XNAS:SQNM Sequenom Inc Quarterly Report 10-Q Filing - 6/30/2012

Effective Date 6/30/2012

XNAS:SQNM (Sequenom Inc): Fair Value Estimate
Premium
XNAS:SQNM (Sequenom Inc): Consider Buying
Premium
XNAS:SQNM (Sequenom Inc): Consider Selling
Premium
XNAS:SQNM (Sequenom Inc): Fair Value Uncertainty
Premium
XNAS:SQNM (Sequenom Inc): Economic Moat
Premium
XNAS:SQNM (Sequenom Inc): Stewardship
Premium
 

 
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
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from               to             
Commission File Number: 000-29101
____________________ 
SEQUENOM, INC.
(Exact name of registrant as specified in its charter)
____________________ 
DELAWARE
77-0365889
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification Number)
 
3595 John Hopkins Court San Diego, California
92121
(Address of principal executive offices)
(Zip Code)
Registrant's telephone number, including area code: (858) 202-9000
____________________  
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.    x  Yes     o  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 (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    x  Yes     o  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 definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
o
Accelerated filer
x
 
 
 
 
Non-accelerated filer
o  (Do not check if a smaller reporting company)
Smaller reporting company filer
o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  o    No  x
The number of shares of the Registrant's Common Stock outstanding as of July 23, 2012, was 114,565,254.
 



 SEQUENOM, INC.
INDEX
 
 

2


PART I - FINANCIAL INFORMATION
Item  1.    Financial Statements
SEQUENOM, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except par value and share information)
 
 
June 30,
2012
 
December 31,
2011
 
(Unaudited)
 
 
Assets
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
60,156

 
$
28,926

Marketable securities
38,481

 
55,290

Restricted cash
204

 
66

Accounts receivable, net
7,577

 
6,972

Inventories
10,551

 
8,729

Other current assets and prepaid expenses
3,803

 
3,533

Total current assets
120,772

 
103,516

Equipment and leasehold improvements, net
27,178

 
19,629

Intangible assets, net
2,147

 
1,154

Goodwill
10,007

 
10,007

Other assets
950

 
1,241

Total assets
$
161,054

 
$
135,547

Liabilities and stockholders' equity
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
17,512

 
$
8,435

Accrued expenses
14,223

 
15,743

Deferred revenue
2,247

 
2,137

Long-term debt and obligations, current portion
6,126

 
1,902

Other current liabilities
897

 
787

Total current liabilities
41,005

 
29,004

Deferred revenue, less current portion
565

 
780

Long-term debt and obligations, less current portion
14,162

 
13,273

Other long-term liabilities
3,299

 
1,102

Commitments and contingencies


 


Stockholders' equity:
 
 
 
Convertible preferred stock, par value $0.001; 5,000,000 shares authorized, no shares issued or outstanding at June 30, 2012 and December 31, 2011, respectively

 

Common stock, par value $0.001; 185,000,000 shares authorized, 114,565,254 and 99,348,623 shares issued and outstanding at June 30, 2012 and December 31, 2011, respectively
115

 
99

Additional paid-in capital
947,858

 
883,006

Accumulated other comprehensive income
412

 
570

Accumulated deficit
(846,362
)
 
(792,287
)
Total stockholders' equity
102,023

 
91,388

Total liabilities and stockholders' equity
$
161,054

 
$
135,547

See accompanying notes.

3


SEQUENOM, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS
(In thousands, except per share information)
 
 
Three months ended
June 30,
 
Six months ended
June 30,
 
2012
 
2011
 
2012
 
2011
 
(Unaudited)
 
(Unaudited)
Revenues:
 
 
 
 
 
 
 
Genetic analysis product sales and services
$
10,142

 
$
11,731

 
$
20,281

 
$
23,575

Diagnostic services
8,110

 
1,601

 
12,891

 
3,267

Total revenues
18,252

 
13,332

 
33,172

 
26,842

Cost of revenues:
 
 
 
 
 
 
 
Cost of genetic analysis product sales and services
2,964

 
3,316

 
5,571

 
6,774

Cost of diagnostic services
9,407

 
1,109

 
16,278

 
2,755

Total cost of revenues
12,371

 
4,425

 
21,849

 
9,529

Gross margin
5,881

 
8,907

 
11,323

 
17,313

Operating expenses
 
 
 
 
 
 
 
Selling and marketing
11,303

 
7,678

 
21,060

 
13,738

Research and development
13,870

 
17,146

 
26,533

 
27,777

General and administrative
9,949

 
5,038

 
17,299

 
9,876

Total operating expenses
35,122

 
29,862

 
64,892

 
51,391

Loss from operations
(29,241
)
 
(20,955
)
 
(53,569
)
 
(34,078
)
Interest income
22

 
49

 
44

 
5

Interest expense
(267
)
 
(18
)
 
(483
)
 
(45
)
Gain on marketable securities

 
2

 

 
2

Other (expense) income, net
(116
)
 
(4
)
 
(45
)
 
471

Loss before income taxes
(29,602
)
 
(20,926
)
 
(54,053
)
 
(33,645
)
Income tax (expense) benefit
(20
)
 
(12
)
 
(22
)
 
37

Net loss
$
(29,622
)
 
$
(20,938
)
 
$
(54,075
)
 
$
(33,608
)
Net loss per common share, basic and diluted
$
(0.26
)
 
$
(0.21
)
 
$
(0.48
)
 
$
(0.34
)
Weighted average number of shares outstanding, basic and diluted
114,549

 
99,083

 
112,531

 
99,012

Comprehensive loss
$
(29,807
)
 
$
(20,779
)
 
$
(54,233
)
 
$
(33,169
)
See accompanying notes.

4


SEQUENOM, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
 
 
Six months ended
June 30,
 
2012
 
2011
 
(Unaudited)
Operating activities
 
 
 
Net loss
$
(54,075
)
 
$
(33,608
)
Adjustments to reconcile net loss to net cash used in operating activities:
 
 
 
Stock-based compensation
6,113

 
6,120

Warrant issued for license

 
1,155

License fee payable

 
1,500

Depreciation and amortization
4,755

 
2,997

Deferred rent
1,561

 
(400
)
Other non-cash items
348

 
(78
)
Changes in operating assets and liabilities:
 
 
 
Accounts receivable, net
(679
)
 
357

Inventories
(1,842
)
 
(206
)
Prepaid expenses and other assets
499

 
(988
)
Accounts payable and accrued expenses
7,736

 
2,746

Deferred revenue
(79
)
 
175

Other liabilities

 
(15
)
Net cash used in operating activities
(35,663
)
 
(20,245
)
Investing activities
 
 
 
Purchases of equipment and leasehold improvements
(12,107
)
 
(6,896
)
Purchases of intangible assets
(1,300
)
 

Purchases of marketable securities
(10,329
)
 
(88,731
)
Proceeds from sales of marketable securities

 
9,997

Maturities of marketable securities
27,151

 
24,900

(Increase in) release of restricted cash
(139
)
 
1,330

Net cash provided by (used in) investing activities
3,276

 
(59,400
)
Financing activities
 
 
 
Payments on debt and obligations
(33
)
 
(1,755
)
Borrowings on term loan
5,000

 
5,000

Proceeds from private placement, net of issuance costs
58,161

 

Proceeds from exercise of warrants, stock options, and ESPP purchases
593

 
1,065

Net cash provided by financing activities
63,721

 
4,310

Net increase (decrease) in cash and cash equivalents
31,334

 
(75,335
)
Effect of exchange rate changes on cash and cash equivalents
(104
)
 
250

Cash and cash equivalents at beginning of period
28,926

 
116,647

Cash and cash equivalents at end of period
$
60,156

 
$
41,562

See accompanying notes.

5


SEQUENOM, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. Summary of Significant Accounting Policies
We are a molecular diagnostics testing and genetics analysis company committed to providing molecular diagnostics testing services, research use only products, services, applications, and genetic analysis products that translate the results of genomic science into solutions for biomedical research, translational research, molecular medicine applications, and other areas of research, including agricultural and livestock. Our development and commercialization efforts in various diagnostic areas include noninvasive women's health-related and prenatal diagnostics, ophthalmology, and other medical conditions such as oncology, infectious diseases, and autoimmunity.
Basis of Presentation and Consolidation
The accompanying condensed consolidated financial statements have been prepared in conformity with U.S. generally accepted accounting principles, or GAAP, and include the accounts of Sequenom, Inc. and our wholly-owned subsidiaries located in the United States, Germany, the United Kingdom, Japan, India, and Hong Kong. All significant intercompany accounts and transactions have been eliminated in consolidation. These condensed statements do not include all of the information and disclosures required by GAAP for complete financial statements. In the opinion of management these statements reflect all adjustments, which are of a normal recurring nature, necessary for a fair statement of the results presented. Interim results are not necessarily indicative of results for a full year or any other period(s).
The condensed consolidated balance sheet at December 31, 2011, has been derived from the audited financial statements at that date, but does not include all of the information and disclosures required by GAAP for complete financial statements. Subsequent events were evaluated by management through the date of filing of this Form 10-Q.
These condensed financial statements should be read in conjunction with the audited financial statements and disclosures included in our Annual Report on Form 10-K for the year ended December 31, 2011, as filed with the Securities and Exchange Commission, or SEC, on March 9, 2012.
Correction of Previously Reported Segment Disclosures
In connection with the preparation of the Condensed Consolidated Financial Statements for the three and six months ended June 30, 2012, our management determined that the amounts previously reported in our segment disclosure table for operating income (loss) allocated to our Molecular Diagnostics and Genetic Analysis segments and those Unallocated were incorrect due to an error in summarization of operating expense amounts related to our segments. These incorrect summaries resulted in an immaterial overstatement of operating expenses allocated to the Molecular Diagnostics and Genetic Analysis business segments, with an equal understatement reported as Unallocated, except for the three months ended March 31, 2012, where the operating expenses for the Genetic Analysis segment were understated, offset by the expenses reported as Unallocated. The error had no effect on our consolidated balance sheets, statements of operations and comprehensive loss, or statements of cash flows for each period presented. Revenues allocated to our operating segments were not impacted by this incorrect summarization. The amounts presented in the operating segment disclosure for the three months ended March 31, 2012, each year ended December 31, 2011, 2010, and 2009, the three months ended March 31, 2011, the three and six months ended June 30, 2011 and the three and nine months ended September 30, 2011, have been restated, as set forth in the following tables (in thousands):

 
For the three months ended,
 
 
 
 
 
March 31, 2012
 
 
 
 
 
Previously
 
 
 
 
 
 
 
 
 
 
 
Reported
 
Restated
 
 
 
 
 
 
 
 
Revenues:
 
 
 
 
 
 
 
 
 
 
 
Molecular Diagnostics
$
4,780

 
$
4,780

 
 
 
 
 
 
 
 
Genetic Analysis
10,140

 
10,140

 
 
 
 
 
 
 
 
Total revenues
$
14,920

 
$
14,920

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Operating (loss) income:
 
 
 
 
 
 
 
 
 
 
 
Molecular Diagnostics
$
(17,242
)
 
$
(12,855
)
 
 
 
 
 
 
 
 
Genetic Analysis
2,701

 
2,279

 
 
 
 
 
 
 
 
Unallocated
(9,787
)
 
(13,752
)
 
 
 
 
 
 
 
 
Total operating loss
$
(24,328
)
 
$
(24,328
)
 
 
 
 
 
 
 
 

6


 
For the year ended,
 
For the year ended,
 
For the year ended,
 
December 31, 2011
 
December 31, 2010
 
December 31, 2009
 
Previously
 
 
 
Previously
 
 
 
Previously
 
 
 
Reported
 
Restated
 
Reported
 
Restated
 
Reported
 
Restated
Revenues:
 
 
 
 
 
 
 
 
 
 
 
Molecular Diagnostics
$
8,319

 
$
8,319

 
$
2,554

 
$
2,554

 
$
94

 
$
94

Genetic Analysis
47,588

 
47,588

 
44,905

 
44,905

 
37,769

 
37,769

Total revenues
$
55,907

 
$
55,907

 
$
47,459

 
$
47,459

 
$
37,863

 
$
37,863

 
 
 
 
 
 
 
 
 
 
 
 
Operating (loss) income:
 
 
 
 
 
 
 
 
 
 
 
Molecular Diagnostics
$
(43,799
)
 
$
(38,596
)
 
$
(36,216
)
 
$
(32,847
)
 
$
(27,034
)
 
$
(27,034
)
Genetic Analysis
14,216

 
15,480

 
11,873

 
12,815

 
4,379

 
6,378

Unallocated
(44,681
)
 
(51,148
)
 
(96,676
)
 
(100,987
)
 
(48,067
)
 
(50,066
)
Total operating loss
$
(74,264
)
 
$
(74,264
)
 
$
(121,019
)
 
$
(121,019
)
 
$
(70,722
)
 
$
(70,722
)
 
For the three months ended,
 
For the three months ended,
 
For the three months ended,
 
March 31, 2011
 
June 30, 2011
 
September 30, 2011
 
Previously
 
 
 
Previously
 
 
 
