ITEM 1. BUSINESS
Overview
We develop, manufacture and sell proprietary biological testing technologies and products with applications throughout the diagnostics and life sciences industries. These industries depend on a broad range of tests, called bioassays, to perform diagnostic tests and conduct life science research.
Our xMAP® (Multi-Analyte Profiling) technology, an open architecture, multiplexing technology, allows simultaneous analysis of up to 500 bioassays from a small sample volume, typically a single drop of fluid, by reading biological tests on the surface of microscopic polystyrene beads called microspheres. xMAP technology combines this miniaturized liquid array bioassay capability with small lasers, light emitting diodes (LEDs), digital signal processors, photo detectors, charge-coupled device imaging and proprietary software to create a system offering advantages in speed, precision, flexibility and cost. Our xMAP technology is currently being used within various segments of the life sciences industry, which includes the fields of drug discovery and development, and for clinical diagnostics, genetic analysis, bio-defense, food safety and biomedical research. In addition to our xMAP technology, we have our proprietary MultiCode® technology, used for real-time polymerase chain reaction (PCR) and multiplexed PCR assays. During the fourth quarter of 2014, in conjunction with the appointment of our new CEO, Luminex evaluated its historical reporting segments: the technology and strategic partnerships (TSP) segment and the assays and related products (ARP) segment. As a result of this evaluation and based upon how our new Chief Executive Officer as Chief Operating Decision Maker (CODM) and our management team collectively is managing our business, we determined that the two former segments have become so integrated and interrelated that they no longer provide an accurate representation of our current business when reported separately. Additionally, we have taken actions to consolidate sales and service functions. Therefore, effective with the fourth quarter of 2014, we no longer have two operating segments and, accordingly, will present our business as one operating segment and one reporting unit. Accordingly, prior periods' information has been restated to conform to the current periods' presentation. Our products are described below under “Products.”
Our primary focus for growth is the development and sale of molecular diagnostic assays utilizing xMAP®, xTAG® and MultiCode technology on our installed base of systems. We utilize a direct sales model for sales of these products, which is intended to take advantage of our increasing installed base of xMAP-based instrumentation. Our assays are primarily focused on multiplexed applications for the human molecular clinical diagnostics market. Our assay products are currently focused on three segments of the molecular diagnostic testing market: human genetics, personalized medicine and infectious disease. We have established our position in the marketplace through our global regulatory compliant product development and manufacturing processes,
We have established a position in several segments of the life sciences industry by developing and delivering products that meet customer needs in specific market segments, including multiplexing, accuracy, precision, sensitivity, specificity, reduction of labor and ability to test for proteins and nucleic acids. These needs are addressed by our proprietary technology, which allows the end user in a laboratory to perform biological testing in a multiplexed format. Multiplexing allows for many different laboratory results to be generated from one sample at one time. This is important because our end user customers and partners, which include laboratory professionals performing research and clinical laboratories performing tests on patients as ordered by a physician and other laboratories, have a fundamental need to perform high quality testing as efficiently as possible. Until the availability of multiplexing technology such as xMAP, the laboratory professional had to perform one test per sample in a sequential manner, and if additional testing was required on a sample, a second procedure would be performed to generate the second result, and so on until all the necessary tests were performed. We have a full range of instruments in our xMAP line: our LX200 system offers 100-plex testing; our FLEXMAP 3D® system is our high-throughput, 500-plex testing system; and our MAGPIX® system provides 50-plex testing at a lower cost using imaging rather than flow cytometry. By using xMAP technology, the end users have the opportunity to become more efficient by generating multiple simultaneous results per sample. We believe that this technology may also offer advantages in other industries, such as in food safety/animal health, newborn screening and bio-defense/bio-threat markets. Using the products Luminex has available today, up to 500 simultaneous analyte results can be generated from a single sample.
A significant portion of our revenue is derived from our partnership channel. We license our xMAP technology to our partners, who then develop products that incorporate the xMAP technology into products that they sell to end users. We also develop and manufacture the proprietary xMAP laboratory instrumentation and the proprietary xMAP microspheres and sell these products to our partners. When our partners sell xMAP-based reagent consumable products or xMAP-based testing services, which run on the xMAP instrumentation, to end users, such as testing laboratories, we obtain a royalty on the sales from the partner. As of December 31, 2014, we had 66 strategic partners, 46 of which have developed reagent-based products utilizing our technology. Luminex and these partners have sold approximately 11,700 xMAP-based instruments in laboratories worldwide as of December 31, 2014.
Luminex was incorporated under the laws of the State of Texas in May 1995 and reincorporated in the State of Delaware in February 2000.
Recent Events
CEO Transition
Our Board of Directors named Nachum "Homi" Shamir as President and CEO effective October 15, 2014. In addition, he was also elected to our Board of Directors. Patrick J. Balthrop, Sr. retired as President and CEO following ten years of service as our chief executive and also resigned as a director. Mr. Balthrop continues to serve the Company and its shareholders as a consultant to the Board and Mr. Shamir, and will be assisting in the transition through April 14, 2015.
Segment Reporting
During the fourth quarter of 2014, in conjunction with the appointment of our new CEO, Luminex evaluated its historical reporting segments: the TSP segment and the ARP segment. As a result of this evaluation and based upon how our new Chief Executive Officer as Chief Operating Decision Maker (“CODM”) and our management team collectively is managing our business, we determined that the two former segments have become so integrated and interrelated that they no longer provide an accurate representation of our current business when reported separately. Additionally, we have taken actions to consolidate sales and service functions. Effective with the fourth quarter of 2014, we no longer have two operating segments and, accordingly, will present our business as one operating segment and one reporting unit. Accordingly, prior periods' information has been restated to conform to the current periods' presentation.
Available Information
Our shares of common stock are traded on the Nasdaq Global Select Market under the symbol “LMNX.” Our principal executive offices are located at 12212 Technology Blvd., Austin, Texas 78727, and our telephone number is (512) 219-8020. Our website address is www.luminexcorp.com. Our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to these reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, are available free of charge through our website as soon as reasonably practicable after such material is electronically filed with, or furnished to, the Securities and Exchange Commission, or the SEC. Information contained or accessible on our website is not incorporated by reference into this report and such information should not be considered to be part of this report except as expressly incorporated herein. The public may read and copy these materials at the SEC’s public reference room at 100 F Street, N.E., Washington, D.C. 20549 or on the SEC’s website at www.sec.govU. The SEC’s website contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC. Questions regarding the public reference room may be directed to the SEC at 1-800-732-0330.
Industry Background
The life sciences industry uses bioassays to detect the presence and characteristics of certain biochemicals, proteins or nucleic acids in a sample. Drug discovery, genetic analysis, pharmacogenomics, clinical diagnostics and general biomedical research all use bioassays. For example, bioassays can be used to:
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measure the presence and quantity of substances such as infectious agents, antigens for histocompatibility, hormones, cancer markers and other proteins in a patient’s blood, other body fluid or tissue to assist physicians in diagnosing, treating or monitoring disease conditions;
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detect genetic variations, such as single nucleotide polymorphisms or genetic mutations present in inherited diseases;
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measure the response to a compound or dosage by measuring cellular activity for drug discovery and development; and
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assist physicians in prescribing or dosing the appropriate drug therapy based on the patient’s genetic makeup, a field known as pharmacogenetics.
The life sciences customer can purchase bioassays in the form of complete off-the-shelf kits, develop them from scratch or utilize a customized service to meet their specific needs.
The table below briefly describes the key bioassay technologies in the life sciences industry:
Our xMAP Technology
Our xMAP technology combines existing biological testing techniques with illumination, advanced digital signal processing, detection and proprietary software. With our technology, discrete bioassays are performed on the surface of color-coded microspheres. These microspheres are read in a compact analyzer that utilizes lasers or LEDs, detectors, charge-coupled device imaging and high-speed digital signal processing to simultaneously identify the bioassay and measure the individual assay results. The key features of xMAP technology include the following:
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Multi-analyte/multi-format
xMAP technology has been designed to simultaneously perform up to 500 distinct bioassays in a single tube or well of a microtiter plate using only a small amount of sample. Moreover, unlike most existing technologies that are dedicated to only one type of bioassay, xMAP can perform multiple types of assays including enzymatic, genetic and immunologic tests on the same instrumentation platform.
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Flexibility/scalability
xMAP technology allows flexibility in customizing test panels. Panels can be modified to include new bioassays in the same tube by adding additional microsphere sets. It is also scalable, meaning that there is no change in the manufacturing process and only minimal changes to the required labor to produce a small or large number of microsphere-based tests.
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Both protein and nucleic acid applications on a single platform
xMAP technology has an advantage due to its ability to analyze both proteins and nucleic acids. This allows customers to utilize a single platform to evaluate samples across more biological parameters and generate a more complete assessment of these samples. Alternative technologies are typically restricted to either proteins or nucleic acid, requiring customers to use two or more technologies from other vendors to get the same information.
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High throughput
Our technology can perform up to 500 tests in a single well permitting up to 96,000 unattended tests to be detected in approximately one hour with only a small amount of sample. Rapid sample analysis permits efficient use for high-throughput applications.
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Ease of use
Most xMAP-based bioassays are simple to perform. A test sample is added to a solution containing microspheres that have been coated with reagents. The solution is then processed through our xMAP technology system which incorporates proprietary software to automate data acquisition and analysis in real-time.
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Cost effective
By performing multiple assays at one time, xMAP technology is designed to be cost effective for customers compared to competitive techniques such as ELISA or real-time PCR. By analyzing only those assays in which a customer is interested, xMAP is also more cost effective than most competing microarray technologies. In addition, microsphere-based bioassays are inexpensive compared to other technologies, such as biochips.
Two types of microspheres, polystyrene microspheres and polystyrene magnetic microspheres, are both fundamental components of the xMAP technology. We purchase and manufacture microspheres and, in a proprietary process, dye them with varying intensities of proprietary dyes to achieve up to 500 distinct colors. The specific dye proportions permit each color-coded microsphere to be readily identified based on its distinctive fluorescent signature. Our customers create bioassays by attaching different biochemical reactants to each distinctly colored microsphere set. These unique reactants bind, or capture, specific substances present in the test sample. The microsphere sets can then be combined in test panels as required by the user, with a maximum of 500 tests per panel. Customers can order either standard microspheres or magnetic microspheres.
To perform a bioassay using xMAP technology on our flow cytometry platforms, a researcher attaches biochemicals, or reagents, to one or more sets of color-coded microspheres, which are then mixed with a test sample. This mixture is injected into the xMAP analyzer such as the Luminex 200 instrument, or LX200, where the microspheres pass single-file in a fluid stream through two laser beams. The first laser excites the internal dyes that are used to identify the color of the microsphere and the test being performed on the surface of the microsphere. The second laser excites a fluorescent dye captured on the surface of the microspheres that is used to quantify the result of the bioassay taking place. Our proprietary optics, digital signal processors and software record the fluorescent signature of each microsphere and compare the results to the known identity of that color-coded microsphere set. The results are analyzed and displayed in real-time with data stored on the computer database for reference, evaluation and analysis.
We have a full range of instruments in our xMAP line. Our LX200 system offers 100-plex testing. Our FLEXMAP 3D® system is our high-throughput, 500-plex testing system and our MAGPIX® system provides 50-plex testing at a lower cost using imaging rather than flow cytometry.
Our xTAG and MultiCode Technologies
Our xTAG technology consists of several components including multiplexed PCR or target identification primers, DNA Tags, xMAP microspheres and data analysis software. xTAG technology permits the development of molecular diagnostic assays for clinical use by hospital and reference laboratories. xTAG technology has been applied, in particular, to human genetic assays, pharmacogenetic assays and infectious disease assays.
Our MultiCode technology is based upon a unique assay chemistry that is a flexible platform for both real-time PCR and multiplex PCR-based applications. We have multiple molecular diagnostic assays based on the MultiCode platform. Our MultiCode technology is powered by a base pair (man-made nucleotide pair isoC:isoG in addition to the A:T and G:C nucleotide pairs found in nature) that does not exist in nature, but can be combined with natural base pairs, and incorporated into a wide range of molecular diagnostic applications. The MultiCode base pair is recognized by naturally occurring enzymes and can be used for the specific placement of reporter molecules and to increase the molecular recognition capabilities of hybridization-based assays. The MultiCode base pair enables solutions to complex molecular challenges that were previously not possible with natural nucleic acid alone.
We have multiple assay development activities ongoing and these activities are focused in the areas of infectious disease, human genetics, pharmacogenetics and bio-threat. In 2015, we have plans to submit certain assay products to regulatory authorities, including the U.S. Food and Drug Administration (FDA) and foreign equivalents, for clearance in order to comply with established guidelines across the jurisdictions in which we participate.
Business Strategy
Our Company’s current focus is the transition from a technology-based tools company to a market-based diagnostic company and the establishment of Luminex as an industry leader and our xMAP and MultiCode technologies as the industry standards for performing molecular diagnostic bioassays. To achieve these objectives, we have implemented and are pursuing the following strategies:
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Focus on key markets
We have identified the following key market segments: (i) molecular infectious disease, (ii) genetic or inherited disease, (iii) human leukocyte antigen (HLA) transplant diagnostics, (iv) pharmacogenetic testing, (v) immunodiagnostics, (vi) life sciences research, and (vii) bio-defense, or bio-threat testing. We will continue to employ a combination of both a partnership-driven business model and a product-driven business model focused on selected market segments and bioassay applications.
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Develop and deliver market-leading molecular diagnostic platforms and assays
Our acquisitions and research and development have expanded the breadth of technology and solutions we offer our customers to meet their needs. We acquired the MultiCode RTx real-time PCR technology for both quantitative and qualitative low-plex real-time assays and GenturaDx and its IDbox sample-to-answer platform, which is compatible with our MultiCode RTx technology, to provide our customers with molecular assays that are easy to implement. A key focus currently is the final development of our ARIES® system. The ARIES sample-to-answer instrument, when combined with our proprietary real-time PCR chemistry and a new menu of highly automated assays that we are developing, is designed to enable us to offer a differentiated, easy to use solution. ARIES is designed to help labs overcome today's challenges: seeking to avoid healthcare cost increases while maintaining quality, the scarcity of highly trained personnel and limited lab bench space with its barcode data entry, efficient workflow, importance of slim design that occupies minimal bench space, universal protocols that enable true walkaway automation, and ability to simplify laboratory developed tests (LDTs).
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Develop next generation products
We are focusing resources on improving the simplicity and ease of use of our multiplex products through the development of a new version of our multiplex PCR technology. This new NxTAG™ chemistry is expected to enable customers to experience streamlined workflow without sacrificing throughput. We recognize that the crucial aspect of our current technology that we want to preserve for our larger customers is the ability to process anywhere from 1 to 96 patients in a single batch. This throughput flexibility and capacity is a crucial aspect for tests like our xTAG Respiratory Viral Panel (RVP), in which seasonality and local outbreaks can cause testing volumes to surge unpredictably. We intend to offer the convenience of a one-step workflow with the throughput of a batch-based system. In addition, products using this new chemistry are expected to have the convenience of room temperature shipping and storage. We intend to release our NxTAG Respiratory Pathogen Panel (RPP) product in 2015. Additionally, we continue pursuing projects such as the development of consumables, automation, software and the expansion and enhancement of our multiplexing capabilities to advance our technologies and market acceptance.
We have developed a full range of multiplexing instruments and consumables to cover a broad range of customer applications and budgets. We have developed, and continue to improve, the xTAG multiplex PCR chemistry for our proprietary multiplex assays in areas such as human genetic testing, personalized medicine testing and infectious disease testing. All of these technology solutions provide our customers with a breadth of innovative solutions to meet their many testing needs.
In addition, we are collaborating with industry participants, biomedical research institutions and government entities to develop additional products. We continuously consider other adjacent markets where our platform and assay offerings would be beneficial.
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Opportunistically pursue acquisitions that could accelerate our business strategies
We utilize analytical tools and an evaluation template to assess potential acquisition targets to accelerate our business strategies in the key markets described above. This approach led to several successful acquisitions historically, including the most recent acquisition of GenturaDx in 2012, which is the foundation of our new ARIES platform in development. We actively evaluate opportunities to enhance our capabilities or our access to targeted markets or technologies, or provide us other advantages in executing our business strategies in our key markets.
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Continue to develop the partnership channel focused in select key markets
As of December 31, 2014, 46 of our 66 strategic partners have developed and commercialized xMAP based assay products and are submitting royalties. We also have strategic partners who distribute Luminex products. During 2014, the 46 strategic partners who have commercialized xMAP based assay products accounted for approximately 66% of our total revenue and all of our strategic partners represented approximately 71% of our total revenue. We intend to continue pursuing opportunities to expand market acceptance of xMAP technology through development, marketing and distribution partnerships with leading companies in the life sciences markets. By leveraging our strategic partners’ market positions and utilizing their distribution channels and marketing infrastructure, we believe we can continue to expand our installed instrument base. Furthermore, our partners’ investments in research and development for xMAP applications provide Luminex xMAP customers with more assay product options than any one company or Luminex could develop and commercialize individually.
We will continue to focus our commercialization efforts through our strategic partners covering large sectors of the life science research market where Luminex believes it has competitive advantages over alternative technologies and approaches. We define strategic partners as those companies in the life sciences markets that develop and distribute assays and tests on xMAP technology or may only distribute our xMAP technology based systems and consumables. With our partners’ support and through our direct commercial efforts in the molecular diagnostics clinical laboratory segment, we have targeted major pharmaceutical companies, large clinical laboratories, research institutions and major medical institutions for our principal marketing efforts. We believe these customers provide the greatest opportunity for maximizing the use of xMAP based products and continued adoption by these industry leaders will promote wider market acceptance of our xMAP technology.
Products
Instruments
Luminex® LX 100/200™ (LX Systems). The LX Systems are compact analyzers that integrate fluidics, optics and digital signal processing to perform up to 100 bioassays simultaneously in a single tube or well of a microtiter plate using only a small amount of sample. By combining semiconductor lasers with digital signal processors and microcontrollers, these systems perform rapid, multi-analyte profiles under the control of a Windows®-based personal computer and our proprietary software.
FLEXMAP 3D®. The FLEXMAP 3D system is intended for use as a general laboratory instrument in markets, including but not limited to, life science research and diagnostics. This device can simultaneously measure up to 500 analytes from a single sample and offers increased speed and enhanced ease-of-use and serviceability. Like our LX Systems, the FLEXMAP 3D system combines semiconductor lasers with digital signal processors and microcontrollers and these systems perform rapid, multi-analyte profiles under the control of a Windows®-based personal computer and our proprietary software.
MAGPIX®. The MAGPIX system is a versatile multiplexing analyzer capable of performing qualitative and quantitative analysis of proteins and nucleic acids in a variety of sample matrices. This system can perform up to 50 tests in a single reaction volume, reducing sample input, reagents and labor while improving productivity. MAGPIX is based on an innovative detection mechanism that uses LEDs and a charge-coupled device (CCD) imaging system, rather than the lasers and detection mechanisms used in our flow cytometry-based instruments.
Consumables
MicroPlex® Microspheres. Our xMAP systems use polystyrene microspheres that are approximately 5.6 microns in diameter. We dye the microspheres in sets with varying intensities of a red and a near infrared dye to achieve up to 100 distinct color sets. Each microsphere can carry the reagents of an enzymatic, genetic or immunologic bioassay.
MagPlex® Microspheres. These microspheres feature super-paramagnetic properties that make them ideal for running automated xMAP-based assays. We dye the microspheres in sets with varying intensities of a red and a near infrared dye to achieve up to 500 distinct color sets. These microspheres can be moved or held in place by a magnetic field. Many automated systems utilize magnetic properties to automate the performance of the assay. Automating sample testing using MagPlex microspheres on a robotic sample preparation system decreases hands-on technician time, improves precision, and streamlines workflow.
xTAG® Microspheres. These dyed microspheres are linked to a set of 100 proprietary nucleic acid capture sequences providing a “universal array” for DNA and RNA work. They are designed for conducting genotyping and other nucleic acid-based experiments in the life sciences markets. When used in conjunction with our Luminex systems, the xTAG microspheres are designed to simplify the genotyping assay development process and increase assay flexibility. The xTAG microspheres may be used in customized end user identified single nucleotide polymorphisms or in pre-defined kits developed by our strategic partners.
SeroMAP™ Microspheres. These 100 distinct sets of microspheres are designed for specific protein based serological applications. Certain Luminex partners use this product for enhanced sensitivity in serum-based assays.
Calibration and Control Microspheres. Calibration microspheres are microspheres of known fluorescent light intensities used to calibrate the settings for the classification and reporter channel for the Luminex systems. Control microspheres are microspheres that are used to verify the calibration and optical integrity for both the classification and reporter channels for the various systems.
Software
xPONENT®. Our xPONENT software is included in all of our new instruments and enhances both ease-of-use and automation capabilities expanding xMAP functionality in our core markets. The software suite incorporates important features, all designed to simplify laboratory workflow and increase productivity, including: enhanced security (21 CFR Part 11 compliance and electronic signatures); integration capabilities that allow users to transmit and receive data from Laboratory Information Systems (LIS/LIMS); integration with the most popular automated sample preparation systems; the ability to run magnetic bead applications; and touch-screen capability. xPONENT is sold on new Luminex 100, 200, FLEXMAP 3D, and MAGPIX systems and is available as an upgrade to the existing LX systems in the marketplace.
Assay Product Families
A product family consists of two or more assay products which are focused on similar or related markets. Each assay consists of a combination of chemical and biological reagents and our proprietary bead technology used to perform diagnostic and research assays on samples. As of February 23, 2015 the following product families are commercially available:
Respiratory Viral Family
This family of products includes RVP, as well as xTAG RVP FAST, a newer version of the original RVP assay. These in vitro diagnostic (IVD) products enable our laboratory end users to identify the causative agent for respiratory infections, a major cause of illness and mortality globally, for physicians and their patients.
Gastrointestinal Pathogen Detection Family
The Gastrointestinal Pathogen Panel (GPP) family of products includes IVD assays as well as individual analyte specific reagents, which can be developed by Clinical Laboratory Improvement Amendments labs into laboratory developed tests. These products enable laboratory end users to identify the pathogens causing infectious gastroenteritis, which is a major cause of morbidity and mortality globally.
MultiCode Assays and Products Family
This product family includes our FDA-cleared HSV1/2 kit as well as a number of analyte specific reagents and other products. These products are generally designed to detect infectious agents in clinical samples using our proprietary MultiCode RTx real-time PCR chemistry.
Cystic Fibrosis Family
These FDA-cleared and Conformité Européenne (CE) marked IVD kits include the first-ever FDA-cleared IVD for cystic fibrosis genotyping. Current recommendations by the American College of Medical Genetics and the American College of Obstetricians and Gynecologists include screening for 23 mutations in the cystic fibrosis transmembrane conductance regulator gene. The xTAG Cystic Fibrosis kits screen for these mutations in addition to a variety of other important cystic fibrosis (CF) mutations, commonly found in the ethnically diverse North American and European populations. These kits are typically used for screening newborns and for diagnosing adult carriers of the CF gene.
Personalized Medicine Product Family
This product family includes three assays used to determine the drug metabolism status of individuals for specific medications. All three products include genotyping of genes encoding different cytochrome P450 drug metabolizing enzymes. This type of information is typically used to determine if a patient will need a lower or higher dose of a specific drug, or whether they should be switched to a different medication altogether. Two of the products in this category are the FDA-cleared CYP2D6 and CYP2C19 assays used for identifying patients with variants that affect the metabolism and efficacy of some pharmaceutical compounds.
Specialty Product Family and Instrumentation
This family of products includes a variety of assays targeted towards specialty, niche markets.
In addition to the commercially available assays, we are an original equipment manufacturer (OEM) of custom reagents and instrumentation for certain of our customers.
Sales and Marketing
Our sales and marketing strategy is to expand the installed base and utilization of xMAP, xTAG and MultiCode technologies. We are focused on generating recurring revenues from the sale of Luminex-developed assays, microspheres and other consumables, as well as from royalties on bioassay kits and testing services developed or performed by others that use our technology. We have two key elements of our sales and marketing strategy: i) our dedication to marketing the assays developed internally directly to end users and ii) our allegiance to Luminex’s historic strategic partner program with life sciences companies that develop applications or perform testing using our technology platforms and distribute our systems to their customers.
We continue to use strategic partners as the primary distribution channel for our systems, and we will continue to pursue new partnerships focusing on partners with market presence in our key segments described above. Some of our strategic partners develop application-specific bioassay kits for use on our xMAP platform that they, in turn, sell to their customers thereby generating royalties for us. Certain strategic partners also perform testing services for third parties using our technology also resulting in royalties for us. Other strategic partners buy our products, including xMAP Luminex systems and consumables, or xTAG test kits, and then resell those products to their customers. As of December 31, 2014, we had 66 strategic partners, compared to approximately 58 strategic partners as of December 31, 2013. On a regular basis, we update our strategic partner listing to reflect results of partner consolidations due to mergers and acquisitions, commercial sales inactivity, as well as termination or expiration of existing non-performing partner agreements, which in 2014 did not account for material revenue. During 2014, 48 strategic partners with commercialized products utilizing xMAP technology submitted royalties. As of December 31, 2014, 46 of these strategic partners with commercialized products remain, of which 24 companies principally serve the clinical diagnostics market and 22 companies principally serve the life science research market. Revenues through these commercialized, royalty-submitting, strategic partners constituted 66% of our revenues for 2014. We also believe our strategic partners provide us with complementary capabilities in product development, regulatory expertise and sales and marketing. By leveraging our strategic partners’ bioassay testing competencies, customer relationships and distribution channels, we believe that we can continue to achieve measurable market penetration and technology adoption.
We also serve as the OEM for certain strategic partners that choose to sell our xMAP technology as an embedded system under their own branding and marketing efforts.
Customers
In each of the last three years, one or more customers each accounted for more than 10% of our total revenues. Laboratory Corporation of America (LabCorp) accounted for 21%, 18% and 19% of our total revenues in 2014, 2013 and 2012, respectively. Thermo Fisher Scientific, Inc. accounted for 17%, 17% and 24% of our total revenues in 2014, 2013 and 2012, respectively. No other customer accounted for more than 10% of our total revenues in 2014, 2013 or 2012; however, Bio-Rad Laboratories, Inc. accounted for 7%, 9% and 8% of our total revenues in 2014, 2013 and 2012, respectively. The loss of any of these customers could have a material adverse effect on our business, financial condition and results of operations.
International Operations
We currently sell our products to a number of customers outside the United States, primarily including customers in other areas of North America, Europe and Asia-Pacific. For the annual periods ended December 31, 2014, 2013 and 2012, foreign sales to customers totaled $39.0 million, $35.1 million, and $34.7 million, respectively, representing 17%, 16% and 17%, respectively, of our total revenues for such periods. We have foreign subsidiaries in Canada, the Netherlands, Australia, the People’s Republic of China and Japan, which increase our international support, service and marketing capabilities. Our foreign subsidiaries are a direct and integral component of the U.S. entity’s operations and their efforts support the sales made by our North American entities. Sales to territories outside of the U.S. are primarily denominated in U.S. dollars. We believe that our activities in some countries outside the U.S. involve greater risk than our domestic business due to the foreign economic conditions, exchange rate fluctuations, local commercial and economic policies and political uncertainties. See Note 19 to our Consolidated Financial Statements.
Technical Operations
Our Technical Operations Group provides technical support to our customers, our distributors, our strategic partners and their customers. Most of our technical operations personnel have experience as biologists, biochemists or electrical engineers and have extensive experience in academic, industrial and commercial settings. Cross training is a major focus, as is empowering group members to solve problems outside their primary assignment.
Remote Support
Our technical support department assists users primarily through a toll-free hotline, internet interface and e-mail communications. We deliver “24/7” remote technical support with our staff based at our Austin and Toronto locations and from our European, Chinese and Japanese subsidiaries to better serve our customer base. Personnel assist our distributors, strategic partners and customers with product orders, software, hardware, system implementation and development of their bioassays. A comprehensive software and database system is utilized to track customer interactions, follow trends and measure utilization. The information is categorized and presented to management for regular review.
Training
Through our training group, we offer comprehensive programs in basic system training, advanced assay development, instrument field service and technical support functions. A significant part of our training material is now web-based and available online. For larger customers who have many users, such as our strategic partners, training may be performed on-site at their locations.
Field Support
We currently have field service and field application personnel based across North America, Europe, China and Japan in areas of our more significant system concentration. We intend to place additional field service personnel and pursue third-party service provider agreements through our certified service professional program, as required, in order to ensure responsive and cost-effective support of our customers worldwide. In addition, several of our distributors and strategic partners provide their own field service and field application support. As we continue to expand our installed base, we believe a strong, reliable, efficient field support organization is crucial to maintaining a high level of customer satisfaction.
Research and Development
Our research and development groups work to develop next generation systems, chemistries, assays and software to provide new, innovative products to our customers. Our research and development expense for the years ended December 31, 2014, 2013 and 2012, was $43.1 million, $45.0 million and $43.0 million, respectively including customer-sponsored research funding of $0.7 million, $0.8 million, and $1.1 million, respectively.
Our current research and development projects include:
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New platform development
We have continued the development of the ARIES instrument for sample-to-answer molecular diagnostic automated testing. This involves the final design and development of the instrument, consumables and software, as well as the development of a menu of assay products based on the ARIES platform. The ARIES system is expected to launch in 2015.
