Table of Contents
UNITED STATES
SECURITIES
AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
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x
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QUARTERLY
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
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For the
quarterly period ended September 30, 2008
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OR
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o
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TRANSITION
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
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For the transition period
from to
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Commission
file number: 001-33753
Genoptix, Inc.
(Exact name of registrant as specified in its charter)
Delaware
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33-0840570
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(State or other jurisdiction of
incorporation or organization)
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(I.R.S. Employer
Identification No.)
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2110 Rutherford Road
Carlsbad, CA 92008
(Address of principal executive offices, including zip code)
(760) 268-6200
(Registrants telephone number, including area code)
N/A
(Former name, former address and former fiscal year, if changed since
last report)
Indicate
by check mark whether the registrant (1) has filed all reports required to
be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes
x
No
o
Indicate by check mark whether
the registrant is a large accelerated filer, an accelerated filer, a
non-accelerated filer, or a smaller reporting company. See the definitions of
large accelerated filer, accelerated filer, and smaller reporting company
in Rule 12b-2 of the Exchange Act.
Large accelerated filer
o
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Accelerated filer
o
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Non-accelerated filer
x
(Do not check if a smaller reporting company)
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Smaller reporting company
o
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Indicate by check mark
whether the registrant is a shell company (as defined in Rule 12b-2 of the
Exchange Act)
.
Yes
o
No
x
As
of October 27, 2008, 16,600,353 shares of the registrants common stock, $0.001
par value per share, were outstanding.
Table of Contents
GENOPTIX, INC.
QUARTERLY REPORT ON FORM 10-Q
For the Quarterly Period Ended September 30, 2008
TABLE OF
CONTENTS
2
Table of Contents
PART I.
FINANCIAL INFORMATION
Item 1.
Financial
Statements.
GENOPTIX, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except par values)
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September 30,
2008
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December 31,
2007
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(unaudited)
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Assets
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Current assets:
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Cash and cash equivalents
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$
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21,809
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$
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50,624
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Short-term securities
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75,321
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34,836
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Accounts receivable, net of allowance for
doubtful accounts of $3,263 and $1,594 at September 30, 2008 and December 31,
2007, respectively
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16,362
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9,013
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Deferred tax asset
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6,380
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Other current assets
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1,280
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1,409
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Total current assets
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121,152
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95,882
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Property and equipment, net
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9,555
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1,950
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Long-term securities
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3,775
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Deferred tax asset
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3,668
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Restricted cash
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360
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Other long-term assets
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179
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Total assets
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$
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138,689
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$
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97,832
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Liabilities and Stockholders Equity
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Current liabilities:
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Accounts payable and accrued expenses
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$
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7,561
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$
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4,238
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Accrued compensation
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4,939
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2,496
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Income tax payable
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2,853
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74
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Deferred revenues
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58
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95
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Deferred rent
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248
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Total current liabilities
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15,659
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6,903
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Deferred rent, net of current portion
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1,510
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324
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Commitments and contingencies
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Stockholders equity:
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Preferred stock, $0.001 par value; 5,000
shares authorized; no shares issued and outstanding at September 30, 2008 and
December 31, 2007
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Common stock, $0.001 par value; 100,000
shares authorized; 16,598 and 16,095 shares issued and outstanding at
September 30, 2008 and December 31, 2007, respectively
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17
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16
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Additional paid-in capital
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138,253
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132,532
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Accumulated other comprehensive (loss)
income
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(760
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)
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53
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Accumulated deficit
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(15,990
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)
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(41,996
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)
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Total stockholders equity
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121,520
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90,605
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Total liabilities and stockholders equity
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$
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138,689
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$
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97,832
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See
accompanying notes to the condensed consolidated financial statements.
3
Table of Contents
GENOPTIX, INC.
CONDENSED CONSOLIDATED STATEMENTS OF
OPERATIONS
(unaudited)
(in thousands, except per share data)
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Three Months Ended
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Nine Months
Ended
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September 30,
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Septe
mber 30,
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2008
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2007
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2008
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2007
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Revenues
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$
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32,087
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$
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16,171
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$
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82,210
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$
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40,770
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Cost of revenues
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12,282
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6,513
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32,663
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16,543
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Gross profit
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19,805
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9,658
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49,547
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24,227
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Operating expenses:
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Sales and marketing
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5,098
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3,127
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14,529
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7,869
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General and administrative
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5,786
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2,732
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16,091
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6,997
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Research and development
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333
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143
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1,003
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463
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Total operating expenses
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11,217
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6,002
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31,623
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15,329
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Income from operations
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8,588
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3,656
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17,924
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8,898
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Interest income
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671
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118
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2,279
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245
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Interest expense
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(5
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)
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(72
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)
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(5
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)
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(231
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)
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Other (loss) income
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(16
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)
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(1
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28
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41
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Income before income taxes
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9,238
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3,701
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20,226
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8,953
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Income
tax (benefit) expense
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(6,190
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)
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114
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(5,780
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)
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274
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Net income
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$
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15,428
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$
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3,587
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$
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26,006
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$
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8,679
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Net income per share: (1)(2)
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Basic
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$
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0.93
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$
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0.43
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$
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1.59
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$
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0.82
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Diluted
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$
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0.87
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$
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0.06
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$
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1.48
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$
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0.10
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Shares used to compute net income per share:
(1)(2)
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Basic
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16,535
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239
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16,336
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191
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Diluted
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17,754
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1,674
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17,616
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1,635
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(1)
As a result of the conversion of the
Companys preferred stock into 11,032 shares of common stock upon completion of
the Companys initial public offering in November 2007, there is a lack of
comparability in the basic and diluted net income per share amounts for the
periods presented above. For calculations of the pro forma net income per share
for the periods presented, see Note 8 in the notes to the condensed
consolidated financial statements.
(2)
For the three and nine months ended September 30,
2007, the Company had net income of $3,587 and $8,679, respectively, of which $3,485
and $8,522, respectively, was allocated to preferred stockholders for purposes
of calculating net income per share pursuant to the terms of the preferred
stock, resulting in $102 and $157, respectively, of net income allocable to
common stockholders. For an explanation of the method and amounts used in the
computation of the per share amounts, see Note 8 in the notes to the condensed
consolidated financial statements.
See accompanying notes to the condensed consolidated financial
statements.
4
Table of Contents
GENOPTIX, INC.
CONDENSED CONSOLIDATED STATEMENTS
OF CASH FLOWS
(unaudited)
(in thousands)
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Nine Months Ended
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September 30,
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2008
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2007
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Operating activities:
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Net income
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$
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26,006
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$
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8,679
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Adjustments to reconcile net income to net
cash provided by operating activities:
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Depreciation
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878
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405
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Stock-based compensation expense
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5,156
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390
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Provision for doubtful accounts
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2,280
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1,152
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Deferred taxes
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(9,519
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)
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Realized loss on sale of investment
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66
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Amortization of premium/discount on
investments
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(163
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)
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Excess tax benefits from stock-based
compensation awards
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(118
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)
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Gain on sale of property and equipment
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(10
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)
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Non-cash interest expense
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57
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Changes in operating assets and
liabilities:
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Accounts receivable
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(9,629
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)
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(3,960
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)
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Other current and long-term assets
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(50
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)
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(885
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)
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Accounts payable and accrued expenses
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3,075
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2,399
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Accrued compensation
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2,443
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722
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Income taxes
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2,897
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74
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|
Deferred revenues
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(37
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)
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(32
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)
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Deferred rent
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149
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|
52
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|
Net cash provided by operating activities
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23,424
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9,053
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Investing activities:
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|
|
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Purchase of property and equipment
|
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(6,961
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)
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(788
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)
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Proceeds from sales of property and
equipment
|
|
21
|
|
|
|
Purchase of investment securities
|
|
(103,605
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)
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|
|
Proceeds from sales and maturities of
investment securities
|
|
58,100
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|
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|
Restricted cash
|
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(360
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)
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|
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Net cash used in investing activities
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(52,805
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)
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(788
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)
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|
|
|
|
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Financing activities:
|
|
|
|
|
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Proceeds from issuance of common stock, net
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1,177
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|
50
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|
Costs paid in connection with public
offerings
|
|
(764
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)
|
(1,074
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)
|
Excess tax benefits from stock-based
compensation awards
|
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118
|
|
|
|
Proceeds from exercise of warrants
|
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35
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|
|
|
Proceeds from issuance of notes payable
|
|
|
|
284
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|
Principal payments on notes payable
|
|
|
|
(1,230
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)
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Principal payments on capital lease
obligations
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|
|
|
(19
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)
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Net cash provided by (used in) financing
activities
|
|
566
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|
(1,989
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)
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Net (decrease) increase in cash and cash
equivalents
|
|
(28,815
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)
|
6,276
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|
Cash and cash equivalents at beginning of
period
|
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50,624
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|
3,865
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Cash and cash equivalents at end of period
|
|
$
|
21,809
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$
|
10,141
|
|
|
|
|
|
|
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Supplemental information:
|
|
|
|
|
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Income taxes paid, net
|
|
$
|
842
|
|
$
|
|
|
Interest paid
|
|
$
|
5
|
|
$
|
174
|
|
Non-cash investing and financing
activities:
|
|
|
|
|
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Unrealized loss on investment securities,
net
|
|
$
|
1,342
|
|
$
|
|
|
Capitalized tenant improvement allowance
|
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$
|
1,285
|
|
$
|
|
|
Accrued purchases of property and equipment
|
|
$
|
248
|
|
$
|
|
|
See
accompanying notes to the condensed consolidated financial statements.
5
Table
of Contents
GENOPTIX,
INC.
NOTES TO
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
1.
Organization
and Summary of Significant Accounting Policies
Organization
Genoptix, Inc., or the Company, was incorporated in Delaware on January 20,
1999. Genoptix, Inc. does business as Genoptix Medical Laboratory. The
Company operates as a certified high complexity clinical laboratory in
accordance with the federal governments Clinical Laboratory Improvement
Amendments of 1988, or CLIA, and is dedicated to the delivery of clinical
diagnostic services to community-based hematologist/oncologist physician
customers.
Basis of Presentation and Principles of Consolidation
The Companys industry is highly regulated. The manner in which licensed
physicians can organize to perform and bill for medical services is governed by
state laws and regulations. Business corporations, like the Company, often are
not permitted to employ physicians to practice medicine or to own corporations
that employ physicians to practice medicine or to otherwise exercise control
over the medical judgments or decisions of physicians.
The Company provides its medical services through Cartesian Medical Group,
or Cartesian, an entity that it manages, and it is this entity that employs the
physicians who provide medical services on behalf of the Company. The Company
has a controlling financial interest in Cartesian and consolidates the results
of Cartesian based on the criteria under Emerging Issues Task Force, or EITF,
Issue No. 97-2,
Physician Practice
Management Entities and Certain Other Entities with Contractual Management
Agreements
. All intercompany accounts have been eliminated in
consolidation.
The Company has prepared the accompanying unaudited condensed consolidated
financial statements in accordance with United States of America generally
accepted accounting principles, or GAAP, for interim financial information and
with the instructions to Form 10-Q and Article 10 of Regulation S-X.
Accordingly, they do not include all of the information and disclosures
required by GAAP for complete financial statements. In the opinion of
management, all adjustments have been included and represent only normal
recurring adjustments considered necessary for a fair presentation. Operating
results for the three and nine months ended September 30, 2008 are not
necessarily indicative of the results that may be expected for the year ending December 31,
2008. These unaudited condensed consolidated financial statements should be
read in conjunction with the audited consolidated financial statements and
related notes thereto for the year ended December 31, 2007 included in the
Annual Report on Form 10-K filed by the Company with the Securities and
Exchange Commission, or SEC, on February 12, 2008.
Use of Estimates
The preparation of condensed consolidated financial statements in
conformity with GAAP requires management to make estimates and assumptions that
affect the amounts reported in the condensed consolidated financial statements
and accompanying notes to the condensed consolidated financial statements. The
most significant estimates in the Companys condensed consolidated financial
statements relate to revenue recognition, allowance for doubtful accounts,
income taxes and stock-based compensation expense. Actual results could differ
from those estimates.
Revenue
Recognition
The
Company
recognizes revenues in accordance with the SECs Staff Accounting Bulletin, or
SAB, No. 104,
Revenue Recognition
,
when the price is fixed or determinable, persuasive evidence of an arrangement
exists, the service is performed and collectibility of the resulting receivable
is reasonably assured.
The
Companys specialized diagnostic services are performed based on a written test
requisition form and revenues are recognized once the diagnostic services have
been performed, the results have been delivered to the ordering physician, the
payor has been identified and eligibility and insurance have been verified.
These diagnostic services are billed to various payors, including Medicare,
commercial insurance companies and other directly billed healthcare
institutions such as hospitals and individuals. The Company reports revenues from contracted
payors, including Medicare, certain insurance companies and certain healthcare
institutions, based on the contractual rate, or in the case of Medicare, the
published fee schedules. The Company reports revenues from non-contracted
payors, including certain insurance companies and individuals, based on the
amount expected to be collected. The difference between the amount billed and
the amount expected to be collected is recorded as a contractual allowance to
arrive at the reported revenues. The expected revenues from non-contracted
payors are based on the historical collection experience of each payor or payor
group, as appropriate. In each reporting period, the Company reviews its
historical collection experience for non-contracted payors and adjusts its
expected revenues for current and subsequent periods accordingly. During the
three months ended
6
Table
of Contents
GENOPTIX,
INC.
NOTES TO
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(unaudited)
September 30,
2008, the Company recorded positive changes in prior period accounting
estimates to reduce contractual allowances, which increased the Companys
revenues by $2.5 million, of which $1.6 million pertains to the six months
ended June 30, 2008. During the nine months ended September 30, 2008,
the Company recorded positive changes in prior year accounting estimates to
reduce contractual allowances, which increased the Companys revenue by $2.2
million. In comparison, the Companys revenues increased by $612,000 and
$828,000 for the three and nine months ended September 30, 2007,
respectively, as a result of changes in such prior period accounting estimates.
These favorable changes in accounting estimates related to non-contracted
payors and resulted from continued improvements to the Companys billing
systems and collection processes, as well as increased hiring of personnel and
management focused on the collection of accounts receivable for services
rendered in prior periods. As of September 30, 2008 and December 31,
2007, the Company had uncollected accounts receivable from non-contracted
payors of approximately $9.2 million and $5.3 million, respectively.
Allowance for
Doubtful Accounts
An allowance for doubtful
accounts is recorded for estimated uncollectible amounts due from the Companys
contracted payors. The process for estimating the collection of receivables
associated with the Companys specialized diagnostic services involves
significant assumptions and judgments. Specifically, the allowance for doubtful
accounts is adjusted periodically, based upon an evaluation of historical
collection experience with specific payors and other relevant factors. The
realization cycle for certain governmental and managed care payors can be
lengthy involving denial, appeal and adjudication processes, and is subject to
periodic adjustments that may be significant. The provision for doubtful
accounts is charged to general and administrative expense. Accounts receivable
are written off as uncollectible and deducted from the allowance after
appropriate collection efforts have been exhausted.
The Company recorded a
provision for doubtful accounts at a rate of approximately 3% of revenues for
both the three and nine months ended September 30, 2008, which remained
consistent with comparable periods in 2007 of approximately 3% of revenue.
During the three and nine months ended September 30, 2008, the Company
recorded $822,000 and $2.3 million, respectively, of provision for doubtful
accounts, as compared to $405,000 and $1.2 million for the comparable periods
in 2007.
During the three and nine months ended September 30, 2007,
the Company recorded positive changes in prior period accounting estimates to
reduce the allowance for doubtful accounts by $134,000 and $197,000,
respectively. No similar changes in estimates were recorded in the three and
nine months ended September 30, 2008. During the nine months ended September 30,
2008, the Company reduced the allowance for doubtful accounts by $611,000 for
write-offs, net of recoveries.
Reverse Stock Split
On October 15, 2007, the Company effected a 1-for-4.75 reverse stock
split of the Companys common stock. The accompanying condensed consolidated financial
statements and notes to the condensed consolidated financial statements give
retroactive effect to the reverse stock split for prior periods presented.
Recent
Accounting Pronouncements
Effective January 1, 2008, the Company adopted
Statement of Financial Accounting Standards,
or SFAS, No. 157,
Fair Value
Measurements
. In February 2008, the Financial Accounting
Standards Board, or FASB, issued FASB Staff Position, or FSP, No. 157-2,
Effective Date of FASB Statement No. 157
, which
provides a one year deferral of the effective date of SFAS No. 157 for
non-financial assets and non-financial liabilities, except those that are
recognized or disclosed in the financial statements at fair value at least
annually. Therefore, the Company has adopted the provisions of SFAS No. 157
with respect to its financial assets and liabilities only. SFAS No. 157
defines fair value, establishes a framework for measuring fair value under GAAP
and enhances disclosures about fair value measurements. Fair value is defined
under SFAS No. 157 as the exchange price that would be received for an
asset or paid to transfer a liability (an exit price) in the principal or most
advantageous market for the asset or liability in an orderly transaction
between market participants on the measurement date. During the third quarter,
the Company adopted FSP No. 157-3,
Determining the Fair Value
of a Financial Asset When the Market for That Asset Is Not Active
.
FSP No. 157-3 clarifies the application of SFAS No. 157, in a market
that is not active and provides an example to illustrate key considerations in
determining the fair value of a financial asset when the market for that
financial asset is not active. This FSP applies to financial assets within the
scope of accounting pronouncements that require or permit fair value
measurements in accordance with SFAS No. 157. The adoption of SFAS No. 157
did not have a material impact on the Companys condensed consolidated results
of operations and financial condition at adoption. For the three and nine
months ended September 30, 2008 the Company recorded a temporary
impairment of $1.2 million (see Note 2 and Note 3).
7
Table
of Contents
GENOPTIX,
INC.
NOTES TO
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(unaudited)
Effective January 1,
2008, the Company adopted SFAS No. 159,
The Fair
Value Option for Financial Assets and Financial Liabilities
. SFAS No. 159
allows an entity the irrevocable option to elect fair value for the initial and
subsequent measurement for certain financial assets and liabilities on a
contract-by-contract basis. The Company did not elect to adopt the fair value
option for certain financial instruments on the adoption date.
Restricted Cash
As of September 30, 2008, the Company had total restricted cash of $360,000. Restricted cash consists of amounts held in
a certificate of deposit to collateralize a standby letter of credit per the
terms of an operating lease agreement. The standby letter of credit expires on June 30,
2012, allowing for $90,000 annual reductions on June 30 of each year prior
to expiration.
2.
Investment Securities
In accordance with SFAS No. 115,
Accounting for Certain Debt and Equity Securities
, all of
the Companys investment securities are classified as available-for-sale.
Investment securities consist of corporate debt, government-sponsored
enterprise and high-grade auction rate securities, or ARS. The Company reports
corporate debt securities and government-sponsored enterprise securities as
short-term based on its intent to fund current operations and its ability to
easily convert the securities into cash. The Companys ARS are reported as
long-term since they are unavailable to fund current operations based on the
current illiquid auction market (see Note 3). The investment securities are
carried at fair value, with unrealized gains and losses reported as a separate
component of accumulated other comprehensive (loss) income. The cost of debt
investment securities is adjusted for amortization of premiums and accretion of
discounts to maturity. Amortization and accretion are included in interest
income. Interest earned and realized gains or losses on available-for-sale
investment securities are included in interest income. The cost of investment
securities sold is based on the specific identification method.
The following is a summary of the Companys
investment securities:
|
|
September 30,
2008
|
|
December 31,
2007
|
|
|
|
(in thousands)
|
|
Short-term
securities
|
|
|
|
|
|
Corporate debt securities
|
|
$
|
35,994
|
|
$
|
6,430
|
|
Government-sponsored enterprise securities
|
|
39,327
|
|
11,006
|
|
Auction rate securities
|
|
|
|
17,400
|
|
|
|
$
|
75,321
|
|
$
|
34,836
|
|
Long-term
securities
|
|
|
|
|
|
Auction rate securities
|
|
$
|
3,775
|
|
$
|
|
|
As of September 30,
2008, all of the corporate debt and government-sponsored enterprise investment
securities have contractual maturities of less than 19 months and 29
months, respectively.
