-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, NOVO0FlCrUmwo8yKQqIvVB02AFaUC89Jldj1ycrBGcb9BVlFR8saJW1oM/C2Xll6 dwXb+DSsnM7WhO14s7fwjw== 0001017062-01-000661.txt : 20010402 0001017062-01-000661.hdr.sgml : 20010402 ACCESSION NUMBER: 0001017062-01-000661 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 20001231 FILED AS OF DATE: 20010330 FILER: COMPANY DATA: COMPANY CONFORMED NAME: VENTANA MEDICAL SYSTEMS INC CENTRAL INDEX KEY: 0000893160 STANDARD INDUSTRIAL CLASSIFICATION: SURGICAL & MEDICAL INSTRUMENTS & APPARATUS [3841] IRS NUMBER: 942976937 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 000-20931 FILM NUMBER: 1584947 BUSINESS ADDRESS: STREET 1: 3865 N BUSINESS CENTER DRIVE CITY: TUCSON STATE: AZ ZIP: 85705 BUSINESS PHONE: 5208872155 MAIL ADDRESS: STREET 1: 3865 N BUSINESS CENTER DR CITY: TUCSON STATE: AZ ZIP: 85705 10-K 1 0001.txt FORM 10-K - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 ---------------- FORM 10-K ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 2000 Commission File No. 000-20931 ---------------- VENTANA MEDICAL SYSTEMS, INC. (Exact name of small business issuer as specified in its charter) Delaware 94-2976937 (State of Incorporation) (IRS Employer Identification No.) 3865 North Business Center Drive Tucson, AZ 85705 (Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (520) 887-2155 ---------------- Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Common Stock, $.001 par value ---------------- 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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or other information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [_] The aggregate value of voting stock held by non-affiliates of the Registrant was approximately $298,747,235 based upon the average of the high and low prices of the Registrant's Common Stock reported for such date on the Nasdaq National Market. Shares of Common Stock have been excluded in that such persons may be deemed to be affiliates. The determination of affiliate status is not necessarily a conclusive determination for other purposes. As of December 31, 2000, the Registrant had outstanding 15,444,122 shares of Common Stock. DOCUMENTS INCORPORATED BY REFERENCE Not applicable - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- PART I Item 1. Description of Business This report on Form 10-K may contain projections, estimates and other forward-looking statements that involve a number of risks and uncertainties. For a discussion of factors which may affect the outcome projected in such statements, see "Cautionary Factors That May Affect Future Results," beginning on page 14. While this outlook represents our current judgment on the future direction of our business, such risks could cause actual results to differ materially from our future performance listed below. We undertake no obligation to release publicly the results of any revisions to these forward- looking statements to reflect events and circumstances arising after the date of this report on Form 10-K. For our current and historical financial positions, see "Selected Financial Data," beginning on page 26. Summary of Our Business Unless the context requires otherwise, all references to we, our or us refer to Ventana Medical Systems, Inc., a corporation originally incorporated in the state of Delaware in 1993, and its six subsidiaries: . Ventana Medical Systems GmbH . Ventana Medical Systems Japan K.K. . Ventana Medical Systems, Pty. Ltd. . Ventana Medical Systems, S.A. . BioTek Solutions, Inc. . BioTechnology Tools, Inc. We develop, manufacture and market instruments and consumables that are used to automate diagnostic and drug discovery procedures in clinical histology laboratories and drug discovery laboratories worldwide. Our instrument-reagent systems are designed to prepare and stain patient tissue or cells mounted on a microscope slide for examination by a pathologist. The consumable products we market that are required to operate our instruments include reagents and other accessories. Our systems are designed to provide users with high-quality and consistent results, high throughput and significant labor savings. Our clinical products are used by histology labs, which are labs that focus on the analysis of human tissue, to assist anatomical pathologists in the diagnosis of cancer and infectious diseases. Most histology labs are hospital based although some independent reference labs offer histology services. Our drug discovery products are used by research labs at large pharmaceutical and biotechnology companies and medical research centers to assist in the discovery of new drugs. Our instruments have been placed in the majority of the top fifty U.S. cancer centers, which are recognized as leaders in cancer research and treatment as reported in the July 2000 issue of U.S. News and World Report. These include Johns Hopkins Hospital, the Mayo Clinic, Memorial Sloan-Kettering Cancer Center and M.D. Anderson Medical Center. Histology tests performed on our instruments are used by pathologists and oncologists to assist in diagnosis of cancer and infectious diseases and to select an appropriate therapy. According to the National Cancer Institute, cancer is the second leading cause of death in the United States. Currently 8.4 million people in the U.S. have a history of invasive cancer. Mortality rates are improved by early detection and the selection of appropriate therapies. Based upon our modeling of the market, we estimate that histology labs worldwide purchase in excess of $1.3 billion in instruments and consumables on an annual basis. In addition, the pharmaceutical and biotechnology companies who are analyzing the human genome and proteome to accelerate new drug discovery also benefit from automating the analysis of human and animal tissue and cells. 1 Industry Overview We target our instrument-reagent systems at two markets: the histology lab and the drug discovery lab. We currently derive the majority of our revenues and profits from ongoing sales of consumables to histology labs and the sale of instrument systems, although we expect sales to research labs engaged in drug discovery to grow over time. Histology Histology is the study of the microscopic structure of tissues. In a histology lab, an anatomical pathologist attempts to identify the causes and consequences of disease in a specific part of the body. An anatomical pathologist uses tools ranging from the naked eye to powerful microscopes and even molecular analysis of cell proteins and genes. This is done by examining tissue samples obtained during surgery or through biopsy procedures to identify structural and other changes in cells, tissues and organs. Anatomical pathology examinations are among the most reliable ways to establish: (1) a diagnosis of the type of disease suffered by the patient, (2) a prognosis on the likely progression of the disease, and (3) a determination as to which therapies are most likely to be effective in treating the patient. Based upon a survey of hospitals, we estimate that there are about 6,000 histology labs worldwide. Of this total we estimate about 2,900 are in North America, 2,000 in Europe and 1,100 in Japan and the remainder of the world. Histology is principally a North American term. In many countries histology (the analysis of tissue) and cytology (the analysis of cells) labs are combined into a single anatomical pathology lab. All patient samples entering the histology lab move through seven basic processing steps or work cells: . Accessioning--Tissue is entered into the hospital information system for medical records and billing purposes. . Grossing--Following accessioning, the gross patient tissue specimen is examined by a pathologist. Several tissue samples are then cut from the gross specimen for further examination and placed in small plastic cassettes. . Tissue Processing--Cassettes from gross specimens are generated throughout the day and placed at the end of the day in an instrument called a tissue processor for overnight batch processing. Tissue processors preserve the tissue through the use of a fixative, usually formalin, and infusing the tissue with paraffin so it can be more readily sectioned or cut. An alternative to using a fixative is to freeze tissue and handle it in a frozen state although, we estimate that less than 5% of patient specimens entering histology labs are frozen. . Embedding--The first activity that usually occurs in a histology laboratory each morning is to remove the processed tissue from each cassette and embed it in a paraffin block. This work is performed manually and is undertaken to produce a specimen of uniform size that can be cut on a microtome. . Sectioning--Each tissue block is next transferred to the sectioning area of the lab where very thin sections are cut on a microtome and mounted on a microscope slide. The number of slides that are cut from each block varies according to the case and is usually determined by the pathologist who is performing the gross analysis. . Hemotoxlyn and Eosin, or H&E, Staining--Each microscope slide is then stained with two basic stains, Hemotoxlyn and Eosin, that help the pathologist identify each cell's nucleus, cytoplasm and membrane. . Microscopic Examination--Finally, each H&E stained slide is examined by a pathologist using a microscope to determine if the tissue or cells are healthy or diseased. In particular, the pathologist is looking for the presence of microorganisms that could indicate an infectious disease or deformed cells that could indicate the presence of cancer. In cases where an H&E stained slide appears to have abnormalities, the pathologist performing the initial examination of a patient specimen may request that the slide undergo additional testing. We estimate this happens in approximately 15% of cases. 2 Additional tests which may be requested by the pathologist include immunohistochemistry, Special Stains or in situ hybridization tests. These tests are significantly more complex than the H&E stains and require special reagents. . Immunohistochemistry, or IHC, stains are used primarily by pathologists and oncologists to assist in the diagnosis of cancer and to determine different treatment options. Pathologists use IHC stains to test for the presence or over expression of the proteins involved in cancer. . Special Stains are used primarily to assist in the diagnosis of infectious diseases, although they can also be used to assist in cancer diagnosis. Special Stains are chemical dye stains that localize to microorganisms located in tissue and to specific tissue types. . In situ hybridization, or ISH, stains can be used to assist in the diagnosis of infectious diseases or genetic mutations that are usually associated with the presence of cancer. We do not currently participate in all histology lab work cells. We currently offer products that are used in tissue processing, IHC staining, Special Stains and ISH staining. Tissue Processing. In developed nations, all histology labs have at least one automated tissue processor instrument and most labs have two or more. In less developed countries, tissue processing is still performed manually in most labs. We estimate that the worldwide installed base of tissue processing instruments is greater than 10,000 and, based upon our field experience, we estimate annual shipments to be between 1,000 and 1,500 instruments. The size of the annual market is driven primarily by replacements, although some shipments reflect growth driven by an increase in surgical procedures. Tissue processors consume a substantial quantity of reagents (fixatives, alcohol, xylene, paraffin), however we do not participate in this reagent market. IHC Staining. We estimate that there are in excess of 30 million slides stained with IHC annually on a worldwide basis. The majority of these slides are stained in the approximately 6,000 hospital-based histology labs. However, in North America and Japan some hospitals send their IHC slides to regional reference labs for staining rather than performing the work themselves. We estimate that the number of IHC slides processed by labs in the U.S. on an annual basis is growing at about a 6%-8% rate due to: . increasing acceptance of the value of the technology by pathologists and oncologists; . the increasing incidence of cancer as the population ages; . the emergence of new stains that may influence therapy choices; and . the shifting of the market from manual to automated IHC slide processing. We estimate that approximately 50% of the IHC slides processed in North America and Europe are stained on automated instruments. Most of the rest of the world is using manual staining, which we believe represents a substantial growth opportunity as a portion of these users are converted to automated systems. IHC instruments require reagents and accessories to operate. We supply a full line of these consumables for use with our instruments. Our experience in the industry suggests that we are the worldwide market leader in supplying automated IHC staining systems. Special Stains. We estimate that the Special Stains market is slightly smaller than the worldwide IHC market and growing rapidly. There is an opportunity to place instruments with virtually every hospital-based histology lab as Special Stains slides are rarely sent to reference labs. Currently, nearly all Special Stains slides are manually processed. We believe that a major segment of the market will switch toward automated slide processing over the next 5-10 years. ISH Staining. The clinical market for ISH staining is currently very small due to the difficulty of performing ISH stains manually and the small number of stains accepted for clinical use. We expect automation to grow the clinical market. Currently, the principal clinical tests are used to detect infectious diseases, primarily 3 viruses, in tissue. However, ISH tests for genetic mutations may eventually become important clinical tests. One of the few ISH genetic mutation tests performed in the histology lab today is the test for Her-2/neu gene over- amplification in cancerous breast tissue. This is currently a small market as most laboratories prefer to measure Her-2/neu status using an IHC stain. New Drug Research The research market for new drugs comprises over 500,000 researchers worldwide located in labs operated by traditional pharmaceutical companies, biopharmaceutical companies, governments and medical research centers. In these labs, research is being conducted to determine the causes of disease and the discovery of drugs to treat disease. Genomics, or the study of genes and their function, is seeking to accelerate the drug discovery process by understanding the molecular mechanisms of disease. The genomics revolution is providing researchers with a dramatic increase in the number of potential drug targets, such as a specific protein involved in a disease process, against which to conduct screens of compound collections, or compound libraries. Genomics is the analysis of nucleic acids, which are the fundamental regulatory molecules of life. Nucleic acids take two forms, DNA or RNA. These molecules contain and convey the instructions that govern all cellular activities, including protein manufacture and cell reproduction. DNA and RNA consist of linear strands of nucleotide bases, the specific sequences of which constitute the genetic information in the cell. The unique genetic blueprint for all living organisms is encoded in the DNA. The entire DNA content of an organism is known as its genome, which is organized into functional units called genes. Any defect or mutation in the sequence of nucleotide bases in the DNA or RNA can disrupt cell or protein function and lead to disease. Genomics has created opportunities to fundamentally alter the field of human medicine through the discovery of new biological targets for drugs and an improved ability to diagnose and manage disease. Interest in understanding the relationships between genes and disease has generated a worldwide effort to identify and sequence the genes of many organisms, including the approximately three billion nucleotide pairs and the estimated 30,000 genes within the human genome. Once researchers identify the genes and their nucleotide sequences, we anticipate that an understanding of the specific function of each of these genes and the role that different genes play in disease will require many years of additional research. Proteomics is the analysis of proteins which are encoded by active genes and are the direct cause of diseases in the body. It is believed that there are many more proteins in the human body than genes. The human proteome is years away from being decoded but this task will be simplified as the function of the estimated 30,000 human genes is uncovered. Proteomics is likely to increase in importance in drug discovery labs. Business Strategy Our objectives are to: (1) expand our worldwide leadership position in automating histology labs and (2) leverage the core technologies we have developed for the histology lab into drug discovery labs. Our business strategies to achieve these objectives are as follows: . Provide high-quality, innovative and flexible automation systems for tissue analysis. Our position as a leader in the histology lab automation market has been built on innovative automated instrument-reagent systems. Our systems have been designed as broad enabling platforms that permit customers to easily expand their test menu. These automated systems allow for superior patient care by providing anatomical pathologists with higher quality, more consistent and more timely staining than through manual methods. Further, labs benefit by increasing output and reducing labor costs through automation and walk-away convenience. . Provide high throughput, value-added testing systems for drug discovery applications. We intend to pursue the same broad strategies in the drug discovery market as we are pursuing in the histology market. We also intend to consider developing relationships with other organizations with complementary skills or technologies, which should allow us to quickly acquire capabilities we need in a rapidly changing market. 4 . Maximize placement of our automated systems in histology and drug discovery laboratories both domestically and worldwide. Rapidly automating manual work cells permits us to strengthen our competitive position by establishing a large base of instruments that current or future market entrants must overcome. We estimate that our worldwide installed base of IHC and Special Stains instruments is significantly larger than the combined installed bases of instruments of all of our current competitors. We believe that the size and quality of our direct sales coverage will permit us to maximize instrument placements and maximize revenue stream per placement. . Ensure a steady sales stream of consumables for use in these instruments. Each IHC, Special Stain and ISH instrument placed typically provides us with a recurring revenue stream through the sale of reagents and other consumable supplies. Our strategy is to increase this revenue stream by converting all existing manual tests performed by the customer to full automation and by selling the customer all the required reagents for the automated tests. We intend to expand our menu of automated tests over time, which should increase the consumable revenue we receive from each instrument placement, as typically our systems are closed systems which can only be operated with consumables produced by us. . Continue ongoing technological development and improvement of our instruments and reagents. We design all of our own products, unlike most of our competitors, who rely on outside design firms to create their instruments. We are developing new instruments and enhancing existing instruments and developing reagents for our installed base of instruments as well as for new products. Our engineering, marketing and reagent research and development organizations work closely with their manufacturing counterparts on all new products to ensure they can be produced cost effectively. We protect our designs with an aggressive intellectual property strategy. History of the Company We were incorporated in California in 1985 by a pathologist practicing at the University of Arizona Medical Center who was interested in automating IHC staining. In 1989 we procured venture capital funding and launched our first instrument-reagent system in 1991. In 1993 we were reincorporated in Delaware. We have launched multiple new systems since then, some of which were developed internally and some of which were acquired. 5 Our Products We market four product lines: tissue processors, IHC staining instruments, Special Stains instruments and ISH staining instruments. All of these instruments use consumables such as reagents, barcode labels, and wicking pads, many of which we sell. Our product offerings are summarized in the table below: Product Offerings
Instrument Targeted Customers Uses Consumables ---------- ------------------ ---- ----------- Renaissance Tissue Histology Labs Fix tissue and embed Yes--but largely Processor sample in paraffin. supplied by third parties TechMate 500 System Histology Labs Stain tissue with 10 accessory products Reference Labs antibodies and 2 detection systems detection chemistry 30 primary antibodies to identify proteins. BenchMark IHC and ISH Histology Labs Prepare and stain 16 accessory products System Reference Labs issue with antibodies 6 detection systems and detection 30 primary antibodies chemistry to identify proteins. Prepare and stain tissue with probes and detection chemistry to help identify infectious diseases and genetic mutations. NexES IHC System Histology Labs Stain tissue with 6 detection systems antibodies and 214 primary detection chemistry antibodies to identify proteins. NexES Special Stains Histology Labs Stain tissue with 14 accessory products System Reference Labs chemical dyes to 14 Special Stains identify microorganisms and specific types of tissue. Discovery ISH and Biotechnology Hybridize nucleic 13 accessory products IHC System Companies, acid microarrays with 2 detection systems Pharmaceutical ISH probes. Companies, Government Conduct mRNA studies Labs, Medical in tissue. Research Labs Prepare and stain tissue with antibodies and detection chemistry to identify proteins.
