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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


 

Form 10-Q

 


 

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

 

For the quarterly period ended March 31, 2005.

 

or

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934.

 

For the transition period from              to             .

 

Commission File Number: 000-20931

 


 

Ventana Medical Systems, Inc.

(Exact name of registrant as specified in its charter)

 


 

Delaware   94-2976937

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. employer

identification no.)

1910 Innovation Park Drive

Tucson, AZ

  85737
(Address of principal executive offices)   (Zip Code)

 

Registrant’s telephone number, including area code: (520) 887-2155

 

Not Applicable

(Former name, former address and former fiscal year, if changed from last report)

 


 

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

 

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

 

The number of shares outstanding of the registrant’s common stock, $0.001 par value was 35,683,075 as of April 14, 2005.

 



Ventana Medical Systems, Inc.

 

INDEX

 

     PAGE

PART I. FINANCIAL INFORMATION     
     Item 1.    Financial Statements (Unaudited)     
          Condensed Consolidated Balance Sheets March 31, 2005 and December 31, 2004    3
          Condensed Consolidated Statements of Operations Three Months Ended March 31, 2005 and 2004    4
          Condensed Consolidated Statements of Cash Flows Three Months Ended March 31, 2005 and 2004    5
          Notes to Condensed Consolidated Financial Statements    6
     Item 2.    Management’s Discussion and Analysis of Financial Condition and Results of Operations    11
     Item 3.    Quantitative and Qualitative Disclosures About Market Risk    19
     Item 4.    Controls and Procedures    20
PART II. OTHER INFORMATION     
     Item 1.    Legal Proceedings    21
     Item 2.    Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities    23
     Item 6.    Exhibits    24
          Signature    25
          Exhibits    26

 

 

2


Ventana Medical Systems, Inc.

Condensed Consolidated Balance Sheets

(in thousands, except per share data)

(unaudited)

 

    

March 31,

2005


   

December 31,

2004


 

ASSETS

                

Current assets:

                

Cash and cash equivalents

   $ 42,811     $ 33,354  

Short-term investments

     20,192       20,149  

Trade accounts receivable, net

     32,367       33,292  

Inventories, net

     11,243       10,877  

Deferred tax assets

     6,562       6,544  

Prepaids and other current assets

     2,833       2,188  
    


 


Total current assets

     116,008       106,404  

Property and equipment, net

     49,277       47,679  

Deferred tax assets, net of current portion

     14,641       11,329  

Goodwill

     2,804       2,804  

Intangible assets, net

     7,163       7,097  

Capitalized software development costs, net

     2,311       2,249  

Other assets

     2,029       2,586  
    


 


Total assets

   $ 194,233     $ 180,148  
    


 


LIABILITIES AND STOCKHOLDERS’ EQUITY

                

Current liabilities:

                

Accounts payable

   $ 11,353     $ 10,418  

Other current liabilities

     25,273       25,849  
    


 


Total current liabilities

     36,626       36,267  

Long term debt

     2,047       2,182  

Other long-term liabilities

     550       549  

Commitments and Contingencies

                

Stockholders’ equity:

                

Common stock - $.001 par value; 50,000 shares authorized; 35,660 and 35,100 shares issued and outstanding at March 31, 2005 and December 31, 2004, respectively

     35       35  

Additional paid-in capital

     186,413       176,211  

Accumulated deficit

     (9,244 )     (13,860 )

Accumulated other comprehensive income (loss)

     (580 )     40  

Treasury stock - 1,199 shares and 1,189 shares at cost at March 31, 2005 and December 31, 2004, respectively

     (21,614 )     (21,276 )
    


 


Total stockholders’ equity

     155,010       141,150  
    


 


Total liabilities and stockholders’ equity

   $ 194,233     $ 180,148  
    


 


 

3


Ventana Medical Systems, Inc.

Condensed Consolidated Statements of Operations

(in thousands except per share data)

(Unaudited)

 

     Three Months Ended
March 31,


     2005

   2004

Sales:

             

Reagents and other

   $ 38,909    $ 31,036

Instruments

     6,113      5,474
    

  

Total net sales

     45,022      36,510

Cost of goods sold

     11,600      9,692
    

  

Gross profit

     33,422      26,818

Operating expenses:

             

Research and development

     6,135      5,150

Selling, general and administrative

     19,800      18,253

Amortization of intangible assets

     476      289
    

  

Income from operations

     7,011      3,126

Interest and other income

     101      50
    

  

Income before taxes

     7,112      3,176

Provision for income taxes

     2,496      573
    

  

Net income

   $ 4,616    $ 2,603
    

  

Net income per common share:

             

—Basic

   $ 0.13    $ 0.08
    

  

—Diluted

   $ 0.13    $ 0.07
    

  

Shares used in computing net income per common share:

             

—Basic

     34,193      33,572
    

  

—Diluted

     36,805      35,724
    

  

 

4


Ventana Medical Systems, Inc.

