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Form 10-Q
Table of Contents

 

 

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 June 30, 2012

OR

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from             to            

Commission file number: 001-34939

 

 

Complete Genomics, Inc.

(Exact Name of Registrant as Specified in its Charter)

 

 

 

Delaware   20-3226545

(State or Other Jurisdiction of

Incorporation or Organization)

 

(I.R.S. Employer

Identification No.)

 

2071 Stierlin Court

Mountain View, California

  94043
(Address of Principal Executive Offices)   (Zip Code)

(650) 943-2800

(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 mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act:

 

Large accelerated filer   ¨    Accelerated filer   x
Non-accelerated filer   ¨  (Do not check if a smaller reporting company)    Smaller reporting company   ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

As of July 30, 2012, the number of outstanding shares of the registrant’s common stock, par value $0.001 per share, was 34,293,284.

 

 

 


Table of Contents

COMPLETE GENOMICS, INC.

FORM 10-Q FOR THE QUARTER ENDED JUNE 30, 2012

INDEX

 

     Page  
Part I — Financial Information   

Item 1. Financial Statements (unaudited)

  

Condensed Consolidated Balance Sheets as of June 30, 2012 and December 31, 2011

     3   

Condensed Consolidated Statements of Comprehensive Loss for the Three and Six Months Ended June  30, 2012 and 2011

     4   

Condensed Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2012 and 2011

     5   

Notes to Condensed Consolidated Financial Statements

     6   

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

     16   

Item 3. Quantitative and Qualitative Disclosures About Market Risk

     25   

Item 4. Controls and Procedures

     25   
Part II — Other Information   

Item 1. Legal Proceedings

     26   

Item 1A. Risk Factors

     27   

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

     44   

Item 3. Defaults Upon Senior Securities

     44   

Item 4. Mine Safety Disclosures

     44   

Item 5. Other Information

     44   

Item 6. Exhibits

     45   

Signatures

     46   

EX-31.1

  

EX-31.2

  

EX-32.1

  

EX-32.2

  

 

2


Table of Contents

PART I — FINANCIAL INFORMATION

COMPLETE GENOMICS, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(UNAUDITED)

 

     June 30, 2012     December 31, 2011  
     (in thousands, except par value and share data)  

Assets

    

Current assets

    

Cash and cash equivalents

   $ 39,258      $ 77,074   

Short-term investments

     4,000        6,000   

Accounts receivable

     7,139        6,488   

Inventory

     7,628        4,121   

Prepaid expenses

     1,663        1,141   

Other current assets

     77        341   
  

 

 

   

 

 

 

Total current assets

     59,765        95,165   

Property and equipment, net

     34,222        33,592   

Other assets

     1,196        1,446   
  

 

 

   

 

 

 

Total assets

   $ 95,183      $ 130,203   
  

 

 

   

 

 

 

Liabilities and Stockholders’ Equity

    

Current liabilities

    

Accounts payable

   $ 6,493      $ 5,363   

Accrued liabilities

     5,806        5,400   

Notes payable, current

     21,608        7,099   

Deferred revenue

     9,783        10,026   
  

 

 

   

 

 

 

Total current liabilities

     43,690        27,888   

Notes payable, net of current

     —          16,162   

Deferred rent, net of current

     3,117        3,539   
  

 

 

   

 

 

 

Total liabilities

     46,807        47,589   
  

 

 

   

 

 

 

Commitments and contingencies (Note 7)

    

Stockholders’ equity

    

Preferred stock, par value $0.001 – 5,000,000 shares authorized and no shares outstanding at June 30, 2012 and December 31, 2011

     —          —     

Common stock, $0.001 par value—300,000,000 shares authorized and 34,272,657 shares issued and outstanding at June 30, 2012; 300,000,000 shares authorized and 33,409,638 shares issued and outstanding at December 31, 2011

     34        33   

Additional paid-in capital

     298,597        293,777   

Accumulated deficit

     (250,255     (211,196
  

 

 

   

 

 

 

Total stockholders’ equity

     48,376        82,614   
  

 

 

   

 

 

 

Total liabilities and stockholders’ equity

   $ 95,183      $ 130,203   
  

 

 

   

 

 

 

See accompanying notes to condensed consolidated financial statements.

 

3


Table of Contents

COMPLETE GENOMICS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS

(UNAUDITED)

 

     Three months ended
June 30,
    Six months ended
June 30,
 
     2012     2011     2012     2011  
     (in thousands, except share and per share data)  

Revenue

   $ 8,693      $ 5,865      $ 12,601      $ 12,698   

Cost and expenses:

        

Cost of revenue

     8,122        6,122        13,420        12,704   

Research and development

     8,946        8,028        17,639        14,836   

Sales and marketing

     4,642        3,138        9,895        5,838   

General and administrative

     3,581        3,468        7,717        6,248   

Restructuring charges

     1,496        —          1,496        —     
  

 

 

   

 

 

   

 

 

   

 

 

 

Total cost and expenses

     26,787        20,756        50,167        39,626   
  

 

 

   

 

 

   

 

 

   

 

 

 

Loss from operations

     (18,094     (14,891     (37,566     (26,928

Interest expense

     (735     (810     (1,499     (1,150

Interest and other income (expense), net

     2        (258     6        (341
  

 

 

   

 

 

   

 

 

   

 

 

 

Net loss

   $ (18,827   $ (15,959   $ (39,059   $ (28,419
  

 

 

   

 

 

   

 

 

   

 

 

 

Net loss per share — basic and diluted

   $ (0.55   $ (0.56   $ (1.16   $ (1.05
  

 

 

   

 

 

   

 

 

   

 

 

 

Weighted-average shares of common stock outstanding used in computing net loss per share — basic and diluted

     34,079,053        28,290,470        33,780,754        27,131,605   
  

 

 

   

 

 

   

 

 

   

 

 

 

Comprehensive loss

   $ (18,827   $ (15,959   $ (39,059   $ (28,419
  

 

 

   

 

 

   

 

 

   

 

 

 

See accompanying notes to condensed consolidated financial statements.

 

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Table of Contents

COMPLETE GENOMICS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

 

     Six months ended
June 30,
 
     2012     2011  
     (in thousands)  

Cash flows from operating activities

    

Net loss

   $ (39,059   $ (28,419

Adjustments to reconcile net loss to net cash used in operating activities:

    

Depreciation and amortization

     7,206        5,301   

Change in inventory reserves

     157        32   

Change in fair value of warrant liability

     —          361   

Stock-based compensation

     3,000        1,567   

Noncash interest expense related to notes payable

     492        108   

Other

     84        8   

Changes in assets and liabilities

    

Accounts receivable

     (698     (2,320

Inventory

     (3,664     (342

Prepaid expenses

     (522     326   

Other current assets

     264        5   

Other assets

     225        (366

Accounts payable

     725        1,019   

Accrued liabilities

     252        1,561   

Deferred revenue

     (243     1,338   

Deferred rent

     (422     (381
  

 

 

   

 

 

 

Net cash used in operating activities

     (32,203     (20,202
  

 

 

   

 

 

 

Cash flows from investing activities

    

Purchase of available-for-sale securities

     (15,998     (43,657

Proceeds from maturities of available-for-sale securities

     17,998        —     

Purchase of property and equipment

     (7,443     (7,822

Purchase of patent

     —          (250
  

 

 

   

 

 

 

Net cash used in investing activities

     (5,443     (51,729
  

 

 

   

 

 

 

Cash flows from financing activities

    

Proceeds from notes payable

     —          20,000   

Repayment of notes payable

     (1,991     (8,644

Proceeds from issuance of common stock, net of costs

     1,091        73,932   

Proceeds from issuance of common stock under equity incentive plans

     730        482   
  

 

 

   

 

 

 

Net cash (used in) provided by financing activities

     (170     85,770   
  

 

 

   

 

 

 

Net increase (decrease) in cash and cash equivalents

     (37,816     13,839   

Cash and cash equivalents at beginning of period

     77,074        68,918   
  

 

 

   

 

 

 

Cash and cash equivalents at end of period

   $ 39,258      $ 82,757   
  

 

 

   

 

 

 

Supplemental disclosure of cash flow information

    

Cash paid for interest

   $ 1,150      $ 953   

Supplemental disclosure of noncash investing and financing activities

    

Issuance of warrants for common stock in connection with term debt

   $ —        $ 987   

Acquisition of property and equipment under accounts payable

   $ 405      $ 2,198   

Reclassification of warrant liability to additional-paid-in capital upon exercise of warrant

   $ —        $ 643   

See accompanying notes to condensed consolidated financial statements.

 

5


Table of Contents

Complete Genomics, Inc.

Notes to Condensed Consolidated Financial Statements (unaudited)

1. THE COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Nature of Operations

Complete Genomics, Inc., (the “Company”) is a life sciences company that has developed and commercialized a DNA sequencing platform for whole human genome sequencing and analysis. The Company’s Complete Genomics Analysis Platform (“CGA Platform”) combines its proprietary human sequencing technology with its advanced informatics and data management software and its end-to-end outsourced service model to provide customers with data that is immediately ready to be used for genome-based research. The Company’s solution provides academic, biopharmaceutical and translational medicine researchers with whole human genome data and analysis without requiring them to invest in in-house sequencing instruments, high-performance computing resources and specialized personnel. In the DNA sequencing industry, whole human genome sequencing is generally deemed to be coverage of at least 90% of the nucleotides in the genome. The Company was incorporated in Delaware on June 14, 2005 and began operations in March 2006.

The Company has incurred net operating losses and significant negative cash flow from operations during every year since inception. At June 30, 2012, the Company had an accumulated deficit of $250.3 million. Management believes that based on the current level of operations, cash and cash equivalents balances and interest income the Company will earn on these balances will not be sufficient to meet the anticipated cash requirements for the six months beyond June 30, 2012. The Company’s recurring operating losses and negative cash flow from operations and its requirement for additional funding to execute its business objectives beyond this period gives rise to substantial doubt as to the Company’s ability to continue as a going concern. These financial statements do not include any adjustments that might result from the outcome of this uncertainty.

The Company announced on June 5, 2012 that it has engaged Jefferies & Company, Inc. to act as financial advisor to the Company and to assist in its review of strategic alternatives, which could include a merger, business combination, equity investment or sale of the Company. There can be no assurance that the Company will be successful in executing on any of these possible strategic alternatives. If the Company is unable to execute on one of these possible strategic alternatives or otherwise raise additional financing on a timely basis, it will need to significantly scale back or discontinue operations.

Basis of Presentation

The interim condensed consolidated financial statements have been prepared and presented by the Company in accordance with accounting principles generally accepted in the United States (“GAAP”) and the rules and regulations of the Securities and Exchange Commission, without audit, and reflect all adjustments, consisting of adjustments of a normal, recurring nature, necessary to state fairly the Company’s interim financial information. The accounting principles and methods of computation adopted in these financial statements are the same as those of the audited financial statements for the year ended December 31, 2011.

The preparation of the Company’s unaudited condensed consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the unaudited condensed consolidated financial statements and the reported amounts of expenses during the reporting period.

