SECURITIES AND EXCHANGE COMMISSION Washington, DC 20549 FORM 10-K (X) ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended June 30, 2003 OR ( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ________to __________ Commission File Number: 0-17272 TECHNE CORPORATION (Exact name of Registrant as specified in its charter) Minnesota 41-1427402 (State of Incorporation) (IRS Employer Identification No.) 614 McKinley Place N.E., Minneapolis, MN 55413 (Address of principal executive offices) (Zip Code) Registrant's telephone number: (612) 379-8854 Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Common Stock, $.01 par value. Indicate by check mark whether the Company (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: (X) Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ( ) Indicate by check mark whether the Registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). (X) The aggregate market value of the Common Stock held by non-affiliates of the Registrant, based upon the closing sale price on September 12, 2003 as reported on The Nasdaq Stock Market was approximately $1,302,581,000. Shares of Common Stock held by each officer and director and by each person who owns 5% or more of the outstanding Common Stock have been excluded. Shares of $.01 par value Common Stock outstanding at September 12, 2003: 41,027,576 DOCUMENTS INCORPORATED BY REFERENCE Portions of the Company's Proxy Statement for its 2003 Annual Meeting of Shareholders are incorporated by reference into Part III. TABLE OF CONTENTS Page PART I Item 1. Business 3 Item 2. Properties 13 Item 3. Legal Proceedings 13 Item 4. Submission of Matters to a Vote of Security Holders 14 Supplemental Item - Executive Officers of the Company 14 PART II Item 5. Market for the Company's Common Equity 14 and Related Stockholder Matters Item 6. Selected Financial Data 15 Item 7. Management's Discussion and Analysis of 16 Financial Condition and Results of Operations Item 7A. Quantitative and Qualitative Disclosures 23 about Market Risk Item 8. Financial Statements and Supplementary Data 24 Item 9. Changes in and Disagreements with Accountants 37 on Accounting and Financial Disclosure PART III Item 10. Directors and Executive Officers 37 Item 11. Executive Compensation 38 Item 12. Security Ownership of Certain Beneficial 38 Owners and Management Item 13. Certain Relationships and Related Transactions 38 Item 14. Controls and Procedures 38 Item 15. Audit Committee Financial Expert 38 Item 16. Principal Accountant Fees and Services 38 PART IV Item 17. Exhibits, Financial Statement Schedules, 39 and Reports on Form 8-K SIGNATURES 41 2 PART I ITEM 1. BUSINESS OVERVIEW Techne Corporation (the Company) is a holding company which has two wholly- owned operating subsidiaries: Research and Diagnostic Systems, Inc. (R&D Systems) located in Minneapolis, Minnesota and R&D Systems Europe Ltd. (R&D Europe) located in Abingdon, England. R&D Systems is a specialty manufacturer of biological products. Its two major operating segments are hematology controls, which are used in hospital and clinical laboratories to check the accuracy of blood analysis instruments, and biotechnology products, including purified proteins (cytokines) and antibodies which are sold exclusively to the research market and assay kits which are sold to the research and clinical diagnostic markets. R&D Europe distributes R&D Systems' biotechnology products in Europe. R&D Europe has a German sales subsidiary, R&D Systems GmbH (R&D GmbH). The Company's foreign sales corporation, Techne Export Inc., was dissolved in fiscal 2002. R&D Systems was founded and incorporated in 1976 in Minneapolis, Minnesota and was acquired by the Company in 1985. In 1977, R&D Systems introduced its first product, a platelet-rich-plasma control. In 1981, R&D Systems was the second manufacturer in the world to release a whole blood control with platelets, thereby establishing itself as one of the leaders in the field of hematology control products manufacturing. Subsequently, R&D Systems has developed several types of hematology controls designed to keep pace with the technology of the newest models of hematology instruments. These products are sold throughout the United States directly by R&D Systems and in many foreign countries through distributors. In 1985, R&D Systems entered the research reagent market with its first cytokine, TGF-beta. Cytokines are specialized protein molecules that stimulate or suppress various cell functions in the body. Cytokines are in demand by biomedical researchers who want to learn more about their diverse effects. Encouraged by its success in the cytokine market, R&D Systems formed a biotechnology division in 1986 with the goal of producing and marketing a wide range of human cytokines through genetic engineering. Recombinant DNA technology offers several advantages over extraction of these proteins from natural sources, including lower production cost and potentially unlimited supply. In fiscal 1992, R&D Systems purchased Amgen Inc.'s research reagent and diagnostic assay kit business. With this purchase, R&D Systems obtained Amgen's Erythropoietin (EPO) kit, the Company's first enzyme-linked immunosorbent assay kit for a cytokine that had been cleared by the U.S. Food and Drug Administration (FDA) for clinical diagnostic use. In fiscal 1994, the Company acquired its European biotechnology distributor, British Bio-technology Products Ltd. (renamed R&D Systems Europe Ltd.) from British Bio-technology Group plc. R&D Europe distributes biotechnology products developed and manufactured by R&D Systems. Between fiscal 1998 and 2000, the Company made equity investments in the preferred stock of ChemoCentryx, Inc. (CCX), a technology and drug development company. The Company currently holds approximately 26% of the outstanding stock of CCX. In addition to the equity investment and joint research efforts, the Company obtained research and diagnostic market rights to all products discovered or developed by CCX. In fiscal 1999, R&D Systems purchased Genzyme Corporation's research products business. This acquisition established R&D Systems as the world's leading supplier of research and diagnostic cytokine products. Included in cost of sales for fiscal 2003, 2002 and 2001 were $2.3 million, $1.8 million and $1.1 million, respectively, of royalties paid to Genzyme under the purchase agreement. The royalty agreement expired on June 30, 2003. 3 In fiscal 2002, the Company made an equity investment of $3 million and entered into a research and license agreement with Discovery Genomics, Inc. (DGI). DGI holds licenses from the University of Minnesota to develop technologies used for functional genomics and the discovery of druggable targets. The Company currently holds a 39% equity interest in DGI and also received the rights to develop antibodies and immunoassay kits for proteins discovered by DGI and the rights to sell such products to the research market. THE MARKET The Company, through its two operating subsidiaries, manufactures and sells products for the clinical diagnostics market (hematology controls and calibrators) and the biotechnology research and clinical diagnostics market (cytokines, assays and related products). In fiscal 2003, 2002 and 2001, R&D Systems' Hematology Division revenues accounted for approximately 11%, 12% and 13%, respectively, of consolidated revenues. Revenues from R&D Systems' Biotechnology Division were 63%, 65% and 64% and revenues from R&D Europe were 26%, 23% and 23% of consolidated revenues for fiscal 2003, 2002 and 2001, respectively. Biotechnology Products R&D Systems is the world's leading supplier of cytokines and cytokine-related reagents to the biotechnology research community. These valuable proteins exist in minute amounts in different types of cells and can be extracted from these cells or made through recombinant DNA technology. In 1985, R&D Systems introduced its first cytokine and continues to add to this product line. The first cytokines were extracted from natural sources (human and porcine platelets and bovine brain). Currently almost all of cytokines are produced by recombinant DNA technology. R&D Systems also sells antibodies for specific cytokines, cytokine assay kits, clinical diagnostic kits, kits for cytokine receptor binding studies, and related research reagents. The growing interest by researchers in cytokines exists because of the profound effect a tiny amount of a cytokine can have on the cells and tissues of the body. Cytokines are intercellular messengers. They act as signals by interacting with specific receptors on the effected cells. They carry vital signals to the cell's genetic machinery that can trigger events that can lead to significant changes in a cell, tissue or organism. For example, cytokines can signal a cell to differentiate, i.e., to acquire the features necessary for it to take on a more specialized task. Another example of cytokine action is the key role they play in stimulating cells surrounding a wound to grow and divide and to attract migratory cells to the injury site. R&D Systems' Biotechnology Division was formed in response to a growing need for highly purified biologically active proteins. R&D Systems believes that its cytokines are addressing the growing demand for these products within the scientific research community. During fiscal 1990, the Biotechnology Division released its first cytokine assay kits under the tradename Quantikine(r). These kits are used by researchers to quantify the level of a specific cytokine in a sample of blood, serum, or other biological fluid. In fiscal 1996, the Biotechnology Division expanded its Quantikine line by introducing a line of assay kits for mouse cytokines and has subsequently released kits for other animal models, including rat and pig. These kits are used extensively by research scientists doing cytokine studies using animal models, such as those used in pharmaceutical discovery and development programs. R&D Systems currently manufactures and sells over 5,000 biotechnology products. 