##### Table of Contents



SECURITIES AND EXCHANGE COMMISSION    FORM 10-Q x
    
    Quarterly report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
 For the quarterly period ended September 30, 2004
 o
    
    Transition report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
 For the transition
period from toCommission file number 1-9957
 Diagnostic Products Corporation  California
    
    95-2802182(State or other jurisdiction of
    
    (IRS Employerincorporation or organization)
    
    Identification No.)
 5210 Pacific Concourse Dr.
Los Angeles, California 90045
(Address of principal executive offices) Registrants telephone number: (310) 725-7039 5700 W. 96th Street
Los Angeles, California 90045(Former name, former address, and former fiscal year, if changed since last report) Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). [ YES X ] [NO ] 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 ] The number of shares of Common Stock, no par value, outstanding as of November
1, 2004, was 29,165,146.




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TABLE OF CONTENTS  PART I. FINANCIAL INFORMATIONITEM I. FINANCIAL STATEMENTSCONSOLIDATED STATEMENTS OF INCOMECONSOLIDATED BALANCE SHEETSCONSOLIDATED STATEMENTS OF CASH FLOWSNOTES TO CONSOLIDATED FINANCIAL STATEMENTSITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONSITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKITEM 4. CONTROLS AND PROCEDURESPART II. OTHER INFORMATIONITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.SIGNATURESEXHIBIT INDEXExhibit 10.4Exhibit 10.5Exhibit 31.1Exhibit 31.2Exhibit 32.1    Table of Contents  
 PART I. FINANCIAL INFORMATION 
 ITEM I. FINANCIAL STATEMENTS DIAGNOSTIC PRODUCTS CORPORATION AND SUBSIDIARIES 
 CONSOLIDATED STATEMENTS OF INCOME
  Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,(Amounts in Thousands, Except Per Share Data)
    
    2004
    
    2003
    
    2004
    
    2003SALES:Non-Affiliated Customers
    
    $
    100,742
    
    
    $
    87,483
    
    
    $
    300,465
    
    
    $
    255,916Unconsolidated Affiliates
    
    
    8,221
    
    
    
    6,254
    
    
    
    25,049
    
    
    
    20,652Total Sales
    
    
    108,963
    
    
    
    93,737
    
    
    
    325,514
    
    
    
    276,568COST OF SALES
    
    
    46,432
    
    
    
    41,335
    
    
    
    137,270
    
    
    
    117,855Gross Profit
    
    
    62,531
    
    
    
    52,402
    
    
    
    188,244
    
    
    
    158,713OPERATING EXPENSES:Selling
    
    
    19,126
    
    
    
    15,649
    
    
    
    57,235
    
    
    
    46,704Research and Development
    
    
    11,188
    
    
    
    10,037
    
    
    
    33,637
    
    
    
    30,087General and Administrative
    
    
    11,752
    
    
    
    8,401
    
    
    
    32,475
    
    
    
    25,309Gain on Sale of Product Line
    
    
    
    
    
    
    (4,218
    )
    
    
    
    
    
    
    (4,218
    )Equity in Income of Affiliates
    
    
    (1,705
    )
    
    
    (1,280
    )
    
    
    (6,535
    )
    
    
    (4,201
    )OPERATING EXPENSES-NET
    
    
    40,361
    
    
    
    28,589
    
    
    
    116,812
    
    
    
    93,681OPERATING INCOME
    
    
    22,170
    
    
    
    23,813
    
    
    
    71,432
    
    
    
    65,032Interest/Other Income-Net
    
    
    1,334
    
    
    
    283
    
    
    
    781
    
    
    
    436INCOME BEFORE INCOME TAXES
AND MINORITY INTEREST
    
    
    23,504
    
    
    
    24,096
    
    
    
    72,213
    
    
    
    65,468PROVISION FOR INCOME TAXES
    
    
    6,573
    
    
    
    6,988
    
    
    
    21,186
    
    
    
    18,986MINORITY INTEREST
    
    
    414
    
    
    
    143
    
    
    
    434
    
    
    
    189NET INCOME
    
    $
    16,517
    
    
    $
    16,965
    
    
    $
    50,593
    
    
    $
    46,293EARNINGS PER SHARE:BASIC
    
    $
    0.57
    
    
    $
    0.59
    
    
    $
    1.74
    
    
    $
    1.61DILUTED
    
    $
    0.55
    
    
    $
    0.57
    
    
    $
    1.69
    
    
    $
    1.56WEIGHTED AVERAGE SHARES OUTSTANDING:BASIC
    
    
    29,120
    
    
    
    28,760
    
    
    
    29,049
    
    
    
    28,691DILUTED
    
    
    29,853
    
    
    
    29,697
    
    
    
    29,880
    
    
    
    29,638
 SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. 2




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DIAGNOSTIC PRODUCTS CORPORATION AND SUBSIDIARIES 
 CONSOLIDATED BALANCE SHEETS
  September 30,
    
    December 31,(Dollars in Thousands)
    
    2004
    
    2003AssetsCURRENT ASSETS:Cash and cash equivalents
    
    $
    70,990
    
    
    $
    69,843Accounts receivable (including receivables from unconsolidated
affiliates of $10,875 and $6,701, respectively)  net of allowance
for doubtful accounts of $3,348 and $3,195, respectively
    
    
    98,188
    
    
    
    90,310Inventories
    
    
    96,027
    
    
    
    86,502Prepaid expenses and other current assets
    
    
    6,456
    
    
    
    5,500Deferred income taxes
    
    
    2,573
    
    
    
    5,413Total current assets
    
    
    274,234
    
    
    
    257,568PROPERTY, PLANT, AND EQUIPMENT  net
    
    
    138,676
    
    
    
    104,420INSTRUMENTS  net
    
    
    77,095
    
    
    
    77,230DEFERRED INCOME TAXES
    
    
    
    
    
    
    255INVESTMENTS IN AFFILIATED COMPANIES
    
    
    35,587
    
    
    
    29,822OTHER ASSETS  net
    
    
    12,778
    
    
    
    4,864GOODWILL
    
    
    13,397
    
    
    
    13,423TOTAL ASSETS
    
    $
    551,767
    
    
    $
    487,582Liabilities and Shareholders EquityCURRENT LIABILITIES:Notes payable
    
    $
    10,202
    
    
    $
    19,369Accounts payable
    
    
    20,948
    
    
    
    20,983Accrued liabilities
    
    
    43,096
    
    
    
    31,136Income taxes payable
    
    
    11,411
    
    
    
    9,246Total current liabilities
    
    
    85,657
    
    
    
    80,734LONG-TERM LIABILITIES
    
    
    5,485
    
    
    
    1,000DEFERRED INCOME TAXES
    
    
    981MINORITY INTEREST
    
    
    3,869
    
    
    
    2,848SHAREHOLDERS EQUITY:Common Stock  no par value, authorized 60,000,000 shares
at September 30, 2004 and December 31, 2003; outstanding
29,159,246 shares and 28,907,969 shares, respectively
    
    
    70,855
    
    
    
    66,758Retained earnings
    
    
    381,496
    
    
    
    336,129Accumulated other comprehensive income
    
    
    3,424
    
    
    
    113Total shareholders equity
    
    
    455,775
    
    
    
    403,000TOTAL LIABILITIES AND SHAREHOLDERS EQUITY
    
    $
    551,767
    
    
    $
    487,582
 SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. 3




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DIAGNOSTIC PRODUCTS CORPORATION AND SUBSIDIARIES 
 CONSOLIDATED STATEMENTS OF CASH FLOWS
  Nine Months EndedSeptember 30,(Dollars in Thousands)
    
    2004
    
    2003CASH FLOWS FROM OPERATING ACTIVITIES:Net income
    
    $
    50,593
    
    
    $
    46,293Adjustments to reconcile net income to net cash
flows from operating activities:Depreciation and amortization
    
    
    31,542
    
    
    
    25,444Minority interest
    
    
    434
    
    
    
    132Equity in undistributed income of unconsolidated affiliates  net
of distributions
    
