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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

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 ý    No o

        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, 2004, 31,600,717 shares of common stock were outstanding.

QUIDEL CORPORATION
FORM 10-Q
FOR THE QUARTER ENDED
March 31, 2004

INDEX

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PART I FINANCIAL INFORMATION

ITEM 1. Financial Statements

QUIDEL CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands)

See accompanying notes.

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QUIDEL CORPORATION

CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share data, unaudited)

See accompanying notes.

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QUIDEL CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands, unaudited)

See accompanying notes.

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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 generally accepted accounting principles 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 at March 31, 2004, and for the three month periods ended March 31, 2004 and 2003, is unaudited. Operating results for the three months ended March 31, 2004 are not necessarily indicative of the results that may be expected for the year ending December 31, 2004. For further information, refer to the consolidated financial statements and footnotes thereto for the year ended December 31, 2003 included in the Company's 2003 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, the calendar quarter end date is used herein.

Note 2. Comprehensive Earnings

        The components of comprehensive earnings 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 and director stock options. In accordance with APB No. 25, because the exercise price of the Company's employee and director stock options equals or exceeds the estimated market price of the underlying stock on the date of grant, no compensation expense has been recognized.

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        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, 2004 and 2003.

        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 and director stock option plans have characteristics significantly different from those of traded options, the resulting pro forma compensation cost may not be representative of the compensation cost expected in future years. 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, 2004 and 2003, consistent with the provisions of SFAS No. 123, the Company's net earnings (loss) and earnings (loss) per share would have been as indicated below (in thousands, except per share data, unaudited):

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.

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

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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. Deferred Revenue

        The Company continues to discuss future collaborative arrangements with several companies. In connection with these efforts, the Company has received from one company, approximately $1.5 million in cash, which has been recorded as deferred revenue and included in other accrued liabilities in the accompanying balance sheet, pending finalization of any agreements.

Note 7. Income Taxes

        A valuation allowance of $13.3 million had been established against a portion of the Company's deferred tax assets at December 31, 2002. As of December 31, 2003, the Company believed it was more likely than not that it would be able to realize the majority of its deferred tax asset through expected future taxable profits, and released approximately $13.3 million of a valuation allowance. As of March 31, 2004, the Company has recorded a valuation allowance of $1.9 million related to deferred tax assets created by the exercise and/or disposition of employee stock options in recent periods. Any tax benefits realized from the reduction of this valuation allowance will be recorded to additional-paid-in-capital. Should the Company determine that it would not be able to realize all or part of its other components of the 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.

        The Company also reserves for taxes that may become payable as a result of audits in future periods with respect to previously filed tax returns. The Company establishes the reserves based upon its assessment of exposure associated with permanent tax differences, tax credits and interest expense applied to temporary difference adjustments. The tax reserves are analyzed periodically and adjustments are made as events occur to warrant adjustment to the reserve. As of March 31, 2004, we had $12.0 million in net deferred tax assets.

Note 8. Stockholders' Equity

        During the three months ended March 31, 2004, 1,091,065 shares of common stock were issued due to the exercise of common stock options and 18,316 shares of common stock were issued in connection with the Company's employee stock purchase plan, resulting in proceeds to the Company of approximately $5.2 million.

Note 9. Industry and Geographic Information

        The Company operates in one reportable segment. Sales to customers outside the U.S. represented 30% and 44% for the three months ended March 31, 2004 and 2003, respectively. As of March 31, 2004 and December 31, 2003, balances due from foreign customers were $4.0 million and $11.5 million, respectively.

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

        As of March 31, 2004, accounts receivable from three customers with a balance due in excess of 10% of total accounts receivable totaled $5.6 million while at December 31, 2003, accounts receivable from customers with balances due in excess of 10% of total accounts receivable totaled $16.2 million.