4 Current Biotechnology Products Cytokines and Related Antibodies. Cytokines, extracted from natural sources or produced using recombinant DNA technology, are manufactured to the highest purity. Polyclonal antibodies are produced in animals (primarily goats and rabbits). The animals' immune systems recognize the cytokines as foreign and develop antibodies to these cytokines. The polyclonal antibodies are then purified from the animals' blood. Monoclonal antibodies are produced by injecting purified cytokines into mice. The B cells of a mouse's immune system are then isolated and fused with immortalized mouse cells that will produce the desired antibody. Purified cytokines and antibodies are made available both as research reagents and as parts of assay kits (below). Assay Kits. This product line includes R&D Systems' human, murine (mouse and rat) and porcine (pig) Quantikine kits which allow research scientists to quantify the amount of a specific cytokine in a sample of blood or tissue. Also included in this product line are assay kits, developed by R&D Europe, to quantify adhesion molecules. These kits are used by research scientists to measure cellular adhesion molecules in serum, plasma, or cell culture media. Cellular adhesion molecules facilitate the movement of infection fighting cells out of the blood stream to the site of infections. Clinical Diagnostic Kits. The EPO kit, acquired from Amgen Inc. in fiscal 1992, was the first diagnostic assay for which R&D Systems had FDA marketing clearance. R&D Systems also has received FDA marketing clearance for its transferrin receptor (TfR) and Beta2-microglobulin kits. Flow Cytometry Products. This product line includes R&D Systems' Fluorokine kits which are used to measure the presence or absence of receptors for specific cytokines on the surface of cells. DNA and Related Products. This diverse product line includes: primer pairs which are synthetic DNA used to amplify specific genes in the laboratory, messenger RNA kits that allow researchers to quantitate the amount of a specific cytokine messenger RNA, and reagents for the study of DNA damage and repair mechanisms in the cell. Hematology Controls and Calibrators Hematology controls and calibrators, manufactured and marketed through the Hematology Division of R&D Systems, are products made up of the various cellular components of blood. Proper diagnosis of many illnesses requires a thorough and accurate analysis of the patient's blood cells, which is usually done with automatic or semiautomatic hematology instruments. Controls and calibrators ensure that these instruments are performing accurately and reliably. Blood is composed of plasma, the fluid portion of which is mainly water, and blood cells, which are suspended in the plasma. There are three basic types of blood cells: red cells, white cells and platelets. Red cells transport oxygen from the lungs throughout the body, which they do by being rich in hemoglobin. White cells defend the body against foreign invaders. Platelets serve as a "plug" to stem blood flow at the site of an injury by initiating a complex series of biochemical reactions that lead to the formation of a clot. The formed elements of blood (red cells, white cells and platelets) differ a great deal in size and concentration. The white cells are the largest in size and platelets the smallest. The red cells are the most numerous and constitute 95 percent of all blood cells. The average adult has from 20 to 30 trillion red cells. For every 500 red cells there are approximately one white cell and about 20 platelets. As noted above, hematology controls are used in automatic and semiautomatic cell counting analyzers to make sure these instruments are counting blood cells accurately. One of the most frequently performed laboratory tests on a blood sample is called a complete blood count, or CBC for short. Doctors use this test in disease screening and diagnosis. More than a billion of these tests are done every year, the great majority with cell counting instruments. In most laboratories the CBC consists of the white cell count, the red cell count, the 5 hemoglobin reading, and the hematocrit reading or the percent of red cells in a volume of whole blood after it has been centrifuged. Also included in a CBC test is the differential which numbers and classifies the different types of white cells. These and other characteristics or "parameters" of a blood sample can be measured by automatic or semiautomatic cell counters. Cell counters can read the parameters of blood either by impedance, in which a cell interrupts an electrical current and is counted, or by a laser, in which a cell interrupts a laser beam and is counted. The number of parameters measurable in a blood control product depends on the type and sophistication of the instrument for which the control is designed. Ordinarily, a hematology control is used once to several times a day to make sure the instrument is reading accurately. Some instruments need to be calibrated periodically. Hematology calibrators are similar to controls but go through additional processing and testing to ensure that the calibration values assigned are extremely accurate and can be used to adjust the instrument. The Hematology Division of R&D Systems offers a complete line of hematology controls and calibrators for both impedance and laser type cell counters. R&D Systems believes its products have improved stability and versatility and a longer shelf life than most of those of its competitors. The Hematology Division supplies hematology control products for use as proficiency testing materials by laboratory certifying authorities of a number of states and countries. R&D Systems recognizes that developing technologies for cell counting instruments will require increasingly sophisticated and high-quality controls and is prepared to meet this challenge. Current Retail Hematology Products Impedance-Type Whole Blood Controls/Calibrators. The Hematology Division of R&D Systems currently produces controls and calibrators for the following impedance-type instruments: Abbott Cell-Dyn, ABX, Beckman Coulter, CDC Technologies, Hycel, and Sysmex instruments. Laser-Type Whole Blood Controls/Calibrators. Currently produced controls and calibrators for laser-type instruments include products for the following: Beckman Coulter MAXM, STKS and GENS; Abbott Cell-Dyn 3000, 3200, 3500 and 4000 instruments; ABX instruments; Bayer Technicon ADVIA and H series instruments; and Sysmex SE, SF and XE type instruments. Linearity Control. This product provides a means of assessing the linearity of hematology analyzers for white blood cells, red blood cells, hemoglobin, platelets and reticulocytes. Whole Blood Reticulocyte Controls. These controls are designed for manual and automated counting of reticulocytes (immature red blood cells). Whole Blood Flow Cytometry Controls. These products are controls for flow cytometry instruments. These instruments are used to identify and quantify white blood cells by their surface antigens. Whole Blood Glucose/Hemoglobin Control. This product is designed to monitor instruments which measure glucose and hemoglobin in whole blood. Erythrocyte Sedimentation Rate Control. This product is designed to monitor erythrocyte sedimentation rate tests. Multi-Purpose Platelet Reference Controls. These products, Platelet-Trol II and Platelet-Trol extended, are designed for use by automatic and semi- automatic impedance and laser instruments. 6 PRODUCTS UNDER DEVELOPMENT R&D Systems is engaged in ongoing research and development in all of its major product lines: hematology controls and calibrators, biotechnology cytokines, antibodies, assays and related products. The Company believes that its future success depends, to a large extent, on the ability to keep pace with changing technologies and markets. At the same time, the Company continues to examine its production processes to ensure high quality and maximum economy. R&D Systems' Biotechnology Division is planning to release new cytokines, antibodies and cytokine assay kits in the coming year. All of these products will be for research purposes only and therefore do not require FDA clearance. R&D Systems' Hematology Division has developed several new control products in fiscal 2003 and is continuously working on product improvements and enhancements. However, there is no assurance that any of the products in the research and development phase can be developed or, if developed, can be successfully introduced into the marketplace. Included in consolidated research and development expense are the Company's share of losses by CCX and DGI, development stage companies in which the Company has invested. Research and development expense was as follows: Year ended June 30, 2003 2002 2001 ----------- ----------- ----------- R&D Systems' expenses $17,393,441 $15,614,817 $14,022,546 CCX losses 2,580,023 1,350,435 499,687 DGI losses 607,879 505,015 -- ----------- ----------- ----------- $20,581,343 $17,470,267 $14,522,233 =========== =========== =========== Percent of revenue 14.2% 13.3% 12.6% BUSINESS RELATIONSHIPS Between fiscal 1998 and 2000, the Company purchased a total of $5 million of convertible preferred stock of ChemoCentryx, Inc. (CCX), which gave the Company a 49% interest in CCX through January 2001. In February 2001, CCX obtained $23 million in financing through the issuance of 8,846,154 shares of additional preferred stock. The Company currently holds approximately 26% of the outstanding voting stock of CCX. CCX is a technology and drug development company working in the area of chemokines. Chemokines are cytokines which regulate the trafficking patterns of leukocytes, the effector cells of the human immune system. In conjunction with the equity investment and joint research efforts, the Company obtained exclusive worldwide research and diagnostic marketing rights to chemokine proteins, antibodies and receptors discovered or developed by CCX or R&D Systems. The Company accounts for the investment under the equity method of accounting and, through January 2001, recognized 100% of the losses of CCX due to the limited amount of cash consideration provided by the holders of the common shares of CCX. Subsequent to January 2001, the Company is including CCX operating results in its consolidated financial statements based on its ownership percentage. The Company's net investment in CCX was $2,511,023 and $5,091,046 at June 30, 2003 and 2002, respectively. On August 2, 2001, the Company made an equity investment of $3 million and entered into a research and license agreement with Discovery Genomics, Inc. (DGI) of Minneapolis, Minnesota. DGI holds licenses from the University of Minnesota to develop technologies used for functional genomics and the discovery of drugable targets. The Company acquired a 39% equity interest in DGI and warrants to acquire additional equity. The Company also received the rights to develop antibodies and immunoassay kits for proteins discovered by DGI and an exclusive, royalty free license to sell such products in the research market. The Company's investment is accounted for under the equity method of accounting. The Company's net investment in DGI was $1,887,106 and $2,494,985 at June 30, 2003 and 2002, respectively. 