Bio-Rad Laboratories Annual Report 2005

Plain-text annual report

Connected Bio-Rad Laboratories Annual Report 2005 Bio-Rad Laboratories plays a leading role in the advancement of scientiﬁc discovery by providing a broad range of innovative tools and services to the life science research and clinical diagnostics markets. The company is world renowned among hospitals, universities, major research institutions, biotechnology companies and pharmaceutical ﬁrms for its commitment to quality and customer service. With a global team of more than 5,000 employees, Bio-Rad has built strong customer relationships that advance scientiﬁc research and development efforts and support the introduction of new technology used in the growing ﬁelds of genomics, proteomics, drug discovery, food safety, medical diagnostics and more. How do you test for a rare chromosomic disease? How do you help researchers hasten the cure for serious blood disorders? How do you ﬁnd a needle in an information haystack? How do you help in ﬁnding a cure? The answer is that you make connections. At Bio-Rad, we connect the problems to the solutions. And the solutions to the people who need them. 2 : Bio-Rad 2005 Annual Report To our Shareholders: 2005 was another year of growth. Sales increased by $91 million to achieve total sales of $1.181 billion for the year. Both of our Groups contributed to the growth as Life Science grew by 9% and Diagnostics 7%. We were also able to expand net income which reached about 7% of sales.Behind the numbers for 2005 are many accomplishments. A myriad of new products and a number of new systems were introduced; notable among them is the BioPlex® 2200 System, a revolutionary new system for the clinical lab, which has the advantage of being able to perform multiplex diagnostic testing. This was ofﬁcially released for sale in the 4th quarter and we made our ﬁrst placement just before year end. We also continued to make infra-structure improvements, giving us the scale needed to support our ever growing and diverse operations.The year was not without its challenges. Our thermal cycler litigation was more protracted than expected but is now resolved, giving us full access to U.S. and export markets with the products we acquired as part of MJ Research. In the BSE testing market, average selling prices have come down, however, we have maintained good margins for this product and have retained our dominant market position and the loyalty of our customers. That loyalty also extends to our European customers who were inconvenienced by integration problems when we instituted new software as part of a larger project to restructure our European distribution, giving us scale and efﬁciency for the future. Although we were not successful with our targeted antibody acquisition, we had accumulated more than 5% of the Company’s stock and realized a several million dollar gain on the investment. Finally, in the last few days of the year, one of our UK ofﬁces was heavily damaged by an oil depot explosion. Remarkably, no one was injured and we have been able to keep customer impact to a minimum. As we turn our focus to 2006, we are mindful of the fact that the growth in government funding for research in some areas has been moderated in the short term as funds have been redirected to other efforts and that there David Schwartz Chairman of the Board Norman Schwartz President is continuing concern about the rising cost of healthcare. For us, this sharpens our focus to develop and introduce new “tools” to help researchers be more successful in the discovery process and to deliver more effective solutions to the clinical laboratory, aiding in the early diagnosis and better treatment of human disorders.We see a number of opportunities on the horizon. With the thermal cycler litigation resolved, we can now fully serve our markets with one of the broadest line of products available, realizing the full value of the MJ acquisition, completed just over a year ago. With the introduction of the BioPlex® 2200 System, we are now looking forward to introducing further test panels to expand market potential for this exciting prod-uct. Externally, there are a number of interesting product line acquisitions under evaluation and we have ample resources to conclude one or more of these in the new year. For 2006, we have also undertaken a major project in Europe to stream-line our management structure and better align our product management across Europe in line with the vast changes in communication and transportation of goods that have come about as a result of the European Union. The project will be implemented throughout 2006 and we should start to see the beneﬁts toward the end of 2007.The theme of this year’s annual report is “connections”. It is, in the end, the primary task of every employee at Bio-Rad to stay connected to our markets and our customers. Staying connected means understanding the trends in research and healthcare and developing useful products that improve our customers’ work. Our direct sales force around the world, coupled with our interest in helping to advance science and healthcare, keeps us connected to an ever changing environment.We have a lot to look forward to in the coming year and appreciate your interest in Bio-Rad.Identifying Connections Before you can connect to a solution, you have to see it. Which is exactly what Bio-Rad’s Clinical Diagnostics Group does. Clinical Diagnostics develops, manufactures, sells and supports a large portfolio of products for medical screening and diagnostics. Bio-Rad is the number one specialty diagnostic company in the world and is rec- ognized as the gold standard in diabetes monitoring, broad-spectrum screening and hospital epidemiology. The company is also well known for its quality control (QC) systems, blood virus testing and detection, toxi- cology, genetic disorders testing, specialty chemistry, molecular pathology and internet-based software products. Bio-Rad’s clinical diagnostics products encompass a broad range of technologies incorporated into tests used to detect, identify and quantify substances in blood or other bodily ﬂuids and tissues. The test results are used as aids for medical diagnosis, detection, evaluation, monitoring and treatment of diseases and other medical conditions. So the solutions can ultimately be connected, to a cure. Bio-Rad is a global leader in diabetes monitoring, providing a wide range of specialized products including devices used in physicians’ ofﬁces as well as large scale testing systems used in hospitals and clinical labora- tories for high volume testing. The D-10™ Hemoglobin Testing System is a ﬂexible mid-sized instrument that is used in both physician ofﬁce laboratories and clinical laboratories. 6 : Bio-Rad 2005 Annual Report Bio-Rad is a global leader in diabetes monitoring, providing a wide range of laboratory solutions from large-scale testing systems to small-scale hand-held devices.Childhood diabetes, or Type I insulin-dependent diabetes affects millions worldwide.With early diagnosis and treatment, patients can avoid organ damage and long-term complications. Today, proper monitoring and management along with diet and exer-cise can reduce the risk of complications from diabetes and enable children to lead healthy and active lives.Bio-Rad’s Variant™ II, D-10™ and Micromat™ II Testing Systems that employ “Gold Standard” HPLC technology are used in doctors’ ofﬁces, hospitals and clinical laborato-ries to measure hemoglobin A1c levels in diabetic patients. Close monitoring and control of a patient’s A1c level is critical in reducing the risk of complications from diabetes.Because small differences in A1c values make a big difference over a lifetime, Bio-Rad provides precision tools that monitor A1c levels with pinpoint accuracy. While daily in-home glucose monitoring is necessary for children with diabetes, periodic testing in the doctor’s ofﬁce will ensure that parents and children can maintain the tightest level of control over their glucose levels.C O N N E C T E D T O : Disease Management Childhood diabetes can be a painful, frightening and highly disruptive illness that demands a great deal of courage from children, along with signiﬁcant lifestyle changes and ongoing medical attention. Bio-Rad’s sophisticated diabetes systems and support enable doctors to monitor a patient’s status and, ultimately, to help parents and children in their ﬁght to effectively manage and control this disease.C O N N E C T E D T O : Infectious Disease Prevention Hospitals around the world battle an invisible enemy that eludes even the most stringent hygienic controls. Patient exposure to infectious material can result in the immediate spread of the infection commonly known as the “Superbug,” or MRSA (Methicillin Resistant Staphylococcus Aureus). As hospitals implement improved diagnostic testing methods such as Bio-Rad’s MRSASelect™ test, they can signiﬁ-cantly reduce the potential for additional infection.Compared to current products, Bio-Rad’s MRSASelect™ test is a faster, more sensitive and effective method of detecting MRSA. By incorporating this test into their comprehensive prevention programs, hospitals can readily identify and prevent the spread of this silent and dangerous infection. Bio-Rad 2005 Annual Report : 9 MRSA is an infectious bacterial strain that is resistant to penicillin and methicillin antibiotic treatment. Early identiﬁcation and treatment can help slow the spread of antibiotic resistant bacteria and prevent the unnecessary use of costly antibiotic treatments.Rapid and effective diagnostic testing methods such as Bio-Rad’s MRSASelect™ test are now readily available for medical practitioners and patients around the world who have been affected by the often fatal consequences of the Superbug. Worldwide, an estimated 50 million MRSA screening tests are performed each year.While patients in Intensive Care Units and others with weak immune systems are at the highest risk for MRSA, it is also transmissible among low-risk patients and hospital staff. That’s why many health care institutions are implementing comprehensive screening programs to both minimize the health risks for all of those who enter hospitals and lower the costs associated with the spread of the infection. The BioPlex® 2200 platform is the ﬁrst fully-automated system to generate multiple results from a single patient sample. Used with the ANA Screen and accompanying interpretive software, doctors receive valuable data to assist with accurate diagnosis. 10 : Bio-Rad 2005 Annual Report Autoimmune disease, the fourth-largest disability among women in the United States, remains one of the most difﬁcult for which to ﬁnd a cure. Today, however, improved diagnostics is no longer a dream, but a reality.Through the development of revolutionary new technology designed by Bio-Rad—which greatly simplifies and streamlines the diagnostic process—there is hope for these women as well as for the millions worldwide who suffer from illnesses the disease causes.While autoimmune illnesses appear to be hereditary, they are not directly transmitted from one generation to the next. A woman, for example, may have lupus and her daughter Crohn’s disease, while her mother may suffer from rheumatoid arthritis. Because these diseases affect multiple body systems and produce highly divergent and often misleading symptoms, accurate diagnosis is a challenge at best, an impossibility at worst. Bio-Rad’s ANA Screen and system is the most comprehensive autoimmune product available, allowing clinical laboratories and doctors to provide patients with more accurate diagnoses and faster, more effective treatment solutions enabling patients to live longer, healthier lives.Women’s Health An estimated 75 percent of people who suffer from autoimmune disease are women. Their symptoms are often mysterious and misleading, making accurate diagnosis a challenge and proper treatment an uncertainty. With the help of Bio-Rad’s pioneering technology in autoimmune diagnostics, doctors now have access to tools and software that help demystify diagnostic test results and bring the promise of effective treatment closer to reality.CONNECTED TO:Connected for Life What’s the connection between genomics and life? In a word, everything. Bio-Rad’s Life Science Group develops, manufactures and markets a wide range of laboratory instruments, apparatus and consumables used for research in func-tional genomics and proteomics. The group ranks among the top five life science companies worldwide, and maintains a solid reputation for quality and innovation.Bio-Rad’s life science products are based on technologies used to identify, separate, purify and analyze biological materials such as proteins and DNA. Some of these technologies include electrophoresis, imaging, immu-noassay, chromatography, microbiology, bioinformatics, transfection, ampliﬁcation, real-time PCR, microarray analysis and DNA hybridization.These products are used in laboratories throughout the world, connecting researchers to solutions that help people lead longer, healthier lives.Genetic Research Bio-Rad products are connected to today’s most advanced Alzheimer’s research, providing hope that a new generation of elderly people may one day avoid the irreversible cognitive defects of this disease. As lifespans increase, so do the chances that more and more aging adults will suffer the debilitating effects of this degenerative neurological disorder. Alzheimer’s disease today affects an estimated 20 to 30 million elderly people worldwide.CONNECTED TO:Bio-Rad’s iQ™5 Multicolor Real- Time Detection System and compatible reagents enable highly sensitive detection of subtle changes in gene expression—often the most essential hallmarks of disease states such as Alzheimer’s. Bio-Rad 2005 Annual Report : 15 Alzheimer’s disease and its causes are somewhat of a mystery to us today, but may one day be fully under-stood as advancements in genetic research continue.As scientists learn to better understand the interrelationships between individuals’ genetic characteristics and their propensity for cognitive and neurological decline, a new generation of elderly people and their loved ones has hope of greater longevity and a better quality of life.Bio-Rad provides genetic researchers with an entire line of genomics products, enabling them to study the fundamental building blocks of human biology. By observing genetic variations that may predispose certain people to Alzheimer’s disease, scientists are now ﬁnding new clues as to how the disease develops and progresses. Using Bio-Rad products, genetic researchers can develop precise testing methods, along with new therapeutic treatments designed to “switch off” these rogue genes. This research is already yielding a vast amount of data about how genes function and interrelate—information that will lead to a revolution in diagnostic testing and the treatment of Alzheimer’s and other diseases.Bio-Rad’s Bio-Plex® Suspension Array System is a multiplex analysis platform used by researchers to rapidly and simultaneously analyze mul- tiple biomolecules (proteins, peptides or nucleic acids), to identify more effective drug candidates for the disease. 