Prepared by MERRILL CORPORATION

10-Q 1 a2063281z10-q.htm 10-Q Prepared by MERRILL CORPORATION
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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

Form 10-Q

(Mark One)

/x/	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2001

/ /	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to

Commission file number 000-21873

BIOSITE INCORPORATED
(Exact name of Registrant as specified in its charter)

Delaware
(State or other jurisdiction of incorporation or organization)

33-0288606
(I.R.S. Employer Identification No.)

11030 Roselle Street
San Diego, California, 92121
(Address of principal executive offices)

Registrant's telephone number, including area code: (858) 455-4808

Biosite Diagnostics Incorporated
(former name, former address and former fiscal year, if changed since last report)

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 / /

The number of shares of the Registrant's Common Stock, $0.01 par value, outstanding at October 31, 2001 was 14,579,365.

BIOSITE INCORPORATED
FORM 10-Q

INDEX

		Page
PART I. FINANCIAL INFORMATION		1
ITEM 1. FINANCIAL STATEMENTS		1
	Condensed Balance Sheets (Unaudited)	1
	Condensed Statements of Income (Unaudited)	2
	Condensed Statements of Cash Flows (Unaudited)	3
	Notes to Condensed Financial Statements (Unaudited)	4
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS		6
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK		12
PART II. OTHER INFORMATION		24
ITEM 1. LEGAL PROCEEDINGS		24
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K		24
SIGNATURES		25

Biosite®, Triage®, ExpressTest® and Immediate Response Diagnostics® are registered trademarks of Biosite Incorporated. Omniclonal™, Trans-Phage Technology^SM and the Company's logo are trademarks or service marks of Biosite Incorporated.

Part I. Financial Information

ITEM 1. FINANCIAL STATEMENTS

BIOSITE INCORPORATED

Condensed Balance Sheets (Unaudited)
(in thousands except par value)

			September 30, 2001		December 31, 2000
			(Unaudited)		(Note)
Assets
Current assets:
	Cash and cash equivalents		$	6,750	$	1,800
	Marketable securities, available-for-sale			45,297		34,400
	Accounts receivable, net			8,114		11,794
	Inventories, net			7,891		6,445
	Other current assets			3,876		5,648

		Total current assets		71,928		60,087
Property, equipment and leasehold improvements, net				13,316		10,681
Patents and license rights, net				9,368		8,614
Other assets				5,234		3,632

			$	99,846	$	83,014

Liabilities and stockholders' equity
Current liabilities:
	Accounts payable		$	1,910	$	1,293
	Accrued salaries and other			3,516		3,103
	Current portion of long-term obligations			2,079		2,024

		Total current liabilities		7,505		6,420
Long-term obligations				3,619		3,708
Commitments and contingencies
Stockholders' equity:
	Preferred stock, $.01 par value, 5,000 shares authorized, none issued and outstanding at September 30, 2001 and December 31, 2000			—		—
	Common stock, $.01 par value, 25,000 shares authorized; 14,546 and 14,127 shares issued and outstanding at September 30, 2001 and December 31, 2000, respectively			145		141
	Additional paid-in capital			74,746		65,085
	Unrealized net gain (loss) on marketable securities, net of related tax effect			512		(83	)
	Retained earnings			13,319		7,743

		Total stockholders' equity		88,722		72,886

			$	99,846	$	83,014


Note:		The balance sheet at December 31, 2000 has been derived from the audited financial statements at that date but does not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements.

See accompanying notes.

BIOSITE INCORPORATED

Condensed Statements of Income (Unaudited)
(in thousands, except per share amounts)

			Three months ended September 30,						Nine months ended September 30,
			2001			2000			2001			2000
Revenues:
	Product sales		$	15,941		$	13,330		$	45,477		$	38,662
	Contract revenue			1,066			1,052			2,897			2,077

		Total revenues		17,007			14,382			48,374			40,739
Operating expenses:
	Cost of product sales			4,144			3,936			12,831			11,326
	Selling, general and administrative			5,333			4,057			16,507			13,294
	Research and development			3,573			3,656			10,189			10,149
	License and patent disputes			1,185			0			1,658			0

		Total operating expenses		14,235			11,649			41,185			34,769

Operating income				2,772			2,733			7,189			5,970
Interest and other income				677			589			1,921			1,608

Income before provision for income taxes				3,449			3,322			9,110			7,578
Provision for income taxes				(1,319	)		(1,300	)		(3,534	)		(2,877	)

Net income			$	2,130		$	2,022		$	5,576		$	4,701

Net income per share:
	—Basic		$	0.15		$	0.15		$	0.39		$	0.35

	—Diluted		$	0.14		$	0.13		$	0.36		$	0.31

Shares used in calculating per share amounts:
	—Basic			14,538			13,923			14,355			13,614

	—Diluted			15,463			15,620			15,525			15,197

See accompanying notes.

BIOSITE INCORPORATED

Condensed Statements of Cash Flows (Unaudited)
(in thousands)

		Nine Months Ended September 30,
		2001			2000
OPERATING ACTIVITIES
Net cash provided by operating activities		$	17,309		$	5,972
INVESTING ACTIVITIES
	Proceeds from sales and maturities of marketable securities		37,956			19,388
	Purchase of marketable securities		(47,861	)		(25,669	)
	Purchase of property, equipment and leasehold improvements		(5,035	)		(2,768	)
	Patents, license rights, deposits and other assets		(2,471	)		(1,435	)

	Net cash used in investing activities		(17,411	)		(10,484	)
FINANCING ACTIVITIES
	Proceeds from issuance of financing obligations		1,541			1,841
	Principal payments under financing obligations		(1,575	)		(1,556	)
	Proceeds from issuance of common stock, net		5,086			4,499

	Net cash provided by financing activities		5,052			4,784

Increase in cash and cash equivalents			4,950			272
Cash and cash equivalents at beginning of period			1,800			4,594

Cash and cash equivalents at end of period		$	6,750		$	4,866

SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
	Interest paid	$	323		$	370

	Income taxes refund (paid)	$	1,637		$	(1,253	)

See accompanying notes.

BIOSITE INCORPORATED

Notes to Condensed Financial Statements (Unaudited)

1.: BASIS OF PRESENTATION

The accompanying unaudited condensed financial statements have been prepared in accordance with both generally accepted accounting principles for interim financial information, and 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 generally accepted accounting principles for complete financial statements. The accompanying financial statements reflect all adjustments (consisting of normal recurring accruals) that are, in the opinion of management, considered necessary for a fair presentation of the results for the interim periods presented. Interim results are not necessarily indicative of results for a full year. We have experienced significant quarterly fluctuations in our operating results and we expect that these fluctuations in sales, expenses and operating results may continue.

The financial statements and related disclosures have been prepared with the presumption that users of the interim financial information have read or have access to the audited financial statements for the preceding fiscal year. Accordingly, these financial statements should be read in conjunction with the audited financial statements and the related notes thereto contained in our Annual Report on Form 10-K for the year ended December 31, 2000.

2.: EARNINGS PER SHARE

Earnings per share, EPS, is computed in accordance with Statement of Financial Accounting Standards No. 128, Earnings per Share, FAS 128. FAS 128 requires dual presentation of basic and diluted earnings per share. Basic EPS includes no dilution and is computed by dividing net income by the weighted average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution of securities that could share in our earnings, such as common stock equivalents that may be issuable upon exercise of outstanding common stock options. Common stock equivalents are not considered in loss years as the effect is antidilutive.