Condensed Consolidated Statements of Cash Flows

(in thousands)

(Unaudited)

 

     Three Months Ended
March 31,


 
     2005

    2004

 

Operating activities:

                

Net income

   $ 4,616     $ 2,603  

Adjustments to reconcile net income to cash provided by operating activities:

                

Depreciation and amortization

     2,234       2,006  

Deferred income tax benefit

     (3,312 )     —    

Tax benefit from exercise of stock options

     4,381       —    

Accounts receivable

     925       2,684  

Inventory

     (366 )     (341 )

Other assets

     329       (625 )

Accounts payable

     358       3,141  

Other liabilities

     (574 )     (2,159 )
    


 


Net cash provided by operating activities

     8,591       7,309  

Investing activities:

                

Purchase of property and equipment

     (3,365 )     (2,996 )

Purchase of intangible assets

     (533 )     (244 )

Purchases of short-term investments

     (1,549 )     (11,522 )

Proceeds from sale of short-term investments

     1,549       6,464  
    


 


Net cash used in investing activities

     (3,898 )     (8,298 )

Financing activities:

                

Issuance of common stock

     5,482       2,775  

Repayments of debt

     (56 )     (114 )

Purchases of common stock for treasury

     —         (9,228 )
    


 


Net cash provided by (used in) financing activities

     5,426       (6,567 )

Effect of exchange rate change on cash and cash equivalents

     (662 )     (364 )
    


 


Net increase (decrease) in cash and cash equivalents

     9,457       (7,920 )

Cash and cash equivalents, beginning of period

     33,354       19,711  
    


 


Cash and cash equivalents, end of period

   $ 42,811     $ 11,791  
    


 


Supplemental cash flow information:

                

Income taxes paid

   $ 195     $ 5  

Interest paid

   $ 38     $ 19  

Non-cash investing and financing activities:

                

Tendered common stock for stock option exercises

   $ 338     $ —    

 

5


Ventana Medical Systems, Inc.

Notes to Condensed Consolidated Financial Statements

(in thousands, except per share data)

(Unaudited)

 

1. Organization and Significant Accounting Policies

 

Organization: Ventana Medical Systems, Inc. (“Ventana” or the “Company”) develops, manufactures and markets proprietary instruments and reagents that automate diagnostic procedures used for molecular analysis of cells. 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., and Ventana Medical Systems Pty. Ltd. All significant inter-company balances and transactions have been eliminated. We do not have any subsidiaries in which we do not own 100% of the outstanding stock.

 

Basis of Presentation: The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States 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 United States for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three months ended March 31, 2005 are not necessarily indicative of the results that may be expected for the year ended December 31, 2005. For further information, refer to the consolidated financial statements and footnotes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2004.

 

Recently Issued Accounting Pronouncements: On April 14, 2005, the Securities and Exchange Commission (“SEC”) adopted a new rule that amends the compliance dates for Financial Accounting Standards Board’s Statement of Financial Accounting Standards No. 123 (revised 2004), Share-Based Payment (“SFAS No. 123R”). Under the new rule, the Company is required to adopt SFAS No. 123R in the first quarter of fiscal 2006, beginning January 1, 2006. The Company has not yet determined the method of adoption or the effect of adopting SFAS No. 123R, and it has not determined whether the adoption will result in amounts that are similar to the current pro forma disclosures under SFAS No. 123.

 

Stock-Based Employee Compensation: At March 31, 2005, the Company has four active stock-based employee compensation plans. The Company accounts for those plans under the recognition and measurement principles of Accounting Principles Board Opinion No. 25 (APB 25), Accounting for Stock Issued to Employees, and related Interpretations. No stock-based employee compensation cost is reflected in net income, as all options granted under those plans had an exercise price equal to the market value of the underlying common stock on the date of grant.

 

6


Ventana Medical Systems, Inc.

Notes to Condensed Consolidated Financial Statements (continued)

(in thousands, except per share data)

(Unaudited)

 

1. Organization and Significant Accounting Policies (continued)

 

The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of Statement of Financial Accounting Standards No. 123 (SFAS No. 123), Accounting for Stock-Based Compensation, to stock-based employee compensation:

 

     Three Months Ended
March 31


 
     2005

    2004

 

Net income, as reported

   $ 4,616     $ 2,603  

Deduct: Total stock-based employee compensation expense determined under fair value based methods for all awards, net of related tax effects

     (1,186 )     (3,520 )
    


 


Pro-forma net income (loss)

   $ 3,430     $ (917 )
    


 


Net income (loss):

                

Basic - as reported

   $ 0.13     $ 0.08  
    


 


Basic - pro forma

   $ 0.10     $ (0.03 )
    


 


Diluted - as reported

   $ 0.13     $ 0.07  
    


 


Diluted - pro forma

   $ 0.09     $ (0.03 )
    


 


 

As required, the pro forma disclosures above include options granted since January 1, 1995. Consequently, the effects of applying SFAS No. 123 for providing pro forma disclosures may not be representative of the effects on reported net income for future years until all options outstanding are included in the pro forma disclosures. For purposes of pro forma disclosures, the estimated fair value of stock-based compensation plans and other options is amortized to expense primarily over the vesting period.

 

Reclassification: Certain prior year amounts have been reclassified to conform to the current period presentation.

 

2. Inventories

 

Inventories consist of the following:

 

     March 31,
2005


   December 31,
2004


Raw material and work-in-process

   $ 4,978    $ 4,067

Finished goods

     6,265      6,810
    

  

     $ 11,243    $ 10,877
    

  

 

7


Ventana Medical Systems, Inc.