Tissue Processors We entered the tissue processing work cell when we acquired BioTechnology Tools. BioTechnology Tools designed, manufactured and marketed through distributors a tissue processor known as the PTP-1530 which we have subsequently modified and now market as the Renaissance. Our Renaissance tissue processor is a batch instrument that can accommodate up to 350 specimens at a time. This completely enclosed system can be configured as a floor or bench top unit. It has easy-to-use software with flexible programmability and a pulse magnetic stirrer that significantly improves the quality of prepared 6 tissue. The Renaissance quality control system allows the customer to monitor the quality of the reagents being used, and to extend the life of their reagents using a paraffin cleaning system. We do not market a complementary line of consumables with the Renaissance. Staining Systems and Associated Reagents The principal benefits of automated cellular and tissue analysis using our integrated systems as compared with manual methods are: . improved reliability, reproducibility and consistency of test results; . faster turnaround time for test results; . increased test throughput for the testing; . reduced dependence on skilled technicians; . ability to obtain maximum clinical information from minimally-sized biopsies; . ability to document processing protocols; . enhanced cellular differentiation through multiple staining on a single slide; and . standardization of slide preparation among institutions. In addition to these critical clinical and operational advantages, we have determined that our automated approach has cost advantages as well. IHC Staining. Our first product launch in 1991 was an instrument-reagent system to automate IHC staining. Prior to the introduction of this system, all IHC staining was performed manually or using low-level automation. In early 1996, we acquired our principal competitor in the IHC market, BioTek Solutions, Inc. We now enjoy a leading market share position in automated IHC staining worldwide. We currently market three IHC instrument systems with a full line of complementary reagents and accessories. Our line of IHC products includes batch-processing systems targeted to large hospital clinical labs and reference labs and patient priority systems targeted to hospital clinical labs and fast turn around time applications in reference labs. Although our existing batch processing systems are "open," providing the customer with the ability to purchase reagents from either us or other sources, the majority of our United States customers with batch processing systems regularly purchase reagents from us. Our patient priority systems are "closed" in that customers must purchase detection chemistries from us in order to operate the instruments. Our TechMate 500 batch processing instruments has a 120-slide capacity and is designed for large volume testing using a single antibody on multiple patient biopsies and research applications in which long incubation times and unique detection chemistries are required. Our batch processing instruments employ capillary action to perform IHC tests. Patient biopsies are placed on capillary gap slides, which maintain a space of predetermined width between adjacent slides when loaded into TechMate 500 systems. Reagents are loaded into disposable reagent trays and programmable software directs the instrument to apply the reagents in the proper sequence. The instrument immerses the bottoms of the slides in the reagents as programmed and the reagents are drawn up the slide and over the tissue specimen by capillary action. After each reagent application and incubation, the instrument removes the reagent from the specimen by placing the slides onto disposable blotting pads. In North America, we directly manufacture and market reagents for use in our TechMate systems. The TechMate 500 is applicable to both large and moderately sized reference labs and large research labs. Our premier IHC system is the BenchMark which was launched in late 2000. We believe this is a revolutionary instrument from two perspectives. First, it automates all of the steps in the IHC workcell from "BTS" (baking through staining), saving up to 90 minutes of manual preparatory work required prior to an IHC run. Second, the BenchMark will perform both IHC and more complex ISH stains. The BenchMark system is 7 barcode driven and is designed for multiple tests on a single patient biopsy with rapid turnaround time and walk-away convenience. A barcode label affixed to each slide positively identifies the slide and the test procedures to be performed. The instrument scans the barcodes on the slides and the reagent dispenses and processes each slide with the unique steps necessary to perform each test. Our proprietary software controls all aspects of the test procedures. The steps of dispensing, incubating (i.e. temperature and time control) and washing are performed by the instrument using a series of proprietary chemical/mechanical methods developed by us. These methods are critical to obtaining precise, sensitive and rapid test results and make the system reliable and easy to use. Typically, the processing of slides on the instrument requires less than two hours. The BenchMark is based upon a modular design and an external personal computer operating under a Windows environment for software control. Each module holds up to 20 slides in the reaction chamber and 25 reagents on its reagent carousel. The modular design of the BenchMark and external personal computer permits the linkage of up to eight BenchMark IHC/ISH or NexES Special Stains modules together, creating the capacity to process up to 160 slides. The BenchMark therefore offers users a significant degree of flexibility as users can purchase from one to eight modules depending upon their test volume requirements. Reagent products are composed of bulk reagents, for example, reagents that remove paraffin from tissue samples and condition the cells, and dispenser administered reagents such as primary antibodies and detection chemistries, each of which is required for an IHC test. Customers that have patient priority systems must use our detection chemistries on all tests. They have the option of purchasing primary antibodies from us or other sources. Customers who have our batch processing systems have the option of purchasing both antibodies and detection chemistries from us or other sources. Users of a majority of our United States installed batch processing systems regularly purchase reagents from us. Our NexES IHC staining system continues to be a key tool in supporting automation of mid-size and smaller volume customer accounts in IHC. We sell a line of over 214 primary antibodies for use on our IHC systems. These are used to detect antigens in combination with detection chemistry kits on our instruments. The antibodies we market to perform IHC tests currently account for more than 90% of total IHC test volume. We estimate that detection chemistries typically account for approximately 60% of the total expenditures for reagents required to perform IHC tests using our instruments. This figure will decrease as we continue to place BenchMarks. Reagents used to prepare tissue prior to applying a primary antibody will become an important source of revenue to us. We produce a line of detection chemistries for use on both patient priority and batch processing systems which provide the user with standardized reagents, thereby giving the user convenient and rapid results. The detection chemistries have been developed by using proprietary formulations which, when combined with our primary antibodies and other reagents, optimize the results of tests performed on our instruments. These kits generate the visual signal in an IHC reaction at the site where a primary antibody is bound to a specific antigen or molecule in the cell or tissue. The patient priority system utilizes detection kits which include: (i) a DAB Kit which generates a brown color; (ii) an AEC Kit which generates a deep red color; (iii) an Alkaline Phosphatase Red Kit which generates a bright red color; and (iv) an Alkaline Phosphatase Blue Kit which generates a deep blue color. We currently sell DAB and Alkaline Phosphatase Red for use with our batch processing instruments. The detection kits are designed to perform tests on a wide variety of specimens, so a lab can, for example, perform tests on tissue preserved in paraffin and on frozen tissue simultaneously. Our detection chemistries have been formulated to provide long term stability for reproducibility and ease of use as well as a high signal to noise ratio for optimal sensitivity. We offer a line of consumable ancillary products that are necessary for processing slides on our instruments. These include buffers for optimizing the IHC reaction and counterstains for staining cell nuclei, which are used with both patient priority and batch processing instruments. The buffers ensure good morphology, low backgrounds and high signals. The counterstains provide additional convenience for the customer by eliminating the need for additional processing of the slides after staining on the instrument. For use with patient priority 8 instruments, we also supply a proprietary liquid coverslip used to inhibit evaporation during processing in the instrument, fixatives for maintaining the morphology of cells or tissues, enzymes for unmasking antigens and slide barcodes for use in identifying the slide and its specific IHC reaction steps. For use with batch processing instruments, we also provide disposable reagent trays which are used to hold the reagents during IHC reactions, capillary gap slides and wicking pads used for reagent removal between applications. Special Stains. In late 1998, we launched our second instrument-reagent system which handles Special Stains testing. It was the first automated Special Stains system offered to histology labs. We believe that we have established ourselves as the clear market leader in this product segment. We supply both an automated instrument for Special Staining and all the reagents needed to operate the instrument. Two competitors have entered the automated Special Staining market since we launched our system. The Special Stains module can be operated by the same control computer that operates our NexES IHC modules. Any combination of up to eight Special Stains and IHC modules may be operated by a single control computer. This flexibility enables customers to design a combination Special Stains/IHC system that meets the specific needs of their lab. It also provides future flexibility for handling lab growth. The Special Stains module uses a different approach for dispensing reagents than the IHC system. The Special Stains aspiration and dispense system permits us to use a low cost container for our reagents. We currently market fourteen different Special Stains kits that we estimate account for approximately 90% of all types of Special Stains performed in histology labs. We plan to expand this test menu in the future so that our Special Stain system can meet more than 95% of most laboratories Special Staining needs. All of our Special Stain kits were developed using proprietary protocols. ISH Staining. We entered the ISH staining market with the launch of our GenII system in 1995. The GenII was primarily sold into the drug discovery market although some instruments were placed in histology labs for clinical use. We have not aggressively marketed the GenII in recent years due to high field support requirements and low consumption of reagents and accessories. Our recently launched BenchMark instrument has ISH capability. We plan to leverage this capability with a broad menu of clinical ISH tests. ISH tests to identify Epstein Barr Virus and Cytomegalovirus were launched in late 2000. This menu will be supplemented with the launch of Human Papilloma Virus and Her-2/neu gene amplification tests in early 2001. We launched an ISH and IHC staining system for drug discovery labs in December 1999 called the Discovery. The Discovery system can function as a high throughput processor of DNA and RNA microarrays. It can also be used as a high throughput processor of tissue stains used to validate gene drug leads. We anticipate that this system will primarily be sold to companies involved in drug research. The Discovery staining system consists of a staining module and a full line of complementary reagents and accessories. The "front-end" of the system is open, permitting researchers to use their own molecular probes in searching for genetic mutations or antibodies in searching for proteins. The "back-end" of the system, consisting of detection chemistry that attaches to the molecular probe or protein and permits the researcher to visualize the target, is closed and must be purchased from us. The only exception to this is where the detection chemistry is mounted on the target probe. This is the case when a fluorescent in situ hybridization, or FISH, stain is performed. Like the BenchMark system, the Discovery system incorporates a number of important technological advances over our earlier NexES IHC and Special Staining systems. The principal advantage is the ability to accurately control the reaction temperature. In contrast, the NexES IHC and Special Stain modules heat the entire reaction chamber to a pre-set temperature and maintain that temperature during the entire processing cycle. Individual slide heaters in the Discovery permit an optimal protocol to be developed for each test. It also permits the unwinding or denaturing step that is critical to detecting DNA abnormalities. We have filed a number of patents to protect inventions incorporated into the Discovery system. Many of these inventions are also incorporated in our BenchMark system. 9 Our Discovery system is currently being used, or tested for use, in the following drug discovery applications: . Processing Nucleic Acid Microarrays. These assays are used to identify genes that are possible targets for drug therapy. Our Discovery instrument can be used to process DNA and RNA assays. . Processing Tissue Samples. Companies engaged in drug discovery are confirming gene and protein in traditional tissue slides. Our Discovery instrument can be used to detect gene expression levels in tissue and to identify protein levels in tissue. Research & Development Our research and development group is divided into two teams: one that is responsible for instrument development and a second which develops staining protocol and reagents. We have focused our efforts on the development of innovative combined instrument-reagent systems. We are developing new instruments and enhancing existing instruments. In addition, we are developing reagents for our installed base of instruments as well as for new products. Our research and development activities are performed primarily by our staff of 76 employees. These efforts are supplemented by consulting services and assistance from scientific advisors. We spent $11.1 million in 2000, $7.1 million in 1999 and $5.1 million in 1998 on research and development. Instrumentation Development Projects Our instrumentation development is focused on continuous product improvement and new product development. We believe that the modular platform used by our NexES IHC system has enabled us to develop new products more rapidly. We implemented this strategy with the launch of the NexES Special Stains system in 1998, our Discovery System launched in late 1999 and the BenchMark launched in late 2000. We expect to continue this modular development strategy in the future. We continue to explore new opportunities in instrument systems that add value to our customer, including automating other manual processes in the histology lab. Reagent Development Projects Our reagent development is divided into five principal areas: . new antibody development; . detection chemistries; . Special Stain chemistries; . ISH clinical chemistries for BenchMark; and . ISH and IHC applications for the Discovery. We continue to monitor third-party development of new primary antibodies and will license or purchase these as appropriate. Primary antibodies are used to identify abnormal levels of patient expression which assists pathologists in recommending treatment protocols for cancer patients. We also continue to improve the sensitivity and specificity of our detection chemistries. New detection chemistries with higher signal strength and lower background noise were introduced in early 1999. Reagent development also supports the development of new instrument systems. A complete reagent product line was introduced in conjunction with the October 1998 launch of the Special Stain module. Development of reagents to support our Discovery ISH instrument is ongoing. These include applications to hybridize microarrays and to conduct message expression studies in tissue. 10 Customers Our customers consist of clinical histology labs and the drug discovery labs of large pharmaceutical companies, biotechnology companies, government labs and medical research centers. None of our customers accounted for more than 5% of our consolidated revenues in 2000, 1999 or 1998. Patents and Proprietary Rights We have pursued a strategy of patenting key technologies that relate to both the automation and chemistry of analyzing cells and tissues on microscope slides. We presently own 32 United States patents and numerous corresponding foreign patents. We have also filed patent applications in the U.S. and abroad that cover research and development as it relates to existing and future products. In 2000, three of our U.S. patents issued. We also have access to some key technology through exclusive and nonexclusive licenses, such as patented Human Papilloma Virus sequences. Our patent portfolio is divided roughly into two segments: instruments and reagents. Patents and applications related to instruments include: . three U.S. patents directed to the Liquid Cover Slip(TM) technology; . the suite of patents related to the TechMate instrument that covers all aspects of the instrument including the algorithm for the interleaving of steps of a run; . two separate U.S. patents on reagent dispenser designs; . apparatus for automated IHC tissue staining; and . independently heatable slide staining apparatus. Reagent patents and applications include: . tissue fixatives; . hybridization methods and compositions; . IHC staining methods and reagents; . biotin/avidin formulations and methods; and . compositions for manual and automated assessment of various types of cancer including breast, leukemia and prostate. Sales and Marketing Our histology lab strategy involves providing customers with superior levels of customer service. We believe this can only be achieved by selling our products directly to customers, rather than through distributors, in our major markets and by controlling our own telephone and field service forces. Based on our experience in the industry, we believe we have the world's largest direct sales force covering histology labs. We believe that the size and quality of our direct sales coverage will permit us to maximize instrument placements and maximize revenue stream per placement. This sales force is organized geographically by region in North America and by country internationally. In North America we also have a separate sales organization focused solely on national and key accounts. In North America, Japan and in most major European markets we sell all of our products on a direct basis. In most other countries, we rely on distributors to sell and service our products. We also have a dedicated Worldwide Marketing team responsible for identifying new product opportunity, working with R&D on product development and driving revenues worldwide through tactical marketing support. 11 We are in the process of building separate tactical marketing and sales organizations in North America, Western Europe and Japan to cover the drug discovery labs of biotechnology and pharmaceutical companies and medical research labs. These sales forces will primarily promote our Discovery instruments and related consumables. In addition to maintaining direct sales organizations in our major markets, we also maintain direct customer telephone and field service operations. This permits us to maintain a close relationship with our customers which we hope to leverage from instrument placement, through reagent and consumable sales to instrument replacement. This relationship will also allow us to provide high quality and rapid service in response to customer feedback. We also have a comprehensive customer education program, which includes on- site technical training in instrument use, user group meetings and sponsored national teleconferences with leading medical experts who regularly update our customers on diagnostic and testing developments. Competition We face a wide array of different competitors in the histology lab and drug discovery markets. In many product segments our competitors have substantially greater experience than us and far greater name recognition by our customers. In most product segments competition is intense and is based on product performance and price, the breadth of a company's product line, and after- sales service. Histology Our competitors in histology vary by product category. Our principal competitor in tissue processing is Sakura Fine Technical Co., Ltd., a privately held Japanese company with far greater market share, experience and name recognition than we have. Additional competitors in tissue processing include Leica Microsystems Group, a German based competitor, and Thermo BioAnalysis Group, a U.S. public company that owns Shandon Lipshaw, a formidable competitor worldwide in histology lab equipment. Despite the strong entrenched competition in this segment we believe we are increasing our market share through strong sales increases of our Renaissance tissue processor. We are the market share leader in automated IHC staining. We have a worldwide installed base of instruments that exceeds all of our competitors combined. Historically, we have also placed more new instruments each year than all of our competitors combined. Nevertheless, we face strong competition on two fronts. Indirect competition comes from the manual method of performing IHC tests. A number of histology labs in the U.S. and the majority of histology labs outside the U.S. still perform their IHC slide staining manually. Significant barriers to automation of this process exists in some countries where reimbursement for IHC tests by insurance companies and government health care plans is low. Further, significant barriers to automation exist in a number of labs where pathologists prefer manually stained slides which were created using their own staining protocols. Direct competition currently comes from four competitors who market instrument-reagent IHC staining systems. The competitors are Dako, a privately held Danish company that dominates the market for manual IHC reagents; BioGenex Laboratories, Inc., a privately held U.S. company that markets its own instrument and line of reagents; LabVision Corporation, a subsidiary of publicly traded Sybron Corporation, supplies Dako with instruments and also markets its own instruments both on a direct basis and through distributors in most major markets and Diagnostics Products Corp., which markets a high volume IHC slide stainer, principally in Europe. Two automated Special Staining systems compete with our Special Staining module. CytoLogix Corp., a venture-backed, U.S.-based, early-stage company markets the Artisan Staining System. The CytoLogix system has expanded its menu of reagents to include IHC stains and potentially ISH stains. BioGenex also markets a line of Special Stains instruments called Optimax which was originally designed for IHC staining. We believe 12 that the initial success we have enjoyed in automating the Special Stains market will attract additional competitors. Drug Discovery The two principle drug discovery applications we are focusing on are hybridizing nucleic acid microarrays and conducting messenger RNA expression studies in tissue. Other companies providing nucleic acid microarray hybridizers include Genomic Solutions, Inc. and Molecular Dynamics, subsidiary of publicly traded Amersham Pharmacia Biotech. We do not currently face any other competitors that provide automated systems for conducting messenger RNA studies in tissue. We also sell Discovery IHC staining capabilities to drug discovery labs. Other competitors providing this capability include our clinical IHC competitors Dako and BioGenex, among others. Manufacturing We manufacture all of our own instruments except the TechMate 500 system. This product is produced by a third-party manufacturer and accounts for only a small portion of our total sales. We maintain three manufacturing facilities-- an instrument manufacturing facility located in Tucson, Arizona, a separate reagent manufacturing facility also located in Tucson, Arizona and a second reagent manufacturing facility located in Gaithersburg, Maryland. We have announced plans to relocate our Gaithersburg, Maryland facility and consolidate our manufacturing operations in the third quarter of 2001 into our new facility under construction near Tucson, Arizona. Our manufacturing operations are required to follow the FDA Quality Systems Regulations. These regulations require us to maintain documentation and process control in a prescribed manner with respect to manufacturing, testing and quality control. We are also subject to FDA inspections to verify compliance with FDA requirements. We also intend to implement manufacturing policies and procedures that will enable us to receive ISO 9001 certification. ISO 9001 standards are global standards for design and manufacturing process control and quality assurance. Finally, we are required to obtain the CE mark for sale of our products in the countries comprising the European Union. The CE mark is an international symbol of quality assurance and compliance with applicable European Union medical device directives. Contracts We place instruments through direct sales, including nonrecourse leases, instrument rentals and our Performance Evaluation Period program. The program is intended to permit a customer to use an instrument, generally for a period of up to three months, provided that the customer purchases all the consumables needed to operate the instrument from us. At the end of the three- month period, the customer elects to purchase, rent or return the system. For placement of instruments under this program, we incur the cost of manufacturing instruments and we recognize revenue only at the time the instrument is either sold or rented rather than at the time of instrument placement. Employees As of December 31, 2000 we had approximately 515 full-time employees, including our 12 officers. 13 Cautionary Factors That May Affect Future Results Risks Relating to Our ability to sustain revenue growth and Availability of Third-Party profitability may depend on the ability of our Reimbursement and Potential customers to obtain adequate levels of third- Adverse Effects of Health party reimbursement for use of certain Care Reform diagnostic tests in the United States, Europe and other countries. Currently, the availability of third-party reimbursement is limited and uncertain for some IHC tests. In the United States, our products are purchased primarily by medical institutions and laboratories which bill various third-party payors, such as Medicare, Medicaid, other government programs and private insurance plans, for the health care services provided to their patients. Third-party payors may deny reimbursement to our customers if they determine that a prescribed device or diagnostic test has not received appropriate FDA or other governmental regulatory clearances or approvals, is not used in accordance with cost-effective treatment methods as determined by the payor, or is experimental, unnecessary or inappropriate. The success of our products may depend on the extent to which appropriate reimbursement levels for the costs of such products and related treatment are obtained by our customers from government authorities, private health insurers and other organizations, such as health maintenance organizations, or HMOs. Third-party payors are increasingly challenging the prices charged for medical products and services. The trend towards managed health care in the United States and the concurrent growth of organizations such as HMOs could significantly influence the purchase of health care services and products. In addition, the federal government and certain members of Congress have proposed, and various state governments have adopted or are considering, programs to reform the health care system. These proposals are focused, in large part, on controlling the escalation of health care expenditures. The cost containment measures that health care payors are instituting and the impact of any health care reform could have a material adverse effect on the levels of reimbursement the Company's customers receive from third-party payors and the Company's ability to market and sell its products and consequently could have a material adverse effect on the Company's business, financial condition and results of operations. A reduction in government A portion of our products are sold to funding to research centers universities, research laboratories, private will reduce their ability to foundations and other institutions where purchase our products funding is dependent upon grants from government agencies, such as the National Institutes of Health. Research funding by the government could be significantly reduced. Any such reduction may materially affect the ability of many of our research customers to purchase our products. 14 Future operating results may Our operating results may fluctuate depending fluctuate depending on: on sales of instruments and sales of reagents. If our actual earnings in a given quarter under perform analyst estimates, our stock price could be adversely affected. --how many instruments we The initial placement of an instrument is sell and under what terms subject to a longer, less consistent sales they are sold cycle than the sale of reagents, which begin and are typically recurring once an instrument is placed. Instruments are typically sold in the latter part of a quarter and in the fourth quarter of the year due to capital expenditure buying patterns of our customers. The degree of fluctuation will depend on the timing, level and mix of instruments placed through direct sales and instruments placed through Performance Evaluation Period programs and rentals. Our future operating results are likely to fluctuate substantially from period to period because instrument sales are likely to remain an important part of revenues in the near future. --changes in our sales Historically we have experienced turnover in force our sales force. A portion of our sales force is new and we have recently restructured our sales program. If we fail to replace members of our sales force in a timely manner or if our training programs are not successful, it may adversely affect our ability to sell instruments and reagents. --how much reagent our In addition, average daily reagent use by customers use customers may fluctuate from period to period, which may contribute to future fluctuations in revenues. --our operating results may Other factors that may result in fluctuations be effected by other in operating results include: factors . the timing of new product announcements and the introduction of new products and new technologies by us and our competitors; . our ability to collect receivables and maximize payables; . market acceptance of our current or new products; . quarter-to-quarter buying patterns of our customers; . developments with respect to regulatory matters; . availability and cost of raw materials from our suppliers; . competitive pricing pressures; . increased research and development expenses; and . increased marketing and sales expenses associated with the implementation of our market expansion strategy for our instrument and reagent products. 