Certain information and footnote disclosures normally included in the Company’s annual financial statements prepared in accordance with GAAP have been condensed or omitted. The accompanying unaudited financial statements should be read in conjunction with the audited financial statements for the year ended December 31, 2011 included in the Company’s Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 9, 2012. The financial results for any interim period are not necessarily indicative of financial results for the full year or any other interim period.

The Company operates as one segment, providing whole human genome sequencing and analysis.

The condensed consolidated financial statements include the accounts of Complete Genomics, Inc. and those of its wholly-owned subsidiaries. All inter-company accounts and transactions have been eliminated.

Management determined that the decision to defer capital expenditures as part of the restructuring plan announced on June 5, 2012 (see note 11) was a change in circumstances that required an evaluation of the recoverability of the Company’s property and equipment and patent (intellectual property). Therefore, management performed an evaluation of the recoverability of the Company’s property and equipment and patent (intellectual property) by comparing the carrying value of these assets to the projected, undiscounted cash flows generated by these assets over the estimated remaining useful life of these assets. Management determined that the Company’s property and equipment and patent (intellectual property) were not impaired at June 30, 2012, as the projected undiscounted cash flows exceed the carrying value.

Summary of Significant Accounting Policies

The following accounting policy was adopted by the Company during the three months ended June 30, 2012 in addition to the significant accounting policies described in its audited financial statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2011:

 

6


Table of Contents

Restructuring Charges — The Company measures and accrues the liabilities associated with employee separation costs at fair value as of the date the restructuring plan is announced and terminations are communicated to employees. The fair value measurement of restructuring related liabilities requires certain assumptions and estimates be made by the Company. It is the Company’s policy to use the best estimates based on facts and circumstances available at the time of measurement, review the assumptions and estimates periodically, and adjust the liabilities when necessary.

Recent Adopted Accounting Standards

In May 2011, the FASB issued further guidance that generally aligns the principles of fair value measurements with International Financial Reporting Standards. The guidance clarifies the application of existing fair value measurement requirements and expands the disclosure requirements for fair value measurements, and was effective January 1, 2012. The adoption of the guidance had no effect on the Company’s financial position or results of operations.

In June 2011, the FASB issued guidance concerning the presentation of comprehensive income. The guidance gives companies the option to present total comprehensive income, components of net income, and components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. The guidance was effective January 1, 2012 and was applied retrospectively. The adoption of the guidance had no effect on the Company’s financial position or results of operations.

2. CONCENTRATION OF CREDIT RISKS AND OTHER RISKS AND UNCERTAINTIES

The Company is subject to all of the risks and uncertainties inherent in an early-stage company developing and promoting a new approach to DNA sequencing with limited cash and financing capabilities. These risks and uncertainties include, but are not limited to, significant capital requirements, limited management resources, intense competition, development of new technologies, capabilities and services, demand for DNA sequencing services, the need to develop new applications for DNA sequencing services and the changing nature of the DNA sequencing industry. The Company’s operating results may be materially affected by the foregoing factors.

The Company depends on a limited number of suppliers, including sole- and single-source suppliers, of various critical components in the sequencing process. The loss of these suppliers, or their failure to supply the Company with the necessary components in sufficient quantities on a timely basis and without defect, could cause delays in the sequencing process and adversely affect the Company.

The Company primarily derives accounts receivable from direct sales and amounts contractually due, but not received, under contracts. The Company reviews its exposure to accounts receivable and generally requires no collateral for any of its accounts receivable. The allowance for doubtful accounts is the Company’s best estimate of the amount of expected credit losses existing in accounts receivable and is based upon specific customer issues that have been identified. As of June 30, 2012 and December 31, 2011, the Company has $91,000 and $44,000, respectively, recorded as an allowance for doubtful account.

The Company allocates its revenues to individual countries based on the primary locations of its customers.

As of June 30, 2012 and December 31, 2011, customers representing greater than 10% of accounts receivable were as follows:

 

Customer

   June 30,
2012
    December 31,
2011
 

Customer A

     17     16

Customer B

     17     13

Customer C

     11     *   

 

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Table of Contents

For the three and six months ended June 30, 2012 and 2011, customers representing greater than 10% of revenue were as follows:

 

     Three months ended
June 30,
    Six months ended
June 30,
 

Customer

   2012     2011     2012     2011  

Customer A

     15     *        21     *   

Customer B

     24     *        20     *   

Customer C

     *        30     *        14

Customer D

     *        13     *        *   

Customer E

     *        *        *        21

Customer F

     *        *        *        12

 

* Less than 10%

For the three and six months ended June 30, 2012 and 2011, countries representing greater than 10% of revenue were as follows:

 

 

     Three months ended
June 30,
    Six months ended
June 30,
 

Countries

   2012     2011     2012     2011  

United States

     84     70     85     70

United Kingdom

     *        18        *        *   

The Netherlands

     *        *        *        16

 

* Less than 10%

3. NET LOSS PER SHARE

Basic net loss per share is computed by dividing net loss by the weighted-average number of common shares outstanding during the period. The Company’s potential dilutive shares, which include outstanding common stock options, restricted stock units, shares issuable under the employee stock purchase plan and warrants, have not been included in the computation of diluted net loss per share for all periods as the result would be anti-dilutive. Such potentially dilutive shares are excluded when the effect would be to reduce the net loss per share.

The following outstanding shares of potentially dilutive securities were excluded from the computation of diluted net loss per share for the periods presented because including them would have had an anti-dilutive effect:

 

     June 30,  
     2012      2011  

Options to purchase common stock

     4,845,729         4,046,916   

Employee Stock Purchase Plan purchase rights

     286,927         83,562   

Restricted stock units for common stock

     1,223,669         27,500   

Warrants to purchase common stock

     1,533,823         1,533,823   
  

 

 

    

 

 

 

Total

     7,890,148         5,691,801   
  

 

 

    

 

 

 

4. SHORT-TERM INVESTMENTS

Summary of Available-for-Sale Securities

The following table summarizes the Company’s available-for-sale securities (in thousands):

 

     Amortized
cost
     Gross
unrealized
gains
     Gross
unrealized
losses
     Fair
value
 

June 30, 2012

           

Fixed income securities:

           

U.S. government securities

   $ 4,000       $      $      $ 4,000   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total fixed income securities

   $ 4,000       $      $      $ 4,000   
  

 

 

    

 

 

    

 

 

    

 

 

 

December 31, 2011

           

Fixed income securities:

           

U.S. government securities

   $ 6,000       $ —         $ —         $ 6,000   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total fixed income securities

   $ 6,000       $ —         $ —         $ 6,000   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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Table of Contents

5. FAIR VALUE MEASUREMENT

Assets and liabilities recorded at fair value in the financial statements are categorized based upon the level of judgment associated with the inputs used to measure their fair value. Hierarchical levels which are directly related to the amount of subjectivity associated with the inputs to the valuation of these assets or liabilities are as follows:

Level 1: Observable inputs, such as quoted prices in active markets for identical assets or liabilities.

Level 2: Observable inputs, other than Level 1 prices, such as quoted prices for similar assets or liabilities, quoted prices in markets that are not active or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

Level 3: Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.

The following tables set forth the Company’s financial instruments that are measured at fair value on a recurring basis as of June 30, 2012 and December 31, 2011 and by level within the fair value hierarchy. Assets and liabilities measured at fair value are classified in their entirety based on the lowest level of input that is significant to the fair value measurement. The Company’s assessment of the significance of a particular input to the fair value measurement in its entirety requires management to make judgments and consider factors specific to the asset or liability.

As of June 30, 2012, the Company’s fair value hierarchy for its financial assets and financial liabilities that are carried at fair value was as follows:

 

     Level 1      Level 2      Level 3      Total  
     (in thousands)  

Assets

           

Money market funds (included in cash and cash equivalents)

   $ 38,832       $ —        $ —        $ 38,832   

U.S. government securities (included in short-term investments)

   $ —        $ 4,000       $ —        $ 4,000   

As of December 31, 2011, the Company’s fair value hierarchy for its financial assets and financial liabilities that are carried at fair value was as follows:

 

     Level 1      Level 2      Level 3      Total  
     (in thousands)  

Assets

           

Money market funds (included in cash and cash equivalents)

   $ 74,376       $ —         $ —         $ 74,376   

U.S. government securities (included in short-term investments)

   $ —         $ 6,000       $ —         $ 6,000   

Level 2 U.S. government securities are priced using non-binding market consensus prices that are corroborated by observable market data, quoted market prices for similar instruments, or pricing models, such as discounted cash flow techniques. The Company did not have any transfers between Level 1 and Level 2 fair value measurements during the six months ended June 30, 2012.

The Company has determined that its notes payable would be classified as a Level 3 item in the fair value hierarchy. At June 30, 2012, the fair value of the notes payable was approximately $20.5 million compared to the carrying amount of $21.6 million. The Company estimated the fair value of the notes payable based on the cost of capital for comparable public companies that have similar default and credit risks, using a conventional discounted cash flow methodology. Considerable judgment is required in interpreting market data to develop estimates of fair value. The use of different assumptions and/or estimation methodologies may have a material effect on the estimated fair value. For certain financial instruments, including accounts receivable, accounts payable and accrued liabilities, the carrying amounts approximate fair value due to the relatively short maturity of the items.

 

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6. BALANCE SHEET COMPONENTS

Inventory

Inventory consists of the following:

 

     June 30,
2012
     December 31,
2011
 
     (in thousands)  

Raw materials

   $ 2,256       $ 1,617   

Work-in-progress

     4,073         1,923   

Finished goods

     1,299         581   
  

 

 

    

 

 

 
   $ 7,628       $ 4,121   
  

 

 

    

 

 

 

Property and equipment, net

Property and equipment, net, consist of the following:

 

     June 30,
2012
    December 31,
2011
 
     (in thousands)  

Computer equipment

   $ 10,604      $ 10,442   

Computer software

     2,631        2,398   

Furniture and fixtures

     575        586   

Machinery and equipment

     31,551        30,017   

Leasehold improvements

     11,094        10,800   

Equipment under construction

     8,900        3,301   
  

 

 

   

 

 

 
     65,355        57,544   

Less: Accumulated depreciation and amortization

     (31,133     (23,952
  

 

 

   

 

 

 
   $ 34,222      $ 33,592   
  

 

 

   

 

 

 

Depreciation and amortization expense for the three months ended June 30, 2012 and 2011 was $3.6 million and $2.8 million, respectively. Depreciation and amortization expense for the six months ended June 30, 2012 and 2011 was $7.2 million and $5.3 million, respectively. In June 2012, the Company accelerated the amortization of certain leasehold improvements and depreciation of certain furniture and fixtures associated with a leased facility that the Company determined to vacate in July 2012 as part of its restructuring plan announced on June 5, 2012 (see footnote 11). The impact of the accelerated depreciation and amortization related to the vacated facility for the three and six months ended June 30, 2012 was $0.3 million.

