Item 1.
Business
All statements in this report that are not historical are forward-looking statements within the meaning of Section 21E of the Securities Exchange Act. These forward-looking statements can generally be identified as such because the context of the statement will include words such as “may,” “will,” “intend,” “plans,” “believes,” “anticipates,” “expects,” “estimates,” “predicts,” “potential,” “continue,” “opportunity,” “goals,” or “should,” the negative of these words or words of similar import. Similarly, statements that describe our future plans, strategies, intentions, expectations, objectives, goals, or prospects are also forward-looking statements. These forward-looking statements are or will be, as applicable, based largely on our expectations and projections about future events and future trends affecting our business, and so are or will be, as applicable, subject to risks and uncertainties including but not limited to the risk factors discussed in this report, that could cause actual results to differ materially from those anticipated in the forward-looking statements. We caution investors that there can be no assurance that actual results or business conditions will not differ materially from those projected or suggested in such forward-looking statements. Our views and the events, conditions and circumstances on which these future forward-looking statements are based, may change. All forward-looking statements are qualified in their entirety by this cautionary statement and we undertake no obligation to revise or update any such statements to reflect events or circumstances after the date hereof.
SEQUENOM®, Sequenom Center for Molecular Medicine®, MaterniT21®, MaterniT21® PLUS and SensiGene® are registered trademarks and RetnaGene™, VisibiliT™, Heredi-T™ and Nextview™ are trademarks of Sequenom, Inc. This report may also refer to trade names and trademarks of other organizations.
Sequenom, Inc. was incorporated in 1994 under the laws of the State of Delaware. As used in this report, the words “we,” “us,” “our,” the “Company,” and “Sequenom” refer to Sequenom, Inc. and its wholly-owned subsidiaries on a consolidated basis, unless explicitly noted otherwise.
Overview
We are a life sciences company committed to enabling healthier lives through the development of innovative products and services. We serve patients and physicians by providing early patient management information. We offer our services in the U.S. and globally through licensing and commercial partnerships with international emphasis in countries in the European and Asia-Pacific regions.
We conduct our business primarily as a CAP (College of American Pathologists) accredited and CLIA (Clinical Laboratory Improvements Amendment of 1988, as amended) certified molecular diagnostics clinical laboratory located in San Diego, California, Raleigh-Durham, North Carolina and Grand Rapids, Michigan. Patient clinical samples are received by one of our laboratory locations where molecular diagnostic tests are performed and reports are relayed to prescribing physicians. Our testing focus is principally in prenatal health that includes molecular based laboratory developed tests, referred to as LDTs or tests, branded under the names MaterniT21 PLUS, HerediT, Nextview, SensiGene, and VisibiliT.
Strategic Direction
Our mission is to enable healthier lives as the premier provider of innovative genetic information with an exceptional customer experience. Our strategy is focused on expanding our menu of molecular diagnostic testing services for women’s healthcare, with an emphasis on noninvasive prenatal testing, or NIPT, for specific fetal chromosomal abnormalities, and utilizing our expertise in next generation sequencing and circulating cell-free DNA to develop LDT's for use in oncology.
Sequenom was the first to clinically validate NIPT in the U.S. and MaterniT21 PLUS was the first NIPT offered to physicians in the U.S. clinical market. We continue to be a leader in the NIPT market with the expansion of the MaterniT21 PLUS test to include 17 medically relevant conditions, including nine types of whole chromosome fetal aneuploidies and seven fetal microdeletions.
In parallel, we continue to expand and defend our broad NIPT patent portfolio. In October 2014, we purchased from Isis Innovation Ltd., or Isis, the technology transfer company of the University of Oxford, its intellectual property portfolio of globally issued patents for NIPT in the United States, Europe, Japan, Hong Kong, Canada and Australia. In December 2014, we entered into a settlement and patent pool agreement with Illumina, Inc., or Illumina. Pursuant to the patent pool agreement, a patent pool was established which is global in nature and combines the NIPT patents controlled by Illumina and us, including over 425 patents and patent applications. As part of the settlement, we now share in test fees paid by licensees from around the world to the patent pool. At the date of the agreement, there were 21 licensees to the patent pool, including Illumina’s affiliate, Verinata Health, Inc. or Verinata, and Sequenom Laboratories. We expect that the number of licensees using the patent pool will grow as the demand for NIPT increases. Additional information on the settlement agreement and the patent pool agreement can be found later in this Item 1 of this Annual Report under the heading “The Illumina Agreements.”
We sold the Sequenom Bioscience business unit in May 2014 to enable us to focus on improving our core laboratory operations, entering new clinical areas, and strengthening our cash position. The Bioscience business unit developed, manufactured, marketed, sold and serviced mass spectrometry analytical instruments and related instruments, software, reagents and consumables for use in the field of mass spectrometry.
We expanded the features of the MaterniT21 PLUS test to include additional content and we developed a lower cost NIPT risk score test, which can be used in the average risk pregnancy population. We focused on improving our overall profitability in 2014 by lowering our cash used in operations by $60.0 million from 2013 to net cash provided by operating activities of $28.1 million in 2014. We ended the year with $94 million in cash, cash equivalents and marketable securities.
In 2015, we plan to further develop and introduce new testing services to the prenatal health market. In addition we will look to develop an oncology testing service leveraging our research and technology expertise. Overall our plans for 2015 are to continue to research, develop and commercialize tests for prenatally-relevant genetic disorders and diseases, women's health-related disorders and diseases, and oncology.
We identify key goals each year to help provide insight to management’s plans. These management goals are not guidance but are based on our internal projects and programs as we enter the year. Our top three goals for 2015 are to:
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achieve cash flow from operations which is no less than negative $15 million, up to positive $15 million;
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introduce three new laboratory developed tests; and
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develop an oncology research-use-only laboratory-developed test utilizing next generation sequencing of circulating cell-free DNA in blood (also known as liquid biopsy) for clinical studies.
We look to accomplish these goals by:
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expanding adoption of, demand for, and reimbursement for our LDTs in domestic and international markets;
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expanding our LDT offerings through in-house development, technology in-licensing, out-licensing, and/or partnering and acquisitions;
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obtaining our share of test fees under the patent pool agreement entered into with Illumina, which provides a mechanism to receive payment for noninvasive prenatal testing performed under technology licensed from the patent pool;
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utilizing the capacity of our CAP-accredited and CLIA-certified laboratories to fulfill expected increases in demand for Sequenom Laboratories’ LDT offerings; and
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leveraging our scientific knowledge and expertise in sequencing circulating DNA in blood to develop tests serving the oncology market.
The above goals for 2015 and our intentions for accomplishing them, are, or contain, forward looking statements and our ability to achieve these goals and execute our intentions and plans are subject to risks and uncertainties including but not limited to those set forth under Item 1A
Item 1A.
Risk Factors
Before deciding to invest in our company or deciding to maintain or increase your investment, you should carefully consider the risks described below, in addition to the other information contained in this report and in our other filings with the SEC. The risks and uncertainties described below and in our other filings are not the only ones facing us. Additional risks and uncertainties not presently known to us or that we currently deem immaterial may also affect our business. If any of these known or unknown risks or uncertainties actually occurs, our business, financial condition and results of operations could be seriously harmed. In that event, the market price for our common stock could decline and you may lose your investment.
We may not be able to continue to generate significant revenue from any of the tests we have commercialized including the MaterniT21 PLUS test or any test that we may develop in the future.
Our business is substantially dependent on our ability to develop and launch and obtain reimbursement for our diagnostic tests, including the MaterniT21 PLUS test. We have committed significant research and development resources for the development and validation of tests and we have likewise invested significant research and development resources for its potential future diagnostic products. There is no guarantee that we will successfully maintain our current revenues or generate additional revenues or significant revenues from any of our testing services, including the MaterniT21 PLUS test, or any other testing services that we plan to launch in the future. We have launched testing services for prenatal fetal chromosomal abnormalities, CF carrier screening, noninvasive prenatal Rhesus D genotyping, and risk assessment of a patient with “dry” or early stage AMD progressing to “wet” or advanced choroidal neovascular disease within 2, 5, and 10 years. The MaterniT21 PLUS test, which was originally launched in October 2011, detects fetal chromosomal abnormalities. The VisibiliT test, launched in 2014 is a risk score assay for the detection of increased representation of chromosomes 21 and 18. If we, or our partners, are not able to continue to successfully market or sell noninvasive prenatal diagnostic tests or successfully market or sell other tests we may develop for any reason, including the failure to obtain significant reimbursement from payors, or failure to obtain or maintain any required regulatory approvals, we will not generate or maintain significant revenues from the sale of such tests or testing services. A number of factors could impact our ability to continue to sell noninvasive prenatal diagnostic tests or other tests we have developed or may develop in the future or generate significant revenues from the sale of such tests or testing services, including the following:
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the availability of alternative and competing tests or products, such as those using targeted sequencing based or single nucleotide polymorphism (SNP) based approaches for NIPT to detect fetal chromosomal aneuploidies, or other approaches that may have a lower cost of goods and/or be less expensive to perform compared to the MaterniT21 PLUS test or our other tests, and which in turn may result in lower prices offered by competitors;
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technological innovations or other advances in medicine that cause our technologies to be less competitive;
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pricing pressures, lower prices offered by competitors, or changes in third-party payor, government payor or private insurer reimbursement policies including potential delays or refusals to pay and uncertainty related to changes in CPT codes and uncertainty regarding payor adoption of and reimbursement rates for new gene sequencing related CPT codes that took effect in January 2015;
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payors and/or patients may not pay for services;
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payors may seek to reduce the use of our services by ordering physicians;
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our ability to establish and maintain sufficient intellectual property rights in our products, including our ability to overturn the U.S. District Court for the Northern District of California’s order ruling our ‘540 Patent to be invalid, and our ability to ultimately enforce the ‘540 Patent in the future against competitors and obtain injunctive relief and/or monetary damages from competitors;
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parties infringing our intellectual property rights or operating outside our intellectual property rights;
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the ability to implement and maintain controls and risk management measures as appropriate;
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reliance on Sequenom Laboratories, which is subject to routine governmental oversight and inspections for continued operation pursuant to CLIA to process tests ordered by physicians;
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our ability to establish and maintain adequate infrastructure to support the continued commercialization of the MaterniT21 PLUS test and other testing services, including establishing adequate laboratory space, information technology infrastructure, sample collection and tracking systems including the laboratory information management system, or LIMS, electronic ordering and reporting systems and other infrastructure and hiring adequate laboratory and other personnel;
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compliance with federal, state and foreign regulations governing laboratory testing on human specimens;
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the marketing and sale of research use only or other tests;
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the accuracy rates of such tests, including rates of false negatives and/or false positives;
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concerns regarding the safety and effectiveness or clinical validity of noninvasive prenatal or other tests;
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changes in the regulatory environment affecting health care and health care providers, including changes in laws regulating laboratory testing and any laws regulating prenatal testing;
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the extent and success of our sales and marketing efforts and ability to drive continued adoption of our testing services, including the MaterniT21 PLUS test and the VisibiliT test;
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the extent to which payors and health care providers may limit or deny the addition of new laboratory-developed test service providers to their programs;
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general changes or developments in the market for women's and/or prenatal health diagnostics, or diagnostics in general;
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ethical and legal issues concerning the appropriate use of the information resulting from noninvasive prenatal diagnostic tests or other tests;
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the refusal by women to undergo such tests for moral, religious or other reasons, or based on perceptions about the safety or reliability of such tests;
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our ability to provide effective customer support; and
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our ability to license and protect our patented technologies and our other technologies.
We may not be able to collect all or any of the estimated range of $31 million to $34 million of amounts outstanding for tests completed which have not been recognized as revenue upon delivery of the test results.
Our business is substantially dependent on our ability to obtain reimbursement for our LDTs, including the MaterniT21 PLUS test. Collections for services performed have been volatile, and we expect collections to continue to fluctuate depending upon the results of our efforts to collect payment from third party payors. As of December 31, 2014, amounts outstanding for tests completed, net of estimated write-downs and adjustments, which were not recognized as revenue upon delivery of the test result because our accrual revenue recognition criteria were not met and the amounts had not been collected, range from approximately $31 million to $34 million, depending upon the ultimate reimbursement received for these outstanding claims. A number of factors could impact our ability to collect payment on these outstanding claims and impact the amount and timing of any payments, and we cannot provide any assurance as to when, if ever, and to what extent these amounts may be collected. If we are unsuccessful in collecting such outstanding amounts, it will adversely affect our financial position.
Claims by other companies that we infringe their intellectual property rights could adversely affect our business.
From time to time, companies have asserted, and may again assert, patent, copyright or other intellectual proprietary rights against our tests or tests using our technologies, and/or against our customers (licensees and commercial partners). These claims have resulted and may in the future result in lawsuits being brought against us and/or our customers, and could negatively affect demand for our tests, particularly the MaterniT21 PLUS test, and our ability to maintain existing, or enter into new, agreements with customers. We may not prevail in any lawsuits alleging patent infringement given the complex technical issues and inherent uncertainties in intellectual property litigation. If any of our tests, technologies or activities, in particular our tests (including the MaterniT21 PLUS test) from which we derive and expect to continue to derive almost all of our revenues, were found to infringe on another company's intellectual property rights, we could be subject to an injunction that would force the removal of such test from the market or we could be required to redesign such test, which could be costly. We could also be ordered to pay damages or other compensation, including punitive damages and attorneys' fees to such other company. A negative outcome in any such litigation could also severely disrupt the use of our technologies by our customers and licensees or their customers, which in turn could harm our relationships with our customers, our market share and our revenues. Even if we are ultimately successful in defending any intellectual property litigation, such litigation is expensive and time consuming to address, will divert our management's attention from our business and may harm our reputation.
Our ability to compete in the market may decline if we lose some of our intellectual property rights, if patent rights that we rely on are invalidated, or if we are unable to obtain other intellectual property rights.
Our success will depend on our ability to obtain, protect, and maintain the validity of patents on our technology, to protect our trade secrets, and to maintain our rights to licensed intellectual property or technologies. Such patent rights include U.S. Patent No. 6,258,540 pr the 540 Patent, currently ruled invalid by the U.S. District Court for the Northern District of California and appealed to the U.S. Court of Appeals for the Federal Circuit, and foreign equivalents, which we have purchased from Isis for noninvasive prenatal diagnostics and noninvasive prenatal gender determination testing. Such patent rights also include U.S. patents and patent applications, and their foreign equivalents, which we have rights to under the Pooled Patents Agreement with Illumina. Such patent rights also include U.S. and foreign patents and patent applications in-licensed from the Chinese University of Hong Kong, or CUHK, or in-licensed from other third-party entities.
Our patent applications or those of our licensors may not result in the issuance of patents in the U.S. or other countries. Our patents or those of our licensors may not afford meaningful protection for our technology and products. While we do not believe that the District Court’s order ruling that the ‘540 Patent is invalid will impact the competitive landscape (as we have been competing in the marketplace without the benefit of the patent being recognized by competitors), if we are unable to overturn that ruling, it will impact our potential ability in the future to obtain injunctive relief against competitors and/or money damages from competitors. Others may challenge our patents or those of our licensors by proceedings such as interference, oppositions, inter partes review, and reexaminations or in litigation seeking to establish the invalidity of our patents. In the event that one or more of our patents are challenged, the USPTO or a court may invalidate the patent(s) or determine that the patent(s) is not enforceable, which could harm our competitive position. If one or more of our patents are invalidated or found to be unenforceable, or if the scope of the claims in any of these patents is limited by the USPTO or a court decision, we could lose certain market exclusivity afforded by patents owned or in-licensed by us and potential competitors could more easily bring tests or products to the market that directly compete with our own, including the MaterniT21 PLUS test. Such adverse decisions may negatively impact our revenues. See Item 3 of this Report for a discussion of legal proceedings affecting our patents and patent applications.
Competitors may develop products or tests similar to ours that do not conflict with our patents or patent rights. Others may develop products, technologies or methods, including noninvasive prenatal tests or other diagnostic tests in violation of our patents or those of our licensors, or by operating around our patents or license agreements, which could reduce or remove our noninvasive prenatal and other diagnostic commercialization opportunities. To protect or enforce our patent rights, we have initiated interference and inter partes review proceedings, and we may initiate oppositions, reexaminations, or litigation against others. However, these activities are expensive, take significant time and divert management's attention from other business concerns. We may not prevail in these activities. If we are not successful in these activities, the prevailing party may obtain superior rights to our claimed inventions and technology, which could adversely affect our ability to successfully market and commercialize any of our tests that are dependent upon such technologies, including the MaterniT21 PLUS test. The patent position of biotechnology companies generally is highly uncertain and involves complex legal and factual questions that are often the subject of litigation. In 2013, the U.S. Supreme Court decided the case Association for Molecular Pathology v. Myriad Genetics, 133 S. Ct. 2107 (2013) (No. 12-398), a case that held that, “A naturally occurring DNA segment is a product of nature and not patent eligible merely because it has been isolated, but cDNA is patent eligible because it is not naturally occurring.” This Supreme Court decision, and other Supreme Court and lower Federal Court decisions interpreting and/or limiting the scope of patentable subject matter under 35 U.S.C. § 101, as well as the new examination guidelines from the U.S. Patent and Trademark Office issued in 2014 (i.e., the 2014 Interim Guidance on Patent Subject Matter Eligibility (Interim Eligibility Guidance) for USPTO personnel to use when determining subject matter eligibility under 35 U.S.C. 101 in view of recent decisions by the U.S. Supreme Court), have made it more difficult for patentees to obtain and/or maintain patent claims in the United States that are directed to biotechnology-related subject matter, as claims to that subject matter are often perceived to recite or involve Laws of Nature/Natural Principles, Natural Phenomena, and/or Natural Products. No consistent policy has emerged from the USPTO, the offices of foreign countries or the courts regarding the breadth of claims allowed or the degree of protection afforded under biotechnology patents. There is a substantial backlog of biotechnology patent applications at the USPTO and of the equivalent offices around the world and the approval or rejection of patent applications may take several years.
If we breach any of the terms of our license or supply agreements, or these agreements are otherwise terminated or modified, the termination or modification of such agreements could result in our loss of access to critical components and could delay or suspend our commercialization efforts, and we may compete with our suppliers which may adversely affect our business.
We have sourced or licensed components of our technology from other parties. Our failure to maintain continued supply of such components, particularly in the case of sole suppliers, or the right to use these components would seriously harm our business, financial condition, and results of operations. In the event of any adverse developments with these vendors, Sequenom Laboratories’ testing services may be interrupted, which would have an adverse impact on our business. Changes to
or termination of our agreements or inability to renew our agreements with these parties or enter into new agreements with other suppliers could result in the loss of access to these aspects of our technology or other intellectual property rights or technologies that we may acquire from time to time and could impair, delay, or suspend our commercialization efforts, including efforts to market and commercialize the MaterniT21 PLUS test. While we negotiate for agreement periods or notice of termination periods that provide us reasonable periods of time to secure alternative supplies, and require that such agreements may not be terminated without advance notice arbitrarily or without good reason, such as uncured breach or insolvency, these negotiations are often unsuccessful or such provisions may not provide us with adequate time to secure alternative supplies, provide us with access to alternative technologies on commercially acceptable terms, or otherwise provide us with adequate protection.
For example, Illumina, is the sole supplier of sequencers and certain consumables for Sequenom Laboratories' MaterniT21 PLUS test. The supply of sequencers and consumables to Sequenom Laboratories is provided under the Supply Agreement, pursuant to which we and our affiliates will purchase various products from Illumina, which we and they will be able to use for NIPT as well as for other clinical and research uses. The Supply Agreement has a term of five years. Upon the expiration of the Supply Agreement, we face risk and uncertainty regarding our ability to renew the supply agreement or to enter into a new supply agreement with Illumina, if at all, and on financial terms that are acceptable to us. Our failure to maintain continued supply of such sequencers and consumables would seriously harm our business, financial condition, and results of operations.
We depend on third-party products and services and limited sources of supply to develop and perform its tests.
We rely on outside vendors to supply certain products, components and materials used in our test services. Illumina is the sole supplier of sequencers and certain consumables for the MaterniT21 PLUS and the VisibiliT test and those products have lead times of several months. Among other risks, using a platform provided by another party presents potential manufacturing supply and reliability, quality compliance, and intellectual property infringement risks. For example, we have no control over the manufacture of the Illumina sequencers and consumables that we are using for the MaterniT21 PLUS and the VisibiliT test, including whether such sequencers and consumables will meet their quality control requirements to ensure quality and reliability for the sequencers and consumables, and can give no assurance that we will be able to obtain a reliable supply of the sequencers and consumables that we need for our tests. In the event that demand for our tests declines or does not meet our forecasts, we could have excess inventory or increased expenses or our margins could decrease which could have an adverse impact on our financial condition and business.
Many other products, components and materials, including blood collection tubes for the MaterniT21 PLUS and the VisibiliT test and components of the MassARRAY System that is currently used for the CF carrier screen, fetal Rhesus D genotyping test and RetnaGene AMD test, are obtained from a single supplier or a limited group of suppliers and some also have lead-times of several months.
These suppliers may be subject to regulation by the FDA and would therefore need to comply with federal regulations related to the manufacture and distribution of regulated products. Because we cannot ensure the actual production or manufacture of such critical equipment and materials, or the ability of our suppliers to comply with applicable legal and regulatory requirements, we may be subject to significant delays caused by interruption in production or manufacturing.
In the event of any adverse developments with these suppliers or vendors, our test supply may be interrupted and obtaining substitute components could be difficult or require us to re-design our tests which would have an adverse impact on our business.
Certain of our LDTs, including the MaterniT21 PLUS test, may not be eligible for reimbursement by payors or may become ineligible for reimbursement, or reimbursement may be significantly delayed, due to changes in CPT codes, or otherwise, which may limit the demand for these tests by physicians and their patients.
Certain of our current LDTs, or future tests which we intend to launch as a testing service, may not be deemed medically necessary or may otherwise not be subject to reimbursement by payors, which could affect demand for such tests by physicians.
CMS, a federal agency within the Department of Health and Human Services (HHS), establishes reimbursement payment levels and coverage rules for Medicare. State Medicaid plans and third-party payors establish rates and coverage rules independently. As a result, the coverage determination process is often a time-consuming and costly process that requires us to provide scientific and clinical validity for the use of our tests to each payor separately, with no assurance that approval will be obtained. If CMS or other third-party payors decide not to cover our tests, place significant restrictions on the use of our tests, or offer inadequate payment amounts, our ability to generate revenues from our tests could be limited.
Even a payor that covers our tests may reduce utilization or stop or lower reimbursement at any time, which could reduce our revenues. We are currently considered a “non-contracting provider” by many third-party payors because we have not entered into a specific contract to provide our specialized testing services to their insured patients at specified rates of reimbursement. Without such contracts, we may not be able to obtain reimbursement for our tests at acceptable rates, which
could also reduce our revenues. In cases where we have contracts in place, some payors continue to challenge the medical necessity of certain of our tests or have other objections that result in delay or non-payment to us.
Reimbursement for diagnostic tests furnished to Medicare beneficiaries generally is made based on a fee schedule set by CMS using a statutory formula. In recent years, payments under these fee schedules have decreased and may decrease more. In addition, Medicare fee schedules are impacted by the billing codes selected for reporting services, and changes to certain laboratory billing codes for diagnostic tests are being considered which may affect payment levels. We cannot predict whether or when additional third-party payors will cover our tests or offer adequate reimbursement to make them commercially attractive or whether existing payors will reduce utilization or stop or lower reimbursement. Clinicians or patients may decide not to order our tests if third-party reimbursement is inadequate, especially if ordering the test could result in financial liability for the patient, and reduced or discontinued purchases of our products would cause our revenues to decline.
Levels of reimbursement may continue to decrease in the future, and future legislation, regulation or reimbursement policies of third-party payors may harm the demand for and reimbursement available for our products, which in turn, could harm pricing and sales. The payment amounts under the Medicare clinical laboratory fee schedule are important not only for our reimbursement under Medicare, but also because the schedule often establishes the payment amounts set by other third-party payors. For example, state Medicaid programs are prohibited from paying more than the Medicare fee schedule limit for clinical laboratory services furnished to Medicaid recipients. As a result, in light of reductions in the clinical laboratory fee schedule, certain third-party payors may also reduce reimbursement amounts.
In the U.S. the AMA generally assigns specific billing codes for laboratory tests under a coding system known as Current Procedure Terminology, or CPT, codes, which are necessary for us, and our customers, to bill and receive reimbursement for our diagnostic tests. Once the CPT code is established, CMS in turn establishes payment levels and coverage rules under Medicare, and private payors establish rates and coverage rules independently. We cannot guarantee that any of our tests are or will be covered by the CPT codes that we believe may be applied to them or that any of our tests or other products will be approved for coverage or reimbursement by Medicare, Medicaid or any third-party payor. Our tests and the CPT codes we use may not qualify for Medicaid reimbursement in any or all of the 50 states.
In addition, payors have initiated efforts to develop a more specific set of billing codes for laboratory tests so that the particular laboratory test is more precisely identified. CMS has established a new molecular diagnostic code for next generation sequencing tests specific for fetal aneuploidy, code 81420, was implemented on January 1, 2015. We cannot guarantee that this new code will help facilitate the reimbursement process or reduce the time required for third-party payors to process claims. When CMS recommends new codes typically the gap fill process is used in establishing a new code rate; however we cannot guarantee that such process will be used. These coding changes and lack of a CMS fee schedule have negatively affected and may continue to negatively affect our product pricing and the amount of and timing of payor reimbursement. We cannot guarantee that the issuance of the new code will improve our product pricing or the amount of and timing of payor reimbursement.
Under the Pooled Patents Agreement, if Illumina is not able to license additional laboratories, collect test fees or develop in-vitro diagnostic kits for NIPT, our revenues, net earnings, cash flow and profitability could be negatively affected.
Under the Pooled Patents Agreement, Illumina has exclusive worldwide rights to license the pooled patent rights to third-party laboratories to develop and sell their own laboratory-developed NIPT tests. We, Illumina and our respective licensees will pay a per-test fee into the pool for laboratory-developed NIPT tests, which will be shared between Illumina and us. We cannot guarantee that Illumina will be successful in licensing the pooled intellectual property to additional third-party laboratories and generating additional test fees. Also, we have no control over how many laboratory-developed NIPT tests Illumina will sell or over Illumina’s collection of test fees from its licensees. To the extent Illumina is unsuccessful in selling its own laboratory-developed NIPT tests, obtaining additional third-party licensees under the pooled patent rights and/or collecting a test fee from such licensees, our revenues, net income, cash flow and profitability could be negatively affected.