15 Our inability to protect our Our inability to protect our patents and other patents and other proprietary rights could adversely affect our proprietary rights could business. We currently hold 32 United States adversely affect our patents and numerous corresponding foreign business patents and we have filed additional United States and foreign patent applications. The expiration dates of our issued United States patents range from September 2005 to November 2013. --we now own a number of We cannot assure you that our patent U.S. patents and we have applications will result in patents being applied for others but we issued or that any issued patents will provide cannot assure you that we adequate protection against competitive will be issued new technologies or will be held valid if patents challenged. Others may independently develop products or processes similar to ours or design around or otherwise circumvent our patents. --we cannot be sure that we We cannot be certain that we were the first were the first to create creator of inventions covered by our patents or any of our inventions pending patent applications or that we were the because of the way the first to file patent applications for such U.S. patent system works inventions. Patent applications in the United States are maintained in secrecy until patents are issued and publication of discoveries in scientific literature tends to lag behind actual discoveries by several months. Therefore, we cannot be certain that we were the first creator of inventions covered by our patents or pending patent applications or that we were the first to file patent applications for such inventions. --if we are using We may have to participate in "interference" inventions that have been proceedings declared by the United States patented by others we Patent and Trademark Office to determine the would have to stop using priority of inventions. This could result in the invention, obtain a substantial costs for us. If any of the claims license for it or of third-party patents that purport to redesign our product to interfere with one of our patents or patents get around the relevant pending are upheld as valid and enforceable, we patent could be prevented from using the subject matter claimed in those patents. Alternatively, we would be required to obtain licenses from the patent owners of each of those patents or to redesign our products or processes to avoid infringement. We cannot assure you that we would be able to obtain a license or, if we could, that the terms available would be acceptable to us or that we would be successful in any attempt to redesign our products or processes to avoid infringement. --if we cannot get a If we do not obtain the necessary licenses, we license from the owner of could be subject to litigation and we could a patent and we cannot encounter delays in product introductions while design around the patent we attempt to design around such patents. we may be subject to Alternatively, the development, manufacture or litigation sale of such products could be prevented. Litigation would result in significant cost to us as well as diversion of management time. We cannot predict the outcome of this type of litigation. If litigation is decided against us, our results of operations would suffer. 16 --we also rely on trade We also rely upon trade secret protection for secret protection for our our confidential and proprietary information. confidential and We cannot assure you that others will not proprietary information independently develop proprietary information or techniques similar to ours, gain access to our trade secrets or disclose our technology, or that we can effectively protect our trade secrets. If we are forced to litigate to protect our trade secrets we would have to absorb significant costs as well as diversion of our management. If any of the litigation we undertake is unsuccessful and results in the disclosure of our trade secrets our results of operations would suffer. --we cannot assure you that Our policy is to require our employees, confidentiality consultants and significant scientific agreements with our collaborators to sign confidentiality employees, consultants agreements when they begin work with us. These and collaborators will agreements generally provide that all serve their intended confidential information developed or made purpose known to the individual during the course of the individual's relationship with us is to be kept confidential and not disclosed to third parties except in specific circumstances. Agreements with employees provide that all inventions conceived by the individual while working for us are our exclusive property. However, we cannot assure you that these agreements will not be broken or that they will provide meaningful protection or adequate remedies for unauthorized use or disclosure of our trade secrets. Effectively managing our We have grown and continue to grow rapidly both growth may be difficult by adding new products and hiring new employees. This growth is likely to place a significant strain on our managerial, accounting, operational and financial resources and systems. To manage our growth, we must implement systems and train and manage our employees. If we are not successful in managing our expanding operations effectively, we may experience operating problems such as customer service issues, reduced sales, and internal operating issues. Some of our senior management have only recently joined us. Of the 12 employees listed in the management section of this prospectus, 3 have worked for us less than one year. We cannot assure you that our management will be able to effectively or successfully manage our growth. Our ability to develop new Our future growth and profitability will be products will be important dependent, in large part, on our ability to to our success: develop, introduce and market new instruments and reagents used in diagnosing and selecting appropriate treatment for cancer and additional disease states. Our products could also be rendered obsolete or noncompetitive by virtue of technological innovations in the fields of cellular or molecular diagnostics. --our ability to develop We depend in part on the success of medical new products is partly research done by others in developing new dependent on the work of antibodies, nucleic acid probes and clinical others and our ability to diagnostic procedures that can be adapted for license their work use in the our systems. We will then need to license certain of these technologies. We may not be able to get these licenses on terms that would allow us to economically develop and market new instruments. If this were to occur our operating results would suffer. 17 --if any of our products We have products that are currently under under development or development, initial testing or preclinical or those planned for clinical evaluation and we have other products development are not that are scheduled for future development. successful our operating These products: results would suffer . may prove to be unreliable from a diagnostic standpoint; . may be difficult to manufacture in an efficient manner; . may fail to receive necessary regulatory clearances; . may not achieve market acceptance; or . may encounter other unanticipated difficulties. If any of these things were to occur our operating results would suffer. A large portion of our A significant portion of our expense levels are expenses are fixed so if our based on our expectation of a higher level of revenues are below revenues in the future and are relatively fixed expectations we may not in nature. Therefore, if revenue levels are perform as expected below expectations, operating results in a given period are likely to be adversely affected because we will not be able to spread these expenses over a larger revenue base. We need to persuade the The use of automated systems to perform medical community of the diagnostic tests is relatively new. benefits of our products in Historically, the diagnostic tests performed by order to be successful our systems have been performed manually by laboratory personnel. Our ability to sell our products will be largely dependent on our ability to persuade the medical community of the benefits of automated diagnostic testing using our products. The quality and price of our products as compared to manual testing and as to our competitor's products will affect acceptance and sales of our products. Our products are subject to The manufacturing, marketing and sale of our extensive government products are subject to extensive government regulation in the U.S. and regulation in the U.S. and in other countries. abroad The process of obtaining and maintaining regulatory approval can be lengthy, expensive and uncertain. --in the U.S. our products In the U.S. the FDA regulates, as medical are regulated as medical devices, instruments, diagnostic tests and devices by the FDA reagents that are traditionally manufactured and commercially marketed as finished test kits or equipment. Some clinical laboratories, however, choose to purchase individual reagents intended for specific analyses and develop and prepare their own finished diagnostic tests. The FDA has recently promulgated a rule that regulates the reagents sold to clinical laboratories as analyte specific reagents. The rule restricts sales of these reagents to clinical laboratories certified under the Clinical Laboratory Improvement Amendments of 1988, or CLIA, as high complexity testing laboratories. We intend to market some diagnostic products as finished test kits or equipment and others as individual reagents; consequently, some of these products are regulated as analyte specific reagents. 18 --the specific requirements The Federal Food, Drug, and Cosmetic Act that we must follow are governs the design, testing, manufacture, contained in the Federal safety, efficacy, labeling, storage, record Food, Drug, and keeping, approval, advertising and promotion of Cosmetic Act our products. There are two principal FDA regulatory review paths for medical devices: the 510(k) pre-market notification process and the pre-market approval, or PMA, process. The PMA process typically requires the submission of more extensive clinical data and is costlier and more time-consuming to complete than the 510(k) process. --Medical devices require Medical devices generally require FDA approval FDA approval prior to or clearance prior to being marketed in the being marketed in the United States. The process of obtaining FDA U.S. clearances or approvals necessary to market medical devices can be time-consuming, expensive and uncertain, and we cannot assure you that any clearance or approval we seek will be granted or that FDA review will not involve delays which would harm our ability to market and sell our products. Further, clearances or approvals may be conditional in that they place substantial restrictions on the indications for which the product may be marketed or to whom it may be marketed. We can also not assure you that the FDA will not require additional data, require us to conduct further clinical studies or obtain a PMA causing us to incur further cost and delay. --although our IHC and ISH With respect to automated IHC testing products have not needed functions, our instruments have been 510(k) approval to date categorized by the FDA as automated cell some of our future staining devices and have been exempted from products may the 510(k) notification process. To date, ISH tests have not received FDA approval or clearance and, therefore, use of the Discovery for ISH tests will be restricted to research applications. New instrument products that we may introduce could require future 510(k) clearances. --some of our antibody Certain antibodies that we may wish to market products may require PMA with labeling indicating that they can be used approval if we market in the diagnosis of particular diseases may them in a certain way require PMA approval. In addition, the FDA has proposed that some of the antibody products that we may wish to market be subjected to a pre-filing certification process. Certain of our products are currently sold for research use and are labeled accordingly. --if we do not comply with If we do not comply with applicable regulatory regulatory requirements, requirements we could be subject to, among or we fail to get other consequences, fines, injunctions, civil approval for our penalties, suspensions or loss of regulatory products, our results of approvals, recalls or seizures of products, operations would suffer operating restrictions and criminal prosecutions. In particular, the FDA enforces regulations prohibiting the marketing of products for non-indicated uses. In addition, governmental regulations may be established that could prevent or delay regulatory approval of our products. Delays in or failure to receive approval of products we plan to introduce, loss of or additional restrictions or limitations relating to previously received approvals, other regulatory action against us or changes in the applicable regulatory climate could individually or in the aggregate cause our results of operations to suffer. 19 --we and our customers are We are also required to register as a medical inspected for compliance device manufacturer with the FDA and are with FDA regulations inspected on a routine basis by the FDA for compliance with their regulations. Our clinical laboratory customers are subject to CLIA, which is intended to ensure the quality and reliability of medical testing. --other laws and In addition to these regulations, we are regulations may adversely subject to numerous federal, state and local affect our operations laws and regulations relating to such matters as safe working conditions and environmental matters. We cannot assure you that these laws will not adversely affect our results of operations in the future. There are risks associated We may make additional acquisitions of with the acquisition of complementary businesses, products or businesses, products or technologies in the future. Acquisitions of technologies companies, divisions of companies, or products entail numerous risks, including: . the potential inability to successfully integrate acquired operations and products or to realize anticipated synergies, economies of scale or other value; . diversion of management's attention; and . loss of key employees of acquired operations. --acquisitions may not be We cannot assure you that we will not incur profitable and returns problems with respect to any future may not justify the price acquisitions, or that any future acquisitions we paid will increase our profitability. We can also not assure you that we will realize value from any acquisitions which would justify the consideration paid. Any problems like these could cause our results of operations to suffer. --we may issue more stock, Any future acquisitions may also result in the borrow more money, incur issuance of shares of our equity securities, one-time expenses or including our common stock. The issuance of create goodwill additional shares of our common stock could affect the market price. We might also borrow more money, have large one-time write-offs and create goodwill or other intangible assets that could result in amortization expense. These factors may cause our results of operations to suffer. We might be affected if a In the future, our ability to sell instruments competitor develops and and reagents might be affected by the design of markets a new instrument our systems, which require that customers buy that uses cheaper reagents their reagents from us. This would be especially true if and to the extent that competitors are successful in developing and introducing new IHC instruments or if they offer reagent supply arrangements having pricing or other terms more favorable than those offered by us. Increased competition in reagent supply could also affect sales of reagents to batch processing instrument customers since those instruments do not require the use of our reagents. 20 We depend on key personnel We are dependent upon the retention of with whom we have no principal members of our management, Board of employment contracts Directors, scientific, technical, marketing and sales staff and the recruitment of additional personnel. We do not have employment agreements with any of our executive officers and we do not maintain "key person" life insurance on any of our personnel. We compete with other companies, academic institutions, government entities and other organizations for qualified personnel. If we could not hire or retain qualified personnel it would cause our results of operations to suffer. Manufacturing Risks --as we increase production We have only manufactured patient priority of our products we may instruments and reagents for commercial sale experience problems in since late 1991, and manufacturing of our production Techmate 500 instrument is performed by third parties. As we continue to increase production of such instruments and reagents and develop and introduce new products, we may from time to time experience difficulties in manufacturing. We must continue to increase production volumes of instruments and reagents in a cost-effective manner in order to be profitable. --we must stay in To increase production levels, we will need to compliance with the rules scale-up our manufacturing facilities, increase and regulations of our automated manufacturing capabilities and various agencies as we continue to comply with FDA Quality Systems increase production Regulations and other standards prescribed by various federal, state and local regulatory agencies in the United States and other countries, including the ISO 9000 Series certifications. --our operating results We cannot assure you that manufacturing and would suffer if we quality problems will not arise as we increase experienced either our manufacturing operations or that such production or quality scale-up can be achieved in a timely manner or problems at a commercially reasonable cost. Manufacturing or quality problems or difficulties or delays in manufacturing scale- up would affect our operating results. We depend on key suppliers Our reagent products are formulated from both to provide some of the chemical and biological materials using components and raw materials proprietary technology as well as standard for our reagents; if that processing techniques. We currently purchase supply is interrupted our some components and raw materials, primarily results of operations could antibodies, that we use to make our reagent suffer products from single-source vendors. We cannot assure you that the materials or reagents we need will be available in commercial quantities or at acceptable prices. Any supply interruption or yield problems encountered in the use of materials from these vendors could have a material adverse effect on our ability to manufacture our products until a new source of supply is obtained. Finding and using alternative or additional suppliers could be time consuming and expensive. 21 We rely on others to make A number of the components used to make our certain custom parts for our instruments are made on a custom basis to our instruments, if these parts specifications and are currently available from were not delivered on time a limited number of sources. If the supply of or not at all our results of materials or components from any of these operations would suffer vendors were delayed or interrupted for any reason or if the quality or reliability of the materials or components is not adequate for use in our instruments, our ability to make instruments in a timely fashion could be impaired and our results of operations would suffer. Some of our manufacturing Certain of our manufacturing processes, processes involve the use of primarily those involved in manufacturing environmentally hazardous certain of our reagent products, require the materials use of potentially hazardous and carcinogenic chemicals. We are required to comply with applicable federal, state and local laws regarding the use, storage and disposal of these materials. --we could incur We currently use third-party disposal services substantial liability if to remove and dispose of the hazardous it is found that either materials we use. We could in the future we or the third party encounter claims from individuals, governmental disposal service we use authorities or other persons or entities in has violated any connection with exposure to or disposal or environmental laws handling of these hazardous materials or violations of environmental laws by our contractors or us. We could also be required to incur additional expenditures for hazardous materials management or environmental compliance. The costs associated with environmental claims, violations of environmental laws or regulations, hazardous materials management and compliance with environmental laws could cause our results of operations to suffer. We cannot assure you that we We anticipate that our existing capital will be able to fund our resources and available borrowing capacity future capital requirements under our revolving credit line will be through internal sources, adequate to satisfy our capital requirements our existing line of credit for the next 12 months. Our future capital or from other sources requirements will depend on many factors including: . the extent to which our products gain market acceptance; . the mix of instruments placed through direct sales or through our performance evaluation period; . progress of our product development programs; . competing technological and market developments; . expansion of our sales and marketing activities; . the cost of manufacturing scale-up activities; . possible acquisitions of complementary businesses, products or technologies; and . our ability to sustain profitability and timing of regulatory approvals. We may require additional capital resources and we cannot assure you that capital will be available to the extent required, on terms acceptable to us or at all. Any such future capital requirements could result in the issuance of our equity securities, which may affect the market price of our common stock and would dilute our existing stockholders. 22 Item 2. Properties Currently, our U.S. research laboratories, instrument and reagent manufacturing facilities and administrative offices are located in approximately 90,000 square feet of leased space in Tucson, Arizona and Gaithersburg, Maryland. The leases for these facilities expire at various times between January 2002 and November 2004, subject to renewal terms. In May 2000, we purchased vacant land in Tucson and initiated construction of a 182,400 square foot mixed-use facility to house all of our operations that are now resident in various locations around Tucson. Our expected completion date is the third and fourth quarters of 2001. Manufacturing will move into the new facility in the third quarter of 2001. R&D and administration will move in the fourth quarter of 2001. In cases where leases on current facilities expire prior to the completion of this facility, we plan to negotiate month-to-month lease arrangements. Currently, our European headquarters operations are located in an office building we own that consists of 39,000 square feet in Strasbourg, France. This building was acquired in June 2000 and financed through a sale/leaseback. We have leased approximately half of the building square footage to a third party. Our Japanese operations are located in 3,000 square feet of leased office space in Tokyo. We moved into this space in July 2000 and signed a 2 year lease that expires in July, 2002. Once we complete the construction of the new Tucson facility we believe that we will have sufficient space for the foreseeable future. Item 3. Legal Proceedings In January 1997, four individuals who are former BioTek noteholders who held in the aggregate approximately $1.1 million in principal amount of BioTek notes filed an action, Tse, et al. v. Ventana Medical Systems, Inc., et al. No. 97-37, against the Company and certain of its directors and stockholders in the United States District Court for the District of Delaware. The complaint alleged, among other things, that the company violated federal and California securities laws and engaged in common law fraud in connection with the BioTek shareholders' consent to the February 1996 merger of BioTek into Ventana and the related conversion of BioTek notes into Ventana notes. Plaintiffs seek compensatory damages in excess of the principal amount of their BioTek notes, as well as punitive damages, and fees and costs. On April 25, 1997, plaintiffs filed an Amended Complaint. The Amended Complaint made the same allegations as the original Complaint and added a claim under North Carolina securities laws. On December 16, 1997, we filed a motion to dismiss plaintiffs' Amended Complaint. On September 23, 1998, the Court issued its Order granting in part and denying in part our motion to dismiss. The Court dismissed plaintiffs' claims based upon the North Carolina securities laws and California's insider-trading statute. Plaintiffs' surviving claims included violations of federal and California securities laws, common law fraud and breach of fiduciary duty. On June 5, 2000, we filed a motion for summary judgment on all of plaintiffs' remaining claims. On November 22, 2000, the Court issued an Order granting our motion for summary judgment in its entirety. Plaintiffs filed a notice of appeal on December 8, 2000 and will file their appellate brief in May 2001. Based on the facts known to date, we believe that the claims are without merit and we will vigorously defend this suit. On April 1, 1999, a shareholder derivative and class action suit was filed in the Court of Chancery for the State of Delaware entitled Leung v. Ventana Medical Systems, Inc., et al., C.A. No. 17089. Plaintiff, who is related to the plaintiffs in the above federal securities action, alleges breach of fiduciary duty and breach of contract relating to our merger with BioTek and the related conversion of BioTek notes into Ventana notes, as well as our decision to compensate two of our directors by selling Ventana stock to them at a fixed price. On May 6, 1999, we filed a motion to dismiss, or in the alternative, to stay this action in favor of the federal securities action. These motions were heard on October 18, 1999, and on February 29, 2000, the Court granted our motion, dismissing the action in its entirety. Plaintiff filed his notice of appeal on October 24, 2000, and all appellate briefing was completed in March 2001. The hearing of this appeal is not specifically scheduled but the 23 Delaware Supreme Court has indicated that the hearing will take place in May 2001. Based on the facts known to date, we believe that the claims are without merit and we intend to vigorously defend this suit. On June 15, 1999 we filed a proof of claim against Oncor, Inc. in an action pending in the United States Bankruptcy Court for the District of Delaware titled In re Oncor, Inc., No. 9-437 (JJF). Our claims arise out of an Asset Purchase Agreement dated November 23, 1998 and related documents wherein we acquired Oncor's unincorporated In Situ Hybridization Technology Division and rights related thereto. In February 2000, we filed an amended proof of claim alleging, inter alia, that Oncor breached the terms of the Asset Purchase Agreement by purporting to transfer or assign to us Oncor's rights under a license agreement, which were not transferable or assignable under the circumstances then existing. The amended proof of claim seeks damages of no less than approximately $7.3 million. On August 17, 2000, Oncor filed an Omnibus Objection to Claims which included our claims. However, the Omnibus Objection did not set forth any specific allegations with respect to our claims. We continue to believe our claims are meritorious and that we will prevail, however, the results of the proceedings are uncertain and there can be no assurance to that effect. On December 9, 1999 we filed an action, Ventana Medical Systems, Inc. v. CytoLogix Corp., No. CIV99-606 TUC FRZ, alleging patent infringement seeking monetary damages and injunctive relief in the United States District Court in Tucson. The original complaint was amended March 21, 2000 by the addition of another patent to the litigation. We believe our claims are meritorious and that we will prevail, however, because little discovery has been completed, results of the proceedings are uncertain and there can be no assurance to that effect. CytoLogix Corp. has filed three separate actions against us in various courts. The first action is CytoLogix v. Ventana, Case No. CV 12231 REK, filed Oct. 27, 2000 in federal district court in Boston. The complaint claims, under state-law based unfair competition law, that Ventana misappropriated CytoLogix's trade secrets related to individual slide heating and incorporated such secrets into our Discovery and BenchMark instruments. CytoLogix seeks assignment of our patent applications relating to individual slide heating claiming the idea, treble damages (unspecified amount) and an injunction against our further sales of Discovery and BenchMark instruments. We believe that we have meritorious defenses to the claims in this action and that resolution of this matter will not have a material adverse effect on our business, financial condition or results of operation; however, this litigation is in an early stage and the results of the proceeding are uncertain and there can be no assurance to that effect. The second is CytoLogix v. Ventana, Case No. 4 Ni 54/00 (EU) (Nullity suit), filed November 9, 2000 in the German Federal Patent Court, Munich, Germany. CytoLogix seeks to invalidate our German patent (no. DE 69117052.5) which covers various aspects of our automated slide staining system. We believe we can defend this patent through the Nullity proceeding, however because this action is relatively new, results of the proceeding are uncertain and there can be no assurance to that effect. We have responded to this action and now await further orders from the German Federal Patent Court. The third action is CytoLogix v. Ventana, Case No. 01-10178 REK, filed January 30, 2001 in the U.S. District Court, Eastern District of Massachusetts. This complaint claims that we infringed on CytoLogix's patent No. 6,180,061, entitled "Moving Platform Slide Stainer with Heating Elements," and was later amended to add U.S. Patent No. 6,183,693, issued Feb. 7, 2001, entitled "Random Access Slide Stainer with Independent Slide Heating Regulation," both assigned to CytoLogix Corporation. CytoLogix seeks assignment of our patent applications claiming the independent slide heater idea, treble damages (unspecified amount) and an injunction against our further sales of Discovery and BenchMark instruments. We believe that we have meritorious defenses to the claims in this action and that resolution of this matter will not have a material adverse effect on our business, financial condition or results of operation; however, this litigation is in an early stage and the results of the proceeding are uncertain and there can be no assurance to that effect. Item 4. Submission of Matters to a Vote of Security Holders We did not submit any matter for a vote by our shareholders, through the solicitation of proxies or otherwise, during the fourth quarter of the fiscal year covered by this report. 24 PART II Item 5. Market for Registrant's Common Equity and Related Stockholder Matters. Our common stock is listed on the NASDAQ National Market. The closing price of our common stock on December 29, 2000 was $18.50. The following table shows the high and low bid prices in dollars per share for the last two years as reported by NASDAQ. These prices may not be the prices that you would pay to purchase a share of our common stock during the periods shown.
