e10vq
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
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þ |
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QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended September 30, 2006
or
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o |
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TRANSITION REPORTS PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to
Commission File Number: 000-51541
GENOMIC HEALTH, INC.
(Exact name of registrant as specified in its charter)
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Delaware
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77-0552594 |
(State or other jurisdiction of
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(I.R.S. Employer Identification No.) |
incorporation or organization) |
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301 Penobscot Drive
Redwood City, California 94063
(Address of principal executive offices, including Zip Code)
(650) 556-9300
(Registrants telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed
by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or
for such shorter period that the registrant was required to file such reports), and (2) has been
subject to such requirements for the past 90 days.
YES
þ NO
o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated
filer or a non-accelerated filer. See definition of accelerated filer and large accelerated filer
in Rule 12b-2 of the Exchange Act. (Check one):
Large Accelerated Filer
o
Accelerated Filer
o
Non-Accelerated Filer
þ
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of
the Exchange Act). YES
o NO
þ
The number of outstanding shares of the registrants Common Stock, $0.0001 par value, was
24,529,214 as of October 31, 2006.
GENOMIC HEALTH, INC.
INDEX
2
PART 1: FINANCIAL INFORMATION
Item 1. Financial Statements
GENOMIC HEALTH, INC.
Consolidated Balance Sheets
(In thousands, except share and per share amounts)
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September 30, |
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December 31, |
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2006 |
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2005 |
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(Unaudited) |
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Assets |
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Current assets: |
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Cash and cash equivalents |
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$ |
26,565 |
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$ |
18,839 |
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Short-term investments |
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21,778 |
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50,688 |
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Accounts receivable |
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1,907 |
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314 |
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Prepaid expenses and other current assets |
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2,128 |
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1,584 |
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Employee note receivable current portion |
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37 |
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Total current assets |
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52,378 |
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71,462 |
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Property and equipment, net |
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8,230 |
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|
3,597 |
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Restricted cash |
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500 |
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500 |
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Other assets |
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151 |
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240 |
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Total assets |
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$ |
61,259 |
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$ |
75,799 |
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Liabilities and stockholders equity |
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Current liabilities: |
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Accounts payable |
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$ |
1,724 |
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$ |
1,393 |
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Accrued compensation |
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1,686 |
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|
955 |
|
Accrued expenses and other current liabilities |
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1,602 |
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|
1,438 |
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Accrued license fees |
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|
835 |
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|
585 |
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Lease
incentive obligations current portion |
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141 |
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Notes payable current portion |
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1,384 |
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1,052 |
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Deferred revenues |
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1,161 |
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238 |
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Total current liabilities |
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8,533 |
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5,661 |
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Lease
incentive obligations long-term portion |
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622 |
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Notes payable long-term portion |
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2,308 |
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2,621 |
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Stockholders equity |
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Preferred stock, $0.0001 par value; 5,000,000
shares authorized; no shares issued and
outstanding at September 30, 2006 and
December 31, 2005 |
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Common stock, $0.0001 par value; 100,000,000
shares authorized, 24,529,214 and 24,470,981
shares issued and outstanding at September
30, 2006 and December 31, 2005 |
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2 |
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2 |
|
Additional paid-in capital |
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165,908 |
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167,053 |
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Deferred stock-based compensation |
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(3,297 |
) |
Accumulated other comprehensive loss |
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(6 |
) |
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(58 |
) |
Accumulated deficit |
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(116,108 |
) |
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(96,183 |
) |
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Total stockholders equity |
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49,796 |
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67,517 |
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Total liabilities and stockholders equity |
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$ |
61,259 |
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$ |
75,799 |
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See accompanying notes.
3
GENOMIC HEALTH, INC.
Consolidated Statements of Operations
(In thousands, except share and per share amounts)
(Unaudited)
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Three Months Ended |
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Nine Months Ended |
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September 30, |
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September 30, |
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2006 |
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2005 |
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2006 |
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2005 |
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Revenues: |
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Product revenues |
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$ |
6,928 |
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$ |
1,375 |
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$ |
18,932 |
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$ |
2,960 |
|
Contract revenues |
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191 |
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216 |
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1,626 |
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316 |
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Total revenues |
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7,119 |
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|
1,591 |
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20,558 |
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3,276 |
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Operating expenses: |
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Cost of product revenues |
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2,674 |
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1,647 |
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7,201 |
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4,520 |
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Research and development |
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3,229 |
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2,341 |
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8,678 |
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6,971 |
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Selling and marketing |
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6,429 |
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3,390 |
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17,331 |
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10,805 |
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General and administrative |
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3,464 |
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1,724 |
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8,904 |
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4,511 |
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Total operating expenses |
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15,796 |
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9,102 |
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|
42,114 |
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26,807 |
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Loss from operations |
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(8,677 |
) |
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(7,511 |
) |
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(21,556 |
) |
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(23,531 |
) |
Interest income |
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594 |
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|
156 |
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1,932 |
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|
549 |
|
Interest expense |
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|
(105 |
) |
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(91 |
) |
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(312 |
) |
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|
(162 |
) |
Other income, net |
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8 |
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11 |
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|
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|
|
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Net loss |
|
$ |
(8,180 |
) |
|
$ |
(7,446 |
) |
|
$ |
(19,925 |
) |
|
$ |
(23,144 |
) |
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Basic and diluted net loss per share |
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$ |
(0.33 |
) |
|
$ |
(3.55 |
) |
|
$ |
(0.81 |
) |
|
$ |
(11.79 |
) |
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Shares used in computing basic and diluted net loss per share |
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24,516,761 |
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2,095,858 |
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24,499,316 |
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1,963,384 |
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See accompanying notes.
4
GENOMIC HEALTH, INC.
Consolidated Statements of Cash Flows
(In thousands)
(Unaudited)
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Nine Months Ended |
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September 30, |
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2006 |
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2005 |
|
Operating activities |
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Net loss |
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$ |
(19,925 |
) |
|
$ |
(23,144 |
) |
Adjustments to reconcile net loss to net cash used in operating activities: |
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Depreciation and amortization |
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|
1,752 |
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|
1,106 |
|
Employee stock-based compensation |
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1,973 |
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|
792 |
|
Non-employee stock-based compensation expense |
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|
70 |
|
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|
91 |
|
Gain on disposal of property and equipment |
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(31 |
) |
Changes in assets and liabilities: |
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Accounts receivable |
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(1,593 |
) |
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Employee note receivable |
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|
37 |
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|
57 |
|
Prepaid expenses and other assets |
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|
(455 |
) |
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|
(2,464 |
) |
Accounts payable |
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|
331 |
|
|
|
(172 |
) |
Lease incentive obligations |
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|
763 |
|
|
|
|
|
Accrued expenses and other liabilities |
|
|
164 |
|
|
|
850 |
|
Accrued compensation |
|
|
731 |
|
|
|
160 |
|
Accrued license fees |
|
|
250 |
|
|
|
158 |
|
Deferred revenues |
|
|
923 |
|
|
|
200 |
|
|
|
|
|
|
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|
Net cash used in operating activities |
|
|
(14,979 |
) |
|
|
(22,397 |
) |
|
|
|
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Investing activities |
|
|
|
|
|
|
|
|
Purchase of property and equipment |
|
|
(6,385 |
) |
|
|
(1,917 |
) |
Purchase of short-term investments |
|
|
(14,329 |
) |
|
|
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|
Maturities of short-term investments |
|
|
43,291 |
|
|
|
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|
Restricted cash |
|
|
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|
|
(500 |
) |
|
|
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|
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|
Net cash provided by (used) in investing activities |
|
|
22,577 |
|
|
|
(2,417 |
) |
|
|
|
|
|
|
|
Financing activities |
|
|
|
|
|
|
|
|
Proceeds from notes payable |
|
|
910 |
|
|
|
3,705 |
|
Principal payments of notes payable |
|
|
(891 |
) |
|
|
(186 |
) |
Net proceeds from issuance of common stock |
|
|
109 |
|
|
|
247 |
|
|
|
|
|
|
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|
Net cash provided by financing activities |
|
|
128 |
|
|
|
3,766 |
|
|
|
|
|
|
|
|
Net increase
(decrease) in cash and cash equivalents |
|
|
7,726 |
|
|
|
(21,048 |
) |
Cash and cash equivalents at the beginning of period |
|
|
18,839 |
|
|
|
38,275 |
|
|
|
|
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|
Cash
and cash equivalents at the end of period |
|
$ |
26,565 |
|
|
$ |
17,227 |
|
|
|
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|
Supplemental disclosure of cash flow information |
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Cash paid for interest |
|
$ |
105 |
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$ |
162 |
|
See accompanying notes.
5
GENOMIC HEALTH, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2006
(Unaudited)
Note 1. Organization and Summary of Significant Accounting Policies
Genomic Health, Inc. (the Company) was incorporated in Delaware in August 2000. The Company
was organized to deliver individualized genomic information to patients and their physicians to
improve the quality of treatment decisions for patients with cancer.
Since the Companys inception in 2000, the focus of its operations has consisted principally
of the development and commercialization of initial products, raising capital, establishing
facilities and recruiting personnel. Our first test, Oncotype DX, is used for early stage
breast cancer patients to predict the likelihood of cancer recurrence, the likelihood of patient
survival within 10 years of diagnosis and the likelihood of chemotherapy benefit. The Company has
incurred significant losses and expects to incur additional losses in
for at least the next few years as
commercial and development efforts continue.
Initial Public Offering
On October 4, 2005, the Company completed an initial public offering of 5,016,722 shares of
its common stock at $12.00 per share. Net proceeds from the offering after deducting underwriting
discounts, commissions and expenses were $53.5 million. On the closing of the Companys initial
public offering, all of the convertible preferred stock outstanding automatically converted into
16,160,273 shares of common stock and a dividend of 654,046 common shares was distributed to
stockholders.
An additional $5.0 million was raised on October 4, 2005, through the private sale of 416,666
shares of common stock to Incyte Corporation, a related party.
Reverse Stock Split
On September 23, 2005, the Company effected a 1-for-3 reverse split of its common stock. All
common share and per share amounts have been retroactively restated in the accompanying
consolidated financial statements and notes for all periods presented.
Dividend
On September 8, 2005, the Board of Directors of the Company declared a conditional dividend of
791,210 shares of common stock, which was allocated upon the closing of the Companys initial
public offering on a pro rata basis to all of the Companys stockholders and option holders of
record as of September 28, 2005. The Company issued 740,030 shares to its stockholders pursuant to
this dividend at the closing of the initial public offering on October 4, 2005, less an aggregate
of 86 shares for which cash was paid in lieu of fractional interests, and the number of shares
underlying outstanding stock options was increased by approximately 51,080 shares, less any
fractional shares resulting from such adjustment. The dividend has been given retroactive effect in
the accompanying consolidated financial statements.
Basis of Presentation
The accompanying unaudited consolidated financial statements as of September 30, 2006 and for
the three and nine months ended September 30, 2006 have been prepared on the same basis as the
annual financial statements. The unaudited consolidated balance sheet as of September 30, 2006 and
consolidated statements of operations for the three and nine months ended September 30, 2006 and
2005 and the consolidated statements of cash flows for the nine months ended September 30, 2006 and
2005 are unaudited, but include all adjustments, consisting only of normal recurring adjustments,
which we consider necessary for a fair presentation of the financial position, operating results
and cash flows for the periods presented. The results for the three and nine months ended September
30, 2006 are not necessarily indicative of results to be expected for the year ended December 31,
2006 or for any future interim period. The consolidated balance sheet at December 31, 2005 has been
derived from audited statements. However, it does not include all of the information and notes
required by accounting principles generally accepted in the United States for complete consolidated
financial statements. The accompanying consolidated financial statements should be read in
conjunction with the consolidated financial statements and notes thereto included in the Companys
Annual Report on Form 10-K for the year ended December 31, 2005.
6
Stock-based Compensation
On January 1, 2006, the Company adopted Statement of Financial Accounting Standards No. 123
(revised 2004), Share-Based Payment (FAS 123R), which addresses the accounting for stock-based
payment transactions whereby an entity receives employee services in exchange for equity
instruments, including stock options. FAS 123R eliminates the ability to account for stock-based
compensation transactions using the intrinsic value method under Accounting Principles Board
Opinion (APB) No. 25, and instead requires that such transactions be accounted for using a
fair-value based method. The Company has elected to use the modified prospective transition method
as permitted under FAS 123R and, accordingly, prior periods have not been restated to reflect the
impact of FAS 123R. The modified prospective transition method requires that stock-based
compensation expense be recorded for all new and unvested stock options that are ultimately
expected to vest as the requisite service is rendered beginning on January 1, 2006.
Equity instruments granted to nonemployees are valued using the Black-Scholes method and
accounted for as prescribed by FAS 123R and Emerging Issues Task Force (EITF) Consensus No.
96-18, Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or
in Conjunction with Selling, Goods or Services, and will be subject to periodic revaluation over
their vesting terms.
Recent Accounting Pronouncements
In September 2006, the Financial Accounting Standards Board (FASB) issued Statement of
Financial Accounting Standards No. 157, Fair Value Measurements. This pronouncement defines fair
value, establishes a framework for measuring fair value and expands disclosures about fair value
measurements. This Statement is effective for fiscal years beginning after November 15, 2007. The
Company is in the process of determining the impact that SFAS No. 157 will have on its financial
condition, results of operations and cash flows.
In July 2006, the FASB issued FASB Interpretation (FIN) No. 48, Accounting for Uncertainty
in Income Taxes. FIN No. 48 clarifies the accounting for uncertainty in income taxes recognized in
an enterprises financial statements in accordance with SFAS No. 109, Accounting for Income Taxes.
FIN No. 48 prescribes a recognition threshold and measurement attribute for the financial statement
recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN
No. 48 is effective for fiscal years beginning after December 15, 2006. The adoption of this
bulletin is not expected to have a material effect on the Companys consolidated financial
statements.
Note
2. Net Loss Per Share and Comprehensive Loss
Net Loss Per Share
Basic net loss per share is calculated by dividing the net loss by the weighted-average number
of common shares outstanding for the period without consideration for potential common shares.
