20-F 1 form20f.txt UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 20-F (MARK ONE) |_| REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR (g) OF THE SECURITIES EXCHANGE ACT OF 1934 OR |X| ANNUAL REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED NOVEMBER 30, 2004 OR |_| TRANSITION REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD ................. TO ................. COMMISSION FILE NUMBER 0-28856 INSTRUMENTATION LABORATORY S.p.A. (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) NOT APPLICABLE (TRANSLATION OF REGISTRANT'S NAME INTO ENGLISH) REPUBLIC OF ITALY (JURISDICTION OF INCORPORATION OR ORGANIZATION) VIALE MONZA 338 20128 MILANO ITALY (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) SECURITIES REGISTERED OR TO BE REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE SECURITIES REGISTERED OR TO BE REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED ------------------- ----------------------------------------- American Depositary Shares, each NONE representing one Ordinary Share, (euro)0.33 par value per share(1) SECURITIES FOR WHICH THERE IS A REPORTING OBLIGATION PURSUANT TO SECTION 15(d) OF THE ACT: NONE INDICATE THE NUMBER OF OUTSTANDING SHARES OF EACH OF THE ISSUER'S CLASSES OF CAPITAL OR COMMON STOCK AS OF THE CLOSE OF THE PERIOD COVERED BY THE ANNUAL REPORT. 362,521,088 Ordinary Shares, (euro)0.33 par value INDICATE BY CHECK MARK WHETHER THE REGISTRANT (1) HAS FILED ALL REPORTS REQUIRED TO BE FILED BY SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 DURING THE PRECEDING 12 MONTHS (OR FOR SUCH SHORTER PERIOD THAT THE REGISTRANT WAS REQUIRED TO FILE SUCH REPORTS), AND (2) HAS BEEN SUBJECT TO SUCH FILING REQUIREMENTS FOR THE PAST 90 DAYS. YES X NO _ Indicate by check mark which financial statement item the registrant has elected to follow. Item 17 __ Item 18 X --------------------------------- (1) The par value of an Ordinary Share was changed from (euro)1.29 to (euro)0.33 by a resolution made at the shareholders meeting of the Company on March 29, 2004. TABLE OF CONTENTS PRESENTATION OF FINANCIAL INFORMATION........................................1 Part I.......................................................................2 Item 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS............2 Item 2. OFFER STATISTICS AND EXPECTED TIMETABLE..........................2 Item 3. KEY INFORMATION..................................................3 Item 4. INFORMATION ON THE COMPANY......................................14 Item 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS....................34 Item 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES......................54 Item 7. MAJORITY SHAREHOLDERS AND RELATED PARTY TRANSACTIONS............58 Item 8. FINANCIAL INFORMATION...........................................60 Item 9. THE OFFER AND LISTING DETAILS...................................62 Item 10. ADDITIONAL INFORMATION..........................................65 Item 11. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK......73 Item 12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES..........75 Part II.....................................................................76 Item 13. DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES.................76 Item 14. MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS.............................................77 Item 15. CONTROLS AND PROCEDURES.........................................77 Item 16A. DISCLOSURE ON AUDIT COMMITTEE FINANCIAL EXPERT..................78 Item 16B. CODE OF ETHICS..................................................78 Item 16C. PRINCIPAL ACCOUNTANT FEES AND SERVICES..........................78 Item 16D. EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES......79 Item 16E. PURCHASES OF EQUITY SECURITIES..................................80 Item 17. FINANCIAL STATEMENTS............................................81 Item 18. FINANCIAL STATEMENTS............................................81 Item 19. EXHIBITS........................................................82 SIGNATURES..................................................................83 In this annual report ("Annual Report") on Form 20-F, all references to we, our, the "Company" and "IL" are to Instrumentation Laboratory S.p.A. and, unless the context otherwise requires, our subsidiaries. PRESENTATION OF FINANCIAL INFORMATION Unless otherwise indicated, our financial information contained in this Annual Report has been prepared in accordance with accounting principles prescribed by Italian law and supplemented by the accounting principles issued by the Italian Accounting Profession or, in the absence thereof, the International Accounting Standards Committee (collectively, "Italian GAAP"), which, as described in Notes 21 and 22 to the Audited Consolidated Financial Statements, differ in certain significant respects from accounting principles generally accepted in the United States ("U.S. GAAP"). Our Audited Consolidated Financial Statements are not prepared or filed pursuant to Italian Legislative Decree No. 127 of 1991, as we are exempted from such obligation pursuant to Art. 27 of the above-mentioned Legislative Decree. Unless otherwise indicated, any reference in this Annual Report to Audited Consolidated Financial Statements refers to our audited consolidated financial statements (including the notes thereto), included herein. Since November 30, 2002, we have published our consolidated financial statements ("Consolidated Financial Statements") in euro. However, the Consolidated Financial Statements for the fiscal years ended on November 30, 2001 and 2000 were originally prepared in Italian lire and have been translated into euros at the rate of Lit. 1,936.27 per euro, the official rate established by the European Monetary Union on January 1, 1999. The euro did not exist prior to that date and the conversion rate used may not reflect the lire/euro exchange rate that would have applied if the euro had existed at such times. Also, for financial information thus translated from dates and periods before November 30, 2002, you should not assume that you can accurately compare this financial information with that of other companies that have translated a non-Italian lire European currency into euro. In this Annual Report, unless otherwise specified or the context requires otherwise, references to "lira", "lire" or "Lit." are to the Italian lira (singular) or to Italian lire (plural), references to "euro" or "(euro)" are to euros and references to "$", "US $" or "dollars" are to United States dollars. Solely for the convenience of the reader, this Annual Report contains translations of certain euro amounts into dollars at specified rates. These translations should not be construed as representations that the euro amounts actually represent such dollar amounts or could be converted into dollars at those rates. Unless otherwise stated, the translations of euro into dollars have been made at the rate of $1.3259 per euro, the noon buying rate in the City of New York for cable transfers in euro certified by the Federal Reserve Bank of New York for customs purposes (the "Noon Buying Rate") on November 30, 2004. For further information regarding recent rates of exchange between euro and dollars, see "Item 3 - Key Information - Exchange Rates" "Item 3 - Risk of error in forward looking statements" and "Item 5 - Operating and Financial Review and Prospects - Currency Effects" for a discussion of how exchange rates affect us. Certain statements in this Annual Report on Form 20-F, particularly under "Item 4--Information on The Company" and "Item 5--Operating and Financial Review and Prospects" constitute "forward-looking statements" within the meaning of the U.S. securities laws. Such forward-looking statements involve known and unknown risks, uncertainties, and other factors which may cause our actual results, performances or achievements to be materially different from any future results, performance or achievements, expressed or implied by such forward-looking statements. See "Item 3--Key Information--Risk of error in forward looking statements." PART I ITEM 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS A. NOT REQUIRED. B. NOT REQUIRED. C. NOT REQUIRED. ITEM 2. OFFER STATISTICS AND EXPECTED TIMETABLE A. NOT REQUIRED. B. NOT REQUIRED. ITEM 3. KEY INFORMATION A. SELECTED FINANCIAL DATA. The following table presents our selected consolidated financial information for the periods indicated and should be read in conjunction with, and is qualified in its entirety by reference to, the Audited Consolidated Financial Statements and "Item 5 -- Operating and Financial Review and Prospects" appearing elsewhere in this Annual Report. The selected financial information as of November 30, 2003 and 2004 and for the fiscal years ended November 30, 2003 and 2004 has been derived from the Audited Consolidated Financial Statements appearing elsewhere in this Annual Report, which have been audited by BDO Sala Scelsi Farina, S.p.A., independent public accountants, whose report appears elsewhere in this Annual Report. The selected financial information as of November 30, 2000, 2001 and 2002 for the fiscal years ended November 30, 2000, 2001 and 2002, respectively, has been derived from our audited historical financial statements for such periods. Our audited historical financial statements for the fiscal years ended November 30, 2000 and 2001 were audited by Arthur Andersen S.p.A, independent public accountants. Our audited historical financial statements for the fiscal years ended November 30, 2002 were audited by BDO Sala Scelsi Farina S.p.A., independent public accountants. Prior to fiscal year 2002, Arthur Andersen served as our independent auditors. On August 31, 2002, Arthur Andersen LLP, an affiliate of Arthur Andersen, ceased practicing before the SEC. On November 25, 2002, we appointed BDO Sala Scelsi Farina S.p.A. as our independent auditors. Because our former key audit engagement team personnel have since left Arthur Andersen, Arthur Andersen did not participate in the preparation of this report or consent to the reference in this report to its audit report. As a result, investors in Instrumentation Laboratory may have no effective remedy against Arthur Andersen in connection with a material misstatement or omission in the financial statements to which its audit report relates. In addition, even if such investors were able to assert a claim, Arthur Andersen may fail or otherwise have insufficient assets to satisfy claims by investors that might arise under the U.S. federal securities laws or otherwise with respect to its audit report. The Audited Consolidated Financial Statements have been prepared in accordance with Italian GAAP, which differs in certain significant respects from U.S. GAAP. See Notes 21 and 22 to the Audited Consolidated Financial Statements. As of November 30, 2002 the U.S. subsidiary retroactively changed its inventory costing from LIFO to FIFO, to conform to the group accounting practice and to follow the benchmark treatment recommended by IAS 2. This change had no effect on the fiscal year 2002 statement of operations but originated a reduction of the loss reported for fiscal year 2001 of (euro)1,441,000 and a decrease in the shareholders' equity as of November 30, 1999 and 2000 OF (euro)1,275,000 and (euro)1,483,000, respectively. The incremental difference between fiscal yeAR 1999 and fiscal year 2000 is due to the difference of conversion rates of U.S. Dollar into euro. Since November 30, 2002 our financial statements have been presented in euro. However, the financial data below for fiscal years 2000 and 2001 was originally prepared in Italian Lire and has been translated into euro at the rate of 1,936.27 Italian Lire per euro, the official rate established by the European Monetary Union on January 1, 1999.
AS OF OR FOR THE YEAR ENDED NOVEMBER 30 2000 [RESTATED] 2001 [RESTATED] 2002 2003 [RESTATED] 2004 ----------------- ----------------- ---------------- ---------------- ----------------- (IN THOUSANDS OF EURO, EXCEPT PER SHARE AMOUNTS) INCOME STATEMENT DATA (1) ITALIAN GAAP: Net sales and revenues...... (euro) 275,312 (euro) 274,814 (euro) 272,591 (euro) 260,011 (euro) 280,031 Cost of sales and services.................. 143,163 144,207 141,549 131,066 136,893 ----------------- ----------------- ---------------- --------------- --------------- Gross profit............. 132,149 130,607 131,042 128,945 143,138 Research and development costs........ 20,124 19,588 20,072 19,238 17,765 Selling, general and administrative --------------- --------------- expenses................. 92,008 92,699 99,792 93,746 96,534 ----------------- ----------------- ---------------- --------------- --------------- Operating income before amortization of intangible assets and deferred charges.. 20,017 18,320 11,178 15,961 28,839 Amortization of intangible assets and deferred charges ....... 11,337 9,058 8,464 8,423 7,968 ----------------- ----------------- ---------------- --------------- --------------- Operating income........... 8,680 9,262 2,714 7,538 20,871 Interest income............ 1,324 1,277 980 746 739 Interest expense........... 15,924 15,382 12,210 10,810 7,272 Other income (expense) net...................... (10,016) 2,018 (2,696) (5,789) (4,751) ----------------- ----------------- ---------------- --------------- --------------- Income (loss) before income taxes............ (15,936) (2,825) (11,212) (8,315) 9,587 Income taxes............... 1,536 2,916 2,549 2,703 2,806 Minority interest.......... - (68) (80) (67) (103) ----------------- ----------------- ---------------- --------------- --------------- Net income (loss).......... (euro) (17,472) (euro) (5,809) (euro) (13,841) (euro) (11,085) (euro) 6,678 ================= ================= ================ =============== =============== Net income (loss) per share (2)............... (euro) (0.40) (euro) (0.08) (euro) (0.15) (euro) (0.12) (euro) 0.03 U.S. GAAP: Net income (loss).......... (euro) (21,002) (euro) (17,228) (euro) (14,781) (euro) (5,343) (euro) 14,553 ================= ================= ================ =============== =============== Net income (loss) per share (2).................. (euro) (0.48) (euro) (0.24) (euro) (0.16) (euro) (0.06) (euro) 0.06 BALANCE SHEET DATA ITALIAN GAAP: Working capital............ (euro) 22,527 (euro) 31,393 (euro) 8,268 (euro) 6,929 (euro) 14,818 Total assets............... 375,531 353,845 341,836 303,841 304,801 Long-term debt............. 149,466 103,335 87,814 97,234 2,076 Shareholders' equity....... 46,740 98,842 80,316 61,862 155,408 U.S. GAAP: Working capital............ (euro) 23,126 (euro) 29,220 (euro) 4,094 (euro) 2,358 (euro) 1,471 Total assets............... 409,675 388,270 370,096 320,686 331,536 Long-term debt............. 149,466 108,169 108,562 102,564 14,021 Shareholders' equity....... 81,480 119,675 81,748 52,453 149,953 -------------------------------- (1) "Net income (loss) per share" is calculated based on 44,189,477 shares outstanding for fiscal year 2000, 72,861,028 shares outstanding for fiscal year 2001, 90,701,104 shares outstanding for fiscal years 2002 and 2003 and 253,347,488 shares outstanding (the weighted average) for fiscal year 2004.
Exchange Rates The following table sets forth, for each of the periods indicated, the high, low and average Noon Buying Rates expressed in $ per 1.00 euro to the nearest cent: CALENDAR PERIOD HIGH LOW AVERAGE* --------------------- --------------- ------------ ------------- 2004 $1.36 $1.18 $1.25 2003 $1.26 $1.04 $1.14 2002 $1.05 $0.86 $0.95 2001 $0.95 $0.84 $0.89 2000 $1.03 $0.83 $0.92 November 2004 $1.33 $1.27 December 2004 $1.36 $1.32 January 2005 $1.35 $1.30 February 2005 $1.33 $1.28 March 2005 $1.35 $1.29 April 2005 $1.29 $1.29 ----------------------- * The average of the Noon Buying Rates on the last business day of each month during the year. ** euro/US dollar exchange rates for periods prior to the introduction of the euro on January 1, 1999 have been calculated by applying the fixed exchange rate of 1936.27 Italian Lire/euro established by the European Monetary Union. On May 23, 2005, the Noon Buying Rate was U.S.$1.2575 per 1.00 euro. The above rates are given for information only, and differ from the rates used in the preparation of our financial statements included in Item 18 herein. B. NOT REQUIRED. C. NOT REQUIRED. D. RISK FACTORS. We have experienced net losses and negative cash flow in recent fiscal years In recent years we have experienced significant net losses. In order for us to meet our requirements for working capital, research and development expenditures, investments in instruments, debt service and capital expenditures, we must substantially improve our operating performance from recent levels. There can be no assurance that we will achieve or, if achieved, will sustain, profitability in the future. If we cannot achieve and sustain profitability, it is likely that we will not be able to meet our funding requirements. We are substantially leveraged and it may be difficult to satisfy our debt obligations We have substantial indebtedness. At November 30, 2004, our consolidated net financial debt was (euro)28.9 million. Approximately 96% of our indebtedness is short term and is subject to repayment upon demand. We have also along with other Werfen group companies guaranteed a loan of (euro)250 million granted to Izasa Distribuciones Tecnicas S.A. We may issue additional indebtedness in the future. The degree to which we are leveraged has important consequences to you, including the following: (1) our ability to obtain additional financing in the future, whether for working capital, research and development expenditures, investments in instruments, capital expenditures, acquisitions or other purposes, may be impaired; (2) a substantial portion of our cash flow from operations is required to be dedicated to the payment of interest on our indebtedness, thereby reducing funds available to us for other purposes; (3) our flexibility in planning for or reacting to changes in market conditions may be limited; (4) we may be more vulnerable in the event of a downturn in our business; (5) we may be at a competitive disadvantage relative to less leveraged competitors; and (6) to the extent we continue to utilize short-term or variable rate borrowings to fund cash flow and working capital requirements, we will be vulnerable to increases in interest rates. We cannot assure you that our businesses will generate sufficient cash flow from operations or that future financing will be available in an amount sufficient to enable us to service our indebtedness or to make necessary capital expenditures, research and development expenditures or investments in instruments. If we are called upon to make payments under any guarantee under the loan granted to Izasa Distribuciones Tecnicas S.A., we cannot assure you that we will have the resources necessary to make such payments. Further, depending on the timing, amount and structure of any future acquisitions, we may need to raise additional capital to fund the acquisitions of additional businesses. There can be no assurance that we will be able to secure such additional funding on favorable terms, if at all. Our industry is highly competitive The in vitro diagnostics ("IVD") systems industry is highly competitive and continues to experience significant pricing pressures. Some of our competitors are significantly larger and have greater resources than us, and industry consolidation could have the effect of producing more such competitors. Moreover, we encounter different competitors in each of our key product lines, and there can be no assurance that we will not encounter increased competition in the future, which could have a material adverse effect on our financial condition and results of operations. Furthermore, competitive and regulatory conditions in many markets restrict our ability to fully recover increased costs through price increases. We compete principally on the basis of quality and breadth of product offerings, service and price. Competition within the markets which we serve is primarily driven by the need for innovative products that address the needs of customers. There can be no assurance that our competitors will not develop products or services that are more effective or less expensive than our products or which could render certain of our products less competitive. Delays in the launch of new products would result in decreased revenues from sales of instruments, together with related sales of reagents, controls, other consumables and services, during the period of the delay, as well as subsequent periods due to the longer period needed to establish an installed base and any loss of market share due to our customers' purchases of competitors' products during the delay. Moreover, our performance and future growth are dependent upon our continuing ability to develop and market new products. Significant risks in IVD industry exist The IVD industry has been significantly affected by a number of changes to the healthcare industry in general, both on a global level and in particular countries. These changes have included both legislative and regulatory developments as well as private initiatives. Significant changes in the health care systems of various countries have had a substantial impact on the manner in which we conduct our business and such changes also have had a material adverse effect on our financial condition and results of operations. In the United States, where we generated 22.7% of our fiscal year 2004 net revenues, public and private efforts to reduce health care costs, including the growth of managed care organizations and Integrated Provider Networks, have had a significant impact on the critical care and, hemostasis segments of the IVD industry in terms of, among other things, cost containment efforts and centralization of purchasing decisions. Furthermore, attempts to lower costs and increase efficiencies have led to consolidation among healthcare providers in the United States. As a result of these factors, the market for our products in the U.S. remains competitive. In addition, these competitive forces continue to place constraints on the levels of overall pricing, and this has lowered the profit margins of our products sold in the U.S. Governmental initiatives relating to the maintenance of a single European currency, among other factors, has prompted a variety of cost containment initiatives in several European governmental and private healthcare systems. These cost containment initiatives are expected to be continuing factors that may affect our ability to maintain or increase sales or profit margins. In Italy, where we generated 29.8% of our fiscal year 2004 net revenues, hospitals and other health care providers are attempting to reduce their overall costs in providing patient care. As a component of this cost, instrument suppliers, like us, have been adversely impacted as health care providers are constrained in their purchasing of instruments and consumables. Our profit margins have also been adversely affected. Similar trends are also evident in many of the other industrialized countries in which we do business, which trends may also adversely affect our financial condition and results of operations. The Italian health system is a nationalized health service in which units of government at the national, regional and local levels share payment responsibilities and policymaking authority. Under the Italian health system, accounts receivable may remain outstanding for up to 300 days on average. Such extended payment periods are accepted in the industry. As of November 30, 2004, we had (euro)29.5 million in outstanding accounts receivable from Italian governmental entities and agencies, representing approximately 36% of our outstanding trade receivables and 19% of our net sales for fiscal year 2004. Although we have not experienced any write-offs with respect to these receivables, there can be no assurance that we will not experience write-offs in the future. Historically, we generated most of our instrument sales and sales of consumables from instruments placed in the hospital central laboratory. In the last several years, an increasing amount of the hospital IVD testing is being performed in point-of-care locations with the use of instruments specifically designed for this application. We have attempted to address this trend with the development of our own point-of-care instruments and related products. However, there can be no assurance that the market penetration of our point-of-care testing devices will continue or that we will be successful in replacing lost centralized testing-related revenue with revenue generated from sales of our point-of-care products. We may not be able to effectively integrate our strategic acquisitions A key element of our strategy will be to continue to pursue strategic acquisitions of, or alliances with, companies that have products, services and technologies or industry specializations that extend or complement ours. The process of integrating acquired businesses may involve unforeseen difficulties and there can be no assurance that the potential benefits of such integration will be realized to the extent, or on the schedule, expected by us. Moreover, the integration of acquisitions or alliances may require a disproportionate amount of the time and attention of our management and our financial and other resources. Any delays or unexpected costs in connection with such integration could have a material adverse effect on our financial condition and results of operations. There can be no assurance that we will be effective in identifying or making acquisitions or in forging alliances, that any acquired business will be effectively integrated or that any acquired business or alliance will be profitable. Beckman Coulter is our sole distributor of Hemostasis products in North America and the Asia-Pacific region and any disruption in these arrangements will adversely affect our financial condition and results of operations The Strategic Alliance Agreement dated September 1, 1999 is the source of our arrangements with Beckman Coulter. Any termination of the Strategic Alliance Agreement might have a material adverse effect on our results of operations during the period subsequent to such termination due to the transition from Beckman Coulter as the distributor of our products to another distribution alternative. In addition, to the extent that we must rely upon an alternative distributor, there can be no assurance that such distributor will market our products successfully or that the terms of its distribution arrangements will be favorable to us. Fluctuations in currency rates could adversely effect our financial condition and results of operations Our financial condition and results of operations are affected by changes in the value of the euro against other currencies. The results of operations are adversely affected to the extent that the strengthening of the euro against other currencies affects the amount of sales reported in euro with respect to the sales made in such foreign currencies and may affect the demand for products in the countries in which such other currencies are utilized. Any decrease in the value of the euro as compared to other foreign currencies may expose us to adverse effects to the extent our payables and debt are payable in such foreign currency. Please see "Item 11 -- Quantitative and Qualitative Disclosure About Market Risk" for further discussion regarding currency exchange risks. Various risks relating to international operations exist A significant portion of our earnings are attributable to operations conducted outside the United States. As a result, our business is subject to certain risks beyond our control, such as changes in laws and policies affecting trade and investment (including the protection of patents and other intellectual property), increases in tariffs and other trade barriers, varying governmental regulations in the different countries where we market our products, difficulties in managing international operations and potentially adverse tax consequences. Moreover, our operating results are also affected by changes in currency exchange rates as discussed above. Decreased sales in Clinical Chemistry We continue to rely upon OEM developed clinical chemistry instruments. We no longer sell these instruments in the U.S. We primarily sell clinical chemistry instruments in Italy, the United Kingdom, Eastern Europe and the Middle East. Over the last several years, we have experienced a significant decline in our clinical chemistry installed base. Sales for clinical chemistry represented 8.1% of our sales for fiscal year 2004. Dependence on a Single Manufacturing Facilities We have one primary instrument manufacturing facility located in Lexington, Massachusetts and one primary reagent manufacturing facility located in Orangeburg, New York. A single serious incident in either of these facilities, such as a fire, could result in significant interruption of production and result in loss of sales, which could adversely affect our financial condition and results of operations. We rely on patents and other intellectual property We own numerous United States and foreign patents, and have patent applications pending in the United States and abroad. We own numerous United States and foreign registered trademarks, trade names and service marks and have applications for the registration of trademarks, trade names and service marks pending in the United States and abroad. In addition, we possess a wide array of unpatented proprietary technology and know-how. Further, we license certain intellectual property rights from third parties. Our ability to compete effectively with other companies depends, to a significant extent, on our ability to maintain the proprietary nature of our owned and licensed intellectual property. There can be no assurance as to the degree of protection offered by the claims of the various patents, the likelihood that patents will be issued on pending patent applications or, with regard to the licensed intellectual property, that the licenses will not be terminated. If we were unable to maintain the proprietary nature of our intellectual property with respect to our significant current or proposed products, our business could be materially adversely affected. There can be no assurance that we will be able to obtain patent protection for products or processes discovered using our technologies. Furthermore, there can be no assurance that any patents issued to us, or for which we have license rights, will not be challenged, invalidated, narrowed or circumvented, or that the rights granted thereunder will provide significant proprietary protection or competitive advantages to us. There can be no assurance that, if challenged, our issued or licensed patents would be held valid by a court of competent jurisdiction. Legal standards relating to the breadth and scope of patent claims are uncertain, particularly relating to the doctrine of equivalents. Accordingly, the valid scope of patent claims cannot be predicted. There can be no assurance that the claims of the patents owned or licensed by us will be interpreted by a court broadly enough to offer significant patent protection to us, or that the claims of a third party's patents will not be interpreted by a court broadly enough to cover some of our products. Litigation, which could result in substantial costs, may be necessary to enforce patents issued or licensed to us or to determine the scope and validity of third-party proprietary rights. Uncertainties resulting from the initiation and continuation of any patent or related litigation could have a material adverse effect on our financial condition and results of operations. An adverse outcome in connection with an infringement or validity proceeding brought by a third party could subject us to significant liabilities, require disputed rights to be licensed from third parties or require us to cease using the disputed technology, any of which could have a material adverse effect on our financial condition or results of operations. The costs of and the diversion of our resources associated with infringement litigation could have a material adverse effect on our financial condition and results of operations. We are subject to an increasing amount of government regulations As a manufacturer of IVD instruments, we and our products, product development and manufacturing processes are subject to extensive regulation by the United States Food and Drug Administration (the "FDA"), various other United States federal and state agencies, and a number of foreign governmental agencies. We have all necessary governmental approvals to sell our currently marketed products. We may become subject to future legislation and regulations, or interpretations of existing legislation with retroactive effect, concerning the manufacture and marketing of medical devices. This could increase the cost and time necessary to begin marketing new products and could adversely affect us in other respects not presently foreseeable. We cannot predict the effect of possible future legislation and regulations. We are subject to other federal, state, local and foreign laws and regulations relating to such matters as environmental protection, health and safety, manufacturing practices and fire hazard control, and to liabilities and compliance costs associated with past and current handling, processing, storing and disposing of medical or hazardous substances and wastes. From time to time, our operations may result in noncompliance with environmental or occupational health and safety laws, or liability pursuant to such laws. There can be no assurance that we will not be required to incur significant costs to comply with such laws and regulations in the future or that such laws or regulations will not have a material adverse effect upon our financial condition and results of operations. Our ADRs lack liquidity On September 3, 1999, our American Depositary Shares ceased to be listed on the Nasdaq National Stock Market. Our American Depositary Shares ("ADSs") were de-listed because we no longer fulfilled the minimum per share price requirement. Our ADSs are now traded on the Pink Sheets(R) service under the symbol "ISLBY." The trading volumes for the ADSs is very limited and published American Depositary Receipt ("ADR") prices may not represent an amount that is achievable upon resale. As a result, holders of the ADRs may not be able to find purchasers for the ADRs at attractive prices or at all. An investment in the ADRs represents a significant risk. We are still attempting to go private, which may affect your access to information On November 20, 2000, and again on December 28, 2001, Grupo CH-Werfen S.A. (also "Werfen") and Izasa Distribuciones Tecnicas, S.A. (also "Isaza") launched a tender offer for all outstanding shares not already beneficially owned by them. See "Item 4 - Information on the Company-Background." Although our affiliates were not successful in taking us private, our majority shareholders may still attempt to take us private. If we go private by reducing the number of U.S. holders to less than 300, we will apply for termination of registration of our shares under the U.S. Securities Exchange Act of 1934, as amended. If we terminate the registration of our shares, the information we are required to furnish to you would be reduced to that required under Italian law. Further, we would no longer be required to provide financial information in accordance with U.S. generally accepted accounting principles. We may terminate our deposit agreement with the Bank of New York Our ADRs are issuable by the Bank of New York pursuant to a deposit agreement. Under the terms of this agreement, the Bank of New York has agreed that, whenever so directed by us, it will terminate the deposit agreement by mailing notice of such termination to you. If we terminate the deposit agreement, you can: sell your ADRs for which we believe there would be a limited or no market, surrender your ADRs to the Bank of New York and withdraw ordinary shares, or do nothing which would likely result in the sale of your ADRs by the Bank of New York after one year if there are any purchasers. This will further decrease the liquidity of our shares and any remaining shareholder will be a shareholder of an Italian private company and only afforded the rights as prescribed under Italian law. We are controlled by one major shareholder As of May 23, 2005, Grupo CH-Werfen S.A. beneficially owns 96.4% of the outstanding Ordinary Shares, and continues to control us, including with respect to our management and the selection of our Board of Directors and the approval or prevention of certain corporate transactions which require majority shareholder approval. Jose Maria Rubiralta, who is one of our directors and executive officers, and Francisco Rubiralta, who is one of our directors, collectively own 100% of the outstanding stock of Werfen, and, as a result of such ownership, would be deemed to beneficially own all the outstanding Ordinary Shares owned by Werfen. As a result of transactions between us and affiliates of Werfen, potential conflicts of interest could arise. No assurance can be given that such conflicts will be resolved in our favor. We have not regularly paid dividends in the past. We have not paid any dividends on our ordinary shares since the 1991 acquisition. Some dividends will however be distributed as approved at this year's Shareholders Meeting. We cannot assure you that the Company will continue to pay dividends in the future. Under Italian law, management may make proposals regarding payment of dividends, but authority to distribute dividends is reserved to the shareholders. It is the present intention of our management to follow a policy of retaining earnings for use in the business. The determination by management to propose the payment of dividends, and the amount thereof, will depend upon, among other things, our earnings, financial condition and cash requirements, applicable restrictions on the payment of dividends under Italian law and our debt agreements and such other factors as management may deem relevant. We are involved in various legal proceedings, the outcome of which could adversely affect our results of operations We are involved from time to time in various claims and litigation incidental to the ordinary course of our business. A complaint was filed by Bio-Rad Laboratories, Inc. against us, Werfen, Izasa, and four of the Company's current officers and directors in January 2005 in the United States District Court for the Southern District of New York. The complaint asserts claims under common law for fraud, conspiracy to commit fraud and aiding and abetting fraud against all the defendants; negligent misrepresentation against the Company and the individual defendants; as well as breach of fiduciary duty under Italian Civil Code Article 2395 against the individual defendants. The complaint alleges generally that the defendants falsely understated the Company's revenues and profitability in financial statements included in the Company's public filings and public statements from 1999 to 2004, and that the price of the Company's ADSs have therefore been artificially depressed. The plaintiff, which owns ADSs, seeks an unspecified amount of damages. All the defendants have moved to dismiss the complaint. In 1996, 590 Lincoln Street Trust filed a lawsuit alleging a release of hazardous material, on or earlier than 1988, by one of its tenants, including an affiliate of our predecessor that was an operator of the site. In connection with the 1991 acquisition of our predecessor, we assumed various obligations of this predecessor including the potential liabilities involved in this matter. As such, we were named as a defendant in this lawsuit. We have denied liability. In 2002, the case went to trial and a verdict was returned against our indemnitee. A judgment has been entered in the case in the amount of approximately $2.6 million. We have appealed the decision in the case. We believe that, in any case, the proceeding will not have a material adverse effect on our financial condition or results of operations. For a discussion of certain open tax matters, see Note 12 of the Audited Consolidated Financial Statements. We believe that the foregoing claims and litigation will not have a material adverse effect upon our financial condition or results of operations. We and our shareholders face certain risks related to our former employment of Arthur Andersen as our independent auditors Prior to fiscal year 2002, Arthur Andersen served as our independent auditors. On August 31, 2002, Arthur Andersen LLP, an affiliate of Arthur Andersen, ceased practicing before the SEC. On November 25, 2002 we appointed BDO Sala Scelsi Farina S.p.A. as our independent auditors. Because our former key audit engagement team personnel have since left Arthur Andersen, Arthur Andersen did not participate in the preparation of this report or consent to the reference in this report to its audit report. As a result, investors in Instrumentation Laboratory may have no effective remedy against Arthur Andersen in connection with a material misstatement or omission in the financial statements to which its audit report relates. In addition, even if such investors were able to assert a claim, Arthur Andersen may fail or otherwise have insufficient assets to satisfy claims by investors that might arise under the U.S. federal securities laws or otherwise with respect to its audit report. RISK OF ERROR IN FORWARD LOOKING STATEMENTS All statements included or incorporated by reference into this Annual Report that are not clearly historical in nature are forward looking. When used in this Annual Report and in such filings, press releases and oral statements the words "believe," "expect" and "anticipate" and similar expressions are intended to identify forward looking statements, which speak only as of their dates. Examples of forward looking statements include discussion about our: o ability to service future debt; o potential inability to integrate acquisitions; o prediction on the outcome of legal proceedings and effect of such litigation upon our financial condition or results of operations; o anticipated trends in business and industry; o business strategies; o anticipated future growth in markets; o