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

FORM 10-Q

QUIDEL CORPORATION
(Exact name of Registrant as specified in its charter)

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

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

        As of July 31, 2003, 29,091,176 shares of common stock were outstanding.

QUIDEL CORPORATION
FORM 10-Q
FOR THE QUARTER ENDED
June 30, 2003

INDEX

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PART I FINANCIAL INFORMATION

ITEM 1. Financial Statements

QUIDEL CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands)

See accompanying notes.

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QUIDEL CORPORATION

CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share data, unaudited)

See accompanying notes.

4

QUIDEL CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands, unaudited)

See accompanying notes.

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Quidel Corporation

Notes to Condensed Consolidated Financial Statements

(Unaudited)

Note l. Basis of Presentation

        The accompanying unaudited condensed consolidated financial statements of Quidel Corporation (the "Company") have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the U.S. for complete financial statements. In the opinion of management, all adjustments considered necessary for a fair presentation (consisting of normal recurring accruals) have been included. The information at June 30, 2003, and for the three and six month periods ended June 30, 2003 and 2002, is unaudited. Operating results for the six months ended June 30, 2003 are not necessarily indicative of the results that may be expected for the year ending December 31, 2003. For further information, refer to the consolidated financial statements and footnotes thereto for the year ended December 31, 2002 included in the Company's 2002 Annual Report on Form 10-K.

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

Note 2. Comprehensive Earnings

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

Note 3. Stock Compensation

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

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        The fair value of each option grant was estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions used for grants for the three and six months ended June 30, 2003 and 2002.

        The Black-Scholes option-pricing model was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable. Because the Company's employee stock option plans have characteristics significantly different from those of traded options, the resulting pro forma compensation cost may not be representative of that to be expected in future years. Had compensation cost for the Company's stock option plans been determined based on the fair value at the grant date for awards for the three and six months ended June 30, 2003 and 2002, consistent with the provisions of SFAS No. 123, the Company's net earnings (loss) and earnings (loss) per share would have been as indicated below (in thousands, except per share data, unaudited):

Note 4. Computation of Earnings Per Share

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

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

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Note 5. Inventories

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

Note 6. Income Taxes

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

Note 7. Stockholders' Equity

        During the six months ended June 30, 2003, 178,872 shares of common stock were issued due to the exercise of common stock options and 23,500 shares of common stock were issued in connection with the Company's employee stock purchase plan, resulting in proceeds to the Company of approximately $0.6 million.

Note 8. Recent Accounting Pronouncements

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

Note 9. Industry and Geographic Information

        The Company operates in one reportable segment. Sales to customers outside the U.S. represented 40% and 23% for the six months ended June 30, 2003 and June 30, 2002, respectively. As of June 30,

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2003 and December 31, 2002, balances due from foreign customers were $6.3 million and $9.2 million, respectively.

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

        As of June 30, 2003, accounts receivable from three customers with a balance due in excess of 10% of total accounts receivable totaled $6.2 million while at December 31, 2002, accounts receivable from two customers with balances due in excess of 10% of total accounts receivable totaled $8.2 million.

        The following presents net sales for the six months ended June 30, 2003 and 2002 and long-lived assets as of June 30, 2003 and December 31, 2002 by geographic territory (in thousands):

Note 10. Restructuring

        During the second quarter of 2003, the Company announced and implemented a restructuring plan (the "Restructuring Plan"). The Restructuring Plan is primarily driven by manufacturing automation in the Company's San Diego facility, completion of certain research and development projects, implementation of the Company's BaaN enterprise resource planning system in its Santa Clara facility, and the transition of its foreign sales and support offices to independent distributors, which is expected to be effective September 1, 2003. The Restructuring Plan includes a workforce reduction of approximately 77 positions (22%) and closure of the Company's sales and support offices in Heidelberg, Germany and Milan, Italy. The Company recorded a restructuring charge of approximately $0.8 million in the second quarter of 2003. The significant components of the restructuring charge in the second quarter were $0.7 million for employee severance costs and $0.1 million for professional fees. The Company expects to incur an additional restructuring charge of $1.6 million in the third quarter of 2003. The significant components are expected to be $0.7 million for employee severance costs, $0.4 million for contractual lease and commercial contract terminations, $0.3 million for professional fees and $0.2 million in asset impairment charges related to assets that will become obsolete due to restructuring activities.