Diluted net loss per share is computed by dividing the loss by the weighted-average number of
common shares outstanding for the period less the weighted average unvested common shares subject
to repurchase and dilutive potential common shares for the period determined using the
treasury-stock method. For purposes of this calculation, preferred stock and options to purchase
stock are considered to be potential common shares and are only included in the calculation of
diluted loss per share when their effect is dilutive.
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|
Three Months Ended |
|
|
Nine Months Ended |
|
|
|
September 30 |
|
|
September 30 |
|
|
|
2006 |
|
|
2005 |
|
|
2006 |
|
|
2005 |
|
|
|
(In thousands, except share and per share data) |
|
|
|
|
|
|
|
(Unaudited) |
|
|
|
|
|
Numerator: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss |
|
$ |
(8,180 |
) |
|
$ |
(7,446 |
) |
|
$ |
(19,925 |
) |
|
$ |
(23,144 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Denominator: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted-average net common shares
outstanding for basic and diluted
loss per common share |
|
|
24,516,761 |
|
|
|
2,095,858 |
|
|
|
24,449,316 |
|
|
|
1,963,384 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic and diluted net loss per share |
|
$ |
(0.33 |
) |
|
$ |
(3.55 |
) |
|
$ |
(0.81 |
) |
|
$ |
(11.79 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Historical outstanding dilutive
securities not included in diluted
net loss per share calculation |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Preferred stock |
|
|
|
|
|
|
16,160,273 |
|
|
|
|
|
|
|
16,160,273 |
|
Options to purchase common stock |
|
|
2,206,736 |
|
|
|
1,265,313 |
|
|
|
2,206,736 |
|
|
|
1,265,313 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2,206,736 |
|
|
|
17,425,586 |
|
|
|
2,206,736 |
|
|
|
17,425,586 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Comprehensive Loss
The Company reports comprehensive loss and its components as part of total stockholders
equity.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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|
|
|
Three Months Ended |
|
|
Nine Months Ended |
|
|
|
September 30, |
|
|
September 30, |
|
|
|
2006 |
|
|
2005 |
|
|
2006 |
|
|
2005 |
|
|
|
|
|
|
|
(In thousands) |
|
|
|
|
|
|
|
|
|
|
|
(Unaudited) |
|
|
|
|
|
Net loss |
|
$ |
(8,180 |
) |
|
$ |
(7,446 |
) |
|
$ |
(19,925 |
) |
|
$ |
(23,144 |
) |
Unrealized gain on available-for-sale securities |
|
|
47 |
|
|
|
|
|
|
|
52 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Comprehensive loss |
|
$ |
(8,133 |
) |
|
$ |
(7,446 |
) |
|
$ |
(19,873 |
) |
|
$ |
(23,144 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
7
Note 3. Commercial Technology and Licensing Agreements
The Company is a party to various agreements under which it licenses technology on a
nonexclusive basis in the field of human diagnostics. Access to these licenses enables the Company
to process its laboratory tests for Oncotype DX. Costs recorded under these agreements for the
three months ended September 30, 2006 and 2005 and the nine months ended September 30, 2006 and
2005 were $541,000, $11,000, $1,529,000, and $486,000, respectively, and were included in cost of
product revenues.
Note 4. Commitments
Notes Payable
In March 2005, the Company entered into an arrangement to finance the acquisition of
laboratory equipment, computer hardware and software, leasehold improvements and office equipment.
In connection with this arrangement, the Company granted the lender a security interest in the
assets purchased with the borrowed amounts. The Company could not prepay any amounts owing under
the arrangement until April 2006, at which point it could prepay all, but not part, of the amounts
outstanding under the arrangement so long as it also pays a 6% premium on the outstanding principal
balance. This premium is reduced to 5% of the outstanding principal balance in April 2007 and 4% of
the outstanding principal balance in April 2008. In March 2006, the Company increased the amount
borrowed under this financing arrangement by $910,000.
As of September 30, 2006, the Companys aggregate commitments under its financing arrangement
were as follows:
|
|
|
|
|
|
|
Annual |
|
|
|
Payment |
|
|
|
Amounts |
|
|
|
(In thousands) |
|
|
|
(Unaudited) |
|
Years Ending December 31, 2006 (remainder of the year) |
|
$ |
428 |
|
2007 |
|
|
1,713 |
|
2008 |
|
|
1,563 |
|
2009 |
|
|
528 |
|
|
|
|
|
Total minimum payments |
|
|
4,232 |
|
Less: interest portion |
|
|
(540 |
) |
|
|
|
|
Present value of net minimum payments |
|
|
3,692 |
|
Less: current portion of obligations |
|
|
(1,384 |
) |
|
|
|
|
Long-term obligations |
|
$ |
2,308 |
|
|
|
|
|
Note. 5 Stock-Based Compensation
2005 Stock Incentive Plan
On September 8, 2005, the Board of Directors approved the 2005 Stock Incentive Plan (the 2005
Plan) that was later approved by the Companys stockholders. The Company has reserved 5,000,000
shares of the Companys common stock for issuance under the
8
2005 Plan. The 2005 Plan became effective upon the closing of the Companys initial public
offering on October 4, 2005. Pursuant to the 2005 Plan, stock options, restricted shares, stock
units, and stock appreciation rights may be granted to employees, consultants, and outside
directors of the Company. Options granted may be either incentive stock options or nonstatutory
stock options.
Stock options are governed by stock option agreements between the Company and recipients of
stock options. Incentive stock options may be granted under the 2005 Plan at an exercise price of
not less than 100% of the fair market value of the common stock on the date of grant, determined by
the Compensation Committee of the Board of Directors. Nonstatutory stock options may be granted
under the 2005 Plan at an exercise price of not less than 80% of the fair market value of the
common stock on the date of grant, determined by the Compensation Committee of the Board of
Directors. Options become exercisable and expire as determined by the Compensation Committee,
provided that the term of incentive stock options may not exceed 10 years from the date of grant.
Stock option agreements may provide for accelerated exercisability in the event of an optionees
death, disability, or retirement or other events.
Under the 2005 Plan, each outside director who joins the board after the effective date of the
2005 Plan will receive an automatic nonstatutory stock option grant that vests at a rate of 25% at
the end of the first year, with the remaining balance vesting monthly over the next three years. On
the first business day following the annual meeting of the Companys stockholders, each outside
director who is continuing board service and who was not initially elected to the board at the
annual meeting will receive an additional nonstatutory stock option grant, which will vest in full
immediately prior to the next annual meeting of the Companys stockholders. Nonstatutory stock
options granted to outside directors must have an exercise price equal to 100% of the fair market
value of the common stock on the date of grant. Nonstatutory stock options terminate on the earlier
of the day before the tenth anniversary of the date of grant or the date twelve months after
termination of the outside directors service as a member of the board of directors.
Restricted shares, stock appreciation rights, and stock units granted under the 2005 Plan are
governed by restricted stock agreements, SAR agreements, and stock unit agreements between the
Company and recipients of the awards. Terms of the agreements are determined by the Compensation
Committee.
2001 Stock Incentive Plan
The Companys 2001 Stock Incentive Plan (the 2001 Plan) was terminated upon completion of
the Companys initial public offering in October 2005. No shares of common stock are available
under the 2001 Plan other than to satisfy exercises of stock options granted under the 2001 Plan
prior to its termination. Under the 2001 Plan, incentive stock options and nonstatutory stock
options were granted to employees, officers, and directors of, or consultants to, the Company and
its affiliates. Options granted under the 2001 Plan expire no later than 10 years from the date of
grant.
Adoption of FAS 123R
Employee stock-based compensation expense recognized for the three and nine months ended
September 30, 2006 was calculated based on awards ultimately expected to vest and has been reduced
for estimated forfeitures. FAS 123R requires forfeitures to be estimated at the time of grant and
revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. The
Company recorded employee stock-based compensation expense of $790,000 and $2.0 million for the
three and nine months ended September 30, 2006, respectively, as a result of the adoption of FAS
123R. The following table presents the impact of the adoption of FAS 123R on selected statements of
operations line items for the three and nine months ended September 30, 2006:
|
|
|
|
|
|
|
|
|
|
|
For the Three |
|
|
For the Nine |
|
|
|
Months Ended |
|
|
Months Ended |
|
|
|
September 30, 2006 |
|
|
September 30, 2006 |
|
|
|
(In thousands) |
|
|
|
(Unaudited) |
|
Cost of product revenues |
|
$ |
47 |
|
|
$ |
111 |
|
Research and development |
|
|
202 |
|
|
|
557 |
|
Selling and marketing |
|
|
218 |
|
|
|
533 |
|
General and administrative |
|
|
323 |
|
|
|
772 |
|
|
|
|
|
|
|
|
Total |
|
$ |
790 |
|
|
$ |
1,973 |
|
|
|
|
|
|
|
|
9
As a result of adopting FAS 123R on January 1, 2006, the Companys net loss for the three and
nine months ended September 30, 2006 was $518,000 and $1,150,000 higher, respectively, than if it
had continued to account for stock-based compensation under APB No. 25. Basic and diluted net loss
per share for the three and nine months ended September 30, 2006 was $0.02 and $0.05 higher,
respectively, than if the Company had continued to account for stock-based compensation under APB
No. 25
Stock-based compensation expense resulting from the adoption of FAS 123R represents expense
related to stock options granted during the first nine months of 2006, as well as stock options
granted prior to, but not yet vested as of, January 1, 2006. As of September 30, 2006, total
compensation expense related to non-vested stock options not yet recognized was $8.6 million, which
is expected to be allocated to expenses over a remaining vesting period of 34 months.
Pro Forma Information for Period Prior to Adoption of FAS 123R
The following pro forma net loss and loss per share were determined as if the Company had
accounted for employee stock-based compensation for its employee stock option plans under the fair
value method prescribed by FAS 123:
|
|
|
|
|
|
|
|
|
|
|
Three Months |
|
|
Nine Months |
|
|
|
Ended |
|
|
Ended |
|
|
|
September 30, 2005 |
|
|
September 30, 2005 |
|
|
|
(In thousands, except per share amounts) |
|
|
|
(Unaudited) |
|
Net loss as reported |
|
$ |
(7,446 |
) |
|
$ |
(23,144 |
) |
Add: Total stock-based employee compensation expense included in net loss |
|
|
282 |
|
|
|
792 |
|
Deduct: Total stock-based employee compensation expense determined under
the fair-value based method for all awards |
|
|
(371 |
) |
|
|
(1,008 |
) |
|
|
|
|
|
|
|
Net loss |
|
$ |
(7,535 |
) |
|
$ |
(23,360 |
) |
|
|
|
|
|
|
|
Net loss per share: |
|
|
|
|
|
|
|
|
Basic and diluted, as reported |
|
$ |
(3.55 |
) |
|
$ |
(11.79 |
) |
|
|
|
|
|
|
|
Basic and diluted, pro forma |
|
$ |
(3.59 |
) |
|
$ |
(11.90 |
) |
|
|
|
|
|
|
|
Valuation Assumptions
The employee stock-based compensation expense recognized under FAS 123R and presented in the
pro forma disclosure required under FAS 123 was determined using the Black-Scholes option valuation
model. Option valuation models require the input of highly subjective assumptions and these
assumptions can vary over time. Expected volatility is based on comparable peer data as well as the
historical volatility of the Companys stock. The expected life of options granted is estimated
based on historical option exercise and employee termination data and comparable peer data. The
risk-free interest rate is estimated using rates available on U.S. Treasury securities with a
remaining term approximating the expected life of the options. The Company uses a dividend yield of
zero as it has never paid cash dividends and does not anticipate paying cash dividends in the
foreseeable future. The weighted average fair values and the assumptions used in calculating such
values during each fiscal period are as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
Nine Months Ended |
|
|
September 30, |
|
September 30, |
|
|
2006 |
|
2005 |
|
2006 |
|
2005 |
|
|
|
|
|
|
(Unaudited) |
|
|
|
|
Volatility factor |
|
|
65 |
% |
|
|
96 |
% |
|
|
72 |
% |
|
|
84 |
% |
Risk-free interest rate |
|
|
4.59 |
% |
|
|
4.00 |
% |
|
|
4.76 |
% |
|
|
4.00 |
% |
Dividend yield |
|
|
0 |
% |
|
|
0 |
% |
|
|
0 |
% |
|
|
0 |
% |
Expected life of options in years |
|
|
5.5 |
|
|
|
4.0 |
|
|
|
5.3 |
|
|
|
4.0 |
|
Weighted-average fair value |
|
$ |
8.04 |
|
|
$ |
7.99 |
|
|
$ |
7.61 |
|
|
$ |
8.18 |
|
10
Stock Option Activity
The following is a summary of option activity for the nine months ended September 30, 2006:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Shares Available |
|
|
Shares |
|
|
Weighted Average |
|
|
|
for Grant |
|
|
Outstanding |
|
|
Exercise Price |
|
Balance at December 31, 2005 |
|
|
4,290,631 |
|
|
|
2,021,276 |
|
|
$ |
4.75 |
|
Options granted |
|
|
(304,000 |
) |
|
|
304,000 |
|
|
$ |
11.58 |
|
Options exercised |
|
|
|
|
|
|
(58,233 |
) |
|
$ |
1.88 |
|
2001 Plan shares expired |
|
|
(34,347 |
) |
|
|
|
|
|
|
|
|
Options cancelled |
|
|
60,307 |
|
|
|
(60,307 |
) |
|
$ |
5.18 |
|
|
|
|
|
|
|
|
|
|
|
|
Balance at September 30, 2006 |
|
|
4,012,591 |
|
|
|
2,206,736 |
|
|
$ |
5.77 |
|
|
|
|
|
|
|
|
|
|
|
|
The following table summarizes information concerning outstanding and exercisable options
under the 2001 and 2005 Plans as of September 30, 2006:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Options Outstanding |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted Average |
|
|
|
|
|
Options Exercisable |
|
|
|
|
|
|
|
|
|
|
|
|
Shares |
|
Years Remaining |
|
Weighted Average |
|
Number |
|
Weighted Average |
Exercise Price Range |
|
Outstanding |
|
Contractual Life |
|
Exercise Price |
|
Exercisable |
|
Exercise Price |
$ |
0.58 |
|
|
|
|
|
|
$ |
1.32 |
|
|
|
431,583 |
|
|
|
6.52 |
|
|
$ |
1.01 |
|
|
|
284,457 |
|
|
$ |
0.88 |
|
$ |
1.33 |
|
|
|
|
|
|
$ |
2.88 |
|
|
|
681,887 |
|
|
|
8.15 |
|
|
$ |
2.51 |
|
|
|
298,679 |
|
|
$ |
2.41 |
|
$ |
3.17 |
|
|
|
|
|
|
$ |
3.17 |
|
|
|
69,348 |
|
|
|
3.17 |
|
|
$ |
3.17 |
|
|
|
30,339 |
|
|
$ |
3.17 |
|
$ |
9.39 |
|
|
|
|
|
|
$ |
9.39 |
|
|
|
617,809 |
|
|
|
9.17 |
|
|
$ |
9.39 |
|
|
|
|
|
|
|
|
|
$ |
9.55 |
|
|
|
|
|
|
$ |
13.68 |
|
|
|
369,809 |
|
|
|
8.82 |
|
|
$ |
10.93 |
|
|
|
16,744 |
|
|
$ |
10.69 |
|
$ |
13.70 |
|
|
|
|
|
|
$ |
16.70 |
|
|
|
36,300 |
|
|
|
9.60 |
|
|
$ |
14.80 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2,206,736 |
|
|
|
|
|
|
|
|
|
|
|
630,219 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Deferred Stock-based Compensation
Prior to the adoption of FAS 123R, the Company presented deferred stock-based compensation as
a separate component of stockholders equity. In accordance with the provisions of FAS 123R, on
January 1, 2006 the Company reversed the balance in deferred compensation to additional paid-in
capital on its balance sheet.
