filings.toolsItem 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
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Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
FORWARD-LOOKING INFORMATION
This report contains forward-looking statements, which are based on the Company’s current assumptions and expectations. The principal forward-looking statements in this report include: the Company’s expectations regarding product releases, governmental license renewals, future tax rates, capital expenditures, future dividend declarations, adequacy of owned and leased property for future operations, and sufficiency of capital resources to meet the Company’s foreseeable future cash and working capital requirements.
All such forward-looking statements are intended to enjoy the protection of the safe harbor for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995, as amended. Although the Company believes there is a reasonable basis for the forward-looking statements, the Company’s actual results could be materially different. The most important factors which could cause the Company’s actual results to differ from forward-looking statements are set forth in the Company’s description of risk factors in Item 1A to this Annual Report on Form 10-K.
Forward-looking statements speak only as of the date they are made, and the Company does not undertake any obligation to update any forward-looking statements.
OVERVIEW
TECHNE Corporation and subsidiaries (the Company) are engaged in the development, manufacture and sale of biotechnology products and hematology calibrators and controls. These activities are conducted domestically through its wholly-owned subsidiaries, Research and Diagnostic Systems, Inc. (R&D Systems), Boston Biochem, Inc. (Boston Biochem), Tocris Cookson, Inc. (Tocris US), and BiosPacific, Inc. (BiosPacific). The Company’s European biotechnology operations are conducted through its wholly-owned U.K. subsidiaries, R&D Systems Europe Ltd. (R&D Europe) and Tocris Holdings Limited (Tocris UK). R&D Europe has a sales subsidiary, R&D Systems GmbH, in Germany and a sales office in France. The Company distributes its biotechnology products in China through its wholly-owned subsidiary, R&D Systems China Co., Ltd. (R&D China). R&D China has a sales subsidiary, R&D Systems Hong Kong Ltd., in Hong Kong.
On April 1, 2011, the Company acquired for approximately $7.9 million cash, the assets of Boston Biochem, Inc., a leading developer and manufacturer of innovative ubiquitin-related research products. These products provide biomedical researchers the tools that facilitate and accelerate basic research and drug discovery efforts. Boston Biochem was founded in 1997 and currently has over 800 ubiquitin-related products. The Ubiquitin Proteasome Pathway is the principal system for protein degradation and signaling in eukaryotic cells. Ubiquitination also affects proteasome-independent events such as protein localization, activity and function. These pathways are central to the regulation of almost all cellular processes. Ubiquitin and related pathways are associated with the regulation of numerous disease states including multiple cancers, diabetes, Parkinson’s, Alzheimer’s, cystic fibrosis, Angelman’s syndrome, Liddle syndrome and Wilson’s disease.
On April 28, 2011, the Company acquired for £75.0 million cash (approximately $124 million), 100% ownership of Tocris Holdings Limited and subsidiaries (Tocris), a leading supplier of reagents for non-clinical life science research. Pursuant to the purchase agreement, £7.5 million of the purchase price paid to Tocris’ shareholders is being held in escrow for 18 months to secure warranty and indemnity obligations of the shareholders. Tocris’ products are used in both in-vitro and in-vivo experiments, to understand biological processes and diseases. The business is focused on making biologically active neuro- and bio-chemicals which are used by researchers to elucidate biological processes and pathways. The products are used in life-science research activities and as part of the initial drug discovery process. Tocris is a Bristol, U.K. based company with origins deriving from Tocris Neuramin and Cookson Chemical, which were founded in 1982 and 1985, respectively. Tocris currently offers over 2,900 chemical, peptide and antibody products. The principal end users are non-clinical laboratory based researchers, working in areas such as neuroscience, cardiovascular disease, endocrinology and cellular processes. Originally a supplier of small molecules, Tocris has successfully pursued a strategy of extending its product range into related market segments such as signal transduction. The products sold by Tocris are used in various research
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fields including cancer, cardiovascular disease, endocrinology, immunology, metabolic diseases, neurological diseases, pain and inflammation, and respiratory diseases. From a cellular process perspective, Tocris products are used to study angiogenesis, apoptosis, cell cycle, cell metabolism, cellular skeleton and motor proteins, extracellular matrix, adhesion molecules, signal transduction and stem cells. Tocris reagents are also used from a pharmacological perspective to study ion channels, 7-TM receptors, nuclear receptors, enzyme-linked receptors, transporter molecules and enzymes.
