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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 SEPTEMBER 30, 2006
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD ________ TO ________.
COMMISSION FILE NUMBER: 000-31745
THIRD WAVE TECHNOLOGIES, INC.
(Exact name of Registrant as specified in its charter)
DELAWARE 39-1791034
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
502 S. ROSA ROAD, MADISON, WI 53719
(Address of principal executive offices) (Zip Code)
(888) 898-2357
(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 [ ]
Indicate by check whether the Registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of Exchange Act. (Check one):
Large Accelerated Filer [ ] Accelerated Filer [X] Non-Accelerated Filer [ ]
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act). [ ] Yes [X] No
The number of shares outstanding of the registrant's Common Stock, $.001 par
value, as of November 6, 2006, was 41,978,466.
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THIRD WAVE TECHNOLOGIES, INC.
QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTER ENDED SEPTEMBER 30, 2006
TABLE OF CONTENTS
PAGE NO.
--------
PART I FINANCIAL INFORMATION.........................................
Item 1. Consolidated Financial Statements.........................
Consolidated Balance Sheets (Unaudited) as of September 30,
2006 and December 31, 2005..................................
Consolidated Statements of Operations (Unaudited) for the
Three and Nine Months Ended September 30, 2006 and 2005.....
Consolidated Statements of Cash Flows (Unaudited) for the
Nine Months Ended September 30, 2006 and 2005...............
Notes to Consolidated Financial Statements (Unaudited).........
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations....................
Item 3. Quantitative and Qualitative Disclosures About
Market Risk............................................
Item 4. Controls and Procedures...................................
PART II OTHER INFORMATION............................................
Item 1. Legal Proceedings.........................................
Item 2. Unregistered Sales of Equity Securities and Use of
Proceeds...............................................
Item 3. Defaults Upon Senior Securities...........................
Item 4. Submission Of Matters To A Vote Of Security Holders.......
Item 5. Other Information.........................................
Item 6. Exhibits..................................................
SIGNATURES...........................................................
EXHIBITS.............................................................
2
PART I - FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
THIRD WAVE TECHNOLOGIES, INC.
Consolidated Balance Sheets
(UNAUDITED)
SEPTEMBER 30, 2006 DECEMBER 31, 2005
------------------ -----------------
ASSETS
Current assets:
Cash and cash equivalents $ 31,226,265 $ 27,681,704
Short-term investments 1,770,000 11,035,000
Accounts receivable, net of allowance for doubtful
accounts of $200,000 at September 30, 2006 and
December 31, 2005, respectively 4,148,889 3,764,519
Inventories 3,419,297 2,248,183
Prepaid expenses and other 714,750 235,794
------------- -------------
Total current assets 41,279,201 44,965,200
Equipment and leasehold improvements:
Machinery and equipment 16,062,324 15,563,119
Leasehold improvements 2,362,831 2,346,938
------------- -------------
18,425,155 17,910,057
Less accumulated depreciation and amortization 14,337,214 13,192,617
------------- -------------
4,087,941 4,717,440
------------- -------------
Restricted cash -- 805,184
Intangible assets, net of accumulated amortization 1,513,056 2,641,620
Indefinite-lived intangible assets 1,007,411 1,007,411
Goodwill 489,873 489,873
Capitalized license fees 2,929,386 2,797,046
Other assets 967,144 980,954
------------- -------------
Total assets $ 52,274,012 $ 58,404,728
============= =============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 6,291,211 $ 6,850,207
Accrued payroll and related liabilities 3,474,830 2,158,870
Other accrued liabilities 2,345,387 2,344,835
Deferred revenue 114,051 121,497
Capital lease obligations due within one year 132,468 114,693
Long-term debt due within one year 381,279 378,551
------------- -------------
Total current liabilities 12,739,226 11,968,653
Long-term debt 354,766 639,564
Deferred revenue - long-term 63,593 145,382
Capital lease obligations - long-term 126,106 191,924
Other liabilities 4,900,640 5,384,904
Minority interest in subsidiary 597,728 --
Shareholders' equity:
Participating preferred stock, Series A, $.001 par value,
10,000,000 shares authorized, no shares issued and outstanding -- --
Common stock, $.001 par value, 100,000,000 shares authorized,
41,801,305 shares issued, 41,583,305 shares outstanding at
September 30, 2006 and 41,461,377 shares issued, 41,243,377
shares outstanding at December 31, 2005 41,801 41,461
Additional paid-in capital 206,821,976 199,097,187
Unearned stock compensation -- (114,892)
Treasury stock - 218,000 shares acquired at an average price
of $4.02 per share (877,159) (877,159)
Foreign currency translation adjustment (112,032) 47,442
Accumulated deficit (172,382,633) (158,119,738)
------------- -------------
Total shareholders' equity 33,491,953 40,074,301
------------- -------------
Total liabilities and shareholders' equity $ 52,274,012 $ 58,404,728
============= =============
See accompanying notes to consolidated financial statements.
3
THIRD WAVE TECHNOLOGIES, INC.
Consolidated Statements of Operations
(Unaudited)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------- ---------------------------
2006 2005 2006 2005
----------- ----------- ------------ ------------
Revenues:
Clinical product sales $ 5,368,470 $ 4,031,766 $ 15,136,818 $ 11,407,180
Research product sales 1,181,226 1,039,569 5,809,175 6,152,540
License and royalty revenue 51,827 89,763 106,353 272,609
Grant revenue -- 61,293 182,876 287,819
----------- ----------- ------------ ------------
Total revenues 6,601,523 5,222,391 21,235,222 18,120,148
----------- ----------- ------------ ------------
Operating expenses:
Cost of goods sold
Product cost of goods sold 1,549,928 1,108,385 4,229,464 3,960,294
Intangible and long-term asset amortization 687,178 468,035 2,068,563 1,427,625
----------- ----------- ------------ ------------
2,237,106 1,576,420 6,298,027 5,387,919
Research and development 3,451,043 2,063,762 8,785,640 6,569,300
Selling and marketing 2,713,646 3,662,014 8,634,435 10,208,077
General and administrative 3,536,620 2,922,659 11,482,926 8,490,318
Litigation 255,809 2,677,982 1,438,671 5,157,282
Impairment of equipment -- -- -- 202,707
Restructuring (180,000) -- (180,000) --
----------- ----------- ------------ ------------
Total operating expense 12,014,224 12,902,837 36,459,699 36,015,603
----------- ----------- ------------ ------------
Loss from operations (5,412,701) (7,680,446) (15,224,477) (17,895,455)
Other income (expense):
Interest income 368,727 459,704 1,115,637 1,200,042
Interest expense (55,251) (128,516) (161,433) (313,278)
Other (118,845) (30,685) (98,949) (305,721)
----------- ----------- ------------ ------------
Total other income (expense) 194,631 300,503 855,255 581,043
----------- ----------- ------------ ------------
Net loss before minority interest $(5,218,070) $(7,379,943) $(14,369,222) $(17,314,412)
----------- ----------- ------------ ------------
Minority interest $ 65,481 $ -- $ 106,327 $ --
----------- ----------- ------------ ------------
Net loss $(5,152,589) $(7,379,943) $(14,262,895) $(17,314,412)
=========== =========== ============ ============
Net loss per share - basic and diluted $ (0.12) $ (0.18) $ (0.34) $ (0.42)
Weighted average shares outstanding
Basic and diluted 41,515,143 41,073,652 41,427,973 41,094,740
See accompanying notes to consolidated financial statements.
4
THIRD WAVE TECHNOLOGIES, INC.