Stock Options Granted to Nonemployees
The Company grants options to consultants from time to time in exchange for services performed
for the Company. No stock options were granted to consultants during the three months ended
September 30, 2006 and 2005. During the nine months ended September 30, 2006 and 2005, stock
options granted to consultants were 2,350 and 5,372, respectively. The fair value of these option
grants was determined using the Black-Scholes option pricing model using the following assumptions:
|
|
|
|
|
|
|
|
|
|
|
Nine Months |
|
Nine Months |
|
|
Ended September 30 |
|
Ended September 30 |
|
|
2006 |
|
2005 |
|
|
(Unaudited) |
Volatility factor |
|
|
72 |
% |
|
|
80 |
% |
Average risk-free interest rate |
|
|
4.76 |
% |
|
|
4.00 |
% |
Dividend yield |
|
|
0 |
% |
|
|
0 |
% |
Expected life of options |
|
10 |
years |
|
10 |
years |
In general, the options vest over the contractual period of the consulting arrangement and,
therefore, the Company will revalue the options periodically and record additional compensation
expense related to these options over the remaining vesting period. During the three months ended
September 30, 2006 and 2005 and the nine months ended September 30, 2006 and 2005, compensation
expense related to these options was $18,000, $33,000, $70,000 and $91,000, respectively.
11
ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION
The following discussion of our financial condition and results of operations should be read in
conjunction with the financial statements and notes to those statements included elsewhere in
this Quarterly Report on Form 10-Q for the quarter ended September 30, 2006 and our audited
financial statements for the year ended December 31, 2005 included in our Annual Report on
Form 10-K. This Report contains forward-looking statements within the meaning of the Private
Securities Litigation Reform Act of 1995. When used in this Report,
the words expects,
anticipates, intends, estimates, plans, believes, and similar expressions are
intended to identify forward-looking statements. These are statements that relate to
future periods and include statements about our expectation that, for the foreseeable future,
substantially all of our revenues will be derived from Oncotype DX; the factors we believe to
be driving demand for Oncotype DX and our ability to sustain such demand; our expectation that
our research and development expense levels will remain high as we seek to enhance Oncotype DX
and develop new tests; our expectation that our general and administrative, and sales and
marketing expenses and capital expenditures will increase and our anticipated uses of those
funds; the factors that may impact our financial results; the extent and duration of our
net losses; our ability to comply with the requirements of being a public company; our
ability to attract and retain experienced personnel; the impact changes in healthcare policy
or regulation could have on our business; the adequacy of our product liability insurance;
our ability to recognize revenues other than on a cash basis and when we expect we will
recognize a majority of revenues upon providing test services; the level of investment in
our sales force; our ability to expand capacity in our commercial laboratory and our expected
expanded capacity; our dependence on collaborative relationships and the success of those
relationships; whether any new tests will result from our collaborations; our belief that
clinical results support our development of an additional test for colon cancer; our
compliance with federal, state and foreign regulatory requirements; our expectation that
product revenues will increase; how we intend to spend our existing cash and cash equivalents
and how long we expect our existing cash to last; our expected future sources of cash; our
plans to borrow additional amounts under existing or new financing arrangements; the potential
impact resulting from the regulation of Oncotype DX by the U.S. Food and Drug Administration
and our belief that Oncotype DX is properly regulated under CLIA; our intention to submit
comments to FDA on its draft guidance; our beliefs regarding
reimbursement for Medicare inpatients; our plans to pursue reimbursement on a case-by-case
basis; our ability, and expectations as to the amount of time it will take, to achieve
successful reimbursement from third-party payors and government insurance programs; the
factors that will drive the establishment of coverage policies; the impact of changing
interest rates; the amount of future revenues that we may derive from Medicare patients;
increases in patient and physician demand resulting from our direct sales approach; plans
for enhancements of Oncotype DX to address different patient populations of breast cancer;
plans for, and the timeframe for the development of, future tests addressing multiple cancers
and our expectation regarding when we may move another potential test into development; the
outcome or success of clinical trials; the capacity of our laboratory to process tests; our
intellectual property and our strategies regarding filing additional patent applications to
strengthen our intellectual property rights; our expected stock-based compensation expense in
future periods; the impact of accounting pronouncements and our critical accounting policies,
estimates, models and assumptions on our financial results; our anticipated cash needs and our
estimates regarding our capital requirements and our needs for additional financing; and
anticipated trends and challenges in our business and the markets in which we operate.
Forward-looking statements are subject to risks and uncertainties that could cause actual
results to differ materially from those expected. These risks and uncertainties include, but are
not limited to, those risks discussed in Item 1A of this report, as well as our ability to develop
and commercialize new products; the risk of unanticipated delays in research and development
efforts; the risk that we may not obtain reimbursement for our existing test and any future tests
we may develop; the risks and uncertainties associated with the regulation of our products by the
U.S. Food and Drug Administration; the ability to compete against third parties; our ability to
obtain capital when needed; and our history of operating losses. These forward-looking statements
speak only as of the date hereof. The Company expressly disclaims any obligation or undertaking to
update to any forward-looking statements contained herein to reflect any change in the Companys
expectations with regard thereto or any change in events, conditions or circumstances on which any
such statement is based.
In the section of this report entitled Managements Discussion and Analysis of Financial
Condition and Results of Operations, all references to Genomic Health, we, us, or our mean
Genomic Health, Inc.
The Genomic Health logo, Oncotype, Oncotype DX and Recurrence Score are trademarks or
registered trademarks of Genomic Health, Inc. We also refer to trademarks of other corporations and
organizations in this Report.
Business Overview
We are a life science company focused on the development and commercialization of
genomic-based clinical diagnostic tests for cancer that allow physicians and patients to
make individualized treatment decisions. Our first service, Oncotype DX, is used for early stage
breast cancer patients to predict the likelihood of cancer recurrence, the likelihood of patient
survival within 10 years of diagnosis and the likelihood of chemotherapy benefit. All tumor samples
are sent to our laboratory in Redwood City, California for analysis. Upon generation and delivery
of a Recurrence Score report to the physician, we generally bill third-party payors for Oncotype
DX. The list price of our test is $3,460.
12
We launched Oncotype DX in January 2004 and initially made sales to a select number of
physicians in a few markets in the United States through a small direct sales force. Late in 2004
and continuing into 2006, we have experienced a significant increase in demand for Oncotype DX. For
the three months ended September 30, 2006, more than 3,800 tests were delivered for use in
treatment planning, compared to more than 1,850 for the three months ended September 30, 2005.
Since the commercial launch of Oncotype DX more than 17,000
tests have been delivered for
use in treatment planning by more than 4,200 physicians. We believe increased demand in 2005
resulted from the publication of our validation study in The New England Journal of Medicine and
the presentation of our chemotherapy benefit study at the San Antonio Breast Cancer Symposium, both
of which occurred in December 2004. We also experienced increased demand in the first nine months
of 2006 following clinical presentations at the San Antonio Breast Cancer Symposium in December
2005 and the Miami Breast Cancer Symposium in February 2006, as well as the May 2006 publication of
two peer-reviewed articles supporting the use and reimbursement of Oncotype DX and the expansion of
our domestic field sales organization in July 2006. However, this increased demand is not
necessarily indicative of future growth rates, and we cannot assure you that this level of
increased demand can be sustained or that future appearances or presentations at medical
conferences or publication of articles will have similar impact on demand for Oncotype DX.
Moreover, we believe that each year we may experience decreased
demand for our test in the
summer months of July and August, which may be attributed to physicians, surgeons and patients
scheduling vacations during this time. As of September 30, 2006, our laboratory had the capacity to
process up to 6,000 tests per quarter, and our current capacity plan contemplates that we will
have capability to process up to 7,000 tests per quarter by the end of 2006.
We believe the key factors that will drive broader adoption of Oncotype DX will be acceptance
by healthcare providers of its clinical benefits, demonstration of the cost-effectiveness of using
our test, expanded reimbursement by third-party payors, expansion of our sales force and
increased marketing efforts. Reimbursement of Oncotype DX by third-party payors is essential to our
commercial success. In general, clinical laboratory services, when covered, are paid under various
methodologies, including prospective payment systems and fee schedules. Reimbursement from payors
depends upon whether a test covered under the patients policy and if payment practices for
the test have been established. As a relatively new test, Oncotype DX may be considered
investigational by payors and not covered under current reimbursement policies. Until we reach
agreement with a payor on contract terms or a payor establishes a policy for payment of Oncotype
DX, we recognize revenue on a cash basis.
Upon commercialization of Oncotype DX, we began working with third-party payors to establish
reimbursement coverage policies. As of September 30, 2006, Aetna, Inc., Kaiser Foundation Health
Plan, Inc. and National Heritage Insurance Company (NHIC), the local Medicare carrier for
California with jurisdiction for claims submitted by the Company for Medicare patients, had issued
positive coverage determinations for Oncotype DX. In addition, many regional payors, including
Harvard Pilgrim Health Care, Inc., Highmark Blue Cross, Premera Blue Cross, Blue Cross/Blue Shield
of Alabama and Medical Mutual of Ohio had issued policies supporting
reimbursement for our test. Where contracts or policies are not in place, we pursue
case-by-case reimbursement. We believe that as much as 20% of our future test volume may be
derived from Medicare patients. We are working with many payors to establish policy-level
reimbursement which, if in place, should allow us to recognize revenues upon completing our test
and submitting an invoice. We do not expect to recognize the majority of revenues in this
manner until 2007, at the earliest.
In July 2005 we signed a collaborative agreement with Bristol-Myers Squibb Company and ImClone
Systems Incorporated to develop a genomic test to predict the likelihood of response to Erbitux in
colorectal cancer. Erbitux is a targeted therapy currently approved for the treatment of metastatic
colorectal cancer. The agreement provides for research funding support and milestone payments and
gives us commercial rights to diagnostic tests that may result from the collaboration.
In July 2005 we signed a collaborative agreement with National Surgical Adjuvant Breast and
Bowel Project (NSABP) to begin work in colon cancer using our clinical development platform. This
is the same group with which we conducted our successful clinical validation studies in breast
cancer which led to our development of Oncotype DX. The agreement requires certain payments to be
made by us during the research and development period. If the collaboration results in a commercial
product, we will be required to make additional payments upon first commercial sale and during
commercialization of the product. At the American Society of Clinical Oncology meeting in June
2006, a study conducted with the NSABP was presented demonstrating correlation between gene
expression and colon cancer recurrence in patients with stage II and III colon cancer treated with
surgery. These data support additional studies and development of an Oncotype DX test for
colon cancer.
We entered into collaborative agreements with Aventis, Inc., a member of the sanofi-aventis
group, and the Eastern Cooperative Oncology Group to investigate the ability of gene expression in
fixed-paraffin-embedded tissues to predict the likelihood of response to adjuvant chemotherapy,
including Taxotere, in patients with early breast cancer and zero to three involved lymph nodes.
The
13
agreements provide Genomic Health with commercial rights to diagnostic tests that may result
from the collaboration and were effective as of December 1, 2005. We began to recognize revenue
under these agreements in the first quarter of 2006.
We are conducting research and early development studies in a variety of cancers and expect to
move one of these programs into full-scale development by the end of 2006.
Since our inception, we have generated significant net losses. As of September 30, 2006, we
had an accumulated deficit of $116.1 million. We incurred a net loss of $19.9 million in the nine
months ended September 30, 2006. We expect our net losses to
continue for at least the next few years. We anticipate that a substantial portion of our capital resources and efforts over the
next several years will be focused on research and development, both
to develop additional tests
for breast cancer and to develop tests for other cancers, to scale up our
commercial organization, and for other general corporate purposes. Our financial results will be
limited by a number of factors, including establishment of coverage policies by third-party
insurers and government payors, our ability in the short term to collect from payors often
requiring a case-by-case manual appeals process, and our ability to recognize revenues other than
from cash collections on tests billed until such time as reimbursement policies or
contracts are in effect. Until we receive routine reimbursement and are able to record revenues as
tests are performed and reports delivered, we are likely to continue reporting net losses.
