Nanogen, Inc (NGEN) - Description of business
Our company is based on the vision of providing a higher quality of healthcare through advanced diagnostic products. Our business strategy is to assemble the companies, products and knowledge base to become a leading supplier of the technologies and products that will help drive a new era of personalized medicine. We were early to recognize that the adoption of personalized medicine is dependent on the advancement of diagnostic technologies. The commercialization of our products and technologies will help bridge the gap between early-stage scientific research and actual clinical practice. We are developing several product lines that are directly targeting specific markets within the advanced diagnostics field that have significant potential for revenue growth. We see recent successes and a growing capability in the clinical laboratories ability to perform accurate advanced diagnostic testing as a strong validation of our strategy. In addition, the U.S. Food and Drug Administration (the FDA) has recently released guidance encouraging the generation of more pharmacogenomics data and molecular diagnostic testing during drug development and clinical trials, and before the use of medications. We believe these applications of advanced diagnostics will help build demand for our products and technologies.
In the last twelve months we have introduced several new products and believe they present significant opportunities for Nanogen to increase its revenues in 2007 and beyond. These new products represent important milestones for our company and the implementation of a sustainable, multi-product business model that over time will demonstrate improved financial performance. We released several Analyte Specific Reagents (ASRs)
including multiplexed reagents for the detection of the 23 most common genetic mutations related to Cystic Fibrosis and a series of real-time molecular reagents for infectious diseases.
Our 2006 annual revenues of $26.9 million more than doubled as compared to 2005. In 2006, we used $38.4 million of cash in operating activities and our multi-product commercialization strategy continues to require a significant investment. We believe we will continue to use cash and have net losses until revenues from our product offerings climb substantially. To continue to fund our commercialization strategy, in 2006 we raised $15.0 million from issuing equity securities to a corporate investor and $5.5 million from our equity line and also financed certain future royalty streams for an additional $20.0 million of cash. We believe that we will have the ability to sell a sufficient amount of securities to investors to continue our strategy of expanding our product pipelines by acquiring companies or assets and supporting our on-going internal product development.
As a part of our on-going long-term strategy, we actively and selectively seek to acquire companies with complementary products and strong intellectual property positions. We also specifically target companies with existing product lines that complement and add depth to our product portfolio that are or can be turned into cash flow positive entities when integrated into our company. In addition, we are developing an internal infrastructure that allows us to rapidly integrate acquired businesses or product lines into our existing sales, distribution and administrative functions. We have recently acquired or invested in the following companies:
On February 6, 2006, we acquired the rapid cardiac immunoassay point-of-care test business of Spectral Diagnostics Inc. (Spectral). This acquisition expanded our menu of products available for point-of-care customers. The acquired products include rapid tests for levels of CKMB, Myoglobin and Troponin, all of which are frequently used in cardiac care. In addition, we acquired an ability to manufacture these and other point-of-care products. The total purchase price of approximately $7.7 million was comprised of $4.8 million in cash and 975,193 shares of our common stock. The results of these acquired business operations were consolidated within our financial statements beginning February 6, 2006.
On May 1, 2006 we completed the acquisition of the diagnostics division of Amplimedical S.P.A. (Amplimedical), which is a manufacturer and distributor of molecular diagnostic products. Based in Italy, Amplimedical has been active in the European and other markets since the early 1990s with its molecular diagnostic reagents. Nanogen and Amplimedical have shared a business relationship for approximately five years, during which time Amplimedical has been a distributor of Nanogens NanoChip ® Molecular Biology Workstation and NanoChip ® 400 instrument systems in Italy. We believe this acquisition will allow our molecular diagnostics business to further expand in Europe by providing additional resources and scale. Amplimedicals portfolio of real-time molecular diagnostic test kits are all CE marked for in vitro diagnostics. Amplimedicals diagnostic test kits also include multiplexed reagent kits, sold in Europe, such as the CE/IVD-marked set of reagents used to detect mutations in the GJB2 gene for the diagnosis of hereditary deafness and a research-use-only set of reagents to test for genetic causes of beta thalassemia, a type of inherited blood disorder that can cause anemia. The purchase price was approximately $9.9 million that was comprised of a $2.1 million payable secured by a letter of credit, a $6.9 million promissory note convertible into our common stock, and $0.9 million in transaction costs. On June 30, 2006 we paid the promissory note in full by issuing Amplimedical 2,886,935 shares of our common stock at a $2.63 per share conversion price and incurred no interest charges.
In a series of investments from July 2005 through June 2006, we invested approximately $3.0 million to purchase 29.7% of the outstanding stock of Jurilab LTD (Jurilab). In addition, we have the option to purchase the entire company at a not-to-exceed price through December 31, 2007. By investing in Jurilab, a development stage research and development company, we gained access to technologies related to certain gene markers. We believe that this investment strategy is an effective use of our cash because it provides us approximately two years to evaluate Jurilabs technology for potential commercialization and integration into our product lines before we commit to purchasing the entity. We are incorporated under the laws of the state of Delaware and our stock is listed on the Nasdaq Global Market under the symbol NGEN. Our corporate offices are located at 10398 Pacific Center Court, San Diego, California 92121. Our main telephone number is 858-410-4600.
We make available through our internet website our code of business conduct and ethics, annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to these reports as soon as reasonably practicable after such material is electronically filed with or furnished to the Securities and Exchange Commission. Our internet address is www.nanogen.com. The information contained in, or that can be accessed through, our website is not part of this Annual Report.
Technology and Customers
Our diagnostic technologies focus on the identification of circulating proteins associated with specific diseases or on the nucleic acid sequences and gene variations associated with both genetic conditions and infectious diseases. We believe that our research will contribute to a new healthcare paradigm where disease is diagnosed and understood at the personal level. We believe that this will lead to shifting the focus of medicine to be increasingly proactive as well as being increasingly specific to the individual patient. Our tests will provide physicians with the information they require to tailor specific therapies to the individual patient. In support of this objective, we have developed a variety of diagnostic products for both the relatively simple and complex testing required to render disease specific molecular information accessible to researchers and clinicians.
Below illustrates how our platform technologies address our customers requirements for advanced diagnostic products:
Potential customers addressed by our technologies: Advanced Research
( Universities, research
facilities, etc .) Clinical Laboratory ( CLIA
certified central laboratories
and clinical research
laboratories ) Point-of-care ( Emergency
room or urgent care
settings ) Molecular testing platforms ( Instrumentation )
( Reagents, ASRs , Custom Assays )
( Test Kits and Instruments )
Advanced genetic markers
As illustrated above we have four categories of advanced diagnostic technologies: 1) molecular testing platforms 2) molecular reagents 3) point-of-care tests and 4) advanced genetic markers.
1) Molecular Testing Platforms (Instrumentation)
For our customers that need to develop or perform more complex testing than is available with real-time instruments, we have developed the second generation NanoChip ® 400 system. This system is based on our proprietary lab on a chip detection technology that allows testing for multiple gene markers or mutations on one test site. Using our open system architecture, researchers and clinical laboratories can readily develop assays to test multiple genetic mutations for multiple patient samples and to perform them on an automated system. Our first generation system, the Molecular Biology Workstation has been discontinued and while we continue to support existing customers, the system is no longer being marketed or sold.
2) Molecular Reagents (ROU Reagents, ASRs, Custom Assays)
Molecular reagents encompass real-time PCR products and molecular reagents. The real-time products are platform independent and include custom designed products for the research market and ASRs which are sold to laboratories certified under the Clinical Laboratory Improvement Amendments of 1998 (CLIA) to develop, optimize and validate tests for clinical uses and CEIVDs, products that are registered for sale within the European Union. These products amplify disease specific nucleic acid sequences for analysis or identification in a simple test with rapid turn around. The US customers for this product line are primarily advanced research and clinical laboratories that test for single markers or mutations in genes. We also offer reagents for more complex mulitplex testing. These reagents provide laboratories the capability to test a patient sample against multiple targets. We currently offer multiplex reagents for genetic testing including respiratory viruses (RVA), blood clotting (Factor V/II), cystic fibrosis, and warfarin metabolism. The US customers for multiplex reagents are primarily research and clinical laboratories that test for infectious disease and genetic disease conditions. In Europe, the customers are generally government entities contracting for diagnostic tests through tenders.
3) Point-of-Care (Test Kits)
Our point-of-care tests consist of highly specific tests for identifying proteins that play a role in specific diseases. By identifying the level of specific proteins present in a patient sample, doctors can more accurately diagnose and monitor the progress of specific diseases. On February 6, 2006, with our acquisition of Spectrals point-of-care assets, we acquired several revenue generating rapid cardiac immunoassay tests that broadened our menu of products available for point-of-care customers. The acquired products include rapid tests for levels of CKMB, Myoglobin and Troponin I, all of which are frequently used in cardiac care. In addition, we acquired the ability to manufacture these and other point-of-care products. Also in 2006, we received a 510(k) clearance for a rapid diagnostic test for CHF using plasma samples. This product has not yet been introduced to the market. Our research and development efforts are focused on developing a test for congestive heart failure using whole blood samples. The customers for our point of care tests are generally emergency rooms and critical care units. Over time, we believe our technologies will help to move many of these tests from the clinical reference lab to the point-of-care settings such as the emergency room.
4) Advanced Genetic Markers
With our investment in Jurilab we gained access to a large database of advanced genetic markers created by studying the genetic patterns of a founder population in East Finland. This database provides insights to the correlation of genetic patterns as prognostic indicators of disease. We expect this collaboration to enhance the development and commercialization of our technology platforms by adding proprietary solutions to evaluate and diagnose disease. In May 2006, we entered into a collaboration agreement with Jurilab, where Jurilab would identify and validate new prognostic markers for Type II diabetes with certain milestone payments of up to 950,000 or approximately $1.2 million. As of December 31, 2006 we had paid Jurilab 550,000, or approximately $715,000, in milestone payments under this agreement.
The customers for our instrumentation, ASRs, reagents and custom assays are clinical research laboratories, high complexity CLIA certified laboratories and government-based healthcare facilities. In the United States, the
Food and Drug Administration (the FDA) regulates most diagnostic tests and in vitro reagents marketed as test kits as medical devices. The FDA also considers ASRs to be medical devices. ASRs are exempt from pre-market approval requirements; however, the FDA restricts the sale of these products to those clinical laboratories that are certified under the Clinical Laboratory Improvement Amendments of 1988, known as CLIA. FDA regulations concerning ASRs are currently undergoing change and we expect to make adjustments to many, if not all, of our ASR products to conform to revised FDA regulations. All products sold in Europe require CE marking. Our customers in Europe are currently serviced through a distributor network in all countries except for Italy which is supported by Nanogen Advanced Diagnostics SrL.
Customers for our diagnostics technology and products therefore include:
Clinical Laboratories (CLIA certified central laboratories and research laboratories) These customers offer validated tests to aid physicians in the diagnosis of patients conditions. They may either develop reagents internally or may purchase ASRs manufactured under the Good Manufacturing Practices regulations and develop and validate their own tests. Ease of use and throughput is important to these customers.