        The following presents net sales for the three months ended March 31, 2004 and 2003 and long-lived assets as of March 31, 2004 and December 31, 2003 by geographic territory (in thousands):

Note 10. Restructuring

        In April 2003, the Company announced and implemented a restructuring plan (the "Restructuring Plan"). The Restructuring Plan was primarily driven by manufacturing automation in the Company's San Diego facility, completion of certain research and development projects, implementation of the Company's BaaN enterprise resource planning system in its Santa Clara facility, and the transition of the Company's foreign sales and support offices to independent distributors. The Restructuring Plan included a workforce reduction of 63 positions (18% of the Company's total workforce at such time) and closure of the Company's sales and support offices in Heidelberg, Germany and Milan, Italy. The Company recorded a restructuring charge of approximately $2.2 million during 2003. The significant components of the restructuring charge in 2003 were $1.3 million for employee severance costs, $0.5 million for contractual lease and commercial contract terminations, $0.3 million for professional fees and $0.1 million for impairment charges related to assets that were deemed obsolete due to restructuring activities. As March 31, 2004, $2.1 million of the restructuring charge has been paid and $0.1 million is included in other accrued liabilities in the accompanying condensed consolidated balance sheet.

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        The following table provides information regarding our liabilities relating to our restructuring activity (in thousands, unaudited):

Note 11. Patent Litigation

        On February 20, 2004, the Company filed a lawsuit (the "Action") in the U.S. District Court, Southern District of California (the "Court") against Inverness Medical Innovations Inc., Inverness Medical Switzerland GmbH, and Applied Biotech, Inc. (collectively "Inverness") as well as against Armkel LLC, for infringement of our U.S. Patent No. 4,943,522 (the "522 Patent"), which relates to lateral-flow technology, and for declaratory relief. The Company is seeking damages and injunctive relief against Inverness products that infringe its patented technology. The Company's claim for declaratory relief relates to nine Inverness-owned and Inverness-licensed patents (U.S. Patent Nos. 6,485,982: 5,989,921; 5,714,389; 6,352,862; 6,228,660; 6,187,598; 5,656,503; 5,622,871; and 5,602,040), and requests the Court to conclude that its lateral-flow products do not infringe these patents, and that the patents are invalid and unenforceable.

        On March 9, 2004, Inverness and a related party filed, in the U.S. District Court, Southern District of California, denials of the Company's allegations of infringement in the Action, allegations that its 522 Patent is invalid and unenforceable, as well as counterclaims for patent infringement against the Company. On March 12, 2004, Armkel LLC filed, in the U.S. District Court, Southern District of California, an answer to the Company's request for declaratory relief and counterclaims for patent infringement against the Company. The counterclaims by Inverness and the related parties and by Armkel LLC allege that the Company's immunoassay test products, including its tests for influenza, pregnancy, strep, and H pylori, infringe eight of the nine Inverness patents that the Company identified in the Action. In addition, Inverness Medical Switzerland GmbH, Wampole Laboratories, LLC, and Applied BioTech, Inc. filed a separate complaint against the Company alleging that its immunoassay test devices also infringe a ninth patent owned by Inverness, U.S. Patent No. 6,534,320. The relief requested in these claims and counterclaims against the Company includes damages and preliminary and permanent injunctive relief to the effect that if this relief is granted, the Company would be required to cease and desist from manufacturing, selling, marketing, using, and inducing others to use products that represent a substantial majority of its revenues.

        On February 17, 2004, the Company's German affiliate Quidel Deutschland GmbH was provided with a copy of a lawsuit that Inverness Medical Switzerland GmbH, another Inverness subsidiary, and Preymed had apparently filed on or about February 4, 2004 in District Court in Düsseldorf, Germany, which names the Company, Quidel Deutschland GmbH, and its distributor, Progen Biotechnik GmbH, as defendants. The lawsuit alleges that the Company and the other defendants are infringing two Inverness-owned European patents, EP 0 291 194 and EP 0 560 411, and is directed at the Company's lateral flow test devices, including its tests for pregnancy, strep, H pylori, and Chlamydia. The suit seeks injunctive relief, an accounting, damages and annulment. If the Court grants injunctive relief, the Company will be required to cease and desist from manufacturing, selling, marketing, using, and importing its lateral flow products in Germany.

