10-Q 1 g84509e10vq.txt LUMINEX CORPORATION UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 --------------------- FORM 10-Q /X/ Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the quarterly period ended June 30, 2003 OR / / Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the transition period from ________________ to _______________. Commission File No. 000-30109 --------------------- LUMINEX CORPORATION (Exact name of Registrant as specified in its charter) DELAWARE 74-2747608 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 12212 TECHNOLOGY BLVD., AUSTIN, TEXAS 78727 (Address of principal executive offices) (Zip Code) (512) 219-8020 (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 /X/ No / / There were 29,676,818 shares of the Company's Common Stock, par value $.001 per share, outstanding on August 8, 2003. INDEX
PAGE ---- PART I. FINANCIAL INFORMATION Item 1. Financial Statements (unaudited) Condensed Consolidated Balance Sheets as of June 30, 2003 and December 31, 2002.................... 1 Condensed Consolidated Statements of Operations for the three and six months ended June 30, 2003 and 2002.......................................................................... 2 Condensed Consolidated Statements of Cash Flows for the three and six months ended June 30, 2003 and 2002.......................................................................... 3 Notes to Condensed Consolidated Financial Statements............................................... 4 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations............. 8 Factors That May Affect Future Results............................................................. 14 Item 3. Quantitative and Qualitative Disclosures about Market Risk........................................ 21 Item 4. Controls and Procedures........................................................................... 22 PART II. OTHER INFORMATION Item 1. Legal Proceedings................................................................................. 23 Item 2. Change in Securities and Use of Proceeds.......................................................... 23 Item 4. Submission of Matters to a Vote of Security Holders............................................... 23 Item 6. Exhibits and Reports on Form 8-K.................................................................. 23 SIGNATURES and EXHIBITS........................................................................................ S-1
ii PART I ITEM 1. FINANCIAL STATEMENTS LUMINEX CORPORATION CONDENSED CONSOLIDATED BALANCE SHEETS (IN THOUSANDS)
JUNE 30, DECEMBER 31, 2003 2002 ---------- ------------ (unaudited) ASSETS Current assets: Cash and cash equivalents................................................ $ 38,696 $ 40,482 Accounts receivable, net................................................. 3,092 2,460 Inventory, net........................................................... 4,648 6,764 Other.................................................................... 1,258 773 ---------- ----------- Total current assets.................................................. 47,694 50,479 Property and equipment, net................................................. 1,951 2,397 Other....................................................................... 933 747 ---------- ----------- Total assets.......................................................... $ 50,578 $ 53,623 ========== =========== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable......................................................... $ 1,929 $ 1,080 Accrued liabilities...................................................... 1,638 3,107 Deferred revenue......................................................... 793 971 ---------- ----------- Total current liabilities............................................. 4,360 5,158 Deferred revenue............................................................ 2,852 2,894 ---------- ----------- Total liabilities..................................................... 7,212 8,052 ---------- ----------- Stockholders' equity: Common stock............................................................. 30 29 Additional paid-in capital............................................... 122,385 121,702 Accumulated other comprehensive loss..................................... (163) (79) Accumulated deficit...................................................... (78,886) (76,081) ---------- ----------- Total stockholders' equity............................................ 43,366 45,571 ---------- ----------- Total liabilities and stockholders' equity............................ $ 50,578 $ 53,623 ========== ===========
LUMINEX CORPORATION CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, ---------------------- ------------------------ 2003 2002 2003 2002 --------- -------- --------- --------- (unaudited) (unaudited) Revenue............................................................ $ 5,642 $ 3,177 $ 10,744 $ 5,464 Cost of revenue.................................................... 3,705 2,648 7,327 4,643 --------- -------- --------- --------- Gross profit.................................................. 1,937 529 3,417 821 Operating expenses: Research and development...................................... 881 2,144 1,712 4,138 Selling, general and administrative........................... 3,051 4,809 6,556 9,951 --------- -------- --------- --------- Total operating expenses................................... 3,932 6,953 8,268 14,089 --------- -------- --------- --------- Loss from operations............................................... (1,995) (6,424) (4,851) (13,268) Other income, net............................................. 96 182 206 402 Settlement of litigation...................................... - - 1,840 - --------- -------- --------- --------- Net loss........................................................... $ (1,899) $ (6,242) $ (2,805) $ (12,866) ========= ======== ========= ========= Net loss per share, basic and diluted.............................. $ (0.06) $ (0.21) $ (0.09) $ (0.44) ========= ======== ========= ========= Shares used in computing net loss per share, basic and diluted..................................... 29,642 29,293 29,590 29,123
2 LUMINEX CORPORATION CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS)
THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, -------------------------------------------------- 2003 2002 2003 2002 ----------- -------- -------- -------- (unaudited) (unaudited) Operating activities: Net loss.................................................................. $ (1,899) $ (6,242) $ (2,805) $(12,866) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation and amortization............................................ 278 434 593 833 Stock based compensation and other....................................... 70 196 162 495 Changes in operating assets and liabilities: Accounts receivable, net................................................. 369 1,490 (632) 4,402 Inventory, net........................................................... 195 870 2,116 (157) Other assets............................................................. (800) (645) (502) (487) Accounts payable......................................................... 1,017 (273) 849 (1,616) Accrued liabilities...................................................... 323 821 (1,469) 303 Deferred revenue......................................................... (197) (21) (220) 299 ----------- -------- -------- -------- Net cash used in operating activities....................................... (644) (3,370) (1,908) (8,794) ----------- -------- -------- -------- Investing activities: Purchase of property and equipment........................................ (113) (306) (141) (1,037) Net maturities of short-term investments.................................. - - - 16,122 Other investing activities................................................ (50) (75) (181) (75) ----------- -------- -------- -------- Net cash (used in) provided by investing activities......................... (163) (381) (322) 15,010 ----------- -------- -------- -------- Financing activities: Proceeds from issuance of common stock.................................... 80 228 526 678 ----------- -------- -------- -------- Net cash provided by financing activities................................... 80 228 526 678 ----------- -------- -------- -------- Effect of foreign currency exchange rate on cash............................ (57) (42) (82) (40) Change in cash and cash equivalents......................................... (784) (3,565) (1,786) 6,854 Cash and cash equivalents, beginning of period.............................. 39,480 45,349 40,482 34,930 ----------- -------- -------- -------- Cash and cash equivalents, end of period.................................... $ 38,696 $ 41,784 $ 38,696 $ 41,784 =========== ======== ======== ========
