UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended March 31, 2008
OR
o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to
Commission file number: 001-33753
Genoptix, Inc.
(Exact name of registrant as specified in its charter)
Delaware |
| 33-0840570 |
(State or other jurisdiction of incorporation or organization) |
| (I.R.S. Employer Identification No.) |
2110 Rutherford Road Carlsbad, CA 92008 |
(Address of principal executive offices, including zip code) |
|
(760) 268-6200 |
(Registrant’s telephone number, including area code) |
|
N/A |
(Former name, former address and former fiscal year, if changed since last report) |
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer | o |
| Accelerated filer o | ||
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Non-accelerated filer | ý | (Do not check if a smaller reporting company) | Smaller reporting company o |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x
As of April 30, 2008, 16,343,189 shares of the registrant’s common stock, $0.001 par value per share, were outstanding.
GENOPTIX, INC.
QUARTERLY REPORT ON FORM 10-Q
For the Quarterly Period Ended March 31, 2008
TABLE OF CONTENTS
| ||
3 | ||
| Condensed Consolidated Balance Sheets as of March 31, 2008 (unaudited) and December 31, 2007 | 3 |
| Unaudited Condensed Consolidated Statements of Operations for the Three Months Ended March 31, 2008 and 2007 | 4 |
| 5 | |
| Notes to Unaudited Condensed Consolidated Financial Statements | 6 |
Management’s Discussion and Analysis of Financial Condition and Results of Operations | 16 | |
23 | ||
24 | ||
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25 | ||
43 | ||
44 | ||
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EXHIBIT 10.1 |
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EXHIBIT 10.2 |
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EXHIBIT 31.1 |
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EXHIBIT 31.2 |
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EXHIBIT 32.1 |
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2
GENOPTIX, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except par values)
|
| March 31, |
| December 31, |
| ||
|
| (unaudited) |
|
|
| ||
Assets |
|
|
|
|
| ||
Current assets: |
|
|
|
|
| ||
Cash and cash equivalents |
| $ | 31,933 |
| $ | 50,624 |
|
Investment securities available-for-sale |
| 52,729 |
| 34,836 |
| ||
Accounts receivable, net of allowance for doubtful accounts of $2,133 and $1,594 at March 31, 2008 and December 31, 2007, respectively |
| 15,213 |
| 9,013 |
| ||
Other current assets |
| 1,276 |
| 1,409 |
| ||
Total current assets |
| 101,151 |
| 95,882 |
| ||
Property and equipment, net |
| 3,096 |
| 1,950 |
| ||
Other long-term assets |
| 78 |
| — |
| ||
Total assets |
| $ | 104,325 |
| $ | 97,832 |
|
|
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|
|
|
| ||
Liabilities and Stockholders’ Equity |
|
|
|
|
| ||
Current liabilities: |
|
|
|
|
| ||
Accounts payable and accrued expenses |
| $ | 5,691 |
| $ | 4,312 |
|
Accrued compensation |
| 2,312 |
| 2,496 |
| ||
Deferred revenues |
| 68 |
| 95 |
| ||
Total current liabilities |
| 8,071 |
| 6,903 |
| ||
Deferred rent, net of current portion |
| 332 |
| 324 |
| ||
Commitments and contingencies |
|
|
|
|
| ||
Stockholders’ equity: |
|
|
|
|
| ||
Preferred stock, $0.001 par value; 5,000 shares authorized; no shares issued and outstanding at March 31, 2008 and December 31, 2007 |
| — |
| — |
| ||
Common stock, $0.001 par value; 100,000 shares authorized; 16,343 and 16,095 shares issued and outstanding at March 31, 2008 and December 31, 2007, respectively |
| 16 |
| 16 |
| ||
Additional paid-in capital |
| 132,853 |
| 132,532 |
| ||
Accumulated other comprehensive income |
| 42 |
| 53 |
| ||
Accumulated deficit |
| (36,989 | ) | (41,996 | ) | ||
Total stockholders’ equity |
| 95,922 |
| 90,605 |
| ||
Total liabilities and stockholders’ equity |
| $ | 104,325 |
| $ | 97,832 |
|
See accompanying notes to the unaudited condensed consolidated financial statements.
3
GENOPTIX, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
(in thousands, except per share data)
|
| Three Months Ended |
| ||||
|
| March 31, |
| ||||
|
| 2008 |
| 2007 |
| ||
Revenues |
| $ | 22,298 |
| $ | 10,651 |
|
Cost of revenues |
| 9,175 |
| 4,637 |
| ||
Gross profit |
| 13,123 |
| 6,014 |
| ||
Operating expenses: |
|
|
|
|
| ||
Sales and marketing expenses |
| 4,261 |
| 2,321 |
| ||
General and administrative expenses |
| 4,388 |
| 2,134 |
| ||
Research and development expenses |
| 317 |
| 178 |
| ||
Total operating expenses |
| 8,966 |
| 4,633 |
| ||
Income from operations |
| 4,157 |
| 1,381 |
| ||
Interest income |
| 931 |
| 48 |
| ||
Interest expense |
| — |
| (82 | ) | ||
Other income |
| 28 |
| 29 |
| ||
Income before income taxes |
| 5,116 |
| 1,376 |
| ||
Provision for income taxes |
| 109 |
| 51 |
| ||
Net income |
| $ | 5,007 |
| $ | 1,325 |
|
|
|
|
|
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Net income per share: (1)(2) |
|
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Basic |
| $ | 0.31 |
| $ | — |
|
Diluted |
| $ | 0.29 |
| $ | — |
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| ||
Shares used to compute net income per share: (1)(2) |
|
|
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Basic |
| 16,156 |
| 154 |
| ||
Diluted |
| 17,493 |
| 154 |
|
(1) As a result of the conversion of the Company’s preferred stock into 11,032 shares of common stock upon completion of the Company’s initial public offering in November 2007, there is a lack of comparability in the basic and diluted net income per share amounts for the periods presented above. See Note 5 for calculations of the pro forma net income per share for the periods presented.
(2) For the three months ended March 31, 2007, the Company’s net income of $1,325 was allocated to preferred stockholders for purposes of calculating net income per share pursuant to the terms of the preferred stock, resulting in no net income allocable to common stockholders. See Note 5 for an explanation of the method and amounts used in the computation of the per share amounts.
See accompanying notes to the unaudited condensed consolidated financial statements.
4
GENOPTIX, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
(in thousands)
|
| Three Months Ended |
| ||||
|
| March 31, |
| ||||
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| 2008 |
| 2007 |
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Operating activities |
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|
|
|
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Net income |
| $ | 5,007 |
| $ | 1,325 |
|
Adjustments to reconcile net income to net cash provided by operating activities: |
|
|
|
|
| ||
Depreciation |
| 198 |
| 120 |
| ||
Stock-based compensation expense |
| 881 |
| 106 |
| ||
Provision for doubtful accounts |
| 624 |
| 576 |
| ||
Excess tax benefits from stock-based compensation awards |
| (60 | ) | — |
| ||
Amortization of premium/discount on investments |
| (19 | ) | — |
| ||
Gain on sale of property and equipment |
| (19 | ) | — |
| ||
Non-cash interest expense |
| — |
| 19 |
| ||
Changes in operating assets and liabilities: |
|
|
|
|
| ||
Accounts receivable |
| (6,824 | ) | (2,132 | ) | ||
Other current and long-term assets |
| 139 |
| (165 | ) | ||
Deferred rent |
| 32 |
| 9 |
| ||
Deferred revenues |
| (27 | ) | (17 | ) | ||
Accounts payable and accrued expenses |
| 991 |
| 1,054 |
| ||
Accrued compensation |
| (184 | ) | (306 | ) | ||
Income tax (receivable) payable |
| (158 | ) | 51 |
| ||
Net cash provided by operating activities |
| 581 |
| 640 |
| ||
|
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Investing activities |
|
|
|
|
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Purchase of property and equipment |
| (1,345 | ) | (165 | ) | ||
Proceeds from sales of property and equipment |
| 20 |
| — |
| ||
Purchase of investment securities available-for-sale |
| (47,705 | ) | — |
| ||
Proceeds from sales and maturities of investment securities available-for-sale |
| 29,850 |
| — |
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Net cash used in investing activities |
| (19,180 | ) | (165 | ) | ||
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Financing activities |
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Costs paid in connection with secondary public offering |
| (286 | ) | — |
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Proceeds from exercise of stock options, net |
| 134 |
| 1 |
| ||
Excess tax benefits from stock-based compensation awards |
| 60 |
| — |
| ||
Proceeds from issuance of notes payable |
| — |
| 108 |
| ||
Principal payments on notes payable |
| — |
| (423 | ) | ||
Principal payments on capital lease obligations |
| — |
| (11 | ) | ||
Net cash used in financing activities |
| (92 | ) | (325 | ) | ||
|
|
|
|
|
| ||
Net (decrease) increase in cash and cash equivalents |
| (18,691 | ) | 150 |
| ||
Cash and cash equivalents at beginning of period |
| 50,624 |
| 3,865 |
| ||
Cash and cash equivalents at end of period |
| $ | 31,933 |
| $ | 4,015 |
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Supplemental information: |
|
|
|
|
| ||
Income taxes paid |
| $ | 236 |
| $ | 2 |
|
Interest paid |
| $ | — |
| $ | 63 |
|
See accompanying notes to the unaudited condensed consolidated financial statements.
5
GENOPTIX, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
1. Organization and Summary of Significant Accounting Policies
Organization
Genoptix, Inc., or the Company, was incorporated in Delaware on January 20, 1999. Genoptix, Inc. does business as Genoptix Medical Laboratory. The Company operates as a certified ‘‘high complexity’’ clinical laboratory in accordance with the federal government’s Clinical Laboratory Improvement Amendments of 1988, or CLIA, and is dedicated to the delivery of clinical diagnostic services to community-based hematologist/oncologist physician customers.
Basis of Presentation and Principles of Consolidation
The Company’s industry is highly regulated. The manner in which licensed physicians can organize to perform and bill for medical services is governed by state laws and regulations. Business corporations, like the Company, often are not permitted to employ physicians to practice medicine or to own corporations that employ physicians to practice medicine or to otherwise exercise control over the medical judgments or decisions of physicians.
The Company provides its medical services through Cartesian Medical Group, or Cartesian, an entity that it manages, and it is this entity that employs the physicians who provide medical services on behalf of the Company. As of January 1, 2006, the Company determined it had a controlling financial interest in Cartesian and began to consolidate the results of Cartesian based on the criteria under Emerging Issues Task Force, or EITF, Issue No. 97-2, Physician Practice Management Entities and Certain Other Entities with Contractual Management Agreements. All intercompany accounts have been eliminated in consolidation.
The Company has prepared the accompanying unaudited condensed consolidated financial statements in accordance with United States of America generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and disclosures required by United States of America generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments, which (except for the changes in estimates described below) include only normal recurring adjustments considered necessary for a fair presentation, have been included. Operating results for the three months ended March 31, 2008 are not necessarily indicative of the results that may be expected for the year ending December 31, 2008. These unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and related notes thereto for the year ended December 31, 2007 included in the Annual Report on Form 10-K filed by the Company with the Securities and Exchange Commission on February 12, 2008.
Use of Estimates
The preparation of condensed consolidated financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the condensed consolidated financial statements and accompanying notes to the condensed consolidated financial statements. The most significant estimates in the Company’s condensed consolidated financial statements relate to revenue recognition, allowance for doubtful accounts, income taxes and stock-based compensation expense. Actual results could differ from those estimates.
Revenue Recognition
The Company recognizes revenues in accordance with the Securities and Exchange Commission’s Staff Accounting Bulletin No. 104, Revenue Recognition, when the price is fixed or determinable, persuasive evidence of an arrangement exists, the service is performed and collectibility of the resulting receivable is reasonably assured.
6
GENOPTIX, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(unaudited)
The Company’s specialized diagnostic services are performed based on a written test requisition form and revenues are recognized once the diagnostic services have been performed, the results have been delivered to the ordering physician, the payor has been identified and eligibility and insurance have been verified. These diagnostic services are billed to various payors, including Medicare, commercial insurance companies, other directly billed healthcare institutions such as hospitals, and individuals. The Company reports revenues from contracted payors, including Medicare, certain insurance companies and certain healthcare institutions, based on the contractual rate, or in the case of Medicare, the published fee schedules. The Company reports revenues from non-contracted payors, including certain insurance companies and individuals, based on the amount expected to be collected. The difference between the amount billed and the amount expected to be collected from non-contracted payors is recorded as a contractual allowance to arrive at the reported revenues. The expected revenues from non-contracted payors are based on the historical collection experience of each payor or payor group, as appropriate. In each reporting period, the Company reviews its historical collection experience for non-contracted payors and adjusts its expected revenues for current and subsequent periods accordingly. During the three months ended March 31, 2008, the Company recorded positive changes in 2007 accounting estimates to reduce contractual allowances, which increased the Company’s revenues by $651,000. These changes in accounting estimates related to non-contracted payors and resulted from continued improvements to the Company’s billing systems and collection processes, which resulted in favorable experience in the collection of accounts receivable for services rendered in 2007. As of March 31, 2008, the Company had uncollected accounts receivable of approximately $6.0 million from non-contracted payors.
Allowance for Doubtful Accounts
An allowance for doubtful accounts is recorded for estimated uncollectible amounts due from the Company’s contracted payors. The process for estimating the collection of receivables associated with the Company’s specialized diagnostic services involves significant assumptions and judgments. Specifically, the allowance for doubtful accounts is adjusted periodically, based upon an evaluation of historical collection experience with specific payors and other relevant factors. The realization cycle for certain governmental and managed care payors can be lengthy, involving denial, appeal and adjudication processes, and are subject to periodic adjustments that may be significant. The provision for doubtful accounts is charged to general and administrative expense. Accounts receivable are written off as uncollectible and deducted from the allowance after appropriate collection efforts have been exhausted. During the three months ended March 31, 2008, the Company reduced the allowance for doubtful accounts by $85,000 for net write-offs and recoveries.
The Company’s allowance for doubtful accounts has been provided for at a rate of approximately 2.8% of revenues for the three months ended March 31, 2008.
Reverse Stock Split
On October 15, 2007, the Company effected a 1-for-4.75 reverse stock split of the Company’s common stock. The accompanying condensed consolidated financial statements and notes to the condensed consolidated financial statements give retroactive effect to the reverse stock split for all periods presented.
Recent Accounting Pronouncements
Effective January 1, 2008, the Company adopted Statement of Financial Accounting Standards, or SFAS, No. 157, Fair Value Measurements. In February 2008, the Financial Accounting Standards Board, or FASB, issued FASB Staff Position No. 157-2, Effective Date of FASB Statement No. 157, which provides a one year deferral of the effective date of SFAS No. 157 for non-financial assets and non-financial liabilities, except those that are recognized or disclosed in the financial statements at fair value at least annually. Therefore, the Company has adopted the provisions of SFAS No. 157 with respect to its financial assets and liabilities only. SFAS No. 157 defines fair value, establishes a framework for measuring fair value under generally accepted accounting principles and enhances disclosures about fair value measurements. Fair value is defined under SFAS No. 157 as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. The adoption of SFAS No. 157 did not have a material impact on our condensed consolidated results of operations and financial condition for the three months ended March 31, 2008.
Effective January 1, 2008, the Company adopted SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities. SFAS No. 159 allows an entity the irrevocable option to elect fair value for the initial and subsequent measurement for certain financial assets and liabilities on a contract-by-contract basis. The Company did not elect to adopt the fair value option for certain financial instruments on the adoption date.