In addition, under the Pooled Patents Agreement, Illumina has exclusive worldwide rights under the pooled patent rights to develop and sell in-vitro diagnostic kits for NIPT and to license others to do so. Illumina will pay royalties to us for sales of in-vitro diagnostic kits for NIPT by Illumina and such licensees. We have no control over when, if ever, Illumina will develop and sell in-vitro diagnostic kits for NIPT or license others to do so. If Illumina and its licensees fail to develop and sell in-vitro diagnostic kits for NIPT, we will not collect any royalties from Illumina which could negatively affect our revenues, net income, cash flow and profitability.
Under the Pooled Patents Agreement, if Illumina fails to effectively control prosecution, maintenance and enforcement of the pooled patent rights, the value of the pooled patent rights may be diminished and/or we may need to incur significant unexpected legal costs which may adversely impact our financial condition.
Under the Pooled Patents Agreement, Illumina will control prosecution, maintenance and enforcement of the pooled patent rights, and we will be responsible for paying a portion of the costs thereof. We have no control over these costs. We will continue to control, at our sole cost, the prosecution, maintenance and enforcement of the patents we purchased from Isis including the ‘540 patent. If Illumina fails to prosecute, maintain and/or enforce any of the pooled patent rights, the scope and value of the pooled patent rights may be diminished, and the revenues that we receive from our share of the test fees may be reduced. We have the right to assume control of the enforcement of certain of the pooled patent rights if Illumina fails to do so. If we do assume control of enforcement of any of the pooled patent rights, we cannot guarantee that we will be successful in our efforts and the scope and value of the pooled patent rights may be diminished. In addition, our assumption of such control of enforcement of any of the pooled patent rights will cause us to incur significant unexpected legal costs which may adversely impact our financial condition.
The minimum payments we expect to receive under the Pooled Patents Agreement may be reduced which could negatively impact our cash flow and profitability.
Under the Pooled Patents Agreement, we are entitled to receive certain minimum annual payments from Illumina. In certain circumstances, the amount of these minimum payments may be reduced. These circumstances include a reduction in the average amount of the test fees collected, Illumina’s enforcement of the pooled patents and the impairment or diminution in value of the pooled patent rights. We have no control over these circumstances and, should such circumstances occur, it could have a negative impact on our cash flow and profitability.
Our failure to establish enrollment in and obtain favorable payment policies from state Medicaid programs could result in a substantial portion of our services being unreimbursed and adversely affect our results of operations and financial condition.
We have established enrollment in many state Medicaid programs. However, even though we are enrolled in many state Medicaid programs, we are not receiving reimbursement or are receiving lower than expected reimbursement in most of those states. In mid-2013 it became apparent that most states still did not have appropriate procedure codes incorporated into their payment system for reimbursement for molecular tests, and we initiated efforts to reduce the volume of Medicaid tests from those states. At the same time, we increased our efforts to put reimbursement pathways in place with each state, and work with the AMA to get a specific CPT code for the MaterniT21 PLUS test. CMS has established a new molecular diagnostic code for next generation sequencing tests specific for fetal aneuploidy, code 81420, which was implemented on January 1, 2015, however it is not exclusive to the MaterniT21 PLUS test. In those states where we are not enrolled in the Medicaid system, we do not receive reimbursement for our tests. If we are unable to receive reimbursement, or adequate reimbursements under state Medicaid programs, our opportunity for future revenues would be reduced, which would adversely affect our results of operations and financial condition.
Billing complexities associated with obtaining payment or reimbursement for our tests may negatively affect our revenues, cash flow and profitability. We may incur additional financial risk related to collections and reimbursement in connection with the commercialization of our molecular diagnostic tests.
Billing for clinical laboratory testing services is complex. We generally bills third-party payors for our testing services and pursues case-by-case reimbursement where policies are not in place for a particular test. We may also face an increased risk in our collection efforts, including potential write-offs of doubtful accounts and long collection cycles for accounts receivable related to our testing service, which could adversely affect our business, results of operations and financial condition. We began internal billing operations on May 1, 2013. Among the factors complicating our billing of third-party payors are:
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disputes among payors as to which party is responsible for payment;
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disparity in coverage among various payors;
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disparity in information and billing requirements among payors; and
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incorrect or missing billing information, which is required to be provided by the prescribing physician.
These billing complexities, and the related uncertainty in obtaining payment for our tests, could negatively affect our revenues, cash flow and profitability.
Our failure to comply with governmental payor regulations could result in our being excluded from participation in Medicare, Medicaid or other governmental payor programs, which would decrease our revenues and adversely affect our results of operations and financial condition.
The Medicare program is administered by CMS, which, like the states that administer their respective state Medicaid programs, imposes extensive and detailed requirements on diagnostic services providers, including, but not limited to, rules that govern how we structure our relationships with physicians, how and when we submit reimbursement claims and how we provide our specialized diagnostic services. Our failure to comply with applicable Medicare, Medicaid and other governmental payor rules could result in our inability to participate in a governmental payor program, our returning funds already paid to us,
civil monetary penalties, criminal penalties and/or limitations on the operational function of our laboratory. If we were unable to receive reimbursement under a governmental payor program, a substantial portion of our revenues would be lost, which would adversely affect our results of operations and financial condition.
Continued evolution of the U.S. health care reform law could adversely affect our business, profitability and stock price and prevent the commercial success of the MaterniT21 PLUS test.
In March 2010, President Obama signed into law the Patient Protection and Affordable Care Act, or PPACA. At this time, it remains unclear whether there will be any further changes made to PPACA, whether in part or in its entirety.
The PPACA includes expansions of health care fraud and abuse laws, including the False Claims Act and the Anti-Kickback Statute, new government investigative powers, and enhanced penalties for noncompliance. As discussed below, enforcement of any of these laws against our company could harm our business.
It is unclear whether and to what extent, if at all, other anticipated developments resulting from health care reform, such as an increase in the number of people with health insurance and an increased focus on preventive medicine, may provide us additional revenue. Extending coverage to a large population could substantially change the structure of the health insurance system and the methodology for reimbursing medical services, drugs and devices. These structural changes could entail modifications to the existing system of third-party payors and government programs, such as Medicare and Medicaid, the creation of additional government-sponsored health care insurance sources, or some combination of both, as well as other changes. Restructuring the coverage of medical care in the U.S. could impact the reimbursement for diagnostic tests like ours, including the MaterniT21 PLUS test. If reimbursement for our diagnostic tests is substantially less than we or our clinical laboratory customers expect, or rebate obligations associated with them are substantially increased, our business could be materially and adversely impacted.
Any health care reform measures adopted by the U.S. government and other governments could cause significant pressure on the pricing of health care products and services, including the MaterniT21 PLUS test, in the U.S. and internationally, as well as the amount of reimbursement available from governmental agencies or other third-party payors. The continuing efforts of the U.S. and foreign governments, insurance companies, managed care organizations and other payors to contain or reduce health care costs may compromise our ability to set prices at commercially attractive levels for our tests, including the MaterniT21 PLUS test, and other diagnostic tests that we may develop. Changes in health care policy, such as the creation of broad limits for diagnostic products, could substantially diminish the sale of or inhibit the utilization of future diagnostic tests, increase costs, divert management's attention and adversely affect our ability to generate revenues and achieve profitability.
New laws, regulations and judicial decisions, or new interpretations of existing laws, regulations and decisions, relating to health care availability, methods of delivery or payment for diagnostic products and services, or sales, marketing or pricing, may also limit our potential revenues, and we may need to revise our research and development or commercialization programs. The pricing and reimbursement environment may change in the future and become more challenging for a number of reasons, including policies advanced by the U.S. government, new health care legislation or fiscal challenges faced by government health administration authorities. Specifically, in both the U.S. and some foreign jurisdictions, there have been a number of legislative and regulatory proposals and initiatives to change the health care system in ways that could affect our and Sequenom Laboratories' ability to sell our diagnostic tests, including the MaterniT21 PLUS test, profitably. Some of these proposed and implemented reforms could result in reduced utilization or reimbursement rates for our diagnostic products.
If our laboratory facilities are damaged, our business would be seriously harmed.
We operate laboratory facilities in San Diego, California, Grand Rapids, Michigan, and Raleigh-Durham, North Carolina. Damage to our facilities due to war, fire, natural disaster, earthquake, power loss, communications failure, terrorism, unauthorized entry, or other events could prevent us from conducting our business for an indefinite period, could result in a loss of important data or cause us to cease development and processing of our test services. We cannot be certain that our limited insurance to protect against business interruption would be adequate or would continue to be available to us on commercially reasonable terms, or at all.
We must comply with stringent CLIA requirements to operate, and have limited capacity and infrastructure. Our ability to successfully develop and commercialize tests and to generate revenues will depend on our ability to successfully operate our CLIA-certified laboratory, establish and maintain necessary capacity, and maintain required regulatory licensures.
Sequenom Laboratories, a CLIA-certified and CAP-accredited laboratory, has developed, validated and commercialized five laboratory-developed tests to date. For future tests, if we are unable to successfully develop and validate any new tests that we intend to commercialize we may not be able to successfully commercialize such tests on the anticipated timelines or at all. Although we have invested substantially in our infrastructure, and believe that we have sufficient infrastructure and capacity for near-term demand, it is possible that we may not have adequate infrastructure and capacity in place to meet longer term future demand for our currently launched testing services or for the demand of future tests that we develop. Our ability to successfully
develop and validate tests will depend on our ability to successfully operate and maintain required regulatory licensure and we cannot provide assurances that we will have sufficient resources to continue our operations and maintain our licenses. We currently perform the MaterniT21 PLUS test in our San Diego, California, and Raleigh-Durham, North Carolina, facilities. We face risk in relying upon two laboratory locations to meet demand for, perform, and generate revenues from the MaterniT21 PLUS test. Reliance upon two facilities presents risk to our operations in the event that one or both facilities' capacity is exceeded, or one or both facilities experiences production problems or delays.
CLIA requirements are designed to ensure the quality and reliability of clinical laboratories by mandating specific standards in the areas of personnel qualifications, administration and participation in proficiency testing, patient test management, quality control, quality assurance and inspections. Potential sanctions for failure to comply with CLIA requirements may be suspension, revocation or limitation of a laboratory's CLIA certificate, which is necessary to conduct business, as well as significant fines and/or criminal penalties. Laboratories must undergo on-site surveys at least every two years, which may be conducted by the Federal CLIA program or by a private CMS approved accrediting agency, such as CAP, among others. Sequenom Laboratories is also subject to regulation of laboratory operations under state clinical laboratory laws as will be any new CLIA-certified laboratory that we establish or acquire. State clinical laboratory laws may require that laboratories and/or laboratory personnel meet certain qualifications, specify certain quality controls or require maintenance of certain records. Certain states, such as California, Florida, Maryland, New York, Pennsylvania and Rhode Island, require that laboratories obtain licenses to test specimens from patients residing in those states and additional states may require similar licenses in the future. If we are unable to obtain and maintain licenses from states where required, it will not be able to process any samples from patients located in those states. Only Washington and New York States are exempt under CLIA, as these states have established laboratory quality standards at least as stringent as the CLIA requirement's. Potential sanctions for violation of these statutes and regulations include significant fines and the suspension or loss of various licenses, certificates and authorizations, which could adversely affect our business and results of operations.
If we fail to maintain compliance with the CLIA requirements, CMS or state agencies could require us to cease our testing services, including the MaterniT21 PLUS test. Even if it were possible for us to bring our laboratory back into compliance after failure to comply with such requirements, we could incur significant expenses and potentially lose revenues in doing so.
Failure to establish, and perform to, appropriate quality standards to assure that the highest level of quality is observed in the performance of our testing services could adversely affect the results of our operations and adversely impact our reputation.
The provision of clinical testing services, including the MaterniT21 PLUS test, and related services, and the marketing of those services involve certain inherent risks. The services that we provide and markets are intended to provide information for health care providers in providing patient care. Therefore, users of such services may have a greater sensitivity to errors than the users of services that are intended for other purposes, such as research.
Performance defects, incomplete process controls, unexpected failure modes, unanticipated use of Sequenom Laboratories' services, or inadequate disclosure of information (including associated risks or limitations) relating to the use of the services can lead to injury or other adverse events, including laboratory operation disruptions, delays, or incorrect clinical testing results. These events could lead to safety alerts relating to our services (either voluntary or required by governmental authorities) and could result, in certain cases, in the removal of services from the market. Any removal of services could result in significant costs as well as negative publicity that could reduce demand for our test services. Personal injuries relating to the use of our services can also result in product liability claims being brought against us.
Our operating results may fluctuate significantly.
Our revenues and results of operations may fluctuate significantly, depending on a variety of factors, including the following:
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our success in developing, marketing, and selling, and changes in demand for our diagnostic testing services, including the MaterniT21 PLUS test, and the level of reimbursement and collection obtained for these tests;
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the pricing of our diagnostic testing services, and the timing and pricing of new diagnostic testing service offerings, and those of our competitors;
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our ability to manage costs and expenses and effectively implement our business strategy;
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our ability, if necessary, to raise additional capital;
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the amount of royalties that we are required to pay to third parties in connection with the sale of certain of our testing services;
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our success in collecting payments from third-party payors, customers, and collaborative partners, variations in the timing of these payments and the recognition of these payments as revenues;
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our success in responding to customer complaints effectively and managing relationships with our customers;
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our ability to identify and develop in a cost-efficient manner new services, such as noninvasive prenatal and other diagnostic technologies, our ability to improve current services to increase demand for such services and the success of such products and improvements;
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our ability to establish and maintain sufficient intellectual property rights including our ability to overturn the U.S. District Court for the Northern District of California’s order ruling the ‘540 Patent to be invalid, and our ability to ultimately enforce the 540 Patent in the future against competitors and obtain injunctive relief and/or monetary damages from competitors;
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the potential need to acquire licenses to new technology, including genetic markers that may be useful in diagnostic applications, or to use our technology in new markets, which could require us to pay unanticipated license fees and royalties in connection with licenses we may need to acquire;
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our research and development progress, including our ability to develop and validate improved or new tests, , particularly in our expanded field of oncology, and how rapidly we are able to achieve technical milestones;
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the cost, quality and availability of the hardware platforms and consumables, including reagents and related components and technologies, used by us to perform our tests;
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material developments in our customer and supplier relationships, including our ability to successfully transition to new technologies and/or alternative suppliers; and
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the amount of any legal expenses, settlement payments, fines or damages arising from patent litigation or any future litigation.
The absence of or delay in reimbursement for our testing services and generating revenues has had, and will continue to have, a significant adverse effect on our operating results from period to period and will result in increased operating losses unless and until such reimbursement is established, at sufficient levels to cover our costs. Our internationally derived revenues and operating results are also difficult to predict because they depend upon the activities of our licensees in numerous countries.
We believe that period-to-period comparisons of our financial results will not necessarily be meaningful. You should not rely on these comparisons as an indication of our future performance. If our operating results in any future period fall below the expectations of securities analysts and investors, our stock price may decline.
Our increased leverage as a result of our issuance of the 5.00% Convertible Senior Notes due 2017 may harm our financial condition and results of operations.
Our total consolidated long-term debt and obligations as of December 31, 2014, which includes the 5.00% Convertible Senior Notes due 2017, or Convertible Senior Notes, was $139.7 million and represented approximately 129% of our total capitalization as of that date.
Our level of indebtedness could have important consequences on our future operations, including:
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making it more difficult for us to meet our payment and other obligations under the Convertible Senior Notes and our other outstanding debt;
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resulting in an event of default if we fail to comply with the financial and other restrictive covenants contained in our debt agreements, which could result in all of our indebtedness becoming immediately due and payable;
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reducing the availability of our cash flow to fund working capital, capital expenditures, acquisitions and other general corporate purposes, and limiting our ability to obtain additional financing for these purposes;
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limiting our flexibility in planning for, or reacting to, and increasing our vulnerability to, changes in our business, the industries in which we operate and the general economy;
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placing us at a competitive disadvantage compared to our competitors that have less debt or are less leveraged and that, therefore, may be able to take advantage of opportunities that our debt levels or leverage prevent us from exploiting; and
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limiting our ability to obtain additional financing.
Each of these factors may have a material and adverse effect on our business, financial condition and results of operations and our ability to meet our payment obligations under the Convertible Senior Notes and our other indebtedness.
We may not be able to generate enough cash flow from our operations to service our indebtedness.
We have a significant amount of indebtedness. In September 2012, we completed the sale of $130.0 million of our Convertible Senior Notes. Our ability to make payments on, and to refinance, our indebtedness, including the Convertible Senior Notes, and to fund planned commercialization efforts, research and development efforts, working capital and other general corporate purposes depends on our ability to generate cash in the future. This, to a certain extent, is subject to general economic, financial, competitive, legislative, regulatory and other factors, some of which are beyond our control. Historically, our business has generated losses and we may never become profitable. If we are unable to generate the necessary cash flow, we may be required to adopt one or more alternatives, such as selling assets, refinancing or restructuring indebtedness or
obtaining additional equity capital on terms that may be onerous or highly dilutive. Our ability to refinance our indebtedness will depend on the capital markets and our financial condition at such time. If we raise additional debt, it will increase our interest expense, our leverage and our operating and financial costs. In addition, the terms of the indenture governing the Convertible Senior Notes restricts our ability to incur additional debt, and the agreements governing our other existing or future indebtedness may restrict us from adopting any of these alternatives. We may not be able to execute any of these actions on commercially reasonable terms or at all.
The Convertible Senior Notes also include a provision whereby upon a “fundamental change”, which is defined in the indenture related to the Convertible Senior Notes, holders of the Convertible Senior Notes may require us to repurchase, for cash, all or a portion of their Convertible Senior Notes. We may not have sufficient funds to pay the interest or repurchase price when due. In addition, the terms of any borrowing agreements which we may enter into from time to time may require early repayment of borrowings under circumstances similar to those constituting a “fundamental change”. These agreements may also make our repurchase of Convertible Senior Notes an event of default under the agreements.
If we fail to make any required payments under our indebtedness, or otherwise breach the terms of our indebtedness, including the Convertible Senior Notes, all or a substantial portion of our indebtedness could be subject to acceleration. In such a situation, it is unlikely we would be able to repay the accelerated debt, which would have a material adverse impact on our business, results of operations and financial condition.
If we fail to generate enough cash flow from our operations or otherwise obtain the capital necessary to fund our operations, our financial results, financial condition and our ability to continue as a going concern will be adversely affected and we will have to cease or reduce further commercialization efforts or delay or terminate some or all of our diagnostic testing services or other product development programs.
We expect to continue to incur losses and may have to raise additional cash to fund our planned operations.
Our cash, cash equivalents, and current marketable securities were $93.9 million as of December 31, 2014. Based on our current plans, we believe our cash, cash equivalents and current marketable securities and collections from our commercialized testing services and income from the Pooled Patents Agreement will be sufficient to fund our operating expenses and capital requirements through the next twelve months. We are continuing to expand our operations following commercialization of the MaterniT21 PLUS test and our research and development activities related to improvements to current tests and expansion of our test menu, particularly in our expanded field of oncology, may require raising additional funds. In addition, there can be no assurances that these commercialization or research and development activities will be successful. We cannot be certain that our efforts to obtain reimbursement for our tests will be successful. Our current sales and marketing operations may not be sufficient to maintain or increase the level of market awareness and sales required for us to retain significant commercial success for the MaterniT21 PLUS test. If we are not able to successfully implement our marketing, sales commercialization, and reimbursement strategies, we may not be able to expand geographically, increase sales of the MaterniT21 PLUS test or successfully commercialize any future tests or products that we may develop and therefore may not be able to generate revenues sufficient to fund operations. If we are not able to generate revenues sufficient to fund operations, we may need to raise additional funds through financing or other means. The actual amount of funds that we will need and the timing of any such investment will be determined by many factors, some of which are beyond our control.
We may need to raise additional funds in the future to support expanding commercialization of the MaterniT21 PLUS test and continued development and commercialization of our proprietary technology, particularly in our expanded field of oncology. We may need to sell equity or debt securities to raise significant additional funds. However, it may be difficult for us to raise additional capital through the sale of equity or debt securities.
The amount of additional funds we may need depends on many factors, including:
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the degree to which our costs and expenses exceed our revenues;
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our success selling, marketing and generating revenues from the MaterniT21 PLUS test and the level of reimbursement and collections from third-party payors;
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our success in selling, marketing and generating revenues from our testing services for CF carrier screening, fetal Rhesus D genotyping, and AMD, and the level of reimbursement and collections from third-party payors for these and future tests;
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the level of our selling, general, and administrative expenses;
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our obligation to pay royalties to third parties in connection with the sale of our tests;
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our success and the extent of our investment in the research, development and commercialization of diagnostic technology, including molecular diagnostics, noninvasive prenatal diagnostic technology, oncology and the acquisition and/or licensing of third-party intellectual property rights;
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our success in obtaining sufficient quantities and quality of patient samples;
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our success in obtaining regulatory clearance or approval, if applicable, to market any of our testing services in various countries, including the U.S.;
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our success in validating additional laboratory-developed tests and the levels of clinical performance achieved;
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our success either alone or in collaboration with our partners in launching and selling additional diagnostic testing services, particularly in our expanded field of oncology;
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the extent to which we enter into, maintain, and derive revenues from licensing agreements, including agreements to out-license our noninvasive prenatal analysis technology, research and other collaborations, joint ventures and other business arrangements;
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the level of our legal expenses and any damages or settlement payments arising from ongoing or new patent related litigation;
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the amount of any legal expenses, settlement payments, fines or damages arising from any future litigation or demand and the extent to which any of the foregoing is not covered by insurance;
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the dilution from any issuance of securities, whether in connection with future capital-raising or merger or acquisition transactions, the settlement of litigation, or otherwise;
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the extent to which we acquire, and our success in integrating, technologies or companies;
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compliance with corporate governance and regulatory developments or initiatives;
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regulatory changes by the FDA, CMS and other worldwide regulatory authorities; and
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technological developments in our markets.
Additional financing may not be available in amounts or on terms satisfactory to us or at all. General market conditions, the market price of our common stock, our financial condition, uncertainty about the successful commercialization and development of diagnostic tests, particularly in our expanded field of oncology, regulatory developments, the uncertainty regarding the results of ongoing litigation matters, the status and scope of our patent rights or other factors may not support capital raising transactions. In addition, our ability to raise additional capital may depend upon obtaining stockholder approval. There can be no assurance that we will be able to obtain stockholder approval if it is necessary. If we are unable to obtain sufficient additional funds on a timely basis or on terms favorable to us, we may be required to cease or reduce further commercialization of our testing services, to cease or reduce certain research and development projects, to sell, license or otherwise dispose of some or all of our technology or assets, to merge all or a portion of our business with another entity or we may not be able to continue as a going concern. If we raise additional funds by selling shares of our capital stock (or otherwise issue shares of our capital stock or rights to acquire share of our capital stock), the ownership interest of our current stockholders will be diluted.
The development of new, more cost-effective tests that can be performed by our customers or by patients, or the internalization of testing by hospitals or physicians, could negatively impact our testing volume and revenues.
Advances in technology may lead to the development of more cost-effective tests that can be performed outside of a commercial clinical laboratory such as point-of-care tests that can be performed by physicians in their offices, esoteric tests that can be performed by hospitals in their own laboratories or home testing that can be performed by patients in their homes. Although CLIA compliance makes it cost prohibitive for many physicians to operate clinical laboratories in their offices, manufacturers of laboratory equipment and test kits could seek to increase their sales by marketing point-of-care test equipment to physicians. Diagnostic tests cleared or approved by the FDA for home use are automatically deemed to be exempt under CLIA and may also be performed in physician office laboratories with minimal regulatory oversight under CLIA. Test kit manufacturers could seek to increase sales to both physicians and patients of test kits cleared or approved by the FDA for point-of-care testing or home use. Development of such technology and its use by our customers could reduce the demand for Sequenom Laboratories' testing services and negatively impact our revenues. Our future success will depend on our ability to keep pace with the evolving needs of our customers on a timely and cost-effective basis and to pursue new market opportunities that develop as a result of technological and scientific advances.
Quarterly revenues may be difficult to predict.
We may be unable to accurately predict quarterly revenues relating to the MaterniT21 PLUS test and our other tests due to relatively recent changes in billing codes and adoption and implementation of billing codes by payors and uncertainties related to the PPACA. If our quarterly or year-end revenues fall below the expectations of securities analysts and investors, our stock price may decline.
Uncertainty regarding the development of new tests, including our plans to develop tests in the field of oncology, could materially adversely affect our business, financial condition, and results of operations.
We are continuing to focus research and development efforts on tests, in addition to improvements and additions to current tests, including the MaterniT21 PLUS test. We will look to develop an oncology testing service based on our research and technology capabilities to be used initially for research and potential future clinical studies. Our plans for 2015 are to continue
to research, develop and commercialize tests for prenatal genetic disorders and diseases, women's health-related disorders and diseases, and for oncology. The launch of any other test will require the completion of certain clinical development and commercialization activities, and may include the efforts of collaborative partners on which we sometimes rely, and the expenditure of additional cash resources. We can give no assurance that we will be able to successfully complete the clinical development of any other test or diagnostic test or that we will be able to establish or maintain the collaborative relationships (if any collaborators are involved) that are essential to our clinical development and commercialization efforts. We have limited experience in the field of oncology and we cannot guarantee that our research and development activities will be successful in developing any marketable oncology testing service. We also can give no assurance that we will be able to reduce our expenditures sufficiently or otherwise mitigate the risks associated with our business to raise enough capital to complete clinical development or commercialization activities. Clinical development requires large numbers of patient specimens and we may not be able to use prior collected specimens or collect a sufficient number of appropriate specimens in a timely manner in the future to complete clinical development for any planned test. Patient specimens for clinical development for noninvasive prenatal tests may be unavailable or available only in limited quantities due to an increased number of competitive parties seeking such specimens. Also, as noninvasive testing increases in demand and invasive testing (such as amniocentesis) potentially declines over time, less patient specimens for clinical development become available that include confirmatory data from an invasive procedure such as amniocentesis. Failure to possess or to collect a sufficient number of appropriate specimens in a timely manner could prevent or significantly delay our ability to research, develop, complete clinical development and validation, obtain FDA clearance or approval as may be necessary, or launch any of our planned tests. Any failure to complete on-going clinical studies for our planned tests could have material adverse effects on our business, operating results or financial condition.