Previously
 
 
 
Reported
 
Restated
 
Reported
 
Restated
 
Reported
 
Restated
Revenues:
 
 
 
 
 
 
 
 
 
 
 
Molecular Diagnostics
$
1,666

 
$
1,666

 
$
1,601

 
$
1,601

 
$
2,219

 
$
2,219

Genetic Analysis
11,844

 
11,844

 
11,731

 
11,731

 
11,362

 
11,362

Total revenues
$
13,510

 
$
13,510

 
$
13,332

 
$
13,332

 
$
13,581

 
$
13,581

 
 
 
 
 
 
 
 
 
 
 
 
Operating (loss) income:
 
 
 
 
 
 
 
 
 
 
 
Molecular Diagnostics
$
(7,390
)
 
$
(6,618
)
 
$
(9,879
)
 
$
(9,025
)
 
$
(10,631
)
 
$
(9,714
)
Genetic Analysis
3,906

 
4,121

 
3,754

 
4,040

 
2,583

 
3,043

Unallocated
(9,639
)
 
(10,626
)
 
(14,830
)
 
(15,970
)
 
(10,210
)
 
(11,587
)
Total operating loss
$
(13,123
)
 
$
(13,123
)
 
$
(20,955
)
 
$
(20,955
)
 
$
(18,258
)
 
$
(18,258
)
 
For the six months ended,
 
For the nine months ended,
 
 
 
June 30, 2011
 
September 30, 2011
 
 
 
Previously
 
 
 
Previously
 
 
 
 
 
 
 
Reported
 
Restated
 
Reported
 
Restated
 
 
 
 
Revenues:
 
 
 
 
 
 
 
 
 
 
 
Molecular Diagnostics
$
3,267

 
$
3,267

 
$
5,494

 
$
5,494

 
 
 
 
Genetic Analysis
23,575

 
23,575

 
34,929

 
34,929

 
 
 
 
Total revenues
$
26,842

 
$
26,842

 
$
40,423

 
$
40,423

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Operating (loss) income:
 
 
 
 
 
 
 
 
 
 
 
Molecular Diagnostics
$
(17,270
)
 
$
(15,645
)
 
$
(28,080
)
 
$
(25,538
)
 
 
 
 
Genetic Analysis
7,660

 
8,160

 
10,236

 
11,196

 
 
 
 
Unallocated
(24,468
)
 
(26,593
)
 
(34,492
)
 
(37,994
)
 
 
 
 
Total operating loss
$
(34,078
)
 
$
(34,078
)
 
$
(52,336
)
 
$
(52,336
)
 
 
 
 
Use of Estimates
The preparation of financial statements in conformity with GAAP requires us to make certain estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, and expenses, and the related disclosure of contingent assets and liabilities. Actual results could differ materially from those estimates and assumptions.
Revenue Recognition
Our revenue is generated primarily from the sale of products and providing services. Genetic analysis product sales and services revenue primarily consists of sales of MassARRAY systems and consumables used in genetic analysis, including extended warranty services associated with the MassARRAY systems, as well as other amounts earned under contract research agreements. Diagnostic services revenues consist of providing the following laboratory-developed tests, or LDTs: MaterniT21 PLUS LDT for fetal trisomy 21, 18, and 13, SensiGene Cystic Fibrosis Carrier Screening, or SensiGene CF LDT, SensiGene Fetal Rhesus D genotyping, or SensiGene RHD LDT, and the RetnaGene age-related macular degeneration, or RetnaGene AMD LDT.
Revenues are recognized when persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the price is fixed and determinable, and collectability is reasonably assured. Revenue is deferred for fees received before earned. Revenue from sales of MassARRAY systems and consumables are recognized upon shipment and transfer of

7


title to the customer and when all revenue recognition criteria are met. Our contracts do not contain refund or cancellation clauses. Revenues from the sale or licensing of our proprietary software are recognized upon transfer of title to the customer. We recognize revenue on maintenance services for ongoing customer support over the maintenance period.
 
When a collaboration arrangement or sales arrangement contains multiple elements we allocate revenue to each element based on a selling price hierarchy. The selling price for a deliverable is based on its vendor specific objective evidence, or VSOE, if available, third-party evidence, or TPE, if VSOE is not available, or estimated selling price, if neither VSOE nor TPE is available. We limit the amount of revenue recognition for delivered elements to the amount that is not contingent on the future delivery of products or services, future performance obligations, or subject to customer-specified return or refund privileges. We generally allocate revenue to each element based on our best estimate of the selling price, which is established considering internal factors such as historical selling prices, pricing practices and controls, and customer segment pricing strategies.
We evaluate deliverables in a multiple-element arrangement to determine whether each represents a separate unit of accounting. A deliverable constitutes a separate unit of accounting when it has standalone value to the customer and there are no customer-negotiated refund or return rights for the delivered elements. Items are considered to have standalone value when they are sold separately by any vendor or when the customer could sell the item on a standalone basis. In instances when the aforementioned criteria are not met, the deliverable is combined with the undelivered elements and the allocation of the arrangement consideration and revenue recognition is determined for the combined unit as a single unit. Allocation of the consideration is determined by management at the arrangement inception on the basis of each unit's relative selling price.
Diagnostic services revenues from the Sequenom Center for Molecular Medicine, or Sequenom CMM, have been primarily recognized on a cash basis due to the lack of contractual reimbursement agreements with third-party payors and limited collections experience. We generally bill third-party payors upon generation and delivery of a test result to the ordering physician following completion of a test. As such, we take assignment of benefits and risk of collection with the third-party payor. Patients have out-of-pocket costs for amounts not covered by their insurance carrier and we bill the patient directly for these amounts in the form of co-pays and deductibles. Some payors may not cover our test as ordered by the physician under their reimbursement policies. Consequently, we pursue reimbursement on a case-by-case basis. We will recognize diagnostic services revenues upon cash collection until we can reliably estimate the amount that would be ultimately collected for each of our LDTs.
 
Accounts Receivable
We invoice our genetic analysis product sales and services as orders are shipped and/or services provided and any other contractual obligations are met. Our contracts typically require payment within 30 to 60 days of the date of invoice. We maintain allowances for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. We specifically analyze accounts receivable and historical bad debts, client credit, current economic trends, and changes in customer payment trends when evaluating the adequacy of the allowance for doubtful accounts. Account balances are charged-off against the allowance when it is probable the receivable will not be recovered. Allowance for doubtful accounts was $758,000 and $771,000 at June 30, 2012 and December 31, 2011, respectively.
We bill third-party payors for our LDTs upon delivery of test results to ordering physicians and we take assignment of benefits and the risk of collection with these payors. We do not record accounts receivable for billings to third-party payors as these revenues are currently recognized on a cash basis.
We cannot guarantee that we will continue to experience the same credit loss rates that we have in the past. Measurement of such losses requires consideration of historical loss experience, including the need to adjust for current conditions, and judgments about the probable effects of relevant observable data, including present economic conditions such as delinquency rates and financial health of specific customers. We consider all available information in our assessments of the adequacy of the reserves for uncollectible accounts. For billings directly to physician offices or to uninsured patients, we primarily recognize revenue on a cash basis.
 
Collaboration, Development and Licensing Agreements
We enter into license agreements and collaborative research and development arrangements with life sciences partners that may involve multiple deliverables. Our arrangements may contain one or more of the following elements: upfront fees, milestone payments, royalties, and license fees. Each deliverable in the arrangement is evaluated to determine whether it meets the criteria to be accounted for as a separate unit of accounting or whether it should be combined with other deliverables.
Upfront fees received for license and collaborative agreements are recognized ratably over our expected performance period under the arrangement. We make our best estimate of the period over which we expect to fulfill our performance

8


obligations. Given the uncertainties of research and development collaborations, significant judgment is required to determine the duration of the performance period.
Under the milestone method of revenue recognition, contingent consideration received from the achievement of a substantive milestone is recognized in its entirety in the period in which the milestone is achieved, which we believe is more consistent with the substance of our performance under our various license and collaboration agreements. A milestone is defined as an event (i) that can only be achieved based in whole or in part on either the entity's performance or on the occurrence of a specific outcome resulting from the entity's performance, (ii) for which there is substantive uncertainty at the date the arrangement is entered into that the event will be achieved, and (iii) that would result in additional payments being due to the entity. A milestone is substantive if the consideration earned from the achievement of the milestone is consistent with our performance required to achieve the milestone or the increase in value to the collaboration resulting from our performance, relates solely to our past performance, and is reasonable relative to all of the other deliverables and payments within the arrangement.
Shipping and Handling Costs
Shipping and handling costs are included within cost of revenues on the statements of operations and comprehensive loss.
Cash, Cash Equivalents, and Marketable Securities
Cash equivalents consist of short-term, highly liquid investments with original maturities of three months or less when purchased. Investments with an original maturity of more than three months are considered marketable securities and have been classified by management as available-for-sale. Such investments are carried at fair value, with unrealized gains and losses recorded as a component of comprehensive loss and stockholders' equity.
Fair Value Measurements
Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants on the measurement date. Accounting guidance also establishes a fair value hierarchy that requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair value:
Level 1—Observable inputs that reflect quoted prices (unadjusted) for identical assets or liabilities in active markets.
Level 2—Include other inputs that are directly or indirectly observable in the marketplace.
Level 3—Unobservable inputs that are supported by little or no market activities, therefore requiring an entity to develop its own assumptions. As of June 30, 2012 and December 31, 2011, we had no assets or liabilities measured at fair value on a recurring basis within the Level 3 hierarchy.
We value our cash equivalents and marketable securities using quoted market prices or alternative pricing sources and models utilizing observable market inputs and, as such, classify our cash equivalents and marketable securities within Level 1 or Level 2.
The following tables summarize our fair value hierarchy for assets and liabilities measured at fair value on a recurring basis (in thousands):
 
As of June 30, 2012
Description 
Total
 
Level 1
 
Level 2
Money Market Funds
$
48,474

 
$
48,474

 
$

Government and agency-backed debt securities
1,012

 

 
1,012

Mutual funds
351

 
351

 

Certificates of deposit
7,362

 

 
7,362

U.S. treasury securities
29,996

 
29,996

 

Total
$
87,195

 
$
78,821

 
$
8,374

 

9


 
As of December 31, 2011
Description 
Total 
 
Level 1 
 
Level 2 
Money Market Funds
$
13,097

 
$
13,097

 
$

Government and agency-backed debt securities
5,072

 

 
5,072

Mutual funds
323

 
323

 

Certificates of deposit
5,384

 

 
5,384

U.S. treasury securities
44,986

 
44,986

 

Total
$
68,862

 
$
58,406

 
$
10,456

 
There were no transfers in or out of Level 1, Level 2, or Level 3 investments during the six months ended June 30, 2012 or during the year ended December 31, 2011.
Restricted Cash
Restricted cash relates to cash that is pledged as collateral for letters of credit issued by us, primarily in connection with performance guarantees.
Inventories
Inventories are valued at the lower of cost (first-in, first-out) or market value (net realizable value). We estimate the recoverability of our inventory by reference to our internal estimates of future demands and product life cycles, including expiration. During the six months ended June 30, 2012 we used $1.1 million of inventory with no related charge to cost of goods sold, as these items were previously reserved for as excess. We recorded a charge for obsolete and excess inventory of $1.0 million against cost of revenues during the six months ended June 30, 2012 to reserve for inventories we expect to scrap upon conversion to a new version of our MaterniT21 PLUS LDT. Inventories are shown net of obsolete and excess reserves of $1.6 million and $1.8 million at June 30, 2012 and December 31, 2011, respectively.
 
Warranty Cost and Reserves
We provide a warranty provision related to the sales of our MassARRAY systems based on our historical experience of returns and repairs required under the warranty period. We generally provide a one-year warranty on our MassARRAY system and related equipment. We establish an accrual for estimated warranty expenses associated with system sales based on historical amounts, which is recorded as a component of cost of product revenue. Changes in our warranty liability during the six months ended June 30, 2012 were as follows (in thousands):
Balance as of December 31, 2011
$
201

Additions charged to cost of revenues
26

Repairs, replacements, and reductions in liability requirements
(15
)
Balance as of June 30, 2012
$
212

Goodwill and Purchased Intangible Assets
Goodwill is recorded when the consideration paid for an acquisition exceeds the fair value of the identified net tangible and intangible assets of acquired businesses. The allocation of purchase price for acquisitions requires extensive use of accounting estimates and judgments to allocate the purchase price to the identifiable tangible and intangible assets acquired and liabilities assumed based on their respective fair values. Additionally, we must determine whether an acquired entity is considered to be a business or a set of net assets, because a portion of the purchase price can only be allocated to goodwill in a business combination.
Goodwill and intangible assets deemed to have indefinite lives are not amortized, but are subject to annual impairment tests. The amounts and useful lives assigned to intangible assets that have finite useful lives, which consist of purchased patent rights and license and lab accreditation costs, requires the use of estimates and the exercise of judgment. These intangible assets are being amortized over the expected economic use of the asset.
On April 6, 2012, we entered into an asset purchase agreement with Helicos Biosciences Corporation, pursuant to which we purchased certain U.S. patent applications and proprietary materials related thereto for the purchase price of $1.3 million. These U.S. patent applications describe and claim methods of using sequencing to detect fetal abnormalities. As such, we believe they complement and supplement the other patents and patent applications in our patent portfolio that relate to the detection of fetal aneuploidies. These assets will be amortized over their expected economic useful life of 13 years.