7
GENOPTIX, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(unaudited)
2. Investment Securities Available-for-Sale
The following is a summary of investment securities available-for-sale:
|
| March 31, |
| December 31, |
| ||
|
| (in thousands) |
| ||||
Government agency securities |
| $ | 29,021 |
| $ | 11,006 |
|
Corporate debt securities |
| 11,258 |
| 6,430 |
| ||
Auction rate securities |
| 12,450 |
| 17,400 |
| ||
|
| $ | 52,729 |
| $ | 34,836 |
|
Investment securities are classified as available-for-sale and consist of high-grade auction rate securities, or ARS, corporate debt securities and government agency securities. As of March 31, 2008, all of the corporate debt securities and government agency securities have contractual maturities of less than 25 months and 37 months, respectively. The ARS have a long-term contractual maturity that is structured with short-term holding periods. At the end of each holding period, a new auction is held to determine the rate or dividend for the next holding period. The Company can sell or continue to hold securities at par at each auction assuming there are buyers for the ARS at such auction. In order to sell ARS, the auction needs to be successful whereby demand in the marketplace meets or exceeds the supply. The length of each holding period is determined at the original issuance of the ARS. Typically, ARS holding periods range from 7 to 63 days, but occasionally the Company has invested in ARS with longer holding periods.
As of March 31, 2008, the Company held $12.5 million of ARS with stated maturity dates ranging from 2021 to 2047 and holding periods of less than 7 months, down from $17.4 million held at December 31, 2007. As of March 31, 2008, these investments are rated A- or higher and are current on all obligations. However, the liquidity of these investments has been impacted by the inability to match buyers with sellers. We have evaluated each ARS based on the credit quality, subsequent redemption, underlying assets of the issuer and underwriter, likelihood of a successful auction or redemption in the near term and the ability to obtain liquidity in the near-term. As of March 31, 2008, the Company has not recorded any impairment charges.
Fair Value Measurements
Valuation techniques used to measure fair value under SFAS No. 157 must maximize the use of observable inputs and minimize the use of unobservable inputs. The standard describes a fair value hierarchy based on three levels of inputs, of which the first two are considered observable and the last unobservable, which may be used to measure fair value, as follows:
Level 1 |
| Quoted prices in active markets for identical assets or liabilities. |
|
|
|
Level 2 |
| Inputs other than level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. |
|
|
|
Level 3 |
| Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. |
8
GENOPTIX, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(unaudited)
The following table represents the financial instruments on the financial statements of the Company subject to SFAS No.157 and the valuation approach applied to each class:
|
|
|
| Fair Value Measurements at Reporting Date |
| ||||||||
|
| Balance at |
| Quoted Prices in |
| Significant Other (Level 2) |
| Significant |
| ||||
|
| (in thousands) |
| ||||||||||
Government agency securities |
| $ | 29,021 |
| $ | — |
| $ | 29,021 |
| $ | — |
|
Corporate debt securities |
| 11,258 |
| — |
| 11,258 |
| — |
| ||||
Auction rate securities |
| 12,450 |
| — |
| — |
| 12,450 |
| ||||
|
| $ | 52,729 |
| $ | — |
| $ | 40,279 |
| $ | 12,450 |
|
The Company’s government agency and corporate debt securities are valued using market prices on less active markets (level 2). In contrast from level 1 valuations that are obtained from real-time quotes for transactions in active exchange markets involving identical assets, level 2 valuations are obtained from readily-available pricing sources for comparable instruments.
The following table provides a summary of changes in fair value of the Company’s level 3 financial assets:
|
| Level 3 |
| |
|
| (in thousands) |
| |
Balance at December 31, 2007 |
| $ | — |
|
Transfers into Level 3 |
| 17,400 |
| |
Earned income |
| 13 |
| |
Total realized/unrealized losses: |
|
|
| |
Included in earnings |
| — |
| |
Included in comprehensive income |
| (13 | ) | |
Purchases, issuances and settlements |
| (4,950 | ) | |
Balance at March 31, 2008 |
| $ | 12,450 |
|
These level 3 ARS consist of high quality debt instruments whose underlying assets are the revenue streams of municipalities and universities, which are also underwritten by insurance agencies. In February 2008, auctions began to fail for certain securities in the Company’s portfolio. As quoted market prices were unavailable, the Company internally developed valuation techniques that employ, as appropriate, independently sourced market parameters.
9
GENOPTIX, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(unaudited)
As of March 31, 2008, gross unrealized gains and losses of $96,000 and $25,000, respectively, were recorded in accumulated other comprehensive income, net of deferred taxes, compared to $61,000 and $8,000 at December 31, 2007.
3. Comprehensive Income
In accordance with SFAS No. 130, Reporting Comprehensive Income, all components of comprehensive income are reported in the financial statements in the period in which they are recognized. Comprehensive income is defined as the change in equity during a period from transactions and other events and circumstances from non-owner sources.
Below is a reconciliation of net income to comprehensive income for the three months ended March 31, 2008 and 2007.
|
| Three Months Ended |
| ||||
|
| 2008 |
| 2007 |
| ||
|
| (in thousands) |
| ||||
Net income |
| $ | 5,007 |
| $ | 1,325 |
|
Accumulated other comprehensive income: |
|
|
|
|
| ||
Unrealized gains on investment securities available-for-sale |
| 71 |
| — |
| ||
Deferred tax on unrealized gains |
| (29 | ) | — |
| ||
|
| $ | 5,049 |
| $ | 1,325 |
|
4. Stock-Based Compensation
Effective January 1, 2006, the Company adopted SFAS No. 123R, Share-Based Payment, which requires compensation expense related to share-based transactions, including stock options, shares issued under an employee stock purchase plan, or ESPP, and restricted stock units, or RSU, to be measured and recognized in the Company’s condensed consolidated financial statements based on fair value. SFAS No. 123R revises SFAS No. 123, Accounting for Stock-Based Compensation, as amended, and supersedes APB No. 25, Accounting for Stock Issued to Employees. The Company adopted SFAS No. 123R using the prospective approach. Under the prospective approach, SFAS No. 123R applies to new awards and to awards modified, repurchased or cancelled after the required effective date. Stock-based compensation expense recognized during the period is based on the value of the portion of awards that is ultimately expected to vest and thus the gross expense is reduced for estimated forfeitures. The Company recognizes stock-based compensation expense over the vesting period using the straight-line method and classifies these amounts in the condensed consolidated statements of operations based on the department to which the recipient reports.
In connection with the Company’s initial public offering, the Company implemented its ESPP on October 29, 2007, which allows qualified employees the opportunity to purchase Company common stock at a discount. Generally, the plan consists of a two-year offering period with four six-month purchase periods and contains a look-back provision for determining the purchase price. The terms of the initial purchase period vary slightly, as the period extends from October 29, 2007 to June 30, 2008 and allows for cash payments in addition to employee payroll deductions. The Company values and accounts for its ESPP in accordance with Financial Accounting Standard Board Technical Bulletin, or FTB, No. 97-1, Accounting under Statement 123 for Certain Employee Stock Purchase Plans with a Look-Back Option. Based on FTB No. 97-1 and grant date accounting, recognition of stock-based compensation expense cannot occur until all variables, including the total employee elected contributions, are known. As such, minimal expense was recognized in the three months ended March 31, 2008 for this initial purchase period. The Company recorded total stock-based compensation expense for the ESPP of $529,000, primarily related to the subsequent three purchase periods in this first offering.
The fair value of employee and consultant RSUs are expensed over the life of the award. During the three months ended March 31, 2008, the Company recognized $101,000 of RSU stock-based compensation expense. No RSU stock-based compensation expense was recognized during the three months ended March 31, 2007 since no RSU had been granted.
10
GENOPTIX, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(unaudited)
The fair value of the employee stock option grants and ESPP shares in the three months ended March 31, 2008 and 2007 was estimated as of the date of grant using a Black-Scholes valuation model with the following assumptions:
|
| Stock Options |
| ESPP |
| ||
|
| Three Months Ended |
| Three Months Ended |
| ||
|
| 2008 |
| 2007 |
| 2008 |
|
Risk-free interest rate |
| 2.789% |
| 4.75% |
| 3.05 - 3.49% |
|
Dividend yield |
| — |
| — |
| — |
|
Expected life of awards (years) |
| 6.08 |
| 6.08 |
| 0.5 - 2.0 |
|
Volatility |
| 54.00% |
| 65.00% |
| 54.00% |
|
The decline in volatility from the three months ended March 31, 2008 and the comparable period in 2007 is the result of declines in the actual volatility of the Company’s peer group over the estimated life of the options of 6.08 years. These volatility trends are consistent with expectations the Company has regarding volatility trends the Company will experience as it matures and accumulates history as a public company.
The weighted average grant date fair value per share of employee stock options granted during the three months ended March 31, 2008 and 2007 was $13.95 and $10.32, respectively.
The Company derived the risk-free interest rate assumption from the United States Treasury’s rates for U.S. Treasury zero-coupon bonds with maturities similar to those of the expected term of the award being valued. The Company based the assumed dividend yield on its expectation of not paying dividends in the foreseeable future. The Company calculated the weighted average expected life of options using the simplified method as prescribed by Securities and Exchange Commission Staff Accounting Bulletin, or SAB, No. 107, Share-Based Payment . This decision was based on the lack of relevant historical data due to the Company’s limited operating experience as a public company. In addition, due to the Company’s limited historical data, the estimated volatility also reflects the application of SAB No. 107, incorporating the historical volatility of comparable companies with publicly available share prices. SFAS No. 123R requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. The Company utilized its historical forfeitures to estimate its future forfeiture rate at 7% for the three months ended March 31, 2008 and 2007.
The Company records equity instruments issued to non-employee consultants as expense at their fair value over the related service period as determined in accordance with SFAS No. 123R and EITF Issue No. 96-18, Accounting for Equity Instruments That are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling Goods and Services, and periodically revalues the equity instruments as they vest. During the three months ended March 31, 2008 and 2007, the Company recognized $10,000 and $7,000, respectively, of non-employee stock-based compensation expense.
11
GENOPTIX, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(unaudited)
The Company recognized stock-based compensation expense in the condensed consolidated statements of operations, as follows:
|
| Three Months Ended |
| Three Months Ended |
| ||||||||||||||
|
| Options |
| ESPP |
| Total |
| Options |
| ESPP |
| Total |
| ||||||
|
| (in thousands, except per share data) |
| ||||||||||||||||
Cost of revenues |
| $ | 189 |
| $ | 110 |
| $ | 299 |
| $ | 21 |
| $ | — |
| $ | 21 |
|
Sales and marketing expenses |
| 48 |
| 304 |
| 352 |
| 16 |
| — |
| 16 |
| ||||||
General and administrative expenses |
| 110 |
| 115 |
| 225 |
| 47 |
| — |
| 47 |
| ||||||
Research and development expenses |
| 5 |
| — |
| 5 |
| 22 |
| — |
| 22 |
| ||||||
|
| $ | 352 |
| $ | 529 |
| $ | 881 |
| $ | 106 |
| $ | — |
| $ | 106 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||
Impact on net income per share: |
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||
Basic |
| $ | (0.02 | ) | $ | (0.03 | ) | $ | (0.05 | ) | $ | — |
| $ | — |
| $ | — |
|
Diluted |
| $ | (0.02 | ) | $ | (0.03 | ) | $ | (0.05 | ) | $ | — |
| $ | — |
| $ | — |
|
5. Net Income Per Share
Prior to the Company’s initial public offering, net income per share was computed in accordance with EITF Issue No. 03-6, Participating Securities and the Two-Class Method under FASB Statement 128, which established standards regarding the computation of earnings per share, or EPS, by companies that have issued securities other than common stock that contractually entitle the holder to participate in dividends and earnings of the Company. EITF Issue No. 03-6 requires earnings for the period, after deduction of preferred stock dividends, to be allocated between the common and preferred stockholders based on their respective rights to receive dividends, whether or not declared. Basic net income per share is then calculated by dividing income allocable to common stockholders (after the reduction for any preferred stock dividends assuming current income for the period had been distributed) by the weighted average number of shares of common stock outstanding, net of shares subject to repurchase by the Company, during the period. EITF Issue No. 03-6 does not require the presentation of basic and diluted net income per share for securities other than common stock; therefore, the following net income per share amounts only pertain to the Company’s common stock. The Company calculated diluted net income per share under the as-if-converted method unless the conversion of the preferred stock was anti-dilutive to basic net income per share. To the extent preferred stock was anti-dilutive, the Company calculated diluted net income per share under the two-class method.
Subsequent to the Company’s initial public offering, EPS has been computed in accordance with SFAS No. 128, Earnings Per Share. Basic EPS has been calculated by dividing the net income allocable to common stockholders by the weighted average number of common shares outstanding for the period, without consideration for common stock equivalents. Diluted EPS has been computed by dividing the net income allocable to common stockholders by the weighted average number of common shares outstanding for the period and the weighted average number of dilutive common stock equivalents outstanding for the period determined using the treasury-stock method. For purposes of this calculation, common stock subject to repurchase by the Company, convertible preferred stock, stock options, RSUs, and warrants are considered to be common stock equivalents and are only included in the calculation of diluted earnings per share when their effect is dilutive.
12
GENOPTIX, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(unaudited)
|
| Three Months Ended |
| ||||
|
| March 31, |
| ||||
|
| 2008 |
| 2007 |
| ||
|
| (in thousands, except per share data) |
| ||||
Numerator: |
|
|
|
|
| ||
Net income |
| $ | 5,007 |
| $ | 1,325 |
|
Income allocable to preferred stockholders |
| — |
| (1,325 | ) | ||
Net income allocable to common stockholders |
| $ | 5,007 |
| $ | — |
|
|
|
|
|
|
| ||
Denominator: |
|
|
|
|
| ||
Weighted average shares of common stock outstanding |
| 16,185 |
| 197 |
| ||
Weighted average unvested shares of common stock subject to repurchase |
| (29 | ) | (43 | ) | ||
Weighted average shares of common stock outstanding - basic |
| 16,156 |
| 154 |
| ||
Dilutive effect of common equivalent shares |
| 1,337 |
| — |
| ||
Weighted average shares of common stock outstanding - diluted |
| 17,493 |
| 154 |
| ||
|
|
|
|
|
| ||
Net income per share: |
|
|
|
|
| ||
Basic |
| $ | 0.31 |
| $ | — |
|
Diluted |
| $ | 0.29 |
| $ | — |
|
The following amounts were not included in the calculation of net income per share because their affects were anti-dilutive:
|
| Three Months Ended |
| ||
|
| March 31, |
| ||
|
| 2008 |
| 2007 |
|
|
| (in thousands) |
| ||
Preferred stock |
| — |
| 11,032 |
|
Preferred stock warrants |
| — |
| 86 |
|
Common stock options |
| 107 |
| 1,641 |
|
Common stock subject to repurchase |
| — |
| 42 |
|
|
| 107 |
| 12,801 |
|
13
GENOPTIX, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(unaudited)
Pro Forma Net Income Per Share
Pro forma basic and diluted net income per share have been computed to give effect to the conversion of convertible preferred stock into common stock upon the closing of the Company’s initial public offering on an as-if-converted basis at the later of the beginning of the period or the issuance date, as follows:
|
| Three Months Ended |
| ||||
|
| March 31, |
| ||||
|
| 2008 |
| Pro forma |
| ||
|
| (in thousands, except per share data) |
| ||||
Numerator: |
|
|
|
|
| ||
Pro forma net income allocable to common stockholders |
| $ | 5,007 |
| $ | 1,325 |
|
|
|
|
|
|
| ||
Denominator: |
|
|
|
|
| ||
Weighted average shares of common stock outstanding |
| 16,185 |
| 197 |
| ||
Weighted average unvested shares of common stock subject to repurchase |
| (29 | ) | (43 | ) | ||
Adjustments to reflect the weighted average effect of the assumed conversion of convertible preferred stock |
| — |
| 11,032 |
| ||
Pro forma weighted average shares of common stock outstanding - basic |
| 16,156 |
| 11,186 |
| ||
Dilutive effect of common equivalent shares |
| 1,337 |
| 1,532 |
| ||
Pro forma weighted average shares of common stock outstanding - diluted |
| 17,493 |
| 12,718 |
| ||
|
|
|
|
|
| ||
Pro forma net income per share: |
|
|
|
|
| ||
Basic |
| $ | 0.31 |
| $ | 0.12 |
|
Diluted |
| $ | 0.29 |
| $ | 0.10 |
|
6. Income Taxes
Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis and operating loss and tax credit carryforwards. The Company measures tax assets and liabilities using the enacted tax rates expected to apply to taxable income in the years in which the Company expects to recover or settle those temporary differences. The Company recognizes the effect of a change in tax rates on deferred tax assets and liabilities in income in the period that includes the enactment date. The Company provides a valuation allowance against net deferred tax assets unless, based upon the available evidence, it is more likely than not that the deferred tax assets will be realized. The Company’s unrecognized tax benefits were unchanged during the quarter ended March 31, 2008.