Notes to Condensed Consolidated Financial Statements (continued)

(in thousands, except per share data)

(Unaudited)

 

3. Comprehensive Income (Loss)

 

The components of comprehensive income (loss), net of tax, for the three months ending March 31, 2005 and 2004 are as follows:

 

     Three Months Ended
March 31,


 
     2005

    2004

 

Net income

   $ 4,616     $ 2,603  

Net unrealized (losses) gains on available for sale securities

     (38 )     27  

Net change in cumulative translation adjustment

     (582 )     (363 )
    


 


     $ 3,996     $ 2,267  
    


 


 

The components of accumulated other comprehensive income (loss), net of tax, were as follows:

 

     March 31,
2005


    December 31,
2004


 

Net unrealized (losses) gains on available for sale securities

   $ (102 )   $ (64 )

Cumulative translation adjustment

     (478 )     104  
    


 


     $ (580 )   $ 40  
    


 


 

4. Provision for Income Taxes

 

For the three months ending March 31, 2005, income taxes have been provided for using the liability method in accordance with Statement of Financial Accounting Standard No. 109, “Accounting for Income Taxes.” The provision for income taxes reflects management’s estimate of the effective tax rate expected to be applicable for the full fiscal year. This estimate is re-evaluated by management each quarter based on the Company’s estimated tax expense for the year. The Company also evaluated the recoverability of its net deferred tax assets and determined that the balances existing at March 31, 2005, represented the amount that is more likely than not of being recovered in the foreseeable future.

 

The income tax provision for the three months ending March 31, 2004 consisted of certain state and international tax expenses. Income tax expense with respect to domestic income generated during this period was offset by the utilization of existing net operating loss carryforwards. As a result, a comparison of the effect tax rates between March 31, 2005 and 2004 are not meaningful.

 

8


Ventana Medical Systems, Inc.

Notes to Condensed Consolidated Financial Statements (continued)

(in thousands, except per share data)

(Unaudited)

 

5. Stock Repurchase

 

On September 8, 1998, the Company’s Board of Directors authorized the Company to repurchase up to 1.5 million shares of its common stock in the open market or in privately negotiated transactions. In May 2004, our Board of Directors approved an additional repurchase of an additional 2.0 million shares. During the three months ended March 31, 2005 and 2004, the Company re-purchased 10 and 228 shares of its common stock for $338 and $9,228, respectively. The repurchased shares were returned to the status of authorized but unissued shares. The timing and amount of any future repurchases will depend on market conditions and corporate considerations.

 

6. Operating Segment and Enterprise Data

 

The Company has two reportable segments: North America (primarily the United States and Canada) and International (primarily France, Germany, Japan and Australia). Segment information for the three months ended March 31, 2005 and 2004 are as follows:

 

     Three months ended March 31, 2005

     North
America


   International

   Eliminations

    Totals

Sales to external customers

   $ 30,915    $ 14,107    $ —       $ 45,022

Depreciation and amortization expense

     1,843      391      —         2,234

Segment profit

     1,568      3,048      —         4,616

Property and equipment, net

     43,843      5,434      —         49,277

Segment assets

     179,756      36,852      (22,375 )     194,233

Expenditures for long-lived assets

     3,396      502      —         3,898
     Three months ended March 31, 2004

     North
America


   International

   Eliminations

    Totals

Sales to external customers

   $ 24,918    $ 11,592    $ —       $ 36,510

Depreciation and amortization expense

     1,706      300      —         2,006

Segment profit

     522      2,081      —         2,603

Property and equipment, net

     38,748      5,193      —         43,941

Segment assets

     128,815      25,595      (16,369 )     138,041

Expenditures for long-lived assets

     2,721      519      —         3,240

 

9


Ventana Medical Systems, Inc.

Notes to Condensed Consolidated Financial Statements (continued)

(in thousands, except per share data)

(Unaudited)

 

7. Commitments and Contingencies

 

In the ordinary course of business, we are involved in a limited number of other legal actions, both as plaintiff and defendant, and could incur uninsured liability in any one or more of them. Although the outcome of these actions is not presently determinable, it is the opinion of the Company’s management, based upon the information available at this time, that the expected outcome of these matters, individually or in the aggregate, will not have a material adverse effect on the results of operations or financial condition of the Company.

 

10


Ventana Medical Systems, Inc.

 

Item 2. Management’s Discussion and Analysis of Financial Conditions and Results of Operations

 

The following discussion of the financial condition and results of operations of the Company should be read in conjunction with the Condensed Consolidated Financial Statements and related Notes thereto included elsewhere in this Form 10-Q. This Report on Form 10-Q contains certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Forward-looking statements, by their very nature, contain risks and uncertainties. Accordingly, actual events or results may differ materially from those anticipated by such forward-looking statements. A wide variety of factors could cause or contribute to such differences and could adversely impact revenues, profitability, cash flows and capital needs. Such factors, many of which are beyond the Company’s control, include the following: market acceptance of new automated histology products, continued success in asset management, continued improvements in our manufacturing efficiencies, on-schedule launches of our new products, currency exchange rate variability, adverse determinations in various outstanding litigations, competition and competitive pressures on pricing and general economic conditions in the United States and in the regions served by the Company.

