, or FLIPR®, system, our multimode Analyst system, our IonWorks™ automated electrophysiology system and our Discovery-1 cellular imaging system. In addition to high performance instrumentation, we offer reagent kits that enable researchers to perform popular assays with higher-throughput than can be achieved using conventional technologies. Our Drug Discovery product family also includes our Chemiluminescence Imaging Plate Reader, or CLIPR, system, which performs live cell analysis at an ultra high-throughput rate. Together, our Drug Discovery products provide a wide array of solutions for both biochemical and cell-based research in the high-throughput screening and lead optimization market segments.
Our Life Sciences Research products include our Maxline™ family of microplate readers, our FlexStation system, our Skatron liquid handling systems, our Threshold® system and our MetaMorph™ line of cellular imaging software. Maxline microplate readers primarily address the assay development market and offer the assay development scientist nine differentiated instruments that include a wide range of innovative and flexible feature sets. We are widely perceived as a leader in microplate reader technology, and we believe that we have been the first to offer a number of innovative features into the premium end of the microplate reader market. FlexStation is a benchtop workstation that combines fluorescence detection with integrated fluidics, allowing researchers to perform the type of assays enabled by FLIPR in a lower-throughput, less expensive format. Skatron liquid handling systems facilitate assays by dispensing liquids into microplates and washing microplate wells, a key step in many of the most widely used laboratory tests. Our Threshold system is aimed at the biopharmaceutical manufacturing and quality control process, and we believe that the Threshold system is the only commercially available fully integrated system that rapidly and reproducibly detects potential contaminants with picogram level sensitivity. Finally, MetaMorph is a market-leading suite of software products that allows researchers to perform a wide range of sophisticated analyses on cellular images.
OUR PRODUCTS
DRUG DISCOVERY PRODUCTS
Our Drug Discovery systems, which represented 45% of our total revenues in 2002, 48% of our total revenues in 2001 and 51% of our total revenues in 2000, are used to perform both biochemical and cell-based assays and are primarily targeted toward high-throughput screening and lead optimization.
FLIPR System
Our FLIPR system satisfies a key demand from pharmaceutical companies for live cell analysis at a high-throughput rate. Many therapeutic drugs are targeted to cell membrane receptors: special proteins that function as control switches for cell activity and are triggered by the specific binding of soluble natural substances to relay messages to the cell via “signal transduction” mechanisms. Therapeutic drugs which act on receptors either mimic or block the action of the natural receptor-specific substance. The therapeutic potential of such drugs is, therefore, most appropriately studied using live cell systems. These studies are inherently challenging, but a high value is placed upon them by the pharmaceutical industry and the research community.
Our FLIPR was the first instrument to enable high-throughput screening of live cells with high information content on cellular activation. The primary applications for our FLIPR system are the measurement of intracellular calcium ion flux and membrane potential change, both of which provide critical information on the activation of cells by test compounds.
In our FLIPR system, cells, along with appropriate fluorescent dyes, are maintained in microplates in a thermally-controlled compartment together with compound-addition plates. Fluorescence activity is evaluated before, during and after delivery of compounds to the wells to evaluate the effect of compounds on the cells. Laser light provides excitation illumination to the wells and fluorescence from the cells on the bottom of the wells is quantified with an electronic camera. During the reading cycle, a built-in pipettor transfers compound samples from the compound-addition plate to the cell plate and the reaction is continuously monitored by an ultrasensitive charge coupled device, a CCD camera, at intervals of less than one second. This strategy allows for real-time monitoring of cells before and after compound addition, thus allowing the measurement of rapid, non-linear response kinetics. Our FLIPR system’s limited depth-of-field fluorometry optical design is patented. We currently offer two primary products based on our FLIPR technology platform.
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FLIPR2. This product is the second generation FLIPR product. It combines all of the benefits of the original FLIPR along with new automation capabilities and the ability to analyze samples in both 384 well and 96 well microplates. FLIPR2 can screen as many as 50,000 samples daily, and offers optional integrated plate stacker and washer accessories which can dramatically reduce the need for human intervention during sample processing. In addition, the instrument also incorporates interfaces that enable it to integrate into automated screening lines.
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FLIPR3. The third generation FLIPR product, FLIPR3 is a more sensitive, higher-throughput version of FLIPR2. It also incorporates a new detection mode, luminescence, expanding the menu of applications that can be performed on the FLIPR platform.
Analyst System
Our Analyst family of products complements our other drug discovery offerings by providing industry-leading flexibility and throughput for a wide range of biochemical assays. Instruments in this family include the Analyst AD, Analyst HT and Analyst GT, each of which features several different readout modalities, allowing customers to choose the one that is optimal for their particular screen. One of these readout modalities, fluorescence polarization, has become popular in recent years because it enables assays to be performed with greatly simplified protocols. We were pioneers in developing the market for fluorescence polarization, and our proprietary High Efficiency Fluorescence Polarization (HEFP™) technology is incorporated into the Analyst platform. Our HEFP technology enables miniaturized biochemical assays to be performed in a single step, a significant advantage over traditional biochemical assays.
Analyst provides several important customer benefits, including: increased throughput, improved analytical performance and flexibility (especially in higher density formats), lower reagent costs and compatibility with automation equipment. Analyst HT, launched in 1998, performs up to 70,000 screens per day. In 1999, we launched Analyst AD, which was designed specifically for assay development and is fully compatible with Analyst HT. ScreenStation, launched in 2001, integrates assay assembly and detection capabilities, allowing highly automated screening on the Analyst platform. In 2002, we introduced the next generation of the Analyst platform, Analyst GT, a highly sensitive instrument capable of screening over 400,000 wells per day.
IonWorks HT
In 2002, we launched IonWorks HT, a first-of-a-kind product for drug discovery. Like our FLIPR system, IonWorks HT addresses a key demand of pharmaceutical companies for live cell analysis with substantially improved throughput. For years researchers have sought more efficient ways to study ion channels, an important class of drug targets. Traditionally, the best information on ion channel activity has been obtained through patch clamping, a time-consuming, low-throughput method that is best performed by highly skilled scientists. The few higher-throughput alternatives that are available use indirect methods to assay ion channels, an approach that yields less useful data than patch clamping. IonWorks HT is an automated system that obtains the same high-quality information from cells as conventional patch clamping, but at a much faster rate and requiring far less operator skill. While traditional patch clamping may allow researchers to test only 5-15 compounds per day, IonWorks HT operates at speeds of up to 3,000 data points per day. The system consists of an instrument and a proprietary consumable, the PatchPlate.
Discovery-1
Discovery-1, our first generation high-throughput, high-resolution imaging instrument, was developed by our Universal Imaging Corporation (“UIC”) subsidiary. The system comprises instrumentation and a specialized version of our MetaMorph software, which together enable the automated imaging and analysis of individual cells in microwell plates. As cell-based assays become more important and attention shifts from genomics to the study of the activity of proteins within cells, high-throughput visualization of cellular events is increasingly in demand by drug discovery customers. Researchers generally use microscopes to view such intracellular events, using software such as MetaMorph to capture and analyze the images they obtain. However, in a drug screening environment, higher-throughput is required than can be achieved through traditional microscope studies. Discovery-1 automates the process of acquiring detailed images of individual cells and allows researchers to do so in the automation-friendly format of a microwell plate. The MetaMorph software that is included in the Dicovery-1 system provides efficient and flexible analysis of the complex images captured by the instrument.
CLIPR System
Our Chemiluminescence Imaging Plate Reader, or CLIPR, system was introduced in 1999. It satisfies a key demand from pharmaceutical companies for live cell analysis at an ultra high-throughput rate using luminescence technology. This allows customers to perform popular assays, such as those involving reporter genes, at rates of up to 200,000 wells per day. CLIPR’s applications also include non-cell-based assays such as SPA, which is among the most frequently-performed tests in the drug discovery market. These applications complement those of our other Drug Discovery systems, offering solutions for a wide range of biochemical and cell-based assays.
Drug Discovery Reagents
We are expanding our reagent business by focusing on the internal development of proprietary reagent kits optimized for our Drug Discovery instruments. We have historically developed and produced reagent kits for our Threshold systems, and in 1999 we began to sell consumables for our installed base of Drug Discovery instruments with the introduction of kits for performing important assays on FLIPR, CLIPR and Analyst. Our reagent business is supported by a reagent development and marketing team, in-house organic chemistry labs and significant reagent production capacity. Our current Drug Discovery reagent offerings include the following four product families:
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FLIPR Assay Kits. This product family includes the FLIPR Calcium Flux Kit, the FLIPR Calcium Plus Kit and the FLIPR Membrane Potential Kit, products that have revolutionized the way FLIPR assays are performed. The unique feature of these kits is that they enable researchers to eliminate a step in the assay protocol, thereby saving up to 15 minutes of processing time for each 384 well plate. These kits can significantly increase throughput, reduce costs and increase screening efficiency. The FLIPR Calcium Flux Kit addresses the most popular assay performed on the FLIPR system, a test for detecting the activation of GPCRs, a major category of drug targets. The FLIPR Calcium Plus Kit extends the applicability of this assay by allowing researchers to test problematic but important targets such as chemokines and small peptides. In addition, this kit offers a significant improvement in data quality compared to traditional methods. The FLIPR Membrane Potential Assay Kit allows researchers to measure changes in the electrical potential of live cell membranes, a key indicator of ion channel activity.
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IMAP Assay Kits. A proprietary bead-based platform, IMAP allows researchers to determine the activity of kinases, phosphatases and phosphodiesterases in a simple, non-radioactive format. We introduced the first two kits based on this technology in 2001; in 2002, we introduced an additional 16 kits. In addition to the kits, the IMAP platform is also available to customers through our technology access program, which allows researchers to apply this extremely flexible technology to a wide variety of protein kinase targets.
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HEFP™ Assay Kits. This family of kits is optimized for use on the Analyst platform and includes the STX-1 Assay kit for measuring the activity of serine/threonine kinases, the TKXtra Assay Kit for detecting additional kinases, and the cAMP Assay Kit for measuring an important indicator of cellular signaling.
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CatchPoint™ Assay Kits. These kits use a more sensitive and simpler format than traditional methods and are designed for use on both our Gemini instruments and our Analyst platform. This product line includes assay kits for cAMP, cGMP and tyrosine kinase.
LIFE SCIENCES RESEARCH PRODUCTS
Our Life Sciences Research products, which represented 55% of total revenues in 2002, 52% of total revenues in 2001 and 49% of total revenues in 2000, encompass our Maxline, FlexStation, Skatron, Threshold and MetaMorph product lines. The Maxline and FlexStation family of products consists primarily of advanced microplate readers. Microplate readers have become one of the most fundamental tools used in life sciences research by addressing the increasing need for the acquisition and processing of large quantities of biochemical and biological data. Microplate readers provide scientists the benefit of high-throughput analysis in a standardized, multi-sample format. Because of the productivity gains using a multi-sample format, microplates have largely replaced test tubes and cuvettes for many life sciences applications.
A microplate is a disposable plastic vessel that is used with a microplate reader to measure light. The basic principles of microplate readers are that light from an appropriate source is directed to a wavelength selection device, such as a monochromator, and its intensity is measured before and after passing through each of the sample wells of a microplate. Application of a mathematical formula to the light intensity measurements of each microplate well provides a measure of the sample present in the well. The measurement, known as optical density, relative fluorescence, or luminescence, is proportional to the concentration of the substance that is being measured. Historically, the standard microplate was comprised of 96 individual wells. As cost and throughput have become increasingly important, however, the industry has begun to move to higher density plates including 384 wells and 1536 wells. We believe that this trend towards miniaturization will continue to be a significant factor affecting the microplate reader market in the future.
Maxline Detection Systems
Our Maxline strategy has been to continue to introduce new products that include first-of-a-kind features, as well as to offer varying feature sets and price points to address different market segments. We have historically focused on the premium end of the microplate reader market through offering products with advanced capabilities. Some of the first-of-a-kind features that we have pioneered include the first reader and software capable of kinetic analysis, the first monochromator-based reader that enabled continuous wavelength selection and the first reader capable of performance comparable to a spectrophotometer. In each case, we believe that the innovation helped expand the utility of microplate readers and, more broadly, the available market for microplate readers. Our Maxline family currently includes the following primary products:
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Emax. This product is aimed at the market for traditional microplate readers that do not require kinetic capability. We introduced it to provide a reader for customers in academia and other customers with restricted capital budgets.
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Vmax. This was the first microplate reader to offer kinetic read capability and is designed to address the needs of biochemists.
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VERSAmax. The VERSAmax is our low cost variable wavelength offering that provides kinetic capability and temperature control.
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SPECTRAmax 340PC384. This product is a visible range microplate spectrophotometer, offering tunability and the additional capability of our patented PathCheck Sensor technology, which corrects common variability problems across wells of microplates.
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SPECTRAmax 190. The predecessor to this product was the world’s first microplate reader that incorporated a monochromator for continuous wavelength selection. Wavelength selection provides for enhanced convenience and flexibility in assay design. In addition, the SPECTRAmax 190 also includes our patented PathCheck Sensor technology.
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SPECTRAmax PLUS384. The SPECTRAmax PLUS384 combines the high-throughput of a microplate reader with the performance of a cuvette-based spectrophotometer as a result of our patented PathCheck Sensor technology. It is capable of reading wavelengths as short as 190 nanometers and as long as 1,000 nanometers, the equivalent range to a spectrophotometer, and is compatible with both 96-well and 384-well microplates.
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SPECTRAmax GEMINI XS. SPECTRAmax GEMINI was the world’s first dual-scanning microplate spectrofluorometer. By incorporating two scanning monochromators, the GEMINI allows the user to automatically optimize the instrument setting for the particular assay characteristics as well as for every fluorophore that is in use today. GEMINI also was our first microplate reader capable of multi-mode operation, in that the product is capable of fluorescence, luminescence and time-resolved fluorescence measurements. The GEMINI XS (Extra Sensitive), introduced in 2000, extends the GEMINI franchise by significantly improving sensitivity and adding well scanning capability which allows researchers to perform more complex cell based assays.