ability to secure clearance with respect to certain regulatory matters and our belief that we will not be required to submit to the FDA new 510(K) notices for modifications to previously cleared products; o property, plant and equipment facilities sufficiency; o environmental costs as a result of future compliance; o strategy and restructuring plan impact on results of operation; o operating and net income vulnerability due to future changes in currency; o future liquidity requirements, capital resources and financing sources; o results of operations, financial condition or cash flows being materially impacted by the adoption of new accounting standards; o potential conflicts with respect to related party transactions; and o expectations, beliefs, future plans and strategies, anticipated developments and other matters that are not historical facts. These forward looking statements are based largely on our expectations and are subject to a number of risks and uncertainties, certain of which are beyond our control. Forward looking statements may also be contained or made in future filings by us with the Securities and Exchange Commission, in our press releases and in oral statements made by our authorized officers. You should carefully review the other risk factors set forth in this section for a discussion of factors which could result in any of these forward looking statements proving to be inaccurate. ITEM 4. INFORMATION ON THE COMPANY OVERVIEW We are a leading worldwide developer, manufacturer and distributor of critical care and IVD instruments and related reagents, controls, other consumables and services for use primarily in hospital laboratories and hospital point-of-care locations. These products are used to identify and measure substances in a patient's blood and are an integral part of the diagnosis and treatment of patients. Our three major IVD product lines, hemostasis, critical care, and clinical chemistry, are marketed around the world. The percentage of net sales for fiscal years 2004, 2003 and 2002 and for each of the product lines are as follows: NET SALES - IVD PRODUCT LINES 2004 2003 2002 Hemostasis 48.5% 48.1% 49.4% Critical Care 27.5% 27.9% 28.2% Clinical Chemistry 8.1% 9.6% 8.9% We have been a participant in the IVD market for over 40 years and have established a reputation for innovation, reliability and service. In each of our three major product lines, we utilize a systems approach by providing our customers with instruments, reagents, controls, other consumables and services in a single system. We have an extensive sales and distribution network which enables us to distribute our products in over 90 countries. Our revenue is generated from a diverse global customer base, as indicated by the percentage of net sales generated by geographical locations below: NET SALES - GEOGRAPHICALLY 2004 2003 2002 Europe (including Italy) 65.5% 63.6% 58.3% Italy 29.9% 29.7% 26.8% U.S. 22.7% 24.2% 29.7% Rest of the World 11.8% 12.2% 12.0% We have a large active installed base of core instruments, which generate a stream of revenues from the continuous consumption of reagents, controls, other consumables and services. Approximately 79% of our fiscal year 2004 net sales were derived from sales of reagents, controls, other consumables and services. We have developed our strong market position through the introduction of innovative IVD products in our targeted product areas and continually seek to expand our position within those product areas through targeted product development efforts resulting from both our internal research and development teams and strategic alliances, as well as through acquisition or licensing of selected technologies. Our strategy is to be the first choice supplier of critical care and hemostasis IVD systems to the hospital, point-of-care and central laboratory markets. The key elements of our business strategy are: (1) expand point-of-care capabilities and systems; (2) develop and launch innovative products; (3) increase penetration of the U.S. IVD market; (4) achieve further cost savings; and (5) pursue selected acquisition and additional strategic alliances. We changed our fiscal year end from November 30 to December 31 in order to align it with Grupo CH-Werfen, S.A.'s year end. We will file the next annual report on Form 20-F for the period ending December 31, 2005 (and including the period from December 1 to December 31 2004) by June 30, 2006. BACKGROUND General. We acquired our predecessors in October 1991 (the "1991 Acquisition"). We were formed in 1991 by a group of three investors led by Grupo CH-Werfen, S.A. Werfen, a privately held company organized under the laws of the Kingdom of Spain, is the leading distributor, through Izasa Distribuciones Tecnicas S.A., a majority owned subsidiary organized under the laws of the Kingdom of Spain, of health care products in Spain and Portugal. Werfen, through Izasa and its subsidiaries, is our majority shareholder. Our legal and commercial name is Instrumentation Laboratory S.p.A. and we are a corporation organized under the laws of Italy. Our principal executive office is located at Viale Monza 338, 20128 Milano, Italy, and our telephone number is + 39-2-252-22-56. Initial Public Offering and Capitalization Transactions. In October and November 1996, we completed an initial public offering of our Ordinary Shares, (euro)1.29 par value per share, represented by American Depositary Shares. Through the offering and concurrent share issuances, we realized $60 million in net proceeds which we utilized to repay indebtedness. Acquisition of Chromogenix. In September 1996, we acquired Chromogenix, a leading manufacturer of reagents used primarily for hemostasis instruments. The acquisition has enabled us to provide a broader range of reagents, including reagents for ELISA, Bio-immune assays and the APC Resistance test. Acquisition of MSS. In September 1996, we acquired MSS which provides blood gas and electrolyte analyzers, together with reagents, controls, other consumables and services, which are designed to be used by the care provider for point-of-care uses. Rights Offering. In July 1998, we completed a rights offering. Pursuant to the rights offering we issued 27,329,977 Ordinary Shares and received net proceeds of (euro)34.0 million (approximately $37.5 million). All proceeds were used to repay indebtedness. Acquisition of Hemoliance. In January 1999, we acquired Hemoliance, a U.S. joint venture formed between Medical Laboratory Automation, Inc. and Ortho Clinical Diagnostics Inc., a subsidiary of Johnson & Johnson, in consideration for US $130 million. Hemoliance is a manufacturer and distributor of hemostasis systems. Restructuring Plan. In fiscal years 1999 and 2000, we initiated and implemented restructuring plans to achieve significant synergies and cost savings from the integration of Hemoliance's operations with our operations. The restructuring plans also involved the reduction of general and administrative expenses and other operating expenses. We have completed the following restructuring actions in the United States: ceasing operations at a facility, adopting an indirect distribution model and decreasing the number of employees involved in manufacturing, research and development, administration and service activities. In addition, in fiscal year 1999, we transferred our operations from Paderno Dugnano, Italy to existing facilities in Lexington, Massachusetts and transferred the Chromogenix business operations to other existing facilities. The closing of the Ann Arbor, Michigan facilities, and the transfer of the related operations to the Lexington, Massachusetts facility were completed in August 2000. De-listing. On September 3, 1999, our American Depositary Shares ceased to be listed on the Nasdaq National Stock Market. Our ADSs were de-listed because we no longer fulfilled the minimum per share price requirement. Our ADSs are now quoted on the Pink Sheets(R) service under the symbol "ISLBY." Sale of Ascoli facility. On January 31, 2000, we agreed to sell our business relating to the production and distribution of blood bags, including the related production facilities located in Ascoli, Italy. Net proceeds from the sale of this business were (euro)14.5 million and the net gain that was recorded was approximately (euro)6.6 million. Going private transaction in 2001. On November 20, 2000, Izasa Distribuciones Tecnicas S.A. and Grupo CH-Werfen S.A. launched a tender offer for all of our outstanding ordinary shares and American Depositary Shares, not already owned by them or one of their affiliates, as part of a proposed going private transaction. Izasa and Werfen offered US $0.50 per share in cash. Izasa and Werfen eventually waived the condition of going private, and proceeded to close the tender offer. On February 5, 2001, the tender offer expired and Izasa purchased 3,811,547 shares. Together with the shares that Izasa, Werfen and their affiliates already held, after the expiration of the tender offer they beneficially owned approximately 68.5% of our outstanding shares. Increase in Capital Stock in 2001. On April 20, 2001, we convened an Ordinary and Extraordinary Shareholders' Meeting at which the shareholders, among other things, resolved to increase our capital stock in an amount of (euro)59,999,998.83. Newly issued ordinary shares were issued at (euro)1.29 per ordinary share. Izasa, for itself and as assignee of Miscel Holding B.V., agreed to subscribe for all 46,511,627 newly issued ordinary shares. All of our registered shareholders had a right to subscribe to their pro rata share of the ordinary shares offered by us. When the subscription period ended on July 1, 2001, no other shareholders had exercised these rights. In consideration for these subscribed ordinary shares Izasa canceled (euro)59,999,998.83 worth of our outstanding debt owed to it. Going private transaction in 2002. On December 28, 2001, Izasa Distribuciones Tecnicas S.A. and Grupo CH-Werfen S.A. launched another tender offer for all of our outstanding ordinary shares and American Depositary Shares, not already owned by them or one of their affiliates, as part of a proposed going private transaction. Izasa and Werfen again offered US $0.50 per share in cash. Izasa and Werfen eventually waived the condition of going private, and proceeded to close the tender offer. On February 22, 2002, the tender offer expired and Izasa purchased 700,194 American depositary shares. Together with the shares that Izasa, Werfen and their affiliates already held, after the expiration of the tender offer they beneficially owned approximately 85.4% of our outstanding shares. Increase in Capital Stock in 2004. On March 29, 2004, we convened an Ordinary and Extraordinary Shareholders' Meeting at which the shareholders, among other things, resolved to increase our capital stock by a maximum amount of (euro)104,999,999.94. At the same meeting the shareholders resolved to decrease the par value of our ordinary share from (euro)1.29 to (euro)0.33. This decision was taken as under Italian law, the total shareholders' equity of a company is required to be above two-thirds of its share capital. In a case that the total shareholders' equity is less than two-thirds of the originally paid-in amount of share capital, a company's board of directors is required to convene, within one year, a meeting of the shareholders and the shareholders must decide the best mean to address this shortfall. Newly issued ordinary shares were issued at the new par value of (euro)0.33 per ordinary share. An affiliate of Izasa, IL Holding S.p.A, subscribed its pro rata share, 85.4%, of the new ordinary shares. All of our registered shareholders and holders of ADSs (subject to an exemption from the registration requirements under the U.S. securities laws) had a right to subscribe to their pro rata share of the ordinary shares offered by us. When the subscription period ended on May 26, 2004, no other shareholder had exercised these rights, and an affiliate of Izasa, IL Holding S.pA. owned 96.4% of our outstanding shares. In consideration for these ordinary shares subscribed, the Company agreed to cancel the outstanding debt of (euro)89,700,595 the Company owed to IL Holding S.p.A. See "Item 5 - Operating and Financial Review and Prospects" for a discussion of our capital expenditures. PRODUCT LINES We have three core product lines: o Hemostasis systems, representing 48.5% of fiscal year 2004 net sales; o Critical care systems, representing 27.5% of fiscal year 2004 net sales; and o Clinical chemistry systems, representing 8.1% of fiscal year 2004 net sales. In addition, we generate sales from distribution of products manufactured by third parties (collectively, "Distributed Products"), which represented 15.9% of our fiscal year 2004 net sales. HEMOSTASIS SYSTEMS Hemostasis is the natural process that maintains blood in a fluid state within the body, while enabling the body to rapidly respond to damage to blood vessels and prevent blood loss. The hemostasis process reduces blood flow and prevents blood loss at the site of injury by plugging the leak with a fibrinous mass (a clot). Any imbalance in this system can result in abnormal bleeding (e.g., hemophilia) or abnormal clotting (e.g., stroke). We have a broad range of reagents and instruments used to monitor the hemostatic state of patients. Testing can detect hemostatic disorders that can result in abnormal bleeding (e.g., hemophilia), or that can cause abnormal clotting (e.g., APCR-V) or other inherited defects (e.g., protein C deficiency). Testing is also performed to monitor anticoagulant drugs which are used to treat patients with blood clotting disorders, including patients who have experienced or are susceptible to heart attacks or strokes or who have undergone coronary bypass surgery. Approximately two-thirds of hemostasis tests performed are aPTT and PT tests. The aPTT and PT tests are used as general screening tests to provide an overall assessment of a patient's ability to form a clot and are also used to monitor and maintain within a safe treatment range the effects of anticoagulant drugs that are used in the treatment of patients with hemostatic disorders. The Venture Planning Group, Glover, Leonard & Redshaw, Boston Biomedical and company estimates which provide the basis for our hemostasis market share information, estimate the 2004 worldwide market for hemostasis systems in which we operate at approximately $780 million (representing sales of instruments, reagents, controls, other consumables and services). Approximately 30 % of such revenues were derived from the United States, 40% were derived from Western Europe, 17% were derived from Japan and 13% were derived from the rest of the world. Hemostasis systems are primarily sold to hospital laboratories and independent clinical laboratories. The overall market is relatively mature, with sales of instruments consisting primarily of replacement of older instruments. We believe that, based on revenue generated from reagents and instruments, in 2004 we had the second largest overall market share in the worldwide hemostasis systems market with a market share of approximately 27% of end-user sales. Of our fiscal year 2004 sales attributable to hemostasis systems, approximately 61.9% were derived from Europe (22.9% from Italy), 26.5% from the United States and 11.% from the rest of the world. In 2004, reagents, controls and other consumables comprised approximately 70% of the revenues in the worldwide hemostasis market. We believe that the worldwide hemostasis market, including instruments, reagents, controls and other consumables, will continue to grow primarily through increased demand for specialty tests, expanded test menus, advances in testing for risk assessments and growth of point-of-care testing. We offer an extensive line of reagents and controls for hemostasis systems, including reagent formulations designed to address the differences between the U.S. and European marketplace, which we believe has enabled us to penetrate new markets. Although our primary focus is in the aPTT and PT markets, we have developed, and are continuing to develop, reagents for specialty tests. While these specialty tests represent a relatively small percentage of the overall testing volume, this segment of the market generates higher profitability and is expected to grow faster than the overall hemostasis market. In our hemostasis product line, we are pursuing distinct growth strategies with respect to our reagents and to our instruments. For reagents, we are seeking to: (1) increase penetration in the market for specialty testing for deep vein thrombosis and pulmonary embolism exclusions, Thrombophila and Lupus Anticoagulants, bleeding disorders and anticoagulant monitoring through our existing research and development activities and collaboration efforts, as well as improved marketing; (2) continue to provide robust and reliable routine assays by applying the most advanced technologies, plus easy-to use/ready-to use reagents; (3) further develop controls and calibrators; (4) develop new reagents as existing product lines are upgraded and new products are introduced; and (5) reduce reliance on third-party OEMs. We believe there is an emerging trend towards the development of specialty testing, particularly in the United States due to the historically low incidence of such testing in the United States as compared to Europe. We are exploring opportunities within this growth area and are currently developing reagents for innovative immunological, clotting and chromogenic assays. For instruments, we plan to continue to maintain our strong position within the low-to-medium throughput segment of the hemostasis market by upgrading our instruments to meet customers' needs. In addition, we are also developing instruments for the high throughput end of the hemostasis market, which includes the ACL TOP that we began commercialization in 2004. The ACL TOP provides customers with testing process automation with high throughput, continuous operation and broad test menu of routine and specialty assays. With the introduction of the ACL TOP and our reagent menu, our hemostasis systems provide solutions to the low to high market segments. The following sets forth our principal hemostasis products, the instrument list prices of which range from $15,000 to $100,000 for instruments currently marketed:
FISCAL YEAR OF TARGET MARKET NAME INTRODUCTION/STATUS SEGMENT (1) FEATURES -------------------------------------------------------------------------------------------------------------------------------- ACL FAMILY ACL 100 family 1988 Low to Medium o Low-cost automated operation o Walk-away capability (i.e., ability of operator to load samples and walk away) ACL 1000 family 1991 Low to Medium o Low-cost automated operation o Walk-away capability o Random access ACL 7000 1997 Low to Medium o Low cost with features found on larger systems o On board bar code scanner o Walk-away capability o Chromogenic and immunological testing capability ACL 8000/9000/10000 2000 Low to Medium o Increased reagent and sample capacity family o Increased walk-away capability o Automatic rotor changer (ACL 9000/10000) o Chromogenic and immunological testing capability ACL Advance 2000 Medium to High o Increased throughput, fully automated o Increased walk-away capability o Chromogenic and immunological testing capability o Increased on-board reagents ACL TOP 2004 High o Broad test menu for routine and specialty assays: Clotting, chromogenic and immunological o High throughput and continuous operation o Windows(R) 2000 software and touch-screen o Automated reagent management, automated QC, automated maintenance o Bar-coded vials for all materials o Closed-tube sampling with cap-piercing (in development) o Lab Automation System capability (in development) GEM GEM / PCL 1998 Point-of-Care o Rapid, reliable results Coagulation System o Whole blood o Portable, hand-held REAGENTS PT and APTT tests Various N/A o Company manufactured Specialty tests Various N/A o Manufactured through both internal development Immunological tests Various N/A and OEM CONTROLS AND CALIBRATORS Various N/A o Company manufactured ------------------------------ (1) In terms of throughput. Low throughput generally is less than 50 tests per hour. Medium throughput generally is between 50 and 150 tests per hour. High throughput generally is more than 150 tests per hour.
CRITICAL CARE SYSTEMS Critical care tests are typically performed on patients undergoing emergency procedures or otherwise facing life-threatening conditions. Our critical care products include blood gas, electrolyte, metabolite, coagulation and Co-Oximetry analyzers, as well as instruments that include a combination of these five analyte groupings, together with the associated reagents, controls and other consumables and services. Our critical care instruments are focused on the needs of hospital central laboratories, respiratory therapy laboratories and the critical care areas of a hospital, such as STAT (emergency) laboratories, intensive care units, operating rooms and emergency rooms, which we target with our line of point-of-care products. Blood gas analyzers test the level of oxygen and carbon dioxide in a patient's body and the patient's acid/base (pH) levels. Our principal blood gas products include the GEM Premier 3000 and the Synthesis family of products. Electrolyte analyzers measure sodium, potassium, ionized calcium, pH and chloride which are necessary for the proper functioning of the heart and other muscles. Our principal electrolyte products include the ILyte family of products. Co-Oximetry analyzers measure the patient's ability to transport oxygen. Our principal Co-Oximetry products include the IL 682 Co-Oximeter and GEM OPL. Blood gas analyzers are primarily used in hospitals, specifically in respiratory therapy departments, central laboratories and in many of the critical care areas of the hospital, such as intensive care units, emergency rooms and operating rooms. Blood gas instruments must be continuously maintained and calibrated to ensure the instrument's preparedness for STAT blood gas analysis. Each instrument uses a substantial amount of reagents, controls, calibrators and other consumables during normal operation. We offer an extensive line of calibrating gases and reagents, replacement electrodes and membranes, cleaning solutions, data management systems, controls and calibrators for its critical care systems. The Boston Biomedical Consultants (BBC) report, which provided the basis for our critical care market share information, estimated the 2002 worldwide IVD critical care market in which we operate at approximately $588 million (representing sales of instruments, reagents, controls, and other consumables). Approximately 39% of such revenues were derived from the United States, 30% were derived from Europe, and 31% were derived from the rest of the world. Revenue from reagents, controls, and other consumables represents a substantial majority of the revenues in the worldwide critical care market. The additional capabilities provided by blood gas analyzers, such as greater ease-of-use, lactate and glucose measurement, and the ability to analyze samples nearer to the patient, have resulted in increased industry systems placements through the replacement of older and less capable instruments. We believe that in 2004 we had the third largest worldwide market share in the critical care market, with an estimated market share of approximately 13%. Of our fiscal year 2004 revenues attributable to critical care systems, approximately 50.7% were derived from Europe (15.4%. from Italy), 35.5% from the United States and 13.8% from the rest of the world. We believe that future growth in the critical care market will occur primarily through the growth of point-of-care testing and expansion of test menus. To the extent such expansion results in the consolidation into one instrument of tests which generally are performed today on several instruments, we believe that the more rapid replacement of older instrument models will tend to increase IVD industry sales in the future. In addition, we believe that continuing pressures to reduce testing turnaround time and re-engineer hospital services to reduce total hospital costs and patient care time will increase the penetration of time-sensitive testing in the point-of-care areas of acute care hospitals. We believe this trend to more decentralized forms of time-sensitive testing will increase the number of systems servicing the market. The following sets forth our principal critical care products, the instrument list prices for which range from US $3,500 to US $25,000 for instruments currently marketed: FISCAL YEAR OF NAME INTRODUCTION/STATUS IMPORTANT CHARACTERISTICS ------------------------------------------------------------------------------ BLOOD GAS Synthesis family 1997 o First instrument to integrate blood gas, Co-Oximetry, electrolyte and glucose functions in a single instrument using a single sample and channel 2000 o 1740 - expanded menu, without Co-Oximetry testing o 1745 - expanded menu, with Co-Oximetry testing GEM Premier 3000 2000 o Point-of-care and laboratory blood gas, electrolyte and metabolite system which provides fast and accurate results o Utilizes a multi-use disposable cartridge, each capable of performing 75 to 600 tests, instead of traditional electrodes, solutions, gas tanks and other consumables o Small sample size o Integration of external point-of-care systems (i.e., GEM PCL)o GEM PCL 1998 o Point-of-care coagulation hand-held system for the rapid measurement of PT, APTT and LR-ACT CO-OXIMETRY IL 682 Co- 1995 o Operates as independent system, Oximeter or electronically links to IL GEM Premier family and Synthesis family GEM OPL 2000 o Point-of-care co-oximetry testing, electronically links to IL GEM Premier family ELECTROLYTES ILyte Family 1994 o Low-cost, easy-to-use system for the measurement of electrolyte panels DATA MANAGEMENT IMPACT 1997 o Solves the primary barrier to point-of-care IVD growth (i.e., patient and instrument data consolidation and verification) o Enables hospital management to consolidate and control data from all IL blood gas systems regardless of location within the hospital GEMweb 2001 o Web-based remote instrument management system CONTROLS AND Various o Broad line of specific and CALIBRATORS multi-analyte controls for blood gas/Co-Oximetry/electrolyte/ glucose, including patent protected technologies IQM 2003 o Revolutionary automated quality control and quality assurance system for GEM Premier 3000 analyzers CLINICAL CHEMISTRY SYSTEMS Clinical chemistry systems are used for routine and emergency tests to analyze bodily fluids, including serum, urine and spinal fluids for diagnostic profiles, such as cholesterol levels, anemia, cardiac and hepatic diseases, the level of therapeutic drugs and the presence of drugs of abuse. Our principal clinical chemistry instrument is the ILab 600, which is designed for the low-to-medium throughput end of the market, and was launched in 1998. Of our fiscal year 2004 sales attributable to clinical chemistry systems, approximately 83.3% were derived from Europe (45.4% from Italy), zero from the United States and 16.7% from the rest of the world. We sell our clinical chemistry system to clinical and specialty laboratories primarily located in hospitals, as well as to clinical reference laboratories and veterinary laboratories. This relatively mature market is very competitive and price-sensitive, with instrument sales consisting primarily of replacement of older instruments. Over the past several years, the market for new placements of clinical chemistry systems has significantly declined, and we have experienced a related decline in our clinical chemistry installed base. Currently the majority of our clinical chemistry products are sold in Europe, while clinical chemistry sales in the rest of the world continue to decline. One reason we sold our Ascoli factory and streamlined our production facilities into the leased Ascoli facility is that our clinical chemistry sales are now primarily focused in Europe. Prior to fiscal year 1997, our principal clinical chemistry instrument was the Monarch. The Monarch had not been substantially revised since 1991 and we ceased its production in fiscal year 1996. With no comparable replacement product, we have experienced a significant decline in our clinical chemistry installed base and reduced sales of reagents and other consumables relating to this decline in the installed base. Although we launched ILab 600 in 1998 and ILab 300 plus in 2002, we continue to experience lower sales in chemical chemistry. We source all of our clinical chemistry instruments on an OEM basis, while retaining responsibility for reagent production, marketing, product support and advice. Since 1998, due to the competitive pressures existing in the U.S. clinical chemistry market, we decided to discontinue placements of new chemistry systems in the U.S., while continuing to provide reagents, disposables and service to the existing installed base. Sales in the U.S. substantially ceased during 2004. We primarily market these products in Italy, the United Kingdom, Eastern Europe and the Middle East. In addition, we manufacture and distribute a line of clinical chemistry control products, including assayed routine clinical chemistry controls, therapeutic drug controls and urine chemistry controls, which are sold for use with both our and other manufacturers' systems. We primarily seek to enter into arrangements with OEMs and other developers of reagents. The following sets forth our principal clinical chemistry instruments, the instrument list prices of which range from US $72,500 to US $170,000: FISCAL YEAR OF TARGET NAME INTRODUCTION/STATUS MARKET FEATURES SEGMENT(1) --------------------------------------------------------------------------- ILAB FAMILY Ilab 600 1998 Low to o Floor standing Medium o 64 tests on line, plus ISE o 70 reagents on board o Throughput 400 photometric plus ISE o Fully random access Ilab 300 plus 2002 Low o Ease of use o 35 tests on line, plus ISE o 35 reagents on board o Throughput 200 photometric plus ISE REAGENTS AND Various N/A o Broad line of CONTROLS substrates, enzymes, TDM and DAT -------------------- (1) In terms of throughput. Low, medium and high throughput generally are less than 300, between 300 and 1000, and more than 1000 tests per hour, respectively. Other Products We seek to distribute products of third parties which are complementary to our own and which enable us to leverage our existing infrastructure in order to increase revenue and profit with minimal additional investment. Other products, including hematology, flow cytometry, microbiology instruments and consumables, are distributed by us in certain European countries and are distributed primarily through long-term exclusive agreements. In connection with Beckman Coulter's agreement to serve as the exclusive distributor of certain of our products, directly or through its affiliates (collectively "Beckman Coulter"), we serve as the exclusive distributor of Beckman Coulter's hematology, flow cytometry and scientific product lines in Austria and Italy. Approximately 12.2% of our fiscal year 2004 net sales were derived from sales of Beckman Coulter's products. We also distribute in Italy, France, Germany, the United Kingdom and in the Benelux Countries certain products of Biokit, S.A., a majority owned subsidiary of Werfen, which develops and manufactures microbiology test kits and reagents for the diagnosis of infectious diseases. POINT-OF-CARE Over the last few years, an increasing amount of the hospital IVD testing is being performed in point-of-care locations with the use of systems specifically designed for testing at or near the point of patient care. We seek to exploit this trend by developing and increasing the installed base of our own point-of-care instruments and related products. In 1996, we introduced the GEM Premier Plus product line for point-of-care blood gas and electrolyte testing. We launched GEM Premier 3000 product for point-of-care testing in April 2000. We have also expanded our point-of-care capability to our hemostasis product line. For example, we introduced the GEM PCL point-of-care testing system in 1998. Taken together, these new product introductions and strategic alliances position us to be the leading provider of hospital point-of-care testing systems for both the critical care and hemostasis markets. Moreover, we continue to expend significant amounts on point-of-care research and development activities, and we intend to continue to pursue selected acquisitions and additional strategic alliances to increase our point-of-care product lines and distribution capabilities. CUSTOMERS We have a broad customer base that includes primarily hospital laboratories, clinical reference laboratories and point-of-care locations within the hospital market. Although we sell our products worldwide, our sales are concentrated in Italy, where many of the hospitals are managed and funded by regional governments, and the United States. No single end-user customer represented more than 5% of our fiscal year 2004 net revenues. INSTRUMENT PLACEMENTS Most of our instrument placements in our three core product lines are sold directly to customers and distributors, and a minority are sold to third-party lessors, either directly or through the sale to various third-party lessors via a lease agreement with its customer, or are financed by us. One of the financing methods offered by us to offset the large up-front costs of purchasing its systems is the reagent rental agreement. Pursuant to a reagent rental agreement, the customer leases the instrument, often at a nominal lease rate, while we retain title to the instrument. The agreement requires the customer to purchase reagents and service from us for the life of the instrument lease. We invested approximately (euro)21.6 million, (euro)17.0 million and (euro)17.3 million in reagent rental agreements in fiscal years 2002, 2003 and 2004, respectively. Sales of reagents, controls, other consumables and services are affected by the rate of growth of our active installed base. It often takes one to three months from the sale of new instruments before revenues from the consumption of reagents, other consumables and services from such instruments are realized. Thereafter, significant consumables and service revenues are realized over the life of the instrument. COMPETITION The IVD industry is highly competitive, and we encounter competition from several manufacturers in both domestic and foreign markets. Many of our competitors are significantly larger and have greater resources than us. Moreover, we encounter different competitors in each of our key product lines, and there can be no assurance that we will not encounter increased competition in the future, which could have a material adverse effect on our business. Our principal competitors in the critical care product line are Bayer and Radiometer A/S; and in our hemostasis product line are Dade-Behring Inc. and Diagnostica Stago S.A. We have numerous competitors in our clinical chemistry product line. We compete principally on the basis of quality and breadth of product offerings, price and service. Competition within the markets that we serve is primarily driven by the need for innovative products that address the needs of our customers in each market in which we compete. We attempt, to the extent possible, to counter competition by seeking to develop differentiated new products and provide quality products and services that meet the customers' needs. There can be no assurance, however, that our competitors will not develop products or services that are more effective or less expensive than our products or which could render certain of our products less competitive. Delays in the launch of new products would result in decreased revenues from sales of instruments, together with sales of related reagents, controls, other consumables and services, during the period of the delay, as well as during subsequent periods due to the longer period needed to establish an installed base and any loss of market share due to our customers' purchases of competitors' products during the delay. Moreover, our performance and future growth are dependent upon our continuing ability to develop and market new products. RESEARCH AND DEVELOPMENT We maintain an active research and development program focused on developing and commercializing products which complement and update our existing product offerings. We devote significant resources to the continued development and introduction of new products and believe that we are a leader in the introduction of innovative critical care and hemostasis IVD products. Our product development resources will continue to focus on: (1) broadening test menus through the introduction of new reagents; (2) upgrading instrument capabilities, including continued introduction of easier-to-use and lower-cost systems; (3) applying core technologies, either developed internally or through strategic alliances or through acquisitions, to enter new market segments and to broaden product offerings; and (4) broadening and improving current near-patient product offerings. We develop our products through our research and development team and, where strategically beneficial, through university alliances, instrument OEMs and other strategic partnerships. Our research and development expenditures for fiscal years 2002, 2003 and 2004 were (euro)20.1 million, (euro)19.2 million and (euro)17.8 million respectively, representing 9.5% 9.7% and 8.3% respectively, of our net sales for such years (excluding revenues from products distributed by us for third parties). As discussed in "Item 7-Majority Shareholders and Related Party Transactions" we executed a Cost Sharing Agreement with Izasa on May 4, 2001, that requires Izasa to help finance our research and development work. MANUFACTURING We have one primary instrument manufacturing facility located in Lexington, Massachusetts. Currently, we have one primary reagent manufacturing facility located in Orangeburg, New York, and a secondary reagent manufacturing facility located in Ascoli Piceno, Italy. A series of voluntary international quality standards, specific to medical devices, known as ISO 13485, exist for manufacturing, installation, research and development and other areas of our operations. ISO 13485 status at a manufacturing facility indicates to a purchaser that the product was produced in a facility that adheres to a stringent and uniform quality standard. Our facilities in Lexington, Massachusetts and Orangeburg, New York are certified according to the ISO 13485 standard. The Ascoli Piceno plant is certified according to both the ISO 13488 and ISO 9002 standards. SERVICE ORGANIZATION Service is a critical component of providing a complete systems offering. Our service organization is comprised of: (1) individuals responsible for receiving initial customer complaints through our telephone service line; (2) service engineers, who provide trouble shooting in the field and customer training; and (3) service specialists, who act as the interface between us and the service engineers and are responsible for keeping the service engineers informed of the latest developments in all aspects of our products. SALES, DISTRIBUTION AND MARKETING Our sales, distribution and marketing strategy is comprised of: (1) a direct sales force which is responsible for certain of our product lines in specific markets, based on our strengths and relationships within such markets; and (2) established third party distributors. We utilize a direct sales force for our entire product line, including instruments, reagents, controls and other supplies, in Italy, Austria, Belgium, France, Germany, Lithuania, the Netherlands, Mexico, United Kingdom, and for our critical care systems in the United States, Canada and Japan. In 2002, we established new direct sales and marketing organizations in Japan and Canada. In 2002, InSource Health Service and Health Service Corporation of America merged to form MedAssets, one of the largest group purchasing organizations (GPO) in the United States. IL was awarded a three-year contract at that time. In March of 2005, this contract was extended until July 2006. In 2003, we announced the extension of our contract with Amerinet, the fourth largest GPO. This contract is effective through February 2006. In October, 2003, we entered into a two-year supply contract with Premier Purchasing Partners. This contract includes an option for a third-year. Finally, we extended two contracts with the US Government. The General Service Administration contract (instruments) was extended through 2009 and our Veterans Administration contract was extended through 2005. The principal distributors of our products are Beckman Coulter and Izasa. Izasa has been our distributor in Spain and Portugal and in 2001 we signed an agreement granting them exclusive distribution rights. Pursuant to the agreement Izasa is the exclusive distributor of our entire product line in Spain and Portugal. Sales to Izasa accounted for 3.3%, 3.5% and 4.3% of our net revenues in fiscal years 2002, 2003 and 2004, respectively. See "Item 7--Majority Shareholders and Related Party Transactions." Pursuant to the current agreement with Beckman Coulter, Beckman Coulter is the exclusive distributor of our hemostasis systems in the United States, Canada, Australia, New Zealand, China and certain other countries. Sales to Beckman Coulter accounted for 14.3% of our net revenues in fiscal year 2004, 14.1% in fiscal year 2003 and 17.6% in fiscal year 2002. BACKLOG Our business is such that it does not currently experience, nor has it historically experienced, a significant backlog of orders for reagents or instruments. SEASONALITY Although our results of operations vary from fiscal quarter to fiscal quarter, such variations do not generally follow a seasonal trend. INTELLECTUAL PROPERTY We own numerous United States and foreign patents, and have patent applications pending in the United States and abroad. Such patents generally cover only a component of our instruments, reagents or controls and such patents may not prevent a competitor from manufacturing an alternative product. No single patent is material to our business. We also own numerous United States and foreign trademarks, service marks, and trade names. In addition, we have