    
    (4,630
    )
    
    
    (3,754
    )Deferred income taxes
    
    
    3,633
    
    
    
    755Changes in operating assets and liabilities:Accounts receivable
    
    
    (13,277
    )
    
    
    (4,010
    )Inventories
    
    
    (32,092
    )
    
    
    (23,614
    )Prepaid expenses and other assets
    
    
    980
    
    
    
    (3,601
    )Accounts payable
    
    
    2,425
    
    
    
    (1,419
    )Accrued liabilities
    
    
    8,826
    
    
    
    2,222Income taxes payable
    
    
    2,181
    
    
    
    3,085Net cash flows from operating activities
    
    
    50,615
    
    
    
    41,533CASH FLOWS USED FOR INVESTING ACTIVITIES:Investment in affiliated companies
    
    
    (219
    )Additions to property, plant, and equipment
    
    
    (43,249
    )
    
    
    (32,695
    )Net cash flows used for investing activities
    
    
    (43,468
    )
    
    
    (32,695
    )CASH FLOWS USED FOR FINANCING ACTIVITIESRepayments of notes payable-net
    
    
    (5,385
    )
    
    
    (699
    )Proceeds from exercise of stock options
    
    
    4,097
    
    
    
    2,749Cash dividends paid
    
    
    (5,225
    )
    
    
    (5,164
    )Net cash flows used for financing activities
    
    
    (6,513
    )
    
    
    (3,114
    )EFFECT OF EXCHANGE RATE CHANGES ON CASH
    
    
    513
    
    
    
    (3,137
    )NET INCREASE IN CASH AND CASH EQUIVALENTS
    
    
    1,147
    
    
    
    2,587CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD
    
    
    69,843
    
    
    
    54,284CASH AND CASH EQUIVALENTS AT END OF PERIOD
    
    $
    70,990
    
    
    $
    56,871SUPPLEMENTAL CASH FLOW INFORMATION -Non cash transactions  instrument placements transferred from inventories
    
    $
    22,614
    
    
    $
    17,610
 SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. 4




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DIAGNOSTIC PRODUCTS CORPORATION AND SUBSIDIARIES 
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
  Note 1  Basis of Presentation The information for the three and nine-month periods ended September 30, 2004
and 2003 has not been audited by independent registered accountants with the
Public Company Accounting Oversight Board, but includes all adjustments (consisting of normal recurring accruals)
that are, in the opinion of management, necessary to a fair statement of the
results for such periods. Certain information and footnote disclosure normally included in financial
statements prepared in accordance with accounting principles generally accepted
in the United States of America have been omitted pursuant to the requirements
of the Securities and Exchange Commission, although the Company believes that
the disclosures included in these financial statements are adequate to make the
information not misleading. The consolidated financial statements should be read in conjunction with the
consolidated financial statements and notes thereto included in the Companys
2003 Annual Report on Form 10-K as filed with the Securities and Exchange
Commission. The results of operations for the three and nine-month periods ended September
30, 2004 are not necessarily indicative of the results to be expected for the
year ending December 31, 2004. Basic earnings per share is computed by
dividing net income by the weighted-average number of shares outstanding.
Diluted earnings per share include the dilutive effect of stock options. Certain reclassifications have been made to the 2003 periods to conform to the
2004 presentation. Note 2  Inventories Inventories by major categories are summarized as follows: September 30,
    
    December 31,(Dollars in Thousands)
    
    2004
    
    2003Raw materials
    
    $
    39,718
    
    
    $
    39,145Work in process
    
    
    38,951
    
    
    
    38,761Finished goods
    
    
    17,358
    
    
    
    8,596Total
    
    $
    96,027
    
    
    $
    86,502
 Note 3  Property, Plant & Equipment Property, plant and equipment consists of the following: 5




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September 30,
    
    December 31,(Dollars in Thousands)
    
    2004
    
    2003Land and buildings
    
    $
    101,426
    
    
    $
    58,711Machinery and equipment
    
    
    97,499
    
    
    
    79,638Leasehold improvements
    
    
    9,464
    
    
    
    9,384Construction in progress
    
    
    11,928
    
    
    
    30,111Total
    
    
    220,317
    
    
    
    177,844Accumulated depreciation and amortization
    
    
    (81,641
    )
    
    
    (73,424
    )Property, plant and equipment  net
    
    $
    138,676
    
    
    $
    104,420
 In the quarter ended September 30, 2004, the Company moved into its new
corporate headquarters, resulting in the transfer of $42.5 million of related
cost from construction in progress to land and buildings. The balance in
construction in progress primarily relates to the construction of a new
building in Wales and the expansion of the facilities in New Jersey. Note 4  Goodwill and Other Assets Goodwill results primarily from the Companys purchase of certain of its
foreign distributors. As required under Statement of Financial Accounting
Standards No. 142, Goodwill and Other Current Intangible Assets, the Company
completed its annual goodwill impairment testing on September 30, 2004 and does
not believe that goodwill has been impaired. Other assets at September 30,
2004 consist of purchased technology licenses totaling $7,596,000, which is net
of accumulated amortization of $404,000, and accounts receivable for certain
equipment purchases with a due date of greater than a year totaling $5,182,000.
Of the purchased technology licenses amount, $3.0 million represents licenses
purchased during the first quarter of 2004. The remaining licenses with a net
balance totaling approximately $4.6 million were purchased during 2003.
Amortization expense for the three and nine months ended September 30, 2004
totaled $166,000 and $268,000, respectively. Amortization expense for each of
the next five fiscal years is estimated to be $802,000 and will be amortized
using the straight-line method over the shorter of their estimated useful life
or the expiration of the license. Note 5  Comprehensive Income Comprehensive income is summarized as follows: Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,(Dollars in Thousands)
    
    2004
    
    2003
    
    2004
    
    2003Net income
    
    $
    16,517
    
    
    $
    16,965
    
    
    $
    50,593
    
    
    $
    46,293Foreign currency translation adjustment
    
    
    4,297
    
    
    
    (824
    )
    
    
    1,308
    
    
    
    10,800Unrealized gain on foreign exchange contracts
net of tax impact
    
    
    39
    
    
    
    
    
    
    
    2,003Comprehensive income
    
    $
    20,853
    
    
    $
    16,141
    
    
    $
    53,904
    
    
    $
    57,093
 The Company does not provide for U.S. income taxes on foreign currency
translation adjustments because it does not provide for such taxes on
undistributed earnings of foreign subsidiaries as these are considered to be
indefinitely invested. Note 6  Segment and Product Line Information The Company considers its manufactured instruments and medical immunodiagnostic
test kits as one operating segment, as the kits are required to run the
instruments and utilize similar technology and instrument manufacturing
processes. The Company manufactures its instruments and kits principally from
facilities in the United States and the United Kingdom. Kits and instruments
are sold to hospitals, medical centers, clinics, physicians, and other clinical
laboratories throughout the world through a network of distributors, including
consolidated distributors located in the United Kingdom, Germany, Czech
Republic, Poland, Slovenia, Slovakia, Spain, The Netherlands, Belgium,
Luxemburg, Sweden, Denmark, Norway, Finland, Latvia, 6




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Lithuania, Estonia,
France, Australia, New Zealand, China, Brazil, Costa Rica, Venezuela, Uruguay,
Bolivia, Honduras, Guatemala and Panama. The Company sells its instruments and immunodiagnostic test kits under several
product lines. Product line sales information is as follows: Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,(Dollars in Thousands)
    
    2004
    
    2003
    
    2004
    
    2003Sales:IMMULITE (includes service)
    
    $
    99,715
    
    
    $
    82,875
    
    
    $
    296,795
    
    
    $
    243,703Radioimmunoassay (RIA)
    
    
    5,785
    
    
    
    6,572
    
    
    
    18,266
    
    
    
    20,300Other (Includes DPC and non-DPC
manufactured products)
    
    
    3,463
    
    
    
    4,290
    
    
    
    10,453
    
    
    