 

Results of Operations

 

Net Sales

 

Net sales for the three months ended March 31, 2005 increased 23% compared to the same period in 2004 to $45.0 million from $36.5 million. This sales growth was attributable to a 25% increase in reagents and other sales. This growth came from a 11% increase in our installed base from approximately 4,700 in 2004 to approximately 5,200 in 2005 and a 13% year-over-year improvement in the average reagent annuity stream per installed instrument to $25,400 from $22,500 in 2004.

 

By geographic segment, total sales increased in the first quarter of 2005 over 2004 by 24% in North America ($30.9 million versus $24.9 million) and 22% internationally ($14.1 million versus $11.6 million) due to the reasons mentioned above.

 

Gross Profit

 

Gross profit for the three months ended March 31, 2005 increased to $33.4 million from $26.8 million for the same period in 2004. The Company’s gross margin for the quarter ended March 31, 2005 increased to 74.2% from 73.5% for the same period in 2004, primarily due to the higher mix of reagent and other sales, which have a higher margin than instruments.

 

Research and Development

 

Research and development spending for the three months ended March 31, 2005 increased to $6.1 million from $5.2 million for the same period in 2004. This increase was driven by our continued new platform development programs and our reagent chemistry application initiatives focused primarily on the histology market.

 

11


Ventana Medical Systems, Inc.

 

Item 2. Management’s Discussion and Analysis of Financial Conditions and Results of Operations

 

Selling, General and Administrative (“SG&A”)

 

Presented below is a summary of SG&A expense for the three months ended March 31, 2005 and 2004 (in thousands):

 

    

Three Months Ended

March 31,


 
     2005

    2004

 
     $

   % Net
Sales


    $

   % Net
Sales


 

Sales and marketing

   $ 14,142    31 %   $ 13,190    36 %

Administration

     5,658    13 %     5,063    14 %
    

  

 

  

Total SG&A

   $ 19,800    44 %   $ 18,253    50 %
    

  

 

  

 

SG&A expense for the three months ended March 31, 2005 increased to $19.8 million from $18.3 million for the same period in 2004. The increase is primarily attributed to increased investments in our sales force and associated infrastructure and continued development of our marketing organization. We also continued to invest in further establishing our intellectual property position and defending ourselves in litigation matters. Consistent with our longer-term strategy of decreasing expense as a percentage of sales, SG&A expense as a percent of sales decreased to 44% in 2005 from 50% in 2004.

 

Amortization of Intangible Assets

 

Amortization expense of intangible assets for the three months ended March 31, 2005 increased to $0.5 million from $0.3 million for the same period in 2004. The increase is due to incremental amortization associated with a higher carrying base in intangible assets during the three months ended March 31, 2005. Estimated amortization expense for intangible assets as of March 31, 2005 for each of the five succeeding fiscal years is as follows (all amounts are in thousands): 2005: $2,000, 2006: $2,000, 2007: $1,700, 2008: $1,400, 2009: $1,300.

 

Interest and Other Income

 

Interest and other income of $0.1 million for the three months ended March 31, 2005 was consistent with the three months ended March 31, 2004.

 

Provision for Income Taxes

 

For the three months ending March 31, 2005, the provision for income taxes reflects management’s estimate of a 35% effective tax rate expected to be applicable for the full fiscal year. This estimate will be re-evaluated by management each quarter based on the Company’s estimated tax expense for the year. The income tax provision for the three months ending March 31, 2004 consisted of certain state and international tax expenses for which net operating loss carryforwards did not exist. Income tax expense with respect to U.S. income generated during this period was offset by the utilization of existing net operating loss carryforwards. As a result, a comparison of the effective tax rates between March 31, 2005 and 2004 is not meaningful.

 

12


Ventana Medical Systems, Inc.

 

Item 2. Management’s Discussion and Analysis of Financial Conditions and Results of Operations

 

Critical Accounting Policies and Estimates

 

Our discussion of financial condition and results of operations relies on our condensed consolidated financial statements that are prepared based on certain critical accounting policies that require management to make judgments and estimates that are subject to varying degrees of uncertainty. We believe that investors need to be aware of these policies and how they impact our financial statements as a whole, as well as our related discussion and analysis presented herein. While we believe that these accounting policies are based on sound measurement criteria, actual future events can and often do result in outcomes that can be materially different from these estimates or forecasts. The accounting policies and related risks described in our annual report on Form 10-K as filed with the Securities and Exchange Commission on March 15, 2005 are those that depend most heavily on these judgments and estimates. As of April 20, 2005, there have been no material changes to any of the critical accounting policies contained therein.

 

Factors that Could Affect Future Results

 

Because of the following factors, as well as other variables affecting our operating results, past financial performance may not be a reliable indicator of future performance, and historical trends should not be used to anticipate results or trends in future periods.

 

Our products could infringe the intellectual property rights of others, which might cause us to engage in costly litigation, and if we are not successful, could cause us to pay substantial damages and prohibit us from selling our products.

