Item 1. Business
Forward-looking Statements
This Annual Report on Form 10-K contains forward-looking statements that involve risks and uncertainties, including: our ability to obtain regulatory approvals and complete clinical and pre-market activities needed to launch new products and gain market acceptance of any new products; the impact of competition, including products competitive with our Triage® BNP Tests, from companies with greater capital and resources; our ability to effectively promote our products, whether directly or through distributors, including our ability to effectively promote our products in the physician office market; the extent to which our products and products under development are successfully developed and gain market acceptance; our ability to successfully expand our business through direct sales in certain European countries; the outcome of ongoing litigation between us and Roche Diagnostics Corporation and its affiliates; potential contract disputes or patent conflicts; manufacturing inefficiencies, backlog, delays or capacity constraints; the timing of significant orders or the impact of seasonality; regulatory changes, uncertainties or delays; product recalls; dependence on third-party manufacturers and suppliers; changing market conditions and the other risks and uncertainties described under Item 1A, “Risk Factors” and elsewhere in this Annual Report on Form 10-K. Actual results may differ materially from those projected. These forward-looking statements represent our judgment as of the date of the filing of this Annual Report on Form 10-K. We disclaim any intent or obligation to update these forward-looking statements.
Overview
Founded in 1988, Biosite® Incorporated is a medical diagnostic company utilizing a biotechnology approach to create a broad and diverse portfolio of market-leading diagnostic tests. Our business model is designed to be fully integrated from discovery to customer, with a focus on patenting novel protein biomarker panels, manufacturing complex products at appreciable profit margins, employing strategic clinical studies and trials to validate our products’ diagnostic utility, and an emphasis on education when marketing our pioneering diagnostics directly to healthcare providers.
Our product development strategy is to use our expertise and capabilities in high-throughput screening and data mining techniques to validate novel blood protein biomarkers, which when measured individually or in combination with other biomarkers via our proprietary test system, we believe provide better diagnostic information than tests currently available on the market. To accomplish this we first attempt to discover or license the diagnostic rights to novel proteins on an exclusive or semi-excusive basis. We then use monoclonal antibody technology to validate blood-borne protein disease biomarkers and panels of biomarkers that can serve as the basis for new proprietary diagnostic products intended to potentially improve the quality and cost-effectiveness of medical care. We then seek to commercialize our products using our, portable, rapid testing platform, which employs a variety of technologies relating to phage display antibody expression, microfluidics sample processing, and fluorescence energy transfer signaling, for quick, accurate and simultaneous measurement of one or more blood protein biomarker concentrations.
To date our marketing and sales efforts have primarily targeted hospitals, and particularly emergency departments, or EDs, where rapid, accurate diagnosis is important for high quality, cost-effective healthcare. Recently, we also began to market our diagnostic products to physician offices. We believe that in the future our existing or potential products could be used in a variety of healthcare sites for diagnosis, and possibly for pre-emptive detection or monitoring of chronic diseases, such as heart failure.
We have been profitable since the third quarter of 1999 and intend to continue building our business with funds generated from our operations. During 2005 our revenues were $287.7 million, our pre-tax operating margin was 29% and our net income was $54.0 million. Also during 2005, our cash and marketable securities increased 83% from $72.4 million at December 31, 2004 to $132.4 million at the end of 2005. Cash flow activity during this period included cash generated from operating activities of $91.5 million and an additional $33.4 million investment in our corporate complex.
Discovery
The recent upsurge in the understanding and utility of human biomarkers or analytes has been the catalyst for our discovery efforts. These biomarkers include proteins, peptides, enzymes, hormones and other blood-borne molecules that are the biologically active components of normal and diseased physiology. In most diseases, tissue damage and biological response mechanisms change the blood levels of analytes enabling them to be used as diagnostic “disease biomarkers.” Most disease biomarkers currently in clinical use signal disease when their concentrations rise above a defined normal cut-off point. For example, above-normal concentrations of the following markers result in a positive disease diagnosis:
Given the low returns to date, biomarker discovery has historically been viewed as an expensive, time-consuming and risky undertaking for commercial enterprises. As a result, large diagnostic companies generally look to academic researchers for new biomarker validation or rely on clinically proven biomarkers in developing testing menus.
Over the past decade or so, one of the most exciting areas for medical research has been the field of genomics, which is the study of the human genome. This research, aimed at understanding the genetic bases of diseases, has spawned the field of “molecular diagnostics.” Many medical diagnostic companies are pursuing opportunities in the area of molecular diagnostics with the goal of using measurements of genetic differences among patients as a way to diagnose or predict human diseases.
While most commonly associated with genes, the ultimate function of the human genome is to produce proteins, and the multitude of proteins produced by the human genome is termed the human proteome. We focus on mining the human proteome for diagnostic biomarkers for which we can obtain exclusive or semi-exclusive rights to develop, market and sell in major commercial markets. We are discovering useful correlations between blood-borne proteins and the diagnostic questions most frequently and urgently asked by caregivers. As a near term commercial target, we believe the proteome offers important clinical advantages over the genome. First, disruptions in blood levels of proteins reflect not only genetic differences, but also disease-induced abnormalities not programmed into the human genome. Second, antibody-based measurements of blood proteins are faster, simpler and cheaper to report in the clinical setting than are commercial technologies for detecting gene variations. Consequently, while we believe molecular diagnostics will play an important role in disease prediction and detection, we think the near-term commercial potential of blood protein measurement is more attractive.
We have developed our own internal program, Biosite Discovery, focused on identifying novel proteins or combinations of proteins that function as disease biomarkers and have high diagnostic utility. Key to Biosite Discovery is our proprietary Omniclonal® phage display antibody development technology, which enables the rapid and cost-efficient development of immunoassays that can be used to evaluate up to several hundred potential disease biomarkers each year.
Our Biosite Discovery program encompasses a three-step process:
1. Through a variety of collaborations, we collect patient blood samples related to disease states in which we are interested. These samples include disease-specific samples, samples from patients with conditions that mimic the targeted disease, as well as samples from a normal, disease-free population. We seek to establish comprehensive sample banks, accumulating thousands of samples. Sample collection can be time intensive and subject to fluctuations in timing, and, as a result, our ability to establish relationships and collaborations with reliable sources of samples is essential.
2. Once samples are available, we use them for testing as we conduct “marker mining” to find biomarkers with high diagnostic utility for a targeted disease. To do this, we use immunoassays, which require tightly binding, or high-affinity, antibodies, to test potential markers against our samples bank. Our ability to efficiently develop large quantities of high-affinity antibodies for these research immunoassays allows us to screen large numbers of markers in our efforts to identify those most suitable for a diagnostic product.
3. When data for potential biomarkers is available, we use a proprietary software system to define the priority of the biomarkers in terms of their importance in diagnosing the targeted disease. This enables us to determine the optimal markers for a diagnostic product. Once this decision is made, the product proceeds to development.
We believe that our Biosite Discovery model is significantly different from discovery methods employed by other companies in the diagnostics industry and we view this as a competitive advantage. Some of our differentiating qualities include:
Rapid Antibody Development: We believe we enjoy a unique position in the area of phage display antibody development. We believe that our internal antibody development capabilities allow rapid identification and development of antibodies with optimal specificity, affinity and stability characteristics. Using our proprietary Omniclonal phage display antibody development technology, we can quickly create high quality antibody libraries in weeks. Following evaluation for clinical relevance, the useful antibodies can be economically produced in large reproducible quantities.
High Throughput Capacity: Because we utilize a highly efficient antibody technology and have automated the most significant liquid handling steps, we believe we currently have a high throughput capacity to develop high affinity antibodies. With this high throughput capacity, we are able to generate antibodies to a substantial number of targets in a cost-efficient manner. This permits us to take on significant discovery endeavors to identify, evaluate and develop novel diagnostics.
Target Validation Approach: We focus on serious health problems that are in need of improved diagnosis, prognosis and monitoring. To gain access to large numbers of protein targets and clinically documented samples that can be studied for association with selected diseases, we collaborate with commercial companies and clinical institutions. We believe we have expertise in establishing sample banks that can be used for validation purposes. Combined with our ability to efficiently develop assays used to study potential biomarkers, this enables us to study high numbers of proteins thereby increasing the possibility of validating high-potential biomarkers. For instance, in developing our potential sepsis test, we have studied more than 100 proteins and peptides, as well as numerous combinations of these using hundreds of patient samples. We believe that most other diagnostic companies would have to outsource this type of work and rely on slower and more costly methods in order to replicate our processes.
Development
We have a track record of successfully moving novel diagnostics, including the Triage® BNP Test, through the development pipeline. We commercialized the first portable fluorescence-based quantitative immunoassay platform, the Triage MeterPlus. We also developed the first rapid, quantitative point-of-care immunoassays to receive U.S. Food and Drug Administration, or FDA, clearance for the measurement of cardiac markers as an aid in the diagnosis of acute myocardial infarction, of BNP as an aid in the diagnosis of heart failure, and of overdosed and abused drug analytes as an aid in the identification of drug overdose.
Our on-going product development goal is to provide physicians with timely and relevant information upon which to base their diagnoses, prognoses and therapeutic strategies. Historically, we have made significant investments in research and development, exceeding traditional diagnostic industry standards. These investments have yielded several proprietary advances in the biological and physical sciences that serve as the basis for our diagnostic marker discovery platform and make practical the development and manufacture of rapid, accurate and cost-effective diagnostics. Our products integrate our expertise in several core scientific and engineering disciplines, including antibody development and engineering, analyte cloning and synthesis, development of highly sensitive fluorescence energy transfer dyes, signaling chemistry, microcapillary protein array technology and sample handling, each of which is described below. By combining research capabilities in each of these areas, we create novel single and multi-analyte diagnostics that overcome the limitations of traditional diagnostic technologies and seek to address the significant unmet need for effective, real-time diagnostic information. Recently, we have enhanced our expertise in the development of test panels capable of multi-marker measurements.
Antibody Development and Engineering: Traditionally, antibodies have been recognized as valuable tools for the characterization of protein targets because they can be used to localize the protein in tissues, to quantify precisely the protein in body fluids at very low concentrations and to modulate the biological activity of the protein by, for example, binding to the protein and blocking its natural function. Antibodies have traditionally been derived from immunization of animals and either the harvest of antiserum containing antibodies or the development of
monoclonal antibodies using hybridoma technology, which was developed in the 1970s. Antisera are generally of limited utility and monoclonal antibody technology is labor intensive and not cost-effective for the validation of large numbers of protein targets.
Initially, we incorporated hybridoma technology into our research programs; however, the time consuming and resource intensive nature of this hybridoma technology limited the scope of research that could be performed. The advent of phage display of antibodies, and improvements in that approach over the past decade, has enabled the development of antibodies with much greater efficiency than the previous methods. Whereas it could take nine months or more to develop antibodies using hybridoma technology, phage display could produce antibodies within a few months at a substantially lower cost.
For more than a decade, we have been in-licensing and developing proprietary antibody development and production technology based on phage display, which creates genetically engineered, antibody-producing microorganisms. The technology enables the high throughput generation of custom Omniclonal antibody libraries containing gene encoded antibodies specific to a selected target analyte. Omniclonal antibodies produced from such libraries can contain thousands of different antibodies that bind to a target analyte with high affinity, which refers to an antibody’s ability to bind tightly to targets and is a highly desired attribute. Monoclonal antibody candidates can be rapidly selected from an Omniclonal antibody library and produced in quantities sufficient for product development. During the course of product development, unexpected antibody cross reactivities often require additional selection of antibodies to improve the assay specificity. Unlike hybridoma technology, Omniclonal antibody libraries can rapidly provide additional antibody candidates in these circumstances.
The intellectual property required for commercial development of phage display antibodies is fragmented, because important parts of the process were discovered in many laboratories around the world. As a consequence there are many issued patents that cover individual steps between antibody discovery and commercial production. Since the early years of our research programs, we have been successfully negotiating licenses to the critical pieces of technology, in addition to inventing our own processes relating to the commercialization of phage display of antibodies. In effect, we believe that our own inventions and know-how in this field combined with our portfolio of licenses, many of which are non-exclusive, provide us with a unique position. We view this as an important competitive advantage.
Analyte Cloning and Synthesis: Our molecular biology capabilities include the cloning and identification of specific proteins useful in the development of immunoassays. We developed proprietary expression vectors that enable the production and purification of these proteins for the development of antibodies and for use as calibrators and controls in our immunoassay products. In addition, our considerable expertise in synthetic organic chemistry allows the synthesis of targets and useful derivatives. We develop products where the targeted analyte is small (i.e., haptens, such as drugs) or large (i.e., proteins, such as cardiac enzymes). We believe that the ability to develop, stabilize and manufacture the target analyte or its analogues is key to the development of highly accurate immunoassays.
Highly Sensitive Fluorescence Energy Transfer Dyes: Immunoassays require the attachment of a detectable label to an antibody or target analyte. We developed a variety of labels for use in our products. For our qualitative products, a visual label that produces color is attached to antibodies or analytes through either non-covalent or covalent chemical methods to provide yes/no results. For our Triage MeterPlus platform products, we developed novel fluorescent dyes that are attached to antibodies or analytes using both noncovalent and covalent chemical means. Although fluorescence is a potentially powerful label for use in immunoassays, its potential has been limited by the lack of available dyes that are stable and have no sample interference, and by the requirement of a complex instrument for detection. We have invented our own proprietary dyes that satisfy four criteria:
• they are usable with complex biological samples such as serum, plasma and whole-blood;
• they are stable for the dating period of the product;
• they utilize fluorescence energy transfer, which results in a substantial phase shift away from background fluorescence in samples; and
• they are excited at near infrared wavelengths chosen to be compatible with inexpensive solid state components.
Microcapillary/Protein Array Technology: We developed proprietary technology to design, develop and manufacture protein arrays containing microcapillaries to control the flow of fluids in immunoassay processes. Our qualitative testing device format uses microcapillaries to draw fluids across immobilized antibody zones for the detection of specific substances.
Our quantitative testing device format moves fluids through the microcapillaries in a controlled manner. When a sample is added to the quantitative assay device, a filter contained within the device separates blood cells from plasma. Then the plasma moves by capillary action into a chamber that contains dried fluorescent immunoassay reagents. Inside the chamber, the analytes that are to be measured bind to the fluorescent immunoassay reagents. After an incubation time that is determined by another microcapillary element of the array we call the time gate, the sample flows through a microcapillary path termed the protein array. The protein array is comprised of antibodies that are specific to the analytes and immobilized onto the surface of the device in discrete zones. The fluorescent reagents, which are bound to the analyte, bind to the respective zones on the protein array. The excess sample that was added to the device washes the unbound fluorescent reagents from the protein array. The binding of fluorescent reagents at the protein array is detected by our Triage MeterPlus and the fluorescence intensity at the discrete zone is related to the concentration of the substance or analyte being tested and measured in the sample. We also developed the engineering capability to design unique microcapillary structures in plastic parts and to fabricate them in commercial scale quantities using injection molding processes.
Sample Handling: We developed proprietary technology relating to sample handling and preparation, including technology that allows whole-blood to be passively separated into its plasma component or to be passively lysed to release the target analyte. We also developed technologies for the handling of stool samples that concentrate and purify the target analytes or organisms from solid stool materials. In addition, we developed technologies that can be used to assay urine samples.
The MultiMarker Index™: Because many acute diseases and conditions, such as chest pain, stroke, sepsis and abdominal pain, are complex and have multiple causes, we are focusing a considerable portion of our development efforts on multi-marker test panels. Through Biosite Discovery, we believe we can select the optimal markers for a targeted condition. Our research has shown that individual measurements of markers may not always provide the most accurate result. Therefore, we have developed a proprietary process for reducing multiple biomarker measurements to a single MultiMarker Index, or MMX, value that we believe can be more easily interpreted and is more accurate than single marker measurements in the clinical setting for diagnosis and prognosis.
The MMX uses a panel of protein measurements to generate a single quantitative value which reflects the probability or severity of disease. To validate each MMX algorithm we research a large number of protein targets that are potentially relevant to a disease - for instance, more than 70 in the case of stroke. We then measure blood levels for all of these proteins in a large library of patient samples for which the ultimate disease diagnoses or prognoses are known. Using our proprietary computer algorithms, we can empirically determine which protein biomarkers provide diagnostic information about the disease and select for commercial development the panel of protein biomarkers that delivers the required diagnostic utility. To our knowledge, Biosite is unique in the world for using this MMX approach to correlate multiple blood protein levels to disease diagnosis and prognosis.
We recently launched our first product incorporating MMX, the Triage Stroke Panel, in Europe and currently have several additional potential MMX products in development. The Triage Stroke Panel is not currently approved for sale or use in the United States, but a Premarket Approval Application, or PMA, for that product has been submitted to the FDA. In April 2005, we received a letter from the FDA indicating that the PMA submitted in 2004 for the Triage Stroke Panel is on hold pending submission of additional information. The letter further states that the issues raised need to be resolved before the FDA can complete its review, otherwise the PMA in its current form would be considered not approvable. In October 2005, the FDA agreed to our request for a 180-day extension to the PMA.
An important component of our product development strategy is to validate the clinical usefulness of our new products. Historically, most new products in the diagnostics arena measured biomarkers or analytes, such as glucose, cholesterol and prostate specific antigen, for which clinical validity was already established. Consequently, the pre-market validation process for these tests usually focused on showing that the new product measurements correlated with diagnostic products already on the market. Manufacturers could perform this validation in their own laboratories. Many potential Biosite products lack pre-existing diagnostic models and we will be required to demonstrate safety and effectiveness to regulatory agencies, as well as clinical value to medical thought leaders and others.
To this end, we have developed organizational and institutional relationships necessary to sponsor large clinical studies with the goal of obtaining data to support the diagnostic indications that we wish to claim for our products. We may also fund follow-on clinical studies once a product is launched to demonstrate that our products favorably affect outcomes or provide clinical value to the diagnostic process. While our clinical trial process adds considerable time and expense to our development timelines, we believe it provides us with important competitive advantages and, most importantly, can help improve patient care.
We believe that our novel approach to discovering and developing new multi-marker diagnostic products for unmet applications will provide us with the best opportunity to establish and maintain broad patent protection, which may in turn support a favorable market position for our products. Many of the technologies that enable our products are already covered by issued patents or are the subject of patent filings. We have filed foundational patent applications covering our MMX approach to diagnosis and prognosis, which claim both the algorithm used to derive a MMX value, as well as certain combinations of proteins for specific diseases and conditions, such as stroke, sepsis, chest pain, shortness of breath, myocardial infarction, acute coronary syndrome and abdominal pain.
Commercialization
Hospital Market
Currently, our products are principally sold to acute care hospitals and are often used on patients presenting to EDs. In the United States, acute care hospitals number approximately 5,400.
According to reports published by the American Hospital Association, or AHA, U.S. hospitals are increasingly challenged in their efforts to meet the needs of their communities. Issues confronting hospitals today include workforce shortages, increases in liability insurance, higher costs associated with care accompanied by lower payments, shortages of critical care capacity and ED overcrowding resulting in patient diversions and related costs. In 2004, nearly one-third of U.S. hospitals lost money overall.
In recent years, rising demand for ED services in the United States has accompanied constrained capacity. According to statistics published by the U.S. Centers for Disease Control and Prevention, between 1993 and 2003, ED visits increased more than 26%, an estimated average of 2 million visits per year. The greatest increase was among elderly patients, many of whom have chronic medical conditions. In 2003, abdominal pain, chest pain, fever, and cough were the leading patient complaints, accounting for nearly one-fifth of all visits. While the number of ED visits continues to increase, the overall capacity of the nation’s EDs has decreased, with hundreds of emergency departments closing in the past 10 years. The resulting strain on existing EDs has been intensified by a shortage of inpatient beds, which results in backlogs in the ED as patients wait for beds to open so they can be admitted. In 2003, approximately 14% of ED visits in the U.S. resulted in hospital admission. While the problem of ED overcrowding and diversion is most evident in urban and teaching hospitals, nearly 50% of all U.S. hospitals reported capacity problems in 2005.
The supply of hospital workers is not keeping pace with the increase in demand. Many hospitals report or project shortages in nursing and laboratory personnel, areas key to diagnostic evaluation. Furthermore, the AHA reports that 41% of U.S. community hospitals have lost specialty coverage in the ED for a period of time, requiring hospitals to incur additional cost for specialist services, often placing even more burden on ED physicians and other clinicians.
In Europe, where our marketing efforts today focus primarily in western countries, the market is characterized by varying concentrations of hospitals among regions, differing reimbursement systems, pressures to reduce length of stay and declines in hospital capacities, which vary from region to region. Similar to the United States, hospitals in Europe are classified into two tiers: teaching hospitals, which are large university-affiliated institutions supported by state-of-the-art technology and thought leaders, and less advanced regional and rural hospitals that often refer more complex cases to top-tier centers. In Europe, however, there are also more sub-specialty facilities that may specialize in treatment for a particular condition. Today, many European hospitals are government-controlled.
Within hospitals worldwide, diagnosis is typically accomplished through a battery of testing methods including immunoassays. Historically, the majority of immunoassay testing has been accomplished through a centralized process using large automated analyzers housed in the central laboratory. Generally, the cost of a single high-throughput central laboratory instrument is considered to be an expensive investment and involves a multi-year commitment. These platforms are typically marketed to clinical laboratories that run tests, rather than to the physicians who order diagnostics. There are a variety of automated analyzers to choose from and menus are typically not proprietary, therefore, competition is intense and the industry suffers from low margins compared with other medical devices. Competition within the diagnostics industry has traditionally centered around improvements in cost-effectiveness, throughput and the ability to precisely measure disease markers. Industry leaders tend to be those companies with low cost positions and the marketing mass to succeed with commodity product lines.
While automated immunoassay analyzers may meet hospitals’ routine testing needs, the use of centralized
automation can lead to lengthy turnaround times, delaying delivery of vital information to the physician. Additionally, centralized immunoassay analyzers require high volumes of sample throughput to justify the substantial investment in equipment, frequent calibration and quality control testing, training, staffing and other costs required to operate and support the systems.
Given the dynamics of today’s healthcare systems, we believe that significant market potential exists for rapid diagnostics with novel applications that are capable of precise quantitative measurement of single or multiple analytes. We view our medical diagnostic products as a means of improving and advancing medical care by enabling hospital physicians to triage or evaluate patients quickly, accurately and cost-effectively in order to make important medical decisions. Studies, including one published in the February 2004 issue of the New England Journal of Medicine, have shown that rapid testing, including point-of-care testing, may help to reduce overall healthcare delivery costs and improve patient outcomes by providing diagnosis in a reduced period of time, thereby minimizing the time to medical intervention. Patients undergoing emergency procedures can benefit from more timely and accurate testing results, both of which improve decision-making, which could limit unnecessary use of costly inpatient care. Faster diagnosis can also permit earlier and more appropriate patient management, potentially shortening the duration of illness. Furthermore, the development of new diagnostics for diseases that currently lack accurate diagnostic products could improve treatment and provide better outcomes.
Physician Office Market
In 2003, we also began to market our products to outpatient physicians, primarily for use in physician office laboratories. While all of our products are available for use in physician office laboratories, or POLs, to date, our marketing efforts in this segment have focused on the Triage BNP Test, which aids in the diagnosis and assessment of heart failure. Given the chronic nature of this disease and the concern that it may advance to highly serious stages, we believe physicians would have an interest in using the Triage BNP Test for early diagnosis of heart failure and for ongoing assessment and risk stratification.
Among physician offices, immunoassay testing typically occurs in small on-site centralized POLs that serve a physician group or clinic, or in large off-site commercial laboratories. POLs typically use small to mid-size laboratory analyzers to perform immunoassay testing. These laboratories can provide convenience and enable reasonably rapid turnaround of test results, but are typically only justified for larger group practices and clinics. Furthermore, due to space considerations, their test offerings may be limited. Commercial laboratories can provide full service utilizing very large automated analyzers, with broad menus and rapid throughput. However, since tests are performed off-site, delivery of test results may take several days and testing generally tends to be expensive. Although some blood testing does occur in physician offices, this is usually limited to testing that can be accomplished using simple one-step technology that does not require blood to be drawn from the veins in the office.
We market the BNP Test to approximately 15,000 physician office labs that are licensed to run moderately complex tests and serve physicians seeing heart failure patients. In August 2005, the Triage BNP Test was granted a CLIA waiver by the FDA, substantially expanding healthcare professionals’ access to the 15-minute blood test to aid in the diagnosis and assessment of patients with symptoms of heart failure. The CLIA waiver expands access to the test to additional cardiology offices, family practices and internal medicine offices that see heart failure patients which number approximately 6,000, 10,000 and 14,000 respectively, allowing more patients to benefit from rapid evaluation.
We believe that significant validation of the Triage BNP Test in physician offices will be necessary in order to achieve widespread acceptance of this diagnostic test, particularly among family practice and internal medicine physicians, who are unlikely to be familiar with BNP.
Cardiovascular Products
Our cardiovascular products are designed to aid in the rapid and accurate diagnosis of several conditions stemming from disease or dysfunction related to the heart, lungs or other areas of the vascular system. These conditions include acute coronary syndrome, heart failure, pulmonary embolism and stroke. Certain tests are also cleared to aid in the assessment or disease severity or patient risk stratification.