16 : Bio-Rad 2005 Annual Report As researchers study cancer at the cellular level, important discoveries are being made that will take therapeutic intervention to new levels of sophistication and effectiveness.Advances in cancer research will increase the survival rate and improve the quality of life for patients suffering from this complex and highly variable disease. Bio-Rad is helping scientists unlock the biological mysteries of cancer and other diseases by providing a wide range of tools for genomics and proteomics research. These products, designed to simplify and accelerate the complex tasks associated with biomolecular research, enable scientists to identify genes and proteins responsible for the develop-ment and progression of disease. This process of discovery is leading to new, more effective drug candidates, along with simpler, more effective diagnostic testing methods.Continued scientiﬁc research offers hope that biological discovery will lead to the introduction of more effective, personalized treatment solutions that can be tailored to address patients’ unique disease proﬁles. With Bio-Rad’s help, developments in the discovery process are facilitating cancer detection at the cellular level to prevent the onset and progression of the disease.Biomarker Discovery Advancements in genomics and proteomics technology are facilitating important discoveries in the area of cancer research. Using Bio-Rad devices, researchers are working toward the identification of specific disease biomarkers which will lead to improved diagnostic testing methods, earlier detection and more personalized, effective treatment solutions for cancer patients.CONNECTED TO:Seeding the Future As the pace of scientiﬁc discovery accelerates, the creation of new technologies with unprecedented applications calls for a scientiﬁcally literate population and a new approach to educating our youth. Bio-Rad’s Biotechnology Explorer™ program enables students to experience scientiﬁc discovery ﬁrsthand, using modern research tools and curricula based on real world applications.CONNECTED TO:DNA technology is changing the way law enforcement solves crime. Using Bio-Rad’s Crime Scene Investigation PCR Basics™, students get hands-on experience with actual DNA identiﬁcation, collection and analysis methods used in crime scene investigation. Bio-Rad 2005 Annual Report : 19 Science education has never been so exciting! Today, students are learning real world laboratory methods and applications that capture their imaginations and deepen their understanding of core biological concepts.Through their participation in educational initiatives coupled with Bio-Rad’s Biotechnology Explorer™ products, students use modern research tools and gain hands-on, practical experience with real world applications and procedures. Such training prepares them for higher education and inspires their pursuit of careers in the biotechnology, medical research and biopharmaceutical ﬁelds. Designed by scientists and educators working together, Bio-Rad’s hands-on class-room kits and curricula integrate modern science and traditional core biology curricula, supported by a complete line of research-quality laboratory equipment and supplies. Program materials and lessons align with current science content standards and perfor-mance indicators, meeting the most rigorous of college preparatory requirements. Bio-Rad is committed to promoting scientiﬁc literacy by partnering with teachers, schools and local organizations to inspire a new generation of biological scientists. In addition to the Biotechnology Explorer program, the Company sponsors a number of educational outreach activities in the local community including mentoring programs, science fairs and an annual scholarship program that helps support students pursuing degrees in the sciences.Connected to What’s Next Bio-Rad products are found in virtually every laboratory and clinical setting in the world where diagnostics and biomedical research takes place. As we race to ﬁnd the cures to today’s most critical diseases, Bio-Rad is there providing needed advanced tools to make not just progress, but the ultimate connection:Better health for all.Financial Highlights Five-Year Record 2001 2002 2003 2004 2005 ($ in millions, except per share data) Net Sales Gross Proﬁt $ 789.6 $ 865.0 $ 979.6 $ 1090.0 $ 1181.0 $ 443.7 $ 499.6 $ 556.2 $ 610.1 $ 646.5 Research Expenditures $ 73.9 $ 79.8 $ 91.3 $ 108.3 (1) $ 115.1 Net Income Return On Sales $ 44.2 $ 67.9 $ 76.2 $ 68.2 $ 81.6 5.6% 7.8% 7.8% 6.3% 6.9% Book Value Per Share $ 11.43 $ 15.17 $ 19.41 $ 23.10 $ 25.09 Basic Earnings Per Share $ 1.79 $ 2.70 $ 3.00 $ 2.65 $ 3.13 Cash Flow from Operations $ 99.5 $ 105.8 $ 127.6 $ 123.1 $ 108.3 (1) Excludes $14.6 of purchased in-process R&D 2005 Sales By Region Net Sales (in millions) 0 . 1 8 1 1 $ 0 . 0 9 0 1 $ 6 . 9 7 9 $ 0 . 5 6 8 $ 6 . 9 8 7 $ 41% Americas 43% Europe 16% Paciﬁc Rim Cash Flow From Operations (in millions) 6 . 7 2 1 $ 1 . 3 2 1 $ 3 . 8 0 1 $ 8 . 5 0 1 $ 5 . 9 9 $ Basic Earnings Per Share 3 1 . 3 $ 0 0 . 3 $ 0 7 . 2 $ 5 6 . 2 $ 9 7 . 1 $ 01 02 03 04 05 01 02 03 04 05 01 02 03 04 05 Bio-Rad 2005 Annual Report : 21 $1.1 billion $1 billion $900 million $800 million $700 million $600 million $500 million $400 million $300 million $200 million $100 million Sales History 1959 1965 1970 1975 1980 1985 1990 1995 2000 2005 22 : Bio-Rad 2005 Annual Report Bio-Rad 2005 Annual Report : 23 Summary of Operations and Selected Financial Data Year Ended December 31, (in thousands, except per share data) 2005 2004 2003 2002 2001Net sales $ 1,180,985 $ 1,090,012 $ 979,631 $ 865,006 $ 789,639 Cost of goods sold 534,499 479,939 423,401 365,451 345,964Gross proﬁt 646,486 610,073 556,230 499,555 443,675Selling, general and administrative expense 416,084 378,264 317,524 281,579 257,684Product research and development expense 115,104 108,344 91,273 79,788 73,922Purchased in-process research and development expense — 14,620 — — —Impairment losses on long-lived assets 19,770 — — — —Goodwill amortization — — — — 7,746Loss on divestitures — — — — 5,150Interest expense 32,643 20,219 31,006 28,207 24,088Foreign exchange (gains) losses (1,528) 2,394 4,080 5,441 2,097Other (income) expense, net(1) (28,958) (11,095) (3,012) (678) 10,031Income from continuing operations before taxes 93,371 97,327 115,359 105,218 62,957 Provision for income taxes (15,792) (31,035) (38,055) (36,692) (20,132)Income from continuing operations 77,579 66,292 77,304 68,526 42,825Discontinued operations Gain (loss) from discontinued operations (net of tax) — (1,487) (1,133) (663) 1,354 Gain on divestiture (net of tax) 3,974 3,437 — — —Total income (loss) from discontinued operations 3,974 1,950 (1,133) (663) 1,354Net income $ 81,553 $ 68,242 $ 76,171 $ 67,863 $ 44,179Basic earnings per share: Continuing operations $ 2.98 $ 2.58 $ 3.04 $ 2.73 $ 1.74 Discontinued operations 0.15 0.07 (0.04) (0.03) 0.05 Basic earnings per share $ 3.13 $ 2.65 $ 3.00 $ 2.70 $ 1.79Diluted earnings per share: Continuing operations $ 2.91 $ 2.51 $ 2.94 $ 2.63 $ 1.68 Discontinued operations 0.15 0.07 (0.04) (0.02) 0.06 Diluted earnings per share $ 3.06 $ 2.58 $ 2.90 $ 2.61 $ 1.74Cash dividends paid per common share — — — — —Total assets $ 1,426,582 $ 1,371,618 $ 992,596 $ 720,703 $ 684,028Long-term debt, net of current maturities $ 425,687 $ 425,979 $ 225,835 $ 105,768 $ 188,423(1) See Note 11 to the consolidated ﬁnancial statements for components of Other (income) expense, net. Included in 2001 is a $9.4 million write-down of an investment. Included in 2004 is interest and investment income of $6.6 million, income from equity investee of $3.1 million and a litigation settlement of $1.9 million offset by a $2.4 million write-down of an investment. Included in 2005 is interest and investment income of $16.7 million, gains on sales of investments of $11.2 million, and litigation expense of $1.2 million.Consolidated Balance Sheets (in thousands) ASSETS Current assets: Cash and cash equivalents Restricted cash Short-term investments December 31, 2005 2004 $ 296,716 $ 195,734 36,138 — 116,343 165,899 Accounts receivable less allowance of $13,301 in 2005 and $13,406 in 2004 247,192 261,243 Inventories, net: Raw materials Work in process Finished goods Total inventories Deferred tax assets Prepaid expenses and other current assets Total current assets Property, plant and equipment: Land and improvements Buildings and leasehold improvements Equipment Total property, plant and equipment Accumulated depreciation Property, plant and equipment, net Goodwill Purchased intangibles, net Long-term deferred tax assets Other assets 48,271 51,601 44,950 48,206 112,470 112,356 212,342 205,512 30,984 68,496 25,727 54,345 1,008,211 908,460 9,837 9,959 120,015 119,433 322,354 321,215 452,206 450,607 (271,948) (248,283) 180,258 202,324 113,276 113,276 28,449 14,003 82,385 58,638 6,160 82,760 TOTAL ASSETS $ 1,426,582 $ 1,371,618 The accompanying notes are an integral part of these consolidated ﬁnancial statements. 24 : Bio-Rad 2005 Annual Report (in thousands, except share data) LIABILITIES AND STOCKHOLDERS’ EQUITY Current liabilities: Accounts payable Accrued payroll and employee beneﬁts Notes payable Current maturities of long-term debt Sales, income and other taxes payable Litigation accrual Accrued royalties Other current liabilities Total current liabilities Long-term debt, net of current maturities Deferred tax liabilities Other long-term liabilities Total liabilities Commitments and contingent liabilities Stockholders’ equity: Preferred stock, $0.0001 par value, 7,500,000 shares authorized; none outstanding Class A common stock, $0.0001 par value, 80,000,000 shares authorized; outstanding—21,316,556 at 2005; 50,000,000 shares authorized; outstanding—20,997,568 at 2004 Class B common stock, $0.0001 par value, 20,000,000 shares authorized; outstanding 2005—4,909,908; 2004—4,836,540 Additional paid-in capital Retained earnings Accumulated other comprehensive income: Currency translation and other Total stockholders’ equity TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY The accompanying notes are an integral part of these consolidated ﬁnancial statements. December 31, 2005 2004 $ 72,950 $ 71,194 81,076 79,061 2,950 391 15,841 55,701 34,386 55,948 9,055 402 15,835 50,000 39,317 50,511 319,243 315,375 425,687 425,979 2,281 21,397 4,388 28,988 768,608 774,730 — — 2 1 — — 2 1 60,112 49,628 570,807 489,254 27,052 58,003 657,974 596,888 $ 1,426,582 $ 1,371,618 Bio-Rad 2005 Annual Report : 25 Consolidated Statements of Income (in thousands, except per share data) Net sales Cost of good sold Gross proﬁt Selling, general and administrative expense Product research and development expense Year Ended December 31, 2005 2004 2003 $ 1,180,985 $ 1,090,012 $ 979,631 534,499 479,939 423,401 646,486 610,073 556,230 416,084 378,264 317,524 115,104 108,344 91,273 Purchased in-process research and development expense — 14,620 Impairment losses on long-lived assets Interest expense Foreign exchange losses Other income, net Income from continuing operations before taxes Provision for income taxes Income from continuing operations Discontinued operations 19,770 32,643 (1,528) (28,958) 93,371 (15,792) 77,579 — 20,219 2,394 (11,095) — — 31,006 4,080 (3,012) 97,327 115,359 (31,035) 66,292 (38,055) 77,304 Loss from discontinued operations net of tax beneﬁts of $532 in 2004 and $538 in 2003 — (1,487) (1,133) Gain on divestiture net of tax expense of $0 in 2005 and $2,295 in 2004 Total income (loss) from discontinued operations Net income Basic earnings per share: Continuing operations Discontinued operations Net income Weighted average common shares Diluted earnings per share: Continuing operations Discontinued operations Net income 3,974 3,974 3,437 1,950 — (1,133) $ 81,553 $ 68,242 $ 76,171 $ $ $ $ 2.98 0.15 3.13 26,063 2.91 0.15 3.06 $ $ $ $ 2.58 0.07 2.65 25,724 2.51 0.07 2.58 $ $ $ $ 3.04 (0.04) 3.00 25,416 2.94 (0.04) 2.90 Weighted average common shares 26,662 26,489 26,310 The accompanying notes are an integral part of these consolidated ﬁnancial statements. 26 : Bio-Rad 2005 Annual Report Consolidated Statements of Cash Flows (in thousands) Cash ﬂows from operating activities: Cash received from customers Cash paid to suppliers and employees Interest paid Income tax payments Miscellaneous receipts Year Ended December 31, 2005 2004 2003 $ 1,166,711 $ 1,087,946 $ 1,020,135 (1,003,264) (920,606) (826,055) (31,334) (39,597) 15,768 (19,543) (33,637) 8,933 (17,088) (51,280) 1,928 Net cash provided by operating activities 108,284 123,093 127,640 Cash ﬂows from investing activities: Capital expenditures, net Payments for acquisitions and investments Proceeds from divestiture Payments for purchase of intangible assets (36,055) (4,344) — (5,000) (60,493) (58,983) 19,775 (10,000) (69,003) (16,375) — — Purchases of marketable securities and investments (873,822) (2,257,694) (600,000) Sales of marketable securities and investments 942,790 2,174,538 510,135 Foreign currency economic hedges, net Restricted cash Net cash used in investing activities Cash ﬂows from ﬁnancing activities: Net borrowings (payments) on notes payable Long-term borrowings Payments on long-term debt Debt retirement costs on 11 5/8% bonds Debt issuance costs on 7.5% bonds Debt issuance costs on 6.125% bonds Proceeds from issuance of common stock Net cash provided by ﬁnancing activities Effect of exchange rate changes on cash Net increase in cash and cash equivalents Cash and cash equivalents at beginning of year Cash and cash equivalents at end of year 6,397 (36,138) 6,539 (14,998) — — (6,172) (186,318) (190,241) (6,847) (9,580) 435 — 200,000 249,335 (447) (1,781) (132,012) — — (331) 8,915 — — (2,876) 7,464 (9,467) (5,431) — 5,309 1,290 193,227 108,169 (2,420) 337 100,982 130,339 195,734 65,395 (7,906) 37,662 27,733 $ 296,716 $ 195,734 $ 65,395 The accompanying notes are an integral part of these consolidated ﬁnancial statements. Bio-Rad 2005 Annual Report : 27 Consolidated Statements of Changes in Stockholders’ Equity (in thousands) Common Stock, $0.0001 par value: Balance at beginning of year Issuance of common stock Balance at end of year Additional Paid-In Capital: Balance at beginning of year Issuance of common stock Tax beneﬁt from exercise of stock options Balance at end of year Retained Earnings: Balance at beginning of year Net income Balance at end of year Accumulated Other Comprehensive Income (Loss): Balance at beginning of year Other comprehensive income (loss) Balance at end of year Year Ended December 31, 2005 2004 2003 $ 3 $ 3 $ — 3 — 3 3 — 3 49,628 42,164 36,141 8,916 1,568 6,250 1,214 5,309 714 60,112 49,628 42,164 489,254 421,012 344,841 81,553 68,242 76,171 570,807 489,254 421,012 58,003 (30,951) 27,052 32,628 25,375 58,003 2,102 30,526 32,628 Total Stockholders’ Equity $ 657,974 $ 596,888 $ 495,807 Comprehensive Income, net of tax: Net income Currency translation adjustments Net unrealized holding gains net of tax of $999 $ 81,553 $ 68,242 $ 76,171 (30,535) 18,573 28,620 in 2005, $3,870 in 2004 and $1,053 in 2003 41 8,096 2,137 Reclassiﬁcation adjustments for gains included in net income net of tax of $271 in 2005, $623 in 2004 and $108 in 2003 (457) (1,294) (231) Total Comprehensive Income $ 50,602 $ 93,617 $ 106,697 The accompanying notes are an integral part of these consolidated ﬁnancial statements. 28 : Bio-Rad 2005 Annual Report Notes to Consolidated Financial Statements 1. Signiﬁcant Accounting Policies Basis of Presentation The consolidated ﬁnancial statements include the accounts of Bio-Rad Laboratories, Inc. and all subsidiaries (referred to in this report as “Bio-Rad,” “we,” “us” and “our”) after elimination of intercompany balances and transactions. The preparation of ﬁnancial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the amounts reported in the ﬁnancial statements and accompanying notes. Actual results could differ from those estimates. Reclassiﬁcations Certain amounts included in the balance sheet as of December 31, 2004, as well as in the Statement of Cash Flows for the years ended December 31, 2004 and 2003, have been reclassiﬁed to conform to the current year presentation. Amounts related to deferred taxes are discussed in Note 8. Cash and Cash Equivalents Cash and cash equivalents consist of cash and highly liquid investments with original maturities of three months or less which are readily convertible into cash. Cash equivalents are stated at cost, which approximates fair market value. Restricted Cash Restricted cash of $36.1 million represents deposits in a money market account that have been used as collateral to protect the surety company in connection with its execution of a surety bond in the amount of $37.2 million to stay the enforcement of the judgment in the legal matter described in Note 14. Short-Term Investments Short-term investments consist of corporate, state and municipal securities with readily determinable fair market values and original maturities in excess of three months. Investments with maturities beyond one year may be classiﬁed as short-term based on their highly liquid nature and because such marketable securities represent the investment of cash that is available for current operations. Our investments are classiﬁed as “Available- for-sale” and accordingly are reported at fair value, with unrealized gains and losses, if material, reported as a component of stockholder’s equity, net of any related tax effect. Unrealized losses are charged against income when a decline in the fair market value of an individual security is determined to be other than temporary. Real- ized gains and losses on investments are included in interest income. Concentration of Credit Risk Financial instruments that potentially subject us to concentration of credit risk consist primarily of cash and cash equivalents, short-term investments and trade accounts receivable. Cash and cash equivalents and short-term investments are placed with highly rated major ﬁnancial institutions. We perform credit evaluation procedures related to our trade receivables and with the exception of certain developing countries, generally do not require collateral. As a result of increased risk in these developing countries, some Bio-Rad sales are subject to col- lateral letters of credit. Credit risk is limited generally due to the large number of customers and their dispersion across many geographic areas. However, a signiﬁcant amount of trade receivables are with national healthcare Bio-Rad 2005 Annual Report : 29 Notes to Consolidated Financial Statements (continued) systems in countries within the European Economic Community. We do not currently anticipate a credit risk associated with these receivables. Allowance for Doubtful Accounts We maintain an allowance for doubtful accounts for estimated losses resulting from the inability of our custom- ers to make required payments. The amount of the allowance is determined by analyzing known uncollectible accounts, aged receivables, economic conditions in the customers’ country or industry, historical losses and our customers’ credit-worthiness. Amounts later determined and speciﬁcally identiﬁed to be uncollectible are charged or written off against this reserve. This valuation allowance is reviewed quarterly to determine whether a change is warranted. Inventory Valuation Inventories are valued at the lower of actual cost or market and include material, labor and overhead costs. Management reviews the need for an inventory obsolescence reserve on a quarterly basis or, if warranted by circumstances, more frequently. In evaluating this reserve, technology changes, competition, customer demand and manufacturing quality are considered. Property, Plant and Equipment Property, plant and equipment are carried at historical cost. Included in property, plant and equipment is reagent rental equipment. We provide these instruments to our customers for use with our reagents. Property, plant and equipment are assessed for impairment annually or whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. Depreciation is computed on a straight-line basis over the estimated useful lives of the assets. Buildings and leasehold improvements are amortized over 15-30 years or the lives of the leases or improvements, whichever is shorter. With the exception of reagent rental equipment, which is amortized over a 1-3 year period, equipment is depreciated over 3-12 years. Net capital expenditures include proceeds from the sale of property, plant and equipment of $3.2 million, $0.8 million and $1.1 million for the years ended December 31, 2005, 2004 and 2003, respectively. Goodwill Goodwill, representing the excess of the cost over the net tangible and identiﬁable intangible assets of acquired businesses, is stated at cost. Goodwill is assessed for impairment by applying a fair-value based test annually or whenever events or changes in circumstances indicate that the carrying amount may not be recoverable (see Note 6). Income Taxes We account for income taxes under the asset and liability method which recognizes deferred tax assets and liabilities for the expected future tax consequences of temporary differences between carrying amounts and tax basis of assets and liabilities (see Note 8). 