We may not successfully obtain, or maintain, regulatory approval of any noninvasive prenatal or other product which we or our licensing or collaborative partners develop.
Products we or our collaborators develop in the noninvasive prenatal diagnostic or other markets depending on their intended use, may be regulated as medical devices by the FDA and other worldwide regulatory authorities. In the U.S., our tests may require either a Premarket 510(k) Notification or a Premarket Approval Application to be submitted to the U.S. FDA prior to marketing in interstate commerce. The Premarket 510(k) Notification process usually takes from three to nine months from submission to clearance, but can take significantly longer. The PMA approval process is much more costly, lengthy, uncertain and generally takes from nine to eighteen months or longer from submission to approval. In addition, commercialization of any diagnostic or other product that we or our licensees or collaborators develop would depend upon successful completion of non-clinical (bench) testing and clinical studies. Non-clinical bench testing and clinical studies can be long, expensive, and uncertain processes and we do not know whether we, our licensees, or any of our collaborators, would be permitted or able to undertake clinical studies of any potential products. It may take us or our licensees or collaborators many years to complete any such testing, and failure could occur at any stage. Results from preliminary studies do not necessarily predict final results, and acceptable results in early studies may not be repeated in later studies. A number of companies in the diagnostics industry, including biotechnology companies, have suffered significant setbacks in clinical studies, even after promising results in earlier studies. Delays or rejections of potential products may be encountered based on changes in regulatory policy for product approval during the period of product development and regulatory agency review. If our projects reach clinical studies, we or our licensees or collaborators could decide to discontinue development of any or all of these projects at any time for commercial, scientific, or other reasons.
The FDA currently regulates IVD devices under the authority of Section 201(h) of the Federal Food, Drug, and Cosmetic Act. To date, the FDA has exercised its regulatory enforcement discretion to not regulate LDTs as a medical device and exempted from regulation LDTs created and used within a single laboratory. However, at a July 2010 FDA public meeting on oversight of tests, the FDA stated that it was reconsidering its enforcement discretion policy. The FDA commented that regulation of LDTs may be warranted because of the growth in the volume and complexity of testing services utilizing LDTs. On July 31, 2014 the FDA notified the U.S. Congress of its intent to issue draft guidance on regulation of LDTs based on risk to patients rather than whether they were made by a conventional manufacturer or a single laboratory. This draft guidance includes pre-market review for higher-risk LDTs, like those used to guide treatment decisions, including companion diagnostics that have entered the market as LDTs. In addition, under the draft guidance, the FDA would continue to exercise enforcement discretion for LDTs used solely for forensic purposes and LDTs used in CLIA-certified high complexity histocompatibaility labs for transplantation, among others. The final regulation would be phased in over many years. On September 30, 2014, the FDA posted on its website draft guidance on regulation of LDTs, maintaining a ‘risk-based’ approach outlined in its notice to U.S. Congress on July 31, 2014. The published draft guidance is identical to the congressional notification. On October 3, 2014, the FDA published notices in the Federal Register formally announcing the release of the draft guidance and the beginning of a 120-day public comment period, with final guidance potentially issued in the March-April 2015 timeframes. Our revenues from testing services utilizing LDTs comprise almost 100% of our total revenues.
In addition to the potential regulation of LDTs by FDA as mentioned above, certification of the laboratory is required under CLIA to ensure the accuracy and reliability of all laboratory testing, except research, on human specimens through a quality assurance program, which includes standards in the areas of personnel qualifications, administration and participation in proficiency testing, patient test management and quality control procedures. In addition, state laboratory licensing and inspection requirements may also apply.
We cannot predict the extent of the FDA's final guidance on regulation of LDTs in general or with respect to our LDTs in particular. If we are unable to comply with the FDA's final guidance on regulation of LDTs, we may have to cease our testing services which could have a material adverse effect on our business, results of operations, financial condition and cash flows. Additionally, if we are unable to successfully launch any additional LDTs or if we are otherwise required to obtain FDA premarket clearance or approval prior to commercializing any of our products or are not able to comply with any other regulatory requirements that the FDA may impose on LDTs, our ability to generate revenues from providing such products may be delayed and we may never be able to generate significant revenues from providing diagnostic products.
The results of preclinical and clinical studies are not necessarily predictive of future results, and our current diagnostic tests and product candidates may not have favorable results in later studies.
We intend to publish results of certain of our studies, and have published studies of our tests, and there can be no assurance that such results when published will be viewed favorably by clinicians, patients or investors. In addition, our scientific collaborators and other third parties may also publish results relating to their own studies. There can be no assurance that the results of their studies when published will be viewed favorably. If such results are not viewed favorably after publication, it could have a negative impact on the perception of our technology and its tests.
Performance achieved in published studies may not be repeated in later studies that may be required to obtain either FDA premarket clearance or approval. Limited results from earlier-stage verification studies may not predict results from studies in larger numbers of subjects drawn from more diverse populations over a longer period of time. Unfavorable results from ongoing preclinical and clinical studies could result in delays, modifications or abandonment of ongoing or future clinical studies, or abandonment of a product development program or may delay, limit or prevent regulatory approvals or commercialization.
We and our licensees and collaborators may not be successful in developing or commercializing diagnostic products or tests, including noninvasive prenatal diagnostic products or tests, or other products or tests using technologies, services, or discoveries.
Development of products or tests by us, our licensees, or our collaborators are subject to risks of failure inherent in the development and commercial viability of any such product or test, such as demand for such product or test. These risks further include the possibility that such product or test would:
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be found to be ineffective, unreliable, inadequate or otherwise fail to receive regulatory clearance or approval or be subject to new or additional regulatory requirements;
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be difficult or impossible to manufacture or perform on a commercial scale;
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be uneconomical to market or otherwise not be effectively marketed;
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fail to be successfully commercialized if adequate reimbursement from government health administration authorities, private health insurers, and other organizations for the costs of such product is unavailable;
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be impossible to commercialize because such product or test infringes on the proprietary rights of others or competes with products marketed by others that are superior;
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fail to be commercialized prior to the successful marketing of similar products or tests by competitors; or
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be subject to competitive price erosion that makes it uneconomical to market effectively.
If a licensee discovers or develops diagnostic or other products or tests or we or a collaborator, discover or develop diagnostic or other products or tests using our technology, products, services, or discoveries, we may rely on that licensee or collaborator, referred to as partner, for product or test development, regulatory approval, manufacturing, and marketing of those products or tests before we can realize revenues and some or all of the milestone payments, royalties, or other payments we may be entitled to under the terms of the licensing or collaboration agreement. If we or our partners fail to develop successful products or tests, we will not earn the revenues contemplated and we could lose license rights to intellectual property that are required to commercialize such products or tests. Our agreements may allow our partners significant discretion in electing whether to pursue any of these activities. We cannot control the amount and timing of resources our partners may devote to our programs or potential products or tests. As a result, we cannot be certain that our partners will choose to develop or commercialize any products or tests or will be successful in doing so. In addition, if a partner is involved in a business combination, such as a merger or acquisition, or changes its business focus, its performance under its agreement with us may suffer and, as a result, we may not generate any revenues or only limited revenues from the royalty, milestone, and similar payment provisions contained in our agreement with that partner.
We may not be able to form and maintain the collaborative relationships or the rights to third-party intellectual property and technologies that our business strategy requires and such relationships may lead to disputes over technology rights or product revenue, royalties, or other payments.
We form research collaborations and licensing arrangements with collaborators to operate our business successfully. To succeed, we will have to maintain our existing relationships and establish additional collaborations and licensing arrangements. Our current strategy includes pursuing partnering opportunities with companies interested in or involved in the development of pharmaceutical and diagnostic products and tests. Our strategy also includes obtaining ownership of, or licenses to third-party intellectual property rights and technologies to potentially expand our product and testing portfolio and generate additional sources of revenue. Disputes may arise in connection with these collaborations and licensing arrangements, which may result in liability to us or may result in the loss of acquired technology that may adversely affect our business.
We cannot be sure that we will be able to establish any additional research collaborations, licensing arrangements, or other partnerships necessary to develop and commercialize products or that we can do so on terms favorable to us. If we are unable to establish these collaborations or licensing arrangements, we may not be able to successfully generate any milestone, royalty, or other revenues from sales of these products or applications. If our collaborations or licensing arrangements are not successful or we are not able to manage multiple collaborations successfully, our programs will suffer and we may never generate any revenues or only generate limited revenues from sales of products based on licensed rights or technologies or under these collaborative or licensing arrangements. If we increase the number of collaborations or licensing agreements, it will become more difficult to manage the various relationships successfully and the potential for conflicts among the collaborators and licensees or licensors will increase. Conflicts with our collaborators, licensees or licensors, or other factors may lead to disputes over technology or intellectual property rights or product revenue, royalties, or other payments, which may adversely affect our business, including our ability to generate revenues from the MaterniT21 PLUS test.
In addition, our government grants provide the government certain license rights to inventions resulting from funded work. Our business could be harmed if the government exercises those rights.
The agreements and rights we rely upon to protect the intellectual property underlying our tests and technology may not be adequate, which could enable others to use our technology and reduce our ability to compete with them.
We require our employees, consultants, advisors, and collaborators to execute confidentiality agreements and in certain cases, assignment or license agreements. We cannot guarantee that these agreements will provide us with adequate intellectual property ownership or protection against improper or unauthorized use or disclosure of confidential information or inventions. In some situations, these agreements may conflict with or be subject to the rights of others with whom our employees, consultants, advisors, or collaborators have prior employment or consulting relationships. In some situations these types of agreements or relationships are subject to foreign law, which provides us with less favorable rights or treatment than under U.S. law. Others may gain access to our inventions, trade secrets or independently develop substantially equivalent proprietary materials, products, information, and techniques.
Our business and industry are subject to complex and costly regulation and if government regulations are interpreted or enforced in a manner adverse to us, we may be subject to enforcement actions, penalties, exclusion, and other material limitations on our operations.
We are subject to various federal, state and local laws targeting fraud and abuse in the health care industry, including anti-kickback and false claims laws. The federal Anti-Kickback Statute prohibits persons from knowingly and willfully soliciting, offering, receiving or providing remuneration, directly or indirectly, in exchange for or to induce either the referral of an individual, or the furnishing or arranging for a good or service, for which payment may be made under a federal health care program, such as Medicare or Medicaid. The definition of “remuneration” has been broadly interpreted to include anything of value, including, for example, gifts, discounts, the furnishing of free supplies, equipment or services, credit arrangements, payments of cash and waivers of payment. Several courts have interpreted the statute's intent requirement to mean that if any one purpose of an arrangement involving remuneration is to induce referrals of federal healthcare covered business, the statute has been violated. The PPACA, among other things, amends the intent requirement of the federal Anti-Kickback Statute and certain criminal health care fraud statutes to provide that a person or entity no longer needs to have actual knowledge of this statute or specific intent to violate it. In addition, the PPACA provides that the government may assert that a claim including items or services resulting from a violation of the federal Anti-Kickback Statute constitutes a false or fraudulent claim for purposes of the federal civil False Claims Act or the civil monetary penalties statute, which imposes penalties against any person who is determined to have presented or caused to be presented a claim to a federal health program that the person knows or should know is for an item or service that was not provided as claimed or is false or fraudulent.
The Anti-Kickback Statute is broad and prohibits many arrangements and practices that are lawful in businesses outside of the health care industry. Recognizing that the Anti-Kickback Statute is broad and may technically prohibit many innocuous or beneficial arrangements, Congress authorized the HHS Office of Inspector General, or OIG, to issue a series of regulations,
known as “safe harbors.” These safe harbors set forth requirements that, if met in their entirety, will assure health care providers and other parties that they most likely will not be prosecuted under the Anti-Kickback Statute. The failure of a transaction or arrangement to fit precisely within one or more safe harbors does not necessarily mean that it is illegal, or that prosecution will be pursued. However, conduct and business arrangements that do not fully satisfy each applicable safe harbor may result in increased scrutiny by government enforcement authorities, such as the OIG. Penalties for violations of the federal Anti-Kickback Statute include criminal penalties and civil sanctions such as fines, imprisonment and possible exclusion from Medicare, Medicaid and other healthcare programs. Many states have adopted laws similar to the Anti-Kickback Statute. Some of these state prohibitions apply to referral of patients for health care items or services reimbursed by any payor, not only the Medicare and Medicaid programs, and do not contain identical safe harbors. Government officials have brought cases against numerous companies and certain sales and marketing personnel for allegedly offering unlawful inducements to potential or existing customers in an attempt to procure their business.
In addition to the Anti-Kickback Statute, we are also subject to the physician self-referral laws, commonly referred to as the Stark law, which generally prohibits physicians from referring Medicare patients to providers of “designated health services,” including clinical laboratories, with whom the physician or the physician's immediate family member has an ownership interest or compensation arrangement, unless an applicable exception applies. The Stark law is a strict liability statute, meaning that a violation may occur regardless of the parties' intent. Moreover, many states have adopted or are considering adopting similar laws, some of which extend beyond the scope of the Stark law to prohibit the payment or receipt of remuneration for the prohibited referral of patients for designated health care services and physician self-referrals, regardless of the source of the payment for the patient's care. Penalties for violations of the Stark law include denial of payment, refund of payment, imposition of up to $15,000 in civil monetary penalties for each claim submitted in violation of the law, up to $100,000 in civil monetary penalties for each “arrangement or scheme” that violates the law, a civil monetary penalty of three times the amount claimed, and exclusion from participation in the Medicare program and/or other government health programs. If it is determined that certain of our practices or operations violate the Stark law or similar statutes, the imposition of any such penalties could harm our business.
Another development affecting the health care industry is the increased use of the federal civil False Claims Act and, in particular, actions brought pursuant to the False Claims Act's “whistleblower” or “qui tam” provisions. The False Claims Act imposes liability on any person or entity that, among other things, knowingly presents, or causes to be presented, a false or fraudulent claim for payment by a federal health care program. The qui tam provisions of the False Claims Act allow a private individual to bring actions on behalf of the federal government alleging that the defendant has submitted a false claim to the federal government, and to share in any monetary recovery. In recent years, the number of suits brought by private individuals has increased dramatically. In addition, various states have enacted false claim laws analogous to the False Claims Act. Many of these state laws apply where a claim is submitted to any third-party payor and not merely a federal health care program. When an entity is determined to have violated the False Claims Act, it may be required to pay up to three times the actual damages sustained by the government, plus civil penalties of $5,500 to $11,000 for each separate false claim. There are many potential bases for liability under the False Claims Act. Liability arises, primarily, when an entity knowingly submits, or causes another to submit, a false claim for reimbursement to the federal government. The False Claims Act has been used to assert liability on the basis of, among other things, inadequate care, kickbacks and other improper referrals, improper use of Medicare numbers when detailing the provider of services, and allegations as to misrepresentations with respect to the services rendered. Our activities relating to the sale and marketing of our products may be subject to scrutiny under these laws. Also, the Health Insurance Portability and Accountability Act of 1996, or HIPAA, created several new federal crimes, including health care fraud and false statements relating to health care matters. The health care fraud statute prohibits knowingly and willfully executing a scheme to defraud any health care benefit program, including private third-party payors. The false statements statute prohibits knowingly and willfully falsifying, concealing or covering up a material fact or making any materially false, fictitious or fraudulent statement in connection with the delivery of or payment for health care benefits, items or services. We are unable to predict whether we would be subject to actions under the False Claims Act or a similar state law, or under the federal crimes created by HIPAA, or the impact of such actions. However, the costs of defending such claims, as well as any sanctions imposed, could significantly adversely affect our financial performance.
Federal law prohibits any entity from offering or transferring to a Medicare or Medicaid beneficiary any remuneration that the entity knows or should know is likely to influence the beneficiary's selection of a particular provider, practitioner or supplier of Medicare or Medicaid payable items or services, including waivers of copayments and deductible amounts (or any part thereof) and transfers of items or services for free or for other than fair market value. Entities found in violation may be liable for civil monetary penalties of up to $10,000 for each wrongful act. Although we believe that our sales and marketing practices are in material compliance with all applicable federal and state laws and regulations, relevant regulatory authorities may disagree, and violation of these laws or our exclusion from such programs as Medicaid and other governmental programs as a result of a violation of such laws could have a material adverse effect on our business, results of operations, financial condition and cash flows.
Ethical, privacy, or other concerns about the use of genetic information could reduce demand for our products and services.
Genetic testing has raised ethical issues regarding privacy and the appropriate uses of the resulting information. For these reasons, governmental authorities may limit or otherwise regulate the use of genetic testing, including the MaterniT21 PLUS test, or prohibit testing for genetic predisposition to certain conditions, particularly for those that have no known cure. Such concerns may lead individuals to refuse to use genetics tests even if permitted and may lead to negative public relations. Any of these scenarios could reduce the potential markets for our products and services, which would seriously harm our business, financial condition, and results of operations.
If the validity of an informed consent from a subject was to be challenged, we could be forced to stop using some of our resources, which would hinder our diagnostic product development efforts.
We have measures in place to ensure that all clinical data and genetic and other biological samples that we receive from our clinical collaborators have been collected from subjects who have provided appropriate informed consent for the data and samples provided for purposes which extend to include commercial diagnostic product and test development activities. We have measures in place to ensure that data and samples that have been collected by our clinical collaborators are provided to us on a subject de-identified manner. We also have measures in place to ensure that the subjects from whom our data and samples are collected do not retain or have conferred on them any proprietary or commercial rights to the data or any discoveries derived from them. Our clinical collaborators are based in a number of different countries, and, to a large extent, we rely upon our clinical collaborators for appropriate compliance with the subject's informed consent provided and with local law and international regulation. That our data and samples come from and are collected by entities based in different countries results in complex legal questions regarding the adequacy of informed consent and the status of genetic material under a large number of different legal systems. The subject's informed consent obtained in any particular country could be challenged in the future, and those informed consents could prove invalid, unlawful or otherwise inadequate for our purposes. Any findings against us, or our clinical collaborators, could deny us access to or force us to stop using some of our clinical samples, which would hinder our diagnostic product and test development efforts. We could become involved in legal challenges, which could consume our management and financial resources.
If we cannot obtain licenses to patented genetic markers and genes relevant to our diagnostic areas of interest, we could be prevented from obtaining significant revenues or becoming profitable.
The USPTO has issued patents claiming single SNP and gene discoveries and their related associations and functions. The law is evolving and the validity of those types of patents has been and continues to be unclear. If certain SNPs and genes are patented, the validity of such patents is unclear and it is uncertain whether we may need to obtain rights to those SNPs and genes to develop, use, and sell related assays and other types of products or services utilizing such SNPs and genes. Required licenses may not be available on commercially acceptable terms. If we were to fail to obtain licenses to certain patented SNPs and genes claimed under valid patents, we might never achieve significant revenues from our diagnostic product development.
We may not be able to successfully adapt or maintain our products for commercial applications.
A number of potential applications of our technology and potential products and tests, including diagnostic applications for noninvasive prenatal and other molecular testing, may require significant enhancements in our core technology or the in-licensing of intellectual property rights or technologies. In connection with developing new products and applications, we may not effectively deploy our research and development efforts in a cost-efficient manner or otherwise in a manner that leads to the successful commercialization and scale-up of such products and applications. If we are not successful enhancing our technology or the in-licensing of technology our products or tests may not achieve or maintain a significant level of market acceptance, and our business, financial condition and results of operations could be seriously harmed.
We may not be able to successfully compete in the diagnostic industry.
The diagnostic industry is highly competitive. We expect to compete with a broad range of companies in the U.S. and other countries that are engaged in the development and production of products, tests, applications, services, and strategies to develop and commercialize diagnostic, noninvasive prenatal diagnostic, oncology and other products and tests for customers in the molecular medicine fields as well as diagnostic service laboratories and customers in other markets. They include:
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biotechnology, diagnostic, and other life science companies;
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academic and scientific institutions;
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governmental agencies; and
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public and private research organizations.
Some of our competitors and/or potential competitors have greater financial, technical, research, marketing, sales, distribution, operations, service, and other resources than we do. Our competitors may offer broader product lines and services
and have greater name recognition than we do. Several companies are currently offering, making, or developing products and tests that compete with our tests. Our competitors may develop or market technologies, tests or products that are more effective or commercially attractive than our current or future tests or products that may render our technologies or products or tests obsolete or that have superior intellectual property rights. We have limited experience in the field of oncology and we cannot guarantee that our research and development activities will be successful in developing any marketable oncology testing service.
If we do not effectively manage our business as it grows and evolves, it could affect our internal operations as well as our ability to pursue opportunities and expand our business.
As our development and commercialization plans and strategies develop, we expect to expand our employee base for managerial, operational, sales, marketing, financial and other resources. Future growth would impose significant added responsibilities on members of management, including the need to identify, recruit, maintain, motivate and integrate additional employees. Also, our management may need to divert a disproportionate amount of its attention away from our day-to-day activities and devote a substantial amount of time to managing these growth activities. We may not be able to effectively manage the expansion of our operations, which may result in weaknesses in our infrastructure and may impact our ability to maintain effective internal controls for financial reporting. In addition, evolution in our business, particularly our transition to developing and commercializing molecular diagnostic tests, has placed and may continue to place a significant strain on our personnel, facilities, management systems, information technology infrastructure, disclosure controls, internal controls and resources. If we fail to effectively manage the evolution of our business and the transition to also being a provider of diagnostic products and tests, or fail to take other necessary action to maintain close coordination among our various departments, our ability to execute on our business plan, maintain our credibility, pursue business opportunities, maintain and expand our business, and sell our products and tests in new markets may be adversely affected.
We may not successfully complete the sale, or acquisition of, or merger, or joint venture with businesses that we desire to acquire, merge, or partner with.
We may acquire additional businesses or technologies, merge or form joint ventures with other businesses, or enter into other strategic transactions. Managing and completing future acquisitions, mergers, joint ventures, sales, or other strategic transactions entails numerous operational and financial risks, including:
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the inability to retain key employees of any acquired or merged businesses or hire enough qualified personnel to staff any new or expanded operations;
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the impairment of relationships with key customers of acquired or merged businesses due to changes in management and ownership of the acquired or merged businesses;
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the inability to sublease on financially acceptable terms excess leased space or terminate lease obligations of acquired or merged businesses that are not necessary or useful for the operation of our business;
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the exposure to federal, state, local and foreign tax liabilities in connection with any acquisition or merger or the integration of any acquired or merged businesses;
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the exposure to unknown liabilities or disputes with the former stakeholders or management or employees of acquired or merged businesses;
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higher than expected acquisition or merger and integration expenses that would cause our quarterly and annual operating results to fluctuate;
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increased amortization expenses if an acquisition or merger results in significant intangible assets;
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combining the operations and personnel of acquired businesses with our own, which would be difficult and costly;
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disputes over rights to acquired or accessed technologies or with licensors or licensees of those technologies; and
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integrating or completing the development and application of any acquired or accessed technologies, which would disrupt our business and divert management's time and attention.
We may also attempt to acquire businesses or technologies, merge businesses or form joint ventures, or attempt to enter into strategic transactions that we are unable to complete. If we are unable to complete such transactions, we may expend substantial resources and ultimately not successfully complete the transaction. Such transactions may also distract management and result in other adverse effects on our business and operations. These transactions may also involve the issuance of shares of our capital stock, which may result in dilution to our stockholders.
We may potentially compete with our customers or licensees, which may adversely affect our business.
We have entered into diagnostic test services agreements and license agreements, for the MaterniT21 PLUS test, substantially similar tests, and other test services. Some of these contractual partners send patient samples to Sequenom Laboratories for test services and other partners perform the testing in their own laboratory or plan to do so in the future. In addition, we expect more third-party laboratories will license the pooled intellectual property created as a result of the Pooled Patents Agreement. Although there are many potential business opportunities, our customers and licensees may seek diagnostic
testing service business from clients or potential clients that we already have as clients or have chosen to pursue. In such cases we will likely compete against our customers or licensees. Competition from our customers or licensees may adversely affect our business or our ability to successfully commercialize our diagnostic testing services.
If we cannot attract and retain highly-skilled personnel, our growth might not proceed as rapidly as we intend and our business may be adversely affected.
The success of our business will depend on our ability to identify, attract, hire, train, retain, maintain, and motivate highly skilled personnel, particularly sales, scientific, medical, laboratory, CLIA laboratory, and technical personnel, for our future success. Competition for highly skilled personnel is intense, in particular for licensed laboratory technicians in the state of California, and we might not succeed in attracting and retaining these employees. If we cannot attract and retain the personnel we require, we would not be able to expand our business as rapidly as we intend. When we seek to hire personnel to fill open positions, we may be unable to hire qualified replacements for the positions that we need to fill, and there may be significant costs associated with the recruiting, hiring and retention of officers and employees for the open positions. The market price of our common stock has decreased over time, which has reduced the retention value of many of our prior equity awards made to our employees and officers. If we lose key employees, officers, scientists, physician collaborators or if our management team is not able to effectively manage us through these events, our business, financial condition, and results of operations may be adversely affected. We do not carry “key person” insurance covering any of our officers or other employees.
Our success is dependent on the performance of our executive officers and key employees, and any accident or disability suffered by an executive officer or key employee could adversely impact our business.
Our business and operations are substantially dependent on the performance of our executive officers and key employees. If an executive officer is incapacitated or disabled by accident, sickness or otherwise so as to render such individual mentally or physically incapable of performing the services and duties required to be performed by such individual, it may adversely impact our results of operations and financial condition.
We incur significant costs as a result of operating as a public company and our management expects to continue to devote substantial time to public company compliance programs.
As a public company, we incur significant legal, accounting and other expenses due to our compliance with regulations and disclosure obligations applicable to us, including compliance with the Sarbanes-Oxley Act of 2002, or the Sarbanes-Oxley Act, as well as rules implemented by the SEC and The NASDAQ Stock Market. The SEC and other regulators have continued to adopt new rules and regulations and make additional changes to existing regulations that require our compliance. In July 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act, or the Dodd-Frank Act, was enacted. There are significant corporate governance and executive compensation related provisions in the Dodd-Frank Act that have required the SEC to adopt additional rules and regulations in these areas. Stockholder activism, the current political environment and the current high level of government intervention and regulatory reform may lead to substantial new regulations and disclosure obligations, which may lead to additional compliance costs and impact (in ways we cannot currently anticipate) the manner in which we operate our business. Our management and other personnel devote a substantial amount of time to these compliance programs and monitoring of public company reporting obligations and, as a result of the new corporate governance and executive compensation related rules, regulations and guidelines prompted by the Dodd-Frank Act and further regulations and disclosure obligations expected in the future, we will likely need to devote additional time and costs to comply with such compliance programs and rules. These rules and regulations will continue to cause us to incur significant legal and financial compliance costs and will make some activities more time-consuming and costly.