Shares used in calculating basic and diluted earnings per share were as follows (in thousands):

	Three months ended September 30,		Nine months ended September 30,
	2001	2000	2001	2000
Weighted average common shares outstanding—Shares used in calculating per share amounts—Basic	14,538	13,923	14,355	13,614
Net effect of dilutive common share equivalents using the treasury stock method	925	1,697	1,170	1,583

Shares used in calculating per share amounts—Diluted	15,463	15,620	15,525	15,197

3.: BALANCE SHEET INFORMATION

Net inventories consist of the following:

	September 30, 2001		December 31, 2000
	(in thousands)
Raw materials	$	2,119	$	2,207
Work-in-process		3,863		3,287
Finished goods		1,909		951

	$	7,891	$	6,445

4.: COMPREHENSIVE INCOME

Financial Accounting Standards Board's Statement No. 130, Comprehensive Income, FAS 130, establishes rules for the reporting and display of comprehensive income and its components. FAS 130 requires the change in net unrealized gains or losses on marketable securities be included in comprehensive income. As adjusted, our comprehensive income is as follows:

	Three months ended September 30,				Nine months ended September 30,
	2001		2000		2001		2000
	(in thousands)				(in thousands)
Net income	$	2,130	$	2,022	$	5,576	$	4,701
Change in unrealized net gain (loss) on marketable securities, net of tax		339		38		595		(27	)

Comprehensive income	$	2,469	$	2,060	$	6,171	$	4,674

5.: RECENT ACCOUNTING PRONOUNCEMENTS

In July 2001, the Financial Accounting Standards Board issued Statements of Financial Accounting Standards No. 141, Business Combinations, FAS 141 and No. 142, Goodwill and Other Intangibles Assets, FAS 142. FAS 141 requires all business combinations initiated after June 30, 2001 to be accounted for using the purchase method. Under FAS 142, goodwill and intangible assets with indefinite lives are no longer amortized but are reviewed annually, or more frequently if impairment indicators arise, for impairment. Separable intangible assets that are not deemed to have indefinite lives will continue to be amortized over their useful lives, but with no maximum life. The amortization provisions of FAS 142 apply to goodwill and intangible assets acquired after June 30, 2001. With respect to goodwill and intangible assets acquired prior to July 1, 2001, the Company is required to adopt FAS 142 effective October 1, 2002 but may early adopt in the first quarter of 2002. We believe that the adoption of this standard will not have a material impact on the Company's financial statements.

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

The matters discussed in this Management's Discussion and Analysis of Financial Condition and Results of Operations contain forward-looking statements that involve risks and uncertainties, including the timely development, introduction and acceptance of new products, dependence on others, the impact of competitive products, the enforcement, defense and resolution of license and patent matters, changing market conditions and the other risks detailed under "Factors that May Affect Results" and throughout our Annual Report on Form 10-K for the year ended December 31, 2000. Actual results may differ materially from those projected. These forward-looking statements represent our judgment as of the date of the filing of this Form 10-Q and our Form 10-K, respectively. We disclaim any intent or obligation to update these forward-looking statements.

Overview

We were established in 1988. We are a research-based diagnostics company dedicated to the discovery and development of novel protein-based tests that improve a physician's ability to diagnose debilitating and life-threatening diseases and conditions. We combine integrated discovery and diagnostics businesses to access proteomics research, identify proteins with high diagnostic utility, develop and commercialize products and educate the medical community on new diagnostic approaches that improve health care outcomes.

Our diagnostics business is a leading provider of rapid tests that aid in the diagnosis of a variety of critical diseases and conditions. These tests are sold worldwide primarily for use in hospitals. Our two product platforms are designed to provide rapid results through either qualitative visual readings or quantitative meter readings. These platforms are based upon our proprietary technologies in the areas of antibody development, signaling chemistry and micro-capillary fluidics. Our testing formats are designed to measure single analyte targets or multiple analytes simultaneously. They also allow for the analysis of various sample sources, including urine, serum, plasma, whole-blood and stool. Among the products expected to contribute most significantly to product sales in the future are the Triage® Drugs of Abuse Panel, the Triage Cardiac Panel and the Triage BNP Test.

The principal market for our products is comprised of hospitals, which number approximately 5,000 in the United States. We aim to place our products in emergency departments and other point-of-care locations, as well as in laboratories. In marketing our products we utilize a direct sales team that includes general account executives and cardiovascular account executives, who have extensive experience selling cardiovascular devices or drugs. The Fisher HealthCare division of the Fisher Scientific Company, Fisher, distributes our products in U.S. hospitals and supports our direct sales force. In international markets we utilize a network of country-specific and regional distributors.

In March 1999, we launched Biosite Discovery, a collaborative research business dedicated to the identification of new protein markers for acute diseases. Through Biosite Discovery, we conduct analyses on both known disease markers and potential markers accessed from pharmaceutical and biotechnology companies in order to determine their diagnostic utility. We refer to this process as marker mining. If the diagnostic utility of a marker is established, it is then assessed for commercialization potential, with high value markers being added to our product development pipeline. To gain access to novel proteins, we primarily leverage our expertise in phage display antibody development, providing pharmaceutical and biotechnology companies with high throughput development of high affinity antibodies for research use and seeking, in exchange, licenses to their protein targets in addition to fees. Under Biosite Discovery, we have executed collaborative agreements with companies in the areas of cardiovascular, cerebrovascular, infectious disease and oncology.

Our product sales to date have primarily resulted from sales of the Triage Drugs of Abuse Panel product line. The Triage Drugs of Abuse Panel products are marketed pursuant to distribution

agreements in the U.S. hospital market segment by Fisher, which accounted for 85% of our product sales in the first nine months of 2001 and 84% in the full year 2000, and internationally by country- specific and regional distributors. Since its launch in 1992, the Triage Drugs of Abuse Panel product line has experienced continued annual revenue growth. We believe, however, that domestic sales of the Triage Drugs of Abuse Panel products may decline as the available U.S. market becomes saturated and competitive pressures become more prominent in a maturing market.

We have reported quarterly operating profits since the third quarter of 1999, after incurring quarterly operating losses during the prior seven quarters. Our operating results may fluctuate on a quarterly or annual basis in the future and our growth or operating results may not be consistent with predictions made by securities analysts.

We believe that our future operating results will be subject to quarterly fluctuations due to a variety of factors, including:

•: market acceptance of current or new products
•: whether and when new products are successfully developed and introduced by us
•: changes in the mix of products sold
•: the timing and variability of significant orders
•: seasonal customer demand
•: research and development efforts, including clinical trials and new product scale-up activities
•: enforcement, defense and resolution of license and patent disputes
•: ability to execute, enforce and maintain license and collaborative agreements necessary to earn contract revenues
•: attainment of milestones under collaborative agreements necessary to earn contract revenues
•: competitive pressures on average selling prices
•: manufacturing delays or inefficiencies
•: changes in reimbursement policies
•: regulatory uncertainties or delays
•: product recalls
•: shipment problems, and
•: costs and timing associated with business development activities, including potential licensing of technologies.

Operating results would also be adversely affected by a downturn in the market for our products. Because we continue to increase our operating expenses to support our expanded sales and marketing activities, manufacturing operations, Biosite Discovery and new product development, our operating results would be adversely affected if our sales and gross profits did not correspondingly increase or if our Biosite Discovery or product development efforts are unsuccessful or subject to delays. Our limited operating history makes accurate prediction of future operating results difficult or impossible. We may not sustain revenue growth or sustain profitability on a quarterly or annual basis, and our growth or operating results may not be consistent with predictions made by securities analysts.