    12,565$
    108,963
    
    
    $
    93,737
    
    
    $
    325,514
    
    
    $
    276,568
 The Company is organized and managed by geographic area. Transactions between
geographic segments are accounted for as normal sales for internal reporting
and management purposes with all intercompany amounts eliminated in
consolidation. Sales are attributed to geographic areas based on the location
from which the instrument or kit is shipped to the customer. Information
reviewed by the Companys chief operating decision maker on significant
geographic segments is prepared on the same basis as the consolidated financial
statements and is as follows: Euro/DPC
    
    DPC
    
    DPCLimited
    
    Biermann
    
    Medlab
    
    
    
    
    
    Less:United
    
    (United
    
    (German
    
    (Brazilian
    
    
    
    
    
    Intersegment(Dollars in Thousands)
    
    States
    
    Kingdom)
    
    Group)*
    
    Group)*
    
    Other
    
    Elimination
    
    TotalThree Months Ended September 30, 2004Sales
    
    $
    69,476
    
    
    $
    22,432
    
    
    $
    13,599
    
    
    $
    10,640
    
    
    $
    22,491
    
    
    $
    (29,675
    )
    
    $
    108,963Net income
    
    
    8,039
    
    
    
    5,130
    
    
    
    310
    
    
    
    940
    
    
    
    2,452
    
    
    
    (354
    )
    
    
    16,517Three Months Ended September 30, 2003Sales
    
    $
    59,825
    
    
    $
    16,324
    
    
    $
    12,661
    
    
    $
    8,752
    
    
    $
    20,701
    
    
    $
    (24,526
    )
    
    $
    93,737Net income
    
    
    10,972
    
    
    
    3,113
    
    
    
    504
    
    
    
    326
    
    
    
    2,130
    
    
    
    (80
    )
    
    
    16,965
 Euro/DPC
    
    DPC
    
    DPCLimited
    
    Biermann
    
    Medlab
    
    
    
    
    
    Less:United
    
    (United
    
    (German
    
    (Brazilian
    
    
    
    
    
    Intersegment(Dollars in Thousands)
    
    States
    
    Kingdom)
    
    Group)*
    
    Group)*
    
    Other
    
    Elimination
    
    TotalNine Months Ended September 30, 2004Sales
    
    $
    207,165
    
    
    $
    66,480
    
    
    $
    42,479
    
    
    $
    28,162
    
    
    $
    72,612
    
    
    $
    (91,384
    )
    
    $
    325,514Net income
    
    
    24,757
    
    
    
    15,669
    
    
    
    1,553
    
    
    
    987
    
    
    
    7,871
    
    
    
    (244
    )
    
    
    50,593Nine Months Ended September 30, 2003Sales
    
    $
    177,958
    
    
    $
    48,201
    
    
    $
    38,348
    
    
    $
    22,696
    
    
    $
    63,870
    
    
    $
    (74,505
    )
    
    $
    276,568Net income
    
    
    27,854
    
    
    
    9,339
    
    
    
    1,310
    
    
    
    429
    
    
    
    7,372
    
    
    
    (11
    )
    
    
    46,293
 *DPC Biermann includes the Companys operations in Germany, the Czech Republic,
Slovenia, Croatia, and Poland. DPC Medlab includes the Companys operations in
Brazil, Uruguay, Venezuela, Honduras, Guatemala, Costa Rica, Panama, El
Salvador, and Bolivia. Germany and Brazil account for the most significant
portion of sales and net income for their respective groups. 7




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Note 7  Pro Forma Stock-Based Compensation The Company has stock option plans under which options have historically been
granted at exercise prices equal to the market price at the date of grant.
Options granted vest over periods of three to nine years and expire ten years
from the date of grant. Pursuant to Statement of Financial Accounting Standards (SFAS) No. 123,
Accounting for Stock-Based Compensation, the Company has elected to account
for its employee stock options under Accounting Principles Board (APB)
Opinion No. 25, Accounting for Stock Issued to Employees, which recognizes
expense based on the intrinsic value at the date of grant. As stock options
have been issued with exercise prices equal to the respective market prices at
grant date, no compensation expense has resulted. In December 2002, the
Financial Accounting Standards Board (FASB) issued SFAS No. 148, Accounting
for Stock-Based Compensation  Transition and Disclosure, an amendment of FASB
Statement No. 123, which provides alternative methods of transition for a
voluntary change to the fair value based method of accounting for stock-based
employee compensation. SFAS No. 148 also amends the disclosure requirements of
SFAS No. 123 to require prominent disclosures in both annual and interim
financial statements about the method of accounting for stock-based employee
compensation and the effect of the method used on reported results. The
Company elected to maintain the intrinsic method of accounting for stock
options under APB No. 25. Had compensation cost for all options granted been
determined based on the fair value at grant date consistent with SFAS No. 123,
the Companys net income and earnings per share would have been as follows: Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,(Amounts in Thousand, Except Per Share Data)
    
    2004
    
    2003
    
    2004
    
    2003Net Income:As Reported
    
    $
    16,517
    
    
    $
    16,965
    
    
    $
    50,593
    
    
    $
    46,293Pro Forma expense, net of tax
    
    
    (737
    )
    
    
    (745
    )
    
    
    (2,090
    )
    
    
    (2,221
    )Pro Forma
    
    $
    15,780
    
    
    $
    16,220
    
    
    $
    48,503
    
    
    $
    44,072Net Earnings Per ShareBasic:As Reported
    
    $
    0.57
    
    
    $
    0.59
    
    
    $
    1.74
    
    
    $
    1.61Pro Forma Adjustment
    
    
    (0.03
    )
    
    
    (0.03
    )
    
    
    (0.07
    )
    
    
    (0.08
    )Pro Forma
    
    $
    0.54
    
    
    $
    0.56
    
    
    $
    1.67
    
    
    $
    1.53Diluted:As Reported
    
    $
    0.55
    
    
    $
    0.57
    
    
    $
    1.69
    
    
    $
    1.56Pro Forma Adjustment
    
    
    (0.02
    )
    
    
    (0.03
    )
    
    
    (0.07
    )
    
    
    (0.07
    )Pro Forma
    
    $
    0.53
    
    
    $
    0.54
    
    
    $
    1.62
    
    
    $
    1.49
 Note 8  New Accounting Pronouncements In January 2003, the FASB issued FASB Interpretation No. (FIN) 46,
Consolidation of Variable Interest Entities (FIN 46). In December 2003,
FIN 46 was replaced by FASB interpretation No. 46R Consolidation of Variable
Interest Entities. FIN 46R clarifies the application of Accounting Research
Bulletin No. 51, Consolidated Financial Statements, to certain entities in
which equity investors do not have the characteristics of a controlling
financial interest or do not have sufficient equity at risk for the entity to
finance its activities without additional subordinate financial support from
other parties. FIN 46R requires an enterprise to consolidate a variable
interest entity if that enterprise will absorb a majority of the entitys
expected losses, is entitled to receive a majority of the entitys expected
residual returns, or both. FIN 46R was effective for special-purpose entities
being evaluated under FIN 46R for consolidation on December 31, 2003 and was
effective for all other entities being evaluated on March 31, 2004. The
adoption of FIN 46R did not have a material impact on the Companys financial
position or results of operations. 8