We are subject to risks associated with our foreign business activities.
We expect that a portion of our sales will continue to be made outside the U.S. Revenues from our international licensees increased during the year ended December 31, 2014. A successful international effort will require us to develop relationships with international customers and collaborators, including licensees and distributors. We may not be able to identify, attract, retain, or maintain suitable international customers or collaborators. Expansion into international markets may require us to hire additional personnel to develop relationships with foreign customers and collaborators, licensees or distributors and maintain good relations with our foreign customers and collaborators, licensees or distributors. International business activities include many of the same risks to our business that affect our domestic operations, but also involve a number of risks not typically present in domestic operations, including:
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currency fluctuation risks;
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changes in regulatory requirements;
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licenses, tariffs, and other trade barriers;
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political and economic instability and possible country-based boycotts;
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potentially adverse tax consequences;
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compliance with the Foreign Corrupt Practices Act and other countries’ anti-corruption laws;
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the burden of complying with a wide variety of complex foreign laws and treaties; and
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different rules, regulations, and policies governing intellectual property protection and enforcement.
Our international business is subject to additional laws and regulations that could result in increased operational costs and risk. For example, the European Union, or EU, is currently in the midst of reviewing updates to the EU Privacy Directive that would result in additional requirements and costs if passed, such as the appointment of a dedicated privacy officer and increased civil and criminal penalties in the event of any loss or unauthorized disclosure of private information related to any resident of the EU.
We must be in compliance with state and federal security and privacy regulations, which may increase our operational costs.
The privacy and security regulations under HIPAA establish comprehensive federal standards with respect to the uses and disclosures of protected heath information, or PHI, by health plans and health care providers, in addition to setting standards to protect the confidentiality, integrity and availability of electronic PHI. The regulations establish a complex regulatory framework on a variety of subjects, including, without limitation:
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the circumstances under which uses and disclosures of PHI are permitted or required without a specific authorization by the patient, including but not limited to treatment purposes, to obtain payments for services and health care operations activities;
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a patient's rights to access, amend and receive an accounting of certain disclosures of PHI;
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the content of notices of privacy practices for PHI; and
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administrative, technical and physical safeguards required of entities that use or receive PHI electronically.
The Health Information Technology for Economic and Clinical Health Act of 2009, or HITECH, which became effective on February 17, 2010, makes HIPAA's privacy and security standards directly applicable to “business associates”-independent contractors or agents of covered entities that have access to protected health information in connection with providing a service on behalf of a covered entity. We are a covered entity and also a business associate of our covered entity customers. Among other things, HITECH also increased the civil and criminal penalties that may be imposed against covered entities, business associates and possibly other persons, and gave state attorneys general new authority to file civil actions for damages or injunctions in federal courts to enforce the federal HIPAA laws and seek attorney's fees and costs associated with pursuing federal civil actions.
As we expand our business we must continue to implement policies and procedures related to compliance with the HIPAA privacy and security regulations, as required by law, which may increase our operational costs. Furthermore, the privacy and security regulations provide for significant fines and other penalties for wrongful use or disclosure of PHI, including potential civil and criminal fines and penalties. We have evaluated the security of our computer networks and determined that appropriate measures are in place to safeguard PHI contained on such networks. However, no security system is invulnerable to breach, and unauthorized persons may in the future be able to exploit weaknesses in the security systems of our computer networks and gain access to such PHI. Additionally, we share PHI with third-party contractors who are contractually obligated to safeguard and maintain the confidentiality of PHI. Unauthorized persons may be able to gain access to PHI stored in such third-party contractors' computer networks. Any wrongful use or disclosure of PHI by us or our third-party contractors, including disclosure due to data theft or unauthorized access to our or our third-party contractors' computer networks, could subject us to fines or penalties that could adversely affect our business and results of operations. Although the HIPAA statute and regulations do not expressly provide for a private right of damages, we also could incur damages under state laws to private parties for the wrongful use or disclosure of confidential health information or other private personal information by us or our third-party contractors.
In addition, different states and foreign nations, such as the EU, also impose certain requirements on the collection of all types of personal information. For example, the European Union Privacy Directive requires that we adhere to certain “safe harbor” requirements with respect to any personal information of a European resident or customer while various states in the U.S. have implemented equally restrictive requirements, such as 201 CMR 17.00, which requires that any company that obtains personal information of any resident of the Commonwealth of Massachusetts implement and maintain a security program that adequately protects such information from unauthorized use or disclosure. As a business that operates both internationally and across all fifty states, any wrongful use or disclosure of personally identifiable information, even if it does not constitute PHI, by us or our third-party contractors, including disclosure due to data theft or unauthorized access to our or our third-party contractors' computer networks, could subject us to fines or penalties that could adversely affect our business and results of operations, including the cost of providing credit monitoring and identity theft prevention services to affected consumers and loss of EU Safe harbor certification.
Security threats to our IT infrastructure and/or our physical buildings could expose us to liability, and damage our reputation and business.
It is essential to our business strategy that our technology and network infrastructure and our physical buildings remain secure and are perceived by our customers and corporate partners to be secure. Despite security measures, however, any network infrastructure may be vulnerable to cyber-attacks by hackers and other security threats. As a leader in the field of molecular diagnostic testing and genetics analysis, we may face cyber-attacks that attempt to penetrate our network security, including our data centers, to sabotage or otherwise disable our research, products and services, misappropriate our or our customers' and partners' proprietary information, which may include personally identifiable information, or cause interruptions of our internal systems and services. Despite security measures, we also cannot guarantee security of our physical buildings. If successful, physical building penetration or any cyber-attacks could negatively affect our reputation, damage our network infrastructure and our ability to deploy our products and services, and harm our relationship with customers and partners that are affected, and expose us to financial liability. We maintain cyber security risk insurance coverage, however any uncovered claim or a claim in excess of our insurance coverage would have to be paid out of our cash reserves, which could have a detrimental effect on our financial condition. It is difficult to determine whether we have sufficient insurance coverage to cover potential claims. Also, we may not be able to procure or maintain insurance policies with desirable levels of coverage on commercially acceptable terms, or at all. We can provide no assurance that we will be able to avoid significant claims, which could hurt our reputation and our financial condition.
We may not have adequate insurance if we become subject to product liability or other claims.
Our business exposes us to potential product liability and other types of claims and our exposure will increase as we and Sequenom Laboratories and our partners and collaborators expand commercialization of our tests including the MaterniT21 PLUS test. We have product and general liability insurance that covers us against specific product liability and other claims up to an annual aggregate limit of $30.0 million and $2.0 million, respectively. Any claim in excess of our insurance coverage would have to be paid out of our cash reserves, which would have a detrimental effect on our financial condition. It is difficult to determine whether we have obtained sufficient insurance to cover potential claims. Also, we cannot assure you that we can or will maintain our insurance policies on commercially acceptable terms, or at all. We can provide no assurance that we will be able to avoid significant product liability claims, which could hurt our reputation and our financial condition.
Responding to claims relating to improper handling, storage or disposal of hazardous chemicals, and radioactive and biological materials that we use could be time consuming and costly.
We use controlled hazardous and radioactive materials in the conduct of our business, as well as biological materials that have the potential to transmit disease. The risk of accidental contamination or injury from these materials cannot be completely eliminated. If an accident with these substances occurs, we could be liable for any damages that result, which could seriously harm our business. Additionally, an accident could damage our research and manufacturing facilities and operations, resulting in delays and increased costs. Such damage and any expense resulting from delays, disruptions, or any claims may not be covered by our insurance policies.
Hostile takeover bids and unsolicited offers could adversely impact our value and cause the trading price of our common stock to fall.
The current economic environment may encourage potential acquirers to make unsolicited and under-priced offers to acquire our business. If we are the target of a hostile takeover bid or unsolicited offer that undervalues our company, such hostile takeover bid or unsolicited offer may adversely impact public perception of the value of our company, which could cause the trading price of our common stock to fall. In addition, such hostile takeover bids or unsolicited offers may distract management and result in other adverse effects on our business and operations.
Our stock price has been and may continue to be volatile, and your investment could suffer a decline in value.
The trading price of our common stock has been volatile and could be subject to wide fluctuations in price in response to various factors, many of which are beyond our control, including but not limited to:
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our ability to generate cash flow and continue as a going concern;
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actual or anticipated variations in quarterly and annual operating results;
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announcements regarding technological innovations, intellectual property rights, the outcome of patent litigation, research and development progress or setbacks, or product launches by us or our competitors;
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our success in entering into, and the success in performing under, licensing and product and test development and commercialization agreements with others;
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the success of validation studies for tests under development and our ability to continue to publish study results in peer-reviewed journals;
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our success in and the expenses associated with researching, developing, commercializing, and obtaining reimbursement for diagnostic products and tests, alone or in collaboration with our partners and obtaining any required regulatory approval for those products and tests;
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the status of litigation against us; and
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securities analysts' earnings projections or recommendations, third-party research recommendations, or general market conditions.
The stock market in general, The NASDAQ Global Select Market, and the market for life sciences companies in particular, have experienced extreme price and volume fluctuations that may have been unrelated or disproportionate to the operating performance of the listed companies. These price fluctuations may be rapid and severe and may leave investors little time to react. Broad market and industry factors may seriously harm the market price of our common stock, regardless of our operating performance, and may expose us to potential securities class-action litigation.
We have in the past identified material weaknesses in our internal control over financial reporting which could, if not effectively remediated, result in additional material misstatements in our financial statements.
Our management is responsible for establishing and maintaining adequate internal control over our financial reporting, as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934, as amended. As disclosed in Item 9A of our 2012 Annual Report on Form 10-K, management identified material weaknesses in our internal control over financial reporting. A material weakness is defined as a deficiency, or combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of our annual or interim financial statements will not be prevented or detected on a timely basis. As a result of these material weaknesses in conjunction with the 2012 Annual Report, our management concluded at that time that our internal control over financial reporting was not effective based on criteria set forth by the Committee of Sponsoring Organization of the Treadway Commission in Internal Control-An Integrated Framework. In 2013, we implemented a remediation plan designed to address these material weaknesses. If our remedial measures are insufficient to address the material weaknesses, or if additional material weaknesses or significant deficiencies in our internal control are discovered or occur in the future, our consolidated financial statements may contain material misstatements and we could be required to restate our financial results, which could lead to substantial additional costs for accounting and legal fees.
Item 1B.
Item 1B.
UNRESOLVED STAFF COMMENTS
None.
Item 2.
Item 2. PROPERTIES
We are headquartered in San Diego, California and have laboratory locations in San Diego, California, Grand Rapids, Michigan, and Raleigh-Durham, North Carolina. Collectively, we lease or sublease approximately 193,000 square feet under leases that expire at various dates through September 2025, each of which contains laboratory, office, R&D or storage facilities.
The San Diego site is our company headquarters and houses our selling, general and administrative offices, and research and development facilities. The San Diego site consists of three buildings. One of the buildings, which was added in early 2013, is vacant. The lease expires in July 2015 and is currently marketed by us for sublease. We sublease through January 1, 2016, a portion of another San Diego building from the company that purchased our Bioscience segment in 2014.
Locations in Grand Rapids, Michigan, Raleigh-Durham, North Carolina, and San Diego, California, house our CLIA-certified, CAP-accredited molecular diagnostics laboratory and selling, general and administrative offices. We believe our facilities are adequate for our current needs.
Item 3.
Item 3. LEGAL PROCEEDINGS
Patent Litigation
In December 2011, we were named as a defendant in a complaint filed by plaintiff Aria Diagnostics, Inc., in the U.S. District Court for the Northern District of California, case no. 3:11-cv-06391-SI. Since the complaint was filed, Aria changed its name to Ariosa Diagnostics, Inc., or Ariosa. In the complaint, the plaintiff seeks a judicial declaration that no activities related to the plaintiff's noninvasive, prenatal test using cell-free DNA circulating in the blood of a pregnant woman do or will infringe any claim of U.S Patent No. 6,258,540 entitled Noninvasive Prenatal Diagnosis, or the '540 Patent, which was exclusively in-licensed from Isis prior to September 30, 2014, when we purchased the patent from Isis. In March 2012, we filed an answer to the complaint and asserted counterclaims that Ariosa is infringing the '540 Patent and seeking unspecified damages and injunctive relief. Our counterclaims name Isis as a nominal counter-defendant for purposes of subject matter jurisdiction only. With the purchase of the '540 Patent, we will seek to dismiss Isis from the lawsuit as soon as practicable. In
March 2012, Ariosa responded to our answer and counterclaims and asserted affirmative defenses including invalidity of the '540 Patent under U.S. patent laws. In March 2012, we filed a motion against Ariosa for preliminary injunctive relief. On July 5, 2012, the Court denied our motion for preliminary injunctive relief and on July 16, 2012, we filed a Notice of Appeal to the U.S. Court of Appeals for the Federal Circuit (CAFC) from the order denying the preliminary injunction motion. On August 9, 2013, the CAFC vacated and remanded the District Court’s decision, ruling that the District Court incorrectly interpreted the claims of the ‘540 Patent and improperly balanced factors regarding issuance of a preliminary injunction. On August 16, 2013, Ariosa filed a motion for summary judgment in favor of Ariosa on our counterclaim for patent infringement on the ground that the claims of the ‘540 Patent are invalid because they are not drawn to patent-eligible subject matter under the patent code, Title 35 U.S.C. § 101. On October 16, 2013, the District Court issued its order on the interpretation of the claims of the patent. On October 30, 2013, the District Court issued its order granting Ariosa’s motion for summary judgment, finding that the’540 Patent is invalid under Title 35 U.S.C. §101. The Company disagrees with the Order and has appealed the decision to the U.S. Court of Appeals for the Federal Circuit. We intend to vigorously defend against the judicial declarations sought by Ariosa in its complaint and intend to vigorously pursue our claims against Ariosa for damages and injunctive relief. However, the Company cannot predict the outcome of this matter.
In addition, Ariosa has sought to invalidate the ‘540 Patent through a petition for inter parties review ("IPR") (Case IPR2012-00022 (MPT)) under 35 U.S.C. section 312 and 37 C.F.R. section 42.108, before the Patent Trial and Appeal Board (PTAB) of the United States Patent and Trademark Office (USPTO). Trial of the IPR was held before the PTAB on January 24, 2014. The PTAB issued a Decision in the IPR on September 2, 2014, invalidating some claims but upholding the validity of other claims. Both we and Ariosa have requested reconsideration of the PTAB decision.
In January 2012, we were named as a defendant in a complaint filed by plaintiff Natera, a Delaware corporation, in the U.S. District Court for the Northern District of California, case no. 3:12-cv-00132-SI. In the complaint, the plaintiff seeks a judicial declaration that (i) activities related to the plaintiff's noninvasive, prenatal paternity test do not directly or indirectly infringe any claim of the '540 Patent, and (ii) one or more claims of the '540 Patent are invalid for failure to comply with the requirements of the patent laws of the U.S. In April 2012, we filed an answer to the complaint and asserted counterclaims that Natera and DNA Diagnostics Center, Inc., or DDC, are infringing the '540 Patent based on their activities relating to noninvasive prenatal paternity testing and noninvasive prenatal aneuploidy testing and seeking unspecified damages and injunctive relief. Our counterclaims named Isis as a nominal counter-defendant for purposes of subject matter jurisdiction only and we seek to dismiss Isis as soon as practicable now that we have purchased the '540 patent from Isis. On October 16, 2013 the District Court issued its order on the interpretation of the patent claims. Many of the ‘540 Patent claims asserted against Natera are the same claims that were invalidated by the same District Court on October 30, 2013 in the litigation involving Ariosa, set forth above, and we and Natera stipulated to final judgment on the '540 patent claims in this case and have appealed the patent invalidity determination to the U.S. Court of Appeals for the Federal Circuit, which has consolidated the Ariosa, Natera, and Verinata case appeals. We intend to vigorously defend against the judicial declarations sought by Natera in its complaint and intend to vigorously pursue our claims against Natera for damages and injunctive relief. However, we cannot predict the outcome of this matter.
In February 2012, we and Sequenom Center for Molecular Medicine, LLC, were named as defendants in a complaint filed by plaintiffs Verinata Health, Inc., or Verinata, and The Board of Trustees of the Leland Stanford Junior University, or Stanford, in the U.S. District Court for the Northern District of California, case no. 3:12-cv-00865-SI. Verinata was acquired by Illumina, Inc. in 2013. In the complaint (i) Verinata seeks a judicial declaration that activities related to its noninvasive prenatal test using cell-free DNA circulating in the blood of a pregnant woman do not directly or indirectly infringe any claim of the '540 Patent, which at the time was exclusively in-licensed from Isis but has since been purchased from Isis, (ii) Verinata seeks a judicial declaration that each claim of the '540 Patent is invalid for failure to comply with the requirements of the patent laws of the U.S., and (iii) Verinata and Stanford allege that we and Sequenom Center for Molecular Medicine, by performing our noninvasive prenatal MaterniT21 test, have and continue to directly infringe U.S. Patent No. 8,008,018, or the '018 Patent, entitled Determination of Fetal Aneuploidies by Massively Parallel DNA Sequencing and U.S. Patent No. 7,888,017, or the '017 Patent, entitled Noninvasive Fetal Genetic Screening by Digital Analysis, each of which have been exclusively licensed to Verinata by Stanford and seek unspecified damages. In March 2012, we filed an answer to the complaint and asserted counterclaims that Verinata is infringing the '540 Patent and seeking unspecified damages and injunctive relief. Our counterclaims name Isis as a nominal counter-defendant for purposes of subject matter jurisdiction only. In June 2012, plaintiffs Verinata and Stanford amended their complaint and allege that we and Sequenom Center for Molecular Medicine, by performing its noninvasive prenatal MaterniT21 PLUS test, have and continue to directly infringe U.S. Patent No. 8,195,415, or the '415 Patent, entitled Noninvasive Diagnosis of Fetal Aneuploidy by Sequencing, which has been exclusively licensed to Verinata by Stanford and seek unspecified damages. In July 2012, we filed an answer to the complaint.
On October 16, 2013, the District Court issued its order on the interpretation of the ‘540 Patent, ‘018 Patent, ‘017 Patent, and ‘415 Patent claims. Many of the ‘540 Patent claims asserted against Verinata are the same claims that were invalidated by the same District Court on October 30, 2013 in the litigation involving Ariosa, set forth above, and we and Verinata stipulated to final judgment on the ‘540 patent claims in this case and have appealed the patent invalidity determination to the U.S. Court
of Appeals for the Federal Circuit. The District Court set trial beginning February 23, 2015 on the ‘018, ‘017, and ‘415 Patents. On December 2, 2014, Sequenom and Verinata reached a settlement that resolved litigation between them involving the ‘540 Patent, ‘018 Patent, ‘017 Patent, and ‘415 Patent, and all litigation between Sequenom and Verinata related to these patents is now dismissed. As part of that settlement, rights to the ‘540 Patent, ‘018 Patent, ‘017 Patent, and ‘415 Patent, along with other U.S. and foreign patents and pending applications, are now pooled under the Pooled Patents Agreement between Illumina (who acquired Verinata) and us. We and Verinata are now licensees to the patent rights that are pooled under the Pooled Patents Agreement.
On March 12, 2013 the U.S. Patent and Trademark Office, or USPTO, declared a patent interference (Patent Interference No. 105,920 (DK)) between Verinata's '018 Patent, which Verinata had asserted against us in the litigation, and our then in-licensed (from CUHK) pending patent application no. 13/070,275 (publication no. US2011/0318734 entitled “Diagnosing Fetal Chromosomal Aneuploidy Using Massively Parallel Genomic Sequencing”). Two related patent interferences (Patent Interference Nos. 105,923 and 105,924 (DK)) were declared by the USPTO between patent applications related to the patent and application in the ‘920 Interference. On April 7, 2014, the USPTO concluded the interferences, ruling that Verinata’s ‘018 Patent and related patent application lacked sufficient disclosure to meet the written description requirement for the patent claims, and entered judgment canceling all four of the ‘018 patent claims in the interference and the involved claims of the related patent application. Verinata has appealed the USPTO’s decision to the U.S. District Court for the Northern District of California. The District Court had set trial to beginning February 23, 2015 on the appeal from the ‘920, ‘923 and ‘924 interferences but has now stayed all proceedings indefinitely. On December 2, 2014, the involved patents and applications were added to the patent pool. We are not a party to the District Court proceedings.
On May 3, 2013, the USPTO declared a patent interference (Patent Interference No. 105,922 (DK)) between Verinata's '415 Patent, which Verinata has asserted against us in the litigation, and our then in-licensed (from CUHK) pending patent application no. 13/070,266 (publication no. US2012/0003637 entitled “Diagnosing Fetal Chromosomal Aneuploidy Using Massively Parallel Genomic Sequencing”). On April 7, 2014, the USPTO ruled that the pending patent application no. 13/070,266 has sufficient disclosure to meet the written description requirement for the patent claims and ordered the interference to proceed to the priority phase to determine which inventors were the first to invent the subject matter of the interference and entitled to a patent on that subject matter. We also separately challenged the validity of Verinata’s ‘415 Patent in an inter partes review proceeding before the USPTO (Case IPR 013-00390). The USPTO recently issued a decision in the ‘922 Interference and the ‘415 Patent IPR upholding the validity of the ‘415 patent. Pursuant to the terms of our settlement with Verinata, we will not appeal these decisions.
On September 29, 2014 and October 1, 2014 two unknown third parties initiated Opposition Proceedings against European Patent EP2183693 B1, entitled “Diagnosing Fetal Chromosomal Aneuploidy Using Genomic Sequencing,” in the European Patent Office. This patent was previously in-licensed by us from CUHK but has since been added to the patent pool under the Pooled Patents Agreement. We have rights to this patent under the patent pool but we no longer control efforts to defend this patent in the Opposition Proceedings.
In addition, from time to time, we may be involved in litigation relating to claims arising out of our operations in the normal course of business, including claims related to our products, tests, and services, including our LDT services. These other matters are, in the opinion of management, immaterial with respect to our consolidated financial position, liquidity, or results of operations.
Claim estimates that are probable and can be reasonably estimated are reflected as liabilities. Because of the uncertainties related to our pending litigation, investigations, inquiries or claims, management is currently unable to predict the ultimate outcome of any litigation, investigation, inquiry or claim, determine whether a liability has been incurred, or make an estimate regarding the possible loss or range of loss that could result from an unfavorable outcome. It is reasonably possible that some of the matters, which are pending or may be asserted, could be decided unfavorably to us. An adverse ruling or outcome in any lawsuit involving us could materially affect our business, liquidity, consolidated financial position or results of operations ability to sell one or more of our products or could result in additional competition. In view of the unpredictable nature of such matters, we cannot provide any assurances regarding the outcome of any litigation, investigation, inquiry or claim to which we are a party or the impact on us of an adverse ruling of such matters.
Item 4.
Item 4. MINE SAFETY DISCLOSURES
Not applicable.
PART II
Item 5.
Item 5.
MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Market Information
Our common stock is traded on The NASDAQ Global Select Market under the symbol “SQNM.” The following tables set forth the high and low sales prices for the Company's common stock as reported on The NASDAQ Global Select Market for the periods indicated.
Holders
There were approximately 255 holders of record of our common stock as of March 3, 2015.
Dividends
We have never paid cash dividends and do not anticipate any being paid in the foreseeable future. The indentures for our 5.00% Convertible Senior Notes due 2017, which notes are convertible into cash and in certain circumstances, shares of our common stock, require us to increase the conversion rate applicable to the notes if we pay any cash dividends.
Securities Authorized for Issuance Under Equity Compensation Plans
A description of our equity compensation plans is set forth in "Note. 8 Stock Compensation Plans" to the consolidated financial statements included elsewhere in this Annual Report.
Performance Graph*
The following graph compares the cumulative total stockholder return on our common stock between December 31, 2009 and December 31, 2014 with the cumulative total return of (i) the NASDAQ Biotechnology Index (ii) the NASDAQ Composite Index and (iii) NASDAQ Global Select Index, over the same period.
* This section is not “soliciting material”, is not deemed “filed” with the SEC and is not to be incorporated by reference in any of our filing under the Securities Act of 1933 or the Securities Exchange Act of 1934 whether made before or after the date hereof without regard to any general incorporation language in any such filing.
Item 6.
Item 6. SELECTED FINANCIAL DATA
The following table presents our selected historical condensed consolidated financial data. The consolidated statements of operations data for each of the three fiscal years ended December 31, 2014, 2013 and 2012 and the consolidated balance sheet data as of December 31, 2014 and 2013 are derived from our audited consolidated financial statements included elsewhere in this Annual Report.
The consolidated statements of operation data for the fiscal year ended December 31, 2011 and 2010 and the consolidated balance sheet data as of December 31, 2012, 2011 and 2010 are derived from unaudited financial statements that are not included in this Form 10-K.
The selected historical consolidated balance sheet and operating data presented below should be read in conjunction with the consolidated financial statements and the notes to such statements and “Management's Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this Annual Report. Historical results are not necessarily indicative of the results to be expected in the future.
___________________________________________
(1)
Restructuring costs during the year ended December 31, 2014 were $1.9 million based on management's reassessment of the liability related to our vacated facility. Restructuring costs during the year ended December 31, 2013 represent $2.4 million in facility exit costs, $1.7 million of impairment expense for tenant improvements associated with the vacated facility, $0.7 million of impairment expense for intangible assets and prepaid royalties related to our RetnaGene AMD LDT licensed technology, and $1.0 million in employee termination costs.
(2)
Litigation settlement expense, net, during the year ended December 31, 2010 of $55.4 million represents $0.3 million paid in cash and the issuance of 7.0 million shares of our common stock with an aggregate fair value of $55.1 million in settlement of consolidated class action securities lawsuits and payment of related plaintiffs' attorneys' fees.
(3)
In December 2014, we entered into a Pooled Patents Agreement with Illumina, to pool our intellectual property for noninvasive prenatal testing. Of the aggregate $50 million consideration we recognized $22.9 million as a gain in the 4th quarter of 2014.