The Company has two reportable segments based on the nature of its products. As a result of the above acquisitions, the Company has changed the presentation of its segment disclosure from three reporting segments (biotechnology, R&D Europe and hematology) to two reporting segments (biotechnology and hematology). R&D Systems’ Biotechnology Division, R&D Europe, Tocris, R&D China, BiosPacific and Boston Biochem operating segments are included in the biotechnology reporting segment. The Company’s biotechnology reporting segment develops, manufactures and sells biotechnology research and diagnostic products world-wide. The Company’s hematology reporting segment, which consists of R&D Systems’ Hematology Division, develops and manufactures hematology controls and calibrators for sale world-wide. Corresponding items of segment information have been revised for prior periods to conform to the current year presentation.
OVERALL RESULTS
Consolidated net sales and consolidated net earnings increased 7.8% and 2.3%, respectively, for fiscal 2011 as compared to fiscal 2010. Consolidated net sales for fiscal 2011 included $4.7 million of revenues from companies acquired during fiscal 2011. Consolidated net sales and consolidated net earnings in fiscal 2011 were affected by changes in exchange rates from the prior year used to convert consolidated net sales and consolidated net earnings in foreign currencies into U.S. dollars and the impact of repatriation of prior-year earnings in fiscal 2010. The favorable impact in fiscal 2011 on consolidated net sales and consolidated net earnings of the change from the prior year in exchange rates was $466,000 and $258,000, respectively. Consolidated net earnings for fiscal 2010 included a $4.7 million tax benefit as a result of a foreign currency exchange tax loss on the repatriation of prior-year earnings from R&D Europe to the U.S.
Consolidated net sales and consolidated net earnings increased 1.9% and 4.3%, respectively, for fiscal 2010 as compared to fiscal 2009. Consolidated net sales and consolidated net earnings in fiscal 2010 were slightly affected by changes in exchange rates from the prior year used to convert consolidated net sales and consolidated net earnings in foreign currencies into U.S. dollars. The favorable impact in fiscal 2010 on consolidated net sales and consolidated net earnings of the change from the prior year in exchange rates was $888,000 and $68,000, respectively. Consolidated net earnings for fiscal 2010 included a $4.7 million tax benefit as a result of a foreign currency exchange tax loss on the repatriation of prior-year earnings from R&D Europe to the U.S.
RESULTS OF OPERATIONS
Net sales
Net sales (in thousands):
| Year Ended June 30, | ||||||||||||
| 2011 | 2010 | 2009 | ||||||||||
| Biotechnology | $ | 270,287 | $ | 250,653 | $ | 246,454 | ||||||
| Hematology | 19,675 | 18,394 | 17,502 | |||||||||
| $ | 289,962 | $ | 269,047 | $ | 263,956 | |||||||
Consolidated net sales for fiscal 2011 were $290.0 million, an increase of $20.9 million (7.8%) from fiscal 2010. Consolidated net sales for fiscal 2011 included $4.7 million of revenue from companies acquired during fiscal 2011 and were favorably affected by the change from the prior year in exchange rates used to convert sales in foreign currencies into U.S. dollars. Excluding the acquisitions and the effect of changes in foreign currency exchange rates, consolidated net sales increased 5.9% in fiscal 2011 from fiscal 2010.