30 : Bio-Rad 2005 Annual Report Revenue Recognition Revenue is recognized when pervasive evidence of an arrangement exists, the price to the buyer is ﬁxed and determinable, collectibility is reasonably assured and title has passed to the customer or product has been delivered absent speciﬁc contractual speciﬁcations. Equipment that requires factory installation is not recorded until installation is complete and customer acceptance, if required contractually, has occurred. Reagent agree- ments are a diagnostic industry sales method that provides use of an instrument if the customer exclusively purchases the company’s reagents to use on that instrument. We have evaluated the reagent agreements and account for the contracts under the terms of the guidance set forth in EITF 00-21, Accounting for Revenue Arrangements with Multiple Deliverables. All revenues that we earn under our reagent agreements are recog- nized when the reagent has been delivered to the customer. Service revenues on extended warranty contracts are recognized ratably over the life of the service agreement or as services are performed, if not under contract. Shipping and Handling We classify all freight billed to customers as net sales. Related freight costs are included in cost of goods sold. Sales Returns and Warranty At the time the related revenue is recognized, a provision is recognized for estimated product returns. We warrant certain equipment against defects in design, materials and workmanship, generally for a period of one year. Upon shipment of that equipment, we establish, as part of cost of goods sold, a provision for the expected costs of such warranty based on historical experience, speciﬁc warranty terms and customer feed- back. A review is performed on a quarterly basis to assess the adequacy of our warranty reserve. Components of the warranty accrual, included in Other current liabilities and Other long-term liabilities, were as follows (in millions): January 1 Provision for warranty Actual warranty costs December 31 Research and Development 2005 2004 $ 10.1 $ 13.3 (11.4) $ 12.0 $ 9.1 10.4 (9.4) 10.1 Internal research and development costs are expensed as incurred. Third-party research and development costs are expensed when the contracted work has been performed. Purchased in-process research and development costs are expensed at the time of purchase. Foreign Currency Balance sheet accounts of international subsidiaries are translated at the current exchange rate as of the end of the accounting period. Income statement items are translated at average exchange rates. The resulting transla- tion adjustment is recorded as a separate component of stockholders’ equity. Bio-Rad 2005 Annual Report : 31 Notes to Consolidated Financial Statements (continued) Foreign currency transaction gains and losses are included in foreign exchange (gains) losses in the consolidated statement of income. Transaction gains and losses result primarily from ﬂuctuations in exchange rates when intercompany receivables and payables are denominated in currencies other than the functional currency of our subsidiary that recorded the transaction. Forward Exchange Contracts As part of distributing our products, we regularly enter into intercompany transactions. We enter into forward foreign currency exchange contracts to manage foreign exchange risk of future movements in foreign exchange rates that affect foreign currency denominated intercompany receivables and payables. We do not use deriva- tive ﬁnancial instruments for speculative or trading purposes. In accordance with Statement of Financial Accounting Standards (SFAS) 133, Accounting for Derivative Instruments and Hedging Activities, we do not seek hedge accounting treatment for these contracts. As a result, these contracts, generally with maturity dates of 90 days or less and related primarily to currencies of industrial countries, are recorded at their fair value at each balance sheet date. The resulting gains or losses offset exchange gains or losses on the related receiv- ables and payables, both of which are recorded as foreign exchange (gains) losses in the consolidated state- ment of income. The cash ﬂows related to these contracts are classiﬁed as cash ﬂows from investing activities in the Statement of Cash Flows. Employee Stock Compensation Plans We maintain incentive and non-qualiﬁed stock option plans for ofﬁcers and certain other key employees. We also have an employee stock purchase plan that provides that eligible employees may contribute toward the purchase of our Class A common stock. These plans are described more fully in Note 10. Had compensation cost for our stock option and stock purchase plans been accounted for under SFAS 123, Accounting for Stock-Based Compensation, based on the assumptions and methods outlined in Note 10, our pro forma net income and earnings per share would have been as follows (in millions, except per share data): Year Ended December 31, 2005 2004 2003 Net income, as reported $ 81.6 $ 68.2 $ 76.2 Deduct: Total stock-based employee compensation expense determined under fair value methods for all awards, net of related tax effects Pro forma net income Earnings per share: Basic—as reported Basic—pro forma Diluted—as reported Diluted—pro forma 32 : Bio-Rad 2005 Annual Report (3.4) (3.0) $ 78.2 $ 65.2 $ $ $ $ $ 3.13 3.00 3.06 2.93 $ $ $ $ 2.65 2.54 2.58 2.47 $ $ $ $ (2.1) 74.1 3.00 2.91 2.90 2.82 Earnings Per Share Basic earnings per share is computed by dividing net income (loss) by the weighted average number of common shares outstanding for that period. Diluted earnings per share takes into account the effect of dilutive instruments, such as stock options, and uses the average share price for the period in determining the number of common stock equivalents that are to be added to the weighted average number of shares outstanding. Common stock equivalents are excluded from the diluted earnings per share calculation if the effect would be anti-dilutive. Weighted average shares used for diluted earnings per share include the dilutive effect of outstanding stock options to purchase 599,000, 765,000 and 894,000 shares for the years ended December 31, 2005, 2004 and 2003, respectively. Options to purchase 281,000 and 10,000 shares of common stock were outstanding for the years ended December 31, 2005 and 2004, respectively, but were excluded from the computation of diluted earnings per share because the price of the options was greater than the average market price of the common shares. There were no anti-dilutive options for the year ended December 31, 2003. Fair Value of Financial Instruments The estimated fair value of ﬁnancial instruments has been determined using available market information or other appropriate valuation methodologies. Estimates are not necessarily indicative of the amounts that could be realized in a current market exchange as considerable judgment is required in interpreting market data used to develop estimates of fair value. The use of different market assumptions or estimation techniques could have a material effect on the estimated fair value. The estimated fair value of our ﬁnancial instruments is as follows (in millions): Year Ended December 31, 2005 2004 Carrying Amount Fair Value Carrying Amount Fair Value Notes receivable and other Total long-term debt $ $ 82.4 $ 113.4 $ 80.0 $ 104.2 426.1 $ 430.6 $ 426.4 $ 450.5 Financial instruments (e.g., notes receivable) that have fair values based on discounted cash ﬂows, market quotations, and other appropriate valuation techniques are included in Other assets. Long-term debt has an estimated fair value based on quoted market prices for the same or similar issues. For certain ﬁnancial instruments, including cash and cash equivalents, short-term investments, accounts receivable, marketable securities, notes payable, and accounts payable, the carrying amounts approximate fair value. Bio-Rad 2005 Annual Report : 33 Notes to Consolidated Financial Statements (continued) New Financial Accounting Standards In June 2005, the Financial Accounting Standards Board (FASB) issued Staff Position (“FSP”) No. 143-1, “Accounting for Electronic Equipment Waste Obligations,” which provides guidance on accrual accounting for historical waste obligations associated with the European Union Waste, Electrical and Electronic Equipment Directive (“WEEE Directive”). FSP No. 143-1 is effective for the ﬁrst reporting period ending after June 8, 2005 or the date of the adoption of the WEEE Directive into law by the applicable European Union member country. Because European Union member countries have not yet, among other steps, (i) fully enacted their national laws relating to WEEE, (ii) completed implementation of their administrative measures and programs, (iii) clariﬁed the scope of products considered WEEE, and/or (iv) established pricing for recycling of WEEE, we cannot at this time reasonably estimate the effect of applying this guidance in future periods. However, we continue to monitor WEEE developments in the respective EU countries in an effort to determine the ﬁnancial statement impact, if any, of this directive. In May 2005, the FASB issued SFAS 154, Accounting Changes and Error Corrections—A Replacement of APB Opinion No. 20 and FASB Statement No. 3. SFAS 154 replaces APB Opinion No. 20, Accounting Changes and FASB Statement No. 3, Reporting Accounting Changes in Interim Financial Statements, and changes the requirement for the accounting for and reporting of a change in accounting principle. APB No. 20 previously required that most voluntary changes in accounting principle be recognized by including in net income of the period of the change the cumulative effect of changing to the new accounting principle. SFAS 154 requires retrospective application to prior periods’ ﬁnancial statements for voluntary changes in accounting principle. SFAS 154 is effective for accounting changes and corrections of errors made in ﬁscal years beginning after December 15, 2005. In December 2004, the FASB issued SFAS 123(R), Share-Based Payment, which is a revision of SFAS 123, Accounting for Stock-Based Compensation, and supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees. SFAS 123(R) requires companies to recognize the cost of employee services received in exchange for awards of equity instruments, based on the grant date fair value of those awards in their ﬁnancial statements. Pro forma disclosure is no longer an alternative under the new standard. SFAS 123(R) will also require the beneﬁts associated with tax deductions in excess of recognized compensation cost to be reported as a ﬁnancing cash ﬂow rather than as an operating cash ﬂow as currently required. Bio-Rad has adopted the provisions of SFAS 123(R) beginning January 1, 2006 and will continue to evaluate the impact of SFAS 123(R) on the consolidated ﬁnancial statements as it begins recognizing compensation expense for the unvested portion of awards granted prior to adoption and for new awards granted subsequent to adoption. Bio-Rad has elected to use the “modiﬁed prospective” transition method under SFAS 123(R) in the ﬁrst quarter of 2006. Under the “modiﬁed prospective” method, compensation cost for the unvested portion of previously granted awards and all new awards will be recognized on or after the date of adoption. The compensation cost related to unvested awards at the date of adoption is based on the grant-date fair value of those awards as calculated for pro forma disclosures under the original SFAS 123 as adjusted for the effect of estimated forfeiture rates. We will recognize compensation cost for stock-based awards issued after December 31, 2005 on a straight-line basis over the requisite service period for the entire award. The new standard will result in increased compensation expense. 34 : Bio-Rad 2005 Annual Report 2. Acquisitions In August 2004, we acquired the outstanding shares of MJ GeneWorks, Inc. and its subsidiaries, a life science company specializing in instruments and consumables used in modern biological research. The total purchase price of $90.0 million included $7.0 million of net tangible assets, $40.5 million of goodwill and $42.5 million of intangible assets. We paid $31.0 million in cash and assumed liabilities including $9.0 million in notes payable and capital leases and a $50.0 million litigation accrual (see Note 14). Acquired in-process research and development of $13.7 million was charged to expense in the third quarter of 2004. The allocation of the total purchase price to net tangible assets, goodwill and other intangible assets has been recorded at their fair market value based upon management estimates and third-party valuations. We included these operations in our Life Science segment. In March 2004, we purchased for cash the controls business of Hematronix, Inc. of Plano, Texas. Bio-Rad acquired tangible and intangible assets and assumed certain liabilities for approximately $17 million. Acquired in-process research and development of $0.9 million was charged to expense in the ﬁrst quarter of 2004. We included these operations in our Clinical Diagnostics segment. 3. Short-Term Investments Short-term investments consist of the following (in millions): Available-for-sale securities: Auction rate securities Certiﬁcate of deposit Variable rate notes U.S. Agencies Asset backed securities Corporate obligations Other Total short-term investments December 31, 2005 2004 $ 3.9 $ 146.5 — 8.7 25.5 36.6 31.4 10.2 4.0 8.4 7.0 — — — $ 116.3 $ 165.9 Management classiﬁes investments in marketable securities at the time of purchase and reevaluates such classiﬁcation at each balance sheet date. Securities classiﬁed as Available-for-sale are stated at fair value which approximates cost. As of December 31, 2005, the short-term investments will mature within one year. 4. Investments We own shares of ordinary voting stock of Sartorius AG, of Goettingen, Germany, a process technology supplier to the biotechnology, pharmaceutical, chemical and food and beverage industries. We purchased shares in 2005 and 2004 for approximately $4 and $11 million, respectively, bringing our total investment to approximately 26% of the outstanding voting shares of Sartorius at December 31, 2005. The Sartorius family trust and Sartorius Bio-Rad 2005 Annual Report : 35 Notes to Consolidated Financial Statements (continued) family members hold a controlling interest of the outstanding voting shares. We do not have any representative or designee on Sartorius’ board of directors, nor do we have any other inﬂuence over the operating and ﬁnancial policies of Sartorius. Therefore, we account for this investment using the cost method. In December 1997, we began investing in Instrumentation Laboratory, S.p.A. (IL), an Italian based clinical diag- nostics company. A privately held company based in Spain controls the majority of the outstanding stock of IL. As of December 31, 2004, we valued our investment in IL at $4.0 million which reﬂects a $2.4 million write-down recorded in Other income, net. In October 2005, Bio-Rad entered into an agreement to sell all its shares back to IL. We received cash of $12.0 million and recorded in Other income, net, a pre-tax gain of $7.9 million (see Note 11). On July 26, 2005, BioSource International, Inc. (BioSource) announced in a press release that it had entered into a deﬁnitive merger agreement under which Invitrogen Corporation will acquire BioSource for $12.50 per share in cash. In October 2005, we tendered our shares of BioSource to Invitrogen Corporation for $12.50 per share in cash and received cash of $8.3 million. We recorded in Other income, net, a pre-tax gain of $3.3 million (see Note 11). 