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SPECTRAmax GEMINI EM. The GEMINI EM expands the capabilities of the GEMINI XS through several new features, including the ability to read microplates from either the top or the bottom. These features expand the menu of applications that can be performed on the GEMINI platform to include cell-based assays.
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SPECTRAmax LMax. SPECTRAmax LMax is our first reader to offer customers sensitive luminescence detection in a bench-top instrument.
FlexStation
Our FlexStation system is a benchtop workstation that integrates liquid handling and detection and has applications in drug discovery as well as life sciences research. This product offers flexibility to address a wide range of research applications by combining both multi-channel, plate-to-plate fluid transfer and fluorescence measurement in one system. For drug discovery applications, FlexStation can play a key role in reducing assay development bottlenecks by providing a convenient means of developing assays for later transfer to higher-throughput screening. For basic and applied research in life sciences, the flexibility of this system enables scientists to develop, optimize, and run their assays on one system with the same small footprint as a standard benchtop microplate reader.
We offer three proprietary reagent kits that are based on our successful FLIPR assay technology and are optimized to perform on the FlexStation system. These products are our FlexStation Calcium Flux Assay Kit, FlexStation Calcium Plus Assay Kit and FlexStation Membrane Potential Assay Kit.
Skatron
We acquired a line of liquid handling systems, primarily washers, through our acquisition of Skatron Instruments AS in 1999. Washers are used to dispense and remove fluid from microwell plates and are used as an integral step during the course of many assays. The Skatron products bring a complete line of state-of-the-art microwell plate washers and other related tools, including cell harvesters, to the Life Sciences Research product family. These products include a variety of cell and plate washers that offer 96, 384 and 1536 well dispensing and washing capabilities.
Threshold System
Our Threshold system is comprised of a detection instrument and proprietary reagents. Our Threshold system incorporates our LAPS technology to quantitate a variety of biomolecules such as DNA, proteins and mRNA rapidly and accurately. The demand for systems which can quantitate contaminants in the manufacturing and quality control of bioengineered products is a result of the growing number of biopharmaceutical therapeutics both entering clinical trials and receiving regulatory approval for commercial sale. The Threshold system emerged from a need by biopharmaceutical companies for more sensitive and reproducible methods to detect contaminants in biopharmaceuticals during the manufacturing and quality control process. Traditional detection methods, such as DNA hybridization, can be slow, difficult to use in a manner that provides reproducible and transferable results, and often require the use of radioactive materials for detection. We believe that the Threshold system is the only commercially available, fully-integrated system capable of rapidly and accurately quantitating DNA with picogram level sensitivity. The Threshold family of products includes a workstation, software and consumable reagent kits.
MetaMorph Software
MetaMorph is a suite of software products for the acquisition and analysis of detailed cellular images. The software works in tandem with microscope and camera systems to acquire images of cells; once acquired, the images can be quantified and analyzed in a variety of ways. The product family, developed by our UIC subsidiary, consists of the following software packages:
• MetaMorph. The latest version of UIC’s flagship product is a state-of-the-art software package for capturing and analyzing cellular images. MetaMorph’s functions include control of a wide variety of imaging devices as well as a large menu of tools for image processing and analysis.
• MetaFluor. MetaFluor software allows researchers to image and analyze ratiometric indicators of intracellular events.
• MetaVue. A lower-cost version of MetaMorph, MetaVue is an entry-level product tailored to common imaging applications.
We sell MetaMorph software either as a stand-alone product or as part of an integrated system including a camera, software and peripherals. We are an authorized reseller of cameras and peripheral equipment for several major manufacturers including Nikon and Roper. Additionally, we have authorized several value-added resellers, who integrate multiple components to create complete imaging systems, to distribute MetaMorph.
OTHER SOFTWARE AND CUSTOMER SERVICE
All of our instrument products incorporate internally designed and developed software which are sold as an integral part of the instrument system. We believe that our software is an important differentiator for our instrument products relative to the competition based on its ease-of-use and advanced data analysis capabilities.
Our service and support offerings include field service, customer support, applications assistance and training through an organization of factory-trained
and educated service and application support personnel around the world. We offer services to our installed base of customers on both a contract and time and materials basis and we offer a variety of post-warranty contract options for all our instrument offerings that customers may purchase. Our installed base provides us with stable, recurring after-market service and support revenue, as well as product upgrade and replacement opportunities.
RESEARCH AND DEVELOPMENT
Our research and development team included 117 full time employees as of December 31, 2002. We have typically invested 16% to 21% of our revenues in research and development, which has resulted in a strong track record of technological innovation. 72% of our revenues in 2002 were derived from products that we introduced in the last three years. Our research and development expenditures were approximately $18.0 million in 2002, $15.1 million in 2001 and $16.8 million in 2000.
Our research and development activities are focused on:
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broadening our technology solution, including development of new proprietary reagent kits and additional solutions for automated cell electrophysiology measurements;
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providing more sensitive quantitative evaluation of biological events;
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providing greater throughput capability, especially with smaller sample volumes; and
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developing increasingly sophisticated data management and analysis capability.
MARKETING AND CUSTOMERS
Our sales and marketing organization included 158 full time employees in North America, Europe and Japan as of December 31, 2002. We distribute our products primarily through direct sales representatives in North America. We have subsidiaries in the United Kingdom, Germany and Japan responsible for selling and servicing our products. Our direct sales effort is supported by a team of service, technical and applications specialists employed by us. We also sell our products through international distributors, most of which enter into distribution agreements with us that provide for exclusive distribution arrangements and minimum purchase targets. Such agreements also generally prohibit the distributors from designing, manufacturing, promoting or selling any products that are competitive with our products.
Our customers include leading pharmaceutical and biotechnology companies as well as medical centers, universities, government research laboratories and other institutions throughout the world. No single customer accounted for more than 5% of our total 2002 revenues.
Sales to customers outside the United States accounted for 39%, 36% and 37% of total revenues and total sales denominated in foreign currencies accounted for 31%, 31% and 20% of total revenues in 2002, 2001 and 2000, respectively. We anticipate that international sales will account for an increasing percentage of revenues in the future. We expect to continue expanding our international operations in order to take advantage of increasing international market opportunities resulting from worldwide growth in the life sciences industry.
MANUFACTURING
We manufacture our products at our facilities in Sunnyvale, California and Norway. Both of these facilities are ISO 9001 certified. We assemble the Discovery-1 system at our facility in Downingtown, Pennsylvania. We manufacture our own components where we believe it adds significant value, but we rely on suppliers for the manufacture of selected components and subassemblies, which are manufactured to our specifications. We conduct all final testing and inspection of our products. We have established a quality control program, including a set of standard manufacturing and documentation procedures intended to ensure that, where required, our instruments are manufactured in accordance with Good Manufacturing Practices.
PATENTS AND PROPRIETARY TECHNOLOGIES
We protect our proprietary rights from unauthorized use by third parties to the extent that our proprietary rights are covered by valid and enforceable patents or are effectively maintained as trade secrets. Patents and other proprietary rights are an essential element of our business. Our policy is to file patent applications and to protect technology, inventions and improvements to inventions that are commercially important to the development of our business. As of December 31, 2002, we were maintaining 57 U.S. patents and other corresponding foreign patents based on our discoveries that have been issued or allowed. These patents expire at various dates between 2003 and 2018. In addition, as of that date, we had 38 patent applications pending in the United States and had filed several corresponding foreign patent applications.
We are a party to various license agreements that give us rights to use certain technologies. We pay royalties to the parties from which we licensed or acquired the core technologies.
We also rely on trade secret, employee and third-party nondisclosure agreements and other protective measures to protect our intellectual property rights pertaining to our products and technology.
COMPETITION
The market for life sciences instrumentation is highly competitive, and we expect competition to increase. We compete for the allocation of customer capital funds with many other companies marketing capital equipment, including those not directly competitive with any of our products. Some of our products also compete directly with similar products from other companies.
The life sciences research market is characterized by intense competition among a number of companies, including Bio-Tek Instruments, PerkinElmer, Tecan and Thermo Electron, that offer, or may in the future offer, products with performance capabilities generally similar to those offered by our products. We expect that competition is likely to increase in the future, as several current and potential competitors have the technological and financial ability to enter the microplate reader market. Our Maxline products are generally priced at a premium to other microplate readers. We compete in the microplate reader market primarily on the basis of performance and productivity. Many companies, research institutions and government organizations that might otherwise be customers for our products employ methods for bioanalytical analysis that are internally developed.
The drug discovery market is also characterized by intense competition among a number of companies, including Amersham Biosciences, Applied Biosystems, PerkinElmer and Tecan, that offer, or may in the future offer, products with performance capabilities generally similar to those offered by our products. We believe that the primary competitive factors in the market for our products are throughput, quantitative accuracy, breadth of applications, ease-of-use, productivity enhancement, quality, support and price/performance. We believe that we compete favorably with respect to these factors.
Many of our competitors have significantly greater financial, technical, marketing, sales and other resources than we do. In addition to competing with us with respect to product sales, these companies and institutions compete with us in recruiting and retaining highly qualified scientific and management personnel.
GOVERNMENT REGULATION
In the United States, the development, manufacturing, distribution, labeling and advertising of products intended for use in the diagnosis of disease or other conditions is extensively regulated by the U.S. Food and Drug Administration, known as the FDA. These products generally require FDA clearance before they may be marketed, and also are subject to postmarket manufacturing, reporting and labeling requirements. With the exception of certain of our Maxline microplate readers, none of our products is intended for use in the diagnosis of disease or other conditions, and, therefore, they are not currently subject to FDA regulation. The Maxline readers intended for diagnostic uses are the subject of an FDA marketing clearance. If we were to offer any of our other products for diagnostic uses, those products would become subject to FDA regulation.
EMPLOYEES
As of December 31, 2002, we employed 433 persons full time, including 117 in research and development, 119 in manufacturing, 158 in marketing and sales and 39 in general administration and finance. Of these employees, 85 hold Ph.D. or other advanced degrees. None of our employees is covered by collective bargaining agreements, and we consider relations with our employees to be good.
BUSINESS RISKS
Our business faces significant risks and the risks described below may not be the only risks we face. Additional risks that we do not know of or that we currently think are immaterial may also impair our business operations. If any of the events or circumstances described in the following risks actually occurs, our business, financial condition or results of operations could be harmed and the trading price of our common stock could decline.
VARIATIONS IN THE AMOUNT OF TIME IT TAKES FOR US TO SELL OUR PRODUCTS AND COLLECT ACCOUNTS RECEIVABLE AND THE TIMING OF CUSTOMER ORDERS MAY CAUSE FLUCTUATIONS IN OUR OPERATING RESULTS, WHICH COULD CAUSE OUR STOCK PRICE TO DECLINE.
The timing of capital equipment purchases by customers has been and is expected to continue to be uneven and difficult to predict. Our products represent major capital purchases for our customers. The list prices for our instruments range from $5,000 to $494,500. Accordingly, our customers generally take a relatively long time to evaluate our products, and a significant portion of our revenues is typically derived from sales of a small number of relatively high-priced products. Purchases are generally made by purchase orders and not long-term contracts. Delays in receipt of anticipated orders for our relatively high priced products could lead to substantial variability from quarter to quarter. Furthermore, we have historically received purchase orders and made a significant portion of each quarter’s product shipments near the end of the quarter. If that pattern continues, even short delays in the receipt of orders or shipment of products at the end of a quarter could have a materially adverse affect on results of operations for that quarter.
We expend significant resources educating and providing information to our prospective customers regarding the uses and benefits of our products. Because of the number of factors influencing the sales process, the period between our initial contact with a customer and the time when we recognize revenues from that customer, if ever, varies widely. Our sales cycles typically range from three to six months, but can be much longer. During these cycles, we commit substantial resources to our sales efforts in advance of receiving any revenues, and we may never receive any revenues from a customer despite our sales efforts.
The relatively high purchase price for a customer order contributes to collection delays that result in working capital volatility. While the terms of our sales orders generally require payment within 30 days of product shipment and do not provide return rights, in the past we have experienced significant collection delays. We cannot predict whether we will continue to experience similar or more severe delays.
The capital spending policies of our customers have a significant effect on the demand for our products. Those policies are based on a wide variety of factors, including resources available to make purchases, spending priorities, and policies regarding capital expenditures during industry downturns or recessionary periods. Any decrease in capital spending by our customers resulting from any of these factors could harm our business.
WE DEPEND ON ORDERS THAT ARE RECEIVED AND SHIPPED IN THE SAME QUARTER AND THEREFORE HAVE LIMITED VISIBILITY OF FUTURE PRODUCT SHIPMENTS.
Our net sales in any given quarter depend upon a combination of orders received in that quarter for shipment in that quarter and shipments from backlog. Our products are typically shipped within 30 to 90 days of purchase order receipt. As a result, we do not believe that the amount of backlog at any particular date is indicative of our future level of sales. Our backlog at the beginning of each quarter does not include all product sales needed to achieve expected revenues for that quarter. Consequently, we are dependent on obtaining orders for products to be shipped in the same quarter that the order is received. Moreover, customers may reschedule shipments, and production difficulties could delay shipments. Accordingly, we have limited visibility of future product shipments, and our results of operations are subject to significant variability from quarter to quarter.
MANY OF OUR CURRENT AND POTENTIAL COMPETITORS HAVE SIGNIFICANTLY GREATER RESOURCES THAN WE DO, AND INCREASED COMPETITION COULD IMPAIR SALES OF OUR PRODUCTS.
We operate in a highly competitive industry and face competition from companies that design, manufacture and market instruments for use in the life sciences research industry, from genomic, pharmaceutical, biotechnology and diagnostic companies and from academic and research institutions and government or other publicly-funded agencies, both in the United States and abroad. We may not be able to compete effectively with all of these competitors. Many of these companies and institutions have greater financial, engineering, manufacturing, marketing and customer support resources than we do. As a result, our competitors may be able to respond more quickly to new or emerging technologies or market developments by devoting greater resources to the development, promotion and sale of products, which could impair sales of our products. Moreover, there has been significant merger and acquisition activity among our competitors and potential competitors. These transactions by our competitors and potential competitors may provide them with a competitive advantage over us by enabling them to rapidly expand their product offerings and service capabilities to meet a broader range of customer needs. Many of our customers and potential customers are large companies that require global support and service, which may be easier for our larger competitors to provide.