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##### Table of Contents



Note 9  Commitments and Contingent Liabilities In the fourth quarter of fiscal year 2002, the Company discovered internally
that certain senior managers and other employees of its Chinese subsidiary had
made certain improper payments that may have violated foreign and U.S. laws.
Beginning in the early 1990s, the Chinese subsidiary made cash payments and
provided in kind benefits to hospital and laboratory customers of the Chinese
subsidiary and to employees of such customers. Because certain of the customers
were state owned enterprises and the payments may have been for the purpose, or
may have had the effect, of causing those customers to purchase products from
the Chinese subsidiary, these payments and benefits may have violated the U.S.
Foreign Corrupt Practices Act as well as certain domestic Chinese laws. In
addition, the deduction of these payments and benefits by the subsidiary on its
tax returns may have been improper under the Chinese tax law, resulting in
underpayments of Chinese taxes. An independent investigation by the Companys audit committee concluded that no
current members of the Companys senior management knew of or were involved in
the provision of the payments and benefits. The Company has made changes in the
management of the Chinese subsidiary, including replacement of the senior
managers involved, and has implemented procedures and controls to address these
issues and to promote compliance with applicable laws. The Company voluntarily
disclosed these payment issues to the Securities and Exchange Commission (SEC)
and the Department of Justice (DOJ) in the first quarter of 2003 and has been
cooperating fully with these agencies in their investigations since that time.
As of September 30, 2004, the Company was engaged in active settlement
discussions with the SEC and the DOJ. The termination of the improper payments in China may have a significant
adverse effect on future operations in China because such termination could
negatively influence a significant number of the Chinese subsidiarys
customers decisions as to whether to continue to do business with that
subsidiary. For the year ended December 31, 2003, the Chinese subsidiary had
sales of $9.8 million. In the third quarter of 2004, and the nine months ended
September 30, 2004, the Companys Chinese subsidiary had sales of $2.5 million
and $6.8 million, respectively. In the fourth quarter of 2002, the Company
accrued $1.5 million for actual and estimated costs to resolve this matter. In
the third quarter of 2004 the Company accrued an additional $1.0 million based
on its revised estimates of costs that will be paid to the U.S. Government to
resolve the matter. As of September 30, 2004, $2.4 million remained in the
accrual. Although the actual costs to be paid to the U.S. Government, including
fines and penalties, to resolve this matter could significantly exceed the
amount accrued, the Company does not believe it would exceed $5.7 million. In
addition, the Company recorded a charge of $1.4 million to its 2002 fourth
quarter tax provision related to the possible non-deductibility of the payments
in China. During the third quarter of 2003, the Company recorded an additional
charge of $0.9 million to its income tax provision for this and other Chinese
tax-related matters. Legal expenses relating to this matter of approximately
$884,000, $822,000 and $1,547,000 have been incurred and charged to general and
administrative expense during the year ended December 31, 2003, the three
months and the nine months ended September 30, 2004, respectively. It is
anticipated that legal fees for issues related to China will decrease in the
remainder of 2004. In February 2004, the Company was informed by the U.S. Food and Drug
Administration (FDA) that, based on inspectional findings that included data
integrity and procedural issues related solely to the Companys application for
the IMMULITE Chagas test, the Company was subject to the FDAs Application
Integrity Policy (AIP). The FDA suspended its review of all applications
submitted by the Company and will not review any future applications until the
FDA determines that the Company has resolved these issues, although studies to
support future applications can be conducted while on AIP. The AIP may be
invoked when the FDA determines that there are serious questions as to the
reliability of data submitted by applicants. The AIP sets forth corrective
actions by which applicants may seek to restore the FDAs confidence in the
integrity of data in their applications and permit the agency to proceed with
review of such applications. With respect to DPC, the FDA stated that in connection with the Companys
Chagas test application, among other things, the Company had failed properly to
report and monitor clinical study data and that there were recordkeeping
deficiencies. To address the AIP issues, the Company is developing and
implementing a corrective action plan that will be audited by a third party and
reviewed by the FDA. The independent third party substantially completed its
audit of DPC in October of 2004 and will submit a written report to the FDA.
Based on the status of its corrective action plan and the status of completion
of the third party audit, the Company believes that its corrective action plan
to resolve the AIP issues should be completed and reviewed by the FDA by the
end of the first quarter of 2005. The FDAs application of the AIP to DPC does
not restrict DPC 9




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##### Table of Contents



from introducing new tests outside of the United States. However, the
Companys inability to introduce new tests in the United States during the
pendency of the AIP may have a negative impact on its future sales and profits. In July 2004, the Company was served with a subpoena requiring it to produce to
the Federal grand jury for the Central District of California, documents
relating to trading in the Companys securities and the exercise of options by
officers, directors and employees of the Company between December 30, 2003 and
April 1, 2004. The subpoena also seeks all documents relating to the FDAs
review of the Companys diagnostic test to detect Chagas and any audits or
reviews by the FDA between 2000 and the present relating to the Companys
products. Finally, the subpoena seeks the personnel file of a former Company
employee. The Company is cooperating with the United States Attorney and the
SEC regarding these matters. An independent committee of the Board of
Directors has conducted an investigation of the trading issues and has
presented its findings and conclusions to the United States Attorney and the
SEC. 10




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##### Table of Contents



ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Forward-Looking Statements Except for the historical information contained herein, this report and the
following discussion in particular contain forward-looking statements
(identified by the words estimate, project, anticipate, plan, expect,
intend, believe, hope, and similar expressions) which are based upon
managements current expectations and speak only as of the date made. These
forward-looking statements are subject to risks, uncertainties, and factors
that could cause actual results to differ materially from the results
anticipated in the forward-looking statements. These risks and uncertainties
include:  -
    
    the Companys ability to successfully market new and existing
products;-
    
    the Companys ability to keep abreast of technological innovations
and successfully incorporate them into new products;-
    
    the Companys dependence on the IMMULITE product line and a sole
supplier for key chemical components in the IMMULITE assays;-
    
    the Companys ability to address and resolve issues relating to the
FDAs Application Integrity Policy on a timely basis;-
    
    the Companys ability to have new tests reviewed and approved by
the FDA;-
    
    the risks inherent in the development and release of new products,
such as delays, unforeseen costs, technical difficulties, and
regulatory approvals;-
    
    competitive pressures, including technological advances and patents obtained by competitors;-
    
    environmental risks related to substances regulated by various federal, state, and international laws;-
    
    currency risks based on the relative strength or weakness of the U.S. dollar;-
    
    domestic and foreign governmental health care regulation and cost containment measures;-
    
    political and economic instability in certain foreign markets;-
    
    changes in accounting and auditing standards promulgated by the
Financial Accounting Standards Board, the Securities and Exchange
Commission, the Public Company Accounting Oversight Board, or the
American Institute of Certified Public Accountants; and-
    
    the effects and costs of governmental or other actions relating to
certain payments by the Companys Chinese subsidiary. Overview Diagnostic Products Corporation develops and manufactures automated diagnostic
test systems and related reagent test kits that are used by hospital,
reference, and physicians office laboratories throughout the world. The
Companys principal product line, IMMULITE, is a fully automated,
computer-driven modular system that uses specialized proprietary software to
provide rapid, accurate test results that reduce the customers labor and
reagent costs. The Companys immunoassay tests provide critical information
useful to physicians in the diagnosis, monitoring, management, and prevention
of various diseases. DPC manufactures immunodiagnostic test kits (also called reagents or
assays) using several different technologies and assay formats. The IMMULITE
instruments are closed systems, meaning that they will not perform other
manufacturers tests. Accordingly, a major factor in the successful marketing
of these systems is the ability to offer a broad menu of assays (tests that can
be used on the instrument). In addition to about 100 IMMULITE assays, the
Company sells a broad range of tests based on other technologies that can be
performed manually using the customers own laboratory equipment, such as
radioimmunoassay (RIA) and enzyme immunoassay (EIA) tests. In addition to breadth of menu, major competitive factors for the IMMULITE
instruments include time-to-first result (how quickly the instrument performs
the test), ease of use, and overall cost effectiveness. Because of these
competitive factors and the rapid technological developments that characterize
the industry, the Company devotes approximately 10% of its annual revenues to
research and development activities, all of which are expensed as incurred. The Companys products are sold throughout the world directly through
affiliated and independent distributors. Historically, foreign sales
(including U.S. export sales, sales to non-consolidated subsidiaries and
independent 11




