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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

For the quarterly period ended March 31, 2003
or

For the transition period from                               to                              

Commission File Number: 0-10961

QUIDEL CORPORATION

(Exact name of Registrant as specified in its charter)

10165 McKellar Court, San Diego, California 92121
(Address of principal executive offices)

(858) 552-1100
(Registrant's telephone number, including area code)

        Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes /x/    No / /

        Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes ý    No o

        As of April 30, 2003, 28,943,620 shares of common stock were outstanding.

QUIDEL CORPORATION
FORM 10-Q
FOR THE QUARTER ENDED
March 31, 2003

INDEX

2

QUIDEL CORPORATION

CONSOLIDATED BALANCE SHEETS

(in thousands)

See accompanying notes.

3

QUIDEL CORPORATION

CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share data, unaudited)

See accompanying notes.

4

QUIDEL CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands, unaudited)

See accompanying notes.

5

Quidel Corporation

Notes to Condensed Consolidated Financial Statements

(Unaudited)

Note 1. Basis of Presentation

        The accompanying unaudited condensed consolidated financial statements of Quidel Corporation (the "Company") have been prepared in accordance with accounting principles generally accepted in the U.S. for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the U.S. for complete financial statements. In the opinion of management, all adjustments considered necessary for a fair presentation (consisting of normal recurring accruals) have been included. The information for the three months ended March 31, 2003 and 2002, is unaudited. Operating results for the three months ended March 31, 2003 are not necessarily indicative of the results that may be expected for the year ending December 31, 2003. For further information, refer to the consolidated financial statements and footnotes thereto for the year ended December 31, 2002 included in the Company's 2002 Annual Report on Form 10-K.

        The Company's first, second and third fiscal quarters end on the Sunday closest to March 31, June 30 and September 30, respectively. For ease of reference, such quarter end date is used herein.

Note 2. Comprehensive Income

        The components of comprehensive income are as follows (in thousands, unaudited):

Note 3. Stock Compensation

        The Company has elected to follow Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to Employees," and related Interpretations, in accounting for its employee stock options. Under APB No. 25, because the exercise price of the Company's employee stock options equals or exceeds the estimated market price of the underlying stock on the date of grant, no compensation has been recognized.

        The estimated weighted average fair value of options granted during the three months ended March 31, 2003 and 2002 was $2.29 and $5.07 respectively. The fair value of each option grant was estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions used for grants for the three months ended March 31, 2003 and 2002, respectively: risk-free interest rate of 3.8% for both periods; expected option life of 6.1 years for both periods; expected volatility of .84 and .85; and a dividend rate of zero for both periods.

        The Black-Scholes option-pricing model was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable. Because the Company's employee stock option plans have characteristics significantly different from those of traded options, the resulting pro forma compensation cost may not be representative of that to be expected in future years.

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Had compensation cost for the Company's stock option plans been determined based on the fair value at the grant date for awards for the three months ended March 31, 2003 and 2002, consistent with the provisions of SFAS No. 123, the Company's net earnings and earnings per share would have been as indicated below:

Note 4. Computation of Earnings Per Share

        Basic earnings per share was computed by dividing net earnings by the weighted average number of common shares outstanding during the period. Diluted earnings per share reflects the potential dilution that could occur if the earnings were divided by the weighted-average number of common shares and potentially dilutive common shares from outstanding stock options. Potential dilutive common shares were calculated using the treasury stock method and represent incremental shares issuable upon exercise of the Company's outstanding stock options and warrants.

        The following table reconciles the weighted average shares used in computing basic and diluted earnings per share in the respective periods:

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Note 5. Inventories

        Inventories are recorded at the lower of cost (first-in, first-out) or market and consist of the following (in thousands):

Note 6. Income Taxes

        The Company has significant tax net operating loss carryforwards (NOL's) and other deferred tax assets which may be used to reduce future income taxes payable. The Company currently has a valuation allowance of approximately $13.0 million against its deferred tax assets. These NOL's and other deferred tax assets may be available to reduce income taxes payable and the effective tax rate during 2003. The Company continues to monitor the need for the deferred tax asset valuation allowance and will remove all or a portion of the valuation allowance upon management's determination that it is more likely than not that such asset will be realized. Upon removal of the valuation allowance, the Company will record a corresponding income tax benefit on its income statement.