7 Original Equipment Manufacturer (OEM) agreements represent the largest market for hematology controls and calibrators made by R&D Systems. In fiscal 2003, 2002 and 2001, OEM contracts accounted for $7,153,518, $7,609,425 and $7,096,901, respectively, or 5%, 6% and 6% of total consolidated revenues. GOVERNMENT REGULATION All manufacturers of hematology controls and calibrators are regulated under the Federal Food, Drug and Cosmetic Act, as amended. All of R&D Systems' hematology control products are classified as "In Vitro Diagnostic Products" by the FDA. The entire hematology control manufacturing process, from receipt of raw materials to the monitoring of control products through their expiration date, is strictly regulated and documented. FDA inspectors make periodic site inspections of the Hematology Division's control operations and facilities. Hematology control manufacturing must comply with Good Manufacturing Practices (GMP) as set forth in the FDA's regulations governing medical devices. Three of R&D Systems' immunoassay kits, EPO, TfR and Beta2-microglobulin, have FDA clearance to be sold for clinical diagnostic use. R&D Systems must comply with GMP for the manufacture of these kits. Biotechnology products manufactured in the United States and sold for use in the research market do not require FDA clearance. Some of R&D Systems' research groups use small amounts of radioactive materials in the form of radioisotopes in their product development activities. Thus, R&D Systems is subject to regulation by the US Nuclear Regulatory Commission (NRC) and has been granted an NRC license due to expire in April 2004. The license is renewable annually. R&D Systems is also subject to regulation and inspection by the Department of Health of the State of Minnesota for its use of radioactive materials. It has been granted a certificate of registration, which is renewable annually, by the Minnesota Department of Health. The current certificate expires April 1, 2004. R&D Systems has had no difficulties in renewing these licenses in prior years and has no reason to believe they will not be renewed in the future. If, however, the licenses were not renewed, it would have minimal effect on R&D Systems' business since there are other technologies the research groups could use to replace radioisotopes. AVAILABILITY OF RAW MATERIALS The primary raw material for the Company's hematology controls is whole blood. Human blood is purchased from commercial blood banks and porcine and bovine blood is purchased from nearby meat processing plants. After raw blood is received, it is separated into its components, processed and stabilized. Although the cost of human blood has increased owing largely to the requirement that it be tested for certain diseases, the higher cost of these materials has not had a serious adverse effect on the Company's business. R&D Systems does not perform its own testing as the supplier tests all human blood purchased. R&D Systems' Biotechnology Division develops and manufactures the majority of its cytokines from synthetic genes developed in- house, thus significantly reducing its reliance on outside resources. R&D Systems typically has several outside sources for all critical raw materials necessary for the manufacture of products. PATENTS AND TRADEMARKS R&D Systems owns patent protection for certain hematology controls. R&D Systems may seek patent protection for new or existing products it manufactures. No assurance can be given that any such patent protection will be obtained. No assurance can be given that R&D Systems' products do not infringe upon patents or proprietary rights owned or claimed by others, particularly for genetically engineered products. 8 R&D Systems has not conducted a patent infringement study for each of its products. See Item 3 Legal Proceedings below. R&D Systems and R&D Europe have a number of licensing agreements with patent holders under which they have the non-exclusive right to patented technology or the non-exclusive right to manufacture and sell certain patented cytokine and cytokine related products to the research market. For fiscal 2003, 2002 and 2001, total royalties expensed under these licenses were approximately $2,273,000, $2,143,000 and $1,563,000, respectively. R&D Systems has obtained federal trademark registration for certain of its hematology controls and biotechnology product groups. R&D Systems believes it has common law trademark rights to certain marks in addition to those which it has registered. SEASONALITY OF BUSINESS Sales of products by R&D Systems and R&D Europe, particularly R&D Europe, historically experience a slowing of sales or of the rate of sales growth during the summer months. R&D Systems also usually experiences a slowing of sales during the Thanksgiving to New Year holiday period. The Company believes this slowing is a result of vacation schedules in Europe and Japan and of academic schedules in the United States. SIGNIFICANT CUSTOMERS No single customer accounted for more than 10% of total revenues during fiscal 2003, 2002 or 2001. BACKLOG There was no significant backlog of orders for the Company's products as of the date of this report or as of a comparable date for fiscal 2002. The majority of the Company's biotechnology products are shipped within one day of receipt of the customers' order. The majority of hematology products are shipped based on a preset, recurring schedule. COMPETITION The worldwide market for cytokines and research diagnostic assay kits is being supplied by a number of biotechnology companies, including BD Biosciences, BioSource International, PeproTech, Inc., Sigma Chemical Co., Amersham Pharmacia and EMD Biosciences, Inc. R&D Systems believes that it is the leading worldwide supplier of cytokine related products in the research marketplace. R&D Systems believes that the expanding line of its products, their recognized quality, and the growing demand for these rare and versatile proteins, antibodies and assay kits, will allow the Company to remain competitive in the growing biotechnology research and diagnostic market. Competition is intense in the hematology control business. The first control products were developed in response to the rapid advances in electronic instrumentation used in hospital and clinical laboratories for blood cell counting. Historically, most of the instrument manufacturing companies made controls for use in their own instruments. With rapid expansion of the instrument market, however, a need for more versatile controls enabled non- instrument manufacturers to gain a foothold. Today the market is comprised of manufacturers of laboratory reagents, chemicals and coagulation products and independent control manufacturers in addition to instrument manufacturers. The principal hematology control competitors of 9 R&D Systems' retail products are Beckman Coulter, Inc., TOA Sysmex, Streck Laboratories, Abbott Diagnostics and Hematronix, Inc. R&D Systems believes it is the third largest supplier of hematology controls in the marketplace behind Beckman Coulter and Streck Laboratories. EMPLOYEES R&D Systems had 474 full-time and 40 part-time employees as of June 30, 2003. R&D Europe had 51 full-time and 10 part-time employees as of June 30, 2003, including 10 full-time and 1 part-time at R&D Europe's sales subsidiary in Germany. ENVIRONMENT Compliance with federal, state and local environmental protection laws in the United States, England and Germany had no material effect on R&D Systems or R&D Europe in fiscal 2003. FOREIGN AND DOMESTIC OPERATIONS The following table represents certain financial information relating to foreign and domestic operations for the fiscal years ended June 30 (all amounts are in thousands of US dollars): 2003 2002 2001 -------- -------- -------- Net Sales to External Customers Hematology Division: US $ 14,119 $ 13,101 $ 12,357 Other 2,547 2,470 2,353 Biotechnology Division: US 73,655 67,856 58,662 Other 17,310 16,798 14,995 R&D Europe: Other 37,380 30,675 26,990 -------- -------- -------- $145,011 $130,900 $115,357 ======== ======== ======== Gross Margin R&D Systems (US) $ 93,991 $ 87,558 $ 76,578 R&D Europe (England) 13,151 9,178 8,731 R&D GmbH (Germany) 2,473 1,657 1,623 -------- -------- -------- $109,615 $ 98,393 $ 86,932 ======== ======== ======== Net Earnings (Loss) Parent and R&D Systems (US) $ 41,630 $ 24,436 $ 31,006 R&D Europe (England) 6,306 4,324 3,310 R&D GmbH (Germany) 648 225 229 ChemoCentryx (US) (2,580) (1,350) (500) Discovery Genomics (US) (608) (505) -- -------- -------- -------- $ 45,396 $ 27,130 $ 34,045 ======== ======== ======== Identifiable Assets Parent and R&D Systems (US) $229,714 $214,606 $197,743 R&D Europe (England) 31,472 22,594 17,029 R&D GmbH (Germany) 2,091 1,047 753 -------- -------- -------- $263,277 $238,247 $215,525 ======== ======== ======== 10 CAUTIONARY STATEMENTS The Company wishes to caution investors that the following important factors, among others, in some cases have affected and in the future could affect the Company's actual results of operations and cause such