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

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

Future Uncertainties

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

Overview

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

Results of Operations

Net Sales

        Net sales increased 6% to $18.3 million for the three months ended June 30, 2003 from $17.4 million for the three months ended June 30, 2002 and increased 11% to $42.3 million for the six months ended June 30, 2003 from $38.1 million for the six months ended June 30, 2002. The increases for the three and six months ended June 30, 2003 as compared to the three and six months ended June 30, 2002 were primarily due to increases in sales of our influenza products partially offset by decreases in our pregnancy, urinalysis, H. pylori and ultrasound products.

Distribution Developments and Trends

        A significant portion of the Company's U.S. sales are made to distribution partners. The Company offers various incentives, largely through volume discount programs, to certain of these distributors based on sales objectives developed with the distributor. The Company also provides incentives from time to time for jointly developed sales and marketing programs.

        As a result of a recent marketing strategy developed for the Company's influenza and Group A strep product lines, the Company made increased sales of these products in the second quarter even though sales for influenza and Group A strep have historically been heavily weighted in the third and

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fourth calendar quarters. The program is intended to build brand loyalty by incentivizing end-users to purchase Company products in advance of the fall and winter months, thereby facilitating repurchases of the same products as usage increases during the year. To date, the Company is satisfied with this marketing approach and does not anticipate that these early purchases will adversely impact expected aggregate sales in the third and fourth quarters of 2003.

        The Company's sales estimates for future periods are closely based on estimated end-user demand for its products. Sales to the Company's distribution partners would fall short of expectations if distributor inventories increase because of less than estimated end-user consumption. With the introduction of low cost pregnancy test products by competitors, the Company has observed a decline in U.S. sales of its own pregnancy products over the past several quarters. Given current estimates of existing distributor inventories and a shortfall in end-user demand as compared to sales to distributors to date, the Company believes that its U.S. sales of pregnancy products may decline in the near future. The Company's estimated future growth, therefore, is based on significant increases in sales of its other products.

        As discussed within, under "Restructuring Charge," the Company expects the transition from direct sales to independent distribution in Germany and Italy to be effective September 1, 2003. The Company believes that continued market penetration will offset the revenue decline resulting from this distribution change.

Research Contracts, License Fees and Royalty Income

        Research contracts, license fees and royalty income increased to $0.5 million for the three months ended June 30, 2003 from $0.4 million for the three months ended June 30, 2002 and increased to $1.0 million for the six months ended June 30, 2003 from $0.9 million for the six months ended June 30, 2002. The revenue for all periods principally relates to royalties received on our patented technologies utilized by third-parties. The agreement covering these royalty payments extends through November 2009, the expiration date of the patents.

Cost of Sales and Gross Profit From Net Sales

        Gross profit increased to $9.0 million for the three months ended June 30, 2003 from $8.1 million for the three months ended June 30, 2002 and increased to $21.8 million for the six months ended June 30, 2003 from $18.8 million for the six months ended June 30, 2002. Gross profit as a percentage of net sales increased to 49% for the three months ended June 30, 2003 from 47% for the three months ended June 30, 2002 and increased to 52% for the six months ended June 30, 2003 from 49% for the six months ended June 30, 2002. The increases for both the three and six months ended June 30, 2003 as compared to the three and six months ended June 30, 2002, were primarily due to increased sales volume, product mix, manufacturing efficiencies related to the outsourcing of our packaging operations, partially offset by the impairment of certain manufacturing equipment which was determined to be obsolete.

Research and Development Expense

        Research and development expense increased to $1.9 million for the three months ended June 30, 2003 from $1.5 million for the three months ended June 30, 2002 and increased to $4.3 million for the six months ended June 30, 2003 from $3.1 million for the six months ended June 30, 2002. Research and development expense as a percentage of net sales, increased to 10% for the three months ended June 30, 2003 from 9% for the three months ended June 30, 2002 and increased to 10% for the six months ended June 30, 2003 from 8% for the six months ended June 30, 2002. The increases for both the three and six months ended June 30, 2003 as compared to the three and six months ended June 30, 2002, were primarily due to increased costs associated with our LTF ("Layered Thin Film™") technology, including additional employees, project supplies and patent fees. We anticipate that we will

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continue to devote a significant amount of financial resources to research and development for the foreseeable future.