Consolidated Statements of Cash Flows
(Unaudited)
NINE MONTHS ENDED
SEPTEMBER 30,
---------------------------
2006 2005
------------ ------------
OPERATING ACTIVITIES:
Net loss $(14,262,895) $(17,314,412)
Adjustments to reconcile net loss to net cash
used in operating activities:
Minority Interest in net loss of subsidiary (106,327) --
Depreciation and amortization 1,230,262 1,297,395
Amortization of intangible assets 1,128,564 1,128,564
Amortization of licensed technology 939,998 299,602
Noncash stock compensation 2,720,817 (354,827)
Impairment charge and (gain) loss on disposal of equipment 28,564 208,731
Changes in operating assets and liabilities:
Accounts Receivable (625,604) 2,084,109
Inventories (1,171,114) (997,692)
Prepaid expenses and other assets (333,386) (266,647)
Accounts payable (1,118,105) (349,913)
Accrued expenses and other liabilities 971,293 1,542,341
Deferred revenue (89,235) 1,950
------------ ------------
Net cash used in operating activities (10,687,168) (12,720,799)
INVESTING ACTIVITIES:
Purchases of equipment and leasehold improvements (570,668) (307,185)
Proceeds on sale of equipment -- 197,287
Purchases of licensed technology (702,274) --
Maturity of short-term investments 11,035,000 11,070,000
Purchases of short-term investments (1,770,000) (11,835,000)
Change in restricted cash balance 805,184 --
------------ ------------
Net cash provided by (used in) investing activities 8,797,242 (874,898)
FINANCING ACTIVITIES:
Proceeds from long-term debt -- 800,000
Payments on long-term debt (282,070) (126,040)
Payments on capital lease obligations (106,702) (70,591)
Proceeds from issuance of common stock, net 729,286 680,674
Proceeds from minority investment in subsidiary 5,093,973 --
Repurchase of common stock for treasury -- (877,159)
------------ ------------
Net cash provided by financing activities 5,434,487 406,884
------------ ------------
Net increase (decrease) in cash and cash equivalents 3,544,561 (13,188,813)
------------ ------------
Cash and cash equivalents at beginning of period 27,681,704 55,619,981
------------ ------------
Cash and cash equivalents at end of period $ 31,226,265 $ 42,431,168
============ ============
Noncash investing and financing activities:
During the nine months ended September 30, 2006 and 2005, the Company entered
into capital lease obligations of $58,659 and $165,217, respectively.
During the nine months ended September 30, 2006 the Company entered into a
license agreement under which the Company will pay 1,000,000 Euros over two
years. The estimated present value of the license is $1,122,338.
See accompanying notes to consolidated financial statements.
5
THIRD WAVE TECHNOLOGIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2006
(Unaudited)
(1) Basis of Presentation
The accompanying unaudited consolidated financial statements of Third Wave
Technologies, Inc. have been prepared in accordance with accounting principles
generally accepted in the United States 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 accounting principles generally accepted in the United States for complete
financial statements. In the opinion of management, all adjustments, consisting
of normal recurring adjustments, considered necessary for a fair presentation
have been included. Interim results are not necessarily indicative of results
that may be expected for the year ending December 31, 2006.
The balance sheet at December 31, 2005 has been derived from the audited
financial statements at 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.
The accompanying unaudited consolidated financial statements should be read in
conjunction with the audited financial statements and footnotes thereto included
in our Form 10-K for the fiscal year ended December 31, 2005 filed with the
Securities and Exchange Commission.
(2) Net Loss Per Share
In accordance with accounting principles generally accepted in the United
States, basic net loss per share has been computed using the weighted-average
number of shares of common stock outstanding during the respective periods.
Diluted net loss per share takes into account the weighted average shares from
options that could potentially dilute basic net income per share in the future.
Shares associated with stock options are excluded for the three and nine months
ended September 30, 2006 and 2005 because they are anti-dilutive.
The following table presents the calculation of basic and diluted net loss per
share:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30 SEPTEMBER 30
------------------------- ---------------------------
2006 2005 2006 2005
----------- ----------- ------------ ------------
Numerator:
Net loss $(5,152,589) $(7,379,943) $(14,262,895) $(17,314,412)
=========== =========== ============ ============
Denominator
Weighted average shares outstanding - basic 41,515,143 41,073,652 41,427,973 41,094,740
Dilutive securities - stock options N/A N/A N/A N/A
----------- ----------- ------------ ------------
Weighted average shares outstanding - diluted 41,515,143 41,073,652 41,427,973 41,094,740
Basic net loss per share $ (0.12) $ (0.18) $ (0.34) $ (0.42)
Dilutive net loss per share $ (0.12) $ (0.18) $ (0.34) $ (0.42)
(3) Stock-Based Compensation
The Company has Incentive Stock Option Plans for its employees and Nonqualified
Stock Option Plans (collectively, the Plans) for employees and non-employees
under which an aggregate of 13,213,183 stock options may be granted. Options
under the Plans have a maximum life of ten years. Options vest at various
intervals, as determined by the Board of Directors at the date of grant. At
September 30, 2006, approximately 2.4 million shares were available for future
grant under the plans.
Stock Options
The following table summarizes the stock option activity under the Plans for the
nine months ended September 30, 2006:
6
WEIGHTED
AVERAGE AGGREGATE
NUMBER OF WEIGHTED AVERAGE CONTRACTUAL INTRINSIC
SHARES EXERCISE PRICE LIFE VALUE
---------- ---------------- ----------- ---------
Outstanding at December 31,2005 9,101,298 $4.34
Granted 909,250 2.99
Exercised (272,661) 2.05
Forfeited (1,489,072) 4.96
---------- -----
Outstanding at September 30, 2006 8,248,815 $4.15 6.3 8,019,029
Options exercisable at September 30, 2006 5,688,164 $4.49 5.6 5,191,384
The weighted-average fair value of stock options granted in the nine months
ended September 30, 2006 and 2005 was $1.90 and $3.05, respectively, using the
Black-Scholes option-pricing model. The calculations were made assuming a
dividend yield of 0%, a weighted-average expected option life of five years and
a weighted-average risk-free interest rate of 4.83%, and 4.28% in 2006 and 2005,
respectively. The volatility factor used in the Black-Scholes model for 2006 and
2005 was 74% and 81%, respectively. The expected life of stock options is
estimated based on historical experience. The expected volatility is estimated
based on historical financial data for the Company. The interest rates were
based on the U.S. Treasury constant maturity interest rate whose term is
consistent with the expected life of the stock options. As of September 30,
2006, there was approximately $4.5 million of total unrecognized compensation
cost related to the stock options granted under the plans. The intrinsic value
of the shares exercised in the nine months ended September 30, 2006 and 2005 was
$0.4 million and $0.6 million, respectively.
Restricted Stock Units
The Company's stock plan also permits the granting of restricted stock units to
eligible employees and non-employee directors. Restricted stock units are
payable in shares of Company stock upon vesting. The restricted stock units vest
at various intervals as determined by the Board of Directors at the date of
grant. The following table presents a summary of the Company's nonvested
restricted stock units granted to employees as of September 30, 2006.
NINE MONTHS ENDED
SEPTEMBER 30, 2006
----------------------------
NUMBER OF WEIGHTED AVERAGE
SHARES FAIR VALUE
--------- ----------------
Nonvested shares of restricted stock units
at December 31, 2005 -- $ --
Granted 112,530 2.84
Vested -- --
Forfeited (3,451) 2.84
------- -----
Nonvested shares of restricted stock units
at September 30, 2006 109,079 $2.84
======= =====
As of September 30, 2006, there was approximately $0.3 million of total
unrecognized compensation cost related to the nonvested restricted stock units
granted under the plan. The expense is expected to be recognized over the
vesting period. Compensation expense related to restricted stock units was
approximately $28,000 in the nine months ended September 30, 2006. As of
September 30, 2006, there were 109,079 restricted stock units outstanding.