Recent Developments

On May 10, 2001, we received notice from XOMA Ltd. and its affiliates ("XOMA"), alleging that we have breached our obligations under three license agreements with XOMA. The license agreements relate to the bacterial expression of antibodies. On June 8, 2001, we filed an action in the U.S. District Court for the Northern District of California, seeking declaratory relief that XOMA has no right to terminate the agreements and that Biosite is not infringing any XOMA patents, and injunctive relief related to XOMA's threat to terminate the agreements. We believe that XOMA's conduct threatens to cause damages to Biosite which are not easily calculable or easily compensable by money damages. On July 5, 2001, XOMA filed a complaint in the same court (the "XOMA action").In September, 2001, the Court denied Biosite's request for a preliminary injunction, dismissed XOMA's action in part with leave to amend, and dismissed Biosite's action without prejudice to Biosite's right to plead its claims in defense and counterclaims in the XOMA action. XOMA's complaint, which has now been amended, alleges fraud, breach of contract, patent infringement, misappropriation and unfair business practices on the part of Biosite. XOMA seeks injunctive relief, unspecified damages, a trebling of damages under the patent laws and punitive damages. On November 7, 2001, Biosite filed its answer denying the material allegations of the XOMA amended complaint, and counterclaims against XOMA including claims for breach of contract and tortious interference. Biosite intends to contest XOMA's claims vigorously. We believe that there has been no misrepresentation or breach of the agreements, that our rights under the agreements have not been terminated and, accordingly, no misappropriation or unfair business practice has occurred, and that our activities do not infringe XOMA's patents. The range of possible outcomes from these proceedings could include judgments in our favor, judgments against us or settlements that might or might not have a material adverse impact on our business. Although we continue to conduct business with existing and potential partners, our dispute with XOMA has interfered with certain activities with existing partners with a resulting reduction of our contract revenues.

Results of Operations

Product Sales. Product sales for the three and nine months ended September 30, 2001 were $15.9 million and $45.5 million, respectively, representing increases of 20% and 18%, compared to $13.3 million and $38.7 million, respectively, for the same periods of 2000. The increase in product sales was primarily attributable to the growth in net sales of our Triage Cardiac Panel and Triage BNP Test. Net sales of our quantitative platform products, consisting of the Triage Cardiac Panel, Triage BNP Test and Triage Meter, were approximately $5.1 million and $14.9 million, respectively, for the three and nine months ended September 30, 2001, as compared to $3.2 million and $10.1 million, respectively, for the same periods of 2000. The Triage Cardiac System's net sales growth for the three and nine months ended September 30, 2001, as compared to the same periods of 2000, was primarily due to growth in our customer base and to a lesser extent due to changes in the average net sales price. The Triage BNP Test was launched in the U.S. in December 2000.

Net sales of our qualitative platform products, consisting of the Triage Drugs of Abuse Panel and Triage Micro Panels, were approximately $10.8 million and $30.6 million, respectively, for the three and nine months ended September 30, 2001, as compared to $10.1 million and $28.5 million, respectively, for the same periods of 2000. The growth in our qualitative platform products for the three and nine months ended September 30, 2001 as compared to the same periods of 2000 was primarily related to an increase in the average net sales price of the Triage Drugs of Abuse Panel and sales volume growth of the Triage Micro Panels. Net sales of the Triage Drugs of Abuse Panel for the three and nine months ended September 30, 2001 increased $284,000 and $1.1 million respectively, as compared to the same periods in 2000. We believe that the domestic sales of the Triage Drugs of Abuse Panel products may decline as the available U.S. market becomes saturated and competitive pressures become more prominent in a maturing market.

Contract Revenues. Contract revenues consist of revenues associated with our research and development and licensing arrangements, including license fees, milestone revenues, royalties, research funding and antibody fees. Contract revenues for the three and nine months ended September 30, 2001 were approximately $1.1 million and $2.9 million, respectively, as compared to $1.1 million and $2.1 million, respectively, for the same periods of 2000. Contract revenues recognized during the three and nine months ended September 30, 2001 consisted primarily of research funding and antibody fees. In June 2000, the Company entered into an alliance with Medarex Inc. Under the terms of the agreement, Biosite receives research funding of $3.0 million per year over eight years from Medarex, along with research fees and, if any products are generated through the collaboration, milestone payments and royalties. For the three and nine months ended September 30, 2001, we recognized $750,000 and $2.3 million, respectively, of research funding from the alliance with Medarex. Contract revenues recognized during the third quarter of 2000 consisted primarily of $750,000 of research funding from Medarex, while contract revenues recognized during the first nine months of 2000 consisted primarily of license fees, research funding from Medarex and a milestone payment related to the launch of the Triage Cardiac System in a certain international territory. Costs associated with contract revenues are included in research and development expenses. Although we continue to conduct business with existing and potential partners, our dispute with XOMA has interfered with certain activities with existing partners with a resulting reduction of our contract revenues.

Cost of Sales and Gross Profit From Product Sales. Gross profit from product sales for the three and nine months ended September 30, 2001 were $11.8 million and $32.6 million, respectively, representing increases of 26% and 19%, respectively, compared to $9.4 million and $27.3 million, respectively, for the same periods of 2000. Gross profits increased primarily due to an overall increase in net sales. The overall gross margin for the third quarter of 2001 was 74%, compared to 70% for the same period of 2000. The overall gross margin for the first nine months of 2001 was 72%, compared to 71% for the first nine months of 2000. The increase in the overall gross margin for the third quarter of 2001 compared with the same period of 2000 was primarily due to an increase in the average net sales price of our products and to the temporary utilization of two production shifts for our quantitative platform products in order to meet increased manufacturing demands resulting from the planned installation of significant automated production equipment, which requires higher than normal down days for installation and validation, and anticipated increased customer demand for the products. Using two production shifts spreads our fixed manufacturing overhead costs over a greater volume of product manufactured. Sales of our quantitative platform products represented 32% and 33%, respectively, of our product sales for the three and nine months ended September 30, 2001, compared to 24% and 26%, respectively, for the same periods in 2000. Our newer products are expected to continue to realize lower gross margins than the Triage Drugs of Abuse Panel during the early stages of their commercialization as that product platform's manufacturing costs are spread over lower sales volumes and efficiencies within the manufacturing processes are optimized. We also believe that the overall gross margin may decrease as a result of competitive pricing pressures related to the maturing Triage Drugs of Abuse product line, the elimination of the second shift, and the changing mix of net sales of products with different gross margins.

Selling, General and Administrative Expenses (SG&A expenses). SG&A expenses for the three and nine months ended September 30, 2001 were $5.3 million and $16.5 million, respectively, representing increases of 32% and 24% respectively, compared to $4.1 million and $13.3 million, respectively, for the same periods of 2000. The increase in SG&A expenses during the third quarter and first nine months of 2001, as compared to the same period of 2000, was primarily due to increases in employee expenses as we increased the size of our sales force and added clinical and implementation specialists and to increases in marketing and clinical education programs associated with our newer products.

Research and Development Expenses. Research and development expenses for the three and nine months ended September 30, 2001 were $3.6 million and $10.2 million, respectively, compared to

$3.7 million and $10.1 million, respectively, for the same periods of 2000. During the third quarter and first nine months of 2001, our research and development resources were focused primarily on new product development, the development of potential improvements to our existing products, and research activities associated with Biosite Discovery. Expenses related to the performance of our obligations associated with earning our contract revenues were incurred by our research and development group, primarily Biosite Discovery. We expect that our research and development expenses for the fourth quarter of 2001 to be comparable with the third quarter of 2001. The expenditures will relate primarily to product development efforts, clinical studies, Biosite Discovery, and new product scale-up activities associated with the Triage TOX Drug Screen, which is currently under FDA review. The timing of the expenditures and their magnitude are primarily dependent on the progress and success of the research and development and the timing of potential product launches.