applications for registration of trademarks, service marks and trade names pending in the United States and abroad. Further, we license certain intellectual property rights from third parties. We believe that patents and other proprietary rights are important to the development of our business, but also rely upon trade secrets, know-how, continuing technological innovations and licensing opportunities to develop and maintain our competitive position. To maintain the confidentiality of our trade secrets and proprietary information, we require our employees, consultants and collaborative partners to execute confidentiality agreements upon the commencement of their employment or other relationship with us. In the case of employees and consultants, the agreements also provide that all inventions resulting from work performed by them while in our employ will be our exclusive property. No assurance can be given that the claims in our owned or licensed patents or patent applications, either as initially allowed by the United States Patent and Trademark Office or any of its foreign counterparts, or as may be subsequently interpreted by courts inside or outside the United States, will be sufficiently broad to protect our proprietary rights, will be commercially valuable or will provide competitive advantages to us. Further, there can be no assurance that patents will be granted with respect to any of our pending patent applications or with respect to any patent applications filed by us in the future. There can be no assurance that any of our issued or licensed patents would ultimately be held valid or that efforts to defend any of its patents, trade secrets, know-how or other intellectual property rights would be successful. In some cases, litigation or other proceedings may be necessary to defend against or assert claims of infringement, to enforce patents issued to us or our licensors, to protect trade secrets, know-how or other intellectual property rights owned by us, or to determine the scope and validity of our proprietary rights or of third parties. Such litigation could result in substantial costs to and diversion of our resources. An adverse outcome in any such litigation or proceeding could subject us to significant liabilities, require us to cease using the subject technology or require us to license the subject technology from the third party, all of which could have a material adverse effect on our business, financial condition and results of operations. ITALIAN HEALTH CARE REGULATION Public health care institutions constitute the main structure of the Italian health care system, currently encompassing hospitals, clinics and medical schools. Private institutions are also numerous, but generally operate under conventions with the National Health Service and their size is more limited or specialized. The primary health care regulations govern the general regulatory framework of health-related activities, the organization of public structures and their personnel, and the supply of health care services to citizens. The creation of the current system dates back to Law 833 of December 23, 1978, which instituted a National Health Service ("Servizio Sanitario Nazionale") and introduced an extensive decentralization of powers. The Ministry of Health remains empowered to fix the general guidelines of national health policy and planning while the organization and management of public services basically occur at the regional level. Several subsequent laws set out the functioning and relations among the various levels (regional and national) of the public administration. Twenty regional administrations are responsible for the assistance activities in their territories and coordinate the activity of the approximately 620 autonomous local health authorities, which have been transformed into quasi-private enterprises, called "Aziende Sanitanie Locali or "ASLs," organized at the regional level. Universities, certain hospitals and research centers also enjoy legal and financial autonomy. The functioning of public health structures generally, and of ASLs in particular, is regulated at the national as well as regional level by a number of laws and administrative provisions. Virtually all regions have a law governing public procurements in the health sector. Such provisions generally follow the same pattern of national laws governing tenders for public works, for which the prevailing rule is the making of a public tender, in which the goods or services to be supplied are indicated in a public invitation to bid and then awarded to the most appropriate offer among those submitted by the participants to the tender. In some cases, companies participating in these offers must be pre-qualified and registered in a Suppliers' Register kept at each ASL. Private, arm's length negotiation of contracts is allowed in a very limited number of cases (such as, for example, where products to be purchased are covered by patents or similar exclusive rights). The public health care system has provided Italian citizens with a number of free services (ranging from hospital care to medical analysis, local physician assistance and supply of pharmaceuticals), substantially funded by the public sector (in some cases with the partial contribution of the patients) on a regional basis. A certain degree of inefficiency, significant personnel costs and other factors have characterized the management of public health structures, and resulted in the accumulation of a substantial debt by the ASLs and significant delays in collection for suppliers. Accounts receivables from local entities may remain outstanding for up to 300 days on average. Some solutions for a consolidation/securitization of the debt have been recently proposed by some regions, with a view to reaching a settlement of pending cases (and particularly, following adoption of EU rules on interest for delayed payments, limiting the resulting financial charges) and enable a swifter management of the ongoing business. The success of similar initiatives cannot be predicted. Italian constitutional reform approved in 2001 expanded the legislative and administrative powers of the regional and local governments. This decentralization may result in the individual regions addressing healthcare reforms individually and not collectively. Changes in the Parliament majority (since 2001 center-right, with general elections due in 2006) should not change the general governmental objective to reduce public expenditure in the health care sector. This shift toward regional power and the continuing trend to contain public expenditure may not necessarily be favorable to our industry. CERTAIN REGULATORY MATTERS Our products, product development activities and manufacturing processes are subject to extensive and rigorous regulation, including by the FDA as well as by a number of agencies in other countries that exercise regulatory authority over our products. In the United States, the FDA regulates the introduction of medical devices as well as the manufacturing, labeling and record keeping procedures for such devices. For purposes of these regulations, our products are generally treated as medical "devices." In order for us to market our new products in the United States, we must typically obtain from the FDA concurrence with a 510(k) pre-market notification or approval of a more extensive submission known as PMA. A manufacturer may seek FDA clearance to distribute a new medical device by filing a 510(k) pre-market notification. A 510(k) pre-market notification requires the manufacturer of a medical device to establish that the device is "substantially equivalent" to a medical device legally marketed in the United States. The 510(k) pre-market notification must be accompanied by appropriate information or data establishing the claim of substantial equivalence, which, depending on the type of product, may require clinical data. If this substantial equivalence is established to the satisfaction of the FDA, the manufacturer will receive FDA clearance for marketing of the medical device. If the manufacturer cannot establish substantial equivalence or if the FDA determines that a device requires a more rigorous review, the FDA will require that the manufacturer submit a PMA ("pre-market approval") application prior to obtaining approval to market the device in the United States, which process is expensive and time-consuming, generally taking more than two years and often substantially longer. All of our currently-marketed products have received FDA clearance pursuant to 510(k) pre-market notifications or are classified as exempt from this process. Although we anticipate that, at least in the near-term, our products will be evaluated under the 510(k) pre-market notification process, there can be no assurance that our current or future products will not be subjected to the PMA process or that our current or future products in development will receive FDA marketing clearance. In addition, we have made modifications to our cleared products, which we believe do not require submission of new 510(k) notices per the available FDA guidance documents. There can be no assurance, however, that the FDA would agree with any of our determinations and not require us to submit new 510(k) notices for any of the changes made to its products. Failure to comply with applicable regulatory requirements could result in, among other things, warning letters, fines, injunctions, civil penalties, recall or seizure of the products, total or partial suspension of production, refusal of the government to grant pre-market clearance or pre-market approval for devices, withdrawal of approvals and criminal prosecution. Moreover, approval by the FDA or other regulatory authority does not preempt private product liability claims. Our facilities are also subject to inspection on a routine basis by federal and state agencies, including the FDA, to ensure that we are in compliance with Good Manufacturing Practices. These regulations require that we control our quality systems and maintain our documents in a prescribed manner with respect to research and development, manufacturing, testing, quality control and servicing activities. The FDA also conducts unannounced audits, but routine inspections occur approximately once every two years. Other FDA requirements govern product labeling and prohibit a manufacturer from marketing an approved device for unapproved applications. Clinical laboratories in the United States are regulated under the Clinical Laboratory Improvement Act ("CLIA"), which requires all clinical laboratories to meet specified standards depending on the level of test complexity in the areas of personnel qualification, administration, participation in proficiency testing, patient test management, quality control, quality assurance and inspections, categorization of which is the responsibility of the FDA. The majority of our tests are classified as moderate complexity tests. There can be no assurance that these tests will not be recategorized, or that other tests performed on our other products will not be categorized to a higher level of complexity or that such categorization or regulations and future administrative interpretations of the CLIA would not have a material adverse effect on our financial condition and results of operations. Sales of medical devices outside the United States are subject to foreign regulatory requirements that vary widely from country to country. These laws and regulations range from simple product registration requirements in some countries to complex clearance and production controls in others. As a result, the processes and time periods required to obtain foreign marketing approval may be longer or shorter than those necessary to obtain FDA approval. These differences may affect the efficiency and timeliness of international market introduction of our products, and there can be no assurance that we will be able to obtain regulatory approvals or clearances for its products in foreign countries. Medical devices cannot be sold in EU countries unless they display the CE mark. We have obtained CE mark certification for our current products in accordance to the European Union Directives applicable to them and already in force. We are continuously monitoring EU regulations and their national transpositions, taking account of the forthcoming EU enlargement, so as to plan and achieve compliance to schedule. In addition, international sales of medical devices manufactured in the United States but not cleared by the FDA for distribution in the United States are subject to FDA export requirements. We may become subject to future legislation and regulations concerning the manufacture and marketing of medical devices. This could increase the cost and time necessary to begin marketing new products and could affect us in other respects not presently foreseeable. We cannot predict the effect of possible future legislation and regulations. We are also subject to numerous federal, state, local and foreign laws and regulations relating to such matters as environmental protection, health and safety, manufacturing practices and fire hazard control to liabilities and compliance costs associated with past and current handling, processing, storing, and disposing, of medical or hazardous substances or wastes. From time to time our operations may result in non-compliance with environmental or occupational health and safety laws, or liability pursuant to such laws. There can be no assurance that we will not be required to incur significant costs to comply with such laws and regulations in the future or that such laws or regulations will not have a material adverse effect upon our ability to do business. C. ORGANIZATIONAL STRUCTURE As discussed above under "Item 4 -- Information on the Company --- Background," we are part of a group of companies that is dedicated to manufacturing and distributing health care products. Our basic organizational structure is as follows: ---------------------------------------------- Jose Maria Rubiralta and Francisco Rubiralta ---------------------------------------------- | 100% | ---------------------- Grupo CH-Werfen S.A. ---------------------- | 100% | ------------------------------------- Izasa Distribuciones Tecnicas S.A. __________ ------------------------------------- | | | | 100% | | | | -------------------- | 77.8% Miscel Holding B.V. | -------------------- | | | 22.2% | | | ------------------------------------- | IL Holding S.p.A. __________| ------------------------------------- 96.4% ------------------------------------- Instrumentation Laboratory S.p.A. ------------------------------------- | | ------------------ Subsidiaries ------------------ All of our subsidiaries are wholly owned except for Instrumentation Laboratory (Lietuva) B.I., of which we own 67%. Our significant subsidiaries include: Instrumentation Laboratory GmbH, Instrumentation Laboratory U.K. Ltd. (U.K.), Instrumentation Laboratory S.A. (France), Instrumentation Laboratory Belgium N.V. (Belgium), Instrumentation Laboratory Group B.V. (Holland), Instrumentation Laboratory (Netherlands) B.V. (Holland), Instrumentation Laboratory (Lietuva) B.I. (Lithuania), Instrumentation Laboratory Espana, S.L., Instrumentation Laboratory Company (U.S.A.), IL Diagnostic, S.A. de C.V. (Mexico), Medical Laboratory Automation Inc., Lessix AB (Sweden), Chromogenix Holding AB (Sweden) and Chromogenix AB (Sweden). We completely liquidated our wholly owned subsidiaries Instrumentation Laboratory AG (Switzerland), Instrumentation Laboratory (France) S.a.r.l. and Labgas S.a.r.l. (France) in 2001. On March 24, 2004 the Company's Board of Directors approved the liquidation of the subsidiaries "Lessix AB," "Chromogenix Holding AB" and "Chromogenix AB", but the liquidation process is not completed yet. Following a resolution of the Board of the Company on February 23, 2005, the entire capital of Instrumentation Laboratory Ges.m.b.H. Austria was transferred to Comesa GmbH, a Werfen group company on April 7, 2005. D. PROPERTY, PLANTS AND EQUIPMENT The general location, use and approximate size of the principal physical properties used by us are set forth below as at November 30, 2004. -------------------------- ----------------- ------------- -------------- OWNED/LEASED APPROXIMATE (EXPIRATION AREA IN LOCATION PRIMARY USE DATE OF LEASE) SQUARE FEET -------------------------- ----------------- ------------- -------------- Milan, Italy Europe, Middle Leased 88,000 East, Africa (expires 2010) and Latin America Headquarters; sales and marketing -------------------------- ----------------- ------------- -------------- Lexington, Massachusetts U.S. and Canada Leased 140,000 Headquarters; (expires instrument 2006) manufacturing; research and development; quality assurance; instrument software -------------------------- ----------------- ------------- -------------- Orangeburg, New York Reagent Owned 100,000 manufacturing -------------------------- ----------------- ------------- -------------- Ascoli Piceno, Italy Reagent Leased 21,500 manufacturing (expires 2006) -------------------------- ----------------- ------------- -------------- In addition to the facilities described above, we lease other non-principal facilities for sales, distribution and marketing. We monitor our production requirements as compared with our production capacity. We believe that the existing facilities and their level of utilization are sufficient for our current and reasonably anticipated future needs for productive capacity. ENVIRONMENTAL MATTERS We are subject to environmental laws in the jurisdictions in which we operate. We do not currently anticipate any material adverse effect on our operations or financial condition as a result of our efforts to comply with, or our liabilities under, environmental laws. We do not currently anticipate any material capital expenditures for environmental control facilities. Some risk of environmental liability is inherent in our business, and there can be no assurance that material environmental costs will not arise in the future. In particular, we might incur capital and other costs to comply with increasingly stringent environmental laws and enforcement policies. Although it is difficult to predict future environmental costs, we do not anticipate any material adverse effect on our results of operations, financial condition or competitive position as a result of future costs of environmental compliance. ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our Audited Consolidated Financial Statements for the fiscal years ended November 30, 2002, 2003 and 2004 included elsewhere in this report. The financial statements have been prepared in accordance with Italian GAAP, which differs in certain significant respects from U.S. GAAP. For a discussion of the principal differences between Italian GAAP and U.S. GAAP as they relate to our Consolidated Financial Statements, see Notes 21 and 22 to the Consolidated Financial Statements. OVERVIEW We derive revenue from selling and leasing specialized medical instruments and consumables used in these instruments. Periods containing increased sales of installed instruments generally result in increased revenues and lower margins assuming all other factors remain static. In the long run, increasing the installed base of instruments is the path to increasing the sales of the higher margin consumables. The majority of our instrument sales during the years ended November 30, 2003 and 2004 have resulted from replacing older units. It is frequently the case that new instruments are more efficient, enabling them to perform more tests than older equipment and therefore using less consumables. Thus any major increase in sales of new installed instruments will be met with lower sales of consumables. As a result, a unit by unit analysis of the installed base, while a useful measure, is not necessarily indicative of a business line's performance. By August 2000, we completed a restructuring involving the closing and sales of all of our European manufacturing facilities. We transferred the majority of our operations to our existing manufacturing facilities in the United States. The only products we still manufacture in Europe (at our leased Italian facility) are the clinical chemistry reagent products because the market for these goods is primarily in Europe. For the year ended November 30, 2004, we recorded a net income of (euro)6.7 million as compared to a net loss of (euro)11.1 million for the year ended November 30, 2003, and a net loss of (euro)13.8 million for the year ended November 30, 2002. The net losses reported in fiscal years 2003 and 2002 were largely attributable to a low level in the gross margins of the Company's core product lines, significant research and development costs, increased goodwill amortization and higher interest expense resulting from the acquisition of Hemoliance. In fiscal years 2004, 2003 and 2002 the Company experienced a stabilization in prices for most of its product lines. However, while prices generally stabilized, the pricing level remains low due to prior years reductions. The result from operations continue to be significantly affected by competitive pricing pressures and customer consolidation. Research and development costs also continue at a high level, due to the Company's continued investment in product development to broaden its product offerings within its two core product lines to meet the changing demands of its markets and to better address the areas of highest growth within these markets. While the Company believes that its profitability will continue to be negatively affected by these industry factors at least for the near term, management designed and implemented plans to improve the results of operations and the Company believes it is taking the steps necessary to achieve sustainable growth through improved operating performance. On May 26, 2004 IL Holding S.p.A., an affiliate of Izasa, subscribed for 271,819,984 of our ordinary shares. In consideration for these ordinary shares the affiliate of Izasa, IL Holding S.p.A., cancelled a certain portion of our outstanding debt owed to it equal to (euro)89.7 million. Our outstanding net indebtedness as of November 30, 2004 was (euro)28.9 million after giving effect to the May 26, 2004 debt reduction. We changed our fiscal year end from November 30 to December 31 in order to align it with Grupo CH-Werfen, S.A.'s year end. As a result, in the future our fiscal year will commence on January 1 and will end on December 31 of each year. We will have a short fiscal year lasting from November 30, 2004 to December 31, 2004. We will file the next annual report on Form 20-F for the 12 months ending December 31, 2005 (and including the one month period from December 1 to December 31, 2004). CRITICAL ACCOUNTING POLICIES Our significant accounting policies are more fully described in Note 3 to our Consolidated Financial Statements. However, in accordance with recent Securities and Exchange Commission guidance, those material accounting policies which we believe are particularly important to the understanding of our financial statements are discussed below. In applying these policies, our management uses its judgment to determine certain estimates. Those estimates are based on our historical experience, terms of existing contracts, our observance of trends in the industry, information provided by our customers and information available from other sources, as appropriate. Our significant accounting policies include: Allowance for doubtful accounts Accounts receivable are reduced by an amount which may be uncollectable in the future. We have a broad customer base that primarily includes hospitals and clinical reference laboratories. Although we sell our products worldwide, our sales are concentrated in the United States and Europe, where a significant portion of our sales is ultimately funded through the government or governmental reimbursement programs. The estimated allowance for doubtful accounts is based primarily on management's evaluation of the financial condition of the customer. Inventories and related reserve for obsolete and excess inventory Inventories are valued at the lower of cost or market and have been reduced by a reserve for excess and obsolete inventories. The estimated reserve is based on management's review of inventories on hand compared to estimated future utilization and sales. Property, plant and equipment, goodwill and other intangibles Property, plant and equipment, goodwill and other intangibles are amortized over their useful lives. Useful lives are based on management's estimates of the period that the assets will generate revenue. We assess the future useful life of property, plant and equipment, goodwill and other intangible assets whenever events or changes in circumstances indicate that the current useful life might have diminished. We consider future undiscounted cash flow in assessing the recoverability of these assets. If any impairment is identified, any excess of the carrying value over fair value is recorded as a loss. Future discounted cash flow is used as a basis for estimating fair value when quoted market prices are not readily available. Instruments at customers Instruments leased to customers under sales-type lease contracts are recorded at an amount equal to the net investment in the lease, with the finance income being recognized over the life of the related contracts. Instruments held by customers under reagent rental contracts, in which we retain title, are carried at cost less accumulated depreciation. The cost of the instruments is depreciated on a straight-line basis over the average length of the related contracts, but not exceeding 5 years. Under the contracts, customers are generally required to purchase specified minimum amounts of reagents. Revenue recognition Sales are recorded at the time of shipment of the goods to customers or performance of the service. Revenues from instrument rentals are recognized over the life of the rental contract. Revenues from service contracts are recognized over the life of the service contract. Revenue from sales-type leases is recognized at the inception of the lease equal to the present value of the lease payments to be received. The cost of the leased products is charged to cost of goods sold at the time the corresponding revenue is recognized. During 2004 we began a new line of business whereby we are acting as an agent in the sale of certain diagnostics products to a related party. As a result we have presented the net margin of these transactions as revenue. Derivatives We enter into derivative transactions to hedge specific transactions as well as to reduce our exposure to interest rate and foreign exchange risks. The interest rate differentials to be received or paid on interest rate swaps and other interest rate agreements designated as hedges of specific underlying debt instruments are included in interest income or expense on an accrual basis over the period hedged. Foreign exchange derivatives (options) are used to hedge future expenses denominated in foreign currencies, but are not designated against specific future transactions. At the reporting date, these options are accounted for at estimated fair market value. The resulting losses are recognised in the statement of operations, while the resulting gains are accounted for only when realized. PRIOR DEVELOPMENTS Prior to fiscal year 2002, Arthur Andersen served as our independent auditors. On August 31, 2002, Arthur Andersen LLP, an affiliate of Arthur Andersen, ceased practicing before the SEC. On November 25,2002 we appointed BDO Sala Scelsi Farina S.p.A. as our independent auditors for the fiscal year ended November 30, 2002. Because our former key audit engagement team personnel have since left Arthur Andersen, Arthur Andersen did not participate in the preparation of this report or consent to the reference in this report to its audit report. As a result, investors in Instrumentation Laboratory may have no effective remedy against Arthur Andersen in connection with a material misstatement or omission in the financial statements to which its audit report relates. In addition, even if such investors were able to assert a claim, Arthur Andersen may fail or otherwise have insufficient assets to satisfy claims by investors that might arise under the U.S. federal securities laws or otherwise with respect to its audit report. RESULTS OF OPERATIONS The following table sets forth statement of operations data for the years ending November 30, 2002, 2003 and 2004, expressed as a percentage of consolidated net sales.
YEAR ENDED NOVEMBER 30, ------------------------------------------- 2002 2003 2004 ------------- ------------- ---------- Net sales 100.0% 100.0% 100.0% Cost of sales.................................... 51.9 50.4 48.9 ------------- ------------- ---------- Gross profit............................ 48.1 49.6 51.1 Research and development costs................... 7.4 7.4 6.3 Selling, general and administrative expenses..... 36.6 36.1 34.5 ------------- ------------- ---------- Operating income before amortization of intangible assets and deferred charges...................... 4.1 6.1 10.3 Amortization of intangible assets and deferred 3.1 3.2 2.8 charges ------------- ------------- ---------- Operating income ................................ 1.0 2.9 7.5 Net interest expense............................. 4.1 3.9 2.4 Other (income) expense, net...................... 1.0 2.2 1.7 Income taxes..................................... 0.9 1.0 1.0 ------------- ------------- ---------- Net loss................................ (5.0)% (4.2)% 2.4% ============= ============= ========== COMPARISON OF FISCAL YEARS ENDED NOVEMBER 30, 2004 AND 2003 YEAR ENDED YEAR ENDED PERCENTAGE NOVEMBER 30, 2003 NOVEMBER 30, 2004 INCREASE/(DECREASE) ----------------- ----------------- ------------------- NET SALES BY PRODUCT LINES Net sales (in millions of (euro)) Hemostasis 125.0 135.8 8.6% Critical care 72.6 77.1 6.2% Clinical chemistry 24.9 22.7 (8.8)% Other 37.5 44.4 18.4% Total net sales 260.0 280.0 7.7%
Net sales increased (euro)20.0 million or 7.7% to (euro)280.0 million in the yeAr ended November 30, 2004, from (euro)260.0 million in the year ended November 30, 2003. This increasE is a result of higher sales in our hemostasis and critical care business lines and from distributed products, partially offset by a decrease in sales in clinical chemistry.
YEAR ENDED YEAR ENDED PERCENTAGE NOVEMBER 30, 2003 NOVEMBER 30, 2004 INCREASE/(DECREASE) ----------------- ----------------- ------------------- NET SALES GEOGRAPHICALLY Net sales (in millions of (euro)) United States 63.0 63.5 0.8% Europe 165.5 183.4 10.8% Rest of the World 31.5 33.1 5.1% Total net sales 260.0 280.0 7.7%
Geographically, the limited increase in net sales in the U.S. is also due to the strengthening of the euro against the U.S. dollar. Sales in the U.S. denominated in dollars increased by $8.1 million (or 11.7%) but increased just by (euro)0.5 million (or 0.8%) when translated in euro. Sales in Europe increased by (euro)17.9 million (or 10.8%). Sales in the rest of the world, also denominated in U.S. dollars, increased by $5.8 million (or 16.8%) but increased by (euro)1.6 million (or 5.1%) when translated in euro. Overall unit placements of core instruments increased 0.4% in the year ended November 30, 2004, versus the same period of fiscal year 2003. The following paragraphs summarize the results for our three main business segments. Hemostasis
YEAR ENDED YEAR ENDED PERCENTAGE NOVEMBER 30, 2003 NOVEMBER 30, 2004 INCREASE/(DECREASE) ----------------- ----------------- ------------------- HEMOSTASIS BUSINESS UNIT Net sales (in millions of (euro)) United States 34.6 36.1 4.3% Europe 75.8 84.1 10.9% Rest of the World 14.6 15.6 6.8% Total Hemostasis Business Unit 125.0 135.8 8.6% Percentage of total net sales 48.1% 48.5%
Net sales attributable to the hemostasis business unit in the year ended November 30, 2004 increased 8.6 % to (euro)135.8 from (euro)125.0 million in the year ended November 30, 2003. Sales increased in all geographical areas. Sales in the U.S. denominated in dollars increased by $5.8 million (or 15.3%) but increased just by (euro)1.5 million (or 4.3%) When translated in euro. Sales in Europe increased by (euro)8.3 million (or 10.9%). Sales in the Rest of the world, also denominated in U.S. dollars, increased by $2.9 million (or 18.5%) but increased by (euro)1.0 million (or 6.8%) when translated in euro. Unit placements of Core instruments within the hemostasis business unit decreased 4.8% in the year ended November 30, 2004 versus the same period of fiscal year 2003. Critical Care
YEAR ENDED YEAR ENDED PERCENTAGE NOVEMBER 30, 2003 NOVEMBER 30, 2004 INCREASE/(DECREASE) ----------------- ----------------- ------------------- CRITICAL CARE BUSINESS UNIT Net sales (in millions of (euro)) United States 27.8 27.4 (1.4)% Europe 35.0 39.1 11.7% Rest of the World 9.8 10.6 8.1% Total Critical Care Business Unit 72.6 77.1 6.2% Percentage of total net sales 28.2% 27.5%
Net sales attributable to the critical care business unit in the year ended November 30, 2004 increased 6.2% to (euro)77.1 million from (euro)72.6 million in the yEar ended November 30, 2003. Sales increased in Europe and in the rest of the world, but decreased in the U.S. when expressed in euro. Sales in the U.S. denominated in U.S. dollars increased by US $2.9 million or 9.5% but decreased by (euro)0.4 million (or 1.4%) when translated in eUro. Unit placements of core instruments within the critical care business unit increased 5.2% in the year ended November 30, 2004 versus the same period of fiscal year 2003. Clinical Chemistry
YEAR ENDED YEAR ENDED PERCENTAGE NOVEMBER 30, 2003 NOVEMBER 30, 2004 INCREASE/(DECREASE) ----------------- ----------------- ------------------- CLINICAL CHEMISTRY BUSINESS UNIT Net sales (in millions of (euro)) United States 0.6 0.1 (92.8)% Europe 20.3 18.9 (6.9)% Rest of the World 4.0 3.7 (7.5)% Total Clinical Chemistry Business Unit 24.9 22.7 (8.8)% Percentage of total net sales 9.6% 8.1%
Net sales attributable to the clinical chemistry business unit in the year ended November 30, 2004 decreased 8.8% to (euro)22.7 million from (euro)24.9 million in the yEar ended November 30, 2003. This decrease is mainly attributed to the decline in our clinical chemistry installed base and reduced sales of reagents and other consumables relating to this decline in the installed base. We continue to only place new instruments in Italy, the UK, Eastern Europe and the Middle East. Such decrease is expected to continue in the future. Sales in the U.S. for fiscal year 2004 were (euro)0.1 million compared to (euro)0.6 million In fiscal year 2003. For fiscal year 2004, sales in Italy increased by 3.1%. Other Products Net sales attributable to other products increased 18.4% to (euro)44.4 million in the Year ended November 30, 2004 from (euro)37.5 million in the year ended November 30, 2003. MosT of these sales relate to the distribution of Beckman Coulter products in Italy and Austria. GROSS PROFIT
YEAR ENDED YEAR ENDED PERCENTAGE NOVEMBER 30, 2003 NOVEMBER 30, 2004 INCREASE/(DECREASE) ----------------- ----------------- ------------------- GROSS PROFITS BY PRODUCT LINES Total gross profits (in millions of (euro)) 128.9 143.1 11.1% Percentage of total net sales 49.6% 51.1%
Gross profit increased (euro)14.2 million to (euro)143.1 million in the year ended NovEmber 30, 2004, from (euro)128.9 million in the year ended November 30, 2003. Gross profit as a percenTage of net sales was 51.1% in the year ended November 30, 2004, versus 49.6% in the year ended November 30, 2003. The increase in the gross margin in fiscal year 2004 compared to fiscal year 2003 is primarily attributable to the increase in sales. Also, the gross margin value as a percentage of sales improved as a result of the weakening of the U.S. dollar against the EURO compared to fiscal year 2003, due to more costs being incurred in U.S. dollars relative to revenues earned in U.S. dollars. While prices have stabilized (albeit at low levels) we expect to continue to experience margin pressure related to industry pricing trends. Our strategy is to address these pressures by seeking to increase sales of premium products, which are less sensitive to these pricing pressures and broadening the test menus available on the instruments. For distribution of gross profits by our three main business segments, please see Note 17 to the consolidated financial statements. RESEARCH AND DEVELOPMENT COSTS
YEAR ENDED YEAR ENDED PERCENTAGE NOVEMBER 30, 2003 NOVEMBER 30, 2004 INCREASE/(DECREASE) ----------------- ----------------- ------------------- RESEARCH AND DEVELOPMENT COSTS (in millions of (euro)) Total R&D costs 19.2 17.8 (7.6)% Percentage of critical care and hemostasis net sales 9.7% 8.4%
Research and development costs decreased (euro)1.4 million or 7.6% to (euro)17.8 milliOn in the year ended November 30, 2004, versus (euro)19.2 million in the year ended November 30, 2003. Research and development costs as a percentage of net sales attributable to the critical care and hemostasis business units (which represents all of the research and development costs) were 8.4% in the year ended November 30, 2004 versus 9.7% in the year ended November 30, 2003. All of our research and development costs are denominated in dollars. Research and development costs denominated in dollars increased by $0.2 million (or 0.6%) but decreased by (euro)1.4 million (or 7.6%) when translated in euro. These expenditures are principally attributable to new product development projects for the next generation of products within our core product lines. We intend to maintain these current levels of spending to support our product launch timetable. R&D expenditures are net of Izasa's contribution to our research and development costs pursuant to a cost sharing agreement between Izasa and the U.S. subsidiary of the Group. By said agreement, Izasa contributes to financing the Group's research and development activities on the basis of its share of total Group worldwide sales on related products. The contribution amounted to (euro)2.7 million and (euro)2.4 million in 2003 and 2004, respectively. SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
YEAR ENDED YEAR ENDED PERCENTAGE NOVEMBER 30, 2003 NOVEMBER 30, 2004 INCREASE/(DECREASE) ----------------- ----------------- ------------------- SELLING, GENERAL AND ADMINISTRATIVE EXPENSES (in millions of (euro)) Total SG&A expenses 93.7 96.5 3.0% Percentage of net sales 36.1% 34.5%
Selling, general and administrative expenses increased (euro)2.8 million or 3.0% to (Euro)96.5 million in the year ended November 30, 2004, compared to (euro)93.7 million in the year eNded November 30, 2003. Selling, general and administrative expenses as a percentage of net sales were 34.5% in the year ended November 30, 2004, versus 36.1% in year ended November 30, 2003. As part of our business strategy, we continuously evaluate our cost structure, seeking to lower our operating costs. We have not made definitive plans to further reduce selling, general and administrative costs. AMORTIZATION OF INTANGIBLE ASSETS AND DEFERRED CHARGES decreased (euro)0.4 million or 5.4% to (euro)8.0 million in the year ended November 30, 2004, from (euro)8.4 million in yeAr ended November 30, 2003. The small decrease is mainly attributable to the completion of the amortization of certain intangibles. INTEREST EXPENSE
YEAR ENDED YEAR ENDED PERCENTAGE NOVEMBER 30, 2003 NOVEMBER 30, 2004 INCREASE/(DECREASE) ----------------- ----------------- ------------------- INTEREST EXPENSE (in millions of (euRO)) Interest expense on short-term bank borrowings 4.8 4.9 2.0% Interest expense on long-term debt 6.0 2.3 (60.9)% Total interest expense 10.8 7.2 (32.7)%
Interest expense decreased (euro)3.6 million or 32.7% to (euro)7.2 million in the yEar ended November 30, 2004 from (euro)10.8 million in the year ended November 30, 2003. The decreasE is due to a reduction in the interest expense for long-term debt, which amounted to (euro)2.3 million in 2004 compared to (euro)6.0 million in 2003, which is mainly a result of a reductioN of our long-term debt by (euro)89.7 million in connection with the share capital increase in MArch 2004. OTHER INCOME/(EXPENSE), NET
YEAR ENDED YEAR ENDED PERCENTAGE NOVEMBER 30, 2003 NOVEMBER 30, 2004 INCREASE/(DECREASE) ----------------- ----------------- ------------------- OTHER INCOME/(EXPENSE), NET (in millions of (euro)) Supplementary leaving indemnities and restructuring charges (1.0) (1.7) 76.4% Net gains/(losses) on foreign exchange and forward exchange contracts (2.7) (1.1) (59.2)% Litigation settlements and estimated costs to settle (0.2) (0.5) 214.1% Gain (loss) on disposal of fixed assets 0.1 (0.2) 391.7% Bank charges (0.9) (1.2) 32.2% Other expenses (1.1) (0.1) (96.0)% Total other expense, net (5.8) (4.8) (17.9)%
Other expense, net of (euro)4.8 million in the year ended November 30, 2004, was principally comprised of: (i) (euro)1.7 million of supplementary leaving indemnities, (ii) (euro)1.1 million of net losses on foreign exchange and forward exchange contracts, (iii) (euro)1.2 milLion of bank charges. INCOME TAX EXPENSE was (euro)2.8 million in the year ended November 30, 2004. Our effective tax rate can be affected by the country from which income is generated and the availability of net operating loss carry forwards to offset operating income. Also, our effective tax rate is affected by the Italian "tax on added value" (IRAP), which has a different base of taxation and may be payable even in the case of pre-tax losses. NET INCOME was (euro)6.7 million or (euro)0.03 per share for the year ended November 30, 2004, versus a net loss of (euro)11.1 million or (euro)0.12 per share for the year ended November 30, 2003. COMPARISON OF FISCAL YEARS ENDED NOVEMBER 30, 2003 AND 2002
YEAR ENDED YEAR ENDED PERCENTAGE NOVEMBER 30, 2002 NOVEMBER 30, 2003 INCREASE/(DECREASE) ----------------- ----------------- ------------------- NET SALES BY PRODUCT LINES Net sales (in millions of (euro)) Hemostasis 134.8 125.0 (7.3)% Critical care 76.8 72.6 (5.5)% Clinical chemistry 24.3 24.9 2.5% Other 36.7 37.5 2.2% Total net sales 272.6 260.0 (4.6)%
Net sales decreased (euro)12.6 million or 4.6% to (euro)260.0 million in the yeAr ended November 30, 2003, from (euro)272.6 million in the year ended November 30, 2002. This decreasE is a result of lower sales in our hemostasis and critical care business lines.