results to differ materially from those anticipated in forward-looking statements made in this document and elsewhere by or on behalf of the Company: Technological Obsolescence and Competition The biotechnology industry is subject to rapid and significant technological change. While the hematology controls industry historically has been subject to less rapid change, it too is evolving and is impacted significantly by changes in the automated testing equipment offered by hardware manufacturers. Competitors of the Company in the United States and abroad are numerous and include, among others, specialized biotechnology firms, medical laboratory instrument and equipment manufacturers and disposables suppliers, major pharmaceutical companies, universities and other research institutions. There can be no assurance that the Company's competitors will not succeed in developing technologies and products that are more effective than any which have been or are being developed by the Company or that would render the Company's technologies and products obsolete or noncompetitive. Many of these competitors have substantially greater resources and product development, production and marketing capabilities than the Company. With regard to diagnostic kits, which constitute a relatively minor portion of the Company's business, many of the Company's competitors have significantly greater experience than the Company in undertaking preclinical testing and clinical trials of new or improved diagnostic kits and obtaining FDA and other regulatory approvals of such products. Research Spending The Company's biotechnology products are sold primarily to research scientists at pharmaceutical and biotechnology companies and at university and government research institutions. Changes in spending on research by such companies and in funding of such universities and institutions by government, including the National Institutes of Health, affect the revenues and earnings of the Company. The Company's Biotechnology Division carries essentially no backlog of orders and changes in the level of orders received and filled daily can cause fluctuations in quarterly revenues and earnings. Foreign Currency Exchange Rates Approximately one quarter of the Company's sales are made through its European subsidiary, R&D Systems Europe, which makes its sales in foreign currencies. The Company's revenues and earnings are, therefore, affected by fluctuations in currency exchange rates. Patents and Proprietary Rights The Company's success will depend, in part, on its ability to obtain licenses and patents, maintain trade secret protection and operate without infringing the proprietary rights of others. The Company has filed a very limited number of United States and foreign patent applications for products in which it believes it has a proprietary interest. The Company has obtained and is negotiating licenses to produce a number of cytokines and related products claimed to be owned by others. The Company has not conducted a patent infringement study for each of its products. It is possible that products of the Company may unintentionally infringe patents of third parties or that the Company may have to alter its products or processes, pay licensing fees or cease certain activities because of patent rights of third parties, thereby causing additional unexpected costs and delays which may have a material adverse effect on the Company. The patenting of hematology and biotechnology processes and products involves complex legal and factual questions and, to date, there has emerged no consistent policy regarding the breadth of claims in biotechnology patents. 11 Protracted and costly litigation may be necessary to enforce rights of the Company and defend against claims of infringement of rights of others. See Item 3 Legal Proceedings below. Financial Impact of Expansion Strategy The Company engages in an expansion strategy which includes internal development of new products, collaboration with manufacturers of automated instruments which may use the Company's products, investment in joint ventures and companies developing new products related to the Company's business and acquisition of companies for new products or additional customer base. Each of the strategies carries risks that objectives will not be achieved and future earnings will be adversely affected. During the early development stage, under the equity method of accounting, a percentage of the losses of certain companies in which the Company may invest will be reported as losses of the Company, as is the case with ChemoCentryx, Inc. and Discovery Genomics, Inc. The Company may not have control of the expense levels of such companies and their losses may be greater than those anticipated by the Company. Government Regulation Ongoing research and development activities, including preclinical and clinical testing, and the production and marketing of certain of the Company's products are subject to regulation by numerous governmental authorities in the United States and other countries. Some of the Company's products and manufacturing processes and facilities require governmental approval prior to commercial use. The approval process applicable to clinical diagnostic products of the type which may be developed by the Company may take a year or more. Delays in obtaining regulatory approvals would adversely affect the marketing of products developed by the Company and the Company's ability to receive product revenues or royalties. There can be no assurance that regulatory approvals for such products will be obtained without lengthy delays, if at all. Attraction and Retention of Key Employees Recruiting and retaining qualified scientific and production personnel to perform research and development work and product manufacturing is critical to the Company's success. Although the Company believes it has been and will be able to attract and retain such personnel, there can be no assurance that the Company will be successful. In addition, the Company's anticipated growth and expansion into areas and activities requiring additional expertise, such as clinical testing, government approvals, production and marketing, will require the addition of new management personnel and the development of additional expertise by existing management personnel. The failure to attract and retain such personnel or to develop such expertise would adversely affect the Company's business. INVESTOR INFORMATION The Company is subject to the information requirements of the Securities Exchange Act of 1934 (the "Exchange Act"). Therefore, the Company files periodic reports, proxy statements, and other information with the Securities and Exchange Commission (the "SEC"). Such reports, proxy statements, and other information may be obtained by visiting the Public Reference Room of the SEC at 450 Fifth Street, NW, Washington, DC 20549 or by calling the SEC at 1-800-SEC-0330. In addition, the SEC maintains an Internet site (http://www.sec.gov) that contains reports, proxy and information statements, and other information regarding issuers that file electronically. Financial and other information about the Company is available on its website (http://www.techne-corp.com). The Company makes available on its website, copies of its annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act as soon as reasonably practicable after filing such material electronically or otherwise furnishing it to the SEC. 12 ITEM 2. PROPERTIES The Company owns the facilities its R&D Systems subsidiary occupies in Minneapolis, Minnesota. The R&D Systems complex currently includes 365,000 square feet of administrative, research and manufacturing space. The Hematology Division manufacturing and shipping operations are located at 640 McKinley Place N.E. (47,000 square feet). Biotechnology Division manufacturing and research operations are located at 600 McKinley Place NE (85,000 square feet) and 2201 Kennedy Street (200,000 square feet). Administrative, sales and marketing functions are also located at the 2201 Kennedy Street building. The Company also occupies an additional 20,000 square feet in space connecting the three buildings. This area houses a lunchroom, a library and warehouse space. In addition, the Company constructed a 13,000 square foot entrance to the facility. In March 2002, the Company purchased property adjacent to its Minneapolis facility for approximately $8.9 million. The Company has begun to renovate this property and, when complete (planned for fiscal 2004), the building will add approximately 176,000 square feet of space. The Company plans to lease out approximately 70% of the building as retail and office space and use the remainder as warehouse and storage space. The Company has begun construction on an infill to connect this building to its current facility. The 78,000 square foot infill, planned to be completed in fiscal 2004, will be used primarily for laboratory space. The Company has entered into an option agreement for additional real estate adjacent to the current facility. This option is exerciable through January 2005. In December 2002, the Company purchased approximately 649 acres of farmland, including buildings, in southeast Minnesota for $2.7 million. A portion of the land and buildings are being leased to third parties as cropland and for a dairy operation. Rental income from the property was $72,000 in fiscal 2003. The remaining property will be used by the Company to house goats used for polyclonal antibody production. Building construction of approximately $1.6 million is planned for this site in fiscal 2004. R&D Europe leases approximately 17,000 square feet in a building in Abingdon, England. Base rent was $405,000 in fiscal 2003. R&D GmbH leases approximately 2,300 square feet as a sales office in Wiesbaden-Nordenstadt, Germany. Base rent was $33,000 in fiscal 2003. The Company believes the acquired property, purchase option and leased property discussed above are adequate to meet its occupancy needs in the foreseeable future. ITEM 3. LEGAL PROCEEDINGS On June 13, 2003, the Company submitted to the U.S. Patent and Trademark Office ("PTO") a "Request for Interference" to initiate an action between the Company and Streck Laboratories, Inc. regarding certain patents issued to Streck. The Streck patents relate to the addition of reticulocytes to hematology controls. The Company has reason to believe that it invented the invention(s) claimed in the Streck patents before Streck and is seeking a decision by the PTO that the Company is entitled to a patent covering the invention(s) and that the Streck patent is invalid. 