License and patent disputes. Expenses associated with license and patent disputes incurred during the three and nine months ended September 30, 2001 totaled $1.2 million and $1.7 million, respectively. The expenses consisted primarily of legal costs related to our litigation with XOMA, Inc. No expenses associated with the XOMA litigation were incurred prior to May 2001. We intend to vigorously defend ourselves in these disputes and expect that the total costs associated with executing our defense in the XOMA litigation may continue to be significant in 2001 and 2002.

Interest and Other Income, net. Interest and other income for the three and nine months ended September 30, 2001 increased $88,000 and $313,000, respectively, from the same periods of 2000. The increases resulted primarily from the higher average balance of cash and marketable securities during the third quarter and first nine of 2001 as compared to the same periods of 2000.

Benefit (Provision) for Income Taxes. As a result of the pre-tax income and the estimated tax credits to be generated in 2001, we recorded a provision for income taxes of $3.5 million for the first nine months of 2001. For the same period in 2000, we recorded a provision for income taxes of $2.9 million. We will continue to assess the likelihood of realization of our tax credits and other net deferred tax assets. If future events occur that do not make the realization of such assets more likely than not, a valuation allowance will be established against all or a portion of the net deferred tax assets.

Liquidity and Capital Resources

We have financed our operations through cash from operations, private and public placements of equity securities, debt and capital lease financing, cash received under collaborative agreements and interest income. As of September 30, 2001, we had cash, cash equivalents and marketable securities of approximately $52.0 million compared to $36.2 million as of December 31, 2000.

The increase in cash, cash equivalents and marketable securities during the nine months of 2001 was largely attributable to cash generated from operating activities, which totaled $17.3 million for the first nine months of 2001, compared to $6.0 million for same period of 2000. The cash generated from operating activities resulted primarily from the reduction of accounts receivable of $3.6 million, tax benefit of disqualifying dispositions of $4.5 million and a refund of income taxes paid of $1.6 million. Other significant sources of cash included proceeds from the issuance of common stock under employee stock plans totaling $5.1 million and proceeds from equipment financing arrangements of $1.5 million. Significant uses of cash for the first nine months of 2001 included the purchase of leasehold improvements and capital equipment of $5.0 million, principal payments under equipment financing arrangements of $1.6 million and the purchase of certain license rights to patented technologies of $1.5 million.

The increase in cash, cash equivalents and marketable securities during the first nine months of 2000 was largely attributable to cash generated from the operating activities of $6.0 million, the receipt

of $4.5 million in proceeds from the issuance of common stock under our employee stock plans, and the receipt of $1.8 million in proceeds from equipment financing. Significant uses of cash for the first nine months of 2000 included purchase of leasehold improvement and capital equipment of approximately $2.8 million, principal payments under equipment financing obligations of $1.6 million, and an additional $1.0 million payment made under a technology licensing arrangement previously entered into.

Our primary short-term needs for capital, which are subject to change, are for the support of our commercialization efforts related to new products, expansion of our manufacturing capacity and efficiency, new product development, license and patent disputes, clinical trials, development and expansion of our Biosite Discovery antibody research capacity, and the continued advancement of research and development efforts. We executed agreements to license technologies patented by others that call for milestone payments and future royalties based on product sales utilizing the licensed technologies. We may enter into additional licensing agreements that may include up-front and annual cash payments and future royalties based on product sales utilizing the licensed technologies. We utilized and may continue to utilize credit arrangements with financial institutions to finance the purchase of capital equipment. Additionally, we may utilize cash generated from operating activities, if any, to meet our capital requirements.

We are also evaluating various alternatives in addressing our future facilities expansion needs. The alternatives being evaluated include negotiations with various parties for the leasing of additional facility space and potentially a new corporate facility to be constructed in San Diego, which would be adequate for our foreseeable future needs. If a new corporate facility were to be constructed to meet future needs, we would not anticipate expanding our operations to the new facility prior to 2003. Expanding into a new facility would be expected to result in reimbursable cash expenditures prior to occupancy for purchase of land and construction and an increase in occupancy costs.

We believe that our available cash, cash from operations and funds from existing credit arrangements will be sufficient to satisfy our funding needs for at least the next 24 months. Thereafter, if cash generated from operations is insufficient to satisfy our working capital and capital expenditure requirements, we may be required to sell additional equity or debt securities or obtain additional credit facilities. Additional capital, if needed, may not be available on satisfactory terms, if at all. Furthermore, any additional equity financing may be dilutive to stockholders, and debt financing, if available, may include restrictive covenants. Our future liquidity and capital funding requirements will depend on numerous factors, including:

•: the extent to which our new products and products under development are successfully developed, gain market acceptance and become and remain competitive
•: the costs and timing of further expansion of sales, marketing and manufacturing activities, expansion of our Biosite Discovery capacity and facilities expansion needs
•: the enforcement, defense and resolution of license and patent disputes
•: the ability to execute, enforce and maintain license and collaborative agreements and attain the milestones under these agreements necessary to earn contract revenues
•: the timing and results of research and development efforts including clinical studies and regulatory actions regarding our potential products
•: changes in third-party reimbursement policies, and
•: the costs and timing associated with business development activities, including potential licensing of technologies patented by others.

Our failure to raise capital on acceptable terms, when needed, could have a material adverse effect on our business.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We are exposed to changes in interest rates, primarily from our variable-rate long-term debt arrangements and, to a lesser extent, our investments in available-for-sale marketable securities. Under our current policies, we do not use interest rate derivatives instruments to manage this exposure to interest rate changes. We do have the option to convert our variable-rate long-term debt arrangements to fixed-rate debt arrangements for a nominal transaction fee. As of September 30, 2001, we had variable-rate debt totaling approximately $522,000. A hypothetical 1% adverse move in interest rates along the entire interest rate yield curve would not materially affect the fair value of our financial instruments that are exposed to changes in interest rates.

Additionally, our purchases of Triage Meters from LRE Technology Partner GmbH, LRE, are denominated in German Deutsche Marks (DM) and sales of some products to some international customers are denominated in the local currency of customers. We have on occasion purchased forward exchange contracts to manage this exposure to exchange rate changes. As of September 30, 2001, we had no outstanding forward exchange contracts. Total receivables and payables denominated in foreign currencies as of September 30, 2001 were not material.

FACTORS THAT MAY AFFECT RESULTS

This report includes forward-looking statements about our business and results of operations which are subject to risks and uncertainties that could cause our actual results to vary materially from that indicated from such forward-looking statements. Factors that could cause or contribute to such differences include those discussed below, as well as those discussed elsewhere in the Form 10-Q and in our Annual Report on Form 10-K for the year ended December 31, 2000. The factors discussed below should be read in conjunction with the risk factors discussed in our Annual Report on Form 10-K, which are incorporated by reference.

We Have Only a Limited History of Profitability and We May Not Maintain Profitability. In Addition Our Quarterly Results Will Fluctuate.