Government-based Healthcare Facilities These customers are generally hospitals, laboratories or other healthcare facilities in Italy and other European or Middle East countries. These customers generally purchase products via government sponsored tenders which are competitively awarded multiyear contracts for specific diagnostic products.
Emergency Room and Urgent Care Facilities The customers of our point-of-care products are primarily in near patient settings in hospital laboratories and/or emergency rooms. To market and sell to these customers we are required to receive the approval of the FDA through a pre-market application. The point-of-care products we acquired from Spectral, in February 2006, have received FDA clearance and are CE marked for distribution in Europe. Our other point-of-care products currently in development, such as the congestive heart failure product, using whole blood samples, will require FDA clearance before we distribute the product in the United States and CE marking prior to distribution in Europe. Products
We generate our product sales revenue with our advanced diagnostic product lines that we categorize as: 1) instrumentation, 2) reagents, and 3) test kits.
We have developed the NanoChip ® System to address the needs of the molecular diagnostics customer with an objective to become the preferred platform for development of applications for multiplex detection of genetic mutations or infectious disease pathogens by the clinical or clinical research laboratory. We believe our design is unique in the industry as it offers flexibility to the clinical laboratories to match their testing requirements. For example, our instrumentation systems allow the clinical laboratory customer to determine if it is more commercially effective for them to test for multiple genetic mutations on an individual set of genes, or a specific genetic mutation on multiple sets of individual genes or some combination of both. The NanoChip ® 400 consists of a consumable cartridge containing a proprietary semiconductor microchip (the NanoChip ® Electronic Microarray), a fluidic and optical instrument, and embedded software that can be programmed by the end-user to control all aspects of microchip operations including processing, detection and reporting. The system has been designed so that once programmed, the end-user need only insert a consumable cartridge into the instrument and all subsequent steps may be handled automatically under computer control. The NanoChip 400 System provides multisample and multianalyte reporting capabilities when creating research or homebrew, clinical tests. This system uses our 400-site or 100-site NanoChip cartridge.
In addition, we offer instrumentation products that are designed for use with certain of our point of care immunoassay tests. These include:
LifeSign DXpress TM Reader The LifeSign DXpress Reader is a multi-functional portable tabletop camera-based instrument that will be used to read results of in vitro immunodiagnostic assays. This system will be available for sale in connection with the launch of the quantitative CHF test.
i Lynx Reader The iLynx reader is a portable system used in conjunction with the tests acquired in connection with the Spectral asset purchase, including rapid qualitative tests for CKMB, Myoglobin and Troponin, in individual, tandem and in an all-in-one testing format used in cardiac care. This system is a qualitative reader with the ability to record useful information relating to the conduct of the tests. Reagents:
We offer the following reagent products to customers for use in the development and conduct of molecular tests:
NGEN TM Reagents are reagents designed for use in detecting nucleic acid sequences for specific organisms or genetic mutations. These reagents can be used in connection with PCR amplified patient samples and hybridization detection utilizing fluorescently-labeled probes.
MGB Alert TM Reagents are clinical reagents used for detecting nucleic acid sequences for specific organisms or genetic mutations associated with diseases in a real-time PCR format.
MGB Eclipse ® Probe Systems are reagents used in the development of diagnostics or other research applications in a real-time PCR format.
Custom Assays Our applications scientists develop products to meet our customers application needs through specific assay development services. Test Kits:
Our point of care products and our molecular reagent products sold in Europe are sold as test kits. In the future, we plan to expand our test kit offerings to include kits for use by US-based customers on the NC400 system.
These test kits include:
Cardiac STATus ® and Decision Point TM On February 6, 2006 we acquired several FDA cleared point-of-care products from Spectral that include rapid qualitative tests for CKMB, Myoglobin and Troponin, in individual, tandem and in an all-in-one testing format used in cardiac care.
StatusFirst TM CHF NT-proBNP is designed for use with the LifeSign DXpress Reader to provide quantitative determination of NT-proBNP levels in human plasma. We are developing a similar product that will utilize whole blood rather than plasma. This potential congestive heart failure test allows for efficient triaging of congestive heart failure patients, while providing accurate diagnostic test results. This product will be manufactured by Princeton BioMeditech (PBM).
QPCR Alert molecular diagnostic products that are sold in Europe under CE-IVD regulations for use in infectious disease testing or in testing for certain generic diseases. Our Growth Strategy
We plan to grow our business through marketing of our existing products as well as the development and launch of new products. As part of our growth strategy, we will continue to invest in the internal development of new diagnostic products as well as the acquisition of complementary entities or product lines that address large and growing markets.
Molecular Testing Platform
With the development of our second generation molecular testing platform, the NanoChip ® 400 system, we have focused on penetrating the high value, complex testing requirements of the molecular diagnostics market by creating an open platform that can help automate laboratory testing. This molecular testing platform was designed with an open architecture to facilitate development of molecular tests by our customers and collaborators, driving the growth in assay development far beyond our internal capacities. We believe the NanoChip ® 400 System could transform molecular diagnostics by delivering speed, efficiency and accuracy on a robust platform. We seek to establish our platform as the preferred system for the molecular diagnostics industry in order to reap the benefits of the higher margin profits on consumables. With each placement of the NanoChip ® System, we create a potential source of on-going revenue through the sale of our consumables such as the NanoChip ® Cartridges, ASRs and other products.
Reagents and Custom Assays
We believe we will increase our revenues by developing proprietary reagents that may be used on the NC400 as well as reagents that do not necessarily require our instrumentation. During 2006, we introduced multiplex reagents for use in CFTR testing and certain pharmacogenomic testing. We also introduced ten real time tests based on our proprietary MBG technology that may be used on multiple instrument platforms. These new products will enable customers to test for various infectious diseases. We believe that offering products for both the multiplexed and real-time markets supports our growth objective by offering customers a choice of technologies for testing. In addition, we will continue to supply our research reagents and our customized assay services in support of customer requests.
FDA-cleared and CE marked test kits are an important component of our growth plans. Our acquisition of Amplimedical provides a significant portfolio of real-time IVD kits for use by customers in infectious disease and genetic testing. Our acquisition of the Cardiac STATus ® and Decision Point products provides a basis for growth in point of care testing. Emergency rooms and urgent care units represent a significant market for rapid point-of-care testing for cardiovascular conditions. We are in development of a CHF test that once fully developed and cleared/approved by the FDA, European and Canadian regulatory authorities will add to our point-of-care product line. We also plan to develop FDA cleared and CE marked kits for multiplex molecular assays that can be used on the NC400. These products will enable us to expand our addressable market beyond the complex CLIA certified laboratories that can use ASRs in testing applications.
Products and Applications in Research and Development
Below is a brief description of some of our future products and applications currently in research and development by us or with our collaborators.
In 2007, we are pursuing a two track approach to the development of our instrumentation platforms. The first track is focused on developing the clinical user interface of our molecular testing platform technology to support 510(k) applications for the detection of gene mutations. The second track is continued investment in the open system version of the NanoChip400 ® system that allows our customers to tailor its use to their specific requirements. Also, we continue to work to miniaturize our electronic array technology with the support of several government and privately funded grants.
Identification of genetic and infectious disease
We are also working to increase our menu of advanced molecular reagents. These reagents consist of our proprietary real time PCR technologies and are sold as ASRs to CLIA certified laboratories for their internal
development of highly sensitive assays. During 2006 we introduced ten advanced molecular reagents and we will continue to introduce additional products in the coming years to broaden our suite of real time tests We expect to expand both infectious disease and genetic disease reagents. In conjunction with our investment in Jurilab, we are in the early stages of developing a product to screen patients for a genetic predisposition to develop Type II Diabetes.
We are currently developing a point-of-care test for CHF, for use with human whole blood samples, which will give a quantitative reading of NT-proBNP, a marker for CHF, a chronic disease that affects millions of patients each year. The Status First TM product will provide a result in approximately 15 minutes. Working with partners, we expect to add a test for Drugs of Abuse (DOA) and will continue to develop and add products to our point of care cardiac and urgent care menu.
We also are actively engaged, with our partner HX Diagnostics, in the development of a pandemic diagnostic product under a contract we received from the CDC.
Pharmacogenomics is the science of individualizing therapy based on genetic differences among patients. Certain genes have been shown to be required for the breakdown and elimination of drugs in the body (pharmacokinetics). Individuals metabolize drugs differently based on the individuals genetic make up. Certain variations in these genes can result in an inability to process specific categories of drugs, leading to a buildup of toxic chemicals in the body. Other genetic changes can result in extremely rapid breakdown of a drug, limiting the drugs effectiveness. By determining a patients genetic profile prior to prescribing a drug, a physician can reduce the potential for serious or fatal side effects. We believe that the ability of our technology to screen simultaneously for various differences in a patients DNA has wide applicability to pharmacogenomics. We are currently developing pharmacogenomic products to help assess the ability of patients to metabolize warfarin and certain other drugs.
Research and Development
As of December 31, 2006, we had 79 full-time employees in research and development. Our research and development expenses were $26 million in 2006, $22 million in 2005 and $18 million in 2004. These research and development expenses have been directed toward developing products in areas where there is a significant opportunity for a return on investment. Most of our research and development has been conducted at our facilities in San Diego California; Bothell Washington; Toronto, Canada; or Turin, Italy or in collaboration with various partners.
Sales and Marketing
Our sales representatives are able to recommend the appropriate business solution to meet the needs of our customers by presenting multiple technology and instrumentation options. Sales representatives are trained to find new market opportunities, provide diagnostic solutions to address unmet customer needs, and to provide comprehensive after-sale product support. In addition, our field technical support group provides thorough training and ongoing technical support for our products.
We sell our NC400, multiplex reagents, and custom assays in the United States through our own direct sales force. We sell our real-time ASRs and our point of care kits in the US through distributors. On August 9, 2006, we entered into an exclusive distribution agreement with Fisher Scientific to sell our real-time products in the US market. With our acquisition of Spectral Diagnostics, we assumed a relationship with Cardinal Healthcare to distribute our Cardiac STATus, Decision Point, and i-Lynx point-of-care products in the U.S.
As of December 31, 2006, our staff included approximately 51 sales, marketing and technical support representatives. These representatives principally focus on complex CLIA certified laboratories including clinical research laboratories, reference laboratories and public health laboratories. We continually educate our sales representatives on the technical, clinical and economic merits of our products.
All sales to customers outside the United States are made through distributors or agents. We currently have distributors addressing the major markets in Europe and Middle East. In the future, we plan to add additional distributors to address India and potentially the major Asian markets. To support our commercial efforts in Europe, in 2006 we acquired the assets of Amplimedical S.r.L., a limited liability company, in Italy. This wholly-owned subsidiary operates as our primary European sales, marketing and technical support office. We closed our previous European sales and support office in The Netherlands following the acquisition of Amplimedical.