 

Third parties may assert patent, trademark, or copyright infringement or other intellectual property claims against us, based on their patents or other intellectual property. We may be required to pay substantial damages (including treble damages) for past infringement; if it is ultimately determined our products infringe a third-party’s intellectual property rights. Even if infringement claims against us are without merit, defending a lawsuit takes significant time, is expensive, and may divert management’s attention from other business concerns. If we are not successful in a lawsuit, we may be unable to sell our products or to continue to sell our products until we obtain a license from the owner of the relevant technology or other intellectual property rights, which may not be available to us. Even if a license is available, it may require us to pay substantial royalties. (For further discussion of litigation matters, please refer to our annual report on Form 10-K as filed with the Securities and Exchange Commission on March 15, 2005 and Part II, Item 1, Legal Proceedings ).

 

If we are unsuccessful in appealing the adverse judgment we received in connection with the CytoLogix litigation, we may be forced to pay damages to CytoLogix.

 

As discussed in more detail in our annual report on Form 10-K as filed with the Securities and Exchange Commission on March 15, 2005 and under Part II, Item 1, Legal Proceedings, we have been involved in litigation with CytoLogix, Inc., pursuant to which a jury determined that we infringed certain CytoLogix patents. The patents in question relate to prior versions of our BENCHMARK and DISCOVERY instruments and do not apply to the current versions of the BENCHMARK XT / LT and DISCOVERY XT instruments.

 

13


Ventana Medical Systems, Inc.

 

Item 2. Management’s Discussion and Analysis of Financial Conditions and Results of Operations

 

We have appealed the decision. However, our success cannot be guaranteed, and, if we are ultimately unsuccessful in the litigation, we may be forced to pay damages including royalties to CytoLogix for our first-generation BENCHMARK and DISCOVERY products. In addition, our BENCHMARK XT/LT and DISCOVERY XT instruments are the subject of separate litigation.

 

If we fail to comply with the FDA’s Quality System regulations, our manufacturing operations could be delayed, and our product sales and profitability could suffer.

 

When manufacturing our medical devices, including Analyte Specific Reagents, we are required to adhere to Quality System regulations, which require us to manufacture our products and maintain records in a prescribed manner. We are subject to future FDA Quality System inspections, and we cannot assure you that we will pass these inspections or maintain compliance.

 

Complying with international regulatory requirements is an expensive, time-consuming process, and approval is never certain.

 

Sales of our products in the European Union (EU) are subject to strict regulatory requirements, and approval is never certain. All of our products must be in compliance with the “In Vitro Diagnostics Directive” and bear the CE mark before being imported for sale in the EU. The CE mark is a symbol indicating the device conforms to the essential requirements of the applicable directive and can be commercially distributed throughout the EU. The In Vitro Diagnostic Directive also subjects our manufacturing facilities to compliance inspections and requires design, manufacturing, and quality process documentation and controls. Some of our products do not bear the CE mark. We cannot assure you that the CE mark will be granted for all our products or that regulatory review will not involve delays that would harm our ability to market and sell our products in the EU.

 

If our customers do not receive adequate third-party reimbursement, our products may not be accepted in the market.

 

In the United States, our products are primarily purchased by medical institutions and laboratories that bill third-party payers, such as government health administration authorities, private health coverage insurers, managed care organizations, and other similar organizations. Our ability to earn sufficient returns on our products will depend in part on the extent to which reimbursement for our products and related treatments will be available to our customers from third-party payers. Third-party payers are increasingly attempting to limit both the coverage and the level of reimbursement of products to contain costs, and if successful, our ability to sustain revenue growth and profitably will be adversely affected.

 

Clinical Laboratory Improvement Act (CLIA) regulations could harm our business by limiting the potential market for our products.

 

Any of the customers using our products for clinical use in the United States may be regulated under the CLIA. CLIA is intended to ensure the quality and reliability of clinical

 

14


Ventana Medical Systems, Inc.

 

Item 2. Management’s Discussion and Analysis of Financial Conditions and Results of Operations

 

laboratories in the U.S. by mandating specific standards in the areas of personnel qualification, administration, proficiency testing, patient test management, quality control, quality assurance, and inspections. The regulations promulgated under CLIA establish three levels of clinical tests, and the standards applicable to a clinical laboratory depend on the level of the tests it performs. CLIA requirements may prevent some clinical laboratories from using our products. Therefore, CLIA regulations and future administrative interpretations of CLIA could harm our business by limiting the potential market for our products.

 

Unanticipated changes in our tax rates or exposure to additional tax liabilities could affect our profitability.

 

We are subject to income taxes in both the U.S. and various foreign jurisdictions, and our domestic and international tax liabilities are subject to the allocation of expenses in different jurisdictions. Our effective tax rates could be adversely affected by changes in the mix of earnings in countries with differing statutory tax rates, in the valuation of deferred tax assets and liabilities or in tax laws, or by material audit assessments, which could affect our profitability. In particular, the carrying value of deferred tax assets, which are predominantly in the U.S., is dependent on our ability to generate future taxable income in the U.S. In addition, the amount of tax we pay is subject to ongoing audits in various jurisdictions, and a material assessment by a governing tax authority could affect our profitability. Further, if we elect to repatriate cash held outside the U.S. pursuant to The American Jobs Creation Act of 2004, our tax rate may increase even if by a lesser amount than without such legislation.