10


We annually evaluate our goodwill and purchased intangibles at the reporting unit level during the fourth quarter each fiscal year, or more frequently if we believe indicators of impairment are present. We periodically re-evaluate the original assumptions and rationale utilized in the establishment of the carrying value and estimated lives of our long-lived assets. The criteria used for these evaluations include management's estimate of the asset's continuing ability to generate income from operations and positive cash flows in future periods as well as the strategic significance of any intangible assets in our business objectives. If assets are considered to be impaired, the impairment recognized is the amount by which the carrying value of the assets exceeds the fair value of the assets.
 
Research and Development Costs
Research and development costs are expensed as incurred. These costs include personnel expenses, fees paid to collaborators, laboratory supplies, facilities, miscellaneous expenses, and allocation of corporate costs. These expenses are incurred during internal research and development activities, as well as providing services under collaborative research agreements.
Foreign Currency Translation and Transactions
The financial statements of our subsidiaries in Germany, United Kingdom, and Japan are measured using, respectively, the Euro, Great British Pound, and Japanese Yen, as the functional currency. Assets and liabilities of these subsidiaries are translated at the rates of exchange in effect at the balance sheet date. Income and expense items are translated at the average daily rate of exchange during the reporting period. Resulting remeasurement gains or losses are recognized as a component of other comprehensive income (loss) in the statements of operations and comprehensive loss and equity. Transactions denominated in currencies other than the local currency are recorded based on exchange rates at the time such transactions arise. Subsequent changes in exchange rates result in transaction gains and losses, which are reflected in income as unrealized (based on period-end translations) or realized upon settlement of the transaction. Transaction gains or losses were not material for the three and six months ended June 30, 2012 and 2011.
Income Taxes
Our provision for income taxes is computed using the asset and liability method, under which deferred tax assets and liabilities are recognized for the expected future tax consequences of temporary differences between the financial reporting and tax bases of assets and liabilities, and for the expected future tax benefit to be derived from tax loss and credit carryforwards. Deferred tax assets and liabilities are determined using the enacted tax rates in effect for the years in which those tax assets are expected to be realized. A valuation allowance is established when it is more likely than not the future realization of all or some of the deferred tax assets will not be achieved. The evaluation of the need for a valuation allowance is performed on a jurisdiction by jurisdiction basis, and includes a review of all available positive and negative evidence. When we establish or reduce the valuation allowance against deferred tax assets, our provision for income taxes will increase or decrease, respectively, in the period such determination is made. As of June 30, 2012 and December 31, 2011, we maintained a valuation allowance against U.S. and foreign deferred tax assets that we concluded had not met the “more likely than not” threshold. Changes in the valuation allowance when they are recognized in the provision for income taxes are included as a component of the estimated annual effective tax rate.
We recognize excess tax benefits associated with stock-based compensation to stockholders' equity only when realized. When assessing whether excess tax benefits relating to stock-based compensation have been realized, we follow the with-and-without approach, excluding any indirect effects of the excess tax deductions. Under this approach, excess tax benefits related to stock-based compensation are not deemed to be realized until after the utilization of all other tax benefits available to us.
We recognize the impact of a tax position in our financial statements only if that position is more likely than not of being sustained upon examination by taxing authorities, based on the technical merits of the position. Any interest and penalties related to uncertain tax positions will be reflected in income tax expense.
Stock-based Compensation
We measure and recognize compensation expense for all stock-based payments made to employees, directors, and consultants based on estimated fair value, net of an estimated forfeiture rate. These stock-based awards include stock options, stock purchase rights under the 1999 Employee Stock Purchase Plan, or ESPP, and restricted stock and stock units. We estimate the fair value of stock options granted and stock purchases under our ESPP using the Black-Scholes-Merton, or BSM, option-pricing model. The fair value of our restricted stock units is based on the market price of our common stock on the date of grant. The determination of fair value of stock-based awards using the BSM pricing model requires the use of certain estimates and highly judgmental assumptions that affect the amount of stock-based compensation expense recognized in our condensed consolidated statements of operations and comprehensive loss. These include estimates of the expected volatility of our stock

11


price, expected life of an award, expected dividends, and the risk-free interest rate. We amortize the fair value of stock-based compensation on a straight-line basis over the requisite service periods of the awards. Our net loss included the following compensation expense related to our stock-based compensation awards (in thousands):
 
 
Three months ended
June 30,
 
Six months ended
June 30,
 
2012
 
2011
 
2012
 
2011
Selling and marketing expense
$
933

 
$
1,003

 
$
1,785

 
$
1,717

Research and development expense
1,138

 
1,357

 
2,278

 
2,382

General and administrative expense
1,160

 
1,158

 
2,050

 
2,021

 
$
3,231

 
$
3,518

 
$
6,113

 
$
6,120

Cash flows resulting from tax deductions in excess of the cumulative compensation cost recognized for options exercised (excess tax benefits) are classified as cash inflows from financing activities and cash outflows from operating activities. Due to our net loss position, no tax benefits have been recognized in the condensed consolidated statements of cash flows.
We have not recognized, and do not expect to recognize in the near future, any tax benefit related to stock-based compensation cost as a result of the full valuation allowance of our net deferred tax assets and our net operating loss carryforwards.
The fair value of options granted to non-employees is estimated at the measurement date using the BSM pricing model and remeasured at each reporting date to fair value, with changes recorded in the statement of operations and comprehensive loss in the current period. Stock-based compensation for options granted to non-employees was not significant for all periods presented.
Comprehensive Loss
Comprehensive loss and its components encompasses all changes in equity other than those with stockholders and includes net loss, unrealized gains and losses on our available-for-sale marketable securities, and foreign currency translation gains and losses.
 
Net Loss Per Share
Basic and diluted net loss applicable to common stock per share is computed using the weighted-average number of common shares outstanding during the period. In a period of a net loss position, basic and diluted weighted-average shares are the same. Shares used in calculating basic and diluted net loss per common share exclude as antidilutive the following common share equivalents:  
 
As of June 30,
 
2012
 
2011
Options to purchase common stock
5,637,039

 
4,311,276

Restricted stock not yet vested and released
837,294

 
1,111,994

Warrants to purchase common stock
250,000

 
259,035

 
6,724,333

 
5,682,305

Recent Accounting Pronouncements
In June 2011, the Financial Accounting Standards Board, or FASB, issued Accounting Standards Update, or ASU, No. 2011–05, Presentation of Comprehensive Income. The guidance requires an entity to present items of net income and other comprehensive income, or OCI, and total comprehensive income either in a single continuous statement of comprehensive income or two separate but continuous statements. We are no longer allowed to present OCI in the statement of stockholders' equity. Earnings per share will continue to be based on net income. The adoption of this update did not have a material impact on our condensed consolidated financial statements.
In May 2011, the FASB issued ASU 2011–04, Amendments to Achieve Common Fair Value Measurements and Disclosures Requirements in U.S. GAAP and IFRSs, which clarified and amended the wording used to describe many of the requirements in GAAP for measuring fair value and for disclosing information about fair value measurements. The FASB also clarified the intent of existing fair value measurement requirements. The adoption of this update did not have a material impact on our condensed consolidated financial statements.


12



2. Other Financial Information
The following table provides information regarding our genetic analysis product sales and services revenues (in thousands):
 
Three months ended
June 30,
 
Six months ended
June 30,
 
2012
 
2011
 
2012
 
2011
Product sales
$
8,329

 
$
10,011

 
$
16,784

 
$
19,919

Maintenance services
1,378

 
1,229

 
2,612

 
2,467

Contract research
435

 
491

 
885

 
1,189

Total genetic analysis product sales and services revenues
$
10,142

 
$
11,731

 
$
20,281

 
$
23,575

 
The following is a summary of our marketable securities (in thousands):
 
June 30, 2012
 
Amortized
Cost 
 
Gross
Unrealized
Gains 
 
Gross
Unrealized
Losses 
 
Estimated
Fair Value 
Government and agency-backed debt securities
$
1,011

 
$
1

 
$

 
$
1,012

Mutual funds
224

 
127

 

 
351

Certificates of deposit
7,114

 
13

 
(5
)
 
7,122

U.S. treasury securities
29,993

 
3

 

 
29,996

Total marketable securities
$
38,342

 
$
144

 
$
(5
)
 
$
38,481

 
 
December 31, 2011
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Estimated
Fair Value
Government and agency-backed debt securities
$
5,067

 
$
5

 
$

 
$
5,072

Mutual funds
224

 
100

 
(1
)
 
323

Certificates of deposit
4,901

 
11

 
(3
)
 
4,909

U.S. treasury securities
44,971

 
15

 

 
44,986

Total marketable securities
$
55,163

 
$
131

 
$
(4
)
 
$
55,290

As of June 30, 2012, we had certain marketable securities in a gross unrealized loss position, which had been in such position for less than twelve months. There were no unrealized losses due to credit issues for the periods presented. There were no impairments considered other-than-temporary, as it is management's intention and ability to hold the securities until maturity or a recovery of the cost basis or recovery of fair value. The following table shows the fair values and the gross unrealized losses of our marketable securities that were in an unrealized loss position as of June 30, 2012 and December 31, 2011 aggregated by investment category (in thousands):
 
 
June 30, 2012
 
December 31, 2011
 
Fair Value
 
Gross
Unrealized
Losses
 
Fair Value 
 
Gross
Unrealized
Losses 
Government and agency-backed debt securities
$

 
$

 
$
1,011

 
$
(1
)
Certificates of deposit
4,787

 
(5
)
 
3,701

 
(3
)
Total
$
4,787

 
$
(5
)
 
$
4,712

 
$
(4
)
Realized gains and losses are determined based on the specific identification method and are reported in other income (loss), net, in the condensed consolidated statements of operations and comprehensive loss. Gross realized gains and losses on sales of marketable securities were immaterial for all periods presented. As of June 30, 2012, all of our marketable securities were due within one year.
 

13


The components of inventories were as follows (in thousands):
 
June 30,
2012
 
December 31,
2011
Raw materials
$
8,988

 
$
7,069

Work in process
530

 
113

Finished goods
1,033

 
1,547

Total
$
10,551

 
$
8,729

Equipment and leasehold improvements and related accumulated depreciation and amortization were as follows (in thousands):
 
June 30,
2012
 
December 31,
2011
Laboratory equipment
$
38,413

 
$
32,864

Leasehold improvements
10,991

 
6,819

Office furniture and equipment
17,605

 
15,486

 
67,009

 
55,169

Less accumulated depreciation and amortization
(39,831
)
 
(35,540
)
Total
$
27,178

 
$
19,629

3. Acquisitions
SensiGen, LLC
In February 2009, we completed a taxable acquisition of certain assets and assumption of certain liabilities of SensiGen, LLC, or SensiGen. The acquisition of the SensiGen assets provided us with intellectual property related to certain molecular diagnostics for women's health and cancer. The acquisition resulted in the recognition of goodwill at the time of purchase of $7.0 million and is now part of our wholly-owned subsidiary Sequenom CMM. Under the terms of the asset purchase agreement (the Agreement), we acquired certain assets related to SensiGen's business in gene-based molecular diagnostic tests relating to cervical cancer, head and neck cancer, chronic kidney disease, and lupus. We paid SensiGen cash consideration of $1.9 million and issued common stock valued at $1.9 million. An additional $1.3 million was contingently payable to SensiGen upon the completion of certain triggering events occurring prior to the end of the agreement period in February 2012 with either cash or shares of our common stock. We satisfied certain of the triggering events related to the Agreement with aggregate cash payments of $650,000 and the Agreement expired in February 2012.
4. Segment Reporting
We operate our business on the basis of two reportable segments, Molecular Diagnostics (including Sequenom CMM) and Genetic Analysis. A further description of the operations of these segments is below.

For the three months ended June 30, 2012 we generated 44.4% of our revenues from our Molecular Diagnostics segment, which were primarily derived from providing diagnostic testing services for Sequenom CMM's MaterniT21 PLUS LDT, SensiGene CF LDT, SensiGene RHD LDT, and RetnaGene AMD LDT. For the three months ended June 30, 2011 we generated 12.0% of our revenues from our Molecular Diagnostics segment, which were primarily derived from providing diagnostic testing services for Sequenom CMM's SensiGene CF LDT, and to a much lesser extent the SensiGene RHD LDT and the RetnaGene AMD LDT. For the six months ended June 30, 2012 we generated 38.9% of our revenues from our Molecular Diagnostics segment, which were primarily derived from providing diagnostic testing services for Sequenom CMM's MaterniT21 PLUS LDT, SensiGene CF LDT, SensiGene RHD LDT, and RetnaGene AMD LDT. For the six months ended June 30, 2011 we generated 12.2% of our revenues from our Molecular Diagnostics segment, which were primarily derived from providing diagnostic testing services for Sequenom CMM's SensiGene CF LDT, and to a much lesser extent the SensiGene RHD LDT and RetnaGene AMD LDT. There were no revenues related to the MaterniT21 PLUS LDT in the three and six months ended June 30, 2011 due to commencement of its commercialization in the fourth quarter of 2011. In February 2012, the MaterniT21 LDT was rebranded under the name MaterniT21 PLUS LDT and the expanded test included detection of increased representation of chromosome 18 and 13 material (associated with trisomy 18 and 13, respectively), in addition to chromosome 21 material (associated with trisomy 21). Revenue for Molecular Diagnostics is generated primarily from customers located within the United States.
 