Accrued liabilities

Accrued liabilities consist of the following:

 

     June 30,
2012
     December 31,
2011
 
     (in thousands)  

Accrued paid time off

   $ 2,289       $ 1,840   

Accrued compensation and benefits—other

     903         1,909   

Accrued restructuring charges

     874         —     

Deferred rent, current

     840         793   

Other

     900         858   
  

 

 

    

 

 

 
   $ 5,806       $ 5,400   
  

 

 

    

 

 

 

7. COMMITMENTS AND CONTINGENCIES

In October 2007, the Company entered into an agreement for office facilities consisting of approximately 10,560 square feet under an operating lease, which began on January 1, 2008. This agreement, as amended, expires in August 2016.

 

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In October 2008, the Company entered into an agreement for office facilities consisting of approximately 66,096 square feet under an operating lease, which began on March 1, 2009 and expires in August 2016.

In April 2011, the Company entered into an agreement for office facilities consisting of approximately 19,334 square feet under an operating lease, which began on July 15, 2011 and expires in March 2013. In connection with the restructuring plan (see Note 11), the Company determined to vacate these facilities in July 2012.

The Company recognizes rent expense on a straight-line basis over the non-cancellable lease term and records the difference between cash rent payments and the recognition of rent expense as a deferred rent liability. Where leases contain escalation clauses, rent abatements and/or concessions, such as rent holidays and landlord or tenant incentives or allowances, the Company applies them in the determination of straight-line rent expense over the lease term. Rent expense for the three months ended June 30, 2012 and 2011 was $0.7 million and $0.5 million, respectively. For the six months ended June 30, 2012 and 2011 rent expense was $1.3 million and $1.0 million, respectively.

Future minimum lease payments under these non-cancellable operating leases as of June 30, 2012 are as follows:

 

     (in thousands)  

Years ending December 31,

  

2012 (six months remaining)

   $ 1,726   

2013

     3,025   

2014

     2,940   

2015

     3,020   

2016

     2,065   
  

 

 

 

Total future minimum lease payments

   $ 12,776   
  

 

 

 

Term Loans

On December 17, 2010, the Company entered into a loan and security agreement with Atel Ventures, Inc. (“Atel”). On March 25, 2011, the Company entered into a loan and security agreement with Oxford Finance Corporation (“Oxford”).

Atel Loan Agreement

The loan and security agreement with Atel (the “Atel Loan Agreement”) consists of a $6.0 million term loan for equipment purchases. Under the terms of the Atel Loan Agreement, the term loan balance is being repaid in 36 equal monthly payments of principal and interest. Interest accrues on the term loan at a rate of 11.26% per annum. The outstanding borrowings under the term loan are collateralized by a senior priority interest in certain of our current property and equipment, and all property and equipment that was purchased during the term of the Atel Loan Agreement. In connection with entering into the loan and security agreement with Oxford, the Company and Atel made certain administrative and technical amendments to the Atel Loan Agreement.

In connection with the Atel Loan Agreement, the Company issued to Atel a warrant to purchase 49,834 shares of common stock at an exercise price of $7.224 per share. The warrant was exercised in full on June 17, 2011.

The Atel Loan Agreement contains customary representations and warranties, covenants, including closing and advancing conditions, events of defaults and termination provisions. The affirmative covenants include, among other things, that the Company maintains certain cash account balances, and liability and other insurance, and that the Company pledges security interests in any ownership interest of a future subsidiary. The negative covenants preclude the Company from, among other things, disposing of certain assets, engaging in any merger or acquisition, incurring additional indebtedness, encumbering any collateral, paying dividends or making prohibited investments, in each case without the prior consent of Atel, or defaulting under the term loan with Oxford (described below). In February 2012, the Company determined that it violated a covenant in the Atel Loan Agreement because its audited 2011 consolidated financial statements contained an explanatory paragraph regarding substantial doubt about the Company’s ability to continue as a going concern in the opinion on the financial statements from the Company’s independent registered public accounting firm. The Atel Loan Agreement was amended to include, among other things, a waiver for this covenant violation.

Oxford Loan Agreement

The loan and security agreement with Oxford (the “Oxford Loan Agreement”) provides for a term loan of $20.0 million. The outstanding balance of the term loan must be repaid in full by October 1, 2014 (the “Maturity Date”). Under the terms of the Oxford Loan Agreement, the outstanding balance accrues interest at a rate of 9.80% per annum. Until May 1, 2012 (the “Amortization Date”), the Company made monthly payments equal to the accrued interest on the outstanding loan balance. After the Amortization Date and through the Maturity Date the outstanding loan balance will be repaid in thirty (30) equal monthly payments of principal and interest.

 

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As a condition to the Oxford Loan Agreement, a portion of the term loan was used to repay the remaining balance of $7.4 million on the existing term loan agreement with Comerica Bank. Following repayment of the outstanding indebtedness, the Comerica Loan Agreement was terminated. The Oxford Loan Agreement is secured by a senior priority on all of the Company’s assets, excluding its intellectual property and those assets securing borrowings under the Atel loan agreement. In addition, the Company agreed not to pledge its intellectual property to another entity without Oxford’s approval or consent.

In connection with the entry into the Oxford Loan Agreement, the Company issued to Oxford warrants to purchase an aggregate of 160,128 shares of its common stock (the “Warrant Shares”) at an exercise price of $7.495 per share. The warrants expire on the seventh anniversary of the issuance date. The Company also agreed to use best efforts to provide Oxford certain registration rights covering the Warrant Shares.

The Oxford Loan Agreement contains customary representations and warranties, covenants, closing and advancing conditions, events of defaults and termination provisions. The affirmative covenants include, among other things, that the Company timely files taxes, maintain certain operating accounts subject to control agreements in favor of Oxford, maintain liability and other insurance, and pledge security interests in any ownership interest of a future subsidiary. The negative covenants preclude, among other things, disposing of certain assets, engaging in any merger or acquisition, incurring additional indebtedness, encumbering any collateral, paying dividends or making prohibited investments, in each case, without the prior consent of Oxford. The Oxford Loan Agreement provides that an event of default will occur if (1) there is a material adverse change in the Company’s business, operations or condition (financial or otherwise), (2) there is a material impairment in the prospects of the Company repaying any portion of its obligations under the term loan, (3) there is a material impairment in the value of the collateral pledged to secure its obligations under the agreement or in Oxford’s perfection or priority over the collateral, (4) the Company defaults in the payment of any amount payable under the agreement when due, or (5) the Company breaches any negative covenant or certain affirmative covenants in the agreement (subject to a grace period in some cases). The repayment of the term loan is accelerated following the occurrence of an event of default or otherwise, which would require the Company to immediately pay an amount equal to the sum of: (i) all outstanding principal plus accrued but unpaid interest, (ii) the prepayment fee, (iii) the final payment, plus (iv) all other sums, that have become due and payable but have not been paid, including interest at the default rate with respect to any past due amounts. In February 2012, the Company determined that it violated a covenant in the Oxford Loan Agreement because its audited 2011 consolidated financial statements contained an explanatory paragraph regarding substantial doubt about the Company’s ability to continue as a going concern in the opinion on the financial statements from the Company’s independent registered public accounting firm. The Oxford Loan Agreement was amended to include, among other things, a waiver for this covenant violation.

Management believes that based on the current level of operations and anticipated growth, cash and cash equivalents balances and interest income the Company will earn on these balances will not be sufficient to meet the anticipated cash requirements for the six months beyond June 30, 2012. Accordingly, amounts due under the Atel Loan Agreement and the Oxford Loan Agreement have been reclassified to notes payable, current.

Future contractual loan payments under the Oxford and Atel loan agreements as of June 30, 2012 are as follows:

 

     (in thousands)  

Years ending December 31,

  

2012 (six months remaining)

   $ 5,894   

2013

     11,202   

2014

     8,295   
  

 

 

 

Total payments

     25,391   

Less:

  

Cash interest payment and balloon payment accretion

     3,058   

Unamortized portion of value of warrants issued in connection with Atel and Oxford loans

     725   
  

 

 

 

Total principal payments - notes payable

   $ 21,608   
  

 

 

 

Contingencies

The Company is subject to claims and assessments from time to time in the ordinary course of business. The Company’s management does not believe that any such matters, individually or in the aggregate, will have a material adverse effect on the Company’s business, financial condition, results of operations or cash flows.

 

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Indemnification

In the normal course of business, the Company enters into contracts and agreements that contain a variety of representations and warranties and provide for general indemnifications. The Company’s exposure under these agreements is unknown because it involves claims that may be made against the Company in the future, but that have not yet been made. To date, the Company has not paid any claims or been required to defend any action related to its indemnification obligations. However, the Company may record charges in the future as a result of these indemnification obligations.

In accordance with its Certificate of Incorporation and Bylaws, as well as Indemnification Agreements, the Company has indemnification obligations to its officers and directors for certain events or occurrences, subject to certain limits, while they are serving at the Company’s request in such capacity. There have been no claims to date, and the Company has director and officer insurance that enables it to recover a portion of certain amounts paid for future potential claims.

Legal Proceedings

On August 3, 2010, a patent infringement lawsuit was filed by Illumina, Inc. and Solexa, Inc. (an entity acquired by Illumina), or the plaintiffs, against the Company, in the U.S. District Court for Delaware. The U.S. District Court in Delaware subsequently granted the Company’s motion to transfer the case to the U.S. District Court for the Northern District of California. The case caption is Illumina, Inc. and Solexa, Inc. v. Complete Genomics, Inc., Civil Action No. 3:10-cv-05542. The complaint alleges that Complete Genomics’ Analysis Platform, and in particular the combinatorial probe anchor ligation technology, infringes upon three patents held by Illumina and Solexa. The plaintiffs seek unspecified monetary damages and injunctive relief. On September 23, 2010, the Company filed an answer to the complaint as well as its counterclaims against the plaintiffs. On May 5, 2011, the Court entered a stipulated order to dismiss two patents from the lawsuit. The dismissal is without prejudice but includes conditions on the plaintiffs’ ability to file lawsuits on these patents, including a limitation that the plaintiffs may not re-file such lawsuits against the Company until the later of (1) August 1, 2012, or (2) the exhaustion of all appeal rights in both (a) the pending reexaminations in the U.S. Patent and Trademark Office and (b) the pending civil litigation in which these patents are also asserted, Life Technologies Corp. v. Illumina, Case No. 3:11-cv-00703 (S.D. Cal.). The Company believes that it has substantial and meritorious defenses to the plaintiffs’ claims and intends to vigorously defend its position. However, if the Company is found to infringe one or more valid claims of a patent-in-suit and if the Court grants an injunction, the Company may be forced to redesign portions of its sequencing process, seek a license, cease the infringing activity and/or pay monetary damages. A negative outcome in this matter could therefore have a material adverse effect on the Company’s financial position, results of operations, cash flows and business. In addition, the Company has incurred and anticipates that it will continue to incur significant expense and invest substantial time in defending against these claims. The Company is not currently able to estimate the potential loss, if any, that may result from this litigation.