        The Company is also aware of Inverness's active participation in suing other third parties for patent infringement on the basis that it allegedly owns, or has an exclusive license to, patent rights covering aspects of current lateral flow technology. The Company believes that it has various defenses to claims that have been made or might be made, but no assurances can be given that the Company will prevail. Because of the Company's current use of lateral flow technology and the fact that a substantial portion of its revenues are from products impacted by these disputes, the Company's business would be materially and adversely affected if it is unable to successfully prosecute and/or defend against any such patent infringement allegations or to obtain a commercially reasonable license from Inverness.

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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, intellectual property, product liability, environmental and other litigation, required patent license fee payments not currently reflected in our costs, seasonality, the severity of cold and flu seasons, 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 (the "FDA"), 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 Securities and Exchange Commission (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 are a worldwide leader in developing, manufacturing and marketing point-of-care ("POC") rapid diagnostic tests for the detection and management of a variety of medical conditions and illnesses. Our current product areas include pregnancy, infectious diseases, autoimmune diseases, osteoporosis and urinalysis. In the U.S., we lead the market in several POC product categories for sales through medical product distributors. This leadership position includes an estimated 50%, 49% and 43% market share in pregnancy, influenza and Group A Strep products, respectively, as of December 31, 2003. Our products provide healthcare professionals with accurate and cost-effective diagnostic information at the POC. We sell our products to professionals for use in physician offices, hospitals, clinical laboratories and wellness screening centers. We focus our products substantially on women's and family health in areas such as reproduction, infectious diseases, general health screening and diseases associated with the elderly.

        We commenced our operations in 1979 and launched our first products, dipstick-based pregnancy tests, in 1984. Our product base and technology platforms have expanded through internal development and acquisitions of other products and technologies. The current product areas are pregnancy, infectious diseases, autoimmune diseases, osteoporosis and urinalysis, for professional and research use.

        We market our products in the U.S. through a network of national and regional distributors, supported by a direct sales force. In the rest of the world, we sell and market through distributors in Asia-Pacific, Europe, the Middle East, Africa and Latin America and in other international locations by channeling products through distributor organizations and sales agents.

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Results of Operations

Three months ended March 31, 2004 compared to three months ended March 31, 2003

Net Sales

        Net sales decreased 20% to $19.1 million for the three months ended March 31, 2004 from $23.9 million for the three months ended March 31, 2003. The decrease for the three months ended March 31, 2004 as compared to the three months ended March 31, 2003 was primarily due to a decline of approximately 73% in influenza test sales in Japan, and a decrease of approximately 37% in domestic Group A Strep test sales, partially offset by increases in sales of approximately 37% for our influenza test in the U.S. and an aggregate 12% increase in sales of our other rapid immunoassay point-of-care products in the U.S..

Research Contracts, License Fees and Royalty Income

        Research contracts, license fees and royalty income increased to $0.6 million for the three months ended March 31, 2004 from $0.5 million for the three months ended March 31, 2003. The revenue for all periods principally relates to royalties received on our patented technologies utilized by third-parties. The agreements 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 decreased to $9.7 million for the three months ended March 31, 2004 from $12.8 million for the three months ended March 31, 2003. Gross profit as a percentage of net sales decreased to 51% for the three months ended March 31, 2004 from 54% for the three months ended March 31, 2003. The decreases were primarily due to lower sales of our Strep A and influenza tests and a less favorable product mix, primarily resulting from declines in our higher-margin influenza products, partially offset by cost savings relating to our restructuring activities during 2003.

Research and Development Expense

        Research and development expense increased to $2.5 million for the three months ended March 31, 2004 from $2.4 million for the three months ended March 31, 2003. Research and development expense as a percentage of net sales increased to 13% for the three months ended March 31, 2004 from 10% for the three months ended March 31, 2003. The increases for the three months ended March 31, 2004 as compared to the three months ended March 31, 2003 were primarily due to additional employees and project supplies related to our continued focus on our LTF™ ("Layered Thin Film") technology, offset by cost savings relating to our restructuring activities during 2003.