The provision for income taxes for the three months ended March 31, 2008 and 2007 was $109,000 and $51,000, respectively. The income tax expense relates primarily to federal and state alternative minimum taxes and other state taxes, offset in 2008 by the effect of disqualifying dispositions of employee stock.
7. Subsequent Events
Auction Rate Securities
On April 29, 2008, an issuer redeemed $2.0 million of ARS investment securities available-for-sale. As of April 30, 2008, the Company had a remaining balance of $10.5 million of ARS investment securities available-for-sale.
14
GENOPTIX, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(unaudited)
Operating Lease
In April 2008, the Company entered into a six-year lease beginning January 1, 2009 for additional office space in Carlsbad, California to house its future administrative offices, as well as its billing and customer service departments. The lease contains one five-year extension option and is subject to annual rent increases. The Company’s existing headquarters will be fully dedicated to clinical laboratory applications when the administration functions are moved in January 2009. The noncancelable future minimum annual payments under the new lease total approximately $1.3 million, $1.4 million, $1.4 million, $1.5 million and $3.1 million in 2009, 2010, 2011, 2012 and thereafter, respectively. No base operating lease payments are due in 2008 related to this new lease. In connection with this new lease, the Company’s February 2008 two-year lease for additional administrative space will be terminated effective January 1, 2009 and the functions performed there will be moved to the Company’s new building. Termination of the Company’s February 2008 lease will cancel future minimum payments of $361,000 and $30,000 in 2009 and 2010, respectively.
15
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion contains forward-looking statements, which involve risks and uncertainties. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of various factors, including those set forth below under Part II, Item 1A, “Risk Factors”in this Quarterly Report on Form 10-Q. The interim financial statements and this Management’s Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with the condensed consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q and the consolidated financial statements and notes thereto for the year ended December 31, 2007, and our related Management’s Discussion and Analysis of Financial Condition and Results of Operations, both of which are contained in the Annual Report on Form 10-K filed by us with the Securities and Exchange Commission on February 12, 2008.
Forward-Looking Statements
The information in this discussion contains forward-looking statements and information within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, which are subject to the “safe harbor” created by those sections. These forward-looking statements include, but are not limited to, statements concerning our strategy, future operations, future financial position, future revenues, projected costs, prospects and plans and objectives of management. The words “anticipates”, “believes”, “estimates”, “expects”, “intends”, “may”, “plans”, “projects”, “will”, “would” and similar expressions are intended to identify forward-looking statements, although not all forward-looking statements contain these identifying words. We may not actually achieve the plans, intentions or expectations disclosed in our forward-looking statements and you should not place undue reliance on our forward-looking statements. Actual results or events could differ materially from the plans, intentions and expectations disclosed in the forward-looking statements that we make. These forward-looking statements involve risks and uncertainties that could cause our actual results to differ materially from those in the forward-looking statements, including, without limitation, the risks set forth in Part II, Item 1A, “Risk Factors” in this Quarterly Report on Form 10-Q and in our other filings with the Securities and Exchange Commission. We do not assume any obligation to update any forward-looking statements.
Overview
We are a specialized laboratory service provider focused on delivering personalized and comprehensive diagnostic services to community-based hematologists and oncologists, or hem/oncs. Our highly trained group of hematopathologists, or hempaths, utilizes sophisticated diagnostic technologies to provide a differentiated, specialized and integrated assessment of a patient’s condition, aiding physicians in making vital decisions concerning the treatment of malignancies of the blood and bone marrow, and other forms of cancer.
We were organized in 1999, and we began offering specialized diagnostic services in the third quarter of 2004. Our key service offerings include COMPASS and CHART. By ordering our COMPASS service offering, the hem/onc authorizes our hempath to determine the appropriate diagnostic tests to be performed, and our hempath then integrates patient history and previous and current test results into a comprehensive diagnostic report. As part of our CHART service offering, the hem/onc also receives a detailed assessment of a patient’s disease progression over time. Test requisitions for more than half of the patient samples we processed for the three months ended March 31, 2008 included our COMPASS or CHART service offerings.
Revenues primarily consist of payments or reimbursements received from governmental payors, such as Medicare and Medicaid, private insurers, including managed care organizations, private payors, such as hospitals, patients, and others for the specialized diagnostic services rendered to our hem/onc customers. Our revenues are affected by changes in customer and case volume, payor mix and reimbursement rates.
Billing for diagnostic services is generally highly complex. Depending on our billing arrangement with each third party payor and applicable law, we are often obligated to bill in the specific manner prescribed by the various payors, each of which may have different billing requirements. Billing for diagnostic services in connection with governmental payor programs is subject to numerous federal and state regulations and other requirements, resulting in additional costs to us. We report revenues from contracted payors, including Medicare, certain insurance companies and certain healthcare institutions, based on the contractual rate, or in the case of Medicare, the published fee schedules. We report revenues from non-contracted payors, including certain insurance companies and individuals, based on the amount expected to be collected. We estimate amounts to be collected based on our historical collection experience.
16
As a specialized diagnostic service provider, we rely extensively on our high quality of service to promote and maintain our relationships with our community-based hem/onc customers. We compete primarily based on the quality of testing, reporting and information systems, reliability in patient sample transport, reputation in the medical community and access to our highly qualified hempaths. Our primary competitors include hospital pathologists, esoteric testing laboratories, national reference laboratories and academic laboratories.
We believe the key challenges in being able to continue to increase our market share, revenues and profitability are our ability to continue to hire and retain qualified sales representatives, key management and other personnel, Cartesian’s ability to hire and retain hempaths, changes in reimbursement levels for our specialized diagnostic services, changes in regulations, payor policies and contracting arrangements with payors, increased competition from competitors attempting to replicate our key service offerings or provide other services that compete with ours, our ability to scale our internal infrastructure, our ability to maintain and strengthen our relationships with our hem/onc customers, and our ability to continue to improve our operational, financial and management controls and reporting systems and procedures.
To address these challenges, our management is focused upon expanding our sales organization as the primary driver for our continued growth while maintaining our existing hem/onc customer relationships. Our management tracks and measures the general buying patterns of our hem/onc customers (including cases per month and revenues and cost of revenues per case) and is focused on adding additional sales resources in key markets to enhance our penetration in those markets. Our management is also engaged in ensuring Cartesian is focused on recruiting, hiring and retaining hempaths to provide the professional services component to support continued growth. Management measures the levels and timeliness of reimbursement from third party payors and reviews on a monthly basis the levels of receivables and average time for collections, as well as cost and margin trends to ensure that investments in our infrastructure and personnel are in line with current sales levels.
Seasonality
The majority of our testing volume is dependent on patient visits to hem/oncs’ offices and other healthcare providers. Volume of testing generally declines during the year-end holiday periods and other major holidays. In addition, volume of testing tends to decline due to adverse weather conditions, such as excessively hot or cold spells or hurricanes or tornados in certain regions, consequently reducing revenues and cash flows in any affected period. Therefore, comparison of the results of successive periods may not accurately reflect trends for successive periods.
Critical Accounting Policies and Estimates
Management’s discussion and analysis of our financial condition and results of operations are based upon our financial statements, which are prepared in accordance with United States of America generally accepted accounting principals. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets and liabilities, related disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. We continually evaluate our estimates and judgments, the most critical of which are those related to revenue recognition, allowance for doubtful accounts, income taxes and stock-based compensation expense. We base our estimates and judgments on historical experience and other factors that we believe to be reasonable under the circumstances. Materially different results can occur as circumstances change and additional information becomes known.
The Company adopted SFAS No. 157, Fair Value Measurements, and SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities, in the current period without material impact to the financial statements. For additional information on the recent accounting pronouncements affecting our business, see Note 1 and Note 2 of the Notes to Condensed Consolidated Financial Statements.
Results of Operations
Comparison of the Three Months Ended March 31, 2008 and 2007
Revenues
Revenues primarily consist of payments or reimbursements received from governmental payors, such as Medicare and Medicaid, private insurers, including managed care organizations, private payors, such as hospitals, patients, and others for the specialized diagnostic services rendered to our hem/onc customers. Substantially all of our revenues result from our having been assigned the right to bill and collect for the professional services provided by the hempaths employed by Cartesian who work with us in our laboratory facility pursuant to our Clinical Laboratory Professional Services Agreement, or PSA, with Cartesian. Our revenues from services not performed by Cartesian were less than 5% of our total revenues during the three months ended March 31, 2008 and 2007.
17
For the three months ended March 31, 2008, we derived approximately 59% of our revenues from private insurance, including managed care organizations and other healthcare insurance providers, 40% from Medicare and Medicaid and 1% from other sources. Our revenues are affected by changes in customer and case volume, payor mix and reimbursement rates. Billing and reimbursement for our specialized diagnostic services in connection with governmental payor programs is subject to numerous federal and state regulations and other billing requirements. Reimbursement under Medicare for our specialized diagnostic services is subject to a Medicare physician fee schedule, and to a lesser degree, a clinical laboratory fee schedule, both of which are typically updated annually.
|
| Three Months Ended March 31, |
| % |
| ||||
|
| 2008 |
| 2007 |
| Change |
| ||
Revenues (1) (in thousands) |
| $ | 22,298 |
| $ | 10,651 |
| 109 | % |
Number of cases |
| 7,828 |
| 4,402 |
| 78 | % | ||
Revenues per case |
| $ | 2,848 |
| $ | 2,420 |
| 18 | % |
(1) |
| During the three months ended March 31, 2008, we recorded positive changes in 2007 accounting estimates to reduce contractual allowances, which increased our revenues by $651,000. These changes in accounting estimates related to non-contracted payors and resulted from continued improvements to our billing systems and collection processes, which resulted in favorable experience in the collection of accounts receivable for services rendered in 2007. |
Revenues increased to $22.3 million, or 109%, for the three months ended March 31, 2008 (inclusive of the changes in 2007 accounting estimates noted above and recorded in the three months ended March 31, 2008) from $10.7 million for the comparable period in 2007. The increase of $11.6 million is primarily due to case volume increases of 3,426, or 78%; revenues per case increases of $428, or 18%, as a result of a net increase in Medicare reimbursement rates for our key service offerings; and better than expected collections on our non-contracted business as reflected by the $651,000 of positive change in accounting estimates to reduce contractual allowances. Case volumes, and therefore revenues, have increased during the three months ended March 31, 2008, primarily as a result of the 62% increase in our sales force from March 31, 2007 to March 31, 2008. This has enabled us to penetrate more accounts over a wider geographic area, increase our customer base and further concentrate our sales representatives on in-person customer visits. Sales force productivity during the three months ended March 31, 2008 also increased primarily as a result of more efficient selling efforts, enhanced recognition in the market, smaller geographies per sales representative and expanded service offerings.
Cost of Revenues
Cost of revenues consists of the compensation and fringe benefits of hempaths, licensed technicians, clinical service coordinators, or CSCs, and other support personnel, outside laboratory costs, laboratory supplies, shipping and distribution costs and depreciation and facility-related costs allocated to cost of revenues. Our cost of revenues generally increases as our case volume and revenues increase. We expect that our cost of revenues will continue to increase as our case volume and revenues increase and we hire additional hempaths, technicians and support personnel, incur increased outside laboratory, shipping, distribution and facility costs and spend more on supplies to support these anticipated increases in case volume and related revenues.
18
|
| Three Months Ended March 31, |
| % |
| ||||
|
| 2008 |
| 2007 |
| Change |
| ||
|
|
|
|
|
|
|
| ||
Cost of revenues (in thousands) |
| $ | 9,175 |
| $ | 4,637 |
| 98 | % |
Cost of revenues as a % of revenues |
| 41 | % | 44 | % |
|
| ||
Number of cases |
| 7,828 |
| 4,402 |
| 78 | % | ||
Cost of revenues per case |
| $ | 1,172 |
| $ | 1,053 |
| 11 | % |
Cost of revenues increased to $9.2 million for the three months ended March 31, 2008 from $4.6 million for the comparable period in 2007. As a percentage of revenue, cost of revenues for the three months ended March 31, 2008 decreased to 41% from 44% for the comparable period in 2007. This is primarily due to higher revenues, offset by increased logistic costs, stock-based compensation expense and payroll related expenses associated with the hiring of laboratory personnel and Cartesian physicians. This has resulted in gross margins of 59% and 56% for the three months ended March 31, 2008 and 2007, respectively.
Sales and Marketing Expenses
Sales and marketing expenses consist primarily of compensation and fringe benefits, related travel costs for our sales personnel in the field and depreciation and facility-related costs allocated to sales and marketing expenses. We expect our sales and marketing expenses to increase as we hire additional sales representatives and managers as part of our growth strategy.
|
| Three Months Ended March 31, |
| % |
| ||||
|
| 2008 |
| 2007 |
| Change |
| ||
|
|
|
|
|
|
|
| ||
Sales and marketing expenses (in thousands) |
| $ | 4,261 |
| $ | 2,321 |
| 84 | % |
Sales and marketing expenses as a % of revenues |
| 19 | % | 22 | % |
|
| ||
Sales and marketing expenses increased to $4.3 million for the three months ended March 31, 2008 from $2.3 million for the comparable period in 2007. The increase of $2.0 million, or 84%, was primarily due to increases of $1.7 million for employee related costs (including salaries, sales commissions and stock-based compensation expense) and other cost increases due to increased number of sales representatives, sales managers and customer service personnel that we have hired to drive and support our revenue growth. The number of sales representatives (including three regional managers) increased from 26 to 42 from March 31, 2007 to March 31, 2008. As a percentage of revenues, sales and marketing expenses have declined as we have gained productivity from a more experienced sales force and leveraged fixed costs associated with corporate sales activities.
General and Administrative Expenses
General and administrative expenses relate to billing, finance, human resources and other administrative functions and primarily consist of compensation and fringe benefits, professional services and depreciation and facility-related costs allocated to general and administrative expenses. In addition, the provision for doubtful accounts is included in general and administrative expenses. We anticipate increases in our general and administrative expenses as we add personnel, comply with the reporting obligations applicable to publicly held companies, incur additional expenses associated with the expansion of our facilities and backup systems and continue to build our corporate infrastructure to support our anticipated growth.
19
|
| Three Months Ended March 31, |
| % |
| ||||
|
| 2008 |
| 2007 |
| Change |
| ||
General and administrative expenses (in thousands) |
| $ | 4,388 |
| $ | 2,134 |
| 106 | % |
General and administrative expenses as a % of revenues |
| 20 | % | 20 | % |
|
| ||
General and administrative expenses increased to $4.4 million for the three months ended March 31, 2008 from $2.1 million for the comparable period in 2007. The increase of $2.3 million, or 106%, was primarily due to increases of $1.1 million for employee related costs (including salaries, bonuses and stock-based compensation expense), $592,000 for legal, insurance and consulting costs, and $315,000 for facility and equipment-related costs. Employee related costs increased as a result of the total general and administrative headcount increasing 95% from 22 to 43 from March 31, 2007 to March 31, 2008, respectively, in support of our revenue growth and operating as a public company. In addition, we have expanded our corporate infrastructure to make our operations more efficient and scalable by enhancing our information systems and implementing finance initiatives to improve billing and support our finance team in complying with added public company reporting obligations. Legal and consulting expenses increased as a result of regulatory initiatives, additional public company obligations and the ongoing development and maintenance of our compliance programs. Facility allocations increased due to additional corporate lease expansions in support of revenue and headcount growth. As a percentage of revenues, general and administrative expenses have remained consistent due to leveraging our existing personnel to offset increased public company costs.