Note 7. Stockholders' Equity

        During the three months ended March 31, 2003, 31,316 shares of common stock were issued for the exercise of common stock options and 23,500 shares of common stock were issued in connection with the Company's Employee Stock Purchase Plan, resulting in proceeds to the Company of approximately $0.2 million.

Note 8. Recent Accounting Pronouncements

        In January 2003, the FASB issued FASB Interpretation No. 46 (FIN 46), "Consolidation of Variable Interest Entities, an interpretation of ARB No. 51." FIN 46 provides guidance on: 1) the identification of entities for which control is achieved through means other than through voting rights, known as "variable interest entities" (VIEs); and 2) which business enterprise is the primary beneficiary and when it should consolidate the VIE. This new model for consolidation applies to entities: 1) where the equity investors (if any) do not have a controlling financial interest; or 2) whose equity investment at risk is insufficient to finance that entity's activities without receiving additional subordinated financial support from other parties. In addition, FIN 46 requires that both the primary beneficiary and all other enterprises with a significant variable interest in a VIE make additional disclosures. FIN 46 is effective for all new VIEs created or acquired after January 31, 2003. For VIEs created or acquired prior to February 1, 2003, the provisions of FIN 46 must be applied for the first interim or annual period beginning after June 15, 2003. Certain disclosures are effective immediately. As we currently have no

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VIEs, the Company does not expect the implementation of FIN 46 to have a material effect on its financial condition or results of operations.

Note 9. Industry and Geographic Information

        The Company operates in one reportable segment. Sales to customers outside the U.S. represented 44% and 26% for the three months ended March 31, 2003 and 2002, respectively. As of March 31, 2003 and December 31, 2002, balances due from foreign customers were $6.3 million and $9.2 million, respectively.

        The Company had sales to individual customers in excess of 10% of net sales, as follows:

        As of March 31, 2003 and December 31, 2002, accounts receivable from three customers with balances due in excess of 10% of total accounts receivable totaled $6.1 million and $8.2 million, respectively.

        The following presents net sales for the three months ended March 31, 2003 and 2002 and long-lived assets as of March 31, 2003 and December 31, 2002 by geographic territory:

Note 10. Subsequent Event

        On April 29, 2003, the Company announced and commenced implementation of a Restructuring Plan (the "Restructuring Plan"). The Company has now implemented its Baan enterprise resource planning system in its Santa Clara facility, benefited from manufacturing automation in its San Diego facility, completed certain research and development projects, and is transitioning its foreign sales and

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support offices to independent distributors, which is expected to be effective September 1, 2003. The Restructuring Plan includes a workforce reduction of approximately 77 positions (22%), and closure of the Company's sales and support offices in Heidelberg, Germany and Milan, Italy. The Company expects to record a charge of approximately $2.3 million and expects the cash outlays to occur in the second and third quarters of 2003. The significant components of the restructuring charge are expected to be $1.3 million for employee severance costs, $0.4 million for contractual lease and commercial contract terminations, $0.4 million for professional fees and $0.2 million in asset impairment charges related to assets that have become obsolete due to restructuring activities.

ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

        In this quarterly report, all references to "we," "our" and "us" refer to Quidel Corporation and its subsidiaries.

Future Uncertainties

        This discussion contains forward-looking statements within the meaning of the federal securities laws that involve material risks and uncertainties. Many possible events or factors could affect our future financial results and performance, such that our actual results and performance may differ materially. As such, no forward-looking statement can be guaranteed. Differences in operating results may arise as a result of a number of factors, including, without limitation, seasonality, adverse changes in the competitive and economic conditions in domestic and international markets, actions of our major distributors, manufacturing and production delays or difficulties, adverse actions or delays in product reviews by the United States Food and Drug Administration ("FDA"), product liability, intellectual property, environmental and other litigation, and the lower acceptance of our new products than forecast. Forward-looking statements typically are identified by the use of terms such as "may," "will," "should," "might," "believe," "expect," "anticipate," "estimate" and similar words, although some forward-looking statements are expressed differently. The risks described in this report and in other reports and registration statements filed with the SEC from time to time should be carefully considered. The following should be read in conjunction with the unaudited condensed consolidated financial statements and notes thereto included elsewhere in this Form 10-Q. We undertake no obligation to publicly release the results of any revision of these forward looking statements.