We have reported quarterly operating profits since the third quarter of 1999 after incurring quarterly operating losses during the prior seven quarters. Our operating results may fluctuate on a quarterly or annual basis in the future. We believe that our future operating results will be subject to quarterly fluctuations due to a variety of factors, including:

•: market acceptance of current or new products
•: whether and when new products are successfully developed and introduced by us
•: changes in the mix of products sold
•: the timing and variability of significant orders
•: seasonal customer demand
•: research and development efforts, including clinical trials and new product scale-up activities
•: enforcement, defense and resolution of license and patent disputes
•: ability to execute, enforce and maintain license and collaborative agreements necessary to earn contract revenues
•: attainment of milestones under collaborative agreements necessary to earn contract revenues
•: competitive pressures on average selling prices
•: manufacturing delays or inefficiencies

•: changes in reimbursement policies
•: regulatory uncertainties or delays
•: product recalls
•: shipment problems, and
•: costs and timing associated with business development activities, including potential licensing of technologies.

Operating results would also be adversely affected by a downturn in the market for our products. Because we continue to increase our operating expenses to support our expanded sales and marketing activities, manufacturing operations and new product development, our operating results would be adversely affected if our sales and gross profits did not correspondingly increase or if our product development efforts are unsuccessful or subject to delays. Our limited operating history makes accurate prediction of future operating results difficult or impossible. We may not sustain revenue growth or sustain profitability on a quarterly or annual basis and our growth or operating results may not be consistent with predictions made by securities analysts.

We Are Dependent on the Development and Introduction of New Products for Revenue Growth and Profitability.

Except for our commercialized products, all of our products are still under development and may not be successfully developed or commercialized on a timely basis, or at all. If we are unable, for technological or other reasons, to complete the development, introduction or scale-up of manufacturing for any new product or if any new product is not approved for marketing or does not achieve a significant level of market acceptance, we will be harmed.

We believe that our revenue growth and profitability will substantially depend upon our ability to complete development of and successfully introduce these new products as well as continue to achieve a growing level of market acceptance of new products such as the Triage Cardiac Panel and the Triage BNP Test. In addition, the successful development of some of these new products will depend on the development of new technologies. We will be required to undertake time-consuming and costly development activities and seek regulatory approval for these new products. We may experience difficulties that could delay or prevent the successful development, introduction and marketing of these new products. Regulatory clearance or approval of any new products may not be granted by the U.S. Food and Drug Administration, the FDA, or foreign regulatory authorities on a timely basis, or at all, and the new products may not be successfully commercialized.

If we fail to establish and maintain:

•: reliable, cost-efficient, high volume manufacturing capacity
•: a cost-effective sales force and administrative infrastructure, or
•: an effective product distribution system for our products

we may not be able to successfully commercialize our current or new products.

We Are Dependent in the Near Term on Sales of the Triage Drugs of Abuse Panel. A Significant Reduction in Sales of the Triage Drugs of Abuse Panel Would Harm Us.

Sales of the Triage Drugs of Abuse Panel products accounted for approximately 60% of our product sales in the first nine months of 2001 and 68% of our product sales for the calendar year 2000. We expect our revenue and profitability to substantially depend on the sale of the Triage Drugs of Abuse Panel products for the foreseeable future. A significant reduction in demand for the Triage

Drugs of Abuse Panel products would have a material adverse effect on us. We believe that domestic net sales of the Triage Drugs of Abuse Panel products may decline as the available U.S. market becomes saturated. Competitive pressures could also erode our profit margins for the Triage Drugs of Abuse Panel products. Our continued growth will depend on our ability to

•: successfully commercialize our newer products
•: develop and commercialize other products, and
•: gain additional acceptance of the Triage Drugs of Abuse Panel products in new market segments, such as international markets.

We may not be able to successfully commercialize new products, including the Triage Cardiac Panel and Triage BNP Test, and we may not be able to maintain or expand our share of the drug-testing market. Technological change or the development of new or improved diagnostic technologies could result in our products becoming obsolete or noncompetitive.

We Are Dependent on Key Distributors and Have Limited Direct Sales Experience. If Our Distributors Terminate Their Relationship With Us or Fail to Adequately Perform, Our Product Sales Will Suffer.

We rely upon a key distributor alliance with Fisher to distribute our products in the United States and may rely upon distributors to distribute products under development. All of our products are currently marketed pursuant to distribution agreements in the U.S. hospital market segment by Fisher (which accounted for 85% of product sales in the first nine months of 2001 and 84% for the year 2000) and internationally by country-specific and regional distributors. The loss or termination of one or more of these distributors could have a material adverse effect on our sales.

If any of our distribution or marketing agreements are terminated and we are unable to enter into alternative agreements or if we elect to distribute new products directly, we would have to invest in additional sales and marketing resources, including additional field sales personnel, which would significantly increase future selling, general and administrative expenses. We have limited experience in direct sales, marketing and distribution of our products. Our direct sales, marketing and distribution efforts may not be successful. Further, we may not be able to enter into new distribution or marketing agreements on satisfactory terms, or at all. A failure to enter into acceptable distribution agreements or our failure to successfully market our products would have a material and adverse effect on us.

Competition and Technological Change May Make Our Products Less Attractive or Obsolete.

Diagnostics

The market in which we compete is intensely competitive. Our competitors include:

•: health care companies
•: laboratory-based tests and analyzers, and
•: clinical reference laboratories.

Currently, the majority of diagnostic tests used by physicians and other health care providers are performed by independent clinical reference laboratories and hospital-based laboratories. We expect that these laboratories will compete vigorously to maintain their dominance of the testing market. In order to achieve market acceptance for our products, we will be required to demonstrate that our products provide cost-effective and time saving alternatives to tests performed by clinical reference laboratories or traditional hospital-based laboratory procedures. This will require physicians to change their established means of having such tests performed. Our products may not be able to compete with the testing services provided by traditional laboratory services.

In addition, companies with a significant presence in the diagnostic market, such as:

•: Abbott Laboratories
•: Dade Behring
•: Roche Boehringer Mannheim Corporation
•: Bayer Diagnostics, and
•: Ortho Clinical Diagnostics, a division of Johnson & Johnson

have developed or are developing diagnostic products that do or will compete with our products. These competitors have substantially greater financial, technical, research and other resources and larger, more established marketing, sales, distribution and service organizations than us. Moreover, these competitors offer broader product lines and have greater name recognition than us, and offer discounts as a competitive tactic. In addition, several smaller companies are currently making or developing products that compete with or will compete with our products. Our competitors may succeed in developing or marketing technologies or products that are more effective or commercially attractive than our products, or that would render our technologies and products obsolete. Moreover, we may not have the financial resources, technical expertise or marketing, distribution or support capabilities to compete successfully in the future. In addition, competitors, many of which have made substantial investments in competing technologies, may be more effective than us or may prevent, limit or interfere with our ability to make, use or sell its products either in the United States or in international markets.

Discovery

Several companies, including Cambridge Antibody Technology, Morphosys, and Dyax have invested significantly in phage display technology and each generally employs naïve human antibody libraries to select antibodies for target validation purposes and for the development of therapeutic antibodies. Our competitors entered the marketplace before Biosite Discovery and have established a significant presence in the marketplace. Our competitors may succeed in establishing agreements and providing antibodies to biotechnology and pharmaceutical companies and prevent Biosite Discovery from penetrating the marketplace.

Our Limited Manufacturing Experience and Our Potential Inability to Scale-Up Manufacturing May Adversely Affect Our Ability to Produce Products.

We must manufacture our products in compliance with regulatory requirements, in sufficient quantities and on a timely basis, while maintaining product quality and acceptable manufacturing costs. Significant additional work will be required for the scaling-up of each new product prior to commercialization, and this work may not be completed successfully.

In addition, although we expect some of our newer products and products under development to share production attributes with our existing products, production of these products may require the development of new manufacturing technologies and expertise. These products may not be able to be manufactured by us or any other party at a cost or in quantities to make these products commercially viable. If we are unable to develop or contract for manufacturing capabilities on acceptable terms for our products under development, our ability to conduct pre-clinical and clinical testing will be adversely affected, resulting in the delay of submission of products for regulatory clearance or approval and initiation of new development programs, which would have a material adverse effect on us.