We have built our own internal services organization. This field service organization provides initial installation of the NanoChip ® system, on-going technical support and warranty and maintenance work as needed.
Collaborations and Strategic Arrangements
We intend to continue entering into collaborations to expand applications of our technology platforms and to accelerate the commercialization of products. We will pursue additional collaborations in various forms, including research and development agreements, licensing agreements and joint ventures. These collaborations permit integration of the technologies and resources of our partners with our technologies, while allowing us to pursue diagnostics and other opportunities outside the scope of these collaborations.
We are currently involved in the following corporate collaborations:
In a series of investments from July 2005 through June 2006, we invested approximately $3.0 million to purchase 29.7% of the outstanding stock in Jurilab LTD (Jurilab), a Finnish company that has assembled a large database of genetic markers by studying the genetic patterns of a founder population in East Finland. This unique database was constructed over the last twenty years providing novel insights to the correlation of genetic patterns as a prognosticator of disease. Our investment in Jurilab is an example of our desire to add proprietary content on top of our advanced diagnostic tools and thereby create unique solutions to evaluate and diagnose disease. The investment agreement provides us with an option to purchase the entire company at a not-to-exceed price through December 31, 2007.
In May 2006, we entered into a collaboration agreement with Jurilab, where Jurilab would identify and validate new prognostic markers for Type II diabetes with certain milestone payments of up to approximately $1.2 million. As of December 31, 2006, we paid Jurilab approximately $715,000 for the completion of certain milestones under this agreement.
Our license agreement with Applied Biosystems Inc. (Applied Biosystems), with the underlying patents expiring at various dates between 2010 and 2015, provided us approximately $6 million in revenues in 2006. In January 2006, we renegotiated our contract with Applied Biosystems to include additional rights to certain intellectual property and a modification to our manufacturing and know-how transfer agreement. Under the revised agreement, we were guaranteed minimum quarterly royalties through December 31, 2006; however, actual royalties exceeded the minimum guarantees. There are no longer any guaranteed minimums.
Although we expect this relationship to continue into the foreseeable future this contract can be terminated by Applied Biosystems with a 180-day notice.
In September 2006, we entered into an agreement to assign certain rights associated with our Applied Biosystems royalty agreement from the period of July 2006 through December 2011 to Drug Royalty Trust (DRT) for an upfront payment of $20.0 million. Under the agreement, we have guaranteed minimum royalty payments from Applied Biosystems to DRT. If the royalty payments fall below certain minimums in a given fiscal year, we are required to pay cash to DRT for the difference between the actual royalty payments from Applied Biosystems and the minimums. In addition, if royalty payments from Applied Biosystems are above certain thresholds for a given calendar year we will receive, in cash, a certain percentage of the amount above the threshold.
In June 2005, we signed a letter of agreement with FasTraQ, Inc. (FasTraQ) for the development of a certain future product. Our Chief Executive Officer and Chairman of the Board, Mr. Birndorf, is a director and an investor in FasTraQ and our newest director, Dr. Heiner Dreismann, became CEO of FasTraQ in 2006. In October and December 2005 we amended this letter of agreement. As a result of this agreement and related amendments we made an initial non-refundable payment of $500,000 in 2005 to begin the initial development of this product. As of December 31, 2005, we expensed the initial $500,000. In February 2006, we converted this letter of agreement into two executed contracts, a Development and License Agreement and a Collaboration Agreement. In February 2006, we committed to provide FasTraQ up to an additional $500,000 in funding based on certain milestones, of which $200,000 was paid in 2006 and expensed into research and development.
Princeton BioMeditech (PBM)
Through our SynX acquisition, we were a party to a 2001 development and manufacturing agreement between SynX and PBM to jointly develop and market various point-of-care tests for certain biomarkers and protein targets. As of January 2006, we terminated all of our previous agreements with PBM and replaced them with renegotiated contracts. These new agreements include a manufacturing and distribution agreement and a development agreement. There were no payments between us and PBM associated with entering into these agreements and there were no minimum purchase requirements between the parties.
We agreed to continue the joint development of a point-of-care product for diagnosis of CHF that incorporates PBMs proprietary technology, our proprietary reagents and an exclusive license between us and Roche Diagnostics GmbH. PBM is responsible for the development of a reasonably priced instrument and for manufacturing of a CHF test that uses our reagents to determine the amount of target NT-proBNP present in a patient. We will fund a certain percentage of the development cost of the instrument, up to an agreed upon maximum amount. In addition, we are required to develop and manufacture the reagents used in the instrument and supply them to PBM. We are also responsible to conduct the testing of our reagents required to obtain regulatory approval to market them. The parties will share revenues associated with this point-of-care instrument and test with the majority of revenues being allocated to the party responsible for selling, marketing and distributing the instrument and test within a specific geographic territory. Each party will be responsible for its own manufacturing, sales and marketing expenses and both parties are required to provide each other a forecast of expected demand for each others product (reagents or instruments).
We provided PBM with an option to purchase or to receive a nonexclusive license for certain biological markers for the incorporation into a future point-of-care instrument related to congestive heart failure, stroke or traumatic brain injury. We have agreed to negotiate in good faith commercially reasonable terms for such a license or supply arrangement. However, if we are unable to agree upon such terms PBM will pay Nanogen a certain royalty for the use of these markers.
Pharmacogenetics Diagnostic Laboratory
Beginning in July 2005, we have made a series of investments Pharmacogenetics Diagnostic Laboratory, LLC (PGx) a development stage research and development company. These investments totaled $500,000 as
of December 31, 2006. We believe our ownership interest in PGx will provide us with access to technology related to pharmacogenetics.
On August 3, 2006, we entered into research and development collaboration arrangements with Fisher Scientific International Inc., (Fisher Scientific) and Athena Diagnostic, a wholly-owned subsidiary of Fisher Scientific. In March 2006, we entered into an agreement to provide certain research services for the Abgene subsidiary of Fisher Scientific during 2007. We agreed to share certain technology and patent rights related to the development, manufacture and marketing of new molecular diagnostic products. Under these arrangements, Fisher Scientific has the option to provide up to $10 million in 2007 and 2008 for the research and development of infectious disease and molecular diagnostic tests that will be mutually agreed upon. These arrangements are included in non-binding general agreements, thus the obligation of the parties are subject to further negotiation and final terms of definitive collaboration agreements. Additional projects have yet to be identified and committed by both parties.
We have been working with HX Diagnostics (HX) under an agreement signed in August 2006 to develop a point of care test for the detection of pandemic flu or other viruses. HX provided $1.3 million of funding for this project during 2006. Under the terms of the agreement, HX will have exclusive commercialization rights for a completed product to detect a pandemic flu while we will retain the distribution rights to detect other flu viruses. Our collaboration on this program formed the basis for the contract awarded to Nanogen by the Center for Disease Control (CDC) in December 2006. The CDC may provide funding for the next phase of this project and potentially beyond.
Hitachi, Ltd., Nissei Sangyo Co. Ltd. and Hitachi Instruments Service Co. Ltd.Research Agreement
In 2000, we executed a research agreement with Hitachi, Ltd., Nissei Sangyo Co. Ltd. and Hitachi Instruments Service Co. Ltd. of Japan (collectively, Hitachi) to develop, manufacture and distribute potential products based on the parties proprietary technologies. Pursuant to the terms of the agreement, Hitachi and we each may contribute, toward our research and development efforts, cash over the period of the agreement. We are liable to repay to Hitachi 50% of all funding provided by Hitachi over an indefinite period of time. Repayment amounts are determined as a percentage of our gross NanoChip ® Cartridge sales until the liability is paid in full.
In accordance with Statements of Financial Accounting Standards (SFAS) No. 68 Research and Development Arrangements , we recorded sponsored research revenue under this arrangement as expenses were incurred, in amounts not exceeding scheduled payments under the agreement. Sponsored research revenue recognized under this agreement totaled $500,000 for the year ended December 31, 2004. We had no revenue under this agreement in the years ended December 31, 2005 or 2006. Upon receipt of the funds, we recorded a long-term liability for 50% of the amount in Other long-term liabilities in the accompanying balance sheet, which accumulated to approximately $4.9 million as of December 31, 2006. . We have classified the entire balance of this liability as long-term due to the immaterial amount of current payments due under this obligation in 2007, as such payments are calculated under the agreement as percentage of gross NanoChip ® Cartridge revenue.
In 2003, in accordance with the terms of the agreement, Hitachi exercised its right to terminate the collaborative research agreement. The termination of this agreement did not accelerate the repayment due Hitachi for the 50% of the funding. Based on discussions, we determined to focus our efforts on the development and manufacture of the NanoChip ® 400 instrument. Hitachi is responsible for world-wide manufacturing of the NanoChip ® system. We are responsible for development of assays and for marketing and sales.
National Institutes of Health (NIH)
The National Institute of Allergy and Infectious Diseases for the NIH, provides funding for several grants. In July 2002, we were awarded a grant which focused on the development of a compact centrifugal micro fluidics based biological warfare agent (BWA) analyzer. In March of 2005 we began phase two of this grant and were awarded an additional $529,000 over a two year period. In May and September 2003, Nanogen was awarded a second and third grant. The second grant is for the development of a dieletrophorectic (DEP) separator for cell/pathogen separation. The third grant is aimed at developing an on-chip real-time DNA amplification for BWA detection. The total awards of these grants totaled approximately $1.5 million over a 4-year period. In July 2005, we were awarded a fourth grant for the diagnosis of Sepsis and community acquired pneumonia for a total of $2.5 million over five years. In September 2006, the Medical College of Wisconsin was awarded a five year $8.1 million grant, in which we are a subcontractor, to develop a rapid point-of-care diagnostic for bioterrorism A and pandemic influenza. Our expected share is $3.7 million as a subcontractor. Revenue is recognized under these grants as expenses are incurred and totaled $998,000, $650,000, $415,000 and $188,000 for the years ended December 31, 2006, 2005, 2004 and 2003, respectively.
Bill and Melinda Gates Foundation Grant
In July 2005, the University of Washington was awarded a $15.4 million grant from the Bill and Melinda Gates Foundation as lead partner of a consortium, which includes us, to develop a prototype portable device that healthcare workers could pack into remote regions to quickly and easily make life-saving diagnoses on such diseases as malaria. Our share over 5 years is expected to be $3.6 million. This consortium will concentrate on filling the need for an affordable portable device to do point-of-care testing and provide rapid results. Revenue under this grant is recognized as expenses are incurred and totaled $480,000 and $429,000 in the years ended December 31, 2006 and 2005, respectively.