YEAR ENDED YEAR ENDED PERCENTAGE NOVEMBER 30, 2002 NOVEMBER 30, 2003 INCREASE/(DECREASE) ----------------- ----------------- ------------------- NET SALES GEOGRAPHICALLY Net sales (in millions of (euro)) United States 80.9 63.0 (22.1)% Europe 159.0 165.5 4.1% Rest of the World 32.7 31.5 (3.7)% Total net sales 272.6 260.0 (4.6)%
Geographically, this decrease in net sales is also due to the strengthening of the euro against the U.S. dollar. Sales in the U.S. denominated in dollars decreased by $5.2 million (or 6.9%) but decreased by (euro)17.9 million (or 22.1%) when translated in euro. Sales in Europe increased by (euro)6.5 million (or 4.1%). Sales in the rest of the world, also denominated in U.S. dollars, increased by $4.6 million (or 15.1%) but decreased by (euro)1.2 million (or 3.6%) when translated in euro. Overall unit placements of core instruments increased 7.8% in the year ended November 30, 2003, versus the same period of fiscal year 2002. The following paragraphs summarize the results for our three main business segments. Hemostasis
YEAR ENDED YEAR ENDED PERCENTAGE NOVEMBER 30, 2002 NOVEMBER 30, 2003 INCREASE/(DECREASE) ----------------- ----------------- ------------------- HEMOSTASIS BUSINESS UNIT Net sales (in millions of (euro)) United States 45.6 34.6 (23.7)% Europe 73.7 75.8 2.8% Rest of the World 15.5 14.6 (6.5)% Total Hemostasis 134.8 125.0 (7.3)% Business Unit Percentage of total net sales 49.4% 48.1% (2.0)%
Net sales attributable to the hemostasis business unit in the year ended November 30, 2003 decreased 7.3% to (euro)125.0 million from (euro)134.8 million in the year ended NovEmber 30, 2002. Sales increased in Europe and in the rest of the world, but decreased in the U.S. The main reason for the decrease in sales denominated in euro was the weakening U.S. dollar, but the decrease was also contributed by lower sales to our U.S. sole distributor, Beckman Coulter. We believe that Beckman Coulter's unit sales increased in the U.S., but our lower sales to Beckman Coulter were a result of Beckman Coulter trying to decrease their existing inventories. Unit placements of core instruments within the hemostasis business unit increased 1.6% in the year ended November 30, 2003 versus the same period of fiscal year 2002. Critical Care
YEAR ENDED YEAR ENDED PERCENTAGE NOVEMBER 30, 2002 NOVEMBER 30, 2003 INCREASE/(DECREASE) ----------------- ----------------- ------------------- CRITICAL CARE BUSINESS UNIT Net sales (in millions of (euro)) United States 33.8 27.8 (18.0)% Europe 33.9 35.0 3.2% Rest of the World 9.1 9.8 7.8% Total Critical Care 76.8 72.6 (5.5)% Business Unit Percentage of total net sales 27.9% 28.2% 1.06%
Net sales attributable to the critical care business unit in the year ended November 30, 2003 decreased 5.5% to (euro)72.6 million from (euro)76.8 million in the yEar ended November 30, 2002. Sales increased in Europe and in the rest of the world, but decreased in the U.S. even though in the U.S. we continued to experience strong unit sales of our newly marketed analyzers, which are more efficient and can perform more tests than older analyzers. Sales in the U.S. denominated in U.S. dollars decreased by $0.6 million or 1.8%, but decreased by (euro)6.0 million (or 18.0%) when translated in euro. Unit placements of Core instruments within the critical care business unit increased 15.5% in the year ended November 30, 2003 versus the same period of fiscal year 2002. Clinical Chemistry
YEAR ENDED YEAR ENDED PERCENTAGE NOVEMBER 30, 2002 NOVEMBER 30, 2003 INCREASE/(DECREASE) ----------------- ----------------- ------------------- CLINICAL CHEMISTRY BUSINESS UNIT Net sales (in millions of (euro)) United States 1.5 0.6 (58.5)% Europe 18.9 20.3 7.4% Rest of the World 4.0 4.0 0% Total Clinical Chemistry 24.3 24.9 2.3% Business Unit Percentage of total net sales 8.9% 9.6% 7.9%
Net sales attributable to the clinical chemistry business unit in the year ended November 30, 2003 increased 2.3% to (euro)24.9 million from (euro)24.3 million in the yEar ended November 30, 2002. This increase is mainly attributed to strong instrument sales in Eastern Europe and the Middle East partially offset by a decline in sales in the U.S. We continue to only place new instruments in Italy, the UK, Eastern Europe and the Middle East. As a result, our installed base, particularly in the U.S., is declining, resulting in decreased sales for consumables on a continuing basis. Such decrease is expected to continue in the future. Sales in the U.S. for fiscal year 2003 decreased by (euro)0.9 million (or 58.5%) to (euro)0.6 million, compared to fiscal year 2002. For fiscal 2003, sales in Italy decreased by 1.7%. Other Products Net sales attributable to other products increased 2.3% to (euro)37.5 million in the year ended November 30, 2003 from (euro)36.7 million in the year ended November 30, 2002. Most of these sales relate to the distribution of Beckman Coulter products in Italy and Austria. GROSS PROFIT
YEAR ENDED YEAR ENDED PERCENTAGE NOVEMBER 30, 2002 NOVEMBER 30, 2003 INCREASE/(DECREASE) ----------------- ----------------- ------------------- GROSS PROFITS BY PRODUCT LINES Total gross profits (in 131.0 128.9 (1.6)% millions of (euro)) Percentage of total net sales 48.1% 49.6% 3.1%
Gross profit decreased (euro)2.1 million to (euro)128.9 million in the year ended NovEmber 30, 2003, from (euro)131.0 million in the year ended November 30, 2002. Gross profit as a percenTage of net sales was 49.6% in the year ended November 30, 2003, versus 48.1% in the year ended November 30, 2002. The decrease in the gross margin in fiscal year 2003 compared to fiscal year 2002 is primarily attributable to the decrease in sales. However, the gross margin value as a percentage of sales improved as a result of the weakening of the U.S. dollar against the EURO compared to fiscal year 2002, due to more costs being incurred in U.S. dollars relative to revenues earned in U.S. dollars. While prices have stabilized (albeit at low levels) we expect to continue to experience margin pressure related to industry pricing trends. Our strategy is to address these pressures by seeking to increase sales of premium products, which are less sensitive to these pricing pressures and broadening the test menus available on the instruments. For distribution of gross profits by our three main business segments, please see Note 17 to the consolidated financial statements. RESEARCH AND DEVELOPMENT COSTS
YEAR ENDED YEAR ENDED PERCENTAGE NOVEMBER 30, 2002 NOVEMBER 30, 2003 INCREASE/(DECREASE) ----------------- ----------------- ------------------- RESEARCH AND DEVELOPMENT COSTS (in millions of (euro)) Total R&D costs 20.1 19.2 (4.1)% Percentage of critical care 9.5% 9.7% 2.1% and hemostasis net sales
Research and development costs decreased (euro)0.9 million or 4.1% to (euro)19.2 milliOn in the year ended November 30, 2003, versus (euro)20.1 million in the year ended November 30, 2002. Research and development costs as a percentage of net sales attributable to the critical care and hemostasis business units (which represents all of the research and development costs) were 9.7% in the year ended November 30, 2003 versus 9.5% in the year ended November 30, 2002. These expenditures are principally attributable to new product development projects for the next generation of products within our core product lines. We intend to maintain these current levels of spending to support our product launch timetable. R&D expenditures are net of Izasa's contribution to our research and development costs pursuant to a cost sharing agreement between Izasa and the U.S. subsidiary of the Group. By said agreement, Izasa contributes to financing the Group's research and development activities on the basis of its share of total Group worldwide sales on related products. The contribution amounted to (euro)2.2 million and (euro)2.7 million in 2002 and 2003, respectively. SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
YEAR ENDED YEAR ENDED PERCENTAGE NOVEMBER 30, 2002 NOVEMBER 30, 2003 INCREASE/(DECREASE) ----------------- ----------------- ------------------- SELLING, GENERAL AND ADMINISTRATIVE EXPENSES (in millions of (euro)) Total SG&A expenses 99.8 93.7 6.0% Percentage of net sales 36.6% 36.1% (1.4)%
Selling, general and administrative expenses decreased (euro)6.1 million or 6.0% to (euro)93.7 million in the year ended November 30, 2003, compared to (euro)99.8 million in the year ended November 30, 2002. Selling, general and administrative expenses as a percentage of net sales were 36.1% in the year ended November 30, 2003, versus 36.6% in year ended November 30, 2002. As part of our business strategy, we continuously evaluate our cost structure, seeking to lower our operating costs. We have not made definitive plans to further reduce selling, general and administrative costs. AMORTIZATION OF INTANGIBLE ASSETS AND DEFERRED CHARGES decreased 0.5% to (euro)8.4 million in the year ended November 30, 2003, from (euro)8.5 million in year ended November 30, 2002. The small decrease is mainly attributable to the completion of the amortization of certain intangibles. INTEREST EXPENSE
YEAR ENDED YEAR ENDED PERCENTAGE NOVEMBER 30, 2002 NOVEMBER 30, 2003 INCREASE/(DECREASE) ----------------- ----------------- ------------------- INTEREST EXPENSE (in millions of (euro)) Interest expense on 5.2 4.8 (7.7)% short-term bank borrowings Interest expense on 7.0 6.0 (14.3)% long-term debt Total interest expense 12.2 10.8 (11.5)%
Interest expense decreased (euro)1.4 million or 11.5% to (euro)10.8 million in the year ended November 30, 2003 from (euro)12.2 million in the year ended November 30, 2002. The decrease is mainly due to a reduction in the interest expense for long-term debt, which amounted to (euro)6.0 million in 2003 compared to (euro)7.0 million in 2002. Also, the decrease in variable interest rates positively affected interest expense for short term bank borrowings and long term debt. We expect the interest expense for the long-term portion of our debt to decrease as a result of a reduction of our long-term debt by (euro)89.7 million in connection with the share capital increase in March 2004. OTHER INCOME/(EXPENSE), NET
YEAR ENDED YEAR ENDED PERCENTAGE NOVEMBER 30, 2002 NOVEMBER 30, 2003 INCREASE/(DECREASE) ----------------- ----------------- ----------------- OTHER INCOME/(EXPENSE), NET (in millions of (euro)) Supplementary leaving indemnities and restructuring charges (1.5) (1.0) (33.0)% Net gains/(losses) on foreign exchange and forward exchange contracts 1.9 (2.7) (242.0)% Litigation settlements and estimated costs to settle (1.3) (0.2) (85.0)% Gain on disposal of fixed assets 0.1 0.1 - Bank charges (0.7) (0.9) 28.0% Other expenses (1.2) (1.1) 8.3% Total other expense, net (2.7) (5.8) 114.8%
Other expense, net of (euro)5.8 million in the year ended November 30, 2003, was principally comprised of: (i) (euro)1.0 million of supplementary leaving indemnities and restructuring charges, (ii) (euro)2.7 million of net losses on foreign exchange and forWard exchange contracts, (iii) (euro)0.9 million of bank charges, and (iv) (euro)1.1 million of other expenses. INCOME TAX EXPENSE was (euro)2.7 million in the year ended November 30, 2003. Our effective tax rate can be affected by the country from which income is generated and the availability of net operating loss carryforwards to offset operating income. Also, our effective tax rate is affected by the Italian "tax on added value" (IRAP), which has a different base of taxation and may be payable even in the case of pre-tax losses. NET LOSS was (euro)11.1 million or (euro)0.12 per share for the year ended November 30, 2003, versus a net loss of (euro)13.8 million or (euro)0.15 per share for the year ended November 30, 2002. LIQUIDITY AND CAPITAL RESOURCES Our principal liquidity requirements are for working capital, consisting primarily of accounts receivable and inventories, investments in instrument rentals, debt service and capital expenditures. Our principal sources of liquidity are cash flows from operations and additional borrowings under unsecured, uncommitted lines of credit. Aggregate amounts due under our debt agreements during each of fiscal years 2005 and 2006 are (euro)1.3 million and (euro)0.3 respectively. We have included a chart at the end of this section that summarizes our future debt payment obligations. Our investment in instruments under reagent rental agreements refers to our providing IVD instruments to our customers (i) at no cost in exchange for an agreement to purchase reagents and other consumables for a fixed time period, and (ii) under sales-type lease contracts. With respect to instruments placed in connection with reagent rental agreements, the instruments are carried at our purchase or production costs, less accumulated depreciation computed over the average life of the related contracts, and, accordingly, represents our cost before any revenue on the instruments and related reagents. Our typical costs under reagent rental arrangements include depreciation of purchase or production cost of the instrument, financial charge and costs of reagents, controls and service, and our typical revenue under reagent rental arrangements includes revenue from the sale of reagents and controls and from service. With respect to instruments placed under sales-type leases, the instruments are recorded at an amount equal to our net investment in the lease (i.e., the present value of the lease payments to be recorded) and, accordingly, represents the sales price (with the selling profits recognized at the inception of the lease) before any revenue on the related reagents and consumables. With respect to sales-type leases, our typical costs include financial charges and the costs of reagents, controls and services and our typical revenues include revenue from the sale of instruments, the sale of reagents and controls, service and financial income. CONSOLIDATED STATEMENTS OF CASH FLOWS Years Ended November 30, 2002, 2003 and 2004
YEAR ENDED YEAR ENDED YEAR ENDED NOVEMBER 30, 2002 NOVEMBER 30, 2003 NOVEMBER 30, 2004 ----------------- ----------------- ----------------- (in millions of (euro)) Net cash provided by operating activities 25.6 36.7 31.6 Net cash used in investing activities (16.2) (19.5) (16.6) Net cash provided by/(used in) financing activities (1.2) (17.8) (9.8)
Net cash provided by operating activities for the year ended November 30, 2004 was (euro)31.6 million, while net cash provided by operating activities for the year ended November 30, 2003 was (euro)36.7 million. This decrease resulted principally from the net effect of the increase in the net income in fiscal year 2004 compared to fiscal year 2003, increase in accounts receivable and a reduction in accrued expenses. Net cash provided by operating activities in 2003 was also affected by a reduction in accounts receivable, which resulted primarily from the sale of certain trade receivables from Italian public health care entities. Net cash provided by operating activities for the year ended November 30, 2002 was (euro)25.6 million. Net cash used in investing activities for the year ended November 30, 2004 was (euro)16.6 million, while net cash used in investing activities in the year ended November 30, 2003 was (euro)19.5 million. Net cash used in investing activities generally reflects our investment in instruments under reagent rental agreements and capital expenditures, offset by any proceeds from sales of fixed assets. Our investment in instrument rentals was (euro)17.3 million and (euro)17.0 million for the years ended November 30, 2004 and 2003, respectively. In fiscal year 2004 and 2003 the cash used in investing activities was affected by the proceeds from the sale of fixed assets, mainly instruments at customers, of (euro)8.9 million and (euro)4.8 million, respectively. In fiscal year 2002 the net cash used in investing activities was (euro)16.2 million while the investment in instrument rentals was (euro)21.6 million. In fiscal year 2002 the cash used in investing activities was also affected by the proceeds from the sale of fixed assets, mainly instruments at customers, of (euro)11.9 million. Dividends to shareholders in the amount of 0.2 Eurocents per ordinary share, for a total amount of (euro)725,042, will be distributed as approved at this year's Company's Shareholders Meeting. Funds for the payment of dividends will be provided by cash generated from operations. Capital expenditures were (euro)8.2 million for the year ended November 30, 2004 versus (euro)7.3 million in the year ended November 30, 2003. Capital expenditures are a significant use of funds and are primarily for manufacturing plants, machinery and equipment. We expect capital expenditures to remain stable but subject to fluctuation as currency exchange rates change since our most important manufacturing plants are located in the U.S. Capital expenditures were (euro)6.1 million in the year ended November 30, 2002. Net cash used in financing activities for year ended November 30, 2004 was (euro)9.8 million versus (euro)17.8 million in the year ended November 30, 2003. Net cash used in financing activities for year ended November 30, 2002 was (euro)1.2 million. In the year ended November 30, 2004, we had a net income of (euro)6.7 million and cash flows for operating and investing activities was positive (euro)15.0 million. In fiscal year 2003, we sustained a net loss of (euro)11.1 million and net cash flow from operating and investing activities was positive (euro)17.2 million compared to a net loss of (euro)13.8 million and negative cash flow from operating and investing activities of (euro)9.4 million for fiscal year 2002. Our improved net cash flow from operating and investing activities in fiscal year 2004 and 2003 was mainly attributable to better operating performance. At November 30, 2004, our consolidated debt, net of cash, was (euro)28.9 million. FINANCING ARRANGEMENTS At November 30, 2004, we had several short-term and long-term credit lines from banks and other financial institutions, pursuant to which (euro)47.8 million was outstanding and (euro)55.2 million was available for further borrowing. Our short-term credit lines are primarily in the form of unsecured, uncommitted short-term bank loan facilities that are repayable on demand and may be revoked by the lender upon notice. The only covenants applying to our facilities relate to our committed loan facility provided by Heller Healthcare Finance, Inc., discussed below. These short-term credit lines are denominated in various currencies (although the majority are in euro) which bear interest based on Euribor, bank base rate or variable rates, ranging from 4.50% to 9.50% as of November 30, 2004. Because these short-term borrowings bear interest at a floating rate, increases in short-term interest rates can adversely affect our results of operations. On May 4, 2001, our U.S. subsidiary executed a loan and security agreement with Heller Healthcare Finance, Inc., to be used for working capital. This loan, which has a maximum aggregate principal amount of US $15 million, is in the nature of a line of credit. At November 30, 2004, approximately US $1.7 million was outstanding, which were fully repaid in May 2005. We paid an interest rate of U.S. dollar prime rate plus 2% (currently at 7.0%) plus all fees on the current amount outstanding on a monthly basis. Werfen and Instrumentation Laboratory S.p.A. provided a guarantee. The original term of the line of credit was for two years and on May 27 2003 was extended to May 1, 2005. We had also to comply with various negative covenants, including restrictions on: o making prepayments on any existing or future indebtedness; o borrowing additional funds; o our ability to merge or consolidate; o declaring dividends; o investing in joint ventures or other acquisitions; and o creating additional liens. In addition to these short-term and long-term debt arrangements, on November 30, 2003, we also had significant borrowings from Werfen's affiliates. On November 30, 2003, (euro)87.7 million was outstanding in the aggregate on these loans. The interest rate we paid on the Werfen loans floated based on the six-month Euribor plus 320 basis points per annum. On March 29, 2004, IL Holding S.p.A., an affiliate of Izasa, agreed to subscribe for 271,819,984 of our ordinary shares. In consideration for these ordinary shares the affiliate of Izasa, IL Holding S.p.A., cancelled all of our outstanding debt and certain portion of the accrued interest owed to Werfen and its affiliates. On July 18, 2002, we executed as a guarantor a loan agreement with other Werfen group companies in favor of Izasa Distribuciones Tecnicas S.A., relating to a syndicated loan of (euro)100 million granted to Izasa. On March 24, 2004, we executed as a guarantor a loan agreement with other Werfen group companies in favor of Izasa Distribuciones Tecnicas S.A., relating to a syndicated loan of (euro)115 million granted to Izasa. On April 12, 2005, we executed as a guarantor a loan agreement with other Werfen group companies in favor of Izasa Distribuciones Tecnicas S.A., relating to a syndicated loan of (euro)250 million granted to Izasa, which replaces 2002 and 2004 syndicated loans above described. The following summarizes certain of our contractual obligations at November 30, 2004 and the effect such obligations are expected to have on our liquidity and cash flow in future periods. We do not have significant capital lease obligations or other financial commitments.
(in millions of euro:) ----------------------------- -------------------------------------------------------------- Payments Due by Period ----------------------------- -------------------------------------------------------------- Less than 1 - 3 4 - 5 After 5 Contractual Obligations Total 1 year years years years ----------------------------- ---------------- ---------- -------- ----------- ------------- Long-Term Debt 3.4 1.3 0.8 1.0 0.3 ----------------------------- ---------------- ---------- -------- ----------- ------------- Operating Leases 24.5 9.3 9.3 4.8 1.1 ----------------------------- ---------------- ---------- -------- ----------- ------------- Total Contractual Cash Obligations 27.9 10.6 10.1 5.8 1.4 ----------------------------- ---------------- ---------- -------- ----------- ------------- (in millions of euro :) ----------------------------- -------------------------------------------------------------- Amount of Commitment Expiration Per Period ----------------------------- -------------------------------------------------------------- Other Commercial Commitments Total Amounts Less than 1 - 3 4 - 5 After 5 Committed 1 year years years years ----------------------------- ---------------- ---------- -------- ----------- ------------- Lines of Credit 44.3 44.3 - - - ----------------------------- ---------------- ---------- -------- ----------- ------------- Standby Letters of Credit - - - - - ----------------------------- ---------------- ---------- -------- ----------- ------------- Guarantees 205.0 31.5 116.0 57.5 - ----------------------------- ---------------- ---------- -------- ----------- ------------- * ----------------------------- ---------------- ---------- -------- ----------- ------------- Standby Repurchase Obligations - - - - - ----------------------------- ---------------- ---------- -------- ----------- ------------- Other Commercial Commitments 57.1 57 - - - ----------------------------- ---------------- ---------- -------- ----------- ------------- Total Commercial Commitments 306.4 132.9 116.0 57.5 - ----------------------------- ---------------- ---------- -------- ----------- ------------- *On April 12, 2005, we executed as a guarantor a loan agreement with other Werfen group companies in favor of Izasa Distribuciones Tecnicas S.A., relating to a syndicated loan of (euro)250 million granted to Izasa, which is replacing these guarantees.
Our borrowings are predominantly denominated in euro and U.S. dollars. Changes in exchange rates between the currencies in which we generate cash flow and the currencies in which its borrowings are denominated will affect our liquidity. As of November 30, 2004, we had in place interest rate swaps and currency options for a total notional amount of (euro)39.9 million. We believe that with the debt repayment made in 2004 we had and will continue to have better cash flows to fund our operations. However, we continue to seek to improve our operating performance from the levels achieved in fiscal years 2002, 2003 and 2004 in order for us to meet our requirements for working capital, research and development expenditures, investments in instruments, debt service and capital expenditures. We believe that cash flow from operations and borrowings under our various lines of credit and credit facilities will be sufficient to fund working capital needs and capital spending and debt service requirements for at least the next 12 months. There can be no assurance that we will achieve or, if achieved, will sustain profitability or positive cash flow from operating activities in the future. If we cannot achieve and sustain profitability or positive cash flow, it is likely that we will not be able to meet our funding requirements. CURRENCY EFFECTS Our results of operations and financial condition are affected by changes in the value of the euro against other currencies. The results of operations are adversely affected to the extent that the strengthening of the euro against other currencies affects the amount of sales reported in euro with respect to the sales made in such foreign currencies and may affect the demands for products in the countries in which such currencies are utilized. Any decrease in the value of the euro as compared to other foreign currencies may expose us to adverse effects to the extent our payables and debt are payable in such foreign currency. With the completion of the relocation of all manufacturing to the U.S., the strengthening of the U.S. dollar against the euro has and could continue to impact our operating and net income. Please see "Item 11 -- Quantitative and Qualitative Disclosure About Market Risk" for further discussion regarding currency exchange risks. RESULTS UNDER U.S. GAAP Reconciliation of Italian GAAP with U.S. GAAP Our Audited Consolidated Financial Statements for the year ended November 30, 2004 have been prepared in accordance with Italian GAAP, which differs in certain significant respects from U.S. GAAP. The principal differences between Italian GAAP and U.S. GAAP, as applied to our Audited Consolidated Financial Statements, are (i) the method of accounting for goodwill; (ii) the method of accounting for share capital issuance costs; (iii) the method of accounting for finance sale and lease back; (iv) the accounting for goodwill denominated in foreign currencies; (v) the method of accounting for imputed interest on accounts receivable; (vi) the method of accounting for pension plans; (vii) the method of accounting for consolidation of subsidiary; (viii) the method of accounting for sale of distribution rights; (ix) the method of accounting for derivatives; (x) the method of accounting for deferred taxes; (xi) the method of accounting for monetary revaluation and (xii) the method of accounting for loss coverage. Please see Note 21 and 22 of the Consolidated Financial Statements. Our net income and shareholders' equity under Italian GAAP were (euro)6.7 million and (euro)155.4 million, respectively, for the year ended November 30, 2004. Under U.S. GAAP, we would have reported a net income and shareholders' equity of (euro)14.5 million and (euro)145.9 million, respectively, in the year ended November 30, 2004. TAXES Our effective tax rate and net income can be affected by the country from which income is generated and the availability of net operating loss carry forwards to offset operating income. For example, we have significant net operating loss carryforwards in the U.S. which can be used only to offset income generated from our U.S. operations. As of November 30, 2004, we had net operating loss carryforwards of approximately (euro)126 million expiring in 2005 through 2022. Please see Note 12 to the Audited Consolidated Financial Statements. The utilization of net operating loss carryforwards in the United States is subject to a variety of complicated U.S. tax rules, including rules triggered by shifts in our ownership, and therefore, there can be no assurance that the net operating loss carryforwards can be utilized without limitation. For a discussion of certain open tax matters, see Note 12 to the Audited Consolidated Financial Statements. INFLATION Inflation has been relatively moderate in Italy as well as in our other principal markets in recent years. We believe that inflation has not had a significant effect on our net sales or profitability in the last three fiscal years. OFF-BALANCE SHEET ARRANGEMENTS As described in note 8 to the consolidated financial statements, in fiscal years 2002, 2003 and 2004 the Company entered into sale and leaseback transactions, by which certain equipment in use at customers was sold and leased back over a period that is in line with the estimated useful life of the equipment. These transactions have been accounted for as operating leases, as allowed by the Italian law, even though they represent finance leases. Similarly, we have included these transactions under operating leases in the contractual obligations table (see "Item 5 - Liquidity and Capital Resources"). Total lease cost charged to income statement for the years ended November 30, 2004 and 2003 amounted to (euro)5.1 million and (euro)4.7 million, respectively. Had the Company accounted for this transaction as a finance lease, the net income for the fiscal year 2004 would have been higher by (euro)0.6 million and net equity as of November 30, 2004 would have been higher by (euro)1.5 million. Assets (instruments at customers) as of November 30, 2004 would have been higher by (euro)12.1 million and liabilities (financial debt) would have been higher by (euro)10.6 million, of which (euro)5.1 million would be short term. RECENT ACCOUNTING STANDARDS In December 2004, the FASB issued statement No. 123 (revised 2004), "Stock-Based Payment" (SFAS 123R). This statement replaces SFAS 123 "Accounting for Stock-Based Compensation", supersedes APB Opinion No. 25, "Accounting for Stock Issued to Employees" (APB 25) and amends SFAS 95, "Statement of Cash Flows", to require that excess tax benefits be reported as a financing cash inflow rather than as a reduction of taxes paid. SFAS 123R is effective the first interim or annual reporting period that begins after June 15, 2005. We expect to adopt the provisions of the new standard effective January 1, 2006. We are currently evaluating the requirements of SFAS 123R, including the adoption method alternatives, but we do not expect adoption of this statement to have a material effect on our operating result. ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES A. DIRECTORS AND SENIOR MANAGEMENT Under Italian law and pursuant to our By-laws, the Board of Directors is responsible for managing our business and supervising our operations and has the power to take actions coming within the scope of our corporate purpose except for the actions reserved by law or our By-laws to the shareholders. Pursuant to our By-laws, the Board must consist of not less than three and not more than nine members. The number of directors is fixed by resolution of the shareholders. Currently, the number of directors is fixed at four. Directors are elected at the general meeting of the shareholders to serve terms not exceeding three years. Directors may be re-elected for consecutive terms. They may be removed at any time by the voting shareholders at a general meeting, and they may resign at any time by written notice to the Board of Directors and to the Chairman of our Board of Statutory Auditors. In case of removal without cause, directors are entitled to damages. Subject to certain limitations, the Board of Directors may delegate its powers to individuals (designated as "Managing Directors") or committees. Each director listed below was re-appointed at the Annual Shareholders' Meeting convened on March 30, 2005. The following table sets forth the name and position of each person who is a director. Each director's term will expire at the annual shareholders' meeting at which our financial statements for the fiscal year ending December 31, 2006 are approved. DIRECTOR AGE POSITION -------- --- -------- Jose Maria Rubiralta (Chairman) 63 President Francisco Rubiralta (Vice-Chairman) 66 Director Jose Luis Martin (Managing Director) 48 Director Carlos Pascual (Managing Director) 43 Director The following are our executive officers, their current functional position and ages. The terms of Jose Manent, Jose Luis Martin, as Chief Financial Officer and Senior Vice President and James C. McGaha do not expire. Jose Maria Rubiralta, Carlos Pascual and Jose Luis Martin's terms as members of the Board of Directors will expire at the annual shareholders' meeting at which our financial statements for the fiscal year ending December 31, 2006 are approved. EXECUTIVE OFFICERS AGE POSITION ------------------ --- -------- Jose Maria Rubiralta 63 President, Chairman of the Board Jose Manent 54 Chief Executive Officer Jose Luis Martin 48 Managing Director, Chief Financial Officer and Senior Vice President of the Company Carlos Pascual 43 Managing Director, Senior Vice President and General Manager - Europe James C. McGaha 58 Vice President - Quality Assurance and Regulatory Affairs The following sets forth the biographies of the directors and executive officers listed in the tables immediately above, which include the functional positions which such individuals hold with us. Our executive officers and our subsidiaries are appointed by the Board of Directors of the respective company and serve at the discretion thereof. Jose Maria Rubiralta Francisco Rubiralta's brother, has been President of IL since October 1991. Mr. Rubiralta was the Chief Executive Officer of IL from October 1991 to December 1999. Mr. Rubiralta is also the Chief Executive Officer and President of Izasa Distribuciones Tecnicas, S.A., a company he founded in 1966 which is involved in the distribution of diagnostic, hospital and research products principally in the Iberian Peninsula. Mr. Rubiralta also serves as President and Director of Werfen, the holding company for the Rubiraltas' global healthcare investments. Mr. Rubiralta is a director of Global Steel Wire, S.A., a steel manufacturer listed on the Madrid Stock Exchange. Jose Manent has been Chief Executive Officer of IL since December 1999. Prior to his appointment as Chief Executive Officer, Mr. Manent was the Senior Vice President of Corporate Development of IL from October 1991 with worldwide responsibility for IL's Strategic Business Units. Mr. Manent joined Werfen in 1978 and was the co-founder (with Messrs. Rubiralta and Rubiralta) of Biokit, a Werfen subsidiary. Francisco Rubiralta Jose Maria Rubiralta's brother, has served as a director of IL since October 1991 and is Chief Executive Officer and President of Grupo C.E.L.S.A. and a director of Werfen. Mr. Rubiralta is a director of Global Steel Wire, S.A., steel manufacturers listed on the Madrid Stock Exchange. Jose Luis Martin has been Chief Financial Officer and Senior Vice President of IL since October 1991. He is also a Managing Director of IL. Mr. Martin has worldwide responsibility for all financial and information systems activity for IL. Mr. Martin also serves as Chief Financial Officer of Werfen. Prior to joining Werfen in 1983, Mr. Martin spent four years working for Arthur Andersen & Co. Carlos Pascual has been Senior Vice President of Europe, Asia, Latin America and Africa since July 1997. Prior to assuming his current position, Mr. Pascual served as Finance Director - Europe for six years. Mr. Pascual joined Werfen in 1988 after having held various positions with Arthur Andersen. James C. McGaha Jr. has been Vice President of Quality Assurance and Regulatory Affairs of IL since June 1994. From March 1992 until June 1994 Mr. McGaha was Vice President of Operations for United Biomedical Inc. Prior to assuming his current position, Mr. McGaha spent 14 years in various positions with Baxter Healthcare Corporation and Ortho Diagnostics Systems Inc. BOARD OF STATUTORY AUDITORS ("COLLEGIO SINDACALE") Pursuant to the Italian Civil Code, in addition to appointing the Board of Directors, shareholders also appoint our Board of Statutory Auditors, which is composed of three independent experts in administrative and accounting matters. Our shareholders also elect two alternate auditors who will automatically be substituted for an auditor who resigns or is otherwise unable to serve as an auditor. The role of the Board of Statutory Auditors involves controlling our administration and, in particular, its compliance with applicable law and our By-laws, and considering the consistency of the balance sheet and the profit and loss account with our accounting records (which, following the general reform of Italian corporate law in 2004, are checked by independent public accountants). The Statutory Auditors are jointly and severally liable with our directors for any acts or omissions of the directors if the damage resulting from such act or omission could have been avoided by the Statutory Auditors' supervision. The Board of Statutory Auditors also ascertains our cash balance at least quarterly. The Board of Statutory Auditors can inspect and control us at any time. The Board of Statutory Auditors reports annually to the shareholders. The members of the Board of Statutory Auditors have an obligation to be present at the meetings of the Board of Directors and at the shareholders' meetings. In addition, the Board of Statutory Auditors is required to meet at least once each quarter. Statutory Auditors remain in office for three fiscal years and may be re-elected for consecutive terms. They may be removed only for cause and with court approval. The following table sets forth the names of the members of our Board of Statutory Auditors and their current positions. The current Board of Statutory Auditors was appointed at the Annual Shareholders' Meeting convened on April 28, 2005 and will serve for the next three fiscal years. NAME POSITION ---- -------- Paolo Giacinto Bonazzi Chairman Giorgio Fumagalli Principal Marco Giuliani Principal Flavio Venturi Alternate Guglielmo Fanti Alternate At the shareholders' meeting of March 29, 2004, BDO Sala Scelsi Farina SpA has been appointed as independent public accountants of the Company in accordance with the provisions of Section 2409bis, 2nd paragraph, of the Italian Civil Code, as amended by Legislative Decree No. 6 of January 17, 2003. B. COMPENSATION For the year ended November 30, 2003, the aggregate compensation paid by us to all members of the Board of Directors, members of the Board of Statutory Auditors and our executive officers listed above for services in all capacities was approximately (euro)2.4 million, excluding the accrual for termination indemnity required by Italian law. We currently have no pension plan for directors and executives. Mr. McGaha as employee of Instrumentation Laboratory Company (USA) is eligible to participate in the U.S. employee pension and savings plan, as every other employee of such company. Please see Note 14 of the consolidated financial statements for further explanation of this pension plan. C. BOARD PRACTICES See "Item 6A--Directors and Senior Management" D. EMPLOYEES As of November 30, 2004, we had approximately 1,332 full-time and part-time employees, 661 of whom were located in the United States, 315 in Italy, 260 in the remainder of Europe and 96 in other locations around the world. Except as described below, we have no collective bargaining agreements with any unions and believe that our overall relations with employees are satisfactory. Employees in Italy are generally covered by collective employment agreements that are negotiated between the national association of the companies within a particular industry and the respective national unions. The most recent agreement for "metal and mechanical workers," which covers all our employees in Italy other than executives, was signed on May 7, 2003 and expired on December 31, 2004. Such agreement governs the economic treatment of employees, including items such as working hours, maternity benefits, holiday time and minimum wages paid to employees. In addition to the national collective bargaining agreement for "metal and mechanical workers," individual employers in Italy including us, enter into separate, local contracts with the labor unions representing their employees. Our local contract provides for additional incentive pay, sets daily working times and addresses other specific issues affecting working conditions. Italian law provides that, upon termination of employment, employees are entitled to receive a defined compensation payment based on length of employment. As of November 30, 2004, we had (euro)6.7 million reserved for such termination payments, as required by Italian law. E. SHARE OWNERSHIP On March 31, 1998, our shareholders approved a resolution to adopt a stock option plan for the benefit of our senior management and key employees. These individuals may be granted, in a period extending until May 5, 2002, stock options exercisable for a period of ten (10) years from the date of granting for up to 750,000 Ordinary Shares. At the same meeting, our shareholders authorized the issuance of 750,000 Ordinary Shares, par value (euro)1.29 each, to service the plan. In this respect the Board of Directors on July 23, 1998 authorized the issuance of options for up to 170,000 Ordinary Shares to be exercised from 2002 to 2008. At the Shareholders' Meeting convened on March 29, 2004 the par value of the underlying Ordinary Shares was also reduced to the new par value of (euro)0.33 per share. The total number of Ordinary Shares, par value (euro)0.33, subject to options as of the end of the granting period (May 5, 2002) was accordingly of 170,000 Ordinary Shares; the last expiration date of the options is July 23, 2008. The total number of Ordinary Shares subject to options held by our directors and executive officers as a group was 16,000 on May 23, 2005. ITEM 7. MAJORITY SHAREHOLDERS AND RELATED PARTY TRANSACTIONS A. MAJORITY SHAREHOLDERS The following table sets forth certain information regarding the beneficial ownership of our Ordinary Shares as of May 23, 2005 by (i) each person who is known by us to be the beneficial owner of more than five percent of our Ordinary Shares and (ii) all our directors and executive officers as a group. Except as otherwise indicated, the persons or entities listed below have sole voting and investment power with respect to all shares of Ordinary Shares owned by them, except to the extent such power may be shared with a spouse. All shareholders have the same voting rights. To our knowledge, apart from the share transfers set forth in footnote (1) to this table, there has been no significant change in the ownership percentage held by any major shareholder during the past three years.