13 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matter was submitted to a vote of the Company's security holders during the fourth quarter of the Company's 2003 fiscal year. EXECUTIVE OFFICERS OF THE COMPANY (a) The names, ages and positions of each executive officer of the Company are as follows: Name Age Position Officer Since - ---------------- --- ---------------------------------- ------------- Thomas E. Oland 62 Chairman of the Board, President, 1985 Treasurer, Chief Executive and Chief Financial and Accounting Officer and Director Dr. Monica Tsang 58 Vice President, Research 1995 Marcel Veronneau 48 Vice President, Hematology 1995 Operations The term of office of each executive officer is from one annual meeting of directors until the next annual meeting of directors or until a successor is elected. There are no arrangements or understandings among any of the executive officers and any other person (not an officer or director acting as such) pursuant to which any of the executive officers was selected as an officer of the Company. (b) The business experience of the executive officers during the past five years is as follows: Thomas E. Oland has been Chairman of the Board, President, Treasurer, Chief Executive and Chief Financial and Accounting Officer of the Company since December 1985. Dr. Monica Tsang was elected a Vice President of the Company in March 1995. Prior thereto, she served as Executive Director of Cell Biology for R&D Systems' Biotechnology Division and has been an employee of R&D Systems since 1985. Marcel Veronneau was elected a Vice President of the Company in March 1995. Prior thereto, he served as Director of Operations for R&D Systems' Hematology Division since joining the Company in 1993. An additional officer, Dr. James A. Weatherbee, who served as Vice President and Chief Scientific Officer since 1995, is on medical leave. Dr. Weatherbee and Dr. Tsang are husband and wife. PART II ITEM 5. MARKET FOR THE COMPANY'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS The Company's common stock trades on The NASDAQ Stock Exchange under the symbol "TECH." The following table sets forth for the periods indicated the range of the closing price per share for the Company as reported by NASDAQ. FISCAL 2003 PRICE FISCAL 2002 PRICE HIGH LOW HIGH LOW ----------- ----------- ----------- ----------- 1st Quarter $32.79 $22.79 $35.49 $25.90 2nd Quarter 34.75 28.42 36.85 27.91 3rd Quarter 28.99 20.76 37.05 27.02 4th Quarter 31.02 18.95 32.72 25.30 As of September 12, 2003, there were approximately 325 shareholders of record. As of September 12, 2003, there were over 20,000 beneficial shareholders of the Company's common stock. TECHNE Corporation has never paid cash dividends on its common stock. Payment of dividends is within the discretion of TECHNE's Board of Directors, although the Board of Directors plans to retain earnings for the foreseeable future for operating the Company's business. 14 ITEM 6. SELECTED FINANCIAL DATA (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) REVENUE, EARNINGS AND CASH FLOW DATA FOR THE YEARS ENDED JUNE 30 2003 2002 2001 2000 1999(1) - ----------------------------- -------- -------- -------- -------- -------- Net sales $145,011 $130,900 $115,357 $103,838 $ 90,901 Gross margin 75.6% 75.2% 75.4% 74.2% 69.9% Selling, general and administrative expenses 13.4% 15.1% 15.1% 16.4% 18.6% Research and development expenses 14.2% 13.3% 12.6% 10.8% 13.2% Interest expense $ 974 $ 1,320 $ 1,381 $ 1,441 $ -- Earnings before income taxes(2) 69,555 37,736 47,808 39,412 26,054 Net earnings(2) 45,396 27,130 34,045 26,583 16,656 Diluted earnings per share(2) 1.08 0.64 0.80 0.63 0.40 Capital expenditures 15,194 22,276 6,815 30,368 5,564 Depreciation and amortization(3) 6,353 12,688 12,737 12,651 11,890 Change in net working capital 24,259 6,148 34,560 36,352 (12,544) Net cash provided by operating activities(2) 54,089 27,667 46,372 38,739 28,422 Return on sales(2) 31.3% 20.7% 29.5% 25.6% 18.3% Return on average equity(2) 20.5% 14.1% 21.4% 22.3% 20.7% BALANCE SHEET, COMMON STOCK AND EMPLOYEE DATA AS OF JUNE 30 2003 2002 2001 2000 1999 (1) - ----------------------------- -------- -------- -------- -------- --------- Cash, cash equivalents and short-term available-for- sale investments $117,501 $ 97,064 $ 97,072 $ 59,824 $ 29,114 Receivables 20,440 19,414 18,322 15,601 13,520 Inventories 6,332 6,077 5,438 4,652 5,715 Working capital 138,707 114,448 108,300 73,740 37,388 Total assets 263,277 238,247 215,525 180,410 123,801 Long-term debt, less current portion 15,852 17,101 18,050 18,935 -- Stockholders' equity 236,617 206,517 177,660 141,145 96,838 Average common and common equivalent shares (in thousands) 42,032 42,523 42,668 42,206 41,373 Book value per share(4) $ 5.78 $ 4.97 $ 4.29 $ 3.41 $ 2.41 Share price: High 34.75 37.05 74.00 70.00 14.75 Low 18.95 25.30 22.50 12.38 6.13 Price to earnings ratio 28 44 41 103 31 Current ratio 13.86 8.82 7.81 6.87 3.78 Quick ratio 12.76 7.96 7.26 6.00 3.17 Full-time employees 525 509 494 440 402 (1) The Company acquired the research products business of Genzyme Corporation on July 1, 1998. (2) Fiscal 2002 results include a $17,500,000 before tax charge ($11,375,000 after tax and $.27 diluted earnings per share) for settlement of litigation with Amgen, Inc. (3) The fiscal 2003 decrease in depreciation and amortization was primarily the result of adoption of Statement of Financial Accounting Standards No. 142. (4) Total stockholders' equity divided by total shares outstanding at June 30. The Company has not declared any cash dividends in the past, and it is not anticipated that it will declare any dividends in the foreseeable future. 15 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS COMPANY STRUCTURE TECHNE Corporation (the Company) has two operating subsidiaries: Research and Diagnostic Systems, Inc. (R&D Systems) and R&D Systems Europe Ltd. (R&D Europe). R&D Systems, located in Minneapolis, Minnesota, has two operating segments: its Biotechnology Division and its Hematology Division. The Biotechnology Division develops and manufactures purified cytokines (proteins), antibodies and assay kits which are sold to biomedical researchers and clinical research laboratories. The Hematology Division develops and manufactures whole blood hematology controls and calibrators which are sold to hospitals and clinical laboratories to check the performance of hematology instruments to assure the accuracy of hematology test results. R&D Europe, the Company's third operating segment, located in Abingdon, England, is the European distributor of R&D Systems' biotechnology products. R&D Europe has a German sales subsidiary, R&D Systems GmbH. The Company's foreign sales corporation, Techne Export Inc., was dissolved in fiscal 2002. CRITICAL ACCOUNTING POLICIES Management's discussion and analysis of the Company's financial condition and results of operations are based upon the Company's consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an ongoing basis, management evaluates its estimates. Management bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. The Company has identified the policies outlined below as critical to its business operations and an understanding of results of operations. The listing is not intended to be a comprehensive list of all accounting policies. Valuation of accounts receivable. The Company performs ongoing credit evaluations of its customers and adjusts credit limits based upon payment history and the customers' current creditworthiness, as determined by management's review of their current credit information. The Company continuously monitors collections and payments from its customers and maintains a provision for estimated credit losses based upon the Company's historical experience and any specific customer collection issues that have been identified. While such credit losses have historically been within the Company's established provisions, if the financial condition of the Company's customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required. Valuation of inventory. Inventories are valued at the lower of cost (first-in, first-out method) or market. The Company regularly reviews inventories on hand for slow-moving and obsolete inventory, inventory not meeting quality control standards and inventory subject to expiration. The manufacturing process for proteins and antibodies has and may continue to produce quantities in excess of forecasted usage. Individual protein and antibody sales volumes can be volatile and the Company believes that forecasting sales volumes for individual products beyond a two-year period is highly 16 uncertain. As a result, the Company values its manufactured protein and antibody inventory based on a two-year sales forecast. Any significant unanticipated changes in product demand or market conditions could have an impact on the value of inventories and the change in value would be reflected in cost of sales in the period of the change. Income taxes. The Company operates within multiple taxing jurisdictions and is subject to audit in these jurisdictions. These audits can involve complex issues, which may require an extended period of time to resolve. In management's opinion, adequate provisions for income taxes have been made for all years presented. Assessment of claims or pending litigation. The Company is routinely subject to claims and involved in legal actions which are incidental to the business of the Company. Although it is difficult to predict the ultimate outcome of these matters, management believes that any ultimate liability will not materially affect the consolidated