Financial Operations Overview
Revenues
We derive our revenues from product sales and contract research arrangements. We operate in
one industry segment. Our product revenues are derived solely from
the sale of our Oncotype DX test. Payors are billed upon generation and delivery of a Recurrence Score report to the
physician. Product revenues are recorded on a cash basis unless a contract or policy is in place
with the payor at the time of billing and collectibility is reasonably assured. Contract revenues
are derived from studies conducted with biopharmaceutical and pharmaceutical companies and are
recorded on an accrual basis as contractual obligations are completed.
Cost of Product Revenues
Cost of product revenues represents the cost of materials, direct labor, costs associated with
processing tissue samples including histopathology, anatomical pathology, paraffin extraction,
reverse transcription polymerase chain reaction, or RT-PCR, and quality control analyses, license
fees and delivery charges necessary to render an individualized test result. Costs associated with
performing our test are recorded as tests are processed. License fees are recorded at the
time product revenues are recognized or in accordance with other contractual obligations. License
fees represent a significant component of our cost of product revenues and are expected to remain
so for the foreseeable future.
Research and Development Expenses
Research and development expenses represent costs incurred to develop our technology and to
carry out our clinical studies to validate our multi-gene tests and include salaries and
benefits, allocated overhead and facility occupancy costs, contract services and other outside
costs, and costs to acquire in-process research and development projects and technologies that have
no alternative future use. Research and development expenses also include costs related to
activities performed under contracts with biopharmaceutical and pharmaceutical companies.
We charge all research and development expenses to operations as they are incurred. All
potential future product programs outside of breast cancer are in the clinical research phase, and
the earliest we expect another cancer program to reach the clinical development stage is in late
2006. However, the expected time frame that a product related to one of these other cancers can be
brought to market is uncertain given the technical challenges and clinical variables that exist
between different types of cancers.
We do not record or maintain information regarding costs incurred in research and development
on a program or project specific basis. Our research and development staff and associated
infrastructure resources are deployed across several programs. Many of our costs are thus not
attributable to individual programs. We believe that allocating costs on the basis of time incurred
by our employees does not accurately reflect the actual costs of a project.
14
As a result of the uncertainties discussed above, we are unable to determine the duration and
completion costs of our research and development programs or when, if ever, and to what extent we
will receive cash inflows from the commercialization and sale of a product.
Selling and Marketing Expenses
Our selling and marketing expenses consist primarily of personnel costs and education and
promotional expenses associated with Oncotype DX. These expenses include the costs of educating
physicians, laboratory personnel and other healthcare professionals regarding our genomic
technologies, how our Oncotype DX test was developed and validated and the value of the
quantitative information that Oncotype DX provides. Selling and marketing expenses also include the
costs of sponsoring continuing medical education, medical meeting participation and dissemination
of our scientific and economic publications related to Oncotype DX.
General and Administrative Expenses
Our general and administrative expenses consist primarily of personnel related costs, legal
costs, including intellectual property, accounting costs and other professional and administrative
costs.
Critical Accounting Policies and Significant Judgments and Estimates
This discussion and analysis of our financial condition and results of operations is based on
our consolidated financial statements, which have been prepared in accordance with U.S. generally
accepted accounting principles. The preparation of these financial statements requires management
to make estimates and judgments that affect the reported amounts of assets, liabilities and
expenses and the disclosure of contingent assets and liabilities at the date of the financial
statements, as well as revenues and expenses during the reporting periods. We evaluate our
estimates and judgments on an ongoing basis. We base our estimates on historical experience and on
various other factors we believe are reasonable under the circumstances, the results of which form
the basis for making judgments about the carrying value of assets and liabilities that are not
readily apparent from other sources. Actual results could therefore differ materially from those
estimates under different assumptions or conditions.
We believe the following critical accounting policies reflect our more significant estimates
and assumptions used in the preparation of our financial statements.
Revenue Recognition
Product revenues for our first product, Oncotype DX, from the commercial launch in January
2004 through September 30, 2006, have largely been recognized on a cash basis because we have limited collection
experience and a limited number of contracts. Beginning in the fourth quarter of 2005 and
continuing through first nine months of 2006, we recognized some product revenue from private
payors on an accrual basis. In the first nine months of 2006, a portion of Medicare-related product
revenue was recognized on a accrual basis. In accordance with our
policy, revenues for tests
performed will be recognized on an accrual basis when the related costs are incurred, provided
there is a contract or coverage policy in place and the following criteria are met:
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persuasive evidence that an arrangement exists; |
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delivery has occurred or services rendered; |
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the fee is fixed or determinable; and |
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collectability is reasonably assured. |
Determination of the last two criteria is based on managements judgment regarding the nature of
the fee charged for products or services delivered and the collectability of those fees.
We generally bill third-party payors for Oncotype DX upon generation and delivery of a
Recurrence Score report to the physician. As such, we take assignment of benefits and the risk of
collection with the third-party payor. We usually bill the patient directly for amounts owed after
multiple requests for payment have been denied or only partially paid by the insurance carrier. As
a relatively new
15
test, Oncotype DX may be considered investigational by payors and not covered under their
reimbursement policies. Consequently, we pursue case-by-case reimbursement where policies are not
in place or payment history has not been established.
Contract revenues are derived from studies conducted with biopharmaceutical and pharmaceutical
companies and are recognized on a contract specific basis. Under certain contracts, our input,
measured in terms of full-time equivalent level of effort or running a set of assays through our
laboratory under a contractual protocol, triggers payment obligations and revenues are recognized
as costs are incurred or assays are processed. Certain contracts have payment obligations that are
triggered as milestones are complete, such as completion of a successful set of experiments. In
these cases, revenues are recognized when the milestones are achieved.
Stock-based Compensation Expense
On
January 1, 2006, we adopted Statement of Financial Accounting Standards No. 123
(revised 2004), Share-Based Payment (or FAS 123R). FAS 123R, which addresses the accounting for
stock-based payment transactions whereby an entity receives employee services in exchange for
equity instruments, including stock options. FAS 123R eliminates the ability to account for
stock-based compensation transactions using the intrinsic value method under Accounting Principles
Board Opinion (APB) No. 25, and instead requires that such transactions be accounted for using a
fair-value based method. SFAS 123R is a new and very complex accounting standard, the application
of which requires significant judgment and the use of estimates, particularly surrounding
assumptions used in determining fair value using the Black-Scholes valuation method, such as stock
price volatility and expected options lives, as well as expected option forfeiture rates, to value
equity-based compensation. There is little historical evidence or guidance available with respect
to developing these assumptions and models. Expected volatility is based on
comparable peer data as well as historical volatility of our stock. The expected life of options
granted is estimated based on historical option exercise and employee termination data.
We
have elected the modified prospective transition method as permitted under FAS 123R
and, accordingly, prior periods have not been restated to reflect the impact of FAS 123R. The
modified prospective transition method requires that stock-based compensation expense be recorded
for all new and unvested stock options that are ultimately expected to vest as the requisite
service is rendered beginning on January 1, 2006. Stock-based compensation expense resulting from
the adoption of FAS 123R represents expense related to stock options granted during the first nine
months of 2006, as well as stock options granted prior to, but not yet vested as of, January 1,
2006. As of September 30, 2006, total compensation expense related to non-vested stock options not
yet recognized was $8.6 million, which is expected to be recognized over a period of 34 months.
Refer to Note 5 of notes to our consolidated financial statements included elsewhere in this report
for further information.
Clinical Collaborator Costs
We enter into collaboration and clinical trial agreements with clinical collaborators and
record these costs as research and development expenses. We record accruals for estimated study
costs comprised of work performed by our collaborators under contract terms.
In addition to costs for research and development, under one of our collaboration agreements,
we make annual payments resulting from the commercial launch of Oncotype DX. These payments are
recorded in cost of product revenues as a license payment. Expense is recorded ratably over the
year before the relevant payment is made. However, either party may terminate the agreement upon 30
days prior written notice. If this collaborative arrangement were not cancelable, a liability for
the entire stream of remaining payments of $2.2 million would be recorded, payments would be made
annually and expense would be recognized ratably through 2011.
16
Results of Operations
Three Months Ended September 30, 2006 and 2005
Revenues. Total revenues were $7.1 million for the three months ended September 30, 2006
compared to $1.6 million for the comparable period in 2005. Product revenues from Oncotype DX were
$6.9 million for the three months ended September 30, 2006 compared to $1.4 million for the
comparable period in 2005. This increase resulted from increased demand and progress made in
reimbursement for our test. Approximately 47% of product revenue for the three months ended
September 30, 2006 was recorded on an accrual basis compared to none for the three months ended
September 30, 2005. The balance of product revenue was recognized upon cash collection. Product
revenue from Medicare was $2.8 million, representing 41% of total product revenue for the three
months ended September 30, 2006, compared to none for the three months ended September 30, 2005.
Contract revenues were $191,000 for the three months ended September 30, 2006, compared to
$216,000 for the comparable period in 2005. Contract revenues represent studies assessing our gene
expression technology or collaborative work in gene selection and protocol design with our
pharmaceutical partners
Cost of Product Revenues. For the three months ended September 30, 2006, cost of product
revenues was $2.7 million for Oncotype DX, consisting of tissue sample processing costs of $2.1
million and license fees of $541,000. For the three months ended September 30, 2005, cost of
product revenues was $1.6 million, consisting of tissue sample processing costs of $1.4 million and
license fees of $194,000. Test volume for the three months ended September 30, 2006 was
more than two times greater than for the comparable period in 2005, resulting in a decrease in the
cost per test delivered. During the three months ended September 30, 2006 and 2005, we
recorded tissue sample processing costs for Oncotype DX that included direct material costs, direct
labor costs, equipment costs, shipping costs and other infrastructure costs. All costs recorded for
tissue sample processing in those periods represent the cost of all
the tests processed
regardless of whether revenue was recognized with respect to that test. License fees were
recorded in cost of product revenues for contractual obligations and royalties due on product
revenues.
Research and Development Expenses. Research and development expenses increased to $3.2 million
for the three months ended September 30, 2006, from $2.3 million for the comparable period in 2005.
The increase in research and development expenses was primarily due to a $370,000 increase in
personnel related costs, a $214,000 increase in reagents and lab supplies expense, and a $176,000
increase in infrastructure-related expense. We expect that our research and development expenses
will increase as investment in tests for cancers, including cancers other than breast
cancer, continue.
Selling and Marketing Expenses. Selling and marketing expenses increased to $6.4 million for
the three months ended September 30, 2006 from $3.4 million for the comparable period in 2005. The
$3.0 million increase in selling and marketing expenses was primarily due to a $1.4 million
increase in personnel related costs, mostly to expand our domestic field sales organization, a $1.1
million increase in promotional field and marketing expense and $293,000 in higher travel expenses
associated with field sales personnel. We expect that selling and marketing expenses will continue
to increase in future periods. We expanded our domestic field sales force to support Oncotype DX in
July 2006, which is an acceleration over our previous planned expansion timeline.
General and Administrative Expenses. General and administrative expenses increased to $3.5
million for the three months ended September 30, 2006 from $1.7 million for the comparable period
in 2005. The $1.7 million increase in general and administrative expenses was primarily due to a
$662,000 increase in personnel costs, an increase of $347,000 in legal and accounting fees,
$237,000 in higher billing and collection fees paid to third-party billing and collection vendors,
and an increase of $107,000 in insurance related costs. We expect general and administrative
expenses to continue to increase as we spend more on fees for billing and collections as our
revenue grows as well as costs associated with regulatory matters and other costs associated with
the growth of our business.
Interest Income. Interest income was $594,000 for the three months ended September 30, 2006
compared to $156,000 for the comparable period in 2005. The increase in interest income was due to
higher average cash balances and higher market yields.
Interest Expense. Interest expense was $105,000 for the three months ended September 30, 2006
compared to $91,000 for the comparable period in 2005, reflecting interest expense incurred on our
equipment financing line established at the end of March 2005 under which draws have been made and
interest expense has been incurred.
17
Results of Operations
Nine Months Ended September 30, 2006 and 2005
Revenues. Total revenues were $20.6 million for the nine months ended September 30, 2006
compared to $3.3 million for the comparable period in 2005. Product revenues from Oncotype DX were
$18.9 million for the nine months ended September 30, 2006 compared to $3.0 million for the
comparable period in 2005. Approximately 35% of product revenue in the nine months ended September
30, 2006 was recorded on an accrual basis compared to none for the nine months ended September 30,
2005. Product revenue from Medicare was $9.6 million, representing 51% of total product revenue for
the nine months ended September 30, 2006, compared to none for the first nine months of 2005. This
increase is a result of the February 27, 2006 effective coverage date for Medicare patients and the receipt
of payments for tests provided to Medicare patients prior to the effective coverage date.
Contract revenues were $1.6 million for the nine months ended September 30, 2006 compared to
$316,000 for the comparable period in 2005. Increased contract revenue reflects the initiation of
the collaboration with sanofi-aventis and the Eastern Cooperative Oncology Group as well as ongoing
work with Bristol-Myers Squibb and ImClone Systems.
Cost of Product Revenues. For the nine months ended September 30, 2006, cost of product
revenues was $7.2 million for Oncotype DX, consisting of tissue sample processing costs of $5.7
million and license fees of $1.5 million. For the nine months ended September 30, 2005, cost of
product revenues was $4.5 million, consisting of tissue sample processing costs of $4.0 million and
license fees of $486,000. During the nine months ended September 30, 2006 and 2005, we recorded
tissue sample processing costs for Oncotype DX that included direct material costs, direct labor
costs, equipment costs, shipping costs and other infrastructure costs.
Research and Development Expenses. Research and development expenses increased to $8.7 million
for the nine months ended September 30, 2006 from $7.0 million for the comparable period in 2005.
The increase was primarily due to a $1.4 million increase in personnel and related costs, a
$274,000 increase in collaboration expense and a $269,000 increase in depreciation expense,
partially offset by a $312,000 decrease in license fee expense.
Selling and Marketing Expenses. Selling and marketing expenses increased to $17.3 million for
the nine months ended September 30, 2006 from $10.8 million for the comparable period in 2005. The
$6.5 million increase was primarily due the expansion of our salesforce to support Oncotype DX,
including a $3.6 million increase in personnel related costs, a $1.5 million increase in
promotional field and marketing expense and $795,000 in higher travel expenses.