NUMBER OF ORDINARY PERCENTAGE BENEFICIAL OWNER SHARES OF CLASS ------------------ -------------------- ------------- 5% SHAREHOLDERS: Werfen (1) 349,305,155 96.4% Jose Maria and Francisco Rubiralta (2) 349,305,155 96.4% ------------------------- (1) Shares beneficially owned by Werfen are held through Izasa and its subsidiary IL Holding S.p.A. During a going private transaction between November 20, 2000 - February 5, 2001 Izasa purchased 3,811,547 Ordinary Shares increasing Werfen's ownership in the Company from 60% to 68.5%. On July 1, 2001 Izasa and its assignee Miscel Holding B.V. agreed to subscribe for all newly issued 46,511,627 Ordinary Shares in a share capital increase open to all registered shareholders. As a result Werfen's ownership in the Company increased from 68.5% to 84.7%. On November 25, 2003 Izasa and Miscel Holding BV transferred all their ordinary shares to IL Holding S.p.A., an affiliate of Izasa. On May 26, 2004, IL Holding S.p.A., an affiliate of Izasa, subscribed for 271,819,984 newly issued Ordinary Shares in a share capital increase open to all registered shareholders and holders of ADRs (subject to an exemption from the registration requirements under the U.S. securities laws). Messrs. Jose Maria Rubiralta, who is one of our directors and executive officers and Francisco Rubiralta, who is another of our directors, are brothers. Messrs. Rubiralta and Rubiralta collectively own 100% of the outstanding stock of Werfen and, as a result of such ownership, would be deemed to beneficially own the Ordinary Shares beneficially owned by Izasa and its subsidiaries. Accordingly, the Rubiraltas effectively control our business. (2) Includes 349,305,155 Ordinary Shares owned by Izasa and its subsidiary IL Holding S.p.A. Messrs. Rubiralta and Rubiralta are deemed to be the beneficial owner of all Ordinary Shares owned by Izasa and its subsidiaries. The information on the number of shares owned by Izasa and IL Holding S.p.A. is correct; beneficial ownership by Werfen and/or Messrs. Rubitalta might vary if and to the extent they own ADRs (all of which are registered in the Company's ledger under the name of the Bank of New York).
B. RELATED PARTY TRANSACTIONS We and our direct or indirect subsidiaries purchase from and sell products to Werfen and its affiliates. Izasa, a wholly owned subsidiary of Werfen, serves as distributor of our products in Spain, Portugal, Argentina and Uruguay. Total sales to Werfen's affiliates for fiscal years 2002, 2003 and 2004, were (euro)13.7 million, (euro)12.7 million and (euro)16.3 million, respectively. We serve as distributor of products of Biokit, S.A., a majority owned subsidiary of Werfen, in Italy, France, Germany, the United Kingdom and the Benelux countries. Total purchases from Werfen for fiscal years 2002, 2003 and 2004, were (euro)8.4 million, (euro)10.5 million and (euro)11.8 million, respectively. In addition, in fiscal years 2002, 2003 and 2004 a Werfen affiliate charged us approximately, (euro)2.2 million (euro)2.5 million and (euro)2.1 million, respectively for software development services. Certain of our executive officers and other individuals historically have been employed by Werfen or its affiliates or another entity and, pursuant to agreements with us have provided services to us and our subsidiaries at an hourly rate as agreed between the parties. During fiscal years 2002, 2003 and 2004, certain of our subsidiaries were charged (euro)0.6 million, (euro)0.5 million and (euro)0.4 million, respectively in management fees for corporate services provided to those companies and for administrative and out of pocket expenses incurred in rendering those services. We had outstanding loans with Werfen and Izasa as discussed in "Item 5 - Operating and Financial Review and Prospects." Interest charged on these loans in fiscal years 2002, 2003 and 2004 amounted, (euro)6.0 million, (euro)5.2 million and (euro)1.6 million, respectively, and the interest rates on the loans floated based on the six-month Euribor plus 320 basis points per annum. Werfen also is the guarantor on our loan with Heller Healthcare Finance. On April 6, 2001, we executed a distribution agreement with Izasa Distribuciones Tecnicas S.A. whereby we appointed Izasa as our exclusive distributor of in-vitro diagnostic hemostasis and critical care instruments in Spain. The initial term of the agreement is 10 years. In consideration for the exclusive distributorship Izasa paid us (euro)9 million in cash. On May 4, 2001, we executed a cost sharing agreement with Izasa Distribuciones Tecnicas S.A. whereby Izasa undertook to contribute to the financing of the costs associated with the research and development work carried out by us. This research mainly comprises research related to in-vitro diagnostic hemostasis and critical care instruments that Izasa sells in Spain subject to the distribution agreement executed on April 6, 2001. Izasa will pay for its share of the costs to develop the products it sells. This agreement expires on April 6, 2011. The contributions for 2002, 2003 and 2004 amounted to (euro)2.2 million, (euro)2.7 million and (euro)2.4 million, respectively. On July 18, 2002, we executed as a guarantor a loan agreement with other Werfen group companies in favor of Izasa Distribuciones Tecnicas S.A., relating to a syndicated loan of (euro)100 million granted to Izasa. On March 24, 2004, we executed as a guarantor a loan agreement with other Werfen group companies in favor of Izasa Distribuciones Tecnicas S.A., relating to a syndicated loan of (euro)115 million granted to Izasa. On April 12, 2005, we executed as a guarantor a loan agreement with other Werfen group companies in favor of Izasa Distribuciones Tecnicas S.A., relating to a syndicated loan of (euro)250 million granted to Izasa, which replaces the 2002 and 2004 syndicated loans above described. Following a resolution of the Board of the Company on February 23, 2005, the entire capital of Instrumentation Laboratory Ges.m.b.H. Austria was transferred to Comesa GmbH, a Werfen group company, on April 7, 2005. The price for the sale of the shares was fixed at (euro)3.4 million based on an independent third party appraisal. As a result of transactions between us and affiliates of Werfen, potential conflicts of interest could arise. No assurance can be given that such conflicts will be resolved in our favor. We believe that the transactions with Werfen and its affiliates are conducted on an arm's-length basis and are on no more favorable terms to us than can be obtained from an unrelated third party. Please refer to footnote 20 of our financial statements attached to this annual report on Form 20-F. C. NOT REQUIRED. ITEM 8. FINANCIAL INFORMATION A. CONSOLIDATED STATEMENTS AND OTHER FINANCIAL INFORMATION. Reference is made to "Item 18: Financial Statements." Dividends In the past we have not paid any dividends on our ordinary shares. Dividends however will be distributed as approved at the Company's Shareholders Meeting convened on March 30, 2005 in the amount of 0.2 Eurocents per ordinary share for a total amount of (euro)725,042. Litigation We are involved from time to time in various claims and litigation incidental to the ordinary course of our business. In 1996, 590 Lincoln Street Trust filed a lawsuit alleging a release of hazardous material, on or earlier than 1988, by one of its tenants, including an affiliate of our predecessor that was an operator of the site. In connection with the 1991 acquisition of our predecessor, we assumed various obligations of this predecessor including the potential liabilities involved in this matter. As such, we were named as a defendant in this lawsuit. We have denied liability. In 2002, the case went to trial and a verdict was returned against our indemnitee. A judgment has been entered in the case in the amount of approximately $2.6 million. We have appealed the decision in the case. We believe that, in any case, the proceeding will not have a material adverse effect on our financial conditions or results of operations. As of November 30, 2004 we have recorded an accrual of $2.2 million related to this judgment. A complaint was filed by Bio-Rad Laboratories, Inc. against us, Werfen, Izasa, and four of the Company's current officers and directors in January 2005 in the United States District Court for the Southern District of New York. The complaint asserts claims under common law for fraud, conspiracy to commit fraud and aiding and abetting fraud against all the defendants; negligent misrepresentation against the Company and the individual defendants; as well as breach of fiduciary duty under Italian Civil Code Article 2395 against the individual defendants. The complaint alleges generally that the defendants falsely understated the Company's revenues and profitability in financial statements included in the Company's public filings and public statements from 1999 to 2004, and that the price of the Company's ADSs have therefore been artificially depressed. The plaintiff, which owns ADSs, seeks an unspecified amount of damages. All the defendants have moved to dismiss the complaint. For a discussion of certain open tax matters, see Note 12 of the Audited Consolidated Financial Statements. We believe that the foregoing claims and litigation will not have a material adverse effect upon its financial condition or results of operations. We, as a foreign private issuer and a private Italian company have no obligation to switch our financial reporting to the new International Financial Reporting Standards, "IFRS". As a result, our financial reporting will continue to be prepared in accordance with Italian GAAP. B. SIGNIFICANT CHANGES Please see "Item 4--Information on the Company-Background- Increase in Capital Stock in 2004." ITEM 9. THE OFFER AND LISTING DETAILS A. OFFER AND LISTING DETAILS There is currently no established trading market for our ADSs, except for limited and sporadic quotations in the Pink Sheets(R). Our ADSs (each representing one Ordinary Share) are traded on the Pink Sheets(R) under the symbol "ISLBY." The Bank of New York is our depositary bank (the "Depositary") for the purpose of issuing the ADRs evidencing the ADSs. Prior to August 18, 2000, our ADSs were quoted on the OTC Bulletin Board. Prior to September 4, 1999, our ADSs traded on the Nasdaq National Stock Market. The table below sets forth, for the periods indicated, (a) the high and low closing trading prices for our ADSs quoted on Nasdaq National Stock Market prior to September 4, 1999 (the Nasdaq quotations represent prices between dealers, not including retail mark-ups, mark-downs or commissions, and do not necessarily represent actual transactions) and (b) the high and low reported sales prices for our ADSs on the over-the-counter market until August 18, 2000, and on the Pink Sheets(R) after August 18, 2000. The ADSs were de-listed from the Nasdaq National Market System because we no longer fulfilled the minimum per share price requirement of US $1.00 per share. The ADSs are no longer eligible for quotation on the OTC Bulletin Board because market makers have not been providing regular quotations. According to the Pink Sheets(R) internet site, the last trade date was March 13, 2005. The last sale was made at US $ 0.15 per share. The Ordinary Shares underlying the ADSs are not traded on any exchange nor are they quoted on any market; therefore, no pricing information for such shares is available.
PERIOD HIGH LOW ------ ---- --- ($ PER ADSs) May 2005 (through May 27)................................................... 0.15 0.15 April 2005.................................................................. 0.15 0.15 March 2005.................................................................. 0.15 0.15 February 2005............................................................... 1.00 0.15 January 2005................................................................ 0.17 0.15 December 2004............................................................... 1.00 0.15 2004 Fourth Quarter.............................................................. 1.00 0.15 Third Quarter............................................................... 0.17 0.15 Second Quarter.............................................................. 0.3 0.3 First Quarter .............................................................. 0.3 0.3 2003 Fourth Quarter.............................................................. 1.25 0.3 Third Quarter............................................................... 0.3 0.05 Second Quarter (through May 30)............................................. 0.32 0.05 First Quarter .............................................................. 0.45 0.30 2002 Fourth Quarter.............................................................. 0.42 0.30 Third Quarter............................................................... 0.41 0.41 Second Quarter.............................................................. 0.65 0.41 First Quarter............................................................... 0.60 0.40 2001 Fourth Quarter.............................................................. .45 .35 Third Quarter............................................................... .65 .40 Second Quarter.............................................................. .75 .40 First Quarter............................................................... .75 .35 1999 September 4 through November 30............................................. 1 1/8 3/8 September 1 through September 3 (from Nasdaq)............................... 1 5/16 7/8 Third Quarter............................................................... 1 1/2 1 3/16 Second Quarter.............................................................. 1 1/4 7/8 First Quarter............................................................... 1 9/16 7/8 1998 Fourth Quarter.............................................................. 1 3/8 7/8 Third Quarter............................................................... 1 11/16 1 7/32 Second Quarter.............................................................. 3 9/32 1 1/2 First Quarter............................................................... 3 9/32 2 9/32 1997 Fourth Quarter.............................................................. 3 2 9/32 Third Quarter............................................................... 3 1/8 2 5/8 Second Quarter.............................................................. 4 1/4 2 3/4 First Quarter............................................................... 11 1/8 3 1/4
As of May 27, 2005, 362,521,088 ordinary shares were outstanding. As of the same date, there were outstanding 13,215,933 ADSs (equivalent to 13,215,933 Ordinary Shares). The share equivalent of the outstanding ADSs was equal to 3.6% of the total number of outstanding ordinary shares. B. NOT REQUIRED. C. MARKETS. See "Item 9A-- Offer and Listing Details." D. NOT REQUIRED. E. NOT REQUIRED. F. NOT REQUIRED. ITEM 10. ADDITIONAL INFORMATION A. NOT REQUIRED. B. Articles of Association were filed with the SEC on Form F-1 filed on October 22, 1996, file registration number 333-05682, and are incorporated herein by reference. The amended By-laws are filed herewith. C. MATERIAL CONTRACTS Beckman Coulter Relationship On July 28, 1999, Werfen and Beckman Coulter terminated the Strategic Alliance Agreement, dated as of June 13, 1992, and entered into the Strategic Alliance and Cross Distribution Agreement (the "Strategic Alliance Agreement"). Pursuant to the Strategic Alliance Agreement, Beckman Coulter is the exclusive distributor for our hemostasis systems in the United States, Canada, Australia, New Zealand, China and certain other countries, except with respect to GEM-PCL where the right to distribute is not exclusive. This distributorship is automatically extended to new products manufactured or sold by us or our affiliates in the relevant territory. Pursuant to the Strategic Alliance Agreement, we serve as exclusive distributor of certain flow cytometry, hematology and particle characterization products of Beckman Coulter in Austria and Italy. The distributorship described in this paragraph is automatically extended to new products manufactured or sold by Beckman Coulter or its affiliates in the relevant territory. Other affiliates of Werfen also serve as distributors of Beckman Coulter products in certain countries. The Strategic Alliance Agreement expires on July 28, 2009. The Strategic Alliance Agreement provides that it may be renewed by either party for two succeeding five year periods if notice of renewal is delivered while the remaining term of the agreement is more than two years. The Strategic Alliance Agreement may be terminated by either party if the other party falls into bankruptcy, receivership or any similar insolvency situation and any such proceeding remains undismissed or unstayed for 60 days. The Strategic Alliance Agreement specifies certain revenue, market share and other targets for particular regions which, if not achieved in any calendar period, constitute inadequate performance and are cause for termination of the distribution rights in the relevant region upon 6 months' notice by the other party. In addition, the Strategic Alliance Agreement may be terminated by either party to the Strategic Alliance Agreement in the event of a reorganization, merger, consolidation or a direct or indirect sale of all or substantially all of the assets of the other party (provided that certain intra-company transfers are not deemed to constitute a change of control or sale of ownership). If Beckman Coulter's right to distribute coagulation products in Canada, Puerto Rico and the United States is terminated, Beckman Coulter may elect to terminate the Strategic Alliance Agreement. If Werfen's right to distribute Beckman Coulter's products in Italy and/or Spain and Portugal is terminated, Werfen may elect to terminate the Strategic Alliance Agreement. Any termination notice delivered in accordance with the two preceding sentences must be within 30 days of the termination of the relevant party's right to distribute and specify a termination date no less than 6 months from the date of the notice. As a result of the appointment of Beckman Coulter as exclusive distributor Werfen and its affiliates is prohibited from selling the coagulation products to any end-user or distributor. Please also see the various descriptions in "Item 4 - Information on the Company", "Item 5 - Operating and Financial Review and Prospects", and "Item 7 - Majority Shareholders and Related Party Transactions" herein. D. EXCHANGE CONTROLS. Currently, there are no exchange controls in Italy that affect the payment of dividends or other remittances to holders of the ADSs or Ordinary Shares who reside outside of Italy. We are not aware of any plans by the Italian government to institute any exchange controls that would affect the payment of dividends or other remittances to holders of ADSs or Ordinary Shares who reside outside Italy. Neither Italian law nor our By-laws limit the rights of nonresident or foreign owners to hold or vote the Ordinary Shares or the ADSs. E. TAXATION The summary is based upon tax laws and practice of the United States and Italy as in effect on the date of this Annual Report, which are subject to change (with a possible retroactive effect). Prospective investors in Ordinary Shares or ADSs should consult their own advisors as to the United States, Italian or other tax consequences of the purchase, ownership and disposition of ADSs, including, in particular, the effect of any state or local tax laws. For purposes of the current income tax convention between the United States and Italy (the "Income Tax Convention"), the current estate tax convention between the United States and Italy (the "Estate Tax Convention") and the United States Internal Revenue Code of 1986, as amended, beneficial owners of ADRs evidencing ADSs will be treated as the beneficial owners of the Ordinary Shares represented by those ADSs. UNITED STATES TAXES The following discussion is a general summary of certain U.S. federal income tax matters. This discussion is based upon the Internal Revenue Code of 1986, as amended (the "Code"), Treasury regulations promulgated thereunder, administrative pronouncements and judicial decisions, as in effect on the date of this Annual Report and all of which are subject to change, possibly with retroactive effect. This discussion does not purport to be a comprehensive description of all of the tax considerations that may be relevant to a U.S owner. In addition, the tax treatment of a U.S. owner may vary depending upon the particular situation of the U.S. owner. This discussion deals only with U.S. owners who hold Ordinary Shares or ADSs as "capital assets" within the meaning of Section 1221 of the Code and whose "functional currency" within the meaning of Section 985 of the Code is the U.S. dollar. This discussion does not address the tax treatment of certain owners (including, but not limited to, insurance companies, tax-exempt organizations, financial institutions, persons subject to the alternative minimum tax, broker-dealers, dealers in securities or currencies, traders in securities that elect to mark-to-market, beneficial owners of 10% or more of the shares of the Company and certain U.S. expatriates) who may be subject to special rules not discussed below. The summary does not discuss the treatment of Ordinary Shares or ADSs that are held in connection with a permanent establishment or fixed base through which a beneficial owner carries on business or performs personal services in Italy. The summary also does not address the consequences of any United States state or local tax law to a U.S. owner. U.S. owners are advised to consult their own advisors as to the United States, Italian or other tax consequences of the ownership and disposition of Ordinary Shares or ADSs, including, in particular, the effect of any United States state or local tax laws. For purposes of the summary, beneficial owners of Ordinary Shares or ADSs that are considered residents of the United States for purposes of the current Income Tax Convention between the United States and Italy, and that are not subject to an anti-treaty shopping provision that applies in limited circumstances, are referred to as "U.S. owners." Beneficial owners who are citizens or residents of the United States, corporations organized under U.S. law, and U.S. partnerships, estates or trusts (to the extent their income is subject to U.S. tax either directly or in the hands of partners or beneficiaries) generally will be considered to be residents of the United States under the Income Tax Convention. Special rules apply to U.S. owners that are also residents of Italy. Beneficial owners that are not U.S. owners should note that portions of the following summary may not be relevant to them. Taxation of Dividends and Stock Distributions The gross amount of any dividends before reduction for Italian withholding tax paid to a U.S. owner generally will be treated as ordinary income to the extent paid out of current and or accumulated earnings and profits for United States federal income tax purposes. Dividends paid in taxable years beginning before January 1, 2009 to a non-corporate U.S. owner who meets certain eligibility requirements will qualify for U.S. federal income taxation at a reduced rate of 15% or lower if we are a "qualified foreign corporation." We generally will be a "qualified foreign corporation" if either (i) we are eligible for benefits under the Income Tax Convention or (ii) our Ordinary Shares or ADSs are listed on an established securities market in the United States. As we are eligible for benefits under the Income Tax Convention, we presently are a "qualified foreign corporation", and we generally expect to be a "qualified foreign corporation" during such taxable years, but no assurance can be given that a change in circumstances will not affect our treatment as a "qualified foreign corporation" in any of such taxable years. A non-corporate U.S. owner will not be eligible for the reduced rate (a) if the U.S. owner has not held the Ordinary Shares or ADSs for at least 61 days of the 121-day period beginning on the date which is 60 days before the ex-dividend date, (b) to the extent the U.S. owner is under an obligation to make related payments on substantially similar or related property or (c) with respect to any portion of a dividend that is taken into account by the U.S. owner as investment income under Section 163(d)(4)(B) of the U.S. Internal Revenue Code. Any days during which a U.S. owner has diminished the U.S. owner's risk of loss with respect to the Ordinary Shares or ADSs (for example, by holding an option to sell such shares or ADSs) are not counted towards meeting the 61-day holding period. Special rules apply in determining the foreign tax credit limitation with respect to dividends subject to U.S. federal income taxation at the reduced rate. U.S. owners should consult their own tax advisors concerning whether dividends received by them qualify for the reduced rate. Dividends paid to U.S. owners that are corporations will not be eligible for the dividends received deduction. Dividend distributions in excess of our current and accumulated earnings and profits would first be treated as non-taxable return of the U.S. owner's tax basis in his or her Ordinary Shares to the extent thereof and then as gain from the sale of Ordinary Shares. Dividends paid in lire will be includible in the income of such U.S. owners in a dollar amount calculated by reference to the exchange rate in effect on the day the dividends are received by the Custodian. If the Custodian converts the lire into dollars on the day it receives them, U.S. owners generally should not be required to recognize foreign currency gain or loss in respect of the dividend income. U.S. owners who receive a "treaty refund" (as defined below under "Italian Taxes") may be required to recognize foreign currency gain or loss to the extent the amount of the treaty refund (in dollars) received by the U.S. owner differs from the dollar equivalent of the treaty refund on the date the dividends were received by the Custodian. A U.S. owner may be eligible, subject to general limitations and conditions, to credit or (at such U.S. owner's election) deduct in computing United States federal income tax liability Italian withholding tax (described in "--Italian Taxes") from such U.S. owner's dividends, to the extent such U.S. owner is not eligible for the "treaty refund." The limitations on U.S. foreign tax credits and in the case of a U.S. owner that elects to deduct foreign taxes, deductions, and the timing thereof are complex and U.S. owners should consult with their own tax advisors with regard to the availability of a foreign tax credit or deduction and the application of the limitations on foreign tax credits and deductions to their particular situations. In this regard, foreign tax credits generally are not allowed with respect to certain short-term or hedged positions in stock. For taxable years beginning before December 31, 2006 dividends generally will constitute foreign source "passive income" or, in the case of certain U.S. owners, "financial services income" for U.S. foreign tax credit purposes. However, under recently enacted legislation, for taxable years beginning after December 31, 2006, dividends that constitute "financial services income" generally will be considered foreign source "general category income", along with other foreign source income that is not passive income, for U.S. foreign tax credit purposes. Distributions of additional shares to U.S. owners with respect to their Ordinary Shares or ADSs that are made as part of a pro rata distribution to all shareholders of the Company generally will not be subject to U.S. federal income tax. A beneficial owner of Ordinary Shares or ADSs that is, with respect to the United States, a foreign corporation or a nonresident alien individual generally will not be subject to U.S. federal income tax on dividends received on Ordinary Shares or ADSs, unless such income is effectively connected with the conduct by the beneficial owner of a trade or business in the United States. Taxation of Capital Gains Gain or loss realized by a U.S. owner on the sale or other disposition of Ordinary Shares or ADSs will be subject to U.S. federal income taxation as capital gain or loss in an amount equal to the difference between the U.S. owner's adjusted basis in the Ordinary Shares or ADSs and the amount realized on the disposition (or its dollar equivalent, determined at the spot rate on the date of disposition, if the amount realized is denominated in a foreign currency). Deposits and withdrawals of Ordinary Shares by U.S. owners in exchange for ADSs will not result in the realization of gain or loss for U.S. federal income tax purposes. The capital gain or loss will be long term if the U.S. owner has held the Ordinary Shares or ADSs for more than one year. For certain noncorporate U.S. owners, such long-term capital gain will be subject to tax at a reduced rate. With limited exceptions, capital losses are generally deductible only against capital gains and not against ordinary income. Capital gain recognized by a U.S. owner on the taxable sale or other taxable disposition of Ordinary Shares or ADSs will be United States source income. Therefore, such gain will not increase the U.S. owner's limitation on use of foreign tax credits. Any loss recognized upon such sale or disposition generally will be allocated to reduce U.S. source income. A beneficial owner of Ordinary Shares or ADSs that is, with respect to the United States, a foreign corporation or a nonresident alien individual will not be subject to U.S. federal income tax on gain realized on the sale of Ordinary Shares or ADSs, unless (1) such gain is effectively connected with the conduct by the beneficial owner of a trade or business in the United States or (2) in the case of gain realized by a beneficial owner who is an individual, such individual is present in the United States for 183 days or more in the taxable year of the sale and certain other conditions are met. Dividends paid on Ordinary Shares to U.S. owners and proceeds from the sale, exchange or redemption of Ordinary Shares by U.S. owners may be subject to U.S. information reporting requirements and U.S. backup withholding tax. Backup withholding will not apply if the holder (1) is a corporation or other exempt recipient or (2) complies with the applicable backup withholding requirements. Any amount withheld under the U.S. backup withholding tax rules will be allowed as a refundable credit against the U.S. owner's U.S. federal income tax liability, provided the required information is furnished to the U.S. Internal Revenue Service. ITALIAN TAXES The following discussion is a general summary of material Italian tax consequences of the ownership and sale of Ordinary Shares or ADSs by a U.S. owner that is not a resident (for tax purposes) of Italy. The summary does not purport to be a comprehensive description of all of the tax considerations that may be relevant to a decision to purchase Ordinary Shares or ADSs. In addition, the tax treatment of a holder may vary depending upon the particular situation of the holder. The summary does not discuss the treatment of Ordinary Shares or ADSs that are held in connection with a permanent establishment or fixed base through which a beneficial owner carries on business or performs personal services in Italy. The summary is based upon tax laws and practice of the United States and Italy as in