financial position or results of operations of the Company. As additional information becomes available, the Company will assess the potential liabilities related to claims or pending litigation and revise estimates as needed. Such revisions could materially impact the Company's consolidated financial position or results of operations. RESULTS OF OPERATIONS Net sales for fiscal 2003 were $145,010,900, an increase of $14,110,505 (11%) from fiscal 2002. Net sales by R&D Systems' Biotechnology Division for the period increased $6,309,833 (7%). Net sales by R&D Systems' Hematology Division increased $1,095,382 (7%) and net sales by R&D Europe increased $6,705,290 (22%). R&D Europe's net sales for fiscal 2003 were affected by changes in foreign currency exchange rates. In British pounds, R&D Europe's net sales increased 11% from the prior year. The increase in consolidated net sales for the fiscal year was due largely to increased sales of proteins and antibodies. Net sales for fiscal 2002 were $130,900,395, an increase of $15,543,833 (13%) from fiscal 2001. Net sales by R&D Systems' Biotechnology Division for the period increased $10,998,256 (15%). Net sales by R&D Systems' Hematology Division increased $860,192 (6%) and net sales by R&D Europe increased $3,685,385 (14%). The increase in consolidated net sales for the fiscal year was due largely to increased sales of proteins and antibodies. Gross margins, as a percentage of net sales, increased slightly from 75.2% in fiscal 2002 to 75.6% in fiscal 2003. Biotechnology Division gross margins decreased slightly from 79.2% to 79.0%. Hematology Division gross margins increased from 45.0% to 47.2% in fiscal 2003 as a result of lower raw material costs. Blood costs increased significantly during the prior year as a result of a decreased blood supply, but returned to a more normal level by the end of fiscal 2002. R&D Europe gross margins increased from 36.1% to 41.8% in fiscal 2003 mainly as a result of favorable exchange rates due to the weakening of the U.S. dollar to the British pound sterling. Gross margins, as a percentage of net sales, decreased slightly from 75.4% in fiscal 2001 to 75.2% in fiscal 2002. Biotechnology Division gross margins increased from 78.6% to 79.2% in fiscal 2002 as a result of increased manufacturing efficiencies. Hematology Division gross margins decreased from 46.7% to 45.0% in fiscal 2002 as a result of higher raw material costs as discussed above. R&D Europe gross margins decreased from 38.3% to 36.1% in fiscal 2002 mainly as a result of changes in exchange rates. 17 Included in cost of sales for fiscal 2003, 2002, and 2001 were $2.3 million, $1.8 million and $1.1 million, respectively, of royalties paid under an agreement which concluded on June 30, 2003. Selling, general and administrative expenses decreased $422,683 (2%) in fiscal 2003 and increased $2,438,042 (14%) in fiscal 2002. The decrease in selling, general and administrative expenses in fiscal 2003 was a direct result of a $1.2 million decrease in profit sharing and stock bonus contributions from the prior year due to sales and profit targets not being met. This decrease was partially offset by a $751,000 increase in wages and benefits. The increase in fiscal 2002 was due to increased wages and benefits ($903,000), profit sharing and stock bonus contributions ($442,000) and legal expenses ($373,000) from fiscal 2001. Research and development expenses increased $3,111,076 and $2,948,034 in fiscal 2003 and 2002, respectively. Included in research and development expenses are the Company's share of losses by ChemoCentryx (CCX) and Discovery Genomics, Inc. (DGI), development stage companies in which the Company has invested. Research and development expenses are composed of the following: YEAR ENDED JUNE 30, 2003 2002 2001 ----------- ----------- ----------- R&D Systems' expenses $17,393,441 $15,614,817 $14,022,546 ChemoCentryx, Inc. losses 2,580,023 1,350,435 499,687 Discovery Genomics, Inc. losses 607,879 505,015 -- ----------- ----------- ----------- $20,581,343 $17,470,267 $14,522,233 =========== =========== =========== Exclusive of CCX and DGI, research and development expenses by the Company increased $1,778,624 and $1,592,271 in fiscal 2003 and 2002, respectively. These increases were primarily the result of the development and release of new cytokines, antibodies and assay kits by R&D Systems' Biotechnology Division and the development and release of several new Hematology Division control products. Amortization of intangible assets. On July 1, 2002, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 142, GOODWILL AND OTHER INTANGIBLE ASSETS, under which goodwill is no longer amortized. Goodwill amortization expense was $6.27 million in both fiscal 2002 and 2001. As of June 30, 2002 the Company had net unamortized goodwill of $12,540,000. The Company assessed the recoverability of its goodwill and other intangible assets as of July 1, 2002 (adoption) and determined that no impairment existed. The Company completed its annual impairment testing of goodwill and concluded that no impairment existed as of June 30, 2003. The Company used cash flow and fair value methodologies to assess impairment. The pro forma effects of implementation of SFAS No. 142 to prior periods would be as follows: YEAR ENDED JUNE 30, 2002 2001 ----------- ----------- Reported net income $27,129,669 $34,045,376 Goodwill amortization, net of tax 4,076,000 4,076,000 ----------- ----------- Adjusted net income $31,205,669 $38,121,376 =========== =========== Reported basic earnings per share $ 0.65 $ 0.82 Goodwill amortization 0.10 0.10 ----------- ----------- Adjusted basic earnings per share $ 0.75 $ 0.92 =========== =========== Reported diluted earnings per share $ 0.64 $ 0.80 Goodwill amortization 0.09 0.09 ----------- ----------- Adjusted diluted earnings per share $ 0.73 $ 0.89 =========== =========== Litigation settlement. In fiscal 2002, the Company recorded a $17.5 million charge as a result of a litigation settlement. In fiscal 2000, Amgen, Inc. had presented invoices in the amount of $28 million for materials provided to the Company over past years, allegedly pursuant to a contract under which no accounting or invoices were rendered for nine years. In May 2002, the parties agreed to a $17.5 million cash settlement of the dispute. The settlement was paid in June 2002 with cash on hand and the liquidation of approximately $15 million of short-term available-for-sale investments. The after-tax amount of the charge to the Company's fiscal 2002 results was approximately $11.4 million or $.27 per diluted share. Excluding the settlement, earnings per diluted share would have been $.91 for fiscal 2002 compared to $.80 in the prior year. Other non-operating expense (income). Other non-operating expense (income) consists mainly of foreign currency transaction gains and losses, rental income, and real estate and utility expenses related to properties under construction/renovation. 18 Earnings before taxes increased from $37,735,669 in fiscal 2002 to $69,555,293 in fiscal 2003. Excluding the litigation settlement discussed above from fiscal 2002 results, earnings before taxes increased $14.3 million in fiscal 2003. R&D Systems' Biotechnology Division earnings increased $10,714,234, R&D Systems' Hematology Division earnings increased $843,416 and R&D Europe earnings increased $3,817,858. These increases in earnings were due mainly to increased sales and decreased goodwill amortization of $6.27 million and were partially offset by increased losses of $1,332,425 by CCX and DGI included in the Company's results. Earnings before taxes decreased from $47,808,376 in fiscal 2001 to $37,735,669 in fiscal 2002. The decrease was the result of the litigation settlement discussed above. Excluding the settlement, the Company's earnings before taxes for fiscal 2002 would have been approximately $55.2 million compared to $47.8 million in the prior year, an increase of $7.4 million. R&D Systems' Biotechnology Division earnings increased $8,010,086, R&D Systems' Hematology Division earnings increased $37,292 and R&D Europe earnings increased $1,193,382. These increases in earnings were due mainly to increased sales and were partially offset by increased losses of $1,355,763 by CCX and DGI included in the Company's results. Income taxes for fiscal 2003, 2002 and 2001 were provided at rates of approximately 35%, 28% and 29%, respectively. The increased tax rate in fiscal 2003 was primarily the result of changes in Minnesota income tax regulations which resulted in state tax expense of $666,000 ($1,552,000 expense offset by $886,000 of tax credit carryforwards) in fiscal 2003 compared to a credit of $1 million in fiscal 2002. The tax rate in fiscal 2001 includes the effect of a one-time $1.2 million credit as a result of the close-out of pending issues related to a state income tax examination for fiscal years 1996 through 1999. U.S. federal and state taxes have been reduced as a result of tax-exempt interest income, the benefit of extraterritorial income in fiscal 2003 and 2002, the benefit of the foreign sales corporation in fiscal 2001, and the federal and state credit for research and development expenditures. Foreign income taxes have been provided at rates which approximate the tax rates in the countries in which R&D Europe operates. Without significant business developments, the Company expects income tax rates for fiscal 2004 to be from 35% to 36%. QUARTERLY FINANCIAL INFORMATION (UNAUDITED) (IN THOUSANDS, EXCEPT PER SHARE DATA) FISCAL 2003 FISCAL 2002 FIRST SECOND THIRD FOURTH FIRST SECOND THIRD FOURTH QTR. QTR. QTR. QTR. QTR. QTR. QTR. QTR.