Sales and Marketing Expense

        Sales and marketing expense increased to $4.4 million for the three months ended June 30, 2003 from $3.8 million for the three months ended June 30, 2002 and to $8.9 million for the six months ended June 30, 2003 from $7.8 million for the six months ended June 30, 2002. Sales and marketing expense as a percentage of net sales increased to 24% for the three months ended June 30, 2003 from 22% for the three months ended June 30, 2002 and increased to 21% for the six months ended June 30, 2003 from 20% for the six months ended June 30, 2002. The increases for both the three and six months ended June 30, 2003 as compared to the three and six months ended June 30, 2002, were primarily due to costs associated with the launch of our infectious vaginitis products, bone ultrasonometer and urinalysis instrument, including infrastructure, advertising and sales promotions.

General and Administrative Expense

        General and administrative expense increased to $2.4 million for the three months ended June 30, 2003 from $2.2 million for the three months ended June 30, 2002 and increased to $5.2 million for the six months ended June 30, 2003 from $4.5 million for the six months ended June 30, 2002. General and administrative expense as a percentage of net sales remained constant at 13% for the three months ended June 30, 2003 and 2002 and remained constant at 12% for the six months ended June 30, 2003 and 2002. The absolute dollar increases for both the three and six months ended June 30, 2003 were primarily due to increased professional fees related to the re-audit of fiscal 2001 financial statements and tax consulting fees.

Restructuring Charge

        During the second quarter of 2003, we announced and implemented a restructuring plan (the "Restructuring Plan"). The Restructuring Plan is primarily driven by manufacturing automation in our San Diego facility, completion of certain research and development projects, implementation of our BaaN enterprise resource planning system in our Santa Clara facility, and the transition of our foreign sales and support offices to independent distributors, which is expected to be effective September 1, 2003. The Restructuring Plan includes a workforce reduction of approximately 77 positions (22%) and closure of our sales and support offices in Heidelberg, Germany and Milan, Italy. We recorded a charge of approximately $0.8 million in the second quarter of 2003. The significant components of the restructuring charge in the second quarter were $0.7 million for employee severance costs and $0.1 million for professional fees. We expect to incur an additional restructuring charge of $1.6 million in the third quarter of 2003. The significant components are expected to be $0.7 million for employee severance costs, $0.4 million for contractual lease and commercial contract terminations, $0.3 million for professional fees and $0.2 million in asset impairment charges related to assets that will become obsolete due to restructuring activities.

Income Taxes

        Income tax benefit was $0.3 million for the three months ended June 30, 2003 compared to an income tax provision of $0.2 million for the three months ended June 30, 2002, and the income tax provision was $0.9 million for the six months ended June 30, 2003 compared to $1.3 million for the six months ended June 30, 2002.

Liquidity and Capital Resources

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

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        At June 30, 2003, we had cash and cash equivalents of approximately $13.3 million compared to $2.9 million at December 31, 2002.

        The net increase in cash and cash equivalents for the six months ended June 30, 2003 was $10.4 million, the components of which are discussed below. The cash generated from operating activities of $11.0 million is largely comprised of our net earnings of $1.3 million, non cash expenses of $3.3 million related to depreciation and amortization and decreases in our deferred tax asset of $0.7 million, a decrease in accounts receivable and inventories of $4.4 million and $2.0 million, respectively, partially offset by decreases in accounts payable and other accrued liabilities of $0.8 million. Another source of cash during the period was $0.6 million in proceeds from issuance of common stock under our stock option and employee stock purchase plans. Our primary uses of cash for the six months ended June 30, 2003 were acquisitions of manufacturing equipment and assets related to information technology of $1.1 million, as well as payments on obligations under capital leases totaling $0.2 million.