Overview

        We commenced our operations in 1979 and launched our first products, dipstick-based pregnancy tests, in 1984. Our product base has expanded through internal development and acquisitions of other products and technologies. Our primary product areas are pregnancy and ovulation, infectious diseases, autoimmune diseases, osteoporosis and urinalysis. We discover, develop, manufacture and market rapid diagnostic products for point-of-care ("POC") detection. These products provide simple, accurate and cost-effective diagnoses for acute and chronic conditions. Products are sold worldwide to professionals in physician offices and clinical laboratories, and to consumers through organizations that provide private label, store brand products.

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Results of Operations

Net Sales

        Net sales increased 15% to $23.9 million for the three months ended March 31, 2003 from $20.8 million for the three months ended March 31, 2002. The increase for the three months ended March 31, 2003 as compared to the three months ended March 31, 2002 was primarily due to increased sales of our influenza products of approximately $5.5 million offset by a decrease in sales of our pregnancy products of approximately $1.9 million.

Research Contracts, License Fees and Royalty Income

        Research contracts, license fees and royalty income increased to $0.5 million for the three months ended March 31, 2003 from $0.4 million for the three months ended March 31, 2002. The revenue for both periods primarily relates to royalties received on our patented technologies utilized by third-parties. The agreement covering the royalty payments extends through November 2009, the expiration date of the patents.

Cost of Sales and Gross Profit From Net Sales

        Gross profit increased to $12.8 million for the three months ended March 31, 2003 from $10.7 million for the three months ended March 31, 2002. Gross profit as a percentage of net sales increased to 54% for the three months ended March 31, 2003 from 51% for the three months ended March 31, 2002. The increases were primarily due to increased sales volume, product mix and manufacturing efficiencies related to the outsourcing of our packaging operations, partially offset by an increase in our inventory reserves.

Research and Development Expense

        Research and development expense increased to $2.4 million for the three months ended March 31, 2003 from $1.6 million for the three months ended March 31, 2002. Research and development expense as a percentage of net sales increased to 10% for the three months ended March 31, 2003 from 8% for the three months ended March 31, 2002. The increases for the three months ended March 31, 2003 as compared to the three months ended March 31, 2002 were primarily due to increased costs associated with our LTF ("Layered Thin Film™") products, including additional employees, project supplies and patent fees. We anticipate that we will continue to devote a significant amount of financial resources to research and development for the foreseeable future.

Sales and Marketing Expense

        Sales and marketing expense increased to $4.5 million for the three months ended March 31, 2003 from $4.0 million for the three months ended March 31, 2002. Sales and marketing expense as a percentage of net sales was 19% for both the three months ended March 31, 2003 and 2002. The dollar increases for the three months ended March 31, 2003 as compared to the three months ended March 31, 2002 were primarily related to costs associated with the launch of our infectious vaginitis products, bone ultrasonometer and urinalysis instrument, including infrastructure, advertising and sales promotions.

General and Administrative Expense

        General and administrative expense increased to $2.8 million for the three months ended March 31, 2003 from $2.3 million for the three months ended March 31, 2002. General and administrative expense as a percentage of net sales increased to 12% for the three months ended March 31, 2002 from 11% for the three months ended March 31, 2002. The increases for the three months ended March 31, 2003 as compared to the three months ended March 31, 2002 were primarily

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due to increased professional fees related to the re-audit of fiscal 2001 financial statements and tax consulting fees.

Amortization of Intangibles

        Amortization of intangibles was $0.5 million for both the three months ended March 31, 2003 and 2002.

Interest Expense

        Interest expense was $0.2 million for both the three months ended March 31, 2003 and 2002.

Income Taxes

        Income tax provision was $1.1 million for both the three months ended March 31, 2003 and 2002.

Liquidity and Capital Resources

        Our principal sources of liquidity have historically been cash flow from operations and borrowings under our line of credit. Our principal requirements for cash currently are for the funding of operations and capital expenditures.

        At March 31, 2003, we had cash and cash equivalents of approximately $13.4 million compared to $2.9 million at December 31, 2002.