General and Administrative Expenses. General and administrative expenses increased to $8.9
million for the nine months ended September 30, 2006 from $4.5 million for the comparable period in
2005. The $4.4 million increase was due to a $1.4 million increase in personnel costs, $851,000 in
higher billing and collection fees paid to third-party billing and collection vendors, an increase
of $849,000 in legal and accounting fees, $390,000 in higher depreciation expense, an increase of
$342,000 in insurance related costs and $284,000 in higher public company costs, including investor
relations.
Interest Income. Interest income was $1.9 million for the nine months ended September 30, 2006
compared to $549,000 for the comparable period in 2005, reflecting higher average cash balances and
higher market yields.
Interest Expense. Interest expense was $312,000 for the nine months ended September 30, 2006
compared to $162,000 for the comparable period in 2005, reflecting interest expense incurred on our
equipment financing line established at the end of March 2005.
Liquidity and Capital Resources
Since our inception in August 2000, we have incurred significant losses and, as of September
30, 2006, we had an accumulated deficit of approximately $116.1 million. We have not yet achieved
profitability and anticipate that we will continue to incur net losses for at least the next few years.
We expect that our research and development, selling and marketing and general and administrative
expenses will continue to grow and, as a result, we will need to generate significant product
revenues to achieve profitability. We may never achieve profitability.
Sources of Liquidity
Since our inception through September 30, 2006, we have received net proceeds of $103.2
million from the sale of preferred stock and $360,000 from the issuance of common stock to
employees, consultants and directors in connection with the exercise of stock
18
options. In October 2005, we completed our initial public offering and a concurrent private
placement of our common stock, resulting in net proceeds of $58.5 million. Purchases of equipment
and leasehold improvements have been partially financed through loans. At September 30, 2006 and
December 31, 2005, cash, cash equivalents and short-term investments were $48.3 million and $69.5
million, respectively, and debt under our equipment loan was $4.2 million and $4.3 million,
respectively.
Cash Flows
As of September 30, 2006, cash, cash equivalents and short-term investments were $48.3
million, compared to $17.2 million at September 30, 2005. This increase of $31.2 million was
primarily due to net proceeds from our initial public offering of $53.5 million, proceeds from a
sale of common stock of $5.0 million and net proceeds from our equipment loans of $173,000,
partially offset by cash used in operating activities of $21.1 million and purchases of property,
equipment and leasehold improvements of $7.4 million.
Net cash used in operating activities was $15.0 million for the nine months ended September
30, 2006, compared to $22.4 million for the nine months ended September 30, 2005. The decrease in
cash used in operating activities of $7.4 million was primarily due to a decrease in net loss of
$3.2 million and a decrease in prepaid expenses and other assets of $2.0 million. The
decrease in net loss resulted from an increase in revenues for Oncotype DX and from pharmaceutical
collaborators of $17.3 million and an increase in net interest income of $1.2 million, partially
offset by an increase in operating expenses of $15.3 million.
Net cash provided by investing activities was $22.6 million for the nine months ended
September 30, 2006, compared to $2.4 million cash used in investing activities for the nine months
ended September 30, 2005. This increase of $25.0 million in cash provided was due to a decrease of
$29.0 million in short-term investments offset by an increase in cash used of $4.5 million for the
acquisition of property and equipment and for leasehold improvements.
Net cash provided by financing activities during the nine months ended September 30, 2006 was
$128,000, compared to $3.8 million for the nine months ended September 30, 2005. These amounts
included net proceeds from our equipment loan of $19,000 and $3.5 million for the nine months ended
September 30, 2006 and 2005, respectively.
Off-Balance Sheet Activities
As of September 30, 2006, we have not engaged in any off-balance sheet activities.
Contractual Obligations
As of September 30, 2006, we had the following contractual commitments:
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Payments Due by Period |
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More |
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Less than |
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than 5 |
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Total |
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1 Year |
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1-3 Years |
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3-5 Years |
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Years |
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(In thousands) |
Notes payable obligations |
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$ |
4,232 |
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$ |
1,713 |
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$ |
2,489 |
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$ |
30 |
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$ |
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Operating lease obligations |
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4,330 |
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766 |
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1,603 |
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1,614 |
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347 |
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Total |
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$ |
8,562 |
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$ |
2,479 |
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$ |
4,092 |
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$ |
1,644 |
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$ |
347 |
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In addition to the above, we are required to make a series of annual payments under one of our
collaboration agreements beginning on the date that we commercially launched Oncotype DX. The
initial payment of $150,000 was made in January 2004. For a period of seven years on each
anniversary of this first payment, we are required to make additional payments in increasing
amounts. A payment of $150,000 was made in January 2005 and $300,000 was made in January 2006. We
are required to make additional payments of $300,000 in 2007, and $475,000 in each of 2008 through
2011.
In March 2005, we entered into an arrangement to finance the acquisition of laboratory
equipment, computer hardware and software, leasehold improvements and office equipment. In
connection with this arrangement, we granted the lender a security interest in the assets purchased
with the borrowed amounts. We could not prepay any amounts owed until April 2006, at which point we
could prepay all, but not part, of the amounts owing under the arrangement so long as we also pay a
6% premium on the remaining payments. This premium is reduced to 5% in 2007 and 4% in 2008. As of
September 30, 2006, borrowings under this arrangement were $4.2 million at an annual interest rate
of 10.23%, 10.30%, 10.49%, 10.56%, 10.65%, 11.01% or 11.18%, depending on the
19
applicable note. As of September 30, 2006, we are required to make payments under this
arrangement of $428,000 in 2006, $1.7 million in 2007, $1.6 million in 2008 and $528,000 in 2009,
all of which are included in the table above.
As of September 30, 2006, we leased approximately 48,000 square feet of laboratory and office
space under a lease we entered into in September 2005. The lease has a term of six years. As of
September 30, 2006, we are required to make aggregate rent payments under the lease agreement of
$178,000 in 2006, $730,000 in 2007, $753,000 in 2008, $779,000 in 2009 and $1.8 million in 2010 and
thereafter, all of which are included in the table above.
Operating Capital and Capital Expenditure Requirements
We expect to continue to incur substantial operating losses in the future and to make capital
expenditures to keep pace with the expansion of our research and development programs and to scale
up our commercial operations. It may take several years to move any one of a number of product
candidates in clinical research through the development phase and validation phase to
commercialization. We expect that our cash and cash equivalents will be used to fund working
capital and for capital expenditures and other general corporate purposes, such as licensing
technology rights, partnering arrangements for our tests outside the United States or reduction
of debt obligations. We have spent approximately $5.4 million through September 30, 2006 for
facility expansion and improvements and are considering an additional
approximately $1.7 million in
further facility improvements. We may also use cash to acquire or invest in complementary
businesses, technologies, services or products. We have no current plans, agreements or commitments
with respect to any such acquisition or investment, and we are not currently engaged in any
negotiations with respect to any such transaction.
The amount and timing of actual expenditures may vary significantly depending upon a number of
factors, such as the progress of our product development, regulatory requirements,
commercialization efforts, the amount of cash used by operations and progress in reimbursement. We
expect that we will receive limited payments for Oncotype DX billings in the foreseeable future. As
reimbursement contracts with third-party payors are put into place, we expect an increase in the
number and level of payments received for Oncotype DX billings.
We currently anticipate that our cash, cash equivalents and short-term investments, together
with collections for Oncotype DX and amounts available under our equipment credit facility, will be
sufficient to fund our operations and facility expansion plans for at least the next 12 months. We
cannot be certain that any of our reimbursement contract programs or development of future products
will be successful or that we will be able to raise sufficient additional funds to see these
programs through to a successful result.
Our future funding requirements will depend on many factors, including the following:
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the rate of progress in establishing reimbursement arrangements with third-party payors; |
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the cost of expanding our commercial and laboratory operations, including our selling and marketing efforts; |
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the rate of progress and cost of research and development activities associated with
expansion of Oncotype DX for breast cancer; |
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the rate of progress and cost of research and development activities associated with
products in the research phase focused on cancers, other than breast cancer; |
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the cost of acquiring or achieving access to tissue samples and technologies; |
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the costs of filing, prosecuting, defending and enforcing any patent claims and other intellectual property rights; |
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the effect of competing technological and market developments; |
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the cost and delays in product development as a result of any changes in regulatory
oversight applicable to our products; and |
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the economic and other terms and timing of any collaborations, licensing or other
arrangements into which we may enter. |
Until we can generate a sufficient amount of product revenues to finance our cash
requirements, which we may never do, we expect to finance future cash needs primarily through
public or private equity offerings, debt financings, borrowings or strategic
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collaborations. The issuance of equity securities may result in dilution to stockholders. We
do not know whether additional funding will be available on acceptable terms, or at all. If we are
not able to secure additional funding when needed, we may have to delay, reduce the scope of or
eliminate one or more research and development programs or selling and marketing initiatives. In
addition, we may have to work with a partner on one or more of our product development programs or
market development programs, which would lower the economic value of those programs to our company.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
We are exposed to interest rate risk primarily through our investment portfolio. Our
marketable securities consist of high-quality debt securities with maturities beyond 90 days at the
date of acquisition, which mature within one year or less. As of September 30, 2006, we had cash,
cash equivalents and short-term investments totaling $48.3 million. Our investment policy calls for
investments in short-term, low risk, investment-grade instruments. Based on our portfolio content
and our ability to hold investments to maturity, we believe that, if market interest rates were to
increase immediately and uniformly by 10% from levels at September 30, 2006, the decline in fair
value would not be material.
ITEM 4. CONTROLS AND PROCEDURES.
(a) Evaluation of disclosure controls and procedures. We maintain disclosure controls and
procedures, as such term is defined in Rule 13a-15(e) under the Securities Exchange Act of 1934
(the Exchange Act), that are designed to ensure that information required to be disclosed by us
in reports that we file or submit under the Exchange Act is recorded, processed, summarized, and
reported within the time periods specified in Securities and Exchange Commission rules and forms,
and that such information is accumulated and communicated to our management, including our chief
executive officer and chief financial officer, as appropriate, to allow timely decisions regarding
required disclosure. In designing and evaluating our disclosure controls and procedures, management
recognized that disclosure controls and procedures, no matter how well conceived and operated, can
provide only reasonable, not absolute, assurance that the objectives of the disclosure controls and
procedures are met. Our disclosure controls and procedures have been designed to meet reasonable
assurance standards. Additionally, in designing disclosure controls and procedures, our management
necessarily was required to apply its judgment in evaluating the cost-benefit relationship of
possible disclosure controls and procedures. The design of any disclosure controls and procedures
also is based in part upon certain assumptions about the likelihood of future events, and there can
be no assurance that any design will succeed in achieving its stated goals under all potential
future conditions.
Based on their evaluation as of the end of the period covered by this Quarterly Report on Form
10-Q, our chief executive officer and chief financial officer have concluded that, as of such date,
our disclosure controls and procedures were effective at the reasonable assurance level.
(b) Changes in internal controls. There was no change in our internal control over financial
reporting (as defined in Rule 13a-15(f) under the Exchange Act) identified in connection with the
evaluation described in Item 4(a) above that occurred during our last fiscal quarter that has
materially affected, or is reasonably likely to materially affect, our internal control over
financial reporting.
PART II. OTHER INFORMATION
ITEM 1A. RISK FACTORS.
We are an early stage company with a history of losses, and we expect to incur net losses for the
foreseeable future.
We have incurred substantial net losses since our inception. For the year ended December 31,
2005 and the nine months ended September 30, 2006, we incurred net losses of $31.4 million and
$19.9 million, respectively. From our inception in August 2000 through September 30, 2006, we had
an accumulated deficit of approximately $116.1 million. To date, we have not, and we may never,
achieve revenues sufficient to offset expenses. We expect to devote substantially all of our
resources to continue commercializing our existing test, Oncotype DX, and to develop future
tests.
We expect to incur additional losses this year and in future years, and we may never achieve
profitability. In addition, we have only recently begun to commercialize Oncotype DX and do not
expect our losses to be substantially mitigated by revenues from Oncotype DX or future products, if
any, for a number of years.
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We expect to continue to incur significant research and development expenses, which may make it
difficult for us to achieve profitability.
In recent years, we have incurred significant costs in connection with the development of
Oncotype DX. Our research and development expenses were $9.5 million for the year ended December
31, 2005 and $8.7 million for the nine months ended September 30, 2006. We expect our research and
development expense levels to remain high for the foreseeable future as we seek to enhance our
existing test and develop new tests. As a result, we will need to generate significant
revenues in order to achieve profitability. Our failure to achieve profitability in the future
could cause the market price of our common stock to decline.
If third-party payors, including managed care organizations and Medicare, do not provide
reimbursement or rescind their reimbursement policies for Oncotype DX, its commercial success
could be compromised.
Oncotype DX has a list price of $3,460. Physicians and patients may decide not to order
Oncotype DX unless third-party payors, such as managed care organizations as well as government
payors such as Medicare and Medicaid, pay a substantial portion of the tests price. There is
significant uncertainty concerning third-party reimbursement of any test incorporating new
technology, including Oncotype DX. Reimbursement by a third-party payor may depend on a number of
factors, including a payors determination that tests using our technologies are:
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medically necessary, |
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cost-effective, and |
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supported by peer-reviewed publications. |
Since each payor makes its own decision as to whether to establish a policy to reimburse,
seeking these approvals is a time-consuming and costly process. To date, we have secured
policy-level reimbursement approval from only a limited number of third-party payors and have a
limited number of approvals for state Medicaid programs. We cannot be certain that coverage for
Oncotype DX will be provided in the future by any third-party payors.
Several
entities conduct technology assessments of new medical tests and devices and
provide the results of their assessments for informational purposes to other parties. These
assessments may be used by third-party payors and health care providers such as Blue Cross and Blue
Shield, which provide healthcare coverage for nearly one-third of all Americans, as grounds to deny
coverage for a test or procedure. Oncotype DX has received negative assessments and may receive
additional negative assessments in the future. For example, in early 2005, the Medical Advisory
Panel of the Blue Cross and Blue Shield Associations Technology Evaluation Center, a technology
assessment group, concluded that the existing clinical data in support of Oncotype DX did not meet
the panels technology criteria for clinical effectiveness and appropriateness.