Employee Stock Purchase Plan
The Company also has an Employee Stock Purchase Plan (Purchase Plan) under which
an aggregate of 1,256,800 common shares may be issued. All employees are
eligible to participate in the Purchase Plan. Eligible employees may make
contributions through payroll deductions of up to 10% of their compensation. The
price of common stock purchased under the Purchase Plan is 85% of the lower of
the fair market value of the common stock at the beginning or end of the
offering period. There were 67,267 and 57,428 shares sold to employees in the
nine months ended September 30, 2006, and 2005, respectively. At September 30,
2006, approximately 364,000 shares were available for issuance under the
Purchase Plan.
Review of Stock Option Grants and Procedures
In October 2006, the Company's audit committee concluded a voluntary
investigation of the Company's historical stock option granting practices and
related accounting. This investigation, which was conducted with the assistance
of outside legal counsel, covered the timing, pricing and authorization of all
the Company's stock option grants made since the Company's initial public
offering in February 2001. Based on this review, the Company determined that it
used incorrect measurement dates with respect to the accounting for certain
previously granted stock options, primarily during the years 2002 through 2004.
The audit committee concluded that deficiencies in the grant process were the
result of administrative errors and misunderstanding of applicable accounting
rules, and were not attributable to fraud or intentional misconduct.
7
Based upon the Company's determination that certain of its historic stock option
grants had intrinsic value on the grant date, the Company had unrecorded
non-cash stock compensation expense. The Company has concluded that the
additional unrecorded non-cash stock compensation expense is not material to its
financial statements in any of the periods to which such charges would have
related, and therefore will not revise its historic financial statements.
The Company recorded an additional non-cash stock-based compensation charge
totaling $176,000 in the quarter ended September 30, 2006, representing the
effect of the adjustment resulting from the non-cash charges discussed above
that relate to 2006. Additionally, the Company expects to record a
reclassification between accumulated deficit and additional paid in capital,
within the equity section of the consolidated balance sheet to be included in
its Form 10-K for the fiscal year ending December 31, 2006, of approximately
$731,000. This reclassification represents the effect of the adjustment
resulting from the non-cash charges discussed above that related to fiscal 2005
and prior years. Neither the current period charge nor the reclassification
affect the Company's cash position. There were no significant income tax effects
relating to this adjustment for the Company.
Prior to January 1, 2006, we used the intrinsic value method prescribed in
Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees", and related interpretations, in accounting for stock options granted
under our Plans. Generally, no compensation cost was required to be recognized
for options granted to employees because the options had an exercise price equal
to the market value per share of the underlying common stock on the date of
grant. Prior to 2006, the Purchase Plan was considered noncompensatory under APB
Opinion No. 25 and, therefore, no expense was recorded for the 15% discount.
Prior to January 1, 2006, options granted to non-employee consultants were
accounted for in accordance with SFAS No. 123 and Emerging Issues Task Force
(EITF) Issue No. 96-18, "Accounting for Equity Instruments That Are Issued to
Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or
Services," and therefore were measured based upon their fair value as calculated
using the Black-Scholes option pricing model. The fair value of options granted
to non-employees was periodically remeasured as the underlying options vested.
On January 1, 2006, the Company adopted SFAS No. 123 (revised 2004),
"Share-Based Payment", which is a revision of SFAS No. 123. SFAS No. 123(R)
permits public companies to adopt its requirements using one of two methods: (1)
a "modified prospective" method in which compensation cost is recognized
beginning with the effective date (a) based on the requirements of SFAS No.
123(R) for all-share based payments granted after the effective date and (b)
based on the requirements of SFAS No. 123 for all awards granted to employees
prior to the effective date of SFAS No. 123(R) that remain unvested on the
effective date; or (2) a "modified retrospective" method which includes the
requirements of the modified prospective method described above, but also
permits entities to restate based on the amounts previously recognized under
SFAS No. 123 for purposes of pro forma disclosures either (a) all prior periods
presented or (b) prior interim periods of the year of adoption. The Company has
adopted the modified prospective approach.
As prescribed in the modified prospective approach, prior periods have not been
restated to reflect the effects of implementing FAS 123(R). For the three and
nine month periods ended September 30, 2005, the pro forma stock option expense,
net loss and net loss per share are as follows:
THREE MONTHS NINE MONTHS
------------ ------------
Net loss, as reported $(7,379,943) $(17,314,412)
Add: Stock-based compensation, as reported 422,357 (354,827)
Add: Stock-based compensation, using fair
value method (1,217,295) (3,557,025)
Add: Stock-based compensation, related to
the employee stock purchase plan
determined under SFAS No. 123 0 (95,847)
----------- ------------
Pro forma net loss $(8,147,881) $(21,322,111)
=========== ============
Net loss per share, basic and diluted, as reported $ (0.18) $ (0.42)
Pro forma net loss per share, basic and diluted $ (0.20) $ (0.52)
The stock-based compensation expense attributable to SFAS No. 123(R) for
the three months and nine months ended September 30, 2006 was $0.6 million and
$2.0 million, respectively.
8
(4) Inventories
Inventories are carried at the lower of cost or market using the first-in,
first-out (FIFO) method for determining cost.
Inventories consist of the following:
SEPTEMBER 30, DECEMBER 31,
2006 2005
------------- ------------
Raw materials $2,344,098 $1,486,166
Finished goods 1,521,610 1,271,101
Work in process 383,589 165,916
Reserve for excess and obsolete inventory (830,000) (675,000)
---------- ----------
Total inventories $3,419,297 $2,248,183
========== ==========
(5) Stock Compensation
Included in operating expenses are the following stock compensation charges, net
of reversals related to terminated employees:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------- ----------------------
2006 2005 2006 2005
-------- -------- ---------- ---------
Cost of goods sold $ 43,636 $ 40,143 $ 105,945 $ 27,163
Research and development 155,982 1,969 476,892 (499,113)
Selling and marketing 183,728 33,150 565,234 45,557
General and administrative 551,821 347,095 1,572,746 71,566
-------- -------- ---------- ---------
Total stock compensation $935,167 $422,357 $2,720,817 $(354,827)
-------- -------- ---------- ---------
(6) Comprehensive Loss
The components of comprehensive loss are as follows:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------- ---------------------------
2006 2005 2006 2005
----------- ----------- ------------ ------------
Net loss $(5,152,589) $(7,379,943) $(14,262,895) $(17,314,412)
Other comprehensive income (loss):
Foreign currency translation adjustments (114,167) 4,625 (159,474) 9,187
----------- ----------- ------------ ------------
Comprehensive loss $(5,266,756) $(7,375,318) $(14,422,369) $(17,305,225)
=========== =========== ============ ============
9
(7) Amortizable Intangible Assets
Amortizable intangible assets consist of the following:
SEPTEMBER 30, 2006 DECEMBER 31, 2005
-------------------------- --------------------------
GROSS GROSS
CARRYING ACCUMULATED CARRYING ACCUMULATED
AMOUNT AMORTIZATION AMOUNT AMORTIZATION
----------- ------------ ----------- ------------
Costs of settling patent litigation $10,533,248 $ 9,020,192 $10,533,248 $ 7,891,628
Reacquired marketing and distribution rights 2,211,111 2,211,111 2,211,111 2,211,111
Customer agreements 38,000 38,000 38,000 38,000
----------- ----------- ----------- -----------
Total $12,782,359 $11,269,303 $12,782,359 $10,140,739
=========== =========== =========== ===========
(8) Restructuring and Impairment of Long Lived Assets
During the third quarter of 2002, we announced a restructuring plan designed to
simplify product development and manufacturing operations and reduce operating
expenses. The restructuring charges recorded were determined based upon plans
submitted by the Company's management and approved by the Board of Directors
using information available at the time. The restructuring charge included $2.5
million for the consolidation of facilities, $500,000 for prepayment penalties
mainly under capital lease arrangements, an impairment charge of $7.2 million
for abandoned leasehold improvements and equipment to be sold and $900,000 of
other costs related to the restructuring. The Company also recorded a $1.1
million charge within cost of goods sold related to inventory that was
considered obsolete based upon the restructuring plan.