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##### Table of Contents



distributors, and sales of consolidated subsidiaries) have accounted for more
than 70% of revenues; although, since 1998, domestic sales growth has outpaced
foreign sales growth. The Company derives revenues from two principal sources: reagent (test kit)
sales and IMMULITE instrument placements. The Company recognizes sales of test
kits upon shipment and transfer of title to the customer. IMMULITE instruments are placed with customers under many different types of
arrangements that generally fall into the following categories: sale, lease,
reagent rental, and soft placement. The Company sells instruments directly to
end-users, to third party leasing companies that lease the instruments to
end-users, and to independent distributors that then resell the instruments to
their customers. Instrument sales, which represent the smallest component of
placements, are recognized upon shipment and transfer of title. The Company
also sells instruments under sales-type leases, which are recorded as revenue
upon shipment in an amount equal to the present value of the future minimum
lease payments to be received over the lease term. Many instruments are placed other than by outright sale or capital lease. The
Company enters into various types of operating lease arrangements with
customers that generally provide for terms of three to five years and periodic
rental payments. Revenue on these types of leases is recognized on a pro rata
basis over the term of the lease. When an instrument is placed on a reagent
rental basis, the customer agrees to pay a mark-up on reagents, but is not
charged for the instrument. The Company also places instruments at no charge
to the customer (soft placement) subject to the customers agreement to
purchase a minimum amount of reagents. In reagent rentals and soft placements,
the only revenue recognized is based on reagent shipments. Under operating
lease, rental, and soft placements, DPC continues to own the instrument that is
placed with the customer and the instruments come back to the Company at the
end of the rental or lease period. These instruments are generally amortized
on a straight-line basis over five years and maintenance costs are expensed as
incurred. The Company also enters into service contracts with customers and
recognizes service revenue over the related contract life (related costs are
expensed as incurred). Two important indicators used by management to evaluate financial performance
are instrument shipments and reagent utilization. The number of IMMULITE
instruments that the Company reports being shipped in any period is net of
instruments which come back to the Company due to the end of a lease or rental
period, or in connection with a trade-in on the purchase of a new model. The
Company refurbishes and seeks to place these returned instruments at reduced
prices. Because of the different methods in which instruments are placed,
total instrument sales vary from period to period based on the relative mix of
placement methods, and such sales do not necessarily have a direct correlation
to the number of instruments shipped during the period. An important measure of the penetration of IMMULITE reagent sales is the
average amount of reagent sales per instrument shipped. It takes a number of
weeks or months after an instrument is shipped for it to become fully
functional with regard to reagent utilization because of the time it takes for
the customer to become familiar with the operation of the instrument and all of
the tests that a customer can run on the instrument. The Company calculates
average reagent utilization for a fiscal period by dividing IMMULITE reagent
sales for the period by the total number of instruments shipped as of the end
of the previous fiscal period. 12




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##### Table of Contents



Results of Operations SUMMARY FINANCIAL DATA (Dollars in Thousands, Except Per Share Data) Three Months Ended
    
    Nine Months Ended2004
    
    % change
    
    2003
    
    2004
    
    % change
    
    2003Sales
    
    $
    108,963
    
    
    
    16.2
    %
    
    $
    93,737
    
    
    $
    325,514
    
    
    
    17.7
    %
    
    $
    276,568Gross Profit
    
    
    62,531
    
    
    
    
    
    
    
    52,402
    
    
    
    188,244
    
    
    
    
    
    
    
    158,713% of sales
    
    
    57.4
    %
    
    
    
    
    
    
    55.9
    %
    
    
    57.8
    %
    
    
    
    
    
    
    57.4
    %Operating Expenses:Selling
    
    
    19,126
    
    
    
    
    
    
    
    15,649
    
    
    
    57,235
    
    
    
    
    
    
    
    46,704Research and Development
    
    
    11,188
    
    
    
    
    
    
    
    10,037
    
    
    
    33,637
    
    
    
    
    
    
    
    30,087General and Administrative
    
    
    11,752
    
    
    
    
    
    
    
    8,401
    
    
    
    32,475
    
    
    
    
    
    
    
    25,309Gain on Sale of Product Line
    
    
    
    
    
    
    
    
    
    
    (4,218
    )
    
    
    
    
    
    
    
    
    
    
    (4,218
    )Equity in Income of Affiliates
    
    
    (1,705
    )
    
    
    
    
    
    
    (1,280
    )
    
    
    (6,535
    )
    
    
    
    
    
    
    (4,201
    )Total Operating Expenses
    
    
    40,361
    
    
    
    41.2
    %
    
    
    28,589
    
    
    
    116,812
    
    
    
    24.7
    %
    
    
    93,681% of sales
    
    
    37.0
    %
    
    
    
    
    
    
    30.5
    %
    
    
    35.9
    %
    
    
    
    
    
    
    33.9
    %Operating Income
    
    
    22,170
    
    
    
    -6.9
    %
    
    
    23,813
    
    
    
    71,432
    
    
    
    9.8
    %
    
    
    65,032% of sales
    
    
    20.3
    %
    
    
    
    
    
    
    25.4
    %
    
    
    21.9
    %
    
    
    
    
    
    
    23.5
    %Interest/Other Income-net
    
    
    1,334
    
    
    
    
    
    
    
    283
    
    
    
    781
    
    
    
    
    
    
    
    436Income Before Income Taxes and
Minority Interest
    
    
    23,504
    
    
    
    
    
    
    
    24,096
    
    
    
    72,213
    
    
    
    
    
    
    
    65,468Provision for Income Taxes
    
    
    6,573
    
    
    
    
    
    
    
    6,988
    
    
    
    21,186
    
    
    
    
    
    
    
    18,986Income Tax Rate
    
    
    28.0
    %
    
    
    
    
    
    
    29.0
    %
    
    
    29.3
    %
    
    
    
    
    
    
    29.0
    %Minority Interest
    
    
    414
    
    
    
    
    
    
    
    143
    
    
    
    434
    
    
    
    
    
    
    
    189Net Income
    
    $
    16,517
    
    
    
    -2.6
    %
    
    $
    16,965
    
    
    $
    50,593
    
    
    
    9.3
    %
    
    $
    46,293Earnings per share:Basic
    
    $
    0.57
    
    
    
    
    
    
    $
    0.59
    
    
    $
    1.74
    
    
    
    
    
    
    $
    1.61Diluted
    
    $
    0.55
    
    
    
    
    
    
    $
    0.57
    
    
    $
    1.69
    
    
    
    
    
    
    $
    1.56
 Sales The 16% sales increase in the third quarter of 2004 reflected continued demand
for the IMMULITE product line. Sales of all IMMULITE products, instruments,
service, and reagents in the third quarter of 2004 were $99.7 million, a 20%
increase over the third quarter of 2003. In the third quarter of 2004,
IMMULITE products represented 92% of sales versus 88% in 2003. In the first
nine months of 2004, sales of IMMULITE products increased 22% to $296.8 million
from $243.7 million in the first nine months of 2003. In the first nine months
of 2004, IMMULITE products represented 91% of sales versus 88% in 2003.
Various categories of IMMULITE product line sales in the three months and nine
months ended September 30, 2004 and 2003 are shown in the following chart: 13




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##### Table of Contents



IMMULITE Product Line Sales (Dollars in Thousands) Three Months Ended September 30,
    
    Nine Months Ended September 30,2004 Sales
    
    % change from 2003
    
    2003 Sales
    
    2004 Sales
    
    % change from 2003
    
    2003 SalesIMMULITE 2000/2500Reagents
    
    $
    58,351
    
    
    
    29.0
    %
    
    $
    45,250
    
    
    $
    173,055
    
    
    
    30.4
    %
    
    $
    132,677Instruments and Service
    
    
    9,016
    
    
    
    38.2
    %
    
    
    6,523
    
    
    
    27,874
    
    
    
    41.7
    %
    
    
    19,669Total
    
    $
    67,367
    
    
    
    30.1
    %
    
    $
    51,773
    
    
    $
    200,929
    
    
    
    31.9
    %
    
    $
    152,346IMMULITE (including IMMULITE 1000)Reagents
    
    $
    27,667
    
    
    
    7.1
    %
    
    $
    25,835
    
    
    $
    82,156
    
    
    
    5.7
    %
    
    $
    77,721Instruments and Service
    
    
    4,681
    
    
    