In January
2006, the California Medicare contractor with responsibility for processing and paying
claims submitted by us released a local coverage determination providing coverage for Oncotype
DX when used in accordance with the terms of the determination. The local coverage determination
is effective for Oncotype DX tests provided on or after February 27, 2006. Until recently
there has been some question as to whether claims for Oncotype DX tests performed on Medicare
beneficiaries who were hospital inpatients at the time the tumor tissue samples were obtained
may be billed by us to the California Medicare contractor or must be incorporated in the payment
that the hospital receives for their services related to the patients breast cancer.
As of September 30, 2006, the volume of patients who fell into this category represented an
insignificant portion of our total testing population.
Based
on a final rule with comment period posted November 1, 2006 on the
Centers for Medicare/Medicaid Services (CMS) website, it is now clear that effective January 2007, we will be
permitted to submit claims to the California Medicare contractor for the Oncotype DX tests
performed on Medicare beneficiaries who were hospital inpatients at the time the tumor tissue
samples were obtained, provided the test was ordered at least 14 days following the date of the
patients discharge from the hospital and where other specified conditions are met. Whether we
will be able to seek retrospective application of this final rule and submit claims for similarly
situated patients who received the Oncotype DX test between February 27, 2006 and January 2007
remains unclear. Beginning in January 2007, we expect to begin making arrangements with hospitals for
payment of the test when performed for the very small portion of Medicare beneficiaries who are
hospital inpatients at the time specimens are collected but who do not meet criteria under the
final rule. Finally, we are seeking confirmation from CMS that the final rule does not apply to
the Oncotype DX tests performed on tumor tissue samples obtained while the patient is a hospital
outpatient, and that the tests performed on tissue samples taken from hospital outpatients is
reimbursable under Part B of the Medicare program, regardless of when the testing of such tissue
samples takes place.
Insurers, including managed care organizations as well as government payors such as Medicare,
have increased their efforts to control the cost, utilization and delivery of health care services.
From time to time, Congress has considered and implemented changes in the Medicare fee schedules in
conjunction with budgetary legislation, most recently in
February 2006. Further reductions of
reimbursement for Medicare services may be implemented from time to time. Reductions in the
reimbursement rates of other third-
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party payors have occurred and may occur in the future. These measures have resulted in
reduced prices, added costs and decreased test service utilization for the clinical laboratory
industry.
If we are unable to obtain reimbursement approval from private payors and Medicare and
Medicaid programs for Oncotype DX, or if the amount reimbursed is inadequate, our ability to
generate revenues from Oncotype DX could be limited. Even if we are being reimbursed, insurers may
cancel their contracts with us at any time or stop paying for our test service which would reduce
our revenue.
If the U.S. Food and Drug Administration, or FDA, were to begin regulating our test, we
could be forced to stop sales of Oncotype DX, we could experience significant delays in
commercializing any future products, we could incur substantial costs and time delays associated
with meeting requirements for pre-market approval or we could experience decreased demand for or
reimbursement of our test.
Clinical
laboratory tests like Oncotype DX are regulated under the Clinical Laboratory
Improvement Amendments of 1988, or CLIA, as administered through the
CMS, as well as by applicable state laws. Diagnostic kits that are sold and distributed
through interstate commerce are regulated as medical devices by the FDA. Clinical laboratory tests
that are developed and validated by a laboratory for its own use are called home brew tests. Most
home brew tests currently are not subject to FDA regulation, although reagents or software provided
by third parties and used to perform home brew tests may be subject to regulation. We believe that
Oncotype DX is not a diagnostic kit and also believe that it is a home brew test. As a result, we
believe Oncotype DX should not be subject to regulation under
established FDA policies. The container we
provide for collection and transport of tumor samples from a pathology laboratory to our laboratory
is a medical device subject to FDA regulation but is currently exempt
from pre-market review by the
FDA.
In January 2006, we received a letter from the FDA regarding Oncotype DX inviting us to meet
with the FDA to discuss the nature and appropriate regulatory status of and the least burdensome
ways that we may fulfill any FDA pre-market review requirements that may apply. In
September 2006, the FDA issued draft guidance on a new class of tests called In Vitro
Diagnostic Multivariate Index Assays. This draft guidance, which is intended for public comment,
represents the first public discussion surrounding the FDAs position regarding the
regulation of certain laboratory-developed tests. Under this draft
guidance, Oncotype DX
could be classified as either a Class II or a Class III
medical device, which may require varying
levels of FDA pre-market review depending upon intended use and on the
level of control necessary to assure the safety and effectiveness of
the test. The draft guidance is open
for public comment until December 6, 2006, during which time we and others have the opportunity to comment on their proposed
guidelines.
We
intend to submit formal comments in response to the draft guidance and to continue our ongoing dialogue with the FDA with
respect to the regulatory status of the Oncotype DX breast
cancer tests. We have presented
information regarding Oncotype DX to the FDA and continue to
believe that our tests are
appropriately regulated under CLIA and should not require pre-market
review by the FDA. We cannot provide any assurance that FDA regulation, including
pre-market review, will not be required in the future for Oncotype
DX. If pre-market review is
required, our business could be negatively impacted until such review is completed and approval or
clearance to market is obtained, and the FDA could require that we stop selling our test
pending pre-market approval. If our test is allowed to remain on the market but there is
uncertainty about our test or if it is labeled investigational by the FDA, orders or
reimbursement may decline. The regulatory approval process may involve, among other things,
successfully completing additional clinical trials and submitting a
pre-market clearance notice or
filing a pre-market approval application with the FDA. If pre-market review is required by the FDA,
there can be no assurance that our test will be cleared or approved on a timely basis, if
at all. Ongoing compliance with FDA regulations would increase the cost of conducting our business,
subject us to inspection by the FDA and to the requirements of the FDA and penalties for failure to
comply with these requirements. Should any of the reagents obtained by us from vendors and used in
conducting our home brew test be affected by future regulatory actions, our business could
be adversely affected by those actions, including increasing cost of testing or delaying, limiting
or prohibiting the purchase of reagents necessary to perform testing.
If we were required to conduct additional clinical trials prior to marketing our test,
those trials could lead to delays or failure to obtain necessary regulatory approvals and harm our
ability to become profitable.
If
the FDA decides to regulate our test, it may require extensive pre-market clinical
testing prior to submitting a regulatory application for commercial sales. If we are required to
conduct pre-market clinical trials, whether using prospectively acquired samples or archival
samples, delays in the commencement or completion of clinical testing could significantly increase
our test development costs and delay commercialization. Many of the factors that may cause
or lead to a delay in the commencement or completion of clinical trials may also ultimately lead to
delay or denial of regulatory approval. The commencement of clinical trials may be delayed due to
insufficient patient enrollment, which is a function of many factors, including the size of the
patient population,
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the nature of the protocol, the proximity of patients to clinical sites and the eligibility
criteria for the clinical trial. We may find it necessary to engage contract research organizations
to perform data collection and analysis and other aspects of our clinical trials, which might
increase the cost and complexity of our trials. We may also depend on clinical investigators,
medical institutions and contract research organizations to perform the trials properly. If these
parties do not successfully carry out their contractual duties or obligations or meet expected
deadlines, or if the quality, completeness or accuracy of the clinical data they obtain is
compromised due to the failure to adhere to our clinical protocols or for other reasons, our
clinical trials may have to be extended, delayed or terminated. Many of these factors would be
beyond our control. We may not be able to enter into replacement arrangements without undue delays
or considerable expenditures. If there are delays in testing or approvals as a result of the
failure to perform by third parties, our research and development costs would increase, and we may
not be able to obtain regulatory approval for our test services. In addition, we may not be able to
establish or maintain relationships with these parties on favorable terms, if at all. Each of these
outcomes would harm our ability to market our test service, or to become profitable.
Complying with numerous regulations pertaining to our business is an expensive and time-consuming
process, and any failure to comply could result in substantial penalties.
We are subject to CLIA, a federal law that regulates clinical laboratories that perform
testing on specimens derived from humans for the purpose of providing information for the
diagnosis, prevention or treatment of disease. CLIA is intended to ensure the quality and
reliability of clinical laboratories in the United States by mandating specific standards in the
areas of personnel qualifications, administration, and participation in proficiency testing,
patient test service management, quality control, quality assurance and inspections. We have a
current certificate of accreditation under CLIA to perform testing. To renew this certificate, we
are subject to survey and inspection every two years. Moreover, CLIA inspectors may make random
inspections of our laboratory.
We are also required to maintain a license to conduct testing in California. California laws
establish standards for day-to-day operation of our clinical laboratory, including the training and
skills required of personnel and quality control. Moreover, several states require that we hold
licenses to test specimens from patients residing in those states. Other states have similar
requirements or may adopt similar requirements in the future. Finally, we may be subject to
regulation in foreign jurisdictions as we seek to expand international distribution of our test.
If we were to lose our CLIA accreditation or California license, whether as a result of a
revocation, suspension or limitation, we would no longer be able to sell Oncotype DX, which would
limit our revenues and harm our business. If we were to lose our license in other states where we
are required to hold licenses, we would not be able to test specimens from those states.
We are subject to other regulation by both the federal government and the states in which we
conduct our business, including:
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Medicare billing and payment regulations applicable to clinical laboratories; |
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the federal Medicare and Medicaid Anti-kickback Law and state anti-kickback prohibitions; |
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the federal physician self-referral prohibition, commonly known as the Stark Law, and the state equivalents; |
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the federal Health Insurance Portability and Accountability Act of 1996; |
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the Medicare civil money penalty and exclusion requirements; and |
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the federal civil and criminal False Claims Act. |
The risk of our being found in violation of these laws and regulations is increased by the
fact that many of them have not been fully interpreted by the regulatory authorities or the courts,
and their provisions are open to a variety of interpretations. Any action brought against us for
violation of these laws or regulations, even if we successfully defend against it, could cause us
to incur significant legal expenses and divert our managements attention from the operation of our
business. If our operations are found to be in violation of any of these laws and regulations, we
may be subject to any applicable penalty associated with the violation, including civil and
criminal penalties, damages, fines, we could be required to refund payments received by us, and we
could be required to curtail or cease our operations. Any of the foregoing consequences could
seriously harm our business and our financial results.
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Our financial results depend on sales of one test, Oncotype DX, and we will need to
generate sufficient revenues from this and other tests to run our business.
For the foreseeable future, we expect to derive substantially all of our revenues from sales
of one test, Oncotype DX. We have only been selling this test since January 2004.
We are in the early stages of research and development for other tests that we may offer as
well as for enhancements to our existing test. We are not currently able to estimate when
we may be able to commercialize tests for other cancers or whether we will be successful in
doing so. If we are unable to increase sales of Oncotype DX or to successfully develop and
commercialize other tests or enhancements, our revenues and our ability to achieve
profitability would be impaired, and the market price of our common stock could decline.
We may experience limits on our revenues if only a small number of physicians decide to order our
test.
If
medical practitioners do not order Oncotype DX or any future tests developed by us,
we will likely not be able to create demand for our products in sufficient volume for us to become
profitable. To generate demand, we will need to continue to make oncologists, surgeons and
pathologists aware of the benefits of Oncotype DX and any products we may develop in the future
through published papers, presentations at scientific conferences and one-on-one education by our
sales force. In addition, we will need to demonstrate our ability to obtain adequate reimbursement
coverage from third-party payors.
Existing guidelines and practices regarding the treatment of breast cancer recommend that
chemotherapy be considered in most cases, including many cases in which our test may
indicate, based on our clinical trial results, that chemotherapy is of little or no benefit.
Accordingly, physicians may be reluctant to order a test that may suggest recommending
against chemotherapy in treating breast cancer where current guidelines recommend consideration of
such treatment. Moreover, our test provides quantitative information not currently provided
by pathologists and it is performed at our facility rather than by the pathologist in a local
laboratory, so pathologists may be reluctant to order or support our test. These facts may
make it difficult for us to convince medical practitioners to order Oncotype DX for their patients,
which could limit our ability to generate revenues and our ability to achieve profitability.
We may experience limits on our revenues if only a small number of patients decide to use our test.
Some patients may decide not to order our test due to its list price of $3,460, part
or all of which may be payable directly by the patient if the applicable payor denies reimbursement
in full or in part. Even if medical practitioners recommend that their patients use our test, patients may still decide not to use Oncotype DX, either because they do not want to be
made aware of the likelihood of recurrence or they wish to pursue a particular course of therapy
regardless of test results. If only a small portion of the patient population decides to use our
test, we will experience limits on our revenues and our ability to achieve profitability.
If we are unable to develop products to keep pace with rapid technological, medical and
scientific change, our operating results and competitive position would be harmed.
In recent years, there have been numerous advances in technologies relating to the diagnosis
and treatment of cancer. For example, new hormonal therapies such as aromatase inhibitors are
viewed by physicians as promising therapies for breast cancer with more tolerable side effects than
those associated with tamoxifen, the hormonal therapy commonly used today in treatment. For
advanced cancer, new chemotherapeutic strategies are being developed that may increase survival
time and reduce toxic side effects. These advances require us continuously to develop new products
and enhance existing products to keep pace with evolving standards of care. Our test could
become obsolete unless we continually innovate and expand our product to demonstrate recurrence and
treatment benefit in patients treated with new therapies. New treatment therapies typically have
only a few years of clinical data associated with them, which limits our ability to perform
clinical studies and correlate sets of genes to a new treatments effectiveness. If we are unable
to demonstrate the applicability of our test to new treatments, then
sales of our test could decline, which would harm our revenues.
Our rights to use technologies licensed from third parties are not within our control, and we may
not be able to sell our products if we lose our existing rights or cannot obtain new rights on
reasonable terms.