We believe that competition within the markets we serve is primarily driven by the need for innovative products that address the needs of customers. We attempt to counter competition by seeking to develop new products and provide quality products and services that meet customers’ needs. We cannot assure you, however, that we will be able to successfully develop new products or that our existing or new products and services will adequately meet our customers’ needs.
Rapidly changing technology, evolving industry standards, changes in customer needs, emerging competition and frequent new product and service introductions characterize the markets for our products. To remain competitive, we will be required to develop
new products and periodically enhance our existing products in a timely manner. We are facing increased competition as new companies entering the market with new technologies compete, or will compete, with our products and future products. We cannot assure you that one or more of our competitors will not succeed in developing or marketing technologies or products that are more effective or commercially attractive than our products or future products, or that would render our technologies and products obsolete or uneconomical. Our future success will depend in large part on our ability to maintain a competitive position with respect to our current and future technologies, which we may not be able to do. In addition, delays in the launch of our new products may result in loss of market share due to our customers’ purchases of competitors’ products during any delay.
IF WE ARE NOT SUCCESSFUL IN DEVELOPING NEW AND ENHANCED PRODUCTS, WE MAY LOSE MARKET SHARE TO OUR COMPETITORS.
The life sciences instrumentation market is characterized by rapid technological change and frequent new product introductions. 72% of our revenues in 2002 were derived from the sale of products that were introduced in the last three years, and our future success will depend on our ability to enhance our current products and to develop and introduce, on a timely basis, new products that address the evolving needs of our customers. We may experience difficulties or delays in our development efforts with respect to new products, and we may not ultimately be successful in developing or commercializing them, which would harm our business. Any significant delay in releasing new systems could cause our revenues to suffer, adversely affect our reputation, give a competitor a first-to-market advantage or cause a competitor to achieve greater market share. In addition, our future success depends on our continued ability to develop new applications for our existing products. If we are not able to complete the development of these applications, or if we experience difficulties or delays, we may lose our current customers and may not be able to attract new customers, which could seriously harm our business and our future growth prospects.
WE MUST EXPEND A SIGNIFICANT AMOUNT OF TIME AND RESOURCES TO DEVELOP NEW PRODUCTS, AND IF THESE PRODUCTS DO NOT ACHIEVE COMMERCIAL ACCEPTANCE, OUR OPERATING RESULTS MAY SUFFER.
We expect to spend a significant amount of time and resources to develop new products and refine existing products. In light of the long product development cycles inherent in our industry, these expenditures will be made well in advance of the prospect of deriving revenues from the sale of new products. Our ability to commercially introduce and successfully market new products is subject to a wide variety of challenges during this development cycle that could delay introduction of these products. In addition, since our customers are not obligated by long-term contracts to purchase our products, our anticipated product orders may not materialize, or orders that do materialize may be canceled. As a result, if we do not achieve market acceptance of new products, our operating results will suffer. Our products are also generally priced higher than competitive products, which may impair commercial acceptance. We cannot predict whether new products that we expect to introduce will achieve commercial acceptance.
We currently anticipate that our IonWorks product family will include in the near term our recently launched IonWorks HT system and an additional IonWorks system based on technology acquired through the acquisition of Cytion S.A. Our IonWorks product family may not achieve significant commercial acceptance or generate significant revenues within the time frame that we have anticipated, or at all. Any such failure would adversely affect our financial performance. In particular, we recently launched our IonWorks HT system. This system has not achieved, and may not achieve or maintain, significant commercial acceptance. The system could fail to obtain significant commercial acceptance due to general economic conditions, competitive conditions, customer concerns related to the price or performance of the IonWorks HT system or other factors. In addition, we recently commenced the process of transferring the production of PatchPlates, a component of our IonWorks HT system, from the current manufacturer to in-house manufacturing. Any problems or delays in this transfer could adversely affect the ability of the IonWorks HT system to achieve or maintain significant commercial acceptance. It is likely that any failure of the IonWorks HT system to achieve commercial acceptance within the time frame that we have anticipated would cause us to fail to meet our previously stated 2003 revenue expectations, which would likely cause our stock price to decline.
The successful commercialization of our IonWorks product family, as well as the achievement of the benefits of our 2001 acquisition of Cytion, will depend in part on our ability to develop new products that include technology acquired through the acquisition of Cytion, or enhancements thereto, in a timely and efficient manner. Failure to develop new products in a timely and efficient manner, or at all, may prevent us from offering first-to-market products in segments of the electrophysiology market. As a result, we may lose customers, and our business and results of operations may be harmed. In January 2003, we initiated activities associated with the closure of the Cytion facility in Switzerland and the integration of Cytion’s technology and operations into operations located at our other facilities. In addition to the costs and potential delays associated with this facility closure, the closure may adversely impact our ability to successfully develop products that include technology acquired through the acquisition of Cytion, or enhancements thereto. Further, while we believe that the technology acquired through the acquisition of Cytion complements our IonWorks HT system, we may not be able to develop and commercialize any new products that include technology acquired through the acquisition of Cytion and are complementary to the IonWorks HT system. Any failure to develop new products that include technology acquired through the acquisition of Cytion, or enhancements thereto, in a timely and efficient manner, or at all, or any failure of such products to achieve commercial acceptance within the time frame that we have anticipated would adversely affect our business and financial performance.
WE OBTAIN SOME OF THE COMPONENTS AND SUBASSEMBLIES INCLUDED IN OUR SYSTEMS FROM A SINGLE SOURCE OR A LIMITED GROUP OF SUPPLIERS, AND THE PARTIAL OR COMPLETE LOSS OF ONE OF THESE SUPPLIERS COULD CAUSE PRODUCTION DELAYS AND A SUBSTANTIAL LOSS OF REVENUES.
We rely on outside vendors to manufacture many components and subassemblies. Certain components, subassemblies and services necessary for the manufacture of our systems are obtained from a sole supplier or limited group of suppliers, some of which are our competitors. Additional components, such as optical, electronic and pneumatic devices, are currently purchased in configurations specific to our requirements and, together with certain other components, such as computers, are integrated into our products. We maintain only a limited number of long-term supply agreements with our suppliers.
Our reliance on a sole or a limited group of suppliers involves several risks, including the following:
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we may be unable to obtain an adequate supply of required components;
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we have reduced control over pricing and the timely delivery of components and subassemblies; and
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our suppliers may be unable to develop technologically advanced products to support our growth and development of new systems.
Because the manufacturing of certain of these components and subassemblies involves extremely complex processes and requires long lead times, we may experience delays or shortages caused by suppliers. We believe that alternative sources could be obtained and qualified, if necessary, for most sole and limited source parts. However, if we were forced to seek alternative sources of supply or to manufacture such components or subassemblies internally, we may be forced to redesign our systems, which could prevent us from shipping our
systems to customers on a timely basis. Some of our suppliers have relatively limited financial and other resources. Any inability to obtain adequate deliveries, or any other circumstance that would restrict our ability to ship our products, could damage relationships with current and prospective customers and could harm our business.
For example, we rely on a single supplier, Essen Instruments, for the PatchPlate consumable that is part of the IonWorks HT. We decided in 2002 to bring the production of PatchPlates in-house, and Essen is assisting us in transferring their PatchPlate manufacturing technology to us. We have purchased from Essen the inventory we believe is sufficient to meet our needs for PatchPlates until we commence production on our own. However, we may not have sufficient inventory and until we have successfully completed the transfer of the technology and commenced in-house manufacturing on a commercial scale, we will continue to rely on Essen as our sole supplier of PatchPlates. Any failures by Essen to meet our requirements for PatchPlates could harm our business.
WE MAY ENCOUNTER MANUFACTURING AND ASSEMBLY PROBLEMS OR DELAYS, WHICH COULD RESULT IN LOST REVENUES.
We assemble our systems in our manufacturing facilities located in Sunnyvale, California, Downington, Pennsylvania, and Norway. Our manufacturing and assembly processes are highly complex and require sophisticated, costly equipment and specially designed facilities. As a result, any prolonged disruption in the operations of our manufacturing facilities could seriously harm our ability to satisfy our customer order deadlines. If we cannot deliver our systems in a timely manner, our revenues will likely suffer.
Our product sales depend in part upon manufacturing yields. We currently have limited manufacturing capacity and experience variability in manufacturing yields. We are currently manufacturing high-throughput instruments in-house, in limited volumes and with largely manual assembly. If demand for our high-throughput instruments increases, we will either need to expand our in-house manufacturing capabilities or outsource to other manufacturers. If we fail to deliver our products in a timely manner, our relationships with our customers could be seriously harmed, and revenues would decline.
As we develop new products, we must transition the manufacture of a new product from the development stage to commercial manufacturing. We cannot predict whether we will be able to complete these transitions on a timely basis and with commercially reasonable costs. We cannot assure you that manufacturing or quality control problems will not arise as we attempt to scale-up our production for any future new products or that we can scale-up manufacturing and quality control in a timely manner or at commercially reasonable costs. If we are unable to consistently manufacture our products on a timely basis because of these or other factors, our product sales will decline.
For example we are in the process of transferring the production of PatchPlates, a component of our IonWorks HT system, from the current manufacturer to in-house manufacturing. Since the production of PatchPlates is a complex process, it may take longer than we anticipate to reach full production capacity using our own manufacturing. Any problems or delays in this transfer could harm our business.
IF WE DELIVER PRODUCTS WITH DEFECTS, OUR CREDIBILITY WILL BE HARMED AND THE SALES AND MARKET ACCEPTANCE OF OUR PRODUCTS WILL DECREASE.
Our products are complex and sometimes have contained errors, defects and bugs when introduced. If we deliver products with errors, defects or bugs, our credibility and the market acceptance and sales of our products would be harmed. Further, if our products contain errors, defects or bugs, we may be required to expend significant capital and resources to alleviate such problems. Defects could also lead to product liability as a result of product liability lawsuits against us or against our customers. We have agreed to indemnify our customers in some circumstances against liability arising from defects in our products. In the event of a successful product liability claim, we could be obligated to pay damages significantly in excess of our product liability insurance limits.
MOST OF OUR CURRENT AND POTENTIAL CUSTOMERS ARE FROM THE PHARMACEUTICAL AND BIOTECHNOLOGY INDUSTRIES AND ARE SUBJECT TO RISKS FACED BY THOSE INDUSTRIES.
We derive a significant portion of our revenues from sales to pharmaceutical and biotechnology companies. We expect that sales to pharmaceutical and biotechnology companies will continue to be a primary source of revenues for the foreseeable future. As a result, we are subject to risks and uncertainties that affect the pharmaceutical and biotechnology industries, such as availability of capital and reduction and delays in research and development expenditures by companies in these industries, pricing pressures as third-party payors continue challenging the pricing of medical products and services, government regulation, and uncertainty of technological change.
In addition, our future revenues may be adversely affected by the ongoing consolidation in the pharmaceutical and biotechnology industries, which would reduce the number of our potential customers. Furthermore, we cannot assure you that the pharmaceutical and biotechnology companies that are our customers will not develop their own competing products or in-house capabilities.
OUR PRODUCTS COULD INFRINGE ON THE INTELLECTUAL PROPERTY RIGHTS OF OTHERS, WHICH MAY CAUSE US TO ENGAGE IN COSTLY LITIGATION AND, IF WE ARE NOT SUCCESSFUL, COULD ALSO CAUSE US TO PAY SUBSTANTIAL DAMAGES AND PROHIBIT US FROM SELLING OUR PRODUCTS.
Third parties may assert infringement or other intellectual property claims against us. We may have to pay substantial damages for infringement if it is ultimately determined that our products infringe a third party’s proprietary rights. Further, any legal action against us could, in addition to subjecting us to potential liability for damages, prohibit us from selling our products before we obtain a license to do so from the party owning the intellectual property, which, if available at all, may require us to pay substantial royalties. Even if these claims are without merit, defending a lawsuit takes significant time, may be expensive and may divert management attention from other business concerns. There may be third-party patents that may relate to our technology or potential products. Any public announcements related to litigation or interference proceedings initiated or threatened against us could cause our stock price to decline. We believe that there may be significant litigation in the industry regarding patent and other intellectual property rights. If we become involved in litigation, it could consume a substantial portion of our managerial and financial resources.
On April 16, 2002, Caliper Technologies Corp. filed a patent infringement lawsuit against us alleging that our IMAP assay kits infringe U.S. patents held by Caliper. We believe that none of our products infringe any claim of the Caliper patents. On May 8, 2002, we filed an answer and counter-claim to Caliper’s lawsuit denying all allegations of infringement, setting forth certain affirmative defenses and making a counter-claim for declaratory relief that, among other things, we are not infringing and have not infringed any valid and enforceable claim of the Caliper patent and that the Caliper patent is invalid. Caliper has also made a motion for preliminary injunction, expected to be decided in the second or third quarter of calendar 2003. We intend to oppose vigorously this motion. If Caliper were to prevail in this motion, we may be prohibited from selling IMAP assay kits until completion of the litigation, which may take several additional months. If we do not prevail in litigation, we may be prohibited permanently from selling IMAP assay kits. Our inability to sell IMAP assay kits could have an adverse impact on our overall customer relations. The IMAP product line represented approximately 1% of our revenues in 2002. We can not assure you that we will prevail in the Caliper lawsuit or that, even if we prevail, attention to the lawsuit will not consume substantial financial and management resources.
WE MAY NEED TO INITIATE LAWSUITS TO PROTECT OR ENFORCE OUR PATENTS, WHICH WOULD BE EXPENSIVE AND, IF WE LOSE, MAY CAUSE US TO LOSE SOME OF OUR INTELLECTUAL PROPERTY RIGHTS, WHICH WOULD REDUCE OUR ABILITY TO COMPETE IN THE MARKET.