    -11.1
    %
    
    
    5,267
    
    
    
    13,710
    
    
    
    0.5
    %
    
    
    13,636Total
    
    $
    32,348
    
    
    
    4.0
    %
    
    $
    31,102
    
    
    $
    95,866
    
    
    
    4.9
    %
    
    $
    91,357IMMULITE Product Line Sales
    
    $
    99,715
    
    
    
    20.3
    %
    
    $
    82,875
    
    
    $
    296,795
    
    
    
    21.8
    %
    
    $
    243,703
 The Company shipped a total of 271 IMMULITE systems during the third quarter of
2004, including 199 IMMULITE 2000 and 2500 systems and 72 IMMULITE 1000
systems. The current quarters instrument shipments reflected a full quarter of
IMMULITE 2500 shipments. The total base of IMMULITE systems shipped grew to
9,759, including 3,486 IMMULITE 2000 and 2500 systems. In the third quarter of
2003, the Company shipped a total of 198 IMMULITE systems, including 113
IMMULITE 2000 systems. The reduction in the number of IMMULITE 1000s shipped in the third quarter is
a result of the time that the IMMULITE 1000 and its predecessor system, the
IMMULITE, have been available in the market, which is over ten years. The
Company also ships refurbished IMMULITE systems that come back, for example, at
the end of a rental period. These refurbished systems are included in sales
but not in the Companys count of units shipped. The number of new IMMULITE
systems shipped may continue to decline as more refurbished IMMULITE
instruments become available at a lower price than new IMMULITE instruments. In the fourth quarter of 2003, the Company reduced the price of the IMMULITE
2000 in anticipation of the release of the IMMULITE 2500, which occurred in
June of 2004. The IMMULITE 2000/2500 has a longer sales process than the
IMMULITE 1000 due to its higher sales price, and the IMMULITE 2000/2500
experiences a longer time delay between instrument placement and the ramp-up of
reagent sales. The 2500 is targeted primarily at the hospital market because it
is able to more rapidly report certain test results, such as tests used in
emergency rooms to aid in the diagnosis of certain cardiac conditions. For this
reason, although the 2500 has a higher price than the 2000, the 2500 may erode
sales of the 2000. However the two instruments are otherwise very similar and
the Company will continue to market the 2000 to a significant group of
customers for which the faster test results are not critical, such as large
reference laboratories. The Company has 71 tests that have been approved by the
FDA for use on the IMMULITE 2500, compared to 76 on the IMMULITE 2000. The
Companys ability to add FDA approved tests to the IMMULITE 2500 menu will
depend on the resolution of the FDA inquiry discussed below. The Company is,
however, able to market new tests abroad without FDA approval and expects to
introduce new tests for the IMMULITE 2500, such as Pro-BNP and an ANA screen,
in foreign markets in the first half of 2005. The increase in IMMULITE and IMMULITE 2000/2500 instrument and service revenue
in the third quarter of 2004 is due to both an increase in revenue from
instruments that were sold and an increase from revenue relating to service and
parts. Included in IMMULITE 2000/2500 equipment sales is revenue relating to
the Companys sample management system (SMS), a sample-handling device that can
be attached to the IMMULITE 2000/2500. In the first nine months of 2004, the
increase in IMMULITE 2000/2500 instruments and service included a significant
increase in instrument revenue as a result of an increase in the number of
instruments that were in operation. For the third quarter of 2004, IMMULITE 2000/2500 reagent utilization per
instrument was $17,752 and IMMULITE reagent utilization per instrument was
$4,462 as compared to the third quarter of 2003, when they were $17,043 and
$4,368, respectively. The increase in average utilization per instrument is in
part related to the strength of the euro relative to the dollar. However,
reagent utilization on the IMMULITE is expected to fall 14




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over time as high volume IMMULITE installations are replaced with IMMULITE
2000s and incremental IMMULITE placements go into lower volume environments. Sales of the Companys mature RIA product line declined approximately 12% in
the third quarter of 2004, representing 5% of sales, compared to 7% of sales in
the third quarter of 2003. This trend is expected to continue as customers
move to more automated methods of testing that do not require radioactive
reagents. Sales of other DPC products declined to $1.4 million in the third
quarter of 2004 from $2.6 million in the third quarter of 2003. The primary
reason for this was a decline in sales of the Companys micro-plate allergy
product line. The Company ceased manufacturing this product line at the end of
2003 because of the availability of allergy testing on the IMMULITE 2000.
These sales will continue to decline as inventories are depleted. Sales of
non-DPC products, primarily through its consolidated international affiliates,
increased 23% in the third quarter of 2004 to $2.1 million from $1.7 million in
the third quarter of 2003. In the third quarter of 2004, sales to domestic customers grew by 17%, and
increased to 30% from 29% of total sales in the third quarter of 2003. The
increase in domestic sales was due to increased penetration into most customer
segments. Foreign sales (including U.S. export sales, sales to
non-consolidated foreign subsidiaries, and sales of consolidated foreign
subsidiaries) as a percentage of total sales were approximately 70% in the
third quarter of 2004 and 71% in 2003. Europe, the Companys principal foreign
market, represented 43% of sales in the third quarter of 2004 and 2003. Sales
of the Companys German Group, which includes certain Eastern European
countries, accounted for approximately 12.5% of sales in the third quarter of
2004 and increased 7.4% over the third quarter of 2003 primarily as a result of
the strength of the euro. Sales in the Brazil region, which includes certain
other Central and South American countries, accounted for approximately 10% of
total sales in the third quarter of 2004, an increase of 22% over the third
quarter of 2003. Although the Brazilian real remained stable relative to the
U.S. dollar, in the past few years, the real has been very volatile relative to
the dollar. In the first nine months of 2004, sales to domestic customers grew by 18% and
remained at 29% of sales. Europe represented 46% of sales in the first nine
months of 2004 and 2003. Sales in the Companys German Group increased 11%
primarily as a result of the strength of the euro, and accounted for 13% of
total sales in the first nine months of 2004. Sales in the Brazil region
accounted for approximately 9% of sales, which sales increased 24% relative to 2003. Due to the significance of foreign sales, the Company is subject to currency
risks based on the relative strength or weakness of the U.S. dollar. In
periods when the U.S. dollar is strengthening, the effect of translation of
financial statements of consolidated affiliates is that of lower sales and net
income. In periods where the dollar is weakening, the impact is the reverse.
Based on comparative exchange rates in the third quarter of 2004 and 2003, the
dollar weakened relative to the euro and remained fairly stable relative to the
Brazilian real. In the first nine months of 2004, the dollar weakened relative
to both the euro and the real. The effect of the changes in exchange rates on
sales was a positive 4% in the third quarter and 6% in the first nine months of
2004. Due to intense competition, the Companys foreign distributors are
generally unable to increase prices to offset the negative effect when the U.S.
dollar is strong. In the fourth quarter of fiscal year 2002, the Company discovered internally
that certain senior managers and other employees of its Chinese subsidiary had
made certain improper payments that may have violated foreign and U.S. laws.
Beginning in the early 1990s, the Chinese subsidiary made cash payments and
provided in kind benefits to hospital and laboratory customers of the Chinese
subsidiary and to employees of such customers. Because certain of the customers
were state owned enterprises and the payments may have been for the purpose, or
may have had the effect, of causing those customers to purchase products from
the Chinese subsidiary, these payments and benefits may have violated the U.S.
Foreign Corrupt Practices Act as well as certain domestic Chinese laws. In
addition, the deduction of these payments and benefits by the subsidiary on its
tax returns may have been improper under the Chinese tax law, resulting in
underpayments of Chinese taxes. An independent investigation by the Companys audit committee concluded that no
current members of the Companys senior management knew of or were involved in
the provision of the payments and benefits. The Company has made changes in the
management of the Chinese subsidiary, including replacement of the senior
managers involved, and has implemented procedures and controls to address these
issues and to promote compliance with applicable laws. The Company voluntarily
disclosed these payment issues to the Securities and Exchange Commission (SEC)
and the Department of Justice (DOJ) in the first quarter of 2003 and has been 15