The Company holds a single ARS. ARS are collateralized
debt instruments with
long-term
contractual maturities that are structured with short-term holding periods. The
length of each holding period is determined at the original issuance of the
ARS. They provide liquidity through a Dutch auction
process that resets the applicable interest rate at pre-determined intervals,
typically every 7 to 35 days. At
the end of each holding period, a new auction is held to determine the rate or
dividend for the next holding period. The Company can sell at each auction at
par, assuming there are buyers for the ARS at such auction, sell at a discount
in a secondary market or continue to hold the investment securities. In order
to sell ARS at par, the auction needs to be successful whereby demand in the marketplace
meets or exceeds the supply at scheduled auctions. The ARS has a contractual
maturity in 2038, with a 35-day holding period between scheduled auctions.
Gross unrealized gains of
$146,000 and gross unrealized losses of $1.4 million were recorded in
accumulated other comprehensive (loss) income, which included a temporary
impairment of $1.2 million for ARS at September 30, 2008, as compared to
gross unrealized gains of $61,000 and losses of $8,000 at December 31,
2007. Additionally, a gross realized loss of $66,000 was recognized in the
condensed consolidated statements of operations for the three months ended September 30,
2008.
8
Table
of Contents
GENOPTIX,
INC.
NOTES TO
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(unaudited)
3.
Fair Value Measurements
Valuation techniques used to measure fair value under SFAS No. 157
must maximize the use of observable inputs and minimize the use of unobservable
inputs. The standard describes a fair value hierarchy based on three levels of
inputs, of which the first two are considered observable and the last
unobservable, which may be used to measure fair value, as follows:
Level 1
|
|
Quoted
prices in active markets for identical assets or liabilities
|
|
|
|
Level 2
|
|
Inputs
other than level 1 that are observable, either directly or indirectly, such
as quoted prices for similar assets or liabilities; quoted prices in markets
that are not active; or other inputs that are observable or can be
corroborated by observable market data for substantially the full term of the
assets or liabilities
|
|
|
|
Level 3
|
|
Unobservable
inputs that are supported by little or no market activity and that are significant
to the fair value of the assets or liabilities
|
The following table represents the financial instruments on the financial
statements of the Company subject to SFAS No.157 and the valuation approach
applied to each class:
|
|
|
|
Fair Value Measurements at September 30, 2008
|
|
|
|
Balance at
September 30,
2008
|
|
Quoted Prices
in Active
Markets for
Identical Assets
(Level 1)
|
|
Significant
Other
Observable
Inputs
(Level 2)
|
|
Significant
Unobservable
Inputs
(Level 3)
|
|
|
|
(in thousands)
|
|
Cash and
cash equivalents
|
|
|
|
|
|
|
|
|
|
Cash
|
|
$
|
6,042
|
|
$
|
6,042
|
|
$
|
|
|
$
|
|
|
Money market funds
|
|
11,770
|
|
|
|
11,770
|
|
|
|
Corporate debt securities
|
|
3,997
|
|
|
|
3,997
|
|
|
|
|
|
$
|
21,809
|
|
$
|
6,042
|
|
$
|
15,767
|
|
$
|
|
|
Short-term
securities
|
|
|
|
|
|
|
|
|
|
Corporate debt securities
|
|
$
|
35,994
|
|
$
|
|
|
$
|
35,994
|
|
$
|
|
|
Government-sponsored enterprise securities
|
|
39,327
|
|
|
|
39,327
|
|
|
|
|
|
$
|
75,321
|
|
$
|
|
|
$
|
75,321
|
|
$
|
|
|
Long-term
securities
|
|
|
|
|
|
|
|
|
|
Auction rate securities
|
|
$
|
3,775
|
|
$
|
|
|
$
|
|
|
$
|
3,775
|
|
The Companys corporate debt and
government-sponsored enterprise investment securities are valued using market
prices on less active markets (level 2). Level 2 valuations are
obtained from readily available pricing sources for comparable instruments or
other significant and available observable inputs. In contrast, active market
(level 1) valuations are obtained from real-time quotes for transactions
in active exchange markets involving identical assets and unobservable market
(level 3) valuations are required where no
quoted
market prices or observable inputs are available.
The Companys level 3 ARS consists of debt issued by a municipality, which
is underwritten by an insurance agency and rated A2 by Moodys Investors
Service and AA by Standard & Poors. It is classified as a long-term
investment security due to the current illiquidity in the ARS markets. This
auction began failing in February 2008 when sell orders exceeded buy
orders at the auction dates. The funds associated with this failed auction will
not be accessible until the issuer redeems the ARS, a successful auction
occurs, a buyer is found outside of the auction process, or the ARS matures in
2038.
9
Table
of Contents
GENOPTIX,
INC.
NOTES TO
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(unaudited)
The valuation of this security is based on level 3 unobservable inputs. The
Company has evaluated this ARS based on interest rate spreads, the credit
quality, underlying assets of the issuer and underwriter, likelihood of a
successful auction or redemption in the near term and the ability to obtain
liquidity in the near-term. As a result of the estimated fair value, the Company
has recorded a temporary impairment in the valuation of this security of $1.2
million during the three months ended September 30, 2008. The unrealized
loss in the current period, net of deferred tax, is included in accumulated
other comprehensive (loss) income. Due to the uncertainty related to the timing
of liquidity in the ARS market, the Company has classified this ARS investment
security as a long-term asset on the balance sheet with a fair value of $3.8
million as of September 30, 2008.
The following table provides a summary of changes in fair value of the
Companys level 3 financial assets:
|
|
Level 3
Auction Rate
Securities
|
|
|
|
(in thousands)
|
|
Balance at December 31, 2007
|
|
$
|
|
|
Transfers into level 3
|
|
17,400
|
|
Earned income
|
|
27
|
|
Total realized/unrealized losses:
|
|
|
|
Included in earnings
|
|
|
|
Included in accumulated other comprehensive
(loss) income
|
|
(1,252
|
)
|
Net purchases and (redemptions)
|
|
(12,400
|
)
|
Balance at September 30, 2008
|
|
$
|
3,775
|
|
Total amount of net unrealized losses for
the period included in accumulated other comprehensive (loss) income
attributable to the change in fair market value relating to assets still held
at September 30, 2008
|
|
$
|
(1,225
|
)
|
4.
Property and Equipment, Net
Property and equipment consisted of the following:
|
|
Estimated
Useful Life
|
|
September 30,
2008
|
|
December 31,
2007
|
|
|
|
(in years)
|
|
(in thousands)
|
|
Machinery and equipment
|
|
5
|
|
$
|
3,104
|
|
$
|
1,742
|
|
Computers
|
|
3
|
|
2,784
|
|
2,021
|
|
Furniture and fixtures
|
|
5
|
|
916
|
|
519
|
|
Leasehold improvements
|
|
Lesser of remaining lease term or 5
|
|
114
|
|
52
|
|
Construction in process
|
|
|
|
5,582
|
|
59
|
|
Total property and equipment
|
|
|
|
12,500
|
|
4,393
|
|
Accumulated depreciation
|
|
|
|
(2,945
|
)
|
(2,443
|
)
|
Total property and equipment, net
|
|
|
|
$
|
9,555
|
|
$
|
1,950
|
|
The Company leases all of its facilities under
operating leases. Some of these lease agreements contain tenant improvement
allowances funded by the landlord, rent holidays and rent escalation clauses.
GAAP requires rent expense to be recognized on a straight-line basis over the
lease term. The difference between the rent due under the stated periods of the
leases compared to that
10
Table
of Contents
GENOPTIX,
INC.
NOTES TO
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(unaudited)
of
the straight-line basis is recorded as deferred rent. The Company uses the date
that it obtains the legal right to use and control the leased space to begin
recording rent expense and amortizing deferred rent on a straight-line basis
through the end of the lease.
The Company capitalizes tenant improvements related
to landlord lease incentives as property and equipment with an offsetting
credit to deferred rent. As of September 30, 2008, the Company capitalized
$1.3 million of these tenant improvements. Once placed into service, the
capitalized tenant improvements will be depreciated over the lesser of the
remaining lease term or asset life. The Company is amortizing the lease
incentives, recorded as deferred rent, on a straight-line basis over the term
of the lease.
5.
Comprehensive Income
In accordance with SFAS No. 130,
Reporting Comprehensive
Income
, all components of comprehensive income are reported in the
financial statements in the period in which they are recognized. Comprehensive
income is defined as the change in equity during a period from transactions and
other events and circumstances from non-owner sources.
Below is a reconciliation of net income to comprehensive income for the
three and nine months ended September 30, 2008 and 2007:
|
|
Three Months Ended
|
|
Nine Months Ended
|
|
|
|
September 30,
|
|
September 30,
|
|
|
|
2008
|
|
2007
|
|
2008
|
|
2007
|
|
|
|
(in thousands)
|
|
Net income
|
|
$
|
15,428
|
|
$
|
3,587
|
|
$
|
26,006
|
|
$
|
8,679
|
|
Accumulated other comprehensive (loss)
income:
|
|
|
|
|
|
|
|
|
|
Gross unrealized loss on long-term
securities
|
|
(1,217
|
)
|
|
|
(1,342
|
)
|
|
|
Deferred tax
|
|
529
|
|
|
|
529
|
|
|
|
|
|
(688
|
)
|
|
|
(813
|
)
|
|
|
Comprehensive income
|
|
$
|
14,740
|
|
$
|
3,587
|
|
$
|
25,193
|
|
$
|
8,679
|
|
6.
Stock-Based Compensation
In accordance with SFAS No. 123R,
Share-Based Payment,
the Company records compensation expense related to share-based transactions,
including stock options, shares issued under an employee stock purchase plan,
or ESPP, and restricted stock units, or RSUs, which is measured and recognized
in the Companys condensed consolidated financial statements based on fair
value. Effective January 1, 2006, the Company adopted SFAS No. 123R
using the prospective approach. Under the prospective approach, SFAS No. 123R
applies to new awards and to awards modified, repurchased or cancelled after
the required effective date. Stock-based compensation expense recognized during
the period is based on the value of the portion of awards that is ultimately
expected to vest and thus the gross expense is reduced for estimated
forfeitures. The Company recognizes stock-based compensation expense over the
vesting period using the straight-line method and classifies these amounts in
the condensed consolidated statements of operations based on the department to
which the recipient reports.
During the three and nine months ended September 30, 2008, there were
50,000 and 356,000, respectively, of outstanding stock options exercised, as
compared to 20,000 and 124,000 for the comparable periods in 2007.
In connection with the Companys
initial public offering, the Company implemented an ESPP on October 29,
2007, which allows qualified employees the opportunity to purchase Company
common stock at a discount. Generally, the plan consists of a two-year offering
period with four six-month purchase periods and contains a look-back provision
for determining the purchase price. The Company values and accounts for its
ESPP in accordance with
FASB Technical Bulletin, or
FTB, No. 97-1,
Accounting under Statement 123 for Certain Employee
Stock Purchase Plans with a Look-Back Option.
The objective
of the measurement process for ESPPs with a look-back option is to reasonably
measure the fair value of the award at the grant date. The date at which both
the Company and employee have a mutual understanding of the terms of the award
in exchange for the services already rendered and the employees total
contributions are known becomes the grant date. At this time, the Company
becomes contingently obligated to issue equity instruments to the employee.
Typically, the grant date is the first day of each six-month purchase period. The terms
of the Companys initial purchase period varied slightly, as the period extended
from October 29, 2007 to June 30, 2008 and allowed for
11
Table of
Contents
GENOPTIX,
INC.
NOTES TO
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(unaudited)
cash payments in addition to employee payroll
deductions.
In June 2008,
the employee cash payments were received for this first purchase, thereby
establishing the grant date for fair value measurement and the recording of the
related stock-based compensation expense. On June 30, 2008, upon the
closing of the first purchase period, the Company issued approximately 63,000
shares of common stock to employees.
Beginning in January 2008,
the Company began utilizing RSUs as an additional means to compensate its
employees, directors and consultants. The fair value of these granted RSUs is
calculated using the intrinsic value method based on the grant date value and
is expensed over the life of the award ranging from one to three years. The
weighted average grant valuation per award is $29.94 and $29.29 for the three
and nine months ended September 30, 2008, respectively. During both the
three and nine months ended September 30, 2008, the Company issued 7,000
shares for these awards. There were no awards granted for the comparable
periods in 2007. During the three and nine months ended September 30,
2008, the Company recognized $563,000 and $962,000, respectively, of RSUs
stock-based compensation expense.
The weighted average fair value per share of
the employee stock option grants and ESPP shares for the three and nine months
ended September 30, 2008 and 2007 was estimated as of the date of grant
using a Black-Scholes valuation model with the following weighted average
assumptions:
|
|
Stock Options
|
|
ESPP
|
|
|
|
Three Months Ended
September 30,
|
|
Nine Months Ended
September 30,
|
|
Three Months
Ended
September 30,
|
|
Nine Months
Ended
September 30,
|
|
|
|
2008
|
|
2007
|
|
2008
|
|
2007
|
|
2008
|
|
2008
|
|
Risk-free interest rate
|
|
3.27
|
%
|
4.54
|
%
|
2.92
|
%
|
4.69
|
%
|
2.38
|
%
|
2.83
|
%
|
Dividend yield
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Expected life of awards (years)
|
|
6.02
|
|
6.08
|
|
6.01
|
|
6.08
|
|
1.16
|
|
1.12
|
|
Volatility
|
|
48.82
|
%
|
56.00
|
%
|
51.47
|
%
|
58.30
|
%
|
37.68
|
%
|
37.85
|
%
|
Forfeitures
|
|
7.00
|
%
|
7.00
|
%
|
7.00
|
%
|
7.00
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Grant date fair value (per share)
|
|
$
|
16.79
|
|
$
|
10.60
|
|
$
|
14.43
|
|
$
|
10.80
|
|
$
|
11.45
|
|
$
|
14.45
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The
Company derived the risk-free interest rate assumption from the United States
Treasurys rates for U.S. Treasury zero-coupon bonds with maturities similar to
those of the expected term of the award being valued. The Company based the
assumed dividend yield on its expectation of not paying dividends in the
foreseeable future. The Company calculated the weighted average expected life of
options using the simplified method as prescribed by SAB No. 110,
Share-Based Payment
, based on the lack of
relevant historical data due to the Companys limited operating experience as a
public company. In addition, due to the Companys limited historical data, the
estimated volatility also reflects the application of SAB No. 110,
incorporating the historical volatility of comparable companies with publicly
available share prices. SFAS No. 123R requires forfeitures to be estimated
at the time of grant and revised, if necessary, in subsequent periods if actual
forfeitures differ from those estimates. For stock options, the Company
utilized its historical forfeitures to estimate its future forfeiture rate at
7%. For its ESPP, the Company does not utilize a separate forfeiture rate since
it adjusts ESPP stock-based compensation to actual contributions from the
remaining participants at the end of each respective purchase period.
The Company records equity
instruments issued to non-employee consultants as expense at their fair value
over the related service period as determined in accordance with SFAS No. 123R
and
EITF Issue No. 96-18,
Accounting for
Equity Instruments That are Issued to Other Than Employees for Acquiring, or in
Conjunction with Selling Goods and Services
, and periodically
revalues the equity instruments as they vest. During the three and nine months
ended September 30, 2008, the Company recognized $14,000 and $38,000,
respectively, of non-employee stock-based compensation expense, as compared to
$5,000 and $22,000 for the comparable periods in 2007.
12
Table of Contents
GENOPTIX,
INC.
NOTES TO
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(unaudited)
The Company recognized stock-based compensation
expense, as follows:
|
|
Three Months Ended
September 30, 2008
|
|
Three Months Ended
September 30, 2007
|
|
|
|
Options
& Other
Awards
|
|
ESPP
|
|
Total
|
|
Options
& Other
Awards
|
|
ESPP
|
|
Total
|
|
|
|
(in thousands, except per share data)
|
|
Cost of revenues
|
|
$
|
451
|
|
$
|
142
|
|
$
|
593
|
|
$
|
44
|
|
$
|
|
|
$
|
44
|
|
Sales and marketing
|
|
139
|
|
226
|
|
365
|
|
31
|
|
|
|
31
|
|
General and administrative
|
|
877
|
|
113
|
|
990
|
|
60
|
|
|
|
60
|
|
Research and development
|
|
|
|
|
|
|
|
16
|
|
|
|
16
|
|
|
|
$
|
1,467
|
|
$
|
481
|
|
$
|
1,948
|
|
$
|
151
|
|
$
|
|
|
$
|
151
|
|
Impact on
net income per common share: (1)
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
$
|
(0.09
|
)
|
$
|
(0.03
|
)
|
$
|
(0.12
|
)
|
|
|
|
|
|
|
Diluted
|
|
$
|
(0.08
|
)
|
$
|
(0.03
|
)
|
$
|
(0.11
|
)
|
|
|
|
|
|
|
|
|
Nine Months Ended
September 30, 2008
|
|
Nine Months Ended
September 30, 2007
|
|
|
|
Options
& Other
Awards
|
|
ESPP
|
|
Total
|
|
Options
& Other
Awards
|
|
ESPP
|
|
Total
|
|
|
|
(in thousands, except per share data)
|
|
Cost of revenues
|
|
$
|
1,011
|
|
$
|
634
|
|
$
|
1,645
|
|
$
|
95
|
|
$
|
|
|
$
|
95
|
|
Sales and marketing
|
|
317
|
|
1,169
|
|
1,486
|
|
72
|
|
|
|
72
|
|
General and administrative
|
|
1,479
|
|
546
|
|
2,025
|
|
158
|
|
|
|
158
|
|
Research and development
|
|
|
|
|
|
|
|
47
|
|
|
|
47
|
|
|
|
$
|
2,807
|
|
$
|
2,349
|
|
$
|
5,156
|
|
$
|
372
|
|
$
|
|
|
$
|
372
|
|
Impact on
net income per common share: (1)
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
$
|
(0.17
|
)
|
$
|
(0.14
|
)
|
$
|
(0.31
|
)
|
|
|
|
|
|
|
Diluted
|
|
$
|
(0.16
|
)
|
$
|
(0.13
|
)
|
$
|
(0.29
|
)
|
|
|
|
|
|
|
(1)
There is a lack of comparability in the basic and diluted net income
per share amounts for the periods presented above due to use of the two-class
method in the periods prior to the Companys initial public offering. Therefore,
the impact on net income per common share for the three and nine months ended
2007 is not presented. For an explanation of the methods used to calculate net
income per share for the periods presented, see Note 8 in these notes to
condensed consolidated financial statements.
7.
Income Tax (Benefit) Expense
Income taxes are accounted for under the asset and
liability method. Deferred tax assets and liabilities are recognized for the
future tax consequences attributable to differences between the financial
statement carrying amounts of existing assets and liabilities and their
respective tax basis and operating loss and tax credit carryforwards. The
Company measures tax assets and liabilities using the enacted tax rates
expected to apply to taxable income in the years in which the Company expects
to recover or settle those temporary differences. The Company recognizes the
effect of a change in tax rates on deferred tax assets and liabilities in
income during
the period that includes the enactment
date. The Company provides a valuation allowance against net deferred tax
assets unless, based upon the available evidence, it is more likely than not
that the net deferred tax assets will be realized.
13
Table of Contents
GENOPTIX,
INC.
NOTES TO
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(unaudited)
As of December 31, 2007, the Company had federal and state net
operating loss carryforwards of approximately $28.0 million and $27.0 million,
respectively. In each period since the Companys inception, the Company had
recorded a valuation allowance for the full amount of the Companys net
deferred tax assets, as the realization of the net deferred tax assets did not
meet the more likely than not requirement under SFAS No. 109,
Accounting for Income Taxes
. If not used,
the federal and state net operating loss carryforwards will begin expiring in
2020 and 2010, respectively. As of December 31, 2007, the Company had
federal research credit carryforwards of $908,000, which will begin expiring in
2021 and state research credit carryforwards of $1.2 million, which do not
expire. Under Sections 382 and 383 of the Internal Revenue Code of 1986,
as amended, substantial changes in our ownership have required us to limit the
amount of net operating loss and research and development credit carryforwards
that were previously available to offset future taxable income. The Company has
had three change in ownership events that limit the utilization of net
operating loss and credit carryforwards. The change in ownership events
occurred in March 2000, December 2001 and March 2008 and
resulted in annual net operating loss carryforward limitations of $63,000,
$96,000 and $16.1 million, respectively. As a result of a net unrealized
built-in gain from the March 2008 change in ownership, the Companys net
operating loss carryforward annual limitation of $16.1 million was increased to
$39.7 million for each of the five years starting after the change in
ownership. These limitations will result in the expiration of unused federal
and state net operating loss carryforwards of $6.6 million and $7.4 million,
respectively. Additionally, these limitations will result in the expiration of
federal and state tax credits in the amount of $154,000 and $130,000,
respectively. The net deferred tax assets were reduced due to the net operating
loss and tax credit limitations, with a corresponding reduction of the valuation
allowance. Additional limitations on the use of these tax attributes could
occur in the event of possible disputes arising in examination from various
taxing authorities. Currently, the Company is not under examination by any
taxing authorities.