(4)
In May 2014, we sold our Biosciences business, which had been under review for strategic alternatives. As a result of this sale our Bioscience segment has been excluded from continuing operations and reported as discontinued operations.
(5)
In September 2012, we issued $130.0 million aggregate principal amount of 5.00% Convertible Senior Notes due 2017 and received net proceeds of $124.7 million.
(6)
In January 2012, we completed an underwritten public offering of 14.95 million shares of our common stock for $4.15 per share, resulting in net proceeds of $58.2 million. During the year ended December 31, 2010 we completed an underwritten public offering and a private placement of 16.1 million and 12.4 million shares of our common stock for $6.00 per share and $4.15 per share, respectively, resulting in net proceeds of $90.6 million and $47.8 million, respectively.
Item 7.
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Introduction
Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) is designed to provide the reader of the Company’s financial statements with a narrative from the perspective of management on the Company’s financial condition, results of operations, liquidity and certain other factors that may affect future results. The MD&A should be read in conjunction with our consolidated financial statements and accompanying notes to such statements included elsewhere in this report. This discussion and analysis may contain forward-looking statements that involve risks and uncertainties. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of certain factors, such as those set forth under the heading “Risk Factors,” and elsewhere in this Annual Report.
All references to 2014, 2013 and 2012 refer to our calendar years ended December 31.
Company Overview
We are a life sciences company committed to enabling healthier lives through the development of innovative products and services. We serve patients and physicians by providing early patient management information. We offer our services in the U.S. and globally with international emphasis in countries in the European and Asia-Pacific regions. We conduct our business in one operating segment, Sequenom Laboratories.
Sequenom Laboratories provides molecular based laboratory developed tests, with a focus principally on prenatal care. Sequenom Laboratories is a CAP (College of American Pathologists) accredited and CLIA (Clinical Laboratory Improvements Amendment of 1988, as amended) certified molecular diagnostics laboratory that develops, validates and exclusively offers tests branded under the names MaterniT21® PLUS, HerediT™, SensiGene® and VisibiliT™. These genetic tests, offered as a testing service to physicians for the benefit of their patients, provide early patient management information for obstetricians, geneticists, and maternal fetal medicine specialists.
On May 30, 2014, we completed the sale of our Bioscience business to BioSciences Acquisition Company which purchased substantially all of the assets used in what we previously reported as our Bioscience business segment. With this divestiture, we now operate in a single business segment.
As a result of the Bioscience segment sale, we have retrospectively revised the consolidated statements of operations for the years ended December 31, 2013 and 2012, the consolidated statements of cash flows for the years ended December 31, 2013 and 2012, and the consolidated balance sheet as of December 31, 2013, to reflect the financial results from the Bioscience business segment, and the related assets and liabilities, as discontinued operations.
Our strategic focus for 2015 will be to achieve cash flow from operations which is no less than negative $15 million, up to positive $15 million and to expand our portfolio of products by introducing three new laboratory developed tests. We also plan on entering new markets by launching an early access program with a research-use-only test for clinical studies in oncology. Our ability to achieve these objectives is dependent on a number of factors, including the risks as summarized under the heading Risk Factors in Item 1A of this Annual Report. With the recent Pooled Patents Agreement entered into with Illumina, we expect to receive test fees from the patent pool. We continue to focus on obtaining profitable test volume through increased market penetration, payor contracts, cash collections and growing revenue for a sustainable, profitable business model while investing in research and development programs to develop additional or enhanced products and tests.
2014 Overview
•
Total revenue during 2014 increased $32.0 million, or 27%, to $151.6 million when compared to $119.6 million during 2013.
•
Net loss from continuing operations decreased $95.2 million, or 87%, to $14.4 million when compared to $109.6 million loss in 2013.
•
Total accessions for all tests during 2014 increased 12,000, or 6%, to 197,500 when compared to 185,500 during 2013.
•
Net cash used in operating activities was $28.1 million for the year ended December 31, 2014, compared to $88.1 million in the prior year.
•
As of December 31, 2014, we had available cash and cash equivalents and current marketable securities totaling $93.9 million and working capital of $65.7 million.
•
In May 2014, we sold our Biosciences business for a cash sale price of $31.0 million, plus a $2.0 million, milestone
payment. As a result of this sale our Bioscience segment has been excluded from continuing operations and reported as discontinued operations.
•
In September 2014, we purchased the noninvasive prenatal testing intellectual property from Isis for $10.6 million.
•
In December 2014, we entered into a Pooled Patents Agreement with Illumina, to pool our intellectual property for noninvasive prenatal testing. Illumina made an aggregate $50 million upfront payment to us as part of the overall agreement.
Revenue
Our revenue and accessions for the years ended December 31, 2014, 2013 and 2012 were as follows:
Diagnostic Services
Each test performed relates to a patient specimen collected by a health care professional, and received by the laboratory. Such specimen encounter is commonly referred to as an “accession” in the laboratory sector. Although accessions are not billed until the test is complete and results are reported to the ordering physician, we believe that the number of accessions received is useful to understand the volume of our business. These tests are typically completed within five or fewer business days from the date of accession. Revenue for diagnostic services performed in our laboratory are generated primarily from customers located within the United States. Our international customers collect and ship patient specimens to the laboratory, and we process the specimens in our laboratory in the United States. We also have royalty agreements with domestic and international customers to whom we have licensed our technology in certain countries.
Diagnostic services revenue is derived from providing testing services for our tests and is primarily recognized on a cash basis as payments are received. We account for revenue on a cash basis until we have a history of collections from a third-party payor and we are able to demonstrate that we can make a reasonable estimate of collectible amounts before moving to the accrual method of revenue recognition for such payor and test. In the second quarter of 2014, we adopted accrual accounting for select payors. For the payors recorded on an accrual basis in 2014, we recognized revenue of $19.6 million, and of that revenue we collected $17.8 million as of December 31, 2014.
For the years ended December 31, 2014 and 2013 we recognized $23.4 million and $11.6 million, respectively, on an accrual basis for royalties and test service revenue generated from our domestic and international customers (client bill) for those agreements under which we are able to make a reasonable estimate of collectible amounts.
The $32.0 million, or 27%, and the $73.1 million, or 157%, increases in diagnostic services revenue during 2014 and 2013, respectively, are primarily attributable to the increase in the number of accessions, an increased percentage of accessions on which we ultimately collect, a decrease in the average number of days to collect a receivable and collections for accessions billed in prior periods.
Our revenue is impacted by the number and type of tests billed, the number of tests which are reimbursed by third-party payors and patients, and the rate paid per test. The number of tests billed has increased consistent with the increase in the number of accessions. The average rate received per MaterniT21 PLUS test reimbursed declined by about 17% in 2014 to approximately $1,000 per test primarily as a result of competition and obtaining payment from additional payors including certain state Medicaid programs. While the amount per reimbursed test decreased, the number of tests we were reimbursed for increased and the average days between billing and collections also decreased.
The following is a summary of accessions and diagnostic services revenue for the quarters in 2014 and 2013:
Collections for services in prior periods have been volatile, and we expect collections to continue to fluctuate depending upon the results of our efforts to collect payment from third party payors and patients for prior period claims. Our reimbursed rates and cash collections are also subject to seasonality. Patient deductibles generally reset at the beginning of each year which means that patients early in the year are responsible for a greater portion of the cost of our tests, and we have lower collection rates from individuals than from third-party payors. For those payors on accrual accounting, we lower our estimated revenue in the first quarter to reflect the lower percentage expected from the third party payors.
Collections recorded as revenue on the cash basis during the annual period of 2014 and 2013, for services performed in a prior year totaled $37.9 million and $26.4 million, respectively. As of December 31, 2014, amounts outstanding for tests delivered, net of estimated write-downs and adjustments, which were not recognized as revenue upon delivery of the test result because our accrual revenue recognition criteria were not met and the amounts had not been collected, range from approximately $31 million to $34 million, depending upon the ultimate reimbursement received for outstanding claims. We cannot provide any assurance as to when, if ever, and to what extent these amounts will be collected.
One single payor represented more than 10% of total revenue in 2014, accounting for $17.4 million, or 11% of revenue. In 2013 there were two payors which accounted for $25.0 million or 21% and $12.6 million or 11% of revenue, respectively.
The increases in the number of accessions during 2014 and 2013 of 6% and 102%, respectively, are primarily attributable to the market adoption domestically and internationally of the MaterniT21 PLUS test. Client bill revenue which is primarily international customers accounted for $23.4 million and $11.6 million of diagnostic services revenue during 2014 and 2013, respectively.
We believe that our diagnostic services revenue will continue to be affected by our current revenue recognition policy of generally recognizing revenue upon cash collection, the overall acceptance and demand for our new and existing commercial products and services, the adoption rates of our existing LDTs and any future LDTs we may develop, and payment patterns of third-party payors and patients. We also believe that our diagnostic service revenue will be affected as other companies license our technologies and other patent rights through the patent pool with Illumina, for which we will receive a test fee. We continue to pursue collection for our tests with third-party payors, including Medicare and Medicaid, where appropriate. Diagnostic services revenue collected from Medicaid payors during 2014 and 2013 were $9.8 million and $3.0 million, or 6% and 3%, respectively.
Cost of Revenue and Gross Margins
Our costs of revenue and gross margins were as follows:
Diagnostic Services
Cost of diagnostic services revenue represents the cost of materials, direct labor, equipment, outside laboratory costs, royalties and infrastructure expenses associated with accessioning patient specimens (including quality control analyses and shipping charges to transport patient specimens), and license fees. Infrastructure expenses include allocated facility occupancy
and information technology costs. Costs associated with performing tests are recorded as tests are processed. Costs recorded for patient specimen processing represent the cost of all the tests processed during the period regardless of whether revenue is recognized with respect to that test. Royalties for licensed technology calculated as a percentage of revenue is recorded as license fees in cost of revenue at the time revenue are recognized or in accordance with other contractual obligations. While license fees are generally calculated as a percentage of revenue, the percentage increase in license fees does not correlate exactly to the percentage increase in revenue because certain agreements contain provisions for fixed annual payments and other agreements have tiered rates and payments that may be capped at annual minimum or maximum amounts. License fees represent a significant component of our cost of revenue and are expected to remain so for the foreseeable future. License fees as a percentage of cost of diagnostic services revenue were 15%, 14% and 15% during 2014, 2013 and 2012, respectively.
The decrease in cost of diagnostic services revenue during 2014 when compared to 2013, is primarily attributable to improved cost of materials and labor which is offset by higher test volumes. In 2014 the company initiated various initiatives to lower laboratory operational costs related to materials labor and overhead. The increase in cost of diagnostic services revenue during 2013 when compared to the same period in 2012, is primarily attributable to increased labor, royalties associated with increased test volumes, and increased costs for the additional laboratory location in North Carolina, which became operational in 2013.
Gross margin as a percentage of diagnostic services revenue is also affected by our current revenue recognition policy of generally recognizing revenue upon cash collection, which may result in costs being incurred in one period that relate to revenue recognized in a later period. The increase in gross margin in 2014 and 2013 when compared to a negative gross margin during 2012, is primarily attributable to the increased revenue, improved utilization of fixed overhead from an increased number of accessions completed, collections for accessions performed in a prior year and cost cutting initiatives.
We expect that gross margin for our diagnostic services will continue to fluctuate and be affected by the adoption rate of our LDT's, our revenue recognition policy, the levels of reimbursement, and payor and other contracts we may enter into for our tests. We also expect that our margins will be affected by the per test license fee we will pay for tests we perform under the Pooled Patents Agreement.
We continue to look at ways to reduce our costs per test but expect the overall cost of revenue to fluctuate with test volume. We have the ability to expand capacity within our laboratory, including our location in Raleigh-Durham, North Carolina.
Operating Expenses
Our operating expenses were as follows:
Selling and Marketing Expenses
Selling and marketing expenses consists primarily of compensation and related departmental expenses for sales and marketing, customer support, and business development personnel.
The $6.8 million, or 18%, decrease in selling and marketing expenses during 2014, when compared to 2013, is primarily due to the cost saving efforts that we put in place at the end of 2013, which lowered costs of personnel and related costs by $3.8 million, marketing cost by $1.1 million and travel costs by $1.6 million.
The $3.8 million, or 11%, increase in selling and marketing expenses during 2013, when compared to 2012, is primarily due to the expansion of our Sequenom Laboratories sales force, including the costs of labor, travel and commissions.
We expect our selling and marketing expenses to fluctuate in future periods as new products are introduced.
Research and Development Expenses
Research and development expenses consists primarily of compensation and related personnel expenses, product development costs, quality and regulatory costs, and expenses relating to licensing costs and work performed under research and development contracts.
The $13.7 million, or 35%, decrease in research and development expenses during 2014, when compared to 2013, is primarily due to $5.2 million from the completion of the Raleigh-Durham, North Carolina laboratory location which incurred development cost prior to the location becoming operational in 2013, a $4.6 million decrease from a reduction in headcount and related costs, $2.5 million in lower clinical samples collected and lower project and sponsored research and development of $1.0 million and $0.6 million, respectively.
The $1.5 million, or 4%, decrease in research and development expenses during 2013, when compared to 2012, is primarily due to $1.2 million in lower supplies and overhead, which were attributed to the completion and validation of the Raleigh-Durham, North Carolina laboratory location during 2013, and decreases in discretionary and share-based compensation expenses of $0.7 million and $0.1 million, respectively.
We expect our research and development expenses to fluctuate in future periods as we continue to invest in our product pipeline and other molecular diagnostic areas.
General and Administrative Expenses
General and administrative expenses consist primarily of compensation and related departmental expenses for executive, legal, accounting, finance, non-allocated information technology and human resource personnel and outside professional fees.
The $5.6 million, or 11%, decrease in general and administrative expenses during 2014, when compared to 2013, is primarily related to litigation costs of $20.1 million in 2013 which declined to $13.1 million in 2014, a decrease of $7.0 million, partially offset by increased bonus expenses of $1.2 million and an increase in the cost of billing operations of $0.5 million.
The $12.8 million, or 32%, increase in general and administrative expenses during 2013, when compared to 2012, is primarily related to increased legal costs of $9.1 million, associated primarily with patent litigation, increased billing costs of $2.4 million due to our growth in diagnostic services collections and increased headcount to support our operations resulting in higher labor and related costs of $1.6 million.
We expect general and administrative expenses to decrease in future periods as we realize lower patent related litigation cost and obtain efficiencies from our cost cutting initiatives.
Restructuring Costs
As part of a 2013 cost reduction effort, we recorded $2.4 million in facility exit costs, $1.7 million of impairment expense for tenant improvements associated with the vacated facility, $0.7 million of impairment expense for intangible assets and prepaid royalties related to our RetnaGene AMD LDT licensed technology, and $1.0 million in employee termination costs during 2013.
In 2014 we recorded $1.9 million of additional restructuring expense related to the vacated San Diego facility as we no longer expect that we can sublease this facility.
Gain on Pooled Patents Agreement
The gain recognized on the Pooled Patents Agreement relates to two elements which were delivered to Illumina in 2014, $21.0 million for the transfer of IVD technology and $1.85 million for the settlement of claims and disputes. In 2015, we expect to recognize the remaining $21.0 million of deferred gain upon completion of delivery of the samples and related study protocols.
Other Income and Expense, and Income Tax
Interest expense, net
The decrease of $0.3 million in interest expense during 2014 is attributable to the reduction in the outstanding balances on our term loan.
The increase in interest expense during 2013 is attributable to the issuance of our 5.00% Convertible Senior Notes due 2017, or Convertible Senior Notes, in September 2012 and higher outstanding balances on our term loan.
Income tax benefit
As a result of the gain from the sale of discontinued operations of $24.3 million in 2014, we recorded an income tax expense from discontinued operations of $8.3 million. We also recognized a corresponding tax benefit in continuing operations in 2014. This benefit is a result of the required accounting for discontinued operations which requires a separate tax presentation for discontinued and continuing operations.
Discontinued Operations
On May 30, 2014, we completed the sale of our Bioscience business to BioSciences Acquisition Company (“BioSciences”) who purchased substantially all of the assets used in, and assumed the liabilities of, the business previously reported as the Bioscience business segment.
The sale, with a cash price of $31.0 million plus a $2.0 million milestone payment realized provides us with additional working capital. As part of the sale, we were required to deposit in escrow $1.5 million to secure our indemnification obligations and any working capital adjustment to the purchase price. The escrow funds are restricted but we expect to receive access to these funds within one year.
As part of the sale, we entered into several agreements with BioSciences. A supply agreement is effective for three years under which we may purchase consumables and systems for our laboratory business. We expect to purchase an immaterial amount of such products under the supply agreement in the next twelve months. Also, we agreed to provide certain administrative services to BioSciences from the time of the sale until December 31, 2014. All leases associated with the Bioscience business segment were assumed by BioSciences, however, we sublease back a portion of a building in San Diego for office space where some of our administrative employees are located. The associated rent expense is immaterial.
As a result of the Bioscience segment sale our consolidated statements of operations, cash flows and the consolidated balance sheets have been retrospectively revised to reflect the financial results from the Bioscience business segment as discontinued operations.
Liquidity and Capital Resources
We have a history of losses from operations and have an accumulated deficit. Our capital requirements to sustain operations, including Sequenom Laboratories' billed but unpaid tests, research and development projects, and litigation have been and will continue to be significant. As of December 31, 2014 and 2013, we had working capital of $65.7 million and $51.9 million, respectively. These amounts do not include our unrecorded accounts receivable (due to our cash basis accounting for certain diagnostic services provided), which are discussed below.
We consider the material drivers of our cash flow to be testing volumes and collections of billed tests for our diagnostic testing services, our share of test fees and royalties from the Pooled Patents Agreement, working capital, inventory management, and operating expenses. Our principal sources of liquidity are our cash, cash equivalents, and marketable securities, collections for our accounts receivable, collections from our commercialized tests and services and collections of test fees from the Pooled Patents Agreement. We have also financed our operating and capital requirements during the last three years with proceeds from the sale of our Bioscience segment, funds received from the Pooled Patents Agreement with Illumina in 2014, issuance of our Convertible Senior Notes and the public offering of our common stock during 2012.
We have expanded the operations of our laboratories following commercialization of the MaterniT21 PLUS test, including research and development activities related to improvements to current tests and expansion of our diagnostic testing menu.
As of December 31, 2014, amounts outstanding for tests delivered, net of estimated write-downs and adjustments, which were not recognized as revenue upon delivery of the test result because our accrual revenue recognition criteria were not met and the amounts had not been collected, range from approximately $31 million to $34 million, depending upon the ultimate reimbursement received for outstanding claims. We cannot provide any assurance as to when, if ever, and to what extent these amounts will be collected.
As of December 31, 2014, cash, cash equivalents, and current marketable securities totaled $93.9 million, compared to $71.3 million at December 31, 2013. The $22.6 million increase is due primarily to the proceeds from the sale of our Bioscience segment, and funds received from the Pooled Patents Agreement with Illumina. We had purchases of equipment
and leasehold improvements of $2.2 million, and repayment on our term loan of $7.5 million. Our cash equivalents and current marketable securities are held in a variety of securities that include U.S. government treasuries, certificates of deposits, and money market funds that have ratings of AA or better, or are fully guaranteed by the U.S. government, and mutual funds.
We expect that our cash, cash equivalents and current marketable securities are sufficient to provide for our operating needs through at least the end of 2015.
Operating Activities
Cash used in operations during 2014 was $28.1 million, compared to cash used of $88.1 million during 2013. The improvement was from higher revenue and lower operating costs.
Investing Activities
Net cash provided in investing activities was $32.9 million during 2014, compared to net cash provided by investing activities of $30.0 million during 2013. Investing cash inflows in 2014, included $29.3 million cash received from the sale of our Bioscience business segment and a net $36.0 million received in connection with the Pooled Patents Agreement. Offsetting these items were net purchases of marketable securities of $20.9 million, $9.3 million used for the purchase of the Isis intangible asset and $2.2 million used for the purchase of property, equipment and leasehold improvements.
Financing Activities
Net cash used by financing activities during 2014, was $5.7 million, compared to cash used of $6.1 million during 2013. Financing activities during 2014 include payments on debt obligations of $7.5 million, partially offset by $1.8 million in cash proceeds from the exercise of stock options and employee contributions under our employee stock purchase plan.
Contractual Obligations
The following table summarizes our contractual obligations as of December 31, 2014 (in thousands):
(1)
Long-term obligations include our Convertible Senior Notes, which are convertible at any time prior to the third trading day immediately preceding their maturity date in October 2017, at the option of the holders, into shares of our common stock at specified conversion rates, our bank loans due May 2015, and our financing obligation for building and improvements recorded in connection with our Raleigh-Durham, North Carolina, location.
(2)
Future minimum guaranteed payment obligations for royalties, milestone payments, and research funding obligations under all such agreements. The expected timing of payments included in the table above is estimated based on current information. Timing of payment and actual amounts paid may differ depending on the timing of receipt of services and/or achievement of milestones.
Off-Balance Sheet Arrangements
We have no significant contractual obligations not fully recorded on our consolidated balance sheets or fully disclosed in the notes to our consolidated financial statements.
Critical Accounting Policies and Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires us to make estimates and assumptions that affect amounts reported in the accompanying consolidated financial statements and related notes. In preparing our financial statements we make assumptions and estimates about future events and apply judgments that affect the reported amounts of assets, liabilities, revenue, expenses and the related disclosures. We base our assumptions, estimates and judgments on historical experience, current trends and other factors that management considers relevant. Because future events and their effects cannot be determined with certainty, actual results could differ materially from our assumptions and estimates. Our Senior Management has reviewed these critical accounting policies and related disclosures with the Audit Committee of our Board of Directors.
We believe the following accounting policies to be critical to the judgments and estimates used in the preparation of our consolidated financial statements.
Revenue Recognition
Our revenue is generated primarily from diagnostic services from providing laboratory-developed tests, or LDTs, primarily for the detection of specific fetal abnormalities or other genetic conditions as well as other amounts earned for royalties and license agreements.
We recognize revenue when persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the price is fixed or determinable, and collectability is reasonably assured. We assess whether the fee is fixed or determinable based on the nature of the fee charged for the services delivered, whether there are existing contractual arrangements, and historical payment patterns. When recording revenue we evaluate collectability and consider whether we have sufficient history to reliably estimate a payor's individual payment patterns. Revenue is deferred for fees received before they are earned. Royalty revenue is generally recorded on an accrual basis when earned.
Diagnostic services revenue is recognized upon cash collection until we can reliably estimate the amount that would be ultimately collected for our LDTs and the above criteria have been met, subsequent to such time we recognize revenue on an accrual basis. We generally bill third-party payors upon generation and delivery of a test result to the ordering physician following completion of a test. As such, we take assignment of benefits and risk of collection with the third-party payor. Patients have out-of-pocket costs for amounts not covered by their insurance carrier and we bill the patient directly for these amounts in the form of co-pays and deductibles in accordance with their insurance carrier and health plans. Some payors may not cover our test as ordered by the physician under their reimbursement policies. Consequently, we pursue reimbursement on a case-by-case basis. From time to time, we receive requests for refunds of payments made by third-party payors. Upon becoming aware of a refund request, we establish an accrued liability for tests covered by the refund request until we determine the amounts upon which a refund is due. Accrued refunds were $0.4 million and $1.7 million at December 31, 2014 and 2013, respectively.
We enter into license arrangements that may involve multiple elements and we evaluate the agreements to determine whether each deliverable represents a separate unit of accounting. A deliverable constitutes a separate unit of accounting when it has stand-alone value to the customer. Items are considered to have stand-alone value when they are sold separately by any vendor or when the customer could resell the item on a stand-alone basis. Consideration is allocated at the inception of the contract to all deliverables based on their relative selling price. The relative selling price for each deliverable is determined using vendor specific objective evidence (VSOE) of selling price or third-party evidence of selling price if VSOE does not exist. If neither VSOE nor third-party evidence exists we use our best estimate of the selling price for the deliverable; such amounts are recognized as revenue when each unit is delivered.
If the delivered element does not have stand-alone value without one of the undelivered elements in the arrangement, we combine such elements and account for them as a single unit of accounting. Such amounts are recognized as revenue when the last deliverable of the combined units is delivered.
Development, License or Patent Agreements
We may from time to time enter into development, license or patent agreements with collaborative partners under which one or multiple deliverables are exchanged. We apply the accounting guidance in ASC 605-25 for multiple element arrangements to determine the separate units of account and basis for allocating consideration received or paid in these transactions. The value of deliverables under the arrangements are often derived using discounted cash flow analysis and may also require third-party valuation experts. Establishing fair value based on discounted cash flow models or third-party valuation experts involves management’s judgment and considers multiple factors, including market conditions and company-specific factors, including those factors contemplated in negotiating the agreements as well as internally developed assumptions related to market opportunity, estimated sales and costs, probability of success, and the time needed to commercialize a product candidate pursuant to the license. In validating assumptions used in determining fair value, we consider whether changes in key
assumptions used will have a significant effect on the allocation of the arrangement consideration between the multiple deliverables.
Recently Adopted Accounting Pronouncements
In June 2014, the Financial Accounting Standards Board, or FASB, issued an accounting standards update that requires a performance target that affects vesting of a share-based payment award and that could be achieved after the requisite service period to be treated as a performance condition. As such, the performance target should not be reflected in estimating the grant-date fair value of the award. Compensation cost should be recognized over the required service period, if it is probable that the performance target will be achieved. This guidance will be effective for fiscal years beginning after December 15, 2015, which will be the Company's fiscal year 2016, with early adoption permitted. We do not expect the adoption of the guidance will have a material impact on the Company's consolidated financial statements.
In May 2014, the FASB issued an accounting standards update that creates a single source of revenue guidance for companies in all industries. The new standard provides guidance for all revenue arising from contracts with customers and affects all entities that enter into contracts to provide goods or services to their customers, unless the contracts are within the scope of other accounting standards. It also provides a model for the measurement and recognition of gains and losses on the sale of certain nonfinancial assets. This guidance must be adopted using either a full retrospective approach for all periods presented or a modified retrospective approach and will be effective for fiscal years beginning after December 15, 2016, which will be the Company's fiscal year 2017. We have not yet evaluated the potential impact of adopting the guidance on the Company's consolidated financial statements.