14


For the three months ended June 30, 2012 and 2011, we generated 55.6% and 88.0%, respectively, of our revenues from our Genetic Analysis segment. For the six months ended June 30, 2012 and 2011, we generated 61.1% and 87.8%, respectively, of our revenues from our Genetic Analysis segment. Product sales and services revenues for this segment were derived from sales of consumables, including our SpectroCHIP arrays used with our iPLEX assay and other assays, MassARRAY systems, maintenance agreements, sales and licensing of our proprietary software, and contract research services. Revenue for the Genetic Analysis segment is generated primarily from customers located in North America, and customers and distributors located in Europe and Asia.
We evaluate segment performance based on a revenue and operating income (loss) basis exclusive of general and administrative expenses, stock-based compensation, litigation settlement expense, other indirect costs, and certain other adjustments, which are not allocated to our segments for performance assessment by our chief operating decision maker. Unallocated operating expenses excluded from our segments for performance assessment represent expenses that do not reflect, according to criteria established by us, operating expenses associated with our reportable segment activities. No evaluation of segment performance or allocation of resources is done by our chief operating decision maker in consideration of discrete segment assets and we do not discretely allocate assets to our operating segments. Intersegment revenues and transfers are immaterial. The accounting policies of the reportable segments are the same as those described in the summary of significant accounting policies.
The following table sets forth our revenues and operating income (loss) from our Genetic Analysis and Molecular Diagnostics segments (in thousands):
 
Three months ended
June 30,
 
Six months ended
June 30,
 
2012
 
2011
 
2012
 
2011
Revenues:
 
 
 
 
 
 
 
Genetic Analysis
$
10,142

 
$
11,731

 
$
20,281

 
$
23,575

Molecular Diagnostics
8,110

 
1,601

 
12,891

 
3,267

Total revenues
$
18,252

 
$
13,332

 
$
33,172

 
$
26,842

Operating (loss) income:
 
 
 
 
 
 
 
Genetic Analysis
$
663

 
$
4,040

 
$
3,742

 
$
8,160

Molecular Diagnostics
(13,454
)
 
(9,025
)
 
(27,109
)
 
(15,645
)
Unallocated
(16,450
)
 
(15,970
)
 
(30,202
)
 
(26,593
)
Total operating loss
$
(29,241
)
 
$
(20,955
)
 
$
(53,569
)
 
$
(34,078
)
5. Debt and Obligations
Debt
In May 2011, we and our wholly-owned subsidiary Sequenom CMM entered into a Loan and Security Agreement, or the Loan Agreement, with Silicon Valley Bank, or SVB, that allows for term loans of up to $20.0 million through August 31, 2012, revolving cash borrowings of up to $10.0 million, as well as letters of credit all under a secured credit facility. All borrowings under the Loan Agreement are secured by substantially all of our and Sequenom CMM's assets, except for intellectual property, and are subject to certain other exceptions. The Loan Agreement includes limitations on our ability, among other things, to incur debt, to grant liens, to make certain investments, to make certain restricted payments such as dividend payments, and to dispose of assets, as well as requirements to meet a number of affirmative and negative covenants.
Under the Loan Agreement, term loans bear interest at the rate fixed on the date of funding equal to the U.S. treasury rate plus 3.25% per annum (3.64% - 4.24% at June 30, 2012). The term loan borrowings are to be repaid in 33 equal installments of principal, plus accrued interest commencing on September 1, 2012. The term loan requires a final payment of the greater of $420,000 or 3.5% of all advances made under the term loan, in addition to principal repayments, at the loan maturity date, which is May 1, 2015. We have the option to prepay the outstanding balance of the term loan in full, subject to the final payment, and a prepayment fee of 2% of the principal amount prepaid if the prepayment occurs before August 31, 2012. Under this term loan we had borrowed $20.0 million and $15.0 million as of June 30, 2012 and December 31, 2011, respectively.
 Under the terms of the revolving credit facility, we may borrow up to $10 million based on a percentage of eligible accounts receivable, as defined in the Loan Agreement. Amounts outstanding under the revolving credit facility accrue interest, payable monthly, at a floating rate equal to 1% over the U.S. prime rate, with principal due on May 31, 2014. We have the option to terminate the revolving credit facility prior to the loan maturity date and repay the outstanding balance in full, subject to a termination fee between 1% to 3% depending upon when prepayment occurs. No amounts had been drawn under this credit line as of June 30, 2012.

15


At June 30, 2012 we were in compliance with all covenants under the Loan Agreement. These include a minimum liquidity covenant requiring us to maintain with SVB unrestricted cash and marketable securities plus available amounts equal to or greater than the sum of all indebtedness owed to SVB plus our operating liquidity.
6. Commitments and Contingencies
Building Leases
We lease office and manufacturing facilities under various non-cancellable operating lease agreements. Facility leases generally provide for periodic rent increases, and many contain escalation clauses and renewal options. Certain leases require the Company to pay property taxes and routine maintenance. We are headquartered in San Diego, California and lease facilities in the United States, Germany, China, United Kingdom, Australia, and Japan. These leases have various terms that expire at various dates through December 2016.
 
In November 2011 we entered into a lease and a sublease agreement for two new facilities located in San Diego, California, and Durham, North Carolina, respectively. The lease has an initial term through January 2016. The sublease has an initial term through December 2016. We are making certain leasehold improvements to each of these facilities, which we will amortize over the shorter of the lease term or their expected useful life. The landlords for each of these properties have granted us certain leasehold improvement allowances, which will reduce rent expense over the initial lease and sublease terms.
Purchase Obligations
We have committed to make future minimum payments to third parties for certain inventories and research and development supplies.
7. Litigation
Patent Litigation
In December 2011, we were named as a defendant in a complaint filed by plaintiff Aria Diagnostics, Inc., or Aria, in the United States District Court for the Northern District of California, case no. 3:11-cv-06391-SI. In the complaint, the plaintiff seeks a judicial declaration that no activities related to the plaintiff's noninvasive, prenatal test using cell-free DNA circulating in the blood of a pregnant woman do or will infringe any claim of U.S Patent No. 6,258,540 entitled Noninvasive Prenatal Diagnosis, or the '540 Patent, which we have exclusively in-licensed from Isis Innovation Limited, or Isis. In March 2012, we filed an answer to the complaint and asserted counterclaims that Aria is infringing the '540 Patent and seeking unspecified damages and injunctive relief. Our counterclaims name our licensor Isis as a nominal counter-defendant for purposes of subject matter jurisdiction only and we seek to realign Isis as a co-counter plaintiff in the matter. In March 2012, Aria responded to our answer and counterclaims and asserted affirmative defenses including invalidity of the '540 Patent under United States patent laws. In March 2012 we filed a motion against Aria for preliminary injunctive relief. On July 5, 2012, the Court denied our motion for preliminary injunctive relief and on July 16, 2012 we filed a Notice of Appeal to the United States Court of Appeals for the Federal Circuit from the order denying the preliminary injunction motion. We intend to vigorously defend against the judicial declaration sought by Aria in its complaint and intend to vigorously pursue our claims against Aria for damages and injunctive relief. In January 2012, we filed a separate complaint against defendant Aria in the United States District Court for the Southern District of California (the Southern District Complaint) alleging that Aria is infringing the '540 Patent and seeking unspecified damages and injunctive relief. In March 2012, the Southern District Complaint was dismissed without prejudice and the subject matter of the complaint was re-filed as the counterclaims referred to above, in the United States District Court for the Northern District of California. Since the complaints were filed, Aria has changed its name to Ariosa Diagnostics, Inc.
In January 2012, we were named as a defendant in a complaint filed by plaintiff Natera, a Delaware corporation, in the United States District Court for the Northern District of California, case no. 3:12-cv-00132-SI. In the complaint, the plaintiff seeks a judicial declaration that (i) activities related to the plaintiff's noninvasive, prenatal paternity test do not directly or indirectly infringe any claim of the '540 Patent, which we have exclusively in-licensed from Isis, and (ii) one or more claims of the '540 Patent are invalid for failure to comply with the requirements of the patent laws of the United States. In April 2012, we filed an answer to the complaint and asserted counterclaims that Natera and DNA Diagnostics Center, Inc., or DDC, are infringing the '540 Patent based on their activities relating to noninvasive prenatal paternity testing and noninvasive prenatal aneuploidy testing and seeking unspecified damages and injunctive relief. Our counterclaims name our licensor Isis as a nominal counter-defendant for purposes of subject matter jurisdiction only and we seek to realign Isis as a co-counter plaintiff in the matter. We intend to vigorously defend against the judicial declarations sought by Natera in its complaint and intend to vigorously pursue our claims against Natera for damages and injunctive relief. In January 2012, we filed a separate complaint against defendants Natera and DDC in the United States District Court for the Southern District of California (the Southern District Natera Complaint) alleging that Natera and DDC are infringing the '540 Patent and seeking unspecified damages and

16


injunctive relief. In March 2012, the Southern District Natera Complaint was dismissed without prejudice and the subject matter of the complaint was re-filed as the counterclaims referred to above, in the United States District Court for the Northern District of California.
In February 2012, we and Sequenom CMM were named as defendants in a complaint filed by plaintiffs Verinata Health, Inc., or Verinata, and The Board of Trustees of the Leland Stanford Junior University, or Stanford, in the United States District Court for the Northern District of California, case no. 3:12-cv-00865-SI. In the complaint (i) Verinata seeks a judicial declaration that activities related to its noninvasive prenatal test using cell-free DNA circulating in the blood of a pregnant woman do not directly or indirectly infringe any claim of the '540 Patent, which we have exclusively in-licensed from Isis, (ii) Verinata seeks a judicial declaration that each claim of the '540 Patent is invalid for failure to comply with the requirements of the patent laws of the United States, and (iii) Verinata and Stanford allege that we and Sequenom CMM, by performing its noninvasive prenatal MaterniT21 LDT, have and continue to directly infringe U.S. Patent No. 8,008,018 entitled Determination of Fetal Aneuploidies by Massively Parallel DNA Sequencing and U.S. Patent No. 7,888,017 entitled Noninvasive Fetal Genetic Screening by Digital Analysis, each of which have been exclusively licensed to Verinata by Stanford and seek unspecified damages. In March 2012, we filed an answer to the complaint and asserted counterclaims that Verinata is infringing the '540 Patent and seeking unspecified damages and injunctive relief. Our counterclaims name our licensor Isis as a nominal counter-defendant for purposes of subject matter jurisdiction only and we seek to realign Isis as a co-counter plaintiff in the matter. In June 2012, plaintiffs Verinata and Stanford amended their complaint and allege that we and Sequenom CMM, by performing its noninvasive prenatal MaterniT21 LDT, have and continue to directly infringe U.S. Patent No. 8,195,415 entitled Noninvasive Diagnosis of Fetal Aneuploidy by Sequencing, which has been exclusively licensed to Verinata by Stanford and seek unspecified damages. In July 2012, we filed an answer to the complaint. We intend to vigorously defend against the judicial declarations sought and allegations of infringement set forth by plaintiffs in their complaint and intend to vigorously pursue our claims against Verinata for damages and injunctive relief.
In February 2012, we and Sequenom CMM were named as defendants in a complaint filed by plaintiffs ArcticDx, Inc., or ArcticDx, ArcticAx, Inc., or ArcticAx, and ArcticAx US Ltd. (together with ArcticDx and ArcticAx, collectively referred to as Arctic) in the United States District Court for the Eastern District of Texas, case no. 2:12-cv-00081-JRG-RSP. In the complaint (i) ArcticDx alleges that we and Sequenom CMM, by performing its RetnaGene AMD LDT to predict genetic predisposition to late-stage (wet) age-related macular degeneration (AMD), have and continue to directly infringe U.S. Patent No. 8,114,592, which ArcticDx has exclusively licensed from the Cambridge Enterprise Limited and seeks unspecified damages and injunctive relief, (ii) Arctic seeks a judicial declaration that activities related to its Macula Risk genetic test for the indication of individuals with AMD do not directly or indirectly infringe any claim of U.S. Patent No. 8,053,190 (the '190 Patent), U.S. Patent No. 7,867,727 (the '727 Patent), U.S. Patent No. 7,695,909 (the '909 Patent), U.S. Patent No. 7,351,524 (the '524 Patent), and U.S. Patent No. 8,088,579 (the '579 Patent), all of which we have exclusively in-licensed from Optherion, Inc., and (iii) Arctic seeks a judicial declaration that the claims of the '190 Patent, the '727 Patent, the '909 Patent, the '524 Patent, and the '579 Patent (collectively the DJ Patents) are invalid for failure to comply with the requirements of the patent laws of the United States. In May 2012, we filed a motion to dismiss the declaratory judgment causes of action as to each of the DJ Patents for lack of case or controversy and a motion to transfer the case to the United States District Court for the Southern District of California. We intend to vigorously defend against the allegations of infringement set forth by Arctic in its complaint. The Court has set a trial date for October 2013.
Former Employee Litigation
In August 2010, Paul Hawran, our former chief financial officer, sued the three directors who comprised the special committee that during 2009 conducted the investigation of activity related to a prior trisomy 21 test under development at that time, alleging that they had defamed him, invaded his privacy, negligently and intentionally interfered with his prospective economic advantage, and committed unfair business practices under California Business and Professions Code Section 17200. Mr. Hawran alleged in his complaint that he was asked to resign because he had raised concerns about the conduct of certain of our directors. The lawsuit, Hawran v. Hixson et al, case no. 37-2010-00058632-CU-DF-NC, was filed in the Superior Court of California for the North County of San Diego. In September 2010, we were served with an amended complaint in this lawsuit, in which Mr. Hawran named us as a defendant in addition to the three individuals previously named and added claims of breach of contract and intentional and negligent misrepresentation. In October 2010, the defendants filed a motion to strike the complaint under California Code of Civil Procedure Section 425.16 on the grounds that Mr. Hawran's claims arise from acts in furtherance of the defendants' right of petition or free speech under the United States or California Constitution in connection with a public issue and filed a demurrer to each and every cause of action in the complaint. On January 3, 2011, the court issued a minute order dismissing some, but not all, of the claims alleged in the amended complaint. The defendants filed a notice of appeal regarding the minute order on January 11, 2011 and Mr. Hawran filed a cross-appeal regarding the same on January 31, 2011. The individual defendants and we intend to vigorously defend ourselves against the claims advanced. The appeal is currently pending.

