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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-Q
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(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, 2001
[ ] 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: 000-30369
VIROLOGIC, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 94-3234479
(STATE OR OTHER JURISDICTION OF (IRS EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
270 EAST GRAND AVENUE
SOUTH SAN FRANCISCO, CA 94080
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
TELEPHONE NUMBER (650) 635-1100
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
As of May 8, 2001 there were 20,026,072 shares of the registrant's common
stock outstanding.
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VIROLOGIC, INC.
INDEX
PAGE
NO.
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PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Balance Sheets as of March 31, 2001 and
December 31, 2000........................................... 1
Condensed Statements of Operations for the three
months ended March 31, 2001 and 2000........................ 2
Condensed Statements of Cash Flows for the three
months ended March 31, 2001 and 2000........................ 3
Notes to Condensed Financial Statements............ 4
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations................. 7
Item 3. Quantitative and Qualitative Disclosures About
Market Risk............................................... 9
PART II. OTHER INFORMATION
Item 1. Legal Proceedings................................... 16
Item 2. Changes in Securities and Use of Proceeds........... 16
Item 3. Defaults Upon Senior Securities..................... 16
Item 4. Submission of Matters to a Vote of Security
Holders................................................... 16
Item 5. Other Information................................... 16
Item 6. Exhibits and Reports on Form 8-K.................... 16
SIGNATURES.................................................. 17
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VIROLOGIC, INC.
CONDENSED BALANCE SHEETS
(IN THOUSANDS)
MARCH 31, DECEMBER 31,
2001 2000
----------- ------------
(UNAUDITED) (NOTE 1)
ASSETS
Current assets:
Cash and cash equivalents................................. $ 5,695 $ 12,623
Short-term investments.................................... 11,470 11,171
Accounts receivable, net of allowance for doubtful
accounts of $257 in 2001 and $175 in 2000.............. 2,668 2,404
Inventory................................................. 691 449
Restricted cash........................................... 800 1,050
Other current assets...................................... 891 1,152
-------- --------
Total current assets.............................. 22,215 28,849
Property and equipment, net................................. 13,328 13,234
Restricted cash............................................. 950 979
Other assets................................................ 745 585
-------- --------
Total assets...................................... $ 37,238 $ 43,647
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable.......................................... $ 3,010 $ 1,865
Accrued compensation...................................... 1,726 1,305
Accrued liabilities....................................... 1,084 2,678
Deferred revenue.......................................... 384 116
Current portion of capital lease obligations.............. 504 398
Current portion of loans payable.......................... 1,403 1,390
-------- --------
Total current liabilities......................... 8,111 7,752
Long-term portion of capital lease obligations.............. 1,057 945
Long-term portion of loans payable.......................... 656 1,019
Long-term deferred rent..................................... 281 288
Commitments and contingencies
Stockholders' equity:
Common stock.............................................. 20 20
Additional paid-in capital................................ 88,676 88,772
Deferred compensation..................................... (1,976) (2,495)
Accumulated other comprehensive income.................... 262 178
Notes receivable from officers and employees.............. (31) (31)
Accumulated deficit....................................... (59,818) (52,801)
-------- --------
Total stockholders' equity........................ 27,133 33,643
-------- --------
Total liabilities and stockholders' equity........ $ 37,238 $ 43,647
======== ========
See accompanying notes to Condensed Financial Statements.
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VIROLOGIC, INC.
CONDENSED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
THREE MONTHS ENDED
MARCH 31,
-------------------
2001 2000
------- --------
Revenue..................................................... $ 3,088 $ 877
Operating costs and expenses:
Cost of revenue........................................... 2,288 684
Research and development.................................. 2,688 2,275
General and administrative................................ 2,960 2,637
Sales and marketing....................................... 2,441 803
------- --------
Total operating costs and expenses................ 10,377 6,399
------- --------
Operating loss.............................................. (7,289) (5,522)
Interest income............................................. 355 115
Interest expense............................................ (83) (57)
------- --------
Net loss.................................................... (7,017) $ (5,464)
Deemed dividend to preferred stockholders................... -- (15,700)
------- --------
Net loss allocable to common stockholders................... $(7,017) $(21,164)
======= ========
Basic and diluted net loss per common share................. $ (0.35) $ (4.19)
======= ========
Weighted-average shares used in computing basic and diluted
net loss per common share................................. 19,860 5,043
======= ========
See accompanying notes to Condensed Financial Statements.
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VIROLOGIC, INC.
CONDENSED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
THREE MONTHS ENDED
MARCH 31,
------------------
2001 2000
------- -------
OPERATING ACTIVITIES
Net loss.................................................... $(7,017) $(5,464)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization............................. 694 349
Non-cash stock-based compensation......................... 411 1,004
Expense related to issuance of warrants................... 26 --
Changes in assets and liabilities:
Accounts receivable.................................... (264) 48
Inventory.............................................. (242) (123)
Other current assets................................... 235 (68)
Accounts payable....................................... 1,145 196
Accrued compensation................................... 421 533
Accrued liabilities.................................... (1,594) 957
Deferred revenue....................................... 268 11
Deferred rent.......................................... (7) 7
------- -------
Net cash used in operating activities............. (5,924) (2,550)
INVESTING ACTIVITIES
Intangible and other assets................................. (160) (307)
Purchases of short-term investments......................... (1,340) --
Maturities and sales of short-term investments.............. 1,125 --
Restricted cash............................................. 279 (358)
Capital expenditures........................................ (496) (541)
------- -------
Net cash used in investing activities............. (592) (1,206)
FINANCING ACTIVITIES
Proceeds from loans payable................................. -- 808
Principal payments on loans payable......................... (350) (213)
Principal payments on capital lease obligations............. (74) --
Net proceeds from issuance of common stock.................. 12 92
Repayments of notes receivable.............................. -- 4
Net proceeds from issuance of preferred stock............... -- 15,700
Prepaid offering costs...................................... -- (938)
------- -------
Net cash (used in) provided by financing
activities....................................... (412) 15,453
------- -------
Net increase (decrease) in cash and cash
equivalents...................................... (6,928) 11,697
Cash and cash equivalents at beginning of period............ 12,623 2,208
------- -------
Cash and cash equivalents at end of period.................. $ 5,695 $13,905
======= =======
See accompanying notes to Condensed Financial Statements.