We license from third parties technology necessary to develop our products. For example, we
license technology from Roche Molecular Systems, Inc. that we use to analyze genes for possible
inclusion in our tests and that we use in our laboratory to conduct our test. In
return for the use of a third partys technology, we may agree to pay the licensor royalties based
on sales of our products. Royalties are a component of cost of product revenues and impact the
margin on our test. We may need to
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license other technology to commercialize future products. Our business may suffer if these
licenses terminate, if the licensors fail to abide by the terms of the license or fail to prevent
infringement by third parties, if the licensed patents or other rights are found to be invalid or
if we are unable to enter into necessary licenses on acceptable terms.
Our competitive position depends on maintaining intellectual property protection.
Our ability to compete and to achieve and maintain profitability depends on our ability to
protect our proprietary discoveries and technologies. We currently rely on a combination of patent
applications, copyrights, trademarks, trade secret laws and confidentiality agreements, material
data transfer agreements, license agreements and invention assignment agreements to protect our
intellectual property rights. We also rely upon unpatented know-how and continuing technological
innovation to develop and maintain our competitive position. Patents may be granted to us jointly
with other organizations, and while we may have right of first refusal, we cannot guarantee that a
joint owner will not license rights to another party.
As of September 30, 2006, we had two issued patents, one of which was issued jointly to us and
to the NSABP. Our pending patent applications may not result in issued patents, and we cannot
assure you that our issued patent or any patents that might ultimately be issued by the U.S. Patent
and Trademark Office will protect our technology. Any patents that may be issued to us might be
challenged by third parties as being invalid or unenforceable, or third parties may independently
develop similar or competing technology that avoids our patents. We cannot be certain that the
steps we have taken will prevent the misappropriation and use of our intellectual property,
particularly in foreign countries where the laws may not protect our proprietary rights as fully as
in the United States.
From time to time, the United States Supreme Court, other federal courts or the U.S. Patent
and Trademark Office may change the standards of patentability and any such changes could have a
negative impact on our business.
We may face intellectual property infringement claims that could be time-consuming and costly to
defend and could result in our loss of significant rights and the assessment of treble damages.
We have received notices of claims of infringement, misappropriation or misuse of other
parties proprietary rights and may from time to time receive additional notices. Some of these
claims may lead to litigation. We cannot assure you that we will prevail in these actions, or that
other actions alleging misappropriation or misuse by us of third-party trade secrets, infringement
by us of third-party patents and trademarks or the validity of our patents, will not be asserted or
prosecuted against us. We may also initiate claims to defend our intellectual property.
Intellectual property litigation, regardless of outcome, is expensive and time-consuming, could
divert managements attention from our business and have a material negative effect on our
business, operating results or financial condition. If there is a successful claim of infringement
against us, we may be required to pay substantial damages (including treble damages if we were to
be found to have willfully infringed a third partys patent) to the party claiming infringement,
develop non-infringing technology, stop selling our test service or using technology that contains
the allegedly infringing intellectual property or enter into royalty or license agreements that may
not be available on acceptable or commercially practical terms, if at all. Our failure to develop
non-infringing technologies or license the proprietary rights on a timely basis could harm our
business. In addition, revising our test to include the non-infringing technologies would
require us to re-validate our test, which would be costly and time consuming. Also, we may
be unaware of pending patent applications that relate to our test. Parties making
infringement claims on future issued patents may be able to obtain an injunction that would prevent
us from selling our or using technology that contains the allegedly infringing intellectual
property, which could harm our business.
We recently entered a license agreement with Pfizer Inc. and the Wistar Institute of Anatomy
and Biology regarding a gene in the Oncotype DX gene panel, bringing to conclusion discussions
regarding the use of the gene that began in late 2004. There are a number of patents and patent
applications that may constitute prior art in the field of genomic-based diagnostics. We may be
required to pay royalties, damages and costs to firms who own the rights to these patents, or we
might be restricted from using any of the inventions claimed in those patents.
If we are unable to compete successfully, we may be unable to increase or sustain our revenues or
achieve profitability.
Our principal competition comes from existing diagnostic methods used by pathologists and
oncologists. These methods have been used for many years and are therefore difficult to change or
supplement. In addition, companies offering capital equipment and kits or reagents to local
pathology laboratories represens another source of potential competition. These kits are used
directly by the pathologist, which facilitates adoption more readily
than tests like
Oncotype DX that are performed outside the pathology laboratory. In addition, few diagnostic
methods are as expensive as Oncotype DX.
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We also face competition from companies, such as Agendia B.V., that offer products or have
conducted research to profile gene expression in breast cancer using fresh or frozen tissue.
Commercial laboratories with strong distribution networks for diagnostic tests, such as Genzyme
Corporation, Laboratory Corporation of America Holdings and Quest Diagnostics Incorporated, may
become competitors. Other potential competitors include companies that develop diagnostic tests
such as Bayer Healthcare LLC, Celera Genomics, a business segment of Applera Corporation, Roche
Diagnostics, a division of F. Hoffmann-La Roche Ltd, and Veridex LLC, a Johnson & Johnson company,
other small companies and academic and research institutions. Our competitors may invent and
commercialize technology platforms that compete with ours. In addition, in December 2005, the
federal government allocated a significant amount funding to The Cancer Genome Atlas, a project
aimed at developing a comprehensive catalog of the genetic mutations and other genomic changes that
occur in cancers and maintaining the information in a free public database. As more information
regarding cancer genomics becomes available to the public, we anticipate that more products aimed
at identifying targeted treatment options will be developed and these products may compete with
ours.
Many of our present and potential competitors have widespread brand recognition and
substantially greater financial and technical resources and development, production and marketing
capabilities than we do. Others may develop lower-priced, less complex tests that could be viewed
by physicians and payors as functionally equivalent to our test, which could force us to lower the
list price of our test and impact our operating margins and our ability to achieve profitability.
If we are unable to compete successfully against current or future competitors, we may be unable to
increase market acceptance for and sales of our test, which could prevent us from increasing or
sustaining our revenues or achieving or sustaining profitability and could cause the market price
of our common stock to decline.
Our research and development efforts will be hindered if we are not able to contract with third
parties for access to archival tissue samples.
Under standard clinical practice in the United States, tumor biopsies removed from patients
are chemically preserved and embedded in paraffin wax and stored. Our clinical development relies
on our ability to secure access to these archived tumor biopsy samples, as well as information
pertaining to their associated clinical outcomes. Others have demonstrated their ability to study
archival samples and often compete with us for access. Additionally, the process of negotiating
access to archived samples is lengthy since it typically involves numerous parties and approval
levels to resolve complex issues such as usage rights, institutional review board approval, privacy
rights, publication rights, intellectual property ownership and research parameters. If we are not
able to negotiate access to archival tumor tissue samples with hospitals and collaborators, or if
other laboratories or our competitors secure access to these samples before us, our ability to
research, develop and commercialize future products will be limited or delayed.
If we cannot maintain our current clinical collaborations and enter into new collaborations, our
product development could be delayed.
We rely on and expect to continue to rely on clinical collaborators to perform a substantial
portion of our clinical trial functions. If any of our collaborators were to breach or terminate
its agreement with us or otherwise fail to conduct its collaborative activities successfully and in
a timely manner, the research, development or commercialization of the products contemplated by the
collaboration could be delayed or terminated. If any of our collaboration agreements is terminated,
or if we are unable to renew those collaborations on acceptable terms, we would be required to seek
alternative collaborations. We may not be able to negotiate additional collaborations on acceptable
terms, if at all, and these collaborations may not be successful.
In the past, we have entered into clinical trial collaborations with highly regarded
organizations in the cancer field, including the National Surgical Adjuvant Breast and Bowel
Project, or NSABP, and Northern California Kaiser Permanente. Our success in the future depends in
part on our ability to enter into agreements with other leading cancer organizations. This can be
difficult due to internal and external constraints placed on these organizations. Some
organizations may limit the number of collaborations they have with any one company so as to not be
perceived as biased or conflicted. Organizations may also have insufficient administrative and
related infrastructure to enable collaborations with many companies at once, which can extend the
time it takes to develop, negotiate and implement a collaboration. Additionally, organizations
often insist on retaining the rights to publish the clinical data resulting from the collaboration.
The publication of clinical data in peer-reviewed journals is a crucial step in commercializing and
obtaining reimbursement for a test such as ours, and our inability to control when, if ever,
results are published may delay or limit our ability to derive sufficient revenues from any product
that may result from a collaboration.
27
From time to time we expect to engage in discussions with potential clinical collaborators
which may or may not lead to collaborations. However, we cannot guarantee that any discussions will
result in clinical collaborations or that any clinical studies which may result will be enrolled or
completed in a reasonable time frame or with successful outcomes. Once news of discussions
regarding possible collaborations are known in the medical community, regardless of whether the
news is accurate, failure to announce a collaborative agreement or the entitys announcement of a
collaboration with an entity other than us may result in adverse speculation about us, our product
or our technology, resulting in harm to our reputation and our business.
New test development involves a lengthy and complex process, and we may be unable to commercialize
any of the tests we are currently developing.
We
have multiple tests under development and devote considerable resources to research
and development. For example, we are currently conducting research on the application of our
technology to predict recurrence and the therapeutic benefit of chemotherapy in colon, prostate,
renal cell and lung cancers and melanoma. There can be no assurance that our technologies will be
capable of reliably predicting the recurrence of cancers, beyond breast cancer, with the
sensitivity and specificity necessary to be clinically and commercially useful for the treatment of
other cancers, or that we can develop those technologies at all. In addition, before we can develop
diagnostic tests for new cancers and commercialize any new products, we will need to:
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conduct substantial research and development; |
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conduct validation studies; |
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expend significant funds; and |
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develop and scale-up our laboratory processes. |
This process involves a high degree of risk and takes several years. Our product development
efforts may fail for many reasons, including:
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failure of the product at the research or development stage; |
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difficulty in accessing archival tissue samples, especially tissue samples with known clinical results; or |
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lack of clinical validation data to support the effectiveness of the product. |
Few research and development projects result in commercial products, and success in early
clinical trials often is not replicated in later studies. At any point, we may abandon development
of a product candidate or we may be required to expend considerable resources repeating clinical
trials, which would adversely impact the timing for generating potential revenues from those
product candidates. In addition, as we develop products, we will have to make significant
investments in product development, marketing and selling resources. If a clinical validation study
fails to demonstrate the prospectively defined endpoints of the study, we would likely abandon the
development of the product or product feature that was the subject of the clinical trial, which
could harm our business.
The loss of key members of our senior management team or our inability to retain highly skilled
scientists, clinicians and salespeople could adversely affect our business.
Our success depends largely on the skills, experience and performance of key members of our
executive management team. The efforts of each of these persons will be critical to us as we
continue to develop our technologies and testing processes and as we attempt to transition to a
company with more than one commercialized product. If we were to lose one or more of these key
employees, we may experience difficulties in competing effectively, developing our technologies and
implementing our business strategies.
Our research and development programs and commercial laboratory operations depend on our
ability to attract and retain highly skilled scientists and technicians, including geneticists,
licensed laboratory technicians, chemists and engineers. We may not be able to attract or retain
qualified scientists and technicians in the future due to the intense competition for qualified
personnel among life science businesses, particularly in the San Francisco Bay Area. We also face
competition from universities and public and private research institutions in recruiting and
retaining highly qualified scientific personnel. In addition, our success depends on our ability to
attract and retain salespeople with extensive experience in oncology and close relationships with
medical oncologists, surgeons,
28
pathologists and other hospital personnel. We may have difficulties locating, recruiting or
retaining qualified salespeople, which could cause a delay or decline in the rate of adoption of
our products. If we are not able to attract and retain the necessary personnel to accomplish our
business objectives, we may experience constraints that will adversely affect our ability to
support our discovery, development and sales programs. All of our employees are at-will employees,
which means that either we or the employee may terminate their employment at any time.
If our sole laboratory facility becomes inoperable, we will be unable to perform our test
and our business will be harmed.
We
do not have redundant laboratory facilities. We perform all of our
diagnostic testing in
our laboratory located in Redwood City, California. Redwood City is situated on or near earthquake
fault lines. Our facility and the equipment we use to perform our
tests would be costly to
replace and could require substantial lead time to repair or replace. The facility may be harmed or
rendered inoperable by natural or man-made disasters, including earthquakes, flooding and power
outages, which may render it difficult or impossible for us to
perform our tests for some
period of time. The inability to perform our tests may result in the loss of customers or
harm our reputation, and we may be unable to regain those customers in the future. Although we
possess insurance for damage to our property and the disruption of our business, this insurance may
not be sufficient to cover all of our potential losses and may not continue to be available to us
on acceptable terms, or at all.
In order to rely on a third party to perform our tests, we could only use another
facility with established state licensure and CLIA accreditation under the scope of which Oncotype
DX could be performed following validation and other required procedures. We cannot assure you that
we would be able to find another CLIA-certified facility willing to adopt Oncotype DX and comply
with the required procedures, or that this laboratory would be willing to perform the tests
for us on commercially reasonable terms. In order to establish a redundant laboratory facility, we
would have to spend considerable time and money securing adequate space, constructing the facility,
recruiting and training employees, and establishing the additional operational and administrative
infrastructure necessary to support a second facility. Additionally, any new clinical laboratory
facility opened by us would be subject to certification under CLIA and licensed by several states,
including California and New York, which can take a significant amount of time and result in delays
in our ability to begin operations.
Changes in healthcare policy could subject us to additional regulatory requirements that may
interrupt commercialization of Oncotype DX and increase our costs.
Healthcare policy has been a subject of extensive discussion in the executive and legislative
branches of the federal and many state governments. We developed our commercialization strategy for
Oncotype DX based on existing healthcare policies. Changes in healthcare policy, such as the
creation of broad limits for diagnostic products in general or requirements that Medicare patients
pay for portions of tests or services received, could substantially interrupt the sales of Oncotype
DX, increase costs and divert managements attention. For example, in 1989, the U.S. Congress
passed federal self-referral prohibitions commonly known as the Stark Law, significantly
restricting, regulating and changing laboratories relationships with physicians. We cannot predict
what changes, if any, will be proposed or adopted or the effect that such proposals or adoption may
have on our business, financial condition and results of operations.