On June 15, 2012, a second patent infringement lawsuit was filed by Illumina, Inc. and Illumina Cambridge Ltd. (a subsidiary of Illumina), or the plaintiffs, against the Company, in the U.S. District Court for the Southern District of California. The case caption is Illumina, Inc. and Illumina Cambridge Ltd. v. Complete Genomics, Inc., Civil Action No. ‘12CV1465 AJB BGS. The complaint alleges that Complete Genomics’ Analysis Platform infringes upon one patent held by Illumina. The plaintiffs seek unspecified monetary damages (including treble damages) and injunctive relief. On July 9, 2012, the Company filed an answer to the complaint as well as its counterclaims against the plaintiffs. The Company believes that it has substantial and meritorious defenses to the plaintiffs’ claims and intends to vigorously defend its position. However, if the Company is found to infringe one or more valid claims of the patent-in-suit and if the Court grants an injunction, the Company may be forced to redesign portions of its sequencing process, seek a license, cease the infringing activity and/or pay monetary damages. A negative outcome in this matter could therefore have a material adverse effect on the Company’s financial position, results of operations, cash flows and business. In addition, the Company anticipates that it will incur significant expense and invest substantial time in defending against these claims. The Company is not currently able to estimate the potential loss, if any, that may result from this litigation.

From time to time, the Company may become involved in other legal proceedings and claims arising in the ordinary course of its business. Other than as described above, the Company is not currently a party to any legal proceedings the outcome of which, if determined adversely to the Company, would individually or in the aggregate has a material adverse effect on its financial position, results of operations, cash flows or business.

8. COMMON STOCK

On March 8, 2012, the Company entered into an At Market Issuance Sales Agreement (the “ATM Agreement”) with MLV & Co. LLC (“MLV”), which provides that, upon the terms and subject to the conditions and limitations set forth therein, the Company may sell from time to time, at its option, shares of its common stock through MLV, as its sales agent. On March 12, 2012, the Company filed a prospectus supplement with the Securities and Exchange Commission to its currently effective Registration Statement on Form S-3 (File No. 333- 178728) with respect to the sale of up to an aggregate of $30.0 million of the Company’s common stock through MLV pursuant to the ATM Agreement. The Company is required to pay MLV a commission of up to 3% of the gross proceeds from the sale of shares of its common stock pursuant to the ATM Agreement and provide MLV with customary indemnification rights. As of June 30, 2012, the Company had received proceeds of $1.2 million from the sale of an aggregate of 398,047 shares of common stock through MLV and had $28.8 million of its common stock remaining available to issue and sell under its current prospectus supplement relating to the ATM Agreement.

 

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9. WARRANTS FOR COMMON STOCK

In March 2011, the Company issued a warrant to purchase 160,128 shares of common stock at an exercise price of $7.495 per share in connection with the Oxford Loan Agreement. The warrant expires on the seventh anniversary of its issuance date. The initial fair value of the warrant was calculated using the Black-Scholes option pricing model with the following assumptions: seven year contractual term; 75.01% volatility; 0% dividend rate; and a risk-free interest rate of 2.87%. The fair value of the warrant was determined to be $1.0 million and was recorded as equity in additional paid-in capital and a discount to the carrying value of the loan. All of the warrants remain outstanding at June 30, 2012. The discount is being amortized to interest expense using the effective interest rate method over the 42-month term of the loan.

In December 2010, the Company issued a warrant to purchase 49,834 shares of common stock at an exercise price of $7.224 per share in connection with the Atel Loan Agreement. The warrant expires on the tenth anniversary of its issuance date. The initial fair value of the warrant was calculated using the Black-Scholes option pricing model with the following assumptions: 10 year contractual term; 76.2% volatility; 0% dividend rate; and a risk-free interest rate of 3.33%. The fair value of the warrant was determined to be $0.3 million and was recorded as a liability and a discount to the carrying value of the loan. The fair value of the warrant was recorded as a liability due to certain mandatory redemption features at the option of the holder. The discount was being amortized to interest expense using the effective interest rate method over the three-year term of the loan. These warrants were marked to market each reporting period until they were exercised. The final mark to market revaluation of the warrants occurred on June 17, 2011, the date the warrants were exercised.

10. STOCK-BASED COMPENSATION

Stock-based Compensation Plans

The number of shares reserved for issuance under the 2010 Equity Incentive Award Plan (the “2010 Plan”) and the Employee Stock Purchase Plan (the “ESPP”) increased by 1,300,000 shares and 668,192 shares, respectively, effective January 1, 2012. As of June 30, 2012, there were 1,572,806 and 1,400,308 shares available to be granted under the 2010 Plan and the ESPP, respectively.

Compensation Expense

During the three and six months ended June 30, 2012 and 2011, the Company granted stock options to purchase common stock and restricted stock units as follows:

 

     Three months ended June 30,      Six months ended June 30,  
     2012      2011      2012      2011  
     (in thousands, except share and per share amounts)  

Number of options granted to non-employees

     4,000                 4,000           

Number of options granted to employees

     1,437,103         1,443,300         1,504,078         1,547,000   

Weighted-average grant date fair value per share of options granted to employees

   $ 2.05       $ 7.62       $ 2.05       $ 7.44   

Total fair value of options granted to employees which vested

   $ 1,540       $ 658       $ 2,455       $ 993   

Number of restricted stock units granted to employees

     1,220,000                 1,220,000           

Weighted-average grant date fair value per share of restricted stock units

   $ 2.07       $       $ 2.07       $   

 

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The following table summarizes stock-based compensation expense from stock option and restricted stock unit awards to employees, directors and nonemployees as well as from employee purchase rights under the ESPP for the three and six months ended June 30, 2012 and 2011:

 

     Three months ended June 30,      Six months ended June 30,  
     2012      2011      2012      2011  
     (in thousands)  

Employee awards

   $ 1,621       $ 1,044       $ 2,995       $ 1,517   

Nonemployee awards

     2         29         5         50   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total stock-based compensation expense

   $ 1,623       $ 1,073       $ 3,000       $ 1,567   
  

 

 

    

 

 

    

 

 

    

 

 

 

As of June 30, 2012, the Company had unrecognized stock-based compensation expense related to unvested stock options and restricted stock units of $12.7 million, which is expected to be recognized over the remaining weighted-average vesting period of 2.6 years.

11. RESTRUCTURING CHARGES

On June 5, 2012, the Company announced a restructuring plan (the “Q2 2012 Plan”) to reduce employee headcount and defer capital expenditures in an effort to reduce cash consumption. The Company notified approximately 55 employees of their involuntary termination. As a result of the restructuring plan, the Company recorded a restructuring charge of $1.5 million for the three and six months ended June 30, 2012. The restructuring charge is comprised of $1.4 million in employee severance benefits and $0.1 million related to contract cancellation charges and cancelled marketing program costs. As a result of the Q2 2012 Plan to defer capital expenditures, the Company reassessed the estimated useful lives of its sequencing equipment and determined that the equipment would be used until December 2017. This change in estimate was applied prospectively from the date of the assessment. Depreciation expense for the three and six months ended June 30, 2012 was reduced by $0.3 million, consisting of a $0.2 million decrease in cost of revenues for the three and six months ended June 30, 2012 and a $0.1 million decrease in inventory as of June 30, 2012.

As of June 30, 2012, the activity and liability balances related to the restructuring charge are as follows:

 

     Severance-
related
charges
    Other     Total  
     (in thousands)  

Q2 2012 Plan

   $ 1,391      $ 105      $ 1,496   

Cash payments

     (552     —          (552

Non-cash charges

     —          (70     (70
  

 

 

   

 

 

   

 

 

 

Liability as of June 30, 2012

   $ 839      $ 35      $ 874   
  

 

 

   

 

 

   

 

 

 

At June 30, 2012, the remaining restructuring liability was included in accrued liabilities in the Condensed Consolidated Balance Sheet. The Company expects the remaining restructuring liability to be substantially paid by the end of 2012.

Also in connection with the Q2 2012 Plan, the Company determined to vacate one of its leased buildings in July 2012 (the lease for which will expire in March 2013). The Company will measure and accrue future facilities exit costs at fair value upon its exit and record the amount as a restructuring charge in the third quarter of 2012. The amount of the restructuring charge is anticipated to be approximately $0.6 million and will be substantially paid by the first quarter of 2013. These facilities exit costs will consist primarily of remaining contractual obligations under the lease agreement and operating and maintenance expenses incurred after vacating the facility.

 

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), which are subject to the “safe harbor” created by those sections. Forward-looking statements are based on our management’s beliefs and assumptions and on information currently available to our management. All statements other than statements of historical factors are “forward-looking statements” for purposes of these provisions. In some cases you can identify forward-looking statements by terms such as “may,” “will,” “should,” “could,” “would,” “expect,” “plan,” “anticipate,” “believe,” “estimate,” “project,” “predict,” and “potential,” and similar expressions intended to identify forward-looking statements. Such forward-looking statements are subject to risks, uncertainties and other important factors that could cause actual results and the timing of certain events to differ materially from future results expressed or implied by such forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those identified below, and those discussed in the section titled “Risk Factors” in this report. Furthermore, such forward-looking statements speak only as of the date of this report. Except as required by law, we undertake no obligation to update any forward-looking statements to reflect events or circumstances after the date of such statements.

Overview

We are a life sciences company that has developed and commercialized a DNA sequencing platform for whole human genome sequencing and analysis. Our goal is to become the preferred solution for whole human genome sequencing and analysis. Our Complete Genomics Analysis Platform, or CGA Platform, combines our proprietary human genome sequencing technology with our advanced informatics and data management software and our innovative, end-to-end, outsourced service model to provide our customers with data that is immediately ready to be used for genome-based research. We believe that our solution can provide academic, biopharmaceutical, and translational medicine researchers with whole human genome data and analysis at an unprecedented combination of quality, cost and scale without requiring them to invest in in-house sequencing instruments, high-performance computing resources and specialized personnel. By removing these constraints and broadly enabling researchers to conduct large-scale complete human genome studies, we believe that our solution has the potential to advance medical research and expand understanding of the basis, treatment and prevention of complex diseases.

We have targeted our complete human genome sequencing service at academic, governmental and other research institutions, as well as biopharmaceutical and healthcare organizations. In the DNA sequencing industry, whole human genome sequencing is generally deemed to be coverage of at least 90% of the nucleotides in the genome. We perform our sequencing service at our Mountain View, California headquarters facility, which began commercial operation in May 2010. In the near term, we expect to use our available capital to fund our research and development initiatives, obtain CLIA certification to supply sequenced genomes to clinical customers, and eventually grow our sales and marketing and general and administrative organization and expand our sequencing capacity to support our commercial operations and anticipated growth. In future years, we may construct additional genome sequencing centers in the United States and in other locations to accommodate an expected growing, global demand for high-quality, low-cost whole human genome sequencing on a large scale.

Our ability to generate revenue, and the timing of our revenue, will depend on generating new orders and contracts, receiving qualified DNA samples from customers and the rate at which we can convert our backlog of sequencing orders into completed and delivered data and the price per genome contracted with the customer. We define backlog as the number of genomes for which customers have placed orders or entered into contracts with volume estimates that we believe are firm and for which no revenue has yet been recorded. As of June 30, 2012, we had a backlog of orders for sequencing approximately 4,600 genomes, which we believe could contribute approximately $22.0 million toward revenue over the next 12 months. The speed with which we can convert orders into revenue depends principally on:

 

   

the speed with which our customers provide us with qualified samples after submitting an order;

 

   

the rate at which our system can sequence a genome; and

 

   

the rate at which all significant contractual obligations are fulfilled.