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VIROLOGIC, INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS
MARCH 31, 2001
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The accompanying unaudited condensed financial statements have been
prepared in accordance with 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
footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all adjustments (consisting
only of adjustments of a normal recurring nature) considered necessary for a
fair presentation have been included. Operating results for the three-month
period ended March 31, 2001 are not necessarily indicative of the results that
may be expected for the year ending December 31, 2001. The condensed balance
sheet as of December 31, 2000 has been derived from the audited financial
statements as of that date but does not include all of the information and
footnotes required by accounting principles generally accepted in the United
States for complete financial statements. For further information, refer to the
audited financial statements and notes thereto included in our Annual Report to
Stockholders on Form 10-K for the year ended December 31, 2000.
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates.
Revenue Recognition
Revenue is recognized upon completion of tests made on samples provided by
customers and the shipment of test results to those customers. Services are
provided to certain patients covered by various third-party payor programs,
including Medicare. Billings for services under third-party payor programs are
included in revenues net of allowances for contractual discounts and allowances
for differences between the amounts billed and estimated payment amounts.
Deferred revenue relates to cash received in advance of delivery of test
results.
Inventory
Inventory is stated at the lower of standard cost, which approximates
actual cost, or market. At March 31, 2001 and December 31, 2000, inventories
consisted mainly of raw materials used in the performance of tests.
Reclassification
Certain reclassifications of prior year amounts have been made to conform
with the current year presentation.
Recent Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 133, "Accounting for Derivative
Instruments and Hedging Activities" ("SFAS 133"). SFAS 133 requires the Company
to recognize all derivatives on the balance sheet at fair value. Derivatives
that are not hedges must be adjusted to fair value through net income. If the
derivative is a hedge, depending on the nature of the hedge, changes in the fair
value of the derivative are either offset against the change in fair value of
assets, liabilities, or firm commitments through earnings or recognized in the
other comprehensive income until the hedged item is recognized in earnings. The
ineffective portion of the derivative's change in fair value will be immediately
recognized in earnings. SFAS 133 is effective for the
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VIROLOGIC, INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 2001
Company's year ending December 31, 2001. The Company does not currently hold any
derivatives and therefore the adoption of SFAS 133 had no impact on the
Company's financial statements.
2. COMPREHENSIVE INCOME (LOSS)
Comprehensive income (loss) is comprised of net income (loss) and other
comprehensive income (loss). Other comprehensive income includes certain changes
in equity that are excluded from net income (loss). Specifically, unrealized
gains and losses on our available-for-sale securities, which are reported
separately in stockholders' equity, are included in accumulated other
comprehensive income. Comprehensive income (loss) and its components for the
quarters ended March 31, 2001 and 2000 are as follows (in thousands):
THREE MONTHS ENDED
MARCH 31,
------------------
2001 2000
------- -------
(UNAUDITED)
Net loss.................................................... $(7,017) $(5,464)
Changes in unrealized gain on securities available-for-sale,
net of tax................................................ 84 --
------- -------
Comprehensive loss.......................................... $(6,933) $(5,464)
======= =======
3. NET LOSS PER SHARE
Basic earnings (loss) per share is calculated based on the weighted-average
number of common shares outstanding during the periods presented, less the
weighted-average shares outstanding which are subject to the Company's right of
repurchase. Diluted earnings per share would give effect to the dilutive effect
of common stock equivalents consisting of convertible preferred stock and stock
options and warrants, calculated using the treasury stock method. Potentially
dilutive securities have been excluded from the diluted earnings per share
computations as they have an antidilutive effect due to the Company's net loss.
The computation of pro forma net loss per share includes shares issuable
upon the conversion of outstanding shares of convertible preferred stock, using
the as-if converted method, from the original date of issuance of the preferred
stock.
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VIROLOGIC, INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 2001
A reconciliation of pro forma basic and diluted net loss per common share
is as follows (in thousands, except per share data):
THREE MONTHS ENDED
MARCH 31,
-------------------
2001 2000
------- --------
(UNAUDITED)
ACTUAL:
Net loss.................................................... $(7,017) $ (5,464)
Deemed dividend to preferred stockholders................... -- (15,700)
------- --------
Net loss allocable to common stockholders................... $(7,017) $(21,164)
======= ========
Weighted-average shares of common stock outstanding......... 19,873 5,098
Less: weighted-average shares subject to repurchase......... (13) (55)
------- --------
Weighted-average shares used in basic and diluted net loss
per common share.......................................... 19,860 5,043
======= ========
Basic and diluted net loss per common share................. $ (0.35) $ (4.19)
======= ========
PRO FORMA:
Net loss allocable to common stockholders................... $(21,164)
========
Shares used above........................................... 5,043
Adjusted to reflect weighted-average effect of assumed
conversion of preferred stock............................. 7,869
--------
Weighted-average shares used in pro forma basic and diluted
net loss per common share................................. 12,912
========
Pro forma basic and diluted net loss per common share....... $ (1.64)
========
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ITEM 2.MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion of the financial condition and results of
operations should be read in conjunction with the financial statements and the
notes thereto included in this Form 10-Q.