Center for Disease Control
On December 4, 2006, we were one of four companies awarded a contract from the U.S. Centers for Disease Control and Prevention (CDC) to develop a unique multi-analyte point-of-care diagnostic assay for influenza in support of the US Governments efforts to strengthen its readiness for a potential influenza pandemic. The goal of the project is to employ technology in a low cost, high sensitivity immunoassay that simultaneously detects Influenza Type A, Type B, seasonal flu and avian flu in a simple to use assay format. This development program is related to our partnership with HX Diagnostics, Inc. which will have the right to commercialize the product. The current award of $4.5 million funds the first two phases of a five-phase development project and, if all five phases are funded by the CDC, can total approximately $12.5 million over the next two to three years.
Patents and Proprietary Technology Rights
We consider the protection of our proprietary technologies and products to be an important element in the success of our business strategy. In 2006, we were granted 26 U.S. patents bringing our current total to 137 issued U.S. patents and numerous foreign patents expiring at varying dates. In addition, we have a number of pending patent applications filed in the U.S. and abroad.
Patent applications may not be issued. Issued patents may not be found valid if challenged. In addition, intellectual property rights licensed by us may not be successfully integrated into commercial products. Others may independently develop similar technologies or duplicate any technology developed by us. Because of the extensive time required for development, testing, and regulatory review of a potential product, it is possible that, before new products can be commercialized, our related patents may expire or remain in existence for only a short period following commercialization, thus reducing any advantage of the patent, which could adversely affect our ability to protect future product development and, consequently, our business, financial condition and results of operations.
We seek to protect our inventions through filing U.S. patents and foreign counterpart applications in selected other countries. Because patent applications in the U.S. are maintained in secrecy for at least eighteen months after the applications are filed and since publication of discoveries in the scientific or patent literature often lags behind actual discoveries, we cannot be certain that we were the first to make the inventions covered by each of our issued or pending patent applications or that we were the first to file for protection of inventions set forth in such patent applications. Our planned or potential products may be covered by third-party patents or other intellectual property rights, in which case continued development and marketing of the products would require a license. Required licenses may not be available to us on commercially acceptable terms, if at all. If we do not obtain these licenses, we could encounter delays in product introductions while we attempt to design around the patents, or could find that the development, manufacture or sale of products requiring these licenses is foreclosed.
We may rely on trade secrets to protect our technology. Trade secrets are difficult to protect. We seek to protect our proprietary technology and processes by confidentiality agreements with our employees and certain consultants and contractors. These agreements may be breached, we may not have adequate remedies for any breach and our trade secrets may otherwise become known or be independently discovered by competitors. To the extent that our employees or our consultants or contractors use intellectual property owned by others in their work for us, disputes may also arise as to the rights in related or resulting know-how and inventions.
The medical diagnostics and biotechnology industries are subject to intense competition. Our competitors in the United States and abroad are numerous and include, among others, diagnostic, health care, pharmaceutical and biotechnology companies.
Many of our competitors have substantially greater financial, technical, research and other resources and larger, more established marketing, sales, distribution and service organizations than we do. Moreover, many of our competitors offer broader product lines and have greater brand recognition than we do, and offer price discounts as a competitive tactic. In addition, there can be no assurance that competitors, many of which have made substantial investments in competing technologies, will not prevent, limit or interfere with our ability to make, use or sell our products either in the United States or in international markets.
In the markets for clinical molecular diagnostic products, a number of companies including Roche, ABI, Celera Diagnostics, Luminex and Third Wave compete with us for product sales, primarily on the basis of technology, quality, reputation, accuracy, ease of use, price, reliability, the timing of new product introductions and product line offerings. In the point of care market, there are numerous competitors that offer rapid cardiac tests. In particular, Biosite currently has FDA-cleared tests and a large installed base of customers for cardiac rapid tests including CHF. In markets outside of the United States, other factors, including local distribution systems, complex regulatory environments and differing medical philosophies and product preferences, influence competition as well.
Our micro-array instrumentation and ASR products are to be used only for research purposes or by CLIA-certified laboratories when developing and validating their own diagnostic tests. When we begin to distribute and manufacture products for non-CLIA laboratories and point-of-care customers, we are subject to additional FDA requirements such as pre-market applications.
In March 2006, we received FDA clearance to begin marketing our NT-proBNP congestive heart failure product for use with human plasma.
In the third quarter of 2005, we received an untitled letter from the Office of In Vitro Diagnostic Devise Evaluation and Safety (OIVD), a division of the FDA. The letter described the OIVDs concerns that our microarray NanoChip ® systems and certain related ASRs might be construed as a medical device that requires a premarket notification/application. During the first quarter of 2006 we met with the FDA and made certain changes in our marketing materials and sales approach. In September 2006, the FDA published Draft Guidance for Industry and FDA Staff: Commercially Distributed Analyte Specific Reagents (ASRs): Frequently Asked Questions setting forth the FDAs interpretation of the regulations governing the sale of ASR products. Subsequently, we received a second letter from the OIVD in which the FDA asserted that our microarray and multiplexed reagents require FDA pre-market review. In November 2006, we met with the FDA to discuss the second letter. As a result of these communications, we relabeled the NC400 for Research Use Only and have committed to the FDA to submit the NC400 and our assays to the agency for pre-market approval beginning in 2007. We believe that our real time ASR products are not subject to FDA pre-market review. If there is an unfavorable decision or action by the FDA in these matters, it could delay or prevent sales of our NanoChip ® 400 to clinical laboratories in the United States and could adversely impact sales of our ASRs to clinical laboratories in the United States.
There can be no assurance that new legislation will not impose additional costs or lengthen review times for our products.
Additionally, should we develop food pathogen products, they will be subject to the regulations of various domestic and foreign government agencies which regulate food safety and food adulteration, including the U.S. Department of Agriculture.
Manufacturing and Raw Materials
In July 2000, we executed a ten-year agreement with Hitachi, Ltd., Nissei Sangyo Co. Ltd. and Hitachi Instruments Service Co. Ltd. of Japan to develop, manufacture and distribute products based on the parties proprietary technologies. In June 2003, we entered into another manufacturing agreement with Hitachi for the manufacture of our second generation clinical instrument. Hitachi has exclusive manufacturing rights and distribution rights in Japan. We have retained exclusive rights pursuant to each agreement to manufacture the NanoChip ® Cartridges.
Pursuant to the manufacturing agreements each party is obligated to provide the other with certain notice periods if such party determines to curtail or terminate the manufacturing relationship. Nevertheless, while alternative manufacturers of our NanoChip400 ® exist, a lengthy process would be required to negotiate and begin work under a manufacturing agreement with a new manufacturer which could disrupt our manufacturing process and harm revenues from NanoChip ® product sales.
We purchase raw materials essential to our business in the ordinary course of business from numerous suppliers. Substantially all the raw materials used for our commercial manufacturing of oligonucleotides, assay systems and other reagent products are available from multiple sources; however, other raw materials for supply contract and OEM manufacturing are proprietary products of other companies. Raw materials may be rejected if they do not meet manufacturing specifications, are contaminated and/or have other failures. A material shortage, contamination, or failure could adversely impact the commercial manufacturing of our products and related revenues.
We have implemented modern quality systems and concepts throughout the organization. Our regulatory department supervises our quality systems and is responsible for assuring compliance with all applicable regulations, standards and internal policies. Our senior management team is actively involved in setting quality policies and managing internal regulatory and monitoring external quality performance.
Our regulatory, quality and government affairs department has successfully led us through multiple quality and compliance audits by regulatory bodies and customers.
Geographic Area Financial Information
For financial information concerning the geographic areas in which we operate, see Note 14, Geographic Sales and Significant Customers to the consolidated Financial Statements.
As of December 31, 2006, we had 288 employees of whom 39 hold Ph.D. degrees and 22 hold other advanced degrees. Approximately 79 are involved in research and development, 101 in operations, manufacturing and quality assurance, 64 in sales and marketing, and 44 in finance, legal and other administrative functions. Our success will depend in large part upon our ability to attract and retain employees. We face competition in this regard from other companies, research and academic institutions, government entities and other organizations. None of our employees are covered by a collective bargaining agreement except for our Italian employees that operate through government mandated workers councils.
Item 1A. Risk Factors
We have a history of net losses. We expect to continue to incur net losses and we may not achieve or maintain profitability.
Since our inception, we have incurred cumulative net losses which, as of December 31, 2006, total approximately $360.7 million. Moreover, our negative cash flow and losses from operations will continue for the foreseeable future. We may never generate sufficient product revenue to become profitable. We also expect to have quarter-to-quarter fluctuations in revenues, expenses and losses, which could be significant. The amount and timing of product revenue recognition and cash flow may depend on whether potential customers for the molecular testing platform choose to enter into sales, reagent rentals, cost-per-test or development site transactions. We believe our future operating results may be subject to quarterly fluctuations due to a variety of factors, including, but not limited to, goodwill or other impairment charges, non-cash stock option expenses, market acceptance of the second generation NanoChip ® 400 System, acquisitions, and potential other products under development, including the CHF product and diagnostics related to infectious disease, the type of acquisition program our potential customers may choose, whether and when new products are successfully developed and introduced by us or our competitors, and the achievement of milestones under our collaborative agreements various government and private agencies. The recognition of revenue under contracts, grants and sponsored research agreements will be subject to significant fluctuations in both timing and amount and therefore our results of operations for any period may not be comparable to the results of operations for any other period.
To develop and sell our products successfully, we may need to increase our spending levels in research and development, as well as in selling, marketing and administration. We may have to incur these increased spending levels before knowing whether our products can be sold successfully.
We will need additional capital in the future. If additional capital is not available, we may have to curtail or cease operations.
We will need to raise more money to continue the research and development necessary to further develop our current products to bring our products to market and to further our manufacturing and marketing capabilities. We may seek additional funds through public and private securities offerings, arrangements with corporate partners, borrowings under lease lines of credit or other sources. If we can not raise more money, we will have to reduce our capital expenditures, scale back our development of new products, significant reduce our workforce and seek to license to others products or technologies that we otherwise would seek to commercialize ourselves. The amount of money we will need will depend on many factors, including among others:
the amount of revenue we are able to generate;
the progress of our research and development programs;
the commercial arrangements we may establish;
the time and costs involved in:
scaling up our manufacturing capabilities;
meeting regulatory requirements, including meeting necessary Quality System Regulations (QSRs) and obtaining necessary domestic and international regulatory clearances or approvals;
acquisition(s) or investment(s) into other businesses;
filing, prosecuting, defending and enforcing patent claims and litigation; and
the scope and results of our future clinical trials, if any. Additional capital may not be available on terms acceptable to us, or at all. Any additional equity financing will be dilutive to stockholders, and debt financing, if available, may include restrictive covenants and require significant collateral.
If our products are not successfully developed or commercialized, we could be forced to curtail or cease operations.
We are at an early stage of development. As of December 31, 2006 we had only a limited product offering that includes real-time PCR products (both custom and proprietary tests), molecular testing platforms (NanoChip ® system), ASRs and the point-of-care diagnostic tests for myocardial infarction and drugs of abuse. Our congestive heart failure point of care test remains in development. Our second generation molecular testing platform, the NanoChip ® 400, began shipping in October 2005. Many of our ASRs are under development. Our molecular testing platforms and ASR products may not be successfully developed or commercialized on a timely basis, or at all. If we are unable, for technological or other reasons, to complete the development, introduction or scale-up of manufacturing of our new products, or if our products do not achieve a significant level of market acceptance, we would be forced to curtail or cease operations.