The facilities charge contained estimates based on the Company's potential to
sublease a portion of its corporate office. The Company has offered the
corporate office space for sublease, but has been unable to sublease the space.
Accordingly, the Company decreased its estimate of the amount of sublease income
it expects to receive. The estimated lease and operating expenses were also
reduced, based on a portion of the office space being utilized and revisions to
the building lease.
The following table shows the changes in the restructuring accrual since
December 31, 2005. The restructuring accrual was reduced in the quarter ended
September 30, 2006 due to an amendment to the building lease that resulted in
lower lease payments over the original remaining life of the lease. The
remaining restructuring balance of $0.7 million is for rent payments on a
non-cancelable lease, net of estimated sublease income, which will continue to
be paid over the lease term through 2011. The current portion of the accrual is
included in other accrued liabilities on the balance sheets and the remainder is
included in other long-term liabilities.
Accrued restructuring balance at December 31, 2005 $ 957,563
Payments made (117,767)
Adjustment (180,000)
=========
Accrued restructuring balance at September 30, 2006 $ 659,796
=========
(9) Other Long-term Liabilities
Other long-term liabilities consist of the long-term portion of the following
items:
SEPTEMBER 30, 2006 DECEMBER 31, 2005
------------------ -----------------
License payments $1,291,896 $1,430,942
Long-term Incentive Plan 1,667,289 1,312,841
Restructuring 536,488 775,174
Rent 1,138,909 1,159,094
Other 266,058 706,853
---------- ----------
$4,900,640 $5,384,904
========== ==========
(10) Shareholders' Equity
The Board of Directors had authorized a program for the repurchase by the
Company of up to 5% of its outstanding common stock. Third Wave has repurchased
218,000 shares of common stock as of December 31, 2005 for $877,159. The program
expired on December 31, 2005.
10
(11) New Accounting Pronouncements
On December 16, 2004, the Financial Accounting Standards Board (FASB) issued
SFAS No. 123 (revised 2004), "Share-Based Payment," which is a revision of SFAS
No. 123. SFAS No. 123(R) supersedes APB Opinion No. 25 and amends SFAS No. 95,
"Statement of Cash Flows." Generally, the approach in SFAS No. 123(R) is similar
to the approach described in SFAS No. 123. However, SFAS No. 123(R) requires all
share-based payments to employees, including grants of employee stock options,
to be recognized in the income statement based on their fair values. Pro forma
disclosure is no longer an alternative.
The Company adopted SFAS No. 123(R) on January 1, 2006. SFAS No. 123(R) permits
public companies to adopt its requirements using one of two methods: (1) a
"modified prospective" method in which compensation cost is recognized beginning
with the effective date (a) based on the requirements of SFAS No. 123(R) for
all-share based payments granted after the effective date and (b) based on the
requirements of SFAS No. 123 for all awards granted to employees prior to the
effective date of SFAS No. 123(R) that remain unvested on the effective date; or
(2) a "modified retrospective" method which includes the requirements of the
modified prospective method described above, but also permits entities to
restate based on the amounts previously recognized under SFAS No. 123 for
purposes of pro forma disclosures either (a) all prior periods presented or (b)
prior interim periods of the year of adoption. The Company adopted the modified
prospective approach.
In September 2006, the FASB issued FIN No. 48, "Accounting for Uncertainty in
Income Taxes," which clarifies the accounting for uncertainty in income taxes
recognized in an enterprise's financial statements in accordance with SFAS No.
109, "Accounting for Income Taxes." This interpretation prescribes a recognition
threshold and measurement attribute for the financial statement recognition and
measurement of a tax position taken or expected to be taken in a tax return.
This interpretation also provides guidance on derecognition, classification,
interest and penalties, accounting in interim periods, disclosure, and
transition. FIN No. 48 is effective for fiscal years beginning after December
15, 2006. The adoption of Interpretation No. 48 is not expected to have any
significant effect on the Company's consolidated financial position or results
of operations.
In September 2006, the Securities and Exchange Commission ("SEC) issued Staff
Accounting Bulletin ("SAB") No. 108, "Considering the Effects of Prior Year
Misstatements when Quantifying Misstatements in Current Year Financial
Statements." SAB 108 provides guidance on the consideration of effects of the
prior year misstatements in quantifying current year misstatements for the
purpose of a materiality assessment. The SEC staff believes registrants must
quantify errors using both a balance sheet and income statement approach and
evaluate whether either approach results in quantifying a misstatement that,
when all relevant quantitative and qualitative factors are considered, is
material. SAB 108 is effective for the first annual period ending after November
15, 2006 with early application encouraged. The Company adopted SAB 108 in the
quarter ended September 30, 2006. The adoption of this guidance has not had a
material impact on the Company's consolidated financial statements.
In May 2005, the FASB issued SFAS No. 154, "Accounting Changes and Error
Corrections - a replacement of Accounting Principles Board Opinion ("APB") No.
20 and SFAS No. 3," which changes the requirements for the accounting for, and
reporting of, a change in accounting principle. SFAS No. 154 is effective for
accounting changes and correction of errors made in fiscal years beginning after
December 15, 2005; however, the statement does not change the transition
provisions of any existing accounting pronouncements. The adoption of this
guidance has not had a material impact on the Company's consolidated financial
statements.
(12) Reclassifications
Certain reclassifications have been made to the 2005 financial statements to
conform to the 2006 presentation.
11
THIRD WAVE TECHNOLOGIES, INC.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
This Management's Discussion and Analysis of Financial Condition and Results of
Operations as of September 30, 2006 and for the three and nine months ended
September 30, 2006 and 2005 should be read in conjunction with our Form 10-K for
the fiscal year ended December 31, 2005 filed with the Securities and Exchange
Commission. In this Form 10-Q, the terms "we," "us," "our," "Company," and
"Third Wave" each refer to Third Wave Technologies, Inc. The following
discussion of our financial condition and results of our operations should be
read in conjunction with our Financial Statements, including the Notes thereto,
included elsewhere in this Form 10-Q.
OVERVIEW
Third Wave Technologies, Inc. develops and markets molecular diagnostic reagents
for a variety of DNA and RNA analysis applications to meet the needs of our
customers. The Company offers a number of products based on its Invader(R)
chemistry for clinical testing. Third Wave offers in vitro diagnostic kits and
analyte specific, general purpose, and research use only reagents for nucleic
acid analysis. We believe our proprietary Invader(R) chemistry, a novel,
molecular chemistry, is easier to use, cost-effective, and enables higher
testing throughput. These and other advantages conferred by our chemistry enable
us to provide clinicians and researchers with superior molecular solutions.
Approximately 160 clinical laboratory customers are using Third Wave's molecular
diagnostic reagents. Other customers include pharmaceutical and biotechnology
companies, academic research centers and major health care providers. Our
customer base is dominated by a small number of large clinical testing labs. We
regularly experience pricing and other competitive pressures in these accounts.
If for any reason, we are unable to maintain or renew our contracts,
particularly our contracts with key customers, or if, for any reason, we are
unable to maintain current pricing levels and/or volumes with our customers, or
are unable to manufacture the required product, our revenues and business may
suffer materially.