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cooperating fully with these agencies in their investigations since that time.
As of September 30, 2004, the Company was engaged in active settlement
discussions with the SEC and the DOJ. The termination of the improper payments in China may have a significant
adverse effect on future operations in China because such termination could
negatively influence a significant number of the Chinese subsidiarys
customers decisions as to whether to continue to do business with that
subsidiary. For the year ended December 31, 2003, the Chinese subsidiary had
sales of $9.8 million. In the third quarter of 2004 and the nine months ended
September 30, 2004, the Companys Chinese subsidiary had sales of $2.5 million
and $6.8 million, respectively. In the fourth quarter of 2002, the Company
accrued $1.5 million for actual and estimated costs to resolve this matter. In
the third quarter of 2004, the Company accrued an additional $1.0 million based
on its revised estimates of costs that will be paid to the U.S. Government to
resolve the matter. As of September 30, 2004, $2.4 million remained in the
accrual. Although the actual costs to be paid to the U.S. Government, including
fines and penalties, to resolve this matter could significantly exceed the
amount accrued, the Company does not believe it would exceed $5.7 million. In
addition, the Company recorded a charge of $1.4 million to its 2002 fourth
quarter tax provision related to the possible non-deductibility of the payments
in China. During the third quarter of 2003, the Company recorded an additional
charge of $0.9 million to its income tax provision for this and other Chinese
tax-related matters. Legal expenses relating to this matter of approximately
$884,000, $822,000 and $1,547,000 have been incurred and charged to general and
administrative expense during the year ended December 31, 2003, the three
months and the nine months ended September 30, 2004, respectively. It is
anticipated that legal fees for issues related to China will decrease in the
remainder of 2004. In February 2004, the Company was informed by the U.S. Food and Drug
Administration (FDA) that, based on inspectional findings that included data
integrity and procedural issues related solely to the Companys application for
the IMMULITE Chagas test, the Company was subject to the FDAs Application
Integrity Policy (AIP). The FDA suspended its review of all applications
submitted by the Company and will not review any future applications until the
FDA determines that the Company has resolved these issues, although studies to
support future applications can be conducted while on AIP. The AIP may be
invoked when the FDA determines that there are serious questions as to the
reliability of data submitted by applicants. The AIP sets forth corrective
actions by which applicants may seek to restore the FDAs confidence in the
integrity of data in their applications and permit the agency to proceed with
review of such applications. With respect to DPC, the FDA stated that in connection with the Companys
Chagas test application, among other things, the Company had failed properly
to report and monitor clinical study data and that there were record keeping
deficiencies. To address the AIP issues, the Company is developing and
implementing a corrective action plan that will be audited by a third party and
reviewed by the FDA. The independent third party substantially completed its
audit of DPC in October of 2004 and will submit a written report to the FDA.
Based on the status of its corrective action plan and the status of completion
of the third party audit, the Company believes that its corrective action plan
to resolve the AIP issues should be completed and reviewed by the FDA by the
end of the first quarter of 2005. The FDAs application of the AIP to DPC does
not restrict DPC from introducing new tests outside of the United States.
However, the Companys inability to introduce new tests in the United States
during the pendency of the AIP may have a negative impact on its future sales
and profits. In late July 2004, the Company was served with a subpoena requiring it to
produce to the Federal grand jury for the Central District of California,
documents relating to trading in the Companys securities and the exercise of
options by officers, directors and employees of the Company between December
30, 2003 and April 1, 2004. The subpoena also seeks all documents relating to
the FDAs review of the Companys diagnostic test to detect Chagas and any
audits or reviews by the FDA between 2000 and the present relating to the
Companys products. Finally, the subpoena seeks the personnel file of a former
Company employee. The Company is cooperating with the United States Attorney
and the SEC regarding these matters. An independent committee of the Board of
Directors has conducted an investigation of the trading issues and has
presented its findings and conclusions to the United States Attorney and the
SEC. Cost of Sales Gross margin increased to 57.4% in the third quarter of 2004 from 55.9% in the
third quarter of 2003. This increase was due in part to a shift in the mix of
revenues toward reagents, particularly IMMULITE 2000 16




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reagents, an increase in domestic end user sales and the strength of the euro
relative to the dollar. Gross margin for the first nine months of 2004 was
57.8% compared to 57.4% in the same period of 2003. All products manufactured
in the United States are dollar-based. However, a large percentage of these
products are sold to Company-owned international distributors, which sell the
products in their local currencies. In periods of a weakening dollar, sales as
measured in dollars increase, resulting in higher gross margins. A
strengthening dollar generally results in lower gross margins at international
distributors. Operating Expenses and Other Selling expense in the third quarter of 2004 increased to 17.6% of sales from
16.7% in the third quarter of 2003 in part due to an increase in expenses
related to the increase in sales, such as sales compensation, and the increase
in the value of the euro relative to the dollar. General and administrative
expense increased to 10.8% of sales in the third quarter of 2004 from 9.0% in
the third quarter of 2003. Included in general and administrative expense for
the third quarter of 2004 is $822,000 in legal fees related to the Companys
internal investigation of its Chinese subsidiary and an additional $1.0 million
accrual related to revised estimates of the cost to resolve this issue. As of
September 30, 2004, $2.4 million remained in the accrual, although the actual
costs, including fines and penalties, to resolve this matter could
significantly exceed the amount reserved. The review of this matter is
ongoing, but the related legal expenses are expected to decrease in the
remainder of 2004. See Note 9 of Notes to the Consolidated Financial
Statements. General and administrative expense in the fourth quarter of 2004
will be negatively impacted by legal costs incurred to respond to the subpoena
referred to above, legal and other costs related to the SEC and FDA matters,
and expenses relating to the independent auditors review of the Companys
internal controls in connection with their year-end attestation. In the third quarter of 2003, the Company recognized a $4.2 million dollar gain
on the sale of its PathoDx product line which reduced total operating expenses
in 2003 compared to 2004. Equity in income of affiliates represents the
Companys share of earnings in non-consolidated affiliates, principally the
45%-owned Italian distributor. The amount increased to $1.7 million in the
third quarter 2004 from $1.3 million in 2003. In the nine months ended September 30, 2004, operating expenses increased in
absolute-terms in part due to the increase in sales and the increase in the
value of the euro relative to the dollar. Operating expenses for the nine
months ended September 30, 2004 increased as a percentage of sales to 35.9%
from 33.9% in 2003. The 2003 gain associated with the sale of the PathoDx
product line contributed to 1.5% of the increase and the remainder related to
the items discussed above including $1.5 million in legal and accounting fees
related the Companys investigation of its Chinese subsidiary as compared to
$775,000 in the first nine months of 2003. Interest/other (expense) income-net includes interest income, interest expense,
and foreign exchange transaction losses and gains. The net amount of income
was $1.3 million in the third quarter of 2004 versus $283,000 in 2003. This
difference was driven in part by a $756,000 increase in foreign currency
transaction gains over the third quarter of 2003 to $757,000 and an increase in
net interest and other income of $295,000 over the third quarter of 2003 to
$577,000 which was in part due to the capitalization of interest related to the
Companys construction projects and a reduction of other expenses in Brazil.
For the first nine months of 2004 interest/other income was $781,000 versus
$436,000 in 2003. Income Taxes and Minority Interest The Companys effective tax rate includes federal, state, and foreign taxes.
The Companys tax rate decreased to 28.0% in the third quarter of 2004 from
29.0% in the third quarter of 2003 and is expected to be similar in the fourth
quarter. The decrease in the third quarter was related to the Companys foreign
sales being greater than it had previously anticipated. The tax rate for the
first nine months of 2004 was 29.3% versus 29.0% in the first nine months of
2003. Minority interest represents the 44% interest in
the Companys Brazilian distributor held by a third party. Increases or decreases in
this amount reflect increases or decreases in the profitability of the Brazilian distributor. Contractual Obligations and Commitments The Companys contractual obligations and commitments have not changed
significantly from those discussed in Item 7 of the Companys Annual Report on
Form 10-K for the year ended December 31, 2003. 17