Acute coronary syndrome, or ACS: A spectrum of conditions involving chest discomfort or other symptoms caused by lack of oxygen to the heart muscle. These conditions may include acute angina, silent heart attack and heart attack. The accurate diagnosis and proper management of patients with these conditions require the emergency medicine physician to consider the entire spectrum of ACS, with emphasis placed on early diagnosis and rapid treatment. Each of
these syndromes has its own prognosis, pathophysiology and specific management strategy.
Heart failure: A chronic inability of the heart to maintain an adequate output of blood from one or both of its ventricles, resulting in congestion or swelling of certain veins or organs, and an inadequate blood supply to the body. In advanced stages heart failure can lead to severely decompensated heart pumping action. Early diagnosis is important to reducing the risk of disease advancement.
Pulmonary embolism: A pulmonary embolism, or thromboembolism, occurs when a blood clot, generally a venous thrombus, becomes dislodged from its site of formation and embolizes to the arterial blood supply of one of the lungs. Symptoms may include difficulty breathing, pain during breathing, and more rarely circulatory instability and death. Treatment is with anticoagulant medication.
Stroke: The most acute event related to cerebral ischemia, which occurs when there is a decreased supply of blood to the brain or part of the brain caused by blockage of the supplying blood vessels, resulting in damage to the brain. A similar event, transient ischemic attack, or TIA, causes short-term ischemia but does not result in permanent brain damage. However recently issued stroke guidelines recommend that TIA be treated with the same urgency as stroke. We believe that further research may lead to the definition of a spectrum of conditions associated with cerebral ischemia.
The following table sets forth information on select Biosite products commercially available in 2005 in the United States and/or Europe.
(1) These indications have received FDA clearance. Pursuit of new applications would require that we seek additional clearances for the new applications from the FDA.
(2) In December 2004, we filed a PMA with the FDA seeking approval to market our diagnostic product for stroke. In April 2005, the PMA was placed on hold pending the submission of additional data requested by the FDA. In October 2005, the FDA granted the 180-day extension for the PMA. We are on track to submit additional clinical data pertaining to our Triage Stroke Panel within the extension granted by the FDA. The data are intended to broaden and further diversify the population analyzed in Biosite’s initial clinical study. The Triage Stroke Panel was launched in several European countries during the third quarter of 2005.
According to the 2005 U.S. National Hospital Ambulatory Medical Care Survey, millions of individuals visit EDs with complaints of shortness of breath, breathing difficulty and chest pain. All are symptoms common to serious cardiovascular diseases; however they can also be related to diseases and conditions such as pneumonia, bronchitis and flu. Because many of these patients are among the elderly, a patient population subject to multiple overlapping diseases, physicians must consider several possible diagnoses. Differentiating patients experiencing or at risk of acute events from patients with less severe conditions can be vital to saving lives or precluding disease advancement. Additionally, misdiagnosis of cardiovascular disease is a significant source of healthcare costs in the United States, with the cost of unnecessary hospitalization of chest pain patients estimated to exceed $2.5 billion annually.
All of our cardiovascular tests are available in a rapid format that measures biomarkers simultaneously and provides a quantitative result in about 15 minutes. Since January 2004, the Triage BNP Test has also been available in a format that can be run on Beckman Coulter Immunoassay Systems. Given the complexity of many cardiovascular diseases, we believe that in most cases the measurement of multiple markers, each of which can provide information on a different aspect of an event, will be superior to the measurement of a single marker in terms of achieving rapid and accurate diagnosis.
Drug Overdose Products
Drug abuse plays a significant role in emergency medicine cases, either as a primary cause or as a contributing factor. A diagnostic dilemma confronts physicians when patients present with symptoms that could be either drug related or non-drug related. For instance, a patient brought into an ED in a coma may be under the influence of narcotics or sedatives, thus requiring a certain type of treatment or intervention. Conversely, the same patient may have had a stroke or suffered some form of trauma requiring a completely different type of care. The ability to obtain a differential diagnosis in a timely manner greatly aids the course of treatment.
We introduced the first Triage Drugs of Abuse Panel in 1992 and launched the second-generation Triage TOX Drug Screen in January 2002. The Triage Drugs of Abuse Panels and Triage TOX Drug Screen are rapid, qualitative urine screens that analyze a single test sample for different illicit and prescription drugs or drug classes, and provide results in approximately 10 to 15 minutes. The Triage Drugs of Abuse Panels are configured to test for various combinations of drugs and provide a visual result in about ten minutes. The Triage TOX Drug Screen is a test device used for the simultaneous detection of parent compound and/or the major metabolites of up to eight drug classes (nine unique assays) in urine. A qualitative (positive or negative) result is available in about 15 minutes.
Illicit drugs detectable by the Triage Drugs of Abuse Panels and Triage TOX Drug Screen include:
• amphetamines/methamphetamines (ecstasy, speed, crystal);
• cocaine (crack);
• opiates (heroin);
• phencyclidine (angel dust); and
• cannabinoids/THC (pot, marijuana).
Prescription drugs tested by the Triage Drugs of Abuse Panel include:
• barbiturates (Phenobarbital);
• benzodiazepines (Valium, Librium, Halcion);
• tricyclic antidepressants (Elavil, Tofranil);
• propoxyphene (Darvon); and
• methadone.
Sales and Distribution
To market our products, we utilize a direct sales team that focuses on hospitals with more than 200 beds and smaller hospitals that are high volume users of our products. The Fisher HealthCare Division of the Fisher Scientific Company, or Fisher, distributes our products primarily in hospitals in the United States and supports our direct sales force, particularly in smaller hospitals and in U.S. physician offices. We have a distribution agreement with Fisher that extends through December 31, 2008. Sales to Fisher represented 84% and 86% of our product sales in 2005 and 2004, respectively.
Physician Sales & Services, or PSS, and Henry Schein, Inc., or Henry Schein, also distribute our product to U.S. physician offices. We may also engage other distributors and/or supplement our own small direct sales force for this
market in the future. A field-based network of clinically experienced individuals supports the sales effort access to all of our markets by providing pre- and post- sale education and training.
In international markets, we have established direct selling efforts in several European countries and utilize a network of country-specific and regional distributors in other areas. In the future, we may transition to direct sales and distribution of our products in additional countries. Sales to international customers in 2005, 2004, and 2003 totaled $35.9 million, $26.0 million and $14.5 million, respectively.
Because our products are designed to improve the practice of medicine, rather than merely reduce the cost of testing, we invest substantially in relevant education for healthcare clinicians using our diagnostic products. While diagnostic companies traditionally market their products solely to clinical laboratories, we believe we generate demand for our products among laboratory clinicians, physicians and hospital administrators by demonstrating the medical and economic advantages of our diagnostic products. Supporting our worldwide sales team is a field-based network that includes clinically experienced individuals providing pre- and post- sale education and training and customer and technical support resources to assist with ongoing utilization of our products. As of December 31, 2005, our worldwide sales team and our supporting in-house and field-based network consisted of 94 and 75 representatives, respectively.
Products Under Development
Our strategy for potential future products, including our current products under development, is to focus our attention on large market opportunities where we can potentially achieve market leadership and/or a proprietary patent position related to disease biomarkers with novel therapeutic, diagnostic and/or prognostic applications. Our development efforts focus on new marker mining as well as on the investigation of new applications for existing markers and/or combinations of existing markers. To support our efforts, we utilize a variety of means to gain access to potential markers such as internal research, licensing and collaborations. We are currently researching many potential disease marker candidates. Additionally, we have established clinical collaborations with many leading medical institutions that provide samples for use in our research efforts. Among the products with novel diagnostic and/or prognostic applications that we are attempting to develop are diagnostic products for cerebral ischemia or stroke, cardiovascular disease, sepsis, acute kidney injury and abdominal pain.
Cardiovascular Disease
Cardiovascular disease is a primary focus area of our research and development efforts and product development is underway in a number of different areas. In addition to developing diagnostic products that can be used to detect a specific disease, we are also concentrating our efforts on the development of multi-marker panels that can be used with patients exhibiting symptoms that could be associated with a variety of diseases. These panels are intended to help physicians quickly and accurately distinguish between causes of symptoms. Together with various commercial and clinical collaborators, we are continuing to analyze other protein targets believed to be associated with ACS and other cardiovascular diseases.
We are continuing to research potential cardiac markers and combinations of cardiac markers that may further assist in evaluating and diagnosing chest pain patients. In December 2005, we submitted a 510(k) Premarket Notification to the FDA seeking clearance for the Triage MPO Test and the Triage CardioProfilER Panel with MPO. A biomarker of inflammation of the vasculature, myeloperoxidase, or MPO, has been found to be elevated in patients with an acute risk of near-term cardiac events. MPO appears to be an indicator of unstable atherosclerotic plaque and has been shown to elevate earlier than current markers of cardiac cell death. MPO is believed to be useful as an aid in the early diagnosis of myocardial infarction and could signal risk for heart disease or heart attack in patients with chest pain or ACS. We licensed certain diagnostic rights to MPO in 2004 under an agreement with The Cleveland Clinic Foundation and Prognostix, Inc.
Sepsis
Sepsis is a complex syndrome that can take on a variety of different forms. In general, it is an inflammatory reaction initiated by microorganisms, including bacteria, viruses and fungi, which can cause widespread damage to the blood vessels leading to circulatory shock, organ failure, gangrene of extremities and death. In the United States, each year approximately 750,000 patients develop sepsis and the aging population is accelerating the prevalence of the disease. Overall mortality of patients developing sepsis ranges from 30% to 60%. Total annual costs for sepsis exceed $16 billion in the United States with the average hospital cost per adult case estimated to be approximately $22,000.
The complications associated with sepsis can advance quickly. Diagnosis is complicated by a lack of effective diagnostic tools to detect the disease in its early stages. We are currently studying markers that may be useful in the
diagnosis or risk prognosis of septic patients. We have commenced collection of approximately 7,000 patient samples to be used in studying potential biomarkers for sepsis.
Acute Kidney Injury
We have recognized that there is a medical need to make an early assessment of kidney injury in several hospital settings. At this time there is no methodology to make a timely assessment of kidney injury. Physicians currently use creatinine, which is only a functional marker, as an indicator that an injury has taken place. Although creatinine is widely used by the medical community, its limitations are also widely acknowledged. The use of this current method does not enable effective treatment to be provided because creatinine lags behind renal injury. We believe there is a compelling business opportunity for a rapid and accurate diagnostic test that can aid in the early identification of kidney injury, 48-72 hours prior to a rise in creatinine. Patients with acute renal failure and complications with other organ dysfunction can have mortality rates as high as 40 percent to 70 percent, and acute renal failure is associated with various high cost medical problems, treatments, and procedures. By rapidly assessing the likelihood and potentially the extent of kidney injury prior to the kidney undergoing irreversible damage, we believe we can give healthcare providers the opportunity to use available treatment options to avoid or reduce injury and significantly improve the outcome of the patient.
Abdominal Pain
Abdominal pain complaints represent the number one reason for visits to U.S. EDs. The diagnosis of this symptom is complicated by factors such as severity, duration and location of pain and the possibility of multiple etiologies. A complex and often expensive “rule out” diagnostic pathway used by physicians may include various laboratory tests, imaging studies and surgical interventions. We are exploring opportunities to use biomarker panels to diagnose some of the most serious conditions that cause abdominal pain and we expect to initially analyze approximately 40 protein biomarkers in 5,000 patient samples that we are in the process of collecting from our network of clinical collaborators.
Competition
The market in which we compete is intensely competitive. Our competitors include:
• manufacturers of laboratory-based tests and analyzers;
• clinical reference laboratories; and
• other rapid diagnostic product manufacturers.
Currently, the majority of diagnostic immunoassays utilized by physicians and other healthcare providers are performed by independent clinical reference laboratories and hospital-based laboratories using automated analyzers. We expect that companies offering automated laboratory analyzers will compete vigorously to maintain their dominance of the testing market. Although we now offer our Triage BNP Test for use on Beckman Coulter Immunoassay Systems, our remaining products are not currently designed for automated batch testing. In order to achieve the broadest market acceptance for our products, we will be required to demonstrate that our products provide cost-effective and time saving alternatives to certain tests performed on automated analyzers. This may require healthcare providers to change their established means of having such tests performed. Our rapid products may not be able to compete with the testing services provided by traditional laboratory services.
In addition, companies with a significant presence in the diagnostic market, such as:
• Abbott Laboratories;
• Bayer Diagnostics;
• Beckman Coulter;
• Dade Behring;
• Diagnostic Products Corp;
• Johnson & Johnson; and
• Roche Diagnostics
have developed or are developing diagnostics and/or testing systems that do or will compete with our products.
For example, our two formats of the Triage BNP Test are currently among several FDA-cleared blood tests for use as an aid in the diagnosis of heart failure. Roche Diagnostics and Dade Behring, which offer tests that measure NT-proBNP, a marker associated with heart failure, received FDA clearance for their tests in November 2002 and September 2004, respectively. Abbott Laboratories and Bayer Diagnostics, which have certain diagnostic rights to
BNP, also recently entered the market for BNP testing. Additionally, in 2004, Abbott Laboratories acquired i-STAT Corp., which manufactures and sells a point-of-care testing platform that competes with our Triage MeterPlus platform. We believe Abbott Laboratories will launch a BNP test for use on the i-STAT point-of-care testing platform in the near future. We believe this competition is also resulting in less favorable market pricing for BNP testing in general.
Similarly, we expect competition on any MPO test that we launch in the future. For instance, Biosite is only one of three licensees of relevant intellectual property rights from The Cleveland Clinic Foundation and Prognostix, Inc. Prognostix already has a MPO test that is commercially available. The other licensees, Abbott Laboratories and Dade Behring, have not publicly announced their plans to launch a MPO test or the timing of any proposed launch, but we expect to face competition from them in this potential market as well.
All of the companies listed above that have a significant presence in the diagnostic market have substantially greater financial, technical, research and other resources and larger, more established marketing, sales, distribution and service organizations than us. Moreover, these competitors offer broader product lines and have greater name recognition than us, and offer discounts as a competitive tactic.
Employees
As of December 31, 2005, we employed 1,003 regular full-time or part-time individuals. Of these, 52 held Ph.D.s and 92 held other advanced degrees. None of our employees are covered by a collective bargaining agreement. We believe that we maintain good relations with our employees.
Research and Development
We have increased our investments in research and development in each of the last three years. As of December 31, 2005, we employed 217 employees in research and development, including 37 Ph.D.s. Our research and development organization is dedicated to the study of novel disease biomarkers or combinations of disease biomarkers, the development of new technologies that can be applied to future products and the development of new products compatible with our existing platform technologies. We also have research staff dedicated to the development and production of antibodies through a variety of techniques. Recombinant techniques are used to express proteins for use as diagnostic markers. Our staff of chemists and biochemists synthesize drug targets and compounds for diagnostic use and seek to perfect techniques for coupling these compounds to biological reagents such as antibodies or labels when necessary. We developed a proprietary process utilizing phage display antibody technology that enables the selection and production of antibodies more rapidly and efficiently than is possible using hybridoma technology. Our engineering staff is involved in the design and development of new diagnostic device technologies as well as the processes for their fabrication and interaction with biological and chemical reagents. Our product development group completes final optimization of assays and our clinical and regulatory affairs group oversees all in-house clinical studies and coordinates external clinical studies of our products and prepares applications for worldwide product licensure applications.
Manufacturing
As of December 31, 2005, we had 436 employees, and approximately 116 temporary employees, in manufacturing involved in reagent production, device assembly, engineering, quality assurance/quality control and materials management.
Except for the Triage BNP Test for the Beckman Coulter Immunoassay Systems and the Triage MeterPlus, all of our products are manufactured at our facility in San Diego, California. We have contracted with Beckman Coulter, Inc., which has a manufacturing plant located in Minnesota, to manufacture the Triage BNP Test for Beckman Coulter Immunoassay Systems. The Triage MeterPlus is manufactured by LRE Technology Partner GmbH, or LRE, which is located in Germany. We developed most of the antibodies used in the manufacture of our products, and in most cases we own or license the relevant cell lines. In addition, we maintain our own in-house antibody production capability. All other raw materials required to manufacture our products are obtained from outside suppliers.
We invest in the design and development of manufacturing systems and technologies that can produce a high quality product using controlled, cost-effective manufacturing processes and equipment. We have developed and continue to develop and improve novel and sophisticated processes and equipment for the manufacture of our Triage MeterPlus platform products. Significant additional resources, implementation of additional automated and semi-automated manufacturing equipment or changes to our manufacturing processes were, and may continue to be, required
for the scaling-up of each new product prior to commercialization, or in order to adjust to changes in customer demand once commercialization begins, and this work may not be completed successfully or efficiently.
Our San Diego manufacturing facility is a registered medical device establishment with the FDA and a licensed medical device manufacturer with the California State Department of Health & Human Services. We have also been licensed and certified to manufacture products using controlled substances by the U.S. Drug Enforcement Agency. We received ISO 9001 re-certification in 2005.
Sales and Marketing
As of December 31, 2005, we had 216 employees, worldwide, in various sales and marketing functions. In the United States, we employ a direct sales force and utilize Fisher, PSS and Henry Schein to distribute our products to our primary markets, hospitals and physician offices. We also employ a field-based network of clinically experienced individuals that support the sales force by providing pre- and post- sales education and training. In international markets, we have established direct selling efforts in France, Germany, Belgium and Luxembourg, the United Kingdom, Italy and the Netherlands, and we utilize a network of country-specific and regional distributors in other areas.
We anticipate that we may, if appropriate, enter into additional distribution agreements with respect to our current products, products currently under development and products that we may develop in the future. We may not be able to enter into these or other distribution agreements on acceptable terms, if at all. If we elect to distribute products directly, our direct sales, marketing and distribution efforts may not be successful. A failure to enter into acceptable distribution agreements or a failure by us to successfully market our products would have a material and adverse effect on us.
Strategic and Distribution Arrangements
Our strategy for the research, development, commercialization and distribution of some of our products entails entering into various arrangements with clinical and commercial collaborators, licensors, licensees, manufacturers and others, and is dependent upon the success of these parties in performing their responsibilities. These parties might not perform their obligations as expected or we might not derive any revenue from these arrangements. Under our existing arrangements, we are not obligated to make any material capital expenditures. If we successfully develop products under some of our existing arrangements, we may be required to pay royalties on sales of products that incorporate licensed technology.
Fisher HealthCare Division of Fisher Scientific Company
We have a distribution agreement under which Fisher distributes our products primarily to hospitals within the United States. The term of our current distribution agreement with Fisher expires on December 31, 2008. Under the agreement, Fisher’s distribution rights are semi-exclusive in the U.S. hospital market and non-exclusive in the U.S. physician office market. Either party has the right to terminate the agreement in the case of an uncured breach by the other party. In addition, under certain circumstances, the distribution relationship may become non-exclusive or terminate with prior notice. For instance, if our direct sales to customers in the U.S. hospital market during a six month period exceed a specified percentage of the total sales of our products by both us and Fisher in that market segment, Fisher will have the option of converting the agreement to a mutually non-exclusive arrangement. The specified percentage of direct sales in the contract that would trigger this option far exceeds the current level of direct sales. If Fisher were to exercise the option, either party would have the ability to terminate the agreement upon prior notice to the other party. Similarly, if Fisher elects to promote and sell certain products that are competitive with our products, then we will have the option of converting the agreement to a mutually non-exclusive arrangement. If we were to exercise that option, either party would have the ability to terminate the agreement upon prior notice to the other party. Sales to Fisher represented 84%, 86% and 90% of our product sales in 2005, 2004, and 2003, respectively.
LRE Technology Partner GmbH
We have an agreement with LRE for the manufacturing and supply of the Triage MeterPlus, which is used with our rapid Triage BNP Test, as well as with the Triage Cardiac Panel, Triage CardioProfilER Panel, Triage D-Dimer test, Triage Profiler SOB Panel and the Triage TOX Drug Screen. All of our products in development are also intended to be used with the Triage MeterPlus. Under the terms of the LRE agreement, LRE manufactures the Triage MeterPlus according to specifications provided by us. LRE is our exclusive supplier of the Triage MeterPlus during the term of the current LRE agreement, which expires in February 2007. We purchase the Triage MeterPlus from LRE in Euros
through firm purchase orders on a per meter price basis.
Beckman Coulter, Inc.
We have an agreement with Beckman Coulter under which it manufactures the Triage BNP Test for Beckman Coulter Immunoassay Systems for us, and we exclusively sell and market the product. Although this product runs on Beckman Coulter’s automated immunoassay analyzers, it is designed to provide results standardized to match our Triage BNP Test for the Triage MeterPlus. We began selling the product in Europe in December 2003 and in the United States in January 2004.
Biosite Discovery
Biosite Discovery is a collaborative research and in-licensing program dedicated to the identification and evaluation of new protein targets for acute diseases. Through Biosite Discovery, we conduct analyses on both known proteins that may be markers of disease and proteins accessed from commercial and clinical collaborators in order to determine diagnostic utility. Since 1999, we have initiated over 40 license and collaboration agreements relating to our discovery program including arrangements with Amgen Inc., Amylin Pharmaceuticals, Inc., Banyan Biomarkers, Inc., CardioPep Pharma GmbH, Cincinnati Children’s Research Foundation and Columbia University, The Cleveland Clinic Foundation and PrognostiX, Inc., Compugen, Ltd, Inc., Eli Lilly and Company, FivePrime Therapeutics, Inc., Incyte Corporation, Lexicon Genetics, Inc., Medarex, Inc., MedImmune, Inc., Molecular Staging, Inc., Neurocrine Biosciences, Inc., Novartis Pharma AG and Power3 Medical Products, Inc. In parallel, we have initiated over 100 clinical collaboration agreements with leading universities, hospitals and health systems. Also under Biosite Discovery, we have executed several license or cross-license agreements with companies such as BioInvent International, MorphoSys AG and Dyax Corp.
Proprietary Technology and Patents
Our intellectual property portfolio includes patents, patent applications, trade secrets, know-how and trademarks. Our success will depend in part on our ability to obtain additional patents, maintain trade secrets and operate without infringing the proprietary rights of others, both in the United States and in other countries.
We periodically file patent applications to protect the technology, inventions and improvements that may be important to the development of our business. We rely on trade secrets, know-how, continuing technological innovations and licensing opportunities to develop and maintain our competitive position. We file patent applications on our own behalf as assignee and, when appropriate, have filed and expect to continue to file, applications jointly with our collaborators. These patent applications cover, among other things, devices, compositions of matter, methods of treatment, methods of discovery, use of novel compounds, and novel modes of action that are important in our research and development activities. As of March 1, 2006, we have been issued approximately 86 U.S. patents, and have been granted approximately 82 patents in other countries. These patents have expiration dates (not including any patent term extensions) ranging from 2009 to 2021. We have also licensed a significant number of other patents and patent applications from third parties. For example, we licensed technology and patents relating to our Triage BNP Tests from Scios, Inc. We also continue actively to seek patent protection in the United States and in foreign countries, and we intend to file additional patent applications relating to our technology and to specific products, as we consider appropriate.
To protect our rights to know-how and technology, we also ask our employees, technical consultants and advisors, and collaborators to enter into confidentiality agreements that prohibit the unauthorized use of, and restrict the disclosure of, confidential information and require disclosure and assignment to us of their ideas, developments, discoveries and inventions. In connection with our research and development activities, we also sponsor research at various outside institutions. Generally, under these agreements, we fund the work of investigators in exchange for the results of the specified work and the right or option to a license to any patentable inventions that may result in certain designated areas. If the sponsored work produces patentable subject matter, we generally either own the rights, or have the first right to negotiate for license rights, related to that subject matter. Any resulting license would be expected to require us to pay royalties on net sales of licensed products.
Our ability to obtain and enforce patents is uncertain and involves complex legal and factual questions, and we cannot guarantee that any patents will issue from any pending or future patent applications owned by or licensed to us. In addition, because patent applications in the United States are maintained in secrecy for eighteen months after the filing of the applications, and publication of discoveries in the scientific or patent literature often lag behind actual discoveries, we cannot be sure that the inventors of subject matter covered by our patents and patent applications were
the first to invent or the first to file patent applications for these inventions. In the event that a third party has also filed a patent on a similar invention, we may have to participate in interference proceedings declared by the U.S. Patent and Trademark Office, and similar proceedings in foreign jurisdictions, to determine priority of invention, which could result in a loss of our patent position. Furthermore, we may not have identified all U.S. and foreign patents that pose a risk of infringement.
In November 2004, we announced that Roche Diagnostics Corporation, together with certain of its affiliates, filed a complaint in the United States District Court, Southern District of Indiana, Indianapolis Division alleging that Biosite is infringing two patents, U.S. Patent 5,366,609 and U.S. Patent 4,816,224, owned by Roche and/or its affiliates. We believe these allegations of infringement are without merit and we intend to vigorously contest these claims.
Also, in November 2004, we filed a complaint in the United States District Court, Southern District of California, alleging that Roche Diagnostics Corporation and Roche Diagnostics GmbH are infringing two patents, U.S. Patent 6,174,686 and U.S. Patent 5,795,725, owned by Biosite. In October 2005, we amended our complaint, further alleging infringement of a third Biosite patent, U.S. Patent 6,939,678. All of the Biosite patents relate to methods for the measurement of cardiac troponin forms. We believe that our claims have merit and we are vigorously pursuing their prosecution.
In December 2005, we announced that we are in discussions with Roche regarding a potential settlement of both pending cases. Biosite and Roche filed joint requests to stay the litigation in the United States District Courts in the Southern District of California and the Southern District of Indiana through April 2006, both of which have now been granted.