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Simplified assay products
Our research and development group has been working on the development of a new, easy-to-use chemistry for running multiplexed tests in 96-well plates. This chemistry is expected to combine our xTAG and xMAP technologies into a simple to use, closed-tube format. The first product using this streamlined format, the NxTAG RPP, is expected to launch in 2015.
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Partnership projects
Our research and development group is collaborating with Merck on the development of a companion diagnostic that will help screen patients into Merck's investigational candidate drug study for Alzheimer's disease. Luminex is also working with the Defense Threat Reduction Agency of the United States government to develop a hand-held diagnostic instrument. Luminex on occasion collaborates on other partnered research programs.
Manufacturing
We have historically purchased many of the components and raw materials used in our products from numerous suppliers worldwide. For reasons of quality assurance, sole source availability or cost effectiveness, certain components and raw materials used in the manufacture of our products are available only from one supplier. We have worked closely with our suppliers to develop contingency plans to assure continuity of supply while maintaining high quality and reliability, and in some cases, we have established long-term supply contracts with our suppliers. Due to the high standards and FDA requirements applicable to the manufacturing of our products, we may not be able to quickly establish additional or replacement sources for certain components or materials. In the event that we are unable to obtain sufficient quantities of raw materials or components on commercially reasonable terms or in a timely manner, our ability to manufacture our products on a timely and cost-competitive basis may be compromised, which may have a material adverse effect on our business, financial condition and results of operations.
We have approximately 60,700 square feet of manufacturing space located at our principal executive offices in Austin, Texas. We recently expanded this space to enable ARIES cassette automation. We initially certified our Quality Management System (QMS) to the ISO 9001:2000 standard and in 2010 updated our certification to ISO 9001:2008. ISO is an internationally recognized standard for quality management systems. Subsequent audits by the registrar have been and will continue to be carried out at regular intervals to ensure we are maintaining our system in compliance with ISO standards. Recertification is required every three years and we have been successfully recertified since obtaining our original ISO certification. Also, we have our QMS certified to the ISO 13485:2012 Quality Management Standard and the Canadian Medical Devices Conformity Assessment System (CMDCAS) for Medical Devices. These standards include a special set of requirements specifically related to the supply of medical devices and related services. Additionally, we seek to manufacture to current Good Manufacturing Practice requirements and our QMS is implemented in accordance with FDA Quality System Regulations.
In addition, we have approximately 6,000 square feet of manufacturing space located in Toronto, Canada and approximately 10,000 square feet of manufacturing space located in Madison, Wisconsin. The Toronto and Madison facilities and related QMS have been certified to the ISO 13485:2012 standard and registered under the CMDCAS.
Instruments
Contract manufacturers assemble certain components of our xMAP technology systems. The remaining assembly and manufacturing of our systems are performed at our facility in Austin, Texas. The quality control and quality assurance protocols are all performed at our facility. Parts and component assemblies that comprise our xMAP technology system are obtained from a number of sources. We have identified alternate sources of supply for several of our strategic parts and component assemblies. Additionally, we have entered into supply agreements with most of our suppliers of strategic parts and component subassemblies to help ensure component availability and flexible purchasing terms with respect to the purchase of such components. As of December 31, 2014, a total of 11,687 Luminex multiplexing analyzers had been shipped since inception.
Microspheres
We manufacture as well as procure undyed, standard and magnetic carboxylated polystyrene microspheres. We synthesize our dyes and manufacture our dyed polystyrene microspheres using a proprietary method in our Austin, Texas manufacturing facility in large lots. We dye the microspheres with varying intensities of red and near infrared dyes to produce our distinctly colored microsphere sets. We currently purchase polystyrene microspheres from one supplier, in accordance with a supply agreement. We believe this agreement will help ensure microsphere availability and flexible purchasing terms with respect to the purchase of such microspheres. While we believe the microspheres will continue to be available from our supplier in quantities sufficient to meet our production needs, we believe our in-house manufacturing capabilities along with other potential suppliers would provide sufficient microspheres for us if given adequate lead-time to manufacture the microspheres to our specifications.
Assays and Reagents
Contract manufacturers produce certain components of our xMAP-based and MultiCode-based developed reagents. The remaining assembly and manufacturing of our developed kits are performed at one of our facilities in Austin, Texas; Toronto, Canada; or Madison, Wisconsin. The quality control and quality assurance protocols are all performed at our facilities. Reagents, consumables and other raw material that comprise our kits are obtained from a number of sources.
Increasing regulatory requirements coupled with rising demand for new clinical applications are driving demand for laboratory developed tests. Our proprietary technologies and platforms offer a unique combination of flexibility and throughput, as our systems' open architecture, software and standard protocols allow our customers the ability to use our proprietary reagents to validate and verify a new test, while being able to utilize the same system to handle increasing volumes once the assay is commercialized.
Backlog
Our backlog as of December 31, 2014 and December 31, 2013 totaled $7.0 million and $5.8 million, respectively. Backlog consists of customer orders for which a delivery schedule within the next twelve months has been specified. Orders included in backlog may be canceled or rescheduled by customers without significant penalty. Backlog as of any particular date should not be relied upon as indicative of our net revenues for any future period.
Competition
We design our xMAP technology for use by customers across the various segments of the life sciences industry. Our competition includes companies marketing conventional testing products based on established technologies such as ELISA, real-time PCR, mass spectrometry, sequencing, gels, biochips and flow-based technologies as well as companies developing their own advanced testing technologies.
The pharmaceutical industry is a large market for the genomic, protein and high-throughput screening applications of the xMAP technology. In each application area, Luminex faces a different set of competitors. Genomic and protein testing can be performed by products available from Affymetrix, Inc., Life Technologies Corporation (a Thermo Fisher Scientific, Inc. brand), Becton, Dickinson and Company, Illumina, Inc., Qiagen N.V., Meso Scale Discovery (a division of Meso Scale Diagnostics LLC), and PerkinElmer, Inc., among others.
Our diagnostic market competitors include, among others, Abbott Laboratories, Life Technologies Corporation (a Thermo Fisher Scientific, Inc. brand), BioFire Diagnostics, Inc. (a bioMérieux company), Cepheid, GenMark Dx, Johnson & Johnson, Roche Diagnostics, Siemens Medical and Hologic, Inc., Alere, Inc., Quidel Corporation and Illumina, Inc. Some of these companies have technologies that can perform a variety of established assays. In addition, certain of these companies offer integrated systems and laboratory automation that are designed to meet the need for improved work efficiencies in the clinical laboratory.
Competition within the academic biomedical research market is highly fragmented. There are hundreds of suppliers to this market including, among others, Amersham Pharmacia Biotech, a part of GE Healthcare, Life Technologies Corporation and Becton, Dickinson and Company.
Intellectual Property
To establish and protect our proprietary technologies and products, we rely on a combination of patent, copyright, trademark and trade secret laws and confidentiality agreements. We have filed for registration or obtained registration for trademarks used with our products and key technologies.
We have implemented a strategy designed to optimize our intellectual property rights. For core intellectual property, we are pursuing patent coverage in the United States and those foreign countries that correspond to the majority of our current and anticipated customer base. We currently own 315 issued patents worldwide, including over 124 issued patents in the United States. Other countries in which we have issued patents directed to various aspects and applications of our products and technology include France, Germany, United Kingdom, Australia, Japan, Netherlands, Canada, Hong Kong and China, amongst others. In addition, our patent portfolio includes 162 pending patent applications in the United States and other foreign jurisdictions. We believe our patents and pending claims provide, or will provide, protection for systems and technologies that allow real-time multiplexed analytical techniques for the detection and quantification of many analytes from a single sample. We also hold patents covering the precision-dyeing process used in the manufacture of our fluorescent microspheres and patents covering digital over-sampling to measure the area of a fluorescence pulse instead of “peak detection,” giving increased sensitivity with no lost events. In addition, multiple granted patents and pending applications describe aspects of Multicode technology, xTAG technology, as well as ARIES, our automated real-time PCR system, and NxTAG technology.
The source code for our proprietary software is protected as a trade secret and/or as a copyrighted work. Aspects of this software also are covered by an issued patent.
We also rely on trade secret protection of our intellectual property. We attempt to protect our trade secrets by entering into confidentiality agreements with strategic partners, third parties, employees and consultants. Our employees and third-party consultants also sign agreements requiring that they assign to us their interests in inventions and original works of expression and any corresponding patents and copyrights arising from their work for us. See risk factor on property rights we rely upon to protect the technology underlying our products on page 22.
Government Regulation
Food and Drug Administration
The FDA regulates medical devices pursuant to various statutes, including the Federal Food, Drug and Cosmetic Act as amended and supplemented by the Medical Device Amendments of 1976; the Safe Medical Devices Act of 1990; the Medical Device Amendments of 1992; the FDA Export Reform and Enhancement Act of 1996; the FDA Modernization Act of 1997; the Public Health, Security and Bioterrorism Preparedness and Response Act of 2002; the Medical Device User Fee and Modernization Act of 2002; and the Project BioShield Act of 2004. Medical devices, as defined by statute, include instruments, machines, in vitro reagents or other similar or related articles, including any components, parts or accessories of such articles that are intended for use in the diagnosis of disease or other condition or in the cure, mitigation, treatment or prevention of disease; or are intended to affect the structure or function of the body and do not achieve their intended purpose through chemical action or metabolization. The FDA classifies medical devices intended for human use into three classes. For Class I devices, general controls (for example, labeling and Good Manufacturing Practices) provide reasonable assurance of safety and effectiveness. Class II devices are products for which general controls do not provide reasonable assurance of safety and effectiveness and for which there is sufficient information to establish special controls (for example, special control documents, guidelines and patient registries). Class III devices are products for which neither general nor special controls provide reasonable assurance of safety and effectiveness. Generally, Class III includes devices that support or sustain human life, are for uses that are substantially important in preventing impairment of human health, are used as a stand-alone assay for patient screening or diagnosis of disease, or present a potential, unreasonable risk of illness or injury.
We manufacture versions of the Luminex instruments for use with diagnostic assay kits that are available through our strategic partners. For FDA purposes, the Luminex systems are IVD cleared and are considered a component of our partners’ kit products. Depending on the particular kit’s regulatory classification into Class I, II, or III and its intended use, kits manufactured by our strategic partners that are used in conjunction with our technology are subject to FDA requirements such as Good Manufacturing Practices and others, and may be subject to clearance or approval before they can be marketed and sold. After incorporating the Luminex systems into their products, our strategic partners may be required to make various premarket submissions such as premarket approval applications, premarket notifications, and/or investigational device exemption applications to the FDA for their products and are required to comply with numerous requirements and restrictions prior to clearance or approval of the applications. Our partners are also subject to a number of other requirements in the Food, Drug, and Cosmetic Act and its regulations, such as Good Clinical Practice requirements and Device Registration and Listing requirements. There can be no assurance that such requirements will always be met without interruption, or that the FDA will file, clear or approve our strategic partners’ submissions. A total of 53 Luminex products have been cleared, licensed or registered in 2014, including 3 products cleared for use by the FDA in the United States and 50 products cleared, licensed or registered for use in foreign jurisdictions.
We also manufacture kit products that are intended for research use only (RUO) applications (not for diagnostic use), as well as kits that are IVD cleared for diagnostic use (currently regulatory classification of Class I and II), as well as IUO or clinical applications. Although certain products intended for research use only are not currently subject to clearance or approval by the FDA, research use only products fall under the FDA’s jurisdiction if they are used for clinical rather than research purposes. Further, even where a product is not otherwise subject to clearance or approval by the FDA, the FDA, in order to limit sales to those who use the products for research only, can determine the manner in which we can market and sell our products and/or the types of customers to which we can market and sell our products.
In addition to the FDA, the U.S. Department of Health and Human Services, state authorities and foreign government regulators scrutinize genetic analysis tools that are labeled for research use only by clinical laboratories. We cannot predict the nature of future regulatory or policy initiatives with respect to the sale and use of products for the development of assays by laboratories, or the extent to which any such initiative will impact our business.
The laboratories that purchase certain of our products are subject to extensive regulation under the Clinical Laboratory Improvement Amendments of 1988 (CLIA), which require laboratories to meet specified standards in areas such as personnel qualifications, administration, participation in proficiency testing, patient test management, quality control, quality assurance, and inspections. Adverse interpretations of current CLIA regulations or future changes in CLIA regulations could have an adverse effect on sales of any affected products.
In December 2007, we submitted to the FDA our request for 510(k) clearance on our Luminex LX 100/200 Instrument. On December 13, 2007 the FDA received our 510(k) #k073506 submission for the Luminex LX 100/200 IS System. On March 7, 2008, the instrument received FDA 510(k) clearance. All related future diagnostic assay kits subject to FDA clearance may reference the 510(k) #k073506 for the instrument in their respective applications. A master file letter from Luminex allowing the partner to reference the file may be required. Subsequent clearances for FLEXMAP 3D and MAGPIX were received by the FDA on January 9, 2013 and March 21, 2013, respectively.
Certain of our instruments use lasers to identify the bioassays and measure their results. Therefore, we are required to ensure that these products comply with FDA regulations pertaining to the performance of laser products. The Radiation Control for Health and Safety Act, administered by the FDA, imposes performance standards and record keeping, reporting, product testing and product labeling requirements for devices that emit radiation. These regulations are intended to ensure the safety of laser products by establishing standards to prevent exposure to excessive levels of laser radiation. There can be no assurance that the FDA will agree with our interpretation and implementation of these regulations.
We, and our strategic partners, are subject to periodic inspection by the FDA for, among other things, compliance with the FDA’s current Good Manufacturing Practice regulations. These regulations, also known as the Quality System Regulations, govern the methods used in, and the facilities and controls used for, the design, manufacture, packaging, labeling, servicing, installation and distribution of all finished medical devices intended for human use. Additionally, our strategic partners are subject to other pre-market and post-market controls such as labeling, complaint handling, medical device reporting, corrections and removals reporting and record keeping requirements. If the FDA has evidence demonstrating that a company is not in compliance with applicable regulations, it can detain or seize products, request or, in certain circumstances, require a recall, impose operating restrictions, enjoin future violations, recommend criminal prosecution to the Department of Justice and assess civil and criminal penalties against us, our officers and our employees. Other regulatory agencies may have similar powers. In addition, various federal and state statutes and regulations govern or influence the manufacturing, safety and storage of our products and components of our products, as well as our record-keeping.
Foreign Jurisdictions
Medical device laws and regulations are also in effect in many countries outside of the United States. These range from comprehensive pre-approval requirements for medical products to simpler requests for product data or certification. The number and scope of these requirements are increasing. There can be no assurance that we, and our strategic partners, will be able to obtain any approvals that may be required to market xMAP technology products outside the United States. In addition, we may incur significant initial and/or ongoing costs in obtaining or maintaining our foreign regulatory approvals. Further, the export by us of products that have not yet been cleared for domestic commercial distribution is subject to FDA or other export requirements and/or restrictions.
We have agreements relating to the sale of our products to government entities and, as a result, we are subject to various statutes and regulations that apply to companies doing business with the government. A failure to comply with these regulations could result in suspension of these contracts, or administrative or other penalties, and could have a material adverse effect on our ability to compete for future government contracts and programs.
We produce CE marked products, which are subject to a number of different European Union (EU) Directives, including, but not limited to, the In Vitro Diagnostic Devices Directive (98/79/EEC). CE marking of our products is currently by self-declaration, not issued by a third party, based on the intended uses of our products. A product that is not CE marked is automatically considered to be non-compliant. The law is enforced through market surveillance by appointed national enforcement agencies. Imported products are checked for compliance at customs offices.
The State Food and Drug Administration, P.R. China, is the government regulation authority in charge of safety management of drug, food, health food and cosmetics for the People’s Republic of China. In December 2007 we submitted the application for a certificate to combine both Luminex 100 and Luminex 200 into one product called "Luminex System". This certificate is required for registration and approval to import our products into China. Luminex received the registration certificate from the People’s Republic of China for the Luminex 100 and Luminex 200 Systems on March 4, 2009 and received recertification on October 17, 2013. The MAGPIX System received its registration certificate on June 16, 2014. Such re-certifications are an ongoing requirement with the People’s Republic of China.
Failure by us, or our strategic partners, to comply with applicable federal, state and foreign medical product laws and regulations could have a material adverse effect on our business. In addition, federal, state and foreign regulations regarding the manufacture and sale of medical devices and components of such devices are subject to future changes. We cannot predict what impact, if any, such changes might have on our business, but any such change could have a material impact.
WEEE
The European Community Council Directive 2002/96/EC on Waste Electrical and Electronic Equipment (WEEE) outlines the responsibility for the disposal of waste electrical and electronic equipment. Compliance with WEEE is placed with the manufacturers of such equipment. Those manufacturers are required to establish an infrastructure for collecting WEEE, in such a way that users of electrical and electronic equipment from private households should have the ability of returning WEEE at least free of charge. All Luminex-manufactured equipment is in compliance with this directive. We have been in compliance with the requirements since August 13, 2005, regarding the labeling and disposal of our products containing electronic devices in each of the EU member states where our regulated products are distributed.
RoHS
RoHS stands for “The Restriction on the Use of Certain Hazardous Substances in Electrical and Electronic Equipment” and implements EU Directive 2002/95 which bans the placing on the EU market of new electrical and electronic equipment containing more than agreed levels of lead, cadmium, mercury, hexavalent chromium, polybrominated biphenyl and polybrominated diphenyl ether flame retardants.
The Directive directly affects producers who manufacture or assemble electrical or electronic equipment in the EU, importers of electrical or electronic equipment from outside the EU and companies that re-brand electric producers as their own. The Directive applies to electrical and electronic equipment falling under the categories 1, 2, 3, 4, 5, 6, 7 and 10 set out in Annex IA of the WEEE Directive (2002/96/EC). Equipment categories 8 and 9 defined in the WEEE Directive are currently outside the scope of the RoHS Directive. Luminex IVD equipment is classified as category 8 (Medical Devices) in Annex IA of the WEEE Directive, which is not covered within the scope of the RoHS Directive. Luminex research equipment is classified as category 9 (Monitoring and Control Instruments) in Annex IA of the WEEE Directive, which is not covered within the scope of the RoHS Directive.
European IVD Directive
The EU’s regulation of in vitro medical devices is under the In Vitro Diagnostic Directive (IVDD) 98/79/EC of October 27, 1998, as implemented in the EU member states.
The principle behind the IVDD is that no in vitro device or accessory may be placed on the market or put into service unless it satisfies the essential requirements set forth in the IVDD. Devices considered to meet the essential requirements must bear the CE marking of conformity when they are placed on the market. The responsibility for placing the CE marking on the device lies with the manufacturer. A manufacturer placing devices on the market in its name is required to notify its national competent authorities.
Luminex has declared that the LX100 IS, the LX200 IS, the FLEXMAP 3D and the MAGPIX are classified as self-declaration devices and are in conformity with Article 1, Article 9, Annex I (Essential Requirements), and Annex III and the additional provisions of IVDD 98/79/EC. However, there can be no assurance that the EU member states will agree with our interpretation and implementation of these regulations. As the European marketplace continues to be material to our operations, failure by us or our strategic partners to comply with the IVDD could have a material adverse effect on our business.
Environmental
We are subject to federal, state and local laws and regulations relating to the protection of human health and the environment. In the course of our business, we are involved in the handling, storage and disposal of certain chemicals and biohazards. The laws and regulations applicable to our operations include provisions that regulate the discharge of materials into the environment. Some of these environmental laws and regulations impose “strict liability,” rendering a party liable without regard to negligence or fault on the part of such party. Such environmental laws and regulations may expose us to liability for environmental contamination, including remediation costs, natural resource damages and other damages as a result of the conduct of, or conditions caused by, us or others, or for acts that were in compliance with all applicable laws at the time such acts were performed. In addition, where contamination may be present, it is not uncommon for neighboring landowners and other third parties to file claims for personal injury, property damage and recovery of response costs. Although it is our policy to use generally accepted operating and disposal practices in accordance with applicable environmental laws and regulations, hazardous substances or wastes may have been disposed or released on, under or from properties owned, leased or operated by us or on, under or from other locations where such substances or wastes have been taken for disposal. These properties may be subject to investigation, remediation and monitoring requirements under federal, state and local environmental laws and regulations. We believe that our operations are in substantial compliance with applicable environmental laws and regulations. However, failure to comply with these environmental laws and regulations may result in the imposition of administrative, civil and criminal penalties or other liabilities. We do not believe that we have been required to expend material amounts in connection with our efforts to comply with environmental requirements or that compliance with such requirements will have a material adverse effect upon our capital expenditures, results of operations or competitive position. Because the requirements imposed by such laws and regulations may frequently change and new environmental laws and regulations may be adopted, we are unable to predict the cost of compliance with such requirements in the future, or the effect of such laws on our capital expenditures, results of operations or competitive position. Moreover, the modification or interpretation of existing environmental laws or regulations, the more vigorous enforcement of existing environmental laws or regulations, or the adoption of new environmental laws or regulations may also negatively impact our strategic partners, which in turn could have a material adverse effect on us and other similarly situated component companies.
Sunshine Act
In 2010, Congress enacted a statute called the Transparency Reports and Reporting of Physician Ownership or Investment Interests (commonly known as the Sunshine Act), as part of the Patient Protection and Affordable Care Act, as amended by the Health Care and Education Reconciliation Act of 2010 (collectively, the Health Reform Law). The Sunshine Act aims to promote transparency and requires manufacturers of most drugs, devices, biologicals and medical supplies covered by Medicare, Medicaid or the Children's Health Insurance Program (CHIP) to report annually to the Centers for Medicare and Medicaid Services (CMS) any payments or other transfers of value made to physicians and teaching hospitals, with limited exceptions. Manufacturers must also disclose to CMS any physician ownership or investment interests. In 2014, the annual reporting requirement applicable to manufacturers covered by the Sunshine Act, including Luminex entities operating or selling in the US, took effect, and CMS released datasets for payments made in 2013 to the public through the CMS website. Annual reports addressing transfers of value and relationships for the preceding calendar year will be published on the CMS website each year. We have provided internal training regarding the Sunshine Act requirements to relevant personnel and have implemented procedures to track and report any transfers of value covered by the Sunshine Act. Failure to comply with the reporting requirement may result in substantial monetary penalties.
Other
Based on the Health Reform Law, the IRS implemented a Medical Device Excise Tax of 2.3% of the sale price on non-exempt medical devices. This tax on manufacturers has not had, nor do we expect it to have, a material impact on our operations.
Employees
As of February 23, 2015 and December 31, 2014, respectively, we had a total of 741 and 745 employees and contract employees, as compared with 731 as of December 31, 2013. The year over year increase is primarily the result of the addition of sales and marketing employees focused on direct sales to our end customers, as well as personnel added related to development, production, regulatory clearance and quality control for our new sample to answer instrument (ARIES) and our bead products and assays. None of our employees are represented by a collective bargaining agreement, and we have not experienced any work stoppage. We believe that relations with our employees are good.
Seasonality
Worldwide sales, including U.S. sales, do not reflect any significant degree of seasonality; however, sales of our Respiratory Viral products have demonstrated seasonal fluctuations consistent with the onset and decline of influenza-like illnesses.
Segment Reporting
During the fourth quarter of 2014, in conjunction with the appointment of our new CEO, Luminex evaluated its historical reporting segments: the TSP segment and the ARP segment. As a result of this evaluation and based upon how our new Chief Executive Officer as Chief Operating Decision Maker and our management team collectively is managing our business, we determined that the two former segments have become so integrated and interrelated that they no longer provide an accurate representation of our current business when reported separately. Additionally, we have taken actions to consolidate sales and service functions. Effective with the fourth quarter of 2014, we no longer have two operating segments and, accordingly, will present our business as one operating segment and one reporting unit. Accordingly, prior periods' information has been restated to conform to the current periods' presentation.
Financial information relating to our reportable segment for the years ended December 31, 2014, 2013 and 2012 can be found in Item 7 “Management’s Discussion and Analysis of Financial Information and Results of Operations” and Item 8 “Financial Statements and Supplementary Data”.
Executive Officers of the Registrant as of February 23, 2015
Nachum Shamir. Mr. Shamir joined the Company on October 14, 2014 as President and Chief Executive Officer and was elected to our Board. From 2006 to 2014, Mr. Shamir was the President, Chief Executive Officer and Director of Given Imaging Ltd. (Given), a developer, manufacturer and marketer of diagnostic products for the visualization and detection of disorders of the gastrointestinal tract. Prior to joining Given, Mr. Shamir served as Corporate Vice President of Eastman Kodak Company, a technology company focused on imaging solutions and services for businesses from 2004 to 2006, and as the President of Eastman Kodak's Transaction and Industrial Solutions Group from 2005 to 2006, which includes several business units, including Kodak Versamark, Inc. (whose operations were previously those of Scitex Digital Printing Inc.) of which Mr. Shamir had served as President and Chief Executive Officer. From June 2003 to January 2004, Mr. Shamir served as the President and Chief Executive Officer of Scitex Corporation, a multinational public company which specialized in producing products, systems and equipment for the graphic design, printing and publishing markets through its various operating units. From January 2001 to January 2004, Mr. Shamir served as the President and Chief Executive Officer of Scitex Digital Printing, a subsidiary of Scitex Corporation Ltd., having previously served as its Chief Operating Officer since July 2000. Prior thereto, Mr. Shamir was Managing Director and General Manager of Scitex Digital Printing (Asia Pacific) Pte Ltd., a Singapore-based company, from its incorporation in 1994. From 1993 until 1994 Mr. Shamir was with the Hong Kong based Scitex Asia Pacific (H.K.) Ltd. Before joining Scitex, Mr. Shamir held senior management positions at various international companies mainly in the Asia Pacific regions. Mr. Shamir currently serves on the board of directors of Invendo Medical GmbH, a manufacturer and distributor of a single use and computer-assisted colonoscopy system. Mr. Shamir holds a Bachelor of Science from the Hebrew University of Jerusalem and a Masters of Public Administration from Harvard University.
Harriss T. Currie. Mr. Currie served as Vice President, Finance, Treasurer and Chief Financial Officer since October of 2002 and was appointed Senior Vice President, Finance (as well as Chief Financial Officer and Treasurer) in March 2013. Since joining Luminex in November of 1998, Mr. Currie previously served in the capacities of Controller and Treasurer. Prior to joining us, he was employed as the chief financial officer, secretary and treasurer of SpectraCell Laboratories, a specialized clinical testing laboratory company, from 1993 to 1998 where he also served as vice president of finance for two subsidiary companies. Mr. Currie earned his B.B.A. from Southwestern University and his M.B.A. in Finance and Marketing from The University of Texas at Austin. Prior to returning to graduate school for his M.B.A., Mr. Currie was a certified public accountant with Deloitte & Touche LLP.
Jeremy Bridge-Cook, Ph.D. Dr. Bridge-Cook has served as Senior Vice President, Research and Development since June 2009. Dr. Bridge-Cook joined Luminex in March 2007 as Vice President of Luminex Molecular Diagnostics. Previously, Dr. Bridge-Cook served as senior vice president, corporate development of Tm Bioscience Corporation, which was acquired by Luminex in 2007. Dr. Bridge-Cook joined Tm Bioscience Corporation in July 2000 as director of business development and served in various capacities thereafter, including vice president of business development, vice president of marketing and business development, and finally senior vice president, corporate development. Prior to joining Tm Biosciences Corporation, Dr. Bridge-Cook worked for three years as an investment analyst at MDS Capital Corp. and University Medical Discoveries Inc. Dr. Bridge-Cook has a Ph.D. in Immunology from the University of Toronto and a B.Sc. in Biology from McMaster University.
Russell W. Bradley. Mr. Bradley joined Luminex in May 2005 as Vice President of Business Development and Strategic Planning and was appointed as Senior Vice President, Corporate Development and Global Marketing in August 2013 and then promoted to Senior Vice President, Corporate Development and Chief Marketing and Sales Officer in October 2014. Previously, Mr. Bradley spent 17 years at Beckman Coulter, Inc., a manufacturer of biomedical testing systems and products, where he served in various roles of increasing responsibility including commercial leadership of Beckman Coulter's flow cytometry business and most recently as the director of the Beckman Coulter CARES initiative, leading the company’s clinical HIV monitoring business in developing regions around the globe. During his tenure at Beckman Coulter, Mr. Bradley was involved in the evaluation, market assessment and commercial launch of multiple life science technologies and applications. Mr. Bradley holds a B.Sc. in Immunology and Biochemistry from Monash University, Melbourne, Australia.
David S. Reiter. Mr. Reiter joined Luminex as Vice President, General Counsel and Corporate Secretary in October 2003 and was appointed Senior Vice President, General Counsel and Corporate Secretary in March 2013. Prior to becoming General Counsel, Mr. Reiter was in private practice with the firm of Phillips & Reiter, PLLC from 2002 to 2004, which provides outsourced general counsel services for early to mid-stage companies. Mr. Reiter is a graduate of the University of Southern California (Juris Doctorate/Master of International Relations), University of Sheffield, UK (M.B.A.) and the University of Notre Dame (B.A. in Government). Mr. Reiter is a member of the Texas Bar and the American Bar Association. On December 19, 2014, Mr. Reiter informed the Company of his intention to resign as the Company's Senior Vice President, General Counsel and Corporate Secretary to pursue other interests. We anticipate Mr. Reiter's resignation will be effective April 1, 2015.