As of September 30, 2008, although realization
is not assured, the Company believed it was more likely than not that it would
be able to realize its net deferred tax assets through the ordinary course of
business and expected future taxable income. Therefore, the Company recorded a
$9.8 million tax benefit representing the release of the valuation
allowance against the net deferred tax assets during the three months ended September 30,
2008.
The income tax benefit for the three and
nine months ended September 30, 2008 was $6.2 million and $5.8 million,
respectively. The income tax expense for the three and nine months ended September 30,
2007 was $114,000 and $274,000, respectively. As of September 30, 2008, the Company had $10.0 million in net
deferred tax assets. Similarly, the Company had $14.9 million in net deferred
tax assets at December 31, 2007 that were offset entirely by the valuation
allowance.
The Companys unrecognized income tax benefits decreased by $428,000 during
the three months ended September 30, 2008. The adjustment decrease relates
primarily to the recognition of additional uncertain income tax benefits
related to its federal and state research credit carryforwards.
8.
Net Income Per Share
Prior to the Companys initial public offering, net income per share was
computed in accordance with EITF Issue No. 03-6,
Participating Securities and the Two-Class Method
under FASB Statement 128
, which established standards regarding the
computation of earnings per share, or EPS, by companies that have issued
securities other than common stock that contractually entitle the holder to
participate in dividends and earnings of the Company. EITF Issue No. 03-6
requires earnings for the period, after deduction of preferred stock dividends,
to be allocated between the common and preferred stockholders based on their
respective rights to receive dividends, whether or not declared. Basic net
income per share is then calculated by dividing income allocable to common
stockholders (after the reduction for any preferred stock dividends assuming
current income for the period had been distributed) by the weighted average
number of shares of common stock outstanding, net of shares subject to
repurchase by the Company, during the period. EITF Issue No. 03-6 does not
require the presentation of basic and diluted net income per share for
securities other than common stock; therefore, the following net income per
share amounts only pertain to the Companys common stock. The Company
calculated diluted net income per share under the as-if-converted method unless
the conversion of the preferred stock was anti-dilutive to basic net income per
share. To the extent preferred stock was anti-dilutive, the Company calculated
diluted net income per share under the two-class method.
14
Table of Contents
GENOPTIX,
INC.
NOTES TO
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(unaudited)
Subsequent to the Companys initial public offering,
EPS has been computed in accordance with SFAS No. 128,
Earnings Per Share
. Basic EPS has been
calculated by dividing the net income by the weighted average number of common
shares outstanding for the period, without consideration for common stock
equivalents. Diluted EPS has been computed by dividing the net income by the
weighted average number of common shares outstanding for the period and the
weighted average number of dilutive common stock equivalents outstanding for the
period determined using the treasury-stock method. For purposes of this
calculation, common stock subject to repurchase by the Company, convertible
preferred stock, stock options, RSUs and warrants are considered to be common
stock equivalents and are only included in the calculation of diluted earnings
per share when their effect is dilutive.
|
|
Three Months Ended
|
|
Nine Months Ended
|
|
|
|
September 30,
|
|
September 30,
|
|
|
|
2008
|
|
2007
|
|
2008
|
|
2007
|
|
|
|
(in thousands, except per share data)
|
|
Numerator:
|
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
15,428
|
|
$
|
3,587
|
|
$
|
26,006
|
|
$
|
8,679
|
|
Income allocable to preferred stockholders
|
|
|
|
(3,485
|
)
|
|
|
(8,522
|
)
|
Net income allocable to common stockholders
|
|
$
|
15,428
|
|
$
|
102
|
|
$
|
26,006
|
|
$
|
157
|
|
|
|
|
|
|
|
|
|
|
|
Denominator:
|
|
|
|
|
|
|
|
|
|
Weighted average shares of common stock
outstanding
|
|
16,568
|
|
318
|
|
16,379
|
|
249
|
|
Weighted average unvested shares of common
stock subject to repurchase
|
|
(33
|
)
|
(79
|
)
|
(43
|
)
|
(58
|
)
|
Weighted average shares of common stock
outstanding - basic
|
|
16,535
|
|
239
|
|
16,336
|
|
191
|
|
Dilutive effect of common equivalent shares
|
|
1,219
|
|
1,435
|
|
1,280
|
|
1,444
|
|
Weighted average shares of common stock
outstanding - diluted
|
|
17,754
|
|
1,674
|
|
17,616
|
|
1,635
|
|
|
|
|
|
|
|
|
|
|
|
Net income per share:
|
|
|
|
|
|
|
|
|
|
Basic
|
|
$
|
0.93
|
|
$
|
0.43
|
|
$
|
1.59
|
|
$
|
0.82
|
|
Diluted
|
|
$
|
0.87
|
|
$
|
0.06
|
|
$
|
1.48
|
|
$
|
0.10
|
|
The following amounts were
not included in the calculation of net income per share because their effects
were anti-dilutive:
|
|
Three Months Ended
|
|
Nine Months Ended
|
|
|
|
September 30,
|
|
September 30,
|
|
|
|
2008
|
|
2007
|
|
2008
|
|
2007
|
|
|
|
(in thousands)
|
|
Preferred stock
|
|
|
|
11,032
|
|
|
|
11,032
|
|
Preferred stock warrants
|
|
|
|
86
|
|
|
|
86
|
|
Common stock options
|
|
76
|
|
|
|
87
|
|
|
|
|
|
76
|
|
11,118
|
|
87
|
|
11,118
|
|
15
Table of Contents
GENOPTIX,
INC.
NOTES TO
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(unaudited)
Pro Forma Net Income Per Share
Pro forma basic and diluted net income per share have
been computed to give effect to the conversion of convertible preferred stock
into common stock upon the closing of the Companys initial public offering on
an as-if-converted basis at the later of the beginning of the period or the
issuance date, as follows:
|
|
Three Months Ended
|
|
Nine Months Ended
|
|
|
|
September 30,
|
|
September 30,
|
|
|
|
2008
|
|
Pro Forma
2007
|
|
2008
|
|
Pro Forma
2007
|
|
|
|
(in thousands, except per share data)
|
|
Numerator:
|
|
|
|
|
|
|
|
|
|
Pro forma net income allocable to common
stockholders
|
|
$
|
15,428
|
|
$
|
3,587
|
|
$
|
26,006
|
|
$
|
8,679
|
|
|
|
|
|
|
|
|
|
|
|
Denominator:
|
|
|
|
|
|
|
|
|
|
Weighted average shares of common stock
outstanding
|
|
16,568
|
|
318
|
|
16,379
|
|
249
|
|
Weighted average unvested shares of common
stock subject to repurchase
|
|
(33
|
)
|
(79
|
)
|
(43
|
)
|
(58
|
)
|
Adjustments to reflect the weighted average
effect of the assumed conversion of convertible preferred stock
|
|
|
|
11,032
|
|
|
|
11,032
|
|
Pro forma weighted average shares of common
stock outstanding - basic
|
|
16,535
|
|
11,271
|
|
16,336
|
|
11,223
|
|
Dilutive effect of common equivalent shares
|
|
1,219
|
|
1,501
|
|
1,280
|
|
1,505
|
|
Pro forma weighted average shares of common
stock outstanding - diluted
|
|
17,754
|
|
12,772
|
|
17,616
|
|
12,728
|
|
|
|
|
|
|
|
|
|
|
|
Pro forma net income per share:
|
|
|
|
|
|
|
|
|
|
Basic
|
|
$
|
0.93
|
|
$
|
0.32
|
|
$
|
1.59
|
|
$
|
0.77
|
|
Diluted
|
|
$
|
0.87
|
|
$
|
0.28
|
|
$
|
1.48
|
|
$
|
0.68
|
|
16
Table of Contents
Item
2. Managements Discussion and Analysis of Financial Condition and Results of
Operations.
The following discussion contains forward-looking statements, which
involve risks and uncertainties. Our actual results could differ materially
from those anticipated in these forward-looking statements as a result of
various factors, including those set forth below under Part II, Item 1A, Risk
Factors in this Quarterly Report on Form 10-Q. The interim financial
statements and this Managements Discussion and Analysis of Financial Condition
and Results of Operations should be read in conjunction with the condensed
consolidated financial statements included elsewhere in this Quarterly Report
on Form 10-Q, and the consolidated financial statements and notes thereto
for the year ended December 31, 2007 and our related Managements
Discussion and Analysis of Financial Condition and Results of Operations, both
of which are contained in the Annual Report on Form 10-K filed by us with
the Securities and Exchange Commission, or SEC, on February 12, 2008. Unless the context indicated otherwise, as
used in this Quarterly Report on Form 10-Q, the terms we, us and our
refer to Genoptix, Inc.
We maintain a website at www.genoptix.com to which we regularly post
copies of our press releases as well as additional information about us. Our
filings with the SEC are available free of charge through our website as soon
as reasonably practicable after being electronically filed with or furnished to
the SEC. Interested persons can subscribe on our website to email alerts that
are sent automatically when we issue press releases, file our reports with the
SEC or certain other information is available. Information contained in our
website does not constitute a part of this report.
Forward-Looking Statements
The information in this discussion and in other items of this Quarterly
Report on Form 10-Q contains forward-looking statements and information
within the meaning of Section 27A of the Securities Act of 1933 and Section 21E
of the Securities Exchange Act of 1934, which are subject to the safe harbor
created by those sections. These forward-looking statements include, but are
not limited to, statements concerning our strategy, future operations, future
financial position, future revenues, projected costs, prospects and plans and
objectives of management. The words anticipates, believes, estimates, expects,
intends, may, plans, projects, will, would and similar expressions
are intended to identify forward-looking statements, although not all
forward-looking statements contain these identifying words. We may not actually
achieve the plans, intentions or expectations disclosed in our forward-looking
statements and you should not place undue reliance on our forward-looking
statements. Actual results or events could differ materially from the plans,
intentions and expectations disclosed in the forward-looking statements that we
make. These forward-looking statements involve risks and uncertainties that could
cause our actual results to differ materially from those in the forward-looking
statements, including, without limitation, the risks set forth in Part II,
Item 1A, Risk Factors in this Quarterly Report on Form 10-Q and in
our other filings with the SEC. We do not assume any obligation to update any
forward-looking statements.
Overview
We are a
specialized laboratory service provider focused on delivering personalized and
comprehensive diagnostic services to community-based hematologists and
oncologists, or hem/oncs. Our highly trained group of hematopathologists, or
hempaths, utilizes sophisticated diagnostic technologies to provide a
differentiated, specialized and integrated assessment of a patients condition,
aiding physicians in making vital decisions concerning the treatment of
malignancies of the blood and bone marrow and other forms of cancer.
We were organized
in 1999. We began offering specialized diagnostic services in the third quarter
of 2004. Our key service offerings include COMPASS and CHART. By ordering our
COMPASS service offering, the hem/onc authorizes our hempath to determine the
appropriate diagnostic tests to be performed and we evaluate, synthesize and
summarize the results into an easy to read comprehensive report. As part of our
CHART service offering, the hem/onc receives a detailed assessment of a patients
disease progression over time, as our hempath integrates patient history and
previous and current test results into a comprehensive diagnostic report. Test
requisitions for more than half of the patient samples we processed for the
three and nine months ended September 30, 2008 included our COMPASS or
CHART service offerings.
Revenues primarily
consist of payments or reimbursements received from governmental payors, such as
Medicare and Medicaid, private insurers, including managed care organizations,
private payors, such as hospitals, patients and others for the specialized
diagnostic services rendered to our hem/onc customers. Our revenues are
affected by changes in customer and case volume, payor mix and reimbursement
rates.
Billing for
diagnostic services is generally a highly complex activity. Depending on our
billing arrangement with each third party payor and applicable law, we are
often obligated to bill in the specific manner prescribed by the various
payors, each of which may have different billing requirements. Billing for
diagnostic services in connection with governmental payor programs is subject
to numerous federal and state regulations and other requirements, resulting in
additional costs to us. We report revenues from contracted
17
Table of Contents
payors, including Medicare, certain insurance
companies and certain healthcare institutions, based on the contractual rate,
or in the case of Medicare, the published fee schedules. We report revenues
from non-contracted payors, including certain insurance companies and
individuals, based on the amount expected to be collected. We estimate amounts
to be collected based on our historical collection experience.
As a specialized
diagnostic service provider, we rely extensively on our high quality of service
to promote and maintain our relationships with our community-based hem/onc
customers. We compete primarily based on the quality of testing, operations
processes, reporting and information systems, reliability in patient sample
transport, reputation in the medical community and access to our highly
qualified hempaths. Our primary competitors include hospital pathologists,
esoteric testing laboratories, national reference laboratories and academic
laboratories.
We believe the key
challenges in being able to continue to increase our market share, revenues and
profitability are our ability to continue to hire and retain qualified sales
representatives, key management and other personnel, Cartesians ability to
hire and retain hempaths, changes in reimbursement levels for our specialized
diagnostic services, changes in regulations, payor policies and contracting
arrangements with payors, increased competition from competitors attempting to
replicate our key service offerings or provide other services that compete with
ours, our ability to scale our internal infrastructure, our ability to maintain
and strengthen our relationships with our hem/onc customers and our ability to
continue to improve our operational, financial and management controls and
reporting systems and procedures.
To address these
challenges, our management is focused upon expanding our sales organization as
the primary driver for our continued growth while maintaining our existing
hem/onc customer relationships. Our management tracks and measures the general
buying patterns of our hem/onc customers (including cases per month, revenues
and cost of revenues per case and turn-around-time per case) and is focused on
adding additional sales resources in key markets to enhance our penetration in
those markets. Our management is also engaged in ensuring Cartesian is focused
on recruiting, hiring and retaining hempaths to provide the professional
services component to support continued growth. Management measures the levels
and timeliness of reimbursement from third party payors and reviews on a
monthly basis the levels of receivables and average time for collections, as
well as cost and margin trends to ensure that investments in our infrastructure
and personnel are in line with current sales levels.
Management has initiated efforts to ensure that office and laboratory
space is leased and improved to accommodate the necessary capacity requirements
to meet our current and expanding business. Specifically, during the three
months ended September 30, 2008, we substantially completed tenant improvements
within our existing facility having converted warehouse and adjacent space to
laboratory operations. Additionally, during this same period, we initiated
tenant improvements on our newly leased office space, which will house our
administrative functions. Together, these facility actions will approximately
double our overall testing capacity and increase both cost of revenue and
administrative expenses relating to the associated lease expense and
depreciation of tenant improvements. For the three and nine months ended September 30,
2008, capital expenditures for these two projects totaled $3.8 million and $4.7
million, respectively. We expect to occupy these newly developed spaces by late
2008, and as a result of our newly increased capacity, we currently are not
anticipating the need to expand into a new facility located in another region
in 2009, as previously contemplated.
Seasonality
The majority of
our testing volume is dependent on patient visits to hem/oncs offices and
other healthcare providers. Volume of testing generally declines during the
vacation seasons, year-end holiday periods and other major holidays,
particularly when those holidays fall during the middle of the week. In
addition, volume of testing tends to decline due to adverse weather conditions,
such as excessively hot or cold spells or hurricanes or tornados in certain
regions, consequently reducing revenues and cash flows in any affected period.
Therefore, comparison of the results of successive periods may not accurately
reflect trends for successive periods.
Critical
Accounting Policies and Estimates
Managements
discussion and analysis of our financial condition and results of operations
are based upon our financial statements, which are prepared in accordance with
United States of America generally accepted accounting principles, or GAAP. The
preparation of these financial statements requires us to make estimates and
judgments that affect the reported amounts of assets and liabilities, related
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. We continually evaluate our estimates and judgments, the most
critical of which are those related to revenue recognition, allowance for
doubtful accounts, income taxes and stock-based compensation expense. We base
our estimates and judgments on historical experience and other factors that we
believe to be reasonable under the circumstances.
18
Table of Contents
Materially different results can occur as
circumstances change and additional information becomes known.
We
believe there have been no significant changes during the nine months ended September 30,
2008 to the items that we disclosed as our critical accounting policies and
estimates in Managements Discussion and Analysis of Financial Condition and
Results of Operations in our Annual Report on Form 10-K for the year
ended December 31, 2007, except for the items discussed below.
We adopted SFAS No. 157,
Fair Value Measurements
, and SFAS
No. 159,
The Fair Value Option for
Financial Assets and Financial Liabilities,
in the current period
without material impact to the financial statements. For additional information
on the recent accounting pronouncements affecting our business, see Note 1,
Note 2 and Note 3 in the Notes to Condensed Consolidated Financial Statements.
In accordance with
SFAS No. 123R,
Share-Based Payment,
we recorded compensation expense related to share-based transactions, including
stock options, shares issued under our employee stock purchase plan, or ESPP,
and restricted stock units, or RSUs, all of which are measured and recognized
in our condensed consolidated financial statements based on fair value.
Effective January 1, 2006, we adopted SFAS No. 123R using the
prospective approach. Under the prospective approach, SFAS No. 123R
applies to new awards and to awards modified, repurchased or cancelled after
the required effective date. Stock-based compensation expense recognized during
the period is based on the value of the portion of awards that is ultimately
expected to vest and thus the gross expense is reduced for estimated forfeitures.
We recognize stock-based compensation expense over the vesting period using the
straight-line method and classify these amounts in the condensed consolidated
statements of operations based on the department to which the recipient
reports.
In connection
with our initial public offering, we implemented our ESPP on October 29,
2007, which allows qualified employees the opportunity to purchase our common
stock at a discount. Generally, the plan consists of a two-year offering period
with four six-month purchase periods and contains a look-back provision for
determining the purchase price. The terms of the initial purchase period varied
slightly, as the period extended from October 29, 2007 to June 30,
2008 and allowed for cash contributions in addition to employee payroll
deductions. We value and account for our ESPP in accordance with
FASB Technical Bulletin, or FTB, No. 97-1,
Accounting
under Statement 123 for Certain Employee Stock Purchase Plans with a Look-Back
Option.
This
technical guidance required the delay of recognition of the associated
stock-based compensation expense relating to this initial purchase period until
the actual employee participation was known. In June 2008, the employee
cash contributions were received and the related stock-based compensation
expense was recorded.
Results of Operations
Comparison of Three and Nine Months Ended September 30,
2008 and 2007
Revenues
Revenues primarily
consist of payments or reimbursements received from governmental payors, such
as Medicare and Medicaid, private insurers, including managed care
organizations, private payors, such as hospitals, patients and others for the
specialized diagnostic services rendered to our hem/onc customers.
Substantially all of our revenues result from our having been assigned the
right to bill and collect for the professional services provided by the
hempaths employed by Cartesian who work with us in our laboratory facility
pursuant to our
Clinical
Laboratory Professional Services Agreement, or PSA, with Cartesian. Our revenues from services not performed by Cartesian were less than 5%
of our total revenues during the three and nine months ended September 30,
2008 and 2007.
For the three and nine months ended September 30,
2008, we derived approximately 62% and 60%, respectively, of our revenues from
private insurance, including managed care organizations and other healthcare
insurance providers; approximately 37% and 39%, respectively, from Medicare and
Medicaid; and the remaining approximate 1% for each period are from other
sources. Our revenues are affected by changes in customer and case volume,
payor mix, contractual allowances and reimbursement rates. Billing and
reimbursement for our specialized diagnostic services in connection with
governmental payor programs are subject to numerous federal and state
regulations and other billing requirements. Reimbursement under Medicare for
our specialized diagnostic services is subject to a Medicare physician fee
schedule, and to a lesser degree, a clinical laboratory fee schedule, both of
which are typically updated annually. The Medicare Improvements for Patients
and Providers Act of 2008, or MIPPA, includes a provision for a 1.1% conversion
factor increase effective January 2009.