Government Regulation
The testing, manufacture and sale of our products are subject to regulation by numerous governmental authorities, principally the FDA and corresponding state and foreign regulatory agencies. Pursuant to the Federal Food, Drug and Cosmetic Act, the FDA regulates the pre-clinical and clinical testing, manufacture, labeling, distribution and promotion of medical devices. In the United States, we are not able to commence interstate marketing or commercial sales of new products under development until we receive clearance or approval from the FDA, which can be a lengthy, expensive and uncertain process. Clearance or approval to commercially distribute new medical devices is generally received from the FDA through clearance of a 510(k) Premarket Notification or approval of a Premarket Approval Application.
The 510(k) Premarket Notification process requires us to demonstrate substantial equivalence to a medical device first marketed in interstate commerce prior to May 1976, the enactment date of the Medical Device Amendments. We must submit data that supports our claim of substantial equivalence. For any devices that are cleared through the 510(k) process, modifications or enhancements that could significantly affect safety or effectiveness, or constitute a major change in the intended use of the device, will require new 510(k) Premarket Notification submissions. It generally takes from three to five months to obtain 510(k) clearance but can take longer or not at all.
A PMA must be filed if a new device is not substantially equivalent to a medical device first marketed in interstate commerce prior to May 1976. A PMA application must be supported by valid scientific evidence to demonstrate the safety and effectiveness of the device, typically including the results of human clinical investigations, bench tests and laboratory studies. The PMA approval process can be expensive, uncertain and lengthy, and many devices for which FDA approval of a PMA application have been sought by other companies have never been approved for marketing.
Both before and after a product is commercialized, we have ongoing responsibilities under the regulations of the FDA and other agencies. Noncompliance with applicable laws and the requirements of the FDA and other agencies can result in, among other things, fines, injunctions, civil penalties, recall or seizure of products, total or partial suspension of production, failure of the government to grant pre-market clearance or pre-market approval for devices, withdrawal of marketing clearances or approvals, and criminal prosecution. The FDA has the authority to request recall, repair, replacement or refund of the cost of any device manufactured or distributed by us. The FDA also administers certain controls over the export of medical devices from the United States.
The use of our products is affected by the Clinical Laboratory Improvement Amendments of 1988, or CLIA, and related federal and state regulations, which provide for regulation of laboratory testing. The scope of these regulations includes quality control, proficiency testing, personnel standards and federal inspections. Under CLIA quality control rules in effect from 1992 through 2002, laboratories using “unitized” test systems were in compliance
with CLIA if they followed the manufacturers’ instructions for daily quality control, or QC, by relying on the internal controls built into unitized test systems, including our Triage products.
On January 24, 2003, the Centers for Medicare and Medicaid Services, or CMS, publicly issued a final QC rule under CLIA, which went into effect April 24, 2003. On January 12, 2004, CMS published updated Interpretive Guidelines for CLIA-regulated laboratories. We continue to work with CMS and our customers to evaluate the new Interpretive Guidelines and assist our customers in complying with any provisions, including QC requirements for “unitized” test systems that may be new. CMS has stated that the surveys of clinical laboratories will be “educational”, with respect to new QC requirements of the new Interpretive Guidelines and enforcement action will not be taken against a lab under the new CLIA QC rules if a laboratory director chooses to follow the manufacturer’s directions for QC.
While we believe the weight of scientific data and professional acceptance support the appropriateness of our internal quality controls, there can be no assurance that the application of these new Interpretive Guidelines will be favorable to our products. Moreover, future amendments of CLIA, the promulgation of additional regulations or guidelines impacting laboratory testing, and uncertainties relating to the enforcement of CLIA may have a material adverse effect on our ability to market our products, our business and financial condition, our results of operations and our customers’ access to our products.
We are also subject to the regulatory approval and compliance requirements for each foreign country to which we export our products. In the European Union, a single quality system and regulatory approval process has been created, and approval is represented as ISO certification and CE marking, respectively.
We may not be able to obtain necessary regulatory approvals or clearances for our products on a timely basis, if at all. Delays in receipt of or failure to receive such approvals or clearances, the loss of previously received approvals or clearances, limitations on intended use imposed as a condition of such approvals or clearances, or failure to comply with existing or future regulatory requirements would have a material adverse effect on us.
WHERE YOU CAN FIND MORE INFORMATION
Our Internet address is www.biosite.com. We make available, free of charge, on our website at www.biosite.com our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to those reports, as soon as reasonably practicable after we electronically file such material with, or furnish it to, the Securities and Exchange Commission, or SEC. We also post copies on our website of our current charters for each committee of our board of directors, as well as our current Code of Business Conduct and Ethics, Corporate Governance Guidelines and Whistleblower Policy Statement. Currently, our board of directors maintains an Audit Committee, Compensation Committee, Nominating and Corporate Governance Committee and Stock Option Committee. The information found on our website shall not be deemed incorporated by reference by any general statement incorporating by reference this report into any filing under the Securities Act of 1933 or under the Securities Exchange Act of 1934, except to the extent we specifically incorporate the information found on our website by reference, and shall not otherwise be deemed filed under such Acts. All of the referenced documents are also available free of charge to any stockholder upon request. Requests should be submitted to Investor Relations, Biosite Incorporated, 9975 Summers Ridge Rd., San Diego, California 92121.
Item 1A.
Item 1A. Risk Factors
This Annual Report on Form 10-K includes forward-looking statements about our business and results of operations that are subject to risks and uncertainties. See “Forward-Looking Statements” above. Factors that could cause or contribute to such differences include those discussed below. In addition to the risk factors discussed below, we are also subject to additional risks and uncertainties not presently known to us or that we currently deem immaterial. If any of these known or unknown risks or uncertainties actually occur, our business could be harmed substantially.
Our quarterly and annual revenues and operating results may fluctuate. We may not maintain profitability.
We have reported consecutive quarterly operating profits since the third quarter of 1999, after incurring quarterly operating losses during the prior seven quarters. In the future, quarterly or annual operating results may fluctuate and we may not be able to maintain profitability. We believe that our future operating results may be subject to quarterly and annual fluctuations due to a variety of factors, including:
• competition, including from products competitive with our Triage BNP Tests and from companies with greater financial capital and resources;
• our ability to promote and sell products in the markets in which we compete, including the hospital market, the physician office market and international markets;
• regulatory approvals, market acceptance and sales execution of existing or new products;
• whether and when we successfully develop and introduce new products;
• changes in the mix of products sold;
• seasonal or unanticipated changes in customer demand or the timing of significant orders;
• manufacturing problems, inefficiencies, capacity constraints, backlog or delays;
• research and development efforts, including clinical studies and new product scale-up activities;
• regulatory changes, uncertainties or delays;
• effectiveness in transitioning and operating a direct sales distribution model in certain international countries and expenses associated with these transitions;
• competitive pressures on average selling prices of our products;
• changes in reimbursement policies;
• costs, timing and effectiveness of further expansion of our sales force and field support resources;
• our ability to execute, maintain and achieve performance milestones under license and collaborative agreements;
• product recalls;
• prosecution, defense and resolution of license, patent or other contract disputes;
• costs and timing associated with business development activities, including potential licensing of technologies or intellectual property rights; and
• temporary and permanent costs and timing associated with the relocation of our personnel, assets and activities to our new corporate facilities.
Our operating results would also be adversely affected by a downturn in the market for our products or slower than anticipated product sales growth, including as a result of market saturation of our products. We continue to increase our operating expenses to support our expanded sales and marketing activities, manufacturing operations and new product development. Therefore, our operating results would be adversely affected if our sales and gross profits did not correspondingly increase at the same or higher rate or if our product development efforts are unsuccessful or subject to delays. Accurate prediction of future operating results is difficult or impossible. We may not achieve revenue growth or sustain profitability on a quarterly or annual basis, and our growth or operating results may not be consistent with predictions made by us or by securities analysts.
We are dependent on the market acceptance of our existing products and products under development for revenue growth and profitability.
We believe that our revenue growth and profitability will substantially depend upon our ability to expand market acceptance and sales of our newer products, such as the Triage BNP Tests, Triage Cardiac Panel, Triage CardioProfilER Panel, Triage Profiler Shortness of Breath Panel, Triage D-Dimer Test and, subject to obtaining appropriate regulatory approvals, our products currently under development, such as the Triage Stroke Panel, Triage MPO tests and other tests for ACS, sepsis, abdominal pain and acute kidney injury. Our revenue growth will also depend on our effectiveness in transitioning to and operating a direct sales and distribution model in certain international countries, and on our ability to appropriately manage our operating expenses and our capital expenditures to optimize our profitability. We have made and continue to make significant investments in headcount, manufacturing equipment, facilities and infrastructure to address our current and planned future revenue growth. We are also making significant investments in new market segments in the United States, such as physician office testing. These investments and commitments are predicated on assumptions of market acceptance of our products and revenue growth.
If we fail to plan, establish and maintain:
• reliable, cost-efficient, high-volume manufacturing capacity;
• a cost-effective sales force, customer education and product support resources and administrative infrastructure;
• effective marketing to customers, especially in markets where we have limited experience or significant competition;
• an effective distribution system for our products; or
• appropriate strategies or tactics to address our competitors,
sales of our products may not meet expectations and our profitability may suffer.
Our Triage BNP Tests have encountered, and may continue to encounter, significant competition from products developed and commercialized by companies with greater financial capital and resources.
Product sales of our Triage BNP Tests represented 67% of our product sales in both 2005 and 2004. Our Triage BNP Tests are currently two of several FDA-cleared tests used to aid in the diagnosis of heart failure. Bayer, Dade Behring, Roche Diagnostics and Abbott Laboratories have launched competitive tests at various times since November 2002. Shionogi & Co., Ltd. sells a BNP radioimmunoassay product for research purposes only in the United States. Scios, Inc., from which we licensed the technology and patents related to our Triage BNP Tests in 1996, was acquired by Johnson & Johnson in April 2003.
We have experienced, and continue to experience, competition from these companies and anticipate competition from others in the future. Beginning in the third quarter of 2003, we experienced significant competition, primarily from Bayer, resulting in a loss of customers who wanted to utilize an automated immunoassay system for BNP testing. After initiating sales outside of the United States in November 2003, Abbott Laboratories began selling a BNP test in the United States during the first quarter of 2004. In addition, Abbott Laboratories recently announced that it will offer a BNP test on its i-STAT meter product, which is designed for use at the point-of-care. Dade Behring began selling a NT-pro BNP diagnostic product in September 2004. These and other competitors may succeed in developing or marketing products that are more effective or commercially attractive than the Triage BNP Tests. The risk of competition may increase as other potential competitors gain access to competing technologies, such as NT-pro BNP, which Roche is offering for license. Moreover, we may not have the financial resources, technical expertise or marketing, distribution or support capabilities to successfully compete with these and other competitors in the future. In addition, as the market for BNP testing matures and more competitive products become available, the average sales price for our Triage BNP Tests may decline, which may adversely impact our product sales, gross margins and our overall financial results.
Competition and technological change in the diagnostic testing market may make our products less attractive or obsolete.
In addition to the specific competitive risks that we face in the market for our Triage BNP Tests, we face intense competition for our other products and in the general market for diagnostic testing. Our competitors include:
• companies making laboratory-based tests and analyzers;
• clinical reference laboratories; and
• other rapid diagnostic product manufacturers.
Currently, the majority of diagnostic products used by physicians and other healthcare providers are performed by independent clinical reference laboratories and hospital-based laboratories using automated testing systems. Therefore, with the exception of our Triage BNP Test for Beckman Coulter Immunoassay Systems, in order to achieve market acceptance for our products we will be required to demonstrate that our products provide clinical, cost-effective and time saving alternatives to automated tests traditionally used by clinical reference laboratories or hospital-based laboratories. In the future, this may prove to be more difficult as heart failure testing becomes more widely available on automated testing systems.
Our competitors have developed or are developing diagnostic products and/or testing systems that do or will compete with our products. Many of our competitors have substantially greater financial, technical, research and other resources and larger, more established marketing, sales, distribution and service organizations than we do. Moreover, these competitors offer broader product lines and have greater name recognition than we do, and offer discounts as a competitive tactic. In addition, several smaller companies are currently making or developing products that compete with or will compete with our products. We utilize long-term contracts with some of our customers as a method of defending against competition. Such contracts are of varying terms and expiration dates. Expiring contracts may not be renewed and long-term contracts may not be acceptable to new customers, which could harm our competitive strategy.
Our competitors may succeed in developing or marketing technologies or products that are more effective or commercially attractive than our products, or that would render our technologies and products obsolete. The success of our competitors, many of whom have made substantial investments in competing technologies, or our failure to compete successfully, may prevent, limit or interfere with our ability to make, use or sell our products in either the United States or in international markets.
The effect of market saturation may negatively affect the sales growth of our products, including our Triage BNP Tests.
The growth in our product sales in recent periods has been driven primarily by growth in the sales volumes of our Triage BNP Tests. For example, growth in the sales volume of our Triage BNP Tests represented 69% and 85%, respectively, of our total product sales growth in 2005 and 2004. Our meter-based Triage BNP Test, launched domestically in January 2001, was the first blood test available to aid in the detection of heart failure and benefited from a first to market position in the market until the entry of the direct competition in June 2003. Today, our Triage BNP Test products are among several FDA-cleared products for the use as an aid in the diagnosis of heart failure.
As the acute care and initial diagnosis market segment for natriuretic testing in the U.S. hospital setting becomes saturated, we expect the sales growth rates for our Triage BNP Tests in future periods to be lower than the growth rates we experienced over the past several years. We have historically experienced decreases in the sales growth rates related to market saturation for our other products, such as our Triage Drugs of Abuse Panel products. Unless we are able to successfully introduce new products into the market and achieve market acceptance of those products in a timely manner, the effect of market saturation on our existing products may negatively impact our product sales, gross margins and financial results. Even if we are able to successfully commercialize any new products, we may not experience sales growth rates for those products that are similar to the sales growth rates we achieved with our Triage BNP Tests.
If we do not successfully develop new products and new manufacturing processes as currently planned, we may not recover our significant investments in those projects.
We are investing in the research and development of potential new products, including products for stroke, MPO, ACS, sepsis, abdominal pain and acute kidney injury, and in expanded uses of our existing products. In
certain cases, the successful development of our new products will depend on the development of new technologies. We are also making significant investments in processes and equipment to improve our manufacturing efficiency and capacity, in anticipation of new products and revenue growth, as well as in the construction of our new corporate complex. Our revenue growth and profitability are impacted by these investments. We are required to undertake time consuming and costly development activities and seek regulatory approval for potential new products and for potential new uses of existing products. Products that appear promising during product development and preclinical studies, including our Triage Stroke Panel, may not demonstrate clinical study results needed to support regulatory approval, or other parties have or may have patent or other proprietary rights to our potential new products, and may not allow us to sell them on reasonable terms, or at all. We may experience difficulties that could delay or prevent the successful development, introduction or market acceptance of any such new products. We will be harmed if we are unable, for technological or other reasons, to:
• complete new product development, processes, or capital projects, including projects intended to automate portions of our manufacturing processes, in a timely manner or at all;
• complete appropriate clinical studies to validate the use of potential new products or expanded use of existing products;
• implement or effectively or efficiently scale-up manufacturing for new products; or
• obtain regulatory approval or clearance to market a new product for an intended use or an existing product for an alternative use.
Manufacturing risks and inefficiencies may adversely affect our ability to produce products and could reduce our gross margins and increase our research and development expenses.
We are subject to manufacturing risks, including our limited manufacturing experience with newer products and processes, which may hinder our ability to scale-up manufacturing. Additionally, unanticipated acceleration or deceleration of customer demand may lead to manufacturing inefficiencies. We must manufacture our products in compliance with regulatory requirements, in sufficient quantities and on a timely basis, while maintaining acceptable product quality and manufacturing costs. Significant additional resources, implementation of additional automated and semi-automated manufacturing equipment and changes in our manufacturing processes and organization have been, and may continue to be, required for the scale-up of each new product prior to commercialization or to meet increasing customer demand once commercialization begins, and this work may not be successfully or efficiently completed.
In addition, although we expect some of our newer products and products under development to share production attributes with our existing products, production of these products may require the development of new manufacturing technologies and expertise. It may not be possible for us, or any other party, to manufacture these products at a cost or in quantities to make these products commercially viable. If we are unable to develop or contract for manufacturing capabilities as needed, on acceptable terms, our ability to conduct pre-clinical and clinical testing will be adversely affected, resulting in delayed submissions for regulatory clearance or approval of products and initiation of other development programs, both of which would have a material adverse effect on us.
Manufacturing and quality problems have arisen and may arise in the future as we attempt to scale-up our manufacturing capacity and implement automated and semi-automated manufacturing methods. For instance, we have experienced problems with third-party contractors that work with us in connection with our development of automated and semi-automated manufacturing equipment and we continue to rely on third parties for the manufacture of much of our automated and semi-automated manufacturing equipment. Consequently, scale-up and implementation of automated and semi-automated manufacturing methods may not be achieved in a timely manner or at a commercially reasonable cost, or at all. In addition, we continue to make significant investments to improve our manufacturing processes and to design, develop and purchase manufacturing equipment that may not yield the improvements that we expect. Unanticipated acceleration and deceleration of customer demand for our products has resulted, and may continue to result, in inefficiencies or constraints related to our manufacturing, which has harmed and may in the future harm our gross margins and overall financial results. Such inefficiencies or constraints may also result in delays, lost potential product sales or loss of current or potential customers due to their dissatisfaction.
We are dependent on key distributors and have limited direct distribution experience. If any of our distribution relationships are terminated, or our distributors fail to adequately perform, our operating expenses will increase and our product sales may decrease.
We primarily rely upon Fisher for distribution of our products in the U.S. hospital market and may rely upon Fisher or other distributors to distribute new products or our existing products in other markets. Fisher accounted for 84% and 86% of our product sales in 2005 and 2004, respectively. We have a distribution agreement with Fisher
that expires on December 31, 2008. We distribute products in the United States physician office market primarily through PSS and Henry Schein. Internationally, we distribute products through country-specific and regional distributors, as well as through our direct sales force in selected countries. The loss or termination of one or more of our distributors could have a material adverse effect on our sales in the market served by that distributor.
If any of our distribution or marketing agreements are terminated or expire, and we are unable to enter into alternative agreements or if we elect to distribute our products directly, we will have to invest in additional sales, marketing and administrative resources, including additional field account executives and customer support resources, which would significantly increase our expenses. For instance, if we distribute our products directly to customers, we would need to hire additional personnel and would incur additional expenses relating to customer order processing and servicing, warehousing, shipping, billing and collections, which are costs that our distributors currently bear. We may also need to invest in additional capital equipment, third-party services and facilities in order to administer the logistics of direct distribution. Changes in the distribution of our products may also result in contract termination fees, transition-related expenses, disruption of our business, increased competition and lower product sales and operating profits. In addition, following the expiration or termination of any distribution agreement, a former distributor may attempt to compete directly with us by offering competitive products to our current customers. We have limited experience in direct sales, marketing and distribution of our products, both domestically and internationally. Our direct sales, marketing and distribution efforts may not be successful and we may not be able to successfully transition from a distributor model to a direct sales model. Further, we may not be able to enter into new distribution or marketing agreements on satisfactory terms, or at all. A failure to enter into acceptable distribution agreements, to successfully market our products or to implement the logistics associated with direct product distribution to our customers would have a material adverse effect on us.
We may be unable to accurately predict future sales through our distributors, which could harm our ability to efficiently manage our internal resources to match market demand.
A significant portion of our product sales is made to Fisher domestically and other distributors internationally. As a result, our financial results, quarterly product sales, trends and comparisons are affected by seasonal factors and fluctuations in the buying patterns of end-user customers, Fisher and our other distributors, and by the changes in inventory levels of our products held by these distributors. For example, higher utilization rates of our Triage BNP Tests may be due to a higher number of ED visits by patients exhibiting shortness of breath, a symptom of heart failure and of influenza. However, higher utilization may also result from greater awareness, education and acceptance of the uses of our Triage BNP Tests, as well as additional users within the hospitals.
We are unable to verify the inventory levels of our international distributors and only have limited visibility over the inventory levels of our products at Fisher or our other domestic distributors. While we attempt to assist Fisher in maintaining targeted stocking levels of our products, we may not be successful. Attempting to assist Fisher in maintaining targeted stocking levels of our products involves the exercise of judgment and use of assumptions about future uncertainties including end-user customer demand and, as a result, actual results could differ from our estimates. Inventory levels of our products held by distributors may exceed or fall below the levels we consider desirable on a going-forward basis, which may harm our future financial results. This may result from unexpected buying patterns of our distributors or our inability to efficiently manage or invest in internal resources, such as manufacturing capacity, to meet the actual demand for our products. In addition, if we begin direct distribution in any territory following the expiration or termination of a distribution agreement for that territory, it is likely that our product sales in that territory will decrease as our prior distributor sells its remaining inventory of our products.
The process of obtaining clearance or approval to market new medical devices in the United States is expensive, time consuming and uncertain. We may not obtain required approvals for the commercialization of our products in the United States in a timely manner, if at all.
Our future performance depends on, among other matters, our estimates as to when and at what cost we will receive regulatory approval for new products. Regulatory approval can be a lengthy, expensive and uncertain process, making the timing and cost of obtaining approvals difficult to predict.
In the United States, clearance or approval to commercially distribute new medical devices is received from the FDA through clearance of a Premarket Notification, or 510(k), or through approval of a Premarket Approval Application, or PMA. To receive 510(k) clearance, a new product must be substantially equivalent to a medical device first marketed in interstate commerce prior to May 1976. The FDA may determine that a new product is not substantially equivalent to a device first marketed in interstate commerce prior to May 1976 or that additional information is needed before a substantial equivalence determination can be made. A “not substantially equivalent”
determination, or a request for additional information, could prevent or delay the market introduction of new products that fall into this category. The 510(k) clearance and PMA approval processes can be expensive, uncertain and lengthy. It generally takes from three to five months from submission to obtain 510(k) clearance, and from six to eighteen months from submission to obtain PMA approval; however, it may take longer, and 510(k) clearance or PMA approval may never be obtained.
For devices that are cleared through the 510(k) process, modifications or enhancements that could significantly affect safety or effectiveness, or constitute a major change in the intended use of the device, require new 510(k) submissions. We have made modifications to some of our products since receipt of initial 510(k) clearance. With respect to several of these modifications, we filed new 510(k)s describing the modifications and have received FDA 510(k) clearance. We made other modifications to some of our products that we believe do not require the submission of new 510(k)s. The FDA may not agree with any of our determinations not to submit a new 510(k) or PMA for any of these modifications made to our products. If the FDA requires us to submit a new 510(k) or PMA for any device modification, we may be prohibited from marketing the modified products until the new submission is cleared by the FDA.
The FDA has made, and may continue to make, changes in its approval requirements and processes. We cannot predict what these changes will be, how or when they will occur or what effect they will have on the regulation of our products. Any new regulations may impose additional costs or lengthen review times of our products. Delays in receipt of or failure to receive United States regulatory approvals or clearances for our new products would have a material adverse effect on our business, financial condition and results of operations.
In October 2004, we filed a 510(k) with the FDA seeking clearances for the Triage Profiler CP™ Panel. The Triage Profiler CP Panel incorporates a proprietary MultiMarker Index algorithm which analyzes information from all four markers on the panel and presents a single composite index result. Because of the proprietary MultiMarker Index algorithm used in the calculation of the composite result, the FDA determined that the device is not substantially equivalent to devices marketed in interstate commerce prior to May 28, 1976 and therefore classified the device by statute into Class III (Premarket Approval). We believe that the FDA’s decision to request that we file a PMA in no way reflects on the quality of the data we previously submitted, or on the perceived diagnostic utility of the MultiMarker Index algorithm. Rather, we believe that the FDA’s decision was based on the fact that the Triage Profiler CP Panel has new technological characteristics that may not be generally used in medical practice today. We are working with the FDA to determine the appropriate regulatory pathway for this potential product.
We submitted a PMA for our Triage Stroke Panel in December 2004. In April 2005, we received a letter from the FDA indicating that the PMA submitted in 2004 for our Triage Stroke Panel is on hold pending submission of additional information. The letter further states that the issues raised need to be resolved before the FDA can complete its review, otherwise the PMA in its current form would be considered not approvable. In October 2005, the FDA agreed to our request for a 180-day extension to the PMA. We are on track to submit additional clinical data pertaining to our Triage Stroke Panel within the extension granted by the FDA.
Because we export our products to foreign countries, we are also subject to applicable regulatory approval requirements in those countries, which may impose additional costs upon us or prevent or delay us from marketing our products in those countries.
In addition to regulatory requirements in the United States, we are also subject to the regulatory approval requirements for each foreign country to which we export our products. In the European Union, for example, the In Vitro Diagnostic Directive Medical Device Directive, or IVDD, mandates requirements for a quality management system and technical product information. Regulatory compliance with the IVDD is represented by affixing the “CE” mark to product labeling. Depending on product classification, the IVDD requirements may entail review by an European Union Member State Notified Body or self-certification by the manufacturer. Although all of our products are currently eligible for CE marking through self-certification, this process can be lengthy and expensive. As another example, in Canada, our products require approval by Health Canada prior to commercialization along with International Standards Organization, or ISO, 13485/CMDCAS certification. It generally takes three to six months from submission to obtain a Canadian Device License. In some cases, device license approval may take longer or may not be obtained at all. Any changes in foreign approval requirements and processes may cause us to incur additional costs or lengthen review times of our products. We may not be able to obtain foreign regulatory approvals on a timely basis, if at all, and any failure to do so may cause us to incur additional costs or prevent us from marketing our products in foreign countries, which may have a material adverse effect on our business, financial condition and results of operations.