Nancy M. Fairchild. Ms. Fairchild joined Luminex Corporation as Senior Director, Human Resources in March 2010. She was promoted to a Vice President, Human Resources in August 2012 and then promoted to Senior Vice President, Human Resources in January 2015. Prior to Luminex, Ms. Fairchild served as Chief Administrative Officer and Vice President of Human Resources and Organizational Development for the Electric Reliability Council of Texas which provides the energy grid services for Texas, from 2006 to 2010. In this role she managed Strategic Planning, Project Management, Facilities and Human Resources. Earlier in her career, she served as Vice President Human Resources for Esoterix, Inc., an international healthcare company specializing in laboratory services, from 2001 to 2006, the Sr. Vice President of Human Resources for Southern Union Company, a large natural gas conglomerate, from 1989 to 2001, and President of EnergyWorX, a training subsidiary, from 1996 to 2000. Ms. Fairchild is currently a member of the Board of Directors and Chair of the Audit Committee for Workforce Solutions, a local workforce development board in Texas, representing the biotech sector. She graduated with highest honors from Texas State University with a B.S. degree in Math Education and a Master’s degree in Counseling.
ITEM 1A.
ITEM 1A. RISK FACTORS
If we do not introduce new products in a timely manner, we may lose market share and be unable to achieve revenue growth targets.
We sell many of our products in industries characterized by rapid technological change, frequent new product and service introductions, and evolving customer needs and industry standards. Many of the businesses competing with us in these industries have significant financial and other resources to invest in new technologies, substantial intellectual property portfolios, substantial experience in new product development, regulatory expertise, manufacturing capabilities, and established distribution channels to deliver products to customers. Our products could become technologically obsolete over time, or we may invest in technologies that do not lead to revenue growth or continue to sell products for which the demand from our customers is declining, in which case we may lose market share or not achieve our revenue growth targets. The success of our new product offerings will depend upon several factors, including our ability to:
•accurately anticipate customer needs;
•innovate and develop new technologies and applications;
•obtain required regulatory clearances;
•successfully commercialize new technologies in a timely manner;
•price our products competitively, and manufacture and deliver our products in sufficient volumes and on time; and
•differentiate our offerings from our competitors' offerings.
Many of our products are used by our customers to develop, test and manufacture their products. We must anticipate industry trends and consistently develop new products to meet our customers' expectations. In developing new products, we may be required to make significant investments before we can determine the commercial viability of the new product. If we fail to accurately foresee our customers' needs and future activities, we may invest heavily in research and development of products that do not lead to significant revenue. We may also suffer a loss in market share and potential revenue if we are unable to commercialize our technology in a timely and efficient manner.
If our current technology and products and our products under development do not become widely used in the life sciences and clinical diagnostics industries, we may not be able to maintain or increase profitability.
Life sciences companies have historically conducted biological tests using a variety of technologies, including bead-based analysis. The commercial success of our technology depends upon its widespread adoption as a method to perform bioassays. In order to be successful, we must convince potential partners and customers to utilize our system instead of competing technologies. Market acceptance depends on many factors, including our ability to:
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timely and successfully launch our products under development;
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manage trends relating to, or the introduction or existence of, competing products or technologies that may be more effective, cheaper or easier to use than our products and technologies;
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manage our competition, including the presence of competing products sold by companies with longer operating histories, more recognizable names and more established distribution networks;
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convince prospective strategic partners and customers that our technology is an attractive alternative to other technologies for pharmaceutical, research, clinical, biomedical and genetic testing and analysis;
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encourage these partners to develop and market products using our technology;
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manufacture products in sufficient quantities with acceptable quality and at an acceptable cost;
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obtain and maintain sufficient pricing and royalties from partners on such Luminex products; and
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place and service sufficient quantities of our products, including the ability to provide the level of service required in the mainstream clinical diagnostics market segment.
Because of these and other factors, our products may not gain or sustain sufficient market acceptance to maintain or increase profitability. Additionally, we may have to write off excess or obsolete inventory if sales of our products are not consistent with our expectations or if the demand for our products changes.
The life sciences industry is highly competitive and subject to rapid technological change, and we may not have the right technologies and resources necessary to compete successfully.
We compete with companies in the United States and abroad that are engaged in the development and production of similar products. We will continue to face intense competition from existing competitors and other companies seeking to develop new technologies. Many of our competitors have access to greater financial, technical, scientific, research, marketing, sales, distribution, service and other resources than we do and may have longer operating histories or more recognizable names. These companies may develop technologies that are superior alternatives to our technologies or may be more effective at commercializing their technologies in products.
The life sciences industry is characterized by rapid and continuous technological innovation. We may need to develop new technologies for our products to remain competitive. One or more of our current or future competitors could render our present or future products or those of our partners obsolete or uneconomical by technological advances, including the introduction or existence of, competing products or technologies that may be more effective, cheaper or easier to use than our products and technologies. In addition, the introduction or announcement of new products by us or others could result in a delay of or decrease in sales of existing products as we await regulatory approvals, while customers evaluate these new products, or if customers choose to purchase the new products instead of legacy products. We may also encounter other problems in the process of delivering new products to the marketplace such as problems related to design, development, supply chain or manufacturing of such products, and as a result we may be unsuccessful in selling such products. Our future success depends on our ability to compete effectively against current technologies, as well as to respond effectively to technological advances by developing and marketing products that are competitive in the continually changing technological landscape.
Several companies provide systems and reagents for DNA amplification or detection. Life Technologies Corporation (a brand of Thermo Fisher Scientific) and F. Hoffman-La Roche Ltd. (Roche) sell systems integrating DNA amplification and detection (sequence detection systems) to the commercial market. Roche, Abbott Laboratories, Becton, Dickinson and Company, Qiagen N.V., Hologic, Inc., Meridian Bioscience, Inc., bioMérieux S.A., Illumina, Inc. and Quidel Corporation sell sequence detection systems, some with separate robotic batch DNA purification systems and sell reagents to the clinical market. Other companies offer molecular tests. Additionally, we anticipate that in the future, additional competitors will emerge that offer a broad range of competing products.
Currently, a limited number of direct customers and strategic partners account for a significant portion of our revenue and the loss of any one of these or their inability to perform to expectations could have a material adverse effect on our business, financial condition and results of operations. Our success depends significantly on the establishment and maintenance of successful relationships with our direct customers and strategic partners.
LabCorp, Thermo Fisher Scientific Inc., and Bio-Rad Laboratories, Inc., accounted for 45% of total revenue (21%, 17% and 7%, respectively) in the twelve months ended December 31, 2014. For comparative purposes, these same three companies accounted for 44% of total revenue (18%, 17% and 9%, respectively) in the twelve months ended December 31, 2013 and 51% of total revenue (19%, 24% and 8%, respectively) in the twelve months ended December 31, 2012. No other customer accounted for more than 7% of total revenue during the twelve months ended December 31, 2014. In total, for the year ended December 31, 2014, our top four customers accounted for 51% of our total revenue. In total, for the year ended December 31, 2013, our top four customers accounted for 50% of our total revenue. The loss of any of our significant direct customers or strategic partners could have a material adverse effect on our growth and future results of operations.
Delays in implementation, delays in obtaining regulatory approval, changes in strategy or the financial difficulty of our strategic partners for any reason could have a material adverse effect on our business, financial condition and results of operations.
Our ability to enter into agreements with additional strategic partners depends in part on convincing them that our technology can help achieve and accelerate their goals or efforts. We will expend substantial funds and management efforts with no assurance that any additional strategic relationships will result. We cannot guarantee that we will be able to negotiate additional strategic agreements in the future on acceptable terms, if at all, or that current or future strategic partners will not pursue or develop alternative technologies either on their own or in collaboration with others. Some of the companies we are targeting as strategic partners offer products competitive with our xMAP technology, which may hinder or prevent strategic relationships. Delays in implementation of new products by our strategic partners or their ability to obtain regulatory approval for their products could negatively affect our business. Termination of strategic relationships, the failure to enter into a sufficient number of additional strategic relationships on favorable terms, or disputes with our partners could reduce sales of our products, lower margins on our products and limit the creation of market demand for and acceptance of our products.
In most of our strategic partnerships we have granted non-exclusive rights with respect to commercialization of our products and technology. The lack of exclusivity could deter existing strategic partners from commercializing xMAP technology and may deter new strategic partners from entering into agreements with us.
A significant portion of our future revenues will come from sales of our systems and the development and sale of bioassay kits utilizing our technology by our strategic partners and from use of our technology by our strategic partners in performing services offered to third parties. We believe that our strategic partners will have economic incentives to develop and market these products, but we cannot accurately predict future sales and royalty revenues because many of our existing strategic partner agreements do not include minimum purchase requirements or minimum royalty commitments. Some of our existing strategic partner agreements contain minimum purchase requirements for certain years, but unless renegotiated, those minimum purchase requirements could expire. In addition, we have no control with respect to our strategic partners’ sales personnel and how they prioritize products based on xMAP technology nor can we control the timing of the development or release of products by our strategic partners. The amount of these revenues depends on a variety of factors that are outside our control, including the amount and timing of resources that current and future strategic partners devote to develop and market products incorporating our technology. Furthermore, the development and marketing of certain bioassay kits will require our strategic partners to obtain governmental approvals, which could delay or prevent their commercialization efforts. If our current or future strategic partners do not successfully develop and market products based on our technology and obtain necessary government approvals, our revenues from product sales and royalties will be significantly reduced.
The property rights we rely upon to protect the technology underlying our products may not be adequate to maintain market exclusivity. Inadequate intellectual property protection could enable third parties to exploit our technology or use very similar technology and could reduce our ability to distinguish our products in the market.
Our success depends, in part, on our ability to obtain, protect and enforce patents on our technology and products and to protect our trade secrets, including the intellectual property of entities we may acquire. Any patents we own may not afford full protection for our technology and products. Others may challenge our patents and, as a result, our patents could be narrowed or invalidated. In addition, our current and future patent applications may not result in the issuance of patents in the United States or foreign countries. Competitors may develop products that are not covered by our patents. Furthermore, there is a substantial backlog of patent applications at the U.S. Patent and Trademark Office and certain patent offices in foreign jurisdictions, and the approval or rejection of patent applications may take several years.
We currently own 315 issued patents worldwide, including 124 issued patents in the United States. Other countries in which we have issued patents directed to various aspects and applications of our products and technology include France, Germany, United Kingdom, Australia, Japan, Netherlands, Canada, Hong Kong and China, amongst others. In addition, our patent portfolio includes 162 pending patent applications in the United States and other foreign jurisdictions. We also have patents covering key aspects of MultiCode and xTAG technology utilized in our assay products as well as ARIES, our soon to be launched automated real-time PCR system, and NxTAG.
We require our employees, consultants, strategic partners and other third parties to execute confidentiality agreements. Our employees and third-party consultants also sign agreements requiring that they assign to us their interests in inventions and original expressions and any corresponding patents and copyrights arising from their work for us. In addition, we have implemented a patent process to file patent applications on our key technology. However, we cannot guarantee that these agreements or this patent process will provide us with adequate protection against improper use of our intellectual property or disclosure of confidential information. In addition, in some situations, these agreements may conflict with, or be subject to, the rights of third parties with whom our employees, consultants or advisers have prior employment or consulting relationships. Further, others may independently develop substantially equivalent proprietary technology, techniques and products or counterfeit versions of our products or otherwise gain access to our trade secrets. Our failure to protect our proprietary information and techniques may inhibit or limit our ability to exclude certain competitors from the market.
In order to protect or enforce our patent rights, we may have to initiate legal proceedings against third parties, such as infringement suits or interference proceedings. These legal proceedings could be expensive, take significant time and/or divert management’s attention from other business concerns. These proceedings may cause us to lose the benefit of some of our intellectual property rights, the loss of which may inhibit or preclude our ability to exclude certain competitors from the market. These proceedings also may provoke these third parties to assert claims against us. The patent position of companies like ours generally is highly uncertain, involves complex legal and factual questions and has recently been the subject of much litigation. No consistent policy has emerged from the U.S. Patent and Trademark Office or the courts regarding the breadth of claims allowed or the degree of protection afforded under patents like ours.
Our success depends partly on our ability to operate without infringing on or misappropriating the proprietary rights of others.
We have been (and from time to time we may be) notified that third parties consider their patents or other intellectual property relevant to our products. We may be sued for infringing the intellectual property rights of others, including claims with respect to intellectual property of entities we may acquire. In addition, we may find it necessary, if threatened, to initiate a lawsuit seeking a declaration from a court that we do not infringe on the proprietary rights of others or that their rights are invalid or unenforceable. Intellectual property litigation is costly, and, even if we prevail, the cost of such litigation could affect our profitability. Furthermore, litigation is time-consuming and could divert management’s attention and resources away from our business. If we do not prevail in any litigation, we may have to pay damages and could be required to stop the infringing activity or obtain a license. Any required license may not be available to us on acceptable terms, if at all. Moreover, some licenses may be nonexclusive, and therefore, our competitors may have access to the same technology licensed to us. If we fail to obtain a required license or are unable to design around a patent, we may be unable to sell some of our products, which could have a material adverse effect on our business, financial condition and results of operations.
We require collaboration with other organizations in obtaining relevant biomarkers, access to oligonucleotides and enzymes that are patented or controlled by others. If we cannot continue to obtain access to these areas or identify freedom to operate opportunities, our business, financial condition and results of operations could be negatively affected.
Security breaches and other disruptions could compromise our information, expose us to liability and harm our reputation and business.
In the ordinary course of our business we collect and store sensitive data, including intellectual property, personal information, our proprietary business information and that of our customers, suppliers and business partners, and personally identifiable information of our customers and employees in our data centers and on our networks. The secure maintenance and transmission of this information is critical to our operations and business strategy. We rely on commercially available systems, software, tools and domestically available monitoring to provide security for processing, transmitting and storing this sensitive data.
Computer hackers may attempt to penetrate our computer systems or our third party IT service providers' systems and, if successful, misappropriate personal or confidential business information. In addition, an associate, contractor, or other third-party with whom we do business may attempt to circumvent our security measures in order to obtain such information, and may purposefully or inadvertently cause a breach involving such information. While we will continue to implement additional protective measures to reduce the risk of and detect cyber incidents, cyber-attacks are becoming more sophisticated and frequent, and the techniques used in such attacks change rapidly. Despite our cybersecurity measures (including employee and third-party training, monitoring of networks and systems, and maintenance of backup and protective systems) which are continuously reviewed and upgraded, the Company’s information technology networks and infrastructure may still be vulnerable to damage, disruptions or shutdowns due to attack by hackers or breaches, employee error or malfeasance, power outages, computer viruses, telecommunication or utility failures, systems failures, natural disasters or other catastrophic events. Any such compromise of our, or our third party IT service providers' data security and access, public disclosure, or loss of personal or confidential business information could result in legal claims or proceedings, liability under laws that protect the privacy of personal information, and
regulatory penalties, disrupt our operations, damage our reputation and customers’ willingness to transact business with us, and subject us to additional costs and liabilities any of which could adversely affect our business.
Our success depends on our ability to service and support our products directly or in collaboration with our strategic partners.
To the extent that we or our strategic partners fail to maintain a high quality level of service and support for xMAP technology products, there is a risk that the perceived quality of our xMAP technology products will be diminished in the marketplace. Likewise, we may fail to provide the level, quantity or quality of service expected by the marketplace. This could result in slower adoption rates and lower than anticipated utilization of xMAP products which could have a material adverse effect on our business, financial condition and results of operations.
We expect our operating results to continue to fluctuate from quarter to quarter.
The sale of our instrumentation and assay products typically involves a significant technical evaluation and commitment of capital by us, our partners and the end user. Accordingly, the sales cycle associated with our products typically is lengthy and subject to a number of significant risks, much of which is beyond our control, including partners’ budgetary constraints, inventory management practices, regulatory approval and internal acceptance reviews. As a result of this lengthy and unpredictable sales cycle, our operating results have historically fluctuated significantly from quarter to quarter. We expect this trend to continue for the foreseeable future.
The vast majority of our system sales are made to our strategic partners. Our partners typically purchase instruments in three phases during their commercialization cycle: first, instruments necessary to support internal assay development; second, instruments for sales force demonstrations; and finally, instruments for resale to their customers. As a result, most of our system placements are highly dependent on the continued commercial success of our strategic partners and can fluctuate from quarter to quarter as our strategic partners move from phase to phase. We expect this trend to continue for the foreseeable future.
Our assay products are sometimes sold to large customers. The ordering and consumption patterns of these customers can fluctuate, affecting the timing of shipments and revenue recognition. In addition, certain products assist in the diagnosis of illnesses that are seasonal, and customer orders can fluctuate for this reason.
Because of the effect of bulk purchases, defined as the purchase of $100,000 or more of consumables in a quarter, and the introduction of seasonal components to our assay menus, we experience fluctuations in the percentage of our quarterly revenues derived from our highest margin items: consumables, royalties and assays. Our gross margin percentage is highly dependent upon the mix of revenue components each quarter. These fluctuations contribute to the variability and lack of predictability of both gross margin percentage and total gross profit from quarter to quarter. We expect this trend to continue for the foreseeable future.
Due to the early stage of the market for molecular tests, projected growth scenarios for our assays are highly volatile and are based on a number of underlying assumptions that may or may not prove to be valid, including our ability to be successful with our direct assay sales strategy.
We may be unsuccessful in implementing our acquisition strategy. We may face difficulties integrating acquired entities with our existing businesses. Our business may be harmed by prior or future acquisitions.
Acquisitions of assets or entities designed to accelerate the implementation of our strategic plan are an important element of our long-term strategy. We may be unable to identify and complete appropriate future acquisitions in a timely manner, or at all, and no assurance can be provided that the market price of potential business acquisitions will be acceptable. In addition, many of our competitors have greater financial resources than we have and may be willing to pay more for these businesses or selected assets. In the future, should we identify suitable acquisition targets, we may be unable to complete acquisitions or obtain the financing, if necessary, for these acquisitions on terms favorable to us. Potential acquisitions pose a number of risks, including, among others, that:
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we may not be able to accurately estimate the financial effect of acquisitions on our business;
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future acquisitions may require us to incur debt or other obligations, issue additional securities, incur large and immediate write-offs, issue capital stock potentially dilutive to our stockholders or spend significant cash, or may negatively affect our operating results and financial condition;
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if we spend significant funds or incur additional debt or other obligations, our ability to obtain financing for working capital or other purposes could decline, and we may be more vulnerable to economic downturns and competitive pressures;
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technological advancement or worse than expected performance of acquired businesses may result in the impairment of intangible assets;
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we may be unable to realize the anticipated benefits and synergies from acquisitions as a result of inherent risks and uncertainties, including difficulties integrating acquired businesses or retaining their key personnel, partners, customers or other key relationships, entering market segments in which we have no or limited experience, and risks that acquired entities may not operate profitably or that acquisitions may not result in improved operating performance;
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we may fail to successfully obtain appropriate regulatory approval or clearance for products under development of our acquired businesses;
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we may fail to successfully manage relationships with customers, distributors and suppliers;
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our customers may not accept products of our acquired businesses;
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we may fail to effectively coordinate sales and marketing efforts of our acquired businesses;
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we may fail to combine product offerings and product lines of our acquired businesses quickly and effectively;
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we may fail to effectively enhance acquired technology and products to develop new products relating to the acquired businesses;
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an acquisition may involve unexpected costs or liabilities, including as a result of pending and future shareholder lawsuits relating to acquisitions or exercise by shareholders of their statutory appraisal rights, or the effects of purchase accounting may be different from our expectations;
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an acquisition may involve significant contingent payments that may adversely affect our future liquidity or capital resources;
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acquisitions and subsequent integration of these companies may disrupt our business and distract our management from other responsibilities; and
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the costs of unsuccessful acquisition efforts may adversely affect our financial performance.
Other risks of integration of acquired businesses include:
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disparate information technology, internal control, financial reporting and record-keeping systems;
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differences in accounting policies, including those requiring judgment or complex estimation processes;
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new partners or customers who may operate on terms and programs different than ours;
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additional employees not familiar with our operations;
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unanticipated additional transaction and integration-related costs;
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our current and prospective customers and suppliers may experience uncertainty associated with an acquisition, including with respect to current or future business relationships with us and may attempt to negotiate changes in existing business;
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facilities or operations of acquired businesses in remote locations or potentially foreign jurisdictions and the inherent risks of operating in unfamiliar legal and regulatory environments; and
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new products, including the risk that any underlying intellectual property associated with such products may not have been adequately protected or that such products may infringe on the proprietary rights of others.
If our direct selling efforts for our products are less successful than anticipated, our business expansion plans could suffer and our ability to generate revenues could be diminished. In addition, our limited history in selling our molecular diagnostics products on a direct basis makes forecasting difficult.
We have a relatively small sales force compared to some of our competitors. If our direct sales force is not successful, or new additions to our sales team fail to gain traction among our customers, we may not be able to increase market awareness and sales of our products, or maintain historical sales levels. If we fail to establish our systems in the marketplace, it could have a negative effect on our ability to sell subsequent systems and hinder the planned expansion of our business.
We transitioned to selling our molecular diagnostics products on a direct basis in 2013, so we only have a two year direct sales history. As a result, we have limited historical experience forecasting the direct sales of our molecular diagnostics products. Our ability to produce product quantities that meet customer demand is dependent upon our ability to forecast accurately, plan production accordingly and scale our manufacturing efforts.
Unfavorable economic conditions and the uncertain economic outlook may adversely impact our business, results of operations, financial condition or liquidity.
Global economic conditions could adversely affect our results of operations. The credit markets and the financial services industry continue to experience volatility, both domestically and internationally. These conditions not only limit our access to capital but also make it extremely difficult for our customers, our vendors and us to accurately forecast and plan future business activities, and they could cause U.S. and foreign businesses and consumers to slow spending on our products and services, which would delay and lengthen sales cycles. Some of our customers rely on government research grants to fund technology purchases. If negative trends in the economy affect the government’s allocation of funds to research, there may be less grant funding available for certain of our customers to purchase technologies like those Luminex sells. Certain of our partners and their and our customers may face challenges gaining timely access to sufficient credit or may otherwise be faced with budget constraints, which could result in decreased purchases of, or development of products based on, our products or in an impairment of their ability to make timely payments to us. If our partners and our customers do not make timely payments to us, we may be required to assume greater credit risk relating to those customers, increase our allowance for doubtful accounts and our days sales outstanding would be negatively impacted. Although we maintain allowances for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments and such losses have historically been within our expectations and the provisions established, we may not continue to experience the same loss rates that we have in the past given the current condition of the worldwide economy. Additionally, these economic conditions and market turbulence may also impact our suppliers causing them to be unable to supply in a timely manner sufficient quantities of customized components, thereby impairing our ability to manufacture on schedule and at commercially reasonable costs.
If the governmental laws and regulations change in ways that we do not anticipate and if we fail to comply with laws and regulations that affect our business, we could be subject to enforcement actions, injunctions and civil and criminal penalties or otherwise be subject to increased costs that could delay or prevent marketing of our products.
The production, testing, labeling, marketing and distribution of our products for some purposes and products based on our technology are subject to governmental regulation by the FDA and by similar agencies in other countries. Some of our products and products based on our technology for in vitro diagnostic purposes are subject to clearance by the FDA prior to marketing for commercial use. To date, eight strategic partners have obtained such clearances. Others are anticipated. The process of obtaining necessary FDA clearances can be time-consuming, expensive and uncertain. Further, clearance may place substantial restrictions on the indications for which the product may be marketed or to whom it may be marketed. In addition, because some of our products employ laser technology, we are also required to comply with FDA requirements relating to radiation performance safety standards.
Periodically the FDA issues guidance documents that represent the FDA’s current thinking on a topic. These issues are initially issued in draft form prior to final rule generally with enforcement discretion for some grace period of time. Changes made through this process may impact the release status of products offered and our ability to market those products affected by the change. For example, the FDA released on September 14, 2007 the final document “Guidance for Industry and FDA Staff Commercially Distributed Analyte Specific Reagents (ASRs): Frequently Asked Questions.” This guidance may limit or delay distribution of assays on our platform, including assays that we developed internally and distributed, to the extent additional regulatory clearance is required prior to distribution.
Cleared medical device products are subject to continuing FDA requirements relating to, among others, manufacturing quality control and quality assurance, maintenance of records and documentation, registration and listing, import/export, adverse event and other reporting, distribution, labeling and promotion and advertising of medical devices. Our inability or the inability of our strategic partners to obtain required regulatory approval or clearance on a timely or acceptable basis could harm our business. In addition, failure to comply with applicable regulatory requirements could subject us or our strategic partners to regulatory enforcement action, including warning letters, product seizures, recalls, withdrawal of clearances, restrictions on or injunctions against marketing our products or products based on our technology, and civil and criminal penalties.
Medical device laws and regulations are in effect within the United States and also in many countries outside the United States. These range from comprehensive device clearance requirements for some or all of our medical device products to requests for product data or certifications regarding the hazardous material content of our products. As a device manufacturer, beginning in March 2014 we are required to annually report to CMS any payments or transfers of value we have made to physicians and teaching hospitals and any physician ownership or investment interest in the company. As part of the European Council Directive 2002/96 of February 13, 2003, we are expected to comply with certain requirements regarding the collection, recycling and labeling of our products containing electronic devices in each of the European Union, or EU, member states where our regulated products are distributed. While we are taking steps to comply with the requirements of WEEE, we cannot be certain that we will comply with the national stage implementation of WEEE in all member states. Our products are currently exempt from the European Council Directive 2002/95 of January 27, 2003, Restriction of the Use of Certain Hazardous Substances in Electrical and Electronic Equipment (RoHS), which required the removal of certain specified hazardous substances from certain products beginning July 1, 2006 in each of the member states. However, the EU has indicated that it may, and it is generally expected it will, include medical devices, including some of our products, under the jurisdiction of RoHS. If this exemption is revoked, it could result in increased costs to us and we cannot guarantee we will ultimately be able to comply with RoHS or related requirements in other jurisdictions. In addition, the State of California adopted the Electronic Waste Recycling Act, effective January 1, 2007, which requires the California Department of Toxic Substances Control to adopt regulations to prohibit the sale of electronic devices in California if they are also prohibited from sale in the EU under the RoHS directive because they contain certain heavy metals. The number and scope of these requirements are increasing and we will likely become subject to further similar laws in other jurisdictions. Failure to comply with applicable federal, state and foreign medical device laws and regulations may harm our business, financial condition and results of operations. We are also subject to a variety of other laws and regulations relating to, among other things, environmental protection and workplace health and safety.
Our strategic partners and customers expect our organization to operate on an established quality management system compliant with FDA Quality System Regulations and industry standards, the In Vitro Diagnostic Directive 98/79/EC of 27 October 1998 (Directive) as implemented nationally in the EU member states and industry standards, such as ISO 9000. We became ISO 9001:2000 certified in March 2002 and self-declared our Luminex 100, Luminex 200, FLEXMAP 3D and MAGPIX instruments to the Directive. Our devices are in conformity with Article 1, Article 9, Annex I (Essential Requirements), and Annex III and the additional provisions of the Directive as of December 7, 2003. Subsequent audits are carried out annually to ensure we maintain our system in substantial compliance with ISO and other applicable regulations and industry standards. We became ISO 13485:2003 and CMDCAS certified in July 2005. Failure to maintain compliance with FDA, CMDCAS and EU regulations and other medical device laws, or to obtain applicable registrations where required, could reduce our competitive advantage in the markets in which we compete and also decrease satisfaction and confidence levels with our partners.
Our success depends on our ability to attract and retain our management and staff.
We depend on the principal members of our management and scientific staff, including our chief executive officer, Homi Shamir, and our operations, marketing, research and development, technical support, technical service and sales staff. The loss of services of key members of management could delay or reduce our product development, marketing and sales and technical support efforts. In addition, recruiting and retaining qualified scientific and other personnel to perform research and development, technical support, technical service and marketing and sales work will be critical to our success. There is a shortage in our industry of qualified management and scientific personnel, and competition for these individuals is intense. There can be no assurance that we will be able to attract additional and retain existing personnel necessary to achieve our business objectives.
Our reliance on strategic partnerships makes forecasting difficult.
As a result of our reliance on our strategic relationships, it can be difficult to accurately forecast future operating results. Estimating the timing and amount of sales of our products is particularly difficult for the following reasons (among others):
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We do not control the timing or extent of product development, marketing or sale of our products by our strategic partners.
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We do not control the incentives provided by our strategic partners and distributors to their sales personnel.
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We utilize a limited number of geographically focused distributors for a portion of our sales, including several of our key assay products and the loss of or nonperformance by these distributors could harm our revenues in the territories serviced by these distributors.
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A significant number of our strategic partners intend to produce clinical diagnostic applications that may need to be approved by the FDA or other regulatory bodies in jurisdictions outside of the United States.
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Certain strategic partners may have unique requirements for their applications and systems. Assisting the various strategic partners may strain our research and development and manufacturing resources. To the extent that we are not able to timely assist our strategic partners, the commercialization of their products will likely be delayed.
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Certain strategic partners may fail to deliver products that satisfy market requirements, or such products may fail to perform properly.
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We have limited access to partner and distributor confidential corporate information. A sudden unexpected change in ownership or strategy or other material event due to information of which we are not currently aware could adversely impact partner purchases of our products.
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Partners tend to order in bulk prior to the production of new lots of their products and prior to major product development initiatives. The frequency of these bulk purchases is difficult to predict and may cause large fluctuations in microsphere sales quarter to quarter.