        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 decreased to $3.8 million for the three months ended March 31, 2004 from $4.5 million for the three months ended March 31, 2003. Sales and marketing expense as a percentage of net sales increased to 20% for the three months ended March 31, 2004 from 19% for the three months ended March 31, 2003. The absolute dollar decrease for the three months ended March 31, 2004 as compared to the three months ended March 31, 2003 was primarily due to cost savings relating to our restructuring activities during 2003, including the closure of our sales and marketing offices in Germany and Italy.

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General and Administrative Expense

        General and administrative expense was $2.8 million for both the three months ended March 31, 2004 and 2003. General and administrative expense as a percentage of net sales increased to 15% for the three months ended March 31, 2004 from 12% for the three months ended March 31, 2003. The three months ended March 31, 2004 included increased legal fees associated with our intellectual property litigation, partially offset by higher professional fees during 2003 related to the re-audit of our fiscal 2001 financial statements and certain tax consulting projects and cost savings relating to our restructuring activities during 2003.

Amortization of Intangibles

        On January 1, 2002, we adopted SFAS No. 141, "Business Combinations," ("SFAS No. 141") and SFAS No. 142, which eliminated the amortization of goodwill. SFAS No. 142 also requires periodic evaluations for impairment of goodwill balances. We completed our annual evaluation for impairment of goodwill in December 2003, and determined that there was no impairment as of December 31, 2003. A significant decline in our projected revenue or earnings growth or cash flows, a significant decline in our stock price or the stock price of comparable companies, loss of legal ownership or title to an asset, and any significant change in our strategic business objectives and utilization of our assets are among many factors that could result in an impairment charge that could have a material negative impact on our operating results. Our revenues and related earnings were adversely impacted for the three months ended March 31, 2004 as compared to the three months ended March 31, 2003, primarily due to a decline of approximately 73% in influenza test sales in Japan, and a decrease of approximately 37% in domestic Strep A test sales, partially offset by increases in sales of approximately 37% for our influenza test in the U.S. and an aggregate 12% increase in sales for our other rapid immunoassay point-of-care products in the U.S.. We believe the revenue decline was seasonal in nature and do not believe there was any impairment as of March 31, 2004. Our other intangible assets, which are being amortized over a period of three to 12 years, include purchased technology, license agreements, patents, trademarks and a favorable lease.

        Amortization of intangibles was $0.5 million for both the three months ended March 31, 2004 and 2003.

Other Expense

        Other expense remained constant at $0.2 million for both the three months ended March 31, 2004 and 2003. The balance primarily relates to interest expense paid on obligations under capital leases, which are primarily related to our San Diego facility, partially offset by interest income associated with an increased cash balance.

Income Taxes

        Income tax provision was $0.2 million for the three months ended March 31, 2004 as compared to $1.1 million for the three months ended March 31, 2003.

Liquidity and Capital Resources

        Our principal source of liquidity has historically been cash flow from operations. Our principal requirements for cash currently are for the funding of operations and capital expenditures.

        At March 31, 2004, we had cash and cash equivalents of approximately $38.9 million compared to $25.6 million at December 31, 2003.

        The net increase in cash and cash equivalents for the three months ended March 31, 2004 was $13.3 million, the significant components of which are discussed below. The cash generated from operating activities of $9.1 million is largely comprised of our net earnings of $0.3 million, non-cash

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expenses of $1.6 million related to depreciation and amortization and a decrease in accounts receivables of $13.8 million, partially offset by increases in inventories of $1.9 million and decreases in accounts payable, accrued royalties and other accrued liabilities of $1.0 million, $1.9 million and $2.1 million, respectively. Another source of cash during the period was $5.2 million in proceeds from issuance of common stock in connection with our employee stock purchase plan and the exercise of outstanding options under our stock option plan. Our primary uses of cash for the three months ended March 31, 2004 were acquisitions of manufacturing equipment and assets related to information technology of $0.9 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 agreements governing our line of credit and term loan facilities contain 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, 2004, there were no borrowings outstanding under either the line of credit or the term loan. As of March 31, 2004, we had $10 million of availability both under the line of credit and term loan, and we were in compliance with all covenants.