We are subject to ongoing regulation of the products for which we have obtained regulatory clearance or approval, among other things, which may result in significant costs or in certain circumstances, the suspension or withdrawal of previously obtained clearances or approvals.
Any products for which we obtain regulatory approval or clearance continue to be extensively regulated by the FDA and other federal, state and foreign regulatory agencies. These regulations impact many aspects of our operations, including manufacturing, labeling, packaging, adverse event reporting, storage, advertising, promotion and record keeping. For example, our manufacturing facilities, including those at our new corporate complex, and those of our suppliers are, or can be, subject to periodic regulatory inspections. The FDA and foreign regulatory agencies may require post-marketing testing and surveillance to monitor the effects of approved products or place conditions on any product approvals that could restrict the commercial applications of those products. In addition, the subsequent discovery of previously unknown problems with a product may result in restrictions on the product, including withdrawal of the product from the market. We are also subject to routine inspection by the FDA and certain state agencies for compliance with Quality System Requirement and Medical Device Reporting requirements in the United States and other applicable regulations worldwide, including but not limited to ISO regulations. In addition to product-specific regulations, we are subject to numerous federal, state and local laws relating to such matters as safe working conditions, manufacturing practices, environmental protection, fire hazard control and disposal of hazardous or potentially hazardous substances. We may incur significant costs to comply with these laws and regulations. If we fail to comply with applicable regulatory requirements, we may be subject to fines, suspension or withdrawal of regulatory approvals, product recalls, seizure of products or injunctions against their distribution, disgorgement of money, operating restrictions and criminal prosecution.
Delays in the conduct or completion of our clinical studies or the analysis of the data from our clinical studies may result in delays in our planned filings for regulatory approvals, and may adversely affect our ability to commercialize our products.
We cannot predict whether we will encounter problems with any of our completed, ongoing or planned clinical studies that would cause us or regulatory authorities to delay or suspend our ongoing or planned clinical studies, or delay the analysis of data from our completed or ongoing clinical studies.
Any of the following could delay the completion of our ongoing and planned clinical studies:
• ongoing discussions with the FDA or comparable foreign authorities regarding the scope or design of our clinical studies;
• delays in enrolling patients;
• lower than anticipated retention rate of patients in a clinical study;
• unexpected results or adverse events of clinical studies;
• insufficient supply or deficient quality of materials necessary for the performance of clinical studies; or
• difficulties in coordinating clinical study activities with third-party clinical study sites.
If the results of our ongoing or planned clinical studies for our potential products are not available when we expect or if we encounter any delay in the analysis of data from our clinical studies, we may not be able to commence marketing or commercial sales of products when we expect.
Changes in U.S. laboratory regulations for our customers may adversely affect us.
The use of our products is affected by the Clinical Laboratory Improvement Amendments of 1988, or CLIA, and related federal and state regulations, which provide for regulation of laboratory testing. The scope of these regulations includes quality control, proficiency testing, personnel standards and federal inspections.
Under CLIA quality control rules in effect from 1992 through 2002, laboratories using “unitized” test systems were in compliance with CLIA if they followed the manufacturers’ instructions for daily quality control, or QC, by relying on the internal controls built into unitized test systems, including our Triage products. On January 24, 2003, the Centers for Medicare and Medicaid Services, or CMS, publicly issued a final QC rule under CLIA, which went into effect on April 24, 2003. So long as laboratory directors, at a minimum, review manufacturers’ QC instructions, find those instructions to reasonably monitor the accuracy of the analytic process and the laboratory then follows those manufacturers’ instructions, the QC requirements contained in the 2003 modifications of the CLIA regulations will be satisfied. Future amendments of CLIA, the promulgation of additional regulations or guidelines impacting laboratory testing, and uncertainties relating to the enforcement of CLIA may have a material adverse effect on our ability to market our products, our business and financial condition, our results of operations and our customers’ access to our products.
Diagnostic test systems are classified into one of three CLIA regulatory categories based on their potential risk to public health. Waived tests are the lowest regulated category and those most used in physician offices. In August 2005, we announced that the FDA granted a CLIA waiver to reclassify the Triage BNP Test used on our Triage MeterPlus from CLIA moderately complex to waived.
We are dependent on sole-source suppliers for our products. A supply interruption would harm us.
Sole-source vendors provide some key components and raw materials used in the manufacture of our products. Any interruption in supply of a sole-sourced component or raw material would have a material adverse effect on our ability to manufacture these products until a new source of supply is qualified or alternative manufacturing processes are implemented and, as a result, would have a material adverse effect on us. In addition, an uncorrected impurity or supplier’s variation in a raw material, either unknown to us or incompatible with the manufacturing processes of our products, could have a material adverse effect on our ability to manufacture products. We have products under development that, if developed and subject to obtaining appropriate regulatory approvals, may require us to enter into additional supplier arrangements or implement alternative manufacturing processes. We may not be able to enter into additional supplier arrangements on commercially reasonable terms, or at all. We also may not be able to implement alternative manufacturing processes that are effective and cost efficient, or at all. Failure to obtain a supplier on acceptable terms, or at all, or the implementation of alternative processes for the manufacture of our future products, if any, could increase our manufacturing costs or limit our production capacity for one or more of our products, which would have a material adverse effect on us.
For example, we rely upon LRE Technology Partner Gmbh, or LRE, for production of the fluorometer that is used with our Triage MeterPlus Platform products, which include the rapid Triage BNP Test, Triage Cardiac Panel, Triage CardioProfilER Panel, Triage Profiler Shortness of Breath Panel, Triage TOX Drug Screen and other products currently under development. In addition, we rely on Beckman Coulter to manufacture the Triage BNP Test for Beckman Coulter Immunoassay Systems and related calibrations and controls for us. If these or any other sole-source suppliers are unable or unwilling to manufacture sufficient quantities of the relevant items that meet our quality standards, we would be required to identify and qualify alternative suppliers. Although we generally maintain safety stock inventory levels of these items, which would allow us some time to identify and qualify alternative suppliers, a delay or inability to identify and qualify alternative suppliers may materially and adversely affect:
• our sales and profit margins;
• our ability to adequately service our existing customers and market our products to potential new customers;
• our ability to develop and manufacture products on a timely and competitive basis; or
• the timing of market introductions and subsequent sales of products.
Our patents and proprietary technology may not provide us with any benefit and the patents of others may prevent us from commercializing our products.
Our ability to compete effectively will depend in part on our ability to develop and maintain proprietary aspects of our technology, and to operate without infringing the proprietary rights of others or to obtain licenses to such proprietary rights. Our patent applications may not result in the issuance of any patents. Additionally, our patent applications may not have priority over others’ applications, or, if issued, our patents may not offer protection against competitors with similar technology. Any patents issued to us may be challenged, invalidated or circumvented in the future and the rights created thereunder may not provide a competitive advantage. Any of these circumstances could prevent us from selling any or all of our products. Others may have filed and in the future are likely to file patent applications that are similar or identical to ours. To determine the priority of inventions, from time to time, we participate in interference proceedings declared by the United States Patent and Trademark Office, or USPTO, and similar proceedings in foreign jurisdictions. These proceedings could result in a substantial cost to us.
Our products and activities may be covered by technologies that are the subject of patents issued to, and patent applications filed by, others. We have obtained licenses, and we may negotiate to obtain other licenses, for technologies patented by others. Some of our current licenses are subject to rights of termination and may be terminated. Our licensors may not abide by their contractual obligations and, as a result, may limit the benefits we currently derive from their licenses. We may not be able to renegotiate or obtain licenses for technology patented by others on commercially reasonable terms, or at all. We may not be able to develop alternative approaches if we are unable to obtain licenses and our current and future licenses may not be adequate for the operation of our business.
The failure to obtain, maintain or enforce necessary licenses or to identify and implement alternative approaches would prevent us from operating some or all of our business and would have a material adverse effect on us.
We rely upon trade secrets, technical know-how and continuing invention to develop and maintain our competitive position. Others may independently develop substantially equivalent proprietary information and techniques or otherwise gain access to our trade secrets or disclose such technology. We may not be able to meaningfully protect our trade secrets, or be capable of protecting our rights to our trade secrets.
Legal proceedings to obtain patents and litigation of third-party claims of intellectual property infringement or relating to existing licenses could require us to spend substantial amounts of money and could impair our operations.
Litigation may be necessary to enforce any patents issued to us, to protect trade secrets or know-how owned by us, to determine the enforceability, scope and validity of the proprietary rights of others, or to enforce our rights under license and other intellectual property-related agreements. Litigation related to intellectual property matters has in the past, and may in the future, result in material expenses to us and be a significant diversion of effort by our technical and management personnel, regardless of the outcome. Litigation, if initiated, could seek to recover damages as a result of any sales of the products subject to the litigation and to enjoin further sales of such products. The outcome of litigation, both pending and potentially in the future, is inherently uncertain. An adverse outcome in any litigation or the failure to obtain a necessary license could subject us to significant liability and could prevent us from selling any or all of our products, which could have a material adverse effect on our business, financial condition and results of operations.
Our commercial success also depends in part on us neither infringing patents or proprietary rights of third parties nor breaching any licenses that may relate to our technologies and products. We are aware of several third-party patents that may relate to our technology. In addition, we have received and may in the future receive notices claiming infringement from third parties as well as invitations to take licenses under third-party patents. There can be no assurance that we do not or will not infringe these patents, or other patents or proprietary rights of third parties. Any legal action against us or our collaborators claiming damages and seeking to enjoin commercial activities relating to our products and processes affected by third-party rights, in addition to subjecting us to potential liability for damages, may require us or our collaborators to obtain a license in order to continue to manufacture or market the affected products and processes. There can be no assurance that our collaborators or we would prevail in any such action or that any license (including licenses proposed by third parties) required under any such patent would be made available on commercially acceptable terms, if at all. There are a significant number of U.S. and foreign patents and patent applications in our areas of interest, and we believe that there may be significant litigation in the industry regarding patent and other intellectual property rights.
In November 2004, Roche Diagnostics Corporation, together with several of its affiliates, filed a complaint in the United States District Court, Southern District of Indiana, Indianapolis Division, alleging that Biosite is infringing two patents, U.S. Patent 5,366,609 and U.S. Patent 4,816,224, owned by Roche and/or its affiliates. We believe these allegations of infringement are without merit and we are vigorously contesting these claims. Also, in November 2004, we filed a complaint in the United States District Court, Southern District of California, alleging that Roche Diagnostics Corporation and Roche Diagnostics GmbH are infringing two patents, U.S. Patent 6,174,686 and U.S. Patent 5,795,725, owned by Biosite. In October 2005, we amended our complaint, further alleging infringement of a third Biosite patent, U.S. Patent 6,939,678. All of the Biosite patents relate to methods for the measurement of cardiac troponin forms. We believe that our claims have merit and we are vigorously pursuing their prosecution.
In December 2005, we announced that we are in discussions with Roche regarding a potential settlement of both pending cases. Biosite and Roche filed joint requests to stay the litigation in the United States District Courts in the Southern District of California and the Southern District of Indiana through April 2006, both of which have now been granted. Given the stage of both actions and the current stay of the proceedings, we cannot predict the ultimate outcome of either matter at this time.
We may not be successful in transitioning from the use of distributors in international markets to directly selling our products in those markets, which may result in lower product sales and higher expenses.
Until recently, we sold all of our products internationally through independent distributors. We transitioned to a direct sales and distribution model in France and Germany in 2003, in Belgium, Luxembourg, the United Kingdom and Italy in 2004, and in the Netherlands in 2006. Over the next few years, we may transition the distribution of our products in some additional international countries to a direct sales and distribution model. In any country in which
we transition to a direct sales and distribution model, we will need to make investments in facilities, resources and personnel. In addition, we will assume additional administrative expenses to manage our operations in those countries. We may also incur expenses associated with the termination of our existing distribution arrangements in those countries. We possess limited experience in managing operations outside of the United States and in direct sales, marketing and distribution of our products in international markets. If our efforts to implement direct sales and distribution in countries where we elect to do so are unsuccessful, we may not achieve our projected sales objectives, and we may also incur additional expenses, or our operating profits may be lower than anticipated.
Our international sales and operations may be harmed by political, social or economic changes, or by other factors.
Export sales to international customers amounted to $35.9 million for 2005 and $26.0 million for 2004. Since 2003, we have significantly expanded our direct sales and distribution operations outside of the United States in France, Germany, Belgium, Luxembourg, the United Kingdom, Italy, and the Netherlands and we may expand these operations into additional countries in the future. Our accounts receivable balance for our international customers and distributors was $9.0 million and $7.4 million at December 31, 2005 and 2004, respectively. Sales and costs resulting from our direct sales and distribution operations in Europe are denominated primarily in local currencies, including the Euro, and are subject to fluctuations in currency exchange rates. Further, we purchase our Triage MeterPlus inventory from LRE and incur other operating expenses, including clinical trials, which are denominated in Euros and other local currencies. Significant fluctuations in the currency exchange rates may negatively impact our consolidated sales and earnings.
International sales and operations are also subject to a variety of other risks, including:
• greater risk of uncollectible accounts;
• difficulty in staffing, monitoring and managing foreign operations;
• understanding of, and compliance with local employment laws, including reduced flexibility and increased cost of staffing adjustments;
• unknown or changes in regulatory practices, including import or export license requirements, trade barriers, tariffs, employment and tax laws;
• adverse tax consequences, including imposition of withholding or other taxes on payments by subsidiaries;
• restrictions on repatriation of locally-derived revenue;
• competition from locally-produced products with cost advantages or national appeal;
• local business practices that could expose our direct sales and marketing organization to Foreign Corrupt Practices Act risks;
• political, social or economic conditions and changes in these foreign markets; and
• government spending patterns.
As a result, our operating results will fluctuate along with the currencies and general economic conditions in the countries in which we do business, which could harm our operating results.
Healthcare reform and restrictions on reimbursement may adversely affect our results.
In the United States, healthcare providers that purchase our products and other diagnostic products generally rely on third-party payors to reimburse all or part of the cost of the procedure. In international markets, reimbursement and healthcare payment systems vary significantly by country, and include both government sponsored healthcare and private insurance. Third-party payors can affect the pricing or the relative attractiveness of our products by regulating the maximum amount of reimbursement provided by such payors for laboratory testing services. Third-party payors are increasingly scrutinizing and challenging the prices charged for both existing and new medical products and services. Lower than expected or decreases in reimbursement amounts for tests performed using our products may decrease amounts physicians and other practitioners are able to charge patients, which in turn may adversely affect our ability to sell our products to the physicians at prices we target. Third-party reimbursement and coverage may not be available or adequate in either U.S. or foreign markets, current reimbursement amounts may be decreased in the future and future legislation, regulation or reimbursement policies of third-party payors may adversely affect the demand for our products or our ability to sell our products on a profitable basis.
Failure to comply with government regulations regarding our products could harm our business.
Several state and federal laws have been applied to restrict certain marketing practices in the medical device industry in recent years. These include federal and state anti-kickback statutes. The federal health care program anti-kickback statute prohibits persons from knowingly and willfully offering, paying, soliciting, or receiving
remuneration in return for referrals or in return for purchasing, leasing, ordering, or arranging for or recommending purchasing, leasing, or ordering any service or item payable under Medicare, Medicaid, or certain other federally funded health care programs. These provisions have been broadly interpreted to apply to certain relationships between manufacturers, purchasers of manufacturers’ products, and parties in a position to refer or recommend purchases. Under current law, federal courts and the Office of Inspector General of the United States Department of Health and Human Services have stated that the statute may be violated if one purpose (as opposed to a primary or sole purpose) of remuneration is to induce prohibited purchases, recommendations or referrals.
There are a number of statutory exceptions and regulatory safe harbors under the federal anti-kickback statute, including those for properly disclosed reductions in price, payments to bona fide employees, payments to group purchasing organizations, compensation under personal services contracts and warranties. Although a failure to satisfy all of the criteria for a particular safe harbor does not necessarily mean that an arrangement is unlawful, practices that involve remuneration intended to induce purchases or recommendations may be subject to government scrutiny if they do not qualify for a safe harbor.
The majority of states also have statutes or regulations similar to the federal health care program anti-kickback statute. Certain of these laws do not have exemptions or safe harbors. Moreover, in several states, these laws apply regardless of whether payment for the services in question may be made under Medicaid or state health programs. Sanctions under these federal and state laws may include civil money penalties, license suspension or revocation, exclusion or medical product companies, providers, or practitioners from participation in federal or state healthcare programs, and criminal fines or imprisonment. Our practices may not in all cases meet all of the criteria for safe harbor protection from anti-kickback liability. Because of the breadth of these statutes, it is possible that some of our business activities could be subject to challenge under one or more of such laws. Such a challenge could have a material adverse effect on our business and financial condition.
Changing facilities costs and other risks relating to our move to our new corporate complex may negatively impact our operating results.
In October 2003, we completed our purchase of land for the construction of our new corporate complex. We purchased a total of 26.1 usable acres for approximately $28.2 million. We expect the new complex to provide us with up to 800,000 square feet of space, to be constructed in phases as needed. The first phase will provide us with approximately 350,000 square feet of space. The total cost of the land and the construction of the first phase is estimated to be approximately $110.0 million, of which we have incurred approximately $108.6 million through December 31, 2005. We have funded the construction of the complex using our available cash. As of March 1, 2006, our research and development staff, selling, general and administrative staff and a portion of our manufacturing operations have relocated to the new corporate complex. We expect to complete the other buildings in the first phase of construction during the first half of 2006 and to relocate our remaining operations in stages once the buildings are ready for use. We expect our occupancy costs to increase primarily due to increased square footage.
Should there be a downturn in our business or the markets in which we compete, we may not have a need to expand our facilities as we have planned. As a result, we may then seek an alternative use for all or a portion of the property, or seek to sell all or a portion of the property, which may have a negative impact on our operating results. We may also incur unexpected costs and expenses in connection with our move from our existing facilities to our new corporate complex, or we may experience unanticipated decreases in productivity and other losses due to inefficiencies relating to this transition or delays in obtaining any required approvals or clearances from regulatory agencies related to the validation of the manufacturing facilities. For instance, the scale-up of manufacturing at our new corporate complex could result in lower than expected manufacturing output and higher than expected product costs. In addition, we expect to incur some duplicate facilities expenses, such as rent, as we are transferring our operations in stages to the new corporate complex.
Some of our existing office and laboratory leases in the United States will expire during the next year. In the event of any delays in the construction or completion of the other buildings at our new corporate complex, we may not be able to extend these existing leases on acceptable terms or at all and we may not be able to find acceptable alternative facilities. This and other consequences of any delay in the construction or completion of our new corporate complex may significantly disrupt our business, increase our operating expenses and reduce our productivity, which could harm our financial results.
Recently, the San Diego Airport Authority issued a draft of proposed changes to land uses, such as restrictions on maximum building heights, personnel densities and hazardous materials storage, in areas surrounding airports throughout San Diego County. Several of these changes, if approved, could potentially negatively impact our ability
to construct our corporate complex as we currently plan. In that case, we may need to alter our development plans for the remainder of our corporate complex. However, any such regulatory changes are still in the early stages and it is not possible for us to predict whether any changes will be adopted or implemented, and whether such changes could adversely impact our corporate complex.
Long-lived and intangible assets may become impaired and result in an impairment charge.
At December 31, 2005, we had approximately $163.2 million of long-lived assets, including $29.1 million of land, $56.0 million of buildings and improvements, $22.8 million of building construction-in-progress, $98,000 of leasehold improvements, $43.1 million of equipment, furniture and fixtures and $7.9 million of capitalized license rights and other assets. Building, building improvements, leasehold improvements, equipment, intangible assets and certain other long-lived assets are amortized or depreciated over the lesser of their useful lives or the remaining lease term. In San Diego, we lease five buildings with leases that expire between March and June 2006. The carrying amounts of long-lived and intangible assets are affected whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Such events or changes might include a significant decline in market share, a significant decline in profits, rapid changes in technology, significant litigation or other matters. Adverse events or changes in circumstances may affect the estimated undiscounted future operating cash flows expected to be derived from long-lived and intangible assets. In the event impairment exists, an impairment charge would be determined by comparing the carrying amount of the asset to the applicable estimated future cash flows, discounted at a risk-adjusted interest rate. An impairment charge may result in a material adverse effect on our operating results. In addition, the remaining amortization period for the impaired asset would be reassessed and revised if necessary.
At December 31, 2005, we had approximately $7.4 million of short-term and long-term deferred tax assets, consisting primarily of temporary differences between book and tax treatment of certain items such as depreciation. No valuation allowance has been recorded to offset the deferred tax assets as we have determined that it is more likely than not that these assets will be realized. We will continue to assess the likelihood of realization of such assets; however, if future events occur which do not make the realization of such assets more likely than not, we will record a valuation allowance against all or a portion of the net deferred tax assets. Examples of future events that may occur which would make the realization of such assets unlikely would be a lack of taxable income resulting from poor operating results or rising tax deductions generated from disqualifying dispositions of shares issued under our stock plans.
We may need additional capital. If additional capital is not available, we may have to curtail or cease operations.
If cash generated from operations is insufficient to satisfy our working capital and capital expenditure requirements, we may be required to sell additional equity or debt securities or obtain additional credit facilities. Additional capital, if needed, may not be available on satisfactory terms, or at all. Furthermore, any additional equity financing may be dilutive to stockholders, and debt financing, if available, may include restrictive covenants. Our future liquidity and capital funding requirements will depend on numerous factors, including:
• the costs, timing and effectiveness of further expansion of sales, marketing and manufacturing activities and resources;
• expansion of our manufacturing capacity and our facilities expansion needs, including the construction of our new corporate complex;
• the effects of competition, including products competitive with our Triage BNP Tests, from companies with greater financial capital and resources;
• the effect on sales and cash receipts for our Triage BNP Tests due to market saturation in the hospital market for natriuretic peptide testing in the United States;
• regulatory changes, uncertainties or delays;
• the impact of the prosecution, defense and resolution of ongoing and potential future license and patent disputes;
• the extent to which our new products and products under development are successfully developed, gain regulatory approval and market acceptance and become and remain competitive;
• seasonal or unanticipated changes in customer demand;
• the scope, timing and results of research and development efforts, including clinical studies and regulatory actions regarding our potential products;
• changes in third-party reimbursement policies;
• the ability to execute, enforce and maintain license and collaborative agreements and attain the milestones under these agreements necessary to earn contract revenues;
• the costs and timing associated with business development activities, including potential licensing of technologies patented by others; and
• the timing and amount of any repurchase of our stock or early retirement of our debt.
If we require additional capital, and if we are not able to raise capital on acceptable terms when needed, we would have to scale back our operations, reduce our work force and license or sell to others products we would otherwise seek to develop or commercialize ourselves.
We are dependent on others for the development of products. The failure of our collaborations to successfully develop products would harm our business.
Our business strategy includes entering into agreements with clinical and commercial collaborators and other third parties for the development, clinical evaluation and marketing of existing products and products under development. Many of the agreements are subject to rights of termination and may be terminated without our consent. These parties also may not abide by their contractual obligations to us and may discontinue or sell their current lines of business. Research performed under a collaboration for which we receive or provide funding may not lead to the development of products in the timeframe expected, or at all. If these agreements are terminated earlier than expected, or if third parties do not perform their obligations to us properly and on a timely basis, we may not be able to successfully develop new products as planned, or at all.
We may not be able to manage our growth, and we may experience constraints or inefficiencies caused by unanticipated acceleration and deceleration of customer demand.
We have experienced growth and anticipate continued growth in the number of our employees, the scope of our operating and financial systems and the geographic area of our operations if market acceptance of our products increases and potential new products are developed and commercialized. This growth will result in an increase in responsibilities for both existing and new management personnel. Our ability to manage growth effectively will require us to continue to implement and improve our operational, financial and management information systems and internal control, and to train, motivate and manage our employees. We may not be able to adequately manage our expansion, and a failure to do so could have a material adverse effect on us.
Unanticipated acceleration and deceleration of customer demand for our products has and may continue to result in constraints or inefficiencies related to our manufacturing, sales force, implementation resources and administrative infrastructure. Such constraints or inefficiencies may adversely affect us as a result of delays, lost potential product sales or loss of current or potential customers due to their dissatisfaction. Similarly, over-expansion or investments in anticipation of growth that does not materialize could harm our financial results and result in overcapacity. For instance, we have made non-cancelable purchase commitments for certain inventory and product components. Any such inventory or components that are not used when planned are subject to loss because of spoilage or obsolescence.
If we lose our key personnel or are unable to attract and retain additional personnel, we may not be able to manage our business, pursue collaborations or develop our own products.
Our future success depends in part on the continued service of our key technical, sales, marketing and executive personnel, and our ability to identify, hire and retain qualified personnel. Competition for such personnel is intense and involves factors such as compensation, equity incentives, work culture, organization and direction. We may not be able to retain existing personnel or identify or hire additional personnel. If we are unable to retain existing personnel or identify or hire additional personnel, we may not be able to research, develop, commercialize or market our products, and as a result, our business may be harmed.
We may have significant clinical and product liability exposure.