effect on the date of this Annual Report, which are subject to change. Prospective investors in Ordinary Shares or ADSs should consult their own advisors as to the United States, Italian or other tax consequences of the purchase ownership and disposition of the ADSs. Taxation of Dividends The non Italian resident shareholders are subject to a 27% withholding tax on dividends relating to common stock and resolved for distribution after July 1, 1998. Non resident shareholders owning ordinary shares will be entitled to a refund of 4/9 of the tax withheld, provided that the dividends have been subject to income tax in the country of residence of the beneficial owner. The foregoing provisions will not affect the applicability of the relevant Tax Treaty's provisions, if such Tax Treaty provides more favorable treatment; however, application of any such Tax Treaty shall be conditional upon the substantial and formal requirements. Under the Tax Treaty's prevision, dividends derived and beneficially owned by U.S. owners other than corporations (and similar entities) are subject to Italian withholding tax at a reduced rate of 15%. U.S. corporations and similar entities are subject to a withholding tax of 5 - 10% depending upon the percentage of the share capital owned and the period of ownership of the shares of the Italian distributing company, as specified in the Tax Treaty. However, the amount initially made available to the Depositary for payment to U.S. owners will generally reflect a withholding at the 27% rate. U.S. owners who comply with the appropriate certification procedures generally may then claim an additional payment of 12% of the dividend (representing the difference between the 27% rate and the 15% rate, and referred to herein as a "treaty refund"). Described below are the expected procedures for making such certification. The certification procedure will require U.S. owners to obtain from the U.S. Internal Revenue Service the form of certification required by the Italian tax authorities with respect to each dividend payment. The request for that certificate must include a statement, signed under penalties of perjury, to the effect that the U.S. owner is a U.S. resident individual or corporation and does not maintain a permanent establishment in Italy, and must set forth other required information. The time for processing requests for certification by the Internal Revenue Service normally is at least two months or more. Accordingly, in order to be eligible for the procedure described below, U.S. owners should begin the process of obtaining certificates immediately after receiving instructions from the Depositary on how to claim a treaty refund. According to the Tax Treaty, a higher benefit is provided in the following cases: (i) a maximum 5% withholding tax is applicable on the gross amount of dividends if the beneficial owner is a company which has owned more than 50% of the voting stock of the company paying the dividends for a 12-month period ending on the date the dividend is declared; (ii) a 10% withholding tax is applicable if the above interest is lower than 50% but higher than 10%. Moreover, according to the "Interpretative Exchange of Notes" published in the Italian Official Gazette of February 2, 1986, U.S. companies owning at least 10% of the share capital of the distributing company will be entitled to obtain from the IRS a tax credit against the amount of corporate tax paid on the income distributed by the Italian company (to be determined in compliance with the procedures set forth by the IRS). Such tax credit will be granted if the company producing the distributed income is resident in Italy and is not considered as resident in the U.S. according to the U.S. tax laws. The Depositary's instructions will specify certain deadlines for delivering to the Depositary the documentation required to obtain a treaty refund, including the certification that the U.S. owners must obtain from the U.S. Internal Revenue Service. In the case of ADSs held by U.S. owners through a broker or other financial intermediary, the required documentation should be delivered to such financial intermediary for transmission to the Depositary. In all other cases, the U.S. owners should deliver the required documentation directly to the Depositary. The Company and the Depositary have agreed that if the required documentation is received by the Depositary within a specified period after the dividend payment date and, in the reasonable judgment of the Company, such documentation satisfies the requirements for a refund by the Company of Italian withholding tax under the Convention and applicable law, the Company will as soon as practicable thereafter pay the treaty refund to the Depositary for the benefit of the U.S. owners entitled thereto. If the Depositary does not receive a U.S. owner's required documentation within a specified period 30 days after the dividend payment date, such U.S. owner may for a short period (specified in the Depositary's instructions) continue to claim a treaty refund by delivering the required documentation (either through the U.S. owner's financial intermediary or directly, as the case may be) to the Depositary. However, after this period, the treaty refund must be claimed directly from the Italian tax authorities rather than through the Depositary. Expenses and extensive delays have been encountered by U.S. residents seeking refunds directly from the Italian tax authorities. Pursuant to Italian law, Italian companies are required to supply to the Italian tax authorities certain information concerning the identity of non-resident shareholders in connection with the payment of dividends. Holders of Ordinary Shares will be required to obtain their Italian tax identification number, or alternatively, in the case of individuals or entities which are not residents of Italy, their name, address and place and date of birth, or in the case of legal entities, their name, country of establishment and address (and in the case of partnerships, the information required for individuals with respect to one of their representatives). Under Italian law, the Company is entitled to suspend payment of dividends until proper communication of the tax identification number or alternative information, as the case may be, is received from the shareholder or the tax authorities. In the case of ADSs beneficially owned by U.S. owners, the Company understands that supplying information concerning the Depositary, in its capacity as the sole holder of record of the Ordinary Shares represented by the ADSs, will satisfy these requirements. U.S. owners will be required to provide such information, however, to the extent such U.S. owners wish to benefit from reduced withholding tax rates on dividends under the Income Tax Convention, and therefore claims for such benefits must be accompanied by the required information. Distributions of additional shares to beneficial owners with respect to their ADSs that are made as part of a pro rata distribution to all shareholders of the Company generally will not be subject to Italian tax. Currently, the Company's Shares are not held in the Centralized Stock Administration System managed by Monte Titoli S.p.A., and there is no current intent that the Shares will be so held. However, if at some point in the future the Shares become held in the centralized system, the withholding tax will not be levied by the distributing company and in its place a substitutive tax (at the 27% rate described above) shall be levied by the Italian or non resident intermediary, provided the latter adheres to the Monte Titoli centralized system and has appointed a tax representative in Italy. Under the above provisions, the intermediaries shall charge the substitutive tax applying a value as on the date at which the dividend has become collectable and the substitutive tax shall be paid to the Italian Treasury by the fiscal representative. According to the system described above, intermediaries may directly apply the reduced Treaty tax rates, provided that, in any case, they have obtained proper evidence that the beneficial owner of the shares is entitled to benefit from the Treaty provisions. Taxation of Capital Gains As a consequence of the general tax reform convening income from capital and capital gains (Legislative Decree no. 461 of November 21, 1997) substantial amendments in the taxation of capital gains, for capital gains realized after July 1, 1998 has been introduced. After the said date, accordingly capital gains realized by disposal of the shares of an Italian company (or of rights deemed equivalent to share rights) will be considered as taxable in Italy, wherever the shares are located. The Tax Treaty protection will still be effective and, therefore, no capital gains tax will be applicable to residents of U.S. and of other countries with similar Tax Treaties with Italy. If the capital gain taxation should apply, the tax rates will be equal to 12.5% or to the ordinary Italian tax rates (that may vary from a minimum at 23% to a maximum of 43%) applied only on 40% of the capital gain realized, depending upon the percentage of interest held and sold by the seller (for a listed company, the higher rate applies if an amount exceeding 2% of the voting rights, or 5% of the capital stock is sold in a 12 month period). Other Italian Taxes Estate and Gift Tax. As of October 25, 2001, persons are no longer liable to pay estate and gift taxes in Italy. Transfer Tax. Legislative Decree no. 435 of November 21, 1997, has introduced substantial amendments to the discipline of the stock transfer tax. According to the new rules, the previous exemption for transactions with non resident parties is no more effective. Nevertheless, transactions effected (either as seller or purchaser) will still be granted tax exemption if (i) effected between a non - resident subject and a qualified intermediary (as defined by the Decree) or undertakings for collective investment in transferable securities; (ii) the transaction is effected outside of Italy between non - residents. Transactions meeting the foregoing criteria will be taxed as follows: (a) if the contract is made between private individuals or non - qualified intermediaries, the tax rate is equal to 0.14%; (b) if the transaction is effected by a non-qualified subject in counterpart or with the intervention of a qualified intermediary the tax rate is equal to 0.05%; (c) if the transaction is effected between qualified intermediaries the tax rate is 0.012%. F. NOT REQUIRED. G. NOT REQUIRED. H. DOCUMENTS ON DISPLAY. We are subject to the informational requirements of the Securities Exchange Act of 1934 and accordingly file reports, proxy statements and other information with the SEC. You may read and copy any document filed by us with the SEC without charge at the SEC's public reference room at 450 Fifth Street, N.W., Washington, D.C. 20549. Copies of documents may be obtained by mail from the Public Reference Branch of the SEC at such address, at prescribed rates. Please call the SEC at 1-800-SEC-0330 for further information on the public reference room. The SEC also maintains an internet website that contains reports, proxy statements and other information about issuers, including us, who file electronically with the SEC. The address of that site is http://www.sec.gov. I. NOT APPLICABLE. ITEM 11. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK We are exposed to market risks with respect to the value of foreign currencies in relation to the euro and changes in interest rates. We currently mitigate these exposures with the use of derivative financial instruments. Management has in place risk management procedures that periodically assess the level of market risk, related assets and liabilities and considers the appropriate courses of action. Historically, we have used interest rate swaps and foreign currency options and forward contracts to manage our market risk exposures. In managing these risks, the Company entered into the following contracts (in thousands of euro): November 30, 2004 ----------------- notional amount --------------- Interest Rate Swaps 21,000 Currency Options 39,936 The notional value of a derivative for the interest interest rate swap is the contractual amount on the basis of which the differentials are exchanged. The Currency Options notional value represents the contractual amount to be exchanged at the exercise date. The amounts expressed in foreign currency are converted into euro applying the exchange rate at year-end. The notional amounts above indicated do not represent amounts exchanged by the parties, that are limited to interest rate and exchange rate differentials, and thus are not a measure of credit exposure of the Company. Credit exposure is represented by the fair value of contracts that are positive at year-end, reduced by the effect of netting agreements. The Company does not expect to incur credit-related losses, also given the high credit standing of the counterparts involved. INTEREST RATE SWAPS In 2003 the company entered into an interest rate swap in order to exchange with a counterpart, at specified intervals for a 5-year period, the difference between interest amounts calculated by reference to the notional principal amount and agreed floating interest rate. The Company has entered into such an agreement to reduce the risk of increases in euro interest rate. At November 30, 2004, we had variable rate debt of approximately (euro)47.8 million. Based upon our overall interest rate exposure on variable rate debt, and taking into account the interest rate swaps discussed above, a hypothetical two percentage point increase or decrease in the related indexes (euribor/eurodollar/LIBOR rate) would increase or decrease interest expense and cash needs by (euro)1.0 million per year. Currency Options The Company uses currency options to partially hedge purchase costs of products that are denominated in U.S. Dollars and Japanese Yens. Currency options, purchased or sold in the over-the-counter market for a premium, provide the Company the right to buy or sell an agreed amount of U.S. Dollars at a specified exchange rate at the end of a specified period, currently not exceeding 60 months. Since such options are not designated against specific transactions, they have been accounted for at estimated fair market value. Fair market value reflects the estimated amount that the Company would pay or receive to terminate the contracts at the reporting date, therefore taking into account the current unrealised gains or losses of open contracts. In order to estimate the fair value of derivatives, the Company has used dealers' quote. Our results of operations and financial condition are affected by changes in the value of the euro against other currencies. The results of operations are adversely affected to the extent that the strengthening of the euro against other currencies affects the amount of sales reported in euro with respect to the sales made in such foreign currencies and may affect the demand for products in the countries in which such other currencies are utilized. Any decrease in the value of the euro as compared to other foreign currencies may expose us to adverse effects to the extent our payables and debt are payable in such foreign currency. With the completion of the relocation of all manufacturing to the U.S., the strengthening of the U.S. dollar against the euro could negatively impact our operating and net income. On the contrary a weakening of the U.S. dollar against the euro could positively impact our result of operations. Taking into account the currency options discussed above, the effect of a hypothetical 10% increase in the U.S. dollar against the euro would have decreased our fiscal year 2004 result of operations by approximately 52% from (euro)20.9 million to (euro)10.0 million, while a hypothetical 10% decrease in the U.S. Dollar against the euro would have increased our fiscal year 2004 result of operations by approximately 44% from (euro)20.9 million to (euro)30.2 million. ITEM 12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES NOT REQUIRED. PART II ITEM 13. DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES NOT APPLICABLE. ITEM 14. MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS A. NOT APPLICABLE. B. NOT APPLICABLE. C. NOT APPLICABLE. D. NOT APPLICABLE. E. NOT APPLICABLE. ITEM 15. CONTROLS AND PROCEDURES Pursuant to rules adopted by the Securities and Exchange Commission as directed by Section 302 of the Sarbanes-Oxley Act of 2002, the Company is providing the following information: As of the end of the period covered by this report (the "Evaluation Date") the Company conducted an evaluation (under the supervision and with the participation of the Company's chief executive officer and chief financial officer), pursuant to Rule 13a-15 promulgated under the Securities Exchange Act of 1934, as amended (the "Exchange Act") of the effectiveness of design and operation of the Company's disclosure controls and procedures. Based on this evaluation, the Company's chief executive officer and chief financial officer have concluded that as of the Evaluation Date such disclosure controls and procedures were reasonably designed to ensure that information required to be disclosed by the Company in reports it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission. During the period covered by this Annual Report on Form 20-F there have not been any significant changes in the internal controls, or in factors that could significantly affect the internal controls, nor were there any significant deficiencies or material weaknesses in the internal controls requiring corrective actions. ITEM 16A. DISCLOSURE ON AUDIT COMMITTEE FINANCIAL EXPERT The Company is not required by any applicable law or regulation to have, and does not currently have, an audit committee of its Board of Directors. As the Company does not have an audit committee, the Board of Directors has determined that the Company does not have an audit committee financial expert within the meaning of the regulations adopted under Sarbanes-Oxley Act of 2002. In this context it should be noted that many of the customary duties of an audit committee are performed by a Board of Statutory Auditors, which is composed of three independent experts in administrative and accounting matters. The Company is required to have a Board of Statutory Auditors under Italian law and they are appointed by the shareholders for a three-year term. Accordingly, the Company believes that there is a meaningful independent review of its financial statements beyond that performed by the independent public accountants also appointed by the shareholders in accordance with Italian law. ITEM 16B. CODE OF ETHICS Pursuant to rules adopted by the Securities and Exchange Commission, we are providing the following information: By resolution of May 25, 2004, the Board of Directors has adopted a Code of Ethics which covers the responsibilities of the members of the Board, of the Chief Executive Officer, Chief Financial Officer and Controller or other senior financial officers. ITEM 16C. PRINCIPAL ACCOUNTANT FEES AND SERVICES Details of the aggregate fees billed for each of the last two fiscal years for professional services rendered by our independent registered public accounting firm, BDO Sala Scelsi Farina, S.p.A., for the audit of the financial statements together with procedures for approving services by the auditor are set out below: 2004 2003 Audit fees (euro)346,550 (euro)331,000 Audit-Related fees - - Tax fees: - - compliance services advisory services - - All other fees - - ----------------------------- Total (euro)346,550 (euro)331,000 ----------------------------- ITEM 16D. EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES NOT APPLICABLE. ITEM 16E. PURCHASES OF EQUITY SECURITIES During the period covered by this Annual Report, we did not make any purchases of shares or other units of any class of the Company's equity securities registered pursuant to section 12 of the Securities Exchange Act of 1934, nor were such purchases made on our behalf. Part III ITEM 18. FINANCIAL STATEMENTS The financial statements and notes to the financial statements of Instrumentation Laboratory S.p.A. are available on pages F-1 through F-45. Reports of Independent Auditors are included within this Item 18. ITEM 19. EXHIBITS Exhibit Description ------- ----------- 1.1 Articles of Association were filed with the SEC on Form F-1 filed on October 22, 1996, file registration number 333-05682, and are incorporated herein by reference. 1.2 Amended By-laws of the Company.* 4.1 Strategic Alliance and Cross Distribution Agreement, dated July 28, 1999, by and between C.H. Werfen S.A. and Beckman Coulter Inc., filed with the SEC on May 31, 2000, under Form 20-F, is incorporated herein by reference. (Confidential materials omitted and filed separately with the Securities and Exchange Commission pursuant to a claim of confidential treatment.) 4.2 Distribution Agreement dated as of April 6, 2001, by and between the Company and Izasa, filed with the SEC on May 31, 2001, under Form 20-F, is incorporated herein by reference. (Confidential materials omitted and filed separately with the Securities and Exchange Commission pursuant to a claim of confidential treatment.) 4.3 Cost Sharing Agreement dated as of May 4, 2001, by and between the Company and Izasa, filed with the SEC on May 31, 2001, under Form 20-F, is incorporated herein by reference. (Confidential materials omitted and filed separately with the Securities and Exchange Commission pursuant to a claim of confidential treatment.) 4.4 Deposit Agreement, among the Registrant, The Bank of New York, as Depositary, and all owners and beneficial owners from time to time of American Depositary Receipts (including as an exhibit the form of American Depositary Receipt), filed with the SEC as exhibit 4.3 on Form F-1 filed on October 22, 1996, file registration number 333-05682, and is incorporated herein by reference. 8 List of Subsidiaries.* 10.1 English Summary of a Syndicated Loan Agreement dated as of April 12, 2005 among Izasa Distribuciones Tecnicas S.A. and a group of financial entities.* 11 Code of Ethics filed with the SEC on May 28, 2004 under Form 20-F, is incorporated herein by reference.* 12 Section 302 Certifications.* 13 Section 906 Certifications.* ------------------ * Filed herewith SIGNATURES The registrant hereby certifies that it meets all of the requirements for filing on Form 20-F and that it has duly caused and authorized the undersigned to sign this annual report on its behalf. INSTRUMENTATION LABORATORY S.p.A. By: /s/ Jose Luis Martin -------------------------------- Name: Jose Luis Martin Title: Chief Financial Officer Date: May 27, 2005 INDEX TO FINANCIAL STATEMENTS Report of Independent Auditors for the years ended November 30, 2003 and 2004. AUDITED CONSOLIDATED FINANCIAL STATEMENTS Audited Consolidated Balance Sheets as of November 30, 2003 and 2004....... F-1 Audited Consolidated Statements of Operations for the years ended November 30, 2002, 2003 and 2004........................................... F-3 Audited Consolidated Statements of Cash Flows for the years ended November 30, 2002, 2003 and 2004........................................... F-4 Audited Consolidated Statements of Changes in Shareholders' Equity for the years ended November 30, 2002, 2003 and 2004....................... F-6 Notes to the Audited Consolidated Financial Statements..................... F-7 [GRAPHIC OMITTED] REPORT OF INDEPENDENT REGISTERED ACCOUNTING FIRM To the Shareholders of Instrumentation Laboratory S.p.A.: We have audited the accompanying consolidated balance sheets of Instrumentation Laboratory S.p.A. (an Italian corporation) and Subsidiaries (collectively, the "Company") as of November 30, 2003 and 2004 and the related consolidated statements of operations, shareholders' equity and cash flows for each of the three years in the period ended November 30, 2004, expressed in Euro. 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. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of November 30, 2003 and 2004 and the results of its operations and its cash flows for each of the three years in the period ended November 30, 2004 in conformity with accounting principles generally accepted in Italy. The accounting practices of the Company used in preparing the accompanying financial statements vary in certain respects from accounting principles generally accepted in the United States of America. A description of the significant differences between the Company's accounting practices and accounting principles generally accepted in the United States of America and the approximate effect of those differences on consolidated net results and shareholders' equity are set forth in Notes 21 and 22 of the notes to the audited consolidated financial statements. BDO Sala Scelsi Farina Societa di Revisione per Azioni /s/ BDO Sala Scelsi Farina S.p.A. Milan, Italy February 11, 2005 except for notes 21, 22, 23, 24 and 25 which are as of May 16, 2005 INSTRUMENTATION LABORATORY S.P.A. AND SUBSIDIARIES AUDITED CONSOLIDATED BALANCE SHEETS AS OF NOVEMBER 30, 2003 AND 2004 (THOUSANDS OF EURO OR THOUSANDS OF U.S. DOLLARS, EXCEPT PER SHARE DATA)
NOTE 2003 2004 2004 ------- ------ ------ ------ EURO EURO U.S.$(1) ASSETS CURRENT ASSETS: Cash and cash equivalents 14,372 18,861 25,008 Trade receivables, net of allowance for doubtful accounts and sales returns of Euro 4,598 thousands in 2003 and Euro 5,084 thousands in 2004 5 75,992 81,200 107,663 Other receivables 3,153 2,461 3,263 Inventories, net 7 46,314 45,559 60,407 Prepaid expenses and other current assets 4,913 6,601 8,752 ------- ------- ------- Total current assets 144,744 154,682 205,093 NON-CURRENT RECEIVABLES AND OTHER ASSETS 435 330 438 INSTRUMENTS AT CUSTOMERS, net 8 26,501 26,360 34,951 PROPERTY, PLANT AND EQUIPMENT: Land and buildings 5,631 7,580 10,050 Leasehold improvements 6,152 5,042 6,685 Plant, machinery and equipment 36,735 36,170 47,958 Furniture, fixtures and vehicles 16,661 16,237 21,529 Construction in progress 1,471 2,359 3,128 Accumulated depreciation (45,337) (46,736) (61,967) ------- ------- ------- 21,313 20,652 27,383 INTANGIBLE ASSETS AND DEFERRED CHARGES, net 9 110,848 102,777 136,272 ------- ------- ------- Total assets 303,841 304,801 404,137 ======= ======= ======= (1) Exchange rate: Euro 1.00 = U.S. $ 1.3259 as of November 30, 2004
The accompanying notes are an integral part of these consolidated financial statements. INSTRUMENTATION LABORATORY S.P.A. AND SUBSIDIARIES AUDITED CONSOLIDATED BALANCE SHEETS AS OF NOVEMBER 30, 2003 AND 2004 (THOUSANDS OF EURO OR THOUSANDS OF U.S. DOLLARS, EXCEPT PER SHARE DATA)
NOTE 2003 2004 2004 ------- ------ ------ ------ EURO EURO U.S.$(1) LIABILITIES AND SHAREHOLDERS' EQUITY CURRENT LIABILITIES: Bank overdrafts and short-term debt 10 50,058 44,347 58,800 Current portion of long-term debt 11 - 1,343 1,781 Trade and other payables 45,678 57,055 75,649 Income taxes payable 12 2,547 1,647 2,184 Accrued expenses and other liabilities 13 39,532 35,472 47,032 ------- ------- ------- Total current liabilities 137,815 139,864 185,446 LONG-TERM DEBT, net of current portion 11 97,234 2,076 2,753 DEFERRED INCOME TAXES 12 302 - - RESERVE FOR SEVERANCE INDEMNITIES 14 6,217 6,979 9,253 MINORITY INTEREST 411 474 629 ------- ------- ------- Total liabilities 241,979 149,393 198,081 ------- ------- ------- COMMITMENTS AND CONTINGENCIES 15 - - - SHAREHOLDERS' EQUITY: 16 Share capital (90,701,104 and 362,521,088 shares authorized, issued and outstanding at November 30, 2003 and 2004, par value Euro 1.29 each and Euro 0.33, respectively) 117,004 119,632 158,620 Additional paid-in capital 11,496 - - Cumulative translation adjustment (3,697) (6,481) (8,593) Retained earnings (Accumulated deficit) (62,941) 42,257 56,029 ------- ------- ------- Total shareholders' equity 61,862 155,408 206,056 ------- ------- ------- Total liabilities and shareholders' equity 303,841 304,801 404,137 ======= ======= ======= (1) Exchange rate: Euro 1.00 = U.S. $ 1.3259 as of November 30, 2004
The accompanying notes are an integral part of these consolidated financial statements. INSTRUMENTATION LABORATORY S.P.A. AND SUBSIDIARIES AUDITED CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE YEARS ENDED NOVEMBER 30, 2002, 2003 AND 2004 (THOUSANDS OF EURO OR THOUSANDS OF U.S. DOLLARS, EXCEPT PER SHARE DATA)
NOTE 2002 2003 2004 2004 ---- ---- ---- ---- ---- EURO EURO EURO U.S.$(1) Net sales 17 272,591 260,011 280,031 371,293 Cost of sales and services 141,549 131,066 136,893 181,506 ------- ------- ------- ------- Gross profit 131,042 128,945 143,138 189,787 Research and development costs 25 20,072 19,238 17,765 23,555 Selling, general and administrative expenses 99,792 93,746 96,534 127,994 ------- ------- ------- ------- Operating income before amortization of intangible assets and deferred charges 11,178 15,961 28,839 38,238 Amortization of intangible assets and deferred charges 9 8,464 8,423 7,968 10,565 ------- ------- ------- ------- Operating income 2,714 7,538 20,871 27,673 Interest income 18 980 746 739 980 Interest (expense) 18 (12,210) (10,810) (7,272) (9,642) Other (expense) income, net 19 (2,696) (5,789) (4,751) (6,299) ------- ------- ------- ------- Income (loss) before income taxes and minority Interest (11,212) (8,315) 9,587 12,712 Income taxes 12 2,549 2,703 2,806 3,720 Minority interest 80 67 103 137 ------- ------- ------- ------- Net income (loss) (13,841) (11,085) 6,678 8,855 ======= ======= ======= ======= Income (loss) per share 3 (0.1516) (0.1222) 0.0264 0.0349 ======= ======= ======= ======= (1) Exchange rate: Euro 1.00 = U.S. $ 1.3259 as of November 30, 2004
The accompanying notes are an integral part of these consolidated financial statements. INSTRUMENTATION LABORATORY S.P.A. AND SUBSIDIARIES AUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED NOVEMBER 30, 2002, 2003 AND 2004 (THOUSANDS OF EURO OR THOUSANDS OF U.S. DOLLARS, EXCEPT PER SHARE DATA)
2002 2003 2004 2004 ---- ---- ---- ---- EURO EURO EURO U.S.$(1) CASH FLOWS FROM OPERATING ACTIVITIES: Net income (loss) (13,841) (11,085) 6,678 8,855 Adjustments to reconcile net income (loss) to net cash provided by operating activities Depreciation and amortization 22,673 23,645 23,754 31,495 Provision for severance indemnities 987 1,141 1,238 1,642 Net (gain) on sale of fixed assets (117) (72) (210) (278) (Decrease) of deferred income taxes and other long-term liabilities (533) (1,159) (715) (948) Decrease (increase) in: Accounts receivable 10,640 12,756 (4,516) (5,988) Inventories 1,224 5,431 755 1,001 Prepaid expenses (2,144) 117 (1,688) (2,238) Increase (decrease) in: Accounts payable 5,474 1,631 11,298 14,980 Accrued expenses and income taxes 1,234 4,322 (4,960) (6,576) ------- ------- ------- ------- Net cash provided by operating activities 25,597 36,727 31,634 41,945 ------- ------- ------- ------- CASH FLOWS FROM INVESTING ACTIVITIES: Investment in instruments at customers (21,568) (17,013) (17,315) (22,958) Purchase of fixed assets (6,090) (7,270) (8,238) (10,923) Increase in intangible assets and deferred charges (304) (177) - - Decrease (Increase) in investments and other long term assets (123) 130 105 139 Proceeds from sale of fixed assets 11,904 4,840 8,864 11,753 ------- ------- ------- ------- Net cash provided by (used in) investing activities (16,181) (19,490) (16,584) (21,989) ------- ------- ------- ------- (1) Exchange rate: Euro 1.00 = U.S. $ 1.3259 as of November 30, 2004
The accompanying notes are an integral part of these consolidated financial statements.