Manufacturing and quality control problems have arisen and may arise as we attempt to scale-up our manufacturing and such scale-up may not be achieved in a timely manner or at a commercially reasonable cost, or at all. Our manufacturing facilities and those of our contract manufacturers are, or will be, subject to periodic regulatory inspections by the FDA and other federal and state regulatory

agencies and these facilities are subject to Quality System Regulations requirements of the FDA. We or our contractors may not satisfy such regulatory requirements, and any failure to do so would have a material adverse effect on us.

We Are Dependent on Sole-Source Suppliers For Our Products. A Supply Interruption Would Harm Us.

Key components and raw materials used in the manufacture of our products are provided by single-source vendors. Any supply interruption in a sole-sourced component or raw material would have a material adverse effect on our ability to manufacture these products until a new source of supply is qualified and, as a result, would have a material adverse effect on us. In addition, an uncorrected impurity or supplier's variation in a raw material, either unknown to us or incompatible with our manufacturing processes of our products, could have a material adverse effect on our ability to manufacture products. We have under development products that, if developed, may require us to enter into additional supplier arrangements. We may not be able to enter into additional supplier arrangements on commercially reasonable terms, or at all. Failure to obtain a supplier for the manufacture of our future products, if any, would have a material adverse effect on us.

We rely upon LRE for production of the fluorescent meter used in connection with our Triage Meter System platform products, including the Triage Cardiac System and Triage BNP System and others currently under development. Our dependence upon LRE for the manufacture of the meter may adversely affect

•: our profit margins
•: our ability to develop and manufacture products on a timely and competitive basis, or
•: the timing of market introductions and subsequent sales of products incorporating the LRE meter.

Health Care Reform and Restrictions on Reimbursement May Adversely Affect Our Results.

In the United States, health care providers that purchase our products and other diagnostic products generally rely on third-party payors to reimburse all or part of the cost of the procedure. Third-party payors can affect the pricing or the relative attractiveness of our products by regulating the maximum amount of reimbursement provided by such payors for testing services. In addition, the tests performed by public health departments, corporate wellness programs and other large volume users in the drug screening market are generally not subject to reimbursement. Further, some health care providers are moving towards a managed care system in which providers contract to provide comprehensive health care for a fixed cost per patient. We are unable to predict what changes will be made in the reimbursement methods utilized by third-party payors. We could be adversely affected by changes in reimbursement policies of governmental or private health care payors, particularly to the extent any such changes affect reimbursement for procedures in which our products are used.

Third-party payors are increasingly scrutinizing and challenging the prices charged for medical products and services. Decreases in reimbursement amounts for tests performed using our products may decrease amounts physicians and other practitioners are able to charge patients, which in turn may adversely affect our ability to sell our products on a profitable basis. Failure by physicians and other users to obtain reimbursement from third-party payors, or changes in government and private third-party payors' policies toward reimbursement of tests utilizing our products could have a material adverse effect on us. Given the efforts to control and reduce health care costs in the United States in recent years, there can be no assurance that currently available levels of reimbursement will continue to be available in the future for our existing products or products under development.

In addition, market acceptance of our products in international markets is dependent, in part, upon the availability of reimbursement within prevailing health care payment systems. Reimbursement

and health care payment systems in international markets vary significantly by country, and include both government sponsored health care and private insurance.

We believe that the overall escalating cost of medical products and services has led to and will continue to lead to increased pressures on the health care industry, both foreign and domestic, to reduce the cost of products and services, including products offered by us. Third-party reimbursement and coverage may not be available or adequate in either U.S. or foreign markets, current reimbursement amounts may be decreased in the future and future legislation, regulation or reimbursement policies of third-party payors may adversely affect the demand for our products or our ability to sell our products on a profitable basis.

Our Patent and Proprietary Technology May Not Provide Us With Any Benefit and the Patents of Others May Prevent Us From Commercializing Our Products.

Our ability to compete effectively will depend in part on our ability to develop and maintain proprietary aspects of our technology, and to operate without infringing the proprietary rights of others or to obtain licenses to such proprietary rights. Our patent applications may not result in the issuance of any patents. Additionally, our patent applications may not have priority over others' applications, or, if issued, our patents may not offer protection against competitors with similar technology. Any patents issued to us may be challenged, invalidated or circumvented in the future and the rights created thereunder may not provide a competitive advantage.

Our products and activities may be covered by technologies that are the subject of patents issued to, and patent applications filed by, others. We have obtained licenses for some technologies. We may negotiate to obtain other licenses for technologies patented by others. Some of our current licenses are subject to rights of termination and may be terminated. Our licensors may not abide by their contractual obligations and, as a result, may limit the benefits we currently derive from their licenses. We may not be able to renegotiate or obtain licenses for technology patented by others on commercially reasonable terms, or at all. We may not be able to develop alternative approaches if we are unable to obtain licenses and our current and future licenses may not be adequate for the operation of our business. The failure to obtain, maintain or enforce necessary licenses or to identify and implement alternative approaches would prevent us from operating some or all of our business and would have a material adverse effect on us.

Litigation may be necessary to enforce any patents issued to us, to protect trade secrets or know-how owned by us or to determine the enforceability, scope and validity of the proprietary rights of others. We have already settled a number of patent infringement claims in the past.

The Legal Proceedings to Obtain Patents and Litigation of Third-Party Claims of Intellectual Property Infringement Could Require Us to Spend Substantial Amounts of Money and Could Impair Our Operations.

We may become subject to additional patent infringement claims and litigation or interference proceedings conducted in the U.S. Patent and Trademark Office, or USPTO, to determine the priority of inventions. We also may receive correspondence from other parties calling to our attention the existence of patents that they believe cover technology that is or may be incorporated in our products and products under development. Some of this correspondence may include offers to negotiate the licensing of the patented technologies. There can be no assurance that these matters would not result in litigation to determine the enforceability, scope, and validity of the patents. Litigation, if initiated, could seek to recover damages as a result of any sales of the products and to enjoin further sales of such products.

Litigation that could be brought forth by other parties may result in material expenses to us and significant diversion of effort by our technical and management personnel, regardless of the outcome.

The outcome of litigation is inherently uncertain and there can be no assurance that a court would not find the third-party claims valid and that we had no successful defense to such claims. An adverse outcome in litigation or the failure to obtain a necessary license could subject us to significant liability and could prevent us from selling our products, which would have a material adverse effect on us.

We also rely upon trade secrets, technical know-how and continuing invention to develop and maintain our competitive position. Others may independently develop substantially equivalent proprietary information and techniques or otherwise gain access to our trade secrets or disclose such technology, and we may not be able to protect our trade secrets or our rights to our trade secrets.

Others may have filed and in the future are likely to file patent applications that are similar or identical to ours. To determine the priority of inventions, we may have to participate in interference proceedings declared by the USPTO that could result in substantial cost to us. Patent applications of others may have priority over patent applications filed by us.