We rely on patents to protect a large part of our intellectual property and our competitive position. In order to protect or enforce our patent rights, we may initiate patent litigation against third parties, such as infringement suits or interference proceedings. Litigation may be necessary to:
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assert claims of infringement;
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enforce our patents;
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protect our trade secrets or know-how; or
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determine the enforceability, scope and validity of the proprietary rights of others.
Lawsuits could be expensive, take significant time and divert management’s attention from other business concerns. They would put our patents at risk of being invalidated or interpreted narrowly and our patent applications at risk of not issuing. We may also provoke third parties to assert claims against us. Patent law relating to the scope of claims in the technology fields in which we operate is still evolving and, consequently, patent positions in our industry are generally uncertain. We cannot assure you that we will prevail in any of these suits or that the damages or other remedies awarded, if any, will be commercially valuable. During the course of these suits, there may be public announcements of the results of hearings, motions and other interim proceedings or developments in the litigation. If securities analysts or investors perceive any of these results to be negative, our stock price could decline.
THE RIGHTS WE RELY UPON TO PROTECT OUR INTELLECTUAL PROPERTY UNDERLYING OUR PRODUCTS MAY NOT BE ADEQUATE, WHICH COULD ENABLE THIRD PARTIES TO USE OUR TECHNOLOGY AND WOULD REDUCE OUR ABILITY TO COMPETE IN THE MARKET.
Our success will depend in part on our ability to obtain commercially valuable patent claims and to protect our intellectual property. Our patent position is generally uncertain and involves complex legal and factual questions. Legal standards relating to the validity and scope of claims in our technology field are still evolving. Therefore, the degree of future protection for our proprietary rights is uncertain.
The risks and uncertainties that we face with respect to our patents and other proprietary rights include the following:
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the pending patent applications we have filed or to which we have exclusive rights may not result in issued patents or may take longer than we expect to result in issued patents;
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the claims of any patents which are issued may not provide meaningful protection;
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we may not be able to develop additional proprietary technologies that are patentable;
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the patents licensed or issued to us or our customers may not provide a competitive advantage;
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other companies may challenge patents licensed or issued to us or our customers;
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patents issued to other companies may harm our ability to do business;
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other companies may independently develop similar or alternative technologies or duplicate our technologies; and
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other companies may design around technologies we have licensed or developed.
In addition to patents, we rely on a combination of trade secrets, nondisclosure agreements and other contractual provisions and technical measures to protect our intellectual property rights. Nevertheless, these measures may not be adequate to safeguard the technology underlying our products. If they do not protect our rights, third parties could use our technology, and our ability to compete in the market would be reduced. In addition, employees, consultants and others who participate in the development of our products may breach their agreements with us regarding our intellectual property, and we may not have adequate remedies for the breach. We also may not be able to effectively protect our intellectual property rights in some foreign countries. For a variety of reasons, we may decide not to file for patent, copyright or trademark protection or prosecute potential infringements of our patents. We also realize that our trade secrets may become known through other means not currently foreseen by us. Notwithstanding our efforts to protect our intellectual property, our competitors may independently develop similar or alternative technologies or products that are equal or superior to our technology and products without infringing on any of our intellectual property rights or design around our proprietary technologies.
WE MAY HAVE DIFFICULTY MANAGING OUR GROWTH.
We expect to experience significant growth in the number of our employees and customers and the scope of our operations, including as a result of potential acquisitions. This growth may continue to place a significant strain on our management and operations. Our ability to manage this growth will depend upon our ability to broaden our management team and our ability to attract, hire and retain skilled employees. Our success will also depend on the ability of our officers and key employees to continue to implement and improve our operational and other systems, to manage multiple, concurrent customer relationships and to hire, train and manage our employees. Our future success is heavily dependent upon growth and acceptance of new products. If we cannot scale our business appropriately or otherwise adapt to anticipated growth and new product introductions, a key part of our strategy may not be successful.
WE RELY UPON DISTRIBUTORS FOR PRODUCT SALES AND SUPPORT OUTSIDE NORTH AMERICA.
In 2002, approximately 9% of our sales were made through distributors. We often rely upon distributors to provide customer support to the ultimate end users of our products. As a result, our success depends on the continued sales and customer support efforts of our network of distributors. The use of distributors involves certain risks, including risks that distributors will not effectively sell or support our products, that they will be unable to satisfy financial obligations to us and that they will cease operations. Any reduction, delay or loss of orders from our significant distributors could harm our revenues. We also do not currently have distributors in a number of significant international markets that we have targeted and will need to establish additional international distribution relationships. There can be no assurance that we will engage qualified distributors in a timely manner, and the failure to do so could have a materially adverse affect on our business, financial condition and results of operations.
IF WE CHOOSE TO ACQUIRE NEW AND COMPLEMENTARY BUSINESSES, PRODUCTS OR TECHNOLOGIES INSTEAD OF DEVELOPING THEM OURSELVES, WE MAY BE UNABLE TO COMPLETE THESE ACQUISITIONS OR MAY NOT BE ABLE TO SUCCESSFULLY INTEGRATE AN ACQUIRED BUSINESS OR TECHNOLOGY IN A COST-EFFECTIVE AND NON-DISRUPTIVE MANNER.
Our success depends on our ability to continually enhance and broaden our product offerings in response to changing technologies, customer demands and competitive pressures. To this end, from time to time we have acquired complementary businesses, products or technologies instead of developing them ourselves, and we may choose to do so in the future. For example, in June 2002 we acquired Universal Imaging Corporation, or UIC. We do not know if we will be able to complete any additional acquisitions, or whether we will be able to successfully integrate any acquired business, operate it profitably or retain its key employees. Integrating any business, product or technology we acquire could be expensive and time consuming, disrupt our ongoing business and distract our management. In addition, in order to finance any acquisitions, we might need to raise additional funds through public or private equity or debt financings. In that event, we could be forced to obtain financing on terms that are not favorable to us and, in the case of equity financing, that may result in dilution to our stockholders. If we are unable to integrate any acquired entities, products or technologies effectively, our business will suffer. In addition, any impairment of goodwill and amortization of other intangible assets or charges resulting from the costs of acquisitions could harm our business and operating results.
We acquired Cytion S.A. in 2001. In January 2003, we initiated activities associated with the closure of the Cytion facility in Switzerland. We may continue to incur costs from integrating Cytion’s technology and operations into operations located at our other facilities, which may be expensive and time consuming and may adversely impact our ability to successfully develop products. Such costs may include costs for reorganization, closure of the facility, satisfaction of contractual obligations, employee redeployment or severance, conversion of information systems or other costs arising from the coordination of our development teams. Successful product development may place a significant burden on our existing management and our internal resources, which could have a materially adverse effect on our business, financial condition and operating results. Finally, the market price of our common stock could decline if we do not achieve the perceived benefits of the acquisition as rapidly or to the extent anticipated by financial analysts or investors.
WE DEPEND ON OUR KEY PERSONNEL, THE LOSS OF WHOM WOULD IMPAIR OUR ABILITY TO COMPETE.
We are highly dependent on the principal members of our management, engineering and scientific staff. The loss of the service of any of these persons could seriously harm our product development and commercialization efforts. In addition, research, product development and commercialization will require additional skilled personnel in areas such as chemistry and biology, software engineering and electronic engineering. Our corporate headquarters is located in Sunnyvale, California, where demand for personnel with these skills is extremely high and is likely to remain high. As a result, competition for and retention of personnel, particularly for employees with technical expertise, is intense and the turnover rate for qualified personnel is high. If we are unable to hire, train and retain a sufficient number of qualified employees, our ability to conduct and expand our business could be seriously reduced. The inability to retain and hire qualified personnel could also hinder the planned expansion of our business.
WE ARE DEPENDENT ON INTERNATIONAL SALES AND OPERATIONS, WHICH EXPOSES US TO FOREIGN CURRENCY EXCHANGE RATE, POLITICAL AND ECONOMIC RISKS.
We maintain facilities in Norway, the United Kingdom, Germany and Japan, and sales to customers outside the United States accounted for approximately 39% our revenues in 2002. We anticipate that international sales will continue to account for a significant portion of our revenues.
All of our sales to international distributors are denominated in U.S. dollars. Most of our direct sales in the United Kingdom, Germany, France, Canada and Japan are denominated in local currencies and totaled $32.2 million (32% of total revenues) in 2002. To the extent that our sales and operating expenses are denominated in foreign currencies, our operating results may be adversely affected by changes in exchange rates. Historically, foreign exchange gains and losses have been immaterial to our results of operations. However, we cannot predict whether these gains and losses will continue to be immaterial, particularly as we increase our direct sales outside North America. For example, we cannot predict whether other foreign exchange gains or losses in the future would have a material effect on our income. Owing to the number of currencies involved, the substantial volatility of currency exchange rates, and our constantly changing currency exposures, we cannot predict the effect of exchange rate fluctuations on our future operating results. We do not currently engage in foreign currency hedging transactions, but may do so in the future.
Our reliance on international sales and operations exposes us to foreign political and economic risks, including:
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political, social and economic instability;
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trade restrictions and changes in tariffs;
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import and export license requirements and restrictions;
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difficulties in staffing and managing international operations;
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disruptions in international transport or delivery;
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difficulties in collecting receivables; and
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potentially adverse tax consequences.
If any of these risks materialize, our international sales could decrease and our foreign operations could suffer.
OUR OPERATING RESULTS FLUCTUATE AND ANY FAILURE TO MEET FINANCIAL EXPECTATIONS MAY DISAPPOINT SECURITIES ANALYSTS OR INVESTORS AND RESULT IN A DECLINE IN OUR STOCK PRICE.
We have experienced and in the future may experience a shortfall in revenue or earnings or otherwise fail to meet public market expectations, which could materially and adversely affect our business and the market price of our common stock. Our total revenues and operating results may fluctuate significantly because of a number of factors, many of which are outside of our control. These factors include:
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customer confidence in the economy, evidenced, in part, by stock market levels;
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changes in the domestic and international economic, business and political conditions;
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economic conditions within the pharmaceutical and biotechnology industries;
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level of product and price competition;
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length of our sales cycle and customer buying patterns;
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size and timing of individual transactions;
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timing of new product introductions and product enhancements;
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mix of products sold;
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levels of international transactions;
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activities of and acquisitions by competitors;
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timing of new hires and the allocation of our resources;
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changes in foreign currency exchange rates; and
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our ability to develop and market new products and control costs.
One or more of the foregoing factors may cause our operating expenses to be disproportionately high during any given period or may cause our revenues and operating results to fluctuate significantly. In particular, we typically experience a decrease in the level of sales in the first calendar quarter as compared to the fourth quarter of the preceding year because of budgetary and capital equipment purchasing patterns in the life sciences industry. Our quarterly operating results have fluctuated in the past, and we expect they will fluctuate in the future as a result of many factors, some of which are outside of our control.
In addition, if sales levels in a particular quarter do not meet expectations, we may not be able to adjust operating expenses sufficiently quickly to compensate for the shortfall, and our results of operations for that quarter may be seriously harmed. We manufacture our products based on forecasted orders rather than to outstanding orders. Our manufacturing procedures may in certain instances create a risk of excess or inadequate inventory levels if orders do not match forecasts. In addition, our expense levels are based, in part, on expected future sales, and we generally cannot quickly adjust operating expenses. For example, research and development and general and administrative expenses are not affected directly by variations in revenues.
Based upon the preceding factors, we may experience a shortfall in revenue or earnings or otherwise fail to meet public market expectations, which could materially and adversely affect our business, financial condition, results of operations and the market price of our common stock. Because our revenues and operating results are difficult to predict, we believe that period-to-period comparisons of our results of operations are not a good indication of our future performance.
OUR STOCK PRICE IS VOLATILE, WHICH COULD CAUSE STOCKHOLDERS TO LOSE A SUBSTANTIAL PART OF THEIR INVESTMENT IN OUR STOCK.
The stock market in general, and the stock prices of technology companies in particular, have recently experienced volatility which has often been unrelated to the operating performance of any particular company or companies. During 2002, the closing sales price of our common stock ranged from $10.22 to $21.47. Our stock price could decline regardless of our actual operating performance, and
stockholders could lose a substantial part of their investment as a result of industry or market-based fluctuations. In the past, our stock has traded relatively thinly. If a more active public market for our stock is not sustained, it may be difficult for stockholders to resell shares of our common stock. Because we do not anticipate paying cash dividends on our common stock for the foreseeable future, stockholders will not be able to receive a return on their shares unless they sell them.
The market price of our common stock will likely fluctuate in response to a number of factors, including the following:
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domestic and international economic, business and political conditions;
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economic conditions within the pharmaceutical and biotechnology industries;
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our failure to meet our performance estimates or the performance estimates of securities analysts;
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changes in financial estimates of our revenues and operating results or buy/sell recommendations by us or securities analysts; and
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the timing of announcements by us or our competitors of significant products, contracts or acquisitions or publicity regarding actual or potential results or performance thereof.
PROVISIONS OF OUR CHARTER DOCUMENTS AND DELAWARE LAW MAY INHIBIT A TAKEOVER, WHICH COULD LIMIT THE PRICE INVESTORS MIGHT BE WILLING TO PAY IN THE FUTURE FOR OUR COMMON STOCK.
Provisions in our certificate of incorporation and bylaws may have the effect of delaying or preventing an acquisition, merger in which we are not the surviving company or changes in our management. For example, our certificate of incorporation gives our board of directors the authority to issue shares of preferred stock and to determine the price, rights, preferences and privileges and restrictions, including voting rights, of those shares without any further vote or action by our stockholders. The rights of the holders of common stock will be subject to, and may harmed by, the rights of the holders of any shares of preferred stock that may be issued in the future. The issuance of preferred stock may delay, defer or prevent a change in control, as the terms of the preferred stock that might be issued could potentially prohibit our consummation of any merger, reorganization, sale of substantially all of our assets, liquidation or other extraordinary corporate transaction without the approval of the holders of the outstanding shares of preferred stock. The issuance of preferred stock could also have a dilutive effect on our stockholders. In addition, because we are incorporated in Delaware, we are governed by the provisions of Section 203 of the Delaware General Corporation Law. These provisions may prohibit large stockholders, in particular those owning 15% or more of the outstanding voting stock, from consummating a merger or combination involving us. Further, in October 2001, our Board of Directors adopted a stockholder rights plan, commonly known as a “poison pill.” These provisions described above and our poison pill could limit the price that investors might be willing to pay in the future for our common stock.