INSTRUMENTATION LABORATORY S.P.A. AND SUBSIDIARIES AUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED NOVEMBER 30, 2002, 2003 AND 2004 (THOUSANDS OF EURO OR THOUSANDS OF U.S. DOLLARS, EXCEPT PER SHARE DATA) 2002 2003 2004 2004 ---- ---- ---- ---- EURO EURO EURO U.S.$(1) CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from issuance of long-term debt 875 - 2,076 2,753 Repayment of long-term debt (4,000) (1,098) (7,533) (9,989) Increase (decrease) in bank overdrafts and short-term debt 1,896 (16,707) (4,368) (5,792) ------- ------- ------- ------- Net cash provided by (used in) financing activities (1,229) (17,805) (9,825) (13,028) ------- ------- ------- ------- EFFECT OF EXCHANGE RATES ON CASH (60) (1,218) (736) (976) ------- ------- ------- ------- NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 8,127 (1,786) 4,489 5,952 CASH AND CASH EQUIVALENTS at beginning of the year 8,031 16,158 14,372 19,056 ------- ------- ------- ------- CASH AND CASH EQUIVALENTS at end of the year 16,158 14,372 18,861 25,008 ======= ======= ======= ======= SUPPLEMENTAL INFORMATION: Cash paid during the year for: Interest 13,547 13,909 7,525 9,977 Income tax 1,785 2,883 2,965 3,931 Non cash conversion from debt to equity - - 89,701 118,934 (1) Exchange rate: Euro 1.00 = U.S. $ 1.3259 as of November 30, 2004
The accompanying notes are an integral part of these consolidated financial statements. INSTRUMENTATION LABORATORY S.P.A. AND SUBSIDIARIES AUDITED CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY FOR THE YEARS ENDED NOVEMBER 30, 2002, 2003 AND 2004 (THOUSANDS OF EURO OR THOUSANDS OF U.S. DOLLARS, EXCEPT PER SHARE DATA)
RETAINED ADDITIONAL CUMULATIVE EARNINGS SHARE PAID-IN TRANSLATION (ACCUMULATED TOTAL CAPITAL CAPITAL ADJUSTMENT DEFICIT) EQUITY ------- ------- ---------- ------- ------ BALANCE AT NOVEMBER 30, 2001 as restated 117,004 79,958 8,235 (106,355) 98,842 -------- -------- -------- -------- -------- Loss coverage - (68,462) - 68,462 - Change in minority interest - - - (70) (70) Loss from translation of foreign currency financial statements - - (4,615) - (4,615) Net loss for the year - - - (13,841) (13,841) -------- -------- -------- -------- -------- BALANCE AT NOVEMBER 30, 2002 117,004 11,496 3,620 (51,804) 80,316 -------- -------- -------- -------- -------- Other variations - - - (52) (52) Loss from translation of foreign currency financial statements - - (7,317) - (7,317) Net loss for the year - - - (11,085) (11,085) -------- -------- -------- -------- -------- BALANCE AT NOVEMBER 30, 2003 117,004 11,496 (3,697) (62,941) 61,862 -------- -------- -------- -------- -------- Loss coverage (87,073) (11,496) - 98,569 - Issuance of 271,819,984 ordinary shares at Euros 0.33 par value in exchange for outstanding debt 89,701 - - - 89,701 Other variations - - - (49) (49) Loss from translation of foreign currency financial statements - - (2,784) - (2,784) Net income for the year - - - 6,678 6,678 -------- -------- -------- -------- -------- BALANCE AT NOVEMBER 30, 2004 119,632 - (6,481) 42,257 155,408 -------- -------- -------- -------- -------- BALANCE AT NOVEMBER 30, 2004 in U.S.$(1) 158,620 - (8,593) 56,029 206,056 ======== ======== ======== ======== ======== (1) Exchange rate: Euro 1.00 = U.S. $ 1.3259 as of November 30, 2004
The accompanying notes are an integral part of these consolidated financial statements. 1. GROUP STRUCTURE AND ACTIVITY The Instrumentation Laboratory Group is engaged in the design, manufacture, distribution and service of laboratory test instruments used primarily for the diagnosis of disease or health conditions. The Group also manufactures and sells reagents, controls and supplies for hospitals and independent clinical laboratories. In 1991 IL Holding S.p.A., an Italian inactive subsidiary of the ultimate parent company CH-Werfen, S.A. (Spain), acquired from a U.S. corporation (the 'Seller') the share capital of a number of companies collectively known worldwide as 'Instrumentation Laboratory' for U.S. $139 million as well as the patents and trademarks related to the Instrumentation Laboratory business for U.S. $35.6 million. In 1992 the wholly-owned Italian subsidiaries Instrumentation Laboratory S.r.l. and Instrumentation Laboratory Sud S.p.A. were merged into the parent company, IL Holding S.p.A., which changed its name to Instrumentation Laboratory S.p.A (the 'Company'). In September 1996, the Company acquired Chromogenix, a leading manufacturer of reagents used primarily for hemostasis instruments, based in Sweden, and Mallinckrodt Sensor Systems Inc. ('MSS'), which provides blood gas and electrolyte analysers, together with reagents, controls, other consumables and services, which are designed to be used by the care provider for near-patient uses ('1996 Acquisitions'). The purchase price of Euro 59.1 million has been allocated to specifically identifiable tangible and intangible net assets acquired, with the resulting excess purchase price of Euro 40.4 million assigned to goodwill. In January 1999, the Company acquired Hemoliance ('1999 Acquisitions'), a joint venture consisting of two companies, Medical Laboratory Automation Inc. (MLA) and Ortho-Clinical Diagnostic Inc. ('OCD'). The Company purchased 100% of MLA total common stock for U.S.$ 75 million, and the assets of OCD for U.S.$ 55 million. In connection with the 1999 Acquisition certain restructuring actions relating to the acquired business were undertaken, including closing down a facility, transitioning the business to an indirect distribution model and severing a number of employees. Accordingly, a restructuring reserve of approximately U.S.$ 19.1 million was recognized as a liability assumed as of the consummation date of acquisition and included in the allocation of the acquisition cost. The excess of purchase price over the fair value of the identifiable assets and liabilities acquired, as resulting after the accrual of the restructuring reserve, has been assigned to goodwill for a total amount of US $ 114.7 million and is being amortized over 20 years. As of November 30, 2003 and 2004 the parent company Instrumentation Laboratory S.p.A. owned the following subsidiaries, either directly or indirectly: Company 2003 2004 ------- ---- ---- Instrumentation Laboratory GmbH (Germany) 100% 100% Instrumentation Laboratory Ges.mbH (Austria) 100% 100% Instrumentation Laboratory U.K. Ltd. (U.K.) 100% 100% Instrumentation Laboratory S.A. (France) 100% 100% Instrumentation Laboratory Belgium N.V. 100% 100% Instrumentation Laboratory Group B.V. 100% 100% Instrumentation Laboratory (Netherlands) B.V. 100% 100% Instrumentation Laboratory Espana, S.L. 100% 100% Instrumentation Laboratory Company (U.S.A.) 100% 100% IL Diagnostic, S.A. de C.V. (Mexico) 100% 100% Medical Laboratory Automation Inc. 100% 100% Lessix AB (Sweden - in liquidation) 100% 100% Chromogenix Holding AB (Sweden - in liquidation) 100% 100% Chromogenix AB (Sweden - in liquidation) 100% 100% Instrumentation Laboratory (Lietuva) B.I. 67% 67% The shareholders' meeting held on November 17, 2004 resolved to change the Company fiscal year end from November 30 to December 31 in order to align it with CH-Werfen, S.A.'s year end. 2. BASIS OF THE CONSOLIDATED FINANCIAL STATEMENTS The accompanying consolidated financial statements include the accounts of the parent company, Instrumentation Laboratory S.p.A., and of the subsidiaries owned directly or indirectly (the 'Company' or the 'Group'). The subsidiaries included in the consolidation as of November 30, 2004 and 2003 are those listed above in Note 1. The consolidated balance sheet and the consolidated income statement are presented in a format used in the international practice. Accordingly, the accompanying consolidated financial statements are not prepared pursuant to the format of Italian decree No. 127 of 1991, which implemented in Italy the Seventh EU Directive on consolidated accounts. The financial statements used in the consolidation have been prepared following the general rules provided by the Italian Civil Code, interpreted by the accounting principles stated by the Italian Accounting Profession ('Consigli Nazionali dei Dottori Commercialisti e dei Ragionieri') or, in the absence thereof, with the statements of International Accounting Standards and International Financial Reporting Standards issued by I.A.S.B. (collectively, 'Italian GAAP'). 3. SUMMARY OF SIGNIFICANT ACCOUNTING AND REPORTING POLICIES The most significant accounting principles used in the preparation of the consolidated financial statements are: Principles of Consolidation (a) Assets and liabilities of consolidated companies are combined on a line-by-line basis, eliminating the book value of the related investments against the shareholders' equity of the subsidiaries. (b) Unrealized intercompany profits and losses are eliminated, together with all intercompany accounts and transactions. (c) Any excess of the purchase price over the fair value of the specifically identifiable tangible and intangible net assets of acquired companies at the acquisition date, is recognized as an asset (goodwill) and amortized over its useful life not exceeding 20 years, as described in Note 1. The goodwill arising on the 1991 Acquisition was charged directly to shareholder's equity, consistent with one of the possibilities then allowed under Italian GAAP. Cash and cash equivalents The Company considers cash and cash equivalents to be its cash on hand and on deposit with banks. Receivables and Payables Receivables and payables are stated at nominal value. Receivables are reduced to expected realizable value by the allowance for doubtful accounts and sales returns. Allowance for doubtful accounts Accounts receivable are reduced by an amount which may be uncollectable in the future. The estimated allowance for doubtful accounts is determined primarily on management's evaluation of the financial condition of the customer. Inventories Inventories, which include material, labour and manufacturing overhead, are valued at the lower of cost, on a FIFO basis, or market value. Estimated losses from obsolete or slow-moving inventories are currently provided for. Instruments at Customers Instruments held by customers under reagent rental contracts, in which the Company retains title, are accounted for at cost less accumulated depreciation. The cost of the instruments is depreciated on a straight-line basis over the average length of the related contracts, but not exceeding 5 years. Instruments leased to customers under sales-type lease contracts are recorded at an amount equal to the net investment in the lease, with the finance income being recognized over the life of the related contracts. Under the contracts, customers are generally required to purchase specified minimum amounts of reagents. Property, Plant and Equipment Property, plant and equipment is recorded at the acquisition cost for the Group, which for certain assets is represented by the fair market value of assets at the time of their acquisition. Depreciation is provided on a straight-line basis over the estimated useful lives of fixed assets as follows: Buildings 18 - 50 years Leasehold improvements 4 - 10 years Plant, machinery and equipment 3 - 15 years Furniture, fixtures and vehicles 3 - 20 years Leasehold improvements are amortized over the shorter of the estimated useful life of the related assets or the remaining lease term. The costs of repairs, maintenance and replacements, which do not significantly improve or extend the useful life of the respective assets, are charged to expense as incurred. Sale and Lease-back transactions Instruments at customers sold to leasing companies under sale and lease back transactions are accounted for as operating leases, as allowed by the Italian law, since they are sold at cost, and the lease term approximates the expected useful life. Intangible Assets and Deferred Charges Intangible assets and deferred charges are carried at cost and amortized using the straight-line method over their estimated useful lives as follows: Patents, trademarks and other rights 5 - 20 years Deferred charges 3 - 5 years Goodwill 20 years Goodwill is amortized using the straight-line method from the date of acquisition over the expected period benefited, currently estimated at 20 years. The Company assesses the future useful life of this asset whenever events or changes in circumstances indicate that the current useful life has diminished. Income Taxes The provision for current income taxes is based on a reasonable estimate of taxable income for the year for each consolidated company. Deferred tax assets or liabilities are recognized for temporary differences between financial reporting and tax bases of assets and liabilities at each reporting period. Deferred tax assets are recognized when their realization is reasonably certain. Tax losses carried forward are recognised only when utilized. Accrual for Severance Indemnities and Pension Liabilities This accrual has been determined in accordance with the related laws in the various countries in which the Group operates and includes contributions to pension funds computed on the basis of generally accepted actuarial rules, as well as employee severance indemnities and benefit plans. Pension plans have been accounted for in accordance with IAS No. 19, in the absence of specific Italian accounting principles on this matter. Revenue Recognition Revenue from product sales is recognized at the time of shipment. Service revenues are recognized over the applicable contractual periods or as services are performed. Revenues from instrument rentals are recognized over the life of the rental contract. Revenue from sales-type leases is recognized at the inception of the lease equal to the present value of the lease payments to be received. The cost of the leased products is charged to cost of goods sold at the time the corresponding revenue is recognized. During 2004 the Company began a new line of business whereby it is acting as an agent in the sale of certain diagnostics products to a related party. As a result the Company has presented the net margin of these transactions as revenue. Warranty Costs The Company provides a reserve for warranty costs expected to be incurred on product sales covered by the Group's various warranty agreements. Research and Development Costs Research and development costs are charged to expense as incurred. Derivatives The Company enters into derivative transactions to hedge specific transactions as well as to reduce its exposure to interest rate and foreign exchange risks. The interest rate differentials to be received or paid on interest rate swaps and other interest rate agreements designated as hedges of specific underlying debt instruments are included in interest income or expense on an accrual basis over the period hedged. Foreign exchange derivatives (options) are used to hedge future expenses denominated in foreign currencies, but are not designated against specific future transactions. At the reporting date, these options are valued at estimated fair market value. The resulting losses are recognised in the income statement, while the resulting gains are accounted for only when realized. Foreign Currency Translation (a) Translation of Financial Statements denominated in foreign currencies Assets (except for goodwill) and liabilities of the Group's foreign subsidiaries are translated into Euro at the year-end exchange rates while revenues and expenses are translated at the average exchange rates for the period. Goodwill arising from the acquisitions of foreign entities is translated using the exchange rate at the date of the transaction. The resulting translation differences are included in shareholders' equity under the caption 'Cumulative Translation Adjustment'. (b) Translation of transactions and balances denominated in foreign currencies Transactions in foreign currencies are recorded at a rate approximating the exchange rate at the transaction date. Foreign currency assets and liabilities are translated at the rate prevailing at year-end and the resulting exchange gains or losses are recorded in the statement of operations. (Loss)/income per share (Loss)/income per share is computed based upon the weighted average number of common shares outstanding during the period. The weighted average number of common shares outstanding in fiscal 2002, 2003 and 2004 is 90,701,104, 90,701,104 and 253,347,488, respectively. Common stock options, which were outstanding in 2002, 2003 and 2004, have been excluded as their effect would be antidilutive. As of November 30, 2003 and 2004 there are 170,000 stock options outstanding. Statements of Cash Flows The cash flow statements are prepared in accordance with International Accounting Standards, using the indirect method. 4. TRANSLATION OF EURO AMOUNTS INTO U.S. DOLLAR AMOUNTS The consolidated financial statements are stated in Euro, the currency of the country in which the parent company is incorporated and operates. The translation of the Euro amounts into U.S. Dollars is included solely for the convenience of the reader, using the noon buying rate certified for customs purposes by the Federal Reserve Bank of New York as of November 30, 2004, which was Euro 1.00 to U.S. $ 1.3259. The convenience translation should not be construed as a representation that the Euro amounts have been, could have been, or could in the future be, converted into U.S. Dollars at this or any other rate of exchange. 5. TRADE RECEIVABLES As of November 30, 2003 and 2004 approximately 35% and 36%, respectively, of trade receivables were from a number of local entities and agencies that provide healthcare services throughout Italy and are managed and funded directly or indirectly by the Italian government. Under the Italian health system, accounts receivable may remain outstanding for up to 300 days on average. These extended payment periods are accepted in the industry. Total sales to these customers represent approximately 17%, 19% and 19%, respectively, of consolidated net revenues for the years ended November 30, 2002, 2003 and 2004. The Company's management does not expect any significant losses as a result of the concentration of these receivables. At November 30, 2003 and 2004 trade receivables from public Italian healthcare entities are net of Euro 25.7 million and Euro 26.6 million, respectively, sold through a factoring transaction. 6. STRATEGIC ALLIANCE During 1992 the ultimate parent company, CH-Werfen, S.A., entered into a long-term strategic alliance agreement with another medical products manufacturer (Coulter Corporation, which in 1997 merged with Beckman, another leading diagnostics manufacturer, hereafter 'Beckman Coulter') in order to optimise their respective activity in the healthcare business. Such agreement was terminated in July 1999 when the parties entered into a new long-term strategic alliance and distribution agreement (the 'Strategic Alliance Agreement'). This agreement has an initial duration of 10 years. Under the Strategic Alliance Agreement: (a) Beckman Coulter is the exclusive distributor of the Group's hemostasis systems in the United States, Canada, Australia, New Zealand, China and certain other countries. (b) The Group is the exclusive distributor of Beckman Coulter's hematology, flow cytometry and particle characterization product lines in Austria and Italy. (c) Other affiliates of Werfen also serve as distributors of Beckman Coulter products in certain countries. Under the Strategic Alliance Agreement, Group companies are prohibited from manufacturing any product competitive with the products sold by Beckman Coulter. The Strategic Alliance Agreement specifies certain targets for particular regions which, if not achieved, constitute inadequate performance and might imply the termination of the distribution rights in such region. If a party exercises this termination right with respect to specified regions and/or products, then the other party may terminate the Strategic Alliance Agreement. In addition, the Strategic Alliance Agreement may be terminated by either party to the Strategic Alliance Agreement in the event of a reorganization, merger, consolidation or a direct or indirect sale of all or substantially all of the assets of the other party. Group receivables and payables from/to Beckman Coulter as of November 30, 2003 and 2004 and sales and purchases to/from Beckman Coulter for the years then ended were as follows (in thousands of Euro): 2003 2004 ---- ---- Trade receivables 8,618 10,824 Trade payables 3,733 7,869 Sales 36,563 39,908 Purchases 14,466 17,521 Sales of Beckman Coulter products by the Company under the exclusive distribution agreement for the years ended November 30, 2003 and 2004 amounted to Euro 30.8 million and Euro 34.3 million, respectively. 7. INVENTORIES As of November 30, 2003 and 2004 inventories were as follows (in thousands of Euro): 2003 2004 ---- ---- Raw materials 13,040 13,039 Work-in-process 882 681 Finished goods 38,818 37,814 Service parts 3,528 3,379 ------- ------- 56,268 54,913 Less: Reserve for obsolescence (9,954) (9,354) ------- ------- 46,314 45,559 ======= ======= 8. INSTRUMENTS AT CUSTOMERS As of November 30, 2003 and 2004, instruments at customers consisted of the following (in thousands of Euro): 2003 2004 ---- ---- Instruments Owned by the Group ------------------------------ Instruments cost 75,169 77,180 Less: Accumulated depreciation (50,644) (52,361) ------- ------- 24,525 24,819 ------- ------- Net long-term investment in sales-type -------------------------------------- leased instruments ------------------ Minimum lease payments receivable 3,875 3,505 Less: Allowance for non-collectible amounts (48) (53) Net lease payments receivable 3,827 3,452 Less: Unearned interest income (870) (887) ------- ------- Net investment in sales-type leases 2,957 2,565 Less: Current portion (981) (1,024) ------- ------- 1,976 1,541 ------- ------- 26,501 26,360 ======= ======= Laboratory instruments are either given in free use to customers under reagent rental contracts or leased to customers under long-term leases which qualify as sales-type leases with selling profit recognized at the inception of the lease. As a result, the Group has recorded rental receivables as of November 30, 2003 and 2004 equal to the present value of the lease payments to be received less a reserve to cover potential non-collectible amounts (net investment in sales-type leases). Amounts expected to be received within the next year have been reflected in other receivables in the accompanying consolidated financial statements. Future minimum lease payments to be received for each of the five succeeding fiscal years ending November 30 are as follows (in thousands of Euro): 2005 1,334 2006 1,074 2007 653 2008 339 2009 105 ----- 3,505 ===== Depreciation of instruments owned by the Group for the years ended November 30, 2003 and 2004 amounted to Euro 8.5 million and Euro 9.4 million, respectively. Since 2001 the Company has entered into sale and leaseback transactions, by which certain equipment in use at customers was sold and leased back over a period that is in line with the estimated useful life of the equipment. These transactions have been accounted for as operating leases, as allowed by the Italian law, even though they represent finance leases. Total lease cost charged to the statement of operations for the years ended November 30, 2003 and 2004 amounted to Euro 4.7 million and Euro 5.1 million, respectively. Had the Company accounted for this transaction as a finance lease, the net income for the fiscal year 2004 would have been higher by Euro 0.6 million and net equity as of November 30, 2004 would have been higher by Euro 1.5 million. Assets (instruments at customers) as of November 30, 2004 would have been higher by Euro 12.1 million and liabilities (financial debt) would have been higher by Euro 10.6 million, of which Euro 5.1 million would be short term. 9. INTANGIBLE ASSETS AND DEFERRED CHARGES Intangible assets and deferred charges at November 30, 2003 and 2004, are summarized as follows (in thousands of Euro):
2003 ---- Accumulated ----------- Cost Amortization Net ---- ------------ --- Patents, trademarks and other rights 40,011 (32,558) 7,453 Goodwill arising from 1996 Acquisitions 40,409 (14,868) 25,541 Goodwill arising from 1999 Acquisition 102,436 (25,069) 77,367 Other 4,225 (3,738) 487 ------- ------- ------- 187,081 (76,233) 110,848 ======= ======= ======= 2004 ---- Accumulated ----------- Cost Amortization Net ---- ------------ --- Patents, trademarks and other rights 13,605 (6,684) 6,921 Goodwill arising from 1996 Acquisitions 40,409 (16,949) 23,460 Goodwill arising from 1999 Acquisition 102,436 (30,318) 72,118 Other 4,122 (3,844) 278 ------- ------- ------- 160,572 (57,795) 102,777 ======= ======= =======
Amortization for the years ended November 30, 2002, 2003 and 2004 is as follows:
2002 2003 2004 ---- ---- ---- Patents, trademarks and other rights 992 966 532 Goodwill arising from 1996 Acquisitions 2,081 2,081 2,081 Goodwill arising from 1999 Acquisition 5,249 5,249 5,249 Other 142 169 106 --- --- --- 8,464 8,423 7,968 ===== ===== =====
Goodwill arising from the 1996 Acquisitions represents the excess of the aggregate purchase price over the fair values of the identifiable net assets of Chromogenix and Mallinckrodt Sensor Systems Inc. as at the date of acquisition. Goodwill arising from the '1999 Acquisition' represents the excess of the aggregate purchase price over the fair values of the identifiable net assets of Hemoliance, after the accrual of the restructuring reserve, at the date of acquisition. As of November 30, 2004, the estimated aggregate amortization expense, based on current levels of intangible assets for the succeeding five years is as follows: Years Ending November 30, (Thousands of Euro) ------------------------- 2005 7,970 2006 7,970 2007 7,930 2008 7,860 2009 7,860 10. BANK OVERDRAFTS AND SHORT-TERM DEBT As of November 30, 2003 and 2004, the Group had available short-term credit lines of approximately Euro 90.0 million and Euro 89.6 million, respectively, with various banks in Europe, primarily for working capital purposes. Such short-term credit lines are primarily in the form of uncommitted short-term bank loan facilities that are repayable on demand and may be revoked at any time by the lender upon notice. At the same dates the utilization of such credit lines may be summarized as follows (in thousands of Euro): 2003 2004 ---- ---- Euro denominated bank overdrafts and short-term loans, bearing interest variable from 4.50% to 9.50% at November 30, 2004 24,356 18,676 Euro denominated bank advance on import/export, average interest at 6.08% at November 30, 2003 25,702 25,671 ------ ------ 50,058 44,347 ====== ====== Borrowings under revolving line of credit 50,058 44,347 Weighted average interest rate 5.95% 5.37% Maximum month-end balance during year 72,845 58,779 Average month-end balance during year 62,162 50,018 11. LONG-TERM DEBT Long-term debt at November 30, 2003 and 2004, is summarized as follows (in thousands of Euro): 2003 2004 ---- ---- Euro denominated subordinated revolving loan from Izasa Distribuciones Tecnicas S.A 61,401 - Euro denominated subordinated loan from IL Holding S.p.A. 26,294 - Euro denominated loan expiring in 2010 - 2,076 U.S. Dollar denominated loan expiring in May 2005 9,310 1,343 ------ ------ Other long term debt 229 - ------ ------ 97,234 3,419 Less- Current portion of long-term debt - 1,343 ------ ------ 97,234 2,076 ====== ====== On February 26, 1999 the Company signed a subordinated revolving loan agreement with a Werfen affiliate (Izasa Distribuciones Tecnicas S.A.) in the amount of Spanish Pesetas 21,625 million (approximately Euro 130 million) and a subordinated long-term loan with Werfen S.A. (an affiliated company of CH-Werfen S.A.) in the amount of Spanish Pesetas 4,375 million (approximately Euro 26.3 million). Approximately Euro 114 million of the loan proceeds were used to pay for the acquisition of Hemoliance. Both loans original maturity has been extended to January 31, 2007 and bore interest at a floating rate based on the six-month Euribor plus 320 basis points per annum (ranging from 5.30% to 5.40% at November 30, 2003). On March 30, 2004, IL Holding S.p.A., an Italian subsidiary of Izasa Distribuciones Tecnicas S.A., exchanged Euro 89,700,595, corresponding to the the last portion of the outstanding loan plus matured interest, for 271,819,984 newly issued ordinary shares. The U.S. Dollar denominated loan is secured by the Company's inventory and receivables and bears interest at U.S. Dollar prime rate plus 2% (7.00% At November 30, 2004). Future maturities of long-term debt during the next five years and thereafter are as follows (in thousands of Euro): Years Ending November 30, Amount ------------------------- ------ 2005 1,343 2006 273 2007 519 2008 519 2009 519 2010 246 ----- 3,419 ===== 12. INCOME TAXES Each company included in the consolidation, computes its own income tax liability according to the rules of the country concerned, applying the appropriate tax rate on results reported or expected to be reported in the tax returns, adjusted for estimated non-taxable income and non-deductible expenses. Management is of the opinion that the amount accrued is adequate to cover possible liabilities for income tax for all open years, as it and its tax advisors believe there are sufficient elements to support the specific accounting and tax practices adopted, for which interpretations of the current tax law were required. Tax years beginning subsequent to November 1999 are still subject to review by the tax authorities for the Italian company. In October 1993, Italian tax authorities examined the 1991 tax return of Instrumentation Laboratory S.r.l. (merged into Instrumentation Laboratory S.p.A. during 1992). As a result, in the following years, the Company received assessments contesting the tax deductibility of amortization of goodwill recorded in 1991 through 1994 following a merger which took place in 1990. The Company filed appeal against these assessments received and the first level Tax Court ruled in favour of the Company in relation to all of the four years concerned. In 1999 and 2001 the second level Tax Court ruled in favour of the Company for the 1991, 1992 and 1993 assessments which have been definitively rejected, while discussion for the year 1994 is still pending. No provision has been made in the accompanying financial statements, as Group management is of the opinion that no significant liability will eventually result from the final resolution of the matters indicated in the preceding paragraph. In connection with any pre-1991 Acquisition tax contingencies, it should be noted that under the terms of the Agreement, the Seller is committed to indemnify Instrumentation Laboratory S.p.A. against future tax assessments for the portion exceeding U.S. $ 4 million which relate to periods prior to October 24, 1991. At November 30, 2003 and 2004, the Company has estimated that the tax basis of certain net assets exceeds the amounts recorded for financial reporting purposes. In addition, as of the same dates certain Group companies have tax loss carry forwards of approximately Euro 159 million and Euro 126 million, respectively, subject to review and approval of the applicable tax authorities, which will expire in years 2005 to 2022 if not utilized. A deferred tax asset has not been recorded to reflect the value of future tax benefits since its realization is not reasonably certain. Income tax expense for the fiscal years ended November 30, 2002, 2003 and 2004 are detailed as follows (in thousands of Euro): 2002 2003 2004 ---- ---- ---- Current income taxes 1,073 900 1,252 Deferred income taxes 82 (17) (296) ----- ----- ----- Total income taxes 1,155 883 956 IRAP 1,394 1,820 1,850 ----- ----- ----- Total tax provision for the year 2,549 2,703 2,806 ===== ===== ===== The tax provisions for the years 2002, 2003 and 2004, as shown in the consolidated financial statements, are based on an effective tax rate which differs from the statutory tax rate in Italy. Income taxes include taxes on income for certain foreign subsidiaries, except for the Parent Company and the U.S. subsidiary for which no current income taxes is payable and deferred tax benefits on tax loss carry forward and other timing differences are not recognized due to the current period loss and uncertainty regarding the level of future taxable income. The Italian statutory tax rate at November 30, 2002, 2003 and 2004 should include both 'Corporate income tax' (IRPEG) at 34%, and 'Regional tax on productive activities' (IRAP) at 4.25% which has a different base of taxation and may be payable even in cases of pre-tax losses. 13. ACCRUED EXPENSES AND OTHER LIABILITIES At November 30, 2003 and 2004 accrued expenses and other liabilities consisted of the following (in thousands of Euro): 2003 2004 ------ ------ Payroll, including social charges 16,740 16,432 Service contract deferred income and warranty reserve 3,214 3,329 Accrued interest on loans from: - Izasa Distribuciones Tecnicas, S.A. 824 - - Miscel Holding B.V. 1,767 1,767 - IL Holding S.p.A. 2,808 1,136 Other accrued expenses and liabilities 14,179 12,808 ------ ------ 39,532 35,472 ====== ====== Other accrued expenses and liabilities include mainly professional and consultant fees, taxes other than income and sales commissions. 14. RESERVE FOR SEVERANCE INDEMNITIES All employees of the Group in Italy are entitled to a severance indemnity equivalent to a specified percentage of annual compensation. The benefit is payable upon termination of employment and is subject to annual revaluation at 75% of the official government rate of inflation (2.668% at November 30, 2004). As of November 30, 2003 and 2004, the resulting reserve for severance indemnities amounted to Euro 6.2 million and Euro 6.7 million, respectively. U.S. and UK employees of the Group are eligible to participate in employee pension and savings plans. Provisions for these plans for these subsidiaries are calculated on the basis of the actuarial and accounting rules required by International Accounting Standards and are summarized as follows (in thousands of Euro):
2002 2003 2004 ------ ------ ------ CHANGE IN PROJECTED BENEFIT OBLIGATION (PBO) DURING MEASUREMENT PERIOD PBO, November 30 of previous year 45,997 54,693 47,836 Exchange rate effect on opening balance 324 (10,767) (3,308) Service Cost 1,366 1,375 528 Interest Cost 2,926 2,739 2,386 Actuarial (Gain)/Loss 5,132 1,481 2,890 Benefits Paid (1,206) (1,685) (1,298) Plan amendments 154 - (4,712) ------ ------ ------ PBO, November 30, 54,693 47,836 44,322 ====== ====== ====== CHANGE IN PLAN ASSETS DURING THE MEASUREMENT PERIOD Plan Assets at Fair Value, November 30 of previous year 31,848 29,348 25,756 Exchange rate effect on opening balance 175 (6,127) (1,742) Expected Return on Plan Assets (1,467) 2,369 2,375 Employee Contribution 1,826 1,835 3,236 Benefits Paid (3,034) (1,685) (1,298) Actuarial gain (loss) - 16 105 ------ ------ ------ Plan Assets at Fair Value, November 30, 29,348 25,756 28,432 ====== ====== ====== RECONCILIATION OF PREPAID (ACCRUED) Underfunded Status of the Plan (23,890) (22,080) (15,890) Unamortized Prior Service Cost 403 (98) (164) Unrecognized Net Loss 25,219 23,252 19,185 ------ ------ ------ Prepaid (accrued) Pension Costs 1,732 1,074 3,131 COMPONENTS OF NET PERIODIC BENEFIT COST FOR FISCAL YEAR Service Cost 1,373 1,312 396 Interest Cost 3,079 2,827 2,386 Expected Return on Plan Assets (3,096) (2,570) (2,433) Net amortization and deferral 385 772 571 ------ ------ ------ Net Periodic Pension Cost 1,741 2,341 920
Assumptions used for the above funded status calculation include:
2002 2003 2004 ---- ---- ---- Annual rate of increase in compensation levels: United States plan 6.75% 5.00% 5.00% European plans 4.50% 4.50% 4.75% Discount rate applied to benefit obligation: United States plan 6.75% 6.75% 6.25% European plans 5.50% 5.50% 5.30% Expected long-term rate of return on plan assets: United States plan 9.00% 9.00% 8.50% European plans 7.50% 7.50% 7.50%
The net cumulative unrecognized actuarial loss as of November 30, 2004 amounts to Euro 19.2 million of which Euro 11.1 million relates to a U.S. pension plan and Euro 8.1 million relates to a UK pension plan. The net amount recognized as prepaid pension costs is the result of prepaid pension costs of Euro 2.3 million for U.S. plan and Euro 0.8 million for UK plan. In accordance with IAS No. 19, the Company has recognized the portion of net cumulative unrecognized actuarial losses at the end of the previous reporting period exceeding the greater of a) 10% of the present value of the defined benefit obligation at that date (before deducting plan assets) and b) 10% of the fair value of any plan assets at that date. This portion has been amortized over the expected average remaining working life of the employees participating in that plan. Savings Plan The U.S. subsidiary has also established a saving plan for all employees. Employee contributions to the savings plan can be made both on a pre-tax (salary deferral) and after-tax basis. The U.S. subsidiary may make a matching contribution in an amount equal to 25% of each employee's contribution up to a maximum of 8% of eligible compensation. The total U.S. subsidiary contribution is limited to 2% of eligible compensation. In addition, the U.S. subsidiary can make discretionary contributions to the savings plan. No discretionary contribution was made in 2003 and 2004. The U.S. subsidiary expensed approximately U.S.$ 460,000, $ 494,000 and $ 1,946,000 of employer matching contributions for the years ended November 30, 2002, 2003 and 2004, respectively. Postretirement Benefits The U.S. subsidiary currently provides certain postretirement healthcare and other benefits to eligible employees. The Company accounts for postretirement benefits under the provisions of SFAS No. 106, Employers' Accounting for Postretirement Benefits Other Than Pensions. Under SFAS No. 106, the Company is required to accrue the estimated cost of postretirement benefits during the employees' active service periods up to the date they become eligible for full benefits. 15. COMMITMENTS AND CONTINGENCIES Leases Minimum annual rental commitments as of November 30, 2004 under non-cancellable operating leases, principally for manufacturing, service and distribution centres, and office facilities are payable as follows (in thousands of Euro): Years Ending November 30, Operating ------------------------- --------- Leases ------ 2005 4,255 2006 3,358 2007 1,921 2008 1,687 2009 1,608 Thereafter 1,074 ------ Total minimum lease payments 13,903 ====== As of November 30, 2004, total commitments for lease payments related to sale and lease back of instruments (Note 8) amounted to Euro 10.6 million, of which Euro 5.1 million is short term. Legal Proceedings The Company is involved in several legal actions that arose in the ordinary course of business. While the outcome of each legal action contains an element of uncertainty based on currently known information, management and the Company's legal advisors are of the opinion that the final resolution of these matters will not have a material adverse effect on the consolidated financial statements of the Company. In addition, the Company has been indemnified against certain future environmental contingencies relating to the period prior to the acquisition. In 1996, 590 Lincoln Street Trust filed a lawsuit alleging a release of hazardous material, on or earlier than 1988, by one of its tenants, including an affiliate of the Company's predecessor that was an operator of the site. Later, the Company was named as a defendant. When Werfen acquired the Company, Werfen assumed the Company's liability, if any, relating to this lawsuit. The Company has denied liability in this matter. In 2002 the aforementioned case went to trial and verdict was returned against the Company. A judgment has been entered in the case in the amount of approximately U.S.$ 2.6 million. The Company has appealed the decision in the case. The Company believes that, in any case, the proceeding will not have a material adverse effect on the financial condition or results of operations of the Company. As of November 30, 2004 the Company has recorded an accrual of U.S.$ 2.2 million related to this judgment. Derivative financial instruments Derivative financial instruments are utilized by the Company to reduce its exposure to market risks from changes in interest rates and foreign exchange rates. In managing these risks, the Company entered in the following contracts (in thousands of Euro): November 30, 2004 ----------------- notional amount --------------- Interest Rate Swaps 21,000 Currency Options 39,936 The notional value of a derivative for the Interest Rate Swap is the contractual amount on the basis of which the differentials are exchanged. The Currency Options notional value represents the contractual amount to be exchanged at the exercise date. The amounts expressed in foreign currency are converted into Euro applying the exchange rate at year-end. The notional amounts above indicated do not represent amounts exchanged by the parties, that are limited to interest rate and exchange rate differentials, and thus are not a measure of credit exposure of the Company. Credit exposure is represented by the fair value of contracts that are positive at year-end, reduced by the effect of netting agreements. The Company does not expect to incur credit-related losses, also given the high credit standing of the counterparts involved. Interest Rate Swaps In 2003 the Company entered into an interest rate swap in order to exchange with a counterpart, at specified intervals for a 5-years period, the difference between interest amounts calculated by reference to the notional principal amount and agreed floating or fixed interest rate. The Company has entered in such agreement to reduce risk of increase in Euro interest rate. Currency Options The Company uses currency options to partially hedge purchase costs of products that are denominated in U.S. Dollars and Japanese Yens. Currency options, purchased or sold in the over-the-counter market for a premium, provide the Company the right to buy or sell an agreed amount of U.S. Dollars or Japanese Yens at a specified exchange rate at the end of a specified period, currently not exceeding 60 months. Since such options are not designated against specific transactions, they have been accounted for at estimated fair market value. Fair market value reflects the estimated amount that the Company would pay or receive to terminate the contracts at the reporting date, therefore taking into account the current unrealised gains or losses of open contracts. In order to estimate the fair value of derivatives, the Company has used dealers' quote. 16. SHAREHOLDERS' EQUITY Initial Public Offering On October 31, 1996 the Company launched an initial public offering (Offering) of its ordinary shares. Such shares have been traded on the Nasdaq National Stock Market until September 3, 1999 when they where de-listed because the Company no longer fulfilled minimum per share price requirement. Currently the Company's shares are quoted on the Pink Sheets service. Share Capital Shareholders at the Company's shareholders meeting held on March 29, 2004 approved the coverage of the 2004 and previous years losses, amounting to Euro 98,141 thousand, through the utilization of additional paid-in capital in the amount of Euro 11,496 thousands and through the reduction of the share capital by decreasing the par value of an Ordinary Share from Euro 1.29 to Euro 0.33. Shareholders at the same shareholders' meeting approved a capital increase which was finalized in May 2004 with the issuance of 271,819,984 new ordinary shares, par value Euro 0.33 each. Accordingly, the share capital outstanding as of November 30, 2003 and 2004 consisted respectively of 90,701,104 ordinary shares with a nominal value of Euro 1.29 each and of 362,521,088 ordinary shares with a nominal value of Euro 0.33 each. On November 25, 1997, the Company's shareholders approved a resolution to adopt a stock option plan for the benefit of senior management and key employees of the Company and its subsidiaries. The Company may grant to these individuals stock options which can be exercised within a period of 5 years for up to 750,000 ordinary shares. At the same meeting, the shareholders authorized the issuance of 750,000 shares, par value Lire 2,500 each (now Euro 1.29 each), to service the plan. In this respect the Board of Directors on July 22, 1998, authorized the issuance of options for up to 170,000 ordinary shares to be exercised up to 2008. The shareholders' meeting held on March 29, 2004 amended such resolution by reducing the par value of the shares to be issued to service the plan from Euro 1.29 to Euro 0.33. Change in minority interest During 2002 a change in minority interest occurred as a result of the decrease in the holding of Instrumentation Laboratory (Lietuva) B.I. subsidiary from 76% to 67%. The related amount of Euro 70 thousand represents the difference between the selling price of the 9% of the Parent company investment and the related portion of the Lietuva subsidiary Net Equity as of November 30, 2001. Reconciliation to Parent Company Equity The reconciliation of net result and shareholders' equity of Instrumentation Laboratory S.p.A. (the Group's parent company), as reflected in the statutory accounts or in the draft statutory accounts subject to approval of the Board of Directors, and consolidated net loss and shareholders' equity as reported in the accompanying financial statements as of November 30, 2002, 2003 and 2004 is as follows (in thousand of Euro):