3 LUMINEX CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) NOTE 1 - BASIS OF PRESENTATION The accompanying unaudited condensed consolidated financial statements have been prepared by Luminex Corporation (the "Company") in accordance with accounting principles generally accepted in the United States for interim financial information and the rules and regulations of the Securities and Exchange Commission. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation. In the opinion of management, all adjustments (consisting of normal recurring entries) considered necessary for a fair presentation have been included. Operating results for the three and six months ended June 30, 2003 are not necessarily indicative of the results that may be expected for the year ending December 31, 2003. These financial statements should be read in conjunction with the financial statements and notes thereto included in the Company's Annual Report on Form 10-K for the year ended December 31, 2002. NOTE 2 - INVENTORY, NET Inventory consisted of the following (in thousands):
JUNE 30, DECEMBER 31, 2003 2002 -------- ------------ Parts and supplies............................................ $ 4,547 $ 6,995 Work-in-progress.............................................. 487 304 Finished goods................................................ 914 965 -------- ------------ 5,948 8,264 Less: Allowance for excess and obsolete inventory............. (1,300) (1,500) -------- ------------ $ 4,648 $ 6,764 ======== ============
NOTE 3 - BUSINESS RESTRUCTURING COSTS In November 2002, the Company's management approved a business restructuring plan to reduce headcount and infrastructure. Components of business restructuring charges and the remaining accruals as of June 30, 2003 were as follows (in thousands):
EMPLOYEE FACILITY SEPARATION COSTS RESTRUCTURING COSTS TOTALS ---------------- ------------------- ----------- Total business restructuring costs..................... $ 1,401 $ 928 $ 2,329 Cash activitiy......................................... (364) - (364) Non-cash activitiy..................................... - (136) (136) ---------------- ------------------- ----------- Balance at December 31, 2002........................... 1,037 792 1,829 Cash activity.......................................... (850) (792) (1,642) Non-cash activity...................................... (100) - (100) ---------------- ------------------- ----------- Balance at March 31, 2003.............................. 87 - 87 Adjustment to accrual.................................. (52) - (52) ---------------- ------------------- ----------- Balance at June 30, 2003............................... $ 35 $ - $ 35 ================ =================== ===========
4 Remaining cash expenditures resulting from the restructuring are estimated to be $35,000 and consist of final settlement of employee separation costs that were incurred as part of the reduction in force during the fourth quarter of 2002. We expect to incur all of the remaining cash expenditures related to the business restructuring in the third quarter of 2003. The Company has substantially completed the business restructuring initiated during the fourth quarter of 2002. There can be no assurance that the estimated costs of the Company's business restructuring plan will not change. NOTE 4 - ACCRUED WARRANTY COSTS Sales 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. The Company estimates the amount of warranty claims on sold product 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. Warranty expenses and accruals for the six months ended June 30, 2003 were as follows (in thousands): Accrued warranty costs at December 31, 2002............ $ 312 Warranty expenses...................................... (257) Accrual for warranty costs............................. 510 ------- Accrued warranty costs at June 30, 2003................ $ 565 =======
NOTE 5 - SETTLEMENT OF LITIGATION As a result of a procedural omission, the Company is unable to pursue a patent in Japan, which corresponds to some of the Company's issued U.S. patents related to the Company's method of "real time" detection and quantification of multiple analytes from a single sample. On January 31, 2000, the Company filed a lawsuit in Travis County, Texas state district court alleging negligence and breach of contract on the part of the Company's prior patent counsel in this matter. On March 7, 2003, the parties executed a full, final and complete release regarding such action, without an admission of liability or wrongdoing on the part of the defendants. As consideration in connection with the settlement and release, the Company received approximately $1.8 million, net of legal and related costs and expenses. NOTE 6 - NET LOSS PER SHARE In accordance with Statement of Financial Accounting Standards ("SFAS") No. 128, Earnings Per Share, basic and diluted net loss per share is computed by dividing the net loss for the period by the weighted average number of common shares outstanding during the period. The Company has excluded all potentially dilutive securities such as convertible preferred stock, outstanding stock options and outstanding warrants to purchase common stock from the calculation of diluted loss per common share because such securities are anti-dilutive due to the Company's net loss for all periods presented. The total shares excluded from the calculations of diluted net loss per share, prior to application of the treasury stock method for options and warrants, were 2,315,773 and 2,388,976 for the three and six months ended June 30, 2003, respectively, and 2,191,754 and 2,202,504 for the three and six months ended June 30, 2002, respectively. NOTE 7 - STOCK BASED COMPENSATION During the three and six months ended June 30, 2003, the Company granted options to purchase 108,250 shares of common stock with exercise prices per share between $5.15 and $6.17 and 1,324,500 shares of common stock with exercise prices per share between $4.00 and $6.17, respectively. During the three and six months ended June 30, 2002, the Company granted options to purchase 795,500 shares of common stock with exercise prices per share between $6.37 and $7.51 and 899,000 shares of common stock with exercise prices per share between $6.37 and $18.00, respectively. For the three and six months ended June 30, 2003, the Company recorded stock compensation expense related to these issuances of $71,000 and $157,000, respectively. Comparatively, the Company recorded 5 stock compensation expense related to issuances for the three and six months ended June 30, 2002 of $180,000 and $360,000, respectively. SFAS No. 123 prescribes accounting and reporting standards for all stock-based compensation plans, including employee stock options. As allowed by SFAS No. 123, the Company has elected to continue to account for its employee stock-based compensation using the intrinsic value method in accordance with Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB 25"). SFAS No. 123 allows companies to estimate the pro forma fair value of their stock-based compensation using a generally recognized option pricing model and provide those results in the form of footnote disclosure. The fair value of each option grant was estimated using the Black-Scholes Option-Pricing model based on the date of grant and the following weighted average assumptions at June 30:
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30, --------------------------- ------------------------- 2003 2002 2003 2002 -------- ------- ------- ------ Dividend yield..................................... 0.0% 0.0% 0.0% 0.0% Expected volatility................................ 0.9% 0.9% 0.9% 0.9% Risk-free rate of return........................... 5.0% 5.0% 5.0% 5.0% Expected life...................................... 10 yrs 10 yrs 10 yrs 10 yrs Weighted average fair value at grant date......................... $ 5.19 $ 5.62 $ 4.21 $ 6.43 ======== ======= ====== =======
For purposes of pro forma disclosures, the estimated fair value of the options is expensed over the options' vesting periods. Because, for pro forma purposes, the estimated fair value of the Company's employee stock options is treated as if amortized to expense over the options vesting period, the effects of applying SFAS No. 123 for pro forma disclosure are not necessarily indicative of future amounts (in thousands, except per share amounts):
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30, --------------------------- ------------------------- 2003 2002 2003 2002 -------- -------- ----------- ---------- Net loss, as reported............................................ $ (1,899) $ (6,242) $ (2,805) $ (12,866) Add: Stock based employee compensation expense included in reported net loss......................................... - 16 - 135 Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards... (1,499) (2,777) (2,683) (5,348) -------- -------- ----------- --------- Pro forma net loss............................................... $ (3,398) $ (9,003) $ (5,488) $ (18,079) ======== ======== =========== ========== Earnings per share Basic and Diluted - as reported........................... $ (0.06) $ (0.21) $ (0.09) $ (0.44) Basic and Diluted - pro forma............................. $ (0.11) $ (0.31) $ (0.19) $ (0.62)