Research and Development Expenses
Research and development expenses primarily consist of compensation and fringe benefits and depreciation and facility-related costs allocated to research and development expenses. Our research and development activities primarily relate to the development and validation of diagnostic tests in connection with our specialized diagnostic services.
|
| Three Months Ended March 31, |
| % |
| ||||
|
| 2008 |
| 2007 |
| Change |
| ||
Research and development expenses (in thousands) |
| $ | 317 |
| $ | 178 |
| 78 | % |
Research and development expenses as a % of revenues |
| 1 | % | 2 | % |
|
| ||
For the three months ended March 31, 2008, research and development expenses increased to $317,000 from $178,000 for the comparable period in 2007. The increase of $139,000, or 78%, was primarily due to costs associated with in-house validation of diagnostic tests. As a percentage of revenues, research and development has decreased due to increased revenues.
Interest Income, Interest Expense and Other Income
|
| Three Months Ended March 31, |
| % |
| ||||
|
| 2008 |
| 2007 |
| Change |
| ||
|
| (in thousands) |
|
|
| ||||
Interest income |
| $ | 931 |
| $ | 48 |
| 1840 | % |
Interest expense |
| $ | — |
| $ | (82 | ) | — |
|
Other income |
| $ | 28 |
| $ | 29 |
| -3 | % |
Interest income for the three months ended March 31, 2008 increased primarily due to increased cash and investment balances from our initial public offering proceeds and cash provided from operations.
Interest expense for the three months ended March 31, 2008 was $0 as a result of our repayment of borrowings in the fourth quarter 2007 in connection with our initial public offering.
20
Provision for Income Taxes
|
| Three Months Ended March 31, |
| % |
| ||||
|
| 2008 |
| 2007 |
| Change |
| ||
|
| (in thousands) |
|
|
| ||||
Provision for income taxes |
| $ | 109 |
| $ | 51 |
| 114 | % |
The provision for income taxes increased to $109,000 for the three months ended March 31, 2008 from $51,000 for the comparable period in 2007, equivalent to effective tax rates of 2.1% and 3.7%, respectively. The increase of $58,000, or 114%, was primarily due to an increase in our state tax expense. Additionally, due to limitations on our ability to fully utilize net operating loss carryforwards for alternative minimum tax purposes, we are unable to fully offset our alternative minimum taxable income. These resulted in a provision for income taxes for the three months ended March 31, 2008 and 2007.
As of December 31, 2007, we had federal and state net operating loss carryforwards of approximately $28.5 million. If not used, the federal and state net operating loss carryforwards will begin expiring in 2020 and 2008, respectively. As of December 31, 2007, we had federal research credit carryforwards of $372,000, which will begin expiring in 2021 and state research credit carryforwards of $427,000, which do not expire. Under Sections 382 and 383 of the Internal Revenue Code of 1986, as amended, substantial changes in our ownership may limit the amount of net operating loss and research and development credit carryforwards that could be used annually in the future to offset taxable income. We have had two “change in ownership” events that limit the utilization of net operating loss and credit carryforwards. The “change in ownership” events occurred in March 2000 and December 2001 and result in annual net operating loss limitations of $59,000 and $165,000, respectively. Additionally, we believe our recent secondary offering, which was completed in March 2008, may have caused a “change of ownership” event. This additional “change of ownership” event may limit the future utilization of federal and state net operating loss carryforwards, credit carryforwards and other deferred tax assets. Until we have determined the amount subject to limitation, the deferred tax assets will not be reduced. Additional limitations on the use of these tax attributes could occur in the event of possible disputes arising in examination from various taxing authorities. Currently, we are not under examination by any taxing authorities. Any net operating loss or credit carryforwards that will expire prior to utilization as a result of such limitations will be removed from deferred tax assets with a corresponding reduction of the valuation allowance.
Liquidity and Capital Resources
As of March 31, 2008, we had $84.7 million in cash, cash equivalents and investment securities available-for-sale, primarily consisting of money market funds, auction rate securities, or ARS, government agency securities and commercial paper. We have established guidelines relating to diversification and maturities of our investment securities to preserve principal and maintain liquidity.
At March 31, 2008, the Company held $12.5 million of high-grade ARS valued using level 3 criteria under SFAS No. 157. ARS are collateralized long-term debt instruments that provide liquidity through a Dutch auction process that resets the applicable interest rate at pre-determined intervals, typically every 7 to 35 days. If any auctions fail, the funds associated with these failed auctions will not be accessible until the issuer calls the security, a successful auction occurs, a buyer is found outside of the auction process, or the security matures. The valuation of the level 3 securities is based on unobservable inputs, which consist of recommended fair values provided by our broker, combined with internal analysis of interest rate spreads, subsequent redemption, and credit quality. Because we were required to value these securities using only level 3 inputs, our valuation determinations are somewhat subjective and the actual fair values, as determined at a later date or by a third party, may be different than the fair values we have determined. On April 29, 2008, an issuer redeemed $2.0 million of ARS investment securities available-for-sale. This issuance was classified as investment securities available-for-sale as of March 31, 2008. As of April 30, 2008, we had a remaining balance of $10.5 million of ARS investment securities available-for-sale.
Our primary ongoing source of cash is cash receipts on accounts receivable from our revenues. Aside from the growth in revenues, net cash collections of accounts receivable are impacted by the efficiency of our cash collections process as measured by the change in days sales outstanding, or DSO, which can vary from period to period depending on the payment cycles and the mix of our payors. Our DSO averaged 64 days in the three months ended March 31, 2008 down from 72 days in the three months ended March 31, 2007. As of March 31, 2008, our DSO was 71 days due to the timing of specific payments received in early April 2008 rather than March 2008, as well as, increasing revenues. Based on these additional cash collections, our DSO has been reduced to below 55 days in April 2008, a level consistent with our previous operating trend.
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Our primary uses of cash are to fund operating expenses and for the acquisition of property and equipment. Cash used to fund operating expenses excludes the impact of non-cash items such as the provision for doubtful accounts, depreciation and stock-based compensation expense and is impacted by the timing of when we pay these expenses as reflected in the change in our outstanding accounts payable and accrued expenses. Acquisitions of property and equipment primarily consist of purchases of laboratory equipment, computer hardware and software and facility improvements.
Below is a summary of our cash flows provided by (used in) operating, investing and financing activities for the three months ended March 31, 2008 and 2007:
|
| Three Months Ended March 31, |
| ||||
|
| 2008 |
| 2007 |
| ||
|
| (in thousands) |
| ||||
Net cash provided by operating activities |
| $ | 581 |
| $ | 640 |
|
Net cash used in investing activities |
| (19,180 | ) | (165 | ) | ||
Net cash used in financing activities |
| (92 | ) | (325 | ) | ||
Net (decrease) increase in cash and cash equivalents |
| $ | (18,691 | ) | $ | 150 |
|
Operating Activities
Net cash provided by operating activities during the three months ended March 31, 2008 and 2007 was $581,000 and $640,000, respectively. The net decrease of $59,000, or 9%, was primarily due to $4.7 million of incremental increases to accounts receivable as a result of the timing of specific payments received in early April 2008 rather than March 2008, offset by an increase in net income of $3.7 million, as well as an additional $784,000 of non-cash expenses primarily consisting of stock-based compensation expense.
Investing Activities
Net cash used in investing activities during the three months ended March 31, 2008 and 2007 was $19.2 million and $165,000, respectively. The net increase of $19.0 million in cash used in investing activities primarily pertains to $17.9 million of net purchases of investment securities. This increased activity pertains to investment securities available-for-sale purchased with proceeds from our initial public offering. Additionally, we had increased capital expenditures of $1.2 million pertaining to increased purchases of laboratory equipment, computers and software, furniture and tenant improvements in support of our headcount growth across all functional areas and facility expansion.
Financing Activities
Net cash used in financing activities during the three months ended March 31, 2008 of $92,000 pertains to payments of $286,000 associated with our secondary public offering, which is offset by the proceeds from the exercise of stock options for the same period and excess tax benefits related to disqualifying dispositions on stock-based compensation awards. Net cash used in financing activities during the three months ended March 31, 2007 of $325,000 pertains to the principal payments on long-term financing of $434,000 and is offset by note payable issuances of $108,000.
Our future capital uses and requirements depend on numerous factors. These factors include but are not limited to the following:
· changes in regulations or payor policies, including reimbursement levels from governmental payors and private insurers, or contracting arrangements with payors or changes in other laws, regulations or policies; and
· the extent to which we expand our operations and increase our market share.
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We expect to continue to spend substantial amounts of capital to grow our business. We estimate the costs associated with increasing our personnel in the near-term to be approximately $8.0 million to $12.0 million, the costs associated with establishing a second laboratory facility to be approximately $15.0 million to $25.0 million and the costs associated with expansion of our backup systems to be up to approximately $5.0 million. We believe our current cash, cash equivalents and investment securities available-for-sale will be adequate to fund our planned growth and operating activities through at least the next 24 months. While we anticipate that cash from our operations in addition to our current cash, cash equivalents and investment securities available-for-sale will be sufficient to fund our growth as well as our operating activities in the future, we may raise additional funds through public or private equity offerings or debt financings. We do not know if we will be able to obtain additional financing on favorable terms, if at all. If we cannot raise funds on acceptable terms, if and when needed, we may not be able to maintain or grow our business at the rate that we currently anticipate and we may not be able to respond to competitive pressures or unanticipated capital requirements, or we may be required to reduce operating expenses, which would significantly harm our business, financial condition and results of operations.
As of March 31, 2008, we had $1.0 million available for future draws under an accounts receivable revolving line of credit, which expires on June 30, 2008. We currently have no plans to utilize or extend this available financing. As of March 31, 2008, we are in full compliance with all covenants.
Contractual Obligations and Commitments
There have been no material changes, outside of the ordinary course of business, in our outstanding contractual obligations from those disclosed within “Management’s Discussion and Analysis of Financial Condition and Results of Operations”, as contained in the Annual Report on Form 10-K filed by the Company with the Securities and Exchange Commission on February 12, 2008, except as noted below.
In February 2008, we entered into a two-year lease (with three one-year extension options) for additional office space in Carlsbad, California to house our expanding billing and client services departments. The noncancelable future minimum payments under the lease total $293,000, $361,000 and $30,000 for the years ending December 31, 2008, 2009 and 2010, respectively.
In April 2008, we entered into a six-year lease beginning January 1, 2009 for additional office space in Carlsbad, California to house our future administration offices, as well as our billing and customer services departments. The lease contains one five-year extension option and is subject to annual rent increases. Our existing headquarters building will be fully dedicated to clinical laboratory applications when the administration functions are moved in January 2009. The noncancelable future minimum payments under the lease total approximately $1.3 million, $1.4 million, $1.4 million, $1.5 million, and $3.1 million in 2009, 2010, 2011, 2012, and thereafter, respectively. No base operating lease payments are due in 2008 related to this new lease. In connection with this lease, our February 2008 lease will be terminated effective January 1, 2009, which will cancel future minimum payments of $361,000 and $30,000 in 2009 and 2010, respectively.
From time to time, we may enter into contracts with suppliers, manufacturers and other third parties under which we may be required to make payments. Our disclosures do not reflect any future obligations that may arise due to the establishment of our second laboratory facility, including facility leasing costs, tenant improvements and other facility startup, expansion and infrastructure costs.
Off-Balance Sheet Arrangements
We have not engaged and do not expect to engage in any off-balance sheet activities.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Market risk represents the risk of loss that may impact our financial position, results of operations or cash flows due to adverse changes in financial and commodity market prices and rates. We are exposed to market risk primarily in the area of changes in United States interest rates and conditions in the credit markets. We do not have any material foreign currency or other derivative financial instruments. Under our current policies, we do not use interest rate derivative instruments to manage exposure to interest rate changes. We attempt to increase the safety and preservation of our invested principal funds by limiting default risk, market risk and reinvestment risk. We mitigate default risk by investing in investment grade securities.
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All of our investment securities are classified as available-for-sale and therefore reported on the balance sheet at market value. Our investment securities consist of high-grade ARS, corporate debt securities and government agency securities. As of March 31, 2008, our investment securities available-for-sale consisted of $12.5 million of high-grade ARS issued primarily by municipalities and universities. Our ARS are debt instruments with a long-term maturity and with an interest rate that is reset in short intervals through Dutch auctions. The recent conditions in the global credit markets have prevented some investors from liquidating their holdings of ARS because the amount of securities submitted for sale has exceeded the amount of purchase orders for such securities. If there is insufficient demand for the securities at the time of an auction, the auction may not be completed and the interest rates may be reset to predetermined higher rates. If the credit ratings of the security issuers deteriorate and any decline in market value is determined to be other-than-temporary, we would be required to adjust the carrying value of the investment through an impairment charge. We have been informed of auction failures where there has been insufficient demand at auctions for securities that we hold. To date, we have not recorded any realized gains or losses or recognized any significant unrealized gains or losses on our investment portfolio. On April 29, 2008, an issuer redeemed $2.0 million of ARS investment securities we held as available-for-sale. Therefore, as of April 30, 2008, we had a remaining balance of $10.5 million of ARS investment securities available-for-sale.
When auctions for these securities fail, the investments may not be readily convertible to cash. In the event we need to access the funds that are in an illiquid state, we will not be able to do so without the possible loss of principal, until a future auction for these investments is successful, they are redeemed by the issuer or they mature. At this time, management has not obtained sufficient evidence to conclude that these investments are impaired or that they will not be settled in the short term, although the market for these investments is presently uncertain. If we are unable to sell these securities in the market or they are not redeemed, then we may be required to hold them to maturity. We do not currently need to access these funds for operational purposes for the foreseeable future. Currently, we have not recorded any impairment charges we will continue to monitor and evaluate these investments on an ongoing basis for impairment. Based on our ability to access our cash and other investment securities, our expected operating cash flows, and our other sources of cash, we do not anticipate that the potential illiquidity of these investments will affect our ability to execute our current business plan.
Item 4T. Controls and Procedures
We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our periodic reports filed with the Securities and Exchange Commission, or SEC, is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and that such information is accumulated and communicated to our management, including our chief executive officer and chief financial officer, as appropriate, to allow for timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and no evaluation of controls and procedures can provide absolute assurance that all control issues and instances of fraud, if any, within a company have been detected. Management is required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.
As required by Rule 13a-15(b) of the Securities Exchange Act of 1934, as amended, or Exchange Act, prior to the filing of this report we carried out an evaluation, under the supervision and with the participation of our management, including our chief executive officer and chief financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Exchange Act) as of the end of the period covered by this report. Based on their evaluation, our chief executive officer and chief financial officer concluded that our disclosure controls and procedures were effective as of the end of the period covered by this report.
In addition, management, including our chief executive officer and chief financial officer, did not identify any change in our internal control over financial reporting that occurred during our latest fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
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You should consider carefully the following information about the risks described below, together with the other information contained in this Quarterly Report on Form 10-Q and in our other public filings in evaluating our business. We have marked with an asterisk (*) those risk factors that reflect substantive changes from the risk factors included in our Annual Report on Form 10-K filed by the Company with the Securities and Exchange Commission on February 12, 2008. If any of the following risks actually occurs, our business, financial condition, results of operations and future growth prospects would likely be materially and adversely affected. In these circumstances, the market price of our common stock would likely decline.
Risks Relating to Our Business Operations
* Reimbursement levels for our specialized diagnostic services are subject to continuing change and any reductions in reimbursement levels would decrease our revenues and adversely affect our results of operations and financial condition.
Reimbursement to healthcare providers, such as specialized diagnostic service providers like us, is subject to continuing change in policies by governmental payors, such as Medicare and Medicaid, private insurers, including managed care organizations, and other private payors, such as hospitals and private medical groups. Reimbursement from governmental payors is subject to statutory and regulatory changes, retroactive rate adjustments and administrative rulings, and other policy changes, all of which could materially decrease the range of services for which we are reimbursed or the reimbursement rates we are paid. For example, the consumer price index, or CPI, update of the clinical laboratory fee schedule for 2004 through 2008 was frozen by the Medicare Prescription Drug, Improvement and Modernization Act of 2003, or MMA. Although this modification to Medicare’s reimbursement rates did not materially affect the amount paid by Medicare for our current services, future modifications to Medicare’s reimbursement rates or the reimbursement rates from other governmental payors could significantly reduce the amounts we receive for the services we provide. Payment rates also may be impacted if we are no longer able to submit claims to Medicare for our pathology services for hospital patients, but are instead required to bill hospitals for payments. Current legislation allows us to submit such claims to Medicare through June 30, 2008.