The testing, manufacturing and marketing of medical diagnostic products entails an inherent risk of clinical and product liability claims. Our launch of new products, subject to obtaining appropriate regulatory approvals, to assist in the diagnosis of other indications, such as stroke, sepsis, abdominal pain and acute kidney injury, may further increase our risk of these claims. Potential clinical and product liability claims may exceed the amount of our insurance coverage or may be excluded from coverage under the terms of the policy. In the future, our existing insurance may not be renewed at a cost and level of coverage comparable to that presently in effect, or at all. In the event that we are held liable for a claim against which we are not indemnified or for damages exceeding the limits of our insurance coverage, our liabilities could exceed our total assets.
Future changes in financial accounting standards or practices or existing taxation rules or practices may cause adverse unexpected revenue and/or expense fluctuations and affect our reported results of operations.
A change in accounting standards or practices or a change in existing taxation rules or practices can have a significant effect on our reported results and may even affect our reporting of transactions completed before the change is effective. New accounting pronouncements and taxation rules and varying interpretations of accounting pronouncements and taxation practice have occurred and may occur in the future. Changes to existing rules or the questioning of current practices may adversely affect our reported financial results or the way we conduct our business. For example, as a result of changes approved by the Financial Accounting Standards Board, or FASB, on January 1, 2006 we began recording compensation expense in our statements of income for equity compensation instruments, including employee stock options, using the fair value method. Our reported financial results beginning for the first quarter of 2006 and for all foreseeable future periods will be negatively and materially impacted by this accounting change. Other potential changes in existing taxation rules related to stock options and other forms of equity compensation could also have a significant negative effect on our reported results.
Evolving regulation of corporate governance and public disclosure may result in additional expenses and continuing uncertainty.
Changing laws, regulations and standards relating to corporate governance and public disclosure, including the Sarbanes-Oxley Act of 2002, new SEC regulations and Nasdaq National Market rules are creating uncertainty for companies such as ours. These new or changed laws, regulations and standards are subject to varying interpretations, in many cases due to their lack of specificity, and as a result, their application in practice may evolve over time as new guidance is provided by regulatory and governing bodies. This could result in continuing uncertainty regarding compliance matters and higher costs necessitated by ongoing revisions to disclosure and governance practices. We are committed to maintaining high standards of corporate governance and public disclosure. As a result, we intend to invest resources to comply with evolving laws, regulations and standards, and this investment may result in increased general and administrative expenses and a diversion of management time and attention from revenue-generating activities to compliance activities. If our efforts to comply with new or changed laws, regulations and standards differ from the activities intended by regulatory or governing bodies due to ambiguities related to practice, regulatory authorities may initiate legal proceedings against us and we may be harmed.
Investor confidence and share value may be adversely impacted if our independent auditors are unable to provide us with the attestation of the adequacy of our internal controls over financial reporting, as required by Section 404 of the Sarbanes-Oxley Act of 2002.
Pursuant to Section 404 of the Sarbanes-Oxley Act of 2002, we are required to include in our annual reports on Form 10-K a report of management on our internal controls over financial reporting, including an assessment by management of the effectiveness of those internal controls over financial reporting. In addition, our independent auditors must attest to and report on management’s assessment of the effectiveness of our internal controls over financial reporting. How companies are implementing these new requirements including internal control reforms, if any, to comply with Section 404’s requirements, and how independent auditors are applying these new requirements and testing companies’ internal controls, remain subject to some uncertainty. We expect that our internal controls will continue to evolve as our business activities change. Although we will continue to diligently and vigorously review our internal controls over financial reporting in order to ensure compliance with the Section 404 requirements, any control system, regardless of how well designed, operated and evaluated, can provide only reasonable, not absolute, assurance that its objectives will be met. If, during any year, our independent auditors are not satisfied with our internal controls over financial reporting or the level at which these controls are documented, designed, operated, tested or assessed, or if the independent auditors interpret the applicable requirements, rules or regulations differently than we do, then they may decline to attest to management’s assessment or may issue a report
that is qualified. This could result in an adverse reaction in the financial marketplace due to a loss of investor confidence in the reliability of our financial statements, which could negatively impact the market price of our shares.
Item 1B.
Item 1B. Unresolved Staff Comments
Not applicable.
Item 2.
Item 2. Properties
In October 2003, we completed our purchase of land for the construction of our new corporate complex. We purchased a total of 26.1 usable acres for approximately $28.2 million. We expect the new complex to provide us with up to 800,000 square feet of space, to be constructed in phases as needed. The first phase will provide us with approximately 350,000 square feet of space. The total cost of the land and the construction of the first phase is estimated to be approximately $110.0 million. We have funded the construction of the complex using our available cash. As of March 1, 2006, our research and development staff, selling, general and administrative staff and a portion of our manufacturing operations have relocated to the new corporate complex. We expect to complete the other buildings in the first phase of construction during the first half of 2006 and to relocate our remaining operations in stages once the buildings are ready for use. We expect our occupancy costs to increase primarily due to increased square footage. Should there be a downturn in our business or the markets in which we compete, we may not have a need to expand our facilities as we have planned. As a result, we may then seek an alternative use for all or a portion of the property, or seek to sell the property, which may have a negative impact on our operating results.
We lease approximately 77,000 square feet of space in five buildings in the Sorrento Valley area of San Diego, California under leases that expire between March and June 2006. These leased facilities are used for some of our research and development facilities and manufacturing operations. We also lease office space in Buc, France, Ghent, Belgium, Willich, Germany, Scorze, Italy, Madrid, Spain and Hong Kong, China for our international operations under leases that expire between July 2006 and December 2012. Certain of the leases contain the right of early termination at Biosite’s sole discretion at specific dates during the applicable lease term. We believe our facilities are adequate for our current needs and that suitable additional or alternative space, such as our new corporate complex, will be available in the future on commercially reasonable terms as needed.
Item 3.
Item 3. Legal Proceedings
From time to time, we may be involved in litigation relating to claims arising out of our operations in the normal course of business. As of the date of this Annual Report on Form 10-K, we are not engaged in any legal proceedings other than those described below that may, individually or in the aggregate, have a material adverse effect on our business, financial condition or operating results.
In November 2004, Roche Diagnostics Corporation, together with certain of its affiliates, filed a complaint in the United States District Court, Southern District of Indiana, Indianapolis Division alleging that Biosite is infringing two patents, U.S. Patent 5,366,609 (the “‘609 Patent”) and U.S. Patent 4,816,224 (the “‘224 Patent”), owned by Roche and/or its affiliates (the “Indiana Case”). Biosite filed an answer and counterclaims to Roche’s complaint in February 2005. In March 2005, at the mutual request of Biosite and Roche, the Indiana Case was, for purposes of claim construction of the ‘609 Patent only, consolidated-in-part with two other cases filed by Roche against several unrelated parties and pending in the same trial court. The hearing on this subject of claim construction, which is commonly referred to as a Markman hearing, with respect to the ‘609 Patent occurred on August 1, 2005 and in October 2005 the court issued a ruling on the subjects at issue at that hearing. The parties are engaged in discovery with respect to the Indiana Case. Roche is seeking unspecified monetary damages and injunctive relief, among other remedies. We believe Roche’s allegations of infringement of the ‘609 Patent and ‘224 Patent are without merit and we are vigorously contesting these claims.
Also, in November 2004, Biosite filed a complaint in the United States District Court, Southern District of California alleging that Roche Diagnostics Corporation and Roche Diagnostics GmbH are infringing two patents, U.S. Patent 6,174,686 and U.S. Patent 5,795,725, owned by Biosite. The patents relate to methods for the measurement of cardiac troponin forms. Roche filed an answer and counterclaims to our complaint in March 2005.
In October 2005, Biosite amended its complaint, further alleging that Roche Diagnostics Corporation and Roche Diagnostics GmbH are also infringing U.S. Patent 6,939,678, a newly issued patent assigned to Biosite that is also related to methods for the measurement of cardiac troponin forms. The parties have commenced preliminary discovery with respect to the California case. Biosite is seeking unspecified monetary damages and injunctive relief, among other remedies. We believe our claims have merit and we are vigorously pursuing their prosecution.
All parties in both lawsuits have been served. In December 2005, we announced that we are in discussions with Roche regarding a potential settlement of both pending cases. Biosite and Roche filed joint requests to stay the litigation in the United States District Courts in the Southern District of California and the Southern District of Indiana through April 2006, both of which requests have been granted. Given the stage of both actions and the current stay of the proceedings, we cannot predict the ultimate outcome of either matter at this time.
Item 4.
Item 4. Submission of Matters to a Vote of Security Holders
Not applicable.
PART II
Item 5.
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Our common stock is traded on the Nasdaq National Market, under the symbol BSTE. The following tables set forth the high and low sale prices for our common stock as reported on the Nasdaq National Market for the periods indicated.
There were approximately 96 holders of record of our common stock as of March 1, 2006. We have not paid any cash dividends to date and do not anticipate any being paid in the foreseeable future.
The information required to be disclosed by Item 201(d) of Regulation S-K, “Securities Authorized for Issuance Under Equity Compensation Plans”, is incorporated by reference within Item 12 of Part III of this Annual Report on Form 10-K.
In February 2006, we announced a program to repurchase up to $30 million of our common stock. The timing of repurchases and the exact number of shares of our common stock to be repurchased will depend on prevailing market conditions and other factors. Repurchases under the program will be made using our own cash reserves and may be made in the open market, in privately negotiated transactions, or through the use of derivative securities or similar arrangements. As of March 14, 2006, we have repurchased an aggregate of 355,526 shares of our common stock at a total cost of approximately $18.7 million, including commissions. All of these purchases have been made through open market transactions pursuant to a 10b5-1 trading plan.
Item 6.
Item 6. Selected Financial Data
The following table sets forth selected consolidated financial data for each of our last five fiscal years during the period ended December 31, 2005. You should read this data in conjunction with Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations”, as well as our consolidated financial statements and related notes appearing elsewhere in this Form 10-K.
(in thousands, except per share data)
(1) Computed on the basis described in Note 1 of our Notes to Consolidated Financial Statements.
Item 7.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The matters discussed in this “Management’s Discussion and Analysis of Financial Condition and Results of Operations” contain forward-looking statements that involve risks and uncertainties. See “Forward-Looking Statements.”
Overview
Founded in 1988, Biosite® Incorporated is a medical diagnostic company utilizing a biotechnology approach to create a broad and diverse portfolio of market-leading diagnostic tests. Our business model is designed to be fully integrated from discovery to customer, with a focus on patenting novel protein biomarker panels, manufacturing complex products at appreciable profit margins, employing strategic clinical studies and trials to validate our products’ diagnostic utility, and an emphasis on education when marketing our pioneering diagnostics directly to healthcare providers.
Our products are principally sold to acute care hospitals, which number approximately 5,400 in the United States. To market our products, we utilize a direct sales team that focuses its efforts primarily on larger centers with more than 200 beds and smaller hospitals that are high volume users of our products. We also use a network of distributors both in the United States and internationally.
The Fisher HealthCare Division of the Fisher Scientific Company, or Fisher, distributes our products primarily in hospitals in the United States and supports our direct sales force, particularly in smaller hospitals. We have a distribution agreement with Fisher that extends through December 31, 2008, subject to some limited exceptions pursuant to which a party may elect to terminate the agreement earlier. Sales to Fisher represented 84% and 86% of our product sales in 2005 and 2004, respectively. We primarily utilize distributor relationships with Physician Sales & Services, or PSS, and Henry Schein, Inc., or Henry Schein, to market our products to physician office laboratories in the United States.
In international markets, we have established direct selling efforts in several countries and utilize a network of country-specific and regional distributors in other areas. Since 2003, we have initiated direct sales and distribution operations in France, Germany, Belgium, Luxembourg, the United Kingdom, Italy and the Netherlands. In the future, we may transition to direct sales and distribution of our products in additional countries. We also employ a field-based network of clinically experienced individuals that support our direct sales force by providing pre- and post- sale education and training.
Our total revenues for 2005 were $287.7 million, representing a 17% increase over 2004. This growth resulted largely from increased sales of our Triage BNP Test products, which are primarily used to aid in the diagnosis of heart failure. Our meter-based Triage BNP Test, launched domestically in January 2001, was the first blood test available to aid in the detection of heart failure and benefited from a semi-exclusive position in the market, until the entry of direct competition in June 2003. In December 2003, we received clearance from the United States Food and Drug Administration, or FDA, to market our Triage BNP Test for Beckman Coulter Immunoassay Systems and we began selling the product in the United States in January 2004. As a result, a customer can perform b-type natriuretic peptide, or BNP, testing using either our rapid, portable Triage MeterPlus system or any of Beckman Coulter, Inc.’s automated immunoassay systems.
Today, our Triage BNP Test products are among several FDA-cleared blood products for use as an aid in the diagnosis of heart failure. These include products from Bayer Healthcare, Dade Behring, Roche Diagnostics and Abbott Laboratories, which offer products based on large, centralized automated testing platforms. In addition, Abbott Laboratories has announced that it will offer a BNP test on its i-STAT meter product, which is designed for use at the point-of-care. We have experienced, and continue to experience, competition from these companies and anticipate competition from others in the future. Our competitors may succeed in developing or marketing products that are more effective or more commercially attractive than the Triage BNP Tests. Moreover, we may not have the financial resources, technical expertise or marketing, distribution or support capabilities to compete successfully with these and other competitors in the future.
With several diagnostic products commercialized, our focus has expanded to include the search for proprietary disease markers that can potentially be applied to our testing platforms or to platforms marketed by other diagnostic companies with whom we might collaborate. To that end, in 1999 we launched Biosite Discovery. Through Biosite
Discovery, we leverage our expertise in phage display antibody development to access protein targets via collaborations with clinical institutions or commercial companies, or via our internal research and licensing programs. Biosite Discovery has also attracted the interest of leading clinical collaborators, who provide patient samples and assist in the analysis of clinical data. The discovery of new disease markers and the extension of applications for existing products could enable us to expand our product sales into other healthcare market segments. Included in contract revenues for the year ended December 31, 2005 are annual maintenance fees on antibodies produced by Biosite that continue to be used in research and development programs of our partners.
We have reported consecutive quarterly operating profits since the third quarter of 1999, after incurring quarterly operating losses during the prior seven quarters. Our operating results may fluctuate on a quarterly or annual basis in the future and our growth or operating results may not be consistent with predictions made by us or by securities analysts. We may not be able to maintain profitability in the future. Some of the risks and uncertainties associated with our business and future operating results are discussed below under the heading “Liquidity and Capital Resources,” and in Item 1A, “Risk Factors” of this Annual Report on Form 10-K.
Critical Accounting Policies Involving Management Estimates and Assumptions
The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions in certain circumstances that affect amounts reported in the accompanying financial statements and related footnotes. In preparing these financial statements, management has made its best estimates and judgments of certain amounts included in the financial statements, giving due consideration to materiality. We do not believe there is a great likelihood that materially different amounts would be reported related to the accounting policies described below. However, application of these accounting policies involves the exercise of judgment and use of assumptions as to future uncertainties and, as a result, actual results could differ from these estimates. Our senior management has discussed the development and selection of the critical accounting estimates, and related disclosures, with the Audit Committee of our Board of Directors.
Revenue Recognition. We recognize product sales upon shipment, including to Fisher and our other distributors, unless there are significant post-delivery obligations or collection is not considered probable at the time of shipment. Generally, we do not have any significant post-delivery obligations associated with our product sales. We accrue for warranty costs and other allowances at the time of shipment based on historical experience, trends and estimates.
Our collaborative development agreements generally contain specific payments for specific activities or elements of the agreements. Among the payments we might receive under the agreements are: up-front technology access fees, research funding, antibody development fees upon the delivery of antibodies, annual maintenance fees on targets for which we have produced antibodies for as long as the targets remain in development by our collaborators, milestone fees on drug targets that reach certain development milestones and royalties should products successfully be commercialized as a result of the collaboration. Up-front technology access fees are recognized over the term of the agreement or ongoing research period, as applicable, unless we have no further continuing performance obligations related to the fees. Research funding is recognized over the applicable research period on a straight-line basis, which approximates the underlying performance. Milestone payments, such as antibody development fees and clinical milestones, are recognized when earned, as the milestone events are substantive and their achievability is not reasonably assured at the inception of the agreement. Contract revenues that are based on the performance of and collection by our collaborators or their partners are deferred until such performance is complete and collection is probable. We believe that each payment element of these agreements represents the fair value of the element at the date of the agreement.
The SEC’s Staff Accounting Bulletin, or SAB, No. 104, Revenue Recognition, provides guidance on the application of generally accepted accounting principles to selected revenue recognition issues. We believe that our revenue recognition policy is appropriate and in accordance with generally accepted accounting principles and SAB No. 104.
Warranty Reserves. Our warranty reserve primarily relates to warranty coverage extended with the placement of the Triage MeterPlus. The Triage MeterPlus is manufactured by LRE Technology Partners GmbH, or LRE, who provides Biosite a contractual warranty against manufacturer’s defects and poor workmanship. Should a meter not function to specification and the cause is determined to be due to a manufacturer’s defect or poor workmanship, the malfunctioning meter would be returned to LRE for replacement or repair. LRE would incur and bear all the cost to replace or repair the meter. We have established a warranty allowance for the costs to replace or repair meters that would not be covered by LRE’s warranty. Historical experience and trends detailing returns and replacement
activity in total and those that have been covered by LRE’s manufacturer’s warranty are used in estimating our warranty allowance.
Allowance for Doubtful Accounts. We also maintain an allowance for doubtful accounts for potential uncollectible accounts receivable arising from our customers’ inability to make required payments. Our estimate is determined by analyzing historical bad debts, customer payment history and patterns, customer creditworthiness, and economic, political or regulatory factors affecting the customer’s ability to make the required payments.
Inventories and Related Allowances. Net inventories are valued at the lower of the first-in, first-out, or FIFO, cost or market value and have been reduced by an allowance for excess, obsolete and potential scrap inventories. The estimated allowance for excess and obsolete inventories is based on inventories on hand compared to estimated future usage and sales and assumptions about the likelihood of scrap or obsolescence. During our manufacturing processes, some work-in-process inventories require additional testing or re-work. These inventories are separately tracked and reviewed on a monthly basis to determine their status and an estimated reserve for potential scrap is calculated. We utilize a standard cost system to track our inventories on a part-by-part basis. When necessary, adjustments are made to the standard materials, standard labor and standard overhead costs to approximate actual labor and actual overhead costs on a FIFO cost basis.
Intangible and Other Long-Lived Assets. At December 31, 2005, we had approximately $163.2 million of long-lived assets, including $29.1 million of land, $56.0 million of buildings and improvements, $22.8 million of building construction-in-progress, $98,000 of leasehold improvements, $43.1 million of equipment, furniture and fixtures and $7.9 million of capitalized license rights and other assets. Building, building improvements, leasehold improvements, equipment, intangible assets and certain other long-lived assets are amortized or depreciated over the lesser of their useful lives or the remaining lease term. We lease five buildings in the San Diego with leases that expire between March and June 2006. Useful lives are based on management’s estimates of the period that the assets will generate revenue directly or indirectly. License rights related to products for sale are amortized to cost of sales over the life of the license, generally not to exceed 10 years, using a systematic method based on the estimated revenues generated from products during the shorter of the license period or 10 years from the inception of the license. The estimated revenues used as the base by which we amortize the license rights include only estimated sales for products we are currently selling and do not include any estimated revenues expected to be realized during the license amortization term from products still in development today. Our intangible assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable.
Income Tax Reserve. It is our policy to record tax benefits only if we conclude that it is at least probable that the deduction or credit will be sustained upon examination by tax authorities. In the period that permanent tax benefits, including research and development tax credits, are generated, we recognize the tax benefits at their estimated net realizable value. With regard to research tax credits, the determination of qualified expenses and activities involves judgment. Tax authorities have regularly examined and challenged research and development tax credits claimed by companies and have disallowed tax credit amounts based on the tax authorities’ evaluation and judgment. We reduce tax benefits to their estimated net realizable value based upon our management’s assessment of exposure associated with permanent tax differences, tax credits and interest expense applied to temporary difference adjustments. The tax benefits are analyzed periodically and adjustments are made as events occur to warrant adjustments to the estimate of the net realizable value of the tax benefits.
Valuation of Stock-based Compensation Payments. With respect to accounting for stock-based compensation payments to our employees for periods through December 31, 2005, we followed Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, or APB 25, and related interpretations. During these periods, stock options issued to non-employees were recorded at their fair value as determined in accordance with FAS No. 123, Accounting for Stock-based Compensation, or FAS 123, and Emerging Issues Task Force, or EITF, Issue No. 96-18, Accounting for Equity Instruments that are Issued to Other than Employees for Acquiring, or in Conjunction with Selling, Goods or Services, and were periodically remeasured as the stock options vest. Beginning January 1, 2006, we will adopt FAS No. 123 (revised 2004), a revision to FASB Statement No. 123, or FAS 123(R).
Included in the footnotes to the accompanying financial statements is adjusted pro forma information regarding net income as required by FAS No. 123, which has been determined as if we had accounted for our employee stock-based compensation under the fair value method of that Statement for the periods presented. For all options granted on or after April 1, 2005, we changed our fair value option pricing model from the Black-Scholes model to a binomial model. The fair value of stock options and purchase rights granted prior to April 1, 2005 was determined using the Black-Scholes model. We believe that the binomial model considers characteristics of fair value option pricing that are not available under the Black-Scholes model. Similar to the Black-Scholes model, the binomial
model takes into account variables such as volatility, dividend yield rate and risk free interest rate. However, in addition, the binomial model considers the contractual term of the option, the probability that the option will be exercised prior to the end of its contractual life, and the probability of termination or retirement of the option holder in computing the value of the option.
The valuation of stock-based compensation instruments is determined at the date of grant and includes assumptions with regards to: 1) expected life of stock options, which is primarily based on the historical exercise behavior of our employees, and stock purchase rights issuable under our employee stock purchase plan, or ESPP, 2) expected volatility during the expected life of the stock options and stock purchase rights using historical and implied volatility, 3) expected dividends during the expected life of the stock options and stock purchase rights and 4) the expected risk-free interest during the expected life of the stock options and stock purchase rights.
Recent Developments
Triage MPO - FDA 510(k) Filing
In December 2005, we submitted a 510(k) Premarket Notification to the FDA for diagnostic tests for myeloperoxidase, or MPO, a biomarker of inflammation in the walls of coronary arteries. MPO appears to be an indicator of unstable atherosclerotic plaque, and has been shown to elevate earlier than current markers of cell death. We licensed certain diagnostic rights to MPO in 2004 under an agreement with The Cleveland Clinic Foundation and Prognostix, Inc.
MPO is believed to be useful as an aid in the early diagnosis of myocardial infarction and could signal risk for heart disease or heart attack in patients with chest pain or ACS. Subject to obtaining appropriate regulatory approvals, we plan to offer a single Triage MPO Test and a second generation Triage CardioProfilER Panel that will include MPO.
We believe the addition of MPO to the Triage CardioProfilER Panel can advance the diagnostic and prognostic utility of the product, which is used for emergency assessment of chest pain patients. The panel currently measures the levels of troponin and its complexes, along with CK-MB, BNP and myoglobin in blood and is used as an aid in the diagnosis of myocardial infarction (heart attack), diagnosis and assessment of severity of heart failure and risk stratification of patients with ACS.
Roche Litigation
In December 2005, we announced that we are in discussions with Roche regarding a potential settlement of both cases in our pending litigation. Biosite and Roche filed joint requests to stay the litigation in the United States District Courts in the Southern District of California and the Southern District of Indiana through April 2006. Both stays have been granted.
Change in Management
In January 2006, we announced that Tom Watlington, our executive vice president and chief operating officer, will leave Biosite by the end of the first quarter of 2006. In March 2006, we entered into a Transition Agreement with Mr. Watlington under which, among other things, he will continue to provide consulting services to Biosite through the end of 2006.
Stock Repurchase Program
In February 2006, we announced a program to repurchase up to $30 million of Biosite common stock. As of March 14, 2006, we have repurchased an aggregate of 355,526 shares of our common stock at a total cost of approximately $18.7 million, including commissions.
Results of Operations
Years ended December 31, 2005 and 2004
Product Sales. Product sales by product family were as follows (in thousands):
Product sales for 2005 were $282.8 million, representing an increase of 18% compared to $240.6 million for 2004. The $42.2 million increase in total product sales consisted primarily of product sales growth resulting from an increase in sales volume of $46.7 million, partially offset by a decrease in product sales resulting from lower average selling prices of approximately $4.5 million. In 2005, growth in the sales volume of our Triage BNP Tests represented 69% of the product sales growth resulting from an increase in sales volume.
Primarily as a result of significant fluctuations in customer demand, inventory levels of our products have been and in the future may be below or above targeted stocking levels. Our product sales are also impacted by the buying patterns of our distributors. Additionally, we believe that our products are subject to some seasonality in their use. Higher utilization rates of our Triage BNP Tests may be due to a higher number of ED visits by patients exhibiting shortness of breath, a symptom of heart failure and of influenza. However, higher utilization may also result from greater awareness, education and acceptance of the uses of our Triage BNP Test products, as well as additional users within the hospitals. Product sales to our distributors in future periods will be impacted as we and our distributors attempt to adjust our distributors’ inventories to targeted stocking levels and as we seek continued improvement in our effectiveness and efficiency in adjusting our manufacturing output and capacity.