Low High ------ ------ Year Ended December 31, 1999 First Quarter............................................... $16.75 $23.88 Second Quarter.............................................. $17.13 $28.63 Third Quarter............................................... $13.75 $22.25 Fourth Quarter.............................................. $15.69 $34.75 Year Ended December 31, 2000 First Quarter............................................... $21.63 $69.50 Second Quarter.............................................. $23.00 $49.25 Third Quarter............................................... $20.00 $28.63 Fourth Quarter.............................................. $17.06 $33.00
As of December 31, 2000, there were approximately 3,600 beneficial holders of our common stock. Dividend Policy Holders of our common stock are entitled to receive dividends only when declared by our Board of Directors. Our line of credit with Bank of America forbids us from declaring dividends on any of our equity securities. To date dividends have never been declared or paid and we do not plan to make any dividend payments in the future. Instead we will reinvest in the expansion and development of our business. If the Board of Directors decides to declare a dividend in the future, the decision will be based on our earnings, financial condition, cash requirements, and any other factors they deem relevant. 25 Item 6. Selected Financial Data Selected Consolidated Financial Data
Year Ended December 31, ------------------------------------------------ 1996 1997 1998 1999 2000 -------- -------- -------- -------- -------- (in thousands, except per share data) Statement of Operations Data: Sales: Reagents and other........ $ 15,538 $ 22,905 $ 31,967 $ 45,340 $ 49,682 Instruments............... 8,591 9,248 15,737 24,069 21,467 -------- -------- -------- -------- -------- Total net sales......... 24,129 32,153 47,704 69,409 71,149 Cost of goods sold.......... 10,632 11,138 14,542 21,218 36,377 -------- -------- -------- -------- -------- Gross Profit................ 13,497 21,015 33,162 48,191 34,772 Operating expenses: Selling, general and administrative........... 11,206 16,953 23,805 32,381 43,800 Research and development.. 2,749 3,050 5,057 7,078 11,116 Nonrecurring expenses..... 10,262 1,656 3,160 -- 4,519 Amortization of acquisition costs........ 424 509 599 1,051 1,474 -------- -------- -------- -------- -------- (Loss) income from operations................. (11,144) (1,153) 541 7,681 (26,137) Other (expense) income...... (137) 781 1,089 (370) 1,346 -------- -------- -------- -------- -------- (Loss) income before taxes and cumulative effect of accounting change.......... (11,281) (372) 1,630 7,311 (24,791) Benefit from (provision for) income taxes............... -- -- -- 5,500 (350) -------- -------- -------- -------- -------- (Loss) income before cumulative effect of accounting change.......... (11,281) (372) 1,630 12,811 (25,141) Cumulative effect of accounting change, net of tax(1)..................... -- -- -- -- (2,154) -------- -------- -------- -------- -------- Net (loss) income....... $(11,281) $ (372) $ 1,630 $ 12,811 $(27,295) ======== ======== ======== ======== ======== Amounts per common share, diluted: (Loss) income before cumulative effect of accounting change........ $ (1.22) $ (.03) $ .11 $ .88 $ (1.70) Cumulative effect of accounting change........ -- -- -- -- (0.15) -------- -------- -------- -------- -------- Net (loss) income per share, diluted......... $ (1.22) $ (.03) $ .11 $ .88 $ (1.85) ======== ======== ======== ======== ======== Pro forma (loss) income assuming the accounting change is applied retroactively: Net (loss) income......... $(11,793) $ (523) $ 1,282 $ 11,668 $(25,141) Net (loss) income per common share, diluted.... $ (1.28) $ (0.04) $ 0.09 $ 0.80 $ (1.70) Balance Sheet Data: Cash, cash equivalents and short-term investments..... $ 11,067 $ 18,902 $ 2,424 $ 1,787 $ 38,512 Long-term debt and redeemable preferred stock...................... 12,500 471 1,907 2,044 3,408 Working capital............. 15,888 28,524 22,277 28,408 49,977 Total assets................ 32,410 48,352 56,280 73,161 109,582 Accumulated deficit......... (33,410) (33,782) (32,152) (19,341) (46,636) Total stockholders' equity.. 15,270 42,403 45,784 60,500 87,088
- -------- (1) During the fourth quarter of 2000, the Company changed its method of accounting for revenue recognition in accordance with Staff Accounting Bulletin No. 101, Revenue Recognition in Financial Statements, effective January 1, 2000. The cumulative effect of adopting this new accounting principle amounted to a charge of $2,154, net of tax. 26 The following table contains summary unaudited quarterly consolidated statements of operations for the four quarters ended December 31, 2000 and the four quarters ended December 31, 1999. We have prepared the quarterly consolidated statements of operations data on the same basis as the Consolidated Statements of Operations beginning on page F-3. Our results of operations have varied and may continue to fluctuate significantly from quarter to quarter. Results of operations in any period should not be considered indicative of the results to be expected for any future period. Summary Quarterly Condensed Consolidated Financial Data
Year Ended December 31, 2000 ----------------------------------------------------------------- Restated Restated Restated First First Second Second Third Third Fourth Quarter Quarter Quarter Quarter Quarter Quarter Quarter ------- -------- -------- -------- ------- -------- ------- (in thousands, except per share data) Statement of Operations Data: Sales: Reagents and other.... $12,001 $12,001 $ 12,304 $ 12,304 $12,703 $12,703 $12,674 Instruments........... 5,828 5,125 5,436 6,419 4,899 5,196 4,727 ------- ------- -------- -------- ------- ------- ------- Total net sales...... 17,829 17,126 17,740 18,723 17,602 17,899 17,401 Cost of goods sold...... 6,134 5,970 18,464 18,782 5,733 5,786 5,839 ------- ------- -------- -------- ------- ------- ------- Gross profit (loss)..... 11,695 11,156 (724) (59) 11,869 12,113 11,562 Operating expenses: Selling, general and administrative....... 1,984 1,984 3,461 3,461 2,665 2,665 3,006 Research and development.......... 7,960 7,960 14,930 14,930 9,816 9,816 11,094 Nonrecurring expenses............. -- -- 4,519 4,519 -- -- -- Amortization of acquisition costs.... 278 278 391 391 381 381 424 ------- ------- -------- -------- ------- ------- ------- Income (loss) from operations............. 1,473 934 (24,025) (23,360) (993) (749) (2,962) Other (expense) income.. (48) (48) 452 452 508 508 434 ------- ------- -------- -------- ------- ------- ------- Income (loss) before taxes and cumulative effect of accounting change................. 1,425 886 (23,573) (22,908) (485) (241) (2,528) (Provision for) benefit from income taxes...... (456) (350) 106 -- -- -- -- ------- ------- -------- -------- ------- ------- ------- Income (loss) before cumulative effect of accounting change...... 969 536 (23,467) (22,908) (485) (241) (2,528) ------- ------- -------- -------- ------- ------- ------- Cumulative effect of accounting change, net of tax(1).............. -- (2,154) -- -- -- -- -- ------- ------- -------- -------- ------- ------- ------- Net income (loss).. $ 969 $(1,618) $(23,467) $(22,908) $ (485) $ (241) $(2,528) ======= ======= ======== ======== ======= ======= ======= Per Share Data: Income (loss) before cumulative effect of accounting change: --Basic.............. $ .07 $ .04 $ (1.55) $ (1.52) $ (.03) $ (.02) $ (.17) --Diluted............ $ .06 $ .03 $ (1.55) $ (1.52) $ (.03) $ (.02) $ (.17) Net Income: --Basic.............. $ .07 $ (.11) $ (1.55) $ (1.52) $ (.03) $ (.02) $ (.17) --Diluted............ $ .06 $ (.11) $ (1.55) $ (1.52) $ (.03) $ (.02) $ (.17) Shares used in computing net income (loss) per share, basic........... 14,305 14,305 15,097 15,097 15,186 15,186 15,307 ======= ======= ======== ======== ======= ======= ======= Shares used in computing net income (loss) per share, diluted......... 16,467 16,467 15,097 15,097 15,186 15,186 15,307 ======= ======= ======== ======== ======= ======= =======
- -------- (1) During the fourth quarter of 2000, the Company changed its method of accounting for revenue recognition in accordance with Staff Accounting Bulletin No. 101, Revenue Recognition in Financial Statements. Pursuant to Financial Accounting Statement No. 3, Reporting Financial Changes in Interim Financial Statements, effective January 1, 2000, the Company recorded the cumulative effect of the accounting change and accordingly, the quarterly information for the first three quarters of 2000 which had been previously reported have been restated. No restatement of 1999 is required under the implementation guidance of Staff Accounting Bulletin No. 101. 27 Summary Quarterly Condensed Consolidated Financial Data (Continued)
Year Ended December 31, 1999 --------------------------------- First Second Third Fourth Quarter Quarter Quarter Quarter ------- ------- ------- ------- (in thousands, except per share data) Statement of Operations Data: Sales: Reagents and other....................... $10,512 $11,589 $11,679 $11,560 Instruments.............................. 5,120 4,726 4,733 9,490 ------- ------- ------- ------- Total net sales........................ 15,632 16,315 16,412 21,050 Cost of goods sold......................... 4,988 4,765 5,148 6,317 ------- ------- ------- ------- Gross profit............................... 10,644 11,550 11,264 14,733 Operating expenses: Selling, general and administrative...... 7,399 7,875 7,829 9,278 Research and development................. 1,629 1,908 1,696 1,845 Nonrecurring expenses.................... 253 258 256 284 ------- ------- ------- ------- Amortization of acquisition costs........ 1,363 1,509 1,483 3,326 Other (expense) income................... 24 (22) 44 (416) ------- ------- ------- ------- Income before income taxes............... 1,387 1,487 1,527 2,910 (Provision for) benefit from income taxes................................... (138) 138 -- 5,500 ------- ------- ------- ------- Net income........................... $ 1,249 $ 1,625 $ 1,527 $ 8,410 ======= ======= ======= ======= Net income per common share: --Basic.................................. $ .09 $ .12 $ .11 $ .62 ======= ======= ======= ======= --Diluted................................ $ .09 $ .11 $ .11 $ .56 ======= ======= ======= ======= Pro forma amounts assuming the accounting changes are applied retroactively: Net income............................... $ 925 $ 1,844 $ 1,724 $ 7,175 ======= ======= ======= ======= Net Income per common share: --Basic.................................. $ .07 $ .14 $ .13 $ .53 ======= ======= ======= ======= --Diluted................................ $ .06 $ .12 $ .12 $ .48 ======= ======= ======= ======= Shares used in computing net income per share, basic.............................. 13,404 13,462 13,520 13,551 ======= ======= ======= ======= Shares used in computing net income per share, diluted............................ 14,578 14,766 14,465 14,908 ======= ======= ======= =======
28 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations Introduction In Management's Discussion and Analysis we explain our general financial condition and the results of operations including: . what factors affect our business; . what our earnings and costs were in 2000 and 1999; . why those earnings and costs were different from the year before; . where our earnings came from; . how all of this affects our overall financial condition; and . what our research and development expenditures were in 2000 and 1999 and what we expect to spend in the near future. Forward-Looking Statements Some statements contained in this Annual Report, including, without limitation, statements containing the words "believes," "anticipates," "estimates," "expects," and words of similar import, constitute "forward- looking statements." You should not place undue reliance on these forward- looking statements. Our actual results could differ materially from those anticipated in these forward-looking statements for many reasons, including the risks faced by us described in the Cautionary Factors section beginning on page 14, among others, and those included in other documents we file with the SEC. Results of Operations Comparison of 2000 and 1999 Net sales increased to $71.1 million in 2000 from $69.4 million in 1999. Our revenue growth of 2% was impacted by reagent dispenser quality issues experienced in the second and third quarters of 2000. We also changed our method of revenue recognition for products which require installation at the customer's site in accordance with Staff Accounting Bulletin (SAB) No. 101 Revenue Recognition in Financial Statements. The change in revenue recognition method had a favorable effect of $0.6 million on net sales for 2000. The cumulative effect of the accounting change resulted in a charge to operations of $2.2 million (net of an income tax benefit of $1.4 million), which is included in operations for the year ended December 31, 2000. Gross margin of 49% in 2000 was impacted by second quarter 2000 charges totaling $11.8 million associated with reagent dispenser quality issues, planned relocation of our Gaithersburg, Maryland production facility, exiting the electron microscopy product line and write-down of older generation staining instruments in anticipation of the launch of the BenchMark advanced staining system in the fourth quarter of 2000. The charges, in conjunction with the additional investment in manufacturing management and quality systems infrastructure, accounted for the decrease from the 69% gross margin achieved in 1999. Fiscal 2000 results were negatively impacted by $22.5 million in write-offs and accruals relating to several different issues. The following table summarizes details of the charges and non-recurring expenses:
Costs incurred Reserve through Revision Balances as of Initial December 31, to December 31, Charges 2000 Estimates 2000 ------- ------------ --------- -------------- (In thousands) Reagent dispenser quality issue.......................... $ 5,355 $ 3,117 $ 272 $2,510 Exit of electron microscopy product line................... 4,581 4,060 (521) -- Impairment of inventory, diagnostic instruments and intangibles.................... 8,615 7,798 493 1,310 Cost to close Gaithersburg, Maryland facility.............. 2,611 1,200 (294) 1,117 Other charges including contracted R&D................. 1,362 1,362 -- -- ------- ------- ----- ------ Total charges and non- recurring expenses........... $22,524 $17,537 $ (50) $4,937 ======= ======= ===== ======
Charges of $5.4 million were related to quality problems with the Company's dispensers and reagents used with the majority of its staining instruments. As a result, charges were taken to write-off inventory and set up reserves to cover product replacements, returns, and warranty matters. 29 A charge of $4.6 million was recorded to account for the Company's decision to exit its electron microscopy (EM) product line. Charges were taken to write-down all EM inventory and field instruments to their net realizable value. In addition, goodwill recognized in the BTTI acquisition was written down $1.4 million to reflect the impact of product discontinuance. Charges of $8.6 million were recorded in recognition of the decreased value of certain instrument inventory, fixed assets and intangible assets given the launch of the Company's new BenchMark advanced staining system in 2000. In addition, intangible assets associated with the Company's 1996 acquisition of BioTek Solutions, Inc. were written down $3.1 million to reflect the impact of product discontinuation. The Techmate IHC staining system product line acquired in the BioTek transaction was among those whose value was impacted by the launch of BenchMark. The Company also recognized charges of $2.6 million relating to closure of its production facility in Gaithersburg, Maryland. The Gaithersburg facility was acquired in late 1998 with the acquisition of all the oncology assets of Oncor, Inc. Other charges recognized in 2000 totaled $1.4 million which included expenses related to contracted research and development being handled by an outside company. Research and development expenses increased by $4 million in 2000 versus 1999, to 15.6% of net sales from 10.2% in 1999. The spending increase reflects our ongoing research and development efforts in a variety of areas such as the launch of the BenchMark advanced IHC and ISH Staining System, the US launch of our Discovery system, the December 2000 launch of our Pathway test for breast cancer patients and further expansion of our Special Stains reagent menu. For the near future, research and development costs are anticipated to increase at a rate similar to or slightly greater than the sales growth rate, as we continue to invest in technology to address potential market opportunities. Selling, general and administrative expenses increased by $11.4 million in fiscal 2000 over fiscal 1999 and increased as a percent of net sales to 62% in 2000 from 47% in 1999. The spending increase is attributed primarily to the charges recorded in the second quarter of 2000 associated with various product discontinuations and revaluations of field instruments given the launch of BenchMark. We anticipate selling, general and administrative expenses to return to a similar cost as a percent of net sales rate as experienced in 1999 in the near future. Non-recurring expenses of $4.5 million were recognized in 2000 in conjunction with the write down of intangibles associated with the BioTechnology Tools and BioTek acquisitions. The charges reflect the impact of various product discontinuations on expected future cash flows. Amortization expense increased to $1.5 million in 2000 from $1.1 million in 1999. Intangible assets increased in 2000 through the acquisition of QDL Laboratories and a payment made to Vysis on a license to market certain consumables. Interest and other income, net, was income of $1.3 million in 2000 versus an expenditure of $0.4 million in 1999. The interest income was attributed to the investment of proceeds from the private placement of 1,250,000 shares of Common Stock in 2000. Although the Company experienced a significant loss during the year as discussed above, management believes that the Company will return to profitability in 2001 as the events that gave rise to the loss were considered discreet and isolated and unlikely to recur. No additional income tax benefit was recognized in 2000 related to the deferred tax asset that arose relative to the increase in the net operating loss carry forward and other future tax deductible items as it cannot be readily determined whether such assets will be recoverable in the near term. Management will continue to closely monitor operating results and analyze its ability to recover these deferred tax assets in the very near term. As a result, the Company's valuation allowance increased by $8.3 million in 2000 to $10.7 million at December 31, 2000. In the meantime, the Company does not anticipate recording any income tax benefit or expense of any material amount in 2001, unless a change, positively or negatively, in the valuation allowance for deferred tax assets is warranted based upon the outlook of future earnings. 30 The majority of the Company's deferred tax assets relate to net operating loss carryforwards. At December 31, 2000, the Company had $21 million and $18 million in federal and state net operating loss carryforwards for income tax purposes, respectively. The federal and state net operating loss carryforwards will begin to expire in 2007 and 2005, respectively, if not previously utilized. In addition, the Company has certain foreign net operating loss carryforwards of $6.9 million and research and development credits of $1 million. As a result of the above, our net loss for the year was $27.3 million, which included $22.5 million in charges and non-recurring expenses recognized in the second quarter of 2000 and included the adverse impact of $2.2 million related to the change in accounting principle for the adoption of SAB No. 101. Comparison of 1999 and 1998 Net sales increased to $69.4 million in 1999 from $47.7 million in 1998. This 45% increase was primarily a result of a full year's product availability of our Special Stains instrument system and tissue processor line (both introduced commercially in late 1998), successful entrance into the genomics market with the launch of the Discovery ISH system in late 1999 and strong performance from our core IHC business. Sales in 1999 grew 29% in North America and 152% internationally from 1998. The strong growth in North America is primarily being driven by market demand as well as the overall economic health within this region. The growth in international sales is attributed to strong commercial operations driving a clear leadership position. Gross margin in 1999 of 69% was consistent with 1998 performance. Improvement in the overall margin structure of our instruments and reagents was offset by a slight mix shift towards instrument sales in 1999 as a percent of total revenue (35%) versus 1998 (33%). Research and development expenses increased by $2 million in 1999 compared with 1998 expenditures, to 10.2% of net sales from 10.6% in 1998. The spending increase reflects our ongoing research and development efforts in a variety of areas such as the introduction of our Discovery ISH instrument, expansion of our Special Stains reagent menu and in situ hybridization prognostic markers. For the near future, research and development expenses are expected to increase at a rate similar to or slightly greater than the sales growth rate, as we continue to invest in technology to address potential market opportunities. Selling, general and administrative expenses increased by $8.6 million in fiscal 1999 over fiscal 1998, but decreased as a percent of net sales to 47% in 1999 from 50% in fiscal 1998. The spending increase is due principally to the growth in the size of our direct sales force and its commissions, and the expansion of our geographic distribution channels. The increase also reflects our efforts to invest in key areas such as product strategy and customer support coverage in order to be positioned to take advantage of future market opportunities. We anticipate selling, general and administrative costs increasing at a rate similar to or slightly less than our sales growth rate in the near future. Amortization expense increased to $1.1 million in 1999 from $0.6 million in 1998, reflecting a full years' amortization of intangibles acquired in the fourth quarter of 1998. Interest and other income, net, was an expenditure of $0.4 million in 1999 versus income of $1.1 million in 1998. Interest income in 1999 was reduced as a result of decreased investment balances attributed to the acquisitions of the assets of Oncor, Inc. and the stock of Biotechnology Tools, Inc. in late 1998. The Company also settled some litigation in 1999. In the fourth quarter of 1999, we deemed it "more likely than not" that our deferred tax assets would be realized in the future. This judgment reflects the fact that 1999 marked the third consecutive year of profitable North American operations, and the fact we expect to operate profitably on a worldwide basis in 2000. This resulted in an income tax benefit of $5.5 million. As a result of the above, our net income increased to a record $12.8 million, a 686% improvement over 1998 results. 