17


In addition, from time to time, we may be involved in litigation relating to claims arising out of our operations in the normal course of business. These other matters are, in the opinion of management, immaterial with respect to our consolidated financial position, liquidity, or results of operations.
Claim estimates that are probable and can be reasonably estimated are reflected as liabilities of the Company. Because of the uncertainties related to our pending litigation, investigations, inquiries or claims, management is currently unable to predict the ultimate outcome of any litigation, investigation, inquiry or claim, determine whether a liability has been incurred, or make an estimate regarding the possible loss or range of loss that could result from an unfavorable outcome. It is reasonably possible that some of the matters, which are pending or may be asserted, could be decided unfavorably to the Company. An adverse ruling or outcome in any lawsuit involving us could materially affect our business, liquidity, consolidated financial position or results of operations ability to sell one or more of our products or could result in additional competition. In view of the unpredictable nature of such matters, we cannot provide any assurances regarding the outcome of any litigation, investigation, inquiry or claim to which we are a party or the impact on us of an adverse ruling of such matters.
8. Stockholders' Equity
On January 25, 2012, we closed an underwritten public offering of 14,950,000 shares of our common stock at $4.15 per share. The offering resulted in aggregate net proceeds of $58.2 million after deducting underwriting commissions and transaction expenses.
Stock Compensation Plans
In May 2006, our stockholders approved our 2006 equity incentive plan (the 2006 Plan), as the successor to our 1999 stock option plan (the 1999 Plan). On June 11, 2012, our stockholders approved an amendment to our 2006 Plan to increase the number of shares of our common stock available for issuance under such plan by 5,000,000 shares. As of June 30, 2012, the aggregate number of shares of common stock that may be issued under the 2006 Plan is 18,216,951, and includes the number of shares shares outstanding under the 1999 Plan that may terminate, be forfeited, or be repurchased and would otherwise have been returned to the share reserve under the 1999 Plan. At June 30, 2012, there were 6,322,824 shares available for future option grants under the 2006 Plan.
In February 2010, our Board of Directors approved a New-Hire Equity Incentive Plan (New-Hire Plan) with a total share reserve of 550,000 shares of common stock, as amended. Equity awards under the New-Hire Plan are eligible to be issued only to persons entering into employment with us and are not available to current or former employees or directors unless there has been a bona fide period of non-employment. As of June 30, 2012, 324,200 equity awards had been issued under the New-Hire Plan. At June 30, 2012, there were 225,800 shares available for future option grants under the New-Hire Plan.
In November 1999, we adopted the ESPP with offerings under the ESPP beginning on the first business day in February and August each calendar year and are for a duration of six months. The ESPP limits stock purchases to (i) no more than 10,000 shares per individual per offering and (ii) no more than $25,000 per individual per calendar year. The price at which our common stock is purchased under the ESPP is equal to 85% of the fair market value of the common stock on the first or last day of the offering period, whichever is lower.
During the purchase periods ended January 31, 2012 and 2011, a total of 149,444 shares and 81,350 shares, respectively, were purchased by and distributed to employees at an average price of $3.66 and $4.93 per share, respectively. The total intrinsic value of purchase rights exercised was $97,000 and $156,000 for the purchase periods ended January 31, 2012 and 2011, respectively.
For the three months ended June 30, 2012 and 2011, we recognized $99,000 and $127,000, respectively, as stock-based compensation expense related to the ESPP. For the six months ended June 30, 2012 and 2011, we recognized $237,000 and $202,000, respectively, as stock-based compensation expense related to the ESPP. As of June 30, 2012, total unrecognized non-cash, compensation expense for non-vested purchase rights granted prior to that date was $34,000, with a weighted-average amortization period of 1 month. As of June 30, 2012, we had reserved 598,177 shares of common stock for issuance under the ESPP.

18


Stock-Based Compensation Expense
The estimated fair value of each stock option award granted and for stock purchased under the ESPP was determined on the date of grant using the BSM pricing model with the following assumptions:
Stock options
 
Three months ended
June 30,
 
2012
 
2011
Risk-free interest rate
1.49
%
 
2.43
%
Volatility
94.8
%
 
98.4
%
Dividend yield
%
 
%
Expected life (years)
7.6

 
7.6

Weighted-average fair value
$
3.32

 
$
6.49

ESPP
 
Three months ended
June 30,
 
2012
 
2011
Risk-free interest rate
0.13
%
 
0.18
%
Volatility
66.0
%
 
99.7
%
Dividend yield
%
 
%
Expected life (years)
0.5

 
0.5

Weighted-average fair value
$
1.52

 
$
2.98

Our determination of fair value is affected by our stock price as well as assumptions regarding a number of complex and subjective variables that require judgment. The risk-free interest rate assumption is based on observed interest rates appropriate for the expected term of our employee stock options. The expected volatility is based on the historical volatility of our stock. We have not paid any dividends on common stock since our inception and do not anticipate paying dividends on common stock in the foreseeable future. The computation of the expected option life assumption is based on a weighted-average calculation combining the average historical exercise activity and assumptions regarding the estimated life of all unexercised, outstanding stock options. The computation of the expected term of the common stock purchased under the ESPP is based on the semi-annual purchase period.
We recognize stock-based compensation cost over the vesting period using the straight-line single option method. Stock-based compensation expense is recognized only for those awards that are ultimately expected to vest. Forfeitures are required to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. Pre-vesting forfeitures were estimated to be 11.2% based on historical experience. Changes in forfeiture estimates impact compensation cost in the period in which the change in estimate occurs.
Stock Options
A summary of the combined activity related to our stock option grant awards is as follows:
 
Shares Subject to Options
 
Weighted-Average Exercise Price per Share
 
Weighted-Average Remaining Contractual Term (in years)
 
Aggregate Intrinsic Value
Outstanding at December 31, 2011
7,846,413

 
$
7.49

 
 
 
 
Granted
3,867,171

 
$
4.69

 
 
 
 
Forfeitures and cancelled
(319,111
)
 
$
9.39

 
 
 
 
Exercised
(12,511
)
 
$
3.62

 
 
 
 
Outstanding at June 30, 2012
11,381,962

 
$
6.49

 
7.8
 
$
1,656,346

Option vested and exercisable at June 30, 2012
5,637,039

 
$
7.38

 
6.4
 
$
1,550,361

The aggregate intrinsic value of stock options exercised in the three months ended June 30, 2012 and 2011 was $8,000 and $371,000, respectively. Cash received from stock option exercises for the three months ended June 30, 2012 and 2011 was $40,000 and $446,000, respectively. The aggregate intrinsic value of stock options exercised in the six months ended June 30,

19


2012 and 2011 was $10,000 and $517,000, respectively. Cash received from stock option exercises for the six months ended June 30, 2012 and 2011 was $45,000 and $664,000, respectively. As of June 30, 2012, there was $21.0 million of unamortized compensation cost related to unvested stock option awards, which is expected to be recognized over a remaining weighted-average vesting period of 3.0 years.
 
Restricted Stock
Restricted stock and restricted stock units are generally performance based awards, and vest upon achievement of defined performance targets. The following table summarizes activity related to our restricted stock units and awards:
 
Number of Shares
 
Weighted-Average
Grant Date
Fair Value
Outstanding at December 31, 2011
974,940

 
$
4.65

Grants and awards
13,980

 
$
4.49

Vested and released
(118,715
)
 
$
4.61

Forfeitures and cancelled
(32,911
)
 
$
4.49

Outstanding at June 30, 2012
837,294

 
$
4.32

The fair value of restricted stock that vested in the three months ended June 30, 2012 and 2011was $82,000 and $69,000, respectively. The fair value of restricted stock that vested in the six months ended June 30, 2012 and 2011was $570,000 and $223,000, respectively.
Warrants
In May 2011, pursuant to a license agreement, we issued to The Chinese University of Hong Kong Foundation Limited (an affiliate of CUHK) a warrant to purchase up to 200,000 shares of our common stock at a price of $7.00 per share, the closing price of our common stock at the time of issuance of the warrant. As of June 30, 2012, the warrant had not been exercised and expires in May 2018.
In connection with an amendment to our lease for our corporate headquarters in San Diego, California in September 2005, we issued to the landlord a warrant to purchase 50,000 shares of our common stock with an exercise price of $2.64 per share. As of June 30, 2012, the warrant had not been exercised and expires in October 2015.
9. Savings and Pension Plans
We have a 401(k) savings plan covering most United States employees. In the United Kingdom we make contributions to defined contribution pension plans. Under these plans, individual employees may make contributions to the plan, which can be matched by us in an amount determined by our Board of Directors or as determined by local statutes. As of June 30, 2012, we have not made any matching contributions.

20


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
All statements in this report that are not historical are forward-looking statements within the meaning of Section 21E of the Securities Exchange Act. These forward-looking statements can generally be identified as such because the context of the statement will include words such as “may,” “will,” “intend,” “plans,” “believes,” “anticipates,” “expects,” “estimates,” “predicts,” “potential,” “continue,” “opportunity,” “goals,” or “should,” the negative of these words or words of similar import. Similarly, statements that describe our future plans, strategies, intentions, expectations, objectives, goals, or prospects are also forward-looking statements. These forward-looking statements are or will be, as applicable, based largely on our expectations and projections about future events and future trends affecting our business, and so are or will be, as applicable, subject to risks and uncertainties including but not limited to the risk factors discussed in this report, that could cause actual results to differ materially from those anticipated in the forward-looking statements. We caution investors that there can be no assurance that actual results or business conditions will not differ materially from those projected or suggested in such forward-looking statements. Our views and the events, conditions and circumstances on which these future forward-looking statements are based, may change. All forward-looking statements are qualified in their entirety by this cautionary statement and we undertake no obligation to revise or update any such statements to reflect events or circumstances after the date hereof.
SEQUENOM®, Sequenom Center for Molecular Medicine®, SpectroCHIP®, iPLEX®, SensiGene®, SEQureDx® iSEQ®, and MassARRAY® are registered trademarks and RetnaGene™, MaterniT21™, and MaterniT21TM PLUS are trademarks of Sequenom, Inc. This report may also refer to trade names and trademarks of other organizations.
The MaterniT21 laboratory developed test, or LDT, was commercialized in October 2011 and in February 2012 was rebranded under the name MaterniT21 PLUS. The expanded test includes detection of any increased representation of chromosome 18 and 13 material (associated with trisomy 18 and 13, respectively), in addition to chromosome 21 material (associated with trisomy 21).
Sequenom, Inc., was incorporated in 1994 under the laws of the State of Delaware. As used in this report, the words “we,” “us,” “our,” the “Company,” and “Sequenom” refer to Sequenom, Inc. and its wholly-owned subsidiaries on a consolidated basis, unless explicitly noted otherwise.
Overview
We are a molecular diagnostics testing and genetics analysis company committed to providing molecular diagnostics testing services, research use only products, services, applications, and genetic analysis products that translate the results of genomic science into solutions for biomedical research, translational research, molecular medicine applications, and other areas of research, including agricultural and livestock. Our development and commercialization efforts in various diagnostic areas include noninvasive women's health-related and prenatal diagnostics, ophthalmology, and other medical conditions such as oncology, infectious diseases, and autoimmunity.
We have continued to see growth in our diagnostic services test volumes, in particular with increases attributable to the MaterniT21 PLUS LDT since its product launch in October 2011. Our diagnostic testing services continue to be on a cash basis for revenue recognition, until we can reliably estimate the amount that would be ultimately collected for each of our LDTs.  Additionally, we continue to invest in our diagnostic services infrastructure to support and expand our operations to effectively meet our increasing demand for our laboratory developed tests. 
Operating Segments
We operate our business on the basis of two reportable segments, Molecular Diagnostics (including Sequenom CMM) and Genetic Analysis. A further description of the operations of these segments is below.
For the three months ended June 30, 2012 we generated 44.4% of our revenues from our Molecular Diagnostics segment, which were primarily derived from providing diagnostic testing services for Sequenom CMM's MaterniT21 PLUS LDT, SensiGene CF LDT, SensiGene RHD LDT, and RetnaGene AMD LDT. For the three months ended June 30, 2011 we generated 12.0% of our revenues from our Molecular Diagnostics segment, which were primarily derived from providing diagnostic testing services for Sequenom CMM's SensiGene CF LDT, and to a much lesser extent the SensiGene RHD LDT and RetnaGene AMD LDT. For the six months ended June 30, 2012 we generated 38.9% of our revenues from our Molecular Diagnostics segment, which were primarily derived from providing diagnostic testing services for Sequenom CMM's MaterniT21 PLUS LDT, SensiGene CF LDT, SensiGene RHD LDT, and RetnaGene AMD LDT. For the six months ended June 30, 2011 we generated 12.2% of our revenues from our Molecular Diagnostics segment, which were primarily derived from providing diagnostic testing services for Sequenom CMM's SensiGene CF LDT, and to a much lesser extent the SensiGene RHD LDT and RetnaGene AMD LDT. There were no revenues related to the MaterniT21 PLUS LDT in the three and six months ended June 30, 2011 due to commencement of its commercialization in the fourth quarter of 2011. Revenue for Molecular Diagnostics is generated primarily from customers located within the United States.