The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options, which have no vesting restrictions and are fully transferable. In addition, this option valuation model requires the input of highly subjective assumptions including the expected stock price volatility. Because the Company's employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the Black-Scholes model does not necessarily provide a reliable single measure of the fair value of its employee stock options. 6 NOTE 8 - COMPREHENSIVE LOSS In accordance with the disclosure requirements of SFAS No. 130, "Reporting Comprehensive Income," the Company's comprehensive loss is comprised of net loss and foreign currency translation. Comprehensive loss for the three months ended June 30, 2003 and 2002 was approximately $2.0 million and $6.3 million, respectively. Comprehensive loss for the six months ended June 30, 2003 and 2002 was approximately $2.9 million and $12.9 million, respectively. NOTE 9 - GUARANTEES The terms and conditions of the Company's development and supply and license agreements with its 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 date, the Company has not had to reimburse any of its partners for any losses arising from such indemnification obligations. NOTE 10 - ADOPTION OF NEW ACCOUNTING STANDARDS In January 2003, the FASB issued Interpretation 46, Consolidation of Variable Interest Entities, an Interpretation of Accounting Research Bulletin No. 51 (FIN 46). FIN 46 requires the consolidation of entities in which an enterprise absorbs a majority of the entity's expected losses, received a majority of the entity's expected residual returns, or both, as a result of ownership, contractual or other interests in the entity. Currently, entities are generally consolidated by an enterprise when it has a controlling financial interest through ownership of a majority voting interest in the entity. The consolidation requirements of FIN 46 apply to variable interest entities created after January 31, 2003. The consolidation requirements apply to older entities in the first fiscal year or interim period beginning after June 15, 2003. Although the Company does not believe the full adoption of FIN 46 will have any effect on its financial position or results of operations, the Company cannot make any definitive conclusion until it completes its evaluation. 7 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following information should be read in conjunction with the condensed consolidated financial statements and the accompanying notes included in Item 1 of this Report, our Annual Report on Form 10-K for the year ended December 31, 2002 and "Factors That May Affect Future Results" included in this Report. SAFE HARBOR CAUTIONARY STATEMENT All statements in this Report that do not discuss past results are forward-looking statements. Generally, the words "believe," "expect," "intend," "estimate," "anticipate," "will" and similar expressions identify forward-looking statements. All statements which address our outlook for our businesses and their respective markets, such as projections of future performance, statements of management's plans and objectives, forecasts of market trends and other matters are forward-looking statements. It is important to note that our actual results or performance could differ materially from those projected in such forward-looking statements. Forward-looking statements are based on management's current expectations and are therefore subject to certain risks and uncertainties, including those discussed under the section titled "Factors That May Affect Future Results" included in this Report. Specific uncertainties which could cause our actual results to differ materially from those projected include risks and uncertainties relating to market demand and acceptance, the dependence on strategic partners for development, commercialization and distribution of products, fluctuations in quarterly results due to a lengthy and unpredictable sales cycle, our ability to scale up manufacturing operations, potential shortages of components, competition, the timing of regulatory approvals and any modification of the Company's operating plan in response to its ongoing evaluation of its business and search for a new chief executive officer. We expressly disclaim any intent, obligation or undertaking to release publicly any updates or revisions to any forward-looking statements contained in this Report to reflect any change in our expectations with regard to such statements or any change in events, conditions or circumstances on which any such statements are based. OVERVIEW During 2003, we (i) are experiencing significant increases in revenue versus the prior year, (ii) are realizing the benefits of the cost control measures that were taken in 2002 and (iii) have received the final report from a strategic consulting firm with extensive experience in the life sciences industry to assist management in evaluating and refining the core focus and operating plans for the Company. In addition, the Management Evaluation and Search Committee, with the assistance of a nationally known management recruiting firm, continues to evaluate candidates for the Company's chief executive officer position. For the six months ended June 30, 2003 and 2002, we had net losses of approximately $2.8 and $12.9 million, respectively. For the quarters ended June 30, 2003 and 2002, the net losses were approximately $1.9 million and $6.2 million, respectively. We currently expect to continue to experience quarterly net losses and anticipate that our quarterly results of operations will continue to fluctuate for the foreseeable future as a result of several factors, including the risks discussed below in this Report under the heading "Factors That May Affect Future Results." Our limited operating history, customer concentration and continued fluctuations in buying patterns of our strategic partners make accurate predictions of future operations difficult. Our ability to achieve sustained profitability continues to depend upon our ability to establish meaningful and successful strategic partnership arrangements with companies that will develop and market products incorporating our technology and market and distribute our systems and consumables. Strategic partners will develop application-specific bioassay kits for use on our systems that they will sell to their customers generating royalties for us. Strategic partners may also perform testing services for third parties using our technology that will also result in royalties for us. Some strategic partners will also buy our products and then resell those products to their customers. Through June 30, 2003, we have 17 strategic partners who are paying royalties and have either released commercialized products based on the Luminex platform or are reselling our products. Our strategic partner relationships accounted for 91% of the Company's revenues for the second quarter of 2003. We believe actions taken in the third and fourth quarter of 2002 to right size our infrastructure and reduce the cash burn rate have allowed, and will better allow, management to further develop our technology, more effectively 8 deliver our products and serve our customers' needs. In the near future, we anticipate, among other things: (i) hiring a new chief executive officer, (ii) continuing to refine our strategic and operating focus, (iii) continuing to improve our customer and strategic partner relationships and (iv) finalizing the formulation of a strategic plan to act on the results of our consulting study. CRITICAL ACCOUNTING POLICIES AND ESTIMATES 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 accounting principles generally accepted in the United States. 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. Estimates and assumptions are reviewed periodically. Actual results may differ from these estimates under different assumptions or conditions. We believe the following represent our critical accounting policies: - Revenue on sales of our products is recognized when persuasive evidence of an agreement exists, delivery has occurred, the fee is fixed and determinable and collectibility is probable. Generally, these criteria are met at the time our product is shipped. We expect that each system's sale will generate a recurring revenue stream from the sale of consumable products. Royalty revenue is generated when a partner sells products incorporating our technology or provides testing services to third parties using our technology. Royalty revenue is recognized as it is reported to us by our partners, and payment is typically submitted concurrently with the report. We also sell to our customers extended service contracts for maintenance and support of our products. Revenue for service contracts is recognized ratably over the term of the agreement. For the three and six months ended June 30, 2003, six customers represented 57% and 56% of the Company's revenue, respectively. We believe these customer relationships continue to be good; however, the loss of a significant customer, a significant reduction in product purchases or financial difficulty for a significant customer could have a material adverse effect on our business, financial condition and results of operations. We believe these customers will continue as significant customers for the remainder of 