31 Liquidity and Capital Resources Cash and equivalents were $38.5 million at December 31, 2000, an increase of $36.7 million from December 31, 1999. In March 2000 we completed a private placement of 1,250,000 shares of our common stock, raising $50 million in gross proceeds before deducting commission and expenses of the offering. Spending against cash reserves was attributable to our ongoing investment in the growth of the business including working capital, and the Tucson operating facility currently under construction and partially offset by cash generated from the exercise of employee stock options. We believe that our current cash and equivalents, line of credit and cash generated from operations will satisfy funding requirements including working capital, capital expenditure, and the $15.3 million in purchase commitments for the construction of a new corporate headquarters and manufacturing facility in suburban Tucson, Arizona through fiscal 2001. Foreign Currency Risk We do not currently hedge against foreign currency fluctuations, because we do not believe that we run a serious risk of experiencing permanent impairment to any material assets denominated in foreign currency, but we intend to re- evaluate this situation from time to time. As a result, to the extent local currency revenues and expenses in our foreign subsidiaries are translated into U.S. dollars at differing rates over time, we may experience fluctuations in our operating results. We conduct a relatively small but growing portion of our business in the Euro, the Japanese Yen and the Australian dollar. New Pronouncements In June 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 133, (FAS 133), "Accounting for Derivative Instruments and Hedging Activities." This statement provides a comprehensive and consistent standard for the recognition and measurement of derivatives and hedging activities. In July 1999, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 137, which deferred the effective date of FAS 133 for one year. In June 2000, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 138, (FAS 138), "Accounting for Certain Derivative Instruments and Certain Hedging Activities-an amendment to FASB Statement No 133." This statement amended certain provisions of FAS 133. Accordingly, the Company will adopt FAS 133, as amended by FAS 138, effective the first quarter of fiscal 2001. Management believes this statement will not have an impact on the Company's financial statements. Item 7A. Quantitative and Qualitative Disclosures About Market Risk The Company is exposed to financial market risks, including changes in interest rates and foreign currency exchange rates. Nevertheless, the fair value of the Company's investment portfolio and related income would not be significantly impacted by either a 100 basis point increase or decrease in interest rates, due primarily to the short-term nature of the major portion of the Company's investment portfolio. At December 31, 2000, the Company's only investments are in money market accounts and overnight reverse repurchase agreements ($38.5 million) that are reflected as cash equivalents because all maturities are within 90 days. The Company's interest rate risk with respect to existing investments is limited due to the short-term duration of these arrangements and the yield's earned which approximate current interest rates. At present, the Company has only $4.2 million in long-term debt and there are no borrowings under our line of credit facility at December 31, 2000. As such, our interest rate risk is limited with respect to existing debt. A substantial portion of the Company's revenue and capital spending is transacted in U.S. dollars. However, the Company does at times enter into these transactions in other currencies, such as the Euro, the Japanese Yen and the Australian dollar. No hedging transactions were entered into to limit this exposure. 32 Item 8. Financial Statement and Supplementary Data The Independent Auditor's Report, Consolidated Financial Statements and Notes to Consolidated Financial Statements begin on Page F-1. Item 9. Changes In and Disagreements with Accountants on Accounting and Financial Disclosure Not applicable. 33 PART III Item 10. Directors and Executive Officers Pursuant to our Certificate of Incorporation, as amended, our Board of Directors currently consists of eight persons, divided into three classes serving staggered terms of three years. Currently there are two Class I directors, three Class II directors and three Class III directors. The terms of the Class II directors will expire at the 2001 Annual Meeting of Shareholders. The terms of the Class III and Class I directors will expire in 2002 and 2003 respectively. Jack W. Schuler Mr. Schuler has served as a director of Ventana (Age 60) since April 1991 and as Chairman of the Board of Directors since November 1995. Mr. Schuler Class III Director has been Chairman of the Board of Directors of Stericycle, Inc. since March 1990. Mr. Schuler Member of the Compensation is also a partner in Crabtree Partners. Prior and Nominating Committees to joining Stericycle, Mr. Schuler held various executive positions at Abbott from December 1972 through August 1989, serving most recently as President and Chief Operating Officer. He is currently a director of Medtronic, Inc. and Chiron Corporation. Mr. Schuler received a B.S. in Mechanical Engineering from Tufts University and an M.B.A. from Stanford University. John Patience Mr. Patience has served as a director of (Age 53) Ventana since July 1989 and as Vice Chairman since January 1999. Since April 1995, Class III Director Mr. Patience has been a partner in Crabtree Partners. Mr. Patience was a co-founder and Member of the Nominating served as a General Partner of Marquette Committee Venture Partners from January 1988 until March 1995. Marquette was one of our initial investors. Mr. Patience was previously a partner in the consulting firm of McKinsey & Co., specializing in health care. He is currently a director of Stericycle, Inc. Mr. Patience received a B.A. in Liberal Arts and an L.L.B. from the University of Sydney, Australia and an M.B.A. from the University of Pennsylvania Wharton School of Business. Christopher M. Gleeson Mr. Gleeson became President and Chief (Age 51) Executive Officer and a director in May 1999. He joined Ventana in March 1999 as Executive Class II Director Vice President and Chief Operating Officer. Prior to joining the Company, Mr. Gleeson was Senior Vice President of Bayer Diagnostics and General Manager of the U. S. Commercial Operations for Chiron Diagnostics, and prior to that, the founder, owner and Managing Director of Australian Diagnostics Corporation, a leading diagnostics distributor in Australia. He is a director of Pharmanetics, Inc. Mr. Gleeson attended Monash University in Melbourne, Australia. Kendall B. Hendrick Mr. Hendrick joined Ventana in August 1998 and (Age 41) has served as Vice President and General Manager of Research & Development since May 1999. From April 1990 to August 1998, Mr. Hendrick held various product development management positions with Abbott Laboratories, Diagnostics Division, most recently as the Director of the Architect Research & Development Program. Mr. Hendrick holds a B.S. in Mechanical Engineering from Virginia Polytechnic Institute.
34 Kirk M. Kimler Mr. Kimler joined the Company in 1999 and is (Age 38) currently the Vice President of Worldwide Marketing. From August 1988 to October 1999, Mr. Kimler held various sales and marketing positions with Abbott Laboratories, Diagnostics Division to include Marketing Manager, Architect and South East Commercial Operations. Prior to Abbott, Mr. Kimler was an officer in the United States Army. Mr. Kimler holds a B.A. in Economics from the University of Notre Dame and an M.B.A. from the University of Chicago. Nicholas Malden Mr. Malden joined Ventana as Chief Financial (Age 43) Officer in October 2000. From 1985 until joining Ventana, Mr. Malden held various financial management positions with The Gillette Company, most recently as vice president-finance for the Duracell Global Business Management Group. Mr. Malden has a B.A. in Political Science from Grinnell College and an M.B.A. from Emory University. Hany Massarany Mr. Massarany joined Ventana in July 1999 and (Age 39) is currently Vice President and General Manager of Molecular Discovery Systems. Prior to joining Ventana Mr. Massarany held management positions with Bayer Diagnostics and Chiron Diagnostics. Mr. Massarany holds a B.S. from Monash University in Australia and an M.B.A. from the University of Melbourne. Mark Nechita Mr. Nechita joined Ventana in June 2000, as (Age 41) Vice President, Human Resources, Environmental Health and Safety. Prior to joining Ventana, Mr. Nechita worked in Human Resources in the United States and internationally for RJR Nabisco, FMC and most recently, Cordant Technologies where he was Vice President, Human Resources for their Huck Fasteners unit. Mr. Nechita has a B.S. in Industrial and Labor Relations from Cornell University. Johnny D. Powers, Ph.D. Dr. Powers joined Ventana in February 1996 and (Age 39) is currently Vice President, Operations. From June 1990 until joining Ventana, Dr. Powers held various management positions with Organon Teknika Corporation serving most recently as Director of Manufacturing Technologies. Dr. Powers holds a B.A. in Chemistry from Wake Forest University, a Ph.D. in Chemical Engineering from North Carolina State University, an M.S. in Chemical Engineering from Clemson University, and an M.B.A. from Duke University. Bernard O.C. Questier Mr. Questier has served as Vice President and (Age 47) General Manager of Europe, Middle East & Africa since May 1999. He joined the Company as Vice President of European Operations in February 1996. From October 1990 until joining Ventana in October 1995, Mr. Questier held a number of management positions in E.I. DuPont de Nemours, most recently as Business Manager for NEN Life Science Products in Europe. Mr. Questier received a degree in Chemical Engineering from the Technical Institute in Oostende, Belgium.
35 Tamaki Tateiwa Mr. Tateiwa has served as President of (Age 61) Ventana's wholly owned subsidiary in Japan, Ventana Medical Systems Japan K.K. in Tokyo, since August 1997. From 1977 to 1997, Mr. Tateiwa held various management positions with Dainabot K.K. Mr. Tateiwa received a B.S. in Engineering from the University of Electro- Communications in Japan. Stephen A. Tillson, Ph.D. Dr. Tillson joined Ventana in May 1992 and has (Age 60) served as Vice President of Scientific Affairs since August 1995. From January 1990 to May 1992, Dr. Tillson served as a principal of Ticon Company Consulting. He has 25 years experience in the diagnostic and pharmaceutical industry. Dr. Tillson holds a Ph.D. from Purdue University and received a B.S. from California State Polytechnic University and an M.B.A. from St. Mary's College of California. Urs Wiederkehr Mr. Wiederkehr joined Ventana in June 2000 and (Age 39) is currently General Manager of North American Commercial Operations. Mr. Wiederkehr held various US and Internationally based sales and marketing positions with Abbot Laboratories from 1988 to 1998 and was most recently an independent consultant in the diagnostics field. Mr. Wiederkehr holds a B.S. in Chemistry from the Basel Technical Institute, in Switzerland and an M.B.A. from the Basel Management Institute. Rex J. Bates Mr. Bates has served as a director of Ventana (Age 77) since April of 1996. From August 1991 to May 1995, Mr. Bates served on the Board of Class II Director Directors of Twentieth Century Industries and was a member of its compensation committee. Member of the Audit and Prior to Twentieth Century Industries, Nominating Committee Mr. Bates served as the Vice-Chairman of the Board of Directors of the State Farm Mutual Automobile Insurance Company. Mr. Bates also served as State Farm's Chief Investment Officer. In March of 1991, Mr. Bates retired from State Farm. Prior to Mr. Bates' employment with State Farm, he was a partner in the investment firm of Stein, Roe & Farnham in Chicago. Mr. Bates received a B.S. and an M.B.A. from the University of Chicago. Edward M. Giles Mr. Giles has served as a director of Ventana (Age 65) since September 1992. Mr. Giles has served as Chairman of The Vertical Group, Inc., a venture Class II Director capital investment firm, since January 1989. Mr. Giles was previously President of F. Member of the Compensation Eberstadt & Co., Inc., a securities firm, and and Nominating Committees Vice Chairman of Peter B. Cannell & Co., Inc., an investment management firm. He is currently a director of Synthetech, Inc. Mr. Giles received a B.S.Ch.E. in Chemical Engineering from Princeton University and an M.S. in Industrial Management from the Massachusetts Institute of Technology. Thomas M. Grogan, M.D. Dr. Grogan is a founder, a director, Chairman (Age 55) Emeritus, Chief Scientific Officer and Medical Director of Ventana. He has served as a Class III Director director since the founding of the Company in June 1985 and as Chairman of the Board of Member of the Nominating Ventana from June 1985 to November 1995. He is Committee also currently a professor of pathology at the University of Arizona, College of Medicine, where he has taught since 1979. He received a B.A. in Biology from the University of Virginia and an M.D. from George Washington School of Medicine. Dr. Grogan completed a post-doctorate fellowship at Stanford University.
36 Mark C. Miller Mr. Miller has served as a director of Ventana (Age 45) since January 2001. Mr. Miller has also been President and Chief Executive Officer and a Class I Director director of Stericycle, Inc. since May 1992. Prior to joining Stericycle Mr. Miller served as Vice President Pacific/Asia/Africa for the International Division of Abbott Laboratories, which he joined in 1977 and where he held a number of management and marketing positions. Mr. Miller also serves on the board of directors of AmericasDoctor.com, Inc. and Lake Forest Hospital. Mr. Miller received a B.S. in Computer Science from Purdue University. James R. Weersing Mr. Weersing has served as a director of (Age 61) Ventana since October 1994. Since 1984, Mr. Weersing has been a Managing Director of MBW Class I Director Venture Partners, a venture capital investment Member of the Audit and firm. Mr. Weersing has also served as President Compensation Committees of JRW Technology, Inc., a consulting firm and, since January 2000, President and CEO of Iomed, Inc. Mr. Weersing received a B.S.M.E. and an M.B.A. from Stanford University.
Section 16(a) Beneficial Ownership Reporting Compliance During the last year Dr. Grogan, Dr. Powers and Mr. Giles each failed to file one report on Form 4 in a timely manner. Such transactions have subsequently been reported. 37 Item 11. Executive Compensation The following table sets forth all compensation paid by us to the chief executive officer and the most highly compensated executive officers and key employees whose total remuneration exceeded $100,000 for services rendered in all capacities to us during the last three completed fiscal years. Summary Compensation Table
Long-Term Compensation Awards ------------------------- Annual Compensation Restricted Securities Name and Principal -------------------- Stock Underlying All Other Position Year Salary ($) Bonus ($) Awards ($) Options/SARs Compensation ($) ------------------ ---- ---------- --------- ---------- ------------ ---------------- Christopher M. Gleeson.. 2000 226,719 -- -- 20,625 105,359(1) President, Chief 1999 163,846 10,000 -- 200,000 20,625(1) Executive Officer and Director 1998 -- -- -- -- -- Tamaki Tateiwa.......... 2000 173,258 -- -- 15,025 4,928(2) Vice President, General 1999 170,604 -- -- 10,800 4,438(2) Manager of Japanese Operations 1998 145,340 -- -- 4,683 3,865(2) Kendall B. Hendrick..... 2000 173,200 13,000 263,750(3) 14,481 -- Vice President, General 1999 156,914 5,000 -- 10,502 7,212(1) Manager of Research & 1998 65,403 -- -- 35,000 46,932(1) Development Johnny D. Powers, 2000 163,877 10,000 -- 9,897 -- Ph.D................... Vice President, 1999 150,683 -- -- 21,549 -- Operations 1998 144,107 -- -- 14,213 -- Bernard O.C. Questier... 2000 161,629 -- -- 13,107 8,800(2) Vice President, General 1999 153,375 -- -- 12,670 8,800(2) Manager of Europe, Middle East 1998 150,000 -- -- 16,836 8,800(2) & Africa
- -------- (1) Relocation expenses inclusive of tax reimbursement on non-deductible portion. (2) Automobile allowance. (3) Grant of 10,000 shares of restricted stock on October 31, 2000. For the purposes of this table, the shares are valued at $26.375 (the market price on October 30, 2000). The shares will vest five years from the date of grant. (4) Please see "Employment Agreements" on Page 39 for information with respect to currency fluctuations. 38 Aggregate Option Exercises in the Last Fiscal Year and Year-End Values. The following table sets forth, for each of the executives named in the summary compensation table below, information with respect to each exercise of stock options during the fiscal year ended December 31, 2000, and the value of unexercised options at December 31, 2000. Aggregate Option Exercises in Fiscal 2000 and Year-End Values
Number of Securities Underlying Unexercised Value of Unexercised Shares Options at In-the-Money Options Acquired on December 31, 2000 at December 31, 2000(1) Exercise Value ------------------------- ------------------------- Name (#) Realized ($) Exercisable Unexercisable Exercisable Unexercisable ---- ----------- ------------ ----------- ------------- ----------- ------------- Christopher M. Gleeson.. -- -- 57,434 163,191 38,988 123,512 Tamaki Tateiwa.......... -- -- 62,202 13,506 350,135 42,240 Kendall B. Hendrick..... -- -- 29,166 30,817 5,502 4,188 Johnny D. Powers, Ph.D. ................. -- -- 80,492 15,167 158,136 18,626 Bernard O.C. Questier... -- -- 77,080 12,490 744,720 12,623
- -------- (1) The value of "in-the-money" stock options represents the positive spread between the exercise price of stock options, which ranges from $0.84 per share to $27.375 per share, and the fair market value for our common stock of $18.50 per share as of December 31, 2000, which was the closing price of our Common Stock on December 31, 2000. Employment Agreements We have an employment agreement with Bernard O.C. Questier, our Vice President of European Operations. The agreement provides for annual compensation of $164,500, which is fixed to the French Franc to protect against currency fluctuations should the United States Dollar depreciate relative to the French Franc; however, if the United States dollar appreciates relative to the French Franc, Mr. Questier's salary shall remain unchanged. The agreement states that if Mr. Questier is terminated, he will continue to be paid through the quarter in which notice of termination is given plus one additional full quarter. The agreement does not provide for any specified term of employment. We currently have no employment contracts or agreements with any other officers named in the Summary Compensation Table or with any other person. Compensation Committee Interlocks and Insider Participation in Compensation Decisions The Compensation Committee of the Board of Directors consists of Jack W. Schuler, James Weersing and Edward M. Giles. The Compensation Committee makes recommendations to the Board of Directors concerning salaries and incentive compensation for our employees and consultants. However, the Compensation Committee has full power and authority to grant stock options to our executive officers under the 1996 Stock Option Plan. 39 Option Grants in the Last Fiscal Year The following table sets forth information with respect to each grant of stock options made during the fiscal year ended December 31, 2000 to each executive officer named in the Summary Compensation Table above: Individual Grants
Potential Realizable Value at Assumed Annual Rates of Stock Price Number of Appreciation Securities % of Total for Option Underlying Options Exercise or Term(4) Options Granted in Base Price Expiration --------------- Name Granted(1) 2000(2) ($/Sh)(3) Date 5% ($) 10% ($) ---- ---------- ---------- ----------- ---------- ------- ------- Christopher M. Gleeson.. 16,000(a) 1.8% $23.500 12/31/2009 236,464 599,247 4,625(b) 0.5% $23.500 1/23/2010 68,353 173,220 Tamaki Tateiwa.......... 7,750(a) 0.9% $23.500 12/31/2009 114,537 290,260 7,275(b) 0.8% $23.500 1/23/2010 107,517 272,470 Kendall B. Hendrick..... 10,000(a) 1.1% $23.500 12/31/2009 147,790 374,529 4,481(b) 0.5% $23.500 1/23/2010 66,225 167,827 Johnny D. Powers, Ph.D. ................. 6,000(a) 0.7% $23.500 12/31/2009 88,674 224,718 3,897(b) 0.4% $23.500 1/23/2010 57,594 145,954 Bernard O.C. Questier... 7,500(a) 0.9% $23.500 12/31/2009 110,843 280,897 5,607(b) 0.6% $23.500 1/23/2010 82,866 209,999
- -------- (1) The above options were granted under the Company's 1996 Stock Option Plan. Vesting periods are as follows: (a) five years and (b) immediate. (2) Based on an aggregate of 876,337 options granted by the Company during the year ended December 31, 2000. (3) The option exercise price per share was equal to the fair market value of the Common Stock on the date of grant. (4) The 5% and 10% assumed annual rates of compounded stock price appreciation are mandated by rules of the Securities and Exchange Commission. There can be no assurance provided to any executive officer or any other holder of the Company's securities that the actual stock price appreciation over the 10-year option term will be at the assumed 5% and 10% levels or at any other defined level. Unless the market price of the Common Stock appreciates over the option term, no value will be realized from the option grants made to the executive officers. 40 Item 12. Security Ownership of Certain Beneficial Owners and Management The following table sets forth information, as of February 28, 2001 with respect to the number of shares of our common stock beneficially owned by individual directors, by all of our directors and officers as a group, and by persons known by us to own more than 5% of our common stock. We have no other class of voting stock outstanding.