Changes in these variables (or orders cancellations or reductions) will cause our results of operations to fluctuate, perhaps significantly. We also have a very limited history to guide us in predicting variables like equipment and/or operating failure, throughput yield, customer delivery of qualified genomic samples and other factors that could affect revenue.

Although we do not anticipate any material seasonal effects, given our limited operating history as a revenue generating company, our sales cycle is uncertain. A limited number of customers accounted for all of the revenue we recognized for the six months ended June 30, 2012, with Inova Translational Medicine Institute and SAIC-Frederick, Inc., National Cancer Institute accounting for approximately 21% and 20% of this revenue, respectively. The loss of one or more of the customers named above could have a material adverse effect on our future results of operations.

We have not been profitable in any period since we were formed. We incurred net losses of $18.8 million and $16.0 million for the three months ended June 30, 2012 and 2011, respectively. Also, we incurred net losses of $39.1 million and $28.4 million for the six

 

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months ended June 30, 2012 and 2011, respectively. As of June 30, 2012, our accumulated deficit was $250.3 million. We believe that, based on our current level of operations and anticipated growth, our cash and cash equivalents balances and interest income we earn on these balances will not be sufficient to meet our anticipated cash requirements for the six months beyond June 30, 2012. Our recurring operating losses and negative cash flow from operations and our requirement for additional funding to execute our business objectives beyond this period gives rise to substantial doubt as to our ability to continue as a going concern.

The Company announced on June 5, 2012 that it has engaged Jefferies & Company, Inc. to act as financial advisor to the Company and to assist in its review of strategic alternatives, which could include a merger, business combination, equity investment or sale of the Company. There can be no assurance that the Company will be successful in executing on any of these possible strategic alternatives. If the Company is unable to execute on one of these possible strategic alternatives or otherwise raise additional financing on a timely basis, it will need to significantly scale back or discontinue operations.

On June 5, 2012, we also announced a restructuring plan to reduce headcount and defer capital expenditures in an effort to reduce cash consumption. We notified approximately 55 employees of their involuntary termination. As a result of the restructuring plan, we recorded a restructuring charge of $1.5 million for the three and six months ended June 30, 2012. The restructuring charge is comprised of $1.4 million in employee severance benefits and $0.1 million related to contract cancellation charges and cancelled marketing program costs. These amounts are being funded by our available working capital. As a result of the reductions in headcount, we expect to realize approximately $7.0 million of annualized savings.

As a result of the plan to defer capital expenditures, we reassessed the estimated useful lives of our sequencing equipment and determined that the equipment would be used until December 2017. This change in estimate was applied prospectively from the date of the assessment. Depreciation expense for the three and six months ended June 30, 2012 was reduced by $0.3 million, consisting of a $0.2 million decrease in cost of revenues for the three and six months ended June 30, 2012 and a $0.1 million decrease in inventory as of June 30, 2012.

We announced in connection with this restructuring plan that we would focus on development of clinical applications for our whole human genome sequencing service, while continuing to provide high-quality genomes to research customers. We will maintain our current monthly manufacturing capacity of approximately 1,000 genomes at 40x coverage or 500 genomes at 80x coverage and delay capacity expansion until demand for clinical-grade genomes supports expansion. The delay in expanding capacity will defer capital expenditures.

Also in connection with this restructuring plan, we determined to vacate one of our leased buildings in July 2012 (the lease for which will expire in March 2013). We will measure and accrue future facilities exit costs at fair value upon exit and record the amount as a restructuring charge in the third quarter of 2012. The amount of the restructuring charge is anticipated to be approximately $0.6 million and will be substantially paid by the first quarter of 2013. These facilities exit costs will primarily consist of remaining contractual obligations under the lease agreement and operating and maintenance expenses incurred after vacating the facility.

Critical Accounting Policies and Estimates

Our management’s discussion and analysis of our financial condition and results of operations are based on our unaudited condensed consolidated financial statements that have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of our financial statements requires our management to make estimates, assumptions and judgments that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the applicable periods. Management bases its estimates, assumptions and judgments on historical experience and on various other factors that it believes to be reasonable under the circumstances. Different assumptions and judgments would change the estimates used in the preparation of our financial statements, which, in turn, could materially change the results from those reported. Our management evaluates its estimates, assumptions and judgments on an ongoing basis. Historically, our critical accounting estimates have not differed materially from actual results. However, if our assumptions change, we may need to revise our estimates, or take other corrective actions, either of which may also have a material adverse effect on our statements of operations, liquidity and financial condition.

Management determined that the decision to defer capital expenditures as part of the restructuring plan announced on June 5, 2012 (see Note 11) was a change in circumstances that required an evaluation of the recoverability of the Company’s property and equipment and patent (intellectual property). Therefore, management performed an evaluation of the recoverability of the Company’s property and equipment and patent (intellectual property) by comparing the carrying value of these assets to the projected, undiscounted cash flows generated by these assets over the estimated remaining useful life of these assets. Management determined that the Company’s property and equipment and patent (intellectual property) were not impaired at June 30, 2012, as the projected undiscounted cash flows exceed the carrying value. However, management cannot assure that the property and equipment and patent (intellectual property) will remain recoverable in the future.

The following accounting policy was adopted during the three months ended June 30, 2012, in addition to the critical accounting policies described in “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Critical Accounting Policies and Estimates” in our Annual Report on Form 10-K for the year ended December 31, 2011:

Restructuring Charges – We measure and accrue contractual liabilities associated with employee separation costs at fair value as of the date the restructuring plan is announced and terminations are communicated to employees. The fair value measurement of restructuring related liabilities requires certain assumptions and estimates to be made by us. It is our policy to use the best estimates based on facts and circumstances available at the time of measurement, review the assumptions and estimates periodically, and adjust the liabilities when necessary.

 

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Recent Adopted Accounting Standards

In May 2011, the FASB issued further guidance that generally aligns the principles of fair value measurements with International Financial Reporting Standards. The guidance clarifies the application of existing fair value measurement requirements and expands the disclosure requirements for fair value measurements, and was effective January 1, 2012. The adoption of the guidance had no effect on our financial position or results of operations.

In June 2011, the FASB issued guidance concerning the presentation of comprehensive income. The guidance gives companies the option to present total comprehensive income, components of net income, and components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. The guidance was effective January 1, 2012 and was applied retrospectively. The adoption of the guidance had no effect on our financial position or results of operations.

Results of Operations

Comparison of Three Months Ended June 30, 2012 and 2011

The following table shows the amounts of the listed items from our statements of operations for the periods presented, showing period-over-period changes (in thousands, except for percentages).

 

     Three months ended
June 30,
       
     2012     2011     $ Change     % Change  
                 (unaudited)        

Revenue

   $ 8,693      $ 5,865      $ 2,828        48

Cost and expenses:

        

Cost of revenue

     8,122        6,122        2,000        33

Research and development

     8,946        8,028        918        11

Sales and marketing

     4,642        3,138        1,504        48

General and administrative

     3,581        3,468        113        3

Restructuring charges

     1,496        —          1,496        *   
  

 

 

   

 

 

   

 

 

   

Total costs and expenses

     26,787        20,756        6,031        29
  

 

 

   

 

 

   

 

 

   

Loss from operations

     (18,094     (14,891     (3,203     22

Interest expense

     (735     (810     75        (9 )% 

Interest and other income (expense), net

     2        (258     260        (101 )% 
  

 

 

   

 

 

   

 

 

   

Net loss

   $ (18,827   $ (15,959   $ (2,868     18
  

 

 

   

 

 

   

 

 

   

 

* Increase meaningless

Revenue

During the three months ended June 30, 2012, revenue was $8.7 million, compared to $5.9 million during the same period in 2011, an increase of 48%. We recognized revenue for over 2,100 genomes in the three months ended June 30, 2012, compared to over 900 during the same period in 2011, a 133% increase. The increase in our revenue resulted from the significant increase in the number of genomes for which revenue was recognized, offset by the decrease in the average selling price per genome.

During the second quarter of 2011, the average selling price per genome for revenue recognized was approximately $6,000, compared to approximately $4,000 during the second quarter of 2012. This decrease in price per genome was driven both by competitive pricing pressures from alternatives to whole genome sequencing, such as exome sequencing, as well as price competition from other suppliers of whole human genome sequencing services. We expect this price pressure to continue for the foreseeable future.

Cost of Revenue

During the three months ended June 30, 2012, cost of revenue was $8.1 million, compared to $6.1 million during the same period in 2011, a 33% increase. The modest increase in cost of revenue was achieved while recognizing revenue for approximately 133% more genomes than the same period last year. The increase in cost of revenue was primarily a result of the increase in the number of genomes for which revenue was recognized, offset by efficiencies gained in our sequencing processes and increases in our laboratory capacity utilization while maintaining similar fixed costs. During the second quarter of 2011, the average cost per genome for revenue recognized was approximately $6,500, compared to approximately $4,000 during the second quarter of 2012.

 

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Cost of revenue as a percent of revenue was 93% in the second quarter of 2012, compared to 104% in the second quarter of 2011. This decrease in cost of revenue as a percent of revenue was due to improvements in our manufacturing process, offset by the decline in average selling prices. We anticipate that these costs as a percentage of revenue will fluctuate as our capacity utilization changes, as the sequencing prices we charge to our customers change and as we continue to improve and automate our sequencing processes.

Research and Development

Research and development expenses were $8.9 million during the three months ended June 30, 2012, compared to $8.0 million during the three months ended June 30, 2011, representing an increase of $0.9 million, or 11%. The increase in research and development expenses was primarily due to an increase in salaries and benefits expense of $0.7 million primarily resulting from increased employee headcount, a $0.3 million reduction in amounts capitalized for internal-use software, a $0.2 million increase in facilities expenses, a $0.2 million increase in depreciation expense and a $0.2 million increase in stock-based compensation expense. The overall increase in research and development expenses was partially offset by a decrease in development material expenses of $0.6 million.

We expect to continue to invest in research and development activities as we seek to enhance our sequencing processes, components and systems to improve the yield and throughput, to reduce the cost of our sequencing service and to commercialize new technologies that will lower costs and increase accuracy of our sequencing services. However, as result of our restructuring activities in June 2012, we believe that in the near future, our research and development expenses will decrease.

Sales and Marketing

Sales and marketing expenses were $4.6 million during the three months ended June 30, 2012, compared to $3.1 million during the three months ended June 30, 2011, representing an increase of $1.5 million, or 48%. The increase in sales and marketing expenses was due primarily to an increase in employee salaries and benefits expense of $0.9 million resulting from increased headcount, expenses incurred of $0.5 million for genome sequencing services performed for marketing purposes during the second quarter of 2012, and a $0.2 million increase in stock-based compensation expense. The overall increase in sales and marketing expenses was partially offset by a decrease in consulting expense of $0.1 million.