        We have a $10 million term loan facility which matures in August 2004 and which bears interest at a rate equal to the lender's base rate minus one quarter of one percent. We also have a $10 million line of credit facility which matures in July 2004 and, at our option, bears interest at a rate equal to the lender's base rate minus one quarter of one percent or at the London InterBank Offering Rate plus two and one quarter percent. The agreement governing our line of credit and term loan facilities contains certain customary covenants restricting our ability to, among other matters, incur additional indebtedness, create liens or other encumbrances, pay dividends or make other restricted payments, make investments, loans and guarantees or sell or otherwise dispose of a substantial portion of assets to, or merge or consolidate with, another entity. As of June 30, 2003, there were no borrowings outstanding under either the line of credit or the term loan. As of June 30, 2003, we had $10 million of availability both under the line of credit and term loan, and we were in compliance with all covenants.

        We plan approximately $2.9 million in capital expenditures for the remainder of 2003. The primary purpose for our capital expenditures is manufacturing equipment and information technology. We plan to fund these capital expenditures with cash flow from operations and borrowings under our existing credit facility. We have no material commitments with respect to such planned expenditures as of the date of this report on Form 10-Q.

        We also intend to continue evaluation of acquisition and technology licensing candidates. As such, we may need to incur additional debt, or sell additional equity, to successfully complete these acquisitions. Cash requirements fluctuate as a result of numerous factors, such as the extent to which we generate cash from operations, progress in research and development projects, competition and technological developments and the time and expenditures required to obtain governmental approval of our products. Based on the current cash position and the current assessment of future operating results, we believe that our existing sources of liquidity will be adequate to meet operating needs during the next twelve months.

        At June 30, 2003 and December 31, 2002, we did not have any other relationships with unconsolidated entities or financial partners, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. As such, we are not materially exposed to any financing, liquidity, market or credit risk that could arise if we had engaged in such relationships.

Critical Accounting Policies and Estimates

        Our discussion and analysis of our financial condition and results of operations are based on our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the U.S. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses,

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and related disclosure of contingent assets and liabilities. On an on-going basis, we evaluate our estimates, including those related to customer programs and incentives, bad debts, inventories, intangible assets, income taxes, restructuring and contingencies and litigation. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

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

        We record estimated reductions to revenue for customer programs and incentive offerings including special pricing agreements, price protection, promotions and other volume-based incentives. While we have maintained customer incentive programs during 2003, if market conditions were to decline, we may take actions to further increase customer incentive offerings possibly resulting in an incremental reduction of revenue at the time the incentive is offered. We record revenues from product sales, net of related rebates and discounts which are estimated at the time the sale is recognized. Revenue from product sales are recorded upon passage of title and risk of loss to the customer. Title to the product and recognition of revenue passes upon delivery to the customer when sales terms are Free On Board ("FOB") destination and at the time of shipment when the sales terms are FOB shipping point. Our judgement is required in estimating amounts of excess channel inventory. Excess channel inventory exists when our distributors' inventory of our product exceeds its estimate of demand for our products at the end user level, after considering factors such as product shelf life and market for the product. We obtain information from our distributors to evaluate channel inventory at customer locations. After a review and based on our estimates of inventory channel levels at June 30, 2003, it was determined that there were no excess channel inventory issues.

        We also earn income for performing services under joint development agreements and licensing of technology. Milestone payments are considered to be payments received for the accomplishment of a discrete, substantive earnings event. The non-refundable payment arising from the achievement of a defined milestone is recognized as revenue when the performance criteria for that milestone have been met since substantive effort is required to achieve the milestone, the amount of the milestone payments appears reasonable, commensurate with the effort expended and collection of the payment is reasonably assured. Income from the grant of license rights is recorded when the event triggering payment to us has occurred as specified by the terms of the related license agreements and collectibility is reasonably assured. We maintain allowances for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. If the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required.

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

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

•

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

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•

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



•

loss of legal ownership or title to the asset;



•

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



•

the impact of significant negative industry or economic trends.

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

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

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

ITEM 3. Quantitative and Qualitative Disclosures About Market Risk

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

        The fair market value of floating interest rate debt is subject to interest rate risk. Generally, the fair market value of floating interest rate debt will vary as interest rates increase or decrease. A hypothetical 100 basis point adverse move in interest rates along the entire interest rate yield curve would not materially affect the fair value of our interest-sensitive financial instruments at June 30, 2003. Based on our market risk sensitive instruments outstanding at June 30, 2003 and December 31, 2002, we have determined that there was no material market risk exposure to our consolidated financial position, results of operations or cash flows as of such dates.