OUR ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THOSE ANTICIPATED IN OUR FORWARD-LOOKING STATEMENTS.
This report contains forward-looking statements within the meaning of the federal securities laws that relate to future events or our future financial performance. When used in this report, you can identify forward-looking statements by terminology such as “anticipates,” “plans,” “predicts,” “expects,” “estimates,” “intends,” “will,” “continue,” “may,” “potential,” “should” and the negative of these terms or other comparable terminology. These statements are only predictions. Our actual results could differ materially from those anticipated in our forward-looking statements as a result of many factors, including those set forth here under “Business Risks” and elsewhere in this report.
Although we believe that the expectations reflected in our forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. Neither we nor any other person assumes responsibility for the accuracy and completeness of these statements. We assume no duty to update any of the forward-looking statements after the date of this report or to conform these statements to actual results.
AVAILABLE INFORMATION
We maintain a site on the world wide web at www.moleculardevices.com, however, information found on our web site is not incorporated by reference into this report. We make available free of charge on or through our website our annual report of Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC.
ITEM 2.
ITEM 2. PROPERTIES
We lease two facilities in Sunnyvale, California and one facility in Downington, Pennsylvania which include laboratory, manufacturing and administrative space. We also lease sales and service offices in the United Kingdom, Germany and Japan, a manufacturing facility in Norway, and a research and development facility in Switzerland. We believe that our current facilities will be sufficient for our operations through at least 2003. These properties are described below:
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
On April 16, 2002, Caliper Technologies Corp. filed a patent infringement lawsuit against us alleging that our IMAP assay kits infringe U.S. patents held by Caliper. We believe that none of our products infringe any claim of the Caliper patents. On May 8, 2002, we filed an answer and counter-claim to Caliper’s lawsuit denying all allegations of infringement, setting forth certain affirmative defenses and making a counter-claim for declaratory relief that, among other things, we are not infringing and have not infringed any valid and enforceable claim of the Caliper patent and that the Caliper patent is invalid. Caliper has also made a motion for preliminary injunction which is expected to be decided in the second or third quarter of calendar 2003. We intend to oppose vigorously this motion. If Caliper were to prevail in this motion, we may be prohibited from selling IMAP assay kits until completion of the litigation, which may take several additional months. If we do not prevail in litigation, we may be prohibited permanently from selling IMAP assay kits. Our inability to sell IMAP assay kits could have an adverse impact on our overall customer relations.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Our common stock is traded on the Nasdaq National Market under the symbol “MDCC.”
The prices per share reflected on the table below represent the range of high and low closing sales prices of the common stock on the Nasdaq National Market, for the period indicated.
Historically, we have not paid cash dividends on our common stock and do not intend to pay any cash dividends in the foreseeable future. The Board of Directors will determine any future cash dividends. As of March 21, 2003, we had approximately 158 stockholders of record. On March 21, 2003, the last sale price reported on the Nasdaq National Market for our common stock was $11.00 per share.
We entered into an employment arrangement with Patricia Sharp, Vice President of Human Resources, pursuant to which we were obligated to issue to her shares of our common stock in exchange for services rendered. As a result of this arrangement, we issued shares of our common stock to Ms. Sharp in 2001 and 2002 on the dates and amounts indicated below in reliance on the exemption from registration afforded by Section 4(2) of the Securities Act of 1933, as amended.
Certain information required to be disclosed by Item 201(d) of Regulation S-K is incorporated herein by reference.
ITEM 6.
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
The following table sets forth selected historical financial information for Molecular Devices, certain portions of which are based on, and should be read in conjunction with, our audited consolidated financial statements that are being filed as a part of this report.
ITEM 7.
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
OVERVIEW
Except for the historical information contained herein, the following discussion contains “forward-looking” statements. For this purpose, any statements that are not statements of historical fact may be deemed to be forward-looking statements. Words such as “believes”, “anticipates”, “plans”, “predicts”, “expects”, “estimates”, “intends”, “will”, “continue”, “may”, “potential”, “should” and similar expressions are intended to identify forward-looking statements. There area number of important factors that could cause our results to differ materially from those indicated by these forward-looking statements, including, among others, those discussed in this section as well as under “Item I. Business-Business Risks” and “Qualitative and Quantitative Disclosures about Market Risk” and the risks detailed from time to time in the Company’s SEC reports, including this Annual Report on Form 10-K for the year ended December 31, 2002.
We are a leading supplier of high-performance bioanalytical measurement systems which accelerate and improve drug discovery and other life sciences research. Our systems and consumables enable pharmaceutical and biotechnology companies to leverage advances in genomics, proteomics and combinatorial chemistry by facilitating the high-throughput and cost-effective identification and evaluation of drug candidates. Our solutions are based on its advanced core technologies that integrate our expertise in engineering, molecular and cell biology, and chemistry. We enable our customers to improve research productivity and effectiveness, which ultimately accelerates the complex process of discovering and developing new drugs.
Our customers include small and large pharmaceutical, biotechnology and industrial companies as well as medical centers, universities, government research laboratories and other institutions throughout the world. No single customer accounted for more than 5% of our consolidated revenues in 2002, 2001 or 2000. We recognize revenue on the sale of our products, when collectibility is reasonably assured, at the time of shipment and transfer of title to customers and distributors. There are no significant customer acceptance requirements or post shipment obligations on our part. Service contract revenue is deferred at the time of sale and recognized ratably over the period of performance. Total service revenue was 8%, 6% and 4% of total revenues in 2002, 2001 and 2000, respectively. In 2002, sales to customers outside the United States accounted for 39% of total revenues and total sales denominated in foreign currencies accounted for 31% of total revenues. We currently do not hedge our exposure to movements in foreign currency exchange rates, however we may do so in the future. We typically experience a decrease in the level of sales in the first calendar quarter as compared to the fourth quarter of the preceding year because of budgetary and capital equipment purchasing patterns in the life sciences industry. We expect this trend to continue in future years.
In June 2002, we acquired Universal Imaging Corporation, a developer and distributor of cellular imaging software and drug discovery tools. In 2001, we acquired Nihon Molecular Devices, a sales and service operation in Japan, as well as Cytion S.A., a research and development company in Switzerland.
We acquired all of the outstanding stock of LJL BioSystems in a tax-free, stock-for-stock transaction in August 2000, as a result of which LJL BioSystems became a wholly owned subsidiary. The transaction was accounted for under the pooling-of-interests method of accounting and, accordingly, all financial information includes the operations of LJL BioSystems for all periods presented.
All of the acquired companies were integrated into our existing business and accordingly no new operating segments were created.
CRITICAL ACCOUNTING POLICIES
Management’s discussion and analysis of Molecular Devices’ financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an ongoing basis, management evaluates its estimates, including those related to revenue recognition, bad debts, inventories, intangible assets, equity investments, income taxes and warranty obligations. Management bases its estimates on historical experience and on various assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.
We believe the following critical accounting policies affect the more significant judgments and estimates used in the preparation of our consolidated financial statements:
Revenue Recognition and Warranty
We recognize product revenue at the time of shipment and transfer of title when collectibility is reasonably assured. Software revenue is recognized at the time of sale and in accordance with AICPA Statement of Position No. 97-2, “Software Revenue Recognition” (“SOP 97-2”). There are no significant customer acceptance requirements or post-shipment obligations on the part of Molecular Devices for product or software sales.
Future warranty costs are estimated based on historical experience and provided for at the time of sale. Freight costs for revenue-generating shipments are charged to costs of goods sold. Amounts received prior to completion of the earnings process are recorded as customer deposits or deferred revenue, as appropriate. Service contract revenue is deferred at the time of sale and recognized ratably over the period of performance.
Accounts Receivable
We sell our products primarily to corporations, academic institutions, government entities and distributors within the drug discovery and life sciences research markets. We perform ongoing credit evaluations of our customers and generally do not require collateral. We maintain reserves for potential credit losses, which are based on a number of factors including, but not limited to, the current financial condition of specific customers, payment trends and the overall economic environment. Such losses have been historically within management’s expectations.
Inventories
Inventories are stated on a first-in, first-out basis at the lower of cost or market. We write down our inventory for estimated obsolescence or unmarketable inventory equal to the difference between the cost of inventory and the estimated market value based upon assumptions about future demand and market conditions. If actual market conditions are less favorable than those we project, additional inventory write downs may be required.
Equity Investments
We invest in equity instruments of privately held companies for business and strategic purposes. These investments are included in other long-term assets and are accounted for under the cost method when ownership is less than 20 percent of voting securities and we do not have the ability to exercise significant influence over operations. When our ownership exceeds 20 percent of voting securities but is less than 50 percent, or we have the ability to exercise significant influence, the investment is accounted for under the equity method. Under the equity method, the investee’s proportionate share of net income or loss and amortization of the investee’s net excess investment over its equity in net assets is included in net income or loss. As of December 31, 2002, we did not hold any investments accounted for under the equity method. We regularly review the assumptions underlying the operating performance and cash flow forecasts in assessing the fair values. We monitor the preceding factors to identify events or circumstances which would cause us to test for other than temporary impairment and revise our assumptions for the estimated recovery of equity investments.
Income Taxes
Income taxes are accounted for under the liability method whereby deferred tax asset or liability account balances are calculated at the balance sheet date using current tax laws and rates in effect for the year in which the differences are expected to affect taxable income. Valuation allowances are established when necessary to reduce deferred tax assets to the amounts expected to be realized in the future.
At December 31, 2002, we had net deferred tax assets of $8.5 million. Realization of these assets is dependent on our ability to generate significant future taxable income. We believe that sufficient income will be earned in the future to realize these assets. We will evaluate the realizability of the deferred tax assets and assess the need for valuation allowances periodically.
Various factors may have favorable or unfavorable effects upon our effective tax rate in 2003 and subsequent years. These factors include, but are not limited to, interpretations of existing tax laws, changes in tax laws and rates, future levels of R&D spending, future levels of capital expenditures, and our success in R&D and commercializing products.
RESULTS OF OPERATIONS
The following table summarizes our consolidated statement of income as a percentage of revenues:
YEARS ENDED DECEMBER 31, 2002 AND 2001
Revenues for 2002 increased by 11% to $102.2 million from $92.2 million in 2001. This increase was due to the launch of the IonWorks HT, along with the inclusion of seven months of revenue from Universal Imaging Corporation (“UIC”), acquired on June 1, 2002. Our revenues are broken into two product families. The Drug Discovery product family, which includes cell analysis and HTS systems, consists of IonWorks HT, FLIPR, CLIPR, Analyst, Discovery-1 and Cytosensor systems. The Life Sciences Research product family, which includes bench top detection and liquid handling products, consists of Maxline, Skatron, MetaMorph and Threshold products. Drug Discovery product family revenues increased 4% in 2002 due to launch of IonWorks HT in the third quarter, increased sales of FLIPR products and the addition of the Discovery-1 product line from UIC. Revenues in the Life Sciences Research product family increased 16% in 2002 largely due to the addition of the MetaMorph product line from UIC and growth in sales of the Threshold and Skatron product lines.
Gross margin decreased to 60.3% in 2002, from 61.5% in 2001. This decrease was primarily due to overall product sales that were more heavily weighted in lower margin products.
Research and development expenses increased by 19% to $18.0 million (18% of revenues) in 2002 from $15.1 million (16% of revenues) in 2001. This increase was primarily driven by inclusion of a full year’s research and development expenses at Cytion S.A. (“Cytion”), which we acquired in July 2001, and the research and development expenses incurred at UIC.
Selling, general and administrative expenses increased by 6% to $35.4 million (35% of revenues) in 2002 from $33.4 million (36% of revenues) in 2001. This increase resulted from the inclusion of the selling, general and administrative expenses of UIC.
Other income, net, consisting primarily of interest income, decreased by 59% to $1.6 million in 2002 from $3.8 million in 2001. This was due to lower average cash and short-term investment balances (due to the share repurchase plan executed in the first quarter and the UIC acquisition in the second quarter) and decreased interest rates in 2002.
We recorded tax provisions of $2.9 million (an effective tax rate of 30%) and $4.6 million (an effective tax rate of 38.5%) for 2002 and 2001, respectively. The decrease in our effective tax rate resulted from tax benefits recognized in 2002 associated with our international operations. The effective tax rates for 2002 and 2001 are calculated on profit before tax excluding the write-off of acquired in-process research and development expenses in 2001, which is not deductible for income tax purposes.
YEARS ENDED DECEMBER 31, 2001 AND 2000
Revenues for 2001 decreased by 4% to $92.3 million from $96.0 million in 2000. The soft economic environment in 2001 affecting purchasing decisions on our higher priced instrument systems resulted in this top-line decline. Drug Discovery product family revenues were down 10.8% from 2000, due in large part to significant declines in the LJL product line. This decline was offset by a 3.2% increase in revenues from our Life Sciences Research product family, led by the FlexStation, which was introduced in the first quarter of 2001.
Gross margin decreased to 61.5% in 2001, from 62.9% in 2000. The decrease related in part from decreased list prices for our LJL product line, as well as increased discounting on other high-cost instruments in an attempt to offset the impact of the soft economic environment.
Research and development expenses for 2001 decreased to $15.1 million from $16.8 million in 2000, or a decrease of 10%. Research and development expenses as a percentage of revenues were 16% in 2001 and 18% in 2000. The decrease was the result of a reduction in spending in response to our revised economic outlook, as well as synergies created by our merger with LJL BioSystems, offset by increased spending related to our acquisition of Cytion. We do not believe the decreased spending has materially impacted any development projects.
In July 2001, we acquired Cytion and accounted for the acquisition under the purchase method of accounting. We allocated a portion of the purchase price to purchased in-process technologies for $12.6 million. We wrote this off entirely in the third quarter of 2001. The write-off of purchased in-process technologies represented the fair value at the acquisition date, calculated utilizing the income approach, of the portion of certain in-process research and development projects that were not reliant upon core technology. The acquired in-process research and development had no alternative future use at the date of acquisition.