Percent of Common Number of Stock Name and Address of Beneficial Owner Shares Owned ------------------------------------ --------- ---------- Kopp Investment Advisors, Inc. ........................... 2,657,923 14.6 7701 France Avenue South Suite 500 Edina, MN 55435 Wellington Management Co. LLP............................. 1,955,300 10.8 75 State Street Boston, MA 02109 MBW Venture Partners. L.P................................. 1,442,350 7.9 365 South Street Morristown, NJ 07960 Berger, LLC............................................... 1,254,630 6.9 210 University Blvd, Ste 900 Denver, CO 80206 Franklin Resources Asset Management....................... 1,142,600 6.3 777 Mariners Island Blvd. San Mateo, CA 94404 US Trust Company of New York.............................. 1,126,573 6.2 114 West 47th Street New York, NY 10036 Jack W. Schuler(3)........................................ 1,343,957 7.4 John Patience(4).......................................... 652,449 3.6 Edward M. Giles(5)........................................ 578,749 3.2 Thomas M. Grogan, M.D.(6)................................. 186,509 1.0 Rex J. Bates(7)........................................... 85,151 * Johnny D. Powers, Ph.D.(8)................................ 85,071 * Bernard O.C. Questier(9).................................. 82,824 * Christopher M. Gleeson(10)................................ 79,246 * Tamaki Tateiwa(11)........................................ 66,766 * Stephen A. Tillson(12).................................... 37,895 * James R. Weersing(13)..................................... 37,007 * Kendall B. Hendrick(14)................................... 34,395 * Kirk M. Kimler(15)........................................ 18,298 * Hany Massarany(16)........................................ 9,902 * Urs Wiederkehr............................................ 511 * Mark Nechita.............................................. 222 * Nicholas Malden........................................... 0 * Mark C. Miller............................................ 0 * All Directors and Officers as a group (18 persons)........ 3,298,952 18.2
- -------- * Less than 1% 1. Except as indicated in the footnotes to this table and pursuant to applicable community property laws, the persons named in the table have sole voting and investment power with respect to all shares of Common Stock. 41 2. Applicable percentage of ownership is based on 15,444,122 shares of common stock outstanding as of December 31, 2000, together with shares issuable pursuant to applicable options and warrants of such stockholder which may be exercised within 60 days after February 28, 2001. Share of common stock subject to options and/or warrants currently exercisable or exercisable within 60 days after February 28, 2001, are deemed outstanding for computing the percentage ownership of the person holding such options and/or warrants, but are not deemed outstanding for computing the percentage of any other person. 3. Includes 265,250 shares issuable upon the exercise of options exercisable within 60 days of February 28, 2001, held by Mr. Schuler; 73,512 shares beneficially owned by Mr. Schuler, as custodian for Tanya Eva Schuler; 73,512 shares beneficially owned by Mr. Schuler, as custodian for Therese Heidi Schuler; and 73,512 shares beneficially owned by Mr. Schuler, as custodian for Tino Hans Schuler; and 20,000 shares beneficially owned by the Schuler Family Foundation, and 1,250 shares owned by Mrs. Schuler. 4. Includes 258,375 shares issuable upon the exercise of options exercisable within 60 days of February 28, 2001, held by Mr. Patience, as well as 4,800 shares held in the name of Mrs. Patience. 5. Includes 478,501 shares beneficially owned by Vertical Fund Associates, L.P. Also includes 26,500 shares issuable upon the exercise of options exercisable within 60 days of February 28, 2001, held by Edward M. Giles. Also includes 37,462 beneficially owned by Edward M. Giles IRA. Mr. Giles, one of our directors, is chairman of the Vertical Group, Inc. Mr. Giles disclaims beneficial ownership of the shares beneficially owned by such entities affiliated with the Vertical Group, Inc., except to the extent of his partnership interest therein. 6. Includes 9,612 shares beneficially owned by Andrew Grogan. Includes 10,612 shares beneficially owned by Emily Grogan. Includes 7,710 shares beneficially owned by C. Ovens, Inc. Includes 47,454 shares issuable upon exercise of options exercisable within 60 days of February 28, 2001, held by Dr. Grogan. 7. Includes 26,500 shares issuable upon the exercise of options exercisable within 60 days of February 28, 2001, held by Mr. Bates. 8. Includes 83,134 shares issuable upon the exercise of options exercisable within 60 days of February 28, 2001, held by Dr. Powers. 9. Includes 79,068 shares issuable upon the exercise of options exercisable within 60 days of February 28, 2001, held, held by Mr. Questier. 10. Includes 66,768 shares issuable upon exercise of options exercisable within 60 days of February 28, 2001, held by Mr. Gleeson. 11. Includes 66,766 shares issuable upon exercise of options exercisable within 60 days of February 28, 2001, held by Mr. Tateiwa. 12. Includes 17,738 shares issuable upon exercise of options exercisable within 60 days of February 28, 2001, held by Mr. Tillson. 13. Includes 26,500 shares issuable upon the exercise of options exercisable within 60 days of February 2001, held by Mr. Weersing. Includes 6,209 shares beneficially owned by James R. Weersing and Mary H. Weersing, Trustees of the Weersing Family Trust U/D/T dated April 24, 1991. 14. Includes 32,592 shares issuable upon exercise of options exercisable within 60 days of February 28, 2001, held by Mr. Hendrick. 15. Includes 16,934 shares issuable upon exercise of options exercisable within 60 days of February 28, 2001, held by Mr. Kimler. 16. Includes 9,902 shares issuable upon exercise of options exercisable within 60 days of February 28, 2001, held by Mr. Massarany. 42 Item 13. Certain Relationships and Related Transactions On February 8, 2001, our Board of Directors unanimously approved, with Messrs. Schuler and Patience abstaining, an additional option to purchase 50,000 shares to each of Messrs. Schuler and Patience. These options carry an exercise price of $20.4375 per share, which was equal to the fair market value of our common stock on the date of grant. The options vest on a monthly basis over a 12-month period commencing on February 26, 2001. This grant was a renewal of an arrangement that has been in place since February 26, 1996 by which Messrs. Schuler and Patience devote a significant portion of their work time to our business. 43 PART IV Item 14. Exhibits and Reports on Form 8-K. 1. Financial Statements The following consolidated financial statements of Ventana Medical Systems, Inc. and Report of Ernst & Young, LLP, Independent Auditors, are in this Form 10-K. Report of Ernst & Young LLP, Independent Auditors........................ F-1 Consolidated Balance Sheets as of December 31, 2000 and 1999............. F-2 Consolidated Statements of Operations for the Years Ended December 31, 2000, 1999 and 1998..................................................... F-3 Consolidated Statements of Stockholders' Equity for the Years Ended December 31, 2000, 1999 and 1998........................................ F-4 Consolidated Statements of Cash Flow for the Years Ended December 31, 2000, 1999 and 1998..................................................... F-5 Notes to Consolidated Financial Statements............................... F-6
2. Financial Statement and Schedules for the Years ended December 31, 2000, 1999 and 1998 Schedule II--Valuation and Qualifying Accounts has been provided on page 47. All other schedules are omitted because the information required to be set forth therein is not applicable or is shown in the consolidated financial statements or notes thereto. 3. Exhibits The following Exhibits are filed herewith pursuant to Rule 601 of Regulation S-K:
Exhibit Number Description Notes ------- ----------- ----- 3.1 Restated Certificate of Incorporation or Registrant (1) 3.2 Bylaws of Registrant (1) 4.1 Specimen Common Stock Certificate (1) 10.1 Form of Indemnification Agreement for directors and officers (1) 10.2 1988 Stock Option Plan and forms of agreements thereunder (1) 10.3 1996 Stock Option Plan and forms of agreements thereunder (1) 10.4 1996 Employee Stock Purchase Plan (1) 10.5 1996 Directors Option Plan (1) 10.6 1998 Nonstatutory Stock Option Plan and forms of agreements thereunder (2) 10.7 Form of Stock Purchase Warrant to Purchase shares of Series D Preferred Stock (1) 10.8 Bank of America Business Loan Agreement dated June 9, 1998 (3) 10.9 Amendment to Bank of America Business Loan Agreement dated October 1, 1998 (3) 10.10 Amendment to Bank of America Business Loan Agreement dated March 17, 1999 (3) 21.1 Subsidiaries of Registrant 23.1 Consent of Ernst & Young LLP, Independent Auditors
44 - -------- (1) Filed with the Registration Statement on Form S-1 (Commission File No. 333-4461), declared effective by the Commission July 26, 1996. (2) Filed with the Registration Statement on Form S-8 (Commission File No. 333-92883), filed with the Commission on December 16, 1999. (3) Filed with the report on Form 10-K filed March 31, 2000 (Commission File No. 000-20931). (b) Current Reports on Form 8-K We did not file any reports on Form 8-K during the last quarter of the fiscal year ended December 31, 2000. 45 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, hereunto duly authorized, in the City of Tucson, State of Arizona, on this 29th day of March 2001. VENTANA MEDICAL SYSTEMS, INC. /s/ Nicholas Malden By: _________________________________ Nicholas Malden, Vice President, Chief Financial Officer and Secretary Pursuant to the requirements of the Securities Act of 1934, this report has been signed by the following persons on behalf of the registrant and in the capacities and on the dates indicated:
Signature Title Date --------- ----- ---- /s/ Christopher M. Gleeson President, Chief Executive March 29, 2001 ____________________________________ Officer and Director Christopher M. Gleeson (Principal Executive Officer) /s/ Nicholas Malden Vice President, Chief March 29, 2001 ____________________________________ Financial Officer and Nicholas Malden Secretary (Principal Financial and Accounting Officer) /s/ Rex J. Bates Director March 29, 2001 ____________________________________ Rex J. Bates /s/ Edward M. Giles Director March 29, 2001 ____________________________________ Edward M. Giles /s/ Thomas M. Grogan Director March 29, 2001 ____________________________________ Thomas M. Grogan /s/ Mark C. Miller Director March 29, 2001 ____________________________________ Mark C. Miller /s/ John Patience Director March 29, 2001 ____________________________________ John Patience /s/ Jack W. Schuler Director March 29, 2001 ____________________________________ Jack W. Schuler /s/ James R. Weersing Director March 29, 2001 ____________________________________ James R. Weersing
46 SCHEDULE II VALUATION AND QUALIFYING ACCOUNTS VENTANA MEDICAL SYSTEMS, INC. (in thousands)
Additions ------------------- Balance at Charged to Charged Balance at Beginning Costs and to Other End of Description of Period Expenses Accounts Deductions Period ----------- ---------- ---------- -------- ---------- ---------- Year Ended December 31, 2000 Deducted from asset accounts: Allowance for doubtful accounts.. $883 $1,895 $ 30(1) $ 169(2) $2,639 ==== ====== ===== ====== ====== Allowance for obsolete inventory.......... $476 $4,310 $ -- $2,429(3) $2,357 ==== ====== ===== ====== ====== Year Ended December 31, 1999 Deducted from asset accounts: Allowance for doubtful accounts.. $694 $ 196 $ 152(1) $ 159(2) $ 883 ==== ====== ===== ====== ====== Allowance for obsolete inventory.......... $104 $ 408 $ -- $ 36(3) $ 476 ==== ====== ===== ====== ====== Year Ended December 31, 1998 Deducted from asset accounts: Allowance for doubtful accounts.. $300 $ 392 $ 41(1) $ 39(2) $ 694 ==== ====== ===== ====== ====== Allowance for obsolete inventory.......... $104 $ -- $ -- $ -- $ 104 ==== ====== ===== ====== ======
- -------- (1) Charged to revenue (2) Uncollectible accounts written off, net of recoveries (3) Inventories written off, net of recoveries 47 REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS Board of Directors Ventana Medical Systems, Inc. We have audited the accompanying consolidated balance sheets of Ventana Medical Systems, Inc., as of December 31, 2000 and 1999, and the related consolidated statements of operations, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 2000. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Ventana Medical Systems, Inc., at December 31, 2000 and 1999, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2000, in conformity with accounting principles generally accepted in the United States. As discussed in Note 1 to the consolidated financial statements, in 2000 the Company changed its method of accounting for revenue recognition. /s/ Ernst & Young LLP Phoenix, Arizona January 25, 2001 F-1 VENTANA MEDICAL SYSTEMS, INC. CONSOLIDATED BALANCE SHEETS (In thousands, except share data)
December 31, ------------------ 2000 1999 -------- -------- ASSETS ------ Current assets: Cash and cash equivalents................................ $ 38,512 $ 1,787 Trade accounts receivable, net of allowance for doubtful accounts of $2,639 and $883, respectively............... 16,682 20,776 Inventories.............................................. 8,100 13,474 Prepaid expenses......................................... 460 574 Deferred tax assets...................................... 4,817 1,692 Other current assets..................................... 492 722 -------- -------- Total current assets................................... 69,063 39,025 Property and equipment, net................................ 22,329 14,441 Intangibles, net........................................... 11,887 14,178 Capitalized software development costs, net................ 1,190 1,084 Deferred tax assets, net of current portion................ 3,985 4,433 Other assets............................................... 1,128 -- -------- -------- Total assets........................................... $109,582 $ 73,161 ======== ======== LIABILITIES AND STOCKHOLDERS' EQUITY ------------------------------------ Current liabilities: Accounts payable......................................... $ 5,943 $ 4,017 Other current liabilities................................ 13,143 6,600 -------- -------- Total current liabilities.............................. 19,086 10,617 Long-term debt............................................. 3,408 2,044 Commitments and Contingencies Stockholders' equity: Common stock--$.001 par value; 50,000,000 shares authorized, 15,444,122 and 13,593,640 shares issued and outstanding at December 31, 2000 and 1999, respectively............................................ 15 14 Additional paid-in-capital............................... 134,862 80,542 Accumulated deficit...................................... (46,636) (19,341) Accumulated other comprehensive income................... (553) (115) Treasury stock--40,000 shares, at cost................... (600) (600) -------- -------- Total stockholders' equity............................. 87,088 60,500 -------- -------- Total liabilities and stockholders' equity............. $109,582 $ 73,161 ======== ========
See accompanying notes. F-2 VENTANA MEDICAL SYSTEMS, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (In thousands, except per share data)
Years Ended December 31, -------------------------- 2000 1999 1998 -------- ------- ------- Sales: Reagents and other............................... $ 49,682 $45,340 $31,967 Instruments...................................... 21,467 24,069 15,737 -------- ------- ------- 71,149 69,409 47,704 Cost of goods sold................................. 36,377 21,218 14,542 -------- ------- ------- Gross profit....................................... 34,772 48,191 33,162 Operating expenses: Selling, general and administrative.............. 43,800 32,381 23,805 Research and development......................... 11,116 7,078 5,057 Non-recurring expenses........................... 4,519 -- 3,160 Amortization of acquisition costs................ 1,474 1,051 599 -------- ------- ------- (Loss) income from operations...................... (26,137) 7,681 541 Interest and other income (expense)................ 1,346 (370) 1,089 -------- ------- ------- (Loss) income before taxes and cumulative effect of accounting change................................. (24,791) 7,311 1,630 (Provision for) benefit from income taxes.......... (350) 5,500 -- -------- ------- ------- (Loss) income before cumulative effect of accounting change................................. (25,141) 12,811 1,630 Cumulative effect of accounting change, net of applicable income tax benefit of $1,436........... (2,154) -- -- -------- ------- ------- Net (loss) income.............................. $(27,295) $12,811 $ 1,630 ======== ======= ======= Basic earnings per common share: Before cumulative effect of accounting change.... $ (1.70) $ .95 $ .12 Cumulative effect of accounting change........... (.15) -- -- -------- ------- ------- Net (loss) income.............................. $ (1.85) $ .95 $ .12 ======== ======= ======= Diluted earnings per common share: Before cumulative effect of accounting change.... $ (1.70) $ .88 $ .11 Cumulative effect of accounting change........... (.15) -- -- -------- ------- ------- Net (loss) income.............................. $ (1.85) $ .88 $ .11 ======== ======= ======= Pro forma amounts assuming the accounting changes are applied retroactively: Net (loss) income................................ $(25,141) $11,668 $ 1,282 Net (loss) income per common share: --Basic........................................ $(1.70) $ .88 $ .10 --Diluted...................................... $(1.70) $ .80 $ .09 Shares used in computing earnings per common share: --Basic.......................................... 14,770 13,478 13,320 ======== ======= ======= --Diluted........................................ 14,770 14,636 14,627 ======== ======= =======
See accompanying notes. F-3 VENTANA MEDICAL SYSTEMS, INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (In thousands, except share data)
Accumulated Common Stock Additional Other ----------------- Paid-In Accumulated Comprehensive Treasury Shares Amount Capital Deficit Income Stock Total ---------- ------ ---------- ----------- ------------- -------- -------- Balance at January 1, 1998................... 13,247,226 $13 $ 76,313 $(33,782) $(141) $ -- $ 42,403 Net income.............. -- -- -- 1,630 -- -- 1,630 Translation adjustment.. -- -- -- -- (52) -- (52) Comprehensive income.... -- -- -- -- -- -- 1,578 Sale of common stock-- other.................. 174,593 -- 1,502 -- -- -- 1,502 Repayment of director's loans.................. -- -- 901 -- -- -- 901 Purchase of common stock.................. -- -- -- -- -- (600) (600) ---------- --- -------- -------- ----- ----- -------- Balance at December 31, 1998................... 13,421,819 13 78,716 (32,152) (193) (600) 45,784 Net income.............. -- -- -- 12,811 -- -- 12,811 Translation adjustment.. -- -- -- -- 78 -- 78 Comprehensive income.... -- -- -- -- -- -- 12,889 Sale of common stock-- other.................. 171,821 1 1,826 -- -- -- 1,827 ---------- --- -------- -------- ----- ----- -------- Balance at December 31, 1999................... 13,593,640 14 80,542 (19,341) (115) (600) 60,500 Net (loss) income....... -- -- -- (27,295) -- -- (27,295) Translation adjustment.. -- -- -- -- (438) -- (438) Comprehensive (loss) income................. -- -- -- -- -- -- (27,733) Sale of common stock, net of issuance costs of $3,154.............. 1,250,000 1 46,846 -- -- -- 46,847 Exercise of stock options................ 600,482 -- 6,052 -- -- -- 6,052 Tax benefit from stock options................ -- -- 1,422 -- -- -- 1,422 ---------- --- -------- -------- ----- ----- -------- Balance at December 31, 2000................... 15,444,122 $15 $134,862 $(46,636) $(553) $(600) $ 87,088 ========== === ======== ======== ===== ===== ========
See accompanying notes. F-4 VENTANA MEDICAL SYSTEMS, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands)
Years Ended December 31, --------------------------- 2000 1999 1998 -------- ------- -------- Operating activities: Net (loss) income................................ $(27,295) $12,811 $ 1,630 Adjustments to reconcile net (loss) income to net cash used in operating activities: Depreciation and amortization.................. 5,497 3,689 2,850 Cumulative effect of accounting change......... 2,154 -- -- Non-cash intangibles and property and equipment charges....................................... 7,914 -- -- Purchased in-process research and development.. -- -- 2,900 Benefit from deferred taxes.................... (1,255) (5,980) (145) Changes in operating assets and liabilities net of effects from acquisitions: Accounts receivable............................ 4,094 (4,245) (6,340) Inventories.................................... 5,374 (2,465) (4,160) Other assets................................... (1,040) (1,002) 198 Accounts payable............................... 1,926 481 (63) Other current liabilities...................... 4,389 815 586 -------- ------- -------- Net cash provided by (used in) operating activities.................................. 1,758 4,104 (2,544) Investing activities: Purchase of property and equipment............... (15,150) (6,843) (5,377) Purchase of intangible assets.................... (1,208) (78) (5) Acquisition of certain Oncor, Inc. assets........ -- -- (5,000) Acquisition of Biotechnology Tools, Inc.......... -- (358) (5,257) Acquisition of Quantitative Diagnostic Laboratories.................................... (2,500) -- -- -------- ------- -------- Net cash used in investing activities........ (18,858) (7,279) (15,639) Financing activities: Net proceeds from private placement.............. 46,847 -- -- Issuance of common stock......................... 6,052 2,460 2,403 Net change in long term debt..................... 1,364 -- -- Purchase of common stock......................... -- -- (600) Repayment of debt, net of gain on extinguishment.................................. -- -- (46) -------- ------- -------- Net cash provided by financing activities........ 54,263 2,460 1,757 Effect of exchange rate changes on cash.......... (438) 78 (52) -------- ------- -------- Net increase (decrease) in cash and cash equivalents..................................... 36,725 (637) (16,478) Cash and cash equivalents, beginning of year..... 1,787 2,424 18,902 -------- ------- -------- Cash and cash equivalents, end of year....... $ 38,512 $ 1,787 $ 2,424 ======== ======= ======== Supplemental cash flow information: Income taxes paid.............................. $ 350 $ 104 $ 240 Interest paid.................................. $ 278 $ 145 $ 260