If third-party payors increasingly restrict payments for healthcare expenses or fail to adequately pay for multi-analyte testing, we may experience reduced sales which would hurt our business and our business prospects.
Third-party payors, such as government entities and government-sponsored healthcare programs (e.g. Medicare, Medicaid, Tricare), health maintenance organizations, preferred provider organizations and other private or commercial insurers are continually seeking to reduce healthcare expenses. Increasingly, third-party payors are challenging the utilization of and prices charged for medical services, including clinical diagnostic tests. Some payors are attempting to contain costs by limiting coverage, reducing reimbursement and increasing patient cost-sharing obligations. The federal government has implemented and continues to utilize cost-cutting strategies for government-sponsored healthcare programs, including coverage limitations and reimbursement rate reductions required by the Health Reform Law. In some cases, commercial payors are influenced by government-sponsored healthcare programs and policies. Therefore, coverage and reimbursement from commercial payors may be negatively impacted as a result of changes in government-sponsored healthcare programs. Further, cost containment initiatives by governmental or educational entities or programs may reduce funding for genetic research and development activities and retard the growth of the genetic testing market.
Without adequate coverage or reimbursement, consumer demand for tests could decrease. Decreased demand could cause our direct customers or strategic partners to reduce purchases or to cancel programs or development activities, which could cause sales of our products and services to fall. In addition, decreased demand could place pressure on us, or our direct customers and strategic partners, to lower prices on these products or services, resulting in lower margins. Reduced sales or margins by us, or our direct customers and strategic partners, would adversely affect our business, profitability and business prospects.
As we continue to expand our business, we may experience problems in scaling our manufacturing operations, or delays or component shortages that could limit the growth of our revenue.
As we continue to expand our manufacturing capabilities in order to meet our growth objectives, we may not be able to produce sufficient quantities of products or maintain consistency between differing lots of consumables. If we encounter difficulties in scaling our manufacturing operations as a result of, among other things, quality control and quality assurance issues and availability of components and raw material supplies, we will likely experience reduced sales of our products, increased repair or re-engineering costs due to product returns, and defects and increased expenses due to switching to alternate suppliers, any of which would reduce our revenues and gross margins.
We presently outsource certain aspects of the assembly of our systems to contract manufacturers. Because of a long lead-time to delivery, we are required to place orders for a variety of items well in advance of scheduled production runs. We have increased our flexibility to purchase strategic components within shorter lead times by entering into supply agreements with the suppliers of these components. Although we attempt to match our parts inventory and production capabilities to estimates of marketplace demand, to the extent system orders materially vary from our estimates, we may experience continued constraints in our systems production and delivery capacity, which could adversely impact revenue in a given fiscal period. Should our need for raw materials and components used in production continue to fluctuate, we could incur additional costs associated with either expediting or postponing delivery of those materials. In an effort to control costs we have implemented a lean production system. Managing the change from discrete to continuous flow production requires time and management commitment. Lean initiatives and limitations in our supply chain capabilities may result in part shortages that delay shipments and cause fluctuations in revenue in a given period.
We currently purchase certain key components of our product line from a limited number of outside sources and, in the case of some components, a single source, and these components may only be available through a limited number of providers. We do not have agreements with all of our suppliers. While we currently believe that we will be able to satisfy our forecasted demand for our products, the failure to find alternative suppliers in the event of any type of supply failure at any of our current vendors at reasonably comparable prices could have a material adverse effect on our business, financial condition and results of operations. Additionally, we have entered into supply agreements with most of our suppliers of strategic reagents and component subassemblies to help ensure component availability, and flexible purchasing terms with respect to the purchase of such components. If our suppliers discontinue production of a key component, we will be required to revalidate and may be required to resubmit a previously cleared product. Our reliance on our suppliers and contract manufacturers exposes us to risks including:
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the possibility that one or more of our suppliers or our assemblers that do not have supply agreements with us could terminate their services at any time without penalty;
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natural disasters such as earthquakes, tsunamis, and floods that impact our suppliers;
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the potential obsolescence and/or inability of our suppliers to obtain required components;
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the potential delays and expenses of seeking alternate sources of supply or manufacturing services;
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the inability to qualify alternate sources without impacting performance claims of our products;
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reduced control over pricing, quality and timely delivery due to the difficulties in switching to alternate suppliers or assemblers; and
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increases in prices of raw materials and key components.
Consequently, in the event that supplies of components or work performed by any of our assemblers are delayed or interrupted for any reason, our ability to produce and supply our products could be impaired.
If the quality of our products does not meet our customers’ expectations, then our reputation could suffer and ultimately our sales and operating earnings could be negatively impacted.
In the course of conducting our business, we must adequately address quality issues associated with our products and services, including defects in our engineering, design, and manufacturing processes, as well as defects in third-party components included in our products. Because our instruments and consumables are highly complex, the occurrence of defects may increase as we continue to introduce new products and services and as we rapidly scale up manufacturing to meet increased demand for our products and services. Although we have established internal procedures to minimize risks that may arise from product quality issues, there can be no assurance that we will be able to eliminate or mitigate occurrences of these issues and associated liabilities. In addition, identifying the root cause of quality issues, particularly those affecting reagents and third-party components, may be difficult, which increases the time needed to address quality issues as they arise and increases the risk that similar problems could recur. Finding solutions to quality issues can be expensive and we may incur significant costs or lost revenue in connection with, for example, shipment holds, product recalls, and warranty or other service obligations. In addition, quality issues can impair our relationships with new or existing customers and adversely affect our brand image, and our reputation as a producer of high quality products could suffer, which could adversely affect our business, financial condition, or results of operations.
Our operations in foreign countries expose us to certain risks inherent in doing business internationally, which may adversely affect our business, results of operations or financial condition.
We expect that revenue from U.S. sales will continue to represent the majority of our total revenue, but our future profitability will depend in part on our ability to grow and ultimately maintain our product sales in foreign markets, particularly in Asia and Europe. In fiscal 2014, approximately 17% of our revenue was derived from sales to non-U.S. customers, with approximately 8% of revenue from sales to customers in Europe. As such, a significant slowdown in these foreign economies or lower investments in new infrastructure could have a negative impact on our sales. We also purchase a portion of the materials included in our products from overseas sources. As a result of acquisitions and organic growth, we have operations and manufacturing facilities in foreign countries that expose us to certain risks. For example, fluctuations in exchange rates may affect our revenues, expenses and results of operations as well as the value of our assets and liabilities as reflected in our financial statements. We are also subject to other types of risks, including the following:
•
changes in or interpretations of foreign law that may adversely affect our ability to sell our products, perform services or repatriate profits to the United States;
•
tariffs, customs and other barriers to importing/exporting materials and products in a cost effective and timely manner;
•
hyperinflation or economic or political instability in foreign countries;
•
imposition of limitations on or increase of withholding and other taxes on remittances and other payments by foreign subsidiaries;
•
conducting business in places where business practices and customs are unfamiliar and unknown;
•
difficulties in staffing and managing international operations;
•
the burden of complying with complex and changing foreign regulatory requirements;
•
difficulties in accounts receivable collections;
•
the imposition of restrictive trade policies, including export restrictions;
•
worldwide political conditions;
•
the imposition of inconsistent laws or regulations;
•
reduced protection of intellectual property rights and trade secrets in some foreign countries;
•
the imposition or increase of investment requirements and other restrictions by foreign governments;
•
the interpretation of contractual provisions governed by foreign laws in the event of a contract dispute;
•
uncertainties relating to foreign laws, including labor laws, and legal proceedings;
•
the burden of complying with foreign and international laws and treaties;
•
significant currency fluctuations;
•
the burden of complying with and changes in international taxation policies;
•
having to comply with a variety of U.S. laws, including the Foreign Corrupt Practices Act; and
•
having to comply with U.S. export control regulations and policies that restrict our ability to communicate with non-U.S. employees and supply foreign affiliates, partners and customers.
Our international sales and purchases are subject to numerous U.S. and foreign laws and regulations, including, without limitation, tariffs, trade barriers, regulations relating to import-export control, technology transfer restrictions, the International Traffic in Arms Regulation promulgated under the Arms Export Control Act, the Foreign Corrupt Practices Act and the anti-boycott provisions of the U.S. Export Administration Act. If we fail to comply with these laws and regulations, we could be liable for administrative, civil or criminal liabilities, and in the extreme case, we could be suspended or debarred from government contracts or have our export privileges suspended, which could have a material adverse effect on our business.
International sales and purchases are also subject to a variety of other risks, including risks arising from currency fluctuations, collection issues and taxes. Our international sales are subject to variability as our selling prices become less competitive in countries with currencies that are declining in value against the U.S. Dollar and more competitive in countries with currencies that are increasing in value against the U.S. Dollar. In addition, our international purchases can become more expensive if the U.S. Dollar weakens against the foreign currencies in which we are billed.
We have not entered into any foreign currency derivative financial instruments; however, we may choose to do so in the future in an effort to manage or hedge our foreign exchange rate risk.
The capital spending policies of our customers have a significant effect on the demand for our products.
Our customers include clinical diagnostic, pharmaceutical, biotechnological, chemical and industrial companies, and the capital spending policies of these companies can have a significant effect on the demand for our products. These policies are based on a wide variety of factors, including general or local economic conditions, governmental regulation or price controls, the resources available for purchasing research equipment, the spending priorities among various types of analytical equipment and the policies regarding capital expenditures during recessionary periods. Any decrease in capital spending by life sciences companies could cause our revenues to decline. As a result, we are subject to significant volatility in revenue. Therefore, our operating results can be materially affected (negatively and positively) by the spending policies and priorities of our customers.
If we become subject to claims relating to improper handling, storage or disposal of hazardous materials, we could incur significant cost and time to comply.
Our research and development processes involve the controlled storage, use and disposal of hazardous materials, including biological hazardous materials. We are subject to foreign, federal, state and local regulations governing the use, manufacture, storage, handling and disposal of materials and waste products. We may incur significant costs complying with both existing and future environmental laws and regulations. In particular, we are subject to regulation by the Occupational Safety and Health Administration (OSHA) and the Environmental Protection Agency (EPA), and to regulation under the Toxic Substances Control Act and the Resource Conservation and Recovery Act in the United States OSHA or the EPA may adopt regulations that may affect our research and development programs. We are unable to predict whether any agency will adopt any regulations that would have a material adverse effect on our operations.
The risk of accidental contamination or injury from hazardous materials cannot be eliminated completely. In the event of an accident, we could be held liable for any damages that result, and any liability could exceed the limits or fall outside the coverage of our workers’ compensation insurance. We may not be able to maintain insurance on acceptable terms, if at all.
If a catastrophe strikes our manufacturing or warehousing facilities, we may be unable to manufacture or distribute our products for a substantial amount of time and we may experience inventory shortfalls, which would cause us to experience lost revenues.
Our manufacturing facilities are located in Austin, Madison and Toronto. Although we have business interruption insurance, our facilities and some pieces of manufacturing equipment are difficult to replace and could require substantial replacement lead-time. Various types of disasters, including tornadoes, fires, floods and acts of terrorism, may affect our manufacturing facilities. In the event our existing manufacturing facilities or equipment are affected by man-made or natural disasters, we may be unable to manufacture products for sale or meet customer demands or sales projections. If our manufacturing operations were curtailed or ceased, it would seriously harm our business.
The "conflict minerals" rule of the Securities and Exchange Commission, or SEC, has caused us to incur additional expenses, could limit the supply and increase the cost of certain metals used in manufacturing our products, and could make us less competitive in our target markets.
On August 22, 2012, the SEC adopted a rule requiring disclosure by public companies of the origin, source and chain of custody of specified minerals, known as conflict minerals, that are necessary to the functionality or production of products manufactured or contracted to be manufactured. The rule requires companies to obtain sourcing data from suppliers, engage in supply chain due diligence, and file annually with the SEC a specialized disclosure report on Form SD covering the prior calendar year, commencing with calendar year 2013. The rule could limit our ability to source at competitive prices and to secure sufficient quantities of certain minerals used in the manufacture of our products, specifically tantalum, tin, gold and tungsten, as the number of suppliers that provide conflict-free minerals may be limited. We may incur material costs associated with complying with the disclosure requirements, such as costs related to the determination of the origin, source and chain of custody of the minerals used in our products, the adoption of conflict minerals-related governance policies, processes and controls, and possible changes to products or sources of supply as a result of such activities. Within our supply chain, we may not be able to sufficiently verify the origins of the relevant minerals used in our products through the data collection and due diligence procedures that we implement, which may harm our reputation. Furthermore, we may encounter challenges in satisfying those customers that require that all of the components of our products be certified as conflict free, and if we cannot satisfy these customers, they may choose a competitor’s products. We continue to investigate the presence of conflict materials within our supply chain.
If we become subject to product liability claims, we may be required to pay damages that exceed our insurance coverage.
Our business exposes us to potential product liability claims that are inherent in the testing, production, marketing and sale of biotechnological, human (including genetic) diagnostic and therapeutic products. Although we believe that we are reasonably insured against these risks and we generally have limited indemnity protections in our supplier agreements, there can be no assurance that we will be able to obtain insurance in amounts or scope sufficient to provide us with adequate coverage against all potential liabilities. A product liability claim in excess of our insurance coverage or claim that is outside or exceeds our indemnity protections in our supplier agreements or a recall of one of our products would have to be paid out of our cash reserves.
Our success depends on building and sustaining our technology infrastructure.
We are increasingly dependent on information technology to enable us to improve the effectiveness of our operations and to maintain financial accuracy and efficiency. If we do not allocate and effectively manage the resources necessary to build, implement and sustain the proper technology infrastructure, we could be subject to transaction errors, the inability to properly support and service our customers, processing inefficiencies, loss of customers, business disruptions or loss of or damage to intellectual property through security breach or cyber-attack, each of which could materially adversely affect our business.
Our government contracts and administrative processes and systems related to such contracts are subject to audits and cost adjustments by the federal government, which could reduce our revenue, disrupt our business or otherwise adversely affect our results of operations.
We must comply with and are affected by laws and regulations relating to the award, administration, and performance of U.S. Government contracts. A violation of specific laws and regulations could result in the imposition of fines and penalties or the termination of our contracts, as well as suspension or debarment. These fines and penalties could be imposed for failing to follow procurement integrity and bidding rules, employing improper billing practices or otherwise failing to follow rules relating to billing on cost-type contracts, receiving or paying kickbacks, or filing false claims, among other potential violations. In addition, we could suffer serious reputational harm if allegations of impropriety related to such contracts were made against us.
In addition, our contracts with the U.S. Government are subject to future funding and are subject to the right of the government to terminate the contracts in whole or in part for its convenience. There is pressure for the U.S. Government to reduce spending, and non-appropriation of funds or the termination for the government’s convenience of our contracts could cause our actual results of operations to differ materially and adversely from those anticipated. Further, for U.S. Government contracts that include option years, the U.S. Government generally has the unilateral right to not exercise option periods, and may not exercise an option period if the agency is not satisfied with our performance on the contract or does not receive funding to continue the program, among other reasons.
Further, federal government agencies, including the Defense Contract Audit Agency (DCAA), routinely audit and investigate government contracts and government contractors’ administrative processes and systems. These agencies review our performance on government contracts, pricing practices, cost structure and compliance with applicable laws, regulations and standards. They also review our compliance with government regulations and policies and the adequacy of our internal control systems and policies, including our purchasing, accounting, estimating, compensation and management information processes and systems. Any costs found to be improperly allocated to a specific government contract, unallowable or unreasonable will not be reimbursed, and any such costs already reimbursed must be refunded and certain penalties may be imposed. Moreover, if any of the administrative processes and systems related to such contracts is found not to comply with governmental requirements, we may be subjected to increased government scrutiny that could delay or otherwise adversely affect our ability to compete for or perform government contracts or collect our revenue in a timely manner. Therefore, an unfavorable outcome of an audit of our government contracts by the DCAA or another government agency could cause our actual results of operations to differ materially and adversely from those anticipated. Each of these outcomes could adversely affect our results of operations. We do not know the outcome of any existing or future audits and if any future audit adjustments significantly exceed our estimates, our profitability could be adversely affected.
We rely on the innovation and resources of larger industry participants and public programs in our partnership business to advance genomic research and educate physicians/clinicians on genetic diagnostics.
The linkages between genetic anomalies that our products detect and the underlying disease states are not always fully medically correlated. Additionally, the availability of correlated genetic markers is dependent on significant investment in genomic research, often funded through public programs for which there are no assurances of on-going support. Should any government limit patent rights to specific genetic materials, private investment in this area could also be significantly curtailed. In addition, the adoption of genetic diagnostics is dependent to a great extent on the education and training of physicians and clinicians. We do not have the resources to undertake such training, and are relying on larger industry participants and professional medical colleges to establish, communicate and educate physicians and clinicians on best practices related to genetic diagnostics.
We are subject to evolving legislative, regulatory, judicial and ethical standards on use of technology and biotechnology.
The adoption of genetic testing is occurring within the broader context of a myriad of decisions related to genetic patenting and genotyping. Issues associated with health insurance, data access, intellectual property protection, national and international legislative and regulatory initiatives and other variables may have a significant impact on the wide-spread adoption of genetic testing or on specific segments or tests within the genetic testing market.
Our effective tax rate may fluctuate and we may incur obligations in tax jurisdictions in excess of amounts that have been accrued.
We are subject to income taxes in the United States and various foreign jurisdictions. Our effective tax rate may be lower or higher than experienced in the past due to numerous factors, including a change in the mix of our profitability from country to country, the establishment or release of valuation allowances against our deferred tax assets, and changes in tax laws. In addition, we take certain income tax positions on our tax returns that we recognize in our financial statements if it is more likely than not they will not withstand challenge by tax authorities. We are subject to tax audits in various jurisdictions, including the United States, and tax authorities may disagree with certain positions we have taken and assess additional taxes. There can be no assurance that we will accurately predict the outcomes of these audits, and the actual outcomes could have a material impact on our net income or financial condition. Any of these factors could cause us to experience an effective tax rate significantly different from previous periods or our current expectations, which could have an adverse effect on our business and results of operations. The recognition of deferred tax assets is reduced by a valuation allowance if it is more likely than not that the tax benefits will not be realized. We regularly review our deferred tax assets for recoverability and establish a valuation allowance based on historical income, projected future income, the expected timing of the reversals of existing temporary differences and the implementation of tax-planning strategies.
Changes in tax laws or tax rulings could materially impact our effective tax rate. There are several proposals to reform U.S. tax rules being considered by U.S. law makers, including proposals that may reduce or eliminate the deferral of U.S. income tax on our unrepatriated earnings, potentially requiring those earnings to be taxed at the U.S. federal income tax rate, reduce or eliminate our ability to claim foreign tax credits, and eliminate various tax deductions until foreign earnings are repatriated to the U.S. Our future reported financial results may be adversely affected by tax rule changes which restrict or eliminate our ability to claim foreign tax credits or deduct expenses attributable to foreign earnings, or otherwise affect the treatment of our unrepatriated earnings.
Our stock price has been and is likely to continue to be volatile.
The trading price of our common stock has been and is likely to continue to be highly volatile and subject to wide fluctuations in price. This volatility is in response to various factors, many of which are beyond our control, including:
•
actual or anticipated variations in quarterly operating results from historical results or estimates of results prepared by securities analysts;
•
developments in patents or other intellectual property rights and litigation;
•
new, or changes in, recommendations, guidelines or studies that could affect the use of our products;
•
announcements of acquisitions or of technological innovations or new products or services by us or our competitors;
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developments in relationships with our partners, customers and suppliers;
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additions or departures of key personnel;
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announcements by us of significant acquisitions, strategic partnerships, joint ventures or capital commitments;
•
conditions or trends in the life science, biotechnology and pharmaceutical industries, including the regulatory environment;
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published studies and reports relating to the comparative efficacy of products and markets in which we participate;
•
changes in financial estimates by securities analysts;
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general worldwide economic conditions and interest rates;
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the success or lack of success of integrating our acquisitions;
•
instability in the United States and other financial markets and the ongoing and possible escalation of unrest in the Middle East, other armed hostilities or further acts or threats of terrorism in the United States or elsewhere;
•
sales of our common stock; and
•
the potential adverse impact of the secondary trading of our stock on foreign exchanges which are subject to less regulatory oversight than the NASDAQ Global Select Market, without our permission, and the activity of the market makers of our stock on such exchanges, including the risk that such market makers may engage in naked short sales and/or other deceptive trading practices which may artificially depress or otherwise affect the price of our common stock on the NASDAQ Global Select Market.
In addition, the stock market in general, and the NASDAQ Global Select Market and the market for technology companies in particular, has experienced significant price and volume fluctuations that have often been unrelated or disproportionate to the operating performance of those companies. Further, there has been particular volatility in the market prices of securities of life sciences companies. These broad market and industry factors may seriously harm the market price of our common stock, regardless of our operating performance. In the past, following periods of volatility in the market price of a company’s securities, securities class action litigation has often been instituted. A securities class action suit against us could result in substantial costs, potential liabilities and the diversion of management’s attention and resources.
We may incur impairment charges on our goodwill and intangible assets which would reduce our earnings.
We are subject to Accounting Standards Codification (ASC) 350 “Goodwill and Other” (ASC 350) which requires that goodwill and other intangible assets that have an indefinite life be tested at least annually for impairment. Goodwill and other intangible assets with indefinite lives must also be tested for impairment between the annual tests if a triggering event occurs that would likely reduce the fair value of the asset below its carrying amount. As of December 31, 2014, goodwill and other intangible assets with indefinite lives represented approximately 30% of our total assets. In the future, if we determine that there has been impairment, our financial results for the relevant period would be reduced by the amount of the impairment, net of tax effects, if any.
Anti-takeover provisions in our certificate of incorporation, bylaws and Delaware law could make a third party acquisition of us difficult.
Our certificate of incorporation and bylaws contain provisions that could make it more difficult for a third party to acquire us, even if doing so would be beneficial to our stockholders. We are also subject to certain provisions of Delaware law that could delay, deter or prevent a change in control of us. These provisions could limit the price that investors might be willing to pay in the future for shares of our common stock.
ITEM 1B.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
ITEM 2.
ITEM 2. PROPERTIES
Our principal research and development, manufacturing and administrative facilities are located in Austin, Texas, and consist of approximately 184,000 square feet of leased space pursuant to lease agreements which expire between July 31, 2017 and April 30, 2020. We have options to renew these lease agreements in Austin. We maintain 20,000 square feet of leased office space in The Netherlands, approximately 34,700 square feet of leased office and manufacturing space in Toronto, Canada and approximately 35,000 square feet of leased office and manufacturing space in Madison, Wisconsin. In addition, we maintain approximately 3,900 square feet and approximately 2,000 square feet of leased office space in Shanghai and Beijing, respectively, People's Republic of China, approximately 2,900 square feet of lease office space in Hong Kong and approximately 4,000 square feet of leased office space in Tokyo, Japan.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
On August 30, 2012 Abbott Laboratories, Inc. (Abbott) was named as a defendant in the complaint filed by ENZO Life Sciences, Inc. (ENZO) in U.S. District Court in Delaware for alleged infringement of its US Patent 7,064,197 as a result of Abbott's distribution of Luminex's xTAG Respiratory Viral Panel. Luminex and Abbott have entered into an agreement requiring Luminex to defend and indemnify Abbott for any alleged patent infringement resulting from its distribution of Luminex's Respiratory Viral Panel. The complaint seeks unspecified monetary damages and injunctive relief. Abbott filed an answer to the complaint on October 15, 2012. On November 30, 2012, Luminex intervened in the lawsuit. On January 2, 2013 ENZO filed additional claims against Luminex, alleging infringement of US Patent 7,064,197 resulting from Luminex's sale of its xTAG, FlexScript LDA, SelecTAG, and xMAP Salmonella Serotyping Assay products and alleging infringement of US Patent 8,097,405 resulting from Luminex's sale of Multicode products. Luminex filed an answer to ENZO's additional claims on January 28, 2013. On October 2, 2013 ENZO filed additional claims against Luminex, alleging infringement of U.S. Patent 6,992,180 resulting from Luminex’s sale of Multicode products. Luminex filed an answer to ENZO’s additional claims on October 21, 2013. A trial date has not been set. The parties to the lawsuit have engaged in the discovery process.
On November 1, 2013 Irori Technologies, Inc. (Irori) filed a complaint against Luminex in U.S. District Court in the Southern District of California, alleging infringement of its U.S. Patent 6,372,428, 6,416,714, and 6,352,854 resulting from Luminex’s sale of its xMAP and xTAG based products. Luminex filed a motion to dismiss on January 9, 2014. Irori filed its response to our motion to dismiss on February 7, 2014. The court granted the motion to dismiss without prejudice on February 25, 2014. On March 18, 2014, Irori filed an amended complaint, again alleging infringement of its US Patent 6,372,428, 6,416,714, and 6,352,854 resulting from Luminex’s sale of its xMAP and xTAG based products. The complaint seeks unspecified monetary damages and injunctive relief. Luminex filed an answer to Irori’s amended complaint on April 2, 2014. On June 10, 2014, Luminex filed with the USPTO’s Patent Trial and Appeal Board a total of five petitions for inter partes review seeking to invalidate the claims of the three patents involved in the litigation. On June 17, 2014 Luminex filed a motion to stay proceedings in the district court pending the USPTO’s resolution of the inter partes review of Irori’s patents. Irori filed its opposition to the motion to stay on July 7, 2014, and Luminex filed a reply on July 14, 2014. On July 16, 2014, the court granted Luminex’s motion to stay the case until the earlier of i) a determination by the United States Patent and Trademark Office that reexamination proceedings will not take place or ii) the conclusion of reexamination proceedings and appeals. On December 11, 2014, the USPTO's Patent Trial and Appeal Board instituted review on all five inter partes review petitions that Luminex filed. Irori’s responses to the petitions
are due February 26, 2015, and oral argument (if requested by either party) is scheduled for August 5, 2015.
When and if it appears probable in management's judgment, and based upon consultation with outside counsel, that we will incur monetary damages or other costs in connection with any claims or proceedings, and such costs can be reasonably estimated, we record the estimated liability in the financial statements. If only a range of estimated losses can be estimated, we record an amount within the range that, in management's judgment, reflects the most likely outcome; if none of the estimates within that range is a better estimate than any other amount, we record the liability at the low end of the range of estimates. Any such accrual would be charged to expense in the appropriate period. We disclose significant contingencies when the loss is not probable and/or the amount of the loss is not estimable, when we believe there is at least a reasonable possibility that a loss has been incurred. We recognize costs associated with legal proceedings in the period in which the services were provided. There can be no assurance that we will successfully defend these suits or that a judgment against us would not materially adversely affect our operating results.
ITEM 4.
ITEM 4. MINE SAFETY DISCLOSURES
None.
PART II
ITEM 5.
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Market Information
Our common stock is traded on the NASDAQ Global Select Market under the symbol “LMNX.”
The following table sets forth the range of high and low sale prices on The NASDAQ Global Select Market, as applicable, for each quarter during 2014 and 2013. On February 23, 2015, the last reported sale price of our common stock was $16.21 per share.
Holders
As of February 23, 2015, we had 477 holders of record of our common stock. Because many of our shares are held by brokers and other institutions on behalf of stockholders, we are unable to estimate the total number of beneficial stockholders represented by these record holders.
Dividends
We have never declared or paid cash dividends on our common stock and, while this policy is subject to periodic review by our board of directors, we currently intend to retain any earnings for use in our business and do not anticipate paying cash dividends in the foreseeable future. Our ability to declare dividends may also from time to time be limited by the terms of any applicable credit facility. Luminex does not currently have a credit facility.
Recent Sales of Unregistered Securities
There were no sales of unregistered securities of Luminex during the twelve months ended December 31, 2014.
Performance Graph
The following graph compares the change in Luminex’s cumulative total stockholder return on its common shares with the NASDAQ Composite Index and the NASDAQ Biotechnology Index.
Issuer Purchases of Equity Securities
The stock repurchase activity for the fourth quarter of 2014 was as follows:
(1)
Total shares purchased includes shares attributable to the withholding of shares by Luminex to satisfy the payment of tax obligations related to the vesting of restricted shares.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The following selected consolidated financial data should be read in conjunction with the Consolidated Financial Statements and Notes thereto and with Item 7
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following information should be read in conjunction with the Consolidated Financial Statements and the accompanying Notes included below in Item 8 and “Risk Factors” included above in Item 1A of this Annual Report on Form 10-K. This discussion contains forward-looking statements that involve risks and uncertainties. Our actual results may differ materially from those anticipated in these forward-looking statements.
Overview
We develop, manufacture and sell proprietary biological testing technologies and products with applications throughout the diagnostics and life sciences industries. These industries depend on a broad range of tests, called bioassays, to perform diagnostic tests and conduct life science research. Our xMAP (Multi-Analyte Profiling) technology, an open architecture, multiplexing technology, allows simultaneous analysis of up to 500 bioassays from a small sample volume, typically a single drop of fluid, by reading biological tests on the surface of microscopic polystyrene beads called microspheres. xMAP technology combines this miniaturized liquid array bioassay capability with small lasers, digital signal processors and proprietary software to create a system offering advantages in speed, precision, flexibility and cost. Our xMAP technology is currently being used within various segments of the life sciences industry which includes the fields of drug discovery and development, and for clinical diagnostics, genetic analysis, bio-defense, food safety and biomedical research. In addition to our xMAP technology, our other offerings include our proprietary MultiCode technology, used for real-time PCR (Polymerase Chain Reaction) and multiplexed PCR assays. Our MultiCode assay chemistry is a flexible platform for both real-time PCR and multiplex PCR-based applications. Our MultiCode technology is powered by a base pair (man-made nucleotide pair isoC:isoG in addition to the A:T and G:C nucleotide pairs found in nature) that does not exist in nature, but can be combined with natural base pairs, and incorporated into a wide range of molecular diagnostic applications. The MultiCode base pair is recognized by naturally occurring enzymes and can be used for the specific placement of reporter molecules and to increase the molecular recognition capabilities of hybridization-based assays. The MultiCode base pair enables solutions to complex molecular challenges that were previously not possible with natural nucleic acid alone.