Reductions in Medicare’s reimbursement rates for pathology services, for which we currently are paid under the Medicare physician fee schedule, would reduce the amount we receive for a substantial number of our specialized diagnostic tests. The Medicare physician fee schedule is typically updated annually and CMS, the agency responsible for administering the Medicare program, has made a number of methodological changes to components of the formula used to calculate the payment rate. These methodological changes have not in the past resulted in any significant reductions in the reimbursement for the pathology services we provide, but future modifications may result in reduced payment rates. Because of another longstanding formula used to calculate the annual update factors for the physician fee schedule, a decrease in the reimbursement rates for pathology services is scheduled to go into effect July 2008 unless Congress acts to change the formula used or continues, as it has done in the past to mandate freezes or increases in the fee schedule. More specifically, as a result of the Medicare, Medicaid and SCHIP Extension Act of 2007, the conversion factor was increased by 0.5% for payment of claims with dates of service from January 1, 2008 through June 30, 2008. For claims with dates of service from July 1, 2008 and thereafter, the conversion factor will revert to the previous payment methodology as was outlined in the Federal Register dated November 27, 2007 unless Congress acts again to set aside the formula to update the fee schedule.
The Medicare Modernization Act of 2003 mandated creation of Medicare Administrative Contractors, or MACs, replacing the current system of fiscal intermediaries who oversee fee-for-service claims for the Medicare Part A and Part B programs. In November 2007, CMS awarded the MAC Jurisdiction 1 (California, Hawaii, Nevada, American Samoa, Guam and the Northern Mariana Islands) to Palmetto GBA. The full transition to Palmetto GBA is expected to occur in September 2008. Although the MAC stated methodology for consolidation of Local Coverage Determinations, or LCD, is based on the least restrictive LCD principal, should the MAC select to alter existing LCDs providing coverage related to our specialized diagnostic services, this policy change may result in reductions to, delays in or denials for reimbursement for the services offered. Moreover, the transition from a fiscal intermediary to a MAC may result in delays in reimbursement that could have an impact on us and our results of operations.
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Other policy changes may include competitive bidding by clinical laboratories for the provision of services to the Medicare program, which is currently the subject of a CMS demonstration project in Carlsbad, California, pursuant to the requirements of the MMA. Currently, the implementation of the demonstration project is being delayed due to a federal preliminary injunction issued on April 8, 2008 against the implementation of the project. Pending CMS’s completion of a formal administrative rulemaking process regarding the demonstration project, it is unclear whether, and in what form, the competitive bidding demonstration project will be implemented. If implemented, competitive bidding could decrease our reimbursement rates for clinical laboratory tests.
In addition, some private insurers and other third party payors link their rates to Medicare’s reimbursement rates, and a reduction in Medicare reimbursement rates for clinical laboratory and pathology services could result in a corresponding reduction in the reimbursements we receive from such third party payors. Any reductions in reimbursement levels for our specialized diagnostic services would decrease our revenues and adversely affect our results of operations and financial condition.
* Operating as a non-contracting provider with certain payors may adversely affect our results of operations and financial condition and contracting with those payors may be disadvantageous to us.
We are currently considered a “non-contracting provider” by a number of third party payors because we have not entered into a specific contract to provide our specialized diagnostic services to their insured patients at specified rates of reimbursement. We were generally subject to reimbursement as a non-contracting provider for approximately half of our revenues for the three months ended March 31, 2008 and 2007. Use of a non-contracting provider typically results in greater coinsurance or copayment requirements for the patient, unless we elect to treat them as in-network in accordance with applicable law, which results in decreased revenues because we do not generally collect the full applicable out-of-network patient coinsurance or copayment obligations. In instances where we are prohibited by law from treating these patients as in-network, thus requiring them to pay additional costs or copayments, such patients may express concern about these additional costs to their hem/onc. As a result, that hem/onc may reduce or avoid prescribing our services for such patients, which would adversely affect our results of operations and financial condition.
Should any of the third party payors with whom we are not contracted insist that we enter into a contract for the specialized diagnostic services we provide, the resulting contract may contain pricing and other terms that are materially less favorable to us than the terms under which we currently operate. If revenues from a particular payor grow, there is heightened risk that such a third party payor will insist that we enter into contractual arrangements that contain such terms. If we refuse to enter into a contract with such a third party payor, they may refuse to cover and reimburse for our services, which may lead to a decrease in case volume and a corresponding decrease in our revenues. If we contract with such a third party payor, although our case volume may increase as a result of the contract, our revenues per case under the contractual agreement and gross margins may decrease. The overall net result of contracting with third party payors may adversely affect our business, results of operations and financial condition.
* Changes in regulations, payor policies or contracting arrangements with payors or changes in other laws, regulations or policies may adversely affect coverage or reimbursement for our specialized diagnostic services, which may decrease our revenues and adversely affect our results of operations and financial condition.
Governmental payors, as well as private insurers, and other private payors have implemented and will continue to implement measures to control the cost, utilization and delivery of healthcare services, including clinical laboratory and pathology services. Congress has from time to time considered and implemented changes to laws and regulations governing healthcare service providers, including specialized diagnostic service providers. These changes have adversely affected and may in the future adversely affect coverage for clinical laboratory and pathology services, including the specialized diagnostic services we provide. In addition, as a result of the focus on healthcare reform in connection with the 2008 Presidential election, there is risk that Congress may implement changes in laws and regulations governing healthcare service providers, including measures to control costs or reductions in reimbursement levels, which may have an adverse impact on our business. We also believe that healthcare professionals, including hem/oncs, will not use our services if third party payors do not provide adequate coverage and reimbursement for them. These changes in federal, state, local and third party payor regulations or policies may decrease our revenues and adversely affect our results of operations and financial condition. For example, prior to February 19, 2007, we were reimbursed for all the flow cytometry studies we performed. On February 19, 2007, the California contractor for Medicare that we bill for flow cytometry studies issued a local coverage determination for those studies, limiting reimbursement to only 20 flow cytometry studies for services performed on or after that date. Since our diagnostic tests use approximately 24 flow cytometry studies, we submit an appeal with Medicare to receive reimbursement beyond the 20 studies allowed by the LCD.
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For approximately half of our revenues for the three months ended March 31, 2008 and 2007, we were generally subject to reimbursement as a non-contracting provider, and payments to us as a non-contracting provider can be changed by third party payors at any time. We will continue to be a non-contracting provider until such time as we enter into contracts with third party payors for whom we are not currently contracted. We estimate contractual allowances with respect to revenues from third party payors with whom we are not currently contracted. For the three months ended March 31, 2008, we recorded positive changes in 2007 accounting estimates to reduce contractual allowances, which increased our revenues by $651,000 based on favorable experience in the collection of accounts receivable. Because a substantial portion of our revenues is from third-party payors with whom we are not currently contracted, it is likely that we will be required to make positive or negative adjustments to accounting estimates with respect to contractual allowances in the future (as we have made in each of the last several quarters), which may adversely affect our results of operations, our credibility with financial analysts and investors, and our stock price. Although, during the past several quarters we have experienced favorable changes in accounting estimates resulting in net increases in our revenues, it is possible that future adjustments may be less favorable and may result in net decreases in our revenues, which would adversely affect our results of operations.
Increased competition, including from competitors replicating our key service offerings in the future, and the failure to provide a higher quality of service than that of our competitors could adversely affect our revenues and profitability.
The laboratory services industry generally is intensely competitive both in terms of service and price, and it continues to undergo significant consolidation, permitting larger clinical laboratory service providers to increase cost efficiencies and change service levels, resulting in more intense competition. Most of our existing competitors and many potential competitors have substantially greater financial, selling, logistical and laboratory resources, more experience in dealing with third party payors for the services we provide, and greater market penetration, purchasing power and marketing budgets, as well as more experience in providing diagnostic services.
As a specialized diagnostic service provider, we rely extensively on our high quality of service to attract and retain community-based hem/oncs and other healthcare professionals as our customers at the expense of our larger competitors. We compete primarily on the basis of the quality of testing, reporting and information systems, reliability in patient sample transport, reputation in the medical community and access to our highly qualified hempaths. For example, we provide treating hem/oncs with telephonic access on an almost real-time basis to the specific hempath that generates a report and analysis on the specific patient. Our failure to provide services superior to the laboratories with which we compete could adversely affect our revenues and profitability.
Because we do not rely on our intellectual property portfolio to impede others from copying our business, there are no significant barriers to entry into our business, and new or existing laboratories could replicate our key service offerings and business model and enter our market to compete with us with relatively low upfront investments, which would adversely affect our business and prospects.
We are highly dependent on Cartesian Medical Group, Inc. for the services of our hempaths and any significant difficulties in recruiting or retaining these highly trained hempaths could adversely affect our revenues and results of operations.
Our business is highly dependent on the availability of hempaths, who provide professional services to us through Cartesian who is actively recruiting additional hempaths to work with us as we continue to expand our business. There are currently approximately 1,500 hempaths licensed in the United States, and only approximately 75 new hempaths receive board certification in the United States each year. Our PSA with Cartesian is automatically renewed on a yearly basis but may be terminated by the Company at any time on 60 days’ prior written notice, and either party may terminate the PSA upon the other party’s uncured material breach. Should Cartesian be unable to retain the hempaths that provide professional services to us, or if Cartesian fails in its efforts to recruit additional hempaths to provide us professional services, our ability to maintain and grow our business may be impaired. In addition, Cartesian may be required to offer higher compensation to hempaths in connection with recruitment and retention efforts, and these increased compensation expenses would be reflected in the amount we pay to Cartesian through the PSA. We may be unable to recover these increased expenses through price increases or reimbursements for our diagnostic services. In addition, if Cartesian were to experience significant turnover in hempaths, our ability to perform our specialized diagnostic services and our revenues and results of operations could be adversely affected.
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We must hire and retain qualified sales representatives to grow our sales.
Our ability to retain existing customers for our specialized diagnostic services and attract new customers is dependent upon retaining existing sales representatives and hiring new sales representatives, which is an expensive and time-consuming process. We face intense competition for qualified sales personnel and our inability to hire or retain an adequate number of sales representatives could limit our ability to maintain or expand our business and increase sales. Even if we are able to increase our sales force, our new sales personnel may not commit the necessary resources or provide sufficient high quality service and attention to hem/oncs to effectively market and sell our specialized diagnostic services. If we are unable to maintain and expand our marketing and sales networks or if our sales personnel do not perform to our high standards, we may be unable to maintain or grow our existing business and our results of operations and financial condition will likely suffer accordingly.
Our sales personnel have developed and maintain close relationships with a number of healthcare professionals. In particular, our sales force focuses its efforts on developing relationships with community-based hem/oncs and other healthcare professionals who are decision makers in their offices. Our sales depend on the use of our specialized diagnostic services by these community-based hem/oncs and other healthcare professionals, and successful marketing of our services depends on educating these community-based hem/oncs and other healthcare professionals as to the distinctive characteristics, benefits, high quality and value of our specialized diagnostic services compared to those of our competitors.
If a sales representative ceases employment, we risk the loss of customer goodwill based on the impairment of relationships developed between the sales representative and the healthcare professionals for whom the sales representative was responsible. This is particularly a risk if the representative goes to work for a competitor, as the healthcare professionals that are our customers may choose to use a competitor’s services based on their relationship with the departed sales representative.
If we fail to attract and retain key management and other personnel, we may be unable to successfully maintain or develop our business.
Our success depends on our continued ability to attract, retain and motivate highly qualified management, laboratory and other personnel. For example, we are highly dependent on the operational and financial expertise of our executive officers. The loss of the services of any of our executive officers, particularly Tina Nova Bennett, Ph.D., our president and chief executive officer, could impede our growth. In particular, our executive officers currently perform all of our policy-making functions, are in charge of our principal business units, divisions and functions and are solely responsible for all key decisions. We are also dependent on our key employees and consultants, who are important to our business and assist and support our executive officers in implementing and executing these officers’ key decisions. If we lose any of our executive officers or key employees and consultants, other of these individuals may be required to fulfill his or her duties and spend time finding a replacement. We may not be able to find suitable replacements, and our business may be harmed as a result. We do not maintain “key woman” or “key man” insurance policies on the lives of these individuals or the lives of any of our other employees. We employ our executive officers and key employees on an at-will basis and their employment can be terminated by us or them at any time.
Our industry has experienced a high rate of turnover of management personnel in recent years. In addition to the intense competition for qualified personnel in the healthcare industry, the San Diego area is characterized by a high cost of living, particularly for housing. As such, we could have difficulty attracting experienced personnel to our company and may be required to expend significant financial resources in our employee recruitment and retention efforts. If we are not able to attract and retain the necessary personnel to accomplish our business objectives, we may experience constraints that will impede significantly the achievement of our operational objectives, our revenue growth and our ability to implement our business strategy.
* We may experience difficulties in managing our growth, and our growth rate may decline.
Our revenues have grown to $22.3 million for the three months ended March 31, 2008 from $10.7 million for the three months ended March 31, 2007. This growth has put significant pressure on our systems and operations. As of March 31, 2008, we employed 186 employees, including three part-time employees. Our current organization, and our systems and facilities currently in place, may not be adequate to support our future growth. In order to effectively manage our operations and any significant growth, we may need to:
· scale our internal infrastructure, including establishing a new administrative facility and a second laboratory facility, while continuing to provide quality services on a timely basis to community-based hem/oncs and other customers;
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· maintain and strengthen our relationships with our hem/onc customers as we increase the number of our sales and marketing personnel and increase our presence in the various geographic markets we serve;
· attract and retain sufficient numbers of talented employees and consultants, including sales personnel, hempaths, CSCs, scientists, laboratory technicians and administrative employees, to handle the increasing number of tests we are requested to conduct;
· manage our relationship with Federal Express to ensure its ability to handle increasing sample transport and deliveries;
· continue to enhance our compliance and quality assurance systems; and
· continue to improve our operational, financial and management controls and reporting systems and procedures.
If we are not able to successfully implement the tasks necessary to further expand our operations, our business, including the quality of our services and our billing, reimbursement, compliance and quality assurance systems, our results of operations and our financial results could be adversely affected. In addition, as our revenues grow, our period over period growth rate may decline.
* We are currently expanding our infrastructure, including through the acquisition and development of additional office space and the expansion of our current laboratory capacity at our existing facility, and we intend to further expand our infrastructure by establishing a new laboratory facility and implementing additional backup systems, which, among other things, could divert our resources and may cause our margins to suffer.
In February 2008, we entered into a two-year lease (with three one-year extension options) for additional office space in Carlsbad, California to house our expanding billing and client services departments. Within the first half of 2008, we will initiate construction to expand our current laboratory capacity by building out unimproved areas within our existing facility.
In April 2008, we entered into a six-year lease beginning January 1, 2009 for additional office space in Carlsbad, California to house our future administration offices, as well as our billing and customer services departments. In connection with this lease, the February 2008 lease, where we entered into a two-year lease (with three one-year extension options) for additional office space in Carlsbad, California to house our expanding billing and client services departments, will be terminated effective January 1, 2009. Our existing headquarters building will be fully dedicated to clinical laboratory applications when the administration functions are moved in January of 2009.
Although all our facilities are in close proximity, there may be logistical issues that arise by virtue of separating these departments from the rest of our operations, including issues related to information systems integration and connectivity speed.
Moreover, in order to better serve our expanding customer base, to create a backup to our current laboratory facility, and to gain additional referrals for our specialized diagnostic services, we intend to expand our infrastructure, including establishing a second laboratory facility in another geographic market and expanding further our backup systems. Although we currently anticipate selecting a site for our new facility this year, in order to establish the new laboratory facility, we will be required to spend considerable time and money securing adequate space, constructing the facility, obtaining the federal, state and local certifications required by all applicable laws and regulations, recruiting and training employees and establishing the additional operational, logistical and administrative infrastructure necessary to support a second facility. Even after the new laboratory facility is operational, it may take time for us to derive the same economies of scale as in our existing facility. Moreover, we may suffer reduced economies of scale in our existing laboratory facility as we seek to balance the amount of work allocated to each laboratory facility. Similarly, we may invest in new backup systems in order to prevent the interruption in our current systems, which may be costly and would take time and resources to implement. Each expansion of our facilities or systems could divert resources, including the focus of our management, away from our current business. In addition, each expansion of our facilities may increase our costs and potentially decrease operating margins, both of which would, individually or in the aggregate, negatively impact our business, financial condition and results of operations. We will need to continue to expand our managerial, operational, financial, sales, marketing and other infrastructure in order to adequately manage our business and provide support for our services. In addition, to the extent our service levels in our existing or new facilities suffer, this may adversely impact our business, financial condition and results of operations.