We rely on a sole supplier for some of our laboratory instruments and may not be able to find
replacements in the event our sole supplier no longer supplies that equipment.
We rely solely on Applied Biosystems, a division of Applera Corporation, to supply some of the
laboratory equipment on which we perform our tests. We periodically forecast our needs for
laboratory equipment and enter into standard purchase orders with Applied Biosystems based on these
forecasts. We believe that there are relatively few equipment manufacturers other than Applied
Biosystems that are currently capable of supplying the equipment necessary for Oncotype DX. Even if
we were to identify other suppliers, there can be no assurance that we will be able to enter into
agreements with such suppliers on a timely basis on acceptable terms, if at all. If we should
encounter delays or difficulties in securing from Applied Biosystems the quality and quantity of
equipment we require for Oncotype DX, we may need to reconfigure our test service process, which
would result in delays in commercialization or an interruption in sales. If any of these events
occur, our business and operating results could be harmed. Additionally, if Applied Biosystems
deems us to have become uncreditworthy, it has the right to require alternative payment terms from
us, including payment in advance. We are also required to indemnify Applied Biosystems against any
damages caused by any legal action or proceeding brought by a third party against Applied
Biosystems for damages caused by our failure to obtain required approval with any regulatory
agency.
29
If we are unable to support demand for our test, our business may suffer.
We have limited experience in processing our test and even more limited experience in
processing large volumes of tests. We recently completed the expansion of our clinical
laboratory facilities and have ramped up our testing capacity. We have begun to implement
increases in scale and related processing, customer service, billing and systems process
improvements, and to expand our internal quality assurance program to support testing on a larger
scale. We will also need additional certified laboratory scientists and other scientific and
technical personnel to process our tests. We cannot assure you that any increases in scale,
related improvements and quality assurance will be successfully implemented or that appropriate
personnel will be available. Failure to implement necessary procedures or to hire the necessary
personnel could result in higher cost of processing or an inability to meet market demand. Since we
have limited experience handling large volumes of Oncotype DX tests, there can be no
assurance that we will be able to perform tests on a timely basis at a level consistent
with demand. If we encounter difficulty meeting market demand for Oncotype DX, our reputation could
be harmed and our future prospects and our business could suffer.
We may be unable to manage our future growth effectively, which would make it difficult to execute
our business strategy.
Future growth will impose significant added responsibilities on management, including the need
to identify, recruit, train and integrate additional employees. In addition, rapid and significant
growth will place strain on our administrative and operational infrastructure, including customer
service and our clinical laboratory. Our ability to manage our operations and growth will require
us to continue to improve our operational, financial and management controls, reporting systems and
procedures. If we are unable to manage our growth effectively, it may be difficult for us to
execute our business strategy.
If we were sued for product liability, we could face substantial liabilities that exceed our
resources.
The marketing, sale and use of our test could lead to the filing of product liability
claims if someone were to allege that our test failed to perform as it was designed. We may
also be subject to liability for errors in the information we provide to customers or for a
misunderstanding of, or inappropriate reliance upon, the information we provide. A product
liability claim could result in substantial damages and be costly and time consuming for us to
defend. Although we believe that our existing product liability insurance is adequate, we cannot
assure you that our insurance would fully protect us from the financial impact of defending against
product liability claims. Any product liability claim brought against us, with or without merit,
could increase our insurance rates or prevent us from securing insurance coverage in the future.
Additionally, any product liability lawsuit could cause injury to our reputation, result in the
recall of our products, or cause current collaborators to terminate existing agreements and
potential collaborators to seek other partners, any of which could impact our results of
operations.
If we use biological and hazardous materials in a manner that causes injury, we could be liable
for damages.
Our activities currently require the controlled use of potentially harmful biological
materials, hazardous materials and chemicals and may in the future require the use of radioactive
compounds. We cannot eliminate the risk of accidental contamination or injury to employees or third
parties from the use, storage, handling or disposal of these materials. In the event of
contamination or injury, we could be held liable for any resulting damages, and any liability could
exceed our resources or any applicable insurance coverage we may have. Additionally, we are subject
on an ongoing basis to federal, state and local laws and regulations governing the use, storage,
handling and disposal of these materials and specified waste products. The cost of compliance with
these laws and regulations might be significant and could negatively affect our operating results.
Our dependence on distributors for foreign sales of Oncotype DX could limit or prevent us from
selling our test in foreign markets and from realizing long-term international revenue
growth.
International sales as a percentage of net revenues are expected to remain minimal in the near
term as we focus our efforts on the sale of Oncotype DX in the United States. We currently depend
on one third-party distributor to sell Oncotype DX in Israel. Over the long term, we intend to grow
our business internationally, and to do so we will need to attract additional distributors to
expand the territories in which we sell Oncotype DX. Distributors may not commit the necessary
resources to market and sell Oncotype DX to the level of our expectations. If current or future
distributors do not perform adequately, or we are unable to locate distributors in particular
geographic areas, we may not realize long-term international revenue growth.
30
We may acquire other businesses or form joint ventures that could harm our operating results,
dilute your ownership of us, increase our debt or cause us to incur significant expense.
As part of our business strategy, we may pursue acquisitions of complementary businesses and
assets, as well as technology licensing arrangements. We also may pursue strategic alliances that
leverage our core technology and industry experience to expand our product offerings or
distribution. We have no experience with respect to acquiring other companies and limited
experience with respect to the formation of collaborations, strategic alliances and joint ventures.
If we make any acquisitions, we may not be able to integrate these acquisitions successfully into
our existing business, and we could assume unknown or contingent liabilities. Any future
acquisitions by us also could result in significant write-offs or the incurrence of debt and
contingent liabilities, any of which could harm our operating results. Integration of an acquired
company also may require management resources that otherwise would be available for ongoing
development of our existing business. We may not identify or complete these transactions in a
timely manner, on a cost-effective basis, or at all, and we may not realize the anticipated
benefits of any acquisition, technology license, strategic alliance or joint venture.
To finance any acquisitions, we may choose to issue shares of our common stock as
consideration, which would dilute your interest in us. If the price of our common stock is low or
volatile, we may not be able to acquire other companies for stock. Alternatively, it may be
necessary for us to raise additional funds for acquisitions through public or private financings.
Additional funds may not be available on terms that are favorable to us, or at all.
Our inability to raise additional capital on acceptable terms in the future may limit our ability
to develop and commercialize new tests and technologies.
We expect capital outlays and operating expenditures to increase over the next several years
as we expand our infrastructure, commercial operations and research and development activities.
Specifically, we may need to raise capital to, among other things:
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sustain commercialization of our initial test or enhancements
to that test; |
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increase our selling and marketing efforts to drive market adoption and address competitive developments; |
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further expand our clinical laboratory operations; |
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expand our technologies into other areas of cancer; |
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fund our clinical validation study activities; |
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expand our research and development activities; |
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acquire or license technologies; and |
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finance capital expenditures and our general and administrative expenses. |
Our present and future funding requirements will depend on many factors, including:
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the level of research and development investment required to maintain and improve our technology position; |
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costs of filing, prosecuting, defending and enforcing patent claims and other intellectual property rights; |
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our need or decision to acquire or license complementary technologies or acquire complementary businesses; |
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changes in product development plans needed to address any difficulties in commercialization; |
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competing technological and market developments; |
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the rate of progress in establishing reimbursement arrangements with third-party payors; and |
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changes in regulatory policies or laws that affect our operations. |
31
If we raise funds by issuing equity securities, dilution to our stockholders could result. Any
equity securities issued also may provide for rights, preferences or privileges senior to those of
holders of our common stock. If we raise funds by issuing debt securities, these debt securities
would have rights, preferences and privileges senior to those of holders of our common stock, and
the terms of the debt securities issued could impose significant restrictions on our operations. If
we raise funds through collaborations and licensing arrangements, we might be required to
relinquish significant rights to our technologies or products, or grant licenses on terms that are
not favorable to us. If adequate funds are not available, we may have to scale back our operations
or limit our research and development activities.
Our operating results may fluctuate, which could cause our stock price to decrease.
Fluctuations in our operating results may lead to fluctuations, including declines, in our
share price. Our operating results and our share price may fluctuate from period to period due to a
variety of factors, including:
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demand by physicians and patients for Oncotype DX; |
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reimbursement decisions by third-party payors and announcements of those decisions; |
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clinical trial results and publication of results in peer-reviewed journals or the presentation at medical conferences; |
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the inclusion or exclusion of our tests in large clinical trials conducted by others; |
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new or less expensive services or new technology introduced or offered by our competitors or us; |
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the level of our development activity conducted for new tests, and our success in commercializing these developments; |
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the level of our spending on Oncotype DX commercialization efforts, licensing and
acquisition initiatives, clinical trials, and internal research and development; |
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changes in the regulatory environment, including any decision from FDA to regulate our activities; |
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the impact of seasonality on our business; |
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changes in recommendations of securities analysts or lack of analyst coverage; |
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failure to meet analyst expectations regarding our operating results; |
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additions or departures of key personnel; and |
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general market conditions |
Variations in the timing of our future revenues and expenses could also cause significant
fluctuations in our operating results from period to period and may result in unanticipated earning
shortfalls or losses. In addition, the Nasdaq National Market in general, and the market for life
science companies in particular, have experienced significant price and volume fluctuations that
have often been unrelated or disproportionate to the operating performance of those companies.
In addition, future sales of common stock by our officers, including sales under Rule 10b5-1
sales plans, sales of substantial amounts of our common stock by insiders or other stockholders in
the public market or otherwise or the awareness that a large number of shares is available for
sale, could adversely affect the market price of our common stock.
We must implement additional and expensive finance and accounting systems, procedures and controls
as we grow our business and organization and to satisfy new reporting requirements, which will
increase our costs and require additional management resources.
As a public reporting company, we are required to comply with the Sarbanes-Oxley Act of 2002
and the related rules and regulations of the Securities and Exchange Commission, including expanded
disclosures and accelerated reporting requirements and
32
more complex accounting rules. We are required to comply with Section 404 of the
Sarbanes-Oxley Act as of December 31, 2006. Compliance with Section 404 and other requirements will
increase our costs and require additional management resources. We recently have been upgrading our
finance and accounting systems, procedures and controls and will need to continue to implement
additional finance and accounting systems, procedures and controls as we grow our business and
organization and to satisfy new reporting requirements. If we are unable to complete the required
Section 404 assessment as to the adequacy of our internal control over financial reporting, if we
fail to maintain or implement adequate controls, or if our independent registered public accounting
firm is unable to provide us with an unqualified report as to the effectiveness of our internal
control over financial reporting as of the date of our first Form 10-K for which compliance is
required, our ability to obtain additional financing could be impaired. In addition, investors
could lose confidence in the reliability of our internal control over financial reporting and in
the accuracy of our periodic reports filed under the Exchange Act. A lack of investor confidence in
the reliability and accuracy of our public reporting could cause our stock price to decline.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.
On September 28, 2005, a Registration Statement on Form S-1 (File No. 333-126626) relating to
our initial public offering was declared effective by the SEC. The closing was October 4, 2005; the
net offering proceeds to us were approximately $53.5 million. Through September 30, 2006, $21.7
million of the net proceeds were used to build our commercial capabilities in selling and marketing
related to Oncotype DX, $11.1 million were used to fund research and development programs for
Oncotype DX and in other cancers, and $5.4 million were used to expand facilities and laboratory
operations capacity and for information systems infrastructure. A portion of the net proceeds may
also be used for working capital and general corporate purposes and to acquire or invest in
complementary businesses, technologies, services or products. Pending use for these or other
purposes, net proceeds have been invested in interest bearing, investment-grade securities.
ITEM 6. EXHIBITS
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Exhibit |
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Number |
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Description |
31.1
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Rule 13a-14(a) Certification of Chief Executive Officer. |
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31.2
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Rule 13a-14(a) Certification of Chief Financial Officer. |
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32.1#
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Statement of Chief Executive Officer under Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. §1350). |
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32.2#
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Statement of Chief Financial Officer under Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. §1350). |
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# |
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In accordance with Item 601(b)(32)(ii) of Regulation S-K and SEC Release Nos. 33-8238 and
34-47986, Final Rule: Managements Reports on Internal Control Over Financial Reporting and
Certification of Disclosure in Exchange Act Periodic Reports, the certifications furnished in
Exhibits 32.1 and 32.2 hereto are deemed to accompany this Form 10-Q and will not be deemed
filed for purpose of Section 18 of the Exchange Act. Such certifications will not be deemed
to be incorporated by reference into any filing under the Securities Act. |
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly
caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
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Genomic Health, Inc. |
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Date: November 14, 2006
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By:
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/s/ Randal W. Scott |
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Randal W. Scott, Ph.D. |
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Its:
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Chairman of the Board of Directors and |
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Chief Executive Officer |
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(Principal Executive Officer) |
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Date: November 14, 2006
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By:
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/s/ G. Bradley Cole |
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G. Bradley Cole |
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Its:
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Executive Vice President and Chief |
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Financial Officer (Principal Financial |
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Officer and Accounting Officer) |
34
GENOMIC HEALTH, INC.
EXHIBIT INDEX
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Exhibit |
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Number |
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Description |
31.1
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Rule 13a-14(a) Certification of Chief Executive Officer. |
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31.2
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Rule 13a-14(a) Certification of Chief Financial Officer. |
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32.1#
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Statement of Chief Executive Officer under Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. §1350). |
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32.2#
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Statement of Chief Financial Officer under Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. §1350). |
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# |
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In accordance with Item 601(b)(32)(ii) of Regulation S-K and SEC Release Nos. 33-8238 and
34-47986, Final Rule: Managements Reports on Internal Control Over Financial Reporting and
Certification of Disclosure in Exchange Act Periodic Reports, the certifications furnished in
Exhibits 32.1 and 32.2 hereto are deemed to accompany this Form 10-Q and will not be deemed
filed for purpose of Section 18 of the Exchange Act. Such certifications will not be deemed
to be incorporated by reference into any filing under the Securities Act. |