Our end user customers and partners, which include laboratory professionals performing research, clinical laboratories performing tests on patients as ordered by physicians and other laboratories, have a fundamental need to perform high quality testing as efficiently as possible. Luminex employs a two-pronged business model. We have licensed our xMAP technology to partner companies, which in turn then develop products that incorporate the xMAP technology into products that our partners sell to end users. We develop and manufacture the proprietary xMAP laboratory instrumentation and the proprietary xMAP microspheres and sell these products to our partners. Our partners then sell xMAP instrumentation and xMAP-based reagent consumable products, which run on the instrumentation, to the end user laboratory. As of December 31, 2014, Luminex had 66 strategic partners, of which 46 have released commercialized reagent-based products utilizing our technology.
Luminex has several forms of revenue that result from our business model:
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System revenue is generated from the sale of our xMAP multiplexing analyzers and peripherals.
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Consumable revenue is generated from the sale of our dyed polystyrene microspheres, along with sheath and drive fluid. Our larger commercial and development partners often purchase these consumables in bulk to minimize the number of incoming qualification events and to allow for longer development and production runs.
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Royalty revenue is generated when a partner sells our proprietary microspheres to an end user, a partner sells a kit incorporating our proprietary microspheres to an end user or when a partner utilizes a kit to provide a testing result to a user. End users can be facilities such as testing labs, development facilities and research facilities that buy prepared kits and have specific testing needs or testing service companies that provide assay results to pharmaceutical research companies or physicians.
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Assay revenue is generated from the sale of our kits which are a combination of chemical and biological reagents and our proprietary xMAP bead technology used to perform diagnostic and research assays on samples as well as real-time PCR and multiplexed PCR assays using our proprietary MultiCode technology.
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Service revenue is generated when a partner or other owner of a system purchases a service contract from us after the standard warranty has expired or pays us for our time and materials to service instruments. Service contract revenue is amortized over the life of the contract and the costs associated with those contracts are recognized as incurred.
•
Other revenue consists of items such as training, shipping, parts sales, license revenue, grant revenue, contract research and development fees, milestone revenue and other items that individually amount to less than 5% of total revenue.
2014 Highlights
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Consolidated revenue was $227.0 million for 2014, representing a 6% increase over revenue for 2013.
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System shipments of 950 multiplexing analyzers, which included 372 MAGPIX systems, resulting in cumulative life-to-date multiplexing analyzer shipments of 11,687, up 9% from a year ago.
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Royalty revenue reflecting over $456 million of royalty bearing end user sales on our technology for the year, a 7% increase in royalty revenue over the prior year.
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Assay revenue of $87.7 million, an 18% increase over 2013
•
Received FDA clearance to add new clinical targets and additional sample type for use with xTAG® Gastrointestinal Pathogen Panel.
Reimbursement Landscape
Over the past two years, the molecular diagnostic market has experienced what we believe to be a temporary deceleration in the utilization of molecular assays, particularly in the human genetics segment. This deceleration was driven by administrative issues associated with the new molecular diagnostic code system implemented by the Centers for Medicare and Medicaid Services (CMS) in 2013. After implementation of the new molecular diagnostic codes, a number of our laboratory customers experienced Medicare fee schedule reductions, delays in pricing and implementation of key molecular codes, denials of coverage for existing tests and delays in payment for tests performed by some payers, all of which resulted in lower than anticipated testing volumes for our customers and, therefore, decreased assay revenues in 2013. In addition, effective January 1, 2014, CMS began bundling Medicare payment for most clinical laboratory tests into hospital payment rates. As a result, most independent laboratories must now obtain payment from the hospital rather than directly billing Medicare. Despite these changes, based on feedback from our customers regarding the 2014 Medicare Clinical Laboratory Fee Schedule and the reinstatement in 2013 of coverage for Cystic Fibrosis genetic testing, the single largest test that was not being reimbursed, we believe that reimbursement challenges diminished in 2014. However, we may be impacted by future changes to the reimbursement landscape. Commercial payors may adopt coding and bundling requirements that are similar to those made by Medicare. Further, in April 2014, the Protecting Access to Medicare Act (PAMA) was enacted. Beginning in 2016, PAMA requires clinical laboratories to report to CMS the volume of each laboratory test and the price paid by private payors. CMS must set future Medicare fee schedules using weighted medians from these datasets. This requirement could exert downward pressure on Medicare reimbursement, because reimbursement rates for clinical laboratory services of commercial payors are often lower than rates paid by Medicare. We will continue to monitor the reimbursement landscape closely.
Consumables Sales and Royalty Revenue Trends
We have experienced significant fluctuations in consumable revenue over the past three years. Overall, the fluctuations manifested themselves through periodic changes in volume from our largest bulk purchasing partners. These customers account for more than 75% of our total consumable sales volume. During 2015, we expect a contraction of approximately $10 million in consumable sales as the result of transient inventory challenges that our largest bulk purchasing partner is experiencing. We expect this lower level of purchasing to continue over the next several years. However, even though we experience variability in consumable revenue, the key indicator of the success of our partners’ commercialization efforts is the rising level of royalties and reported royalty bearing sales. We believe that our relationship with our largest bulk purchasing partner remains strong and they are continuing to invest in our technology. The royalty stream from our largest bulk purchasing partner has grown steadily, indicating further penetration and use of our technology within their market.
Change in Cash Position
Our cash, cash equivalents and investments increased by approximately $35.3 million for the year ended December 31, 2014 to $107.7 million from $72.4 million at December 31, 2013. The increase in cash, cash equivalents and investments is primarily attributable to strong operating cash flows of $49.3 million, coupled with $4.7 million in proceeds from our employee stock purchase plan (ESPP) and stock option exercises, which funded our capital expenditures of $17.1 million.
Segment Information
During the fourth quarter of 2014, in conjunction with the appointment of our new CEO, Luminex evaluated its historical reporting segments: the TSP segment and the ARP segment. As a result of this evaluation and based upon how our new Chief Executive Officer as Chief Operating Decision Maker (“CODM”) and our management team collectively is managing our business, we determined that the two former segments have become so integrated and interrelated that they no longer provide an accurate representation of our current business when reported separately. Additionally, we have taken actions to consolidate sales and service functions. Effective with the fourth quarter of 2014, we no longer have two operating segments and, accordingly, will present our business as one operating segment and one reporting unit. Accordingly, prior periods' information has been restated to conform to the current periods' presentation.
Future Operations
We expect our areas of focus over the next twelve months to be:
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clinical validation and preparation for commercial launch of our ARIES system, the next generation sample-to-answer platform for our MultiCode-RTx technology, including in vitro diagnostic (IVD) assays;
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development of the next generation multiplex chemistry, including the next generation of our Respiratory Viral Panel line of IVD assays;
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continued execution of our pharmacogenetic (PGx) strategy;
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continued execution of our direct sales strategy, including developing the infrastructure necessary to support our sales force and decreasing reliance on our distributors;
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commercialization, regulatory clearance and market adoption of products, including commercialization of MultiCode analyte specific reagents outside of the United States;
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maintenance and improvement of our existing products and the timely development, completion and successful commercial launch of our pipeline products;
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adoption and use of our platforms and consumables by our customers for testing services;
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expansion and enhancement of our installed base and our market position within our identified target market segments;
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monitoring and mitigating the effect of the ongoing uncertainty in global finance markets and changes in government funding on planned purchases by end users; and
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continued adoption and development of partner products incorporating Luminex technology through effective partner management.
We anticipate continued revenue concentration in our higher margin items (assays, consumables and royalties) contributing to favorable, but variable, gross margin percentages. Additionally, we believe that a sustained investment in research and development is necessary in order to meet the needs of our marketplace and provide a sustainable new product pipeline. We may experience volatility in research and development expenses as a percentage of revenue on a quarterly basis as a result of the timing of development expenses, clinical validation and clinical trials in advance of the commercial launch of our new products.
Critical Accounting Policies
The discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with United States generally accepted accounting principles (GAAP). The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. The following is a discussion of our most critical accounting policies used in the preparation of our financial statements, and the judgments and estimates involved under each. We also have other significant accounting policies that do not involve critical accounting estimates because they do not generally require us to make estimates and judgments that are difficult or subjective. These are described in Note 1 of our Consolidated Financial Statements provided herein in Item 8. Estimates and assumptions are reviewed periodically. Actual results may differ from these estimates under different assumptions or conditions.
Revenue Recognition. Revenue is generated primarily from the sale of our products and related services, which are primarily support and maintenance services on our systems. We recognize product revenue at the time the product is shipped provided there is persuasive evidence of an agreement, no right of return exists, the fee is fixed or determinable and collectability is probable. There is no customer right of return in our sales agreements. If the criteria for revenue recognition are not met at the time of shipment, the revenue is deferred until all criteria are met.
We regularly enter into arrangements for system sales that are multiple-element arrangements, including services such as installation and training, and multiple products. These products or services are primarily delivered within a short time frame, approximately three to six months, of the agreement execution date and can also be performed by one of our third-party partners. Based on the terms and conditions of the sale, we believe that these services can be accounted for separately from the delivered system as our delivered products have value to our customers on a stand-alone basis. Items are considered to have stand-alone value when they are sold separately by any vendor or when the customer could resell the item on a stand-alone basis. Accordingly, the estimated selling price of services or products not yet performed or delivered at the time of system shipment are deferred and recognized as revenue as such services are performed. We have typically been able to determine the selling price of each deliverable in a multiple-element arrangement based on the price for such deliverable when it is sold separately. If vendor specific objective evidence (VSOE) is not determinable and when third-party evidence is not available, we use the estimated selling price of a deliverable which is determined based upon our pricing policies, expected margin of the deliverable, geographical location and information gathered from customer negotiations.
Within the diagnostic portion of our business, we provide systems and certain other hardware to customers through reagent rental agreements under which the customers commit to purchasing minimum quantities of disposable products at a stated price over a defined contract term, which is normally two to three years. All of these reagent rental agreements are operating leases. Instead of rental payments, we recover the cost of providing the system and other hardware in the amount we charge for our diagnostic assays and other disposables. Revenue is recognized over the defined contract term as assays and other disposable products are shipped. The depreciation costs associated with the system and other hardware are charged to cost of sales on a straight-line basis over the estimated life of the system. The costs to maintain these instruments in the field are charged to cost of sales as incurred.
Revenue from extended service agreements is deferred and recognized ratably over the term of the agreement. We may also be entitled to milestone payments that are contingent upon our achieving a predefined objective. We follow the milestone method of recognizing revenue from milestones and milestone payments are recorded as revenue in full upon achievement of the milestone. Revenues from royalties related to agreements with strategic partners are recognized when such amounts are reported to the Company; therefore, the underlying end user sales may be related to prior periods.
Additional revenue is derived from cost-type contracts with the U.S. government. Revenue and profit under cost-plus service contracts is recognized as costs are incurred plus negotiated fees. Fixed fees on cost-plus service contracts are recognized ratably over the contract performance period as services are performed. Contract costs include labor and related employee benefits, subcontracting costs and other direct costs, as well as allocations of allowable indirect costs. For contract change orders, claims or similar items, judgment is required for estimating the amounts, assessing the potential for realization, and determining whether realization is probable. From time to time, facts develop that require revisions of revenue recognized or cost estimates. To the extent that a revised estimate affects the current or an earlier period, the cumulative effect of the revision is recognized in the period in which the facts requiring the revision become known. Reimbursements of certain costs, including certain hardware costs or out-of-pocket expenses are included in revenue with corresponding costs included in cost of revenue as costs are incurred.
Inventory. Inventories are valued at the lower of cost or market value, with cost determined according to the standard cost method. Inventories have been written down through an allowance for excess and obsolete inventories. The two major components of the allowance for excess and obsolete inventory are (i) a specific write-down for inventory items that we no longer use in the manufacture of our products or that no longer meet our specifications and (ii) a write-down against slow moving items for potential obsolescence. Inventory is reviewed on a regular basis and adjusted based on management’s review of inventories on hand compared to estimated future usage and sales. While management believes that adequate write-downs for inventory obsolescence have been made in the consolidated financial statements, scientific and technological advances will continue and we could experience additional inventory write-downs in the future. However, we do not believe this estimate is subject to significant variability.
Warranties. We provide for the estimated cost of initial product warranties at the time revenue is recognized. While we engage in product quality programs and processes, our warranty obligation is affected by product failure rates, material usage and service delivery costs incurred in correcting a product failure. While management believes that adequate reserve has been made in the consolidated financial statements for product warranties, should actual product failure rates, material usage or service delivery costs differ from our estimates, revisions to the estimated warranty liability would be required. However, we do not believe this estimate is subject to significant variability.
Purchase Price Allocation, Intangibles and Goodwill. The purchase price allocation for acquisitions requires extensive use of accounting estimates and judgments to allocate the purchase price to the identifiable tangible and intangible assets acquired, including in-process research and development, and liabilities assumed based on their respective fair values. Intangible assets with definite lives are amortized over the assets’ estimated useful lives using the straight-line method. We periodically review the estimated useful lives of our identifiable intangible assets, taking into consideration any events or circumstances that might result in a diminished fair value or revised useful life.
Goodwill represents the excess of the cost over the fair value of the assets of the acquired business. We evaluate the carrying value of goodwill on a reporting unit level annually, on October 1st of each year, or more frequently if there is evidence that certain events or changes in circumstances indicate that the carrying amount of these assets may not be recoverable. As of October 1, 2014, all of our goodwill related to one reporting unit, our previous ARP segment, for goodwill impairment testing. As the change to one reporting segment was made after October 1, 2014, we performed our analysis on goodwill under the ARP segment as of October 1, 2014. We have historically estimated the fair value of our ARP segment reporting unit using a discounted cash flow (DCF) analysis (“step one” analysis) of our projected future results or using a more qualitative analysis (“step zero” analysis) under the accounting guidance which allows an entity to first assess qualitative factors to determine if it is more likely than not that the fair value of a reporting unit is less than its carrying amount. In fiscal 2012, we used the "step zero" analysis in our annual impairment analysis for goodwill. In performing the impairment test in the fourth quarter of 2013 and 2014, we used the "step one" analysis. This analysis requires a comparison of the carrying value of the reporting unit to the estimated fair value of the reporting unit. Determining the fair value of goodwill is subjective in nature and often involves the use of estimates and assumptions. Our annual test, performed on the first day of the fourth quarter, did not result in an impairment charge for 2014 as the estimated fair value of the ARP segment reporting unit exceeded the carrying value by a significant enough amount that any reasonably likely change in the assumptions used in the analysis would not cause the carrying value to exceed the estimated fair value for the reporting unit as determined under our "step one" analysis.
We utilize an income approach based on a DCF analysis to determine fair value estimates, and then use market comparisons as a reasonableness check to ensure that neither the income approach nor the market comparisons yielded significantly different results. The income approach calculates the fair value by estimating the after-tax cash flows attributable to a reporting unit and then discounting the after-tax cash flows to a present value using a risk-adjusted discount rate. Our estimates are based on revenue projections by product line, and include judgment based on historical growth and scheduled product approvals by the various governmental authorities. We believe our assumptions are consistent with the plans and estimates used to manage the underlying businesses. The most significant assumptions used in the DCF methodology are the discount rate, based upon the estimated weighted average cost of capital (WACC), and the terminal growth rate, based upon strategic studies we commissioned and our own internal analysis. We used a WACC rate of 14.5% and a terminal growth rate of 2.9% in our 2014 analysis. To determine our WACC rate, we performed a peer company analysis and considered the weighted average return on debt and equity, the updated risk-free interest rate, beta, equity risk premium, and entity specific size risk premium.
Our analysis yielded an estimated fair value in excess of the carrying value by over 25% for 2014. Concurrent with the above analysis, we performed a sensitivity analysis based upon reasonably likely changes to determine if our DCF analysis would result in impairment if the following changes were made to our assumptions: i) assumed the fair value of the reporting unit was lower by 10% or ii) future revenue was 75% of our projections in the DCF model. Neither of these sensitivity analyses resulted in an estimated fair value less than the carrying amount of the reporting unit.
Accounting for Income Taxes. We calculate our provision for income taxes using the asset and liability method, under which deferred tax assets and liabilities are recognized by identifying the temporary differences arising from the different treatment of items for tax and accounting purposes. In determining the future tax consequences of events that have been recognized in our financial statements or tax returns, judgment is required. Differences between the anticipated and actual outcomes of these future tax consequences could have a material impact on our consolidated results of operations or financial position. The recognition of deferred tax assets is reduced by a valuation allowance if it is more likely than not that the tax benefits will not be realized. We regularly review our deferred tax assets for recoverability and establish a valuation allowance based on historical income, projected future income, the expected timing of the reversals of existing temporary differences and the implementation of tax-planning strategies. Undistributed earnings of our foreign subsidiaries are considered permanently reinvested and, accordingly, no provision for U.S. federal or state income taxes has been provided thereon.
The GAAP guidance requires recognition of the impact of a tax position in our financial statements only if that position is more likely than not to be sustained upon examination by taxing authorities, based on the technical merits of the position. Any interest and penalties related to uncertain tax positions will be reflected in income tax expense. Determining the consolidated provision for income taxes involves judgments, estimates and the application of complex tax regulations. We are required to provide for income taxes in each of the jurisdictions where we operate, including estimated liabilities for uncertain tax positions. Although we believe that we have provided adequate liabilities for uncertain tax positions, the actual liability resulting from examinations by taxing authorities could differ from the recorded income tax liabilities and could result in additional income tax expense having a material impact on our consolidated results of operations. Changes of estimates in our income tax liabilities are reflected in our income tax provision in the period in which the factors resulting in the change to our estimate become known to us. We benefit from the tax credit incentives under the U.S. research and experimentation tax credit extended to taxpayers engaged in qualified research and experimental activities while carrying on a trade or business. The tax credit expired on December 31, 2014, and if not renewed under similar terms as in prior years, the result could have a material impact on our financial results.
We recognize excess tax benefits associated with share-based compensation to stockholders’ equity only when realized. When assessing whether excess tax benefits relating to share-based compensation have been realized, we follow the with-and-without approach, excluding any indirect effects of the excess tax deductions. Under this approach, excess tax benefits related to share-based compensation are not deemed to be realized until after the utilization of all other tax benefits available to us.
In March 2010, significant reforms to the healthcare system were adopted as law in the U.S. The law includes provisions that, among other things, imposes new and/or increased taxes. Specifically, the law requires the medical device industry to subsidize healthcare reform in the form of a 2.3% excise tax on U.S. sales of certain medical devices effective January 1, 2013. Our products which have received FDA approval fall under the government classification and are subject to the excise tax.
Stock compensation. All stock-based compensation cost, including grants of stock options, restricted stock units and shares issued under the Company’s employee stock purchase plan, is measured at the grant date based on the fair value of the award and is recognized as an expense on a straight-line basis over the requisite service period, which is generally the vesting period. The fair value of our stock options is estimated using the Black-Scholes option pricing model. The Black-Scholes valuation calculation requires us to estimate key assumptions such as expected volatility, expected term and risk-free rate of return. Calculation of expected volatility is based on historical volatility. The expected term is calculated using the contractual term of the options as well as an analysis of our historical exercises of stock options. The estimate of risk-free rate is based on the U.S. Treasury yield curve in effect at the time of grant. We have never paid cash dividends and do not currently intend to pay cash dividends, thus we have assumed a 0% dividend yield.
The amount of stock-based compensation expense recognized during a period is based on the value of the portion of the awards that are ultimately expected to vest. As part of the requirements of ASC 718, the Company is required to estimate potential forfeitures of stock grants and adjust compensation cost recorded accordingly. The estimate of forfeitures is based on historical forfeiture performance and will be adjusted over the requisite service period to the extent that actual forfeitures differ, or are expected to differ, from such estimates. Changes in estimated forfeitures will be recognized through a cumulative catch-up adjustment in the period of evaluation and will also impact the amount of stock compensation expense to be recognized in future periods. Ultimately, the actual expense recognized over the vesting period will only be for those awards that vest, except for the limited number of market based awards under long term incentive plans. If we use different assumptions for estimating stock-based compensation expense in future periods or if actual forfeitures differ materially from our estimated forfeitures, the change in our stock-based compensation expense could materially affect our operating income, net income and net income per share.
Consolidated Results of Operations
The following table sets forth the percentage of total revenue of certain items in the Consolidated Results of Operations. The financial information and the discussion below should be read in conjunction with the Consolidated Financial Statements and Notes thereto.
Year Ended December 31, 2014 Compared to Year Ended December 31, 2013
Revenue. Total revenue increased to $227.0 million for the year ended December 31, 2014 from $213.4 million in 2013. The increase was primarily attributable to an increase of $13.6 million in assay revenue and $2.5 million in royalty revenue, partially offset by a decrease of $2.6 million in system revenue. The increase in assay revenue is attributable to growth in both of our primary assay portfolios; infectious disease assays and genetic testing assays, which grew at 18% and 20%, respectively, over the prior year. The increase in royalty revenue was driven by our partners' continued menu expansion and increased utilization of our partners’ assays on our technology. System revenue decreased from $31.8 million in 2013 to $29.2 million in 2014. We sold 950 multiplexing analyzers in 2014, which included 372 of our MAGPIX systems, as compared to 1,078 multiplexing analyzers sold in 2013, which included 495 MAGPIX systems, bringing total multiplexing analyzer shipments since inception to 11,687 as of December 31, 2014. Additionally, system revenue generated in our Brisbane, Australia facility, which was closed in 2014, declined by $1.2 million in 2014 from the prior year.
A breakdown of revenue for the years ended December 31, 2014 and 2013 is as follows:
We continue to have revenue concentration in a limited number of customers. In 2014, the top five customers, by revenue, accounted for 55% of total revenue up from 54% of total revenue in 2013. In particular, two customers accounted for 38% of 2014 total revenue (21% and 17%, respectively) up from 34% of 2013 total revenue (18% and 16%, respectively). No other customer accounted for more than 10% of total revenue in 2014 or 2013.
Revenue from the sale of systems and peripheral components decreased 8% to $29.2 million for the year ended December 31, 2014 from $31.8 million for the year ended December 31, 2013, due to the decrease in the total multiplexing analyzer placements. We sold 950 total multiplexing analyzers in 2014 as compared to 1,078 in 2013. We anticipate that our increased focus on direct sales will drive the placement of reagent rental multiplexing analyzer systems in lieu of multiplexing analyzer system sales to distributors. For the year ended December 31, 2014, five of our partners accounted for 721, or 76%, of total multiplexing analyzers sold. Five of our partners accounted for 895, or 83%, of total multiplexing analyzers sold for the year ended December 31, 2013.
Consumable sales, comprised of microspheres and sheath fluid, decreased to $48.3 million during 2014 from $48.5 million in 2013. During the year ended December 31, 2014, we had 68 bulk purchases of consumables totaling approximately $37.6 million (78% of total consumable revenue), ranging from $0.1 million to $4.8 million, as compared with 74 bulk purchases totaling approximately $38.8 million (80% of total consumable revenue), in the year ended December 31, 2013. The decrease in bulk purchases in 2014 is the primary driver to the decrease in consumable revenue from the prior year and is primarily the result of transient inventory challenges experienced by our largest partner, which is expected to affect consumable sales over the next several years. Partners who reported royalty bearing sales accounted for $38.3 million, or 79%, of consumable sales for the year ended December 31, 2014 compared to $38.4 million, or 79%, of the total consumable sales for the year ended December 31, 2013.
Royalty revenue, which results when our partners sell products or services incorporating our technology, increased 7% to $39.4 million for the year ended December 31, 2014 from $37.0 million for the year ended December 31, 2013. We believe this is primarily the result of menu expansion and increased utilization of our partners’ assays on our technology. Our partners’ end user sales may reflect volatility from quarter to quarter and therefore, that same volatility is reflected in our reported royalty revenues on a quarterly basis. Total royalty bearing sales on xMAP and MultiCode technology reported to us were $452.6 million and $3.6 million, respectively, for the year ended December 31, 2014 as compared to $443.5 million and $2.9 million, respectively, for the year ended December 31, 2013.
Assay revenue increased 18% to $87.7 million for the year ended December 31, 2014 from $74.1 million for the year ended December 31, 2013. The increase in assay revenue is driven primarily by an increase in both of our primary assay portfolios: infectious disease testing and genetic testing assay products which increased 18% and 20% from 2013, respectively. Additionally, infectious disease testing and genetic testing assay products represented 67% and 33%, respectively, of total assay revenue in 2014, consistent with 2013. Our top customer, by revenue, accounted for 51% of total assay revenue for the year ended December 31, 2014 compared to 49% for the year ended December 31, 2013. No other customer accounted for more than 10% of total assay revenue during those periods. For the years ended December 31, 2014 and December 31, 2013, direct assay sales comprised 99% and 97% of total assay sales, respectively. Certain genetic testing assay products revenue from our largest customer is under significant pressure from competing technologies and, although timing is uncertain, a loss of a significant portion of that revenue is expected within the next twelve months.
Service revenue, comprised of extended warranty contracts earned ratably over the term of a contract and time and materials for billable service work not under an extended warranty contract, increased 5% to $9.4 million during 2014 from $8.9 million in 2013. This increase is attributable to increased penetration of the expanded installed base. At December 31, 2014, we had 1,522 Luminex systems covered under extended service agreements and $4.1 million in deferred revenue related to those contracts. At December 31, 2013, we had 1,516 Luminex systems covered under extended service agreements and $3.8 million in deferred revenue related to those contracts.
Other revenue, which includes training revenue, shipping revenue, miscellaneous part sales, amortized license fees, milestone payments from our development agreement with Merck and revenue from agreements with U.S. government agencies, decreased to $13.0 million for the year ended December 31, 2014 compared to $13.1 million for the year ended December 31, 2013.
Gross Profit. Gross profit increased to $159.9 million for the year ended December 31, 2014, as compared to $143.6 million for the year ended December 31, 2013. Gross margin (gross profit as a percentage of total revenue) was 70% for the year ended December 31, 2014, up from 67% for the year ended December 31, 2013. Gross margin was higher in 2014 primarily as a result of the inclusion in 2013 of $2.6 million of impairment of inventory related to our restructuring plan focused on our Newborn Screening Group and our Brisbane, Australia office. Additionally, concentration of sales in our higher margin items (assays, consumables and royalties) was higher than in the prior year, representing 77% of revenue for the year ended December 31, 2014 compared to 75% for the year ended December 31, 2013. We anticipate continued fluctuation in gross margin and related gross profit primarily as a result of variability in consumable and system purchases and seasonality effects inherent in our assay revenue.
Research and Development Expense. Research and development expense decreased to $43.1 million, or 19% of total revenue, for the year ended December 31, 2014 from $45.0 million, or 21% of total revenue, for the year ended December 31, 2013. The decrease in research and development expense was primarily the result of the savings in materials spending associated with advancement in the ARIES development phases, including transitioning from alpha system builds in the prior year to wrapping up development and preparing for clinical trials in the current year, and the savings realized from our restructuring activities in the prior year. The focus of our research and development activities has been the development and clinical validation of our next generation sample-to-answer platform for our ARIES system.
Selling, General and Administrative Expense. Selling, general and administrative expenses, excluding the amortization of acquired intangible assets, decreased to $82.8 million for the year ended December 31, 2014 from $87.3 million for 2013. The decrease was primarily attributable to an expense of $7.0 million related to the termination of our molecular diagnostics distribution agreements and our full allowance against all accounts receivable balances related to the bankruptcy of a previous customer totaling $3.9 million each reflected in our 2013 results, partially offset by increased personnel costs due to incremental headcount and increased incentive compensation as well as additional litigation expenditures in 2014. Selling, general and administrative headcount at December 31, 2014 was 290 as compared to 281 at December 31, 2013. As a percentage of revenue, selling, general and administrative expense, excluding the amortization of acquired intangible assets, decreased to 36% in 2014 compared to 41% in 2013.
Restructuring costs. We recorded total pre-tax restructuring charges of $3.1 million in 2014. The portion of these charges that pertained to the non-cash impairment of inventory and certain of the employee separation costs, $1.2 million, was recorded to cost of revenue. The portion of these charges that pertained to the non-cash loss on disposal of our Brisbane, Australia business, the non-cash impairment of intangible assets, fixed assets, certain employee separation costs and facility exit costs, $1.9 million, was recorded to restructuring costs in our operating expenses. We recorded total pre-tax restructuring charges of $5.0 million in 2013. The portion of these charges that pertained to the non-cash impairment of inventory and certain of the employee separation costs, $2.6 million, was recorded to cost of revenue. The portion of these charges that pertained to the non-cash impairment of intangible assets, fixed assets and certain employee separation costs, $2.4 million, was recorded to restructuring costs in our operating expenses. As a result of the organizational change, the Company eliminated approximately 5% of its aggregate workforce.