2003. Total deferred revenue as of June 30, 2003 was $3.6 million and consisted of (i) payments received for sales to customers with rights of return that had not yet expired in the amount of $86,000, (ii) upfront payments from strategic partners to be used for the purchase of products or to be applied towards future royalty payments in the amount of $1.1 million, (iii) unamortized revenue related to extended service contracts in the amount of $410,000 and (iv) unamortized license fees in the amount of $2.0 million. Upfront payments from our strategic partners are nonrefundable and will be recognized as revenue as our strategic partners purchase products or apply such amounts against royalty payments. Nonrefundable license fees are amortized into revenue over the estimated life of the license agreements. - Inventories are valued at the lower of cost or market value and have been reduced by an allowance for excess and obsolete inventories. At June 30, 2003, there were two major components of the allowance for excess and obsolete inventory. First, the Company has a specific reserve for inventory components that we no longer use in the manufacture of our systems. Second, we have a reserve against slow moving items for potential obsolescence. The total estimated allowance is reviewed on a regular basis and adjusted based on management's review of inventories on hand compared to estimated future usage and sales. The Company believes that its inventory is properly valued based on current market conditions. - We continuously monitor collections and payments from our customers and maintain allowances for doubtful accounts based upon our historical experience and any specific customer collection issues we have identified. While such credit losses historically have been within our expectations, there can be no assurance we will continue to experience the same level of credit losses that we have in the past. A significant change in the liquidity or financial position of any one of our significant customers, or a further 9 deterioration in the economic environment, in general, could have a material adverse impact on the collectibility of our accounts receivable and our future operating results, including a reduction in future revenues and additional allowances for doubtful accounts. RESULTS OF OPERATIONS THREE MONTHS ENDED JUNE 30, 2003 COMPARED TO THREE MONTHS ENDED JUNE 30, 2002 Revenue. Total revenue increased to $5.6 million for the three months ended June 30, 2003 from $3.2 million for the comparable period in 2002. The increase was primarily attributable to increased instrument sales, as well as increased consumable sales. A breakdown of revenue for the three months ended June 30, 2003 and 2002 is as follows (in thousands):
THREE MONTHS ENDED JUNE 30, -------------------- 2003 2002 -------- ------- Instrument sales..................................... $ 3,482 $ 1,582 Consumable sales..................................... 1,235 1,008 Service contracts.................................... 265 172 Royalty revenue...................................... 285 186 Other revenue........................................ 375 229 -------- ------- $ 5,642 $ 3,177 ======== =======
Instrument sales and peripheral component sales increased to $3.5 million for the three months ended June 30, 2003 from $1.6 million for the second quarter of 2002. Instrument placements increased to 140 for the second quarter of 2003 as compared to 60 placements for the corresponding prior year period. The increase in instrument placements is primarily due to the increase in commercialized partners. Consumable sales, comprised of microspheres and sheath fluid, increased to $1.2 million during the second quarter of 2003 up from $1.0 million for the second quarter of 2002. The increase is primarily the result of the increased installed base of Luminex systems as compared to the prior year period. Service contracts, comprised of extended warranty contracts earned ratably over the term of the agreement, increased to $265,000 during the second quarter of 2003 from $172,000 for the second quarter of 2002. This increase is attributable to increased sales of extended service agreements, which is a direct result of the increase in the commercial base of Luminex systems as compared to the prior year period. At June 30, 2003, we had 171 Luminex systems covered under an extended service agreement. Royalty revenue increased to $285,000 during the three months ended June 30, 2003 from $186,000 for the three months ended June 30, 2002. This increase is attributable to increased sales of royalty bearing commercial products by our partners and an increase in the commercial base of Luminex systems as compared to the prior year period. For the three months ended June 30, 2003, we had 15 commercial partners pay royalties as compared with 10 for the three months ended June 30, 2002. Additionally, the 10 partners for whom we recognized royalties in the second quarter of 2002 represented approximately $251,000 or 88% of the second quarter 2003 total, an increase of approximately 35% over their prior year payments. Other revenues, comprised of training revenue, shipping revenue and miscellaneous parts sales, increased to $375,000 for the three months ended June 30, 2003 from $229,000 for the three months ended June 30, 2002. This increase is primarily the result of increased miscellaneous part sales as our partners perform service work on Luminex instruments that are outside the Company's standard one-year warranty period. Gross Profit. Gross profit increased to $1.9 million for the three months ended June 30, 2003, as compared to $529,000 for the three months ended June 30, 2002. The gross margin rate (gross profit as a percentage of total revenue) increased to 34% for the three months ended June 30, 2003 from 17% for the three months ended June 30, 10 2002. The rate increase in gross margin was primarily attributable to reductions in our fixed costs as part of the restructuring efforts undertaken by the Company in 2002 and the allocation of our remaining fixed costs over a higher revenue base. In addition, the gross margin rate for the three months ended June 30, 2002 was adversely affected by the inclusion of costs associated with the cancellation or delay of inventory items. Our production schedule was adjusted during that period to reflect a lower rate of system orders. Research and Development Expense. Research and development expenses decreased to $881,000 for the three months ended June 30, 2003 from $2.1 million for the comparable period in 2002. The decrease was primarily attributable to the elimination of expenditures related to our Rules-Based Medicine research and development project ("RBM") as of September 2002, coupled with the effects of our restructuring efforts in the fourth quarter of 2002. RBM expenses totaled approximately $850,000 for the second quarter of 2002. The specific component contributing to this net decrease, exclusive of the elimination of RBM expenditures during the second three months of 2003, was a reduction in research and development personnel costs of $372,000. We currently expect research and development expenses related to the ongoing development of our xMAP technology and consumables to be $1.0 to $1.5 million per quarter for the remainder of 2003 and $3.7 to $4.7 million on an annual basis for 2003. Selling, General and Administrative Expense. Selling, general and administrative expenses decreased to $3.1 million for the three months ended June 30, 2003 from $4.8 million for the comparable period in 2002. The decrease was primarily attributable to our restructuring and cost control efforts and included reduced personnel costs of approximately $883,000, a decrease in legal and professional fees of $112,000, a decrease in stock compensation expense of $125,000 and reductions in travel, entertainment and marketing expenses of $503,000. Selling, general and administrative expenses currently are expected to be in the range of $3.0 to $4.0 million per quarter for the remainder of 2003 and $12.6 to $14.6 million on an annual basis for 2003. Other Income, net. Other income decreased to $96,000 for the three months ended June 30, 2003 from $182,000 for the comparable period in 2002. The decrease was primarily attributable to a decrease in the average cash and cash equivalents balances and a lower yield on the investment balances. The average rate on current invested balances fell to 1.0% at June 30, 2003 from 1.8% at June 30, 2002. SIX MONTHS ENDED JUNE 30, 2003 COMPARED TO SIX MONTHS ENDED JUNE 30, 2002 Revenue. Total revenue increased to $10.7 million for the six months ended June 30, 2003 from $5.5 million for the comparable period in 2002. The increase was primarily attributable to increased instrument sales, as well as increased consumable sales. A breakdown of revenue for the six months ended June 30, 2003 and 2002 is as follows (in thousands):
SIX MONTHS ENDED JUNE 30, -------------------- 2003 2002 -------- ------- Instrument sales..................................... $ 6,523 $ 2,856 Consumable sales..................................... 2,412 1,714 Service contracts.................................... 519 301 Royalty revenue...................................... 504 245 Other revenue........................................ 786 348 -------- ------- $ 10,744 $ 5,464 ======== =======