Product sales of our cardiovascular products, consisting of our Triage BNP Tests, Triage Cardiac Panel, Triage CardioProfilER Panel, Triage Profiler Shortness of Breath Panel, Triage D-Dimer Test, and Triage MeterPlus, totaled $231.9 million for 2005. This represented an increase of 20% as compared to $192.5 million for 2004. The product sales growth of our cardiovascular products was primarily due to growth in sales volume of our Triage BNP Tests of $32.3 million, and of our Triage Profiler Panels of $9.0 million. This increase was partially offset by a reduction in product sales due to a decline in the average sales price of our Triage BNP Tests of $4.7 million. Our product sales growth rate for our Triage BNP Tests in future periods may be lower than in the past periods because of increased competition from alternative tests and testing platforms that aid in the diagnosis of heart failure. In addition, because most U.S. hospitals are already performing some form of testing for natriuretic peptides, the sales growth for our Triage BNP Tests resulting from the addition of new hospital customers in the United States may be less than what we have experienced in the past. In addition, as the global market for BNP testing matures and more competitive products become available, the average sales price for our Triage BNP Tests may continue to decline, which would negatively impact our revenue from product sales.
Product sales of the Triage Drugs of Abuse Panel, Triage TOX Drug Screen, Triage C. difficile Panel and Triage Parasite Panel were $50.9 million for
2005. This represented an increase of 6% as compared to $48.1 million for 2004. The increase in sales of these products for 2005 was primarily due to the growth in sales volume of our Triage TOX Drug Screen of $4.3 million. The increase was partially offset by a decrease in sales volume of the Triage Drugs of Abuse Panel of $2.6 million. We believe that domestic sales of the Triage Drugs of Abuse Panel products may decline as the available U.S. market becomes saturated and competitive pressures become more prominent in a maturing market.
Contract Revenues. Contract revenues consist of revenues associated with our research and development and licensing arrangements, including license fees, milestone revenues, royalties, research funding and antibody fees. Contract revenues for 2005 were $4.9 million, compared to $4.3 million for 2004. Contract revenues recognized during 2005 and 2004 consisted primarily of research funding. During both 2005 and 2004, we recognized $3.0 million of research funding from an alliance with Medarex Inc., which expires in 2008. The increase in contract revenues for 2005 as compared to 2004 was related to an increase of $900,000 in annual maintenance fees on antibodies produced by Biosite that are used in research and development programs of our partners. The increase was partially offset by a $250,000 decrease in research milestone payments. Biosite Discovery activities are performed and its costs are incurred by certain of our research and development teams. These Biosite Discovery research and development resources concurrently focus on programs for our partners, which generate our contract revenues, and on internal research and development programs. Costs of the research and development resources performing collaborative and internal Biosite Discovery activities were $8.0 million for 2005, compared to $6.5 million for 2004. These costs are included in research and development expenses.
Cost of Product Sales and Gross Profit From Product Sales. Gross profit from product sales for 2005 was $197.7 million, representing an increase of 23% compared to $161.2 million for 2004. The $36.5 million increase in gross profit from product sales in 2005, compared to 2004, consisted of $28.3 million attributable to product sales growth and of $8.2 million resulting from changes in the gross margins of our different products. The overall gross margin for 2005 increased to 70%, compared to 67% for 2004. The increase in the overall gross margin was primarily due to operational improvements that resulted in greater manufacturing efficiencies and lower scrap.
Although our gross profits may continue to grow, we expect our overall gross margin to fluctuate as a result of the changing mix of products sold with different gross margins, changes in our manufacturing processes or costs, and competitive pricing pressures. Any new products that we successfully develop, acquire and sell may change our future gross margins. Manufacturing inefficiencies, including inefficiencies experienced as we attempt to manufacture newer products on a larger scale, and increase or decrease our manufacturing capacity, production volumes and manufacturing output will also impact our gross margins. Our manufacturing overhead costs are spread over the changing production volumes manufactured during a quarter on a first-in, first-out basis.
We expect the cost of product sales in 2006 to be materially higher than 2005 due to the expensing of share-based compensation, such as stock options, as a result of the adoption of FAS 123(R). We also expect that our fixed occupancy costs will significantly increase as we continue to transition our manufacturing operations to our new corporate complex, in which our manufacturing operations will occupy a much larger space than in our existing facilities. We may also incur unexpected costs and expenses in connection with our move from our existing facilities to our new corporate complex, or we may experience unanticipated decreases in productivity and other losses due to inefficiencies relating to this transition or due to delays, whether due to regulatory approvals for the validation of the manufacturing facilities, or from other causes. For instance, the scale-up of manufacturing at our new corporate complex could result in lower than expected manufacturing output and higher than expected product costs. In addition, we have incurred and expect to continue to incur some duplicate facilities expenses during the period of time in which we transfer our operations to the new corporate complex as we will transfer our operations in stages. Any delays could cause us to incur these duplicate expenses for longer than we currently anticipate.
Selling, General and Administrative Expenses. Selling, general and administrative, or SG&A, expenses for 2005 were $74.8 million, representing an increase of 14%, compared to $65.4 million for 2004. At December 31, 2005, our headcount for sales, marketing and administrative functions totaled 350 employees, compared with 315 employees at December 31, 2004. The increase in SG&A expenses was primarily associated with the addition of sales, clinical education and technical service resources, and administrative support. The expansion of our direct sales, marketing and distribution operations in Europe resulted in increases in SG&A expenses of $3.6 million in 2005 as compared to 2004. We began direct sales, marketing and distribution in certain European countries at different dates from July 2003 to February 2006, and we are continuing to scale-up our direct operations in Europe. In the future, we also may transition to direct sales and distribution in additional countries, which will require additional sales, marketing and administrative resources outside the United States. Our facilities expenses related to SG&A activities increased by approximately $2.4 million in 2005, as compared to 2004, primarily due to costs related to the relocation to our new corporate complex in 2005. Also, as a result of growth in sales activities,
marketing activities and general administrative resources for 2005, employee-related expenses in the United States increased approximately $2.2 million as compared to 2004.
We expect SG&A expenses to materially increase in 2006 as compared to 2005 due to the expensing of share-based compensation, such as stock options, as a result of the adoption of FAS 123(R) on January 1, 2006. We also expect SG&A expenses in 2006 to be higher than in 2005, as we continue to increase our sales, marketing, clinical education, technical service and general administration resources in the United States, as well as continue to build our direct sales, distribution and administrative infrastructure in Europe. We also expect other non-employee-related costs, including sales and marketing program activities for our new products, to grow as our overall operations grow. The timing of these increased expenditures and their magnitude are primarily dependent on the commercial success and sales growth of our products as well as the timing of any new product launches. We also expect SG&A expenses to increase due to costs associated with our continuing consolidation from our previous facilities to our new corporate complex and higher occupancy costs primarily due to increased square footage at the new corporate complex and, for a period of time, occupancy costs of both facilities.
Research and Development Expenses. Research and development, or R&D, expenses for 2005 were $42.2 million, representing an increase of approximately 18% compared to $35.7 million for 2004. The increase in R&D expenses for 2005 consisted primarily of an increase in employee expenses of $2.9 million. Additionally, for 2005, we experienced increases in consultant, clinical studies and patent-related expenses of $1.9 million and increases in facilities costs of $611,000 as compared to 2004. During 2005, our R&D resources were focused primarily on product development for potential new diagnostic products, including a new ACS panel and other diagnostic products for critical health conditions such as sepsis and abdominal pain. We also focused on the development of potential improvements to our existing products, including our Triage Cardiac Panel, manufacturing processes and research activities associated with Biosite Discovery. Expenses related to the performance of our obligations associated with earning our contract revenues were incurred by our R&D group and were primarily related to Biosite Discovery.
We expect R&D expenses in 2006 to be higher than in 2005 and to relate primarily to:
• the expensing of share-based compensation, such as stock options, due to the adoption of FAS 123(R);
• product development efforts, including the development of potential diagnostic products for ACS, stroke, MPO, sepsis, acute kidney injury and abdominal pain;
• clinical studies, including studies associated with potential diagnostic products for stroke and studies related to the exploration and validation of other potential uses for our Triage BNP Tests;
• engineering development programs intended to miniaturize the Triage MeterPlus Platform and automate and improve manufacturing processes;
• manufacturing scale-up for potential new products, including the Triage Stroke Panel;
• costs associated with FDA submissions for products under development, including the Triage Stroke Panel, and other interactions with the FDA;
• Biosite Discovery activities;
• performance-based compensation; and
• costs associated with our move from our existing facilities to our new corporate complex and higher occupancy costs primarily due to increased square footage at the new corporate complex and occupancy of both facilities for a period of time.
The timing of such increased expenditures and their magnitude are primarily dependent on the commercial success and sales growth of our products, as well as the timing and progress of our R&D efforts.
License and Patent Disputes. Expenses associated with license and patent disputes were $2.0 million in 2005, compared to $178,000 in 2004. The expenses consisted of legal costs related to two lawsuits involving Roche Diagnostics Corporation and several of its affiliates. In November 2004, Roche and certain of its affiliates filed a complaint in the United States District Court, Southern District of Indiana, Indianapolis Division alleging that Biosite is infringing two patents, U.S. Patent 5,366,609 and U.S. Patent 4,816,224, owned by Roche and/or its affiliates. We believe these allegations of infringement are without merit and we are vigorously contesting these claims. Also, in November 2004, we filed a complaint in the United States District Court, Southern District of California alleging that Roche Diagnostics Corporation and Roche Diagnostics GmbH are infringing two patents, U.S. Patent 6,174,686 and U.S. Patent 5,795,725, owned by Biosite. In October 2005, we amended our complaint, further alleging infringement of a third Biosite patent, U.S. Patent 6,939,678. All of the Biosite patents relate to methods for the measurement of cardiac troponin forms. In December 2005, we announced that we are in discussions with Roche regarding a potential settlement of both pending cases. Biosite and Roche filed joint
requests to stay the litigation in the United States District Courts in the Southern District of California and the Southern District of Indiana through April 2006, both of which requests have now been granted.
Interest and Other Income, Net. Interest and other income, net was $2.7 million for 2005, compared to $1.3 million for 2004. The increases resulted primarily from an increase in interest income due to higher average balances of cash and marketable securities and higher interest rates in 2005 compared to 2004.
Provision for Income Taxes. As a result of the pre-tax income and the estimated tax credits and other permanent differences between our reported and tax results in 2005, we recorded a provision for income taxes of $32.3 million for 2005, equivalent to an effective tax rate of 37.4%. For 2004, we recorded a provision for income taxes of $24.2 million, equivalent to an effective tax rate of 36.8%. The increase in the effective tax rate was due primarily to a decrease in R&D tax credits generated in 2005 as compared to 2004. The 2005 R&D tax credits were limited by the statutory restriction that limits the tax credits to research expenses as a percentage of product sales. We will continue to assess the likelihood of realization of our tax credits and other net deferred tax assets. If future events occur that do not make the realization of such assets more likely than not, a valuation allowance will be established against all or a portion of the net deferred tax assets.
Years ended December 31, 2004 and 2003
Product Sales. Product sales for 2004 were $240.6 million, representing an increase of 42% compared with $169.3 million for 2003. The $71.3 million increase in total product sales consisted of $63.1 million of product sales growth resulting from an increase in sales volume, and $8.2 million resulting from an increase in average selling prices of our products. Growth in the sales volume of our Triage BNP Tests represented 85% of the product sales growth resulting from an increase in sales volume.
Product sales of our cardiovascular products, consisting of our Triage BNP Tests, Triage Cardiac Panel, Triage Profiler Panels and Triage MeterPlus, totaled $192.5 million for 2004. This represented an increase of 51% as compared with $127.2 million for 2003. The product sales growth of our cardiovascular products for 2004 was primarily due to the growth in sales volume of our Triage BNP Tests which totaled $53.7 million. Included in the sales volume growth of our Triage BNP Tests was $13.4 million related to our Triage BNP Test for Beckman Coulter Immunoassay Systems which we began selling in January 2004 in the United States.
Product sales of the Triage Drugs of Abuse Panel, Triage TOX Drug Screen, Triage C. difficile Panel and Triage Parasite Panel were $48.1 million for 2004. This represented an increase of 14% compared with $42.1 million for 2003. The increase in sales of these products was primarily due to the $3.8 million growth in sales volume of our Triage TOX Drug Screen. There was also a $1.5 million increase in product sales resulting from an increase in our average net selling prices for these products.
Contract Revenues. Contract revenues for 2004 were $4.3 million, compared with $4.1 million for 2003. We recognized $3.0 million of research funding from our alliance with Medarex during both 2004 and 2003. Other contract revenues recognized during those periods of 2004 and 2003 included antibody fees, milestone payments and license fees. Biosite Discovery activities were performed, and its costs are incurred, by certain of our research and development teams. These Biosite Discovery research and development resources concurrently focus on programs for our partners, which generated our contract revenue, and on internal research and development programs. Costs of the research and development resources performing collaborative and internal Biosite Discovery activities were approximately $6.5 million for 2004 compared with $5.7 million for 2003. These costs are included in research and development expenses.
Cost of Product Sales and Gross Profit From Product Sales. Gross profit from product sales for 2004 was $161.2 million, representing an increase of 46% compared with $110.7 million for 2003.
The $50.5 million increase in gross profits consisted of $46.7 million that resulted from product sales growth, and $3.9 million resulting from changes in the gross margins of each of our products. For 2004 and 2003, the gross margins for our cardiovascular products were 65% and 62%, respectively, while our gross margins for our Triage Drugs of Abuse Panel and other products were 71% and 75%, respectively. Sales of our cardiovascular products represented 80% of our product sales for 2004, compared with 75% for 2003. The overall gross margin for 2004 was 67%, compared with 65% in 2003. The increase in the overall gross margin was primarily due to the changing mix of our products sold with differing gross margins, and greater manufacturing efficiencies generated primarily from higher production volumes and manufacturing output during the manufacture of products sold in 2004 compared with 2003.
Selling, General and Administrative Expenses. SG&A expenses increased 26% to $65.4 million in 2004 from $51.9 million in 2003. At December 31, 2004, our headcount performing sales, marketing and administrative functions totaled 315 employees, compared with 261 employees at December 31, 2003. The increase in SG&A expenses was primarily associated with the addition of sales, clinical education and technical service resources in the United States, and higher performance-based compensation, such as sales commissions and bonuses based on our financial performance. Our employee-related expenses in the United States increased $7.3 million from 2003 to 2004. The formation and expansion of our direct sales and distribution operations in France, Germany, Belgium, Luxembourg, Italy and the UK resulted in an increase in SG&A expenses of $2.9 million from 2003 to 2004. Expanded sales activities related to our broader product lines and scale-up in additional markets such as physician offices, marketing activities relating to new products, and increased administrative costs to support our expanded operations resulted in an increase of $3.3 million from 2003 to 2004.
Research and Development Expenses. R&D expenses for 2004 were $35.7 million, representing an increase of 46% compared with $24.5 million for 2003. The increase in R&D expenses consisted primarily of a $3.5 million increase in employee expenses, an increase in consultant, clinical studies and patent-related expenses, including involvement in pending interference and opposition proceedings, totaling $2.9 million, and an increase in supplies used in our R&D activities of $3.3 million. During 2004, our research and development resources were focused primarily on product development for potential new diagnostic products, including the Triage Profiler CP Panel, Triage Profiler SOB Panel, Triage D-Dimer Test, Triage Stroke Panel and other diagnostic products for critical health conditions such as sepsis and abdominal pain. We also focused the development of potential improvements to our existing products, including our Triage Cardiac Panel, and manufacturing processes and research activities associated with Biosite Discovery. Expenses related to the performance of our obligations associated with earning our contract revenues were incurred by our research and development group and were primarily related to Biosite Discovery.
License and Patent Disputes. Expenses associated with license and patent disputes incurred during 2004 totaled $178,000. We did not incur any such expenses during 2003. The 2004 expenses consisted of legal costs related to our two pending litigations with Roche Diagnostics Corporation and several of its affiliates.
Interest and Other Income, Net. Interest and other income, net was $1.3 million for 2004, compared with $1.4 million for 2003. Our interest income during 2004 was $290,000 lower than interest income earned in 2003. During 2004, for liquidity purposes in anticipation of cash needs, including new corporate complex construction costs, as well as anticipation of rising interest rates, we maintained a larger portion of our cash and marketable securities in cash and cash equivalents, which yielded lower interest income than our marketable securities. The decrease in interest income was offset by an increase in realized gains primarily from the collection of intercompany receivables denominated in foreign currencies of $232,000 in 2004.
Provision for Income Taxes. We recorded a provision for income taxes of $24.2 million for 2004 compared with $15.1 million in 2003. Our annual effective tax rate for 2004 and 2003 was 36.8% and 37.8%, respectively. The decrease in the effective tax rate was due primarily to a decrease in our overall state tax rate of 0.6% as more of our product sales and income was apportioned to states with lower income tax rates.
Liquidity and Capital Resources
Historically, our sources of cash have included:
• cash generated from operations, primarily from the collection of accounts receivable resulting from product sales;
• private and public placements of equity securities, including cash generated from the exercise of stock options and participation in our employee stock purchase plan;
• proceeds from equipment financing;
• cash received under collaborative development agreements; and
• interest income.
Our historical cash outflows have primarily been associated with:
• cash used for operating activities such as the purchase and growth of inventory, expansion of our sales and marketing and R&D activities and other working capital needs; and
• the purchase of land and construction of facilities; and
• expenditures related to equipment and leaseholds used to increase our manufacturing capacity, improve our manufacturing efficiency and expand our research and development activities.
Other factors that impact our cash inflow and outflow include the following:
• We have experienced gross margins greater than 65% and operating margins greater than 20% in each of the last three years. As our product sales have increased significantly since 2001, our gross profit and operating income have increased significantly as well, providing us with an increasing source of cash to finance the expansion of our operations; and
• Fisher, which accounted for 84% of our product sales in 2005, has historically been a timely and predictable payor of its outstanding accounts receivable. We have a distribution relationship with Fisher that expires on December 31, 2008.
As of December 31, 2005, we had cash, cash equivalents and marketable securities of $132.4 million compared with $72.4 million as of December 31, 2004. The increase in cash, cash equivalents and marketable securities during 2005 was largely attributable to $91.5 million of cash generated from operating activities, for which the sales volume growth of our Triage BNP Tests was the primary driver. Additionally, we generated $29.3 million in cash from proceeds from the issuance of shares under our stock plans during 2005. We believe the increased activity related to the exercise of stock options and participation in our employee stock purchase plan by employees was driven by increases in the market price of our common stock. Future proceeds from exercise of stock options and participation in our employee stock purchase plan will depend primarily upon the behavior, expectations and needs of the plan participants and upon our stock price. The primary non-operating cash outflows during 2005 were cash used for the construction of our new corporate complex, which totaled $33.4 million, and for equipment and other fixed asset purchases of $20.5 million.
In February 2006, we announced a program to repurchase up to $30 million of Biosite common stock. As of March 14, 2006, we have repurchased an aggregate of 355,526 shares of our common stock at a total cost of approximately $18.7 million, including commissions.
In October 2003, we completed our purchase of land for the construction of our new corporate complex. We purchased a total of 26.1 usable acres for approximately $28.2 million. Through December 31, 2005, we have expended an additional $80.4 million for the design and construction of the new corporate complex. We expect the new complex to provide us with up to 800,000 square feet of space, to be constructed in phases as needed. The first phase will provide us with approximately 350,000 square feet of space. The total cost of the land and the construction of the first phase are estimated to cost approximately $110.0 million. We plan to finance the remaining construction costs using our available cash. As of March 1, 2006, our research and development staff, selling, general and administrative staff and a portion of our manufacturing operations have relocated to the new corporate complex. We expect to complete the other buildings in the first phase of construction during the first half of 2006 and to relocate our remaining operations in stages once the buildings are ready for use. We expect our occupancy costs to increase primarily due to increased square footage. Should there be a downturn in our business or the markets in which we compete, we may not have a need to expand our facilities as we have planned. As a result, we may then seek an alternative use for all or a portion of the property, or seek to sell the property, which may have a negative impact on our operating results. We may also incur unexpected costs and expenses in connection with our
move from our existing facilities to our new corporate complex, or we may experience unanticipated decreases in productivity and other losses due to inefficiencies relating to this transition, or delays in obtaining any required approvals or clearances from regulatory agencies related to the validation of the manufacturing facilities. For instance, the scale-up of manufacturing at our new corporate complex could result in lower than expected manufacturing output and higher than expected product costs. In addition, we have incurred and expect to continue to incur some duplicate facilities expenses, such as rent, as we are transferring our operations to the new corporate complex in stages.
Our primary short-term needs for capital, which are subject to change, include:
• any repurchase of our common stock;
• the remaining construction costs in the first phase of our new corporate complex, as well as our other facilities expansion needs;
• support of our commercialization efforts related to our current and future products, including expansion of our direct sales force and field support resources both in the United States and abroad;
• expenditures for equipment and other fixed assets for use in our new corporate complex, and for manufacturing and research and development purposes;
• improvements in our manufacturing capacity and efficiency, new discovery and product development efforts;
• clinical studies, and the continued advancement of research and development efforts;
• the prosecution, defense and resolution of ongoing license and patent disputes; and
• potential milestone payments under licensing agreements that cover intellectual property rights of third parties.
For 2006, we plan to spend approximately $35 million in cash for capital expenditures, primarily for manufacturing and R&D equipment, furniture, fixtures and computer equipment. We intend to use our currently available cash and cash we expect to generate from operating activities to address our capital requirements. We expect that the performance of our product sales and the resulting operating income will significantly impact our cash management decisions. We have utilized, and may continue to utilize, credit arrangements with financial institutions to finance the purchase of capital equipment. Factors such as interest rates and available cash will impact our decision to continue to utilize credit arrangements as a source of cash.
We believe that our available cash, cash from operations and proceeds from the issuance of stock under our stock plans will be sufficient to satisfy our funding needs for at least the next 24 months, except in the event that we determine to accelerate the development and/or construction of the remaining phases of our corporate complex. We have used available cash balances to purchase the land for our new corporate complex and pay for the design and construction costs to date. For the remainder of the construction costs, we plan to use our available cash. If cash generated from operations is insufficient to satisfy our working capital and capital expenditure requirements, we may be required to sell additional equity or debt securities or obtain additional credit facilities. Additional capital, if needed, may not be available on satisfactory terms, if at all. Furthermore, any additional equity financing may be dilutive to stockholders, and debt financing, if available, may include restrictive covenants. Our future liquidity and capital funding requirements will depend on numerous factors, including:
• the costs, timing and effectiveness of further expansion of sales, marketing and manufacturing activities and resources;
• expansion of our manufacturing capacity and our facilities expansion needs, including the construction of our new corporate complex;
• the effects of competition, including products competitive with our Triage BNP Tests, from companies with greater financial capital and resources;
• the effect on sales and cash receipts for our Triage BNP Tests due to market saturation in the hospital market for natriuretic peptide testing in the United States;
• regulatory changes, uncertainties or delays;
• the impact of the prosecution, defense and resolution of ongoing and potential future license and patent disputes;
• the extent to which our new products and products under development are successfully developed, gain regulatory approval and market acceptance and become and remain competitive;
• seasonal or unanticipated changes in customer demand;
• the scope, timing and results of research and development efforts, including clinical studies and regulatory actions regarding our potential products;
• changes in third-party reimbursement policies;
• the ability to execute, enforce and maintain license and collaborative agreements and attain the milestones under these agreements necessary to earn contract revenues;
• the costs and timing associated with business development activities, including potential licensing of technologies patented by others; and
• the timing and amount of any repurchase of our stock or early retirement of our debt.
Our failure to raise capital on acceptable terms, when needed, could have a material adverse effect on our business.
Contractual Obligations
The following table summarizes our contractual obligations as of December 31, 2005. This table should be read in conjunction with the remainder of this Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations”, as well as in conjunction with our consolidated financial statements and related notes appearing elsewhere in this Annual Report on Form
10-K.
(1) Purchase obligations include commitments to purchase components and raw materials used in the manufacture of our products, and other recurring purchases made in the normal course of business to meet operational and capital expenditure requirements.
We have executed agreements to license technologies that are covered by the intellectual property rights of third parties. The financial and commercial terms of each of these agreements vary significantly, and in virtually all cases our payment obligations under any individual agreement are not material to our business as a whole. For the most part, the license agreements call for potential cash outflows for milestone payments and future royalties based on product sales utilizing the licensed technologies. The milestone payments under these agreements are primarily dependent on achieving product development goals, commencement of clinical studies of a product utilizing the licensed technology or meeting commercialization objectives, or any combination thereof. Examples of milestones for which we would make payments would include: 1) initiation of clinical studies of a potential product that is covered by the licensed technologies, 2) FDA clearance to market a product that is covered by the licensed technologies, and 3) the first sale of a product that is covered by the licensed technologies in a specific territory. The attainment of the milestones is highly uncertain and dependent upon many contingencies. Additionally, we exercise discretion whether to continue to utilize the licensed technologies. At any time, we may, for technical or economic reasons, decide to discontinue utilizing the licensed technologies and would incur no further financial obligations beyond those payments already made. As of December 31, 2005, there were no milestones, either individually or in the aggregate, under our licensing and collaborative agreements for which we believe material payments were required to be made, and, in the future, we believe that there are approximately $812,000 in payments that are reasonably likely to be made.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
We are exposed to changes in interest rates, primarily from our investments in available-for-sale marketable securities. Under our current policies, we do not use interest rate derivatives instruments to manage this exposure to interest rate changes. A hypothetical 1% adverse move in interest rates along the entire interest rate yield curve would not materially affect the fair value of our financial instruments that are exposed to changes in interest rates.