FORWARD-LOOKING STATEMENTS
This Quarterly Report on Form 10-Q contains certain forward-looking
statements within the meaning of the "safe harbor" provisions of the Private
Securities Litigation Reform Act of 1995 including, without limitation,
statements regarding our PhenoSense testing products, the growth of our
pharmaceutical business, research and development expenditures, adequacy of our
capital resources, and other financial matters. These statements, which
sometimes include words such as "expect," "goal," "may," "anticipate," "should,"
"continue," or "will," reflect our expectations and assumptions as of the date
of this Quarterly Report based on currently available operating, financial and
competitive information. Actual results could differ materially from those in
the forward-looking statements as a result of a number of factors, including our
ability to raise additional capital, the market acceptance of our PhenoSense
testing products, the effectiveness of our competition's existing products and
new products, the ability to effectively manage growth and the risks associated
with our dependence on patents and proprietary rights. These factors and others
are more fully described in "Risk Factors" and elsewhere in this Form 10-Q. We
assume no obligation to update any forward-looking statements.
OVERVIEW
We are a biotechnology company developing, marketing and selling innovative
products to guide and improve treatment of viral diseases. We incorporated in
the state of Delaware on November 14, 1995 and commenced commercial operations
in 1999. We developed a practical way of directly measuring the impact of
genetic mutations on drug resistance and using this information to guide
therapy. We have proprietary technology, called PhenoSense, for testing drug
resistance in viruses that cause serious viral diseases such as AIDS, hepatitis
B and hepatitis C. Our first product, PhenoSense HIV, is a test that directly
and quantitatively measures resistance of a patient's HIV to anti-viral drugs.
The results help physicians select appropriate drugs for their HIV patients. We
are also developing PhenoSense products for other serious viral diseases and are
collecting PhenoSense test results and related clinical data in an interactive
database that we plan to make available to physicians for use in therapy
guidance. We believe our products have the potential to revolutionize the way
physicians treat many serious viral diseases.
RESULTS OF OPERATIONS
Three Months Ended March 31, 2001 and 2000
Revenue. Revenue increased to $3.1 million in the first quarter of 2001
from $0.9 million in the corresponding quarter of 2000, an increase of $2.2
million. The increase was primarily attributable to greater sales of PhenoSense
HIV. PhenoSense HIV was launched commercially in November 1999. We plan to
continue to expand our PhenoSense patient testing business as well as our
pharmaceutical business, which is comprised of resistance testing for clinical
studies, drug screening, characterization and basic research.
Cost of revenue. Cost of revenue increased to $2.3 million in the first
quarter of 2001 from $0.7 million in the corresponding quarter of 2000, an
increase of $1.6 million. The increase in cost of revenue was due to the higher
volume of testing provided in the first quarter of 2001 and continued expansion
of our clinical laboratory activities. Included in these costs are materials and
supplies, labor and overhead related to the tests. We anticipate that total cost
of revenue will increase while gross margins improve as greater sales are
achieved.
Research and development. Research and development expenses increased to
$2.7 million in the first quarter of 2001 from $2.3 million in the corresponding
quarter of 2000, an increase of $0.4 million. These expenses are primarily
related to research and development efforts relating to enhancing our PhenoSense
HIV
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test. We expect research and development spending to increase over the next
several years as we expand our research, product development and automation
efforts for other viral diseases.
General and administrative. General and administrative expenses increased
to $3.0 million in the first quarter of 2001 from $2.6 million in the
corresponding quarter of 2000, an increase of $0.3 million. The increase was
primarily due to greater spending on salaries and benefits resulting from
increased headcount and implementation of a new enterprise resource planning
system. The increase was partially offset by a reduction in noncash compensation
expenses related to granting stock and options prior to our initial public
offering.
Sales and marketing. Sales and marketing expenses increased to $2.4 million
in the first quarter of 2001 from $0.8 million in the corresponding quarter of
2000, an increase of $1.6 million. This increase was primarily due to the
deployment of our sales force and increased spending on public relations and
marketing materials related to the commercialization of PhenoSense HIV.
Interest income. Interest income increased to $355,000 in the first quarter
of 2001 from $115,000 in the corresponding quarter of 2000, an increase of
$240,000. This increase was primarily due to higher average cash balances
resulting from the Company's initial public offering in May 2000.
Interest expense. Interest expense increased to $83,000 in the first
quarter of 2001 from $57,000 in the corresponding quarter of 2000, an increase
of $26,000. This increase was due to increased equipment financing.
LIQUIDITY AND CAPITAL RESOURCES
We have financed our operations since inception primarily through public
and private sales of common and preferred stock and equipment financing
arrangements. As of March 31, 2001, ViroLogic had an accumulated deficit of
approximately $59.8 million. Management expects to continue to incur substantial
operating losses for at least the next two years primarily as a result of
expected increases in expenses for:
- Expanding patient sample processing capabilities
- Research and product development costs
- Sales and marketing
- Additional clinical laboratory and research space and other necessary
facilities
- General and administrative costs
Net cash used in operating activities was $5.9 million and $2.6 million for
the three months ended March 31, 2001 and 2000, respectively. Cash used in
operating activities primarily relates to ongoing operating losses as discussed
above.
Net cash used in investing activities was $0.6 million and $1.2 million for
the three months ended March 31, 2001 and 2000, respectively. The decrease
relates primarily to lower restricted cash requirements relating to our leased
facilities.
Net cash used in financing activities was $0.4 million for the three months
ended March 31, 2001, and net cash provided by financing activities was $15.5
million for the three months ended March 31, 2000. The higher figure for 2000 is
due primarily to the sale of Series C preferred stock for approximately $15.7
million in January and February 2000.
We believe that our available cash, investments and short-term restricted
cash of $18.0 million as of March 31, 2001, available borrowing capacity under
existing equipment financing arrangements and cash flows generated from
subletting a portion of our facilities will be adequate to fund our operations
through at least December 31, 2001. Additionally, we obtained an extension on
one of our equipment financing arrangements through September 2001, of which
$2.2 million is unused and available as of March 31, 2001. In February 2001, our
board of directors engaged UBS Warburg LLC and CIBC World Markets to assist us
in pursuing various strategic alternatives, including research and development
collaborations, international alliances, marketing partnerships, and financing
opportunities.