21


Diagnostic services revenues have been recognized on a cash basis due to the lack of contractual reimbursement agreements with third-party payors and limited collections experience. We generally bill third-party payors upon generation and delivery of test results to the ordering physician. As such, we take assignment of benefits and risk of collection with the third-party payor. Patients have out-of-pocket costs for amounts not covered by their insurance carrier and we bill the patient directly for these amounts in the form of co-pays and deductibles. Some payors may not cover our testing services as ordered by the physician under their reimbursement policies. Consequently, we pursue reimbursement on a case-by-case basis. We recognize diagnostic services revenues upon cash collection until we can reliably estimate the amount that would be ultimately collected for each of our LDTs.
 
For the three months ended June 30, 2012 and 2011, we generated 55.6% and 88.0%, respectively, of our revenues from our Genetic Analysis segment. For the six months ended June 30, 2012 and 2011, we generated 61.1% and 87.8%, respectively, of our revenues from our Genetic Analysis segment. Product sales and services revenues for this segment were derived from sales of consumables, including our SpectroCHIP arrays used with our iPLEX assay and other assays, MassARRAY hardware, maintenance agreements, sales and licensing of our proprietary software, and contract research services. Revenue for Genetic Analysis is generated from customers located in North America, and customers and distributors located in Europe and Asia.
We evaluate segment performance based on a revenue and operating income (loss) basis exclusive of general and administrative expenses, stock-based compensation, litigation settlement expense, other indirect costs, and certain other adjustments, which are not allocated to our segments for performance assessment by our chief operating decision maker. Unallocated operating expenses excluded from our segments for performance assessment represent expenses that do not reflect, according to criteria established by us, operating expenses associated with our reportable segment activities. No evaluation of segment performance or allocation of resources is done by our chief operating decision maker in consideration of discrete segment assets and we do not discretely allocate assets to our operating segments. Intersegment revenues and transfers are immaterial. The accounting policies of the reportable segments are the same as those described in the summary of significant accounting policies.
The following table sets forth our revenues from our Genetic Analysis and Molecular Diagnostics segments (in thousands):
 
Three months ended
June 30,
 
Six months ended
June 30,
 
2012
 
2011
 
2012
 
2011
Revenues:
 
 
 
 
 
 
 
Genetic Analysis
$
10,142

 
$
11,731

 
$
20,281

 
$
23,575

Molecular Diagnostics
8,110

 
1,601

 
12,891

 
3,267

Total revenues
$
18,252

 
$
13,332

 
$
33,172

 
$
26,842

Molecular Diagnostics and SEQureDx Technology
Sequenom, Inc.
We are committed to researching, developing, and pursuing the commercialization of various noninvasive molecular diagnostic tests for prenatal genetic disorders, and diseases, women's health-related disorders and diseases, ophthalmology, and other medical conditions such as oncology, infectious diseases, and autoimmune diseases. Currently, we are primarily focused on developing and commercializing prenatal diagnostic tests using our foundational, patent-protected, noninvasive, circulating cell-free fetal, or ccff, nucleic acid-based assay technology, which we in-license from Isis Innovation Limited, or Isis. This technology uses a maternal blood sample for a prenatal diagnosis or risk assessment in order to provide reliable information about the presence, amount, or absence of fetal genetic material in early pregnancy. We have branded our technology for prenatal diagnostics under the trademark SEQureDx. Our efforts in molecular diagnostics are focused on developing noninvasive in vitro diagnostic tests using our proprietary MassARRAY system and/or nucleic acid sequencing platforms currently provided by Illumina, Inc., and other vendors. We plan to execute the development, validation, and other activities necessary to file submissions with the U.S. Food and Drug Administration, or FDA, seeking clearance or approval for commercialization in the United States of certain of our in vitro diagnostic tests where we believe it will afford us competitive advantages to do so, such as providing us with the flexibility to sell the tests as FDA cleared in vitro diagnostic, or IVD, kits to other laboratories, and an alternative in the event the FDA decides to exercise its enforcement jurisdictional authority with respect to regulation of laboratory-developed tests as in vitro diagnostics. Historically, the FDA has exercised enforcement discretion and exempted from regulation LDTs, but the FDA has stated that additional regulation of LDTs may be warranted. In 2010 we submitted a pre-investigational device exemption submission and supplemental submissions in 2011 and 2012 to the FDA for an in vitro diagnostic test for fetal chromosome 21 aneuploidy, such as trisomy 21, and have met with the FDA to discuss our proposed preclinical and clinical study designs. Patient enrollment has been initiated for this clinical study.


22


Sequenom Center for Molecular Medicine
Sequenom CMM is our wholly-owned subsidiary, and operates a laboratory located in Grand Rapids, Michigan, and a second laboratory located in San Diego, California, that are both accredited by the College of American Pathology, or CAP, and compliant with the certification requirements for high complexity testing under the Clinical Laboratory Improvement Amendments, of 1988, as amended, or CLIA. Sequenom CMM develops and validates its LDTs for use in, and solely by, Sequenom CMM as a testing service to physicians. Sequenom CMM utilizes our patented SEQureDx ccff technology in developing and performing some of its LDTs. Sequenom CMM has validated and currently offers to physicians four LDTs: MaterniT21 PLUS to determine the relative amounts of chromosome 21, 18, and 13 material present in circulating cell-free DNA in a maternal blood sample; SensiGene RHD Genotyping to determine maternal blood type and Rhesus D factor; SensiGene Cystic Fibrosis Carrier Screening to help identify individuals who may have an increased risk of having certain cystic fibrosis genetic mutations; and RetnaGene AMD to predict genetic predisposition to develop late-stage (wet) age-related macular degeneration, or AMD. Patient samples are collected by health care professionals and submitted to Sequenom CMM for testing and test results are reported back to the ordering physician.
We have invested substantially in Sequenom CMM's information technology infrastructure to enhance the laboratory's ability to track samples and provide electronic ordering and reporting and have put in place sample collection and transportation logistics that can be scaled as demand for Sequenom CMM's molecular diagnostic testing services increases. Currently, we offer pricing on our diagnostic testing services that address the following general parameters: for insured patients, the payor is being billed at the full list price, with the patients having certain out-of-pocket expenses, and any outstanding amounts being pursued from the payor, not the patient, on appeal. Uninsured patients are billed using a separately maintained price list. Sequenom CMM operates primarily as an out-of-network laboratory provider with most private insurance companies.  We are working with many insurers and network providers to become a contracted laboratory provider. We expect the adoption of our tests by insurers to vary as well as the amounts received from our billing to fluctuate until we are able to establish a sufficient number of contracts or meaningful payment histories.
Prenatal Diagnostics Licenses
Isis License Agreement
We have exclusively in-licensed from Isis patent rights (including U.S. Patent No. 6,258,540 and its foreign equivalents) to use ccff nucleic acids for diagnostic testing of serum and plasma samples obtained from pregnant women. These exclusive license rights, which are platform independent and not limited to mass spectrometry, cover the general diagnostic use of ccff nucleic acids in territories that include the United States, Canada, Europe, Japan, Australia, and Hong Kong.
Subject to the license rights granted under the agreement with Isis, intellectual property rights created in connection with improvements made to the licensed technology will belong to the party developing the improvements. We also granted a perpetual royalty-free license to the University of Oxford, which is the parent of Isis, to use and publish material relating to the licensed technology and any of our improvements solely for non-commercial use. The University of Oxford's right to publish is subject to our right to delay publication of information to protect the licensed technology or our improvements.
We have made up-front payments to Isis and agreed to pay to Isis royalties on net sales of products developed or produced using the licensed patent rights, including specified minimum royalty amounts and milestone payments upon commercial events with respect to products for particular indications.
The agreement with Isis will remain in force for the life of any patent issued in connection with the patent application covering the licensed technology, subject to earlier termination by either party upon uncured material breach or other specified circumstances. Isis may terminate the agreement if we file a petition to wind-up or dissolve or upon 30 days' written notice if we were to challenge the validity of the patent rights covering the licensed technology or fail to make the up-front payments as provided in the agreement. We may terminate the agreement for any reason with six months' advance written notice. In the event we fail to achieve certain milestone requirements with respect to particular indications, Isis may convert the exclusive license into a non-exclusive license with respect to those indications.
CUHK License Agreements
In May 2011, we entered into a License Agreement with The Chinese University of Hong Kong, or CUHK, pursuant to which CUHK granted us an exclusive, worldwide (excluding Hong Kong), royalty-bearing license to use, and to sublicense, certain intellectual property covered by patent applications owned by CUHK for prenatal diagnostics, prognostics, and analysis for research and commercial purposes. This license agreement covers intellectual property rights relating to size-based genomic analysis. Pursuant to this license agreement we have paid an aggregate license fee to CUHK of $3,000,000. Because we consider the technology to still be in the research and development phase and to have no alternative future uses, we recorded the aggregate license fee as research and development expense in 2011. We are obligated to pay royalties on sales of products incorporating the licensed intellectual property and amounts we receive from any sublicensees. We are also obligated to pay