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Risk Factors

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

        Fluctuations in our operating results, for any reason, that decrease sales or profitability could cause our growth or operating results to fall below the expectations of investors and securities analysts, and this could cause our stock price to decline. The market price of our common stock has fluctuated substantially in the past. Between June 30, 2002 and June 30, 2003, the price of our common stock, as reported on the Nasdaq National Market, has ranged from a low of $2.06 to a high of $6.89. We expect the market price of our common stock to continue to experience significant fluctuations in the future in response to a variety of factors, including fluctuation in our operating results.

        For the six months ended June 30, 2003, total revenues increased 11% to $42.2 million from $38.1 million for the six months ended June 30, 2002. We had net earnings of $1.3 million for the six months ended June 30, 2003 compared to net earnings of $1.6 million for the six months ended June 30, 2002. The increase in revenues for the six months ended June 30, 2003 was primarily due to an increase in sales of our influenza products, partially offset by decreases in pregnancy, urinalysis, H. pylori and ultrasound products. The decrease in earnings for the six months ended June 30, 2003 was primarily due to a restructuring charge of $0.8 million and increases in certain operating expenses, partially offset by an increase in gross margins. We may not continue our revenue growth or continue to achieve profitability. Operating results may continue to fluctuate, in a given quarter or annual period, or from prior periods as a result of a number of factors, many of which are outside of our control.

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

•

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



•

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



•

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



•

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



•

declines in orders from major distributors as a result of lower than expected end-user demand.

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

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

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

•

expand our business line;



•

expand the LTF technology platform menu of analytes;



•

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



•

expand our business geographically.

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

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

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

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

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

        Although we have distribution agreements with approximately 80 distributors, the market is dominated by a small group of these distributors. Five of our distributors, which are considered to be among the market leaders, accounted for approximately 61% and 56% of our net sales for the six months ended June 30, 2003 and 2002, respectively. While we believe our relationship with our distributors is good, the loss of a major distributor may have an adverse effect on our net sales. The

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

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

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

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

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

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

        Our competitive position is heavily dependent on obtaining and protecting our proprietary technology or obtaining licenses from others. Our ability to compete successfully in the diagnostic market depends on continued development and introduction of new proprietary technology and the

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improvement of existing technology. If we cannot continue to obtain and protect proprietary technology, our net sales and gross profits could be adversely affected. Moreover, our current and future licenses may not be adequate for the operation of our business.

        We have a license agreement with Becton Dickinson and Company related to our pregnancy and Group A Strep products, which products account for 40% and 55% of our net sales for the six months ended June 30, 2003 and 2002, respectively. The license agreement expires in 2004 when the underlying patent expires. Our ability to obtain patents and licenses, and their benefits, is uncertain. We have 196 issued patents and approximately 70 patent applications pending. Our patents have expiration dates from 2003 to 2020. There are no patents that are expiring in the near term which we consider material to our business. However, our pending patent applications may not result in the issuance of any patents, or if issued, the patents may not have priority over others' applications or may not offer protection against competitors with similar technology. Moreover, any patents issued to us may be challenged, invalidated or circumvented in the future. In addition to the U.S., we have patents issued in Japan, Canada, Germany, France, United Kingdom, Italy, Spain, Australia, Belgium, Korea, Norway, Lithuania, The Netherlands, Austria, Switzerland, Sweden and South Africa. Therefore, third-parties can make, use and sell products covered by our patents in any country in which we do not have patent protection. We license the right to use our products to our customers under label licenses that are for research purposes only. These licenses could be contested, and, because we cannot monitor all potential unauthorized uses of our products around the world, we might not be aware of an unauthorized use and might not be able to enforce the license restrictions in a cost-effective manner. Also, we may not be able to obtain licenses for technology patented by others or on commercially reasonable terms.

We may be involved in intellectual property infringement disputes which are costly and could limit our ability to use certain of our core technologies in the future and sell our products.