See accompanying notes. F-5 VENTANA MEDICAL SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (In thousands, except per share data) 1. Organization and Significant Accounting Policies Organization: Ventana Medical Systems, Inc. (the "Company") develops, manufactures, and markets proprietary instruments and reagents that automate diagnostic procedures used for molecular analysis of cells. At present, the Company's principal markets are North America, Europe, Japan and Australia. Revenue Recognition: The Company recognizes revenue upon shipment of its products that do not require installation at the customer's site. During the year ended December 31, 2000, the Company changed its methods of revenue recognition for its products which do require installation at the customer's site in accordance with Staff Accounting Bulletin (SAB) No. 101 Revenue Recognition in Financial Statements. Previously, the Company had recognized revenue for products upon shipment to the customer, but prior to installation at the customer's site. The Company had routinely completed such installation services in the past, but a substantive effort is required and the Company is the only one who can perform the service. Under the new accounting method adopted retroactive to January 1, 2000, the Company now recognizes revenue upon the completion of installation of the product at the customer's site. The cumulative effect of the accounting change resulted in a charge to operations of $2,154 (net of an income tax benefit of $1,436), which is included in operations for the year ended December 31, 2000. The effect of the change on the year-ended 2000 was to decrease income before cumulative effect of accounting change by $539 ($.04 per basic and diluted shares, respectively). For the year ended December 31, 2000, the Company recognized $2,392 in revenue that is included in the cumulative effect adjustment as of January 1, 2000. The effect of that revenue was to increase income by $1,064 (after reduction for income taxes of $710) during that period. Principles of Consolidation: The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries, Ventana Medical Systems, S.A., Ventana Medical Systems GmbH, Ventana Medical Systems Japan K.K., Ventana Medical Systems Australia Pty. Ltd., BioTek Solutions, Inc. (BioTek) and BioTechnology Tools, Inc. (BTTI). All significant intercompany accounts and transactions have been eliminated. Use of Estimates: The preparation of financial statements in accordance with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. Cash and Cash Equivalents: Cash equivalents include investments (primarily money market accounts and overnight reverse repurchase agreements) with maturities of three months or less from the date of purchase. Inventories: Inventories, principally chemical, biological and instrument parts and reagents and finished instruments, are stated at the lower of cost (first-in first-out basis) or market. Property and Equipment: Property and equipment are stated at cost. Depreciation is computed using the straight-line method over estimated useful lives of three to ten years. Amortization of leasehold improvements is generally calculated using a straight-line method over the term of the lease. Maintenance and repairs are charged to operations as incurred. Property and equipment includes diagnostic instruments used for sales demonstrations or placed with customers under several types of arrangements, including cancelable reagent plans (RAPs), qualified reagent installed bases (QRIBs) and rentals. New instruments are no longer placed into RAP programs. However, certain long-standing agreements continue on a month-to-month basis, wherein the customer is required to purchase a minimum quantity of reagents in order to keep the instrument. QRIB instruments are placed with customers for evaluation periods of up to six months. The customer is required to purchase a minimum amount of reagents and F-6 VENTANA MEDICAL SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) 1. Organization and Significant Accounting Policies (continued) at the end of the evaluation period must purchase, rent or return the instrument. The manufacturing cost of demonstration, RAP, QRIB and rental instruments is amortized over a period of 3 to 4 years to cost of goods sold (RAPs and rentals) and selling, general and administrative expenses (QRIBs and demonstrations). Intangibles: Intangible assets consist primarily of goodwill, customer base, developed technology, workforce in place and supply agreements acquired in the acquisitions of BioTek, BTTI, certain assets and technology from Oncor, Inc., QDL and patents (see Note 12). Such assets are amortized on a straight- line basis over estimated useful lives ranging from 5 to 20 years. Impairment is recognized in operating results if a permanent decline in value occurs. The Company measures possible impairment of its intangible assets periodically by comparing the undiscounted cash flows generated by those assets to their carrying values. The Company periodically evaluates the useful lives assigned to the various categories of intangible assets considering such factors as: (i) demand, obsolescence, competition, market share, and other economic factors; (ii) legal and regulatory provisions; and (iii) the periods expected to be benefited. Capitalized Software Development Costs: The Company capitalizes certain internal salaries expense related to developing computer software used in the Company's instruments. Costs incurred prior to the establishment of technological feasibility are charged to research and development expense. Upon general release to customers of the product in which the software is included, capitalization ceases and such costs are amortized using the straight-line method over the estimated life of 5 years. Capitalized software costs and accumulated costs are as follows at December 31:
2000 1999 ------ ------ Capitalized costs........................................... $1,764 $1,508 Less accumulated amortization............................... 574 424 ------ ------ $1,190 $1,084 ====== ======
Shipping Costs: Substantially all costs of shipping products to customers are included in costs of sales. Concentration of Credit Risk: The Company sells its instruments and reagent products primarily to hospitals, medical clinics, reference laboratories, and universities. Credit losses have been minimal to date. The Company invests its excess cash primarily in U.S. government securities and bank money market accounts and has an established policy relating to diversification and maturities that is designed to maintain safety and liquidity. The Company has not experienced any material losses on its cash equivalents or short-term investments. No single customer accounted for 5% or more of the Company's 2000, 1999 or 1998 net sales. Foreign Currency Translations: The financial statements of foreign subsidiaries have been translated into U.S. dollars in accordance with Statement of Financial Accounting Standards No. 52, Foreign Currency Translation. All balance sheet accounts have been translated using the exchange rates in effect at the balance sheet date. Income statement amounts have been translated using the average exchange rate for the year. The gains and losses resulting from the changes in exchange rates from year to year have been reported in other comprehensive income. The effect on the consolidated statements of operations of transaction gains and losses is not material for all years presented. Income Taxes: The Company accounts for income taxes using the liability method. Deferred tax assets and liabilities are determined based on differences between financial reporting and tax bases of assets and liabilities and are measured using enacted tax rates and laws expected to be in effect when the differences are expected to reverse. Valuation allowances are established when necessary to reduce the carrying amount of deferred tax assets to their net realizable value. F-7 VENTANA MEDICAL SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) 1. Organization and Significant Accounting Policies (continued) Fair Value of Financial Instruments: The Company's cash equivalents, accounts receivable, accounts payable and long-term debt represent financial instruments as defined by Statement of Financial Accounting Standards No. 107, Disclosures About Fair Value of Financial Instruments. The carrying value of these financial instruments is a reasonable approximation of fair value, due to their current maturities. Stock-Based Compensation: The Company has elected to follow Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees ("APB No. 25") and related Interpretations in accounting for its employee stock options because, as discussed below, the alternative fair value accounting provided for under Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation ("SFAS No. 123"), requires the use of option valuation models that were not developed for use in valuing employee stock options. Under APB No. 25, because the exercise price of the Company's stock options equals or exceeds the fair market value of the underlying stock on the dates of grant, no compensation expense is recognized. Recently Issued Accounting Standards: In June 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 133, (FAS 133), "Accounting for Derivative Instruments and Hedging Activities." This statement provides a comprehensive and consistent standard for the recognition and measurement of derivatives and hedging activities. In June 2000, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 138, (FAS 138), "Accounting for Certain Derivative Instruments and Certain Hedging Activities--an amendment to FASB Statement No 133." This statement amended certain provisions of FAS 133. Accordingly, the Company will adopt FAS 133, as amended by FAS 138, effective the first quarter of fiscal 2001. Management believes this statement will not have an impact on the Company's financial statements. 2. Inventories Inventories consist of the following:
December 31, 2000 1999 ------ ------- Raw materials and work-in-process............................... $3,603 $ 5,729 Finished goods.................................................. 4,497 7,745 ------ ------- $8,100 $13,474 ====== =======
3. Property and Equipment Property and equipment consist of the following:
December 31, 2000 1999 ------- ------- Diagnostic instruments......................................... $ 8,402 $10,471 Computers and related equipment................................ 6,995 5,215 Machinery and equipment........................................ 6,985 5,703 Land........................................................... 2,987 -- Fixed assets under capital lease............................... 2,250 -- Leasehold improvements......................................... 867 730 Furniture and fixtures......................................... 616 295 ------- ------- 29,102 22,414 Less accumulated depreciation and amortization................. 10,458 8,098 Projects in progress........................................... 3,685 125 ------- ------- $22,329 $14,441 ======= =======
F-8 VENTANA MEDICAL SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) 4. Intangible Assets Intangible assets consist of the following:
December 31, 2000 1999 ------- ------- Goodwill................................................... $ 7,637 $ 8,231 Customer base.............................................. 4,100 4,100 Patents.................................................... 1,778 570 Supply contract............................................ 1,200 1,200 Developed technology....................................... 1,027 2,800 Workforce in place......................................... 100 100 ------- ------- 15,842 17,001 Less amortization.......................................... 3,955 2,823 ------- ------- $11,887 $14,178 ======= =======
5. Other Current Liabilities Other current liabilities consist of the following:
December 31, 2000 1999 ------- ------ Deferred revenue........................................... $ 4,868 $1,152 Employee compensation and benefits......................... 3,147 2,050 Contingent purchase consideration.......................... 1,377 500 Facility relocation........................................ 1,117 -- Long-term debt, current portion............................ 836 555 Product warranty........................................... 545 255 Sales tax payable.......................................... 315 193 Other accrued liabilities.................................. 938 1,895 ------- ------ $13,143 $6,600 ======= ======
6. Line of Credit The Company has a $10,000 line of credit arrangement with a bank which is subject to renewal in March 2001. Borrowings under the line are collateralized by the Company's receivables, inventories, machinery and equipment, and intellectual property. The line of credit contains certain financial covenants (measured quarterly) with which the Company must comply, prohibits the payment of dividends on the Company's stock and limits the number of treasury shares the Company may purchase. In addition, borrowings are limited based on outstanding accounts receivable of the Company, which as of December 31, 2000 resulted in available borrowing of $10,000, of which, $6,436 has been committed in support of various standby letters of credit. At December 31, 2000, the Company was not in compliance with certain covenants; however, subsequent to year-end, the Company was granted a waiver through May 31, 2001 while the line of credit is being renegotiated with the bank. F-9 VENTANA MEDICAL SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) 7. Long-term Debt Long-term debt consists of the following:
December 31, 2000 1999 ------ ------ Notes payable for European facility, various interest rates...................................................... $2,090 $ -- Note payable to a customer, installment payments over 16 quarters beginning January 1, 2000, interest accruing at 7% beginning January 1, 2000.................................. 1,135 1,652 Capital lease and other obligations, various terms and interest rates............................................. 1,019 947 ------ ------ 4,244 2,599 Less current portion........................................ 836 555 ------ ------ $3,408 $2,044 ====== ======
Future payments under the above obligations are as follows at December 31, 2000: 2001................................................................ $ 836 2002................................................................ 871 2003................................................................ 631 2004................................................................ 316 2005................................................................ 170 Thereafter.......................................................... 1,420 ------ $4,244 ======
8. Stockholders' Equity On February 26, 1996, the Company sold 647 shares of common stock to two directors of the Company and a related partnership at a price of $1.62 per share for their efforts and assistance in completing the BioTek acquisition and assisting management with its integration of the acquired company. Receivables of $901 due from the directors were repaid on February 26, 1998. Warrants for the purchase of 440 shares of Common Stock were outstanding and fully exercisable at December 31, 2000, at an exercise price of $5.82 per share. These warrants may be exercised on a net basis and will begin to expire in February 2001, to the extent not previously exercised. Under the Company's 1988 Stock Option Plan ("the 1988 Plan"), up to 1,340 shares of common stock have been reserved for grant to employees and directors. In order to be incentive stock options (ISOs), options must be granted at not less than 100% of fair market value of the Company's stock on the date of grant. Options generally vest over a four-year period and expire five to ten years after the date of grant. However, the Board of Directors, at its discretion, may decide the period over which options become exercisable and their expiration dates. In April 1996, the Company's Board of Directors authorized the 1996 Stock Option Plan ("the 1996 Plan"). A total of 2,475 shares of common stock have been reserved for issuance under the 1996 Plan. In order to be ISOs, options must be granted at not less than 100% of the fair market value of the Company's stock on the dates of grant. Options generally vest over four years (grants made prior to 1998) or five years (1998 and subsequent grants) and expire in ten years. F-10 VENTANA MEDICAL SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) 8. Stockholders' Equity (continued) In April 1996, the Board of Directors authorized the 1996 Employee Stock Purchase Plan ("the 1996 Purchase Plan"). A total of 400 shares of common stock have been reserved for issuance under the 1996 Purchase Plan. A total of 201 shares of common stock have been issued under the 1996 Purchase Plan at a prices ranging from $8.18 to $19.98 per share. The 1996 Purchase Plan permits eligible employees to purchase common stock through payroll deductions, subject to certain limitations. The price at which stock may be purchased under the 1996 Purchase Plan is equal to 85% of the fair market value of the common stock on the lower of the first day of each 24-month offering period or the last day of each subsequent purchase period. In June 1996, the Company adopted the 1996 Director Stock Option Plan (the "Director Plan") and reserved a total of 250 shares of common stock for issuance thereunder. Commencing with the Company's 1997 annual meeting of stockholders, each nonemployee director was to be granted a nonstatutory option to purchase an amount of shares of the Company's common stock equal to 5 shares multiplied by a fraction, the numerator of which shall be $15.00 and the denominator of which shall be the fair market value of one share of the Company's common stock on the dates of grant. The exercise price of options granted under the Director Plan are equal to the fair market value of one share of the Company's common stock on the dates of grant. A total of 60 shares were issued under the Plan at $10.125-$26.37 per share. Effective November 1998, the Director Plan was modified such that options are granted on a discretionary basis at fair value on the date of grant. 99 shares were issued under this version of the Plan in 1998, bringing the total shares issued under the prior and current version of the Director Plan to 159. Each option granted under the Director Plan vests on a cumulative monthly basis over a one-year period and has a 10-year term. The Director Plan will terminate in June 2001, unless terminated earlier. During 1997, the Company granted options to purchase a total of 300 shares at $12.625 per share, fair market value on the date of the grant, to two Directors of the Company for consulting services to be performed through February 2000. All of these options have vested. In September 1998, the Company's Directors approved the repurchase of up to 750 shares of the Company's common stock. A total of 40 shares were repurchased under this authorization in 1998. On March 9, 1998, the Company's Board of Directors approved the establishment of a rights plan. Pursuant to this plan, the Board of Directors declared a dividend distribution of one Preferred Shares Purchase Right on each outstanding share of the Company's Common Stock for shareholders of record on May 8, 1998. Each right entitles stockholders to buy 1/1000th of a share of the Company's Series A Participating Preferred Stock at an exercise price of eighty-five dollars ($85.00). The Rights become exercisable following the tenth day after a person or group announces an acquisition of 20% or more of the Company's Common Stock or announces commencement of a tender offer the consummation of which would result in ownership by the person or group of 20% or more of the Common Stock. The Company is entitled to redeem the Rights at $0.01 per Right at any time on or before the tenth day following acquisition by a person or group of 20% or more of the Company's Common Stock. If, prior to redemption of the Rights, a person or group acquires 20% or more of the Company's Common Stock, each Right not owned by a holder of 20% or more of the Common Stock will entitle its holder to purchase, at the Right's then current exercise price, that number of shares of Common Stock of the Company (or, in certain circumstances as determined by the Board of Directors, cash, other property or other securities) having a market value at that time of twice the Right's exercise price. If, after the tenth day following acquisition by a person or group of 20% or more of the Company's Common Stock, the Company sells more than 50% of its assets or earning power or is acquired in a merger or other business combination transaction, the acquiring person must assume the obligation under the Rights and the Right will become exercisable to acquire Common Stock of the acquiring person at the discounted price. At any time after an event triggering exercisability of the F-11 VENTANA MEDICAL SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) 8. Stockholders' Equity (continued) Rights at a discounted price and prior to the acquisition by the acquiring person of 50% or more of the outstanding Common Stock, the Board of Directors of the Company may exchange the Rights (other than those owned by the acquiring person or its affiliates) for Common Stock of the Company at an exchange ratio of one share of Common Stock per Right. In January 1999, the Company's Board of Directors authorized the 1998 Nonstatutory Stock Option Plan ("the 1998 NSO Plan"). Under this plan, a total of 1,000 shares of common stock have been reserved for issuance to employees and consultants of the Company, but under no circumstances to officers or directors. Options generally vest over five years and expire ten years after the date of grant, however, the Board of Directors, at its discretion, may decide the period over which options become exercisable and their expiration dates. In March 2000 the Company completed a private placement of 1,250,000 shares of its common stock, raising $50 million in gross proceeds before deducting commissions and expenses of the offering of $3,154. The shares were not registered with the SEC in reliance upon the exemption from registration contained in Section 4(2) of the Securities Act of 1933, as amended, as well as similar exemptions contained in the securities laws, rules and regulations of the applicable states. The shares may not be re-offered or resold in the United States absent registration, or an applicable exemption from registration requirements of the 1933 Act. The Company has earmarked the proceeds for general corporate purposes, including the financing of product and technology acquisitions, and consolidation of its Tucson-based operations into a single site. Pro forma information regarding net income (loss) and earnings per share is required by SFAS No. 123, and such information has been determined as if the Company had accounted for its employee stock options and employee stock purchase plan under the fair value method of that statement. The fair value for these options was estimated at the date of grant using a Black-Scholes option pricing model with the following weighted average assumptions for 2000, 1999 and 1998: risk-free interest rate of 6.0% and dividend yield of 0% for all years, volatility factor of the expected market price of the Company's common stock of .835 and .507 and .619, and an expected life of the options of 5 years. 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, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because the Company's 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 existing models do not necessarily provide a reliable single measure of the fair value of its stock options. For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the related vesting period. The Company's pro forma information follows:
Year Ended December 31 ------------------------ 2000 1999 1998 -------- ------ ------- Pro forma net (loss) income..................... $(35,254) $9,804 $(2,010) ======== ====== ======= Pro forma net (loss) income per share: Basic......................................... $ (2.39) $ .77 $ (.14) Diluted....................................... $ (2.39) $ .67 $ (.14)
Pro forma compensation expense presented may not be representative of future pro forma expense, when amortization of multiple years of awards may be reflected. F-12 VENTANA MEDICAL SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) 8. Stockholders' Equity (continued) A summary of the Company's stock option activity, and related information is as follows:
Outstanding Stock Options -------------------------- Weighted Average Number of Exercise Price Options Per Share --------- ---------------- Balance at January 1, 1998........................ 1,627 $10.88 Granted......................................... 540 19.68 Exercised....................................... (121) 7.52 Canceled........................................ (126) 11.76 ----- ------ Balance at December 31, 1998...................... 1,920 $13.52 Granted......................................... 1,035 18.23 Exercised....................................... (133) 10.43 Canceled........................................ (343) 12.24 ----- ------ Balance at December 31, 1999...................... 2,479 $15.47 Granted......................................... 876 23.15 Exercised....................................... (377) 13.07 Canceled........................................ (475) 13.90 ----- ------ Balance at December 31, 2000...................... 2,503 $18.14 ===== ======
The weighted average fair values of stock options granted during 2000, 1999, and 1998, for which the exercise price was equal to the fair market value of the stock were $19.53, $9.03, and $10.12 per share, respectively.