Other Income, net. Other income, net decreased to a loss of $46,000 for the year ended December 31, 2014 from income of $6.7 million for the year ended December 31, 2013. The 2013 amount was due to the liquidation of our minority interest in a private company in 2013, which resulted in a gain of $5.4 million and a reduction in the contingent consideration liability established in connection with the 2012 acquisition of GenturaDx from $1.4 million to $0 during 2013.
Income taxes. Our effective tax rate for the year ended December 31, 2014 was a benefit of 39%, or $11.0 million, as compared to an expense of 38%, or $4.3 million, for the year ended December 31, 2013. The favorable effective tax rate for 2014 reflects an income tax benefit recorded in the fourth quarter resulting from the partial release of the Canadian deferred tax assets valuation allowance, the recognition of benefits in the Netherlands which were generated by the waiver of intercompany debt and restructuring losses related to the Australian entity and the establishment of a tax asset associated with tax paid on intercompany profits. Further release of the Canadian deferred tax assets valuation allowance will be contingent upon future projections of profitability of our Canadian subsidiary. We will record income tax expense on profits generated in our Canadian subsidiary over the near term and as a result expect our consolidated effective tax rate to be in the 25% to 35% range over the next several years, absent any other significant discrete items. We continue to assess our business model and its impact in various tax jurisdictions.
Year Ended December 31, 2013 Compared to Year Ended December 31, 2012
Revenue. Total revenue increased to $213.4 million for the year ended December 31, 2013 from $202.6 million in 2012. The increase was primarily attributable to a $5.8 million increase in royalty revenue and $3.9 million in other revenue. The increase in royalty revenue was driven by our partners' continued menu expansion and increased utilization of our partners’ assays on our technology. The increase in other revenue was driven by our contracts with the U.S. government and our development agreement with Merck. In addition, system revenue increased from $31.1 million in 2012 to $31.8 million in 2013. We sold 1,078 multiplexing analyzers in 2013, which included 495 of our MAGPIX systems, as compared to 981 multiplexing analyzers sold in 2012, which included 420 MAGPIX systems, bringing total multiplexing analyzer sales since inception to 10,737 as of December 31, 2013. Also included in system revenue for 2013 were sales of 45 automated punching systems compared to 68 in 2012.
A breakdown of revenue for the years ended December 31, 2013 and 2012 is as follows:
In 2013, the top five customers, by revenue, accounted for 54% of total revenue down from 63% of total revenue in 2012. In particular, three customers accounted for 43% of 2013 total revenue (18%, 16% and 9%, respectively) down from 51% of 2012 total revenue (19%, 24% and 8% respectively). No other customer accounted for more than 10% of total revenue in 2013.
Revenue from the sale of systems and peripheral components increased 2% to $31.8 million for the year ended December 31, 2013 from $31.1 million for the year ended December 31, 2012, due to the increase in the total multiplexing analyzer placements from 981 in 2012 to 1,078 in 2013. For the year ended December 31, 2013, five of our partners accounted for 895, or 83%, of total multiplexing analyzers sold. Five of our partners accounted for 811, or 83%, of total multiplexing analyzers sold for the year ended December 31, 2012.
Consumable sales, comprised of microspheres and sheath fluid, increased 1% to $48.5 million during 2013 from $48.0 million in 2012. During the year ended December 31, 2013, we had 74 bulk purchases of consumables totaling approximately $38.8 million (80% of total consumable revenue), ranging from $0.1 million to $4.3 million, as compared with 70 bulk purchases totaling approximately $38.1 million (79% of total consumable revenue), in the year ended December 31, 2012. The increase in bulk purchases was the primary driver to the increase in consumable revenue from the prior year. Partners who reported royalty bearing sales accounted for $38.4 million, or 79%, of total consumable sales for the year ended December 31, 2013.
Royalty revenue, which results when our partners sell products or services incorporating our technology, increased 19% to $37.0 million for the year ended December 31, 2013 from $31.2 million for the year ended December 31, 2012. We believe this was primarily the result of menu expansion and increased utilization of our partners’ assays on our technology. Our partners’ end user sales may reflect volatility from quarter to quarter and therefore, that same volatility is reflected in our reported royalty revenues on a quarterly basis. Total royalty bearing sales on xMAP and MultiCode technology reported to us were $443.5 million and $2.9 million, respectively, for the year ended December 31, 2013 as compared to $397.8 million and $4.7 million, respectively, for the year ended December 31, 2012.
Assay revenue decreased 1% to $74.1 million for the year ended December 31, 2013 from $75.0 million for the year ended December 31, 2012. The modest decline in assay revenue was driven primarily by decreased infectious disease assay sales. Infectious disease testing and genetic testing assays represented 67% and 33%, respectively, of total assay revenue in both 2013 and 2012. For the year ended December 31, 2013, direct assay sales comprised 97% of total assay sales compared to 72% for the year ended December 31, 2012. In 2013, we focused more resources on our direct sales channels which resulted in less reliance on our distributors. The top customer, by revenue, accounted for 49% of total assay revenue in both 2013 and 2012. No other customer accounted for more than 10% of total assay revenue in 2013. In 2012, before our focus on selling directly to the end user, the second and third largest customers represented 18% and 9%, respectively of total assay revenue.
Service revenue, comprised of extended warranty contracts earned ratably over the term of a contract, increased 11% to $8.9 million during 2013 from $8.1 million in 2012. This increase was attributable to increased penetration of the expanded installed base. At December 31, 2013, we had 1,516 Luminex systems covered under extended service agreements and $3.8 million in deferred revenue related to those contracts. At December 31, 2012, we had 1,379 Luminex systems covered under extended service agreements and $3.3 million in deferred revenue related to those contracts.
Other revenue, which includes training revenue, shipping revenue, miscellaneous part sales, amortized license fees, milestone payments from our development agreement with Merck and revenue from agreements with U.S. government agencies, increased 42% to $13.1 million for the year ended December 31, 2013 compared to $9.2 million for the year ended December 31, 2012. This increase was primarily the result of payments related to minimum purchase obligations and our development agreements with Merck and U.S. government agencies.
Gross Profit. Gross profit increased to $143.6 million for the year ended December 31, 2013, as compared to $142.6 million for the year ended December 31, 2012. Gross margin (gross profit as a percentage of total revenue) was 67% for the year ended December 31, 2013, down from 70% for the year ended December 31, 2012. Gross margin was lower in 2013 primarily as a result of the inclusion of $2.6 million of impairment of inventory related to our restructuring plan focused on our Newborn Screening Group and our Brisbane, Australia office. Additionally, concentration of sales in our higher margin items (assays, consumables and royalties) was modestly lower than in the prior year, representing 75% of revenue for the year ended December 31, 2013 compared to 76% for the year ended December 31, 2012.
Research and Development Expense. Research and development expense increased to $45.0 million for the year ended December 31, 2013 from $43.0 million for the year ended December 31, 2012, but remained flat as a percentage of revenue, at 21% in both 2013 and 2012. The increase in expense was primarily associated with (i) the development of a new version of our multiplex PCR technology and (ii) our sample-to-answer instrumentation and assays.
Selling, General and Administrative Expense. Selling, general and administrative expenses, excluding the amortization of acquired intangible assets, increased to $87.3 million for the year ended December 31, 2013 from $72.6 million for 2012. The increase was primarily attributable to an expense of $7.0 million related to the termination of our molecular diagnostics distribution agreements effective as of the first quarter of 2013, an increase of our allowance for bad debts of $3.9 million related to all of the receivables from a previous customer that filed for Chapter 11 bankruptcy and additional infrastructure and personnel and related expenses focused on our direct sales channels. Selling, general and administrative headcount at December 31, 2013 was 281 as compared to 259 at December 31, 2012. As a percentage of revenue, selling, general and administrative expense, excluding the amortization of acquired intangible assets, increased to 41% in 2013 compared to 36% in 2012.
Restructuring costs. We recorded total pre-tax restructuring charges of $5.0 million in 2013. The portion of these charges that pertained to the non-cash impairment of inventory and certain of the employee separation costs, $2.6 million, was recorded to cost of revenue. The portion of these charges that pertained to the non-cash impairment of intangible assets, fixed assets and certain employee separation costs, $2.4 million, was recorded to restructuring costs in our operating expenses. As a result of the organizational change, the Company eliminated approximately 5% of its workforce.
Other Income, net. Other income, net increased to $6.7 million for the year ended December 31, 2013 from $0.3 million for the year ended December 31, 2012 due to the liquidation of our minority interest in a private company, which resulted in a gain of $5.4 million and a reduction in the contingent consideration liability established in connection with the 2012 acquisition of GenturaDx from $1.4 million to $0 during 2013.
Income taxes. Income tax expense decreased to $4.3 million for the year ended December 31, 2013 from $10.4 million for the year ended December 31, 2012 primarily due to decreased profitability in the U.S. during 2013. Our effective tax rate for the year ended December 31, 2013 was 38% compared to 46% for the year ended December 31, 2012. The decrease in our effective tax rate in 2013 was primarily a function of the decrease in the proportion of taxable income attributable to the U.S., an extension of the U.S. federal research and experimentation tax credit in 2013, and an increase in the taxable losses in our foreign jurisdictions for which no income tax benefit is recognized. Our foreign earnings are generally taxed at lower rates than in the United States.
Liquidity and Capital Resources
At December 31, 2014, we held cash, cash equivalents and long-term investments of $107.7 million and had working capital of $146.7 million. At December 31, 2013, we held cash, cash equivalents and short-term investments of $72.4 million and had working capital of $117.9 million. Cash, cash equivalents and investments increased by $35.2 million during the year ended December 31, 2014. The increase in cash, cash equivalents and investments from the prior year is primarily attributable to significant operating cash flows, coupled with $4.7 million in proceeds from the Company's employee stock purchase plan and stock option exercises, which funded our capital expenditures of $17.1 million.
We have funded our operations to date primarily through the issuance of equity securities (in conjunction with an initial public offering in 2000, subsequent option exercises, and our follow-on public offering in 2008) and cash generated from operations. Our cash reserves are held directly or indirectly in a variety of short-term, interest-bearing instruments, including non-government sponsored debt securities. We do not have any investments in asset-backed commercial paper, auction rate securities, or mortgage backed or sub-prime style investments.
Cash provided by operations was $49.3 million for the year ended December 31, 2014 as compared with cash provided by operations of $26.9 million for the year ended December 31, 2013. Cash used in investing activities was $28.5 million for the year ended December 31, 2014 as compared with cash provided by investing activities of $2.7 million for 2013. The change in cash flows of investing activities was primarily attributable to the $9.5 million in proceeds received from the sale of our minority interest investment in a private company in the prior year and a decrease in the net sales of our available-for-sale securities of $14.6 million. Currently, exclusive of changes in available-for-sale securities, we expect cash used in investing activities to be primarily for purchases of property and equipment, additional cost-method investments and continued strategic investments or acquisitions.
Cash provided by financing activities increased to $3.4 million for the year ended December 31, 2014, from cash used in financing activities of $4.4 million for the year ended December 31, 2013, primarily attributable to a decrease in stock repurchases of $14.6 million, partially offset by decreases of $3.9 million in proceeds from the Company's employee stock purchase plan and stock option exercises and of $2.3 million in excess income tax benefit from employee stock-based awards of in 2014 as compared to 2013.
Our future capital requirements will depend on a number of factors, including our success in developing and expanding markets for our products, payments under possible future strategic arrangements, continued progress of our research and development of potential products, the timing and outcome of regulatory approvals, the need to acquire licenses to new technology, costs associated with strategic acquisitions including integration costs and assumed liabilities, the status of competitive products, loss of a significant portion of our revenue stream, and potential costs associated with both protecting and defending our intellectual property. Additionally, actions taken as a result of the appointment of our new CEO and his ongoing internal evaluation of our business could result in expenditures not currently contemplated in our estimates for 2015.
During 2015, we expect a contraction of approximately $10 million in consumable sales as the result of transient inventory challenges that our largest bulk purchasing partner is experiencing. We expect this lower level of purchasing to continue over the next several years. Additionally, certain genetic testing assay products revenue from our largest customer is under significant pressure from competing technologies and, although timing is uncertain, a loss of a significant portion of that revenue is expected within the next twelve months.
One of the short term significant capital requirements is the completion of our current in-process research and development project related to our acquisition of GenturaDx, the foundation of our ARIES System, which is scheduled to be completed with initial commercialization in 2015. The estimated aggregate cost to complete this project is between $2.0 million and $4.0 million. We believe, however, that our existing cash and cash equivalents are sufficient to fund our operating expenses, capital equipment requirements and other expected ordinary course liquidity requirements for the coming twelve months. Factors that could affect our capital requirements, in addition to those listed above include: (i) continued collections of accounts receivable consistent with our historical experience, (ii) our ability to manage our inventory levels consistent with past practices, (iii) signing partnership agreements which include significant up front license fees, (iv) our stock repurchase program from time to time and (v) entering into strategic investment or acquisition agreements requiring significant cash consideration. See also the “Safe Harbor Cautionary Statement” and Item 1A “Risk Factors” above.
To the extent our capital resources are insufficient to meet future capital requirements we will have to raise additional funds to continue the development and deployment of our technologies, or to supplement our position through strategic acquisitions. There can be no assurance that debt or equity funds will be available on favorable terms, if at all. Any downgrade in our credit rating could adversely affect our ability to raise debt capital on favorable terms, or at all. To the extent that additional capital is raised through the sale of equity or convertible debt securities, the issuance of those securities could result in dilution to our stockholders. Moreover, incurring debt financing could result in a substantial portion of our operating cash flow being dedicated to the payment of principal and interest on such indebtedness, could render us more vulnerable to competitive pressures and economic downturns and could impose restrictions on our operations. If adequate funds are not available, we may be required to curtail operations significantly or to obtain funds through entering into agreements on unattractive terms.
Debt
In May 2014, the Company repaid all of its outstanding debt. See Note 14 to the Consolidated Financial Statements for a discussion on long-term debt.
Contractual Obligations
As of December 31, 2014, we had approximately $24.2 million in non-cancellable obligations for the next 12 months. These obligations are included in our estimated cash usage during 2015. The following table reflects our total current non-cancellable obligations by period as of December 31, 2014 (in thousands):
(1)
Purchase obligations predominantly relate to contractual arrangements in the form of purchase orders primarily as a result of normal inventory purchases or minimum payments due resulting when minimum purchase commitments are not met as well as other operating commitments.
(2)
Amounts represent minimum royalties due on net sales of products incorporating licensed technology and subject to a minimum annual royalty payment.
(3)
Due to the uncertainty with respect to the timing of future cash flows associated with Luminex’s unrecognized tax benefits at December 31, 2014, Luminex is unable to make reasonably reliable estimates of the timing of cash settlement with the respective taxing authority. Therefore, $2.3 million of unrecognized tax benefits have been excluded from the contractual obligations table above. See Note 13 to the Consolidated Financial Statements for a discussion on income taxes.
Inflation
We do not believe that inflation has had a direct adverse effect on our operations to date. However, a substantial increase in product and manufacturing costs and personnel related expenses could have an adverse impact on our results of operations in the event these expenses increase at a faster pace than we can increase our system, consumable and royalty revenue rates.
Recently Adopted Accounting Pronouncements
In April 2014, the FASB amended guidance to clarify the accounting for disposals of groups of assets and business units. The amendments alter the definition of a discontinued operation to cover only asset disposals that are a strategic shift with a major effect on an entity's operations and finances. For the Company, the changes should be applied in fiscal years that start on December 15, 2014, or later, but the changes can be applied ahead of the effective date for asset disposals that have not been reported in a set of financial statements. Management applied this new guidance for the automated punching group and the related closure of the Brisbane, Australia manufacturing facility in the third quarter of 2014.
Recent Accounting Pronouncements
In May 2014, the FASB issued a new standard on revenue recognition which outlines a single comprehensive model to use in accounting for revenue arising from contracts with customers and supersedes most current revenue recognition guidance, including industry-specific guidance. The core principle of the revenue model is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The standard is designed to create greater comparability for financial statement users across industries and jurisdictions and also requires enhanced disclosures. The guidance is effective for fiscal years, and interim periods within those years, beginning after December 15, 2016. Early adoption is not permitted. We are currently evaluating the impact of the adoption of this standard on our consolidated financial statements.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Interest Rate Risk. Our interest income is sensitive to changes in the general level of domestic interest rates, particularly since our investments are in long-term instruments available-for-sale. A 50 basis point fluctuation from average investment returns at December 31, 2014 would yield a less than 0.5% variance in overall investment return, which would not have a material adverse effect on our financial condition.
Foreign Currency Risk. Our international business is subject to risks, including, but not limited to: foreign exchange rate volatility, differing tax structures, unique economic conditions, other regulations and restrictions, and changes in political climate. Accordingly, our future results could be materially adversely impacted by changes in these and other factors.
As of December 31, 2014, as a result of our foreign operations, we have costs, assets and liabilities that are denominated in foreign currencies, primarily Canadian dollars and to a lesser extent the Euro, Renminbi, and Yen. For example, some fixed asset purchases and certain expenses are denominated in Canadian dollars while sales of products are primarily denominated in U.S. dollars. All transactions in our Netherlands and Japanese subsidiaries are denominated in Euros and Yen, respectively. All transactions, with the exception of our initial capital investment, in our Chinese subsidiary are denominated in Renminbi. As a consequence, movements in exchange rates could cause our foreign currency denominated expenses to fluctuate as a percentage of net revenue, affecting our profitability and cash flows. A significant majority of our revenues are denominated in U.S. dollars. The impact of foreign exchange on foreign denominated balances will vary in relation to changes between the U.S. dollar, Canadian dollar, Euro, Yen, and Renminbi exchange rates. A 10% change in these exchange rates in relation to the U.S. dollar would result in an income statement impact of approximately $496,000 on foreign currency denominated asset and liability balances as of December 31, 2014. As a result of our efforts to expand globally, in the future we will be exposed to additional foreign currency risk in multiple currencies; however, at this time, our exposure to foreign currency fluctuations is not currently material. We regularly assess the market to determine if additional strategies are appropriate to mitigate future risks.
In addition, the indirect effect of fluctuations in interest rates and foreign currency exchange rates could have a material adverse effect on our business financial condition and results of operations. For example, currency exchange rate fluctuations could affect international demand for our products. In addition, interest rate fluctuations could affect our customers’ buying patterns. Furthermore, interest rate and currency exchange rate fluctuations may broadly influence the United States and foreign economies resulting in a material adverse effect on our business, financial condition and results of operations. As a result, we cannot give any assurance as to the effect that future changes in foreign currency rates will have on our consolidated financial position, results of operations or cash flows. Our aggregate foreign currency transaction loss of $16,000 was included in determining our consolidated results for the year ended December 31, 2014.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Index to Consolidated Financial Statements
PAGE
Report of Independent Registered Public Accounting Firm
Report of Independent Registered Public Accounting Firm
Consolidated Balance Sheets
Consolidated Statements of Comprehensive Income
Consolidated Statements of Cash Flows
Consolidated Statements of Changes in Stockholders’ Equity
Notes to Consolidated Financial Statements
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and Stockholders of
Luminex Corporation
We have audited Luminex Corporation’s internal control over financial reporting as of December 31, 2014, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (1992 framework) (the COSO criteria). Luminex Corporation’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 included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on 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, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, 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, Luminex Corporation maintained, in all material respects, effective internal control over financial reporting as of December 31, 2014, 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 Luminex Corporation as of December 31, 2014 and 2013, and the related consolidated statements of comprehensive income, shareholders’ equity and cash flows for each of the three years in the period ended December 31, 2014 of Luminex Corporation and our report dated February 25, 2015 expressed an unqualified opinion thereon.
/s/ Ernst & Young LLP
Austin, Texas
February 25, 2015
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and Stockholders of
Luminex Corporation
We have audited the accompanying consolidated balance sheets of Luminex Corporation (the Company) as of December 31, 2014 and 2013, and the related consolidated statements of comprehensive income, shareholders' equity and cash flows for each of the three years in the period ended December 31, 2014. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements 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 Luminex Corporation at December 31, 2014 and 2013, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2014, in conformity with U.S. generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Luminex Corporation’s internal control over financial reporting as of December 31, 2014, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (1992 framework) and our report dated February 25, 2015 expressed an unqualified opinion thereon.
/s/ Ernst & Young LLP
Austin, Texas
February 25, 2015
See the accompanying notes which are an integral part of these Consolidated Financial Statements.
See the accompanying notes which are an integral part of these Consolidated Financial Statements.
See the accompanying notes which are an integral part of these Consolidated Financial Statements.
See the accompanying notes which are an integral part of these Consolidated Financial Statements.
LUMINEX CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Description of Business
Luminex Corporation, the “Company” or “Luminex,” develops, manufactures and sells proprietary biological testing technologies and products with applications throughout the life sciences and diagnostics industries. The Company’s xMAP technology, an open architecture, multiplexing technology, allows the Luminex systems to simultaneously perform up to 500 bioassays from a small sample volume, typically a single drop of fluid, by reading biological tests on the surface of microscopic polystyrene beads called microspheres. xMAP technology combines this miniaturized liquid array bioassay capability with small lasers, LEDs, digital signal processors and proprietary software to create a system offering advantages in speed, precision, flexibility and cost. The Company’s xMAP technology is currently being used within various segments of the life sciences industry which includes the fields of drug discovery and development, and for clinical diagnostics, genetic analysis, bio-defense, food safety and biomedical research. In addition to the Company's xMAP technology, its other offerings include its proprietary MultiCode technology, used for real-time PCR and multiplexed PCR assays.
Principles of Consolidation
The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All significant intercompany transactions and balances have been eliminated upon consolidation.
The acquisition of GenturaDx was completed on July 11, 2012; therefore the results of operations of GenturaDx in the Company’s consolidated financial statements only include GenturaDx’s results since that date.
Use of Estimates
The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual amounts and results could differ from those estimates, and such differences could be material to the financial statements.
Cash and Cash Equivalents
Cash and cash equivalents consist of cash deposits and highly liquid investments with original maturities of three months or less when purchased.
Investments
The Company determines the appropriate classification of its investments in debt and equity securities at the time of purchase and reevaluates such determinations at each balance sheet date. Marketable securities that are bought and held principally for the purpose of selling them in the near term are classified as trading securities and are reported at fair value, with unrealized gains and losses recognized in earnings. Debt securities are classified as held-to-maturity when the Company has the positive intent and ability to hold the securities to maturity. Held-to-maturity securities are stated at amortized cost, which approximates fair value of these investments. Debt securities for which the Company does not have the intent or ability to hold to maturity are classified as available-for-sale. Debt and marketable equity securities not classified as held-to-maturity or as trading are classified as available-for-sale, and are carried at fair market value, with the unrealized gains and losses included in the determination of comprehensive income and reported in stockholders’ equity. Marketable securities are recorded as either short-term or long-term on the balance sheet based on contractual maturity date. The fair value of all securities is determined by obtaining non-binding market prices from the Company's third-party portfolio managers on the last day of the quarter, whose sources may use quoted prices in active markets for identical assets or inputs other than quoted prices that are observable either directly or indirectly in determining fair value. Declines in fair value below the Company’s carrying value deemed to be other than temporary are charged against net earnings.
Fair Value of Financial Instruments
The fair values of financial instruments are determined by obtaining non-binding market prices from its third-party portfolio managers on the last day of the quarter, whose sources may use quoted prices in active markets for identical assets or inputs other than quoted prices that are observable either directly or indirectly in determining fair value. The Company’s financial instruments include cash and cash equivalents, short-term investments, accounts receivable, cost-method investments, long-term investments, accounts payable and accrued liabilities. The fair values of these financial instruments were not materially different from their carrying or contract values at December 31, 2014 and 2013. See Note 7 for further details concerning fair value measurements.
Supplemental Cash Flow Statement Information (in thousands)
Concentration of Credit Risk
Financial instruments which potentially subject the Company to concentrations of credit risk consist of short-term and long-term investments and trade receivables. The Company’s short-term investments consist of investments in high credit quality financial institutions, non-government sponsored debt securities and corporate issuers.
The Company provides credit, in the normal course of business, to a number of its customers geographically dispersed primarily throughout the U.S. The Company attempts to limit its credit risk by performing ongoing credit evaluations of its customers and maintaining adequate allowances for potential credit losses and does not require collateral.
Laboratory Corporation of America (LabCorp) accounted for 21%, 18% and 19% of our total revenues in 2014, 2013 and 2012, respectively. Thermo Fisher Scientific, Inc. accounted for 17%, 17% and 24% of our total revenues in 2014, 2013 and 2012, respectively. Bio-Rad Laboratories, Inc. accounted for 7%, 9% and 8% of our total revenues in 2014, 2013 and 2012, respectively. No other customer accounted for more than 10% of our total revenues in 2014, 2013 or 2012.
Inventories
Inventories, consisting primarily of raw materials and purchased components, are stated at the lower of cost or market, with cost determined according to the standard cost method, which approximates the first-in, first-out method. As a developer and manufacturer of high technology medical equipment, the Company may be exposed to a number of economic and industry factors that could result in portions of inventory becoming either obsolete or in excess of anticipated usage. These factors include, but are not limited to, technological changes in the Company's markets, ability to meet changing customer requirements, competitive pressures on products and prices, and reliability and replacement of and the availability of key components from suppliers. The Company's policy is to establish inventory reserves when conditions exist that suggest that inventory may be in excess of anticipated demand or is obsolete based upon the Company's assumptions about future demand for products and market conditions. The Company regularly evaluates the ability to realize the value of inventory based on a combination of factors including the following: historical usage rates, forecasted sales or usage, product expiration or end of life dates, estimated current and future market values and new product introductions. Assumptions used in determining the Company's estimates of future product demand may prove to be incorrect, in which case the provision required for excess and obsolete inventory would have to be adjusted. If inventory is determined to be overvalued, excess or obsolete, the Company would be required to record impairment charges within cost of goods sold at the time of such determination. Although considerable effort is made to ensure the accuracy of forecasts of future product demand, any significant unanticipated changes in demand or expected usage could have a significant negative impact on the value of inventory and the Company's operating results. When recorded, reserves are intended to reduce the carrying value of inventory to its net realizable value.
Property and Equipment
Property and equipment are carried at cost less accumulated amounts for amortization and depreciation. Property and equipment are typically amortized or depreciated on a straight-line basis over the useful lives of the assets, which range from two to seven years. Leasehold improvements and equipment under capital leases are amortized on a straight-line basis over the shorter of the remaining term of the lease or the estimated useful life of the improvements and equipment. The Company classifies the carrying value of Luminex xMAP Instruments placed within the reagent rental program and the instruments on loan to customers in property and equipment as "Assets on loan/rental."
Goodwill and Other Intangible Assets
Goodwill represents the excess of the cost over the fair value of the assets of the acquired business. In accordance with Accounting Standards Codification (ASC) 350 “Goodwill and Other” (ASC 350), goodwill is reviewed for impairment at least annually at the beginning of the fourth quarter, or more frequently if impairment indicators arise, on a reporting unit level. As of October 1, 2014, all of the Company's goodwill related to one reporting unit, the Company's previous ARP segment, for goodwill impairment testing. As the change to one reporting segment was made after October 1, 2014, management performed the analysis on goodwill under the ARP segment as of October 1, 2014. The Company has historically estimated the fair value of our previous ARP segment reporting unit using a discounted cash flow (DCF) analysis (“step one” analysis) of the Company’s projected future results. In 2012, the Company applied the accounting guidance which allows an entity to first assess qualitative factors to determine if it is more likely than not that the fair value of a reporting unit is less than its carrying amount (“step zero” analysis). In performing the impairment test in the fourth quarter of 2013 and 2014, the Company used the "step one" analysis. This analysis requires a comparison of the carrying value of the reporting unit to the estimated fair value of the reporting unit. Determining the fair value of goodwill is subjective in nature and often involves the use of estimates and assumptions. The Company's annual test did not result in an impairment charge in 2014 as the estimated fair value of the ARP segment reporting unit continued to exceed the carrying value by a significant enough amount such that any reasonably likely change in the assumptions used in the analysis would not cause the carrying value to exceed the estimated fair value for the reporting unit as determined under our "step one" analysis. No goodwill impairments were recorded in 2014, 2013 or 2012.
The Company utilizes the income approach based on a DCF analysis to determine fair value estimates, and then uses market comparisons as a reasonability check to ensure that neither the income approach nor the market comparisons yielded significantly different results. The income approach calculates the fair value by estimating the after-tax cash flows attributable to a reporting unit and then discounting the after-tax cash flows to a present value using a risk-adjusted discount rate. The Company's estimates are based on revenue projections by product line, and include judgment based on historical growth and scheduled product approvals by the various governmental authorities. The Company believes its assumptions are consistent with the plans and estimates used to manage the underlying businesses. The most significant assumptions used in the DCF methodology are the discount rate, based upon the estimated weighted average cost of capital (WACC), and the terminal growth rate, based upon strategic studies the Company commissioned and the Company's internal analysis.
The Company used the following rates in 2014:
To determine the Company's WACC rate, management performed a peer company analysis and considered the weighted average return on debt and equity, the updated risk-free interest rate, beta, equity risk premium, and entity specific size risk premium. The Company's analysis yielded an estimated fair value in excess of the carrying value by over 25% for 2014.
Concurrent with the above analysis, management performed a sensitivity analysis based upon reasonably likely changes to determine if the DCF analysis would result in impairment if the following changes were made to management's assumptions: i) assumed the fair value of the reporting unit was lower by 10% or ii) future revenue was 75% of the Company's projections in the DCF model. Neither of these sensitivity analyses resulted in an estimated fair value less than the carrying amount of the reporting unit.