We are also party to transactions known as reagent rentals and cost-per-test agreements. Under these types of transactions, we place molecular testing systems at a customer site with no upfront cost to the customer. The value of the instrument is typically recaptured through a contracted stream of future reagent sales, sold at a premium to cover the cost of the system. These reagent rentals and cost-per-test agreements result in us investing current capital in the cost of an instrument, while revenues recognized and cash received under these agreements are over the life of the contract, as reagents are shipped to the customer.
Lack of market acceptance of our products and technology would harm us.
Our success will depend upon our ability to continue to overcome significant technological challenges and successfully introduce our products into the marketplace. A number of applications envisioned by us may require
significant enhancements to our basic technology platform. There can be no assurance that we can successfully develop such enhancements.
Although we have developed a number of products as discussed above, we may not be able to further develop these products or to develop other commercially viable products. Even if we develop a product, it may not be accepted in the marketplace. If we are unable to achieve market acceptance, we will not be able to generate sufficient product revenue to become profitable. We may also be forced to carry greater inventories of our products for longer periods than we may have anticipated. If we are unable to sell the inventory of our products in a timely fashion and at anticipated price levels, we may not become profitable. In addition, we may have to take accounting charges and reduce the value of our product inventory to its net realizable value. If actual future demand or market conditions are less favorable than those currently projected by us, additional inventory write-downs may be required.
Market acceptance will depend on many factors, including our ability to:
convince prospective strategic partners and customers that our technology is an attractive alternative to other technologies;
manufacture products in sufficient quantities with acceptable quality and at an acceptable cost; and
sell, place and service sufficient quantities of our products. In addition, our technology platform could be harmed by limited funding available for product and technology acquisitions by our customers, internal obstacles to customer approvals of purchases of our products and market conditions in general.
Performance issues with our products may also harm market acceptance of our products and reduce our revenues. During the year ended December 31, 2004, certain clinical laboratories experienced performance issues with our cystic fibrosis analyte specific reagent, CFTR ASR, which negatively impacted our revenue. A new CFTR ASR was introduced in March 2006. We may encounter similar performance product issues that we may not be able to address to the satisfaction of our customers and they may decide to adopt alternative products.
Commercialization of some of our potential products depends on collaborations with others. If our collaborators are not successful or if we are unable to find collaborators in the future, we may not be able to develop these products.
Our strategy for the research, development and commercialization of some of our products requires us to enter into contractual arrangements with corporate collaborators, licensors, licensees and others. Our success depends in part upon the performance by these collaboration partners and potential collaboration partners of their responsibilities under these arrangements. Some collaborators may not perform their obligations as we expect, and we may not derive any revenue or other benefits from these arrangements. We do not know whether our collaborations will successfully develop and market any products under our respective agreements. Moreover, some of our collaborators are also researching competing technologies targeted by our collaborative programs.
Our molecular testing systems platform, the second-generation NanoChip ® 400, is manufactured by Hitachi. As such our success in the molecular testing based diagnostics market is largely dependent upon Hitachis ability to perform under our manufacturing agreement.
Through SynX we were a party to a 2001 development and manufacturing agreement between SynX and Princeton BioMeditech Corporation (PBM) to jointly develop and market various point-of-care tests for certain biomarkers and protein targets. As of January 2006, we terminated all of our previous agreements with PBM and superseded them with renegotiated contracts. These contracts include a manufacturing and distribution agreement and a development agreement. We agreed to continue the joint development of a point-of-care instrument that
incorporates PBMs proprietary technology, our proprietary reagents and an exclusive license between us and Roche Diagnostics GmbH. PBM is responsible for the development of an instrument that uses our reagents to determine the amount of target NT-proBNP present in a patient. We are required to develop and manufacture the reagents used in the instrument and supply them to PBM who manufacture the test device. We also have to conduct the testing of our reagents required to obtain regulatory approval to market and sell them. As a result, our success in the point-of-care market is dependent in part upon PBMs ability to perform under these agreements.
We may be unsuccessful in entering into other collaborative arrangements to develop and commercialize our products. In addition, disputes may arise over ownership rights to intellectual property, know-how or technologies developed with our collaborators.
The transition to new products subjects us to risks and uncertainties including undetected defects or unexpected technical or operational problems which could adversely affect our business.
In October 2005, we announced the release of our second-generation instrument system, the NanoChip ® 400. Risks inherent in the transition to our second-generation system and other new products we may release in the future include the following:
potential delays in initial shipments of new products;
undetected defects or unexpected technical or operational problems with the new products;
the possibility that new products may erode demand for our current products, including those under reagent rental agreements;
a decline in sales of our molecular testing instrumentation and as a result a build-up of an excessive, obsolete supply of inventory;
potential delays in customer purchases in anticipation of new product releases or a decision by customers to evaluate new products for longer periods of time before making a purchase;
uncertainties in product pricing and market acceptance; and
additional costs related to providing customer support and service for both first generation and second generation systems. The occurrence of any one of the foregoing factors could negatively impact our financial results, delay market acceptance of our products, divert our development resources, or otherwise have an adverse effect on our business.
The Fisher Scientific and CDC collaborations and awards may not continue beyond the currently funded projects.
We have entered into two contracts to provide research services to various units of Fisher Scientific under a collaboration announcement of August 2006 that anticipated up to $5.0 million of funding in each of 2007 and 2008. No projects have been identified for either 2007 or 2008 at this time under this collaboration announcement. There is no guarantee that our collaboration with Fisher Scientific will result in the anticipated funding. Fisher Scientific was acquired by Thermo Electron in November 2006.
We have received a $4.5 million contract from the CDC to cover the first two phases of a possible five phase development program totaling up to $12.5 million. Future awards will be given at the discretion of the CDC. In making further contract awards, the CDC may consider the achievement of certain milestones in the current contract but there can be no assurance that we will successfully attain them. The exact reimbursement rates provided by the CDC are also subject to our performance of the contract under allowed rates of reimbursement and the ratio of internal versus outside supplier expenses. The CDC could modify our rates of reimbursement based on our actual performance.
If our acquisitions are unsuccessful, our business may be harmed.
As part of our business strategy, we have acquired companies, technologies and product lines to complement our internally developed products. We expect that acquisitions will remain a part of our growth strategy going forward. Acquisitions involve numerous risks, including the following:
The possibility that we will pay more than the value we derive from the acquisition, which could result in future non-cash impairment charges such as the $59 million non-cash goodwill impairment charge recorded in the fourth quarter of 2005;
Difficulties in integration of the operations, technologies, and products of the acquired companies, which may require significant attention of our management that otherwise would be available for the ongoing development of our business;
The assumption of certain known and unknown liabilities of the acquired companies; and
Difficulties in retaining key relationships with employees, customers, partners and suppliers of the acquired company. Any of these factors could have a negative impact on our business, results of operations or financing position.
Future acquisitions could also result in potentially dilutive issuances of equity securities, the incurrence of debt, contingent liabilities and/or amortization expenses related to certain intangible assets and increased operating expenses, which could adversely affect our results of operations and financial condition. Further, any additional equity financing, debt financing, or credit facility used for such acquisition may not be on satisfactory terms, and any such financing or facility may place restrictions on our business. In addition, to the extent that the economic benefits associated with any of our acquisitions diminish in the future, we may be required to record additional write downs of goodwill, intangible assets or other assets associated with such acquisitions, which would adversely affect our operating results.
We may not realize the benefits that we anticipate from our recent acquisitions of the diagnostic division of Amplimedical, the rapid cardiac immunoassay test business of Spectral Diagnostics, of Epoch Biosciences, Inc. or of SynX Pharma Inc. or other acquisitions due to integration and other challenges.
On May 1, 2006, we completed the acquisition of the molecular testing division of Amplimedical S.r.L. On February 6, 2006, we completed the acquisition of the rapid cardiac immunoassay test business of Spectral Diagnostics (Spectral). In 2004, we completed two significant acquisitions: the acquisition of SynX Pharma, Inc. (SynX) in April 2004 and Epoch Biosciences, Inc. (Epoch) in December 2004. We expect that the Spectral and SynX product lines will accelerate our entry into the point-of-care market and that the Amplimedical and Epoch acquisitions will broaden our reach in the molecular diagnostics market. However, we cannot be certain that we will achieve these and other benefits which we currently expect from these acquisitions. The process of integrating these and other acquired companies requires significant efforts and expenditures, including the coordination of information technologies, research and development, sales and marketing, administration and manufacturing. Combining our product offerings with those of acquired companies is a complex and lengthy process involving a number of steps in which we will seek to achieve increasing degrees of integration of our products. Additionally, Amplimedical is located in Italy, Spectral and SynX are located in Canada, and Epoch is located in the state of Washington, and because our facilities in San Diego, California are or may be physically separated from facilities of other companies we acquire, it may be difficult for us to communicate effectively with, manage and integrate these employees and operations with the rest of the Company. If we are not able to integrate the operations of these acquired companies and businesses successfully, we may not be able to meet our expectations of future results of operations.
Factors that will affect the success of these acquisitions and any future acquisitions include the following:
our ability to manage a more complex corporate structure that requires additional resources for such responsibilities as tax planning, foreign currency management, financial reporting and risk management;
our ability to retain key employees of acquired companies;
our ability to increase revenues due to the integration of the products and technologies of the acquired companies; and
our ability to operate efficiently following the completion of acquisitions and to achieve cost savings. Even if we are able to successfully integrate our acquired operations, we may never realize the anticipated benefits of the SynX, Epoch, Spectral or Amplimedical acquisitions, or any other acquisition. Our failure to achieve these benefits and synergies could have a material adverse effect on our business, results of operations and financial condition.
Competing technologies may adversely affect us.
We expect to encounter intense competition from a number of companies that offer products in our targeted application areas. We anticipate that our competitors in these areas will include:
health care and other companies that manufacture laboratory-based tests and analyzers;
diagnostic and pharmaceutical companies;
companies developing drug discovery technologies;
companies developing molecular diagnostic tests; and
companies developing point-of-care diagnostic tests. If we are successful in developing products in these areas, we will face competition from established companies and numerous development-stage companies that continually enter these markets. In many instances, our competitors have substantially greater financial, technical, research and other resources and larger, more established marketing, sales, distribution and service organizations than us. Moreover, these competitors may offer broader product lines and have greater name recognition than us and may offer discounts as a competitive tactic.
In addition, several development-stage companies are currently making or developing products that compete with or will compete with our potential products. Our competitors may succeed in developing, obtaining approval from the FDA or marketing technologies or products that are more effective or commercially attractive than our current or potential products or that render our technologies and current or potential products obsolete.