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To the extent operating and capital resources are insufficient to meet
future requirements, we will have to raise additional funds to continue the
development and commercialization of future technologies and our business
operations in general. These funds may not be available on favorable terms, or
at all. If adequate funds are not available on attractive terms, we may be
required to curtail operations significantly or to obtain funds by entering into
financing, supply or collaboration agreements on unattractive terms. In
addition, we may choose to raise additional capital due to market conditions or
strategic considerations even if we believe that we have sufficient funds for
current or future operating plans.
We currently lease 67,000 square feet of laboratory and office space in
South San Francisco, California. In July 2001, we will begin leasing an
additional 54,000 square feet. We have committed to pay for tenant improvements
to the new facility of at least $2 million. Initially, this facility will
provide more space than is required for our planned operations. As a result, we
intend to sublease approximately 40,000 square feet to a third party for two
years. In addition, we intend to sublease approximately 12,000 square feet of
one of our existing facilities to another third party for two years. We
anticipate that income generated from both subleases will be greater than our
lease obligations for those spaces. Leases on our current and future facilities
expire in the years 2004 and 2011, respectively. All leases provide options to
extend.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The primary objective of our investment activities is to preserve principal
while at the same time maximizing the income we receive from our investments
without significantly increasing risk. Some of the securities that we invest in
may have market risk. This means that a change in prevailing interest rates may
cause the principal amount of the investment to fluctuate. For example, if we
hold a security that was issued with a fixed interest rate at the
then-prevailing rate and the prevailing interest rate later rises, the principal
amount of our investment will probably decline. To minimize this risk in the
future, we intend to maintain our portfolio of cash equivalents and short-term
investments in a variety of securities, including commercial paper, money market
funds, government and non-government debt securities. Due to the relatively
short-term nature of our investments, we believe we have no material exposure to
interest rate risk arising from our investments. Therefore we have not included
quantitative tabular disclosure in this Form 10-Q.
We do not enter into financial investments for speculation or trading
purposes and are not a party to financial or commodity derivatives.
We have operated primarily in the United States and all sales to date have
been made in U.S. Dollars. Accordingly, we have not had any material exposure to
foreign currency rate fluctuations.
RISK FACTORS
You should carefully consider the following factors and other information
in this Form 10-Q before deciding to invest in the shares.
WE EXPECT TO INCUR FUTURE OPERATING LOSSES AND MAY NOT ACHIEVE PROFITABILITY,
WHICH MAY CAUSE OUR STOCK PRICE TO FALL.
We have experienced significant and increasing operating losses each year
since our inception and expect to incur substantial additional operating losses
for at least the next two years. We experienced net losses allocable to common
stockholders of approximately $38.9 million, $20.2 million, and $8.1 million in
2000, 1999 and 1998, respectively. As of March 31, 2001, we had an accumulated
deficit of approximately $59.8 million. We expect to continue to incur
substantial operating losses for at least the next two years primarily as a
result of expected increases in expenses for:
- Expanding patient sample processing capabilities
- Research and product development costs
- Sales and marketing
- Additional clinical laboratory and research space and other necessary
facilities
- General and administrative costs
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If our history of operating losses continues, our stock price may fall and
you may lose part or all of your investment.
IF WE NEED TO RAISE ADDITIONAL CAPITAL AND IT IS NOT AVAILABLE ON COMMERCIALLY
REASONABLE TERMS, OUR ABILITY TO OPERATE OUR BUSINESS MAY BE DIMINISHED.
We anticipate that our existing capital resources will enable us to
maintain currently planned operations through at least December 31, 2001.
Nevertheless, due to the expected nature of our operations, we will need to
secure additional financings in order to continue our business, and may need
additional financings in the shorter term. Our inability to raise capital would
seriously harm our business and product development efforts. In addition, we may
choose to raise additional capital due to market conditions or strategic
considerations even if we believe we have sufficient funds for our current or
future operating plans. To the extent that additional capital is raised through
the sale of equity or convertible debt securities, the issuance of these
securities could result in dilution to our stockholders. To the extent operating
and capital resources are insufficient to meet future requirements, we will have
to raise additional funds to continue the development and commercialization of
our technologies. These funds may not be available on favorable terms, or at
all. If adequate funds are not available on attractive terms, we may be required
to curtail operations significantly or to obtain funds by entering into
financing, supply or collaboration agreements on unattractive terms.
OUR PHENOSENSE TESTING PRODUCTS MAY NOT ACHIEVE MARKET ACCEPTANCE, WHICH COULD
LIMIT OUR FUTURE REVENUE.
Our ability to establish phenotypic resistance testing as the standard of
care to guide and improve the treatment of viral diseases will depend on
physicians' and clinicians' acceptance and use of phenotypic resistance testing.
Phenotypic resistance testing is new. We cannot predict the extent to which
physicians and clinicians will accept and use phenotypic resistance testing.
They may prefer competing technologies and products such as genotypic testing.
The commercial success of phenotypic resistance testing will require
demonstrations of its advantages and potential economic value in relation to the
current standard of care, as well as to genotypic testing. We have introduced
only one product using our proprietary PhenoSense technology, PhenoSense HIV,
which we began actively marketing in November 1999. We are still in the early
stages of development of new products applying our PhenoSense technology to
other viral diseases. If PhenoSense HIV is not accepted in the marketplace, our
ability to sell other PhenoSense products would be undermined. Market acceptance
will depend on:
- Our marketing efforts and continued ability to demonstrate the utility of
PhenoSense in guiding anti-viral drug therapy, for example, through the
results of retrospective and prospective clinical studies
- Our ability to demonstrate the advantages and potential economic value of
our PhenoSense testing products over current treatment methods and other
resistance tests.