 

If we have problems with key suppliers, our product development and commercialization efforts could be delayed or stopped.

 

Our reagent products are formulated from chemical and biological materials using proprietary technology and standard processing techniques. We purchase components and raw materials used to make our reagent products from single-source vendors. We cannot assure the materials or reagents 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 significant effect on our ability to manufacture our products. Developing alternative or additional suppliers could be time consuming and expensive.

 

A number of components used to manufacture instruments are made on a custom basis to our specifications and are available from a limited number of sources. If the supply of materials or components from any of these vendors were delayed or interrupted for any reason, or if the quality or reliability of the materials or components proves inadequate for use in our instruments, our ability to make instruments in a timely fashion could be impaired, and our results of operations would suffer.

 

We could bring litigation to enforce our intellectual property rights, which might result in substantial expense.

 

We rely on patents to protect our intellectual property rights. The strength of this protection, however, is uncertain. In particular, it is not certain that:

 

    our patents and pending patent applications use technology that we invented first;

 

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Ventana Medical Systems, Inc.

 

Item 2. Management’s Discussion and Analysis of Financial Conditions and Results of Operations

 

    we were the first to file patent applications for these inventions;

 

    others will not independently develop similar or alternative technologies or duplicate our technologies;

 

    any of our pending patent applications will result in issued patents; or

 

    any patents issued to us will provide a basis for commercially viable products, will provide us with any competitive advantages, or will not face third-party challenges or be the subject of further proceedings limiting their scope.

 

We may become involved in interference proceedings in the U.S. Patent and Trademark Office to determine the priority of our inventions. We also could become involved in opposition proceedings in foreign countries challenging the validity of our patents. In addition, costly litigation could be necessary to protect our patent position. Patent law relating to the scope of claims in the technology fields in which we operate is still evolving, and consequently, patent positions in our industry are generally uncertain. We may not prevail in any lawsuit, or if we do prevail, we may not receive commercially valuable remedies. Failure or inability to protect our patent rights or intellectual property could have serious adverse effects on our business and could affect our profitability.

 

We also rely on trade secrets, unpatented proprietary know-how, and continuing technological innovation that we seek to protect with confidentiality agreements with employees, consultants, and others with whom we discuss our business. These individuals may breach our confidentiality agreements, and our remedies may not be adequate to enforce these agreements. Disputes may arise concerning the ownership of intellectual property or the applicability or enforceability of these agreements, and we may not be able to resolve these disputes in our favor. Furthermore, competitors may independently develop trade secrets and proprietary technology similar to ours. We may not be able to maintain the confidentiality of information relating to products.

 

We deal with hazardous materials and generate hazardous wastes and must comply with environmental laws and regulations, which can be expensive and restrict how we do business. We could also be liable for damages or penalties, if we are involved in a hazardous material or waste spill or other accident.

 

Our manufacturing processes, primarily those involved in producing some of our reagent products, require the use of potentially hazardous and carcinogenic chemicals. We are subject to federal, state, and local laws and regulations governing the use, manufacture, storage, handling, and disposal of these materials and waste. In the event of a hazardous material or waste spill or other accident, we could also be liable for damages or penalties. In addition, we may be liable or potentially liable for injury or contamination as a result of our own, or a third party’s, use of these materials, and such liability, if significant, could seriously impair our financial position.

 

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Ventana Medical Systems, Inc.

 

Item 2. Management’s Discussion and Analysis of Financial Conditions and Results of Operations

 

We cannot assure you that we will be able to fund our future capital requirements through internal sources or from other sources.

 

We anticipate our existing capital resources and borrowing capacity will be adequate to satisfy our capital requirements for the next 12 months. Our future capital requirements will depend on many factors including:

 

    the extent that our products gain market acceptance;

 

    the mix of instruments placed through direct sales, rental, or through our PEP program;

 

    the progression 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 with the uncertain timing of regulatory approvals.

 

We may require additional capital resources and 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 equity securities, which may affect the market price of our common stock and would dilute the interests of our existing stockholders.

 

Recent legislation requires us to undertake an annual evaluation of our internal control over financial reporting that may identify internal control weaknesses requiring remediation that could harm our reputation or subject us to investigation and sanctions by regulatory authorities.

 

As required by Section 404 of the Sarbanes-Oxley Act of 2002, we are required to continuously assess, test, and evaluate the design and operating effectiveness of our internal control over financial reporting, or ICFR. While we have concluded that our ICFR was effective as of March 31, 2005, we cannot predict the outcome of our testing in future periods. If we conclude in future periods our ICFR is not effective, we may be required to change our ICFR to remediate deficiencies, which could result in lost investor confidence in the reliability of our financial statements, and we may be subject to investigation and/or sanctions by regulatory authorities. In addition, if we fail to maintain the adequacy of our internal controls, as such standards are modified, supplemented, or amended from time to time, we may not be able to ensure we can conclude on an ongoing basis that we have effective controls over financial reporting in accordance with Section 404, and our independent auditors may not be able to render

 

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Ventana Medical Systems, Inc.