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If our Carlsbad laboratory facility becomes inoperable, we will be unable to perform our specialized diagnostic services and our business will be harmed.
We currently do not have redundant laboratory facilities. We perform all of our diagnostic testing in our laboratory facility located in Carlsbad, California. Carlsbad is situated on or near earthquake fault lines and is located in an area that has experienced severe wildfires during the past several years. In addition, we do not have redundant systems for all of our business processes. Our facilities, the equipment we use to perform our tests and services and our other business process systems would be costly to replace and could require substantial time to repair or replace. The facilities may be harmed or rendered inoperable by natural or man-made disasters, including earthquakes, wildfires, floods, acts of terrorism or other criminal activities, infectious disease outbreaks and power outages, which may render it difficult or impossible for us to perform our tests for some period. In addition, such events may temporarily interrupt our ability to receive specimens or materials from our suppliers and to have access to our various systems necessary to operate our business. For example, in 2007 we experienced a power outage at our Carlsbad laboratory facility and the evacuation of our facilities as a result of severe wildfires. Although our backup generator and other backup procedures and systems allowed us to continue our operations without material interruption, we cannot assure you that similar incidents will not adversely affect our business in the future. The inability to perform our tests and services would result in the loss of customers and harm our reputation, and we may be unable to regain those customers in the future. Our insurance covering damage to our property and the disruption of our business may not be sufficient to cover all of our potential losses and may not continue to be available to us on acceptable terms, or at all.
In the event our laboratory facility is damaged or destroyed, we would need to engage a third party to perform laboratory testing services on our behalf. In order to rely on a third party to perform these testing services, we could only use another facility with established state licensure and Clinical Laboratory Improvement Amendments of 1988, or CLIA, accreditation. We cannot assure you that we would be able to find another CLIA-certified facility, or that another laboratory would be willing to perform the necessary tests for us on commercially reasonable terms. Finding a new laboratory that meets the required state licensure and CLIA accreditation standards or developing new systems necessary to operate our business would be time-consuming and costly and result in delays in our ability to provide our specialized diagnostic services or to provide the same level of quality in our services as we currently provide, which would harm our reputation and adversely affect our business, results of operations and financial condition.
* We incur financial risk related to collections.
Substantially all of our revenues are derived from specialized diagnostic services for which we bill on a fee-for-service basis. Billing for diagnostic services is a complex process and we bill many different payors such as insurance companies, governmental payor programs and patients, each of which has different billing requirements. Although we have experienced favorable trends in the collection of accounts receivable and related reductions to our provisions for doubtful accounts, we face risks in our collection efforts, including potential write-offs of doubtful accounts and long collection cycles for accounts receivable, including reimbursements by third party payors, such as Medicare, Medicaid and other governmental payor programs, hospitals, private insurance plans and managed care organizations. In addition, increases in write-offs of doubtful accounts, delays in receiving payments or potential retroactive adjustments and penalties resulting from audits by payors could adversely affect our business, results of operations and financial condition. As of March 31, 2008, we had an allowance for doubtful accounts of $2.1 million, which includes $85,000 of net write-offs and recoveries in the three months ended March 31, 2008.
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We or our suppliers and/or manufacturers may be subject to litigation relating to, among other things, payor and customer disputes, regulatory actions, professional liability, intellectual property, employee-related matters, product liability and other potential claims, which could adversely affect our business.
We or our suppliers and/or manufacturers may become subject in the ordinary course of business to material litigation related to, among other things, payor or customer disputes, professional liability, regulatory actions, intellectual property, employee-related matters, product liability and other potential claims, as well as investigations by governmental agencies and governmental payors relating to the specialized diagnostic services we provide. Responding to these types of claims, regardless of their merit, could result in significant expense and divert the time, attention and resources of our management. Legal actions could result in substantial monetary damages as well as significant harm to our reputation with community-based hem/oncs and other healthcare professionals and with payors, which could adversely affect our business, financial condition and results of operations.
We, Cartesian and/or our hempaths may be sued, or may be added as an additional party, under physician liability or other liability law for acts or omissions by our hempaths, laboratory personnel, or CSCs, and other employees and consultants, including but not limited to being sued for misdiagnoses or liabilities arising from the professional interpretations of test results. We, Cartesian and/or our hempaths may periodically become involved as defendants in medical malpractice and other lawsuits, and are subject to the attendant risk of substantial damage awards, in particular in connection with our COMPASS service offering. Our hempaths are insured for medical malpractice risks on a claims-made basis under traditional professional liability insurance policies. We also maintain general liability insurance that covers certain claims to which we may be subject. Our general insurance does not cover all potential liabilities that may arise, including governmental fines and penalties that we may be required to pay, liabilities we may incur under indemnification agreements and certain other uninsurable losses that we may suffer. It is possible that future claims will not be covered by or will exceed the limits of our insurance coverage.
We and the suppliers and manufacturers of the diagnostic tests we perform, which are critical to the performance of our specialized diagnostic services, may be exposed to, or threatened with, future litigation by third parties having patent or other intellectual property rights alleging that their diagnostic tests infringe the intellectual property rights of these third parties. In such event, we could no longer have access to, we may be prohibited from marketing or performing, or we may be subject to liabilities or litigations relating to such diagnostic tests unless we obtained a license from such third party. A license may not be available to us on acceptable terms, if at all. If we are unable to license diagnostic tests that are important to our specialized diagnostic services, our business, financial condition and results of operations may be adversely affected.
We rely on a limited number of third parties for manufacture and supply of all of our laboratory instruments, tests and materials, including consumables, and we may not be able to find replacement suppliers or manufacturers in a timely manner in the event of any disruption, which could adversely affect our business.
We rely on third parties for the manufacture and supply of all of our laboratory instruments, equipment and materials, including consumables such as reagents and disposable test kits, that we need to perform our specialized diagnostic services, and rely on a limited number of suppliers for certain laboratory materials and some of the laboratory equipment with which we perform our diagnostic services. We do not have long-term contracts with our suppliers and manufacturers that commit them to supply equipment and materials to us. Certain of our suppliers provide us with analyte specific regents, or ASRs, which serve as building blocks in the diagnostic tests we conduct in our laboratory. These suppliers are subject to regulation by the U.S. Food and Drug Administration, or FDA, and must comply with federal regulations related to the manufacture and distribution of ASR products. Because we cannot ensure the actual production or manufacture of such critical equipment and materials, or the ability of our suppliers to comply with applicable legal and regulatory requirements, we may be subject to significant delays caused by interruption in production or manufacturing. If any of our third party suppliers or manufacturers were to become unwilling or unable to provide this equipment or these materials in required quantities or on our required timelines, we would need to identify and acquire acceptable replacement sources on a timely basis. While we have developed alternate sourcing strategies for the equipment and materials we use, we cannot be certain that these strategies will be effective and even if we were to identify other suppliers and manufacturers for the equipment and materials we need to perform our specialized diagnostic services, there can be no assurance that we will be able to enter into agreements with such suppliers and manufacturers or otherwise obtain such items on a timely basis or on acceptable terms, if at all. If we encounter delays or difficulties in securing necessary laboratory equipment or materials, including consumables, we would face an interruption in our ability to perform our specialized diagnostic services and experience other disruptions that would adversely affect our business, results of operations and financial condition.
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Performance issues, service interruptions or price increases by our shipping carrier could adversely affect our business, results of operations and financial condition, and harm our reputation and ability to provide our specialized diagnostic services on a timely basis.
Expedited, reliable shipping is essential to our operations. One of our marketing strategies entails highlighting the reliability of our point-to-point transport of patient samples.
We rely almost exclusively on a single carrier, Federal Express, for reliable and secure point-to-point transport of patient bone marrow and other samples to our laboratory and enhanced tracking of these patient samples. Federal Express has tailored some of its systems and processes to meet our specific needs in providing high quality services to our hem/onc customers. In our specialty diagnostic field, patient samples more often than not include bone marrow biopsies, which are both technically difficult for a physician to obtain and extremely uncomfortable for patients to endure. Should Federal Express encounter delivery performance issues such as loss, damage or destruction of a sample, it would be difficult to replace our patient samples in a timely manner and such occurrences may damage our reputation and lead to decreased referrals from physicians for our specialized diagnostic services and increased cost and expense to our business. In addition, any significant increase in shipping rates could adversely affect our operating margins and results of operations. Similarly, strikes, severe weather, natural disasters or other service interruptions by delivery services we use would adversely affect our ability to receive and process patient samples on a timely basis.
If Federal Express or we were to terminate our relationship, we would be required to find another party to provide expedited, reliable point-to-point transport of our patient samples. There are only a few other providers of such nationwide transport services, and there can be no assurance that we will be able to enter into arrangements with such other providers on acceptable terms, if at all. Finding a new provider of transport services would be time-consuming and costly and result in delays in our ability to provide our specialized diagnostic services. Even if we were to enter into an arrangement with such provider, there can be no assurance that they will provide the same level of quality in transport services currently provided to us by Federal Express. If the new provider does not provide the required quality and reliable transport services, it could adversely affect our business, reputation, results of operations and financial condition.
Proprietary trademarks, service marks, trade secrets and unpatented expertise are very important to our business.
We use numerous trademarks and service marks to identify the products and services we offer, some of which have been registered with the U.S. Patent and Trademark Office, or USPTO, and others of which are undergoing USPTO review. In addition, we are seeking registration of the name Genoptix in additional fields of use. We cannot guarantee that any of the trademarks or service marks for which we have applied for registration will be granted. Moreover, should a third party challenge one or more of our trademarks or service marks, we cannot guarantee that we would prevail in that challenge. Despite the use of our trademarks or service marks in connection with our services, we are not the sole person entitled to use the names COMPASS or CHART in every category in the United States. For example, third parties have registered the name COMPASS in the United States in the medical field and other categories. None of these third parties have contacted us with a claim that our COMPASS trademark infringes their rights. We cannot guarantee that a third party with rights in a COMPASS or CHART trademark, or in another trademark we use, will not assert those rights against us in the future, by opposing one of our trademark applications, petitioning to cancel one of our trademark registrations, or filing suit against us for trademark infringement seeking damages and/or an injunction to stop us from using our mark.
Although we have taken steps to protect our trade secrets and unpatented expertise, including entering into confidentiality agreements with third parties, and confidential information and inventions agreements with employees, consultants and advisors, third parties may still be able to obtain this information or we may be unable to protect our rights. There can be no assurance that binding agreements will not be breached, that we would have adequate remedies for any breach, or that our trade secrets will not otherwise become known or be independently discovered by our competitors. Enforcing a claim that a third party illegally obtained and is using our trade secrets or unpatented expertise is expensive and time-consuming, and the outcome is unpredictable. Moreover, our competitors may independently develop equivalent knowledge, methods and expertise, and we would not be able to prevent their use.
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If technological innovation or prophylactic treatments were to reduce the need to conduct diagnostic testing on blood and bone marrow samples or allow our customers or other third parties to perform specialized diagnostic services similar to ours, our business, prospects, results of operations and financial condition could be adversely affected.
In order for hem/oncs to arrive at the correct diagnosis, choose or modify appropriate therapeutic regimens and monitor the effectiveness of these regimens, they currently require highly specialized diagnostic services that analyze blood and bone marrow samples. We focus our diagnostic efforts primarily on specific malignancies of the blood and bone marrow. Serial blood and bone marrow examinations are typically performed to follow the progress of the disease and the patient’s response to therapy. Technological innovations or other advances in medicine that result in the creation of enhanced diagnostic tools may enable other clinical laboratories, hospitals, physicians or other medical providers, or patients, to provide specialized diagnostic services similar to ours in a more patient-friendly, efficient or cost-effective manner than is currently possible. Advances in technology or medicine may also result in a cure or prophylactic treatment for some of the diseases on which we focus which could reduce or eliminate the need to obtain and analyze bone marrow samples. This could substantially reduce or eliminate our market opportunity and adversely affect our business, prospects, results of operations and financial condition.
Failure in our information systems, or IS, telephone or other systems could significantly disrupt our operations and adversely affect our business and financial condition.
IS and telephone systems are used extensively in virtually all aspects of our business, including laboratory testing, sales, billing, customer service, logistics and management of medical data. The success of our business depends on the ability to obtain, process, analyze, maintain and manage this data. Our management relies on our information systems because:
· patient samples must be received, tracked and processed on a timely basis;
· test results must be monitored and reported on a timely basis;
· billings and collections for all customers must be managed efficiently and accurately;
· third party ancillary billing services require proper tracking and reporting;
· pricing and other information related to our services is needed by our sales force and other personnel in a timely manner to conduct business;
· centralized procurement and test inventory management systems are required for effective test inventory management;
· regulatory compliance requires proper tracking and reporting; and
· proper recordkeeping is required for operating our business, regulatory compliance, managing employee compensation and other personnel matters.
Our business, results of operations and financial condition may be adversely affected if, among other things:
· our IS, telephone or other systems are interrupted or fail for any extended length of time;
· services relating to our IS, telephone or other systems are not kept current;
· our IS, telephone or other systems become unable to support expanded operations and increased levels of business;
· services provided by one or more of our vendors fail to operate within the expected technical parameters;
· information is lost or unable to be restored or processed; or
· information security is breached.
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Our success depends, in part, on the continued and uninterrupted performance of our IS, telephone and other systems, which are vulnerable to damage from a variety of sources, including telecommunications or network failures, computer viruses, natural disasters and physical or electronic break-ins. We are especially vulnerable to losses of patient information, which could result in violations of federal and state privacy laws. Despite the precautionary measures we have taken to prevent breakdowns in our IS and telephone systems, sustained or repeated system failures that interrupt our ability to process test orders, deliver test results or perform tests in a timely manner or that cause us to lose patient information could adversely affect our business, results of operations and financial condition.
We may experience difficulty in identifying, acquiring or in-licensing, and integrating third parties’ products, services, businesses and technologies into our current infrastructure and we may not be able to successfully execute on and integrate such products, services, businesses or technologies, which could disrupt our business and adversely affect our results of operations and financial condition.
An important part of our business strategy is to opportunistically pursue additional technologies, collaborations and acquisitions that will enable us to accelerate the implementation of our strategic plan and to increase the number of customers we serve and the specialized diagnostic services we provide to those customers, including by way of investments in other companies, licensing of technology, co-development arrangements, collaborations, asset purchases and other similar transactions. For example, we currently outsource select specialized services that we offer and we may in the future seek to acquire the necessary capabilities to provide these services internally. Although we are not currently a party to any other agreements or commitments and we have no understandings with respect to any such opportunities, we may seek to expand our services and technologies, on an opportunistic basis and as resources allow, by acquiring or in-licensing products, services, businesses or technologies that we believe are a strategic fit with our business and growth plans. Future acquisitions or in-licensing of products, services, businesses or technologies, however, may entail numerous operational and financial risks including:
· exposure to unknown liabilities;
· disruption of our business and diversion of our management’s time and attention;
· the availability of financing to pay for these transactions;
· incurrence of substantial debt or dilutive issuances of securities to pay for these transactions;
· higher than expected acquisition, in-licensing and integration costs;
· increased amortization expenses;
· difficulties in and costs of combining the operations and personnel of any acquired or in-licensed products, services, businesses or technologies with our operations and personnel;
· impairment of relationships with key suppliers or customers of any acquired or in-licensed products, services, businesses or technologies due to changes in management and ownership; and
· inability to retain key employees of any acquired or in-licensed products, services, businesses or technologies.