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Critical Accounting Policies The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the 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. These estimates and assumptions
include, but are not limited to, allowance for bad debts, allowance for slow
moving and obsolete inventories, useful lives selected for depreciating
property, plant, and equipment, valuation allowances for deferred income taxes,
estimates used in the recoverability of long-lived assets, and contingency
reserves established with respect to the Companys Chinese subsidiary.
Management bases its estimates and assumptions on historical experience and on
various other factors that it believes to be reasonable under the
circumstances, the results of which form the basis for making judgments about
the carrying values of assets and liabilities. Management does not believe that any of its estimates involve assumptions about
matters that are highly uncertain or that different reasonable estimates, or
changes in accounting estimates that are reasonably likely to occur, would have
a material impact on the financial statements. However, although management
believes its estimate regarding payments to resolve the issues related to the
Companys Chinese subsidiary is reasonable, it is in ongoing negotiations and
the actual costs could significantly exceed the estimate as discussed above. To
the extent there are material differences between managements estimates and
actual results, future results of operations will be affected. However,
managements experience has generally been that the differences between
estimates and actual results have usually been immaterial, and appropriate
adjustments to the consolidated financial statements are made as soon as the
differences become known. Liquidity and Capital Resources The Company has adequate working capital and sources of capital to carry on its
current business and to meet its existing capital requirements. At September
30, 2004 and December 31, 2003, the Company had cash and cash equivalents of
$71.0 million and $69.8 million, respectively. Net cash flow from operating
activities was $50.6 million in the first nine months of 2004 and $41.5 million
in the first nine months of 2003. The increase was primarily a result of an
increase in net income, depreciation and amortization, accounts payable,
accrued liabilities and income taxes payable net of increases in accounts
receivable, and inventories. If the Company continues to grow at the current
rate, it is expected that accounts receivable and inventories will continue to
grow. Additions to property, plant, and equipment in the first nine months of
2004 were $43.2 million, compared to $32.7 million in the first nine months of
2003. In 2003, the increases in plant, property, and equipment primarily
related to the purchase of a new corporate headquarters building. In 2004, the
increase in plant, property, and equipment was in great part related to the
cost of fitting out the Companys new corporate headquarters building and the
construction of a new building in Wales. The Companys new headquarters was
occupied in the third quarter of 2004. The Companys new 30,000 square foot
building in Wales was for the most part completed in the second quarter of 2004
at a total cost of approximately $9 million and will be occupied in the fourth
quarter of 2004. The Company has begun the expansion of its New Jersey
manufacturing facility by 70,000 square feet to 160,000 square feet. This
project will be completed next year at an estimated cost of $9 million. The
Company is also converting its computer system in New Jersey at an estimated
cost of $900,000. The Company decreased borrowings by $5.4 million in the first
nine months of 2004 and by $0.7 million in the first nine months of 2003. The
Companys foreign operations are subject to risks, such as currency
devaluations, associated with political and economic instability. See
discussion above under Results of Operations. The Company placed $22.6
million in instruments in the first nine months of 2004, including operating
and sales-type leases, as compared to $17.6 million in the first nine months of
2003. The Company has a $20 million domestic unsecured line of credit with Wells
Fargo Bank under which there were no borrowings outstanding at September 30,
2004 or December 31, 2003. The Company had other notes payable (consisting of
bank borrowings by the Companys foreign consolidated subsidiaries payable in
their local currency, some of which are guaranteed by the Company) of $14.7
million at September 30, 2004 compared to $19.4 million at December 31, 2003.
The Company received $4.1 million from the exercise of stock options in the
first nine months of 2004 versus $2.7 million in the first nine months of 2003.
The Company has paid a quarterly cash dividend of $.06 per share, on a
split-adjusted basis, since 1995. In the fourth quarter of 2004, the Company
will increase its cash dividend to $.07 per share. 18




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New Accounting Pronouncements In January 2003, the FASB issued FASB Interpretation No. (FIN) 46,
Consolidation of Variable Interest Entities (FIN 46). In December 2003,
FIN 46 was replaced by FIN 46R Consolidation of Variable Interest Entities.
FIN 46R clarifies the application of Accounting Research Bulletin No. 51,
Consolidated Financial Statements, to certain entities in which equity
investors do not have the characteristics of a controlling financial interest
or do not have sufficient equity at risk for the entity to finance its
activities without additional subordinate financial support from other parties.
FIN 46R requires an enterprise to consolidate a variable interest entity if
that enterprise will absorb a majority of the entitys expected losses, is
entitled to receive a majority of the entitys expected residual returns, or
both. FIN 46R was effective for special-purpose entities being evaluated under
FIN 46R for consolidation on December 31, 2003 and was effective for all other
entities being evaluated on March 31, 2004. The adoption of FIN 46R did not
have a material impact on the Companys financial position or results of
operations. 
 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK There has been no material change during the quarter ended September 30, 2004
from the disclosures about market risk provided in the Companys Annual Report
on Form 10-K for the year ended December 31, 2003. 
 ITEM 4. CONTROLS AND PROCEDURES Based on their evaluation of the Companys disclosure controls and procedures
as of September 30, 2004, the Chief Executive Officer and Chief Financial
Officer of the Company have concluded that such disclosure controls and
procedures were adequate and effective and designed to ensure that material
information relating to the Company and its consolidated subsidiaries would be
made known to them by others within those entities. There has been no change
in the Companys internal control over financial reporting identified in
connection with such evaluation that occurred during the Companys last fiscal
quarter that has materially affected or is reasonably likely to materially
affect the Companys internal control over financial reporting. The Company is in the process of documenting and testing its internal control
procedures in order to satisfy the requirements of Section 404 of the
Sarbanes-Oxley Act, which requires annual management assessments of the
effectiveness of its internal controls over financial reporting and a report by
its independent auditors addressing these assessments. During the course of its
testing the Company may identify deficiencies which it may not be able to
remediate in time to meet the deadline imposed by Section 404 of the
Sarbanes-Oxley Act. In addition, if the Company fails to maintain the adequacy
of its internal controls, as such standards are modified, supplemented or
amended from time to time, it may not be able to ensure that it can conclude on
an ongoing basis that it has effective internal controls over financial
reporting in accordance with Section 404 of the Sarbanes-Oxley Act. Failure to
meet the annual assessment deadlines or to achieve and maintain an effective
internal control environment could have a material adverse effect on its stock
price. 19




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PART II. OTHER INFORMATION 
 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K. (a) Exhibits 10.4
    
    Form of Non-Qualified and Incentive Stock Option Agreement10.5
    
    First Amendment to Settlement Agreement effective as of October
1, 2003 (rights regarding IMMULITE chemical compounds) Note: Portions
of this exhibit have been omitted pursuant to a request for
confidential treatment.31.1
    
    Certificate of Chief Executive Officer31.2
    
    Certificate of Chief Financial Officer32.1
    
    Section 906 Officers Certification
 (b) Reports on Form 8-K.   None 
 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized. DIAGNOSTIC PRODUCTS CORPORATION(Registrant)/s/ Michael Ziering
    
    President and
Chief Executive Officer and Chairman of the Board
(Principal Executive Officer)
Director
    
    November 8, 2004Michael Ziering/s/ James L. Brill

James L. Brill
    
    Vice President-Finance
(Principal Financial and
Accounting Officer)
    
    November 8, 2004
   
 EXHIBIT INDEX 10.4
    
    Form of Non-Qualified and Incentive Stock Option Agreement10.5
    
    First Amendment to Settlement Agreement
effective as of October 1, 2003 (rights regarding IMMULITE
chemical compounds) Note: Portions of this exhibit have
been omitted pursuant to a request for confidential
treatment.31.1
    
    Certificate of Chief Executive Officer31.2
    
    Certificate of Chief Financial Officer32.1
    
    Section 906 Officers Certification
 20