In April 2014, the FASB issued an accounting standards update that raises the threshold for disposals to qualify as discontinued operations and allows companies to have significant continuing involvement with and continuing cash flows from or to the discontinued operation. It also requires additional disclosures for discontinued operations and new disclosures for individually material disposal transactions that do not meet the definition of a discontinued operation. This guidance will be effective for fiscal years beginning after December 15, 2014, which will be the Company's fiscal year 2015, with early adoption permitted. The Company elected to use the non-amended guidance to evaluate the reported discontinued operations (see footnote 4) and will adopt the new guidance after its effective date.
Item 7A.
Item 7A.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The primary objective of our investment activities is to preserve principal while at the same time maximizing the income we receive from our investments without significantly increasing risk. Some of the securities that we invest in may have market risk. This means that a change in prevailing interest rates may cause the fair value of the principal amount of the investment to fluctuate. For example, if we hold a security that was issued with a fixed interest rate at the then-prevailing rate and interest rates later rise, the fair value of the principal amount of our investment will probably decline. To minimize this risk our current investment policy requires us to maintain our portfolio of cash equivalents and marketable securities in a variety of securities that are represented by issuances from the U.S. government, repurchase agreements collateralized by U.S. government securities that have ratings of AA, or are fully guaranteed by the U.S. government. Our investment policy also includes a minimum quality rating for all new investments and the overall amount that may be invested with a single security. If an investment we hold falls below this level, we research the reasons for the fall and determine if we should continue to hold the investment in order to minimize our exposure to market risk of the investment.
The appropriate classification of marketable securities is determined at the time of purchase and reevaluated as of each balance sheet date. Based on this determination, as of December 31, 2014 and 2013, all of our investments in marketable securities were classified as available-for-sale and were reported at fair value. We measure fair value based on the prices that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Fair value is determined based on observable market quotes or valuation models using assessments of counterparty credit worthiness, credit default risk or underlying security and overall capital market liquidity. Declines in fair value that are considered other-than-temporary are charged to operations and those that are considered temporary are reported as a component of accumulated other comprehensive income (loss) in stockholders' equity. We use the specific identification method of determining the cost basis in computing realized and unrealized gains and losses on the sale of our available-for-sale securities.
At December 31, 2014, we had $93.9 million in cash, cash equivalents, and marketable securities, all of which are reported at their fair value. Changes in market interest rates would not be expected to have a material impact on the fair value of these assets at December 31, 2014, as the assets consisted of highly liquid securities with short-term maturities.
Foreign currency rate fluctuations
Transactions with our customers and vendors are primarily in USD. Foreign currencies to which we are exposed did not have a material impact on our business or operating results during the periods presented.
Interest Rate Sensitivity
Our investment portfolio is exposed to market risk from changes in interest rates. This risk is mitigated as we have maintained a relatively short average maturity for our investment portfolio. If a 100 basis point change in interest rates were to occur in 2015, our interest income would change by less than $1.0 million in relation to amounts we would expect to earn, based on our cash, cash equivalents, and short-term investments as of December 31, 2014.
Changes in interest rates may impact our interest expense. We have a $130.0 million convertible senior notes (“the Notes”) which bears interest at 5% and matures on October 1, 2017. After the Notes mature or if we would refinance the Notes, an incremental change in the borrowing rate of 100 basis points would increase our interest expense by approximately $1.3 million based on the $130.0 million balance as of December 31, 2014.
Inflation
We do not believe that inflation has had a material adverse impact on our business or operating results during the periods presented.
Item 8.
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements and supplemental data required by this item are set forth at the pages indicated in Part IV, Item 15(a)(1) of this annual report.
Item 9.
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
Item 9A.
Item 9A.
CONTROLS AND PROCEDURES
Our management, with the participation of our Chief Executive Officer, or CEO, and our Chief Financial Officer, or CFO, has evaluated the effectiveness of our disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended, or the Exchange Act) as of the end of the period covered by this report. Based on that evaluation, our management, including our CEO and CFO, has concluded that our disclosure controls and procedures were effective at a reasonable assurance level as of the end of such period.
Management's Report on Internal Control over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Exchange Act Rules 13a-15(f) and 15d-15(f). Our system of internal control over financial reporting is designed to provide reasonable assurance to our management and Board of Directors regarding the preparation and fair presentation of our consolidated financial statements for external purposes in accordance with U.S. generally accepted accounting principles. Internal control over financial reporting includes those policies and procedures that: (1) pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of our assets; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures are being made only in accordance with the authorizations of our management and directors; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of our assets that could have a material adverse effect on our financial statements.
Our management, under the supervision of our CEO and CFO, assessed the effectiveness of our internal control over financial reporting as of December 31, 2014. In making this assessment, we used the framework included in Internal Control - Integrated Framework (1992), or the 1992 Framework, issued by the Committee of Sponsoring Organizations of the Treadway Commission, or COSO. Based on our evaluation under the 1992 Framework, our management concluded that, as of December 31, 2014, our internal control over financial reporting was effective.
The effectiveness of the Company’s internal control over financial reporting as of December 31, 2014 has been audited by Ernst & Young LLP an independent registered public accounting firm, as stated in their report appears below under this Item 9A and expresses an unqualified opinion on the effectiveness of our internal control over financial reporting.
On May 14, 2013, COSO issued an updated version of its Internal Control - Integrated Framework, or the 2013 Framework which officially superseded the 1992 Framework on December 15, 2014. Originally issued in 1992, the framework helps organizations design, implement and evaluate the effectiveness of internal control concepts and simplify their use and application. We are currently in the process of performing an analysis to evaluate what changes to our control environment, if any, would be needed to successfully implement the 2013 Framework. Until such time as our transition to the 2013 Framework is complete, we will continue to use the 1992 Framework in connection with our assessment of internal control.
Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting during the quarter ended December 31, 2014 that have materially affected or are reasonably likely to materially affect our internal control over financial reporting.
Inherent Limitations on Effectiveness of Controls
Our management, including our CEO and our CFO, do not expect that our disclosure controls or our internal control over financial reporting will prevent or detect all error and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system’s objectives will be met. The design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Further, because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that misstatements due to error or fraud will not occur or that all control issues and instances of fraud, if any, have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of simple error or mistake. Controls can also be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. The design of any system of controls is based in part on certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Projections of any evaluation of controls effectiveness to future periods are subject to risks. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies or procedures.
Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders of Sequenom, Inc.
We have audited Sequenom, Inc.'s internal control over financial reporting as of December 31, 2014, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (1992 framework) (the COSO criteria). Sequenom, Inc.'s management is responsible for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management's Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the company's internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the company's assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, Sequenom, Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2014, based on the COSO criteria.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Sequenom, Inc. as of December 31, 2014 and 2013, and the related consolidated statements of operations and comprehensive income (loss), stockholders’ (deficit) equity, and cash flows for each of the three years in the period ended December 31, 2014 of Sequenom, Inc. and our report dated March 9, 2015 expressed an unqualified opinion thereon.
/s/ Ernst & Young LLP
San Diego, California
March 9, 2015
Item 9B.
Item 9B.
OTHER INFORMATION
None.
PART III
Certain information required by Part III is omitted from this report because we will file with the Securities and Exchange Commission a definitive proxy statement within 120 days after the end of our fiscal year for our annual meeting of stockholder (Proxy Statement), and the information included in the Proxy Statement is incorporated herein by reference.
Item 10.
Item 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
The information required by this item is incorporated by reference to our Proxy Statement under the heading “Election of Directors.” Information regarding executive officers is set forth in Item 1 of Part I of this report and is incorporated herein by reference.
We have adopted a code of business conduct and ethics for directors, officers (including our principal executive, financial and accounting officers) and all employees, which we refer to as our Code of Business Conduct and Ethics. The Code of Business Conduct and Ethics is available on our website at http://www.sequenom.com. Stockholders may request a free copy of our Code of Business Conduct and Ethics from:
Sequenom, Inc.
Attention: Investor Relations
3595 John Hopkins Court
San Diego, CA 92121-1331
(858) 202-9000
If we make any substantive amendments to the code of business conduct and ethics or grant any waiver from a provision of the code to any executive officer or director, we will promptly disclose the nature of the amendment or waiver on our website. We will promptly disclose on our website (i) the nature of any amendment to the policy that applies to our principal executive officer, principal financial officer, principal accounting officer or controller, or persons performing similar functions and (ii) the nature of any waiver, including an implicit waiver, from a provision of the policy that is granted to one of these specified individuals, the name of such person who is granted the waiver and the date of the waiver.
Section 16(a) Beneficial Ownership Reporting Compliance
Item 405 of Regulation S-K calls for disclosure of any known late filing or failure by an insider to file a report required by Section 16 of the Exchange Act. This disclosure is incorporated by reference from the information in the section entitled “Section 16(a) Beneficial Ownership Reporting Compliance” in the Proxy Statement.
Item 11.
Item 11. EXECUTIVE COMPENSATION
The information required by this item is incorporated herein by reference from the information in the sections entitled “Executive Compensation” and “Election of Directors” in the Proxy Statement.
Item 12.
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The information required by this item is incorporated herein by reference from the information in the sections entitled “Security Ownership of Certain Beneficial Owners and Management” and “Securities Authorized for Issuance under Equity Compensation Plans” in the Proxy Statement.
Item 13.
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCE
The information required by this item is incorporated herein by reference from the information in the sections entitled “Certain Transactions” and “Independence of the Board of Directors” in the Proxy Statement.
Item 14.
Item 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
The information required by this item is incorporated herein by reference from the information in the section entitled “Principal Accounting Fees and Services” and “Pre-Approval Policies and Procedures” in the Proxy Statement.
PART IV
Item 15.
Item 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a)(1)
Financial Statements
The financial statements required by this item are submitted in a separate section beginning on page of this annual report.
(a)(2)
Financial Statement Schedules
The other financial statement schedules have been omitted because they are either not required, not applicable, or the information is otherwise included.
(a)(3)
Exhibits
The exhibits listed below are required by Item 601 of Regulation S-K. Each management contract or compensatory plan or arrangement required to be filed as an exhibit to this report has been identified.
#
Management contract or compensatory plan.
*
Certain confidential portions of this Exhibit have been omitted pursuant to a request for confidential treatment. Omitted portions have been filed separately with the Securities and Exchange Commission.
(1)
Incorporated by reference to the Registrant's Current Report on Form 8-K (No. 000-29101) filed June 6, 2006.
(2)
Incorporated by reference to the Registrant's Current Report on Form 8-K (No. 000-29101) filed January 15, 2010.
(3)
Incorporated by reference to the Registrant's Current Report on Form 8-K (No. 000-29101) filed March 4, 2009.
(4)
Incorporated by reference to the Registrant's Registration Statement on Form S-1 (No. 333-91665), as amended.
(5)
Incorporated by reference to the Registrant's Annual Report on Form 10-K (No. 000-29101) for the year ended December 31, 2006.
(6)
Incorporated by reference to the Registrant's Current Report on Form 8-K (No. 000-29101) filed February 1, 2010.
(7)
Incorporated by reference to the Registrant's Definitive Proxy Statement on Schedule 14A filed April 29, 2010.
(8)
Incorporated by reference to the Registrant's Current Report on Form 8-K (No. 000-29101) filed June 6, 2006.
(9)
Incorporated by reference to the Registrant's Registration Statement on Form S-8 (No. 333-152230) filed July 10, 2008.
(10)
Incorporated by reference to the Registrant's Quarterly Report on Form 10-Q (No. 000-29101) for the quarter ended March 31, 2000.
(11)
Incorporated by reference to the Registrant's Quarterly Report on Form 10-Q (No. 000-29101) for the quarter ended September 30, 2004.
(12)
Incorporated by reference to the Registrant's Current Report on Form 8-K (No. 000-29101) filed September 14, 2005.
(13)
Incorporated by reference to the Registrant's Current Report on Form 8-K (No. 000-29101) filed January 24, 2007.
(14)
Incorporated by reference to the Registrant's Annual Report on Form 10-K (No. 000-29101) for the year ended December 31, 2008.
(15)
Incorporated by reference to the Registrant's Annual Report on Form 10-K (No. 000-29101) for the year ended December 31, 2009.
(16)
Incorporated by reference to the Registrant's Quarterly Report on Form 10-Q (No. 000-29101) for the quarter ended March 31, 2010.
(17)
Incorporated by reference to the Registrant's Current Report on Form 8-K (No. 000-29101) filed May 13, 2010.
(18)
Incorporated by reference to the Registrant's Quarterly Report on Form 10-Q (No. 000-29101) for the quarter ended March 31, 2011.
(19)
Incorporated by reference to the Registrant's Quarterly Report on Form 10-Q (No. 000-29101) for the quarter ended June 30, 2011.
(20)
Incorporated by reference to the Registrant's Quarterly Report on Form 10-Q (No. 000-29101) for the quarter ended September 30, 2012.
(21)
Incorporated by reference to the Registrant's Current Report on Form 8-K (No. 000-29101) filed September 17, 2012.
(22)
Incorporated by reference to the Registrant's Annual Report on Form 10-K (No. 000-29101) for the year ended December 31, 2013.
(23)
Incorporated by reference to the Registrant's Quarterly Report on Form 10-Q (No. 000-29101) for the quarter ended March 31, 2014.
(24)
Incorporated by reference to the Registrant's Quarterly Report on Form 10-Q (No. 000-29101) for the quarter ended June 30, 2014.
(25)
Incorporated by reference to the Registrant's Quarterly Report on Form 10-Q (No. 000-29101) for the quarter ended September 30, 2014.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
Date: March 9, 2015
POWER OF ATTORNEY
Know all men by these presents, that each person whose signature appears below constitutes and appoints William J. Welch and Carolyn D. Beaver, and each of them, as his attorneys-in-fact and agents, each with power of substitution in any and all capacities, to sign any amendments to this annual report on Form 10-K, and to file the same with exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, hereby ratifying and confirming all that the attorney-in-fact or his substitute or substitutes may do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant in the capacities and on the dates indicated.
SEQUENOM, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders of Sequenom, Inc.
We have audited the accompanying consolidated balance sheets of Sequenom, Inc. as of December 31, 2014 and 2013, and the related consolidated statements of operations and comprehensive income (loss), stockholders' (deficit) equity, and cash flows for each of the three years in the period ended December 31, 2014. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Sequenom, Inc. at December 31, 2014 and 2013, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2014, in conformity with U.S. generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Sequenom, Inc.'s internal control over financial reporting as of December 31, 2014, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (1992 framework) and our report dated March 9, 2015 expressed an unqualified opinion thereon.
/s/ Ernst & Young LLP
San Diego, California
March 9, 2015
SEQUENOM, INC.
CONSOLIDATED BALANCE SHEETS
(In thousands, except par value information)
See accompanying notes to consolidated financial statements.
SEQUENOM, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)
(In thousands, except per share information)
See accompanying notes to consolidated financial statements.
SEQUENOM, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' (DEFICIT) EQUITY
(In thousands)
See accompanying notes to consolidated financial statements.
SEQUENOM, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
See accompanying notes to consolidated financial statements.
SEQUENOM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2014
Note 1. The Company and Its Significant Accounting Policies
The Company
Sequenom Inc., and its wholly owned subsidiary Sequenom Center for Molecular Medicine LLC, doing business as Sequenom Laboratories (collectively "the Company"), is a life sciences company committed to enabling healthier lives through the development of innovative products and services. We serve physicians by providing early patient management information. The Company develops and commercializes innovative molecular diagnostics testing services that serve women's health and oncology markets.
Basis of Presentation and Consolidation
The accompanying consolidated financial statements have been prepared in conformity with U.S. generally accepted accounting principles, or GAAP, and include the accounts of the Company and its wholly-owned subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation.
Discontinued Operations
On May 30, 2014, the Company sold its Bioscience business segment. As a result of this sale, the Company's Bioscience segment has been excluded from continuing operations for all periods herein and reported as discontinued operations. For additional information on the divestiture of the Company's Bioscience segment, see Note 4 Discontinued Operations.
Segment Information
Prior to the divestiture, the Company derived revenue from two business segments: Sequenom Laboratories and Sequenom Bioscience. Therefore, with the reported divestiture the Company operates in a single business segment and all prior period information herein has been recast to conform to this presentation.
Use of Estimates
The preparation of financial statements in conformity with GAAP requires that management make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Examples of the Company’s significant accounting estimates that may involve a higher degree of judgment and complexity than others include revenue recognition and the estimates required in accrual accounting. Actual results could differ materially from those estimates and assumptions.
Revenue Recognition
The Company generates revenue primarily from diagnostic services from providing laboratory-developed tests, or LDTs, primarily for the detection of specific fetal abnormalities or other genetic conditions, as well as other amounts earned for royalties and license agreements.
Revenue is recognized when persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the price is fixed or determinable, and collectability is reasonably assured. The Company assesses whether the fee is fixed or determinable based on the nature of the fee charged for the services delivered, whether there are existing contractual arrangements, and historical payment patterns. In determining when to record revenue, the Company evaluates collectability and considers whether there is sufficient history to reliably estimate a payor's individual payment patterns. Revenue is deferred for fees received before earned. Royalty revenue is generally recorded on an accrual basis when earned.
Diagnostic services revenue is recognized upon cash collection until we can reliably estimate the amount that would be ultimately collected for the test and the above criteria have been met, at which time revenue is recognized on an accrual basis. The Company generally bills third-party payors upon generation and delivery of a test result to the ordering physician following completion of a test. As such, the Company takes assignment of benefits and risk of collection with the third-party payor. Patients have out-of-pocket costs for amounts not covered by their insurance carrier and the Company bills the patient directly for these amounts in the form of co-pays and deductibles in accordance with their insurance carrier and health plans. Some payors may not cover the test as ordered by the physician under their reimbursement policies. Consequently, the Company pursues reimbursement on a case-by-case basis.
From time to time, the Company receives requests for refunds of payments, generally due to overpayments made by third party-payors. Upon becoming aware of a refund request, the Company establishes an accrued liability for tests covered by the
refund request until such time as the Company determines whether or not a refund is due. Accrued refunds were $0.4 million and $1.7 million at December 31, 2014 and 2013, respectively.
License arrangements may involve multiple elements and the Company evaluates the agreements to determine whether each deliverable represents a separate unit of accounting. A deliverable constitutes a separate unit of accounting when it has stand-alone value to the customer. Items are considered to have stand-alone value when they are sold separately by any vendor or when the customer could resell the item on a stand-alone basis. Consideration is allocated at the inception of the contract to all deliverables based on their relative selling price. The relative selling price for each deliverable is determined using vendor specific objective evidence (VSOE) of selling price or third-party evidence of selling price if VSOE does not exist. If neither VSOE nor third-party evidence exists, the Company uses its best estimate of the selling price for the deliverable. Such amounts are recognized as revenue when each unit is delivered.
If the delivered element does not have stand-alone value without one of the undelivered elements in the arrangement, the elements are combined and accounted for as a single unit of accounting. Such amounts are recognized as revenue when the last deliverable of the combined units is delivered.
Cost of Revenue
Cost of revenue includes the cost of materials, direct labor (including laboratory and service personnel), equipment and infrastructure expenses associated with processing blood and other samples, quality control analyses, shipping charges to transport samples, and license fees. Infrastructure expenses include allocated facility occupancy and information technology costs. Costs associated with performing testing services are recorded as tests are processed. Costs recorded for sample processing and shipping charges represent the cost of all the tests processed during the period regardless of whether revenue is recognized with respect to that test. Royalties for licensed technology calculated on a per test basis or as a percentage of product revenue and fixed annual payments relating to the launch and commercialization of LDTs are recorded as license fees in cost of revenue at the time product revenue is recognized or in accordance with other contractual obligations.
Research and Development Expenses
Research and development expenses are comprised of costs incurred to develop technology and carry out clinical studies and include salaries and benefits, reagents and supplies used in research and development laboratory work, infrastructure expenses, including allocated facility occupancy and information technology costs, contract services, and other outside costs. Research and development costs are expensed as incurred.
Costs for collaboration and clinical study agreements with collaborators are recorded as research and development expenses. Accruals are recorded for estimated study costs comprised of work performed by collaborators under contract terms. Advance payments for goods or services that will be used or rendered for future research and development activities are deferred and capitalized and recognized as expense as the goods are delivered or the related services are performed.
Collaboration, Development and Licensing Agreement Expenses
The Company has collaborative agreements with life sciences partners that provide rights to develop, produce, and market products using certain know-how, technology and patent rights maintained by these partners. Terms of the various collaboration agreements may require milestone payments upon the achievement of certain product research and development objectives and payment of royalties on future sales, if any, of commercial products resulting from the collaboration.
Concentration of Risks
Financial instruments, which potentially are a concentration of credit risk, consist primarily of cash, cash equivalents, marketable securities, and accounts receivable. The exposure to credit loss is limited by placing cash, cash equivalents and marketable securities with US financial institutions. Additionally, the Company has established guidelines regarding diversification of investments and their maturities, which are designed to maintain principal and maximize liquidity. Credit risk with respect to accounts receivable is limited due to the Company's large and diverse customer base.
In 2014 one payor represented $17.4 million, or 11% of revenue. In 2013 two payors represented $25.0 million and $12.6 million or 21% and 11% of revenue, respectively. In 2012 two payors represented $6.7 million and $6.0 million or 15% and 13% of revenue, respectively.
The Company requires raw materials and devices of appropriate quality, reliability and to meet applicable regulatory requirements that currently are available from a limited number of sources and in certain cases a single source of supply. Consequently, in the event that supplies are delayed or interrupted for any reason, it could impair the ability to develop and produce services, which could have a material adverse effect on the business, financial condition and results of operations.
Fair Value Measurements
Financial instruments consist principally of cash, cash equivalents, short-term marketable securities, accounts receivable, accounts payable, accrued expenses, long term debt and the Company's 5.00% Convertible Senior Notes due 2017, or Convertible Senior Notes.
The carrying amounts of financial instruments such as cash equivalents, accounts receivable, accounts payable and accrued expenses approximate the related fair values due to the short-term maturities of these instruments. Marketable securities consist of available-for-sale securities that are reported at fair value.
Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants on the measurement date. Accounting guidance also establishes a fair value hierarchy that requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair value:
Level 1-Observable inputs that reflect quoted prices (unadjusted) for identical assets or liabilities in active markets.
Level 2-Includes other inputs that are directly or indirectly observable in the marketplace.
Level 3-Unobservable inputs that are supported by little or no market activities, therefore requiring an entity to develop its own assumptions.
The Company determines the value of cash equivalents and marketable securities using quoted market prices or alternative pricing sources and models utilizing observable market inputs and, as such, classifies cash equivalents and marketable securities within Level 1 or Level 2.
Cash, Cash Equivalents, and Marketable Securities
Cash equivalents consist of short-term, highly liquid investments with original maturities of three months or less at the time of purchase.
Investments with an original maturity of more than three months at the time of purchase are considered marketable securities. All marketable securities have been classified by management as available-for-sale. The available-for-sale securities are carried at fair value, with unrealized gains and losses, determined on a specific identification basis, reported as a component of other comprehensive income (loss) in stockholders' deficit until realized.
A decline in the market value of any marketable security below cost that is determined to be other-than-temporary will result in a revaluation of its carrying amount to fair value. The impairment would be included in other income or expense in the consolidated statements of operations and a new cost basis for the security would be established. There were no such declines in market value of any marketable security in the periods presented.
Accounts Receivable
Diagnostic services revenue is recorded on an accrual basis for payors and tests that meet the revenue recognition criteria for accrual basis and for client bill arrangements, which are primarily labs and international customers, upon delivery of test results to ordering physicians where a contractual agreement exits and for which collectability is reasonably assured.
The Company considers receivables past due based on payment terms and reserves specific receivables if collectability is no longer reasonably assured. The Company evaluates such reserves on a regular basis and adjusts its reserves as needed. Once a receivable is deemed to be uncollectible, such balance is charged against the reserve.
Inventories
Inventories are valued at the lower of cost (first-in, first-out) or market value (net realizable value). Provisions for slow moving, excess and obsolete inventories are estimated based on future demands and product life cycles, including expiration.
Property, Equipment and Leasehold Improvements
Property consists of a leased building that did not meet the sale-leaseback criteria upon completion of the construction of the building and is recorded at its fair value at the date of the lease, less depreciation. The building is being depreciated over a period of 15 years equal to the term of the related lease and extensions.
Equipment is stated at cost and depreciated using the straight-line method over the estimated useful lives of the assets (generally 3 to 5 years).
Leasehold improvements are stated at cost and amortized using the straight-line method over the estimated useful life of the improvement or the remaining term of the lease, whichever is shorter. The maximum estimated useful life of any leasehold improvement is generally 15 years from the completion of the improvement. Maintenance and repairs are charged to operations
as incurred. When assets are sold, or otherwise disposed of, the cost and related accumulated depreciation are removed from the accounts and any gain or loss is included in operating expense.
Financing Lease
For accounting purposes only, the Company is deemed to be the owner of the leased building in Raleigh-Durham, North Carolina, laboratory site as the terms of that facility lease agreement required extensive involvement in the construction of the building. Accordingly, assets were recorded representing the fair value of the building based on the assessed value and the total costs of the improvements, including the costs paid by the lessor (the legal owner of the building), with an associated long-term obligation. Upon completion of construction of the building, the sale-leaseback criteria was not met for de-recognition of the building assets and obligation. Therefore the lease is accounted for as a long-term financing obligation. The Company reports rent expense only on the land portion of the property but not for the building which is owned by the Company for accounting purposes. Rather, building rental payments under the lease are recognized as a reduction of the financing obligation and interest expense.
Operating Leases
The Company leases office, laboratory and research and development facilities, and equipment under various non-cancellable operating lease agreements. Facility leases generally provide for periodic rent increases, and many contain escalation clauses and renewal options. Certain leases require the Company to pay property taxes and routine maintenance. Facility leases have terms that expire at various dates through September 2025.
In cases where the lessor grants leasehold improvement allowances rent expense is reduced by the allowances paid as those amounts are capitalized as improvements which are recognized as deferred rent that is amortized over the shorter of the lease term or the expected useful life of the improvements. During the year ended December 31, 2012, $2.8 million was capitalized from lessor paid leasehold improvements. During the year ended December 31, 2014 and 2013 no leasehold improvements were paid by a lessor.
Rent expense for operating leases is recognized on a straight-line basis. Rent expense of $5.2 million, $5.8 million, and $4.9 million was recognized for all operating leases during the years ended December 31, 2014, 2013 and 2012, respectively. Current and noncurrent deferred rent totaled $1.2 million and $0.1 million, respectively, at December 31, 2014, and $1.4 million and $0.7 million, respectively, at December 31, 2013.