        There are a large number of patents and patent applications in our product areas, and we believe, based on experience and published reports, that litigation in our industry regarding patent and other intellectual property rights is prevalent and will continue. In particular, we are aware of one industry participant which is actively asserting infringement claims against other third-parties on the basis that it owns the patent rights to a key aspect of current lateral flow technology. While we have not to date received any claims of infringement from this industry participant, and while we believe that we have adequate defenses to any claims this industry participant may assert, our business and financial results, because of our current dependence on lateral flow technology, would be materially and adversely affected if we were unable to successfully defend any such claims from this industry participant. As a more general matter, and although we are not currently involved in any litigation in this area, our involvement in litigation to determine rights in proprietary technology could adversely affect our net sales because:

•

as is common with major litigation, it would likely consume a substantial portion of managerial and financial resources;



•

its outcome would be uncertain and a court may find the third-party claims valid and that we have no successful defense to such claims;



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an adverse outcome could subject us to significant liability in the form of penalties, special and punitive damages, or future royalty payments affecting our future earnings;



•

failure to obtain a necessary license upon an adverse outcome could prevent us from selling our current products or other products we may develop; and



•

protection of our rights may not be available under the law or may be inadequate.

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The uncertainty and cost of regulatory approval for our products may have a negative effect on our profitability.

        The testing, manufacture and sale of our products are subject to regulation by numerous governmental authorities, principally the FDA and corresponding state and foreign regulatory agencies. The FDA regulates all of our products, the majority of which are Class I and II devices. Our veterinary products are regulated by the U.S. Department of Agriculture. Our future performance depends on, among other matters, our estimates as to when and at what cost we will receive regulatory approval for new products. Regulatory approval can be a lengthy, expensive and uncertain process, making the timing and costs of approvals difficult to predict. Our net sales would be negatively affected by delays in the receipt of or failure to receive approvals or clearances, the loss of previously received approvals or clearances or the placement of limits on the use of our products.

We are subject to numerous government regulations in addition to FDA regulation, and compliance with changes could increase our costs.

        In addition to the FDA and other regulations described previously, numerous laws relating to such matters as safe working conditions, manufacturing practices, environmental protection, fire hazard control and disposal of hazardous or potentially hazardous substances impact our business operations. If these laws change, are amended, or are added to, the costs of compliance with these laws could substantially increase our costs. While we believe that we currently comply with these laws in all material respects, compliance with any future modifications of these laws or laws regulating the manufacture and marketing of our products could result in substantial costs and loss of sales or customers. Because of the number and extent of the laws and regulations affecting our industry, and the number of governmental agencies whose actions could affect our operations, it is impossible to reliably predict the full nature and impact of future legislation or regulatory developments relating to our industry. To the extent the costs and procedures associated with meeting new requirements are substantial, our business and results of operations could be adversely affected.

We use hazardous materials in our business that may result in unexpected and substantial claims against us relating to handling, storage or disposal.

        Our research and development and manufacturing activities involve the controlled use of hazardous materials, including, but not limited to chemicals and biological materials such as dimethyl sulfate, sodium nitrite, acetaldehyde, acrylamide, potassium bromate and radionuclides. The risk of accidental contamination or injury from these materials cannot be completely eliminated. Federal, state and local laws and regulations govern the use, manufacture, storage, handling and disposal of hazardous materials. These regulations include federal statutes popularly known as CERCLA, RCRA and the Clean Water Act. Compliance with these laws and regulations is expensive. If any governmental authorities were to impose new environmental regulations requiring compliance in addition to that required by existing regulations, these future environmental regulations could impair our research, development or production efforts by imposing substantial costs on our business. In addition, because of the nature of the penalties provided for in some of these environmental regulations, we could be required to pay substantial fines, penalties or damages in the event of noncompliance with environmental laws or the exposure of individuals to hazardous materials. Further, any accident could partially or completely shut down our research and manufacturing facilities and operations.

Our net sales could be affected by third-party reimbursement policies and potential cost constraints.