        The net increase in cash and cash equivalents for the three months ended March 31, 2003 was $10.5 million, the components of which are discussed below. The cash generated from operating activities of $11.0 million is largely comprised of our net earnings of $1.7 million, non cash expenses of $1.6 million related to depreciation and amortization and decreases in our deferred tax asset of $1.0 million, a decrease in accounts receivable and inventories of $4.0 million and $1.3 million, respectively, and increases in accounts payable and other accrued liabilities of $1.4 million. Another source of cash during the period was $0.2 million in proceeds from issuance of common stock under our stock option and employee stock purchase plans. Our primary uses of cash for the three months ended March 31, 2003 were acquisitions of manufacturing equipment and assets related to information technology of $0.6 million, as well as payments on obligations under capital leases totaling $0.1 million.

        We have a $10 million term loan facility which matures in July 2008 and which bears interest at a rate equal to the lender's base rate minus one quarter of one percent. We also have a $10 million line of credit facility which matures in July 2004 and, at our option, bears interest at a rate equal to the lender's base rate minus one quarter of one percent or at the London InterBank Offering Rate plus two and one quarter percent. The agreement governing our line of credit and term loan facilities contains certain customary covenants restricting our ability to, among other matters, incur additional indebtedness, create liens or other encumbrances, pay dividends or make other restricted payments, make investments, loans and guarantees or sell or otherwise dispose of a substantial portion of assets to, or merge or consolidate with, another entity. As of March 31, 2003, there were no borrowings outstanding under either the line of credit or the term loan. As of March 31, 2003, we had $10 million of availability both under the line of credit and term loan, and we were in compliance with all covenants.

        We plan approximately $3.4 million in capital expenditures for the remainder of 2003. The primary purpose for our capital expenditures is manufacturing equipment and information technology. We plan to fund these capital expenditures with cash flow from operations and borrowings under our existing credit facility. We have no material commitments with respect to such planned expenditures as of the date of this filing.

        We also intend to continue evaluation of acquisition and technology licensing candidates. As such, we may need to incur additional debt, or sell additional equity, to successfully complete these

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acquisitions. Cash requirements fluctuate as a result of numerous factors, such as the extent to which we generate cash from operations, progress in research and development projects, competition and technological developments and the time and expenditures required to obtain governmental approval of our products. Based on the current cash position and the current assessment of future operating results, we believe that our existing sources of liquidity will be adequate to meet operating needs during the next twelve months.

        At March 31, 2003 and December 31, 2002, we did not have any other relationships with unconsolidated entities or financial partners, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. As such, we are not materially exposed to any financing, liquidity, market or credit risk that could arise if we had engaged in such relationships.

Critical Accounting Policies and Estimates

        Our discussion and analysis of our financial condition and results of operations are based on our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the U.S. 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. On an on-going basis, we evaluate our estimates, including those related to customer programs and incentives, bad debts, inventories, intangible assets, income taxes, restructuring and contingencies and litigation. 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. Actual results may differ from these estimates under different assumptions or conditions.

        We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our consolidated financial statements:

        We record estimated reductions to revenue for customer programs and incentive offerings including special pricing agreements, price protection, promotions and other volume-based incentives. While we have maintained customer incentive programs during 2003, if market conditions were to decline, we may take actions to further increase customer incentive offerings possibly resulting in an incremental reduction of revenue at the time the incentive is offered. We record revenues from product sales, net of related rebates and discounts which are estimated at the time the sale is recognized. Revenue from product sales are recorded upon passage of title and risk of loss to the customer. Title to the product and recognition of revenue passes upon delivery to the customer when sales terms are Free On Board ("FOB") destination and at the time of shipment when the sales terms are FOB shipping point. We also earn income for performing services under joint development agreements and licensing of technology. Milestone payments are considered to be payments received for the accomplishment of a discrete, substantive earnings event. The non-refundable payment arising from the achievement of a defined milestone is recognized as revenue when the performance criteria for that milestone have been met since substantive effort is required to achieve the milestone, the amount of the milestone payments appears reasonable, commensurate with the effort expended and collection of the payment is reasonably assured. Income from the grant of license rights is recorded when the event triggering payment to us has occurred as specified by the terms of the related license agreements and collectibility is reasonably assured. We maintain allowances for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. If the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required.