5. Discontinued Operations On May 31, 2004, we sold a group of assets and transferred certain liabilities that comprise a substantial portion of our confocal microscopy product line to Carl Zeiss Jena GmbH. Proceeds of $19.8 million were offset by net assets of $5.7 million, lease settlements of $6.7 million and severance, legal and other costs of $1.7 million resulting in a pre-tax gain of $5.7 million. As required by SFAS 144, Accounting for the Impairment or Disposal of Long-Lived Assets, with the disposition of this asset group, the sales and expenses related to this product line for current and prior periods have been reclassiﬁed as a separate line on the income statement titled “Discontinued Operations.” During 2005, Bio-Rad reached an agreement to settle the $6.7 million lease commitment and revised our lease settlement estimate to $2.7 million to exit the facility in 2005. Consequently, we recognized a $4.0 million gain on the revised disposition. There were no sales or pre-tax operating losses attributable to the discontinued operations for the year ended December 31, 2005. The discontinued operations generated net sales of $6.3 million and $23.8 million for the years ended December 31, 2004 and 2003, respectively. The pre-tax operating losses attributable to the discontinued operations for the years ended December 31, 2004 and 2003 were $2.0 million, and $1.7 million, respectively. 6. Goodwill and Other Purchased Intangible Assets In March 2005, we purchased the rights to certain patents for $1.0 million. In June 2004, we purchased $14.0 million of intangible assets related to licensing agreements. We paid $6.0 million upon acquisition and $4.0 million in the third quarter of 2004. The remaining $4.0 million was paid in 2005. These intangibles are part of our Clinical Diagnostics segment. 36 : Bio-Rad 2005 Annual Report As part of the acquisition of MJ GeneWorks, Inc. and its subsidiaries in August 2004 (see Note 2), we added $40.5 million of goodwill and $42.5 million of intangible assets including $13.7 million of in-process research and development and $22.5 million of developed technology. During the fourth quarter of 2005, $19.8 million of impairment losses related to intangible and long-lived assets were recorded in the Life Science segment. Of these losses, $15.8 million related to intangible and tangible assets acquired from MJ GeneWorks (MJ). The circumstance leading to the impairment was the November 10, 2005 recommended ruling of the Connecticut Federal District Court that it would not enforce the August 30, 2005 settlement between Bio-Rad, Applera and Roche (see Note 14). As a result of this decision Bio-Rad continued to be barred from selling, servicing or mar- keting MJ thermal cyclers and real time polymerase chain reaction (PCR) equipment in the United States. The asset group impaired included ﬁxed assets at the Massachusetts manufacturing location making the MJ cyclers along with intangible assets related to developed technology, U.S. customer mailing lists, trade names and non- compete agreements. The determination of fair value was calculated converting estimated future cash ﬂows to their present value, using the rate of return expected by an investor for an investment with similar perceived risk. Additionally, $4.0 million of intangible and tangible assets related to our microarray product line manufactured in Waterloo, Canada, were impaired. In the fourth quarter, we decided to close the plant and no longer manufacture the products that related to the speciﬁc patents purchased from Virtek in 2002. Bio-Rad has developed new microarray products that do not use the technology covered in the patents. The discontinued products covered by the patents will have negligible sales and cash ﬂow in 2006 and beyond. As part of the acquisition of the controls business of Hematronix, Inc. in March 2004 (see Note 2) we added $3.2 million of goodwill and $9.3 million of intangible assets including in-process research and development. Goodwill balances have been included in corporate for segment reporting purposes in Note 15. Other than goodwill, we have no intangible assets with indeﬁnite lives. Information regarding our identiﬁable purchased intangible assets is as follows (in millions): Developed Product Technology Licenses Know How Covenants Not to Compete Patents Customer Lists Other December 31, 2005 Average Useful Life Carrying Amount Accumulated Amortization 2 8 6 2 4 1 3 $ 9.2 $ 14.0 8.7 2.0 1.0 0.6 2.2 $ 37.7 $ 1.4 1.3 3.7 0.7 — 0.2 2.0 9.3 $ Net 7.8 12.7 5.0 1.3 1.0 0.4 0.2 $ 28.4 Bio-Rad 2005 Annual Report : 37 Notes to Consolidated Financial Statements (continued) Developed Product Technology Licenses Know How Covenants Not to Compete Patents Customer Lists Other December 31, 2004 Average Useful Life Carrying Accumulated Amortization Amount 11 16 8 10 16 6 2 $ 28.3 $ 14.1 9.9 6.1 4.6 1.7 2.9 $ 67.6 $ 2.5 0.4 2.8 0.6 0.7 0.3 1.7 9.0 $ Net 25.8 13.7 7.1 5.5 3.9 1.4 1.2 $ 58.6 Recorded purchased intangible asset amortization expense for the years ended December 31, 2005, 2004 and 2003 was $11.0 million, $6.9 million and $1.3 million, respectively. Estimated purchased intangible asset amortization expense (based on existing intangible assets) for the years ended December 31, 2006, 2007, 2008, 2009 and 2010 is $5.3 million, $5.2 million, $4.4 million, $3.2 million and $1.9 million, respectively. 7. Notes Payable and Long-term Debt Notes payable include local credit lines maintained by our subsidiaries aggregating approximately $34.1 million, of which $30.8 million was unused at December 31, 2005. At December 31, 2004 these lines aggregated approximately $62.3 million, of which $53.1 million was unused. The weighted average interest rate on these lines was 8.3% and 6.8% at December 31, 2005 and 2004, respectively. Bio-Rad Laboratories, Inc. guarantees most of these credit lines. In June 2005, Bio-Rad entered into a new Credit Agreement, which amends and restates the Credit Agreement dated September 9, 2003, as amended December 8, 2004. Borrowings are permitted up to a maximum of $150.0 million on a revolving basis and can be used to make acquisitions, for working capital and other general corporate purposes. Borrowings under this line of credit carry a ﬂoating rate of interest based on a reference rate dictated by the type of borrowing plus the applicable margin. Under certain conditions, the Credit Agree- ment may be increased up to an additional $50 million and will mature on June 21, 2010. The Credit Agreement is secured by substantially all of our personal property assets, the assets of our domestic subsidiaries and 65% of the capital stock of certain foreign subsidiaries. It is guaranteed by all of our existing and future domestic subsidiaries (other than immaterial domestic subsidiaries as deﬁned for purposes of the Credit Agreement). 38 : Bio-Rad 2005 Annual Report The principal components of Long-term debt are as follows (in millions): 7.5% Senior Subordinated Notes 6.125% Senior Subordinated Notes Capitalized leases Less current maturities Long-term debt December 31, 2005 2004 $ 225.0 $ 200.0 1.1 426.1 (0.4) 225.0 200.0 1.4 426.4 (0.4) $ 425.7 $ 426.0 In December 2004, Bio-Rad sold $200.0 million principal amount of Senior Subordinated Notes due 2014 (6.125% Notes). The notes pay a ﬁxed rate of interest of 6.125% per year. Upon any sale of our common stock, we have the right to repurchase up to 35% of the 6.125% Notes any time prior to December 15, 2007 at a speciﬁed redemption price plus accrued and unpaid interest and certain other charges. Furthermore, we have the option to redeem any or all of the 6.125% Notes at various declining redemption prices or at 100% of the principal amount plus the “applicable premium” (as deﬁned by the indenture) along with accrued and unpaid interest and certain other charges depending on the date redeemed. Bio-Rad’s obligations under the 6.125% Notes are not secured, rank equal to other senior subordinated notes and rank junior to all Bio-Rad’s existing and future senior debt. In August 2003, Bio-Rad sold $225.0 million principal amount of Senior Subordinated Notes due 2013 (7.5% Notes). The notes pay a ﬁxed rate of interest of 7.5% per year. Upon any sale of our common stock, we have the right to repurchase up to 35% of the 7.5% Notes any time prior to August 15, 2006 at a speciﬁed redemp- tion price plus accrued and unpaid interest and certain other charges. Furthermore, we have the option to redeem any or all of the 7.5% Notes at various declining redemption prices or at 100% of the principal amount plus the “applicable premium” (as deﬁned by the indenture) along with accrued and unpaid interest and certain other charges depending on the date redeemed. Bio-Rad’s obligations under the 7.5% Notes are not secured, rank equal to other senior subordinated notes and rank junior to all Bio-Rad’s existing and future senior debt. In 2002 and through July of 2003, Bio-Rad repurchased in the open market $17.3 million (par value) of its Senior Subordinated Notes due in 2007 (11.675% Notes) at an expense, including interest, unamortized issue costs and unamortized original issue discount of $2.5 million. The remaining $88.7 million (par value) of 11.675% Notes were tendered and repurchased with a portion of the proceeds from the sale of the 7.5% Notes at an expense, including interest, unamortized issue costs and unamortized original discount, of $11.6 million. This expense was included in interest expense. The Credit Agreement, the 6.125% Notes, and the 7.5% Notes require Bio-Rad to comply with certain ﬁnancial ratios and covenants, among other things. The covenants include a leverage ratio test, an interest coverage test and a consolidated net worth test. There are also restrictions on our ability to declare or pay dividends, incur Bio-Rad 2005 Annual Report : 39 Notes to Consolidated Financial Statements (continued) debt, guarantee debt, enter into transactions with afﬁliates, merge or consolidate, sell assets, make investments, create liens and prepay subordinated debt. We were in compliance with all ﬁnancial ratios as of December 31, 2005 and 2004. Maturities of long-term debt at December 31, 2005 are as follows: 2006—$0.4 million; 2007—$0.4 million; 2008—$0.2 million; 2009—$0.1 million; 2010—$0.0 million; thereafter—$425.0 million. 8. Income Taxes The U.S. and international components of income before taxes are as follows (in millions): U.S. International Income from continuing operations before taxes The provision (beneﬁt) for income taxes consists of (in millions): Current: U.S. Federal U.S. State International Deferred: U.S. Federal U.S. State International Year Ended December 31, 2005 2004 2003 $ $ 35.0 $ 3.5 $ 58.4 93.8 43.6 71.8 93.4 $ 97.3 $ 115 .4 Year Ended December 31, 2005 2004 2003 $ 10.8 $ (3.8) $ 0.8 22.6 34.2 1.4 36.4 34.0 $ (12.4) $ (6.2) $ (1.2) (4.8) (18.4) 1.1 2.1 (3.0) 8.6 1.1 33.8 43.5 (3.0) (0.6) (1.8) (5.4) Provision for income taxes $ 15.8 $ 31.0 $ 38.1 40 : Bio-Rad 2005 Annual Report Bio-Rad’s income tax provision differs from the amount computed by applying the U.S. federal statutory rate to income before taxes as follows: U. S. statutory tax rate Export sales beneﬁt Reduction in state tax beneﬁts Difference between U.S. and foreign tax rates (net of foreign tax credits) Loss carryforwards utilized Foreign losses not beneﬁted Capital losses not beneﬁted/(beneﬁted) Nontaxable dividend income Increase (decrease) in tax reserves Other Provision for income taxes Year Ended December 31, 2005 2004 2003 35% (3) — (8) — 3 (5) (6) 3 (2) 17% 35% (2) 2 (2) (1) 3 1 (2) (1) (1) 32% 35% (2) — (1) — 1 — — (1) 1 33% Deferred income taxes reﬂect the net tax effect of temporary differences between the carrying amounts of assets and liabilities for ﬁnancial reporting purposes and the amounts used for income tax purposes. Signiﬁcant components of deferred tax assets and liabilities are as follows (in millions): Deferred tax assets Bad debt reserve Inventory reserve Warranty reserve Vacation pay reserve Net operating loss Royalty reserve Retirement reserve Depreciation/Amortization Amortization of intangibles Impairment of assets Write-off of investment in subs State tax credit carryforward Miscellaneous—other items Valuation allowance Deferred tax liabilities Deferred gain Development cost of Hercules facility Foreign exchange gain/loss Depreciation/Amortization Miscellaneous—other items Year Ended December 31, 2005 2004 $ $ $ $ 3.2 12.2 5.5 6.0 10.1 4.4 3.6 6.4 8.3 6.1 2.4 6.4 9.6 (17.7) 66.5 5.2 1.2 2.3 7.6 7.6 23.9 $ $ $ $ 1.0 9.8 3.9 5.4 8.4 2.9 4.2 6.0 6.4 — 6.4 5.9 9.9 (18.0) 52.2 5.7 1.2 3.3 7.1 7.5 24.8 Bio-Rad 2005 Annual Report : 41 Notes to Consolidated Financial Statements (continued) The balance sheet as of December 31, 2004 reﬂects the reclassiﬁcation of $8.8 million in deferred taxes related to income taxes paid on intercompany proﬁts, resulting in a decrease of $8.8 million in current deferred taxes and an increase of the same amount in prepaid expenses and other current assets. We have also reclassiﬁed $20.4 million to net within a particular tax jurisdiction (a) all current deferred tax liabilities and assets and (b) all non-current deferred tax liabilities and assets, resulting in a decrease in both long-term deferred tax assets and long-term deferred tax liabilities of $20.4 million. At December 31, 2005, Bio-Rad’s international subsidiaries had combined net operating loss carryforwards of $21.6 million. These loss carryforwards have no expiration date. The utilization of these carryforwards is limited to the separate taxable income of each individual subsidiary. At December 31, 2005, Bio-Rad had an unutilized domestic net operating loss carryforward of $12.3 million. The loss carryforward will expire in the year 2018. The utilization of the loss carryforward is limited to Bio-Rad’s domestic taxable income. At December 31, 2005, Bio-Rad had a California tax credit carryforward of $6.4 million. The credit carryforward has no expiration date. The utilization of the tax credit carryforward is limited to the extent Bio-Rad has California taxable income. A valuation allowance is needed to reduce the deferred tax assets to an amount that is more likely than not to be realized. The net change in the valuation allowance in 2005 was a decrease of $0.3 million, primarily resulting from an increase in expected future earnings. Bio-Rad does not provide for taxes which would be payable if the cumulative undistributed earnings of its international subsidiaries, approximately $373 million at December 31, 2005, were remitted to the U.S. parent company. Unless it becomes advantageous for tax or foreign exchange reasons to remit a subsidiary’s earnings, such earnings are indeﬁnitely reinvested in subsidiary operations. The withholding tax and U.S. federal income taxes on these earnings, if remitted, would in large part be offset by tax credits. 9. Stockholders’ Equity Bio-Rad’s outstanding stock consists of Class A Common Stock (Class A) and Class B Common Stock (Class B). Each share of Class A and Class B participates equally in the earnings of Bio-Rad, and is identical in most respects except that Class A has limited voting rights. Each share of Class A is entitled to one-tenth of a vote on most matters, and each share of Class B is entitled to one vote. Additionally, Class A stockholders are entitled to elect 25% of the Board of Directors and Class B stockholders are entitled to elect the balance of the directors. Cash dividends may be paid on Class A shares without paying a cash dividend on Class B shares but no cash dividend may be paid on Class B shares unless at least an equal cash dividend is paid on Class A shares. Class B shares are convertible at any time into Class A shares on a one-for-one basis at the option of the stockholder. 