19
Table
of Contents
|
|
Three Months Ended
September 30,
|
|
%
|
|
Nine Months Ended
September 30,
|
|
%
|
|
|
|
2008
|
|
2007
|
|
Change
|
|
2008
|
|
2007
|
|
Change
|
|
Revenue
(1)
(in
thousands)
|
$
|
32,087
|
|
$
|
16,171
|
|
98
|
%
|
$
|
82,210
|
|
$
|
40,770
|
|
102
|
%
|
Number of cases
|
9,886
|
|
6,029
|
|
64
|
%
|
27,048
|
|
15,717
|
|
72
|
%
|
Revenues per case
|
$
|
3,246
|
|
$
|
2,682
|
|
21
|
%
|
$
|
3,039
|
|
$
|
2,594
|
|
17
|
%
|
(1)
|
|
During
the three months ended September 30, 2008, we recorded positive changes
in prior period accounting estimates to reduce contractual allowances, which
increased our revenues by $2.5 million, of which $1.6 million pertains to the
six months ended June 30, 2008. During the nine months ended September 30,
2008, we recorded positive changes in prior year accounting estimates to
reduce contractual allowances, which increased our revenues by $2.2 million.
In comparison, our revenues increased by $612,000 and $828,000 for the three
and nine months ended September 30, 2007, respectively, as a result of
changes in such prior year accounting estimates. These favorable changes in
accounting estimates related to non-contracted payors and resulted from
continued improvements to our billing systems and collection processes, as
well as increased hiring of personnel and management focused on the
collection of accounts receivable for services rendered in prior periods.
|
Revenues increased to $32.1 million and $82.2 million for the three and
nine months ended September 30, 2008, respectively, (inclusive of the
changes in prior period accounting estimates noted above) from $16.2 million
and $40.8 million for the comparable periods in 2007. The increases of $15.9
million, or 98%, and $41.4 million, or 102%, for the three and nine months
ended September 30, 2008, respectively, as compared to the same period
s in 2007,
were primarily due to case volume increases of 64% and 72%, respectively;
revenue per case increases of $564, or 21%, and $445, or 17%, respectively, as
a result of a net increase in Medicare reimbursement rates for our key service
offerings; and better than expected collections on our non-contracted business
as reflected by the changes in accounting estimates, as discussed above. Case
volumes, and therefore revenues, have increased during the three and nine
months ended September 30, 2008, primarily as a result of the 63% increase
in our sales force from September 30, 2007 to September 30, 2008.
This has enabled us to penetrate more accounts over a wider geographic area,
increase our customer base and further focus our sales representatives on
in-person customer visits. Sales force productivity during the three and nine
months ended September 30, 2008 also increased primarily as a result of
more efficient selling efforts, enhanced recognition in the market, smaller
geographies per sales representative, price increases and expanded service
offerings.
Cost of Revenues
Cost of revenues
consists of employee-related costs (such as salaries, fringe benefits and
stock-based compensation) of our Cartesian hempaths, licensed technicians,
clinical service coordinators, or CSC, and other support personnel, as well as
outside laboratory costs, laboratory supplies, logistic costs, depreciation and
administrative-related costs allocated to cost of revenues. Our cost of
revenues generally increases as our case volumes and revenues increase. We
expect that our cost of revenues will continue to increase, as our case volumes
and revenues increase; we hire additional hempaths, technicians and support
personnel; incur increased outside laboratory costs; and spend more on supplies
to support these anticipated increases. Incrementally, we expect to see
increasing logistic costs due to higher fuel surcharges and increasing facility
costs as we occupy the newly completed laboratory expansion within our current
facility and relocate administrative functions to our new headquarters facility
in late 2008.
|
|
Three Months Ended
|
|
|
|
Nine Months Ended
|
|
|
|
|
|
September 30,
|
|
%
|
|
September 30,
|
|
%
|
|
|
|
2008
|
|
2007
|
|
Change
|
|
2008
|
|
2007
|
|
Change
|
|
Cost of revenues
(in thousands)
|
$
|
12,282
|
|
$
|
6,513
|
|
89
|
%
|
$
|
32,663
|
|
$
|
16,543
|
|
97
|
%
|
Cost of revenues
(% of revenues)
|
38
|
%
|
40
|
%
|
|
|
40
|
%
|
41
|
%
|
|
|
Number of cases
|
9,886
|
|
6,029
|
|
64
|
%
|
27,048
|
|
15,717
|
|
72
|
%
|
Cost of revenues per case
|
$
|
1,242
|
|
$
|
1,080
|
|
15
|
%
|
$
|
1,208
|
|
$
|
1,053
|
|
15
|
%
|
20
Table
of Contents
Cost of revenues increased to $12.3 million and $32.7 million for the
three and nine months ended September 30, 2008, respectively, from $6.5
million and $16.5 million for the comparable periods in 2007. As a percentage
of revenue, cost of revenues for the three and nine months ended September 30,
2008 remained relatively consistent at 38% and 40%, respectively, from 40% and
41% for the comparable periods in 2007. Despite increased stock-based
compensation expense and payroll-related expenses associated with the hiring of
laboratory personnel and Cartesian physicians, these percentages have remained
relatively consistent due to higher revenues and leveraging of our fixed costs.
This, in addition to favorable changes in revenue accounting estimates
for prior periods, has resulted in gross margins of 62% and 60% for the three
and nine months ended September 30, 2008, respectively, from 60% and 59%
for the comparable periods in 2007.
Stock-based compensation expense for cost of revenues was $593,000 and $1.6
million, or 2% of revenues, for each of the three and nine months ended September 30,
2008, respectively. We expect stock-based compensation expense to remain
consistent in future periods as we grant additional awards to existing
employees and new hires.
Sales and Marketing Expenses
Sales and
marketing expenses consist primarily of employee-related costs (such as
salaries, commissions, fringe benefits, stock-based compensation and related
travel costs for our sales personnel in the field) and depreciation and
administrative-related costs allocated to sales and marketing expense
functions. We expect our sales and marketing expenses to increase as we hire
additional sales representatives and managers as part of our growth strategy.
|
|
Three Months Ended
|
|
|
|
Nine Months Ended
|
|
|
|
|
|
September 30,
|
|
%
|
|
September 30,
|
|
%
|
|
|
|
2008
|
|
2007
|
|
Change
|
|
2008
|
|
2007
|
|
Change
|
|
Sales and marketing
(in thousands)
|
|
$
|
5,098
|
|
$
|
3,127
|
|
63
|
%
|
$
|
14,529
|
|
$
|
7,869
|
|
85
|
%
|
Sales and marketing
(% of revenues)
|
|
16
|
%
|
19
|
%
|
|
|
18
|
%
|
19
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Sales
and marketing expenses increased to $5.1 million and $14.5 million for the
three and nine months ended September 30, 2008, respectively, from $3.1
million and $7.9 million for the comparable periods in 2007. The increases of
$2.0 million, or 63%, and $6.6 million, or 85%, for the three and nine months
ended September 30, 2008, respectively, as compared to the same period
s in 2007,
were primarily due to incremental increases of $1.7 million and $6.2 million,
respectively, for employee-related costs (including salaries, sales
commissions, stock-based compensation expense and travel) and other cost
increases due to the increased number of sales representatives, sales managers
and customer service personnel that we have hired to drive and support our
revenue growth. The number of sales representatives (including three regional
managers) increased from 32 to 52 from September 30, 2007 to September 30,
2008, respectively. As a percentage of revenues, sales and marketing expenses
have decreased to 16% and 18% for the three and nine months ended September 30,
2008, respectively, from 19% for each of the comparable periods in 2007, due to
improved efficiencies with expanded territory coverage while fully utilizing
the sales account managers. Stock-based compensation expense for sales and
marketing was $365,000 and $1.5 million, or 1% and 2% of revenues, for the
three and nine months ended September 30, 2008, respectively. We expect
stock-based compensation expense to remain consistent in future periods as we
grant additional awards to existing employees and new hires.
General and Administrative Expenses
General and
administrative expenses relate to billing, finance, human resources and other
administrative functions consisting of employee-related costs (such as
salaries, fringe benefits and stock-based compensation), professional services
and depreciation and administrative-related costs allocated to general and
administrative expenses. In addition, the provision for doubtful accounts is
included in general and administrative expenses. We anticipate increases in our
general and administrative expenses as we add personnel; continue to comply
with the reporting obligations applicable to publicly held companies; incur
additional expenses associated with the expansion of our facilities and backup
systems; and continue to build our corporate infrastructure to support our
anticipated growth. Incrementally, we expect to see increasing facility costs
as we relocate our administrative functions to our new headquarters facility in
late 2008.
21
Table
of Contents
|
|
Three Months Ended
|
|
|
|
Nine Months Ended
|
|
|
|
|
|
September 30,
|
|
%
|
|
September 30,
|
|
%
|
|
|
|
2008
|
|
2007 (1)
|
|
Change
|
|
2008
|
|
2007 (1)
|
|
Change
|
|
General and administrative
(in thousands)
|
|
$
|
5,786
|
|
$
|
2,732
|
|
112
|
%
|
$
|
16,091
|
|
$
|
6,997
|
|
130
|
%
|
General and administrative
(% of revenues)
|
|
18
|
%
|
17
|
%
|
|
|
20
|
%
|
17
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1)
|
|
During the three and nine months ended September 30, 2007, we
recorded positive changes in prior period accounting estimates to reduce the
allowance for doubtful accounts, which decreased general and administrative
expenses by $134,000 and $197,000, respectively. These positive
changes in accounting estimates were the result of continued improvements to
our billing systems and collection processes, as well as favorable experience
in the collection of accounts receivable for services rendered in prior
periods.
|
General
and administrative expenses increased to $5.8 million and $16.1 million for the
three and nine months ended September 30, 2008, respectively, from $2.7
million and $7.0 million for the comparable periods in 2007 (inclusive of the
changes in prior period accounting estimates noted above). The increases of
$3.1 million, or 112%, and $9.1 million, or 130%, for the three and nine months
ended September 30, 2008, respectively, as compared to the same period
s in 2007,
were primarily due to incremental increases of $2.0 million and $5.0 million,
respectively, for employee-related costs (including salaries, bonuses,
stock-based compensation expense and travel), $554,000 and $1.8 million,
respectively, for legal, insurance and consulting costs, and $418,000 and $1.1
million, respectively, for increased provision for doubtful accounts.
Employee-related costs increased as a result of the total general and
administrative headcount increasing 74% from 34 to 59 from September 30,
2007 to September 30, 2008, respectively, in support of operating as a
public company and overall company growth. In addition, we have expanded our
infrastructure by enhancing our information systems and implementing finance
initiatives to improve billing and support our finance
team in complying with added public company reporting obligations. Legal and consulting expenses increased as
a result of regulatory initiatives, additional public company obligations and
the ongoing development and maintenance of our compliance programs. As a
percentage of revenues, general and administrative expenses have increased due
to employee-related costs associated with additional headcount and increased
incentives such as bonuses, profit-sharing and stock-based compensation
expense, as well as provision for doubtful accounts and increased public
company costs. Stock-based compensation expense for general and administrative
was $990,000 and $2.0 million, or 3% and 2% of revenues, for the three and nine
months ended September 30, 2008, respectively. We expect stock-based
compensation expense to remain consistent in future periods as we grant
additional awards to directors, existing employees and new hires.
Research and Development Expenses
Research and
development expenses primarily consist of compensation, fringe benefits,
depreciation, supplies and administrative-related costs allocated to research
and development expenses. Our research and development activities primarily
relate to the development and validation of diagnostic tests in connection with
our specialized diagnostic services.
|
|
Three Months Ended
|
|
|
|
Nine Months Ended
|
|
|
|
|
|
September 30,
|
|
%
|
|
September 30,
|
|
%
|
|
|
|
2008
|
|
2007
|
|
Change
|
|
2008
|
|
2007
|
|
Change
|
|
Research and development
(in
thousands)
|
|
$
|
333
|
|
$
|
143
|
|
133
|
%
|
$
|
1,003
|
|
$
|
463
|
|
117
|
%
|
Research and development
(% of revenues)
|
|
1
|
%
|
1
|
%
|
|
|
1
|
%
|
1
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For
the three and nine months ended September 30, 2008, research and
development expenses increased to $333,000 and $1.0 million, respectively, from
$143,000 and $463,000 for the comparable periods in 2007. The increases of
$190,000, or 133%, and $540,000, or 117%, for the three and nine months ended September 30,
2008, respectively, as compared to the same period
s in 2007,
22
Table of
Contents
were primarily due to costs associated with
in-house validation of diagnostic tests. As a percentage of revenues, research
and development expenses have remained constant.
Interest Income, Interest Expense and Other Income
|
|
Three Months Ended
|
|
|
|
Nine Months Ended
|
|
|
|
|
|
September 30,
|
|
%
|
|
September 30,
|
|
%
|
|
|
|
2008
|
|
2007
|
|
Change
|
|
2008
|
|
2007
|
|
Change
|
|
|
|
(in thousands)
|
|
|
|
(in thousands)
|
|
|
|
Interest income
|
|
$
|
671
|
|
$
|
118
|
|
469
|
%
|
$
|
2,279
|
|
$
|
245
|
|
830
|
%
|
Interest expense
|
|
$
|
(5
|
)
|
$
|
(72
|
)
|
-93
|
%
|
$
|
(5
|
)
|
$
|
(231
|
)
|
-98
|
%
|
Other income
|
|
$
|
(16
|
)
|
$
|
(1
|
)
|
1500
|
%
|
$
|
28
|
|
$
|
41
|
|
-32
|
%
|
Interest income
for the three and nine months ended September 30, 2008 increased primarily
due to increased cash and cash equivalents and investment securities from our
initial public offering proceeds and cash provided by operations. Our one
remaining auction rate security, or ARS, had a cost basis of $5.0 million that
has reset to progressively higher rates of return due to failed Dutch auctions.
Despite the higher return associated with the failed ARS auction, we have had and
will continue to expect lower returns on other investments due to current
market conditions. We intend to continue to manage our investments to minimize
the overall risk and maximize our returns.
Interest expense
for the three and nine months ended September 30, 2008 was $5,000 for each
period, as compared to $72,000 and $231,000 for comparable periods in 2007.
This decrease in interest expense is a result of our repayment of borrowings
during the three months ended December 31, 2007, in connection with our
initial public offering.
Income Tax (Benefit) Expense
The income tax
benefit for the three and nine months ended September 30, 2008 was $6.2
million and $5.8 million, respectively. The income tax expense for the three
and nine months ended September 30, 2007 was $114,000 and $274,000,
respectively. The income tax benefit was driven primarily by the release of a
$9.8 million valuation allowance offsetting our net deferred tax assets during
the three months ended September 30, 2008.
Our
projected taxable income for 2008 should utilize the available federal net
operating losses with any remaining deferred tax assets to be utilized in
subsequent years. Although
realization is not assured, we believe it is more likely than not that we will
be able to realize our net deferred tax assets through the ordinary course of
business and expected future taxable income. As of September 30, 2008, we
had $10.0 million in net deferred tax assets. Similarly, we had $14.9 million
in net deferred tax assets at December 31, 2007, which was offset entirely
by our valuation allowance. Due to our sustained profitability, our future
effective tax rate will be approximately 45%. This rate is subject to the impact
of nondeductible stock-based compensation expense in excess of any tax
deductions from disqualifying dispositions.
As of December 31,
2007, we had federal and state net operating loss carryforwards of
approximately $28.0 million and $27.0 million, respectively. In each period
since our inception, we had recorded a valuation allowance for the full amount
of our net deferred tax assets, as the realization of the net deferred tax
assets did not meet the more likely than not requirement under SFAS No. 109,
Accounting for Income Taxes
. If
not used, the federal and state net operating loss carryforwards will begin
expiring in 2020 and 2010, respectively. As of December 31, 2007, we had
federal research credit carryforwards of $908,000, which will begin expiring in
2021and state research credit carryforwards of $1.2 million, which do not
expire. Under Sections 382 and 383 of the Internal Revenue Code of 1986,
as amended, substantial changes in our ownership have required us to limit the
amount of net operating loss and research and development credit carryforwards
that were previously available to offset future taxable income. We have had
three change in ownership events that limit the utilization of net operating
loss and credit carryforwards. The change in ownership events occurred in March 2000,
December 2001 and March 2008 and result in annual net operating loss
carryforward limitations of $63,000, $96,000 and $16.1 million, respectively.
As a result of a net unrealized built-in gain from the March 2008 change
in ownership, our net operating loss carryforward annual limitation of $16.1
million was increased to $39.7 million for each of the five years starting
after the change in ownership. These limitations will result in the expiration
of unused federal and state net operating loss carryforwards of $6.6 million
and $7.4 million, respectively. Additionally, these limitations will result in
the expiration of federal and state tax credits in the amount of $154,000 and
$130,000, respectively. The net deferred tax assets were reduced due to the net
operating loss and income tax credit limitations, with a corresponding
reduction of the valuation allowance. Additional limitations on the use of
these income tax attributes could occur in the event of possible disputes
arising in examination from various taxing authorities. Currently, we are not
under examination by any taxing authorities.
23
Table
of Contents
Liquidity and Capital Resources
As of September 30,
2008, we had $97.1 million in cash, cash equivalents and short-term investment
securities, primarily consisting of money market funds, corporate debt
investment securities and
government-sponsored
enterprise investment securities. We have
established guidelines relating to diversification and maturities of our
investment securities to preserve principal and maintain liquidity.
As of September 30,
2008, we held an ARS with a cost basis of $5.0 million consisting of
debt issued by a municipality, which is underwritten
by an insurance agency and rated A2 by Moodys Investors Service and AA by
Standard & Poors. It is classified as a long-term investment security
due to the current illiquidity in the ARS markets. Liquidity is obtained through a Dutch auction at pre-determined
intervals, or every 35 days. The recent conditions in the global credit markets have prevented
some investors from liquidating their holdings of ARS because the amount of
securities submitted for sale has exceeded the amount of purchase orders for
such securities. If there is insufficient demand for the securities at the time
of an auction, the auction may not be completed and the interest rates may be
reset to predetermined higher rates.
This auction began failing in February 2008 when
sell orders exceeded buy orders at the auction dates.
When auctions for this ARS failed,
the investment was not readily convertible to cash. The funds associated with this failed auction will not
be accessible without loss of principal until the issuer redeems the ARS, a
successful auction occurs, a buyer is found outside of the auction process, or
the ARS matures in 2038. As such, we may be required to hold it to maturity. Likewise, if the credit
ratings of the security issuers deteriorate and any decline in market value is
determined to be other-than-temporary, we would be required to adjust the
carrying value of the investment through an other-than-temporary impairment
charge to the condensed consolidated statement of operations.
The valuation of this security
is based on an
internally developed valuation analysis of
interest rate spreads, the credit quality, underlying assets of the issuer and
underwriter, likelihood of a successful auction or redemption in the near term
and the ability to obtain liquidity in the near-term. As a result of the
estimated fair value, we have recorded a temporary impairment in the valuation
of this security of $1.2 million during the three months ended September 30,
2008. The unrealized loss in the current period, net of deferred taxes, is
included in accumulated other comprehensive (loss) income. Due to the
uncertainty related to the timing of liquidity in the ARS market, we have
classified this ARS investment security as a long-term asset on our balance
sheet with a fair value of $3.8 million as of September 30, 2008. Because we were required to value this
security using only subjective inputs, our valuations determined at a later
date or by a third party, may be different from the fair values we have
determined as of September 30, 2008.
We do not currently need to access these
funds for operational purposes for the foreseeable future. Based on our ability
to access our cash and cash equivalents and short-term investment securities
and our expected operating cash flows, we do not anticipate that the temporary
illiquidity of this investment will affect our ability to execute our current
business plan.
As of September 30,
2008, the Company had total restricted cash of $360,000. Restricted cash consists of amounts held in a certificate of deposit to
collateralize a standby letter of credit per the terms of an operating lease
agreement. The standby letter of credit expires on June 30, 2012, allowing
for $90,000 annual reductions on June 30 of each year prior to expiration.
Our primary
ongoing source of cash is cash receipts on accounts receivable from our
revenues. Aside from the growth in revenues, net cash collections of accounts
receivable are impacted by the efficiency of our cash collections process as
measured by the change in days sales outstanding, or DSO. DSO can vary from
period to period depending on the payment cycles and the mix of our payors. Our
DSO averaged 53 and 56 days in the three and nine months ended September 30,
2008, respectively, compared to 52 and 61 days for the comparable periods in
2007. As of September 30, 2008, our DSO was 56 days.
Our primary uses
of cash are to fund operating expenses and the acquisition of property and
equipment. Cash used to fund operating expenses excludes the impact of non-cash
items such as the provision for doubtful accounts, depreciation and stock-based
compensation expense and is impacted by the timing of payments as reflected in
the change in our outstanding accounts payable and accrued expenses. Cash used
to fund increased headcount includes salary and related employee benefit
expenses. Acquisitions of property and equipment primarily consist of purchases
of facility improvements, laboratory equipment and computer hardware and
software.