Instrument sales and peripheral component sales increased to $6.5 million for the six months ended June 30, 2003 from $2.9 million for the first half of 2002. Instrument placements increased to 271 for the first half of 2003 as compared to 96 placements for the corresponding prior year period. The increase in instrument placements is primarily due to the increase in commercialized partners. 11 Consumable sales, comprised of microspheres and sheath fluid, increased to $2.4 million during the first half of 2003 up from $1.7 million for the first half of 2002. The increase is primarily the result of the increased installed base of Luminex systems as compared to the prior year period. Service contracts, comprised of extended warranty contracts earned ratably over the term of the agreement, increased to $519,000 during the first half of 2003 from $301,000 for the first half of 2002. This increase is attributable to increased sales of extended service agreements, which is a direct result of the increase in the commercial base of Luminex systems as compared to the prior year period. At June 30, 2003, we had 171 Luminex systems under an extended service agreement. Royalty revenue increased to $504,000 during the six months ended June 30, 2003 from $245,000 for the six months ended June 30, 2002. This increase is attributable to increased sales of royalty bearing commercial products by our partners and an increase in the commercial base of Luminex systems as compared to the prior year. For the six months ended June 30, 2003, we had 17 commercial partners pay royalties as compared with 11 for the six months ended June 30, 2002. Additionally, the 11 partners for whom we recognized royalties in the six months ended June 30, 2002 represented approximately $465,000 or 92% of the total for the six months ended June 30, 2003, an increase of approximately 47% over their prior year payments. Other revenues, comprised of training revenue, shipping revenue and miscellaneous parts sales, increased to $786,000 for the six months ended June 30, 2003 from $348,000 for the six months ended June 30, 2002. This increase is primarily the result of increased miscellaneous part sales as our partners perform service work on Luminex instruments that are outside the Company's standard one-year warranty period. Gross Profit. Gross profit increased to $3.4 million for the six months ended June 30, 2003, as compared to $821,000 for the six months ended June 30, 2002. The gross margin rate increased to 32% for the six months ended June 30, 2003 from 15% for the six months ended June 30, 2002. The rate increase in gross margin was primarily attributable to reductions in our fixed costs as part of the restructuring efforts undertaken by the Company in 2002 and the allocation of our remaining fixed costs over a higher revenue base. In addition, the gross margin rate for the six months ended June 30, 2002 was adversely affected by the inclusion of costs associated with the cancellation or delay of inventory items. Our production schedule was adjusted during that period to reflect a lower rate of system orders. Research and Development Expense. Research and development expenses decreased to $1.7 million for the six months ended June 30, 2003 from $4.1 million for the comparable period in 2002. The decrease was primarily attributable to the elimination of expenditures related to RBM as of September 2002, coupled with the effects of our restructuring efforts in the fourth quarter of 2002. RBM research and development expenses totaled approximately $1.5 million for the first half of 2002. Specific components contributing to this net decrease, exclusive of the elimination of RBM expenditures during the first six months of 2003, were a reduction in research and development personnel costs of $796,000 and a reduction in professional fees of $149,000. We currently expect research and development expenses related to the ongoing development of our xMAP technology and consumables to be $1.0 to $1.5 million per quarter for the remainder of 2003 and $3.7 to $4.7 million on an annual basis for 2003. Selling, General and Administrative Expense. Selling, general and administrative expenses decreased to $6.6 million for the six months ended June 30, 2003 from $10.0 million for the comparable period in 2002. The decrease was primarily attributable to our restructuring and cost control efforts and included reduced personnel costs of approximately $2.2 million, a decrease in consumable supplies of $148,000, a decrease in stock compensation expense of $340,000 and reductions in travel, entertainment and marketing expenses of $672,000. These expense reductions were partially offset by an increase of $328,000 in professional fees primarily related to the engagement of the strategic consulting firm to assist management in evaluating the core focus and operating plans for the Company. Selling, general and administrative expenses currently are expected to be in the range of $3.0 to $4.0 million per quarter for the remainder of 2003 and $12.6 to $14.6 million on an annual basis for 2003. Other Income, net. Other income decreased to $206,000 for the six months ended June 30, 2003 from $402,000 for the comparable period in 2002. The decrease was primarily attributable to a decrease in the average cash and short-term investment balances and a lower yield on the investment balances. The average rate on current invested balances fell to 1.0% at June 30, 2003 from 1.8% at June 30, 2002. 12 LIQUIDITY AND CAPITAL RESOURCES At June 30, 2003, we held cash and cash equivalents of $38.7 million and had working capital of $43.3 million. At December 31, 2002, we held cash and cash equivalents of $40.5 million and had working capital of $45.3 million. We have funded our operations to date primarily through the issuance of equity securities. Our cash reserves are held directly or indirectly in a variety of short-term, interest-bearing instruments, including obligations of the United States government or agencies thereof and U.S. corporate debt securities. Cash used in operations was $1.9 million for the six months ended June 30, 2003, compared with $8.8 million for the six months ended June 30, 2002. In the first quarter of 2003, we settled a pending lawsuit and entered into a full, final and complete release with our prior patent counsel, without an admission of liability or wrongdoing on the part of the defendants. As consideration for the settlement and release, the Company received approximately $1.8 million, net of legal and related costs and expenses. This cash infusion significantly offset payment of approximately $1.6 million in restructuring obligations, which were accrued in the fourth quarter of 2002. Additionally, we currently expect to receive an additional $600,000 in nonrefundable license fees from strategic partners during 2003. Such license fees are amortized into income over the life of the agreement. Our research and development expenses during the six months ended June 30, 2003 were $1.7 million. Research and development expenses related to the ongoing development of our xMap technology and consumables are currently expected to be in the range of $1.0 million to $1.5 million per quarter and between $3.7 million and $4.7 million on an annual basis for 2003. Selling, general and administrative expenses for 2003 should continue to be lower than 2002 primarily as a result of the restructuring efforts taken in the fourth quarter of 2002. We currently expect total selling, general and administrative expenses to be in the range $3.0 million to $4.0 million per quarter and $12.6 to $14.6 million for 2003. We have non-cancellable purchase commitments with certain of our component suppliers. Should our production requirements fall below the level of our commitments, we could be required to take delivery of inventory for which we have no immediate need or incur an increased cost per unit going forward. We are not otherwise committed to scheduled purchase requirements. However, 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 made a conscious effort to manage our inventory levels down in light of the relatively large balances on hand during the first half of 2002 and the lower volume of sales during 2002. The effort to manage our inventory, coupled with sales during the first half of 2003, placed a constraint on our ability to produce systems for sale. However, based on our current supply of certain long lead-time to deliver components, we believe the Company has the ability to meet delivery requirements for existing customer orders during the third quarter of 2003. 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 constraints in our systems delivery capacity, which would adversely impact revenue in a given fiscal period. Should the Company's 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. 13 We currently have approximately $3.4 million in non-cancellable obligations for the remainder of 2003. These obligations are included in our estimated cash usage during 2003.