42 : Bio-Rad 2005 Annual Report 10. Stock Option and Purchase Plans Stock Option Plans Bio-Rad maintains stockholder approved incentive and non-qualiﬁed stock option plans for ofﬁcers and certain other key employees. No options have been issued to non-employees. The 2003 Stock Option Plan of Bio-Rad Laboratories, Inc. (the Plan) authorizes the grant to employees of incen- tive stock options and non-qualiﬁed stock options. A total of 1,675,000 shares have been reserved for issuance and may be of either Class A or Class B Common Stock. At December 31, 2005, 1,092,798 shares remain avail- able to be granted. Under the Amended 1994 Stock Option Plan, Bio-Rad may grant options to its employees for up to 3,550,000 shares of common stock provided that no option shall be granted after March 1, 2004. Under the plans, Class A and Class B options are granted at prices not less than fair market value on the date of grant. Generally, options granted have a term of 10 years and vest in increments of 20% per year over a ﬁve- year period on the yearly anniversary date of the grant. For options granted before January 1, 2001, options vest in increments of 25% over a four-year period on the yearly anniversary date of the grant. Pro forma compensation costs are calculated for the fair value of the employees’ purchase rights, which was estimated using the Black-Scholes model. For purposes of the pro forma disclosures, the estimated fair value of the options granted is amortized to expense over the options’ vesting period. The fair value of options granted was estimated using the Black-Scholes model with the following weighted average assumptions: Expected volatility Risk-free interest rate Expected life (in years) Expected dividend Year Ended December 31, 2005 2004 2003 37% 3.45% 4.7 — 39% 2.73% 4.3 — 37% 2.65% 4.2 — See Note 1 for a description of the effect of the pro forma compensation expense derived using the fair value method on our results. Bio-Rad 2005 Annual Report : 43 Notes to Consolidated Financial Statements (continued) Activity under the 1994 and 2003 Plan’s are summarized below (amounts reported in the Price columns represent the weighted average exercise price): Year Ended December 31, 2005 2004 2003 Shares Price Shares Price Shares Price Outstanding at beginning of year 1,630,717 $ 27.14 1,582,915 $ 20.04 1,591,832 $ 15.84 Granted Exercised Forfeited Expired 307,822 57.25 306,990 53.82 302,993 (299,485) 16.26 (221,759) (49,848) 46.05 — — (33,629) (3,800) 14.02 25.13 9.85 (222,699) (89,211) — 35.71 12.58 16.57 — Outstanding at end of year 1,589,206 $ 34.43 1,630,717 $ 27.14 1,582,915 $ 20.04 Options exercisable at year-end 746,765 $ 20.50 849,633 $ 15.22 780,415 $ 13.22 Weighted average fair value of options granted during the year $ 20.76 $ 18.74 $ 11.85 The following summarizes information about stock options outstanding at December 31, 2005: Range of Exercise Prices $10.75-$11.97 $13.34-$35.50 $36.00-$56.40 $57.49-$62.04 Options Outstanding Options Exercisable Weighted Number Average Remaining Contractual Life (in years) Outstanding at 12/31/05 Weighted Average Exercise Price Number Exercisable at 12/31/05 Weighted Average Exercise Price 421,947 505,048 443,577 218,634 4.02 5.48 8.03 8.88 $ 11.41 $ 29.07 $ 50.99 $ 57.60 409,307 253,842 83,616 — $ 11.42 $ 26.35 $ 47.15 — Employee Stock Purchase Plan Bio-Rad has an employee stock purchase plan that provides that eligible employees may contribute up to 10% of their compensation up to $25,000 annually toward the quarterly purchase of our Class A common stock. The employees purchase price is 85% of the lesser of the fair market value of the stock on the ﬁrst business day or the last business day of each calendar quarter. No compensation expense is recorded in connection with the Plan. Bio-Rad has authorized the sale of 2,390,000 shares of common stock under the Plan. We sold 92,869 shares for $4.0 million, 68,932 shares for $3.1 million and 71,314 shares for $2.4 million under the Plan to employees in 2005, 2004 and 2003, respectively. The weighted average fair value of purchase rights granted in 2005, 2004 and 2003 was $11.38, $10.81 and $9.76, respectively. At December 31, 2005, 607,438 shares remain authorized under the Plan. 44 : Bio-Rad 2005 Annual Report The fair value of the employees’ purchase rights was estimated using the Black-Scholes model with the following assumptions: Expected volatility Risk-free interest rate Expected life (in years) Expected dividend Year Ended December 31, 2005 2004 2003 28.53% 2.95% 0.25 — 20.91% 41.86% 1.22% 0.93% 0.25 — 0.25 — See Note 1 for a description of the effect of the pro forma compensation expense derived using the fair value method on our results. 11. Other Income and Expense Other income, net includes the following income (expense) components (in millions): Year Ended December 31, 2005 2004 2003 Interest and investment income Income from equity investee (Note 17) Write-down of investments (Note 4) Litigation settlement (Note 14) Gains on sales of investments (Note 4) Miscellaneous other items Other income, net $ 3.2 $ 16.7 $ 0.1 — (1.2) 11.2 2.2 6.6 3.1 (2.4) 1.9 — 1.9 $ 29.0 $ 11.1 $ — — — — (0.2) 3.0 Bio-Rad 2005 Annual Report : 45 Notes to Consolidated Financial Statements (continued) 12. Supplemental Cash Flow Information The reconciliation of net income to net cash provided by operating activities is as follows (in millions): Year Ended December 31, 2005 2004 2003 Net Income $ 81.6 $ 68.2 $ 76.2 Adjustments to reconcile income to net cash provided by operating activities (net of effects of acquisitions): Depreciation Amortization Foreign currency economic hedge transactions, net Gains on dispositions of securities (Increase) decrease in accounts receivable, net Increase in inventories, net Decrease (increase) in other current assets Increase (decrease) in accounts payable and other current liabilities Increase (decrease) in income taxes payable Increase (decrease) in deferred taxes Write-down of investments Debt retirement costs on 11-5/8% bonds Impairment losses on long-lived assets Other 49.1 11.9 (6.4) (13.3) (7.7) (18.7) (12.1) 20.5 1.6 (15.0) — — 19.8 (3.0) 46.2 9.3 (6.5) (1.9) (4.4) (5.5) 3.5 1.1 (2.8) 2.5 2.4 — — 40.0 2.0 15.0 (0.3) 10.0 (8.2) (14.2) (1.6) (5.6) (8.0) — 9.5 — 11.0 12.8 Net cash provided by operating activities $ 108.3 $ 123.1 $ 127.6 13. Commitments and Contingent Liabilities Rents and Leases Net rental expense under operating leases was $23.7 million in 2005, $23.0 million in 2004 and $23.0 million in 2003. Leases are principally for facilities and automobiles. Annual future minimum lease payments at December 31, 2005 under operating leases are as follows: 2006— $20.9 million; 2007—$13.9 million; 2008—$8.4 million; 2009—$5.3 million; 2010—$3.6 million; subsequent to 2010—$8.0 million. Deferred Proﬁt Sharing Retirement Plan We have a proﬁt sharing plan covering substantially all U.S. employees. Contributions are made at the discretion of the Board of Directors. Bio-Rad has no liability other than for the current year’s contribution. Contributions charged to income were $7.5 million, $7.0 million and $6.5 million in 2005, 2004 and 2003, respectively. 46 : Bio-Rad 2005 Annual Report Other Post-Employment Beneﬁts In several foreign locations we are statutorily required to provide a lump sum severance or termination indemnity to our employees. Under these plans, the vested beneﬁt obligation at December 31, 2005 and 2004 was $15.4 million and $17.3 million, respectively and has been included in Other long-term liabilities in the consolidated balance sheets. These plans are not required to be funded, and as such, there is no trust or other device used to accumulate assets to settle these obligations. Foreign Exchange Contracts We enter into forward foreign exchange contracts as an economic hedge against foreign currency denominated intercompany receivables and payables. At December 31, 2005, we had contracts maturing in January through March 2005 to sell foreign currency with a nominal value of $61.1 million and an unrealized loss of $0.2 million. Contracts to purchase foreign currency had a nominal value of $15.5 million with an unrealized gain of $0.1 million. Insurance We carry a deductible for workers’ compensation and a portion of our group health insurance cost. Accruals for losses are based on our claims experience and actuarial assumptions followed in the insurance industry. Should a greater amount of claims occur compared to our estimates or cost of medical care increase beyond what has been anticipated, reserves recorded may not be sufﬁcient and additional charges to income may be required. Letters of Credit In the ordinary course of business, we are at times required to post letters of credit. The letters of credit are issued by our banks to guarantee our obligations to insurance companies. We were contingently liable for $4.8 million of standby letters of credit with banks as of December 31, 2005. Taxes Settlement of open tax years, as well as tax issues in other countries where we conduct our business, are not expected to have a material effect on the consolidated ﬁnancial position or liquidity of Bio-Rad and, in the opinion of management, adequate provision has been made for income and franchise taxes for all years under examination or subject to future examination. 14. Legal Proceedings Applera Corporation (Applera) and Roche Molecular Systems (Roche) ﬁled a patent infringement case against MJ Research, Inc. and John and Michael Finney in the U.S. District Court for the District of Connecticut in June 1998. On August 18, 2004, Bio-Rad acquired MJ Research through the acquisition of 100% of the stock of its parent company, MJ GeneWorks, Incorporated, from John and Michael Finney. The complaint alleged that MJ Research infringed certain patents relating to PCR and instruments for performing PCR. In response to their claims, MJ Research ﬁled counterclaims including, among others, allegations that Applera had licensed and enforced these patents through anticompetitive conduct in violation of federal and state antitrust laws. A trial on these matters commenced in March 2004. The Court elected to hold the trial in two phases: a patent phase and an antitrust phase. Bio-Rad 2005 Annual Report : 47 Notes to Consolidated Financial Statements (continued) In the patent phase, which has concluded, the jury found that MJ Research infringed three U.S. patents related to PCR process technology and three U.S. patents related to thermal cycler instrument technology. The jury found the infringement of four of the six patents to be willful. MJ Research ﬁled for Chapter 11 bankruptcy protection in the U.S. Bankruptcy Court for the District of Nevada on March 29, 2004, and later, the Bankruptcy Court granted MJ Research’s motion to dismiss the bankruptcy case, which became ﬁnal in September 2004. In April 2004, the jury awarded damages to Applera and Roche in the amount of $19.8 million. Applera and Roche sought an enhancement of damages, including legal fees, since several infringements were found to be willful. On March 30, 2005, the Court granted Applera’s and Roche’s motion for enhancement of damages and increased the damages awarded to $35.4 million in addition to awarding reasonable attorneys’ fees and costs in an amount yet to be determined by the Court. On March 31, 2005 the Court entered judgment in favor of Applera and Roche in that amount, subject to later amendment after it awards attorneys’ fees and costs. In connection with this ruling, in April we posted a surety bond in the amount of $37.2 million collateralized by the restricted cash of $36.1 million to stay the enforcement of the judgment pending appeal. Regarding the antitrust phase of the trial, the Court ruled against MJ Research on all of its patent misuse defenses and federal antitrust counterclaims and dismissed all of its counterclaims, including the state antitrust and unfair competition claims, based on those rulings. The Court denied MJ Research’s motion for reconsidera- tion of the Court’s ruling on patent misuse. On April 1, 2005, Applera moved the Court for entry of a permanent injunction on the asserted claims of the three U.S. patents related to thermal cycler instrument technology. On April 14, 2005, MJ Research and John and Michael Finney ﬁled a notice of appeal to the United States Court of Appeals for the Federal Circuit. In addition, they ﬁled several post-judgment motions, including a motion for a new trial and a motion for judgment as a matter of law. Applera ﬁled a motion to amend the judgment to include prejudgment interest in the amount of approximately $1.0 million. On May 13, 2005, Applera also moved the Court for joinder of Bio-Rad as an additional defendant in the case. We opposed the motion for joinder and the motion for entry of a permanent injunction. In connection with these matters, Bio-Rad established a $50.0 million litigation accrual as part of the purchase accounting of the acquisition of MJ GeneWorks. On August 25, 2005, the Court denied MJ Research’s and Michael and John Finney’s motion for a new trial and their motion for judgment as a matter of law. On August 29, 2005, the Court granted Applera’s motion to amend the judgment to include prejudgment interest in the amount of approximately $0.9 million. On August 30, 2005, the Court granted Applera’s motion for entry of a permanent injunction but denied Applera’s motion for join- der of Bio-Rad as an additional defendant in the case. The injunction ruling, among other things, enjoined MJ Research, Michael and John Finney and, among others, MJ Research’s successors (which includes Bio-Rad) from making, using, offering to sell, or selling in the U.S. any products that were found at trial to directly infringe certain claims of two of the three U.S. patents held by Applera relating to thermal cycler instrument technology. The injunction further enjoined them from contributing to the infringement of these claims by selling, offering to sell, or importing into the U.S. any products found at trial to infringe and from inducing others to infringe certain claims of all three of the U.S. patents relating to thermal cycler instrument technology. On August 30, 2005, Bio-Rad entered into what it believed was an enforceable settlement agreement with Applera and Roche to settle this and all other pending litigation among the parties. On Friday, September 2, 2005, 48 : Bio-Rad 2005 Annual Report Bio-Rad issued a press release in response to Applera’s September 1, 2005 press release regarding the injunction, in which Bio-Rad stated its belief that the parties had reached a settlement. On September 8, 2005, Bio-Rad ﬁled a motion with the Court to enforce the settlement agreement and for an award of attorneys’ fees and costs. In addition, on September 30, 2005, Bio-Rad ﬁled a motion to stay the injunction pending a favorable ruling on its motion to enforce the settlement agreement or, if that motion was not granted, a decision by the Court of Appeals for the Federal Circuit on the appeal of the judgment. Applera and Roche opposed these motions. On September 12, 2005, Applera ﬁled motion to hold MJ Research and Bio-Rad in contempt for allegedly violating the injunction. MJ Research and Bio-Rad opposed this motion. On November 10, 2005, the Court issued a recommended ruling to deny the motion to enforce the settlement agreement and for an award of attorney’s fees and costs. On February 9, 2006, Bio-Rad entered into a settlement agreement with Applera and Roche, which resolves the above described patent infringement lawsuit pending in the U.S. District Court of Connecticut. In connec- tion with the settlement of this lawsuit, Bio-Rad’s 1998 thermal cycler supplier license relating to Applera’s core thermal cycler patents and Roche’s PCR patents has been amended to include the MJ Research thermal cyclers that were subject to this litigation. Bio-Rad and MJ Research were also defendants in another action in the U.S. District Court for the District of Connecticut. Applera commenced the action against us on November 9, 2004. The complaint alleged that Bio-Rad was infringing a U.S. patent which is a counterpart to the revoked European real-time PCR patent described below. The complaint sought damages and injunctive relief. On February 9, 2006, Bio-Rad entered into a settlement agreement (with an effective date of April 1, 2005) with Applera, which resolves this lawsuit as well as any issues surrounding back royalties. The total net settlement amount with respect to all of the above referenced settlement agreements, including amounts related to previously accrued back royalties, was approximately $62 million. Bio-Rad recognized $1.2 million of additional expense in the fourth quarter of 2005 to adjust its estimated liability as a result of the settle- ments (see Note 16). In connection with the settlements, Bio-Rad entered into a royalty-bearing license