Finally, we may devote resources to potential acquisitions, in-licensing or collaboration opportunities that are never completed, acquired by others, or fail to realize the anticipated benefits of such efforts. Any of these matters could disrupt our business and adversely affect our results of operations and financial condition.
We use biological and hazardous materials that require considerable expertise and expense for handling, storage or disposal and may result in claims against us.
We work with hazardous materials, including chemicals, biological agents and compounds, blood and bone marrow samples and other human tissue, that could be dangerous to human health and safety or the environment. Our operations also produce hazardous and biohazardous waste products. Federal, state and local laws and regulations govern the use, generation, manufacture, storage, handling and disposal of these materials and wastes. Compliance with applicable environmental laws and regulations may be expensive, and current or future environmental laws and regulations may impair business efforts. If we do not comply with applicable regulations, we may be subject to fines and penalties.
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In addition, we cannot entirely eliminate the risk of accidental injury or contamination from these materials or wastes. Our general liability insurance and/or workers’ compensation insurance policy may not cover damages and fines arising from biological or hazardous waste exposure or contamination. Accordingly, in the event of contamination or injury, we could be held liable for damages or penalized with fines in an amount exceeding our resources, and our operations could be suspended or otherwise adversely affected.
* We have a limited operating history, have had net operating losses for several years, had an accumulated deficit of $37.0 million as of March 31, 2008, and only recently became profitable, and we are unable to predict with certainty whether we will remain profitable.
We are an early stage company with a limited operating history. We did not commence selling our specialized diagnostic services until the third quarter of 2004 and only became profitable in the first quarter of 2007. Consequently, any predictions about our future performance may not be as accurate as they could be if we had a longer history of successfully commercializing specialized diagnostic services.
We have incurred losses in each full fiscal year since our inception prior to 2007. As of March 31, 2008, we had an accumulated deficit of $37.0 million. For the years ended December 31, 2005 and 2006, we had net losses of $9.2 million and $3.8 million, respectively. For the three months ended March 31, 2008, we had net income of $5.0 million, which includes a $651,000 increase to our net income as a result of positive changes in 2007 accounting estimates. We may incur operating losses in the future as we expand our infrastructure, increase selling expenses and increase general and administrative expenses to comply with public company obligations or if we are unable to continue to maintain or increase our revenues or control expenses. Because of the numerous risks and uncertainties associated with our growth prospects, sales and marketing and other efforts and other factors, we are unable to predict with certainty whether we will remain profitable or predict the extent of our profitability or future losses.
We may be subject to claims that our employees, consultants or independent contractors have wrongfully used or disclosed alleged trade secrets of their other clients or former employers to us.
In addition to our employees, we engage the services of consultants to assist us with certain aspects of our business. Many of these employees or consultants were previously employed at or may have previously been or are currently providing consulting services to, other clinical laboratories or diagnostics companies, including our competitors or potential competitors. Although no claims against us are currently pending, we may be subject to claims that we or these employees or consultants have inadvertently or otherwise used or disclosed trade secrets or other proprietary information of their former employers or their former or current customers. Litigation may be necessary to defend against these claims. Even if we are successful in defending against these claims, litigation could result in substantial costs and be a distraction to management.
Risks Relating to Regulatory and Compliance Matters
We conduct business in a heavily regulated industry, and changes in regulations or violations of regulations may, directly or indirectly, reduce our revenues, adversely affect our results of operations and financial condition and harm our business.
The clinical laboratory testing industry is highly regulated, and there can be no assurance that the regulatory environment in which we operate will not change significantly and adversely in the future. Areas of the regulatory environment that may affect our ability to conduct business include, without limitation:
· federal and state laws applicable to billing and claims payment and/or regulatory agencies enforcing those laws and regulations;
· federal and state laboratory anti-mark-up laws;
· federal and state anti-kickback laws;
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· federal and state false claims laws;
· federal and state self-referral and financial inducement laws, including the federal physician anti-self-referral law, or the Stark Law;
· coverage and reimbursement levels by Medicare, Medicaid, other governmental payors and private insurers;
· restrictions on reimbursements for our services;
· federal and state laws governing laboratory testing, including CLIA;
· federal and state laws governing the development, use and distribution of diagnostic medical tests known as “home brews”;
· the Health Insurance Portability and Accountability Act of 1996, or HIPAA;
· federal and state regulation of privacy, security and electronic transactions;
· state laws regarding prohibitions on the corporate practice of medicine;
· state laws regarding prohibitions on fee-splitting;
· federal, state and local laws governing the handling and disposal of medical and hazardous waste; and
· Occupational Safety and Health Administration, or OSHA, rules and regulations.
These laws and regulations are extremely complex and in many instances, there are no significant regulatory or judicial interpretations of these laws and regulations. While we believe that we are currently in material compliance with applicable laws and regulations, a determination that we have violated these laws, or the public announcement that we are being investigated for possible violations of these laws, would adversely affect our business, prospects, results of operations and financial condition. In addition, a significant change in any of these laws may require us to change our business model in order to maintain compliance with these laws, which could reduce our revenues or increase our costs and adversely affect our business, prospects, results of operations and financial condition.
* If we fail to comply with healthcare fraud and abuse laws that govern, among other things, sales and marketing, billing and claims processing practices, we could face substantial penalties and our business, results of operations and financial condition could be adversely affected.
We are subject to various state and federal healthcare fraud and abuse laws and regulations, including, but not limited to:
· the federal Anti-Kickback Statute, which prohibits persons from knowingly and willfully soliciting, receiving, offering or providing remuneration, directly or indirectly, in cash or in kind, in exchange for or to induce either the referral of an individual for, or the purchase, order or recommendation of, any good or service for which payment may be made under governmental payor programs such as Medicare and Medicaid;
· the federal False Claims Act which prohibits individuals or entities from knowingly presenting, or causing to be presented to the federal government, claims for payment that are false or fraudulent;
· HIPAA, which created federal criminal laws that prohibit executing a scheme to defraud any healthcare benefit program or making false statements relating to healthcare matters;
· the Stark Law, which prohibits a physician from making a referral to an entity for certain designated health services reimbursed by Medicare or Medicaid if the physician (or a member of the physician’s family) has a financial relationship with the entity, and which also prohibits the submission of any claim for reimbursement for designated health services furnished pursuant to a prohibited referral; and
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· state law equivalents of each of the above federal laws, such as anti-kickback and false claims laws which may apply to items or services reimbursed by any third party payor, including commercial insurers.
Sanctions under these federal and state laws may include civil monetary penalties, exclusion of a clinical laboratory’s participation in or reimbursement from governmental payor programs, criminal fines and imprisonment. Although we endeavor to comply in all material respects with these rules and regulations, our sales and marketing, billing and claims processing practices may not, in all cases, meet all of the criteria for safe harbor protection or exemptions from liability under these laws. For example, in most cases, patients who utilize service providers that are not participants in a preferred provider network are subject to increased financial obligations in the form of greater coinsurance or copayment requirements. For approximately half of our revenues for the three months ended March 31, 2008 and 2007, we were generally subject to reimbursement as a non-contracting provider. In order to maintain our competitiveness with other clinical laboratories, except as required by applicable laws, we frequently accept third party insurance payment as payment in full and, in turn, waive all or a part of a patient’s coinsurance obligations such that the patient’s financial burden is no greater than if he or she would have selected an in-network provider. A successful challenge to our practice of accepting third party insurance payments as payment in full under the laws discussed above could adversely affect our business, results of operations and financial condition.
* Our failure to comply with governmental payor regulations could result in our being excluded from participation in Medicare, Medicaid or other governmental payor programs, which would decrease our revenues and adversely affect our results of operations and financial condition.
Reimbursement from Medicare and Medicaid accounted for approximately 40% of our revenues for the three months ended March 31, 2008. The Medicare program is administered by CMS which, like the states that administer their respective state Medicaid programs, imposes extensive and detailed requirements on diagnostic services providers, including, but not limited to, rules that govern how we structure our relationships with physicians, how and when we submit reimbursement claims and how we provide our specialized diagnostic services. Our failure to comply with applicable Medicare, Medicaid and other governmental payor rules could result in our inability to participate in a governmental payor program, our returning funds already paid to us, civil monetary penalties, criminal penalties and/or limitations on the operational function of our laboratory. If we were unable to receive reimbursement under a governmental payor program, a substantial portion of our revenues would be lost, which would adversely affect our results of operations and financial condition.
Our business could be harmed by future interpretations of clinical laboratory mark-up prohibitions.
Our laboratory currently uses the services of outside reference laboratories to provide certain complementary laboratory services to those services provided directly by our laboratory. Although Medicare policies do not prohibit certain independent-laboratory-to-independent-laboratory referrals and subsequent mark-up for services, California and other states have rules and regulations that prohibit or limit the mark-up of these laboratory-to-laboratory services. A challenge to our charge-setting procedures under these rules and regulations could have a material adverse effect on our business, results of operations and financial condition.
* Our business could be harmed from the loss or suspension of a license or imposition of a fine or penalties under, or future changes in, the law or regulations of the Clinical Laboratory Improvement Amendments of 1988, or those of other state or local agencies.
We are subject to CLIA, which is administered by CMS and extends federal oversight to virtually all clinical laboratories by requiring that they be certified by the federal government or by a federally-approved accreditation agency. CLIA is designed to ensure the quality and reliability of clinical laboratories by mandating specific standards in the areas of personnel qualifications, administration and participation in proficiency testing, patient test management, quality control, quality assurance and inspections. The sanction for failure to comply with CLIA requirements may be suspension, revocation or limitation of a laboratory’s CLIA certificate, which is necessary to conduct business, as well as significant fines and/or criminal penalties. If a laboratory is certified as “high complexity” under CLIA, the laboratory may obtain ASRs, which are used to develop in-house diagnostic tests known as “home brews.” We received our CLIA accreditation certificate as a “high complexity” laboratory in mid-2004. To renew this certificate, we are subject to survey and inspection every two years as well as the possibility of unannounced surveys at any time. Our CLIA accreditation was last renewed in March 2008.
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We are also subject to regulation of laboratory operations under state clinical laboratory laws. State clinical laboratory laws may require that laboratories and/or laboratory personnel meet certain qualifications, specify certain quality controls or require maintenance of certain records. For example, California requires that we maintain a license to conduct testing in California and California law establishes standards for our day-to-day laboratory operations, including the training and skill required of laboratory personnel and quality control. Certain other states, including Florida, Maryland, New York, Pennsylvania and Rhode Island, each require that we hold licenses to test specimens from patients residing in those states, and additional states may require similar licenses in the future. Potential sanctions for violation of these statutes and regulations include significant fines and the suspension or loss of various licenses, certificates and authorizations, which could adversely affect our business and results of operations.
Certain of our specialized diagnostic tests take advantage of the “home brew” exception from the FDA review, and any changes to the FDA’s policies with respect to this exception could adversely affect our business and results of operations.
Clinical laboratory diagnostic tests that are developed and validated by a laboratory for use in examinations the laboratory performs itself are called “home brew” tests. The FDA maintains that it has authority to regulate the development and use of “home brews” as diagnostic medical devices under the Federal Food, Drug and Cosmetic Act, or FDCA, but to date has decided not to exercise its authority with respect to most “home brew” tests as a matter of enforcement discretion. A substantial portion of our specialized diagnostic tests are “home brew” tests for which we have not obtained the FDA premarket clearance or approval. In addition, manufacturers and suppliers of ASRs, which we obtain for use in our “home brews,” are required to register with the FDA, to conform manufacturing operations to the FDA’s Quality System Regulation, or QSR, and to comply with certain reporting and other recordkeeping requirements. The FDA regularly considers the application of additional regulatory controls over the sale of ASRs and the development and use of “home brews” by laboratories such as ours. We cannot predict the extent of the FDA’s future regulation and policies with respect to “home brew” tests and there can be no assurance that the FDA will not require us to obtain premarket clearance or approval for certain of the diagnostic tests that we perform. Any such premarket clearance requirements could restrict or delay our ability to provide our specialized diagnostic services and may adversely affect our business and results of operations.
Failure to comply with the HIPAA security and privacy regulations may increase our operational costs.
The HIPAA privacy and security regulations establish comprehensive federal standards with respect to the uses and disclosures of personal health information, or PHI, by health plans and healthcare providers, in addition to setting standards to protect the confidentiality, integrity and availability of electronic PHI. The regulations establish a complex regulatory framework on a variety of subjects, including:
· the circumstances under which uses and disclosures of PHI are permitted or required without a specific authorization by the patient, including but not limited to treatment purposes, activities to obtain payments for services and healthcare operations activities;
· a patient’s rights to access, amend and receive an accounting of certain disclosures of PHI;
· the content of notices of privacy practices for PHI; and
· administrative, technical and physical safeguards required of entities that use or receive PHI electronically.
We have implemented policies and procedures related to compliance with the HIPAA privacy and security regulations, as required by law. The privacy regulations establish a uniform federal “floor” and do not supersede state laws that are more stringent. Therefore, we are required to comply with both federal privacy regulations and varying state privacy laws. The federal privacy regulations restrict our ability to use or disclose patient identifiable laboratory data, without patient authorization, for purposes other than payment, treatment or healthcare operations (as defined by HIPAA), except for disclosures for various public policy purposes and other permitted purposes outlined in the privacy regulations. The privacy and security regulations provide for significant fines and other penalties for wrongful use or disclosure of PHI, including potential civil and criminal fines and penalties. Although the HIPAA statute and regulations do not expressly provide for a private right of damages, we also could incur damages under state laws to private parties for the wrongful use or disclosure of confidential health information or other private personal information.
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Our business could be materially harmed by future interpretation or implementation of state laws regarding prohibitions on the corporate practice of medicine.
The manner in which licensed physicians can be organized to perform and bill for medical services is governed by state laws and regulations. Under the laws of some states, including California, business corporations generally are not permitted to employ physicians or to own corporations that employ physicians or to otherwise exercise control over the medical judgments or decisions of physicians. All of the hempaths that we utilize in connection with providing our specialized diagnostic services are employed by Cartesian. Cartesian is a California professional corporation we formed for the purpose of providing professional medical services in conjunction with the diagnostic services that we provide. On December 31, 2005, we entered into the PSA with Cartesian pursuant to which these hempaths provide professional services to us. Prior to that time, we employed these hempaths, which could result in the potential assertion by regulatory authorities that we were engaged in the corporate practice of medicine.
We believe that we currently are in compliance in all material respects with the laws governing the corporate practice of medicine in California. If regulatory authorities or other parties were to assert that we were engaged in the corporate practice of medicine currently or prior to December 31, 2005, or if California laws governing the corporate practice of medicine were to change, we could be required to restructure our contractual and other arrangements, and we and/or our hempaths could be subject to civil or criminal penalties. In addition, the provision of our specialized diagnostic services, which rely heavily on the professional services provided by our hempaths, could be interrupted or suspended, which would adversely affect our business, results of operations and financial condition.
Risks Relating to Our Finances and Capital Requirements
* Negative conditions in the global credit markets may impair the liquidity of a portion of our investment portfolio.
Our investment securities consist of high-grade ARS, corporate debt securities and government agency securities classified as available-for-sale. As of March 31, 2008, our portfolio included $12.5 million of ARS issued by municipalities and universities. The recent negative conditions in the global credit markets have prevented some investors from obtaining liquidity in these types of investments. As of March 31, 2008, we held four issues of ARS. In April 2008, we were able to liquidate our position in one without suffering any loss. Of the remaining three, one has not failed any auctions and the next auction is scheduled for second quarter of 2008. The remaining two securities have suffered multiple failed auctions to date. As a result, these securities are currently not liquid, and we could be required to hold them until redemption by the issuer or to maturity. In the event we need to access the funds that are in an illiquid state, we will not be able to do so without a loss of principal, until a future auction on these investments is successful, the securities are redeemed by the issuer or they mature. If the credit ratings of the security issuers deteriorate and any decline in market value is determined to be other-than-temporary, we would be required to adjust the carrying value of the investment through an impairment charge.
We may need to raise additional capital in the future, which may not be available on favorable terms or at all, which may cause dilution to our existing stockholders or require us to be subject to certain restrictions.