Third Wave has received clearance from the U.S. Food and Drug Administration
(FDA) for its Invader(R) UGT1A1 Molecular Assay. The Invader(R) UGT1A1 Molecular
Assay is used to identify patients who may be at increased risk of adverse
reaction to the chemotherapy Camptosar(R) (irinotecan) by detecting and
identifying specific mutations in the UGT1A1 gene that have been associated with
that risk. Camptosar(R), marketed in the United States by Pfizer, Inc., is used
to treat colorectal cancer and has been relabeled to include dosing
recommendations based on a patient's genetic profile. We also market a growing
number of products, including analyte specific reagents (ASRs). These ASRs allow
certified clinical reference laboratories to create assays that test for
infectious disease (e.g., hepatitis C virus), inherited disorders (e.g., Factor
V Leiden), and a host of other markers associated with genetic predispositions
and other diseases. The FDA is currently reviewing draft guidance for the
regulation of ASRs. If the FDA issues guidance or takes other actions that limit
ASRs generally or limits Third Wave's ASRs specifically, such guidance or
actions could materially affect our business. The Company has developed or plans
to develop a menu of molecular diagnostic products for clinical applications
that include genetic testing, pharmacogenetics, and women's health. The Company
also has a number of other Invader(R) products for research, agricultural and
other applications.
Currently, one of our key strategic initiatives is the commercialization of our
Human Papillomavirus (HPV) offering. To bring this product to market we will
need to receive premarket approval, known as a PMA, from the FDA. Seeking a PMA
for our HPV offering (and for any other product offerings) will be costly and
there can be no assurance that we will receive FDA approval or that other
difficulties will not delay or prevent the successful commercialization of our
HPV offering. If we are unable to successfully commercialize our HPV offering,
our business and prospects may be materially adversely affected. Additionally,
we anticipate significant competition in the HPV market as additional large
competitors have announced plans to enter the market in the near future. This
competition may have a significant impact on the success of our
commercialization of our HPV offering.
Our financial results may vary significantly from quarter to quarter due to
fluctuations in the demand for our products, timing of new product introductions
and deliveries made during the quarter, the timing of research, development and
grant revenues, and increases in spending, including expenses related to our
product development submissions for FDA clearances or approvals and intellectual
property litigation.
12
CRITICAL ACCOUNTING POLICIES
Management's discussion and analysis of our financial condition and results of
operations are based upon our consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States. We review the accounting policies we use in reporting our
financial results on a regular basis. The preparation of these financial
statements requires us to make estimates and judgments that affect the reported
amounts of assets, liabilities, revenues and expenses and related disclosure of
contingent assets and liabilities. On an ongoing basis, we evaluate our
estimates, including those related to accounts receivable, inventories,
equipment and leasehold improvements and intangible assets. We base our
estimates on historical experience and on various other assumptions that are
believed to be reasonable under the circumstances, the results of which form the
basis for making judgments about the carrying value of assets and liabilities
that are not readily apparent from other sources. Results may differ from these
estimates due to actual outcomes being different from those on which we based
our assumptions. These estimates and judgments are reviewed by management on an
ongoing basis, and by the Audit Committee at the end of each quarter prior to
the public release of our financial results. We believe the following critical
accounting policies affect our more significant judgments and estimates used in
the preparation of our consolidated financial statements.
REVENUE RECOGNITION
Revenue from product sales is recognized upon delivery which is generally when
the title passes to the customer, provided that the Company has completed all
performance obligations and the customer has accepted the products. Customers
have no contractual rights of return or refunds associated with product sales.
Consideration received in multiple element arrangements is allocated to the
separate units based upon their relative fair values. The multiple element
arrangements involve contracts with customers in which the Company is selling
reagent products and leasing equipment to the customer for use during the term
of the contract. Based upon the guidance in paragraph 9 of EITF No. 00-21
"Revenue Arrangements with Multiple Deliverables", both the reagents and
equipment have value to the customer on a standalone basis, there is objective
and reliable evidence of fair value for both the reagents and equipment and
there are no rights of return. The Company has sold both the reagents and
equipment separately, and therefore is able to determine a fair value for each.
The respective fair values are used to allocate the proceeds received to each of
the elements for purposes of recognizing revenue.
Grant and development revenues consist primarily of research grants from
agencies of the federal government and revenue from companies with which the
Company has established strategic alliances, the revenue from which is
recognized as research is performed. Payments received which are related to
future performance are deferred and recorded as revenue when earned. Grant
payments designated to purchase specific assets to be used in the performance of
a contract are recognized as revenue over the shorter of the useful life of the
asset acquired or the contract.
License and royalty revenue include amounts earned from third parties for
licenses of the Company's intellectual property and are recognized when earned
under the terms of the related agreements. License revenues are generally
recognized upon receipt unless the Company has continuing performance
obligations, in which case the license revenue is recognized ratably over the
period of expected performance.
RESTRUCTURING AND OTHER CHARGES
The restructuring and other charges resulting from the restructuring plan in the
third quarter of 2002 have been recorded in accordance with EITF Issue No. 94-3,
"Liability Recognition for Certain Employee Termination Benefits and Other Costs
to Exit an Activity (including Certain Costs Incurred in a Restructuring)",
Staff Accounting Bulletin No. 100, "Restructuring and Impairment Charges," and
Statement of Financial Accounting Standards (SFAS) No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets." The restructuring charge was
comprised primarily of costs to consolidate facilities, impairment charges for
abandoned leasehold improvements and equipment to be sold or abandoned,
prepayment penalties related mainly to capital lease obligations on equipment to
be sold or abandoned, and other costs related to the restructuring. The
remaining accrued restructuring balance is for rent payments on a non-cancelable
lease, net of estimated sublease income. In calculating the cost to consolidate
the facilities, we estimated the future lease and operating costs to be paid
until the leases are terminated and the amount, if any, of sublease receipts for
each location. This required us to estimate the timing and costs of each lease
to be terminated, the amount of operating costs, and the timing and rate at
which we might be able to sublease the site. To form our estimates for these
costs, we performed an assessment of the affected facilities and considered the
current market conditions for each site. Our assumptions on the lease payments,
operating costs until terminated, and the offsetting sublease receipts may turn
out to be incorrect and our actual cost may be materially different from our
estimates.
13
LONG-LIVED ASSETS--IMPAIRMENT
Equipment, leasehold improvements and amortizable identifiable intangible assets
are reviewed for impairment whenever events or changes in circumstances indicate
that the carrying amount may not be recoverable. For assets held and used, if
the sum of the expected undiscounted cash flows is less than the carrying value
of the related asset or group of assets, a loss is recognized for the difference
between the fair value and carrying value of the asset or group of assets. For
assets removed from service and held for sale, we estimate the fair market value
of such assets and record an adjustment if fair value less costs to sell is
lower than carrying value.
Goodwill and intangible assets deemed to have indefinite lives are not
amortized, but are subject to annual impairment tests under SFAS No. 142,
"Goodwill and Other Intangible Assets." The annual impairment test was completed
in the quarter ended September 30, 2006 and resulted in no impairment.
STOCK-BASED COMPENSATION EXPENSE
Prior to 2006, we accounted for share-based payments to employees using APB
Opinion No. 25's intrinsic value method and, as such, generally recognized no
compensation cost for employee stock options when granted. On January 1, 2006 we
adopted SFAS No. 123(R) as a result of which we recognize expense for all
share-based payments to employees, including grants of employee stock options,
based on their fair values. We have adopted the modified prospective transition
method as permitted by SFAS No. 123(R).
In October 2006, our audit committee concluded a voluntary investigation of the
Company's historical stock option granting practices and related accounting.
This investigation, which was conducted with the assistance of outside legal
counsel, covered the timing, pricing and authorization of all our stock option
grants made since our initial public offering in February 2001. Based on this
review, the Company determined that it used incorrect measurement dates with
respect to the accounting for certain previously granted stock options,
primarily during the years 2002 through 2004. The audit committee concluded that
deficiencies in the grant process were the result of administrative errors and
misunderstanding of applicable accounting rules, and were not attributable to
fraud or intentional misconduct.