agree- ment with Applera relating to Bio-Rad’s real-time instrument business in the United States and a term limited license in the rest of the world. Applera also ﬁled four actions in the Regional Court of Düsseldorf, Germany during the period from August 2002 through September 2003 against MJ Research and others alleging infringement of four European patents relat- ing to thermal cyclers. Bio-Rad is also a defendant in one of the actions. The suit seeks actual damages, costs and expenses and injunctive relief. Three of the actions had a trial before the Düsseldorf court in April 2004. One of these actions has since been dismissed, and two of these actions have been resolved in the settlement with Applera described above. In May 2004, the Düsseldorf court issued an adverse ruling against MJ Research and us, which included an injunction against us and MJ Research from selling any real-time PCR instruments and reagents in Germany. In December 2004, the European Patent Ofﬁce revoked the patent and the injunctions against MJ Research and Bio-Rad were lifted, allowing MJ Research and us to resume sales of real-time PCR thermal cyclers and reagents. Applera appealed revocation of the patent, and the appeal hearing will be held in July 2006. Bio-Rad 2005 Annual Report : 49 Notes to Consolidated Financial Statements (continued) Bio-Rad is also a defendant in an action in Japan which is similar to the action concerning the revoked European patent relating to real-time PCR. Applera commenced this action against us on May 7, 2002. The complaint alleges that Bio-Rad is infringing a Japanese patent which is a counterpart to the revoked European patent and seeks injunctive relief but not damages. In November 2003, the Japanese court issued an adverse ruling against us which enjoined us from selling real-time PCR instruments and reagents in Japan. Bio-Rad appealed the decision and also ﬁled a separate action in the Japanese Patent Ofﬁce seeking revocation of the Japanese patent. In March 2005, the Japanese Patent Ofﬁce revoked the Japanese patent. Applera’s appeal was denied by the Japanese Intellectual Property High Court in January 2006, which Applera may appeal to the Japanese Supreme Court. Bio-Rad is also party to various claims, legal actions and complaints arising in the ordinary course of business. We do not believe that any ultimate liability resulting from any of these lawsuits will have a material adverse effect on our results of operations, ﬁnancial position or liquidity. However, Bio-Rad cannot give any assurance regarding the ultimate outcome of these lawsuits and their resolution could be material to our operating results for any particular period, depending upon the level of income for the period. 15. Segment Information Bio-Rad is a multinational manufacturer and worldwide distributor of its own life science research products and clinical diagnostics products. We have two reportable segments: Life Science and Clinical Diagnostics. These reportable segments are strategic business lines that offer different products and services and require different marketing strategies. The Life Science segment develops, manufactures, sells and services reagents, apparatus and instruments used for biological research. These products are sold to university and medical school laboratories, pharmaceutical and biotechnology companies, food testing laboratories and government and industrial research facilities. The Clinical Diagnostics segment develops, manufactures, sells and services automated test systems, infor- matics systems, test kits and specialized quality controls for the healthcare market. These products are sold to reference laboratories, hospital laboratories, state newborn screening facilities, physicians’ ofﬁce laboratories, transfusion laboratories, and insurance and forensic testing laboratories. The remainder of our former Analytical Instruments segment is included in Other Operations. The material prod- uct lines of this segment were sold in 2001 and 2000. The accounting policies of the segments are the same as those described in Signiﬁcant Accounting Policies (see Note 1). Segment proﬁt or loss used for corporate management purposes includes an allocation of corporate expense based upon sales and an allocation of interest expense based upon accounts receivable and invento- ries. Segments are expected to manage only assets completely under their control. Accordingly, segment assets include primarily accounts receivable, inventories and gross machinery and equipment. Goodwill balances have been included in corporate for segment reporting purposes. 50 : Bio-Rad 2005 Annual Report Information regarding industry segments at December 31, 2005, 2004 and 2003 and for the years then ended is as follows (in millions): Segment net sales Allocated interest expense Depreciation and amortization Segment proﬁt (loss) Segment assets Capital expenditures Life Science 549.9 504.7 456.2 $ Clinical Diagnostics 618.4 576.4 514.8 $ Other Operations 12.6 8.9 8.6 $ $ $ $ $ 13.8 8.0 6.7 24.6 18.8 10.3 (0.5) 31.4 73.2 276.3 277.5 252.7 11.9 24.1 36.2 $ $ $ $ $ 18.7 12.1 9.6 33.0 32.6 29.2 64.4 60.1 59.8 392.9 401.2 379.5 25.1 34.6 30.7 0.1 0.1 0.1 0.1 0.2 0.3 (0.6) (0.1) (0.2) 5.4 6.0 5.0 0.1 0.1 0.1 $ $ $ $ $ $ 2005 2004 2003 2005 2004 2003 2005 2004 2003 2005 2004 2003 2005 2004 2003 2005 2004 2003 The Life Science segment proﬁt (loss) for 2005 includes $19.8 million of impairment losses on long-lived assets (see Note 6). The Life Science segment proﬁt (loss) for 2004 includes $13.7 million of in-process research and development expense purchased as part of the MJ GeneWorks, Inc. acquisition. The difference between total segment allocated interest expense, depreciation and amortization, and capital expenditures and the corresponding consolidated amounts is attributable to our corporate headquarters. The following reconciles total segment proﬁt to consolidated income before taxes (in millions): Total segment proﬁt Other income, net Foreign exchange gains (losses) Costs related to bond redemption Net corporate operating, interest and other Year Ended December 31, 2005 2004 2003 $ $ 63.3 29.0 1.5 — $ 91.4 11.1 (2.4) — 132.8 3.0 (4.1) (14.1) income and expense not allocated to segments (0.4) (2.8) (2.2) Consolidated income before taxes from continuing operations $ 93.4 $ 97.3 $ 115.4 Bio-Rad 2005 Annual Report : 51 Notes to Consolidated Financial Statements (continued) The following reconciles total segment assets to consolidated total assets (in millions): Total segment assets Cash and other current assets Net property, plant and equipment excluding segment speciﬁc gross machinery and equipment Goodwill Other long-term assets Total assets December 31, 2005 2004 $ 674.6 $ 563.1 (35.3) 113.3 110.9 684.7 469.0 (16.4) 113.3 121.0 $ 1,426.6 $ 1,371.6 The following presents sales to external customers by geographic area based primarily on the location of the use of the product or service (in millions): Europe Paciﬁc Rim United States Other (primarily Canada and Latin America) Total sales Year Ended December 31, 2005 2004 2003 $ 508.3 $ 502.2 $ 193.6 421.3 57.8 168.2 370.2 49.4 434.5 159.8 335.2 50.1 $ 1,181.0 $ 1,090.0 $ 979.6 The following presents long-lived assets by geographic area based upon the location of the asset (in millions): Europe Paciﬁc Rim United States Other (primarily Canada and Latin America) Total long-lived assets 16. Subsequent Events Year Ended December 31, 2005 2004 2003 $ 75.0 $ 57.7 $ 8.5 332.1 2.8 8.0 394.4 3.1 48.4 7.5 254.4 5.7 $ 418.4 $ 463.2 $ 316.0 On February 9, 2006, Bio-Rad completed negotiations with Applera Corporation and Roche Molecular Systems, Inc. to settle the patent infringement litigation against MJ Research, a wholly owned subsidiary of Bio-Rad. The December 31, 2005 ﬁnancial statements reﬂect the impact of this settlement (see Note 14). 52 : Bio-Rad 2005 Annual Report 17. Quarterly Financial Data (Unaudited) Summarized quarterly ﬁnancial data for 2005 and 2004 are as follows (in millions, except per share data): 2005 Net sales Gross proﬁt Net income Basic earnings per share Diluted earnings per share 2004 Net sales Gross proﬁt Net income Basic earnings per share Diluted earnings per share First Quarter Second Quarter Third Quarter Fourth Quarter $ 299.2 $ 291.3 $ 283.2 $ 166.4 33.5 1.29 1.26 $ $ 160.6 18.4 0.71 0.69 $ $ 156.8 16.2 0.62 0.61 $ $ $ $ $ 262.7 $ 260.5 $ 258.9 $ 149.3 22.0 0.86 0.83 $ $ 149.7 22.9 0.89 0.86 $ $ 142.8 6.3 0.24 0.24 $ $ $ $ 307.3 162.7 13.5 0.51 0.50 307.9 168.3 17.0 0.66 0.65 In the fourth quarter of 2005, Bio-Rad recorded $19.8 million of impairment losses related to intangible and long-lived assets (see Note 6). In the fourth quarter of 2004, Bio-Rad reﬁned its procedures to more accurately reﬂect the application of its revenue recognition policy, resulting in a decrease in net sales and net income of approximately $5.0 million and $1.7 million, respectively. Also, in the fourth quarter of 2004, we adopted the equity method of accounting for one of our investments previously accounted for on the cost method. The result was an increase in net income of $2.1 million. None of these items had a signiﬁcant effect on any prior quarter or ﬁscal year. Bio-Rad 2005 Annual Report : 53 Report Of Independent Registered Public Accounting Firm To the Board of Directors and Stockholders of Bio-Rad Laboratories, Inc., Hercules, California We have audited the accompanying consolidated balance sheets of Bio-Rad Laboratories, Inc. and subsidiar- ies (the “Company”) as of December 31, 2005 and 2004, and the related consolidated statements of income, stockholders’ equity, and cash ﬂows for each of the three years in the period ended December 31, 2005. These ﬁnancial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these ﬁnancial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the ﬁnancial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the ﬁnancial statements. An audit also includes assessing the accounting principles used and signiﬁcant estimates made by management, as well as evaluat- ing the overall ﬁnancial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such consolidated ﬁnancial statements present fairly, in all material respects, the ﬁnancial posi- tion of Bio-Rad Laboratories, Inc. and subsidiaries as of December 31, 2005 and 2004, and the results of their operations and their cash ﬂows for each of the three years in the period ended December 31, 2005, in confor- mity with accounting principles generally accepted in the United States of America. We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of the Company’s internal control over ﬁnancial reporting as of December 31, 2005, based on the criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 2, 2006 expressed an unqualiﬁed opinion on management’s assessment of the effectiveness of the Company’s internal control over ﬁnancial reporting and an unqualiﬁed opinion on the effectiveness of the Company’s internal control over ﬁnancial reporting. San Francisco, California March 2, 2006 54 : Bio-Rad 2005 Annual Report Management’s Discussion and Analysis Management’s Discussion and Analysis of Results of Operations and Financial Condition This discussion should be read in conjunction with the information contained in Bio-Rad’s Consolidated Finan- cial Statements and the accompanying notes which are an integral part of the statements. References are to the Notes to Consolidated Financial Statements. Other than statements of historical fact, statements made in this Annual Report include forward looking state- ments, such as statements with respect to our future ﬁnancial performance, operating results, plans and objectives that involve risk and uncertainties. We have based these forward looking statements on our current expectations and projections about future events. However, actual results may differ materially from those cur- rently anticipated depending on a variety of risk factors including among other things: our ability to successfully develop and market new products; our reliance on and access to necessary intellectual property; our substantial leverage and ability to service our debt; competition in and government regulation of the industries in which we operate; and the monetary policies of various countries. We undertake no obligation to publicly update or revise any forward looking statements, whether as a result of new information, future events, or otherwise. Overview Bio-Rad is a multinational manufacturer and worldwide distributor of our own Life Science research and Clinical Diagnostics products. Our business is organized into two primary segments, Life Science and Clinical Diagnostics, with the mission to provide scientists with specialized tools needed for biological research and clinical diagnostics. We sell more than 8,000 products and services to a diverse client base comprised of scientiﬁc research, healthcare, industry, education and government customers worldwide. We manufacture and supply our customers with a range of reagents, apparatus and equipment to separate complex chemi- cal and biological materials and to identify, analyze and purify components. Because our customers require replication of results in manufacturing processes and their experiments and tests, we estimate that approxi- mately 70% of our revenues are recurring. Approximately 36% of our 2005 consolidated net sales are from the United States, and approximately 64% are international sales, largely denominated in local currency with the majority of these sales in Euros, Yen and British Sterling. As a result, our consolidated sales expressed in dollars beneﬁt when the U.S. dollar weakens and suffers when the dollar strengthens in relation to other currencies. Currency ﬂuctuations beneﬁted our consolidated sales expressed in U.S. dollars in 2005 and 2004. The market for reagents and apparatus remains good while growth rates have slowed due to both public and private grant funding being more measured. The market for large capital equipment in 2004 and 2005 declined from prior periods, as many pharmaceutical and biotechnology customers delayed or reduced their capital spending. Bio-Rad is generally less impacted by capital spending as lower cost reagents and apparatus comprise more than 70% of product sales. Bio-Rad 2005 Annual Report : 55 Management’s Discussion and Analysis (continued) The following shows gross proﬁt and expense items as a percentage of net sales: Net sales Cost of goods sold Gross proﬁt Selling, general and administrative expense Product research and development expense, excluding in-process research and development Income from continuing operations Discontinued operations Net income Year Ended December 31, 2005 2004 2003 100.0 45.3 54.7 35.2 9.7 6.6 0.3 6.9 100.0 44.0 56.0 34.7 9.9 6.1 0.2 6.3 100.0 43.2 56.8 32.4 9.3 7.9 (0.1) 7.8 We intend for the discussion of our ﬁnancial condition and results of operations that follow to assist you in understanding how accounting principles, policies and estimates affect our results, and the signiﬁcant factors that caused changes in our operations and ﬁnancial position for the years ended December 31, 2005 and 2004. Critical Accounting Policies and Estimates The accompanying discussion and analysis of Bio-Rad’s ﬁnancial condition and results of operations are based upon the consolidated ﬁnancial statements, which have been prepared in accordance with generally accepted accounting principles in the United States (GAAP). The preparation of ﬁnancial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities and contingencies as of the date of the ﬁnancial statements and reported amounts of revenues and expenses during the reporting periods. We evaluate our estimates on an on-going basis. Bio-Rad 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. However, future events are subject to change and the best current estimates and assumptions routinely require adjustment. Actual results could differ from these estimates. We have determined that for the periods reported in our 2005 Annual Report, the following account- ing policies and estimates are critical in understanding the ﬁnancial condition and results of our operations. Accounting for Income Taxes As part of the process of preparing consolidated ﬁnancial statements, management is required to estimate our income taxes in each of the jurisdictions in which we operate. This process involves estimating our actual cur- rent tax exposure together with assessing temporary differences resulting from differing treatment of items for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included within the consolidated balance sheet. Management must then assess the likelihood that the deferred tax assets will be recovered from future taxable income and to the extent management believes that recovery is not likely, a valuation allowance must be established. To the extent management establishes a valuation allowance or 56 : Bio-Rad 2005 Annual Report increases this allowance