Since 2003, we have significantly expanded our direct sales and distribution operations in France, Germany, Belgium, Luxembourg, the United Kingdom and Italy, and we may expand into additional countries in the future. Sales and costs resulting from our direct sales and distribution operations in Europe are denominated in local currencies and are subject to fluctuations in currency exchange rates. Further, we purchase our Triage MeterPlus inventory from LRE in Euros, and we incur employee and other operating costs in foreign currencies. As a result,
our costs will fluctuate along with the currencies and general economic conditions in the countries in which we do business, which could harm our operating results. In prior years, we have on occasion purchased forward exchange contracts to manage this exposure to exchange rate changes and may do so in the future. As of December 31, 2005, we had no outstanding forward exchange contracts. We recognized a net currency exchange loss on foreign currency denominated transactions of $207,000 for 2005 compared to a net gain of $310,000 for 2004. Significant fluctuations in currency exchange rates may negatively impact our consolidated sales and earnings.
International sales and operations are also subject to a variety of other risks, including:
• greater risk of uncollectible accounts;
• difficulty in staffing, monitoring and managing foreign operations;
• understanding of, and compliance with local employment laws, including reduced flexibility and increased cost of staffing adjustments;
• unknown or changes in regulatory practices, including import or export license requirements, trade barriers, tariffs, employment and tax laws;
• adverse tax consequences, including imposition of withholding or other taxes on payments by subsidiaries;
• restrictions on repatriation of locally-derived revenue;
• competition from locally-produced products with cost advantages or national appeal;
• local business practices that could expose our direct sales and marketing organization to Foreign Corrupt Practices Act risks;
• political, social or economic conditions and changes in these foreign markets; and
• government spending patterns.
Item 8.
Item 8. Financial Statements and Supplementary Data
Refer to the Index on Page F-l hereto.
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
Not applicable.
Item 9A.
Item 9A. Controls and Procedures
Conclusion Regarding the Effectiveness of Disclosure Controls and Procedures
Under the supervision and with the participation of our management, including our Chief Executive Officer (CEO) and Chief Financial Officer (CFO), we conducted an evaluation of our disclosure controls and procedures, as such term is defined under Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended, or the Exchange Act, as of the end of the period covered by this Annual Report on Form 10-K. Based on this evaluation, our CEO and CFO concluded that our disclosure controls and procedures were effective as of the end of the period covered by this Annual Report on Form 10-K.
Management’s Report on Internal Control Over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rule 13a-15(f) and 15d-15(f). Under the supervision and with the participation of our management, including our CEO and CFO, we conducted an evaluation of the effectiveness of our internal control over financial reporting as of December 31, 2005 based on the framework in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on our evaluation under the framework in Internal Control - Integrated Framework, our management concluded that our internal control over financial reporting was effective as of December 31, 2005.
Our management’s assessment of the effectiveness of our internal control over financial reporting as of December 31, 2005 has been audited by Ernst &Young LLP, an independent registered public accounting firm, as stated in their report which is included herein.
Report of Independent Registered Public Accounting Firm on Internal Control Over Financial Reporting
The Board of Directors and Stockholders
Biosite Incorporated
We have audited management’s assessment, included in the accompanying Management’s Assessment of Internal Controls Over Financial Reporting, that Biosite Incorporated maintained effective internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). Biosite Incorporated’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the company’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, management’s assessment that Biosite Incorporated maintained effective internal control over financial reporting as of December 31, 2005, is fairly stated, in all material respects, based on the COSO criteria. Also, in our opinion, Biosite Incorporated maintained, in all material respects, effective internal control over financial reporting as of December 31, 2005, based on the COSO criteria.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Biosite Incorporated as of December 31, 2005 and 2004, and the related consolidated statements of income, stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2005 of Biosite Incorporated and our report dated March 13, 2006 expressed an unqualified opinion thereon.
Item 9B.
Item 9B. Other Information
Not applicable.
PART III
Some information required by Part III is incorporated by reference from our definitive Proxy Statement to be filed with the Securities and Exchange Commission in connection with the solicitation of proxies for our 2005 Annual Meeting of Stockholders (the “Proxy Statement”).
Item 10.
Item 10. Directors and Executive Officers of the Registrant
The information required by this item is contained in the sections entitled “Election of Directors” and “Executive Officers” in the Proxy Statement and is incorporated herein by reference.
Item 11.
Item 11. Executive Compensation
The information required by this item is contained in the section entitled “Executive Compensation” in the Proxy Statement and is incorporated herein by reference.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
The information required by this item is contained in the sections entitled “Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters” and “Equity Compensation Plan Information” in the Proxy Statement and is incorporated herein by reference.
Item 13.
Item 13. Certain Relationships and Related Transactions
The information required by this item is contained in the section entitled “Certain Relationships and Related Transactions” in the Proxy Statement and it incorporated herein by reference.
Item 14.
Item 14. Principal Accountant Fees and Services
The information required by this item is contained in the section entitled “Ratification of Selection of Independent Auditors” in the Proxy Statement and is incorporated herein by reference.
PART IV
Item 15.
Item 15. Exhibits, Financial Statement Schedules
(a) (1) Financial Statements
Refer to the Index on page F-l hereto.
(2) Financial Statement Schedules
Refer to Schedule II, Valuation and Qualifying Accounts, hereto.
The other financial statement schedules required by this item have been omitted since they are either not required, not applicable or the information is otherwise included herein.
(3) Exhibits
EXHIBIT
NUMBER
DESCRIPTION OF DOCUMENT
3.(1) (1)
Restated Certificate of Incorporation.
3.(2) (1)
Certificate of Amendment to the Restated Certificate of Incorporation.
3.(3) (1)
Certificate of Designation, Rights and Preferences of Series A Participating Preferred Stock.
3.(4) (2)
Certificate of Amendment to the Restated Certificate of Incorporation.
3.(5) (3)
Certificate of Amendment to the Restated Certificate of Incorporation.
3.(6) (4)
Amended and Restated Bylaws.
4.1(2)
Form of Common Stock Certificate with rights legend.
10.1(5) (A)
Amended and Restated 1989 Stock Plan of Biosite Incorporated.
10.2(6) (A)
Amended and Restated 1996 Stock Incentive Plan of Biosite Incorporated (“1996 Stock Plan”).
10.3(5) (A)
Form of Incentive Stock Option Agreement under the 1996 Stock Plan.
10.4(5) (A)
Form of Nonstatutory Stock Option Agreement under the 1996 Stock Plan.
10.5(7) (A)
Biosite Incorporated Amended and Restated Employee Stock Purchase Plan.
10.6(8) (A)
Form of Indemnity Agreement between the Company and its officers and directors.
10.7(5)
Sublease Agreement between Biosite and General Atomics, dated February 17, 1992, as amended on August 10, 1992, January 21, 1993, October 29, 1993, March 1, 1995 and October 1, 1996.
10.8(5) (+)
Development, Supply and Distribution Agreement between Biosite and Kyoto Dai-Ichi Kagaku Co., Ltd., dated as of February 14, 1995.
10.9(5) (+)
Antibody License Agreement between Biosite and Sandoz Pharma Ltd. (currently known as Novartis Pharma AG), dated September 22, 1995, and amended on July 26, 1996.
10.10(5) (+)
Easy Assay License Agreement between Biosite and Sandoz Pharma Ltd. (currently known as Novartis Pharma AG), dated September 22, 1995.
10.11(5)
Debenture Purchase Agreement between Biosite and Sandoz Pharma Ltd. (currently known as Novartis Pharma AG), dated as of September 22, 1995.
10.12(5)
Lease Agreement between Biosite and Sorrento West Limited dated September 21, 1994.
10.13(9)
Rights Agreement dated as of October 22, 1997 between Biosite (formerly Biosite Diagnostics Incorporated) and Fleet National Bank (f/k/a BankBoston, N.A.) as Rights Agent.
10.14(10)
Amendment No. 1 to Rights Agreement dated as of December 9, 1999 between Biosite Incorporated (formerly Biosite Diagnostics Incorporated) and Fleet National Bank (f/k/a BankBoston, N.A.) as Rights Agent.
10.15(11)
Amendment No. 2 to Rights Agreement dated as of July 18, 2001 between Biosite Incorporated (formally Biosite Diagnostics Incorporated) and Fleet National Bank (f/k/a BankBoston, N.A.) and American Stock Transfer and Trust as successor Rights Agent.
10.16(12) (+)
Distribution Agreement between Biosite and Fisher Scientific Company L.L.C. effective January 1, 2004.
10.17(*)
Distribution Agreement between Biosite and Fisher Scientific Company L.L.C. effective January 1, 2006.
10.18(*)
Semi-exclusive BNP Diagnostic License Agreement between Biosite Diagnostics Incorporated and Scios, Inc. effective December 30, 1996.
10.19(*)
First Amendment to Semi-exclusive BNP Diagnostic License Agreement between Biosite Diagnostics Incorporated and Scios, Inc. effective August 1, 1997.
10.20(*)
Amendment #2 to Semi-exclusive BNP Diagnostic License Agreement between Biosite Incorporated and Scios, Inc. effective August 30, 2002.
10.21(*)
BNP Assay Development, Manufacture and Supply Agreement between Biosite Incorporated and Beckman Coulter, Inc. effective June 24, 2003.
10.22(13) (A)
Biosite Incorporated 2002 Nonqualified Stock Incentive Plan.
10.23(14) (A)
Biosite Incorporated Executive Bonus Plan.
10.24(15) (A)
Biosite Incorporated Nonqualified Deferred Compensation Plan effective June 1, 2002.
10.25(16) (A)
Biosite Incorporated Change in Control Severance Benefit Plan.
10.26(16) (A)
Form of Director Fee Deferral Program under the 1996 Stock Plan.
10.27(17) (A)
Biosite Incorporated 409A Nonqualified Deferred Compensation Plan effective January 1, 2005.
21.1
Subsidiaries of the Company.
23.1
Consent of Independent Registered Public Accounting Firm.
31.1
Section 302 Certification of Kim D. Blickenstaff, Chief Executive Officer
31.2
Section 302 Certification of Christopher J. Twomey, Chief Financial Officer
32.1
Section 906 Certification of Kim D. Blickenstaff, Chief Executive Officer
32.2
Section 906 Certification of Christopher J. Twomey, Chief Financial Officer
(1) Incorporated by reference to an exhibit to Biosite’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2001.
(2) Incorporated by reference to an exhibit to Biosite’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2003.
(3) Incorporated by reference to an exhibit to Biosite’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2005.
(4) Incorporated by reference to Exhibit 3.(ii) to Biosite’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2003.
(5) Incorporated by reference to an exhibit to Biosite’s Registration Statement on Form S-1, No. 333-17657.
(6) Incorporated by reference to Exhibit A to Biosite’s Definitive Proxy Statement dated April 25, 2005 and filed with the Securities and Exchange Commission.
(7) Incorporated by reference to Exhibit B to Biosite’s Definitive Proxy Statement dated April 27, 2004 and filed with the Securities and Exchange Commission.
(8) Incorporated by reference to Exhibit B to Biosite’s Definitive Proxy Statement dated April 27, 2004 and filed with the Securities and Exchange Commission.
(9) Incorporated by reference to Exhibit 4.1 to Biosite’s Registration Statement on Form 8-A, filed on October 28, 1997.
(10) Incorporated by reference to Exhibit 4.2 to Amendment No. 1 to Biosite’s Registration Statement on Form 8-A, filed on July 18, 2001.
(11) Incorporated by reference to Exhibit 4.3 to Amendment No. 1 to Biosite’s Registration Statement on Form 8-A, filed on July 18, 2001.
(12) Incorporated by reference to an exhibit to Biosite’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2003.
(13) Incorporated by reference to an exhibit to Biosite’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2005.
(14) Incorporated by reference to an exhibit to Biosite’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2003.
(15) Incorporated by reference to an exhibit to Biosite’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2003.
(16) Incorporated by reference to an exhibit to Biosite’s Annual Report on Form 10-K for the year ended December 31, 2004.
(17) Incorporated by reference to an exhibit to Biosite’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2005.
(A) Indicates management contract or compensatory plan or arrangement.
(+) Confidential treatment has been granted for certain portions of these exhibits, which have been omitted and filed separately with the Securities and Exchange Commission pursuant to Rule 24b-2 under the Securities Exchange Act of 1934.
(*) Confidential treatment has been requested for certain portions of these exhibits, which have been omitted and filed separately with the Securities and Exchange Commission pursuant to Rule 24b-2 under the Securities Exchange Act of 1934.
b) Exhibits
Refer to Item 15(a)(3) above.
c) Financial Statement Schedules
Refer to Item 15(a)(2) 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 to be signed on its behalf by the undersigned, thereunto duly authorized.
BIOSITE INCORPORATED
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.
Biosite Incorporated
Report of Independent Registered Public Accounting Firm on Financial Statements
Consolidated Balance Sheets as of December 31, 2005 and 2004
Consolidated Statements of Income for each of the three years in the period ended December 31, 2005
Consolidated Statements of Stockholders’ Equity for each of the three years in the period ended December 31, 2005
Consolidated Statements of Cash Flows for each of the three years in the period ended December 31, 2005
Notes to Consolidated Financial Statements
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM ON FINANCIAL STATEMENTS
The Board of Directors and Stockholders
Biosite Incorporated
We have audited the accompanying consolidated balance sheets of Biosite Incorporated as of December 31, 2005 and 2004, and the related consolidated statements of income, stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2005. Our audits also included the financial statement schedule listed in the Index at Item 15(a). These financial statements and schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (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 Biosite Incorporated at December 31, 2005 and 2004, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2005 in conformity with generally accepted accounting principles in the United States. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of Biosite Incorporated’s internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 13, 2006 expressed an unqualified opinion thereon.
/s/ Ernst & Young LLP
San Diego, California
March 13, 2006
BIOSITE INCORPORATED
CONSOLIDATED BALANCE SHEETS
(in thousands, except par value)
See accompanying notes.
BIOSITE INCORPORATED
CONSOLIDATED STATEMENTS OF INCOME
(in thousands, except per share amounts)
See accompanying notes.
BIOSITE INCORPORATED
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(in thousands)
See accompanying notes.
BIOSITE INCORPORATED
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
See accompanying notes.
BIOSITE INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Organization and Summary of Significant Policies
Organization and Business Activity
Founded in 1988, Biosite Incorporated is a leading provider of novel, rapid medical diagnostic products intended to aid physicians in the diagnosis of critical diseases and health conditions. Currently, we offer diagnostic products for drug screening, heart attack, heart failure, acute coronary syndromes, or ACS, evaluation of shortness of breath and certain bacterial and parasitic infections. Our products are principally sold to acute care hospitals, which number approximately 5,400 in the United States. To market our products, we utilize a direct sales team that focuses its efforts primarily on larger hospitals with more than 200 beds and smaller hospitals that are high volume users of our products, and we use a network of distributors both in the United States and internationally.
The Fisher HealthCare Division of the Fisher Scientific Company, or Fisher, distributes our products primarily in hospitals in the United States and supports our direct sales force, particularly in smaller hospitals. We utilize distributor relationships with Physician Sales & Services, or PSS, and Henry Schein, Inc., or Henry Schein, to market our products to physician office laboratories in the United States. In international markets, we have established direct selling efforts in several European countries and utilize a network of country-specific and regional distributors in other areas. During 2003 and 2004, we initiated direct sales and distribution operations in France, Germany, Belgium and Luxembourg, the United Kingdom and Italy. In the future, we may transition to direct sales and distribution of our products in additional countries. We also employ a field-based network of clinically experienced individuals that support our direct sales force by providing pre- and post- sale education and training. Additionally, we provide other customer and technical support resources to assist with ongoing utilization of our products.
With several diagnostic products commercialized, our focus has expanded to include the search for proprietary disease markers that can potentially be applied to our testing platforms or to platforms marketed by other diagnostic companies with whom we might collaborate. To that end, in 1999 we launched Biosite Discovery. Through Biosite Discovery, we leverage our expertise in phage display antibody development to access protein targets via collaborations with clinical institutions or commercial companies, or via our internal research and licensing programs. Biosite Discovery has also attracted the interest of leading clinical collaborators, who provide patient samples and assist in the analysis of clinical data. The discovery of new disease markers and the extension of applications for existing products could enable us to expand our product sales into other healthcare market segments.
Principles of Consolidation
The consolidated financial statements include our financial statements and those of our wholly-owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation.
Revenue Recognition
We recognize product sales upon shipment unless there are significant post-delivery obligations or collection is not considered probable at the time of shipment. Generally, we do not have any significant post-delivery obligations associated with our product sales. We accrue for warranty costs and other allowances at the time of shipment based on historical experience, trends and estimates.
Our collaborative development agreements generally contain specific payments for specific activities or elements of the agreements. Among the payments we might receive under the agreements are: up-front technology access fees, research funding, antibody development fees upon the delivery of antibodies, annual maintenance fees on targets for which Biosite has produced antibodies for as long as the targets remain in development by our partners, milestone fees on drug targets that reach certain pre-clinical milestones and royalties should products successfully be commercialized as a result of the collaboration. Up-front technology access fees are recognized over the term of the agreement or ongoing research period, as applicable, unless we have no further continuing performance obligations related to the fees. Research funding is recognized over the applicable research period on a straight-line basis, which approximates the underlying performance. Milestone payments, such as antibody development fees and clinical milestones, are recognized when earned, as the milestone events are substantive and their achievability is not
reasonably assured at the inception of the agreement. The achievement of milestones may not be dependent on our performance. Contract revenues that are based on the performance of and collection by our collaborative partners or their partners are deferred until such performance is complete and collection is probable. We believe that each payment element of these agreements represents the fair value of the element at the date of the agreement.
Segment Information, Major Customers and Suppliers
Financial Accounting Standards Board, or FASB, Statement No. 131, Segment Information, FAS 131, amends the requirements for public enterprises to report financial and descriptive information about their reportable operating segments. Operating segments, as defined in FAS 131, are components of an enterprise for which separate financial information is available and is evaluated regularly by us in deciding how to allocate resources and in assessing performance. FAS 131 also requires disclosures about our products and services, geographic areas and major customers.
Management of Biosite has determined that we currently operate principally in one operating segment: the discovery, development, manufacture and marketing of rapid, accurate and cost-effective diagnostics that improve the quality of patient care and simplify the practice of laboratory medicine. Our chief operating decision-making group is the Management Group, which is comprised of the Chief Executive Officer, President, Senior Vice Presidents and Vice Presidents. The Management Group primarily decides how to allocate resources based on the overall operating results and the contribution of each functional area towards achieving our business and financial goals. Our principal functional areas are: 1) Finance and Administration, 2) Sales and Marketing, 3) Research and Development and 4) Manufacturing.
We have a distribution agreement with Fisher that extends through December 31, 2008. Sales to Fisher represented 84%, 86% and 90% of our product sales in 2005, 2004 and 2003, respectively. At December 31, 2005 and 2004, receivable amounts due from Fisher represented approximately 64% and 78%, respectively, of our accounts receivable. Export sales to international customers amounted to $35.9 million, $26.0 million and $14.5 million in 2005, 2004 and 2003, respectively.
Certain components and raw materials used in the manufacture of our products are provided by single-source vendors. Any supply interruption in a sole-sourced component or raw material would affect our ability to manufacture these products until a new source of supply is qualified or alternative manufacturing processes are implemented or developed. We generally maintain safety stock inventory levels of these items, which would allow us some additional time should we need to identify and qualify alternative suppliers. LRE Technology Partner GmbH, or LRE, is the sole manufacturer of the fluorescent meters used with our Triage MeterPlus platform products, including the Triage BNP Test, Triage Cardiac Panel, Triage Profiler Shortness of Breath Panel, Triage D-Dimer Test and Triage TOX Drug Screen and others currently under development, including the Triage Stroke Panel. Beckman Coulter, Inc. is the sole manufacturer of Biosite’s Triage BNP test for Beckman Coulter Immunoassay Systems, and related calibrations and controls for that product. Other sole-source suppliers provide selected components of our products.
Use of Estimates
The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Cash and Cash Equivalents
Cash and cash equivalents consist of cash and highly liquid investments in debt securities with maturities of 90 days or less when purchased.
Marketable Securities
Based on the nature of the assets held by us and management’s investment strategy, our investments have been classified as either available-for-sale or trading securities. Management determines the appropriate classification of securities at the time of purchase. Securities classified as available-for-sale or trading are carried at estimated fair value, as determined by quoted market prices at the balance sheet date. The net unrealized gains or losses on available-for-sale securities, net of tax, are reported as a component of comprehensive income. Unrealized gains or losses on trading securities are reported in interest income. At December 31, 2005, we had no investments that were classified as held-to-maturity. The amortized cost of debt securities classified as available-for-sale is adjusted for amortization of premiums and accretion of discounts to maturity. Such amortization is included in interest income. Realized gains and losses on sales of available-for-sale securities are computed based upon the amortized cost adjusted for any other than temporary declines in fair value and are included in interest income. The cost of securities sold is based on the specific identification method. Interest on trading securities and securities classified as available-for-sale is included in interest income.
Accounts Receivable
Accounts receivable consists of trade receivables due from customers for the sale of our products. Payment terms vary on a customer by customer basis, and generally range from cash on delivery to net, 60 days in the United States and from cash in advance to net, 120 days internationally. We also utilize various programs, including letters of credit and insurance, to reduce risks of uncollectibility. A receivable is considered past due when it has exceeded its payment terms. Accounts receivable has been reduced by an estimated allowance for doubtful accounts. We estimate our allowance for doubtful accounts based on facts, circumstances and judgments regarding each account. Our estimate is determined by analysis of items such as historical bad debts, customer payment history and patterns, customer creditworthiness, economic, political or regulatory factors affecting the customer’s ability to make the required payments and individual circumstances.
Inventories
Inventories are valued at the lower of cost (first in, first out) or market value and have been reduced by an estimated allowance for excess, obsolete and potential scrapped inventories. The estimated allowance is based on management’s review of inventories on hand compared to estimated future usage and sales, as well as, judgments, quality control testing data, and assumptions about the likelihood of scrap and obsolescence. During our manufacturing processes, some work-in-process inventories require additional testing or re-work. These inventories are separately tracked and reviewed on a monthly basis to determine their status and an estimated reserve for potential scrap is calculated. We utilize a standard cost system to track our inventories on a part-by-part basis. If necessary, adjustments are made to the standard materials, standard labor and standard overhead costs to approximate actual labor and actual overhead costs on a first-in, first-out, or FIFO, cost basis.
Warranty Reserve
Our warranty reserve primarily relates to warranty coverage that we offer with the placement of the Triage MeterPlus. The Triage MeterPlus is manufactured by LRE who provides Biosite a contractual warranty against manufacturer’s defects and poor workmanship. Should a meter not function to specification and the cause is determined to be due to a manufacturer’s defect or poor workmanship, the malfunctioning meter would be returned to LRE for replacement or repair. LRE would incur and bear all the cost to replace or repair the meter. We have
established a warranty allowance for the costs to replace or repair meters that would not be covered by LRE’s warranty. Historical experience and trends detailing returns and replacement activity in total and those that have been covered by LRE’s manufacturer’s warranty are used in estimating our warranty allowance.
Property, Equipment and Leasehold Improvements
Property, equipment and leasehold improvements are stated at historical cost.
Depreciation and Amortization
Depreciation of equipment is computed using the straight-line method over the estimated useful lives of the assets, generally three to seven years. Building and building improvements are depreciated over their estimated useful lives ranging from five to forty years. Amortization of leasehold improvements is computed using the straight-line method over the shorter of the estimated useful lives of the assets or the remaining lease term. Useful lives are based on management’s estimates of the period that the assets will generate revenue directly or indirectly.
License Rights
License rights related to products for sale are stated at cost and amortized to cost of sales over the life of the license, not to exceed ten years, using a systematic method based on the estimated revenues generated from products during generally the shorter of the license period or ten years from the inception of the license. The estimated revenues used as the base by which we amortize the license rights include only estimated sales for products we are currently selling and do not include any estimated product sales expected to be realized during the license amortization term from products still in development today.
Long-lived and Intangible Assets
Our policy is to review the carrying amounts of long-lived and intangible assets whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Such events or circumstances might include a significant decline in market share, a significant decline in profits, rapid changes in technology, significant litigation or other items. In evaluating the recoverability of intangible assets, management’s policy is to compare the carrying amounts of such assets with the estimated undiscounted future operating cash flows. In the event impairment exists, an impairment charge would be determined by comparing the carrying amount of the asset to the applicable estimated future cash flows, discounted at a risk-adjusted interest rate. In addition, the remaining amortization period for the impaired asset would be reassessed and revised if necessary. We do not believe the carrying amounts of long-lived and intangible assets are impaired at December 31, 2005.
Stock-Based Compensation
With respect to accounting for stock-based compensation payments to our employees for the periods through December 31, 2005, we followed Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, or APB 25, and related interpretations. During these periods, stock options issued to non-employees were recorded at their fair value as determined in accordance with FAS No. 123, Accounting for Stock-based Compensation, or FAS 123, and Emerging Issues Task Force, or EITF, Issue No. 96-18, Accounting for Equity Instruments that are Issued to Other than Employees for Acquiring, or in Conjunction with Selling, Goods or Services, and were periodically remeasured as the stock options vest. Beginning January 1, 2006, we will adopt FAS No. 123 (revised 2004), a revision to FASB Statement No. 123, or FAS 123(R).