Over the next 12
to 18 months, we estimate the costs associated with increasing our personnel to
be approximately $20.0 to $25.0 million; the costs associated with the
expansion of our existing laboratory and administrative facilities and
establishing other new laboratory facilities to be approximately $10.0 to $15.0
million; and the costs associated with additional capital expenditures to be
approximately $10.0 to $15.0 million. We believe our current cash and cash
equivalents and investment securities will be adequate to fund our planned growth
and operating activities through at least the next 24 months.
24
Table
of Contents
Regardless, we may
be required to raise additional funds through public or private equity
offerings or debt financings. We do not know if we will be able to obtain
additional financing on favorable terms, if at all (particularly in light of
the difficult current financial environment and weak economic conditions). If
we cannot raise funds on acceptable terms, if and when needed, we may not be
able to maintain or grow our business at the rate that we currently anticipate
and we may not be able to respond to competitive pressures or unanticipated
capital requirements, or we may be required to reduce operating expenses, which
would significantly harm our business, financial condition and results of
operations.
Our future capital
uses and requirements depend on numerous factors. These factors include but are
not limited to the following:
·
the current economy and financial markets;
·
changes in regulations or payor policies, including
reimbursement levels from governmental payors and private insurers, or
contracting arrangements with payors or changes in other laws, regulations or
policies; and
·
the extent to which we expand our operations and
increase our market share.
Below is a summary
of our cash flows provided by (used in) operating, investing and financing
activities for the nine months ended September 30, 2008 and 2007:
|
|
Nine Months Ended
|
|
|
|
September 30,
|
|
|
|
2008
|
|
2007
|
|
|
|
(in thousands)
|
|
Net cash provided by operating activities
|
|
$
|
23,424
|
|
$
|
9,053
|
|
Net cash used in investing activities
|
|
(52,805
|
)
|
(788
|
)
|
Net cash provided by (used in) financing
activities
|
|
566
|
|
(1,989
|
)
|
Net (decrease) increase in cash and cash
equivalents
|
|
$
|
(28,815
|
)
|
$
|
6,276
|
|
Operating Activities
Net cash provided
by operating activities during the nine months ended September 30, 2008
and 2007 was $23.4 million and $9.1 million, respectively. The net incremental
increase of $14.4 million, or 159%, was primarily due to incremental increases
of $17.3 million in net income due primarily to increased revenues, an
additional $4.8 million of non-cash stock-based compensation expense, an
increased provision for doubtful accounts of $1.1 million, an additional
increase of $2.4 million in accounts payable, accrued expenses and accrued
compensation due to timing of payouts, an increase of $2.8 million in income
tax payable primarily due to a recent California law temporarily suspending the
use of net operating loss benefits resulting in retroactive California state
income tax payable since January 1, 2008; offset by a $9.5 million change
in deferred taxes primarily due to the release of our valuation allowance
against our net deferred tax assets and $5.7 million of incremental increases
to accounts receivable as a result of increased revenues.
Investing Activities
Net cash used in
investing activities during the nine months ended September 30, 2008 and
2007 was $52.8 million and $788,000, respectively. The net incremental increase
of $52.0 million in cash used in investing activities primarily pertains to
$45.5 million of net purchases of short-term and long-term investment securities.
This increased activity pertains to short-term and long-term investment
securities purchased and sold with proceeds from our initial public offering
and cash generated from operations. Additionally, we had increased capital
expenditures of $6.2 million pertaining to tenant improvements for expansion of
our current facility and our new corporate offices and purchases of laboratory
equipment, computers, software and furniture in support of our headcount growth
across all functional areas and facility expansion.
Financing Activities
Net cash provided
by financing activities during the nine months ended September 30, 2008 of
$566,000 pertains to $1.2 million of net proceeds from the exercise of stock
options and warrants, including the purchase by employees of approximately
63,000 shares under the ESPP and $118,000 excess tax benefits related to
disqualifying dispositions on stock-based compensation awards, offset by
payments of $764,000 for expenses associated with our public offerings. Net
cash used in financing activities during the nine months ended September 30,
2007 of $2.0 million pertains to the principal payments on long-term financing
and capital leases of $1.2 million and costs paid in connection with our public
offerings $1.1 million; offset by notes payable issuances of $284,000 and
proceeds from the exercise of stock options of $50,000.
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Contractual Obligations and Commitments
There
have been no material changes, outside of the ordinary course of business, in
our outstanding contractual obligations from those disclosed within
Managements Discussion and
Analysis of Financial Condition and Results of Operations, as contained in our
Annual Report on Form 10-K filed by us with the SEC on February 12,
2008, except as noted below.
In February 2008,
we entered into a two-year lease (with three one-year extension options) for
additional office space in Carlsbad, California to house our expanding billing
and customer service departments. The noncancelable future minimum payments
under the lease total $293,000, $361,000 and $30,000 for the years ending December 31,
2008, 2009 and 2010, respectively. In connection with the April 2008 lease
noted below, the February 2008 lease was terminated in August 2008.
As such, the 2008 payments under this contract have been transferred and will
increase the noncancelable future minimum lease payments under the April 2008
lease. In addition, the 2009 and 2010
future minimum payments of $361,000 and $30,000, respectively, were
cancelled.
In April 2008,
we entered into a six-year operating lease beginning January 1, 2009 for
additional office space in Carlsbad, California to relocate and house our
future administration offices commencing
as of the date of substantial
completion of improvements, estimated to occur
in late
2008. Our billing and customer service departments relocated to this facility
in August 2008 at the time of the lease termination discussed above. The lease contains one five-year extension
option and is subject to annual rent increases. In September 2008,
we amended the lease to include an additional suite in the building to house
our human resources department. Our existing building will be fully dedicated
to clinical laboratory applications when the administration functions are moved
in late 2008 to our new headquarters facility. The amended noncancelable future minimum payments under the lease
total approximately $73,000, $1.5 million, $1.5 million, $1.6 million, $1.6
million and $3.4 million in 2008, 2009, 2010, 2011, 2012 and thereafter,
respectively.
From time to time,
we may enter into contracts with suppliers, manufacturers and other third
parties under which we may be required to make payments. Our disclosures do not
reflect any future obligations that may arise in the event that we establish
additional facilities to house our operations.
Off-Balance
Sheet Arrangements
We have not
engaged and do not expect to engage in any off-balance sheet activities.
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
Market risk
represents the risk of loss that may impact our financial position, results of
operations or cash flows due to adverse changes in financial and commodity
market prices and rates. We are exposed to market risk primarily in the area of
changes in United States interest rates and conditions in the credit markets.
We do not have any material foreign currency or other derivative financial
instruments. Under our current policies, we do not use interest rate derivative
instruments to manage exposure to interest rate changes. We attempt to increase
the safety and preservation of our invested principal funds by limiting default
risk, market risk and reinvestment risk. We mitigate default risk by investing
in investment grade securities.
All of our investment
securities are classified as available-for-sale and therefore reported on the
balance sheet at market value. Our investment securities consist of corporate
debt securities,
government-sponsored
enterprise securities
and ARS.
As of September 30,
2008, we held an ARS with a cost basis of $5.0 million consisting of
debt issued by a municipality, which is underwritten
by an insurance agency and rated A2 by Moodys Investors Service and AA by
Standard & Poors. It is classified as a long-term investment security
due to the current illiquidity in the ARS markets. Liquidity is obtained through a Dutch auction at
pre-determined intervals, or every 35 days. The recent conditions in the global credit markets have prevented
some investors from liquidating their holdings of ARS because the amount of
securities submitted for sale has exceeded the amount of purchase orders for
such securities. If there is insufficient demand for the securities at the time
of an auction, the auction may not be completed and the interest rates may be
reset to predetermined higher rates.
This auction began failing in February 2008 when
sell orders exceeded buy orders at the auction dates.
When auctions for this ARS failed,
the investment was not readily convertible to cash. The funds associated with this failed auction will not
be accessible without loss of principal until the issuer redeems the ARS, a
successful auction occurs, a buyer is found outside of the auction process,
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or the ARS
matures in 2038. As such, w
e may be required to hold it to maturity. Likewise, if the credit
ratings of the security issuers deteriorate and any decline in market value is
determined to be other-than-temporary, we would be required to adjust the
carrying value of the investment through an other-than-temporary impairment
charge to the condensed consolidated statement of operations.
The valuation of this
security is based on an
internally
developed valuation analysis of interest rate spreads, the credit quality,
underlying assets of the issuer and underwriter, likelihood of a successful
auction or redemption in the near term and the ability to obtain liquidity in
the near-term. As a result of the estimated fair value, we have
recorded a temporary impairment in the valuation of this security of $1.2
million during the three months ended September 30, 2008. The unrealized
loss in the current period, net of deferred tax, is included in accumulated
other comprehensive (loss) income. Due to the uncertainty related to the timing
of liquidity in the ARS market, we have classified this ARS investment security
as a long-term asset on our balance sheet with a fair value of $3.8 million as
of September 30, 2008. Because
we were required to value this security using only subjective inputs, our
valuations determined at a later date or by a third party, may be different
from the fair values we have determined as of September 30, 2008.
We do not currently need to access these
funds for operational purposes for the foreseeable future. Based on our ability
to access our cash and cash equivalents and short-term investment securities
and our expected operating cash flows, we do not anticipate that the temporary
illiquidity of this investment will affect our ability to execute our current
business plan.
Item 4T. Controls and Procedures.
We maintain
disclosure controls and procedures that are designed to ensure that information
required to be disclosed in our periodic reports filed with the SEC is
recorded, processed, summarized and reported within the time periods specified
in the SECs rules and forms and that such information is accumulated and
communicated to our management, including our chief executive officer and chief
financial officer, as appropriate, to allow for timely decisions regarding
required disclosure. In designing and evaluating the disclosure controls and
procedures, management recognizes that any controls and procedures, no matter
how well designed and operated, can provide only reasonable assurance of
achieving the desired control objectives and no evaluation of controls and
procedures can provide absolute assurance that all control issues and instances
of fraud, if any, within a company have been detected. Management is required
to apply its judgment in evaluating the cost-benefit relationship of possible
controls and procedures.
As required by Rule 13a-15(b) of
the Securities Exchange Act of 1934, as amended, or Exchange Act, prior to the
filing of this report we carried out an evaluation, under the supervision and
with the participation of our management, including our chief executive officer
and chief financial officer, of the effectiveness of the design and operation
of our disclosure controls and procedures (as defined in Rules 13a-15(e) and
15d-15(e) of the Exchange Act) as of the end of the period covered by this
report. Based on their evaluation, our chief executive officer and chief
financial officer concluded that our disclosure controls and procedures were
effective as of the end of the period covered by this report.
In addition,
management, including our chief executive officer and chief financial officer,
did not identify any change in our internal control over financial reporting
that occurred during our latest fiscal quarter that has materially affected, or
is reasonably likely to materially affect, our internal control over financial
reporting.
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PART II. OTHER INFORMATION
Item 1A. Risk Factors.
You
should consider carefully the following information about the risks described
below, together with the other information contained in this Quarterly Report
on Form 10-Q and in our other public filings in evaluating our business.
We have marked with an asterisk (*) those risk factors that reflect substantive
changes from the risk factors included in our Annual Report on Form 10-K
that we filed with the Securities and Exchange Commission, or SEC, on February 12,
2008. If any of the following risks actually occurs, our business, financial
condition, results of operations and future growth prospects would likely be
materially and adversely affected. In these circumstances, the market price of
our common stock would likely decline.
Risks Relating to Our Business
Operations
*
Reimbursement levels for our
specialized diagnostic services are subject to continuing change and any
reductions in reimbursement levels would decrease our revenues and adversely
affect our results of operations and financial condition.
Reimbursement to healthcare providers, such as
specialized diagnostic service providers like us, is subject to continuing
change in policies by governmental payors, such as Medicare and Medicaid,
private insurers, including managed care organizations and other private
payors, such as hospitals and private medical groups. Reimbursement from
governmental payors is subject to statutory and regulatory changes, retroactive
rate adjustments and administrative rulings and other policy changes, all of
which could materially decrease the range of services for which we are
reimbursed or the reimbursement rates we are paid. For example, the consumer
price index, or CPI, update of the clinical laboratory fee schedule for 2004
through 2008 was frozen by the Medicare Prescription Drug, Improvement and
Modernization Act of 2003, or MMA. Although this modification to Medicares reimbursement
rates did not materially affect the amount paid by Medicare for our current
services, future modifications to Medicares reimbursement rates or the
reimbursement rates from other governmental payors could significantly reduce
the amounts we receive for the services we provide. Payment rates also may be
impacted given that, as of January 1, 2010, we will no longer be able to
submit claims to Medicare for our pathology services for hospital patients, but
instead will be required to bill hospitals directly for services rendered.
Reductions in Medicares reimbursement rates for
pathology services, for which we currently are paid under the Medicare
physician fee schedule, would reduce the amount we receive for a substantial
number of our specialized diagnostic tests. The Medicare physician fee schedule
is typically updated annually and CMS, the agency responsible for administering
the Medicare program, has made a number of methodological changes to components
of the formula used to calculate the payment rate. Although, these
methodological changes in the past have resulted in significant reductions in
the reimbursement for the pathology services we provide, Congressional action
has consistently overridden such reductions and provided increases to the fee
schedule on an annual basis. For example, for the 2008 annual period, the fee
schedule methodology would have reduced Medicare payments for many of the
services we provide by approximately 10%. However, effective January 1,
2008, as a result of the Medicare, Medicaid and SCHIP Extension Act of 2007,
the conversion factor was increased by 0.5% for payment of claims with dates of
service from January 1, 2008 through June 30, 2008. On July 15,
2008, Congress overrode a Presidential veto to pass the Medicare Improvements
for Patients and Providers Act of 2008, or MIPPA, which extended the 0.5%
conversion factor increase for the remainder of 2008, followed by a 1.1%
increase effective January 2009. Nevertheless, future Congressional action
cannot be assured (particularly in light of the elections in November 2008)
and future methodological changes may result in reductions or increases to the
Medicare physician fee schedule.
The Medicare Modernization Act of 2003 mandated
creation of Medicare Administrative Contractors, or MACs, replacing the current
system of fiscal intermediaries who oversee fee-for-service claims for the
Medicare Part A and Part B programs. In November 2007, CMS
awarded the MAC Jurisdiction 1 (California, Hawaii, Nevada, American Samoa,
Guam and the Northern Mariana Islands) to Palmetto GBA. The full transition to
Palmetto GBA has occurred effective September 2, 2008. The MAC stated
methodology for consolidation and transition of Local Coverage Determinations,
or LCD, was based on the principal of least restrictive. New LCDs related to
our specialized diagnostic services were introduced as a result of the
consolidation process. This policy change may result in reductions to, delays
in or denials for reimbursement for the services offered. Additionally, the
transition from a fiscal intermediary to a MAC is in a very early stage and may
result in delays in reimbursement that could have an impact on us and our
results of operations.
Other policy changes may include competitive bidding
by clinical laboratories for the provision of services to the Medicare program,
which was the subject of a CMS demonstration project in Carlsbad, California,
pursuant to the requirements of the MMA. The implementation of the
demonstration project was delayed due to a federal preliminary injunction and
the MIPPA subsequently
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repealed the competitive bidding demonstration
project. If later implemented, competitive bidding could decrease our
reimbursement rates for clinical laboratory tests.
In addition, some private insurers and other third
party payors link their rates to Medicares reimbursement rates and a reduction
in Medicare reimbursement rates for clinical laboratory and pathology services
could result in a corresponding reduction in the reimbursements we receive from
such third party payors. Any reductions in reimbursement levels for our
specialized diagnostic services would decrease our revenues and adversely
affect our results of operations and financial condition.
*
Operating as a non-contracting
provider with certain payors may adversely affect our results of operations and
financial condition and contracting with those payors may be disadvantageous to
us.
We are currently considered a non-contracting
provider by a number of third party payors because we have not entered into a
specific contract to provide our specialized diagnostic services to their insured
patients at specified rates of reimbursement. We were generally subject to
reimbursement as a non-contracting provider for approximately half of our
revenues for the three and nine months ended September 30, 2008 and 2007.
Use of a non-contracting provider typically results in greater coinsurance or
copayment requirements for the patient, unless we elect to treat them as
in-network in accordance with applicable law, which results in decreased
revenues because we do not generally collect the full applicable out-of-network
patient coinsurance or copayment obligations. In instances where we are
prohibited by law from treating these patients as in-network, thus requiring
them to pay additional costs or copayments, such patients may express concern
about these additional costs to their hem/onc. As a result, that hem/onc may
reduce or avoid prescribing our services for such patients, which would
adversely affect our results of operations and financial condition.
Should any of the third party payors with whom we are
not contracted insist that we enter into a contract for the specialized
diagnostic services we provide, the resulting contract may contain pricing and
other terms that are materially less favorable to us than the terms under which
we currently operate. If revenues from a particular payor increase, there is
heightened risk that such a third party payor will insist that we enter into
contractual arrangements that contain such terms. If we refuse to enter into a
contract with such a third party payor, they may refuse to cover and reimburse
for our services, which may lead to a decrease in case volume and a
corresponding decrease in our revenues. If we contract with such a third party
payor, although our case volume may increase as a result of the contract, our
revenues per case under the contractual agreement and gross margins may
decrease. The overall net result of contracting with third party payors may
adversely affect our business, results of operations and financial condition.
*
Changes in regulations, payor
policies or contracting arrangements with payors or changes in other laws,
regulations or policies may adversely affect coverage or reimbursement for our
specialized diagnostic services, which may decrease our revenues and adversely
affect our results of operations and financial condition.
Governmental payors, private insurers and other
private payors have implemented and will continue to implement measures to
control the cost, utilization and delivery of healthcare services, including
clinical laboratory and pathology services. Congress has from time to time
considered and implemented changes to laws and regulations governing healthcare
service providers, including specialized diagnostic service providers. These
changes have adversely affected and may in the future adversely affect coverage
for clinical laboratory and pathology services, including the specialized
diagnostic services we provide. In addition, as a result of the focus on
healthcare reform in connection with the 2008 Presidential election, there is
risk that Congress may implement changes in laws and regulations governing
healthcare service providers, including measures to control costs or reductions
in reimbursement levels, which may have an adverse impact on our business. We
also believe that healthcare professionals, including hem/oncs, will not use
our services if third party payors do not provide adequate coverage and
reimbursement for them. These changes in federal, state, local and third party
payor regulations or policies may decrease our revenues and adversely affect
our results of operations and financial condition.
For approximately half of our revenues for the three
and nine months ended September 30, 2008 and 2007, we were generally
subject to reimbursement as a non-contracting provider and payments to us as a
non-contracting provider can be changed by third party payors at any time. We
will continue to be a non-contracting provider until such time as we enter into
contracts with third party payors for whom we are not currently contracted. We
estimate contractual allowances with respect to revenues from third party
payors with whom we are not currently contracted.
During the three months ended September 30,
2008, we recorded positive changes in prior period accounting estimates to
reduce contractual allowances, which increased our revenues by $2.5 million, of
which $1.6 million pertains to the six months ended June 30, 2008. During
the nine months ended September 30, 2008, we recorded positive changes in
prior year accounting estimates to reduce contractual allowances, which
increased our revenues by $2.2 million. In comparison, our revenues increased
by $612,000 and $828,000 for the three and nine months ended September 30,
2007, respectively, as a result of changes in such prior period accounting
estimates. Because a substantial portion of our
revenues is from third party payors with whom we are not currently contracted,
it is likely that we will be required to make positive or negative adjustments
to accounting estimates
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with respect to contractual allowances in the future
(as we have made in each of the last several quarters), which may adversely
affect our results of operations, our credibility with financial analysts and
investors and our stock price. Although during the past several quarters we
have experienced favorable changes in accounting estimates resulting in net
increases in our revenues, it is possible that future adjustments may be less
favorable and may result in net decreases in our revenues, which would
adversely affect our results of operations.
Increased competition, including from
competitors replicating our key service offerings in the future and the failure
to provide a higher quality of service than that of our competitors could
adversely affect our revenues and profitability.
The laboratory services industry generally is
intensely competitive both in terms of service and price and it continues to
undergo significant consolidation, permitting larger clinical laboratory
service providers to increase cost efficiencies and change service levels,
resulting in more intense competition. Most of our existing competitors and
many potential competitors have substantially greater financial, selling,
logistical and laboratory resources, more experience in dealing with third
party payors for the services we provide and greater market penetration,
purchasing power and marketing budgets, as well as more experience in providing
diagnostic services.