If the market does not accept phenotypic resistance testing, or our
PhenoSense products in particular, our ability to generate revenue will be
limited.
OUR REVENUES WILL BE DIMINISHED IF PAYORS DO NOT AUTHORIZE REIMBURSEMENT FOR OUR
PRODUCTS.
Government and third-party payors, which reimburse patients and healthcare
providers for medical expenses, are attempting to contain or reduce the costs of
healthcare. This could limit the price that we can charge for our products and
hurt our ability to generate revenues. In the United States, federal and state
government healthcare programs have been attempting to reduce costs and
otherwise implement government control of healthcare costs. In addition,
increasing emphasis on managed care in the United States will continue to put
pressure on the pricing of healthcare products. Significant uncertainty exists
as to the reimbursement status of new medical products like PhenoSense HIV,
especially in light of any negative results from clinical studies. Third-party
payors, including state payors and Medicare, are challenging the prices charged
for medical products and services. If government and other third-party payors do
not provide adequate coverage and reimbursement for PhenoSense HIV or other
phenotypic testing products, our revenues will be reduced.
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IF WE ARE UNABLE TO EXPAND OUR SALES AND MARKETING CAPABILITIES, WE MAY NOT BE
ABLE TO EFFECTIVELY COMMERCIALIZE OUR PRODUCTS.
We currently have sixteen sales people and limited marketing resources. In
order to commercialize our products effectively, we must expand our sales and
marketing capabilities or arrange with a third party to perform these services,
and are taking steps in this direction. We may not be able to do this
successfully. If we enter into co-promotion or other marketing arrangements, our
share of product revenues is likely to be lower than if we directly marketed and
sold our products through our own sales force. If we fail to effectively
commercialize our products our revenue will be reduced.
WE HAVE LIMITED EXPERIENCE PROCESSING PATIENT SAMPLES FOR OUR PHENOSENSE HIV
TEST AND MAY ENCOUNTER PROBLEMS OR DELAYS IN PROCESSING TESTS, OR IN EXPANDING
OUR AUTOMATED TESTING SYSTEMS, WHICH COULD RESULT IN LOST SALES REVENUE.
Over the last year, we have begun to process a significant number of
patient samples and are continuing to develop our quality-control procedures. In
order to meet the projected demand for PhenoSense HIV and other future
phenotypic resistance testing products, we will have to process many more
patient samples than we are currently processing. We also have to establish more
consistency with respect to test turnaround so that results are delivered in a
timely manner. Thus, we need to develop and implement additional automated
systems to perform our tests. We also need to develop more sophisticated
software to support the automated tests, analyze the data generated by our
tests, and report the results. We may not be able to do this. Further, as we
attempt to scale up our processing of patient samples, processing or quality
control problems may arise. If we are unable to consistently process patient
samples on a timely basis because of these or other factors, or if we encounter
problems with our automated processes, our revenues will be limited.
WE FACE INTENSE COMPETITION, AND IF OUR COMPETITORS' EXISTING PRODUCTS OR NEW
PRODUCTS ARE MORE EFFECTIVE THAN OUR PRODUCTS, THE COMMERCIAL OPPORTUNITY FOR
OUR PRODUCTS WILL BE REDUCED OR ELIMINATED.
The commercial opportunity for our products will be reduced or eliminated
if our competitors develop and market new testing products that are superior to,
or are less expensive than, PhenoSense HIV or other phenotypic resistance
testing products we develop using our proprietary PhenoSense technology. The
biotechnology industry evolves at a rapid pace and is highly competitive. Our
major competitors include manufacturers and distributors of phenotypic drug
resistance technology, such as Virco. We also compete with makers of genotypic
tests such as Applied Biosystems, Visible Genetics Inc. and laboratories
performing genotypic testing as well as other genotypic testing referred to as
virtual phenotyping. Each of these competitors is attempting to establish its
test as the standard of care. Virco's phenotypic test and genotypic tests have
been commercially available for a longer time than has PhenoSense HIV. Genotypic
tests are cheaper and generally faster than our phenotypic resistance tests. Our
competitors may successfully develop and market other testing products that are
either superior to those that we may develop or that are marketed prior to
marketing of our testing products. Some of our competitors have substantially
greater financial resources and research and development staffs than we do. In
addition, some of our competitors have significantly greater experience in
developing products, and in obtaining the necessary regulatory approvals of
products and processing and marketing products.
IF WE DO NOT SUCCESSFULLY INTRODUCE NEW PRODUCTS USING OUR PHENOSENSE
TECHNOLOGY, WE MAY NOT ACHIEVE PROFITABILITY.
We may not be able to develop and market phenotypic resistance testing
products for viral diseases other than HIV, including hepatitis B and hepatitis
C. Demand for these products will depend in part on the development by others of
additional anti-viral drugs to fight these diseases. Physicians will likely use
our resistance tests to determine which drug is best for a particular patient
only if there are multiple drug treatment options. Several anti-viral drugs are
in development but we cannot assure you that they will be approved for
marketing, or if these drugs are approved that there will be a need for our
resistance tests. If we are unable to develop and market phenotypic resistance
test products for other viral diseases, or if an insufficient number of
anti-viral drug products are approved for marketing, we may not achieve
profitability.
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SOME OF OUR VENDORS ARE OUR SOLE SOURCE OF SUPPLY FOR CERTAIN OF OUR TESTING
MATERIALS, AND THERE ARE LIMITED SOURCES AND SUPPLIES OF SOME OF THESE
MATERIALS, WHICH COULD RESULT IN OUR INABILITY TO SECURE SUFFICIENT MATERIALS TO
CONDUCT OUR BUSINESS.