General and Administrative

General and administrative expenses were $3.6 million for the three months ended June 30, 2012, compared to $3.5 million for the three months ended June 30, 2011, representing an increase of $0.1 million, or 3%. The increase in general and administrative expenses was primarily due to a $0.1 million increase in stock-based compensation and a $0.2 million increase in facilities expenses, partially offset by a $0.1 million decrease in recruiting fees.

Restructuring Charges

On June 5, 2012, we announced a restructuring plan to reduce employee headcount and defer capital expenditures in an effort to reduce cash consumption. We notified approximately 55 employees of their involuntary termination. As a result of the restructuring plan, we recorded a restructuring charge of $1.5 million for the three months ended June 30, 2012. The restructuring charge was comprised of $1.4 million in employee severance benefits and $0.1 million related to contract cancellation charges and cancelled marketing programs. The Company expects the remaining restructuring charges in the amount of $0.9 million to be substantially paid by the end of 2012.

Interest Expense

During the three months ended June 30, 2012, we incurred interest expense of $0.7 million compared to $0.8 million during the three months ended June 30, 2011. The decrease in interest expense between the two periods was primarily due to lower debt balances related to our loans.

Interest and Other Income (Expense), Net

Interest and other income (expense), net, for the three months ended June 30, 2012 was income of $2,000 compared to expense of $0.3 million for the three months ended June 30, 2011. The change between the two periods was primarily due to the change in the valuation of our warrant liability in the second quarter of 2011. The final mark to market revaluation of the warrants occurred on June 17, 2011, the date the warrants were exercised.

 

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Comparison of Six Months Ended June 30, 2012 and 2011

The following table shows the amounts of the listed items from our statements of operations for the periods presented, showing period-over-period changes (in thousands, except for percentages).

 

     Six months ended
June 30,
       
     2012     2011     $ Change     % Change  
                 (unaudited)        

Revenue

   $ 12,601      $ 12,698      $ (97     (1 )% 

Cost and expenses:

        

Cost of revenue

     13,420        12,704        716        6

Research and development

     17,639        14,836        2,803        19

Sales and marketing

     9,895        5,838        4,057        69

General and administrative

     7,717        6,248        1,469        24

Restructuring charges

     1,496        —          1,496        *   
  

 

 

   

 

 

   

 

 

   

Total costs and expenses

     50,167        39,626        10,541        27
  

 

 

   

 

 

   

 

 

   

Loss from operations

     (37,566     (26,928     (10,638     40

Interest expense

     (1,499     (1,150     (349     30

Interest and other income (expense), net

     6        (341     347        (102 )% 
  

 

 

   

 

 

   

 

 

   

Net loss

   $ (39,059   $ (28,419   $ (10,640     37
  

 

 

   

 

 

   

 

 

   

 

* Increase meaningless

Revenue

During the six months ended June 30, 2012, revenue was $12.6 million, compared to $12.7 million during the same period in 2011, a 1% decrease. We recognized revenue for approximately 3,000 genomes during the six months ended June 30, 2012, compared to approximately 1,600 genomes during the same period in 2011, an increase of 88%. The significant increase in the number of genomes for which revenue was recognized during the six months ended June 30, 2012 was more than offset by the decrease in the average selling price per genome.

During the first six months of 2011, the average selling price per genome for revenue recognized was approximately $8,000, compared to approximately $4,000 during the first six months of 2012. This decrease in price per genome was driven both by competitive pricing pressures from alternatives to whole genome sequencing, such as exome sequencing, as well as price competition from other suppliers of whole human genome sequencing services. We expect this price pressure to continue for the foreseeable future.

Cost of Revenue

During the six months ended June 30, 2012, cost of revenue was $13.4 million compared to $12.7 million during the same period in 2011, an increase of 6%. The slight increase in cost of revenue was achieved while shipping genomic data for approximately 88% more genomes than the same period last year. This increase in cost of revenue was primarily a result of the increase in the number of genomes for which revenue was recognized, offset by efficiencies gained in our sequencing processes and increases in our laboratory capacity utilization while maintaining similar fixed costs. During the first six months of 2011, the average cost per genome for revenue recognized was approximately $8,000, compared to approximately $4,500 during the first six months of 2012.

Cost of revenue as a percent of revenue increased to 106% in the first six months of 2012, compared to 100% in the first six months of 2011. This increase in cost of revenue as a percent of revenue was due to the decline in our average selling prices, outpacing the decline in our average unit costs. We anticipate that these costs as a percentage of revenue will fluctuate as our capacity utilization changes, as the sequencing prices we charge to our customers change and as we continue to improve and automate our sequencing processes.

Research and Development

Research and development expenses were $17.6 million during the six months ended June 30, 2012 compared to $14.8 million during the six months ended June 30, 2011, representing an increase of $2.8 million, or 19%. The increase in research and development expenses was primarily due to a $1.7 million increase in salaries and benefits expense resulting from increased headcount, a $0.5 million increase in facilities expenses, a $0.5 million increase in stock-based compensation expense, a $0.3 million increase in depreciation expense, a $0.3 million increase in development materials, and a $0.2 million increase in consulting expense. The increase in research and development expenses was partially offset by a $0.6 million decrease in non-revenue genomic services.

 

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We expect to continue to invest in research and development activities as we seek to enhance our sequencing processes, components and systems to improve the yield and throughput and to reduce the cost of our sequencing service. However, we believe that in the near future, our research and development expenses will decrease as a result of our restructuring plan executed in June 2012.

Sales and Marketing

Sales and marketing expenses were $9.9 million during the six months ended June 30, 2012 compared to $5.8 million during the six months ended June 30, 2011, representing an increase of $4.1 million, or 70%. The increase in sales and marketing expenses was due primarily to a $2.0 million increase in employee salaries and benefits expense due to increased headcount, $1.2 million for genome sequencing service expenses performed for marketing purposes, a $0.4 million increase in stock-based compensation expense, and a $0.2 million increase in both facilities expenses and travel expenses.

General and Administrative

General and administrative expenses were $7.7 million for the six months ended June 30, 2012 compared to $6.2 million for the six months ended June 30, 2011, representing an increase of $1.5 million, or 24%. The increase in general and administrative expenses was primarily due to an increase in employee salaries and benefits of $0.3 million due to increased headcount, a $0.4 million increase in legal expenses due to the pending litigation against Illumina, Inc., a $0.3 million increase in stock based compensation, a $0.3 million increase in facilities expenses, and a $0.1 million increase in our allowance for doubtful accounts.

Restructuring Charges

On June 5, 2012, we announced a restructuring plan to reduce employee headcount and defer capital expenditures in an effort to reduce cash consumption. We notified approximately 55 employees of their involuntary termination. As a result of the restructuring plan, we recorded a restructuring charge of $1.5 million for the six months ended June 30, 2012. The restructuring charge was comprised of $1.4 million in employee severance benefits and $0.1 million related to contract cancellation charges and cancelled marketing program costs. The Company expects the remaining restructuring charges in the amount of $0.9 million to be substantially paid by the end of 2012.

Interest Expense

During the six months ended June 30, 2012, we incurred interest expense of $1.5 million compared to $1.2 million during the six months ended June 30, 2011. The increase in interest expense was primarily due to higher debt balances outstanding during the first six months of 2012 when compared to the same period in 2011.

Interest and Other Income (Expense), Net

Interest and other income (expense), net, for the six months ended June 30, 2012 was an income of $6,000 compared to expense of $341,000 for the six months ended June 30, 2011. The change between the two periods was primarily due to the change in the valuation of our warrant liability in the first half of 2011. The final mark to market revaluation of the warrants occurred on June 17, 2011, the date the warrants were exercised.

Liquidity and Capital Resources

Since our inception, we have generated operating losses in every quarter, resulting in an accumulated deficit of $250.3 million as of June 30, 2012. We have financed our operations to date primarily through private placements of preferred stock and promissory notes, borrowings under our credit facilities, proceeds from our initial public offering, follow-on public offerings and term debt. As of June 30, 2012, we had working capital of $16.1 million, consisting of $59.8 million in current assets and $43.7 million in current liabilities. As of December 31, 2011, we had working capital of $67.3 million, consisting of $95.2 million in current assets and $27.9 million in current liabilities. Cash in excess of immediate operating requirements is invested primarily in money market funds and short-term investments in accordance with our investment policy, primarily with the goals of capital preservation and liquidity maintenance.

We believe that, based on our current level of operations and anticipated growth, our cash and cash equivalent and short-term investment balances, including interest income we earn on those balances, will not be sufficient to meet our anticipated cash requirements for the six months beyond June 30, 2012. The report of our independent registered public accounting firm on our consolidated financial statements for the year ended December 31, 2011 includes an explanatory paragraph stating that our recurring losses from operations and significant negative cash flow from operations raise substantial doubt on our ability to continue as a going concern. If we fail to raise additional capital in sufficient amounts and in a timely manner, we will be unable to operate our business as it is currently operated to December 31, 2012.

On June 5, 2012 we announced that we have engaged Jefferies & Company, Inc. to act as financial advisor to the Company and to assist in our review of strategic alternatives, which could include a merger, business combination, equity investment or sale of the Company. There can be no assurance that we will be successful in executing on any of these possible strategic alternatives. If we are unable to execute on one of these possible strategic alternatives or otherwise raise additional financing on a timely basis, we will need to significantly scale back or discontinue operations.

 

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Cash Flows for the Six Months Ended June 30, 2012 and 2011

The following table summarizes our cash flows for the six months ended June 30, 2012 and 2011.

 

     Six months ended
June 30,
 
     2012     2011  
     (in thousands)  

Net cash used in operating activities

   $ (32,203   $ (20,202

Net cash used in investing activities

     (5,443     (51,729

Net cash (used in) provided by financing activities

     (170     85,770   
  

 

 

   

 

 

 

Net (decrease) increase in cash and cash equivalents

   $ (37,816   $ 13,839   
  

 

 

   

 

 

 

Operating Activities

Net cash used in operating activities was $32.2 million during the six months ended June 30, 2012 and consisted of a net loss of $39.1 million and a net increase in operating assets and liabilities of $4.1 million, offset by noncash items of $11.0 million. Noncash items for the six months ended June 30, 2012 consisted primarily of the noncash interest expense related to notes payable of $0.5 million, depreciation expense of $7.2 million, a change in inventory reserves of $0.2 million and stock-based compensation expense of $3.0 million. The significant items impacting the net increase in operating assets and liabilities include increases in accounts receivable, inventory and prepaid expenses of $0.7 million, $3.7 million and $0.5 million, respectively, and decreases in deferred rent and deferred revenue of $0.4 million and $0.2 million, respectively. The net increase in operating assets and liabilities was partially offset by increases in accounts payable and accrued liabilities of $0.7 million and $0.3 million, respectively. The increase in accounts receivable and decrease in deferred revenue were due to increased revenue recognized during the second quarter of 2012. The increase in inventory was due to increased purchases of inventory to support orders in backlog and the increase in accounts payable was primarily due to the timing of receipts and payments for inventory and expenses at the end of the quarter.