As a specialized diagnostic service provider, we rely
extensively on our high quality of service to attract and retain
community-based hem/oncs and other healthcare professionals as our customers at
the expense of our larger competitors. We compete primarily on the basis of the
quality of testing, reporting and information systems, reliability in patient
sample transport, reputation in the medical community and access to our highly
qualified hempaths. For example, we provide treating hem/oncs with telephonic
access on an almost real-time basis to the specific hempath that generates a
report and analysis on the specific patient. Our failure to provide services
superior to the laboratories with which we compete could adversely affect our
revenues and profitability.
Because we do not rely on our intellectual property
portfolio to impede others from copying our business, there are no significant
barriers to entry into our business and new or existing laboratories could
replicate our key service offerings and business model and enter our market to
compete with us with relatively low upfront investments, which would adversely
affect our business and prospects.
We are highly dependent on Cartesian
Medical Group, Inc. for the services of our hempaths and any significant
difficulties in recruiting or retaining these highly trained hempaths could
adversely affect our revenues and results of operations.
Our business is highly dependent on the availability
of hempaths, who provide professional services to us through Cartesian.
Cartesian is actively recruiting additional hempaths to work with us as we
continue to expand our business. There are currently approximately 1,500
hempaths licensed in the United States and only approximately 75 new hempaths
receive board certification in the United States each year. Our PSA with
Cartesian is automatically renewed on a yearly basis but may be terminated by
us at any time on 60 days prior written notice and either party may
terminate the PSA upon the other partys uncured material breach. Should
Cartesian be unable to retain the hempaths that provide professional services
to us, or if Cartesian fails in its efforts to recruit additional hempaths to
provide us professional services, our ability to maintain and grow our business
may be impaired. In addition, Cartesian may be required to offer higher
compensation to hempaths in connection with recruitment and retention efforts
and these increased compensation expenses would be reflected in the amount we
pay to Cartesian through the PSA. We may be unable to recover these increased
expenses through price increases or reimbursements for our diagnostic services.
In addition, if Cartesian were to experience significant turnover in hempaths,
our ability to perform our specialized diagnostic services and our revenues and
results of operations could be adversely affected.
We must hire and retain qualified
sales representatives to grow our sales.
Our ability to retain existing customers for our
specialized diagnostic services and attract new customers is dependent upon
retaining existing sales representatives and hiring new sales representatives,
which is an expensive and time-consuming process. We face intense competition for
qualified sales personnel and our inability to hire or retain an adequate
number of sales representatives could limit our ability to maintain or expand
our business and increase sales. Even if we are able to increase our sales
force, our new sales personnel may not commit the necessary resources or
provide sufficient high quality service and attention to hem/oncs to
effectively market and sell our specialized diagnostic services. If we are
unable to maintain and expand our marketing and sales networks or if our sales
personnel do not perform to our high standards, we may be unable to maintain or
grow our existing business and our results of operations and financial
condition will likely suffer accordingly.
Our sales personnel have developed and maintain close
relationships with a number of healthcare professionals. In particular, our
sales force focuses its efforts on developing relationships with
community-based hem/oncs and other healthcare professionals who are
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decision makers in their offices. Our sales depend on
the use of our specialized diagnostic services by these community-based
hem/oncs and other healthcare professionals and successful marketing of our
services depends on educating these community-based hem/oncs and other
healthcare professionals as to the distinctive characteristics, benefits, high
quality and value of our specialized diagnostic services compared to those of
our competitors.
If a sales representative ceases employment, we risk
the loss of customer goodwill based on the impairment of relationships
developed between the sales representative and the healthcare professionals for
whom the sales representative was responsible. This is particularly a risk if
the representative goes to work for a competitor, as the healthcare
professionals that are our customers may choose to use a competitors services
based on their relationship with the departed sales representative.
If we fail to attract and retain key
management and other personnel, we may be unable to successfully maintain or
develop our business.
Our success depends on our continued ability to
attract, retain and motivate highly qualified management, laboratory and other
personnel. For example, we are highly dependent on the operational and
financial expertise of our executive officers. The loss of the services of any
of our executive officers, particularly Tina S. Nova, Ph.D., our president and
chief executive officer, could impede our growth. In particular, our executive
officers currently perform all of our policy-making functions, are in charge of
our principal business units, divisions and functions and are solely
responsible for all key decisions. We are also dependent on our key employees
and consultants, who are important to our business and assist and support our
executive officers in implementing and executing these officers key decisions.
If we lose any of our executive officers or key employees and consultants,
other of these individuals may be required to fulfill his or her duties and
spend time finding a replacement. We may not be able to find suitable
replacements and our business may be harmed as a result. We do not maintain key
woman or key man insurance policies on the lives of these individuals or the
lives of any of our other employees. We employ our executive officers and key
employees on an at-will basis and their employment can be terminated by them or
us at any time.
Our industry has experienced a high rate of turnover
of management personnel in recent years. In addition to the intense competition
for qualified personnel in the healthcare industry, the San Diego area is
characterized by a high cost of living, particularly for housing. As such, we
could have difficulty attracting experienced personnel to our company and may
be required to expend significant financial resources in our employee
recruitment and retention efforts. If we are not able to attract and retain the
necessary personnel to accomplish our business objectives, we may experience
constraints that will impede significantly the achievement of our operational
objectives, our revenue growth and our ability to implement our business
strategy.
*
We may experience difficulties in
managing our growth and our growth rate may decline.
Our revenues have grown to $32.1 million and
$82.2 million for the three and nine months ended September 30, 2008,
respectively, from $16.2 million and $40.8 million for the comparable
periods in 2007. This growth has put significant pressure on our systems and
operations. As of September 30, 2008, we employed 246 employees, including
Cartesian employees and six part-time employees. Our current organization, and
our systems and facilities currently in place, may not be adequate to support
our future growth. In order to effectively manage our operations and any
significant growth, we may need to:
·
scale our internal infrastructure, including
establishing a new administrative facility, building out additional laboratory
space in our existing facilities and establishing a second laboratory facility,
while continuing to provide quality services on a timely basis to
community-based hem/oncs and other customers;
·
maintain and strengthen our relationships with our
hem/onc customers as we increase the number of our sales and marketing
personnel and increase our presence in the various geographic markets we serve;
·
attract and retain sufficient numbers of talented
employees and consultants, including sales personnel, hempaths, CSCs,
scientists, laboratory technicians and administrative employees, to handle the
increasing number of tests we are requested to conduct;
·
manage our relationship with Federal Express to ensure
its ability to handle increasing sample transport and deliveries;
·
manage our relationships with third parties for the
provision of certain services and the manufacture and supply of certain test
kits, reagents and other laboratory materials;
·
continue to enhance our compliance and quality
assurance systems; and
·
continue to improve our operational, financial and
management controls and reporting systems and procedures.
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If we are not able to successfully implement the tasks
necessary to further expand our operations, our business, including the quality
of our services and our billing, reimbursement, compliance and quality
assurance systems, our results of operations and our financial results could be
adversely affected. In addition, as our revenues grow, our period over period
growth rate may decline.
*
We are currently expanding our
infrastructure, including through the acquisition and development of additional
office space and the expansion of our current laboratory capacity at our
existing facility and we intend to further expand our infrastructure by
establishing a new laboratory facility and implementing additional backup
systems, which, among other things, could divert our resources and may cause
our margins to suffer.
In February 2008, we entered into a two-year
lease (with three one-year extension options) for additional office space in
Carlsbad, California to house our expanding billing and customer service
departments. The noncancelable future minimum payments under the lease totaled
$293,000, $361,000 and $30,000 for the years ending December 31, 2008,
2009 and 2010, respectively. In connection with the April 2008 lease noted
below, the February 2008 lease was terminated in August 2008. As
such, the 2008 payments under this contract have been transferred and will
increase the noncancelable future minimum lease payments under the April 2008
lease. In addition, the 2009 and 2010
future minimum payments of $361,000 and $30,000, respectively, were
cancelled.
In April 2008, we entered into a six-year
operating lease beginning January 1, 2009 for additional office space in
Carlsbad, California to relocate and house our future administration offices
commencing
as of the date of substantial completion of improvements,
estimated to occur
in late 2008. Our billing and customer
service departments relocated to this facility in August 2008 at the time
of the lease termination discussed above. The lease contains one five-year extension option and is subject to
annual rent increases. In September 2008,
we amended the lease to include an additional suite in the building to house
our human resources department. Our existing building will be fully dedicated
to clinical laboratory applications when the administration functions are moved
in late 2008 to our new headquarters facility. The amended noncancelable future minimum payments under the lease
total approximately $73,000, $1.5 million, $1.5 million, $1.6 million, $1.6
million and $3.4 million in 2008, 2009, 2010, 2011, 2012 and thereafter,
respectively.
Although all our facilities are in close proximity,
there may be logistical issues that arise by virtue of separating these
departments from the rest of our operations, including issues related to
information systems integration and connectivity speed.
Moreover, in order to better serve our expanding
customer base, to create a backup to our current laboratory facility and to
gain additional referrals for our specialized diagnostic services, we intend to
expand our infrastructure, including establishing a second laboratory facility
in another geographic market and expanding further our backup systems. Although
we currently anticipate selecting a site for our new facility in late-2009, in
order to establish the new laboratory facility, we will be required to spend
considerable time and resources securing adequate space, constructing the
facility, obtaining the federal, state and local certifications required by all
applicable laws and regulations, recruiting and training employees and
establishing the additional operational, logistical and administrative
infrastructure necessary to support a second facility. Even after the new
laboratory facility is operational, it may take time for us to derive the same
economies of scale as in our existing facility. Moreover, we may suffer reduced
economies of scale in our existing laboratory facility as we seek to balance
the amount of work allocated to each laboratory facility. Similarly, we may
invest in new backup systems in order to prevent the interruption in our
current systems, which may be costly and would take time and resources to
implement. Each expansion of our facilities or systems could divert resources,
including the focus of our management, away from our current business. In
addition, each expansion of our facilities may increase our costs and potentially
decrease operating margins, both of which would, individually or in the
aggregate, negatively impact our business, financial condition and results of
operations. We will need to continue to expand our managerial, operational,
financial, sales, marketing and other infrastructure in order to adequately
manage our business and provide support for our services. In addition, to the
extent our service levels in our existing or new facilities suffer, this may
adversely impact our business, financial condition and results of operations.
If our Carlsbad laboratory facility
becomes inoperable, we will be unable to perform our specialized diagnostic
services and our business will be harmed.
We currently do not have redundant laboratory
facilities. We perform all of our diagnostic testing in our laboratory facility
located in Carlsbad, California. Carlsbad is situated on or near earthquake
fault lines and is located in an area that has experienced severe wildfires
during the past several years. In addition, we do not have redundant systems
for all of our business processes. Our facilities, the equipment we use to
perform our tests and services and our other business process systems would be
costly to replace and could require substantial time to repair or replace. The facilities
may be harmed or rendered inoperable by natural or people-made disasters,
including earthquakes, wildfires, floods, acts of terrorism or other criminal
activities, infectious disease outbreaks and power outages, which may render it
difficult or impossible for us to perform our tests for some period. In
addition, such events may
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temporarily interrupt our ability to receive specimens
or materials from our suppliers and to have access to our various systems
necessary to operate our business. For example, in 2007 we experienced a power
outage at our Carlsbad laboratory facility and the evacuation of our facilities
as a result of severe wildfires. Although our backup generator and other backup
procedures and systems allowed us to continue our operations without material
interruption, we cannot assure you that similar incidents will not adversely
affect our business in the future. The inability to perform our tests and
services would result in the loss of customers and harm our reputation and we
may be unable to regain those customers in the future. Our insurance carriers
and insurance policies covering damage to our property and the disruption of
our business may become financially unstable or may not be sufficient to cover
all of our potential losses and may not continue to be available to us on
acceptable terms, or at all.
In the event our laboratory facility is damaged or
destroyed, we would need to engage a third party to perform laboratory testing
services on our behalf. In order to rely on a third party to perform these
testing services, we could only use another facility with established state
licensure and CLIA accreditation. We cannot assure you that we would be able to
find another CLIA-certified facility, or that another laboratory would be
willing to perform the necessary tests for us on commercially reasonable terms.
Finding a new laboratory that meets the required state licensure and CLIA
accreditation standards or developing new systems necessary to operate our
business would be time-consuming and costly and result in delays in our ability
to provide our specialized diagnostic services or to provide the same level of
quality in our services as we currently provide, which would harm our
reputation and adversely affect our business, results of operations and
financial condition.
*
We incur financial risk related to
collections.
Substantially all of our revenues are derived from
specialized diagnostic services for which we bill on a fee-for-service basis.
Billing for diagnostic services is a complex process and we bill many different
payors such as insurance companies, governmental payor programs and patients,
each of which has different billing requirements. Although we have experienced
favorable trends in the collection of accounts receivable and related
reductions to our provisions for doubtful accounts, we face risks in our
collection efforts, including potential write-offs of doubtful accounts and
long collection cycles for accounts receivable, including reimbursements by
third party payors, such as Medicare, Medicaid and other governmental payor
programs, hospitals, private insurance plans and managed care organizations. In
addition, increases in write-offs of doubtful accounts, delays in receiving
payments or potential retroactive adjustments and penalties resulting from
audits by payors could adversely affect our business, results of operations and
financial condition. As of September 30, 2008, we had an allowance for
doubtful accounts of $3.3 million, which includes net write-offs and
recoveries of $611,000 for the nine months ended September 30, 2008.
We or our suppliers and/or manufacturers may
be subject to litigation relating to, among other things, payor and customer
disputes, regulatory actions, professional liability, intellectual property,
employee-related matters, product liability and other potential claims, which
could adversely affect our business.
We or our suppliers and/or manufacturers may become
subject in the ordinary course of business to material litigation related to,
among other things, payor or customer disputes, professional liability,
regulatory actions, intellectual property, employee-related matters, product
liability and other potential claims, as well as investigations by governmental
agencies and governmental payors relating to the specialized diagnostic
services we provide. Responding to these types of claims, regardless of their
merit, could result in significant expense and divert the time, attention and
resources of our management. Legal actions could result in substantial monetary
damages as well as significant harm to our reputation with community-based
hem/oncs and other healthcare professionals and with payors, which could
adversely affect our business, financial condition and results of operations.
We, Cartesian and/or our hempaths may be sued, or may
be added as an additional party, under physician liability or other liability
law for acts or omissions by our hempaths, laboratory personnel, CSCs, and
other employees and consultants, including but not limited to being sued for
misdiagnoses or liabilities arising from the professional interpretations of
test results. We, Cartesian and/or our hempaths may periodically become
involved as defendants in medical malpractice and other lawsuits and are
subject to the attendant risk of substantial damage awards, in particular in
connection with our COMPASS service offering. Our hempaths are insured for
medical malpractice risks on a claims-made basis under traditional professional
liability insurance policies. We also maintain general liability insurance that
covers certain claims to which we may be subject. Our general insurance does
not cover all potential liabilities that may arise, including governmental
fines and penalties that we may be required to pay, liabilities we may incur
under indemnification agreements and certain other uninsurable losses that we
may suffer. It is possible that future claims will not be covered by or will
exceed the limits of our insurance coverage.
We and the suppliers and manufacturers of the
diagnostic tests we perform, which are critical to the performance of our
specialized diagnostic services, may be exposed to, or threatened with, future
litigation by third parties having patent or other intellectual property rights
alleging that their diagnostic tests infringe the intellectual property rights
of these third parties. In such event, we could no longer have access to, we
may be prohibited from marketing or performing, or we may be subject to
liabilities
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or litigations relating to such diagnostic tests
unless we obtained a license from such third party. A license may not be
available to us on acceptable terms, if at all. If we are unable to license
diagnostic tests that are important to our specialized diagnostic services, our
business, financial condition and results of operations may be adversely
affected.
We rely on a limited number of third
parties for manufacture and supply of all of our laboratory instruments, tests
and materials, including consumables, and we may not be able to find
replacement suppliers or manufacturers in a timely manner in the event of any
disruption, which could adversely affect our business.
We rely on third parties for the manufacture and
supply of all of our laboratory instruments, equipment and materials, including
consumables such as reagents and disposable test kits, that we need to perform
our specialized diagnostic services and rely on a limited number of suppliers
for certain laboratory materials and some of the laboratory equipment with
which we perform our diagnostic services. We do not have long-term contracts
with our suppliers and manufacturers that commit them to supply equipment and
materials to us. Certain of our suppliers provide us with analyte specific reagents,
or ASRs, which serve as building blocks in the diagnostic tests we conduct in
our laboratory. These suppliers are subject to regulation by the U.S. Food and
Drug Administration, or FDA, and must comply with federal regulations related
to the manufacture and distribution of ASR 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. If any of our third party suppliers or
manufacturers were to become unwilling or unable to provide this equipment or
these materials in required quantities or on our required timelines, we would
need to identify and acquire acceptable replacement sources on a timely basis.
While we have developed alternate sourcing strategies for the equipment and
materials we use, we cannot be certain that these strategies will be effective
and even if we were to identify other suppliers and manufacturers for the
equipment and materials we need to perform our specialized diagnostic services,
there can be no assurance that we will be able to enter into agreements with
such suppliers and manufacturers or otherwise obtain such items on a timely
basis or on acceptable terms, if at all. If we encounter delays or difficulties
in securing necessary laboratory equipment or materials, including consumables,
we would face an interruption in our ability to perform our specialized
diagnostic services and experience other disruptions that would adversely
affect our business, results of operations and financial condition.
*
Performance issues, service
interruptions or price increases by our shipping carrier could adversely affect
our business, results of operations and financial condition and harm our
reputation and ability to provide our specialized diagnostic services on a
timely basis.
Expedited, reliable shipping is essential to our
operations. One of our marketing strategies entails highlighting the
reliability of our point-to-point transport of patient samples.
We rely almost exclusively on a single carrier,
Federal Express, for reliable and secure point-to-point transport of patient
bone marrow and other samples to our laboratory and enhanced tracking of these
patient samples. Federal Express has tailored some of its systems and processes
to meet our specific needs in providing high quality services to our hem/onc
customers. In our specialty diagnostic field, patient samples more often than
not include bone marrow biopsies, which are both technically difficult for a
physician to obtain and extremely uncomfortable for patients to endure. Should
Federal Express encounter delivery performance issues such as loss, damage or
destruction of a sample, it would be difficult to replace our patient samples
in a timely manner and such occurrences may damage our reputation and lead to
decreased referrals from physicians for our specialized diagnostic services and
increased cost and expense to our business. In addition, any significant
increase in shipping rates or fuel surcharges could adversely affect our
operating margins and results of operations. Similarly, strikes, severe
weather, natural disasters or other service interruptions by delivery services
we use would adversely affect our ability to receive and process patient
samples on a timely basis.
If Federal Express or we were to terminate our
relationship, we would be required to find another party to provide expedited,
reliable point-to-point transport of our patient samples. There are only a few
other providers of such nationwide transport services and there can be no
assurance that we will be able to enter into arrangements with such other
providers on acceptable terms, if at all. Finding a new provider of transport
services would be time-consuming and costly and result in delays in our ability
to provide our specialized diagnostic services. Even if we were to enter into
an arrangement with such provider, there can be no assurance that they will
provide the same level of quality in transport services currently provided to
us by Federal Express. If the new provider does not provide the required
quality and reliable transport services, it could adversely affect our business,
reputation, results of operations and financial condition.
Proprietary trademarks, service
marks, trade secrets and unpatented expertise are very important to our
business.
We use numerous trademarks and service marks to
identify the products and services we offer, some of which have been registered
with the U.S. Patent and Trademark Office, or USPTO, and others of which are
undergoing USPTO review. In addition,
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we are seeking registration of the name Genoptix in
additional fields of use. We cannot guarantee that any of the trademarks or
service marks for which we have applied for registration will be granted.
Moreover, should a third party challenge one or more of our trademarks or
service marks, we cannot guarantee that we would prevail in that challenge.
Despite the use of our trademarks or service marks in connection with our
services, we are not the sole person entitled to use the names COMPASS or CHART
in every category in the United States. For example, third parties have
registered the name COMPASS in the United States in the medical field and other
categories. None of these third parties has contacted us with a claim that our
COMPASS trademark infringes their rights. We cannot guarantee that a third
party with rights in a COMPASS or CHART trademark, or in another trademark we
use, will not assert those rights against us in the future, by opposing one of
our trademark applications, petitioning to cancel one of our trademark
registrations, or filing suit against us for trademark infringement seeking
damages and/or an injunction to stop us from using our mark.