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        We write down our inventory for estimated obsolescence or unmarketable inventory equal to the difference between the cost of inventory and the estimated market value based on assumptions about future demand and market conditions. If actual market conditions are less favorable than those projected by management, additional inventory write-downs may be required.

        Intangible assets with definite lives are amortized over their estimated useful lives. Useful lives are based on the expected number of years the asset will generate revenue or otherwise be used by us. On January 1, 2002, we adopted SFAS No. 142 "Goodwill and Other Intangible Assets" ("SFAS No. 142"), which requires that goodwill and other intangible assets that have indefinite lives not be amortized but instead be tested at least annually for impairment, or more frequently when events or changes in circumstances indicate that the asset might be impaired. Examples of such events or circumstances include:

•

the asset's ability to continue to generate income from operations and positive cash flow in future periods;



•

any volatility or significant decline in our stock price and market capitalization compared to our net book value;



•

loss of legal ownership or title to the asset;



•

significant changes in our strategic business objectives and utilization of the asset; and



•

the impact of significant negative industry or economic trends.

        If a change were to occur in any of the above mentioned factors or estimates, the likelihood of a material change in our reported results would increase.

        For indefinite-lived intangible assets, impairment is tested by comparing the carrying value of the asset to the fair value of the reporting unit to which they are assigned. For goodwill, a two-step test is used to identify the potential impairment and to measure the amount of impairment, if any. The first step is to compare the fair value of a reporting unit with its carrying amount, including goodwill. If the fair value of a reporting unit exceeds its carrying amount, goodwill is considered not impaired; otherwise goodwill is impaired and the loss is measured by performing step two. Under step two, the impairment loss is measured by comparing the implied fair value of the reporting unit with the carrying amount of goodwill.

        We record a valuation allowance to reduce our deferred tax assets to an amount that we believe is more likely than not to be realized. While we have considered future taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for the valuation allowance, in the event we were to determine that we would be able to realize our deferred tax assets in the future in excess of our net recorded amount, an adjustment to the deferred tax asset would increase earnings in the period such determination was made. Likewise, should we determine that we would not be able to realize all or part of our net deferred tax asset in the future, an adjustment to the deferred tax asset would be charged to earnings in the period such determination were made.

ITEM 3. Quantitative and Qualitative Disclosures About Market Risk

        We are exposed to the risk of future currency exchange rate fluctuations, which are accounted for as an adjustment to stockholders' equity. Exchange gains and losses arising from transactions denominated in foreign currencies are recorded in operations and have historically not been material. Nonetheless, changes from reporting period to reporting period in the exchange rates between various foreign currencies and the U.S. dollar have had and will continue to have an impact on the accumulated other comprehensive loss component of stockholders' equity we report, and such effect may be material in any individual reporting period.

        The fair market value of floating interest rate debt is subject to interest rate risk. Generally, the fair market value of floating interest rate debt will vary as interest rates increase or decrease. A hypothetical 100 basis point adverse move in interest rates along the entire interest rate yield curve would not materially affect the fair value of our interest-sensitive financial instruments at March 31, 2003. Based on our market risk sensitive instruments outstanding at March 31, 2003 and December 31, 2002, we have determined that there was no material market risk exposure to our consolidated financial position, results of operations or cash flows as of such dates.

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Risk Factors

Our operating results may fluctuate as a result of factors that are outside our control, and this could have a negative effect on the price of our common stock.

        Fluctuations in our operating results, for any reason, that decrease sales or profitability could cause our growth or operating results to fall below the expectations of investors and securities analysts, and this could cause our stock price to decline. The market price of our common stock has fluctuated substantially in the past. Between March 31, 2002 and March 31, 2003, the price of our common stock, as reported on the Nasdaq National Market, has ranged from a low of $2.06 to a high of $6.89. We expect the market price of our common stock to continue to experience significant fluctuations in the future in response to a variety of factors, including fluctuation in our operating results.