        We currently have planned approximately $4.5 million in capital expenditures for the remainder of 2004. The primary purpose for our capital expenditures is to acquire manufacturing equipment and information technology. We plan to fund these capital expenditures with cash flow from operations. We have approximately $3.4 million of firm purchase commitments with respect to such planned expenditures as of the date of this filing. These commitments largely relate to manufacturing equipment for our LTF™ product line.

        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 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 12 months.

Off-Balance Sheet Arrangements

        At March 31, 2004 and December 31, 2003, 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

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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 revenues from product sales. These revenues are recorded net of rebates and other discounts which are estimated at the time of sale, and are largely driven by various customer program offerings, including special pricing agreements, promotions and other volume-based incentives. 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 FOB destination and at the time of shipment when the sales terms are FOB shipping point. We also earn income from the licensing of technology and may earn income for performing services under joint development agreements. Royalty income from the grant of license rights is recorded during the period the cash is received from the licensee. Milestone payments, which may arise under joint development agreements, would be recognized when earned, as evidenced by written acknowledgment from the collaborator or other persuasive evidence that the milestone has been achieved, provided that (i) the milestone event is substantive and its achievability was not reasonably assured at the inception of the agreement, and (ii) our performance obligations after the milestone achievement will continue to be funded by the collaborator at a level comparable to before the milestone achievement. If both of these criteria are not met, the milestone payment is recognized over the remaining minimum period of our performance obligations under the agreement. Income earned from licensing and distribution activities are classified under revenues in the accompanying consolidated statements of operations. We are not currently performing services under any joint development agreements.

        We maintain an allowance for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. Our allowance for doubtful accounts is based on our assessment of the collectibility of specific customer accounts, the aging of accounts receivable, our history of bad debts, and the general condition of the industry. If a major customer's credit worthiness deteriorates, or our customers' actual defaults exceed our historical experience, our estimates could change and adversely impact our reported results.

        Our policy is to value inventories at the lower of cost or market on a part-by-part basis. This policy requires us to make estimates regarding the market value of our inventories, including an assessment of excess or obsolete inventories. We determine excess and obsolete inventories based on an estimate of the future demand for our products within a specified time horizon, generally 12 months. The estimates we use for demand are also used for near-term capacity planning and inventory purchasing and are consistent with our revenue forecasts. If our demand forecast is greater than our actual demand, we may be required to take additional excess inventory charges, which would decrease gross margin and adversely impact net operating results in the future.

        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, 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;

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•

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 an asset;



•

significant changes in our strategic business objectives and utilization of our assets; 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 completed our annual evaluation for impairment of goodwill in December 2003, and determined there were no impairment indicators for the three months ended March 31, 2004.

        A valuation allowance of $13.3 million had been established against a portion of our deferred tax assets at December 31, 2002. As of December 31, 2003, we believed it was more likely than not that we would be able to realize the majority of our deferred tax asset through expected future taxable profits, and released approximately $13.3 million of a valuation allowance. As of March 31, 2004, we have recorded a valuation allowance of $1.9 million related to deferred tax assets created by the exercise and/or disposition of employee stock options in recent periods. Any tax benefits realized from the reduction of this valuation allowance will be recorded to additional paid-in capital. Should we determine that we would not be able to realize all or part of our other components of the 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. As of March 31, 2004, we had $12.0 million in net deferred tax assets.

        We also reserve for taxes that may become payable as a result of audits in future periods with respect to previously filed tax returns. We establish the reserves based on our assessment of exposure associated with permanent tax differences, tax credits and interest expense applied to temporary difference adjustments. The tax reserves are analyzed periodically and adjustments are made as events occur to warrant adjustment to the reserve.

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RISK FACTORS