We rely on a few vendors as our sole source of supply for various materials
in our testing process. In some cases, there are no other available sources of
materials that we require for our tests. In other instances, there are limited
sources and limited supplies of necessary materials. Any extended interruption,
delay or decreased availability of the supply of these materials could result in
our failure to meet our customers' demands, and prevent us from running our
business as contemplated. We might also face significant additional expenditures
if we are forced to find alternate sources of supplies, or change materials we
use. If significant customer relationships were harmed by our failing to report
test results on a timely basis, or another negative impact on our ability to
procure necessary materials, then our operations and revenues could be adversely
affected. Similarly, if our expenses were to increase dramatically as a result
of changes to our relationships with vendors or ability to procure materials, it
would make it more difficult for us to attain profitability, offer our tests at
competitive prices, and continue our business as currently conducted or at all.
WE ARE DEPENDENT ON A LICENSE FOR TECHNOLOGY WE USE IN OUR PHENOSENSE TESTING,
AND OUR BUSINESS WOULD SUFFER IF THE LICENSE WAS TERMINATED OR NOT RENEWED.
We license technology that we use in our PhenoSense testing from Roche
Molecular Systems, Inc. We hold a non-exclusive license for the life of the
patent term of the last licensed Roche patent. We believe that many of our
competitors, including Virco and other resistance testing companies, also
license this technology on non-exclusive terms. In order to maintain this
license, however, we must pay royalties, make a semi-annual royalty report and
participate in proficiency testing. If Roche were to terminate this license or
this license was not renewed, we would have to change a portion of our testing
methodology, which would halt our testing, at least temporarily, and cause us to
incur substantial additional expenses.
THE INTELLECTUAL PROPERTY UNDERLYING OUR PHENOSENSE TECHNOLOGY AND TRADE SECRETS
MAY NOT BE ADEQUATE, ALLOWING THIRD PARTIES TO USE OUR PHENOSENSE TECHNOLOGY OR
SIMILAR TECHNOLOGIES, AND THUS REDUCING OUR ABILITY TO COMPETE IN THE MARKET.
The strength of our intellectual property protection is uncertain. In
particular, we cannot be sure that we were the first to invent the technologies
covered by our patent or pending patent applications; we were the first to file
patent applications for these inventions; others will not independently develop
similar or alternative technologies or duplicate any of our technologies; any of
our pending patent applications will result in issued patents; any patents
issued to us will provide a basis for commercially viable products or will
provide us with any competitive advantages or will not be challenged by third
parties. Other companies may have patents or patent applications relating to
products or processes similar to, competitive with or otherwise related to our
products. Patent law relating to the scope of claims in the technology fields in
which we operate, including biotechnology and information technology, is still
evolving and, consequently, patent positions in our industry are generally
uncertain. We cannot assure you that we will prevail in any of these lawsuits or
that, if successful, we will be awarded commercially valuable remedies. In
addition, it is possible that we will not have the required resources to pursue
such litigation or to otherwise protect our patent rights. We also rely on
unpatented trade secrets to protect our proprietary technology. Other companies
may independently develop or otherwise acquire equivalent technology or gain
access to our proprietary technology.
OUR PRODUCTS COULD INFRINGE ON THE INTELLECTUAL PROPERTY RIGHTS OF OTHERS, WHICH
MAY CAUSE US TO ENGAGE IN COSTLY LITIGATION AND, IF WE ARE NOT SUCCESSFUL, COULD
CAUSE US TO PAY SUBSTANTIAL DAMAGES AND PROHIBIT US FROM SELLING OUR PRODUCTS.
Third parties may assert infringement or other intellectual property claims
against us based on their patents or other intellectual property claims. We may
have to pay substantial damages, possibly including treble damages, for past
infringement if it is ultimately determined that our products infringe a third
party's patents. Further, we may be prohibited from selling our products before
we obtain a license, which, if available at all, may require us to pay
substantial royalties. Even if infringement claims against us are without merit,
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defending a lawsuit takes significant time, may be expensive and may divert
management attention from other business concerns.
WE MAY BE UNABLE TO BUILD BRAND LOYALTY BECAUSE OUR TRADEMARKS AND TRADE NAMES
MAY NOT BE PROTECTED.
Our registered or unregistered trademarks or trade names such as the name
PhenoSense, may be challenged, canceled, infringed, circumvented or declared
generic or determined to be infringing on other marks. We may not be able to
protect our rights to these trademarks and trade names, which we need to build
brand loyalty. Brand recognition is critical to our short term and long term
marketing strategies especially as we commercialize future enhancements to our
products.
OUR BUSINESS OPERATIONS AND THE OPERATION OF OUR CLINICAL LABORATORY FACILITY
ARE SUBJECT TO STRINGENT REGULATIONS AND IF WE ARE UNABLE TO COMPLY WITH THEM,
WE MAY BE PROHIBITED FROM ACCEPTING PATIENT SAMPLES OR MAY INCUR ADDITIONAL
EXPENSES TO ATTAIN AND MAINTAIN COMPLIANCE.
The operation of our clinical laboratory facility is subject to a stringent
level of regulation under the Clinical Laboratory Improvement Amendments of
1988. Laboratories must meet various requirements, including requirements
relating to quality assurance, quality control and personnel standards. Our
laboratory is also subject to regulation by the State of California and various
other states. We have received accreditation by the College of American
Pathologists and therefore are subject to their requirements and evaluation. Our
failure to comply with applicable requirements could result in various
penalties, including loss of certification or accreditation. We believe that the
FDA will not seek to fully regulate our PhenoSense products under our current
labeling and marketing plans. However, we cannot predict the extent of future
FDA regulation, and we might be subject in the future to greater regulation, or
different regulations, that could have a material effect on our finances and
operations. We also believe that the FDA will not require that phenotypic
testing conducted at a clinical laboratory be subject to premarketing clearance.