(1) ------- ------- ------- ------- ------- ------- ------- ------- Net sales $34,548 $33,300 $37,737 $39,426 $29,843 $31,137 $34,285 $35,636 Gross margin 25,858 24,929 28,980 29,847 22,295 23,109 25,893 27,096 Earnings (loss) be- fore taxes 15,907 14,988 19,118 19,543 12,256 12,407 15,350 (2,277) Income taxes 5,462 5,107 6,724 6,866 3,831 3,972 4,776 (1,973) Net earnings (loss) 10,445 9,881 12,394 12,677 8,425 8,435 10,574 (304) Basic earn- ings (loss) per share 0.25 0.24 0.30 0.31 0.20 0.20 0.25 (0.01) Diluted earn- ings (loss) per share 0.25 0.23 0.30 0.31 0.20 0.20 0.25 (0.01) (1) Results include a $17,500,000 before tax charge ($11,375,000 after tax) for settlement of litigation with Amgen, Inc. Excluding the settlement basic and diluted earnings per share would have been $.27 and $.26, respectively. LIQUIDITY AND CAPITAL RESOURCES Cash, cash equivalents and short-term available-for-sale investments at June 30, 2003 were $117,501,331 compared to $97,063,821 at June 30, 2002. At June 30, 2001, cash, equivalents and short-term available-for-sale investments were $97,071,868. The Company has an unsecured line of credit of $750,000 available at June 30, 2003. The line of credit expires on October 31, 2003. The interest rate on the line of credit is at the prime rate (4.0% at June 30, 2003). Management of the Company expects to be able to meet its future cash and working capital requirements for operations, debt repayment, facility expansion and capital additions through currently available funds, cash generated from operations and maturities of short-term available-for-sale investments. 19 Cash flows from operating activities. The Company generated cash from operations of $54,088,895, $27,667,227 and $46,371,711 in fiscal 2003, 2002 and 2001, respectively. The increase in cash generated from operating activities in fiscal 2003 of approximately $26.4 million was the result of increased net earnings, increased losses by equity method investees and increased income taxes payable, partially offset by decreased goodwill amortization and decreased trade and other accounts payable. Net earnings increased approximately $18.3 million from fiscal 2002 to fiscal 2003 while losses by equity method investees, which do not affect the Company's cash balances, increased $1.3 million from fiscal 2002. The increase in income taxes payable of $10.9 million was mainly the result of higher U.S. taxable income in fiscal 2003 ($3.9 million increase in U.S. income taxes payable compared to fiscal 2002) and lower income tax payments made in fiscal 2003 ($5.1 less than made in fiscal 2002). Goodwill amortization decreased $6.27 million in fiscal as a result of adoption of Statement of Financial Accounting Standards No. 142. The decrease in trade and other accounts payable was mainly the result of $3.8 million less in royalties payable to Genzyme, Inc. stemming from the fiscal 1999 acquisition of Genzyme's research product business under which royalties were due through fiscal 2003. The decrease in cash generated from operating activities in fiscal 2002 of approximately $6.9 million was mainly the result of decreased net earnings due to the litigation settlement and increased income tax payments. Cash flows from investing activities. Capital additions (excluding the land and building purchases and construction discussed below) were $1,178,332, $2,645,977 and $4,920,832 in fiscal 2003, 2002 and 2001, respectively. Included in fiscal 2003, 2002 and 2001 capital additions are building improvements of $202,000, $522,000 and $2.3 million related to R&D Systems' remodeling. The remaining capital additions were for laboratory, manufacturing and computer equipment. Capital additions for laboratory, manufacturing and computer equipment planned for fiscal 2004 are expected to be approximately $1.5 million and are expected to be financed through currently available cash and cash generated from operations. Included in fiscal 2003 capital additions was $11.1 million for renovation of property purchased in fiscal 2002 and the construction of an infill connecting the purchased property to R&D Systems' existing property, $202,000 for the completion of a parking ramp and $2.7 million for the purchase of property in southeastern Minnesota as described in Note C to the Consolidated Financial Statements. Included in fiscal 2002 capital additions was $6 million for the purchase of property adjacent to the Company's Minneapolis facility, $7.8 million for renovation of the property and the construction of the infill and $5.9 million for the construction of the parking ramp. Included in fiscal 2001 capital additions was $1.9 million for the construction of the parking ramp. The land and building purchases and construction were all financed through cash on hand, cash generated from operations and maturities of short-term available-for- sale investments. Remaining construction costs for the Minneapolis property are estimated to be approximately $7 million with the completion of the construction expected in fiscal 2004. Construction costs for buildings planned at the property in southeastern Minnesota are estimated at $1.6 million in fiscal 2004. All construction is expected to be financed through cash on hand and cash generated from operations. The Company's net purchases of (proceeds from) short-term available-for-sale investments in fiscal 2003, 2002 and 2001 was $6,514,928, ($5,132,736) and $33,335,894, respectively. The Company's investment policy is to place excess cash in municipal and corporate bonds with the objective of obtaining the highest possible return with the lowest risk, while keeping funds accessible. The Company paid $1,999,000 in March 2002 as a nonrefundable deposit on an option, which expires in 2005, to purchase additional property adjacent to its Minneapolis facility. In fiscal 2000, the Company had paid an original $1,000 deposit on this option. In August 2001, the Company made an equity investment of $3 million in Discovery Genomics, Inc. (DGI). DGI holds licenses from the University of Minnesota to develop technologies used for functional genomics and the discovery of drug targets. The Company holds a 39% equity interest in DGI and accounts for this investment under the equity method of accounting. The Company's net investment in DGI was $1,887,106 and $2,494,985 at June 30, 2003 and 2002, respectively. 20 Cash flows from financing activities. The Company received $2,442,471, $332,173 and $814,892 for the exercise of options for 264,898, 87,400 and 89,616 shares of common stock in fiscal 2003, 2002 and 2001, respectively. In fiscal 2003, 2002 and 2001, the Company purchased and retired 1,026,500, 30,000 and 40,000 shares of Company common stock at market values of $22,512,572, $745,615 and $1,163,768, respectively. In May 1995, the Company announced a plan to purchase and retire its common stock. Since May 1995, the Board of Directors has authorized the purchase of $40 million of common stock. Through June 30, 2003, $33,176,069 of common stock had been purchased under the plan. Any additional purchases will be funded from currently available cash. The Company has never paid cash dividends and currently has no plans to do so in fiscal 2004. The Company's net earnings will be retained for reinvestment in the business. Contractual obligations. The following table summarizes the Company's contractual obligations and commercial commitments as of June 30, 2003: PAYMENTS DUE BY PERIOD ($000'S) ------------------------------------------ LESS THAN 1-3 4-5 AFTER TOTAL 1 YEAR YEARS YEARS 5 YEARS ------- --------- ------ ------ ------- Long-term debt $17,086 $1,234 $2,626 $2,846 $10,380 Operating leases 5,660 491 939 853 3,377 Minimum royalty payments 119 119 -- -- -- ------- ------ ------ ------ ------- $22,865 $1,844 $3,565 $3,699 $13,757 ======= ====== ====== ====== ======= OFF-BALANCE SHEET ARRANGEMENTS The Company is not a party to any off-balance sheet transactions, arrangements or obligations that have, or are reasonably likely to have, a material effect on the Company's financial condition, changes in the financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources. NEW ACCOUNTING PRONOUNCEMENTS In December 2002, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 148, ACCOUNTING FOR STOCK-BASED COMPENSATION-TRANSITION AND DISCLOSURE, an amendment of SFAS No.123. This statement provides alternative methods of transition for a voluntary change to the fair value method of accounting for stock-based compensation. The statement amends the disclosure requirements of SFAS No. 123 to require prominent disclosure in both annual and interim financial statements about the method of accounting for stock-based compensation and the effect of the method used on reported results. The Company accounts for stock-based compensation arrangements in accordance with the provisions of Accounting Principles Board Opinion No. 25, ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES, and complies with the disclosure provisions of SFAS No. 123. The transition provisions are effective for fiscal years ending after December 15, 2002. The disclosure provisions are effective for interim periods beginning after December 15, 2002. The Company implemented the required disclosure provisions in Form 10-Q for the quarter ended March 31, 2003. In January 2003, the FASB issued Interpretation No. 46 (FIN 46), CONSOLIDATION OF VARIABLE INTEREST ENTITIES. FIN 46 addresses the consolidation by businesses of variable interest entities and requires businesses to consolidate a variable interest entity if it has a variable interest that will absorb a majority of the entity's expected losses if they occur, or receive a majority of the entity's expected returns if they occur, or both. FIN 46 became effective for variable interest entities created after January 31, 2003. For variable interest entities created prior to January 31, 2003, the provisions of FIN 46 are applicable to the Company for the quarter ended September 30, 2003. The Company is currently assessing the impact of FIN 46 on its consolidated financial statements. 