Although we have taken steps to protect our trade
secrets and unpatented expertise, including entering into confidentiality
agreements with third parties and confidential information and inventions
agreements with employees, consultants and advisors, third parties may still be
able to obtain this information or we may be unable to protect our rights.
There can be no assurance that binding agreements will not be breached, that we
would have adequate remedies for any breach, or that our trade secrets will not
otherwise become known or be independently discovered by our competitors.
Enforcing a claim that a third party illegally obtained and is using our trade
secrets or unpatented expertise is expensive and time-consuming and the outcome
is unpredictable. Moreover, our competitors may independently develop
equivalent knowledge, methods and expertise and we would not be able to prevent
their use.
If technological innovation or
prophylactic treatments were to reduce the need to conduct diagnostic testing
on blood and bone marrow samples or allow our customers or other third parties
to perform specialized diagnostic services similar to ours, our business,
prospects, results of operations and financial condition could be adversely
affected.
In order for hem/oncs to arrive at the correct
diagnosis, choose or modify appropriate therapeutic regimens and monitor the
effectiveness of these regimens, they currently require highly specialized
diagnostic services that analyze blood and bone marrow samples. We focus our
diagnostic efforts primarily on specific malignancies of the blood and bone
marrow. Serial blood and bone marrow examinations are typically performed to
follow the progress of the disease and the patients response to therapy.
Technological innovations or other advances in medicine that result in the
creation of enhanced diagnostic tools may enable other clinical laboratories,
hospitals, physicians or other medical providers, or patients, to provide
specialized diagnostic services similar to ours in a more patient-friendly,
efficient or cost-effective manner than is currently possible. Advances in
technology or medicine may also result in a cure or prophylactic treatment for
some of the diseases on which we focus which could reduce or eliminate the need
to obtain and analyze bone marrow samples. This could substantially reduce or
eliminate our market opportunity and adversely affect our business, prospects,
results of operations and financial condition.
*
Failure in our information systems,
or IS, telephone or other systems could significantly disrupt our operations
and adversely affect our business and financial condition.
IS and telephone systems are used extensively in
virtually all aspects of our business, including laboratory testing, sales,
billing, customer service, logistics and management of medical data. The
success of our business depends on the ability to obtain, process, analyze,
maintain and manage this data and periodically enhance our IS, telephone and
other systems to facilitate the continued growth of our business. Our
management relies on our information systems because:
·
patient samples must be received, tracked and
processed on a timely basis;
·
test results must be monitored and reported on a
timely basis;
·
billings and collections for all customers must be
managed efficiently and accurately;
·
third party ancillary billing services require proper
tracking and reporting;
·
pricing and other information related to our services
is needed by our sales force and other personnel in a timely manner to conduct
business;
·
centralized procurement and test inventory management
systems are required for effective test inventory management;
·
regulatory compliance requires proper tracking and
reporting; and
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·
proper recordkeeping is required for operating our
business, regulatory compliance, managing employee compensation and other
personnel matters.
Our business, results of operations
and financial condition may be adversely affected if, among other things:
·
our IS, telephone or other systems are interrupted or
fail for any extended length of time;
·
services relating to our IS, telephone or other
systems are not kept current;
·
our IS, telephone or other systems become unable to
support expanded operations and increased levels of business;
·
services provided by one or more of our vendors fail
to operate within the expected technical parameters;
·
information is lost or unable to be restored or
processed; or
·
information security is breached.
Our success depends, in part, on the continued and
uninterrupted performance of our IS, telephone and other systems, which are
vulnerable to damage from a variety of sources, including telecommunications or
network failures, computer viruses, natural disasters and physical or
electronic break-ins. We are especially vulnerable to losses of patient
information, which could result in violations of federal and state privacy
laws. Despite the precautionary measures we have taken to prevent breakdowns in
our IS and telephone systems, sustained or repeated system failures that
interrupt our ability to process test orders, deliver test results or perform
tests in a timely manner or that cause us to lose patient information could
adversely affect our business, results of operations and financial condition.
*
We may experience difficulty in
identifying, acquiring or in-licensing and integrating third parties products,
services, businesses and technologies into our current infrastructure and we
may not be able to successfully execute on and integrate such products,
services, businesses or technologies, which could disrupt our business and
adversely affect our results of operations and financial condition.
An important part of our business strategy is to
opportunistically pursue additional technologies, collaborations and
acquisitions that will enable us to accelerate the implementation of our
strategic plan and to increase the number of customers we serve and the
specialized diagnostic services we provide to those customers, including by way
of investments in other companies, licensing of technology, co-development
arrangements, collaborations, asset purchases and other similar transactions.
For example, we currently outsource select specialized services that we offer
and we may in the future seek to acquire the necessary capabilities to provide
these services internally. Although we are not currently a party to any other
agreements or commitments and we have no understandings with respect to any such
opportunities, we may seek to expand our services and technologies, on an
opportunistic basis and as resources allow, by acquiring or in-licensing
products, services, businesses or technologies that we believe are a strategic
fit with our business and growth plans. Future acquisitions or in-licensing of
products, services, businesses or technologies, however, may entail numerous
operational and financial risks including:
·
exposure to unknown liabilities;
·
disruption of our business and diversion of our
managements time and attention;
·
the availability of financing to pay for these
transactions;
·
incurrence of substantial debt or dilutive issuances
of securities to pay for these transactions;
·
higher than expected acquisition, in-licensing and
integration costs;
·
increased amortization expenses;
·
difficulties in and costs of combining the operations
and personnel of any acquired or in-licensed products, services, businesses or
technologies with our operations and personnel;
·
increased regulatory, compliance and litigation risk;
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·
impairment of relationships with key suppliers or
customers of any acquired or in-licensed products, services, businesses or
technologies due to changes in management and ownership; and
·
inability to retain key employees of any acquired or in-licensed
products, services, businesses or technologies.
Finally, we may devote resources to potential
acquisitions, in-licensing or collaboration opportunities that are never
completed, acquired by others, or fail to realize the anticipated benefits of
such efforts. Any of these matters could disrupt our business and adversely
affect our results of operations and financial condition.
We use biological and hazardous
materials that require considerable expertise and expense for handling, storage
or disposal and may result in claims against us.
We work with hazardous materials, including chemicals,
biological agents and compounds, blood and bone marrow samples and other human
tissue, that could be dangerous to human health and safety or the environment. Our
operations also produce hazardous and biohazardous waste products. Federal,
state and local laws and regulations govern the use, generation, manufacture,
storage, handling and disposal of these materials and wastes. Compliance with
applicable environmental laws and regulations may be expensive and current or
future environmental laws and regulations may impair business efforts. If we do
not comply with applicable regulations, we may be subject to fines and
penalties.
In addition, we cannot entirely eliminate the risk of
accidental injury or contamination from these materials or wastes. Our general
liability insurance and/or workers compensation insurance policy may not cover
damages and fines arising from biological or hazardous waste exposure or
contamination. Accordingly, in the event of contamination or injury, we could
be held liable for damages or penalized with fines in an amount exceeding our
resources and our operations could be suspended or otherwise adversely
affected.
*
We have a limited operating history,
have had net operating losses for several years, had an accumulated deficit of
$16.0 million as of September 30, 2008, and only recently became
profitable, and we are unable to predict with certainty whether we will remain
profitable.
We are an early stage company with a limited operating
history. We did not commence selling our specialized diagnostic services until
the third quarter of 2004 and only became profitable in the first quarter of
2007. Consequently, any predictions about our future performance may not be as
accurate as they could be if we had a longer history of successfully
commercializing specialized diagnostic services.
We have incurred losses in each full fiscal year since
our inception prior to 2007. As of September 30, 2008, we had an
accumulated deficit of $16.0 million. For the years ended December 31,
2005 and 2006, we had net losses of $9.2 million and $3.8 million,
respectively.
During the
three months ended September 30, 2008, we recorded positive changes in
prior period accounting estimates to reduce contractual allowances, which
increased our revenues by $2.5 million, of which $1.6 million pertains to the
six months ended June 30, 2008. During the nine months ended September 30,
2008, we recorded positive changes in prior year accounting estimates to reduce
contractual allowances, which increased our revenues by $2.2 million. In
comparison, our revenues increased by $612,000 and $828,000 for the three and
nine months ended September 30, 2007, respectively, as a result of changes
in such prior period accounting estimates. We may
incur operating losses in the future as we expand our infrastructure, increase
selling expenses and increase general and administrative expenses to comply
with public company obligations or if we are unable to continue to maintain or
increase our revenues or control expenses. Because of the numerous risks and
uncertainties associated with our growth prospects, sales and marketing and
other efforts and other factors, we are unable to predict with certainty
whether we will remain profitable or predict the extent of our profitability or
future losses.
We may be subject to claims that our
employees, consultants or independent contractors have wrongfully used or
disclosed alleged trade secrets of their other clients or former employers to
us.
In addition to our employees, we engage the services
of consultants to assist us with certain aspects of our business. Many of these
employees or consultants were previously employed at or may have previously
been or are currently providing consulting services to, other clinical
laboratories or diagnostics companies, including our competitors or potential
competitors. Although no claims against us are currently pending, we may be
subject to claims that we or these employees or consultants have inadvertently
or otherwise used or disclosed trade secrets or other proprietary information
of their former employers or their former or current customers. Litigation may
be necessary to defend against these claims. Even if we are successful in
defending against these claims, litigation could result in substantial costs
and be a distraction to management.
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Risks Relating to Regulatory and Compliance
Matters
*
We conduct business in a heavily
regulated industry and changes in regulations or violations of regulations may,
directly or indirectly, reduce our revenues, adversely affect our results of
operations and financial condition and harm our business.
The clinical laboratory testing industry is highly
regulated and there can be no assurance that the regulatory environment in
which we operate will not change significantly and adversely in the future. In
particular, there is risk of healthcare reform or other legislative activity
following the 2008 Presidential election, which may result in changes in the
regulatory or payor environment that may adversely affect our business. Areas
of the regulatory environment that may affect our ability to conduct business
include, without limitation:
·
federal and state laws applicable to billing and
claims payment and/or regulatory agencies enforcing those laws and regulations;
·
federal and state laboratory anti-mark-up laws;
·
federal and state anti-kickback laws;
·
federal and state false claims laws;
·
federal and state self-referral and financial
inducement laws, including the federal physician anti-self-referral law, or the
Stark Law;
·
coverage and reimbursement levels by Medicare,
Medicaid, other governmental payors and private insurers;
·
restrictions on reimbursements for our services;
·
federal and state laws governing laboratory testing,
including CLIA;
·
federal and state laws governing the development, use
and distribution of diagnostic medical tests known as home brews;
·
the Health Insurance Portability and Accountability
Act of 1996, or HIPAA;
·
federal and state regulation of privacy, security and
electronic transactions;
·
state laws regarding prohibitions on the corporate
practice of medicine;
·
state laws regarding prohibitions on fee-splitting;
·
federal, state and local laws governing the handling
and disposal of medical and hazardous waste;
·
Occupational Safety and Health Administration rules and
regulations; and
·
changes
to other federal, state and local laws, including tax laws.
These laws and regulations are extremely complex and
in many instances, there are no significant regulatory or judicial
interpretations of these laws and regulations. While we believe that we are
currently in material compliance with applicable laws and regulations, a
determination that we have violated these laws, or the public announcement that
we are being investigated for possible violations of these laws, would
adversely affect our business, prospects, results of operations and financial
condition. In addition, a significant change in any of these laws may require
us to change our business model in order to maintain compliance with these
laws, which could reduce our revenues or increase our costs and adversely
affect our business, prospects, results of operations and financial condition.
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*
If we fail to comply with healthcare
fraud and abuse laws that govern, among other things, sales and marketing,
billing and claims processing practices, we could face substantial penalties
and our business, results of operations and financial condition could be
adversely affected.
We are subject to various state and federal healthcare
fraud and abuse laws and regulations, including, but not limited to:
·
the federal Anti-Kickback Statute, which prohibits
persons from knowingly and willfully soliciting, receiving, offering or
providing remuneration, directly or indirectly, in cash or in kind, in exchange
for or to induce either the referral of an individual for, or the purchase,
order or recommendation of, any good or service for which payment may be made
under governmental payor programs such as Medicare and Medicaid;
·
the federal False Claims Act that prohibits
individuals or entities from knowingly presenting, or causing to be presented
to the federal government, claims for payment that are false or fraudulent;
·
HIPAA, which created federal criminal laws that
prohibit executing a scheme to defraud any healthcare benefit program or making
false statements relating to healthcare matters;
·
the Stark Law, which prohibits a physician from making
a referral to an entity for certain designated health services reimbursed by
Medicare or Medicaid if the physician (or a member of the physicians family)
has a financial relationship with the entity and which also prohibits the
submission of any claim for reimbursement for designated health services
furnished pursuant to a prohibited referral; and
·
state law equivalents of each of the above federal
laws, such as anti-kickback and false claims laws which may apply to items or
services reimbursed by any third party payor, including commercial insurers.
Sanctions under these federal and state laws may
include civil monetary penalties, exclusion of a clinical laboratorys
participation in or reimbursement from governmental payor programs, criminal
fines and imprisonment. Although we endeavor to comply in all material respects
with these rules and regulations, our sales and marketing, billing and
claims processing practices may not, in all cases, meet all of the criteria for
safe harbor protection or exemptions from liability under these laws. For
example, in most cases, patients who utilize service providers that are not
participants in a preferred provider network are subject to increased financial
obligations in the form of greater coinsurance or copayment requirements. For
approximately half of our revenues for the three and nine months ended September 30,
2008 and 2007, we were generally subject to reimbursement as a non-contracting
provider. In order to maintain our competitiveness with other clinical
laboratories, except as required by applicable laws, we frequently accept third
party insurance payment as payment in full and, in turn, waive all or a part of
a patients coinsurance obligations such that the patients financial burden is
no greater than if he or she would have selected an in-network provider. A
successful challenge to our practice of accepting third party insurance
payments as payment in full under the laws discussed above could adversely
affect our business, results of operations and financial condition.
*
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.
Reimbursement from Medicare and Medicaid accounted for
approximately 37% and 39% of our revenues for the three and nine months ended September 30,
2008, respectively. 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.
Our business could be harmed by
future interpretations of clinical laboratory mark-up prohibitions.
Our laboratory currently uses the services of outside
reference laboratories to provide certain complementary laboratory services to
those services provided directly by our laboratory. Although Medicare policies
do not prohibit certain independent-laboratory-to-independent-laboratory
referrals and subsequent mark-up for services, California and other states have
rules and regulations that prohibit or limit the mark-up of these
laboratory-to-laboratory services. A challenge to our charge-setting procedures
under these rules
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and regulations could have a material adverse effect
on our business, results of operations and financial condition.
*
Our business could be harmed from the
loss or suspension of a license or imposition of a fine or penalties under, or
future changes in, the law or regulations of the CLIA or those of other state
or local agencies.
We are subject to CLIA, which is administered by CMS
and extends federal oversight to virtually all clinical laboratories by
requiring that they be certified by the federal government or by a
federally-approved accreditation agency. CLIA is 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. The sanction for failure to comply with CLIA
requirements may be suspension, revocation or limitation of a laboratorys CLIA
certificate, which is necessary to conduct business, as well as significant
fines and/or criminal penalties. If a laboratory is certified as high
complexity under CLIA, the laboratory may obtain ASRs, which are used to
develop in-house diagnostic tests known as home brews. We received our CLIA
accreditation certificate as a high complexity laboratory in mid-2004. To
renew this certificate, we are subject to survey and inspection every two years
as well as the possibility of unannounced surveys at any time. Our CLIA
accreditation was last renewed in March 2008.
We are also subject to regulation of laboratory
operations under state clinical laboratory laws. 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. For example, California requires that we maintain a license to
conduct testing in California and California law establishes standards for our
day-to-day laboratory operations, including the training and skill required of
laboratory personnel and quality control. Certain other states, including
Florida, Maryland, New York, Pennsylvania and Rhode Island, each require that
we hold licenses to test specimens from patients residing in those states and
additional states may require similar licenses in the future. 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.
Certain of our specialized diagnostic
tests take advantage of the home-brew exception from the FDA review and any
changes to the FDAs policies with respect to this exception could adversely
affect our business and results of operations.
Clinical laboratory diagnostic tests that are
developed and validated by a laboratory for use in examinations the laboratory
performs itself are called home brew tests. The FDA maintains that it has
authority to regulate the development and use of home brews as diagnostic
medical devices under the Federal Food, Drug and Cosmetic Act but to date has
decided not to exercise its authority with respect to most home brew tests as
a matter of enforcement discretion. A substantial portion of our specialized diagnostic
tests are home brew tests for which we have not obtained the FDA premarket
clearance or approval. In addition, manufacturers and suppliers of ASRs, which
we obtain for use in our home brews, are required to register with the FDA,
to conform manufacturing operations to the FDAs Quality System Regulation and
to comply with certain reporting and other recordkeeping requirements. The FDA
regularly considers the application of additional regulatory controls over the
sale of ASRs and the development and use of home brews by laboratories such
as ours. We cannot predict the extent of the FDAs future regulation and
policies with respect to home brew tests and there can be no assurance that
the FDA will not require us to obtain premarket clearance or approval for
certain of the diagnostic tests that we perform. Any such premarket clearance
requirements could restrict or delay our ability to provide our specialized
diagnostic services and may adversely affect our business and results of
operations.
Failure to comply with the HIPAA
security and privacy regulations may increase our operational costs.
The HIPAA privacy and security regulations establish
comprehensive federal standards with respect to the uses and disclosures of
personal health information, or PHI, by health plans and healthcare 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:
·
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, activities to obtain payments
for services and healthcare operations activities;
·
a patients rights to access, amend and receive an
accounting of certain disclosures of PHI;
·
the content of notices of privacy practices for PHI;
and
·
administrative, technical and physical safeguards
required of entities that use or receive PHI electronically.
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We have implemented policies and procedures related to
compliance with the HIPAA privacy and security regulations, as required by law.
The privacy regulations establish a uniform federal floor and do not
supersede state laws that are more stringent. Therefore, we are required to
comply with both federal privacy regulations and varying state privacy laws.
The federal privacy regulations restrict our ability to use or disclose patient
identifiable laboratory data, without patient authorization, for purposes other
than payment, treatment or healthcare operations (as defined by HIPAA), except
for disclosures for various public policy purposes and other permitted purposes
outlined in the privacy regulations. 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.
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.
Our business could be materially harmed by
future interpretation or implementation of state laws regarding prohibitions on
the corporate practice of medicine.
The manner in which licensed physicians can be
organized to perform and bill for medical services is governed by state laws
and regulations. Under the laws of some states, including California, business
corporations generally are not permitted to employ physicians or to own corporations
that employ physicians or to otherwise exercise control over the medical
judgments or decisions of physicians. All of the hempaths that we utilize in
connection with providing our specialized diagnostic services are employed by
Cartesian. Cartesian is a California professional corporation we formed for the
purpose of providing professional medical services in conjunction with the
diagnostic services that we provide. On December 31, 2005, we entered into
the PSA with Cartesian, pursuant to which these hempaths provide professional
services to us. Prior to that time, we employed these hempaths, which could
result in the potential assertion by regulatory authorities that we were
engaged in the corporate practice of medicine.
We believe that we currently are in compliance in all
material respects with the laws governing the corporate practice of medicine in
California. If regulatory authorities or other parties were to assert that we
were engaged in the corporate practice of medicine currently or prior to December 31,
2005, or if California laws governing the corporate practice of medicine were
to change, we could be required to restructure our contractual and other
arrangements and we and/or our hempaths could be subject to civil or criminal
penalties. In addition, the provision of our specialized diagnostic services,
which rely heavily on the professional services provided by our hempaths, could
be interrupted or suspended, which would adversely affect our business, results
of operations and financial condition.
Risks Relating to Our Finances and
Capital Requirements
*
Negative conditions in the global
credit markets and financial services and other industries may impair the
liquidity of a portion of our investment portfolio or may otherwise adversely
affect our business.
All of our investment securities are
classified as available-for-sale and therefore reported on the balance sheet at
market value. Our investment securities consist of corporate debt investment
securities,
government-sponsored
enterprise investment securities and ARS.