We recorded an additional non-cash stock-based compensation charge totaling
$176,000 in the quarter ended September 30, 2006, representing the effect of the
adjustment resulting from the non-cash charges discussed above that relate to
2006. Additionally, we expect to record a reclassification between accumulated
deficit and additional paid in capital, within the equity section of the
consolidated balance sheet to be included in our Form 10-K for the fiscal year
ending December 31, 2006, of approximately $731,000. This reclassification
represents the effect of the adjustment resulting from the non-cash charges
discussed above that related to fiscal 2005 and prior years. Neither the current
period charge nor the reclassification affect our cash position. There were no
significant income tax effects relating to this adjustment for the Company.
INVENTORIES--SLOW MOVING AND OBSOLESCENCE
Significant management judgment is required to determine the reserve for
obsolete or excess inventory. Inventory on hand may exceed future demand either
because of process improvements or technology advancements, the amount on hand
is more than can be used to meet future need, or estimates of shelf lives may
change. We currently consider all inventory that we expect will have no activity
within one year as well as any additional specifically identified inventory to
be subject to a provision for excess inventory. We also provide for the total
value of inventories that we determine to be obsolete based on criteria such as
changing manufacturing processes and technologies. At September 30, 2006, our
inventory reserves were $830,000, or 20% of our $4.2 million total gross
inventories.
NEW ACCOUNTING PRONOUNCEMENTS
On December 16, 2004, the Financial Accounting Standards Board (FASB) issued
SFAS No. 123 (revised 2004), "Share-Based Payment," which is a revision of SFAS
No. 123. SFAS No. 123(R) supersedes APB Opinion No. 25 and amends SFAS No. 95,
"Statement of Cash Flows." Generally, the approach in SFAS No. 123(R) is similar
to the approach described in SFAS No. 123. However, SFAS No. 123(R) requires all
share-based payments to employees, including grants of employee stock options,
to be recognized in the income statement based on their fair values. Pro forma
disclosure is no longer an alternative.
14
The Company adopted SFAS No. 123(R) on January 1, 2006. SFAS No. 123(R) permits
public companies to adopt its requirements using one of two methods: (1) a
"modified prospective" method in which compensation cost is recognized beginning
with the effective date (a) based on the requirements of SFAS No. 123(R) for
all-share based payments granted after the effective date and (b) based on the
requirements of SFAS No. 123 for all awards granted to employees prior to the
effective date of SFAS No. 123(R) that remain unvested on the effective date; or
(2) a "modified retrospective" method which includes the requirements of the
modified prospective method described above, but also permits entities to
restate based on the amounts previously recognized under SFAS No. 123 for
purposes of pro forma disclosures either (a) all prior periods presented or (b)
prior interim periods of the year of adoption. The Company adopted the modified
prospective approach.
In September 2006, the FASB issued FIN No. 48, "Accounting for Uncertainty in
Income Taxes," which clarifies the accounting for uncertainty in income taxes
recognized in an enterprise's financial statements in accordance with SFAS No.
109, "Accounting for Income Taxes." This interpretation prescribes a recognition
threshold and measurement attribute for the financial statement recognition and
measurement of a tax position taken or expected to be taken in a tax return.
This interpretation also provides guidance on derecognition, classification,
interest and penalties, accounting in interim periods, disclosure, and
transition. FIN No. 48 is effective for fiscal years beginning after December
15, 2006. The adoption of Interpretation No. 48 is not expected to have any
significant effect on the Company's consolidated financial position or results
of operations.
In September 2006, the Securities and Exchange Commission ("SEC) issued Staff
Accounting Bulletin ("SAB") No. 108, "Considering the Effects of Prior Year
Misstatements when Quantifying Misstatements in Current Year Financial
Statements." SAB 108 provides guidance on the consideration of effects of the
prior year misstatements in quantifying current year misstatements for the
purpose of a materiality assessment. The SEC staff believes registrants must
quantify errors using both a balance sheet and income statement approach and
evaluate whether either approach results in quantifying a misstatement that,
when all relevant quantitative and qualitative factors are considered, is
material. SAB 108 is effective for the first annual period ending after November
15, 2006 with early application encouraged. The Company adopted SAB 108 in the
quarter ended September 30, 2006. The adoption of this guidance has not had a
material impact on the Company's consolidated financial statements.
In May 2005, the FASB issued SFAS No. 154, "Accounting Changes and Error
Corrections - a replacement of Accounting Principles Board Opinion ("APB") No.
20 and SFAS No. 3," which changes the requirements for the accounting for, and
reporting of, a change in accounting principle. SFAS No. 154 is effective for
accounting changes and correction of errors made in fiscal years beginning after
December 15, 2005; however, the statement does not change the transition
provisions of any existing accounting pronouncements. The adoption of this
guidance has not had a material impact on the Company's consolidated financial
statements.
15
RESULTS OF OPERATIONS
Three and Nine Months Ended September 30, 2006 and 2005
NET LOSS. Net loss for the three months ended September 30, 2006 improved to
$5.2 million from $7.4 million for the corresponding period of 2005. Net loss
for the nine months ended September 30, 2006 improved to $14.3 million from
$17.3 million for the corresponding period of 2005.
REVENUES. Revenues for the three months ended September 30, 2006 of $6.6 million
represented an increase of $1.4 million, compared to revenues of $5.2 million
for the corresponding period of 2005. Revenues for the nine months ended
September 30, 2006 of $21.2 million represented an increase of $3.1 million,
compared to revenues of $18.1 million for the corresponding period of 2005.
Following is a discussion of changes in revenues:
Clinical molecular diagnostic product revenue increased to $5.4 million in the
quarter ended September 30, 2006 from $4.0 million in the quarter ended
September 30, 2005. Clinical molecular diagnostic product revenue increased to
$15.1 million in the nine months ended September 30, 2006 from $11.4 million in
the nine months ended September 30, 2005.
Research product revenues increased to $1.2 million in the three months ended
September 30, 2006 from $1.0 million in the three months ended September 30,
2005. Research product revenues decreased to $5.8 million in the nine months
ended September 30, 2006 from $6.1 million in the nine months ended September
30, 2005. The decrease in research product sales during 2006 resulted from a
decrease in genomic research product sales to a Japanese research institute for
use by several end users. The decrease in research revenue from the Japanese
research institute was partially offset by an increase in revenue from our Agbio
business.
Significant Customers. We generated $2.8 million, or 13% of our revenues, from
sales to a major Japanese research institute for use by several end-users during
the nine months ended September 30, 2006, compared to $3.6 million, or 20% of
our revenues during the nine months ended September 30, 2005. In addition, we
generated $2.2 million or 10% of our revenues, from sales to a large clinical
lab during the nine months ended September 30, 2006.
COST OF GOODS SOLD. Cost of goods sold consists of materials used in the
manufacture of product, depreciation on manufacturing capital equipment,
salaries and related expenses for management and personnel associated with our
manufacturing and quality control departments and amortization of licenses and
settlement fees. For the three months ended September 30, 2006, cost of goods
sold increased to $2.2 million, compared to $1.6 million for the corresponding
period of 2005. For the nine months ended September 30, 2006, cost of goods sold
increased to $6.3 million, compared to $5.4 million for the corresponding period
of 2005. The increase in the three and nine month periods was primarily due to
the increase in sales volume, amortization of new licenses and the write-off of
defective inventory due to a supplier relocation in the third quarter.