Biotechnology segment net sales increased $19.6 million (7.8%) in fiscal 2011 from fiscal 2010. Included in biotechnology net sales were $4.7 million of sales by Boston Biochem and Tocris, which were acquired by the Company during fiscal 2011, and $2.5 million of sales of new protein based biotechnology products which had their first sale in fiscal 2011. The majority of the biotechnology net sales increase, exclusive of acquisitions, was from
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increased sales volume. Biotechnology net sales to U.S. industrial pharmaceutical and biotechnology customers, biotechnology’s largest customer group, increased 4.8% in fiscal 2011 compared to the prior fiscal year. Biotechnology net sales to U.S. academic customers and Pacific Rim distributors increased 6.4% and 4.1%, respectively, in fiscal 2011 from fiscal 2010. Biotechnology sales by R&D China and R&D Europe increased 26.0% (22.6% in constant currency) and 4.4% (4.1% in constant currency) in fiscal 2011 from fiscal 2010, respectively. Hematology segment net sales in fiscal 2011 increased $1.3 million (7.0%) mainly due to increased sales volume.
Consolidated net sales for fiscal 2010 were $269.0 million, an increase of $5.1 million (1.9%) from fiscal 2009. Consolidated net sales were favorably affected by the change from the prior year in exchange rates used to convert sales in foreign currencies into U.S. dollars. Excluding the effect of changes in foreign currency exchange rates, consolidated net sales increased 1.6% in fiscal 2010 from fiscal 2009.
Biotechnology segment net sales in fiscal 2010 increased $4.2 million (1.7%) from fiscal 2009. The majority of the biotechnology net sales increase was from increased sales volume. Included in consolidated net sales in fiscal 2010 were $2.8 million of sales of new protein based biotechnology products, which had their first sale in fiscal 2010. Biotechnology net sales to U.S. academic customers, Pacific Rim distributors and sales by R&D China increased 4.0%, 10.5% and 21.8%, respectively, in fiscal 2010 from fiscal 2009. Biotechnology net sales to U.S. industrial pharmaceutical and biotechnology customers were flat in fiscal 2010 compared to the prior fiscal year. R&D Europe net sales increased 0.3% in fiscal 2010. R&D Europe net sales decreased slightly (0.9%) for fiscal 2010 when measured at currency rates in effect in fiscal 2009. Hematology net sales in fiscal 2010 increased $892,000 (5.1%) mainly due to increased sales volume.
Gross margins
Gross margins, as a percentage of net sales, were as follows:
| Year Ended June 30, | ||||||||||||
| 2011 | 2010 | 2009 | ||||||||||
| Biotechnology | 79.8 | % | 81.9 | % | 81.2 | % | ||||||
| Hematology | 47.0 | % | 47.7 | % | 45.9 | % | ||||||
| Consolidated | 77.6 | % | 79.6 | % | 78.8 | % |
The consolidated gross margin for fiscal 2011 was negatively impacted 0.7% as a result of purchase accounting related to inventory and intangible assets from the Boston Biochem and Tocris acquisitions. Under purchase accounting, inventory acquired is valued at fair market value less expected selling and marketing costs, resulting in reduced margins in future periods as the inventory is sold. At the acquisition dates, the value of acquired inventory was increased $25.7 million. Approximately $1.8 million of which was included in cost of sales in fiscal 2011. In addition, under purchase accounting, intangible assets related to technology acquired are amortized to cost of sales over their estimated useful life. Technology acquired as of the acquisition dates was $27.2 million. Approximately $455,000 of which was amortized to cost of sales in fiscal 2011. The improvement in consolidated gross margins for fiscal 2010 was mainly the result of incremental profit on increased sales volume in the biotechnology segment.