Net cash used in operating activities was $20.2 million during the six months ended June 30, 2011 and consisted of a net loss of $28.4 million, offset by noncash items of $7.4 million and a net change in operating assets and liabilities of $0.8 million. Noncash items for the six months ended June 30, 2011 consisted primarily of the change in the fair value of our warrant liability of $0.4 million, depreciation expense of $5.3 million and stock-based compensation expense of $1.6 million. The significant items in the change in operating assets and liabilities include an increase in accounts payable of $1.0 million, an increase in accrued liabilities of $1.6 million and an increase in deferred revenue of $1.3 million, partially offset by an increase in accounts receivable of $2.3 million. The increases in accounts receivable and deferred revenue were due to increased revenue and advance billing arrangements during the first six months of 2011. The increase in accounts payable was due to purchases and expenses incurred as a result of the growth of the Company during the first six months of 2011.

Investing Activities

Net cash used in investing activities was $5.4 million and $51.7 million for the six months ended June 30, 2012 and 2011, respectively. Net cash used for the six months ended June 30, 2012 represents proceeds from the maturities of short-term investment of $18.0 million, offset by net purchases of investments of $16.0 million and purchases of property and equipment of $7.4 million. Net cash used in investing activities during the six months ended June 30, 2011was due to the purchase of $43.7 million in available-for-sale investments, purchases of property and equipment of $7.8 million and the purchase of a patent for $0.2 million. The purchases of property and equipment during the first six months of 2012 and 2011 were primarily for sequencing equipment used in production.

Financing Activities

Net cash used in financing activities during the six months ended June 30, 2012 of $0.2 million consisted of repayments of notes payable of $2.0 million, offset by net proceeds from the issuance of common stock of $1.1 million and proceeds from the issuance of common stock under equity incentive plans of $0.7 million.

Net cash provided by financing activities during the six months ended June 30, 2011 of $85.8 million consisted primarily of $73.9 million in net proceeds from our common stock offering in the second quarter of 2011 and $20.0 million in proceeds from our term loan with Oxford. These proceeds were partially offset by repayments on term loans of $8.6 million.

 

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Operating and Capital Expenditure Requirements

To date, we have not achieved profitability on a quarterly or annual basis and we expect this trend to continue as our cash expenditures will remain significant in the short-term. We plan to fund our short-term liquidity requirements using cash and cash equivalents and short-term investments, including interest income earned on those balances. At July 1, 2012, our principal short-term liquidity needs are:

 

   

to fund our operating losses;

 

   

to fund our working capital for commercial operations, including personnel costs and other operating expenses;

 

   

to fund our activities relating to becoming a CLIA-certified and staffed laboratory for providing clinical-quality genome sequencing;

 

   

to finance the further research and development of our sequencing technology and services;

 

   

to finance sales and marketing and general and administrative activities; and

 

   

to service our debt obligations.

Based on our current operating plans, we forecast investing approximately $2 to $3 million in additional capital during the remainder of 2012. We anticipate that we will continue to incur net losses for the foreseeable future.

In addition to our eventually resuming expenditures for the expansion of our Mountain View sequencing capacity, further development of our sequencing technology and services, and expansion of our sales and marketing activities, our principal long-term liquidity needs are:

 

   

to fund our working capital for commercial operations, including any growth in working capital required by growth in our business;

 

   

to finance the possible development of additional sequencing centers; and

 

   

to service our debt obligations.

The timing and amount of our future capital requirements will depend on many factors, including, but not limited to, the following:

 

   

the financial success of our genome sequencing business;

 

   

our ability to increase the sample preparation, sequencing and computing capacities in our Mountain View and Santa Clara leased facilities;

 

   

the average selling price per genome at which we are able to sell our whole genome sequencing services;

 

   

whether repayment of our term loan(s) is accelerated if an event of default is triggered;

 

   

the rate at which we eventually establish satellite genome sequencing centers, if any, and whether we can find suitable partners to establish such centers, if at all;

 

   

whether we are successful in obtaining payments from customers;

 

   

whether we can enter into collaborations or establish a recurring customer base;

 

   

the progress and scope of our research and development projects;

 

   

our ability to obtain CLIA certification, staff our laboratory to deliver clinical-grade genome sequencing and capture clinical customers;

 

   

the effect of any joint ventures or acquisitions of other businesses or technologies that we may enter into or make in the future;

 

   

the filing, prosecution and enforcement of patent claims; and

 

   

the costs associated with our current litigation with Illumina, Inc. and any other litigation.

Our forecast of the period of time through which our financial resources will be adequate to support our operations and the costs to support our general and administrative, sales and marketing and research and development activities are forward-looking statements and involve risks and uncertainties. Actual results could vary materially and negatively as a result of a number of factors, including the factors discussed under the caption “Risk Factors.” We have based these estimates on assumptions that may prove to be wrong, and we could use our available capital resources faster than we currently expect.

 

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Term Loans

On December 17, 2010, we entered into a loan and security agreement with Atel Ventures, Inc. (“Atel”). On March 25, 2011, we entered into a new loan and security agreement with Oxford Finance Corporation (“Oxford”).

Atel Loan Agreement

The loan and security agreement with Atel (the “Atel Loan Agreement”) consists of a $6.0 million term loan for equipment purchases. Under the terms of the Atel Loan Agreement, the term loan balance is being repaid in 36 equal monthly payments of principal and interest. Interest accrues on the term loan at a rate of 11.26% per annum. The outstanding borrowings under the term loan are collateralized by a senior priority interest in certain of our current property and equipment, and all property and equipment that was purchased during the term of the Atel Loan Agreement. In connection with entering into the loan and security agreement with Oxford, we and Atel made certain administrative and technical amendments to the Atel Loan Agreement.

In connection with the Atel Loan Agreement, we issued to Atel a warrant to purchase 49,834 shares of our common stock at an exercise price of $7.224 per share. The warrant was exercised in full on June 17, 2011.

The Atel Loan Agreement contains customary representations and warranties, covenants, including closing and advancing conditions, events of defaults and termination provisions. The affirmative covenants include, among other things, that we maintain certain cash account balances, and liability and other insurance, and that we pledge security interests in any ownership interest of a future subsidiary. The negative covenants preclude us from, among other things, disposing of certain assets, engaging in any merger or acquisition, incurring additional indebtedness, encumbering any collateral, paying dividends or making prohibited investments, in each case without the prior consent of Atel, or defaulting under the term loan with Oxford (described below). In February 2012, we would breached a covenant in the Atel Loan Agreement because our audited 2011 consolidated financial statements contained an explanatory paragraph regarding substantial doubt about our ability to continue as a going concern in the opinion on the financial statements from our independent registered public accounting firm. The Atel Loan Agreement was amended to include, among other things, a waiver for this covenant violation.

Oxford Loan Agreement

The loan and security agreement with Oxford (the “Oxford Loan Agreement”) provides for a term loan of $20.0 million. The outstanding balance of the term loan must be repaid in full by October 1, 2014 (the “Maturity Date”). Under the terms of the Oxford Loan Agreement, the outstanding balance accrues interest at a rate of 9.80% per annum. Until May 1, 2012 (the “Amortization Date”), we made monthly payments equal to the accrued interest on the outstanding loan balance. After the Amortization Date and through the Maturity Date the outstanding loan balance will be repaid in thirty (30) equal monthly payments of principal and interest.

As a condition to the Oxford Loan Agreement, a portion of the term loan was used to repay the remaining balance of $7.4 million on our existing term loan agreement with Comerica Bank. Following repayment of the outstanding indebtedness, the Comerica Loan Agreement was terminated. The Oxford Loan Agreement is secured by a senior priority on all of our assets, excluding our intellectual property and those assets securing borrowings under the Atel loan agreement. In addition, we have agreed not to pledge our intellectual property to another entity without Oxford’s approval or consent.

In connection with the entry into the Oxford Loan Agreement, we issued to Oxford warrants to purchase an aggregate of 160,128 shares of our common stock (the “Warrant Shares”) at an exercise price of $7.495 per share. The warrants expire on the seventh anniversary of the issuance date. We also agreed to use best efforts to provide Oxford certain registration rights covering the Warrant Shares.

The Oxford Loan Agreement contains customary representations and warranties, covenants, closing and advancing conditions, events of default and termination provisions. The affirmative covenants include, among other things, that we timely file taxes, maintain certain operating accounts subject to control agreements in favor of Oxford, maintain liability and other insurance, and pledge security interests in any ownership interest of a future subsidiary. The negative covenants preclude, among other things, disposing of certain assets, engaging in any merger or acquisition, incurring additional indebtedness, encumbering any collateral, paying dividends or making prohibited investments, in each case, without the prior consent of Oxford. The Oxford Loan Agreement provides that an event of default will occur if (1) there is a material adverse change in our business, operations or condition (financial or otherwise), (2) there is a material impairment in the prospects of us repaying any portion of our obligations under the term loan, (3) there is a material impairment in the value of the collateral pledged to secure our obligations under the agreement or in Oxford’s perfection or priority over the collateral, (4) we default in the payment of any amount payable under the agreement when due, or (5) we breach any negative covenant or certain affirmative covenants in the agreement (subject to a grace period in some cases). The repayment of the term loan is accelerated following the occurrence of an event of default or otherwise, which would require us to immediately pay an amount equal to the sum of: (i) all outstanding principal plus accrued but unpaid interest, (ii) the prepayment fee, (iii) the final payment, plus (iv) all other sums, that have become due and payable but have not been paid, including interest at the default rate with respect to any past due amounts. In February 2012, we breached a covenant in the Oxford Loan Agreement because our audited 2011 consolidated financial statements contained an explanatory paragraph regarding substantial doubt about our ability to continue as a going concern in the opinion on the financial statements from our independent registered public accounting firm. The Oxford Loan Agreement was amended to include, among other things, a waiver for this covenant violation.

 

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Management believes that based on the current level of operations and anticipated growth, cash and cash equivalents balances and interest income we will earn on these balances, will not be sufficient to meet the anticipated cash requirements for the six months beyond June 30, 2012. Accordingly, amounts due under the Atel Loan Agreement and the Oxford Loan Agreement have been reclassified to notes payable, current.

Contractual Obligations and Commitments

The following summarizes the future commitments arising from our contractual obligations at June 30, 2012 (in thousands):

 

     Payment due by period  

Contractual obligations

   Total      Less than
1 year
     1-3 years      3-5 years      More than
5 years
 

Debt obligations(1)

   $ 22,035       $ 9,813       $ 12,222       $ —         $ —     

Interest(2)

     3,356         1,780         1,576         —           —     

Operating lease obligations(3)

     13,638         3,458         5,840         4,340         —     

Purchase obligations(4)

     9,915         9,098         815         2         —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 48,944       $ 24,149       $ 20,453       $ 4,342       $ —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) Represents our outstanding debt under our term loans as of June 30, 2012.
(2) Represents interest payments on our outstanding debt under our term loans as of June 30, 2012.
(3) Consists of contractual obligations under non-cancellable office space operating leases.
(4) Consists primarily of purchase obligations related to our data center, inventory purchases and non-cancellable orders for sequencing components. The table above also includes agreements to purchase goods or services that have cancellation provisions requiring little or no payment. The amounts under such contracts are included in the table above because management believes that cancellation of these contracts is unlikely and the Company expects to make future cash payments according to the contract terms or in similar amounts for similar materials.