RESEARCH AND DEVELOPMENT EXPENSES. Research and development expenses consist
primarily of salaries and related personnel costs, material costs for assays and
product development, fees paid to consultants, depreciation and facilities costs
and other expenses related to the design, development, testing, (including
clinical trials to validate the performance of our products) and enhancement of
our products, and acquisition of technologies used in our products. Research and
development costs are expensed as they are incurred. Research and development
expenses for the three months ended September 30, 2006 were $3.5 million,
compared to $2.1 million for the three months ended September 30, 2005. Research
and development expenses for the nine months ended September 30, 2006 were $8.8
million, compared to $6.6 million for the nine months ended September 30, 2005.
The increase in research and development expenses was primarily due to an
increase in personnel, product development expense (including costs incurred by
us in pursuit of FDA premarket approval for our HPV offering), and an increase
in stock based compensation expense of $0.2 million and $1.0 million in the
three and nine month periods, respectively, compared to the same periods in
2005. We will continue to invest in research and development, and expenditures
in this area will increase as we expand our product development efforts. In
addition, as the Company moves towards consideration of FDA cleared or approved
products, there will be increased expenses attributed to these activities.
SELLING AND MARKETING EXPENSES. Selling and marketing expenses consist primarily
of salaries and related personnel costs for our sales and marketing management
and field sales force, commissions, office support and related costs, and travel
and entertainment. Selling and marketing expenses for the three months ended
September 30, 2006 were $2.7 million, a decrease of $1.0 million, compared to
$3.7 million for the corresponding period of 2005. Selling and marketing
expenses for the nine months ended September 30, 2006 were $8.6 million, a
decrease of $1.6 million, compared to $10.2 million for the corresponding period
of 2005. The decrease in selling and marketing expenses was due to a decrease in
personnel related and equipment expense, offset by an
16
increase in stock based compensation expense of $0.2 million and $0.5 million in
the three and nine month periods, respectively, compared to the same periods in
2005.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses consist
primarily of salaries and related expenses for executive, finance and other
administrative personnel, legal and professional fees, office support and
depreciation. General and administrative expenses increased to $3.5 million in
the three months ended September 30, 2006, from $2.9 million for the
corresponding period in 2005. General and administrative expenses increased to
$11.5 million in the nine months ended September 30, 2006, from $8.5 million for
the corresponding period in 2005. The increase in general and administrative
expense was due to an increase in legal fees related to our patents and the
equity investment in our Japan subsidiary, a sales tax charge and an increase in
stock based compensation expense of $0.2 million and $1.5 million in the three
and nine month periods, respectively compared to the same periods in 2005.
LITIGATION EXPENSE. Litigation expense consists of legal fees and other costs
associated with patent infringement and other lawsuits. Litigation expense
decreased to $0.3 million in the three months ended September 30, 2006 from $2.7
million in the corresponding period in 2005. Litigation expense decreased to
$1.4 million in the nine months ended September 30, 2006 from $5.2 million in
the corresponding period in 2005. The decreases were the result of the decreased
litigation activity due to the resolution of the lawsuits with Innogenetics,
Chiron Corporation, Bayer Corporation, and Digene Corporation. We anticipate
litigation expense to remain below the 2005 levels for the remainder of the
year.
IMPAIRMENT. In the nine months ended September 30, 2005 an impairment charge of
$0.2 million was recorded for the loss on equipment that was sold.
RESTRUCTURING. In the three and nine months ended September 30, 2006 a credit of
$0.2 million was recorded to adjust the restructuring accrual due to an
amendment to the building lease.
INTEREST INCOME. Interest income for the three months ended September 30, 2006
and 2005 was $0.4 million and $0.5 million, respectively. Interest income for
the nine months ended September 30, 2006 and 2005 was $1.1 million and $1.2
million, respectively.
INTEREST EXPENSE. Interest expense for the three months ended September 30, 2006
and 2005 was approximately $0.1 million. Interest expense for the nine months
ended September 30, 2006 and 2005 was $0.2 million and $0.3 million,
respectively.
OTHER INCOME (EXPENSE). Other expense for the three months ended September 30,
2006 was approximately $0.1 million compared to $31,000 for the same period in
2005. Other expense for the nine months ended September 30, 2006 was
approximately $0.1 million compared to $0.3 million for the same period in 2005.
The change in other expense was primarily due to the adjustments related to
foreign currency transactions in the periods.
MINORITY INTEREST. Minority interest for the three and nine months ended
September 30, 2006 was $65,000 and $106,000, respectively. Minority interest
represents Third Wave Japan's minority investors' share of the equity and
earnings of the subsidiary.
LIQUIDITY AND CAPITAL RESOURCES
Since our inception, we have financed our operations primarily through private
placements of equity securities, research grants from federal and state
government agencies, payments from strategic collaborators, equipment loans,
capital leases, product sales, a convertible note and an initial public
offering. As of September 30, 2006, we had cash and cash equivalents and
short-term investments of $33 million.
Net cash used in operations for the nine months ended September 30, 2006 was
$10.7 million, compared to $12.7 million in the corresponding period in 2005.
The change was primarily due to lower operating losses.
Net cash provided by investing activities for the nine months ended September
30, 2006 was $8.8 million, compared to net cash used of $0.9 million in the
corresponding period in 2005. Investing activities included capital expenditures
of $0.6 million in the nine months ended September 30, 2006 versus $0.3 million
for the same period in 2005. Investing activities in the nine months ended
September 30, 2006 included the payment on license fee arrangements of $0.7
million and a change in the restricted cash balance of $0.8 million. Investing
activities in the nine months ended September 30, 2005 also included proceeds
from the sale of equipment of $0.2 million. In addition, net cash provided by
investing activities included $9.3 million from the maturity of short term
investments in the nine months ended September 30, 2006, compared to cash usage
of $0.8 million to purchase short-term investments in 2005.
17
Net cash provided by financing activities was $5.4 million in the nine months
ended September 30, 2006 compared to $0.4 million in 2005. Cash provided by
financing activities in the nine months ending September 30, 2006 consisted of
proceeds from the sale of common stock under the Company's employee stock
purchase plan and stock option plans of $0.7 million compared to $0.7 million in
the corresponding period of 2005. In the nine months ended September 30, 2006,
$0.3 million was used to repay debt, compared to $0.1 million in the same period
in 2005. Additionally, in the nine months ended September 30, 2006 and 2005,
$107,000 and $71,000 was used for capital lease obligations, respectively.
Financing activities in the nine months ended September 30, 2005 also included
proceeds from long-term debt of $0.8 million and the repurchase of common stock
for treasury of $0.9 million. Financing activities in the nine months ended
September 30, 2006 also included proceeds from a minority equity investment in
our Japan subsidiary of $5.1 million. The proceeds from the equity investment
are required to be used in the operations of our Japan subsidiary.
The Company has three notes payable to a bank in the original amounts of
$200,000, $270,000, and $800,000. These notes have respective final maturity
dates of July 1, 2007, October 1, 2009, and July 1, 2008, bear annual interest
at 4.25%, 4.93%, and 5.2%, respectively, and require monthly principal and
interest payments. The borrowings under the notes payable are secured by
short-term investments consisting of certificates of deposit in the aggregate
amount of $775,000. The Company has an available and unused $1,000,000 letter of
credit with the same bank that expires on September 1, 2007.
We believe that current cash reserves together with our ability to generate cash
through operations, financing activities and other sources will be sufficient to
support short-term and long-term liquidity requirements for current operations
(including annual capital expenditures). However, we cannot assure you that our
business or operations will not change in a manner that would consume available
resources more rapidly than anticipated.