Selling, general and administrative expenses
Selling, general and administrative expenses increased $3.2 million (9.8%) and decreased $989,000 (3.0%) in fiscal 2011 and 2010, respectively. Selling, general and administrative expenses were as follows (in thousands):
| Year Ended June 30, | ||||||||||||
| 2011 | 2010 | 2009 | ||||||||||
| Biotechnology | $ | 30,058 | $ | 27,511 | $ | 27,527 | ||||||
| Hematology | 1,451 | 1,393 | 1,463 | |||||||||
| Unallocated corporate expenses | 4,388 | 3,796 | 4,699 | |||||||||
| $ | 35,897 | $ | 32,700 | $ | 33,689 | |||||||
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The change from the comparable fiscal year was primarily the result of the following (in thousands):
| Increase/(Decrease) | ||||||||
| 2011 | 2010 | |||||||
| Professional and other acquisition related costs | $ | 1,735 | $ | 0 | ||||
| Acquired company selling, general and administrative expenses | 945 | 0 | ||||||
| Non-acquisition related legal fees | (555 | ) | (690 | ) | ||||
| Profit sharing and bonus expense | 806 | (403 | ) | |||||
| Stock-based compensation expense | 3 | (343 | ) | |||||
| Customer relationships and trade names amortization | 50 | 0 | ||||||
| Other, including annual wage, salary and benefit increases | 213 | 447 | ||||||
| $ | 3,197 | $ | (989 | ) | ||||
The decrease in non-acquisition related legal fees in fiscal 2011 and 2010 was primarily from lower costs associated with ongoing patent interference and infringement litigation. The increase in fiscal 2011 and decrease in fiscal 2010 in profit sharing and bonus expense reflect the change in financial results from each of the respective prior years. The remainder of the change in selling, general and administrative expenses for both fiscal years was mainly the result of annual wage, salary and benefit increases, partially offset by a decrease in stock-based compensation expense in fiscal 2010.
Research and development expenses
Research and development expenses increased $864,000 (3.4%) and $1.6 million (6.6%) in fiscal 2011 and 2010, respectively, as compared to prior-year periods. The increases were primarily the result of the development of new proteins, antibodies and assay kits by R&D Systems’ Biotechnology Division. The Company introduced 1,646 and 1,482 new biotechnology products in fiscal 2011 and 2010, respectively. Research and development expenses are composed of the following (in thousands):
| Year Ended June 30, | ||||||||||||
| 2011 | 2010 | 2009 | ||||||||||
| Biotechnology | $ | 25,176 | $ | 24,331 | $ | 22,792 | ||||||
| Hematology | 809 | 790 | 772 | |||||||||
| $ | 25,985 | $ | 25,121 | $ | 23,564 | |||||||
Amortization of intangible assets
Total amortization expense was $1.5 million, $960,000 and $960,000 in fiscal 2011, 2010 and 2009, respectively, related mainly to technologies, trade names and customer relationships acquired as a result of acquisitions in fiscal 2006 and fiscal 2011. Amortization expense related to technologies included in cost of sales was $890,000, $435,000 and $435,000 in fiscal 2011, 2010 and 2009, respectively. Amortization expense related to trade names, customer relationships and a non-compete agreement included in selling, general and administrative expense was $575,000, $525,000 and $525,000 in fiscal 2011, 2010 and 2009, respectively. Intangible assets are being amortized over lives of 5 to 15 years.
Interest income
Interest income for fiscal 2011, 2010 and 2009 was $3.8 million, $4.4 million and $7.6 million, respectively. The decrease in both fiscal 2011 and 2010 from the prior fiscal year was primarily the result of lower rates of return on cash and available-for-sale investments, offset in part by higher cash and available-for-sale investment balances prior to the acquisitions in late fiscal 2011.
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Other non-operating expense, net
Other non-operating expense, net, consists of foreign currency transaction gains and losses, rental income, building expenses related to rental property and the Company’s share of losses by equity method investees as follows (in thousands):
| Year Ended June 30, | ||||||||||||
| 2011 | 2010 | 2009 | ||||||||||
| Foreign currency gains (losses) | $ | 844 | $ | (960 | ) | $ | (34 | ) | ||||
| Rental income | 549 | 413 | 481 | |||||||||
| Real estate taxes, depreciation and utilities | (2,293 | ) | (2,200 | ) | (2,208 | ) | ||||||
| Losses by equity method investees | (926 | ) | (1,510 | ) | (1,290 | ) | ||||||
| $ | (1,826 | ) | $ | (4,257 | ) | $ | (3,051 | ) | ||||
Income taxes
Income taxes for fiscal 2011, 2010 and 2009 were provided at rates of approximately 31.9%, 29.8% and 32.3%, respectively, of consolidated earnings before income taxes. The fiscal 2011 consolidated tax rate was positively impacted by the renewal of the U.S. research and development credit and included $431,000 of credit for the January to June 2010 period. The fiscal 2010 consolidated tax rate was positively impacted by a $4.7 million tax benefit from a foreign currency exchange tax loss related to the repatriation of £50 million ($74.4 million) from R&D Europe to the U.S. The Company had previously paid U.S. income taxes on the foreign earnings that were included in the repatriated funds. Excluding this tax benefit, the effective tax rate for fiscal 2010 would have been 32.8%. This is slightly higher than the fiscal 2009 effective tax rate primarily as a result of the expiration of the U.S. research and development credit at the end of the second quarter of fiscal 2010. The fiscal 2009 consolidated tax rate was positively impacted by the renewal of the U.S. research and development credit. The fiscal 2009 credit included $354,000 of credit for the January to June 2008 period. U.S. federal taxes have been reduced by the manufacturer’s deduction provided for under the American Jobs Creation Act of 2004. Foreign income taxes have been provided at rates which approximate the tax rates in the countries in which R&D Europe and R&D China operate. The Company expects income tax rates for fiscal 2012 to range from 31% to 33%.