Selling, general and administrative expenses for 2001 increased to $33.4 million from $31.9 million in 2000, or an increase of 5%. The increased spending for the period is primarily the result of additional spending on marketing, sales and service related activities as we continued our efforts to expand worldwide market coverage and introduce new products. In 2001, we purchased our Japanese distributor, Nihon Molecular Devices. Selling, general and administrative expenses as a percentage of revenues were 36.2% in 2001 and 33.2% in 2000. The increase from 2000 to 2001 was a result of the costs at our Japanese subsidiary, as well as the decline in overall revenues.
Other income (net), consisting primarily of interest income, decreased by 23% in 2001 to $3.8 million from $4.9 million in 2000 due to lower average cash and investment balances and the significant decline in interest rates in 2001. Lower average cash balances result principally from a share repurchase plan under which we repurchased more than 1.5 million shares of our common stock and our acquisition of Cytion.
We recorded income tax provisions of $4.6 million in 2001 and $6.4 million in 2000. These provisions reflected a 38.5% effective tax rate. The effective tax rates for 2001 and 2000 are calculated on profit before tax excluding the write-off of acquired in-process research and development expenses in 2001 and merger expenses related to the LJL BioSystems merger in 2000, which are not deductible for income tax purposes.
LIQUIDITY AND CAPITAL RESOURCES
We had cash, cash equivalents and short-term investments of $53.8 million at December 31, 2002 compared to $67.3 million at December 31, 2001. In 2002, operating activities provided $15.3 million in cash.
Net cash used by investing activities was $24.8 million in 2002, which included $22.9 million spent on the acquisition (net of cash acquired) of UIC and $2.3 million of capital expenditures, partially offset by the proceeds from the net maturities of $835,000 of short-term investments.
Net cash used in financing activities was $3.7 million in 2002, due to $4.5 million spent to repurchase 220,000 shares of our common stock, offset by $798,000 of proceeds from the issuance of common stock for options exercised and employee stock purchases. The share repurchases all occurred in the first quarter of 2002, and accounted for approximately 1.4% of the shares outstanding as of December 31, 2002 and 2001. Additionally, approximately 1.3 million shares remain available for repurchase under the stock repurchase program approved by our Board of Directors in October 2001.
Our cash and investments policy emphasizes liquidity and preservation of principal over other portfolio considerations. We select investments that maximize interest income to the extent possible given these two constraints. We satisfy liquidity requirements by investing excess cash in securities with different maturities to match projected cash needs and limit concentration of credit risk by diversifying our investments among a variety of high credit-quality issuers. We believe that our existing cash and investment securities and anticipated cash flow from our operations will be sufficient to support our current operating plan for the foreseeable future.
Our facilities are leased under noncancelable operating leases. In addition, we have a contractual commitment for the purchase of certain resale products and manufacturing components with certain vendors ending in 2003. As of December 31, 2002, the following is a summary of our contractual obligations (in millions):
RECENT ACCOUNTING PRONOUNCEMENTS
In August 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” (FAS 144), which supersedes both Statement of Financial Accounting Standards No. 121, “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of” (FAS 121) and the accounting and reporting provisions of APB Opinion No. 30, “Reporting the Results of Operations - Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions” (Opinion 30), for the disposal of a segment of a business (as previously defined in that Opinion). FAS 144 retains the fundamental provisions in FAS 121 for recognizing and measuring impairment losses on long-lived assets held for use and long-lived assets to be disposed of by sale, while also resolving significant implementation issues associated with FAS 121. For example, FAS 144 provides guidance on how a long-lived asset that is used as part of a group should be evaluated for impairment, establishes criteria for when a long-lived asset is held for sale, and prescribes the accounting for a long-lived asset that will be disposed of other than by sale. FAS 144 retains the basic provisions of Opinion 30 on how to present discontinued operations in the income statement but broadens that presentation to include a component of an entity (rather than a segment of a business). Unlike FAS 121, an impairment assessment under FAS 144 will never result in a write-down of goodwill. Rather, goodwill is evaluated for impairment under FAS No. 142, “Goodwill and Other Intangible Assets.” The Company adopted FAS 144 in 2002. The adoption of SFAS 144 did not have a material impact on financial position or results of operations.
In June 2002, the FASB issued SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities.” SFAS No. 146 provides guidance related to accounting for costs associated with disposal activities covered by SFAS No. 144 or with exit or restructuring activities previously covered by EITF Issue No. 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring).” SFAS No. 146 supercedes EITF Issue No. 94-3 in its entirety. SFAS No. 146 requires that costs related to exiting an activity or to a restructuring not be recognized until the liability is incurred. The statement further establishes fair value as the objective for initial measurement of the liability and that employee benefit arrangements requiring future service beyond a “minimum retention period” be recognized over the future service period. SFAS No. 146 will be applied prospectively to exit or disposal activities that are initiated after December 31, 2002.
In November 2002, the FASB released FASB Interpretation No. 45 (“FIN 45”), “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others: an interpretation of FASB Statements No. 5, 57, and 107 and rescission of FASB Interpretation No. 34.” FIN 45 establishes new disclosure and liability-recognition requirements for direct and indirect debt guarantees with specified characteristics. The initial measurement and recognition requirements of FIN 45 are effective prospectively for guarantees issued or modified after December 31, 2002. However, the disclosure requirements are effective for interim and annual financial-statement periods ending after December 15, 2002. We have adopted the disclosure provisions and do not expect the full adoption of FIN 45 to have a material impact on our financial position or results of operations.
In December 2002, the FASB issued SFAS No. 148, “Accounting for Stock-Based Compensation - Transition and Disclosure - an amendment of SFAS No. 123” (“SFAS 148”). This statement amends SFAS 123 to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, SFAS 148 amends the disclosure requirements of SFAS 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. The transition and annual disclosure requirements of SFAS 148 are effective for the Company’s fiscal year 2002. The interim disclosure requirements are effective for the first quarter of fiscal year 2003. We continue to account for stock-based compensation using APB 25 and have not adopted the recognition provisions of SFAS 123, as amended by SFAS 148. We do not expect the adoption of SFAS 148 to have material impact on our financial position or results of operations. See note 8 of the Notes to Consolidated Financial Statements included in this report for disclosures required by SFAS 148.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to market risk, including changes in interest rates and foreign currency exchange rates. The primary objective of our investment activities is to preserve principal while at the same time maximizing the income we receive from our investments without significantly increasing risk. A discussion of our accounting policies for financial instruments and further disclosures relating to financial investments is included in the Summary of Significant Accounting Policies note in the Notes to Consolidated Financial Statements included in this report.
Our interest income is sensitive to changes in the general level of interest rates, primarily U.S. interest rates. In this regard, changes in U.S. interest rates affect the interest earned on our cash equivalents and short-term investments. We invest our excess cash primarily in demand deposits with United States banks and money market accounts and short-term securities. These securities, consisting of $3.4 million of commercial paper and $6.7 million of U.S. government agency securities, are carried at market value, which approximate cost, typically mature or are redeemable within 90 to 360 days, and bear minimal risk. We have not experienced any significant losses on the investments.
We are exposed to changes in foreign currency exchange rates primarily in the United Kingdom, France, Japan, Germany and Canada, where we sell direct in local currencies. All other foreign sales are denominated in U.S. dollars and bear no exchange rate risk. However, a strengthening of the U.S. dollar could make our products less competitive in overseas markets. Gains and losses resulting from foreign currency transactions have historically been immaterial. Translation gains and losses related to our foreign subsidiaries in the United Kingdom, Japan, Germany, Switzerland and Norway are accumulated as a separate component of stockholders’ equity. We do not currently engage in foreign currency hedging transactions, but may do so in the future.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The following consolidated financial statements of Molecular Devices and financial statement schedules are attached to this report as pages 35 through 56.
Financial Statements:
All other schedules are omitted because they are not applicable or the required information is shown in the consolidated financial statements or notes thereto.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
Not applicable.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information with respect to Directors and Executive Officers may be found in the sections entitled “Proposal 1 - Election of Directors,” and “Executive Officers of the Company,” respectively, appearing in the definitive Proxy Statement to be delivered to stockholders in connection with the solicitation of proxies for our Annual Meeting of Stockholders to be held on May 29, 2003 (the “Proxy Statement”). Such information is incorporated herein by reference.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this item is set forth in the Proxy Statement under the heading “Executive Compensation,” which information is incorporated herein by reference.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this item is set forth in the Proxy Statement under the heading “Security Ownership of Certain Beneficial Owners and Management,” which information is incorporated herein by reference.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this item is set forth in the Proxy Statement under the heading “Certain Transactions,” which information is incorporated herein by reference.
ITEM 14.
ITEM 14. CONTROLS AND PROCEDURES
(a) Evaluation of disclosure controls and procedures: The Company’s principal executive and financial officers reviewed and evaluated the Company’s disclosure controls and procedures (as defined in Exchange Act Rule 13a-14) as of a date within 90 days before the filing date of this Form 10-K. Based on that evaluation, the Company’s principal executive and financial officers concluded that the Company’s disclosure controls and procedures are effective in timely providing them with material information relating to the Company, as required to be disclosed in the reports the Company files under the Exchange Act.
(b) Changes in internal controls: There were no significant changes in the Company’s internal controls or other factors that could significantly affect those controls subsequent to the date of the Company’s evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
PART IV
ITEM 15.
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) The following documents are filed as a part of this report:
1. Financial Statements - See Index to Consolidated Financial Statements as Item 8 on page 27 of this report.
2. Financial Statement Schedule - See Index to Consolidated Financial Statements as Item 8 on page 27 of this report.
3. Exhibits
(d) Financial Statement Schedule
See Item 15(a) above.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report on Form 10-K to be signed on its behalf by the undersigned, thereunto duly authorized on March 27, 2003.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
CERTIFICATION
I, Joseph D. Keegan, Ph.D., certify that:
1. I have reviewed this annual report on Form 10-K of Molecular Devices Corporation;
2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;
3. Based on my knowledge, the consolidated financial statements, and other financial information included in this annual report, fairly present in all material respects the consolidated financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report;
4. The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared;
b) evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the “Evaluation Date”); and
c) presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;
5. The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent functions):
a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and
6. The registrant’s other certifying officers and I have indicated in this annual report whether there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
CERTIFICATION
I, Timothy A. Harkness, certify that:
1. I have reviewed this annual report on Form 10-K of Molecular Devices Corporation;
2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;
3. Based on my knowledge, the consolidated financial statements, and other financial information included in this annual report, fairly present in all material respects the consolidated financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report;
4. The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared;
b) evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the “Evaluation Date”); and
c) presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;
5. The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent functions):
a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and
6. The registrant’s other certifying officers and I have indicated in this annual report whether there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
The Board of Directors and Stockholders
Molecular Devices Corporation and Subsidiaries
We have audited the accompanying consolidated balance sheets of Molecular Devices Corporation and its subsidiaries as of December 31, 2002 and 2001, and the related consolidated statements of operations, stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2002. Our audits also included the financial statement schedule listed in the Index at Item 15(a). These financial statements and schedules are the responsibility of the company’s management. Our responsibility is to express an opinion on these financial statements and schedules based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Molecular Devices Corporation and its subsidiaries as of December 31, 2002 and 2001, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2002, in conformity with accounting principles generally accepted in the United States. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
As discussed in Note 1 to the consolidated financial statements, in 2002 the Company changed its method of accounting for goodwill and other intangible assets.
/s/ Ernst & Young LLP
Palo Alto, California
January 27, 2003
MOLECULAR DEVICES CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
See accompanying notes.
MOLECULAR DEVICES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
See accompanying notes.
MOLECULAR DEVICES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
See accompanying notes.
MOLECULAR DEVICES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
See accompanying notes.
MOLECULAR DEVICES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
Molecular Devices Corporation (“Molecular Devices”), a Delaware corporation, is principally involved in the design, development, manufacture, sale and service of bioanalytical measurement systems for life sciences and drug discovery applications. The principal customers for Molecular Devices’ products include leading pharmaceutical and biotechnology companies as well as medical centers, universities, government research laboratories and other institutions throughout the world.
The consolidated financial statements include the accounts of Molecular Devices and its wholly owned subsidiaries. All significant intercompany balances and transactions have been eliminated.
Molecular Devices acquired all of the outstanding stock of LJL BioSystems, Inc. (“LJL BioSystems”) in a tax-free, stock-for-stock transaction on August 30, 2000. LJL BioSystems was also engaged in the design, development, manufacture, sale and service of bioanalytical measurement systems for life sciences and drug discovery applications. Molecular Devices has accounted for the transaction as a pooling of interests, and accordingly, the consolidated financial statements and all financial information have been restated to reflect the combined operations, financial position and cash flows of both companies for periods prior to the acquisition. (See Note 5)
Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.
Cash Equivalents
Cash equivalents consist of highly liquid investments, principally money market accounts and marketable debt securities, with maturities of three months or less at the time of purchase.
Investments
Molecular Devices’ short-term investments consist of marketable securities classified as “available-for-sale,” with maturities of one year or less at the time of purchase. Available-for-sale securities are carried at fair market value, with unrealized gains and losses, net of tax, included in accumulated other comprehensive income (loss) in stockholders’ equity. Gains and losses on securities sold are based on the specific identification method and are included in the results of operations. Realized gains and losses have been historically immaterial and combined with interest income in the “other income, net” line of the consolidated statement of operations.
Fair values of marketable securities are based on quoted market values at December 31, 2002 and 2001. At December 31, 2002, the difference between the fair value and amortized cost of marketable securities was not significant. Short-term investments consisted of $6.7 million and $4.0 million in federal government securities and $3.4 million and $6.9 million of corporate securities maturing within twelve months or less as of December 31, 2002 and 2001, respectively.