Our commercial success depends in part on us neither infringing patents or proprietary rights of third parties nor breaching any licenses that may relate to our technologies and products. We are aware of several third-party patents that may relate to our technology. We may infringe these patents, or other patents or proprietary rights of third parties. In addition, we have received and may in the future receive notices claiming infringement from third parties as well as invitations to take licenses under third-party patents. Any legal action against us or our collaborative partners claiming damages and seeking to enjoin commercial activities relating to our products and processes affected by third-party rights, in addition to subjecting us to potential liability for damages, may require us or our collaborative partner to obtain a license in order to continue to manufacture or market the affected products and processes. We or our collaborative partners may not prevail in any such action and any license (including licenses proposed by third parties) required under any such patent may not be made available on commercially acceptable terms, or at all. There are a significant number of U.S. and foreign patents and patent applications in our areas of interest, and we believe that there may be

significant litigation in the industry regarding patent and other intellectual property rights. Litigation, including the litigation with XOMA, concerning patent and other intellectual property rights could consume a substantial portion of our managerial and financial resources, which would have a material adverse effect on us.

We May Need Additional Capital. If Additional Capital is not Available, We May Have to Curtail or Cease Operations.

If cash generated from operations is insufficient to satisfy our working capital and capital expenditure requirements, we may be required to sell additional equity or debt securities or obtain additional credit facilities. Additional capital, if needed, may not be available on satisfactory terms, or at all.

Furthermore, any additional equity financing may be dilutive to stockholders, and debt financing, if available, may include restrictive covenants. Our future liquidity and capital funding requirements will depend on numerous factors, including:

•: the extent to which our new products and products under development are successfully developed, gain market acceptance and become and remain competitive
•: the costs and timing of further expansion of sales, marketing and manufacturing activities, expansion of our Biosite Discovery capacity and facilities expansion needs
•: the enforcement, defense and resolution of license and patent disputes
•: the ability to execute, enforce and maintain license and collaborative agreements and attain the milestones under these agreements necessary to earn contract revenues
•: the timing and results of research and development efforts including clinical studies and regulatory actions regarding our potential products
•: changes in third-party reimbursement policies, and
•: the costs and timing associated with business development activities, including potential licensing of technologies patented by others.

The failure by us to raise capital on acceptable terms when needed would cause us to have to scale back our operations, reduce our work force and license to others products we would otherwise seek to develop or commercialize ourselves. See "Management's Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources."

The Regulatory Approval Process is Expensive, Time Consuming and Uncertain Which May Prevent Us From Obtaining Required Approvals or Have Approvals Rescinded for the Commercialization of Our Products.

The testing, manufacture and sale of our products are subject to regulation by numerous governmental authorities, principally the FDA and corresponding state and foreign regulatory agencies. Pursuant to the Federal Food, Drug, and Cosmetic Act, and the regulations promulgated thereunder, the FDA regulates the preclinical and clinical testing, manufacture, labeling, distribution and promotion of medical devices. We will not be able to commence marketing or commercial sales in the United States of new products under development until we receive clearance or approval from the FDA, which can be a lengthy, expensive and uncertain process. Noncompliance with applicable requirements can result in, among other things, fines, injunctions, civil penalties, recall or seizure of products, total or partial suspension of production, failure of the government to grant pre-market clearance or pre-market approval for devices, withdrawal of marketing clearances or approvals and criminal

prosecution. The FDA also has the authority to request recall, repair, replace or refund of the cost of any device manufactured or distributed by us.

In the United States, medical devices are classified into one of three classes, i.e. Class I, II or III, on the basis of the controls deemed necessary by the FDA to reasonably ensure their safety and effectiveness. Class I devices are subject to general controls, e.g., labeling, pre-market notification and adherence to the Quality System Regulation, QSR, and Class II devices are subject to general and special controls, e.g., performance standards, post-market surveillance, patient registries and FDA guidelines. Generally, Class III devices are those which must receive pre-market approval by the FDA to ensure their safety and effectiveness, e.g., life-sustaining, life-supporting and implantable devices or new devices which have been found not to be substantially equivalent to legally marketed devices.

Before a new device can be introduced in the market, the manufacturer must generally obtain FDA clearance through clearance of a 510(k) notification or approval of a pre-market approval, PMA, application. A PMA application must be filed if a proposed device is a new device not substantially equivalent to a legally-marketed Class I or Class II device or if it is a pre-amendment Class III device for which the FDA has called for PMAs. A PMA application must be supported by valid scientific evidence to demonstrate the safety and effectiveness of the device, typically including the results of clinical investigations, bench tests, laboratory and animal studies. The PMA application must also contain a complete description of the device and its components and a detailed description of the methods, facilities and controls used to manufacture the device. In addition, the submission must include the proposed labeling, advertising literature and any training materials. The PMA approval process can be expensive, uncertain and lengthy, and a number of devices for which FDA approval has been sought by other companies have never been approved for marketing.

Upon receipt of a PMA application, the FDA makes a threshold determination as to whether the application is sufficiently complete to permit a substantive review. If the FDA determines that the PMA application is complete, the FDA will accept the application for filing. Once the submission is accepted, the FDA begins an in-depth review of the PMA. The FDA review of a PMA application generally takes one to three years from the date the application is accepted, but may take significantly longer. The review time is often significantly extended by FDA requests for additional information or clarification of information already provided in the submission. During the review period, it is likely that an advisory committee, typically a panel of clinicians, will be convened to review and evaluate the application and provide recommendations to the FDA as to whether the device should be approved. The FDA is not bound by the recommendation of the advisory panel. Toward the end of the PMA review process, the FDA generally will conduct an inspection of the manufacturer's facilities to ensure that the facilities are in compliance with applicable QSR requirements. If FDA evaluations of both the PMA application and the manufacturing facilities are favorable, the FDA may issue either an approval letter or an approvable letter, which usually contains a number of conditions that must be met in order to secure final approval of the PMA. When and if those conditions have been fulfilled to the satisfaction of the FDA, the agency will issue a PMA approval letter, authorizing commercial marketing of the device for certain indications. If the FDA's evaluation of the PMA application or manufacturing facilities is not favorable, the FDA will deny approval of the PMA application or issue a non-approvable letter. The FDA may determine that additional clinical investigations must be performed, in which case the PMA may be delayed for one or more years while additional clinical investigations are conducted and submitted in an amendment to the PMA. Modifications to a device that is the subject of an approved PMA, its labeling or manufacturing process may require approval by the FDA of PMA supplements or new PMAs. Supplements to an approved PMA often require the submission of the same type of information required for an initial PMA, except that the supplement is generally limited to that information needed to support the proposed change from the product covered by the original PMA.

A 510(k) clearance will be granted if the submitted information establishes that the proposed device is "substantially equivalent" to a legally marketed Class I or Class II medical device or to a pre-amendment Class III medical device for which the FDA has not called for PMAs. The FDA recently has been requiring more rigorous demonstration of substantial equivalence than in the past, including in some cases requiring submission of clinical data. It generally takes from three to twelve months from submission to obtain 510(k) pre-market clearance but may take longer. The FDA may determine that a proposed device is not substantially equivalent to a legally marketed device or that additional information is needed before a substantial equivalence determination can be made. A "not substantially equivalent" determination, or a request for additional information, could prevent or delay the market introduction of new products that fall into this category. For any devices that are cleared through the 510(k) process, modifications or enhancements that could significantly affect safety or effectiveness, or constitute a major change in the intended use of the device, will require new 510(k) submissions.

We have made modifications to our products since receipt of initial 510(k) clearance. With respect to several of these modifications, we filed new 510(k) notices describing the modifications and have received FDA clearance of those 510(k) notices. We made other modifications to the Triage Drugs of Abuse Panel which we believe do not require the submission of new 510(k) notices. There can be no assurance, however, that the FDA would agree with any of our determinations not to submit a new 510(k) notice for any of these modifications, or would not require us to submit a new 510(k) notice for any of these modifications made to the Triage Drugs of Abuse Panel. If the FDA requires the Company to submit a new 510(k) notice for any device modification, we may be prohibited from marketing the modified Triage Drugs of Abuse Panel until the 510(k) notice is cleared by the FDA.