As these companies develop their technologies, they may develop proprietary positions that may prevent us from successfully commercializing products.
Also, we may not have the financial resources, technical expertise or marketing, distribution or support capabilities to compete successfully in the future.
The uncertainty of patent and proprietary technology protection may adversely affect us.
Our success will depend in part on obtaining, maintaining and enforcing meaningful patent protection on our inventions, technologies and discoveries. Our ability to compete effectively will depend on our ability to develop and maintain proprietary aspects of our technology, and to operate without infringing the proprietary rights of others, or to obtain rights to third-party proprietary rights, if necessary. Our pending patent applications may not result in the issuance of patents. Our patent applications may not have priority over others applications,
and even if issued, our patents may not offer protection against competitors with similar technologies. Any patents issued to us may be challenged, invalidated or circumvented, and the rights created thereunder may not afford us a competitive advantage. Budgetary concerns may cause us to not file, or continue, litigation against known infringers of our patent rights, or may cause us not to file for, or pursue, patent protection for all of our inventive technologies in jurisdictions where they may have value.
We also rely upon trade secrets, technical know-how and continuing inventions to develop and maintain our competitive position. Others may independently develop substantially equivalent proprietary information and techniques or otherwise gain access to our trade secrets or disclose our technology and we may not be able to meaningfully protect our trade secrets, or be capable of protecting our rights to our trade secrets. We seek to protect our technology and patents, in part, by confidentiality agreements with our employees and contractors. Our employees may breach their existing confidentiality agreements and these agreements may not protect our intellectual property. This could have a material adverse effect on us.
Our products could infringe on the intellectual property rights of others, which may subject us to future litigation and cause us to be unable to license technology from third parties.
Our commercial success also depends in part on us neither infringing valid, enforceable patents or proprietary rights of third parties, nor breaching any licenses that may relate to our technologies and products. We are aware of other third-party patents that may relate to our technology. It is possible that we may unintentionally infringe these patents or other patents or proprietary rights of third parties. In the past, we and the companies we have acquired have received, and may in the future receive, notices claiming infringement from third parties as well as invitations to take licenses under third-party patents which have, in some instances, resulted in litigation, settlement of litigation and our licensing of third party intellectual property rights. In particular, the receipt of infringement notices by us may subject us to costly litigation, divert management resources and result in the invalidation of our intellectual property rights. These claims may require us to pay significant damages, cease production of infringing products, terminate our use of infringing technologies or develop non-infringing technologies. Further, any legal action against us or our collaborative partners claiming damages and seeking to enjoin commercial activities relating to our products and processes affected by third- party rights may require us or our collaborative partners to obtain licenses in order to continue to manufacture or market the affected products and processes. These actions may also subject us to liability for damages. Although in the past we and the companies we have acquired have succeeded in settling some third party claims concerning alleged infringement of intellectual property rights, which settlements have involved the payment of royalties by us or such companies we have acquired, there can be no assurance that in the future we would be successful in settling such claims. In addition, there can be no assurance that, even if such settlements are achieved, that they would be on commercially reasonably terms or would not otherwise have a material adverse impact on the companys business. We or our collaborative partners may not prevail in an action and any license required under a patent may not be made available on commercially acceptable terms, or at all.
There are many U.S. and foreign patents and patent applications held by third parties in our areas of interest, and we believe that there may be significant other litigation in the industry regarding patent and other intellectual property rights. Additional litigation could result in substantial costs and the diversion of managements efforts regardless of the result of the litigation. Additionally, the defense and prosecution of interference proceedings before the U.S. Patent and Trademark Office, or USPTO, and related administrative proceedings would result in substantial expense to us and significant diversion of effort by our technical and management personnel. We may in the future become subject to other USPTO interference proceedings to determine the priority of inventions. In addition, laws of some foreign countries do not protect intellectual property to the same extent as do laws in the U.S., which may subject us to additional difficulties in protecting our intellectual property in those countries.
We have opposed one allowed European patent granted to Oxford Gene Technology that had broad claims to array technology for analyzing a predetermined polynucleotide sequence. After our opposition to this patent, Oxford Gene Technology narrowed its claims. However, we are still opposing such narrower claims before the
European Patent Offices Opposition Division. Even if Oxford Gene Technology successfully defends its current, narrower claims, and even if a patent is subsequently granted for such claims, we do not believe that our product will infringe upon such claims. Nonetheless, Oxford Gene Technology may still later assert that some of our products infringe upon its patents that Oxford Gene Technology may obtain from time to time. If the decision of the Opposition Division is successfully appealed by Oxford Gene and the original claims are reinstated, or if an application relating to arrays is issued in another country with claims as broad as the original European patent, we could be subject to infringement accusations that could delay or preclude sales of some of our anticipated diagnostic products, and we may incur unanticipated cost in defending such accusations.
We may continue to be involved in intellectual property litigation that may be costly, time-consuming and may impact our competitive position.
In December 2002, Oxford Gene filed a complaint against us in the United States District Court for the District of Delaware claiming that we infringe U.S. Patent No. 6,054,270 entitled Analytical Polynucleotide Sequences. In April 2003, we filed an answer to the complaint that denied that we infringe this patent. In October 2003, we entered into a tolling agreement with Oxford Gene pursuant to which the lawsuit was dismissed by Oxford Gene without prejudice. Under the tolling agreement, we are obligated to give Oxford Gene notice if we determine that we desire to commercialize DNA arrays for use in certain assay formats. If that notice is given, we and Oxford Gene are obliged to discuss in good faith for 30 days whether we wish to acquire, and whether Oxford Gene is willing to grant a license under the patent involved in the litigation. If we and Oxford Gene are unable to enter into such a license or other agreement within such 30 days, Oxford is free to re-initiate the litigation.
On June 30, 2005, we gave Oxford Gene notice that we desired to commercialize DNA arrays for use in such assay formats. Oxford Gene is now free to re-initiate the litigation against us under the tolling agreement. If the litigation were to be reinitiated, significant attorneys costs and fees could result. Although it is our position that Oxford Genes assertions of infringement have no merit, neither the outcome of any further litigation nor the amount and range of potential fees can be assessed. No assurances can be given that we would prevail in any future lawsuits or that we could successfully defend ourselves against any future claims.
The regulatory clearances and approvals required to manufacture, market and sell our products are uncertain, and our failure to comply with such clearances and approvals could have a material adverse effect on our company.
Unless otherwise exempt, medical devices require FDA approval or clearance prior to marketing in the United States. We believe our currently marketed products, including general laboratory instruments and analyte specific reagents as well as certain of those products we intend to market in the future, other than our CHF test in development and assets we acquired in our Spectral acquisition, are not subject to 510(k) clearance or premarket approval requirements. As a result, to date we have not applied for FDA or any other regulatory approvals or clearances with respect to any of our products other than with respect to our CHF test. Obtaining 510(k) clearance and premarket approval may be time-consuming, expensive and uncertain. The regulatory approval or clearance process required to manufacture, market and sell our existing and future products is currently uncertain. If the FDA or other regulatory authorities assert that our products are subject to 510(k) clearance and premarket approval requirements or other similar procedures, our business may experience incremental costs, increased regulatory risks and production delays. In addition, we could be subject to:
the recall or seizure of our products;
total or partial suspension of the production of our products;
the failure of the government to grant premarket clearance or premarket approval for our devices or the withdrawal of marketing clearances or approvals once granted to us;
substantial delay in the manufacture or sale of our current or future products;
limitations on intended uses imposed as a condition of approvals or clearances; or
criminal prosecution, civil penalties, other administrative sanctions or judicially imposed sanctions, such as injunctions. In the third quarter of 2005, we received an untitled letter from the Office of In Vitro Diagnostic Devise Evaluation and Safety (OIVD), a division of the FDA. The letter described the OIVDs concerns that the microarray NanoChip ® systems and certain related ASRs might be construed as a medical device that requires a premarket notification/application. During the first quarter of 2006 we met with the FDA and made certain changes in our marketing materials and sales approach in response to their input. In September 2006, the FDA, published Draft Guidance for Industry and FDA Staff: Commercially Distributed Analyte Specific Reagents (ASRs): Frequently Asked Questions setting forth the FDAs interpretation of the regulations governing the sale of ASR products. Subsequently, we received a second letter from the OIVD in which the FDA asserted that our microarray and multiplexed reagents require premarket review. In November 2006, we met with the FDA to discuss the second letter. We believe that our microarray NanoChip ® systems and ASR products are not subject to FDA premarket review. If there is an unfavorable decision by the FDA in these matters, it could delay or prevent sales of our NanoChip ® 400 to clinical laboratories in the United States and could adversely impact sales of our ASRs to clinical laboratories in the United States. During 2007, we plan to submit the 501(k) for the NanoChip ® 400 system with one or more assays to the FDA for clearance.
Thus far the FDA has not agreed with our position that the NanoChip ® 400 and all of our ASR products are not subject to 510(k) clearance or the premarket approval process. The FDA may ultimately require that we submit our existing and/or future products to the premarket approval process or the 510(k) clearance process, either of which may be time- consuming, expensive and uncertain. In addition, if we submit our current products to the premarket approval process or the 510(k) clearance process, it is unclear what the impact would be on our products that have been or are being sold without such approvals. We may be allowed to continue to market our current products pending the outcome of the clearance or approval process for each product, but there can be no assurance that the FDA would not require us to withdraw one or more of our products from the marketplace pending receipt of such approvals or clearances. If the FDA makes any such determination or otherwise disagrees with our position, the FDA could preclude us from shipping the NanoChip ® 400 in the United States until we have received FDA clearance. In addition, the FDA could subject us to any of the penalties described above, including administrative or judicially imposed sanctions and the recall or seizure of our products. Any such result could substantially delay the release of our current and future products. Furthermore, any such result would have a material adverse effect on our business, financial position and results of operations, and the market value of our common stock could decline.
Based on the new draft guidance documents and our ongoing interactions with the FDA, we will undertake to accelerate the development and filing of 510(k) applications for the NanoChip ® 400 and test kits for use on the system. This will increase our costs of product development and divert resources from other product development efforts. We believe that our real-time ASR products comply with regulations. However, if FDAs guidance documents are finalized in their current form, we will incur substantial cost to repackage our products to meet the draft guidelines. This will also increase cost and divert resources from other efforts. Further, there can be no assurance that the reconfigured ASR products would be acceptable to all of our customers.
The regulatory approval process for our products may be expensive, time-consuming and uncertain.
To the extent that our products require FDA or other regulatory approval or clearance prior to marketing, such regulatory approval process may be expensive, time-consuming, uncertain and may prevent us from obtaining or maintaining required approvals for the commercialization of our products, which may have a significant impact on our business. It generally takes at least three to six months from the time of submission or more to obtain 510(k) clearance, but the process may take longer if the FDA requests more data or research. The premarket approval process takes between one and two years from the time of submission. Regulatory clearance
or approval of any of our products may not be granted by the FDA or foreign regulatory authorities for several years, if at all. Our failure to obtain required approvals from regulatory authorities could have a material adverse effect on our business, results of operations and financial condition. In other countries, the manufacture or sale of our products may require approval by local government agencies with missions comparable to the FDAs. The process of obtaining any such approval may also be lengthy, expensive and uncertain.