Intangible Assets
Intangible assets that have finite useful lives consist of purchased patent rights and licenses. These intangible assets are being amortized over the expected economic use of the assets.
Goodwill
Goodwill represents the excess purchase price of net tangible and identifiable intangible assets acquired in business combinations over their estimated fair value. The allocation of purchase price for acquisitions requires extensive use of accounting estimates and judgments to allocate the purchase price to the identifiable tangible and intangible assets acquired and liabilities assumed based on their respective fair values. Goodwill is deemed to have an indefinite life and, therefore, is not amortized.
Goodwill is tested for impairment at the reporting unit level during the fourth quarter each fiscal year, or more frequently if indicators of impairment are present. If goodwill is considered to be impaired, the impairment recognized is equal to the amount by which the carrying value of the reporting units goodwill exceeds the implied fair value of that goodwill.
Valuation of Long-Lived and Intangible Assets
The Company periodically re-evaluates the original assumptions and rationale utilized in the establishment of the carrying value and estimated lives of long-lived assets and finite-lived intangible assets. Long-lived assets and finite-lived intangibles are assessed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. If an asset is considered to be impaired, the impairment recognized is equal to the amount by which the carrying value of the asset exceeds its fair value.
Share-Based Compensation
The Company measures and recognizes compensation expense for all share-based payments made to employees, directors, and consultants based on estimated fair value, net of estimated forfeitures. These share-based awards include stock options, restricted stock and restricted stock units, and stock purchase rights under the Company's employee stock purchase plan. The fair value of stock options granted and stock purchase rights is estimated using the Black-Scholes-Merton ("BSM"), option-pricing model and for market-based grants the Monte Carlo simulation model is used. These models require the use of
estimates such as stock price volatility and expected option lives, as well as expected option forfeiture rates, to value employee share-based compensation at the date of grant or modification. The fair value of restricted stock awards and restricted stock units is based on the market price of the Company's common stock on the date of grant.
Share-based compensation cost is recognized on a straight-line basis over the requisite service period of the award or, in the case of market-based awards, on an accelerated basis, over the greater of the vesting period or derived service period. Share-based compensation expense is recognized only for those awards that are ultimately expected to vest for awards with only a service condition. For stock option modifications, the Company compares the fair value of the original award immediately before and after the modification. For Type I modifications, or probable-to-probable vesting conditions, the incremental fair value of fully vested awards is recognized as expense on the date of the modification, with the incremental fair value of unvested awards recognized ratably over the new service period. Forfeitures are estimated at the time of grant and revised if necessary, in subsequent periods, if actual forfeitures differ from those estimates. Changes in forfeiture estimates impact compensation cost in the period in which the change in estimate occurs.
Due to a net loss carryforward position, no tax benefits for share-based compensation have been recognized in the consolidated statements of cash flows. The Company has not recognized, and does not expect to recognize in the near future, any tax benefit related to share-based compensation cost as a result of the full valuation allowance of the Company's net deferred tax assets and net operating loss carryforwards.
The fair value of options granted to non-employees is estimated at the measurement date using the BSM pricing model and remeasured at each reporting date to fair value, with changes in fair value recognized as expense in the statement of operations and comprehensive income (loss).
Restructuring Costs
During the year ended December 31, 2013, the Company announced and executed a restructuring plan to exit its marketing of RetnaGene AMD LDT, reduce the Company’s workforce and not to move into a leased facility. The Company measured and accrued the liabilities associated with employee separation costs at fair value as of the date the plan was announced and terminations were communicated to employees, which primarily consisted of severance pay and other separation costs such as outplacement services and benefits.
The fair value measurement of restructuring related liabilities requires certain assumptions and estimates to be made by the Company, such as the retention period of certain employees, the timing and amount of sublease income on the property, and the operating costs to be paid until lease termination. The Company’s policy is to use its best estimates based on facts and circumstances available at the time of measurement, review the assumptions and estimates periodically, and adjust the liabilities when necessary.
Income Taxes
As a result of a gain of $24.3 million from the sale of the discontinued operations in 2014, we recorded income tax expense from discontinued operations of $8.3 million. We also recognized a corresponding tax benefit in continuing operations in 2014. This benefit is a result of the required accounting for discontinued operations which requires a separate tax presentation for discontinued and continuing operations.
Our provision for income taxes is computed using the asset and liability method, under which deferred tax assets and liabilities are recognized for the expected future tax consequences of temporary differences between the financial reporting and tax bases of assets and liabilities, and for the expected future tax benefit to be derived from tax loss and credit carryforwards. Deferred tax assets and liabilities are determined using the enacted tax rates in effect for the years in which those tax assets are expected to be realized. A valuation allowance is established when it is more likely than not the future realization of all or some of the deferred tax assets will not be achieved. The evaluation of the need for a valuation allowance is performed on a jurisdiction by jurisdiction basis, and includes a review of all available positive and negative evidence. When we establish or reduce the valuation allowance against deferred tax assets, our provision for income taxes will increase or decrease, respectively, in the period such determination is made. As of December 31, 2014 and 2013, we maintained valuation allowances against U.S. and foreign deferred tax assets that we concluded had not met the “more likely than not” threshold. Changes in the valuation allowance when they are recognized in the provision for income taxes may result in a change in the estimated annual effective tax rate.
We recognize excess tax benefits associated with share-based compensation to stockholders' equity only when realized. When assessing whether excess tax benefits relating to share-based compensation have been realized, we follow the with-and-without approach, excluding any indirect effects of the excess tax deductions. Under this approach, excess tax benefits related to share-based compensation are not deemed to be realized until after the utilization of all other tax benefits available to us.
We recognize the impact of a tax position in our financial statements only if we believe that position is more likely than not of being sustained upon examination by taxing authorities, based on the technical merits of the position. Any interest and penalties related to uncertain tax positions will be reflected in income tax expense.
Accumulated Other Comprehensive Income (Loss)
Comprehensive loss and its components encompasses all changes in equity other than those with stockholders, and includes net loss, unrealized gains and losses on available-for-sale marketable securities and foreign currency translation adjustments.
Functional Currency
The U.S. dollar is the functional currency of the Company’s international operations. The Company remeasures its foreign subsidiaries’ monetary assets and liabilities to the U.S. dollar and records the net gains or losses resulting from remeasurement in other expense, net in the consolidated statements of operations.
Net Earnings (Loss) Per Share
Basic and diluted net loss per common share for the periods presented is computed by dividing net loss by the weighted-average number of common shares outstanding during the respective periods, without consideration of common stock equivalents. Common stock equivalents, determined on a weighted-average, that could potentially reduce net earnings per common share in the future that were not included in the determination of diluted earnings (loss) per common share as their effects were antidilutive are as follows (in thousands):
The control number for determining whether to present potential dilutive common shares in the diluted EPS computation is income from continuing operations. As a result, if there is a loss from continuing operations, diluted EPS would be computed in the same manner as basic EPS is computed, even if we report net earnings after including discontinued operations.
Recently Adopted Accounting Pronouncements
In June 2014, the Financial Accounting Standards Board, or FASB, issued an accounting standards update that requires a performance target that affects vesting of a share-based payment award and that could be achieved after the requisite service period to be treated as a performance condition. As such, the performance target should not be reflected in estimating the grant-date fair value of the award. Compensation cost should be recognized over the required service period, if it is probable that the performance target will be achieved. This guidance will be effective for fiscal years beginning after December 15, 2015, which will be the Company's fiscal year 2016, with early adoption permitted. The Company does not expect the adoption of the guidance will have a material impact on the Company's consolidated financial statements.
In May 2014, the FASB issued an accounting standards update that creates a single source of revenue guidance for companies in all industries. The new standard provides guidance for all revenue arising from contracts with customers and affects all entities that enter into contracts to provide goods or services to their customers, unless the contracts are within the scope of other accounting standards. It also provides a model for the measurement and recognition of gains and losses on the sale of certain nonfinancial assets. This guidance must be adopted using either a full retrospective approach for all periods presented or a modified retrospective approach and will be effective for fiscal years beginning after December 15, 2016, which will be the Company's fiscal year 2017. The Company has not yet evaluated the potential impact of adopting the guidance on the Company's consolidated financial statements.
In April 2014, the FASB issued an accounting standards update that raises the threshold for disposals to qualify as discontinued operations and allows companies to have significant continuing involvement with and continuing cash flows from or to the discontinued operation. It also requires additional disclosures for discontinued operations and new disclosures for individually material disposal transactions that do not meet the definition of a discontinued operation. This guidance will be effective for fiscal years beginning after December 15, 2014, which will be the Company's fiscal year 2015, with early adoption
permitted. The Company elected to use the non-amended guidance to evaluate the reported discontinued operations (see footnote 4) and will adopt the new guidance after its effective date.
Note 2. Supplementary Financial Information
Marketable Securities, available-for-sale (in thousands):
As of December 31, 2014, gross unrealized losses on marketable securities were insignificant. There were no impairments considered other-than-temporary for the years presented, as the Company has the intent and ability to hold the securities until maturity or a recovery of the cost basis or recovery of fair value. As of December 31, 2014, all marketable securities were due within one year.
Inventories (in thousands):
Other Current Assets and Prepaid Expenses (in thousands):
Property, Equipment and Leasehold Improvements (in thousands):
Depreciation expense for the years ended December 31, 2014, 2013 and 2012 was $11.5 million, $13.6 million, and $9.9 million, respectively. Depreciation of assets under capital leases is included in depreciation expense.
Accrued Expenses (in thousands):
Note 3. Significant Acquisitions and Other Transactions
Acquisition of Patent Rights
On September 30, 2014, the Company entered into a patent purchase agreement (Patent Purchase Agreement) with Isis Innovation Limited (“Isis”). The acquired patents and patent applications from Isis relate to noninvasive prenatal testing for use in the United States, Canada, Japan, Australia, Hong Kong and Europe. The Company received an irrevocable, perpetual, fully-paid, exclusive license (with the right to sublicense) to certain know-how and intellectual property related to noninvasive prenatal testing, subject to certain reserved rights retained by Isis. The purchase is an asset acquisition and the accounting guidance requires assets acquired to be measured at the cost of the consideration paid or the fair value of the asset acquired, whichever measure is more reliable. The Company previously held an exclusive license to the patents and patent applications under the Exclusive License of Technology Agreement, dated October 14, 2005, between Isis and the Company, as amended (the “Exclusive License Agreement”). Under the Patent Purchase Agreement the Exclusive License Agreement was terminated as of September 30, 2014.
In consideration for the exclusive rights to the license, the Company made an up-front payment of $9.25 million to Isis and agreed to waive $2.1 million in legal fees owed to the Company by Isis. Additionally, Isis agreed to waive $1.4 million of royalties owed by the Company to Isis, under the Exclusive License Agreement. Including the remaining intangible asset value of $0.65 million from the Exclusive License Agreement, the acquired patent value was $10.6 million. The purchased patent rights will be amortized on a straight-line basis over their expected useful life, which was determined to be 3.5 years or through March 2018. Under the agreement the Company may also be required to make future payments to Isis based on meeting or exceeding certain revenue targets.
As of December 31, 2014 the carrying amount of the Company's intangible assets was $13.9 million less accumulated amortization of $2.7 million. Future estimated amortization of intangible assets at December 31, 2014 is as follows (in thousands):
Pooled Patents Agreement
On December 2, 2014, the Company entered into a Pooled Patents Agreement (the “Pooled Patents Agreement”) with Illumina, Inc. (“Illumina”), pursuant to which the parties pooled their intellectual property directed to noninvasive prenatal testing (“NIPT”). Under the Pooled Patents Agreement, Illumina has exclusive worldwide rights to utilize the pooled intellectual property to develop and sell in-vitro diagnostic (IVD) kits for NIPT and to license to third-party laboratories wanting to develop and sell their own laboratory-developed NIPT tests under the collection of pooled patents. The Company maintained a non-exclusive right to sublicense the intellectual property rights it acquired from Isis to third-party laboratories for its own developed NIPT tests. In addition, the Company and Illumina each have rights to utilize all pooled patents to develop and sell their own respective laboratory-developed NIPT tests. Additionally, as part of the Pooled Patents Agreement, Illumina gained access to samples and applicable study protocols from the Company’s clinical studies for high and low risk pregnancies.
In consideration, Illumina made an aggregate $50.0 million upfront payment to the Company as part of the agreement, of which $6.0 million was received in January 2015. Illumina will also pay royalties to the Company for sales of IVD kits for NIPT. The Company, Illumina and their sublicensees will each pay a per-test fee into a pool for laboratory-developed NIPT tests depending on the annualized volumes of tests, which will be shared between the Company and Illumina. Illumina has agreed to make minimum yearly payments to the Company under the pool covering both IVD royalties and Sequenom’s share of the collected test fees through 2020. The Pooled Patents Agreement will remain in effect until the date of expiration of the last to expire pooled patent on, which may be extended if patent applications in the pool are approved. Neither party may terminate the Pooled Patents Agreement except by mutual written agreement of the parties.
In accordance with the Pooled Patents Agreement, Sequenom and the Chinese University of Hong Kong (“CUHK”) entered into an agreement (the “CUHK Agreement”), pursuant to which certain license agreements by and between Sequenom and CUHK, were amended and assigned to Illumina for inclusion in the patent pool, subject to the Pooled Patents Agreement. Illumina is responsible for paying all royalties to CUHK under the CUHK License Agreements, and granted the Company a sublicense under each agreement to exploit laboratory-developed NIPT tests in accordance with the Pooled Patents Agreement. In consideration, the Company paid CUHK a one-time $6.15 million upfront payment and will pay additional royalties of varying percentages through 2019. The CUHK Agreement shall remain in effect until the expiration of the CUHK License Agreements. Each of the CUHK License Agreements expires concurrently with the last-to-expire patent that is a subject of the agreement or on the 20th anniversary of the commencement date of the agreement, whichever is later.
Concurrently with the execution of the Pooled Patents Agreement, Sequenom, Illumina, the Sequenom Center for Molecular Medicine, LLC (“SCMM ” a subsidiary of Sequenom Inc.), and Verinata Health, Inc., a subsidiary of Illumina (“Verinata ”) entered into a Settlement Agreement (the “Settlement Agreement ”), pursuant to which the parties settled certain claims and released the other parties from potential liability. Each party to the Settlement Agreement released the other parties and their affiliates, licensors, licensees, developers and certain purchasers from all claims for the exploitation, on or before the December 2, 2014 effective date of the Settlement Agreement, of NIPT products and services, as well as any other claims based on acts relating to the subject matter of the dismissed disputes or that could have been brought in response thereto. None of the parties made any admission of liability in entering into these arrangements.
In connection with entering into the Pooled Patents Agreement, the Company also entered into an Amended and Restated Sale and Supply Agreement with Illumina (the “Supply Agreement”), pursuant to which Sequenom and its affiliates will purchase various products from Illumina for use in NIPT as well as for other clinical and research uses. The Supply Agreement amends, restates and replaces Sequenom’s prior Sale and Supply Agreement with Illumina. Subject to certain conditions and limitations, including an annual purchase minimum, under the Supply Agreement Sequenom and its affiliates will receive pricing no less favorable than that offered by Illumina to similar customers in the United States. The Supply Agreement has a term of five years; provided, however, that it may be earlier terminated (i) in the event that either party breaches a material provision and fails to cure such breach within thirty days after receiving written notice of the breach, or (ii) by written notice if the other party becomes the subject of a voluntary or involuntary petition in bankruptcy or any proceeding relating to insolvency, receivership, liquidation or composition for the benefit of creditors that is not dismissed within 60 days.
The Company determined that the Pooled Patents Agreement, the Settlement Agreement, the Supply Agreement and the CUHK Agreement were all part of a single transaction with multiple elements as the various agreements were contemporaneously negotiated, contingent upon one another and negotiated with the same counterparties. As the agreements were considered to be part of one transaction with multiple elements, the Company followed the accounting guidance in ASC 605-25 to determine the separate units of account and the basis for allocating the consideration received. The Company evaluated all elements of the agreements and identified the following deliverables that had value; (1) the physical samples and applicable study protocols, (2) transfer of IVD technology (3) settlement of claims and disputes between the Company and Illumina and (4) the $6.15 million upfront payment made to CUHK. The Company allocated consideration to the physical samples and transfer of IVD technology based on its best estimate of selling price for each of the deliverables, which were derived from Company models as well as through the use of a third-party valuation expert. The Company determined the value to be allocated to the settlement of claims and disputes based on the residual value method due to the complex nature of the litigation and the inability to make a reliable estimate of value for this component. Consideration allocated to each element was $21.0 million for each of (i) the physical samples and (ii) the transfer of IVD technology and $1.85 million for the settlement of claims and disputes. The $6.15 million payment made by the Company to CUHK was reflected as a reduction of the proceeds received from Illumina as this was primarily for the amendment of certain license agreements by and between Sequenom and CUHK, and the assignment of those agreements to Illumina for inclusion in the patent pool, and resulted in net consideration to be allocated by the Company of $43.85 million.
Effective December 2, 2014, the Company transferred to Illumina the IVD technology and settled all claims and disputes with Illumina set forth in the Settlement Agreement. As such, the Company satisfied two deliverables in the arrangement and recognized $22.85 million as a gain on the Pooled Patents Agreement in the consolidated statement of operations and comprehensive income (loss) during the fourth quarter of 2014. The Company will recognize a gain of $21.0 million once the remaining applicable study protocols associated with the physical samples are delivered to Illumina, which is expected to occur during the first half of 2015.
Note 4. Discontinued Operations
The results of operations from discontinued operations presented below include certain allocations that management believes fairly reflect the utilization of services provided to the Bioscience business segment. The allocations do not include amounts related to general corporate administrative expenses or interest expense. Therefore, the results of operations from the Bioscience business segment do not necessarily reflect what the results of operations would have been had the business operated as a stand-alone entity.
The gain on the sale of the Bioscience business segment, net of $8.3 million of related tax expense was $16.0 million, with an aggregate cash sale price of $31.8 million, plus a $2.0 million, milestone payment, less net book value of $6.2 million,
adjustments for working capital of $0.8 million, and transaction costs of approximately $2.5 million, which consist primarily of investment banking and legal fees.
The following table summarizes the assets and liabilities of discontinued operations as of December 31, 2013 related to the Bioscience business segment (in thousands):
In connection with the sale of the Bioscience segment, the Company also entered into other agreements designed to facilitate the orderly transfer of business operations to BioSciences. One agreement is a three year Supply Agreement with BioSciences where the Company may purchase consumables and systems for the laboratory business and for the first twelve months of the agreement has preferred pricing. Purchases made by the Company of consumables and systems for the years ended December 31, 2014, 2013 and 2012, were $0.7 million, $0.9 million and $0.6 million, respectively, these sales have been eliminated from discontinued operations reported revenue because the transaction was intra-entity.
Note 5. Research and Development and Collaboration and Licensing Agreements
The Company has entered into various collaborative agreements that provide rights to develop, produce and market products using certain know-how, technology and patent rights maintained by the Company's collaborative partners. Terms of the various collaboration agreements may require us to make milestone payments upon the achievement of certain product research and development objectives and pay royalties on future sales, if any, of commercial products resulting from the collaboration. Certain of the licensing agreements require guaranteed minimum royalty payments. Terms of the licensing agreements generally range from the remaining life of the patent up to 17 years and, in some cases, may be subject to earlier termination by either party upon specified circumstances.
Total expense incurred under all research and development collaboration and licensing agreements for royalties, milestone payments, and research funding obligations, including amortization, during the years ended December 31, 2014, 2013 and 2012 was $13.6 million, $12.0 million and $5.5 million, respectively.
Future minimum guaranteed payment obligations for royalties, milestone payments, and research funding obligations under all such agreements at December 31, 2014 are as follows (in thousands):
Note 6. Long-Term Obligations (in thousands, except percentages):
Future maturities of long-term obligations at December 31, 2014 are as follows (in thousands):
Convertible Senior Notes
On September 17, 2012, the Company issued $130.0 million aggregate principal amount of Convertible Senior Notes ("the Notes") in a private offering to qualified institutional buyers in reliance on Rule 144A under the Securities Act of 1933, as amended. The Notes bear interest at a fixed rate of 5.00% per year, payable semiannually in arrears on April 1 and October 1 of each year. The Notes mature on October 1, 2017, unless earlier converted, redeemed, or repurchased. The Notes are convertible at any time prior to the third trading day immediately preceding the maturity date, at the option of the holders, into shares of common stock.
The net proceeds received were $124.7 million after deducting underwriting discounts and commissions and other offering costs of $5.3 million. The debt issuance costs are recorded in other assets and are amortized to interest expense, using the effective interest method, over the five-year term of the Notes. At December 31, 2014 and 2013, unamortized deferred debt issuance costs totaled $3.1 million and $4.1 million, respectively.
The Notes are initially convertible into a total of 28.1 million shares of common stock, which is equal to an initial conversion rate of 216.0644 shares of common stock per $1,000 principal amount of the Notes (equivalent to an initial conversion price of approximately $4.63 per share of common stock), and will be subject to adjustment upon the occurrence of certain events. The maximum conversion rate is 275.4821 shares of common stock per $1,000 principal amount of the Notes, which would result in a maximum issuance of 35.8 million shares of common stock if all holders converted at the maximum conversion rate. In addition, under certain circumstances the Company, in connection with a make-whole fundamental change (as defined in the indenture governing the Notes), may be required to increase the conversion rate for holders of the Notes and as of December 31, 2014, no change to the conversion rate has occurred on the Notes.
The Company may not redeem the Notes prior to October 1, 2015. On or after October 1, 2015, the Company may redeem for cash all, but not less than all, of the Notes if the last reported sale price of the common stock equals or exceeds 140% of the applicable conversion price for at least 20 trading days during the 30 consecutive trading day period ending on the trading day immediately prior to the date on which the notice of the redemption is delivered. The redemption price will equal 100% of the principal amount of the Notes to be redeemed, plus any accrued and unpaid interest to, but excluding, the redemption date. In addition, if the Notes are called for redemption, a make-whole fundamental change will be deemed to occur. As a result, in certain circumstances, this would increase the conversion rate for holders who convert their Notes after a notice of redemption is delivered and on or prior to the close of business on the third business day immediately preceding the relevant redemption date. Upon a fundamental change, subject to certain exceptions, the holders may require that the Company repurchase some or all of their Notes for cash at a repurchase price equal to 100% of the principal amount of the Notes being repurchased, plus any accrued and unpaid interest to, but excluding, the fundamental change repurchase date.
On September 17, 2012, the Company entered into an indenture with Wells Fargo Bank, National Association, as trustee, relating to the Notes. The Notes are senior, unsecured obligations and rank equal in right of payment with existing and future senior, unsecured indebtedness, and will be senior in right of payment to any future indebtedness that is expressly subordinated to the Notes. The Notes will be effectively subordinated to existing and future secured indebtedness to the extent of the assets securing such indebtedness and will be structurally subordinated to all indebtedness and other liabilities and commitments of subsidiaries, including trade payables and any guarantees that they may provide with respect to any existing or future indebtedness.
Bank Loans
In May 2011, the Company entered into a Loan and Security Agreement, or the Loan Agreement, with Silicon Valley Bank, or SVB, that allowed for term loans of up to $20.0 million to be borrowed through August 31, 2012, revolving cash borrowings of up to $10.0 million, as well as letters of credit all under a secured credit facility. All borrowings under the Loan Agreement are secured by substantially all of the Company's assets, except for intellectual property, and are subject to certain other exceptions. The Loan Agreement includes limitations on the ability, among other things, to incur debt, to grant liens, to make certain investments, to make certain restricted payments such as dividend payments, and to dispose of assets, as well as requirements to meet a number of affirmative and negative covenants.
The Company borrowed under the term loans $5.0 million and $15.0 million during the years ended December 31, 2012 and 2011, respectively. Under the Loan Agreement, the term loans bear interest at the rate fixed on the date of funding equal to the U.S. treasury rate plus 3.25% per annum. The term loan borrowings are being repaid in 33 equal installments of principal, plus accrued interest which commenced on September 1, 2012. The term loans requires a final payment of 3.5% of all advances made under the term loans, in addition to principal repayments, at the loan maturity date, which is May 1, 2015, which is being amortized as interest expense over the term of the loan. The Company has the option to prepay the outstanding balance of the term loans in full, subject to the final payment.
At December 31, 2014, the Company was in compliance with all covenants under the Loan Agreement. These include a minimum liquidity covenant requiring the Company to maintain with SVB unrestricted cash and marketable securities plus available amounts equal to or greater than the sum of all indebtedness owed to SVB plus operating liquidity.
Obligation for Building and Improvements
In November 2011, the Company entered into a lease agreement for a building in Raleigh-Durham, North Carolina, that is accounted for as a financing lease. The term of the lease and the obligation was initially 15 years through October 2026, including two 5-year extensions of the lease. Rent payments under the lease are allocated primarily between interest expense and reduction to the long-term obligation. In the event the lease is terminated prior to the end of the 15-year period, any gain representing the amount by which the balance of the obligation exceeds the net book value of the related building and improvements would be recognized.