 

Item 2. Management’s Discussion and Analysis of Financial Conditions and Results of Operations

 

the required attestation concerning our assessment and the effectiveness of the internal controls over financial reporting. If we fail to maintain an effective internal control environment or our independent auditors are unable to render the required attestation, it could have a material adverse effect on investor confidence in our reported financial information. Any such events could adversely affect our financial results and/or the market price of our common stock, and our reputation may be harmed.

 

Liquidity and Capital Resources

 

Cash and cash equivalents was $42.8 million at March 31, 2005. We have funded our capital requirements since inception through sales of equity securities, debt financing and cash flows from operations. Net cash provided by operating activities was $8.6 million and $7.3 million for the three months ended March 31, 2005 and 2004, respectively. Net cash provided by operating activities exceeded net income in 2004 primarily due to the effect of depreciation and amortization and decreases in operating assets.

 

We use cash in our investing activities primarily to fund investments in property and equipment and in 2004 to purchase short-term investments. Net cash used in investing activities for the three months ended March 31, 2005 and 2004 was $3.9 million and $8.3 million, respectively. At March 31, 2005, we have $20.2 million in short-term investments that primarily consist of corporate and various government agency debt securities. We classify these short-term investments as available-for-sale.

 

Net cash provided by financing activities for the three months ended March 31, 2005 was $5.4 million, primarily from proceeds received from the exercise of stock options and employee stock purchases. For the three months ended March 31, 2004, net cash used in financing activities of $6.6 million consisted primarily of our stock repurchases net of proceeds from the exercise of stock options and employee stock purchases.

 

We believe that our cash flow from operations together with our current cash reserves will be sufficient to fund our projected capital requirements through 2005. In the event that additional capital is required, we will first access our short-term investments. In the event that additional capital is required, we may seek to raise such capital through public or private equity or debt financings. Future capital funding transactions may result in dilution to current shareholders.

 

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Ventana Medical Systems, Inc.

 

Item 3. Quantitative and Qualitative Disclosures About Market Risk

 

For quantitative and qualitative disclosures about market risk affecting Ventana, see Item 7A, “Quantitative and Qualitative Disclosures About Market Risk,” of our Annual Report on Form 10-K for the fiscal year ended December 31, 2004, which is incorporated herein by reference. Our exposure to market risk has not changed materially since December 31, 2004.

 

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Ventana Medical Systems, Inc.

 

Item 4. Controls and Procedures

 

(a) Evaluation of Disclosure Controls and Procedures

 

Our Chief Executive Officer and Chief Financial Officer have evaluated the effectiveness of our disclosure controls and procedures (as such term is defined in Rules 13a-14(c) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of March 31, 2005 (the “Evaluation Date”). Based on their evaluation, such officers have concluded that, as of the Evaluation Date, our disclosure controls and procedures are effective in alerting them, on a timely basis, to material information relating to us (including our consolidated subsidiaries) required to be included in our periodic filings under the Exchange Act.

 

(b) Changes in Internal Controls

 

Since the Evaluation Date, there have not been any significant changes in our internal controls or in other factors that could significantly affect such controls.

 

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Ventana Medical Systems, Inc.

 

PART II - OTHER INFORMATION

 

Item 1. Legal Proceedings

 

VENTANA v. VISION BIOSYSTEMS, LTD., Civil Action No. 05-10614 GAO, was filed in March 2005, in the U.S. District Court, Eastern District of Massachusetts. This complaint alleges that Vision’s BOND OCR system infringes U.S. Patent No. 6,352,861. The complaint has not yet been served upon Vision.

 

DIGENE CORPORATION v. VENTANA, Civil Action No. 01-752, was filed in November 2001, in the U.S. District Court, District of Delaware. This complaint alleges we infringe two U.S. patents held by Digene, U.S. 4,849,331 and 4,849,332, by activities relating to our INFORM ® HPV Family 16 and Family 6 probe products. We filed an answer denying the allegations in February 2002. The parties have filed cross-motions for summary judgment. In addition, in November 2002, Digene filed a motion to amend its Complaint to add numerous causes of action related to our September 2002 acquisition of Beckman Coulter’s (“Beckman”) HPV business and to add Beckman as a party. Digene seeks, among other remedies, an injunction against the sale of our INFORM HPV products, unspecified monetary damages, cancellation of the Beckman HPV acquisition, and related claims. Several motions were filed by the parties, one of them being a motion to compel arbitration submitted by Beckman and Ventana. In May 2003, the judge ordered further discovery be taken on the issues of arbitrability. In January 2004, the Court held a hearing on arbitrability. In March 2004, the Judge dismissed without prejudice all of the pending motions in the case, and without comment. In May 2004, the Court ordered arbitration proceed as against Beckman, only, and stayed the proceedings pending in the District Court until the conclusion of the arbitration. Digene filed a Motion for Reconsideration of the Court’s order, which was denied by the Court in July 2004. In December 2004, Digene initiated the arbitration against Beckman before the American Arbitration Association, or AAA, in New York. In January 2005, the matter was removed to the International Centre for Dispute Resolution, or ICDR, a division of AAA. In February 2005, we filed a Motion for Leave to Petition the Arbitral Panel to participate in the Arbitration with the District Court and notified the ICDR of this request. The Court has granted our motion and once the arbitrators have been selected, we will submit a Petition to participate in the Arbitration. Beckman and Digene are presently in the process of selecting arbitrators.