We also cannot assure you that we will not require substantial additional
funding before we can achieve profitable operations. Our capital requirements
depend on numerous factors, including the following:
- our progress with our research and development programs;
- the needs we may have to pursue FDA clearances or approvals of our
products;
- our level of success in selling our products and technologies;
- our ability to establish and maintain successful collaborative
relationships;
- the costs we incur in securing intellectual property rights, whether
through patents, licenses or otherwise;
- the costs we incur in enforcing and defending our patent claims and
other intellectual property rights;
- the need to respond to competitive pressures;
- the possible acquisition of complementary products, businesses or
technologies; and
- the timing of capital expenditures
CONTRACTUAL OBLIGATIONS
During the quarter ended September 30, 2006 we amended our facility lease. As a
result of the amendment, our operating lease obligations have changed as follows
(in thousands):
FOURTH 2011 AND
TOTAL QUARTER 2006 2007-2008 2009-2010 THEREAFTER
---------- ------------ ---------- ---------- ----------
Pre-amendment operating lease obligation $ 10,481 $ 470 $ 3,986 $ 4,311 $ 1,714
(Decrease)/increase in obligation $ 542 $ (152) $ (291) $ (1,396) $ 2,381
Post-amendment operating lease obligation $ 11,023 $ 318 $ 3,695 $ 2,915 $ 4,095
18
FORWARD-LOOKING STATEMENTS
This Form 10-Q contains forward-looking statements within the meaning of Section
21E of the Securities Exchange Act of 1934, as amended, and Section 27A of the
Securities Act of 1933, as amended. When used in this Form 10-Q the words
"believe," "anticipates," "intends," "plans," "estimates," and similar
expressions are forward-looking statements. Such forward-looking statements
contained in this Form 10-Q are based on current expectations. Forward-looking
statements may address the following subjects: results of operations; customer
growth and retention; development of technologies; losses or earnings; operating
expenses, including, without limitation, marketing expense, litigation expense,
and technology and development expense; and revenue growth. We caution investors
that there can be no assurance that actual results, outcomes or business
conditions will not differ materially from those projected or suggested in such
forward-looking statements as a result of various factors, including, among
others, our limited operating history, unpredictability of future revenues and
operating results, competitive pressures and also the potential risks and
uncertainties discussed under the heading "Overview" in the Management's
Discussion and Analysis of Financial Condition and Results of Operations section
of this Form 10-Q and in the "Risk Factors" and Management's Discussion and
Analysis of Financial Condition and Results of Operations sections of our annual
report on Form 10-K for the fiscal year ended December 31, 2005 filed with the
Securities and Exchange Commission, which factors are specifically incorporated
herein by this reference. You should also carefully consider the factors set
forth in other reports or documents that we file from time to time with the
Securities and Exchange Commission. Except as required by law, we undertake no
obligation to update any forward-looking statements. We expressly disclaim any
obligation or undertaking to release publicly any updates or revisions to any
forward-looking statements contained herein to reflect any change in our
expectations with regard thereto or any change in events, conditions, or
circumstances on which any such statements are based.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our exposure to market risk is currently confined to changes in foreign exchange
and interest rates. Our exposure to market risk was discussed in the
Quantitative and Qualitative Disclosures About Market Risk section of our annual
report on Form 10-K for the fiscal year ended December 31, 2005 filed with the
Securities and Exchange Commission. There have been no material changes to such
exposures during the third quarter of 2006.
ITEM 4. CONTROLS AND PROCEDURES
As required by Rule 13a-15(b) under the Securities Exchange Act of 1934, the
Company's management, including our Chief Executive Officer and Chief Financial
Officer, conducted an evaluation as of the end of the period covered by this
report, of the effectiveness of the Company's disclosure controls and procedures
as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934. Based on
that evaluation, our Chief Executive Officer and Chief Financial Officer
concluded that the Company's disclosure controls and procedures were effective
as of the end of the period covered by this report. There have been no
significant changes during the period covered by this report in the Company's
internal control over financial reporting that have materially affected, or are
reasonably likely to materially affect, internal controls over financial
reporting. As a result of our review of Stock Option Grants and Procedures (see
Footnote 3 to the financial statements), subsequent to the period covered by
this report we modified our procedures for granting stock options to ensure
correct measurement dates are used in the future.
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
From time to time, we may be involved in litigation relating to claims arising
out of our operations in the usual course of business.
In September 2004, we filed a suit against Stratagene Corporation in the United
States District Court for the Western District of Wisconsin. The complaint
alleged patent infringement of two of our patents concerning our proprietary
Invader(R) technology by Stratagene's sale of its QPCR and QRTPCR Full Velocity
products. The case was tried before a jury in August 2005, and the jury found
that Stratagene willfully infringed our patents and that our patents were valid.
The jury awarded us $5.29 million in damages. The Court subsequently entered a
permanent injunction barring Stratagene from making, selling or offering to sell
its Full Velocity QPCR and QRT-PCR products and any other products that practice
our patented Invader(R) methods. In December 2005, the Court tripled the damages
award to $15.9 million and ruled that Stratagene must pay attorney fees of $4.2
million. In January 2006, the Court awarded additional interest on the damages
award in the amount of $485,716, increasing the total damages amount to $16.4
million. Also in January 2006, Stratagene posted a $21 million civil bond to
stay payment of the judgment while it conducts its appeal. Stratagene has
appealed the verdict, the award of enhanced damages, and the award of attorneys'
fees and costs to the Court of Appeals for the Federal Circuit in Washington,
D.C. Appellate briefing was completed on July 10, 2006. Oral arguments before
the
19
Appellate court are set for December 7, 2006.
In May 2005, Stratagene Corporation filed suit against us in the United States
District Court for the District of Delaware. The complaint alleges patent
infringement of claims of two Stratagene patents relating to our Invader Plus(R)
chemistry. The complaint was served on us in September 2005. Recently, at the
request of both parties, the Court rescheduled the trial date to April 7, 2008.
In October 2005, we filed a declaratory judgment suit in the United States
District Court for the Western District of Wisconsin against Digene Corporation
seeking a ruling that our HPV ASRs do not infringe any valid claims of Digene's
human papillomavirus related patents. In January 2006, we reached an agreement
with Digene to dismiss the suit without prejudice. We also agreed that neither
party would file a suit against the other relating to the Digene HPV patents for
one year.
The Company intends to vigorously pursue its infringement claims against third
parties and to vigorously defend itself against infringement claims brought
against it by third parties. There can be no assurance, however, that the
Company will prevail in these proceedings and should the outcome of any of these
actions be unfavorable, the Company's business, financial condition, results of
operations and cash flows could be materially adversely affected.
ITEM 1A. RISK FACTORS
There have been no material changes in our risk factors from those disclosed in
our Form 10-K for the fiscal year ended December 31, 2005 filed with the
Securities and Exchange Commission.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS. - None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES - None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS -- None.
ITEM 5. OTHER INFORMATION. - None.
ITEM 6. EXHIBITS
The exhibits required to be filed as a part of this Report are listed in the
Exhibit Index.
20
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
THIRD WAVE TECHNOLOGIES, INC.
Date: November 8, 2006 /s/ Kevin T. Conroy
-----------------------------------------
Kevin T. Conroy, Chief Executive Officer
Date: November 8, 2006 /s/ Maneesh K. Arora
-----------------------------------------
Maneesh K. Arora, Chief Financial Officer
21
EXHIBIT INDEX
EXHIBIT NO. DESCRIPTION INCORPORATED BY REFERENCE TO
- ----------- ----------- ----------------------------
10.1 Amendment Two to Lease dated
September 1, 2006, by and between
University Research Park, Inc. and
Third Wave Technologies, Inc.
31.1 CEO's Certification Pursuant to
Section 302 of the Sarbanes Oxley
Act of 2002
31.2 CFO's Certification pursuant to
Section 302 of the Sarbanes Oxley
Act of 2002.
32 CEO and CFO Certification pursuant
to 18 U.S.C. Section 1350, of
Chapter 63 of Title 18 of the
United States Code
22