QUARTERLY FINANCIAL INFORMATION (Unaudited)
(in thousands, except per share data)
| Fiscal 2011 | Fiscal 2010 | |||||||||||||||||||||||||||||||
| First Qtr. | Second Qtr. | Third Qtr. | Fourth Qtr.(1) | First Qtr. | Second Qtr. | Third Qtr. | Fourth Qtr. | |||||||||||||||||||||||||
| Net sales | $ | 67,945 | $ | 67,708 | $ | 76,271 | $ | 78,038 | $ | 66,534 | $ | 65,521 | $ | 70,278 | $ | 66,714 | ||||||||||||||||
| Gross margin(3) | 52,595 | 52,381 | 60,330 | 59,631 | 53,524 | 52,083 | 55,771 | 52,771 | ||||||||||||||||||||||||
| Earnings before taxes | 38,953 | 37,673 | 45,384 | 42,971 | 39,707 | 36,699 | 41,439 | 38,601 | ||||||||||||||||||||||||
| Income taxes | 12,580 | 11,139 | 14,320 | 14,640 | 12,935 | 11,978 | 9,051 | (2) | 12,706 | |||||||||||||||||||||||
| Net earnings | 26,373 | 26,534 | 31,064 | 28,331 | 26,772 | 24,721 | 32,388 | (2) | 25,895 | |||||||||||||||||||||||
| Basic earnings per share | 0.71 | 0.72 | 0.84 | 0.76 | 0.72 | 0.66 | 0.87 | (2) | 0.70 | |||||||||||||||||||||||
| Diluted earnings per share | 0.71 | 0.71 | 0.84 | 0.76 | 0.72 | 0.66 | 0.87 | (2) | 0.69 |
| (1) | Includes the results of operations and acquisition costs related to the Boston Biochem (April 1, 2011) and Tocris (April 28, 2011) acquisitions. |
|---|
| (2) | Includes a $4.7 million ($0.12 per share) tax benefit from a foreign currency exchange loss related to repatriation of funds from R&D Europe to the U.S. |
|---|
| (3) | Fiscal 2010 includes reclassification of amortization expense as discussed in Note A of the Consolidated Financial Statements. |
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LIQUIDITY AND CAPITAL RESOURCES
Cash, cash equivalents and available-for-sale investments at June 30, 2011 were $273 million compared to $310 million at June 30, 2010. The Company has an unsecured line of credit of $750,000 available at June 30, 2011 which expires on October 31, 2011. The interest rate charged on the line of credit is a floating rate at the one month London interbank offered rate (Libor) plus 1.75%. There were no borrowings on the line in the current or prior fiscal year.
At June 30, 2011, approximately 82%, 15%, and 3% of the Company’s cash and equivalent account balances of $77.6 million are located in the U.S., United Kingdom and China, respectively. At June 30, 2011, approximately 96% of the Company’s available-for-sale investment accounts are located in the U.S., with the remaining 4% in China. Management of the Company expects to be able to meet its foreseeable future cash and working capital requirements for operations, facility expansion and capital additions at each of its geographical locations through currently available funds, cash generated from operations and maturities of available-for-sale investments.