REMAINING 2003 2004 2005 2006 2007 THEREAFTER TOTAL --------- -------- -------- ------- -------- ---------- -------- Non-cancellable rental obligations............................... $ 385 $ 770 $ 794 $ 806 $ 824 $ 1,980 $ 5,559 Non-cancellable purchase obligations................................ 3,045 1,652 - - - - 4,697 --------- -------- -------- ------- -------- ---------- -------- Anticipated liquidity impact as of June 30, 2003............................. $ 3,430 $ 2,422 $ 794 $ 806 $ 824 $ 1,980 $10,256 ========= ======== ======== ======= ======== ======== =======
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 costs involved in preparing, filing, prosecuting, maintaining, defending and enforcing patent claims and other intellectual property rights, the need to acquire licenses to new technology and the status of competitive products. Additionally, any actions taken based on recommendations of the strategic consulting firm hired in November 2002 to evaluate and refine the focus and operating plans for the Company could result in expenditures not currently contemplated in our estimates for 2003. We believe, however, that our existing cash and cash equivalents will be sufficient to fund our operating expenses and capital equipment requirements for 2003. Based upon our current operations, management anticipates total cash use for 2003, to be approximately $6.0 to $9.0 million, giving us an anticipated balance at December 31, 2003 of $31.0 to $34.0 million. We have no credit facility or other committed sources of capital. To the extent capital resources are insufficient to meet future capital requirements, we will have to raise additional funds to continue the development of our technologies. There can be no assurance that debt or equity funds will be available on favorable terms, if 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. FACTORS THAT MAY AFFECT FUTURE RESULTS WE HAVE A HISTORY OF LOSSES AND AN ACCUMULATED DEFICIT OF APPROXIMATELY $78.9 MILLION AS OF JUNE 30, 2003. We have incurred significant net losses since our inception, including losses of $2.8 million for the six months ended June 30, 2003, $24.9 million in 2002 and $15.7 million in 2001. At June 30, 2003, we had an accumulated deficit of approximately $78.9 million. To achieve profitability, we will need to generate and sustain substantially higher revenue while achieving reasonable cost and expense levels. If we fail to achieve profitability within the time frame expected by securities analysts or investors, the market price of our common stock will likely decline. Furthermore, as we continue to incur losses and utilize cash to support operations, we further decrease the cash available to the Company. As of June 30, 2003, cash and cash equivalents totaled $38.7 million, a decrease of $1.8 million, from $40.5 million at December 31, 2002. We do not know when or if we will become profitable. If we do achieve profitability, we may not be able to sustain or increase profitability on a quarterly or an annual basis. IF OUR TECHNOLOGY AND PRODUCTS DO NOT BECOME WIDELY USED IN THE LIFE SCIENCES INDUSTRY, IT IS UNLIKELY THAT WE WILL EVER BECOME PROFITABLE. Life sciences companies have historically conducted biological tests using a variety of technologies, including bead-based analysis. However, compared to certain other technologies, our xMAP technology is relatively new and unproven, and the use of our technology by life sciences companies is limited. The commercial success of our 14 technology will depend upon its widespread adoption as a method to perform bioassays. In order to be successful, we must convince potential customers to utilize our system instead of competing technologies. Market acceptance will depend on many factors, including our ability to: - convince prospective strategic partners and customers that our technology is an attractive alternative to other technologies for pharmaceutical, research, clinical and biomedical testing and analysis; - manufacture products in sufficient quantities with acceptable quality and at an acceptable cost; and - place and service sufficient quantities of our products. Because of these and other factors, our products may not gain sufficient market acceptance to achieve profitability. OUR SUCCESS DEPENDS LARGELY ON THE ESTABLISHMENT OF MEANINGFUL AND SUCCESSFUL RELATIONSHIPS WITH OUR STRATEGIC PARTNERS. The development and commercialization of our xMAP technology is highly dependent on our ability to establish successful strategic relationships with a number of partners. As of June 30, 2003, we had 17 strategic partners who were paying royalties and had either commercialized products using the Luminex platform or were reselling our products. Furthermore, for the three and six months ended June 30, 3003, six customers represented 57% and 56% of the Company's revenue, respectively. The loss of any of our significant strategic partners, or any of our significant customers, would have a material adverse effect on our growth and future results of operations. Delays in implementation, 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 assure you 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. Termination of strategic relationships, or the failure to enter into a sufficient number of additional agreements on favorable terms, could reduce sales of our products, lower margins on our products and limit the creation of market demand and acceptance. The vast majority 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 predict future sales and royalty revenues because our existing strategic partner agreements do not include minimum purchase requirements. In addition, we do not have the right or ability to provide incentives to our strategic partners' sales personnel to sell products based on xMAP technology or to control the timing of the release of products by our strategic partners. The amount of these revenues will depend 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. Further, 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. OUR LIMITED OPERATING HISTORY AND RELIANCE ON STRATEGIC PARTNERS TO MARKET OUR PRODUCTS MAKES FORECASTING DIFFICULT. Because of our limited operating history, it is difficult to accurately forecast future operating results. Our operating expenses are largely based on anticipated revenue trends and a high percentage of our expenses are, and will continue to be, fixed in the short-term. The level of our revenues will depend upon the rate and timing of the 15 adoption of our technology as a method to perform bioassays. Due to our limited operating history, predicting this timing and rate of adoption is difficult. In addition, we currently anticipate that the vast majority of future sales of our products and products incorporating our technology will be made by our strategic partners. For the following reasons, estimating the timing and amount of sales of these products that may be made by our strategic partners is particularly difficult: - We have no control over the timing or extent of product development, marketing or sale of our products by our strategic partners. - Our strategic partners are not committed to minimum purchase commitments and we do not control the incentives provided by our strategic partners to their sales personnel. - A significant number of our strategic partners intend to produce clinical diagnostic applications that may need to be approved by the Food and Drug Administration, or FDA. - 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. OUR SUCCESS WILL DEPEND ON OUR ABILITY TO ATTRACT AND TO RETAIN OUR MANAGEMENT AND STAFF. In March 2002, we created a Management Evaluation and Search Committee to evaluate our existing management team and organizational structure and to provide recommendations regarding changes and additions to our management team and organizational structure, if deemed appropriate. From that process (which is ongoing), we are actively seeking a new chief executive officer and have engaged in significant staff reductions (including restructuring our management team and organizational structure during 2002) to align our operating costs with the Company's current business. During 2002, there was a significant turnover of senior management, as eight officers ceased to be employed by the Company, including those whose employment terminated in connection with the September 2002 sale of RBM to a newly formed company headed by Dr. Mark Chandler, the Company's then chairman, chief executive officer and co-founder. In connection with Dr. Chandler's departure following the closing of the RBM transaction, Thomas W. Erickson was engaged in September 2002 to serve as Interim President and Chief Executive Officer while the Management Evaluation and Search Committee sought a new chief executive officer. Mr. Erickson is currently under contract with us through December 2003. Additionally, as a result of the management restructuring, certain of the remaining members of management have taken on additional responsibilities and the Company has employed interim personnel and third-party consultants to fill the vacated positions. We have reduced the overall work force from 164 at June 30, 2002 to 123 at June 30, 2003. The reduction in force was designed to reduce overhead costs and align staffing and personnel costs with the Company's current business. This reduction in force required remaining employees to assume additional responsibilities and, when combined with the changes in senior management, has created challenges in maintaining continuity of customer relationships, research and development and strategic planning for the Company. We depend on the principal members of our management and scientific staff, including our research and development, customer support, technical service and sales staff. The loss of services of key members of management could delay or reduce our product development, sales and customer support efforts. In addition, recruiting and retaining qualified scientific and other personnel to perform research and development, customer support, technical service 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. 