Although the FDA has stated in the past that it believes that its jurisdiction
extends to tests generated in a clinical laboratory, the agency has said it will
allow the home brewed tests to be run and the results commercialized without FDA
premarket approval. We cannot be sure, however, that the FDA will not in the
future require premarket clearance, and clinical data demonstrating the
sensitivity and specificity, of our PhenoSense products. If we do not comply
with existing or additional regulations, or if we incur penalties, it could
increase our expenses, prevent us from increasing revenues, or hinder our
ability to conduct our business. In addition, changes in existing regulations or
new regulations may delay or prevent us from marketing our products.
OUR INFORMATION AND OTHER INTERNAL SYSTEMS MAY NOT WORK EFFECTIVELY AND AS A
RESULT WE MAY NOT BE ABLE TO PROCESS ORDERS, RECORD TRANSACTIONS AND MEET OUR
REPORTING OBLIGATIONS, WHICH IN TURN COULD AFFECT OUR ABILITY TO RUN OUR
BUSINESS EFFICIENTLY OR PROFITABLY.
In 2000, we installed several new information systems, including enterprise
resource and laboratory information systems. If our new information and internal
systems do not work effectively, we may experience delays or failures in our
operations. These delays or failures could adversely impact the promptness and
accuracy of our transaction processing, financial accounting and reporting and
our ability to properly forecast earnings and cash requirements. Our current and
planned systems, transaction processing, procedures and controls may not be
adequate to support future operations. To manage the expected growth of our
operations and personnel, we will need to continue to improve our operational
and financial systems, transaction processing, procedures and controls.
CLINICIANS OR PATIENTS USING OUR PRODUCTS OR SERVICES MAY SUE US AND OUR
INSURANCE MAY NOT SUFFICIENTLY COVER ALL CLAIMS BROUGHT AGAINST US WHICH WILL
INCREASE OUR EXPENSES.
Clinicians, patients and others may at times seek damages from us if drugs
are incorrectly prescribed for a patient based on testing errors or similar
claims. Although we have obtained liability insurance coverage, we cannot
guarantee that liability insurance will continue to be available to us on
acceptable terms or that our coverage will be sufficient to protect us against
all claims that may be brought against us. We may incur
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significant legal defense expenses in connection with a liability claim, even
one without merit or for which we have coverage.
OUR LACK OF OPERATING EXPERIENCE MAY CAUSE US DIFFICULTY IN MANAGING OUR GROWTH
AND ATTRACTING AND RETAINING SKILLED PERSONNEL, WHICH COULD HINDER OUR
COMMERCIAL EFFORTS AND IMPAIR OUR ABILITY TO COMPETE.
We have limited experience selling our products and processing patient
samples. If our management is unable to manage our growth effectively, it is
possible that our systems and our facilities may become inadequate. Our success
also depends on our continued ability to attract and retain highly qualified
management and scientific personnel. Competition for personnel is intense. We
believe stock options are a critical component of motivating and retaining our
key employees. As we mature as a public company, stock options may be less
attractive to potential candidates for our management and scientific positions,
and, therefore, it may be more difficult to fill those positions. If we cannot
successfully attract and retain qualified personnel, our research and
development efforts could be hindered and our ability to run our business
effectively and compete with others in our industry will be harmed.
WE MAY BE SUBJECT TO LITIGATION, WHICH WOULD BE TIME CONSUMING AND DIVERT OUR
RESOURCES AND THE ATTENTION OF OUR MANAGEMENT.
We were involved in a dispute with a significant stockholder and former
officer. We settled the dispute in November 1999. In connection with the
settlement, we purchased shares of our common stock held by him for $225,000 in
cash, and allowed him to retain other shares that we had a right to repurchase.
In 1999, we recorded $1.9 million in legal fees and costs related to this
settlement, including a non-cash charge related to the common stock retained by
him. In the future, our stockholders or former employees may bring further
claims and we may have to spend significant additional resources and time. Even
if we are eventually successful in our defense of any such claim, the time and
money spent may prevent us from operating our business effectively or profitably
or may distract our management.
OUR OPERATING RESULTS MAY FLUCTUATE FROM QUARTER TO QUARTER, MAKING IT LIKELY
THAT, IN SOME FUTURE QUARTER OR QUARTERS, WE WILL FAIL TO MEET ANALYSTS'
ESTIMATES OF OPERATING RESULTS OR FINANCIAL PERFORMANCE, CAUSING OUR STOCK PRICE
TO FALL.
If revenue declines in a quarter, our losses will likely increase or our
earnings will likely decline because many of our expenses are relatively fixed.
Though our revenues may fluctuate significantly as we continue to build the
market for our products, expenses such as research and development, sales and
marketing and general and administrative are not affected directly by variations
in revenue. In addition, our cost of revenue could also fluctuate significantly
due to variations in the demand for our product and the relatively fixed costs
to produce it. We cannot accurately predict how volatile our future operating
results will be because our past and present operating results, which reflect
moderate sales activity, are not indicative of what we might expect in the
future. It is likely that in some future quarter or quarters, our operating
results will be below the expectations of securities analysts or investors, as
they have been in the past. In this event, the market price of our common stock
may fall abruptly and significantly. Because our revenue and operating results
are difficult to predict, we believe that period-to-period comparisons of our
results of operations are not a good indication of our future performance.
IF A NATURAL DISASTER STRIKES OUR CLINICAL LABORATORY FACILITY, WE WOULD BE
UNABLE TO PROCESS OUR CUSTOMERS' SAMPLES FOR A SUBSTANTIAL AMOUNT OF TIME AND WE
WOULD LOSE REVENUE.