Concentration of Credit Risk
Financial instruments, which potentially subject Molecular Devices to concentrations of credit risk, are primarily cash, cash equivalents, short-term investments and accounts receivable. Molecular Devices deposits cash with high credit quality financial institutions. Molecular Devices’ cash equivalents and marketable securities are primarily invested in federal government agency obligations and corporate securities that have various maturities during 2003.
Molecular Devices sells its products primarily to corporations, academic institutions, government entities and distributors within the drug discovery and life sciences research markets. Molecular Devices performs ongoing credit evaluations of its customers and generally does not require collateral. Molecular Devices maintains reserves for potential credit losses and such losses have been historically within management’s expectations.
Inventories
Inventories are stated on a first-in, first-out basis at the lower of cost or market. We write down our inventory for estimated obsolescence or unmarketable inventory equal to the difference between the cost of inventory and the estimated market value based upon assumptions about future demand and market conditions. If actual market conditions are less favorable than those projected by management, additional inventory write downs may be required.
Capitalized Software Costs
Software development costs incurred subsequent to the establishment of technological feasibility are capitalized in accordance with SFAS No. 86; “Accounting for the Costs of Computer Software to Be Sold, Leased, or Otherwise Marketed.” No amounts have been capitalized to date as costs incurred after the establishment of technological feasibility have not been material.
Equipment and Leasehold Improvements
Equipment is recorded at cost and depreciated using the straight-line method over the estimated useful lives of the assets (ranging from three to five years). Leasehold improvements are amortized over the remaining term of the lease, or the life of the asset, whichever is shorter. Maintenance and repairs are expensed as incurred. Depreciation expense for 2002, 2001 and 2000 was $3.2 million, $2.6 million, and $2.1 million, respectively.
Goodwill
Goodwill represents the difference between the purchase price and the fair value of net assets when accounted for by the purchase method of accounting. Prior to 2002, goodwill was amortized using the straight-line method over 10 to 15 years. In January 2002, we adopted FAS 142 and, accordingly, ceased amortizing goodwill. In conjunction with the adoption of FAS 142, we performed an initial impairment test of goodwill and found no impairment. The gross amount of goodwill was $27.0 million and $8.2 million at December 31, 2002 and 2001, respectively.
The following table presents the impact of adopting of FAS 142 had the standard been in effect for the years ended December 31, 2001 and 2000 (in thousands, except per share data):
Other Assets
Other assets include patents, developed technology, license fees, tradename and strategic investments in privately held companies that have been accounted for under the cost method. Patents, developed technology and license fees are amortized over their expected useful life of ten years. Tradename is assessed to have an indefinite life and therefore is not subject to amortization.
Impairment of Long-Lived Assets
Molecular Devices evaluates long-lived assets, including goodwill and investments accounted for under the cost method, for impairment whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable based on expected undiscounted cash flows attributable to that asset. The amount of any impairment is measured as the difference between the carrying value and the fair value of the impaired asset. For long-lived assets, fair value would be measured based on discounted expected cash flows. There were no long-lived assets that were considered to be impaired during any period presented.
Equity Investments
We invest in equity instruments of privately held companies for business and strategic purposes. These investments are included in other long-term assets and are accounted for under the cost method when ownership is less than 20 percent of voting securities and we do not have the ability to exercise significant influence over operations. When our ownership exceeds 20 percent of voting securities but is less than 50 percent, or we have the ability to exercise significant influence, the investment is accounted for under the equity method. Under the equity method, the investee’s proportionate share of net income or loss and amortization of the investee’s net excess investment over its equity in net assets is included in our net income or loss. As of December 31, 2002, we did not hold any investments accounted for under the equity method. We regularly review the assumptions underlying the operating performance and cash flow forecasts in assessing the fair values. We monitor the preceding factors to identify events or circumstances which would cause us to test for other than temporary impairment and revise our assumptions for the estimated recovery of equity investments. There were no investments considered impaired during any of the periods presented.
Income Taxes
Income taxes are accounted for under the liability method whereby deferred tax asset or liability account balances are calculated at the balance sheet date using current tax laws and rates in effect for the year in which the differences are expected to affect taxable income. Valuation allowances are established when necessary to reduce deferred tax assets to the amounts expected to be realized in the future.
Foreign Currency Translation
Molecular Devices translates the assets and liabilities of its foreign subsidiaries into dollars at the rates of exchange in effect at the end of the period and translates revenues and expenses using rates in effect during the period. Gains and losses from these translations are accumulated as a separate component of stockholders’ equity. Gains and losses resulting from foreign currency transactions are immaterial and are included in the statements of operations.
Revenue Recognition and Warranty
We recognize product revenue at the time of shipment and transfer of title when collectibility is reasonably assured. Software revenue is recognized at the time of sale and in accordance with AICPA Statement of Position No. 97-2, “Software Revenue Recognition” (“SOP 97-2”). There are no significant customer acceptance requirements or post-shipment obligations on the part of Molecular Devices for product or software sales.
Future warranty costs are estimated and provided for at the time of sale. Freight costs for revenue-generating shipments are charged to costs of goods sold. Amounts received prior to completion of the earnings process are recorded as customer deposits or deferred revenue, as appropriate. Service contract revenue is deferred at the time of sale and recognized ratably over the period of performance.
Advertising Costs
Molecular Devices expenses the cost of advertising as incurred. Such costs approximated $1.1 million, $1.2 million and $1.4 million for 2002, 2001 and 2000, respectively.
Recent Accounting Pronouncements
In August 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” (FAS 144), which supersedes both Statement of Financial Accounting Standards No. 121, “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of” (FAS 121) and the accounting and reporting provisions of APB Opinion No. 30, “Reporting the Results of Operations-Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions” (Opinion 30), for the disposal of a segment of a business (as previously defined in that Opinion). FAS 144 retains the fundamental provisions in FAS 121 for recognizing and measuring impairment losses on long-lived assets held for use and long-lived assets to be disposed of by sale, while also resolving significant implementation issues associated with FAS 121. For example, FAS 144 provides guidance on how a long-lived asset that is used as part of a group should be evaluated for impairment, establishes criteria for when a long-lived asset is held for sale, and prescribes the accounting for a long-lived asset that will be disposed of other than by sale. FAS 144 retains the basic provisions of Opinion 30 on how to present discontinued operations in the income statement but broadens that presentation to include a component of an entity (rather than a segment of a business). Unlike FAS 121, an impairment assessment under FAS 144 will never result in a write-down of goodwill. Rather, goodwill is evaluated for impairment under FAS No. 142, “Goodwill and Other Intangible Assets.” The Company adopted FAS 144 in 2002. The adoption of SFAS 144 did not have a material impact on financial position or results of operations.
In June 2002, the FASB issued SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities.” SFAS No. 146 provides guidance related to accounting for costs associated with disposal activities covered by SFAS No. 144 or with exit or restructuring activities previously covered by EITF Issue No. 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring).” SFAS No. 146 supercedes EITF Issue No. 94-3 in its entirety. SFAS No. 146 requires that costs related to exiting an activity or to a restructuring not be recognized until the liability is incurred. The statement further establishes fair value as the objective for initial measurement of the liability and that employee benefit arrangements requiring future service beyond a “minimum retention period” be recognized over the future service period. SFAS No. 146 will be applied prospectively to exit or disposal activities that are initiated after December 31, 2002.
In November 2002, the FASB released FASB Interpretation No. 45 (“FIN 45”), “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others.” FIN 45 establishes new disclosure and liability-recognition requirements for direct and indirect debt guarantees with specified characteristics. The initial measurement and recognition requirements of FIN 45 are effective prospectively for guarantees issued or modified after December 31, 2002. However, the disclosure requirements are effective for interim and annual financial-statement periods ending after December 15, 2002. We have adopted the disclosure provisions and do not expect the full adoption of FIN 45 to have a material impact on our financial position or results of operations.
In December 2002, the FASB issued SFAS No. 148, “Accounting for Stock-Based Compensation-Transition and Disclosure-an amendment of SFAS No. 123” (“SFAS 148”). This statement amends SFAS 123 to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, SFAS 148 amends the disclosure requirements of SFAS 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. The transition and annual disclosure requirements of SFAS 148 are effective for the Company’s fiscal year 2002. The interim disclosure requirements are effective for the first quarter of fiscal year 2003. We continue to account for stock-based compensation using APB 25 and have not adopted the recognition provisions of SFAS 123, as amended by SFAS 148. We do not expect the adoption of SFAS 148 to have material impact on our financial position or results of operations. (See Note 8)
Per Share Data
Basic net income per share is computed based on the weighted average number of shares of Molecular Devices’ common stock outstanding. Dilutive net income per share is computed based on the weighted average number of shares of Molecular Devices’ common stock and other dilutive securities. Dilutive securities consist of the incremental common shares issuable upon the exercise of stock options and warrants (using the treasury stock method).
Computation of diluted earnings (loss) per share is as follows (in thousands, except per share amounts):
Options to purchase 2,115,476 shares of common stock at a weighted average per share exercise price of $30.84 were outstanding during 2002, but were not included in the computation of diluted earnings per share for that years as the options’ weighted-average exercise price was greater than the average market price of the common shares and, therefore, the effect would have been anti-dilutive. In 2001 and 2000, the total number of shares excluded from the calculations of diluted net loss per share was 307,000 and 1,163,000, respectively. Such securities, had they been dilutive, would have been included in the computations of diluted net loss per share using the treasury stock method.
Stock Based Compensation
As permitted by Statement of Financial Accounting Standards No. 123 (SFAS 123), “Accounting for Stock-Based Compensation,” Molecular Devices applies the intrinsic value method of accounting as described in APB Opinion 25 and related interpretations in accounting for its stock option plans and, accordingly, recognizes no compensation expense for stock option grants with an exercise price equal to the fair market value of the shares at the date of grant. If Molecular Devices and LJL BioSystems had elected to recognize compensation cost based on the fair value of the options granted at grant date and shares issued under stock purchase plans as prescribed by SFAS 123, net income (loss) and earnings (loss) per share would have been reduced to the pro forma amounts indicated in the table below (in thousands, except per share amounts):
The pro forma net income and net income per share disclosed above is not likely to be representative of the effects on net income and net income per share on a pro forma basis in future years, as subsequent years may include additional grants and years of vesting.
The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model with the following assumptions:
The weighted average fair value of options granted during the year ended December 31, 2002, 2001 and 2000 was $14.06, $18.05, and $38.37, respectively.
Comprehensive Income (Loss)
Comprehensive income (loss) is comprised of net income (loss) and other items of comprehensive income (loss). Other comprehensive income (loss) includes cumulative translation adjustments from the translation of foreign subsidiaries’ financial statements, and unrealized gains and losses on available-for-sale securities, if material.
Change in Presentation
Certain prior year amounts have been reclassified to conform to the current year presentation.
NOTE 2. BALANCE SHEET AMOUNTS
NOTE 3. LONG-TERM DEBT
In February 1998, LJL BioSystems entered into an equipment financing agreement that provided a $1.3 million line of credit. The initial term of this agreement was through February 16, 1999. Amounts borrowed under this agreement incurred interest at 11.08% to 12.16%. The agreement was extended twice with the latest extension expiring on December 31, 1999. In March 2001, Molecular Devices paid $571,000 in principal and interest to terminate this agreement. As of December 31, 2002, Molecular Devices had no debt obligations.
NOTE 4. COMMITMENTS
Molecular Devices’ facilities are leased under noncancelable operating leases. The leases generally require payment of taxes, insurance and maintenance costs on leased facilities. Minimum annual rental commitments under these noncancelable operating leases for the years ended 2003, 2004, 2005, 2006, 2007 and thereafter, are approximately $5.2 million, $5.3 million, $5.3 million, $5.4 million, and $5.8 million, respectively.
Net rental expense under operating leases related to Molecular Devices’ facilities was approximately $5.0 million, $2.8 million, and $2.5 million, respectively, for each of the three years ended December 31, 2002, 2001 and 2000.
Molecular Devices has a contractual commitment for the purchase of certain resale products and manufacturing components with vendors, ending in 2003. The minimum purchase commitment is based on a set percentage of our forecasted production, and for 2003, at current prices, is approximately $1.4 million. These purchase commitments are not expected to result in a loss.
At the time of sale, the Company records an estimate for warranty costs that may be incurred under product warranties. Warranty expense and activity are estimated based on historical experience. The warranty accrual is evaluated periodically and adjusted for changes in experience. Changes in the Company’s warranty liability during 2002 were as follows (in thousands):
NOTE 5. ACQUISITIONS AND INVESTMENTS
Universal Imaging Corporation
On June 1, 2002, Molecular Devices acquired Universal Imaging Corporation (“UIC”) pursuant to a Stock Purchase Agreement, in exchange for $22 million in cash. In addition, Molecular Devices incurred $1.2 million of acquisition costs. As a result of the acquisition, UIC became a wholly-owned subsidiary of Molecular Devices. The results of operations for UIC were included in Molecular Devices’ results of operations beginning June 1, 2002. The acquisition expands Molecular Devices’ portfolio of novel tools for cell analysis to include MetaMorph, cellular imaging software widely used in life sciences research, and the Discovery-1 screening system for drug discovery. The excess of the purchase price over the identified net assets of UIC has been allocated to goodwill, tradename and developed technology as follows (in thousands):
The condensed balance sheet of UIC as of May 31, 2002 was as follows (in thousands):
Cytion S.A.
On July 19, 2001, Molecular Devices acquired all of the capital stock of Cytion S.A. (“Cytion”) in exchange for $7.5 million in cash and 400,000 shares of Molecular Devices’ common stock valued at $7.4 million, based on the five-day average closing stock price as of July 10, 2001 announcement date. In addition, Molecular Devices assumed $581,000 of liabilities and incurred $900,000 of acquisition costs both of which were offset by deferred taxes of $549,000 generated by the transaction. Cytion was a Swiss developer of automated patch clamping systems based in Switzerland. The excess of the purchase price over the identified net assets
of Cytion has been allocated to goodwill, acquired in-process research and development and patents. The following is the allocation of the purchase price (in thousands):
The condensed balance sheet of Cytion as of July 19, 2001 was as follows (in thousands):
A one-time charge of $12.6 million for purchased in-process research and development expenses was recorded upon closing of the acquisition in the third quarter of 2001. The amounts allocated to in-process research and development were expensed upon acquisition because technological feasibility had not been established and no future alternative uses existed. The value of the projects was determined by estimating the costs to develop the in-process technology into commercially feasible products and estimating the present value of the net cash flows which management believed would result from the products.