We are uncertain of the regulatory path to market that the FDA will ultimately apply to our products currently in development. Although the Triage Drugs of Abuse Panel, Triage C. difficile Panel, Triage Parasite Panel, Triage Cardiac Panel and Triage BNP Test received 510(k) clearance, a PMA was initially required for the Triage BNP Test and may be required for the other products now in development. There can be no assurance that the FDA will not determine that we must adhere to the more costly, lengthy and uncertain PMA approval process for any of our products in development.

We may not be able to obtain necessary regulatory approvals or clearances for our products on a timely basis, if at all. Delays in receipt of or failure to receive such approvals or clearances, the loss of previously received approvals or clearances, limitations on intended use imposed as a condition of such approvals or clearances, or failure to comply with existing or future regulatory requirements would have a material adverse effect on our business, financial condition and results of operations.

Before the manufacturer of a device can submit the device for FDA approval or clearance, it generally must conduct a clinical investigation of the device. Although clinical investigations of most devices are subject to the investigational device exemption, IDE, requirements, clinical investigations of in vitro diagnostic, IVD, tests, such as all of the Company's products and products under development, are exempt from the IDE requirements, including the need to obtain the FDA's prior approval, provided the testing is noninvasive, does not require an invasive sampling procedure that presents a significant risk, does not intentionally introduce energy into the subject, and is not used as a diagnostic procedure without confirmation by another medically established test or procedure. In addition, the IVD must be labeled for research use only, RUO, or investigational use only, IUO, and distribution controls must be established to assure that IVDs distributed for research or clinical investigation are used only for those purposes.

We intend to conduct clinical investigations of our products under development, which will entail distributing them in the United States on an IUO basis. There can be no assurance that the FDA would agree that our IUO distribution of our IVD products under development will meet the requirements for IDE exemption. Furthermore, failure by us or the recipients of our products under

development to maintain compliance with the IDE exemption requirements could result in enforcement action by the FDA, including, among other things, the loss of the IDE exemption or the imposition of other restrictions on our distribution of our products under development, which would adversely affect our ability to conduct the clinical investigations necessary to support marketing clearance or approval.

Any devices manufactured or distributed by us pursuant to FDA clearance or approvals are subject to pervasive and continuing regulation by FDA and certain state agencies. Manufacturers of medical devices for marketing in the United States are required to adhere to QSR, which includes testing, control, documentation, and other quality assurance requirements. Manufacturers must also comply with Medical Device Reporting, MDR, requirements that a manufacturer report to the FDA any incident in which its product may have caused or contributed to a death or serious injury, or in which its product malfunctioned and, if the malfunction were to recur, it would be likely to cause or contribute to a death or serious injury. Labeling and promotional activities are subject to scrutiny by the FDA and, in certain circumstances, by the Federal Trade Commission. Current FDA enforcement policy prohibits the marketing of approved medical devices for unapproved uses.

We are subject to routine inspection by the FDA and certain state agencies for compliance with QSR requirements, MDR requirements and other applicable regulations. The QSR requirements include the addition of design controls that will likely increase the cost of compliance. Changes in existing requirements or adoption of new requirements could have a material adverse effect on our business, financial condition and results of operation. There can be no assurance that we will not incur significant costs to comply with laws and regulations in the future or that laws and regulations will not have a material adverse effect upon our business, financial condition and results of operations.

We are also subject to numerous federal, state and local laws relating to such matters as safe working conditions, manufacturing practices, environmental protection, fire hazard control and disposal of hazardous or potentially hazardous substances. There can be no assurance that we will not incur significant costs to comply with laws and regulations in the future or that such laws or regulations will not have a material adverse effect upon our business, financial condition and results of operations.

The use of our products is also affected by the Clinical Laboratory Improvement Amendments of 1988, CLIA, and related federal and state regulations which provide for regulation of laboratory testing. The scope of these regulations includes quality control, proficiency testing, personnel standards and federal inspections. CLIA categorizes tests as "waived," "moderately complex" or "highly complex," on the basis of specific criteria. There can be no assurance that any future amendment of CLIA or the promulgation of additional regulations impacting laboratory testing will not have a material adverse effect on our ability to market our products or on our business, financial condition or results of operations.

We Are Dependent on Others for the Development of Products. The Failure of Our Collaborations to Successfully Develop Products Would Harm Our Business.

Our strategy for the research, development, commercialization and distribution of some of our products entails entering into various arrangements with third parties. We are or will be dependent upon the success of these parties in performing their responsibilities. These parties may not perform their obligations as expected and no revenue may be derived from these arrangements. Under our Biosite Discovery collaborations, we rely and are dependent upon other parties to perform their responsibilities. Although we continue to conduct business with existing and potential partners, our dispute with XOMA has interfered with certain activities with existing partners that may result in lower contract revenues in the future.

We entered into agreements with partners for the development and marketing of products. The agreements are subject to rights of termination and may be terminated. Our collaborators may not abide by their contractual obligations and may discontinue or sell their current lines of business. The

research for which we receive or provide funding may not lead to the development of products. We intend to enter into additional development and marketing agreements. We may not be able to enter into agreements on acceptable terms, or at all.

We are continuing to enhance, with LRE, a hand-held point-of-care fluorescent meter for use in Triage Meter System products. The meter can be programmed to run a specific test through the use of changeable proprietary software that is also under further improvements by LRE. LRE may not improve the hardware or software on schedule, or at all, and new software that permits the meter to be used for another Triage Meter System product may not be further improved.

We May Not Be Able to Manage Our Growth.

We anticipate increased growth in the number of our employees, the scope of our operating and financial systems and the geographic area of our operations as new products are developed and commercialized. This growth will result in an increase in responsibilities for both existing and new management personnel. Our ability to manage growth effectively will require us to continue to implement and improve our operational, financial and management information systems and to train, motivate and manage our employees. We may not be able to manage our expansion, and a failure to do so could have a material adverse effect on us.

If We Lose Our Key Personnel or Are Unable to Attract and Retain Additional Personnel, We May Not Be Able to Pursue Collaborations or Develop Our Own Products.

Our future success depends in part on the continued service of our key technical, sales, marketing and executive personnel, and our ability to identify, hire and retain qualified personnel. Competition for such personnel is intense and we may not be able to retain existing personnel or identify or hire additional personnel.

We May Have Significant Product Liability Exposure.

The testing, manufacturing and marketing of medical diagnostic devices entails an inherent risk of product liability claims. Potential product liability claims may exceed the amount of our insurance coverage or may be excluded from coverage under the terms of the policy. Our existing insurance may not be renewed at a cost and level of coverage comparable to that presently in effect, or at all. In the event that we are held liable for a claim against which we are not indemnified or for damages exceeding the limits of our insurance coverage, that claim could exceed our total assets.

Part II. Other Information

ITEM 1. LEGAL PROCEEDINGS

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

(a): Exhibits

None

(b): Reports on Form 8-K

None

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.

Dated: November 13, 2001				BIOSITE DIAGNOSTICS INCORPORATED
		By:		/s/ CHRISTOPHER J. TWOMEY Christopher J. Twomey Vice President, Finance and Chief Financial Officer (Principal Financial and Accounting Officer)

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INDEX

Part I. Financial Information

ITEM 1. FINANCIAL STATEMENTS

BIOSITE INCORPORATED Notes to Condensed Financial Statements (Unaudited)

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Part II. Other Information

ITEM 1. LEGAL PROCEEDINGS

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K