Cash flows from operating activities
The Company generated cash from operations of $127 million, $111 million and $111 million in fiscal 2011, 2010 and 2009, respectively. The cash generated from operating activities in fiscal 2011 as compared to fiscal 2010 was mainly the result of changes in income taxes payable and deferred income taxes as a result of timing of tax payments and the usage in fiscal 2011 of the foreign tax credit carryforward generated in fiscal 2010 plus increased net earnings of $2.5 million.
The cash generated from operating activities in fiscal 2010 as compared to fiscal 2009 was mainly the result of changes in operating assets and liabilities offset by increased net earnings of $4.5 million. In fiscal 2010 changes in operating assets and liabilities negatively impacted net cash from operating activities by $7.8 million compared to a $4.1 million negative impact in fiscal 2009.
Cash flows from investing activities
On April 1, 2011, the Company acquired the assets of Boston Biochem, a leading developer and manufacturer of innovative ubiquitin-related biotechnology research products, for approximately $7.9 million. On April 28, 2011, the Company acquired 100% ownership of Tocris, a leading supplier of reagents for non-clinical life science research for £75 million (approximately $124 million). The acquisitions were financed through cash and cash equivalents on hand and sales of available-for-sale investments.
The Company’s net (sales) purchases of available-for-sale investments in fiscal 2011, 2010 and 2009 were ($22.2) million, $110 million and ($26.5) million, respectively. The large net purchase of available-for-sale investments in fiscal 2010 was primarily the result of the repatriation of funds from the U.K., where the funds had been invested in instruments classified as cash and equivalents, to the U.S., where the funds were invested in available-for-sale investments. The Company’s investment policy is to place excess cash in municipal and corporate bonds with the objective of obtaining the highest possible return while minimizing risk and keeping the funds accessible.
Capital additions consist of the following (in thousands):
| Year Ended June 30, | ||||||||||||
| 2011 | 2010 | 2009 | ||||||||||
| Laboratory, manufacturing, and computer equipment | $ | 2,605 | $ | 1,972 | $ | 2,573 | ||||||
| Construction/renovation | 1,025 | 2,672 | 1,810 | |||||||||
| Property purchases | 0 | 0 | 2,173 | |||||||||
| $ | 3,630 | $ | 4,644 | $ | 6,556 | |||||||
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Included in fiscal 2011, 2010 and 2009 capital additions were approximately $528,000, $2.7 million and $1.8 million, respectively, related to the construction and renovation of laboratory space at the Company’s Minneapolis facility. Fiscal 2011 also included a $420,000 construction expenditure related to a new tenant in Minneapolis and $77,000 of smaller renovation projects at R&D Europe and R&D China. In fiscal 2009, the Company purchased two parking lots adjacent to its Minneapolis facility for $2.2 million. The property purchase was financed through available cash. Capital additions for laboratory, manufacturing and computer equipment and space renovations planned for fiscal 2012 are expected to be approximately $7.4 million, including approximately $4.2 million of renovations in Minneapolis, and are expected to be financed through currently available cash and cash generated from operations.
In fiscal 2010 and 2009, the Company received $50,000 and $1.3 million, respectively, in distributions from Nephromics, LLC (Nephromics). The Company began investing in Nephromics in fiscal 2007 and has an ownership percentage of 16.8% at June 30, 2011. At June 30, 2011 and 2010, the Company’s net investment in Nephromics was $3.7 million and $4.0 million, respectively.
Cash flows from financing activities
In fiscal 2011, 2010 and 2009, the Company paid cash dividends of $39.7 million, $38.4 million and $28.2 million, respectively. The Board of Directors periodically considers the payment of cash dividends.
The Company received $4.8 million, $3.3 million and $953,000 for the exercise of options for 114,000, 73,000 and 21,000 shares of common stock in fiscal 2011, 2010 and 2009, respectively. The Company recognized excess tax benefits from stock option exercises of $847,000, $196,000 and $107,000 in fiscal 2011, 2010 and 2009, respectively.
In fiscal 2011, 2010 and 2009, the Company purchased 4,923, 9,827 and 22,637 shares of common stock, respectively, for its employee stock bonus plans at a cost of $294,000, $607,000 and $1.7 million, respectively.