        We sell many of our products to physicians and other healthcare providers. They will not use our products if they do not get reimbursed for the cost by their patients' healthcare insurers or payors, such as Blue Cross, Blue Shield, Medicare, or other public or private healthcare programs. Our net sales could be adversely affected by changes in reimbursement policies of these governmental or private

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healthcare payors. In the U.S., healthcare providers such as hospitals and physicians who purchase diagnostic products generally rely on third-party payors, principally private health insurance plans, federal Medicare and state Medicaid, to reimburse all or part of the cost of the procedure. We believe that the overall escalating cost of medical products and services has led to and will continue to lead to increased pressures on the healthcare industry, both foreign and domestic, to reduce the cost of products and services, including our products. Given the efforts to control and reduce healthcare costs in the U.S. in recent years, currently available levels of reimbursement may not continue to be available in the future for our existing products or products under development. Third-party reimbursement and coverage may not be available or adequate in either U.S. or foreign markets, current reimbursement amounts may be decreased in the future and future legislation, regulation or reimbursement policies of third-party payors may reduce the demand for our products or our ability to sell our products on a profitable basis.

If we are not able to manage our growth strategy, and if we experience difficulties integrating acquired companies or technologies after the acquisition, our earnings may be adversely affected.

        During 1999 and 2000, we acquired three businesses, Litmus Concepts Inc., Metra Biosystems, Inc. and the urine test strip business from Dade Behring Marburg GmbH. Our business strategy contemplates further growth in the scope of operating and financial systems and the geographic area of our operations, including further expansion outside the U.S., as new products are developed and commercialized. We may experience difficulties integrating our own operations with those of companies or technologies that we have acquired or we may acquire, and as a result we may not realize our anticipated benefits and cost savings within our expected time frame, or at all. Because we do not have a large executive staff, future growth may also divert management's attention from other aspects of our business, and will place a strain on existing management, as well as on our operational, financial and management information systems. Furthermore, we may expand into markets in which we have less experience or incur higher costs. Should we encounter difficulties in managing these tasks, our growth strategy may suffer and our net sales and gross profits could be adversely affected.

Our business could be negatively affected by the loss of key personnel or our inability to hire qualified personnel.

        Our future success depends in part on our ability to retain our key technical, sales, marketing and executive personnel and our ability to identify and hire additional qualified personnel. Competition for these personnel is intense, both in the industry in which we operate and also in the geographic area (Northern San Diego County) where our headquarters and many of our operations are located. If we are not able to retain existing key personnel, or identify and hire additional qualified personnel, our business could be negatively impacted. In addition, we expect to further grow our operations, and our needs for additional management and other key personnel may increase.

We are exposed to business risks which, if not covered by insurance, could have an adverse effect on our profits.

        We maintain insurance that we believe is appropriate to protect us against the kinds of insurable risks, such as product liability claims or business interruptions, that companies of our size and companies in our industry typically insure against. However, there is a risk that claims may be made against us for types of damages, or for amounts of damages, that are not covered by our insurance. For example, there is a risk of product liability claims arising from our testing, manufacturing and marketing of medical diagnostic devices, both those currently being marketed as well as those under development. Although we believe our coverage for product liability claims is adequate and claims to date have not been material, it is possible that potential product liability or other claims may exceed the amount of our insurance coverage or may be excluded from coverage under the terms of our

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policy. Also, if we are held liable, our existing insurance may not be renewed at the same cost and level of coverage as currently in effect, or may not be renewed at all. If we are held liable for a claim against which we are not indemnified or for damages exceeding the limits of our insurance coverage, whether arising out of product liability matters or from some other matter, that claim could have a material negative effect on our results of operations.

We face risks relating to our international sales and foreign operations, including the risk of currency fluctuations, which could increase our costs or stifle our growth opportunities.

        Our products are sold internationally, primarily to customers in Japan and Europe, including Germany, Italy and Poland. Sales to foreign customers accounted for 40% and 23% of our net sales for the six months ended June 30, 2003 and 2002, respectively, and are expected to continue to account for a significant percentage of our net sales. In December 2001, we began manufacturing our urinalysis products in Marburg, Germany. To date, we have not encountered any delays or problems in the integration of this process; however, any future delays could result in shipment delays and increased manufacturing costs and could have a material adverse effect on our results of operations. International sales and manufacturing operations are subject to inherent risks, which could increase our costs and stifle our growth opportunities. These risks include:

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exposure to currency exchange fluctuations, such as the 8% increase in the value of the Euro against the U.S. dollar for the six months ended June 30, 2003 and the 18% increase in the value of the Euro against the U.S. dollar for the year ended December 31, 2002;



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longer payment cycles and greater difficulty in accounts receivable collection;



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compliance with multiple foreign laws, tariffs or other barriers as we continue to expand into new countries and geographic regions;



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difficulties in obtaining export licenses;



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reduced protection for, and enforcement of, intellectual property rights, particularly as we seek to expand our business beyond Europe;



•

political and economic instability in some of the regions that we may expand into in the future; and



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potentially adverse tax consequences.