Intangible assets are amortized on a straight line basis over their respective estimated useful lives ranging from 5 to 15 years. As a result of the acquisition of GenturaDx in July 2012, the Company acquired in process research and development of $40.1 million. In-process research and development will be an indefinite-lived intangible asset until completion or abandonment at which point it will be accounted for as a finite-lived intangible asset or written off if abandoned.
Impairment of Long-Lived Assets
Long-lived assets held and used by the Company are reviewed for impairment whenever events or changes in circumstances indicate that their net book value may not be recoverable. When such factors and circumstances exist, the Company compares the projected undiscounted future cash flows associated with the related asset or group of assets over their estimated useful lives against their respective carrying amounts. Impairment, if any, is based on the excess of the carrying amount over the fair value of those assets and is recorded in the period in which the determination was made.
Revenue Recognition and Allowance for Doubtful Accounts
Revenue is generated primarily from the sale of the Company’s products and related services, which are primarily support and maintenance services on the Company's systems. The Company recognizes product revenue at the time the product is shipped provided there is persuasive evidence of an agreement, no right of return exists, the fee is fixed or determinable and collectability is probable. There is no customer right of return in the Company’s sales agreements. If the criteria for revenue recognition are not met at the time of shipment, the revenue is deferred until all criteria are met.
The Company regularly enters into arrangements for system sales that are multiple-element arrangements, including services such as installation and training, and multiple products. These products or services are primarily delivered within a short time frame, approximately three to six months, of the agreement execution date and can also be performed by one of the Company’s third-party partners. Based on the terms and conditions of the sale, management believes that these services can be accounted for separately from the delivered system as the delivered products have value to customers on a stand-alone basis. Items are considered to have stand-alone value when they are sold separately by any vendor or when the customer could resell the item on a stand-alone basis. Accordingly, the estimated selling price of services or products not yet performed or delivered at the time of system shipment are deferred and recognized as revenue as such services are performed. The Company has typically been able to determine the selling price of each deliverable in a multiple-element arrangement based on the price for such deliverable when it is sold separately. If vendor specific objective evidence (VSOE) is not determinable and when third-party evidence is not available, management uses the estimated selling price of a deliverable which is determined based upon the Company’s pricing policies, expected margin of the deliverable, geographical location and information gathered from customer negotiations.
The Company provides systems and certain other hardware to customers through reagent rental agreements under which the customers commit to purchasing minimum quantities of disposable products at a stated price over a defined contract term, which is normally two to three years. Instead of rental payments, the Company recovers the cost of providing the system and other hardware in the amount charged for diagnostic assays and other disposables. Revenue is recognized over the defined contract term as assays and other disposable products are shipped. The depreciation costs associated with the system and other hardware are charged to cost of sales on a straight-line basis over the estimated life of the system. The costs to maintain these instruments in the field are charged to cost of sales as incurred.
Revenue from extended service agreements is deferred and recognized ratably over the term of the agreement. The Company may also be entitled to milestone payments that are contingent upon achieving a predefined objective. The Company follows the milestone method of recognizing revenue from milestones and milestone payments are recorded as revenue in full upon achievement of the milestone. Revenues from royalties related to agreements with strategic partners are recognized when such amounts are reported to the Company; therefore, the underlying end user sales may be related to prior periods.
Additional revenue is derived from cost-type contracts with the U.S. government. Revenue and profit under cost-plus service contracts is recognized as costs are incurred plus negotiated fees. Fixed fees on cost-plus service contracts are recognized ratably over the contract performance period as services are performed. Contract costs include labor and related employee benefits, subcontracting costs and other direct costs, as well as allocations of allowable indirect costs. For contract change orders, claims or similar items, judgment is required for estimating the amounts, assessing the potential for realization, and determining whether realization is probable. From time to time, facts develop that require revisions of revenue recognized or cost estimates. To the extent that a revised estimate affects the current or an earlier period, the cumulative effect of the revision is recognized in the period in which the facts requiring the revision become known. Reimbursements of certain costs, including certain hardware costs or out-of-pocket expenses are included in revenue with corresponding costs included in cost of revenue as costs are incurred.
The Company continuously monitors collections and payments from its customers and maintains allowances for doubtful accounts based upon its historical experience and any specific customer collection issues that have been identified. While such credit losses have historically been within the Company’s expectations, there can be no assurance that the Company will continue to experience the same level of credit losses that it has in the past. A significant change in the liquidity or financial position of any one of the Company’s significant customers, or a deterioration in the economic environment, in general, could have a material adverse impact on the collectability of the Company’s accounts receivable and its future operating results, including a reduction in future revenues and additional allowances for doubtful accounts.
Product-Related Expenses
The Company provides for the estimated cost of initial product warranties at the time revenue is recognized. While the Company engages in product quality programs and processes, the Company’s warranty obligation is affected by product failure rates, material usage and service delivery costs incurred in correcting a product failure. Should actual product failure rates, material usage or service delivery costs differ from the Company’s estimates, revisions to the estimated warranty liability would be required. Shipping and handling costs associated with product sales are included in cost of sales. Advertising costs are charged to operations as incurred. The Company does not have any direct-response advertising. Advertising expenses, which include trade shows and conventions, were approximately $2.3 million, $2.6 million and $2.4 million for 2014, 2013 and 2012, respectively, and were included in selling, general and administrative expense in the Consolidated Statements of Comprehensive Income.
Research and Development Costs
Research and development costs are expensed in the period incurred. Nonrefundable advance payments for research and development activities for materials, equipment, facilities, and purchased intangible assets that have an alternative future use are deferred and capitalized. The capitalized amounts are expensed as the related goods are delivered or the services are performed. In addition, the Company capitalizes certain internally developed products used for evaluation during development projects that also have alternative future uses. These internally developed assets are generally depreciated on a straight-line basis over the useful life of the assets, which range from one to two years.
Foreign Currency Translation
The financial statements of the Company’s foreign subsidiaries are translated in accordance with ASC 830, “Foreign Currency Matters”. The reporting currency for the Company is the U.S. dollar. With the exception of its Canadian subsidiary, whose functional currency is the U.S. dollar, the functional currency of the Company’s foreign subsidiaries is their local currency. Accordingly, assets and liabilities of these subsidiaries are translated at the exchange rate in effect at each balance sheet date. Before translation, the Company re-measures foreign currency denominated assets and liabilities, including inter-company accounts receivable and payable, into the functional currency of the respective entity, resulting in unrealized gains or losses recorded in selling, general and administrative expenses in the Consolidated Statement of Comprehensive Income. Revenues and expenses are translated using average exchange rates during the respective period. Foreign currency translation adjustments are accumulated as a component of other comprehensive income as a separate component of stockholders’ equity. Gains and losses arising from transactions denominated in foreign currencies are included in selling, general and administrative expenses in the Consolidated Statement of Comprehensive Income and to date have not been material.
Incentive Compensation
Management incentive plans are tied to various financial and non-financial performance metrics. Bonus accruals made throughout the year related to the various incentive plans are based on management’s best estimate of the achievement of the specific metrics. Adjustments to the accruals are made on a quarterly basis as forecasts of performance are updated. At year-end, the accruals are adjusted to reflect the actual results achieved.
Income Taxes
The Company accounts for income taxes under the asset and liability method. Deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax balances are adjusted to reflect tax rates based on currently enacted tax laws, which will be in effect in the years in which the temporary differences are expected to reverse. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the results of operations in the period of the enactment date. A valuation allowance is recorded to reduce the carrying amounts of deferred tax assets unless it is more likely than not that those assets will be realized.
The Company recognizes excess tax benefits associated with share-based compensation to stockholders’ equity only when realized. When assessing whether excess tax benefits relating to share-based compensation have been realized, the Company follows the with-and-without approach excluding any indirect effects of the excess tax deductions. Under this approach, excess tax benefits related to share-based compensation are not deemed to be realized until after the utilization of all other tax benefits available to the Company.
The Company accounts for uncertain tax positions in accordance with ASC 740, “Income Taxes” which clarifies the accounting for uncertainty in tax positions. These provisions require recognition of the impact of a tax position in the Company’s financial statements only if that position is more likely than not of being sustained upon examination by taxing authorities, based on the technical merits of the position. Any interest and penalties related to uncertain tax positions will be reflected as a component of income tax expense.
Earnings Per Share
Basic net income per share is computed by dividing the net income for the period by the weighted average number of common shares outstanding during the period. Diluted net income per share is computed by dividing the net income for the period by the weighted average number of common shares and potential common shares from outstanding stock options, restricted stock units and contingently issuable shares resulting from an award subject to performance or market conditions determined by applying the treasury stock method. In periods with a net loss, potentially dilutive securities composed of incremental common shares issuable upon the exercise of stock options and warrants, and common shares issuable on conversion of preferred stock, would be excluded from historical diluted loss per share because of their anti-dilutive effect.
Stock-Based Compensation
The Company accounts for stock-based employee compensation plans under the fair value recognition and measurement provisions of ASC 718 “Stock Compensation” (ASC 718). ASC 718 requires the recognition of compensation expense, using a fair-value based method, for costs related to all share-based payments including stock options, restricted stock units and shares issued under the Company’s employee stock purchase plan. Pursuant to ASC 718, stock-based compensation cost is measured at the grant date, based on the fair value of the award, and is recognized as expense over the requisite service period.
Segment Reporting
During the fourth quarter of 2014, in conjunction with the appointment of our new CEO, the Company evaluated its historical reporting segments: the technology and strategic partnerships (TSP) segment and the assays and related products (ARP) segment. As a result of this evaluation and based upon how the new Chief Executive Officer as Chief Operating Decision Maker (“CODM”) and the Company's management team collectively is managing its business, management determined that the two former segments have become so integrated and interrelated that they no longer provide an accurate representation of the Company's current business when reported separately. Additionally, management has taken actions to consolidate sales and service functions. Effective with the fourth quarter of 2014, the Company no longer has two operating segments and, accordingly, will present the Company's business as one operating segment and one reporting unit. Accordingly, prior periods' information has been restated to conform to the current periods' presentation. See Note 19 - Segment and Geographic Information.
NOTE 2 - RESTRUCTURING
In August 2013, the Company announced a restructuring plan focused on its Newborn Screening Group and its Brisbane, Australia office where automated punching systems were designed and manufactured. The Company halted development of the newborn screening assay in 2013. In the first quarter of 2014, management determined that it would close the manufacturing facility in Brisbane, Australia and the facility was closed in the third quarter of 2014. The Company reviewed the requirements for held-for-sale and discontinued operations presentation and determined the manufacturing facility in Brisbane, Australia did not meet the altered definition of a discontinued operation under the amended accounting guidance as it was not a strategic shift with a major effect on the Company's operations and finances. Management has applied this new guidance for the facility in Brisbane, Australia.
The Company has recorded pre-tax restructuring charges primarily consisting of the non-cash impairment of inventory, intangible assets, property and equipment, together with employee separation costs. The Company measured and accrued the liabilities associated with employee separation costs at fair value as of the date the plan was announced and terminations were communicated to employees, which primarily included severance pay and other separation costs such as outplacement services and benefits. As a result of the organizational change, the Company eliminated approximately 5% of its aggregate workforce. In conjunction with the restructuring plan, the Company evaluated its tangible and intangible assets for estimated impairment and recorded non-cash impairment charges of $4.1 million in 2013 and a further impairment of $2.8 million in 2014, including a write-down of goodwill of $1.2 million resulting from the disposal of the manufacturing facility in Brisbane, Australia. The Company determined the fair value of the assets based upon prices for similar assets. The amount of goodwill the Company included in the carrying amount of the disposed manufacturing facility in Brisbane, Australia was based upon the relative fair value of that business compared to the portion of the reporting unit that was retained. See Note 9 - Goodwill and Other Intangible Assets. Pretax loss related to the Brisbane, Australia facility was $2.8 million, $3.9 million and $2.5 million for the years ended December 31, 2014, 2013 and 2012, respectively.
The Company measured and accrued the facilities exit costs at fair value upon the Company's exit in the third quarter of 2014. Facilities exit costs primarily consist of cease-use losses recorded upon vacating the facilities.
NOTE 3 - BUSINESS COMBINATIONS
2012 Acquisition
On July 11, 2012, the Company completed its acquisition of GenturaDx, Inc., a British Virgin Islands corporation with operations in Hayward, California (GenturaDx). GenturaDx was a molecular diagnostics company in late stage development of a fully integrated, highly automated, real-time polymerase chain reaction (PCR) system that employs a single-use cassette for sample-to-answer workflow. Under the terms of the acquisition agreement, the Company acquired all of the outstanding capital stock of GenturaDx in exchange for approximately $49.3 million cash consideration, subject to working capital adjustments, plus (i) $3.0 million in consideration contingent upon achieving certain future development and regulatory milestones by December 31, 2013, (ii) up to $7.0 million in consideration contingent upon achieving certain future development and regulatory milestones by June 30, 2014 and (iii) additional consideration contingent upon acquired products exceeding certain revenue thresholds in each of 2013, 2014 and 2015. No additional amounts have been paid or are expected to be paid related to the contingent consideration and our original contingent consideration liability estimate of $1.4 million adjusted to $0 in 2013 as a component of other income, net based on changes in the fair value of the liability resulting from changes in the assumptions pertaining to the achievement of the defined milestones and revenue thresholds.
Of the approximately $8.1 million related to the GenturaDx acquisition that was deposited in escrow as security for potential indemnity claims and certain other expressly enumerated matters, approximately $5.0 million remains in escrow as of December 31, 2014. The Company's acquisition of GenturaDx was funded with cash on hand. The results of operations for GenturaDx have been included in the Company’s consolidated financial statements from the date of acquisition.
The purchase price consideration is as follows (in thousands):
The acquisition of GenturaDx has been accounted for as a business combination in accordance with ASC 805 and, as such, the assets acquired and liabilities assumed have been recorded at their respective fair values. The determination of fair value for the identifiable tangible and intangible assets acquired and liabilities assumed requires extensive use of estimates and assumptions. Significant estimates and assumptions include, but are not limited to estimating future cash flows and determining the appropriate discount rate. The following table summarizes the estimated fair values of GenturaDx’s assets acquired and liabilities assumed at the acquisition date (in thousands):
The $40.1 million of intangible assets subject to amortization have been identified as in-process research and development (IPR&D) that had not yet reached technological feasibility as of the acquisition date. Technological feasibility is primarily established by obtaining regulatory approval to perform certain diagnostic testing on the Company's systems. The IPR&D project relates to GenturaDx's diagnostic testing prototype system designed to run sample-to-answer cassettes in clinical settings and the related cassette design. This project, renamed ARIES, is expected to be completed in 2015. The fair value of the IPR&D has been estimated using the multi-period excess earnings method, a form of the income approach and cash flow projections were discounted using a rate of 29.5%, which reflects the risk associated with the intangible asset related to the other assets and the overall business operations of the Company.
The excess of the purchase price over the fair value of the tangible net assets, liabilities and intangible assets acquired was recorded to goodwill. The goodwill recognized is mainly attributable to the compatibility between the Company's MultiCode-RTx chemistry and the prototype system and the expectation that the system together with the Company's MultiCode-RTx chemistry will allow the Company to leverage years of previous assay development and make custom assay development accessible to a greater number of diagnostic labs, even those with little molecular diagnostics experience.
Acquisition related costs of $4.3 million have been included in selling, general and administrative costs for 2012. GenturaDx had no revenue and operating loss of $7.9 million from the date of acquisition to December 31, 2012, including the impact of the acquisition costs. In the fourth quarter of 2012, the Company ceased using the Hayward, California facility, whose operating lease commitment, which ends in August 2015, was acquired under the GenturaDx acquisition in July 2012. The Company accrued a liability based upon the estimated fair value of the costs that will continue to be incurred under the lease, including sublease rental income. The total minimum rentals the Company is expected to receive under the non-cancellable sublease for the Hayward, California facility was approximately $350,000 as of December 31, 2014.
Unaudited Pro Forma Financial Information
GenturaDx’s results of operations have been included in the Company’s financial statements since the date of the acquisition. The unaudited pro forma financial information set forth below assumes that GenturaDx had been acquired at the beginning of 2012, and includes removal of interest expense on GenturaDx’s debt extinguished at the date of acquisition, removal of acquisition costs and the impact of purchase accounting adjustments, and tax adjustments. This unaudited pro forma financial information is presented for informational purposes only and is not necessarily indicative of the results of operations that actually would have resulted had the acquisition been in effect at the beginning of 2012. In addition, the unaudited pro forma financial information is not intended to be a projection of future results and does not reflect any operating efficiencies or cost savings that might be achievable.
NOTE 4 - INVESTMENTS
Available-for-sale securities consisted of the following as of December 31, 2014 (in thousands):
Available-for-sale securities consisted of the following as of December 31, 2013 (in thousands):
There were $0 in proceeds from the sales of available-for-sale securities during the years ended December 31, 2014 and 2013. Realized gains and losses on sales of investments are determined using the specific identification method and are included in other income (expense) in the Consolidated Statement of Comprehensive Income. Net unrealized holding losses on available-for-sale securities are included in accumulated other comprehensive (loss) income as of December 31, 2014. All of the Company's available-for-sale securities with gross unrealized losses as of December 31, 2014 and 2013 had been in a loss position for less than 12 months.
The estimated fair value of available-for-sale debt securities at December 31, 2014, by contractual maturity, was as follows (in thousands):
Expected maturities may differ from contractual maturities because the issuers of the securities may have the right to prepay obligations without prepayment penalties.
NOTE 5 - ACCOUNTS RECEIVABLE AND RESERVES
The Company records an allowance for doubtful accounts based upon a specific review of all outstanding invoices, known collection issues and historical experience. The Company regularly evaluates the collectability of its trade accounts receivables and performs ongoing credit evaluations of its customers and adjusts credit limits based upon payment history and its assessment of the customer’s current creditworthiness. These estimates are based on specific facts and circumstances of particular orders, analysis of credit memo data and other known factors. Accounts receivable consisted of the following at December 31 (in thousands):
The following table summarizes the changes in the allowance for doubtful accounts (in thousands):
NOTE 6 - INVENTORIES, NET
Inventories consisted of the following at December 31 (in thousands):
The Company has non-cancellable purchase commitments with certain of its component suppliers in the amount of approximately $20.1 million at December 31, 2014. Should production requirements fall below the level of the Company’s commitments, the Company could be required to take delivery of inventory for which it has no immediate need or incur an increased cost per unit going forward.
NOTE 7 - FAIR VALUE MEASUREMENT
ASC 820 defines fair value, establishes a framework for measuring fair value under generally accepted accounting principles and enhances disclosures about fair value measurements. Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Valuation techniques used to measure fair value must maximize the use of observable inputs and minimize the use of unobservable inputs. The ASC describes a fair value hierarchy based on the following three levels of inputs that may be used to measure fair value, of which the first two are considered observable and the last unobservable:
Level 1-Quoted prices in active markets for identical assets or liabilities.
Level 2-Inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.
Level 3-Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.
The Company determines the fair value of its investment portfolio assets by obtaining non-binding market prices from its third-party portfolio managers on the last day of the quarter, whose sources may use quoted prices in active markets for identical assets (Level 1 inputs) or inputs other than quoted prices that are observable either directly or indirectly (Level 2 inputs) in determining fair value. There were no transfers between Level 1, Level 2 or Level 3 measurements for the year ended December 31, 2014.
The following table represents the Company’s fair value hierarchy for its financial assets and liabilities measured at fair value on a recurring basis as of December 31, 2014 and 2013 (in thousands):
The Company records contingent consideration resulting from a business combination at its fair value on the acquisition date. The Company determines the fair value of the contingent consideration based primarily on the timing and probability of success of clinical events or regulatory approvals, the timing and probability of success of meeting commercial milestones, such as sales levels of a specific product, and discount rates. The contingent consideration liability arose in connection with the GenturaDx acquisition. The Company re-evaluates its assumptions for its contingent consideration fair value determinations each quarter. Changes to the fair value of contingent consideration obligations can result from adjustments to discount rates, accretion of the discount rates due to the passage of time, changes in our estimates of the likelihood of or timing of achieving any development or commercial milestones, changes in the probability of certain clinical events or changes in the assumed probability associated with regulatory approval. As a result of changes in assumptions surrounding the probability of success of meeting the timing of commercial milestones contemplated in the GenturaDx acquisition agreement, the Company adjusted the contingent consideration liability related to the GenturaDx acquisition to $0 in 2013. The assumptions related to determining the value of contingent consideration include a significant amount of judgment, and any changes in the underlying estimates could have a material impact on the amount of contingent consideration expense recorded in any given period.
Changes in the recurring fair value measurements of financial assets and liabilities using significant unobservable inputs (Level 3) during the years ended December 31, 2014 and 2013 were as follows (in thousands):
NOTE 8 - PROPERTY AND EQUIPMENT
Property and equipment consisted of the following at December 31 (in thousands):
Depreciation expense was $8.9 million, $10.2 million, and $8.8 million for the years ended December 31, 2014, 2013, and 2012, respectively.
NOTE 9 - GOODWILL AND OTHER INTANGIBLE ASSETS
On July 11, 2012, the Company completed the acquisition of GenturaDx. As a result, the Company recorded approximately $8.3 million of goodwill and approximately $40.1 million of other identifiable intangible assets. This goodwill is not expected to be deductible for tax purposes. The changes in the carrying amount of goodwill during the period are as follows (in thousands):
The current in process research and development project is scheduled to be completed in 2015. The estimated costs to complete this project are between $2.0 million and $4.0 million.
The Company’s intangible assets are reflected in the table below (in thousands, except weighted average lives):
The estimated aggregate amortization expense for the next five years and thereafter is as follows (in thousands):
NOTE 10 - OTHER COMPREHENSIVE (LOSS) INCOME
Comprehensive (loss) income represents a measure of all changes in equity that result from recognized transactions and other economic events other than those resulting from investments by and distributions to shareholders. Other comprehensive (loss) income for the Company includes foreign currency translation adjustments and net unrealized holding gains and losses on available-for-sale investments.
The following table presents the changes in each component of accumulated other comprehensive (loss) income, net of tax (in thousands):
The following table presents the tax (expense) benefit allocated to each component of other comprehensive (loss) income (in thousands):
NOTE 11 - OTHER ASSETS
Other assets consisted of the following at December 31 (in thousands):
For the years ended December 31, 2014 and 2013, the Company recognized amortization expense related to the amortization of purchased technology rights of approximately $1,410,000 and $1,639,000, respectively. Future amortization expense is estimated to be $392,000 in 2015, $166,000 in 2016, $148,000 in 2017, $102,000 in 2018, $90,000 in 2019 and $645,000 thereafter.
Non-Marketable Securities and Other-Than-Temporary Impairment
The Company owns a minority interest in a private company based in the U.S. through its investment of $1.0 million in the third quarter of 2012. This minority interest is included at cost in other long-term assets on the Company’s Consolidated Balance Sheets as the Company does not have significant influence over the investee as the Company owns less than 20% of the voting equity and the investee is not publicly traded.
The Company's other minority interest in a private company was acquired by a third party in July 2013 and, as a result, the Company's minority interest in that private company was sold. The Company realized a gain of $5.4 million on this minority interest investment in the third quarter of 2013.
The Company regularly evaluates the carrying value of cost-method investments for impairment and whether any events or circumstances are identified that would significantly harm the fair value of the investments. The primary indicators the Company utilizes to identify these events and circumstances are the investee's ability to remain in business, such as the investee's liquidity and rate of cash use, and the investee’s ability to secure additional funding and the value of that additional funding. In the event a decline in fair value is judged to be other-than-temporary, the Company will record an other-than-temporary impairment charge in other income, net in the Consolidated Statements of Operations. As the inputs utilized for the Company's periodic impairment assessment are not based on observable market data, these cost-method investments are classified within Level 3 of the fair value hierarchy. To determine the fair value of these investments, the Company uses all available financial information related to the entities, including information based on recent or pending third-party equity investments in these entities. In certain instances, a cost-method investment's fair value is not estimated as there are no identified events or changes in the circumstances that may have a significant adverse effect on the fair value of the investment and to do so would be impractical.
NOTE 12 - ACCRUED LIABILITIES
Accrued liabilities consisted of the following as of December 31 (in thousands):
Sales of certain of the Company’s systems are subject to a warranty. System warranties typically extend for a period of twelve months from the date of installation or no more than 15 months from the date of shipment. The Company estimates the amount of warranty claims on sold products that may be incurred based on current and historical data. The actual warranty expense could differ from the estimates made by the Company based on product performance. Warranty expenses are evaluated and adjusted periodically.
The following table summarizes the changes in the warranty accrual (in thousands):
NOTE 13 - INCOME TAXES
The components of income before income taxes for the years ended December 31 are as follows (in thousands):
The components of the provision (benefit) for income taxes attributable to continuing operations for the years ended December 31 are as follows (in thousands):
The provision for income taxes differs from the amount computed by applying the statutory federal rate to pretax income as follows (in percentages):
The Company accounts for income taxes using the liability method in accordance with ASC 740 "Income Taxes". Under this method, deferred income taxes are recognized for the future tax consequences of differences between the tax and financial accounting bases of assets and liabilities at the end of each reporting period. Deferred income taxes are based on enacted tax laws and statutory tax rates applicable to the periods in which the differences are expected to affect taxable income. A valuation allowance is established when necessary to reduce deferred tax assets to the amounts expected to be realized. Significant components of the Company’s deferred tax assets and liabilities as of December 31 are as follows (in thousands):
Under ASC 740, the Company can only recognize a deferred tax asset to the extent that it is “more likely than not” that these assets will be realized. In evaluating the need for a valuation allowance, all available evidence, both positive and negative, is considered to determine whether, based on the weight of that evidence, a valuation allowance is needed. The Company has established a valuation allowance against a portion of its remaining deferred tax assets because it is more likely than not that certain deferred tax assets will not be realized. In determining whether deferred tax assets are realizable, the Company considered numerous factors including historical profitability, the amount of future taxable income and the existence of taxable temporary differences that can be used to realize deferred tax assets. The valuation allowance decreased approximately $25.1 million in 2014 from 2013 primarily due to our Canadian subsidiary which recorded a partial release to valuation allowances on its net deferred tax assets. Based on our recent history of generating income in Canada and our expectation to continue to generate future income in Canada for the next several years, we determined that it was more likely than not that a portion of Canadian deferred tax assets would be realized.
At December 31, 2014, the Company had gross federal, state and foreign net operating loss carryforwards of approximately $71.4 million, $49.7 million, and $8.5 million respectively. These losses expire beginning in 2015, except for $1.3 million of losses that have unlimited carryforward periods. Approximately $19.5 million of the federal net operating loss carryforward is attributable to excess employee stock option deductions, the benefit from which will be allocated to additional paid-in capital rather than current earnings if subsequently realized. Federal and state net operating losses of approximately $51.9 million and $49.7 million, respectively, were acquired as part of the acquisitions of U.S. companies. These acquired net operating losses are subject to annual limitations due to the "change of ownership" provisions of Section 382 of the Internal Revenue Code of 1986 and similar state provisions. The Company has federal, state, and foreign credit carryforwards of approximately $10.7 million, $2.2 million, and $12.8 million, respectively. These credits begin to expire in 2018, except for approximately $4.0 million which have an indefinite carryforward period. Approximately $7.0 million of the federal credits are attributable to excess employee stock option deductions, the benefit of which has been allocated to additional paid-in capital rather than current earnings when realized. State credits of approximately $1.1 million were acquired as part of the acquisition of GenturaDx in 2012 and are subject to annual limitations due to the "change of ownership" provisions of Section 382 of the Internal Revenue Code of 1986 and similar California state tax provisions. In addition, the Company has a gross scientific research and experimental development pool in Canada of approximately $54.0 million which has an indefinite carryforward period.
Undistributed earnings of the Company's foreign subsidiaries are considered permanently reinvested and, accordingly, no provision for U.S. federal or state income taxes has been provided thereon. The cumulative amount of undistributed earnings of the Company's non-US subsidiaries was approximately $1.3 million at December 31, 2014, $0.9 million at December 31, 2013, and $1.2 million at December 31, 2012. Determination of the amount of unrecognized deferred income tax liabilities on these earnings is not practicable at this time because such liability, if any, is dependent upon circumstances existing if and when remittance occurs.
In the fourth quarter of 2014, the Company recognized an income tax benefit of approximately $3.0 million to record deferred charges related to intercompany profits on sales of assets for which the assets had not been disposed of as of December 31, 2014. Taxes due and paid on such intercompany profits are required to be recognized as a prepaid expense tax until the assets are sold to a third party. Approximately $2.5 million of this income tax benefit is attributable to years prior to 2014. The Company has concluded that the correction of the error of the prior period amounts is not material to any previously reported periods.
As of both December 31, 2014 and December 31, 2013, the Company had recorded gross unrecognized tax benefits of approximately $2.3 million. All of the unrecognized tax benefits as of December 31, 2014, if recognized, would impact the effective tax rate. The Company recognizes interest expense and penalties associated with uncertain tax positions as a component of income tax expense. During the years ended December 31, 2014 and 2013, the Company recognized approximately $31,900 and $14,000 in tax related interest and penalties, respectively. Reserves for interest and penalties as of December 31, 2014 and 2013 are not significant as the Company has net operating loss carryovers.