Net Income (Loss) Shareholders' Equity ----------------- -------------------- 2002 2003 2004 2002 2003 2004 ----------------------------------------------------------------------------- Instrumentation Laboratory S.p.A. (14,986) (83,155) 12,787 113,632 30,477 132,964 Difference between carrying value of investments in subsidiaries and their net results and equity 1,685 78,008 2,129 (19,779) 9,837 7,320 Adjustments to conform with Group accounting principles 2,109 1,142 232 980 2,122 2,354 Elimination of intercompany transactions and other consolidation adjustments (2,649) (7,080) (8,470) (14,517) 19,428 12,770 -------- -------- -------- -------- ------ ------- Consolidated (13,841) (11,085) 6,678 80,316 61,862 155,408 ======== ======== ======== ======== ====== =======
17. NET SALES Sales from service contracts and their related costs were as follows (in thousands of Euro): 2002 2003 2004 ---- ---- ---- Net sales 25,191 20,945 19,698 Costs and expenses 19,169 17,804 17,755 ------ ------ ------ Gross profit 6,022 3,141 1,943 ===== ===== ===== Segment information The Group is a manufacturer of in vitro diagnostics test instruments and supplies and provides related services to the hospital and lab market, that management considers to be a single business segment, even though net sales and gross profit information is reported internally by product lines. The Group evaluates performance based both on net sales and gross profit information by product lines and on operating results by geographical areas, which are calculated after deductions for directly related expenses but before special charges and amortization of intangible assets. The accounting policies used for management internal reporting are those used for the consolidated financial statements described in Note 3. Selected information by major product lines as of November 30, 2002, 2003 and 2004 is as follows (in thousands of Euro):
Critical Clinical -------- -------- Hemostasis care Chemistry Other Total ---------- ---- --------- ----- ----- 2002 ---- Net sales 134,774 76,826 24,329 36,662 272,591 Gross profit 71,005 39,228 9,701 11,108 131,042 2003 ---- Net sales 125,019 72,596 24,889 37,507 260,011 Gross profit 66,289 39,486 8,600 14,570 128,945 2004 ---- Net sales 135,793 77,112 22,694 44,432 280,031 Gross profit 72,215 44,484 7,804 18,635 143,138
The product line denominated as 'Other' relates mainly to the distribution of Beckman Coulter products in Italy. Selected information about the Group geographic areas of operations is as follows (in thousands of Euro):
North Rest of ----- ------- Europe America World Total ------ ------- ----- ----- 2002 ---- Sales 158,972 96,589 17,030 272,591 Operating income (loss) before amortization 26,075 (21,074) 6,177 11,178 2003 ---- Sales 165,475 78,158 16,378 260,011 Operating income (loss) before amortization 33,905 (23,989) 6,045 15,961 2004 ---- Sales 181,720 80,629 17,682 280,031 Operating income (loss) before amortization 39,798 (17,162) 6,203 28,839
Selected information about the Group long-lived assets by geographic areas is as follows (in thousands of Euro):
North Rest of ----- ------- Europe America World Total ------ ------- ----- ----- 2003 ---- Tangible assets - Net 4,421 16,392 500 21,313 Reagent rentals - Net 20,045 3,277 3,179 26,501 Intangible assets (excluding Goodwill) - Net 1,448 123 - 1,571 Long-term receivables and other 290 47 98 435 2004 ---- Tangible assets - Net 3,310 14,531 2,811 20,652 Reagent rentals - Net 20,789 2,666 2,905 26,360 Intangible assets (excluding Goodwill) - Net 1,172 35 - 1,207 Long-term receivables and other 210 43 77 330
18. INTEREST INCOME AND EXPENSE Interest income and expense for the year ended November 2002, 2003 and 2004 were as follows (in thousands of Euro):
2002 2003 2004 ---- ---- ---- Interest income from deposits and other short-term financial assets 980 746 739 ------ ------ ------ Total interest income 980 746 739 ====== ====== ====== Interest expense on short-term bank borrowings 5,225 4,844 4,941 Interest expense on long-term debt 6,985 5,966 2,331 ------ ------ ------ Total interest expense 12,210 10,810 7,272 ====== ====== ======
19. OTHER INCOME (EXPENSE), NET Other income and expense include mainly bank charges, gain and losses of disposal of rentals, etc. as well as non recurring income and expenses (such as supplementary leaving indemnities). Other income (expense), net, consists of the following (in thousands of Euro):
2002 2003 2004 ---- ---- ---- Supplementary leaving indemnities (1,515) (981) (1,730) Gain (loss) on foreign exchange and forward exchange contracts 1,896 (2,667) (1,089) Litigation settlements and estimated costs to settle (1,260) (220) (471) Gain (loss) on disposal of fixed assets 117 72 (210) Bank charges (700) (914) (1,208) Other, net (1,234) (1,079) (43) ------- ------- ------- Total Other income (expense), net (2,696) (5,789) (4,751) ======= ======= =======
20. RELATED PARTY TRANSACTIONS Group companies purchase from, and sell products to, other entities of the Werfen Group. Total purchases from related parties for the year ended November 30, 2002, 2003 and 2004 were approximately Euro 8.4 million, Euro 10.5 million and Euro 13.1 million, respectively. In addition, for the year ended November 30, 2002, 2003 and 2004 a Werfen affiliate charged the Company approximately Euro 2.2 million, Euro 2.5 million and Euro 2.1 million, respectively, for software development services. These services relate basically to software applied for analytical instruments. Total sales to related parties for the year ended November 30, 2002, 2003 and 2004 were approximately Euro 13.7 million, Euro 12.7 million and Euro 16.3 million, respectively. As of November 30, 2003 and 2004, the most significant balances with Werfen Group companies are the following (in thousands of Euro): Commercial transactions (included in trade receivables and trade and other payables)
2003 2004 ---- ---- Receivables Payables Receivables Payables ----------- -------- ----------- -------- Izasa Distribuciones Tecnicas, S.A. 3,238 1,390 2,010 1,930 Biokit S.A. 291 - 255 Biokit Distribution S.A. - 5,017 - 5,102 NTE, S.A. - 638 - 701 Werfen Medical IL Ltd. Korea 414 - 305 - Comesa Austria 2 69 - 30 Comesa Poland 261 - 260 - ----- ----- ----- ----- 4,206 7,114 2,830 7,763 ===== ===== ===== ===== Financial transactions (including interests) 2003 2004 ---- ---- Receivables Payables Receivables Payables ----------- -------- ----------- -------- Izasa Distribuciones Tecnicas, S.A. - 62,225 - - Miscel Holding B.V. - 1,767 - 1,767 IL Holding S.p.A. - 29,102 - 1,136 ------ ------ ------ ----- - 93,094 - 2,903 ====== ====== ====== =====
Certain executive officers of the Company and other individuals historically have been employed by Werfen or its affiliates and, pursuant to agreements with the Company, have provided services to the Company and its subsidiaries as agreed between the parties. During fiscal 2002, 2003 and 2004, Izasa Distribuciones Tecnicas S.A. ('Izasa') charged certain Group companies approximately Euro 582 thousands, Euro 457 thousands and Euro 350 thousands, respectively, in management fees for corporate services provided to these companies and administrative and out-of-pocket expenses incurred in rendering those services. In connection with the acquisition of Hemoliance, completed in January 1999, certain Werfen Group companies granted long-term subordinated loans to the Company (Note 11). Interest charged on these loans in fiscal years 2002, 2003 and 2004 amounted to Euro 6.0 million, Euro 5.2 million and Euro 1.6 million, respectively. In 2001, the Company signed a distribution agreement with the Parent Company Izasa (its sole distributor in Spain and Portugal since before 1990), by which Izasa has been appointed exclusive distributor of the Company's products in Spain for the initial term of 10 years. The consideration paid by Izasa is Euro 9 million that has been recorded as non recurring income. Also in 2001 Izasa entered into a cost sharing agreement with the U.S. subsidiary of the Group. By said agreement Izasa contributes to finance the Group research and development activities on the basis of its share of total Group worldwide sales on related products. The contributions for fiscal years 2002, 2003 and 2004 amounted to Euro 2.2 million, Euro 2.7 million and Euro 2.4 million and have been classified as a reduction of research and development costs of the periods. On July 18, 2002, we executed as a guarantor a loan agreement with other Werfen group companies in favor of Izasa Distribuciones Tecnicas S.A., relating to a syndicated loan of (euro)100 million granted to Izasa. On March 24, 2004, we executed as a guarantor a loan agreement with other Werfen group companies in favor of Izasa Distribuciones Tecnicas S.A., relating to a syndicated loan of (euro)115 million granted to Izasa. On April 12, 2005, we executed as a guarantor a loan agreement with other Werfen group companies in favor of Izasa Distribuciones Tecnicas S.A., relating to a syndicated loan of (euro)250 million granted to Izasa, which replaces 2002 and 2004 syndicated loans above described. 21. SUMMARY OF SIGNIFICANT DIFFERENCES BETWEEN ACCOUNTING PRINCIPLES FOLLOWED BY THE COMPANY AND U.S. GENERALLY ACCEPTED ACCOUNTING PRINCIPLES The Group's financial statements have been prepared in accordance with Italian GAAP (see Note 2), which differ in certain respects from U.S. generally accepted accounting principles ("U.S. GAAP"). The effects of these differences are reflected in the reconciliation provided in Note 22 and principally relate to the items discussed in the following paragraphs. Accounting for Goodwill Goodwill arising from 1996 and 1999 Acquisitions is amortized over 20 years for Italian GAAP. On December 1, 2002 the Company adopted SFAS 142 which requires that goodwill and intangible assets, with indefinite lives, no longer be amortized but instead be tested for impairment at least annually, or when events indicate that an impairment may have occurred. The goodwill amortization recorded under Italian GAAP, in fiscal years 2003 and 2004, have been fully reversed in the accompanying reconciliation. Also, the adjustment in the reconciliation of the net loss under U.S. GAAP, reflects a decrease in the amount of goodwill recorded from the Chromogenix acquisition under U.S. GAAP as compared to Italian GAAP, due to the difference in the valuation of foreign currency forward contracts in existence at the date of acquisition. Accounting for Finance Sale and Lease Back As discussed in Note 3, instruments at customers sold to leasing companies under sale and lease back transactions are accounted for as operating leases, as allowed by the Italian law, even if they would qualify as a finance lease. Such accounting is not allowed by U.S. GAAP. Accounting for Goodwill Denominated in Foreign Currencies The goodwill arising from the acquisitions of MSS and Hemoliance (see Note 1 and Note 9) was translated at historical exchange rate in the financial statements as at November 30, 2002, 2003 and 2004. Such accounting is not allowed under U.S. GAAP, which requires that all the items of foreign financial statements be translated by using current exchange rates. Discount and Imputed Interest on Accounts Receivable Accounts receivable that originated from trade sales to Italian public agencies are contractually due within one year and consequently under Italian GAAP are stated at face value and classified as short-term assets, even though in practice a portion of these is generally collected after one year with no recognition of interest thereon. U.S. GAAP (APB 21) requires that these receivables be stated at fair value based on the discounted cash flows expected to be collected, and the difference between such value and the face amount be treated as discount and amortized as interest income over the period in which the receivables remain outstanding. Accounting for Pension Plans Group accounting policy requires that pensions and severance obligations be accounted for in accordance with the laws of the countries in which each subsidiary operates. This may differ from U.S. GAAP, because in certain European countries different consideration is given to the projected benefit obligation under defined benefit plans. Also, in accordance with IAS No. 19, the Company has recognized the portion of net cumulative unrecognized actuarial losses at the end of the previous reporting period exceeding the greater of a) 10% of the present value of the defined benefit obligation at that date (before deducting plan assets) and b) 10% of the fair value of any plan assets at that date. In these circumstances U.S. GAAP requires the Company to recognize in other comprehensive income an additional minimum liability. The amount recognized is the excess of the unfunded accumulated benefit obligation over the accrued pension cost. The accompanying reconciliation reflects the estimate of the effect that would result from the adoption of U.S. GAAP. Disclosures are presented in Note 14. Consolidation of subsidiary As a result of the acquisition of a further 25% shareholding, starting from December 1, 2000, the investment in a subsidiary established in the Republic of Lithuania has been consolidated on a line-by-line basis. As of November 30, 2000 the investment was stated at cost because the volume of operations carried out by the subsidiary during the year 2000 was not material. As required by Italian GAAP, the excess of equity over cost of a newly consolidated entity has been recorded to net equity. Under US GAAP, such excess, representing accumulated earnings, has been recorded in income. Accounting for derivatives The Company enters into derivative transactions to hedge specific transactions as well as to reduce its exposure to interest rate and foreign exchange risks. The interest rate differentials to be received or paid on interest rate swaps and other interest rate agreements designated as hedges of specific underlying debt instruments are included in interest income or expense on an accrual basis over the period hedged. Foreign exchange derivatives (options) are used to hedge future expenses denominated in foreign currencies, but are not designated against specific future transactions. At the reporting date, these options are valued at estimated fair market value. Under U.S. GAAP the fair value of the currency option has been recorded on the balance sheet at year-end with all changes in fair value recorded in the income statement. Deferred Income Taxes Deferred tax assets or liabilities are recognized for temporary differences between financial reporting and tax bases of assets and liabilities at each reporting period. Deferred tax assets are recognized when their realization is reasonably certain. In addition, benefits from tax loss carry-forwards are recognized when utilized except if it is reasonably certain that future taxable profit will be available against which the unused tax losses can be utilised, and such losses are originated by identified circumstances that it is reasonably certain will not be repeated. Under U.S. GAAP, income taxes are required to be accounted for in accordance with Statement of Financial Accounting Standards No. 109 (SFAS 109), 'Accounting for income taxes'. SFAS 109 requires deferred tax assets and liabilities be recognized for differences between financial reporting and tax bases of assets and liabilities at each reporting date. The benefits of tax loss carry-forwards are recognized as deferred tax assets. Tax assets are reduced by way of an appropriate valuation allowance to the amount that it is more likely than not to be realized. Accounting for monetary revaluation The Mexican subsidiary, in compliance with local accounting principles, prepared the financial statements including the effects of monetary inflation. In compliance with U.S. GAAP these effects have been eliminated in the reconciliation between Italian and U.S. GAAP as of November 30, 2002, 2003 and 2004. Accounting for Transfer of financial assets As described in Note 5, the Company entered into several factoring transactions by which trade receivables were sold. Some of these transactions do not meet all the criteria required under FASB 140 to record a sale of trade receivables as opposed to a secured borrowing. Loss coverage On April 17, 2002, the Company's shareholders' meeting approved the coverage of 2001 and previous years losses, amounting to Euro 68,462 thousand, through the utilization of additional paid-in capital. On March 29, 2004 the Company's shareholders' meeting approved the partial coverage of 2003 losses, amounting to Euro 11,496 thousands through the utilization of residual additional paid-in capital. This procedure, necessary to be in compliance with Italian Civil Code rules, is not allowed under U.S. GAAP and SEC regulations and consequently retained earnings and Additional paid-in capital should be, as of November 30, 2004, equal to 37,701 thousands Euro (Dr. balance) and 79,958 thousands of Euro (Cr. balance), respectively (see the 'Audited Consolidated Statements of Changes in Shareholders' Equity for the years ended November 30, 2002, 2003 and 2004'). Restatement During 2004, the Company restated its previously released reconciliation between net result and shareholders' equity determined under Italian GAAP and U.S. GAAP as of and for the year ended November 30, 2003 to correct the calculation of the provision for income taxes and the related deferred tax accounts under U.S. GAAP. The Company should have reported gross, certain deferred tax liabilities associated with differences related to differing tax and book bases of goodwill. As a result, the Company has restated the reconciliation to record under U.S. GAAP a deferred tax liability of approximately U.S.$ 1,583,000 at November 30, 2003 a provision for income taxes of approximately U.S.$ 791,000 and a cumulative effect of change in accounting principle of U.S.$ 792,000 in fiscal 2003. 22. RECONCILIATION BETWEEN NET RESULT AND SHAREHOLDERS' EQUITY DETERMINED UNDER ITALIAN GAAP AND U.S. GAAP The following is a summary of the significant adjustments to net result for the years ended November 30, 2002, 2003 and 2004 and to shareholders' equity as of November 30, 2003 and 2004 that would be required if U.S. GAAP had been applied instead of Italian GAAP in the consolidated financial statements:
Year ended November 30, ----------------------------------------------------- 2003 ---- NET INCOME (LOSS) 2002 (restated) 2004 2004 ------ ----------- ------ ------ (Thousands of Euro, except (Thousands of per Share Data) U.S.$, except per Share Data) Net income (loss) according to the financial statements prepared under Italian GAAP (13,841) (11,085) 6,678 8,855 Items increasing (decreasing) reported Net results: Accounting for goodwill 34 7,364 7,364 9,764 Accounting for finance sale & lease-back 455 559 664 880 Accounting for goodwill denominated in foreign currencies (1,447) (293) 321 426 Discount of accounts receivables (1,605) (1,170) (1,250) (1,657) Imputed interest on accounts receivable 1,704 1,605 1,170 1,551 Consolidation of subsidiary (70) (52) (49) (65) Accounting for derivatives 333 (333) (196) (260) Deferred income taxes (445) (1,015) (356) (472) Accounting for monetary revaluation 304 (114) 207 274 Tax effect of reconciling items (203) (128) - - -------- -------- -------- -------- Approximate net income (loss) from continuing operations in accordance with US GAAP (14,781) (4,662) 14,553 19,296 ======== ======== ======== ======== Cumulative effect of change in accounting principle - (681) - - -------- -------- -------- -------- Approximate net income (loss) in accordance with US GAAP (14,781) (5,343) 14,553 19,296 ======== ======== ======== ======== Net income (loss) per share - basic and diluted (0.16) (0.06) 0.06 0.08 Weighted average common shares outstanding 90,701,104 90,701,104 253,347,488 253,347,488 CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME (LOSS) Year ended November 30, ----------------------------------------------------- 2003 ---- NET INCOME (LOSS) 2002 (restated) 2004 2004 ------ ----------- ------ ------ (Thousands of Euro) (Thousands of U.S.$) Approximate net income (loss) in accordance with US GAAP (14,781) (5,343) 14,553 19,295 Cumulative translation adjustment (16,532) (23,206) (10,038) (13,309) Reversal of inflation accounting to Monetary Revaluation reserve (304) 114 (687) (911) Minimum pension liability, net of tax (6,310) (858) (30) (40) -------- -------- -------- -------- Total comprehensive income (loss) (37,927) (29,293) 3,798 5,035 ======== ======== ======== ========
At November 30, --------------------------------------------- SHAREHOLDERS' EQUITY 2003 ------ (restated) 2004 2004 ---------- ------ ------ (Thousands of Euro) (Thousands of U.S.$) Shareholders' equity according to the financial statements prepared under Italian GAAP 61,862 155,408 206,055 Items increasing (decreasing) reported shareholders' equity: Accounting for goodwill 6,896 14,260 18,908 Accounting for finance sale & lease back 885 1,549 2,054 Discount and imputed interest on accounts receivable (271) (350) (465) Accounting for goodwill denominated in foreign currencies (299) (7,232) (9,589) Accounting for pension plans (14,923) (14,953) (19,826) Accounting for monetary revaluation - (480) (637) Accounting for derivatives - (196) (260) Deferred income taxes (1,697) (2,053) (2,722) Tax effect of reconciling items - - - ------- ------- ------- Approximate shareholders' equity in accordance with US GAAP 52,453 145,953 193,518 ======= ======= =======
23. ADDITIONAL FINANCIAL STATEMENT DISCLOSURES REQUIRED BY U.S. GAAP AND THE SEC The following information is presented on a U.S. GAAP basis: Pension Plans Under US GAAP the U.S. subsidiary was required to recognize additional minimum liabilities of U.S. $ 6,899,000, U.S. $ 5,178,000, U.S. $ 1,847,000 and US $ 150,000 respectively in fiscal years 2001, 2002, 2003 and 2004, in connection with the plan for its employees, representing the excess of the unfunded accumulated benefit obligation over the accrued pension costs. The additional minimum liability required to be recognized by the UK subsidiary aggregated GBP 704,000, GBP 1,315,000 and GBP 696,000 respectively in fiscal year 2002, 2003 and 2004 corresponding to U.S. $ 1,089,000, U.S. $ 3,529,000, and U.S. $ 1,274,000 respectively. Disclosure on pension plans is presented in Note 14 in accordance with IAS and US GAAP. Postretirement Benefits A reconciliation of the beginning and ending balances of the accumulated postretirement benefit obligation is as follows (in thousands of Euro):
2002 2003 2004 ------- ------- ------- CHANGE IN ACCUMULATED POSTRETIREMENT BENEFIT OBLIGATION (APBO) DURING MEASUREMENT PERIOD APBO, November 30 previous year 6,149 3,641 2,837 Effect of exchange rate on opening balance (640) (626) (166) Service Cost 275 95 46 Interest Cost 341 171 163 Actuarial (Gain)/Loss (406) (344) 77 Benefits Paid (126) (100) (128) Plan amendment (1,952) - - ------- ------- ------- APBO, November 30 3,641 2,837 2,829 A reconciliation of the beginning and ending balances of the accumulated postretirement benefit obligation is as follows (in thousands of Euro): CHANGE IN PLAN ASSETS DURING THE MEASUREMENT PERIOD Plan Assets at Fair Value, November 30 of previous year - - - Employer Contribution 127 100 128 Benefits Paid (127) (100) (128) ------- ------- ------- Plan Assets at Fair Value, November 30 - - - The net prepaid (accrued) postretirement benefit obligation includes the following (in thousands of Euro): RECONCILIATION OF PREPAID (ACCRUED) Accumulated postretirement benefit obligation 3,641 2,837 2,829 Plan assets at fair value - - - ------- ------- ------- Accumulated postretirement benefit obligation in excess of plan assets (3,641) (2,837) (2,829) Unamortized Prior Service Cost - (861) (750) Unrecognized Net Actuarial Loss (Gain) (1,828) (237) (146) Unrecognized Net transition obligation 843 - - ------- ------- ------- ACCRUED POSTRETIREMENT BENEFIT OBLIGATION (4,626) (3,935) (3,725) Net periodic postretirement benefit expense includes the following components (in thousands of Euro): COMPONENTS OF NET PERIODIC BENEFIT COST FOR FISCAL YEAR 2002 2003 2004 ------- ------- ------- Service Cost 275 95 46 Interest Cost 341 171 163 Net amortization of Prior Service Cost - (61) (57) Net amortization of unrecognized gain - (4) - Net amortization of transition obligation 229 - - ------- ------- ------- NET PERIODIC PENSION COST 845 201 152
The assumed health care cost trend rate used in measuring the accumulated postretirement benefit obligation was 5.00% in 2002, 5% in 2003 and 5% in 2004. The discount rate used in determining the accumulated postretirement benefit obligation was 6.75%, 6.25% and 6.00% at November 30, 2002, 2003 and 2004, respectively. Stock Option Plan On November 25, 1997, Company's shareholders approved a resolution to adopt a stock option plan for the benefit of some managers and key employees. The Company granted these individuals stock options exercisable for a period of ten (10) years for up to 750,000 Ordinary Shares. At the same meeting, our shareholders authorized the issuance of 750,000 Ordinary Shares, par value (euro) 1.29 each, to service the plan. In this respect the Board of Directors on July 22, 1998 authorized the issuance of options for up to 170,000 Ordinary Shares to be exercised from 2002 to 2008. At the Shareholders' Meeting convened on March 29, 2004 the par value of the underlying Ordinary Shares was also reduced to the new par value of (euro)0.33 per share. In more details, the vesting period is as follows: o 50% of granted options to be exercised starting from the end of the fourth year subsequent the date of Shareholders' meeting resolution; o 25% of granted options to be exercised starting from the end of the fifth year subsequent the date of Shareholders' meeting resolution; o 25% of granted options to be exercised starting from the end of the sixth year subsequent the date of Shareholders' meeting resolution. The total number of Ordinary Shares subject to options as of May 16, 2005 was 750,000. The total number of Ordinary Shares subject to options held by Company's directors and executive officers as a group was 16,000 on May 16, 2005. The Company adopted the provisions of Statement of Financial accounting Standards No.123 'Accounting for Stock Based Compensation' ("SFAS 123"). As permitted by SFAS 123, the Company has elected and plans to continue to account for stock based compensation using the intrinsic value method under Accounting Principles Board Opinion No. 25. Accordingly, no compensation has been recognized for stock options. The fair value of each stock option granted was estimated at the date of grant using the Black Scholes Option pricing model with the following weighted average assumptions: Risk free interest rate 5.46 % Expected lives 10 years Expected volatility 149 % The weighted average fair value of the options granted in 1998 at market value was $1.48. The following table summarizes information about stock options outstanding at November 30, 2004: Range of exercise Number of options Weighted average Weighted average price outstanding remaining exercise price (in US Dollars) contractual life (in US Dollars) 0.43 170,000 3.64 0.43 The following table summarizes information about options outstanding at November 30, 2003 and 2004: Options outstanding at fiscal year ---------------------------------------- 2003 2004 Weighted ------- ------- -------- Average ------- Exercise Price -------------- (in US Dollars) Balance at December 1, 170,000 170,000 0.43 Granted - - - Exercised - - - ---------------------------------------- Balance at November 30, 170,000 170,000 0.43 Exercisable at November 30, 127,500 170,000 0.43 Had compensation expense for all stock options granted in 1998 been determined under SFAS 123, the Company's net loss and net loss per share would have been as follows (in thousands of US Dollars):
2002 2003 2004 -------- -------- -------- restated -------- Net income (loss) attributable to common stockholders - as reported under U.S. GAAP (14,681) (6,382) 19,296 Less: Total stock based employee compensation expense determined under the fair value based method for all awards (42) (42) (19) Pro-forma net income (loss) under U.S. GAAP attributable to common stockholders (14,723) (6,424) 19,277 Net loss per share - as reported basic and diluted (0.16) (0.07) 0.08 Net loss per share - pro forma basic and diluted (0.16) (0.07) 0.08
The adoption of SFAS 123 would have no effect on diluted earnings per share for the years ended November 30, 2002, 2003 and 2004 since the effects of common stock equivalents are antidilutive. The effects of applying SFAS 123 in this pro-forma disclosure are not indicative of future amounts and additional awards in future years are anticipated. Deferred Income Taxes Domestic and foreign components of pre-tax income (loss) are as follows:
2002 2003 2004 ---- ---- ---- (Thousands of Euro) Domestic 10,289 14,405 17,192 Foreign (21,873) (15,153) 523 -------- -------- ------ Total pre-tax loss (11,584) (748) 17,715 ======== ======== ====== The provisions for income taxes are as follows: 2002 2003 2004 ---- ---- ---- (Thousands of Euro) Current 2,467 2,720 3,102 Deferred 730 447 60 -------- -------- ------ Total 3,197 3,167 3,162 ======== ======== ======
The tax effects of significant differences are as follows: NOVEMBER 30, ---------------------------- 2003 2004 -------- -------- RESTATED -------- (Thousands of Euro) Deferred tax assets: Accrued liabilities not currently deductible 2,452 3,162 Depreciation and amortization (4,669) (2,000) Goodwill (1,362) (1,864) Inventories basis difference 1,647 1,396 Reserves 788 819 Pension and postretirement benefit 1,284 239 R&E Capitalization 11,943 11,502 R&D Capitalization 5,052 5,975 Tax loss carry-forwards 52,368 38,237 Other 348 61 -------- -------- 69,851 57,257 Less: Valuation allowance (71,850) (59,581) -------- -------- Net deferred tax liability (1,999) (2,053) ======== ======== Tax loss carry-forwards are expected to reverse at an average rate of 33%. A valuation allowance has been provided for deferred tax assets of the Company and certain foreign subsidiaries which have experienced cumulative losses in recent years, since the Company does not believe their realization is more likely than not based upon the weight of available evidence. Reclassification of Balance Sheet With regard to the consolidated financial statements, the following significant captions determined under U.S. GAAP would have been as follows: 2003 2004 2004 ---- ---- ---- (Thousands of Euro) (Thousands of U.S.$) Intangible assets 117,445 109,805 145,591 Current assets 144,473 154,332 204,628 Current liabilities 148,169 152,861 202,678 Total assets 326,740 331,536 439,583 Short term debt 56,112 52,249 39,406 Long term debt 102,564 14,021 18,590 Valuation and Qualifying Accounts A summary of the Group valuation and qualifying accounts (in thousands of Euro) follows:
Balance at Effect of exchange Charged to Deductions Balance at ----------- ------------------- ----------- ---------- ---------- Beginning of rate on opening Costs and End of ------------ --------------- --------- ------ Period Balance Expenses Period ------ ------- -------- ------ 2002 ---- Reserve for doubtful accounts receivable 5,862 (287) 404 (204) 5,775 Obsolescence reserve for inventory 11,396 (570) 3,460 (3,576) 10,710 2003 ---- Reserve for doubtful accounts receivable 5,775 (428) 340 (1,089) 4,598 Obsolescence reserve for inventory 10,710 (903) 3,067 (2,920) 9,954 2004 ---- Reserve for doubtful accounts receivable 4,598 (223) 1,235 (526) 5,084 Obsolescence reserve for inventory 9,954 (519) 3,074 (3,155) 9,354
Fair Value of Financial Instruments In the normal course of its business, the Company utilizes various types of financial instruments. These instruments include recorded assets and liabilities, as well as items that principally involve off-balance sheet risk. Information about the fair value of the Company's financial instruments, including derivatives, is presented below. - Trade receivables: the fair value of accounts receivable (other than those from Italian public agencies) due within one year are not included below because they are approximated by their carrying values. The fair value of accounts receivable originated from trade sales to Italian public agencies that are expected to be collected after one year, was estimated based on the discounted value of future cash flows expected to be collected.
AT NOVEMBER 30, --------------- 2003 2004 ------------------------------------------------------------------------ Carrying Value Fair Value Carrying Value Fair Value ------------------------------------------------------------------------ (Thousands of Euro) Trade receivables 75,992 74,822 81,200 79,950
- Short-term debt: the carrying value of short-term debt approximates fair value because of the short period of time between the originations of the borrowings and their maturities. - Current portion of long-term debt and long-term: the fair value of long-term debt, including current maturities, approximates fair value because such debt bears variable interest rate. - Derivatives: currency options are stated at fair market value as described in note 15. Recent Accounting Pronouncements In December 2004, the FASB issued statement No. 123 (revised 2004), "Stock-Based Payment" (SFAS 123R). This statement replaces SFAS 123 "Accounting for Stock-Based Compensation", supersedes APB Opinion No. 25, "Accounting for Stock Issued to Employees" (APB 25) and amends SFAS 95, "Statement of Cash Flows", to require that excess tax benefits be reported as a financing cash inflow rather than as a reduction of taxes paid. SFAS 123R is effective the first interim or annual reporting period that begins after June 15, 2005. The Company expects to adopt the provisions of the new standard effective January 1, 2006. The Company is currently evaluating the requirements of SFAS 123R, including the adoption method alternatives, but does not expect adoption of this statement to have a material effect on the operating result of the Company. 24. USE OF ESTIMATES The preparation of financial statements in accordance with Italian GAAP, along with the reconciliation to US GAAP, requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. The most significant estimate relate to recoverability and depreciable lives of fixed assets and intangible assets, allowance for doubtful accounts, inventory obsolescence and deferred taxes. Actual results could differ from these estimates. 25. SUBSEQUENT EVENTS A complaint was filed by Bio-Rad Laboratories, Inc. against the Company, Werfen, Izasa, and four of the Company's current officers and directors in January 2005 in the United States District Court for the Southern District of New York. The complaint asserts claims under common law for fraud, conspiracy to commit fraud and aiding and abetting fraud against all the defendants; negligent misrepresentation against the Company and the individual defendants; as well as breach of fiduciary duty under Italian Civil Code Article 2395 against the individual defendants. The complaint alleges generally that the defendants falsely understated the Company's revenues and profitability in financial statements included in the Company's public filings and public statements from 1999 to 2004, and that the price of the Company's ADSs have therefore been artificially depressed. The plaintiff, which owns ADSs, seeks an unspecified amount of damages. All the defendants have moved to dismiss the complaint. At this stage the Company is not in a position to assess the outcome of this proceeding. Following a resolution of the Board of the Company on February 23, 2005, the entire capital of Instrumentation Laboratory Ges.m.b.H. Austria was transferred on April 7, 2005 to Comesa GmbH, a Werfen group company. The price for the sale of the shares was fixed at Euro 3.4 million based on an independent third party appraisal. As a consequence of the sale, Instrumentation Laboratory Ges.m.b.H. Austria, which represented sales in the amount of Euro 4.6 million, Euro 5.3 million and Euro 7.2 million in fiscal years 2002, 2003 and 2004, respectively, will be deconsolidated effective January 1, 2005.