The results of operations for Cytion are included in Molecular Devices’ results of operations beginning July 20, 2001.
Nihon Molecular Devices
On January 5, 2001, Molecular Devices acquired all of the capital stock of Nihon Molecular Devices (NMD), its Japanese distributor, in exchange for $3.2 million in cash. The acquisition was accounted for as a purchase. As a result, NMD became a wholly owned subsidiary of Molecular Devices. The results of operations for NMD are included in Molecular Devices’ results of operations beginning January 5, 2001. JCR Pharmaceuticals Co., Ltd. and Molecular Devices jointly established NMD in 1995 to import and sell Molecular Devices’ products in Japan. The excess of the purchase price over the identified net tangible assets of NMD ($2.1 million) has been allocated to goodwill.
LJL BioSystems
On August 30, 2000, Molecular Devices acquired all of LJL BioSystems’ outstanding stock in a tax-free, stock-for-stock transaction. LJL BioSystems’ stockholders received 0.30 of a share of Molecular Devices’ common stock for each share of LJL BioSystems’ common stock. Molecular Devices issued approximately 4.5 million shares of common stock to acquire the outstanding LJL BioSystems shares on the closing date. In addition, Molecular Devices assumed outstanding options to acquire LJL BioSystems shares, which were converted into options to acquire approximately 557,000 shares of Molecular Devices’ common stock. Molecular Devices has accounted for the transaction as a pooling of interests, and, accordingly, the consolidated financial statements and all financial information have been restated to reflect the combined operations, financial position and cash flows of both companies. During the quarter ended September 30, 2000, Molecular Devices incurred approximately $15.2 million in merger related expenses, including transition costs, investment banking, legal and other advisory services, which were charged to operations as incurred.
Pro Forma Results
The unaudited pro forma results of operations for the years ended December 31, 2002, 2001, and 2000 for Molecular Devices are set forth below. This presentation assumes that the UIC acquisition had been consummated January 1, 2001 and that the Cytion and NMD acquisitions had been consummated on January 1, 2000. In accordance with FAS 141 and SEC regulations, this presentation excludes the charges for acquired in-process research and development, and the merger expenses associated with the LJL BioSystems pooling (in thousands, except per share amounts):
The unaudited pro forma information does not purport to be indicative of the results that actually would have occurred had the UIC acquisition been consummated on January 1, 2001, and had the Cytion and NMD acquisitions occurred on January 1, 2000, or of results that may occur in the future.
Upstate Group, Inc.
In December 2000, Molecular Devices acquired a minority equity interest in Upstate Group, Inc, (“Upstate”), a private company, for $10 million in cash. The companies also announced the launch of a ten-year strategic partnership to provide new consumable reagent kits to the high-throughput screening market. Under the partnership agreement, Molecular Devices is the exclusive distributor of all kits co-developed by Upstate and Molecular Devices, which will be optimized to perform on Molecular Devices’ drug discovery instrumentation platforms. Upstate is a leading supplier of reagents to the drug discovery and life sciences research markets, with particular strength in “cell-signaling” reagents such as kinases. Molecular Devices accounts for its investment in Upstate using the cost method because Molecular Devices does not have the ability to exercise significant influence over Upstate’s operating and financial policies.
NOTE 6. GOODWILL AND PURCHASED INTANGIBLE ASSETS
In 2002, $18.8 million of goodwill was acquired, bringing the December 31, 2002 balance to $26.0 million.
Purchased intangible assets not subject to amortization are comprised of tradename, valued at $707,000 and $0 at December 31, 2002 and 2001, respectively.
Purchased intangible assets subject to amortization consisted of the following (in thousands):
The estimated future amortization expense of purchased intangible assets is as follows (in thousands):
NOTE 7. STOCKHOLDERS’ EQUITY
Treasury Stock
In the first quarter of 2002, Molecular Devices completed the repurchase of 220,000 shares of its common stock. In the third and fourth quarters of 2001, Molecular Devices completed the repurchase of 1,510,000 shares of its common stock. These repurchases occurred at various times throughout the periods subsequent to approval of two repurchase programs by the Molecular Devices Board of Directors in July 2001 and October 2001, each allowing for the repurchase of up to 1.5 million shares. In October 2001, 1,500,000 shares were retired. As of December 31, 2002, 242,298 shares remained on our balance sheet as treasury stock, at cost.
NOTE 8. EQUITY INCENTIVE PLANS
Under Molecular Devices’ 1995 Stock Option Plan (“1995 Plan”), a total of 3,250,000 shares of Molecular Devices’ common stock have been reserved for issuance as either incentive or nonqualified stock options to officers, directors, employees and consultants of Molecular Devices. Option grants expire in ten years and generally become exercisable in increments over a period of four to five years from the date of grant. Options may be granted with different vesting terms from time to time.
In September 1995, Molecular Devices established the 1995 Non-Employee Directors’ Stock Option Plan (the “Directors’ Plan”). Under the Directors’ Plan, Molecular Devices is authorized to grant nonqualified stock options to purchase up to 347,500 shares of common stock at the fair market value of the common shares at the date of grant. Options granted under the Directors’ Plan vest and become exercisable in three equal annual installments commencing one year from the date of the grant.
In July 2001, Molecular Devices established the 2001 Stock Option Plan (the “2001 Plan”). Under the 2001 Plan, a total of 100,000 shares of Molecular Devices’ common stock have been reserved for issuance to employees of Molecular Devices or its affiliates who are working or residing outside of the United States and are not officers or directors of Molecular Devices. Option grants expire in twelve years and generally become exercisable in increments over a period of four to five years from the date of grant. Options may be granted with different vesting terms from time to time.
LJL BioSystems’ stock plans included the 1994 Equity Incentive Plan (the “1994 Plan”), the 1997 Stock Plan (the “1997 Plan”), and the 1998 Directors’ Plan (the “Directors’ Plan”). Upon closing of the merger, Molecular Devices assumed all outstanding options under these plans, which were converted into options to purchase Molecular Devices common stock. Molecular Devices also assumed the shares available for grant under the 1994 and 1997 Plans to LJL BioSystems’ employees. Options granted under the 1994 Plan and 1997 Plan generally vest over a five-year period.
In connection with an increase of 1,000,000 shares to the Molecular Devices 1995 Plan on May 24, 2001, an amendment to LJL BioSystems’ stock plans was approved to prohibit future grants under the plans and to decrease the aggregate number of shares authorized for issuance to the number of shares subject to outstanding options under the plans. In 2002 and 2001, the aggregate number of shares authorized under the LJL BioSystems’ plans was decreased by 634,521 and 610,391, respectively.
The following table summarizes the activity under all of the Molecular Devices’ plans and LJL BioSystems’ plans on a combined basis:
The following table is a summary of Molecular Devices’ outstanding and exercisable options at December 31, 2002:
There were 684,296, and 450,161 options exercisable under the various plans at December 31, 2001 and 2000, respectively.
Deferred Compensation
Deferred compensation is recorded when the exercise price of an option is less than the deemed fair value of the underlying stock on the date of grant. For options granted in September 1995, Molecular Devices recognized $578,000 as deferred compensation. The deferred compensation expense was being amortized ratably over the vesting period of the options, generally 3 - 5 years. The amortization of this deferred compensation was completed during 2000.
For options granted in 1997, LJL BioSystems recognized $772,000 as deferred compensation. On March 10, 1998, LJL BioSystems granted an option to an employee to purchase shares of common stock at a price 15% below fair market value at the date of the grant. Deferred compensation of $33,600 was recorded based on the estimated fair value of the options granted. The amortization of this deferred compensation was completed during 2000.
During 1998, Molecular Devices granted 42,500 shares of restricted stock to certain employees. These restricted shares vested in quarterly increments from the date of grant over two years. Molecular Devices recognized $782,000 of deferred compensation for the total value of these shares on their respective dates of grant. The deferred compensation expense was recognized ratably over the two-year vesting period. The amortization of this deferred compensation was completed during 2000.
During 2000, Molecular Devices granted 2,500 shares of restricted stock to an employee. These restricted shares vest in quarterly increments from the date of grant over two years. Molecular Devices recognized $223,000 of deferred compensation for the total value of these shares on the date of grant. The deferred compensation expense is being recognized ratably over the two-year vesting period.
Employee Stock Purchase Plans
Under the Molecular Devices’ Employee Stock Purchase Plan (the “Molecular Devices Purchase Plan”), 400,000 shares of common stock have been authorized for issuance. Shares may be purchased under the Molecular Devices Purchase Plan at 85% of the lesser of the fair market value of the common stock on the grant or the purchase date. As of December 31, 2002, 216,097 shares remained available for purchase.
401(k) Plan
Molecular Devices’ 401(k) Plan (“Plan”) covers substantially all of its U.S. based employees. Under the Plan, as amended in February 2001, eligible employees may contribute up to 25% of their eligible compensation, subject to certain Internal Revenue Service restrictions. Molecular Devices began matching a portion of employee contributions in 1997, up to a maximum of 3% or $2,500, whichever is less, of each employee’s eligible compensation. The match, which is subject to board approval based on a number of factors, is effective December 31 of each year and vests over a period of four years of service. For the years ended
December 31, 2002, 2001 and 2000, Molecular Devices recognized as expense and provided approximately $388,000, $406,000 and $270,000, respectively, under the Plan.
LJL BioSystems maintained the tax deferred LJL BioSystems, Inc. 401(k) Plan (“LJL Plan”), that covered all employees over twenty-one years of age whom became eligible to enroll the first day of the calendar month following their employment date. Employees were allowed to contribute up to 15% of their compensation to the 401(k) Plan on a pre-tax basis, subject to the maximum amount allowable under IRS regulations. Effective November 1, 2001, the LJL Plan was discontinued and employee account balances were merged into the Plan.
NOTE 9. INCOME TAXES
The components of the provisions (benefits) for income taxes consist of the following (in thousands):
The provision (benefit) for income taxes differ from the amounts computed by applying the statutory federal income tax rate to income (loss) before income taxes. The source and tax effects of the differences are as follows:
Foreign pretax income was $3.9 million, $1.3 million, and $308,000 in 2002, 2001 and 2000, respectively.
Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting and the amount used for income tax purposes.
The net valuation allowance decreased by $970,000 in 2002 and increased by $2.2 million in 2001. Approximately, $2.9 million of the valuation allowance relates to stock option deductions that will be credited to equity when realized.
As of December 31, 2002, Molecular Devices had net operating loss carryforwards for federal income tax purposes of approximately $9.9 million, which expire in the years 2012 through 2019 and federal research and development tax credits of approximately $1.8 million, which expire in the years 2012 through 2022. Molecular Devices had net operating loss carryforwards for state income tax purposes of approximately $8.0 million which expire in the years 2004 through 2010 and research and development credits of approximately $700,000 for state income tax purposes which carryforward indefinitely. Utilization of the net operating loss carryforwards may be subject to substantial annual limitation due to the ownership change limitations provided by the Internal Revenue Code and similar state provisions. Such an annual limitation could result in the expiration of the net operating loss carryforwards before utilization.
NOTE 10. INDUSTRY SEGMENT, GEOGRAPHIC AND CUSTOMER INFORMATION
Molecular Devices operates in a single industry segment, and the chief operating decision maker views its operations as follows: the design, development, manufacture, sale and service of bioanalytical measurement systems for drug discovery and life sciences research applications.
Foreign subsidiaries’ operations consist of research and development, sales, service, manufacturing and distribution. Summarized data for Molecular Devices’ domestic and international operations was as follows (in thousands):
(1)
Includes the write-off of acquired in-process research and development and merger and acquisition related expenses
Molecular Devices products are broken into two product families. The Drug Discovery family includes the IonWorks HT, FLIPR, CLIPR, Cytosensor, Analyst, and Discovery-1 product lines, and related consumables. The Life Sciences Research family includes the Maxline, Threshold, MetaMorph and Skatron product lines. Consolidated revenue from Molecular Devices’ product families was as follows (in thousands):
Sources of consolidated revenue from significant geographic regions were as follows (in thousands):
NOTE 11. LEGAL PROCEEDING
On April 16, 2002, Caliper Technologies Corporation (“Caliper”) filed a patent infringement lawsuit against Molecular Devices alleging that our IMAP assay kits infringe U.S. patents held by Caliper. We believe that none of our products infringe any claim of the Caliper patents. On May 8, 2002, we filed an answer and counter-claim to Caliper’s lawsuit denying all allegations of infringement, setting forth certain affirmative defenses and making a counter-claim for declaratory relief that, among other things, we are not infringing and have not infringed any valid and enforceable claim of the Caliper patent and that the Caliper patent is invalid. Caliper has also made a motion for preliminary injunction, expected to be decided in the second or third quarter of calendar 2003. We intend to oppose vigorously this motion. If Caliper were to prevail in this motion, we may be prohibited from selling IMAP assay kits until completion of the litigation, which may take several additional months. If we do not prevail in litigation, we may be prohibited permanently from selling IMAP assay kits.
NOTE 12. COMPARATIVE QUARTERLY FINANCIAL DATA (UNAUDITED)
Summarized quarterly financial data is as follows:
(1)
Includes a charge of approximately $12.6 million for the write-off of acquired in-process research and development related to the acquisition of Cytion S.A.
(2)
Includes a charge of approximately $15.2 million of direct costs related to the LJL BioSystems merger.
NOTE 13. RELATED PARTY TRANSACTION
Molecular Devices paid $700,000 to Essen Instruments (“Essen”), primarily for inventory, in 2002. There were no similar transactions in 2001 and 2000. Molecular Devices’ Chief Financial Officer is a member of the Board of Directors of Essen and Molecular Devices is also a minority investor in Essen.
MOLECULAR DEVICES CORPORATION AND SUBSIDIARIES
SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS
(IN THOUSANDS)
EXHIBIT INDEX