in a period, an expense within the tax provision in the statement of operations must be included. Signiﬁcant management judgment is required in determining the provision for income taxes, deferred tax assets and liabilities and any valuation allowance recorded against the net deferred tax assets. We have recorded a valuation allowance of $17.7 million and $18.0 million as of December 31, 2005, and 2004, respectively, due to uncertainties related to our ability to utilize some of the deferred tax assets, primarily consisting of certain foreign net operating losses carried forward, before they expire. The valuation allowance is based on manage- ment’s current estimates of taxable income for the jurisdictions in which Bio-Rad operates and the period over which the deferred tax assets will be recoverable. In the event that actual results differ from these estimates, or these estimates are adjusted in future periods, an additional valuation allowance may need to be established which would increase the tax provision, lowering income and impacting Bio-Rad’s ﬁnancial position. Should realization of these deferred assets previously reserved occur, the tax provision would decrease, raising income and positively impacting Bio-Rad’s ﬁnancial position. Valuation of Long-lived and Intangible Assets and Goodwill We assess the impairment of identiﬁable intangibles, long-lived assets and related goodwill and enterprise level goodwill whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Projected future operating results and cash ﬂows of the reporting units’ asset or asset group are used to estab- lish the fair value used in evaluating the carrying value of long-lived, intangible assets and goodwill. Factors that we consider important which could trigger an impairment review include the following: - signiﬁcant under-performance relative to expected historical or projected future operating results; - signiﬁcant changes in the manner of use of the long-lived assets, intangible assets or the strategy for our overall business; - signiﬁcant negative industry or economic trends. When Bio-Rad determines that the carrying value of intangibles, long-lived assets or enterprise level goodwill may not be recoverable based upon the existence of one or more of the above indicators of impairment, we measure any impairment based on a projected discounted cash ﬂow method using a discount rate determined by management to be commensurate with the risk inherent in our current business model. For the year 2005, that review indicated an impairment had taken place in purchased intangible assets related to existing thermal cycler and microarray technology. There were no impairments taken in the year 2004 and 2003. Valuation of Inventories Bio-Rad values inventory at the lower of the actual cost to purchase and/or manufacture the inventory, or the current estimated market value of the inventory. We review inventory quantities on hand and record a provision for excess and obsolete inventory based primarily on an estimated forecast of product demand and production requirements for the next twelve months on a quarterly basis or, if warranted by the circumstances, more fre- quently. In addition, our industry is characterized by technological change, frequent new product development and product obsolescence that could result in an increase in the amount of obsolete inventory quantities on Bio-Rad 2005 Annual Report : 57 Management’s Discussion and Analysis (continued) hand. Additionally, our estimates of future product demand may prove to be inaccurate, in which case we may have understated or overstated the provision required for excess and obsolete inventory. In the future, if inven- tory is determined to be overvalued, we would be required to recognize such costs in our cost of goods sold at the time of such determination. Likewise, if inventory is determined to be undervalued, we may have over- reported cost of goods sold in previous periods and would be required to recognize such additional operating income at the time of sale. Therefore, although we make efforts to ensure the accuracy of our forecasts of future product demand, any signiﬁcant unanticipated changes in demand, technological developments or regulations could have a signiﬁcant impact on the value of our inventory and reported operating results. Allowance for Doubtful Accounts Bio-Rad maintains an allowance for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. The amount of the allowance is determined by analyzing known uncollectible accounts, the age of our receivables, economic conditions in the customers’ country or industry, historical losses and our customers’ general credit-worthiness. Amounts later determined and speciﬁcally identi- ﬁed to be uncollectible are charged or written off against this reserve. This valuation allowance is reviewed on a quarterly basis to determine whether an increase or decrease is warranted. Should the estimates be higher than the actual uncollectible accounts, we would report lower proﬁtability when the estimates are made and higher proﬁtability when the receivable is collected through negotiation or litigation. Warranty Reserves Bio-Rad warrants certain equipment against defects in design, materials and workmanship, generally for a period of one year. Upon shipment of that equipment, we establish, as part of cost of goods sold, a provision for the expected costs of such warranty based on historical experience, speciﬁc warranty terms and customer feedback. A review is performed on a quarterly basis to assess the adequacy of our warranty reserve, and adjusted, if necessary. The warranty percentage and accrual are based on actual experience and expected future costs to be incurred. Should realized costs be higher than expected costs, cost of goods sold would be lower in the period of estimation and higher when realized. Litigation Reserves Estimated amounts for claims that are probable and can be reasonably estimated are recorded as liabilities in the consolidated balance sheets. The likelihood of a material change in these estimated reserves is dependent on the possible outcome of settlement negotiations, regulatory or judicial review and the development of facts and circumstances in extended litigation which could change claims or assessments when both the amount and range of loss on some outstanding litigation is uncertain. We are obligated to disclose in the footnotes of the ﬁnancial statements when we are unable to make a reasonable estimate of the liability that could result from unfavorable outcomes in litigation. As events occur, we will assess the potential liability related to our pending litigation and revise our estimates. Such revisions in our estimates of the potential liability could materially impact our results of operations and ﬁnancial position. Recent Accounting Pronouncements In December 2004, the FASB issued SFAS 123(R), Share-Based Payment, which is a revision of SFAS 123, Accounting for Stock-Based Compensation, and supersedes APB Opinion No. 25, Accounting for Stock 58 : Bio-Rad 2005 Annual Report Issued to Employees. SFAS 123(R) requires companies to recognize the cost of employee services received in exchange for awards of equity instruments, based on the grant date fair value of those awards in their ﬁnancial statements. Pro forma disclosure is no longer an alternative under the new Standard. SFAS 123(R) will also require the beneﬁts associated with tax deductions in excess of recognized compensation cost to be reported as a ﬁnancing cash ﬂow rather than as an operating cash ﬂow as currently required. Bio-Rad has adopted the provisions of SFAS 123(R) beginning January 1, 2006 under the “modiﬁed prospec- tive” transition method. Under this method, compensation cost for the unvested portion of previously granted awards and all new awards will be recognized on or after the date of adoption. The compensation cost related to unvested awards at the date of adoption is based on the grant-date fair value of those awards as calculated for pro forma disclosures under the original SFAS 123 as adjusted for the effect of estimated forfeiture rates. Our 2006 results are expected to include approximately $5 million of additional compensation expense as a result of the adoption of SFAS 123(R). Because this estimate is based on assumptions including anticipated levels of new awards to be granted, changes in stock price, forfeitures of awards and employee exercise pat- terns, the actual impact on earnings may differ from this estimate. Bio-Rad will recognize compensation cost for stock-based awards issued after December 31, 2005 on a straight-line basis over the requisite service period for the entire award. Corporate Results—Sales, Margins and Expenses Bio-Rad net sales for the year 2005 were $1,181.0 million, an increase of 8.3% over the prior year. The impact of foreign exchange translation throughout the year provided growth from foreign denominated net sales of approximately 1.1% for the full year. The Life Science segment had sales growth of 9.0% in 2005, beneﬁting from an approximate 0.8% increase due to foreign exchange. Currency neutral sales growth of 8.2% was provided by the acquisition of MJ Research, process media sales, multi-analyte detection, and protein separation apparatus and reagents. Offsetting these speciﬁc growth areas was a decline in Food Science products as the average pricing for our BSE test declined year over year in a very competitive market. During the fourth quarter, we were enjoined by court order not to sell or service MJ products in the United States, which negatively impacted sales. The Clinical Diagnostics segment had sales growth of 7.3% in 2005, beneﬁting from an approximate 1.4% increase due to foreign exchange. Currency neutral sales growth was 5.9% in the Clinical Diagnostics segment. Our quality control products had growth across several product lines. Diagnostic tests provided for diabetes monitoring, genetic disorder identiﬁcation, and improved demand for blood virus products in the U.S. and Asia also contributed to overall growth. Bio-Rad net sales for the year 2004 were $1,090.0 million, an increase of 11.3% over the prior year after presenting our confocal microscopy operations, sold in May 2004, as discontinued operations. The impact of a weakening U.S. dollar throughout the year provided growth from net foreign currency denominated sales of approximately 5.8% for the full year. Bio-Rad 2005 Annual Report : 59 Management’s Discussion and Analysis (continued) The Life Science segment had sales growth of 10.6% in 2004, beneﬁting from an approximate 5.8% increase due to foreign exchange. Currency neutral sales growth of 4.8% was provided by the acquisition of MJ Research and our protein expression product lines, ampliﬁcation and electrophoresis reagents. Offsetting the sales growth of this segment is continued aggressive competitor pricing for the BSE test, continued general weakness related to some government grant spending (most notably Japan), and diminished capital equipment purchases by large pharmaceutical companies. The Clinical Diagnostics segment had sales growth of 12.0% in 2004, beneﬁting from an approximate 5.7% increase due to foreign exchange. Currency neutral sales growth of 6.3% was provided in several broad product lines of the Clinical Diagnostics segment. Quality control products grew due to the Hematronix acquisition and the growth of existing product offerings. Also contributing to growth were diagnostic products for autoimmune, diabetes and blood virus testing. The 2005 consolidated gross margins declined to 54.7% in the current year from 56.0%. The decline in the Life Science segment’s gross margin accounts for the decline for Bio-Rad as a whole. Several factors contributed to the Life Science decline. Lower average pricing on the BSE product lines and the court-ordered halt to MJ product sales and service relating to the patent litigation with ABI resulted in the immediate expensing of all production costs leading to higher service and warranty expense as customer accommodations were made. The Clinical Diagnostics segment’s margin improved by less than one percent. Moderation in the increase of plant overhead costs and lower reagent rental depreciation were contributing factors to this improvement. The 2004 consolidated gross margins declined to 56.0% from 56.8% in the prior year. The majority of the decline in the Life Science segment is attributable to the BSE product line, as average selling price declined. Additionally, there were increased intangible asset amortizations from the MJ acquisition, MJ integration costs and unabsorbed factory overhead costs from lower than anticipated volumes. The Clinical Diagnostics segment’s gross margin improved by about one percent. Efﬁciency gains in factory performance resulted in a general trend of improving the Clinical Diagnostic segment’s margin. Consolidated selling, general and administrative expense was 35.2% of net sales for the year 2005 compared to 34.7% for the year 2004. The Life Science segment and Corporate shared services added expenses at a rate that exceeded sales growth. Life Science increases are attributable to higher personnel and facilities costs related to the acquisition of MJ, legal expenses related to patent litigation, the amortization of intangibles and an increase in the experience of uncollectible receivables. Corporate shared services had increased spending in information technology, acquisition related expenses and legal fees. Overall for 2005, Bio-Rad increased costs associated with regulatory requirements for global tax and audit compliance and security and disaster recovery for our information technology infrastructure. Additionally, we incurred professional services in association with the attempted acquisition of BioSource International, Inc. and settling the Instrumentation Laboratories (IL) litigation. The Clinical Diagnostic segment’s selling, general and administrative (SG&A) expense grew at a rate slower than sales. The largest element of absolute cost is personnel which also was responsible for generating the most growth in expenses. 60 : Bio-Rad 2005 Annual Report Consolidated selling, general and administrative expense for 2004 was 34.7% of sales, compared to 32.4% for the year ended 2003. Both the Life Science and Clinical Diagnostics segments added expenses at a rate of growth higher than sales. The Life Science segment had increased facility costs after relocating to new facilities and consulting costs associated with implementation of new distribution, manufacturing and ﬁnancial software systems. Costs also increased related to the MJ acquisition and legal matters associated with the gene expres- sion product line. We have seen signiﬁcant cost increases associated with regulatory compliance including Section 404 of Sarbanes-Oxley, global tax compliance and security and disaster recovery for our information technology infrastructure. Product research and development expense in 2005 declined to 9.7% of sales after adjusting for the $14.6 million of purchased in-process R&D from 2004 acquisitions. In absolute dollars, each segment had growth with Life Science increasing more than Clinical Diagnostics. The Life Science segment concentrated on research and development in ampliﬁcation and protein interaction technologies. The Clinical Diagnostics segment concentrated on automation for the serology, autoimmune and blood virus products as well as the segment’s quality control products. Excluding $14.6 million of purchased in-process R&D from both the Hematronix and MJ Research acquisitions, product research and development expense in 2004 rose to 9.9% of sales from 9.3% in 2003. The signiﬁcant increase in spending levels occurred in Life Science in the areas of protein separation, protein function and food safety. Increased spending levels in Clinical Diagnostics are attributable to the BioPlex® 2200, an immunoassay platform that employs multiplexing technology. Clinical Diagnostics continues to invest in expanding its quality control products and blood virus diagnostic tests. Corporate Results Interest expense increased in 2005 to $32.6 million, from $20.2 million in the prior year. The year 2005 had approximately $434.7 million of average borrowings. The increase reﬂects that in late December 2004, we borrowed an additional $200.0 million in a private placement of Senior Subordinated Notes at 6.125%. This additional borrowing has substantially caused all of the 2005 increase in interest expense which includes the amortization of bond origination fees. We now have two principal borrowings: the $225 million 7.5% 10-year bonds due 2013, and the $200 million 6.125% bonds due 2014. Interest expense declined in 2004 to $20.2 million, a decrease of $10.8 million. The year 2004 is representative of approximately $251.6 million of average borrowings, consisting largely of the September 2003, 7.5%, 10-year bonds plus the amortization