In fiscal 2008, the Board of Directors authorized the Company to purchase up to $150 million of its common stock and in fiscal 2009 increased the authorization by $60 million. In fiscal 2010, the Company purchased and retired 284,000 shares of common stock at a market value of $16.9 million, of which $15.0 million was disbursed prior to June 30, 2010 and $1.9 million was disbursed in fiscal 2011. In fiscal 2009 the Company purchased and retired 1.4 million shares of common stock at a market value of $90.6 million. At June 30, 2011, approximately $50.6 million remained available for purchase under the fiscal 2009 authorization.
CONTRACTUAL OBLIGATIONS
The following table summarizes the Company’s contractual obligations and commercial commitments as of June 30, 2011 (in thousands):
| Payments Due by Period | ||||||||||||||||||||
| Total | Less than 1 Year | 1-3 Years | 3-5 Years | After 5 Years | ||||||||||||||||
| Operating leases | $ | 2,848 | $ | 774 | $ | 1,144 | $ | 381 | $ | 549 | ||||||||||
| Minimum royalty payments | 186 | 186 | 0 | 0 | 0 | |||||||||||||||
| $ | 3,034 | $ | 960 | $ | 1,144 | $ | 381 | $ | 549 | |||||||||||
The above table does not include any reserves for income taxes as the Company is unable to reasonably predict the ultimate amount or timing of settlement of any reserve for income taxes.
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OFF-BALANCE SHEET ARRANGEMENTS
The Company is not a party to any off-balance sheet transactions, arrangements or obligations that have, or are reasonably likely to have, a current or future material effect on the Company’s financial condition, changes in the financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.
CRITICAL ACCOUNTING POLICIES
Management’s discussion and analysis of the Company’s financial condition and results of operations are based upon the Company’s Consolidated Financial Statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America (U.S. GAAP). The preparation of these financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an ongoing basis, management evaluates its estimates. Management bases its 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.
The Company has identified the policies outlined below as critical to its business operations and an understanding of results of operations. The listing is not intended to be a comprehensive list of all accounting policies.
Valuation of available-for-sale investments
The Company considers all of its marketable securities available-for-sale and reports them at fair market value. Fair market values are based on quoted market prices. Unrealized gains and losses on available-for-sale investments are excluded from income, but are included, net of taxes, in other comprehensive income. If an “other-than-temporary” impairment is determined to exist, the difference between the value of the investment recorded in the financial statements and the Company’s current estimate of fair value is recognized as a charge to earnings in the period in which the impairment is determined. Net unrealized gains on available-for-sale investments at June 30, 2011 were $1.0 million.
Valuation of inventory
Inventories are stated at the lower of cost (first-in, first-out method) or market. The Company regularly reviews inventory on hand for slow-moving and obsolete inventory, inventory not meeting quality control standards and inventory subject to expiration.
To meet strict customer quality standards, the Company has established a highly controlled manufacturing process for proteins and antibodies. New protein and antibody products require the initial manufacture of multiple batches to determine if quality standards can be consistently met. In addition, the Company will produce larger batches of established products than current sales requirements due to economies of scale. The manufacturing process for proteins and antibodies, therefore, has and will continue to produce quantities in excess of forecasted usage. The Company values its manufactured protein and antibody inventory based on a two-year forecast. The establishment of a two-year forecast requires considerable judgment. Protein and antibody quantities in excess of the two-year usage forecast are not valued due to uncertainty over salability. The value of protein and antibody inventory not valued at June 30, 2011 was $21.8 million.
The fair value of inventory purchased in fiscal 2011 through the acquisitions of Boston Biochem and Tocris were determined based on quantities acquired, selling prices at the date of acquisition and management’s assumptions regarding inventory having future value and the costs to sell such inventories. At the acquisition dates, the value of acquired inventory was increased $25.7 million for a total acquired inventory value of $33.0 million. In addition, the Company acquired inventory that was not valued as part of the purchase price allocation as it was in excess of forecasted usage. The increase in value of the acquired inventory remaining at June 30, 2011 was $23.9 million.