23


additional amounts to CUHK upon the accomplishment of certain development and commercialization milestones. If we fail to achieve certain development and commercialization milestones within specified timeframes, CUHK may terminate this license agreement. In accordance with this license agreement, CUHK will prosecute, defend and maintain certain patent applications relating to the licensed intellectual property at our expense. This license agreement will expire on the later of 20 years or the expiration of the last patent, if any patent is issued, relating to the licensed intellectual property, unless terminated earlier pursuant to the terms of this license agreement. We may terminate this license agreement at any time after one year on 30 days written notice to CUHK.
In May 2011, pursuant to this license agreement, we issued to The Chinese University of Hong Kong Foundation Limited (an affiliate of CUHK) a warrant to purchase up to 200,000 shares of our common stock at a price of $7.00 per share, the closing price of our common stock on May 3, 2011. The warrant was immediately exercisable, in whole or in part, but not for less than 20,000 shares and in increments of 20,000 shares, has a term of seven years, and was valued at $1.2 million using the Black-Scholes-Merton, or BSM, option-pricing model, which we recorded as research and development expense in 2011.
We have also exclusively in-licensed patent rights from CUHK, which cover the use of cell-free fetal nucleic acids from biological samples, including plasma, serum, whole blood and urine, for prenatal diagnostic testing by massively parallel sequencing. These exclusive license rights include pending United States patent application publication no. US2009/0029377A1, and its pending foreign equivalents in Australia, Brazil, Canada, China, Eurasia, Europe, Israel, India, Japan, Korea, Mexico, New Zealand, Singapore, and South Africa. Certain of our license rights, which are unrelated to prenatal diagnostic testing by massively parallel sequencing, are non-exclusive. Under this license agreement with CUHK, CUHK maintains the right to use and develop any of the licensed technology solely for academic, research and publication purposes, and with respect to one of the licensed patent applications, reserves the right to use the licensed application in accordance with its agreement with the Government of the Special Administration Region of Hong Kong. In addition, CUHK has the right to grant to the Commissioner for Innovation and Technology, a non-exclusive, world-wide license to certain of our in-licensed patent rights, which do not relate to prenatal diagnostic testing by massively parallel sequencing. Under this agreement, we paid an upfront license fee to CUHK and are required to make milestone payments upon commercial and regulatory events achieved with respect to products developed or produced using the licensed patent rights and to pay royalties on net sales of such products, including specified minimum royalty amounts. Subject to certain limited circumstances, to maintain our licensed rights under the agreement we are required to assume the financial responsibility for the prosecution, defense and maintenance of all licensed patent applications and patents and are required to provide CUHK with reasonable assistance for the prosecution, defense and maintenance of all licensed patent applications and patents at the request of CUHK.
This agreement with CUHK requires us to use all reasonable efforts and diligence to exploit the licensed patent rights and to proceed with the development, manufacture and sale of products developed or produced using the licensed patent rights, and to diligently develop markets for such products. Under the terms of the agreement, we have agreed to indemnify CUHK from all losses incurred by CUHK relating to our manufacture, use, sale or any other dealing with respect to products developed or produced using the licensed patent rights. CUHK has agreed to indemnify us from all losses incurred as a result of breaches of CUHK's representations and warranties under the agreement, subject to a cap of two times the aggregate payments received by CUHK from us at the time of such breach.
This agreement with CUHK will remain effective until the later of the life of any patent issued covering the licensed technology or September 16, 2028, subject to earlier termination by either party upon an uncured material breach. CUHK may terminate the agreement if we go into liquidation or if a receiver is appointed for our assets or if we fail to make any payment as provided in the agreement or if we assign or transfer any rights under the agreement in violation of its terms or in the event of our cessation of our business relating to the commercialization of the licensed technology. If we sublicense our rights under the agreement and our sublicensee fails to pay us as required under such sublicense agreement and as a result we fail to make requisite payments to CUHK within 30 days, CUHK may terminate our agreement.
We may terminate the agreement with CUHK for any reason with 30 days' advance written notice. In the event we fail to achieve certain commercial milestone requirements with respect to products developed or produced using the licensed patent rights, CUHK may terminate the licensed patent rights with respect to such specific milestone.
Under the terms of the license agreement and other agreements with CUHK, we have rights in improvements to licensed technology when such improvements are based upon and claim priority to existing patent applications that have been licensed by us. We also have a sole and exclusive option to obtain an exclusive license to research results generated by specific CUHK inventors, using a sequencing platform purchased by us for CUHK's use, and which relate to massively parallel sequencing to discover and analyze plasma, serum, blood or other bodily fluid-based markers for prenatal diagnosis, prenatal prognostication, construction of a whole genome genetic map or complete genomic sequencing of the fetus or other prenatal analysis, cancer detection, cancer prognostication, or other analysis for the screening and management of cancer.

24



Other Agreements
In July 2011, we entered into a Sale and Supply Agreement with Illumina, Inc., or Illumina, which was amended to extend the term of the agreement from three to five years, unless terminated earlier as provided for in the agreement, to which we and our subsidiaries will purchase laboratory equipment and consumables that will be used for our fetal chromosomal detection applications, including a noninvasive test that is designed to detect an overabundance of chromosome 21 in pregnant women, a result associated with fetal Down syndrome. This agreement requires that we submit periodic binding forecasts for consumables. Beginning in 2013, in the event that we purchase less than a specified amount of consumables during any calendar year, Illumina will be relieved of certain of its obligations and representations under the agreement, including certain of Illumina's obligations with respect to pricing terms of the consumables that we purchase. Additionally, we and Illumina have agreed to work collaboratively toward our submission for regulatory approval of an in vitro diagnostic product for the detection of fetal chromosomal abnormalities. Either party may terminate the agreement prior to expiration for the uncured material breach of the agreement by the other party or upon the bankruptcy or insolvency of the other party.
Genetic Analysis
Our proprietary MassARRAY system is comprised of hardware, software applications, and consumable chips and reagents. It is a high-performance (in speed, accuracy, sample throughput, and cost efficiency) nucleic acid analysis research use only system that quantitatively and precisely measures genetic target material and variations. Our system is widely accepted as a leading high-performance DNA analysis system for genotyping, somatic mutation analysis, and fine mapping markets and continues to gain traction for applications such as agricultural genomics and clinical research. Our research customers include premier clinical research laboratories, bioagriculture, biotechnology and pharmaceutical companies, academic institutions, and various government agencies worldwide. To provide customer support for our expanding user base, and in an effort to maximize market penetration, we have established direct sales and support employees serving North America, Europe and Asia, in addition to utilizing sales and distribution partners in several major countries throughout the world.
Our MassARRAY system provides reliable results for a wide range of DNA/RNA analysis applications, including single nucleotide polymorphism, or SNP, genotyping, detection of mutations, analysis of copy number variants, and other structural genome variations. In addition, the system provides quantitative gene expression analysis, quantitative DNA methylation analysis, comparative sequence analysis of haploid organisms, SNP discovery, and oligonucleotide quality control. These applications are provided through proprietary research use only application software that operates on the MassARRAY system and through the purchase of consumable chips and reagents. While the MassARRAY system is versatile across many applications, it is a robust and cost-effective genotyping and somatic mutation analysis solution enabled through our research use only iPLEX multiplexing assay, which permits multiplexed SNP and somatic mutation analysis. Our high performance nucleic acid analysis system has been designed to meet customer demand for a bench top instrument with greater flexibility across multiple applications, improved reliability and faster performance and is designed to empower the basic and translational research community to advance findings from discovery genetic and biomarker studies toward biomarker validation and potential clinical utility in diagnosis, prognosis and monitoring of diseases.
Our research and development efforts in genetic analysis are committed to producing new and improved components and applications for the MassARRAY system that deliver greater system versatility and higher data quality at a competitive price per data point. These research and development activities and new applications also serve to facilitate and support our molecular diagnostic initiatives.
Critical Accounting Policies and Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions in certain circumstances that affect amounts reported in the accompanying condensed consolidated financial statements and related notes. Certain of these accounting policies that we believe are the most critical to our investors' understanding of our financial results and conditions are discussed below. In preparing these financial statements, management uses its judgment to determine the appropriate assumptions to be used in the determination of certain estimates. Management considers many factors in selecting appropriate financial accounting policies and controls and in developing the estimates and assumptions that are used in the preparation of the consolidated financial statements. Management must apply significant judgment in this process. The estimation process often may yield a range of potentially reasonable estimates of the ultimate future outcomes and management must select an assessment that falls within the range of reasonable estimates. The application of these accounting policies involves the exercise of judgment and use of estimates and assumptions as to future uncertainties and, as a result, actual results could differ from these estimates. The accounting policies that reflect our more significant estimates, judgments, and assumptions and which we believe are the most critical to aid in fully understanding and evaluating our reported financial results include the following:
revenue recognition;

25


goodwill and impairment evaluations of long-lived assets;
allowance for doubtful accounts;
reserves for obsolete and slow-moving inventory;
income taxes; and
stock-based compensation.
In many cases, the accounting treatment of a particular transaction is specifically dictated by U.S. generally accepted accounting principles, or GAAP, and does not require management's judgment in its application. There are also areas in which management's judgment in selecting among available alternatives would not produce a materially different result. Our senior management has reviewed these critical accounting policies and related disclosures with the Audit Committee of our Board of Directors.
During the first six months of 2012, there were no significant changes in our critical accounting policies and estimates. Please refer to Management's Discussion and Analysis of Financial Condition and Results of Operations contained in Part II, Item 7 of our Annual Report on Form 10-K for the year ended December 31, 2011 for a more complete discussion of our critical accounting policies and estimates.


26


Results of Operations for the Three and Six Months Ended June 30, 2012 and 2011
Comparison of Three Months Ended June 30, 2012 and 2011
Revenues
Genetic analysis product sales and services revenues were derived from sales of consumables, including our SpectroCHIP arrays used with our iPLEX assay and other assays, MassARRAY systems, maintenance agreements, sales and licensing of our proprietary software, and contract research services. Diagnostic revenues were primarily derived from providing diagnostic testing services for Sequenom CMM's LDTs. There were no collections from providing diagnostic testing services for Sequenom CMM's MaterniT21 LDT in the three months ended June 30, 2011 due to commencement of its commercialization in the fourth quarter of 2011.
Revenue for the Molecular Diagnostics segment is generated primarily from customers located within the United States. Revenue for the Genetic Analysis segment is generated from customers primarily located in North America, and customers and distributors located in Europe and Asia.
 
Three months ended
June 30,
 
$
Change
 
%
Change
 
2012
 
2011
 
 
Genetic analysis product sales and services (in thousands)
$
10,142

 
$
11,731

 
$
(1,589
)
 
(14
)%
Diagnostic services (in thousands)
8,110

 
1,601

 
6,509

 
407
 %
Total revenues
$
18,252

 
$
13,332

 
$
4,920

 
37
 %
 
The decrease in our genetic analysis product sales and services revenues is primarily attributable to a decrease in consumables orders from our customers in the translational research and agricultural biology markets against the comparative period, resulting in a decrease of consumables revenues to $5.0 million from $6.1 million during the three months ended June 30, 2012 and 2011, respectively. Additionally, we had a decrease in system sales, including recognition of extended warranty maintenance contracts, to $4.7 million from $5.1 million resulting from fewer MassARRAY systems sold during the current period as compared to the same period in 2011. Contract research services also decreased to $435,000 from $491,000 during the three months ended June 30, 2012 and 2011, respectively.
Molecular Diagnostics testing services revenue is recognized upon cash collection as payments are received. The increase in revenue is attributable to the introduction of Sequenom CMM's RetnaGene AMD LDT and MaterniT21 LDT in the second and fourth quarters of 2011, respectively, and an increase in the number of SensiGene CF and SensiGene RHD tests collected during the three months ended June 30, 2012, compared to the same period in 2011, as our testing volume and related cash collections have increased.
Domestic and non-U.S. revenues were $11.0 million and $7.3 million for the three months ended June 30, 2012, respectively, and $6.0 million and $7.3 million for the three months ended June 30, 2011, respectively.
Our revenues have historically fluctuated from period to period and likely will continue to fluctuate substantially in the future based upon the unpredictable sales cycle for the MassARRAY system, general economic conditions, revenue recognition criteria, the overall acceptance and demand for our new and existing commercial products and services, as well as the adoption rates of our existing LDTs as well as future tests, and payment patterns of third-party payors and patients.
Cost of Genetic Analysis Product Sales and Services and Diagnostic Services and Gross Margins
Cost of revenues consists of employee-related costs (salaries, bonuses, fringe benefits, and stock-based compensation) of our laboratory and manufacturing personnel, and other support personnel, as well as outside laboratory costs, laboratory and manufacturing inventory and supplies, logistic costs, depreciation, and administrative-related costs allocated to cost of revenues. Gross margin consists of our revenues less cost of revenues.
 
Three months ended
June 30,
 
$
Change 
 
%
Change 
 
2.012
 
2.011
 
Genetic Analysis (in thousands)
$
7,178

 
$
8,415

 
$
(1,237
)
 
(15
)%
Genetic Analysis (% of revenues)
71
 %
 
72
%
 
 
 
 
Molecular Diagnostics (in thousands)
$
(1,297
)
 
$
492

 
$
(1,789
)
 
(364
)%
Molecular Diagnostics (% of revenues)
(16
)%
 
31
%
 
 
 
 
Gross margin (in thousands)
$
5,881

 
$
8,907

 
$
(3,026
)
 
(34
)%
Gross margin (% of revenues)
32
 %
 
67
%
 
 
 
 


27


Cost of genetic analysis product sales and services for the three months ended June 30, 2012 and 2011 were $3.0 million and $3.3 million, respectively.
Costs of diagnostic services are recognized upon providing test results to ordering physicians and were $9.4 million and $1.1 million for the three months ended June 30, 2012 and 2011, respectively. The decrease in gross margin is due to higher laboratory costs as test volumes increase. Due to revenue being recognized when cash is received, costs incurred in one period includes costs related to revenue recognized in a later period. Gross margin on diagnostic tests were affected by increased test volumes, cash collected during the period, overall reimbursement for the amount paid per test, and the increase in headcount and laboratory operational costs to support increased production capacity for diagnostic testing, and by cash collected during the period, including the overall reimbursement per test. Collection for our tests may be delayed by third-party payors while we seek to establish contracts with many of the payors.
Gross margins for our Molecular Diagnostics segment will be affected by the adoption rates of our diagnostic tests, the levels of reimbursement, and payor and other contracts we may enter into for our tests. Gross margins for our Genetic Analysis segment will fluctuate on a quarterly basis and be affected by, among other things, the selling price for MassARRAY systems and consumables, consumable sales per MassARRAY system sold, the mix of product sales and the type of services, competitive conditions, sales volumes, discounts offered, sales through distributors, as well as the cost of goods sold, inventory reserves and obsolescence charges required, and royalty payment obligations on in-licensed technologies.
Selling and marketing expenses
Selling and marketing expenses consisted primarily of salaries and related expenses for sales and marketing, customer support, and business development personnel and their related department expenses.
 