        Even that portion of our international sales which is negotiated for and paid in U.S. dollars is subject to currency risks, since changes in the values of foreign currencies relative to the value of the U.S. dollar can render our products comparatively more expensive. These exchange rate fluctuations could negatively impact international sales of our products and our anticipated foreign operations, as could changes in the general economic conditions in those markets. In order to maintain a competitive price for our products in Europe, we may have to provide discounts or otherwise effectively reduce our prices, resulting in a lower margin on products sold in Europe. During 2002, Economic Monetary Union countries in Europe adopted the Euro as their single currency. As of yet, we have not seen any unusual costs associated with the use of the Euro, but we continue to monitor its impact on our operations. Continued change in the values of European currencies or changes in the values of other foreign currencies could have a negative impact on our business, financial condition and results of operations. Although we do not currently hedge against exchange rate fluctuations, any measures we take to hedge against exchange rate fluctuations may not adequately protect us from their potential harm.

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Future sales by existing stockholders could depress the market price of our common stock and make it more difficult for us to sell stock in the future.

        Sales of our common stock in the public market, or the perception that such sales could occur, could negatively impact the market price of our securities and impair our ability to complete equity financings. We currently have outstanding the following shares of common stock:

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Approximately 29.1 million shares of common stock that have been issued in registered offerings and are freely tradable in the public markets.



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In addition, approximately 5.8 million shares of common stock are issuable upon exercise of stock options outstanding as of June 30, 2003 under our various stock option plans at a weighted average exercise price of $4.34 per share.



•

We have in effect registration statements under the Securities Act registering approximately 7.0 million shares of common stock reserved under our employee stock option and purchase plans.

        We are unable to estimate the number of shares of common stock that may actually be resold in the public market since this will depend on the market price for the common stock, the individual circumstances of the sellers and other factors. We also have a number of institutional stockholders that own significant blocks of our common stock. If one or more of these stockholders sell large portions of their holdings in a relatively short time, for liquidity or other reasons, the prevailing market price of our common stock could be negatively affected.

ITEM 4. Controls and Procedures

        As of the end of the period covered by this quarterly report on Form 10-Q, we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Exchange Act Rule 13a-15. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective in timely alerting them to material information (including information about our consolidated subsidiaries) required to be included in our periodic SEC reports. There were no significant changes in our internal control over financial reporting during the period covered by this quarterly report on Form 10-Q that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

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PART II OTHER INFORMATION

ITEM 1. Legal Proceedings

        We are involved in litigation matters from time to time in the ordinary course of business. Management believes that any and all current actions, in the aggregate, will not have a material adverse effect on us. We maintain insurance, including coverage for product liability claims, in amounts which management believes appropriate given the nature of our business.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

        Our Annual Meeting of Stockholders was held on May 21, 2003. All of the directors nominated for election as stated in our Proxy Statement were elected as follows:

ITEM 5. OTHER EVENTS

        Effective as of May 21, 2003, Margaret G. McGlynn, R.Ph. retired from our Board of Directors.

ITEM 6. Exhibits and Reports on Form 8-K

(a)

Exhibits

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*

Filed herewith.

(1)

Indicates a management plan or compensatory plan or arrangement.

(b)

Reports on Form 8-K filed in the quarter ended June 30, 2003

On April 1, 2003, we filed a current report on Form 8-K announcing the streamlining of our executive leadership structure.

On May 1, 2003, we filed a current report on Form 8-K announcing the issuance of our news release on April 29, 2003 reporting our financial results for the first fiscal quarter of 2003.

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SIGNATURE

        Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

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