A reconciliation of the beginning and ending balance of unrecognized tax benefits is as follows (in thousands):
As of December 31, 2014, there were no unrecognized tax benefits that the Company expects would change significantly over the next 12 months.
The Company files U.S., state, and foreign income tax returns in jurisdictions with varying statutes of limitations. In the United States and Canada, the statute of limitations with respect to the federal income tax returns for tax years after 2010 are open to audit; however, since the Company has net operating losses, the taxing authority has the ability to review tax returns prior to the 2010 tax year and make adjustments to these net operating loss carryforwards. There are numerous other income tax jurisdictions for which tax returns are not yet settled, none of which are individually significant. We are currently under audit in Canada for the Company’s scientific research and experimental development pool claims for the 2011 tax year. Although we do not expect a material adjustment, the outcome of the audit is not known at this time. We are not under audit in any other major taxing jurisdictions at this time.
NOTE 14 - LONG-TERM DEBT
On December 31, 2013, long-term debt consisted of a loan payable to Technology Partnerships Canada in the amount of $1.6 million.
In May 2014, the Company repaid all of its outstanding debt. In 2014 and 2013, the Company had imputed interest expense related to its long-term debt of $6,000 and $48,000, respectively. The effective interest rate was 3.90% as of December 31, 2013. At December 31, 2013, the fair value of the Company’s long-term debt was approximately $1.5 million. The Company’s long-term debt was classified as a Level 3 instrument.
NOTE 15 - NET INCOME PER SHARE
The following table sets forth the computation of basic and diluted net income per share (in thousands, except share and per share data):
Restricted stock awards (RSAs) and stock options to acquire 442,000, 381,000, and 364,000 shares for the years ended December 31, 2014, 2013 and 2012, respectively, were excluded from the computations of diluted earnings per share because the effect of including the RSAs and stock options would have been anti-dilutive.
NOTE 16 - STOCKHOLDERS' EQUITY, EMPLOYEE BENEFIT PLANS AND STOCK-BASED COMPENSATION
Preferred Stock
The Company’s Board of Directors has the authority to issue up to 5,000,000 shares of preferred stock in one or more series and to fix the rights, preferences, privileges and restrictions thereof, including dividend rights, dividend rates, conversion rights, voting rights, terms of redemption, redemption prices, liquidation preferences and the number of shares constituting any series or the designation of such series, without further vote or action by the Company’s stockholders. At December 31, 2014 and 2013, there was no preferred stock issued and outstanding.
Stock-Based Compensation
At December 31, 2014, the Company has one stock-based employee compensation plan pursuant to which grants may be made: the Second Amended and Restated 2006 Equity Incentive Plan (the “Equity Incentive Plan”) which was approved at the Company’s Annual Meeting on May 25, 2006 and amended at the Company’s Annual Meetings on each of May 21, 2009 and May 17, 2012. No further grants shall be made pursuant to the 2000 Long-Term Incentive Plan (the “2000 Plan”), the 2001 Broad-Based Stock Option Plan (the “2001 Plan”) or the 2006 Management Stock Purchase Plan (the “MSPP”), which was terminated effective March 7, 2012. In addition, at December 31, 2014, the Company has one plan pursuant to which discount purchases may be made by the participants in such plan: the Luminex Corporation Employee Stock Purchase Plan (the "ESPP"), which was approved at the Company's Annual Meeting on May 17, 2012.
Equity Incentive Plans
Under the Company’s Equity Incentive Plan and the 2000 Plan, certain employees, consultants and non-employee directors have been granted RSAs, restricted share units (RSUs) and options to purchase shares of common stock. The options, RSAs, and RSUs generally vest in installments over a three to five year period, and the options expire either five or ten years after the date of grant. Under the Equity Incentive Plan, certain employees, directors of, and consultants to the Company are eligible to be granted RSAs, RSUs, and options to purchase common stock. The ESPP provides for the granting of rights to certain employees of the Company to defer an elected percentage, up to 15%, of their base salary through the purchase of the Company's common stock, discounted by 15%. As of December 31, 2014, there were approximately 2.6 million shares authorized for future issuance under the Company’s Equity Incentive Plan and approximately 319,000 shares eligible for purchase pursuant to the terms and conditions of the ESPP as more fully described below.
The Equity Incentive Plan, the ESPP and the 2000 Plan are administered by the Compensation Committee of the Board of Directors. The Compensation Committee has the authority to determine the terms and conditions under which awards will be granted from the Equity Incentive Plan, including the number of shares, vesting schedule and term, as applicable. Any option award exercise prices, as set forth in the Equity Incentive Plan, will be equal to the fair market value on the date of grant. Under certain circumstances, the Company may repurchase previously granted RSAs and RSUs.
On March 25, 2011, March 7, 2012 and March 19, 2013 the Compensation Committee of the Board adopted the Luminex Corporation 2011 Long Term Incentive Plan (the “2011 LTIP”), the Luminex Corporation 2012 Long Term Incentive Plan (the "2012 LTIP"), and the 2013 Long Term Incentive Plan (the "2013 LTIP"), respectively. Awards under all of the LTIP plans were granted by the Compensation Committee in the form of RSUs and are to be treated as Performance Awards under the Equity Incentive Plan. Grants of RSUs under the LTIP plans shall initially be unvested and represent the maximum amount of shares that participants may receive under the plan, assuming achievement of the maximum level of performance goals established for the grant, and subject to adjustment for certain transactions and other extraordinary or non-recurring events that may affect Luminex or its financial performance.
On March 25, 2011, the Company’s former chief executive officer (CEO) was granted an award for an unvested RSU under the 2011 LTIP for up to $2,200,000 worth of shares (grant date fair value) of Luminex common stock, and the Company’s chief financial officer (CFO) was granted an award for an unvested RSU under the 2011 LTIP for up to $825,000 worth of shares (grant date fair value) of Luminex common stock. The actual maximum number of shares of 119,304 shares and 44,740 shares for the former CEO and CFO, respectively, was determined on March 25, 2011, based upon the closing price of the stock on that date. Performance goals under the grants are based on the following components, with the following weights given to each: 50% on the trading price of Luminex common stock at the end of the performance period and 50% on Luminex’s total income from operations per diluted share at the end of the performance period.
The 2011 LTIP performance goals are as described below:
•
Partial or complete achievement of the trading price goal is dependent upon the average closing price of Luminex’s common stock for the twenty consecutive trading days ending December 31, 2013, inclusive, subject to certain adjustments as described in the 2011 LTIP. There is a range of trading price targets as follows: a minimum threshold of $28.50 per share, a target of $32.38 per share, and a maximum goal of $51.42 per share. No shares were earned for this goal under the 2011 LTIP.
•
Partial or complete achievement of the income from operations goal is dependent upon the total income from operations per diluted share for the year ended December 31, 2013, as further described in the 2011 LTIP. Total income from operations means Luminex’s income from operations as reflected on the Company’s Consolidated Statement of Comprehensive Operations for the year ended December 31, 2013, as further described in the 2011 LTIP. There is a range of targets as follows: a minimum threshold of $0.73 per share, a target of $0.81 per share, and a maximum goal of $1.19 per share. The final determination and certification of the shares earned for this goal was made by the Compensation Committee of the Board of Directors on February 26, 2014 resulting in no shares earned for this goal under the 2011 LTIP.
On March 7, 2012, the Company’s former CEO was granted an award for an unvested RSU under the 2012 LTIP for up to $2,200,000 worth of shares (grant date fair value) of Luminex common stock, and the Company’s CFO was granted an award for an unvested RSU under the 2012 LTIP for up to $550,000 worth of shares (grant date fair value) of Luminex common stock. The actual maximum number of shares of 98,434 shares and 24,608 shares for the former CEO and CFO, respectively, was determined on March 7, 2012, based upon the closing price of the stock on that date. Performance goals under the grants are based on the following components, with the following weights given to each: 50% on the trading price of Luminex common stock at the end of the performance period and 50% on Luminex’s total income from operations at the end of the performance period.
The 2012 LTIP performance goals are as described below:
•
Partial or complete achievement of the trading price goal is dependent upon the average closing price of Luminex’s common stock for the twenty consecutive trading days ending December 31, 2014, inclusive, subject to certain adjustments as described in the 2012 LTIP. There is a range of trading price targets as follows: a minimum threshold of $29.29 per share, a target of $32.54 per share, and a maximum goal of $39.75 per share. No shares were earned for this goal under the 2012 LTIP.
•
Partial or complete achievement of the total income from operations goal is dependent upon the total income from operations for the year ended December 31, 2014, as further described in the 2012 LTIP. Total income from operations means Luminex’s income from operations as reflected on the Company’s Consolidated Statement of Comprehensive Operations for the year ended December 31, 2014, as further described in the 2012 LTIP. There is a range of targets as follows: a minimum threshold of $58,663,000, a target of $67,286,000, and a maximum goal of $85,831,000. The final determination and certification of the shares earned for this goal will be made by the Compensation Committee of the Board of Directors after the filing of this Annual Report on From 10-K, but we expect no shares will be earned for this goal under the 2012 LTIP.
On March 19, 2013, the Company’s former CEO was granted an award for an unvested RSU under the 2013 LTIP for up to $1,200,000 worth of shares (grant date fair value) of Luminex common stock, and the Company’s CFO was granted an award for an unvested RSU under the 2013 LTIP for up to $300,000 worth of shares (grant date fair value) of Luminex common stock. The actual maximum number of shares of 71,727 shares and 17,931 shares for the former CEO and CFO, respectively, was determined on March 19, 2013, based upon the closing price of the stock on that date. The performance goal under the grants is based on Luminex’s fully diluted earnings per share at the end of the performance period (Adjusted EPS Goal). Partial or complete achievement of the Adjusted EPS Goal is dependent upon Luminex's fully diluted earnings per share for the year ended December 31, 2015, as further described in the 2013 LTIP. There is a range of targets as follows: a minimum threshold of $1.06 per share, a target of $1.18 per share, and a maximum goal of $1.36 per share.
In the event that a participant achieves less than the maximum level of the performance goal, the total number of shares represented by such RSU shall be reduced to reflect where actual performance lies in the range of performance goals and weighted aggregate corresponding payout opportunities established for the grant. Calculation of shares between threshold and maximum performance shall be determined based on straight-line interpolation.
Accounting for Stock Compensation
Stock-based compensation costs are generally based on the fair value calculated from the Black-Scholes option-pricing model on the date of grant for stock options and market value on the date of grant for RSAs. The fair values of stock and stock options are amortized as compensation expense on a straight-line basis over the vesting period of the grants.
In accordance with ASC 718 the Company evaluates the assumptions used in the Black-Scholes model at each grant date using a consistent methodology for computing expected volatility, expected term and risk-free rate of return. Calculation of expected volatility is based on historical volatility. The expected life is calculated using the contractual term of the options as well as an analysis of the Company’s historical exercises of stock options. The estimate of the risk-free rate is based on the U.S. Treasury yield curve in effect at the time of grant. The Company has never paid cash dividends and does not currently intend to pay cash dividends, and thus has assumed a 0% dividend yield. The assumptions used are summarized in the following table:
As part of the requirements of ASC 718, the Company is required to estimate potential forfeitures of stock grants and adjust compensation cost recorded accordingly. The estimate of forfeitures is based on historical forfeiture performance and will be adjusted over the requisite service period to the extent that actual forfeitures differ, or are expected to differ, from such estimates. Changes in estimated forfeitures will be recognized through a cumulative catch-up adjustment in the period of evaluation and will also impact the amount of stock compensation expense to be recognized in future periods.
The Company’s stock option activity for the years ended December 31, 2012, 2013 and 2014 is as follows:
During the years ended December 31, 2014, 2013 and 2012, the total exercise intrinsic value of stock options exercised was $2.8 million, $8.7 million and $6.9 million, respectively, and the total fair value of stock options that vested was $2.4 million, $2.5 million and $2.0 million, respectively. Exercise intrinsic value represents the difference between the market value of the Company's common stock at the time of exercise and the price paid by the employee to exercise the options. The Company had $3.2 million of total unrecognized compensation costs related to stock options at December 31, 2014 that are expected to be recognized over a weighted-average period of 2.8 years.
The Company’s restricted share activity for the years ended December 31, 2012, 2013 and 2014 is as follows:
As of December 31, 2014, there was $22.3 million of unrecognized compensation cost related to RSAs and RSUs. That cost is expected to be recognized over a weighted average-period of 2.6 years. The total fair value of restricted shares vested during the year ended December 31, 2014, 2013 and 2012 was $6.5 million, $7.2 million, and $8.3 million, respectively.
RSAs and RSUs may be granted at the discretion of the Board of Directors under the Equity Incentive Plan in connection with the hiring or retention of key employees and are subject to certain conditions. Restrictions expire at certain dates after the grant date in accordance with specific provisions in the applicable agreement. During the year ended December 31, 2014, the Company awarded 637,184 shares of restricted stock awards, which had a fair value at the date of grant ranging from $16.82-$21.10. During the year ended December 31, 2013, the Company awarded 353,537 shares of restricted stock awards, which had a fair value at the date of grant ranging from $16.18-$18.11. During the year ended December 31, 2012, the Company awarded 329,096 shares of restricted stock awards, which had a fair value at the date of grant ranging from $17.26-$22.71. During the year ended December 31, 2014, the Company awarded 139,417 shares of restricted stock units, which had a fair value at the date of grant ranging from $17.91-$20.14. During the year ended December 31, 2013, the Company awarded 199,051 shares of restricted stock units, which had a fair value at the date of grant ranging from $16.73-$20.51. During the year ended December 31, 2012, the Company awarded 246,205 shares of restricted stock units, which had a fair value at the date of grant ranging from $16.16-$23.82. Compensation under these restricted stock awards and units was charged to expense over the restriction period and amounted to $8.1 million, $7.5 million, and $8.4 million in 2014, 2013 and 2012, respectively.
There were no significant stock compensation costs capitalized into assets as of December 31, 2014, 2013 or 2012.
The Company received $3.7 million, $7.6 million, and $3.5 million for the exercise of stock options during the years ended December 31, 2014, 2013 and 2012, respectively. Cash was not used to settle any equity instruments previously granted. The Company issued shares pursuant to grants relating to each of the Equity Incentive Plan, 2000 Plan and 2001 Plan from reserves upon the exercise of stock options and vesting of RSAs.
Employee Savings Plans and Other Benefit Plans
Effective January 1, 2001, the Company began sponsoring a retirement plan authorized by section 401(k) of the Internal Revenue Code for the Company’s employees in the United States. In accordance with the 401(k) plan, all employees are eligible to participate in the plan on the first day of the month following the commencement of full time employment. For 2014, 2013 and 2012, each employee could contribute a percentage of compensation up to a maximum of $17,500, $17,500, and $17,000 per year, respectively, with the Company matching 50% of each employee’s contributions. Effective January 1, 2010, the Company began contributing to a deferred profit sharing plan for its Canadian employees. All Canadian employees are eligible to participate in the plan. The Company’s contributions to these plans for 2014, 2013 and 2012 were $2.5 million, $2.4 million, and $2.1 million, respectively.
Several of the Company’s Netherlands employees are covered by a defined benefit plan. The cost and total liability to the Company is not significant. Effective January 1, 2011, all of the Company’s new hires in the Netherlands are eligible to participate in a defined contribution plan.
Employee Stock Purchase Plan
In May 2012, the Company's stockholders approved the ESPP, which provides for the granting of up to 500,000 shares of the Company's common stock to eligible employees. The ESPP period is semi-annual and allows participants to purchase the Company's common stock at 85% of the lesser of (i) the closing market value per share of the common stock on the first trading date of the option period or (ii) the closing market value per share of the common stock on the last trading date of the option period. The first plan option period began on July 1, 2012. As of December 31, 2014, 2013 and 2012, 181,401 shares, 106,522 shares and 35,296 shares, respectively had been issued out of the ESPP. The related stock-based compensation expense was $0.4 million, $0.4 million and $0.2 million for 2014, 2013 and 2012, respectively.
The Company uses the Black-Scholes model to estimate the fair value of shares to be issued as of the grant date using the following weighted average assumptions:
The following are the stock-based compensation costs recognized in the Company’s consolidated statements of comprehensive income (in thousands):
Reserved Shares of Common Stock
At December 31, 2014 and 2013, the Company had reserved 4,790,386 and 6,034,452 shares of common stock, respectively, for the issuance of common stock upon the exercise of options, issuance of RSAs, RSUs, purchase of common stock pursuant to the ESPP or other awards issued pursuant to the Company’s equity plans and arrangements. The following table summarizes the reserved shares by plan as of December 31, 2014:
NOTE 17 - COMMITMENTS AND CONTINGENCIES
Lease Arrangements
The Company has operating leases related primarily to its office and manufacturing facilities with original lease periods of up to ten years. Rental and lease expense for these operating leases for the years 2014, 2013 and 2012 totaled approximately $4.5 million, $5.1 million, and $5.5 million, respectively.
In the fourth quarter of 2012, the Company ceased using the Hayward, California facility, whose operating lease commitment was acquired under the GenturaDx acquisition in July 2012. The Company has accrued a liability based upon the estimated fair value of the costs that will continue to be incurred under the lease, including an estimate of sublease rental income.
Minimum annual lease commitments as of December 31, 2014 under non-cancellable leases for each of the next five years and in the aggregate were as follows (in thousands):
These non-cancellable lease commitments related to facilities include certain rent escalation provisions which have been included in the minimum annual rental commitments shown above. These amounts are recorded to expense on a straight-line basis over the life of the lease. In addition, some of the Company’s leases contain options to renew the lease for five to ten years at the then prevailing market rental rate, right of first refusal to lease additional space that becomes available, or leasehold improvement incentives.
Non-Cancellable Purchase Commitments
As of December 31, 2014 the Company had approximately $20.1 million in purchase commitments primarily with several of its inventory suppliers as well as other operating commitments. Certain of our supply agreements require purchase and delivery of minimum amounts of components through 2018, and purchases under these arrangements were $2.4 million, $1.8 million and $2.1 million for the years ended December 31, 2014, 2013 and 2012, respectively.
Employment Contracts
The Company has entered into employment contracts with certain of its key executives. Generally, certain amounts may become payable in the event the Company terminates the executives’ employment without cause or the executive resigns for good reason.
Legal Proceedings
On August 30, 2012 Abbott Laboratories (Abbott) was named as a defendant in the complaint filed by ENZO Life Sciences, Inc. (ENZO) in U.S. District Court in Delaware for alleged infringement of its US Patent 7,064,197 as a result of Abbott's distribution of the Company's xTAG Respiratory Viral Panel. The Company and Abbott have entered into an agreement requiring Luminex to defend and indemnify Abbott for any alleged infringement resulting from its distribution of the Respiratory Viral Panel. The complaint seeks unspecified monetary damages and injunctive relief. Abbott filed an answer to the complaint on October 15, 2012. On November 30, 2012, the Company intervened in the lawsuit. On January 2, 2013 ENZO filed additional claims against the Company, alleging infringement of US Patent 7,064,197 resulting from the Company's sale of its xTAG, FlexScript LDA, SelecTAG, and xMAP Salmonella Serotyping Assay products and alleging infringement of US Patent 8,097,405 resulting from the Company's sale of Multicode products. The Company filed an answer to ENZO's additional claims on January 28, 2013. On October 2, 2013 ENZO filed additional claims against the Company, alleging infringement of U.S. Patent 6,992,180 resulting from the Company’s sale of Multicode products. The Company filed an answer to ENZO’s additional claims on October 21, 2013. A trial date has not been set. The parties to the lawsuit have engaged in the discovery process.
On November 1, 2013 Irori Technologies, Inc. filed a complaint against the Company in U.S. District Court in the Southern District of California, alleging infringement of its U.S. Patent numbers 6,372,428, 6,416,714, and 6,352,854 resulting from the Company’s sale of its xMAP and xTAG based products. The complaint seeks unspecified monetary damages and injunctive relief. The Company filed a motion to dismiss on January 9, 2014. Irori filed its response to our motion to dismiss on February 7, 2014. The matter is currently before the court. On December 11, 2014, the USPTO's Patent Trial and Appeal Board instituted review on all five inter partes review petitions that Luminex filed. Irori’s responses to the petitions are due February 26, 2015, and oral argument (if requested by either party) is scheduled for August 5, 2015.
When and if it appears probable in management's judgment, and based upon consultation with outside counsel, that the Company will incur monetary damages or other costs in connection with any claims or proceedings, and such costs can be reasonably estimated, the Company records the estimated liability in the financial statements. If only a range of estimated losses can be estimated, the Company records an amount within the range that, in management's judgment, reflects the most likely outcome; if none of the estimates within that range is a better estimate than any other amount, the Company records the liability at the low end of the range of estimates. Any such accrual would be charged to expense in the appropriate period. The Company discloses significant contingencies when the loss is not probable and/or the amount of the loss is not estimable, when the Company believes there is at least a reasonable possibility that a loss has been incurred. The Company recognizes costs associated with legal proceedings in the period in which the services were provided. There can be no assurance that the Company will successfully defend these suits or that a judgment against the Company would not materially adversely affect operating results.
Other Matters
In January 2013, the Company finalized the termination of its molecular diagnostics distribution agreements and an expense of $7.0 million was recorded in selling, general and administrative expenses in the first quarter of 2013. All payments were made in the second quarter of 2013.
NOTE 18 - GUARANTEES
The terms and conditions of the Company’s development and supply and license agreements with its strategic partners generally provide for a limited indemnification of such partners, arising from the sale of Luminex systems and consumables, against losses, expenses and liabilities resulting from third-party claims based on an alleged infringement on an intellectual property right of such third party. The terms of such indemnification provisions generally limit the scope of and remedies for such indemnification obligations to a multiple of amounts paid by such strategic partner to Luminex during the previous annual period(s). To date, the Company has not had to reimburse any of its strategic partners for any losses arising from such indemnification obligations.
NOTE 19 - SEGMENT AND GEOGRAPHIC INFORMATION
During the fourth quarter of 2014, in conjunction with the appointment of our new CEO, the Company evaluated its historical reporting segments: the technology and strategic partnerships (TSP) segment and the assays and related products (ARP) segment. As a result of this evaluation and based upon how the new Chief Executive Officer as Chief Operating Decision Maker (“CODM”) and the Company's management team collectively is managing its business, management determined that the two former segments have become so integrated and interrelated that they no longer provide an accurate representation of the Company's current business when reported separately. Additionally, management has taken actions to consolidate sales and service functions. Effective with the fourth quarter of 2014, the Company no longer has two operating segments and, accordingly, will present the Company's business as one operating segment and one reporting unit. Accordingly, prior periods' information has been restated to conform to the current periods' presentation.
The table below provides information regarding product revenues and property and equipment, net from the Company’s sales to customers within the United States and in foreign countries for the years ended December 31 (in thousands):
The Company's aggregate foreign currency transaction losses of $16,000, $385,000 and $215,000 were included in determining the consolidated results for the years ended December 31, 2014, 2013 and 2012, respectively.
NOTE 20 - RECENT ACCOUNTING PRONOUNCEMENTS
In April 2014, the FASB amended guidance to clarify the accounting for disposals of groups of assets and business units. The amendments alter the definition of a discontinued operation to cover only asset disposals that are a strategic shift with a major effect on an entity's operations and finances. For the Company, the changes should be applied in fiscal years that start on December 15, 2014, or later, but the changes can be applied ahead of the effective date for asset disposals that have not been reported in a set of financial statements. Management applied this new guidance for the automated punching group and the related closure of the Brisbane, Australia manufacturing facility in the third quarter of 2014.
In May 2014, the FASB issued a new standard on revenue recognition which outlines a single comprehensive model to use in accounting for revenue arising from contracts with customers and supersedes most current revenue recognition guidance, including industry-specific guidance. The core principle of the revenue model is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The standard is designed to create greater comparability for financial statement users across industries and jurisdictions and also requires enhanced disclosures. The guidance is effective for fiscal years, and interim periods within those years, beginning after December 15, 2016. Early adoption is not permitted. The Company is currently evaluating the impact of the adoption of this standard on its consolidated financial statements.
NOTE 21 - SELECTED QUARTERLY RESULTS (UNAUDITED)
The following table sets forth certain quarterly financial data for the periods indicated (in thousands, except per share data):
(1) Net income in the fourth quarter of 2014 included an income tax benefit from the release of a portion of the valuation allowance on deferred tax assets in Canada and the recognition of a tax benefit related to intercompany profits on sales of assets for which the assets had not been disposed of as of December 31, 2014. See Note 13 - Income Taxes.
(2) Loss from operations and net loss in the first quarter of 2013 included a $7.0 million charge associated with the termination of the Company's prior molecular diagnostic distribution agreements.
(3) Loss from operations in the third quarter of 2013 included an expense for the full allowance against accounts receivable balances related to the bankruptcy of a customer totaling $3.9 million and restructuring charges of $4.3 million.
(4) Net income in the third quarter of 2013 included a $5.4 million gain on the sale of a minority interest in a private company and an adjustment of the fair value of the Company's contingent consideration liability to $0, which was established as part of the GenturaDx acquisition.
See Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations for further discussion.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
ITEM 9A.
ITEM 9A. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures, as defined in Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934 (Exchange Act), which are designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms and that such information is accumulated and communicated to the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. We carried out an evaluation, under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures as of the end of the period covered by this report. Based on the evaluation and criteria of these disclosure controls and procedures, the Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective.
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 Rules 13a-15(f) and 15d-15(f). Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting as of December 31, 2014 based on the 1992 framework in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on that evaluation, our management concluded that our internal control over financial reporting was effective as of December 31, 2014. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Projections of any evaluation of effectiveness to future periods are subject to the risks that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Our independent registered public accounting firm, Ernst & Young LLP, has issued a report on their assessment of the effectiveness of our internal control over financial reporting, which is provided at Item 8, page 56.
Changes in Internal Control Over Financial Reporting
There were no changes in our internal control over financial reporting identified in connection with the evaluation required by Exchange Act Rule 13a-15(d) during the fourth quarter of 2014 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
ITEM 9B.
ITEM 9B. OTHER INFORMATION
None.
PART III
ITEM 10.
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
The information required by this Item concerning our directors, audit committee, and audit committee financial experts, code of ethics and compliance with Section 16(a) of the Exchange Act is incorporated by reference to information under the captions “Proposal 1 - Election of Class III Directors”, “Corporate Governance” and “Section 16(a) Beneficial Ownership Reporting Compliance” in our definitive proxy statement for our 2015 Annual Meeting of Stockholders to be held on or about May 14, 2015 (Proxy Statement). It is anticipated that our Proxy Statement will be filed with the Securities and Exchange Commission on or about March 30, 2015.
Pursuant to General Instruction G(3), certain information with respect to our executive officers is set forth under the caption “Executive Officers of the Registrant as of February 23, 2015" in Item 1 of this Annual Report on Form 10-K.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
Information required by this Item is incorporated by reference to the section of the Proxy Statement entitled “Executive and Director Compensation.”
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
Information required by this Item is incorporated by reference to the section of the Proxy Statement entitled “Security Ownership of Certain Beneficial Owners and Management.”
Securities Authorized for Issuance Under Equity Compensation Plans
The following table sets forth, as of December 31, 2014, certain information with respect to shares of our common stock authorized for issuance under our equity compensation plans.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
Information required by this Item is incorporated by reference to the sections of the Proxy Statement entitled “Certain Relationships and Related Party Transactions” and “Corporate Governance.”
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
Information required by this Item is incorporated by reference to the section of the Proxy Statement entitled “Ratification of Appointment of Independent Registered Public Accounting Firm.”
PART IV
ITEM 15.
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
(a)
The following documents are filed as a part of this Annual Report on Form 10-K:
(1)
Financial Statements:
The Financial Statements required by this item are submitted in Part II, Item 8 of this report.
(2)
Financial Statement Schedules:
All schedules are omitted because they are not applicable or the required information is shown in the Financial Statements or in the notes thereto.
(3)
Exhibits:
EXHIBIT
NUMBER
DESCRIPTION OF DOCUMENT
The following materials from Luminex Corporation's Annual Report on Form 10-K for the year ended December 31, 2014, formatted in XBRL: (i) Condensed Consolidated Balance Sheets; (ii) Condensed Consolidated Statements of Comprehensive Income; (iii) Condensed Consolidated Statements of Cash Flows; and (iv) Notes to Condensed Consolidated Financial Statements.
# Management contract or compensatory plan or arrangement.
*
Schedules, annexes and exhibits omitted pursuant to Item 601(b)(2) of Regulation S-K. Luminex agrees to furnish a supplemental copy of omitted schedules to the Securities and Exchange Commission upon request.
SIGNATURES
Pursuant to the requirements of the 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.
LUMINEX CORPORATION
By: /s/ Nachum Shamir
Nachum Shamir
President and Chief Executive Officer
Date: February 25, 2015
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.
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Nachum Shamir and Harriss T. Currie, each his true and lawful attorney-in-fact and agent, with full power of substitution and resubstitution, for him and in his name, place and stead, in any and all capacities, to sign any and all amendments to this Report, and to file the same, with all exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, full power and authority to do and perform each and every act and thing requisite and necessary to be done in connection therewith, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents, or their substitutes or substitute, may lawfully do or cause to be done by virtue hereof.
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.
S-1
S-2
EXHIBIT INDEX
# Management contract or compensatory plan or arrangement.
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Schedules, annexes and exhibits omitted pursuant to Item 601(b)(2) of Regulation S-K. Luminex agrees to furnish a supplemental copy of omitted schedules to the Securities and Exchange Commission upon request.