Three months ended
June 30,
 
$
Change 
 
%
Change 
 
2.012
 
2.011
 
Selling and marketing (in thousands)
$
11,303

 
$
7,678

 
$
3,625

 
47
%
Selling and marketing (% of revenues)
62
%
 
58
%
 
 
 
 
The increase in selling and marketing expenses for the three months ended June 30, 2012, compared to the same period in 2011 is primarily related to increased headcount to support our operations resulting in higher compensation and other labor related costs of $2.2 million, increased travel expenses of $0.6 million related to increased headcount of sales representatives, and increased third-party marketing of $0.5 million attributable to promoting the MaterniT21 PLUS LDT.
Research and development expenses
Research and development expenses consisted primarily of salaries and related personnel expenses, product development costs, quality and regulatory costs, and expenses relating to licensing costs and work performed under research contracts.
 
Three months ended
June 30,
 
$
Change
 
%
Change
 
2012
 
2011
 
Research and development (in thousands)
$
13,870

 
$
17,146

 
$
(3,276
)
 
(19
)%
Research and development (% of revenues)
76
%
 
129
%
 
 
 
 
The decrease in research and development expenses for the three months ended June 30, 2012, as compared to the same period in 2011 is primarily related to a $4.7 million decrease in research-related intellectual property licensing and collaboration costs and a $0.8 million decrease in clinical study costs due to completion of certain studies; partially offset by increased headcount to support our operations resulting in higher compensation and other labor related costs of $2.1 million.
General and administrative expenses
General and administrative expenses consisted primarily of salaries and related expenses for executive, legal, finance, information technology, and human resource personnel, and their related department expenses.  
 
Three months ended
June 30,
 
$
Change
 
%
Change
 
2.012
 
2011
 
General and administrative (in thousands)
$
9,949

 
$
5,038

 
$
4,911

 
97
%
General and administrative (% of revenues)
55
%
 
38
%
 
 
 
 

28


The increase in general and administrative expenses for the three months ended June 30, 2012, as compared to the same period in 2011, was primarily related to increased legal costs of $3.5 million, mainly associated with patent litigation and increased headcount to support our operations resulting in higher compensation and other labor related costs of $1.1 million.
Interest Income
Interest income was $22,000 and $49,000 for the three months ended June 30, 2012 and 2011, respectively. The decrease was attributable to the mix of our investment portfolios between cash, cash equivalents and marketable securities balances during the three months ended June 30, 2012, as compared to the same period in 2011.

Interest Expense
Interest expense was $267,000 and $18,000 for the three months ended June 30, 2012 and 2011, respectively. The increase was attributable to increased balances on our term loan debt.
Other Expense, net
Other expense, net, was $116,000 and $4,000 for the three months ended June 30, 2012 and 2011, respectively. The increase was primarily due to unfavorable foreign currency exchanges.
Income Tax Expense
The provision for income taxes was an expense of $20,000 and $12,000 for the three months ended June 30, 2012 and 2011, respectively. The income tax expense and benefit in each periods was primarily due to statutory tax liabilities resulting from our state and foreign operations.

29


Comparison of Six Months Ended June 30, 2012 and 2011
Revenues
Genetic analysis product sales and services revenues were derived from sales of consumables, including our SpectroCHIP arrays used with our iPLEX assay and other assays, MassARRAY systems, maintenance agreements, sales and licensing of our proprietary software, and contract research services. Diagnostic revenues were primarily derived from providing diagnostic testing services for Sequenom CMM's LDTs. There were no collections from providing diagnostic testing services for Sequenom CMM's MaterniT21 LDT in the six months ended June 30, 2011 due to commencement of its commercialization in the fourth quarter of 2011.
Revenue for the Molecular Diagnostics segment is generated primarily from customers located within the United States. Revenue for the Genetic Analysis segment is generated from customers primarily located in North America, and customers and distributors located in Europe and Asia.
 
Six months ended
June 30,
 
$
Change
 
%
Change
 
2012
 
2011
 
 
Genetic analysis product sales and services (in thousands)
$
20,281

 
$
23,575

 
$
(3,294
)
 
(14
)%
Diagnostic services (in thousands)
12,891

 
3,267

 
9,624

 
295
 %
Total revenues
$
33,172

 
$
26,842

 
$
6,330

 
24
 %
 
The decrease in our genetic analysis product sales and services revenues is primarily attributable to a decrease in MassARRAY system sales, including recognition of extended warranty maintenance contracts, to $8.9 million from $11.0 million resulting from fewer MassARRAY systems sold during the current period as compared to the same period in 2011. Consumables orders from our customers in the translational research and agricultural biology markets decreased against the comparative period, resulting in a decrease of consumables revenues to $10.5 million from $11.4 million during the six months ended June 30, 2012 and 2011, respectively. Additionally, contract research services decreased to $0.9 million from $1.2 million during the six months ended June 30, 2012 and 2011, respectively.
Molecular Diagnostics segment testing services revenue is recognized upon cash collection as payments are received. The increase is attributable to the introduction of Sequenom CMM's RetnaGene AMD LDT and MaterniT21 LDT in the second and fourth quarters of 2011, respectively, and an increase in the number of SensiGene CF and SensiGene RHD tests collected during the six months ended June 30, 2012, compared to the same period in 2011, as our testing volume and related cash collections have increased.
Domestic and non-U.S. revenues were $20.3 million and $12.9 million for the six months ended June 30, 2012, respectively, and $12.5 million and $14.3 million for the six months ended June 30, 2011, respectively.
Our revenues have historically fluctuated from period to period and likely will continue to fluctuate substantially in the future based upon the unpredictable sales cycle for the MassARRAY system and consumables, general economic conditions, revenue recognition criteria, the overall acceptance and demand for our new and existing commercial products and services, as well as the adoption rates of Sequenom CMM's existing LDTs as well as future LDTs, and payment patterns of third-party payors and patients.
Cost of Genetic Analysis Product Sales and Services and Diagnostic Services and Gross Margins
Cost of revenues consists of employee-related costs (salaries, bonuses, fringe benefits, and stock-based compensation) of our laboratory and manufacturing personnel, and other support personnel, as well as outside laboratory costs, laboratory and manufacturing inventory and supplies, logistic costs, depreciation, and administrative-related costs allocated to cost of revenues. Gross margin consists of our revenues less cost of revenues.
 
Six months ended
June 30,
 
$
Change 
 
%
Change 
 
2.012
 
2.011
 
Genetic Analysis (in thousands)
$
14,710

 
$
16,801

 
$
(2,091
)
 
(12
)%
Genetic Analysis (% of revenues)
73
 %
 
71
%
 
 

 
 

Molecular Diagnostics (in thousands)
$
(3,387
)
 
$
512

 
$
(3,899
)
 
(762
)%
Molecular Diagnostics (% of revenues)
(26
)%
 
16
%
 
 

 
 

Total Gross margin (in thousands)
$
11,323

 
$
17,313

 
$
(5,990
)
 
(35
)%
Total Gross margin (% of revenues)
34
 %
 
64
%
 
 
 
 


30


Cost of genetic analysis product sales and services for the six months ended June 30, 2012 and 2011 were $5.6 million and $6.8 million, respectively.
Costs of diagnostic services are recognized upon providing test results to ordering physicians and were $16.3 million and $2.8 million for the six months ended June 30, 2012 and 2011, respectively. The decrease in gross margin is due to higher laboratory costs as test volumes increase. Due to revenue being recognized when cash is received, costs incurred in one period includes costs related to revenue recognized in a later period. Gross margin on diagnostic tests were affected by increased test volumes, cash collected during the period, overall reimbursement for the amount paid per test, and the increase in headcount and laboratory operational costs to support increased production capacity for diagnostic testing.
Gross margins for our Molecular Diagnostics segment will be affected by the adoption rates of our diagnostic tests, the levels of reimbursement, and payor and other contracts we may enter into for our tests. Gross margins for our Genetic Analysis segment will fluctuate on a quarterly basis and be affected by, among other things, the selling price for MassARRAY systems and consumables, consumable sales per MassARRAY system sold, the mix of product sales and the type of services, competitive conditions, sales volumes, discounts offered, sales through distributors, as well as the cost of goods sold, inventory reserves and obsolescence charges required, and royalty payment obligations on in-licensed technologies.
Selling and marketing expenses
Selling and marketing expenses consisted primarily of salaries and related expenses for sales and marketing, customer support, and business development personnel and their related department expenses.
 
Six months ended
June 30,
 
$
Change 
 
%
Change 
 
2.012
 
2.011
 
Selling and marketing (in thousands)
$
21,060

 
$
13,738

 
$
7,322

 
53
%
Selling and marketing (% of revenues)
63
%
 
51
%
 
 
 
 
The increase in selling and marketing expenses for the six months ended June 30, 2012, compared to the same period in 2011, is primarily related to increased headcount to support our operations resulting in higher compensation and other labor related costs of $3.9 million, increased facilities and support expenses of $1.3 million to support the additional headcount, increased travel expenses of $1.1 million related to increased headcount of sales representatives, and increased third-party marketing of $0.8 million attributable to promoting the MaterniT21 PLUS LDT.
Research and development expenses
Research and development expenses consisted primarily of salaries and related personnel expenses, product development costs, quality and regulatory costs, and expenses relating to licensing costs and work performed under research contracts.
 
Six months ended
June 30,
 
$
Change
 
%
Change
 
2012
 
2011
 
Research and development (in thousands)
$
26,533

 
$
27,777

 
$
(1,244
)
 
(4
)%
Research and development (% of revenues)
80
%
 
103
%
 
 
 
 
The decrease in research and development expenses for the six months ended June 30, 2012, as compared to the same period in 2011 is primarily related to a $5.5 million decrease in research-related intellectual property licensing and collaboration costs; partially offset by an increase of $4.2 million in higher compensation and other labor related costs associated with increased headcount and CLIA laboratory expansion.
General and administrative expenses
General and administrative expenses consisted primarily of salaries and related expenses for executive, legal, finance, information technology, and human resource personnel, and their related department expenses.  
 
Six months ended
June 30,
 
$
Change
 
%
Change
 
2.012
 
2011
 
General and administrative (in thousands)
$
17,299

 
$
9,876

 
$
7,423

 
75
%
General and administrative (% of revenues)
52
%
 
37
%
 
 
 
 


31


The increase in general and administrative expenses for the six months ended June 30, 2012, as compared to the same period in 2011, was primarily related to increased legal costs of $4.8 million, mainly associated with patent litigation, and increased headcount to support our operations resulting in higher compensation and other labor related costs of $1.8 million.
Interest Income
Interest income was $44,000 and $5,000 for the six months ended June 30, 2012 and 2011, respectively. The increase was attributable to the overall increase in our investment portfolios and varying levels of cash, cash equivalents and marketable securities balances during the six months ended June 30, 2012, as compared to the same period in 2011.

Interest Expense
Interest expense was $483,000 and $45,000 for the six months ended June 30, 2012 and 2011, respectively. The increase was attributable to increased balances on our term loan debt.
Other (Expense) Income, net
Other (expense) income, net, was an expense of $45,000 and income of $471,000 for the six months ended June 30, 2012 and 2011, respectively. The decrease was primarily due to nonrecurring income in the prior period of $250,000 related to a U.S. Government grant and $100,000 gain on disposal of assets, and unfavorable foreign currency exchanges of $121,000.
Income Tax Expense
The provision for income taxes was an expense of $22,000 and a benefit of $37,000 for the six months ended June 30, 2012 and 2011, respectively. The income tax expense and benefit in each periods was primarily due to statutory tax liabilities resulting from our state and foreign operations.
Liquidity and Capital Resources
As of June 30, 2012, cash, cash equivalents, and current marketable securities totaled $98.6 million, compared to $84.2 million at December 31, 2011. Our cash equivalents and current marketable securities are held in a variety of securities that are represented by issuance from the U.S. Government, repurchase agreements collateralized by U.S. Government securities that have ratings of AA, or are fully guaranteed by the U.S. Government.
We have a history of recurring losses from operations and had an accumulated deficit of $846.4 million as of June 30, 2012. Our capital requirements to sustain operations, including research and development projects, have been and will continue to be significant. We expect to incur significant expenses associated with patent litigation for at least the remainder of 2012 and for 2013. As of June 30, 2012 and December 31, 2011, we had working capital of $79.8 million and $74.5 million, respectively.
On January 25, 2012, we completed an underwritten public offering of 14,950,000 shares of our common stock, including 1,950,000 shares sold pursuant to the full exercise of an over-allotment option previously granted to the underwriters. All of the shares were offered by us at a price of $4.15 per share. The gross proceeds to us from this offering were $62.0 million, before deducting the underwriting discounts and commissions and other estimated offering expenses payable by us.
We consider the material drivers of our cash flow to be testing volumes and collections of billed tests for our diagnostic testing services, sales volumes of our genetic analysis products and services, working capital, inventory management, and operating expenses. Our principal sources of liquidity are our cash, cash equivalents, and marketable securities and collections for our commercialized tests and product sales and services. Cash used in operations for the six months ended June 30, 2012, was $35.7 million, compared to $20.2 million for the six months ended