We may need to raise additional capital in the future. Our operations have consumed substantial amounts of cash since inception. To date, our sources of cash have been primarily limited to our initial public offering, private placements of preferred stock and debt, and more recently cash flow from operations. We expect to continue to spend substantial amounts of capital to grow our business. To fund such growth, we may raise additional funds through public or private equity offerings or debt financings. We do not know if we will be able to continue to generate cash flow from operations or if we will be able to obtain additional financing on favorable terms, if at all. If we cannot raise funds on acceptable terms, if and when needed, we may not be able to maintain or grow our business at the rate that we currently anticipate and respond to competitive pressures or unanticipated capital requirements, or we may be required to reduce operating expenses, which could significantly harm our business, financial condition and results of operations. In addition, to the extent that we raise additional capital by issuing equity securities, our existing stockholders’ ownership in our company will be diluted.
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We expect to continue to incur significant increased costs as a result of operating as a public company, and our management expects to continue to devote substantial time to public company compliance programs.
As a public company, we incur significant legal, accounting and other expenses that we did not incur as a private company, which we currently expect to be at least $2.2 million per year. In addition, the Sarbanes-Oxley Act of 2002, or the Sarbanes-Oxley Act, as well as rules subsequently implemented by the Securities and Exchange Commission, or SEC, and The NASDAQ Stock Market, or NASDAQ, in the past several years have imposed various requirements on public companies, including establishment and maintenance of effective disclosure and financial controls and changes in corporate governance practices. Our management and other personnel continue to devote a substantial amount of time to these compliance programs and other programs related to being a public company, such as investor relations and monitoring of public company reporting obligations. These rules and regulations will continue to increase our legal and financial compliance costs and will make some activities more time-consuming and costly. As a public company, it is more difficult and more expensive for us to renew director and officer liability insurance, and we may be required to accept reduced policy limits and coverage or incur substantially higher costs to obtain the same or similar coverage.
The Sarbanes-Oxley Act requires, among other things, that we maintain effective internal control over financial reporting. In particular, commencing this year, we must perform system and process evaluation and testing of our internal control over financial reporting to allow management and our independent registered public accounting firm to report on the effectiveness of our internal control over financial reporting, as required by Section 404 of the Sarbanes-Oxley Act, or Section 404. Our testing, or the subsequent testing by our independent registered public accounting firm, may reveal significant deficiencies or material weaknesses in our internal control over financial reporting. We are incurring significant expense and devote substantial management effort toward ensuring compliance with Section 404. If we are not able to comply with the requirements of Section 404 in a timely manner, or if we or our independent registered public accounting firm identify deficiencies in our internal control over financial reporting that are deemed to be significant deficiencies or material weaknesses, the market price of our common stock could decline and we could be subject to sanctions or investigations by NASDAQ, the SEC or other regulatory authorities, which would entail expenditure of additional financial and management resources.
Risks Relating to the Securities Markets and Investment in Our Common Stock
There may not be a viable public market for our common stock.
We cannot predict the extent to which investor interest in our company will sustain an active trading market for our stock on The NASDAQ Global Market or any other stock market or how liquid any such market might remain. If an active public market is not sustained, it may be difficult for our stockholders to sell their shares of common stock at a price that is attractive to them, or at all.
Fluctuations in our operating results and market volatility may affect our stock price.
The market price of our common stock is volatile and may fluctuate significantly in response to a number of factors, many of which we cannot control, including:
· changes in coverage and/or reimbursement guidelines and amounts;
· variations in deductible and coinsurance amounts;
· changes in regulations affecting the healthcare or diagnostic services industry;
· failure to comply with applicable regulations;
· changes in the payor mix or the mix or cost of our specialized diagnostic services;
· the timing and volume of patient orders and the timing and cost of our sales and marketing campaigns;
· increased investigative or enforcement initiatives by governmental and other third party payors;
· additions or departures of key personnel;
· variations in our quarterly operating results, including the number of business days in each quarter;
· seasonality and volume declines due to adverse weather conditions and holidays;
· changes in our accounting estimates;
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· changes in our DSO level;
· changes in securities analysts’ estimates of our financial performance;
· announcements of acquisitions or other strategic transactions by us or our competitors;
· announcements of new products or services offered by us or our competitors;
· fluctuations in stock market prices and trading volumes of similar companies or in the broader markets generally;
· sales of large blocks of our common stock, including sales by our executive officers, directors and significant stockholders;
· any litigation in which we become involved;
· fluctuations in security market indices of which we may be included now or in the future;
· discussion of us or our stock price by the financial and medical press and in online investor communities;
· impairment of any of our assets, including our investment securities; and
· changes in accounting principles generally accepted in the United States.
Due to these factors, stockholders may not be able to sell their shares of our common stock at favorable prices or at all.
Anti-takeover provisions in our charter documents and under Delaware law could make an acquisition of us, which may be beneficial to our stockholders, more difficult and may prevent attempts by our stockholders to replace or remove our current management.
Provisions in our amended and restated certificate of incorporation and amended and restated bylaws, both of which became effective upon the completion of our initial public offering, may delay or prevent an acquisition of us or a change in our management. These provisions include a classified board of directors, a prohibition on actions by written consent of our stockholders and the ability of our board of directors to issue preferred stock without stockholder approval. In addition, because we are incorporated in Delaware, we are governed by the provisions of Section 203 of the Delaware General Corporation Law, which, subject to certain exceptions, prohibits stockholders owning in excess of 15% of our outstanding voting stock from merging or combining with us. Although we believe these provisions collectively provide for an opportunity to receive higher bids by requiring potential acquirers to negotiate with our board of directors, they would apply even if the offer may be considered beneficial by some stockholders. In addition, these provisions may frustrate or prevent any attempts by our stockholders to replace or remove our current management by making it more difficult for stockholders to replace members of our board of directors, which is responsible for appointing the members of our management.
* If our executive officers, directors and largest stockholders choose to act together, they may be able to control our operations and act in a manner that advances their interests and not necessarily those of other stockholders.
As of March 31, 2008, our executive officers, directors and holders of 5% or more of our outstanding common stock beneficially owned approximately 46% of our common stock. As a result, these stockholders, acting together, are able to control all matters requiring approval by our stockholders, including the election of directors and the approval of mergers or other business combination transactions. The interests of this group of stockholders may not always coincide with our interests or the interests of other stockholders, and they may act in a manner that advances their interests and not necessarily those of other stockholders.
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* Future sales of our common stock may depress our stock price.
Sales of a substantial number of shares of our common stock in the public market could occur at any time. These sales, or the perception in the market that the holders of a large number of shares intend to sell shares, could reduce the market price of our common stock. Approximately 8,476,869 shares of our common stock outstanding as of March 31, 2008, are currently restricted as a result of securities laws or lock-up agreements, but will be available for resale in the public market as described below. As a result of the 180-day lock-up agreements between the underwriters for our initial public offering and our security holders, the 90-day lock-up agreements between the underwriters for our secondary offering and our officers, directors and the selling stockholders in that transaction, and the provisions of Rule 144 under the Securities Act, or Rule 144, and Rule 701 under the Securities Act of 1933, as amended, or the Securities Act, or Rule 701, the shares of our common stock that will be available for sale in the public market are as follows:
· 1,123,335 shares will be eligible for sale under Rule 144 or Rule 701 upon the expiration of the various lock-up agreements without regard to volume limitations, manner of sale requirements or other restrictions, unless extended for up to a specified number of additional days as required under the lock-up agreements;
· 7,342,990 shares will be eligible for sale under Rule 144 upon the expiration of the various lock-up agreements, subject to volume limitations, manner of sale requirements and other restrictions, unless extended for up to a specified number of additional days as required under the lock-up agreements; and
· 1,028,127 shares will be eligible for sale, upon the exercise of vested options and warrants (based on the number of options and warrants outstanding as of March 31, 2008), upon the expiration of the various lock-up agreements, unless extended for up to a specified number of additional days as required under the lock-up agreements.
Due to the timing of our quarterly earnings release, the lock-up agreements between the underwriters and certain of our stockholders, which was entered into in conjunction with our initial public offering, will automatically be extended an additional 18 days from the date we report results of the first quarter. As a result of this automatic extension, no shares subject to the initial public offering lock-up agreement may be sold prior to May 27, 2008, unless such lock-up restriction is waived in writing by the underwriters for our initial public offering.
Amendments to Rule 144 effective as of February 15, 2008 reduce the holding period for restricted shares of common stock to six months under specified circumstances, modify the restrictions on the sale of restricted shares of common stock held by affiliates and modify certain other restrictions on resale of the shares of common stock under Rule 144 to make it easier for stockholders under specified circumstances to sell their shares.
Moreover, the holders of up to approximately 5,785,674 shares of common stock (including shares of our common stock issuable upon the exercise of outstanding warrants) will have rights, subject to some conditions, to require us to file registration statements covering their shares or to include their shares in registration statements that we may file for ourselves or other stockholders. These rights will terminate upon the earlier of four years following the closing of our initial public offering or, as to a particular holder of registration rights, when all securities held by that stockholder subject to registration rights may be sold pursuant to Rule 144 within a single 90-day period. We also registered all shares of common stock that we may issue under our equity compensation plans. These shares can be freely sold in the public market upon issuance, subject to the lock-up agreements between the underwriters for our initial public offering and our security holders and our window period and insider trading policies, if applicable.
We have never paid dividends on our capital stock, and because we do not anticipate paying any cash dividends in the foreseeable future, capital appreciation, if any, of our common stock may be the sole source of gain on an investment in our stock.
We have paid no cash dividends on any of our classes of capital stock to date and we currently intend to retain our future earnings, if any, to fund the development and growth of our business. We do not anticipate paying any cash dividends on our common stock in the foreseeable future. Furthermore, to the extent we incur additional indebtedness, the loan documents governing such indebtedness may restrict our ability to pay dividends. As a result, we anticipate that capital appreciation, if any, of our common stock may be our stockholders’ sole source of gain for the foreseeable future.
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We may become involved in securities class action litigation that could divert management’s attention and harm our business.
The stock markets have from time to time experienced significant price and volume fluctuations that have affected the market prices for the common stock of diagnostic companies. These broad market fluctuations may cause the market price of our common stock to decline. In the past, securities class action litigation has often been brought against a company following a decline in the market price of its securities. This risk is especially relevant for us because clinical laboratory service companies have experienced significant stock price volatility in recent years. We may become involved in this type of litigation in the future. Litigation often is expensive and diverts management’s attention and resources, which could adversely affect our business.
If we are not the subject of securities analyst reports or if any securities analyst downgrades our common stock or our sector, the price of our common stock could be negatively affected.
Securities analysts may publish reports about us or our industry containing information about us that may affect the trading price of our common stock. There are many publicly traded companies active in the healthcare industry, which may mean it will be less likely that we receive analysts’ coverage, which in turn could affect the price of our common stock. In addition, if a securities or industry analyst downgrades the outlook for our stock or one of our competitors’ stocks or chooses to terminate coverage of our stock, the trading price of our common stock may also be negatively affected.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Use of Proceeds
Our initial public offering of common stock was effected through a Registration Statement on Form S-1 (File No. 333-144997) that was declared effective by the SEC on October 29, 2007, which registered an aggregate of 5,750,000 shares of our common stock, including 750,000 shares that the underwriters had the option to purchase to cover over-allotments. On November 2, 2007, 4,735,714 shares of common stock were sold on our behalf, including 450,000 shares sold by us upon exercise in full of the underwriters’ over-allotment options, and 1,014,286 shares of common stock were sold on behalf of the selling stockholders, including 300,000 shares sold by the selling stockholders upon exercise in full of the underwriters’ over-allotment option, at an initial public offering price of $17.00 per share, for an aggregate gross offering price of $80.5 million to us resulting in net offering proceeds to us of approximately $72.5 million (after deducting underwriting discounts, commissions and offering costs) and gross offering proceeds of $17.2 million to the selling stockholders.
As of March 31, 2008, we had invested $52.7 million of net proceeds from our initial public offering in ARS, government agency and corporate debt securities with the balance of the net proceeds held in money market funds. Through March 31, 2008, we have used $15.9 million of the net proceeds to fund the incremental working capital requirements to grow our business, $1.6 million to purchase capital equipment and $1.8 million to repay our outstanding long-term debt. The proceeds used to date were used to make direct payments to third parties who were not our officers or directors (or their associates), persons owning ten percent or more of any class of our equity securities, or any other affiliate (except that the proceeds used for salary expense included in regular compensation expenses for officers). We intend to use the remaining proceeds to increase our personnel, expand our current laboratory capacity within our existing facility, establish additional administrative offices and a second laboratory facility, expand our backup systems, opportunistically pursue new collaborations or acquisitions and fund working capital and general corporate purposes. We cannot specify with certainty all of the particular uses for the net proceeds from our initial public offering. Accordingly, our management has broad discretion in the application of the net proceeds.
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Exhibit |
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| Description |
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3.1 | (1) |
| Amended and Restated Certificate of Incorporation of the Registrant. |
3.2 | (1) |
| Amended and Restated Bylaws of the Registrant. |
4.1 | (2) |
| Form of the Registrant’s Common Stock Certificate. |
4.2 | (2) |
| Amended and Restated Warrant to Purchase Stock issued by the Registrant on April 19, 2002 to General Electric Corporation. |
4.3 | (2) |
| Amended and Restated Warrant to Purchase Stock issued by the Registrant on July 29, 2002 to General Electric Corporation. |
4.4 | (2) |
| Amended and Restated Warrant to Purchase Stock issued by the Registrant on November 26, 2002 to Comerica Bank. |
4.5 | (2) |
| Amended and Restated Warrant to Purchase Stock issued by the Registrant on March 8, 2004 to Comerica Bank. |
4.6 | (2) |
| Warrant to Purchase Stock issued by the Registrant on May 9, 2005 to Comerica Bank. |
4.7 | (2) |
| Warrant to Purchase Stock issued by the Registrant on May 30, 2006 to Comerica Bank. |
4.8 | (2) |
| Amended and Restated Investors’ Rights Agreement, dated May 9, 2005, by and among the Registrant and certain of its stockholders. |
4.9 | (2) |
| First Amendment to Amended and Restated Investors’ Rights Agreement, dated August 3, 2005, by and among the Registrant and certain of its stockholders. |
4.10 | (3) |
| Form of Restricted Stock Unit Award Agreement for Executives and Form of Restricted Stock Unit Award Grant Notice for Executives. |
10.1 |
|
| Standard Multi-Tenant Office Lease dated April 14, 2008, by and between the Registrant and Allen Joseph Blackmore, Trustee of the Blackmore Family Trust, Restated 1995. |
10.2 |
|
| Amendment to Amended and Restated Loan and Security Agreement by and between the Registrant and Comerica Bank dated March 7, 2008. |
31.1 | * |
| Certification of the Principal Executive Officer Pursuant to Rule 13a-14 and Rule 15d-14of the Securities Exchange Act of 1934, as amended. |
31.2 | * |
| Certification of the Chief Financial Officer Pursuant to Rule 13a-14 and Rule 15d-14of the Securities Exchange Act of 1934, as amended. |
32.1 | * |
| Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
* These certifications are being furnished solely to accompany this quarterly report pursuant to 18 U.S.C. Section 1350, and are not being filed for purposes of Section 18 of the Securities Exchange Act of 1934 and are not to be incorporated by reference into any filing of Genoptix, Inc., whether made before or after the date hereof, regardless of any general incorporation language in such filing.
(1) Incorporated herein by reference to the corresponding exhibit to the Registrant’s Current Report on Form 8-K (File No. 001-33753) as filed with the Securities and Exchange Commission on November 2, 2007.
(2) Incorporated herein by reference to the Registrant’s Registration Statement on Form S-1 (File No. 333-144997), as amended, filed with the Securities and Exchange Commission.
(3) Incorporated herein by reference to the Registrant’s Current Report on Form 8-K (File No. 001-33753), as filed with the Securities and Exchange Commission on April 16, 2008.
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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.
| GENOPTIX, INC. | |
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Date: May 8, 2008 | By: | /s/ Douglas A. Schuling |
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| Douglas A. Schuling |
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| Senior Vice President and Chief Financial |
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