We expect to submit some of our products in the future to the 510(k) clearance process or premarket approval process and, as such, expect to incur significant expenses in order to receive such clearances or approvals. We also cannot predict the likelihood of obtaining such clearances or approvals. The failure to obtain such clearances or approvals could prevent the successful development, introduction and marketing of certain of our products, and could cause the market price for our stock to decline.
In addition, whether or not our products are subject to 510(k) clearance or premarket approval, we are subject to certain FDA regulations covering, among other things, manufacturing, promotions and medical device reporting. For instance, manufacturing facilities are required to adhere to the FDAs current Quality System Regulations, including extensive record keeping and reporting and periodic inspections of our manufacturing facilities. Similar requirements are imposed by foreign governmental agencies. Compliance with these regulations requires substantial expenditures of time, money and effort in such areas as production and quality control to ensure full compliance. Failure to comply with such regulations at one of our manufacturing facilities could result in an enforcement action brought by the FDA, which could include withholding the approval of products manufactured at that facility or all facilities registered with FDA under our name.
If we are unable to manufacture products on a commercial scale, our business may suffer.
Hitachi manufactures our NanoChip ® System, including the second-generation NanoChip ® 400; PBM will manufacture certain of our point-of-care products; and we manufacture our NanoChip ® Cartridges, our ASRs, the cardiac product line acquired from Spectral, and most of our other products. We, Hitachi and PBM rely on subcontractors to manufacture the limited quantities of microchips and other components we require for use by and sale to our customers, as well as for internal and collaborative purposes. Manufacturing, supply and quality control problems may arise as we, Hitachi or PBM either alone, together or with subcontractors, attempt to further scale up manufacturing procedures or to manufacture new products. We, Hitachi or PBM may not be able to scale-up in a timely manner or at a commercially reasonable cost. Problems could lead to delays or pose a threat to the ultimate commercialization of our products and cause us to fail.
We, Hitachi or PBM or any of our contract manufacturers could encounter manufacturing difficulties, including those relating to:
the ability to scale up manufacturing capacity;
quality control and assurance; or
shortages of components or qualified personnel. Our manufacturing facilities and those of Hitachi and PBM and any other of our contract manufacturers are or will be subject to periodic regulatory inspections by the FDA and other federal, state and international regulatory agencies and these facilities are or may become subject to Quality System Regulation, or QSR, requirements of the FDA. If we, Hitachi, PBM or our third-party manufacturers, fail to maintain facilities in accordance with QSR regulations, other international quality standards or other regulatory requirements, then the manufacture process could be suspended or terminated which would harm us.
Our dependence on suppliers for materials could impair our ability to manufacture our products.
Outside vendors provide key components and raw materials used by us, Hitachi and PBM in the manufacture of our products. Although we believe that alternative sources for these components and raw
materials are available, any supply interruption in a limited or sole source component or raw material would harm our and Hitachis or PBMs ability to manufacture our products until a new source of supply is identified and qualified, including qualification under applicable FDA regulations. In addition, an uncorrected defect or suppliers variation in a component or raw material, either unknown to us, Hitachi or PBM or incompatible with our, Hitachi or PBMs manufacturing processes, could harm our, Hitachi or PBMs ability to manufacture our products. We, Hitachi or PBM may not be able to find a sufficient alternative supplier in a reasonable time period, or on commercially reasonable terms, if at all. If we, Hitachi or PBM fail to obtain a supplier for the manufacture of components of our products, we may be forced to curtail or cease operations.
Lead times for obtaining materials and components for our products and the manufacturing and introduction of our products may vary significantly which could lead to excess inventory levels as well as shortages of critical components and products if our supply and demand forecasts are inaccurate.
We anticipate that our products, including our ASRs and most of our other products will be manufactured and introduced by us and third parties, if any, based on forecasted demand and that we will seek to purchase components and materials in anticipation of the actual receipt of purchase orders from our customers. Lead times for materials and components to be included in our products vary significantly and may depend on factors such as the business practices of each specific supplier and the terms of the particular contracts, as well as the overall market demand for such materials and components at any given time. Also, we often rely on our own and third party forecasted demand for various products and the accuracy of such forecasts may depend on a number of factors, including but not limited to, government reports and recommendations for certain genetic testing, regulatory burdens, competitive products, the nature and effectiveness of our products, the timing and extent of the introduction of our products into the marketplace and other factors. If the forecasts are inaccurate, we could experience fluctuations in excess inventory of our products, or shortages of critical components or products, either of which could cause our business to suffer.
We currently rely on one manufacturer of our NanoChip ® 400 and other hardware products, and we will rely on another manufacturer for our some of point-of-care products, and such reliance may delay the manufacture and shipment of our products to customers.
We have signed an exclusive manufacturing agreement with Hitachi to manufacture our second generation NanoChip ® 400 workstations and other hardware products to be developed by us. In addition, we have an exclusive manufacturing agreement with PBM for the manufacture of certain future point-of-care products, including CHF tests.
Because we are solely dependent on these companies for the manufacture of these products, any disruption in either of these companies businesses or in our relationship with such companies may have a material adverse effect on our business. To the extent we have adverse developments in our relationship with Hitachi or PBM, or to the extent we develop contractual disputes, it may have an adverse impact on our business, our ability to implement existing products or launch new products. In particular, to the extent we seek to amend, modify or extend or otherwise change aspects of our contractual relationship with either of these parties, we may experience manufacturing delays associated with negotiating the terms of those arrangements and other related complications. If we determine to curtail or terminate our manufacturing relationship with either of these parties, a lengthy process would be required to negotiate and begin work under a manufacturing agreement with a new manufacturer which could disrupt our manufacturing process and harm our business. Furthermore, the manufacturing of certain point-of-care products, including CHF tests, depends on certain intellectual property owned by PBM and licensed by PBM from third parties, and we may not be able to manufacture or find an alternative manufacturer of the design of these products without this intellectual property, which would severely impact our point-of-care products.
The number of our sales and marketing employees may not result in corresponding numbers of sales or placements of the NanoChip ® System, the sale of ASRs, point-of-care diagnostic products or other Nanogen products.
As of December 31, 2006, we had 64 total employees in our worldwide sales and marketing group.
Developing, training and monitoring this sales and marketing force has required and will further require capital and time expenditures by us and certain of our employees. The size of our sales and marketing force may not result in corresponding numbers of sales or placements of the NanoChip ® System nor increased product revenues associated with such sales or placements or our ASRs, point-of-care diagnostic products or other products. We may be required to increase or decrease the size of the sales and marketing force as deemed necessary and such increases or decreases in staff will require additional capital and time expenditures by us and our employees.
Failure to expand our international sales as we intend would reduce our ability to become profitable.
We expect that a portion of our sales will be made outside the United States. A successful international effort will require us to develop relationships with international customers and partners. We may not be able to identify, attract or retain suitable international customers and distribution partners. As a result, we may be unsuccessful in our international expansion efforts. Furthermore, expansion into international markets will require us to continue to establish and expand foreign sales and marketing efforts, hire additional sales and marketing personnel and maintain good relations with our foreign customers and distribution partners.
International operations involve a number of risks not typically present in domestic operations, including:
currency fluctuation risks;
changes in regulatory requirements;
political and economic instability, including the war on terrorism; and
difficulties in staffing and managing foreign offices. In addition, we expect increased costs in deploying the NanoChip ® System, including the second-generation NanoChip ® 400, ASRs, point-of-care diagnostics, and other products in foreign countries due to:
licenses, tariffs and other trade barriers;
costs and difficulties in establishing and maintaining foreign distribution partnerships;
potentially adverse tax consequences; and
the burden of complying with a wide variety of complex foreign laws and treaties. Our international sales and marketing efforts will also be subject to the risks associated with the imposition of legislation and regulations relating to the import or export of high technology products. We cannot predict whether tariffs or restrictions upon the importation or exportation of our products will be implemented by the United States or other countries.
We may lose money when we exchange foreign currency received from international sales into U.S. dollars. A portion of our business is expected to be conducted in currencies other than the U.S. dollar. We recognize foreign currency gains or losses arising from our operations in the period incurred. As a result, currency fluctuations between the U.S. dollar and the currencies in which we do business will cause foreign currency transaction gains and losses. We cannot predict the effects of exchange rate fluctuations upon our future operating results because of the number of currencies involved, the variability of currency exposure and the potential volatility of currency exchange rates. We currently do not engage in foreign exchange hedging transactions to manage our foreign currency exposure.
We may have significant product liability exposure.
We face an inherent business risk of exposure to product liability and other claims in the event that our technologies or products are alleged to have caused harm. These risks are inherent in the testing, manufacturing and marketing of our products. In addition, we began a targeted acquisition strategy during 2004, and our due diligence of acquired companies may fail to reveal material risks relating to product liabilities of such companies. Any product liability claim brought against us could be expensive to defend and could result in a diversion of managements attention from our core business. We may be required to pay substantial damages in connection with any product liability claims. A successful product liability claim or series of claims could have an adverse effect on our business, financial condition and results of operations. Further, we may not be able to maintain adequate levels of product liability insurance at reasonable cost or reasonable terms. Excessive insurance costs or uninsured claims would add to our future operating expenses and adversely affect our financial condition.
If we lose our key personnel or are unable to attract and retain additional personnel, we may not be able to pursue collaborations or develop our own products.
We are highly dependent on the principal members of our scientific, manufacturing, marketing, administrative, management and executive personnel, the loss of whose services might significantly delay or prevent the achievement of our objectives. We face competition from other companies, academic institutions, government entities and other organizations in attracting and retaining personnel. For the twelve months ended December 31, 2006, 2005 and 2004, we experienced turnover rates of 13%, 17% and 27%, respectively. Turnover at these rates may continue and, if they continue, may adversely affect us.
The turnover rates above exclude the impact of reductions in workforce. In October 2006, we announced a reduction in force of approximately 15% of our workforce and incurred severance related expenses of approximately $500,000 in the fourth quarter of 2006. This reduction in force was a combination of selective rehiring of voluntary terminations and planned separations as we integrated the activities or our various acquisitions. Several of the planned separations did not occur until the first quarter of 2007. Future layoffs could have an adverse effect on us.
Health care reform and restrictions on reimbursement may adversely affect our business.
In recent years, health care payors as well as federal and state governments have focused on containing or reducing health care costs. We cannot predict the effect that any of these initiatives may have on our business, and it is possible that they will adversely affect our business. Health care cost containment initiatives focused on genetic testing could cause the growth in the clinical market for diagnostic testing to be curtailed or slowed. In addition, health care cost containment initiatives could cause pharmaceutical companies to reduce research and development spending. In either case, our business and our operating results would be harmed. In addition, diagnostic testing in clinical settings is often billed to third-party payors, including private insurers and governmental organizations. If our current and future clinical products are not considered cost-effective by these payors, reimbursement may not be available to users of our products. In this event, potential customers would be much less likely to use our products, and our business and operating results could be seriously harmed.