        For the three months ended March 31, 2003, total revenues increased 15% to $24.4 million from $21.2 million for the three months ended March 31, 2002. We had net earnings of $1.7 million for the three months ended March 31, 2003 compared to net earnings of $1.5 million for the three months ended March 31, 2002. The increase in earnings for the three months ended March 31, 2003 is primarily due to an increase in sales of our influenza products offset by decreases in our pregnancy products. Our earning were also favorably impacted by an approximate 3% increase in gross profit percentage for the three months ended March 31, 2003 primarily due to increased sales volume and product mix. This favorable impact was offset by increased operating expenses primarily related to costs associated with our LTF products, product launches and certain one time professional fees relating to the re-audit of our fiscal 2001 financial statements. We may not continue our revenue growth or continue to achieve profitability. Operating results may continue to fluctuate, in a given quarter or annual period, or from prior periods as a result of a number of factors, many of which are outside of our control.

        Other factors that are beyond our control and that could affect our operating results in the future include:

•

seasonal fluctuations in our sales of Group A Strep and influenza tests, which are generally highest in fall and winter, thus resulting in generally lower operating results in the second and third calendar quarters and higher operating results in the first and fourth calendar quarters;



•

changes in the level of competition, such as would occur if one of our larger and better financed competitors introduced a new product to compete with one of our products;



•

changes in economic conditions in our domestic and international markets, such as economic downturns, reduced consumer demand, inflation and currency fluctuations, particularly as we expand into markets outside Western Europe where economic conditions may differ from those prevailing at given times among developed nations; and



•

changes in sales levels, since a significant portion of our costs are fixed costs with the result that relatively higher sales could likely increase profitability but relatively lower sales would reduce revenue but would not reduce costs by the same proportion, and hence could cause operating losses.

Our operating results may also fluctuate as a result of factors that we do control, such as efforts in introducing new products or developing new markets. We may have to expend considerable resources in order to pursue these steps, and this could have a negative effect on our profits.

        We must change the mix of products we sell from time to time. For example, while we do not believe that we currently have major products that are nearing the end of their life cycle, we may in the future be required to replace aging products. We also attempt to focus development efforts on products with relatively higher margins. The development, manufacture and sale of our diagnostic products require a significant investment of resources. We may incur increased operating expenses as a result of

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our increased investment in sales and marketing activities, manufacturing scale-up and new product development associated with our efforts to:

•

expand our business line;



•

expand the LTF technology platform menu of analytes;



•

develop products with higher margins internally, or in collaborations with the external pharmaceutical community; and



•

expand our business geographically.

        The funds for these projects have in the past come primarily from our business operations and a working capital line of credit. If our business slows and we become less profitable, and as a result have less money available to fund research and development, we will have to decide at that time which programs to cut, and by how much. This decision will be based on a number of factors, including the amount of the funding shortfall, how promising a particular project appears to be, and how close the project is to being commercially available. Our operations will be adversely affected if our net sales and gross profits do not correspondingly increase, or if our product development efforts are unsuccessful or delayed. Development of new markets also requires a substantial investment of resources, such as new employees, offices and manufacturing facilities, and, if adequate financial, personnel, equipment or real estate resources are not available, we may be required to delay or scale back market developments.

Unexpected significant increases in demand for our products could require us to spend considerable resources to meet the demand, or harm our customer relationships if we are unable to meet demand.

        If we experience unexpected significant increases in the demand for our products, we may be required to expend additional capital resources to meet these demands. These capital resources could involve the cost of new machinery, or even the cost of new manufacturing facilities. This would increase our capital costs, which could affect our earnings. If we are unable to develop necessary manufacturing capabilities in a timely manner, our net sales could be adversely affected. Failure to cost-effectively increase production volumes, if required, or lower than anticipated yields or production problems encountered as a result of changes that we may make in our manufacturing processes to meet increased demand, could result in shipment delays as well as increased manufacturing costs, which could also have a material adverse effect on our net sales.

        Unexpected increases in demand for our products could also require us to obtain additional raw materials in order to manufacture products to meet the demand. The majority of raw materials and purchased components used to manufacture our products are readily available. However, some raw materials require significant ordering lead time and/or are currently obtained from a sole supplier or a limited group of suppliers. We have long-term supply agreements with these vendors. The reliance on sole or limited suppliers and the failure to maintain long-term agreements with other suppliers involve several risks, including the inability to obtain an adequate supply of raw materials and components and reduced control over pricing, quality and timely delivery. Although we attempt to minimize our supply risks by maintaining an inventory of raw materials and periodically evaluating other sources, any interruption in supply could have a material adverse effect on our net sales or cost of sales.