As of September 30,
2008, we held an ARS with a cost basis of $5.0 million consisting of
debt issued by a municipality, which is underwritten
by an insurance agency and rated A2 by Moodys Investors Service and AA by
Standard & Poors. It is classified as a long-term investment security
due to the current illiquidity in the ARS markets. Liquidity is obtained through a Dutch auction at
pre-determined intervals, or every 35 days. The recent conditions in the global credit markets have prevented
some investors from liquidating their holdings of ARS because the amount of
investment securities submitted for sale has exceeded the amount of purchase
orders for such investment securities. If there is insufficient demand for the
investment securities at the time of an auction, the auction may not be
completed and the interest rates may be reset to predetermined higher rates.
This auction began failing in February 2008 when
sell orders exceeded buy orders at the auction dates.
When auctions for this ARS failed,
the investment was not readily convertible to cash. The funds associated with this failed auction will not
be accessible without loss of principal until the issuer redeems the ARS, a
successful auction occurs, a buyer is found outside of the auction process, or
the ARS matures in 2038. As such, we may be required to hold it to maturity. Likewise, if the credit
ratings of the security issuers deteriorate and any decline in market value is
determined to be other-than-temporary, we would be required to adjust the
carrying value of the investment through an other-than-temporary impairment
charge to the condensed consolidated statement of operations.
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The valuation of this
security is based on an
internally
developed valuation analysis of interest rate spreads, the credit quality,
underlying assets of the issuer and underwriter, likelihood of a successful
auction or redemption in the near term and the ability to obtain liquidity in
the near-term. As a result of the estimated fair value, we have
recorded a temporary impairment in the valuation of this security of $1.2
million during the three months ended September 30, 2008.The unrealized
loss in the current period, net of deferred tax, is included in accumulated
other comprehensive (loss) income. Due to the uncertainty related to the timing
of liquidity in the ARS market, we have classified this ARS investment security
as a long-term asset on our balance sheet with a fair value of $3.8 million as
of September 30, 2008. Because
we were required to value this security using only subjective inputs, our
valuations determined at a later date or by a third party, may be different
from the fair values we have determined as of September 30, 2008.
We do not currently need to access these
funds for operational purposes for the foreseeable future. Based on our ability
to access our cash and cash equivalents and short-term securities and our
expected operating cash flows, we do not anticipate that the temporary
illiquidity of this investment will affect our ability to execute our current
business plan.
In addition to
the continuing deterioration in the global credit markets, the financial
services industry and the U.S. economy as a whole have been experiencing a
period of substantial turmoil and uncertainty characterized by unprecedented
intervention by the United States federal government and the failure, bankruptcy,
or sale of various financial and other institutions. The impact of these events
on our business and the severity of the current economic crisis is uncertain.
It is possible that the current crisis in the global credit markets, the
financial services industry and the U.S. economy may adversely affect our
business, vendors and prospects as well as our liquidity and financial
condition. More specifically, our insurance carriers and insurance policies
covering all aspects of our business may become financially unstable or may not
be sufficient to cover any or all of our losses and may not continue to be
available to us on acceptable terms, or at all.
*
We may need to raise additional
capital in the future, which may not be available on favorable terms or at all,
which may cause dilution to our existing stockholders or require us to be
subject to certain restrictions.
We may need to raise additional capital in the future.
Our operations have consumed substantial amounts of cash since inception. To
date, our sources of cash have been primarily limited to our initial public
offering, private placements of preferred stock and debt, and more recently
cash flow from operations. We expect to continue to spend substantial amounts
of capital to grow our business. To fund such growth, we may raise additional
funds through public or private equity offerings or debt financings. We do not
know if we will be able to continue to generate cash flow from operations or if
we will be able to obtain additional financing on favorable terms, if at all
(particularly in light of the difficult current financing environment and weak
economic conditions). If we cannot raise funds on acceptable terms, if and when
needed, we may not be able to maintain or grow our business at the rate that we
currently anticipate and respond to competitive pressures or unanticipated
capital requirements, or we may be required to reduce operating expenses, which
could significantly harm our business, financial condition and results of
operations. In addition, to the extent that we raise additional capital by
issuing equity securities, our existing stockholders ownership in our company
will be diluted.
*
We expect to continue to incur
significant increased 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 that we did not incur as a private company, which
we currently expect to be at least $2.2 million per year. In addition, the
Sarbanes-Oxley Act of 2002, or the Sarbanes-Oxley Act, as well as rules subsequently
implemented by the SEC and The NASDAQ Stock Market, or NASDAQ, in the past
several years have imposed various requirements on public companies, including
establishment and maintenance of effective disclosure and financial controls,
changes in corporate governance practices and substantial changes in executive
compensation disclosure. The SEC and other regulators have continued to adopt
new rules and regulations and make additional changes to existing
regulations that require our compliance. Our management and other personnel
continue to devote a substantial amount of time to these compliance programs
and other programs related to being a public company, such as investor
relations and monitoring of public company reporting obligations. These rules and
regulations will continue to increase our legal and financial compliance costs
and will make some activities more time-consuming and costly. As a public
company, it is more difficult and more expensive for us to renew director and
officer liability insurance and we may be required to accept reduced policy
limits and coverage or incur substantially higher costs to obtain the same or
similar coverage.
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The Sarbanes-Oxley Act requires, among other
things, that we maintain effective internal control over financial reporting.
In particular, commencing this year, we must perform system and process
evaluation and testing of our internal control over financial reporting to
allow management and our independent registered public accounting firm to
report on the effectiveness of our internal control over financial reporting,
as required by Section 404 of the Sarbanes-Oxley Act, or Section 404.
Our testing, or the subsequent testing by our independent registered public
accounting firm, may reveal significant deficiencies or material weaknesses in
our internal control over financial reporting. We are incurring significant
expense and devote substantial management effort toward ensuring compliance
with Section 404. If we are not able to comply with the requirements of Section 404
in a timely manner, or if we or our independent registered public accounting
firm identify deficiencies in our internal control over financial reporting
that are deemed to be significant deficiencies or material weaknesses, the
market price of our common stock could decline and we could be subject to sanctions
or investigations by NASDAQ, the SEC or other regulatory authorities, which
would entail expenditure of additional financial and management resources.
*
Future changes in
financial accounting standards or practices, or existing taxation rules or
practices, may cause adverse unexpected revenue or expense fluctuations and
affect our reported results of operations.
A change in accounting standards or practices, or a change in existing
taxation rules or practices, can have a significant effect on our reported
results and may even affect our reporting of transactions completed before the
change is effective. New accounting pronouncements, taxation rules and
varying interpretations of accounting pronouncements and taxation practice have
occurred and may occur in the future. For example, in September 2008 the
State of California passed a law, effective January 1, 2008, to suspend
California net operating losses for two-years pertaining to certain
corporations doing business within California. This net operating loss
suspension had no impact on our income tax benefit, as reported. However, this
does require us to pay income tax associated with our taxable income for the
tax years 2008 and 2009, which our California deferred net operating loss
otherwise would have eliminated. Changes to existing rules or the
questioning of current practices may adversely affect our reported financial
results or the way we conduct our business. Our effective tax rate can also be
impacted by changes in estimates of prior years items, the outcome of audits
by federal, state and foreign jurisdictions and changes in overall levels of
income before income tax.
Risks
Relating to the Securities Markets and Investment in Our Common Stock
There
may not be a viable public market for our common stock.
We cannot predict
the extent to which investor interest in our company will sustain an active
trading market for our stock on The NASDAQ Global Market or any other stock
market or how liquid any such market might remain. If an active public market
is not sustained, it may be difficult for our stockholders to sell their shares
of common stock at a price that is attractive to them, or at all.
*
Fluctuations in our operating results
and market volatility may affect our stock price.
The market price
of our common stock is volatile and may fluctuate significantly in response to
a number of factors, many of which we cannot control, including:
·
changes in coverage and/or reimbursement guidelines
and amounts;
·
variations in deductible and coinsurance amounts;
·
changes in regulations affecting the healthcare or
diagnostic services industry;
·
failure to comply with applicable regulations;
·
changes in the payor mix or the mix or cost of our
specialized diagnostic services;
·
the timing and volume of patient orders and the timing
and cost of our sales and marketing campaigns;
·
changes in compensation expense and other expenses
that result in changes in our operating results;
·
increased investigative or enforcement initiatives by
governmental and other third party payors;
·
additions or departures of key personnel;
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·
variations in our quarterly operating results,
including the number of business days in each quarter;
·
seasonality and volume declines due to adverse weather
conditions and holidays;
·
changes in our accounting estimates;
·
changes in our DSO level;
·
changes in securities analysts estimates of our
financial performance;
·
announcements of acquisitions or other strategic
transactions by us or our competitors;
·
announcements of new products or services offered by
us or our competitors;
·
fluctuations in stock market prices and trading
volumes of similar companies or in the broader markets generally;
·
changes in economic conditions, in the global credit
markets and financial services and other industries and the United States
Federal government response to developments in the economy and such markets and
industries;
·
sales of large blocks of our common stock, including
sales by our executive officers, directors and significant stockholders;
·
distributions of large blocks of our common stock by
significant stockholders to their limited partners;
·
uncertainty with respect to the reasons for changes in
the trading volume or the market price of our common stock;
·
any litigation in which we become involved;
·
fluctuations in security market indices of which we
may be included now or in the future;
·
discussion of us or our stock price by the general
media, online investor communities or financial industry or medical press;
·
impairment of any of our assets, including our
investment securities;
·
changes in GAAP; and
·
changes in federal or state tax laws.
Due to these
factors, stockholders may not be able to sell their shares of our common stock
at favorable prices or at all.
Anti-takeover
provisions in our charter documents and under Delaware law could make an acquisition
of us, which may be beneficial to our stockholders, more difficult and may
prevent attempts by our stockholders to replace or remove our current
management.
Provisions in our
amended and restated certificate of incorporation and amended and restated
bylaws, both of which became effective upon the completion of our initial
public offering, may delay or prevent an acquisition of us or a change in our
management. These provisions include a classified board of directors, a
prohibition on actions by written consent of our stockholders and the ability
of our board of directors to issue preferred stock without stockholder
approval. In addition, because we are incorporated in Delaware, we are governed
by the provisions of Section 203 of the Delaware General Corporation Law,
which, subject to certain exceptions, prohibits stockholders owning in excess
of 15% of our outstanding voting stock from merging or combining with us.
Although we believe these provisions collectively provide for an opportunity to
receive higher bids by requiring potential acquirers to negotiate with our
board of directors, they would apply even if the offer may be considered
beneficial by some stockholders. In addition, these provisions may frustrate or
prevent any attempts by our stockholders to replace or remove our current
management by making it more difficult for stockholders to replace members of
our board of directors, which is responsible for appointing the members of our
management.
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*
If our executive officers, directors
and largest stockholders choose to act together, they may be able to control
our operations and act in a manner that advances their interests and not
necessarily those of other stockholders.
As of October 27,
2008, our executive officers, directors and holders of 5% or more, based on
available information, of our outstanding common stock beneficially owned
approximately 32% of our common stock. As a result, these stockholders, acting
together, are able to exert significant control over all matters requiring
approval by our stockholders, including the election of directors and the
approval of mergers or other business combination transactions. The interests
of this group of stockholders may not always coincide with our interests or the
interests of other stockholders and they may act in a manner that advances
their interests and not necessarily those of other stockholders.
*
Future sales of our common stock may
depress our stock price.
Sales of a
substantial number of shares of our common stock in the public market could
occur at any time. These sales, or the perception in the market that the
holders of a large number of shares intend to sell shares, could reduce the
market price of our common stock. As a result of the provisions of Rule 144
under the Securities Act, or Rule 144, and Rule 701 under the
Securities Act of 1933, as amended, or the Securities Act, or Rule 701, substantially
all of the outstanding shares of our common stock are available for sale in the
public market, subject in the case of shares of our common stock held by
affiliates to volume limitations, manner of sale requirements and certain other
requirements. In addition, approximately 1.2 million shares are eligible for
sale upon the exercise of vested options outstanding as of September 30,
2008.
Moreover, certain
holders of shares of our common stock have rights, subject to some conditions,
to require us to file registration statements covering their shares or to
include their shares in registration statements that we may file for ourselves
or other stockholders. These rights will terminate upon the earlier of four
years following the closing of our initial public offering or, as to a
particular holder of registration rights, when all securities held by that
stockholder subject to registration rights may be sold pursuant to Rule 144
within a single 90-day period. We also registered all shares of common stock
that we may issue under our equity compensation plans. These shares can be
freely sold in the public market upon issuance, subject to our window period
and insider trading policies, if applicable.
We
have never paid dividends on our capital stock and because we do not anticipate
paying any cash dividends in the foreseeable future, capital appreciation, if
any, of our common stock may be the sole source of gain on an investment in our
stock.
We have paid no
cash dividends on any of our classes of capital stock to date and we currently
intend to retain our future earnings, if any, to fund the development and
growth of our business. We do not anticipate paying any cash dividends on our
common stock in the foreseeable future. Furthermore, to the extent we incur
additional indebtedness, the loan documents governing such indebtedness may
restrict our ability to pay dividends. As a result, we anticipate that capital
appreciation, if any, of our common stock may be our stockholders sole source
of gain for the foreseeable future.
We
may become involved in securities class action litigation that could divert
managements attention and harm our business.
The stock markets
have from time to time experienced significant price and volume fluctuations
that have affected the market prices for the common stock of diagnostic
companies. These broad market fluctuations may cause the market price of our
common stock to decline. In the past, securities class action litigation has
often been brought against a company following a decline in the market price of
its securities. This risk is especially relevant for us because clinical
laboratory service companies have experienced significant stock price
volatility in recent years. We may become involved in this type of litigation
in the future. Litigation often is expensive and diverts managements attention
and resources, which could adversely affect our business.
If
we are not the subject of securities analyst reports or if any securities
analyst downgrades our common stock or our sector, the price of our common
stock could be negatively affected.
Securities
analysts may publish reports about us or our industry containing information
about us that may affect the trading price of our common stock. There are many
publicly traded companies active in the healthcare industry, which may mean it
will be less likely that we receive analysts coverage, which in turn could
affect the price of our common stock. In addition, if a securities or industry
analyst downgrades the outlook for our stock or one of our competitors stocks
or chooses to terminate coverage of our stock, the trading price of our common
stock may also be negatively affected.
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Item 2. Unregistered Sales of
Equity Securities and Use of Proceeds.
Use
of Proceeds
Our
initial public offering of common stock was effected through a Registration
Statement on Form S-1 (File No. 333-144997) that was declared
effective by the SEC on October 29, 2007, which registered an aggregate of
5,750,000 shares of our common stock, including 750,000 shares that the
underwriters had the option to purchase to cover over-allotments. On November 2,
2007, 4,735,714 shares of common stock were sold on our behalf, including
450,000 shares sold by us upon exercise in full of the underwriters
over-allotment options and 1,014,286 shares of common stock were sold on behalf
of the selling stockholders, including 300,000 shares sold by the selling
stockholders upon exercise in full of the underwriters over-allotment option,
at an initial public offering price of $17.00 per share, for an aggregate gross
offering price of $80.5 million to us resulting in net offering proceeds
to us of approximately $72.5 million (after deducting underwriting
discounts, commissions and offering costs) and gross offering proceeds of
$17.2 million to the selling stockholders.
As
of September 30, 2008, we had invested $8.1 million of net proceeds
from our initial public offering in corporate debt investment securities,
government-sponsored enterprise investment securities and ARS with the balance
of the net proceeds held in money market funds. Through September 30,
2008, we have used $55.4 million of the net proceeds to fund the
incremental working capital requirements to grow our business,
$7.2 million to purchase capital equipment and $1.8 million to repay
our outstanding long-term debt. The proceeds used to date were used to make
direct payments to third parties who were not our officers or directors (or
their associates), persons owning ten percent or more of any class of our
equity investment securities, or any other affiliate (except for proceeds used
for normal operating expense relating to officers and directors, such as
approved compensation and business expense reimbursements). We intend to use
the remaining proceeds to increase our personnel, expand our current laboratory
capacity within our existing facility, establish additional administrative
offices and a second laboratory facility, expand our backup systems,
opportunistically pursue new collaborations or acquisitions and fund working
capital and for general corporate purposes. We cannot specify with certainty
all of the particular uses for the net proceeds from our initial public
offering. Accordingly, our management has broad discretion in the application
of the net proceeds.
Item 5. Other Information.
On November 5, 2008, our Board of Directors authorized the amendment and
restatement of our Amended and Restated Bylaws, to, among other things, amend
certain provisions providing for advance notice of stockholder proposals and
nominations for director (other than proposals properly made in accordance with
Rule 14a-8 under the Securities Exchange Act of 1934, as amended, and proposals
brought (or nominations made) by or at the direction of our Board of Directors)
in order to (i) clarify that stockholder proposals and nominations for director
must comply with the advance notice provisions in the Amended and Restated
Bylaws; and (ii) provide us and our stockholders with expanded and updated
information that may be material to stockholders evaluation of such proposals
and nominees for director, including, among other things, expanded disclosure
regarding director nominees and proponents economic, voting and other
interests and relationships, including derivative securities, voting
arrangements, short positions or other interests, related to us and our common
stock.
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Item 6.
Exhibits.
EXHIBIT INDEX
Exhibit
Number
|
|
Description
|
3.1(1)
|
|
Amended and Restated
Certificate of Incorporation of the Registrant.
|
3.2
|
|
Amended and Restated
Bylaws of the Registrant.
|
4.1(2)
|
|
Form of the
Registrants Common Stock Certificate.
|
4.2(2)
|
|
Amended and Restated
Warrant to Purchase Stock issued by the Registrant on April 19, 2002 to
General Electric Corporation.
|
4.3(2)
|
|
Amended and Restated
Warrant to Purchase Stock issued by the Registrant on July 29, 2002 to
General Electric Corporation.
|
4.4(2)
|
|
Amended and Restated
Warrant to Purchase Stock issued by the Registrant on November 26, 2002
to Comerica Bank.
|
4.5(2)
|
|
Amended and Restated
Warrant to Purchase Stock issued by the Registrant on March 8, 2004 to
Comerica Bank.
|
4.6(2)
|
|
Warrant to Purchase Stock
issued by the Registrant on May 9, 2005 to Comerica Bank.
|
4.7(2)
|
|
Warrant to Purchase Stock
issued by the Registrant on May 30, 2006 to Comerica Bank.
|
4.8(2)
|
|
Amended and Restated
Investors Rights Agreement, dated May 9, 2005, by and among the
Registrant and certain of its stockholders.
|
4.9(2)
|
|
First Amendment to Amended
and Restated Investors Rights Agreement, dated August 3, 2005, by and
among the Registrant and certain of its stockholders.
|
10.1
|
|
Termination of Lease,
dated August 8, 2008, by and between Blackmore Signal Hill, L.P. and the
Registrant.
|
10.2(3)
|
|
First Amendment To Standard Multi-Tenant
Office Lease, dated September 15, 2008,
by and between Allen Joseph Blackmore,
Trustee and the Registrant.
|
31.1*
|
|
Certification of the
Principal Executive Officer Pursuant to Rule 13a-14 and
Rule 15d-14of the Securities Exchange Act of 1934, as amended.
|
31.2*
|
|
Certification of the Chief
Financial Officer Pursuant to Rule 13a-14 and Rule 15d-14of
the Securities Exchange Act of 1934, as amended.
|
32.1*
|
|
Certification of Chief
Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
|
*
These certifications are being furnished solely to
accompany this quarterly report pursuant to 18 U.S.C. Section 1350, and
are not being filed for purposes of Section 18 of the Securities Exchange
Act of 1934 and are not to be incorporated by reference into any filing of
Genoptix, Inc., whether made before or after the date hereof, regardless
of any general incorporation language in such filing.
(1)
Incorporated herein by reference to the corresponding
exhibit to the Registrants Current Report on Form 8-K (File No. 001-33753)
as filed with the Securities and Exchange Commission on November 2, 2007.
(2)
Incorporated herein by reference to the Registrants
Registration Statement on Form S-1 (File No. 333-144997), as amended,
filed with the Securities and Exchange Commission.
(3)
Incorporated herein by reference to the Registrants
Current Report on Form 8-K (File No. 001-33753), as filed with the
Securities and Exchange Commission on September 17, 2008.
47
Table
of Contents
SIGNATURE
Pursuant to the requirements
of the Securities Exchange Act of 1934, the registrant has duly caused this
report to be signed on its behalf by the undersigned thereunto duly authorized.
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GENOPTIX, INC.
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|
|
|
|
|
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Date: November 6,
2008
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By:
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/s/ Douglas A. Schuling
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|
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Douglas A. Schuling
|
|
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Senior Vice
President and Chief FinancialOfficer
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|
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(Duly Authorized Officer
and Principal
Financial Officer)
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48
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