of bond origination fees and interest on local foreign lines of credit. During 2003, we reﬁnanced all of our long-term debt incurring additional interest costs of $14.6 million for open market purchas- es and the tendering of $106.0 million of our 11-5/8% senior subordinated notes due in 2007. Foreign exchange gains (losses) for 2005 and 2004 were $1.5 million and ($2.4) million, respectively. The sig- niﬁcant difference between 2005 and 2004 was the result of discontinuing our hedging program of the Brazilian Real due to the high cost during a period of extended weakness in 2004. During 2005 the Real has strengthened against the U.S. dollar generating gains as we have continued not to hedge our current intercompany receivable balance. All years include the net cost of Bio-Rad’s economic hedging program valuing open option contracts Bio-Rad 2005 Annual Report : 61 Management’s Discussion and Analysis (continued) to fair market value at period end and the revaluation of intercompany receivables and payables represented by the established European, Asian and North American currencies. Other income and expense for the year 2005 includes two atypical events. First is the sale of our investment in Instrumentation Laboratories for $12 million resulting in a $7.9 million gain. Second is a gain of $3.3 million on the tendering of our shares in BioSource International, Inc., a potential acquisition that later accepted a buy-out from another company. The years 2005 and 2004 both include $16.7 million and $6.6 million, respectively, of interest and investment income generated by our net cash position and notes receivable. Dividend and inter- est income increased in 2005 as we invested an incremental $200 million, the proceeds of the December 2004 borrowing, and short-term interest rates rose throughout 2005. In 2004, we settled by negotiation and received cash payments of $3.3 million in two matters that originated prior to 2002. First was a $1.9 million settlement with an outside legal ﬁrm which represented us in the mid 1990’s. The second settlement was with Digilab LLC for contested transition services settled in connection with the sale of our spectroscopy product line in October 2001. Also in 2004, we recorded a write-down of $2.4 million for an other than temporary impairment of our investment in Instrumentation Laboratories, an Italian diagnostic company in which we hold a 3% stake, and recorded $3.1 million of other income associated with an equity method investee, a Japanese equipment manufacturer in which we hold a 40% stake. Bio-Rad’s consolidated effective tax rate was 17%, 32% and 33% in 2005, 2004 and 2003, respectively. The 2005 effective tax rate reﬂects a one time beneﬁt of 5% related to a capital loss for tax purposes. The 2005 and 2004 effective tax rates reﬂect tax rate beneﬁts of 6% and 2% respectively for nontaxable divi- dend income. The tax rate for 2005 reﬂects a beneﬁt in the difference between U.S. and foreign taxes net of foreign tax credit related to certain one time events in France and the United Kingdom. The tax rate for all years reﬂects a tax beneﬁt related to export sales. Our effective tax rate may be impacted in the future, either favorably or unfavorably, by many factors including but not limited to statutory tax rates, changes in existing laws or regulations, tax audits and settlements, and generation of tax credits. Financial Condition Historically, our principal capital requirement was for working capital to fund our internal growth. Management assesses Bio-Rad’s liquidity in terms of our ability to generate cash to fund our operations and make acquisi- tions. The relevant factors that effect liquidity are cash ﬂows from operations, capital expenditures, acquisition opportunities, common stock repurchases, the adequacy of available bank lines of credit and the ability to raise long-term capital by borrowing in the debt markets with satisfactory terms and conditions. At December 31, 2005, we had available $413.1 million in cash, cash equivalents and short-term invest- ments, and $30.8 million under international lines of credit. Under the $150.0 million restated and amended Revolving Credit Facility, we have $145.6 million available with $4.4 million reserved for standby letters of credit issued by our banks to guarantee our obligations to certain insurance companies. Management believes that this availability, together with cash ﬂow from operations, will be adequate to meet our current 62 : Bio-Rad 2005 Annual Report objectives for operations, research and development, capital additions for plant, equipment and systems and an acquisition consistent with opportunities presently available. Cash Flow from Operations Net cash provided by operations was $108.3 million, $123.1 million and $127.6 million in 2005, 2004 and 2003, respectively. The decrease is primarily attributable to higher cash outlays for inventory and selling, general and administrative spending at a rate of growth greater than sales growth. The selling, general and administrative spending increases are attributable to higher spending for information technology, legal fees and personnel costs. While interest payments increased $11.8 million due to the December 2004 borrowing for $200 million, this is partially offset by increased investment income generated by those funds in an environment of rising short-term interest rates. Finally, an increase in income taxes paid of $6.0 million further lowered net cash ﬂows provided by operating activities. Bio-Rad’s management regularly reviews the allowance for uncollectible receivables and believes net accounts receivable are fully realizable. Management routinely reviews inventory for the impact of obsolesence and changes in market prices caused by the introduction of new products, technologies and in government reim- bursement policies. Cash Flow from Investing Activities Net capital expenditures in 2005 totaled $36.1 million, compared to $60.5 million and $69.0 million in 2004 and 2003, respectively. Net capital expenditures for 2005 reﬂects less investment in facility, equipment and new information technology systems. Also, spending on reagent rental equipment declined. The years 2004 and 2003 contained much higher spending as a new 160,000 square foot building on our Hercules campus was completed and equipped. Additionally, a leased manufacturing facility was improved and equipped in this period. A principal expenditure in all years is clinical diagnostics equipment placed with customers to be used with our clinical diagnostics reagents. For 2005, this amount represents $13.9 million of capital additions. We continue to invest in business systems to modernize and standardize distribution capabilities and enhance data communication. Other ongoing expenditures are for the replacement and improvement of production equipment and facilities to meet the necessary Good Manufacturing Practices (GMP) mandated by the Food and Drug Administration (FDA) for Clinical Diagnostics and to meet the requirements of other regulatory bodies as well as many customers in the Life Science market. Net cash used in investing activities was $6.2 million for the year 2005. The decline in payments for acquisi- tions and intangible assets is due to the decrease in acquisition activity as compared to 2004. During 2004, we acquired MJ GeneWorks, Hematronix and increased our investment in Sartorius. Proceeds from divestitures in 2004 are from the divestiture of the confocal microscopy product line. The $69.0 million of net sales of market- able securities and investments represents an increased investment in cash equivalents in a rising short-term interest rate environment. Cash and short-term investments, in part, represent our resources available to do an acquisition before drawing on our available credit facilities and incurring additional debt. Actual acquisition spending, however, may vary depending upon the availability and timing of a suitable candidate. Bio-Rad 2005 Annual Report : 63 Management’s Discussion and Analysis (continued) Cash Flow from Financing Activities Net cash ﬂow provided from ﬁnancing was $1.3 million for 2005 and reﬂects the reduction in activities during 2005, as no borrowings occurred and early payments on existing international debt were repaid. During the fourth quarter of 2004, we borrowed $200 million at 6.125% due 2014 in a private placement. This borrowing, along with the $225 million at 7.5% due 2013, provides us with capital at a ﬁxed rate for the next nine and eight years, respectively. Our focus for the company is to make an acquisition to supplement our internal growth. We routinely meet and discuss potential acquisitions with speciﬁc companies, principals or their agents. A speciﬁc acquisition of a material nature has not, as of this date, been identiﬁed but we continue to attempt to locate opportunities. Bio-Rad completed three signiﬁcant ﬁnancing transactions during 2003. These transactions were the comple- tion of a $150.0 million revolving credit facility, the placement of $225.0 million aggregate principal amount of Senior Subordinated Notes in a private offering and completion of a cash tender offer to retire all of our out- standing 11-5/8% Senior Subordinated Notes due in 2007. The $225.0 million private placement was exchanged for the new 7.5% Exchange Notes that have been regis- tered under the Securities Act of 1933, as amended, or applicable state securities laws. This transaction was completed on October 30, 2003, with the new Exchange Notes being virtually identical in all material respects to the 7.5% private placement. The $150.0 million revolving credit facility is secured by substantially all of our personal property assets and the assets of our domestic subsidiaries and 65% of the capital stock of certain foreign subsidiaries, and is guar- anteed by all of our existing and future domestic subsidiaries (other than immaterial domestic subsidiaries as deﬁned for purposes of the new credit facility). The Board of Directors has authorized us to repurchase up to $18 million of Bio-Rad’s common stock over an indeﬁnite period of time. Through December 31, 2005, we have cumulatively repurchased 1,179,272 shares of Class A Common Stock and 60,000 shares of Class B Common Stock for a total of $14.7 million. Our credit agreements restrict our ability to repurchase our own stock. There were no share repurchases made during 2005 or 2004. Contractual Obligations The following summarizes certain of our contractual obligations as of December 31, 2005 and the effect such obligations are expected to have on our cash ﬂows in future periods (in millions): Contractual Obligations Total Less Than One Year 1-3 Years 3-5 Years More than 5 Years Long-term debt, including current portion (1) $ 426.1 $ 0.4 $ 0.6 $ 0.1 $ 425.0 Interest payments Operating lease obligations (2) Purchase obligations (3) Long-term liabilities 239.6 60.1 13.2 21.4 29.1 20.9 9.4 — 87.4 87.4 22.3 2.1 4.6 8.9 1.0 1.2 35.7 8.0 0.7 15.6 (1) These amounts represent expected cash payments, include capital lease obligations and are included in our Consolidated Balance Sheets. See Note 7 of the Consolidated Financial Statements for additional information about our debt. (2) Operating lease obligations are described in Note 13 of the Consolidated Financial Statements. (3) Purchase obligations include agreements to purchase goods or services that are enforceable and legally binding on Bio-Rad and that specify all signiﬁ- cant terms. Purchase obligations exclude agreements that are cancelable without penalty. 64 : Bio-Rad 2005 Annual Report Financial Risk Management Bio-Rad uses derivative ﬁnancial instruments to reduce our exposure to ﬂuctuations in foreign exchange rates and, on occasion, interest rates. No derivative ﬁnancial instruments are entered into for the purpose of speculat- ing or trading. Company policy limits all derivative positions exclusively to reducing risk by hedging an underly- ing economic exposure. These derivative investments do not qualify for hedge accounting treatment under SFAS 133, Accounting for Derivative Instruments and Hedging Activities. Derivative instruments used in these transactions will be valued at fair value and changes in fair value will be included in reported earnings. Bio-Rad operates and conducts business in many countries and is exposed to movements in foreign currency exchange rates. Additionally, Bio-Rad’s consolidated net equity is impacted by the conversion of the net assets of international subsidiaries for which the functional currency is not the U.S. Dollar. Foreign currency exposures are managed on a centralized basis by our treasury department. This allows for the netting of natural offsets and lowers transaction costs and exposures. Bio-Rad currently makes more than 60% of its sales outside the United States and weakening in one currency can often be offset by strengthening in another currency. Bio-Rad typically enters into forward exchange contracts to sell its foreign currency. Contracts primarily in British Sterling, Japanese Yen and the Euro, are entered into typically for 30 to 60 days. Bio-Rad records the change in the value of its foreign currency intercompany receivables and payables as a foreign exchange gain or loss on its statements of income along with the change in the fair market value of the forward exchange contract used as an economic hedge of that asset or liability. Bio-Rad uses sensitivity analysis to assess the market risk associated with its foreign currency exchange risk. Market risk is the potential change in fair value of derivative positions from an adverse movement in currency exchange rates. At year-end, a 10% adverse loss on quoted foreign currency exchange rates would result in an approximate $8 million loss on our derivative position. This impact of a change in exchange rates excludes the offset derived from the change in our underlying assets and liabilities, which could reduce the effect to zero. Our long-term debt consists primarily of ﬁxed rate instruments. Bio-Rad uses sensitivity analysis to assess the market risk associated with its interest rate risk. As of December 31, 2005 our interest rate risk was not signiﬁcant. Bio-Rad 2005 Annual Report : 65 Corporate Information Directors David Schwartz Chairman of the Board James J. Bennett Director Albert J. Hillman Director Ruediger Naumann-Etienne Director Philip L. Padou Director Alice N. Schwartz Director Norman Schwartz Director Ofﬁcers David Schwartz Chairman of the Board Norman Schwartz President and Chief Executive Ofﬁcer Brad Crutchﬁeld Vice President and Group Manager Life Science John Goetz Vice President and Group Manager Clinical Diagnostics Ronald W. Hutton Treasurer Robyn Hawkins Manager, Quality Systems James R. Stark Corporate Controller Other Executives Patrick Bugeon Group Operations Manager, France Clinical Diagnostics John Hertia Group Operations Manager, U.S. Clinical Diagnostics Nicholas Roelofs Group Operations Manager, U.S. Life Science Bruce Bartholomew Manager, North America Sales, Clinical Diagnostics Steve Binder Director, Technology Development, Clinical Diagnostics John Bussell Manager, Clinical Systems Francois Capit Regional Manager, Asia Paciﬁc Patrick Carroll Manager, North America Sales, Life Science Annual Meeting The Annual Meeting of Stockholders will be held on Tuesday, April 25, 2006 at 4:00 p.m., Paciﬁc Time, at the Corporate Ofﬁces of the Company in Hercules, California. Bio-Rad will provide without charge to each stockholder, upon written request to the Secretary, a copy of its 2005 Annual Report ﬁled with the Securities and Exchange Commission on Form 10-K. Transfer Agent Computershare Investor Services LLC 2 North LaSalle Street Chicago, Illinois 60602 Tel: (312) 360-5132 Fax: (312) 601-4332 www.computershare.com Scott Jenest Manager, Manufacturing, Life Sciences Bill Kuhlman Manager, Process Chromatography Ann Madden Manager, Clinical Microbiology Paul Menter Manager, Laboratory Separations Daniel Merle Manager, Business Development, Clinical Diagnostics Todd Morrill Manager, Business Development, Life Science Leonard Pulig Manager, Marketing, Life Science Auditors Deloitte & Touche LLP San Francisco, California Sanjiv Suri Regional Manager, Eastern Europe, Latin America Common Stock Traded on the American Stock Exchange Sadashi Suzuki Regional Manager, Japan Class A Common Stock Symbol BIO Annette Tumolo Manager, Gene Expression Class B Common Stock Symbol BIOb Giovanni Magni Vice President and International Sales Manager Diane Dahowski Manager, BioPlex Christine A. Tsingos Vice President and Chief Financial Ofﬁcer Sanford S. Wadler Vice President, General Counsel and Secretary Patrice Deletoille Manager, Blood Virus David Forrester Regional Manager, Europe 66 : Bio-Rad 2005 Annual Report Bio-Rad Laboratories 1000 Alfred Nobel Drive Hercules, CA 94547 Tel: (510) 724-7000 Fax: (510) 741-5817 www.bio-rad.com

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