Included in the disclosures to the accompanying financial statements is adjusted pro forma information regarding net income as required by FAS 123, which has been determined as if we had accounted for our employee stock-based compensation under the fair value method of FAS 123 for the periods presented. For all options granted on or after April 1, 2005, we changed our fair value option pricing model from the Black-Scholes model to a binomial
model. The fair value of stock options and purchase rights granted prior to April 1, 2005 was determined using the Black-Scholes model. We believe that the binomial model considers characteristics of fair value option pricing that are not available under the Black-Scholes model. Similar to the Black-Scholes model, the binomial model takes into account variables such as volatility, dividend yield rate and risk free interest rate. However, in addition, the binomial model considers the contractual term of the option, the probability that the option will be exercised prior to the end of its contractual life, and the probability of termination or retirement of the option holder in computing the value of the option.
The valuation of stock-based compensation instruments is determined at the date of grant and includes assumptions with regards to: 1) expected life of stock options, which is primarily based on the historical exercise behavior of our employees, and stock purchase rights issuable under our employee stock purchase plan, or ESPP, 2) expected volatility during the expected life of the stock options and stock purchase rights using historical and implied volatility, 3) expected dividends during the expected life of the stock options and stock purchase rights and 4) the expected risk-free interest during the expected life of the stock options and stock purchase rights.
The weighted average estimated fair values of stock options granted during 2005, 2004 and 2003 were $27.29, $31.17 and $29.83, respectively. The weighted average estimated fair values of stock purchase rights granted during 2005, 2004 and 2003 were $24.76, $16.23 and $25.29, respectively. The fair value for these stock options and stock purchase rights was estimated at the date of grant with the following weighted-average assumptions for 2005, 2004 and 2003:
For purposes of adjusted pro forma disclosures, the estimated fair value of the stock-based compensation is amortized to expense over the vesting periods of the granted options. Our adjusted pro forma information is as follows (in thousands, except per share data):
The pro forma effects on net income for 2005, 2004 and 2003 may not be representative of the effects on reported net income or loss in future years. In management’s opinion, existing stock option valuation models do not provide a reliable single measure of the fair value of employee stock options that have vesting provisions and are not transferable. In addition, option valuation models require the input of highly subjective assumptions, including expected stock price volatility and the expected life of the options. Changes in the subjective input assumptions can materially affect the fair value estimate of employee stock options and ESPP.
Research and Development
Research and development costs are expensed as incurred. Such costs include personnel costs, supplies, clinical trials, allocated facilities, information systems, depreciation, amortization and other indirect costs.
Concentration of Credit Risk
We sell our products in the United States primarily to Fisher. Credit is extended based on an evaluation of the customer’s financial condition, and generally collateral is not required. We perform credit evaluations and maintain an allowance for potential credit losses. Credit losses in the United States have been minimal and within management’s expectations. In international markets, we have established direct selling efforts in several countries and utilize a network of country-specific and regional distributors in other areas. During the last half of 2003 and 2004, we significantly expanded our direct sales and distribution operations outside of the United States in France, Germany, Belgium and Luxembourg, the United Kingdom and Italy, and we may expand into additional countries in the future. We also utilize various risk management programs, including letters of credit and insurance, to reduce risks of uncollectibility.
We invest our excess cash in debt instruments of the U.S. Government, state municipalities, financial institutions and corporations with strong credit ratings. We have established guidelines relative to diversification and maturities that maintain safety and liquidity. These guidelines are periodically reviewed and modified to take advantage of trends in yields and interest rates.
Earnings Per Share
Basic earnings per share includes no dilution and is computed by dividing net income by the weighted average number of common shares outstanding for the period. Diluted earnings per share reflects the potential dilution of securities that could share in our earnings, such as common stock equivalents which may be issuable upon exercise of outstanding common stock options.
Shares used in calculating basic and diluted earnings per share were as follows (in thousands):
Comprehensive Income
Financial Accounting Standards Board’s Statement No. 130, Comprehensive Income, FAS 130, establishes rules for the reporting and display of comprehensive income and its components. FAS 130 requires the change in net unrealized gains or losses on marketable securities and foreign currency translation adjustments be included in comprehensive income. Comprehensive income is included in our Consolidated Statements of Stockholders’ Equity. The accumulated unrealized gain or (loss) on marketable securities, net of tax, was $(218,000) and $(79,000) as of December 31, 2005 and 2004, respectively. The accumulated foreign currency translation gain or (loss) as of December 31, 2005 and 2004 was $(353,000) and $1.2 million, respectively.
Recent Accounting Pronouncements
Share-Based Payments
In December 2004, the Financial Accounting Standards Board, or FASB, issued FAS No. 123 (revised 2004), or Statement No. 123(R), Share-Based Payment, which is a revision of FASB Statement No. 123, Accounting for Stock-Based Compensation. Statement 123(R) supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees, and amends FASB Statement No. 95, Statement of Cash Flows. Generally, the approach in Statement No. 123(R) is similar to the approach described in FAS No. 123. However, Statement No. 123(R) requires all share-based payments to employees, including grants of employee stock options, to be recognized in the income statement based on their fair values. Pro forma disclosure is no longer an alternative.
We will adopt the provisions of Statement No. 123(R) using the “modified prospective” method on January 1, 2006. Statement No. 123(R) will apply to all new awards and unvested awards that are outstanding on January 1, 2006. Compensation expense for outstanding awards for which the requisite service period has not been rendered as of January 1, 2006 will be recognized over the remaining service period using the compensation cost calculated for pro forma disclosure purposes under FASB Statement No. 123.
As permitted by FAS No. 123, through December 31, 2005 we accounted for share-based payments to employees using APB No. 25’s intrinsic value method and, as such, we recognized no compensation cost for employee stock options. Accordingly, the adoption of Statement No. 123(R)’s fair value method will have a material impact on our results of operations. The future impact of the adoption of Statement No. 123(R) will depend to a significant degree on levels of share-based payments granted in the future, our stock price volatility and the exercise behavior of our employees. Statement No. 123(R) also requires the benefits of tax deductions in excess of recognized compensation cost to be reported as a financing cash flow, rather than as an operating cash flow as required under current literature. This requirement will shift cash flows related to the tax deductions from our net operating cash flows to our net financing cash flows in periods after adoption. While we cannot estimate what those amounts will be in the future (because they depend on, among other things, the stock option exercise behavior of our employees), the amount of operating cash flows recognized in prior periods for such excess tax deductions were $13.4 million, $5.6 million and $7.9 million in 2005, 2004 and 2003, respectively.
Reclassification
Certain amounts in the 2004 and 2003 financial statements have been reclassified to conform to the presentation of the 2005 financial statements.
2. Licensing Rights and Agreements
We have entered into licensing and collaborative agreements where we utilize certain technologies licensed or owned by others in exchange for up-front, milestone or royalty payments or some combination thereof. The milestone payments under these agreements are primarily dependent on overcoming research and development hurdles, achieving product development goals or meeting commercialization objectives, or any combination thereof. Examples of milestones for which we would make payments would include: 1) initiation of clinical trials of a potential product that is covered by the licensed technology, 2) FDA clearance to market a product that is covered by the licensed technology, and 3) the first sale of product that is covered by the licensed technology in a specific territory. The attainment of the milestones is highly uncertain and dependent upon many contingencies. Additionally, we exercise discretion whether to continue to utilize the licensed technologies. At any time, we may, for technical or economic reasons, decide to discontinue utilizing the licensed technologies and would incur no further financial obligations beyond those payments already made. As of December 31, 2005, there were no milestones, either individually or in the aggregate, under our licensing and collaborative agreements for which we believe material payments are currently required to be made in the future. At December 31, 2005 and 2004, the total cost of license rights was $12.3 million and $11.8 million, respectively and accumulated amortization of the license
rights was approximately $7.5 million and $6.3 million, respectively. Amortization expense of license rights totaled $1.2 million for each of the years ended December 31, 2005, 2004 and 2003. The estimated aggregate amortization expense related to license rights for the next five years and thereafter is as follows: 2006 - $1.4 million, 2007 - $1.5 million, 2008 - $1.1 million, 2009 - $344,000, 2010 - $267,000, thereafter - $193,000.
3. Distribution and Biosite Discovery Collaborative Agreements
Distribution Agreements
We have a distribution agreement under which Fisher distributes our products primarily to hospitals within the United States. The term of our distribution agreement with Fisher expires on December 31, 2008. Under the agreement, Fisher’s distribution rights are semi-exclusive in the U.S. hospital market and non-exclusive in the U.S. physician office market. Either party has the right to terminate the agreement in the case of an uncured breach by the other party. In addition, under certain circumstances, the distribution relationship may become non-exclusive or terminate with prior notice. For instance, if our direct sales to customers in the U.S. hospital market during a six month period exceed a specified percentage of the total sales of our products by both us and Fisher in that market segment, Fisher will have the option of converting the agreement to a mutually non-exclusive arrangement. The specified percentage of direct sales in the contract that would trigger this option far exceeds the current level of direct sales. If Fisher were to exercise the option, either party would have the ability to terminate the agreement upon prior notice to the other party. Similarly, if Fisher elects to promote and sell certain products that are competitive with our products, then we will have the option of converting the agreement to a mutually non-exclusive arrangement. If we were to exercise that option, either party would have the ability to terminate the agreement upon prior notice to the other party. Sales to Fisher represented 84%, 86% and 90% of our product sales in 2005, 2004 and 2003, respectively.
We also have distributor agreements with PSS and Henry Schein to market our products to physician office practices in the United States. Internationally, in addition to utilizing a direct sales force in certain countries, we sell our products to country-specific and regional distributors.
Biosite Discovery
In 1999, we launched Biosite Discovery, a research program dedicated to the identification of new protein targets for acute diseases. Through Biosite Discovery, we conduct analyses on both known proteins that may be markers of disease and proteins accessed from clinical and commercial collaborators in order to determine their diagnostic utility. We offer antibody development services to pharmaceutical and biotechnology companies seeking high-affinity antibodies for use in their drug research. In return, we seek diagnostic licenses to their targets, as well as other potential fees. Among the payments we might receive are: up-front technology access fees, antibody development fees upon the delivery of antibodies, annual maintenance fees on targets for which we have produced antibodies for as long as the targets remain in our collaborator’s drug development program, milestone fees on targets that reach certain clinical milestones and royalties should products successfully be commercialized as a result of the collaboration. Under Biosite Discovery, we have executed agreements with different commercial and clinical collaborators, and we have executed several license or cross-license agreements with other companies.
During 2005, 2004 and 2003, we recognized contract revenues of $4.9 million, $4.3 million and $4.1 million, respectively, related to activities performed or milestones achieved under the collaborative agreements. Under the terms of our agreement with Medarex, Inc., Medarex provides us with research funding of $3.0 million per year. Costs of the research and development resources performing collaborative and internal Biosite Discovery activities in 2005, 2004 and 2003 were approximately $8.0 million, $6.5 million and $5.7 million, respectively, and are included in research and development expenses.
4. Cash, Cash Equivalents and Marketable Securities
The following is a summary of cash, cash equivalents and marketable securities by balance sheet classification at December 31, 2005 (in thousands):
The following is a summary of cash, cash equivalents and marketable securities by balance sheet classification at December 31, 2004 (in thousands):
The amortized cost and estimated fair values of available-for-sale marketable securities at December 31, 2005, by contractual maturity, are as follows (in thousands):
Gross realized gains from the sale of cash equivalents and marketable securities were approximately $1,000, $14,000 and $206,000 for the years ended December 31, 2005, 2004 and 2003, respectively. Gross realized losses from the sale of cash equivalents and marketable securities were approximately $0, $6,000 and $5,000 for the years ended December 31, 2005, 2004 and 2003, respectively.
5. Balance Sheet Information
Net inventories consist of the following (in thousands):
Property, equipment and leasehold improvements consist of the following (in thousands):
Depreciation expense was approximately $13.7 million, $15.4 million and $9.4 million for years ended December 31, 2005, 2004 and 2003, respectively. Cost of equipment under equipment financing notes was approximately $30.3 million and $30.2 million at December 31, 2005 and 2004, respectively. Accumulated depreciation of equipment under equipment financing notes at December 31, 2005 and 2004 was approximately $14.0 million and $9.8 million, respectively.
6. Debt and Commitments
Debt consisted of the following (in thousands):
As of December 31, 2005, approximate future principal payments of the equipment financing notes are due as follows: 2006 - $6.1 million; 2007 - $5.6 million; 2008 - $4.0 million; 2009 - $1.2 million; 2010 - $115,000 and thereafter - $0.
Interest expense was approximately $255,000 for the year ended December 31, 2003. Beginning July 1, 2003, interest incurred was capitalized as part of the costs of our new corporate complex. For the years ended December 31, 2005, 2004 and 2003, we incurred and capitalized interest totaling $913,000, $1.0 million and $384,000, respectively.
We lease certain office, manufacturing and research facilities under operating leases. The minimum annual rent on the facilities is subject to increases based on changes in the Consumer Price Index, taxes, insurance and operating costs, subject to certain minimum and maximum annual increases. We record rent expense on a straight-line basis over the term of the leases.
Approximate annual future minimum operating lease payments as of December 31, 2005 are as follows (in thousands):
Rent expense for the years ended December 31, 2005, 2004 and 2003 was approximately $2.5 million, $2.5 million and $2.1 million, respectively.
In October 2003, we completed our purchase of land for the construction of our new corporate complex. We purchased a total of 26.1 usable acres for approximately $28.2 million. Through December 31, 2005, we have expended an additional $80.4 million for the design and construction of the new corporate complex. We expect the new complex to provide us with up to 800,000 square feet of space and to be constructed in phases as needed. The first phase will provide us with approximately 350,000 square feet of space. The total cost of the land and the construction of the first phase is estimated to be approximately $110.0 million. As of March 1, 2006, our research and development staff, selling, general and administrative staff and a portion of our manufacturing operations have relocated to the new corporate complex. We expect to complete the other buildings in the first phase of construction during the first half of 2006 and to relocate our remaining operations in stages once the buildings are ready for use. We expect our occupancy costs to increase primarily due to increased square footage. Should there be a downturn in our business or the markets in which we compete, we may not have a need to expand our facilities as we have planned. As a result, we may then seek an alternative use for all or a portion of the property, or seek to sell the property, which may have a negative impact on our operating results. We may also incur unexpected costs and expenses in connection with our move from our existing facilities to our new corporate complex, or we may experience unanticipated decreases in productivity and other losses due to inefficiencies relating to this transition, or delays in obtaining any required approvals or clearances from regulatory agencies related to the validation of the manufacturing facilities. For instance, the scale-up of manufacturing at our new corporate complex could result in lower than expected manufacturing output and higher than expected product costs. In addition, we expect to incur some duplicate facilities expenses, such as rent, as we are transferring our operations to the new corporate complex in stages.
7. Stockholders’ Equity
Stock Plans
In December 1996, we adopted the 1996 Stock Incentive Plan (the “1996 Stock Plan”). The 1996 Stock Plan replaced our 1989 Stock Plan. Although future awards will be made under the 1996 Stock Plan, awards made under the 1989 Stock Plan will continue to be administered in accordance with the 1989 Stock Plan. The 1996 Stock Plan provides for awards in the form of restricted shares, stock units, options or stock appreciation rights or any combination thereof. The aggregate number of shares authorized for issuance under the 1996 Stock Plan as of December 31, 2005 was 7,000,000 shares. Additionally, at December 31, 2005, 142,271 unpurchased shares of common stock pursuant to unissued, expired or cancelled options under the 1989 Stock Plan are available for awards under the 1996 Stock Plan.
In November 2002, the Board of Directors adopted the Biosite Incorporated 2002 Nonqualified Stock Incentive Plan (the “2002 Stock Plan”). The Board of Directors adopted the plan to accommodate Biosite’s continuing growth
and expansion. The aggregate number of shares authorized for issuance under the 2002 Stock Plan as of December 31, 2005 was 1,450,000 shares, of which 900,000 shares are solely for use as inducement awards in connection with the recruitment of non-officer employees.
Options granted under the stock plans are generally subject to four-year vesting and expire ten years from the date of grant. As of December 31, 2005, no shares were available for future issuance under the 1989 Stock Plan, 332,497 shares were available for future issuance under the 1996 Stock Plan and 275,633 shares were available for future issuance under the 2002 Stock Plan.
Information with respect to option activity under our stock plans is as follows:
The following is a further breakdown of the options outstanding under the 1989 Stock Plan, 1996 Stock Plan and 2002 Stock Plan as of December 31, 2005:
Employee Stock Purchase Plan
In December 1996, we adopted an Employee Stock Purchase Plan (“ESPP”), which provides all qualifying employees the opportunity to purchase common stock at a discount and pay for such purchases through payroll deductions, subject to certain limitations. As of December 31, 2005, a pool of 900,000 shares of common stock has been reserved for issuance under the ESPP (subject to anti-dilution provisions). The ESPP includes an evergreen provision under which, for a period of ten years beginning on January 1, 2005, an increase in the pool of shares of common stock available for issuance under the ESPP occurs annually equal to the lesser of 1) one and one-half percent of the common shares outstanding at the end of the prior year; or 2) 1,500,000 shares of stock; provided, however, that in no event shall the annual increase cause the shares available for purchase under the ESPP to exceed 5% of the outstanding common shares of Biosite at the end of the prior year. In December 2005, the Compensation Committee of our Board of Directors limited the increase in the pool of shares of common stock available for issuance under the ESPP on January 1, 2006 to 200,000 shares. During the years ended December 31, 2005, 2004 and 2003, 125,285, 141,631 and 106,669 shares, respectively, were issued under the ESPP. As of December 31, 2005, 274,090 shares of common stock were available for issuance under the ESPP.
At December 31, 2005, a total of 882,220 shares of our common stock were reserved for future issuances under all of our stock plans and the ESPP.
Stockholder Rights Plan
In October 1997, our Board of Directors declared a dividend distribution of one preferred stock purchase right (a “Right”) for each outstanding share of common stock of Biosite held of record at the close of business on November 3, 1997. Each Right represents a contingent right to purchase, under certain circumstances, one-one-thousandth of a share of a new series of Biosite preferred stock at a price of $100.00 per one one-thousandth of a share, subject to adjustment. The Rights would be traded independently from Biosite’s common stock and become exercisable under certain circumstances involving the acquisition or a tender or exchange offer by a person or group for 15% or more of Biosite’s common stock. The Rights expire on June 1, 2011, unless redeemed by our Board of Directors. The Rights can be redeemed by the Board at a price of $0.01 per Right at any time before the Rights become exercisable, and in limited circumstances thereafter.
8. Income Taxes
Significant components of the income tax provision are as follows (in thousands):
Significant components of our net deferred tax assets as of December 31, 2005 and 2004 are as follows (in thousands):
As of December 31, 2005, we had California research and development tax credits of approximately $1.1 million. These tax credits do not expire. We also had foreign net operating loss carryovers of approximately $2.1 million. These carryovers begin to expire in 2010.
No valuation allowance has been recorded to offset the deferred tax assets as we have determined that it is more likely than not that such assets will be realized. We will continue to assess the likelihood of realization of such assets; however, if future events occur which do not make the realization of such assets more likely than not, we will record a valuation allowance against all or a portion of the net deferred tax assets.
The reconciliation of the federal statutory tax rate to our effective tax rate is as follows:
It is our policy to record tax benefits only if we conclude that it is at least probable that the deduction or credit will be sustained upon examination by tax authorities. In the period that permanent tax benefits, including research and development tax credits, are generated, we recognize the tax benefits at their estimated net realizable value. With regard to research tax credits, the determination of qualified expenses and activities involves judgment. Tax authorities have regularly examined and challenged research and development tax credits claimed by companies and have disallowed tax credit amounts based on the tax authorities’ evaluation and judgment. We reduce tax benefits to their estimated net realizable value based upon management’s assessment of exposure associated with permanent tax differences, tax credits and interest expense applied to temporary difference adjustments. The tax benefits are analyzed periodically and adjustments are made as events occur to warrant adjustments to the estimate of the net realizable value of the tax benefits.
As of December 31, 2005, we had approximately $1.7 million of undistributed earnings related to our foreign subsidiaries. We believe that these earnings will be indefinitely reinvested. Accordingly, we have not provided for U.S. Federal income taxes related to these earnings. However, upon distribution of these earnings in the form of dividends or otherwise, we would be subject to both U.S. income taxes and withholding taxes payable to the various foreign countries.
9. Employee Savings Plans
Employee 401(k) Plan
In 1991, we implemented a 401(k) program that allows all qualifying employees to contribute up to a maximum of 20% of their annual salary, subject to annual limits. The Board of Directors may, at its sole discretion, approve contributions by Biosite. No such contributions have been approved or made.
Nonqualified Deferred Compensation Plan
In March 2005, we completed the implementation of a 409A Nonqualified Deferred Compensation Plan, or the Plan, for the benefit of a select group of our management or highly compensated employees, including our executive officers. The Plan is intended to comply with Section 409A of the Internal Revenue Code of 1986, as amended (the “Code”). The Plan is an unfunded arrangement and is intended to be exempt from the requirements of the Employee Retirement Income Security Act of 1974, as amended, or ERISA.
A participant in the Plan may annually elect to defer up to 25% of their base salary, 100% of bonuses and/or commissions. The deferred compensation is contributed to either a retirement account or an in-service account established by the participant at the time the deferral election is made. These marketable securities investments are classified as trading securities We may also make discretionary contributions to participants’ accounts in the future, although we do not currently do so. Amounts contributed to participants’ accounts through participant deferrals or through our discretionary contributions are generally not subject to income tax until they are distributed from the accounts. All contributions made by participants are vested immediately. Any discretionary contributions made by us in the future, if any, are subject to such vesting arrangements as we may determine.
Amounts credited to a retirement account are distributed upon the retirement of a participant, in a lump sum or in annual installments during a specified number of years after retirement. Amounts credited to an in-service account are distributed at the beginning of a year selected by the participant that is no sooner than a specified number of years after the year the deferral election is made, in a lump sum or in annual installments during a specified number of years after the initial distribution. In the event of a participant’s disability, death or, subject to certain limitations set forth in the Plan, a participant’s termination of employment, all amounts credited to his or her account are distributed immediately in a lump sum. Early distributions may be permitted in the event of unforeseeable emergencies. A participant may from time to time designate one or more persons as his or her beneficiaries entitled to receive distributions under the Plan.
The Plan may be amended or terminated by our Board of Directors at any time, although no such amendment or termination may deprive a participant of any rights accrued under the Plan prior to the date of the amendment or termination. Other amendments may be made to conform the Plan to the provisions of applicable law, including the Code and ERISA.
10. License and Patent Disputes
Expenses associated with license and patent disputes incurred during the years ended December 31, 2005, 2004 and 2003 totaled $2.0 million, $178,000 and $0, respectively. The 2005 and 2004 expenses consisted of legal costs related to our ongoing litigation with Roche Diagnostics Corporation and its affiliates, or Roche. In November 2004, Roche filed a complaint in the United States District Court, Southern District of Indiana, Indianapolis Division alleging that Biosite is infringing two patents, U.S. Patent 5,366,609 and U.S. Patent 4,816,224, owned by Roche. Roche seeks to recover damages of an unspecified amount and to enjoin our manufacture, use or sale of the allegedly infringing products and our contribution to and/or inducement of such alleged infringement. We believe these allegations of infringement are without merit and intend to vigorously contest these claims.
Also, in November 2004, Biosite filed a complaint in the United States District Court, Southern District of California alleging that Roche Diagnostics Corporation and Roche Diagnostics GmbH are infringing two patents, U.S. Patent 6,174,686 and U.S. Patent 5,795,725, owned by Biosite. The patents relate to methods for the measurement of cardiac troponin forms. Roche filed an answer and counterclaims to our complaint in March 2005. In October 2005, Biosite amended its complaint, further alleging that Roche Diagnostics Corporation and Roche Diagnostics GmbH are also infringing U.S. Patent 6,939,678, a newly issued patent assigned to Biosite that is also related to methods for the measurement of cardiac troponin forms. The parties have commenced preliminary discovery with respect to the California case. Biosite is seeking unspecified monetary damages and injunctive relief, among other remedies. We believe our claims have merit and we are vigorously pursuing their prosecution.
In December 2005, we announced that we are in discussions with Roche regarding a potential settlement of both pending cases. Biosite and Roche filed joint requests to stay the litigation in the United States District Courts in the Southern District of California and the Southern District of Indiana through April 2006, both of which requests have been granted. Given the stage of both actions and the current stay of the proceedings, we cannot predict the ultimate outcome of either matter at this time.
11. Quarterly Information (Unaudited)
The following quarterly information includes all adjustments which management considers necessary for a fair statement of such information. For interim quarterly financial statements, the provision for income taxes is estimated using the best available information for projected results for the entire year.
Schedule II
Biosite Incorporated
Valuation and Qualifying Accounts
Years ended December 31, 2005, 2004 and 2003
(1) Uncollectible accounts written off, net of recoveries
(2) Write off of obsolete, excess or impaired inventory
(3) Cost incurred associated with the replacement and repair of the Triage Meters and devices