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Valuation of intangible assets and goodwill
When a business is acquired, the purchase price is allocated, as applicable, between tangible assets, identifiable intangible assets and goodwill. Determining the portion of the purchase price allocated to intangible assets requires significant estimates. The fair value of intangible assets acquired in fiscal 2011, including developed technologies, trade names, customer relationships and a non-compete agreement, were based on management’s forecasted cash inflows and outflows using a relief-from-royalty and multi-period excess earnings method with consideration to other factors including an independent valuation of management’s assumptions. Intangible assets are being amortized over their estimated useful lives, ranging from 5 to 15 years. The Company reviews the carrying amount of intangible assets for impairment whenever events or changes in circumstances indicate the carrying amount of an asset may not be recoverable. Intangible assets, net of accumulated amortization, were $52.3 million at June 30, 2011.
Goodwill recognized in connection with a business acquisition represents the excess of the aggregate purchase price over the fair value of net assets acquired. Goodwill is tested for impairment annually or more frequently if changes in circumstance or the occurrence of events suggest impairment exists. Assessing the impairment of goodwill requires the Company to make judgments regarding the fair value of the net assets of its reporting units and the allocation of the carrying amount of shared assets to the reporting units. The Company’s annual assessment included comparison of the carrying amount of the net assets of a reporting unit, including goodwill, to the fair value of the reporting unit. A significant change in the Company’s market capitalization or in the carrying amount of net assets of a reporting unit could result in an impairment charge in future periods. The Company completed its annual impairment testing of goodwill and concluded that no impairment existed as of June 30, 2011, as the fair values of the Company’s reporting units substantially exceeded their carrying values, with the exception of the Tocris and Boston Biochem reporting units which were acquired in the fourth quarter of fiscal 2011. The carrying values of Tocris and Boston Biochem approximate fair values at June 30, 2011. Goodwill at June 30, 2011 was $86.6 million.
Valuation of investments
The Company has made equity investments in several start-up and early development stage companies, among them ChemoCentryx, Inc. (CCX), Nephromics, Hemerus Medical LLC (Hemerus), and ACTGen, Inc (ACTGen). The accounting treatment of each investment (cost method or equity method) is dependent upon a number of factors, including, but not limited to, the Company’s share in the equity of the investee and the Company’s ability to exercise significant influence over the operating and financial policies of the investee. In determining which accounting treatment to apply, the Company must make judgments based upon the quantitative and qualitative aspects of the investment.
The Company periodically assesses its equity investments for impairment. Development stage companies of the type the Company has invested in are dependent on their ability to raise additional funds to continue research and development efforts and on receiving patent protection and/or U.S. Food and Drug Administration (FDA) clearance to market their products. If such funding were unavailable or inadequate to fund operations or if patent protection or FDA clearance were not received, the Company would potentially recognize an impairment loss to the extent of its remaining net investment. The Company’s net investments at June 30, 2011 in CCX, Nephromics, Hemerus and ACTGen were $14.3 million, $3.7 million, $773,000 and $925,000, respectively.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 2011, the FASB issued Accounting Standards Update (ASU) No. 2011-05 Comprehensive Income under an amendment to Topic 220. Under this update, an entity has the option to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. In both choices, an entity is required to present each component of net income along with total net income, each component of other comprehensive income along with a total for other comprehensive income, and a total amount for comprehensive income. ASU No. 2011-05 eliminates the option to present the components of other comprehensive income as part of the statement of changes in stockholders’ equity. The update does not change the items that must be reported in other comprehensive income or when an item of other comprehensive income must be reclassified to net income. The Company must comply with ASU No. 2011-05 for the quarter ended September 30, 2012. The Company does not believe this update will have a material impact on the Company’s consolidated financial statements.
In June 2009, the FASB issued Statement of Financial Accounting Standard No. 167, now codified in ASC Topic 810, Consolidation. This Statement amends the consolidation guidance applicable to variable interest entities and was effective for the Company beginning July 1, 2010. The adoption of the Statement did not have a material impact on the Company’s Consolidated Financial Statements.
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