Off-Balance Sheet Arrangements

We do not currently have, nor have we ever had, any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. In addition, we do not engage in trading activities involving non-exchange traded contracts.

 

ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK

As of June 30, 2012, our investment portfolio consists of money market funds and fixed- income government securities. The primary objectives of our investment are to preserve capital and maintain liquidity. Our primary exposures to market risk are interest rate income sensitivity, which is affected by changes in the general level of U.S. interest rates, and conditions in the credit markets, including default risk. However, since all of our investments are in money market funds and highly liquid short-term governmental securities, we do not believe we are subject to any material market interest rate risk exposure. We do not have any foreign currency or any other derivative financial instruments.

 

ITEM 4: CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

Our management, with the participation of our chief executive and financial officers, evaluated the effectiveness of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act, as of June 30, 2012. The term “disclosure controls and procedures,” as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act, means controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company’s management, including its chief executive and financial officers, as appropriate, to allow timely decisions regarding required disclosure. Management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives and management necessarily applies its judgment in

 

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evaluating the cost-benefit relationship of possible controls and procedures. Based on the evaluation of our disclosure controls and procedures as of June 30, 2012, our chief executive officer and chief financial officer concluded that, as of such date, our disclosure controls and procedures were effective at a reasonable assurance level.

Changes in Internal Control over Financial Reporting

There was no change in our internal control over financial reporting during the quarter ended June 30, 2012 identified in connection with the evaluation required by Rule 13a-15(d) and 15d-15(d) of the Exchange Act that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART II — OTHER INFORMATION

 

ITEM 1: LEGAL PROCEEDINGS

On August 3, 2010, a patent infringement lawsuit was filed by Illumina, Inc. and Solexa, Inc. (an entity acquired by Illumina), or the plaintiffs, against the Company, in the U.S. District Court for Delaware. The U.S. District Court in Delaware subsequently granted the Company’s motion to transfer the case to the U.S. District Court for the Northern District of California. The case caption is Illumina, Inc. and Solexa, Inc. v. Complete Genomics, Inc., Civil Action No. 3:10-cv-05542. The complaint alleges that Complete Genomics’ Analysis Platform, and in particular the combinatorial probe anchor ligation technology, infringes upon three patents held by Illumina and Solexa. The plaintiffs seek unspecified monetary damages and injunctive relief. On September 23, 2010, the Company filed an answer to the complaint as well as its counterclaims against the plaintiffs. On May 5, 2011, the Court entered a stipulated order to dismiss two patents from the lawsuit. The dismissal is without prejudice but includes conditions on the plaintiffs’ ability to file lawsuits on these patents, including a limitation that the plaintiffs may not re-file such lawsuits against the Company until the later of (1) August 1, 2012, or (2) the exhaustion of all appeal rights in both (a) the pending reexaminations in the U.S. Patent and Trademark Office and (b) the pending civil litigation in which these patents are also asserted, Life Technologies Corp. v. Illumina, Case No. 3:11-cv-00703 (S.D. Cal.). The Company believes that it has substantial and meritorious defenses to the plaintiffs’ claims and intends to vigorously defend its position. However, if the Company is found to infringe one or more valid claims of a patent-in-suit and if the Court grants an injunction, the Company may be forced to redesign portions of its sequencing process, seek a license, cease the infringing activity and/or pay monetary damages. A negative outcome in this matter could therefore have a material adverse effect on our financial position, results of operations, cash flows and business. In addition, the Company has incurred and we anticipate that it will continue to incur significant expense and invest substantial time in defending against these claims. We are not currently able to estimate the potential loss, if any, that may result from this litigation.

On June 15, 2012, a second patent infringement lawsuit was filed by Illumina, Inc. and Illumina Cambridge Ltd. (a subsidiary of Illumina), or the plaintiffs, against the Company, in the U.S. District Court for the Southern District of California. The case caption is Illumina, Inc. and Illumina Cambridge Ltd. v. Complete Genomics, Inc., Civil Action No. ‘12CV1465 AJB BGS. The complaint alleges that Complete Genomics’ Analysis Platform infringes upon one patent held by Illumina. The plaintiffs seek unspecified monetary damages (including treble damages) and injunctive relief. On July 9, 2012, the Company filed an answer to the complaint as well as its counterclaims against the plaintiffs. The Company believes that it has substantial and meritorious defenses to the plaintiffs’ claims and intends to vigorously defend its position. However, if the Company is found to infringe one or more valid claims of the patent-in-suit and if the Court grants an injunction, the Company may be forced to redesign portions of its sequencing process, seek a license, cease the infringing activity and/or pay monetary damages. A negative outcome in this matter could therefore have a material adverse effect on our financial position, results of operations, cash flows and business. In addition, we anticipate that the Company will incur significant expense and invest substantial time in defending against these claims. We are not currently able to estimate the potential loss, if any, that may result from this litigation.

For more information regarding the risk of this litigation and future litigation, please see “Risk Factors—We currently are, and could in the future be, subject to litigation regarding patent and other proprietary rights that could harm our business” and “—We may incur substantial costs as a result of our current, or future, litigation or other proceedings relating to patent and other proprietary rights.”

From time to time, we may become involved in other legal proceedings and claims arising in the ordinary course of our business. Other than as described above, we are not currently a party to any legal proceedings the outcome of which, if determined adversely to us, we believe would individually or in the aggregate have a material adverse effect on our financial position, results of operations, cash flows or business.

 

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ITEM 1A. RISK FACTORS

Investing in our common stock involves a high degree of risk. You should carefully consider the risks described below and the other information in this Quarterly Report on Form 10-Q. If any of such risks actually occur, our business, operating results or financial condition could be adversely affected. In those cases, the trading price of our common stock could decline and you may lose all or part of your investment.

Risks Related to Our Limited Operating History, Financial Condition and Capital Requirements

We do not have sufficient cash to fund our operations to December 31, 2012.

We believe that based on the current level of our operations, cash and cash equivalents balances and interest income the Company will earn on these balances will not be sufficient to meet the Company’s anticipated cash requirements for the six months beyond June 30, 2012. The Company’s recurring operating losses and negative cash flow from operations and its requirement for additional funding to execute its business objectives beyond this period gives rise to substantial doubt as to the Company’s ability to continue as a going concern.

We announced on June 5, 2012 that we have engaged Jefferies & Company, Inc. to act as financial advisor to the Company and to assist in our review of strategic alternatives, which could include a merger, business combination, equity investment or sale of the Company. There can be no assurance that we will be successful in executing on any of these possible strategic alternatives. If we are unable to execute on one of these possible strategic alternatives or otherwise raise additional financing on a timely basis, we will need to significantly scale back or discontinue the Company’s operations.

We are an early, commercial-stage company and have a limited operating history, which may make it difficult to evaluate our current business and predict our future performance.

We are an early, commercial-stage company and have a limited operating history. We were incorporated in Delaware in June 2005 and began operations in March 2006. From March 2006 until mid-2009, our operations focused on research and development of our DNA sequencing technology platform. Our revenue for the six months ended June 30, 2012 and 2011 was $12.6 million and $12.7 million, respectively. Our limited operating history, particularly in light of our novel, service-based business model in the rapidly evolving genome sequencing industry, make it difficult to evaluate our current business and predict our future performance. Our lack of a long operating history, and especially our very short history as a revenue-generating company, make any assessment of our profitability or prediction about our future success or viability subject to significant uncertainty. We have encountered and will continue to encounter risks and difficulties frequently experienced by early, commercial-stage companies in rapidly evolving industries. If we do not address these risks successfully, our business will suffer.

On June 5, 2012, we announced a restructuring plan under which we are delaying sequencing capacity expansion, deferring certain capital expenditures, eliminated approximately 55 employee positions, and shifting our focus from sequencing for research customers to sequencing for clinical customers. Among other risks, this restructuring could impact our ability to retain employees and secure new customers or maintain current or obtain anticipated orders for sequencing services from existing customers.

In the same June 5, 2012 announcement, we reported that the Company has engaged Jefferies & Company, Inc. to act as financial advisor to the Company and to assist in its review of strategic alternatives, which could include a merger, business combination, equity investment or sale of the Company. Among other risks, this announcement could similarly impact our ability to retain employees and secure new customers or maintain current or obtain anticipated orders for sequencing services from existing customers.

We will require substantial additional funding and may be unable to raise capital when needed, which could force us to delay, reduce or cancel certain business objectives or we may be unable to continue as a going concern.

Our capital requirements are substantial, particularly as we further develop our business, eventually resume expansion of sample preparation, sequencing and computing capacities in our Mountain View and Santa Clara, California facilities. Our business model requires us to make significant research and development investments in many areas including sample preparation, sequencing, and bioinformatics. Historically, we have financed our operations through private placements of preferred stock, convertible debt, borrowings under our credit facility, secured debt and through public offerings of our common stock.

The amount of additional capital and timing at which we require the additional capital necessary to fund our operations and expand our business depends on many factors, including:

 

   

the financial success of our genome sequencing business;

 

   

the average selling price per genome at which we are able to sell our whole genome sequencing services;

 

   

whether repayment of our term loan(s) is accelerated if an event of default occurs;

 

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Table of Contents
   

whether we are successful in obtaining payments from customers;

 

   

whether we can establish a recurring customer base, in particular with clinical customers;

 

   

the progress and scope of our research and development projects;

 

   

our progress in obtaining a CLIA license to operate a clinical laboratory;

 

   

the filing, prosecution and enforcement of patent claims; and

 

   

the costs associated with our current litigation with Illumina, Inc. and any other litigation.

Our term loans contain restrictions that limit our flexibility in operating our business and provisions that enable the lenders to accelerate repayment of the outstanding amounts in the event of default.

Our term loans with Oxford Finance Corporation (“Oxford”) and Atel Ventures, Inc. (“Atel”) contain various covenants that limit our ability to engage in specified types of transactions. These covenants limit our ability to, among other things:

 

   

sell, transfer, lease or dispose of our assets;

 

   

create, incur or assume additional indebtedness;

 

   

encumber or permit liens on certain of our assets;

 

   

make restricted payments, including paying dividends on, repurchasing or making distributions with respect to our common stock;

 

   

make specified investments (including loans and advances);

 

   

consolidate, merge, sell or otherwise dispose of all or substantially all of our assets; and

 

   

enter into certain transactions with our affiliates.

A breach of any of these covenants or a material adverse change to our business could result in a default under either or both of our term loans. In addition, our term loan with Oxford provides that an event of default will occur, among other instances, if there is a material adverse change in our business, operations or condition (financial or otherwise) or if there is a material impairment in the prospects of us repaying any portion of our obligations under the term loan. These provisions are inherently subjective in nature. If we fail to raise additional capital in a timely mann

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