The loss of key distributors or an unsuccessful effort to directly distribute our products could lead to reduced sales.

        Although we have distribution agreements with approximately 80 distributors, the market is dominated by a small group of these distributors. Five of our distributors, which are considered to be among the market leaders, accounted for approximately 62% and 59% of our net sales for the three months ended March 31, 2003 and 2002, respectively. While we believe our relationship with our distributors is good, the loss of a major distributor may have an adverse effect on our net sales. The loss or termination of our relationship with any of these key distributors could significantly disrupt our

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business unless suitable alternatives can be timely found. Finding a suitable alternative may pose challenges in our industry's competitive environment, and another suitable distributor may not be found on satisfactory terms. For instance, many distributors already have exclusive arrangements with our competitors, and others do not have the same level of penetration into our target markets as our existing distributors. We could expand our efforts to distribute and market our products directly; however, this would require an investment in additional sales and marketing resources, including hiring additional field sales personnel, which would significantly increase our future selling, general and administrative expenses. In addition, our direct sales, marketing and distribution efforts may not be successful.

We may not achieve market acceptance of our products among physicians and other healthcare providers, and this would have a negative effect on future sales growth.

        A large part of our business is based on the sale of rapid POC diagnostic tests that physicians and other healthcare providers can administer in their own facilities without sending samples to laboratories. Thus, clinical reference laboratories and hospital-based laboratories are significant competitors for our products, and provide many of the diagnostic tests used by physicians and other healthcare providers. Our estimated market share in fiscal 2002 for some of our key products was 55% in pregnancy, 49% in Group A Strep and 41% for influenza tests. Our future sales depend on, among other matters, capture of sales from these laboratories by achieving market acceptance from physicians and other healthcare providers. If we do not capture sales at the levels we have budgeted for, our net sales may not grow as much as we hope and the costs we have incurred will be disproportionate to our sales levels. We expect that these laboratories will compete vigorously to maintain their dominance of the testing market. Moreover, even if we can demonstrate that our products are more cost-effective or save time, physicians and other healthcare providers may resist changing their established source for these tests.

Intense competition with other manufacturers of POC diagnostic products may reduce our sales.

        In addition to competition from laboratories, our POC diagnostic tests compete with similar products made by our competitors. We have a large number of multinational and regional competitors making investments in competing technologies, including several large pharmaceutical and diversified healthcare companies. These competitors include Abbott Laboratories, Beckman Coulter Primary Care Diagnostics, Becton Dickinson and Company and Genzyme Diagnostics Corporation. In November 1999, Abbott Laboratories ceased manufacturing certain diagnostic products in its primary manufacturing facility in conjunction with a consent decree from the FDA. Currently, we are not aware of a date at which Abbott Laboratories may re-enter the market. A number of our competitors have a potential competitive advantage because they have substantially greater financial, technical, research and other resources, and larger, more established marketing, sales, distribution and service organizations than we have. Moreover, some competitors offer broader product lines and have greater name recognition than we have. If our competitors' products are more effective than ours, or take market share from our products through more effective marketing or competitive pricing, our net sales could be adversely affected. Competition also has the effect of limiting the prices we can charge for our products.

To remain competitive, we must continue to develop or obtain proprietary technology rights; otherwise, other companies may increase their market share by selling products that compete with our products.

        Our competitive position is heavily dependent on obtaining and protecting our proprietary technology or obtaining licenses from others. Our ability to compete successfully in the diagnostic market depends on continued development and introduction of new proprietary technology and the improvement of existing technology. If we cannot continue to obtain and protect proprietary

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technology, our net sales and gross profits could be adversely affected. Moreover, our current and future licenses may not be adequate for the operation of our business.

        We have a license agreement with Becton Dickinson and Company related to our pregnancy and Group A Strep products, which products account for 36% and 51% of our net sales for the three months ended March 31, 2003 and 2002, respectively. The license agreement expires in 2004 when the underlying patent expires. Our ability to obtain patents and licenses, and their benefits, are uncertain. We have 196 issued patents and approximately 70 applications are pending. Our patents have expiration dates from 2003 to 2020. There are no patents that are expiring in the near term which we consider material to our business. However, our pending patent applications may not result in the issuance of any patents, or if issued, the patents may not have priority over others' applications or may not offer protection against competitors with s