We rely on a single clinical laboratory facility to process patient samples
for our PhenoSense HIV test and have no alternative facilities. We will also use
this facility for conducting other tests we develop, and even if we move into
different or additional facilities they will likely be in close proximity to our
current clinical laboratory. Our clinical laboratory and some pieces of
processing equipment are difficult to replace and could require substantial
replacement lead-time. Our processing facility may be affected by natural
disasters such as earthquakes and floods. Earthquakes are of particular
significance since our clinical laboratory is located in South San Francisco,
California, an earthquake-prone area. In the event our existing clinical
laboratory
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facility or equipment is affected by man-made or natural disasters, we would be
unable to process patient samples and meet customer demands or sales
projections. If our patient sample processing operations were curtailed or
ceased, we would not be able to perform our tests and we would lose revenue.
CONCENTRATION OF OWNERSHIP AMONG OUR EXECUTIVE OFFICERS, DIRECTORS AND PRINCIPAL
STOCKHOLDERS MAY PREVENT INVESTORS FROM INFLUENCING SIGNIFICANT CORPORATE
DECISIONS.
At March 20, 2001, our directors, entities affiliated with our directors
and our executive officers own, in the aggregate, approximately 21% of our
outstanding common stock. These stockholders, as a group, are able to
substantially influence our management and affairs. If acting together, they
would be able to influence most matters requiring the approval by our
stockholders, including the election of directors, any merger, consolidation or
sale of all or substantially all of our assets and any other significant
corporate transaction. The concentration of ownership may also delay or prevent
a change in our control at a premium price if these stockholders oppose it.
OUR STOCK PRICE MAY BE VOLATILE, AND OUR STOCK COULD DECLINE IN VALUE.
The market prices for securities of biotechnology companies in general have
been highly volatile and may continue to be highly volatile in the future. Our
stock price has fluctuated widely since we became a publicly traded company. The
following factors, in addition to other risk factors described in this section,
may have a significant adverse impact on the market price of our common stock:
- Announcements of technological innovations or new commercial products by
our competitors
- Results from clinical studies
- Developments concerning proprietary rights, including patents
- Publicity regarding actual or potential medical results relating to
products under development by our competitors
- Regulatory developments in the United States and foreign countries
- Changes in payor reimbursement policies
- Litigation
- Economic and other external factors or other disaster or crisis
- Period-to-period fluctuations in financial results
IF OUR STOCKHOLDERS SELL SUBSTANTIAL AMOUNTS OF OUR COMMON STOCK, THE MARKET
PRICE OF OUR COMMON STOCK MAY FALL.
If our stockholders sell substantial amounts of our common stock, including
shares issued upon the exercise of outstanding options and warrants, the market
price of our common stock may fall. These sales also might make it more
difficult for us to sell equity or equity-related securities in the future at a
time and price that we deem appropriate. Sales of a substantial number of shares
could occur at any time. This may have an adverse effect on the price of our
common stock and may impair our ability to raise capital in the future.
PROVISIONS OF OUR CHARTER DOCUMENTS AND DELAWARE LAW MAY INHIBIT A TAKEOVER,
WHICH COULD LIMIT THE PRICE INVESTORS MIGHT BE WILLING TO PAY IN THE FUTURE FOR
OUR COMMON STOCK.
Provisions in our certificate of incorporation and bylaws may have the
effect of delaying or preventing an acquisition, or merger in which we are not
the surviving company or changes in our management. In addition, because we are
incorporated in Delaware, we are governed by the provisions of Section 203 of
the Delaware General Corporation Law. These provisions could discourage
acquisitions or other changes in our control and otherwise limit the price that
investors might be willing to pay in the future for our common stock.
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PART II
ITEM 1. LEGAL PROCEEDINGS
None.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
(a) None.
(b) None.
(c) None.
(d) USE OF PROCEEDS
The effective date of our registration statement on Form S-1 (No.
333-30896) relating to our initial public offering was May 1, 2000. The initial
public offering resulted in gross proceeds of approximately $35.0 million, of
which $2.5 million was applied toward the underwriting discount. Expenses
related to the offering totaled approximately $1.3 million. From the time of the
receipt through March 31, 2001, we used approximately $12 million of the net
proceeds for operating activities. The remaining net proceeds of $19 million are
invested in interest-bearing cash accounts or short-term investments with strong
credit ratings. For further information about the Company's investment policy,
refer to the notes included in the Company's Annual Report on Form 10-K for the
year ended December 31, 2000.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS
None.
ITEM 5. OTHER INFORMATION
On April 25, 2001 we announced the appointment of Kathy L. Hibbs as Vice
President, General Counsel. In connection with Ms. Hibbs' employment, she
entered into an Executive Severance Agreement on May 8, 2001.
On May 8, 2001 we announced the appointment of Edmon R. Jennings to the
Board of Directors.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
EXHIBIT
NUMBER CAPTION
- ------- -------
3.1 Bylaws as currently in effect.
10.1 Equipment Financing Agreement by and between ViroLogic and
De Lage Landen Financial Services, Inc. dated as of January
29, 2001.
(b) Reports on Form 8-K
There were no reports on Form 8-K filed during the quarter ended March 31,
2001.
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SIGNATURES
Pursuant to the requirements of the Securities Act of 1934, as amended, the
registrant has duly caused this Quarterly Report on Form 10-Q to be signed on
its behalf by the undersigned, thereunto duly authorized, in the City of South
San Francisco, County of San Mateo, State of California, on May 14, 2001.
By: /s/ WILLIAM D. YOUNG
------------------------------------
William D. Young
Chief Executive Officer
(Principal Executive Officer)
By: /s/ KAREN J. WILSON
------------------------------------
Karen J. Wilson
Vice President and Chief Financial
Officer
(Principal Financial and Accounting
Officer)
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EXHIBITS INDEX
EXHIBIT
NUMBER CAPTION
- ------- -------
3.1 Bylaws as currently in effect.
10.1 Equipment Financing Agreement by and between ViroLogic and
De Lage Landen Financial Services, Inc. dated as of January
29, 2001.