Stock Options at December 31, 2000 -------------------------------------------------------- Options Outstanding Options Exercisable ----------------------------------- -------------------- Weighted Weighted Average Average Remaining Weighted Number of Exercise Contractual Average Options Price Life Number Exercise Range of Exercise Prices Outstanding Outstanding (Years) Exercisable Price - ------------------------ ----------- ----------- ----------- ----------- -------- $ 0.60-$ 1.62........... 62 $ .96 4.5 62 $ .96 $10.00-$10.15........... 136 10.04 6.4 124 10.04 $12.25-$14.63........... 396 12.72 7.1 271 12.66 $15.00-$17.88........... 869 17.35 7.9 429 17.31 $20.13-$27.38........... 1,040 22.95 9.2 226 22.51 ----- ------ --- ----- ------ 2,503 $18.14 8.1 1,112 $15.51 ===== ====== === ===== ======
9. Income Taxes Income (loss) before income taxes and cumulative effect of accounting change is comprised as follows:
Years Ended December 31, 2000 1999 1998 -------- ------ ------- Domestic......................................... $(22,137) $5,764 $ 3,261 Foreign.......................................... (2,654) 1,547 (1,631) -------- ------ ------- $(24,791) $7,311 $ 1,630 ======== ====== =======
F-13 VENTANA MEDICAL SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) 9. Income Taxes (continued) The components of the (benefit) provision for income taxes before cumulative effect of an accounting change are as follows:
Years Ended December 31, 2000 1999 1998 -------- --------- -------- Current: U.S. Federal........................... $ -- $ 150 $ 145 State.................................. 350 250 -- Foreign................................ -- 80 -- ------- --------- ------- 350 480 145 Deferred: U.S. Federal........................... -- (5,083) (145) State.................................. -- (897) -- Foreign................................ -- -- -- ------- --------- ------- 350 (5,980) (145) ------- --------- ------- $ 350 $ (5,500) $ -- ======= ========= ======= A reconciliation of the U.S. Federal statutory income tax rate to the effective tax rate follows: % of Pre-tax Income Years Ended December 31, 2000 1999 1998 -------- --------- -------- U.S. Federal Statutory Rate.............. (35)% 35 % 35 % State taxes.............................. (6.5) 8 8 Domestic differences not previously benefitted.............................. -- (8) (34) Change in valuation allowance............ 43 (110) (9) ------- --------- ------- Effective tax rate....................... 1.5 % (75)% -- % ======= ========= =======
F-14 VENTANA MEDICAL SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) 9. Income Taxes (continued) The Company's deferred tax assets (liabilities) consist of the following:
December 31, 2000 1999 -------- ------- Non-current: Net operating loss carry forwards....................... $ 8,264 $ 1,336 Foreign loss carry forwards............................. 3,105 1,125 Depreciation expense.................................... 1,242 1,001 General business credit carry forwards.................. 1,033 1,033 Capitalized software development costs.................. (1,015) -- In-process R&D write-off................................ 999 1,077 Capitalized research and development.................... 630 1,264 AMT credit carry forward................................ 242 -- Other................................................... 144 -- -------- ------- 14,644 6,836 Current: Deferred revenue........................................ 1,889 456 Allowance for bad debts................................. 1,124 292 Facility shutdown accruals.............................. 447 -- AMT credit carry forward................................ -- 237 Miscellaneous........................................... 1,357 707 -------- ------- 4,817 1,692 Total deferred tax assets................................. 19,461 8,528 Valuation reserve......................................... (10,659) (2,403) -------- ------- Net deferred tax assets............................... $ 8,802 $ 6,125 ======== =======
During the fourth quarter of 1999, the Company reevaluated the estimated amount of valuation allowance required in light of the profitability achieved in 1998 and 1999 as well as the expected profits in 2000 to reduce the valuation allowance on deferred tax assets in accordance with SFAS No. 109, Accounting for Income Taxes ("SFAS No. 109") to an amount the Company believes is more likely than not of being recovered. Accordingly, a credit to income tax benefit of $5,980 was reflected in the fourth quarter of 1999's consolidated statement of operations and the corresponding deferred tax asset was recorded on the Company's consolidated balance sheet. The amount of net deferred tax assets estimated to be recoverable was based upon the Company's assessment of the likelihood of near term operating income, coupled with uncertainties with respect to the impact of future competitive and market conditions. The valuation allowance decreased by $1,007 in 1998 and $8,006 in 1999. The 1999 decrease relates to the assessment described in the previous paragraph. The 1998 deferred tax benefit of $145 exactly offset the 1998 current expense of $145, and thus no 1998 tax provision is reflected in the accompanying consolidated statement of operations. No additional valuation allowance was considered necessary for the deferred tax assets of $8,802 that are reflected on the consolidated balance sheets at December 31, 2000 as management believes that such assets will be recovered in the next several years. The deferred tax assets reflected on the consolidated balance sheets increased during 2000 by $2,677 which was directly attributable to the cumulative effect of the accounting change relating to the new revenue recognition policy adopted January 1, 2000, and the income tax benefit relating to stock option exercises by employees in the first quarter of 2000 reflected in the Company's equity F-15 VENTANA MEDICAL SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) 9. Income Taxes (continued) accounts. The Company did not recognize any additional deferred tax assets that arose in 2000 relative to the increases in the net operating loss carry forwards as it cannot be readily determined with certainty to what extent such assets will be recoverable in the future. As a result, the Company's valuation allowance increased by $8,256 during 2000. The Company does not anticipate recording any income tax benefit or expense of any material amount in 2001 unless a change, positively or negatively, in the valuation allowance for the deferred tax assets is warranted based upon the trends in the Company's future earnings. Temporary differences between the net operating losses for financial reporting and income tax purposes primarily relate to the deferral of research and development expenses for tax purposes. At December 31, 2000, the Company has net operating loss carry forwards for federal and state income tax purposes of approximately $21,103 and $18,152, respectively. These federal and state carry forwards will begin to expire in 2007 and 2005, respectively, if not previously utilized. Approximately $1,400 of state net operating loss carry forwards expired unused in 2000. The Company also has research and development tax credit carry forwards of approximately $1,033 which will begin to expire in 2005, if not previously utilized. Utilization of the Company's net operating loss carry forwards will be subject to limitations due to the "change in ownership" provisions of the Internal Revenue Code of 1996, as amended, as a result of the Company's prior issuances of equity securities. These carry forwards, therefore, may expire prior to being fully utilized. Future financings may cause additional changes in ownership and further limitations on the use of federal net operating loss carry forwards. In addition, the Company has certain foreign net operating loss carry forwards approximating $6,900 which begin to expire in 2001. 10. Commitments and Contingencies The Company conducts its corporate operations from leased facilities. In addition to monthly rental payments, the Company is responsible for certain monthly operating and maintenance expenses of such facilities. The lease expires in 2001. The future minimum rental payments under this and other operating lease arrangements at December 31, 2000 are as follows: 2001................................................................ $1,119 2002................................................................ 800 2003................................................................ 566 2004................................................................ 345 2005................................................................ 190 ------ $3,020 ======
Rent expense totaled $1,653, $1,259 and $548 for the years ended December 31, 2000, 1999 and 1998, respectively. In 2000, the Company entered into purchase commitments totaling $15,328 for the construction of a new corporate headquarters and manufacturing facility in suburban Tucson, Arizona. DAKO, a European distributor and customer, initiated binding arbitration with the Company in 1997 regarding the pricing of the Company's TechMate 250 product. The dispute was settled in 1998 with the Company agreeing to pay DAKO a total of $1,651 beginning January 2000 (see Note 7). The Company filed legal actions against CytoLogix Corp. in 1999 and 2000 alleging patent infringement. Management believes the Company will prevail on its claims, however, there can be no assurance of the final F-16 VENTANA MEDICAL SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) 10. Commitments and Contingencies (continued) resolution. CytoLogix Corp. has filed three separate legal actions against the Company in various courts. One complaint claims that Ventana misappropriated CytoLogix's trade secrets and seeks assignment of a specific Company patent, treble damages (unspecified) and an injunction against further sales of the Company's Discovery and BenchMark instruments. In another action in Germany, CytoLogix seeks to invalidate a specific German patent that the Company owns. Lastly, CytoLogix claims that the Company infringed on two of CytoLogix's patents and seeks assignment of the Company's patent applications, treble damages (unspecified) and an injunction against further sales of the Company's Discovery and BenchMark instruments. Management believes that the Company has meritorious defenses to these claims and that resolution of these matters will not have a material impact on the Company's financial statements. The Company is also involved in various other actions arising in the normal course of business. Management, in conjunction with outside counsel, periodically reviews such matters and makes any accruals deemed necessary. Management is of the opinion that the disposition of all claims outstanding will not have a material effect on the Company's financial position, cash flows or results of operations. 11. Operating Segment and Enterprise Data The Company has two reportable segments: North America (primarily the United States) and International (primarily France, Germany, Japan and Australia). These operating segments are the segments of the Company for which separate financial information is available and for which operating profit/loss amounts are regularly evaluated by the Company's Chief Operating Decision Maker (its Board of Directors) in deciding how to allocate resources and in assessing performance. F-17 VENTANA MEDICAL SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) 11. Operating Segment and Enterprise Data (continued) The Company's Chief Operating Decision Maker evaluates performance and allocates resources based on profit or loss from operations. The accounting policies of the reportable segments are the same as those described in the summary of significant accounting policies. Inventory transfers to foreign subsidiaries are made at standard cost. The North America operations include corporate activity (including all interest income) that benefits the Company as a whole. The following summary includes net sales only to unaffiliated customers. Net sales are attributed to segments based on the location from which the shipment to the customer was made; reagents and instruments are sold in each segment.
Year ended December 31, 2000 ------------------------------------------------- North America International Eliminations Totals ------------- ------------- ------------ -------- Sales to external customers................. $ 53,520 $17,629 $ -- $ 71,149 Nonrecurring expenses...... 4,519 -- -- 4,519 Depreciation and amortization expense...... 4,490 1,007 -- 5,497 Segment profit (loss)...... (24,393) (2,902) -- (27,295) Segment assets............. 106,742 18,278 (15,438) 109,582 Expenditures for long-lived assets.................... 15,247 3,611 -- 18,858 Year ended December 31, 1999 ------------------------------------------------- North America International Eliminations Totals ------------- ------------- ------------ -------- Sales to external customers................. $ 53,692 $15,717 $ -- $ 69,409 Depreciation and amortization expense...... 3,307 382 -- 3,689 Segment profit (loss)...... 11,098 1,467 246 12,811 Segment assets............. 80,191 15,324 (22,354) 73,161 Expenditures for long-lived assets.................... 5,439 1,840 -- 7,279 Year ended December 31, 1998 ------------------------------------------------- North America International Eliminations Totals ------------- ------------- ------------ -------- Sales to external customers................. $ 41,469 $ 6,235 $ -- $ 47,704 Nonrecurring expenses...... 3,160 -- -- 3,160 Depreciation and amortization expense...... 2,565 285 -- 2,850 Segment profit (loss)...... 3,147 (1,631) 114 1,630 Segment assets............. 74,724 8,257 (26,701) 56,280 Expenditures for long-lived assets.................... 12,154 404 -- 12,558
12. Acquisitions Bio Technology Tools, Inc. The Company acquired Bio Technology Tools, Inc. (BTTI) on October 14, 1998 for $6,457. The acquisition has been accounted for as a purchase, which resulted in $6,196 allocated to goodwill. The results of operations of BTTI are included in the accompanying consolidated financial statements from the date of acquisition. BTTI manufactures and markets a wide range of microtome products, tissue processors, cryogenic hardware and peripheral equipment, primarily for research and educational institutions in the United States, Europe and Japan. Goodwill recorded in the connection with this transaction is being amortized on a straight-line basis over a 15-year period (see Note 13). Acquisition of Certain Technology from Oncor, Inc. The Company acquired certain oncology diagnostic technology and assets from Oncor, Inc. on November 23, 1998 for $5,000 in cash. The Company plans to incorporate certain aspects of the acquired F-18 VENTANA MEDICAL SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) 12. Acquisitions (continued) technology in future products. The Company charged to expense at the date of the acquisition $2,900 relating to the portion of the purchase price allocated to those in-process research and development projects where technological feasibility had not yet been established and where there are no alternative future uses. This amount is included as non-recurring expense in the accompanying consolidated statements of operations. The purchase price for the technology was allocated as follows: Tangible net assets................................................ $ 521 In-process research and development expense........................ 2,900 Goodwill........................................................... 279 Supply agreement................................................... 1,200 Workforce in place................................................. 100 ------ $5,000 ======
The Company is amortizing goodwill on a straight-line basis over 15 years. The value assigned to an existing supply agreement assumed by the Company is being amortized on a straight-line basis over the life of the patent underlying the key technology involved in the supply agreement. The workforce in place costs are being amortized on a straight-line basis over 5 years. Quantitative Diagnostic Laboratories, Inc. The Company acquired Quantitative Diagnostic Laboratories, Inc. (QDL) on April 1, 2000 for $2,500. QDL is a specialty reference lab that provides quantitative immunohistochemistry (IHC) services to pathologists and is also involved in cancer research. The acquisition has been accounted for as a purchase, which resulted in $2,152 allocated to goodwill. The results of this acquisition is included in the accompanying consolidated financial statements from the date of acquisition. Goodwill recorded in connection with this transaction is being amortized on a straight-line basis over a 5-year period. 13. Charges and Non-Recurring Expenses Fiscal 2000 results were negatively impacted by $22,524 in write-offs and accruals relating to several different issues. The following table summarizes details of the charges and non-recurring expenses:
Costs incurred Reserve through Revision Balances as of Initial December 31, to December 31, Charges 2000 Estimates 2000 ------- ------------ --------- -------------- Reagent dispenser quality issue.......................... $ 5,355 $ 3,117 $ 272 $2,510 Exit of electron microscopy product line................... 4,581 4,060 (521) -- Impairment of inventory, diagnostic instruments and intangibles.................... 8,615 7,798 493 1,310 Cost to close Gaithersburg, Maryland facility.............. 2,611 1,200 (294) 1,117 Other charges, including contracted R&D................. 1,362 1,362 -- -- ------- ------- ----- ------ Total charges and non- recurring expenses........... $22,524 $17,537 $ (50) $4,937 ======= ======= ===== ======
Charges of $5,355 were related to quality problems with the Company's dispensers and reagents used with the majority of its staining instruments. As a result, charges were taken to write-off inventory and set up reserves to cover product replacements, returns, and warranty matters. F-19 VENTANA MEDICAL SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) 13. Charges and Non-Recurring Expenses (continued) A charge of $4,581 was recorded to account for the Company's decision to exit its electron microscopy (EM) product line. Charges were taken to write- down all EM inventory and field instruments to their net realizable value. In addition, goodwill recognized in the BTTI acquisition was written down $1,445 to reflect the impact of certain product discontinuance. Charges of $8,615 were recorded in recognition of the decreased value of certain instrument inventory, fixed assets and intangible assets given the launch of the Company's new BenchMark advanced staining system in 2000. In addition, intangible assets associated with the Company's 1996 acquisition of BioTek Solutions, Inc. were written down $3,074 to reflect the impact of discontinuing certain products. The Techmate IHC staining system product line acquired in the BioTek transaction was among those whose value was impacted by the launch of BenchMark. The Company also recognized charges of $2,611 relating to closure of its production facility in Gaithersburg, Maryland. The Gaithersburg facility was acquired in late 1998 with the acquisition of all the oncology assets of Oncor, Inc. Other charges recognized in 2000 totaled $1,362 which included expenses related to contracted research and development being handled by an outside company. 14. Earnings (loss) Per Share The following tables sets forth the components of the computation of 2000, 1999 and 1998 basic and diluted earnings (loss) per share:
2000 1999 1998 -------- ------- ------ Numerator: Net (loss) income................................ $(27,295) $12,811 $1,630 ======== ======= ====== Denominator: Basic: Weighted average shares........................ 14,770 13,478 13,320 Effect of dilutive securities: Employee stock options......................... -- 656 776 Warrants....................................... -- 502 531 -------- ------- ------ 14,770 14,636 14,627 ======== ======= ======
Loss per share in 2000 is computed using the weighted average number of shares of common stock outstanding; common equivalent shares from stock options and warrants are excluded from the computation in 2000 as their effect is antidilutive. F-20 EX-21.1 2 0002.txt SUBSIDIARIES OF REGISTRANT EXHIBIT 21.1 SUBSIDIARIES OF THE REGISTRANT Ventana Medical Systems, S.A. Ventana Medical Systems GmbH Ventana Medical Systems Japan K.K. Ventana Medical Systems, Pty. Ltd. BioTek Solutions, Inc. BioTechnology Tools, Inc. EX-23.1 3 0003.txt CONSENT OF ERNST & YOUNG LLP EXHIBIT 23.1 CONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS We consent to the incorporation by reference in the Registration Statement (Form S-8 No. 333-92883) pertaining to the registration of the 1998 Nonstatutory Stock Option Plan and in the Registration Statement (Form S-8 No. 333-16707 and No. 333-37758) pertaining to the registration of the 1996 Stock Option Plan, 1996 Director Option Plan, 1988 Stock Option Plan, and 1996 Employee Stock Purchase Plan of Ventana Medical Systems, Inc. of our report dated January 25, 2001, with respect to the consolidated financial statements of Ventana Medical Systems, Inc. included in this Annual Report (Form 10-K) for the year ended December 31, 2000. Our audits also included the financial statement schedule of Ventana Medical Systems, Inc. listed in Item 14(2). This schedule is the responsibility of the Company's management. Our responsibility is to express an opinion based on our audits. In our opinion, the financial statement schedule referred to above, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein. /s/ Ernst & Young LLP Phoenix, Arizona March 29, 2001 -----END PRIVACY-ENHANCED MESSAGE-----