 

In June 2003, Ventana and Beckman filed a request for arbitration with the International Chamber of Commerce, or ICC, in Paris, France, to contest the purported termination by Institut Pasteur of the Sublicense Agreement we acquired from Beckman in September 2002. Institut Pasteur has responded, and the parties selected a panel of arbitrators. In December 2003, the panel framed the Terms of Reference, the issues to be heard in the case. In February 2004, we submitted our Statement of Claim. In March 2004, Institut Pasteur filed a Statement of Defenses. Institut Pasteur also filed a Motion to Stay the Arbitration pending the outcome of the Delaware patent litigation, and an oral hearing was conducted in May 2004. The Motion for Stay was denied, and in June 2004, we filed our Statement of Reply and rebuttal to Institut Pasteur’s defenses. In July 2004, Institut Pasteur submitted its Statement of Response and rebuttal. The ICC hearing was conducted in September, 2004. Post-hearing submissions were filed in November 2004, and a Submission of Costs was filed in February 2005. The parties are awaiting the decision of the ICC, likely in late April 2005.

 

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Ventana Medical Systems, Inc.

 

Item 1. Legal Proceedings – (continued)

 

BIOGENEX LABORATORIES, INC. v. VENTANA, Case No. C03 03916 JF, was filed in August 2003, in the U.S. District Court, Northern District of California, San Jose Division. This Complaint alleges we infringe three U.S. patents held by BioGenex, U.S. Patent Nos. 5,578,452, 5,244,787, and 6,451,551. BioGenex seeks, among other remedies, an injunction against our alleged infringement and unspecified monetary damages. We filed our answer in October 2003. In June 2004, BioGenex moved to amend its complaint adding allegations that we also infringe U.S. Patent No. 6,632,598, and has also filed an action for contempt against us arising out of previous litigation associated with BioTek Solutions Inc., which we acquired in 1996. A show cause hearing on the contempt action was originally set for August 2004 but remains to be heard. In February 2005, the Court ruled in favor of our Motion for Summary Judgment of non-infringement of the ‘551 patent. The Court also found the ‘452 patent invalid against us for purpose of this litigation. Finally, the Court denied BioGenex’s motion to add the ‘598 patent to the suit. A case management conference is scheduled for August 2005.

 

For further discussion of legal proceedings affecting the Company, see Item 3, “Legal Proceedings,” of our Annual Report on Form 10-K for fiscal year ended December 31, 2004.

 

We record contingent liabilities resulting from claims against us when it is probable (as that word is defined in Statement of Financial Accounting Standards No. 5) that a liability has been incurred and the amount of the loss is reasonably estimable. We disclose contingent liabilities when there is a reasonable possibility that the ultimate loss will exceed the recorded liability. Estimating probable losses requires analysis of multiple factors, in some cases including judgments about the potential actions of third-party claimants and courts. Therefore, actual losses in any future period are inherently uncertain. In all of the cases noted where we are the defendant, we believe we have meritorious defenses to the claims in these actions and resolution of these matters will not have a material adverse effect on our business, financial condition, or results of operation; however, the results of the proceedings are uncertain, and there can be no assurance to that effect.

 

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Ventana Medical Systems, Inc.

 

Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities

 

On September 8, 1998, our Board of Directors authorized us to repurchase up to 1.5 million shares of its common stock in the open market or in privately negotiated transactions. In May 2004, our Board of Directors approved an additional repurchase of an additional 2.0 million shares. During the three months ended March 31, 2005, we re-purchased 9,768 of its common stock for $337,875. The repurchased shares were returned to the status of authorized but unissued shares. The timing and amount of any future repurchases will depend on market conditions and corporate considerations.

 

Stock Repurchases During the First Quarter 2005

 

Period


   Total Number
of Shares


   Average Price
Paid Per Share


   Total Number of
Shares Purchased
as Part of Publicly
Announced Plans
or Programs


   Maximum
Number of Shares
that may yet be
Repurchased Under
the Plans or Programs


January 1, 2005 - January 31, 2005

   —        —      —      2,332,800

February 1 - February 28, 2005

   9,768    $ 34.59    9,768    2,323,032

March 1 - March 31, 2005

   —        —      —      2,323,032

 

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Ventana Medical Systems, Inc.

 

Item 6. Exhibits

 

See Exhibits Index

 

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SIGNATURE

 

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

 

    Ventana Medical Systems, Inc.
Date: April 22, 2005   By:  

/s/ Nicholas Malden


        Nicholas Malden
       

Senior Vice President, Chief Financial Officer

and Secretary

 

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EXHIBITS

 

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),(3)
10.7    2001 Outside Director Stock Option Plan   (4)
31.1    Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer    
31.2    Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer    
32.      Section 1350 Certifications of Chief Executive Officer and Chief Financial Officer    

(1) Filed with the Registration Statement on Form S-l (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) Form of 1998 Nonstatutory Stock Option Plan, as amended, agreements filed with the Registration Statement on Form S-8 (Commission File No. 333-105976), on June 10, 2003.
(4) Filed with the Registration Statement on Form S-8 (Commission File No. 333-69658), filed with the Commission on September 19, 2001.

 

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