16 WE EXPECT OUR OPERATING RESULTS TO CONTINUE TO FLUCTUATE SIGNIFICANTLY FROM QUARTER TO QUARTER. The sale of bioassay testing devices typically involves a significant technical evaluation and commitment of capital by customers. Accordingly, the sales cycle associated with our products typically is lengthy and subject to a number of significant risks, including customers' budgetary constraints and internal acceptance reviews that are beyond our control. 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 commercialization timetables 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. WE HAVE ONLY PRODUCED OUR PRODUCTS IN LIMITED QUANTITIES AND WE MAY EXPERIENCE PROBLEMS IN SCALING UP OUR MANUFACTURING OPERATIONS OR DELAYS OR COMPONENT SHORTAGES THAT COULD LIMIT THE GROWTH OF OUR REVENUE. To date, we have produced our products in limited quantities compared to the quantities necessary to achieve desired revenue growth. We may not be able to produce sufficient quantities or maintain consistency between differing lots of consumables. If we encounter difficulties in scaling up our manufacturing operations due to, among other things, quality control and quality assurance and component 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. We have non-cancelable purchase requirements with certain of our components suppliers which require us to take delivery of a minimum number of component parts for our products or the cost per unit will increase, which would adversely impact our gross margin. We are not otherwise committed to scheduled purchase requirements. However, 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 made a conscious effort to manage our inventory levels down in light of the relatively large balances on hand during the first half of 2002 and the lower volume of sales during 2002. The effort to manage our inventory, coupled with sales during the first half of 2003, placed a constraint on our ability to produce systems for sale. However, based on our current supply of certain long lead-time to deliver components, we believe the Company has the ability to meet delivery requirements for existing customer orders during the third quarter of 2003. 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 constraints in our systems delivery capacity, which would adversely impact revenue in a given fiscal period. Should the Company's need for raw materials and components used in productions continue to fluctuate, we could incur additional costs associated with either expediting or postponing delivery of those materials. In addition, certain key components of our product line are currently purchased from a limited number of outside sources and may only be available through a limited number of providers. We do not have agreements with all of our suppliers. Our reliance on our suppliers and contract manufacturers exposes us to risks including: - the possibility that one or more of our suppliers or our assemblers could terminate their services at any time without penalty; - the potential inability of our suppliers to obtain required components; - the potential delays and expenses of seeking alternate sources of supply or manufacturing services; - reduced control over pricing, quality and timely delivery due to the difficulties in switching to alternate suppliers or assemblers; and 17 - 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. BECAUSE WE RECEIVE REVENUES PRINCIPALLY FROM LIFE SCIENCES COMPANIES, THE CAPITAL SPENDING POLICIES OF THESE ENTITIES 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 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. THE LIFE SCIENCES INDUSTRY IS HIGHLY COMPETITIVE AND SUBJECT TO RAPID TECHNOLOGICAL CHANGE AND WE MAY NOT HAVE THE RESOURCES NECESSARY TO SUCCESSFULLY COMPETE. 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, as well as 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. 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. Our present or future products could be rendered obsolete or uneconomical by technological advances by one or more of our current or future competitors. In addition, the introduction or announcement of new products by us or by others could result in a delay of or decrease in sales of existing products, as customers evaluate these new products. Our future success will depend on our ability to compete effectively against current technologies, as well as to respond effectively to technological advances. THE INTELLECTUAL 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 will depend on our ability to obtain, protect and enforce patents on our technology and to protect our trade secrets. 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. Further, there is a substantial backlog of patent applications at the U.S. Patent and Trademark Office, and the approval or rejection of patent applications may take several years. We have obtained 15 patents in the United States and one in Japan directed to various aspects and applications of our technology. We have 17 pending applications in the United States and 24 in foreign jurisdictions. In Japan, due to a procedural omission, we are unable to obtain patent protection for our method of "real time" detection and quantification of multiple analytes from a single sample similar to the protection we have obtained in the United States. Although we are pursuing patent protection in Japan for other aspects of our technology, we may not be able to prevent competitors from developing and marketing technologies similar to our xMAP technology in Japan. 18 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, the Company has implemented a patent process to file patent applications on its 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 advisors have prior employment or consulting relationships. Further, others may independently develop substantially equivalent proprietary technology and techniques, 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 divert management's attention from other business concerns. If we lose, we may 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. We 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 WILL DEPEND PARTLY ON OUR ABILITY TO OPERATE WITHOUT INFRINGING ON OR MISAPPROPRIATING THE PROPRIETARY RIGHTS OF OTHERS. We may be sued for infringing on the intellectual property rights of others. In addition, we may find it necessary, if threatened, to initiate a lawsuit seeking a declaration from a court that we do not infringe 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 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 affect on our business, financial condition and results of operations. We are aware of a European patent granted to Dr. Ioannis Tripatzis, which covers certain testing agents and certain methods of their use. Dr. Tripatzis has publicly stated his belief that his European patent covers aspects of our technology if practiced in Europe. This European patent expires in 2004. We cannot assure you that a dispute with Dr. Tripatzis will not arise involving our European activities or that any dispute with him will be resolved in our favor. IF WE FAIL TO COMPLY WITH THE EXTENSIVE GOVERNMENT REGULATIONS THAT AFFECT OUR BUSINESS, WE COULD BE SUBJECT TO ENFORCEMENT ACTIONS, INJUNCTIONS, AND CIVIL AND CRIMINAL PENALTIES THAT COULD DELAY OR PREVENT MARKETING OF OUR PRODUCTS. The testing, production, labeling, distribution and marketing of our products for some purposes and products based on our technology expected to be produced by our strategic partners are subject to governmental regulation by the Food and Drug Administration in the United States and by similar agencies in other countries. Some of our products and products based on our technology expected to be produced by our strategic partners for in vitro diagnostic purposes are subject to approval or clearance by the FDA prior to marketing for commercial use. To date, only three strategic partners have obtained such approvals or clearances. The process of obtaining necessary FDA clearances or approvals can be time-consuming, expensive and uncertain. Further, clearance or approval may place substantial restrictions on the indications for which the product may be marketed or to whom it may be marketed. In addition, we are also required to comply with FDA requirements relating to laser safety. 