21 FORWARD-LOOKING INFORMATION Statements in this Annual Report, and elsewhere, that are forward-looking involve risks and uncertainties which may affect the Company's actual results of operations. Certain of these risks and uncertainties which have affected and, in the future, could affect the Company's actual results are discussed below. The Company's biotechnology products are sold primarily to research scientists at pharmaceutical and biotechnology companies and at university and government research institutions. Changes in spending on research by such companies and in funding of such universities and institutions by government, including the National Institutes of Health, affects the revenues and earnings of the Company. The Company carries essentially no backlog of orders and changes in the level of orders received and filled daily can cause fluctuations in quarterly revenues and earnings. Approximately one quarter of the Company's sales are made through its European subsidiary, R&D Systems Europe, which makes its sales in foreign currencies. The Company's revenues and earnings are, therefore, affected by fluctuations in currency exchange rates. The biotechnology industry is subject to rapid and significant technological change. While the hematology controls industry historically has been subject to less rapid change, it too is evolving and is impacted significantly by changes in the automated testing equipment offered by hardware manufacturers. Competitors of the Company are numerous and include, among others, specialized biotechnology firms, medical laboratory instrument and equipment manufacturers and disposables suppliers, major pharmaceutical companies, universities and other research institutions. There can be no assurance that the Company's competitors will not succeed in developing technologies and products that are more effective than any which have been or are being developed by the Company or that would render the Company's technologies and products obsolete or noncompetitive. The Company's success will depend, in part, on its ability to obtain licenses and patents, maintain trade secret protection and operate without infringing the proprietary rights of others. The Company has obtained and is negotiating licenses to produce a number of cytokines and related products claimed to be owned by others. Since the Company has not conducted a patent infringement study for each of its products, it is possible that products of the Company may unintentionally infringe patents of third parties or that the Company may have to alter its products or processes, pay licensing fees or cease certain activities because of patent rights of third parties, thereby causing additional unexpected costs and delays which may have a material adverse effect on the Company. The Company's expansion strategies, which include internal development of new products, collaborations, investments in joint ventures and companies developing new products related to the Company's business, and the acquisition of companies for new products and additional customer base, carry risks that objectives will not be achieved and future earnings will be adversely affected. During the early development stage, under the equity method of accounting, a percentage of the losses of certain companies in which the Company invests will be reported as losses of the Company. The Company may not have control of the expense levels of such companies and their losses may be greater than those anticipated by the Company. Ongoing research and development activities and the production and marketing of certain of the Company's products are subject to regulation by numerous governmental authorities in the United States and other countries. The approval process applicable to clinical diagnostic products of the type that may be developed by the Company may take a year or more. Delays in obtaining approvals could adversely affect the marketing of new products developed by the Company. Recruiting and retaining qualified scientific and production personnel to perform research and development work and product manufacturing are critical to the Company's success. The Company's anticipated growth and its expected expansion into areas and activities requiring additional expertise will require the addition of new personnel and the development of additional expertise by existing personnel. The failure to attract and retain such personnel could adversely affect the Company's business. For additional information on risks and uncertainties, see the Company's periodic reports filed with the Securities and Exchange Commission. 22 ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK At the end of fiscal 2003, the Company had a professionally managed investment portfolio of fixed income securities, excluding those classified as cash and cash equivalents, of $78,130,269 (see Note A of Notes to Consolidated Financial Statements). These securities, like all fixed income instruments, are subject to interest rate risk and will decline in value if market interest rates increase. The Company operates internationally, and thus is subject to potentially adverse movements in foreign currency rate changes. The Company is exposed to market risk from foreign exchange rate fluctuations of the euro and the British pound to the U.S. dollar as the financial position and operating results of the Company's U.K. and German subsidiaries are translated into U.S. dollars for consolidation. The Company's exposure to foreign exchange rate fluctuations also arises from transferring funds from the U.K. subsidiary to the U.S. parent and from transferring funds from the German subsidiary to the U.K. subsidiary. At June 30, 2003 and 2002, the Company had $358,195 and $397,349 dollar denominated intercompany debt at its U.K. subsidiary and the U.K. subsidiary had $295,242 and $37,291 dollar denominated intercompany debt at its German subsidiary. These intercompany balances are revolving in nature and are not deemed to be long-term balances. The Company's U.K. subsidiary recognized net foreign currency gains of 223,938 pounds ($356,554) and 242,614 pounds ($351,548) for the years ended June 30, 2003 and 2002, respectively. The currency gains were primarily the result of a strong British pound compared to the euro. The Company does not enter into foreign exchange forward contracts to reduce its exposure to foreign currency rate changes on intercompany foreign currency denominated balance sheet positions. As of June 30, 2003, the Company's long-term debt consisted of a mortgage note payable. The interest rate on the mortgage was fixed at 7% through November 2002. The terms of the note payable were modified in December 2002 to include a floating interest rate at the one month London interbank offered rate (Libor) plus 2.5% with a floor of 4%. The floating interest rate on the mortgage note payable was below the 4% floor as of June 30, 2003. 23 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA CONSOLIDATED STATEMENTS OF EARNINGS TECHNE CORPORATION AND SUBSIDIARIES YEAR ENDED JUNE 30, 2003 2002 2001 ------------ ------------ ------------ Net sales $145,010,900 $130,900,395 $115,356,562 Cost of sales 35,396,174 32,507,846 28,424,906 ------------ ------------ ------------ Gross margin 109,614,726 98,392,549 86,931,656 Operating expenses: Selling, general and administrative 19,376,538 19,799,221 17,361,179 Research and development 20,581,343 17,470,267 14,522,233 Amortization of intangible assets (Note D) 1,939,250 8,549,246 8,889,254 Litigation settlement (Note F) -- 17,500,000 -- Interest expense 973,780 1,320,479 1,381,276 Interest income (2,933,348) (3,737,307) (3,383,698) Other non-operating expense (income), net 121,870 (245,026) 353,036 ------------ ------------ ------------ 40,059,433 60,656,880 39,123,280 ------------ ------------ ------------ Earnings before income taxes 69,555,293 37,735,669 47,808,376 Income taxes (Note H) 24,159,000 10,606,000 13,763,000 ------------ ------------ ------------ Net earnings $ 45,396,293 $ 27,129,669 $ 34,045,376 ============ ============ ============ Earnings per share: Basic $ 1.10 $ 0.65 $ 0.82 Diluted $ 1.08 $ 0.64 $ 0.80 Weighted average common shares outstanding: Basic 41,237,473 41,507,727 41,438,670 Diluted 42,031,510 42,522,664 42,668,236 See Notes to Consolidated Financial Statements. 24 CONSOLIDATED BALANCE SHEETS TECHNE CORPORATION AND SUBSIDIARIES JUNE 30, 2003 2002 ------------ ------------- ASSETS Current assets: Cash and cash equivalents $ 39,371,062 $ 26,392,480 Short-term available-for-sale investments (Note A) 78,130,269 70,671,341 Trade accounts receivable, less allowance for doubtful accounts of $268,000 and $263,000, respectively 18,386,603 16,913,002 Interest receivable 2,053,667 2,500,616 Inventories (Note B) 6,332,248 6,077,035 Deferred income taxes (Note H) 4,237,000 3,762,000 Prepaid expenses 1,003,888 915,854 Income taxes receivable -- 1,845,421 ------------ ------------ Total current assets 149,514,737 129,077,749 Property and equipment, net (Note C) 81,166,311 70,312,602 Goodwill, net (Note D) 12,540,000 12,540,000 Intangible assets, net (Note D) 4,417,750 6,357,000 Deferred income taxes (Note H) 8,715,000 9,400,000 Other long-term assets (Notes A and F) 6,923,330 10,559,608 ------------ ------------ $263,277,128 $238,246,959 ============ ============ LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Trade accounts payable $ 2,215,928 $ 4,326,359 Salaries, wages and related accounts 1,780,607 2,873,505 Other accounts payable and accrued expenses 2,605,593 6,480,023 Income taxes payable 2,971,984 -- Current portion of long-term debt (Note E) 1,233,921 949,637 ------------ ------------ Total current liabilities 10,808,033 14,629,524 Long-term debt, less current portion (Note E) 15,851,901 17,100,652 ------------ ------------ Total liabilities 26,659,934 31,730,176 ------------ ------------ Commitments and contingencies (Note F) Stockholders' equity (Note G): Undesignated capital stock, no par; authorized 5,000,000 shares; none issued or outstanding -- -- Common stock, par value $.01 a share; authorized 100,000,000 shares; issued and outstanding 40,913,226 and 41,562,136 shares, respectively 409,132 415,621 Additional paid-in capital 63,279,243 58,584,103 Retained earnings 169,808,690 147,369,149 Accumulated other comprehensive income 3,120,129 147,910 ------------ ------------ Total stockholders' equity 236,617,194 206,516,783 ------------ ------------ $263,277,128 $238,246,959 ============ ============ See Notes to Consolidated Financial Statements. 25 CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY TECHNE CORPORATION AND SUBSIDIARIES