In addition, sales of our future products may depend, in large part, on the availability of adequate reimbursement to users of those products from government insurance plans, managed care organizations and private insurance plans. Physicians recommendations to use our products may be influenced by the availability of reimbursement by insurance companies and other third-party payors. There can be no assurance that insurance companies or third-party payors will provide coverage for our products or that reimbursement levels will be adequate for the reimbursement of the providers of our products. In addition, outside the United States, reimbursement systems vary from country to country and there can be no assurances that third-party reimbursement will be made available at an adequate level, if at all, for our products under any other reimbursement system. Lack of or inadequate reimbursement by government or other third-party payors for our products could have a material adverse effect on our business, financial condition and results of operations.
If ethical and other concerns surrounding the use of genetic information become widespread, we may have less demand for our products.
Genetic testing has raised ethical issues regarding confidentiality and the appropriate uses of the resulting information. For these reasons, governmental authorities may call for limits on or regulation of the use of genetic testing or prohibit testing for genetic predisposition to certain conditions, particularly for those that have no known cure. Any of these scenarios could reduce the potential markets for our products, which could seriously harm our business, financial condition and results of operations.
We use hazardous materials in our business. Any claims relating to improper handling, storage or disposal of these materials could be time consuming and costly.
Our research and development processes involve the controlled storage, use and disposal of hazardous materials including, but not limited to, biological hazardous materials and radioactive compounds. We are subject to federal, state and local regulations governing the use, manufacture, storage, handling and disposal of materials and waste products. Although we believe that our safety procedures for handling and disposing of these hazardous materials comply with the standards prescribed by law and regulation, the risk of accidental contamination or injury from hazardous materials cannot be completely eliminated. In the event of an accident, we could be held liable for any damages that result, and any liability could exceed the limits or fall outside the coverage of our insurance. We may not be able to maintain insurance on acceptable terms, or at all. We could be required to incur significant costs to comply with current or future environmental laws and regulations.
Our stock price could continue to be highly volatile and our stockholders may not be able to resell their shares at or above the price they paid for them.
The market price of our common stock, like that of many other life sciences companies, has been highly volatile and is likely to continue to be highly volatile. The following factors, among others, could have a significant impact on the market price of our common stock:
period-to-period fluctuations in sales, inventories and our operating results;
asset impairment charges, including goodwill and other intangible assets;
adoption of new stock option expensing rules;
the announcement of issues involving our liquidity;
that announcement of product development failures;
the announcement of financing or acquisitions that dilutes our equity;
the results of our premarket studies and clinical trials or those of our collaborators or competitors or for diagnostic testing in general;
evidence of the safety or efficacy of our potential products or the products of our competitors;
the announcement by us or our competitors of technological innovations or new products;
the announcement by us of acquisitions by customers of our molecular testing platforms, ASRs or our other products;
announcements by us of government or private grants or contracts or of failure to obtain such government or private grants or contracts;
announcements by us of involvement in litigation;
developments concerning our patents or other proprietary rights or those of our competitors, including other litigation or patent office proceedings;
loss of key board, executive, management or other personnel or the increase or decrease in size of our sales and marketing staff;
governmental regulatory actions or the failure to gain necessary clearances or approvals;
the ability to obtain necessary licenses;
changes or announcements in reimbursement policies;
developments with our subsidiaries and collaborators;
changes in or announcements relating to acquisition programs for our products, including the expiration or continuation of our development site agreements;
market conditions for life science stocks, nanotechnology stocks and other stocks in general;
changes in estimates of our performance by securities analysts and the loss of coverage by one or more securities analysts;
the announcement by us of any stock repurchase plan, any purchases made thereunder by us and any cessation of the program by us; and
changes in the United States war on terrorism and other geopolitical and military situations in which the country is involved. Investor confidence and share value may be adversely impacted if our independent auditors are unable to provide us with the attestation of the adequacy of our internal controls over financial reporting, as required by Section 404 of the Sarbanes-Oxley Act of 2002.
As directed by Section 404 of the Sarbanes-Oxley Act of 2002, the SEC adopted rules requiring public companies to include a report of management on our internal controls over financial reporting in our annual reports on Form 10-K and quarterly reports on Form 10-Q that contains an assessment by management of the effectiveness of our internal controls over financial reporting. In addition, our independent auditors must attest to and report on managements assessment of the effectiveness of our internal controls over financial reporting as of the end of the fiscal year. How companies are maintaining their compliance with these requirements including internal control reforms, if any, to comply with the requirements of Section 404, and how independent auditors are applying these requirements and testing companies internal controls, remain subject to some uncertainty. We expect that our internal controls will continue to evolve as our business activities change. In addition, the acquisitions of SynX and Epoch made during 2004, our minority interest investment in Jurilab in 2005, and the acquisitions Spectral and Amplimedical in 2006, and any future acquisitions we make may impact our ability to maintain effective internal controls over financial reporting. Further, if, during any year, our independent auditors are not satisfied with our internal controls over financial reporting, including the internal controls over financial reporting of SynX, Epoch, Jurilab, Spectral or Amplimedical or the level at which these controls are documented, designed, operated, tested or assessed, or if the independent auditors interpret the requirements, rules or regulations differently than we do, then they may decline to attest to managements assessment or may issue a report that is qualified. This could result in an adverse reaction in the financial marketplace due to a loss of investor confidence in the reliability of our financial statements, which ultimately could negatively impact the market price of our shares.
Our anti-takeover provisions could discourage potential takeover attempts and make attempts by stockholders to change management more difficult.
The approval of two-thirds of our voting stock is required to take some stockholder actions, including the amendment of any of the anti-takeover provisions contained in our certificate of incorporation or amendment of our bylaws.
Further, pursuant to the terms of our stockholder rights plan adopted in November 1998, as amended, we have distributed a dividend of one right for each outstanding share of common stock. These rights will cause
substantial dilution to the ownership of a person or group that attempts to acquire us on terms not approved in advance by our board of directors and may have the effect of deterring unsolicited takeover attempts.
Our business is subject to changing regulation of corporate governance and public disclosure that has increased both our costs and the risk of noncompliance.
Because our common stock is publicly traded, we are subject to certain rules and regulations of federal, state and financial market exchange entities charged with the protection of investors and the oversight of companies whose securities are publicly traded. These entities, including the Public Company Accounting Oversight Board, the SEC and the Nasdaq Global Market, have continued to develop additional regulations and requirements in response to laws enacted by Congress, most notably the Sarbanes-Oxley Act of 2002. Our efforts to comply with these new regulations have resulted in, and are likely to continue to result in, increased general and administrative expenses and a diversion of management time and attention from revenue-generating activities to compliance activities.
Moreover, because these laws, regulations and standards are subject to varying interpretations, their application in practice may evolve over time as new guidance becomes available. This evolution may result in continuing uncertainty regarding compliance matters and additional costs necessitated by ongoing revisions to our disclosure and governance practices.
We have agreed to guarantee certain annual minimum payments and perform other obligations under our agreement with DRT for the assignment of our rights associated with our Applied Biosystems royalty agreement, or the ABI agreement. A reduction of royalty payments under or early termination of the ABI agreement would seriously impair our ability to make these minimum payments or perform our obligations under the DRT agreement, which would have a material adverse effect on us.
In September 2006 we assigned to DRT our rights to receive royalty payments and related reports under the ABI agreement for an upfront payment approximately $20 million. Under our agreement with DRT, if annual royalties generated under the ABI agreement is less than a specified minimum amount, we are required to make payments to DRT to achieve such minimum amount. To secure our obligations under the DRT agreement, including the obligation to make such minimum royalty payments, we granted DRT a first priority security interest in our patents licensed under the ABI agreement. If the ABI agreement does not generate sufficient sales volume, or if the ABI agreement is terminated by ABI prior to the expiration of the DRT agreement, we will be required to make minimum royalty payments to DRT. There is no assurance that we will have sufficient funds or assets to cover such payments. If the ABI agreement is terminated, we may not be able to obtain replacement royalty arrangement on a timely basis or at all to cover our payment obligations under the DRT agreement. Furthermore, failure to make minimum payment or perform other obligations under the DRT agreement may result in a default under our security agreement with DRT, which, if not cured, would impair our ownership and practice of the patents licensed under the ABI agreement. This will have a material adverse effect on us.
Our relationship with Jurilab subjects us to numerous risk and uncertainties.
Since July 2005, we acquired a minority equity interest in Jurilab of approximately 29.7% and we hold two of Jurilabs four board of director seats. Our relationship with Jurilab subjects us to numerous risk and uncertainties, including:
we have invested approximately $3.0 million in Jurilab and we may lose all of our investment;
we are required to consolidate Jurilabs financial statements with our own and as a result our operating results may be less predictable, subject to significant fluctuation beyond our control and adversely affected by the results of Jurilab;
we are required to maintain internal controls and related documentation as required by Section 404 of the Sarbanes-Oxley Act of 2002 despite only being a minority owner of this Finnish company that is not
otherwise subject to this U.S regulatory requirement; however, any significant deficiencies or material weaknesses found in the internal control structure at Jurilab may result in an unfavorable audit opinion on our consolidated internal control structure;
our relationship with Jurilab may require our management to devote substantial time and resources to Jurilabs business, which may adversely affect our business;
we have the right to acquire Jurilab, and if we exercise this right, it would entail significant risks, which risks would be even more acute because Jurilab is an early stage company; and
in the event we were to acquire Jurilab, we would likely be required to seek additional financing that may not be available to us on acceptable terms, or at all. Terrorist attacks, war, natural disasters and other catastrophic events may negatively impact aspects of our operations, revenue, costs and stock price.
Threats of terrorist attacks in the United States of America, as well as future events occurring in response to or in connection with them, including, without limitation, future terrorist attacks or threats against United States of America targets, rumors or threats of war, actual conflicts involving the United States of America or its allies, including the on-going U.S. conflicts in Iraq and Afghanistan, further conflicts in the Middle East and in other developing countries, or military or trade disruptions affecting our domestic or foreign suppliers of merchandise, may impact our operations. Our operations also may be affected by natural disasters or other similar events, including floods, hurricanes, earthquakes or fires. Our California and Washington facilities, including our corporate offices and principal product development facilities, are located near major earthquake faults. The potential impact of any of these events to our operations includes, among other things, delays or losses in the delivery of products by us and decreased sales of such products. Additionally, any of these events could result in increased volatility in the United States of America and worldwide financial markets and economies. Also, any of these events could result in economic recession in the United States of America or abroad. Any of these occurrences could have a significant impact on our operating results, revenue and costs and may result in the volatility of the future market price of our common stock.
Item 1B. Unresolved Staff Comments