19 Approved or cleared products are subject to continuing FDA requirements relating to, among others, quality control and quality assurance, maintenance of records and documentation, adverse event and other reporting, and labeling and promotion 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 enforcement action, including product seizures, recalls, withdrawal of clearances or approvals, 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 also in effect in many countries outside the United States. These range from comprehensive device approval requirements for some or all of our medical device products to requests for product data or certifications. The number and scope of these requirements are increasing. 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 work place 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, such as ISO 9000. We became ISO 9001:2000 certified in March 2002. Subsequent audits are carried out at six-month intervals to ensure we maintain our system in substantial compliance with ISO standards. Failure to maintain compliance with FDA regulations and ISO registration could reduce our competitive advantage in the international market and also decrease satisfaction and confidence levels with our partners. 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 human diagnostic and therapeutic products. While we believe that we are reasonably insured against these risks, 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 a recall of one of our products would have to be paid out of our cash reserves. 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, health maintenance organizations and private insurers, are restricting payments for healthcare. These restrictions may decrease demand for our products and the price we can charge. Increasingly, Medicaid and other third-party payors are challenging the prices charged for medical services, including clinical diagnostic tests. They are also attempting to contain costs by limiting coverage and the reimbursement level of tests and other healthcare products. Without adequate coverage and reimbursement, consumer demand for tests will decrease. Decreased demand could cause sales of our products, and sales and services by our strategic partners, to fall. In addition, decreased demand could place pressure on us, or our strategic partners, to lower prices on these products or services, resulting in lower margins. Reduced sales or margins by us, or our strategic partners, would hurt our business, profitability and business prospects. OUR OPERATING RESULTS MAY BE AFFECTED BY CURRENT ECONOMIC AND POLITICAL CONDITIONS. With the current events in the Middle East and continuing concern for future terrorist attacks, there exist many economic and political uncertainties. These uncertainties could adversely affect our business and revenues in the short or long term in ways that cannot presently be predicted. 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: 20 - general economic conditions and interest rates; - instability in the United States and other financial markets and the possibility of war, other armed hostilities or further acts of terrorism in the United States or elsewhere; - actual or anticipated variations in quarterly operating results from historical results or estimates of results prepared by securities analysts; - announcements of technological innovations or new products or services by us or our competitors; - changes in financial estimates by securities analysts; - conditions or trends in the life science, biotechnology and pharmaceutical industries; - announcements by us of significant acquisitions, strategic partnerships, joint ventures or capital commitments; - additions or departures of key personnel; and - sales of our common stock. In addition, the stock market in general, and The Nasdaq Stock 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. OUR DIRECTORS AND OFFICERS HAVE A SIGNIFICANT OWNERSHIP POSITION IN THE COMPANY'S COMMON STOCK, WHICH COULD DELAY OR PREVENT A MERGER OR OTHER CHANGE IN CONTROL TRANSACTION. Our directors and executive officers beneficially owned approximately 12% of our outstanding common stock as of August 8, 2003. These persons will be able to exercise significant influence over all matters requiring stockholder approval, including the election of directors and the approval of significant corporate transactions. This ownership position could also delay or prevent a change in control of the Company even if beneficial to our stockholders. ANTI-TAKEOVER PROVISIONS IN OUR CERTIFICATE OF INCORPORATION, BYLAWS AND STOCKHOLDER RIGHTS PLAN AND DELAWARE LAW COULD MAKE A THIRD PARTY ACQUISITION OF US DIFFICULT. Our certificate of incorporation, bylaws and stockholder rights plan 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 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Our interest income is sensitive to changes in the general level of domestic interest rates, particularly since the majority of our investments are in short-term instruments held to maturity. A 25 basis point fluctuation from average investment returns at June 30, 2003 would yield an approximate 25% variance in overall investment return. Due to the nature of our short-term investments, we have concluded that there is no material market risk exposure. All payments for our products, including sales to foreign customers, are required to be made in U.S. dollars; therefore, we do not engage in any foreign currency hedging activities. Accordingly, our foreign currency market risk is limited. 21 ITEM 4. CONTROLS AND PROCEDURES Under the supervision and with the participation of our senior management, including our Interim President and Chief Executive Officer and Acting Chief Financial Officer, we conducted an evaluation of our disclosure controls and procedures, as defined in Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934 (the "Exchange Act"), as of the end of the period covered by this Report. Based on that evaluation, our Interim President and Chief Executive Officer and Acting Chief Financial Officer concluded that our disclosure controls and procedures effectively and timely provide them with material information relating to the Company required to be disclosed in the reports the Company files or submits under the Exchange Act. 22 PART II ITEM 1. LEGAL PROCEEDINGS As a result of a procedural omission, we are unable to pursue a patent in Japan which corresponds to some of our issued U.S. patents related to our method of "real time" detection and quantification of multiple analytes from a single sample. On January 31, 2000, we filed a lawsuit in Travis County, Texas state district court alleging negligence and breach of contract on the part of our prior patent counsel in this matter. On March 7, 2003, we reached a settlement with the defendants and executed and entered into a full, final and complete release regarding such action, without an admission of liability or wrongdoing on the part of the defendants. As consideration in connection with the settlement and release, the Company received approximately $1.8 million, net of legal and related costs and expenses. ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS (a) During the second quarter of 2003, we issued 20,400 shares of the Company's common stock pursuant to the exercise of options granted to our directors, employees and consultants pursuant to our 1996 Stock Option Plan for an exercise price of $3.92 per share. These shares were issued in reliance upon the exemption from the registration requirements of the Securities Act of 1933 set forth in Section 4(2) or Rule 701 thereof. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS At the Company's 2003 Annual Meeting of Stockholders, which was held on May 22, 2003, the stockholders of the Company elected G. Walter Loewenbaum II and Kevin M. McNamara to serve as a Class II director for a term of three years by the following votes:
Number of Shares ---------------------- For Withheld ---------- --------- G. Walter Loewenbaum.......................... 23,160,976 3,996,638 Kevin M. McNamara............................. 23,616,201 3,541,413
The other directors whose terms of office as a director continue after the meeting are as follows: C. Thomas Caskey, M.D., Robert J. Cresci, Fred C. Goad, Jr., Laurence E. Hirsch, Jim D. Kever and William L. Roper, M.D. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits:
EXHIBIT NUMBER DESCRIPTION OF DOCUMENTS ------- ------------------------ 10.1 Second Amendment to Management Services Agreement by and between Luminex Corporation and Thomas W. Erickson, effective as of September 1, 2003. 31.1 Certification by CEO pursuant to section 302 of the Sarbanes-Oxley Act of 2002. 31.2 Certification by CFO pursuant to section 302 of the Sarbanes-Oxley Act of 2002. 32.1 Certification by CEO pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 32.2 Certification of CFO pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
23 (b) Reports on Form 8-K: A Form 8-K was filed April 21, 2003 relating to the Company's April 21, 2003 press release setting forth the Company's first quarter 2003 earnings. 24 SIGNATURES Pursuant to the requirements 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, on August 14, 2003. LUMINEX CORPORATION By: /s/ HARRISS T. CURRIE ---------------------------------------------- Harriss T. Currie Acting Chief Financial Officer and Controller (Principal Financial and Accounting Officer) By: /s/ THOMAS W. ERICKSON ---------------------------------------------- Thomas W. Erickson Interim President and Chief Executive Officer (Principal Executive Officer) S-1