Note 7. Commitments and Contingencies
Patent Litigation
In December 2011, the Company was named as a defendant in a complaint filed by plaintiff Aria Diagnostics, Inc., in the U.S. District Court for the Northern District of California. Since the complaint was filed, Aria changed its name to Ariosa Diagnostics, Inc., or Ariosa. In the complaint, the plaintiff seeks a judicial declaration that no activities related to the plaintiff's noninvasive, prenatal test using cell-free DNA circulating in the blood of a pregnant woman do or will infringe any claim of U.S Patent No. 6,258,540 entitled Noninvasive Prenatal Diagnosis, or the '540 Patent, which was exclusively in-licensed from Isis prior to September 30, 2014 when the Company purchased the patent from Isis. In March 2012, the Company filed an answer to the complaint and asserted counterclaims that Ariosa is infringing the '540 Patent and seeking unspecified damages and injunctive relief. The Company's counterclaims name Isis as a nominal counter-defendant for purposes of subject matter jurisdiction only. With the purchase of the '540 Patent, the Company will seek to dismiss Isis from the lawsuit as soon as practicable. In March 2012, Ariosa responded to the Company's answer and counterclaims and asserted affirmative defenses including invalidity of the '540 Patent under U.S. patent laws. In March 2012, the Company filed a motion against Ariosa for preliminary injunctive relief. On July 5, 2012, the Court denied the Company's motion for preliminary injunctive relief and on July 16, 2012 the Company filed a Notice of Appeal to the U.S. Court of Appeals for the Federal Circuit (CAFC) from the order denying the preliminary injunction motion. On August 9, 2013, the CAFC vacated and remanded the District Court’s decision, ruling that the District Court incorrectly interpreted the claims of the ‘540 patent and improperly balanced factors regarding issuance of a preliminary injunction. On August 16, 2013, Ariosa filed a motion for summary judgment in favor of Ariosa on the Company's counterclaim for patent infringement on the ground that the claims of the ‘540 Patent are invalid because they are not drawn to patent-eligible subject matter under the patent code. On October 16, 2013 the District Court issued its order on the interpretation of the claims of the patent. On October 30, 2013 the District Court issued its order granting Ariosa’s motion for summary judgment, finding that the’540 Patent is invalid. The Company disagrees with the Order and has appealed the decision to the U.S. Court of Appeals for the Federal Circuit. The Company intends to vigorously defend against the judicial declarations sought by Ariosa in its complaint and intends to vigorously pursue the Company's claims against Ariosa for damages and injunctive relief. However, the Company cannot predict the outcome of this matter.
In addition, Ariosa has sought to invalidate the ‘540 Patent through a petition for inter parties review ("IPR") before the Patent Trial and Appeal Board (PTAB) of the United States Patent and Trademark Office (USPTO). Trial of the IPR was held before the PTAB on January 24, 2014. The PTAB issued a Decision in the IPR on September 2, 2014 invalidating some claims but upholding the validity of other claims. Both the Company and Ariosa have requested reconsideration of the PTAB decision.
In January 2012, the Company was named as a defendant in a complaint filed by plaintiff Natera, a Delaware corporation, in the U.S. District Court for the Northern District of California. In the complaint, the plaintiff seeks a judicial declaration that (i) activities related to the plaintiff's noninvasive, prenatal paternity test do not directly or indirectly infringe any claim of the '540 Patent, and (ii) one or more claims of the '540 Patent are invalid for failure to comply with the requirements of the patent laws of the U.S. In April 2012, the Company filed an answer to the complaint and asserted counterclaims that Natera and DNA Diagnostics Center, Inc., or DDC, are infringing the '540 Patent based on their activities relating to noninvasive prenatal paternity testing and noninvasive prenatal aneuploidy testing and seeking unspecified damages and injunctive relief. The Company's counterclaims named Isis as a nominal counter-defendant for purposes of subject matter jurisdiction only and the Company seeks to dismiss Isis as soon as practicable now that the Company has purchased the '540 patent from Isis. On October 16, 2013 the District Court issued its order on the interpretation of the patent claims. Many of the ‘540 Patent claims asserted against Natera are the same claims that were invalidated by the same District Court on October 30, 2013 in the litigation involving Ariosa, set forth above, and the Company and Natera stipulated to final judgment on the '540 patent claims in this case and have appealed the patent invalidity determination to the U.S. Court of Appeals for the Federal Circuit, which has consolidated the Ariosa, Natera, and Verinata case appeals. The Company intends to vigorously defend against the judicial declarations sought by Natera in its complaint and intend to vigorously pursue our claims against Natera for damages and injunctive relief. However, the Company cannot predict the outcome of this matter.
In February 2012, the Company was named as defendants in a complaint filed by plaintiffs Verinata Health, Inc., or Verinata, and The Board of Trustees of the Leland Stanford Junior University, or Stanford, in the U.S. District Court for the Northern District of California. Verinata was acquired by Illumina, Inc. in 2013. In the complaint (i) Verinata seeks a judicial declaration that activities related to its noninvasive prenatal test using cell-free DNA circulating in the blood of a pregnant woman do not directly or indirectly infringe any claim of the '540 Patent, which at the time was exclusively in-licensed from Isis but has since been purchased from Isis, (ii) Verinata seeks a judicial declaration that each claim of the '540 Patent is invalid for failure to comply with the requirements of the patent laws of the U.S., and (iii) Verinata and Stanford allege that the Company, by performing its noninvasive prenatal MaterniT21 test, has and continues to directly infringe U.S. Patents which have been exclusively licensed to Verinata by Stanford and seek unspecified damages. In March 2012, the Company filed an answer to the complaint and asserted counterclaims that Verinata is infringing the '540 Patent and seeking unspecified damages
and injunctive relief. The Company's counterclaims name Isis as a nominal counter-defendant for purposes of subject matter jurisdiction only. In June 2012, plaintiffs Verinata and Stanford amended their complaint and allege that the Company, by performing its noninvasive prenatal MaterniT21 PLUS test, have and continue to directly infringe on a Patent which has been exclusively licensed to Verinata by Stanford and seek unspecified damages. In July 2012, the Company filed an answer to the complaint.
On October 16, 2013, the District Court issued its order on the interpretation. Many of the ‘540 Patent claims asserted against Verinata are the same claims that were invalidated by the same District Court on October 30, 2013 in the litigation involving Ariosa, set forth above, and the Company and Verinata stipulated to final judgment on the ‘540 patent claims in this case and have appealed the patent invalidity determination to the U.S. Court of Appeals for the Federal Circuit. The District Court set trial beginning February 23, 2015. On December 2, 2014, the Company and Verinata reached a settlement that resolved litigation between them, and all litigation between the Company and Verinata related to these patents is now dismissed. As part of that settlement the patents and pending applications, are now pooled under a Pooled Patents Agreement between the Company and Illumina (who acquired Verinata). The Company and Verinata are now licensees to the patent rights that are pooled under the Pooled Patents Agreement.
On March 12, 2013, the U.S. Patent and Trademark Office, or USPTO, declared a patent interference between Verinata's patent, which Verinata had asserted against us in the litigation, and the Company's then in-licensed (from CUHK) pending a patent application. Two related patent interferences were declared by the USPTO between patent applications related to the patent and application. On April 7, 2014, the USPTO concluded the interferences, ruling that Verinata’s lacked sufficient disclosure to meet the written description requirement for the patent claims, and entered judgment canceling all four of the patent claims in the interference and the involved claims of the related patent application. Verinata has appealed the USPTO’s decision to the U.S. District Court for the Northern District of California. The District Court has set trial beginning February 23, 2015 on the appeal. On December 2, 2014, the involved patents and applications were added to the patent pool. The Company is not a party to the District Court proceedings.
On May 3, 2013, the USPTO declared a patent interference between Verinata's Patent, which Verinata has asserted against us in the litigation, and the Company's then in-licensed (from CUHK) pending patent application. On April 7, 2014, the USPTO ruled that the pending patent application has sufficient disclosure to meet the written description requirement for the patent claims and ordered the interference to proceed to the priority phase to determine which inventors were the first to invent the subject matter of the interference and entitled to a patent on that subject matter. The Company also separately challenged the validity of Verinata’s Patent in an inter partes review proceeding before the USPTO. The USPTO recently issued a decision in the Interference and the patent IPR upholding the validity of the patent. Pursuant to the terms of its settlement with Verinata, the Company will not appeal these decisions.
On September 29, 2014, and October 1, 2014 two unknown third parties initiated Opposition Proceedings against a European Patent. This patent was previously in-licensed by the Company from CUHK but has since been added to the patent pool under the Pooled Patents Agreement. The Company has rights to this patent under the patent pool but no longer controls efforts to defend this patent in the Opposition Proceedings.
In addition, from time to time, the Company may be involved in litigation relating to claims arising out of the Company's operations in the normal course of business, including claims related to the Company's products, tests, and services, including LDT services. These other matters are, in the opinion of management, immaterial with respect to the Company's consolidated financial position, liquidity, or results of operations.
Claim estimates that are probable and can be reasonably estimated are reflected as liabilities. Because of the uncertainties related to the Company's pending litigation, investigations, inquiries or claims, management is currently unable to predict the ultimate outcome of any litigation, investigation, inquiry or claim, determine whether a liability has been incurred, or make an estimate regarding the possible loss or range of loss that could result from an unfavorable outcome. It is reasonably possible that some of the matters, which are pending or may be asserted, could be decided unfavorably to us. An adverse ruling or outcome in any lawsuit involving us could materially affect the Company's business, liquidity, consolidated financial position or results of operations ability to sell one or more of the Company's products or could result in additional competition. In view of the unpredictable nature of such matters, the Company cannot provide any assurances regarding the outcome of any litigation, investigation, inquiry or claim to which the Company is a party or the impact on us of an adverse ruling of such matters.
Operating Leases
Future minimum annual obligations under all non-cancellable operating lease commitments, including the facility leases, at December 31, 2014 are as follows (in thousands):
Note 8. Preferred and Common Stock
Preferred Shares
The Board of Directors has the authority to designate up to 5.0 million shares of preferred stock in one or more series and to define the terms of each series of preferred stock, including dividend, conversion, voting, redemption and liquidation rights and preferences. As of December 31, 2014 no preferred stock has been issued or is outstanding.
Stock Purchase Rights Agreement
The Company has a Rights Agreement to protect stockholders' interest in the event of a proposed takeover of the Company. Each outstanding share of common stock has attached to it one preferred share purchase right, or Right, which entitles the registered holder to purchase one one-hundredth of a share of Series A Preferred Stock at a price of $120.00 subject to adjustment. The rights are exercisable only if a person, entity or group acquires, or announces their intention to acquire beneficial ownership of 15% or more of outstanding common stock, or Acquiring Person. Upon exercise, holders, other than the Acquiring Person, will have the right to receive shares of common stock or Series A Preferred Shares, cash, debt, stock or a combination thereof having a market value of two times the exercise price of the Right. The Rights expire on March 20, 2019.
Common Shares
As of December 31, 2014, the Company has authorized 185.0 million shares of common stock, of which 16.4 million shares are available for future issuance.
Common shares reserved for future issuance upon the exercise, issuance or conversion of the respective equity instruments at December 31, 2014 are as follows (in thousands):
On January 25, 2012, the Company closed an underwritten public offering of 15.0 million shares of common stock at $4.15 per share, resulting in gross proceeds of $62.0 million. After deducting $3.8 million in underwriting discounts and commissions and other offering costs, net proceeds were $58.2 million.
Note 9. Stock Compensation Plans
Equity Incentive Plans
The 2006 Equity Incentive Plan, or the 2006 Plan, as approved by stockholders, provides for the granting of stock options, restricted stock, restricted stock units, stock appreciation rights, and performance awards to employees, directors and consultants.
As of December 31, 2014, under the 2006 Plan, up to an aggregate of 20.9 million shares of common stock may be issued, of which 12.5 million shares are reserved for issuance upon exercise of granted and outstanding options and vesting of restricted stock units, and 8.4 million shares are available for future grants.
The New-Hire Equity Incentive Plan, or the New-Hire Plan, which was approved by the Board of Directors in 2010, provides for the granting of stock options to eligible persons entering into employment with the Company and are not available to current or former employees or directors unless there has been a bona fide period of non-employment. As of December 31, 2014, under the New-Hire Plan, up to an aggregate of 550,000 shares of common stock may be issued, of which 311,000 shares are reserved for issuance upon exercise of granted and outstanding options, and 239,000 shares are available for future stock option grants.
Stock options generally vest over a four-year period and have a maximum term of ten years from the date of grant, subject to earlier cancellation prior to vesting upon cessation of service to the Company. A summary of activity related to stock option awards is as follows:
The aggregate intrinsic value of stock options exercised during the years ended December 31, 2014, 2013 and 2012 was $0.5 million, $0.1 million, and $0.0 million, respectively. Cash received from stock option exercises during the years ended December 31, 2014, 2013 and 2012 was $1.3 million, $0.3 million, and $0.1 million, respectively.
Restricted stock awards generally vest over a four-year period and have a maximum term of ten years from the date of grant, subject to earlier cancellation or forfeiture prior to vesting upon cessation of service to the Company. The following table summarizes activity related to restricted stock awards and restricted stock units:
The total fair value of restricted stock awards and restricted stock units that vested during the years ended December 31, 2014, 2013 and 2012 was $2.3 million, $1.5 million, and $0.6 million, respectively. As permitted under the 2006 Plan, 215,000 shares were repurchased for an aggregate value of $0.7 million during the year ended December 31, 2014 to satisfy tax withholding obligations for employees in connection with the vesting of restricted stock units.
Employee Stock Purchase Plan
The 1999 Employee Stock Purchase Plans, or the ESPP, permits eligible employees to purchase shares of common stock at a discount through payroll deductions, with six-month offerings beginning on the first business day in February and August each calendar year. Under the terms of the ESPP, employees can elect to have up to 15% of their annual compensation, up to a maximum of $25,000 per year, withheld to purchase shares of common stock and limited to no more than 10,000 shares per individual per offering period. The price at which common stock is purchased under the ESPP is equal to 85% of the fair market value of the common stock on the first or last day of the offering period, whichever is lower.
During the years ended December 31, 2014, 2013 and 2012, a total of 0.6 million shares, 0.6 million shares, and 0.4 million shares, respectively, were purchased by and distributed to employees at an average price of $1.90, $2.49, and $2.91 per share, respectively. The total intrinsic value of purchase rights exercised during the periods presented was $0.6 million, $0.7 million, and $0.2 million, respectively.
As of December 31, 2014, 1.4 million shares of common stock were reserved for future issuance under the ESPP.
Market Condition Grants
The fair value of stock options awarded that include market-based performance conditions is estimated on the date of grant using a Monte Carlo simulation model, based on the market price of the underlying common stock, expected performance measurement period, expected stock price volatility and expected risk-free interest rate. There have been two market condition grants, both grants were made in 2014 with an exercise price of $3.07. The first grant was for 75,500 shares with a market performance goal of a 25% premium to the exercise price of the option for 30 consecutive days. The grant date fair value was determined to be $2.45 per share. The second grant was for 200,000 shares with a market performance goal of a closing stock price of $5.00 per share for 30 consecutive days. The grant date fair value was determined to be $2.42 per share. The two market condition grants are recognized over the vesting period which is 4 years.
The grant date value is based on the following assumptions:
Share-based Compensation Expense
Following are the weighted-average underlying assumptions used to determine the fair value of stock option award grants and for stock purchase rights under the ESPP:
The determination of fair value is affected by the stock price as well as assumptions regarding a number of complex and subjective variables that require judgment. The computation of the expected option life assumption is based on a weighted-
average calculation combining the average historical exercise activity and assumptions regarding the estimated life of all unexercised, outstanding stock options. The risk-free interest rate assumption is based on observed interest rates appropriate for the expected term of employee stock options. The expected volatility is based on the historical volatility of the Company's stock. No dividends on common stock have been paid since the Company's inception and, the Company does not anticipate paying dividends on common stock in the foreseeable future.
We amortize the fair value of share-based compensation on a straight-line basis over the requisite service periods of the awards for awards with only a service condition. Awards that contain a performance condition are amortized on an accelerated basis.
Modifications
In 2014 share-based compensation related grants were modified for executives retiring from employment with the Company, but continuing to serve the Company in a consultant role or as a member of the Company’s Board following their retirement. In connection with their retirement and return to service as a consultant or non-employee director, the Company’s board of directors approved an amendment to each stock option held by the executives extending the term in which the stock options may be exercised. These modifications resulted in an aggregate incremental compensation cost of $1.5 million, of that amount $1.2 million was attributable to vested awards and expensed immediately.
Total share-based compensation expense for all stock awards recognized in the consolidated statements of operations and comprehensive income (loss) is as follows (in thousands):
As of December 31, 2014, there was $7.0 million of unamortized compensation cost related to unvested stock option awards, which is expected to be recognized over a remaining weighted-average vesting period of 2.2 years. As of December 31, 2014, there was $3.1 million of unamortized compensation cost related to unvested restricted stock awards which is expected to be recognized over a remaining weighted-average vesting period of 2.5 years.
Warrants
In connection with an amendment to the corporate headquarters lease in 2005, a warrant was issued to purchase 50,000 shares of the Company's common stock with an exercise price of $2.64 per share to the lessor. The warrant, which remains outstanding at December 31, 2014, was immediately exercisable and expires in October 2015. The fair value of the warrant, calculated using the Black-Scholes option pricing model, was recorded as prepaid rent and is being amortized as rent expense over the remaining life of the lease.
In connection with a license agreement to The Chinese University of Hong Kong Foundation Limited (an affiliate of CUHK), we issued a warrant to purchase up to 200,000 shares of common stock at a price of $7.00 per share, the closing price of common stock on May 3, 2011. The warrant, which expires in May 2018 and remains outstanding at December 31, 2014, was immediately exercisable, in whole or in part, but not for less than 20,000 shares and in increments of 20,000 shares. The fair value of the warrant of $1.2 million was recognized as research and development expense during the year ended December 31, 2011.
Note 10. Fair Value Measurements
Assets and Liabilities Measured at Fair Value on a Recurring Basis
The following tables summarize the fair value hierarchy for assets and liabilities measured at fair value on a recurring basis (in thousands):
There were no transfers in or out of Level 1, Level 2, or Level 3 investments during the years ended December 31, 2014 and 2013.
For fair values determined by Level 1 inputs, which utilize quoted prices in active markets for identical assets, the level of judgment required to estimate fair value is relatively low. The value of investments in money market funds, U.S. treasury securities and mutual funds was determined using Level 1 inputs. Fair values determined by Level 2 inputs, which utilize data points that are observable such as quoted prices, interest rates and yield curves and fair values determined by Level 3 inputs, which utilize unobservable data points supported by little or no market activities, require the exercise of judgment and use of estimates, that if changed, could significantly affect the Company's financial position and results of operations. Investments in certificates of deposit are valued using Level 2 inputs.
Level 2 securities are initially valued at the transaction price and subsequently valued and reported utilizing fair values provided by investment managers who estimate the fair value using inputs other than quoted prices that are observable either directly or indirectly, such as quotes from multiple third-party pricing vendors, fund or trust companies and quoted prices for securities with similar maturity and rating features along with additional procedures performed to corroborate the fair value of securities, including the comparison of fair values provided by investment managers to those obtained from other reliable sources.
Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis
Certain non-financial assets and liabilities are measured at fair value on a nonrecurring basis in accordance with authoritative guidance. These include items such as non-financial assets and liabilities initially measured at fair value in a business combination and non-financial long-lived asset groups measured at fair value for an impairment assessment. In general, non-financial assets including goodwill, intangible assets, and property and equipment are measured at fair value when there is an indication of impairment and are recorded at fair value only when any impairment is recognized.
Facility Exit Liabilities. In connection with the restructuring in August 2013, as further described in Note 11 Restructuring Costs, and the exit of an operating lease on a facility in San Diego, which expires in July 2015, the fair values of the remaining lease liability and remaining tenant improvement liabilities was determined as of the cease-use date. The fair value of the remaining tenant improvement liabilities was determined using the aggregate of the remaining committed purchase orders for construction of the improvements (Level 1 inputs). The fair value of the remaining lease liability was determined as the present value of the remaining payments due under the lease and ancillary costs, reduced by estimated sublease rental income that could be reasonably obtained from the property, discounted using a credit-adjusted risk-free interest rate of 5.9% (Level 3 inputs). The estimated future payments were, net of estimated future sublease payments, based on current rental rates available in the local real estate market, and an evaluation of the ability to sublease the facility which was estimated to be in April 2014. The fair values were recorded as liabilities at the cease-use date with a corresponding expense recognized in restructuring costs in the consolidated statement of operations.
In 2014 management reassessed the remaining liabilities in connection with the facility exit and based on the shortened period where the facility could be subleased and consideration of other new information an additional $1.9 million of restructuring expense was recorded related to the vacated facility. The restructuring cost was for the entire lease obligation and costs to maintain the facility through the lease expiration.
As of December 31, 2014, the fair value of the remaining lease liability on the vacated facility was measured using the remaining lease liability. As of December 31, 2013, the fair value of the remaining lease liability on the vacated facility was measured using estimated net cash flows, discounted using a credit-adjusted risk-free rate, which are considered Level 3 inputs. The following table summarizes assets and liabilities measured at fair value on a nonrecurring basis during the year ended December 31, 2013 and the respective input levels based on the fair value hierarchy contained in fair value measurements and disclosures accounting guidance and the effect of the measurements on the statement of operations (in thousands):
Leasehold Improvements. In connection with the restructuring in August 2013, the carrying values of the leasehold improvement assets associated with the vacated leased facility were no longer recoverable, and an asset impairment charge was recorded during the year ended December 31, 2013, which is reported in restructuring costs in the consolidated statement of operations. As of December 31, 2014, all liabilities for the leasehold improvement have been paid.
Other Assets. In connection with the restructuring in August 2013 and the reduction in estimate of future cash flows to be generated by the RetnaGene AMD LDT product line, discussed in Note 11 Restructuring Costs, the carrying values of the RetnaGene AMD LDT licensed technology and prepaid minimum royalty balance were no longer recoverable, and, as a result, recognized asset impairment charges were recognized during the year ended December 31, 2013, which is reported in restructuring costs in the consolidated statement of operations.
Fair Value of Other Financial Instruments
The carrying amounts of certain financial instruments, including cash and cash equivalents, accounts payable and accrued expenses, approximate fair value due to their short-term nature. Based on current borrowing rates currently available in the market for bank loans with similar terms, management believes that the fair values of its bank loans approximates their respective carrying values (Level 1).
The carrying amounts and fair values of Convertible Senior Notes are as follows (in thousands):
At December 31, 2014, the fair value of Convertible Senior Notes was based on quoted market prices of similar instruments (Level 1).
Note 11. Restructuring Costs
As part of an overall cost reduction effort, in August 2013, the Company communicated to employees a plan to reduce the workforce. The restructuring resulted in the release of 57 employees, a reduction in estimated future cash flows to be generated by the RetnaGene AMD LDT, which resulted in an asset impairment of licensed technology, and the decision to exit a leased facility in San Diego, which is available for sublease until the lease expires in July 2015.
In connection with the restructuring, the Company recorded $2.4 million in facility exit costs, $1.7 million of impairment expense for tenant improvements associated with the vacated facility, $0.7 million of impairment expense for intangible assets and prepaid royalties related to the RetnaGene AMD LDT licensed technology, and $1.0 million in employee termination costs during the year ended December 31, 2013.
In 2014, based on the shortened period where the facility could be subleased and consideration of other new information management reassessed the remaining liabilities in connection with the restructuring and recorded an additional $1.9 million of restructuring expense related to the vacated facility. The restructuring cost is for the lease obligation and costs to operate the facility through the lease expiration.
The following table summarizes the restructuring activity during the year ended December 31, 2014 and related liabilities as of December 31, 2014 (in thousands):
The remaining liabilities at December 31, 2014, of $1.2 million are payable within the next twelve months through the remainder of the lease for the facility vacated, which expires in July 2015.
Note 12. Income Taxes
The reconciliation of income tax computed at the federal statutory tax rate to the benefit for income taxes from continuing operations is as follows (in thousands):
Income tax benefit from continuing operations consists of the following (in thousands):
In addition, current income tax expense of $8.1 million, $1.7 million and $0.4 million from discontinued operations was recorded for the years ended December 31, 2014, 2013 and 2012, respectively.
Deferred income taxes reflect the net effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of deferred tax assets and liabilities are shown below. A full valuation allowance has been recorded, as realization of such assets is uncertain (in thousands):
At December 31, 2014, federal and state tax net operating loss carryforwards totaled approximately $483.1 million and $436.0 million, respectively. The federal tax loss carryforwards will begin to expire in 2019, unless previously utilized. The state tax loss carryforwards began to expire in 2010.
At December 31, 2014, federal and California research and development tax credit carryforwards totaled approximately, $8.9 million and $17.3 million respectively. The federal research and development tax credit carryforwards will begin to expire in 2027 unless previously utilized. The California research and development credit will carryforward indefinitely.
Pursuant to Internal Revenue Code, or IRC, Sections 382 and 383, annual use of net operating loss and research and development credit carryforwards may be limited in the event of a cumulative change in ownership of more than 50% within a three-year period. During the year ended December 31, 2013, the Company completed an analysis under IRC Sections 382 and 383 from June 7, 2006 through December 31, 2012, and determined that several ownership changes occurred during this period with the last one occurring in December 2010. However, these ownership changes did not result in the forfeiture of any net operating losses or research and development credits. As a result, as of December 31, 2013, the reinstated deferred tax assets for federal and state net operating losses totaled $507.5 million and $449.8 million, respectively, and federal and California research and development credits of $8.5 million and $16.2 million, respectively, generated through December 31, 2013. In addition, a corresponding increase to the valuation allowance was recorded as of December 31, 2014. Upon reinstatement of these operating losses and research and development credits, the Company recorded $5.5 million of related unrecognized tax benefits. The Company is in the process of completing the Section 382 analysis through December 31, 2014 and the Company does not believe that they have experienced any additional ownership changes.
The Company's income tax return recognizes the impact of an uncertain income tax position at the largest amount that is more-likely-than-not to be sustained upon audit by the relevant taxing authority. An uncertain income tax position will not be recognized if it has less than a 50% likelihood of being sustained.
Following is a tabular reconciliation of unrecognized tax benefit activity for the three years ended December 31, 2014 (excluding interest and penalties) (in thousands):
The Company recognizes interest and/or penalties related to income tax matters in income tax expense. The Company had no accruals for interest or penalties in the consolidated balance sheets at December 31, 2014 and 2013, and has not recognized any interest or penalties in the statements of operations for the years ended December 31, 2014, 2013 or 2012.
The unrecognized tax benefits as of December 31, 2014, if recognized, would not impact income tax expense or effective tax rate as long as deferred tax assets remain subject to a full valuation allowance.
The Company is subject to taxation in the United States, foreign and various state jurisdictions. The tax years for 1996 and forward are subject to examination by federal and California tax authorities due to the carryforward of unutilized net operating losses and research and development credits. The Company does not expect any changes to unrecognized tax benefits over the next twelve months.
Note 13. Quarterly Financial Data (unaudited)
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(1) Net earnings during the fourth quarter of 2014 includes a $22.9 million gain from the Pooled Patents Agreement. That gain was offset by a $1.2 million tax expense due to a reduction in a tax benefit estimated in the prior quarter. The first and second quarter of 2014 include restructuring costs of $0.9 million and $1.0 million, respectively.
(2) Net loss during the third quarter of 2013 includes $5.7 million in restructuring costs and impairment charges.